|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||7,130||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
|TEV (in $M):||0||TEV/EBIT|
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CIT, founded in 1908, is a leading commercial and consumer finance company providing loan, lease, factoring and other borrowings to clients in a wide variety of industries. (see attached spread sheet for financials) CIT is broadly diversified (across industries, asset types, and geographies) and provides primarily asset backed lending solutions to clients in 5 broad categories: Commercial Corporate Finance, Transportation Finance, Trade Finance, Vendor Finance and Consumer and Small Business Lending. CIT finances its lending operations with capital raised in the unsecured debt markets.
Commercial Corporate Finance ($18.7bn assets; $291mm annualized earnings)
Provides lending, leasing and other financial services to mid-market firms thought a dedicated sales force focusing on Healthcare, Communications, Media and Entertainment, Energy and Infrastructure.
Transportation Finance ($12.7bn assets; $251mm annualized earnings)
Provides leasing and secured financing for end users of aircraft, railcars and locomotives. Customers are typically large airlines and North American railroad companies.
Trade Finance ($6.9bn assets; $144mm annualized earnings)
Provides factoring, receivable and collection management and secured financing to companies in the apparel, textile, furniture, home furnishings, electronics and other industries.
Vendor Finance ($16.8bn assets; $271mm annualized earnings)
Provides financing globally for customer purchases from leading IT, telecom equipment, healthcare and other diversified manufactures. Important vendors include Dell, Snap-On, Avaya and Microsoft.
Consumer and Small Business ($23bn assets; $40mm annualized earnings*)
Provides subprime home lending, student lending and small business lending. The student lending business comprises $10.3bn of assets, 97% of which are guaranteed by the
*excludes write down on home lending operation
On July 17th CIT announced that it would exit the home lending and construction business. The construction business portfolio was sold at a $229mm pre-tax gain. The company recognized a $765mm pre tax loss upon marking the Subprime portfolio to market and moving it into a held for sale account. CIT’s home lending business has assets of $10.4bn (representing 93.8% of face loans outstanding) supported by $850mm of capital.
CIT also announced that it would consider selling the student loan business if legislation (with proposals to cut fees by 50 bps currently being debated) were to be enacted that limited the economic potential of the business. Based on current legislative proposals, the company would not expect to take a write down on this business. In the event of adverse legislation, assets in the student portfolio would retain their economics, but originating and new loans may be made less attractive based on some current proposals.
Also, on July 17th , the company gave earnings guidance of $2.6 to $2.7 per share for the 2nd half of 2007 – this would equate to $5.2-5.4 annually as CIT’s business is not particularly seasonal. Guidance excludes results from the home lending business. Management’s guidance calls for earning roughly 16% on book equity not attributed to the home lending portfolio. Assuming all of the $850 of equity attributed to the home lending business is tangible, the company’s projections call for earning 21% on tangible common equity. CIT’s earnings benefit from a currently favorable corporate credit environment. CIT’s longer term equity earning power should benefit from structural improvement the company made to its balance sheet over the past 3 years. In 2005, CIT issued $350mm of 6.35% perpetual preferred and $150mm of L+112 perpetual preferred. In the first half of 2007 the company issued $750mm of 6.1% 60 year subordinated debt (4% after tax cost of money). The addition of $1,250mm (vs tangible equity of $5.5bn and notional equity of $6.8bn) very low cost “senior” instruments with limited contractual terms should serve to enhance prospective returns on equity without materially increasing risk to shareholders. All things equal, CIT’s recent financing should assist the company in delivering attractive returns on equity.
Home Lending Business
After giving effect to the write down announced July 17th, CIT’s mortgage portfolio ($11bn face outstanding) was marked at 93.8% of face ($10.4bn) and is supported by $850mm of capital. CIT’s mortgage portfolio is match funded and therefore the company should not be required to sell the assets in the current market environment. (in 2002/03 CIT ran off discontinued portfolios instead of selling at an inopportune time, management gave indications on the most recent call and to analysts that they would pursue an orderly run-off if they were not able to get bids that represented fair value). CIT’s subprime portfolio is performing significantly better then the industry. Some stats on CIT’s Subprime portfolio: FICO of 636, 89% of the portfolio is 1st lien, 92% is owner occupied, average LTV is 82%, 43% is fixed rate, 10% is interest only and 0% is Neg am. Vintage concentration is 24% 2005, 32% 2006, 26% 2007 and the remaining 18% 2004 or earlier. As of 6/30/07 delinquencies were 6.5% compared with over 15% for the industry and 24% reported by Countrywide for subprime in the 2nd quarter. The portfolio is regionally diversified with less than 20% in CA. Based on the existing performance and composition of the portfolio, the 6/30/07 mark seems like a reasonable approximation of what the company will receive in an orderly run-off.
Non Home Lending Businesses
CIT’s non home loan business is performing very well; non performing assets are less than 1% of assets outstanding. Fundamentals appear positive for the Transportation business and neutral to positive for the trade and vendor financing operations. The Commercial business is likely to experience an increase in defaults and delinquencies, but based on CIT’s past performance, it is reasonable to assume that the loans were well underwritten and that CIT will suffer manageable losses on defaults (based on the company’s successful workouts of problem loans during the 2002/03 period). A credit down turn is not entirely bad for CIT, a weaker credit environment would allow CIT to charge a higher spread. CIT is also a leading provider of DIP financing.
For perspective, back in 2002/2003 when CIT was spun out of Tyco, non performing assets were over 4% of assts and charge offs reached 2.3% (NPA and charge offs include liquidating MHC, telecom and Latin America portfolios). CIT’s end markets (airline, retail, IT and energy) were in shambles and the company financed nearly 25% of its balance sheet with commercial paper. Even in that environment, CIT remained profitable. Currently CIT is in much better shape, its current performance outside of Subprime is outstanding, it customer’s end markets have a neutral to favorable outlook, the company is less dependant on commercial paper, and the company’s problem portfolio is well secured and reasonably marked.
CIT’s franchise is in originating and managing mid market and specialty finance lending. CIT is beginning to capitalize on its origination franchise by sponsoring 3rd party financing vehicles and earning fees from such vehicles for asset origination, servicing and management. In the 2nd quarter, CIT created a REIT (tk:CRE) to hold some of its Healthcare related assets, and in the 3rd quarter, the company is expected to complete the IPO of a business designed to hold a portion of the company’s airplane assets. CIT currently gets roughly 50% of its total net revenue from fees and other services, including syndication, agent, origination, advisor and management fees.
CIT match funds its assets with similar duration liabilities. If CIT were to lose access to the commercial paper, bank and bond market for a long period of time the company could run off its current portfolio and stop originating new assets or it could originate new assets and sell/syndicate them as whole loans or leases. At 6/30/07 CIT had $6.2bn of commercial paper outstanding – available bank lines at 6/30/07 were $7.5bn, available asset backed facilities were $5.5bn and the company had unrestricted cash of roughly $5.2bn. On July 27 the company issued $3bn of student loan ABS freeing up a further $1.9bn on the asset backed facility. If CIT were to be shut out of the commercial paper market the company would seem to have adequate bank facilities and cash to meet obligations and continue operations.
Given a static 6/30/07 portfolio, CIT should generate$3bn over the next 12 mths net of all contractual payments. The company would use $3.7bn in the 12 mths ending 6/2009 and then be a net cash generator for subsequent 12mth periods.
Valuation -- Please see attached spreadsheets.
$35 per share, CIT trades at 1x book (1.2x tangible book) and 6.5x second half of 2007 projected earnings annualized. Assuming a 15% ROE (CIT’s stated long-term target), CIT trades at roughly 6.5x earnings. At 10% ROE, slightly below 10x, at 12% ROE 8x earnings, at 15% ROE 6.5x and at 17% ROE around 5.7x earnings. CIT is potentially an attractive acquisition for larger finance companies/banks and or an industrial company. In the past CIT has been owned by RCA, Manufactures Hanover and Tyco.
CIT should grow book value by 10 to 15% per year. A reasonable worst case would be a reduced ROE and the company trading at tangible book. Over time, CIT’s origination franchise should create enough fees and service revenue to justify a significant premium to tangible book. On the upside CIT could demonstrate $5.2 to $5.5 dollars of normalized earnings power and be awarded a 10-12x multiple.
CIT is currently cheap because of concerns surrounding the asset quality of its subprime mortgage portfolio. CIT’s student lending business is also under a cloud and the company will likely face headwinds with regard to corporate credit.CIT is attractive because: 1. It is available at a very low multiple to it earnings power. It has a long-term record of successfully originating and managing secured credit risk across a variety of industries and assets. Downside should be limited to tangible book. 2. There is potential for outsized return driven by success sale or liquidation of the company’s subprime portfolio and the company’s ability to demonstrate more than $5 per share of earnings power.
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