The Factor

July 17, 2009

Don’t worry this is not a column about Bill O’Reilly, the voluble Fox News personality. No, what I’m talking about is the bread-and-butter business of CIT Group, the mid-market lender now limping along on life support.

The Wall Street Journal today wrote one of the first decent articles discussing CIT’s importance in the world of factoring–an ancient form of business financing that CIT long dominated in the US.

In short, a factor is a lender that provides a company with upfront cash for the contractual right to collect on its account receivables. The company sells this contractual right at a discount to the full value of the receivables that it could in theory collect at a later date.

The factor is responsible for collecting on those receivables and gets to pocket the difference between what it paid for that right and the amount it actually collects. It’s a low-margin business, but one that provides a valuable means of financing for companies with inconsistent cash flows.

In New York, for instance, factoring has been the lifeblood for many a garment industry company.

I know a little about this because my father, an attorney, for years helped many garment industry clients negotiate factoring deals with CIT and other factoring firms. I remember how pleased it made my dad to see a Law & Order episode that actually involved some wrongdoing involving a factoring firm. I can’t remember the plot line but a murder was involved. Isn’t that always the case?

One of the big concerns about a CIT bankruptcy is that companies that rely on the lender for factoring will be sent scrambling to find alternative financing. The trouble is most commercial banks don’t like factoring because of its low-margins and it’s seen as a grubby, bottom of the barrel trade.

That’s one reason CIT CEO Jeffrey Peek tried to expand CIT into other more glamorous financing arenas, such as private equity, housing and student lending. Under Peek, CIT even ventured into investment banking. Peek’s goal was to to turn CIT into a mini-Wall Street firm. And just like many Wall Street firms, CIT failed miserably.

I’m sympathetic to the impact a CIT collapse would have on small businessess, in particular factoring clients. But I’m against a government bailout of CIT largely because the firm has failed largely because of Peek’s missteps and greed.

My dad disagrees with me and thinks CIT should be saved because he sees how painful its failure will be for so many companies that have done nothing but rely on it for financing. He says the failure of CIT could spiral out of control. He points out that not only will factoring clients lose a potential source of cash flow, but some banks may pull lines of credit as well. The banks could do this if they fear a company can no longer count on a reliable source of revenue.

So this is why I still think a private-sector bailout of CIT makes the most sense and this is why it’s imperative for the federal government to lean on Goldman Sachs. Goldman is CIT’s biggest secured lender–extending a $3 billion line of credit to CIT last year. Goldman also just proved it’s the nation’s most profitable financial firm. It certainly has the ability to pull-off a deal.

It makes sense for Goldman to play the white night. As I’ve pointed out before it would be good for the firm’s bruised image. And Goldman already has signaled its attention to move into CIT’s space with a $10 billion commitment to a new mid-market lender called GS Loan Partners.

Goldman could easily fold CIT into GS Loan Parnters. The small businesses that rely on CIT for factoring dollars would be saved. And Goldman would get another market to dominate.

Just do it, Lloyd.

UPDATE: My colleagues on the news side of Reuters are reporting that Goldman and JPMorgan Chase are in talks with CIT to provide the ailing lender with up to $3 billion in financing. Lloyd have you been reading?

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