Operators bank on plan to ease credit crunch

The third time may be the charm for restaurant owner Charlie Green.

After being rejected twice in recent months for a Small Business Administration loan, he’s set to apply again just as the federal government has outlined plans to help banks turn the lending spigot back on.

Green is looking for just $250,000 to reach the $1.1 million he needs to open his second Dallas-based restaurant, Olivella’s Neo Pizza Napoletana, in the city’s Victory Park, a retail and entertainment complex.

“The banks took too many risks and that hurt the economy,” he says. “Now, they aren’t taking any risks, and that hurts the economy, too.”

Even with a successful restaurant in operation for more than a year—Olivella’s in Dallas books about $750,000 annually from 900 square feet—as well as a cosignor with additional collateral to back the loan, Green has been unable to garner an SBA loan, which is already at least 75-percent guaranteed by the federal government. He was forced to tap the banking world when investors he had lined up for his second venture backed out or committed less capital than originally promised, mainly because they had watched their own wealth dwindle in the housing and stock market meltdowns.

“It’s a pandemic,” Green says. “People just don’t feel comfortable anymore.”

Green’s story is not unique. Operators and entrepreneurs around the country have been shut out of the SBA loan market as banks and other lenders were unable—or unwilling—to offer new loans once the financial meltdown began last year. A freeze of the secondary market, where loans are packaged and sold to investors as securities, was the main culprit. Without the ability to sell loans to free up space on a corporate balance sheet, new lending was out of the question. Even the largest of SBA lenders, like CIT Group, which typically ranks as the largest lender by dollars lent, was basically immobilized.

“Investors were running for the hills,” says Christine Reilly, president of CIT Small Business Lending. “That had a dramatic impact on lending.”

During the last three months of 2008, the number of SBA loans fell 57 percent from the same time frame a year earlier, and the amount of money loaned fell 40 percent to about $2 billion.

Independent restaurant owners, franchisees and large chains all have been plagued by a lack of access to credit, whether via the SBA market or through large national lenders. The freeze has impeded growth, stalled the sale of locations and at times forced closures of businesses that needed credit to survive.

The federal government is attempting to reverse the situation.

The government’s efforts include $1 trillion to help stimulate the secondary loan market through the Term Asset-Backed Securities Loan Facility, or TALF, and $15 billion to purchase securities backed by the SBA 7(a) and 504 lending programs. In addition, fees for both SBA borrowers and lenders will be reduced, and the percentage guaranteed will be increased to as much as 90 percent of the loan.

The plan has been viewed as a positive for the restaurant industry by almost all accounts.

“It’s a beautifully simplistic solution,” Reilly says. “Once lenders have liquidity, they can turn around and start turning their application flow back on. I would hope in a couple months you see things start to move.”

The plan calls for direct purchases of the loan securities from those packaged on or after July 1, 2008.

“These direct purchases of 7(a) and 504 securities will provide liquidity to lenders, including community banks and credit unions, enabling them to restart the process of recycling capital and extending loans,” the White House says in a statement.

President Barack Obama and his economic team still are detailing plans for a public-private hybrid investment fund to purchase troubled assets from banks and working on ways to increase the transparency of firms that have received federal bailout funding. Once such moves are made, sources say, a thawing of the credit markets may begin.

“It’s nice to see that the government finally saw the light and saw it wasn’t moving fast enough for Main Street,” Reilly says.

Lenders and restaurant operators are together anxiously awaiting what will happen to the credit markets in the next few months.

Officials of the National Restaurant Association and the International Franchise Association both have applauded the administration’s push to make it easier for small-business owners to borrow money. IFA president Matthew Shay said the administration’s “direct intervention in the small-business secondary loan market is the missing piece of the small-business lending puzzle.”

Operators agree.

“I watch [the government’s actions] every day,” says Roger Flynn, vice president of franchise development at Cheese-burger Bobby’s. “They have to get lending going for the franchising industry. If they want this economy to turn it around, we’re the ones that will do it.”

A growing fast-casual chain that only began franchising last year, Cheeseburger Bobby’s has three locations and two under development. Cheeseburger Bobby’s International LLC is based in Kennesaw, Ga. The company has developed a relationship with SBA lender Diamond Financial Services to pro-actively help prospective franchisees garner SBA pre-approvals or other financing, such as equipment leasing.

Diamond Financial is helping a handful of restaurant chains to work more aggressively with franchisees or potential franchisees on loan approvals or other financing packages.

“We’ve had to adjust to so much uncertainty out there, so we’re trying to give more confidence early on,” says Don Johnson, a principal at Raleigh, N.C.-based Diamond Financial. “Franchisors had always waited a bit, but are now seeing the benefit of early pre-qualifying, because once [a franchisee] learns their loan potential, or once they are pre-qualified, it gives them confidence…it’s a chance to be more aggressive.”

Bruegger’s Enterprises Inc. also has teamed up with Diamond Financial to help franchisees looking to expand or potential franchisees assess their SBA loan potential. The Burlington, Vt.-based chain has more than 280 units.

“The No. 1 concern for franchise candidates these days is the availability of financing,” Chris Cheek, head of franchising for Bruegger’s, says in a company statement. “Our goal with this approach is to answer that question right up front at the beginning of the process.”

As Diamond Financial works with banks and other lenders to secure funding in various forms, its network of both borrowers and lenders is vast, allowing the company to see any changes to deal flow ahead of others, Johnson says.

“I think the economy might be starting to move a little bit,” he says. “With government action [and] the SBA changes, signs are pointing toward what can be a better year for business lending.”

He added that any traction on a lending thaw still could take another quarter.

Others say that even with action from the federal government, the industry needs to recover from its own sales implosion at the hands of the longest domestic recession in a quarter century before the lending environment truly improves.

“Politics is a whole other topic, but fundamentally as it relates to restaurant finance, what has to stabilize and improve is consumer confidence,” says Cheryl Carner, national director of retail finance at CapitalSource Inc., a middle-market commercial lender. “When that happens, consumers spend more money and spend more money in restaurants, and that will lead to stability in the financial performance of restaurants. That is what is needed to generate more interest from the lending parties.”

Carner says that even with the promises of direct purchases of loans in the secondary market, lenders to the retail and restaurant segments still need to decide whether new loans make sense on a case-by-case basis. With little visibility on what the rest of the year will bring in terms of any economic recovery or change in consumer sentiment, financing still may be difficult to close.

“Your job as a lender is to come up with your own view as to whether [a restaurant company’s] projections are viable…‘Does this loan make sense?’” she says. “I have not talked to anyone that knows what’s going to happen this year. If they don’t know what to expect, how can I underwrite that loan?”

Restaurant deals that are making it through the pipeline, Carner says, are for those businesses that can demonstrate a solid financial history; operate in a sector that is performing better than others, such as quick service; and have a franchised-focused business model. In addition, having a lower capital expenditure profile can be beneficial, Carner says, as any cash flow can be used to service debt rather than be put toward development, remodeling or other high-cost initiatives.

Along with consumer confidence, a restaurant’s sales are a vital part of the operation’s health and lending potential, Carner says.

“It all starts and stops with consumer confidence,” she says. “You have a fairly robust fixed-cost structure, you have to pay rent and hire labor, you have to keep the lights on.… So the top line is so critical.”

At Tampa, Fla.-based Checkers Drive-In Restaurants, the chain’s stellar sales performance has helped it secure financing for current and new franchisees, says Michael Arrowsmith, vice president of development. Five new restaurants have opened so far this year for the 825-unit chain. The operators were able to secure financing relatively easily, Arrowsmith says.

“When you have a brand that is doing well in this economy,” he says, “you become an economic investment that makes sense.”

He pointed to the chain’s strong cash flow and positive same-store sales and the lower initial investment cost when compared with competitors, especially given the chain’s new, smaller unit designs. He says now is the time for stronger concepts to grow, as real estate opportunities are plentiful and more qualified franchisees are available, particularly from the pool of recently laid off experienced professionals who are looking for a second career.

Still, Checkers is not immune to the market’s challenges.

“The name of the game, of course, is liquidity,” Arrowsmith says. “Until the markets calm down to where liquidity is available on a more regular basis…well, we need a strong market.”