CIT May Pit Bondholders Against Each Other With Debt Swap Offer

By Pierre Paulden and Linda Shen

Oct. 1 (Bloomberg) -- CIT Group Inc., the 101-year-old commercial lender, will seek board approval as soon as this week for a voluntary debt exchange that may pit bondholders against each other and leave shareholders almost wiped out.

The company has been in talks with a steering committee of bondholders before a deadline today to present a restructuring plan, according to a person familiar with the matter who declined to be identified because the negotiations are private. At the same time, New York-based CIT is proposing that debt holders vote on a pre-packaged bankruptcy plan in case the exchange fails, the person said.

CIT may adopt a plan similar to one used by Residential Capital LLC in December in which the company offered higher priority for repayment to holders of bonds that mature sooner, according to Adam Steer, an analyst at CreditSights Inc. in New York. CIT needs to exchange debt to raise sufficient equity to meet Federal Reserve capital requirements and fund itself, he said.

“We have seen exchanges in the past that pit long-dated bondholders against short-dated bondholders,” Steer said in an interview. “We believe CIT’s exchange could have a similar dynamic.”

A CIT spokesman, Tim Lynch, declined to comment on the exchange terms.

CIT needs to cut debt after posting more than $5 billion in losses during the past nine quarters and losing access to the unsecured debt markets it relied on for funding. The company said in July it may seek court protection from creditors after Chief Executive Officer Jeffrey Peek failed to win a second government bailout and had to turn to bondholders for $3 billion in rescue financing.

Bondholder Protection

The cost to protect CIT debt from default through Dec. 20 jumped 4 percentage points yesterday to 26 percent upfront, according to CMA DataVision. The cost of credit-default swaps implies that traders have priced in a 45 percent chance the company defaults in three months, an increase of 7 percentage points, a standard pricing model used by Bloomberg shows. The model assumes investors could recover 40 cents on the dollar in a bankruptcy proceeding.

CIT said in an Aug. 17 regulatory filing that it has to come up with a plan “acceptable” to the majority of a bondholder steering committee that provided it with emergency cash by Oct. 1.

The restructuring plan for CIT, which had a net loss of $1.62 billion in the second quarter, may include debt-for- equity-swaps and offers to extend debt maturities, CIT said in an Aug. 17 regulatory filing.

“To do what they want to do out of court, they need very high consent levels to eliminate the problem of holdouts,” said Kevin Starke, an analyst at CRT Capital Group LLC in Stamford, Connecticut.

Court Authority

If CIT fails to convince enough creditors in each class of bonds to swap their debt, the company can file for bankruptcy and use the “authority of the courts to force the rest of each class to take the deal offered,” he said.

About $9.14 billion of CIT loans and bonds mature through 2010, including $1.15 billion by the end of this year, according to data compiled by Bloomberg. The company has $43 billion of loans and bonds, Bloomberg data show.

CIT fell 99 cents, or 45 percent, to $1.21 in New York Stock Exchange composite trading yesterday, contributing to a 73 percent decline this year.

CIT’s $750 million of 4.75 percent notes due December 2010 declined 2.125 cents to 69.375 cents on the dollar, according to data from Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The $750 million of 6.1 percent notes due in March 2067 fell 3.25 cents to 15 cents on the dollar, Trace data show.

Bankruptcy Chances

The cost to protect against a CIT default for five years rose to the highest since Sept. 21. Credit-default swaps increased 2 percentage points to 36 percent upfront, according to CMA DataVision.

That means it would cost $3.6 million initially and $500,000 annually to protect $10 million of CIT debt from default for five years. The cost suggests traders have priced in an 83 percent chance of default by December 2014.

“It’s still highly possible they end up in bankruptcy court,” Steer said. The company needs to balance the demands of holders of near-term debt with the longer-dated bonds, he said.

In a pre-packaged bankruptcy, a company and its creditors agree to a reorganization plan before the business files for protection.

“If bankruptcy is inevitable, a pre-pack is a cleaner option to resolve claims quicker,” said Brian Charles, a debt analyst at brokerage firm RW Pressprich & Co. in New York. “If the company feels it can manage through the bankruptcy quickly, it can preserve franchise value.”

Ripple Effect

CIT funds about 1 million businesses from Dunkin’ Brands Inc. in Canton, Massachusetts, to Eddie Bauer Holdings Inc., the bankrupt clothing chain in Bellevue, Washington. The company says it’s the third-largest U.S. railcar-leasing firm and the world’s third-biggest aircraft financier.

A collapse would ripple across the “small and medium-sized businesses who rely on CIT to operate -- to pay their vendors, ship goods to their customers and make their payroll,” CIT said in internal documents obtained by Bloomberg News in July that make the case for its importance to the U.S. economy.

A pre-packaged bankruptcy would “wipe out the common equity” of CIT, said Sandler O’Neill & Partners LP analyst Michael Taiano in New York.

CIT is considering an offer of financing from Citigroup Inc. and Barclays Capital, according to other people familiar with the situation. Bondholders are also seeking to provide about $2 billion in loans as the restructuring deadline approaches, the people said. CIT may choose other options, they said.

Spokesmen for Citigroup and Barclays Capital and declined to comment.

To contact the reporters on this story: Pierre Paulden in New York at ppaulden@bloomberg.net; Linda Shen in New York at lshen21@bloomberg.net