DBRS Comments on CIT Group Inc.’s 2Q11 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 2Q11 financial results. The trend on all long-term ratings is Positive.

DBRS views CIT’s results as evidencing the appreciable progress the Company has made in advancing its strategy of reducing funding costs and rightsizing the balance sheet, while expanding the role of CIT Bank (the Bank). While DBRS views these actions as critical to position CIT for a return to long-term, sustainable profitability, the progress has come at a cost to short-term results. To this end, 2Q11 GAAP results were negatively affected by $113 million of accelerated Fresh Start Accounting (FSA) and the $50 million fees associated with the prepayment of second lien debt. As a result, for the quarter, CIT reported a pretax loss of $21.8 million compared to pretax income of $135.5 million in the prior quarter and pre-tax income of $270.1 million in the comparable period a year ago.

On an adjusted basis, excluding the impact of FSA and the aforementioned prepayment fees, CIT generated pre-tax income of $17.2 million, which is in line with the pre-tax profit of $17 million in the prior quarter, but significantly better than the pre-tax loss of $119.9 million in 2Q10 (both adjusted on the same basis). Underlying results were impacted by higher non-recurring operating expenses, higher litigation costs, and lower net finance revenue as a result of a smaller asset base. This was somewhat offset by improving credit costs. Importantly, margins are improving. Excluding FSA and prepayment penalties on debt, finance margin was 1.45% in 2Q11, while essentially unchanged from 1Q11, this is 72 basis points higher than a year ago. DBRS sees this year on year improvement as demonstrating the positive impact of the Company’s ongoing efforts to lower the overall level of debt and refinance higher cost debt. Going forward, DBRS expects the underlying earnings profile will continue to improve, as the Company restores the strength of the franchise, generates new higher yielding business and makes additional progress in lowering the presence of high cost debt on the balance sheet.

Company-wide funded volumes increased 30% on a linked quarter basis and 67% year-on-year to $1.7 billion, driven by double digit growth in the Corporate Finance, Vendor Finance and Transportation Finance segments. Notably, 70% of the volume in the quarter was funded within CIT Bank compared to 61% in the prior quarter and 27% a year ago. DBRS views this trajectory in Bank originated volumes as illustrating the advancement of the Company’s strategy to become more “bank centric” by expanding the role of CIT Bank. Moreover, DBRS sees the positive trajectory in new business volumes as demonstrating CIT’s progress in its plans to restore the franchise and customer confidence in the Company.

Credit metrics continue their positive trajectory of the most recent quarters. On a pre-FSA basis, gross charge-offs declined 54% on a linked quarter basis to $97.4 million, or 1.58% of average finance receivables. Importantly, gross charge-offs and non-accrual loans declined across all four core business segments. Non-accrual loans, excluding FSA accounting, decreased 16% quarter-on-quarter to $1.4 billion. Notably, for the fourth consecutive quarter, the pace of new inflows into non-accrual status decreased, suggesting further improvement in asset quality in the near term. This continuation in positive credit trends resulted in a 31% (quarter-on-quarter) decline in provisions for loan losses to $84.7 million. Given the challenging operating environment for small and middle market businesses, which are CIT’s core clientele, owed to an uneven economic recovery, DBRS views the positive credit trends as illustrating the Company’s sound underwriting and servicing abilities, as well as the continued progress in removing risk from the balance sheet. Nevertheless, DBRS remains cautious given the uncertainties as to sovereign debt and the sustainability of the global economic recovery.

CIT’s liquidity remains well-managed and the Company continues to make noteworthy progress in reducing the preponderance of higher cost debt while strengthening its funding profile. To this end, CIT redeemed $2.5 billion of 7.0% second lien debt during the quarter. Despite this reduction in debt, CIT ended the period with cash and short-term securities totaling $10.1 billion, representing 21% of total assets. Further, during the quarter, CIT completed an exchange of $8.8 billion of Series A Notes for new Series C Notes which have less restrictive covenants and CIT announced the redemption of $500 million of the first lien debt in July 2011. Moreover, as discussed above, CIT has increased the amount of new business volumes being funded through the Bank. Regarding capital, CIT continues to maintain a solid capital position, with a preliminary Tier 1 capital ratio of 19.1% and a Total Capital ratio of 20.0%, both well in excess of regulatory minimums.

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

The principal applicable methodology is Rating Finance Companies Operating in the United States, which can be found on our 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: William Schwartz
Initial Rating Date: 17 May 2010
Most Recent Rating Update: 23 March 2011