I’m not a big believer in following professional investors you admire blindly. They all make mistakes from time to time. I’ve written about a couple of such mistakes previously:
Tom Brown
http://www.gurufocus.com/news.php?id=106174
Richard Pzena
http://www.gurufocus.com/news.php?id=105974
However, I certainly think that when several value investors with good track records all are interested in the same investment it is well worth the look. It is well worth it if for nothing more than gaining an understanding of why they might be interested.
CIT Group (CIT, Financial) certainly fits this bill as it represents a sizable chunk of the portfolios of Berkowitz, Loeb, Einhorn and Tilson.
CIT has the smell of bankruptcy on it having recently (last December) emerged from the process. It was a victim of the financial crisis as it was unable to get credit in the midst of the great panic. Several of the gurus listed above got into CIT by buying bonds during bankruptcy.
As Berkowitz recently said in an interview “CIT was purified in bankruptcy, they now have good tangible book value with money good.” The company has reduced debt by almost $11 billion and accumulated almost $10 billion in cash so it is in a much improved financial situation.
And at this point in an emerging recovery CIT is in a good position. They are the number one lender in small business loans, and in the new world the quality of loans being written is high. But the opportunity here or the hidden value isn’t in the asset base, it is on the liability side.
The Opportunity
I’ve read comments from several of the gurus holding CIT. While CIT earns a nice 9.5% on the money it lends customers, it also pays a painful 7.05% for its own financing. In the current interest rate environment where rates are almost zero, this really is painful. A healthy bank would have a cost of funds of more like 1%.
If CIT can gradually refinance its existing expensive debt and take in more deposits through its bank subsidiary it can massively expand its lending margin. Glenn Toungue of T2 partners recently said in an article that if they could get the cost of financing down to just 4% “ That would translate to annual earnings of roughly $5 per share. Were that to happen, the shares, recently $37, would merit a price-earnings ratio of at least 12, suggesting they could rise to $60.”
Interestingly the man who is now running CIT is none other than John Thain (he of the very successful Goldman/NYSE background). In a recent interview with Bloomberg Berkowitz called him “the right guy, at the right place, at the right time”. Hopefully he doesn’t have to put in $35,000 toilets at CIT as he did at Merril Lynch during his brief time there.
One concern you always have to have about a leveraged financial institution like CIT is that you really have a hard time getting comfortable with the true value of the assets on its balance sheet. In this case there is some reason to think they are conservatively valued as management has every incentive coming out of bankruptcy to start off with a clean slate which would mean properly writing off problem loans.
While lowering the cost of funding is likely the core driver behind the interest in CIT equity, there is also the possibility that an acquirer could be attracted to the high yield on CIT’s loan book and the increased belief that the value of that loan book is reliable.
The time to invest in financials is certainly not after several years of economic malaise, but rather after a blow up when credit standards are fresh on lenders minds and prices of financials are depressed. The idea that CIT’s loan book has been properly written down does make it more appealing to me. I’m not quite ready to buy, but will keep studying it.
