3) CIT -- Immediate access to expanded deposits Our projections call for CIT to increase its deposits from under $5.0 billion to $10.0 billion by early 2013. We are not confident its state/Federal Deposit Insurance Corp. regulators would be comfortable with the bank absorbing this level of annualized deposit growth (up 25%). And $10 billion in deposits is about 60% of the deposit-based funding this company would need to operate at optimal funding efficiency.
4) CIT -- Access to A-/AA-rated debt In our own modeling, we are assuming that the company pays off all but $7.5 billion of its 7.00% series A second-lien notes and that it keeps the $3.0 billion, first-lien term facility in place. Being acquired by a larger A-/AA-rated lender would allow refinancing both of these facilities at below 4.00%.
5) CapitalSource -- Immediate Access to DDA and related products CapitalSource does not need any relief on the debt side of the funding equation; all of its nonbank-related debt should be gone by the end of 2012, and it should be relatively cash rich at this point. Becoming a bank holding company or being acquired by a bank would allow CapitalSource to offer business checking (valuable even in a post-Regulation Q [bans checking accounts from bearing interest] world), manage its own lock boxes, and offer cash-management services to its customers.
6. Earnings Potential = Execution Risk Our valuation of both of these stocks is heavily driven by the assumption that over the course of the next 24-36 months, they will be successful in replacing legacy loans with new, attractively structured commercial loans and leases. In CIT's case, we are assuming that the company is able to replace approximately $8.2 billion in low-yielding guaranteed student loans with a like amount of commercial assets. We would like to say our earnings-potential estimates are firm and precise, but each is assumption heavy.
7. Restructuring Option = Aggressive Dividend Assumptions We are assuming that a tangible common equity (TCE) ratio of 15% will placate any regulatory concerns over the arguably aggressive dividend policies we are advocating in our restructuring estimates. While this makes tremendous sense, we would be surprised to see either company's regulators endorse this plan with enthusiasm.
We did not look at one specific bank buying either institution. Three factors would impact willingness to pay and interest levels in our view: 1) Size: CapitalSource would be a small meal for all of the banks in the large-bank group; 2) Need: We would measure by loan-to-deposit ratios, higher=needier; 3) Acquirer's price/earnings ratio: From an EPS dilution/accretion perspective, the higher the acquirer's P/E, the more that institution can pay, or the less cost it is for it to pay a given price.