How and when do Airlines fail?
Airlines fail each year. Fact. Many more are likely to fail in these troublesome times too. Most airlines fail in the autumn, so it is worth trying to understand why this is the case. We all know that airlines tend to be seasonal because most of us want to use airlines during the summer; so unless the airline is for business travel only; they will:
a) Take payments throughout the year,
b) Take more payments from February to June,
c) ‘Deliver’ the flights in the summer months,
This makes airlines awash with cash in the period up-to the summer, after which they lose the cashflow as the bills start to come in; and when they have to continue to pay staff costs, for airport slots, fuel, and (the big one) their quarterly airline leasing payments.
Airline creditors then need to enforce any defaulting debt, which is generally after the end of September ‘quarter date’; after which the failing airlines file for bankruptcy, liquidation or receivership.
So, we can expect to see the weakest airlines fail from this month and next. Covid-19 further exasperates these issues and impacts those operators that are less robust. Cashflow difficulties in ‘normal years’ can often be ‘limped-through’ at this time by such airlines as they start to take winter booking and bookings ‘for next summer’; but will this be so clear-cut this year?
The pandemic has highlighted airline industry challenges in protecting customer money, along with cashflow within the airlines and wider payments stakeholders, e.g. acquirers and card schemes, which work to safeguard customer funds.
Good news though for airlines (maybe), is that this may have come at the right time of year:
- Some of the cashflow ‘came-in’ during February and March; at the same time as Covid
- This gave airlines time to ground planes, cut costs and renegotiate with airports, staff (furlough schemes), and leasing renegotiation / delayed payments;
- With the public accepting ‘vouchers’ from the airlines for the cancelled flights, this also equated to a new funding method for the airlines through this difficult time.
Who normally loses, and who will lose this time?
When any business fails, it is the creditors that lose. For airlines, the biggest ‘creditor’ is the large numbers of customers who have paid for, but not yet taken their flights; they in the main, then recover the money from insurance policies or from their card company, who in turn recover the money from the card acquirer that processed the transactions for the airline.
The leasing companies recover their planes, whilst unpaid fuel suppliers and airports and staff lose out too. But let’s focus on the card payments part……
Each customer that recovers their card payments does so at the expense of the merchant acquirer; i.e. the bank (typically a bank but increasingly other types of licensed payment institutions) that has been contracted to provide the card processing for the airlines. In the last few years such acquirers have taken more of the risks and shared more of the risks across multiple acquirers.
This means that the airlines have leveraged multiple card processors, that have effectively advanced funds to an airline where the airline CFO negotiations have taken advantage of naïve acquirers. These acquirers have participated in such transactions to greedily seek the processing volumes and revenues with little to no understanding of the potential liabilities that they are covering: i.e. they are then funding the airline cashflow, for their fee, but also accepting that if the airline fails: the loss will be theirs!
So again, some of these less-aware ‘banks’ and newer acquirers that decided to blindly fund these airlines will also lose out. With each airline that fails, we may well see the collapse of some of the acquirers that effectively funded and guaranteed the payments to the airline. If the acquirers do not then fail, they may otherwise suffer significant financial and operational strain. Where the acquirers do not have the capital to survive (or if they have not stored the pre-payments as reserves) then Visa, Mastercard and other card companies will need to step-in to cover the losses. And as we can see from airline annual accounts these customer pre-payments can be tens of millions for very small airlines and £billions for the larger ones.
How will this change in the future – protecting customer money?
Sadly, this infrastructure will no longer function once the ‘music stops’ and we see the next tranche of airline and acquirer failures. Visa, Mastercard, and acquirers will rightly no longer have an appetite for funding airline cashflow and look for alternative ways to funds these arrangements. They should have lost this appetite years ago, but had not really in most cases understood the real extent of the problem!
When you and I pay money into a bank, into a financial instrument of any sort, financial regulators across the EU and around the globe ‘guarantee’ such payments and require financial institutions to have very specific and comprehensive ‘safeguarding’ of customer funds. i.e. our cash is not available to the financial institutions (in the main) for funding the financial institutions’ own cashflow, its losses and/or mis-management. If they fail, in general, your money is safe, or at least up to specific limits.
With AIRLINES this is different. We pay them €£$ billions each year through our cards, and the card companies pay this money almost immediately to the airlines to fund their operations with no regulatory oversight or protections whatsoever. The card companies ‘once upon a time’ had rules that required only the biggest and most capitalised card processing companies (USD100,000,000 balance sheet capital) to support the airlines in this way: but now many others have entered this trading:
• without understanding the potential losses
• not put in place systems to protect, hold or look after the customer money
• agreed to pay the money to the airlines with the airlines having no segregation of customer funds from their own finds in the way that any other business holding customer funds MUST do.
Reading the accounts of some of the biggest airlines in Europe, we have seen that they use these funds (openly) in lieu of corporate-banking finance, or debenture funding. Such funding might not even be available, as the funders of such airlines will be afeared to provide such facilities to such poor credit risks. This means that as customers, we always fund airlines that professional lenders would often not help fund.
Travel bodies that usually ‘step-in’ such as ATOL/ABTA/CAA, or national equivalents, have realised that this is not a very positive position and have started to re-position themselves as uninvolved in the ‘financial guarantee’ part of the transactions.
What should be done and how will or should the industry change?
By default, the card schemes are very aware, as are the acquirers and airlines that this issue exists; so will need to work together to ensure that the customer money is at all times protected and effectively ‘held in escrow’ by trusted and independent parties until they have taken their flights. They will make sure that airlines, should they fail, have the money, and that this money is ‘immediately’ available to be refunded to the customers; and never, never accessible to the liquidators, administrators, or bankruptcy officials to use to favour other creditors.
In the EU and in the UK (not sure whether the UK is part of the EU anymore), we have a regulatory system to protect customer funds in most financial institutions: but we have no strong travel industry regulator that has insisted, or is insisting that customer funds ‘in the travel pre-payments world’ are protected. Nothing in law requires the airline CFO to protect customer funds either.
We have as a payments industry, that readily allows the airline liabilities to be passed to the card payment sector, which then plays ‘Russian roulette’ with our holiday funds without understanding the risks, the liabilities and greedily fighting over the transaction processing revenues and at the same time passively funding the airlines. We now urgently need:
• A strong government (EU/UK) to step-in and insist upon regulation that safeguards our money when we buy flights and holidays;
• Airlines that think about customer funds ahead of trading cashflow to make sure that they separate out these funds from their trading; and when they do not do so, have consequences. Personal consequences;
• An accounting industry / sector that properly reports if an airline accounts the customer funds that are held as liabilities (prepayments) rather than as a working capital item in the airline accounts, and which realises the income only at the time that the product has been delivered (akin to the way that insurance companies only realises its income at the time of exhausting the insurable risks liability).
And to do this our governments need to recognise this problem. Sadly, they may not recognise this challenge until later this year (or next) when we have lost a few more major EU airlines, have created financial hardship for many consumers and adversely impacted the reputation and operations of a chunk of the card payments industry and its participants.
“There is turbulence ahead”. But not the normal kind.
About Kevin Smith
With over 25 years in the payments business, Kevin is a trusted and experienced practitioner and thought leader in payments, technology, issuance, acceptance and acquiring.
About Bill Trueman
Bill Trueman is a professional banker and a payments and risk specialist, with over 25 years of experience. He headed-up risk functions and special investigations in Lloyds Bank issuing and acquiring; acquiring and processing at First Data, and then for insurance risks at RBS / Direct Line.
Riskskill is a leading Europe-based payments and risk management consultancy. Riskskill.com is a global GARS Reviewer for Visa. For more information visit website at http://www.riskskill.com/
For further information, please contact: Bill Trueman or Kevin Smith at firstname.lastname@example.org