CIT Gets the Subprime Monkey Off Its Back

For some firms that dabbled in real-estate lending, the stock market’s advice seems to be:

For some firms that dabbled in real-estate lending, the stock market’s advice seems to be: “Run away at any cost.”

As CIT Group (CIT) and H&R Block (HRB) demonstrate, investors are rewarding once-diversified companies that ditch all businesses that touch the housing or mortgage markets.

Shares in CIT Group surged 30% Tuesday after the commercial finance firm said it was cutting adrift its housing-related business divisions.

CIT’s home lending business will be sold to Lone Star Funds for $1.5 billion. Its manufactured housing portfolio will go to Vanderbilt Mortgage and Finance, Inc. (Warren Buffett’s Berkshire Hathaway [BRK.A] owns Clayton Homes, which owns Vanderbilt.)

These two divisions are being sold for 63 to 64 cents on the dollar, so CIT will take a big hit in the short term. From the sale of the home lending unit, CIT will register a $2.5 billion loss in the second quarter.

“This is lock, stock and barrel,” CIT chairman and chief executive Jeffrey Peek told analysts. “We are out.” The sales remove the uncertainty surrounding those assets, “and advances our strategic transformation into a company focused entirely on commercial finance,” he said in a statement.

The deals result in about $1.8 billion in cash proceeds to CIT. The firm needs enough capital to sustain its other business lines, which focus on lending and leasing to a variety of industries. Credit rating agencies have raised concerns about CIT’s exposure to riskier assets. “With this risk behind the company, we believe upgrades from the rating agencies appear likely,” wrote Sameer Gokhale, an analyst at Keefe, Bruyette & Woods (kbw). Gokhale had worried that a shortage of capital would force CIT to sell its stable, profitable railcar financing business, but the analyst now says that sale “may not be required.”

Dominion Bond Rating Service said Tuesday CIT’s transactions were “yet another significant step that further stabilizes the company’s liquidity profile and operating business.” “Albeit at a cost,” the deals reduce uncertainty on CIT’s balance sheet and allow management to focus on the company’s balance sheet and its commercial lending franchise, the Canadian rating agency said in a statement.

The jump in CIT’s shares on Tuesday is reminiscent of the revival of H&R Block’s (hrb) stock after the tax preparer sold off its mortgage business in May. H&R Block shares are up 20% since the announcement of the deal to sell Option One for $1.3 billion to an affiliate of WL Ross & Co.

It’s now clear that the revival of the housing and mortgage markets could take years, not months. For investors with patience like Wilbur Ross, Warren Buffett or the private Lone Star Funds, these long-term bets might make sense. But for public companies that require financing, housing and mortgage exposure is poison.

CIT and H&R Block might be rewarded for escaping the housing slowdown’s clutches. After all, they have other businesses to fall back on. But mortgages are the bread and butter of the U.S. banking industry. The problem for much of the financial sector is that it can’t escape, no matter how much it might want to do so.

(UPDATE: Above, I discuss Eddie Lampert’s investment in CIT Group.)

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