CIT Finds Rough Current Above the Waterline

Bigtime

Another concern for CIT investors is size. Even though CIT had a long history of independence before Tyco(TYC Quote) acquired it in 2001, its business landscape has changed dramatically since then, primarily because of the acquisition of smaller players. If nothing else, the Tyco acquisition -- which turned sour in Dennis Kozlowski's wake -- shows CIT was aware of the trend several years ago.

In recent years, former competitors Heller Financial, Foothill Capital and Century Business Credit each were gobbled up by bigger firms like Wells Fargo(WFC Quote) and General Electric(GE Quote).

Today, CIT's main competition doesn't come from similarly sized lenders, but big financial conglomerates such as GE Capital, Wells Fargo, Citigroup(C Quote) and Bank One(ONE Quote). And that could put CIT at a disadvantage, since bigger institutions generally pay less for their funding, especially when the bonds they issue carry a higher credit rating.

Moody's Investors Service, for instance, gives CIT's unsecured corporate debt an A2 rating. While sound, it's still five notches below the Triple A rating carried by GE Capital's bonds. (CIT and GE Capital both have top-rated commercial paper.)

Borrowing cheaply is critical because lenders' profitability depends on the spread between their own funding costs and what they charge borrowers. As recently as last month, CIT, in a corporate filing, said its funding costs were still higher than "traditionally experienced'' and that it expects earnings to "be negatively impacted for the foreseeable future, as results will continue to reflect more expensive borrowing spreads.''

"Over the long haul it's difficult to survive as an independent because the cost of capital is much less being part of a larger institution,'' said Sean Egan, president of Egan-Jones Ratings, a small bond-rating firm.

Egan-Jones gives CIT's unsecured debt a Triple B rating, slightly lower than the Moody's rating, because it's concerned about the company's aircraft leasing exposure. The rating firm also questions whether CIT has been aggressive enough in writing down the value of the $710 million in telecommunications assets in its lending portfolio.

In the end, Egan said he could see CIT being bought by a big bank that wants to increase its market share in lending to midsized businesses.