Verizon Selling Bonds Backed by Cell Phone Payments
Verizon Wireless is making its first trip to the securitization market to help offset the expense of providing customers with financing for mobile phones.
Wireless carriers are increasingly allowing customers to pay for devices in installments, often with no down payment. Since the carriers must pay vendors for the equipment upfront, these plans tie up a lot of working capital, particularly for expensive smartphones. Securitization allows them to free up working capital by selling the rights to future installment payments.
The inaugural Verizon Owner Trust (VZOT) 2016-1 is backed by $1.52 billion in consumer device contracts, according to Fitch Ratings.
It will replace an accounts receivable factoring facility with banks that Verizon currently uses to offset the expense of equipment installment plans.
The deal follows a year’s worth of management deliberations over the tapping the securitization market, which Verizon expects to lower the cost of financing device payment-plan agreements. Securitization can provide access to a broader investor base. It can also provide longer-term financing than factoring facilities, which is better suited to short-term cash needs.
Other wireless carriers, including Sprint Corp., are also exploring the financing of mobile phone purchases through asset-backeds.
Fitch has assigned a preliminary ‘AAA’ to the $1 billion tranche of class A notes, as well as ‘AA’ and ‘A’ ratings to tranches of class B and c notes, respectively, that are each sized at $84.5 million.
New York-based Verizon was one of the last of the U.S. carriers to provide handset loans to consumers in place of traditional service contracts. The company previously announced it was retiring its bank-partner securitization vehicle in the second quarter. At a media, communications and entertainment conference hosted by Bank of America Merrill Lynch on June 7, Verizon chief financial officer Francis Shammo said the use of an ABS instrument would shave financing costs as well as provide a buffer against pressure on its corporate credit ratings.
Or, as Shammo put it, “because I don’t want to be in the finance business,” according to a transcript of his comments.
Verizon’s prior funding through credit agreements with partner banks were “generally at a little bit higher cost,” he said. These arrangements also pressured Verizon’s own credit ratings since ratings agencies considered the arrangements to be unsecured debt.
By comparison, the notes issued by the VZOT trust “will be treated as a separate pool of financing short-term asset-backed security debt similar to the auto industry and so forth,” Shammo said at the conference. “So there is a benefit from a borrowing perspective, because a lot of this will be rated triple A.”
Verizon carries lower investment-grade ratings of ‘BBB+’ from Standard & Poor’s and ‘Baa1’ from Moody’s Investors Service, which are each two notches above speculative-grade status. Fitch rates the company ‘A-’, or three notches above junk-grade.
Handset securitization is expected to become a regular avenue for the four U.S. wireless carriers (Verizon, Sprint Corp., AT&T and T-Mobile), who supplied subscribers with an estimated $40 billion in device financing in 2015, according to rating agency DBRS.
T-Mobile and AT&T also rely on accounts receivables factoring facilities to fund handset purchases for customers. Sprint was the first U.S. telecom to announce last fall it would consider use of an ABS handset financing trust.
Verizon engineered credit enhancement levels of 30.6% to gain the triple-A rating on the Class A notes stack, as well as establish a target overcollateralization of 17.75% of the initial pool balance. In the initial VZOT pool, Verizon has 2.5 million accounts with $1.8 billion in aggregate balance from $1.9 billion from original principal balances.
The average FICO score of subscribers in the pool is a prime-level 708, and a majority of the contracts belong to long-time customers: the weighted average customer tenure is 87 months and 57% of the pool is comprised of subscribers who have more than 61 months of continuous service with Verizon.
Most of the risk factors weighed by Fitch focus on the limited historical performance and default data for handset contracts (Fitch has assigned a base default rate of 4% to the pool). There is also the contract arrangement permitting handset owners in the pool to trade in working phones as soon as 50% of the device’s original balance is paid off – a receivables shortfall Verizon must remit to investors supported by secondary-market sales of the phones.
At an annual ABS briefing hosted by Moody’s in New York on June 16, Verizon senior vice president and treasurer Scott Krohn said that while Verizon was late to the game with phone financing and leasing, it has quickly scaled its loan product platform, according to a Moody’s summary of a panel discussion at the gathering. The company built enough of an inventory to launch private securitizations over the previous five quarters while it prepared for the public ABS route.
While the unsecured nature of the loans carries risks, Krohn said underlying loans to the pool assets have unique motivations against delinquency. Customers are reluctant to lose their wireless phone service, and carriers have remedies such as cutting off data access to all phones in a family plan for a delinquent bill.
Moody’s stated in its report that the historical data on customers’ payment behavior on service-contract arrangements “could mitigate” the limited performance information on loan contracts for mobile phone purchases.