DBRS Comments on CIT Group Inc.’s 2Q12 Results, Ratings Unaffected at BB (low), Trend Positive

DBRS, Inc. (DBRS) has today commented that the ratings of CIT Group Inc. (CIT or the Company), including its Issuer Rating of BB (low), remain unchanged following the Company’s 2Q12 financial results. The trend on all long-term ratings is Positive.

Despite the slowing U.S. economy, CIT reported solid results which DBRS views as demonstrating the Company’s progress in strengthening underlying profitability, lowering the cost of funds, growing the core commercial business while expanding the role of CIT Bank. For the quarter, CIT reported a net loss, on a GAAP basis, of $70.7 million, a noteworthy improvement from the $446.5 million net loss in the prior quarter, which was significantly impacted by accelerated debt refinancing charges. However, in DBRS’s view, CIT’s GAAP earnings mask the true earnings generation of the franchise. As such, DBRS looks to the Company’s underlying earnings, which excludes the impact of Fresh Start Accounting (FSA) and debt refinancing charges. On this basis, CIT reported underlying pre-tax income of $119.1 million, 23% lower on a linked quarter basis, but up significantly from $16.8 million in the comparable period a year ago. The solid underlying results were driven by higher commercial asset origination volumes at attractive yields and lower funding costs partially offset by lower gains on asset sales compared to the prior quarter. Moreover, all four commercial segments were profitable in the quarter on a pre-tax, pre-debt repayment basis.

Margins continue to benefit from the Company’s success in shifting the funding mix towards lower cost deposits while reducing the high-cost debt in the funding stack. Indeed, net financing margin, excluding FSA and pre-payment penalties, was 3.02%, a significant 162 basis point (bps) increase year-on-year (YoY). On a sequential basis, net finance margin was 105 bps higher, reflecting improved funding costs and a shift to higher yielding assets. Given the benefit of the above trend, interest recoveries and other yield-related fees, DBRS expects margins in 2H12 to moderate modestly, then progressively expand over the longer-term reflecting CIT’s progress in lowering funding costs. As such, DBRS expects that the underlying earnings profile will continue to strengthen, as the Company invests in supporting the solid franchise, generates new higher yielding volume and takes additional proactive steps to lower the cost of funding.

In DBRS’s view, CIT’s results illustrate the ongoing restoration of the franchise evidenced by solid loan growth and higher business volumes despite the unsettled operating environment. To this end, commercial and leasing assets grew for the third consecutive quarter while pricing remained favorable. Funded new business volume totaled $2.4 billion, a 38% increase YoY, while committed new business volume of $2.7 billion, representing a 31% increase YoY. New business volumes were higher in three out of the Company’s four commercial segments. Within Trade Finance, factoring volumes declined modestly from 1Q12 to $5.9 billion. Importantly, CIT continues to advance its transformation to a more bank-centric model with over 90% of U.S. lending volume funded through the Bank.

Credit performance continues to be near historic lows. Net charge-offs and non-accrual balances declined sequentially and YoY. Within the Company’s core commercial segments, net charge-offs declined 14 bps on a linked quarter basis to 0.42% of average finance receivables, or $16.6 million. Non-accrual loans decreased 6% quarter-on-quarter (QoQ) to $454.5 million, or 2.80% of finance receivables. The improvement primarily reflects lower non-accruals in Vendor Finance and Corporate Finance due to the repayment and sale of loans. Provision for loan losses declined modestly in the quarter to $414.2 million; however, reserve coverage remained stable at 2.06% of finance receivables. DBRS considers the favorable trends in credit metrics as evidencing the Company’s sound underwriting and servicing capabilities. Nonetheless, given the tepid U.S. economic recovery, DBRS continues to be cautious regarding further improvement in credit quality.

CIT continues to make good progress in rebalancing its funding profile. Deposit growth and capital market activities resulted in deposits representing 23% of funding, with secured and unsecured funding comprising 33% and 44% respectively at quarter-end. Deposits grew 5% QoQ to $7.2 billion, including 75% growth in CIT Bank’s retail internet deposits to over $2.0 billion. CIT continues to address the remaining high-cost debt in its capital structure. In the quarter, CIT redeemed or repurchased $4.2 billion of high-cost Series C notes and recently announced that it will redeem another $600 million of Series C notes on August 20, 2012. Despite turbulent conditions in the global capital markets, CIT maintains good access. During 2Q12, the Company issued $2.0 billion of unsecured notes, completed a U.S. Vendor Finance asset-backed transaction and closed a $1.0 billion committed U.S. Vendor Finance conduit facility. Further, in July 2012, CIT completed a CAD 515 million Canadian Vendor Finance securitization. As a result of these actions, CIT’s average cost of funds declined to 3.83% in 2Q12, a 41 bps improvement from 1Q12. Liquidity remains solid with total cash and investment securities of $7.0 billion, or 16% of total assets. With regards to capital, CIT’s capital ratios substantially exceed regulatory minimums with a preliminary Tier 1 capital ratio of 18.0% and a total capital ratio of 19% at June 30, 2012.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: David Laterza
Approver: Roger Lister
Initial Rating Date: May 17, 2010
Most Recent Rating Update: February 13, 2012

For additional information on this rating, please refer to the linking document under Related Research.