Posted by: Stacy Perman on November 2, 2009
After several months of twists and turns in an effort to avoid bankruptcy, on Sunday CIT Group put an end to its ongoing saga and indeed filed for a prepackaged bankruptcy plan. Under the plan, the 101-year-old lender will end the year out of court protection and under the control of its debt holders.
The company released a statement that said, in part: “Under the plan, CIT expects to reduce total debt by approximately $10 billion, significantly reduce its liquidity needs over the next three years, enhance its capital ratios and accelerate its return to profitability.”
CIT’s latest move comes after the firm attempted to find any avenue but bankruptcy that would keep it afloat. In July, the company was denied a second federal bailout after it had already received $2.3 billion in Troubled Asset Relief Funds (TARP). The government’s lifeline was given in the form of preferred stock – and as a result of CIT’s bankruptcy proceedings, the government is expected to take a bath on that $2.3 billion.
To date, CIT has been the biggest player in factoring – a form of debt financing used by those businesses that are unable to secure traditional loans or credit lines. This allows companies to sell their receivables at a discount in return for cash. A number of suppliers and manufacturers such as apparel makers deploy factoring as way to hold them over until retailers pay.
One of the biggest questions now is how CIT’s own considerable problems will impact the retail sector — particularly with the crucial holiday season just around the corner. Last July, when the company announced that it had failed in its bid to secure a second government rescue retailers were girding themselves for the possible fallout. However, the worst-case scenario appears to have passed.
Craig Shearman, the vice president for government affairs at the National Retail Federation, a trade group, says that the timing of CIT’s bankruptcy has actually boded well for retailers. “We think we dodged a bullet for the holiday season,” he says. “If there had been a collapse in September it could have created a hole in the retail supply chain big enough for Santa Claus to drive his sleigh through. At this point, most merchandise is either in distribution centers or already on store shelves.”
So for now, CIT will be added to the growing list of taxpayer agonies. And as one of the largest corporate bankruptcies, it has demonstrated that it was certainly not too big too fail.
Back in September when the company was battling to stay alive and defending its decision to keep Peek on, I spoke with banking consultant Bert Ely, who had taken a look at CIT’s numbers and concluded: “Barring a miracle, CIT will end up in bankruptcy no matter who is CEO.”
Now that the company has indeed filed, I spoke once more with Ely. “I think it was almost the only step that they had available to them,” he told me. “It just wasn’t fundamental problems, but they had too much debt and their credit ratings were too low. Therefore they couldn’t earn a wide enough net interest margin to cover their operating expenses. Going forward the only way they could survive in the long term was to basically improve their credit ratings and the only way to do that is to convert debt to equity – and that is essentially what will happen with this prepackaged bankruptcy.”
In this scenario, the bondholders (along with the federal government) will take the biggest hit. CIT said that none of its operating subsidiaries (such as CIT Bank and Utah state bank) will be included in the filings, enabling its operating entities to more or less continue to run smoothly.
In the short term at least, CIT will emerge with a stronger balance sheet. The more difficult challenge for the company however will be if as Ely says, “it will still be considered a viable business going forward.” CIT which lends to some 1 million small and medium sized businesses has seen a number of its customers abandon them, concerned about securing their own financing.