Credit Crunch Squeezes Franchisees

Lenders are tightening credit to restaurant franchisees in a shift that could make it harder for owners to remodel existing locations and buy new restaurants.

It is a sign of how the turmoil on Wall Street is spreading to large companies and small business owners. Panera Bread Co., Yum Brands Inc., Sonic Corp. and DineEquity Inc., owner of Applebee's and IHOP, each rely to some degree on bank financing to build new restaurants or sell company-owned locations to franchisees.

General Electric Co.'s GE Capital, a large commercial lender, is becoming more stringent in pricing and issuing loans for new franchisees. Some restaurant executives and investment bankers say GE's franchise finance arm has essentially put a hold on new loans.

A spokesman for the Fairfield, Conn., firm said it is accepting loan applications but not quoting prices until the markets settle. "We're taking a longer look and even a closer look than we have in different times," he said.

McDonald's Corp. warned franchisees earlier this month that Bank of America Corp., another large franchise lender, had tightened lending to its restaurant owners, and that franchisees should find other lenders for immediate borrowing. McDonald's has since said its franchisees have access to sufficient credit for restaurant improvements.

The lending pullback comes as restaurant chains are struggling through a deep downturn. High ingredient prices and consumers curtailing dining outside the home are eating into profits.

Tighter credit could impede plans by restaurant operators to remodel existing stores, install new equipment, open new locations or convert existing company-owned stores to franchised locations, said Sharon Zackfia, a restaurant industry analyst at brokerage William Blair & Co.

"While clearly other sources exist for franchisee funding options, the recent pullbacks of two of the main lenders in the arena are disconcerting," Ms. Zackfia wrote in an investor note.

Last week, Sonic, a drive-in-chain with 3,400 locations, announced plans to sell its holdings in more than 200 underperforming stores. Stephen Vaughan, Sonic's chief financial officer, said the Oklahoma City-based company has "already had conversations with people who we feel are confident they can get financing."

A spokesman for Glendale, Calif.-based DineEquity said it remains on track to convert about 290 company-owned Applebee's locations to franchises through 2009, in part because potential buyers have their own financing or are bringing cash to the table. Spokespersons for Yum, which owns KFC and Taco Bell, and Panera didn't return calls seeking comment.

Credit in the restaurant industry has become tighter after several years during which major lenders backed leveraged buyouts and expansions. Company-owned Bennigan's filed for Chapter 7 liquidation in July.

Lenders are requiring restaurant operators to put up about half of the loan amount in cash before going forward with a loan, according to one restaurant investor. Banks were asking for as little as 20% in equity as of six months ago, this person said.

Some analysts think that tighter credit could help the industry by slowing expansion and reducing the glut of restaurants.