CIT Group Bankruptcy and DIP Financing

About three months ago I predicted that CIT would file Chapter 11 bankruptcy on November 1. Yesterday I was watching the news all day and finally at about 3:30 p.m. I saw that it had done so.

CIT represents the fifth largest bankruptcy in U.S. history. There are a number of ways a business (whether large or small) can undergo bankruptcy. The least painful is a “prepackaged” bankruptcy in which the company emerges out of Chapter 11 in the shortest possible time frame.

What does all this mean to small businesses that borrow as much as $2.3 billion at any one time for working capital? Hopefully nothing.

Part of the strategy of a prepackaged bankruptcy is that the company entering Chapter 11 has agreed in advance on most of the key issues so most credit parties are in agreement before the fillings are ever made. In the case of CIT, it received a $4.5 billion loan from Citi Bank to allow it to continue operating under the bankruptcy trustee’s supervision while the company goes through the reorganization process. This financing is called debtor in possession (or DIP) financing. The bankruptcy court protects the DIP financing source to make sure it gets all its money back.

CIT is expected to reach agreements with all its creditors and reemerge from Chapter 11 by the end of the year. Many agreements must be reached and many bankruptcy court hearings must be held.

CIT’s goal is to keep the company in one piece. In the end, it may be broken up into several companies so more creditors can be paid.

The parties that get hurt as a result of this bankruptcy are common shareholders, who will have their entire interest in the company lost; U.S. taxpayers, who injected $2.3 billion, which is almost certain to be lost; bondholders will settle for some percentage of their original debt -- my estimate is 75 percent or less; and secured creditors will also have to take a haircut, though their losses should be less than the bondholders'.

Hopefully, small businesses that rely on CIT for factoring and asset-based lending will be able to continue as usual. My advice to those companies is to move to a more stable financing partner as soon as possible.

This bankruptcy is the first ever of its kind involving a company that holds cash reserves as factors and ABL lenders do.

The wild card involves the cash coming through the factoring lockbox. Business owners factoring are counting on reserve money coming back when one of their debtors pays. Many of CIT's factoring transactions are full recourse. Unfortunately, the bankruptcy court could rule that the factored invoice is an asset of the company. It may require customers of CIT to lose some of their reserve money. We have a saying in banking that I strongly believe in. “The first loss is the least.” So if you're a CIT factoring customer get out, take whatever loss you must, and move to a more stable financing company as soon as possible.

Sam Thacker is a partner in Austin, Texas-based Business Finance Solutions.

You may contact Sam directly at sam@lesliethacker.com

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EXTRA: If you have questions for Sam regarding business financing, the credit market, and similar issues, please send an e-mail. Your questions will be recorded and Sam will answer the best ones in his Ask the Expert podcast show.