DBRS: CIT Results Higher QoQ, Segment Performance Mixed Reflecting Challenging Environment

Summary:
• Pre-tax income from continuing operations was $153.1 million, a 4% improvement from $147.6 million in the prior quarter, but 30% lower year-on-year (YoY), reflecting a good performance in Transportation and International Finance (TIF) offset by the still difficult operating environment for North American Commercial Finance (NACF).
• Net finance margins remain stable despite competitive environment while core operating expenses were marginally lower.
• DBRS rates CIT Group Inc. Issuer Rating at BB, Under Review with Positive Implications.

DBRS, Inc. (DBRS) views CIT Group Inc.’s (CIT or the Company) 2Q15 results as acceptable with the challenging operating environment in the U.S. middle market remaining a headwind to improving returns. Tepid merger and acquisition (M&A) activity in the U.S. middle market, low interest rates, and yield compression due to competition for U.S. middle market lending continues to constrain the operating results of the NACF segment. Meanwhile, continuing favorable industry fundamentals in many transportation businesses and CIT’s strong market position continue to drive TIF’s solid operating results.

For 2Q15, NACF reported pre-tax earnings of $47.5 million, 32% higher on a linked quarter basis. Modest growth in earning assets and a slight increase in yields drove net finance revenue expansion which along with higher capital market fees and lower credit costs supported the results. While the sequential results are improved, the segment’s results remain below levels generated in 2013 and 1H14, and the segment’s return on assets continues to be below CIT internal targets. Positively, NACF origination volumes, excluding factoring volumes, totaled $1.6 billion in the quarter, a 20% improvement from the prior quarter, and more in line with volume trends established in the last three quarters of 2014. Within the TIF segment, pre-tax earnings were stable quarter-over-quarter (QoQ) at $156.9 million. The solid operating results were underpinned by growth across all transportation businesses, stable margins and lower operating costs. Results also include a net benefit in provision for credit losses reflecting recoveries in China and minimal losses throughout the rest of the segment portfolio. Positively, utilization rates in both the aircraft and railcar businesses remain sound and forward deliveries of both new aircraft and railcars over the next 12 months remain well-placed.

Despite the low rate environment and the competitive pressures in the U.S. middle market, DBRS considers CIT’s ability to maintain a stable net finance revenue margin at 4.00% as reflecting CIT’s disciplined approach to new business as well as the benefits of its continuing efforts to reduce overall funding costs. For 2Q15, average funding costs were stable QoQ at 3.04%, but 16 basis points (bps) lower than in the comparable period a year ago. Importantly, funding costs are expected to improve further with the addition of the lower cost deposits from OneWest Bank in 3Q15.

Reduced compensation costs and slightly lower marketing expenses contributed to the slight QoQ reduction in core operating expenses (excluding restructuring charges, acquisition related costs, and deposit related and debt extinguishment costs). As a percentage of average earning assets, operating expenses (exclusive of restructuring), improved by 13 bps QoQ to 2.74%, but continue to be above the Company’s near-term target range. The Company expects a 20 bps benefit to the operating efficiency ratio from the forthcoming international platform exits, which are expected to be completed in 2H15.

DBRS rates CIT Group Inc.’s Issuer Rating at BB. The ratings are currently Under Review with Positive Implications. The Review reflects CIT’s agreement to acquire OneWest Bank, which is expected to close on August 3, 2015. DBRS expects to conclude the review in the coming weeks.

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