Commentaries

Who will be CIT’s Buffett?

The behind-the-scene negotiations surrounding CIT Group’s threatened bankruptcy filing is bringing to mind the 2001 collapse of Finova, another sizeable mid-market lender.

 On the eve of Finova’s bankruptcy filing in March 2001, Warren Buffett seemingly came to the rescue with a $6 billion loan package to help keep the financial firm running in bankruptcy and payoff creditors. The financial package, which Buffett put together with Leucadia National Corporation, came from a new company called Berkadia.

The offer from Buffett set-off an usual bidding war for the right to provide rescue money to the bankupt company. Rival bids soon emerged from GE Capital and Goldman Sachs.

Ultimately, the Buffett and Leucadia partnership prevailed. Finova, which did a lot of factoring for mid-sized companies like CIT, emerged from bankruptcy and the loan was paid off several years ago.

Finova shareholders, of course, lost out in the bankruptcy. But the firm’s creditors were treated rather well and the firm was able to continue running some of its lending business.

Right now, Reuters and others are reporting that Goldman Sachs and JPMorgan Chase are talking about providing some short-term financing of up to $3 billion to CIT. But CNBC is also reporting that the banks may be talking about providing CIT with bankruptcy financing to continue operating.

If I had to place a bet, it’s looking like a Finova all over again.

The Factor

Don’t worry this is not a column about Bill O’Reilly, the voluble Fox News personality. No, what I’m talking about is the bread-and-butter business of CIT Group, the mid-market lender now limping along on life support.

The Wall Street Journal today wrote one of the first decent articles discussing CIT’s importance in the world of factoring–an ancient form of business financing that CIT long dominated in the US.

In short, a factor is a lender that provides a company with upfront cash for the contractual right to collect on its account receivables. The company sells this contractual right at a discount to the full value of the receivables that it could in theory collect at a later date.

The factor is responsible for collecting on those receivables and gets to pocket the difference between what it paid for that right and the amount it actually collects. It’s a low-margin business, but one that provides a valuable means of financing for companies with inconsistent cash flows.

In New York, for instance, factoring has been the lifeblood for many a garment industry company.

I know a little about this because my father, an attorney, for years helped many garment industry clients negotiate factoring deals with CIT and other factoring firms. I remember how pleased it made my dad to see a Law & Order episode that actually involved some wrongdoing involving a factoring firm. I can’t remember the plot line but a murder was involved. Isn’t that always the case?

One of the big concerns about a CIT bankruptcy is that companies that rely on the lender for factoring will be sent scrambling to find alternative financing. The trouble is most commercial banks don’t like factoring because of its low-margins and it’s seen as a grubby, bottom of the barrel trade.

CIT doomed by PE

The most compelling argument for saving CIT Group from collapse is the impact it would have on small- and mid-sized business that depend on the New York-based lender for financing. But it’s increasingly looking like that argument is more hype than anything else.

First of all, CIT pretty much hasn’t been doing any new lending for the past six months, when its financial troubles really began to mount. Most of the lines of credit the firm has out to hundreds of thousands of small companies were arranged long before the collapse of Lehman Brothers.

Second, and maybe the best reason for letting CIT fail, is that a good number of CIT’s financing deals are with companies owned and operated by private equity firms. Our sister publication PEHub reports that in recent years, CIT has moved aggressively to provide financing to mid-sized companies that were taken over in leveraged buyouts. PEHUB has found at least 36 PE-owned companies that CIT is the primary lender to.

For instance, CIT has provided the bulk of the financing to Texas-based chain CiCi’s Pizza, acquired by Canadian private equity firm Onex in 2007. CIT’s financing has been provided the fuel for the chain’s rapid expansion.

Sure, the PE-owned companies are small- and mid-sized businesses. But this isn’t mom and pop we’re talking about here.

And CIT hasn’t just been a lender to PE-owned companies, it’s also arranged deals through its investment banking arm.

The case for saving CIT becomes a lot less compelling when you realize that an indirect beneficiary of keeping the lender afloat will be the strip-and-flip crowd. The idea of bailing out CIT to save the investment returns of PE funds isn’t too compelling. In fact, it would make for bad public policy.

Could Goldman pinch CIT?

It appears the federal government is on the verge of walking away from CIT Group and the same can be said for Goldman Sachs–even though the investment firm is one of the mid-market lender’s biggest bankers.

On Monday, I suggested that Goldman CEO Lloyd Blankfein could turn around the public’s nasty impression of his Wall Street firm by stepping in an buying-out CIT. But I didn’t really expect it to happen. Then yesterday there was a rumor floating around that Goldman, with the tacit support of the Obama administration, was trying to put together a private-sector bailout package for CIT.

That rumor, however, proved to be idle hedge fund specuation. It doesn’t appear Goldman, which says it has no material exposure to CIT, will be part of the CIT solution. Goldman says it has sufficient collateral from CIT and from unspecificed hedges, to minimize any of the risk it may have on a $3 billion secured line of credit.

But it appears Goldman may have a good reason to stand pat and let CIT sink or slowly drown. A hedge fund source just reminded me that last October–just as the financial world was melting down–Goldman announced it had closed a $10.5 billion fund to make “senior secured loans” to companies.  This is how GS Loan Partners describes itself on a Goldman website:

Our focus is on originating loans for mid- to large-sized leveraged and management buyout transactions, recapitalizations, refinancings, financings, acquisitions and restructurings for private equity firms, private family companies and corporate issuers.

Leaving aside the LBO-stuff, that sounds a lot like the kind of business CIT had been famous for. It makes you wonder if there is any angle Goldman isn’t playing?

UPDATE:

Who pays on Goldman’s CIT hedges

Goldman Sachs keeps saying it has no exposure is CIT Group were to go bust, even though it has a $3 billion line of credit to the ailing mid-market lender.

David Viniar, the investment bank’s CFO, reitereated that mantra today during a conference call with analysts, saying Goldman has sufficient collateral and hedges to render any losses on CIT immaterial. Of course, that’s what Goldman said about its exposure to American International Group, even after taking $13 billion from the Fed to retire some CDOs that AIG had written credit defaults swap on.

But let’s take Viniar’s word on CIT. John Carney over at Clusterstock raises an interesting question in wondering just how Goldman has hedged itself and which parties may stand as potential paying counterparties to Goldman.

Sure, maybe Goldman can easily withstand a CIT collapse. But what about the counterparties that have provided the hedge to Goldman.

Goldman’s “True Blood” moment

-Matthew Goldstein is a Reuters columnist. The opinions expressed are his own.-

Goldman Sachs CEO Lloyd Blankfein has an image problem on his hands.

The most ardent critics of his firm are likening it to a blood-sucking vampire, while others simply see the Wall Street investment bank as a greedy and ruthless financial titan. But there is a way for Blankfein to start turning public opinion around, and that involves a quick buyout of ailing mid-market lender CIT Group, which provides financing to some retailers, manufacturers and aviation operators.

While a collapse of New York-based CIT would not pose the kind of systemic risk that last September’s bankruptcy of Lehman Brothers did, the lender’s sudden disappearance from the market would make it even more difficult for some small- and mid-sized American companies to finance their operations.

A CIT bankruptcy would also prolong the worst recession since the Great Depression and rekindle investor jitters about the overall strength of the financial sector.

But Goldman could easily avert a crisis in mid-America by swooping in and buying the lender, which has some $60 billion in debt. It wouldn’t take much for Goldman, which last summer provided $3 billion in secured financing to CIT, to get a deal done.

CIT’s market value is $451 million and falling fast. In a bankruptcy, the shares would be all but worthless. So the company, which must deal with $10 billion in maturing debt next year, could be had for considerable discount.