So the government has found where the “Too Big to Fail” line is, and its CIT Group (NYSE: CIT). Long-time readers know I was all for bailing out Bear, Lehman Brothers (OTC: LEHMQ), Fannie Mae (NYSE: FNM), Freddie Mac (NYSE: FRE) and American International Group (NYSE: AIG). I was also all for having the government buy toxic assets. I thought all these things were sensible responses to a very real danger of a economic collapse.
All that being said, there has to be a line, and the line can’t be “any firm where there might be pain.” That is what we have with CIT. Will it be painful? Yes. CIT is a long-time lender to lots of medium-sized businesses, some of whom might not be able to get other funding. Yes, some of them will wind up going under. But the simple reality is that CIT has been a pretty loose lender for a long time. In fact, I’d argue that CIT was primarily an asset-based lender, meaning that they viewed the collateral asset (e.g., the receivable) as the primary credit factor. Admittedly, I don’t know any of CIT’s lenders, but just from following the company over the years, that’s always been my impression.
In today’s world, asset-based lending is all but extinct. Think about it. Its basically the same attitude as the no-doc home mortgage lender. You figure that the house is worth more than the loan, so it doesn’t really matter how credit worthy the borrower is. Worst case scenario is that you liquidate your collateral and come out whole.
It isn’t that quality collateral can’t be a factor in lending, but I really think CIT’s model assumes a world of high liquidity. In other words, a world where various pots of money exist to buy up the collateral if need be. This was the domain of certain hedge funds or other alternative asset vehicles at one time. Not any more.
The other problem CIT has is a lack of credible funding source. I use the word “credible” intentionally, because any non-back lender has to be able to prove access to the capital markets, which CIT cannot do. So anyone relying on CIT to fund their business will logically draw down their credit lines, which is exactly what has gotten us to this point. Its about credibility as much as it is about CIT’s actual loan portfolio.
Speaking of the loan portfolio, its pretty weak. The Wall Street Journal ran a piece showing how bad their delinquencies are. I don’t know this for sure, because I’ve never owned CIT debt, but I’d bet their delinquencies have always been weaker than the average, just considering their borrower profile. But that’s no excuse. The fact is that CIT lends to a lot of businesses that are vulnerable to a deep downturn.
So put this all together, and you have a basic business model: asset-based lender without access to bank funding, that just flat out doesn’t fit in today’s world. CIT may as well be making type writer ribbons. I’m sorry, it just has to go.
This is the moment were we take the training wheels off the economy. We had to do it at some point. We had to eventually send a message to the world of finance that not everything was going to be bailed out.
How great would it be for CIT to work something out with bond holders? I mean, an actual “normal” deal to avoid bankruptcy? I mean, it would almost be like capitalism is back!
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