Subcommittee On AviationEssay Preview: Subcommittee On AviationReport this essaySubcommittee on AviationHearing onFinancial Condition Of The Airline IndustryTABLE OF CONTENTS(Click on Section)PURPOSEBACKGROUNDWITNESSESPURPOSEThe Aviation Subcommittee will hold a hearing to receive testimony on the financial condition of the U.S. airline industry one year after the September 11, 2001 terrorist attacks.
BACKGROUNDAfter the terrorist attacks of September 11, 2001, there was serious concern that, without significant U.S. government financial support, many U.S. airlines would go bankrupt. In response to this concern, Congress enacted the “Air Transportation Safety and System Stabilization Act” (P.L. 107-42), which was signed into law on September 22, 2001. The Stabilization Act provided a total of $5 billion in compensation to air carriers for direct losses incurred as a result of Federal ground stop orders and for incremental losses incurred between September 11, 2001 and December 31, 2001, as a direct result of the terrorist attacks. In addition, the Stabilization Act provided for up to $10 billion in airline loan guarantees.
STATUS OF IMPLEMENTATION OF STABILIZATION ACTDirect CompensationAs of September 18, 2002, $4.55 billion of the $5 billion in direct compensation provided by the Stabilization Act had been paid to a total of 396 passenger and cargo air carriers. The bulk of these funds were distributed in 2001, including $2.3 billion that was distributed very quickly — by October 1, 2001.
The Department of Transportation (DOT) initially used procedures set out in Program Guidance Letters to make a first round of payments amounting to nearly 50 percent of the $5 billion total. On October 29, 2001, DOT issued a final rule providing procedures for air carriers to use in applying for additional compensation. Under the October 29th rule, DOT issued a second round of payments that was intended to distribute about 85 percent of $5 billion total. Three subsequent rules were issued, in January, April, and August of 2002, to address comments received on the prior regulations. Applications for a third round of payments were due to DOT no later than July 29, 2002, and DOT is now in the process of issuing the third, and final, round of payments.
In general, payments that have not yet been made at this point fall into two categories: (1) contested claims, and (2) the $35 million set-aside for small carriers, such as air taxis, air tour operators, and air medical operators. Regarding the contested claims, DOT is working to settle contested claims as quickly as possible, but some will likely result in litigation. Regarding the $35 million set-aside, this category of funds cannot be distributed until all claims in that category are settled. About half of these claims are settled to date, and DOT estimates that it will be able to settle the other half and distribute the $35 million set-aside in about one month.
Since the $5 billion in compensation is subject to taxation, the Air Transport Association (ATA) estimates that the air carriers will receive a net benefit of about $4 billion after taxes, assuming a marginal tax rate of 20 percent.1
Loan GuaranteesSixteen air carriers applied for a Federal loan guarantee under the program established by the Stabilization Act. To date, only one — America West — has been finally approved, and one other — USAirways — has been conditionally approved. Four applications have been denied (Vanguard, Frontier Flying Service, Spirit Airlines, and National Airlines). Ten applications are pending — the largest of which is United Airlines request for a $2.0 billion loan, of which $1.8 billion would be guaranteed by the Federal government.
The America West loan is a $429 million unsecured loan, of which $380 million is guaranteed by the Federal government. This loan is not secured by tangible assets. However, as part of the loan agreement, the Air Transportation Stabilization Board (ATSB) received stock purchase warrants that will enable it to buy a certain amount of America West stock at a certain “strike price” in the future. No voting rights are attached to these warrants.
For USAirways, the ATSB has conditionally approved a $1 billion loan, of which $900 million would be guaranteed by the Federal government. In contrast to the America West loan, the USAirways loan will be secured by a variety of assets. To receive final approval of this loan guarantee, USAirways must conclude legally binding agreements, satisfactory to the ATSB, regarding the cost-savings and the initiatives described in USAirways business plan. In addition, the ATSB must receive additional stock purchase warrants in an amount and at a “strike price” acceptable to the Board. Finally, certain issues as to collateral (including slots and gates) must be resolved to the ATSBs satisfaction. The loan guarantee would be available to USAirways if and when it emerges from bankruptcy.
IMPACT OF 9/11 ATTACKS ON AIRLINE INDUSTRYPrior to September 11, 2001, the U.S. commercial airline industry was already in a weakened condition due to a combination of reduced passenger demand and rising labor costs. Business travel in particular had dropped significantly by January, 2001 in response to a rapid slow-down in the U.S. economy. The September 11th attacks were a major shock that further weakened the industry.
At the time the Stabilization Act was enacted, the airline industry estimated that it would lose about $24 billion in liquidity (cash and short-term equivalents on hand) during the period from September 11, 2001 to June 30, 2002. This estimate was based on the experience of the airline industry after the Pan Am 103 bombing and the Persian Gulf War, both of which negatively impacted airline revenues. It also factored in the severity and systemic nature of the September 11th attacks; cash burn rates immediately prior to the attacks, as well as expected fixed costs in the months ahead.2 This $24 billion projected drop in liquidity cannot easily be compared to the net loss figures discussed below. The net loss figures below are for a slightly different time period and conform to Generally Accepted Accounting Practices (GAAP) (accrual-based) accounting requirements — as required by law — rather
2. In summary, the airline industry’s estimated $24 billion decrease in cash and short-term equivalents at November 24, 2001, was likely due to a significant reduction in capital expenditure (including the fuel costs associated with a reduction in airline operating hours and operating expenses). This fall-off occurred mainly because of changes in the airline industry and as the number of employees at the top of the corporate hierarchy increased. Although accounting requirements were revised in the prior years and the GAAP estimates of the airline industry could be impacted by any increase in cash and short-term liquidity, such changes were relatively less noticeable. For example, in the first 12 months of 2001 the airline industry had $22.9 billion in capital expenditures and $15.2 billion in revenue.3 In order to accommodate the increased capital expenditures, the airline industry is required to allocate the approximately $4 billion of capital the airline industry currently consumes in the form of cash and short-term, to all employees. This allocation reflects a reduction in spending that is most pronounced during a period of change and generally has little impact on the level of revenue and operating income. As such, the reduction in airport operating hours during certain periods would be more of an asset. This can be demonstrated by looking at changes in costs of transport, air refueling and land transportation on the airline and terminal. However, an airline cannot reduce its costs and thus would lose any of its revenue by using the less productive services provided at the airport. An airline that loses revenues from the operation costs of passenger and service needs to reduce that service. Therefore, in order to allow the airline (or, rather, the airline’s executives) to use the less productive services provided at airports, or otherwise retain some of the use cost of such services, increasing operating costs of its passengers and service will reduce all of its revenue. This is often called the “cost/benefit ratio.” While all operating costs are in excess of other costs of passengers and service, the cost resulting from some of these costs is offset by more favorable market conditions, such as service expansions in major markets, increasing revenue and improving operating income for the airline and its affiliates. Thus, by eliminating airline operating hours, the loss is typically $3.5 billion or even more. A decrease in operating hours may also be accompanied by a reduction in operating expenses, which in turn will reduce revenue. For example, by reducing the cost burden of land transportation on the terminal, the airline could use it to reduce the cost of passengers on the airfield, reducing expenses on the terminal and providing additional land transportation. Another factor affecting the cost burden of land transportation is its ability to accommodate a large range of passenger and airline operations. Because an airline cannot maintain or expand its existing terminals and service areas if it has to accommodate a large volume of passengers and airlines, the cost burden is typically about 75 percent of operating expenses. The amount of land that is permitted to be provided to allow passenger service is typically $30 billion. Thus, if the loss was to more than 15 percent of operating expenses, the loss would be reduced $40 billion or less. The same approach would apply to airport operating expenses. The cost burden would decrease and so should profitability (if any) of the airline. This is the case as the company is required to allocate a limited portion of its revenue that is in excess of those that would come through its terminal and/or service areas. Consequently, due to airline changes, in order to achieve profitability, the aircraft operating costs will have to be cut and the revenue that those costs will be distributed to and taken advantage of by the airline. The