The Importance of Being John Thain

On Main Street, John Thain may be known for spending $1.2 million to redecorate his office at Merrill Lynch. On Wall Street, he is known for making money for shareholders, and that reputation is lifting the stock of CIT Group (CIT), the financial services firm that emerged from bankruptcy in December. In the four weeks following Thain's hiring as CEO on Feb. 7, CIT shares rose nearly 20%—three times as much as the market—and CIT bonds rallied as well.

Thain has announced no splashy hires or bold initiatives. Apparently, investors have so much faith in him that his decision to sign up was enough to boost the stock. "There has to be potential for the operating environment to improve," says Sameer Gokhale, an analyst at Keefe, Bruyette & Woods. "Otherwise, why would he take the position?"

Thain, 54, went to Merrill in 2007 from the New York Stock Exchange where, as CEO, he turned the clubby organization into a modern, international public company now known as NYSE Euronext. Before that he was chief operating officer at Goldman Sachs (GS), where he worked for 24 years. "He's the right guy at the right place at the right time," says Bruce Berkowitz, founder of Fairholme Capital Management, CIT's biggest shareholder with 7.2% of the stock. "He will reshape the entire organization, which has been cleansed by Chapter 11." CIT, with $58 billion in assets, lends to small businesses, leases airplanes, and acts as a "factor"—which means, among other things, helping suppliers collect money from retailers, particularly in the garment industry.

Berkowitz is one of many on Wall Street who have forgiven Thain for the lavish spending on his office at Merrill when the giant brokerage was losing billions on securities tied to subprime mortgages. Fact is, Thain may have benefited Merrill shareholders when he negotiated the firm's sale to Bank of America (BAC) the weekend Lehman Brothers failed and wiped out its stockholders. "Shareholders will gladly take bad press over what they would have gotten had he not sold the company," says Matthew Schultheis, an analyst at Boenning & Scattergood.

Investors remained confident on Apr. 27 after Thain issued CIT's first post-bankruptcy financial results and reported net income of $97 million. Although much of the profit stemmed from accounting adjustments related to the company's bankruptcy, the shares closed at 39.98, near their post-bankruptcy high.

As ugly as CIT's bankruptcy was—$2.3 billion of government bailout money vaporized—it left Thain with a cushion against failure by eliminating $10.4billion of company debt and pushing out significant repayment deadlines to 2013. "They bought themselves a couple of years," says Schultheis.

Ultimately, Thain must change CIT or sell it. Right now, CIT pays nearly as much to borrow money as it makes by lending it out. CIT's average cost of funds is nearly 6.5%, while its loans and leases earn less than 7.5%. Banks that CIT competes against pay much less for their money. Wells Fargo (WFC), for example, pays less than 1%.

Thain's strategy is to make CIT a full-scale bank that takes in enough low-cost deposits to fund its lending profitably. CIT has a subsidiary bank but remains under orders from regulators to not take in more than $5.5 billion of certain deposits without their approval. The firm is already up against the limit. Thain began calling on bank regulators as soon as he took the job and continues to do so today. He has said it will be at least next year before regulators lift the deposit limits.

In the meantime, Thain has to recruit new senior executives. He hasn't announced any hires because his choices must be approved by the Federal Reserve Bank of New York, Thain told investors in an Apr. 27 conference call. Thain declined to comment for this article.

There's also salvage work to be done on what's left of the bad loans CIT made during the boom. CIT is part of creditor groups that have been battling with owners of the bankrupt Philadelphia daily newspapers and the over-leveraged Texas Rangers baseball team. And there are assets to be sold, including an ailing portfolio of student loans.

At the same time, better- financed competitors are moving in on CIT's turf. In March, Wells Fargo bought the factoring unit of GMAC, positioning it to snag some of CIT's most profitable business. Thain can't spend much to counter such moves: He needs cash to pay down debt and to satisfy regulators. "We're being quite cautious about managing our liquidity," he said on the conference call. "I think that's prudent, given that liquidity is how financial institutions generally get into trouble."

The bottom line: Thain's hiring lifted CIT stock. But to survive, the firm needs a fundamental overhaul to lower its borrowing costs.

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