Opportunities in a struggling company
Published March 13, 2013
The fallout from the 2008 financial crisis was far and wide and is still being felt in many respects. In some cases, companies went under — the most prominent example being Lehman Brothers — while in other situations, the government bailed out firms or arranged a merger, as it did with Bear Stearns. Then there are the relative success stories, like New York-based CIT Group, which filed for bankruptcy in the aftermath of the financial crisis but was able to re-emerge as a leaner but stronger company.
A "double hit"
CIT is a diversified lender to both small and medium-sized companies, and operates a strong leasing portfolio. During the financial crisis, however, the company suffered a double hit. CIT, which funded itself with short-term debt and made long-term loans to customers, faced mounting pressure when liquidity dried up in the credit market and it became increasingly difficult to fund its near-term maturities. At the same time, many of its customers also faced liquidity pressures as economic and operating trends deteriorated, causing them to make late payments or to default. Many of CIT’s customers accelerated requests for funding on committed loan lines, requiring the company to raise even more cash to fund them, which put additional pressure on its balance sheet.
The company initially was able to obtain more than $5 billion in government funding and from private investors. But by late 2009, CIT was forced to file for bankruptcy protection. This presented an opportunity for American High-Income Trust to get involved directly as a creditor in the firm’s restructuring. The fund lent CIT an emergency facility to provide liquidity and allow it to emerge from bankruptcy. In doing so, the fund was also able to make an investment in the company’s new loans at an attractive rate. “It’s not that common but we have the ability to do it,” American High-Income Trust® President David Barclay says of the emergency lending facility to CIT. “Situations present themselves in different ways, but no matter how you approach an investment, you need to have the deep research to be able to do the fundamental business and company analysis.”
"Investing in emergency loans can be risky, but the depth of the research team and our willingness to take a more active lending role than typical made it possible. It was a unique environment, but we were able to step back and see the benefits of financing a company in that situation."
Research, rebuilding and returns
That’s where analyst Jonathan Deeringer entered the picture. His research led him to conclude that CIT’s underwriting business, which he thought was difficult to replicate due to its complexity and longevity, was not broken. If the company could ride out a difficult post-bankruptcy period of balance sheet restructuring, Jonathan believed market trends would gradually recover and CIT would be able to take advantage of an easing competitive environment as traditional banks pulled back from the lending market. In addition, he was encouraged by the company’s improved liquidity, strong asset base and new management team, led by former Merrill Lynch CEO John Thain.
“We believed that if given enough breathing room and if credit quality trends stabilized, CIT had the underwriting structure in place for the company to return to lending growth under new management as the banks pulled back,” explains Jonathan, adding that even if that thesis didn’t play out as expected, he was still comfortable making the investment. “When we saw that CIT entered bankruptcy, we did an analysis showing that even if the company stopped lending, the value of its assets in the wind-down process would be able to cover its secured debt.”
Fortunately, CIT was able to emerge from bankruptcy and to gradually increase its lending activities. This has allowed for further investment in the company to support its efforts to rebuild a healthier lending platform. “What’s happened since then is that credit quality has indeed stabilized and CIT has shrunk its balance sheet, returning to its core lending niches,” he says, noting that the company has been able to reduce its financing costs over time. “The return on assets has improved and CIT has dramatically strengthened its liquidity and capital cushion to the point where the company is better off than it was before bankruptcy.”
The benefits of stepping back
Jonathan says the next leg of the thesis is for CIT to continue on its path to more profitable lending, and ultimately to achieve an investment-grade rating. He said the latter could be influenced by the Federal Reserve, which is reviewing the conditions of CIT’s supervisory arrangement that were set under its bankruptcy. “CIT has the strongest tangible capital ratios of any major bank in the U.S.,” he notes. “I expect the Fed to relax the restrictions soon, which will remove a key obstacle in the company returning to investment grade.” He says CIT has already replaced secured debt with unsecured debt at low costs, which has freed up a lot of assets on its balance sheet, but ratings agencies have been slow to recognize its progress.
In the end, Jonathan says he would not have been able to move forward on the investment in CIT Group were it not for the strong leadership and collaborative efforts of his colleagues. He says he consulted with other analysts inside and outside of his group in order to get a better understanding of the regulatory environment, securitization markets, and the bankruptcy process. “Investing in emergency loans can be risky, but the depth of the research team and our willingness to take a more active lending role than typical made it possible,” he says. “It was a unique environment, but we were able to step back and see the benefits of financing a company in that situation.”