By Chris Gillick
This past July, just when it seemed like the credit crisis had passed and the financial system had regained its footing, along came CIT Group and a new bag of trouble.
Wall Street had turned off the spigot of cheap, unsecured borrowing for the middle-market lender. Meanwhile, the company had reconfigured as a bank holding company in order to qualify for Troubled Asset Relief Program funds. CIT quickly went through some $2.3 billion in government aid. With $1 billion of floating rate senior notes coming due, and the clock ticking, the outlook for the company appeared grim. Eventually, the government would deny the company a second bailout. Bankruptcy was imminent. CIT’s stock plunged.
But the firm’s summertime blues turned into one of the year’s biggest paydays for event-driven and distressed hedge funds, both for large players and smaller, more nimble ones. With a capital structure as large and complex as CIT’s—the lender’s balance sheet has more than $70 billion in assets—traders had a plentiful supply of paper to swap across the board.
Large funds bought senior unsecured notes at less than 60 cents on the dollar while loaning the company money at attractive rates. Smaller funds, meanwhile, bought notes from retail investors and doubled their money on a convertible arbitrage play. By the fall, skinning CIT was still a possibility across the entire capital structure.
“There’s a limited going-concern value that’s being assigned to those assets,” explained Michael Thompson of Bay Harbour Management at the AR symposium in New York on November 4. “If you go through the analysis, not just of the underlying assets, but also the underlying businesses in which this company is engaged, there’s a real potential going-concern value there.”
On December 10, CIT exited a Chapter 11 pre-packaged bankruptcy that had been filed just 40 days earlier. Newly issued stock now trades on the New York Stock Exchange, though the original common and preferred shareholders were wiped out, including the government’s TARP stake.
For the larger funds, the main part of this trade was buying senior unsecured paper near 60 cents and receiving 70 cents in new bonds plus 91% of new equity from the prepackaged bankruptcy.
An orderly bankruptcy and quick exit might never have occurred without the help of three major hedge funds. In July, Baupost Group, Oaktree Capital Management and Silver Point Capital took a major role in providing $2 billion of a $3 billion senior-level financing secured by collateral worth five times that amount. The hedge funds, along with PIMCO, Capital Research and Management, and Centerbridge Partners, soon formed a steering committee, while Barclays arranged funding for a period of two and a half years.
The terms of the loan were steep. Accompanying an interest rate of LIBOR plus 10%, with a 3% LIBOR floor, the rescuing firms stacked the deal with fees, including a 5% commitment fee, a 2% exit fee, a 6.5% prepayment penalty or “call premium” and a 1% annual payment on the amounts that were not drawn down. So before any money even exchanged hands, the six firms were set to collect $100 million, or 5% of $2 billion, in fees.
But before any of the firms could participate in this sweetheart deal, they had to tender their maturing August 17 notes back to the company. CIT initially offered 82.5 cents on the dollar and demanded 90% of the note holders to participate. With the tender undersubscribed, CIT upped the bid to 87.5 cents and reduced the participation threshold to 58%, catering to the exact amount already tendered by the rescue creditors. Meanwhile, investors who refused to tender their August notes bet that the company would pay out at par anyway—which it did. At the time of the revised tender, the August notes were trading at around 92 cents on the dollar, and hedge funds of all sizes were able to make a quick 8% gross return in two weeks’ time.
The euphoria of the new credit facility was short-lived, however. In late October, the company created yet another senior credit facility for $4.5 billion, with less onerous terms than the original. This sparked the ire of yet another player in this saga, Carl Icahn, a major bondholder. In an open letter dated October 23, Icahn accused CIT management of “buying votes” among small bondholders to approve the additional financing, and he decried a proposed debt-for-equity exchange offer as less valuable than what bondholders would receive in bankruptcy. Icahn then offered to match the financing himself with lower costs.
After much public debate, the financier and CIT eventually agreed to the pre-packaged bankruptcy, which was filed on November 1 to avoid another $1 billion of notes coming due. Icahn would provide an additional $1 billion in financing. CIT’s senior facilities remained unaffected during its bankruptcy, which was the fifth largest in U.S. history.
Meanwhile, smaller funds such as Mudrick Capital Management, run by former Contrarian Capital Management portfolio manager Jason Mudrick, were doubling their investments in some of the more overlooked parts of the CIT capital structure. In July, Mudrick began buying retail-focused unsecured bonds called InterNotes at a cost basis of 35 cents on the dollar. The InterNotes were trading at a 40% discount to the senior unsecured notes at the time yet have received the same treatment in bankruptcy—70 cents worth of new bonds plus equity—good enough for a near 100% return.
Mudrick Capital also found a quicker way to double its money, by buying CIT’s Series C preferred shares. The Series C shares initially were convertible for 3.95 common shares each, but in the event of a common stock delisting would receive 9.09 common shares. With such an event imminent, Mudrick began buying up Series C notes at $0.91a share in early November, while simultaneously shorting the requisite 9.09 shares of common at $0.20, for a total value of $1.82. After converting the preferred shares, Mudrick had a 100% instantaneous return.
“My team and I noticed this extra share kicker in the prospectus early on,” says Mudrick. “We kept buying until the arbitrage went down to zero. The opportunity lasted a few days.”
In addition, funds have profited from the appreciation of unsecured Canadian bonds issued by a CIT subsidiary with a corporate guarantee and are getting what managers call a “double dip,” or $2 of claim for every $1 of exposure. Per the bankruptcy plan, these notes received 100 cents of new bonds plus a 10.25% coupon. AR
