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CIT Bankruptcy Will Prolong, Deepen the Recession

By Keith Girard
July 16, 2009

The collapse of small business lender CIT Group seems all but inevitable, after the company said on July 15 that “there is no appreciable likelihood” that it will get additional government support to help it weather a liquidity crisis.

The news sent shockwaves down Main Street. There’s a palpable fear that Washington doesn’t realize the role CIT plays in the economy, and groups, including the National Retail Federation and the International Franchise Association, have been urging the administration to keep it in business.

The Treasury Department, however, has taken the position — at least for the moment — that CIT does not meet its “too big to fail” criteria to warrant additional aid. That may be true by numbers alone. But a strong argument can be made that CIT is “too critical to the economy” to fail.

“If the criterion for whether a financial institution should receive government assistance is whether it is ‘too large to fail,’ CIT is most certainly too important to the retail industry to be allowed to fail, and the retail industry is too important to the economy to be placed under additional stress,” argues Tracy Mullin, president and chief executive of the National Retail Federation.

How CIT got mired in a liquidity crisis is complicated, but like what happened on much of Wall Street, its CEO steered the company into risky subprime mortgages and student loans with disastrous results. In this case, the CEO is Jeffrey Peek, a denizen of Wall Street, who joined CIT in 2003 after failing to land the top job at Merrill Lynch, which collapsed last year.

The company has posted eight straight quarterly losses totaling $3.4 billion. Analysts are predicting losses the rest of this year, according to a survey by Bloomberg. CIT has about $1.5 billion in unfunded commitments, primarily untapped credit lines, which is small peanuts compared to banking giants that have received bailouts, such as Citigroup and Bank of America.

But the company plays a critical role in the economy because it has been one of the biggest lenders to small businesses that can’t get traditional financing elsewhere. Not only has it been one of the biggest originators of Small Business Administration (SBA) loans, it’s also been a critical supplier of short-term cash through what’s known as “factoring.”

As any small or big business owner knows, cash flow is king, whether it’s to meet a payroll, buy inventory, or simply pay bills. That’s especially true for tens of thousands of businesses that are cyclical and face uneven cash flow.

To meet short-term needs, small businesses could turn to a “factor” like CIT to exchange their receivables for short-term cash or credit. The company has more than 500,000 trade vendor customers out of its 1 million total customers, a large percentage of which are small businesses, according to a recent regulatory filing.

As the nation’s largest factor company, CIT literally provides the grease that keeps the wheels of thousands of Main Street businesses and manufacturers turning.

“CIT’s unique ability to work with new entrepreneurs and small business owners trying to expand their businesses will be impossible to duplicate,” says Lloyd Chapman, president and founder of the American Small Business League, who also favors a bailout.

Without CIT, suppliers could be forced to shut their doors, or retailers would be required to pay up front and draw down on their own credit lines at a time when credit remains difficult to obtain, Mullin says.

“If CIT were to fail, a chain reaction would be set off that could very well leave retailers with a shortage of merchandise during the crucial holiday season this fall,” Mullin explains. Indeed, most retailers do almost half their business during the critical window between Thanksgiving and Christmas.

Likewise, the International Franchise Association is urging the Obama Administration to take immediate action. IFA President and CEO Matthew Shay says allowing CIT to fail will not only send the wrong political signal to Main Street, it will exacerbate a credit crisis that has left small business borrowers with few other options.

Banco Popular, Comerica, and UPS Capital have all exited the SBA lending business nationally; GE Capital has halted virtually all franchisee lending; and banks such as Wells Fargo and PNC have also cut back or significantly tightened lending standards, the IFA notes.

Even CIT, the largest originator of SBA-backed franchise loans in fiscal year 2008, has been forced to take itself out of the game. Since October, CIT has funded fewer than 100 SBA loans, totaling $65.7 million, according to a CNN/Money analysis. That compares with 1,195 loans, totaling $766.6 million, in 2008.

In its factoring business, CIT processed $8.3 billion in the first quarter of 2009, but the volume is down 21 percent from the same quarter a year earlier. Its dwindling business has led some to argue that the company is already among the walking dead. Bankruptcy, they say, could only help it by letting it reorganize.

But that would also leave tens of thousands of small businesses in the lurch. They would become creditors because CIT is holding their invoices as collateral for lines of credit. According to some estimates, a CIT bankruptcy could trigger a cascade of as many as 300,000 small business bankruptcies.

The situation led to a recent run on CIT that, in part, contributed to its liquidity crisis. Small businesses scrambled to draw down their credit lines ahead of a feared bankruptcy, pulling out more than $750 million this week alone, according to The Wall Street Journal.

If CIT fails, it’s unlikely to upset the financial system like the collapse of Citigroup or insurer American International Group. But there is no question that it will prolong and deepen the recession — just what we don’t need at a time when there is some hope that the economic downturn is slowing.

Source:  http://www.allbusiness.com/company-activities-management/financial-performance/12393969-1.html



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