CIT in Funding Dilemma as It Regains Its Footing

CIT Bank is operating under a cease-and-desist order, it's still small, and its parent company is paying a rate (13%) on billions in secured debt that many borrowers would laugh at.

Despite all these facts, a key nod from regulators would clear a path for CIT Group Inc. to become a strong competitor to midsize commercial banking companies. CIT's first-quarter results revealed a scrubbed balance sheet and a strong liquidity position. Though its prospects are brightening, however, the company is nearly as dependent on government support as before it entered bankruptcy in November.

What has changed is that CIT no longer needs politically unpalatable infusions of Treasury cash. Instead, it needs permission from the Federal Deposit Insurance Corp. and Federal Reserve Board to tap its banking unit for funding, which the cease-and-desist order bars.

There is reason to believe it is on its way to getting the permissions. CEO John Thain, who joined the company in February, just named a chief risk officer and a chief audit officer — hirings that had to be approved by the New York Federal Reserve Bank. Moreover, the company's return to health would both validate FDIC Chairman Sheila Bair's decision to deny it access to the Temporary Liquidity Guarantee Program last year and restore a major credit source for small and midsize businesses.

Furthermore, a financing company with a 7% overall cost of funding is not going to survive for long without regulators' indulgence. As retiring Chief Financial Officer Joseph Leone observed on CIT's earnings call last month, funding at that cost is "unacceptable and not viable."

"Politically it makes a lot of sense to give CIT access to deposit funding," said Sameer Gokhale, an analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc., who predicted a 2011 lifting of CIT Bank's cease-and-desist order in his forecast for the company. "And they need that to happen."

It is not that CIT is wholly dependent on the government for cheaper funding. On the earnings call, two analysts asked Thain and Leone whether there might be value in paying off its highest-cost funding by running down its $5 billion of cash on hand and pursuing a wholesale refinancing of its debt.

"We will certainly explore what other alternatives there might be in the capital markets," Thain told an analyst, a moment later adding, "At least [in the] near term, we're going to continue the trend that we're on."

This was shorthand for management's unwillingness to trigger prepayment penalties on its debt for marginal gains. The better option, CIT's executives have noted, would be to simply finance its businesses by greatly expanding its deposits. But the regulatory order bars the company's bank from gathering more than $5.5 billion, and most of CIT's major operations are outside the bank. (CIT Bank holds one-sixth of the company's $58 billion of assets.)

Dispensations from the FDIC, the bank's lead regulator, and the Federal Reserve, which oversees its parent company, could change that. But despite a Tier One capital ratio of more than 15%, Gokhale and other analysts suggested, it is hard for CIT to make a case when it is just a few months out of bankruptcy and still assembling a management team.

If one is willing to overlook CIT's net interest margin of 0.65%, it is a pretty strong company. Though commercial banks like Comerica Inc. and KeyCorp are still working through losses, CIT probably put credit issues behind it with double-digit "fresh-start accounting adjustments" across its major portfolios. Its three biggest ongoing business lines by assets are commercial lending operations ($12 billion), commercial factoring ($25 billion in volume last year) and its transportation equipment leasing business ($13 billion of airplanes and rail cars).

All three are poised to do well — assuming they can be financed at reasonable cost. Rail-car leasing, the company's weak spot in its "planes and trains" business, should improve with the economy, and it is hard to imagine that CIT's 24% bankruptcy writedown of its transportation assets leaves room for further hits.

The company has a dominant position in commercial factoring, an industry that is looking up across the board. According to Andrew Tananbaum, the president and CEO of Capital Factors LLC, the major factors have become progressively more optimistic as the threat of widescale retail bankruptcies among existing customers has diminished. Once an orphan business line among banks, the industry is now coming back into fashion, as Wells Fargo and Co.'s purchase of a $4 billion GMAC factoring program this month attests.

But perhaps most of all it should benefit from wide margins in middle-market lending. Though CIT overextended itself in the runup to the financial crisis, it is still a preeminent player in a sector that the country's biggest banks have never quite been able to give the right attention.

Timing will be key, however — and will probably determine how much advantage CIT can derive from its restructuring. As Gokhale noted, slashing operating expenses is currently the "one area where John Thain has complete control," and growth is unfeasible without lower funding costs. As long as CIT's ability to rebuild itself inside a bank is in doubt, the company will have a hard time leveraging its longstanding relationships with borrowers and factoring clients.

Just ask a competitor.

"If one looks at the factoring business over long periods … , the factors that succeed are the ones that customers find to be well-capitalized, stable and supportive," Tananbaum said. "CIT went through something very disruptive and had a chance to reorganize, but the other top-tier factors — nothing that disruptive has happened to us."