CIT Group Inc.‘s (CIT) second quarter 2012 loss came in at 35 cents per share compared with the Zacks Consensus Estimate loss of 54 cents. The company had reported a loss of 25 cents in the prior-year quarter. The results included debt refinancing charges related to the prepayment of high-cost debt.
Negative net revenue, lower total interest income and rise in operating expenses adversely impacted CIT’s quarterly results. Nevertheless, lower interest expenses, continuously improving credit quality and stable capital ratios were the positives.
CIT recorded a net loss of $70.7 million in the quarter under review, compared with $49.7 million in the year-ago quarter.
Performance in Detail
On a non-GAAP basis, total net revenue was $228.9 million, down 22.0% on a year-over-year basis. Lower net finance revenue was the primary reason for the fall, which was partially offset by improved other income. Moreover, net revenues were nowhere near the Zacks Consensus Estimate of $818.0 million.
Net interest revenue was negative $229.9 million in the reported quarter, compared with negative $206.8 million in the year-ago quarter. Benefits from lower interest expense were more than offset by even lower total interest income, which resulted in negative net interest revenue. The major reason behind the higher interest expenses was the redemption of nearly $4.2 billion of high-cost debt by CIT during the quarter.
Net finance revenue as a percentage of average earning assets (excluding fresh start accounting and debt prepayment penalties) improved 162 basis points (bps) year over year to 3.02%. The rise was driven mainly by lower funding costs, reduction of low-yielding assets, higher prepayments and interest recoveries along with the benefit from the suspension of depreciation on operating lease equipment held for sale.
Operating expenses were $240.2 million, marginally rising from $238.5 million in the prior-year quarter and it included roughly $14 million for the establishment of an indemnification reserve related to pre-emergence asset sales largely offset by benefits related to favorable resolutions of tax and legal matters. The rise was also attributable to increased compensation and benefits expenses.
Credit Quality
CIT’s credit quality continued to improve during the reported quarter with almost all the major metrics declining. Net charge-offs (NCOs) were $17 million, down from $22 million in the prior quarter and $55 million in the prior-year quarter. The sequential dip was largely attributable to Transportation Finance segment, while the year-over-year fall reflected improvements in Corporate Finance and Vendor Finance divisions.
NCOs as a percentage of average finance receivables decreased 11 bps sequentially and 62 bps year over year to 0.33%. Moreover, non-accrual loans dropped 5.6% sequentially and 58.6% year over year to $455 million. Non-accruing loans as a percentage of finance receivables slipped 9 bps sequentially and 215 bps year over year to 2.26%.
Further, with continued reduction in specific reserves and improved portfolio credit quality, provision for credit losses declined 79.1% sequentially and 89.4% year over year to $8.9 million.
Balance Sheet Updates
As of June 30, 2012, cash and short-term investment securities were $7.0 billion, consisting of $6.1 billion of cash and $0.9 billion of short-term investments. Additionally, the company had approximately $1.4 billion of unused and committed liquidity under a $2 billion revolving credit facility as of June 30, 2012.
CIT continues with its restructuring initiatives to bring down its cost of capital and improve profitability. Since January 2010, the company has either eliminated or refinanced over $26 billion of high-cost first and second lien debt.
Additionally, on July 20, CIT announced that it would redeem $600 million of its 7% Series C Notes maturing in 2017 on August 20. The company anticipates additional interest expenses in the third quarter as a result of the repayment of this debt. Following the completion of this redemption, nearly $4.0 billion of debt would be left pertaining to the Series C notes in the company’s balance sheet along with unsecured revolving credit facility.
Moreover during the quarter, CIT issued senior unsecured notes worth $2 billion. Of the total, $1.25 billion worth of senior notes are due in 2017 and the remaining lot, worth $750 million, is due in 2020.
Capital Ratios
Capital ratios were stable as of June 30, 2012, with a Tier 1 capital ratio of 18.0% and a total capital ratio of 18.9%, both showing improvements from the end of the prior quarter. Book value per share was $41.73 as of June 30, 2012 compared with $44.61 as of June 30, 2011.
Our Take
CIT’s initiatives to restructure its balance sheet as well as repay and refinance its costly debt will not only bring down the funding costs, but also would lead to an improvement in its net interest margin as well as profitability. Moreover, the company is poised to benefit from its strong capital and liquidity position.
However, CIT’s growth prospects will likely be adversely affected by sluggish growth in the industries where the company provides finance, stringent regulations as well as the weak economic recovery. Further, the company will have to focus on improving its top line; otherwise, its bottom line will continue to remain under pressure.
CIT currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain a long-term ‘Neutral’ recommendation on the stock.
One of CIT’s peers, Harbinger Group Inc. (HRG) is expected to announce its fiscal third-quarter results on August 9.
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