A top source of loans for small businesses faces the likelihood of bankruptcy after the Treasury and Federal Reserve on Wednesday rejected calls for a bailout.
CIT Group, which provides nearly 1 million small businesses the credit they need to get by from day to day, announced that several days of discussions with regulators failed to produce agreement on further assistance after a $2.3 billion cash infusion for the company last winter.
Trading in CIT shares was halted on the New York Stock Exchange in advance of the announcement, which increases the likelihood that the lender will fall into bankruptcy after suffering for months from the bankruptcy of Eddie Bauer and other clients.
The company has been unable to raise money in financial markets all year and had pleaded with the Federal Deposit Insurance Corp. to approve its application for a guarantee on its debt offerings like the government provided to most banks during the credit crisis. But the FDIC, worried about the company’s junk credit ratings and exposing taxpayers to the risk of an impending bankruptcy, refused to budge.
The FDIC, seeking to draw a line in the sand to discourage further bailouts, maintained that while CIT is crucial for some small businesses with shaky credit ratings, it does not play a massive or indispensable role in the financial system and should be allowed to fail. Banks and other lenders could step in to fill the void.
But the company’s important role helping keep small companies afloat got a more sympathetic hearing from members of Congress and some officials at the Treasury and Fed. The two agencies have set up several programs to spur lending to small businesses but they have not had much success.
House Financial Services Committee Chairman Barney Frank, Massachusetts Democrat, helped spur rumors early Wednesday that a rescue of CIT was imminent, telling reporters that he spoke with Treasury Secretary Timothy F. Geithner “and I understand they’re working hard to try to come up with something responsible to try to prevent the failure” of the company. “I think there would be a great deal of harm to the overall economy” if CIT is allowed to fail, he said.
Rumors multiplied that the Treasury and the Fed would try to cobble together a package of short-term loans to help keep CIT afloat while it restructured to avoid bankruptcy. The Fed last winter approved CIT’s bid to become a bank holding company so it could have access to Fed lending facilities, and CIT sought to build on that relationship.
Many observers thought that the White House would be sensitive to the political criticism that would result if it abandoned a small-business lender after rescuing big companies like Citigroup, General Motors Corp. and Chrysler LLC from bankruptcy.
But the Treasury and Fed in the end sided with the FDIC in determining that the outlook for CIT was too shaky to merit another rescue.
“Even during periods of financial stress, we believe that there is a very high threshold for exceptional government assistance to individual companies,” a Treasury spokeswoman said.
“The CIT dilemma became a political football” because of the implications for small-business owners, who tend to be prominent and politically active in many congressional districts, said Adam Steer, an analyst at CreditSights. “Not supporting CIT could carry with it the stigma that the government was more willing to bail out Wall Street than small businesses.”
But he said the lender does not play a critical role in the economy or credit markets. CreditSights estimates that CIT provides credit to less than 1 percent of U.S. retail and manufacturing companies. Like the FDIC, the investor research firm has concluded CIT’s business model is broken beyond repair because the credit markets are now closed to the kind of marginal credit it provided in the past.
Wall Street reaction Wednesday suggested investors were not concerned about the fate of the company. The Dow Jones Industrial Average gained nearly 257 points despite CIT’s well-publicized woes. The company’s stock ended trading at $1.64, not far above the $1 threshold that would trigger its delisting from the stock exchange.
While a Treasury rescue would have kept CIT alive for a while, Mr. Steer said, it would have turned CIT into a “zombielike bank that lacks a viable business model and is only alive thanks to government support.”
Other analysts said the action showed the government is insensitive to the needs of small businesses even while it throws billions of dollars at failing big businesses.
“The poor small-business owner on Main Street hasn’t seen a penny of stimulus money,” said Sam Thacker, credit adviser for AllBusiness.com, a Dun & Bradstreet service.
“CIT has long been considered the lender of last resort for small businesses,” he said. The company is the largest provider of loans guaranteed by the Small Business Administration. But perhaps more importantly, it provides the crucial behind-the-scenes financing that many small businesses need to finance the import and sale of goods to big retailers like Wal-Mart and Target, he said.
Mr. Thacker said he disagrees that small businesses could readily find other lenders if CIT goes bankrupt. He said the failure of the firm would leave a “void” in the lending market, especially for thousands of small firms that have shaky credit or provide imported merchandise to big retailers.
“They have typically done loans that other banks turned down,” he said. Particularly in the behind-the-scenes trade financing business, “if there are still some players out there, I’m not sure who they are. I’m going to start looking for them.”
Associations representing small businesses, franchise outlets and retailers all had called for a bailout.
“CIT may appear too small to merit ‘too big to fail’ consideration by the Treasury Department, but in fact, CIT plays a critical role for small-business borrowers nationwide and steps should be taken to keep it solvent,” said Matthew Shay, president of the International Franchise Association.
The credit crisis has wiped out many small-business lending outlets in the past year, including Banco Popular, Comerica and UPS Capital, while GE Capital and banks such as Wells Fargo and PNC have halted or cut back on lending to small franchises, he said.
“Borrowers have few remaining options,” he said.