Sense on Cents

Desperate companies, just like desperate individuals, will take desperate measures when pushed to the brink.

We clearly see this as the terms of the CIT financing arranged over the weekend are released. Bloomberg exposes this loan sharking in reporting, CIT Hit With Interest Rate More Than 25 Times Libor:

CIT, the 101-year-old commercial lender struggling to retire $1 billion of debt maturing next month, agreed to pay a 5 percent fee to the creditors and annual interest of at least 13 percent. On top of that, the New York-based company pledged assets worth more than five times the amount of the loan as collateral.

“The terms are egregious,” said Dwayne Moyers, the chief investment officer at Fort Worth, Texas-based SMH Capital Advisors, which oversees $1.4 billion, including more than $70 million of CIT bonds. “They ripped the faces off everyone with these terms.” (LD’s highlighting)

The rate on the financing was initially released as 10.5%. That level looks downright cheap compared to these terms.

The question begs, though, whether even under these terms CIT will survive:

CIT, led by Chairman and Chief Executive Officer Jeffrey Peek, said in a regulatory filing yesterday that the loan doesn’t solve the funding challenges and it may be forced to seek bankruptcy protection unless holders of $1 billion in floating-rate notes due Aug. 17 accept 82.5 cents on the dollar for the debt.

I addressed the concerns CIT immediately faces in writing yesterday “CIT-go Into Bankruptcy?” A question I raised:

> Were certain unsecured creditors just abused by this transaction?

Though neither CIT nor the creditors providing the $3 billion in new capital will publicize it, these lenders hold secured debt and as such they just stepped in front of a wide array of unsecured creditors in a likely bankruptcy. Who are some of these unsecured creditors? Small and mid-sized retail outlets and franchises which pledged receivables for future credit.  CIT will pay 10.5% and pledged $30 billion in face value of assets/receivables as collateral for the $3 billion loan.  Will the small and mid-sized companies be able to tap their credit lines? Great question.

I obviously stand corrected in terms of the rate on the loan.

The outlook for unsecured creditors (customers who have pledged assets/receivables and other bondholders) remains decidedly challenged as Bloomberg asserts:

The company has said its 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.

“As a CIT unsecured bondholder you’re better off than you were on Friday, but if they go into bankruptcy you’re not going to be too happy other holders jumped ahead of you,” Cohen said.

Bondholders that didn’t participate in the rescue financing may fare worse in a CIT bankruptcy because so much of the assets are pledged as collateral, said Adam Cohen, founder of debt research firm Covenant Review LLC in New York.

In regard to the secured creditors involved in this specific $3 billion financing, they are going to do just fine. Make no mistake, this financing was no mission of mercy, nor should it be, but as Bloomberg highlights:

“This is called Don Corleone financing,” Egan said, referring to the patriarch in the organized-crime family depicted in the 1972 film, “The Godfather.” “You can’t lose money on this deal.”

Outside of the “urban underworld,” Egan, 52, said he couldn’t recall seeing a loan backed by as much collateral that paid interest rates so high. “These terms would make a pawn- shop operator blush.”

What will this loan shark financing do for lending to small and medium sized companies? Well, do you know any businesses which can afford to pay 14% so CIT can make .50% on this financing?

LD