Asian executives must be wondering what other calamities fate can possibly have in store for them. But the region's financial crisis calls for its airline executives to do more than simply take chicken off the inflight menus on services to Hong Kong. The chicken flu crisis is just another in a cascade of major and minor shocks which have spread throughout Asia and are severely testing its airlines' financial and operational resilience.
The decision by the Australasian carriers to drop their South Korean services in early January was the first real manifestation of the strategic and financial changes to come. South Korea's normally strong demand for outbound tourism had made it Australia's second largest international market. But neither Qantas and Air New Zealand, with four weekly services each, or Ansett International with its two weekly services, were able to sustain the losses after passenger loads dropped 65 per cent in the final quarter of 1998.
While the region's airlines stare at order books based on steady 8.5 per cent annual traffic growth, in the short term they are adjusting as best they can to new realities. 'This crisis is incredibly sudden, deep and broad - there are now half-a-dozen countries where the currency can go up or down 15 per cent in a single day,' says Peter Harbison, managing director of the Centre for Asia-Pacific Aviation in Sydney. 'Every carrier has to reassess each one of its routes in a very short time.' 'There will be a lot more rationalisation of routes. People will have to get together and talk about codesharing,' adds a senior official at Philippine Airlines.
The depth of the crisis requires carriers to take immediate action: the depreciation of most Asian currencies against the dollar - with the exception of the Hong Kong dollar and the yen - has made the position of many carriers untenable. The South Korean won has fallen 50 per cent and the Indonesian rupiah by even more, with 30 per cent currency drops in Malaysia and the Philippines.
As a result the first six months of 1998 are likely to see a wholesale switching of capacity away from the more distressed markets, where foreign exchange losses cannot be sustained, towards destinations where yields have remained stable and the depreciation has boosted demand by making fares cheaper for inbound traffic.
Along with the two South Korean carriers - Korean Air and Asiana - Thai International has been the hardest hit. While the three carriers are unlikely to go bust, they have been hamstrung by government requirements to maintain unprofitable services in the national interest.They have responded in two ways. First, all have been onto Seattle and Toulouse to cancel aircraft options and negotiate the deferral of new orders. At the same time much benefit has already been drawn from delivery delays resulting from Boeing's production difficulties at the end of last year.
Second, the South Korean carriers in particular have been active in trying to forge short-term alliances throughout the region, offering other carriers shared services from South Korea while the crisis continues, so that they can redeploy their capacity more profitably elsewhere. By mid-January there had been no takers but the Australians and Japanese had started to show interest in a temporary arrangement. 'There are teams of people at airlines now responsible for contacting other airlines,' says one South Korean airline official. 'The urgency is like, yesterday,' he adds. However the official declines to confirm reports that Korean Air and Asiana plan to cancel their European services until the summer.
The medium-term impact of developing temporary alliances will be to accelerate the pace of regional liberalisation and push forward negotiations with the US and Europe. 'We are looking for exceptional solutions for exceptional changes,' says a Philippine transport official.
So far the proposed changes are small. Malaysia will push a proposal at the next meeting of Asean tourism ministers in March to lift restrictions on tourist fare discounts in the region. However, the need to redeploy capacity over a short timescale is placing bilateral flexibility at a premium, and should push Asia's typically restrictive regimes towards more liberalised international agreements. 'We are looking at short-term changes which could become long-term structural changes,' says Harbison.
Swinging currencies
With dollar revenues plummeting and currencies swinging wildly, financial managers have been placed under intense pressure to respond. Among the region's carriers only Cathay Pacific and Qantas have been active in hedging currencies, leaving other carriers to assess their exposures. 'Historically, most Asian carriers are short in US dollars and long in six or seven regional currencies,' says the treasurer of one flag carrier. 'Everyone is reviewing their systems and reporting standards, looking for forex data on ticket sales and redefining their exposures. To be prudent you need to start nickel and diming these positions - to assess exactly how much of your costs and revenues are in each exposed currency.'
The distressed forex positions and shattering balance sheets throughout the region have multiplied the concern of bankers who had been seeking to finance the bulge in capacity that was due to come on line over the next three years.
The warning signals existed before South Korea joined the ranks of those with severe economic troubles and were already beginning to bite, they say. The supply and demand of ATKs in the region was forecast to match up in 1999 but average load factors among members of the Association of Asia-Pacific Airlines had already fallen 3 percentage points in the third quarter of 1997, indicating that this estimate was already out of date.
Changing attitudes
Airlines pressing ahead with deliveries have found a rapid turnaround in the attitudes of lenders who, over the past two years, have pushed pricing downwards in their rush to tap into the previous boom in deliveries. 'There is a sense of panic,' says one finance director. 'They think that all of Asia is a basket case when in fact there is a range of basket cases. You cannot look at all of us the same way.'
The crisis has created a new class of bargain hunters in the region. Financiers have been active in pitching sale and leaseback structures to distressed carriers to solve short-term cash flow problems. Korean Air has already sold four Airbus A300-600Rs to Crédit Lyonnais and Asiana is following suit, while Thai is examining similar options. 'Sale and leaseback is the quickest and most efficient way to get cash and generate book gains,' says José Abramovic, head of aerospace financing at Crédit Lyonnais in Singapore.
Unfortunately, different accounting standards throughout the region have limited the positive impact of these structures on balance sheets.
Like their US counterparts, South Korean carriers cannot adjust the value of their aircraft assets on balance sheet to reflect the depreciation of their national currency. However they still have to book the corresponding increase in liabilities in the first year they occur. In Thailand and the Philippines, however, airlines are allowed to revalue assets to take account of currency movements and spread the impact on related liabilities over four years.
Ian Reid, head of Asian aerospace at Chase Manhattan in Hong Kong, notes that carriers are now seeking to offload older aircraft instead of keeping them when new capacity comes on line. 'Six months ago there were no planes to sell; now everybody has planes to sell, at a price.'
Bankers are already stressing that airlines are going to face increasing difficulties financing new aircraft purchases, forcing them to switch to operating or finance leases as governments encourage them to cut back on foreign exchange spending. New aircraft purchases offer little opportunity to boost cash reserves since most downpayments - refundable on delivery - have already been wrapped into the overall financing.
Nervous banks
With US and European banks nervous about the sector, the withdrawal of South Korean banks from aircraft lending and the disappearance of the Japanese - which traditionally account for a third of all financing - has come at the worst possible time. 'There are two categories of bank,' says one Tokyo lender. 'Banks that are open and the Japanese. The latter have their own problems and are already heavily exposed to Asian airlines.'
Banks have been left to juggle with pricing in a market which had moved steadily downwards over the past two years. 'Just like guessing where the bottom of the currency market is, everyone is estimating where the top of the pricing curve is,' says Reid. He believes it could reach similar levels to 1992, the top of the last cycle. Lenders are also seeking additional security for their loans as well as improved advance rates.
The deteriorating credit quality of carriers in the region has already pushed up the cost of funds, while competing transactions have forced airlines to accept even higher finance charges. In addition governments and private sector lenders throughout the region are looking to sell vast amounts of secured and unsecured assets and this is swallowing up funds once earmarked for aircraft. Despite this the latter are still regarded as one of the safest secured assets.
The Asian crisis also promises a sharp return to the market for the export credit agencies. They are likely to take the opportunity to improve their own loan portfolios by providing guarantees to airlines which have avoided them in the past because they could secure better lending terms from commercial banks. 'We are looking forward to doing business with carriers we have not done [so with] before,' says an official at the US Exim Bank. However, the agencies will back away from carriers, like the South Koreans, to which they are already heavily exposed but which desperately need their support.
The only constant in the Asian market at present is that banks are still falling over themselves to lend to Chinese carriers, encouraged by the guarantees available from the Bank of China and the International Commercial Bank of China. Domestic traffic in China remains healthy and the knock-on effects of the malaise elsewhere have yet to be felt.
Airlines are at one in emphasising that their current crisis is one of revenue and cash flow, with the sharp currency swings exacerbating a market which was already exhibiting signs of a severe softening. In particular, the Hong Kong market has failed to recover from its hangover since the changeover to Chinese rule last July. Cathay Pacific's attempts to revive tourism by offering heavily discounted fares have been undermined by the bird flu scare.
Meanwhile Japan's outbound sector - by far the largest in the region - remains weak. Japan's outbound market, flat throughout 1997, slipped back in the final quarter and traffic between Japan and Hong Kong has fallen 30 per cent year-on-year.
It is hard to find many positive outcomes for the industry from the daily tremors which emanate from the equity and currency markets. The double-digit traffic growth which many markets have experienced over the past five years has gone out the window and is likely to be replaced, at best, with a modest 2 to 3 per cent increase in each of the next two years.
But, as ever, there are a few silver linings. First, fuel prices have continued to drop, pushed by global over- supply and, in Asia, by the dumping of capacity by South Korean refineries anxious to earn hard currency. Jet fuel in the Singapore market has fallen by $7 a barrel since November 1997.
More tourists
At the same time, the currency devaluations imply that inbound traffic to strong tourist markets like Thailand and Indonesia should be boosted as they become cheaper. Recent data from the Association of Asia-Pacific Airlines suggests that there has already been a modest effect. On the other hand, this positive impact will be limited by the constraints of the infrastructure available to cope with new inbound demand, and by the temptation for airlines to raise domestic fares to compensate for currency depreciations against the dollar.
Meanwhile, with airline stock prices dropping and depreciating currencies making the stock even cheaper, many analysts expect European and US carriers to examine the possibility of taking equity stakes in their chosen Asian partners. Carriers in the region may find themselves bounced into agreements which they would not have been offered, or have considered, this time last year.
Perhaps the crucial test for airlines in Asia-Pacific will be the ability of their managements to deal with the current crisis. Most have grown up in a market defined by rapid traffic growth, where increased market share has been an overriding strategic goal. Crucially, financial crisis management - such as order deferrals, loan renegotiations and fire sales - has not been a feature. For many, it's just like being thrown in the deep end - you either sink or swim.
Source: Airline Business
