Regulators Face Pressure To Act After CIT Bankruptcy

CIT Group (CIT), an embattled small business lender that filed for bankruptcy Sunday as a result of lack of government-sponsored financial assistance, is now hoping regulators will give it a second chance to turn itself around.

The firm’s Chapter 11 filing appears to be the oddest kind of bankruptcy in a very long time. The 101-year old firm will be allowed to draw on $125 million of a $500 million loan from Bank of America (BAC), pay employees and vendors, as well as make intercompany loans, U.S. Bankruptcy Judge Allan Gropper ruled earlier today. “We are on a very fast track,” Gropper told the court.

Not everyone is so optimistic the firm will still resemble its former self by the time it submits a pre-packaged plan to the court on December 8, however. “CIT in general isn’t out of the woods yet,” Jeffrey Knopman, principal of vendor and retailer broker Profit Solutions, told Reuters. “I think the jury’s still out on the longer term.”

Much of the long-term scenario is falling on the decisions of regulatory officials right now.

CIT is hoping that regulators will agree to allow it to move its most profitable operations such as vendor financing over to its Utah bank subsidiary, so that it can fund them with deposits. That is a decision that will ultimately come down to state regulators and to the Federal Deposit Insurance Corporation (FDIC). But given that the bank has already received a cease and desist order which prevents it from collecting new deposits, and that the number of annual small bank failures is beginning to pile up into the three figures right now, the plan looks somewhat like a long-shot.

The problem is that CIT is not just another regional finance house. It is a company that is vital to the needs of hundreds of small U.S. businesses. If, through their own failure to act boldly, regulators allow the firm to fail, then that will represent a very big black mark against their performance in general throughout the financial crisis.

Investors have remained relatively calm about CIT’s bankruptcy, precisely because it has been orderly and well-financed. The same will not be true if the firm ultimately sinks. The point is especially relevant given that Treasury failed to step up and help the lender, at the same time as it threw billions more in GMAC’s (GJM) direction. By filing for short-term bankruptcy protection, CIT’s directors have shown they are willing to let their common stockholders go broke in order to save the lasting legacy of the firm.

That legacy must now be handled with care by the regulatory officials who are the guardians of its fate.