Rating agencies are reporting increased chatter from bankers concerning the franchise sector.

"There is certainly a buzz right now; we have received a flurry of calls," said Fitch Ratings analyst Adam Kaplan. "Bankers are taking our temperature."

The troubled sector experienced a significant decline in new defaults, according to Fitch's 2003 Franchise Loan Year in Review. The number of new defaults in 2003 fell to 144, accounting for $390 million in collateral, compared with 221 and $996 million in collateral in 2002, the rating agency said.

The convenience and gas (C&G) sector's $125 million in newly defaulted collateral represented a 78% improvement over 2002, while Burger King concepts continued to weigh down performance in the quick-serve restaurant (QSR) sector. The struggling fast-food giant accounted for 39% of the $167 million in new QSR defaults in 2003. Nonetheless, the sector managed to reduce defaults by 42% for the year.

"The improved performance of franchise ABS, positive economic trends and the low interest rate environment should spark the primary issuance markets in 2004," the Fitch report said.

Fitch's Kaplan forecast two to three new franchise deals coming to market in 2004 from yet-to-be-named issuers.

"These are issuers that have been in the market in the past," Kaplan said.

There has long been speculation regarding new term issuance from GE Franchise Finance, formerly Franchise Finance Corp. of America, but a deal has yet to materialize. GEFF did not return calls for comment at press time.

"With the benefit of GE's balance sheet, GEFF doesn't have to do a deal," Kaplan said. "But they have been originating and they have got plenty of collateral on their books. If market conditions were right, they could do one or more deals."

Other subsidiaries of GE Capital Corp. made first-time appearances in several other sectors of ABS last year, partially to reduce its use of Edison Securitization Corp. for off-balance sheet financing.

Despite the downward trend in new defaults, recovery rates remain dismal. Investors in C&G saw an average recovery of just 37%, while the QSR sector fared slightly better with an average recovery of 41%.

However, these figures do not include the surprisingly robust recoveries on the bankrupt Swifty Serve Inc. and Clark Retail Enterprises units. The expected rate of 60% to 70% is the result of a sealed bid auction whereby potential purchasers bid on all or some of the units. This allowed the auction agent to decide which combination of purchasers would yield the greatest recovery. While the larger and more geographically diverse chains may use the auction process to drive up recovery rates going forward, its appeal is limited.

"Larger workouts have more to gain through the auction process, but if you are only looking to sell five units, there is not a whole lot of added value," Kaplan said.

He added that the underlying real estate remains the best indicator for a strong recovery.


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