	Legacy Airlines Must Reduce Costs to Restore Profitability

Since 2000, legacy airlines have faced unprecedented internal and external  challenges. Internally, the impact of the Internet on how tickets are sold  and consumers search for fares and the growth of low cost airlines as a  market force accessible to almost every consumer has hurt legacy airline  revenues by placing downward pressure on airfares. This is  especially true of airlines that did not have fuel hedging in place. Legacy airlines, as a group, have been unsuccessful in reducing their costs  to become more competitive with low cost airlines. While legacy airlines have been able to reduce their overall costs  since 2001, these were largely achieved through capacity reductions and  without an improvement in their unit costs. During the first quarter of 2005, both  legacy and low cost airlines continued to struggle to reduce costs, in part  because of the increase in fuel costs. Legacy airlines have  lost a cumulative $28 billion since 2001 and are predicted to lose another  $5 billion in 2005, according to industry analysts. Low cost airlines also reported net operating losses of  almost $0.2 billion, driven primarily by ATA’s losses. Bankruptcy is Common in the Airline Industry, but There is No Evidence that it is Harmful to the Industry or Competitors

Airlines seek bankruptcy protection for such reasons as severe liquidity  pressures, an inability to obtain relief from employees and creditors, and  an inability to obtain new financing, according to airline officials and  bankruptcy experts. As a result of the structural problems and external  shocks previously discussed, there have been 160 total airline bankruptcy  filings since deregulation in 1978, including 20 since 2000, according to the  Air Transport Association. With very few exceptions, airlines that enter bankruptcy do not emerge  from it. We also reviewed numerous other bankruptcy and airline industry studies  and spoke to industry analysts to determine what evidence existed with  regard to the impact of bankruptcy on the industry. Both studies  found that airlines under bankruptcy protection did not lower their fares  or hurt competitor airlines, as some have contended. This study found that bankrupt firms’ performance  deteriorated prior to filing for bankruptcy and that their rivals’ profits also  declined during this period. Legacy Airlines Face Significant Near-term Liquidity Pressures, including $10.4 Billion in Pensions Contributions over the Next 4 Years

Under current law, legacy airlines’ pension funding requirements are  estimated to be a minimum of $10.4 billion from 2005 through 2008. In contrast, low cost airlines have eschewed defined benefit pension  plans and instead use defined contribution (401k-type) plans. The size of legacy airlines’  future fixed obligations, including pensions, relative to their financial  position suggests they will have trouble meeting their various financial  obligations. While cash from operations can help fund some of these obligations,  continued losses and the size of these obligations put these airlines in a  sizable liquidity bind. The cost to PBGC and participants of defined benefit pension terminations  has grown in recent years as the level of pension underfunding has  deepened. Dramatic  changes in the level and nature of demand for air travel combined with an  equally dramatic evolution in how airlines meet that demand have forced a  drastic restructuring in the competitive structure of the industry. However, this should not  be confused with causing the industry’s instability. There is no clear  evidence that bankruptcy has contributed to the industry’s economic ills,  including overcapacity and underpricing, and there is some evidence to  the contrary. However, the  termination of pension obligations by United Airlines and US Airways has  had substantial and wide-spread effects on the PBGC and thousands of  airline employees, retirees, and other beneficiaries. If their plans are  frozen so that future liabilities do not continue to grow, allowing an  extended payback period may reduce the likelihood that these airlines will  file for bankruptcy and terminate their pensions in the coming year.
Why GAO Did This Study

Since 2001, the U.S. airline industry has confronted unprecedented financial losses. Two of the nation's largest airlines--United Airlines and US Airways--went into bankruptcy, terminating their pension plans and passing the unfunded liability to the Pension Benefit Guaranty Corporation (PBGC). PBGC's unfunded liability was $9.6 billion; plan participants lost $5.2 billion in benefits. Considerable debate has ensued over airlines' use of bankruptcy protection as a means to continue operations, often for years. Many in the industry and elsewhere have maintained that airlines' use of this approach is harmful to the industry, in that it allows inefficient carriers to reduce ticket prices below those of their competitors. This debate has received even sharper focus with pension defaults. Critics argue that by not having to meet their pension obligations, airlines in bankruptcy have an advantage that may encourage other companies to take the same approach. GAO is completing a report for the Committee due later this year. Today's testimony presents preliminary observations in three areas: (1) the continued financial difficulties faced by legacy airlines, (2) the effect of bankruptcy on the industry and competitors, and (3) the effect of airline pension underfunding on employees, airlines, and the PBGC.

What GAO Found

U.S. legacy airlines have not been able to reduce their costs sufficiently to profitably compete with low cost airlines that continue to capture market share. Internal and external challenges have fundamentally changed the nature of the industry and forced legacy airlines to restructure themselves financially. The changing demand for air travel and the growth of low cost airlines has kept fares low, forcing these airlines to reduce their costs. They have struggled to do so, however, especially as the cost of jet fuel has jumped. So far, they have been unable to reduce costs to a level with their low-cost rivals. As a result, legacy airlines have continued to lose money--$28 billion since 2001. Although some industry observers have asserted that airlines undergoing bankruptcy reorganization contribute to the industry's financial problems, GAO found no clear evidence that historically airlines in bankruptcy have financially harmed competing airlines. Bankruptcy is endemic to the industry; 160 airlines filed for bankruptcy since deregulation in 1978, including 20 since 2000. Most airlines that entered bankruptcy have not survived. Moreover, despite assertions to the contrary, available evidence does not suggest that airlines in bankruptcy contribute to industry overcapacity or that bankrupt airlines harm competitors by reducing fares below what other airlines are charging. While bankruptcy may not be detrimental to rival airlines, it is detrimental for pension plan participants and the PBGC. The remaining legacy airlines with defined benefit pension plans face over $60 billion in fixed obligations over the next 4 years, including $10.4 billion in pension obligations--more than some of these airlines may be able to afford given continued losses. While cash from operations can help fund some of these obligations, continued losses and the size of these obligations put these airlines in a sizable liquidity bind. Moreover, legacy airlines still face considerable restructuring before they become competitive with low cost airlines.