For those of you who missed the news, a bankruptcy judge has allowed United Airlines to default on its pensions. The Pension Benefit Guaranty Corporation - a government entity - will assume United's pension obligations. This 9.8 billion default is the largest default in the history of the US, second to Bethleham Steele's 3.6 billion default in 2002. However, this is just the tip of the ice burg.
Get ready for a possible wave of bankruptcies in the auto and airline industries, with a primary goal being the elimination of their respective pension liabilities.
The result will be an enormous increase in the PBGC's obligations, which the US taxpayer will fund.
Financially, the airline industry is in terrible shape. According to the Reuters website (which is a great site for general financial information), the industry's cost structure is very tight. The average margins are:
gross margin 28%, operating margin 5.4% and net income margin 2.6%. The long-term debt as a percentage of total assets - 1.05%. This means there is a ton of debt which constrains the individual companies' ability to make corporate changes.
Sales for the last 12 months are growing at a 15% clip. Compare this to the cost of oil which increased 110% last year. Because of the intense competition, passing commodity increases onto consumers is difficult.
5 US airlines are already in bankruptcy: United Airlines, US Airways, Hawaiian Airlines, ATA Airlines (also known as "American Trans Air"), and Aloha Airlines.
In short, the industry is in terrible shape.
However, now United has a key competitive advantage: the bankruptcy judge has relieved the company of their annual $645 million pension cost. The savings accounts for ¼ of United's bankruptcy savings of $2 billion. In contrast other airlines with defined benefit programs still have the financial responsibility of their respective underfunded pensions. They will view United's strategic position as grossly unfair. However, the only way they can achieve the same financial results is to declare bankruptcy themselves.
Delta has already stated it may have to enter bankruptcy protection by the end of the year. Northwest and Continental are also hemorrhaging money, meaning bankruptcy may be on both their horizons. Given United's large cost savings as a result of their bankruptcy, competitors may be forced into bankruptcy merely to remain competitive.
The auto industry's financial position is parallel to the airline industry. Two major ratings agencies recently downgraded Ford and GM to junk bond status. Ford has a 12.1 billion underfunded pension liability, while GM's unfunded retiree medical liability is 61 billion. Both carmakers have lost market share to Japanese rivals. The profits of both companies are heavily reliant on gas-guzzling SUV's, whose sales are down in a rising fuel environment. And neither company has a strong position in the hybrid-vehicle market, which many believe to be the next big-thing in cars. As a result, neither company can pullout of their financial nosedives with a new product. As a result, bankruptcy protection may be the only option for both companies.
Enter the Pension Benefit Guaranty Corporation, which is already 23 billion in debt as of its 2004 annual report. In the same report, they warned of a total of $450 billion in underfunded pension in the United States. The underperformance of the equity markets for the last 5 years have compounded this problem. Does anybody remember the Resolution Trust Corporation?
The crisis begins.