American Airlines has been a prolific issuer of bonds, mostly secured on assets. However the airline has also issued some $3.2billion of special facilities revenue bonds in 19 transactions funding projects at the airline’s airport hubs and maintenance facilities. Some $1.4bn of these bonds are unsecured and backed only by the guaranty of the airline, yet investors piled into the deals despite the risk the airline would file for bankruptcy. In 2007 American sold $108.7 million of O’Hare International Airport special facility revenue refunding bonds in 2007 that mature in 2024 and paid a 5.50% rate. Even though the bond documents specifically state the risks of non-payment in the event of a bankruptcy, investors leapt on the deal. The offering statement said: “Irrespective of the treatment of the agreement and the guaranty in a bankruptcy proceeding with respect to the company or the guarantor, owners of the bonds would likely suffer a substantial loss with respect to their investment in the bonds.”
However, secured bonds are not safe either given the recent form of other airline bankruptcies. $1.8 billion of American issued bonds are secured by some form of revenue stream or asset such as a leasehold mortgage interest, lease or sublease agreement. Today, some of those bonds are trading at 80 cents on the dollar while others are closer to 50 cents or on par with their unsecured counterparts. The range shows the market’s doubt over just how secure a secured bond is.
The disparity shows how difficult it is to ascribe a value to the pledged collateral and that a “secured” claim doesn’t guarantee full compensation in bankruptcy. Although some investors will recoup their full investment, this very much depends on whether the asset or revenue stream backing the bonds is challenged by American. When United declared bankruptcy in 2005, the airline challenged repayment of $1.1 billion issued for projects at five airports, the bankruptcy court upheld the airline’s claim that a $250 million issuance of bonds at JFK, Los Angeles International and San Francisco International, were loans and thus unsecured even though when the bonds were issued they were secured by lease agreements and cross-default mechanisms linking the airline’s use of the airport to bond repayment. However the same court also upheld the lease status of United’s $250 million of debt for projects at Denver International Airport. It is very difficult for investors to ascertain which bonds will be upheld by an bankruptcy court that have been challenged by the airline, and until American does so, the value of both secured and unsecured bonds will continue to vary widely.
The next hearing in American Airlines bankruptcy case in the US Bankruptcy Court for the Southern District of New York is set for tomorrow (December 13).
American bondholders count the cost of bankruptcy
