2. Passenger Spend
If airlines are to pass on fuel surcharges to customers, how much can the average customer afford to pay? To try and answer this question we have examined what the average customer in the U.S., the world’s largest single market for air travel, was willing to pay in the pre-pandemic market and compared this to current market conditions.
If we go back to 2019, the top ten U.S. based airlines flew 846 million passengers and generated passenger revenues of $171 billion ⁵. This equates to an average passenger expenditure of $202 in what would have been considered normal conditions and contributed to an average passenger operating margin of 10.9% ⁶.
Fast forward to today and what are the current market conditions?
Let’s assume the following:
- That current passenger numbers match 2021 levels at 571 million ⁷;
- That non-fuel related operating expense per passenger has increased by only a mere 2% since 2019; and
- That the global market share of the top 10 U.S. carriers for passenger flights is a conservative 15%⁸ and hence its share of the $131.8 billion impact of jet fuel price increases on 2022's industry total fuel bill is 15%.
Under these market conditions the required average passenger expenditure to achieve half the operating margin of 2019 would be $230 per passenger. This is an increase of 14% on pre-pandemic spend and comes at a time when inflation in most developed countries is running at over 8%. To put this into context if the U.S. airlines can only achieve the average passenger expenditure of $202, as in 2019, and the larger airlines continue to adopt a no hedging policy then losses in respect of passenger operations could exceed $8.5 billion.
3. Cancellations
All aspects of the aviation industry were decimated by COVID-19 and had to essentially start from scratch when air travel took off again - in a hurry. Airlines and airports have had to comply and enforce ever-changing rules on testing, vaccines and quarantine requirements, find staff to replace those let go during the pandemic, train new staff and manage unprecedented levels of demand. Unfortunately for travellers this has resulted in long lines at airports, lost baggage and cancelled flights.
In the second quarter of 2022 alone, around 64,000 flights have been cancelled across Europe. Under European law, airlines whose flights have been cancelled must give passengers a refund of their fare within seven days ⁹. Should demand plateau, the congestion issues will ease but the processing of refunds will continue to impact cash due to delays in payments caused by the same staffing shortages that contributed to the flight cancellation in the first place!
Across the water, nearly 122,000 flights within, into or out of the U.S. have been cancelled in the first half of 2022 which is around 20% more than the same period in 2019¹⁰ While most U.S. airlines do not offer refunds for cancelled flights, they do rebook at their own cost.
And if things are not difficult enough, the staff that airlines and airports have retained are now feeling overworked, underpaid and unhappy. This has led to pilot strikes at SAS and Lufthansa, cabin crew strikes at Ryanair and the familiar strikes by French air traffic controllers. Ryanair alone had to cancel 420 flights in one day recently due to the French ATC strikes¹¹.
What are the Irish restructuring options available should the sector become financially distressed?
If one or more of the factors outlined above create a demand and supply squeeze, airlines and their lenders may be forced to consider operational or financial restructuring strategies to ensure viability. In this section we explore some of the restructuring options available under the Irish framework.
For airlines and lessors:
Examinership is a restructuring process overseen by the Irish Court for companies that are insolvent but have a reasonable chance of survival as a going concern. The objective of the process is similar to a Chapter 11 in the U.S. and the recently introduced Restructuring Plan in the UK. The principal benefits of examinership are that it is more cost effective than a Chapter 11 process or a UK plan process and the bar to obtain creditor approval is quite low. It is also a recognised process throughout the EU and generally recognised in the U.S. through Chapter 15.
Any company that can demonstrate to the Court that’s it centre of main interests (COMI) is in Ireland can apply for an examiner to be appointed. In some cases, as shown in the recent examinership of Norwegian Air, a non-Irish debtor company that does not have its COMI in Ireland can also have an Examiner appointed if it is related to another company that has its COMI in Ireland, is also in examinership and where the debtor has a “sufficient connection” to Ireland.
Another aspect to consider when it comes to COMI is branch registrations, several well-known U.S., European and Non-EEA airlines hold branch registrations in Ireland and this may well support a case for COMI in Ireland, however this has not yet been tested before the Irish Courts.
A Scheme of Arrangement process is a procedure which provides a structure for a distressed company to agree with its creditors a rearrangement, including compromise, of its debts and obligations. The scheme, if approved by the members and creditors of the company, is sanctioned by the Irish High Court and facilitates the company to continue as a going concern. Recently, Nordic Aviation Capital, with the assistance of the EY Ireland Restructuring team, successfully implemented a Scheme of Arrangement to restructure its $6 billion of debt.
For debt providers
The most effective and often only course of action for a debt provider, in a situation where a borrower is facing financial distress, is to appoint a receiver pursuant to the underlying security. Debt providers may baulk at this option as the prospect of a bank taking control of an aircraft might seem ludicrous, but the receiver will step into the shoes of the lessor and take immediate steps to take control and safeguard the assets. The overall objective of the receiver will be to sell or redeploy the aircraft and return the proceeds to the charge holder.
Appointing a receiver can be very beneficial particularly when the lender has lost faith in the lessor’s ability to properly care for the aircraft or if the lessor is not prioritising the redeployment of the aircraft should it come off lease due to an airline insolvency. Furthermore, if the borrowing entity is a Japanese Operating Lease with Call Option (JOLCO) the lender usually must step in and negotiate directly with the airline in an insolvency situation, this role can instead be passed to a Receiver freeing up the lender’s time and resources.
The EY Ireland Restructuring team has recently acted as receiver over two Boeing 787-9’s as well as JOLCO structures and in all cases has achieved a more than satisfactory outcome for the charge holder.