Presumably everyone is tired of hearing about COVID-19. However, there is no doubt that its all-encompassing impact on the world’s economic activity has adversely affected most industries, including transportation, and has ultimately affected companies’ balance sheets. IATA reported that in April 2020, global aviation demand was down by 94.3 percent compared to April 2019. By the end of May, however, daily flights had risen by 30 percent globally, showing the aviation industry is attempting to restore some version of normality. However, as airlines are operating far from capacity, they are losing millions of dollars a week. Meanwhile, shipping companies are facing their own set of issues, such as the safety and repatriation of their crew, as well as supply chain disruptions. With high costs and lower demand, the industry is facing a lack of liquidity and mounting debt. Due to the sheer scale of the crisis, across the transportation industry prospective and protective measures can be taken in order to preserve some of that all-important liquidity to enable some of the hardest hit transportation operators to stay afloat.
Repayment of debt
Companies are not earning the same levels of income they are used to, due to the sharp decline in trade and passenger demand. Even the 2008 financial crisis did not have such a drastic impact on revenue generation for transportation owners and operators. Their business models are based on a projected amount of income. When income streams dry up, companies find themselves struggling to meet their debt commitments. Some lessors may permit “rent holidays”, allowing lease or charter payments to be deferred. It is pragmatic for lessors to allow for this holistic approach and be flexible on repayments to prevent their lessees from going insolvent.
There is a fragile balance in this current climate if a lender is to choose to enforce its debt – there is a perpetual risk that the lessee may go insolvent and your asset will be returned.
However, due to the nosedive in demand and ever-increasing production of new transportation assets, it will make it hard, if not nearly impossible, to lease the asset under current lease terms. With charter and lease rates rapidly dropping, it can be more profitable long term to defer rental payments. There are certain market players that want new debt to be issued, as they are seeking to take advantage of the market opportunities (particularly record-low interest rates).
In the shipping industry, the rates in the second-hand market for bulkers are causing owners to sell their vessels, while the reduced price of assets is a strong incentive for buyers. However, buyers who do not have cash stockpiles may have to fight for funding – some banks may be more reluctant to lend as they are spread thinly for cash and may push funding into the next quarter or even next financial year.
Companies that are contractually obligated to, are still taking delivery of aircraft and vessels that were ordered before the crisis. Liquidity is going out the door, in addition to the daily operating costs that are not being offset by income, due to the decline in demand. Some of the larger companies (which have adequate bargaining power to do so) are deferring and spreading costs over time to maintain liquidity. Delta paid $62 million to terminate an aircraft purchase agreement with LATAM, under which they were to purchase four A350s. Even though Delta is effectively paying for “nothing”, it helps the airline avoid paying the full purchase price and the costs associated with reconfiguring the aircraft. Long term, it will assist the airline’s liquidity as the aircraft are not needed at the moment, and will be an additional expense until passenger traffic recovers to 2019 levels, which (according to industry chatter) may only be in 2023-2024.
Capital market transactions are an alternative way in which companies can increase their liquidity during the current crisis. Issuing new shares, share buybacks, capital reductions and reducing dividends are options only well suited for large companies.
There was strong demand for Boeing’s $25 billion bond offering in May. However, United had to scrap its proposed $2.25 billion private bond offering because investors wanted higher returns as opposed to the proposed 9 percent yield secured against older aircraft that are prone to devaluation.
An industry first was Norwegian’s $1.2 billion debt for equity swap in which lessors gained a stake in the airline. Lessors now have a 53.1 percent stake in the airline, bondholders have a 41.7 percent stake and existing shareholders only hold a 5.2 percent stake. $730 million of debt was converted into equity by lessors to avoid the return of leased aircraft. This strategy represents a truly bold move to preserve the business as a going concern, but it is yet to be seen if it will pay off by preventing punitive bankruptcy measures.
Airlines have become creative in raising liquidity, including by selling frequent flyer and loyalty programs. JetBlue was one of the first airlines to do so when it sold $150 million of loyalty points to Barclays.
Restructuring tends to have negative connotations; nevertheless, it functions to restructure or repurpose debt obligations to assist companies to survive an economic downturn. Many companies, including airlines, have adopted cost-cutting measures, such as laying off staff, in efforts to save money as there is a highly reduced need for staff when aircraft are grounded.
In more extreme measures, airlines have filed for bankruptcy. In May, LATAM filed for Chapter 11 bankruptcy protection in the United States, which will enable the airline to reorganize and restructure its debt obligations to ensure its sustainability. This follows Avianca, the flag-carrier of Colombia, which filed for Chapter 11 to allow it to reorganize and give it more time to pay its debts. Additionally, Virgin Australia entered into voluntary administration at the end of April so that it could recapitalize its business. The fates of these airlines have yet to be determined as filing for bankruptcy does not mean that they will cease to exist. All of the major airlines in the United States filed for bankruptcy proceedings at some point in the 2000s, and yet they emerged stronger than before. Reducing creditor exposure, reducing the number of outstanding debt claims and allowing for “free and clear” asset sales (basically selling off assets clear of encumbrances or liens in favor of third party lenders) are all strong arguments in favor of cash-strapped businesses going through Chapter 11 (or similar procedures).
It is tempting for lessors and financiers to sue lessees for non-payment of rent and other costs under financial lease arrangements. In the current crisis, extending goodwill and negotiating a repayment plan can be more beneficial than litigation. Litigation is costly – not only in monetary terms but also in management time. If payment is demanded but the company fundamentally lacks liquidity, this may push the company into insolvency, leading to a no-win situation. Financiers need operators in order for their business to succeed.
If, during this difficult time, goodwill is not extended, it can harm a lender’s relationship with its counterparty. As many lessors and owners are deferring payments, those who are not may lose their customers to more agreeable financiers in the market. Besides impacting a lender’s ability to retain clients, not extending goodwill can prevent the attainment of new ones.
New streams of revenue
The market challenges posed by COVID-19 have, in a paradigm-shifting way, tested companies to become more creative and resourceful, generating new revenue streams. It is estimated that the shipping industry is utilizing 75 VLCCs, 47 Suezmaxes, and 36 Aframaxes on short-term time charters with floating storage options to store oil. Cargo carriers are still operating to supply the world with goods; however, crew and inspection issues, along with port docking restrictions, have hindered the flow of international trade somewhat.
Airlines and other operators are also getting creative with the assets they possess as travel demand has waned. They have resorted to converting their passenger aircraft to be able to transport cargo and generate this new revenue stream to offset the drop in passenger air traffic. British Airways, American Airlines, Lufthansa, Icelandair, Finnair and other airlines have enabled their aircraft to transport much-needed medical supplies and other goods.
The transportation industry in particular is facing unprecedented times in which maintaining liquidity is more important than ever. As this crisis is impacting a plethora of businesses and financial markets, it is crucial that lenders are willing to lend and to extend goodwill in order to assist the survival of market participants. Although there are a number of ways companies are looking to raise financing, by issuance of new debt and raising equity, it is clear that counterparties must work together to ensure the collective survival and resilience of participants in the shipping and aviation industries.