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Adverse Economics

Gas prices pressure may lead to more loan defaults

CHICAGO -- Despite some signs of stabilization during first-half 2005, gasoline price increases and volatility and the accompanying economic uncertainty may further exacerbate an already problematic U.S. franchise loan asset-backed securities sector for the remainder of 2005 and well into 2006, according to Fitch Ratings.

Increased pressure on convenience store and gas station operators may ultimately result in higher incidents of default on their franchise loans, Fitch said.

Fitch said it anticipates that the restaurant sector [image-nocss] could also see increased defaults as economic pressures mount. Recovery rates on current and future defaults will also likely be hampered by continually adverse economics at the operator level, according to Fitch Senior Director Joseph Tuczak. "Lower than expected recoveries on defaults will make transactions with already eroded credit enhancement more susceptible to further credit rating action," said Tuczak.

In the Convenience and Gas (C&G) segment in particular, Fitch said it remains concerned about operator profitability in an environment of high and volatile gasoline prices. Operators will be stressed by price volatility, potential shortages until Gulf Coast refinery production returns to prior levels, and by consumers trading down from premium to regular gasoline, which combine to make managing margins more challenging.

Higher gasoline prices may also negatively affect in-store sales of convenience items, Fitch said, which generally have higher margins than gasoline and account for a majority of an operator's profitability. This sector may also be negatively affected as consumers increase their gasoline purchases from supercenters and warehouse clubs, which typically set their fuel prices below local gasoline competitors. "Consumers may also utilize these venues for future purchases of discretionary and convenience items as well," said Tuczak.

Additionally, consumers are more inclined to use credit/debit cards due to higher prices and in response to more operators requiring customers to prepay due to increased theft potential. The resulting increase of paying at the pump results in increased transaction processing fees that further cut into an operator's profitability and will also hurt in-store sales of higher margin convenience items.

In the restaurant segment, Fitch is concerned that consumers may reduce the frequency of dining and their spending habits when they do dine out. Restaurant operator profitability may also be affected as higher transportation and delivery costs drive up their product costs which cannot immediately or easily be passed on to consumers. Fitch is also particularly concerned about casual dining restaurants adjacent to or near interstates.

Tuczak added, 'These types of restaurants are particularly vulnerable as consumers reduce travel in response to higher gas prices and as traveler's trade down in their dining selections to quick-service restaurants."

While gasoline prices can be expected to decline as refinery and production output levels return to prior levels, Fitch said the timing and size of any decline is uncertain, further stressing restaurant and C&G operators who were already competing in economically challenging environments. Fitch's Outlook for U.S. franchise loan ABS performance remains Negative, it said.

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