CIT preparing to seek Chapter 11 bankruptcy protection as early as Sunday

Filing could wipe out U.S. stake and have broad ripple effect

NEW YORK -- CIT Group, a major lender to small businesses, is preparing to file for Chapter 11 bankruptcy protection as early as this weekend, sources familiar with the matter said Friday, which would likely wipe out the federal government's $2.3 billion stake in the company.

A CIT bankruptcy filing would be one of the largest in U.S. history, with potentially broad ripple effects. The firm provides loans to about 1 million companies, including many already struggling in the economic downturn.

Burdened by a heavy debt load, CIT has been struggling for months to stay afloat, first seeking additional government funds, then turning to its creditors for relief. In early October, CIT announced a two-pronged restructuring plan aimed at reducing its debt.

Under the plan, CIT sought to persuade enough of its bondholders to exchange their existing debt for new bonds that would mature later, along with preferred stock in a reorganized company. At the same time, CIT had solicited approval from creditors on a pre-packaged bankruptcy plan. The bondholders had until Thursday night to make their decisions.

CIT said on Friday that it was still counting the more than 150,000 ballots that were distributed. But a source with direct knowledge of the situation said the debt-exchange offer had failed to attract enough support. The company, however, has won enough backing for the pre-packaged bankruptcy plan, said the source, who spoke on condition of anonymity because the official vote tabulation was ongoing. A bankruptcy filing could happen on Sunday or Monday, the source said.

Under the pre-packaged bankruptcy, CIT bondholders would recover 70 cents on the dollar in new notes and equity in the reorganized company. But documents filed with the Securities and Exchange Commission show that preferred shareholders -- including the U.S. government -- would get nothing. The documents state that the government could recover some value if new securities in the reorganized company trade at a high enough level, although that is unlikely, a source with knowledge of the matter said.

The government used $2.3 billion in funding from the Troubled Assets Relief Program to shore up CIT in December at the height of the financial crisis. CIT had sought additional federal funding in July, as its financial position deteriorated. But government officials, who had grown more concerned about whether they were throwing good money after bad as the crisis abated, declined after determining that CIT's collapse would not significantly disrupt the economy's recovery.

On Friday, as it simultaneously counted votes and prepared for a Chapter 11 filing, CIT said that it had reached two important agreements with bondholders that would help the company execute a bankruptcy reorganization, which it hopes would take about 60 days.

CIT has said it envisions a quick restructuring in bankruptcy that will result in a better-capitalized firm. The company has said that neither its bank nor its operating units would be part of the bankruptcy filing, which would allow the company to keep servicing its small-business customers during the proceedings.

CIT said it had resolved a dispute with financier Carl Icahn, who will provide a $1 billion loan. Icahn, who says he is CIT's largest bondholder, earlier this week tried to persuade bondholders to reject CIT's debt-swap and bankruptcy proposals by offering 60 cents on the dollar. The $1 billion loan from Icahn will help shore up CIT's capital and can be used as bankruptcy financing, along with a $4.5 billion loan from some bondholders that materialized earlier this week.

CIT also said it had reached a settlement with investment bank Goldman Sachs that would keep open a $2.13 billion loan even if CIT filed for bankruptcy.

"It was viewed as being highly risky to have gone any deeper," said Scott Peltz, managing director of the corporate restructuring group at RSM McGladrey. "Coupled with the fact that they don't believe CIT is essentially too big to fail, and that the market can absorb this, then ultimately it looks like the government made a pretty good choice."