DBRS: CIT 4Q Pre-Tax Earnings Higher Sequentially on Asset Sales; Opex Rises on Acquisitions

Summary:
• Pre-tax income from continuing operations was $222.4 million, up from $116.7 million in the prior quarter due to higher gains on the sale of assets, partially offset by higher operating expenses reflecting recent acquisitions.
• Net finance revenue higher on stable earning assets and modest improvement in adjusted margins.
• 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) 4Q14 results as solid, impacted by recent acquisitions made to redeploy excess capital, as well as a higher level of asset sales compared to the prior quarter. For the quarter, CIT reported gains on asset sales of $93.1 million, up from $37.1 million in 3Q14. Gain on asset sales benefited from the sale of the U.K. corporate lending portfolio as CIT continues to pare back its non-strategic portfolio. Also, CIT generated a $30 million gain on the sale of the initial aircraft into its recently created joint venture with Century Tokyo Leasing. DBRS-calculated adjusted revenue was 3% higher sequentially at $438 million (excluding gains on investments, gain on portfolio sales, gain on sale of leasing equipment, fair value movement of derivatives, impairments on assets held for sale, and recoveries on pre-emergence loans). DBRS considers the expansion in adjusted revenue in a competitive market for middle market lending and still subdued merger and acquisition activity as evidencing the strength of the Company’s commercial lending franchise.

Net finance revenues improved modestly quarter-on-quarter (QoQ) as average earning asset balances were relatively stable while adjusted net finance margin expanded. For 4Q14, the Company reported an adjusted net finance margin of 4.34%, an 8 basis point (bps) improvement from the prior quarter. Higher interest recoveries due to declining non-accrual balances and the benefit of suspended depreciation on operating lease assets held for sale were the key contributors to the improving margin. DBRS notes deposit costs were stable QoQ.

Operating expenses, excluding restructuring expenses, were higher QoQ primarily due to the acquisition of Direct Capital, higher deposit costs and exit costs related to the non-strategic portfolio. As a percentage of average earning assets, operating expenses, exclusive of restructuring were 2.82%, 19 bps higher sequentially, but were still above the Company’s near-term target range of 2.00% to 2.50%. DBRS expects that as the last of the non-strategic portfolios are exited through 2015 and the integration of NACCO and Direct Capital progresses, CIT will make further progress towards its target for operating efficiency.

Asset quality metrics remain at or near cyclical lows reflecting CIT’s conservative commercial underwriting standards and the strengthening U.S. economy. Non-accruals were 0.82% at December 31, 2014, the lowest levels since before the financial crisis and evidencing the impact of CIT’s progress in exiting non-strategic portfolios. Within CIT’s North American Commercial lending portfolio, DBRS notes that CIT held approximately $500 million of direct loan exposure (3% of the segments total lease and lending portfolio) to the energy sector. DBRS notes that approximately 80% of the exposure is secured and that the portfolio remains unaffected by the rapid decline in energy prices. Lastly, DBRS highlights that CIT’s Transportation railcar business held approximately 12,000 tank cars that carry crude oil and 9,000 sand cars. Currently, utilization of these railcars remains very strong and most are on long-term lease. Nonetheless, DBRS is mindful that credit issues could potentially surface should energy prices remain at current levels or lower, for a prolonged period.

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 in 1H15, subject to regulatory approval.

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