Multi-Unit Franchisee Magazine Issue III, 2012 | Page 86

FranchiseMarketUpdate
By Darrell Johnson

Phase Two
Economic cycles shed light on tomorrow

O

ne of the most challenging components of making decisions to invest in franchise units is trying
to predict the future. Predictions require assumptions, and in these difficult economic times, when
global events have direct ramifications domestically, developing
a reasonable set of assumptions is hard.
Or is it? Using history as our guide, the U.S. economic forecast
for the next few years is rather predictable. Hundreds of years of
economic downturns caused by financial crises like the one we
experienced in 2008 follow a pattern that consists of three phases.
For the first two to three years there is a significant contraction in lending as borrowers deleverage and bank concerns over
loan losses trump their desire for earnings. Until the impact of
the downturn is understood in credit loss
ratings, banks (and their friendly regulators) are unable to determine whether they
have adequate capital reserves. The result
is an unwillingness to lend to just about
anyone. From 2008–2010 that’s exactly
what happened as borrowers deleveraged
and banks significantly reduced lending,
so score one for historical predictability.
The second phase of three to five
years is characterized by a choppy economic recovery and increased competition for credit. Business and consumer
deleveraging both slow and then start
climbing again. Simultaneously, banks
start to lend again, but on very conservative terms and only to well-qualified
borrowers. Banks have quantified their losses during the previous phase. They know their capital positions, but still do not
have enough earnings pressure to push credit out. The chief
credit and chief risk officers hold sway over the chief lending
officers. While banks have the capital to create the ability to
lend, the challenge is their willingness to lend. Small businesses
can solve the willingness part with information about their business and its operations that makes it more compelling than the
next small-business borrower prospect.
Does all this feel familiar today? I believe we entered the second phase in 2010 and that the choppy recovery and conservative
lending will continue for the next two to three years. Perhaps
the most significant difference in this second phase dow