Debt: Its effects on the Aviation Industry
It is an unfortunate truth that we live under a consumer based society here in the United States. Yet, what is not often mentioned is the fact that we also live in a debt based economy. Most of the transactions in our economy today are used to purchase said consumption or credit based transactions. Even the very US dollar we use is a credit against the federal reserve system. It is clearer than that that is a large part of business and personal life in the US economy.
In this article we will not seek to dive too deeply in the origin of the credit based system, Nor the philosophical or political meaning of debt itself. Rather, we will focus on what a debt-based system means for the aviation industry and its various segments. We will try to provide an analysis by answering the following questions: What is the definition of debt? Why is debt so important in our economy?, To what extent does debt play a role in the aviation industry as a whole?, and finally, What are the effects and ramifications of a debt based system on the various segments of the aviation industry?
- Credit and Debt systems are heavily integrated with all aspects of the industry, and have important key roles in financing multiple areas of the industry.
- Credit and Debt play a crucial role in how airlines, flight schools, private charter segments, and individual pilots are operating in their respective fields of the industry. As the economic environment starts to influence the credit and debt systems, it’s necessary to be aware of how each area of the industry is influenced by credit and debt.
- There can be large-scale ramifications for the acquisition of too much debt, or not being able to pay off debt in a timely manner. When the environment can cause disruptions for individuals and businesses in aviation, it’s necessary to be aware of the potential ramifications of credit and debt when making decisions.
Credit and Debt.
Let us start by analyzing what exactly is debt, and in order to do so we must first understand credit. This is because there can be no debt without the extension of credit. There must be a debtor and a creditor and that with which that is being lent in order to have debt itself. So, what is that?
Credit and debt is generally a type of unsecured liability that is incurred through revolving credit loans. Credit accounts are reviewed, reported, and tracked by credit bureaus. The majority of outstanding debt on a borrower’s credit report is typically credit debt, since these accounts are revolving and remain open indefinitely. While credit can be made useful for making purchases over time, debt does carry some of the industry’s highest interest rates.
Generally, debt refers to the accumulated balances that borrowers carry over from month to month. Credit can be useful for borrowers seeking to make purchases with deferred payments over time. This type of debt does carry some of the industry’s highest interest rates,however, credit card borrowers do have the option to pay off their balances each month to save on interest over the long term.
According to Investopedia, debt is the most popular form of revolving credit and offers numerous benefits for borrowers. Accounts are issued with revolving credit limits that borrowers can utilize as needed. Payments are typically much lower than a standard non-revolving loan. Users also have the option to pay off balances to avoid high-interest costs. Additionally, most credit companies offer incentives such as cash back or points that can be used toward future purchases or even to pay down outstanding balances for individuals to use for their credit and debt purchases.
Credit and Debt and their importance in our economy.
The federal reserve system is debt based itself; The very dollar bills that we use are actual notes, which are debt instruments, for the collection of something in return for that note. Prior to 1971 the U.S dollar’s value was based upon either gold or silver. The Coinage Act of 1834 effectively set a fixed gold price of $20.67 per ounce. This was how Congress set the amount of gold required in official money. During this time , the official value for the U.S Dollar could be considered 23.2 grains of gold, or 371.25 grains of silver. President Franklin D. Roosevelt made it so the country operated with paper money from the Federal Reserve in exchange for gold that citizens were told to hand in.
Then, In 1971, President Richard Nixon effectively took the U.S. off the gold standard, and made it so that the U.S. would no longer convert dollars to gold at a fixed value. That move delinked the dollar’s value to the price of a tangible good and allowed it to float freely.
Foreign exchange markets: the U.S. dollar’s value has been determined through trade in the foreign exchange markets. Participants in those markets tend to use a variety of factors in determining what positions to take, including the relative economic strength of the two countries, interest rates, and other macroeconomic factors. Central banks occasionally interfere with the currency markets to counteract volatility. There’s no direct mechanism for establishing the value of the U.S. dollar. Although central-bank interventions in foreign exchange markets occur occasionally, the role of government in setting the dollar’s value is a thing of the past.
Every day credit transactions: most transactions today are done with credit cards. A lot of folks might think that this is actual money that they have from the bank. However, what’s actually happening here is that this is essentially a loan lent to you every time you swipe your credit card you are borrowing that money. Every dollar spent on a credit card is a new loan being taken out from the bank. Mastercard generates revenue by charging financial institutions that issue Mastercard-branded payment products a fee based on gross dollar volume of activity. Consumers do not pay Mastercard directly for the charges they accrue; rather, these are paid to the issuing financial institution. A typical Mastercard transaction involves four other parties: the account holder or consumer, the issuing bank, the merchant, and the merchant’s acquiring bank.
Business transactions: In business transactions, credit is extended to companies to cover overhead costs until they have collected their receipts whether that be over a week a month or months. This can be done through various instruments such as credit cards, line of credit or loan for working capital. This is essentially the small everyday credit transactions by users at a much greater rate because businesses operate on a much larger scale. This means that businesses also rely on these transactions to operate, businesses establish their own credits and debts which are typically essential to power or fund a business.
Capital investments: Businesses and companies in particular use credit or debt for capital investments. Particularly through selling of bonds.Capital investments can refer to a business’s acquisition of a capital asset or a type of loan by a financial institution in a business. In the latter, a financial institution, commonly a venture capital group or bank, loans a business money in exchange for a promise of repayment through a fixed interest, also none as a bond. This may or may not be paid out of future profits.
Debt’s role in the aviation industry
Like most other aspects of the US economy, the aviation industry relies heavily on debt both on the business side and the consumer side. Whether it’s aviation businesses using debt to cover cost of operations until they receive receipts, or using that as an instrument for funding capital investment and development of the business. Also on the consumer side customers using their credit cards, use debt via those credit cards to pay for travel. The pilot training segment related to the individual pilot training uses a substantial amount of debt. For example a pilot may take out student loans or other types of financing (debt) to pay for pilot training.
How do airlines use debt to finance and run their business?
The airline industry is a service industry that typically uses credit to pay for overhead costs, and make sure operations are able to run smoothly. Airlines rely on the income it generates to pay off its debt, because of this airlines see tremendous levels of strain as they are constantly under pressure to generate income and maintain business demands.In addition, the airline industry is a seasonal industry. People tend to travel more in the summer months when the weather is warm and children are on summer holidays.This seasonality can make it difficult to pay down debt throughout the year as incoming cash flows fluctuate.
Assets and facilities: Unlike many service businesses, airlines need more than storefronts and telephones to get started and operated. They need an enormous range of expensive equipment and facilities, from airplanes to flight simulators to maintenance hangars. As a result, the airline industry is a capital-intensive business, requiring large sums of money to operate effectively, as mentioned by AvJobs. Most equipment is financed through loans or the issuance of stock. Increasingly, airlines are also leasing equipment, including equipment they owned previously but sold to someone else and leased back. Whatever arrangements an airline chooses to pursue, its capital needs are required for consistent profitability.
Aircraft equipment: Many airplanes flown by an airline are not owned by the airline, but are leased from third-party leasing companies. The exact ratio of owned to leased will vary by airline, but the trend has been toward a greater reliance on leases over the past decade. Here again, most airplanes are financed through loans or the issuance of stock.
Programs and credit cards: Frommers shares that ‘Major U.S. airlines pulled in an astonishing $3.8 billion in the first half of 2018 by selling the value of their frequent flier miles to the lending banks that operate their credit cards. American Airlines and United alone brought home a total in the neighborhood of $1 billion each.’. Airlines make use of debt payment systems they set-up for consumers to use in order to pay for their own debt payments. Airlines offering special incentives for staying loyal to their brand to allow for consumers to gain special rewards is one way that airlines are using debt and credit payment systems.
How does private charter use debt to finance and run their business?
For the private charter segment, debt is a means of leasing an aircraft. Debt for private aircraft can also offer many of the same benefits of owning one—without the long-term financial commitment. Owners often rent their planes to generate revenue when not using their aircraft themselves. Some examples of using debt financing include some of the following methods:
Leasing plans: Dry-leasing is the most common practice for leasing an aircraft, it refers to leasing an aircraft without pilots, cabin crew, maintenance or insurance, and typically applies to longer timeframes; wet-leasing includes these privileges but typically for shorter periods of time. Regardless, each method is less expensive than purchasing over-all, providing greater liquidity in the long term. Leasing can also be a good way to fly an aircraft without the full commitment involved.
Part-time plans: Part-time plans are a great way to have some ownership and space in a personal plane with less financial stipends and lower monthly fees. These plans entail paying on a “per flight” basis. Fractional ownership is similar to full aircraft ownership From a tax and legal standpoint, owning an aircraft even fractionally is similar to fully owning an aircraft, however, the difference is that flyers acquire a share in it through a management company such as NetJets. While fractional generally translates to higher cost on a per-hour basis than owning outright, it allows you to only buy the amount of time that you need. Membership plans are available from charter brokers (or licensed resellers of unused fractional shares), who acquire blocks of time from charter companies at a discounted rate. They then sell these as “jet membership” or “block-time” cards to private flyers. Of course, there’s also simply chartering a plane for one-time use—typically the most cost-effective way to fly privately, according to Investopedia.
Traditional loans: An article by PNC shows how traditional aircraft loans can be a fixed rate or a floating rate. Their loans offer unique benefits for private charter segments to finance their businesses. Some financial institutions offer hybrids, such as a floating rate loan with the option to buy a “swap.” In other words, you can lock in your rate and benefit from early payoff and interest rate increases, which is not a bad idea in a rising rate environment. Traditional loans can be structured for as short as 30 months or as long as 120 months with amortizations as long as 240 months.
How do flight schools use debt to finance their business?
In a similar way that airlines and private charter segments are using credit and debt systems to help fund their overhead cost and maintain cost of operations, flight schools also use credit and debt in a similar manner. Flight school typically will have to lease aircraft, and put their payroll on a revolving credit as well. Flight schools use debt for financing in a number of ways, two of the main areas that use debt financing are with flight instructors and equipment/facilities.
Flight instructor salaries: While the pilot shortage is still in the state of affairs, the salaries for flight instructors have increased as they have also become more in demand to train this new influx of pilots coming into the industry to capitalize on the industry conditions. Pilots are going to need to be paid more and more importantly, flight instructors. Especially good flight instructors will cost a pretty penny to employ for any flight school. This is one of the reasons that flight instructor salaries are on a revolving credit system, and is reliant on the debt that a flight school utilizes. More information about flight instructors and the pilot shortage can be found in our previous article: ‘Inflation: Rising Prices and its Effects on Pilots and Their Training’.
Aircraft leasing: Flight schools are often poised with the question of how to acquire their aircraft for the flight line. The most common and least risky method for acquiring aircraft for your new flight school is to lease an aircraft and other equipment. Many aircraft owners find that they do not fly their airplanes as much as they once anticipated. Turning their airplane’s time in the hangar into flight time will help them defray the cost of ownership along with the recurring fixed costs they incur. At the same time, it is a way for you to acquire training resources with limited capital outlay, which reduces your debt load and still provides desirable aircraft for your flight line. Some flight schools have found ways around low resource utilization, by using state of the art resource management systems that use powerful algorithms to track and improve overall aircraft utilization.
Maintenance: Maintenance is another cost of aircraft that can be extremely costly, necessary, and can sometimes be unexpected. Maintenance costs are typically put on the same debt financing occurrence that salaries and leasing is paid with. Maintenance costs can become one of the main ways that an aircraft is needing constant financing even besides the initial equipment itself.
How does the individual pilot going through pilot training use debt to finance their training?
Most prospective pilots do not outright have the funds to pay for flight school out of pocket, which can range from $30,000 to over $100,000. Students typically need to go through a lender in order to pay for their education and training and pay the cost back later, usually with interest. Therefore, students and individuals are the ones that are also largely affected by the credit and debt financing systems in the aviation industry. Some of the ways student pilots may seek financing for their endeavors in the industry are as follows:
Federal student loans: a Bachelor’s degree in Aviation through an accredited university or accredited flight school is eligible for federal student loans to help cover cost, which is of course a debt financing system. Federal student loans are either a direct subsidized loan or a direct unsubsidized loan. With a direct subsidized loan, the Department of Education pays the interest accrual while students are in school and during your six-month grace period immediately following graduation. While with a direct unsubsidized loan, students are responsible for paying all of the interest, and the interest accrues while you’re in school.
Private and personal loans: The range of APRs advertised for reputable private student loans generally have a lower floor and a lower ceiling than those of personal loans, as mentioned by Dan Rooker, a Certified Student Loan Professional. However, if you opt for a longer loan term (such as 15 years), you might pay as much or more interest toward your debt than if you borrow a higher-rate personal loan on a shorter term — say five years. That’s why it’s wise to prequalify for multiple loan types and compare overall costs. Like with some personal loans, you could also apply for a private student loan with the help of a cosigner in case you’re unable to meet credit requirements independently. Personal loans for flight school If you have excellent credit or a plan to apply with a cosigner who has a top-notch credit score, a personal loan could yield a single-digit APR. For most borrowers, particularly those with closer to fair credit, a personal loan will come with a double-digit rate and one that’s potentially much higher than a private student loan.
What are the ramifications of all this debt in the industry?
It is clear that when times are good there’s no need to worry about that because one can always finance the debt whether that be from the business side or the consumer side. The challenge arises when times take a downturn, or in a particular industry where segments are not doing particularly well economically. The challenge is exponentially heightened if there is a downturn in the overall economy across all markets and segments. When the economy ceases to grow, stops creating new businesses and jobs that further dries economic development, then debt no longer becomes an instrument to be used for further growth but becomes a burden.
Below will discuss what are some of the ramifications for some of the major segments of the aviation industry and individuals as it relates to debt in an environment that is not conducive to having dead or high amounts thereof.
What are the ramifications of debt on the airline segment?
For the aviation sector, the airline segment is often the most affected by negative aspects within the industry, especially when dealing with debt, credit, and financing. As debt financing is a typical practice, airlines are not in the best economic position to rely on being able to pay off their revolving debt and keep operations running smoothly. airlines are poised with some ramifications of the debt if the situation is not seeming bright.
Deep restructuring: Airlines will have the need to aggressively reduce operating costs and increase free cash flow. Fundamentally altering long-term cost will be the key factor at restructuring the cost and economic well-being of this aviation sector. Programming and software that’s more efficient will be needed in order to consolidate on technology and improve efficiency. Airlines will need to do everything they can to save on the cost they can while not cutting any short cuts as far as safety and other standards.
Industry mergers: Airline industries have already, and will continue to merge operations in order to keep costs lower and try to aid in profit margin increases. Smaller companies will likely have to merge or sell their assets to bigger companies in order to stay in business or not go bankrupt. At the same rate, larger companies may try to buy-out smaller companies for the same reasons. For more about this see our previous article: ‘Airline Mergers: A Solution To The Pilot Shortage?’.
Increased cost of operations: Airlines have already had problems with increased cancellations and delays. With the pilot shortage not seeing a clear solution, airlines will likely have to lessen the flights they have available or cancel some destinations altogether. With airlines already struggling with revenue, less available flights would mean they would have to charge more for these tickets. It would not at all be surprising to see that there decreased flight traffic, and increased fares. Pilot incentives: The pilot shortage is one of the biggest problems of today. With airlines trying to get new pilots in and keep the ones they already have, signing bonuses and other financial incentives are being used. Wages for pilots during this shortage will likely remain on the higher-end with room for growth depending how the circumstances change over-time.
What are the ramifications of debt on a private charter?
The private charter segment is unique in the ways that it deals with financing and the economics of the industry. Private charter segments are also poised with special circumstances and things to consider when it pertains to the ramifications of their debt financing being mishandled or an unsteady environment approaching, as these expenses may start to come directly out of pocket (of owners) if there is an issue with the revolving credit payment system.
Fuel prices: Fluctuating fuel prices, especially in the state of fuel prices increasing as a result of inflation, can be a big financial burden onto the private aviation sector. Fuel is costly with the amount a private aircraft will need and is typically paid for using debt financing. There are many factors that contribute to the price of fuel and how that is subject to change at any moment, while this is one of the costs that is dependent on the debt financing, it’s important to look out for.
Insurance: It is absolutely critical for the private charter to have the proper insurance and coverage. Insurance premiums are subject to rise given the recent state of the economy, and are also typically paid for with a revolving debt financing system that is tied into the cost of operations for an aircraft. With this essential part needing to be covered with debt financing, it can lead to large ramifications if that debt is not handled properly.
Taxes: As that private charter segments are dealing with their own financing and special occurrences. Taxes for large aircraft and other high expenses may be paid using debt financing. Taxes can be an recurring bill, depending on how they are paid, mishandling of debt and credits can put tax payments at risk as a ramifications.
What are the ramifications of debt in flight schools?
Increased cost for flight training and operations: As talked about in our article, ‘Inflation: Higher costs and their effects on Flight Schools’, the biggest concern for flight school and students is notable the cost of training and operations. Aircraft can be extremely costly to operate, especially for smaller flight schools and private instructors. Insurance fees, taxes and registration fees, along with fuel, oil, and maintenance fees are hiking the price for operations up which is going to have a trickle down effect on the cost of pilot training for new students.
Increased cost for instructors: In the past, flight instructors have not been as in demand and the job itself was typically just a placeholder for pilots between certification and landing a job at an airline. Flight instructors were not paid nearly as much as other positions in the industry, and were not expected to be instructing for very long. With the state of the world today, there is a jumping demand for flight instructors, which means the flight instruction costs more than it used to. Schools and companies have had to provide better incentives to instructors, and new pilots as well.. New pilots are taking these opportunities to get into the industry in a surge so flight instructors are in a much better position than in previous years, with a steady demand and surge in pay. While this is good for instructors, the financial well-being of a flight school may need to be adjusted.
Lower enrollment rates: Inflation reduces the purchasing power of money, essentially for students, it’s going to cost more money to live overall. Even with incentives and the increased demands for pilots, some prospective pilots may take their time getting into the industry to try and wait for a better economy or to better prepare for the journey. Unless income increases at the same rate, people are worse off and are not reasonably able to attend flight school which can be very costly, this may lead to a slow increase for enrollment.
Higher cost of operations, less profitability: Flight schools may be slower in reaching their profit margins and therefor rely more heavily on the debt payment system they are under. They would be faced with higher cost of operations in that, they would be using more credit to run effectively, however there income may not be enough to make a substantial profit in the current market as students are faced with higher cost as well and may not be as eager to start with a larger cost of training that may occur. For more on the likely increase cost of operations, see our article ‘Inflation: Higher costs and their effects on Flight Schools’.
What are the ramifications of debt on the individual pilot?
The rising cost of money is slowly adding the challenges that are faced by flight schools, and airlines who already operate on razor-thin profit margins. Some of these challenges are also going to affect individual pilots, especially those in training and just getting started with their career in the industry. These are some factors from the debt that will affect pilots.
Increased cost of training: Inflation has been shown to have adverse effects on airlines, flight schools, and other aviation businesses, but it also has an effect on pilots with their cost of training. The cost of training is increasing alongside inflation due to its own factors, along with other areas of the aviation industry becoming more costly, this can become a substantial financial hurdle for pilots. For more on the likely challenge for pilot see out article ‘Inflation: Rising prices and its effects on pilots and their training’.
Flight times: As inflation continues to increase with the cost of training it may be more costly to obtain flight times and even getting the opportunity to fly. The pilot shortage brought an increase for flight schools, which is talked about in our article ‘The Pilot Shortage – A Challenge for Airlines, Possible Boom for Flight Schools.’, with this increase means that there are many pilots and students trying to get their flight times in, which is going to have the effect of making flight times and opportunities more important if other areas of the industry are not keeping up with the demand for instructors, students, and needed flight times.
Increased need for efficiency: While flight training is increasing, it’s important to understand where and how in the flight training process that cost can be saved or decreased. One of the ramifications of debt on individual pilots is that pilots will likely have to more strategically plan their training and save costs where they can. Knowing the best instructors and flight schools, while being able to access them properly to save time and money is becoming necessary for pilots during these inflationary periods with increased cost of training. Profound technological developments are likely to be used by pilots to aid them in these efforts.
Higher cost of borrowing for loans to obtain education: Prospective pilots are likely to first look into the cost of how much instructing and such will cost overall. Most student’s seek help from loans and lenders that can help them pay for school upfront and secure interest rates. However, with the debt cycle being influenced by the economic environment, rates and the cost of borrowing may increase and cost more for the student to gain their training. For more on the effects of increased cost of borrowing, see our article ‘High Interest Rates/Cost of Borrowing and Their Effects on Aviation Businesses’
The cycle of things
As it has been observed, credit and debt play a large influence within the aviation industry through all segments. Airlines, flight schools, private charters, and even individual pilots are affected by the debt payment cycles and how they are used and operated within the respective sector of the industry. Especially with the economic conditions we are presented with, it is important to be aware of the ways that these areas are using and are affected by debt.
The aviation industry has been resilient when presented with a cross-roads or a particular set of challenges dealing with the economy. Airlines are typically the most impacted and give an insight for the rest of the industry on how they may be affected as well with higher or fluctuating cost. It is always necessary to highlight that debt and credit work differently for each part of the industry’s segments.
All businesses and individuals, from all segments and experience levels, are going to have to be aware of the ways that credit and debt are going to influence their individual segments they operate under. While the environment of the economy may not be entirely stable and is working itself out, it does not necessarily mean it has to negatively impact the industry and the livelihood of those who work in it. Keeping a strong and stable mind in the face of adversity has always proved to be the most effective plan.
Thank you for reading this week’s On Aviation™ full article. How do you think the extensive use of debt as affected the industry? Please share your thoughts in the comments below and remember to continue the conversation on our Twitter and Instagram.
Orlando – On Aviation™