In the November Billet, the Treasury and Resources Department is recommending the recapitalisation of the Aurigny Group (Cabernet Ltd). This will address its accumulated losses which date back to 2003 and amount to £19.9m. In addition, the Department is recommending that Aurigny is capitalised for its forecast losses totalling £5.3m for the years 2015, 2016 and 2017. The recapitalisation is a legacy of previous States’ decisions made as long ago as 2005 about the debt funding model for the airline, which has seen it borrowing to fund its operating and capital expenditure costs.

Peter O’Donovan, Aurigny’s Finance Director, says: “Recapitalisation will restore Aurigny’s balance sheet to a neutral position. This will help our financial position immensely because we will no longer have to repay borrowing at relatively high rates.” He continues: “Aurigny operates in a highly volatile industry where direct costs can impact on the business without any degree of predictably. Indeed, around two thirds of our direct operating costs are outside of the airline’s control. The recent bird strike, which damaged one of our Embraer’s engines, is an example of how our budget forecasts can be affected by events. Repairs were costly, as was the chartering of alternative jets to service the Gatwick route for six days.”

Aurigny was bought by the States of Guernsey in 2003 to secure the Island’s air link with London Gatwick when British Airways announced it was leaving the route. In its report, the Department argues that the States’ continued ownership of the airline remains overwhelmingly in the Bailiwick’s strategic interest, providing an insurance policy that ensures decisions around its essential public air services are determined not just by commercial considerations, but by wider economic and social ones as well.

Mark Darby, Aurigny’s CEO says: “Aurigny enables business and leisure travellers to connect with Guernsey and London’s second airport. Aurigny also provides a high degree of connectivity between Guernsey and a large number of UK destinations. Our Alderney routes make a loss but are “lifeline” services for thatpart of our community. Our London City route is an example of the role we play in supporting Guernsey’s economy which we introduced a year ago, at the request of Guernsey’s business community.” He continues: “Aurigny is an important contributor to the economy in Guernsey. Not only do we provide vital year round air links, but we employ a high number of local people and pay significant sums to the Treasury. In 2014 alone we paid just under £2m in tax and social security contributions. Our payments to Guernsey and Alderney airports totalled £5m that year.”

Treasury and Resources Minister Gavin St Pier says: “Aurigny remains mandated to break even and our policy letter indicates that this should be possible by 2018, subject to new funding arrangements being put in place for its loss making, but socially and economically essential, Alderney services. Recapitalisation of its historic debts will help to stem its losses and work more effectively towards break even, whilst continuing to provide Guernsey and Alderney with a high degree of air connectivity that could never be delivered year round by a commercial operator.”

Deputy St Pier goes on to say: “Balancing commercial considerations with Aurigny’s wider responsibilities to the Bailiwick remains a constant challenge for the States and the airline. The launch of the London City service is a clear example of how Aurigny has put its role as an economic enabler for the Island ahead of the commercial considerations that might otherwise have discounted introducing the route. For as long as we expect Aurigny to continue fulfilling this social and economic role for the Island, then we have to accept that this will bring with it a risk that ongoing financial support will be required.”

Set out below are Questions and Answers that journalists mayfind useful when reporting this Billet item:

What will recapitalisation do for Aurigny?

Recapitalisation will enable the company to repay some existing loans and overdraft facilities used to fund operating expenses. The airline will benefit from no longer having to service interest payments on these debts. As well as repaying existing debts, the recapitalisation will set aside funds for predicted future losses to the end of 2017. It is not an extra cash boost for Aurigny.

The recapitalisation will also restore Aurigny’s balance sheet to a neutral position, enabling it to repatriate the Group’s company registrations from Jersey to Guernsey. In doing so, there is likely to be a reorganisation of the company registrations within the Group from three to one, thereby reducing the associated administrative overheads involved with the existing registrations and annual accounts/reports.

How did the losses accrue?

The Aurigny Group has made losses in all but two years since it was acquired by the States in 2003. The Department has published the Group’s financial results and loan facilities each year in the Annual Budget report and, in doing so, has summarised the cost and revenue pressures that have affected its performance. These have been many and varied and have, for example, included on an exceptional basis: the closure of UK airspace arising from the impact of the Icelandic volcano ash cloud in 2010; the restructuring of Anglo Normandy Aero Engineering; and, the write-down in the value of the Trislander fleet ahead of its replacement. Underlying issues that have affected the airline on an ongoing basis since it acquisition have been: the substantial increase in fuel prices since 2003 (albeit subject to some recent improvement); increases in airport landing and passenger charges, most notably at Gatwick Airport; the highly competitive environment until 2014 on the airline’s routes to Gatwick and Jersey; and, the requirement to continue providing its loss making, but essential, services to and from Alderney. More recently, the investment in the London City service has impacted on the company’s results, albeit the route is expected to reach a break-even position in time.

Why doesn’t Aurigny publish its accounts?

Appendix 2 of the Department’s policy letter sets out the Group’s annual profit and loss figures. The Department will shortly be reviewing with Aurigny whether its accounts should be published, bearing in mind that they contain commercially sensitive information which could be damaging for the airline if available to its competitors.

Why does the recapitalisation not make provision for the repayment of loans for aircraft purchased by Aurigny?

Aurigny has loan facilities in place for its acquisition of three ATR-72 aircraft, its new Embraer 195 jet and Dornier fleet. They are revenue generating assets of the company which retain significant market value broadly in line with the loan balances. The loans for these aircraft, some of which have been refinanced at cheaper rates of interest using the proceeds of the States of Guernsey bond issue, will be repaid by the airline over the lifetime of the aircraft through passenger revenues.

Is there too much capacity on Aurigny’s London services?

Aurigny is mandated by the Department to operate the Gatwick route and that equates to twelve weekday sectors (single trips) and ten at weekends. Guernsey’s passenger market is a relatively fixed one, but Aurigny works actively with Visit Guernsey to market the Island to incoming visitors, especially in the south east of England to target its London services (Gatwick, Stansted and City). Total passenger numbers across all its London services have increased since the introduction of its City service and a reduction in capacity could impact on a stated intention of increasing inward passenger numbers. Additionally, Aurigny would not want to jeopardise the ownership of its valuable Gatwick slots, which would have to be forfeited if they were not operated by the airline under the “use it or lose it” rules governing slots.

Why is the London City service losing money?

Aurigny has been operating to London City for just over one year which is a short period in terms of gaining a profitable market position. Passenger carryings have exceeded those in its business plan and the route is well supported by Guernsey’s business and finance community. Nevertheless, the plan allows for another two years on the route before it breaks even.

Where are its intentions regarding interline/codeshare agreements?

There are many positives from a passenger perspective of operating codeshare agreements with international carriers but there are also financial risks for Aurigny. Its existing reservations system would need significant alterations to enable a codeshare to work but it continues to explore the possibilities of a codeshare.

What’s the effect of recapitalisation on the States’ Capital Reserve?

In 2013, the States agreed that the recapitalisation of the Aurigny Group should be classified as a Category A “must do” project and approved it for inclusion as a project for capital reserve funding. Subsequently, in 2014, the States agreed that the recapitalisation should be included as part of the States Capital Investment Portfolio. Recapitalisation of the airline has therefore featured in the planning for the use of the capital reserves, albeit the cost of doing so is now higher than was anticipated in 2013. There are a number of reasons for this, including the investment in the newLondon City service and the ownership costs for the acquisition of its new Dornier aircraft to service its essential Alderney services. The Department’s 2016 Budget Report, being debated by the States this month, notes that demands on the capital reserve are such that it is oversubscribed and sets out the steps that the Department is proposing to take to address this shortfall.