Bailing for Dollars

How the feds saved the airlines and made themselves a mint.

American airlines are bleeding again. US Airways, under fresh assault from Southwest Airlines in its Philadelphia redoubt, saw its debt downgraded this week. United Airlines is struggling to exit bankruptcy. Delta Airlines is feuding with its pilots. All are getting murdered by high fuel prices.

So, now would seem a deeply lousy time to expect to profit from airline investments. But there’s one tough-minded investor that has done pretty well on some recent speculative airline investments: Uncle Sam.

The Air Transportation Stabilization Board, set up in the wake of Sept. 11, distributed $5 billion in aid to carriers and was empowered to guarantee up to $10 billion in loans that would be extended by private lenders. Eager to avoid the appearance of a corporate bailout, the ATSB proved a tough negotiator. So far, the ATSB has denied loans to eight applicants and approved them to only six carriers. The feds have guaranteed $1.56 billion on loans of about $1.73 billion. The ATSB has conditionally approved a seventh loan to Evergreen Airlines for $148.5 million. (Here’s a digest of the results, and here’s the ATSB’s not-quite-up-to-date list of actions taken.)

And when ATSB did agree to guarantee loans, it extracted tough terms from borrowers. As compensation for assuming the risk, it demanded significant numbers of warrants—which, like options, allow the holder to buy a share at a set price during a set period of time. It’s like a mortgage company giving you a loan and demanding a chunk of ownership in the house, too. Because five of the six borrowers are publicly held, and because their stocks have held up surprisingly well, the government is now sitting on a portfolio that could be worth up to $200 million.

The government has hit one home run. America West Airlines, the first borrower, took a $429 million, federally backed loan in January 2002. But, as this report notes, the company paid a steep price: “warrants representing approximately one-third of the Company’s common stock.” ATSB received warrants to buy 18.754 million shares of stock at $3 a share. With America West’s stock at about $10, the government’s warrants today could be worth about $8.54 each, or $160 million. Meanwhile, America West has already repaid a small portion of the loan.

(Note: I used the Black-Scholes method to value the warrants. This method can produce different results depending on minor adjustments in assumptions and minute-by-minute changes in the stock price. The figures I used are based on calculations done Thursday, May 6.)

Frontier Airlines has been solid too. In February 2003, Frontier closed on a $70 million loan supported by a $63 million federal loan guarantee. The ATSB received warrants to purchase 3.45 million shares at $6 per share—about 10 percent of the company. Frontier paid back the entire loan in December 2003, several years ahead of schedule, so taxpayers are off the hook. And with Frontier’s stock at about $9, the warrants—which the government keeps even after the loan is repaid—are worth about $21 million.

In November 2002, American Trans Air closed on a $168 million loan, of which $148.5 million was guaranteed by ATSB. ATSB received warrants on 1.478 million shares at $3.53 per share—about 11 percent of the company. ATA has paid back $14 million of the loan and plans to pay back $7 million each quarter. With the company’s stock at about $7.80, the warrants are worth $9.3 million.

World Airways took a $30 million loan, of which ATSB guaranteed $27 million, in December 2003. ATSB received warrants to buy 2.38 million shares at prices ranging from 78 cents to $2.50—about 9 percent of the company. With the stock at about $3.50, the warrants are worth about $5 million.

So far, ATSB’s only potentially problematic guarantee has been its largest—a March 2003, $900 million guarantee on a $1 billion loan to USAirways. In return, the ATSB got warrants to buy 7.64 million shares of the company at $7.42 a share. So far, the company has repaid $250 million of the loan, meaning the taxpayers still have a $675 million exposure. But the stock has plummeted to about $2, meaning the warrants aren’t worth much: about $5.5 million in all.

(Aloha Airlines, the recipient of a $40.5 million loan guarantee, is privately held.)

The numbers look nice, but it’s too soon to exalt ATSB as a brilliant investor. Taxpayers are still on the hook for about $1.25 billion in loans. The failure of one borrower—especially USAirways—could wipe out the paper profits ATSB has racked up thus far. A few days of poor performance could likewise put a dent in the profits. What’s more, because warrants are essentially long-term bets on a company’s health, they don’t function as a hedge. If an airline fails, its stock will go to zero, rending all warrants worthless, and it won’t repay the loan in full.

Up to this point, the agency has been mum about how it plans to manage its trading positions. The ATSB could cash out at any time by selling the warrants to other investors. It could exercise the warrants and assume the role of a large minority shareholder in one or more airlines—which would surely unsettle carriers that aren’t federally held. Or it could hold on to the warrants—which generally don’t expire till 2009 and after—by buying securities like “puts” that would rise in value if the stocks falter—an unlikely scenario. Officials at two airlines where the options are solidly in the money say ATSB hasn’t yet contacted them about its plans.