Tuesday, October 20, 2009

Icahn's role in CIT's future and the firm's impact on broader economy

A great deal has been said recently about Icahn's letter to CIT (see attached). What exactly is he trying to do with this dying firm? Does he really care about CIT's board of directors, their contribution to the firm's ultimate demise, or their compensation? Is he really that interested in having a competent board at CIT to build shareholder value? From the letter:

I am reaching out to you to address what I view as the latest example of incompetent and unconscionable behavior on the part of the Board of Directors of CIT.

The answer is remarkably simple. Icahn is trying to achieve 3 goals with his letter:

1. He wants to take control of CIT and that's why he is targeting the board. The company's argument for keeping the board in place is that "change of control" may jeopardize CIT's small retail bank. But in fact the FDIC has already effectively closed the bank.

Even worse, the plan would leave a majority of the existing Board, or their chosen successors, in control of our company for years to come. The company argues that they must stay in control because a change of control at the company might cause the Federal government to close down our very small bank. Interestingly, the government has already effectively shut down the bank by issuing a “cease and desist” order. Ironically, based on the actions of the government concerning our present Board, we believe that a complete change in the Board would be a positive, rather than a negative, factor in influencing the government to resuscitate our bank.

2. He wants to stop the bleeding by refinancing the "Godfather Loan" and reducing fees.

In the proposed plan to “bail-out” the Board at the expense of most bondholders, the new term loan would amend and increase the company’s existing $3.0 billion first lien secured facility and would result in term debt of approximately $9.0 billion. The term debt would be secured by a first lien on virtually all of the company’s unencumbered assets, which currently total over $30 billion. In exchange for committing to and funding the term loan, the company is offering prospective lenders a total of 5.0% in commitment and funding fees, for a total cost to the company of $300 million in addition to an interest rate of at least 9.50%. In light of the gross over-collateralization and rich pricing being offered to investors, we view this upfront payment as excessive. (By way of example, when the company arranged its $3.0 billion existing term loan in July, 2009, lenders were also paid 5.0% for their commitment in the form of original issue discount. Once freed to trade in the secondary market the loan immediately traded to approximately 105% of par, indicating that a 5.0% OID was far greater than what was necessary to syndicate the facility. While the structure and pricing for the two facilities differ somewhat, it is obvious to us that the company is once again destroying value.)

3. He wants to shut down CIT, wind down its assets, and extract most value on the CIT bonds he bought recently - pure and simple. It amounts to nothing more than an orderly liquidation.

We agree with the Board on one thing, that CIT’s roughly $60 billion of assets should be allowed to be “run-off” or sold.

So Icahn's goal is not to improve CIT's corporate governance or rebuild their business. As any corporate raider, he simply wants to extract maximum value. There is a high likelihood that this was going to happen with or without Icahn - his role here is to make the wind-down more efficient and let CIT die with "dignity".

What does that mean for CIT and the economy as a whole? Most of CIT's small business loans will not be rolled when they mature. Trade receivables finance, leases, and other activities will probably shrink. But this wind-down has implications beyond CIT, who is a lender to some million small businesses. As we discussed before, small business, which in the US accounts for 75 percent of new job creation, is struggling.

The FDIC, watching community banks paralyzed and CIT on the brink is trying to get some TARP money to encourage lending to small businesses. The idea is to have FDIC co-invest side-by-side with private money in injecting new equity into struggling community banks.

Bloomberg: “We’ve suggested a dollar-for-dollar matching program,” Bair said. “This would be an additional validation of viability from the market if the market is willing to put additional capital in, help provide some additional protection to Treasury. Perhaps make the terms a little less onerous. This could perhaps be tied to increasing small-business loans.”

Whatever FDIC does, it will be difficult to replace the small business lending giant, CIT. And creating small business driven job growth is going to be that much tougher.

Icahn Letter to CIT

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