US airlines' first bailout aid was tougher to get and came with more strings than expected

The Treasury Department and U.S. airlines finally reached an agreement on the terms of $25 billion in payroll compensation on Tuesday in what proved to be a more arduous process than many expected.

The funds come from the government bailout package, known as the CARES Act, that President Trump signed into law on March 27. While the law laid out some basic requirements to continue air service to cities across America and gave the Treasury the option to demand warrants — or the right to an ownership stake — the grants were understood to be a relatively clean way for the government to keep airline staff on employment rolls.

"We're impressed, and concerned, with the government's hardline approach," wrote J.P. Morgan analyst Jamie Baker on April 14. "What was once thought to be free, formulaic, and easy turned out to be drawn out, somewhat expensive, and intense."

Despite the process, airlines largely welcomed the funds that are designed to cover all of their non-executive staff compensation and benefits through at least Sept. 30. Alaska Airlines, Allegiant Air, American Airlines, Delta Air Lines, Frontier Airlines, Hawaiian Airlines, JetBlue Airways, SkyWest Airlines, Southwest Airlines and United Airlines have all indicated that they accept the governments terms.

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The U.S. government will take stakes in the country's largest airlines

In exchange for the payroll funds, airlines that take more than $100 million have to provide the government with five-year warrants. This means the U.S. could own around a 3.1% stake in American, 2.1% in United, 1% in Delta and 0.5% in Southwest.

This is unlikely to have any impact on airline operations or management. The stakes do not come with representation on a carriers' board, nor are they large enough to sway shareholder votes.

Instead, the warrants are a way for the government to extract a return from airlines for receipt of taxpayer funds. For example after 9/11, the government made a 30% return on its loan to America West Airlines when it sold what amounted to a third of the airline's equity.

Small airlines that are expected to take less than $100 million in funds, for example Cape Air and Mesa Airlines, do not need to provide the government with warrants.

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Related: Airlines strike bailout deal with feds to stave off layoffs

Payroll funds are lower than expected

The U.S. Treasury is granting less payroll assistance to carriers' than Wall Street analysts expected. On average, the funds awarded on Tuesday were $265 million lower than the consensus analyst forecast.

For example, analysts estimated that Southwest Airlines would receive around $3.5 billion. The airline agreed to $3.2 billion in assistance split between $2.3 billion in grants and a nearly $1 billion low-interest loan.

Carriers will likely continue, if not ramp up, their efforts to voluntarily get staff to work fewer hours or take unpaid leave in order to stretch out what the payroll funds they do receive.

Related: At least 9 US airlines have applied for CARES Act grants to pay staff

Still, airline layoffs are coming

"Unfortunately, we simply don't see any way for most U.S. airlines to avoid massive layoffs unless the industry-specific payroll protection grants/loans are extended," wrote Baker.

Carriers are free to involuntarily furlough or lay off staff after Sept. 30, under the rules governing the payroll assistance.

This increasingly appears inevitable as analyst estimates on the future size of the industry continue to trend downward. While two weeks ago the consensus was 2021 passenger numbers in the U.S. would be roughly 20% to 25% below 2019 levels, now the consensus is they will be at least 30% lower.

In an April 13 report, Cowen analyst Helane Becker estimated that airlines could furlough or lay off as many as 125,000 employees if they reduce their fleets by 30%. This would translate to a reduction of more than 35,000 staff at American, 25,000 at Delta, 18,000 at Southwest and 27,000 at United.

Related: Southwest CEO says airline hopes to avoid furloughs, dropping cities

Airline route maps will be cut

As with the furlough rules, the air service requirements only run through the end of September. At that time each airline will be able to decide whether they need to serve every city on their maps, especially if their traffic is down nearly a third.

The first round of applications for waivers to suspend service hit small airports the hardest. More than 60% of the 126 waivers were to communities that handle roughly less than one million passengers annually, places such as Albany, New York (ALB), and Huntsville, Alabama (HSV).

The Department of Transportation has yet to decide on any of the first round of applications. However, it is widely accepted that it is always more difficult to resume service to a market after flights are suspended than maintaining service.

Related: How will airlines rebuild their route maps after the coronavirus?

No guarantee of airlines' survival

Success will depend on "how successful companies are in aligning their cost structures with a much smaller capacity footprint. To be clear, this aid delays those hard decisions through September 30," wrote Evercore analyst Duane Pfennigwerth on Wednesday.

Airline management teams are already thinking ahead to how they emerge from the coronavirus crisis. Delta CEO Ed Bastian and United CEO Oscar Munoz have both warned of staffing changes in line with a smaller operation, with the former going a step further in terms of rethinking the entire airline.

"We'll have a bit of a white sheet of paper to think about things, whether it's on the fleet side, what will our technology priorities be, what will the organizational needs be," Bastian told employees during a webinar on April 8. "We're going to come out a very different company. We're still going to be Delta, but how we do it is going to be different."

Related: Delta CEO says industry nears 'bottom' of coronavirus crisis, recovery a ways off