Industry Sees Air Bankruptcies, Liquidations On The Horizon

With fuel maintaining historic highs and an emerging consensus that the airline business is unsustainable at its current size, the industry is awaiting the next shoe to drop in the form of bankruptcies or liquidations.

Though airline analysts, credit rating firms and representatives from an aviation bankruptcy advisory firm said major U.S. carriers have enough cash and assets to carry them through 2008, next year is likely to bring capacity reductions in a less voluntary form than the ones implemented this year, as smaller carriers go under and majors struggle with solvency. On the domestic industry's current path, the question is not whether more carriers will go away, but which ones and when.

Fitch Ratings this month said U.S.-based legacy carriers "will experience rapid erosion of cash levels in the post-Labor Day period. This erosion could threaten their survival if adverse fuel trends continue, and multiple bankruptcies and liquidations are increasingly likely looking ahead to 2009."

In a research note published late last month, JPMorgan airline analyst Jamie Baker said major carrier bankruptcy filings this year are unlikely, as many carriers have "been there, done that" and "cash is not yet in crisis," noting that most large carriers in the past have not filed until cash dips below 15 percent of revenue for the 12 preceding months. However, several triggers could change that scenario, Baker said, including sustained oil prices of $150 a barrel and a greater than anticipated hit on air travel demand.

Of the nation's largest carriers, Baker laid out those with the highest risk of filing for Chapter 11, with US Airways and American leading the pack, followed by United, Northwest and JetBlue. Southwest, Alaska, Delta and Continental carry the least Chapter 11 risk, in that order, Baker said.

Despite the risk assessment, Baker outlined a number of levers each carrier could pull to gain additional liquidity, ranging from a large-scale sale of frequent flyer miles, to the sale of subsidiaries, aircraft and airport slots, among others.

During a conference call with airline investors this month arranged by UBS airline analyst Kevin Crissey, managing director of bankruptcy advisory firm AlixPartners' aviation and aerospace practice Philip Toy outlined the best-case scenario for the majors: fuel prices stay high long enough to eliminate some discount carrier competition, taking away their capacity and pricing pressure.

"Then there's a steep drop-off in fuel prices and the economy picks up as well sometime in 2009," Toy said. "Most majors have enough cash and liquidity to carry into 2009 on some level. If demand picked up and fuel prices dropped off, it could be a good outcome for major airlines."

Toy also gave the most likely scenario, which hinges on fuel maintaining its current level: "We would see some filings from first the discount carriers, and then we would see some of the legacy carriers—although the timing is very open on when that would happen," he said. "We hope in that base-case scenario that enough capacity is taken out of the system that the airlines get pricing power and we get some level of stability in the industry."

The Air Transport Association in the past year has documented the run-up in fuel costs and its impact on the business, and its president and CEO, James May, said the industry is not sustainable at current fuel prices. "There is not a carrier in the business that has suggested we can continue to survive at $140 a barrel of oil," May said. "We've had eight carriers that have shuttered operations so far this year, we have two more that are in Chapter 11, at least two more on the brink of Chapter 11 and even the majors are going to be in serious difficulty if oil prices continue to sustain at these levels. It is simply not a viable economic opportunity."

AlixPartners' Toy noted that Delta, Northwest, United and US Airways, which already have reorganized under court protection this decade, have less incentive to do it again. "Maybe they didn't complete the job, so to speak, so there are still opportunities for restructuring, but in this cycle there's less advantage for a United or Delta to enter Chapter 11," he said. "There's not as much upside in restructuring the costs."

The credit crunch has made reorganization financing elusive. "It's much more difficult to get financing for any length of time," AlixPartners managing director Jim Bonsall said. "That's the problem most companies are facing. When companies plan to do a debtor-in-possession, they find the financing is short and it's driven by very specific events for renewal. In the old days—just a year or two ago—banks gave a lot of leeway and there were always companies willing to come in on top of banks. Not so much the case today. We're seeing companies file bankruptcy with no funding. If that happens to an airline, they won't last very long."

Those market realities could lead to liquidations as opposed to reorganizations, AlixPartners said, particularly to carriers with unsustainable business models even after reorganization. Though the firm noted that it does not have U.S. carriers among its current client base, "That could change and probably will change," Bonsall said.

"One boardroom discussion that occurs is: What are you going to do in a bankruptcy and can you make it out? Depending on what that answer is, you may be forced to go into Chapter 7, as opposed to 11," Bonsall said, referring to bankruptcy code chapters for liquidation versus court protected reorganization, respectively.

That possibility would be a lift to airlines—at least the ones who survive—though it would leave consumers with less service options, capacity and higher prices. American Airlines vice president of global sales Frank Morogiello said, "Liquidations would be beneficial. If you took out another 25 percent of available seat miles, that would be sweet. That's a major competitor and another third or fourth guy in volume. Then, with the number of people who are going now, charging more money and maybe even charging the cost of carriage, because we can't cover it right now."