CIT Group: Change in Tax Code Serving Key Purpose?

| About: CIT Group (CIT)

From CIT Group's (NYSE:CIT) 8-k:

On September 15, 2010, CIT Group Inc. filed its 2009 consolidated federal tax return with the U.S. Internal Revenue Service. In connection with that filing, the Company elected to apply Section 382(l)(6) of the Internal Revenue Code of 1986 to the net operating losses and other tax assets that the Company had prior to its emergence from bankruptcy on December 10, 2010.

The Company’s 2009 reorganization constituted an ownership change underSection 382 of the Code, which places an annual dollar limit on the use ofTax Benefits. Section 382 contains two relief provisions for limitations onthe usage of Tax Benefits in Chapter 11 bankruptcy.

Under Section 382(l)(5), there is no annual limitation on the amount of Tax Benefits that the Company can use, but the aggregate amount of Tax Benefits is effectively reduced by deductions for certain interest expense with respect to notes that were exchanged for equity, and if the Company experiences an “ownership change” for U.S. federal income tax purposes within two years of its emergence from bankruptcy, the Company’s remaining Tax Benefits, if any, would be entirely eliminated.

Under Section 382(l)(6), the amount of Tax Benefits that the Company may use each year is limited, but there is no reduction in Tax Benefits, and there is no requirement to eliminate unused Tax Benefits upon a change in ownership within two years of the reorganization.

The Company amended its Certificate of Incorporation prior to emergence from bankruptcy to add Article Twelfth, which imposes certain restrictions on the transfer of the New Common Stock, in order to protect the Tax Benefits if the Company elected to apply Section 382(l)(5). In light of the Company’s election to apply Section 382(l)(6), the Board of Directors has determined that electing to apply Section 382(l)(5) is no longer in the best interests of the Company and its shareholders, and accordingly, Article Twelfth has no further force or effect.

In my humble opinion, the change in the tax code being used by the company serves two purposes: 1) protect the company's Net Operating Losses ($2.6 billion) by limiting their annual use, but extending the period in which they may be used, and 2) by allowing the Net Operating Losses to be used if there is a change of ownership, the Net Operating Losses may become a carrot to help the company sell itself.

As a finance company, CIT has to be able to fund itself in a cost effective manner. As the company has been changing the mix of their book, their investment yield has fallen while their funding cost has remained elevated. This leads to a NIM squeeze and declining profitability. The lack of investment grade ratings will keep the company from being able to fund efficiently - this is why there are very few stand alone finance companies (and why, at one point, the company sold themselves to Tyco (NYSE:TYC)).

If the company is attempting to make themselves more appealing to potential suitors, it would want to retain the tax benefits of the Net Operating Losses and de-lever themselves (recall they have been paying down their term loans). Is Thain looking to flip the company into stronger hands? I wouldn't doubt it.

Personally, I like the company's loans and think there is some value there and the equity might be compelling if one has an eye towards an ownership change.

Disclosure: No positions