Last week CIT Group (CIT - Get Report) sold its commercial aircraft leasing business - a major step to transforming the "systemically important" financial institution into a less complex company and one that makes it more attractive to rival banks.
Under pressure from activist fund managers, CIT Group on October 6 sold the aircraft division for $10 billion to a unit of China's Bohai Capital Holding Co.
The aircraft division has historically been the reason rival banks were reluctant to express interest in CIT, analysts and investors contend. Chris Kotowski, analyst at Oppenheimer & Co., argues that it's not attractive for the big bank holding company to own a commercial aircraft leasing business.
That's because commercial airline businesses are required to make orders for aircraft five to eight years in advance. As a result, they must hold a large amount of capital against those commitments on their books.
Kotowski notes that this is particularly difficult to do for bank holding companies, including CIT Group, because they already are subject to a whole host of tough capital buffer requirements and other regulations in Washington due their size. CIT Group has more than $50 billion in assets it has been designated a so-called "Systemically Important Financial Institution" or SIFI.
In addition to tough capital and liquidity rules, SIFI regulation subjects CIT to costly and time-consuming Federal Reserve Board stress tests to measure whether it can survive a future financial crisis. CIT is on the smaller end of the group of SIFI banks and faces a disproportionately higher cost of compliance. And its first stress test, a private "trial run," didn't go so well. The institution disclosed in June that it received a qualitative objection from the Fed. And while the central bank's reasoning behind the objection is unclear it may have something to do with CIT Group's complexity and risk management.
But in an indication that regulators are supportive of the divestiture, CIT disclosed that the Federal Reserve gave it the go-ahead for a $3.3 billion capital distribution following the completion of the sale. "The Fed is trying to tell the industry that they are happy to see simplification," Kotowski said.
A combination with another SIFI bank would represent the largest merger in the post-2008 regulatory environment - and the first time one SIFI merged with another. Nevertheless, Kotowski suggests that there is a long list of potential buyers include both Canadian and U.S. banks. Some potentially interested banks include Toronto-Dominion Bank (TD - Get Report) , BB&T (BBT - Get Report) and Regions Financial (RF - Get Report) . For now it appears CIT Group is not selling itself. A CIT spokesman said that there are no plans for putting CIT up for auction, adding that the sale helps advance its objective of becoming a leading national middle-market bank.
But activist funds, including Hudson Executive Capital LP, according to people familiar with the situation, have been urging CIT Group to sell both its commercial air leasing business as well as some other assets as part of an effort to drive the financial institution to either auction itself off or drop to below the $50 billion in assets threshold.
The insurgent managers, they note, have engaged with CIT Group's team, including CEO Ellen Alemany, in a collaborative manner and continue to push for a sale or divestitures. Beyond Hudson Executive, a variety of other activists own stakes. According to FactSet, other insurgent investors in CIT include Sandell Asset Management Corp., FrontFour Capital Group LLC, Mario Gabelli's Gabelli Funds LLC, Franklin Mutual Advisers LLC, Carlson Capital LP and Highland Capital.
The activist pressure also raises the question of whether CIT Group will alternatively seek to divest assets to get below the $50 billion threshold and lose all the tough restrictions that come with being a SIFI. With the commercial airline unit sale, CIT Group has dropped from $67 billion in assets to about $55 billion, just $5 billion above the SIFI level. (Even if it moved to divest assets now, the earliest CIT could de-SIFI is 2018, according to a spokesman)
Kotowski acknowledges that there are limitations to the strategy of dropping below the $50 billion threshold. "You don't want to do something that takes you to $48 billion because then you just will grow organically back up to the threshold," he said. "You have to divest to get significantly below if you go that route."
CIT Group also owns a railcar leasing business, which could be sold. However, Alemany said Thursday that selling it doesn't make "any economic sense." Kotowski said he doesn't believe that owning the rail unit is very onerous from a capital buffer point of view. "They can fund a lot of the assets with deposits, which you can't do with the aircraft unit and there isn't the same kind of problem with the advance order book," Kotowski said.
However, there are a number of other units that could be sold, including their shipping portfolio and real estate lending business. "There are lots of pockets of assets that could be sold," Kotowski said.
For now, the activists at the gate are patiently waiting to see when CIT Group will complete its division sale. But once that sale is out of the way they, likely will begin to look for another catalyst to drive CIT's share price up.