Multi-Unit Franchisee Magazine Issue II, 2013 | Page 82
FranchiseMarketUpdate
By Darrell Johnson
’Tis the Best of Lending Times
But not for all: access to capital remains uneven
C
apital access for franchisees has
been a primary concern since the
2008 financial crisis. Although
healthcare and other issues that
Washington has managed to wrap in uncertainty have out-shouted capital access, it
still is a big issue for many small businesses.
The media seem to be sending mixed
signals. Some articles point to a continued
lack of capital availability for small businesses; others to the lending good times
returning. I am fairly certain both points
of view are right, depending on the vantage
point. To understand why, and the implications for multi-unit operators, let’s look
at how far along we are toward financial
recovery since 2008.
History confirms that, following a major
economic downturn precipitated by a financial crisis, there usually are three phases
in the lending cycle. The first is lending
contraction, which we experienced from
2008–2010. Since banks can’t accurately
predict the value of their lending portfolios immediately after a crisis, they (and the
regulators) can’t determine the amount of
capital they should have to support loan
portfolios. Not losing money trumps trying to make money, which banks do by
lending. Therefore, lending shuts down,
and with it access to capital.
Phase two is a transition for lenders
from (1) not losing money to (2) starting
to make money by lending. This phase
begins with a big imbalance in depositto-loan ratios. This is where we are today.
Banks have several trillion dollars more in
deposits than loan assets, pressuring them
to start making money again. As we move
through phase two, lenders begin to respond to that pressure by initiating very
conservative lending to proven operators.
For most multi-unit operators, this
is good news—and a great time to seek
expansion, remodeling, and refinancing
capital. The reason media reports seem
confused about capital access in this phase
is that they hear from experienced opera-
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Multi-Unit Franchisee Is s ue II, 2013
tors that banks are beating each other up
to offer better terms. Some in the media
conclude that the lending good times are
back; and they are right, if only for experienced operators who represent relatively
low risk as viewed by bank credit committees. As we move through phase two, think
of small-business credit access as a “Tale
of Two Cities.”
Progression through phase two is also
marked by much more active SBA lending. From a credit committee perspective,
taking on greater credit risk during a weak
economic recovery is not appealing, even
with a higher potential interest rate return.
However, being able to protect 75 percent
of higher-risk loan assets is a bit more attractive, which is why we see a lot of SBA
activity in this phase, and which will continue well into the next phase.
Phase two ends when lenders start
moving out on the lending risk curve with
conventional (as well as SBA) loans to borrowers possessing less financial strength
and demonstrated operational track records
(this means new franchisees and one-, two-,
and three-unit franchisees). The move to
conventional lending is seen when credit
committees offer to approve riskier borrowers… if they are compensated for doing
so. Thus, when we start seeing a range of
interest rates and term sheets that depend
on perceived borrower risk, we know we
are entering the third phase, when loan
demand and loan supply are in balance.
As noted, the media seem to be confused
about the current state of capital access for
small businesses. For example, they quote
the lowest-risk operators who are getting
lots of interest from banks, while missing
the majority of small businesses that don’t.
Further mixed messages come from larger
banks that say small businesses aren’t interested in borrowing. On the surface, that
seems to make some sense. After all, larger
corporations have deleveraged over the past
six years and have lots of cash. Why shouldn’t
small businesses do the same? Some have.
But we know that while small businesses are
more nimble and opportunistic than their
larger corporate battleship brethren, they
have much less ammunition in the form of
capital—and many still can’t get it.
As we climb slowly, inconsistently, and
uncertainly into the new economic era,
many franchised small businesses are ready
to pounce as opportunities arise. Whether
expanding or acquiring, opportunities are
there, and the indefatigable American business optimism is pushing small businesses up
the economic mountain. Those with solid
performance are already in good shape for
capital access. We need a couple more years
before that’s true for small businesses that
are new, emerging, or cash-flow challenged.
I recently spoke to an organization of
credit risk officers from large banks. They
validated the above views, but also added
an additional aspect to my thinking: small
businesses should not look for large banks
to lead the movement out of phase two.
These banks, overseen by the Federal Reserve and the Office of the Comptroller of
the Currency, operate under such intense
regulatory reporting pressures that a serious, unintended consequence is that they
have been backed into not taking on much
lending risk.
For new and emerging franchisees, your
path to capital access will first go through
smaller banks, non-bank lenders, and the
SBA lending units at banks of any size.
For good multi-unit operators, however,
it is the best of lending times. And for
those whose success still lies ahead, the
good news is we’re off the capital access
bottom; but for the next couple of years,
be prepared to hear “no” a lot before you
encounter a “yes.”
Darrell Johnson is 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 [email protected].