July 13 (Bloomberg) -- CIT Group Inc. bonds plunged on concern that the century-old lender, which has been unable to persuade the government to back its debt sales, won’t be able to meet its credit obligations.

CIT’s $1 billion of floating-rate notes maturing in August plummeted 14.375 cents to 80 cents on the dollar as of 4:21 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

A CIT collapse would put 760 manufacturing clients at risk of failure and “precipitate a crisis” for as many as 300,000 retailers, the New York-based lender said in internal documents obtained by Bloomberg News that make the case for its importance to the U.S. economy. CIT spokesman Curt Ritter declined to comment on the documents.

“If CIT isn’t doing trade finance and lending, its customers will look to other banks for replacement and from what I’ve seen, they aren’t willing to step up,” said Ed Grebeck, chief executive officer of debt consulting firm Tempus Advisors in Stamford, Connecticut.

U.S. officials are “in advanced talks” about aid for CIT, the Wall Street Journal reported, citing people familiar with the matter. No final deal was yet reached and the cost of any rescue isn’t known, the Journal reported, without elaborating.

Share Reaction

After declining 18 cents, or 12 percent, to $1.35 in New York Stock Exchange composite trading, the shares rose to $1.69 in after hours trading.

CIT executives spoke with regulators through the weekend, according to a person familiar with the talks, after its bonds and shares tumbled on concern that the Federal Deposit Insurance Corp. won’t allow the lender into its bond-guarantee program created last year to unfreeze debt markets. CIT may default as soon as April, when a $2.1 billion credit line matures, according to Fitch Ratings.

Moody’s Investors Service slashed CIT’s credit rating four levels to B3, from Ba2, and said the ranking may be cut further because of the company’s “inadequate progress” toward improving its liquidity, according to a statement today. Standard & Poor’s also cut CIT’s rating four levels to CCC+, from BB-, the New York-based rating company said in a statement today, citing company requests to draw down on credit lines.

CIT Assets

A failure of CIT, run by Chief Executive Officer Jeffrey Peek, would be the biggest bank collapse since regulators seized Washington Mutual Inc. in September. CIT reported $75.7 billion in assets and $68.2 billion in liabilities, including $3 billion in deposits, at the end of the first quarter.

The company, which reported more than $3 billion of losses in the past eight quarters, said it hired Skadden, Arps, Slate, Meagher & Flom LLP as an adviser.

New York-based Skadden is known for its work in mergers and acquisitions and bankruptcies. The firm represented BHP Billiton Ltd., the world’s largest mining company, in its $150 billion proposed acquisition of Rio Tinto, and advised Circuit City Stores Inc. in its bankruptcy.

“Skadden is one of the principal law firms representing CIT,” Ritter said in an e-mail on July 11. “They represent the firm on a wide variety of corporate matters. CIT will not comment on any specific aspect of their engagement.”

Jay Goffman, co-head of Skadden’s global corporate restructuring group, declined to comment on the firm’s work for CIT.

Maturing Debt

CIT faces $10 billion of maturing debt through 2010 and hasn’t sold corporate bonds in more than a year, according to data compiled by Bloomberg.

Credit-default swaps on CIT rose 3.5 percentage points to 41 percent upfront, according to broker Phoenix Partners Group, tying a record set Oct. 17. That’s in addition to 5 percent a year, meaning it would cost $4.1 million initially and $500,000 annually to protect $10 million of CIT debt for five years. Earlier today the swaps rose to 41.5 percent upfront, tying a record set Oct. 17.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company’s ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.

1 Million Businesses

CIT, which says it was the first to offer credit to help consumers nationwide buy Studebaker cars, funds about 1 million businesses from Dunkin’ Brands Inc. in Canton, Massachusetts, to Eddie Bauer Holdings Inc., the bankrupt clothing chain in Bellevue, Washington. CIT says it’s the third-largest U.S. railcar-leasing firm and the world’s third-biggest aircraft financier.

CIT became a bank in December to qualify for a government bailout and received $2.33 billion in funds from the U.S. Treasury.

The FDIC is concerned that standing behind CIT debt would put taxpayer money at risk because the company’s credit quality is worsening, people familiar with the regulator’s thinking, who declined to be identified because the talks are private, said last week. Since Nov. 25 the FDIC has backed $274 billion in bond sales under its Temporary Liquidity Guarantee Program, designed to give creditworthy borrowers access to funds after debt markets seized up following the failure of Lehman Brothers Holdings Inc.

‘Active Discussions’

The federal agency, run by Chairman Sheila Bair, is in discussions with CIT about how the lender can strengthen its financial position to get approval, including raising capital, said one of the people. CIT’s measures to improve its credit quality, such as by transferring assets to its bank, have been insufficient, the person said.

CIT is in “active discussions” with regulators on a “series of measures to improve the company’s near-term liquidity position,” it said in a statement distributed by Business Wire. The talks include CIT’s application for FDIC funds and measures such as the transfer of assets to CIT Bank, it said.

Treasury Secretary Timothy Geithner said the U.S. government has the authority and the ability to address the crisis at CIT.

‘Sensible Choices’

“I’m actually pretty confident in that context we have the authority and the ability to make sensible choices,” he said today in response to a question at a news conference in London. “We have a significant interest generally in trying to make sure the financial system gets through this, adjusts where it needs to adjust and emerges stronger.”

CIT’s internal report outlines the potential effects of a failure on customers to which it’s committed $3.9 billion of bank lines.

A failure would ripple across the “small and medium-sized businesses who rely on CIT to operate -- to pay their vendors, ship goods to their customers and make their payroll,” according to the documents.

A “substantial portion” of clients “would not have easy access to additional revolving credit without CIT,” the company said in the presentation. “This could lead to business failure for those who lack additional liquidity.”

BlueTarp Financial is “one of many small businesses that rely on CIT, and without a player like them there is no one else to turn to,” said Bond Isaacson, CEO of the Charlotte, North Carolina-based provider of trade credit to building contractors.

“We are treading on thin ice if CIT is allowed to fail and with them will go a lot of small businesses,” Isaacson said.

The company has already cut back on arranging new loans and its failure wouldn’t cause widespread problems, said Kathleen Shanley, a Chicago-based bond analyst for Gimme Credit LLC.

“Absent a change of heart on the part of the FDIC, it is difficult to see how CIT can survive,” Shanley said. “Fixed- income investors have lost confidence in the viability of CIT’s business model, which will make it extremely difficult for the company to fund its upcoming debt maturities and ongoing operations.”

To contact the reporters on this story: Pierre Paulden in New York at ppaulden@bloomberg.net; Caroline Salas in New York at csalas1@bloomberg.net

Last Updated: July 13, 2009 19:23 EDT