In a world of negative interest rates, any asset that can generate even the smallest positive yield is cherished by investors. The result is a macabre return to the days just before the 2007 credit bubble burst, when virtually any asset was converted into a "security", and as a result of this wholesale rush to securitize, we are now seeing a bizarre scramble by businesses like fast-food chains to mortgage essentially all their assets.
Call them "burger-backed bonds."
According to Bloomberg, franchised companies like burger restaurant Jack in the Box and massage provider Massage Envy are increasingly selling unusual bonds backed by most of their business. The strategy is simple: collateralize everything in hopes of paying a lower interest rate. By pledging virtually all core assets like royalties, fees, and intellectual property to bondholders, companies can win investment-grade credit ratings on their debt and slash their financing costs, making their bonds higher quality even if their overall companies are still relatively risky.
And with the universe of positive-yielding assets evaporating before our eyes by the day, demand for such securities, known as whole-business securitizations, has exploded with more than $6.9 billion of these securities sold so far in 2019, approaching the record set in 2017, according to Bloomberg.
While such "burger-backed bonds" were, as the name implies, issued mostly by fast-food restaurants, a wider array of companies are jumping in. This year, in addition to Massage Envy, a group of preschools and a distributor of music royalties have sold the bonds.
In addition to a broader scarcity of positive yielding investment rate debt - we recently reported that the US share of positive global IG fixed income yield has risen above 94%...
... companies are being nudged toward this kind of financing by bond investors that are gravitating toward relatively safe securities and away from the riskiest debt in the junk-bond market. That’s translating to material savings for corporations that can shift from high-yield borrowings to investment grade, which such securitizations allow.
One such example are the $850 million of whole-business bonds sold by Wendy’s Co. in June, and which yield between 3.78% and 4.08%, which are likely to be refinanced in seven to 10 years. Those bonds won the second-lowest investment grade. By comparison, a smaller unsecured bond that the company sold in 1995, due in 2025 and rated seven steps below investment-grade, yielded around 5.3% in June. As Bloomberg calculates, reducing interest payments by around 1.5 percentage points annually on $850 million of debt can translate to a savings of $12.75 million a year before taxes.
"The cash interest savings is certainly very attractive,” said Kate Jaspon, CFO of Dunkin' Brands which refinanced its debt in a $1.85 billion transaction this year. “The securitization market has allowed us to access an investment-grade market which has been more stable over the years compared to a leveraged-loan or high-yield market."
And while nobody will complain that covenants on debt issued these days are draconian, the terms of such whole-business bonds are even looser than normal, and typically allow companies more flexibility in managing their finances than conventional high-yield bonds or leveraged loans. For example, investor protections on some types of junk bonds might require a company to devote some of its cash flow to debt reduction. But the Dunkin’ whole business bonds have not, freeing up the company to spend the cash on dividends to shareholders or buybacks, Jaspon said.
Yet even as the whole-business bonds market has grown - Kroll calculates that there’s about $26 billion outstanding now - not all deals have done well. Retailer Pet Supplies Plus scrapped a planned $330 million offering earlier this month, citing market conditions, and Kroll downgraded a deal backed by TGI Fridays franchise agreements, citing the chain’s declining sales since the debt was issued in 2017. Furthermore, since this is a relatively new product, it’s not clear how some of these businesses will perform in a downturn, said Brandywine’s Chen, who is sticking with whole-business securitizations from fast-food companies, which tend to perform well in recessions.
So what is it that allows such securitization deals to be sold at higher rates?
As Bloomberg explains, in a typical security, a company with stable cash flows and a heavily-franchised business model pledges assets like royalties into a special entity that is immune from the bankruptcy of the parent company. The money generated from "bankruptcy-remote" entity can fund business operations and pay investors. Additional protections, like stipulations that divert cash to pay investors if business goes south, can elevate the securities to investment-grade ratings.
While companies benefit from selling whole-business bonds by paying lower rates, money managers gain too: they get higher yields than they would earn from run-of-the-mill investment-grade corporate bonds, because the asset-backed securities are more complicated and take more time to analyze. The asset-backed notes are often rated in the BBB tier, among the lowest ratings for high-grade bonds.
“It emboldens issuers to come to this market,” Goodson said. “Core buyers who have always been buyers have started to appreciate the better liquidity.”
As an example, a recent offering by the rights to play music from artists like Bob Dylan paid a 5.2% yield, while preschool chain Primrose Schools sold a bond that yielded 4.48%. In the unsecured bond market, the average BBB bond pays 3.2%.
“When you start to look at BBB rated whole business versus a BBB unsecured issue, it can look compelling,” said Philip Armstrong, a portfolio manager for structured investments at Invesco, which oversees $1.2 trillion. “There’s definitely considerable yield pickup.”
Higher yields have helped draw investors that mainly focus on corporate debt into the asset-backed market. That broader demand has made the securities easier to trade, said Dave Goodson, head of securitized fixed income at Voya Investment Management, which oversees $220 billion.
So the next time you buy a hamburger, consider for a minute just how many Japanese pensioners will end up receiving interest payment from the proceeds.