The red-headed stepchilds of the financial stocks have been the specialty finance companies.  Due to their non-bank status, they were not eligible for government funds under the Obama bailout plan.  Companies such as GMAC, American Express (AXP), and CIT Group (CIT) have suffered staggering losses and writeoffs that have generated real concern about their long-term viability.  The finanicng arm of General Electric (GE Capital) posted enormous losses that helped to drop GE’s credit rating for the first time in their history.

Of these three, I know CIT Group very well and I think it is worth taking a look at. I was a lender in the equipment finance industry for many years and competed against CIT on a number of deals.  I remember them as being a very tough competitor.  They couldn’t beat me on service and speed, but they beat me “10 ways to Sunday” on rate.   They had a much lower cost of capital than my firm did and were very aggressive on pricing.  CIT was the poster child on how to run a specialty finance company and make strong revenues and profits quarter over quarter.

What does CIT do? CIT Group Inc. (CIT) is now a bank holding company (more on that later), which provides commercial financing and leasing products to diverse array of industries, such as, airline, aerospace, communications, entertainment, healthcare, manufacturing, media,rail, transportation, retailing, wholesaling and other industries.

That winning streak ended for CIT (as it did for all banks) in mid-2008, when it became clear that CIT’s business model would not work in the new lending environment that banks found themselves in.  CIT was battered by market conditions but also by its ill-fated decision to enter BOTH the subprime mortgage and student loan markets in the last few years.

CIT has been a smorgasbord of bad news over the past year.  They suffered, to an even greater extent, than the banks in this financial meltdown because they were not afforded the same protections as banks (and assistance).  As a non-bank lender, they missed out on TARP funds and their own financing sources were no longer lending to them or scaling back significantly.  But the news is not all bad.

Here is what is good about CIT:

• They have changed corporate form to a bank holding company creating a deposit base and making themselves eligible for limited government assistance (if needed);
• The company appears to have sufficient assets and capital ratios to weather the current economic storm;
• The secondary markets are beginning to open up…this is where CIT securitizes and sells its loan (an important factor in its profit and liquidity)
• CIT has taken its lumps and written off a staggering amount of assets.  They have aggressively purged their balance sheet of impaired assets and made every effort to shore up their capital structure.

The last positive about CIT is anecdotal rather than analytical.  Even though the economy is extremely bad, the need for financing has not gone away.  Companies still need all manner of commercial financing and CIT still  has one of the best sales, credit and funding teams in the business.  If they are able to secure the financing (government or otherwise), they would be in position to capture significant market share.

I don’t currently own any CIT, but I am watching it.  The chart indicates that it might be overbought, but it is trading above its 50-day MA and holding that level well.  My strategy is to buy on the dips and sell on the rallies.

FOLLOW-UP NOTE: CIT had its credit rating chopped by Fitch Ratings yesterday and that led to a decline in the share price of 35 cents (or 9.2%) on June 2nd.