US Majors: initial responses to the crisis November 2001

The Bush administration took ten days after the events of September 11 to provide support to the US carriers. The closure of all US airspace for the three days after the terrorist attacks cost the airlines an initial $1bn. However, unlike the decision taken by the EC, the US government decided to support the airlines and compensate for loss of traffic beyond the time when US airspace reopened.

In their submission for a financial bail–out to the US House of Representatives, the combined US airlines outlined the following traffic recovery scenario:

• Traffic to recover to 60% of previous expectations (i.e. pre September 11) by December 2001;
• To 75% of previous expectations by end of the first quarter 2002; and
• To 85% of previous expectations by end of the second quarter 2002.

The Air Transportation Safety and System Stabilisation Act gave support to the airlines in two ways. Firstly, a cash injection of $5bn was given to the carriers. This was divided up between the carriers by size (number of ASKs flown). The second form of support was in the form of loan guarantees of which the US government has set aside $10bn. Also, the government has limited the airlines’ insurance liability in case of further terrorist attacks.

The airlines had initially asked for $24bn and been offered $8bn. The $15bn compromise in the short–term at least has removed the threat of an industry melt–down. The bailout was not without its detractors, with some suggesting that the airlines should only be compensated for the three days of closure of US airspace and not the subsequent fall–off in traffic. Critics argued that the bail–out should not have been given without being dependent on fundamental reform of the airline industry’s industrial relations. Also some Congressmen felt uncomfortable with airlines being made a special case, somehow different from sectors such as hotels, leisure and insurance.

The carriers have been somewhat reluctant to use the government loan guarantees. Most carriers have stated that they would prefer if possible to borrow from the private capital markets. The government can ask for warrants over the shares of carriers that it guarantees (giving the government a potential share in any improvement in the industry’s fortunes). So the carriers are cautious about applying for government guarantees in case their existing shareholders are diluted.

Re-capturing lost traffic

The airlines were initially criticised in some quarters for not lowering fare levels sufficiently to stimulate passenger demand - their thinking was that it was probably pointless tying to persuade frightened people to fly by lowering fares. However, by the start of October, with traffic levels still depressed, this policy changed. United announced cuts of between 25-50% in some business class fares, and virtually all the other majors carriers have followed suit with cuts in both business and leisure fares announced. Some carriers have waived Saturday night stopover restrictions.

In an industry-wide move, airlines are offering their frequent fliers up to double reward points for travel before the year end and also lowering redemption levels for frequent fliers seeking to redeem their miles. Similarly all carriers have been reporting record or near record level of operating performance (on-time departures) and their has also been a show of solidarity among airline senior executives who have volunteered to take pay cuts or temporarily suspend all remuneration.

However, there are some ominous signs of resistance to flying. A survey carried out by the Business Travel Coalition, post- September 11, revealed that 97% of UScompanies were advising their employees to scale back on air travel. Typically this amounted to a ban on non-essential travel (conferences, internal meetings etc.) which BTC estimates translates into a 40-50% drop in total journeys. Of course many US companies were already moving in this direction before September 11.

BTC has forecast that US corporate travel in January 2002 will be 50% below the level recorded in the previous January. The BTC emphasises the increased interest that US companies are showing in video-conferencing and web-conferencing.

American Airlines

American brought forward its plans to close TWA’s Terminal Five at New York JFK from December to October, so that its JFK operations will be consolidated in its own terminal. American has also announced that it has brought forward by six months the first phase of its new JFK terminal construction project which is now expected to open in June 2003.

Third quarter losses for American totalled $525m or $414m after taking into account a portion of the government subsidy. Alarmingly for American, one of the effects of cutting capacity was to push up units costs by nearly 8% on an annual basis. This combined will a fall in unit revenue of 16% American does, however, have $3bn in cash and the possibility of raising further funds through EETCs. Its early October EETC was a partial success in that the higher rated tranches were sold but the bankers were unable to dispose of the lower rated tranches, so $1.3bn rather than the planned $2bn was raised.

American’s alliance ambitions still wedded to oneworld. In August, American and BA applied for anti–trust immunity for their transatlantic services, and in October a extensive agreement was signed with Qantas following the transfer of American’s short term 737 delivery positions to the Australian carrier. Immunity will not be granted until the UK, or perhaps now the EU, signs an "open skies" agreement with the US. But that development is looking ever more likely.

America West

America West reported a third quarter net loss of $69m reduced to $32m after government funding. AmWest if one of the most financially fragile carriers, and has failed to make some of its lease payments. Cash is only about $250m and Chapter 11 bankruptcy may not be far away.

Continental

On September 17 Continental announced a 20% cut in system–wide ASKs. At its three major hubs, Continental announced a reduction of flights of 14% at Cleveland, 14% at Houston and 20% at Newark. Ten direct routings have been axed, eight domestic and also Newark- Dusseldorf and Newark–London Stansted. From October 1 the airline grounded its DC–10, 31 narrow–bodied aircraft and 14 Continental Express turboprops.

Continental had been hoping to float its ExpressJet subsidiary, valued pre- September 11th at $320m but this transaction has been indefinitely postponed.

Continental’s third quarter loss was $97m, but government funding actually brought it up to a marginal profit, $3m. The threat of defaulting on lease payment made just after September is now seen as a political gesture. Now Continental will probably not take up a government guaranteed loan

Delta

On October 2, Delta CEO Leo Mullinannounced "major price promotions everywhere" and "significant reductions….for business travellers". In its most high profile promotion, Delta is offering 10,000 free round trip tickets to New York as part of a programme to stimulate tourism and convention business. In return Delta has been named the "official carrier" of New York’s convention and visitors bureau.

Delta has been using its Delta Connection regional carriers extensively to deal with the crisis. Its two wholly owned subsidiaries, Atlantic Coast Airlines and Comair are being used to maintain schedules in Cincinnati and Atlanta respectively. The two other Delta Connection carriers, Atlantic Southeast Airlines and Skywest, are being used to shore up operations at Atlanta and Dallas Fort Worth respectively. Delta has parked 50 aircraft for at least the remainder of 2001 and is in negotiations with Boeing and Bombardier to defer deliveries.

On September 17 Delta was able to close its $1.25bn EETC financing. Although the issue had to be priced significantly above levels that could have been achieved prior to September 11, with US Treasury rates at such low levels, the deal was relatively inexpensive by historical standards — the interest rate on the A tranche was 5.87% pa. The closure of this financing means that by end- September Delta had a cash balance of $2.55bn and it announced that it had a further $8.9bn of unencumbered assets to fall back on. Delta’s third quarter loss was $295m, which government aid helped reduce to $259m.

Northwest

Northwest has been able to preserve service to all its US mainline destinations, but at lowered frequencies, although it has suspended its Delhi–Amsterdam service.

Third quarter results were better than feared — a loss of $100m which turned into a profit of $19m after government funding. Northwest, however, faces serious problems on the Pacific where October traffic was down 40% (compared to just 25% on the Atlantic). The airline announced that as of end–September it had a cash position of over $2bn.

With an elderly fleet, and low capital costs, Northwest is not as exposed as the other Majors when it parks aircraft. It has committed to taking all its scheduled deliveries, about 50 units, this year and next.

Southwest

Even Southwest has been forced to make adjustments to its strategy. It too announced fare sales, and told Boeing that it needed to delay fourth quarter 2001 deliveries of 737–700 aircraft (perhaps with the idea of taking advantage of very depressed second- hand prices). No labour lay–offs have had to be made.

The airline announced that as of end- September it had a cash position of $1bn with a $475m line of credit facility. Moreover, Southwest was able to produce a profit of $83m for the third quarter before and government funding.

Southwest traffic and unit revenues and still trending upwards. Both in terms of operating economics and passenger appeal, the Southwest model has proved very successful in the post–September 11 market. Its stock–market capitalisation was $12.4bn at the end of October while that of the second place airline, Delta, was $2.9bn.

United

Jim Goodwin, the CEO, became the first top management casualty of the crisis when he was sacked by the United board and replaced by John Creighton. United seems to be in severe financial problems, and Goodwin had lost the confidence of the unions, many of whose members are also shareholders in the airline.

As part of its 23% capacity cutback, United has announced:

• The discontinuation of the United Shuttle brand, with 30 out of 36 routes to be streamlined into either United mainline or United Express;
• Six cities to downgraded to become United Express routes five to be operated by Atlantic Coast Airlines and one by Skywest; and
• Six cities to lose all United service and a further eight domestic routes to be closed UAL’s third quarter loss was $542m, before government funding but excluding $617m in special charges. The airline is heading for a $2bn–plus loss for the year.

The company’s cash balance at September 30 was $2.7 bn, including $1.5bn raised in August from an EETC. Nevertheless, bankruptcy proceedings are looking more likely unless the unions forego major rises won before September 11. One of the effects of chapter 11 might be to wipe out the union’s shareholding in the company and eventually restore a more normal corporate governance structure benefits to the company.

United has some comfort in being a cornerstone of the world’s strongest alliance grouping, Star. On September 5, United applied for anti–trust immunity for its transatlantic alliance with bmi.

The anti–trust immunity application states that United, bmi and the other Star partners, intend to "operate as if they were a single firm with a common objective" by sharing pricing, scheduling and revenues on transatlantic routes. United already has such a waiver with Lufthansa, SAS and Austrian.

US Airways

The prolonged closure of one of US Airways’ main hubs, Washington’s Reagan National airport, because of the proximity of its flight paths to the White House and other US institutions has hurt the airline badly. Theairline has been the most draconian in terms of reducing capacity (23%) and employees (11,000 out of a total of 45,000).

The reduction in capacity will be achieved through downgrading services to regional jet services through US Airways Express and by retiring, by April 2002, all the carrier’s 737–200s, MD–80s and F100s. Its 12 A321 deliveries scheduled for next year have been postponed.

US Airways was in deep trouble following the failure of United’s take–over attempt, and third quarter results were very bad — a loss of $766m before government funding, $433m including the government money and special items. The airline announced a cash position of $1bn at the end of September, but how much of this remains is unclear.

US Airways is a prime candidate for Chapter 11, and it is surprising that it has not yet filed.

Outlook

The airlines that would appear to have suffered least from September 11 are the regional jet operators. As the majors downsize capacity but preserve network coverage, the regional jets have been an important tool in replacing 100–plus seater aircraft.

Cash is king and airlines will probably seek to replicate the EETC transactions and raise cash from the sale and leaseback of unencumbered assets. Clearly there is a great disparity among balance sheet strength.

The questions that will need to be addressed are:

• Will the US government will continue to support the airlines through further bail–outs?
• Will it allow the weaker carriers to be acquired by the strong through a more laissez- faire competition policy?
• Will the stronger carriers (the big three) seek to acquire the weaker players and assume the usual merger problems or let them operate under Chapter 11 and potentially undermine the yield structure?
• Will the industry now reduce to the big three network carriers — American, United and Delta — plus Southwest, or, given the depressed price of assets, will new airlines evolve?