Fitch Downgrades Southwest Airlines to 'BBB'; Outlook Negative

CHICAGO--(Business Wire)--
Fitch Ratings has downgraded the debt ratings of Southwest Airlines Co. (NYSE:
LUV) as follows:

--Issuer Default Rating (IDR) to 'BBB' from 'BBB+';

--Senior Unsecured Debt to 'BBB' from 'BBB+';

--Unsecured Bank Credit Facility to 'BBB' from 'BBB+';

--Secured Term Loan Due 2020 to 'BBB+' from 'A-'.

The ratings apply to approximately $2 billion of unsecured notes and debentures,
as well as the $570 million balance on the secured term loan and the undrawn
$600 million revolving credit facility. The Rating Outlook for Southwest is
Negative.

The downgrade reflects the ongoing impact of the recession and the collapse in
full-fare passenger demand on LUV's cash flow generation power and leverage at a
time when jet fuel prices remain volatile and unpredictable. While fuel prices
have declined sharply from last summer's peak, LUV and the entire industry have
seen passenger unit revenue trends deteriorate dramatically since the start of
the year. Following a 3% decline in revenue per available seat mile (RASM)
during the first quarter, demand and yield trends worsened further in May and
June -- driving the carrier's total RASM down by 6% in the second quarter. Given
the fragile state of the economy and business travel demand, Fitch believes that
the outlook for fares and unit revenue in the post-Labor Day period is very
weak, and management remains cautious about the second-half revenue outlook.
Fitch believes that full-year RASM declines in excess of 5% are now more
possible, raising the risk that LUV will not be in a position to report positive
free cash flow for the full year.

Although LUV's liquidity position and unencumbered asset base remain strong, the
need to shore up cash balances over the past year has driven the carrier's
lease-adjusted leverage to levels that are no longer consistent with a high
'BBB' category credit profile. Cash needs grew not only in response to the weak
revenue environment but also as a result of big swings in fuel hedge cash
collateral triggered by the sharp drop in fuel prices last year. Following the
completion of financing activity through mid-July, LUV reported that it had
total unrestricted cash and short-term investments of $2.4 billion. This
provides the airline with a comfortable cushion to withstand a prolonged period
of extreme revenue weakness that may extend well into 2010. However, a
turnaround in the airline's operating performance is clearly required over the
next few quarters if LUV is to succeed in returning leverage and coverage
measures to levels consistent with the company's solid investment grade profile
seen earlier in the decade.

The 'BBB' IDR is supported by Fitch's view that LUV is certain to be a survivor
in any industry shake-out that may occur as more vulnerable legacy carriers face
intense liquidity pressures moving into 2010. Still, a major shift in the
airline's capital structure has taken place as a result of the need to offset
huge swings in cash flow since late 2007 and credit measures will remain weak as
a result. In addition, LUV's long-standing cost advantage to the rest of the
industry is being eroded gradually as non-fuel unit operating costs continue to
rise at a high single-digit percentage rate. In order to mitigate the effects of
unit cost inflation, management has taken a number of steps to reduce headcount,
and the company's 2009 'early-out' program appears to have been successful
(1,400 employees expected to leave by early next year). Looking ahead to 2010,
however, a sharp reversal in unit revenue trends will be necessary if LUV is to
return to a period of solid operating margins and consistent free cash flow
generation.

With respect to recent revenue trends, LUV and the entire industry have been
forced to discount fares aggressively in order to stimulate leisure demand and
boost load factors at a time when business bookings and yields have collapsed.
LUV's recent RASM trends have been much stronger on a relative basis than its
global network carrier competitors. LUV's all-domestic route network has
shielded it from the worst of the premium travel demand collapse seen in
international markets. In addition, LUV's schedule optimization efforts appear
to have been successful in eliminating low-margin flying in high-frequency
markets in favor of new service to higher-yielding markets like Minneapolis-St.
Paul (started in March) and New York-LaGuardia (launched in June). LUV plans to
add Boston and Milwaukee as new network cities later in 2009. Revenue management
initiatives may also soften the impact of weak demand in the second half of the
year, as scheduled available seat miles (ASMs) are planned to fall by 6% in
3Q'09 and 8% in 4Q'09. The current fleet plan for 2010 calls for scheduled
capacity reduction of 1% in 2010, but this level can be calibrated through
retirements and lease returns if industry operating conditions or capacity
levels change.

Balance sheet debt levels have risen sharply since early 2008 as a result of
stress in the industry operating environment, a desire to keep core liquidity
near $2 billion in the midst of tight credit market conditions, and the dramatic
reversal of the carrier's fuel hedge collateral position after energy prices
began to plummet last summer. Following a series of secured transactions,
balance sheet debt rose from $2.1 billion at the end of 2007 to $3.4 billion at
June 30, 2009. Lease-adjusted debt levels were pressured further by the
completion of Boeing B737-700 sale-leaseback financings in late 2008 and early
2009. Management noted on the July 21, 2009 earnings call that it closed on one
additional aircraft-backed financing for $124 million this month. In May, LUV
repaid the $400 million that it had drawn on its $600 million revolving credit
facility in October 2008 during the height of the global financial crisis. The
revolver, which expires in August 2010, is now fully available.

While a revenue recovery will clearly be required to support liquidity
improvements in 2010, free cash flow generation will likely improve in part as a
result of LUV's reduced aircraft capital spending plan. The carrier is taking 13
new Boeing 737-700 aircraft deliveries this year, and the fleet plan calls for
10 firm orders in 2010. This will allow LUV to keep 2009 total capital
expenditures (capex) in the range of $700 million. The carrier expects 2010
capex to total between $800 million and $900 million. First half 2009 cash flow
from operations of $420 million exceeded capex of $272 million during the same
period. After August, LUV will take no more B737-700 deliveries this year. The
carrier expects its year-end 2009 fleet to be flat to down two aircraft compared
with year-end 2008 as a result of aircraft retirements and lease returns.

Following the big swings in fuel hedge cash collateral late last year, LUV took
steps to limit downside liquidity risk by reaching new agreements with its
principal fuel hedge counterparties aimed at capping cash collateral posting
requirements. LUV now has $425 million in cash posted to counterparties. The
airline has also moved to a hedging strategy that deploys call options more
extensively. Management noted on July 21, 2009 that it had over 30% of 3Q'09
fuel consumption and over 45% of 4Q'09 consumption hedged (primarily through
call options) with average caps in the low $70 per barrel range.

A further downgrade of LUV's ratings could follow if signs of industry revenue
recovery are not evident by early 2010 and if LUV continues to report
significant declines in RASM in the second half of 2009. A material fuel price
shock, though mitigated somewhat by fuel hedging in future quarters, could
de-stabilize LUV's operating profile further, and could lead to additional
negative rating actions. Revision of the Rating Outlook to Stable is possible if
improving macroeconomic conditions and better business travel demand drive a
strong unit revenue recovery in 2010.

Fitch's rating definitions and the terms of use of such ratings are available on
the agency's public site, 'www.fitchratings.com'. Published ratings, criteria
and methodologies are available from this site, at all times. Fitch's code of
conduct, confidentiality, conflicts of interest, affiliate firewall, compliance
and other relevant policies and procedures are also available from the 'Code of
Conduct' section of this site.

Fitch Ratings
William Warlick, +1-312-368-3141 (Chicago)
Stephen Brown, +1-312-368-3139 (Chicago)
Cindy Stoller, +1-212-908-0526 (Media Relations, New York)
cindy.stoller@fitchratings.com

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