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My view on what's going on in the financial markets and the global economy, and a few other things that might interest me from time to time.

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The Airline Industry - Are Bailouts Justified?

Updated: Jul 19, 2020

One of the industries that has been most adversely affected by the economic stoppage due to COVID-19 has been the passenger airline industry. This has been especially visible in the U.S. and Europe since most major airlines in these jurisdictions are publicly listed (rather than state-owned / controlled). There are many other industries with similar economic models, consisting of ratios of high fixed costs to low variable costs and dependencies on high customer density. These are the most vulnerable industries, and will likely remain so because of social distancing requirements, at least until a vaccine or viable treatment for COVID-19 is developed, wide-spread immunity occurs, or COVID-19 runs its course and somehow peters out. The effects of social distancing and fear of the virus in general will be extensive and far-reaching for the passenger airline industry. Even legendary investor Warren Buffet recently threw in the towel on Berkshire Hathaway’s holdings in U.S. airlines because he believes that travel will not be the same for many years.

This paper is focused on the passenger airline industry. It has a U.S. slant since the CARES Act singles out the U.S. airline industry specifically for aid, which has been substantial, but I also touch on a few of the European airlines. The CARES Act aid has been complemented by extensive support for airlines by the Federal Reserve in the credit markets. This type of assistance from the U.S. – and other governments – raises many questions and is far from simple even though it might seem so on the surface. Let’s start by looking at the fiscal assistance in the CARES Act and then at the European passenger airline industry. With this context, I will then address the merits and deficiencies of a government bailout for the passenger airline industry. Overall, I’m not convinced it makes sense for a variety of reasons.

CARES Act: The Payroll Support Program (“PSP”) for Passenger Airlines

In the $2.2 trillion CARES Act nearly unanimously approved by Congress and signed into law by President Trump on March 27th, $61 billion was earmarked by the U.S. Department of the Treasury for the airline industry, including passenger airline companies ($50 billion aggregate), air cargo companies and related service businesses (e.g. catering, security, cleaning, etc.). The aid is being offered in two parts, illustrated in the diagram below from Oliver Wyman:

For passenger airline carriers specifically, $25 billion (of total $32 billion payroll assistance) was earmarked as grants pursuant to the Payroll Support Program (“PSP”), illustrated on the left side of the table above. Although classified as “grants”, this aid is actually a combination of grants and low-interest rate loans. The headline amount for each airline is customised so as to cover a significant portion of each airline’s payroll costs through the end of September (to avoid layoffs during this period). The PSP money is subject to certain conditions being met, including: i) no reduction in pay or introduction of furloughs until Sept 30, 2020; ii) no stock buybacks or dividends until at least Oct 1, 2021; iii) no pay rises or severance for highly paid employees until at least March 24, 2022; and iv) on-going provision of minimum service requirements or required routes (which is course is different for each airline). An additional $25 billion (of $29 billion), illustrated on the right side of the chart above, was set aside to provide loans and/ or guarantees to passenger airlines in the form of five-year secured loans at “market rates”.

This structure of the $25 billion PSP was agreed between the government and 10 U.S. airlines on April 14th. Each PSP package is a combination of a 70% grant (meaning this amount is not repaid) and a 30% 10-year low interest rate loan including 5-year (detachable) equity warrants for those publicly-listed airlines that take more than $100 million of aid. The aggregate amount of the PSP package for each passenger airline was “sized” to be roughly equivalent to 76% of each airline’s payroll for the period April 1st to September 30th (2Q and 3Q).

Six of the 10 airlines that had confirmed details of their agreements as of April 14th are American, United, Delta, Southwest, JetBlue and Alaska Air. These are the ones I will focus on in this paper. As of April 14th, either agreement had not been reached or details had not been disclosed regarding at least four other U.S. passenger airlines: Allegiant Air, Frontier Airlines, Hawaiian Airlines and SkyWest Airlines.

In addition to the PSP support, passenger airlines are also eligible for 5-year secured government loans from the U.S. Department of the Treasury, which is separate from the PSP.  Most of the airlines have disclosed that they have applied for such loans, but as of the time that they released their most recent financial statements, none had decided to borrow pursuant to this secured loan facility. Unlike the PSP component, this component will be comprised of secured loans (or guarantees) at “market” prices with five-year maturities and will (again) include equity warrants. I have not been able to find other specifics with respect to the terms of these loans, although American Airlines included the most comprehensive disclosure in their 1Q20 results regarding this second facility. Summary of the PSP for the Six Largest U.S. Airlines

The table below summarises the assistance pursuant to the PSP agreed between the Department of Treasury and the six largest U.S. airlines.

The top of the table provides details for the PSP, which for these six airlines aggregates $21.4 billion (of $25 billion available). The loans are 10-year loans, which are priced at the base rate + 1.0%, stepping up to the base rate + 2.0% after five years. As the table illustrates, detachable warrants were granted to the U.S. Department of the Treasury for each company based on the size of the loan (circa 10%), with warrants ranging from 0.50% (Southwest) to 3.1% (American Airlines) of each company’s fully-diluted shares. The warrants are expected to provide yield enhancement for the PSP package of aid, although the yield enhancement is of course predicated on the share prices at the time the warrants are exercised by the Treasury. To look at the value of the warrants, I calculated returns over a five-years horizon for the Treasury assuming that the share price of each company i) returns to its 52-week high, or ii) returns to its 5-year high (same price for United and Delta, different for others). The outcome - illustrated in the section of the table entitled “Outcome for PSP Assistance in 5 Years (for Govt)” – shows that the U.S. government would earn on the loan component only between 1.75% (Southwest) and 4.61% (United) based on each airline’s 52-week high share price, and between 1.99% (Southwest) and 7.37% (American) if the respective shares were to hit their prior 5-year high. (These returns assume that the base rate stays at 0% throughout the five-year life of the loan.) The next line – “share price for Govt to get back loan AND grant fully” - is the price/share necessary in five years for the government to get back 100% of the entire PSP package, including the grant. As you can see, the price / share levels necessary do not at all appear realistic in light of the five-year historical performance of each company’s shares.

What Other Assistance has been Provided in the U.S. for Passenger Airline Companies?

Between the time the CARES Act was signed into law and the PSP aid was agreed with the six largest U.S. passenger airlines, the Federal Reserve expanded the scope of its quantitative easing (“QE”) programme (see press release herefrom April 9th) to include bonds from “fallen angels” and high yield ETFs, both provisions of which – at least indirectly - helped U.S. passenger airlines. (Recall that the Federal Reserve had already expanded the scope of the QE programme on March 23rd to include investment grade rated corporate bonds.)

The graph to the left illustrates the migration of credit spreads generally since the beginning of the year. The primary bond market has exploded in terms of new issue volumes since the Fed’s actions in late March / early April, as the improvement in tone has allowed companies to (re)gain access to the capital markets.

Airlines have traditionally relied on the public bond markets to raise both unsecured long-term financing and term securitised debt (supported by equipment), so the broader scope of asset purchases by the Fed has improved their access to the debt markets. This support is indirect, however, since the Primary Market Corporate Credit Facility set forth by the Federal Reserve specifically excludes the purchase of primary or secondary bonds from companies that have benefited pursuant to the CARES Act, which would include passenger airline companies. Hoping to rely on the public debt markets is almost certainly why none of the passenger airline companies have not accessed the secured loan facility under the CARES Act, since doing so would come with considerably more strings attached (similar to the PSP facility including additional warrants). However, access to the public debt markets is far from certain because the outlook for passenger airlines is so poor at the moment and creditors remain cautious, justifiably so.

In the table in the preceding section, I included credit metrics at the bottom of the table. Liquidity on hand and cash flow burn rate justify each airline’s ratings, with American (Ba3/B/B) facing the most difficult road ahead and Southwest (Baa1/BBB/BBB+) the best, relatively speaking of course. It should be clear from this data which airlines are most likely to tap the second facility pursuant to the CARES Act provisions focused on airlines.

At the end of the day, the combination of the PSP and the Federal Reserve’s expanding mandate has proven to be a powerful combination of stimulus measures for U.S. passenger airlines, at the very least buying them time whilst their fleets remain largely grounded for the time being.

What’s going on in Europe?

As far as the larger European airlines, I believe that only Air France-KLM (unrated) and EasyJet have officially received state aid, aside from Alitalia which has – yet again – been (re)nationalised. As is typical in Europe, the approach has been piecemeal and poorly coordinated across the member-states although all of the larger airlines, regardless of domicile, serve most of Europe. Furthermore, there is no specific support agreed for the airline industry within any member-state. Here is where we stand at the moment in the E.U.

On May 6th, the European Commission signed off on a €7 billion aid package for Air France-KLM (un-rated) from the French government. The rescue financing consists of €4 billion of low-cost bank-guaranteed debt and a €3 billion “market priced” subordinated loan from the French government. Similar to the CARES Act, the aid comes with strings attached in terms of a restriction on dividends. You can find the details of the package in the May 7th press release from Air France here. In addition to this support, the Dutch government is also considering additional support in the neighbourhood of €2 billion to €4 billion. As an aside, note that Air France-KLM is listed but is owned 14% (each) by the French government and the Dutch government.

In the U.K., EasyJet (Baa2/BBB) accessed £600 million of short-term (up to one year) government supported financing in early April under the Bank of England’s COVID Corporate Financing Facility, which was one of two mechanisms introduced by the UK government in mid-March totalling £330 billion of aggregate support for businesses.

German flagship carrier Deutsche Lufthansa (Ba1/BBB-) is apparently negotiating a €9 billion aid package from the German government which would be subject to EC approval. The German government is apparently seeking a stake of 25% in publicly-listed Lufthansa in exchange for providing this lifeline.

Virgin Airlines is seeking assistance from the U.K. government although the fact that billionaire Sir Richard Branson is the controlling shareholder has complicated matters.   These discussions are on-going. Virgin Airlines Australia, an affiliate only through common ownership, filed for voluntary administration on April 21st. As an aside, to demonstrate that administration or bankruptcy does not necessarily mean going out of business, there are apparently 20 bidders looking at Virgin Airlines Australia at the moment, which is for sale following its failure.

Stronger European airlines like British Airways (Baa3/BBB-/BB+) and Ryanair (BBB/BBB) have not sought assistance at least publicly.  

As I mentioned at the start of this section, the major criticism of the approach so far in Europe is that state-aid has not been uniformly made available to E.U.-based airlines and applied across the union, instead leaving each airline to fend for itself with its own home country government.  This is both inefficient and can be terribly unfair, although it is not an uncommon approach from a fiscal perspective in the E.U.

The table below is from Ryanair and appeared in an article dated May 1, 2020 in Simple Flying, which you can find here. It is slightly dated but provides a decent recap of where Europe stands with its airlines, including some of the smaller flagship carriers.

Issues with Government Aid for the Passenger Airline Industry

Although passengers, lenders and shareholders might be rejoicing, there are a number of issues with governments providing support for the passenger airline industry in the U.S. and Europe. Let me touch on a few of them below.

From the perspective of airlines and customers, is government support the right thing?

Customers will undoubtedly one day fly again, so the fact that the airlines are not folding completely is fortuitous and obviously beneficial from the perspective of the flying public. At airlines, employees keep their jobs, and the many other companies providing services to the airline industry (catering companies, baggage handlers, and so on) also remain in business, at least whilst the government support continues. There is little argument that the ability to ramp back up and fly again quickly is vastly improved since employees are retained and the infrastructure necessary to support airlines during this hiatus remains in place. Messy, distracting and time-consuming restructurings or bankruptcies are avoided. However, a perfectly valid questions is, just how quickly will the airlines need to ramp back up to serve the flying public?

I don’t think we are going to see a flood of passengers that will suddenly want to fly as soon as economies reopen and the pandemic begins to wind down because of lingering fears of contracting the coronavirus. Business travel will undoubtedly be forever reduced, as companies recognise the viability of and cost-savings associated with video calls and virtual meetings in lieu of face-to-face meetings. I am not suggesting that business travel will end, but it is almost certain that it will be significantly reduced for a long period of time. To reach critical load factors, airlines will therefore become increasingly dependent on leisure travellers, and leisure travel will also be transformed by the pandemic. Social distancing is likely to remain in place for some time and will inevitably further reduce load factors. Because of the gradual uptick in passengers flying, airlines will ease methodically into reopening routes, and this arguably plays perfectly into the hands of rapid downsizing now accompanied by voluntary restructurings (covered below) rather than relying on government bailouts. Nonetheless, the U.S. and many European governments have chosen to support their domestic carriers for some period of time to ensure that the reopening occurs smoothly so as to encourage the (eventual) flying public.

Why do airlines deserve special treatment in the first place?

This is a very good question given the pain of the lockdown is being felt across the entire travel, tourism and entertainment business, not just the airline business. I suppose the logic, mentioned in the section above, is that countries want to ensure that the infrastructure is in place to quickly resume moving people around when the economy begins to normalise. There are also arguably national security interests as every country wants to protect its airline companies. The availability of hotels and rental cars seems to be a lower priority since these industries did not receive specific aid, although these industries are very linked to air travel. Nonetheless, the reality is that the passenger airline industry that emerges from this crisis is likely to look very different from the one that existed going into the crisis.

Firstly, there will be fewer passengers flying. As a result, the industry will remain saddled with overcapacity, not only today or later this year, but probably for years to come. This capacity will need to be removed if passenger airline companies ever wish to stand on their own two feet again. If and when airlines bite the bullet and eventually take the difficult steps, there will be severe collateral effects on airports, air leasing companies, catering companies and airplane manufacturers like Boeing and Airbus. Secondly, overall profitability per passenger will decrease because of the shift in passenger mix between higher margin business travellers and lower margin leisure travellers. It’s this simple - if appropriate measures are not taken to “right size” the industry in anticipation of the very slow recovery in the passenger airline business, the end result will either be “good money thrown after bad” (i.e. another round of government support), or a series of business consolidations and/or bankruptcies, either voluntary or involuntary.

Government support rescued existing shareholders and creditors alike (“moral hazard”)

The availability of grants and low-interest loans with limited to no dilution to existing shareholders means that existing shareholders, bondholders and banks of passenger airline companies have wiggled out of potentially disastrous positions with no negative repercussions whatsoever (except for a decrease in the airlines’ stock prices). Without state support, creditors - both bondholders and lenders (i.e. banks) - might have found themselves in a very different position today, holding debt valued at less than 100 cents on the dollar which would reflect the significant diminution in the value of the airline. For those airlines that ultimately fail, existing shareholders would be replaced with existing creditors which would become the new owners of a restructured company. This is the way free markets work, at least ordinarily.

In my opinion, there is one good example of how such a restructuring should work, and this involves low cost European carrier Norwegian Airlines. In the case of Norwegian Airlines, existing shareholders and creditors successfully engineered a debt-for-equity swap to unlock state-aid, which was contingent on an out-of-bankruptcy restructuring. 95% of the existing shareholders were wiped out and replaced by the existing creditors (bondholders, banks and lessors), which became the new owners of 95% of the company. As a result, the Norwegian government unlocked an incremental 2.7 billion krona ($262 million) of additional funding so that the debt-free airline could see itself through this crisis, even though almost all of its planes are currently grounded.

This is an excellent example of how any over-leveraged but viable business in “normal times” in most industries operating in a capitalist society would be restructured to improve the company’s chance of survival. In contrast, the U.S. approach using PSP pursuant to the CARES Act meant that the shareholders of the U.S. airlines gave up virtually nothing (although airline share prices plummeted) aside from modest dilution related to the warrants. Similarly, creditors – including bondholders, banks and lessors - have been effectively rescued and provided with a lifeline, rather than having their debt wiped out and becoming the new owners.

One of the most out-spoken investors on the issue of airline bailouts has been Chamath Palihapitiya, CEO of Social Capital. You can watch his very interesting interview on CNBC Halftime Report on April 9th on YouTube here. It is absolutely worth watching if you haven’t seen it.

Government support levels the competitive playing field for the wrong reasons

The airline business is a high fixed / low variable cost industry with a business model very dependent on load factors. During the industry’s better years, some airlines chose to use their profits to build a liquidity reserve, whilst others chose instead to invest in new airplanes and / or landing slots, make acquisitions, or return money to shareholders via dividends or stock buybacks. Many airlines were also operating less efficiently than they might have been. The result is that entering the government-imposed lockdown on travel to combat COVID-19, there were stronger airlines (e.g. Ryanair in Europe and Southwest in the U.S.) that were “prepared for a rainy day” with strong liquidity positions and prudent debt levels, and many others that were less prepared. However, the provision of state aid levels the playing field, removing the competitive advantage of those stronger airlines that were better prepared for a downturn (because they will rely on the liquidity they have accumulated), whilst at the same time “rewarding” those airlines that were not prepared because the government has – at least for now – stepped in to provide them with a lifeline. I covered this topic more broadly in a blog post on April 15th entitled “A Level Playing Field?

In Europe, Michael O’Leary, the CEO of low-cost airline Ryanair, has been the most outspoken about this issue.  Mr O’Leary is right to complain that airlines which were conservative and “saved for a rainy  day” to navigate through difficult times will emerge from this crisis in a less favourable competitive position because less efficient and less profitable carriers like Air France (and likely Lufthansa) will be bailed out.  His solution, which I think makes perfect sense if the E.U. wishes to support European airlines, would be to i) centralise aid at the E.U. level (rather than having each member-state “rescue” its own airline), and ii) base the aid to be contributed by each member-state on the routes flown by each airline in that country (as opposed to its domicile).   This would certainly do a much better job of ensuring that the playing field once this crisis passes looks more similar to that which existed prior to the shutdown, rather than allowing the most vulnerable airlines entering this crisis to effectively close the gap on stronger peers. As I am finishing this paper, Bloomberg reported this morning that Ryanair is suing the E.U. over a related matter, which is the French government’s decision to defer aviation tax payments for French carriers, meaning that Air France will receive an advantageous tax deferral whilst Ireland-based Ryanair and U.K.-based EasyJet, which also fly a number of routes in France, receive no such break. Here is an extract from the Bloomberg article paraphrasing Mr. O’Leary’s thoughts: “These subsidies for Air France, Alitalia and Lufthansa are “going to hugely distort the level playing field for aviation” by keeping inefficient airlines alive while rivals like Ryanair risk burning through cash reserves, Ryanair Chief Executive Officer Michael O’Leary said earlier this month.”

Government aid might take away the sense of urgency for airlines to sort their operational issues

Passenger airlines will have to take monumental and painful steps to survive, meaning drastic reductions in fixed costs including staff across the board, landing slots and airplanes. In the U.S., the PSP covers most of the airline’s payroll costs only until September 30th, meaning that the painful steps will need to be planned now for the beginning for the 4thquarter. Having liquidity provided at off-market prices could very well mean that airlines don’t act with a sense of urgency because they believe a second round of government support will be made available to extend their lifeline. This could certainly be the mindset because it is difficult to say where we will stand on the pandemic five months from now.

The bailout will have to be paid for eventually

The cost of the support from the U.S. and European governments might seem rather generous to many readers because, in fact, it is. There is a question of whether or not such support was justified in the first instance, which I have touched on throughout this paper. However, if such aid is to be provided, then it should at least allow the government a chance to get its money back, since the bailout is – after all – taxpayer money. As I illustrated earlier in this paper, the return earned by the Department of Treasury is far below what the risk justifies. The packages are way too skewed towards grants. The Department of Treasury should have taken much more equity in each airline in exchange for its valuable provision of liquidity as de facto a lender of last resort. By structuring the aid this way, the issue of moral hazard would be lessened, and the playing field would have not been unfairly levelled. Instead, with the aid skewed towards grants, taxpayers will inevitably be left holding the bag. The cold reality is that you or your company (or both), as taxpayers, will end up paying for this support, not to mention the billions of dollars of other fiscal support pursuant to the CARES Act in the U.S. and similar aid being administered in Europe. This point seems forgotten at the moment because the stimulus for airlines is so welcome during this economic slowdown, especially since most passenger airline companies are only running at 5%-10% of capacity.


Governments in the U.S. and Europe have provided unprecedented support to the passenger airline industry in order to ensure that once the pandemic passes, air travel can resume quickly. It is a noble cause but fraught with complicated side issues, not many of which are thought about at the moment because the focus is on quelling COVID-19. With uncertain timing and many difficult days ahead, it will be interesting to see where the airline industry stands at the end of this year.

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