Companies Securitize Everything as Investors Reach for Yield

As borrowing costs plunge for the highest-quality companies, there's a growing incentive for riskier businesses like fast-food chains to mortgage virtually all their assets.

Franchised companies like burger restaurant Jack in the Box Inc. and massage provider Massage Envy are increasingly selling unusual bonds backed by most of their business. By pledging key 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.

This year borrowers have sold more than $6.9 billion of these securities, known as whole-business securitizations, approaching the most on record, according to data compiled by Bloomberg. Fast-food restaurants used to be the main issuers of this debt, but a wider array of companies are now jumping in. This year, in addition to Massage Envy, a group of preschools and a distributor of music royalties have sold the bonds.

"The sector is growing very fast," said Tracy Chen, who invests in whole-business bonds as head of structured products at $75 billion asset manager Brandywine Global. "You can almost securitize anything."

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. They're looking for an elusive combination of safety and strong returns in a world that has more than $16 trillion of negative-yielding debt. That's translating to material savings for corporations that can shift from high-yield borrowings to investment-grade.

For example, Wendy's Co. sold $850 million of whole-business bonds yielding between 3.78 percent and 4.08 percent in June, which are likely to be refinanced in seven to 10 years. Those bonds won the second-lowest investment grade. A smaller unsecured bond that the company sold in 1995, due in 2025 and rated seven steps below investment grade, yielded around 5.3 percent in June. 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 Group Inc., 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."

Whole-business bonds also 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, which frees up the company to spend the cash on dividends to shareholders or buybacks, Jaspon said.

As the market has grown—there's about $26 billion outstanding now, according to Kroll—not all deals have done well. Retailer Pet Supplies Plus scrapped a planned $330 million offering earlier this month, citing market conditions. Kroll downgraded a deal backed by TGI Fridays franchise agreements, citing the chain's declining sales since the debt was issued in 2017. It's not clear how some of these businesses will perform in a downturn, said Brandywine's Chen. She is sticking with whole-business securitizations from fast-food companies, which tend to perform well in recessions.

The potential savings from borrowing with whole-business bonds has been increasing as concern over the U.S.-China trade war and slowing global growth boost demand for investment-grade notes relative to riskier junk debt. Total returns on high-grade debt are about 13.6 percent this year, compared with around 10.6 percent for high-yield. A bond in the B-rated tier of speculative grade yields, on average, 2.85 percent more than a BBB security, up from about 2 percent a year ago.

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 that unit 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.

Companies benefit from selling whole-business bonds, but 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.

An offering this month backed by the rights to play music from artists like Bob Dylan paid a 5.2 percent yield, while preschool chain Primrose Schools sold a bond that yielded 4.48 percent. In the unsecured bond market, the average BBB bond pays 3.2 percent.

"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 into the asset-backed market some investors that mainly focus on corporate debt. 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.

"It emboldens issuers to come to this market," Goodson said. "Core buyers who have always been buyers have started to appreciate the better liquidity."

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