Risk & Compliance

CIT to Qualify for $2.33B in TARP Funds

Fed preliminarily approves application to convert to a bank holding company.
Stephen Taub and Roy HarrisDecember 23, 2008

Commercial finance company CIT Group Inc. expects to receive $2.33 billion from the Treasury Department under the Troubled Assets Relief Program (TARP) — a result of the Federal Reserve preliminarily approving its application to convert to a bank holding company.

Specifically, CIT has converted CIT Bank of Salt Lake City to a state bank. The Federal Reserve Board also allowed CIT Group to retain certain nonbanking subsidiaries, including for credit extension, loan servicing, and related activities; leasing; financial, and investment advisory services; and private placement services. It also allowed it to keep certain investment transactions as principal, and credit-related insurance agency and underwriting activities, according to the Fed’s announcement.

CIT Bank currently operates as an industrial loan company that is exempt from the definition of bank under the Bank Holding Company Act.

The commissioner of the Utah Department of Financial Institutions also approved the application of CIT Bank to convert from a Utah-chartered industrial bank to a Utah-chartered bank.

“In light of the unusual and exigent circumstances affecting the financial markets, and all other facts and circumstances, the Board has determined that emergency conditions exist that justify expeditious action on this proposal in accordance with the provisions of the BHC Act and the Board’s regulations,” the Fed said.

“Today’s announcement is an inflection point in CIT’s 100 year history,” said Jeffrey M. Peek, CIT chairman and CEO. “Bank holding company status is expected to provide us increased access to funding and a new platform from which we will serve our middle market and small business clients. We believe this step should ultimately enhance the value of our franchise.”

Under its Capital Purchase Program, part of the TARP, Treasury will invest $2.33 billion in CIT’s perpetual preferred stock and related warrants.

In approving the conversion, the Fed said that it consistently has considered capital adequacy to be an especially important aspect in analyzing financial factors. To this end, the Fed noted that CIT Group has converted debt and raised “a material amount of capital” from third parties. “CIT Group is adequately capitalized and as a result of its successful efforts to raise additional capital, will be well capitalized prior to consummation,” it said. “In addition, CIT Bank is currently well capitalized under applicable federal guidelines, and it will remain well capitalized on a pro forma basis on consummation of the proposal. Other financial factors are consistent with approval.”

A report by Gimme Credit called the ruling “a welcome gift from the Federal Reserve,” noting that until recently only brokers like Goldman Sachs and Morgan Stanley, and credit card issuers like American Express and Discover, seemed on the fast track, while “CIT found itself shunted off the main track, until it could raise enough capital to merit redemption.” But this week’s ruling means that bondholders of CIT, which last week raised $300 million in a common equity offering, now have a clear signal on what to do about the company’s debt exchange.

CIT began the exchange offer in November as part of a plan to raise $1.4 billion of regulatory capital, and initially had applied to be both a financial holding company and a bank holding company, Gimme Credit said. (FHCs are allowed to take part in a broader range of activities than plain vanilla BHCs. Discover said last week it was electing to be a FHC.) Last week, CIT backtracked, and said that, following discussions with regulators, it would amend the exchange offer to reflect its application for BHC status only. Insurance activities are the primary businesses affected. CIT will have to discontinue some insurance operations if it isn’t approved as a FHC within two years, but insurance is not a major part of its franchise. The company says it doesn’t believe there will be a material adverse impact from exiting this business. Only a small number of bondholders (less than $30 million) withdrew from the exchange after the amendment was announced. “We don’t yet have the final results of the debt exchange, since the deadline was extended until 11:59 p.m. EST last night. But CIT said that as of the expiration of withdrawal rights last week, $2.34 billion of notes were already tendered, which will generate $1.15 billion of regulatory capital. The equity unit exchange will add about $408 million of regulatory capital. The notes exchange is contingent on CIT receiving an investment from the Treasury Department under the TARP Capital Purchase Program. No official word has yet come down about the TARP investment (CIT put in a request for $2.5 billion). But CIT says in the prospectus for its common stock offering that it doesn’t expect that it will be approved as a BHC unless it also gets a commitment under the TARP program. “The Federal Reserve approval allows CIT to convert its Utah-based industrial bank into a state bank. “CIT isn’t planning to acquire any other banks as part of its plan” as a state bank, “but it does intend to transfer up to $30 billion of assets from its corporate finance, trade finance, consumer, vendor finance, transportation finance. and government-guaranteed student loan businesses into CIT Bank,” Gimme Credit said. “The company has committed to the FDIC that it will maintain a Tier 1 Capital ratio of at least 15% at CIT Bank for the next three years.”

Still, “the news isn’t all good,” the analysis firm said. Unsecured creditors “now will be effectively subordinated to bank-level obligations, and CIT says that it will record “a significant loss” in the fourth quarter to reflect a large increase in the reserve for credit losses. “The fourth quarter will be pressured by net interest margin compression, higher chargeoffs (above the previous guidance of 80-85 basis points) and a possible write-off of ‘account reconciliation differences’ primarily in vendor finance,” Gimme Credit said.