CIT In Danger Yet CIT Senior Unsecured Loan Cheap

CIT Group Inc. has been struggling with many issues. Among them are Liquidity Concern The downgrade to below investment grade and the lack of government support to issue government-guaranteed debt weighed on CIT’s liquidity condition, whose funding relies on issuing secured and unsecured debts. Furthermore, CIT has significant maturities of debts. More than $9 billion of debts will mature by the end of 2010. Yet CIT dodged immediate bankruptcy by repurchased at a discount its debts, which was supposed to mature at Aug 17th. Low NIM Its NIM has been sliding at a nearly constant pace, from 9% in 2003 to 2.2% in Q1 2009, to negative in Q2 2009. It is funding costs through long term debt is higher than the earning interest in assets. This is a challenge the company has to address. Moderate Reserve By Q2 2009, it is nonacrrusal loans increased to $2.3 billion, 4.78% as a percentage of loan portfolio. Where corporate finance loan nonaccrusal rate increased from 5.86% to 9.45%. Its reserve increased to $1.5 billion, 65% of nonaccrusal assets and down by 80% in Q1 2009. Compared to other well established banks, like JPM or WFC, its allowance to nonaccrusal asset ratio was low. Yet, its ratio has been above average across the banking industry. The average ratio of Loss allowance to noncurrent loans was 66.49% in Q1 2009, probably already drifting to below 65% by Q2 2009. Moderate Exposure to Risky Assets By the end of 2nd quarter, CIT has a loan portfolio of $62.7 billion. More than one third of the portfolio was concentrated in industry manufacturing, commercial airlines, and retail. Its exposure to risky assets such as residential mortgages or CRE is limited. By the end of Q2 2009, the company charged off $50 million on CRE and the size of the CRE portfolio was $744.5 million. Worst Case Scenario Analysis - How much can its senior unsecured creditors can claim? Here are two assumptions for loan portfolio. a. CRE loans write off 20%. The CRE portfolio by the end of Q2 2009 was $744.5 million. It would lead to loss of $148.9 million. b. Rest Loans write off 10%. i. 10% is a conservative assumption. Majority of CIT's rest loan are commercial and industry loan, whose highest delinquency rates in commercial and industry loans since 1980s was 6.5% in 1987s. We assume 15% of loans will be delinquent while a defaulted loan will lose 2/3 of its principal value. ii. Given that the size of loan portfolio ex CRE was ~62 billion. 10% write off would lead to a loss of $6.2 billion. The book value of CIT assets was $71 billion excluding intangible assets. Because $1.5 billion capital has been set aside for loan loss, another loss of ~$6.35 billion, $6.2 billion for rest loans and $0.15 billion for CRE, will only dent CIT assets by $4.85 billion. As a result, the fair book value of CIT assets will be worth $66.15 billion. After the following adjustment illustrate how much fair market value can senior unsecured creditors claim $66.15 billion - Tarp money $2.33 billion - Deposits $5.378 billion - Short term liability $5.434 billion ($0.139 billion trading liability, $2.671 credit balance, $0.182 derivative counterparty, $2.441 billion others) --Long term high priority liability $20.735 ($3.1 billion bank credit facilities and $17.635 billion secured debts) =$ 32.273 billion The book value of long term borrowing was $31.253 billion ($7.451 billion variable rated bonds and $23.801 billion fix rated bonds) by the end of Q2 2009. So our calculation indicates that senior unsecured loan might be paid in whole, which is far higher than current trading level 50-60s. Suppose 10% liquidity premium will be charged against %66.15 billion loans during liquidation, senior unsecured loans will still be worth ~82 cents in the end.