Why Banks Are Warming to Restaurant Lending

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Restaurant franchising has evolved, and along with it the interest of lenders.

GE Capital, for instance, recently found three banks that were eager to divvy up its $1.4 billion franchise portfolio, including First Horizon National. The Memphis, Tenn., company claimed the largest slice — $637 million in loans in the Southeast and Southwest — as part of a plan to form a new division focused on the business.

The $27 billion-asset company had been on the lookout for new specialty lending opportunities, David Popwell, president and chief operating officer at First Tennessee Bank, said. GE "reached out to us to see if we were interested, which we were," he said.

"We liked the brands [and] we liked the markets," Popwell added. Franchise restaurants "serve a need that's not going away, and they have very strong brand recognition and identity. … They are profitable enterprises that generate a lot of cash."

The restaurant franchise industry is on pace to expand by 1.6% in 2016, to nearly 160,000 U.S. franchise establishments, while output is on pace to rise by 6.3%, to $248 billion, according to the International Franchise Association. The association also forecasted a 1.6% increase in the number of full-service restaurant franchises, to 38,000, with a 6.3% increase in sales, to $70 billion.

Franchise lending also appealed to First Horizon as an alternative to other forms of commercial finance. "There are many fewer banks specializing in this type of business," Popwell said.

That could be changing.

Wintrust Financial in Rosemont, Ill., and Sterling Bancorp in Montebello, N.Y., also agreed to acquire GE Capital loans to expand their franchise operations. The $23 billion-asset Wintrust will buy $581 million of loans in the Midwest and West, while the $13 billion-asset Sterling laid claim to a $190 million portfolio in Connecticut, New Jersey, New York and Pennsylvania.

Other banks are showing an interest in the franchise restaurant sector. TD Bank's former head of restaurant franchise finance, Brian Frank, joined Texas Capital Bancshares earlier this year to build a national practice for the Dallas company. M&T Bank in Buffalo, N.Y., last year tapped veteran commercial lender Karen Schonfeld to pilot a ramped-up franchise lending division.

For Wintrust, which had about $275 million of franchise loans on March 31, the opportunity to acquire a chunk of the GE Capital portfolio came just as it was moving to expand its 15-year-old franchise lending unit by adding staff and opening an office in Newport, Calif.

"Wintrust viewed the opportunity to bid … as a logical way to enhance our position in the franchise finance industry while building our portfolio at an accelerated pace," a company spokesman said in an email.

A decade ago, GE Capital's loans may have received a less enthusiastic reception from banks, industry experts said. Back then, bankers regarded the restaurant business as too competitive from a franchisee perspective and marred by a high failure rate, said Dennis Monroe, a lawyer at Monroe Moxness Berg who specializes in franchise issues. Also, franchise operators often possess little collateral beyond their restaurant equipment.

"There are still some conservative bankers who consider 'restaurant' to be a four-letter word," Monroe added.

"Restaurants were frowned upon by many banks," Popwell said.

Other factors are changing bankers' attitudes toward franchise finance. Wintrust's spokesman, for instance, noted that franchise loans have performed better than other credit classes "through various economic cycles."

"It is important to understand financing for well-operated franchised restaurants is different from financing an independent restaurant," the Wintrust spokesman said. "Well-defined franchise concepts with rigorous, defined operations and expectations — as required by the franchisor — result in predictable metrics and cash flows. These attributes combined are what has attracted Wintrust, and likely other banks, to this asset class."

Franchise operators' borrowing neeeds vary; they include funds for mergers and acquisitions, frequent remodeling demands, equipment needs and the cost of day-to-day operations, Monroe said.

Franchise lending, while complex, is structured in a way that "institutions that develop some expertise can be pretty effective," he said.

That's the hope at First Horizon, which made its first foray into the business in 2007.

The company already has about $200 million of franchise loans on its books, which will be rolled into the franchise lending unit. The group should have more than $800 million of outstandings after the deal with GE Capital closes in the third quarter.

"There are expansion opportunities and the cycle of renovation is pretty substantial," Popwell said. "The borrowing needs don't stop."

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