Just a few months ago airline executives expressed relief that 2008 was over. At the beginning of the year, government condemnation of so-called business excesses, coupled with depressing economic news decimated premium traffic. Last week headlines suggested the worse was over.

Well, fasten your seatbelts, here comes another shock -- the hysteria surrounding the month-old, world-wide outbreak of a deadly Swine Flu that prompted the U.S. government to declare a health emergency and airlines to waive change fees to affected areas. That sucking sound is the final retreat of whatever small bit of optimism that had emerged in the last few weeks. Since airlines often cite SARS as one of the major blows suffered this decade, it is likely that the slowing of declines cited in first quarter reports issued in the past two weeks could start rising again. This just adds to the growing uncertainty surrounding the aviation sector.

The severe respiratory illness has its epicenter in Mexico and suspected cases have been reported in Canada, the U.S., New Zealand, Spain, Egypt and Britain where a flight attendant was hospitalized after becoming ill on a flight from Mexico. Some countries are considering quarantines and issuing travel advisories for travelers destined for the U.S. and Mexico. Some 1,500 were sickened in Mexico and more than 100 have died, although confirmations that all are related to the deadly Swine Flu – an animal strain of the H1N1 virus – have yet to come. The World Health Organization (WHO) is warning of a pandemic.

News organizations love a good story that enables them to cover 24/7 and whip viewers and readers into a frenzied, addictive search for more. The Swine Flu is just such a story which has rocketed around the word building to a crescendo over the weekend and promising to have enough legs to last awhile. Headlines trumpeted Swine Flu, more easily transmittable through human-to-human contact, will be worse than SARS although it is early days yet. One story noted that H1N1, reconstructed using tissues of victims who died in hours, felled 50 million worldwide in 1918.

More headlines were alarming than accurate with the best coverage coming from the Seattle Post Intelligencer with good, old fashioned reporting designed to inform, not panic.

The Air Transport Association (ATA) said it is in close contact with the Centers for Disease Control (CDC) and U.S. Department of Transportation on actions the U.S. Government is taking to combat the spread of the swine influenza to and within the U.S. It said CDC asked airlines to continue to implement standard protocols for identifying, reporting and managing cases of potential communicable disease for passengers arriving in the U.S. or traveling between U.S. airports.

“No additional screening by CDC has been proposed or required at this time,” said ATA. CDC has issued a ‘Travel Health Precaution,’ but currently has NOT recommended that people avoid travel to Mexico. Some airlines have implemented flexible travel policies. Scientists in the United States and Mexico were trying to determine if the deaths were due to the same new strain of swine flu that sickened seven people in Texas and California.”

No Worse Time
Regardless of whether or not this is the “big one,” with tectonic implications, the news comes at a time the industry can least afford it. Airline stocks plummeted along with the fortunes of pork producers this morning in favor of a wave of orders for drug-company stocks. It is ironic that, during earnings calls last week, airlines noted the relationships between doom-and-gloom headlines and falling traffic.

The uncertainty of U.S. airline profitability for 2009 can be illustrated by the variations in analyst and government forecasts which swing from $4-10 billion in profits to revenue declines of 12 percent, which analysts agree would kill any chance of profitability this year. That would make for the worst environment in history, including the post-9/11 period, according to a General Accountability Office report commissioned by the Senate Committee on Commerce, Science, and Transportation and released Friday.

In addition to the impact on airlines and airports, GAO said falling enplanements threatens the Aviation Trust fund at a time when the industry is clamoring for more funding for NextGen and for the nationwide rollout of near-term procedures that would save money and carbon emissions.

The uncommitted balance of the trust fund fell from about $7.3 billion at the end of fiscal year 2001 to about $1.4 billion at the end of fiscal year 2008. GAO cited a Congressional Budget Office report predicted the uncommitted balance to fall to $752 million this year, while forecasting about $18 billion fewer revenues between 2009 through 2017 compared to its 2007 forecast for that same time period. In testimony earlier this year, the industry called for increasing the general fund contribution to the FAA, now at 15 percent to 25 or 30 percent.

If Congress does not increase general fund contributions further than the appropriations inserted into the omnibus appropriations bill, increasing revenues would be critical and possibly include taxing the new airline fees imposed last year. GAO pointed out that taxes, now based only on ticket costs, do not capture any of the new revenue. “Had the $635 million in baggage fees collected by airlines in the first 3 quarters of 2008 been taxed at the same 7.5 percent rate as fares are taxed, an additional $47.6 million in revenue would have been generated for the trust fund,” said GAO ominously.

GAO cited ancillary revenues as a saving grace to the 2008 revenue picture, saying airlines generated $8 billion last year. Baggage fee revenue jumped 86 percent from $341 million in 2005 to $635 million (one percent of total operating revenues) through September of last year

GAO noted that forecasted trust fund revenues have been consistently below Federal Aviation Administration (FAA) forecasts. “Actual revenues of $12.06 billion in fiscal year 2008 were about 4 percent lower than the $12.62 billion in revenues that FAA forecast in its 2008 budget proposal in February 2007,” said GAO. “FAA recently forecast a 7.8 percent decrease in domestic passenger traffic for fiscal year 2009. Since the trust fund’s creation in 1970, revenues have, in the aggregate, exceeded spending commitments from FAA’s appropriations, resulting in a surplus. In recent years, the trust fund’s uncommitted balance has declined as it has been used to offset lower-than-forecast trust fund revenues. For each fiscal year beginning with 2001, actual revenues have been less than forecast, so that in each year since then the uncommitted balance has fallen. The trust fund’s uncommitted balance, which exceeded $7.3 billion at the end of fiscal year 2001, has since dropped to about $1.4 billion at the end of fiscal year 2008.”

GAO noted increases in general fund appropriations for 2009 and a $1 billion decline in FAA’s appropriation from the trust fund than what was originally outlined in FAA’s fiscal year 2009 budget proposal.

“Although FAA received additional general fund money…the trust fund’s uncommitted balance could potentially fall close to zero in the near future, since revenues coming into the trust fund have consistently fallen short of forecasts. A further decline in the uncommitted balance toward zero warns FAA that funds may not be available to start or continue some projects for which appropriations have been made. The declining uncommitted balance also signals to Congress that it may need to make some difficult choices about whether to reduce FAA’s appropriations or to take actions to either increase revenues going into the Trust Fund or increase appropriations from the general fund for FAA. Congress and FAA should reduce the risk of over committing budgetary resources from the trust fund so that resources are available to cover all the obligations that FAA has the authority to incur and reduce the risk of disruptions in funds for aviation programs and projects,” it said.

Airline Headwinds
Airlines face $4.4 billion in debt and capital lease maturities this year with another $6 billion due next year, according to Fitch Ratings. This is compounded by higher pension obligations owing to a decline in the plans’ asset value. The good news is that any further decline in demand will likely keep oil prices at current levels but it is unclear how that will impact cash flow if the decline owing to the health scare becomes dramatic.

GAO noted that airlines have increased total liquidity from $18.6 billion in the beginning of 2005 to $28.1 billion at the end of 2007. However, liquidity deteriorated last year about $26.6 billion through the third quarter 2008. “In 2008, the 11 largest airlines raised an estimated $8 billion in capital from a variety of sources, including advance frequent flyer mileage sales to credit card companies, equity and debt issuance, and asset sales,” said the report. “However, airline analysts noted most airlines exhausted their available options to generate cash in 2008 and have limited cash-generating opportunities in 2009. Additionally, some analysts noted that sources of aircraft capital, such as the sale and leaseback of aircraft, are largely inaccessible, because of current credit market conditions. However, analysts believe that if fuel prices remain at or near current levels, the airlines will have sufficient cash flow to avoid depleting their cash balances.”

Even with operating profitability airlines face significant challenges this year, said GAO not only from debt and pension obligations but from labor negotiations since nearly every contract at the major airlines is currently open or amendable by the end of this year. There are now 83 open contracts at 34 legacy, low-cost and other airlines, it said, citing the contract restructuring that took place during the 2003/4 period when airlines were trying to avoid bankruptcy. Of the 83 open contracts, 42 are currently in mediation with the National Mediation Board (NMB).

Quantifying Last Year’s Misery
Capacity reductions last year totaled nine percent over all, according to GAO, accomplished with the grounding of 800 aircraft or 18 percent of the fleet and dropping available seat miles by 22 million, 83 percent of which were narrow bodies. The smallest percentage reduction came from larger regional jets and turboprops used to down gauge routes. This 23 percent increase in the number of larger regional aircraft, however, was balanced by a 17 percent decline in the number of 50 seaters and below, according to GAO, which added that aircraft deferrals were growing including 18 at AirTran and 21 and JetBlue which delayed deliveries until 2014 and 2015. Industry headcount dropped seven percent or about 28,000 in 2008 alone with more announced this year.

While analysts fret about industry profitability, GAO noted that traffic declines have hit airports. Large and medium hubs gain at least $9 per passenger, and, when averaged across all-sized airports, passengers make up two thirds of total revenue from non-airline sources. Oakland, for instance lost 30 percent of its enplanements, hitting food and beverage income by 25 percent and car rentals by 20 percent. Sioux City, Iowa, enplanements dropped 50 percent with an expected impact on parking revenues 24 percent and airline-related fees dropping 47 percent after Frontier dropped service there. Medium-hub airports declined the most. Thirty eight airports lost service altogether last year, which, while less than the 100 ATA predicted at the height of the fuel crisis, doubled the service losses during 2007. From the fourth quarter of 2007 to the fourth quarter of 2008, large hub airports lost 8 percent of domestic scheduled seats, medium hub airports lost 12 percent, small hub airports lost 10 percent, and non-hub airports lost 11 percent.

Of the 38 airports that lost all scheduled service, 14 were part of the Essential Air Service (EAS) program and were eligible to regain air service with government assistance. Another 14 airports that had direct service to two or more markets in 2007 had direct service to only one market during the fourth quarter of 2008.

Already subject to higher fares, many of these market suffered fare increases which further impacted traffic. On average, domestic airfares increased by 18 percent from the third quarter of 2007 to the third quarter of 2008 but much of that has been eroded with this year’s fare sales. At airports with capacity reductions of more than 10 percent, fares increased even more, with average airfares increasing by an average of 21 percent during the same time period with some experiencing a 73 percent increase in fares. GAO cited ATA data showing monthly yields declining 11 percent between October and January.

For the first time since the program’s inception in 1991, total PFC collections declined $150 million last year and FAA expects them to continue to decline this year. Despite enplanement declines of between seven and 12 percent across all airports in Q4, ratings agencies say the 100 largest airports are financially strong with a year’s worth of cash reserves excluding debt.

U.S. Airports with Loss of All Commercial Service from Fourth Quarter 2007 to Fourth Quarter 2008
1. Bridgeport, Conn.
2. Bedford/Hanscom, Mass.
3. Brookings, S. Dak.
4. Boulder City, Nev.
5. Bluefield, W.V.
6. Cape Newenham, Alaska
7. El Dorado, Ariz. (b)
8. Wildman Lake, Alaska
9. Excursion Inlet, Alaska (a)
10. Grand Canyon, Ariz.
11. Grand Canyon West, Ariz.
12. Glendive, Mont. (a)
13. Glasgow, Mont. (a)
14. Grand Island, Neb. (a)
15. Gallup, N. Mex.
16. Hot Spring, Ark. (b)
17. Harrison, Ark. (b)
18. Havre, Mont. (a)
19. Kingman, Ariz. (a)
20. Kirksville, Mo. (a)
21. Kinston, N.C.
22. Jonesboro, Ark. (b)
23. Sandy River, Alaska
24. Lopez Island, Wash.
25. Tampa (MacDill Air Force Base), Fla.
26. Jackson, Tenn. (b)
27. Wolf Point, Mont.a
28. Owensboro, Ky. (b)
29. Portage Creek, Alaska
30. Portsmouth, N.H.
31. Roche Harbor, Wash.
32. Rosario, Wash.
33. Santa Fe, N. Mex.
34. Pinehurst, N.C.
35. Philadelphia, N.J.
36. Blue Mountain, Alaska
37. Westsound, Wash.
38. Youngstown, Ohio
Source: GAO Analysis of OAG data.
(a) — Airport participating in the Essential Air Service (EAS) program with service restored as of February
(b) — Airport participating in EAS without service as of February 2009. Service scheduled to be restored in May 2009.

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