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CSE Message Board

  • lookoutgrady lookoutgrady Feb 11, 2011 11:50 AM Flag

    Barrons on CSE Part I

    CIT, CapitalSource Seen as Buy Targets

    IT Group reports December-quarter earnings per share on Feb. 15 and CapitalSource is scheduled to report later in the month. Our confidence is high that both will report stable-to-improving credit quality and that both will have favorable things to say about 2011.

    Most ( CIT (ticker: CIT)) or arguably all ( CapitalSource (CSE)) of this short-term fundamental view is captured in current share prices and the real driver of value during the rest of 2011 is the high likelihood that either or both of these franchises are acquired by year end, in our view.

    Neither CIT nor CapitalSource needs a larger bank partner to execute on the bulk of their business opportunities. Funding markets are liquid and CapitalSource has proved its ability to issue more-than-sufficient retail certificates of deposit (CDs) to fund the needs of the bank. CIT is not restrained by its construction and development loans, its bank has more liquidity than it can deploy, and nothing in the current order (which is tied to brokered CDs) would restrict it from launching a retail deposit funding strategy.

    However, in addition to the likely boost in share value, selling solves a series of problems for both institutions.

    1) Durability & Leverage
    Nothing matches the durability in funding associated with being part of a major deposit-funded bank. All Dodd-Frank [financial] reforms aside, being part of the "too big to fail" club and a subsidiary of a deposit rich is the best way to go into the next recession. Commercial lenders function best when stress factors are highest and demand for their specialized lending and work-out capability is valued at a premium. Commercial lending is a return-on-equity (ROE), not a secular growth business. Optimizing returns, while managing default risks, requires a consistent, reliable source of low-cost leverage.

    2) Full Bank Status
    CIT appears to be making progress with the [Federal Reserve Bank of New York] and at some point; we would expect to see CIT receive permission to start originating more of its U.S.-based lending inside of its bank structure. CapitalSource is expected to apply for bank-holding status this year (will let it open business checking accounts). Regardless of how deserving, we would be surprised to see either company granted full membership in the commercial bank fraternity. While the administration is publicly encouraging banks to lend, we suspect the real message from the various regulatory teams is, "Go away, no innovation on my watch."