cit 2006%20q2

The following transcript has been provided by a third party transcription service for informational purposes only. CIT has not reviewed or edited the transcript and expressly disclaims any responsibility for the accuracy of this transcription.

Thomson StreetEvents www.streetevents.com Contact Us 1

© 2006 Thomson Financial. Republished with permission. No part of this publication may be reproduced or transmitted in any form or by any means without the prior written consent of Thomson Financial.

FINAL TRANSCRIPT

Conference Call Transcript

CIT - Q2 2006 CIT Group Earnings Conference Call

Event Date/Time: Jul. 19. 2006 / 11:00AM ET

FINAL TRANSCRIPT

Jul. 19. 2006 / 11:00AM ET, CIT - Q2 2006 CIT Group Earnings Conference Call



C O R P O R A T E P A R T I C I P A N T S Valerie Gerard CIT Group, Inc. - EVP IR

Jeff Peek CIT Group, Inc. - Chairman, President, CEO

Joe Leone CIT Group, Inc. - CFO

C O N F E R E N C E C A L L P A R T I C I P A N T S Meredith Whitney CIBC World Markets - Analyst

Bob Napoli Piper Jaffray - Analyst

Bruce Harting Lehman Brothers - Analyst

David Hochstim Bear Stearns - Analyst

Laura Kaster Sandler O'Neill - Analyst

Moshe Orenbuch Credit Suisse First Boston - Analyst

Chris Brendler Stifel, Nicolaus - Analyst

Howard Shapiro KBW Asset Management - Analyst

Joel Houck Wachovia Securities - Analyst

Eric Wasserstrom UBS Warburg - Analyst

David Chiaverini [BMO] Capital Markets - Analyst

Stephen Schulz Keefe Bruyette Woods - Analyst

P R E S E N T A T I O N

Operator

Good morning. My name is Wendy and I will be your conference facilitator today. At this time, I would like to welcome everyone to the CIT second-quarter and year-end earnings conference call. All lines have been placed on mute to prevent any background noise. Thank you. I would now like to introduce Valerie Gerard, Executive Vice President-Investor Relations. Ms. Gerard, you may begin your conference.

Valerie Gerard - CIT Group, Inc. - EVP IR

FINAL TRANSCRIPT




Thank you, Wendy, and good morning, everyone. Welcome. This is actually the second-quarter earnings results quarter call and not our year-end, just to clarify that for you. I have a couple of housekeeping items this morning. First, CIT will be hosting its fourth annual investor conference in New York City on November 7. Please mark your calendars. Details will follow. Second, after our formal remarks, we will move into our standard Q&A session. Veteran listeners of this earnings call know that we typically have a robust queue during the Q&A session, so as a reminder, we do limit callers to one question in an effort to run a smooth and efficient call, answering everyone's questions. If you do have a follow-up question, please do return to the queue. Now, as you know, elements of this call are forward-looking in nature and relate only to the time and date of the call. We expressly disclaim any duty to update these statements based on new information, future events or otherwise. For information about risk factors relating to the business, please refer to our SEC reports. Any references to certain non-GAAP financial measures are meant to provide meaningful insight and are reconciled with GAAP in the Investor Relations section of our Web site at www.CIT.com. Now, with that, it is my pleasure to hand the call over to Jeff Peek, our Chairman and CEO.

Jeff Peek - CIT Group, Inc. - Chairman, President, CEO

Thank you, Valerie, and good morning to everyone. We achieved a solid second quarter characterized by broad-based volume growth and improving sales execution. Our robust pipeline supports that the economy continues to power forward as we head into the second half of the year. As the Fed appears close to ending its tightening of interest rates, we start to see a more discernible yield curve. Both of these factors bode well for CIT. Now, the highlights of the quarter -- our diluted earnings per share was $1.16, a 14% increase over operational earnings in the second quarter of 2005. Return on equity of 14.1% held constant with the prior quarter. Credit performance was once again exceptional with net charge-offs of 35 basis points. While we did see an uptick in our forward indicators, portfolio quality still remains strong. New business volume was a record $10 billion. We are up 25% compared to last year and as you know, the second quarter -- second calendar quarter typically is one of our weaker quarters in terms of new business. As a result, managed asset growth was broad-based, reaching $68 billion, up 17% from a year ago and 8% from the beginning of the year. Other revenue exceeded $300 million in the quarter, or 41% of our total revenue. We are certainly encouraged by the increase in fees from our capital markets and advisory businesses. In addition, this has been an exciting quarter for CIT, which began with the establishment of our new global footprint in New York City. We relocated our client-facing New York-based employees and some headquarters functions to a new, world-class facility for conducting business. Branded "the CIT Building", this new location now serves as our global headquarters. The opening of our new headquarters is symbolic of a strategic change that is taking place at CIT, a cultural change. Now, a very significant addition this quarter was the appointment of Jim Duffy as Executive Vice President and Global Head of Human Resources. Jim joins us from Citigroup's Global Consumer Group. A vigorous performance-driven culture will help drive CIT's growth and also create a best-in-class work environment for our employees. Now, let's talk about our sales culture at CIT. Just last month, at our annual Global Sales Summit, we recognized the achievements of our sales team, which under the guidance of our Chief Sales Officer, Walter Owens, has delivered outstanding results. As we invest in sales personnel, we are experiencing increases in both new business originations and sales force productivity. This past quarter, following a 34% increase in our sales force from last year, we experienced double-digit growth in the productivity of our sales force over last year. These were the results that added to the 25% increase in sales volume to a record $10 billion as compared to last year. Driving these organic originations is the crisp execution of our sales force integration, the continued build-out of our industry specialization, and the globalization of our business. While these numbers demonstrate increasing originations and sales productivity, I now want to share with you several examples of how our investments have generated greater volume enabled us to originate higher-margin transactions. We do believe our investments are leveling off, as many of our business units are gaining traction as they complete their sales build-out.

FINAL TRANSCRIPT




Now, I want to talk to you about healthcare. This past quarter, Flint Besecker and the healthcare team doubled volumes over the prior year. Additionally, the team won several significant mandates that will help drive fee income in the third quarter. Among these were a significant real estate advisory mandate and a sizable M&A deal. A third big success for the quarter was a large capital markets financing with American Medical Systems that we got through our newly announced strategic alliance with Piper Jaffray. We all see this as concrete proof that we are transforming CIT from a middle-market focused balance-sheet lender to a trusted adviser. Now, let's talk about communications, media and entertainment. Jim Hudak and his team continue to perform very well, as all of its industry subsectors have seen strong deal flow, up 170%, asset growth up 36%, and revenue growth up 97%. Fee income for the quarter was up nearly 80% from a year ago on significant syndication and advisory freeze from deals such as the recapitalization of the Montreal Canadiens of the National Hockey League, our recapitalization and buyout of Contact Communications, and a recapitalization of PayTech Communications, a long-standing customer. Now, the creation of a sales culture and an origination platform continue to drive the success in some of our other businesses, including Student Loan Xpress and Vendor Finance. Student Loan Xpress had an outstanding second quarter, as volumes more than tripled from last year. Under the leadership of Mike Shaut and Briz Balestri, assets grew more than 65% from a year ago to $7 billion. We benefited from new legislation that allows borrowers to refinance through a variety of student lenders, as well as the July 1 rate increase in which borrowers rushed to consolidate their loans to beat the deadline. Student Loan Xpress is now on the preferred lender list at almost 1200 schools, up 46% from a year ago. In addition, we're making progress with the migration of servicing in-house to our Cleveland facility, which now services more than $3.5 billion in student loans. We expect to service roughly $6 billion of loans at this facility by year-end. Vendor Finance -- in Vendor Finance, we're making good progress under the leadership of Jeff Simon, Terry Kelleher, and Ron Arrington. Our recently announced global financing relationship with Microsoft was an important win for us. CIT will begin as the exclusive vendor financing partner for Microsoft in France and Switzerland almost immediately. We expect the relationship to expand into major markets around the world by 2007, as we complete our build-out. We've also renewed our agreement with Avaya, one of our top global vendor partnerships, through 2009, extending our 20-year relationship with Avaya and its predecessor. Finally, we opened a new, 110,000 square foot origination and operations facility in Jacksonville, Florida, and relocated our Avaya collections and service functions from Livingston, New Jersey to this lower-cost location. One of our other major themes this year is international. I was in Europe during May. I met with Terry Kelleher, [Graham Randall] and the employees of our London office to discuss CIT's continued global expansion and evaluate our products mix and financing capabilities. In addition to the relationship we formed with Microsoft, we had several significant wins around the globe. New vendor signings included global arrangement with AGFA, a leader in image production, where we are the exclusive financing partner for South America. In the UK, we were named as a preferred financing partner for Heidelberg and Toshiba Medical, further strengthening these relationships. We also recently completed a vendor deal with Motorola in China, leveraging our geographic leadership position. In trade finance, we acquired a small German factoring operation from which we will begin to grow our build-out of a pan-European factoring platform. Our global cross-border trade finance strategy emphasizes Asian-European trade flows. We've also created a Latin American team to focus on markets where the U.S. government has initiated trade agreements such as NAFTA. Now, our Aerospace business continues to strengthen. The quality of the portfolio is quite good. We have leased 10 new aircraft and 12 remarketed aircraft to 20 different airlines. Due to the strong global demand for aircraft, we ordered an additional five Airbus 330s, and we exercised options on four A320s that will be delivered beginning in 2007 through 2009. On the acquisition front, our pipeline is currently quite robust with a good supply of properties in many of the businesses in which we operate. In particular, we see a number of opportunities in the international arena in the future. With that, I'd like to turn the call over to our Vice Chairman and Chief Financial Officer, Joe Leone.

Joe Leone - CIT Group, Inc. - CFO

Thanks, Jeff. Good morning, everyone.

FINAL TRANSCRIPT




Jeff took you through some of the accomplishments we had for this quarter, which were many, and I'd like to put some financial metrics in dimension to that, and I'd like to spend time on our revenue trends, credit quality, efficiency and capital. Before I do that, a comment on our asset growth progress -- as Jeff said, we had a very strong quarter. He mentioned historically the second quarter is weak with some seasonality and some run-off in our trade finance businesses. In fact, look back over the last three years. If you look Q1 to Q2, in 2003, 2004 and 2005, we had no asset growth in the second quarter. This year, managed assets were up sequentially almost $2.5 billion, 4%, and that's quite an improvement. So our sales initiative, our salespeople throughout the Company, as Jeff said, led by Walter, our Chief Sales Officer -- the whole sales management team has gotten off to quite a good start in '06 on our sales initiatives. Let's move to revenues. Revenues are strong in the quarter, increasing 14% from a year ago, and we had increases in both net finance revenues and other revenues. So sequentially, revenues were up 6%, driven principally by the strong non spread revenues Jeff mentioned. So on the quarter, some specifics -- net finance income was down in percentage terms from the first quarter sequentially but was flat in dollars due to the strong portfolio growth. Let me give you some of the detail behind the 20 basis point or so decline in our net finance revenue percentages. Yield-related fees declined 5 basis points. We mentioned we had a relatively high level of prepayment activity in the first quarter, in Aerospace in particular. Aerospace net lease and loan income declined due to the collection in the first quarter of higher back rents on some bankrupt U.S. airlines. That reduced net finance revenues by about 7 basis points. Having said that, we continue to see very strong pricing and very strong returns in the air and rail leasing markets. Business mix is always a factor and given the strong growth in student lending, our net finance revenue declined by about 3 basis points. And of course, the yield curve and some of our debt initiatives had an impact, so short-term interest rates increasing, debt maturity lengthening, reduced net finance revenues by about 3 basis points. Growing other revenues is a key strategic focus. Jeff mentioned that and he mentioned we are over $300 million and the percentage of revenues from non-spread revenues exceeded 40% this quarter. Where it was it? Very strong syndication activities, very strong end-of-lease activities, particularly in the international vendor, solid gains on receivables, and an insurance recovery on a revenue-generating asset in our commercial Aerospace portfolio. More color on our syndication strategy -- we need to and we are better leveraging our loan and lease origination competencies with a more robust syndication activity. This quarter, we syndicated or sold over $1 billion of commercial finance loans and leases across our commercial businesses, and we realized very good economics. That's better than the first quarter, when we did about 750 million. Syndication gives us flexibility; it helps us manage risk, minimize capital, and maximize cash flow. We've been talking to many of you over the last few months about this important initiative. An additional note on loan sales -- many of you ask me this. In home lending, we purchased and sold $800 million -- purchased 800 million, sold 800 million of home lending portfolios in the quarter, as we manage our portfolio to targeted demographics and credit criteria. Given our emphasis on expanding syndication and loan sale activity, we expanded our other revenues disclosure for you in our tables in our press release to help you track our progress. Income from these activities was over 60 million this quarter, up sequentially and up from a year ago. Credit quality Jeff mentioned remained excellent, or charge-offs were low at 35 basis points -- continue to have very strong recoveries as well. Delinquency and nonperforming increased about 20 basis points. Most of the commercial finance increase was in three accounts totaling $120 million, two in trade finance and one in corporate finance. These accounts are collateralized by receivables and inventory, generally, and we did place them on non-accrual as there is some shortfall in the collateral. Having said that, we did provide for these loans in our loss reserve. Consumer finance delinquencies increased due to portfolio [seizing] in both home lending and student lending, but both increases were in line with our expectations. Remember, the student loans are all U.S. government-guaranteed. It's important to note we increased our provision for credit losses 15 million from the first quarter and we provided 6 million more than charge-offs. The provision was 113% of charge-offs, reflecting the delinquency trends and loan growth. The reserve composition did shift a bit as we redesignated a certain portion of our hurricane reserves to our reserve for other specifically impaired loans.

FINAL TRANSCRIPT




Moving to operating expenses, they were up 22 million in the quarter. About 15 million -- two-thirds or so -- relates to the build-outs of sales and an even split roughly between commercial finance and specialty finance. What did we do in the quarter? We added to our syndication capabilities. I mentioned the progress we made there on the revenue side. We enhanced our vendor finance operations in Europe. Jeff mentioned we bought a German factoring company and established a European factoring platform. We invested in student loan marketing as the busy season so to speak approaches in the second half of the year. The remaining increases include technology investments in sales support platforms, and we did have a couple of million dollars of restructuring charge as we continue to refine the back office. What I'd like to do is walk you through a couple of businesses that Jeff mentioned earlier to give you an idea how these strategic build-outs are impacting our financial results. First, a couple of businesses in commercial finance where the build-out is substantially complete. Healthcare -- expenses were up $15 million from a year ago. This is year-to-date. And we doubled the sales force over that period. But revenues were up significantly more than that, over $40 million, and Jeff mentioned the portfolio has now grown to over $2 billion. We see a good balance of margin improvement and non spread revenues and the unit's efficiency ratio, which was well over 100% a year ago, is it about 40% today with more operating leverage to come. This is a classic execution of success executed by the healthcare finance team. Jeff mentioned communications in Media and Entertainment and the success we had there. We did build it out, year-over-year. Expenses increased 6 million or so. We grew the sales force by over a third. But revenues were up more than the expense increase, more than double the expense increase, and the efficiency ratio is now an excellent 23%. The revenue growth Jeff mentioned was broad-based. A lot of momentum continues, good pipeline, and I expect to see both good spread and fee opportunities in the second half. Investment banking services -- this is an area that we are in the early stages of the build-out in two ways. We added people in the quarter, and there are longer leadtimes for revenue success. We've only had a nominal amount of revenues from this initiative, and yet we've invested in the business over $10 million. We have a pipeline. We have fee mandates and we hope to report some good revenues for you in the second half of the year. Moving onto specialty finance, similar successes -- let's start with home lending. We added 90 new salespeople year-over-year and expenses increased by about 10 million but revenues increased by a significant multiple of that. Originations were up 29%, and the efficiency ratio improved in that business to the low 30% area. We have substantially completed our front-end build-out here and expect continued, strong returns in the second half, led by our strong leadership team in the home equity business. Student lending, another sales force productivity story. Jeff mentioned some of the numbers. I will mentioned that the originations in the important school channel doubled to $660 million in this year versus last, but efficiency was dampened somewhat in the first six months as we made two decisions -- invest heavily in marketing, as I mentioned earlier, before the busy season; and the duplicate expenses for servicing, bringing it in-house that we have going on. We expect a strong second half with improving efficiency from our investments. Vendor Finance -- significant strides beyond our Microsoft signing. We increased sales personnel by about 30% while only growing operating expenses minimally as we restructured the back office. While total volume is down and that is impacting revenues, that is principally due to lower Dell volumes in the U.S. Excluding Dell U.S. volumes, volume is up 21% and our international Dell volumes are also up nicely. Jeff gave you a sense of that momentum in his comments. I continue to see very strong front-end momentum, both in the U.S. and internationally, and an even more productive second half in the vendor finance business. So in summary, we are investing in the future and the growth of the business. In commercial finance, we are seeing larger deals, more deals, particularly in our industry areas of expertise. Healthcare and communications and media are strong cases for proof of concept of the build-out. We see particular strength in the rail and air releasing businesses, and in the advisory business, we are managing our investment through a period that takes a longer gestation period to get the fees. In specialty finance, strong home lending and consumer success, including student lending, and in technology finance, we are investing in building the largest independent technology leasing platform and the best-in-class vendor finance business in the world. We have diversified our customer base somewhat, and you saw that in some of the announcements we've made over the first six months. Support areas -- we've made additional investment in support areas -- sales support, branding, IT. And we see these investments as leverageable as the portfolio grows. More importantly, at least to me, we have better tools to measure the progress the businesses are making and correct the course when necessary.

FINAL TRANSCRIPT




Moving off of the operating expense line, move to income taxes. The quarter's effective tax rate was 31.4%. The rate includes a $4.5 million charge related to a tax law change, reducing prospective depreciation benefits on leveraged leases. You may have seen this from other registrants and companies. Excluding that charge, the effective tax rate was 30.2%. Remember, that's an after-tax number I gave you. Funding and capital -- we seek continued success at CIT Bank. We now have over 1.4 billion in deposits and are well ahead of our schedule toward our $2 billion year-end goal. Capital levels look healthy, tangible equity to managed assets at 9.5, 9.6%, and we have roughly 400 million of excess capital based upon our risk-adjusted approach. Summarizing the first-half earnings, core EPS is up 13%, 16% excluding options expensing. Year-to-date return on equity is 14.1%, 14.5 or so excluding options, up from 13.9% last year. So we think that's a solid progress on the bottom line, relative to our financial targets. With that, I will turn the call back to Jeff.


Thanks, Joe. In closing, I would just like to recap a few important points. We had a solid second quarter highlighted by strong volume growth and improving sales execution across each of our five business segments. CIT is clearly on the right path. We continue to build and invest for the future and are seeing the results, results which demonstrate the power of our franchise and our commitment to strong risk management, capital discipline, and client relationships. The bottom line is, as Joe just said, we have great momentum and the underlying business and economic trends are favorable. We continue to align our corporate functions to support the Company-wide sales efforts. Our employees understand the importance of this strategy, and we continue to drive accountability for results deeper into the organization. I want to personally thank our more than 7000 global employees for their hard work during the first half of the year. It is their commitment which enables us to continue to meet the global financing needs of our customers. Now, I'd like to open the call for questions. Q U E S T I O N A N D A N S W E R

Operator

(OPERATOR INSTRUCTIONS). Meredith Whitney, CIBC World Markets.

Meredith Whitney - CIBC World Markets - Analyst

Good morning. Jeff, my question is specifically to you. Your reputation as a leading banker is very well-known, and I think that it throws confusion into the market sometimes because, remember, last year, there were rumors that you were interested in buying Legg Mason, and with the announcement this morning with the Piper Jaffray alliance, I think that the stock is as weak as it is not because of the results in the quarter but because there's speculation that you're interested in buying Piper. So if you could clarify your intentions with Piper and then maybe elaborate on the relationship.


Sure, Meredith. I am happy to do that. That actually hadn't occurred to us. You know, we view Piper as a high-quality organization. Our alliance here is to try and -- we view it as an origination platform where we can meet some of the needs for their clients. You know, they also think that they can meet some of the needs for our clients. But it's clearly just an origination platform for both the companies and expanding their kind of

FINAL TRANSCRIPT




client reach, if you want. There's nothing more than that; there's no kind of cross-investment or anything like that, and we view Piper as a terrific firm. On the other hand, it's not exclusive, so I would really direct people to view this as just us extending our origination platform and for our products -- which for those that Piper doesn't have, you know, we get the benefit of close to 100 hard-working Piper bankers for senior loans and senior secured and that type of thing. I'd go farther than that and say that we really have no intention of buying a brokerage house or an investment bank or the like. You know, we're quite happy with the five operating businesses we have here, spending a lot of time on trying to make them more profitable and increase the sales force and manage the build-out and the operating expenses. So there's really certainly no intention or desire on my part to get into a trading business or an investment banking business, anything beyond what we actually have started. I think Joe gave you some of that on it. So, I would not read anything into that other than just it's a very high-quality extension of our origination platform.

Operator

Bob Napoli, Piper Jaffray.

Bob Napoli - Piper Jaffray - Analyst

Well, if it was on the rumor of buying paper, I think your stock would be up! (LAUGHTER). But anyway, just I think just one of my questions, Jeff and Joe, in looking at CIT over many years, if you look at it today, it's not what would have expected over a long time period. We are seeing very rapid growth, a lot of talk about sales efficiency, sales reps, and the expenses jumping up with it and then kind of peeking out a little bit in a really strong environment, some upticks in delinquencies and credit losses. So you know, I guess the big question is CIT has always been known, over at least as long as I've known them, over the last 20 years, as being a company that is not -- is absolutely the best in credit, maybe not the fastest-growing company. And you are kind of turning that culture somewhat here, Jeff, with your moves and I think some concerns on the credit side, and see how the sales culture meshes with the credit culture. So maybe if you could give a little bit of color on that battle or between sales and credit, and the tick-up we've seen this quarter in some of the larger loans in a good environment.


Sure, Bob, let me do that and I will make some comments and then I will just turn it over to Joe a little bit on -- since he's been here a little bit longer than I have, in terms of the credit culture and the numbers. You know, I think what we've been trying to do here is balance the historical culture of credit and Risk Management, which maybe got accentuated coming out of Tyco and with the difficult times in '02, just in the general economy, trying to get back to a balance where (indiscernible) Baltimore ravens of financial services, you know? So I think that we have added I think close to 300 salespeople over the last year, maybe a little more than that, between specialty and commercial. Now, we actually do have some metrics that we can talk to you about in terms of sales force productivity and how each of our salespeople is doing in salesforce.com and that type of thing, which I think kind of brings us into the 21st century of managing sales forces. So I think we are on the right path there, as I think both Joe and I tried to suggest. Most of our business units are pretty well built out in terms of either sales force headcount or upgrading of personnel. So, I think in the second half of the year, we see more of a leveling off of where we are, rather than a continued increase in operating expenses. Certainly while we try and build out the sales side of the house, we are in no way trying to undermine the credit and risk side of the house. We've spent several million dollars this year trying to upgrade our systems capabilities across our whole portfolio, so we've got much quicker access to single creditor concentrations and single borrower concentrations and that type of thing. I think some of the uptick -- I mean the charge-off number still was exceptional in our minds. I think, as Joe said, we had three kind of lumpy names in commercial finance that showed up on nonperforming. The delinquency -- you've really got to back out the student loan part of that because it's not predictive of any kind of loss on the assets; we are only making the federally guaranteed loans. With the bulk purchases we had four or five quarters ago in home lending, we expected to see this seasoning in delinquency. But our whole strategy here is to have a balanced house where our tenacity on risk and credit is balanced by what we're doing on the sales side. Joe?


FINAL TRANSCRIPT




Yes, I would be happy to add a perspective here, Bob. Thanks, Jeff. Two things -- first, thoughts on philosophy and people. You know me, Bob, and many of you do; I've been here 20 years. The person in the senior management group that's been here a lot longer than I have is Larry Marsiello, who runs the credit management side. I will say a few things -- one, think the credit Risk Management side is involved in a very significant way in all of our businesses in a much, much deeper way than ever before. That's Larry's leadership. Two, the tools that are being implemented for us to have early radar tracking systems are -- the tools are much better, the technology is much better, and visibility is much better on what's in the portfolio, and I credit the credit team throughout the Company, the statistical people who working on that throughout the Company. So third, I've got a credit the sales and the risk teams. We, as Jeff mentioned earlier, we've a lot of recent sales conference with a lot of our sales managers. Credit played a major role, a very active role and is tied at the hip in those conferences, so the salespeople know what the box is in terms of what credit can say yes to. So philosophically, I think that all is still here and stronger because I think the technology is better. But then I've got to talk about the numbers, because I think the numbers were pretty good. Stuff happens when you are in commercial finance, so we have three larger loans that we have to work out. You know what? That's what our credit guys do. The loans are collateralized; I said they were reserved, and they are not collateralized by less than 50%. They have significant collateral values against the exposures. These loans were not made in the last six months, either; these loans are tried and true businesses that go through cycles and hit bumps in the road as economies and businesses change. That's what we do. Then the last comment, in terms of numbers, Jeff mentioned little bit about this. We get a question on home lending. We mentioned seasoning. Just give you a couple metrics -- we did have a pretty good growth spurt in home lending in 2005. Generally, we don't buy nor book delinquent loans out of the box. They are current coming out of the box. So as we look at seasoning and as we look at delinquencies, delinquency, which our vendor finance credit people do with a lot of science, the last time we had the seasoning we have today, we actually had higher delinquencies. So our view of the static pool is the portfolio is performing better today than the last time we had the seasoning that we have now. So that's just a little of my feeling philosophically and numbers-wise, Bob. Thank you.

Operator

Bruce Harting, Lehman Brothers.

Bruce Harting - Lehman Brothers - Analyst

Thanks. Can you go through your net interest margin comments again, Joe, and just sort of tally those up and help me understand or reconcile sort of match funding versus what happened in the quarter? Is this just a function of your match funded out to, say, 9 to 12 months but not 3 to 6 months? Then am I just correct to just assume that the airplane -- you know, my airline analyst tells me that American had a plane that had something similar to what it sounds like you are describing, but this was just a one-off issue on a plane that was nearly fully depreciated and therefore why shouldn't I look at that as just part of your sort of 90 to 100 million of annual gains you take on equipment that comes off lease showing that you've sort of depreciated conservatively?


Thanks, Bruce. So I guess two revenue questions -- I'll take the margin one first. I'm going to just repeat what I said, so let me try to -- you know, margins were down about 15, 20 basis points sequentially. We expected some of that, and we talked about that in the first quarter because we had a very strong first quarter in terms of prepayment fees and receiving rents that were due to us that we had never received through bankruptcies in U.S. airlines. So just to give you a couple of things, yield-related fees, which come in sometimes in the margin and sometimes in fee income -- we had lower fees. That cost us 5 basis points in the margin. The fact that we had those back rents last quarter, that was about a 7 basis point factor. So that's about 12 of the 20. The other two factors are a function of the market and our business strategy, and our funding strategy. We match funds. The businesses have no gaps in their profitability. We track that in separately under a very talented treasury team led by Glenn Votek.

FINAL TRANSCRIPT




We do have some sensitivity. We think it's prudent to plan for a positively shaped yield curve, and we consistently fund the Company the same way. I've been here over 20 years. It's never changed. The business mix, because we have more student loans at a lower spread, is about a 3 point basis point factor. The debt lengthening that we did, which we think is prudent and is going to pay dividends in the out years, and the rising short-term interest rates that Jeff spoke about in terms of what has happened in the past and what may or may not happen in the future, that was about 3. So when you add it all up, 5 in yield related fees, 7 in back rents, 3 in mix and 3 in interest rates. So it's not a lot of compression from the yield curve. That's most of the 20. Now, the other question you had, Bruce, relates to our Aerospace business. We had a casualty loss, and there were no human casualties in this, so I want to make sure that's on the record. But we are in the business. This is an asset-management business, our Aerospace business. It's a risk-management business. I think when you look at -- I think, in part of your question, I think you have to the right comment. We have to manage a lot of risks, and when we look at this, we say two things. One, we have cash proceeds in excess of our book value, which means -- it should mean to you -- it means to us, the accountants here, that we have an adequate and conservative depreciation policy. Secondly, we have to cover other risks because this is an earning asset for the Company; we have a revenue stream out under a lease, and there are other terms of the lease. We need to protect those revenues. So the Company lost the asset. We have insurance to protect not only the asset value but the revenue stream. That's why we had the gain that we had, and that's part of the business. As you know, Bruce -- I think you mentioned it in your numbers -- we actively manage, buy and sell aircraft every quarter. This quarter, unfortunately, we didn't have to go actively sell one because one actively had in essence got cash down on us. So, it's part of the business, and I think you should take some comfort that we manage the risk and the finances very well. So hopefully that was responsive to your question.

Bruce Harting - Lehman Brothers - Analyst

Yes, thank you.

Operator

David Hochstim, Bear Stearns.

David Hochstim - Bear Stearns - Analyst

Yes, hi. Just following up on that -- so the aircraft that you've lost -- would it be appropriate to think that that $16.5 million was kind of an accelerated recognition of future lease payments you would have received?


Well, yes and no. I mean, it's future revenues we would have received either through an early termination of the lease, lease payments, etc. So it could come in in a variety of ways.


Then sort of another clarification question I head was just could you give us some sense of how much headcount could be rising over the balance of the year? I think Jeff made a comment that expense growth would be somewhat more muted. But is headcount going to continue to rise at the same rate we've seen?


Yes, David. I feel like, as we've said, many of our business units, such as home lending, have completed their build-out; others are close. You know, I would think that -- I would think, from here to the end of the year, in terms of headcount and in terms of operating expenses, I would

FINAL TRANSCRIPT




think you will see a plateau-ing, so you should not see the level of increase that you're seeing just because I would say 80, 85% of our sales build-out, certainly for this year, is completed.


Great. That would be welcome. Thanks.

Operator

Laura Kaster, Sandler O'Neill.

Laura Kaster - Sandler O'Neill - Analyst

Yes, most of my questions have been asked, but one question I have regarding the sales force build-out -- how do you responded to the concern that you guys are building out your sales force (indiscernible) of the market -- you know, we had very long, very good C&I growth year-to-date, and what happens if we have a market downturn and you are faced with a possible overcapacity?


Well, we thought about that a little bit, Laura. One of the things would be the diversity of the portfolio. I think also some of the areas where you've seen the greatest headcount increase would be in areas like student lending, mortgage lending where we are still a relatively small player. So, we have felt like we've been relatively prudent in these build-outs and really, in some cases, they needed to take us to a point where we started to have some critical mass.

Laura Kaster - Sandler O'Neill - Analyst

Okay, thank you.

Operator

Moshe Orenbuch, Credit Suisse.

Moshe Orenbuch - Credit Suisse First Boston - Analyst

Just maybe help me to flush out kind of some points that have been partially addressed so far. I guess as your revenue mix shifts a little more towards fee income from spread income, I mean, I guess first of all, do you expect that to continue into the back half of this year and into '07? Shouldn't that in effect have a more beneficial effect on the efficiency ratio? And kind of when would you expect to see that efficiency ratio turn?


Well, I think I'll take the first part and I will leave it to Joe, my expert on efficiency ratios. But I think, clearly, Moshe, we think the non-spread, the fee revenue, the fee generation is going to continue. I mean, speaking about the pipeline in the third quarter, we probably have half a dozen large credit syndications that we are in the process of doing where we can see we're going to have relatively large syndication fees coming out of that. As we've built some of these advisory businesses, that has been the intent -- was to try and give us people who could help us generate these larger more fee-intensive transactions. We feel good about where we are on that and certainly just having several real estate advisory people has helped us terrifically on some transactions that we've done here in the last month or so where we never had that real estate advisory before.


FINAL TRANSCRIPT




I think, Moshe, the basic assumption or implication of your question, hypothesis, is a correct one. I think about it a little bit differently. As we think about building out our syndication capabilities, I mentioned some of the things that we think we benefit by. In terms of efficiency, where we focus is a more efficient use of capital and balance sheet. So that I think, to be direct in the answer to you, if we originate a loan holder over three years, we look at the revenues over three years. If we syndicate it, we can increase the revenues in the front year, so that would help the first-year efficiency ratio. But we think about it a little bit beyond that in terms of reaching out into the marketplace with others who may have a higher risk appetite or a lower cost of capital and better leverage our overall efficiency of our sales platform. So not only do we get capital efficiency by using others' balance sheet, not ours, we also think we can leverage the sales force life, producing more loans the may or may not meet our risk and return profile. So I think, over time, the answer to your specific question is yes, but add in capital efficiency to the answer as well. Anything else, Moshe?


I guess I was just wondering if it's something that, given the plans that you mentioned for diminished expense growth in the second half, whether we would actually see that ratio.


You know, we have not given guidance on efficiency ratios. Having said that, you know, it's algebraic, so as we anticipate a slowing expense ratio and what we are driving for is higher revenue growth out of our investments that we've made, and Jeff and I both talked about those investments in slightly different ways, that is our game plan to improve the overall operating efficiency of the Company.


Thanks.

Operator

Chris Brendler, Stifel, Nicolaus.

Chris Brendler - Stifel, Nicolaus - Analyst

Thanks, good morning. Joe, if you could give us a little more color if possible on the credit front? First, you mentioned the fact that the increase in the consumer business was either student lending or home lending seasoning. The split between those two is about 50-50. Is there any one particular part of that segment increasing -- the delinquencies are increasing faster than the other? Just relative to your expectations, across the Company, (indiscernible) credit monitoring practices you mentioned earlier, are you seeing any inflection point in terms of credit quality, or are these trade finance credits just more one-off in your view and we still should be pretty confident about credit? I was surprised to see the reserve as a percentage of receivables actually fell a little bit in the quarter, given what your comment on delinquency. Help me think about that.


Sure. Let me take the last part first. The way we look at reserves -- because we've spent some time in our discussion and some time in the press release talking about this -- when we look at our reserves, we are looking at it without the student lending piece. I think, if you look at it that way, the reserve ratio was essentially flat in percentages, quarter-to-quarter. That's number one. Number two, the consumer finance piece of your question -- clearly the student -- both portfolios performed within our expectations, and I will give you some color on each. On the student lending side, obviously there's normal seasoning of the portfolio, which you are familiar with, but there's another dynamic in a student lending portfolio is when the students get out of school, then they really owe the money, so you have a contractual payment, a contractual date, and therefore an ability to have a contractual delinquency. So having said that, that's within our expectation and clearly it's all U.S. government-guaranteed, so at the end of the day, it's not factored into our loss reserve.

FINAL TRANSCRIPT




On home lending, I will give you a little bit more color than I gave you earlier. It's within our expectation. We're still driving to the same demographics. The FICO score is still in the 635 to 640 area. One update is we did update our appraisal value versus our original LTV. Remember, it was 81% on our way in. A year or so ago, we said it was in the low 70% LTV area. Now, we think our LTV is below 70%. So we've gotten more (indiscernible) more collateral protection. On the delinquencies, delinquencies in the home lending portfolio were a little over 3.35% or so, if my recollection is right. The last time we had the level of seasoning we have, which was two years ago, the delinquencies were over 3.5%. So, that's why it's performing within and slightly better than our expectations. In terms of the commercial finance side, you know, we don't see -- there's no overall systemic weaknesses in the portfolio industry-wide or geographic-wide. You know, three loans I mentioned earlier as I said were not made in the last six months. Two of them go back to the 1990s, and that's just what happens in commercial lending. Business models work for awhile and then they have cash flow problems and then they don't work, either through competitive management or other reasons. So we don't see anything systemic, Chris, in the portfolio, and those three loans I'm very comfortable -- Larry and I speak about these a lot, and we are very comfortable with the provisioning we've made. The collateral value here is significant. It's not 50%; it's not 70%; it's more than that in terms of the collateral protection we have here. Having said that, we think we've provisioned them correctly in our loan loss reserve analysis. Hopefully, I got all the pieces of your question there.

Chris Brendler - Stifel, Nicolaus - Analyst

Just maybe on the forward-looking indicators, before you get to delinquency or watchlist, has that changed materially in the last couple of quarters, or are you still seeing pretty good performance?


No, I think we are still seeing pretty good performance. I don't think we're seeing 35 basis points of loss kind of performance. We think the number we printed was outstanding, and I know we've spent a lot of time talking about three individual loans, but 35 basis points in losses this quarter was outstanding. We think it will go somewhat higher from there but nothing that other than those three loans we've talked about, that stick out in our analysis (indiscernible) big second half issues. We continue to see potential for recoveries. Remember, you know, we had a lot of charge-offs in the weaker periods of 2001/2002/2003, so we had 21 basis points of recovery this quarter, and we thought that was pretty healthy. We continue to see opportunities with the collection efforts that we have and the credit people working these loans hard that we can continue to have a decent level of recovery.

Operator

Howard Shapiro, KBW Asset Management.


Howard?

Howard Shapiro - KBW Asset Management - Analyst

Good morning. Is the 12 basis points of margin compression due to decline in fee income? Should we consider that permanent or is that somewhat volatile on a quarter-to-quarter time period to time period basis?


Well, in the first quarter, we mentioned it was very robust. I think that was higher than the average. I think, this quarter, we had very good fee income in the fee income line and very little other fees that we get into the margin line, so I don't know. I can't tell you 12 is permanently gone,

FINAL TRANSCRIPT




because we would expect to get more yield-related fees and prepayment fees as we go forward, but the first quarter had a relatively robust level, so somewhere in between if you pushed me on a number.


Okay, so it's not unreasonable to assume some kind of margin improvement in the second half of the year?


Yes, well, on that, for that, right? We have to see what the Fed does, what our mix does. we had other factors in the quarter, which were business mix and the shape and the extent of the tightening on the front end by the Fed. Everything else being equal, that would be the 6 basis points or so, but nothing is ever equal. Our margins -- Howard, if you've listened to us over time or listened to me, our margin has a lot of dynamics, whether it's mix, yield curve, our funding strategy, the maturities we have in the second half of the year. On the debt maturities, I normally cover this and I did not. Most of the refinancings of debt we have in the second half of the year are floating rate, so we don't expect a big lift from that in the second half of '06. But in '07, we have some relatively expensive debt maturing in the first half of '07, so that's just more of a 12-month look for you.


Can you just remind us your assumptions for the Fed for the yield curve?


I don't think we've given them out, but I think the Fed has done a good job of burning through what we thought they were going to do when we entered the plan in November. But we don't have a lot of rate sensitivity to the Fed. As I mentioned before, in the quarter sequentially, it was about 3 basis points and I think in the first quarter, it was 2 or 3 as well, so it's in that magnitude of low single digits (multiple speakers).

Operator

Joel Houck, Wachovia Securities.

Joel Houck - Wachovia Securities - Analyst

Jeff, I just want to go back to your comment about transforming the Company from a middle market lender to adviser. What does that mean in your mind, in terms of where -- I know Moshe asked about the direction of fee income, but when you think about it strategically, does that mean 50% fee income at some point? That sounds like a pretty strong comment just to hear you talk about it in the call.


Well, two things, Joel -- first, we got the 41% this quarter, right? You know, we had several relatively sizable fees that we couldn't get into the quarter just because the deal didn't close, but that's the way it is every quarter. So I certainly think it will go higher than -- as a percentage of our revenue, I think it will go higher than 41. I think all of the -- all of us and the Office of the Chairman here could just see the momentum building in terms of the larger deals that the guys are bringing in that have more fee potential. The other thing is I think you have to put that comment in perspective, all right? I mean, that largely pertains to our corporate finance business. You know, I wouldn't read too much -- that comment would not really change trade finance or transportation or our vendor businesses dramatically. So you know, I think that when you hear something like that, it basically applies to our middle market lending business. But I certainly think we can get higher than 41%. I think everybody internally here feels that pretty strongly.

Joel Houck - Wachovia Securities - Analyst

FINAL TRANSCRIPT




Okay, that's helpful. Thanks, Jeff.

Operator

Eric Wasserstrom, UBS.

Eric Wasserstrom - UBS Warburg - Analyst

Thanks. You know, I was looking at the ROEs of the different business lines. With respect to the consumer, it seems like that portfolio is hovering around about 12%. I was wondering, Joe, if you can just help me understand -- recognizing that there might be a little bit of leverage opportunity on the student loan portfolio, as losses continue to move higher then, let's say, the current level on the home equity side, how does that get to the 15% threshold?


Sure. The ROE in the consumer area, just to refresh everyone's memory in terms of what we do, all of the goodwill that was generated in the student loan acquisition is financed with equity, and that's dilutive to the ROE there. That's one thing you have got to keep in mind. Secondly, in the second quarter as I mentioned before, we took the revenues, the revenue growth that we are seeing basically in the first half of the year in student lending and invested it in marketing and we are expecting a relatively profitable on a return basis second half in student lending, so that will lift this higher. On the home lending side, the losses are -- have been in the 80 to 90 basis point area. If we see a significant decline in consumer payment habits, which we have not, our modeling does not indicate a significant increase in the home lending losses for a few reasons. One, I mentioned the collateral. Two, our modeling indicates that the predictor of increased losses in the home lending portfolio has to do with unemployment, not necessarily with home values. The base we have of customers, which this is how we have been managing it for years as I think you know, is nine years in residence and nine years in job. We think we have a pretty stable customer. We still think we have leverage opportunities in the home lending business to get more efficient -- in the efficiency ratio, even though it's in the low 30s, as I mentioned before. So we still see a significant way of improving the consumer profitability (indiscernible) student lending will need to have and we expect it to have a very strong second half of the year.


So would it be fair to say that most of the improvement then is really going to come from the student side as opposed to the home equity side?


Well, on a percentage basis, yes, because home lending -- and home lending is more -- that's why we like the business, a little bit more of an actuarial performer, you know, what you have this quarter is not going to change significantly from the second quarter. In student lending, it's a little different dynamic because of the relative newness of the company to us and secondly, the strategic investments we've made in building out the sales force and the marketing.


Great, thanks very much.

Operator

David Chiaverini, [BMO] Capital Markets.

FINAL TRANSCRIPT




David Chiaverini - [BMO] Capital Markets - Analyst

Thanks. I was curious as to what the cost of the 1.4 billion in deposits was and how that compares to your other sources of funding.


On average, the deposits are about two years, I think just shy of two years. While we weren't expecting, counting on and doing the deposits raising for cost-saving reasons, we think our modeling shows it's about 20 basis points or so, maybe up to 25 basis points cheaper, lower in cost to raise the deposits than in an unsecured public market (indiscernible) institutional markets capital rate. So not only are we getting the liquidity, not only are we getting the diversification of funding, but we are saving about 20 to 25 basis points on a two-year average funding.


Okay. Then the student lending business, is that 100% government guaranteed, or do you have to absorb the first loss of 2% or so?


A couple of thoughts on that -- one, we do originate some unguaranteed loans but we are selling that all out. The guarantee we have -- so the remainder of the portfolio is guaranteed by the U.S. government at the level of 98%, I believe.


Yes.


I think it's all at 98.


You absorb the first 2% loss and then the rest is to government taking that?


On an individual loan, right.


Okay. All right, thanks.


Are there any more callers, operator?

Operator

Yes ma'am. We do have a final question from the line of Stephen Schulz.

FINAL TRANSCRIPT




Stephen Schulz - Keefe Bruyette Woods - Analyst

Thanks for taking the question. Just a quick follow-up to the question on the ROE -- I was curious if, with the kind of expected improvement in the student loan ROE in the second half, whether you would expect the overall ROE to get up to kind of your targeted 15%, just seeing as how it's been hovering around 14% here in the first half.


That's what we would like to do. You know, our discipline is risk-adjust the capital allocation, and each business needs to achieve at least a 15% risk-adjusted return on that capital. So our expectation is for home lending to continue to improve returns, and as I mentioned before, Student Loan Xpress, student lending to improve returns to the consumer finance businesses operating at or above that threshold.

Stephen Schulz - Keefe Bruyette Woods - Analyst

Thanks a lot and thank you, by the way, for adding the disclosure on the syndication fees (inaudible) gains in the detailed release.


Thank you.


Well, thank you very much for joining us today. If any of you have any follow-up questions, please call any member of the IR department. We are around all day. Thanks very much and we will talk to you soon. Bye-bye.

Operator

This concludes today's conference call. You may now disconnect.

D I S C L A I M E R Thomson Financial reserves the right to make changes to documents, content, or other information on this web site without obligation to notify any person of such changes. In the conference calls upon which Event Transcripts are based, companies may make projections or other forward-looking statements regarding a variety of items. Such forward-looking statements are based upon current expectations and involve risks and uncertainties. Actual results may differ materially from those stated in any forward-looking statement based on a number of important factors and risks, which are more specifically identified in the companies' most recent SEC filings. Although the companies mayindicate and believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate or incorrect and, therefore, there can be no assurance that the results contemplated in the forward-looking statements will be realized. THE INFORMATION CONTAINED IN EVENT TRANSCRIPTS IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES THOMSON FINANCIAL OR THE APPLICABLE COMPANY OR THE APPLICABLE COMPANY ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY EVENT TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. © 2005, Thomson StreetEvents All Rights Reserved.

cit 2006%20q2

Economy & Finance

Transcript of cit 2006%20q2