Possible US airport restructuring in the wake of Covid-19
Mayer Brown Airports Team
The world has now spent nearly all of 2020 fighting the coronavirus pandemic. This crisis, along with its related stay-at-home orders and travel restrictions, has upended the previously strong travel industry. Air travel in particular has suffered immensely. At the peak of the shutdowns this spring, air passenger travel dropped nearly 100%. While there has been some improvement since then, full recovery is not expected for some time: United CEO Scott Kirby recently suggested that demand for business travel may not fully recover before August 2024.
This dramatic loss of air traffic, and the revenues that come with it, has a massive effect on the airline industry. Less attention has been paid to the impact it has on the financial strength of the U.S. governmental entities that own and operate airports. These entities are typically entirely reliant on terminal concession and parking revenues, airline gate rentals, and landing fees to maintain operations and pay debt service.
If traffic levels continue to reduce these revenues to a trickle, many airports may find themselves in an unsustainable financial position. While the Coronavirus Aid, Relief, and Economic Security Act, enacted by Congress on March 27, 2020, provided $10 billion for aid to airports, the CEO of the American Association of Airport Executives testified to Congress less than two months later that airports need additional federal assistance at least as large as that initial amount. No additional federal aid has since materialized and there is no clear path for it coming any time in the near future. It also is not clear whether the level of additional federal assistance will be sufficient to address the imbalance between projected traffic and consequent revenues and airport operating costs and debt liabilities.
Private corporations facing these situations, including many airlines, have often turned to Chapter 11 reorganization under the Federal Bankruptcy Code to restructure their future debt obligations and emerge from reorganization with a fresh start. A similar option is available for U.S. public entities under Chapter 9 of the Bankruptcy Code, but historically it has been little used. The circumstances now facing U.S. airports could change that.
While a decision to seek protection under Chapter 9 has historically come with significant stigma—no public official wants to be known as the one who presided over a bankrupt government entity—the current environment, with nationwide financial distress and a generally recognized lack of responsibility on the part of any local authority, makes such a filing more politically plausible. Additionally, bondholders for airport debt may be more willing to participate in a reorganization process because of their quite limited remedies in the event of a default. For instance, airport debt bondholders generally have no lien or ability to foreclose on airport properties and no right to take over airport operations or direct the sale or lease of assets. Further, airport authorities generally do not have the right to levy property, sales, or excise taxes that could provide additional streams of revenue to pay debt service.
Before filing under Chapter 9, an airport authority will likely consider alternatives, most likely refunding and restructuring outstanding debt and amending indenture covenants to provide additional financial flexibility. These alternatives, however, may or may not accomplish the desired results: Refunding and restructuring may not be able to achieve the required level of debt service savings, and indenture amendments may require difficult to achieve super-majority or unanimous consent.
Chapter 9 is available to any political subdivision or public agency or instrumentality of a state that has been authorized to file under relevant state law. If an airport authority is a separate agency, that agency itself could file for Chapter 9. If, however, the airport is operated directly by a city or county through an enterprise fund, the fund itself would not file but the city or county could do so with a reorganization plan that is limited to the adjustment of airport debt.
The airport authority must be “insolvent” within the meaning of the Bankruptcy Code to be eligible, meaning it is “unable to pay its debts as they become due.” Courts have interpreted this as a forward-looking test of cash flow, and recent case law has suggested that there is no set future time period that is required as long as the projections are credible.
If an airport authority meets these eligibility factors, a key benefit of Chapter 9 is that the authority will remain in total control of the process. The process is totally voluntary, so other stakeholders cannot force involuntary filings under Chapter 9. In other words, unlike chapter 11, where all “major actions” require court approval, there would be no control over airport operations by the bankruptcy court during Chapter 9 proceedings. Additionally, only the airport authority is allowed to present a plan of adjustment so it can never be forced to do anything to which it objects. For example, a plan of adjustment could also include the privatization of selected airport operations, such as terminals or parking, with proceeds used to reduce outstanding debt, or even the privatization of the entire airport under the FAA’s Airport Investment Partnership Program. But again, none of these quite significant actions can be imposed on the airport authority.
In the event the authority cannot obtain approval from all impaired creditor classes, the court can impose approval of a plan that is “fair and equitable” and “in the best interests of creditors.” This is a more favorable test than Chapter 11’s requirement that each class must get at least as much value as it would in liquidation.
Airport authorities could also consider a “pre-packaged” approach that has become common under Chapter 11, where all the necessary consents to approval—50% in number and two-thirds in principal amount of each impaired class of creditors—is obtained in advance of the filing. This reduces the time of the actual bankruptcy court process to a matter of just weeks, or even days, and again with no disruption of ongoing operations.
Airlines will naturally play a significant consultative role in any Chapter 9 proceeding for an airport authority. Airlines have a huge stake in the financial structure of airports, since it is their terminal rentals and landing fees, along with other expenditures by their passengers, that are the source of funding for operations and debt service. Additionally, airline consent may be necessary to revise or adopt a new use agreement, which would likely be a key element of any credible long range plan for a debtor airport authority.
While Chapter 9 has remained a little-used restructuring option for nearly 90 years, the depth of the crisis facing air travel—with no clear end in sight—may provide an opportunity for public officials to reconsider the benefits that it provides and allow their airports to emerge in a better position for their benefit and for the benefit of debtholders, airlines, and the traveling public.
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How should economic regulators respond to the impact of Covid-19 on airport charges?
Skylark
Among the many trials and tribulations visited on aviation by the Covid-19 pandemic, the question of how airport charges should be set is probably not foremost in public policy terms, but is nonetheless crucial for the viability and financeability of the airport industry, and by implication the sustainability of the airport infrastructure on which the aviation industry relies.
The challenge to regulators
Within the traditional framework in Europe and elsewhere, airports deemed to have significant market power (SMP) are subject to economic regulation, and those without operate within a competitive market. The evidence is that airports without SMP are finding that their airport charges are being squeezed hard by airlines facing a surplus of airport capacity, either through discounts or deferred payments. However, this article mainly concerns airports with SMP, subject to one form of cost related regulation or another.
As has been pointed out by other commentators, the basic arithmetic of cost related regulation is that when traffic slumps, charges must proportionally increase given the relatively fixed cost nature of airports. Where the slump is occurring midway through a regulatory period, the charges increase is delayed until the regulatory reset (and in the meantime the airport takes the hit). Whereas where the slump occurs at the beginning of the regulatory period, the airlines/consumers incur the increase in charges contemporaneously with the decrease in demand, and revenue to the airport is kept relatively steady. This is illustrated in the graph below, assuming a single till approach and making simple assumptions about traffic and other elements.
Return forecasts based on a 10 million passenger airport that incurs a 75% traffic loss in year one of the slump. This is then recovered over the next two years and pre-slump levels are achieved 3-4 years post-slump.
That’s the theory but the general belief is that given the magnitude of the current Covid-19 crisis, the level and distribution of increase in airport charges under regulation is almost inevitably unsustainable and impractical. So what is to be done?
One answer proposed by commentators is to work within the existing framework but nudge it, essentially to recover today’s losses at a future date. One method would be to adjust the profile of the depreciation of the Regulated Asset Base (RAB) to match volumes rather than asset lives. Therefore, the recovery of the RAB could be aligned to a future recovery period. An alternative is to add today’s losses to the RAB and again recover the losses over the longer term. Attractive though these or similar methods may sound in theory, the practicality is that tomorrow’s airlines are unlikely, unwilling, or both, to pay charges resulting from today’s crisis. Reprofiling charges is likely simply to defer the issue and be unlikely to convince, say, lenders to airports to extend credit lines.
A further solution would be for governments to step in as they have for the airline industry. There has been limited support of this approach as airports are generally not seen as deserving candidates.
Making any prediction about a Covid-19 recovery is guesswork at this stage, however Skylark expects that this issue will play out in one of two ways.
1 One is that building block regulation is essentially abandoned or at least suspended in the name of deregulation. The deregulation could be for a limited period of time, dependent on ‘good regulatory behaviour’. Within the UK there are already precedents for this as a policy response in the shape of the Contracts and Commitments regime at Gatwick Airport (in the context of Gatwick’s accepted SMP) and UK Civil Aviation Authority’s (CAA) statement within the previous regulatory period that it would welcome Heathrow Airport’s achieving commercial deals with its airlines, in the context of its regulatory settlement. This would have various benefits. It would make explicit what is already implicit, that regulation does not have an answer to this crisis. Secondly, it would save the not inconsiderable costs of regulation at a time when the industry can ill-afford it. Thirdly, for regulated airports, the promise of deregulation on the basis of good regulatory behaviour, as it did for Gatwick under contracts and commitment, could enhance shareholder value and assist in making airports and airport infrastructure more fundable.
2 The second is that airports bite the bullet (or are forced to bite it by their financiers) and make cost related charges stick, either over the short term or medium, even if the airport charge increases are eye-watering. Clearly, some airport traffic is footloose and will cease flying or take capacity elsewhere, but it is likely that a significant proportion of surviving traffic is highly dependent on its airport origin and destination to be sustainable (that is after all what SMP implies). Such residual traffic will pay higher charges. Furthermore, we expect that following the shake-out of airlines, reduced capacity due to Covid-19, fares will inevitably rise. In that context higher airport charges (and other related costs such as handling) would be a natural corollary and charges need not increase as a percentage of the overall travel cost. In a sense, we would be resetting the world to the 1980’s where on a smaller traffic base, and embryonic commercial revenues, airports had no choice but to recover costs, or fight for limited public sector borrowing, and for many, ticket prices were higher than they are now.
Does the regulator have a role in this?
The regulator will need to balance consumer protection against airport survival, as in a sense, they do at present. However, one intervention could be related to discriminatory pricing, which regulation (for example the EU Charges Directive) takes a dim view of. To have any chance of sticking, charges would need to be tailored to the ability to pay. The least elastic categories would pay the most under a Ramsey pricing type approach, essentially setting a price markup over marginal cost inverse to the price elasticity of demand. A regulator would need to set aside discrimination concerns to support such an approach, again in the interest of airport survival.
Both of these outcomes would probably lead in the short term to the same outcome – higher airport charges for those with SMP. What of those airports without? It is difficult to offer much comfort prior to a sustained traffic recovery, aside from the old adage about “all boats being raised by a rising (pricing) tide”.
The new normal in the airport sector
Our key takeaways from GAD World 2020
After the worst year ever for the aviation industry, what are investors doing to manage the risk and returns and what are the recovery trends across the regions?
Those in the airport sector often face similar challenges. So each year, when the GAD community gets together, the sector's key players always have something to bond over. This year, it's the communal experience of Covid-19.
Although traffic was virtually non-existent in Q2 2020, "the aviation industry remains essential", Juan Angoitia, Senior Managing Director, Ardian, told us optimistically.
Indeed, airports' initial response to the Covid-19 pandemic was foundational for the return of traffic in the summer months. Namely, the focus on the health and safety of staff and passengers signalled to the world that business can continue, and the focus on the balance sheet, cash flow management, and liquidity protection enabled the business to come back.
Since then, there was some partial recovery, but each region's experience will vary. Europe, for example, reached -70% traffic in August and September (YOY). Traffic at Delhi Airport subdued, but Xi'an Xianyang International Airport has seen traffic at 2019 levels, Denitza Weismantel, SVP, Global Investments & Management, Fraport, told us.
"Everyone has a unique experience in terms of recovery", Gerald Ong, Director, Aviation Marketing, MAHB, said, citing differences in government aid and regional health guidelines. Beyond that, Covid-19 infection levels are also key traffic influencers, Holger Linkweiler, Managing Director, AviAlliance, said.
Even though the recovery experience varies, some global trends emerge.
For example, cargo has become an important revenue source, and island destinations have also proven popular, both of which make routes management crucial. In terms of passenger profile, the top reason to travel is to visit friends and family, while leisure and business travel are considered luxury. Short-haul, direct flights also triumph over long-haul flights, while domestic travel becomes key. (However, international travel will continue to be attractive, Weismantel said, but it will take a longer time to recover.)
Unstructured data: The future of forecasting
As the European summer began, traffic and demand rose and fell quickly. Flexibility, therefore, became crucial, but it would have been better if the airport was able to forecast. Current forecasting models take into account GDP, population, tourism, fares, trade, and geopolitics among other factors. But the current data used for forecasting "are not predictive enough", Arvind Chandrasekhar, Associate Partner, Head of the Solution Group Network & Fleet Management, Lufthansa Consulting, said.
There are vast amounts of resources that the airport sector hasn't tapped into yet, for example:
- Covid-19 data, including (but not limited to) infection rates and the outlook for vaccine development;
- Economics & regulations, e.g. local health guidelines and rules;
- Customer behaviour, e.g. online customer sentiment, Google search data;
- Passenger/ cargo profile, for which some trends have already arisen;
- Airline strategies
Some of this data can be used in combination to show tangible results. Search activity, lower Covid-19 infection rates, and easing restrictions at the destination can indicate an increase in demand and inform route prioritisation decisions. Other examples also include, Air Travel Pulse (co-developed by IATA and McKinsey & Company) which analyses indicators for demand recovery to guide commercial and operational decision-making, Jaap Bouwer, Expert, McKinsey & Company, said. In a similar collaboration with the World Travel & Tourism Council, the World Travel Dashboard was created which, with a focus on tourism, tracks online patterns and trends in customer behaviour.
There is a lot of data out there, but is has to be used in a manner that makes sense.
Arvind Chandrasekhar, Associate Partner, Head of the Solution Group Network & Fleet Management, Lufthansa Consulting, warned.
Traffic recovery and investor appetite
I think we are really well-poised to come out of this pandemic
Kim Day, CEO, Denver International Airport
Despite the challenges of the past 9 months, the industry is optimistic. Kim Day, CEO, Denver International Airport, sees a steep rebound in 2021 when a vaccine becomes available. Travel is still attractive, and the pent-up demand will make an impact in traffic numbers, before levelling off.
"Growth is still in our future", Day told us, "we just don't know when we're going to hit it."
Customer concern, however, cannot be underestimated. Much like safety was a key concern post-9/11, health and cleanliness will stay crucial post-Covid-19.
"I think there's a bit of mystery for people who haven't flown yet", Day said. "Our motto is we're ready, when you're ready.
Despite the blow of Covid-19, and despite the disappointing case of St. Louis, the same optimism is present in investor appetite in the US market. With this experience behind, one of the key takeways from Juan Camargo, Managing Director, Omers, is that political support needs to be obtained from the get-go.
"We have a duty here to minimise the backwards steps we make", Shawn Kinder, Senior Advisor, PJ Solomon, noted in order to protect investors' interest in the region.
"When you're investing in US airports, you have to be optimistic", Brent Tasugi, Principal, Infrastructure Equity, AMP Capital, concluded.
The sluggish return of leisure and business travel during the rebound period put domestic travel and cargo at the forefront of airports' aeronautical revenue source. The increased importance of cargo, despite its crucial role in the global supply chain, was unexpected, and many were caught off guard by the demand.
The infrastructure was put to the test, and in some cases it failed.
Ron Factor, President & COO, Airis
Alain Breuer, Director, LUX Hub Management, Cargolux, recounted that in March 2020, when the pandemic hit, 70% of his workforce was unable to work either because they were infected or they needed to stay home to focus on childcare. It goes without saying that as a consequence, operations halted. Cargo relies heavily on human expertise, and because of that, employee wellness programmes will be key in the future.
Any future facility needs to consider pharma for the welfare of the employees.
Silvio Tano, CEO, Total Airport Services
Furthermore, if cargo continues to play a key role in aeronautical revenue, operational optimisation will be needed. "Customers pay a premium for speed", Breuer reminded us, so simple changes like bringing parking to closer proximity to the warehouses can make a huge difference.
Finally, considering that we live in a world of smart technology, existing facilities cannot keep pace. Modernisation and digitalisation of the antiquated concept of warehouses will be necessary to stay operational and competitive.
The future digital airport
Although it seems impossible to bring an inherently physical industry like the airport sector into the virtual world, efforts to digitise have long been in the cards. This year, it seems, those early investments into making airport visits a digital experience paid off.
Bangalore International Airport has been on this digital journey for years with the intention of:
- enhancing customer experience,
- improving operational efficiency, and
- increasing non-aeronautical revenues.
Now that the industry is preparing for a recovery induced by the promise of a vaccine, enhancing customer experience will be essential. At Bangalore, this takes the form of an enhanced digital presence via an improved website and mobile app, where customers will be able to access a digital concierge, enter a loyalty programme, pre-book smart boxes and even food, Satyaki Raghunath, Chief Strategy & Development Officer, Bangalore International Airport, presented.
What we discovered about technology is that it really allows us to have a larger audience.
Kim Day, CEO, Denver International Airport
The sustainable airport model
While operations were grounded, airports - as Carlos Ozores, Principal, ICF, summarised - found "a moment of opportunity to do something that would otherwise be difficult to do": implementing sustainability measures and roll out new initiatives.
JFK, Newark, and LaGuardia Airports can now boast with their own electric bus fleets, and JFK is opening new charging infrastructures to accommodate the increasingly electric Uber and Lyft vehicles. Despite the challenges of the pandemic, "we are still 100% committed", Christine Weydig, Director of Environmental & Energy Programs, The Port Authority of NY&NJ, said.
As a highly visible sector, such initiatives to serve the community are paramount, according to Arturo Garcia-Alonso, Operations Specialist, AVPORTS, especially if the trends of flight-shaming reach the Americas.
From a financial perspective, investor pressure to demonstrate sustainable business practices are already present, Adriana Bejarano Carrillo, Head of Environmental, Health and Safety, Aeris Holding CR, CCR Airports, told us. And although it is difficult to put a price tag on ESG initiatives, the trends overwhelmingly point towards their necessity. Failure to act is synonymous with being short-sighted. Mitigating ESG concerns now, therefore, is an essential part of the airport's business strategy.
