Tuesday, October 13, 2009

After the Godfather Loan, CIT is trying another debt exchange

The unsecured bondholders have recently sued the lenders of the so-called "the Godfather Loan" (rescue package) lead by Barclays. They claim that the Godfather Loan was done with the knowledge that the company will default as a result of that "rescue package" (amounting to a fraudulent conveyance). The "Godfather" lenders have practically all of the unencumbered assets as the collateral package for their loan (5 x the loan amount). The unsecured lenders (the bond holders) filed a complaint that the $3 billion rescue loan subordinated their claims, making CIT unable to pay the bond holders next summer. This is going to be a long fight.

This chart shows (roughly) the CIT debt maturities going forward. It's not pretty.

To avoid default CIT has to bring down leverage. To accomplish this, they are trying to reduce the debt outstanding by at least $5.7 billion of face value (much of it at nearby maturities). They are offering to exchange existing bonds for new notes and preferred equity. According to JPMorgan, they will need 79% of the bond holders to participate. Not only do they need large numbers of participants to get to the $5.7 billion of reduction, but a number of debt holders have CDS protection against their CIT bonds (basis trade) and would prefer for CIT to default. A default would force convergence of the basis (the CDS would settle at the auction-priced defaulted bond level) and make these guys some money instantly. They are mostly indifferent to the recovery rate on their bonds (the lower the recovery, the more their CDS will pay them). The basis position holders would therefore vote for a for a prepackaged bankruptcy instead of the proposed exchange. The fact that they can't count on the basis holders means that CIT needs an even larger fraction (79%) of the debt holders to agree to the exchange.

But to get 79% of the non-basis holders to agree to the exchange (tender) is going to be rough. It looks increasingly likely that CIT is headed for bankruptcy, which is what the "Godfather Loan" guys (who want to grab the collateral) as well as the basis trade holders ultimately want. Welcome to the world of distressed debt investing.
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