Thain Has High-Grade Mien in CIT Debt Purge: Corporate Finance
Less than three years after CIT Group Inc. (CIT) completed its bankruptcy reorganization, Chief Executive Officer John Thain is persuading investors that its debt is as creditworthy as an investment-grade firm.
The average yield investors demand to hold the bonds of CIT rather than U.S. Treasuries fell to 310 basis points as of Aug. 17, according to Bank of America Merrill Lynch index data. The average spread on an index of BBB rated financial firms that includes Axa SA and American Express Co., which is at least three grades above junk-rated CIT, was 349 basis points.
Investors are clamoring for CIT’s securities as it polishes its credit profile by unencumbering assets and replacing high interest-rate debt with lower coupons. The commercial lender has chipped away at its balance sheet, reducing long-term debt by $10.5 billion since the end of 2010 as its average bond spread has dropped 151 basis points over the same time period.
“As they’re refinancing and as they’re improving their balance sheet, it’s a snowball effect of getting better rates, and they’re also coming at an opportune time because spreads are tightening,” Jody Lurie, a corporate credit analyst at Janney Montgomery Scott LLC in Philadelphia, said in a telephone interview.
CIT Treasurer Glenn Votek has said the company “very much” aspires to restoring investment-grade ratings.
“We realize it’s often faster going down than it is going up,” Votek said in a telephone interview. “It’s a matter of us executing and we hope that recognition would come from the rating agencies. More importantly, it needs to be recognized by the investors that are purchasing our debt securities, and those investors have already shown how they’re thinking about our credit quality.”
CIT will redeem all its so-called series C, 7 percent senior unsecured notes by Sept. 17, in what Thain called a “significant milestone,” according to a press release today.
“Our dedicated efforts over the past three years to eliminate or refinance nearly $31 billion of debt have materially reduced our cost of capital, strengthened the earnings potential of the business and allowed us to more effectively meet the financing needs of our small business and middle market clients, who remain the heart of the American economy,” Thain said in the statement.
CIT has improved with the “passage of time,” according to Bonnie Baha, head of global developed credit at Los Angeles- based DoubleLine Capital LP, which oversees $40 billion and doesn’t own CIT bonds.
“They’ve been paying down expensive debt with cheaper debt and have a bit more discipline than the market anticipated,” Baha said in a telephone interview. “They’ve had the luxury of time, and the market has gone their way.”
CIT sold $1.75 billion of 4.25 percent, five-year notes to yield 364 basis points more than similar-maturity Treasuries and $1.25 billion of 5 percent, 10-year bonds at a relative yield of 350 basis points on July 31, according to data compiled by Bloomberg. Proceeds will go toward retiring the 7 percent series C debt due 2016 and 2017, according to a July 31 news release. CIT lowered its weighted average fixed coupon to 5.68 percent from 6.77 percent in the fourth quarter of 2010, Bloomberg data show.
The company sold $2 billion of bonds in May, including $1.25 billion of 5 percent, five-year bonds, with proceeds also used to refinance the series C notes. Those notes traded at 102.8 cents on the dollar to yield 4.35 percent as of Aug. 17, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. In 2011, the company sold $3.1 billion of five-year bonds at a 7 percent coupon.
CIT’s bond sale last month had its lowest coupons on record for similar-maturity securities, Bloomberg data show.
Thain, the 57-year-old former Merrill Lynch & Co. chairman, was hired in February 2010 to turn around CIT, which had emerged from bankruptcy the previous December.
After becoming a bank during the 2008 credit crisis to qualify for federal help, CIT lost all three of its investment- grade ratings. Denied access to a Federal Deposit Insurance Corp. program to issue government-backed securities, the lender arranged $3 billion of rescue financing in July 2009 from a group of bondholders. CIT filed for bankruptcy that November.
High-yield, high-risk debt, also called speculative grade, is rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s.
Management has focused on getting rid of the expensive debt leftover from the bankruptcy that led to the loss of $2.3 billion in U.S. bailout cash. After CIT refinanced its series A and B debt, the series C became unsecured, unencumbering its balance sheet, which prompted ratings companies to upgrade it, giving it cheaper rates in the market, Lurie said.
“While they’re building out their business and reintroducing themselves as a whole new type of financing structure, they’re looking to do so with a stronger balance sheet,” Lurie said. “That’s why investors see them as attractive, because they know that on a medium- to long-term basis, they’re a credit that’s an improving story.”
S&P boosted the firm to BB- on March 9, three levels below investment grade. CIT has “shifted towards a more bank-centric business model: It has repaid or refinanced a material portion of its high-cost debt, increased deposits, and moved many U.S. originations to its commercial bank subsidiary, CIT Bank,” analysts Brendan Browne and Rian Pressman said in an April 16 report.
Moody’s increased CIT to B1 in February, saying the lender has diversified its funding sources, extended maturities and cut encumbered assets, according to the Feb. 16 note.
After years of trying to reduce the amount of expensive debt it holds on its balance sheet, “the job is nearly done, thanks in part to the increased willingness of corporate bond investors to buy the company’s unsecured debt,” Gimme Credit LLC analyst Kathleen Shanley wrote in an Aug. 8 note.
CIT cut its long-term debt to $23.5 billion at the end of the second quarter from $34 billion as of Dec. 31, 2010, according to the note.
“The overall quality of CIT’s portfolio is currently strong, but it can’t get much better from here, and the company’s cost of funds is still higher than that of many of the larger institutions it must compete with for customers,” Shanley wrote in an e-mail. “With interest rates as low as they are across the board, investors are reaching for yield, but spreads on CIT paper could widen if any unexpected problems emerge in their lending portfolio.”
Relative yields on CIT bonds have narrowed 255 basis points this year to 310 basis points, or 3.1 percentage points, according to Bank of America Merrill Lynch index data. The average spread on the bank’s U.S. High Yield, Diversified Financial Services index has declined 306 basis points to 512 in that period. CIT’s shares rallied 9.9 percent this year to $38.32 Aug. 17, compared with 14.4 percent for the S&P 500 Index, including reinvested dividends.
“I don’t see it as the juice being out of this one,” Lurie said, estimating the company will return to investment grade in late 2013 or early 2014. “Once they have their financing structured in such a way that it’s the lowest cost they can possibly get in a given time period, then they have to focus on profitability, and that’s the next phase.”
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