On 27 March, the US Congress passed the Coronavirus Aid, Relief and Economic Stimulus (CARES) Act, which includes two overarching support programmes for US airlines to help alleviate short-term liquidity pressures. Moody’s Investors Service has published a report exploring these programmes and what impact they could have on the airline industry in the US.
The first option is a programme to protect employment, specifically payroll protection grants; while the second is a loan and/or loan guaranty programme. Each programme is capped at US$25bn, for a potential total value of US$50bn billion. The Act also provides excise tax, income tax and payroll tax relief.
With the sharp decline in service (and hence jet fuel costs) because of the coronavirus, the report says that labour expense and payments on aircraft mortgages and leases will likely be airlines’ largest cash uses in the second and third quarters. This assumes there are no involuntary furloughs of employees, particularly now that employment and payroll will be covered by the Act’s payroll protection grants for those airlines that choose to participate. Any airline that does not participate in the program will have the ability to involuntarily furlough employees.
Moody’s says that the payroll protection component will provide a much-needed speedy relief valve that will alleviate pressure on airlines’ near-term liquidity for those that choose to participate. Cash used for payroll will vary proportionally with the size of each of the seven US airlines that Moody’s rates. Payroll protection grants will be available to cover compensation through 30 September 2020. The amount available to each company will be based on their proportion of total labour expense (payroll and benefits) across all US airlines as reported to the government for the second and third quarters of 2019, if the aggregate amount exceeds US$25bn. The report notes that share repurchases and dividends will be prohibited through September 2021 for any company that takes this aid. The US Treasury department may seek compensation it deems appropriate in exchange for granting the aid, the exact form of which remains unknown but could include equity or debt interests of the participating airlines.
The sheer magnitude of capacity cuts impacting the second quarter of 2020 represents a previously unimaginable level of service reductions. The report says that the three US global carriers will reduce second-quarter domestic and international capacity by about 70% and 90%, respectively; while the other US carriers will likely cut between 50% and 70% of their second-quarter service. Carriers around the world are also cutting service at similar or even higher levels into June 2020.
While the report is not projecting the pace of recovery of passenger demand, Moody’s believes demand will return through the second half of 2020, with further gains continuing through 2021. The ratings firm expects capacity and demand for domestic and nearby international travel will outpace growth for long-haul international travel because countries are likely to maintain service restrictions well beyond 30 June to reduce the risk of imported infections. This risk may extend the period of liquidity pressure on the US airlines, particularly for the big three, to well into the second half of 2020. Alternatively, slower capacity growth as airlines restore their services relative to a stronger recovery in demand could provide fare pricing power in the early stages of the recovery phase.
The combination of current liquidity, prospective additional financing arrangements and federal grants/loans under the CARES Act affords a clearer path for US airlines to manage through the current unprecedented operating environment. Utilisation of the loan programme seems less likely than payroll grants, and may not be necessary following recent and potential liquidity raises.
Grant money will materially extend each company’s liquidity timeline
The federal grant money will be the most significant relief valve for alleviating pressure on the airlines’ liquidity, for each airline that chooses to accept it. The contribution of monthly labour expense to total cash use will determine the extent of the benefit for each airline.
Before any federal aid, the current cash and revolvers of the big three airlines - American Airlines Group (Ba3 review for downgrade), Delta Air Lines (Baa3 review for downgrade) and United Airlines Holdings (Ba2 review for downgrade) - provide an estimated four to five months of liquidity runway, and a few months longer for the other rated airlines. This is before additional debt is raised and other self-help activities.
Whatever the monthly cash burn rate of each airline, the grant money can materially extend Moody’s estimates of each company’s liquidity runway. Delta Air Lines CEO, Ed Bastian, said in a 20 March letter to employees that the airline was burning cash at a rate of about US$50m per day. Moody’s anticipate that the cash use at its direct peers, American Airlines and United Airlines, will be higher because of higher annual interest expense. For example, interest expense on a reported basis in 2019 for the three companies was US$301m for Delta, US$731m for United and US$1.1bn for American. The extent of the big three US airlines’ use of third-party financing for aircraft will also be key to informing differences in actual daily cash use.
Labour costs represent significant portion of monthly cash burn
The payroll protection is intended to cover six months pay through to 30 September 2020. Moody’s estimates that payroll expense for second-quarter 2020 will represent 50%-65% of monthly cash use, based on pre-coronavirus employment. The number of voluntary furloughs will affect payroll payments in upcoming months. Additionally, cash burn in the third quarter will significantly change if passenger demand and capacity increase as expected.
Additional measures will also help reduce cash burn through at least the third quarter
The Moody’s report says that the Act also provides relief from aviation excise taxes, including domestic ticket tax, segment tax, international arrival and departure tax, tax on award mile purchases, and tax on cargo, and also suspends commercial jet fuel taxes. There is also relief for corporate taxes for the airlines.
The report notes that utilisation of the loan programme seems less likely than the payroll grants. The same factors - duration of the virus, impact on demand and the pace of demand recovery - will determine to what extent and in what magnitude an airline would use the CARES Act loan programme. Moody’s understands that the loans would be available only for airlines that have exhausted other sources of reasonably available debt capital and would require security, as well as “appropriate compensation,” likely in the form of additional equity interests in the borrower. According to the loan programme procedures published along with the payroll protection grant procedures on 30 March, the Treasury Department would directly loan money to a participant and it would receive either equity interests in the borrower or a senior debt instrument of the borrower.
Like the payroll grant provisions, participation in this part of the Act would also prohibit returns to shareholders during the twelve months following the repayment of a loan, the maturities of which are capped at five years. The Treasury secretary will set the terms of individual loans, including interest rates. In addition to the embedded restrictiveness of shareholder return policies, the report says that the potential for uneconomic, above-market interest rates would also likely keep airlines from seeking loans under the programme; rather, Moody’s believes that airlines in need of incremental financing would likely choose to utilise underlying collateral for self-help fund-raising activities instead. Any airline that takes a loan or benefits from a guarantee will be required to maintain employment at certain levels, and there are also a number of provisions including maintaining minimum air service levels at remote airports, which could be impactful to decision-making regarding participation in the loan programme.
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