These Airlines, Financial Black Holes for Years, Now Face the Pandemic

Dogged by everything from bloated costs to corruption.

By MC01, a frequent commenter on WOLF STREET:

On July 1, Israel’s flag carrier El Al suspended all operations “indefinitely,” including cargo flights, ironically during a week when the Israeli government announced they will be lifting most restrictions on international travel on August 1.

This is not a sudden crisis, and the causes go back a very long way: El Al has long been operating at a loss, plagued by expensive aircraft leases, a bloated workforce, high wages, and poor financial management. For example, El Al lost $52 million in FY2018 and $60 million in FY2019, the “good times.”

Already at the beginning of the crisis, the Israeli government had announced their willingness to support the airline with $250 million to $400 million in bridge loans. But the Ministry of Finance has put several conditions on this rescue package, chief among which is to cut labor costs.

This is a serious problem. Though unions generally don’t wield as much power as in the 1960s and 1970s, they remain powerful in Israel, and as such El Al cannot cut labor costs without approval from all their employees’ unions.

As reminder of the risks associated with not finding some sort of compromise, after El Al announced they were suspending operations, all the 110 pilots still on payroll were immediately put on unpaid leave: either all parties agree to serious negotiations, or this sad situation will become the “new normal.”

As is usual with cash-strapped companies, El Al has been desperately trying to slash expenses and raise cash. Some measures make sense, such as immediately returning five Boeing 737-800s to lessors, while others don’t make sense: El Al has sold three other 737-800 to an unnamed “foreign leasing company” (widely suspected as being BOC Aviation) and immediately leased them back. While this gave El Al $76 million to burn through, it also removed quality collateral for loans and added a new fixed expense that cannot be skipped without losing the aircraft themselves.

Air France is another company which has long been struggling with a bloated workforce and higher than industry-average personnel costs. And just like it happened with El Al, the present crisis is forcing the French airline group to finally tackle this delicate situation.

The present Air France-KLM CEO, Benjamin Smith (formerly of Air Canada) was given a clear mandate to reduce bloat and allow Air France at least to break even well before the present crisis.

Smith was the main driver behind the decision of shutting down JOON in early 2019, an ill-conceived low-cost subsidiary with a serious image problem, and absorbing the aircraft and crews back into main Air France operations.

Like so many post-2010 airline CEOs, Smith is not enamored with the massive Airbus A380 and was already making plans to get rid of them. The present crisis merely accelerated the process. Air France has never had any real love for the Airbus “doubledecker,” and their order for just five planes was the result of long and strenuous negotiations between the airline and the French government to pad A380 production numbers.

On July 3, Air France announced a massive staff reduction, which will take place from here to 2023. The HOP! subsidiary is slated to lose 1,020 jobs, or about 50% of its workforce.

HOP! is yet another money-losing Air France subsidiary that suffers not only from bloat but also from fierce competition: 2019 saw the arrival in force of low-cost behemoths EasyJet and Ryanair on the internal French market after they “dipped their toes” into it. And at the height of the pandemic, Hungarian-based low-cost powerhouse Wizz (backed by PE firm Indigo Partners) announced their intention to move in force into the Western European market.

HOP! cannot survive, let alone compete against any of these low-cost carriers in its present money-losing form, and drastic measures are needed.

But all these troubles, as serious as they are, pale in comparison to the scandal which engulfed Pakistan International Airlines (PIA). Starting on July 1, EASA, the European aviation regulator, banned PIA from operating in the European air space for six months. This has nothing to do with the present healthcare crisis, but with “mounting concerns about the airline’s ability to operate safely,” following the deadly crash of a PIA Airbus A320 in Karachi on May 22 due to “human error.”

This is all part of an ongoing and rapidly expanding scandal which is engulfing Pakistani commercial aviation and which started in December 2016, when one of its ATR 42 planes crashed near Abbottabad killing all 47 on board. The investigation discovered the pilots’ licenses and type ratings had been issued in a “suspicious” manner.

The investigation proceeded slowly, uncovering a further 17 commercial licenses issued in “suspicious” manner in 2019. Following the May 22 Karachi crash, the Ministry of Aviation admitted to the Parliament of Pakistan that out of 860 commercial pilots active in Pakistan, 262 had “suspicious” or “forged” licenses and type ratings. Of these 262 pilots, 141 work for PIA.

While the Ministry assured all these pilots have been suspended pending an investigation into their licenses, this has raised alarming concerns about the safety of the Pakistani aviation sector which are unlikely to be solved in six months.

Allegations of bribery, corruption and nepotism at Pakistan’s Civil Aviation Authority (CAA) have long been common, and this scandal confirms the worst suspicions.

PIA itself is another “financial black hole” in the mold of Alitalia and South African Airlines. Safe in the assumption it will be bailed out no matter what, it has operated at a loss every fiscal year from 2005 on, including a $191 million loss in FY2019. Revenues peaked in FY2011 at $695 million and have since declined to $563 million in FY2019.

The company is well known for costly shenanigans such as flying aircraft without a single passenger or parcel on board and is being crushed by competition from far better organized airlines such as Emirates and Qatar Airways. This scandal is exactly the last thing PIA needs. By MC01, a frequent commenter on WOLF STREET

It’s all about money, but whose money? Read… Alitalia, Lufthansa, Condor, Norwegian, Other European Airlines Try to Survive, But it Gets Complicated

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  58 comments for “These Airlines, Financial Black Holes for Years, Now Face the Pandemic

  1. MonkeyBusiness says:

    Speaking of Israel, their second wave is probably one of the worst in world. It’s so bad, it led to a huge demonstration.

    Speaking of politics, one thing that Covid has done is prevent a war between Israel and Iran, at least this year.

    Who says there’s no upside to this Covid business?

  2. 2banana says:

    “How do you make a small fortune in general aviation?”

    “Start with a big one.”

    I don’t agree with Buffet on much. But he used to, forever, avoid airlines like the plague.

    Then, relatively recently, invested bigly, got burned, and got out.

    • MCH says:

      Buffet also used to not believe in tech. The biggest holding in $ terms for BRK/A right now is AAPL. The world has changed.

      But I wonder if Buffet will be dumping some of his position, because that’s an outsized stake he is holding right now. So, hopefully he has put options into play here to guard against a drop in the tech. Otherwise. Can we say ouch.

      • Eastwind says:

        Buffet has always been the optimistic investor, always talking up how much he loves this business or that CEO (and I think he’s frequently a sucker for a happy talking female CEO). Munger was always the pessimist that kept him out of trouble. It was Munger’s job to stage an intervention when Buffet started to talk about buying airlines again. But Munger is 95 now and I think the airline investment was clear proof he’s no longer got the energy necessary to argue Buffet out of his bad ideas.

        As for Apple, that’s another case where Buffet is breaking his own ‘rules’. Buffet really has suffered a lot of style drift in the last ten years, but at least with Apple he’s got the Fed put behind him.

        Now if Buffet buys any Tesla, we’ll have proof he’s become senile.

      • Pete in Toronto says:

        Some investors and analysts regard Apple not as a tech company, but a consumer-products company.

  3. 2banana says:

    So, not hiring the best and brightest with rigorous testing has consequences?

    Who knew?

    “The investigation discovered the pilots’ licenses and type ratings had been issued in a “suspicious” manner.”

  4. Jdog says:

    It would be interesting to know just how many planes worldwide have been taken out of service that there are outstanding loans on … My guess would be most of them… That is a lot of dead money.

    • Cas127 says:

      JDOG,

      Actually, individual per plane debt claim stats would be a fantastic metric to have…and given the tremendous tracking capability of the internet age, I wonder if such a database does not already exist somewhere.

      I’m sure there are plenty of “pooled asset” type debt claims which muddle the “per individual plane” stats…but still, approximations could be made.

      Commercial airliners are actually excellent collateral (highly detailed use/maintenance records mandated by law, easily mobile to areas of demand, high use in non-pandemic times, etc) and it would be very interesting to see the existing levels of debt applied to individual aircraft/individual classes, vintages of aircraft.

      • Jdog says:

        I was reading that the mothballed planes still require quite a lot of labor intensive work even if they are not being used. They still have to be inspected, and have battery systems maintained, engines started, etc. They say it takes over 100hrs of labor to put the plane into storage, 24 hrs in weekly maintenance, and 200 hrs to get them back into service. add to that the cost of storage space, and you can imagine the last thing lenders want to do is have to take on these expenses.

        • Cas127 says:

          There are obviously collateral repo costs, but if a lender only advanced 70% of the market value of an aircraft (and maintained or more likely reduced that exposure as the loan paid down) then repo’ing the aircraft actually can potentially be a huge windfall for a lender (ie, get a $100 million dollar aircraft/any collateral in exchange for a $70 million loan that “went bad”).

          That is the underlying logic of any secured loan…the lender only advances a safe fraction of the asset/collateral purchase price…and if anything goes wrong, the borrower/operator is in the “first loss” position – any shortfall in collateral value decline is entirely marked against the borrower’s “equity” before the lender is out a single dollar.

          Actually going full repo does incur a lot of costs as you point out (that is why “extend and pretend” is so common on delinquent loans…but at the end of the day, the lenders’ have drafted the initial loan agreements in such a way as they are heavily protected.

          Aircraft finance is a specialized corner of the lending market with many of its own unique aspects, but I would be very surprised if many of the basic, standard lender protections (limited loan-to-value, borrower in first loss position, etc) don’t ultimately apply there as well…perhaps under different names, etc.

        • Cas127 says:

          Wolf,

          I vaguely (perhaps incorrectly) recall that you were in/started out in auto sales/finance.

          If so, I think you could make a great post out of the semi-obscure lender protection tools/dynamics I briefly mention above (limited loan to value, borrower in first loss position, etc).

          I think it is the rare civilian who has any real appreciation for the multiple legal/contractual tools that experienced lenders employ to defend themselves against borrower defaults.

          And with an almost inevitable tsunami of defaults to come…understanding those tricks of the trade might be really worthwhile.

          I am sure there are multiple ones that I am unaware of…

        • roddy6667 says:

          Quite a few airlines outside the US are using passenger planes to haul cargo. It loses less money than parking them. I saw an article with special cardboard boxes full of smaller cargo that fit in the individual passenger seats. This was in addition to the usual stuff in the belly.

  5. MonkeyBusiness says:

    Oh come on guys, second hand planes should be cheap.

    We all should do our part in the auction market ;)

    “What am I bid for this very fine 747?”

    Answer is zero, since most of us don’t have a place to park the darn thing.

  6. Harrold says:

    To be fair, El Al is not allowed to operate on Shabbat and not allowed to fly thru the airspace of many countries.

    This puts them at a distinct disadvantage compared with secular airlines.

    • MC01 says:

      Mahan Air of Iran is in a worse position since the Israeli and US governments pressured (bullied?) many foreign governments into banning it from their air space due to “suspected ties with the IRGC”. Yet it’s profitable.

      I know this is not really the place for this but one shouldn’t be surprised many governments are taking the epiemic as an occasion to thumb their noses at the US and Israeli governments.
      For example in April Mahan Air carried out daily direct flights from Teheran to Las Piedras (Venezuela) to support the Iranian efforts to patch up rapidly decaying PDVSA infrastructures. The flights passed through Greek, Italian and Spanish air spaces, all countries Mike Pompeo pressured into banning Mahan Air back in November 2019. Nobody made any attempt to divert nor to stop these flights.

    • Volvo P-1800 says:

      El Al = Every Landing, Always Late

    • doug says:

      to be fair, they knew the job was dangerous when they took it.

  7. Upstate says:

    Might be time to put all those 737 Max’s up on blocks and get some blue tarps.

    • California Bob says:

      “Might be time to put all those 737 Max’s up on blocks and get some blue tarps.”

      Most cities have ordnances against these in your driveway.

  8. Michael Droy says:

    Lufthansa – EUR 20bn of planes and spare parts.
    How much of that are they going to write down in this market (yeah yeah none of it we know).
    But from an objective pov they just loast about EUR 8bn on the planes – more if they try and sell them this year.

    • char says:

      They lost more on landing rights is my guess

    • MC01 says:

      Lufthansa will not try and sell any aircraft, at least this year.

      The whole Lufthansa Group, after consultations with the home governments, has announced by October 24 they will be serving 90% of short and medium distance routes and 70% of long distance routes. While I do not share their optimism about the latter, this means about 60% of the pre-crisis fleet (Lufthansa Cargo excluded) will be active by them, more if frequency to medium distance destinations such as Algiers and Cairo is increased.
      So far Lufthansa has sent into long term storage in Teruel only high hours airframes, chiefly those that were previously parked in Munich, but the four A330 emergency cargo conversions will likely join them soon because there’s no more work for them to do and the market is saturated with cargo capacity anyway.

      Personally I think most Lufthansa A380 will join Air France’s at Tarbes to be scrapped: the German airline has always struggled to fill them to capacity and the only consistently profitable A380 route (Frankfurt-Las Vegas) won’t be back for a very long time.
      I have no idea what book value Lufthansa attributed to their A380, but right now that aircraft is even more of a leper than it was one year ago so it may be a good idea for a one time writedown.
      The A340… pretty much the same thing, albeit Lufthansa had already planned to replace them with A350.
      Finally there are the 747. The -8 are safe as they are used to fly money-making routes, chiefly to South America, where the extra cargo capacity is put to good use, but the -400 are most likely toast. Again, a big writedown is mandatory because those airframes are too high hours to be sold for cargo conversions, unless somebody wants to lose his shirt on it like Asiana is doing.

      • char says:

        Yesterday, on Dutch news there was an item about Lufthansa sending some of their 747 to a disused Dutch airport. Don’t know if they were -4 or -8.

        About their intercontinental lines. The America’s are were Spain and Italy was in March. If you look at how much flying has been restored to what it used to be than i doubt that the American flights will be restored.
        Lufthansa also speaks of restored destinations and not flights. If you go from 3 flights per day to ones a week you have restored the destination but you are obvious flying a lot less

  9. MCH says:

    MC01;

    Very interesting stuff, some of which I knew about. But holy smoke, the info on PIA is eye opening, not going to be flying your friendly Pakistani Airlines any time soon. And El Al suspending operations, that’s gonna make some kind of headline in the Jerusalem Post.

    I made the a decision on Hainan more than a year ago because, as finances start to go, so does critical stuff like maintenance. It’s a miracle that they were shut down before something more serious happened.

    C19 appears to be a much needed black swan for the aviation industry, most of it suffering from bloat. I figure on more consolidation in the years ahead. Somehow, I doubt we’ll like the outcome. I can see O’leary doing a happy dance as his continental rivals start to keel over.

    • Apple says:

      Interesting, a 20-year-old named Eli Rosenberg, who currently lives in Jerusalem, is negotiating to take a controlling stake in EL AL.

    • char says:

      O’leary is 737. Easy and Wizz A320. My guess is that Ryanair has problems, especially with Brexit and the XLR. And do realize that nobody likes Ryanair

      • MCH says:

        You mean there are people that like Easyjet and Wizz air?

        And O’Leary is looking at the cattle and not caring one bit what the beef thinks.

        The one thing I like about him is that he is honest, there is no pretension of I like you, do you like me. It is just a straight business transaction, give me your money, I will get you somewhere close to where you need to be.

        • char says:

          Like is not the right word but people wont cheer if Easyjet or Wizz go bankrupt, they do that with Ryanair.

          O’Leary and honest? Half the things he says are complete bullshit said purely to get in the papers and the other half is self serving bullshit. And Ryanair has a very peculiar definition of close. One that is not very close to close

        • MCH says:

          Cas

          You’re probably right, I suppose I have an idealized version of the leprechaun. But he is a jerk and is dishonest.

          Yeah, I know about the close, like it’s close to Rome, if you count hundred plus km close.

        • mark says:

          in my case Ryan Air starts and finishes less than 30 minutes from my home in UK and my house in Spain. Prices are reasonable, two flights a week. Hassle free and on time generally.

          Does what it says on the tin….and mainly full flights on my route says I am not alone….

  10. Olivier says:

    @MC01 Could A380s make good cargo planes?

    • MCH says:

      They could have been, except Airbus cancelled the program way back in 2008 to focus on the pax version. The upper deck could not be used to carry cargo as it was, so it made it very inefficient.

      I’m sure with the current situation, more than one Airbus engineer is looking at how to do an A380 freight conversion.

    • char says:

      Reputation is no.

      A380 has no cargo doors so anything they can move a smaller plane can also move. You just need more of them and an awful lot of them just entered the market. And they are cheaper to operate.

      Other issue is that Boeing and Airbus now have a lot of factories without orders. It is not unlikely that they will fill those factories with cargo planes as Boeing has been doing with the 757 and 7474

      • SwissBrit says:

        Retro fitting a cargo door onto an A380 wouldn’t be too difficult if it was required.
        Whether or not the operating costs would make the conversion costs a viable investment is a complete other issue however.

    • MC01 says:

      A full-on cargo version of the A380 was ruled out by Airbus during the design stage already. Differently from Boeing aircraft, which are designed from scratch with a freighter version in mind, all Airbus aircraft apart from the A300 require extensive modifications to become full-on freighters.
      In the A380 case a dedicated freighter version would have required severe wing modifications and a complete redesign of the highly sophisticated (and immensely expensive) fuel balancing system. And that’s just for starters. Given the small number of orders already, not to mention lack of interest for an A380 freighter, Airbus wisely decided to scuttle the whole operation. Conversions are non-starters.

      Now, Hi Fly of Malta has an “emergency” cargo conversion of their A380 presently operating but one needs to understand this is nothing like, say, the 737 freighters which are the backbone of cargo worlwide. Hi Fly merely chucked most of the seats and added attachment points for tie-down straps. The cargo needs to be laboriously loaded and removed by hand, and is limited in weight and volume by the fact the cabin floors are not reinforced nor certified for heavy cargo.
      With the present glut of cargo aircraft and especially similar emergency conversions this is more a stunt than anything else. Kinda like leasing a used A380 in 2018 was. ;-)

      There’s another issue though. After many years it seems that, finally, there’s some serious possibility production of the Antonov An-124 may actually resume. Nothing beats political tensions like the bundle ADB and Volga-Dnepr made this year. ;-)
      The flyaway cost of a modernized new construction An-124 is presently estimated at $100 million, and given its highly specialized nature it’s an aircraft that will last decades in service.
      Volga-Dnepr has already expressed their interest in buying 3-5 new An-124 should they become available. Gulf cargo operators such as Maximus Air Crago have expresses interest as well.
      By contrast nobody expressed interest for an A380F. I’d say that settles the score.

      • Olivier says:

        @MC01 Thanks for the explanation. When you have time and space some day I would appreciate a disquisition on what differentiates a cargo from a passenger plane. Obviously doors are completely different (I’ve seen pictures of the cut-away nose of a 747 cargo) and the interior of the plane must be structured differently, too, but why does a cargo plane require a different wing design and the like? Or is it just in the case of the A380? That is very mysterious.

        • MC01 says:

          One of the chief issues for Airbus is their COG (Center OF Gravity) is designed for passenger operations.
          Look at a picture of an ordinary A330 and of an A330F, the freighter version: you will notice the latter has a “bump” to extend the frontwheel carriage and hence correct the “nose down attitude” of the A330, which is great for landing and taking off with an aircraft full of passengers but not so much for loading and carrying around pallets of cargo.
          The A321P2F (Passenger to Freight) conversion took so long to develop because correcting the aircraft COG without major (and extremely costly) airframe modification proved much harder than originally anticipated.

          By contrast Boeing are designed from scratch to be converted into freighter: this goes back to the 707, which was based on 367-80 prototype. The 367-80 was designed to serve as a prototype for both the 707 and what later became the military C-135: being such a massive financial commitment already ($16 million in 1954 money with no prospective buyers and without development costs) Boeing could afford to build a single hull.
          So it was decided to design a prorotype which could be demonstrated both as a military transport and as a passenger aircraft.
          The design philosophy proved a hit and as since been incorporated into every Boeing commercial design.

        • char says:

          Difference between cargo and passengers.
          Density is different.
          Electricity demand is much lower with fright
          No need for windows, emergency exits & toilets
          Temperature, air-pressure , noise.
          Speed, some cargo want faster but a lot is more than fast enough
          Fuel costs are a much bigger part of freight operations, not only because older planes.
          Pilot costs and availability

          The density of freight is under normal circumstance higher than people so you need more lift. A larger wing helps with that. The freight model of an airplane is often the fuselage of the short version with the wing and landing gear of the long version

  11. WES says:

    Back in the 1980s Europe wouldn’t let many African airlines land in Europe unless they had European flight crews flying the aircraft!

    I flew on Air Congo and it had Italian pilots! Before landing the pilot first flew low over the runway to clear the runway of people and goats! The most corrupt place I have ever been to! Beats Nigeria hands down!

    I guess fake pilots was a thing even back then!

  12. George W says:

    The U.S. federal budget deficit in June surged to $864 billion.

    I would like to see an article on the difference between trade deficit balances and US deficit spending.

    To me there always seems to be confusion between trade deficits and US deficit spending.

    Suppose the US records a 60 billion dollar trade deficit with China for the month of July 2020. The US treasury does not fund the purchase of goods from China and then sells them to the public recording the loss as deficit spending.

    Loss of tax revenue and increase in the sale of treasury bills/notes/bonds results in increased deficit spending at the federal level not trade deficits.

    I usually miss the obvious but to me there is a general mis-understanding of reporting trade deficits and US deficit spending.

    The loss of tax revenue from Airlines and a whole host of other industries will need to be replaced with the treasury issuing paper to make up the difference in lost tax revenue.

    Sorry, I know this is comment is basically off topic but I am looking for clarification on this subject.

    • Paul says:

      I suggest you Google it and do some research.

      In short, however, the two have essentially nothing to do with each other.

      There might be some apparent correlation in the data, the largest being that both started going out of control after August, 1971 when Nixon “temporarily” closed the gold window, and there is, for sure some linkage in the sense that fake money facilitated both, but that is about all.

    • historicus says:

      zero interest rates for governments is a dangerous situation
      This is why the Feds third unmentioned mandate is so important
      “promote moderate long term interest rates”……ie Not Extreme, either way

  13. MiTurn says:

    MC01,

    Will the A380 ever be a viable proposition? It was dead before, it seems ‘deader’ now.

  14. Raj says:

    Air India is another National Airline which has been bleeding forever. Bloated workforce and Government muddling are key factors in this farce. Successive Indian Governments across the political spectrum are happy to keep pouring money, mainly citing ‘nationalistic’ concerns. Money which could be much better spent on other areas in crying need for funding like primary education, primary healthcare or infrastructure. What a sham!

  15. historicus says:

    Chicago, Atlanta….all the big municipalities rely on tax revenue from airport operations, car rentals, et al
    Further indebtedness

  16. “El Al has sold three other 737-800… and immediately leased them back”

    ¿Stupid move, or hedging bets against holding stranded assets when business doesn’t return?

    • MC01 says:

      The first.
      Alitalia did that for years to raise quick cash and now they have the largest leased fleet among flag carriers (64% of total) with a proportionally large short-term fixed liabilities (€19 million/month).

      It’s a standard move among cash strapped airlines whose executives are quickly running out of options. BOC Aviation (the Singapore-registered leasing arm of the Bank of China) has been very active in these “not-so-sweetheart deals”, including with United Airlines and Etihad earlier this year.

  17. Olivier says:

    In other news I just read that Qantas has grounded its A380 fleet for three years. It sure looks like the end of the road for that plane.

  18. morpheus says:

    When I was a teenager I remember having booked a very cheap flight from Paris to New York.
    The cheapest I found was PIA. It had a stop in Paris from Paki to US.
    The smell was atrocious.
    But.
    They had overbooked it. And they honored my cheap ticket by putting me in business.
    That was one of my best early year memory of flying.
    The flight attendants were beautiful, the silver was silver, the food excellent. We even had a prayer before take off.
    Thank you PIA.

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