CIT Group, a US commercial lender, is negotiating with its bondholders to exchange a portion of its debt for equity. To increase its leverage, it is simultaneously preparing to apply for Chapter 11 bankruptcy protection – and default on $800 million in debt due next month.
As I describe in my most recent monthly column, leverage is a combination of two factors:
First, how much you and your counterpart need a deal. The more desperate you are, the weaker your leverage; the more desperate your counterpart, the stronger your leverage.
Second, the relative value of your and your counterpart’s Plan Bs (your alternatives if you don’t do the deal). The better your Plan B, the stronger your leverage and the better your counterpart’s Plan B, the weaker your leverage.
By preparing for bankruptcy, CIT Group is taking a concrete step to limit the attractiveness of their counterpart’s Plan B. Bondholders reportedly would get about 90 cents on the dollar if they agree to the deal but likely only 70 cents on the dollar in bankruptcy. CIT Group is also taking steps to discourage individual bondholders from holding out in the hopes of getting a better deal than those who sign on to the plan early. The holdouts believe the passage of time improves their leverage because the approaching deadline increases CIT Group’s need level.