Frontier Airlines, The Latest Credit Card Victim

I'm well aware that there's no such thing as a free lunch. But some things come close, at least to the untrained eye, and one of them is the insurance that you get whenever you buy something on a credit card. It doesn't matter if you bought a toaster or an airline ticket: if the machine doesn't work or the airline suddenly ain't flying for some reason, then you're likely much better off if you bought with plastic rather than paying in cash.

Well, it turns out that the insurance isn't free after all, and it's not (just) a way for the credit-card companies to get you to use your card more. They also get to withhold money from vendors, and even push them into bankruptcy as a result. Here's Sean Menke, the CEO of Frontier Airlines:

"Our principal credit card processor, very recently and unexpectedly informed us that, beginning on April 11, it intended to start withholding significant proceeds received from the sale of Frontier tickets. This change in established practices would have represented a material change to our cash forecasts and business plan. Unchecked, it would have put severe restraints on Frontier's liquidity and would have made it impossible for us to continue normal operations."

Yep, never mind jet fuel, it's credit card withholding which did for Frontier. JP Morgan analyst Jamie Baker explains what's going on to Ann Keeton:

Typically, credit card processors turn over revenue to airlines in a couple of days, Baker said. But they can sign agreements with financially weak airlines, such as Frontier, to hold back a percentage of revenue from the time a ticket is purchased until the passenger takes the flight.

That percentage, it turns out, can be very high. The NYT again:

In its court petition, Frontier said that First Data had notified the airline that it was increasing the amount of collateral it required to $130 million from $54.5 million and that it would retain 50 percent of the airline's bank card sales.

In other words, Frontier's credit-card cashflow was being slashed in half, on top of a requirement to post an extra $75 million in collateral. You can see how a demand like that could force Frontier to declare bankruptcy.

I'm assuming, here, that the withholding is connected somehow to the insurance, and that First Data would have been liable to repay those fares if Frontier cancelled its flights. Is that indeed the case? Is there something online which explains how this all works?

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