Why COVID-19 will be most catastrophic for American Airlines: Risk firm on airline industry

According to a new assessment from risk assessment firm RapidRatings, the U.S. airline most in danger of going bankrupt is American Airlines. Rapid Ratings CEO James Gellert joins Yahoo Finance’s On The Move panel to discuss.

Video Transcript

ADAM SHAPIRO: --finance. We're taking a look at markets right now. And right now markets are trading down. We'll get to that in a bit. But one of the toughest hit sectors, or industries rather, has been the airline industry. No need to bring you up to speed on that. The question is, which one of the major airlines Delta, American, United, Southwest, which one is most at risk of failure, bankruptcy, whatever that might look like?

To help us understand how to answer that question we're inviting into the program James Gellert. He is the CEO of Rapid Ratings. They actually do risk assessment for firms like McDonald's and Unilever. And you did some stress tests on the airlines. I just want to show everybody. We have a graphic that shows the results of the stress tests that you did. And basically what you want to focus in on is that a score of 40 or below on the core health score or the FHR, the financial health rating, anything below 40 indicates a greater risk of default.

American was the airline that scored below 40 on both. James, what is that telling potential investors?

JAMES GELLERT: Well, Adam, I think it's re probably reconfirming what a lot of people thought going into the crisis, which is that if you were to rank, order the US airlines, American was at the bottom. And prior to the COVID crisis, we had them rated on the FHR scale at a 59. We stress tested that, as you mentioned, across all companies. We rated tens of thousands of them. And American actually dropped to a 29. As you already pointed out, 40 and below is the high risk area where the majority of companies that have failed historically have been rated. And for reference, two of the most recent airline failures, Avianca and Thai Airways were rated a 19 and a 27, respectively. So American is in that zone. And with the rerating of their Q1 financials not involving the stress test at all, they've already dropped to a 31.

ADAM SHAPIRO: Right, but let's take a look at two things that have also changed. First, they have gotten billions in help from the US treasury. There was one, I think it was Raymond James pointed out they've got six months cash on hand. And they're going to be growing that. Although it's the lowest amount of the major airlines. The revenue picture is slowly picking up. Do you think they're going to make it?

JAMES GELLERT: Well, I think we have to wonder what the timeframe is for a recovery and what the shape of that recovery looks like. To see some traffic coming back into the airlines this month and prospectively for next month is coming off of such a remarkably low base, keeping in mind that the airlines have gone down to, in some cases, less than 10% of their '19 volume, so that's a radical change in the top line revenue.

American has the most debt of any of the US airlines. Their liquidity is also the worst. So they do have cash, and they do have cash and availability of credit to a degree. But it only lasts a certain amount of time. And we have to think into '21 because 2020 is a wash for most of the airlines, no matter how big of a rebound we get in the second half.

So it's really a question of really a race against the clock and whether the liquidity that they can get from this and/or subsequent stem funding in addition to drawing down credit lines or any additional capital they can raise, whether that can last them through a recovery. And it's going to be a real close call.

JARED BLIKRE: I just want to kind of build on that. You-- your firm does this. And you've had these companies maybe in other industries drop below these critical thresholds before. Do some of-- what percentage emerge from this without having to restructure or otherwise default on their loans? And then do you have any policy prescriptions to get these airlines back off the grid-- I'm not even going to continue that terrible pun. But you know what I mean, off the ground.

JAMES GELLERT: Flying again. So look, a percentage of companies certainly do recover out of this low-- or this high-risk, low-rated range. And we need to remember that a low FHR, meaning a high-risk company doesn't necessarily mean the company will fail. But it does mean that if companies that have failed, they've looked like this before. And each time we're rating a company, we take their financial statements. And we algorithmically profile them against now 14 million company years worth of financial data over the last 40 years.

So that's going through of a wide variety of business cycles, economic cycles, and industry trends. Nothing in the airline industry has compared to what we're going through right now, which is really one of the big unknowns. So can it get through? It can get through. But there'll be a variety of factors. Obviously, if we have a second wave of COVID outbreak in the fall, as some are discussing, and we see yet another dip in traffic, then whatever pickup we begin to see in Q3 is going to be immensely impacted.

And then we're really not looking at any real pickup back towards '19 volume levels for the airlines until end of-- end of '21, solidly into '22, or maybe longer.

AKIKO FUJITA: James, I've heard you talk about sort of the recovery or the pickup. But what exactly does that look like from a volume standpoint, from a capacity standpoint? Is it going to be the full recovery, essentially getting back to the levels pre-COVID, or are we looking at a much more reduced sort of travel picture?

JAMES GELLERT: Well, I think we're looking at a reduced travel picture probably for some time. At some point in the future, we will of course come back to '19 levels. But the real issue here for a company like American or any other company that is radically affected on the top line by the COVID crisis and has a poor leverage picture, meaning high-debt, low-liquidity, and that is American to a T, a lot of it depends-- a lot of their recovery depends on what the bond market sentiment is.

There's a lot of paper from airlines in the below investment grade segment of the market. So if American-- if the sentiment is against American, there are plenty of places for investors to put their money in the airline asset class and to be able to do it with a safer yet yieldy investment.

So really, the question here I think is this duration of time that it's going to take, whatever the shape of the recovery looks like. Will American be able to raise more capital, whether that's securitizing assets-- they have planes that they can securitize. They've got airport slots. They've got equipment. Ultimately, they have their points program. All of those are monetizable assets. But if they are doing that in the short term and this is a longer-term recovery, they really won't have anywhere else to go. And if the bond market isn't going to continue to fuel their growth, that's when they run into the wall.

ADAM SHAPIRO: And one thing to point out too, United tried to come to the market two weeks ago with a 2 and 1/4 billion dollar offering but had to pull it because the unencumbered assets were too old. They weren't what the lenders wanted to underwrite those loans. We've got to let you go at this point. The company is Rapid Ratings. CEO James Gellert, thank you for being here with us. We're going to have much more on the airlines going forward.