# American Airlines Group Inc. (AAL) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from American Airlines Group Inc.'s 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/6201/000000620122000026/aal-20211231.htm
Accession: 0000006201-22-000026
Filing date: 2022-02-22
Report date: 2021-12-31
Extracted from a substantive MD&A body after the formal Item 7 span was a TOC or reference stub.
Confidence: high

Company profile: /company/AAL/
All MD&A years: /company/AAL/mda/
Next year: /company/AAL/mda/fy2022/ (FY 2022)

Liquidity and Capital Resources

Liquidity

At December 31, 2021, AAG had $15.8 billion in total available liquidity and $990 million in restricted cash and short-term investments. Additional detail regarding our available liquidity is provided in the table below (in millions):

[[GREPCENT_TABLE]]
[["","AAG","","American"],["","December 31,","","December 31,"],["","2021","","2020","","2021","","2020"],["Cash","$","273","","","$","245","","","$","265","","","$","231"],["Short-term investments","12,158","","","6,619","","","12,155","","","6,617"],["Undrawn facilities","3,411","","","7,396","","","3,411","","","7,396"],["Total available liquidity","$","15,842","","","$","14,260","","","$","15,831","","","$","14,244"]]
[[/GREPCENT_TABLE]]

Given the actions we have taken in response to the COVID-19 pandemic and our assumptions about its future impact on travel demand, which could be materially different due to the inherent uncertainties of the current operating environment, we expect to meet our cash obligations as well as remain in compliance with the debt covenants in our existing financing agreements for the next 12 months based on our current level of unrestricted cash and short-term investments, our anticipated access to liquidity (including via proceeds from financings) and projected cash flows from operations.

In the ordinary course of our business, we or our affiliates may, at any time and from time to time, seek to prepay, retire or repurchase our outstanding debt through cash purchases and/or exchanges for equity or debt, in open-market purchases, privately negotiated transactions or otherwise. Such repurchases, prepayments, retirements or exchanges, if any, will be conducted on such terms and at such prices as we may determine, and will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.

Certain Covenants

Certain of our debt financing agreements (including our secured notes, term loans, revolving credit facilities and spare engine EETCs) contain loan to value (LTV), collateral coverage or peak debt service coverage ratio covenants and certain agreements require us to appraise the related collateral annually or semiannually. Pursuant to such agreements, if the applicable LTV, collateral coverage or peak debt service coverage ratio exceeds or falls below a specified threshold, as the case may be, we will be required, as applicable, to pledge additional qualifying collateral (which in some cases may include cash or investment securities), withhold additional cash in certain accounts, or to pay down such financing, in whole or in part, or the interest rate for the relevant financing will be increased. As of the most recent applicable measurement dates, we were in compliance with each of the foregoing LTV, collateral coverage and peak debt service coverage tests. Additionally, a significant portion of our debt financing agreements contain covenants requiring us to maintain an aggregate of at least $2.0 billion of unrestricted cash and cash equivalents and amounts available to be drawn under revolving credit facilities, and our AAdvantage Financing contains a peak debt service coverage ratio, pursuant to which failure to comply with a certain threshold may result in early repayment, in whole or in part, of the AAdvantage Financing. For further information regarding our debt covenants, see Note 4 to AAG’s Consolidated Financial Statements in Part II, Item 8A and Note 3 to American’s Consolidated Financial Statements in Part II, Item 8B.

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Sources and Uses of Cash

For a comparison of the 2020 and 2019 reporting periods, see Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – “Sources and Uses of Cash” of our 2020 Form 10-K.

AAG

Operating Activities

Our net cash provided by operating activities was $704 million in 2021 as compared to net cash used in operating activities of $6.5 billion in 2020, a $7.2 billion year-over-year increase. In 2021 and 2020, we received cash proceeds of approximately $4.7 billion and $4.2 billion associated with the PSP Financial Assistance, respectively. Excluding the PSP Financial Assistance, our operating cash flows increased $6.7 billion compared to 2020 driven by a decrease in our pre-tax loss as well as working capital increases principally in our air traffic liability as demand for travel returned. In addition, during 2021, we made $247 million in contributions to our pension plans and approximately $520 million in cash payments associated with our voluntary early retirement programs. Excluding the enhanced healthcare benefits provided to eligible team members, we estimate cash payments under these programs to be approximately $170 million in 2022 and approximately $20 million in 2023 and beyond.

Investing Activities

Our net cash used in investing activities was $6.0 billion and $4.3 billion in 2021 and 2020, respectively.

Our principal investing activities in 2021 included $5.5 billion in net purchases of short-term investments as well as a $401 million increase in restricted short-term investments primarily related to collateral associated with the AAdvantage Financing and collateral held to support workers’ compensation obligations. We had capital expenditures of $208 million, net of aircraft purchase deposit returns of $996 million, which expenditures principally related to the harmonization of interior configurations across the mainline fleet and the purchase of two Airbus A321neo aircraft. Additionally, we incurred $204 million related to airport construction projects, net of reimbursements, principally in connection with the renovation and expansion of Terminal 8 at JFK and the modernization of Terminals 4 and 5 at LAX. These cash outflows were offset in part by $193 million of proceeds from the sale of property and equipment principally related to our retired aircraft fleet and $181 million of proceeds primarily from aircraft sale-leaseback transactions.

Our principal investing activities in 2020 included $3.1 billion in net purchases of short-term investments, capital expenditures of $2.0 billion for property and equipment, including 16 Airbus A321neo aircraft, eight Embraer 175 aircraft, three Bombardier CRJ900 aircraft and the harmonization of interior configurations across the mainline fleet as well as a $308 million increase in restricted short-term investments primarily related to cash proceeds from special facility revenue bonds related to JFK. These cash outflows were offset in part by $665 million of proceeds primarily from aircraft sale-leaseback transactions, $351 million of proceeds from the sale of property and equipment and $90 million of proceeds from a vendor.

Financing Activities

Our net cash provided by financing activities was $5.3 billion and $11.0 billion in 2021 and 2020, respectively.

Our principal financing activities in 2021 included $12.2 billion in proceeds from the issuance of debt, including approximately $10.0 billion associated with the AAdvantage Financing, $1.0 billion in aggregate principal amount under the PSP2 Promissory Note, $946 million in aggregate principal amount under the PSP3 Promissory Note and the $150 million issuance of special facility revenue bonds related to JFK. We also received $460 million in net proceeds from the issuance of equity pursuant to an at-the-market offering. These cash inflows were offset in part by $7.3 billion in debt repayments, including prepayments totaling $2.8 billion for our revolving credit facilities, $950 million for the April 2016 Spare Parts Term Loan Facility and $550 million of outstanding loans under the Treasury Loan Agreement and $2.9 billion in scheduled debt repayments. In addition, we had $209 million of deferred financing cost cash outflows.

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Our principal financing activities in 2020 included $11.8 billion in proceeds from the issuance of debt and $3.0 billion in proceeds from the issuance of equity. These proceeds principally include $2.8 billion borrowed under the 2014 Revolving Facility, the 2013 Revolving Facility and the April 2016 Revolving Facility, $2.5 billion in aggregate principal amount of 11.75% senior secured notes, $1.8 billion in aggregate principal amount under the PSP1 Promissory Note, $1.2 billion in aggregate principal amount of two series of 10.75% senior secured notes due 2026, $1.0 billion in aggregate principal amount of AAG’s 6.50% convertible senior notes, $1.0 billion under the Delayed Draw Term Loan Credit Facility, $600 million in connection with the issuance of equipment notes related to EETCs and the financing of certain aircraft, $550 million under the Treasury Term Loan Facility, $500 million in aggregate principal amount of 3.75% unsecured senior notes due 2025 and the $360 million issuance of special facility revenue bonds as well as $1.7 billion of net proceeds from two underwritten public offerings of common stock and $869 million of net proceeds from an at-the-market offering of common stock. These cash inflows were offset in part by $3.5 billion in debt repayments, consisting of approximately $2.5 billion in scheduled debt repayments, including repayment of $500 million of 4.625% senior notes, and the prepayment of the $1.0 billion Delayed Draw Term Loan Credit Facility, as well as $216 million in share repurchases and dividend payments (which occurred in the first quarter of 2020).

American

Operating Activities

American’s net cash provided by operating activities was $3.2 billion in 2021 as compared to net cash used in operating activities of $1.4 billion in 2020, a $4.6 billion year-over-year increase. In 2021 and 2020, American received cash proceeds of approximately $4.2 billion and $3.7 billion associated with the PSP Financial Assistance, respectively. American also had a $2.3 billion net decrease in intercompany cash receipts principally from AAG's financing transactions. Excluding the PSP Financial Assistance and decrease in AAG's financing transactions, American's operating cash flows increased $6.4 billion compared to 2020 driven by a decrease in its pre-tax loss as well as working capital increases principally in American's air traffic liability as demand for travel returned. In addition, during 2021, American made $247 million in contributions to its pension plans and approximately $520 million in cash payments associated with American's voluntary early retirement programs. Excluding the enhanced healthcare benefits provided to eligible team members, American estimates cash payments under these programs to be approximately $170 million in 2022 and approximately $20 million in 2023 and beyond.

Investing Activities

American’s net cash used in investing activities was $5.9 billion and $4.3 billion in 2021 and 2020, respectively.

American’s principal investing activities in 2021 included $5.5 billion in net purchases of short-term investments as well as a $401 million increase in restricted short-term investments primarily related to collateral associated with the AAdvantage Financing and collateral held to support workers’ compensation obligations. American had capital expenditures of $169 million, net of aircraft purchase deposit returns of $996 million, which expenditures principally related to the harmonization of interior configurations across the mainline fleet and the purchase of two Airbus A321neo aircraft. Additionally, American incurred $204 million related to airport construction projects, net of reimbursements, principally in connection with the renovation and expansion of Terminal 8 at JFK and the modernization of Terminals 4 and 5 at LAX. These cash outflows were offset in part by $192 million of proceeds from the sale of property and equipment principally related to American's retired aircraft fleet and $181 million of proceeds primarily from aircraft sale-leaseback transactions.

American’s principal investing activities in 2020 included $3.1 billion in net purchases of short-term investments, capital expenditures of $1.9 billion for property and equipment, including 16 Airbus A321neo aircraft, eight Embraer 175 aircraft, three Bombardier CRJ900 aircraft and the harmonization of interior configurations across the mainline fleet as well as a $308 million increase in restricted short-term investments primarily related to cash proceeds from special facility revenue bonds related to JFK. These cash outflows were offset in part by $665 million of proceeds primarily from aircraft sale-leaseback transactions, $351 million of proceeds from the sale of property and equipment and $90 million of proceeds from a vendor.

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Financing Activities

American’s net cash provided by financing activities was $2.8 billion and $5.8 billion in 2021 and 2020, respectively.

American’s principal financing activities in 2021 included $10.2 billion in proceeds from the issuance of debt, including approximately $10.0 billion associated with the AAdvantage Financing and the $150 million issuance of special facility revenue bonds related to JFK. These cash inflows were offset in part by $7.3 billion in debt repayments, including prepayments totaling $2.8 billion for American’s revolving credit facilities, $950 million for the April 2016 Spare Parts Term Loan Facility and $550 million of outstanding loans under the Treasury Loan Agreement and $2.9 billion in scheduled debt repayments. In addition, American had $207 million of deferred financing cost cash outflows.

American’s principal financing activities in 2020 included $9.0 billion in proceeds from the issuance of debt, including $2.8 billion borrowed under the 2014 Revolving Facility, the 2013 Revolving Facility and the April 2016 Revolving Facility, $2.5 billion in aggregate principal amount of 11.75% senior secured notes, $1.2 billion in aggregate principal amount of two series of 10.75% senior secured notes due 2026, $1.0 billion under the Delayed Draw Term Loan Credit Facility, $600 million in connection with the issuance of equipment notes related to EETCs and the financing of certain aircraft, $550 million under the Treasury Term Loan Facility and the $360 million issuance of special facility revenue bonds. These cash inflows were offset in part by $3.0 billion in debt repayments, consisting of approximately $2.0 billion in scheduled debt repayments and the prepayment of the $1.0 billion Delayed Draw Term Loan Credit Facility.

Commitments

For further information regarding our commitments, see the Notes to AAG’s Consolidated Financial Statements in Part II, Item 8A and the Notes to American’s Consolidated Financial Statements in Part II, Item 8B at the referenced footnotes below.

[[GREPCENT_TABLE]]
[["","AAG","","American"],["Long-term debt and debt covenants","Note 4","","Note 3"],["Leases","Note 5","","Note 4"],["Employee benefit plans","Note 9","","Note 8"],["Commitments, contingencies and guarantees","Note 11","","Note 10"]]
[[/GREPCENT_TABLE]]

Off-Balance Sheet Arrangements

An off-balance sheet arrangement is any transaction, agreement or other contractual arrangement involving an unconsolidated entity under which a company has (1) made guarantees, (2) a retained or a contingent interest in transferred assets, (3) an obligation under derivative instruments classified as equity or (4) any obligation arising out of a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to us, or that engages in leasing, hedging or research and development arrangements with us.

We have no off-balance sheet arrangements of the types described in the first three categories above that we believe may have a material current or future effect on financial condition, liquidity or results of operations.

Pass-Through Trusts

American currently has 344 owned aircraft, 11 leased aircraft and 60 owned spare aircraft engines, which in each case were financed with EETCs issued by pass-through trusts. These trusts are off-balance sheet entities, the primary purpose of which is to finance the acquisition of flight equipment or to permit issuance of debt backed by existing flight equipment. In the case of aircraft EETCs, rather than finance each aircraft separately when such aircraft is purchased, delivered or refinanced, these trusts allow American to raise the financing for a number of aircraft at one time and, if applicable, place such funds in escrow pending a future purchase, delivery or refinancing of the relevant aircraft. Similarly, in the case of the spare engine EETCs, the trusts allow American to use its existing pool of spare engines to raise financing under a single facility. The trusts have also been structured to provide for certain credit enhancements, such as liquidity facilities to cover certain interest payments, that reduce the risks to the purchasers of the trust certificates and, as a result, reduce the cost of aircraft financing to American.

Each trust covers a set number of aircraft or spare engines scheduled to be delivered, financed or refinanced upon the issuance of the EETC or within a specific period of time thereafter. At the time of each covered aircraft or spare engine financing, the relevant trust used the proceeds of the issuance of the EETC (which may have been available at the time of issuance thereof or held in escrow until financing of the applicable aircraft following its delivery) to purchase equipment

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notes relating to the financed aircraft or engines. The equipment notes are issued, at American’s election, in connection with a mortgage financing of the aircraft or spare engines or, in certain cases, by a separate owner trust in connection with a leveraged lease financing of the aircraft. In the case of a leveraged lease financing, the owner trust then leases the aircraft to American. In both cases, the equipment notes are secured by a security interest in the aircraft or engines, as applicable. The pass-through trust certificates are not direct obligations of, nor are they guaranteed by, AAG or American. However, in the case of mortgage financings, the equipment notes issued to the trusts are direct obligations of American and, in certain instances, have been guaranteed by AAG. As of December 31, 2021, $9.4 billion associated with these mortgage financings is reflected as debt in the accompanying consolidated balance sheet.

With respect to leveraged leases, American evaluated whether the leases had characteristics of a variable interest entity. American concluded the leasing entities met the criteria for variable interest entities; however, American concluded it is not the primary beneficiary under these leasing arrangements and accounts for the majority of its EETC leveraged lease financings as operating leases. American’s total future payments to the trusts of each of the relevant EETCs under these leveraged lease financings are $20 million as of December 31, 2021, which are reflected in the operating lease obligations in Note 5 to AAG’s Consolidated Financial Statements in Part II, Item 8A and Note 4 to American’s Consolidated Financial Statements in Part II, Item 8B.

Letters of Credit and Other

We provide financial assurance, such as letters of credit, surety bonds or restricted cash and investments, primarily to support projected workers’ compensation obligations and airport commitments. As of December 31, 2021, we had $439 million of letters of credit and surety bonds securing various obligations, of which $94 million is collateralized with our restricted cash. The letters of credit and surety bonds that are subject to expiration will expire on various dates through 2025.

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Contractual Obligations

The following table provides details of our material cash requirements from known contractual obligations as of December 31, 2021 (in millions). Except to the extent set forth in the applicable accompanying footnotes, the table does not include commitments that are contingent on events or other factors that are uncertain or unknown at this time.

[[GREPCENT_TABLE]]
[["","Payments Due by Period"],["","2022","","2023","","2024","","2025","","2026","","2027 and Thereafter","","Total"],["American (a)"],["Long-term debt:"],["Principal amount (b), (d) (See Note 3)","$","1,637","","","$","4,167","","","$","3,467","","","$","7,749","","","$","4,412","","","$","10,353","","","$","31,785"],["Interest obligations (c), (d)","1,544","","","1,537","","","1,373","","","1,180","","","618","","","762","","","7,014"],["Finance lease obligations (See Note 4)","215","","","183","","","180","","","113","","","87","","","77","","","855"],["Aircraft and engine purchase commitments (e) (See Note 10(a))","1,987","","","1,851","","","3,358","","","3,535","","","1,663","","","688","","","13,082"],["Operating lease commitments (See Note 4)","1,957","","","1,899","","","1,576","","","1,210","","","936","","","4,684","","","12,262"],["Regional capacity purchase agreements (f) (See Note 10(b))","1,495","","","1,834","","","1,875","","","1,729","","","1,123","","","2,317","","","10,373"],["Minimum pension obligations (g) (See Note 8)","\u2014","","","31","","","23","","","\u2014","","","\u2014","","","\u2014","","","54"],["Retiree medical and other postretirement benefits (See Note 8)","94","","","89","","","84","","","81","","","78","","","312","","","738"],["Other purchase obligations (h) (See Note 10(a))","4,364","","","1,758","","","1,416","","","154","","","610","","","942","","","9,244"],["Total American Contractual Obligations","$","13,293","","","$","13,349","","","$","13,352","","","$","15,751","","","$","9,527","","","$","20,135","","","$","85,407"],["AAG Parent and Other AAG Subsidiaries (a)"],["Long-term debt:"],["Principal amount (b) (See Note 4)","$","750","","","$","\u2014","","","$","\u2014","","","$","1,500","","","$","\u2014","","","$","3,746","","","$","5,996"],["Interest obligations (c)","140","","","121","","","121","","","133","","","125","","","649","","","1,289"],["Operating lease commitments (See Note 5)","16","","","14","","","12","","","7","","","5","","","14","","","68"],["Minimum pension obligations (g) (See Note 9)","\u2014","","","1","","","\u2014","","","\u2014","","","\u2014","","","1","","","2"],["Total AAG Contractual Obligations","$","14,199","","","$","13,485","","","$","13,485","","","$","17,391","","","$","9,657","","","$","24,545","","","$","92,762"]]
[[/GREPCENT_TABLE]]

(a)For additional information, see the Notes to AAG’s and American’s Consolidated Financial Statements in Part II, Items 8A and 8B, respectively, referenced in the table above.

(b)Amounts represent contractual amounts due. Excludes $428 million and $30 million of unamortized debt discount, premium and issuance costs as of December 31, 2021 for American and AAG Parent, respectively.

(c)For variable-rate debt, future interest obligations are estimated using the current forward rates at December 31, 2021.

(d)Includes $9.4 billion of future principal payments and $1.5 billion of future interest payments as of December 31, 2021, related to EETCs associated with mortgage financings of certain aircraft and spare engines.

(e)See Part I, Item 2. Properties – “Aircraft and Engine Purchase Commitments” for additional information about the firm commitment aircraft delivery schedule, in particular the footnote to the table thereunder as to potential changes to such delivery schedule. Due to uncertainty surrounding the timing of delivery of certain aircraft, the amounts in the table represent our most current estimate; however, the actual delivery schedule may differ from the table above, potentially materially. Additionally, the amounts in the table exclude 10 and three Boeing 787-8 aircraft scheduled to be delivered in 2022 and 2023, respectively, as well as four and one Boeing 787-9 aircraft scheduled to be delivered in 2023 and 2024, respectively, in each case, for which we have obtained committed lease financing. This financing is reflected in the operating lease commitments line above.

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(f)Represents minimum payments under capacity purchase agreements with third-party regional carriers. These commitments are estimates of costs based on assumed minimum levels of flying under the capacity purchase agreements and our actual payments could differ materially. Rental payments under operating leases for certain aircraft flown under these capacity purchase agreements are reflected in the operating lease commitments line above.

(g)Represents minimum pension contributions based on actuarially determined estimates as of December 31, 2021 and is based on estimated payments through 2031. On March 11, 2021, the ARP was enacted, which included funding relief provisions benefiting single employer qualified retirement benefit pension plans such as those sponsored by American.

(h)Includes purchase commitments for aircraft fuel, flight equipment maintenance, construction projects and information technology support.

Capital Raising Activity and Other Possible Actions

In light of the cash needs imposed by the current operating losses due to reduced demand in response to the COVID-19 pandemic as well as our significant financial commitments related to, among other things, the servicing and amortization of existing debt and equipment leasing arrangements, new flight equipment and pension funding obligations, we and our subsidiaries will regularly consider, and enter into negotiations related to, capital raising and liability management activity, which may include the entry into leasing transactions and future issuances of, and transactions designed to manage the timing and amount of, secured or unsecured debt obligations or additional equity securities in public or private offerings or otherwise. The cash available from operations (if any) and these sources, however, may not be sufficient to cover our cash obligations because economic factors may reduce the amount of cash generated by operations or increase costs. For instance, an economic downturn or general global instability caused by military actions, terrorism, disease outbreaks (in particular the ongoing global outbreak of COVID-19), natural disasters or other causes could reduce the demand for air travel, which would reduce the amount of cash generated by operations. See Part I, Item 1A. Risk Factors – "The outbreak and global spread of COVID-19 has resulted in a severe decline in demand for air travel which has adversely impacted our business, operating results, financial condition and liquidity. The duration and severity of the COVID-19 pandemic, and similar public health threats that we may face in the future, could result in additional adverse effects on our business, operating results, financial condition and liquidity" for additional discussion. An increase in costs, either due to an increase in borrowing costs caused by a reduction in credit ratings or a general increase in interest rates, or due to an increase in the cost of fuel, maintenance, aircraft, aircraft engines or parts, could decrease the amount of cash available to cover cash contractual obligations. Moreover, certain of our financing arrangements contain significant minimum cash balance or similar liquidity requirements. As a result, we cannot use all of our available cash to fund operations, capital expenditures and cash obligations without violating these requirements. See Note 4 to AAG’s Consolidated Financial Statements in Part II, Item 8A and Note 3 to American’s Consolidated Financial Statements in Part II, Item 8B for information regarding our financing arrangements.

In the past, we have from time to time refinanced, redeemed or repurchased our debt and taken other steps to reduce or otherwise manage the aggregate amount and cost of our debt, lease and other obligations or otherwise improve our balance sheet. Going forward, depending on market conditions, our cash position and other considerations, we may continue to take such actions.

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OTHER INFORMATION

Basis of Presentation

See Note 1 to AAG’s Consolidated Financial Statements in Part II, Item 8A and Note 1 to American’s Consolidated Financial Statements in Part II, Item 8B for information regarding the basis of presentation.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities at the date of the financial statements. We believe our estimates and assumptions are reasonable; however, actual results could differ from those estimates. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties and could potentially result in materially different results under different assumptions and conditions. We have identified the following critical accounting policies that impact the preparation of our consolidated financial statements. See the “Basis of Presentation and Summary of Significant Accounting Policies” included in Note 1 to each of AAG’s and American’s Consolidated Financial Statements in Part II, Item 8A and 8B, respectively, for additional discussion of the application of these estimates and other accounting policies.

Passenger Revenue

We recognize all revenues generated from transportation on American and our regional flights operated under the brand name American Eagle, including associated baggage fees and other inflight services, as passenger revenue when transportation is provided. Ticket and other related sales for transportation that has not yet been provided are initially deferred and recorded as air traffic liability on our consolidated balance sheets. The air traffic liability principally represents tickets sold for future travel on American and partner airlines, as well as estimated future refunds and exchanges of tickets sold for past travel.

The majority of tickets sold are nonrefundable. A small percentage of tickets, some of which are partially used tickets, expire unused. Due to complex pricing structures, refund and exchange policies, and interline agreements with other airlines, certain amounts are recognized in passenger revenue using estimates regarding both the timing of the revenue recognition and the amount of revenue to be recognized. These estimates are generally based on the analysis of our historical data. We have consistently applied this accounting method to estimate revenue from unused tickets at the date of travel. Estimated future refunds and exchanges included in the air traffic liability are routinely evaluated based on subsequent activity to validate the accuracy of our estimates. Any adjustments resulting from periodic evaluations of the estimated air traffic liability are included in passenger revenue during the period in which the evaluations are completed. While the contract duration of passenger tickets is generally one year, in response to the COVID-19 pandemic, we extended the contract duration for certain tickets to March 31, 2022, principally those tickets which were scheduled to expire from March 1, 2020 through March 31, 2021. Additionally, tickets to certain international destinations have extended contract duration to December 31, 2022. We also have eliminated change fees for most domestic and international tickets providing more flexibility for customers to change travel plans. Given these changes and the uncertainty surrounding the future demand for air travel, our estimates of revenue that will be recognized from the air traffic liability for future flown or unused tickets as well as our estimates of refunds may be subject to variability and differ from historical experience.

Various taxes and fees assessed on the sale of tickets to end customers are collected by us as an agent and remitted to taxing authorities. These taxes and fees have been presented on a net basis in the accompanying consolidated statements of operations and recorded as a liability until remitted to the appropriate taxing authority.

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Loyalty Revenue

We currently operate the loyalty program, AAdvantage. This program awards mileage credits to passengers who fly on American, any oneworld airline or other partner airlines, or by using the services of other program participants, such as our co-branded credit cards, and certain hotels and car rental companies. Mileage credits can be redeemed for travel on American and other participating partner airlines, as well as other non-air travel awards such as hotels and rental cars. For mileage credits earned by AAdvantage loyalty program members, we apply the deferred revenue method. In response to the COVID-19 pandemic, we suspended the expiration of mileage credits through March 31, 2022 and eliminated mileage reinstatement fees for canceled award tickets.

Mileage credits earned through travel

For mileage credits earned through travel, we apply a relative selling price approach whereby the total amount collected from each passenger ticket sale is allocated between the air transportation and the mileage credits earned. The portion of each passenger ticket sale attributable to mileage credits earned is initially deferred and then recognized in passenger revenue when mileage credits are redeemed and transportation is provided. The estimated selling price of mileage credits is determined using an equivalent ticket value approach, which uses historical data, including award redemption patterns by geographic region and class of service, as well as similar fares as those used to settle award redemptions. The estimated selling price of miles is adjusted for an estimate of mileage credits that will not be redeemed using a statistical model based on historical redemption patterns to develop an estimate of the likelihood of future redemption. Given the inherent uncertainty of the current operating environment due to the COVID-19 pandemic, we will continue to monitor redemption patterns and may adjust our estimates in the future. For the year ended December 31, 2021, a hypothetical 10% increase in the estimated selling price of miles would have decreased revenues by approximately $55 million as a result of additional amounts deferred from passenger ticket sales to be recognized in future periods.

Mileage credits sold to co-branded credit cards and other partners

We sell mileage credits to participating airline partners and non-airline business partners, including our co-branded credit card partners, under contracts with terms extending generally for one to five years. Consideration received from the sale of mileage credits is variable and payment terms typically are within 30 days subsequent to the month of mileage sale. Sales of mileage credits to non-airline business partners are comprised of two components, transportation and marketing. We allocate the consideration received from these sales of mileage credits based on the relative selling price of each product or service delivered.

Our most significant partner agreements are our co-branded credit card agreements with Citi and Barclaycard US. We identified the following revenue elements in these co-branded credit card agreements: the transportation component; and the use of intellectual property, including the American brand and access to loyalty program member lists, which is the predominant element in the agreements, as well as advertising (collectively, the marketing component). Accordingly, we recognize the marketing component in other revenue in the period of the mileage sale following the sales-based royalty method.

The transportation component represents the estimated selling price of future travel awards and is determined using the same equivalent ticket value approach described above. The portion of each mileage credit sold attributable to transportation is initially deferred and then recognized in passenger revenue when mileage credits are redeemed and transportation is provided.

For the portion of our outstanding mileage credits that we estimate will not be redeemed, we recognize the associated value proportionally as the remaining mileage credits are redeemed. Our estimates use a statistical model based on historical redemption patterns to develop an estimate of the likelihood of future redemption. For the year ended December 31, 2021, a hypothetical 10% increase in our estimate of miles not expected to be redeemed would have increased revenues by approximately $70 million.

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Pensions and Retiree Medical and Other Postretirement Benefits

We recognize the funded status (i.e., the difference between the fair value of plan assets and the projected benefit obligations) of our pension and retiree medical and other postretirement benefits plans on the consolidated balance sheets with a corresponding adjustment to accumulated other comprehensive income (loss).

Our pension and retiree medical and other postretirement benefits costs and liabilities are calculated using various actuarial assumptions and methodologies. We use certain assumptions including, but not limited to, the selection of the: (1) discount rate and (2) expected return on plan assets (as discussed below). These assumptions as of December 31 were:

[[GREPCENT_TABLE]]
[["","2021","","2020"],["Pension weighted average discount rate (1)","3.0","%","","2.7","%"],["Retiree medical and other postretirement benefits weighted average discount rate (1)","2.8","%","","2.4","%"],["Expected rate of return on plan assets (2)","8.0","%","","8.0","%"]]
[[/GREPCENT_TABLE]]

(1)When establishing our discount rate to measure our obligations, we match high quality corporate bonds available in the marketplace whose cash flows approximate our projected benefit disbursements. Lowering the discount rate by 50 basis points as of December 31, 2021 would increase our pension and retiree medical and other postretirement benefits obligations by approximately $1.2 billion and $40 million, respectively, and decrease estimated 2022 pension and retiree medical and other postretirement benefits expense by approximately $10 million and $1 million, respectively.

(2)The expected rate of return on plan assets is based upon an evaluation of our historical trends and experience, taking into account current and expected market conditions and our target asset allocation of 30% fixed income securities, 24% U.S. stocks, 22% alternative (private) investments, 16% developed international stocks and 8% emerging market stocks. The expected rate of return on plan assets component of our net periodic benefit cost is calculated based on the fair value of plan assets and our target asset allocation. Lowering the expected long-term rate of return on plan assets by 50 basis points as of December 31, 2021 would increase estimated 2022 pension expense and retiree medical and other postretirement benefits expense by approximately $70 million and $1 million, respectively.

During 2021, we reviewed and revised certain economic and demographic assumptions including the pension and retiree medical and other postretirement benefits discount rates and health care cost trend rates. The net effect of changing these assumptions for the pension plans resulted in a decrease of $720 million in the projected benefit obligation at December 31, 2021. The net effect of changing these assumptions for retiree medical and other postretirement benefits plans resulted in a decrease of $32 million in the accumulated postretirement benefit obligation at December 31, 2021. We also revised our mortality assumptions to incorporate the new improvement scale issued by the Society of Actuaries. This resulted in an increase in our pension and retiree medical and other postretirement benefit obligations by $57 million and less than $1 million, respectively.

See Note 9 to AAG’s Consolidated Financial Statements in Part II, Item 8A and Note 8 to American’s Consolidated Financial Statements in Part II, Item 8B for additional information regarding our employee benefit plans.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are recorded net as noncurrent deferred income taxes.

Our ability to use our NOLs and other carryforwards depends on the amount of taxable income generated in future periods. We provide a valuation allowance for our deferred tax assets when it is more likely than not that some portion, or all of our deferred tax assets, will not be realized. We consider all available positive and negative evidence and make certain assumptions in evaluating the realizability of our deferred tax assets. Many factors are considered that impact our assessment of future profitability, including conditions which are beyond our control, such as the health of the economy, the availability and price volatility of aircraft fuel and travel demand.

We presently have a $34 million valuation allowance on certain net deferred tax assets related to state NOL carryforwards. There can be no assurance that an additional valuation allowance on our net deferred tax assets will not be required. Such valuation allowance could be material.

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Recent Accounting Pronouncements

Accounting Standards Update (ASU) 2020-06: Accounting for Convertible Instruments and Contracts In An Entity's Own Equity (the New Convertible Debt Standard)

The New Convertible Debt Standard simplifies the accounting for certain convertible instruments by removing the separation models for convertible debt with a cash conversion feature and for convertible instruments with a beneficial conversion feature. As a result, more convertible debt instruments will be reported as a single liability instrument with no separate accounting for embedded conversion features. Additionally, the New Convertible Debt Standard amends the diluted earnings per share calculation for convertible instruments by requiring the use of the if-converted method. The treasury stock method is no longer available. Entities may adopt the New Convertible Debt Standard using either a full or modified retrospective approach, and it is effective for interim and annual reporting periods beginning after December 15, 2021. Early adoption is permitted for interim and annual reporting periods beginning after December 15, 2020. The New Convertible Debt Standard is applicable to our 6.50% convertible senior notes due 2025 (the Convertible Notes). We early adopted the New Convertible Debt Standard as of January 1, 2021 using the modified retrospective method to recognize the Convertible Notes as a single liability instrument. As of January 1, 2021, we recorded a $415 million ($320 million net of tax) reduction to additional paid-in capital to remove the equity component of the Convertible Notes from our consolidated balance sheet and a $19 million cumulative effect adjustment credit, net of tax, to retained deficit related to non-cash debt discount amortization recognized in periods prior to adoption resulting in a corresponding reduction of $389 million to the debt discount associated with the Convertible Notes. See Note 4(h) to AAG’s Consolidated Financial Statements in Part II, Item 8A for additional information on the Convertible Notes.

ASU 2019-12: Simplifying the Accounting for Income Taxes (Topic 740)

This standard simplifies the accounting and disclosure requirements for income taxes by clarifying the existing guidance to improve consistency in the application of Accounting Standards Codification 740. This standard also removed the requirement to calculate income tax expense for the stand-alone financial statements of wholly-owned subsidiaries that are not subject to income tax. We adopted this standard effective January 1, 2021, and it did not have a material impact on our consolidated financial statements.

ASU 2021-10: Disclosures by Business Entities about Government Assistance (Topic 832)

This standard provides guidance on the disclosure requirements for business entities receiving government assistance. Specifically, entities are required to disclose information about the nature of the assistance received, including the related accounting, the affected line items on the financial statements and amounts, and the significant terms and conditions, including any commitments and contingencies. This standard is effective for annual periods beginning after December 15, 2021, and early adoption is permitted. We adopted this standard as of December 31, 2021. See Note 1(b) in each of AAG’s and American’s Consolidated Financial Statements in Part II, Items 8A and 8B, respectively, for disclosure related to the financial assistance we have received from Treasury.