The “shelter in place” strain on franchised restaurant chains is taking a toll on some whole business securitizations.
In late March, S&P Global Ratings raised concerns over the near-term cash drain operators in the quick-serve sector, due to the suspension of dine-in service at major chains across the country.
In particular were the performances of the master trusts sponsored by the operators of TGI Friday’s and Dine Brands Global Inc.’s AppleBee’s/IHOP concepts, which each face “particularly severe” revenue strains from the impact of the coronavirus pandemic.
On March 25, S&P put $1.975 billion of outstanding notes from the chains on credit watch for a possible downgrade, given the weakening financial results from the loss of walk-in diners at thousands of U.S. and international locations.
Applebee/IHOP’s $1.525 billion whole business notes are rated BBB, while TGI Friday’s $450 million securitization is already at non-investment grade status with a BB+ rating.
“While other whole business concepts have the potential to mitigate revenue declines by relying on already well-diversified sales channels, [these chains] currently have greater challenges in this area, in our view,” S&P says.
Earlier in the month, Kroll Bond Rating Agency issued a one-notch downgrade to approximately $291 million in bonds backed by franchise revenues from Hooters Restaurant Group. Senior note tranches from HOA Funding’s 2014- and 2015-vintage senior notes fell to BBB- from BBB.
Those restaurant chains, like others across the country, are scrambling to ramp up meal home-delivery services (including alcoholic beverages in permitted jurisdictions) and other side-channel revenues to sustain operations – and debt payments – through the duration of the outbreak, however long it may be.
Prath Reddy, head of capital markets at fintech securitization platform Cadence Group, said that restaurants overall will see a material sales decline from the hold on in-restaurant dining.
“Restaurants in rural areas with limited take-out or drive-through capacity will take the biggest hit, because most people are going there to eat in the restaurant,” Reddy said.
Cadence recently structured a $40 million WBS for Fat Brands Inc., which owns eight restaurant brands including Fatburger and Elevation Burger, and franchises over 380 units worldwide.
Taking a critical role
Troubling signs of the outbreak’s impact in the service sector had been brewing for weeks when third-party meal home delivery service GrubHub estimated on March 13 that restaurant dine-in traffic might decline by as much as 75%. That estimate could turn out to be on the conservative side as the pandemic continues to expand and dine-in bans proliferate (voluntary or otherwise) across the country due to shelter-in-place mandates.
Restaurants that are primarily franchise-operated are now strategizing their short-term survival on the hopes of receiving government relief to meet payroll and (figuratively speaking) keep their doors open.
According to Bloomberg, franchisees will have access to a reported $350 billion small-business loan program that was part of the $2 trillion stimulus relief bill passed by Congress in late March. (At press time the package was headed to the White House for President Trump’s signature).
The loans will be tied to keeping employees on the payroll, which can result in forgiveness of the loans.
To some, the financing is critical to backstop an industry that has been forced to improvise perhaps more than any sector in reaction to COVID-19.
“Franchised restaurant brands have really taken the lead on a national-level response to this crisis,” said a banker active in the restaurant industry. Given the networks of stores and the outbreak’s strain on food supply, “restaurant operators who can continue to operate in some capacity should be an important part of feeding the country over the coming weeks and months.”
While waiting on government backstops, though, restaurants are adapting business models to ramp up home-delivery capabilities (or to supplement falling cash flows) by tapping into reserves and credit lines. S&P notes that Dine Brands drew down $223 million of the $225 million available under its 2019-1 issuance’s variable funding notes.
Those funds are also potentially useful in supporting the securitization cash flow in the first half of the year.
Whole business securitizations have primarily been sponsored by quick-serve restaurant chains, but in recent years have expanded to other industries. That includes gym fitness chains like Planet Fitness, which is also experiencing hardship due to the outbreak: the company has closed nearly 2,000 locations and suspended membership dues. Its ratings are on watch for potential downgrade, as well.
Planet Fitness is countering its current cash-flow drought by redirecting residual funds into debt service to cover first-quarter principal and interest payments on its $1.275 billion securitization., It will also partially fund second quarter P&I obligations, according to S&P, and assign revenue from previously collected membership dues into P&I payments for investors.
Downgrade threats
Reddy said any downgrades in the WBS arena related to the coronavirus outbreak will likely be prompted by a material deterioration in revenue that feeds the securitization payment waterfall—resulting in lower-than-expected debt service coverage ratios and/or higher corporate leverage that could trigger rapid amortization events.
“If we see any BBB-rated WBS deals hit a rapid-amortization trigger because of this, I think that’ll prompt [the ratings agencies] to put the whole sector under review, as these thresholds were believed to be high enough to maintain the structure,” Reddy said.
He added that any combination of a downturn in traffic, prolonged shutdowns, and perhaps even consumers maintaining social distancing after the crisis could lead to lower levels of cash to service the securities and trip triggers.
Should the Dine Brands’ current WBS rating fall to junk, Reddy expects there would most likely lead to sell-offs by the deal’s institutional investors who can only hold investment-grade holdings.
But in turn, Reddy said, high-yield and possibly distressed debt buyers would enter to negotiate a lower price floor.
Jesse Sable, director at S&P, said franchise companies can counter declining revenue streams for whole-business securities by temporarily taking back the stores and operating them as company owned, passing on “synthetic” royalties to the special purpose entity (SPE). Sable said that whole business deals generally have a guarantor, comparable to a holding company, which owns the membership interests in the SPE and pledges to the note holders, in the event of default, whatever value remains.
“Most of these systems have pipelines of interested parties,” Sable said.
According to the banking source, TGI Friday’s has sought to cull underperforming stores, buying back some with the intention of finding new and more effective franchisee partners.
A more likely outcome will be that franchisors work hand in hand with franchisees, and that WBS structures allow franchisors significant flexibility to assist franchisees through difficult periods.
“Many if not most franchisees are small businesses that rely on the strength and negotiating power of the franchisors,” the banker said.
“Franchisors are and will continue to support initiatives to help stabilize franchisees, whether through liquidity or lending programs, supply chain assistance or negotiating landlord concessions and deferrals.”
CLO impact
Even restaurant chains that successfully navigate the COVID-19 crisis may still yet suffer from recent trends in declining industry fortunes. And the impact is also beyond whole-business-securitizations.
Data research firm Trepp recently noted that struggling Pizza Hut and Wendy’s franchisee NPC International was a potential bankruptcy candidate prior to the outbreak. Of note was the impact to CLOs, Trepp reported, 84% of CLOs have exposure to the beverage, food and tobacco (BFT) industry, and the average exposure is 3.65%, somewhere in between that of the the oil and gas sector and hotel/gaming industry.
Only a handful of CLOs have exposure of 10% or more, and even then restaurants make up only a portion of the BFT category. So the impact more restaurant-chain defaults and bankruptcies could have on securitization is relatively small.
Nevertheless, Trepp notes, there several restaurant chains that have significant loans that make up portions of deals in the $640 billion market CLO market. That includes Red Lobster, PF Changs, Chuck E. Cheese, Steak N Shake, and California Pizza Kitchen.
There are also large franchisers, such as Flynn Restaurant Group and Yum! Brands. The latter is a Fortune 400 company with more than 49,000 restaurants worldwide, excluding China, that operate under the brands KFC, Taco Bell, and Pizza Hut.
Franchisee company Carrols Restaurant Group, which operates more than 1000 Burger Kings and 55 Popeyes restaurants, also saw its $425 million term loan, with a spread of Libor plus 325 basis points, fall in price.
