CIT Group files for Chapter 11

CIT Group Inc., a major lender to small and medium-size businesses, filed for bankruptcy protection Sunday afternoon, a process that almost certainly will wipe out the federal government’s $2.3-billion investment in the company.

CIT is the first firm to fail after a government bailout.

The company said it hoped to significantly reduce its debt in what is known as a prepackaged plan for reorganization, which would allow it to emerge from Chapter 11 protection by the end of the year. It is one of the biggest bankruptcy filings in U.S. history and could have broad ripple effects. The firm provides loans to about 1 million companies, including many already struggling in the economic downturn.

As expected, CIT’s operating subsidiaries, including CIT Bank, are not included in the bankruptcy, and the firm said Sunday that it would continue to serve its customers during court proceedings.

“The decision to proceed with our plan of reorganization will allow CIT to continue to provide funding to our small-business and middle-market customers, two sectors that remain vitally important to the U.S. economy,” said Jeffrey M. Peek, the outgoing chief executive of CIT, which will be controlled by debt holders after the reorganization.

CIT relied on borrowing from investors to lend to smaller businesses. But investors retreated during the financial crisis, and CIT, which provides crucial short-term financing to various retail and manufacturing businesses, has struggled to find sources of funding. In early October, it began offering bondholders the opportunity to exchange debts coming due for new bonds with later maturity dates and preferred stock in the reorganized firm. At the same time, CIT asked bondholders to approve the prepackaged bankruptcy plan.

The debt-exchange plan was rejected, but 90% of the bondholders who voted approved of the bankruptcy, the firm said.

Under the bankruptcy plan, CIT bondholders would get 70 cents on the dollar in new notes and equity in the reorganized company. But the government, whose investment was in the form of preferred shares, probably would recover nothing.

The $2.3-billion rescue by taxpayers was made last December. Facing mounting losses, CIT sought additional federal funding in July. But officials declined after determining that the firm’s collapse would not significantly disrupt the economy’s recovery.

Under the bankruptcy plan, CIT expects to reduce about $10 billion of its $30 billion in unsecured debt. Its long-term survival, however, is far from certain, analysts said, as financial companies require the confidence of market participants -- lenders, customers and credit rating firms -- to survive.

“There’s no guarantee,” said Scott Peltz, managing director of the corporate restructuring group at RSM McGladrey, adding that it would be crucial for the restructured company to earn an investment-grade rating. “Without it, they’d still have an unworkable capital structure,” he said.