CIT failure would chill US restaurant operators

* CIT bankruptcy would disrupt restaurant franchising

* Small banks may help fill the gap

By Lisa Baertlein

LOS ANGELES, July 16 (Reuters) - A potential bankruptcy of CIT Group Inc CIT.N would be another blow to restaurant operators and other franchisees by removing yet another funding source at a time when many large banks have frozen lending.

But longer term, analysts say the long-suffering restaurant sector should be able to hunt down alternatives.

"We think long term our people will find other places to go, short term there will be pain," said Matthew Shay, chief executive of the International Franchise Association, which has lobbied the Obama administration to rescue CIT -- one of the largest providers of loans to small businesses in the United States.

"If CIT were to go away, it would take a financing option away from our franchisees who want to buy stores or expand their networks," said Michelle King, spokeswoman for Dunkin' Brands Inc, which is owned by private equity firms Bain Capital Partners, the Carlyle Group [CYL.UL] and Thomas H. Lee Partners.

Franchisees, whose numbers are dominated by restaurant operators, make up a large percentage of the nation's small business operators.

CIT has provided funding for operators of restaurants ranging from Dunkin' Donuts to Yum Brands Inc's (YUM.N) Pizza Hut.

The lender warned late on Wednesday that government bailout talks had ended, a move that could set the stage for bankruptcy. [ID:nN16402649]

But CIT has effectively been out of the market this year, said Craig Moore, president of CiCi Enterprises, which owns and operates 650 CiCi Pizza restaurants in 30 states and does not borrow from CIT.

"We started seeing it at the end of last year. It really got tough as we rolled over to the beginning of the year," said Moore, who like other restaurant operators is reporting that small, community banks have begun to step into the gap.

But Shay doubts that local bankers can completely fill the gap: "One of our concerns is how much capacity do these community banks have?" he said.

Large restaurant operators have reported that the recession and ongoing credit crunch have made it harder to sell existing restaurants to franchisees.

The lack of loans, or unusually tough loan requirements, also made it tougher for people who have lost jobs to start their own businesses.

"We've never seen more inquiries for franchisees than right now. Everybody's trying to get control of their lives," Moore said. "The reality is the American dream is dead right now." (Reporting by Lisa Baertlein; Editing by Tim Dobbyn)