Ropes & Gray attorneys share insights from our participation in the ABS East 2024 conference, which, at more than 6,000 attendees, was the largest in the event’s history. Patricia Lynch, Chris Poggi and Matthieu Wharmby flag key takeaways relevant to the complex ABS sectors where Ropes & Gray regularly advises major sponsors, issuers and investors.
Overview: Notable Developments in Esoteric ABS
The amount of private cash available to invest and the issuer demand for liquidity are driving a continued increase in issuance volume in the market for esoteric ABS, including an increase in volume of 144A transactions by approximately 30% year over year. As noted below, whole business securitization activity has grown significantly compared with 2023 and is expected to grow even more next year, while securitizations involving digital infrastructure (including data center and fiber ABS) and interests in private funds are expected to grow exponentially over the coming years.
Whole Business Securitization Sector Sees Growth
The WBS sector has seen strong growth YTD in 2024, compared to the relatively muted activity in 2022-23, when many existing issuers delayed refinancings to avoid locking in historically high fixed interest rates. 2024 has seen strong issuance as yields began to tighten in favor of issuers. Meanwhile, investors have been seeking out the relative value available in WBS offerings versus comparable investment-grade corporate bonds where yields are harder to come by.
One continuing theme has been the expansion of WBS deal types beyond the restaurant brands that have traditionally made up the bulk of the space. To date in 2024, nearly half of the WBS offerings have been in non-restaurant sectors such as music publishing rights, fitness, cleaning/repair services and early childhood education. Ropes & Gray has advised issuers in connection with WBS offerings in all of these novel sectors this year, including for Planet Fitness (the largest non-restaurant WBS issuance to date), Servpro, and The Goddard School.
Another recent development discussed at the conference was the growing use of unfunded commitments under WBS transactions to achieve various issuer objectives. While revolving Variable Funding Note (VFN) commitments have been widely used for more than a decade in order to provide access to working capital at a floating rate under WBS transactions, certain recent transactions have included a “growth” VFN component that allows an increase to the VFN commitment to be unlocked subject to certain growth milestones being attained by the securitized system. Recently, for the first time in the WBS space, the Zaxby’s Series 2024-1 transaction included a committed delayed draw tranche within its term WBS, which allowed Zaxby’s to access additional capital later in time at fixed rate pricing equivalent to the term notes funded at closing, subject to achievement of certain metrics. Ropes & Gray represented Zaxby’s in connection with its Series 2024-1 WBS offering.
Conference participants also noted the increasing use of WBS offerings as a financing tool in merger and acquisition transactions, such as store acquisitions and company acquisitions (in particular with the emergence of bridge-to-WBS acquisition financing).
Looking ahead, conference participants were highly bullish on the outlook for WBS, expecting strong growth next year, as: issuers that have delayed refinancings look to a market expected to benefit from lower rates and tighter spreads in 2025; new first-time restaurant and non-restaurant issuers enter the market; and U.S.-based franchised businesses grow internationally.
Accelerating Growth Expected to Continue for Digital Infrastructure ABS
Digital infrastructure ABS (primarily backed by data centers, fiber networks, and cell towers) has experienced tremendous growth over the past few years. Over $20 billion in digital infra ABS has been issued to date in 2024, and conference panelists estimated that the space could grow to up to $70 billion annually by 2030, as investors become more familiar with these asset classes and rating agency methodologies are further refined. Meanwhile, investor demand has continued to meet the increased supply, even as average spreads on digital infra ABS bonds tightened into Q3 of the year.
Several aspects of digital infrastructure ABS are attractive to investors, such as the non-correlated nature of the asset, low churn, high initial infrastructure cost as a barrier to entry for competitors, creditworthy customers (with respect to data centers and business-to-business contracts), and strong customer demand. Crucially, this asset class offers attractive spreads compared to similarly rated investment-grade corporate bonds. For issuers, the ability to replace costly high-yield debt with investment-grade ABS notes can dramatically reduce their cost of capital, making the relative complexity of the structures worthwhile. Ropes & Gray has advised several major national fiber, copper and hybrid technology broadband providers in connection with the structuring and issuance of their inaugural ABS offerings, including Frontier Communications in the issuance of nearly $3 billion in fiber-backed ABS notes.
Conference participants expect M&A activity in the digital infrastructure space to drive additional financing activity, and for ABS to fill those needs as the most efficient source of capital financing available to many issuers. This is among many other tailwinds, including AI and massive anticipated growth in data storage and transmission needs.
Fund-Backed ABS Yet Another Area Experiencing Innovation and Growth
Conference participants also flagged investment fund-backed ABS as an area experiencing rapid innovation and growth. In particular, collateralized fund obligations (CFOs) and rated feeder funds have grown in popularity as investment fund sponsors have looked to generate leverage to drive investor returns, while traditional ABS investors seek diversification to non-traditional sectors such as private equity and secondaries funds. Panelists expect further growth in this space, including ABS backed by capital call and NAV facilities, given investment funds’ needs for liquidity. Ropes & Gray recently advised AlpInvest in connection with a $1 billion rated CFO ABS transaction, which represents the largest publicly rated GP-led CFO in history.
