The coronavirus story is moving fast. It was a momentous weekend for the airline industry and what I say today is different from what I would have said on 13 March. The Airfinance Journal's analysis has moved on very quickly, from focusing on liquidity to talking of potentially massive government bailouts for a grounded airline sector.
The Financial Times quoted an airline chief executive officer (CEO) as saying this is “the worst crisis in the history of aviation”. I agree. I have worked with airlines through the Gulf Wars, the 1997/98 Asian financial crisis, 9/11, SARS and the global financial crisis. This is undoubtedly the most serious of them all due to the global spread of the pandemic, the extent of the groundings and the size of the revenue impact.
IATA estimated a week ago that airlines stood to lose $113 billion in passenger revenues – approximately 20% of the total - in 2020. Offsetting this are variable cost savings from fuel, air traffic control, over-flight expenses, landing fees and some engineering and staff expenses. Assuming that these variable costs saving are equal to 50% of revenue lost, the net cash impact is 10% of passenger revenues or 7% of total revenues. However, IATA is expected to up its forecast this week following the latest travel ban developments.
Given the scale of the crisis, it is critical to move fast – we have seen Air France-KLM draw its €1.1 billion ($1.2 billion) standby facility, United raise $2 billion last week and heard reports of BA putting additional facilities in place.
A number of dialogues regarding government support were reported over the weekend:
• Peter Norris of Virgin Group proposed a £7.5 billion ($9.2 billion) bailout for UK airlines;
• Lufthansa is in discussion for loans from a German state bank;
• Air France-KLM reported it was in touch with the French government for support;
• The three largest US carriers were said to be in discussions with the US government regarding unspecified assistance; and
• SAS announced its intention to lay off 90% of staff and seem to be getting some financial assistance from the Danish government.
Compounding the difficulty is the fact that some airlines have become complacent about liquidity.
There used to be a rule of thumb that airlines should keep a minimum cash balance of 25% of revenues (or three months’ worth) to cover external risks such as a strike, a grounding – such as for the Boeing 737 Max – a crash, a terrorist act or a pandemic.
But even three months is insufficient given the scale of this crisis. We have had CEOs of three major airlines – BA, Norwegian and Korean Air – declaring that the very survival of their airlines is threatened.
Of the 220 airlines that we follow in The Airline Analyst, only 20% achieved the three-month threshold as of their most recent financial statements or achieved it through a combination of cash and standby loan facilities. Highly ranked airlines include Air Arabia, Aegean Airlines, Wizz Air, Ryanair, IAG, Finnair and Easyjet.
Many have low liquidity, including 85 airlines that hold less than 10% of revenues in cash, have no standby loan facilities and few unencumbered assets. Examples include Norwegian, Avianca, Condor and Spicejet.
Other airlines that do not stack up very well include Lufthansa, Delta, American, United and Korean Air. All have less than 15 percent of revenues as liquidity. Last week the US airlines were vying with each other for bragging rights about which had the most liquidity in the world. This did not take into consideration the vast scale of their operations. Bigger airlines need bigger liquidity buffers.
What differentiates Norwegian, Avianca, Condor and Spicejet from the others I mention is that they have limited unencumbered assets available.
So where can airlines turn to get across to the other side?
Typically, they turn to the assets they operate, the aircraft manufacturers and governments.
The key for the airlines will be demonstrating that they still have a credible business model and that they have sufficient unencumbered or partially encumbered assets that the leasing companies, banks, manufacturers and government agencies will find acceptable as collateral. And the leasing companies will have to present data to their equity and debt investors that their investments are safe, even if there is an increase in airline defaults.
A saving grace is that modern technology aircraft in normal times are eminently financeable. Approximately 40% of the world’s commercial fleet is leased, not owned, making leasing companies – which are generally well capitalised, one of the primary sources of liquidity for airlines. The risk- return relationship of investing in aircraft has attracted many new investors to the asset class, including private equity, hedge funds and sovereign wealth funds. Bank lending secured by aircraft has also been at a high during the last two years.
The major leasing companies will see an opportunity to support their customers and do good deals for themselves. However, their stock prices took a battering in the week ending 13 March; their shares were marked down by 50-65% and some fell as low as 50% of book value. The spreads on their ABS financings also blew out last week. This implies that investors expect a high level of airline defaults (or negotiated returns) for aircraft currently under lease that will be difficult to lease to another airline quickly. This puts a constraint on lessors’ access to capital at least in the short term, which may reduce their financial capacity.
The manufacturers are key stakeholders in the whole situation. While they try to limit their financing to the industry to backstop financing commitments in support of strategic sales, they have provided critical financing support to key customers in crises past, be it secured financing, sale-leasebacks, aircraft trade-ins, equity or pre-delivery payment refunds and deferrals. Deferrals or sliding aircraft deliveries “to the right” would also be expected. However, this time around, the Max crisis will put constraints on Boeing’s ability to provide financial support to its customers, which is a new concern.
As for government support, we had some positive practical action by the EU in recent days in suspending the “use it or lose it” slot rules till the end of June. This will be good for the airlines involved and the environment. It has also been suggested that Alitalia may be fully nationalised and that in the present circumstances this would not be objected to by the European Union (EU).
What remains to be seen is how the different governments approach the liquidity challenge. Some airlines have arrived at this place with conservative leverage and high liquidity with an ability to ride out a disruption of six months or more. Others have expanded recklessly and have arrived in the same place running on empty. To treat both cases equally would be a distortion of competition.
No doubt this crisis is unprecedented in terms of its impact on the airline industry. Air space closure following 9/11 was only four days and warranted government compensation to the US airlines of $10 billion.
The US government also provided an airline industry stabilization guaranteed loan program of up to $5 billion but they rejected United Airlines as not requiring it. United later turned to a Chapter 11 filing instead.
Perhaps the financial crisis of 2007/08 is the nearest parallel when the industry experienced a sustained downturn for an extended period. But air space was open, and many routes remained cash flow positive at the operating level. We are facing a much more serious situation today and the dollar value of commitments required of governments will be many times higher than those which followed 9/11.
Will there be time to customise solutions by carrier or will expediency require a one-size-fits-all approach?
This could take the form of tax relief, grants to cover the costs incurred while travel bans are in place and, possibly, loans secured by aircraft. Again, some carriers have significant numbers of unencumbered aircraft and some have none. Will the latter be allowed to fail? Or will the approach turn to application of securitisation techniques, mezzanine financing or equity investment? Whichever way, the numbers are set to become dizzyingly large.
Comments on some individual carriers:
- Lufthansa – despite having total liquidity of $4.7 billion it has reportedly approached German state bank KfW for liquidity support.
- Air France-KLM – has drawn its €1.1 billion standby facility.
- Flybe –not a casualty of coronavirus – it was going to happen, sooner or later.
- Norwegian – also not a coronavirus victim – if anything it looks likely that coronavirus will be their SAVIOUR by making government support politically acceptable.
- BA – major exposure to North Atlantic – now that Trump’s ban has been extended to the UK it will have a huge impact on it.
- Virgin Atlantic – major exposure to the North Atlantic – extension of Trump’s ban will have an even bigger impact on it.
- Ryanair, Easyjet and Wizz Air rank highly on liquidity measures.
- American Airlines, Delta Air Lines, United Airlines – despite their profitability of the last few years, in percentage terms, even including their standbys, their liquidity protection is at the low end of expectations.
- Alitalia – another airline that may ironically benefit from coronavirus by legitimising state support.
- Lot Polish Airlines/Condor – one would expect Lot’s acquisition of Condor to be under review.
- South-East Asian airlines – already experiencing lower margins before coronavirus and have huge aircraft orders in place. Balance sheets are deteriorating.
- North-East Asian Airlines – Japan Airlines and ANA are in reasonably good shape. The biggest problems are in Korea for both the established carriers – Korean Air and Asiana – and the numerous “low-cost” start-ups of recent years.
- China – the market is waiting for news of Hainan Airlines – but again this is not a coronavirus victim. Air China, Chine Eastern and China Southern have tiny amounts of cash but report huge credit line availability from domestic banks.
- Cathay Pacific – reported total liquidity of $2.6 billion as of 31 December 2019 but will be burning through that rather quickly.
- Avianca – restructured its debt last year, could have done without going straight into crisis as their plans are predicated on asset sales and further debt reduction.
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