CIT: Not Too Big to Fail

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Can't Rely on Customer Deposits

What's more, CIT's problems are relatively simple to solve. Unlike other lenders who made millions of dubious loans that could take a decade or more to collect, CIT's loan portfolio remains in relatively good shape. In the first quarter ended Mar. 31, CIT charged off 2.41% of its loans as uncollectable, vs. 2.85% for Bank of America (BAC) and 8.5% for American Express (AXP). Rather, CIT's real problem is that unlike traditional banks that fund their lending with cheap, stable consumer deposits, it has long relied mostly on wholesale funds that grew prohibitively expensive amid the market downturn. As a result, CIT's net interest margin— the difference between what it pays for funds and then earns in loans — shrunk to 1.13% of earning assets in the first quarter, or less than half its net interest margin for the same period of 2008. That, coupled with the rise in troubled loans, prompted CIT to record a $438 million loss in the first quarter.

Analysts say that CIT could pull out of its current tailspin by filing a prepackaged bankruptcy that worked like this: While CIT shareholders would be wiped out, it could reduce its debt load by allowing bondholders holding subordinated notes to swap their unsecured claims for equity in the firm that emerges from Chapter 11. That, in turn, would likely raise CIT's currently poor standing with the credit-rating agencies and allow it to lower its borrowing costs going forward. "I can't imagine a scenario where CIT would have to liquidate its operations," Ely says. "The key to turning itself around is to reduce its funding costs, and they key to that is improving its credit rating."

To grease the skids for CIT's re-emergence from bankruptcy, analysts believe that regulators could tap a special Federal Deposit Insurance Corp. fund to guarantee a small portion of CIT's debts after it emerged from bankruptcy to help ensure continuity for the nearly 1 million businesses that currently borrow from the firm. That would put the government, which provided CIT access to $2.3 billion in Troubled Asset Relief Program (TARP) funds last December, on the hook for another couple of billion. But that would be far less than what the earlier bailouts cost—and could signify to taxpayers that the era of 11-figure bailouts is winding to a close.

Foust is chief of BusinessWeek's Atlanta bureau. Francis is a correspondent in BusinessWeek's Washington bureau.

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