CIT Execs Should Resign

I don't know who is supposed to be happy about the CIT bondholder-led financing. Certainly, not the shareholders, unsecured creditors or the non-participating bondholders. Nor the customers of CIT who are likely going to have to find alternative sources of financing when CIT does file Chapter 11 – and it will.

No, the only people who benefit from this "usurious" loan under "duress" are the participating bondholders (the "Passive-Aggressive Lenders" or "PA Lenders", for short).

And, perhaps, the Obama Administration which can now proclaim that capitalism finally exists and works in this country because it refused to provide TARP funds in addition to the $2.3 billion already provided.

Note: I use the appellation Passive-Aggressive Lenders because this is the same group of bondholders who has stood on the sidelines for the past several months, such as PIMCO, obviously waiting for a government-style bailout that wouldn't cost them a cent of principal. You know, the people like Bill Gross who presumably calls himself a capitalist even though he will gleefully promote government handouts or guarantees to serve his own agenda.

But when the government refused to play ball, the nice PA Lenders turned downright nasty and imposed "egregious terms" and what Sean Egan, president of Egan-Jones Rating Co., referred to as "Don Corleone Financing."

Let's consider the financing terms. A new lending facility of $2 billion initially. Fee for providing loan: 5% of principal amount or a quick $100 million. Interest payable at 10% over LIBOR, with a minimum LIBOR rate of 3%.

Therefore, the minimum interest charged will be 13% per annum. In exchange for the $2 billion, plus another $1 billion in less than a month (not sure if additional 5% fee applies to that sum as well, but why wouldn't it?), PA Lenders receive a security interest in previously unencumbered assets of CIT having a nominal value of at least five times the $3 billion loan amount.

Let's just say the PA Lenders received really, really good collateral coverage, or so it seems if the numbers bear any relationship to the truth. A good synopsis of the most relevant terms is set forth in a Bloomberg article entitled: CIT Rescue Group 'Ripped' Lender With 5% Fee, Collateral Demand.

Has anything been solved by CIT's new borrowing? Very little, if anything, as a bankruptcy filing is nearly inevitable. Why? Because CIT has lots of bad loans on its books and its good customers will probably jump ship as soon as they can find a more stable lender than CIT. In order words, CIT's business is kaput with or without a bankruptcy.

Who do we have to thank for this pitiful mess. Jeffrey Peak, CEO of CIT, and the Board of Wreckers, er ..., Board of Directors of CIT. By approving this financing deal, they committed one of the deadly sins of management (in addition to all their prior poor management decisions) ... believing that any alternative is better than a Chapter 11 which must be staved off at all costs no matter what. (Remember how GM sucked up TARP funds for months before it eventually had to file for bankruptcy anyway?)

While it's true that the date of bankruptcy has been temporarily delayed, the bond rating agencies and the FDIC, by their actions or inactions, don't seem convinced that CIT's problems have been adequately addressed by this pathetic stop-gap measure. On the other hand, CIT has now given up any negotiating power it may have had in a Chapter 11 with billions of dollars of unencumbered assets at stake. Hey, maybe a regular unsecured creditor/bondholder would have rather taken its chances with an unsecured claim equal in priority to the PA Lenders unsecured bondholder debt (the outstanding debt prior to the new $3 billion or secured debt).

Now, even though only the new financing is secured, the excessive fees and interest will surely more than compensate the PA Lenders for the new loan as well as a way to make back some money on the old stuff outstanding.

There was an interesting wrinkle along with the new financing. CIT has initiated an exchange offer to buy back $1 billion of bonds maturing in August for 82.5 cents on the dollar. So, while the PA Lenders loot the remaining unencumbered assets, unsecured bondholders who would have had a right to share in the proceeds of those assets until last weekend are being asked to compromise their claims.

Why should they unless shareholders are wiped out? Why should they now that the PA Lenders have extracted unreasonable loan terms from an insipid CIT? Frankly, I am surprised that the bondholders with upcoming maturities haven't filed an involuntary bankruptcy petition to stop this mismanagement of CIT's assets as they know for certain they are not going to be voluntarily paid in full.

In sum, the new financing was not commercially reasonable. It encumbered at least $15 billion or more of theretofore unencumbered assets. The fees (and there are many in addition to the initial financing fee) and interest rate on the new financing are unserviceable for any length of time. The CEO and the BOD have completely mismanaged the company to the brink of bankruptcy while begging for another government intervention as opposed to coming up with an intelligent strategy for restructuring the company months ago before it got to the brink or instituting an orderly wind-down of its assets with sufficient notice to its customers to find alternative sources of funding.

The CEO and BOD of CIT have exhibited an unforgivable level of incompetence. The only saving grace would be for the CEO to immediately resign or be terminated and then the last act of the BOD before resigning themselves would be to appoint a new CEO who knows how to liquidate a company that others have screwed up.

Disclosure: No position in CIT.