A Bad Whole Business Securitization

Yellow Pages Whole Business Securitization Printing Red Ink

Last month, a dubious milestone passed almost unnoticed; Moody’s announced that a U.S. Whole Business Securitization will be defaulting on its payments of interest by the end of this year or early next year.  Yes, it can’t even make its interest payments (much less repay the outstanding principal).

This securitization, placed in October 2007, was originally rated ‘Aaa’ by Moody’s and ‘AAA’ by S&P, and shadow rated Investment Grade (i.e risk to Ambac) 1.  Following a series of downgrades it’s currently rated ‘C/CCC+’ (M/S&P).

For the readers curious about this collapse, please note the issue is “$547Million Local Insight Media Finance LLC, Series 2007-1, $5Million Class A-1 + $542Million Class A-2” (collectively, the “Senior Notes”) and an additional ~$126M Class B subordinated notes issued through the securitization.

While the $5Million A-1 notes have been retired, an additional ~$195Million of Series 2008-1 Class A-2 notes were issued (without an Ambac surety bond) in this securitization with an original ‘Baa3’ rating from Moody’s.  These notes similarly are now rated ‘C’ and face the same upcoming default.

This securitization is primarily repaid by telephone yellow page revenues generated by two telephone directory companies: CBD Media LLC – “The exclusive directory publisher for Cincinnati Bell-branded yellow pages in the Cincinnati-Hamilton metropolitan area” – and ACS Media LLC – “The largest publisher of print and Internet advertising directories in Alaska” – owned by The Berry Co. LLC (formerly known as Local Insight Media Holdings Inc.)

How does a highly-rated Whole Business Securitization like this one fail?  Perhaps the easiest way is if the whole business itself fails.

Faulty Analysis

With respect to this securitization of yellow pages revenues, it is clear that the rating agencies involved mistakenly assumed that an industry’s immediate past performance would continue unchanged despite the emergence and rise of powerful internet competition, particularly local search engines.

S&P noted in its Presale for this securitization that:

“The U.S. telephone directory industry enjoys fairly stable, recession-resistant industry fundamentals…. From 2001-2005, industry revenues grew at a compounded annual rate of about 2% 2

and provided other upbeat commentary on the state of the yellow page industry and the mitigants to risk embedded in Insight Media’s business and the structure’s mechanics.

Moody’s was not as descriptive in its commentary in its Presale Report 3 but praised, “…The consistency of cash flows generated from the two directory companies included in the transaction owned by Local insight Media, Inc.”

These assumptions clearly worked their way into each of the rating agency’s stress scenarios for this securitization and their determination of the amount of credit enhancement needed to support it.

Performance Shock

It is clear that the analysts of this securitizations either didn’t ask the “does it make sense” question or found the wrong answer to that question.

Does it make sense that, in the face of formidable new competitors with lower costs and more accessible offerings, revenues would remain stable?  The correct answer is no.

S&P explicitly stated in this Presale that, “The revenue stress for the senior debt was assumed to have either limited or no growth for the first three years of the transaction followed by …. Cumulative revenue point declines of 35.5% in years 4 through 30.” Assumed declines started at only 2.5% in year 4, 5% in years 5 & 6, 4% in year 7, and decline further to a 1% annual decline rate in years 13-30.

It appears (as described in its respective Presale) that Moody’s reached a similar conclusion: “Internet Shock Factor:  This is to capture the possible effect of the internet on yellow page revenues in the future.  The parameter is introduced several years after closing….”

In reality, the stresses faced by this securitization were and are greater – and hit far sooner than Moody’s or S&P predicted.

In sharp contrast to Moody’s and S&P’s assumptions, cash flow in this securitization, and in the  yellow pages industry in general, has declined precipitously.

Industry revenue declined 40% from 2005 to 2011 (from a peak of $14.2Billion to $8.6Billion) 4.

3 of the industry’s leading publishers filed for bankruptcy in 2009 and Local Media Insight – the originator of this securitization and the “fifth-largest U.S. publisher of directories” – filed Chapter 11 in November 2010. It emerged in November 2011, renamed The Berry Co. LLC.

More of this sorry industry picture can be gleaned from this aptly titled WSJ article, “Yellow Pages’ Last Lifeline: Clinging to Each Other.” 5

Transaction Failure

The securitization simply did not have enough credit enhancement to cover for this rapidly diminishing cash flow.  Its structure could not compensate for this fundamental flaw.

With respect to the A-2 notes, the structure provided for an initial 5 year revolving period with a limited scheduled amortization of 2.5% of initial principal each year and a 5 year expected repayment, due this month.

The 5 year revolving period was optionally extendable for up to 2 additional 1 year periods.  The legal final maturity of these notes is 30 years from issuance.  As is common, the transaction includes several partial amortization events (allowing for redirected cash flow to pay down the Senior Notes until, hopefully, the breach of 1 or more leverage ratio tests is cured) and rapid termination events (where all free cash is directed to pay down the Senior Notes until they are fully retired).

This securitization’s failure happened quickly.

It hit a rapid amortization event in the period ending 12-31-10 when its DSCR declined to 1.43x (below its 1.5x trigger level).

At this point its leverage ratio had already increased to nearly 10x (up from 7.4x at closing) and its net securitizable cash flow had declined over 25% from the previous yearly period 6.

It is stupefying and hard to believe that this securitization’s cash flow has evaporated to such an extent that interest can’t be covered.

Interest payment obligations rank so high in priority in its payment waterfall that one would think that sufficient collections would be coming in to meet them.

Given the destruction of cash flow, it is painfully evident that the ~23% of subordination provided in support of the Senior Notes was grossly insufficient coverage.  This Whole Business Securitization has a serious hole in it.

A Bad Template For a Good Market

The Whole Business Securitization market has been a bright spot in the recovery of the securitization industry from the depths of the Great Recession.

Whole Business Securitizations have successfully securitized a number of fast food and casual dining brands including Domino’s Pizza, Sonic, Church’s, and others.

This month Whole Business Securitization expanded to the successful issuance of “Fairway Outdoor Funding, LLC Secured Billboard Revenue Notes, Series 2012-1”, a Whole Business Securitization of outdoor advertising billboards.

One should probably not argue that Americans’ continuing appetites for fast food and donuts will be impacted by the internet!

The outdoor advertising industry, with its high barriers to entry and its cost efficiency to advertisers, has been holding up well against  the internet and other advertising medium.

As for the recovery of the yellow pages industry?    Simply read this comment, ascribed to Local Media Insight 3 years before they declared bankruptcy:  “Local Insight Media does not view Yahoo! Or Google as a threat, but as another product offering that can be sold through its consultative sales process.” 7. This might be one of the most misguided predictions in business history.

As the old maxim goes, “Past performance is no guarantee of future results.”

That’s why the starting point for any securitization cash modeling analysis (or any “worst-base-best” case analysis) should include the possibility that revenues could decline.

Let’s hope that the “does it make sense” question is asked and properly answered in the analysis of all these transactions.

Judicious Focus
By Avi Oster
Managing Director
Judicious Advisors LLC

Posted 11-1-12

 

Notes:

  1. Based on surety bond provided by Ambac Assurance Corp.
  2. 9-21-07
  3. 9-25-07
  4. Borrell Associates, as quoted in the WSJ article “Yellow Pages’ Last Lifeline: Clinging to Each Other” on 8-21-12
  5. By John Jannarone, 8-21-12, available by subscription only.
  6. Moody’s Research 4-4-11
  7. S&P Presale

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