CIT on the rocks - FDIC Said to be Unwilling to Back CIT Debt on Risk

Notes still worth 70 cents on the Dollar ? Company in contact with a bankruptcy law fiem ? Sounds to me like some tug-of-war between CIT and FDIC´s Bair...

CIT bonds are 3 to 7 points lower across the board, according to quotes from online trading platform MarketAxess. Its 5.60% notes due 2011, for example, are 7 points lower at 72 cents, while its 5.125% paper due 2014 is off 3.5 points at 54 cents.

 

CIT can refinance itself on the backs of the shorts.

Take it back to 20.

 

The short-term financing crisis over at CIT is gaining momentum after Moody’s slashed the corporate lender by four levels to B3 from Ba2 on Monday.

By the way, if you’ve not heard of CIT, this is probably a good time to get acquainted with the company. Bloomberg reports CIT is the third-largest US railcar-leasing firm and the world’s third-biggest aircraft financier. It also funds about 1m businesses, including 300,000 retailers. In short, Barclays Capital estimates that if the company was to fail it would be the fourth-largest bankruptcy by assets in US history, in between General Motors and Enron.

The issue at hand, of course, is whether CIT will be able to honour about $1bn worth of floating-rate notes maturing this August. As yet, it has been unable to issue any new bonds to cover the short-term financing gap it is facing. Adding pressure too is the fact that the FDIC has already said it will not stand behind CIT’s debt should the company default.

Interestingly, Barclays says that on paper, the company should in theory have had enough cash to survive until the first quarter of 2010. However, that picture could have drastically changed if cash has been falling faster than projected due to deposit outflows and customers drawing on credit facilities. If that is so, the company could now report a loss of as much as $500m according to the analysts when it announces earnings on July 23rd, which would see it fail its minimum total capital ratio and force it into bankruptcy.

Given its prominent position, however, the analysts are hopeful some degree of government support will eventually come CIT’s way. Accordingly they give the outright probability of a CIT bankruptcy about a 30 per cent chance. That also has much to do with the alternative options CIT still has to raise cash.

One real option, according to the analysts, is a debt exchange for its longer-term debt, a mechanism that is gaining popularity by the day in the distressed corporate sector. As the analysts write:

We believe CIT could attempt to extend the maturities of front-end debt by offering a voluntary exchange. The example we cite as an illustration of a similar transaction is the exchange announced by ResCap in May 2008 (see our report titled ResCap: Valuing the Exchange Offer). This deal offered front-end bondholders a priority claim on assets in exchange for extending maturities and reducing principal. Bondholders accepted the deal because they feared bankruptcy and because they gained a priority claim on assets. We believe CIT could attempt something similar to extend the $11.2bn of debt maturing in 2010 and 2011 (excluding the bank lines). A debt exchange is unlikely to eliminate the risk of bankruptcy, but it could delay it for a number of years. We note that an exchange such as ResCap’s would not trigger CDS.

An exchange could be used to raise capital in addition to alleviating liquidity risk. If bonds are exchanged at a discount to par, as they were in the case of ResCap, capital is created. If CIT offered to exchange 2010 and 2011 debt at a discount of 20%, which we believe investors would accept if offered a priority claim on assets, $2.2bn of capital would be created (20%*$11.2bn). This would help fix CIT’s capital shortfall.

If CIT does successfully manage to get such an exchange underway it might be enough to see it fulfil its minimum total capital ratio in August. Furthermore, success on this front could be enough to persuade the FDIC to grant limited access to its Temporary Liquidity Guarantee Program, opening the door to longer-term support.

Another route, however, is using some of its $48bn worth of unencumbered assets — mostly in the form of finance receivables or operating lease equipment — to raise cash via secured borrowing.

But there is a problem. As Barclays highlights, the small print on CIT’s covenants says:

SECTION 6. NEGATIVE COVENANTS

The Company hereby agrees that, so long as any Commitment remains in effect, or any principal of or interest on any Loan or any other amount shall be unpaid hereunder, the Company shall not: 6.1. Negative Pledge. (a) (1) Create, incur or suffer to exist any Lien upon any of its property or assets to secure indebtedness for money borrowed, incurred, issued, assumed or guaranteed by the Company or (2) create any Lien upon any of its property or assets to secure any indebtedness or other obligations of any Person if such Lien is a Lien created by any action of the Company (including any grant by the Company of any Lien pursuant to a written instrument or by the pledge by the Company of property, but excluding Liens arising by operation of law), without, in the case of any Lien described in the foregoing clauses (1) and (2), thereby expressly securing the due and punctual payment of the principal of and interest on the Loans and all other amounts payable by the Company hereunder equally and ratably with any and all other obligations and indebtedness secured by such Lien, so long as any such other obligations and indebtedness shall be so secured….”

That pledge effectively limits the company’s ability to incur secured debt or to subordinate existing senior debt. This could create a bit of a catch-22. If CIT does try to leverage capital via debt exchange or cash on its hereto unencumbered assets — would the move be treated as a breach of its covenants? But, as Barclays also notes, CIT has already managed to circumvent the clause by moving assets into subsidiaries and to date has some $18bn of secured debt. There could still be hope.

But, even if it does manage to shuffle the liabilities around in time to raise enough capital, Barclays admits the lender may still be vulnerable in the longer term.

Firstly, there’s the firm’s transformation into a bank holding company for the purpose of qualifying for the government bailout. This, ironically, could now expose it via its depositary institution the CIT Bank of Utah. In the first quarter the bank reportedly held some $3.5bn in deposits. A run on the bank here, say the analysts, could trigger the seizure of its banking arm and through that accelerate the CIT’s group path towards bankruptcy.

Meanwhile, raising cash via secured borrowing, while positive for front-end bondholders isn’t so good for the company’s longer-term bondholders. Accordingly, it would unlikely restore the firm’s ability to tap fresh funds via new issuance. As Barclays concludes:We believe secured borrowing remains a viable alternative for the company to gain access to a large amount of cash, which could then be used to meet upcoming debt maturities. Once again, the outcome of this solution is positive for front-end bondholders, as the probability of near-term default is lowered, and is negative for intermediate and longend bondholders because expected recovery will decline.

Either way July 23rd should certainly be circled as a key date this summer.

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