CIT kicks the ball down the road

July 20, 2009

What are the chances of this CIT deal actually preventing a bankruptcy filing, rather than just delaying it for a few months? At first glance, it would seem that the chances are good: why else would bondholders throw $3 billion of good money after the bad money they’ve already invested? But at second glance it’s not so simple: that $3 billion in new funding not only carries a double-digit interest rate, but is also secured by a whopping $10 billion in assets.

Consider the $1.1 billion of CIT debt which is coming due in August. Those bonds were changing hands last week at an extremely steep discount, which means that many of the current bondholders bought them at 50 or 30 or even 10 cents on the dollar. For those bondholders, this deal is a no-brainer. They’re advancing CIT enough money to pay off the August bonds in full, which means that they get to double their initial investment right there. They’re getting more than 10% interest on the money they’re lending. And they’re massively overcollateralized on that money, too, which means that their recovery given default is almost certain to be 100%. Add it all up, and you’re looking at a very high return for very little risk.

So where does that leave CIT? For one thing, it leaves the lender with no unpledged assets at all, which is not a position any financial institution likes to be in. But more to the point, the $3 billion is going to run out very quickly, some time in the first quarter.

Over the rest of this year, CIT is going to have to embark upon a series of debt-for-equity or debt-for-debt swaps, all designed to take out a huge chunk of those monster first-quarter maturities and allow the company time to start making money again. But it’s not clear why CIT’s bondholders would particularly want new equity or longer-maturity debt. And the one asset which Jeffrey Peek had to play with until this weekend — those $10 billion in unpledged assets — is now spoken for.

This deal makes sense for the lenders, then, and at worst delays the inevitable for CIT. But it’s still far from clear that the private sector is capable of putting together a lasting solution to the problem of a leveraged financial institution facing a massive liquidity crisis.

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