California Apparel News

It has been a tense week for industry watchers and customers of CIT Group Inc., the largest factor to the apparel industry, after news broke on July 12 that the company was facing a financial crisis.

The New York Stock Exchange halted trading on shares of CIT on July 15, citing news that a temporary loan agreement was hammered out with federal regulators.

But talks had ended late on July 15 without a solution, according to CIT, which said it has been told there is “no appreciable likelihood” of government funding in the near term. The company said it is evaluating its alternatives.

CIT, the largest factor to the apparel industry, had been negotiating with federal regulators all week in an attempt to bolster its liquidity. The situation has industry watchers nervous about the potential impact on a large swath of fashion companies.

CIT funds more than a million businesses—many of which are small- or mid-sized companies, including many in the apparel industry. The company and federal regulators were working on an aid package that would allow the company to remain afloat.

After news of the commercial lender’s problems broke on July 12—including a Wall Street Journal report that the company had hired attorneys to explore a possible bankruptcy filing—many companies drew down their lines of credit.

Steve Barraza, who founded Tianello, his Los Angeles womenswear company, in 1992, said it would be rough going if CIT Group declared bankruptcy.

“It would be pretty tough, I tell you, especially if we couldn’t get our advance and we have payrolls coming up. We are all kind of scrambling. I am with CIT, and a lot of our stores are with CIT. It is a big part of their credit line,” he said, noting that 95 percent of his business is done with 1,200 specialty stores across the country.

After he heard about the potential demise of CIT, he immediately started calling other factors on July 13 to see what he could line up. “You have to do that. This is the kind of business where everybody depends on factors,” he said. “If you don’t have a factor, you don’t grow.”

Lonnie Kane, president of the 30-year-old womenswear company in Vernon, Calif., named for his wife, designer Karen Kane, said he has been following the CIT situation closely. CIT is his factor.

The week before the glum CIT news hit the newspapers, he started drawing down his money from his account with the financial corporation. “Any apparel manufacturer who has competent advisors has been told to do the same thing—draw down your money,” he explained. “Your average apparel company conducting business in a competent manner has protected their assets. The smaller companies living hand to mouth are probably quite nervous right now.”

Kane has been quite happy working with CIT and hopes he doesn’t have to change factors. “Changing factors, which I am certainly not advising, in a short period of time is very complicated and a very difficult thing to do. The new factor buys out the old factor, and that might be a little complicated right now,” he said. “And to strike a deal when your bargaining power is limited, you don’t want to buy at the high end of the market.”Assessing the impactAny disruption in CIT’s business could have a far-reaching impact on the apparel business. According to some in the industry, CIT was able to leverage its market penetration to offer lower financing terms than more-conservative lenders.

The repercussions for the apparel industry are far reaching, from small- and mid-sized manufacturers to specialty stores and independent sales representatives.

“Anyone who is factored is going to be affected,” said Ilse Metchek, president of the California Fashion Association.

Among the likely changes will be stricter rules for lending money, more-limited access to credit and increases in lending rates.

“Purchase-order financing is very expensive [compared with traditional factoring],” she said.

But Metchek notes there will be alternative ways to do business. Other than paying cash, most alternatives carry their own sets of risks to retailers and manufacturers.

“Cash is king at the manufacturing level,” Metchek said. “The word consignment is coming up. But consignment demands a re-evaluation of accounting procedures, a reaccounting of terms and insurance policies. CBT—'cash before delivery'—that means the retailers who are laying out hard-pressed cash are not going to buy from an untested resource. A new company is a risk. COD is problematic. If the retailers’ business is bad, they can always refuse delivery.”

The companies well-positioned to weather this crisis are those well-funded companies with good cash flow and large orders with major retailers.

“The core companies are doing quite well,” Metchek said. “They’re going so fast they need money. The top five vendors of any department store are getting all the business.”

And some retailers heeded the economic warning signs and planned ahead. Fred Levine, co-owner of the M.Fredric chain of specialty stores, said in the past six months, factors have made it very tough to get credit. So he weaned his store off of credit. He said only a handful of vendors demand factoring, and 95 percent of his vendors choose to work directly with his stores instead of dropping his business. “It is one less headache,” he said of his new arrangement of working without factors. “And it has turned many retailers into much more-shrewd businessmen and -women.”

But working without factoring can be a challenge for many manufacturers who use the 80 percent advance on the retailer’s invoice to help finance production and manage their cash flow. Without factoring, they have to wait to get paid.

“CIT has a historic presence in providing capital and liquidity to the retail industry; their market importance is very high,” said Bill Susman, president of New York–based investment bank and financial consultancy Financo Inc.

“The current challenges that CIT faces will likely result in higher borrowing costs and lower capital availability for some period of time. It could be three months, it could be a year. I believe it will be closer to three months, but until the supply and demand of capital for retailers reaches a new equilibrium, the market price for capital will likely go up.”

Jeffrey Van Sinderen, a retail analyst who works for Los Angeles–based B. Riley & Co., said there remains some hope that a last-minute deal could be struck.

“It certainly looks a lot more dire today than it did yesterday,” he said on July 16. “I’m really surprised that the feds didn’t cooperate. [But] at this point, it looks like the likelihood is that they have to file bankruptcy. [And] if it is an all-out bankruptcy, it’s pretty devastating for the industry, especially for the small companies that are not especially well-capitalized. In a bankruptcy situation, there’s going to be a lot of vendors that go out of business.”

Particularly at risk are smaller companies that have no access to other sources of funding.

“Think about the CIT customers—the small- or mid-sized businesses that are basically depending on liquidity from CIT just to make their payrolls,” Van Sinderen said. “In these times, companies that can’t make their payrolls are going to be in deep, deep trouble. ... It’s happening at a horrible time. I just hope the government realizes the impact that this will have if there’s not some sort of solution to come in at the last minute.”

Attorney Mark D. Brutzkus, with Ezra, Brutzkus Gubner LLP in Woodland Hills, Calif., said there’s still a chance the government and CIT can reach an agreement on an aid package, adding, “if the deal with the government fell through, you could have a white knight come in at the 11th hour. The problem is CIT is so big, there’s nobody who could step up to fill the void.”

Brutzkus stressed the far-reaching ramifications of a bankruptcy would have on the industry.

“Everybody from the start-up to the $150 to $200 million [company], for the most part, their working capital depends on the advances they get from CIT for the purposes of payroll, overhead [and] to get their production out,” he said. “It would be a disaster. The whole supply chain would be screwed up.”

Legal ramifications

Furthering complicating the situation are the legal issues, which will make it difficult for companies to simply switch factors if CIT should file for bankruptcy.

“The factoring agreement is often a long-term contract that can’t be terminated at the election of the factoring client,” said attorney Gregory Weisman, a partner and chair of the apparel-practices group at Silver & Freedman in Los Angeles. “Technically, clients in the middle of their multiyear term can’t up and terminate their contract without seeking bankruptcy-court approval and ’relief’ from the stay that is placed automatically on the debtor. The bankruptcy trustee gets to decide whether to let a company out of the contract after evaluating its effect on such debtor. Here, it’s a critical timing issue. Manufacturers can’t wait. They need to move goods. A lot of companies will probably turn to self-help remedies. They’ll ship and invoice themselves—whether they are permitted to under contract or not. That’s what people are going to do because they have no other choice. The conundrum is that the way a factoring agreement is typically structured, the factor owns every client invoice today and even those issued tomorrow. Some clients have made exceptions for COD, international sales or ’house accounts,’ but that’s it. This is uncharted territory for this industry with little precedence for guidance.”

And if CIT did let a manufacturer out if its factoring agreement, the apparel maker would be faced with a new set of challenges, he said.

“Be careful what you wish for because what happens when you now own your own paper?” he said. “Who’s going to give the retailers payment terms in this terrible economy? Who’s going to pay you?”

In addition, CIT sometimes loans money on a “non-recourse” basis, where they can only look at the retailer for collection.

“I hope the feds understand how interwoven everybody in this industry is, and if CIT goes under, the ripple effect will be huge,” he said.

Weisman said he remains hopeful CIT will find a buyer for its profitable factoring unit but noted that it would be a difficult sale.

“I think someone will buy that part of the business,” he said. “But if you’re a buyer for this business and you notice that there was this run on the bank and all these people are leaving, why would you pay much for it?”

No matter what happens, the industry is in for a fundamental shift in business.

“There is no precedent for what’s going to happen,” Weisman said. “This is potentially going to change the way the industry works for a long time.” Industry muscleThree of the industry’s largest national trade associations joined in the efforts to persuade federal regulators to reach a deal.

The American Apparel & Footwear Association, based in Arlington, Va., sent letters to Sen. Christopher Dodd (D–Conn.), chairman of the U.S. Senate Committee on Banking, Housing & Urban Affairs; Rep. Barney Frank (D–Mass.), chairman of the House Committee on Financial Services; Treasury Secretary Timothy Geithner; and others, warning of what would happen if CIT were allowed to enter bankruptcy.

“CIT is a critical financial partner to many of our members, many of whom are small- and medium-sized businesses and make a substantial portion of the clothing and shoes worn by hard-working American families. In fact, for some members, CIT is the only lending source available,” AAFA President and Chief Executive Officer Kevin M. Burke said.

“If we fail to act, everyone in the supply chain—including the designer, the manufacturer and the consumer—will suffer.”

According to the AAFA, CIT represents 60 percent of the factoring in the domestic apparel and footwear industry. The group said a bankruptcy filing could have a “crippling impact” on companies who would lose credit approval and funding. In addition, the AAFA warned, it could “further weaken the overseas market's confidence in our economy.”

The National Retail Federation similarly asked the Obama administration to assist CIT, citing “severe consequences for the retail industry and the nation’s economy.”

NRF also sent letters to Geithner and Federal Deposit Insurance Corp. Chairwoman Sheila Bair.

“CIT is most certainly too important to the retail industry to be allowed to fail, and the retail industry is too important to the economy to be placed under additional stress,” NRF President and Chief Executive Officer Tracy Mullin said. “A failure of CIT would impact thousands of retailers and, consequently, the consumer spending that makes up two-thirds of our nation’s economy. That cannot be allowed to happen at a time when retailers are already struggling to survive the national recession.”

“The jobs of countless hard-working Americans are at stake,” she added.

The National Council of Textile Organizations also sent letter of members of Congress and to Geithner urging assistance for CIT.

“In this terrible economic climate, our member companies tell us that the loss of factoring and loan instruments from CIT could put many textile companies and their suppliers out of business. Textile mills, like much of the manufacturing base, have seen orders decline by 20 percent or more during the last six months,” NCTO President Cass Johnson said. “Many manufacturers are running on survival mode right now. A major disruption in financing and factoring would be enough to put many of them under, particularly since there is no substitute for an institution which offers the size and breadth of services to small business that CIT does.”

Following news of the collapsed talks on July 15, NCTO released a second statement from Johnson, saying “It sends a chilling message when the government will bail out Wall Street but then turns its back on the biggest lender to Main Street. We urge the government to reconsider its decision.”

Looking for solutionsThe company applied for FDIC’s Temporary Liquidity Guarantee Program and is “is also actively discussing liquidity solutions that do not involve access to the TLGP program,” according to a statement released on July 12. Among the possible solutions CIT is pursuing are a “near-term transfer of assets into CIT Bank through Section 23A waivers and the transfer of its vendor finance and trade finance businesses into CIT Bank.”

CIT, however, remained noncommittal about the outcome or timeline of its efforts to bolster liquidity, noting in a statement that “there can be no assurance that any of CIT’s discussions with the government will result in any regulatory action nor as to the timing or terms of any such approvals.”

In late 2008, the Federal Reserve approved CIT’s application to become a bank holding company, which qualified CIT to apply for federal bailout money. In late December, the company received $2.33 billion in TARP (Trouble Asset Relief Program) funds from the U.S. Treasury.

With additional reporting by Deborah Belgum and Andrew Asch