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Contingency Plans Take Shape As CIT Teeters

While lender CIT Group fights for survival, many of its small and medium-size business customers are lining up new lenders, and its rivals are angling for its business.

CIT may have bought itself some time. Late Sunday, the company's board of directors was to review a proposal to borrow additional money from its bondholders, a plan that could allow the company to avoid a bankruptcy filing, according to a person familiar with the plan. The plan, first reported on the Wall Street Journal's website, could provide $3 billion in financing.

The person would not allow his name to be used because there was no final deal yet.

@CIT's fate is being closely watched because hundreds of thousands of companies, ranging from apparel makers and retailers, rely on CIT financing for cash to keep their businesses running.

Further trouble at the bank holding company could hurt some retail and manufacturing customers unable to obtain credit elsewhere, but the company's scramble to save itself has not set off alarms in the financial markets. This latest test to the nation's financial system is a stark contrast to the aftermath of Lehman Bros.' failure last September, an unexpected event that paralyzed credit and stock investors.

One difference is CIT's smaller size. A CreditSights report last week estimated CIT's lending supports less than 1% of U.S. retail and manufacturing business. But another difference this time is that lenders and borrowers are doing more to prepare for an event that could wreak further damage on a weak economy. Furthermore, there apparently is private capital this time willing to hold up CIT without additional government assistance.

"With the run-up to the (failures) of Fannie Mae, Freddie Mac and Lehman, the markets came unglued," says Michael Darda of trading firm MKM Partners. "That's not happening now. It's something the system can absorb."

Observers have been pleasantly surprised with the market's ability to look past the teetering of CIT and adjust. Even as the CIT soap opera unfolded last week, stocks rose more than 7% to score their second-best week of the year, based on the broad Wilshire 5000 index. The bond market has enjoyed an impressive rebound this year. The prices on corporate debt of highly rated U.S. companies are rebounding, driving yields down nearly 50% from Dec. 31, 2008, to 3.13 percentage points above Treasuries with similar maturities, says Merrill Lynch.

It's almost as if investors have quarantined CIT's problems. All this while the value of CIT's bonds have fallen to about 50 cents on the dollar and the stock price has fallen roughly 85% this year to 70 cents a share on Friday. @@Such resilience in the face of CIT's uncertain fate is a sign of how much better the financial system is withstanding this latest shock. CIT's trouble "doesn't seem to have the systematic risk as Lehman did," says Marilyn Cohen of money management firm Envision Capital.

A major player

That's not to understate the importance of CIT, though. Founded more than 100 years ago, CIT is a big player in getting cash to mainly small and midsize companies. A bank holding company with more than $75 billion in assets, it was a top lender under the Small Business Administration's loan program for the past nine years.

CIT also has a large factoring business, where it buys and sells accounts receivable at a discount from small companies. How factoring works: Company A gets an order from Company B for 32,000 sandals. Rather than make the sandals, ship them and wait for Company A to write a check, Company B could sell the receivables to CIT for a discount, get much-needed cash up front, and let CIT collect on the sandals. CIT bought GE Capital's U.S. factoring business in 2003, turning into a factoring juggernaut. CIT provides factoring to 2,000 vendors, who, in turn, sell to 330,000 customers, CIT says. CIT had no comment for this story.

"There are other factoring companies, but CIT is the largest one," says Adrienne Tennant, managing director for FBR Capital Markets, an investment bank in Arlington, Va. "They were the most adept at taking on slightly more risk."

There's no question that trouble at CIT is a risk to the frail economy. More than 30 trade associations, including the American Apparel & Footwear Association (AAFA), on Friday urged Treasury Secretary Timothy Geithner to reconsider the decision to not bail the lender out. "Without CIT, thousands of retailers may be forced out of business because their suppliers will be put out of business," their letter says.

"This is huge," says Kevin Burke, president of the AAFA, the lead group behind the plea. The timing is not ideal, either. Companies are now producing goods for the Christmas season. "If there's doubt about financing, that production is not happening," Burke says. If goods are being shipped, the shipper will keep possession of the goods until he gets paid. "It's a total mess," Burke says.

It's a mess, but one that it seems businesses have been preparing for, including:

Competitors stepping up to take away CIT's business. @Other lenders continue to expand loans to small businesses, where CIT is stepping away. Wells Fargo, for instance, has taken CIT's place as the top lender to small businesses under the U.S. Small Business Administration program. Wells Fargo's vice president of SBA lending, Tom Burke, won't address whether the bank is getting CIT customers. But he says, "We've started to see a steady increase in loan applications" since February, largely due to changes made to the SBA program this year that make the loans more affordable.

Rivals are also picking off some of CIT's lucrative factoring business. "We're getting a deluge of calls and requests for factoring," says Louis Cappelli, CEO of Sterling Bancorp, the holding company of one of the nation's oldest factoring businesses. "We're poised to do more business."

For weeks, companies that use CIT for factoring have been turning to The Receivables Exchange, an electronic bazaar that lets companies auction their invoices for immediate cash to the highest bidder, says CEO Justin Brownhill. Business has jumped 10-fold since January and is on pace to double in July, he says.

Wells Fargo, too, is a large player in the factoring business and is prepared to gear up fast as companies look for help, says Stuart Brister, CEO of Wells Fargo Trade Capital. Since the deals are handled electronically, Wells can easy take on many more customers if there's need, he says.

Customers of CIT adjusting their businesses. @Entrepreneurs have sensed tighter lending at CIT for some time and have been lining up backup plans.

FD Johnson, a distributor of industrial lubrication equipment, used CIT for financing for the leases on laptops that its employees used, says Chip Hautala, director of technology and finance.

But when the economy began to sour late last year, the company diversified its financing so as not to rely on one large lender, Hautala says. "We're financially sound, and we have a good relationship with several local banks, so I'm not really worried about CIT," he says.

Gary Holmes, co-founder of Accounting Practice Sales, which helps facilitate the purchase and sale of accounting and tax firms, had a similar experience with CIT, saying they were a strong partner until last fall.

"We used CIT quite extensively in the past," says Holmes. "They were our biggest lender." But in the fall, CIT notified APS that "they wouldn't be doing any more loans for professional practices," he says.

Since then, APS has tapped into other sources for deals, but it's still a tough environment to get financing, Holmes says.

Seeking information

Seeing a major player in the financial sector stumble is hardly good news for an economy on the mend.

There are CIT clients that range from dance studios and flower shops to technology companies that are operating in the dark until there's more information about the lender's future. Many haven't heard anything from CIT about its current troubles. "I haven't gotten any contact whatsoever," says Richard McFarland, founder of telecommunications firm Voice4Net.

Some businesses that assumed CIT would be there for them are scaling down growth plans. For example, Craig Moore, president of pizza franchisor CiCi Enterprises, which has 650 sites is in 35 states, says CIT had been a very good partner, but grew tightfisted with its lending.

This year, CiCi's had planned to open 70 to 80 stores, he says, but had cut that to 50. Now, he says, it'll be closer to 35 or 40. They used multiple lenders, but he says CIT was "a big one" for them.

Even Sterling's Cappelli says it could be hard for factoring firms to seamlessly absorb CIT clients. "It will be a challenge," he says.

Investors and traders will have to wait and brace for any possible ripple effects based on CIT's fate.

"You're talking about the grocery store on the corner (perhaps having some trouble borrowing). Will that be a catastrophe for the economy? Probably not," says Lee Olver of SMH Capital. "But it won't help anything."

3 Responses »

  1. With 20 years of experience, American Prudential Capital can help CIT clients make as smooth a transition as possible to our factoring services.

  2. Regarding this comment: “You’re talking about the grocery store on the corner (perhaps having some trouble borrowing). Will that be a catastrophe for the economy? Probably not,” says Lee Olver of SMH Capital. “But it won’t help anything.”
    SMBs account for most of the jobs in the US and when they suffer either by government wrongheaded initiatives (Cap/Trade, Card Check, taxes, mandated health care) or market downturns - the first reaction is to lay folks off. Individually it does not amount to a "catastrophe". In the aggregate it does.

  3. Many people had never heard of A/R factoring until news broke of CIT Group's possible demise. There's been a lot of buzz about the affect on small businesses and SMB financing. With the threat of immenent doom to millions of small businesses if CIT goes down, I hope people don't get the wrong idea about factoring as an alternative to traditional forms of finance. It's still a smart way to infuse cash into a business without acquiring debt.