CHICAGO - Investors owning United Airlines' aircraft-backed bonds are hoping for a smooth landing later this week, when the bankrupt airline is scheduled to decide which aircraft leases it will keep and which it will reject.
Investors in these bonds, known as enhanced equipment trust certificates, or EETCs, have formed an ad hoc committee of secured creditors that is working to maximize the value of their holdings.
The ad hoc committee of 26 companies includes institutional investors such as Teachers Insurance and Annuity Association, New York, which owns around $100 million in United EETCs, and John Hancock Financial Services Inc., Boston, which has around $321 million in United EETCs.
One investor, who preferred not to be identified, said he wouldn't be surprised if Chicago-based UAL Corp., the airline's parent, asks for an extension on negotiations. Late last year, U.S. Airways Group Inc., Arlington, Va., got an extension when negotiating aircraft leases with bondholders.
The creditors are threatening to repossess the aircraft, and UAL is threatening to reduce the lease or mortgage rates. But United doesn't want to lose 100 to 150 planes, so "creditors are in a good bargaining position," said one portfolio manager, who requested anonymity.
Akin Gump Strauss Hauer & Feld LLP, New York, attorneys for the secured creditors committee, refused to comment on the matter.
EETCs were issued through private placements initially, but 10 years ago the airlines began selling them to the public, and these certificates are now worth around $30 billion to $35 billion, according to industry reports.
Sasha Kemper, senior fixed-income analyst at Principal Global Investors, Des Moines, Iowa, said her firm likes EETCs for their high yields. She declined to say how much the company has invested in them, but noted they are just a small part of Principal's overall investment portfolio.
Airlines have been issuing these bonds to the tune of $5 billion a year for the last five to 10 years, she estimated. They are complex investments, with different payment schedules and three different tranches. The senior or A tranche usually gets fully paid when an issuer is in default, while the B and the C tranches, which are subordinated debt, do not get repaid until the senior tranche has been fully paid, Ms. Kemper said. Most of the deals are structured with two-thirds senior debt, one-third subordinated debt.
Principal, which invests only in the senior tranches, has trust certificates with many airlines, including U.S. Airways and United. "Our negotiations with U.S. Airways are almost complete, and it looks like the A tranche holders will come out whole," Ms. Kemper said.
Generally, money managers and insurance companies investing in EETCs for pension funds use only the investment-grade bonds (A tranches), which are rated by the agencies and secured by the aircraft.
"If you select wisely in terms of planes, it's a good way to get extra investment yield. We're now getting a yield of 8% to 9%, around 400 to 500 basis points over Treasuries. The B and C tranches, which are riskier, get a slightly higher yield," said Ms. Kemper, who called the whole sector "extremely risky." To minimize risk, Principal limits how much it puts into the sector, invests with diverse carriers, and is selective about which planes its chooses. "We prefer newer aircraft that's in demand with a large order book," she said.
The sector is still young, Ms. Kemper noted. "These bankruptcies are important because they will test the structure (of the EETCs) and determine whether it works when the airline is in Chapter 11."
Also weighing on the sector is the potential war in Iraq, said John Fruit, an airline analyst at U.S. Bancorp Asset Management, Minneapolis, which owns around $40 million to $50 million in EETCs in its $6 billion corporate bond portfolio.
"Airline traffic will be impacted by a war in Iraq, and that in turn will affect aircraft valuations," said Mr. Fruit.
Valuations of older aircraft are already down 30% to 40% since the Sept. 11, 2001, terrorist attacks, and a number of those planes are just parked in the desert, he said. "The United bankruptcy is creating more uncertainty about the value of the planes. Depending on the leases United confirms, it could affect the total market."
He said the senior tranches of the U.S. Airways certificates have been holding up well since the airline reaffirmed certain leases "Even though they're not trading at par, as long as the company backing them is not in liquidation, there is value, especially in the newer aircraft. The planes are key to the airline's operations," he said.
He considers A tranches issued by Delta Air Lines Inc., Atlanta, and Northwest Airlines Inc., Eagan, Minn., most attractive. "The higher quality issues have a 500-basis-point spread, trading three to four percentage points above Treasuries," he said. "The subordinated tranches are not as liquid. There are questions about what those planes, particularly older planes, are worth, but the values are often subjective."
A Jan. 21 report from Morgan Stanley, New York, said United has taken little action on its aircraft fleet so far, formally rejecting or abandoning less than a dozen aircraft.
The Morgan Stanley report noted United's actions will have a broad impact on aircraft values and lease rates.
Insurance companies have been major owners of EETCs because they like the high yields, according to U.S. Bancorp's Mr. Fruit.
"But hedge funds have been moving into them as the yields have gotten higher, even though they're not a traditional investment for hedge funds. Yields on some of the unsecured tranches have been as high as 15% to 20%," he said.