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CIT Group: 300,000 Mom and Pop Businesses Are Too Big To Fail

One of the non-banks to partake in the Treasury's TARP funds last year is CIT Group, which provides lifeblood financing to small and mid-sized manufacturers and retailers. But in spite of that $2.3 billion infusion, CIT is still short on funds, and rating agencies have reduced CIT to junk bond creditworthiness. The feds are said to be working on a solution. But can there be any question that CIT, and their hundreds of thousands of small business customers, are important enough to "the system" to warrant few billion dollars more of bailout?

Over its 100 year history, CIT Group has provided financing in small quantities, either to small businesses, or to consumers buying from big manufacturers. It lent to Studebaker car dealers in 1916, financed consumer purchases of furniture and appliances in the 1920s, and started factoring, or lending against businesses' accounts receivable, in 1928.

At year end, assets totaled $80 billion - puny compared to JPMorgan Chase, but nevertheless crucial to its small business clientele, including 300,000 retailers. In its 2008 annual report, CIT mentions transactions ranging from a $250 million credit line for an apparel company, as well as a $600,000 loan to a Dunkin' Donuts franchisee. It's also the largest lender under programs of the Small Business Administration.

But after earning roughly $1 billion in net income for both 2005 and 2006, CIT lost $2.9 billion in 2008, and another $500 million in 1Q 2009. Total equity was $7.5 billion.

As a finance company, rather than a bank, CIT raises its funds in the capital markets - commercial paper, securitized receivables, and corporate bonds, which shriveled up and became very expensive in the credit crisis. The credit markets are back in business, somewhat, but with its credit ratings in tatters, CIT is not able to get financing at the cost it needs.

CIT changed its structure to a bank holding company late in 2008, in part to be able to borrow debt that is guaranteed by the FDIC (under the Temporary Loan Guarantee Program, or TGLP). CIT's first quarter report told us that it would need an estimated $10 billion of funds for the next 12 months, but had access to only $6.4 billion, and would have to cut back on lending to customers if the difference weren't found somewhere (that is, from the TGLP).

The Associated Press mentions a few solutions, as well as potholes:

Another option for CIT is getting additional bailout funds on top of the $2.3 billion it received in December from the $700 billion financial bailout plan. But analysts say the company's problems are deeper than a short-term cash crunch.

"We believe CIT's funding model is broken and have our doubts over whether an additional capital injection would cure the problem," the research firm Creditsights Inc. wrote in a report early Tuesday.

The government also could broker a deal between CIT and another company. Under that plan, CIT would fail and another firm would step in to make sure its borrowers still have access to credit. But such a move might require the Fed or Treasury to guarantee the new firm against losses on CIT's loans.

I can't estimate the impact, but surely it's large. Is it right to put all those small businesses in jeopardy? At risk are the loans they won't get in the future, but more important the receivables they've handed over to CIT for factoring. Sorting out that in a bankruptcy setting will be a colossal and costly mess. And the end of many, many American-dream entrepreneurial successes.

When the feds put $180 billion into AIG, they claimed it had to be done to keep the system whole, so the swap counterparties wouldn't fail. Since then, we've learned that a number of big banks took much of those rescue funds, and were paid 100 cents on the dollar. Why is this army of small businesses any less essential?

A comment to Floyd Norris's blog in the Times sums up the small business issues clearly. (It's supposedly an editorial in another publication, but I couldn't track down the original.)

Banks, stock companies [sic], automotive manufacturers, and AIG were assisted, but here is a company that helped small businesses. Both Democrats and Republicans say they want to get credit going, want to support small business, and here is an opportunity. The large companies who lend to each other have been helped, but not the small businesses. Credit needs to get flowing again and cutting off those who service small businesses is not the answer.
For a slightly different take on CIT, see this BNET Finance post by my colleague Alain Sherter.