For small businesses, CIT is already failing

ROAD TO RESCUE

• Home prices up for 1st time in 3 years
• New home sales: 'Really good news'
• Wall Street: Here comes the hard part
• 7 regional banks fail
• Banker: "TARP helped avert a global calamity"

Craig Moore, president of CiCi Enterprises, says CIT hasn't been a reliable lender since late 2008.

Photos

SOS: Send loans now

With bank lending to small businesses nearly frozen, these 8 entrepreneurs are among the thousands fighting for the credit lines and loans they need to keep their companies alive.

View photos

Quick Vote

Are homes affordable where you live?

• Yes, thanks to the housing bust.
• Yes, always have been.
• No, they're still too pricey.

or View results

Photos

Startup stories: 'How we got the cash'

Small businesses are struggling to find banks willing to lend. Here's how - and where - 6 entrepreneurs got the loans and credit lines they need.

View photos

NEW YORK (CNNMoney.com) -- The small business credit market is about to take another major hit. Six weeks after Advanta abruptly froze all of its 1 million credit-card accounts, lending giant CIT Group faces potential bankruptcy.

Following a flurry of media speculation, the ailing company announced late Wednesday that it would not receive government assistance. CIT said on its Web site that it is "evaluating alternatives."

Over the past nine months, the one-time financial services powerhouse has all but ceased making new loans, which left small business advocates and owners with mixed feelings about whether CIT should be left to fail.

CIT was historically the biggest issuer of Small Business Administration-backed loans, topping the agency's lender list year after year. Last year, it made 1,195 loans through the SBA's 7(a) program, totaling $766.6 million.

But in the wake of the credit crisis that followed Lehman Brothers' September collapse, CIT's lending came to a standstill. Since October, CIT (CIT, Fortune 500) has funded fewer than 100 SBA loans, totaling $65.7 million.

"In order to service its debt and meet obligations, [CIT] has been cutting back on new originations," explains David Chiaverini, research analyst at BMO Capital Markets.

CIT CEO Jeffrey Peek said in November that his company was "the bridge between Wall Street and Main Street," and "one of the few significant sources of liquidity for small and mid-sized businesses who are struggling to survive." But by then, CIT was already burning down its bridge, turning away many of the small businesses that had come to rely on the company.

Craig Moore is president of CiCi Enterprises, a pizza franchisor based in Coppell, Texas. CIT Group was CiCi's go-to lender for financing new franchises.

"We had used them quite a bit in the past years because they made the process easy to get through. But at the end of last year, they tightened so quick they almost stopped lending to us overnight," Moore says.

Moore had 300 franchise candidates in the pipeline. Very suddenly, half of them couldn't get loans and became non-viable, including 16 that had been working with CIT. Moore says some are still hanging on, hoping the credit markets loosen up, while other potential owners are tapping family and friends for startup money.

"We had a goal of building 80 stores this year and we may end up with 40. That drop is due to the financing issues," says Moore. "On a bigger scale, that's 40 stores which each could have hired 35 employees."

CIT wasn't just known for its startup loans. It also provided loans and lines of credit to existing small businesses. If the company falls into bankruptcy, those credit lines may vanish.

J.P. Morgan's analysts estimate that CIT had $1.5 billion in unfunded commitments in March, primarily comprising untapped credit lines and other guarantees that customers could draw down if they chose. That's a big deal for affected business, but it's a comparatively small amount in the overall lending landscape. When Advanta froze its small business credit cards, it had about $5 billion in outstanding balances.

CIT is also a major player in factor financing. Factoring companies buy invoices from manufactures and retailers, immediately paying them a portion of the invoices' face value and assuming the task -- and the risk -- of collecting payments from customers. For businesses that can't afford to wait, factoring offers fast access to operating cash.

CIT Trade Finance processed a factoring volume of $8.3 billion in the first quarter of 2009, but there too, signs of the company's cutbacks are showing. CIT's factoring volume dropped 21% from the same quarter a year earlier, which the company attributed to the weakened retail environment.

If CIT now falls into bankruptcy, its factoring clients will need to find a new lender. Some may also be left chasing CIT for unpaid balances. As of March 31, CIT held $2.7 billion in credit balances for its factoring client, according to an SEC filing.

Robert Saquet, president of Eggers Furniture, a retail store in Middleboro, Mass., is wondering how his shop will be affected if CIT disappears from the factoring market.

"Many manufacturers would not be able to stay in business without a factor creating immediate cash flow," Saquet says. Three of his largest suppliers use CIT as a factor. "Without a source of cash, they would have to demand pre-payment from retail stores. Retail stores are struggling and are not able to get the credit to raise more cash, so they would have to stop buying from factories that are not able to extend terms."

Small companies have been hit hard by the recession, and CIT is suffering in tandem with those it serves. Defaults and delinquencies are rising as cash-strapped business owners fall behind on their bills. Meanwhile, the value of the collateral pledged against CIT's loans is deteriorating, as home and commercial real-estate prices plunge.

"The weak economic environment had a much greater impact on certain segments of our corporate loans portfolio than we have anticipated previously," CIT CEO Peek told analysts in a conference call to discuss the company's most recent quarterly results.

CIT received $2.3 billion in TARP money in December and converted itself into a bank-holding company. But other help from the federal government has been elusive. CIT applied in January for access to a debt-guarantee program run by the FDIC, but its application has been left languishing. Analysts say there's little chance at this point that it will be approved.

BMO Capital Markets' Chiaverini sees bankruptcy as CIT's most likely next step.

"The best case for CIT is to get its liquidity issues resolved -- bankruptcy could actually get things back to normal on the lending front," he says. "If it does go into bankruptcy, I think what will happen is unsecured debt holders will convert their debt into equity and it will emerge stronger without the overhang of debt coming due. Then, it can start lending again."

Some small business advocates had been crossing their fingers for a bailout. In a letter to Treasury Secretary Timothy Geithner, the International Franchise Association said that "we are very concerned that allowing CIT to enter bankruptcy will send the wrong signal to small businesses on Main Street."

CIT's financing volume is way down this year, but in past years it has been "one of, if not the, top lenders to the franchise industry," says IFA spokeswoman Alisa Harrison.

Lloyd Chapman, president of the American Small Business League, also issued a statement urging government assistance. "CIT's unique ability to work with new entrepreneurs and small business owners trying to expand their businesses will be impossible to duplicate," he said. "If our hard-earned tax dollars are going to be used to save financial institutions, we should use those funds to save firms like CIT that have a 100-year track record of helping those small businesses where most Americans work."

CIT's role in small business financing will be hard to fill, but for many companies, the damage is already happening. Saving CIT would only help Main Street businesses if the company became healthy enough to resume making loans.

CiCi's President Moore is pleased that the government will not prop up CIT. Still, he realizes that his company's fortunes are tied to those of CIT and its Wall Street brethren.

"A business will last only if it learns to live within rules," he says. "But I hope they come back alive, because then there's a better chance we will flourish."