CIT Group Inc.
Q1 2020 Earnings Call Transcript

Published: 21 Apr 2020

[Operator:]

Good morning and welcome to CIT’s First Quarter 2020 Earnings Conference Call. My name is Elisa and I will be your operator today. At this time, all participants are in a listen-only mode. There will be a question-and-answer session later in the call. [Operator Instructions] As a reminder, this conference call is being recorded.I would now like to turn the call over to Barbara Callahan, Head of Investor Relations. Please proceed, ma’am.

[Barbara Callahan:]

Thank you, Elisa. Good morning and welcome to CIT’s first quarter 2020 earnings conference call. Our call today will be hosted by Ellen Alemany, Chairwoman and CEO; and John Fawcett, our CFO. Also joining us for the Q&A discussion is our Chief Credit Officer, Marisa Harney.During this call, we’ll be referencing the earnings presentation as well as a supplemental presentation that describes our preparedness in response to COVID-19. Both are available on the Investor Relations section of our website at cit.com. Our forward-looking statements disclosure and non-GAAP reconciliations are included in today’s earnings materials and within our SEC filings. These cover our presentation materials, prepared comments and the questions-and-answers segment of today’s call.I’ll now turn the call over to Ellen Alemany.

[Ellen Alemany:]

Thank you, Barbara. Good morning, everyone, and thanks for joining the call. Wherever you’re tuning in from, I hope you’re safe and well.The first quarter has clearly presented a new paradigm for all of us. And the personal and economic challenges related to the COVID-19 pandemic have been unprecedented. Oftentimes, periods of great challenge provide an opportunity to also test the company’s strength, agility and values.And these past few months have tested us and demonstrated that we have the fortitude to navigate the issues before us. CIT today is the result of a multiyear enterprise transformation that has led to an organization with ample liquidity, sufficient capital, substantially less risk in the portfolio, nimble operational capacity, leading franchises with deep expertise supporting them for diversified and stable core deposit channels, and a seasoned management team that knows how to navigate in a dynamic environment.We entered 2020 with a much stronger foundation which has enabled us to actively respond to the challenges presented by this pandemic as well as advance some of our key strategic initiatives in the quarter. Let me touch on our COVID response first and then I’ll share other highlights from the quarter.In a matter of weeks, we have effectively transformed the way we operate while also prioritizing the health, safety and financial needs of our employees, customers and communities.First and foremost, we work to ensure our employees were safe and we took a number of steps early in the process to enact the best available guidance on healthy workplace protocols in social distancing. We were one of the first banks to fully shift to remote working model in key urban centers like New York City and Chicago as the outbreak started to progress in mid-March.Currently, 93% of our employees are effectively working remotely as a result of our investments in technology and the digital transformation we put in place over recent years. This is a best-in-class standard in our industry and a vital part of our business continuity.We also continue to evolve our workplace protocols as more information is available on reducing the spread of this virus and understanding the best ways to ultimately emerge from the current isolation measures. We are offering enhanced health benefits for COVID testing and care, as well as ongoing wellness programming to help employees through the stress and isolation of these new lifestyle requirements.We implemented an enhanced pay plan for employees that are not able to work remotely and are providing vital services in support of our business. And I’m proud to say that all of our branches remain open and able to serve customers. We modified ours and enhanced safety protocols, but we remain open for business.We’re also focused on working with our customers who have been affected by the pandemic and providing relief when we can. We are working with more than 8,600 small businesses, primarily in our business capital position to provide them deferrals on their existing loans and leases. We quickly stood up an entirely new operational process in order to participate in the government’s Paycheck Protection Program.We’re providing mortgage forbearance to borrowers. We’re waiving fees so customers could access deposits without penalty. And we continue to have ongoing dialogue with our commercial clients, and offer them our banking and structuring expertise and assistance in navigating during this period.We know it is a challenging time for many and we’re committed to working with our customers. Commitment to our communities remains very important as well and CIT has committed $1 million to support non-profit partners with COVID-19 relief efforts in our key markets. While this is still an evolving landscape, I’m proud of the way we’ve been able to adapt to the situation, and demonstrate our resilience and commitment to do what’s right for our team, our customers, our communities, and ultimately, our shareholders.Turning to the quarter, our results were primarily affected by the impact of the pandemic on the macroeconomic environment, which led to an increased credit reserves and goodwill impairment; the adoption of CECL, which dramatically changed the credit reserve model amid a volatile period; and the completion of the Mutual of Omaha Bank acquisition, which added about $8 billion of assets and $7 billion of deposits, and impacted the comparability of our results versus prior periods.We posted a net loss of $628 million or $6.40 per diluted common share due to the increased credit reserves and goodwill impairment. John will go into more detail on the underlying drivers of performance. But I first wanted to touch on a few key highlights. We completed the acquisition on January 1 and immediately kicked off our integration efforts, which remain on track and are expected to be completed by yearend.We improved our deposit costs by 34 basis points in the quarter through the addition and growth of the Homeowners Association deposit channel and also through our efforts to further optimize funding in the consumer channel. The community association banking business, which is the division that drives the HOA deposits, has been off to a strong start and had one of their best growth quarters ever.Between the existing portfolio and the growth in the quarter, that business added another $5 billion of lower cost deposits, CIT’s funding profile and further bolstered our deposit base. We have already made investments in this business and launched the new reserve deposit product suite, as well as expanded our sales team. And we expect to remain on track in doubling the size of this business in 5 years.Our balance sheet remains strong, ending the quarter with more than $42 billion in deposits and $9.5 billion in liquid assets. Our core average loans and leases were up 1% from the prior quarter, excluding the acquisition. Our loan and lease to deposit ratio at the bank increased slightly to 95% and we remain on target with our expense initiatives.Managing our risk remain critically important as it has been for some time. We have maintained prudent underwriting standards and are thoughtfully originating business in areas where we believe there are opportunities.We continue to proactively manage our portfolio and over recent years, we have sold or significantly reduced our high risk portfolios and shifted to more collateral based lending. We know there are still some portfolios that we will feel the stress of the economic disruption more than others, and we have shared more disclosure in the COVID response deck that was posted today.I will touch on 2 key areas which are energy and retail. As you know, we are a leader in the power and renewables space, and have continued to grow that part of our power and energy business. We do still have loan exposure to oil and gas though. And it is comprised of about $1 billion in funded exposure, most of which is secured and represents about 3% of our total loans.Our exposure to the retail sector is primarily in our factoring business and half of that factoring exposure is made up of our top-10 customers, which are investment-grade or near investment-grade companies.Our client base is fairly diversified across consumer segments and we continue to have frequent dialogue with our clients and work closely with them through this period. Some clients have also shifted their business to produce or procure masks, gowns and other much needed items for the fight against the coronavirus, and we’re pleased to help support them in those efforts.We are closely monitoring these and other portfolios that may be further impacted as a result of the current economic environment.As mentioned this quarter, we adopted CECL, and we leverage the capital stress testing capabilities we built when we were a CCAR bank. We conducted a robust process as we set our reserves that reflected what our best view of the economic environment was at that point in time and its potential impact on the portfolio going forward. Don will walk you through the details of that process shortly. And as we mentioned we also have our Chief Credit Officer, Marisa Harney available for Q&A later in the call.To summarize, we have ample liquidity and a robust stress testing process to ensure we can meet our funding needs even in a stressed environment. We continue to run severely adverse stress scenarios even though we have no longer subject to the CCAR process, which informs our capital levels. Our reserves are strong, covering 2.9% of loans and we have an additional $120 million of allowance for off-balance sheet credit exposures.We are confident and our ability to respond to the challenges before us and weather this economic downturn. The work we have done in recent years has best positioned us for this period. We are actively managing every facet of the company and the continuity of our business.And with that, I’ll turn it over to John.

[John Fawcett:]

Thank you, Ellen, and good morning, everyone. Our results this quarter reflect 3 key events during the quarter

[Ellen Alemany:]

Thanks, John. As mentioned, these are unprecedented times, and I have confidence that we have the resources, expertise and rigor to continue to navigate this environment with diligence and care. CIT of today is completely different than the company that went through the last economic disruption. We are a national back with diverse and stable sources of funding. We have strong liquidity levels and robust risk management practices.We will continue to focus on ensuring we have ample capital and liquidity to whether this environment and believe the strength of our balance sheet gives us stabilizing force through this volatile period. We are also focused on pursuing opportunities where we see them in the HOA banking channel and other areas of the commercial segment that could align to our strengths.We remain steadfast in doing the right thing for our employees, customers, communities and shareholders. And with that, we’re happy to take your questions.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question today comes from Moshe Orenbuch of Credit Suisse. Please go ahead.

[Moshe Orenbuch:]

Hi, great, thanks. I guess, I saw the disclosure there and the discussion about the performance and the reserve needs in this severely adverse scenario. I’m wondering if you could talk about whether there are portfolios that you think would perform potentially less bad than in the severely adverse and ones that could perform worse than that, given what you know today about current effects and trends?

[Ellen Alemany:]

You know what, Moshe, we have Marisa Harney, our Credit Officer on the line. I’m going to turn that one over to Marisa.

[Moshe Orenbuch:]

Great. Thanks. Thanks.

[Marisa Harney:]

Sure, thanks, Ellen. Good morning. Less bad and more bad are relative terms, obviously, in the current environment. I think that less bad is going to be more dictated by duration, than necessarily a specific industry. We have a pretty broad-based middle-market business. We also have technology businesses and renewable energy, is that I think I would put on the greener side of being more positive in the current environment.And as Ellen identified, and John identified, I think that, obviously, with oil falling into negative territory, I think oil and gas, which we have about $550 million of E&P exposure, and that’s disclosed in the additional material is clearly something we need to watch closely.And then, there is a very unpredictable environment going on in retail, which will be dictated by, again, the duration of the government – the U.S. government keeping us closed. I think that as Ellen also indicated, 50% of our portfolio in our factoring retail is in investment-grade companies and I expect those to be not as impacted.

[Moshe Orenbuch:]

Okay, thanks. Maybe as a follow-up, John, you talked a bit about the rail portfolio and talked about potential for higher costs as you kind of do repositioning and potentially – maybe is there a way to kind of think about the impact of that on net finance revenue as we go forward?

[John Fawcett:]

Yeah, well, look, as a starting point, I think, obviously, we withdrew guidance as I think most banks did. I think there is just not a lot of visibility. I think, Moshe, when I sat with you on stage back in the end of February at the Credit Suisse Conference, we talked about utilization maybe going down at 92% and then starting to bounce back a little bit around the rest of the year.You’ve got 24% North American fleet is still parked in stores and that seems to be increasing. If you just look, and we don’t usually do this, but weekly rail-loadings are reflecting the economy. Auto is down 67% week on week. And, obviously, we’re light on that obviously, but we’re light in auto tracks. Chemicals and petroleum are down 7% week on week, that’s likely to continue with the global oil. And the bright spots were in agriculture and paper products.And so, it’s tough. I think our guidance is, is that we expect that rail utilization could go into the mid 80s and mid to high 80%s from where we’re at right now. And then, beyond that, you’ve got the incremental cost as utilization declines of the storage of more cars going into storage. So it’s just going to be challenging.I think like everything else, it’s going to be tied largely to the pace of the recovery and what kind of recovery we start to see in terms of whether it’s U-shaped or V-shaped. If it’s a V-shaped recovery, you might expect these trends to reverse fairly quickly. If it’s other than that, it could be [or factored] [ph] much longer. But it’s still going to have an adverse impact on net finance margin going forward.

[Ellen Alemany:]

Yeah, but I also want to add that there is a lot of things that we’re doing about this. One is just rigorous portfolio management. We have received some requests for lease restructuring and rental relief. And we are addressing these on a case-by-case basis. We are looking for opportunities to repurpose sand cars.We’re also working on continuing to drive down our maintenance costs and we have a lot of initiatives going there, including managing our repair process, increasing the use of mobile repair units. And so, this has allowed us to offset the pricing trend a little bit. And then, as John mentioned in his script before that other strategies that selling older cars as a gain, we’ll probably expect lower gains over the next quarter.But I do want to leave everybody with the thought that we should remember that railcars or along with the assets and their performance should be reviewed over cycle, not just this point in time.

[Moshe Orenbuch:]

Got it. Ellen, John and Marisa, thanks. Good luck.

[John Fawcett:]

Thank you.

[Operator:]

The next question today comes from Eric Wasserstrom of UBS. Please go ahead.

[Eric Wasserstrom:]

Right, thank you. Can you hear me all right?

[Ellen Alemany:]

Yes, we can.

[Eric Wasserstrom:]

All right, great, thanks. Moving – John, just to start, could you help us frame what economic outlook is your base-case scenario for whatever your horizon as of this point?

[John Fawcett:]

Yeah. So I think the easiest way to describe the way I think about it is, it’s kind of a scenario cocktail. And we use 3 scenarios. We had an updated baseline pandemic scenario from Moody’s on March 20, which was our baseline. We – and that’s when we kind of snapped the line in terms of preparation for quarter end. We had the more volatile V-shaped scenario, which had a deeper cut into the second quarter and a more spontaneous recovery into the third quarter.And then, we leveraged another scenario, which we label as S3, which is a severely adverse scenario. So just to kind of give you some context in terms of the different scenarios, in terms of GDP, if you looked on our baseline, it had GDP down 5% and then moderating in the third quarter to down just 0.3%.If you look at the more volatile V-shaped scenario, you had GDP in the second quarter down almost 20%, but we’re covering 11% in the third quarter. And in the severely adverse scenario that we also kind of applied as an overlay against the base case, you had GDP down 5% in the second quarter, and then down another almost 3% in the third quarter. And so – it’s a little bit of out to me in terms of pulling all the numbers together.And I think if you look at a new baseline that I guess Moody’s has provided on April 10, it portends that, again, it’s another V-shaped recovery. But in the second quarter, you’d have GDP decline by 30%, but in the third quarter, we bounced back 17%. So – I mean, that’s kind of the thoughts around the way we kind of manage through the process. I think obviously, we’re going to continue to monitor the scenarios, our own portfolios in terms of real experience the capacity of the government programs to provide some level of recovery going into the economy. And I think we’ll have better sense of this and more refinement as we get into the second quarter, but it obviously very fluid.

[Eric Wasserstrom:]

Great. Thank you for that. And so I guess that was really the preface to what is my real question, which is if we think about the vulnerabilities as being in 3 categories around revenue, around operating expense and around provision, if you were to move, let’s say, from that central scenario to the S3 scenario, where would the vulnerability to be most acute relative to your financial position today, more on the revenue side or potentially more on the provision side?

[John Fawcett:]

Well, I think it’s clearly more on the provision side. In the revenue side, I mean, we’re at 0 rate. I mean, so we’re already kind of feeling that challenge and has started to feed through in March. I mean, if you look at the first quarter, January and February are actually quite good months for us. And even halfway into March, we were fine. Part of this is – and part of the way we’re thinking about forecasting in it’s very difficult, because it remains very fluid is that you could almost run rate March into the second quarter. And absent, we wouldn’t expect that we’re going to take another $400 million charge, and obviously, the bill is behind us now.But run rating March and then having potentially some incremental element of provision, I think, it’s really the larger challenge in terms of what we’re going to face on a go forward basis is the provision.

[Ellen Alemany:]

Yeah. I would just to add that on the expense side, we’re on target for all of our cost reductions. We had the $50 million in that cost reductions for 2021 over and above the [$60 million] [ph] in the cost saves from Mutual of Omaha. So we feel we’re on track, and we actually believe, there’s some more opportunities there on the expense side of the business. And I think, we do see some potential opportunities on the revenue side of the business going into the pandemic, we had a really good quarter in capital markets with organic growth. Fees were up like 25%. We’re having very good momentum on the deposit side of the business. In fact, when you look at the defensive drawdowns from the commercial business, we were able to keep 1/3 of those deposits. Now for company like CIT, which really had – I think that’s been a really big accomplishment for CIT to do that, it really shows our strategy of trying to expand customer relationship and focus on deposits.And I think that our strengths in ABL and our industry expertise is going to position us well for a lot of the restructures going on in the market and restructuring activity. In business capital, one of the bright spots has been technology leasing, because of the trend of schooling at home and working at home, we’ve had really good volumes in technology. And I think, one of the first places we’re going to recover here is in construction, which will also bear well for the business. So we do see some bright spots here coming out of it.

[Eric Wasserstrom:]

Okay. Thanks very much for taking my question.

[Operator:]

The next question today comes from Chris Kotowski of Oppenheimer & Company. Please go ahead.

[Chris Kotowski:]

Yeah. Good morning. I guess, my key question is the durability – overall the durability of your pre-provision net revenues. And I guess, looking at the rail and leasing business there, you mentioned the utilization rates coming down and increased maintenance cost and all that. But when we see – if you look at it linked quarter, the net lease revenues went from like $98 million to $78 million. I mean how of that impact have we seen, because I mean it just seems like we would have only had like a couple of weeks of the impact in 1Q. So should we expect another meaningful drop in that net lease revenue? Or can you size that for us in any way?

[John Fawcett:]

Yeah. Hey, Chris, it’s John. I mean, it can probably be sized just because it’s a function of, I guess, the recovery period. I guess, what I would say also, it really depends. So in any given quarter, you’ll have between 4,000, 5,000, 6,000 cars that are renewing and it fundamentally depends on what kind of cars are renewing. That’s going to impact, obviously, the renewal rates going forward. And so it’s all tied back to the recovery or the pace to the kind of recovery we saw. Clearly, we weren’t anticipating utilization going down to 91% or 90.7% in this quarter.If we see a V-shaped recovery that could bounce back pretty quickly, especially if the economy starts to come online, people start going back to work, the social distancing protocols all start to abate and the economy gets back online. But absent an economy, it’s not clear what you’re actually shipping. And so it’s all interrelated. And I’m sorry, I can’t give you better answer, but there is no clear answer.

[Chris Kotowski:]

Okay. All right. That’s it for me. Thank you.

[Operator:]

[Operator Instructions] The next question today comes from Arren Cyganovich of Citi. Please go ahead.

[Arren Cyganovich:]

Thanks. Looking at the COVID deck that you put out, Slide 15, I found pretty useful the – I’d say that the only area that I think I’d be a little bit concerned about is when you look at the size of the various areas that you highlight here. You’re looking at like $3.5 billion, excluding the factoring of kind of problem areas where you have $1.2 billion of capital above your buffer. How do you give us a little bit more comfort that you’re not going to have 50% severity in your oil and gas, and hotel and gaming? There’s all these different kind of subsectors where there’s seemingly a large level of potential loss capability from those books.

[Ellen Alemany:]

Marisa, you want to take that one?

[Marisa Harney:]

Sure. I think that the – again, so these are not equal in severity. As we mentioned in the factoring receivables, a considerable portion of that is investment grade. So we’re not anticipating that’s going to result in any material issues for us. When you look at the oil and gas number, I know you’re running your finger down that left-hand column, only about half of that is actually exposed in the E&P sector and we believe that our customers are hedged 75% this year and 50% into next year at considerably higher levels of oil prices. I guess, anything is considerably higher than negative. But they’re in many cases over $50 a barrel.The real estate is collateralized with good properties and with strong sponsors, and we – so we’re negotiating those individually. We’re really focused on strong partners on the construction side and on the management side. And again, for things like hotels and lodging, duration is going to be key. Our senior living exposure is pretty diversified, and obviously, collateralized as well. And gaming – again, duration on the gaming side, in the last downturn regional gaming actually was much more resilient than tourist-based gaming, although every cycle is different.And so, this is really about making sure that these companies have sufficient liquidity to weather through to an opening. And then, in our franchised finance business, which is relatively small, the quick serve industry, the fast food industry is actually a little bit more resilient than casual, certainly more than casual dining, because they have – it’s lot easier for them to do take-out and drive-through. So again, the severity levels are very different and they’re taken on a case-by-case basis. And I think, as I said before, duration is key.

[Arren Cyganovich:]

Okay. I appreciate. That’s helpful. Maybe we could just dig a little bit more on to the factoring side, because I think this is an area where people don’t have a deep understanding of the risks associated with those and those are, obviously, had large numbers when you just look at the total receivables that you have in that business. And understanding that you have strong counterparties on half of the book and maybe just talk about the other part of the book, the smaller customers you have there, what the credit risk of this book is? Is it more of a credit issue or is it more of a fact that you actually just lose a significant amount of volume here from retailers that may be struggling?

[Marisa Harney:]

Well, I’ll take the credit question. The remainder of the book is spread out over about 25,000 individual retail customers, that these are customers of our clients. And we’ve been monitoring this portfolio very aggressively since – well, for a long time, but in particular since 2016, when it was clear that there was a secular issue in bricks-and-mortar retail.And so, we’ve been taking considerable actions where we could and where it was available to us, to mitigate the risks that we had either through cash collateral, letters of credit and also other techniques that we have in terms of how we manage those receivables in the context of our client exposures. And so, we’ve done a considerable amount of work to reduce lines, lines under which we purchased factored receivables, and as I said, engage in other risk mitigating techniques.Our exposures are short-term. They’re trade receivables. Typically, unless someone is in liquidation, we would expect that they would want to protect their trade credit. And so – and we’ve been monitoring retailers in terms of the ones that we thought had the survivability way before this. So we entered this crisis in good shape. But as I said, it’s extremely unpredictable. It’s going to be driven by duration.But 7 out of 10 of our top-10 clients issued in the capital markets in the last several months, so the markets are open to the industry.

[Ellen Alemany:]

Great. And, I just want to add that, we’re in daily contact with our factoring clients, providing them a lot of expertise and advice during this period. And one is that China factories are back open. They’re running like at 80%. We have observed that certain of our customers are gathering liquidity in anticipation of reopening, which really could portend their intention to meet vendor obligations.We also have exposure to certain retailers who remain open, such as the discount and online stores. But it’s an evolving situation and we’re continuing to work closely with them, navigating with them during this time.

[John Fawcett:]

And the only thing I would add is just to be really clear is we do expect factoring commissions to be down in the second quarter. I mean, this is a supply challenge as well as demand challenge. Retailers have to start opening and shipments have to start coming in from not just China but around the world. So a lot has to happen for us to get back in standing.

[Ellen Alemany:]

Yeah.

[Arren Cyganovich:]

Yeah, thank you.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

[Ellen Alemany:]

Great. Thank you, Elisa. And thank you, everyone, for joining this morning. If you have any follow-up questions, please feel free to contact the Investor Relations team. Our contact information is on the website. Thank you again for your time. Stay safe and healthy, and have a great day.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.