<em>Analysis:</em> U.S. Small Business Funding Dry, Getting Drier

U.S. small businesses, already facing the toughest credit conditions since the 1980s, may soon find things are about to get tougher.

Concerns over the future of CIT Corp. — a major lender to small businesses — which provides capital in situations where many commercial banks fear to tread, makes small business advocates wary about the next few months.

Since small business is typically a major driver of the U.S. economy, any barrier to this sector’s recovery could mean a longer, slower U.S. economic revival, and could limit the effectiveness of the government’s stimulus dollars.

CIT has tried various capital-raising plans, including growing its retail bank and selling assets and stock, to pay off maturing debt and avoid further ratings downgrades.

CIT said it was talking to the U.S. government to gain access to funding, but that there was no guarantee the Federal Deposit Insurance Corp would approve its application to join the Temporary Liquidity Guarantee Program. That has exacerbated a liquidity crunch and led CIT To explore a possible bankruptcy filing, The Wall Street Journal said.

“The CIT crisis takes a lending source that’s been relatively active in a very tight credit market and eliminates one more source of capital,” said Ken Gaebler, president of Gaebler Ventures LLC, a consultancy that helps entrepreneurs raise capital and acts as a business incubator.

CIT’s failure, if it happens, would pull existing lines of credit, forcing creditors to seek alternative funding.

What are those alternatives?

“Good question,” Gaebler said. “Everybody we talk to says, (that) despite anything you heard about stimulus programs loosening credit, people are very shy to make business loans.”

‘SCARY’
“This to me is very scary,” said Michael Alter, president of SurePayroll, which handles payroll for some 20,000 small businesses. “CIT may be too big to fail.”

The first thing small business owners did on Monday, upon reading of the problems at CIT, was max out their credit lines, Alter said. That only puts more pressure on CIT.

The U.S. government may need to organize an orderly selloff of CIT assets, injecting enough liquidity to keep CIT operating while shutting off new loans, he said. CIT’s loan portfolio includes many healthy loans that could attract an investor, adding that the sale of investment bank Bear Stearns could serve as a model.

“The cost of these guys failing is much greater than the cost of government intervention,” Alter said.

Tight credit curtails investment and makes it harder for owners to set succession plans or exit their business. It may also curb the effectiveness of stimulus programs if companies that could carry out stimulus work cannot afford to bid.

Small businesses has accounted for between 60 and 80 percent of all U.S. job creation over the past decade, according to the Small Business Administration, and include half of total jobs in the private sector.

“We’re having a difficult time getting external funding,” said Charles Roberts, chief executive of Ames Rubber Corp in Hamburg, New Jersey, which makes custom rubber components for office equipment and safety products like gas masks.

Roberts’ 60-year-old, privately held company employs 200 workers. It needs to borrow $1 million to $2 million to invest in inventory and take advantage of demand for its products from the military and other customers. But lenders are focused on past cash flows, not potential future returns.

“There should be money out there now, given what the government has given the banks, but why isn’t it flowing freely at the moment?” Roberts asked.

The issue could be most acute for retailers, an area where CIT specializes.

Reliant on fourth-quarter holiday sales, retailers need credit to tide them over during the other three quarters, said Melinda Crump, spokeswoman for Sageworks Inc, which tracks the financials of thousands of privately-held U.S. companies.

“If their access… is cut off, it can really impact their ability to get them to that good quarter,” Crump said.

CREDIT = JOBS?
The International Franchise Association estimated that every $1 million lent to franchise small businesses creates 34 jobs and $3.6 million in annual economic output. But the group predicts a 40-percent decline in such lending this year, leading to the direct loss of 50,000 jobs.

Most government initiatives have contained few, if any, provisions targeting small business lending, and loan availability is the worst since April 1980, the National Federation of Independent Business (NFIB) says.

Of the 6 million U.S. businesses that employ at least one person, some 60 percent require loans, so the loss of a market player holding a few hundred thousand small loans would have a noticeable impact, said NFIB Chief Economist William Dunkelberg.

Credit is “a pain in the butt no matter when you have to do it, but right now capital is a little short,” he said.

The NFIB advocates creating a government-financed job creation fund that would purchase pieces of pools of small business loans, and has recommended suspending payroll taxes for six months to spur consumer spending.

To be sure, while credit is both dearer and tougher to get, it comes at a time when demand is low, and for many that is the bigger issue. An NFIB survey found 5 percent consider credit their No. 1 problem, compared to 35 percent who said so in 1982. Its June survey, to be published Tuesday, is expected to show improved business conditions, Dunkelberg said.

Even if new credit were available, it takes time to replace existing credit lines, likely meaning more small business bankruptcies in coming months.

Eventually, lenders like Chicago’s LaSalle, JP Morgan Chase , the GE Capital arm of General Electric Co and Wells Fargo could step in to fill some of any gap caused by CIT, said Gaebler.

“Those are the guys that are big enough to fill those shoes,” he said. “They’re pretty big shoes to fill.”

(Additional reporting by Chelsea Emery and Nancy Waitz; editing by Patrick Fitzgibbons and Tim Dobbyn)