Why do banks have little risk appetite for financing airline business?

Anyone who has been closely following the developments relating to Go First since the company filed for resolution under IBC in May 2023, would agree that reviving an airline business once it shuts operations is nearly impossible. In this context, it would be interesting to examine the reasons why airline business globally is not an easy one to run and why domestic banks shy away from lending to this sector.

?Airlines is a heavily regulated and a capital intensive business. To be competitive, airlines have to have a certain minimum number of aircrafts in operation. Because of capital constraints It is not possible for any airline company to own a very large fleet of aircrafts. Hence, to overcome this constraint, airlines have a mix of owned and leased aircrafts. Low cost airlines, in particular, have a larger fleet of leased aircrafts of various configuration. To secure the aircrafts, the lessors insist on security in the form of either cash collateral or a Bank Guarantee. This security ensures that the operator (Lessee) pays lease rentals on time and? also gets periodic maintenance carried out so that the aircrafts remain airworthy. As per the lease agreement, the lessor can terminate the lease and take back possession of the aircraft(s) if there is any breach of these terms by the operator. Thus, the only security available to the lenders is the airlines' owned aircrafts and the cash flows. ?Even this security erodes quickly when airlines are not able to pay their dues for availing other services like parking bays, routine maintenance, spares etc. Aviation authorities can seize these aircrafts to recover any unpaid dues. The fact that these aircrafts could be grounded at different airports only compounds the challenge. Even the Oil companies supplying ATF to the airlines secures themselves by obtaining Letters of Credit from Banks.

?The ongoing struggles of Go First to take to skies again only underlines most of the challenges highlighted above. Let's look at some of these in a little more detail to have a better understanding. Go First (previously Go Air) started operations in 2005 as a low cost airline. As of November, 2019 it had a market share of 11 per cent. Go First had a fleet of 54 aircrafts. Its financial stress surfaced due to what the airlines claims as defective engines supplied by Pratt & Whitney. As a result, 28 of its aircrafts were grounded over period of time due to non-supply of replacement engines by P & W. In percentage terms, the fleet of grounded aircrafts rose from 7 per cent in December 2019 to 50 per cent in December 2022. Consequently, its market share declined from 11 per cent as of November 2019 to 6.9 per cent in March 2023. As of April 2023, the airline owed Rs. 6521 crore to financial creditors, Rs. 1200 crore to operational creditors and Rs. 2660 crore to aircraft lessors. Finding it difficult to continue operations and to prevent any precipitative action by the aircraft lessors or the operational creditors; the Wadia owned airlines moved IBC in May 2023. The lessors challenged this stating that they had served notice for de-registering the aircrafts and reclaiming these even before the company filed an application before NCLT. The lessors’ lawyers’ represented that moratorium applicable under IBC should not apply to the leased aircrafts. The NCLT bench gave no relief to the aircraft lessors. The lessors expressing their displeasure highlighted that this would make them rethink about aircrafts already leased to other airlines. Aware of the concerns and its potential fallout, the Central Govt. moved quickly to amend the provisions of the IBC exempting aircraft objects from moratorium, more importantly, these amendments would be effective retrospectively. This effectively settled the legal challenge launched by the aircraft lessors in their favour. However, this also meant that any possibility of a resolution initiated either by the existing promoters or any other potential bidders turned very bleak. Two potential bidders who had submitted an EOI initially did not submit a final bid once the IBC provisions were tweaked. With most of the aircrafts likely to be reclaimed by the lessors, the airlines could hardly run on a highly truncated fleet of owned aircrafts. No airline business can survive without the minimum number of operational and serviceable aircrafts. With any possibility of revival of the airlines becoming dimmer by the day, its CEO resigned in November 2023.

?We already have the example of Jet Airways and Kingfisher airlines which were never able to resume operations once their operations came to a halt. Any airline business has value only as long as it is a going concern. Lenders are extremely risk averse to increasing their exposure as soon as signs of liquidity strain are visible. Though ensuring that the airline is provided need based funding to keep it as a going concern is only likely to enhance its value and safeguard their existing exposure of lenders. Past experience with other failed airlines shows that no lender wants to take the additional risk.

?Lenders to Go First are staring at a potential loss of Rs. 6500 crore. Their recovery largely ?hinges on the collateral security in the form of landed property which they had obtained from the Wadias to secure their exposure. In all likelihood, Go First is heading towards liquidation and its name would get added to the list of yet another failed airline in India’s aviation history. Ironically, this would happen at a time when the Indian Aviation sector is growing at a rapid pace with the number of flyers already exceeding the pre Covid level and both leisure and business travel rebounding strongly.