Rating Guidelines for Franchise Loan Securitizations
to losses in the pool. This is a direct result of these loans’ proximity to the default trigger and, hence, likelihood of default. Under more stringent eco- nomic circumstances (from invest- ment-grade to ‘AAA’ stress), the lower FCCR loans will have lower recoveries. The graphs above and on page 7 illus- trate borrower FCCRs on a cumulative and marginal basis.
Credit Enhancement Of the three analyses performed to es- timate net losses, the LDRM credit factor analysis is the dominant method. The multiple of loss analysis and the FCCR default analysis are used to cali- brate enhancement ranges established by the LDRM credit factor analysis and to confirm, reject, or highlight aspects of the pool that might not be captured in a loan-by-loan analysis. Based on the output from the credit factor analysis compared to the other two analyses, Fitch IBCA can fix an objective bench- mark for appropriately sizing credit en- hancement. To determine final enhancement levels within the bench- mark range, Fitch IBCA incorporates the influence of qualitative factors re- lating to the transaction structure, the originator, the servicer, and environ- mental and legal issues.
Transaction Structures In a typical structure, the originator will sell the franchise loans to a bankruptcy- remote special purpose entity (SPE). The SPE will then sell the loans to a master, owner, or grantor trust, which issues the securities. The trust be- comes the new lender under the fran- chise loan documents, while the original lender typically continues to act as servicer. The original lender and the SPE should provide the appropri- ate representations and warranties re- lating to the ownership of the loans, properties, and equipment, and con- firm that all appropriate Uniform Com- mercial Code filings have been made.
The majority of franchise loan transac- tions are senior/subordinate structures and tranched with multiple classes and multiple ratings. Credit enhancement is generally achieved through subordi- nation of junior classes. A portion of the interest on the underlying loans may be stripped off to create an interest-only (I/O) class or classified as excess spread. Fitch IBCA will generally apply a hair- cut to the excess spread allowable as a form of credit enhancement, increasing the haircut as the rating levels get higher.
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Originator Review The loan originators will generally be specialty commercial finance compa- nies, many of which are small and un- rated. Since the originator performs the initial underwriting of all loans in the pool and will normally act as servicer for the transaction, Fitch IBCA will review the company’s credit quality and, fre- quently, assign an internal or “shadow” rating. While minimum standards will be determined on a case-by-case basis, the originator should have a stable op- erating history, an adequate equity base, a viable strategy, and an experi- enced management team. Originators with a smaller capital base or shorter operating history may gain credit sup- port through a significant equity invest- ment from a larger company with long-term strategic interests in the mar- ket. In performing the credit analysis of the originator, Fitch IBCA’s structured finance group works closely with the financial institutions group, which has significant expertise in analyzing fi- nance companies.
Credit Underwriting Since the credit quality of the loans in the pool will depend on the initial un- derwriting practices of the originator, it is important for the originator to have a formalized credit process and estab- lished lending criteria. These credit underwriting practices should mirror the components used in the LDRM to reunderwrite each loan, such as re- quirements for minimum FCCRs, maximum LTVs, information on the experience of management, strength of the franchise, number of years in busi- ness, and number of units under man- agement. Exceptions to credit policy will be a concern, since they are usually an indication of possible portfolio dete- rioration. It is important to note that while Fitch IBCA deems the origina- tor’s strong credit policies to be critical to anticipating performance of a fran- chise loan pool, the LDRM analysis