After rumors were publicized Tuesday in The New York Post that CIT's (CIT) creditors, including John Paulson & Co, were considering a merger of CIT into IndyMac, its stock shot up on the hope that a rescue plan was in place. Wednesday morning, The Wall Street Journal killed any remaining hopes for CIT's shareholders with an article reporting that the company's assets would either be turned over to bondholders or the company would face bankruptcy. Either scenario would leave shareholders with nothing.
The bigger question, is what will happen to retailers? Did CIT extend its life long enough when it got the emergency funding last August to avoid a major problem for retailers this Christmas shopping season?Last July, retailers were worried that if CIT went bankrupt, they would have nowhere to turn for cash. Retailers place their orders for fall and winter during the summer months. Without cash from CIT, many suppliers would not be able to buy the materials they need to produce goods. That in turn left retailers worried; without goods to sell, there would be no chance of recovery during Christmas -- the best selling season of the year.
CIT's role in all this was that when stores placed orders for merchandise, they did it on credit. Then, they had two to three months to pay the bill. Manufacturers raise cash to buy raw materials by selling these IOUs -- a process called factoring. Without that cash, suppliers would have been unable to buy the raw materials and store shelves would be emptier this Christmas season (though given the current economic conditions, retailers probably ordered less this year anyway).
CIT provides funding for about 760 manufacturers and 3,000 retailers, according to internal reports. While large consumer products companies get credit directly from banks, small businesses must turn to companies like CIT, which is the largest funding source for many small businesses. Franchisers, such as Dunkin Donuts, also fear for their futures if CIT fails. Without it, they may not be able to get the money they need to open new stores or expand operations.
With credit markets still tight and the big banks not lending, small businesses have nowhere to turn but to companies like CIT to raise the cash they need to operate. While some call CIT a loan shark for the interest rates it charges small businesses, others think of it as their only lifeline.
Based on the Journal's report today, CIT has one of two options: working out a new debt deal with bondholders or filing for bankruptcy. The deal on the table would eliminate 30 to 40 percent of its $30 billion in debt. The remaining debt would be exchanged for longer-term debt secured by CIT assets, as well as nearly all the company's equity -- wiping out shareholders.
If bondholders don't accept this offer, bankruptcy is likely. If CIT does file for bankruptcy it will be the fifth-largest filing by assets in U.S. history. CIT says it hopes to be in and out of bankruptcy in 45 days if a deal with creditors can be made.
Taxpayers will also lose if CIT goes under. In December 2008, CIT got $2.3 billion under the TARP program that will likely never be repaid. The company sought more help from the government this spring and summer, when it wanted to use the FDIC's debt guaranty program as part of its rescue attempts. It was refused by the FDIC.
Most likely, a CIT failure at this time won't impact the holiday season this year, because goods already have been manufactured and shipped. By next year, other companies should pick up the slack if CIT does end up in bankruptcy and never emerges.
Lita Epstein has written more than 25 books, including Trading for Dummies and Reading Financial Reports for Dummies.
Professional Vs Do it Yourself Investing
Should you get advice or DYI?View Course »