Recognition of the measurable value of intangible intellectual property reached a new peak in November 2000 when, for the first time, brand value was used as the asset behind an asset-backed security. Future cash revenue arising from the restaurant brand Arby's is the tangible repaying the $290m note issue. A sizeable guarantee from the reinsurance market has provided sufficient investor comfort to make the deal a success, introducing a model that could prove to be a significant new niche for innovative reinsurers.
Unlike a common catastrophe bond, where risk passes from the insurance industry to the capital markets, the Arby's deal transfers risk the other way. The fundamentals of the securitisation are similar, involving the issue and private placement of notes by a special purpose vehicle, but otherwise it is a very different deal indeed.
New York-based Triarc Companies Inc is the franchiser of Arby's restaurants, an established and steadily growing chain of roast beef sandwich shops. A subsidiary special purpose vehicle, Arby's Franchise Trust, has issued $290m worth of non-recourse notes bearing interest at 7.44% and due in 2020. Triarc gets about $250m, $30m has been placed in a reserve account, and about $10m went to cover the expenses of the transaction.
Unlike cat bonds, which tend to be backed by bondholders' cash invested in guaranteed instruments, the security behind the Arby's notes is the forthcoming fee and royalty income from existing and future Arby's franchisees. Current franchise income is sufficient to pay the monthly principal and interest costs of the issue, and the inclusion of income from future franchisees strengthens the security.
Behind that is a financial guarantee policy issued by municipal bond insurer Ambac Assurance Corporation, which itself is covered by a first-loss reinsurance facility provided by the Bermuda branch of European Reinsurance Company of Zurich, part of the Swiss Re Group. Ambac retains an excess of loss position. In common with other financial guarantee arrangements, provisions are in place for Ambac, through a trustee, to assume the management of the franchiser should the current management drop the ball. The combined security was sufficient that the ratings agencies Moody's, Standard & Poor's, and Fitch granted the notes triple-A ratings.
“It is a growth market, but each deal is extremely complex. There is no cookie-cutter approach,” says Jennifer Williams Costain, vice president of Ambac. That complexity makes it difficult to quantify the potential volume of securitisations backed by intellectual property assets. Despite believing such deals will never be as high-volume as the credit card debt asset-backed market, she sees openings in any sector where there is some type of licence or usage rights.
“Software is one application, pharmaceutical receivables based on patents is another, and even some license and usage rights for services such as movie production have potential,” Ms Williams Costain says. “It could be anything with copyright, patent, or other licence or usage rights at the core of the business generating revenue.” Opportunities are limited only by the imagination. “I couldn't have thought of a deal like this unless we had it,” she admits.
Strengthening Triarc's bid for the securitisation was 20 years of cash flow data from Arby's – a 35-year-old 3,200-strong chain of restaurants worldwide with a further 1,100 committed to open – which outlined the predictability, strength and annual growth of the royalty stream. “You need to have a history of cash flows to be able to predict future cash flows,” Ms Williams Costain explains, “so patents may be difficult, but not out of the question.”
In structuring the deal, Ambac says it drew in part on experience of its UK sister company. Ambac UK provided a financial guarantee for a £650m portion of a June 2000 bond issue by Punch Group, Britain's largest independent pub owner. The securitisation restructured debt arising from Punch's 1999 acquisition of the Punch Taverns estate from Allied Domecq plc. However, the deal is substantially different from the Arby's transaction. Clearly the 3,400 pubs which Punch acquired are much more tangible than Triarc's Arby's brand, although the future success of those pubs depends on many similar variables.
“Both Arby's and Punch are made up of a granular consumer product. There are lots of taverns, like there are lots of restaurants. The cash flows received from these units, as opposed to the main operating company, are what get us away from the corporate credit risk. Ultimately, it is the payment by the owner of the restaurant or pub that backs the cash flow that pays the bond.”
Ambac's role is that of fronting insurer, Ms Williams Costain says. The deal originated with the Specialised Asset-Backed Group at Swiss Re New Markets (SRNM) in New York, and began well over a year ago when a merchant banker with Morgan Stanley Dean Witter asked SRNM associate director Mark Green if the reinsurer could “do something” with franchise fees. “We did a quick triage process, and saw it had a lot of potential,” Mr Green explains.
David Moran, who heads the Specialised Group, says the idea is exactly the kind his team looks for. “Our focus is on new and emerging asset classes, those which are more difficult to trade and less liquid. There isn't yet a market for intellectual property and franchise fees, but we were able to underwrite the Arby's deal in such a way that we are happy in the first loss position.”
The main structural technique is to separate the value embedded in the intellectual property from that of the operating company. Mr Moran describes the rating process as “driven by an actuarial and insurance underwriting approach, which includes looking at the stability of the underlying cash flows.” Part of the attraction of asset-backed securitisations is the underwriter's ability to narrow the risk factor to a handful of drivers that fit an actuarial model. “With a corporate loan, there are innumerable things that can go bump in the night. For an asset-backed security, such as credit card debt, there is a default rate that you can underwrite.”
If the way the deal moves risks from the capital to the reinsurance markets is a flip-flap, so is the way this deal was underwritten by a reinsurer then taken to a direct company that assumes an excess position. Neither Ambac nor SRNM were willing to reveal the guarantee company's attachment point, and since the notes were not offered for sale in the US, no SEC filing provides the detail.
Mr Green reveals that Swiss Re Atrium, the reinsurer's in-house broker, was involved in the deal, as were other consultants, but he is unable to disclose their roles. Additional reinsurers may have been involved in assuming the excess portion of the risk. “It is gross to Swiss Re, and undisclosed as to what went on after that,” says Mr Moran.
The reason for non-disclosure of the detail of the transaction is simple. “Clearly there will be competition, but the learning curve is so steep that they can't get there as fast as we can,” Ambac's Ms Williams Costain says. “We can provide feedback from Arby's, but the competition would have to learn the deal from scratch.”
Both parties see a growing market, now that they have proved it can be done. “We hope there is a bunch more work to do in franchise fees and intellectual property,” Mr Moran says. “There seems to be a vast market on both fronts. More deals are in the works.”
Additional innovative securitisations are pending, he says, with the SRNM Specialised Group focused on assets with a current earnings stream such as licensing fees, and other categories of intellectual property that yield a stable cash flow. “Trademarks may have a large value, and perhaps, based on surveys, you may evaluate them, but we find it more difficult to put that through an actuarial process.”
Ambac also has a pipeline of opportunity. “We are looking at a couple more deals,” Ms Williams Costain says, adding: “We will see a lot, but not necessarily write a lot. It is a great idea, but not necessarily fit for everyone.”
Adrian Leonard is a freelance insurance journalist and a regular contributor to Global Reinsurance.