The credit quality of airlines have been significantly impacted due to the disruption caused by COVID-19 and quantifying the impact on credit risk has proven to be a key topic of debate amongst market participants. Assessing the second-order effects of the slowdown to stakeholders has proven to be particularly challenging due to the impact not being limited just to the airlines industry, but to the global economy. Different institutions and market experts are sharing their views, with some preoccupied by the impact on tourism and travel industry especially for countries who are highly dependent on this sector. Others are more concerned about the impact on global cooperation and “National self-interest over cooperation”.
According to S&P Global Ratings out of 1742 issuers impacted by COVID 19 and oil prices, 90 where in the Transportation sector with 15 in Asia-Pacific, 26 in Europe, the Middle East and Africa, 13 in Latin America and 36 in North America.
The impact of COVID-19 on airlines credit quality could lead to reassessment of competitive position of an entity including cost management, financial health, a view on future cash flow and any extraordinary support that can help to absorb losses in the near term. Although there are lot of articles focusing on the rated universe, we discuss the implications that it will have on the unrated universe.
The airlines sector is amongst the industries that is expected to see a longer route to achieve prior levels of revenue. This is not only linked to the ongoing social distancing rules and higher operating expenses, but also growth in consumer sentiment to postpone non-essential travel until the vaccine is not only found but is easily accessible. Therefore, it might take couple of years to return to pre – COVID-19 revenues.
What lessons can we learn from the rated universe and what does it tell us about the unrated universe?
There is no ‘one-size fits all’ answer to this question. Our approach to credit quality assessment of unrated entities using S&P Global Market Intelligence Credit Assessment Scorecards would suggest a combination of historical and forecasted data together with expert-judgment consideration would provide you a greater understanding of what the current situation means for your entity. Credit Assessment Scorecards provide the tools needed to identify and manage potential default risks of private, publicly-traded, rated, and unrated companies and government entities, across a multitude of sectors and geographies.
While most airlines are exposed to similar drivers of top-line such as Revenue Per Available Seat Mile (RASM), when it comes to their expenses, the story might be different. Lower levels of operating leverage or the proportion of fixed costs could help airlines manage their expenses by either downsizing or through voluntary leave. Other factors such as the airline management hedging policy or fleet composition also play a key role in determining the financial impact to the company. In March 2020, the world saw a significant drop in oil prices although, not all airlines could benefit from it due to the hedging position that locked their prices for the short to mid-term.
The composition of the fleet can act as an important determinant in the fate of the airline not only because of the size but also with respect to the financing of the aircrafts (company owned verses leased). In the past, various airlines have embarked on the journey to upgrade their fleet and while some would have more flexibility to postpone these programs, others might struggle.
Differences in their strategy regarding the reduction of scheduled flights, or preserving scheduled flights with reduced capacity to maintain slots may become a differentiating factor for airlines.
Lastly, geographical presence will help some airlines recover from the downturn earlier than others will. With travel restrictions slowly lifting around the world and discussions regarding travel corridors, airlines that are servicing the routes that are no longer in lockdown are expected to see a faster recovery in passenger traffic.
In these exceptional times, airlines might rely on local governments to provide extraordinary support in the form of liquidity or refinancing facilities however, as seen globally, some governments have announced they will assist with the pandemic linked furlough and cover a percentage of employee costs. As enticing as those support packages may look like, not all market players should rush to accept them but pose to reflect on what it might mean for them. For a short amount of time, some market players were intrigued by the possibility of a different solution instead of accepting the rescue packages that comes with some caveats. Although extraordinary support from the government was offered to the major airlines and flag carriers due to the role they are expected to play in the recovery of local economies, some smaller airlines wouldn’t be able to benefit from it to the same extent as bigger players.
What are the recovery prospects for airlines bonds and loans?
As the future growth and success of the airlines industry is dependent on the continuation of globalization, the looming recession has many investors and market participants asking themselves what would be the impact of a missed payment, or what would liquidation mean to them. This analysis is particularly important for those market participants who do not hold any credit insurance.
History tell us that that the prospects of recovery will be institution and instrument specific. We have performed back testing exercise on S&P Global Market Intelligence Loss-Given Default (LGD) model and identified key aspects that one should focus on such as economic value, position in debt waterfall and collateral among others. The LGD Model was constructed over 17 years ago with the aim of estimating LGD at the exposure level and produces estimates of LGD which are point-in-time (PIT), reflecting current economic conditions. This feature is designed to reflect the finding that default during an economic downturn is typically accompanied with lower recoveries.
When it comes to the assessment of economic value, it is crucial not only to take a general view on assets and cash to hand but also to consider both book and independent market value of their aircrafts. Alongside the seniority of the instrument, the collateral that is pledged to the instrument or any pari-passu instruments can be a key determinant in assessing the recovery value.
If you would like to learn more about out Loss-Given Default Model please contact us here.
 COVID-19 Heat Map: Post-Crisis Credit Recovery Could Take To 2022 And Beyond For Some Sectors.
Date: June 24, 2020