CIT Rescue Marks Shift in Crisis

By STEVENSON JACOBS and DANIEL WAGNER

posted: 131 DAYS 3 HOURS AGO

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NEW YORK (July 20) - It's a new twist in the financial crisis: A major bank on the verge of a last-minute rescue — only this time the bailout isn't coming from the government.

A proposed $3 billion rescue of commercial lender CIT Group by its bondholders is the first time since the banking crisis erupted that private investors are stepping in to save a big financial firm without federal help or oversight.

The deal, details of which were still being worked out Monday, suggests the appetite for risk in the private sector is increasing, analysts said. It also could provide a framework for other financial rescues if Washington is turning off the bailout spigot.

The tentative deal was approved by CIT's board Sunday night, according to two people briefed on the talks who requested anonymity because the negotiations were confidential. Details were still being ironed out, with no guarantee the plan wouldn't fall apart.

Still, the deal, along with robust earnings reports last week by several big banks, raise hopes that private capital can start flowing again into the beaten-down banking industry, analysts said. That was all but unthinkable just a few months ago.

"You've got private money coming in and essentially giving a vote of confidence" in banks' future profitability, said Vincent Reinhart, former director of the Federal Reserve's monetary affairs division. "It's encouraging."

CIT lends money to nearly a million small and midsize U.S. companies. It was forced to turn to bondholders for help after the government refused to save the company last week, a sign the administration is pulling back on costly and unpopular bank rescues.

The lifeline for CIT, whose clients include Dunkin' Donuts franchises and clothing maker Eddie Bauer, aims to sustain the company long enough for it to restructure its debt. It does not guarantee CIT will avoid bankruptcy. The company has a $1 billion payment due in August.

The deal would give CIT $3 billion of short-term financing at an interest rate of about 10.5 percent, said another person close to the negotiations who was not authorized to discuss the matter publicly.

Investors embraced the proposed deal. Shares of CIT jumped 55 cents, or 78 percent, to $1.25 in trading Monday.

"It tells me that the appetite for risk is increasing, and people are betting that a recovery is coming," said William Larkin, fixed-income portfolio manager at Cabot Money Management in Salem, Mass.

CIT representatives didn't immediately return calls seeking comment on the financing deal.

Had CIT been allowed to collapse, some experts feared it would have dealt a crippling blow to an economy still bleeding hundreds of thousands of jobs a month despite a nearly $800 billion federal stimulus program.

The retail sector would have been hit especially hard. CIT serves as short-term financier to about 2,000 vendors that supply merchandise to 300,000 stores, according to the National Retail Federation. Analysts say 60 percent of the apparel industry depends on CIT for financing.

"If CIT had gone under, that would have left a huge hole in the supply chain," said Craig Shearman, a spokesman for the National Retail Federation, one of the trade groups that had urged the government to prevent CIT's collapse.

By not getting involved, the administration gambled CIT was not so enmeshed with the financial system as companies like Citigroup, Bank of America and others banks that accepted federal bailout money, analysts said.

"The government's sitting there saying, 'If this doesn't set off a meltdown of the financial system, there's no rationale to bailing out creditors,'" said Daniel Alpert, managing director of the investment bank Westwood Capital LLC.

CIT, squeezed as its debt has come due and borrowers have drawn down their credit lines, has been scrambling to raise $2 billion to $4 billion. It received $2.3 billion from the government's Troubled Asset Relief Program last fall — money that could be lost if CIT files for bankruptcy.

The Federal Reserve put the company through its "stress test" last week and found it faced a $4 billion capital shortfall. It has more than $7 billion in debt due in the first quarter of next year.

CIT had been in round-the-clock talks with regulators to reach a deal for emergency funding before talks broke down last week. The company had warned that depriving it of more federal aid could imperil about a million corporate borrowers.

Once talks with government officials fell apart, CIT turned to some of its major bondholders for financial help. They struck a deal late Sunday.

Federal officials were not involved in the negotiations that led to Sunday's deal, a Treasury official said Monday. He spoke on condition of anonymity because he wasn't authorized to discuss the matter.

The government's hands-off approach marks a major shift in the crisis. In the past 16 months, the government has poured billions into stumbling mega-banks like Citigroup and Bank of America. It's also provided guarantees or guidance on the sales of Bear Stearns, Washington Mutual and Merrill Lynch.

But the nation's biggest banks still enjoy federal support through borrowing or debt guarantees. So how far the government is willing to go with its hands-off policy is unclear.

"The question is, does it only apply to the small- and medium-sized guys, or does it apply to everyone?" said Simon Johnson, a former chief economist with the International Monetary Fund, now a professor at the Massachusetts Institute of Technology's Sloan School of Management.

New York-based CIT has been negotiating with six key bondholders, including bond manager Pimco. CIT's chairman and CEO, Jeffrey Peek, was actively involved in the talks, according to a person briefed on the matter. The person spoke to The Associated Press on condition of anonymity because the talks are confidential.

Scott Talbott, top lobbyist with the Financial Services Roundtable, which represents CIT and other big financial firms, said the government's seeming pullback from the banking sector was a welcome sign.

"When the government steps in, you disrupt the market," he said. "That was necessary to restore liquidity but distorted the free-market system. Now the exit strategy is becoming clear."

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Wagner reported from Washington. AP Business Writers Stephen Bernard, Anne D'Innocenzio and Alan Zibel contributed to this report.

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2009-07-20 18:23:15