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Intense negotiations between CIT Group Inc. and federal regulators raised hopes Monday that the giant finance and factoring firm could avert bankruptcy and spare fashion vendors and their retail accounts.
A failure to resolve the crisis and allow the financial powerhouse to raise capital through bond sales in the private sector would have dire consequences for the industry, experts said.
Analyst David Strasser of Janney Montgomery Scott wrote in a research note Monday that if the government did not come to CIT’s aid, the retail industry could see “significant inventory issues” later in the year.
“Some vendors would simply not be able to finance shipments to retailers for holiday,” he wrote. “We know this is sounding overly catastrophic, but the more we learn about CIT, the more we realize it is a financial lifeline for the retail industry.”
Strasser wrote he believes the government will ultimately step in.
Describing CIT as “an integral component of the retail chain,” Andrew Moser, founder and managing partner of Kairos Group, said a Chapter 11 filing by the firm would have “a dramatic ripple effect, causing many customers-clients themselves to file” and put the fall and holiday selling seasons at even greater risk.
Moser said although there are other banks that can take over lending activity, few financial institutions are set up to take over the factoring part of the business.
One factoring executive, who asked not to be named, said a CIT bankruptcy would weigh heavily on CIT’s more than 500,000 commercial customers. “The credit enhancement — getting a factor’s guarantee — people need CIT for that,” the executive said.
CIT’s spot as the number-one independent leasing company in the U.S. means that a bankruptcy would dramatically alter the retail finance market. “There is no number two,” executive said. “The falloff is huge. Wells Fargo is a likely player, but they run a much more conservatively booked business.”
In the fashion and retail sectors, many believe government officials underestimate CIT’s importance.
“It would be a mistake for the government to discount the importance of CIT in our industry,” said Stanley Officina, president of Ultimate Financial Solutions, a finance and factoring firm. “Some in government may be unfamiliar with how CIT helps to keep goods flowing to retailers.”
A financial executive, who spoke on condition of anonymity, said, “Vendors are going to be reluctant to ship product to stores if they can’t rely on credit guarantees from CIT. Thousands of stores will see the flow of merchandise slow down to a trickle.”
In London, Treasury Secretary Timothy Geithner said the U.S. government could take actions to address the crisis at CIT. “I’m actually pretty confident in that context that we have the authority and the ability to make sensible choices,” he said, declining comment on specific steps the government might take.
“We have a significant interest generally in trying to make sure the financial system gets through this, adjusts where it needs to adjust and emerges stronger,” Geithner said.
Financial sources said although CIT appeared to have the support of the Treasury Department and the Federal Reserve, the Federal Deposit Insurance Corp. remained a stumbling block regarding the New York-based lender’s application to participate in the agency’s Temporary Liquidity Guarantee Program, created last year to unfreeze debt markets.
Participation would allow CIT to raise capital through bond sales in the private sector, with the U.S. government providing debt guarantees.
However, FDIC approval is not expected since the credit quality of CIT’s debt is below the threshold level required, sources said. A spokesman for the FDIC did not return calls.
CIT shares rose sharply in after-hours trading Monday. After falling 18 cents, or 11.8 percent, to $1.35 in New York Stock Exchange trading Monday, the stock jumped more than 22 percent in after-hours trading amid reports the company’s talks with federal regulators on a bailout package were progressing. CIT received $2.3 billion in Trouble Assets Relief Program funds in December, when it also got Federal Reserve approval to become a bank holding company.
In addition to the option of TARP funds, sources said CIT might move funds to CIT Bank, where they could be transferred to the holding company and, as with TARP funding, ease short-term liquidity needs and clear the way for the firm to raise capital in other ways. That could include the liquidation of real estate holdings or even the sale of its factoring arm, considered the crown jewel of CIT’s assets.
The factoring division is profitable and could garner interest from firms such as Wells Fargo, J.P. Morgan Chase and foreign banks.
Although CIT has to consider bankruptcy as an option in case negotiations with regulators fail, the company would not confirm reports that the law firm of Skadden Arps, which has represented CIT on corporate matters, was appointed as its bankruptcy counsel.
In the case of a bankruptcy, vendors who rely on CIT for factoring services would be left uncertain about what they could expect concerning all aspects of their ties to the company. Customers operating with seasonal peaks and valleys who typically work with overadvances are paid down as sales cycles progress conceivably could find themselves getting less.
Financial sources expressed fears about the status of manufacturers’ credit balances in CIT accounts in the event of bankruptcy. Money in a neighborhood bank is backed by FDIC insurance, but credit balances are not. Vendors could find themselves in the position of unsecured creditors, waiting in line with their claims along with other CIT creditors.
“That’s a tough question to answer because there haven’t been a lot of factors that have gone bankrupt,” said Lawrence Gottlieb, head of the restructuring practice at Cooley Godward Kronish, who represents unsecured creditors committees in bankruptcy cases.
Typically, credit balances belong to the factor’s clients.
But in the bankruptcy of Initial Funding, a refactoring firm, a New York State Supreme Court justice in Manhattan ruled in 1998 that credit balances belonged to Initial Funding’s secured lender, making Initial’s clients unsecured creditors.
“While CIT could make the argument that [credit balances are funds] CIT is holding, someone might be able to make the case that they are trust funds, with CIT holding them in trust for creditors,” Gottlieb said. “I am relatively sure that if CIT were to file for Chapter 11, it would bend over backwards to make sure its customers are happy. That would be their first goal if they want to keep their customers.”