|Shares Out. (in M):||201||P/E||10.0||0|
|Market Cap (in M):||6,280||P/FCF||7.6||0|
|Net Debt (in M):||0||EBIT||0||0|
Overview / Thesis
CIT Group is a well capitalized (12.7% Tier 1 Capital) and under-levered (14% Tangible Equity/Assets) commercial lender ($24B of Middle Market Loans/Commercial Real Estate/etc.) and lessor of Transportation assets ($20B of Aircraft/Rail/Maritime). They acquired OneWest Bank (bank with 70 branches in Southern California, $21B of assets, and $14.5B of deposits) on 8/3/2015 in order to increase/improve their deposit based funding (previously deposits were entirely internet-based CDs), lower their funding costs, and accelerate the utilization of their >$5B NOL. They are working towards being a full commercial bank with all assets in their bank (CIT BANK); currently they are originating most new business from the bank and 65% of assets are within the bank. They continue to focus on increasing their deposit-based funding (now 64% of total funding) and lowering their above bank-average funding costs (currently 2.22%). Including a full-year of OneWest, they should generate ~$3.10 in Net Income (consensus is for $3.40 but I think this will be lower due to Rail weakness and additional loan reserves) in 2016 and $4.10 in Cash Earnings (Pre-tax Income minus Cash Taxes) due to >$5B NOL. At the current valuation (10x 2016E PE, 7.5x Cash PE, 0.57x P/B, and 0.65 TBV) we believe it is trading well below the intrinsic value of the business ($40-45+). Management is taking steps that should result in realizing this value.
CIT is spinning (or selling) their ~$10.7B ($10B at time of announcement) Commercial Aircraft business by early 2017.
CIT announced in October 2015 that they are planning to spin (or sell) their Commercial Aircraft business. This should be completed in late 2016/early 2017. Management is currently creating standalone financials.
Management didn’t believe the market was giving them credit for this asset (and that was when the stock was $40+). Additionally, they are trying to transition to being a full commercial bank with all assets in their Bank (vs Holdco), but most Aircraft assets couldn’t be moved to the bank (only 10% currently in bank) and funded by deposits. Also, it was difficult to grow the business as not only do they have to hold 15% of capital for the aircraft assets they own, but also 15% on assets in the order book (an additional $10B on order) so 30% capital on current book assets.
They own 271 aircraft with an average age of 6 years. They also finance/manage an additional 79 aircraft. The fleet has an average age of 6 years, has few older wide-body aircraft, and has averaged 99% utilization the past 10 years (currently 100%).
The spinoff will have ~$11B ($10B at announcement but receiving on order book; currently ~$10.7B) of aircraft assets and ~30% Equity. They currently have $2.2B of Secured Debt that will go with the spinoff but they will have to issue new unsecured debt for the remainder (and payoff unsecured at the parent. They are planning to be leveraged such that it will allow them to be investment grade and the unsecured debt will likely be at lower rate than current CIT unsecured. Unsecured at the parent are at 5.02% while AL unsecured (investment grade) are at 3.6%.
Comps (AER, AL, AYR) are currently trading at 0.85-1.0x BV but had traded higher (1-1.5x) until recently. There is concern in the market regarding China & emerging markets demand & wide-body rates/resale values but CIT has limited older wide-bodies, the long-term trends in the air lease business are favorable, and AL and AER both had solid Q4’s and think these concerns are overblown. A sale (Avolon Holding to Bohai Leasing) took place at >1.5x book value in September 2015 with 2 bidders.
Fresh Start Accounting considerations: CIT previously went through bankruptcy in 2009 and used Fresh Start accounting upon exit. The Aerospace assets are currently understated by $600M due to Fresh Start Accounting. Therefore, it seems unlikely that they can’t get close to book. However, the higher book basis of assets including FSA would mean Net Income would be lower due to a higher depreciation expense.
Excluding the Commercial Air segment (assuming reasonable valuation) they are trading at a remarkably low valuation.
We assume Commercial Air is worth ~0.9-1.0x (similar to comps) the $3.0B stated BV ($3.6B ex Fresh Start) is $2.7-3.0B ($13.5-15/share). If you exclude this you are left with a $16-17.50 Stub:
The business ex-aircraft is trading at ~0.4x BV and ~0.5x TBV which is well below other banks.
This business earns $2.00 in EPS and ~$2.70 in Cash EPS (excluding any share repurchases) on an implied value of $16-17.5.
GAAP Earnings are significantly understated. Cash Earnings will be significantly higher than GAAP for years.
Using more conservative estimates for loan losses/rail weakness/other income than sell-side I calculate ~$3.10 in 2016E EPS (vs $3.41 consensus) and $4.20 in Cash EPS.
$2B of NOLs are limited ($264.7M/year) due to bankruptcy, approx. $3.7B are unlimited.
68% of pre-tax earnings are US earnings currently and ~90% will be US Earnings post spinoff of Commercial Air.
The GAAP tax rate is 30-35%, yet the cash tax rate is currently in the high single digits and will be lower post spinoff as aerospace is mostly non-US.
The NPV of NOLs is ~$1-1.2B (assuming $5.2B NOL at YE 2015) while the DTA on NOLs on BS is ~$1.8B (not discounted; was $2B at YE 2014). This had previously been written down but was written up via a valuation allowance reversal in 2015 as CIT now expects to fully utilize the NOL.
The net DTA doesn’t count as Tier 1 capital but as they realize the NOLs (and as it becomes cash thru earnings) it will become Tier 1 capital, and they will have additional excess capital for buybacks/etc.
CIT can likely continue to lower their funding costs (or sell themselves to bank with lower funding costs) over time which should drive earnings growth.
CIT deposits have historically been high-cost-- largely from online CDs and at highest rates of peers with minimal (4%; all from recent OneWest acquisition) being non-interest bearing deposits.
CIT has an average rate on deposits of 1.25% and an average rate on Long Term Borrowings of 3.97% at YE 2015 (due to low credit ratings and high borrowing costs following 2009 bankruptcy). Midsized commercial banks are ~0.25% funding cost on Deposits (though this requires physical branches) and ~1.75% on Long-Term Borrowings.
As they complete their transition to being a full commercial bank and their credit ratings continue to increase (CIT Bank was raised to investment grade BBB- on 1/27 by S&P as was their Group Credit Profile of Consolidated CIT; unsecured and long term issuer credit rating at CIT Group are still below investment grade BB+) they should be able to lower their funding cost (particularly on their high-cost unsecured debt).
Additionally, I think there’s a decent chance that they will sell the company once they spinoff Commercial Air. At that point they can be almost entirely bank funded and given their higher funding cost vs other banks this would make sense. A new CEO (Ellen Alemany) is taking over in May and may be more amenable to a sale than John Thain. She is 60 and previously was CEO of Citizens Financial Group ($120B of assets in 2013) from 2009 to 2013 and retired during their IPO process from RBS. The only negative of a sale is that it would lower the NPV of NOLs by ~$1.50-2.00 due to limitations from ownership change.
CIT engaged in significant stock buybacks in prior periods which should continue in 2H 2016:
$775M of buybacks in 2014 and $530M in 2015.
They didn’t buyback in Q4 2015 as they are participating in CCAR this year but these should begin again in Q2 or Q3 after receiving approval from regulators. Repurchasing at ~0.5x book value would be very accretive.
In addition, CIT offers a $0.60/share dividend (2% yield).
Significant Insider buying at recent prices:
$14M of Insider Purchases at $25.64-27.77 ($27.08 avg) between 2/4/16 and 2/11/2016 by John Thain (Outgoing CEO/Chairman), Steven Mnuchin (Vice Chairman), Ellen Alemany (Incoming CEO/Chairman) and Alan Frank (Director).
Oil Exposure in Loan Book:
$940M of exposure to Oil & Gas Extraction & Services (primarily Senior Secured loans secured by Working Capital or Long-lived fixed assets). Makes up 4% of Commercial Loans & 3% of Total Loans. 50% E&P, 30% Energy Services, and 20% Midstream. <5% are leveraged loans. 89% are shared national credits.
The reserves they’ve taken were done using $45 Oil so if oil stays lower would experience additional reserves/losses but the company won’t quantify.
RAIL segment weakness:
37.8K of 116K NA railcars are used for Oil/Natural Gas or Coal: 10K sand cars leased to oil/natural gas co’s, 15K tank cars for oil, and 12.8K Coal cars.
They have an order book (most/all is in 2016) of $1.3B which is only 55% leased currently.
Renewals: 3500 Oil-related cars ($200M net investment) are up for renewal in 2016. 20K total cars are up for renewal.
Utilization declined from 98% in Q2 to 97% in Q3 to 96% in Q4 and the company said in Q4 that they expect this to decline to low 90’s (hit 90% in 2009 recession). This is both from existing going off-lease and deliveries from order book unplaced.
Gross Yield declined from 14.5% in Q3 to 13.7% in Q4.
Currently low Non-Accruals/Loan Losses but would rise significantly in case of recession:
Non-Accruals: Increased to $268M (.85% of Finance Receivables) in Q4 from $215M (0.66%) in Q3. This was primarily due to energy but still low.
Net Charge-offs: 0.4% in Q4 from 0.9% in Q3 and 0.4% in Q2. The higher Q3 was due to exiting of international finance. They are continuing to exit these businesses and may see some losses in Q1.
Allowance for Loan Losses (as % of finance receivables): 1.14% in Q4 from 1.03% in Q3.
Past Recession: The Commercial Banking segment experienced 7.7% charge-offs in 2009 and 2-3% in 2010 and 2011. The overall company had 4% Net Charge-offs in 2009, 1.5% in 2010 and 1.1% in 2011. Non-accruals were 0.9% at 12/31/2007, 2.7% at 12/31/2008, and 6.9% at 12/31/2009.
The company is much better prepared to handle any downturn this time though. Currently they have 13.9% Tangible Equity/Assets and 5.5x Debt (incl. deposits)/Tangible Equity versus 7.7% and 10.6x respectively at 12/31/2007.
The Legacy Consumer Mortgage Segment has higher yield than loans they could replace it with:
LCM was acquired in the OneWest Transaction and is made up of Single Family Residential ($4.6B of assets) and Reverse Mortgages ($917M of assets).
Consumer Covered loans make up $5B of these assets, were acquired by OneWest Bank (at a discount) in connection with the IndyMac, First Federal and La Jolla transactions, and are part of loss share agreement with FDIC.
CIT (OneWest) takes the first 20% loss then FDIC covers 80% loss share on next 10% and then 95% thereafter. The covered loans are carried at 77% of Unpaid Balance so additional losses should be somewhat limited.
These currently have a 4.65% Net Finance Margin vs ~4% in their other loans/leases. As this runs down it will be a drag on earnings.
John Thain is retiring on May 10th. Ellen Alemany will become CEO/Chairwoman on that date.
Ellen Alemany previously was CEO of Citizens Financial Group from 2009 (when it was part of RBS) until 2013 as they prepared to spinoff the company. CFG had $122B of assets and 1370 branches in 2013.
She seems reasonably qualified and may be more open to selling the company post-spinoff of Commercial Air than John Thain was.
On 3/1/16 they extended deadline of 10K to 3/15/16 and said there is a material weakness in accounting practices at their reverse mortgage business in discontinued operations.
This is related to the Financial Freedom reverse mortgage servicing business which was acquired as part of OneWest on 8/3/2015. “The identification of the control deficiency resulted in adjustments to the calculation of the HECM Interest Curtailment Reserve. After performing analysis of the underlying data and assumptions, the reserve was adjusted to reflect the results of this analysis. Management concluded that the amounts and disclosures within the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015 and its earnings release issued February 2, 2016 and filed on its Current Report on Form 8-K on February 2, 2016 are not materially misstated.”
Discontinued Operations, which is primarily Financial Freedom, was $500M of assets (and $696M of liabilities) at 12/31/2015.
The company says this is immaterial to past earnings.
Spinoff (or Sale) of Aerospace around YE 2016: Assuming ~0.9-1.0x BV is realized from spinoff, the remaining business is currently trading at 0.4x Book Value and 0.5x Tangible Book Value which is well below other Banks.
Share Repurchases: $770M in 2014 and $530M in 2015. Currently CIT can’t repurchase stock as they are going through CCAR but will likely start again once given approval to.
Possible Sale of Company following Spinoff: Post spinoff almost all assets are eligible to be in the bank and if the market is not giving them credit for the business, it would make sense to sell the company at this point. CIT has been lowering their funding costs but are still significantly higher than other banks. A buyer would be able to extract significant value by lowering the funding cost. There was concern that John Thain was not open to selling the company at $50 but he is retiring in May and Ellen Alemany is becoming CEO/Chairwoman. She previously was CEO of Citizens Financial Group (CFG) starting in 2009 and then left in 2013 as RBS prepared to IPO the subsidiary.
Transportation & International Finance (TIF) ($20B of assets; 4.0% Net Finance Margin):
Aerospace—Commercial ($10.7B of assets; up from $10B at Q3):
Business: Provides commercial aircraft leasing & lending.
Fleet: Owns (271) and finances (79) a fleet of 350 aircraft and have about 100 clients in approximately 50 countries. 6 year average age (20-25 year life) on owned assets and few older wide-body aircraft most at risk of declining value.
100% leased at 12/31/2015 (averaged 99% leased the past 10 years).
Commercial Air Book Value is lower by $600M due to fresh start accounting due to 2009 bankruptcy.
Aerospace—Business Air ($850M of assets):
Offers financing and leasing programs for corporate and private owners of business jets.
Rail ($6.7B of assets):
Business: Leases railcars and locomotives to railroads and shippers throughout North America, and Europe.
Fleet: Their operating lease fleet consists of over 127,000 (116K in US; 11K in Europe) railcars and 400 locomotives and serve over 650 customers. The average age of their fleet is 12 years and assets generally have 35-40 years lives.
Fleet Related to Energy: They have 37,760 railcars related to energy (Oil/Natural Gas/Coal). 10K sand cars leased to Oil/Natural Gas, 15K tank cars for transport of Crude, and 12,760 Coal Cars.
Order Book: 9800 railcars on order worth $1.1B (primarily delivered in next 12M) at 9/30. This would be ~5400 and $600M at 12/31/15 based on Q4 deliveries assuming no additional orders. 55% of current order book is leased.
Renewals: 3500 Oil-related cars ($200M net investment) are up for renewal in 2016. 20K total cars are up for renewal in 2016.
Utilization: Declined from 98% in Q2 to 97% in Q3 to 96% in Q4 and the company said in Q4 that they expect this to decline to low 90’s (hit 90% in 2009 recession) due to weakness in energy. This is both from existing going off-lease and deliveries from order book unplaced.
Rail Book Value is lower by $1.3B due to fresh start accounting from 2009 bankruptcy.
Maritime Finance ($1.7B of assets):
Offers secured loans to owners and operators of oceangoing and inland cargo vessels, as well as offshore vessels and drilling rigs.
Weakness in Maritime in Q4 caused some increased reserves. Lease rates in dry-bulk ships came down and caused subsequent decline in expectation in re-sale prices.
International Finance ($800M of assets):
Offers equipment financing, secured lending and leasing to small and middle-market businesses. Exiting this segment. Completed exit of Mexico and Brazil already. In the process of exiting China and Canada.
North America Banking (NAB) ($24B of assets; 4.0% Net Finance Margin):
Commercial Banking ($10B of assets):
Middle-market lending, primarily senior secured loans (and revolvers) collateralized by accounts receivable, inventory, and machinery & equipment
Commercial Real Estate ($5.4B of assets):
Senior secured commercial real estate loans to developers and other commercial real estate professionals.
Commercial Services ($2.1B of assets):
Provides factoring, receivable management products, and secured financing to businesses (our clients, generally manufacturers or importers of goods) that operate in several industries, including apparel, textile, furniture, home furnishings and consumer electronics.
Equipment Finance ($5.2B of assets):
Provides leasing and equipment financing solutions to small businesses and middle market companies in a wide range of industries.
Consumer Banking ($1.4B of assets):
Offers mortgage lending, deposits and private banking services to its customers. Has a network of 70 retail bank branches in Southern California as a result of acquisition of OneWest Bank (branches now renames CIT Bank).
Spinoff (or Sale) of Aerospace around YE 2016
Continued Share Repurchases
Possible Sale of Company following Spinoff
|Entry||03/03/2016 07:55 PM|
Thanks for the analysis!
|Subject||BOC Aviation IPO, thoughts on sale of aircraft leasing business|
|Entry||05/31/2016 09:48 PM|
BOC Aviation, Bank of China's aircraft leasing arm, conducted a successful IPO today at ~1.05x book value and is trading up a few percent on its first day, suggesting a well-run process and solid demand. BOC Aviation has a similar fleet size to CIT (slightly smaller in owned planes), a younger fleet (~3yrs avg age vs CIT at 6yrs), but similar reliance on narrow-bodies. BOC has a huge funding advantage (given the parent bank relationship) and perhaps as a result carries much more leverage (3x debt/equity pro-forma for the IPO vs CIT at ~2.4x).
Reuters is also out reporting that a number of bidders are interested in CIT aviation and the prospective price is $3-4bn: numbers that suggest at least a book value sale, if not a decent premium. Even the low end of this range would be an excellent outcome for CIT.
Abra, a couple of questions:
- do you know if any cash tax will be payable on the aviation sale? Assuming a slight premium to book, there should theoretically be some tax payable but not sure if the NOLs/DTAs shield taxes on that.
- what do you think CIT's priorities will be for the capital raised? As you mentioned they are already under-levered so to my mind buying back stock is the only real use of capital. $3bn is a huge needle-mover given the market cap today (~$6.8bn) so this could be really accretive and I'm surprised the stock has not responded better
also would love to hear your thoughts re LuckyDog's questions from earlier
|Subject||Re: Nice analysis|
|Entry||09/20/2016 09:59 PM|
good to see some discussion on this :)
you are right, extant RoEs post leasing sale are of course low, but not low enough to justify 0.5x book, plus you have the huge technical tailwind of highly accretive buybacks for a big chunk of the stock if/when they can begin those. Mgmt has also guided to higher RoEs by 2018, partially a function of asset optimization.
I would not be surprised to see transportation finance sold next (maybe next year), and then the whole bank to a larger player. Even if none of that happens with the stock this low and a large amount of excess capital to deploy, it is tough to see how this really hurts you from here. May take time but think AIG asset-sale + stock recovery process is the right analog.
|Subject||Re: Re: Re: Nice analysis|
|Entry||09/23/2016 09:23 PM|
agree its a little disconcerting, but I'm not running for the hills just yet. the likely acquirers are Chinese and as other deals have shown they can tend to go back and forth a bit before committing. The other thing to consider is CIT could be pushing back on price. The reported bid range is wide ($3-4bn) but even so 'only' in the 1-1.3x tangible book range (which should be ~$3bn at the moment). You will recall Avolon got bought out by HNA (the likely acquirer here) above 1.5x book in Feb this year. Since then of course BoC Aviation listed in HK at a small premium to book (not a transaction the other public lessors could be crazy about, in retrospect). Of course there are some differences in fleet age metrics and committed growth, etc, but CIT is a much larger, more diverse platform and frankly would not deserve that large of a discount to book assets in a vacuum, though you could argue the external environment has weakened (weaker new plane demand, widebody rent pressure, etc).
I think CIT ultimately sells at ~1.1-1.2x book, so lets say ~$3.5bn, even though this is not a bad price at all for the acquirer(s). CIT is not a distressed seller but is certainly motivated when their equity trades at 0.6x...
The more I think and look at this space, the more I think aircraft leasing is one of those segments that the market will never quite 'get'. AER, for example, has not lost money since being listed, average impairments less than 1% of average assets throughout the cycle, and generated low double-digit RoEs for over a decade. Comparing their earnings volatility to other leasing businesses (equipment, eg) or even banks suggests much better risk-adjusted returns as well. These businesses are far less volatile than their reputation (and stock prices) suggest, especially for the very large, diversified lessors. There is a reason GE kept their leasing business even while divesting a ton of their other financials businesses.
While some Japanese banks have made occasional acquisitions (RBS' business got bought by SMFG a few yrs ago), I am quite shocked those with funding advantages don't just hoover up the key platforms. That may still be how this ends.
|Subject||Aviation unit sold for $10bn, 1.2x book|
|Entry||10/06/2016 07:37 PM|
So CIT confirmed Avolon will buy its air leasing biz for $10bn, or 1.2x attributed book equity for the unit ($3.9bn contributed vs $3.3bn in unit equity).
CIT also announced at least $3bn in capital returns (and perhaps $3.3bn) once the deal closes (Mar17), with provisionally 'no objections' from regulators. Even with the pop AH that is ~38% of market cap today.
The stock - post AH pop - still trades at ~80% of TBV, and this buyback is massively accretive. Even absent further return-boosting measures (eg sale of transport leasing business), it is hard to see how the stock doesn't accrete much closer to TBV over time.
As an aside - 1.2x book for the 5th largest air lessor makes the other large, public lessors (AER, AL) look quite cheap where they are trading (10%+ below book value).
Long both CIT and AER.