Confidence and capital – Nationwide has neither

Nationwide Airlines is on the ground. A series of business and operational problems met the global economy of skyrocketing avgas prices and left them insolvent by R172m (assets of R46m less liabilities of R218m). They’ve also left friends of mine stranded in South Africa after a trip from Ireland for another friend’s wedding (congratulations Kay and Brennan!).

Simplistic overview of causes

  • High fuel costs – avgas has increased significantly recently.  However, this affects all airlines.
  • High fuel costs combined with fuel inefficient planes.  Nationwide’s older aircraft are less fuel efficient. Fuel costs per flight are thus higher than some competitors. An increase in fuel prices hits them harder.
  • Small capital base (now negative), high fixed costs and challenging break-even targets. Nationwide needed 75% capacity on its flights to break even. This reflects the high fixed costs per flight, and high fixed costs overall. A small capital base means that there was limited time to trade through difficult conditions and preserve the franchise / brand value of the operation.
  • Loss of confidence due to safety concerns, regulatory intervention. Since one of Nationwide’s planes “lost and engine” in flight confidence from the flying public has plummeted.  It has since emerged that the engine was in fact designed to free itself from the plane under certain circumstances. Combined with the pilot’s successful landing shows that the outcome was pretty good compared with other possibilities. However, a large portion of the market was not prepared to fly Nationwide anymore. Combined with the chaos preceding and succeding the operational and safety crisis, I stopped flying Nationwide simply because we had concerns about their ability to get us to our destinations on time. This may not have been based on a thorough analysis, but was based on several specific events. I’m sure I wasn’t the only one to reach this conclusion.
  • Price competition – pretty much the only customers prepared to fly Nationwide were those looking for the cheapest flight at any cost (safety, timeliness etc.). Thus, Nationwide’s pricing power diminished to virtually nothing. This exacerbated the need to fill planes to meet fixed costs.

Lessons for other organisations

Decreased capital bases have become a popular path to increased Return on Equity. Now, theory suggests that decreased equity will boost financial leverage if debt is involved (debt here including debt-like obligations such as fixed equipment leases). On a more practical level, decreased capital provides a smaller buffer against adverse trading conditions (default experience for banks, claims experience for general insurers, equity market declines for life insurers, interest rate shocks for most business). Assuming Nationwide had a viable business, a larger capital base would have allowed them to continue trading through the difficult times and emerge at the end of the tunnel a profitable business.

One of the standard counters to this is that if new capital were needed it could be raised from the efficient, deep, liquid, transparent, costless capital markets. Needless to say, those don’t exist. The practicalities of a bail-out package in sufficient time to keep an airline running make it especially challenging. Incidentally, it’s not unlikely that someone will take over Nationwide’s planes and staff – if our market does need those flights and employees that should find a home somewhere. If there was sufficient slack in the market for the other airlines to mop up the increased relative demand, then a company “exiting” the market is exactly what microeconomics would predict. Pity Mango has our tax money to shield them from a similar fate.

Financial services companies would do well not to dismiss Nationwide’s fate as “nothing to do with me”. Northern Rock’s catastrophic loss of confidence might have been a little closer to home, but shares the same message of significant gearing, illiquid assets and a loss of confidence. Capital strength provides more leeway to ride out tough times, but also adds confidence to customers (deposit holders, policyholders) which is most critical in tough times. The costs of financial distress rise as companies’ capital positions worsen. Low probability events can be catastrophic when they hit, and there is plenty of evidence to show how human beings chronically underestimate the probability of low probability events.

Hedging. Again.

Fuel price skyrocketed. Margins destroyed. Airline no longer profitable. Now, if an increase in fuel price really would be that deadly to an organisation, surely hedging of this otherwise uncontrollable risk should have been sensible? As it turned out, Nationwide was partially taking a bet on fuel prices declining or staying constant. Lose the bet lose your business. If they had hedged, even partially, and fuel prices had declined, they would have still been in a sticky mess, but presumably better than they are now. If the competitive position they would have been in with locked-in higher fuel prices would have meant that they would also have gone out of business, then I’m afraid this sounds more like a wild speculative fling than a sustainable business. Rolling dice on that scale doesn’t inspire confidence.

Three conclusions

  1. High gearing and a small capital base has definite costs they aren’t completely factored into a naive RoE analysis.
  2. Customer confidence is critical to a sustainable business and should be nurtured.
  3. Hedging of major, uncontrollable and potentially fatal risks must be included in an organisations risk and strategic management.

1Time down 11.4% today. Comair up nearly 9%.  Market taking bets on which company is better positioned for the new competitive landscape?

Published by David Kirk

The opinions expressed on this site are those of the author and other commenters and are not necessarily those of his employer or any other organisation. David Kirk runs Milliman’s actuarial consulting practice in Africa. He is an actuary and is the creator of New Business Margin on Revenue. He specialises in risk and capital management, regulatory change and insurance strategy . He also has extensive experience in embedded value reporting, insurance-related IFRS and share option valuation.

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  1. The Nationwide CEO was on record complaining bitterly about the CAA during their engine-losing moment last year. I think the CAA has an obligation to be prudent and conservative during such times – not only to ensure safety, but to ensure confidence in the system.

  2. I have received a refund from my bank for tickets purchased on Nationwide. You need to request a CREDIT / DEBIT card letter of DISPUTE form from your bank if you paid with a card.

    Please find related article below,

    Banks will pay card refunds
    MAYA FISHER-FRENCH – Jun 18 2008 08:52
    Banks confirmed last week that they will refund customers who bought tickets for flights on Nationwide Airlines or concerts by singer Josh Groban using either a debit or credit card. This follows confusion two weeks ago over whether local payment rules protect customers from non-delivery of services by a company in liquidation.

    Four weeks ago the Mail & Guardian said that MasterCard had confirmed that card users could apply for a “charge back” (refund) from their banks for their Nationwide and Josh Groban tickets, according to international card rules, which also apply to Visa. But the M&G received complaints from readers having problems with their local branches in this regard.

    It turns out that there was confusion over whether the local payment rules, which are the responsibility of the Payments Association of South Africa (Pasa), provided for charge backs in the case of the liquidation of the merchant. This week MasterCard said that while it provides protection for customers, including charge backs for airlines that have gone out of business, “where local rules have been established by the Payment Association of South Africa, such rules may supersede MasterCard’s general rules”.

    However, Walter Volker of Pasa confirmed that in the case of liquidation there are no separate local rules and that the MasterCard and Visa rules apply.

    The problem is that when a merchant goes into liquidation there is no recourse for the bank to claim the money back from the merchant. In this case the liability lies with the “acquiring” bank — in other words the bank that provided the “card acquiring” services to Nationwide or Ticket Connection, which sold the Josh Groban tickets. If your bank is not also the acquiring bank, then it will request the acquiring bank to carry out the charge back.

    In the case of Nationwide, if you bought your airline tickets directly, Standard Bank was the acquiring bank and will pay the refunds. Volker said one of the risks a bank takes in signing up a merchant is that the merchant could go bankrupt. He said all banks have to make provisions for such things and that the Nationwide loss was small compared with daily card transactions.

    At the time of going to print Standard Bank had not issued a statement about the effect of the Nationwide charge backs on its business.

    Source: Mail & Guardian Online
    Web Address:

  3. Thanks Hilton. That is interesting at a general level, and probably very helpful to others who were directly affected. Really appreciate the comment.

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