Franchise Loan Defaults Soar

NEW YORK --Defaults on loans to U.S. franchise operators of convenience stores and fast food chains soared this year, due to a slumping economy and aggressive lending practices, according to bond rating service Fitch Investors.More than $900 million of franchise loans were in default for the 12-month period that ended in September, an all-time high according to Fitch, compared with $200 million for the same time in 2000. The current figure climbed from the $745 million of defaults at the end of the second quarter. Furthermore, fast food chains and convenience stores in popular vacation cities such as Orlando and Las Vegas will likely struggle to pay off their loans in the coming months, with consumers cutting back their travel spending since the Sept. 11 airplane attacks in the United States. "Many of these stores rely on tourist traffic to survive. The expected softening in the economy will maintain the pressure on franchisees as stores struggle to stay above water," Fitch analysts said in a report. Fitch reviewed franchise loans that were sold by lenders and repackaged into asset-backed securities. The defaulted loans were equivalent to 12 percent of current loans outstanding, up from 2.6 percent a year ago. The number of franchise borrowers in default more than quadrupled to 180 at the end of the third quarter from 42 for the same period a year earlier. But, fewer franchise loans were delinquent in the third quarter than during the second quarter, a sign typically viewed by the market that the worst may be over. However, Fitch analysts cautioned that it was too early to draw that conclusion because the bulk of loans that were 60 days or more past due in the second quarter went into default in the third quarter. A handful of lenders that specialize in making franchise loans are in better shape than others that have struggled or closed their doors. According to Fitch, the ones "large and in charge" were Franchise Finance Corp. of America, which was acquired by General Electric Co.'s GE Capital unit; Commercial Net Lease; American Commercial Capital, which is now part of Wells Fargo & Co., and Morgan Stanley. Although lenders overall adhered to underwriting standards in making franchise loans, the accuracy and reliability of the numbers used in assumptions in making these long-term business loans have raised questions, Fitch analysts said. Nearly three-quarters of the loans currently in default were originated in 1998 and 1999, toward the end of the greatest economic boom in U.S. history and prior to last year's dot-com collapse. In competing for new businesses, franchise lenders relaxed their lending requirements, making them more vulnerable if borrowers were late with payments or declared bankruptcy. "These aggressive lending practices produced an industry of overleveraged borrowers, many of whom used the lenders to expand their operations," the analysts said. Now, these overextended franchise operators have been hammered in the past year by a shrinking economy, Fitch said. Fast-food chains, such as Pizza Hut and Taco Bell, have been bogged down by declining sales and fuel margins have been hurt by a sharp decline in gasoline prices. Under pressure from ample supply, average retail gasoline prices have fallen nearly a third to $1.20 a gallon since May, its lowest level in two years, the American Automobile Association reported last week.