As announcements of redundancies in the airline industry continue, Jorge Guira, Associate Professor in Law and Finance, and colleagues from the Universities of Southampton and Cranfield, outline the scale of the challenges facing airlines today.
Airlines face an unprecedented international crisis in the wake of the coronavirus pandemic. The International Air Transport Association (IATA) estimates that the global industry will lose US$252 billion in 2020. Many airlines are cutting up to 90% of their flight capacity. On March 1, more than two million people in the US were flying per day. A month on, fewer than 100,000 people are going through airport security daily.
Some climate activists have welcomed the emptied skies, pointing to the dramatic fall in carbon emissions. But others worry that the bounce back and attempts to take back some of the losses might mean that an opportunity for fundamental, sustained change may be missed.
In the US, a federal government US$50 billion bailout fund – part of which will fund cash grants going towards airline workers, and the other part loans for the airlines themselves – was rolled out piecemeal in March, with revisions announced on April 14.
More than 200 airlines applied. American Airlines will get US$5.8 billion, Delta US$5.4 billion, and Southwest US$3.2 billion, among others. Donald Trump, the US president, stated that the airline bailout was needed to return the industry to “good shape” and was “not caused by them”. Another US$4 billion is available for cargo airlines and US$3 for contractors.
In the UK, it was initially announced that no industry-wide bailout would be offered. Instead, the industry would have to rely on broader aid packages covering 80% of salaries (below a cap) for furloughed employees. But subsequently, the government quickly gave easyJet a £600 million loan (US$740 million). Flybe, a smaller regional or “secondary” airline with pre-crisis financial issues, was not bailed out and collapsed. Many money-making routes Flybe ran have since been picked up by others.
Continental Europe is in worse shape. Italy has re-nationalised Alitalia, forming a new state-owned entity and investing €600 million (US$650 million). France has indicated it will do whatever it takes to bailout Air France/KLM (France owns 15% and the Dutch 13%), with a possible €6 billion bailout package (US$6.5 billion).
Meanwhile, Australia’s Qantas secured a A$1 billion loan (US$660 million). Debt-laden Virgin Australia, meanwhile, was denied a A$1.4 billion loan (US$880 million) and has subsequently plunged into voluntary administration. Singapore Airlines, however, got a US$13 billion aid package.
The airline industry has faced many crises before – 9/11 and the 2010 Icelandic volcano eruption, for example. But these pale in comparison to the economic hit that airlines are currently facing. Some are asking: can it recover? Is this an economic crisis that could reshape how we travel and live? Or will it turn out to be more of a pause, before returning to business as usual? And what role does the climate crisis play in all this – how will sustainability figure in any rebooting of the industry going forward?
We are all experts in the airline industry. Darren Ellis (Lecturer in Air Transport Management) considers these questions first, looking at the industry’s structure and response. Jorge Guira (Associate Professor in Law and Finance) then explores bailout options and likely future scenarios for the industry. Finally, Roger Tyers (Research Fellow in Environmental Sociology) considers how the industry might just be at a turning point in terms of how it tackles climate change.
Bailout essentials
Jorge Guira, Associate Professor in Law and Finance
The global outcomes of the crisis, are firmly anchored in national responses. The airline industry is cyclical: it is used to peaks and valleys. Bailouts have repeatedly been vital for airlines, so many countries have some sort of precedent to go by.
In any bailout, the key question is whether this is a solvency or liquidity crisis. Solvency means that the airline will be very unlikely to ever remain financially viable. Liquidity means that the airline has a high risk of running out of cash flow but should be solvent soon, if supported. Assessing this is sometimes complex.
Cash is king. “Streamlining” – a fancy word for cost cutting – can help. Unencumbered assets such as aeroplanes can be sold, or used as collateral for loans. But many planes are often leased, so this may be problematic.
Existing contracts must be reviewed. Breach of covenants, which are legally binding promises to do (or to refrain from doing) things in a certain way, may need to be waived. For instance, lease agreements for the planes often require flights to carry on, and business as usual is suspended at present. Other agreements require flights to maintain landing spaces in airports – leading to the “ghost planes” many were appalled by earlier on in the crisis, and that still continue.
Certain financial tests may not be met, such as how much debt there is compared to earnings. These can alarm creditors. And this can lead to deterioration in bond credit ratings, reflecting increased financial distress. Other triggers may also arise. Defaulting on one financial contract usually requires informing other creditors. This can trigger defaults on other agreements, creating a domino effect.
So renegotiating operating and financial contracts is crucial. Airlines may have to pick and choose who to pay first. Unions must be kept happy, and other stakeholders must focus on recovery.
All this means that state bailouts, help and other guarantees are crucial for the industry to survive. In the US, for example, net operating losses are carried forward and used to shield revenues and offset these from tax for when things return to normal.
If liquidity is the problem, the real issue is time: how long will it take for the airline to get back on its feet and resume flying more normally? If solvency is the problem, the company cannot survive the demand collapse it is facing. The COVID-19 pandemic is such a fraught time for airlines because of the difficulty in predicting when the crisis will end. This can complicate determining whether it is a more temporary liquidity crisis or a deeper solvency concern.
After 9/11, the airline industry completely shut down in the US. People witnessing the horrifying scenes of the Twin Towers’ collapse were hardly eager to board a plane. So, the government chose to step in to restore confidence. And it did so, successfully, by offering aid including loans and used warrants, which involves investing in airlines when the stock is at a reduced or rock bottom price and waiting for it to go up again. The US government’s COVID-19 financial rescue package parallels this approach.
The US approach is noteworthy because of its size and scale, and the fact that it is built on the 9/11 case and has been modified for the unique present circumstances. It is also an interesting counterpoint to the strategy of the strongly free market-oriented UK, and Australia, which has been more restrained in its approach.
Airline norms suggest that 25% of revenues should be kept in case of any emergency, but this has tended not to happen recently. Corporate earnings have generally not been held for a rainy day, and now that rainy day has arrived. This creates a classic moral hazard problem: many airlines seem to act as if they are too important to fail, because in the end, they believe they will be bailed out. And regulation does not otherwise hold any excesses in check.
Compounding this, some US airlines have recently been accumulating cheap debt, due to low interest rates and lots of credit availability. The five big US carriers, instead of paying off debt, have been spending 96% of available cash on stock buybacks. Many question whether airlines should be bailed out in these circumstances. Limits on paying dividends, buyback of stock, and other terms would logically apply here, as in the earlier US bailout measures announced in March.
While the US case may provide a helpful initial focus, the UK approach is likely to be highly influential, perhaps more so given the reduced resource level – and greater level of climate awareness – there. As Darren pointed out earlier, one model does not fit all but this may offer a useful comparative framework for other approaches that favour national champions or nationalisations.
The UK is reportedly considering partial nationalisation, such as in the case of British Airways. British Airways has furloughed 35,000 employees, with many pay packets supported by the government – for now. British Airways appears better placed to cherry pick key routes, assets and companies as it ranks in the top group for liquidity.
If Virgin Atlantic were to collapse, its size means it may fit in the too important to fail category. It appears that bailout talks are ongoing but Richard Branson’s life as an offshore UK resident, and Delta’s ownership of a 49% stake, present potential political clouds. Questions about whether it should get state aid given current crisis conditions also arise. This is generally forbidden, although the EU has temporarily indicated a COVID-19 relaxation of the rules. No environmental strings have apparently been attached, as former EU officials and others have suggested should be the case.
Overall, the survival of the global industry therefore depends on bailouts, not only to keep airlines afloat but also for the wider travel and leisure ecosystem.
The lack of of sustainability conditions in UK and indeed US bailouts appears to be mirrored globally. But a Green New Deal in a second recovery phase of aid could provide this. And greater awareness of the issue thanks to the likes of Greta Thunberg, an increased culture of working from home, and ongoing measures to increase accountability and reporting of emissions means this aspect may well play a vital role in the repackaging of airlines going into the future. Much of it begins with how emissions targeting interacts with the COVID-19 crisis.
Read Darren Ellis and Roger Tyers contributions in the full article in The Conversation Insights series, first published 21 April 2020.
Disclosure statements
Darren Ellis owns Qantas Airways (QAN) shares. He is a member of the Royal Aeronautical Society (MRAeS).
Roger Tyers is an unpaid member of the FlightFree2020 campaign.
Jorge Guira does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.