Air Canada downgraded by Moody's

Air Canada shares fell two per cent Tuesday as Moody's Investor Service cut the Montreal-based airline's credit rating, indicating the agency believes there's an increased possibility the airlinecould default on its debt obligations.

The new rating is Caa1, down from B3.

Air Canada's stock was closed down two cents to 91 cents on the Toronto Stock Exchange. It has lost two thirds of its value from this timelast year.

Moody's vice president Darren Kirk saidAir Canada's debtwill remain "higher than we previously expected" through 2012.

"We are concerned with the company's ability to absorb higher capital expenditures for new planes and additional funding requirements for its sizeable pension shortfalls beginning in 2014," Kirk said in a release.

The downgrade is "no surprise," said Fred Lazar, associate professor of economics at York Universitys Schulich School of Business in Toronto told CBC News.

The main problem, he said, is the airlines high costs, which are "way out of line with those of the major U.S. carriers and with the Asian and Gulf carriers, and those are Air Canadas major competitors."

Labour and pension costs are too high and the company is too top heavy, Lazar said, adding that up to half of management positions could be cut "with no problems."

And the longer the airline delays in cutting costs, he said. "the more likely theyre going to go back into CCAA [court protection from creditors]."

Airline last entered court protection 9 years ago

The airline last sought court protection from creditors on April 1, 2003 and emerged 18 months later. No flights were disrupted as a result of the filing.

"And if they go into CCAA, theyre going to come out a much smaller company," said Lazar

What the Moodys downgrade, the low share price and continuing work disruptions suggest, he said, is that a filing for bankruptcy protection "is imminent before the end of the year," if theres another shock to the airline, such as an increase in fuel prices.

On the positive side for Air Canada, Moody's says the airline's large size and leading market share will probably provide its with enough cash flow to meet its current obligations to debt holders.

Other factors in the downgrade, Moodys said, included "the need to renew expired labour contracts and associated potential for further disruption of its operations, growing competition from lower-cost carriers and the company's very high costs."

"In 2014 it will start taking delivery of Boeing 787 aircraft, which will substantially increase capital spending," the agencyadded.

"At the same time, its contractual cap on past pension service contributions ($225 million in 2013) will end."

Pension deficit a concern

"Moody's estimates Air Canada's current pension solvency deficit to be in excess of $4 billion, which could result in a material increase of its cash funding obligations at the same time that rising capital expenditures are further stressing the company's credit metrics."

Air Canada has been involved in bitter and continuing labour problems over the past year with its pilots, mechanics, flight attendants and ground crews.

Labour Minister Lisa Raitt has angered workers by bringing in back-to-work legislation and sending their contract dispute to arbitration.

On March 23, Standard & Poors Ratings Service warned that Air Canadas credit ratings may be cut, saying it was watching the effects on the firms cash flow of work disruptions and severance costs related to the liquidation of maintenance supplier Aveos.

S&P expressed "concern that ongoing disruptions to Air Canada's operations, caused by labour disputes and the uncertain financial impact relating to a certain number of separation packages that it might be required to provide to Aveos employees, could we believe lead to deterioration in the company's liquidity in the short term."

The bond-rating agency said it would decide within the next three months whether to lower the airlines creditworthiness depending on whether summer bookings decline to the point where cash on hand falls to $1.5 billion.

Air Canada ended 2011 with $2.099 billion in cash.

On February 9, it reported a wider net loss for 2011 of $249 million, compared with a net loss of $24 million the year earlier. Its net debt at the end of the year was of $4.58 billion.