As the US majors posted first-quarter operating losses amounting to a collective deficit of over $1.2 billion, some are turning to their pension schemes to find relief.

The US legacy carriers are finding themselves forced to distinguish between forces they can manage and those that are beyond their control.

They have conceded that fuel is uncontrollable, even for carriers that can afford fuel hedging contracts; they are realising that it is nearly impossible, politically, socially and economically, to seek much more in the form of direct wage concessions from labour, and they are aware that few willing lenders are likely to step forward.

But one by one, the airlines are beginning to see a chance for some help in a hugely looming liability: their pension obligation. As United Airlines wins court approval to reject its retirement schemes in the largest pension default in modern US history, and as Delta Air Lines issues a dire warning that its retirement funding obligations will push it into deeper deficits and the brink of bankruptcy, worker pensions and retirement plans are the battleground. Delta's first quarter losses amount to about a third of the $1.2 billion in operating losses posted by the majors (see tables ). Even without special charges the majors were left showing a net loss of $2.1 billion and Delta $684 million.

Federal involvement in pension obligations, along with the recently heightened role for other federal lenders in the US Airways dilemma, bring the airlines closer to live again in the shadow of the federal government. Indeed in seeking pension reform, Delta chief executive Gerry Grinstein has been unapologetic in saying that what he wants is nothing less than a new framework for a larger policy towards the airline industry.

The pension dilemma is hardly one of the airlines' own making, says Bill Brandt of corporate advisers Development Specialists Inc. Legacy carriers find their workforces ageing, their payrolls trimmed by layoffs and attrition of younger workers, while their competition, staffed by younger workers, is unencumbered by costly traditional "defined benefit" pension plans. Airline pensions had a negative balance of $21.1 billion last year, down from a positive balance of $3 billion in 2000, according to a forthcoming study by Charles River Associates.

The situation was exacerbated by poor returns on investments and low interest rates, two key sources of pension plan funding, and a weakened ability on the part of employers to fund traditional retirement schemes. This is forcing companies to pump cash into the plans to meet federal rules in minimum funding obligations.

Under federal law, airlines and other companies are required to make "catch-up" contribution payments if their plans become underfunded by a certain amount. Bear Stearns airline analyst David Strine says that in 2006 he expects the industry to use up 40% of its operating cashflow to fund its pension plans if there is no relief.

Delta, one of the hardest hit, said in a mid-May regulatory filing that its pensions are underfunded by $5.3 billion. Its required outlays will grow from $450 million this year and $600 million next year to $950 million in 2007 and will balloon to $1.6 billion for 2008. Delta warned that even if legislative action is forthcoming to let it stretch out its required pension payments – as several members of Congress have proposed – it may still be forced into bankruptcy reorganisation.

And Delta's competitive stance is made all the more difficult by United jettisoning its four major pension plans with the acquiescence of the bankruptcy court and of the federal watchdog, the Pension Benefit Guaranty Corporation (PBGC). The four pension plans are underfunded by nearly $10 billion, which is the difference between assets and promised benefits. The government will guarantee $6.6 billion in benefits.

United says replacing pension plans with cheaper ones would save it an estimated $645 million a year over five years. Standard and Poor's airline credit analyst Phil Baggaley says the move may not assure United's access to financing to exit bankruptcy but without it "the chance of attracting the financing appears dim".

Alan Sbarra of Roach and Sbarra Airline Consulting says United's deal with the PBGC is a sign of more to come. "I think since the PBGC has taken over United's pension, it has basically set things in motion that every other airline is going to have to do the same thing," he says.

Indeed, the pensions agency seemed to accept that it will end up allowing further defaults. PBGC executive director Bradley Belt says the agreement "under the circumstances is in the best interests of the pension insurance programme and its stakeholders" because the corporation has an "obligation to reduce its losses" and because the settlement is superior to the recovery that the agency would have received as an unsecured creditor in bankruptcy.

Public attention

The widely watched pension rejection has had the benefit of bringing public attention, and sympathy, to the workers' dilemma, and in part to the airline itself. But United's action also presents a new competitive issue, Baggaley says. It gives United "an operating cost advantage and lightens its financial burden". He adds that United's example "could tip the balance toward a decision to file for Chapter 11 bankruptcy reorganisation in an airline that is already in severe financial distress".

Nowhere is the competitive balance watched more closely than at troubled Delta and at AMR, parent of American Airlines, where chief executive Gerard Arpey has stressed the carrier's efforts to conserve its pensions. Among legacy carriers, American is a favourite for its relatively strong financial performance and continued ability to work with its labour unions.

During the first quarter, it managed to reduce costs by 3.2%, not counting fuel, while unit revenue in its mainline operations rose by 3.7%. It even managed to generate positive cashflow, ending the quarter with $3.5 billion in cash, compared with $3.4 billion at the end of 2004, and that was after it made a $138 million pension plan contribution.

American and its workers are watching the United situation and the Delta-led lobbying campaign with a wary eye. "We believe companies that have acted responsibly should be permitted to continue working collaboratively with their employees to determine the future of their retirement benefits, rather than Congress or the judiciary deciding for them," says Ralph Hunter, chairman of American's Allied Pilots Association.

The pilots, who have been joined by American's two other unions in their position, say that they "are highly sceptical that stripping employees of their hard-earned negotiated benefits, either through legislation or in federal bankruptcy court, will serve to ensure any organisation's long-term success."

Federal involvement

Regardless of the unions' stance, United's default has necessitated a deeper federal role in the industry's future by virtue of the fact that United will issue up to $1.5 billion in notes and convertible stock to the PBGC in exchange for a stake in a reorganised United. The PBGC also expects that it will receive equity in the new airline on its claim for unfunded benefit liabilities. While the size of the PBGC overall stake in United will not be determined until the airline finalises its bankruptcy reorganisation plan, its holdings will likely give the federal agency some significant influence over decisions at United in the years ahead.

That imposes on the pension agency, as well as the Air Transportation Stabilization Board (ATSB), a role in shaping the future direction of airlines. The ATSB, created weeks after the 2001 terrorist attacks to help the staggering US industry recover from a severe downturn, has issued about $1.6 billion in loan guarantees to six carriers. Those loan guarantees carry with them warrants for equity stakes of between 10% and 33% in the airlines. Both US Airways and America West are loan beneficiaries, and under the terms of its loan agreement the ATSB has authority to approve or reject any merger by or between the two.

Bill Brandt, the corporate workout and restructuring expert, says that these agencies will have considerable power because legislators will probably not act quickly. The pension issue, Brandt says, is the "single issue that could be the template for industry change, but Congress has artfully dodged this and other legacy issues".


Source: Airline Business