Historically the securitization of intangible assets in lending transactions has been restricted, as intangible assets are typically less liquid than tangible assets. This has limited the pool of investors willing to invest in such assets resulting in the securitization market for intangible assets remaining in a nascent phase and ultimately meaning intangible asset owners have had to turn to more expensive financing alternatives.
However, signs are emerging of movement in how intangible assets are treated when it comes to the valuation and securitization. The recent announcement by United Airlines Holdings Inc (NASDAQ:UAL) that it is planning to raise $5 billion by borrowing against its frequent-flyer program, demonstrates that in a post COVID-19 world companies and lenders are more prepared to use innovative methods to source under-discovered and off balance sheet value to remain viable. In a similar move, American Airlines Group Inc (NASDAQ: AAL) is also pledging the domestic intangible assets of its AAdvantage program as collateral to secure a $4.75 billion loan from the U.S. government.
Today, intangible assets (such as data, content, software code, brands, confidential information, inventions, industrial know-how, and design rights) account for more than 87 percent of all company value. Yet these assets are essentially ignored by current accounting standards and (to date) most financial institutions have been reluctant to utilize these assets as securitization on lending. With intangible assets now being among the most valuable assets a company owns, the pressure has been building for this situation to change but until recently the finance sector has been reluctant to act amid concerns that intangible assets are difficult or impossible to value (spoiler alert: they aren’t!) .
But COVID-19 has forced change upon the finance sector. No-where is this more evident than in the aviation sector where the pandemic has created an unprecedented situation that no-one even anticipated on this scale. Traditional revenue streams literally disappeared overnight, and many carriers are hanging on by their fingertips to survive. Aircraft (the traditional source of security) are sitting idle with their value written down as many borders remain largely closed to passenger traffic, which has driven demand for air travel to decade lows.
With cash-flow drying up, airlines have had to move to secure new lines of funding. This has forced both the airlines and their funders to look beyond fixed assets as securitization. In light of this, United and American Airlines’ decisions to use their rewards programs as collateral makes sense but also raises the question ‘where does real value exist’ as clearly fixed assets that are (and will remain) underutilized no longer hold the same value to lenders.
This is where intangible assets such as airline loyalty programs are coming into their own. Pre-COVID, United and American Airline’s loyalty programs were recognized as being among the strongest globally, although the financial value of these assets was undefined from a balance sheet perspective because of the way traditional accounting standards treat intangible assets (along with – in some cases – the perceived difficulty in valuing intangibles).
COVID-19 has forced financiers to look again at the value of intangible assets such as loyalty programs, data, patents, and other assets and become more open to using these assets to secure new lines of lending – as has occurred in the cases of United and American Airlines in relation to their loyalty programs.
Until now, the value of airline loyalty programs has been largely opaque. However, as United and American have sought to use these assets to secure new lines of funding, the true value of these assets is being disclosed. In the case of United, its MileagePlus program has been valued in the $20 billion range – almost double the value of United’s current market capitalization, which has fallen to $10.6 billion due to the impact of Covid-19. For American, third-party appraisals have valued its AAdvantage program at between $19.5 billion and $31.5 billion. With intangible assets now driving the overwhelming majority of company value, it highlights the need for the finance sector to create innovative securitization and lending products on the back of these assets.
For this to happen, two things need to occur. The first is that accounting standards need to change to enable the better recognition and reporting of intangible assets and their value. Second there needs to be a significant shift in lender’s understanding and measurement of credit risk in relation to the securitization of intangible assets. As COVID-19 has shown, a reliance on fixed assets can be detrimental at a company level, and also within a financial markets context.
Now more than ever, it is important that companies identify their intangible assets and leverage them more effectively – just as United and American Airlines have done. If your company has had to pivot because it can’t operate as normal, why not look at how you can better leverage your intangible assets, a source of material hidden value in many enterprises?
Ultimately, physical assets simply cannot scale at the speed required but intangible asset-based businesses can. COVID-19 is proving to be an unforeseen wake-up call not only to management teams and directors, but also to the finance sector regarding how valuable these often-overlooked assets can be.