|Shares Out. (in M):||201||P/E||0.0x||0.0x|
|Market Cap (in $M):||5,820||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||0||EBIT||0||0|
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I am recommending CIT as a long at 68% of GAAP tangible book value and at 57% of adjusted tangible book value (which excludes fresh start accounting marks). While many banks are trading below tangible book value today, CIT stands out for two reasons: (i) it has a large margin of safety given its highly liquid and unlevered balance sheet, and given the fact that the balance sheet was marked to market during the bankruptcy process in late 2009, and (ii) it has several "internal" catalysts from re-optimizing its balance sheet and exiting regulatory purgatory which should help increase profits and unlock value over the next two years. In terms of liquidity and capital, CIT has almost 40% of its assets in cash and government guaranteed student loans. Its tier 1 common ratio is 19.1%, which is more than double most banks. CIT will create a lot of value simply by redeploying excess liquidity and capital more productively, which I expect will be a combination of loan growth and buybacks. Accordingly, the discount to book value should decline overtime.
CIT is well known within the value investing community (four prior VIC write-ups) and was widely held by hedge funds during and after its bankruptcy. However, as 2011 has progressed, I think CIT is finding itself somewhat orphaned, having been sold by hedge fund types, but not yet embraced by traditional investors. In addition, the management has been focused internally for the last year and not out telling the story. The stock started trading post bankruptcy at $29 in late 2009, it peaked at $48 earlier this year, and it was pitched at the Ira Sohn conference in May when it was in the low-40s. Now, the stock is back to the $29 level at which it exited bankruptcy despite the fact that its balance sheet and operations have significantly improved. Notably, the CEO bought $1.2mm of stock in the open market in late August at a similar price.
CIT is a diversified commercial lender serving primarily small and mid-sized businesses. CIT emerged from bankruptcy in December 2009 and has been undergoing a major restructuring. The highlights are:
CIT has $48bn of assets, including $10bn of cash and a $35bn financing portfolio consisting of:
CIT's $48bn in assets are currently funded by $4bn in brokered deposits, $11bn in secured debt, $21bn in unsecured/2nd lien debt, and $9bn in equity ($3bn of other makes up the difference). The unsecured/2nd lien debt has staggered maturities, with the earliest maturity in 2014, which it can easily meet with existing cash. Overtime CIT wants to move its funding mix to 35-45% deposits, 25-35% unsecured debt, and 25-35% secured debt. Fixing the funding mix is the key to creating value and to taking earnings from roughly break-even today to "normal" profitability in 2-3 years. I as describe below, I believe that fixing the funding mix is primarily about continued management execution, with only minimal dependence on cooperation from the capital markets.
- First, there is "core" book value and "excess" book value. CIT targets a 13% tier 1 common ratio vs. its current level of 19%, which implies that $14 per share of its TBV is "excess," which I expect will be used for a combination of buybacks, once approved by regulators, and loan portfolio acquisitions. "Core" book value is $29 per share, which represents the amount of equity capital that CIT needs to run its business. The portion of "excess" capital increases overtime as assets shrink.
- Next, there are the fresh start accounting adjustments (FSA) of $8 per share. To oversimplify, this represents mark-to-market hits to the loan book, and does not include permanent write-downs which were also recorded during the bankruptcy. These write-downs accrete back into earnings overtime, and I assume at present value of $4 per share. (The financial exhibit at bottom breaks out the components of the FSA and my estimate of how they accrete overtime.)
- Finally, CIT has a large deferred tax asset with a present value of ~$4 per share. I actually then haircut that by 50% to $2 because I think the public market rarely gives credit for the full value of DTAs... just trying to be realistic.
- So, if you take the current share price of $29 and back out the DTA ($2), back out the fresh start adjustments ($4), back out the excess capital ($14), you are left with $9 of value for the "core" business. On a P/E basis, this implies CIT's "core" business is trading at 3-4x normalized earnings of $2-$3 per share.
- My price target is approximately $46 per share by the end of 2013, for 60% upside. This is based on valuing the core business at 8x normalized EPS of $2.50, equivalent to 80% of "core" book at 2013, and then adding the value of the excess capital, the FSA adjustments and the DTA at that time (as shown in the exhibit below). Note, I am giving credit in the valuation for the per share amount of excess capital as if it will be sitting on the balance sheet in the future, but in reality I expect the excess capital will have been deployed via buybacks and loan portfolio acquisitions. I am effectively assuming that each $1 of excess capital deployed will generate $1 of value for shareholders regardless of whether that excess capital is sitting on the balance sheet, is used for buybacks, or is used to acquire loans. I think this is a reasonable assumption, but I acknowledge that there is a range of outcomes whereby excess capital could be used to add or subtract incremental value.
|Funding Mix EOP $:||2Q'11||2010||2011E||2012E||2013E||2014E||2015E|
|Funding Mix EOP %:|
|Cost of Funds:|
|Net Finance Margin||1.44%||0.74%||1.49%||2.34%||3.08%||3.29%||3.36%|
|Average Earning Assets||$47,835||$38,151||$36,299||$36,970||$37,898||$38,945|
|Normalized I/S (% of AEA)|
|Net Finance Margin||0.74%||1.49%||2.34%||3.08%||3.29%||3.36%|
|Provision for losses||-1.71%||-1.01%||-0.69%||-0.62%||-0.64%||-0.66%|
|ROA Fully-taxed (% of AEA)||-0.73%||-0.11%||0.46%||1.17%||1.36%||1.46%|
|ROA Fully-taxed (% of total assets)||-0.70%||-0.10%||0.39%||0.99%||1.14%||1.20%|
|Target Leverage (Equity/Assets)1||10.4%||11.7%||12.1%||12.1%||12.1%||12.1%|
|ROE on "Core" Book Value||-6.8%||-0.8%||3.2%||8.2%||9.4%||9.9%|
|(+) FSA Interest Income Accretion||$5.40||$3.52||$0.40||$0.20||$0.20||$0.20|
|(-) FSA Interest Expense Accretion||($1.32)||($3.14)||($3.50)||($2.18)||($0.48)||($0.08)|
|(-) FSA Other||($0.02)||$0.17||$0.15||$0.03||$0.00||$0.00|
|(+) FSA Operating Lease Accretion||$0.91||$0.85||$0.86||$0.86||$0.86||$0.86|
|(-) Prepayment Penalties||($0.46)||($0.42)||$0.00||$0.00||$0.00||$0.00|
|o/w FSA EPS||$4.97||$1.40||($2.08)||($1.09)||$0.58||$0.99|
|Book Value Per Share:|
|Tang BV per Share (GAAP)||$42.46||$43.64||$42.68||$43.73||$46.85||$50.63|
|Fresh Start Accounting (FSA) Adjustments||$8.82||$6.42||$9.52||$11.14||$10.28||$8.80|
|Tang BV per Share Ex-FSA||$51.28||$50.06||$52.20||$54.87||$57.13||$59.43|
|Core vs. Excess Book Value:|
|"Core" GAAP Book Value at 13% Tier 1 Common Ratio||$28.63||$27.15||$25.71||$26.34||$27.50||$28.81|
|"Excess" Book Value||$13.83||$16.49||$16.97||$17.39||$19.36||$21.82|
|Implied P/E for Core Business ex-Excess Capital, FSA & DTA||10.6x||4.2x||3.5x||3.2x|
|1 Target leverage appears slightly higher than CIT's stated 13% Tier 1 Common/RWA because the denominator is total assets which is larger.|
|Target P/B for Core Book||0.75x||0.80x||0.80x||0.80x|
|Target P/B for Excess Book||1.00x||1.00x||1.00x||1.00x|
|Target P/B for FSA (DCF value implies ~60% of book value)||0.50x||0.50x||0.50x||0.50x|
|Value for Core Book||$20.36||$20.57||$21.07||$22.00|
|Value for Excess Capital||$16.49||$16.97||$17.39||$19.36|
|Value for FSA Adjustments||$3.21||$4.76||$5.57||$5.14|
|PV of DTA w/50% haircut2||$2.10||$2.15||$1.88||$1.48|
|Implied P/B ex-Fresh Start||0.84x||0.85x||0.84x||0.84x|
|Implied P/B GAAP||0.97x||1.04x||1.05x||1.02x|
|Implied Forward P/E for Core Business||24.0x||9.6x||8.3x||7.9x|
|2 50% haircut b/c realistically the market won't give 100% credit, plus the timing of utilization is not clear, and Tyco is suing for 20% of it.|
This posting is solely for the evaluation of club members and is not a recommendation to buy or sell this stock. The views expressed are those of the author individually and should not be attributed to any affiliated investment firm, which may or may not hold positions consistent with the views expressed herein and may buy or sell shares at any time.
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