CIT’s bailout denial raises bankruptcy threat

updated 11:56 a.m. ET July 16, 2009

WASHINGTON - CIT Group Inc. shares tumbled Thursday as its inability to get emergency government funding raised expectations that the commercial lender will file for bankruptcy protection.

But it is unclear how such a filing by a company that lends to thousands of small and mid-size businesses would affect shaky financial markets hobbled by an economy in recession and bleeding hundreds of thousands of jobs a month. Small businesses are seen as keys to economic recovery.

CIT said late Wednesday that negotiations with regulators about a possible rescue had broken off after days of round-the-clock talks.

The move marked a defining moment for the Obama administration and showed it’s drawing a line in the sand on federal rescues for troubled financial firms.

The Wall Street Journal said in Thursday’s edition that CIT was trying to line up at least $2 billion in rescue financing from existing debtholders and had given them 24 hours to decide if they can come up with the cash. It cited unidentified people familiar with the matter.

The muted response to CIT’s woes suggests investors are more focused on signs that the economic slump may be easing, said Paul Baiocchi, senior market strategist at Delta Global Advisors in San Francisco.

“The market may simply scoff at this news,” Baiocchi said. “We’re seeing more optimism with the earnings outlook this quarter, so that could outweigh CIT’s problems.”

CIT’s small size relative to other big commercial banks may also ease worries of a ripple effect. Though a major lender to small and midsize U.S. business with about a million clients, CIT is one-eighth of the size of Lehman Brothers when massive credit losses forced the investment bank into bankruptcy last fall.

CIT had also begun cutting back on lending in recent months, diminishing the risk a possible bankruptcy could cause significant damage to the broader economy. The lender had $5.3 billion in credit lines to customers as of March, down from $6.1 billion at the end of 2008.

“That shows they were pulling back and should lessen the immediate blow of this,” said Kathleen Shanley, an analyst at corporate bond research firm Gimme Credit. “I don’t see a real contagion effect here.”

And neither, it seems, does the Obama administration’s financial rescue program, headed by Treasury Secretary Timothy Geithner. By withholding aid, the administration is betting that CIT’s likely failure won’t pose a critical risk to an economy weighed down by rising unemployment.

CIT, which got $2.3 billion of bailout money in December, has warned that depriving it of more federal aid could imperil about a million corporate borrowers — from Dunkin’ Donuts franchisees to retailer Dillards Inc.

The Bush administration paid a price for its decision not to save Lehman Brothers, whose collapse helped spark the financial crisis last fall.

Asked about CIT, a Treasury Department spokeswoman said in an e-mail that “even during periods of financial stress, we believe that there is a very high threshold for exceptional government assistance to individual companies.”

With its assets deteriorating and dangerously little cash on hand, the news left CIT with few options outside of bankruptcy.

A bankruptcy filing would wipe out CIT’s shareholders and the government’s $2.3 billion stake. But CIT’s clients would not automatically lose their lines of credit, longtime banking analyst Bert Ely said.

Still, with other lenders to retailers already under financial strain, many CIT clients may lose their financing options.

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