6 LESSONS Corporate Securitization: Seven Lessons for a CFO Prof. Dr. Andre Thibeault 3RF 3R Dr. Dennis Vink © 12 Before the subprime meltdown the In February 2011, Church’s Chicken “The performance of whole asset-backed market had grown to issued secured bonds in the aggre- business securitizations Bbecome one of the largest capital gate principal amount of $245 backed by restaurant markets in the world in terms of million. The new credit facility is the franchise payments, such size and volume. The market was first whole-business securitization not only accessed by financial insti- completed in the restaurant sector as the Church’s Chicken tutions, but also by corporates. since 2007. The bonds are backed by bond, has been «stable,» Corporates increasingly often used the franchise revenues of the nearly note Moody’s Investors securitization techniques to refinance 1,450 franchised Church’s Chicken- Service analysts. These whole lines of businesses by issuing branded and Texas Chicken-branded asset-backed debt that was rated restaurants in operation both haven’t suff ered during multiple notches above the rating of domestically and internationally and the economic downturn the parent company. One of these substantially all of the tangible and because they experienced instruments that were used is whole- intangible assets of the approxima- business securitization, also defined tely 230 company-owned Church’s «milder customer traffi c as operating-asset or corporate secu- Chicken-branded restaurants in declines than did the more ritization. 1 The overall issuance has operation in the United States. The expensive fi ne dining and continued in Europe and the United new credit facility is the first whole- casual dining industry States despite the crisis, albeit at business securitization completed in lower levels. 2 An interesting example the restaurant sector since 2007. segments,» of a recent transaction done in the the analysts note. 3 market is that of Church’s Chicken. 1 In one year’s time, both the Dunkin Brands transaction (May 2006) and the Domino’s Pizza deal (April 2007) pushed about $3.5 billion of asset-backed papers onto the market. 2 See report “Recent Developments in Securitization”, published by the European Central Bank in February 2011. 3 http://www.dowjones.de/site/2011/02/churchs-chicken-puts-franchise-fees-on-abs-menu.html. The Financial Executive n°53 • October 2011 7 The decision to use whole-business special purpose vehicle. This defini- securitization involves an explicit tion comprises the fundamentals of choice regarding the financial struc- asset securitization. ture concerned as well as managerial involvement and control. This article Lesson 2: aims to introduce the reader to the The objective is that only the structural features of whole-business investors in the SPV will have securitization by discussing 7 impor- a claim against the securitized tant lessons. assets in the event of the seller’s R. bankruptcy: not the seller or the © D. First, the general concept of seller’s creditors. Prof. Dr. Andre asset-backed securitization will be Legal concepts in the area of secu- Thibeault discussed. Next, the reader will ritization often differ, and thus have be introduced to the terminology specific accounting and tax rules, Professor of Finance and Risk Management framework for whole-business secu- including tax consequences for both Academic Director at Vlerick ritization. Finally, an answer will sellers and investors. Common-law Center for Financial Services be presented to the question how countries (such as Australia, the whole- business securitization distin- United Kingdom and the United guishes itself from more traditional States) for example, follow different areas of corporate finance. legal rules in comparison with civil investors do not have recourse on countries (most other countries). the seller. That makes securitiza- Lesson 1: Despite fundamental differences in tion different than covered bonds, The definition of asset-backed the legal environment, the primary because covered bonds do not allow securitization refers to the issu- objective of the SPV is to facilitate for risk transfer in the same way as ance of tradable debt papers, the securitization of the assets and to securitized products. In the event which are guaranteed based on a ensure that the SPV is established for of default, asset-backed securities well-defined collection of assets. bankruptcy purposes as a legal entity have recourse only on the pre-de- Unfortunately, the term ‘asset- separate from the seller. In other fined pool of assets in the SPV, backed securitization’ is used diffe- words, the objective is that only the while covered bonds have recourse rently by many, and the usage is investors in the SPV will have a claim on both the SPV and the seller of not necessarily comparable. Asset- against the securitized assets in the the assets. So one distinct feature backed securitization first appeared event of the seller’s bankruptcy: not from securitized products is the in bank funding. Hess and Smith the seller or the seller’s creditors. liability of the seller in the event of (1988), for example, defined asset- Because the pool of assets is insu- default. Note that covered bonds are backed securitization as a financial lated from the operating risk of the frequently used as an alternative for intermediation process, which seller, the SPV in itself may achieve residential mortgage-backed securi- re-bundles individual principal and better financing terms than the seller ties (RMBS). interest payments of existing loans would have received on the basis of to create new securities. More his own merits. This is the key driver Lesson 4: recently, the term ‘asset-backed for reducing financing costs by secu- The element of future exploitation securitization’ has come to be used ritization in comparison with alterna- of the asset is a key distinction to refer to so-called ‘structured tive forms of financing. between standard securitization finance’, the general process by and whole-business securitization. which illiquid assets are pooled, Lesson 3: Whole-business securitization repackaged and sold to investors. So, Asset-backed securities are not uses securitization techniques for asset-backed securitization can best the same as covered bonds. refinancing a whole business or be defined as the process in which The objective of securitization is that operating assets. You may wonder assets are refinanced in the capital the investors in the SPV will have a what exactly is meant by ‘whole market by issuing securities sold to claim against the securitized assets in business’, and where precisely the investors by a bankruptcy-remote the event of the seller’s bankruptcy: difference lies compared with the 8 LESSONS transactions. Consider for instance of the original owner in order to a mortgage pool. If the mortgages generate revenues. The element of have been securitized, the seller future exploitation of the asset is a (sponsor) has no further obliga- key distinction between standard tions towards the consumer. The securitization and operating-asset mortgage has been closed and stipu- securitization. Control over the cash lations concerning future payments – flows of the securitized business is to be made by the consumer – have established either through a sale of been laid down in a contract. Simply the assets, or through an adequate R. R © D. stated, the financial institution then legal structure that ensures continua- collects payments from the consumer tion of cash flows in the event of the Dr. Dennis Vink for the balance of the life of the insolvency of the borrower. 4 Associate Professor of loan. In effect, the traditional classes Finance of securitization assets are self-liqui- Lesson 5: Director at Nyenrode Center for Finance dating. By contrast, in the example The receiver has authorization to in which claims on the basis of seize control over the assets of the operating assets are securitized, the securitized business at the loss of sponsor has an obligation to exploit any other creditor. more usual types of collateral used the underlying assets. To offer an In a standard ‘whole-business secu- in securitization transactions: credit illustration: when a football club ritization’ transaction, a financial cards or mortgages, for example. securitizes its revenues from the sale institution grants the sponsor (or In order to make you understand of tickets, the sponsor must continue originator) a loan secured by a pledge whole-business securitization, its to render services that allow foot- on the assets. This secured loan is definition will be presented first. ball fans to buy their tickets at the then transferred to a bankruptcy-re- Next, the difference will briefly be box office. Thus, the securitization mote special purpose vehicle, which explained between whole-business process requires permanent mana- issues the notes. The security atta- securitization and the more common gerial involvement on the part ched to the loan is also transferred to forms of securitization, as we know them today: for example the use of mortgages and credit cards. Whole-business securitization can be defined as a form of asset-backed financing in which operating assets are financed in the bond market via a bankruptcy-remote vehicle (hereafter: SPV) and in which the operating company keeps complete control over the assets securitized. In case of default, control is handed over to the security trustee for the benefit of the note holders for the remaining term of financing. One of the great challenges lies in defining the difference between operating asset securitization and the more common forms of securitization 5 This feature makes it difficult in some countries to structure a business securitization deal. In fact, it has been proven to be hard to separate the assets legally while the sponsor still retains operating control and services these assets. Under U.K. law, this difficulty has almost been eliminated by the 1986 Insolvency Act, which permits the holder of a charge over substantially all of the assets of a corporate to control the insolvency proceeds of that corporate through an administrative receiver.