DBRS Upgrades CIT Group Inc.’s Issuer Rating to BB, Trend Positive

DBRS, Inc. (DBRS) has today upgraded the ratings of CIT Group Inc. (CIT or the Company), including its Issuer Rating to BB from BB (low). The trend on all long-term ratings, with the exception of the Revolving Credit Facility, is Positive. In addition, DBRS has upgraded the Revolving Credit Facility rating of CIT to BBB (low) from BB (high) with a Stable trend. Concurrently, DBRS has confirmed the Short-term Instruments rating of R-4 with a Stable trend. The rating action follows a review of the Company’s operating results, fundamentals and future prospects.

Today’s rating action reflects DBRS’s recognition of CIT’s progress in strengthening underlying earnings ability underpinned by the Company’s successfully refinancing or redeeming the $31 billion of legacy high-cost debt. Further, the rating action considers CIT’s growing deposit base and the continued advancement of the transformation to a bank-centric model. Ratings also consider CIT’s leading commercial lending franchise, sound credit performance in an uncertain environment and the Company’s solid capital base.

DBRS views CIT’s financial risk profile as strengthening supported by the evolving funding profile and a well-managed liquidity position. CIT continues to grow deposits and move to a more balanced funding profile. At September 30, 2012, deposits totaled $8.7 billion, up 41% from year-end 2011 and now represent 28% of total funding. CIT’s internet bank has been the primary driver of the deposit growth; raising over $4.0 billion of deposits since its launch in October 2011. Nevertheless, while DBRS acknowledges the progress in advancing the shift in the funding mix, DBRS realizes that the transformation to the Company’s targeted funding profile will take time.

DBRS recognizes the Company’s significant achievement in eliminating the presence of high-cost debt in the capital structure. As a result, the Company’s financial flexibility has improved with lower balance sheet encumbrance while earnings have benefited from lower funding costs. Indeed, the Company’s weighted average interest rate has been reduced dramatically. For 3Q12, CIT’s weighted average coupon was 3.28% compared to 4.75% a year ago and 5.97% in 1Q10.

In DBRS’s view, CIT’s GAAP earnings mask the true earning 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 prepayment penalties associated with the acceleration in the repayment of high-cost debt. On this basis, CIT reported pre-tax income of $376.6 million for 9M12 compared to pre-tax income of $161.5 million in the comparable period a year ago. Underlying results benefited from higher origination volumes, the aforementioned reduction in high cost debt, and favorable credit performance. “Economic” net finance margin, which excludes FSA and debt prepayment penalties, improved to 2.97% in 3Q12 from 1.58% a year ago, illustrating the substantial benefit to earnings of the successful reduction in high-cost debt. DBRS will continue to monitor CIT’s ability to improve profitability by executing on its transformation to a bank-centric model which calls for growing high yielding commercial assets funded by lower cost deposits. To this end, 96% of U.S. loan and lease volume in 3Q12 was originated at the Bank compared to 39% in YE10.

CIT’s sound commercial lending franchise is a key factor underpinning the ratings. Importantly, today’s rating action recognizes CIT’s ability to restore its commercial lending franchise to a growth trajectory in a challenging environment. Total new funded volumes in 9M12 increased 33% YoY to $6.5 billion and reported YoY growth in three of four commercial segments. The solid growth in volumes underpinned the increase in commercial finance and leasing assets, which have grown for four consecutive quarters. DBRS views the expansion in lending volumes as evidencing the strength of the franchise and the successful restoration of customer confidence in CIT.

Asset quality metrics remain stable at historical lows despite the uneven macroeconomic environment. For the nine months ending September 30, 2012, net charge-offs were $56.8 million, or 0.37% of average finance receivables compared to 1.38% a year ago. Non-accrual loans totaled $412.0 million, or 2.0% of the book at the end of September 2012, declining from $702.0 million, or 3.53% of the loan book at year-end 2011. The favorable credit performance resulted in provisions for credit losses to decline 80% YoY to $51.5 million. DBRS sees this performance as evidencing the strengthened risk management infrastructure of CIT as well as the Company’s sound servicing capabilities. Nonetheless, given recent indications of slowing economic growth around the globe, DBRS remains cautious that favorable credit performance could stall.

With regards to capital, DBRS considers CIT’s capital position as sound supported by a high quality capital base that provides ample loss absorption capacity. Indeed, at September 30, 2012, CIT’s tangible equity-to-tangible assets ratio stood at a robust 17.9%. CIT remains well-capitalized by regulatory standards. At September 30, 2012, the Company’s Preliminary Tier 1 Capital Ratio stood at 16.7% and Total Capital at 17.5%.

Concurrent with today’s action, DBRS has upgraded the rating of the Revolving Credit Facility (the Facility) to BBB (low), which is two notches above the Company’s Issuer Rating. The notching reflects DBRS’s view that recovery, in the case of default, will be greater than 70%. This view on the recovery reflects the upstream guarantee in place from eight operating subsidiaries of CIT for the benefit of the Facility. The Stable trend reflects that per DBRS policy, the notching on such instruments will narrow and eventually be eliminated as the Issuer Rating strengthens. Based on DBRS policy, the notching up from the Issuer Rating based on the recovery analysis described above is limited on the Revolving Credit Facility to BBB (low). As such, the Issuer Rating and Facility ratings potentially could converge to this rating level.

The Positive trend on the issuer rating reflects DBRS’s expectation that over the next 12 to 18 months CIT will continue to grow commercial assets to support further strengthening of earnings, which is prerequisite for additional positive ratings movement. Moreover, DBRS anticipates earnings to benefit from expanding margins, a higher contribution from non-spread revenue, and improved operating efficiency. DBRS would view favorably CIT’s ability to further advance its transformation to a more bank-centric model. DBRS would also view positively deposit growth underpinned by rational pricing and further diversification of product offerings designed to deepen customer relationships thereby supporting deposit retention. Rating progress would stall should earnings come under pressure signaling deterioration in the strength of the franchise, below peer deposit retention, or credit costs increase beyond DBRS tolerance levels suggesting weakness in risk management and servicing.

Notes:
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 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
Rating Committee Chair: Alan G. Reid
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.