American lender CIT faces bankruptcy again

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CIT Group, the US small business lender that staved off collapse in July, was again teetering on the edge of bankruptcy last night.

With a deadline looming for a financial restructuring, bondholders will decide today on options for propping up the New York-based bank, but it remained far from clear that the company will be able to avoid a Chapter 11 bankruptcy filing. If it did collapse, it would be one of the largest bankruptcies in US history.

It appeared last night that the US government, which injected $2.3bn (£1.4bn) into CIT as part of the industry-wide bailout plan a year ago, would see its investment almost wiped out. A 1 October restructuring deadline was set just over two months ago, when CIT's creditors handed over a $3bn emergency loan, but its finances have failed to heal.

The company's clients include hundreds of thousands of US retailers, Dunkin' Donuts franchise owners, and other small businesses – many of them drew down credit lines promised by CIT, fearing they could be closed off if the bank fails.

CIT first got into difficulty after making bad bets in the sub-prime mortgage market. The credit crisis then shut off its access to short-term funding from the capital markets, on which it relied.

In July, the US government decided that CIT's failure would not endanger the financial system as a whole, and it declined to pump new taxpayer money into the bank, while regulators refused to guarantee its debts.

CIT's advisers have reportedly drawn up a plan that would swap some of the debt coming due imminently for new shares in the company, plus new, longer-dated bonds. That would, in effect, wipe out existing shareholders, which was why CIT shares plunged more than 35 per cent in morning trading yesterday. The deal may also be unpalatable to bondholders whose repayment is not immediately due.

Financial markets suggested a gloomy prognosis. Credit default swaps rose so that it would cost $3.6m upfront to protect $10m of CIT debt from default for five years and $500,000 annually, suggesting traders have priced in an 83 per cent chance of default.

Among the lenders believed to be considering assisting with the refinancing of CIT are Barclays Capital and Citigroup.

Earlier, rumours surfaced that hedge fund manager John Paulson had suggested merging CIT with IndyMac, a failed bank that he took over last year, but hopes for that deal were fading yesterday.

A CIT bankruptcy would rank as the fifth-largest US bankruptcy, after Lehman Brothers and Washington Mutual, telecoms giant WorldCom and General Motors.