With United, US Air and now ATA in bankruptcy, and Delta still teetering on the edge, conventional wisdom and history suggests that some or all of these troubled airlines will liquidate, just like Braniff, Eastern, Pan Am and TWA did a generation ago. Will history repeat itself, or is there a new dynamic in the airline sector that may drive a different outcome?

Robert M. Miller and H. Sean Mathis, principals of Miller Mathis & Co., LLC, a New York City-based investment bank and restructuring firm, who have been integrally involved in many of the major airline bankruptcies including TWA, Braniff, Eastern, Continental, Hawaiian and Atlas Air, believe that the industry may essentially be liquidation proof at this time due to an unusual confluence of circumstances.

"We think that with so many major airlines in or on the brink of bankruptcy it actually makes it far less likely that any of them will wind up liquidating", says Robert Miller, adding: "There is simply not enough capacity in the marketplace to absorb all of the planes that would need to find new homes in the event of a major carrier’s liquidation, much less the liquidation of several major carriers at once or in close proximity. This situation will likely cause the airline’s secured lenders - whose collateral are the planes, engines and spare parts - to not opt for liquidation and instead restructure these carriers."

"The lenders will make informed economic decisions", adds Sean Mathis. "If they believe that they can re-lease the planes on an advantageous economic basis then they will be more inclined to pull the plug. But if they think that the planes will just sit idly earning no return, then they will opt for a restructuring solution even if the economics are worse than what they originally had."

Adds Miller: "We think that this is one of the primary reasons why United has stayed in bankruptcy proceedings as long as it has, despite the fact that the carrier has failed to obtain the government loan guarantee it says it needs to emerge from reorganization. We also think this is a major reason why US Air has not liquidated, as it was widely expected to do shortly after it filed for bankruptcy relief a second time."

To buttress their position Miller and Mathis cite some key factors facing the airlines today: there is a surplus of older, less efficient planes serving the domestic market and a shortage of larger, more efficient planes for long haul, international routes.

In this climate, the choices facing lenders are difficult. Older planes flying domestic routes, such as 757s and 737s, must continue to fly -- however underutilized they may be -- because there are no other economic options. The saturated domestic market may well preclude reconfiguring these planes, and airplane manufacturers like Boeing and Airbus want to sell new, bigger, longer range planes. "There aren’t a lot of takers for older 757s," says Mathis.

"In an earlier time, the market was able to absorb the repossessed assets of a liquidated TWA, Braniff, Pan Am or Eastern," says Miller. "There was a market for those planes back then. The situation today has changed. By keeping the airlines in business, the lenders are hoping for a brighter day."

Most analysts believe that brighter days likely await the reconfiguration of the old hub-and-spoke networks that the major airlines have employed since the days of deregulation in the 1970s. The new airline model -- designed around lower cost point-to-point carriers -- is the future of the industry. Witness the success of Southwest and Jet Blue and the startup of low cost carriers such as Delta’s Song by the majors.

The Effect on Creditors, the Public, etc.
If Miller and Mathis are correct in their view that the major airlines are essentially liquidation proof at the moment, the question is what is the effect of this on lenders, trade creditors and the flying public?

"For secured lenders this means that they will likely stretch to restructure leases and keep the majors in business, rather than face the unpleasant consequences of liquidation and a potential inability to redeploy large fleets of planes. For trade vendors it’s a positive situation, since they normally care much more about having a continuing customer to do business with rather than how much they can get paid on their old claims," say Miller and Mathis, adding: "For the public the situation is also positive, since they will be able to continue to fly on these carriers and their frequent flier miles will be protected and honored."

"What is clear is that the underlying market dynamics are very different today than they were in the days of the old airline brands that have disappeared," says Miller. "And the underlying economics of the airline industry to the secured lenders may be the most critical reason today’s airlines may be able to live for another day," he adds.

A Word From Ed Altman...
(Professor of Finance and Director of the Credit and Debt Markets Research Program at NYU School of Business and a member of the Miller Mathis Advisory Board)

Both the high yield bond market and the defaulted bond and bank loan market have done relatively well in 2004 so far. Through the end of October, high yield bonds have returned 7.97% (Citigroup's HY Index) compared to 5.66% for 10-year US Treasuries and only about 1.6% for the S&P 500. New issues totaled about $113 billion for the first 10 months of 2004 - a very high relative amount but below the near record pace of 2003.

Returns on defaulted bonds and bank loans have also performed reasonably well in 2004 with positive returns for the first three quarters of about 7.0% (based on NYU Salomon Center Indexes of Defaulted Debt).

The default rate on high yield bonds through October 2004 remains quite low, although the Trump and ATA defaults pushed the rate above 1.1%. Recoveries remain quite high -- above 50%, reflecting the improving supply/demand dynamics in the market. I expect higher default rates in 2005 - indeed if Delta Airlines had filed with its $20 billion in bonds, the 2004 dollar-denominated default rate would have increased to over 3.0%.

The views expressed herein are those of Miller Mathis only. Nothing contained herein should be considered as investment advice. Miller Mathis disclaims any and all responsibility.