Airlines Offer Crown Jewel Loyalty Programs To Bond Market

When the coronavirus pandemic brought travel to a halt, airlines turned to whatever sources of funding they could find – even their previously untouched loyalty programs. Whether this is a positive development for the industry depends on who you ask.

United Airlines Holdings Inc., Delta Air Lines Inc. and American Airlines Group Inc. have raised more than $ 25 billion through debt transactions supported by their traveler loyalty programs. Americans $ 10 billion supply, a combination of bonds and loans, was the largest ever for an airline and reportedly attracted $ 45 billion in orders from yield-hungry investors. The carrier used the proceeds to repay a pandemic US Treasury loan that had more onerous terms. Spirit Airlines Inc. and Hawaiian Holdings Inc. have raised an additional $ 2.05 billion supported in part by their loyalty programs.

It is all the more incredible that no airline has attempted to monetize your loyalty program that way until the pandemic. At first glance, this looks like an incredible feat of ingenuity from Wall Street. United was the pioneer of the fundraising vehicle with help from Goldman Sachs Group Inc. after a previous separate debt deal backed by aging planes had to be scrapped due to investor concerns about the value of this collateral amid a potential glut of retired jets. Loyalty programs, on the other hand, generate a lot of money and in theory tend to be less volatile than traditional airline ticket revenues or the underlying fleet value.

All it takes is a quick glance at the yields on these bonds to see that investors place a lot of importance on loyalty programs. United’s MileagePlus debt valued a 7% return in June, compared to the 11% return that had been announced in informal pricing talks a month earlier, just as Warren Buffett said Berkshire Hathaway Inc. had abandoned its stakes in a handful of airlines. In September, Delta issued an eight-year debt that returned just 4.75%. Eight-year US bonds were valued this month at 5.75%, mainly due to the recent rise in US benchmark yields. The spread between T-bills was only 20 basis points wider than Delta’s, even though Moody’s Investors Service rated US securities four rungs lower.

Mileage credit redemptions fell by two-thirds at American in 2020, in line with declining overall passenger revenue, according to the company’s annual report. But the revenue associated with the marketing component of the loyalty program – defined as the use of intellectual property, including the American brand, advertising, and access to the loyal member list – has only declined by one. about fifth. According to a report by Savanthi Syth, analyst at Raymond James Financial Inc., the average member of AAdvantage has been participating in the loyalty program for 10 years, and 40% of users have income over $ 100,000. This type of stability helps explain why credit rating companies are willing to rate these debt transactions higher than the companies themselves.

Loyalty programs offer “a lot of what’s good for airlines without what’s bad for airlines,” Syth said in a telephone interview. But if airlines offer their crown jewel to creditors, what is left for equity investors? Retail traders have piled on these stocks as pandemic shows signs of easing: US exchange-traded fund Global Jets (ticker: JETS) topped $ 4 billion in assets this month, an increase of over 2,600% from the previous year.

Some airlines, including Air Canada and Gol Linhas Aereas Inteligentes SA, have created their loyalty programs with the aim of monetizing these lucrative programs and creating shareholder value. But the independent oversight of loyalty programs has created an inherent conflict of interest and deprived airlines of some of the benefits of having these systems in the first place. The main idea of ​​the airline is to retain customers, but independent programs may seek to maximize profits by selling mileage credits to third parties such as credit card partners. So Air Canada reabsorbed its loyalty program in 2019 and Gol try at do the same with its Smile loyalty system. Rather, monetizing loyalty programs through leverage offers financial benefits without the operational headaches, but there is still a conflict of interest inherent in this transaction as shareholders have fewer rights to these lucrative assets.

“For a stock holder, even airline asset backed securities are a problem,” Syth said. “If you can’t pay the bondholder, the plane will be blown away and you will have less value. The same evaluation should be done with these programs. “

Meanwhile, even bond investors have their limits. Mark Lindbloom, portfolio manager at Western Asset Management, said his analysts were “very comfortable” with the returns offered in the United and Delta deals. He holds these bonds in the $ 38.4 billion Western Asset Core Plus Bond Fund. But the recent sale of US bonds came “at significantly reduced prices – hundreds of basis points,” he said. “We’ve seen this kind of compression before.” Indeed, at some point earlier this month, the debt of the United States which had initially yielded 7% traded at just 3.09%.

It’s not uncommon for businesses to mortgage everything but the kitchen sink in times of crisis. Ford Motor Co. sadly pledged its blue oval logo as part of the 2006 financing guarantee that helped him avoid bankruptcy in the Great Recession. But Ford recovered the logo and other assets in 2012. The difference here is that the airlines are giving any sign that they view their loyalty programs as a more permanent means of raising capital. “It’s like a piggy bank,” Helane Becker, analyst at Cowen Inc., said in a telephone interview. “They can type it up, pay it off and it’s there again.” She compared loyalty assets to a supply chain finance program.

That may be fine, as long as there is a market for airline supplies. Airport checkpoint numbers continue to climb as more Americans receive their Covid-19 vaccines in one of the clearest indicators that life is slowly but surely returning to normal. The advantage of loyalty program debt deals for equity investors is that airlines have now proven they have more access to liquidity in times of crisis than previously thought, Syth said. But shareholders should be aware that the post-pandemic normality of airlines has an added wrinkle: Pledging some of their most valuable assets to bondholders creates an under-the-radar risk that could one day manifest itself in an industry that has had more of its fair share of brush with bankruptcy.

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

To contact the authors of this story:
Brooke Sutherland at [email protected]
Brian Chappatta at [email protected]

To contact the editor responsible for this story:
Daniel Niemi to [email protected]


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