What the government bailout means for airline investors (and CEOs)

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The strings attached to the $50 billion aid package just enacted to aid America’s stricken airlines will fundamentally change the industry for years to come. In exchange for the sorely needed cash, the major carriers will cease the stock buybacks and dividends that have been their main channels for rewarding investors, possibly for years, making their shares far less attractive. Strict caps on C-suite pay could make it difficult to recruit top talent. The biggest threat: The hit from the coronavirus is so unprecedented, so devastating, that carriers––some heavily leveraged today––may need to shoulder hazardous levels of government-guaranteed debt simply to survive.

It’s important to distinguish between the two programs created by the Coronavirus Economic Stabilization Act of 2020, better known as the CARES Act. The measure provides a total of $50 billion in assistance for passenger carriers split evenly between a $25 billion Payroll Protection Grants package, and a $25 billion a Loan and Loan Guarantees facility––we’ll call them “the Grants” and “the Lending” programs.” Each imposes stringent, sometimes overlapping restrictions on the airlines that tap the programs for aid. Let’s look at two areas where the requirements will re-route the flight paths for the Big Four, American, Delta, United Continental and Southwest.

Buybacks and dividends

In the recovery from the Great Recession and beyond, the major carriers have enjoyed the most stable, consistently profitable period in their post-deregulation history. As profits swelled, they returned the vast bulk of the cash to investors via dividends, and most of all, repurchases. In the three years from 2017 to 2019, the Big Four recorded total net income of $32.8 billion, and channeled 70% of those earnings into buybacks and dividends, with the former accounting for 80% of that total.

The payroll grants program and the lending facility impose different restrictions on dividends and repurchases. It’s important to recognize that all of the Big Four are signing up for the grants packages, and will hence be subject to its restrictions as a minimum. Its regulations stipulate that all of the cash be used for wages, salaries and benefits. It’s designed to cover all compensation for Q2 and Q3 of this year. To get the cash, the airlines must maintain the same total payroll, and same level of employment as prevailed in the same two quarters in 2019––no layoffs or furloughs permitted. The Big Four will receive around $22.1 billion of the $25 billion total.

But though the program is titled “grants,” only part of the money is actually a capital injection. Thirty-percent of the aid comes in the form of loans for a maximum of five years. The Treasury guarantees repayment to the banks that make those loans, but the airlines must pay the government back, or risk another round of bankruptcies––and as we’ll see, the second program offers a far bigger bailout in the form of fresh credit.

Under the grant program, Delta, for example, will receive a $3.95 billion capital award, plus a loan for $1.7 billion. To get the aid, the carriers are prohibited from repurchasing shares or paying dividends through September 30, 2021.

That rule doesn’t sound exactly brutal, since the Big Four will most likely lack the earnings to return cash to shareholders by late 2021 in any case. But here’s where the additional bans in the second “Lending Program,” bites hard. That provision makes $25 billion available, once again in five year loans, with the Treasury determining the interest rate based on the risks posed by the borrowers, and the rate on government bonds of the same maturities when the loans are made.

It’s not clear whether all of the majors will grab these credits. But American has already announced that it’s applying for a $4.7 billion loan under the Lending Program. It’s likely that the rest of the Big Four will each need billions from the facility as well, because the aid from the Grants Program alone isn’t nearly big enough to plug the gigantic cash shortfalls caused by the shutdown in air travel. Consider Delta, along with Southwest the most profitable of the Big Four. CEO Ed Bastian predicts that revenues will drop 80% in Q2; a similar drop in Q3 is likely. In that scenario, Delta’s revenues would fall from $25 billion over those six months last year to $5 billion. Keep in mind that to qualify for the Grants Program, Delta will need to spend the same $5.6 billion in payroll in Q2 and Q3 of this year as it dispensed in 2019. The looming, multibillion dollar deficit over those two quarters will almost certainly force the majors to grasp the Lending Program as a lifeline.

By taking cash under the Lending Program, the Big Four are submitting to tighter constraints. Repurchases and dividends can only restart one year after the loans are repaid. The term of the Treasury financing is five years. The carriers will make a top priority of paying of back the Treasury, and escaping from these shareholder-unfriendly strictures. But how long will it take them to accumulate the sufficient cash? That uncertainty could make airline stocks a lot less attractive in the years to come than in the recent golden period where plentiful cash flowed back to investors.

CEO pay gets slashed

It’s the Grants Program that hammers pay at the top. It imposes two levels of limits, one for highly-paid managers, and another for the multi-million comp crowd who show up in the annual proxy. For executives earning up to $425,000 in 2019, the carriers are barred from providing raises for two years, until March of 2022. How about the C-suite? Many of the top airline executives already taking voluntary pay cuts. Bastian is forgoing his entire salary for six months, and United’s CEO Oscar Munoz and President Scott Kirby are not collecting their base pay through June. Doug Parker, chief of American, hasn’t taken a salary since 2015.

Those sacrifices pale next to the clampdown in total comp––including the big number, equity grants––decreed by the Grant Program. It mandates that for any executive earning over $3 million in 2019, they may receive that $3 million plus a limit of “50% of the excess over $3 million during any consecutive twelve-month period.” In plain language, they can now take home just half of anything over $3 million. So, if a CFO made $5 million in 2019, now his pay is capped at $4 million, $3 million plus half the $2 million “excess.” 

American, United and Southwest all filed proxies for 2019, while Delta’s most recent numbers are from 2018. In those four reports, every one of the five highest-ranking executives earned over $3 million for those years. In 2018, Bastian garnered $15 million, and last year, Munoz made $14.5 million, his designated successor Kirby made $8.1 million, and American’s Parker $12 million. The lowest-paid CEO was Gary Kelly of Southwest at $7.7 million.

Those big names are all heading for huge pay cuts. Bastian, assuming he pocketed a similar number in 2019, would see his comp lowered from $15 million to $9 million ($3 million plus half of the $12 million excess).

It’s certain that boards would have lowered pay anyway, given the horrendous losses pending for 2020. But here’s where the Grant and Loan Program overlap. It appears that if a carrier only enrolls in the Grant Program, the restrictions on pay remain just one year, until March of 2021. But if the airline also signs for the what’s called “loans and loan guarantees,” the restrictions remain in place until one year after the loans are repaid, the same timeline banning buybacks and dividends.

If dark skies ahead force the Big Four to keep those Treasury loans on their books until they come due in the spring of 2024, they’d be bound by the limits for the next six years, limits based on pay scales seven years earlier.

The U.S. has every right to set rigorous conditions. But this time the Treasury may scare off the investors and future leaders needed to make the industry fly again.

More personal finance coverage from Fortune:

—What to do if you can’t pay your bills this month
When will stimulus checks be direct deposited or mailed? Ensure yours isn’t delayed
—What you should know about mortgage forbearance and skipping payments
Everything you need to know about furloughs—and what they mean for workers
Freelancers and independent contractors can now apply for SBA Paycheck Protection Program loans. What you need to know
—The IRS launched portal to get your stimulus check if you don’t file taxes
—Listen to Leadership Next, a Fortune podcast examining the evolving role of CEO

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