Frequent flyer loyalty programs emerged in 2020 as a crucial revenue stream for the airline industry, infusing the largest operators with $30 billion in capital that helped them exceed performance expectations and weather the drop off in business stemming from the COVID-19 crisis.
Loyalty program ABS boosted the airlines’ fortunes just as bond spreads tightened significantly in 2021, providing plenty of workable capital to the structured credit markets, said Greg Kabance, a managing director and head of the cross sector, structured finance group at Fitch Ratings.
Credit ratings on the subsequent securitizations “remained relatively stable,” despite program transaction ratings being linked to the sponsoring airlines’ corporate ratings, according to Fitch.
The combined effects of robust consumer spending during the past 18 months and a modest rebound in air travel supported stronger than expected airline loyalty and program cash flow through the third quarter of 2021. Third quarter data show cash collections from loyalty programs increased more than 65% over the lowest levels observed in May and June 2020.
Looking ahead, major airlines may not need to issue ABS secured by loyalty program revenue at previous levels, unless they face a major liquidity crisis. Smaller carriers, however, are expected to tap the ABS market more frequently.
How it works
Airlines create passenger loyalty programs by purchasing the miles from third parties, said Natasha Panjwani, a director of structured finance at Fitch Ratings who authored the report.
The airlines can either award the purchased miles to passengers directly, or sell them to third parties like banks and credit card companies, which create co-branded, partnership agreements at specific exchange rates.
After air travel declined sharply in 2020, airlines were short on other revenue streams to offer up as collateral for securitized deals. Securitization enabled the airlines to capitalize on an asset that has been valued for its high profitability, Kabance said.
Air travel is a crucial part of economic activity, and frequent flyers are likely to continue participating in loyalty programs, Kabance said. In that sense, the transactions resemble a highly secured loan. “If the company goes down, the transaction rating would potentially go down, so it’s a little different from a normal securitization.”
Positioned for success
Airline loyalty ABS deals are structured to include bond and bank components, as well as floating- and fixed-rate notes, giving them wide appeal to potential investors, according to Kabance.
Airlines have refined their loyalty programs over decades, and although the full earning potential of the revenue stream has not been quantified it is widely considered indispensable. Now that the receivables have been securitized successfully, the change will be here forever, Kabance said.
As for the asset class’ appeal to investors, many transactions have been oversubscribed due to a substantial investor pool of about 300 prospects, according to another source familiar with the asset class. This includes bank syndicates, which often account for about half the placements, the source said.
Barclays Capital and Goldman Sachs have acted as structuring lead on most of the deals.
The loyalty program flight plan
Fitch expects airline loyalty programs to continue to raise cash in the near term, and that collections should return to near-2019 levels by yearend 2023.
Another reason that loyalty program ABS should slow down for the next year and a half is that the major airlines simply don’t need the extra cash now, having just raised $30 billion, said Kabance.
“They may reach out [to investors again] in the future,” he said, adding that carriers can always use those funds as a kind of rainy day facility.
