Overview -- We expect United Continental Holdings to report weaker earnings this year than in 2011 as a result of merger integration costs and higher fuel prices. -- Still, credit measures are acceptable for the rating, and we expect performance to improve in 2013. -- We are affirming our 'B' corporate credit rating on the company and raising our recovery and issue ratings on its senior unsecured debt and second-lien secured debt. We also changed ratings on selected enhanced equipment trust certificates. -- The stable outlook reflects our expectation for improvement in credit measures in 2013, but not likely to levels sufficient to support an upgrade. Rating Action On Nov. 20, 2012, Standard & Poor's Ratings Services affirmed its 'B' corporate credit rating on United Continental Holdings Inc. (UCHI). We raised our issue ratings on the company's senior unsecured debt and second-lien secured debt to 'B', equal to the corporate credit rating, from 'B-'. We revised our recovery rating on that debt to '4', indicating our expectation of average (30%-50%) recovery in a default scenario, from '5'. Although we do not assign recovery ratings to airport revenue bonds, we raised our issue ratings to 'B' from 'B-' on airport revenue bonds that we classify as equivalent to senior unsecured debt. We also raised or lowered our issue ratings on selected enhanced equipment trust certificates (see ratings list), based on our assessment of changes in collateral coverage. Rationale Chicago, Ill.-based United Continental Holdings Inc., parent of United Air Lines Inc. and Continental Airlines Inc. (each rated B/Stable/--), has reported weaker earnings this year than in 2011 because of merger-related costs and integration problems, as well as higher fuel costs. We expect the company to report a net loss, after substantial merger-related special charges, of several hundred million dollars, but to return to profitability next year. Our base-case scenario assumptions include: -- U.S. real GDP growth of 2.1% in 2012 and 2.3% in 2013; -- Crude oil (WTI) averages about $94 this year and $89 next year, with crack spreads and other costs that result in jet fuel costs of $3.20-$3.30 per gallon this year and $3.00-$3.10 in 2013; -- Consolidated capacity (available seat miles) shrinks about 1.3% this year and another 1% next year; -- Passenger revenues per available seat mile rise 1.6%-1.8% this year and about 2% next year as the company works through some of its merger-related operational problems but the economy remains soft; and -- Nonfuel operating cost per available seat mile rises close to 3% this year and another 3% in 2013 (not including the effect of mostly merger-related special charges). In this scenario, we project the following key credit measures: -- EBITDA interest coverage of 1.3x-1.5x this year (well below the 2.4x generated in 2011), recovering to about 2x next year; -- Funds flow to debt of 9%-10% this year (compared with 13% in 2011), and 11%-12% in 2013; -- Debt to EBITDA rising to 8.5x-9.0x in 2012, from 6.2x last year, before recovering to about 6.5x in 2013; -- We also consider debt to EBITDAR because of airlines' heavy use of leasing, and that measure is not as highly leveraged: 4.6x in 2011, 5.5x-6.0x this year, and we expect 4.5x-5.0x next year. These credit measures, though below our previous expectations, are acceptable for the rating, particularly given that we expect revenue synergies from the merger of United and Continental to build over time, though labor costs will also rise. We base our corporate credit ratings (CCRs) on United Continental and its subsidiaries on the consolidated credit profile of the parent company. Our ratings reflect United Continental's substantial debt and lease burden, and risks associated with participation in the volatile U.S. airline industry. The company's substantial market position as the largest U.S. airline with a broad route network is a positive. Under our criteria, we categorize UCHI's business risk profile as "weak," its financial profile as "highly leveraged," and its liquidity as "adequate." Our rating changes on selected enhanced equipment trust certificates (EETCs) are based on trends in collateral value that are outside of our previous expectations for the affected issues. The upgrades were mostly on older EETCs that have paid down debt more rapidly than the collateral aircraft value declined. However, in the case of several senior certificates secured by regional jets, we raised the ratings to 'B' from 'B-' not because of positive trends in the values of those planes, but rather because we raised the senior unsecured debt ratings of United Continental and its airline subsidiaries. Although we do not assign recovery ratings to enhanced equipment trust certificates, secured creditors are entitled to a senior unsecured claim for any shortfall in the value of their collateral relative to what they are owed, and we accordingly equalized our issue ratings on these certificates with our revised senior unsecured ratings. The downgrades were mostly of more recent EETCs, where collateral aircraft values (including current technology planes that were about 10 years old when refinanced through these EETCs) have fallen faster than we previously expected. Our review of United and Continental EETCs included enhanced aircraft notes issued by special purpose entity Air 2 US LLC, which leases A320-200 aircraft to United. We affirmed the existing 'BB' rating on the Class A notes and 'B-' rating on the Class B notes. Liquidity We view UCHI's liquidity as "adequate." The company ended the third quarter with $7.2 billion in liquidity (unrestricted cash and short-term investments plus undrawn committed credit lines). This is about 19% of trailing-12-months revenues, lower than in previous quarters this year but still similar to the like ratio for other large "legacy" U.S. airlines. Going forward, sources of funds will mostly consist of cash, funds from operations (FFO), and borrowings (including $1.7 billion raised through offerings of EETCs in the first and third quarters). Recovery analysis We raised our issue ratings on United Continental's, United Air Lines' and Continental Airlines' senior unsecured debt to 'B' from 'B-', and revised the recovery rating to '4', indicating our expectation of average (30%-50%) recovery in a default scenario, from '5'. United Continental has been gradually upgrading its aircraft fleet, and our modeling of the default scenario, which takes a discrete asset approach to estimating an enterprise value, applies lesser stresses to the value of newer, widely used planes than older ones. Also, the company has paid down some debt over the past year, improving asset coverage. We affirmed our '5' recovery rating, indicating our expectation of modest (10%-30%) recovery on United Continental's 4.5% limited subordination notes due 2021. United guarantees these notes, but they could be subordinated to certain unrated notes given to the Pension Benefit Guaranty Corp. We rate United's 9.875% senior secured notes 'BB-' (two notches above the CCR) with a recovery rating of '1', indicating our expectation of a very high (90%-100%) recovery in a default scenario. We rate United's second-lien notes and senior unsecured debt 'B' (equal to the CCR) with a recovery rating of '4'. We rate UCHI's 6% senior convertible notes due 2029, which are structurally subordinated and not guaranteed by United, 'CCC+' with a '6' recovery rating, indicating our expectations of negligible (0-10%) recovery in a default scenario. We rate Continental's 6.75% senior secured notes due 2015 'BB-' (two notches above the CCR) with a recovery rating of '1'. We rate Continental's senior unsecured debt 'B' (equal to the CCR) with a recovery rating of '4'. For the complete recovery analysis, see our recovery report on UCHI to be published later on RatingsDirect. Outlook The outlook is stable. We don't expect to change our CCRs on United Continental or its subsidiaries over the next year. However, we could raise our ratings if strong earnings and faster-than-expected achievement of merger synergies allows the consolidated entity to generate adjusted FFO to debt consistently at least in the mid-teens percent area. On the other hand, we could lower our ratings if financial results deteriorate such that FFO to debt falls into the mid-single-digit percentage area. This could happen in adverse industry conditions, possibly resulting from a major recession or much-worse-than-anticipated merger integration problems. Related Criteria And Research -- Key Credit Factors: Criteria For Rating The Airline Industry, Oct. 22, 2010 -- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- Criteria for Rating Aircraft-Backed Debt and Enhanced Equipment Trust Certificates, Sept. 12, 2002 Ratings List Ratings Affirmed United Continental Holdings Inc. Corporate Credit Rating B/Stable/-- Continental Airlines Inc. Corporate Credit Rating B/Stable/-- Senior Secured BB- Preferred Stock Convertible CCC All EETCs affirmed except ser 1996-B, 1996-C, 1996-2B, 1996-2C, 1997-1A, 1998-1B, 2000-2A1, 2003-ERJ1A, 2004-ERJ1A, 2009-1A, 2009-2A, 2009-2B United Air Lines Inc. Corporate Credit Rating B/Stable/-- All EETCs affirmed, except 2007-1C AIR 2 US LLC Class A enhanced aircraft notes BB- Class B enhanced aircraft notes B- Ratings Affirmed; Recovery Ratings Remain Unchanged United Continental Holdings Inc. 4.5% ltd subord convert. nts due 2021 B- Recovery Rating 5 6.0% sr nts convertible due 2029 CCC+ Recovery Rating 6 Continental Airlines Inc. Senior Secured BB- Recovery Rating 1 United Air Lines Inc. Senior Secured US$1.2 bil term fac bank ln due 2014 BB- Recovery Rating 1 US$500 mil 9.875% nts due 2013 BB- Recovery Rating 1 Upgraded To From Continental Airlines Inc. Equipment Trust Certificates 7.82% pass-thru ser 1996-B BB- B+ 9.5% pass-thru ser 1996-C B+ B 8.56% pass-thru ser 1996-2B B+ B 10.22% pass-thru ser 1996-2C B B- 7.461% pass-thru ser 1997-1A BB- B+ 6.748% pass-thru ser 1998-1B BB+ BB 7.875% pass-thru ser 2003-ERJ1A B B- 9.558% pass-thru ser 2004-ERJ1A B B- Senior Unsecured B B- United Air Lines Inc. 2.553% pass-thru series 2007-1C B B- Upgraded; Recovery Ratings Revised To From Continental Airlines Inc. Senior Unsecured 4.5% sr convertible notes 2015 B B- Recovery Rating 4 5 United Air Lines Inc. Senior Secured 12% 2nd lien notes B B- Recovery Rating 4 5 Downgraded To From Continental Airlines Inc. Equipment Trust Certificates 7.707% pass-thru ser 2000-2A1 BBB- BBB 9% pass-thru ser 2009-1A BBB BBB+ 7.25% pass-thru ser 2009-2A BBB+ A- 9.25% pass-thru ser 2009-2B BB+ BBB- Temporary telephone contact numbers: Philip Baggaley (1-646-285-4615); Betsy Snyder (1-201-962-0008). Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.