DBRS Comments on CIT Group Inc.’s 4Q Earnings; Ratings Unchanged – Senior at B (high), Positive

DBRS, Inc. (DBRS) has today commented that the ratings of CIT Group Inc. (CIT or the Company), including its Issuer Rating of B (high), remain unchanged following the Company’s announcement of financial results for 4Q10 and for full year 2010. The trend on all long-term ratings is Positive, while the trend on the short-term ratings is Stable.

CIT’s 2010 results demonstrate the Company’s progress towards restoring the franchise, improving the funding profile, and strengthening the balance sheet. The results evidence good momentum across the franchise. During 4Q10 CIT funded $1.5 billion of new lending and leasing volumes, evidencing a 41% increase over the prior quarter. New business originations increased in three of the Company’s four commercial segments, while in Trade Finance total factoring volume was stable at $7.0 billion. Moreover, illustrating the progress CIT is making in transforming its funding model to a more “bank-centric” funding model, more than half of the quarter’s U.S. funded volume was originated and funded by CIT Bank. DBRS sees the positive trajectory in new business volumes as demonstrating that the Company continues to advance its plans designed to restore the franchise and customer confidence in the Company post-reorganization.

While the franchise is gaining strength, it is yet to translate to underlying profitability. For 4Q10, CIT reported net income, on a GAAP basis, of $74.8 million compared to $115.8 million in the prior quarter. For the full year 2010, net income was $516.8 million. However, net income benefited from FSA accretion income, which totaled $289 million for 4Q10 and $1.5 billion 2010. While CIT reported positive results, DBRS looks to underlying earnings, which excluding FSA accretion income, and other one time charges such as restructuring charges and gains on sale of assets. In this light, CIT’s results evidenced a pre-tax loss of $247.4 million, widening from a pre-tax loss of $187.4 million in the prior quarter. The wider underlying loss in 4Q was partially driven by higher prepayment penalties related to the redemption of debt. Moreover, earnings were reduced by a $17.3 million increase in provisions for loan losses, however, the increase was attributable to the refinement in charge-off practice and impairments recognized on assets transferred to held for sale. CIT also reported lower net interest income, due to margin compression and portfolio contraction.

Margins, excluding FSA and the effect of prepayment penalties on high-cost debt, fell 39 basis points from the prior quarter to 0.56%. Approximately half of the decrease was attributable to the timing of aircraft redeployments and lower renewal rates in the railcar business, while the remainder was driven by the high quantum of liquidity on the balance sheet and the sale of high-yielding, higher-risk assets in Vendor Finance. DBRS expects margins to improve as the impact of from the aircraft timing issue reverses. Moreover, DBRS sees margins improving as the benefits of the lower cost funding base are realized and as the production of new business volume accelerates; however, DBRS recognizes that this process will take time.

Asset quality continues to evidence stabilization. Non-accrual loans, excluding FSA accounting, decreased 22% to $2.0 billion at year end. Importantly, for the second consecutive quarter, the pace of new inflows into non-accrual status decreased substantially, suggesting longer-term improvement in asset quality. Although, on a pre-FSA basis, gross charge-offs increased from the prior quarter to $306 million, or 4.30% of average finance receivables, the primary driver of this increase was the aforementioned change in charge-off policy. Coverage ratios, including the FSA accretable discount, remain solid at 98% of non-accrual loans. CIT has $372.2 million of non-accretable discount (marks) which provides additional cushion from potential losses on the pre-emergence loan portfolio. Given the challenging environment for small and middle market businesses, DBRS views the trends in the performance of the loan portfolio as illustrating the Company’s sound underwriting and servicing abilities. Further, DBRS sees the trends as illustrating the continued progress in removing risk from the balance sheet.

CIT continues to make progress in strengthening its funding profile. During 4Q10, CIT redeemed $1.4 billion of high-cost debt bringing the total redeemed or refinanced in 2010 to over $7.0 billion. Further, subsequent to year-end, CIT redeemed the remaining $750 million of 10.25% Series B Notes and redeemed $500 million of the 7% Series A Notes, the result of which was to remove a significant portion of higher cost debt, yet more is required, as the presence of high cost debt in the funding stack continues to weigh on margins. CIT continues to hold significant cash balances with total cash of $11.0 billion, or 22% of total assets. Capital continues to exceed regulatory requirements with a Tier 1 capital ratio of 19.1% and a total capital ratio of 20.0% at the end 2010.

The Positive trend reflects DBRS’s expectations that the Company will continue to make progress in improving and diversifying its funding profile, expanding the role of CIT Bank, and restoring growth in the Company’s four core business segments, while restoring underlying profitability. Indeed, the ability to generate sustained underlying profitability could result in upward ratings pressure.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Finance Companies Operating in the United States, which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the issuer. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Steve Picarillo
Approver: Alan G. Reid
Initial Rating Date: 9 November 1999
Most Recent Rating Update: 5 January 2011