Credit markets could weather a CIT failure

NEW YORK (Reuters) - A possible failure of U.S. lender CIT Group is unlikely to roil the credit markets, although some smaller lenders may find bondholders wary of their debt for fear they may follow suit.

Concerns over CIT Group's future have risen as the company's application for federal support remains on hold, sparking fears the company may fail or need to undertake a large overhaul of its debt to survive in the near term.

Despite some parallels with Lehman Brothers' catastrophic collapse in September, analysts agree that should CIT fail, this would be less of a threat to the financial system, albeit a blow to many companies dependent on the lender.

CIT's bonds retraced some of their recent losses on Tuesday on reports that the U.S. Treasury, the Federal Reserve and the Federal Deposit Insurance Corp are exploring aid options for the company, which lends to nearly a million mostly small and mid-size businesses.

With about $40 billion in long-term debt, a default by CIT has the potential to cause large losses among its debtholders. CIT is also one of the most widely referenced names in the credit default swap market.

However, "I think the market is looking at CIT as an isolated situation. There aren't all that many sizable companies that fit into that bucket," said David Havens, a managing director in credit trading at Hexagon Securities in New York.

"There are a lot of small businesses that rely on CIT but there is also the recognition that if pointed in the right direction banks would be able to provide that credit support to those businesses," he said.

The benchmark U.S. investment grade credit derivative index was rangebound between 142 and 145 basis points in the last week, even as concerns over a possible CIT bankruptcy peaked, according to data by Markit Intraday.

The index tightened to 139 basis points on Tuesday, Markit data show.

CIT has around $2.5 billion in debt coming due by the end of 2009, including $1.1 billion in August, according to CreditSights. An additional $8.5 billion in debt also matures in 2010, they said.

Even if the company benefits from additional capital support by the government it may not be out of the woods, analysts at CreditSights said in a report sent late on Monday.

"We believe CIT's funding model is broken and have doubts over whether an additional capital injection would cure the problem," they said.

DAY OF RECKONING

The near systemic meltdown that happened after the collapse of Lehman Brothers in September impelled the government to backstop all the biggest banks as investors pulled back exposures on fears over who would be next to fail.

"The specter of another round of fear and questions over who is next may pose a risk to the banking system as a whole," CreditSights said. "However, we believe that the U.S. banking system has progressed far enough from the dislocation seen in the fourth quarter of 2008 to the point where it can handle a failure of CIT."

Some smaller lenders, however, may find themselves tarred with the same brush by bond investors if CIT fails.

"This credit crisis isn't over," said Haag Sherman, co-founder and managing director of Salient Partners, a Houston-based investment firm. "It is largely over for the big banks who have gone and aggressively written down loans and gone to the capital markets to raise capital: the too-big-to-fail banks."

"For medium-sized and small lenders I think their day of reckoning hasn't really come (yet)," Sherman said.

Lenders face additional losses as cash-strapped consumers fall behind on loan and credit card payments while prime residential mortgages and commercial mortgages loans are also expected to worsen.

"I don't believe that the regulators have a good grasp of the implications of letting CIT go," said George Feiger, chief executive of Contango Capital Advisors in Berkeley, California. If that were to happen, investors may shun the debt of mid-sized lenders in general, Feiger said.

CIT's 5.0 percent bond due 2014 rose 1.35 cents on the dollar on Tuesday to 58.65 cents, according to MarketAxess.

(Editing by James Dalgleish)