DBRS: CIT 3Q Results Solid, Reflecting OneWest Acquisition, Underlying Results Steady

Summary:
• For 3Q15, CIT reported net income of $693.1 million, up significantly from $115.3 million in the prior quarter, reflecting two months of OneWest Bank (OneWest) activity and the benefit of a reversal of the valuation allowance associated with the U.S. deferred tax asset.
• Addition of lower cost OneWest retail deposits positively impacted net finance margin benefiting earnings.
• DBRS rates CIT Group Inc. Issuer Rating at BB (high), Stable.

DBRS, Inc. (DBRS) views CIT Group Inc.’s (CIT or the Company) 3Q15 results as solid and reflective of its recent acquisition of OneWest, which closed on August 3, 2015. Overall, the Company reported net income of $693.1 million, up substantially from $115.3 million in the prior quarter due to contributions from OneWest, as well as the benefit of a reversal of valuation allowances associated with the U.S. deferred tax asset. Excluding the impact of the OneWest acquisition, CIT’s adjusted pre-tax income from continuing operations was $151 million, slightly lower linked-quarter. DBRS views the steady underlying performance in a slow growth environment as demonstrating the strength of CIT’s commercial lending franchise, but illustrating that more work is required to improve returns.

On a sequential basis, net finance revenues were 40.5% higher at $482 million, reflecting higher earning asset balances and expansion in net interest margin (NIM) spurred by OneWest’s lower cost deposit base. Indeed, CIT’s cost of funds declined 70 basis points (bps) quarter-on-quarter (QoQ), and was the primary driver of the 34 bps sequential improvement in net finance margin to 3.67%. While growth in earning assets was largely driven by the acquisition, DBRS notes that CIT generated $1.0 billion of organic growth in the quarter in a still challenging environment for middle market lending. Other income was 39% lower QoQ, as seasonally higher factoring commissions and higher gain on sales of lease equipment were more than offset by impairments on assets moved to held for sale, a mark-to-market charge on the total return swap, and a currency translation adjustment charge related to the sale of the Mexico platform. Finally, on an adjusted basis, which excludes acquisition and other items, operating expense was 29% higher on a linked-quarter, mostly reflective of OneWest’s expense base.

Balance sheet fundamentals remain sound. Asset quality metrics remain stable with the exception of the Company’s oil and gas extraction and services portfolio, which remains pressured by low energy prices. While further negative credit migration in the energy portfolio is possible should oil prices remain at current levels for a sustained period, DBRS notes that post the OneWest acquisition, the energy portfolio comprises just 3% of CIT’s overall loan portfolio. Liquidity is ample with total cash and investment securities comprising 17.6% of total assets. At September 30, 2015, CIT’s estimated Basel III common equity Tier 1 ratio was a sound 12.4% (fully-phased in basis), despite the impact of the OneWest transaction.

During the quarter CIT announced the retirement of its CEO, John Thain, and the appointment of Ellen Alemany, as his replacement effective April 1, 2016, as well as the appointment a new chief financial officer. DBRS views the timing of the management change as logical given the significant progress CIT has made under Mr. Thain in becoming a more bank-centric entity, which was culminated with the recent completion of the OneWest acquisition. DBRS considers Ms. Alemany as well-qualified to lead CIT’s continuing transition to a U.S. commercial bank given her time as head of Citizens Financial Group, Inc., the 13th largest U.S. bank by deposits and a leading U.S. commercial bank.

Also, during the quarter CIT announced strategic initiatives that are designed to further the Company’s evolution to a U.S. commercial bank. As part of this initiative, CIT announced that it had moved its China and Canadian (excluding rail) commercial businesses to held for sale. Already having completed the sale of the Mexico business in 3Q15, CIT has also received recent regulatory approval for the sale of the Brazilian platform, which when combined with the businesses recently transferred to held for the sale, would complete the Company’s exit from its commercial international operations. In addition, CIT announced that it was exploring strategic alternatives for its commercial aircraft leasing business, including a sale or spin of the unit. While the unit generates good returns, regulatory capital requirements for the aircraft and the new order book, are headwinds for the unit to compete effectively in a market that has seen competition intensify over the last number of years. DBRS views the sale of the China and Canada businesses favorably as these businesses generated below average returns and were a challenge for CIT to fund given the current scale of the businesses. With regards to the commercial aircraft leasing business, DBRS will review the proposed structure of the potential transaction when announced and the impact on CIT’s outstanding debt and regulatory capital position.

DBRS rates CIT Group Inc. at BB (high), Stable trend.

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