Rating Guidelines for Franchise Loan Securitizations
The rating analysis also includes many qualitative factors, such as an extensive review of the originator’s and the serv- icer’s business composition, financial condition, management, underwriting, credit policies, and servicing and work- out capabilities. Fitch IBCA also re- views the historical performance of the issuer’s portfolio, the real estate valu- ations (including the scope of the analy- sis), environmental procedures, legal documents (including legal opinions), and the bond structure.
Trends in the Franchise Market
Economies of Scale Financial leverage and “deeper pockets.” Operating leverage via lower costs and purchasing power.
Economies of Scope (Diversification) Product synergies via co-branding.
Strategic Positioning Geographic/demographic focus (i.e. location). “Installed base” as a key asset. Convenience/market segmentation-driven consumption.
Franchise Loans Franchise loans are generally term loans secured by one of three types of collateral — fee-simple mortgages, ground leases, or enterprise loans (equipment leases and space leases). Franchise loans are often compared to commercial mortgage loans, although they differ in many aspects. Foremost, all franchise loans are not generally se- cured by a first lien mortgage and, thus, in a default scenario, the recovery value of a franchise loan is typically not as high as a conventional commercial mortgage loan. Additionally, franchise loans are typically made to borrowers operating a single-use property that is not easily converted to an alternate use. Finally, loans made to franchisees are based on the cash flow stream derived from the underlying business versus the cash flow stream derived from the operation of the property.
The relationship between the fran- chisor and the operator can potentially provide many benefits that strengthen the operator’s credit beyond that of a typical small-business owner. In addi- tion to the benefits associated with the use of the invested brand equity, trade- name, and logo, the franchisee will gen- erally have access to exclusive product offerings, supplier relationships, opera- tional support, and technical assistance from the franchisor. Since the opera- tor’s implementation of the franchise business model has the power to en- hance or diminish the brand loyalty of
the overall franchise, the franchisor will likely monitor the compliance of the franchisee’s operations with the fran- chise business model and its adherence to the franchise policies and proce- dures. The economic linkage among the franchise brand, the franchise loca- tion, and the operator is evidenced by the consumer’s identification of the brand with a uniform product or service offering and a consistent level of qual- ity. Therefore, both the brand equity of the franchise and the business activities of the operator have a material economic effect on the cash flow supporting a fran- chise loan.
Franchise Loan Market The key drivers of growth in the fran- chise sector of the economy are the trends toward convenience, consolida- tion, diversification, and strategic posi- tioning at the borrower level. As national lifestyles become faster paced, consumers are demanding faster serv- ice, geographic proximity, and cus- tomer choice. Operating efficiencies and cost pressures have led to market consolidation, resulting in the increas- ing role of multisite operators. In this market, it is not unusual to see fran- chisors with 150–300 units under man- agement.
Franchisors are being forced by the eq- uity markets to separate brand manage- ment and product placement from
operations management and real estate ownership/management. Franchisors, as brand managers, seek to optimize economies of scope and focus on the real estate ownership/management by seeking to maximize “installed base” (i.e. geographic coverage and regional penetration) and manage the geogra- phy and demographics of location as a key asset. As a result, more franchisors are diversifying their franchise loca- tions and capitalizing on product syner- gies by embarking on co-branding arrangements.
The increased importance of the serv- ice sector in the U.S. economy, the availability of financing for franchise lending, and the ability to securitize support estimates of the potential mar- ket size of many tens of billions of dol- lars.
Franchise Loan Default and Recovery Model Fitch IBCA has developed an analyti- cal model, LDRM, that combines the appropriate features of ABS and CMBS analysis for this asset class. The LDRM uses key factors to determine condi- tional expected default frequency and conditional expected recovery value for each loan in the pool.
The Fitch IBCA approach focuses on the proximity to default for each loan in the total pool and that loan’s relative
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