Small Business Lending Shortage
CIT, the largest small business lender in the country, is in trouble. If they go under, we are all in trouble.
CIT Group Inc., one of the country's primary lenders to small and midsize businesses, is at risk of failure as I write this.
This is a small business lender that has been in business for 101 years. They are the largest Small Business Administration (SBA) 7(a) lender and have been for nine consecutive years. CIT also has a strong reputation for lending to women, minority, and veteran business owners. They have been the leading lender in that category for the past six years.
According to media reports, CIT has loans out to nearly one million small and mid-size businesses. Given that there are 27 million small businesses in the United States, this means that 1 in 27 business owners gets their debt financing from CIT.
While it's true that small business lending is highly fragmented, CIT still owns two or three percentage points of the $1 trillion or so annual SMB lending market.
Currently, CIT has intense solvency challenges. They are victims of some poor strategic decisions that started in 2004, when they ventured into subprime mortgages and student lending, which resulted in large losses.
Tightness in credit markets has also played a large role in CIT's current challenges. The firm has historically relied on the capital markets for funding, principally by borrowing in short-term debt markets.
This is not a great business strategy: borrowing short and lending long. There are some inherent risks in that model. But it is a model that worked well enough for CIT for decades, only failing under the intense pressure of the current, horrible economy.
Although it's on the front pages today, CIT's troubles are not new news. In fact, they received $2.33 billion from the Treasury's Troubled Asset Relief Program (TARP) in December. At that time, CIT was approved to become a bank holding company.
That TARP money stopped the bleeding at CIT but it was a temporary fix. The company is looking at how to repay $2.7 billion of debt that matures by the end of the year, half of which comes due by September.
In the midst of these financial challenges, CIT has effectively stopped lending to small and mid-sized businesses.
If this were the only instance of a large lender getting out of small business lending, it might not be the end of the world.
However, you might recall that Advanta shut down their small business lending program recently, and GECC pulled out of new small business lending about six months ago.
The bottomline is that very little small business lending is taking place right now. It has nothing to do with sensible risk assessment. It has everything to do with cash hoarding to prepare against the worst-case scenario of going under.
The vaporization of the small business lending market is causing problems in the small business economy. Unemployed individuals who want to start or buy a business cannot get financing. Existing businesses that depend on credit for working capital are seeing their credit lines pulled and reduced. Firms with tense capitalization structures that need restructuring have few doors to knock on.
The new Federal Deposit Insurance Corp. program that guarantees newly issued debt could help CIT to become an active small business lender again. FDIC has not allowed CIT into this program because of CIT's financial weakness.
CIT cannot be allowed to go the way of Lehman Brothers. While it may not be too big to fail, it is clearly too important to fail.
It is a fuel provider to the engine that is our small business economy. That economy creates 50 percent of US GDP, generates new jobs at a much faster clip than large companies in a down economy, and employs 56% of private sector workers.
The small business economy is currently inching toward death by a thousand pin pricks. Joe the Plumber is on life support.
Allowing CIT to fail is an implicit death sentence for tens of thousands of small businesses owners. By my estimates, it will increase unemployment by 0.3% within a few months, as many small business owners simply decide to throw in the towel and layoff their small business employees.
Many argue that we are on the path to socialism and that we've had enough government intervention in the financial markets. Let them fail, they say.
The reality, however, is that Darwinism is not good economic policy. This is about survival of all of us collectively, not about survival of the fittest individual companies.
True, CIT should pay for not managing its business well. That's why the right solution is a prepackaged bankruptcy combined with FDIC support.
That bankruptcy will eliminate the equity holdings of current shareholders and it will turn CIT creditors into CIT shareholders. By eliminating liabilities, it will almost instantly revert the CIT balance sheet into that of a very strong and viable company.
Federal funds can serve two purposes.
First, the FDIC can guarantee CIT's new lending, allowing CIT to start lending to small businesses again. However, proper risk assessment must be built into the program. After all, we don't want the government ending up with a massive portfolio of problem loans to business owners who should never have been given financing.
Second, the government can play a role in restructuring CIT's debts to its creditors. A 100% writeoff of CIT debts would jeopardize capital markets, making lenders and investors wary of backing any financial firm. That's a repercussion that needs to be avoided at all costs because we are already well into that mess and don't need to get any deeper.
To me, this is a no-brainer. You have to keep CIT afloat. Those who disagree have no empathy for what it's like to be a small business owner that uses credit to start and expand a business.
Walk a mile in the shoes of a business owner and your tune will definitely change.
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