Pre COVID-19, air travel was generally regarded as one of the safest modes of travel. The aviation industry saw increased passenger numbers and levels of investment and liquidity year on year. This pernicious virus with a high contagion risk has resulted in the grounding of airline fleets, imposition of travel restrictions, physical distancing and increased, and likely expensive but necessary health and safety practices in airports and on aircraft. To survive this crisis, aviation businesses are working together with investors and financiers to deal with the consequences of the impact on their business models. We look briefly at look at implications for three key participants: (i) airlines, (ii) aircraft lessors, and (iii) financiers.
The airline sector is highly competitive. Passengers are accustomed to no frills, low cost air travel with high occupancy rates with busy airports, lines at security, lines at boarding gates and ramps and limited personal and luggage space on board. Airline economic models are based on operating at high capacity, quick turnaround times and low operating costs. This is a highly regulated industry in areas of operation and safety. The pandemic has affected every airline. Some countries were closed completely for international travel and every country has some level of internal movement restrictions with limited exceptions. If aircraft are not flying, then the airlines have zero revenue. Options available to airlines under stress suffering revenue depletion are stark. Some or all of the following are likely to be considered:
Use existing cash reserves to meet immediate costs including crew and staff and aircraft maintenance.
Seek equity injection from existing shareholders.
Seek government support in the form of loans, grants and equity.
Raise or extend financing from existing relationship banks, with security over unencumbered assets.
Potential for strategic asset or business segment sales.
Potential for strategic sale and lease back transactions for aircraft portfolios.
Defer, reschedule or terminate existing aircraft lease agreements.
Reduce all operating costs including staff and crew costs – furlough and redundancy cost impact.
Explore all available restructuring and insolvency protection afforded under national and/or international laws to buy time to review and device scheme of arrangement
In Ireland, each of Aer Lingus and Ryanair have announced planned reduction in size and job cuts and Stobart Air has been rescued by the Stobart Group UK, with accompanying job losses. CityJet was placed into examinership in mid-April and is close to agreeing a scheme of arrangement with the majority of its creditors, which should see the company survive. From a legal perspective, Ireland is a Cape Town Contracting State and Alternative A insolvency regime applies, but to date we have not seen its application or operation in Ireland.
The current level of commercial aircraft subject to lease is estimated to be in the region of 40% with Ireland commanding a 60% share of the global leasing market. The relationship between airlines and lessors is a typically debtor creditor relationship. In the current crisis, airlines ability to generate revenue has been decimated with lease defaults and/or deferrals. This has a significant knock-on effect to the leasing community in Ireland.
The prudent and cautious aircraft lessors have cash reserves to enable them to ride out the current crisis for a period of time. Many investment grade aircraft lessors were fortunate to successfully tap the capital markets upto end of Q1 2020 in private placement, bond issuance or asset backed securitizations. They may be facing possible short term risk of rating downgrade for corporate entity and tradable securities.
In addition to handling requests for payment holidays, rent reduction, deferrals and extended duration and payment terms, the aircraft lessor may have to consider other remedial models such as payment based on utilisation (power by the hour) in combination with frequent adjustments linked to turnover and airline financial performance.
In January 2020, at the aviation conferences in Dublin, industry commentators were buoyed up on the significant amount of liquidity available to the aviation sector. The question now is where are these investors and whether they enter the market? New investors are attracted to the sector for reasons relating to asset values, asset availability and demand, geographic risk and diversification and source of lease receivables. In Q1 2020 the market was perceived to be running very hot. For now, it appears to have rapidly cooled and investors are biding their time. We anticipate that the aviation corporate sector may see increased level of activity later in 2020 and into 2021. Types of opportunities that may arise include: consolidation of lessors in niche segments; strategic mergers and acquisitions; joint ventures; equity investment in strategic airline lessees and/or portfolio sales and purchases. Ireland has a wealth of experienced legal, tax and other aviation advisers to assist existing and new participants to understand the legal landscape for such opportunities.
Funders and financiers
All banks and lenders in all sectors are dealing with reduction in business activity and some level of political pressure to preserve and sustain business and jobs through the crisis. For now, aviation participants – airlines and aircraft lessors - with established banking relationship built up and maintained over time and based on mutuality of interests are likely to endure. Where relationships come under stress, options to consider in negotiations include, payment moratorium or temporary deferrals, extending loan term and adjusted interest rate; covenant relief, waivers or variation; contractual standstill periods and for lessors agree remarketed arrangements and duration. Legal input may be prudent to ensure full compliance with all applicable laws and protect and insulate lenders from allegations of undue pressure or preferential treatment.
In circumstances of unambiguous persistent default, lenders have to tackle recovery and enforcement action and the current restrictions make it extremely difficult to repossess assets. Even where it is possible, due to voluntary surrender or settlement terms, receivers and other officers can’t remarket aircraft. All participants benefit from timely engagement to obtain advice on restructuring, scheme of arrangements, and local law protections available for creditor or debtor. Early engagement with legal advisers may assist and benefit participants in understanding options and solutions available and not just the worst case scenario.
We are now on the cusp of resumption of regular air travel even though the future remains uncertain. For businesses now experiencing financial challenges, it would be prudent to seek advice to understand options available and to begin planning for the longer term. On the plus side this includes exploring possibilities of potential sale of business or a business unit or assets, mergers, consolidation and being ‘sale ready’. For others in severe financial distress, advice is available to cover needs related to wholesale restructuring of operating business. This will involve board of directors and management team taking advise on all available contractual and legal remedies, protections and consequences.
Aviation is vital to Ireland as a business sector and as part of our core transport infrastructure. This crisis will eventually pass, the industry may be reshaped and altered by it and there will likely be some changes to the actors and participants. We benefit from the strength of community within the aviation industry and the connectivity between airline, leasing and financing businesses and the legal and advisory community.
For more information on the continuing impact of the current pandemic on your organisations operations, contact a member of our Aviation & International Asset Finance team.
The content of this article is provided for information purposes only and does not constitute legal or other advice.