Franchise Market Update
Tighter Times Ahead?
Stricter loan underwriting may undermine growth in 2008
BY DARRELL JOHNSON
You’ve been enjoying comfortable growth during most of this
decade. Unit expansion plans have been realized and same
store sales, while becoming more of a challenge each year,
continue to grow. You’ve even met with your banker recently,
and she assured you that the bank wants to grow the
relationship further. Your biggest concern is the steady rise
in interest rates over the past couple of years—or is it?
Yes, the cost of business borrowing has risen in the past four
years. The prime rate and LIBOR rates have about doubled from
their lows to 7. 5 percent and 4. 8 percent today, respectively. On
the fixed-rate side, 10-year Treasuries are higher than they were a
few years ago but recently have signaled recessionary fears and
dipped to the 4 percent range.
Coming off unusually low rates earlier in this decade makes
current rates seem high, but by historical standards they are still
well within ranges that encourage continued growth. But you know
how the lending game is played. Banks use rising interest rates to
choke off demand. However, you may not see that happening this
time. Why? We are in a period of still substantial amounts of
capital in an efficient global banking world. The result is that most
banks and finance companies still have lots of capital to lend.
In the current environment, neither capital availability nor
capital costs are likely to constrain your growth. There is, however,
a much less obvious problem brewing in the back offices of banks.
Your lending officer, who had a lot of clout these past few years, is
quickly losing her influence. The real decision-maker in most banks
as we look ahead to 2008 is the credit officer. It’s not just making
profits that is important for banks. Banks also like to get back their
money.
For much of this decade, banks have been very clever developing
new financing instruments. Recently, some of that cleverness has
been called into question. We all know about the sins of subprime
mortgages, but that is limited to residential housing, isn’t it? Didn’t
business lending, particularly franchise lending, learn important
lessons from the real estate and commercial loan securitization go-go days of the late 1990s? Perhaps it is those very memories that are
leading the power shift in banks toward more conservative
underwriting. Or maybe it’s uncertainty about economic
conditions that is pushing banks toward tighter terms and
conditions.
Whatever the causes, expect more restrictive lending terms in
2008: more equity, higher coverage ratios, more collateral, and
shorter terms to name a few. An irrefutable law of banking is that
credit departments become more influential during times of
economic uncertainty. We are in such a time now.
If that weren’t enough, you also need to prepare for denial based
simply on a bank not being as comfortable with the franchise
concept as it previously was. The bank’s portfolio manager may
determine that it has enough exposure to your concept, or it may
not like the franchisor and franchise system fundamentals. For the
last few years, most successful franchisees haven’t had to worry
about such things. They have had the upper hand in loan
negotiations, knowing that other banks will step in if the current
bank doesn’t make a good proposal. The winds are now shifting.
There are some steps that can be taken. Franchisees should have
more frequent discussions with their loan officers about changes in
underwriting and their comfort with particular concepts. They
should also start talking to other banks, in case their current bank’s
underwriting becomes too rigid or resistant to further exposure to
their concepts.
Source: Office of the Comptroller of the Currency. Notice the last period of credit tightening,
which occurred in 2001 and 2002.
Franchisors should plan on regularly confirming that their
financial requirements for prospective franchisees are aligned with
bank underwriting standards. Franchisors might also consider arming
franchisees with reports written from a banking perspective that
compare a particular system’s performance with others in their
particular peer group or across their industry.
We’re leaving a period of strong, relatively predictable growth and
moving into a period with less predictability and a growing number of
potential economic shocks that can hurt continued business growth.
It’s time to focus some attention on the implications of more
restrictive capital access. Coming up with some practical action steps
would be a good New Year’s resolution. AD
Darrell Johnson is president of FRANdata, Inc., an independent research
company based in Arlington, Va., that has been supplying information
and analysis for the franchising sector since 1989. He can be reached at
(703) 740-4700 or at www.frandata.com.
