United Airlines recently made headline news when it secured $5 billion in financing using their frequent flyer loyalty program MileagePlus as collateral. That got me thinking: if United could pledge their loyalty program as collateral in a secured financing, why not securitize the entire program and issue asset-backed securities (ABS)?
Securitization can sometimes be a cheaper form of financing offering the borrower advantages over secured financing.
Securitization refers to the process of converting an asset that generates cash into a security, such as a bond or certificate. Thus converted, that security is now available to the capital markets and institutional investors, such as insurance companies, mutual funds and pension funds. This is why, as mentioned above, securitizations can be a cheaper source of financing, with some savings, theoretically, passed on to the ultimate borrower. [Full disclosure: aside from my life as a tech entrepreneur, I have provided consulting services on asset backed securities and testified as a securitization expert.]
There are four essential characteristics of securitization.
First, there is a tranching of risk, which means that losses are allocated based upon capital structure subordination.
Second, there is a “recharacterization of cash flows,” which refers to how cash received is paid in a different matter. The most simple example of this is an asset may generate cash on a weekly basis, but the holders of the ABS receive payments monthly. The securitization is therefore recharacterizing weekly cash flows into monthly.
Third, there is a risk transference, where defaults in the securitized asset could cause a loss by the holder of the ABS.
Finally, the securitization is a form of secured debt financing.
The Bonds Of Airline Loyalty
Publicly available materials indicate that the MileagePlus loyalty program potentially satisfies the four characteristics:
1. While the MileagePlus secured facility appears to have only one tranche, bankers could have potentially structured a second or more tranches.
2. The MileagePlus program receives payments from United Airlines and third party partners at various times, but such payments are then collected and distributed in the form of regularly scheduled loan payments to the lenders.
3. There is a risk transference because a default could potentially cause the lender to take on losses.
4. This MileagePlus secured facility is a secured debt financing.
Can The ‘Bowie Bonds’ Model Work For Airlines?
Traditional ABS are supported by more plain vanilla collateral. Examples of consumer ABS collateral include student and auto loans and credit card debt. Commercial ABS could be backed by equipment and aircraft leases and trade receivables.
While securitizing an airline loyalty program may seem esoteric, there are examples of similarly creative approaches: David Bowie, for example, successfully sponsored a securitization of his music loyalty rights through the issuance of what the market called “Bowie Bonds.”
If we can securitize music loyalty rights – and Bowie was not the only performer to do so – then why not airline loyalty programs?
The viability of this idea depends upon whether a rating agency would agree to rate the airline loyalty ABS. Securitization cannot exist without ratings, as the ABS would be impossible to price.
What is more, without a rating there would be little investor demand. If, however, an accredited rating agency were willing to rate the airline loyalty ABS, then cost savings would kick in, because the rating of the ABS is often higher than the rating of the borrower.
Traditional ABS often have the most senior class – which is also the largest and highest rated, at AAA. The subordinated classes would have lower ratings. According to public reports, the MileagePlus loan facility was rated the lowest investment grade rating by Moody’s (Baa3) and likewise by Fitch (BBB-). For comparison, the Bowie Bonds were rated originally at A3 (3 notches above Baa3).
My cursory analysis is based on very limited publicly available information. And there are likely a number of aspects about airline loyalty programs that would need to be addressed and considered in structuring the ABS.
Nonetheless, there may be securitization bankers who are already working on this idea and pitching it to airlines and rating agencies. With the economic pressures on the travel industry continuing to mount, we may see airline loyalty ABS by early next year, if not sooner.
About our guest author, Jack Chen
Jack Chen is the CEO and Co-Founder of Loud-Hailer, which has a patented beacon-free technology platform specializing in hyperlocal engagement and services. He’s always thinking about the convergence of technology, airlines and retail -- not just because it’s his job, but because he’s (well, on pause until the skies open regularly again) a frequent flyer.