Financial struggles of lender CIT to 'test capital markets'

— -- The U.S. financial system could be about to get one of its first big gut checks since the failure of Lehman Bros., as stock and bond investors await the fate of struggling lender CIT.

While CIT is not a massive institution of the size of Citigroup or Bank of America, it's a top player in providing loans to small businesses. Some of these companies may have difficulty securing loans elsewhere.

"CIT will be a test of the capital markets," says Bill Larkin of Cabot Money Management. Will CIT's problems "have a noticeable impact or just fade away?"

The broad market generally took the challenges facing CIT in stride Thursday. Stocks rose nearly 1%, approached their 2009 high based on the Wilshire 5000, and posted their first four-day winning streak since June. And even the Russell 2000 index, which tracks smaller companies, including some that presumably are CIT customers, gained 1.2%.

But investors were much more sober about CIT's prospects. Its shares plunged $1.23, or 75%, to 41 cents. And the value of CIT's bonds have collapsed, with investors pricing those maturing this year for roughly 50 cents on the dollar, Larkin says.

A CIT spokesman declined to comment. But experts see a variety of alternatives for the company, including:

•Using assets as leverage to borrow. CIT still has $37 billion in assets that have not been pledged as collateral, says David Chiaverini of BMO. Lenders might be willing to provide capital in exchange for claims against those assets, he says.

•Debt-for-equity tradeoff. The company's best option for survival is to coerce lenders to trade their bonds for stock in the company, says Christopher Whalen of Institutional Risk Analytics. If lenders aren't willing to cooperate, then the government, which plowed $2.3 billion into the company as part of the TARP program, should use its clout to force it, Whalen says.