A prepackaged pratfall

CIT, a lender to thousands of small businesses, files for bankruptcy – Published on The Economist, Nov. 02, 2009.

THE most gut-wrenching failures may be over, but the financial crisis continues to claim the occasional big victim. CIT, a lender to small and medium-sized businesses, from clothing retailers to Dunkin’ Donuts franchisees, filed for bankruptcy on Sunday November 1st after failing to garner enough support for a debt-restructuring plan. With $71 billion in assets, the century-old firm is only one-ninth the size of Lehman Brothers, which collapsed in September 2008. Nevertheless, its Chapter 11 filing augurs ill for America’s corporate minnows, whose financing options have narrowed dramatically over the past year.

Financial-services firms have a harder time than most bouncing back from bankruptcy, because their business relies so heavily on trust, which has a tendency to evaporate in such situations. CIT has improved its chances by securing the support of the vast majority of its bondholders for a “prepackaged” filing that will reduce its debt by $10 billion while allowing its subsidiaries to go on operating. 

Among those persuaded to come on board is Carl Icahn, a veteran corporate gadfly who had been trying to derail CIT’s restructuring in the hope of profiting by picking through its entrails; he has even offered a $1 billion back-up loan. The firm’s advisers say it could emerge from bankruptcy by the end of the year …

… Whether pouring more money into CIT would ultimately have provided a better deal for taxpayers will never be known, but the politicians probably did the right thing. The market paralysis last year exposed serious flaws in CIT’s business model. Not only had it expanded rapidly in subprime mortgages and student loans but it relied on bond markets for most of its funding. When these seized up, it was soon left scrambling for cash.

The economic effects of the bankruptcy will probably be muted. It hardly comes as a shock, and CIT’s lending has already fallen to a shadow of previous levels. New loans this year have been running at a quarter of the level in 2007, when CIT handed out more than $35 billion (excluding trade financing).

Still, it is hardly cheering news for the thousands of small firms that rely on CIT and its kind for vendor financing, factoring, leasing, insurance and more. Unlike large companies, for whom bond markets have reopened, the small fry find that capital remains scarce (though demand for loans has also dropped). Other small-business lenders, too, have pulled in their horns. To help keep credit flowing, the Treasury has loosened the requirements for loans backed by the Small Business Administration, a government agency, and has eased access to public funds for community banks. These moves are yet to show much benefit.

Nor can clients count on CIT’s stay in bankruptcy going to plan. Filings by large financial firms, even those for which management and creditors have prepared, tend to throw up a host of unexpected complications. Moreover, the company’s fate rests with regulators as well as with the courts. CIT hopes to move some of its biggest businesses to its Utah-based bank subsidiary, but this is currently subject to a cease-and-desist order by the Federal Deposit Insurance Corporation and thus is unable to take new deposits. Even if this is lifted, the company is likely to be kept on a tight leash. For all its efforts to get back on its feet, there is still much for customers and trading partners to worry about. And if they lose faith, CIT might not have a business worth saving. (full text).

Link: Google News-results for CIT (on Nov. 03 /18.30 pm).

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