Standard & Poor’s Ratings Services has lowered its ratings on Southwest Airlines Co. (LUV), lowering the debt ratings to ‘BBB’ from ‘BBB+’ and placing it with negative implications. However, Southwest has retained its investment grade rating.

The downgrade reflects lower operating cash flow caused by record high fuel prices, low global demand for air travel and weak prices. The travel downturn has eroded the airline’s flow of cash at a time when the airline faces substantial fixed obligations and declining cash balances. Southwest’s cash balance fell to $902 million in the third quarter from $1.4 billion at the end of 2008.

Recently, Southwest borrowed $124 million under a new term loan agreement secured by five Boeing 737-700 aircrafts. It also replaced its previous $600 million unsecured revolving credit facility with a new $600 million unsecured revolving credit facility that will expire in Oct. 2012. The rating agency is also concerned by this move as it leads to incremental debt in its capital structure.

The rating downgrade could make it more difficult and expensive for Southwest Airlines to borrow money in the future or refinance its current debt portfolio.

The negative outlook reflects concerns about potential earnings volatility on the back of higher energy costs and delay in turnaround of business travel.

Earlier during July, Moody’s as well as Fitch downgraded Southwest’s credit rating on unsecured debt and some other categories of debt with a negative outlook.

On the same day that its rating was downgraded, the airline reported a third quarter net loss of $16 million or 2 cents a share compared to a loss of $120 million, or 16 cents a share in the year-ago period. Operating revenue fell nearly 8% to $2.7 billion from $2.9 billion.

Southwest has been implementing additional revenue generating measures such as fees for pets and “early bird” seating, which are expected to boost its other revenues going forward. However, the visibility regarding operating environment remains unclear given the fuel price volatility and depressed economic environment.
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