CIT: A Turning Point in the Financial Crisis

If CIT really has dodged a bullet here and avoided bankruptcy, that’s spectacularly good news. I’m assuming here that a deal has done, based on nothing but a single one-line headline on WSJ.com; these things tend to be fraught and fractious, however, so I’m not counting my chickens just yet. But if CIT has really avoided bankruptcy, that’s a major turning point in the history of the financial crisis.

It’s good news for various individual constituencies, of course, especially all the small and medium-sized businesses which will now find it easier to roll over their loans. It’s good for CIT’s shareholders, who might be left with something more than $0. It’s good for CIT CEO Jeffrey Peek, who did his best Dick Fuld impression over the past few months, refusing to raise capital even as everybody else was taking any capital they could get, and as a result almost sent his company the way of Lehman. And it’s spectacularly good news for CIT’s bondholders, who could well see the value of their holdings rise from the single digits into the high double digits as soon as the markets open.

Most of all, however, it’s good news for the system as a whole, which seems to have demonstrated that it’s possible, if not easy, for a private-sector alternative to bankruptcy to be worked out without government interference or guarantees.

I have to say that on Friday, I didn’t think such a thing possible. But with CIT’s unsecured bonds reportedly trading at less than 10 cents apiece on Friday, it was clearly in the large bondholders’ best interests to do some kind of deal, even if doing so meant other bondholders would get a free ride.

The point here is that there is almost nothing which can destroy as much value overnight as the bankruptcy of a financial institution. There were questions over CIT’s solvency, of course. But we’re talking a few billion dollars of shortfall on an $80 billion balance sheet: if capitalism worked the way it’s meant to, then maybe shareholders would be wiped out, but bondholders’ recovery would be high.

But financial-company bankruptcies don’t work that way, as we saw with Lehman Brothers, liquidating a bank is a sure-fire way of getting such low prices for your assets that even secured bondholders start worrying; unsecured bondholders are liable to walk away with little if anything.

It makes sense, then, that those unsecured bondholders would have every incentive to come to some kind of deal with CIT. The problem with any deal done outside bankruptcy court is that any creditors not taking part in the negotiations are going to have to be paid off in full. In turn, that means that the bondholders who are in negotiations are going to have to provide new money, so that CIT has the cash to service its debts. And no one likes throwing good money after bad, especially when that new money doesn’t have the protections afforded to DIP financing in a bankruptcy situation.

If bondholders managed to overcome all those obstacles over the course of the weekend and come to a deal which saves CIT, then maybe the market is starting to be able to work things out on its own, without the need for government involvement. And maybe spreads on bank debt in general will continue to tighten in, as the expected recovery in case of distress rises from the single digits to something much higher. I do hope this deal happens.

Update: The WSJ article is now up:

The deal, which was being considered by CIT’s board Sunday night, charges CIT very high interest rates, and it doesn’t permanently fix the company’s long-term financing needs, say people involved in the transaction. But it buys time for the lender to restructure itself, and minimizes bondholders’ losses. Bondholders calculated they would lose more if CIT filed for bankruptcy and sold assets at fire-sale prices than if they offered the rescue.

Comments

[apppro:]

Truer words have never been spoken! When businesses finally realize that the world is not coming to an end, then recovery will be here. Hey, we totally convinced ourselves into this mess, some positive thinking may just get us going again.

But probably the most important indication of all is who is helping here – Pimco! These guys have been sitting on the sidelines preaching their ‘new normals’. They have had one opportunity after another to get some cash back into the system, but have decided to let things fail before they did. Since they withdrew from the bank “legacy asset” buyback plan when they realized that it wasn’t going to give them the ludicrously low prices they want, they decided to pick the bones of CIT.

Better late then never, but I guess in Pimco’s view they’re not late at all – just right!

Jul 20 06:49 AM

[coldcall:]

"Hey, we totally convinced ourselves into this mess, some positive thinking may just get us going again."

We convinced ourselves that the global financial system was on the brink of total collapse in October 08 and then again in Mar 09? You mean it was all just a fear induced hallucination? You sure about?

On the issue of CIT. Its given bonholders a bit more breathing space, thats all.

And Jeffrey Peek is another Fuld. He is a menace to the future of CIT. He should have been sacked when he refused to raise more capital. The only reason CIT will open for business today is because of the generosity of bond holders. Peek has done nothing but make the CIT situation worse.

Jul 20 07:00 AM

[apppro:]

<<You mean it was all just a fear induced hallucination? You sure about?>>

Pretty much!
We will see that history will write that after we allowed shorts to take down Lehmans for their own greed & hubris, we all convinced ourselves that the end was here out of our own fear and ignornace.

Fear is a very powerful emotion - far more powerful then greed.

All a dream - YES
www.youtube.com/watch?...

Jul 20 07:12 AM

[john s. gordon:]

little too much euphoria here - CIT ain't out of the woods yet.
> jack

Jul 20 08:32 AM

[WhoisJohnGalt:]

Agreed, its newly added debt (double digit rates) may just be delaying its collapse. At least it would happen when the markets aren't eyeing every potential financial bankruptcy as a roadblock to recovery.

On Jul 20 08:32 AM john s. gordon wrote:

> little too much euphoria here - CIT ain't out of the woods yet.

Jul 20 09:18 AM

[RiskReturnO...:]

Buy CIT Bonds ... PIMCO will make sure you get paid interest and principal ... no need to take more risks than needed.

Jul 20 09:33 AM

[Credit Geek:]

The 2 1/2-year term line of credit is reportedly being priced at 10.50%, which will give everyone an indication of just what even its bondholder's think of the company and is at a level that essentially makes the company uncompetitive although it will now be able to refinance maturing obligations and meet customer credit line draw downs. It is not clear yet at this point as to whether the company may still have to file for bankruptcy protection at a later date.

This company is very important in the U.S. as a lender to small- and mid-sized businesses in several dozen industries and provides billions of dollars in corporate, vendor, transportation and trade finance. The inability of hundreds of thousands of businesses to obtain financing to run day-to-day operations would be another body blow to the U.S. economy at a very difficult point in time. It is clear that the problems for CIT are a result of the company diverting from its core business to expand into subprime residential mortgages and student loans. The company reported in the 1st quarter 2009 that Net charge-offs were $37 million, including $21 million of charge-offs in the private student
loan portfolio, up from $31 million last quarter. Non-accrual loans were $191 million, down slightly from $194 million at December 31, 2008, and again primarily reflect losses in the private student loan portfolio. This portfolio is $12.0 billion and the company indicates that $11.3 billion is government guaranteed. However, with so many graduating students in the U.S. unable to locate employment this portfolio is only going to continue to deteriorate and may require government intervention.

The reluctance or poor decision of the company not to seek additional private capital has also been well documented.

The company exited the residential lending business, finally, in the 1st quarter 2009.

A review of the company's balance sheet and public releases indicates that it has approximately $1.1 billion in debt due in August, and another $2.5 billion due in the 4th quarter 2009. The company was able to retire $3.0 billion in maturing debt during the 1st quarter 2009 on its own. The company has also posted a $438.1 million ($504.5 million after preferred dividends; the company just ceased paying a dividend to common shareholders) loss for the first quarter of 2009 and has posted a series of losses going back for several quarters.

However, a close look indicates that the losses are mounting in its core businesses. Corporate financing posted losses of $180 million at 12/31/08 and $240 million thus far as of 3/31/09. Net income in the Transportation, Trade and Vendor segments has been declining or has already turned negative ($25 million loss in Vendor financing). Corporate & Other posted a additional loss of $182 million.

It is entirely unclear how this company is going to survive as business conditions and municipal finance conditions continue to decline in the U.S. over the next nine months.

Jul 20 10:16 AM

[Dialectical...:]

I am stunned when I read comments like this (which I'm seeing a lot more of lately). We have awfully short memories when we try to convince ourselves it was really not all that bad. "It was just that we were worried. Some of the cornerstones to the global financial systems were not actually insolvent, it was just that we all worried they might be. Then we woke up. Really nothing to it..."

This kind of revisionism will likely ensure we end up in a similar mess in the future. "It wasn't that we leveraged risk too much, it was that we started to worry about it."

On Jul 20 07:12 AM apppro wrote:

> <<You mean it was all just a fear induced hallucination? You sure
> about?>>
>
> Pretty much!
> We will see that history will write that after we allowed shorts
> to take down Lehmans for their own greed &amp; hubris, we all convinced
> ourselves that the end was here out of our own fear and ignornace.
>
>
> Fear is a very powerful emotion - far more powerful then greed.<br/>
>
> www.youtube.com/watch?...

Jul 20 01:30 PM

[steve graves:]

It's only 'spectacular news' if the economy turns around and starts growing at a healthy rate soon, which is not going to happen, which means it's not spectacular news. The logic here is fundamentally flawed.

Jul 20 01:54 PM

[Ricard:]

Thanks for the update on this.

"The point here is that there is almost nothing which can destroy as much value overnight as the bankruptcy of a financial institution. There were questions over CIT’s solvency, of course. But we’re talking a few billion dollars of shortfall on an $80 billion balance sheet: if capitalism worked the way it’s meant to, then maybe shareholders would be wiped out, but bondholders’ recovery would be high.

But financial-company bankruptcies don’t work that way, as we saw with Lehman Brothers, liquidating a bank is a sure-fire way of getting such low prices for your assets that even secured bondholders start worrying; unsecured bondholders are liable to walk away with little if anything."


I have to disagree with the above quote. I think what happened with Lehman is what would have happened if entire industries collapsed elsewhere, like, say, the housing market. Having just one firm (CIT) collapse shouldn't cause utter destruction of all of its assets, unless the chance that it would cause another panic throughout what's left of Wall Street is still in the back (or now front) of people's minds.

Had this happened in 2005, or 1998, it wouldn't have been more than a blip on the radar screen.

Jul 20 02:45 PM

[RiskAverseA...:]

... "And no one likes throwing good money after bad..."

Oh really? Go tell that to Uncle Sam!

... "especially when that new money doesn’t have the protections afforded to DIP financing in a bankruptcy situation."

RED ALERT! ... RED ALERT!

Does not the desperation of such a move strike you at all as being troublesome?

Jul 20 11:57 PM

[Daniel Harr...:]

<<We convinced ourselves that the global financial system was on the brink of total collapse in October 08 and then again in Mar 09? You mean it was all just a fear induced hallucination? You sure about?>>

I'm pretty sure that the fear-mongering financial media caused a lot more devastation at the middle-class consumer-demand level than was absolutely necessary.


On Jul 20 07:00 AM coldcall wrote:

> "Hey, we totally convinced ourselves into this mess, some positive
> thinking may just get us going again."
>
> We convinced ourselves that the global financial system was on the
> brink of total collapse in October 08 and then again in Mar 09? You
> mean it was all just a fear induced hallucination? You sure about?
>
>
> On the issue of CIT. Its given bonholders a bit more breathing space,
> thats all.
>
> And Jeffrey Peek is another Fuld. He is a menace to the future of
> CIT. He should have been sacked when he refused to raise more capital.
> The only reason CIT will open for business today is because of the
> generosity of bond holders. Peek has done nothing but make the CIT
> situation worse.
>
>
>
>

Jul 21 06:19 AM

[Ivan Kitov:]

CIT Group is fine as of now and in the near future, but Morgan Stanley is getting a big trouble:

seekingalpha.com/insta...

Jul 21 06:44 AM

[Relative Le...:]

I have to disagree with you on this one, Felix. This CIT "rescue package" is a giant step in the wrong direction. I just posted a rebuttal to your article.

consequencesunintended...

Bottom line, this is by no means a "turning point in the financial crisis" and here are my predictions on how this CIT debacle will play out:

- CIT will be in bankruptcy by year end.
- CIT common equity will eventually go to $0.
- CIT borrowers that can't find an alternative source of financing will be right behind the lender in bankruptcy court.

If anything, a wave of bankruptcies would the key turning point in the financial crisis. Bad businesses need to be allowed to fail. Only after the cancer is removed can we begin the recovery process...

Jul 21 09:28 AM

[s_m_p:]

Wow, this is the weakest analysis I have ever read. This is not a turning point by any means. What happened is you had a company with essentially ALL unsecured debt and NO restrictions in its debt on its ability to raise debt. Given that structure, bondholders holding large amounts of early maturing debt did the rational thing. They essentially swapped their unsecured early maturing debt for slightly longer term but secured debt -- secured, incidentally, by virtually all CIT's good unsecuritized loans according to published reports. This was such an obvious result. Are the credit markets thawing. Yes, they are. But the CIT deal is not indicative; rather, it is a deal that would have happened no matter what. Comparing CIT to Lehman is absurd. Lehman was a much larger company with a much much more complex balance sheet. Yes, CIT experienced a "bank run" as customers drew down credit lines but that is nothing like the instantaneous crippling effect on a trading company when your counterparties lose confidence in your liquidity.

Also, just in terms of the fact, CIT bonds were not really trading at 10 cents on the dollar on friday. As someone who just made a killing on this deal, I can tell you that the low prices quoted in papers were basically due to an extremely small number (in terms of volume) of retail investors mainly selling internotes for far far below market value. Sophisticated investors were never selling notes at 10 cents on the dollar.

Nor is this really great news for either shareholders or CIT customers. At best, it is mediocre news. Shareholders will still get completely raped at best in any debt for equity swap and any CIT customers who would have been affected by the bankruptcy will almost certainly not be given access to more credit anyway.

Jul 21 10:03 AM

[anarchist:]

Shorts brought down Leman? I don't think so. Paulson and the Fed allowed Leman to go under and I doubt that is was just a coincidence that Leman was a competitor of GS. Paulson and Ben always contended that they legally couldn't save Leman but it's weird how they were able to change the rules for all the other investment banks and AIG.


On Jul 20 07:12 AM apppro wrote:

> <<You mean it was all just a fear induced hallucination? You sure
> about?>>
>
> Pretty much!
> We will see that history will write that after we allowed shorts
> to take down Lehmans for their own greed &amp; hubris, we all convinced
> ourselves that the end was here out of our own fear and ignornace.
>
>
> Fear is a very powerful emotion - far more powerful then greed.<br/>
>
> All a dream - YES
> www.youtube.com/watch?...

Jul 21 12:04 PM