Franchise Update Magazine Issue III, 2012 | Page 49
By Darrell Johnson
Thank the Banks! (What?)
Winning the competition for credit
T
here’s a game changer coming
to franchising, and the lending
community is to thank for it.
While it’s hard to thank banks
for the financial mess they created a few
years back, capitalism is built on creative
destruction, and what was destroyed
within the banking industry is how they
evaluated credit. They got it wrong, some
banks failed, many businesses and people
suffered, and banks now are starting to
enter a new period where the old rules
are being seriously revised.
As surprising as it may seem, this is
a good thing for franchising and will be
for years to come (until banks get carried
away again and the cycle repeats). Here’s
how franchising is beginning to win the
competition for credit.
We’re now in the second phase of a
small-business credit recovery following the financial meltdown of 2008. The
first phase began in 2009 and lasted until 2011. From the lending community’s
perspective, that period is best described
as the “Don’t Lose Money” phase. The
easiest way not to lose money if you are
a bank is not to lend it. A more technical description is that banks between
2008 and 2010 could not properly value
their asset portfolios because of market
uncertainty. Therefore, they and their
regulators could not determine whether
the banks had adequate capital reserves.
If banks were unsure of capital reserve
needs, they certainly weren’t going to
expand portfolios.
The second phase started a multi-year
transition away from “Don’t Lose Money”
to a focus on earnings as portfolios get
cleaned up and capital reserve levels become clearer. There’s no immediate rush
to make money, but the most significant
way banks make money is to put loans on
the books. Most banks are flush with cash
and have the same miserable returns on
short-term investments that we all have.
In 2012, we all have been seeing a return to lending, but only to the lowest-risk
borrowers. So far, pricing for different
levels of risk isn’t happening. Higherrisk loans just aren’t being made at any
price. When we see evidence of interest
rate differentiation and term structures
for different levels of small-business loan
risk, we’ll be moving into the third and
final phase of lending recovery. That’s
another few years down the road.
What does all this have to do with
how franchising is gaining a competitive
advantage in the competition for credit?
A lot. Here’s why. Business lending is all
about assessing risks related to the borrowing company’s future performance,
the management team responsible for
making the business work, and the industry dynamics where the company is
operating. The better the information
about each of these risk categories, the
more comfortable a lender becomes about
answering a simple question in credit
committee: “What’s the probability we’ll
get our money back on the terms we’re
considering?”
Here’s where franchising is going to
become a sustainable, distinct asset class
for the first time in the history of smallbusiness lending. A lender considering
a loan request from an independent
business can assess risk only four ways:
that company’s business history; some
general industry statistics (which is why
SBA data, despite often being very inaccurate is often used); the bank’s own
portfolio experience (assuming they
have any with a particular industry or
brand); and a gut feeling for the people
signing on the loan application. In this
second, current phase of lending recovery, the lack of confidence in these risk
assessments leads to a lot of the conservative lending we are all experiencing.
Yet franchising has something huge to
add: performance history.
Franchising is built on uniformity
and conformity. If a lender can look at
the right types of credit performance history of a brand, that lender has a much
more confident answer to the question of
whether they will get their money back.
Bank Credit Reports answer that question,
and in doing so change the small-business
lending game in favor of franchising—not
because all franchise brands are lower
risk, but because franchise brands can
show exactly what risk they represent to a
lender. That has never been done before,
and it is the game changer.
Of course, lenders need easy access to
Bank Credit Reports, FDDs, and other
underwriting information, and now they
have it. More than a year in development, with input from franchisors and
lenders under the auspices of the IFA
and the Consumer Bankers Association,
the vastly upgraded Franchise Registry
is housing underwriting information
on thousands of franchise brands, all
of which is available to lenders only.
What some have dubbed franchising’s
unfair competitive advantage in the
competition for small-business credit
is happening.
And this is just the start. The Franchise Registry, in addition to putting all
this underwriting information alongside the simplified and improved SBA
franchise loan documentation tools, is
adding business development tools for
all conventional as well as SBA lenders to screen franchise brands based on
lender underwriting criteria—and, even
better, to evaluate and connect with prospective franchisees during the franchise
development process. This will align the
lending process much more closely with
the franchise development process. I’ll
explain more on that unprecedented set
of capabilities in a future article. All these
developments initiated in the second half
of 2012 will demonstrate to everyone how
franchising is winning the competition
for credit. n
Grow Market Lead
Market
trends
Darrell Johnson is president and CEO of
FRANdata, an independent research company supplying information and analysis for
the franchising sector since 1989. He can be
reached at 703-740-4700 or djohnson@
frandata.com.
Franchiseupdate I ssue I I I , 2012
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