Improving the Environment for Franchise Lending
Richard Hunt is president of the Consumer Bankers Association, one of the International Franchise Association’s Credit Access Campaign Partners. He can be reached at firstname.lastname@example.org or via Twitter@cajunbanker.
Since the economic downturn in late 2008, banks have been inaccurately portrayed as hoarding cash, cutting off small-business lending and turning their backs on loyal customers. This misperception ignores the simple fact that banks are in the business of lending. Banks want to make as many good loans as they can, but continued economic uncertainty has hit the bottom line of many small businesses and led to what may appear as tighter lending standards.
The Consumer Bankers Association and its member banks are committed to getting loans into the hands of qualified borrowers. CBA is the only national trade group focused exclusively on retail banking—banking services geared toward consumers and small businesses. CBA members include the nation’s largest bank holding companies, as well as regional and super community banks, many of whom are the leading small-business lenders.
Small-business lending is a top priority for CBA and its member banks, and its small-business agenda is shaped and executed by its Small Business Banking Committee. All committee members share in the commitment to jumpstart growth in the small-business lending environment. As the association is beginning to see additional opportunities in the small-business market, the committee identifies new approaches to serve this marketplace understanding that while the small-business market is largely pursued, it has yet to be mastered. One primary goal of the committee is to help its member banks develop a retail banking strategy to maximize the potential of the small-business market and encourage bankers to plan for growth as the economy recovers.
CBA remains committed to improving the small-business lending environment and process. On the lender side of the equation, many banks could do a better job developing better franchise programs and building relationships with franchisors. Many lenders need to leverage programs, such as those available through the U.S. Small Business Administration that eases the desired borrower risk issues.
Extending Loan to Franchisees
On the other side of the fence, CBA member banks have expressed concern that franchisees do not get loans because they are often inexperienced in obtaining a business loan, which has a different application process than many other loan types. When considering extending a loan to franchisees, banks want to know about the franchise itself, how long it’s been in business, how successful other franchisees have been, the level of franchise support to franchisees, length of franchise terms and so forth.
Credit Demand Factors
As the country strives to recover from the economic downturn and begins seeing modest employment gains, banks are starting to see signs of increased demand for small-business loans. During the last few years, banks saw weak and inconsistent demand for small-business loans as many business owners were facing lower sales volumes and a negative economic outlook; planned capital spending remained at 35-year record low levels, a clear sign the economic conditions were not conducive to expansion or growth.
The evidence suggests lowering the unemployment rate—the key to many of the challenges facing the nation’s economy—is critical to small-business success. As the unemployment rate increased, small businesses saw a decline in sales, and poor sales and uncertainty continue to be greater problems for significantly more small-business owners than access to credit.
With job creation comes an increase in demand followed by stronger sales. The nation is slowly seeing an increase in jobs, but it remains an uneven recovery. In April, small businesses added 84,000 new jobs. Of these, 70,000 were in the service-providing industry and only 14,000 were for goods-producing businesses. Overall, if the nation can sustain declines in the unemployment rate, it can expect to see an increase in sales for small businesses, allowing them to expand and invest in more employees and equipment, and resulting in increased demand for loans.
Another critical factor affecting credit demand is the diminished value in a traditional form of collateral used by many small businesses—home equity. The values of personal assets are critical components to the success and ability of small businesses to grow. Federal Reserve Board Governor Elizabeth Duke highlighted this in a recent speech. For small businesses with less than 500 employees, Gov. Duke indicated “more than 70 percent were initiated using personal savings or assets.”
It is important to understand how a decline in sales and home values has affected small-business lending. There are several considerations involved in underwriting a small-business loan. Two of the most critical components are cash flow (historical and projected) and the value of the collateral. While banks have been more prudent with their underwriting, the combined dramatic decline in these two criteria were the driving force behind the reduction in lending. Couple that with an increase in capital requirements and regulatory uncertainty, and it is clear why the last few years have been so difficult. The good news is things are improving.
Signs of Improvement
CBA members report modest increases in demand for small-business loans and the March 2011 Thomson Reuters/PayNet Small Business Lending Index showed a year over year growth of 12 percent. In addition, the Commerce Department announced an increase in consumer spending for the 10th straight month. While still sluggish, these recent increases in consumer spending have improved the financial health of small businesses applying for these loans and led to an increase in lending. CBA members believe these changes affirm the nation is beginning to turn the corner.
So what specifically are banks doing to improve the small-business lending climate? As part of its efforts, CBA, along with the International Franchise Association and several other organizations sponsored a Small Business Lending Summit in Washington, D.C. Through the summit and the ensuing dialogue, CBA and IFA aimed to partner with key stakeholders in the small business, financial and government policy/regulatory communities to seek ways to unleash the power of small businesses and aspiring entrepreneurs to create jobs through increased access to credit.
During a recent congressional hearing on small-business lending, Robert Kottler, executive vice president and director of retail and small business for IBERIABANK and a long-time member of the CBA’s Board of Directors said, “The better prepared and knowledgeable a borrower is about the process, and the lender about the borrower, the more successful the process. Small businesses and lenders alike need to work harder to bridge the divide in order to better understand one another with respect to credit needs and approval.”
Kottler’s comments echoes those of many, including this author, who spoke during the Small Business Lending Summit. Going into the summit, the message was simple: CBA and its member banks recognize small businesses are a key driver in the recovery and growth of the nation’s economy and its banks stand ready to lend, but are just beginning to see an increase in demand.
Coming out of the event, here’s what was learned to make this happen:
Banks need to:
• Develop franchise lending expertise within their small- business banking group.
• Create a screening process to select high-quality franchise organizations and build a relationship with those franchisors.
• Look at every option to say yes—Utilize SBA Guarantee programs to maintain desired risk profile when necessary.
• Create an incentive program for business bankers that drives their sales force to seek out franchise opportunities.
• Provide quick turnaround on loan requests from franchisees.
Steps for Franchises to Boost Lending
There are also things franchises can do to improve the process of getting needed loans in the hands of franchisees. Franchises need to build relationships with the banks in their markets to create an introduction for their franchisees. Franchisors can also improve the loan process by illustrating for lenders what the franchise does to support franchisees. Franchisors could invite lenders to discovery days and highlight their franchisee selection process. They could communicate their brand support and offer solutions when liquidation is necessary.
It cannot be stressed enough that communication between borrowers and lenders is critical. Borrowers and their banks should work hard to form and maintain relationships long before a specific loan request is made.
To close this gap, CBA’s Small Business Committee is in the process of developing a template that franchises can use to better prepare their potential franchisees to secure the financing they need. The template will ease many uncertainties and will provide lenders with information about the franchise brand that may help successfully underwrite a loan.
Through its ongoing relationship with IFA and other partner organizations, CBA is committed to continuing the dialogue needed to improve the small-business lending environment. Small businesses and banks have a tremendous opportunity to contribute to the economic recovery by working together to harness the power of America’s small businesses and aspiring entrepreneurs to create jobs through increased access to credit.