CIT Group: The Great 'Known Unknown' In 2 Charts
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Here’s a remarkable pair of charts for CIT Group Inc. (NYSE: CIT).
The first plots the Fair Value of Liabilities on the x-axis, versus Level 3 Liabilities on the y-axis for regional banks.
Level 3 Liabilities are those that have “unobservable” prices and are sometimes called mark to model. There aren’t reliable market prices for Level 3 Assets and Liabilities, so they are valued using a model instead.
Of course, models can be tricky, especially when "significant" inputs to the model are unobservable, which is the defining characteristic of Level 3 Assets and Liabilities versus a Level 2, where all model inputs are known.
So, what does one do when a model input is unobservable?
Simple: Use a management assumption.
Nearly 45 percent of total liabilities at CIT Group are valued using management assumptions, rather than market pricing. This is far out of line with its peers.
Now let’s look at Level 3 Assets (also “unobservable”).
CIT is not an egregious outlier when it comes to Level 3 Assets.
In fact, relative to peers, the company's percentage of Level 3 Assets looks low. In absolute terms, though, it is still significant. Over 30 percent of CIT's assets are Level 3.
A final question: What does a balance sheet even mean when almost 45 percent of the liabilities and over 30 percent of assets are valued based on management assumptions and models?
It doesn’t have to mean bad news, but it does mean shareholders are placing an enormous amount of trust in management’s discretion.
That means risk.
Tom White can be found on Twitter @tbwhite67
Image credit: Ernst Moeksis, Flickr
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