How United Airlines Mortgaged Its Frequent-Flier Program

United Airlines aircraft at San Francisco International Airport in 2015. (Louis Nastro/Reuters)
Loyalty programs are providing a cash buffer that may stave off bankruptcy.

NRPLUS MEMBER ARTICLE T he airline industry isn’t exactly a lodestar of innovation. Because all flights are more or less created equal, airlines have little room to differentiate their product offerings. In order to make money, they resort to cramming passengers into ever-tighter spaces, as well as charging baggage fees, reservation fees, booking fees, and whatever other fees they can think up. Such is life in a perfectly competitive industry.

But in procuring capital, airlines are proving surprisingly innovative. With revenue plummeting during the coronavirus pandemic, cash-burning airlines have had to devise complex financing schemes in order to stay alive. After abandoning a $2.3 billion bond offering in May because of high borrowing costs, United Airlines secured a $5 billion loan this week by mortgaging its frequent-flier program. Last week, American Airlines announced its intention to do the same.

Wait a minute. Normally a borrower puts up assets as collateral. Aren’t frequent-flier miles a liability? Airlines sell miles to credit-card companies, which offer them as perks to customers. The credit-card companies pay for miles up front, and customers later redeem those miles. In other words, airlines borrow cash from loyalty-program partners and pay it back in flight redemptions, pocketing the profit from ticket sales in the process.

When a customer redeems miles, the airline effectively buys that customer’s ticket from itself, and books the expense of the flight. If XYZ Airline sells $10 of miles at the beginning of the year, it gets $10 in cash. Once the miles are redeemed, XYZ Airline has to book the $10 as a ticket sale. The $10 in revenue then becomes $1 in earnings, assuming a 10 percent profit margin. But until the flight is redeemed, that $10 is pure profit.

Though airline sales have plummeted this year, consumers continue to accrue miles through credit-card purchases, albeit at a slower rate. Revenue from United’s loyalty program decreased 50 percent in April and May compared with revenues in the same timeframe in the previous year, reflecting a broad decline in consumption, but redemptions decreased by 135 percent. The decline in redemptions represents not only a drop-off in bookings but also an increase in cancellations. Remember, until miles are redeemed, they represent pure profit for airlines. So ironically, the cash flow from United’s loyalty program increased during the pandemic, because the decline in redemptions outpaced the decline in sales.

Another way to think of this is that United’s frequent-flier program represents short-term debt whose maturity has been extended. In April and May of this year, United sold $455 million worth of frequent-flier miles. In a normal year, the airline would redeem 60 percent of that $455 million in the two-month period during which the sales were made, leaving it with roughly $180 million in cash. This year, however, the $455 million in sales represented $590 million in cash flow, because skyrocketing cancellations put cash back into United’s coffers (reversing the aforementioned $10 → $1 process).

So the loyalty program gives United a cash buffer at a time of desperate need. Last year, the program yielded $5 billion in revenue; at the current rate, it will likely yield roughly $3 billion this year. United could use that cash to service its debt and maintain its fleet, effectively borrowing from itself. But by posting the cash as collateral and using it to service a seven-year loan, it retains most of the loyalty-program revenue while still meeting its short-term obligations.

Another part of the collateral consists of intellectual property, including customer data (names, contact information, transaction history), trademarked brand names, patents (mostly of software), and other technologies. Should United default on the loan, Goldman Sachs will own its iPhone app and website (which I suppose it could sell), as well as its customers’ personal information (which it probably already has access to).

Thanks to these convoluted loans, United and American may manage to avoid bankruptcy. Bankers are often accused of being slick-talking charlatans who add no tangible value to the world, but United’s loyalty-program-backed loan shows that the wolfs of Wall Street can be creative when the time is right. It’s only a matter of time until they start trading collateralized frequent-flier-mile obligations.

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