The Government’s Cram-Down Artists

Tough love for troubled airlines.

According to today’s New York Times, several banks that hold leases on United Airlines planes are lining up a vital $7 billion refinancing of United’s fleet. United had said that it might file for Chapter 11 if it couldn’t make a $375 million payment due Dec. 2 on the planes—and if it couldn’t get provisional government approval of a $1.8 billion loan guarantee by that date.

Should the refinancing pan out, it will mean that a consortium of international banks and the Air Transportation Stabilization Board went toe-to-toe—and the big banks blinked. The apparent willingness of the government to let the nation’s second-largest airline go bust may have finally impelled the banks to strike a deal. After all, when a company files for Chapter 11, leases are essentially canceled.

Combined with the recent labor concessions that parent company UAL managed to extract, this prospective refinancing takes the company a long way toward fundamentally altering its cost and capital structure. And all without wiping out the common stock, much of which is held by employees.

In the wake of Sept. 11, a raftload of legislation swept through Congress quickly with comparatively little debate or discussion about the consequences. Among the new laws was the Air Transportation Safety and System Stabilization Act, passed on Sept. 22, 2001. It created the Stabilization Board, with a mandate to distribute immediately $5 billion in aid to airlines affected by Sept. 11 and then to consider guaranteeing up to $10 billion in loans extended by private lenders to airlines.

Fears that the loan guarantees would amount to a giveaway to an inefficient industry haven’t materialized. Far from it. In fact, the board has behaved more like Harry Zale, the cram-down artist in Tom Wolfe’s A Man in Full, than like Jimmy Stewart’s accommodating George Bailey. The board’s first answer always seems to be no. And as it wields the sharp elbows of a vulture investor, it has extracted potentially valuable concessions for its investors, the American public. What’s more, its rapid posting of minutes, decisions, and correspondence to airlines on its Web site make it a model of transparency.

The board signaled early on that the pool of guarantees was not to be an entitlement. In order to qualify for guarantees, airlines would have to prove their business was directly affected by Sept. 11, that the government guarantee was a last resort, and that the survival of the airline was vital to the overall health of the commercial aviation system.

The first application, submitted by America West Airlines, on Nov. 13, 2001, was sent back for modification three times before the airline closed on a $429 million loan backed by the government last January. The original defect was America West’s failure to offer the government an equity stake in exchange for agreeing to backstop the loan. In the end, the board received warrants representing about 5 percent of America West’s common stock.

Since then, while 14 other airlines—big and small—have filed for loans, only four loans have been conditionally approved, several have been denied, and several are awaiting decisions. 

One other guaranteed loan has been executed. Earlier this week American Trans Air (ATA) closed on a $168 million loan, of which $148.5 million was to be guaranteed. In return, the board received warrants for approximately 11 percent of ATA’s stock. The largest conditional approval granted so far has been to the bankrupt US Airways, which asked Uncle Sam to guarantee $900 million in new debt. And it’s a fair bet the taxpayers will wind up with a significant chunk of US Air’s stock if it emerges from bankruptcy. So, within a few years, if the economy recovers and the commercial airline industry returns to health, the federal government could wind up with a significant portfolio of airline equities.

The board may not have prevented many airlines from filing for bankruptcy. But I don’t think that was its overriding mandate. By guaranteeing loans, the board would effectively stand in the lenders’ shoes. And no lender likes to lend to a listing enterprise, especially one that has debts it can’t pay anyway. Borrowersfind it much easier to line up financingafter they file for Chapter 11. Even so, managers, and many outside lenders, are often willing to go to great lengths to avoid a filing, and not just because it wipes out common stock and calls into question the repayment of debt. Frequently, creditors who assume control of a failed company then install new management.

The airline industry continues to be plagued by very high fixed costs and liabilities. To varying degrees, all the major airlines are struggling to pay their unionized workforces, maintain leases on airport gates and routes, and continue to make lease payments on planes that aren’t being used. (Comparative newbies like JetBlue and Southwest, having learned from the mistakes of their predecessors, started life with far lower cost structures and are thriving by comparison.)

Most of those the board has turned away are small-fry. In May the board rejected the application of Vanguard Airlines for a federal guarantee of a $15 million financing because it didn’t think the small outfit would be able to pay back the loan. Of course, it was relatively easy to say no to Vanguard—a tiny carrier with comparatively small debts and with few friends in high places. That’s why the biggest test for the board will be the ultimate outcome at United Airlines, whose assets, liabilities, and capital needs are significantly larger than any of the companies with which the board has dealt. UAL first asked for a $1.8 billion loan guarantee in June—18 percent of the board’s total guaranteeing capacity and a sum greater than all the guarantees it had conditionally approved to date.

The negotiations are continuing. And UAL may yet have to file for Chapter 11 in order to obtain the federal guarantee. But with its willingness to take a hard line having spurred management, labor, and existing lenders proactively to strike deals, the board seems to be doing exactly what it was set up to do.