October 2, 2022

Are The Benefits Of Unrestricted Lending Worth The Costs?

Advanta & CIT – Same Customers Equal Same Results

In early May, when Advanta Corp (ADVNA) announced that it was suspending all new credit card lending, it was speculated that many borrowers would simply stop paying.   The fact that borrowers might default on their debts when Advanta refused to extend new credit says a lot about the crowd that Advanta was lending money to.  Like many overleveraged borrowers, Advanta customers were probably using new loans to make their monthly payments.

May 12 (Bloomberg) –– Advanta Corp., the credit-card issuer for small businesses, may leave 1 million customers scrounging to find new lenders and debt holders facing losses of 35 percent after the company shut down accounts to preserve capital.

“Early amortization has been viewed as a catastrophic event for issuers,” Scott Valentin, an analyst at Friedman Billings Ramsey & Co., said today in a research note. Advanta’s filing said that the charge-off rate for uncollectible loans may increase after accounts are closed. Valentin said that’s likely because “the cards have substantially less utility to cardholders,” cutting the incentive to keep up with payments.

Advanta was the 11th-biggest U.S. credit-card issuer at the end of 2008 with about $5 billion in outstanding balances, and the only major lender focused on small business borrowers, Robertson said.

Advanta Defaults Soar To 57%

Two months later, the nature of Advanta’s high risk lending became obvious when they disclosed that the default rate on their loans had soared to a staggering 57%.  A solid risk customer with sufficient income does not stop paying on his debts merely because he is denied further credit.  Much of Advanta’s lending was made to the highest risk customers and the huge default rate proves it.

July 20 (Bloomberg) — Advanta Corp., the credit-card company that cut off almost 1 million small-business accounts after posting three quarterly losses, said the default rate more than doubled in June from May to 56.95 percent.

Advanta’s charge-off rate dwarfs the national average, which set a record in June when it topped 10.4 percent, according to Fitch Ratings. Bank of America Corp. on July 15 posted the highest June write-offs among the nation’s biggest lenders at 13.86 percent, a rate that includes consumer credit cards.

The ugly picture at Advanta may be on the minds of CIT bondholders since both companies lend to the same customer base of struggling small business owners.   If CIT goes the bankruptcy route and ceases all new lending, will CIT default rates skyrocket as they did at Advanta?  Bondholders are calculating that allowing CIT time to restructure will result in lower losses.

July 20 (Bloomberg) — CIT Group Inc. said bondholders agreed to provide $3 billion in emergency financing, giving the 101-year-old commercial finance company time to devise a recovery plan that averts bankruptcy.

CIT, led by Chief Executive Officer Jeffrey Peek, is receiving a $3 billion secured term loan with a 2 ½-year maturity, the New York-based firm said today. Loan proceeds of $2 billion are available immediately and the rest is expected within 10 days, the company said.

CIT has said bankruptcy would put 760 manufacturing clients at risk of failure and “precipitate a crisis” for as many as 300,000 retailers, according to internal documents.

The Dark Side Of Credit

The question that should be addressed here is how many small business owners where put at the “risk of failure” due to Advanta and CIT extending more credit than their customers could reasonably expect to pay back?   Should public companies be allowed to lend capital to whomever they chose to in a free enterprise system?

Lending without regard to a borrower’s ability to repay may seem initially profitable to the lender and beneficial to the borrower.   The past several years have shown that, in the long run,  excessive over extension of credit leads to financial disaster for the lender, borrower and society in general.   Hopefully, proposed regulatory changes for the financial industry will address this matter.

advna

Disclosures: No positions

Feds To CIT – “Your Loan Application Has Been Denied”

CIT Solution Is Bankruptcy – Not Bailout

A CIT spokesman said late today that “There is no appreciable likelihood of additional government support being provided over the near term”.   Taxpayers had previously supplied a massive $2.3 billion dollars in loans under the TARP program late last year.  The large TARP infusion did little to turn around CIT which has reported losses for the past two years of over $3.4 billion.

CIT has $60 billion in finance loans and leases outstanding, an amount that is a mere rounding error in a $14 trillion US economy.  CIT does not represent a systemic risk to the US financial system.  The large amount of losses reported by CIT over the past two years suggest that loan approvals were given to risky enterprises.  CIT would not be losing money and on the verge of bankruptcy if their lending policies had properly accounted for risk.

The weak economy certainly contributed to CIT’s losses, but they could have been mitigated by better risk management.   As a private lender, CIT has the right to lend based on whatever standards they chose.  As a private lender, they also bear the responsibility of loss.

The American taxpayer should not be stuck with the cost of bailing out every failed business enterprise.  There already is a solution for poorly run companies – the solution is known as bankruptcy.  The US Treasury can join other creditors in bankruptcy court – cutting your losses is often the best option.

CIT aggressively expanded its loan portfolio over the past fives years by almost 100% to $60 billion.   CIT attempted to rein in its lending as the recession deepened, but the losses continued.  Increased losses resulted in a dramatic reduction of new lending activity over the past year.  CIT has effectively shut down new lending to small businesses for over a year now.  Customers that qualify for financing have gone elsewhere.

CIT -courtesy WSJ

CIT -courtesy WSJ


For small businesses, CIT is already failing.

“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.

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.”

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.

FDIC Rejects CIT Loan Guarantee Request

Sheila Bair, FDIC Chairman, had previously expressed deep reservations about allowing CIT to access the Temporary Loan Guarantee Program (TLGP) due to CIT’s weak financial condition.   Due to the financial crisis, the FDIC was called upon to provide guarantees to bank issued debt under the TLGP.  This type of massive “mission creep” imperils the primary purpose of the FDIC which is to protect depositor funds.  The FDIC Deposit Insurance Fund (DIF) is nearly depleted.  Sheila Bair made the right call and so did the Federal Government.  Let the owners and creditors of CIT assume the risk of loss – not the US taxpayer.

“Cutting Your Losses”

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Disclosures: No positions

More on this topic: Treasury Bets U.S. Financial System Can Weather CIT Collapse