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Franchise Securitization Is Back

They're baaack —asset-backed securities, or ABS that is. Record low interest rates have spurred investors over the past year to rediscover higher yielding bonds that franchisors like Domino's Pizza issue. The bonds are based on estimated future royalties that franchisees are committed to pay.

 In the go-go late 2000s, franchisor after franchisor, like frozen yogurt chain TCBY, found themselves laden with obligations too difficult to handle because of incurring a securitization debt load that was too high to meet. Part of the problem to note holders was that rating firms did little in understanding franchising risk, often stamping these franchise ABS bonds with low-risk A ratings.

What happens when your franchisor becomes insolvent? An example is Bennigan's and Steak & Ale franchisees, who woke up shocked to read about the liquidation of their franchisor in the morning paper. They quickly discovered that the sign above their store became a noose as customers thought the neighborhood restaurant was gone and stayed away. The franchisees' food suppliers disappeared and the brand trademark was buried in bankruptcy court. Still, the Bennigan's franchisees were luckier and more proactive than many other chains. Some managed to hang on. A buyer purchased the intellectual property rights of the bankrupt franchisor; namely, the valuable trademarks and the signed franchise agreements that obligate franchisees in their commitments. Still, the remaining restaurants exist in a brand considerably diminished.

Now bonds from the securitization of franchise royalties are popular again.

"From 2007 to 2011, no one pitched securitization to us, but we've seen this market come back," said Iconix founder and CEO Neil Cole, who said deals for fast food chains Domino's and Sonic convinced him to raise more money through ABS. … Domino's sold $1.575 billion in 6-1/2-year, BBB-rated bonds late last year at a yield of 5.25 percent. A seven-year U.S. Treasury note yields 1.42 percent, while the average U.S. investment grade corporate bond yield stood at 2.86 percent, according to the Merrill Lynch bond index.Since then, those bonds have traded at around 3 percent, according to ABS traders. [via Reuters]

These non-traditional, non-mortgage-backed ABS have gone from $30 billion before the 2007-2009 financial crisis to $7.9 billion in 2011 and now to $15 billion, according to Reuters. But with competition for these notes now heating up, experts say there is a flight by investors to quality and liquidity, such as auto loan and credit card ABS bonds.

Experts warn that the market could be volatile.

Indeed, liquidity could dry up quickly if the broader U.S. or global economy stumbles. Economists worry that higher taxes and lower spending in the United States could slow growth later this year, as could a return of Europe's debt crisis. And a weaker economy could raise worries about collateral. "Some of these represent wonderful buys, but you'll never be able to sell them to anyone else" if market conditions worsen, said Dan Fuss, Loomis Sayles vice chairman and manager of the Loomis Sayles Bond Fund. [via Reuters]

Dear Reader: If your franchisor could bundle anticipated franchisee royalties and receive a hundred million dollars or more by owing bond holders, what benefits might you gain from that?

  • How might it harm your business?
  • How would you know if your franchisor underwent a whole business securitization?

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Don Sniegowski is editor of Blue MauMau, the daily news journal for franchise & small business owners. Call him at +1 (270) 321-1268, tweet @bluemaumau or email