Tuesday, July 21, 2009

Marks and Klarman Join Together to Rescue CIT

With the incessant barrage of CIT-based headlines over the past week or so, you would be forgiven if you hadn’t bothered to delve into the final details of the $3 billion financing the company has apparently secured. What you unfortunately would have missed as a result of CIT fatigue is the identity of those who are providing this capital.

From Bloomberg today:

Bondholders providing the financing include Boston-based hedge fund Baupost Group LLC, Capital Research & Management Co., Centerbridge Partners LP, Oaktree Capital Management LLC, Pacific Investment Management Co. and Silver Point Capital LP, a person familiar with the deal said.

That’s right. Value investing luminaries Howard Marks of Oaktree Capital Management and Seth Klarman of the Baupost Group both were involved in this deal according to Bloomberg’s source. Why, you ask, would Marks and Klarman get involved with a company that Credit Sites analyst David Hendler as recently as last week said this about?

“This thing doesn’t have a future,” CreditSights analyst David Hendler said yesterday in a telephone interview. “Anything is possible but the problem is not solvable anymore. They’re just in denial it’s finally over,” the New York-based analyst said referring to the rescue financing.

The first (and simple) answer to that question is margin of safety. According RBC analyst Hank Calenti the deal had to be significantly over-collateralized in order to attract investors. In fact, a New York Times report cited by Bloomberg claimed that the loan is backed by a mix of assets with a face value of $30 billion. For only $3 billion worth of financing these investors have claims to a substantial amount of collateral. While this shows how desperate CIT was to avoid bankruptcy, it also highlights why this deal structure was so attractive to Klarman and Marks. Not only do they have a direct claim on corporate debt, aircraft credits and loans to small and medium businesses with a face value of $30 billion, but they also will receive an interest rate of 10 points above Libor. Not the current puny Libor rate of .51%, but Libor with a 3% floor. By my calculations that means that the minimum interest rate is 13% on a $3 billion loan backed by $30 billion in collateral.

Now you can see why Klarman and Marks likely didn’t have to do weeks of due diligence on this specific deal to be willing to participate. And if Credit Sites analyst Adam Steer is right and this rescue has only delayed a bankruptcy filing that is inevitable based on CIT’s broken business model? In that scenario even if equity holders and those who own other CIT bonds (for example PIMCO) are wiped out or suffer low recovery rates, Oaktree and Baupost would be protected by the substantial over-collateralization. While no investors have had a perfect track record in navigating the crisis over the past few years, if you had to follow the so-called smart money you would be hard pressed to find any better candidates than Marks and Klarman.

(Picture courtesy of www.breo.org)