CIT Group Inc, a century old lender to hundreds of thousands and small and medium-sized businesses, filed for bankruptcy on Sunday, as the global credit crisis left it unable to fund itself and the recession clobbered its loans.
The bankruptcy, one of the largest in U.S. corporate history, has been widely expected for months and is unlikely to provide a massive near-term shock to the financial system. But CIT's failure could further constrict credit and weigh on the fragile U.S. economy.
It takes out another source of capital for small businesses, and there are not a lot of companies anxious to make loans available to that group now, said Blake Howells, head of equity research at Becker Capital Management in Portland, Oregon.
The bankruptcy is also a stinging blow for the U.S. government, which invested $2.33 billion in CIT in December through the Troubled Asset Relief Program. Taxpayers will receive money only after bank debt and bond investors are repaid. The loss is among the biggest yet for TARP.
Most of CIT's creditors have already approved its reorganization plan. Getting through bankruptcy quickly is crucial for CIT if it wishes to keep its customers, which include Dunkin' Donuts franchisees and film producer Dark Castle Entertainment.
The longer a financial institution stays in bankruptcy, the more the value of the business dissipates. It's faith and trust and perception that are so important for a financial institution, said Jack Williams, a bankruptcy law professor at Georgia State University College of Law.
CIT's operating subsidiaries, including CIT Bank, are not included in the bankruptcy filing, and expect to continue operating, the company said in a statement.
CIT, which filed for bankruptcy protection in the Southern District of New York, plans to reduce its total debt by about $10 billion in bankruptcy. As of the middle of this year, it had $71 billion of assets and $64.9 billion of debt.
Under the bankruptcy plan approved by bondholders, creditors will end up owning the company. Most bondholders will also end up with new CIT debt worth about 70 percent of the face value of their old debt. Preferred shareholders, including the U.S. government, will get money only after other creditors are paid back. Current common shareholders will receive nothing.
A BROKEN MODEL
CIT financed itself mainly by borrowing from bond markets, which has proven to be a flawed strategy as the credit crunch that began in 2007 has made it much more expensive for troubled companies to fund themselves.
Numerous other financial companies that relied heavily on bond investors to fund themselves -- including Fannie Mae, Freddie Mac, and Lehman Brothers -- have failed.
CIT has historically been one of the biggest lenders to small and mid-sized businesses, a sector that is starved for credit now. U.S. President Barack Obama is offering taxpayer money to community banks in an effort to kickstart lending to these companies, which employ about half of the U.S. work force.
CIT had hoped that its status as a major lender to small businesses would help it win more political support. But in July, the Federal Deposit Insurance Corp refused to guarantee CIT debt issuances, and the company scrambled to find other ways to fund itself.
A group of CIT bondholders lent it $3 billion in July, on a secured basis, and the company found bond holders willing to exchange $1 billion of old debt for new securities.
Those moves bought CIT some time, but it still had about $800 million of unsecured debt maturing in the beginning of November, and more than $3 billion of unsecured debt maturing by the end of March.
CIT has said it hopes to move some of its businesses, including small business lending and vendor finance, to its bank subsidiary and to eventually fund new loans from the bank.
(Reporting by Dan Wilchins and Elinor Comlay; Additional reporting by Caroline Humer; Editing Bernard Orr)