(Editor's Note: The following Credit FAQ discusses transactions issued by U.S-based businesses. The fundamental principles of the rating approach are relevant globally, though different jurisdictions typically have unique considerations, such as those relating to the local bankruptcy regime. In the original version of this article, published Feb. 22, 2019, the left y-axis in chart 1 was incorrect. It has been corrected in this version.)
Corporate securitizations represent a substantial and growing piece of the structured finance market. S&P Global Ratings currently has ratings outstanding on 29 series of notes from 16 U.S.-based issuers in the whole business securitization (WBS, or corporate securitization) space. The issuers represent a range of businesses, including casual dining and quick-service restaurants (QSRs), automotive service providers, fitness clubs, and others. In the U.S., we have been rating such transactions since the mid-2000s (see chart 1).
Chart 1
WBS issuers are special-purpose entities (SPEs) set up, and indirectly owned, by operating businesses that sell the substantial majority of their revenue-generating assets, including intellectual property, real estate, existing and future franchise and licensing agreements, royalties, supply-chain profits, company-owned store EBITDA, and others, to asset-owning SPEs owned by the securitization issuer. The corporate securitizations we have rated to date are primarily backed by highly-franchised businesses. Charts 2 and 3 show the breakdown of currently outstanding WBS notes rated by S&P Global Ratings by sector and rating, respectively.
Chart 2
Chart 3
The majority of issuer credit ratings (ICRs) or equivalents of the sponsors of S&P Global Ratings-rated corporate securitizations are in the 'B' rating category. Given that the majority of our U.S. WBS ratings are in the 'BBB' category (see chart 3), this implies an average of an approximately five-to-six-notch rating elevation of WBS ratings above the corresponding sponsor ICRs or equivalents.
How is such elevation possible? How can the corporate securitization structure have such a transformative effect on our view of the credit risk profile of the business? Here, we address these frequently asked questions by looking at the key ingredients we consider when we rate a whole business securitization.
What Are The Key Ingredients That Allow For Elevation In Whole Business Ratings?
Four key factors allow us to differentiate, from a credit perspective, between the securitization debt and the corporate debt of the same company:
- Asset isolation;
- Post-bankruptcy continuity of cash flow;
- Establishment of a back-up manager; and
- A longer time horizon, which results in more cash to repay debt.
We deep dive into each of these factors below.
Asset isolation
We believe that isolation of the substantial majority of an operating business' revenue-generating assets in an SPE minimizes the likelihood of cashflow disruption in the event of the operator's bankruptcy. Establishing a bankruptcy-remote entity that isolates revenue-generating assets in a securitization highly increases the likelihood that cash flow is not disrupted if the operating company files for bankruptcy.
This is a key differentiator between securitized debt and typical secured or unsecured corporate debt, where the ongoing timing and magnitude of cash flows can depend on the outcome of a bankruptcy proceeding (hence, the use of our recovery ratings to establish issue-level corporate ratings).
Post-bankruptcy continuity of cash flow
The business itself must support our view that cash flows can continue following the operating company's (the manager's) bankruptcy filing. Very few businesses support this view, in our opinion.
To overcome a manager's bankruptcy in our analysis, we have to believe the business itself will continue to generate cash flows following the manager's filing:
- We can generally only assume the business will continue to generate cash flows after the manager's filing when the revenue-generating assets have sufficient credit independence from the manger and behave more like operating assets. For example, an aircraft will likely continue to generate cash flow assuming it is serviced properly, regardless of which specific airline operates it.
- For U.S. corporate securitizations, which are primarily backed by royalties from franchised businesses such as restaurants, we believe many franchisees will likely continue operating their units following a manager's filing as long as unit economics remain attractive and another entity can take over the basic general and administrative (G&A) functions of the manager. We believe the viability of such a post-manager-default situation relies heavily on the existence of either a sustainable customer value proposition or strong brand loyalty. Though the latter can be hard to quantify, we believe that system size and length of operating history, together with the existence of unique intellectual property, are useful indicators. Following a manager's bankruptcy, we expect the business' system-wide revenue will have substantially declined, but it will not have been mostly eliminated.
It is important to emphasize the difference between post-bankruptcy continuity of cash flow and asset isolation, which was discussed in the previous section. Asset isolation considers who has claims to the cash generated by the business and the timing of gaining access to that cash relative to other creditors. Post-bankruptcy continuity, on the other hand, is about having sufficient confidence that the business' assets will continue to generate cash following the manager's filing, irrespective of who has claims to that cash.
Establishment of a back-up manager
For S&P Global Rating to be comfortable that cash flow generation will continue following the the manager's bankruptcy filing, there must be a back-up manager, or we must believe that there is enough depth of backups in the market that the servicing function of the bankrupted manager could be quickly transitioned to a back-up manager.
A longer time horizon, which results in more cash to repay debt
Corporate debt issues typically have maturities between five and ten years. To take a highly simplified view of credit risk, consider a company with corporate debt maturing in seven years and a 6x debt/EBITDA leverage multiple, the business may be able to pay off the debt in year six (one year before legal maturity), assuming a flat EBITDA level over that time. As it only takes six years to pay the debt, and there are seven years of EBITDA, the last year might be considered "excess credit enhancement," at around 1/6 of debt, or 16%.
Securitizations tend to have 30-year legal maturities. In the example above, for a company with a 6x debt/EBITDA multiple, if it takes six years to pay off debt from current EBTIDA level, years seven to 30 are all excess credit enhancement (i.e., if EBIDTA weakens and the business can't pay down the debt in six years, there is a much longer buffer of time and income to repay debt). In the corporate example, if things go wrong, and EBITDA declines, there was only a one-year buffer. In a typical 30-year securitization, on the other hand, there can be over 20 years of additional EBITDA available. Hence, there is substantially more credit enhancement.
It is important to note that this argument is only valid if you can conclude from the prior points that the business is likely to generate income over the next 30 years, even following the manager's bankruptcy filing.
What Determines The Degree Of Rating Elevation Above The ICR?
The key ingredients identified above provide the foundation for rating elevation, but do not tell you, in and of themselves, what degree of rating elevation above the ICR would be possible for businesses and securitization structures that possess them. That determination involves, among other things, an analysis of a business' business risk profile in conjunction with expected and stressed debt service coverage ratios, unique structural features, unique jurisdictional features (such as those related to the bankruptcy regime), and a comparable ratings analysis, which takes a holistic view of the issuer's credit characteristics and performance relative to peers. More detail on this can be found in our criteria piece, "Global Methodology And Assumptions For Corporate Securitizations," published June 22, 2017, on RatingsDirect.
Related Research
- Restaurant Securitizations Are Structured To Survive A Big Bite, Sept. 7, 2017
- Global Methodology And Assumptions For Corporate Securitizations, June 22, 2017
- Corporate Methodology, Nov. 19, 2013
This report does not constitute a rating action.
| Primary Credit Analysts: | Jesse R Sable, CFA, New York (1) 212-438-6719; jesse.sable@spglobal.com |
| Christine D Dalton, New York (1) 212-438-1136; christine.dalton@spglobal.com | |
| Elizabeth T Fitzpatrick, New York (1) 212-438-2686; elizabeth.fitzpatrick@spglobal.com | |
| Secondary Contact: | Molly E McCarthy, New York + 1 (212) 438 2846; molly.mccarthy@spglobal.com |
| Research Assistant: | Matthew S Gardener, New York |
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