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Wednesday, December 7, 2011

Finding blame for American Airline’s bankruptcy

DALLAS – Those looking for easy answers to American Airlines’ bankruptcy filing are likely to be disappointed.

“You’re talking about the straw that broke the camel’s back. But which one of the straws?” asked Rich Gritta, a University of Portland management professor who specializes in aircraft finance.

He ticked off some of the reasons. “Fuel prices spiked. OK, that hurts. 9/11 hurt them very much. But then you have mergers of Delta and Northwest, and United and Continental, which hurts because of those airlines’ consolidation and more economic power,” Gritta said.

But perhaps the biggest factor can be found in the financial statements of other airlines. Most of American’s peers have reorganized through bankruptcy in recent years. And all have emerged as leaner, stronger players.

Like an aircraft accident, the failure of AMR and American combined multiple factors that contributed to the final crash. And hints at what it will become through bankruptcy may be found at airlines that have already been there.

After net income of more than $7 billion in 1999-2000, the U.S. airline industry lost $8.3 billion in 2001 and $11.4 billion in 2002. AMR’s losses alone exceeded $5 billion in those two years.

The sudden drop in earnings and cash flow quickly drained AMR’s reserves. By late 2002, it was evident that the company was nearly bankrupt. AMR’s then-chairman and chief executive, Don Carty, said the airline needed to reduce its costs by $4 billion a year.

In early 2003, AMR officials went to its unions and threatened a bankruptcy filing unless the unions agreed to deep cuts. After weeks of talks, the three unions – the Allied Pilots Association, the Association of Professional Flight Attendants and Transport Workers Union – agreed to concessions totaling $1.6 billion a year.

While the deals forced reduced pay and benefits and more productive work rules on the employees, it preserved their pensions and some other benefits, including company-paid health coverage for retirees.

“They did not get cooperation from the unions. They got collaboration,” aviation consultant Michael Boyd said. “Unheard-of. … It was the first time I had ever seen a union and a company really collaborating for the future.”

After skimming along the edge of bankruptcy in the bleakest days of 2003, 2004 and 2005, AMR finally returned to profitability in 2006 and 2007, its first profitable years since 2000. A primary reason was the concessions from its employees.

American, which had one of the higher cost structures before its 2003 restructuring, became one of the lowest among major U.S. airlines by the end of 2003. But not for long.

US Airways Group in September 2002 became the first of the big carriers to file bankruptcy proceedings after the terrorist attacks, emerging in March 2003. US Airways actually made a second trip into bankruptcy court, in 2004, after the first reorganization didn’t go far enough.

In December 2002, United Airlines and parent UAL entered bankruptcy as well.

United, the second-biggest U.S. carrier behind American, initially focused on employee pay as American had done in its 2003 plan, aviation consultant William Swelbar said. But with the help of the bankruptcy court, United’s cost-cutting went much deeper.

“What United was able to do is get a second and third bite at the apple,” Swelbar said.

It got work rules relaxed so employees could be more productive, doing more tasks and working longer shifts.

And perhaps the biggest advantage came with pension costs. United, in bankruptcy, terminated its pension plans.

“United got three bites of the apple. American got one,” Swelbar said.

When Delta Air Lines and Northwest Airlines followed the other carriers into bankruptcy on Sept. 14, 2005, they had United’s experience to call upon, Swelbar said.

“United was really the template for the legacy carrier restructuring,” he said.

Boyd, speaking of what American and its unions had done in 2003, said: “It was a pretty earth-shaking contract they signed in 2003. But since then, everyone else has gone Chapter 11 and really squeezed employees.”

The good will between American’s labor and management soured not long after the 2003 labor pacts.

As the fortunes of American and AMR improved and AMR share prices rose, executives received large bonuses in the form of AMR stock. Employees fumed.

The 2003 restructuring included an executive compensation plan that tied the award of AMR shares to how well AMR stock performed compared with other airlines. As the shares soared, rising from under $2 in March 2003 to just over $40 in January 2007, top executives and other “key employees” were awarded large numbers of AMR shares.

With workers laboring under the big 2003 pay cuts and annual pay raises of only 1.5 percent, rank-and-file employees saw the executives profiting from their sacrifices. And the pot began to boil.

The stock awards and other stock-based compensation continue to anger employees, even as executives have seen fortunes wiped away by the bankruptcy filing and the likelihood that all shares will be wiped out.

Employees are still citing the 2010 proxy that showed Gerard Arpey, chairman and chief executive until last week’s filing, earned $5.9 million in 2010, even though nearly $4.5 million was in stock-based compensation now up in smoke. Of that $5.9 million, he actually received about $765,000 salary and perquisites.

Similarly, Arpey’s successor, AMR President Tom Horton, reportedly earned $3.7 million. But $2.5 million was stock-based. His salary was $618,135.

As the rift between management and labor grew, the cost advantages that rivals had obtained in bankruptcy court started to be felt. Gritta, the Portland professor, said that American watched as everyone else got an advantage.

“The weights have been taken off their legs so they can run faster. (American’s) still got them on,” Gritta said. “Now, you’re sitting there in the race and you realize everybody’s faster than you.”

A spike in fuel prices in 2008 caused airline expenses to rise, and the economic downturn of 2008-09 hurt ticket sales for the airline industry.

American began burning through cash and taking on debt in a spiral that wouldn’t stop.

American’s profits quickly turned to big losses. In 2008-10, the carrier lost more than $4 billion, and it is on target to lose $1.2 billion in 2011.

The company made what turned out to be its final offer to its pilots union on Nov. 14, one that would have slowed the company’s financial bleeding. But Allied Pilots Association leadership rejected it.

The AMR board, after waiting months for management to reach a new money-saving contract, finally got tired of waiting. The board voted last week to file Chapter 11 papers in U.S. bankruptcy court in New York City.

While the timing may have been caused by the stalled contract talks, Boyd, president of the Boyd Group International of Evergreen, Colo., says the final straw may have been fuel costs.

“That’s the only factor that has changed things for American. They made the decision to keep a pension. They made the decision to not renege on their debt,” he said.

“In the context of $40 a barrel oil, that worked. It doesn’t work at $100 a barrel, and none of us at that time ever thought fuel would go to that level,” Boyd said.

Rather than a $1.2 billion loss this year, AMR probably would have earned more than $1.5 billion if it had paid the same price for jet fuel this year as it did in 2009. Boyd said that rise in fuel costs out-weighs all other factors.

“They did have higher costs than the competition, no question about it; but they could still make money,” Boyd said. “When fuel went up, that changed the whole thing. That’s the one big thing.”

In a report last Friday, Standard & Poor’s Ratings Services said the AMR board had concluded that now was as good a time as any, if the airline was going to file.

“Although AMR still had adequate liquidity to meet at least its near-term needs, it likely would have faced cash pressures by late 2012 and had heavy debt maturities next year,” Standard & Poor’s credit analyst Philip Baggaley said.

For clues to what happens next at American, once again look at the airlines that completed the process previously.

Pensions, health coverage and other benefits will be primary targets. American attacked those issues in contract talks with unions prior to the filing, and it will seek deeper cuts afterward.

Top executives Arpey and Horton told Wall Street repeatedly that AMR has an $800 million disadvantage by maintaining pension and retiree health benefits, both of which its competitors have ditched.

So it is logical to assume, bankruptcy experts say, that one of the first targets will be pensions. United, Delta and US Airways all terminated their pilots’ plans in Chapter 11 and turned them over to the Pension Benefit Guaranty Corp., the government-backed insurance program. And carriers like Southwest Airlines and JetBlue Airways never offered pensions.

Whether American seeks to terminate the plans or simply freeze the plans at current levels remains to be seen. But employees should expect that in the future, they’ll be in plans that are less costly to the company, like 401(k) plans, not defined-benefit pension plans.

In addition, American will seek to increase productivity. The contracts it will ask the court to approve will require more hours of flying for both pilots and flight attendants.

“The area where American suffers relative to the industry is in the hours flown and the benefit packages,” Swelbar said. “This accords them the opportunity to address the two largest areas of deficiency. It’s less a wage issue at American. It’s more a productivity and a benefit cost problem.”

Airline analyst Bob McAdoo of Avondale Partners said it’s logical that the filing was mainly to get changes to the labor agreements. “The other things that you need to do can all be done outside of Chapter 11,” he said.

Another big unknown is what will happen to American’s flight operations. The carrier already had been reducing its schedule this fall as it dealt with fuel costs, questionable demand and an abnormally high number of pilot retirements.

Horton said last week any further shrinkage would be “relatively modest.” He also said the airline is committed to its “cornerstone” strategy, in which it focuses on its hubs in Dallas/Fort Worth, Miami and Chicago, plus Los Angeles and New York City.

But when Horton’s team meets up with powerful lawyers for labor and creditor committees, his plans may be changed.

Industry analysts have speculated that American may become somewhat smaller. Jamie Baker, in a report last week, suggested that AMR might reduce its capacity by 10 percent.

Said analyst Gary Chase of Barclays Capital in a report: “We think AMR could benefit from more substantial capacity reductions, but for now expect only minor changes and think the bulk of AMR’s focus will be on restructuring cost.”