US loan guarantees - not widely needed after all May 2002

To the relief of many in the US government and industry circles, the controversial $10bn federal loan guarantee programme has less than two months left to run. The deadline for submitting applications is June 28, and some Washington lawmakers have been calling for the programme to be wound down even earlier.

Loan guarantees were a key element of the $15bn airline industry bailout package passed by Congress in the wake of September 11. The programme has turned out to be exactly what many had hoped for — a safety net that few airlines would actually need or choose to use. However, without such a safety net, no US airline would have been able to raise cash through normal commercial channels in the aftermath of the terrorist attacks, and there would probably have been several Chapter 11 bankruptcy filings. Of the major carriers, only America West needed immediate assistance — a modest $380m government guaranteed loan that enabled it to avert bankruptcy in January.

Since then no other loan guarantees have been issued. In early May, the Air Transportation Stabilization Board (ATSB) was considering applications from just four small airlines — Vanguard and Spirit (early 1990s low–fare entrants), Alaska–based commuter carrier Frontier Flying Service and cargo operator Evergreen International.

By imposing unexpectedly onerous terms and conditions for the America West "test case" transaction, which included the government obtaining warrants for up to 33% of the carrier’s stock, the ATSB effectively ensured that no airline would apply for federal loan guarantees unless and until it was truly desperate.

Nevertheless, the lack of interest has evidently caught the ATSB by surprise. Its executive director, Joseph Adams Jr, resigned unexpectedly in late April, saying that he had little to do. This was less than four months after his arrival on a 12–month leave from Brera Capital Partners, a New York Citybased investment firm.

Despite their continued financial losses, US major airlines have not needed government guaranteed loans simply because most have continued to be able to raise funds by conventional methods (albeit, in many cases, at higher rates).

The financially strongest airlines — Southwest, American and Delta — were already able to access the capital markets in the fourth quarter of 2001, while carriers like Continental successfully deployed more creative tactics such as secondary share or convertible note offerings.

Even US Airways managed to raise $404m in November through a private financing involving unencumbered aircraft and engines. United raised $775m in a private, long–term debt financing in late January — the same week that it reported a horrendous $2.1bn net loss for 2001.

The US capital markets are reopening for more airlines, with both Northwest and Continental completing EETC offerings in the public markets in March.

Of course, US airlines have received an aggregate total of $3.9bn in government cash grants since September 11. As an unexpected bonus, in recent months many of them have also been able to collect substantial federal income tax refunds resulting from the government’s March economic stimulus package.

Under the new tax rules, the "net operating loss (NOL)" carry–back period is extended from two to five years, enabling many airlines to use their large 2001 and 2002 losses to recover income taxes paid from 1996 to 2000. One early estimate put the total industry gain from that source at $2bn. As a result, industry liquidity remains satisfactory. According to UBS Warburg analyst Sam Buttrick, the major airlines had an aggregate $14.2bn in cash at the end of March, down only slightly from $15.7bn at year–end. Given that the industry is now entering its seasonally strongest period, no major airline is currently viewed as a potential Chapter 11 candidate this year.

Little surprise, therefore, that pressure has been building in Washington to cut short the airline aid programmes, particularly in light of the need to fund critical homeland security improvements. In early May the House appropriations committee considered proposals to double the current $2.50 passenger security fee charged on airline tickets and to terminate early both the loan guarantee and cash grant programmes.

Following a massive outcry and lobbying effort by the airline industry, the ticket tax proposal was subsequently rejected. As many airline CEOs pointed out, the industry could ill afford to price passengers out of a market at a time when economic conditions were weak, yields remained depressed and financial recovery prospects looked uncertain. As regards the possible reduction in the original $5bn cash grant budget, many airlines appear to have already stopped counting on receiving their final cash grant instalments. For most passenger carriers, the final cash grant payments (for which applications were due by mid–May) represent just 15% of the total that they originally expected to receive, and many may have difficulty proving that their September 11–related financial losses exceeded the cash amounts already received.

It is hard to see how the loan guarantee programme could be terminated early, because such a move could have serious implications for the few remaining potential applicants that are currently working to meet the June 28 deadline. Such candidates include Las Vegas–based National Airlines, US Airways and potentially also United.

US Airways has been working on a restructuring plan that calls for the participation of all key stakeholders. The airline disclosed in mid–April that it was likely to apply for a government–guaranteed loan "to provide liquidity to execute the restructuring plan and fund the business as the industry recovers". The plan was expected to be ready by early May, after which US Airways would spend perhaps a month negotiating with its key partners.

Like America West, US Airways is expected to seek the support of banks, creditors, manufacturers, lessors, vendors and state and local governments. However, unlike America West, US Airways has high labour costs and would probably also have to secure pay and work rule concessions to meet the ATSB’s loan guarantee criteria.

United is just getting started with the hardest part of its financial recovery plan — asking its workforce to agree to substantial wage cuts and concessions. The airline indicated in April that it had not yet decided whether to apply for federal loan guarantees, that it would prefer not to but that an application "may be helpful in putting a plan together with the unions and others".

Even under the most optimistic of scenarios, United’s company–wide concessions negotiations are likely to take months. The airline could in theory submit a loan guarantee application (to meet the June 28 deadline) before securing any labour concessions and then use the ATSB’s subsequent demands to put pressure on its workers.

One potential problem that both US Airways and United face when negotiating concessions from third parties is that they have used mainly public capital markets instruments to finance their fleets. Such financings are much harder to renegotiate than operating leases (which constituted the bulk of America West’s aircraft financing commitments).

Of those two candidates, only US Airways has potential liquidity issues arising later this year, because its cash reserves dwindled to just $561m at the end of March.

By comparison, United has an ample $2.9bn in cash reserves, which gives it much staying power to withstand prolonged concessions talks.

The loan guarantee guidelines require applicants to be carriers for whom "credit is not otherwise reasonably available". While US Airways is likely to qualify in that respect, United might find it hard to convince the ATSB because of its strong cash position and success in tapping the commercial debt markets in January.