Southwest Airlines (NYSE:LUV) entered 2020 with one of the biggest cash cushions of any U.S. airline and the strongest balance sheet in the industry, by far. In the first two months after the COVID-19 pandemic crushed U.S. air travel demand, the low-fare airline giant moved aggressively to boost its cash balance even further through a combination of new debt, short-term loans, an equity offering, and the issuance of convertible notes.

As a result, by mid-May, Southwest Airlines had $13 billion of cash on its balance sheet. It said that was enough to cover 20 months of cash burn, assuming no improvement in business trends.

Even with a fortress balance sheet like that, Southwest Airlines hasn't rested over the past month. In early June, the airline refinanced some of its debt, boosting cash and investments to $13.9 billion while also increasing the amount of unencumbered collateral available to support future borrowings.

A Southwest Airlines plane preparing to land, with mountains in the background

Image source: Southwest Airlines.

Shifting to unsecured debt

As the pandemic swept across the airline industry in March and airline share prices crashed, Southwest Airlines drew down its existing $1 billion credit line. It also quickly lined up a 364-day term loan to provide an additional cash infusion. The airline initially borrowed $1 billion before dramatically upsizing the loan to $3.7 billion by late April.

Since then, investor panic has subsided as airline traffic has started to recover at a tentative pace. This has enabled Southwest to line up longer-term financing arrangements without having to pledge most of its assets as collateral.

On May 1, Southwest raised $2.3 billion by selling 80.5 million shares for $28.50 each and an additional $2.3 billion in five-year convertible debt. A few days later, it issued $2 billion of unsecured debt, consisting of $750 million due in 2023 and $1.25 billion due in 2025. It has also sold and leased back 20 aircraft this quarter, raising $815 million in the process. And on June 8, Southwest issued another $1.8 billion of unsecured debt -- an additional $500 million due in 2023 and $1.3 billion due in 2027.

Southwest Airlines has used some of the proceeds of its recent financing activity to fully repay the 364-day term loan and its $1 billion revolving credit line. The interest rates on its new unsecured borrowings have been around 5%, more than it had been paying on its short-term borrowings.

The advantage is that by repaying the term loan in full, Southwest freed up billions of dollars of collateral. The company estimates that it now has $12 billion of unencumbered assets, up from $7.5 billion a month ago. It can also draw on its $1 billion credit line again in the future, if necessary.

A license to take risks

In short, Southwest Airlines has managed to boost its cash balance to a remarkable $13.9 billion while also maintaining massive future borrowing capacity, mainly in the form of a large base of unencumbered assets. Based on its recent cash burn of $20 million per day, Southwest estimates that it now has 24 months of liquidity.

This will give Southwest Airlines more leeway to take risks and focus on long-term goals rather than managing daily cash burn over the next year or so. For example, it can afford to operate a nearly normal schedule this fall and beyond, even if some flights might lose money in the short term. There are two possible benefits from operating a full schedule: it would allow Southwest to avoid layoffs -- reinforcing its status as a great place to work -- and put it in position to gain market share from weaker rivals that must focus on cash preservation.

Southwest Airlines CEO Gary Kelly has warned that airlines are likely to face a brutal competitive environment for the foreseeable future. Thanks to its recent moves to build up a huge cash cushion while leaving plenty of assets unencumbered to support future borrowings, Southwest Airlines is ideally positioned to emerge as a winner.

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