|Shares Out. (in M):||389||P/E||n/a||n/a|
|Market Cap (in $M):||311||P/FCF||n/a||n/a|
|Net Debt (in $M):||68,000||EBIT||0||0|
Long - CIT Group Unsecured Bonds
Current Price: (5.6% April 2011 Bonds): 59
Recovery Value: 80-100
Total Unsecured Bonds: $34 b
CIT bonds are a long because recovery value in liquidation is 80-100 vs. current pricing of 59. To get to a recovery value of 60 would require cumulative losses on CIT's loan portfolio of 40% which is beyond draconian. There is a decent probability that CIT restructures in a pre-pack that gives the unsecured creditors new equity which could result in ultimate recovery value above par should loss realization be less than current pessimistic assumptions. Annualized return in a 2.5-year liquidation is 13%-24% with minimal downside risk. Returns could be much higher if the company is reorganized or survives.
(note: for smaller investors there are retail notes traded that can be purchased 10-15 points back from the more liquid global bonds. The risk/reward is even more compelling at 45 vs. 60).
CIT is a century-old diversified financial lender to small and medium sized business. Loan segments include asset-backed and cash flow lending (32%), aircraft and railcar leasing (22%), small-ticket equipment leasing through vendor programs (19%), student loans (19%), and factoring for the retail industry (8%).
Before new CEO Jeff Peek joined the company in 2004, CIT was respected for being highly competent in their core business units of asset-based lending, factoring, vendor finance, and equipment leasing. Concurrent with Peek's arrival and the loosening credit standards of recent years, CIT expanding into cash flow lending, sub-prime mortgages, student lending, and other marginal areas of business. Industry calls indicate that CIT was originating paper of such low quality that they could not even syndicate some during the great credit bubble.
CIT funded itself predominantly through the short term unsecured market for much of its history. Beginning in late 2007, the company began to experience more difficulty in accessing this funding as we entered the credit crisis. Financing concerns forced CIT to apply for bank-holding company status (BHC) in December 2008 to receive $2.3 b of TARP preferred equity from the government.
The TARP injection along with additional common and preferred equity offerings was not enough to stem a loss of confidence in the market of CIT's loan portfolio and liquidity which came to a head in June/July. Faced with a liquidity crunch the company has resorted to a punitive $3 b secured financing with large owners of unsecured bonds in an effort to keep the company from filing chapter 11 imminently.
CIT is currently tendering at a discount for its upcoming maturity of $1 b of bonds due on 8/17/09. Should the tender be unsuccessful, the company will likely file BK and a slow liquidation is possible. If the tender is successful, CIT will have bought itself time to try and arrange an orderly pre-packaged bankruptcy out of court which will serve retain enterprise value as there will be a better chance for a going concern rather than liquidation.
Purchasing the bonds of troubled financial companies at distressed prices can sometimes be an attractive situation because there is a large portfolio of loans that are worth something. Maybe they aren't worth the par value equity holders believed, but you can create a purchase price of the portfolio at an absurdly low level if the bonds can be purchased at a low dollar value. Recent examples of this type of situation include GMAC, FMCC, and Sallie Mae. CIT Group appears to be another analogy.
Using conservative assumptions, recovery value on the CIT portfolio today is 97 in our base case and 80 in the low case. This assumes that CIT bank is seized by the FDIC even though it is well capitalized, the GS financing facility's over-collateralization is seized and sold, and applies aggressive loss rates to the different loan segments of CIT's portfolio. This also ignores ~$3 b or ~10 bond points of cash flow net of bankruptcy costs generated over 2-3 years due to ceased bond interest payments. Analysis & explanation of base case recoveries is below, apologies if the formatting does not come out great:
|Recovery Analysis||% Recovery||$ Recovery|
|3/31/2009||Low Case||Base Case||High Case||60 recovery||Low Case||Base Case||High Case||60 recovery|
|Commercial real estate||850||30%||49%||70%||25%||255||417||595||213|
|Less: GS facility assets pledged||(3,962)||85%||92%||95%||60%||(3,368)||(3,645)||(3,764)||(2,377)|
|Cash flow loans||10,494||65%||76%||85%||60%||6,821||7,976||8,920||6,297|
|Less: GS facility assets pledged||(1,353)||80%||90%||100%||75%||(1,082)||(1,217)||(1,353)||(1,015)|
|US gov student loans||11,433||99%||100%||100%||99%||11,262||11,433||11,433||11,262|
|Private student loans||740||45%||55%||65%||70%||333||407||481||518|
|Total loan portfolio||62,509|
|Less: Bank assets||(9,582)||100%||100%||100%||100%||(9,582)||(9,582)||(9,582)||(9,582)|
|New cash from July secured loan||3,000||100%||100%||100%||100%||3,000||3,000||3,000||3,000|
|Cash generated in BK||-||100%||100%||100%||100%||-||-||-||-|
|Deposits with banks||5,752||100%||100%||100%||100%||5,752||5,752||5,752||5,752|
|Trading assets - derivitives||180||50%||75%||100%||50%||90||135||180||90|
|Investments - retained interests||192||0%||0%||0%||0%||-||-||-||-|
|Derivitive counterparty receivables||1,174||100%||100%||100%||100%||1,174||1,174||1,174||1,174|
|Goodwill and intangibles||695||0%||0%||0%||0%||-||-||-||-|
|Assets of discontinued operations||-||25%||50%||75%||25%||-||-||-||-|
|% Recovery||Recovery in Bond Points|
|Waterfall||Low Case||Base Case||High Case||60 recovery||Low Case||Base Case||High Case||60 recovery|
|Initial recovery value||51,489||57,412||62,689||44,227|
|Bank credit facilities||5,200|
|Less: Bank liabilities||(6,839)|
|Less: GS financing||(3,181)|
|New $3 b secured loan (July 09)||3,000|
|Plus: Canadian bonds (double-dip)||2,200|
|Plus: Australian bonds (double-dip)||250|
|Other secured liabilities||932|
|Total secured claims||23,148||23,148||23,148||23,148||23,148||$ 100||$ 100||$ 100||$ 100|
|Remaining recovery value||28,341||34,264||39,542||21,079|
|Senior unsecured - variable||9,066|
|Senior unsecured - fixed||24,556|
|Less: Canadian bonds (double-dip)||(2,200)|
|Less: Australian bonds (double-dip)||(250)|
|Trading liabilities - derivitives||161|
|Credit balances of factoring clients||2,702|
|Derivitive counterparty payables||310|
|Other unsecured liabilities||1,028|
|Total unsecured claims||35,372||35,372||35,372||35,372||35,372||$ 80||$ 97||$ 100||$ 60|
|Remaining recovery value||-||-||4,169||-|
|Junior subordinated claims:|
|Junior subnotes||2,099||2,099||2,099||2,099||2,099||$ -||$ -||$ 100||$ -|
|Remaining recovery value||-||-||2,071||-|
|Preferred stock||3,134||3,134||3,134||3,134||3,134||$ -||$ -||$ 66||$ -|
|Remaining recovery value||-||-||-||-|
|Common equity (value/share)||$ -||$ -||$ -||$ -|
Commercial real estate - $850 mm portfolio of which half is 1st lien loans and half is 2nd lien loans or junior. Assume 100% of the 2nd liens default with 10% recovery and 30% of the 1st liens default with 60% recovery.
Asset-backed loans - $6.5 b portfolio net of GS facility. This assumes that all of GS's collateral was from the ABL portfolio rather than the cash flow portfolio within corporate finance. Assume 20% of CIT's customers default with 60% recovery.
Cash flow loans - $10.5 b portfolio. This is a marginal portfolio that was created in the last 5 years using loose underwriting standards. Assume 30% of the portfolio defaults with 20% recovery values given little asset protection.
Transportation finance - $8 b of aircraft (average 5 year old, mostly narrow body) fully leased to customers. Using current secondary market values by plane type yields a value greater than book. Assume a 10% liquidation discount and recovery is over ~90%. There is also $4.8 b of railcars that is 93% utilized which I assume a 10% discount to book in a sale which implies ~$60k/railcar, in-line with replacement cost and private market valuations according to people looking at the portfolio which is currently being shopped. Note that of all of CIT's businesses, the railcars and aircraft are the most salable given the strength of the portfolio's performance and underlying value of the assets.
Trade finance (factoring) - $6 b portfolio. Assume 30% of receivables do not pay with 30% recovery. This would mean that 30% of companies within the retail industry file for bankruptcy and do not pay critical vendors (i.e. they liquidate).
Vendor finance - $13 b portfolio. Assume 30% of small businesses default on their leases of mission critical equipment (computer servers, telephone systems, etc.) and the assets are liquidated for 30% of depreciated cost.
Student loan portfolio - $11.4 b is US government guaranteed. Private student loans of $740 mm are toxic as most are from non-traditional schools including $200 mm tied to a flight school that has since declared bankruptcy and stopped classes. Assume the $200 mm is a zero, and the rest default at 30% with 20% recovery.
Why This Opportunity Exist:
Risks / What Would Make Us Wrong:
Potential Event Timeline / Catalysts
|Subject||is the early bankruptcy threat real?|
|Entry||07/28/2009 08:32 PM|
Thanks for an interesting writeup. This is something I've been very heavily involved in, and I'd love to compare notes in several areas:
What do you think about the prospects for an early bankruptcy? The bondholders putting up $2 billion of the $3 billion in financing are doing everything they can to scare people into tendering, with the bondholders threatening that they won't release funds to pay off the August 2009 floaters if the 90% tender condition isn't met, and the company suggesting that it may be forced into bankruptcy in that same circumstance. It's hard for me to see why any small holders would tender, since there's a very small chance that any small holder's decision not to tender would cause a failure of the 90% condition or be the straw that broke the proverbial camel's back that would cause the company of the bondholders to refuse to waive the minimum tender condition.
Moreover, unless the bondholders behind the financing have a reason (e.g., CDS, but that seems pretty far-fetched to me) to prefer an early bankruptcy, nobody has an incentive to throw the company into bankruptcy immediately over what would certainly be less than $100 million in savings between a payment of par at maturity and a payment of $87.50 in the tender. The next major debt maturity is in November. Do you think it's worth paying the extra $100 million or less (by waiving the 90% condition and paying non-tendered bonds par at maturity) to keep operating for another three months while they prepare more exchange offers and sell assets in an orderly fashion (every time I look at this, my answer is yes)? Also, what do you make of the reports that the Federal Reserve would consider permitting 23A waivers to put some assets on the bank subsidiary's balance sheet in the context of a broader restructuring?
If you don't think that an immediate bankruptcy is likely if the 90% tender threshhold is not achieved, what do you think about buying and not tendering the August 2009 floaters? The upside there is 20% over less than a month (they trade at $80) with a downside of less than that judging from your analysis.
If you think that bankruptcy is likely, what's your view of how the courts would treat the mandatory converts. The bonds alone have value in bankruptcy, but do you think the court would let the holders repudiate their repurchase obligations? I haven't found a case yet that dealt with this issue directly, though I know of one case in which, as part of a prenegotiated bankruptcy, the holders of mandatory converts were treated as bondholders without an equity purchase obligation. If the mandatory convert holders get the same treatment and the company does enter bankruptcy in the next year, it seems to me that the mandatories have the greatest upside.
Why do you think it was so hard for CIT to arrange a secured financing earlier? Did they simply not have a plan for what to do about the August 2009 bond payment (doesn't seem too likely to me). Were they playing chicken with the federal government, deliberately chosing to look like they would fail without government assistance, and lost (seems more likely to me)? The story we hear is that Treasury and the Fed didn't think CIT was too big to fail, so didn't want to take political heat on a bailout, but I toss in bed at night worrying that the real reason is that CIT's credit book looks a lot worse up close in due diligence than it does from far away.
|Subject||top ten worst management team ever?|
|Entry||07/28/2009 10:18 PM|
agree with your write up and am long the bonds. the loss rates on their assets over time are diminimous relative to whats being priced into the bonds. i know this cycle is likely substantially worse but come on. there was no underwriting bubble in computer equipment. i think the ordinary liquidation scenario is a home run what worries me is the forced sale scenario b/c there are so few strategics with capital these days. what do u think has to happen to make the forced sale scenario a reality? just so hard to see how that could create enterprise value and the secureds are so well covered anyway. plus i think they generate substantially more cash in chap 11 then u've alluded to. as for the way management has botched the last six months by betting the house on TLGP, that's truly one for the record books.
|Subject||RE: Fire Sale|
|Entry||07/29/2009 08:15 AM|
Thanks for the comment. I don't have much else to add on the fire-sale scenario. I agree with you that a forced sale of the businesses as going concerns is unrealistic because no strategic that I can think of is in a position to buy right now. As it relates to a fire-sale of the assets in a liquidation, I think it is realistic to assume that the loans/assets that have a longer duration could be argued that they should be sold. However, the assets in question are the student loans (government guaranteed), aircraft, and railcars, all of which have reasonable bids in the secondary market per my checks. I don't see how the secureds can make the argument that you should sell an equipment lease receivable or an ABL that rolls off in less than 2-3 years at worse recoveries than what I am using in my scenarios. Maybe there is some toxic stuff in the cash flow loan portfolio with 5-7 year duration that will get 50 cents but it's not the entire portfolio and won't move the needle materially. Anything can happen but I think losing through low recoveries from a fire-sale is a low probability.
|Entry||07/29/2009 08:36 AM|
Thanks for the note, great questions. I'll add what I can:
I think there is some probability of an early BK. It is worth less than $100 mm to the ultimate estate to stay out of BK for 3 months, but each member of the new secured group has different positions in the capital structure and we can't know for sure what their incentives are. We've heard this is a real issue. If you buy the Augies and the company files they will trade down to the rest of the unsecured bonds which I am guessing will be in the 40-60 context. So even if you agree that ultimate recovery is 80-100 and therefore you don't lose much by taking that flier you will take severe mark to market pain.
With the mandatory converts, yes if the company files before they convert they have the most upside assuming they trade up to the rest of the global notes (illiquidity might prevent that initially). But if CIT makes it past 2010 then they are worth zero which is a risk I wouldn't take. Given their illiquidity I would compare them to the longer-dated retail notes which can be purchased around a similar price (40) so I don't think they are interesting as a stand-alone investment. I have no idea on the potential to repudiate repurchase obligations.
My view on how CIT got into this situation is that government assistance was by far the least painful way out for them and they led themselves to believe they were too important to small businesses for the government not help them, especially after they got BHC and TARP money in December. They relied on additional support, and it didn't happen. I am sure CIT's corporate finance book looks nasty in person just like a Kmart store looked liked in 2003, but the market is pricing these bonds to loss realizations that are absurd.
|Entry||07/29/2009 07:09 PM|
To be clear, the cancelation of the purchase contract (and return of senior note collateral) upon bankruptcy happens in accordance with the plain terms of the purchase contract. It does not require any repudiation. In other words, any obligation to buy CIT stock in 2010 is explicitly contingent upon CIT not filing bankruptcy before that date. So it seems clear that the CIT Z would be treated as an unencumbered senior note in bankruptcy....
|Subject||Really interesting idea...|
|Entry||07/29/2009 08:36 PM|
Conway mentions CIT-Z as the way to play the notes, I simply want to verify that this in fact is the security you mention that "trades". Thanks again for the interesting idea.
|Entry||07/30/2009 07:50 AM|
Thanks for the note and questions.
From the general unsecured bond perspective, we try to be conservative and assume that the Canadian/Australian bonds do get a double-dip in BK and are paid out ahead of the unsecured claims. As to whether or not this happens, I don't know enough to have a view as to if a15 point premium is warranted. I am under the impression that there are not separate filings for the Canadian and Australian subsidiaries so it would be tough to get conviction as to what asset coverage there is for the bonds before the parent guarantee. Please let me know if I am wrong on that.
I totally agree with your point on the secured lenders incentives. All of them purported to own > $400 mm of bonds so theoretically they should all own some longer-dated paper. I think losing in this trade because of a debt exchange where somehow you get screwed at the front-end of the curve is a low probability. But, we've heard that not all the secured lenders have the same incentives in this process so I highlight it as a risk.
I know as much as you on the timing and potential for stronger terms in the new secured deal. A fire sale is a risk - to frame it, if they sold some of their stronger collateral at 50-70 cents to pay off the $3 b secured loan it would hurt recoveries by ~5 cents.
|Entry||07/30/2009 07:51 AM|
Conway, that's our understanding as well. Sorry I wasn't clear - thanks for clarifying.
|Entry||07/30/2009 07:55 AM|
Angus, I am NOT recommeding the CIT-Z's. I am recommending any unsecured bond (global note or internote for smaller investors) closer to the front end of the curve. The CIT-Z's are the mandatory converts that have been discussed earlier in the thread. The are required to convert into CIT common stock in November of 2010 at a minimum price of ~$40/share. If the company survives to then, you will lose ~100% of your investment in the CIT-Z's. Hope that clarifies things.
|Subject||Abra - credit agreement filed|
|Entry||07/30/2009 10:17 AM|
Credit agreement was filed, I didn't see anything different in it vs. what's been announced. If you or anyone else has a different view please let me know.
|Entry||08/06/2009 12:16 PM|
Does anyone here understand what's happening to the CIT common? It strikes me that this is either a zero or ends up being 90+% diluted through debt exchanges that include some component of equity kicker to the debt holders. Why is this up 100% in the past few days?
|Subject||If you like the stock you have to like the bonds|
|Entry||09/16/2009 12:27 PM|
Bonds are trading low 60s.. Recovery 45/50 which gives you downside 10 pts upside 40 pts and if you like the stock it means that the odds on the bonds is better than 50/50. CIT stock is a an option not a value play..... a very interesting option but an option nonetheless.