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.

Consumer Confidence Perception v. Economic Reality

Funny how economic statistics sometimes mean something and sometimes don't -- even when released on the same day and appearing to be somewhat inconsistent. But apparently perception is more important that reality because the Consumer Confidence Index (a simplistic measure of consumer sentiment and perception) rose to 54.9% in April from 40.8% in May whereas the S&P/Case-Shiller National Home Price Index fell at a record annual pace of 19.1%. Stated simply, home prices continue to decline at the fastest rate in history with no relief in sight. We have perception unsupported by behavior, on the one hand, versus a report detailing actual, not supposed or possible behavior, on the other hand. Stock market reaction: positive perception sounds better than negative reality ... let's rally on karma.

Aside from slumping real estate values, consumer credit continues to shrink and unemployment is expected to crest somewhere over 10% but not until next year. Sounds like eroding buying power to me, but I tend to prefer economic indicators based on facts, not unrealized fantasy. So how can consumer confidence rise so dramatically when home prices are falling so dramatically? A very good question but I doubt they asked it to the 5,000 households comprising the Consumer Confidence Index.

But let's try to look at this dispassionately. Where is consumer buying power going to come from as credit card debt limits contract and new credit card debt will likely carry higher interest rates at least once the just passed Credit Card Bill of Rights goes into effect. Moreover, home equity lines are no longer available at anywhere near the dollar level (we're talking trillions here) before the current financial crisis as 30% of the homes in this country already are underwater on their mortgages. So, who is going to fund the recovery when the statistical recession ends. The increasing number of unemployed and those who fear for loss of their jobs as well? Or others without access to credit?

Have you seen the empty stores lining the malls, at least in the malls that are not yet shuttered? Apparently, that doesn't matter to the bulls either because unemployment and lost real estate values are already factored into the the stock market. The bulls say, "it can't get much worse." Does that Orwellian thinking equate to additional dollars at the cash register or make you feel "confident"?

The market, say the perma-bulls explicitly or by implicaton, is discounting all of the actual negative news because there are people saying that they are more confident about the economy. I don't buy that Twitteresque status report. Rather, I think this rally is nothing more that a "ponzi" scheme of sorts. The Wall Street gang keeps telling everyone that the sky isn't falling so the retail investor, directly or indirectly through increased inflows to mutual funds, will buy stock even though there is very little, if any, real reason to do so. Finally, when the over $1 trillion of bonds supported by cratering real estate craters, the stock market will follow suit.

Have we learned nothing in the last year? Inflated real estate values, coupled with egregious underwriting standards and ill-conceived governmental policy, led to the real estate bubble. Now, the same robber-barons that levered us into this mess are trying to suck everybody back into the game. And the Obama Administration and the Federal Reserve are all adding to this frenzy. The FED is printing money with reckless abandon and buying back the Treasury Bonds it issues to finance the debt. In other words, the FED is buying back the debt it issued with phony money. The debt that the Chinese and the OPEC countries no longer want to purchase without assurances that their investment won't be flushed down the toilet with all the toilet paper being manufactured by the FED.

We are issuing debt in this country as if we don't have to pay it back or with the assumption that people will buy it and agree to be paid back with dollars that are worth less in the future. We are headed for inflation armageddon unless we can somehow snooker foreign investors back to the casino where they lose no matter how they play. What do I mean by that? If they continue to finance the U.S. debt unabated, they will surely lose value on their investment as the dollar is devalued due to gargantuan future U.S. debt obligations. If they stop buying U.S. debt, the FED still continues to crank out bogus money now (as opposed to later to pay back debt in the former scenario), thereby destroying the value of current debtholders' investments in U.S. bonds and currency.

But everything is rip-roaringly fine according to the same characters who didn't think they could lose with 30 or 40 to 1 leverage. Yet, they did. How's that consumer confidence going for you now?