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CIT: Economic Risk and Buying Enough Time

July 21, 2009

While we posted yesterday that the CIT crisis was going to be averted for a few days, today’s news and analysis reports that it may not be the case.  The cost of the money that has been loaned by bondholders is 10.5%, which is higher than the usual rate of interest that CIT charges.

According to an article on Dow Jones Newswire today:

CIT is seeking to reduce its debt burden in a tender offer for $1 billion of its bonds. CIT said in the filing if it doesn’t get enough of its outstanding floating-rate senior notes due Aug. 17 tendered, it may need to file for bankruptcy protection, absent additional financing.

CIT also said the government judged the company it needs about $4 billion in additional regulatory capital, including an extra $2.6 billion in tier-one capital, following a stress test.

What this means is that the US government has said that the company needs a bailout (not a government bailout, but a bailout from another source) of $4 billion to escape its collision course with failure and turn things around.  On Sunday night, an agreement was reached to provide the bank with $3 billion of this $4 billion. The cost for the $3 billion was high at 10.5%.  The company is now trying to reduce their debt load by buying back some of their bonds, which are essentially promissory notes or IOU’s, at 83.5 cents for every dollar of their estimated worth.

The basic idea here is that over 90% of the people who hold these bonds need to accept a reduced amount for their notes, or the company could go into bankruptcy protection.

CIT is also supposed to pay off more than $8 billion in loans by the end of 2010.

To make matters worse, CIT customers that have lines of credit are drawing down the funds in case CIT does become insolvent. This quote is taken from this Bloomberg article:

Since late June, CIT has “experienced a significant increase in the draws” on its financing commitments, which has “significantly degraded the company’s liquidity position,” the lender said in the filing.

The drawdowns exacerbate CIT’s liquidity constraints, said Randy Marshall, a New York-based managing director at Protiviti, a consulting and auditing firm.

“This, combined with the stress from the bondholders and the inability to access the credit markets, is really an extremely difficult situation for an organization that, historically, hasn’t had a big deposit base and relied on the credit markets,” Marshall said.

The article goes on to say

CIT has said a bankruptcy would put 760 manufacturing clients at risk of failure and “precipitate a crisis” for as many as 300,000 retailers, according to internal documents.

… [credit default swap] traders have priced in a more than 90 percent chance that the lender will default within the next five years, according to a standard pricing model.

Here is the Bloomberg video report on it:

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