Southwest Airlines says it doesn’t want – or need – to borrow money from Uncle Sam after all.

Earlier this year, Southwest, which carries more domestic passengers each year than any other U.S. airline, received a $ 3.2 billion congressional subsidy through the CARES Act economic stimulus package approved in March. He then signed a non-binding agreement to take out a $ 2.8 billion loan from the Treasury Department, also offered through the CARES Act.

But in a federal filing on Wednesday, the Dallas-based carrier backed down and turned down the loan offer. He said he no longer needed the extra money enough to justify the high cost associated with the loan.

And what was the high cost? Any airline that accepts the loans would be required to give the Treasury Department warrants convertible into shares of its shares. Accepting these terms would have diluted the value of the existing shares of Southwest shareholders and would likely have triggered a further downgrade of its debt rating.

Last week, S&P downgraded its rating on Southwest bonds to BBB, the lowest of the rating company’s investment grade ratings. S&P has also placed Southwest on its negative watch list, which means the airline may find itself a step further into “junk” bond territory. Southwest is currently the only US carrier – and one of three in the world – with a premium credit rating.

Falling into unwanted territory would also likely make it much more costly for Southwest to raise capital in the public debt markets. In its Wednesday filing, Southwest expressed its belief that if it needed additional cash in the future, it would be able to raise that money on more favorable terms through the commercial debt markets. But it would likely be much more costly and difficult if Southwest’s debt rating fell into junk territory.

The combination of taking on additional debt of $ 2.8 billion through the CARES Act and significantly diluting the carrier’s equity as a result would have further undermined Southwest’s debt-to-equity structure. . And that would probably be enough to trigger the dreaded debt rating downgrade.

Southwest is, to date, the only US carrier to turn down the government’s loan offer. And it was able to do so primarily because it was able to use its investment grade debt rating to raise $ 13.2 billion this year in low-interest debt through the government debt markets and its banks. He also sold an additional $ 2.2 billion in shares this year. Combined with the $ 3.3 billion in government subsidies, the carrier has raised $ 18.8 billion in cash since the impact of the pandemic began to be felt in late February.

Meanwhile, the airline claims to have lowered its daily cash consumption rate, which in the spring was north of $ 50 million per day, from $ 23 million to about $ 20 million per day in recent years. weeks only. That’s low enough, Southwest executives say, that it can last at least two more years at its current rate of cash consumption. Of course, Southwest, like its competitors, is working feverishly to find a way back to positive cash flow, and eventually profitability, long before it runs out of cash.

In May and June, CEO Gary Kelly was among the most optimistic leaders in the industry. He said based on the return in demand for leisure travel at this point, Southwest expects at the end of the year to rebuild its flight schedule to around 90% of what it was in 2019. , before the pandemic. By March, Southwest’s flight schedule was down to about 10% from what it was 12 months earlier. As a group, U.S. carriers saw demand for travel in March drop 96% from March 2019.

But on Wednesday, Southwest said it now expects its capacity in the third quarter to be just 65 to 70 percent of what it was in the third quarter of last year. Previously, it expected to reach between 70 and 80% of its capacity during the period of the previous year. This implies that instead of having capacity in the fourth quarter of about 90% of what it was in the fourth quarter of 2019, it will likely only be around 75-85%.

Nonetheless, Southwest’s capacity and overall stimulus packages appear to be more aggressive than those of its larger, more conventional rivals, American, United and Delta. And the rejection of the CARES Act loan and the maintenance of its investment grade debt rating allows Southwest to increase capacity at a unit cost well below that of any of its major rivals. As a result, Southwest remains well positioned to capture a disproportionate share of returning travelers as demand for air travel recovers.

Nonetheless, revenues are likely to be much slower to recover than the capacity of all airlines, meaning they would all have to report previously unimaginable annual losses.

Southwest said on Wednesday it expects its operating revenue for 2020 to be down 70% to 75% from 2019. That seems to ensure the airline will report its first annual loss in 47 years. Southwest has lost $ 1.24 billion in the first six months of this year.

The $ 3.2 billion cash grant Southwest previously accepted from the government was limited to paying airline employee salaries and benefits until September 30. Like all of its competitors, Southwest has agreed not to involuntarily lay off any workers until that date. The airlines are then free to lay off workers.

Hopes that Congress could pass a second airline bailout or bailout – theoretically extending the ban on airline layoffs – were badly damaged when the House left Washington without adopting a plan proposed by Senate Republicans . It is not impossible that Congress could come back and pass such a measure by September 30. But given the start of the election season with the Democratic National Convention this week and the Republican National Convention next week, the chances of Congress taking up this issue again before September 30 now appear remote.

Last week, Southwest said it no longer plans to fire anyone after the restrictions on layoffs expire. However, like all of its US competitors, Southwest has aggressively sought volunteers from its staff to accept incentives to retire early, take extended leave with little or no pay, or leave the company with a small payment in cash. cash or remnants of their benefits. . More than 17,000 Southwest employees – more than 20% of the carrier’s staff before Covid-19 – have accepted these offers and have already started to pull out of the business, either temporarily or permanently.

In its 49-year existence, Southwest has never issued an involuntary layoff, although company executives said earlier this year they feared layoffs were needed due to the unprecedented drop. of travel demand caused by the Covid-19 pandemic. Subsequently, they said such layoffs were not in the cards for the remainder of the year, but gave no guarantees beyond.

Southwest, which started life as a small intra-Texas business operating under a low-cost, low-cost business plan that would not have been permitted had it been submitted to the old board of civil aeronautics, now ranks as the largest Airline. In passenger miles flown, Southwest is the fourth largest US carrier as it has historically not flown beyond the 48 contiguous states and has only started flying to the Caribbean and Mexico in recent years. It launched a service to Hawaii last year.

At around $ 11.5 billion, Southwest’s current debt is less than half of United’s $ 25 billion in debt, only a third of Delta’s $ 31 billion in debt, and only a quarter of $ 40 billion. dollars of US debt. Meanwhile, he has the least so-called leverage among the Big Four. Currently, Southwest’s debt is about 2.5 times its EBITDAR (earnings before interest, debt amortization, and restructuring costs (or rent) – a closely watched metric that speaks to the overall financial health of Southwest. ‘a business and its ability to manage debt given its revenues and costs. The American, on the other hand, has a debt-to-EBITDAR ratio of around 4 to 1. The difference indicates that the South- West should be able to bring its debt down to relatively low and healthy levels much sooner than the US and the other two major U.S. He also says Southwest should be able to return to profitability faster than its competitors.

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