Lending market is shaken, not broken
The boom times are definitely over and commercial lenders have less money to lend. But the downturn in the credit markets has yielded opportunities, and heavy demand for financing.
The lending marketplace for franchise loans is a lot like the earthquake that shook up parts of Southern California recently. Everyone is rattled – from prospective franchisees trying to obtain start-up capital to franchisors attempting to restructure their debt – but the damage may not be permanent. Smart lenders and franchisees, in fact, can benefit from the shake-up and emerge stronger than ever.
First, the basics. Commercial banks are lending less money because they have less money to lend. According to the Wall Street Journal, U.S. banks lost about $480 billion in the past year, due to sub-prime mortgage lending, foreclosures on traditional mortgages and losses on business loans. Eight banks, including the IndyMac Bank in Pasadena, California, have already closed because of bad loans, and more bank failures are likely.
Syndication of loans has virtually ended. Until late last summer, banks and non-bank lenders could spread out their risk, by selling off their loans into the syndicated marketplace. Today, most lenders must cover their loans themselves.
These two constraints mean that lenders are making fewer business and home equity loans – SBA loans were down over 17% in the first quarter of 2008 compared to the same time last year – and, when they do loan money, charging higher interest rates. Jeff Sturgis, vice president of franchise sales and development for Fantastic Sam's Hair Salons in Beverly, Massachusetts, said, "Three years ago you could walk into any bank and they'd fall all over themselves to help you tap into the equity in your house. Now banks are resisting loaning out any money on your home, which is making it difficult for new franchisees to get started."
Franchise lending has a third constraint, said Chris Kelleher, managing director of Auspex Capital in Long Beach, California. In the past year, GE Capital Solutions, Franchise Finance in Scottsdale purchased two other major lenders, the Merrill Lynch Capital Franchise Finance Group and Citi Franchise Finance, both of Irvine, California. "We broker business loans," said Kelleher, "and we used to get five or six players to bid on a package. Now that there's less competition, the pricing of loans has increased significantly and the terms are more difficult."
As you might expect, lenders that remain in the franchise space report that their phones are ringing off the hook. Sharon Soltero, vice president of franchisor relations for Irwin Franchise Capital Corporation in Montvale, New Jersey, said Irwin is making loans of $100,000 to up to $20 million to franchisees of the "top 50 restaurant brands" (they're listed on the Irwin Web site). "Borrowers' equity requirements are getting a little bit higher," she said, "and the numbers must work. We don't want anyone to get overleveraged and unable to repay his debt." As an SBA preferred lender, Irwin will also provide capital to new franchisees, "but we now require them to have some experience, such as a store manager buying the unit she's working in," Soltero said.
Dan Holland, senior vice president of Bank of America's franchise banking group in Atlanta, said he feels his business will benefit from GE Capital's lender consolidation. Holland said his division makes loans of $500,000 into the millions to franchisees of three units up to 800 units. "Interest rates have crept up," he said, "and how much equity a franchisee has to put up depends on the deal. If it's an existing franchisee who wants to build a couple of new stores, he might have so much equity built up in his business that we won't require a lot more."
Nick Cole, managing director of the restaurant finance group at Wells Fargo in Carlsbad, California, said his division makes loans in the $10 million to $250 million range "and we put out more capital in the first half of 2008 than in the first half of 2007."
The credit crunch has created opportunities. Cole said, "We're seeing some great brands trading at levels we have not seen for a long time, and it's frustrating when buyers have a hard time finding the capital to get a deal done." Advanced Restaurant Sales, a firm that facilitates sales of multi-unit franchisees, in Marietta, Georgia, for example, listed over 20 name brand multi-unit franchise companies that were available for purchase in August.
Failed franchises are providing an opportunity for the Midtown Niki Group in San Diego, said business development manager Zach Goldman. Midtown Niki funds build-to-suit buildings, then rents the space to franchisees.
We're taking over space from operators who have closed their doors and converting it to new franchise uses," Goldman said. Midtown Niki recently hired contractors to transform a former Fazoli's Italian restaurant into a new Chipotle, for example.
Jeffrey Fleischer, senior vice president for Spirit Finance Corporation, a private REIT in Scottsdale that specializes in sale-leaseback financing, said his phone is also ringing more. "There are plenty of people looking for capital," he said, "but the challenge is on the debt side. Smaller transactions are still getting done, but the larger wholesale transaction market has been shut down all year. We're actually thinking of raising a new fund that would allow us to avoid leverage and pay cash for these assets. It's a great buying opportunity."
Sentinel Capital Partners, a New York private equity firm, has created a new $765 million fund to take advantage of those opportunities. "It's better to buy when things are relatively gloomy," said David Lobel, Sentinel's founder and managing partner. "I think we're in the 4th inning of a 9 inning downturn."
Specifically, Sentinel wants to buy "good businesses that we can take to the next level," Lobel said. "We'll take on distressed businesses selectively. Casual dining, for example, has seen a sales decline fueled by consumers who are getting pinched by higher prices and lower home valuations. Instead of going out for dinner every three weeks, they're going out every four, and ordering less expensive entrees and sodas instead of cocktails. The corporate Applebee's units for sale, for example, could be a good value in six to 18 months."
By then, the credit markets should be getting back to normal, said Bob Bielinski, managing director, corporate finance of CIT Group in Chicago, who works on transactions involving larger franchisees, with 75 to over 100 units. "For the last few years, the credit markets have not been normal," Bielinski said. "During the boom times, when loans were syndicated, the original lender was three for four steps away from any risk. Now there's a return to fundamentals, with lenders looking carefully at each deal's return on investment and whether the franchise company is a long-established concept like Burger King or Taco Bell, or one that's sprung on the scene in the last few years."
Bielinski, like all of the lenders contacted, does not expect the economic downturn to end quickly. "There isn't a financial institution in the country this credit crunch hasn't touched," Bielinski said. "It's had a huge effect on the consumer. When we see a slowing in the decline of residential real estate, it will be the beginning of things getting better."
In the meantime, Dean Zuccarello, CEO of the Cypress Group, an investment bank that advises on mergers and acquisitions in Englewood, Colorado, suggests franchisees hold tight and ride out the shaking. "Operators of weaker concepts who are over-leveraged can easily find themselves facing bankruptcies or restructuring. But there's opportunity with every storm. During the last downturn, people with capital and expertise who stepped up to the table with equity walked away with millions."