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Oaktree And The Restructuring Of CIT Group A Case Solution
Commercial Investment Trust (CIT) is a financial and bank holding company. CIT also has subsidiaries and together they provide leasing, financing, and advisory services to their clients including middle-market companies in different industries. The financing company relied heavily on capital markets for its funding. During the 2007-2008 financial crises or more precisely the subprime mortgage crisis, the financial sector was impacted. Due to the crisis, the company was under severe financial distress and reported net losses for nine quarters (Hbs.edu, 2013). CIT did not have the resources to fund its operations because it was unable to sell the corporate bonds, which was the major source of funding for the group. Not only it was unable to secure more funding, but the existing debt was also due making its financial position more disturbing. By the end of the year 2009, CIT had more than $2 billion of debt due and more than $4 billion due in the first half of 2010. They needed the funds to continue operating and they were struggling to secure the investments from the investors because their credit rating started deteriorating even before the crisis.
Following questions are answered in this case study solution:
Why is CIT in financial distress? What are the main factors that contributed to CIT’s poor financial performance in 2007-2009?
How did CIT fund its operations leading up to the financial crisis? How did it change during the financial crisis? Why is CIT struggling to refinance its debt now?
What are the unique characteristics of CIT that will influence the outcome of the restructuring? What are the important elements of a restructuring that we need to keep in mind for the case?
What was Oaktree’s strategy for investing in CIT’s publicly traded debt? Compute the return on investment for Oaktree if CIT files for bankruptcy now. Historical recovery rates for senior secured and senior unsecured debt are 80 cents and 45 cents on the dollar, respectively. The five-year default rate for senior secured debt is approximately 3%. The average purchase price for notes held by Oaktree is 65 cents on the dollar. What were the risks for this strategy?
Case Study Questions Answers
CIT Group was performing well until the year 2003. In 2003, Jeffery Peek was appointed as the new CEO of the CIT group. Under the new CEO, CIT expanded its operations into subprime mortgages and student loans. A subprime mortgage is a type of loan granted to those individuals who have a risk of defaulting because of their poor credit rating (Subprime mortgage | Britannica, 2021). CIT enjoyed the benefits of this in the form of a boost in net income and share price. However, during the 2007 crisis, when the subprime mortgages started defaulting, CIT’s performance also started deteriorating. More than 80% of CIT was financed by medium to long-term unsecured debt. The credit rating of CIT was impacted, and it was difficult for the group to fund its operations. Due to a bad credit rating, CIT lost funding from the commercial paper market, which accounted for 15% of its financing. As the doors of additional funding were closing for CIT, its existing medium- and long-term debt was near to due date. They had to sell the bonds at low-interest rates. CIT tried to get relief from different programs like TARP and TLGP, but it did not go well. CIT was not provided access to the Temporary Liquidity Guarantee Program (TLGP) and their financial position worsened as the economy had to go through a recession. The results of all this were the net losses for almost two years and almost 98% loss in share value.
2. How did CIT fund its operations leading up to the financial crisis? How did it change during the financial crisis? Why is CIT struggling to refinance its debt now?
CIT’s operations were mostly financed by the funds raised through the capital markets. For debt financing, around 80% was the medium- to long-term unsecured debt, 15% was the issuance of commercial paper and secured non-recourse borrowing where the issuer cannot go beyond the seizure of collateral in case the borrower defaults and only 5% was the deposits at Utah-based bank. As most of the debt was unsecured, CIT had to pay higher rates to the lenders because of the high risk associated with unsecured debt. Most of the commercial banks were financed mostly with deposits but CIT had only 5% of deposits. Also, during the period 2003-2006, CTI also started lending subprime mortgages which were riskier because of the high risk of default.
CIT enjoyed the benefits of this debt financing until the outbreak of the financial crisis in 2007. Due to the subprime crisis, the credit rating of the financial institutions deteriorated including CIT. So, it became difficult for CIT to fund its operations. The circumstances forced the group to change its source of funding. So, they went for the secured borrowing and ended up putting around 30% of their assets as collateral by the end of 2007. In June 2008, CIT lost its 15% of funding through commercial papers because of the bad credit rating. Due to this, they had to take a secured loan of $3 billion from Goldman Sachs. As most of the debt of CIT was long-term, they did not face that many issues in initial periods of crisis as other banks were facing which relied on short-term financing. During the crisis, when no other investors were willing to lend to CIT, they applied and received funding from the U.S. treasury department, but they had to issue preferred stock and warrants against that. The Troubled Asset Relief Program was introduced by the U.S. government in 2008 to purchase assets and equity from financial institutions to strengthen their financial position (Treasury.gov, 2021). In January 2009, CIT tried to secure debt financing through the Temporary Liquidity Guarantee Program (TLGP) that guaranteed new unsecured debt backed by Federal Deposit Insurance Corporation (FDIC) (Fdic.gov, 2021). They wanted to pay for the maturing debt through this program but due to limitations, they were unable to secure that. So, with no available funding and near-to-maturity debt outstanding, the financial position of CIT was under severe pressure.
Due to high-unsecured debt financing in the past and the outbreak of the financial crisis in 2007, CIT’s credit rating deteriorated. They were unable to secure new funding from the investors and the already issued debt was near to maturity. As of 2009, the CIT group had $59 billion of maturities with $1 billion to be paid in 1 year. They needed funds to refinance its existing debt. The credit rating further deteriorated when they were denied access to the TLGP program, which could solve their refinancing problem. Due to these reasons, they were unable to refinance their debt.
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