The latest chapter in the CIT saga is Chapter 11.

The article has some good stuff in it. I consider this passage to be the most important:

CIT accounts for about 70 percent of all short-term U.S. financing known as factoring, worth about $40 billion a year, according to Ray Ecke, president of Credit Management Resource in Oakland, New Jersey.

In factoring, suppliers and manufacturers sell payments owed for goods and services to companies such as CIT because they need immediate cash. The process gives vendors money to produce goods retailers have ordered. Retailers typically make payments within 90 days. After they do, a factor keeps a fee based on a percentage of the total order.

This is what I referred to in my previous post. What isn’t clear from this article (or any article on CIT), is how large this business unit will be going forward. CIT was in the process of shrinking it during this whole slide into bankruptcy. Now that they’re in bankruptcy and will exit with much better cash flow, I want to see someone mention this on a forward-looking basis. I suspect that the wind down will continue. This may be orderly, but it still pushes many retailers closer to death.

The latest in the CIT saga. Recall that earlier this year American Express shut down two small business lending units. Citigroup has taken the axe to its credit cards across the board, but particularly at the credit limit levels that would be important to small business owners. These sources of funding aren’t just important (even critical) for specific small businesses. They are a fundamental part of the current business model used by many industries.

I like to single out clothing designers and manufacturers only because I was able to talk to some people in that industry. There are similar problems in any industry dominated by startups with quick turnover. These industries rely on credit because they don’t have another trust model. For such industries, this is Armageddon.

What is the inverse of decimation? I’m thinking of the aftermath where only one in ten survive. Some of the culling has already started. It will continue. Nobody is going to rush in to take CIT’s place simply because it isn’t profitable to do so. The big downfall won’t happen this holiday season. Everyone’s financing has already been secured or they have already perished. But expect to see a lot of consistency in Spring fashions. The designers simply won’t be in business any more.

One way of looking at this is that we simply have too many designers, but that’s not exactly true. The issue is the trust model. The link between manufacturers, designers, and retailers is based on credit (which derives from a word meaning “trust”). When the credit disappears, it becomes an issue of who pays for the manufacturing. Unfortunately, in the current business environment, it isn’t the manufacturer, the designer, or the retailer. Clothing design has high turnover, so it is unlikely to be the designer. Over time, it will likely be the manufacturer who extends credit to the designer, and the retailer will submit purchases up front (instead of paying for them with sales). If we could flip a switch, perhaps it would be economical to support many designers. The more accurate thing to say is that we have too many designers for the current business models in the current economic climate, but that’s rather lengthy.

If the holiday retail numbers are fantastic, Armageddon can be avoided. If everyone gets paid back this year (the defaults on CIT’s existing portfolio are few), someone will rush in to fill the void. There will be some fallout caused by the lag in the holiday numbers, but that would ideally only harm one season’s fashions.

I reiterate that this problem is not unique to clothing. Any industry with a similar financing structure is going to be on the chopping block.

CIT bondholders are starting to disagree on who gets the spoils. This is not very surprising, seeing how they have little (read no) downside to their existing bargaining position. Either way, in today’s call hosted by Little Bear Investments, the bondholders are standing firm on their bargaining position.

The final chapter of CIT is boring. Can we just skip to the end? I do want to know how it ends.

I really thought they could delay this until April. A little more information here.

The previous rumor about hedge fund guru John Paulson negotiating a merger between CIT and Indymac looks to have been discredited. This is a good thing, because the idea was really stupid.

I remind everyone that the death of CIT will likely have some pretty terrible consequences, particularly for jobs, as many in the retail industry rely on CIT at some point along their supply chain. If they do manage to stay afloat, the problems will be somewhat mitigated. There will still be some complications caused by their ongoing efforts to reduce risk in their loan portfolio. Whether these problems will be enough to derail the magnificent recovery remains to be seen. Everyone seems to be banking on a jobless recovery anyway.

Two things from today on business financing.

First, a look at the big name in credit for small businesses. From Bloomberg, CIT Group Defers Interest Payments on Bonds Due 2067:

CIT Group Inc., the 101-year-old lender that got $3 billion in financing from creditors in July to avoid collapse, is deferring interest payments on subordinated bonds due in 2067.

These were 60 year bonds sold some time in 2007. Back then, financing terms were quite loose, so it was a pretty good move for CIT. Not such a good move for the bond investors, though. Wonder what the losses on those bonds look like:

CIT’s $750 million of 6.1 percent bonds due in 2067 fell 5 cents to 8 cents on the dollar to yield 81.4 percent, as of 8:33 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

92% loss? I wonder if they’ll defer the payment until after April. Remember that their last round of special financing established a senior position. They’re also considering selling units to raise cash. I don’t think there will be anything left for these bondholders in a bankruptcy. I’d probably still consider these bonds overpriced.

Second, bad news for investment grade business debt. Via Zero Hedge, Collapse In Commercial Paper Outstanding Bodes Ill For Corporate Growth. Skipping to the punchline:

The immediate consequence of this is that the core companies that make up the economy, those that are not too leveraged and actually generate more than nominal cash flow, will retrench expenditures, and will make the case for a revenue bounce in the coming quarters and years even more problematic, even as all the overhead fat has been eliminated, resulting in years of flat if not declining earnings.

I think this latter problem has a greater possibility of a sudden turnaround. I don’t think a turnaround is likely, but there’s no logistical barrier.

It is true that the Fed is trying to flood the market with liquidity. It is less evident that it is succeeding in the areas where such liquidity is most needed.