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CIT Group Inc.'s (CIT - Analyst Report) third quarter 2012 loss came in at 1.52 per share compared with the Zacks Consensus Estimate loss of $1.08. The company had reported a loss of 16 cents in the prior-year quarter. The results include debt refinancing charges related to the redemption of high-cost debt.

Negative net revenue, higher interest expense and rise in operating expenses adversely impacted CIT's results. Nevertheless, continuously improving credit quality and stable capital ratios were the highlights of the quarter.

CIT recorded a net loss of $305 million in the quarter under review, compared with 32.8 million in the year-ago quarter.

Performance in Detail

On a non-GAAP basis, total net revenue was a negative $46.9 million compared with positive revenue of $472.2 million in the previous-year quarter. Negative net finance revenue was the primary reason for the negative total net revenue. Moreover, net revenues were nowhere near the Zacks Consensus Estimate of $760.0 million.

Net interest revenue was a negative $438.0 million in the reported quarter compared with a negative $100.3 million in the year-ago quarter. The main reason for the negative net interest revenue was surging interest expense.

Further, total non-interest income stood at $525.6 million, down 19.4% year over year. The fall was mainly due to lower other income.

Net finance revenue as a percentage of average earning assets (excluding fresh start accounting and debt prepayment penalties) improved 139 basis points (bps) year over year to 2.97%. The rise was driven mainly by lower funding costs as well as reduction of low-yielding assets.

Operating expenses were $237.5 million, rising 4.9% from $226.4 million in the prior-year quarter and included $5 million of restructuring charges. The jump was largely attributable to increase in costs related to raising deposits and higher technology costs, partially offset by decline in professional fees.

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 $18 million, down from $46 million in the prior-year quarter. NCOs as a percentage of average finance receivables declined 47 bps year over year to 0.36%.

Moreover, non-accrual loans dropped 54.9% year over year to $412 million. Non-accruing loans as a percentage of finance receivables slipped 363 bps year over year to 2.48%.

Further, there was no provision for credit losses in the third quarter. This favorable trend reflects the overall improvement in asset quality.

Balance Sheet Updates

As of September 30, 2012, cash and short-term investment securities were $7.2 billion, consisting of $6.5 billion of cash and $0.7 billion of short-term investments. Additionally, CIT had approximately $1.4 billion of unused and committed liquidity under a $2 billion revolving credit facility as of September 30, 2012.

Moreover during the reported quarter, CIT issued senior unsecured notes worth $3 billion. Of the total, $1.75 billion worth of senior notes are due in 2017 and the remaining worth $1.25 billion is due in 2022.

Since CIT emerged from bankruptcy in December 2009, it has been constantly restructuring its balance sheet in order to bring down its cost of capital as well as improve profitability. Since January 2010, the company has either eliminated or refinanced over $31 billion of high-cost first and second lien debt. Hence, there is no high-cost debt left in the company's balance sheet, except for the unsecured revolving credit facility.

Capital Ratios

Capital ratios were stable as of September 30, 2012, with a Tier 1 capital ratio of 16.7% and a total capital ratio of 17.5%, both showing marginal deterioration from the end of the prior quarter. Book value per share was $40.26 as of September 30, 2012 compared with $44.32 as of September 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 impacted 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 pressurized.

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, CapitalSource Inc. is expected to announce its third quarter results on October 30.
 

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