National middle-market lender CIT Group (NYSE:CIT) announced yesterday that it will be acquiring privately owned OneWest Bank for $3.4 billion in cash and stock. The combined company will have $67 billion in combined assets and will give CIT a regional branch network to support it nationwide lending.

The stock moved higher over 10% on the news.

Lessons learned

CIT Chart

CIT data by YCharts

It was just five short years ago that CIT Group was fighting for its life. Two months after accepting $2 billion in TARP bailout money, CIT filed for Chapter 11 bankruptcy protection. The bank simply could not meet its obligations as loan losses mounted, capital eroded, and liquidity dried up.

The root of the problem was funding. CIT relied heavily on short-term debt to fund its lending and operations. When capital markets dried up in 2008 and 2009, the bank's coffers were left dry. 

Soon thereafter, in a prepackaged reorganization, existing shareholders were completely wiped out, a new CEO was hired, and CIT set out to turn itself around. The man to lead the effort was John Thain, former Goldman Sachs executive and head of the formerly independent Merrill Lynch brokerage firm. 

Thain's first priority was to right the bank's balance sheet and return the flailing enterprise to profitability. 

Over the past five years, the bank has repaid or refinanced over $30 million in debt. Employee headcount is down by over an eighth. The bank is once again profitable and even began buying back shares to the tune of $200 million in 2013.

CIT Return on Equity (TTM) Chart

With the company off life support, Thain can now attack the other critical failure from 2009.

Stability and margins
The real death knell for CIT in 2009 was its funding model. Traditionally, banks rely on customer deposits collected from a branch network to fund lending and investing. CIT avoided the expense of a branch network and relied instead on the capital markets to fill the void. When the markets froze up, so did CIT. 

The acquisition of OneWest is a move to end that instability. OneWest brings a 73-branch network spread throughout Southern California. With that network, CIT can now capture cheap and reliable customer deposits to fund the bank's lending and liquidity needs. 

Stability is a big part of the story, but not the whole thing. There are also margins. 

Borrowing in the capital markets can be expensive, particularly so relative to the cheap cost of a checking or savings account. 

As of the first quarter, for example, CIT paid approximately a 1.4% yield for its funding. The average of banks similar in size to CIT is 0.47%. OneWest's cost of funding was 0.70%.

The icing on the cake
With this merger, CIT gains nearly $20 billion in total assets and a branch network that will stabilize funding, and it will enhance its margins. Pretty good, right?

According to management projections, it gets even better. 

The bank also gets OneWest's profits immediately accretive to earnings. OneWest reported a respectable (though not outstanding) 0.80% return on assets in the first quarter on net operating income of $47 million. CIT projects an internal rate of return on the acquisition of 15% in the first year alone.

And just in case you were worried, OneWest has an absolutely rock solid loan portfolio. There are no significant non-performing assets coming into the CIT portfolio as a result of this merger. It is about as clean as you can get in the world of bank M&A. 

As troubled as CIT Group was just a few short years ago, it's a remarkable story to be where it is today.