Just Out Of Bankruptcy, CIT Group Is Being Pressured Again

Jun.14.12 | About: CIT Group (CIT)

CIT Group Inc. (NYSE:CIT) is a bank holding company. It went into bankruptcy in late 2009 as many of its loans soured due to a US recession. It managed to emerge in early 2010. It loans to small and medium businesses in North America, Europe, Asia, and Latin America. It lends in five basic categories: 1) corporate finance, 2) trade finance (retail), 3) transportation finance (aerospace and rail) -- $14B, 4) vendor finance (manufacturers and distributors), and 5) consumer finance (liquidating guaranteed student loans). With the world economy weakening nearly everywhere, small and medium businesses will get hurt disproportionately badly. Any number of them will go under. We are already seeing the PIIGS having problems meeting their bills. It isn't hard to imagine that many of the borrowers from CIT in Europe will have trouble too. The crisis is worsening in the near term. It is not getting better. We are talking about Greece possibly leaving the Euro after its elections on June 17, 2012. It is a virtual certainty that CIT's loans to European entities will become more troubled within the next year. Losses from this area will put pressure on CIT.

One could look at the numbers for CIT, and one might think it is much the same state as many other banks. The problem is that CIT is not the same as all other banks. Many of those banks have lent to large corporations or larger stable companies. CIT has lent primarily to small and medium sized companies. Plus it has huge international exposure. Both of these were great when the economy was growing, especially when the emerging markets economies were on fire. However, both are reasons to be suspect of CIT's performance going forward for the next one to two years. The EU had near 0% GDP growth in the latest quarter, and virtually all seem to agree that it is heading into recession. The PIIGS are already in recession. CIT is exposed to small and medium businesses in those countries. The larger, more stable economies are still highly exposed to PIIGS sovereign debt, real estate debt, commercial debt, etc. They are not necessarily bastions of strength. Asia has been slowing too, as have virtually all of the emerging market countries. The table below compares the GDP's of the BRIC's. This is a barometer of health for CIT.

China

Russia

India

Brazil

Q1 2010 GDP Growth

11.9%

3.8%

9.4%

9.3%

Q1 2011 GDP Growth

9.7%

4.0%

7.8%

4.2%

Q1 2012 GDP Growth

8.1%

4.9%

5.3%

0.8%

Click to enlarge

The trend in all countries except Russia is unmistakably downward. Some think the official data from Russia is suspect. On top of these Japan is still technically in recession, and virtually all agree that the EU is heading quickly toward recession. It barely avoided an official recession declaration with 0% growth in Q1 2012. However, Greece, Slovenia, The Netherlands, Italy, and Portugal are already officially in recession. Many other countries' economies are contracting quickly. Some think Germany, France, etc. are immune. However, banks in these countries are heavily exposed to PIIGS sovereign debt as well as PIIGS real estate debt and commercial debt. Their banking systems are very vulnerable. The strong trend toward an EU recession can only be interpreted as bad news for CIT.

The data from the BRICs has to be interpreted as bad news too. A hard landing in China could send all of the other Asian economies into turmoil. China has $2T to $4T in potentially bad debts. In the case of a hard landing, the number will more likely be closer to the $4T figure. We have seen what a $4T bad debt situation did to both the EU and the US economies recently. Each of those is about three times the size of the Chinese economy. Imagine the disastrous effect such a situation will have on China. Some point to the roughly $3T current account surplus China has. However, this may not be enough. It is certainly not enough to shield China from a lot of pain, if there is a hard landing.

CIT is heavily invested in airline debt. Therefore the health of the airline industry is important to CIT. The table below shows the net income (GAAP) data from the last four quarters of a sample of airlines such as United Continental Holdings Inc. (NYSE:UAL), Delta Air Lines Inc. (NYSE:DAL), AMR Corp. (AAMRQ), Southwest Airlines Co. (NYSE:LUV), and US Airways Group Inc. (LCC).

Net Incomes in $1000's

Q1 2012

Q4 2011

Q3 2011

Q2 2011

UAL

($448,000)

($138,000)

$653,000

$538,000

DAL

$124,000

$425,000

$549,000

$198,000

AAMRQ

($1,660,000)

($1,095,000)

($162,000)

($286,000)

LUV

$98,000

$152,000

($140,000)

$161,000

LCC

$18,000

$76,000

$91,000

($114,000)

Click to enlarge

The high oil prices in Q1 2012 are partially responsible for the Q1 numbers. However, the International Air Transport Association recently trimmed its FY2012 profits estimate for the overall airline industry to $3.0B. This is down from $3.5B estimate in Dec. of 2011, and it its further down from the $4.9B estimate in Sept. 2011. The trend is obvious to even the most bullish. By comparison, these estimates are far down from the still estimated, but now all but certain, estimate for FY2011 profits of $7.9B for the overall airline industry. Many are projecting good eventual growth for the airline industry. However, that growth may not come until 2015 or later due to high oil prices and economic troubles in the U.S. and Europe. This could (and likely will) be disastrous for CIT. In typical John Thain gambling style, CIT is buying more airline loan portfolios. It made a $200 million purchase of airline loans in March 2012. If the recession is a shallow one, Thain's gambling style will probably pay off. If the recession is a longer, more severe one, Thain will get bitten in the ass again. Remember Thain did lead Merrill Lynch into effective bankruptcy a few years ago.

The prospect of a severe EU recession is looking more likely daily. If that were to occur, it would probably lead to a US recession and a Chinese hard landing. Brazil and many other countries are already showing dramatic weakness. They could follow too. At Italy's bond auction today, Thursday June 14, 2012, its borrowing costs soared. Greeks have been withdrawing about $1B per day from their banks. This is not an all out run on banks, but it is getting close. The Spanish 10 year bond yield is up again today to 6.962% (+3.08% on the day). After the downgrade of 18 Spanish banks by Fitch yesterday, Wednesday June 13, 2012, Moody's downgraded Spain's sovereign debt three notches today, Thursday June 14, 2012, from A3 to Baa3 (just one grade above junk status). The EU crisis is worsening.

CIT also lends to retailers. The retail sales figures reported recently have been weak both in the US and in the EU. A sampling of recent Retail Sales numbers is: Dutch (-8.70% YoY), US (-0.2% MoM), Euro Area (-1.0% MoM), Czech (-4.10% YoY), Danish (-6.40% YoY), Greek (-16.20% YoY), German (-3.8% YoY), Japan (+5.8% YoY), Irish (-1.50% MoM), and many more. Except for Japan, which had easy comparisons due to the earthquake/tsunami disaster, they all look terrible. CIT has a significant percentage of its loans in this area (about $7B out of a $34B total portfolio or roughly 20%). If many of the companies in the retail area have significant problems, CIT will suffer.

All this bodes ill for CIT. The two year chart of CIT below provides some technical direction for a trade.

Click to enlarge
(Click to enlarge)

The slow stochastic sub chart shows that CIT is neither overbought nor oversold at this time. The main chart shows that CIT is in a strong down trend that started in March 2012. The price line has already crossed the 200-day SMA moving downward (a sell signal). The 50-day SMA is about to cross the 200-day SMA moving downward. (a more powerful sell signal). With the financial problems in Europe, this down trend is likely to continue. CIT had a loss in Q1 2012. It attributed this to debt restructuring charges of $620 million. It did get lower interest rates on longer term debt, but it will still have problems. It has averaged interest expense of roughly $670,000,000 per quarter over the last four quarters. By contrast Regions Financial Corp (NYSE:RF), which has a market cap of $8.7B -- higher than CIT's $6.7B, averaged only $89,000,000 per quarter in interest expenses. It is harder to be profitable when you have to pay an extra $581,000,000 that the other guy doesn't have to pay. I know which bank I would rather have my money in.

CIT is a sell in this market. There are too many uncertainties. There is too high a chance that a significant percentage of CIT's loans will become troubled -- need write downs or write offs. I have tried to paint a realistic picture of likely airline industry and retail industry problems. These say that CIT's financial situation is likely to worsen soon. Yes, Thain is improving the loan rates for the debt the company itself owes. However, he seems to be ignoring the down trend in the overall world economy. If nothing else, CIT is likely to continue to fall near term in sympathy with the EU financial/banking/credit problems. CIT is a SELL in this situation. If you are an aggressive trader, it is a short. The easy money is probably a short from Wednesday's close of $33.74 to the next support point of approximately $29. If you want to short beyond that, you will want to assure yourself that the situation in the EU is deteriorating more rapidly than many are now thinking. CIT could quite possibly end up back in bankruptcy. It could turn out to be a great longer term short.

NOTE: Much of the financial fundamental information not supplied by the CIT web site was from Yahoo Finance.

Good luck trading.

Disclosure: I am short CIT.