Monday, July 28, 2014

The Beautiful Deal

CIT, the commercial finance company that became a bank following the crisis, announced the $3.4B acquisition of One West this week. It is the largest bank deal this year. It also propels CIT over the $50B strategically important financial institution (SIFI) barrier. Thus, CIT will be subject to additional regulatory requirements. Apparently CIT believes the strategic and financial benefits of the deal more than compensate for the incremental burden. Another benefit from becoming SIFI (AKA too-big-to-fail) is the implicit government guaranty which could reduce funding costs.
The market response, along with the simultaneously announced $500mm stock repurchase and substantial beat of the expected 2Q14 performance, was a very positive 14% increase. The deal is a joint cash ($2B) and stock ($1.4B) transaction. The One West shareholders will have a 15% interest in the new CIT post close. CIT’s Ba3/BB- ratings are expected to remain unchanged.
Both CIT and One West (formerly IndyMac) failed during the financial crisis. CIT reorganized in bankruptcy. It was a non bank before the crisis (banks cannot file for bankruptcy). IndyMac failed and was taken over by the FDIC and sold to a group of private investors including among others Michael Dell, John Paulson, George Soros, and Chris Flowers. The FDIC subsidized the deal through a loss share agreement agreeing to cover most of IndyMac’s loan losses. The continuation of the FDIC agreement is a condition of the deal.

This looks like a brilliant deal for the following reasons:

1)     Government subsidies: they get the FDIC and implicit SIFI subsidies. Although hard to quantify they are very real. This may encourage others not to fear the SIFI designation.
2)     Taxes: they get to accelerate utilization of CIT’s substantial NOLs.
3)     Pricing: the trailing P/E is 14X, the P/TBV 1.4X and a deposit premium of 6%. These are lean multiples. I cannot figure out why they got it so cheap except maybe for the historical baggage associated with IndyMac/One West. Another reason might be they are going early in cycle.
4)     Strategic Fit: similar to PACW’s successful 2.3B 2013 Capital Source acquisition-combining a deposit rich bank with a wholesale funded finance company. The deal lowers CIT’s funding costs and funding risk. DISCLOSURE: I am a PACW shareholder.
5)     Funding: the 60-40 cash stock split maintains financial flexibility and preserves ratings. The issue of whether CIT’s stock is undervalued remains open. The share repurchase helps moderate possible undervaluation concerns.
6)     Earnings Accretion: the combination of low price, stock repurchases and large funding costs savings promise significant 2016 15% EPS accretion. Academics frown on EPS as an accounting measure unrelated to value. For me, EPS accretion is a second order pricing indicator. It keeps management from over paying.
7)     Integration: the size seems manageable and the retention of senior One West officers should aid the integration. Also, the 15% ownership stake in CIT by One West shareholders helps cushion the downside if something goes wrong.
8)     Sale Process: negotiated versus auction of a private versus public firm moderates price competition.

An excellent combination of strategic and financial benefits makes this a good deal and an example of the whole deal concept at work. Kudos to the CIT team.

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