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Tuesday, April 15, 2008

First Data clips Frontier's wings

First Data Corp.'s action to more than double the cash reserve it required from Frontier Airlines Holdings Inc. and withhold 50 percent of the proceeds from ticket sales it processed from the airline caused Frontier and its subsidiaries to file for Chapter 11 bankruptcy protection on April 10, 2008, according to a Frontier executive.

Edward M. Christie III, Vice President of Finance for Frontier, said in the filing, "On April 8, 2008, First Data sent [Frontier] a letter stating its intent to increase – beginning on April 11, 2008 – the collateral required under the Bankcard Agreement from $54,500,000 to $130,000,000 and to retain 50 percent of [Frontier's] bankcard sales proceeds."

In other words, Christie said First Data's move would have deprived the Denver-based airline of half of its income from ticket sales, thereby crippling the airline's ability to operate normally. Frontier filed for bankruptcy to "prevent this threatened April 11, 2008, material alteration of our contract rights, and to develop and implement a comprehensive restructuring plan under the protections of Chapter 11."

Frontier's original agreement with First Data reportedly gave the processor the authority to withhold 45 percent of Frontier's sales until the travel itinerary had been completed. The current increase to 50 percent will apparently rise to 100 percent in May 2008.

The other side

But First Data – one of the largest merchant acquirers with an estimated $1.4 trillion worth of credit and offline debit transactions processed in 2007 – does not view itself as the cause of Frontier's woes.

"We regret that the current economic conditions have led to today's bankruptcy filing by Frontier Airlines," said First Data in a statement. "The terms of our agreement with Frontier Airlines are not unique; they are considered standard industry practice and terms originally agreed upon by Frontier.

"We have been in ongoing dialogue with Frontier Airlines for several months and will continue to work with them in as constructive a manner as possible."

Perspective

Frontier's filing pointed out the economic pressures facing the discount airline and, by default, the entire airline industry. Wavering credit markets and skyrocketing fuel prices have hit the industry hard. Airlines such as Skybus Airlines Inc. and Aloha Airgroup Inc. have recently filed for bankruptcy.

Frontier, the second largest carrier to fly out of Denver International Airport with 60 destinations within the United States as well as locations in Canada and Latin America, posted a net loss of $32,508,000 for the fourth quarter 2007, more than double its net loss at the same time the previous year.

In the filing, Frontier revealed that it owes close to $109 million in unsecured credit to its 30 largest creditors. U.S. Bank, a subsidiary of U.S. Bancorp and the sixth largest commercial bank in the United States, is owed the most at over $93 million. In secured credit, Q Aviation LP, a Fort Worth, Texas-based aircraft leasing company, is owed almost $84 million by Frontier.

Given the state of the airline industry, one may accuse First Data of being heavy-handed in its treatment of Frontier. But others find the processor far from blame.

"I think one could be equally sympathetic to the processor," said Philip J. Philliou, co-founder and Partner at New York-based payments consulting firm Philliou Selwanes Partners. "In the event of bankruptcy, if there's lots of tickets out there, who's going to be responsible for that?

"In the absence of a reserve, that's liable to mean the processor. I would fully expect processors to be demanding reserves from airlines. The question is, how much?

According to Philliou, "how much" is determined by a formula that is typically heavily negotiated by both the airline and the processor so there should be no surprises.

"The question I would have is what exactly was the trigger [for First Data to change its policy]?" Philliou said. "What happened that the formula came out with this new answer?"

Philliou said his consultancy has past experience looking at similar legal agreements between airlines and processors. The agreements are "fairly complicated, but if you look at processing agreements with any airlines, cruise lines, these type of formulas are standard."

"It's based on changing financial circumstances," Philliou said. "Typically, one of the variables would be chargebacks. Chargebacks are heavily monitored.

"Any negative change in the airline's financial condition is obviously going to cause the processor to scrutinize the relationship and make sure that they are protected. That's what they need to do to protect their own interests."

In the black

While the airline industry is suffering, ISOs and merchant level salespeople involved in the petroleum sector are making huge profits off of increases in fuel prices. The higher fuel costs are, the greater residuals. A Texas-based ISO remarked that, due to oil prices, many ISOs are "riding high" in the payments industry.

In the same breath, the ISO showed sympathy for Frontier's dilemma, given the change in its relationship with First Data. By more than doubling its collateral and holdback requirements with the airline, the ISO remarked, "How can any business make money under that?"

Seeing red

Frontier's bankruptcy petition was filed in the U.S. Bankruptcy Court for the Southern District of New York.

The petition gives Frontier the "time and legal protection necessary to obtain additional financing and enhance our liquidity," said Sean Menke, President and Chief Executive Officer at Frontier, in the filing. "The automatic stay provision of the bankruptcy code prohibits the credit card processor from increasing its holdback, and we are prepared to litigate this issue if necessary."

Despite its troubles, Frontier intends to operate its full schedule of flights and conduct normal business operations.

For Philliou, the development between Frontier and First Data "underscores the cash flow sensitivity that the airline industry has at this point. They're under lots of pressures now and so cash flow is very sensitive and any change in cash flow is going to be problematic. That's what we saw … with Frontier."

Toronto-based payments Attorney Adam Atlas agreed. "A lot of businesses operate on very small margins," he said. "Sometimes that margin is so small that a change in pricing by the acquirer could make the difference."

Philliou offers counsel for everyone in the payments industry and abroad. "[O]ur advice right now to airlines, issuing banks and other acquirers is grab a hold of your agreements this week, read through them, look at the financial model, do the math, and pick up the phone and have a very close and direct conversation with one another," he said. "You want to avoid these types of surprises." end of article

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