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Whole Business Securitization in 2020

Despite the disruption to franchise businesses brought on by COVID-19, it was a relatively active year in the securitization of franchise royalties. Such transactions make up the majority of whole business securitizations (“WBSs”), transactions that use the revenue generating assets of an operating company as collateral for bond issuances in a bankruptcy remote structure. Issuances this year under such structures included transactions for ServiceMaster and Bojangles.

Unlike typical asset-based securities, which are collateralized primarily by “financial assets” with fixed payment terms ranging from loans and leases to receivables and structured settlements, a WBS is secured by assets with potentially more volatile income streams like franchise and intellectual property royalties. 

Issuers are drawn to WBSs because the structures tend to achieve higher credit ratings than other forms of secured financing, leading to better pricing. Investors favor WBS structures because cash flows from the underlying collateral are isolated from the sponsor in a bankruptcy remote special purpose vehicle. WBSs also provide the possibility of transitioning management of the collateral to a replacement manager. Despite these strengths, in the case of deals secured by restaurant franchise royalties, COVID-19 presented potentially grave threats. 

Cash flow available to pay bondholders under a restaurant royalty WBS is directly linked to the revenues of individual restaurants because royalties — due to a franchisor under a franchise agreement — are typically established as a percentage of franchisee revenues. Policy measures designed to arrest the spread of coronavirus and the public’s concerns over the safety of dining out resulted in sharp declines in restaurant traffic, credit quality, and investor demand for WBSs would suffer. 

One example of a deal damaged by the effects of COVID-19 was TGIF Funding LLC (Series 2017-1). This transaction’s senior bonds were originally rated BBB- by S&P and BBB by Kroll Bond Rating Agency. Heading into 2020, the rating agencies had each already downgraded the issue on account of falling store count and sales. In 2019, S&P had taken the bonds down to BB+ and Kroll to BBB-. Following a series of downgrades this past year, the senior notes are currently rated B by both agencies and a rapid amortization event was triggered under the deal’s indenture by a fall in systemwide sales. 

It was nonetheless an active year for new deals, with ten transactions closing for a total of over $4.4 billion in issuance according to Finsight. While in volume terms, this represents a decline from last years’ $9.1 billion in issuance, it was nonetheless a remarkable level for a few reasons. First, the scale of the decline was not as great as that experienced in other COVID-ravaged ABS sectors, such as aircraft lease ABS. Second, most of the WBSs closed in 2020 were printed after the effects of COVID in the United States had amplified in March, once again in contrast to aircraft ABS (which virtually ground to a halt after a strong winter). 

The year also saw inaugural WBS issuers come to market, including Bojangles and FAT Brands in the restaurant sector, and ServiceMaster in the commercial and residential cleaning and restoration industry. Percent acted as a Structuring Agent in two rounds of bond issuances for FAT Brands Inc. Most of the proceeds from the second of those deals went to finance the acquisition of Johnny Rockets by FAT Brands Inc.

Lastly, as the year went on, new deals priced at levels that represented substantial yield tightening. As just one example, BBB-rated bonds with a weighted average life of 6.8 years issued by CKE Restaurant Holdings, operating Hardee’s and Carl’s Jr., priced at a yield of 3.981% in November, a full 100 bps tighter than the equivalent bonds from the same issuer’s 2018 deal. 

It may seem strange that primary markets were so active amidst the broader disarray. However, COVID-19 has had an unequal effect on different franchise concepts, even within the restaurant sector. Quick service restaurants were better equipped for delivery, take-out, and drive-through as compared to casual dining concepts, hence the relative pain experienced by TGIF. 

By contrast, brands like Bojangles, Hardee’s, and Carl’s Jr. experienced more modest drops in sales or are even up in respect to monthly sales compared to year ago levels. Fine dining experienced its own grave challenges with considerably less room to maneuver. 

The WBS market was a case of haves and have nots in 2020, with the coronavirus pandemic having a disparate impact on different franchise businesses — even among those in the restaurant sector specifically.

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