European and US airlines face differing credit outlooks amidst operational and financing headwinds

By Aditi Kamath
Jul 26 - Aug 01 2022
Key takeaways:

Despite the rebound in the demand for global air travel, European and US airlines have axed or delayed thousands of flights as manpower shortage hits the shore. The anticipated recovery in the credit health of European and US airlines[1] on the back of increased demand has been clamped by headwinds such as aircraft delivery disruptions, rising jet fuel prices, and wider inflation-driven monetary tightening, potentially increasing operational and financing costs for the industry going forward. The NUS-CRI Aggregate (median) 1-year Probability of Default (Agg PD) shows diverging credit profiles between US and European airlines highlighting the greater degree of credit deterioration faced by the former, possibly attributable to a larger debt burden in the medium term compared to their European counterparts, as well as due to the benefits of widespread cost hedging practices implemented by the European airlines to insulate their margins against fuel price shocks. With the US airline industry navigating these headwinds in an environment where the cost of borrowing and aggregate leverage levels are larger than that faced by European airlines, the NUS-CRI Agg (median) Forward 1-year PD (Forward PD[2]) suggests a worse deterioration in its credit risk outlook.

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Figure 1 (LHS): NUS-CRI Agg (median) 1-year PD for US and European Airlines from Jan-2022 to Jul-2022 with reference to PDiR2.0[3] bounds; Kerosene-Type Jet Fuel Prices: U.S. Gulf Coast (USD/gallon). Figure 1b (RHS): NUS-CRI Agg (median) Forward 1-year PD for US and European Airlines as of Jul-2022 with reference to PDiR2.0 bounds. Source: NUS-CRI, FRED

Both European and US airlines undertook large amounts of debt to finance and sustain operations during the height of the pandemic[4]. However, since 65% of US airlines’ total debt is set to mature sooner[5] than those of European airlines (See Figure 2a), should US airlines wish to tap into the markets for further financing, they are most likely going to be facing a higher refinancing cost[6]. The higher interest expenses could add to their currently strained margins, which are already at -18.2% as of Q1 2022. Furthermore, the Fed has been more aggressive in combating rising inflation using monetary tightening, compared to the ECB which has lagged behind the Fed in hiking rates, leading to higher costs of financing for US airlines as compared to their European counterparts. With US inflation showing no signs of slowing down and the Fed’s commitment to undertake further extensive interest rate hikes, US airlines’ refinancing woes may intensify especially as the 2025 debt pile matures. Similarly, if the ECB were to increase the pace of its rate hikes, even with a marginally lower leverage level, should European airlines wish to refinance, they could face higher borrowing costs.


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Figure 2a (LHS): Debt maturity as a percentage of total debt due by year for European and US airlines. Figure 2b (RHS): Total debt to total capital ratio of US and European airlines Source: Bloomberg, Refinitiv

Jet fuel costs constitute nearly a third of an airliner’s operating cost, therefore many European airlines tend to partially hedge against any expected rise in fuel prices through futures contracts. With jet fuel prices skyrocketing by nearly 90% since the start of this year, the value of these hedges increased by close to EUR 5bn, mitigating a potential deeper worsening in the European airlines’ bottom line, while maintaining a buffer against rising jet fuel costs. On the other hand, most large US carriers, such as American Airlines, Delta Air Lines, and United Airlines, tend to pass on additional costs to consumers to preserve their margins by raising airfares rather than entering into such hedging agreements. Without the complete cost passthrough, the net profit[7] of the US airlines remains weaker than their European counterparts in Q1 2022. Meanwhile, following the inherent cyclicality in travel trends, demand for leisure travel is expected to drop after the summer period, compounding the impact of potentially subdued consumer discretionary spending due to rising inflation levels in both markets moving forward, thus, simultaneously adding further pressure to the US and European airlines industry’s margins and cash flows, as suggested by the initial short-term worsening in credit risk outlook over the next six to twelve months suggested by the Forward PD in Figure 1b.

Severe manpower shortage also dealt a significant blow to the European and US airlines’ revenue-generating abilities as, in effect, thousands of flights had to be rescheduled or canceled, translating to unserved demand hampering the industry’s operating cash flows[8]. As the airline industry reduced its workforce during the operational slump caused by the pandemic, labor supply at its current levels is unable to sustain the sudden recovery in demand. Moreover, global airlines have been competing to secure labor, driving pilot wages up to as much as nearly 20% of US airlines’ operational costs. Companies such as American Airlines have promised up to 17% in wage hikes while some of its subsidiaries are raising temporary contract salaries up to 50%, hurting their bottom line.

Although global air travel has experienced a boost from the pent-up travel demand, the airline industry currently faces a multitude of headwinds arising from labor shortages and aircraft delivery delays which have not allowed the industry to take full advantage of the recovery. Moreover, recessionary pressures arising from surging inflation and rising interest rates have also created a somber global outlook as discretionary spending is expected to slow down, at a time when industry firms face higher costs. Although both European and American airlines face similar macroeconomic headwinds, the former manages to remain healthier as it has been able to partially protect itself from surging fuel prices. Monetary tightening policies employed by the central banks have also played a major role, especially for US airlines which expect a substantial portion of their debt to mature within three years. A possible silver lining could be that in the long term, both European and US airlines may face some improvement in credit health as aircraft deliveries and manpower disruptions resolve along with an easing in fuel prices, partially alleviating the pressure on the industry’s cash flow generating capabilities.

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  1. Europe and US experienced international arrivals increasing by 350% and 112% respectively in the first five months of 2022 compared to the same period in 2021.

  2. ​​The Forward PD estimates the credit risk of a company in a future period, which can be interpreted similarly to a forward interest rate. For example, the 6-month Forward 1-year PD is the probability that the firm defaults during the period from 6 months onwards to 18 months – this is conditional on the firm’s survival in the next 6 months.

  3. The Probability of Default implied Rating version 2.0 (PDiR2.0) provides a more familiar interpretation through mapping the NUS-CRI 1-year PDs to the S&P letter grades. The method targets S&P’s historical credit rating migration experience exhibited by its global corporate rating pool instead of relying solely on the reported default rates.

  4. The airline industry has been burning through substantial amounts of cash over the past two years in order to sustain operations in the absence of revenue-generating opportunities. For example, one of the largest US-domiciled airlines, American Airlines, spent close to USD 27mn/day to maintain operations at the height of the pandemic.

  5. By 2025, US airlines face a massive USD 13.3bn of maturing debts.

  6. Yields on the Bloomberg High-yield and investment grade Airlines total return index have both increased by close to 3 percentage points since the beginning of the year, highlighting the additional premium demanded by investors in face of the incumbent challenges faced by the industry.

  7. Data from Bloomberg

  8. At present, US airlines are operating at a reduced capacity of 84%.

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Published weekly by Credit Research Initiative – NUS | Disclaimer

Contributing Editors: Raghav Mathur, Yao Xuan