[Senate Hearing 109-1093]
[From the U.S. Government Publishing Office]
S. Hrg. 109-1093
AIRLINE FINANCIAL STABILITY
=======================================================================
HEARING
before the
SUBCOMMITTEE ON AVIATION
OF THE
COMMITTEE ON COMMERCE,
SCIENCE, AND TRANSPORTATION
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
__________
JULY 13, 2005
__________
Printed for the use of the Committee on Commerce, Science, and
Transportation
U.S. GOVERNMENT PRINTING OFFICE
62-179 WASHINGTON : 2010
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing Office,
http://bookstore.gpo.gov. For more information, contact the GPO Customer Contact Center, U.S. Government Printing Office. Phone 202�09512�091800, or 866�09512�091800 (toll-free). E-mail, [email protected].
SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
TED STEVENS, Alaska, Chairman
JOHN McCAIN, Arizona DANIEL K. INOUYE, Hawaii, Co-
CONRAD BURNS, Montana Chairman
TRENT LOTT, Mississippi JOHN D. ROCKEFELLER IV, West
KAY BAILEY HUTCHISON, Texas Virginia
OLYMPIA J. SNOWE, Maine JOHN F. KERRY, Massachusetts
GORDON H. SMITH, Oregon BYRON L. DORGAN, North Dakota
JOHN ENSIGN, Nevada BARBARA BOXER, California
GEORGE ALLEN, Virginia BILL NELSON, Florida
JOHN E. SUNUNU, New Hampshire MARIA CANTWELL, Washington
JIM DeMINT, South Carolina FRANK R. LAUTENBERG, New Jersey
DAVID VITTER, Louisiana E. BENJAMIN NELSON, Nebraska
MARK PRYOR, Arkansas
Lisa J. Sutherland, Republican Staff Director
Christine Drager Kurth, Republican Deputy Staff Director
David Russell, Republican Chief Counsel
Margaret L. Cummisky, Democratic Staff Director and Chief Counsel
Samuel E. Whitehorn, Democratic Deputy Staff Director and General
Counsel
Lila Harper Helms, Democratic Policy Director
------
SUBCOMMITTEE ON AVIATION
CONRAD BURNS, Montana, Chairman
TED STEVENS, Alaska JOHN D. ROCKEFELLER IV, West
JOHN McCAIN, Arizona Virginia, Ranking
TRENT LOTT, Mississippi DANIEL K. INOUYE, Hawaii
KAY BAILEY HUTCHISON, Texas BYRON L. DORGAN, North Dakota
OLYMPIA J. SNOWE, Maine BARBARA BOXER, California
GORDON H. SMITH, Oregon MARIA CANTWELL, Washington
JOHN ENSIGN, Nevada FRANK R. LAUTENBERG, New Jersey
GEORGE ALLEN, Virginia BILL NELSON, Florida
JOHN E. SUNUNU, New Hampshire E. BENJAMIN NELSON, Nebraska
JIM DeMINT, South Carolina MARK PRYOR, Arkansas
C O N T E N T S
----------
Page
Hearing held on July 13, 2005.................................... 1
Statement of Senator Burns....................................... 1
Statement of Senator DeMint...................................... 44
Statement of Senator Inouye...................................... 2
Prepared statement........................................... 2
Statement of Senator Lautenberg.................................. 46
Witnesses
Baker, Jamie N., Vice President, U.S. Equity Research, JPMorgan
Securities, Inc................................................ 30
Prepared statement........................................... 31
Hecker, JayEtta Z., Director, Physical Infrastructure Issues,
U.S. Government Accountability Office.......................... 3
Prepared statement........................................... 5
May, James C., President/CEO, Air Transport Association of
America, Inc................................................... 19
Prepared statement........................................... 21
Roach, Jr., Robert, General Vice President of Transportation,
International Association of Machinists and Aerospace Workers
(IAM).......................................................... 36
Prepared statement........................................... 37
AIRLINE FINANCIAL STABILITY
----------
WEDNESDAY, JULY 13, 2005
U.S. Senate,
Subcommittee on Aviation,
Committee on Commerce, Science, and Transportation,
Washington, DC.
The Committee met, pursuant to notice, at 9:58 a.m., Senate
Russell 253, Hon. Conrad Burns, Chairman of the Subcommittee,
presiding.
OPENING STATEMENT OF HON. CONRAD BURNS,
U.S. SENATOR FROM MONTANA
Senator Burns. We'll call the Committee to order this
morning, and there are quite a lot of things going on in this
part of the world, and we want to thank our folks for coming in
this morning. I welcome this panel of witnesses, and especially
in our continuing efforts to work toward ideas for the next FAA
reauthorization bill, we are examining the financial condition
of the airline industry. It is our intent to focus on a wide
array of internal and external factors that shape the industry
today. I think it's important this subcommittee understands the
underlying principles, and problems in the industry in order to
make an educated policy decision. As you know, as policymakers,
we should operate with the idea to do no harm, and when we do
know there are extenuating circumstances under legislation and
sometimes we don't see it coming.
There are certainly several caveats to the airline
industry. I anticipate that we will discuss them, among others,
the relationship between the legacy carriers and the low-cost
carriers, so-called rising fuel costs, aviation taxes and fees,
labor and management relations, capacity concerns, fair
pricing, aircraft leasing, industry consolidation, and the role
that Chapter 11 bankruptcy plays in the industry. As if there
is not enough on the platter already, this sort of fills the
boat.
Since 2000, many in the airline industry have experienced
poor financial results and have lost somewhere around $35
billion with the expectation of heavy losses this year. A
majority of those problems can be traced back to the horrific
events of 9/11 and SARS, but there are also several factors
that were in place, and starting to evolve prior to 9/11.
Legacy carriers--the business models--have been criticized
for years, but the fragile line between profitability and red
ink was not exposed until we had seen the events of 9/11, and
the effects of that along with the downturn of the overall
economy. One could argue that we are starting to see the actual
results of deregulation now much more than the 1980s and 1990s.
We now have prospering, low-cost carriers, evolving
business, and aviation ventures, and because of it, more people
are flying today. In fact, just last month we had a hearing on
passenger levels and system capacity. Our traffic levels are
back to record levels, planes are full, but many of the legacy
carriers are still seriously struggling.
It's tough to understand why, in a business that seems to
be booming, most of the legacy carriers are busting. For a
Senator from Montana, it's even more disconcerting to see our
legacy traditional hub-and-spoke carriers in dire straits. The
hub-and-spoke model has provided historical foundation for
rural access to my state and many others that do not fit into
the traditional low-cost carrier business plan. Legacy carriers
are making significant gains in improving their bottom lines,
but still reporting large financial losses. Today we look at
some of the reasons why.
Our panel consists of a broad spectrum of aviation experts,
and I look forward to their testimony. This morning I want to
thank them for coming, because we know the industry is vitally
important to this country for commerce and I know you take your
job very, very seriously. Senator Inouye, thank you for coming
in this morning, also.
STATEMENT OF HON. DANIEL K. INOUYE,
U.S. SENATOR FROM HAWAII
Senator Inouye. Well, I thank you very much. I have a
prepared statement I'd like to have made part of the record.
Like a few of my colleagues, I do a lot of flying. In fact,
last week, I spent more time in the air than on the ground. I
spent 20 hours in Hawaii and 22 hours in the air. And so I'm
well aware of the low fares. I'm well aware of the packed
aircraft, and, yet, I know that since 2001, we have a shortfall
of $35 billion. About 150,000 have lost their jobs, so this is
a serious situation, and we are looking for answers, and I
would like to commend my Chairman for calling this hearing.
[The prepared statement of Senator Inouye follows:]
Prepared Statement of Hon. Daniel K. Inouye, U.S. Senator from Hawaii
Most aviation observers understand that despite the low fares and
packed airplanes that have become commonplace, the Nation's airlines
continue to struggle through the toughest financial period in the
history of commercial aviation. This has not been a blip on the
proverbial radar screen.
This has been an extended economic slump that resulted in the
collective loss of tens of billions of dollars by the major carriers
and the elimination of nearly 150,000 airline jobs over the past four
years.
Most Americans recognize how important a healthy aviation industry
is for a country as large as the U.S. However, it is often easy to
forget the complex factors affecting our airlines, particularly, when
planes generally run on schedule and move passengers thousands of miles
in a fraction of the time that other modes require.
In my home State of Hawaii, the service air carriers provide is
vital to our way of life. Hawaii residents use planes as a primary mode
of transportation. Many do so on a daily basis as part of their commute
to and from work.
Whether travel, tourism, or trade, in Hawaii, we depend on the
commercial aviation industry to provide us with timely contact between
the islands, the continental U.S., and the rest of the world. Yet our
two primary airlines, Hawaiian and Aloha, have operated under
bankruptcy protection for much of the past two years. Their precarious
financial situation has constantly threatened significant service
disruptions, which would be devastating to the local economy.
Hawaii primarily counts on major carriers for service beyond our
borders, and like our local carriers, these airlines are facing great
financial difficulties.
When the Federal Government shut down the Nation's airspace for
several days following the 9/11 attacks, most Americans experienced a
temporary limit to their mobility in the wake of the tragedy. For the
people of Hawaii, the shutdown directly and immediately impacted their
livelihoods. For those needing medical assistance or facing subsequent
emergencies, it became a matter of life or death.
There are many rural or isolated communities that could face
similar circumstances if a local airline fails or their access to the
National Airspace System is reduced in the wake of extreme cost-cutting
measures. In a globalized economy reliant upon air travel, the impact
to rural communities could be increasingly detrimental. We must
continually work to ensure that all of our citizens have a fair
opportunity to access this nation's unparalleled aviation
infrastructure.
I wish to take this opportunity to recognize the employees in the
aviation industry. They have been especially resilient during this
difficult period. They have seen nearly one-third of all airline jobs
eliminated, and virtually every employee has seen their pay and
benefits reduced. They understand intimately the importance of this
industry and have gone above and beyond to see that it survives.
Unfortunately, if we do not begin to solve the problems plaguing
the air carriers, we will see more failures in coming months and
certainly more jobs cut. The combination of excess capacity, record gas
prices, and a market flush with consistent, low fares has effectively
neutralized the major carriers' intense, cost-cutting measures. The
Bush Administration's effort to add additional security and pension
fees has not been helpful either.
The U.S. airline industry is now at a crossroad. Some legacy
carriers have spent the last few years aggressively working to compete
will the budget carriers and are now approaching profitability. They
are beginning to prove that they can adapt and survive. Yet at the same
time, factors like spiraling gas prices are pushing others to the brink
of bankruptcy or limiting their ability to get out of it.
The financial stability of the airlines is one of the most
important issues that we face this session. We must carefully consider
the needs of the industry as a whole, make certain that urban,
suburban, and rural communities can access air travel, and advance
forward-thinking initiatives that will help ensure a prosperous,
vibrant aviation industry for decades to come.
Senator Burns. Thank you very much, Senator, and your full
statement will be made part of the record. We'll just take the
panel now this morning. As it's listed here, Ms. JayEtta Z.
Hecker, Director of Physical Infrastructure Issues, U.S.
Government Accounting Office, GAO, and we welcome you this
morning and look forward to your testimony. By the way, we
would like to condense some of this. You bring up the
highlights and then we'll put your full statement in the
record. Thank you.
STATEMENT OF JayEtta Z. HECKER, DIRECTOR,
PHYSICAL INFRASTRUCTURE ISSUES,
U.S. GOVERNMENT ACCOUNTABILITY OFFICE
Ms. Hecker. Thank you, Mr. Chairman. Senator Inouye, I'm
very pleased to be here today. As you know, we've been
conducting analyses of the airline industry at the direction of
Congress for a number of years. We had a prior report last year
that talked about the factors that were leading to the
extremely difficult financial condition. The current work that
I'm reporting on is focusing on bankruptcy and pension issues
in airlines and my remarks--I do have a slide presentation. I
don't know if you have that. It may be useful because I have a
number of charts that I think tell the story.
Senator Burns. We all have copies, I think, and as you
know, this is a technology committee, of which we have none.
Ms. Hecker. Hopefully paper will work in this instance. The
two topics are the financial difficulties faced by the legacy
carriers and the major factors behind them, and then the effect
of bankruptcy on the industry and competitors.
On the first topic, there is, of course, no secret that the
airlines face severe financial difficulties. There has been not
only the significant change in demand, particularly the
increased price sensitivity of business travelers, but there
have also been enormous changes in the competitive environment
where low-cost carriers now are available to 85 percent of all
passengers. The low-cost carriers are really the price setters
and have transformed their competitive environment in the
airline industry.
This really has led to the major effort by the legacy
carriers to control costs, and the next slide, the one with the
two lines, basically outlines the changes in the costs for
available seat-miles for both the legacy carriers and the low-
cost carriers, and you see they were going up until 2001, and
then both were coming down, but the main point is that the
difference has actually increased, so as the low-cost carriers
have continued to expand, their costs-per-seat-mile have
actually gone down, and the difference--the cost disadvantage--
has actually increased, and you see the factors there, labor,
pensions, fuel, and a wide variety of other factors.
Of course, the next page shows the fuel prices, and there
is no doubt the prior page said that the difference, this is
not the total fuel, but the difference in the fuel costs for
low-cost carriers, they actually had a fuel advantage, more
fuel efficient airplanes and more efficient use of airplanes,
so all of the costs have been hurt by these rising prices, but,
of course, on a differential basis. My main point is really
this next chart about fixed obligations, and what is important
here is its absence of the liquidity that really drives
carriers into bankruptcy, along with inability to renegotiate
obligations and acquire new capital.
The first column is the cash on hand at the end of 2004 and
then the next four bars basically outline the fixed
obligations. These are fixed. These are not flexible with
changing your business model, and how they severely strain and
overpower the amount of cash on hand. The other thing is to see
how diverse these factors are. There has been a lot of talk
about pensions. Pensions is only one-sixth of the fixed
obligation overhang that is so threatening the financial
condition of the major carriers.
The second objective, then, is to look at the whole issue
of bankruptcy. There is widespread expectation of presumption
that bankruptcy was used to harm competitors by either lowering
prices or keeping capacity in the market longer. Our first
chart on page 8 basically outlines how bankruptcy and
liquidations are more common in the airline industry. In fact,
the airline industry is one of the worst performing sectors of
all, and what we have here is, not only is the rate of
bankruptcy and liquidation more common, but the potential to
recover is also more difficult for carriers.
Our data shows that of 160 bankruptcies since 1978, only 20
have actually survived to this day. Another factor we found is
the airline bankruptcies last longer, and as I said have these
less successful outcomes. The next, page 9, is this growth of
airline industry capacity and charted along with major airline
liquidations, and the point here is that we found little
evidence that bankruptcies are actually contributing to the
overcapacity. As you see, it's really those gray areas, it's
the recessions that have been the only factors that lead to
decreases in industry capacity.
We have concluded that bankruptcies are not looked at for
competitive advantage. It's not a panacea. It involves many
costs, many risks, and in our view is looked at by firms as a
last resort. And if anything, the poor history really is a
testimony to that.
Our concluding observations then is that we, as you said,
Mr. Chairman, the industry is really still playing out the
deregulation policies of the 1970s. The restructuring is
continuing. The emergence, the full, powerful, ever present
emergence of low-cost carriers, as I said, is available to 85
percent of the population, and the legacy carriers
profitability depends on controlling those costs where they
still have that disadvantage.
An important part of our conclusion, contrary to what is
seen as accepted wisdom, bankruptcy and liquidation are a
reflection of, but not the cause of industry stability, and in
our view, some carriers will terminate pension plans through
the bankruptcy process under the current conditions. Our most
focused observation is this last point, though, and it's the
terminating pensions or amortizing their contributions over a
longer period will not solve the underlying legacy problems,
fundamental structural concerns and cost disadvantage, so even
though there may be a potential for a temporary reprieve, it is
only a limited part of the liquidity problem, and the cost-
differential, and, thus, in our view, there shouldn't be a
sense that there is a silver bullet to somehow fix the dire
financial condition of the legacy carriers. That concludes my
remarks, Mr. Chairman.
[The prepared statement of Ms. Hecker follows:]
Prepared Statement of JayEtta Z. Hecker, Director,
Physical Infrastructure Issues, U.S. Government Accountability Office
Mr. Chairman and members of the Subcommittee:
We appreciate the opportunity to participate in today's hearing to
discuss the financial condition of the U.S. airline industry--and
particularly, the financial problems of legacy airlines.\1\ Since 2001,
the U.S. airline industry has confronted financial losses of
unprecedented proportions. From 2001 through 2004, legacy airlines
reported losses of $28 billion, and two of the nation's largest legacy
airlines--United Airlines and US Airways--went into bankruptcy,\2\
eventually terminating their pension plans, and passing the unfunded
liability to the Pension Benefit Guaranty Corporation (PBGC).\3\ Two
other large legacy airlines have announced that they are precariously
close to following suit.
In recent years, considerable debate has ensued over legacy
airlines' use of Chapter 11 bankruptcy protection as a means to
continue operations, often for years. Some in the industry and
elsewhere have maintained that legacy airlines' use of this approach is
harmful to the airline industry as a whole, in that it allows
inefficient carriers to stay in business, exacerbating overcapacity and
allowing these airlines to potentially under-price their competitors.
This debate has received even sharper focus with US Airways' and
United's defaults on their pensions. By eliminating their pension
obligations, critics argue, US Airways and United enjoy a cost
advantage that may encourage other airlines sponsoring defined benefits
plans to take the same approach.
Last year, we reported on the industry's poor financial condition,
the reasons for it, and the necessity of legacy airlines to reduce
their costs if they are to survive.\4\ At the request of the Congress,
we have continued to assess the financial condition of the airline
industry, and, in particular, the problems of bankruptcy and pension
terminations. Our work in this area is still under way.\5\ Nonetheless,
we can offer some preliminary observations about what we are finding.
Our statement today describes our preliminary observations in three
areas: (1) the continued financial difficulty faced by legacy airlines,
(2) the effect of bankruptcy on the industry and competitors, and (3)
the effect of airline pension underfunding on employees, retirees,
airlines, and the PBGC. Our final report, which we expect to issue in
September, will offer additional evidence and insights on these
questions.
In summary:
U.S. legacy airlines have not been able to reduce their
costs sufficiently to profitably compete with low-cost airlines
that continue to capture industry market share. Challenges that
are internal and external to the industry have fundamentally
changed the nature of the industry and forced legacy airlines
to restructure themselves financially. The changing demand for
air travel and growth of low-cost airlines has kept fares low,
forcing legacy airlines to reduce their costs. However, legacy
airlines have struggled to do so, and have been unable to
achieve unit-cost comparability with their low-cost rivals. As
a result, legacy airlines have continued to lose money--$28
billion since 2001--and are expected to lose another $5 billion
in 2005. Additionally, airlines' costs have been hurt by rising
fuel prices--especially legacy airlines that did not have fuel
hedging in place.
Bankruptcies are endemic to the airline industry, the result
of long-standing structural issues within the industry, but
there is no clear evidence that bankruptcy itself has harmed
the industry or its competitors. Since deregulation in 1978,
there have been 160 airline bankruptcy filings, 20 of which
have occurred in the last 5 years. Airlines fail at a higher
rate than most other types of companies, and the airline
industry historically has the worst financial performance of
any sector. This inherent instability that leads to so many
bankruptcies can be traced to the structure of the industry and
its economics, including the highly cyclical demand for air
travel, high fixed costs, and few barriers to entry. The
available evidence does not suggest that airlines in bankruptcy
contribute to industry overcapacity, or that bankrupt airlines
harm competitors by reducing fares below what other airlines
are charging. The history of the industry since deregulation
indicates that past liquidations or consolidations have not
slowed the overall growth of capacity in the industry. Studies
conducted by others do not show evidence that airlines
operating in bankruptcy harmed other competitors. Finally,
while bankruptcy may appear to be a useful business strategy
for companies in financial distress, available analysis
suggests it provides no panacea for airlines. Few airlines that
have filed for bankruptcy protection are still in business
today. Bankruptcy involves many costs, and given the poor track
record, companies are likely to use it only as a last resort.
While bankruptcy may not harm the financial health of the
airline industry, it has become a considerable concern for the
Federal Government and airline employees and retirees because
of the recent terminations of pensions by US Airways and United
Airlines. These terminations resulted in claims on PBGC's
single-employer program of $9.6 billion and plan participants
(i.e., employees, retirees, and beneficiaries) are estimated to
have lost more than $5 billion in benefits that were either not
covered by PBGC, or exceeded the statutory limits. At
termination in May 2005, United's pension plans promised $16.8
billion in benefits backed by only $7 billion in assets (i.e.,
it was underfunded by $9.8 billion). PBGC guaranteed $13.6
billion of the promised benefits, resulting in a claim on the
agency of $6.6 billion and an estimated $3.2 billion loss to
participants. The defined benefit pension plans of the
remaining legacy airlines with active plans are underfunded by
$13.7 billion (based on data from the U.S. Securities and
Exchange Commission, or SEC), raising the potential of
additional sizeable losses to PBGC and plan participants. These
airlines face $10.4 billion in pension contributions over the
next 4 years, significantly more than some of them may be able
to afford given continued losses and their other fixed
obligations. Spreading these contributions over more years, as
some of these airlines have proposed, would relieve some of
this liquidity pressure but would not necessarily keep them out
of bankruptcy because it does not fully address the fundamental
cost structure problems faced by legacy airlines.
Legacy Airlines Must Reduce Costs To Restore Profitability
Since 2000, legacy airlines have faced unprecedented internal and
external challenges. Internally, the impact of the Internet on how
tickets are sold and consumers search for fares and the growth of low-
cost airlines as a market force accessible to almost every consumer has
hurt legacy airline revenues by placing downward pressure on airfares.
More recently, airlines' costs have been hurt by rising fuel prices
(see figure 1).\6\ This is especially true of airlines that did not
have fuel hedging in place. Externally, a series of largely unforeseen
events--among them the September 11th terrorist attacks in 2001 and
associated security concerns; war in Iraq; the SARS crisis; economic
recession beginning in 2001; and a steep decline in business travel--
seriously disrupted the demand for air travel during 2001 and 2002.
Low fares have constrained revenues for both legacy and low-cost
airlines. Yields, the amount of revenue airlines collect for every mile
a passenger travels, fell for both low-cost and legacy airlines from
2000 through 2004 (see figure 2). However, the decline has been greater
for legacy airlines than for low-cost airlines. During the first
quarter of 2005, average yields among both legacy and low-cost airlines
rose somewhat, although those for legacy airlines still trailed what
they were able to earn during the same period in 2004.
Legacy airlines, as a group, have been unsuccessful in reducing
their costs to become more competitive with low-cost airlines. Unit
cost competitiveness is key to profitability for airlines because of
declining yields. While legacy airlines have been able to reduce their
overall costs since 2001, these were largely achieved through capacity
reductions and without an improvement in their unit costs. Meanwhile,
low-cost airlines have been able to maintain low unit costs, primarily
by continuing to grow. As a result, low-cost airlines have been able to
sustain a unit cost advantage as compared to their legacy rivals (see
figure 3). In 2004, low-cost airlines maintained a 2.7 cent per
available seat-mile advantage over legacy airlines. This advantage is
attributable to lower overall costs and greater labor and asset
productivity. During the first quarter of 2005, both legacy and low-
cost airlines continued to struggle to reduce costs, in part because of
the increase in fuel costs.
Weak revenues and the inability to realize greater unit cost-
savings have combined to produce unprecedented losses for legacy
airlines. At the same time, low-cost airlines have been able to
continue producing modest profits as a result of lower unit costs (see
figure 4). Legacy airlines have lost a cumulative $28 billion since
2001 and are predicted to lose another $5 billion in 2005, according to
industry analysts. First quarter 2005 operating losses (based on data
reported to DOT) approached $1.45 billion for legacy airlines. Low cost
airlines also reported net operating losses of almost $0.2 billion,
driven primarily by ATA's losses.
Since 2000, as the financial condition of legacy airlines
deteriorated, they built cash balances, not through operations, but by
borrowing. Legacy airlines have lost cash from operations, and
compensated for operating losses by taking on additional debt, relying
on creditors for more of their capital needs than in the past. In the
process of doing so, several legacy airlines have used all, or nearly
all, of their assets as collateral, potentially limiting their future
access to capital markets.
In sum, airlines are capital- and labor-intensive firms subject to
highly cyclical demand and intense competition. Aircraft are very
expensive and require large amounts of debt financing to acquire,
resulting in high fixed-costs for the industry. Labor is largely
unionized and highly specialized, making it expensive and hard to
reduce during downturns. Competition in the industry is frequently
intense owing to periods of excess capacity, relatively open entry, and
the willingness of lenders to provide financing. Finally, demand for
air travel is highly cyclical, closely tied to the business cycle. Over
the past decade, these structural problems have been exacerbated by the
growth in low-cost airlines and increasing consumer sensitivity to
differences in airfares based on their use of the Internet to purchase
tickets. More recently, airlines have had to deal with persistently
high fuel prices--operating profitability, excluding fuel costs, is as
high as it has ever been for the industry.
Bankruptcy Is Common in the Airline Industry, but There Is No Evidence
That it Is Harmful to the Industry or Competitors
Airlines seek bankruptcy protection for such reasons as severe
liquidity pressures, an inability to obtain relief from employees and
creditors, and an inability to obtain new financing, according to
airline officials and bankruptcy experts. As a result of the structural
problems and external shocks previously discussed, there have been 160
total airline bankruptcy filings since deregulation in 1978, including
20 since 2000, according to the Air Transport Association.\7\ Some
airlines have failed more than once, but most filings were by smaller
carriers. However, the size of airlines that have been declaring
bankruptcy has been increasing. Of the 20 bankruptcy filings since
2000, half of these have been for airlines with more than $100 million
in assets, about the same number of filings as in the previous 22
years. Compared to the average failure rate for all types of
businesses, airlines have failed more often than other businesses. As
figure 5 shows, in some years, airline failures were several times more
common than for businesses overall.
With very few exceptions, airlines that enter bankruptcy do not
emerge from it. Of the 146 airline Chapter 11 reorganization filings
since 1979, in only 16 cases are the airlines still in business. Many
of the advantages of bankruptcy stem from legal protection afforded the
debtor-airline from its creditors, but this protection comes at a high
cost in loss of control over airline operations and damaged relations
with employees, investors, and suppliers, according to airline
officials and bankruptcy experts.
Contrary to some assertions that bankruptcy protection has led to
overcapacity and under-pricing that have harmed healthy airlines, we
found no evidence that this has occurred either in individual markets
or to the industry overall. Such claims have been made for more than a
decade. In 1993, for example, a national commission to study airline
industry problems cited bankruptcy protection as a cause for the
industry's overcapacity and weakened revenues.\8\ More recently,
airline executives have cited bankruptcy protection as a reason for
industry over-capacity and low fares. However, we found no evidence
that this had occurred and some evidence to the contrary.
First, as illustrated by Figure 6, airline liquidations do not
appear to affect the continued growth in total industry capacity. If
bankruptcy protection leads to overcapacity as some contend, then
liquidation should take capacity out of the market. However, the
historical growth of airline industry capacity (as measured by
available seat-miles, or ASMs) has continued unaffected by major
liquidations. Only recessions, which curtail demand for air travel, and
the September 11th attack, appear to have caused the airline industry
to trim capacity. This trend indicates that other airlines quickly
replenish capacity to meet demand. In part, this can be attributed to
the fungibility of aircraft and the availability of capital to finance
airlines.\9\
Similarly, our research does not indicate that the departure or
liquidation of a carrier from an individual market necessarily leads to
a permanent decline in traffic for that market. We contracted with
InterVISTAS-ga\2\, an aviation consultant, to examine the cases of six
hub cities that experienced the departure or significant withdrawal of
service of an airline over the last decade (see table 1). In four of
the cases, both local origin-and-destination (i.e., passenger traffic
to or from, but not connecting through, the local hub) and total
passenger traffic (i.e., local and connecting) increased or changed
little because the other airlines expanded their traffic in response.
In all but one case, fares either decreased or rose less than 6
percent.
Table 1: Case Examples of Markets' Response to Airline Withdrawals
------------------------------------------------------------------------
Change in
Market Year Airline Effect on passenger fares
traffic (percent)
------------------------------------------------------------------------
Nashville, 1995 American Airlines Other airlines' -10.2
TN eliminated hub. traffic increased.
Origin and
destination
traffic increased.
Greensboro, 1995 Continental Lite Other airlines' +5.5
NC eliminated hub. traffic increased.
Origin and
destination
traffic decreased.
Colorado 1997 Western Pacific Other airlines' +43.6
Springs, CO moved operations traffic decreased.
to Denver. Origin and
destination
traffic decreased.
St. Louis, 2001 TWA acquired by Other airlines' +5.4
MO American Airlines. traffic decreased.
Little change in
origin and
destination
traffic.
Kansas City, 2002 Vanguard Airlines Little change in +4.2
MO suspended service. other airlines'
traffic. Little
change in origin
and destination
traffic.
Columbus, OH 2003 America West Other airlines' +3.6
eliminated hub. traffic increased.
Little change in
origin and
destination
traffic.
------------------------------------------------------------------------
Source: InterVISTAS-ga\2\.
Note: Little change in traffic means that traffic increased or decreased
less than 5 percent and that origin-and-destination traffic increased
or decreased less than 10 percent. Changes in passenger traffic and
fares are measured from 4 quarters prior to the airline departure to 8
quarters after.
We also reviewed numerous other bankruptcy and airline industry
studies and spoke to industry analysts to determine what evidence
existed with regard to the impact of bankruptcy on the industry. We
found two major academic studies that provided empirical data on this
issue. Both studies found that airlines under bankruptcy protection did
not lower their fares or hurt competitor airlines, as some have
contended. A 1995 study found that an airline typically reduced its
fares somewhat before entering bankruptcy. However, the study found
that other airlines did not lower their fares in response and, more
importantly, did not lose passenger traffic to their bankrupt rival and
therefore were not harmed by the bankrupt airline.\10\ Another study
came to a similar conclusion in 2000, this time examining the operating
performance of 51 bankrupt firms, including 5 airlines, and their
competitors.\11\ Rather than examine fares as did the 1995 study, this
study examined the operating performance of bankrupt firms and their
rivals. This study found that bankrupt firms' performance deteriorated
prior to filing for bankruptcy and that their rivals' profits also
declined during this period. However, once a firm entered bankruptcy,
its rivals' profits recovered.
Legacy Airlines Face Significant Near-Term Liquidity Pressures,
Including $10.4 Billion in Pensions Contributions Over the Next
4 Years
Under current law, legacy airlines' pension funding requirements
are estimated to be a minimum of $10.4 billion from 2005 through
2008.\12\ These estimates assume the expiration of the Pension Funding
Equity Act (PFEA) at the end of this year.\13\ The PFEA permitted
airlines to defer the majority of their deficit reduction contributions
in 2004 and 2005; if this legislation is allowed to expire it would
mean that payments due from legacy airlines will significantly increase
in 2006. According to PBGC data, legacy airlines are estimated to owe a
minimum of $1.5 billion this year, rising to nearly $2.9 billion in
2006, $3.5 billion in 2007, and $2.6 billion in 2008. In contrast, low-
cost airlines have eschewed defined benefit pension plans and instead
use defined-contribution (401k-type) plans.
However, pension funding obligations are only part of the sizeable
amount of debt that carriers face over the near term. The size of
legacy airlines' future fixed obligations, including pensions, relative
to their financial position suggests they will have trouble meeting
their various financial obligations. Fixed airline obligations
(including pensions, long-term debt, and capital and operating leases)
in each year from 2005 through 2008 are substantial. Legacy airlines
carried cash balances of just under $10 billion going into 2005 (see
figure 7) and have used cash to fund their operational losses. These
airlines fixed obligations are estimated to be over $15 billion in both
2005 and 2006, over $17 billion in 2007, and about $13 billion in 2008.
While cash from operations can help fund some of these obligations,
continued losses and the size of these obligations put these airlines
in a sizable liquidity bind. Fixed obligations in 2008 and beyond will
likely increase as payments due in 2006 and 2007 may be pushed out and
new obligations are assumed.
The enormity of legacy airlines' future pension funding
requirements is attributable to the size of the pension shortfall that
has developed since 2000. As recently as 1999, airline pensions were
overfunded by $700 million based on Security and Exchange Commission
(SEC) filings; by the end of 2004, legacy airlines reported a deficit
of $21 billion (see figure 8), despite the termination of the US
Airways pilots plan in 2003. Since these filings, the total
underfunding has declined to approximately $13.7 billion, due in part
to the termination of the United Airline plans, and the remaining US
Airways plans.\14\
The extent of underfunding varies significantly by airline. At the
end of 2004, prior to terminating its pension plans, United reported
underfunding of $6.4 billion, which represented over 40 percent of
United's total operating revenues in 2004. In contrast, Alaska reported
pension underfunding of $303 million at the end of 2004, or 13.5
percent of its operating revenues. Since United terminated its
pensions, Delta and Northwest now appear to have the most significant
pension funding deficits--over $5 billion and nearly $4 billion
respectively--which represent about 35 percent of 2004 operating
revenues, at each airline.
The growth of pension underfunding is attributable to 3 factors:
Assets losses and low interest rates. Airline pension asset
values dropped nearly 20 percent from 2001 through 2004 along
with the decline in the stock market, while future obligations
have steadily increased due to declines in the interest rates
used to calculate the liabilities of plans.
Management and labor union decisions. Pension plans have
been funded far less than they could have on a tax-deductible
basis. PBGC examined 101 cases of airline pension contributions
from 1997 through 2002, and found that while the maximum
deductible contribution was made in 10 cases, no cash
contributions were made in 49 cases where they could have
contributed.\15\ When airlines did make tax deductible
contributions, it was often far less than the maximum
permitted. For example, the airlines examined could have
contributed a total of $4.2 billion on a tax-deductible basis
in 2000 alone, but only contributed about $136 million despite
recording profits of $4.1 billion (see figure 9).\16\ In
addition, management and labor have sometimes agreed to salary
and benefit increases beyond what could reasonably be afforded.
For example, in the spring of 2002, United's management and
mechanics reached a new labor agreement that increased the
mechanics' pension benefit by 45 percent, but the airline
declared bankruptcy the following December.
Pension funding rules are flawed. Existing laws and
regulations governing pension funding and premiums have also
contributed to the underfunding of defined benefit pension
plans. As a result, financially weak plan sponsors, acting
within the law, have not only been able to avoid contributions
to their plans, but also increase plan liabilities that are at
least partially insured by PBGC. Under current law, reported
measures of plan funding have likely overstated the funding
levels of pension plans, thereby reducing minimum contribution
thresholds for plan sponsors. And when plan sponsors were
required to make additional contributions, they often
substituted ``account credits'' for cash contributions, even as
the market value of plan assets may have been in decline.
Furthermore, the funding rule mechanisms that were designed to
improve the condition of poorly funded plans were ineffective.
\17\ Other lawful plan provisions and amendments, such as lump
sum distributions and unfunded benefit increases may also have
contributed to deterioration in the funding of certain plans.
Finally, the premium structure in PBGC's single-employer
pension insurance program does not encourage better plan
funding.
The cost to PBGC and participants of defined benefit pension
terminations has grown in recent years as the level of pension
underfunding has deepened. When Eastern Airlines defaulted on its
pension obligations of nearly $1.7 billion in 1991, for example, claims
against the insurance program totaled $530 million in underfunded
pensions and participants lost $112 million. By comparison, the US
Airways and United pension terminations cost PBGC $9.6 billion in
combined claims against the insurance program and reduced participants'
benefits by $5.2 billion (see table 2).
Table 2: Airline Pension Termination Information
(in millions of dollars)
----------------------------------------------------------------------------------------------------------------
Fiscal year of Net Estimated
Airline plan Benefit PBGC claim on participant
terminations liability liability PBGC losses
----------------------------------------------------------------------------------------------------------------
Eastern 1991 1,686 1,574 530 112
PanAm 1991, 1992 1,267 1,212 753 55
TWA 2001 1,729 1,684 668 45
US Airways 2003, 2005 7,900 5,926 3,026 1,974
United 2005 16,800 13,600 6,600 3,200
----------------------------------------------------------------------------------------------------------------
Source: PBGC.
Note: ``Benefit liability'' is the value of the benefits promised to participants and their beneficiaries
immediately prior to plan termination. ``PBGC liability'' is the amount that PBGC pays after statutory
guarantee limits are imposed. ``Net claim on PBGC'' is the difference between the PBGC liability and the
assets PBGC obtains from the plan. ``Estimated participant losses,'' the difference between the Benefit
Liability and the PBGC liability, equals the value of the benefits that plan participants and their
beneficiaries lose when PBGC takes over a plan.
In recent pension terminations, because of statutory limits,
active- and high-salaried employees generally lost more of their
promised benefits compared to retirees and low-salaried employees. For
example, PBGC generally does not guarantee benefits above a certain
amount, currently $45,614 annually per participant at age 65.\18\ For
participants who retire before 65, the benefits guaranteed are even
less; participants that retire at age 60 are currently limited to
$29,649. Commercial pilots often end up with substantial benefit cuts
when their plans are terminated, because they generally have high
benefit amounts, and are also required by FAA to retire at age 60. Far
fewer non-pilot retirees are affected by the maximum payout limits. For
example, at US Airways fewer than 5 percent of retired mechanics and
attendants faced benefit cuts as a result of the pension termination.
Tables 3 and 4 summarize the expected cuts in benefits for different
groups of United's active and retired employees.
Table 3: United Airlines Active Employee Pension Termination Benefit
Cuts
------------------------------------------------------------------------
Active Extent of benefit cut
Active employees -------------------------------
Plan employees with
in plan benefit 1% to < 25% to < 50%
cuts 25% 50%
------------------------------------------------------------------------
Management, 20,784 19,231 1,696 15,885 1,650
Administrativ
e, and Public
Contact
Employees
Ground 16,062 16,062 11,448 3,441 1,173
Employees
Flight 15,024 11,109 1,305 7,067 2,737
Attendants
Pilots 7,360 7,270 3,927 2,039 1,304
------------------------------------------------------------------------
Source: PBGC.
Note: Calculation estimates made with 1/1/2005 seriatim data.
Table 4: United Airlines Retiree Pension Termination Benefit Cuts:
------------------------------------------------------------------------
Retirees Extent of benefit cut
Retirees in with -------------------------------
Plan plan benefit 1% to < 25% to <
cuts 25% 50% 50%
------------------------------------------------------------------------
Management, 11,360 2,996 2,816 104 76
Administrativ
e, and Public
Contact
Employees
Ground 12,676 4,961 4,810 121 30
Employees
Flight 5,108 29 27 1 1
Attendants
Pilots 6,087 3,041 1,902 975 164
------------------------------------------------------------------------
Source: PBGC.
Note: Calculation estimates made with 1/1/2005 seriatim data:
It is important to emphasize that relieving legacy airlines of
their defined benefit funding costs will help alleviate immediate
liquidity pressures, but does not fix their underlying cost structure
problems, which are much greater. Pension costs, while substantial, are
only a small portion of legacy airlines' overall costs. As noted
previously in figure 3, the cost of legacy airlines' defined benefit
plans accounted for a 0.4 cent, or 15 percent difference between legacy
and low-cost airline unit costs. The remaining 85 percent of the unit
cost differential between legacy and low-cost carriers is attributable
to factors other than defined benefits pension plans. Moreover, even if
legacy airlines terminated their defined benefit plans it would not
fully eliminate this portion of the unit cost differential because,
according to labor officials we interviewed, other plans would replace
them.
Concluding Observations
While the airline industry was deregulated 27 years ago, the full
effect on the airline industry's structure is only now becoming
evident. Dramatic changes in the level and nature of demand for air
travel combined with an equally dramatic evolution in how airlines meet
that demand have forced a drastic restructuring in the competitive
structure of the industry. Excess capacity in the airline industry
since 2000 has greatly diminished airlines' pricing power.
Profitability, therefore, depends on which airlines can most
effectively compete on cost. This development has allowed inroads for
low-cost airlines and forced wrenching change upon legacy airlines that
had long competed based on a high-cost business model.
The historically high number of airline bankruptcies and
liquidations is a reflection of the industry's inherent instability.
However, this should not be confused with causing the industry's
instability. There is no clear evidence that bankruptcy has contributed
to the industry's economic ills, including overcapacity and
underpricing, and there is some evidence to the contrary. Equally
telling is how few airlines that have filed for bankruptcy protection
are still doing business. Clearly, bankruptcy has not afforded these
companies a special advantage.
Bankruptcy has become a means by which some legacy airlines are
seeking to shed their costs and become more competitive. However, the
termination of pension obligations by United Airlines and US Airways
has had substantial and wide-spread effects on the PBGC and thousands
of airline employees, retirees, and other beneficiaries. Liquidity
problems, including $10.4 billion in near term pension contributions,
may force additional legacy airlines to follow suit. Some airlines are
seeking legislation to allow more time to fund their pensions. If their
plans are frozen so that future liabilities do not continue to grow,
allowing an extended payback period may reduce the likelihood that
these airlines will file for bankruptcy and terminate their pensions in
the coming year. However, unless these airlines can reform their
overall cost structures and become more competitive with low-cost
competition; this will be only a temporary reprieve.
This concludes my statement. I would be pleased to respond to any
questions that you or other Members of the Subcommittee may have at
this time.*
---------------------------------------------------------------------------
* Individuals making key contributions to this testimony include
Paul Aussendorf, Anne Dilger, Steve Martin, Richard Swayze, and Pamela
Vines.
---------------------------------------------------------------------------
ENDNOTES
\1\ While there is variation among airlines in regards to the size
and financial condition, we adhere to a construct adopted by industry
analysts to group large passenger airlines into one of two groups--
legacy and low-cost. Legacy airlines (Alaska, American, Continental,
Delta, Northwest, United, and US Airways) predate airline deregulation
of 1978 and have adopted a hub-and-spoke network model that can be more
expensive to operate than a simple point-to-point service model. Low
cost airlines (AirTran, America West, ATA, Frontier, JetBlue,
Southwest, and Spirit) have generally entered the market since 1978,
are smaller, and generally employ a less costly point-to-point service
model. The 7 low-cost airlines have consistently maintained lower unit
costs than the 7 legacy airlines.
\2\ Two other smaller carriers--ATA Airlines and Aloha--are also in
bankruptcy protection. Hawaiian Airlines just emerged from bankruptcy
protection earlier this month.
\3\ The Pension Benefit Guaranty Corporation's (PBGC) single-
employer insurance program is a Federal program that insures certain
benefits of the more than 34 million worker, retiree, and separated
vested participants of over 29,000 private-sector defined-benefit
pension plans. Defined-benefit pension plans promise a benefit that is
generally based on an employee's salary and years of service, with the
employer being responsible to fund the benefit, invest and manage plan
assets, and bear the investment risk. A single-employer plan is one
that is established and maintained by only one employer. It may be
established unilaterally by the sponsor, or through a collective
bargaining agreement.
\4\ U.S. Government Accountability Office, COMMERCIAL AVIATION:
Legacy Airlines Must Further Reduce Costs to Restore Profitability
(GAO-04-836) August, 2004.
\5\ We found all relevant data for assessing the financial
condition of the airline industry, analyses of the effects of
bankruptcy on the industry as a whole and six case studies of hub
markets affected by airline bankruptcy or service withdrawals,
interviews with industry and subject area experts, and analyses of SEC
and PBGC data to be sufficiently reliable for our purposes.
\6\ Legacy airlines' fuel costs as a percentage of total operating
costs doubled from 11.5 percent during the 4th quarter of 1998 to 22.9
percent during the 4th quarter of 2004. Fuel costs for these airlines
were $5 billion higher in 2004 than in 2003--an amount roughly equal to
their net operating losses.
\7\ Airlines may file for two types of bankruptcy. Chapter 7 of the
bankruptcy code governs the liquidation of the debtor's estate by
appointed trustees of the court. Chapter 11 of the code governs
business reorganizations and allows, among other things, companies to
reject collective bargaining agreements and renegotiate contracts and
leases with creditors with the approval of the court. Companies may
also convert from a Chapter 11 reorganization into a Chapter 7
liquidation or may liquidate within Chapter 11.
\8\ The National Commission to Ensure a Strong Competitive Airline
Industry, Change, Challenge, and Competition, A Report to the President
and Congress, August 1993.
\9\ Conversely, consolidation within the industry may help remove
some capacity. The pending merger between America West and US Airways
contemplates an airline with approximately 10 percent less total
capacity than what the two carriers now operate independently. The U.S.
Federal Government will own a significant stake in the merged company:
the Air Transportation Stabilization Board will own 11.2 percent of the
company, and the PBGC will own at least 5 percent.
\10\ Do Airlines In Chapter 11 Harm Their Rivals?: Bankruptcy and
Pricing Behavior in U.S. Airline Markets, National Bureau of Economic
Research Working Paper 5047, Severin Borenstein and Nancy L. Rose,
February 1995.
\11\ The Effect of Bankruptcy Filings on Rivals' Operating
Performance: Evidence From 51 Large Bankruptcies, Robert E. Kennedy,
International Journal of the Economics of Business; Feb. 2000; pp. 5-
25.
\12\ These estimates include only legacy airlines that continue to
sponsor defined benefit pension plans and reported their estimated
pension obligations to PBGC. Pension law provisions prohibit publicly
identifying the airlines that have reported this information.
\13\ Pension Funding Equity Act of 2004 (Pub. L. 108-218, April 10,
2004). The PFEA also changed the interest rate used to calculate future
liability from the 30-year Treasury bond to a corporate bond rate,
which effectively reduces future liabilities.
\14\ SEC data and PBGC data on the funded status of plans can
differ because they serve different purposes and provide different
information. The PBGC report focuses, in part, on the funding needs of
each pension plan. In contrast, corporate financial statements show the
aggregate effect of all of a company's pension plans on its overall
financial position and performance. The two sources may also differ in
the rates assumed for investment returns on pension assets and in how
these rates are used. As a result, the information available from the
two sources can appear to be inconsistent. PBGC data also are not
timely. For more information, see GAO, Private Pensions: Publicly
Available Reports Provide Useful but Limited Information on Plans'
Financial Condition (GAO-04-395) March 31, 2004.
\15\ These 101 cases covered 18 pension plans sponsored by 5
airlines.
\16\ Pension funding rules permit sponsors to choose the interest
rate used to determine the maximum deductible pension contribution
permitted from an interest rate ``corridor''--a limited range of
interest rates. In calculating the maximum deductible contribution, a
higher interest rate produces a lower deductible contribution limit.
The maximum deductible contributions referred to in this paragraph and
figure 9 are calculated using the lowest interest rate permissible from
the interest rate corridor.
\17\ For further information, see U.S. Government Accountability
Office, PRIVATE PENSIONS: Recent Experiences of Large Defined Benefit
Plans Illustrate Weaknesses in Funding Rules, GAO-05-294, (Washington,
D.C.: May 31, 2005).
\18\ This guarantee level applies to plans that terminate in 2005.
The amount guaranteed is adjusted: (1) actuarially for the
participant's age when PBGC first begins paying benefits and (2) if
benefits are not paid as a single-life annuity. Because of the way the
Employee Retirement and Income Security Act of 1974 (ERISA), as
amended, allocates plan assets to participants, certain participants
can receive more than the PBGC guaranteed amount.
Senator Burns. Thank you. Now we have Mr. Jim May,
President and CEO of the Air Transport Association here. Thank
you for coming.
STATEMENT OF JAMES C. MAY, PRESIDENT/CEO,
AIR TRANSPORT ASSOCIATION OF AMERICA, INC.
Mr. May. Thank you, Mr. Chairman, and thank you, Co-
Chairman Inouye, for allowing us to appear today. My starting
point discussed at length in our written comments is the
financial state of the industry. And unquestionably, as we all
have acknowledged, the last few years have been our most
difficult. 2001 to 2004 aggregate net losses were $32.3
billion, and it has left our airlines deeply in debt, which is
a related issue that we need to be sensitive to. At the end of
2004, the industry's net was more than $81 billion with a debt-
to-capital ratio of 110 percent.
Now, my comments will focus on why a financially stable
airline industry is important to this country, the key factors
inhibiting industry financial stability, and some of the things
that we think need to happen in order to regain, not just
stability, but sustainable growth in profit. Simply put, a
stable industry, including both the passenger and cargo
airlines, is critical to a healthy and robust U.S. economy.
Pulitzer prize-winning economist Dan Gergen released his latest
book last week and said as follows: ``every day the airline
industry propels the economic takeoff from our nation. It is
the great enabler, leading together all corners of the country,
facilitating the movement of people and goods that is the
backbone of economic growth. And it also firmly imbeds us in
that awesome process of globalization that is defining the 21st
Century.''
Now, the alternative to this vision is a wounded industry
unable to provide the air transport demanded by the shipping
and traveling public and unable to provide a return to
shareholders. It is not an acceptable alternative. Over the
past 4 years, airlines have engaged in dramatic efforts to
reduce those costs that are within our control, and I'd like to
stress that point. Reduce those costs that are within our
control. Out of adversity, we have transformed ourselves in
many ways, capital spending, $9.5 billion, a 62 percent
reduction from year 2000 levels. Pay and work rule changes were
hammered out to achieve a 20 percent productivity improvement.
Operating costs have been trimmed, even to the point of
removing pillows and pretzels, and operations have been
streamlined to reduce fuel burn, and we have improved overall
system efficiency, closed up, eliminated routes, and taken down
frequencies.
Now, in this difficult and painful process, as my good
friend Mr. Roach knows, 135,000 dedicated men and women have
lost their jobs. That's an 18 percent reduction from August of
2001.
Unfortunately, the benefits of these changes that have been
made which brought the cost structures of the older network
carriers much closer to those of their younger low-cost
brethren, and I have a small disagreement with the first
witness here on that point because I think we have reduced and
narrowed the cost differences with the low prices have been
more than offset by costs the airlines can't control; fuel,
taxes, and fees. Unfunded mandates, in particular those
unfunded mandates caused by security imperatives. And with oil
trading at an all-time high and the price of jet fuel
skyrocketing, and my colleague to my left will talk about the
difference between the crack spread, which is the difference
between what oil is trading, and what we are actually paying
for jet fuel for airplanes. This industry cannot achieve a
sustained profit sufficient to repair the damage of the last 4
years.
We are looking at a rolling 12-month forecast for the price
of oil to stay above $60 a barrel. Now, in short, those high
fuel prices are overwhelming our ability to achieve
profitability. It's noted that X fuel minus the cost of the
increased fuel, a number of our carriers would have had the
most profitable second quarters in their history, so it's those
external costs.
We are delighted at reports of improved revenues and system
yields at some of the carriers, and certainly the possibility
that one or two airlines might even report some small profits
for the second quarter of this year, but domestic yields in
particular are still weak and it remains to be seen if these
revenue improvements will carry over into the fall and the
winter quarters. At current oil prices, we predict a net
industry loss for the year 2005 in excess of $5 billion.
Now, our industry recovery is also inhibited by the many
taxes and fees it must contend with, and I think this is an
area where the government and this Congress could help more by
doing less. Airlines will pay more than $15 billion in taxes
and fees in 2005, resulting in the highest tax rate of any
industry, according to one respected Wall Street analyst. Even
a modest reduction of the tax burden will help restore the
industry to financial health, facilitate jobs and economic
growth and it's not a new or revolutionary idea that I'm
suggesting to you. More than 10 years ago, the national
Commission to ensure a strong, competitive airline industry,
the so-called Nanetta Commission, recommended, ``the industry
be released of its unfair tax burden''. Now, that was 10 years
ago. Looking forward, I think there is a tremendous opportunity
for positive action approaches. Together, we have a chance to
reshape the FAA's air traffic control system to meet current
and future needs, and reduce our costs in that system. Our
antiquated air traffic control system based on ground-based
radars should be retired to the Smithsonian, where it can be
admired as one of the marvels of 1950s technology. I think we
need to proceed swiftly and purposely with the creation of the
new satellite GPS-based system, one that will reduce costs,
relieve congestion, authorize traffic flow, and open up air
space for future growth. If the industry is to achieve
sustained profitability, it is imperative that Congress and the
FAA do three things.
First, establish an ATC funding mechanism that distributes
costs equitably among all system users, creating a reliable
funding stream that's bonding and flexible enough to
accommodate changes in the way the system is used. We need to
have the FAA operate the ATC more efficiently, including
consolidating unnecessary facilities, decommissioning obsolete
facilities and equipment, and rationalizing the workforce.
There are 14,000 different communications entities within
the FAA as part of the air traffic control system. That is
unsafe.
Finally, the FAA must develop and implement procedures and
technologies that will increase current system capacity and
efficiency as quickly as possible, and that will enable future
growth.
Mr. Chairman, with the health of the airports or the re-
authorization of the airports, and not only this industry and
this committee, I think it's time for an exercise in very
difficult choices. If together we do it right, we are going to
lay the foundation for a bright future for the airlines and the
economy that we enable. We are going to be attacking those
costs that we can't attack without your help, and we are going
to continue to attack the costs that we have some control over
in our own systems. Thank you for the opportunity to appear.
[The prepared statement of Mr. May follows:]
Prepared Statement of James C. May, President/CEO,
Air Transport Association of America, Inc.
The Air Transport Association of America, Inc. (ATA) appreciates
the opportunity to comment on the financial health of the U.S. airline
industry. Unfortunately, the overall financial picture remains grim
because the price of oil continues to surge. Increasing oil and fuel
prices have offset the recent modest improvement some carriers have
experienced on the revenue front. We would like nothing better than to
dwell on what little good news there is, but to do so would be
misleading. The truth is, the financial health of the U.S. airline
industry remains poor, and the industry still has a long way to go
before it can be declared healthy again.
The Current Industry Snapshot
The U.S. airline industry in 2005 remains in critical condition and
is poised to add over $6 billion to the $32.3 billion in losses
incurred between 2001 and 2004. The current state of the industry is
the result of factors and events that have altered industry
fundamentals. The fact that industry fundamentals have changed
distinguishes this down-cycle from all prior cycles.
One fundamental that has changed is that spending on air travel has
dropped to 0.7 percent of U.S. GDP from its historical level of between
0.9 and 1.0 percent of GDP. This means that on a proportional basis
Americans today are spending considerably less on flying than in
previous years--amounting to roughly $29.5 billion annually. If
spending had slipped to just 0.8 percent of GDP, the industry's
financial condition would be markedly different.
All airlines have been affected by these fundamental changes, and
all airlines have responded in kind by sharply reducing or limiting
controllable costs, paring back capital spending, revising long-
standing collective bargaining agreements, streamlining operations, and
improving productivity. While there may be pockets of such costs still
to be addressed at some airlines, no one should forget that more than
100,000 employees--one out of six--have lost their jobs since 9/11.
There is no question that the airline industry has drastically reduced
controllable costs.
Notwithstanding these Herculean efforts, industry profitability
remains elusive, and the timing of the industry's return to
profitability is unclear. While recently there have been some hoped-for
signs of recovery, those signs have been inconsistent and the
industry's financial health remains dependent on many factors outside
of its control: a strong economy, effective security worldwide, reduced
or stable oil prices, and an air traffic control system that will
accommodate, safely and efficiently, the growth demanded by the
American public.
Notwithstanding these financial challenges, it should not be
overlooked that airline safety has remained rock solid. ``Safety
first'' remains the core industry value. In 2004, the National
Transportation Safety Board (NTSB) reported only one fatal accident in
over 10 million scheduled departures. In the three years 2002-2004,
there were just three fatal accidents in 31 million scheduled
departures. In those three years, airlines providing Part 121 scheduled
operations carried nearly 1.9 billion passengers. Without question,
scheduled air service is incredibly safe.
The events and factors that knocked the U.S. airline industry into
a condition requiring the equivalent of intensive care are well known
and need not be repeated here. However, there are certain factors that
warrant further attention because they continue to adversely affect the
industry's financial condition. The common thread running through these
factors is that they are beyond the direct control of the airlines.
1. The Cost of Fuel Forecloses Financial Recovery
The simple truth is that, but for the high price of fuel, the U.S.
airline industry today could earn a small profit. As industry
fundamentals go, the price of fuel is the most significant force
affecting the industry today. For the ten year period 1992-2001, the
median price of crude oil was $19.90. Even in 2001 and 2002, crude oil
was relatively stable in the $25-$26 range. In 2003, the average price
jumped to over $31 a barrel, and in 2004 the average price jumped again
to more than $41 a barrel. Today, crude is over $60 per barrel, and the
2005 price is expected to average at least $52 per barrel. In fact, the
twelve month rolling forecast currently has crude oil at over $60 per
barrel through July 2006.\1\ In essence, oil prices have nearly doubled
in two years, and when compared to the 1992-2001 median average they
have tripled.
---------------------------------------------------------------------------
\1\ Fimat, Energy Overview (July 8, 2005), found at http://
research.fimat.com/dominoapps/fimatres.nsf/
C5934649E5F8BDB886257038004DFC75/$FILE/tcc1_new.pdf.
Jet Fuel prices have mirrored the price of crude oil, and 2005
prices are expected to surpass the 2004 record prices. The true cost
impact on the airlines of this unprecedented increase is staggering and
virtually defies comprehension. As the charts below show, the
industry's 2004 jet fuel expense would have been $11.8 billion at the
average price paid during the 1992-2001 period, compared to the actual
$21.4 billion paid in 2004. We now expect the industry fuel bill to
rise another $6.7 billion in 2005, to more than $28 billion, assuming
fuel consumption remains unchanged. At some airlines, fuel costs now
exceed personnel costs as the number one expense category.\2\
---------------------------------------------------------------------------
\2\ Jet Fuel Expense Surges Past Personnel Costs, MSNBC.com (July
11, 2005).
Given the vigorous competitive climate of the industry, discussed
below, airlines have not been able to include in ticket prices the
increased cost of fuel. To cover the jet fuel price increases from 2003
to 2004, for example, passengers would have had to pay on average an
additional $21 per ticket. Yet ticket prices during this period fell
because of intense competition. The industry would be in a much
different, healthier condition had the airlines been able to pass on
their actual fuel costs.
An operating fundamental of the industry is that airplanes run only
on jet fuel. There is no alternative. The related economic fundamental
is that the dramatic change in the price of fuel now appears to be
permanent. The days of $20-$35 per barrel oil are over. We will be
fortunate if the price slips back to $40-$50 per barrel. Given the
worldwide demand for oil products and finite refining capacity,
particularly in the U.S., some analysts predict even higher prices. A
recent Goldman Sachs report suggests prices may rise as high as $105
per barrel.\3\ Moreover, the market is highly susceptible to any
possible supply disruption, as the price spike in anticipation of
tropical storm Arlene in early June illustrated.\4\ On June 17, oil
surged to a then-all time high--exceeding $58 per barrel--over concerns
about both supply and refining capacity.\5\ Last week, oil prices
eclipsed $60 per barrel, continuing an apparently inexorable climb
upward.
---------------------------------------------------------------------------
\3\ Goldman Sachs, ``U.S. Energy: Oil--Super Spike Period May be
Upon Us,'' March 30, 2005.
\4\ A June 10, 2005 report issued by the Energy Risk Management
Group of Fimat, for example, stated: ``The response to Arlene's
approach shows with brutal clarity how sensitive the market is to any
possible supply disruption. With the potential impact on production and
transportation at least part of the rally was justified. . . . The
storm headlines surprised and prompted waves of short covering and
possibly a moderate amount of fresh speculative buying, as well.''
http://research.fimat.com/dominoapps/fimatres.nsf/
0B9A9C6DBB71AF2E8625701C004AA162/$FILE/tcc1_new.pdf.
\5\ ``Oil Prices Surge All-time High,'' MSNBC, June 17, 2005, at
http://www.msnbc.msn.com/id/5612507.
---------------------------------------------------------------------------
The increase in the price of fuel has been rapid and dramatic.
Because of the complexity of market forces at play in the airline
industry, this fundamental economic change strongly affects the cost
side of the ledger, increasing the revenues needed for profitability.
As a result, complete recovery--defined by a return to profitability--
remains foreclosed. When the industry might achieve profitability
remains uncertain. As one market analyst observed recently:
On a non-fuel basis, operating profitability . . . is as good
as it was in the late 1990s. While these facts are exciting . .
., they may also be totally moot if oil prices do not return to
[historical norms] . . . Unfortunately, high fuel prices are
consuming what would otherwise be an upcycle for the
industry.\6\
---------------------------------------------------------------------------
\6\ Gary Chase, Lehman Brothers, ``Industry Update,'' March 15,
2005.
2. Taxes and Fees Weigh Down the Industry
The industry continues to be weighed down by excessive taxes and
fees imposed on airlines and their customers. The negative economic
impact of these taxes and fees is a drag on the industry and hampers
its ability to return to profitability. This is one area in which the
government could help more by doing less. As one analyst has noted:
[T]he airline industry pays the highest Federal tax rate of any
industry as it continues to lose massive amounts of money
through user and security taxes that amount to an estimated 10
percent of revenues . . . in reality, in a highly competitive,
weak revenue environment, the taxes are paid for by the
airlines . . .
Ray Neidl, Speech at the National Air Service Conference
(January 24, 2005).
The tax and fee burden on airlines operating in, to, and from the
U.S. exceeded $14 billion in FY 2004 and are expected to exceed $15
billion in 2005. This tax burden distorts the normal functioning of
market forces and fundamentally depresses the industry. Nonetheless,
the appetite for taxing the industry remains strong. Since 1988, the
average tax on a $200 domestic round-trip ticket has increased 250
percent, while average domestic yields have actually declined 3
percent. This is so despite the 1993 recommendation, made by the
National Commission to Ensure a Strong Competitive Airline Industry, to
relieve the industry of its ``unfair tax burden.'' \7\
---------------------------------------------------------------------------
\7\ ``Tax policies often have had a major and adverse effect on the
industry. Although the Commission concluded that tax changes alone will
not restore the industry to profitability, we believe there are several
tax provisions that impede the ability of the industry to return to
financial health. We believe those provisions violate reasonable
principles of common sense and good public policy and we are of the
opinion changes must be made to relieve the airline industry's unfair
tax burden.'' Change, Challenge and Competition: A Report to the
President and Congress (August 1993), The National Commission to Ensure
a Strong Competitive Airline Industry.
Aviation taxes have outpaced inflation and prices, and air
transportation is taxed at a higher rate than the consumption of beer
and liquor, telephone service, and most notably, bus and rail
transportation, which face no Federal travel tax.
Federal Consumption Taxes and Fees High on Flyers*
Uncle Sam Taxes Low-Priced Air Travel Above Sins, Luxuries, and Other
Modes
------------------------------------------------------------------------
Product Percent Product Percent
------------------------------------------------------------------------
Plane Ticket: One-Stop 44.2 Heavy Firearms / 11.0
($100) \1\ Ammunition
Plane Ticket: Non-Stop 25.6 Distilled Spirits ($20) 10.7
($100) \1\ \4\
Plane Ticket: One-Stop 25.6 Sport Fishing Equipment 10.0
($200) \1\
Plane Ticket: One-Stop 19.4 Pistol or Revolver 10.0
($300) \1\
Pack of Cigarettes 18.2 Can of Beer ($1.00) \5\ 5.0
($4.50) \2\
Plane Ticket: Non-Stop 16.3 Luxury Vehicle (Portion 3.0
($200) \1\ > $40K)
Plane Ticket: Non-Stop 13.2 Telephone Service 3.0
($300) \1\
Arrow Components 12.4 Elec. Outboard Motors / 3.0
Sonar \6\
Heavy Truck / Trailer / 12.0 Ship Ticket ($1,000) \7\ 0.3
Tractor
Gallon of Gasoline 11.5 Bus Ticket 0.0
($1.60) \3\
Bows 11.0 Rail Ticket 0.0
------------------------------------------------------------------------
\1\ Roundtrip with federally approved $4.50 PFC.
\2\ Taxed at 82 cents per pack.
\3\ Taxed at 18.4 cents per gallon.
\4\ Taxed at $2.14 per 750-milliliter bottle.
\5\ Taxed at 5 cents per can.
\6\ Up to a maximum of $30.00.
\7\ Taxed at $3.00 per ticket.
Note: The Federal Government also taxes the sale of tires over 40
pounds, coal, wine, vaccines, foreign-issued insurance, and selected
other items.
*Analysis considers Federal taxes and fees only; does not examine the
broader impact of State and local taxes, which can be especially high
on alcohol and tobacco.
Sources: ATA research; Internal Revenue Service; Bureau of Alcohol,
Tobacco & Firearms.
ATA appreciates this Committee's efforts to upend the
Administration's proposed increase of the passenger security fee for FY
2006. As this Committee is well aware, security fees and taxes account
for a significant portion of the overall tax and fee burden on the
industry. In FY 2005, we estimate that the industry will provide to DHS
over $3.2 billion in direct fees and taxes. Add to this the foregone
revenue from certain federally mandated programs and the out-of-pocket
expenses for other unfunded mandates, and very quickly the industry's
annual security cost burden exceeds $4 billion. That number will only
increase as more passengers fly. Yet the Administration and Members of
Congress continue to discuss and debate several new mandates.\8\ The
airline industry cannot be expected to achieve profitability if the
government continues to impose more and more taxes, fees, and unfunded
mandates.
---------------------------------------------------------------------------
\8\ These include, but are not limited to, installation and
maintenance of counter-manpads devices, additional in-line EDS baggage
screening equipment, increased cargo screening on passenger and all-
cargo flights, implementation of the DHS Secure Flight passenger
screening program, and promulgation of a rule requiring airlines to
transmit passenger manifest and related passport data one hour before
departure of in-bound international flights.
---------------------------------------------------------------------------
Unfortunately, the ``cash cow'' view of the airline industry
infects the rest of the world. Several G-8 member states recently
proposed a ``solidarity tax'' on airplane tickets as a mechanism to
raise money to assist developing countries address health and welfare
needs. In the view of these countries, because the airline industry
facilitates globalization, and because ``airline passengers seldom
belong to the poorest segments of the population,'' a tax on air
transportation is justified. The problem with this approach, of course,
is that it is basically an ``ends justify the means'' argument and
could apply to any number of issues regardless of merit.
As we have said previously, it does not matter whether a tax or fee
is imposed on passengers or airlines. It is the imposition of the tax
that is significant,\9\ with the result being that the more the
government collects for air travel, the less the airlines are able to
charge. As Treasury Secretary Snow has stated, ``Economics tells us
that anything you tax, you get less of. That's why high marginal taxes
. . . are a bad idea--they kill jobs.'' In our view, with the right tax
policy, the government can foster job creation and financial stability
in the industry.
---------------------------------------------------------------------------
\9\ ``The statutory incidence of a tax indicates who is legally
responsible for the tax. . . . Because prices may change in response to
the tax, knowledge of statutory incidence tells us essentially nothing
about who is really paying the tax. . . The [economic] incidence of a
unit tax is independent of whether it is levied on consumers or
producers. . . In general, the more elastic the demand curve, the less
the tax borne by consumers. . . The key point to remember is that
nothing about the incidence of a tax can be know without information on
the relevant behavioral elasticities.'' Public Finance (4th Ed.),
Harvey S. Rosen (Princeton University Department of Economics).
---------------------------------------------------------------------------
Unfortunately, excessive taxes on the airline industry are
crippling a vital segment of our economy. The U.S. airline industry
plays a major role in driving the commerce of the United States and the
growth of our national economy. An economically crippled airline
industry is a drag on the national economy and ultimately will prevent
it from realizing its full potential. Robust air transportation is
critical to sustaining our recovery and catalyzing the next round of
growth essential to our nation's economic competitiveness. As airline
job losses continue to mount, and service to small- and mid-size
communities is cut, it is not simply the airlines and their employees
who are suffering; it is the broader economy that feels the results.
Air transportation grows both the national and local economies--its
absence reverses that effect.
3. Pricing Power Remains Inadequate for Airlines To Recover Costs
Throughout 2004, and well into 2005, U.S. airlines were unable to
raise prices. Numerous efforts failed because of the intense
competitive nature of the industry and the fundamentals of supply and
demand. Market analysts uniformly observed that all airlines lacked
pricing power to pass through increased costs. For example:
[L]egacy carriers and LCCs continue to fight strenuously for
market share with a complete lack of pricing power creating an
anemic revenue environment . . . Fuel . . . remains a major
factor in the industry's inability to make a profit, and we
remind investors that this is not the first time the airlines
have been faced with tough year over year comps. However, this
is the first time that carriers have not been able to pass
these costs on to the consumer as evident by several failed
fare increases and the declining yields.
Reno Bianchi and Steven K. Burton, Citigroup Corporate Bond
Research, Airline Industry Research Report, December 21, 2004.
The following chart illustrates the lack of pricing power from
January 2001 through the first quarter of 2005 by tracking mainline
passenger yields:
Recently, airlines have been able to maintain some price increases,
and this modest success offers a glimmer of hope for the future. At
this point, however, it remains only a glimmer. During the second week
of June, for example, multiple attempts at fare increases failed under
competitive pressures.\10\ Passengers remain extremely price sensitive,
and price competition among all airlines is robust.\11\ Consequently,
even low-cost airlines are not sanguine about increasing revenue
through fare hikes, as confirmed by Independence Air's Eric Nordling:
``The flying public is highly elastic; it is very sensitive to price.''
\12\
---------------------------------------------------------------------------
\10\ ``Airfare Momentum Stalls After Successive Price Hikes,''
Business Travel News, June 7, 2005; ``Airline Profits Are So Close, Yet
Still So Far,'' New York Times, June 12, 2005; ``Northwest Pulls Fare
Increase,'' Aviation Daily, June 14, 2005.
\11\ ``[Several airlines] raised fares on some routes, then cut
them a day or two later when bookings fell . . .'' ``Even if they
wanted to take advantage of the heavy demand for summer travel, the big
airlines do not have carte blanche to raise fares, because low-fare
airlines keep them from doing so.'' New York Times, June 12, 2005.
\12\ Id.
---------------------------------------------------------------------------
The simple truth is that if the airlines could raise their prices
to cover fuel costs and the many taxes and fees they pay, they would
have done so by now. They haven't, and basic marketplace principles--
competition and elasticity--are continuing to prevent them from doing
so. It remains to be seen when, if ever, pricing power returns to the
point where profitability can be restored notwithstanding increasing
fuel prices.
4. Expanding the Air Traffic Control System's Capacity and Enhancing
ATC Productivity Is Critical to the Financial Health of the
Industry
The American people want convenience and value for their money.
That is why they are flying in record numbers this summer. U.S.
airlines provide safe, convenient, and reliable service at a fair
price.\13\ Maintaining system reliability, however, is becoming
increasingly difficult as airlines, responding to marketplace demands
for service, add flights. The financial health of the industry--today
and in the future--depends in part on the ability of the FAA's Air
Traffic Control (ATC) system to provide the capacity needed to meet not
only the demand for scheduled passenger and cargo operations, but also
the growing appetite of the non-scheduled sector, including air taxis,
business jet operations and, in the near future, Very Light Jets.\14\
---------------------------------------------------------------------------
\13\ Adjusted for inflation, domestic airfares, net of taxes, have
dropped 51 percent over the past 25 years.
\14\ Year One--Taking Flight: 2004 Annual Performance Report,
Federal Aviation Administration, Air Traffic Organization (March 2005)
(the ``ATO 2004 Annual Report''), p. 23.
---------------------------------------------------------------------------
Inadequate ATC system capacity will stymie airline growth and the
ability of the industry to achieve and maintain financial health. That,
in turn, will adversely affect the commerce of the United States and
the American public. Without a dramatic change in the way our nation's
airspace is managed, congestion and resulting delays will be
overwhelming for consumers and businesses alike. As it is, 86.5 million
ATC delay minutes were responsible for adding an estimated $6.2 billion
to direct operating costs for U.S. airlines in 2004. The FAA is
predicting that by the end of 2005 commercial aviation flights will
have regained the peak levels of 2000.\15\ Operations at en route
centers actually have surpassed the number handled in 2000.\16\
---------------------------------------------------------------------------
\15\ ATO 2004 Annual Report, p.23.
\16\ Next Steps for the Air Traffic Organization, Statement of the
Honorable Kenneth M. Mead Before the Committee on Transportation and
Infrastructure, Subcommittee on Aviation, United States House of
Representatives (April 14, 2005) p. 2 (Mead Testimony), p.2.
---------------------------------------------------------------------------
Just maintaining the safety and efficiency of our air traffic
system at the current level of operations is not an option. The FAA
will have to increase system capacity and productivity to accommodate
an estimated 25 percent increase in the volume of air traffic in the
next decade.\17\ In fact, the Joint Planning and Development Office is
seeking to expand capacity by as much as 300 percent by 2015 to
accommodate changes in aircraft size as well as the projected growth in
demand.\18\ ATA members support these efforts.
---------------------------------------------------------------------------
\17\ Federal Aviation Administration, Aerospace Forecasts, Fiscal
Years 2005-2016, Table 36, X-37.
\18\ Joint Planning and Development Office, Next Generation Air
Transportation System Integrated Plan (December 2004), p. 8.
---------------------------------------------------------------------------
The alternative, measures that restrict operations such as those
imposed at Chicago's O'Hare International Airport, are unacceptable.
Arbitrary restrictions on operations will undermine the public benefits
Congress envisioned when it deregulated the industry. Ultimately, such
restrictions will add new operating costs as access to the system is
rationed. Indeed, within the Administration, the notion of ``market-
based'' solutions to allocate landing and take-off rights at certain
airports is gaining currency already. These solutions could result in
new fees and charges that airlines would have to pay. Realistically,
given the fierce price competition within the industry, it is unlikely
these new charges could be passed on to customers.
The solution lies in a modernized ATC system that uses technology
and operational measures to increase capacity and enable growth. In the
near term, consolidating facilities and decommissioning outdated
equipment and procedures should provide help at the margins. Capacity
of the current system can be increased by leveraging existing on-board
technologies and creating new satellite-based routes that are more
flexible than existing routes; gains can also be achieved by doing a
better job keeping slower airplanes separated from faster moving
airplanes. A key measure is to manage the ATC system from a national
perspective instead of the current patchwork of airspace components,
each managed individually. This locally-driven system creates too many
opportunities for bottlenecks and inefficient use of the airspace from
a total system perspective. Looking forward, any new system must be
built on a scalable architecture that maximizes flexibility and ease of
growth.
Conclusion
The U.S. airline industry remains in dire financial condition, with
several airlines in Chapter 11 and other airlines facing that
possibility as oil prices continue to climb. The prospects for a return
to stability and profitability remain uncertain in light of factors
largely out of the control of the airlines. Nevertheless, it can be
said that a glimmer of hope is on the horizon. People are flying again
in record numbers, and airline cost-cutting measures are having a
positive impact.
Looking forward, Congress and the Administration will play a
significant role in the financial health of the industry. The tax and
fee burden remains excessive and should be reduced. By no means should
new taxes and fees be added, no matter what the purpose. Further, when
the Aviation Trust Fund comes up for reauthorization in 2007, it will
be imperative that Congress support the FAA's efforts to expand ATC
system capacity to permit expected industry growth. At that time,
Congress should adopt a new funding formula that fairly apportions
trust fund contributions among system users according to their use of
the ATC system.
Senator Burns. Thank you. Mr. Jamie Baker, Vice President,
JPMorgan Securities, Incorporated, thank you for coming this
morning.
STATEMENT OF JAMIE N. BAKER, VICE PRESIDENT,
U.S. EQUITY RESEARCH, JPMorgan SECURITIES, INC.
Mr. Baker. Thank you. Chairman Burns, members of the
Committee, I do want to thank you for the opportunity to in
fact speak here this morning. Again, my name is Jamie Baker.
I'm the U.S. airline equity analyst at JPMorgan. Please do take
note that the statements that I make here today don't reflect
the official position of JPMorgan on these issues.
Let me start out by emphasizing that, and echoing some of
the recent testimony that it is in fact fuel prices, not
industry mismanagement, that can primarily explain why we have
convened here today. Fuel prices are continuing to mask an
underlying recovery in the airline industry, of which many are
not aware, and I would suggest that with the exception of fuel,
all of the relevant industry cockpit gauges, if you will, are
in the green for the first time since September 11.
Ex-fuel costs for the legacy carriers have not been this
low since 1997, and they are, in fact, headed lower. If you
exclude one-time non-cash and focus on core costs, those that
suggest future performance, then legacy carriers have in fact
decreased their cost disadvantage to the low-cost carriers by
nearly 50 percent. Air fares and revenues both continue to rise
with no apparent negative offset on demand. U.S. capacity,
while still growing is in fact growing at a slower rate than
many of us feared at the beginning of this year. If in fact
fuel casts were hypothetically not an issue, both American and
Continental Airlines would have just enjoyed their most
profitable second quarters in their corporate histories. While
we are not suggesting legacy carriers can fully match the
efficiency of some of the smaller, low-cost competitors, the
gap between the two is clearly diminishing. But unfortunately,
these carriers that I'm employed to follow, they don't fly
gliders, and therefore stripping out fuel expenses is merely an
analytical exercise. Despite nearly a dozen mostly successful
efforts at raising air fares this year, we estimated only $7
per barrel of crude has managed to be offset leaving the
effective price of that still above historic norms. As such,
liquidity is expected to decline significantly.
Delta and Northwest will burn through more than $1 billion
in cash this year inclusive of the capital they have raised
here today, and furthermore, the industry's ability to go
deeper into debt, while seemingly never exhausted, is rapidly
diminishing. Since 2000, airlines have borrowed more than $27
billion. They have seen their credit ratings fall
substantially, and while legacy airlines have begun turning to
nontraditional sources of capital such as the hedge fund
community and the manufacturers, I think the ability to further
tap these resources are unlikely unless pension reform can
positively impact their credit ratings.
Delta has disclosed that its projected minimum pension
funding requirements under current rules will increase to $600
million in 2006, and to more than $1.5 billion by 2008.
Similarly, at Northwest, they are estimating $800 million for
requirements for 2006 and $1.7 billion for 2007. For this
obvious reason, both Delta and Northwest are likely to seek
bankruptcy protection and follow the damaging precedent set by
United Airlines in terminating its defined benefit program.
That is unless we are allowing for long-term amortization
period of deficits for sponsors agreeing to freeze their DB
plans comes into law, and I would suggest sometime within the
next 6 months or so.
These are not my analytical opinion. The broader market
implies between a 55 and 59 percent one-year bankruptcy
probability for Northwest and Delta. For American and
Continental, arguably two better positioned carriers, the
implied bankruptcy probability over the next 4 years is roughly
the same. I point out that these figures have actually worsened
since my colleague, Mark Streeter, testified before the House 3
weeks ago.
But legacy Chapter 11 filings, and the accompanying toll on
workers, and likely service decline to smaller communities,
these are not necessarily inevitable occurrences. Legacy
airline management would much prefer to avoid the Chapter 11
process and instead be left alone to do what they currently
are, further reducing their competitive disadvantage to the
more youthful and fit, those carriers that have sprung up since
deregulation.
Now, if the government sponsors the flexibility to stretch
payments over a period of several years, the sponsors, they
must be forced to maintain fiscal discipline in my opinion. The
price to legacy carriers of potential pension reform should
include at a minimum restrictions on their ability to
repurchase stock, pay dividends, or offer increased defined
benefits, even if funded with cash.
Members of the Committee, if the proposed pension
legislation not supported by the legacy airlines does become
law, I agree with the broader market that both Delta and
Northwest will be forced to file bankruptcy within the next
year or so. The ability of these carriers to complete their
ongoing restructuring outside of the court process is almost
directly tied to pension reform that does not result in onerous
near-term deficit reduction contributions. With United having
already sought its subsidy and therefore having set a damaging
precedent, the government instead has an opportunity to allow
other carriers the opportunity to make good on promises that
they have already made to their employees, while further
protecting taxpayers in the process. Thank you again for the
opportunity to speak here this morning.
[The prepared statement of Mr. Baker follows:]
Prepared Statement of Jamie N. Baker, Vice President,
U.S. Equity Research, JPMorgan Securities Inc.
Chairman Burns and members of the Committee, thank you for inviting
me to speak this morning. My name is Jamie Baker, I am the U.S. Airline
equity analyst at JPMorgan. I would like to provide the Committee with
an overview on the U.S. airline industry, its ongoing efforts at
recovery, and how the pension issue and other factors will continue to
impact this recovery. I will also focus certain comments on the
remaining legacy airline defined benefit plan sponsors, AMR Corp,
Continental Airlines, Delta Air Lines, and Northwest Airlines. Please
note that my testimony and statements are my personal views and do not
represent the official position of JPMorgan.
Fuel Is Masking Fundamental Recovery
Unfortunately for the airlines, fuel costs are masking a
fundamental recovery that is well underway. Were an industry cockpit to
exist, we would suggest all non-fuel gauges would be reading into the
green, the first such instance since September 11, 2001. For example,
ex-fuel unit costs haven't been this low since 1997, and they are
expected to head lower still. Airfares and revenue are both continuing
to rise, with no apparent offset on demand. Capacity, while still
increasing domestically, is rising at a slower growth rate than feared,
with the majority of that growth coming from low-cost carriers. In
fact, if fuel were not an issue, both American and Continental would
have just concluded their most profitable second quarters in their
history. While it is not our intent to suggest that legacy carriers can
fully-match the efficiency and cost competitiveness of their smaller,
low-cost carrier competitors, the chasm between the two sub-sectors is
continuing to diminish.
But Fuel Is a Reality, and Legacy Airlines Don't Fly Gliders
Regrettably, stripping out fuel expense is but a mere analytical
exercise. Jet kerosene prices have actually risen by a greater degree
than raw crude, in part given the shortage of refinery capacity. Year-
to-date, jet kerosene has risen 44 percent vs. a 39 percent increase in
the price of crude.
Despite nearly a dozen, mostly successful efforts at raising fares
in 2005, we estimate that merely $7 per barrel of crude agony has
managed to be offset, leaving the effective price of that commodity
still well above historic norms. While carriers will likely continue
pressing fares higher this year and beyond, each successive fare
increase is expected to generate a diminishing return, given the price-
sensitivity of demand.
Liquidity Is Under Pressure
Legacy airline liquidity is expected to decline significantly in
2005. We estimate that Delta and Northwest will each burn through more
than $1 billion this year, inclusive of the capital raised year-to-
date, unless assuming cash reserves can somehow be replenished.
The industry's ability to go deeper into debt, while seemingly
inexhaustible, does appear to be rapidly diminishing. Since 2000, U.S.
Airlines have borrowed more than $27 billion, and have witnessed
substantial declines in their credit ratings. And while legacy airlines
have been turning to non-traditional lenders, such as hedge funds and
the manufacturers, the ability to further tap these resources is
unlikely, unless pension reform can positively impact their credit
standings.
Our Bankruptcy Probabilities Are Largely Shared By the Market
By looking at credit market implied cumulative default
probabilities (a more accurate analysis, in our opinion, than relying
on equity values), the market ascribes between a 55 percent and 59
percent probability that Northwest and Delta will file bankruptcy
within the next 12 months. Implied one-year risk for American and
Continental, arguably two better-positioned carriers, is significantly
lower, though their implied bankruptcy probability over the next four
years remains in the mid-to-high 50 percent range.
Exhibit V: Credit Market Implied Cumulative Default Probabilities
Cumulative Default Probability Before Time Period Expires (in percent)
----------------------------------------------------------------------------------------------------------------
1 year 2 years 3 years 4 years 5 years 7 years 10 years
----------------------------------------------------------------------------------------------------------------
AMR 12.5 29.1 45.2 57.1 61.1 69.9 80.0
CAL 14.6 30.5 44.4 54.9 64.6 72.3 82.0
DAL 59.0 75.6 80.1 85.0 87.8 93.9 97.8
NWAC 54.7 71.1 73.8 80.8 84.0 91.8 96.6
----------------------------------------------------------------------------------------------------------------
Source: JPMorgan, based on July 8, 2005 credit default swap quotes assuming 10 percent recovery in bankruptcy.
Can the Airlines Raise Additional Capital?
As of late, legacy airlines have been turning to non-traditional
lenders. Delta has pre-sold frequent flier miles forward to American
Express and tapped General Electric for a securitized loan. Continental
recently sold miles forward as well and borrowed against its last major
unencumbered assets (Air Micronesia, its Guam-based operation).
It remains to be seen whether or not other vendors and
manufacturers are willing to invest further in their airline partners.
Nevertheless, the proposed America West /US Airways capitalization
includes proceeds from Airbus, hedge funds, traditional money managers,
and an airline maintenance provider (Air Canada). Therefore, we can
conclude that the legacy airlines could perhaps tap some of these same
sources for additional liquidity, especially if pension reform
positively impacts the credit standing of the legacy airlines.
Will Pension Reform Force Additional Legacy Airline Chapter 11 Filings?
Under some pension reform proposals, the airlines that sponsor
defined benefit plans will face incredibly onerous payments. Relative
to the 2005 required minimum contribution of $450 million, Delta has
disclosed that its projected minimum funding under the current rules
will increase by 33 percent in 2006 to $600 million, by 111 percent in
2007 to $950 million, and by 255 percent in 2008 to $1.7 billion. For
Northwest, they are estimating $800 million in 2006, and $1.7 billion
in 2007.
For this reason, both Delta and Northwest are likely to seek
Chapter 11, and follow the damaging precedent set by United Airlines in
terminating its defined benefit plans. This, unless a rapid decline in
fuel costs or reform allowing for a longer-term amortization of
deficits for sponsors agreeing to freeze DB plans comes into law,
sometime within the next six months or so.
Continental is not as exposed to rising payments given the nature
of the airline's defined benefit plan relative to Northwest and Delta.
Nevertheless, the combination of the current oil price environment,
current industry revenue, and higher required pension payments could
force Continental to consider Chapter 11 as well in 2006.
AMR has enough liquidity-raising options and current liquidity to
perhaps bridge the gap between today's environment and one where
industry revenue and stock market improvement make required pension
payments more manageable.
The issues surrounding credit balances and annual premiums, while
important, are secondary to both the length of the amortization period
and the interest rate to value liabilities in the cases of Delta and
Northwest.
For AMR, the interest rate assumption and premium payments are most
critical given the company's and its workers' desire to maintain
defined benefit plans rather than the freezing approach embraced by
Delta and Northwest management.
UAL is AMR's largest competitor. Although UAL's replacement defined
contribution plan costs are significant, I nonetheless am concerned
that AMR (and other legacy majors) will be at a strategic disadvantage
to UAL going forward because of UAL's successful elimination of its
defined benefit plans.
Multiple Bankruptcies Are By No Means Inevitable
Legacy Chapter 11 filings, with their accompanying toll on workers
and expected service declines to smaller communities, are not
inevitable, in our opinion. Legacy airline managements would much
prefer to avoid the process, and instead remain concentrated on the
task at hand--further reducing their competitive disadvantage versus
the more youthful and fit, those airlines that have sprung up since
airline deregulation. Their ability to succeed, however, is largely
predicated on favourable airline-specific pension reform and/or sharply
lower energy prices.
Should the government afford defined benefit sponsors the
flexibility to stretch payments out over a period of several years, the
sponsors must be forced to maintain fiscal discipline. Such discipline
should include, though not be limited to, restrictions on the ability
to repurchase stock, pay dividends, or offer increased defined benefits
even if funded with cash.
Conclusion
If the proposed pension legislation not supported by the legacy
airlines is passed into law, we agree with the market that near-term
Chapter 11 filings become significantly more likely. Put differently,
certain airlines are likely to pursue a United-type strategy, whereby
the PBGC shortfall will increase and taxpayers and plan participants
will suffer as a result. Alternatively, pension reform that does not
result in onerous near-term deficit reduction contributions would
likely materially diminish bankruptcy risk from non-fuel related
issues, and otherwise allow carriers the chance to make good on
promises already made to employees, while further protecting taxpayers
and stakeholders in the process.
Thank you once again for allowing me to speak to you today.
Senator Burns. Thank you. Now we have Mr. Robert Roach, the
International Association of Machinists and Aerospace Workers
and many years ago, I was a member of your good union.
Mr. Roach. You can still be a member if you want to, Mr.
Chairman. I'll sign you right up.
Senator Burns. I don't think I can throw those baggies like
I used to in Kansas City.
STATEMENT OF ROBERT ROACH, JR., GENERAL VICE
PRESIDENT OF TRANSPORTATION, INTERNATIONAL
ASSOCIATION OF MACHINISTS AND AEROSPACE WORKERS (IAM)
Mr. Roach. Mr. Chairman, thank you for the opportunity to
speak today. My name is Robert Roach, Jr. I'm the Vice
President of the Machinists Union. I'm appearing at the request
of International President, R. Thomas Buffenberger. The
Machinists Union represents more than 100,000 U.S. airline
workers in almost every classification including ramp service
workers, mechanics, public contact employees, and flight
attendants.
Mr. Chairman, the financial condition of the airline
industry to date is clearly miserable, and without drastic and
immediate change, the future continues to be bleak.
September 11 was the start of the current crisis for
airlines however the seeds for this calamity--excuse me, were
planted many years earlier by the airlines themselves. When
airlines were healthy, legacy airlines spent surplus cash by
purchasing aircraft, foolish mega-mergers.
One noted exception is Southwest Airlines, which prudently
expanded their profitable margins while increasing cash
reserves for the inevitable. However, it should be noted that
Southwest Airlines, which is 95 percent unionized, pays the
employees the highest wages and benefits in the industry. I
want to reiterate that. Southwest Airlines pays the highest
wages and benefits in the industry, while still maintaining
profitability.
At the same time, the airlines refuse to properly fund
their pension plans and more than 100,000 participants at US
Airways have lost money. To ask employees to further bail out
corporations is disgraceful and to force retirees to subsidize
corporate incompetence is unforgivable. The Machinists Union
has met with ATA and airline CEOs on how to correct industry
problems. I believe such partnerships should be continued and
expanded. Norman Mineta convened an airline summit with
government officials to jointly develop solutions to the
problems. The IAM is proactive, but we cannot do it alone.
In the airline industry we have suffered more than six
Chapter 11 bankruptcies. Hawaiian and Aloha being two of them,
and United Airlines. My colleagues have said on this panel we
believe Northwest and Delta are fastly approaching that line.
We have reduced costs. We have lost pension money, and our
health benefits have been reduced.
I believe what you're going to hear today is differences of
opinion on how to fix the problem, and that you will hear we
have the low-cost carrier, but the low-cost carrier advantage
is because they are new and because they don't have the certain
wages and benefits that they have today, but as time goes on
they will catch up, that's why if you want to look at a low-
cost carrier, look at Southwest Airlines as a model, that they
are properly managed, and that they have been around 27 years
and at the same time maintaining profitability.
We cannot sit here today and unlike my colleagues, if oil
prices are what they are, then we must do something, and we
believe that that effort is a coordinated effort. We don't
think, as I said before this same committee on September 20,
2001, that you can just throw money at the problem. That
happened in 2001 and we are in worse condition today than we
were then. I think we need coordinated effort. I think with
government, Department of Transportation or some Senate
committee, Presidential commission, along with management and
labor need to sit in a room with a commission and try to find
coordinated solutions to the problems that will confront us in
the future, and to do otherwise would be putting a band-aid on
a bleeding artery.
I thank this committee for the opportunity to speak to them
and present our point of view, and we are prepared to work with
this committee and management to develop solutions to the
problems. Thank you very much, Mr. Chairman.
[The prepared statement of Mr. Roach follows:]
Prepared Statement of Robert Roach, Jr., General Vice President of
Transportation, International Association of Machinists and Aerospace
Workers (IAM)
Thank you, Mr. Chairman, and members of this Committee for the
opportunity to speak to you today. My name is Robert Roach, Jr.,
General Vice President of Transportation for the International
Association of Machinists and Aerospace Workers (IAM). I am appearing
at the request of International President R. Thomas Buffenbarger. The
Machinists Union represents more than 100,000 U.S. airline workers in
almost every classification, including ramp service workers, mechanics,
public contact employees and flight attendants.
Mr. Chairman, the financial condition of the airline industry is
clearly miserable, and without dramatic changes, the future continues
to look bleak. From 2001 to 2004, legacy carriers have lost more than
$28 billion, and they are expected to lose an additional $5 billion in
2005.
Of the 146 airline Chapter 11 filings since 1979, in only 16 cases
are the airlines still in business.
September 11, 2001, is often cited as the start of the current
crisis for airlines. However, the seeds for this calamity were planted
years earlier by the airlines themselves.
When airlines were healthy, legacy carriers spent surplus cash by
purchasing unnecessary aircraft, irresponsibly expanding operations,
and pursuing foolish mega-mergers. One noted exception is Southwest
Airlines, which expanded prudently into profitable markets while
increasing its cash reserves for the inevitable, recurring industry
slump.
At the same time, these airlines refused to properly fund their
employee pension plans, and now more than a hundred thousand
participants and beneficiaries at US Airways and United Airlines have
lost more than $5 billion of their promised pension benefits.
To ask employees to bail out failed corporations is disgraceful. To
force retirees to subsidize corporate incompetence is unforgivable.
The Machinists Union has met with the ATA and individual airline
CEO's to discuss how to correct the industry's problems. I believe such
partnerships should be continued and expanded.
Earlier this year, I asked Transportation Secretary Norman Mineta
to convene an airline summit so airline executives, labor leaders, and
government officials could jointly develop solutions to the industry's
problems.
The IAM has been proactive in our efforts to transform the
industry, but we cannot do it alone.
For a snapshot of the financial condition of the airline industry,
one only has to look at the unprecedented sacrifices employees have
been forced to make just to keep this industry alive.
United Airlines
Almost immediately after signing contracts with the IAM in 2002,
United Airlines came to its unions seeking concessions. The IAM engaged
in these discussions over a period of several months in an effort to
keep the company out of bankruptcy.
In support of the company's attempt to obtain a loan guarantee from
the Air Transportation Stabilization Board (ATSB) in November 2002,
ramp service and public contact employees agreed to cuts that would
save the company $160 million a year.
This was happening as employees saw the value of the company stock
held in their ESOP and employees' 401(k) accounts dwindling. Many
employees lost tens of thousands in retirement savings as a result.
United failed in its attempts to reorganize outside of bankruptcy,
and immediately after its Chapter 11 filing the company asked the
bankruptcy judge to impose ``emergency'' pay cuts of 14 percent on IAM
members. The judge authorized this request.
Laboring under these court-imposed pay cuts, IAM members went to
the bargaining table and in the spring of 2003 agreed to permanent cuts
in pay and benefits that would save United $460 million a year ($2.644
billion from 2003 to 2009). These concessions also included drastic
reductions in retiree healthcare benefits for anyone retiring after
July 1, 2003. As a result, many employees retired from the company in
an effort to preserve these benefits.
United then took steps to cut retiree benefits for existing
retirees and filed a motion in court to ask a judge to impose cuts if
agreements could not be reached with the retirees' representatives.
This heartless move saved United $50 million a year.
In the Spring of 2004, the ATSB denied United's bid for a loan
guarantee a second time and, once again, United turned to its employees
for more cuts. United also ceased funding its pension plans, the first
in a series of steps which ultimately led to their termination by the
Pension Benefit Guaranty Corporation.
In January 2005, United once again sought ``emergency'' pay cuts
from the bankruptcy court--this time it was 11 percent. The IAM and UAL
reached a tentative agreement on June 17, 2005, that, if ratified by
the membership, will provide United with an additional $176 million a
year from 2003 to 2009. Savings attributable to the termination of IAM
member's pensions will save United another $217 million a year.
Successive rounds of cuts have delivered United annual savings of
more than $853 million a year off the backs of IAM members. By the end
of this bankruptcy case, IAM members will have sacrificed more than
$4.6 billion for United Airlines, which is about three times more than
the value of all loan guarantees given out by the ATSB.
US Airways
In US Airways' first bankruptcy in 2002, IAM members agreed to two
rounds of contract concessions totaling $276 million per year, or $1.8
billion over 6\1/2\ years.
Pay was cut by an average of 7.5 percent. Employees also
experienced drastic increases in their contributions for healthcare
coverage, which had the effect of reducing take-home pay even further.
Employees' share of healthcare premiums roughly doubled for single
coverage, and almost tripled for family coverage, translating into an
additional reduction in take home pay of 1 percent to 3 percent,
depending on the employee's classification.
Immediately after filing for bankruptcy for the second time in as
many years, US Airways management petitioned the court to impose
``emergency'' pay cuts of 23 percent for all union-represented
employees, as well as reduced contributions to pension plans.
Management and salaried employees' pay was reduced by only 5 percent to
10 percent.
On October 15, 2004, the bankruptcy court allowed an emergency 21
percent cut in pay.
US Airways then approached the IAM to negotiate permanent
reductions to pay and benefits, and filed a petition with the
bankruptcy court to reject the IAM's collective bargaining agreements.
Ultimately, the parties were not able to reach agreement and the court
granted the company's request to abrogate the IAM's collective
bargaining agreements on January 10, 2005. IAM members then voted to
accept the company's ``last and final offer'' that involved pay and
benefits reductions even more drastic than what were ratified in the
first bankruptcy.
Under these latest terms, IAM members will give up $346 million a
year in pay, benefits, and work rules. Mechanic and related employees
will see their pay reduced by an average of 15 percent. Almost all
Utility jobs are able to be outsourced, and roughly a third of mechanic
and stock clerk jobs can be farmed out.
In addition, the defined benefit pension plans were terminated,
with the sole exception being the IAM's multi-employer defined benefit
National Pension Plan for our Fleet Service members, who experienced
pay cuts of 12.8 percent to 20 percent. In addition to these drastic
reductions in pay, holidays, vacation accruals, sick leave, and retiree
medical benefits have also been significantly reduced.
US Airways employees have accepted up to \1/3\ reductions in their
standard of living in a very short period of time. The typical middle
class household budget does not have a cushion anywhere close to \1/3\
of take-home pay; to be able to adjust to these kinds of reductions.
Workers and their families are being forced into dramatic and drastic
changes that affect the most basic, personal decisions, such as where
to live, where and how to educate children, and making very hard
choices regarding medical care.
Many employees have concluded that a job with US Airways is one
they cannot afford to keep, and as a result, the company is facing
manpower shortages in many locations. This difficulty in finding
employees willing to accept the meager wage scales imposed through
bankruptcy is what caused US Airways' Christmas meltdown in
Philadelphia last year. That event clearly demonstrates the effect of
low wages on the reliability of the industry.
Hawaiian Airlines
When Hawaiian Airlines approached its unions seeking concessions in
an attempt to stay out of bankruptcy, the IAM stepped up to the plate.
However, the company failed in its attempt to reorganize outside of
bankruptcy and filed for Chapter 11 reorganization in the spring of
2003. As part of the reorganization, a Trustee was appointed due to
serious concerns on the part of creditors about actions taken by the
prior CEO.
The Trustee sought cost reductions of more than $1.5 million from
IAM members. The IAM and the company ultimately reached an agreement in
the fall of 2004. Because of the sacrifices made by IAM members, the
company successfully restructured and recently exited bankruptcy.
Aloha Airlines
In order to obtain $40 million in ATSB funds, employees at Aloha
Airlines agreed to a 10 percent across the board pay cut in late 2002,
designed to save the company $37 million annually. IAM members were
willing to make these sacrifices to keep Aloha out of bankruptcy.
Despite these cuts, management was unable to turn the airline
around. The company filed for Chapter 11 protection in December 30,
2004, and returned to employees seeking an additional 10 percent pay
cut, on top of the cuts agreed to just two years before, as well as
reductions in health benefits, changes to work rules, and a freeze in
benefit accruals under the company's defined benefit pension plan.
To force their demand, management went to court to seek abrogation
of the IAM contract. IAM members ratified a second round of concessions
this past winter. Despite reducing pay by more than 20 percent, the
airline continues to struggle to reorganize.
Air Wisconsin
Air Wisconsin was once owned by United Airlines, but for many years
has operated as an independent express carrier for United. When United
filed for bankruptcy, it sought to restructure contracts with its
express feeders and as a result, in 2003, Air Wisconsin came to its
employees seeking concessions. IAM fleet and customer service members
agreed to significant cuts in pay and benefits in order to preserve
their jobs at the airline.
Continental Airlines
As part of a company-wide restructuring, Continental Airlines is
seeking to reduce IAM-represented flight attendant costs by $72 million
annually. Discussions with a Federal mediator are being scheduled.
Alaska Airlines
Alaska Airlines management has demanded concessions and even locked
out nearly 500 IAM ramp service members in Seattle, WA. By outsourcing
our members' work to the lowest bidder, Alaska Airlines now ranks dead
last in the DOT's on-time performance ratings. This is another example
of how an airline's short-sightedness is negatively impacting the
reliability of our nation's air transportation system.
Northwest Airlines
Northwest is also seeking significant cost savings from employees
and termination of pension plans in a bid to avoid bankruptcy.
Mr. Chairman, members of the Committee, the financial condition of
the airline industry is an absolute disaster. Passengers have returned
since 9/11, but the continued reliance on failed business plans
jeopardizes our air transportation system.
Southwest Airlines pays their employees more than any other major
carrier, yet remains profitable, so the industry's problems are clearly
not the result of high labor costs. Nevertheless, employees have given
more than their fair share, yet airlines are still struggling. Fuel
prices are high, and employees are repeatedly asked to subsidize
artificially low ticket prices.
The industry needs new ideas. Airlines can't continue refusing to
charge at least what it costs to provide their service and then claim
financial emergencies.
I urge this committee to explore ways to correct the suicidal
pricing plaguing the industry. Whether it be a mandatory fuel surcharge
or other government intervention, some re-regulation of the industry is
clearly necessary. Left alone, airlines will price themselves out of
existence.
I thank the Committee for inviting us to participate in these
proceedings and listening to our concerns.
I look forward to your questions.
Senator Burns. Thank you, Mr. Roach, for your testimony.
I'm interested, Senator DeMint, do you have a statement this
morning? Thanks for coming.
Senator DeMint. Just wanted to listen.
Senator Burns. You've come to a great place. I mentioned in
my opening statement and the reference toward, you know the new
carriers, the new low-cost carriers and Southwest as a model
that so far has been very profitable, but I would look at them
and say well, we know that they knew how to handle their fuel
costs, that over time will run out. In your estimation, Mr.
Roach, how long will it be that they will, before Southwest
faces the same problems as say our legacy carriers?
Mr. Roach. Well, they are confronting the same problems
today. Fuel hedging slowly decreases up to 2009. What has to
happen, and I believe Southwest management is working toward
solutions as they go along and managing the business as they go
along to be prepared for that. I think if you look at the
pricing of airline tickets on Southwest Airlines, versus US
Airways or United, you'll find that United and US Airways are
charging less for tickets than Southwest Airlines, and so there
is a serious problem. I think that we work with Southwest
Airlines, and we represent 10,000 people there. We work with
them to craft solutions to the problems that they will confront
beyond 2009, such as ticketing problems, working with them in
the areas of helping to move passengers through the airport,
and having efficiencies in place, because, again, if we are
going to have $60 a barrel of fuel, we can't just act like it
doesn't exist.
We have to understand it's going to exist. We have to look
at pricing of the ticket. Every Senator flew in here. When they
got to a cab at the airport, they didn't pay a surcharge. So
you have to price the profitability, and that's what Southwest
Airlines is doing.
Senator Burns. Mr. Baker, do you have a comment on that,
how long will it be before they face some of the challenges
that legacy carriers face?
Mr. Baker. Well, I would echo the point that they are
facing many of those problems today. Our analysis suggests that
if not for their hedge protection on pricing, on fuel pricing,
they wouldn't be capable of producing profit in this economy,
and while it's a factual statement that their labor rates are
above the industry average, Southwest management now concedes
that that puts them at a competitive disadvantage. And
furthermore, many of the pricing changes that are taking place
at the legacy level have negatively affected Southwest's
performance, the revenue performance in cities such as Fort
Lauderdale; Hartford, Connecticut and other secondary cities.
I would suggest that over the next several years, Southwest
will have to tackle these issues. They have conceded that it
will be difficult to achieve wage declines because those
declines are going to have to take place if they are going to
remain competitive with the further-improving legacy carriers.
Senator Burns. Well, I go to the airports right now and
I'll tell you what, I have never seen airports more full, and I
have never seen Washington, D.C. so full of tourists since 9/
11, so the travelers are back. As I mentioned in my statement,
though, I come from a State that has a lot of tourist dollars
and recreational flyers. But we also have a very healthy
network of business up there and I am concerned about the rural
connectivity because of the financial conditions of the legacy
carriers. If it wasn't for the hub-and-spoke situation, well, I
think we fall into a situation where we could lose much of our
service into rural areas. I initially asked, why do airlines
insist that it's so expensive to operate in the rural markets?
From what I can tell, the planes seem to be full, and I know
what it cost me to fly to Billings, Montana, roundtrip. You
could make almost three round trips from Dulles to San
Francisco. And I have a hard time justifying that, but I also
know what the costs per mile are, and maybe what you've got to
have, and you pretty much have to have a face in every window
whenever that airplane leaves the airport, so I'm really
concerned about those trends, so looking ahead, Congress has
provided billions of dollars of direct and indirect assistance
to airlines, and they continue to lose money. Chairman Stevens
and I were discussing how to refinance the FAA. And your
suggestions today, Mr. May, I take it you said over a thousand
communication systems. Can you give me an example----
Mr. May. 14,000, Senator. And it's extraordinary. We have
an infrastructure that's been built up within the air traffic
control system over the past 35 years that is more.
Senator Burns. Can some of that be claimed as redundancy in
case of emergency?
Mr. May. Some of it can be claimed as redundancy in case of
emergency, but I don't think we need triple and quadruple
redundancies, and I think that there is the capacity to do a
transition--I hate to use this phrase before this committee,
but transition to digital that might be particularly
appropriate for the airlines.
Senator Burns. Appropriately delayed by the way.
Mr. May. I understand.
Senator Burns. Senator Inouye?
Senator Inouye. Listening to the testimony, I gather that
there are two major causes of the airlines' current
difficulties, fuel prices and the government, taxes and fees.
Then we hear the word globalization. And my question is how do
we, number one, compare to the operations and the financial
conditions of airlines abroad in Europe and Asia, for example?
Ms. Hecker or anyone else?
Ms. Hecker. I think Mr. May may have more detail, but I
think generally the studies that have been done is that the
U.S. does not compare favorably, that the top performing
carriers because they have a very high growth market in Asia,
and there has been a view that there has been more moderation
in the U.S. in making the kinds of adaptations to the new
market environment that, for example, Asian carriers have and
some have failed. It's not as if they have all succeeded, but
their growth rates, their efficiencies, their business
strategies have admittedly in a growth market been largely
successful.
Mr. May. Senator Inouye, I think it's important to note
that there are some very fundamental differences between some
of the major European and Pan-Asian carriers, and those here in
the United States. They rely to a very great extent on long
haul international routes. The major big six and so-called
carriers here in the United States do a tremendous amount of
domestic short-haul business here in the United States, which
is the essence of the hub-and-spoke system. As Senator Burns
pointed out, without that hub-and-spoke system, we wouldn't
have service to a lot of small and rural communities
represented by this committee on a daily basis, and the
competitive nature of the low-cost carriers is frequently in
that domestic business, and in particular, for medium-sized
communities in that system. So that the 85 percent competitive
route structure of the low-cost carriers with legacy carriers
is having a dramatic impact on domestic yields for our
carriers.
We are actually doing and comparing, very favorably with
the international carriers on our long-haul international
routes, but as my friend Giovanni Bezziana would tell you, they
have many of the same kinds of issues with taxes, fees, and
fuel costs that we do.
Mr. Baker. Just to throw some numbers on top of that,
Senator, for example, the U.S. carriers 75 percent of revenue
is derived in the lower 48, the remainder coming in longer
haul, and across the oceans, and internationally. For European
carriers, those numbers aren't reversed and for that reason,
their exposure if you look at British Airways or Lufthansa,
their exposure to low-cost carriers is less, because they don't
fly those long-haul routes. That's for a very good reason. The
low-cost model, which is a low-labor cost model is not
applicable to long haul travel. That's the reason Southwest
doesn't fly across the ocean, nor does Jet Blue, so it's a
reversal of the portion of revenues that are expensed to low-
cost carriers that, I think, in large part explains the
financial difference between the two geographic sectors.
Senator Inouye. None of the airlines of the United States
have any government ownership interests, but, on the other
hand, you take Saudi Airlines, and I suppose it's owned by the
family, the government, Japan Airlines has a government
interest in it, China Airlines may be completely government-
owned. Is that a level playing field for us?
Mr. May. Makes it particularly difficult for us, Senator
Inouye, but it is the reality of what we are left to deal with.
Nobody ever said it was going to be a fair situation, and it
does have an impact, but again, I think the biggest differences
are not our ability to compete on an international scale, but
the difficulties we have with more domestic short haul.
Senator Inouye. An additional cost has been imposed upon
our citizens, the cost of security, national security, and for
example, airline security has just sky rocketed. In Europe and
Asia, who pays for the security, airport security, for example,
metal detectors?
Mr. May. I'm not an expert on international security, but
it's my understanding that more of it is paid by the
government, as opposed to the individual carriers. In the
United States, we pay either direct fees or mandated, indirect
mandated costs, a billion dollars a year for aviation security
right now.
Senator Inouye. That's what I wanted to get to, because
recently, it has been suggested that the airlines pay for
airport security. And I don't think that's the case in Asia and
Europe. It's a matter of their national security, isn't it, Mr.
Baker?
Mr. Baker. That's correct. I don't have the figures in
front of me, but I would echo Mr. May's comments that overseas
governments tend to be much more generous in terms of affording
that level of security to airports and passengers than here in
the states, where it's largely funded by the carriers out of
ticket prices.
Senator Inouye. Mr. Roach, what has been the response of
the Administration on your suggestion that there be a summit?
Mr. Roach. We had several meetings with Secretary Mineta.
We visited with him in New York very recently. We have not
established any summit meeting. While it has been favorably
discussed, we have not had the meeting, and we think it's
important.
Senator Inouye. Are they open to your suggestion?
Mr. Roach. Yes. Secretary Mineta has been fair to
establish, we talked to several CEOs of several carriers,
United, US Airways, Northwest Airlines and they all seem
favorable to getting it done. We think that the Secretary of
Transportation, or some government agency, needs to call the
meeting and then we'll get everybody in the same room. We have
had this on the Secretary's plate. Similar meetings have been
fruitful, but we think it's important to get everybody in the
same room to start talking about these issues.
Senator Inouye. While all of this financial condition is
existing, what about equipment? Are we keeping up?
Mr. May. Senator, I think one of the most positive messages
we can deliver to this committee is that safety in particular
is at an all-time high. We have never had a more safe period in
the history of our industry than we've got going right now, and
I think that's a result of the extraordinarily, fine
cooperation between the folks that Mr. Roach represents and our
management, because no matter how great our difficulties, we
have worked together to that common goal of keeping safety
first, and we have got some extraordinary equipment that we are
able to work with and take advantage of.
Senator Inouye. Mr. Chairman, I have got a lot of
questions. May I submit them?
Senator Burns. We can submit them and they can respond to
them. Senator DeMint.
STATEMENT OF HON. JIM DeMINT,
U.S. SENATOR FROM SOUTH CAROLINA
Senator DeMint. Thank you, Mr. Chairman. I'm just sitting
here trying to sort out how to fix this, and you have given
significant review of the problem, and I think we have heard
that some of the problems--clearly mismanagement over the
years, as Mr. Roach talked about overreaching during good
times, perhaps not making good decisions. We have also heard
that labor used as considerable leverage over many years to
push salaries and benefits way beyond sustainable levels.
We have heard about the waste of FAA and problems with fuel
costs, taxes and fees, and you know, my inclination is to say
maybe we should sit back and let the market try to fix this,
but I do see the government's hand in this and we perhaps
intertwined to let it go. But it doesn't seem with all of what
we have seen with the industry management, the labor that the
government should come in and just try to fix this problem
because we can. I'd just like to hear more from some of our
witnesses of, I mean I don't know how we can sustain an airline
industry with so many losses.
I'm perplexed at how it continues to attract capital. And
this is seeing something where the market really needs to work
here, and much less government, but I'd be interested in any
comments that you have on what the government should do at this
point.
Mr. May. Senator--I'll jump in here and I know Mr. Roach
has some ideas, too. Mr. Baker said a minute ago----
Senator Burns. Jim, pull your microphone a little, would
you please.
Mr. May. Thank you, sir. Mr. Baker said the market for
Continental and American, except for fuel, would have been the
most profitable quarters they have had in the history of the
business, and I think the productivity gains that we are
making, all of the changes that are taking place in the
industry, and we make no bones we have been less than perfect
in managing the business over the years, I think all of those
changes have been extraordinary, and are leading to sustained
profitability.
Once we begin to address the uncontrolled costs, those
costs over which we don't have any control and they are fuel,
which has had a dramatic impact on our business, taxes and
fees, and unfunded mandates, we spend $50 billion a year for an
industry that only earns roughly 80. But here in the United
States on taxes and fees, security mandates, so on and so
forth. So I would love to sit down with Mr. Roach and bring our
CEOs together and talk about how we need to reform the air
traffic control system, how we need to reduce the impact of
taxes and fees, and Senator, if you've got some magic for $60
oil, I want to hear it, because we are at wit's end.
Mr. Roach. It would be nice to let the market take care of
the situation, but the market does not take care of it. For
example, United Airlines and US Airways are currently in
Chapter 11 insulated from the market and everybody else,
Northwest, Delta, Continental, the other carriers, Southwest
are now paying bills, and this is--the court is now running
those through airlines. So if you can stay into Chapter 11 for
3 years and not go to the government and dump your pension
plans, then the market is not taking care of the situation. It
is the government, it is the courts causing the Northwest,
Delta, everybody else to now follow suit, but the protection
has been given through the law on the Chapter 11, so it is
again, I think, very important that we try to grab solutions
collectively. I don't want to sit in the room and negotiate
contracts with everybody.
We need to sit down and figure out what it is we are going
to do collectively working with the government. I don't want
the government to come in and mandate what we should do. We
should have solutions, and we should have some input from a
governmental agency as to what the industry can do to fix it
and work together.
Mr. Baker. Senator, the testimony that I submitted today
dealt with the issue of pension reform for the airlines. I
think if carriers were seeking something to symbol as a
handout, if you would, they would follow the precedent set by
United Airlines. File Chapter 11, rid themselves of their
obligations and put those obligations at the expense of workers
to the government and to taxpayers. That to me smacks of
subsidization. What certain carriers and lawmakers have
proposed is simply allowing the carriers more time to make good
on promises they have already made, and, therefore,
substantially diminish in my opinion the near-term risk of
bankruptcy.
To me, this is a proposal that would potentially be less
burdensome on workers and taxpayers.
Ms. Hecker. If I can just add one point; that there is no
doubt that pensions are an extremely serious issue. GAO,
though, has done work widespread across the economy and the
issue of pension underfunding, and pensions pushing liquidity
problems on many industries is not exclusively a problem of the
airline industry. And our work has vigorously called for broad
and comprehensive pension reform that fixes the problems that
the current system has created, both in this industry, and many
others, where we have a nationwide severe crisis in the entire
defined benefits system.
Senator DeMint. Thank you, Mr. Chairman.
Senator Burns. If it's anything that's getting our
attention in this town right now is a situation we find with
these pensions. This has the possibility of impacting the
American taxpayer, to a greater extent than the S&Ls, and there
are some folks up here that are very, very concerned about
that, especially in the situation, and in light of our
budgetary problems now, and I'm very, very concerned about it,
and even though as your testimony would signify that only 6
percent of the operating is of their total overall operating
capital is impacted by the pensions, and that sounds greater to
me than the figures would indicate.
Mr. Roach. The issue of pensions, I'd like to say on behalf
of our organization is that we saw this problem in 2000. This
is not a new problem, and we went to the airlines and said this
is a problem. You're not in the pension business. Let's sit
down and work this out. And they refused. Why they refused--
because under current pension law you didn't have to make any
contributions to those pension plans, but this is not just
something that happened yesterday. We saw the problem coming
and we said let's fix the problem before it becomes a crisis,
and again because of the law, you're able to push these
payments back and then all of a sudden they were due. The bill
came due and he couldn't pay it so again, and I may sound like
a broken record, we need to sit in a room together to figure
out what to do next, because how do we address this problem in
2000, I suggested by the Machinists Union we would not be here
today. Believe me.
Senator Burns. Can I suggest to you that the same thing is
true in Social Security, Mr. Roach, and we are not getting much
response from anybody to fix that report before it becomes
uncontrollable and cannot be fixed. But then, as you well know,
we all got ingrained in all of us here in this country that
nobody gets excited. I can go down to your farm and tell you
you're going to have to repaint your barn in 2015, do you want
to sign the contract now. I doubt that you would do that. And
that's, that's the American people, but right now, the cry has
gone out--we have to fix these other funds, but nobody wants to
do that now, but they will when those checks are 2 weeks late
or they are halved in two. Senator Lautenberg.
STATEMENT OF HON. FRANK R. LAUTENBERG,
U.S. SENATOR FROM NEW JERSEY
Senator Lautenberg. Thanks, Mr. Chairman. I'm sorry that I
wasn't here earlier. As everyone knows, there are always
competing committees, and this one ranks very high on my
agenda, but the other one had to deal with chemical safety, and
in my State of New Jersey, we worry about those things.
Honestly, I also worry about the airlines. The service that
commercial aviation provides to our country and our world is
essential. The expansion that this country has had over the
years would never have been possible were it not for the
availability of commercial air service, so I look with
considerable misgivings about what might happen in the aviation
industry if the price of oil and other expenses continue to
increase.
However, I'd like to ask a couple of questions that relate
particularly to the pension problem. I come out of industry. I
ran a pretty good-sized company, a company that I started with
two others and now has 40,000 employees. We had a lot of
experience in running the company and managing the works, and I
know one thing: pension plans are under assault like the
Chairman mentioned. Lord knows where we go in terms of
satisfying the belief that people have that if they work for
Company A or Company B and they had a pension plan and that 20,
25 years later they could go on with life and their families.
Unfortunately, many are not able to do that. And it's not
particular to the aviation industry. It's also true in other
industries, especially manufacturing industries throughout our
country.
And so I must ask the question--kind of a generic
question--that is: did everybody get treated equally when it
came to protecting the pensions of employees in view of either
credit reorganizations or bankruptcies? Are executive pension
plans better funded than employee plans? Are executives taking
the same heat that rank-and-file employees take? Did they run
the same risks as not being able to get their pensions
protected? Mr. May, can you comment on that?
Mr. May. My, I am not an expert on the issue, Senator
Lautenberg. I will offer two brief observations, and would be
happy to do some research and come back to more specifics,
obviously. My sense is that defined benefit plans, no matter
how they are constructed or who they are for, are facing some
very real and significant difficulties, and it's not just in
the airline businesses. As you have pointed out, I was with
somebody from General Motors the other day, and there are a
number of concerns across industry.
As to compensation for our executives, I think it has been
slashed significantly across the board. I think there are very
few of our executives that are coming anywhere close to their
peers in other industries to compensation. As to whatever
specific retirement plans that those executives may have, I
don't happen to be privy to those. I know most of it, I think
you'd be far more expert in this than I, are filed in
disclosures with the SEC, and I know it's public information,
and I would suspect that we could find the answer to that
question there.
Senator Lautenberg. Mr. Roach, how do you see it?
Mr. Roach. Well, traditional pension plans both executives
have, which was shown in American Airlines when they had pay
cuts and $45 million put aside in special funds for their
executives. I think there has been testimony in other hearings
that there are bonus payments that are made. They don't call
them pensions. But you are talking about millions of millions
of dollars that go to executives, while employees pension
benefit plans are being cut. It's not a level playing field.
Senator Lautenberg. I just wonder whether reserving pension
plans or termination programs for executives has in any way
impaired the airline's ability to have some additional funding,
in addition to the pain and the trauma that it causes for
employees who have worked and depended on these pensions for a
long time.
Mr. Roach. Not only does it affect the current employee, it
affects the retired employee. The employee that is retired is
expected an amount of health care, health care costs have
increased in certain cases, but employee who has depended on a
dollar amount for months. It has been very difficult as we
create a lot of morale problems at the airlines because
employees were planning to retire. As you move the older
employee out, younger employees come, it also reduced costs. So
it causes employees to stay around and work longer.
It has created a lot of serious problems with people again
being focused, and that goes back to the question of security.
Employees must be focused at airports. They should not be
focused about should I pay my mortgage. They have to be focused
on the traveling passengers, as well as employees. I think
there is a serious problem. A lot of times in this country you
don't want to confront things until there is a crisis, and I
certainly agree with them and that's why today we have
proposals with Continental Airlines and Northwest Airlines to
fix their pension plans in coordination with some of their
ideas that we have to fix the plans. We have to bite the
bullet. We have to do what is necessary to get these problems
fixed.
Senator Lautenberg. Mr. Chairman, I would ask if you would
consider one of these days having a hearing specifically on
this question. I think it's important to find out what kind of
obligations the Pension Guaranty Fund is going to have. It
could be enormous, and I don't know what we do at that point.
Senator Burns. I would say to my friend that that is not
under jurisdiction of this committee, but it sure has an effect
on how we set policy for our airlines. I'll guarantee you that.
Senator Lautenberg. Information search would be a good idea
if we could do it. I would ask whether recent events have
effected equally the lower-cost carriers versus the legacy
carriers. The competition is robust, as I see from some of the
financial statements. Some of the regional and the smaller
airlines seem to be able to weather this storm better. Is that
true, Mr. May?
Mr. May. Yes, sir, it is. And let's maybe try and divide
the business into three parts. The regional carriers are either
wholly owned, or have significant operating relationships with
the major carriers, and they have been earning profits for some
reasonable period of time because they effectively have a
guaranteed income because of the contractual relationships they
have with their brothers.
The Independence Airs and the smaller low-cost carriers
are, Robert has pointed out Southwest is a prime example, have
had a mixed bag. Independence Air, I think it will come as no
surprise reading the papers, is losing a very significant
amount of money. Herb Kelleher, who is on my board and a great
contributor to our industry, has made it abundantly clear that
if it weren't for the fact he has hedged at $26 for oil, he
would have lost money over the last year or so. And although he
has hedges that aren't quite as favorable going forward, they
rise up into the 40s. A 40-some dollar hedge looks awfully
attractive when oil is trading on the Nynex at 60, so I think
there is a mixed bag among the low-cost carriers, but they are
being impacted as well as our carriers are, although it's easy
to point out that the costs for the seat model is lower for
those carriers. I think Mr. Baker is the bigger expert in this
area.
Senator Lautenberg. I would be interested in your comments,
Mr. Baker. In terms of the financial viability, does the
industry's structure permit the legacy carriers whom we
desperately need, to survive through these drops and these
periods of high-cost operating expenses?
Mr. Baker. I believe most of them are well on the way to
ensuring them whether it will allow them to endure the
business. I would point out that in the first quarter of this
year, if we just strip out fuel expense from both sub-sectors,
low-cost carriers and legacy carriers, we actually witnessed
the first year-on-year decline in low-cost carrier
profitability in several years, whereas non-fuel profits, if
you will, of legacy carriers, were up in excess of 25 percent,
and the reason we witnessed the decline in low-cost carrier
profits is because it coincides with these recovery efforts
with the legacy carriers, choosing to no longer fall back and
instead stand their ground and compete more effectively with
these carriers.
There is no question in my mind, Senator, that a
significant reinvention of legacy cost structure is under way.
It's just that that reinvention is being masked right now by
the escalation of crude prices.
Senator Lautenberg. Mr. May, Mr. Chairman--I'll conclude
with this. I assume that you look at the air traffic control
system and see how it's functioning. I think it functions very,
very well, but I am concerned about the anticipated controller
retirements, as well as the increase in volume of flights as we
go to more regional jets, more activity in the air. We need a
lot of space for military uses, et cetera, and the air space is
not infinite. How will carriers be affected? Have you looked at
that, sir, in terms of what the financial impact might be?
Perhaps longer delays and problems that the FAA might not be
able to quickly find solutions for?
Mr. May. Senator Lautenberg, I think as I said in my oral
testimony, we should take the current ATC system and retire it
to the Smithsonian, where it can be admired as one of the
marvels of 1950s technology. It is capable of handling the
traffic we have today. It is fully incapable of handling the
traffic for the future. One example, Net Jets, has well over
600 aircraft. They are flying in and out of Teterborough in
your state. That's a phenomenon. We have ultralight jets on the
horizon. We have any of a number of regional carriers that are
putting more planes into the system, and fewer of the larger
57s, 67s, et cetera, so I think we have got a very significant
problem on our hands in the future, and we are going to need to
seriously engage in making it an exercise in difficult choices
to make some fundamental change to this system from top to
bottom.
We have got to go to a fully-digital GPS-based system that
can handle the traffic that's coming our way.
Senator Lautenberg. Mr. Chairman, an observation that I
would like to be permitted to make is that I always believed
that FAA should be operating similar to companies where the CEO
is employed to do a job over a period of time, regardless of
what political party is in place or that kind of thing. An
organization where the mission is professionalized and we
thanked the people doing it. We have good FAA people, but the
fact of the matter is one of the reasons the system is so
antiquated, and when we try to change it, there are
discontinuities created along the way. We have spent billions
of dollars with some of the top agencies in the country in
trying to reform the air traffic control system, and every time
we had a start, we run out of cash. It is a system, and it
works surprisingly well, but it's in overload mode most of the
time. Thanks, Mr. Chairman. Thank you all very much.
Mr. May. Senator, if I might be permitted, I know this is
heresy, but if we could have maybe the Congress of the United
States spend a little less time micromanaging the details of
the FAA as to where ILS systems are going, and so on, and so
forth, and earmarks, it would probably operate a lot more
efficiently.
Senator Lautenberg. Shocking suggestion.
Senator Burns. It is heresy. Let's go over three areas.
There are some areas of confusion, and in the area of Chapter
11 bankruptcy, I think we have kind of ironed that out this
morning. Buying new aircraft. Yesterday I read the testimony of
all that are here today, Mr. Roach's testimony questions the
purchasing of new aircraft by struggling air carriers. Do any
of you refute that argument, or are there long-term gains on
that investment? Do we talk about efficiency, or is it just a
bad business decision when we start talking about the
replacement of equipment?
Mr. Roach. I think my testimony is the timing. You have to
purchase new aircraft and you have, because there is more
aircraft, it becomes less efficient, other aircraft becomes
less efficient and it can't be maintained when companies can't
pay their bills and ordering new aircraft, it's a timing issue.
Mr. May. I think the other factor that's important, Mr.
Chairman, is that I think our carriers, in particular the
larger carriers, have learned a very good lesson from
Southwest. Southwest has a single type of aircraft, 737. They
are all effectively identical with the exception of the paint
colors on the outside, and so they have managed their fleet in
a very effective way.
I think what we are seeing today is that many of the legacy
carriers are significantly reducing the numbers of different
airplanes in their fleet, and they are trying to upgrade, as
Mr. Roach says, from a fuel efficiency point of view. I was
with Boeing on Monday of this week up in Hartford, Connecticut,
we were talking about the 787 which is the most fuel efficient
aircraft ever designed, I think, and we are all looking for
those efficiencies in our fleets, and we laid literally
hundreds of aircraft down in the desert to get rid of older,
less fuel efficient planes and bringing in more fuel efficient
planes, so it is a process of renewal and standardization that
is important for the industry.
Senator Burns. On the efficiency part of these new
airplanes, is there anywhere we can go to see what the airlines
use to measure the payout or the return on investment, as far
as efficiency is concerned? I say that because we are dealing
with some new technologies here on this committee with regard
to lighting.
When you look at optical lighting, that these old light
bulbs that we see here today are on their last legs. A lot of
people don't realize that, and you see this optical lighting
showing up in our traffic lights more than anywhere else. They
use from 30 to 40 percent less electricity. So the payout, or
the payback, for that investment is rather large. Do we see
this kind of a situation in the aircraft that's coming onboard
now from the 787 or other types of aircraft that's being
introduced?
Mr. May. I'm sure in our engineering team, along with
Boeing or Airbus engineering teams would be happy to provide
you and this committee with background.
Senator Burns. Now in the area of leasing, some in the
industry have been critical for the role aircraft leasers have
been playing by providing outside cash and loan support. What
role, good or bad, do you think this section of the industry is
having, and what do you see their future role, how will they
evolve in the future? What role will they play? Mr. Baker,
you're probably in a better position to address that.
Mr. Baker. Mr. Chairman, I think one thing that really
separates the current airline crisis from that which followed
the first Gulf War, and that being of somewhat less
significance, is in fact the rise of leasing companies. We were
unable to witness the number of actual liquidations, names like
Eastern, Banff, carriers no longer with us, and the removal of
their capacity played a role in the resurrection or the return
to profitability that we witnessed for all carriers during the
mid-1990s.
I think the role of the leasing community is largely what
is preventing any liquidations from taking place, so I do think
it is yet another example of a barrier to exit, and the airline
industry is notorious in terms of there being very few barriers
to entry. You and I are free to start an airline with
surprisingly little red tape and capital requirement for us to
actually start an airline, and then ceasing to operate that
airline is entirely different. That said, the leasing community
clearly has to be mindful of the overall value of the demand
for aircraft globally, which is why leasing companies such as
GE are in fact playing an important, and critical role in the
resurrection of carriers, the redesign of carriers such as
Delta Airlines. They are now both a potential or an actual
barrier to exit, but they are also aiding the recovery efforts
of these carriers.
Senator Burns. Tell me about in the airline industry. Why
is it still attracting capital even though it has a very poor
performance record?
Mr. May. Senator, that's a great question, and I wish I had
the answer for it. I can't remember the exact number, but there
is something on the order of 16 to 20 applications resting at
the FAA for people coming into the business, as tough as it is,
and as horrible a record as it is, right now.
Ms. Hecker. I think your interest in the role of
manufacturers and lessors is right where the answers are,
though. Those firms have been making money for a number of
years, so they are playing the role, yes, in some recovery, but
they are also keeping the capacity in the system, despite the
limited pricing power, so it's a dynamic that is a very
important one in the sector.
Senator Burns. That tells me that I should be selling
baggage carts rather than investing in the airline stock. Is
that, everybody is making money but the airline, right?
Mr. Roach. Historically in its business everybody connected
with the airline, with caterers, people that sell, lease
airplanes, fix airplanes. They all make money. It's the airline
industry itself that doesn't make money. You're 100 percent
right.
Senator Burns. We'll have to look into that, I suppose. I
started out there, when I came out of the Marine Corps, I
worked for an airline. Now, the $64,000 question. That's not
very much. Looking at the debt, looking at the asset-to-debt
ratio, how much more time have we got before they are all in
Chapter 11?
Mr. May. Senator, how much longer are we going to have $60
oil, and is it going to go to $70? I think you can measure the
successful livelihood of the business in great measure with the
price of oil. It's that important to the equation.
Senator Burns. That we have very little control of right
now. Right now China and there are a lot of foreign countries
that are in the oil business, and are driving oil prices right
now. But I would say on the other hand in Sydney, Montana, I
don't see many, and Williston, North Dakota, if you know what I
mean.
Mr. Baker. Senator, I would suggest, barring a material
price in crude or material pension relief, Northwest and Delta
will be facing Chapter 11 decisions within the next 6 months.
Other carriers are in better positions in terms of liquidity
profiles, like Continental. I would suggest if nothing changed,
if revenue trends stopped improving, if fuel costs stayed
precisely where they are at the pump today, that Continental
would be facing a Chapter 11 decision sometime toward the end
of 2006, beginning of 2007, and American once they went through
the actions consistent with a carrier trying to avoid the
process, so selling off key assets what have you, making an
additional return to labor for another contribution there, they
would be facing a late 2007, or late 2008, bankruptcy decision.
Senator Burns. Is consolidation an answer?
Mr. Baker. I don't happen to believe that it is. I think
that the America West-USAir example is probably the first and
last significant form of consolidation that, that type of
consolidation that we'll see for sometime. I do believe that
over time, assets belonging to failing carriers as they exit
the industry, they will, will ultimately emerge with fewer
airlines, but I think it's more likely to occur if and when
failures take place than through traditional M&A activity.
Every airline cycle, for example, is accompanied by the loss of
certain hubs after the first Gulf War. We lost National as a
hub. We lost Raleigh-Durham. We lost San Jose. This time around
we have lost Columbus, we have lost another iteration of
Raleigh-Durham, and I would suggest going forward, somewhere
down the road 5, 10 years, hubs like Memphis, Cleveland and
Salt Lake would be on my short list.
Mr. Roach. Senator, I think that the mergers and
acquisitions, first of all, exit to the industry has been very
difficult because of less service and Chapter 11, and people
could hang on. We show a number of airlines leaving: TWA,
American, Banff. There are a lot of airlines and 16 or 17
applications to start new airlines.
We talked about the Social Security crisis, the people not
willing to address their problem. We are there in this
industry. We are at a crisis in this industry. There is no
putting it off until tomorrow. Something has to get done. It
has to get done now. Otherwise, we are going to see several
more airlines in Chapter 11 before the year is over.
Senator Burns. The other members have questions, and we'll
submit those questions to you for written response, and if
you'll copy in the Committee with those responses, we would
appreciate that. Thank you for coming today. I think overall we
got a pretty good picture of our challenges. We didn't talk
about taxes and fees enough, but I think there is some work
that the GAO has done, and the information that all of you have
given us, especially from Mr. May's office, where I think we
are going to take a look at that, and we are going to make an
argument for taxes and fees right now are a significant part. I
think there is also an awareness now that even in security as
the war on terror and as it becomes our enemy, that we can't
protect everybody, because Americans are a mobile society. And
anything that infringes on that freedom of movement is looked
upon as not very good for our society. We are going to have to
take a look at our mass transit and our other transportation
facilities, one of these days we are going to have to look at
the security of this country, and it was suggested up in
Montana the other day that we had volunteers.
We decided to send forces in two different ways in World
War II to wage that war, and we left our own country
vulnerable. And I'm saying we may be in the same situation, but
there were voluntary groups, people volunteered to keep our
country safe, and for observations and to respond to local
emergencies. We may have to go back to that because we cannot,
as a government, levy enough taxes to pay for all of it. And so
I think you know there are a lot of us up here that are taking
a different view of what our priorities are, especially in this
area of transportation and keeping it secure.
Thank you for coming this morning. We'll leave the record
open for a couple of weeks. If you'll respond to those
questions, why, we would appreciate that.
[Whereupon, at 11:25 a.m., the hearing was adjourned.]