CIT Group Inc 10-K 2010
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Commission File Number: 001-31369
CIT GROUP INC.
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g)
of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes |X| No | |
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes | | No |X|
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No | |
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this Chapter) is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. | |
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (check one) Large accelerated filer |X| Accelerated filer | | Non-accelerated filer | | Smaller reporting company | |
At February 26, 2010, there were 200,035,561 shares of CITs common stock, par value $0.01 per share, outstanding.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes | | No |X|
The aggregate market value of voting common stock held by non-affiliates of the registrant, based on the New York Stock Exchange Composite Transaction closing price of Common Stock ($2.15 per share, 392,067,503 shares of common stock outstanding), which occurred on June 30, 2009, was $842,945,475. For purposes of this computation, all officers and directors of the registrant are deemed to be affiliates. Such determination shall not be deemed an admission that such officers and directors are, in fact, affiliates of the registrant. Our Common Stock was subsequently cancelled pursuant to the plan of reorganization on December 10, 2009. The approximate aggregate market value of the new voting stock held by non-affiliates on February 26, 2010 was $7,287,295,487.
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.
Yes |X| No | |
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrants definitive proxy statement relating to the 2010 Annual Meeting of Stockholders are incorporated by reference into Part III hereof to the extent described herein.
Item 1. Business Overview
Founded in 1908, CIT Group Inc., a Delaware Corporation, is a bank holding company, that together with its owned subsidiaries, (collectively we, CIT or the Company), provides primarily commercial financing and leasing products and other services to small and middle market businesses across a wide variety of industries. The Company became a bank holding company (BHC) in December 2008, and is regulated by the Board of Governors of the Federal Reserve System (FRS) under the U.S. Bank Holding Company Act of 1956 (BHC Act). CIT operates primarily in North America, with locations in Europe, Latin America and the Asia-Pacific region.
We provide financing and leasing capital to our clients and their customers in over 30 industries and 50 countries. Our businesses focus is primarily on commercial clients with a particular emphasis on small business and middle-market companies. We serve clients in a variety of industries including transportation, particularly aerospace and rail, manufacturing, retailing, healthcare, communications, media and entertainment, energy, and various service-related industries. We are a leader in small business lending. We funded $7.0 billion of new business volume during 2009.
Each business has industry alignment and focuses on specific sectors, products and markets, with portfolios diversified by client and geography. Our principal product and service offerings include:
We source transactions through direct marketing efforts to borrowers, lessees, manufacturers, vendors and distributors, and to end-users through referral sources and other intermediaries. Our business units work together both in referring transactions between units and by combining products and services to meet our customers needs. We also buy and sell participations in syndications of finance receivables and lines of credit and periodically purchase and sell finance receivables on a whole-loan basis.
We set underwriting standards for each business unit and employ portfolio risk management models to achieve desired portfolio demographics. Our collection and servicing operations are centralized across businesses and geographies providing efficient client interfaces and uniform customer experiences.
We generate revenue by earning interest on loans we hold on our balance sheet, collecting rentals on equipment we lease, and earning fee and other income for financial services we provide. We syndicate and sell certain finance receivables and equipment to leverage our origination capabilities, reduce concentrations, manage our balance sheet and maintain liquidity.
As a bank holding company, we have bank and non-bank subsidiaries. CIT Bank, a state chartered bank located in Salt Lake City, Utah, is the Companys primary bank subsidiary. CIT Bank is subject to regulation and examination by the Federal Deposit Insurance Corporation (FDIC) and the Utah Department of Financial Institutions (UDFI). Non-bank subsidiaries, both in the U.S. and abroad, currently own the majority of the Companys assets. As a BHC, we are prohibited from certain business activities including certain real estate investment and equity investment activities, and will exit these within a specified period.
Our funding model is in transition. We historically funded our businesses with unsecured debt and, to a lesser extent, securitizations. However, in 2007 and 2008, the disruption in the global credit markets restricted our access to economic funding via these mediums. Accordingly, we embarked on a strategy to bolster our funding model by becoming a BHC. While we became a BHC in December 2008, we were unable to realize some of the benefits we hoped to achieve.
Failure to obtain these benefits, coupled with accelerating client credit line draw activity, deteriorating portfolio performance and debt rating downgrades, exacerbated our already strained liquidity situation and culminated with the parent company (CIT Group Inc.) and one non-operating subsidiary, CIT Group Funding Company of Delaware LLC (Delaware Funding), filing prepackaged voluntary petitions for relief under Chapter 11 of the U.S. Bankruptcy Code (the Bankruptcy Code) in the U.S. Bankruptcy Court for the Southern District of New York on November 1, 2009. We emerged from bankruptcy on December 10, 2009.
The restructuring strengthened our liquidity and capital. Debt levels were reduced by approximately $10.4 billion, and principal repayments on $23.2 billion of new second lien notes do not start until 2013, relieving near-term funding stress. In accordance with accounting standards for companies that have emerged from bankruptcy (sometimes called fresh start accounting), our balance sheet at December 31, 2009 reflects our assets and liabilities at fair value, and a new equity value was established. All old common stock and preferred stock were cancelled, and 200 million shares of new common stock were issued to eligible debt holders. With our improved liquidity and capital levels, we are working on our business plan and strategy under which we expect to transition to a smaller company focused on serving small- and mid-sized commercial businesses. In addition, we are building a new senior management team, including a new Chairman and CEO, who was hired in February 2010. As a result of these developments, our business, financial condition, and strategy changed significantly, and the information contained in this annual report about CIT following our emergence from bankruptcy, including the financial statements and other information for the year ended December 31, 2009, which reflects fresh start accounting, is not necessarily comparable with information provided for prior periods.
Further discussion of these events and resultant financial statement impacts are located in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations (Introduction) and Item 8. Financial Statements and Supplementary Data (Notes 1 and 2).
CIT meets customer financing needs through five business segments.
Corporate Finance provides a full spectrum of financing alternatives to borrowers, small business and middle market businesses. The Corporate Finance product suite is primarily composed of senior secured loans including revolving lines of credit secured by accounts receivables and inventories, term loans based on operating cash flow and enterprise valuation, and government guaranteed loans (such as SBA loans). Our clients use loan proceeds to fund working capital, asset growth, acquisitions and debt restructurings. We earn interest revenue on the receivables we keep on-balance sheet and seek to recognize economic value on receivables sold.
Corporate Finance has developed industry expertise over many years in the business in order to focus on specific segments within:
We also have one specialized unit:
Transportation Finance specializes in providing customized leasing and secured financing primarily to end-users of aircraft and railcars. Our transportation equipment financing products include operating leases, single investor leases, equity portions of leveraged leases and sale and leaseback arrangements, as well as loans secured by equipment. Our equipment financing clients represent major and regional airlines worldwide, North American railroad companies, and middle-market to larger-sized aerospace and defense companies.
This segment has seasoned management teams servicing the aerospace and rail industries, and in the case of aerospace, has built a global presence with operations in the US, Canada, Europe and Asia. We have extensive experience in managing equipment over its full life cycle, including purchasing new equipment, estimating residual values and remarketing by re-leasing or selling equipment.
See Concentrations section of Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 20 Commitments of Item 8. Financial Statements and Supplementary Data for further discussion of our aerospace portfolio.
Trade Finance provides factoring, receivable and collection management products, and secured financing to our clients, primarily manufacturers, importers and distributors of apparel, textile, furniture, home furnishings and consumer electronics. Although primarily U.S.-based, we also conduct business in Asia, Latin America and Europe.
We offer a full range of domestic and international customized credit protection, lending and outsourcing services that include working capital and term loans, factoring, receivable management outsourcing, bulk purchases of accounts receivable, import and export financing and letter of credit programs.
We typically provide financing to our clients through the purchase of accounts receivable owed to our clients by their customers, typically retailers. We also arrange for letters of credit, collateralized by accounts receivable and other assets, to be opened for the benefit of clients suppliers. The assignment of accounts receivable by the client to a factor is traditionally known as factoring and results in payment by the client of a factoring fee that is commensurate with the underlying degree of credit risk and recourse, and which is generally a percentage of the factored receivables or sales volume. We may advance funds to our clients, typically in an amount up to 80% of eligible accounts receivable, charging interest on the advance (in addition to any factoring fees), and satisfying the advance by the collection of factored accounts receivable. We integrate our clients operating systems with ours to facilitate the factoring relationship.
Clients use our products and services for various purposes including, improving cash flow, mitigating or reducing credit risk, increasing sales, and improving management information. Our clients can outsource their bookkeeping, collection, and other receivable processing with us.
Vendor Finance partners with manufacturers and distributors to deliver financial solutions globally to end-user customers to facilitate the acquisition of our vendor partners products. We focus primarily on information technology, telecommunications and office equipment markets, but we serve other diversified industries as well.
Our vendor relationships include traditional vendor finance programs, joint ventures, virtual joint ventures and referral agreements that have varying degrees of integration with vendor partners. In the case of joint ventures, we engage in financing activities with the vendor through a distinct legal entity that is jointly owned by the vendor and us. We also use virtual joint ventures, in which we originate assets on our balance sheet and share with the vendor economic outcomes from the financing. A key part of these partnership programs is integrating with their go-to-market strategy and leveraging the vendor partners sales process, thereby maximizing efficiency and effectiveness.
These alliances allow our vendor partners to focus on core competencies, reduce capital needs and drive incremental sales volume. We offer our partners (1) financing to end-user customers for purchase or lease of products, (2) enhanced sales tools such as asset management services, loan processing and real-time credit adjudication, and (3) a single point of contact in regional servicing hubs to facilitate global sales. These alliances provide us with an efficient origination platform as we leverage our vendor partners sales forces.
Vendor Finance end-user customers are predominately small to Fortune 1000 companies acquiring office, technology and telecommunications equipment in more than 30 countries.
Our Consumer segment includes our student loan portfolio, currently in run-off, and receivables from other consumer lending activities that were originated by CIT Bank. These receivables are collected in accordance with their contractual terms. We ceased offering private student loans during 2007 and government-guaranteed student loans in 2008.
See Concentrations section of Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for further discussion of our student lending portfolios.
CORPORATE AND OTHER
Certain expenses are not allocated to operating segments and are included in Corporate and Other, and consist primarily of the following: (1) certain funding and liquidity costs, as segment results reflect debt transfer pricing that matches assets (as of the origination date) with liabilities from an interest rate and maturity perspective; (2) provisions for severance and facilities exit activities; (3) certain tax provisions and benefits; (4) a portion of credit loss provisioning in excess of amounts recorded in the segments, primarily reflecting our qualitative determination of estimation risk; (5) dividends that were paid on preferred securities (now cancelled), as segment risk adjusted returns are based on the allocation of common equity; and (6) reorganization adjustments largely related to debt relief in bankruptcy.
CIT Bank is a fully chartered state bank located in Salt Lake City, Utah. It is subject to regulation and examination by the FDIC and the UDFI. In April 2009, the Federal Reserve granted the Company a waiver under Section 23A to transfer $5.7 billion of government guaranteed student loans to CIT Bank. In connection with this transaction, CIT Bank assumed $3.5 billion in debt and paid $1.6 billion in cash to CIT. For the purpose of reporting CITs consolidated balance sheet and segment information, assets and liabilities that are reported by the bank, are included in the originating segment. The student loans transferred to the bank and commercial loans funded by the bank are reported in the Consumer and Corporate Finance segments, respectively. Currently, the bank raises deposits by issuing deposits through broker channels.
CIT employed 4,293 people at December 31, 2009, of which 3,067 were employed in the U.S. and 1,226 outside the U.S.
Our markets are competitive, based on factors that vary with product, customer, and geographic region. Our competitors include captive finance companies, global and domestic commercial and investment banks, community banks and leasing companies. Many of our larger competitors compete with us globally. In most of our business segments, we have a few large competitors with significant penetration and many smaller niche ones.
Many of our domestic and global competitors are large companies with substantial financial, technological, and marketing resources. Most of our competitors currently have a lower cost of funds. We compete primarily on the basis of financing terms, structure, client service and price. From time to time, our competitors seek to compete aggressively and we may lose market share to the extent we are unwilling to match competitor product structure, pricing or terms that do not meet our credit standards or return requirements.
There has been substantial consolidation and convergence among companies in the financial services industry. This trend accelerated over the course of the past two years as the credit crisis and economic dislocation caused numerous mergers and asset acquisitions among industry participants. The trend toward consolidation and convergence significantly increased the geographic reach of some of our competitors and hastened the globalization of the financial services markets. To take advantage of some of our most significant international challenges and opportunities, we will have to compete successfully with financial institutions that are larger and better capitalized and that may have a stronger local presence and longer operating history outside the U.S.
Other competitive factors include industry experience, asset and equipment knowledge, and strong relationships. The regulatory environment in which we and/or our customers operate also affects our competitive position.
CIT Group Inc. is a bank holding company subject to regulation and examination by the Board of Governors of the Federal Reserve Board (FRB) under the Bank Holding Company (BHC) Act. CIT Bank is chartered as a state bank by the Department of Financial Institutions of the State of Utah (UDFI). CIT Group Inc.s principal regulator is the Federal Reserve and CIT Banks principal regulators are the FDIC and the UDFI.
Certain of our subsidiaries are subject to regulation from various agencies. Student Loan Xpress, Inc., a Delaware corporation, conducts its business through various third party banks authorized by the Department of Education, including Fifth Third Bank, Manufacturers and Traders Trust Company and Liberty Bank, as eligible lender trustees. CIT Small Business Lending Corporation, a Delaware corporation, is licensed by and subject to regulation and examination by the U.S. Small Business Administration. CIT Capital Securities L.L.C., a Delaware limited liability company, is a broker-dealer licensed by the National Association of Securities Dealers, and is subject to regulation by the Financial Industry Regulatory Authority and the Securities and Exchange Commission (SEC). CIT Bank Limited, an English corporation, is licensed as a bank and broker-dealer and is subject to regulation and examination by the Financial Services Authority of the United Kingdom.
Our insurance operations are conducted through The Equipment Insurance Company, a Vermont corporation; CIT Insurance Agency, Inc., a Delaware corporation; and Equipment Protection Services (Europe) Limited, an Irish company. Each company is licensed to enter into insurance contracts and is subject to regulation and examination by insurance regulators. We have various banking corporations in Brazil, France, Germany, Italy, and Sweden, and a broker-dealer entity in Canada, each of which is subject to regulation and examination by banking and securities regulators.
Cease and Desist Orders and Written Agreement
On July 16, 2009, the FDIC and UDFI each issued a Cease and Desist Order to CIT Bank (together, the Orders) in connection with the diminished liquidity of Predecessor CIT. CIT Bank, without admitting or denying any allegations made by the FDIC and UDFI, consented and agreed to the issuance of the Orders.
Each of the Orders directs CIT Bank to take certain affirmative actions, including among other things ensuring that it does not allow any extension of credit to CIT or any other affiliate of CIT Bank or engage in any covered transaction, declare or pay any dividends or other payments representing reductions in capital, or increase the amount of Brokered Deposits above the $5.527 billion outstanding at July 16, 2009, without the prior written consent of the FDIC and the UDFI. Since the receipt of the Orders, the Company chose to limit new corporate loan originations by CIT Bank. On August 14, 2009, CIT Bank provided to the FDIC and the UDFI a contingency plan that ensures the continuous and satisfactory servicing of Bank loans if CIT is unable to perform such servicing.
On August 12, 2009, CIT entered into a Written Agreement with the Federal Reserve Bank of New York (the FRBNY). The Written Agreement requires regular reporting to the FRBNY, the submission of plans related to corporate governance, credit risk management, capital, liquidity and funds management, the Companys business and the review and revision, as appropriate, of the Companys consolidated allowances for loan and lease losses methodology. CIT must obtain prior written approval by the FRBNY for payment of dividends and distributions, incurrence of debt, other than in the ordinary course of business, and the purchase or redemption of stock. The Written Agreement also requires notifying the FRBNY prior to the appointment of
new directors or senior executive officers, and places restrictions on indemnification and severance payments. Each of the new directors that were appointed by the Board of Directors subsequent to our emergence from bankruptcy and the appointment of John A. Thain, our new Chairman and CEO were reviewed with the FRBNY.
Pursuant to the Written Agreement, the Board of Directors appointed a Special Compliance Committee of the Board to monitor and coordinate compliance with the Written Agreement. We submitted a capital plan and a liquidity plan on August 27, 2009, and a credit risk management plan on October 8, 2009, as required by the Written Agreement. We prepared and submitted our corporate governance plan and business plan on October 26, 2009. Following emergence from bankruptcy, our liquidity, governance and credit risk management plans were updated and submitted to the FRBNY on January 29, 2010. The Company is continuing to provide periodic reports to the FRBNY as required by the Written Agreement.
Banking Supervision and Regulation
We and our wholly-owned banking subsidiary, CIT Bank, like other bank holding companies and banks, are highly regulated at the federal and state levels. As a bank holding company, the BHC Act restricts our activities to banking and activities closely related to banking. The BHC Act grants a new bank holding company, like CIT, two years to comply with activity restrictions. Under the Gramm-Leach-Bliley Act of 1999 (GLB), the activities of a BHC are restricted to those activities that were deemed permissible by the Federal Reserve at the time the GLB Act was passed. The vast majority of our activities are permissible. However, a limited number of our existing activities and assets must be divested or terminated by December 22, 2010, (unless the FRB extends the two-year period for compliance), comprised primarily of a limited number of equity investments and certain real estate investment activities, for which new investments were discontinued.
CIT is subject to supervision and examination by the FRB. Under the system of functional regulation established under the BHC Act, the FRB supervises CIT, including all of its non-bank subsidiaries, as an umbrella regulator of the consolidated organization. In addition, CIT Bank is subject to regulation by the FDIC and the UDFI and some of our non-depository subsidiaries are subject to regulation by other U.S. regulators. Such functionally regulated non-depository subsidiaries include our broker-dealer, regulated by the SEC, the NASD and FINRA, and our insurance companies, regulated by various insurance authorities.
Capital and Operational Requirements
The FRB and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to U.S. banking organizations. These regulatory agencies may from time to time require that a banking organization maintain capital above the stated minimum levels, whether because of financial condition, the nature of assets, or actual or anticipated growth. The Federal Reserve leverage and risk-based capital guidelines divide a bank holding companys capital framework into tiers. The regulatory capital guidelines currently applicable to bank holding companies are based on the Capital Accord of the Basel Committee on Banking Supervision (Basel I). Bank regulators are phasing in revised regulatory capital guidelines based on the Revised Framework for the International Convergence of Capital Measurement and Capital Standards issued by the Basel Committee on Banking Supervision (Basel II).
We compute and report our capital ratios in accordance with the Basel I requirements for the purpose of assessing our capital adequacy. Tier 1 capital generally includes common shareholders equity, trust preferred securities, non-controlling minority interests and qualifying preferred stock, less goodwill and other adjustments. Tier 2 Capital consists of, among other things, preferred stock not qualifying as Tier 1 capital, mandatory convertible debt securities, limited amounts of subordinated debt, other qualifying term debt, the allowance for credit losses up to 1.25 percent of risk-weighted assets and other adjustments. The sum of Tier 1 and Tier 2 capital less investments in unconsolidated subsidiaries represents our qualifying total regulatory capital. Under the capital guidelines of the Federal Reserve, certain commitments and off-balance sheet transactions are assigned asset equivalent weightings and, together with assets, are divided into risk categories, each of which is assigned a risk weighting ranging from 0% (U.S. Treasury Bonds) to 100%. Risk-based capital ratios are calculated by dividing Tier 1 and Total Capital by risk-weighted assets. The minimum Tier 1 capital ratio is 4% and the minimum Total Capital ratio is 8%. Our Tier 1 and total risk-based capital ratios were well in excess of these guidelines at December 31, 2009. However, we committed to regulators to maintain a Total Capital ratio of 13% for the bank holding company. The Tier 1 and Total Capital ratio at December 31, 2009 were 14.2%. The calculation of regulatory capital ratios are subject to review and consultation with the Federal Reserve, which may result in refinements to estimated amounts. At December 31, 2009, our Tier 1 and Total Capital were comprised solely of common shareholders equity.
The leverage ratio is determined by dividing Tier 1 capital by adjusted quarterly average total assets. CIT, as a bank holding company, is required to maintain a minimum Tier 1 leverage ratio of 4% and is not subject to a Federal Reserve directive to maintain higher capital levels. Our leverage ratio at December 31, 2009 was 11.3%, exceeding requirements.
In connection with the FDICs approval in December 2008 of CIT Banks conversion from a Utah industrial bank to a Utah state bank, CIT Bank committed to maintain a Tier 1 leverage ratio of at least 15% for at least three years after conversion. At December 31, 2009, CIT Banks Tier 1 leverage ratio was 17.1%.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), among other things, establishes five capital categories for FDIC-insured banks: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. A depository institution is deemed to be well capitalized, the highest category, if it has a total capital ratio of 10% or greater, a Tier 1 capital ratio of 6% or greater and a Tier 1 leverage ratio of 5% or greater and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure. Our Banks capital ratios were all in excess of minimum guidelines. Neither CIT nor CIT Bank is subject to any order or written agreement regarding any capital requirements, but each has committed to its principal regulator to maintain certain capital ratios above the minimum requirement. FDICIA requires the applicable federal regulatory authorities to implement systems for prompt corrective action for insured depository institutions that do not meet minimum requirements. Undercapitalized depository institutions are required to submit a capital restoration plan, and any holding company must guarantee the plan. The liability of the parent holding company under any such guarantee is limited to the lesser of five percent of the banks assets at the time it became undercapitalized or the amount needed to comply. In the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parents general unsecured creditors. FDICIA requires various regulatory agencies to prescribe certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation and permits regulatory action against a financial institution that does not meet such standards.
Regulators take into consideration: (a) concentrations of credit risk, (b) interest rate risk, and (c) risks from non-traditional activities, as well as an institutions ability to manage those risks, when determining capital adequacy. This evaluation is made during the institutions safety and soundness examination. An institution may be downgraded to, or deemed to be in, a capital category that is lower than is indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. Under these guidelines, CIT Bank was considered well capitalized as of December 31, 2009.
Acquisitions, Interstate Banking and Branching
Bank holding companies are required to obtain prior approval of the Federal Reserve before acquiring more than five percent of any class of voting stock of any non-affiliated bank. Pursuant to the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the Interstate Act), a bank holding company may acquire banks in states other than its home state, without regard to the permissibility of such acquisition under state law, but subject to any state requirement that the bank has been organized and operating for a minimum period of time, not to exceed five years, and the requirement that the bank holding company, prior to and following the proposed acquisition, control no more than 10% of the total amount of deposits of insured depository institutions in the U.S. and no more than 30% of such deposits in that state (or such amount as established by state law if such amount is lower than 30%).
The Interstate Act also authorizes banks to acquire branch offices outside their home states by merging with out-of-state banks, purchasing branches in other states, or establishing de novo branches in other states, thereby creating interstate branching, provided that, in the case of purchasing branches and establishing new branches in a state in which it does not already have banking operations, such state must have opted-in to the Interstate Act by enacting a law permitting such branch purchases or de novo branching and, in the case of mergers, such state must not opt-out of that portion of the Interstate Act.
CIT Group Inc. is a legal entity separate and distinct from CIT Bank and other subsidiaries. CIT Group Inc., parent of CIT Bank and our other subsidiaries, provides a significant amount of funding to its subsidiaries, which is generally recorded as intercompany loans. Most of CIT Group Inc.s revenue is interest on intercompany loans from its subsidiaries, including CIT Bank. Cash can be transferred to CIT Group Inc. by its subsidiaries, including CIT Bank, through the repayment of intercompany debt or the payment of dividends. CIT Bank is subject to various regulatory policies and requirements relating to the payment of dividends. The appropriate federal regulatory authority is authorized to determine under certain circumstances relating to the financial condition of a bank or BHC that the payment of dividends would be an unsafe or unsound practice and to limit or prohibit payment. Under the terms of the Written Agreement dated August 12, 2009, between CIT and the Federal Reserve Bank of New York, CIT cannot declare or pay dividends on common stock without the prior written consent of the Federal Reserve Bank and the Director of the Division of Banking Supervision of the Board of Governors.
The ability of CIT Group Inc. to pay dividends on common stock may be affected by various minimum capital requirements, particularly the capital and non-capital standards established under FDICIA. The right of CIT Group Inc., our stockholders, and our creditors to participate in any distribution of the assets or earnings of its subsidiaries is further subject to prior claims of creditors of CIT Bank and other subsidiaries.
Federal and state laws impose limitations on the payment of dividends by our bank subsidiary. The amount of dividends that may be paid by a state-chartered bank that is not a member bank of the Federal Reserve System, such as CIT Bank, is limited to the lesser of the amounts calculated under a recent earnings test and an undivided profits test. Under the recent earnings test, a dividend may not be paid if the total of all dividends declared by a bank in any calendar year is in excess of the current years net income combined with the retained net income of the two preceding years, unless the bank obtains the approval of its chartering authority. Under the undivided profits test, a dividend may not be paid in excess of a banks undivided profits. Utah law imposes similar limitations on Utah state banks. Under the terms of the Cease and Desist Orders, each dated July 16, 2009, issued by the FDIC and the UDFI to CIT Bank, CIT Bank cannot declare or pay dividends on its common stock or any other form of payment representing a reduction in capital without the prior written consent of the Regional Director of the FDICs San Francisco Regional Office.
It is also the policy of the FRB that a bank holding company generally only pay dividends on common stock out of net income available to common shareholders over the past year and only if the prospective rate of earnings retention appears consistent with capital needs, asset quality, and overall financial condition. In the current financial and economic environment, the FRB indicated that bank holding companies should not maintain high dividend pay-out ratios unless both asset quality and capital are very strong. A bank holding company should not maintain a dividend level that places undue pressure on the capital of bank subsidiaries, or that may undermine the bank holding companys ability to serve as a source of strength.
U.S. Treasurys TARP Capital Purchase Program
On December 31, 2008, CIT issued $2.3 billion of preferred stock and a warrant to purchase its common stock to the U.S. Treasury as a participant in the TARP Capital Purchase Program. The preferred stock and warrant issued to the U.S. Treasury contained certain restrictions on CITs payment of dividends, repurchase of common or preferred stock and compensation of executive officers. Under the Companys Plan of Reorganization, which was approved by the U.S. Bankruptcy Court on December 8, 2009, CIT issued contingent value rights (CVRs) to the U.S. Treasury in exchange for the $2.3 billion preferred stock and warrant previously issued, which were cancelled. The CVRs expired without any value on February 8, 2010. The Treasury Department has not yet issued regulations regarding the impact of a discharge in bankruptcy on our obligations under the TARP Capital Purchase Program. CIT is continuing to follow the corporate governance best practices we initiated under the TARP Capital Purchase Program.
Source of Strength
CIT, as a bank holding company, is expected to serve as a source of strength to subsidiary banks and to commit capital and other financial resources. This support may be required at times when CIT may not be able to provide such support without adversely affecting its ability to meet other obligations. If CIT is unable to provide such support, the Federal Reserve could instead require the divestiture of CIT Bank and impose operating restrictions pending the divestiture. Similarly, under the cross-guarantee provisions of the Federal Deposit Insurance Act, if a loss is suffered or anticipated by the FDIC either as a result of the failure of a bank subsidiary or related to FDIC assistance provided to such subsidiary in danger of failure, the other banking subsidiaries may be assessed for the FDICs loss, subject to certain exceptions.
Enforcement Powers of Federal Banking Agencies
The Federal Reserve and other banking agencies have broad enforcement powers with respect to an insured depository institution and its holding company, including the power to terminate deposit insurance, impose substantial fines and other civil penalties, and appoint a conservator or receiver. Failure to comply with applicable laws or regulations could subject CIT Group Inc. or CIT Bank, as well as their officers and directors, to administrative sanctions and potentially substantial civil and criminal penalties.
FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, as the capital category of an institution declines. Failure to meet capital guidelines could also subject a depository institution to capital raising requirements.
Prompt corrective action regulations apply only to depository institutions and not to bank holding companies. The FRB is authorized to take appropriate action at the holding company level, based upon the undercapitalized status of the holding companys depository subsidiaries. In certain instances relating to an undercapitalized depository subsidiary, the bank holding company would be required to guarantee the performance of the undercapitalized subsidiarys capital restoration plan and might be liable for civil money damages for failure to fulfill that guarantee. In the event of the bankruptcy of the parent holding company, the guarantee would take priority over the parents general unsecured creditors.
FDIC Deposit Insurance
Deposits of CIT Bank are insured by the FDIC and subject to premium assessments. FDIC deposit insurance premiums are risk based, resulting in higher premium assessments to banks that have lower capital ratios or higher risk profiles. These risk profiles take into account findings by the primary banking regulator through its examination and supervision of the bank. A negative evaluation by the FDIC could increase costs to a bank and result in an aggregate cost of deposit funds higher than that of competing banks.
Transactions with Affiliates
Transactions between CIT Bank and CIT Group Inc. and its subsidiaries and affiliates are regulated by the FRB and the FDIC pursuant to Sections 23A and 23B of the Federal Reserve Act. These regulations limit the types and amounts of transactions (including loans to and credit extensions from CIT Bank) that may take place and generally require those transactions to be on an arms-length basis. These regulations generally do not apply to transactions between CIT Bank and its subsidiaries. In 2009, pursuant to an application filed with the Federal Reserve for an exemption from Section 23A, CIT transferred approximately $5.7 billion of student loan assets and related debt to CIT Bank. In connection with this transfer, CIT is required to repurchase any transferred assets that become past due, to reimburse CIT Bank for credit-related losses due to the transferred assets, or to pledge collateral to CIT Bank to protect it against credit-related losses. CIT does not have any other applications pending or planned for exemption from Section 23A. We do however, anticipate requesting permission during 2010 or 2011 to permit us to transfer certain origination and servicing platforms, but not portfolio assets, into CIT Bank.
In addition to U.S. banking regulation, our operations are subject to supervision and regulation by other federal, state, and various foreign governmental authorities. Additionally, our operations may be subject to various laws and judicial and administrative decisions. This oversight may serve to:
Changes to laws of states and countries in which we do business could affect the operating environment in substantial and unpredictable ways. We cannot accurately predict whether such changes will occur or, if they occur, the ultimate effect they would have upon our financial condition or results of operations.
GLOSSARY OF TERMS
Accretable / Non-accretable fresh start accounting adjustments reflect components of the fair value adjustments to assets and liabilities. Accretable adjustments flow through the related line items on the statement of operations (interest income, interest expense, other income and depreciation expense) on a regular basis over the remaining life of the asset or liability. These primarily relate to interest adjustments on loans and leases, as well as debt. Non-accretable adjustments, for instance credit related write-downs on loans, become adjustments to the basis of the asset and flow back through the statement of operations only upon the occurrence of certain events, such as repayment.
Accumulated Benefit Obligation (ABO) is the actuarial present value as of a date of benefits (whether vested or non-vested) attributed by a pension, or other postretirement benefit formula to employee service rendered before a specified date and based on employee service and compensation (if applicable) prior to that date. The accumulated benefit obligation differs from the projected benefit obligation in that it includes no assumption about future compensation levels.
Average Earning Assets (AEA) is computed using month end balances and is the average of finance receivables (defined below), operating lease equipment, financing and leasing assets held for sale, and certain investments, less the credit balances of factoring clients. We use this average for certain key profitability ratios, including return on AEA and Net Finance Revenue as a percentage of AEA.
Average Finance Receivables (AFR) is computed using month end balances and is the average of finance receivables (defined below) and includes loans and finance leases. It excludes operating lease equipment. We use this average to measure the rate of net charge-offs on an owned basis for the period.
Derivative Contract is a contract whose value is derived from a specified asset or an index, such as an interest rate or a foreign currency exchange rate. As the value of that asset or index changes, so does the value of the derivative contract. We use derivatives to reduce interest rate, foreign currency or credit risks. The derivative contracts we use include interest-rate swaps, cross-currency swaps, foreign exchange forward contracts, and credit default swaps.
Efficiency Ratio is the percentage of salaries and general operating expenses to Total Net Revenue (defined below). We use the efficiency ratio to measure the level of expenses in relation to revenue earned.
Finance receivables include loans and capital lease receivables. In certain instances, we use the term Loans to also mean loans and capital lease receivables, as presented on the balance sheet.
Financing and Leasing Assets include finance receivables, operating lease equipment, assets held for sale, and other investments.
Fresh Start Accounting was adopted upon emergence from bankruptcy. Fresh-start accounting recognizes that CIT has a new enterprise value following its emergence from bankruptcy and requires asset values to be remeasured using fair value in accordance with accounting requirements for business combinations. The excess of reorganization value over the fair value of tangible and intangible assets was recorded as goodwill. In addition, fresh-start accounting also requires that all liabilities, other than deferred taxes, be stated at fair value. Deferred taxes are determined in conformity with accounting requirements for Income Taxes.
Held for Investment describes loans that CIT has the ability and intent to hold in portfolio for the foreseeable future or until maturity. These are carried at amortized cost, unless it is determined that other than temporary impairment has occurred, and then a charge is recorded in the current period statement of operations.
Held for Sale describes assets that we intend to sell in the near-term. These are carried at the lower of cost or market, with a charge reflected in the current period statement of operations if the cost (or current book value) exceeds the market value.
Interest income includes interest earned on finance receivables, cash balances and dividends on investments.
Lease capital and finance is an agreement in which the party who owns the property (lessor), CIT in our finance business, permits another party (lessee), our customers, to use the property with substantially all of the economic benefits and risks of ownership passed to the lessee.
Lease leveraged is a lease in which a third party long-term creditor provides non-recourse debt financing. We are party to these lease types either as a creditor or as the lessor.
Lease operating is a lease in which we retain beneficial ownership of the asset, collect rental payments, recognize depreciation on the asset, and retain the risks of ownership, including obsolescence.
Lower of Cost or Market (LOCOM) relates to the carrying value of an asset. The cost refers to the current book balance, and if that balance is higher than the market value, an impairment charge is reflected in the current period statement of operations.
Net Finance Revenue reflects Net Interest Revenue plus rental income on operating leases less depreciation on operating lease equipment, which is a direct cost of equipment ownership. This subtotal is a key measure in the evaluation of our business.
Net Interest Revenue reflects interest and fees on loans and interest/dividends on investments less interest expense on deposits and short and long term borrowings.
Net (loss) income (attributable) available to Common Shareholders (net (loss) income) reflects net (loss) income after preferred dividends and is utilized to calculate return on common equity and other performance measurements.
Non-GAAP Financial Measures are balances, amounts or ratios that do not readily agree to balances disclosed in financial statements presented in accordance with accounting principles generally accepted in the U.S. We use non-GAAP measures to provide additional information and insight into how current operating results and financial position of the business compare to historical operating results and financial position of the business and trends, as well as adjusting for certain nonrecurring or unusual transactions.
Non-accruing Assets include loans placed on non-accrual status, typically after becoming 90 days delinquent or prior to that time due to doubt of collectibility of principal and interest.
Non-interest Revenue or Other Income includes rental income on operating leases, syndication fees, gains from dispositions of receivables and equipment, factoring commissions, loan servicing and other fees.
Owned assets mean those assets that are on-balance sheet.
Projected Benefit Obligation (PBO) is the actuarial present value as of a date of benefits attributed by a pension, or other post-retirement, benefit formula to employee service rendered prior to a specified date. The projected benefit obligation is measured using assumptions as to future compensation levels if the pension benefit formula is based on those future compensation levels (pay-related, final-pay, final-average-pay, or career-average-pay plans).
Reorganization Adjustments, include items directly related to the reorganization of our business, including gains from the discharge of debt, offset by professional fees and other costs.
Reorganization Equity Value is the value attributed to the new entity and is generally viewed as the estimated fair value of the entity considering market valuations of comparable companies, historical merger and acquisition prices and discounted cash flow analyses.
Reorganization Value is the fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the entity immediately after the restructuring.
Retained Interest is the portion of the interest in assets we retain when we sell assets in an off-balance sheet securitization transaction.
Residual Values represent the estimated value of equipment at the end of the lease term. For operating leases, it is the value to which the asset is depreciated at the end of its useful economic life (i.e., salvage or scrap value).
Return on Common Equity (ROE) is net income available to common stockholders, expressed as a percentage of average common equity, and is a key measurement of profitability.
Risk Weighted Assets (RWA) is the denominator to which Total Capital and Tier 1 Capital is compared to derive the respective ratios. RWA is comprised of both on-balance sheet assets and certain off-balance sheet items (for example loan commitments, purchase commitments or derivative contracts), all of which are adjusted by certain risk-weightings based upon, among other things, the relative credit risk of the counterparty.
Securitized assets are assets that we sold and still service.
Special Purpose Entity (SPE) is a distinct legal entity created for a specific purpose in order to isolate the risks and rewards of owning its assets and incurring its liabilities. We typically use SPEs in securitization transactions, joint venture relationships, and certain structured leasing transactions.
Syndication and Sale of Receivables result from originating leases and receivables with the intent to sell a portion, or the entire balance, of these assets to other financial institutions. We earn and recognize fees and/or gains on sales, which are reflected in other income, for acting as arranger or agent in these transactions.
Tangible Capital and Metrics exclude goodwill, other intangible assets and some other comprehensive income items. We use tangible metrics in measuring capitalization.
Tier 1 Capital and Tier 2 Capital are regulatory capital as defined in the capital adequacy guidelines issued by the Federal Reserve. Tier 1 Capital is Total Stockholders Equity reduced by goodwill and intangibles and adjusted by elements of other comprehensive income. Tier 2 Capital adjusts Tier 1 Capital for other preferred stock that does not qualify as Tier 1, mandatory convertible debt, limited amounts of subordinated debt, other qualifying term debt, and allowance for credit losses up to 1.25% of risk weighted assets.
Total Regulatory Capital is the sum of Tier 1 and Tier 2 capital, subject to certain adjustments, as applicable.
Total Net Revenue is the combination of net interest revenue and other income less depreciation expense on operating lease equipment. This amount excludes provision for credit losses and valuation allowances from total net revenue and other income and is a measurement of our revenue growth.
Yield-related Fees are collected in connection with our assumption of underwriting risk in certain transactions in addition to interest income. We recognize yield-related fees, which include prepayment fees and certain origination fees, in Interest Income over the life of the lending transaction.
The operation of our business, our transition to a bank-centric business model, and the effects of the transactions that were effectuated under the Plan of Reorganization each involve various elements of risk and uncertainty. Additional risks that are presently unknown to us or that we currently deem immaterial may also impact our business. You should carefully consider the risks and uncertainties described below as well as the other information appearing elsewhere in this Annual Report on Form 10-K before making a decision whether to invest in the Company. References in these Risk Factors to the Plan of Reorganization are references to CIT Group Inc.s Modified Second Amended Prepackaged Reorganization Plan of CIT Group Inc. and CIT Group Funding of Delaware LLC, dated December 7, 2009, under Chapter 11 of the Bankruptcy Code as such plan is described in and attached to our Current Report on Form 8-K filed December 9, 2009, which was confirmed by the U.S. Bankruptcy Court for the Southern District of New York (the Bankruptcy Court) on December 8, 2009. Neither the Plan of Reorganization, the projected financial information, nor our disclosure statement previously filed with the Bankruptcy Court are incorporated by reference into this Form 10-K and such documents should not be considered or relied on in making any investment decisions involving our common stock or other securities.
Risks Related to Our Strategy and Business Plan
Following our emergence from bankruptcy, we are undergoing a significant change in our senior management team and our Board of Directors, which may affect our long-term business strategy and our ability to develop and implement that strategy. There is no assurance that we will be able to develop, refine, and implement our business strategy successfully following the significant changes in our leadership.
Since we emerged from our Chapter 11 proceeding, John A. Thain was appointed Chairman and Chief Executive Officer effective February 8, 2010, replacing Jeffrey M. Peek, who resigned effective January 15, 2009. Mr. Thain needs to fill several key positions in his senior management team to replace executives who have resigned or are scheduled to resign or retire, including the Chief Financial Officer, the Chief Risk Officer, and certain other senior executives. In addition, two members of the prior Board of Directors resigned and seven new directors (one of whom resigned shortly thereafter due to short-term health issues) were identified by bondholders in the bankruptcy proceeding, were appointed by the Board, and will serve with five incumbent directors. The new management team and the reconstituted Board of Directors must either refine and implement the current strategy of transitioning to a bank-centric business model or identify and implement an alternative business strategy. As a result of the significant changes in the senior management team, the senior positions that are still open and the changes in the Board of Directors, there is no assurance that our business strategy will not change significantly or that we will be able to successfully implement that strategy.
Although we enhanced our capital structure and improved our liquidity position by implementing our Plan of Reorganization, we are still refining and developing a detailed strategy and business plan, including identifying and securing a stable source of long-term funding. There is no assurance that we will be able to develop and implement such a plan in the time frame available to us.
In our bankruptcy proceeding, we consummated our Plan of Reorganization to enhance our capital structure and improve our liquidity position in the near term. By doing so, we were able to extend the maturities of substantial portions of our debt so that most of our borrowings (with the exception of the Credit Facility and the Expansion Credit Facility) will not begin to come due until 2013. We believe this reorganization affords us a period of time to address the significant financial and economic challenges that led to our reorganization and continue to face our company.
One of the main reasons we needed to reorganize in bankruptcy was our traditional dependence on borrowing with unsecured debt (commercial paper, medium-term notes, and corporate bonds) to fund our loan and lease portfolio. Due to difficult conditions in the credit markets as well as the adverse impact of weaker economic conditions on our financial performance in recent years, we were no longer able to meet our borrowing needs, and we must develop a more stable, longer-term source of funding, not only to meet our long-term liabilities as they come due but to fund our businesses and once again become profitable. We believe that conducting a greater level of our business activities within CIT Bank to facilitate greater funding stability can help us achieve this goal. As a regulated bank, CIT Bank will have access to certain funding sources, such as insured deposits, that are not available to non-banking institutions. There are significant risks associated with
this strategy, however. First, due to regulatory requirements, CIT Bank will generally not be able to fund any businesses conducted outside the Bank and we will need to transfer a substantial portion of our business platforms to CIT Bank in order to use the Bank as a funding source. This will require the approval of our banking regulators, however, and there is no assurance that we will receive such approvals. Moreover, once we transition our businesses to CIT Bank, they will be subject to greater regulatory oversight and there is no assurance that we will be able to conduct them, or achieve growth and profitability in them, as we might wish. Finally, there is no assurance that CIT Bank will become a reliable funding source to the extent we need it to be, either as to the amount of borrowings we might need or as to the cost of funding. This will depend in significant part on our ability to attract deposits at CIT Bank, which currently is limited by its lack of a branch network and by the Cease and Desist Orders restricting the amount of deposits it may seek from brokers, and whether CIT Bank will be accepted by the funding markets as a reliable borrower and on whether and how quickly the availability of funding in these markets is restored.
Even if the bank-centric model is successful, we will continue to conduct substantial businesses outside CIT Bank and will need to obtain funding for those businesses in the capital markets and through third-party bank borrowings. We have not yet made final decisions about which businesses should be transferred to CIT Bank, which might be conducted more effectively outside the Bank and which might best be sold or wound down.
We believe we have a period of time in which to implement these steps so as to develop reasonably stable funding sources sufficient to support longer-term growth, but there is no assurance that we will be able to do so effectively, including for the reasons noted above. In light of this uncertainty, our new management team will continue to refine our business plan and strategy and may decide to supplement or modify it in significant ways.
Our bankruptcy proceedings, which improved our capital structure and short-term liquidity position, contemplated that we would refine and implement our strategy and business plan, based upon assumptions and analyses developed by us. If these assumptions and analyses prove to be incorrect, we may be unsuccessful in executing our strategy and business plan, which could have a material adverse effect on our business, financial condition, and results of operation.
Our bankruptcy proceedings, which improved our capital structure and short-term liquidity position, contemplated that we would refine and implement our strategy and business plan based upon assumptions and analyses developed by us in light of our experience and perception of historical trends, current conditions and expected future developments, as well as other factors that we considered appropriate under the circumstances. Whether actual future results and developments will be consistent with our expectations and assumptions depends on a number of factors, including but not limited to (i) our ability to obtain adequate liquidity and financing sources and establish an appropriate level of debt; (ii) our ability to restore customers confidence in our viability as a continuing entity and to attract and retain sufficient customers; (iii) our ability to retain key employees in those businesses that we intend to continue to emphasize, and (iv) the overall strength and stability of general economic conditions of the financial industry, both in the U.S. and in global markets. The failure of any of these factors could materially adversely affect the successful execution of our strategy and business plan.
In connection with our bankruptcy proceedings, we prepared projected financial information to demonstrate to the Bankruptcy Court the feasibility of our Plan of Reorganization and our ability to continue operations upon emergence from bankruptcy. The projections reflect numerous assumptions concerning anticipated future performance and prevailing and anticipated market and economic conditions that were and continue to be beyond our control and that may not materialize. Further, the projections were limited by the information available to us as of the date of their preparation, and that information has already changed. In addition, our plans continue to rely upon financial forecasts, including with respect to revenue growth, improved earnings before interest, taxes, depreciation and amortization, improved interest margins, and growth in cash flow. Financial forecasts are inherently subject to many uncertainties and are necessarily speculative, and it is likely that one or more of the assumptions and estimates that are the basis of these financial forecasts will not be accurate. In our case, the forecasts are even more speculative than normal, because they involve fundamental changes in the nature of our business. Accordingly, we expect that our actual financial condition and results of operations will differ, perhaps materially, from what we have anticipated. Consequently, there can be no assurance that the results or developments contemplated by the Plan of Reorganization or our strategy and business plan will occur or, even if they do occur, that they will have the anticipated effects on us and our subsidiaries or our businesses or operations. The failure of any such results or developments to materialize as anticipated could materially adversely affect the successful execution of the transactions contemplated by the Plan of Reorganization or subsequent strategy and business plan. In addition, the accounting treatment required for our bankruptcy reorganization may have an impact on our results going forward.
Our debt agreements contain restrictions that may limit flexibility in operating our business.
The indentures for the new second lien notes and the agreement governing our Expansion Credit Facility each contain various covenants that limit our ability to engage in specified transactions. These covenants limit our and our subsidiaries ability to, among other things:
A breach of any of these covenants could result in a default under the new second lien notes or our Expansion Credit Facility and could result in cross defaults against our other outstanding debt and/or credit facilities.
Risks Related to Liquidity and Capital
If the Company does not maintain sufficient capital to satisfy the Federal Reserve Bank of New York, the FDIC and the Utah Department of Financial Institutions, the Federal Reserve Bank of New York or the FDIC could require the Company to divest CIT Bank or otherwise further limit the ability of CIT Bank to conduct business and/or limit access to CIT Bank by the Company or its creditors.
As a condition to becoming a bank holding company and converting CIT Bank from a Utah industrial bank to a Utah state bank, we committed to maintain a total risk-based capital ratio of at least 13% for the bank holding company and a Tier 1 leverage ratio of at least 15% for CIT Bank. While our bankruptcy reorganization increased CITs capital above the levels committed to with the regulators and reduced our liquidity demands over the next several years, if the Company does not develop a long-term funding strategy and maintain capital and liquidity acceptable to the Federal Reserve Bank of New York, the FDIC and the UDFI, the Federal Reserve Bank of New York or the FDIC could take action to require the Company to divest its interest in CIT Bank or otherwise limit access to CIT Bank by the Company and its creditors.
Even if we successfully implement our strategy and business plan, inadequate liquidity could materially adversely affect our future business operations.
Even if we successfully implement our strategy and business plan, obtain sufficient financing from third party sources to continue operations, and successfully operate our business, we may be required to sell assets or engage in other capital generating actions over and above our normal financing activities and cut back or eliminate other programs that are important to the future success of our business. In addition, our customers and counterparties might respond to further weakening of our liquidity position by requesting quicker payment, requiring additional collateral and increasing draws on our outstanding commitments. If this were to happen, our need for cash would be intensified and it could have a material adverse effect on our business, financial condition, or results of operations.
Although we successfully consummated the Plan of Reorganization, our indebtedness and other obligations will continue to be significant. If the current economic environment does not improve, we may not be able to generate sufficient cash flow from operations to satisfy our obligations as they come due, and as a result we would need additional funding, which may be difficult to obtain.
Although we successfully consummated the Plan of Reorganization, and even if we successfully complete the other steps of our strategy and business plan with respect to our capital structure and our businesses, we have a significant amount of indebtedness and other obligations, including potential new securities issued at increased interest rates/cost of capital, which are likely to have several important consequences. For example, the amount of indebtedness and other obligations could:
If we are unable to return to profitability, and/or if current economic conditions do not improve in the foreseeable future, we may not be able to generate sufficient cash flow from operations in the future to allow us to service our debt, pay our other obligations as required and make necessary capital expenditures, in which case we may need to dispose of additional assets and/or minimize capital expenditures and/or try to raise additional financing. There is no assurance that any of these alternatives would be available to us, if at all, on satisfactory terms.
Our business may be adversely affected if we do not successfully expand our deposit-taking capabilities at CIT Bank, which is currently restricted from increasing its level of broker deposits pursuant to Cease and Desist Orders.
The Company currently has limited access to the unsecured debt capital markets and may be unable to broaden such access in the foreseeable future, which will make the Company reliant upon bank deposits and secured financing structures to fund its business in CIT Bank. CIT Bank does not have a retail branch network and obtains its deposits through brokers. The FDIC and the UDFI, pursuant to Cease and Desist Orders, restricted the level of broker deposits that CIT Bank may hold, without the prior written consent of both the FDIC and UDFI. In order to diversify its deposit-taking capabilities beyond broker deposits, the Company will need to establish de novo banking operations or acquire a retail branch network, or internet banking operation and a cash management operation for existing customers. Any such alternatives will require significant time and effort to implement and will be subject to regulatory approval, which may not be obtained, particularly if the financial condition of the Company does not improve. In addition, we are likely to face significant competition for deposits from stronger bank holding companies who are similarly seeking larger and more stable pools of funding. If CIT Bank is unable to expand its deposit-taking capability, it could have a material adverse effect on our business, results of operations, and financial position.
Our liquidity and/or ability to issue unsecured debt in the capital markets likely will be limited by our capital structure and level of encumbered assets, the performance of our business, market conditions, credit ratings, or regulatory or contractual restrictions.
Our traditional business model depended upon access to debt capital markets to provide liquidity and efficient funding for asset growth. These markets exhibited heightened volatility and dramatically reduced liquidity. The unsecured debt markets generally have been unavailable to us since the fourth quarter of 2007, and will likely remain unavailable to us for the foreseeable future. While secured borrowing has been available to us, it is more restrictive and costly as interest rates available to us have increased significantly relative to benchmark rates, such as U.S. treasury securities and LIBOR. Downgrades in our short- and long-term credit ratings in March 2008, April 2009 and June 2009 to below investment grade and ultimately our bankruptcy filing had the practical effect of leaving us without access to the commercial paper market and other unsecured term debt markets.
As a result of these developments and our Chapter 11 bankruptcy proceedings, the Company reduced its funding sources exclusively to secured borrowings, where available. This resulted in significant additional costs due to higher interest rates and restrictions on the types of assets and advance rates as compared to unsecured funding. When the Company entered into the Credit Facility and Expansion Credit Facility, it granted liens on almost all remaining unencumbered assets. In addition, pursuant to its Plan of Reorganization, the Company issued new second lien notes pursuant to which it granted second liens on almost all of its remaining unencumbered assets. The Companys ability to access the secured debt markets in the future will be affected by restrictions in the Credit Facility and Expansion Credit Facility and new second lien notes, and by the existing level of encumbered assets. The Companys ability to access the unsecured debt markets or other capital generating actions is likely to be adversely affected by the Companys outstanding secured financings, which in the aggregate encumber substantially all of the Companys assets. There can be no assurance that we will be able to regain access to the unsecured term debt markets, or full access to the secured debt markets on attractive terms and conditions, and if we are unable to do so, it would adversely affect our business, operating results and financial condition unless the Company is able to obtain alternative sources of liquidity.
Our ability to satisfy our cash needs also is constrained by regulatory or contractual restrictions on the manner in which we may use portions of our cash on hand. The cash at CIT Bank is available solely for the Banks own funding and investment requirements. The restricted cash related to securitization transactions is available solely for specific permitted uses under the securitization transactions. The cash of CIT Bank and the
restricted cash related to securitization transactions cannot be transferred to or used for the benefit of any other affiliate of ours. In addition, as part of our business we extend lines of credit, some of which can be drawn by the borrowers at any time. During the second quarter of 2009 and into July 2009, we experienced a significant increase in such draws, which significantly degraded our liquidity position. If the borrowers on these lines of credit increase their rate of borrowing, either as a result of their business needs or due to a perception that we may be unable to fund these lines in the future, this could substantially degrade our liquidity position, which could have a material adverse effect on our business unless the Company is able to obtain alternative sources of liquidity.
If we do not maintain sufficient capital to satisfy regulatory capital requirements in the future, there could be an adverse effect on the manner in which we do business, or we could become subject to various enforcement or regulatory actions.
Under regulatory capital adequacy guidelines, the Company and its principal banking subsidiary, CIT Bank, are required to meet requirements that involve both qualitative and quantitative measures of assets, liabilities and certain off-balance sheet items. When we became a bank holding company, we committed to the Federal Reserve Bank of New York to maintain total capital of 13% for the Company. We committed to the FDIC to maintain a leverage capital ratio of 15% for CIT Bank. Although CIT Bank continues to maintain regulatory capital on a stand-alone basis at or above the levels committed to with regulators, losses during the first nine months of 2009 reduced CITs level of total capital prior to our reorganization in bankruptcy below the 13% threshold that CIT committed to maintain when it became a bank holding company, and continued losses in future quarters may further reduce the Companys total capital. Our capital levels currently exceed the minimum levels committed to the regulators as a result of consummating the Plan of Reorganization. Future losses may reduce our capital levels and we have no assurances that we will be able to maintain our regulatory capital at satisfactory levels based on the current level of performance of our businesses. Failure to maintain the appropriate capital levels would adversely affect the Companys status as a bank holding company, have a material adverse effect on the Companys financial condition and results of operations, and subject the Company to a variety of enforcement actions, as well as certain restrictions on its business. In addition to the requirement to be well-capitalized, CIT Group Inc. and CIT Bank are subject to regulatory guidelines that involve qualitative judgments by regulators about the entities status as well-managed and the entities compliance with Community Reinvestment Act obligations, and failure to meet those standards may have a material adverse effect on our business.
If we do not maintain sufficient regulatory capital, the Federal Reserve Bank of New York and the FDIC could take action to require the Company to divest its interest in CIT Bank or otherwise limit access to CIT Bank by the Company and its creditors. The FDIC, in the case of CIT Bank, and the Federal Reserve Bank of New York, in the case of the Company, placed restrictions on the ability of CIT Bank and the Company to take certain actions without the prior approval of the applicable regulators. Although our Plan of Reorganization received confirmation from the Bankruptcy Court, if we are unable to finalize and complete our strategy and business plan and access the credit markets to meet our capital and liquidity needs in the future, or if we otherwise suffer continued adverse effects on our liquidity and operating results, we may be subject to formal and informal enforcement actions by the Federal Reserve Bank of New York and the FDIC, we may be forced to divest CIT Bank and/or CIT Bank may be placed in FDIC conservatorship or receivership or suffer other consequences. Such actions could impair our ability to successfully execute any strategy and business plan and have a material adverse effect on our business, results of operations, and financial position.
Risks Related to Regulatory Obligations and Limitations
We are currently subject to the Written Agreement, which may adversely affect our business.
Under the terms of the Written Agreement, the Company must provide the Federal Reserve Bank of New York with (i) a corporate governance plan, focusing on strengthening internal audit, risk management, and other control functions, (ii) a credit risk management plan, (iii) a written program to review and revise, as appropriate, its program for determining, documenting and recording the allowance for loan and lease losses, (iv) a capital plan for the Company and CIT Bank, (v) a liquidity plan, including meeting short term funding needs and longer term funding, without relying on government programs or Section 23A waivers, and (vi) a business plan. The Written Agreement also prohibits the Company, without the prior approval of the Federal Reserve Bank of New York, from paying dividends, paying interest on subordinated debt, incurring or guaranteeing debt outside of the ordinary course of business, prepaying debt or purchasing or redeeming the Companys stock. Under the Written Agreement, the Company must comply with certain procedures and restrictions on appointing or changing the responsibilities of any senior officer or director, restricting the provision of indemnification to officers and directors, and restricting the payment of severance to employees.
We are currently subject to the Cease and Desist Orders, which may adversely affect our business.
CIT Bank relies principally on brokered deposits to fund its ongoing business, which generally require payment of higher yields and may be subject to inherent limits on the aggregate amount available, depending on market conditions. The FDIC and the UDFI have issued, and CIT Bank has consented to (without admitting or denying the allegations), the Cease and Desist Orders, which, among other things, limit the amount of brokered deposits CIT Bank can maintain and restrict CIT Banks ability to enter into transactions with affiliates and to make dividend payments. If we are unable to increase our level of deposits through other sources, or to otherwise comply with the requirements of the Cease and Desist Orders, it could have a material adverse effect on our business. Under the Cease and Desist Orders, CIT Bank submitted a contingency plan providing for and ensuring the continuous and satisfactory servicing of all loans held by CIT Bank, which was accepted as satisfactory by the FDIC, and must obtain prior regulatory approval in order to increase the level of brokered deposits held by CIT Bank above $5,527 million (the balance at December 31, 2009 is $5,087 million). In addition if CIT Bank is deemed not to be well capitalized, it may not raise brokered deposits without prior regulatory approval. CIT Bank must notify the FDIC in writing at least 30 days prior to any management changes, and must obtain prior approval before entering into any golden parachute arrangements or any agreement to make any excess nondiscriminatory severance plan payments. In addition, the FDIC is requiring CIT Bank to submit a liquidity plan for funding any maturing debt and an outline of plans or scenarios for the future operation of CIT Bank if we do not maintain our regulatory capital levels.
Many of our regulated subsidiaries could be negatively affected by a decrease in regulatory capital levels or a failure to improve our performance.
In addition to CIT Bank, we have a number of other regulated subsidiaries that may be affected by a decrease in our regulatory capital levels or a failure to improve our performance. In particular, the regulators of our banking subsidiaries in the UK, Germany, Sweden, France and Brazil, as well as our SBA and insurance subsidiaries, may take action against such entities, including limiting/or prohibiting transactions with CIT Group Inc. and/or seizing such entities.
Our business, financial condition and results of operations could be adversely affected by regulations to which we are subject as a result of becoming a bank holding company, by new regulations or by changes in other regulations or the application thereof.
On December 22, 2008, the Board of Governors of the Federal Reserve System approved our application to become a bank holding company and the Department of Financial Institutions of the State of Utah approved our application to convert our Utah industrial bank to a Utah state bank.
Most of the activities in which we currently engage are permissible activities for a bank holding company. However, since we are not a financial holding company, certain of our existing businesses are not permissible under regulations applicable to a bank holding company, including certain real estate investment and equity investment activities, and we could be required to divest those activities by December 22, 2010. In addition, we are subject to the comprehensive, consolidated supervision of the Federal Reserve, including risk-based and leverage capital requirements and information reporting requirements. We are subject to the Cease and Desist Orders and the Written Agreement. This regulatory oversight is established to protect depositors, federal deposit insurance funds and the banking system as a whole, and is not intended to protect security holders. In addition, pursuant to the Written Agreement with the Federal Reserve Bank of New York, we are required to review the adequacy of resources for corporate governance functions, including whether the staffing levels and resources for audit, risk management, and other control functions are adequate. Providing additional resources in those areas will increase our expenses for the foreseeable future. In addition, if the FDIC and UDFI require CIT Bank to separate all of its operations from the Company, which will eliminate the cost advantages of the scale of operations of the Company, it will increase the expenses of CIT Bank for the foreseeable future.
The financial services industry, in general, is heavily regulated. Proposals for legislation further regulating the financial services industry are continually being introduced in the United States Congress and in state legislatures. The agencies regulating the financial services industry also periodically adopt changes to their regulations. In light of current conditions in the U.S. financial markets and economy, regulators have increased the level and scope of their supervision and their regulation of the financial services industry. In addition, in October 2008, Congress passed the Emergency Economic Stabilization Act of 2008 (EESA), TARP and the Capital Purchase Program. Under EESA, Congress also established the Special Inspector General for TARP, who is charged with monitoring, investigating and reporting on how the recipients of funds under TARP utilize such funds. Similarly, there is a substantial prospect that Congress will restructure the regulation and supervision of financial institutions in the foreseeable future. We are unable to predict how this increased supervision and regulation will be fully implemented or in what form, or whether any additional or similar changes to statutes or regulations, including the interpretation or implementation thereof, will occur in the
future. Any such action, particularly in view of our financial condition, could affect us in substantial and unpredictable ways and could have an adverse effect on our business, financial condition and results of operations.
The financial services industry is also heavily regulated in many jurisdictions outside of the United States. We have subsidiaries in various countries that are licensed as banks, banking corporations, broker-dealers, and insurance companies, all of which are subject to regulation and examination by banking, securities, and insurance regulators in their home jurisdiction. In addition, in several jurisdictions, including the United Kingdom and Germany, the local banking regulators requested the local regulated entity to develop contingency plans to operate on a stand-alone basis. Given the evolving nature of regulations in many of these jurisdictions, it may be difficult for us to meet all of the regulatory requirements, establish operations and receive approvals. Our inability to remain in compliance with regulatory requirements in a particular jurisdiction could have a material adverse effect on our operations in that market, on our ability to permanently reinvest our earnings, and on our reputation generally.
We are also affected by the economic and other policies adopted by various governmental authorities and bodies in the U.S. and other jurisdictions. For example, the actions of the Federal Reserve and international central banking authorities directly impact our cost of funds for lending, capital raising and investment activities and may impact the value of financial instruments we hold. In addition, such changes in monetary policy may affect the credit quality of our customers. Changes in domestic and international monetary policy are beyond our control and difficult to predict.
As a bank holding company engaged in the financial services industry, our business is subject to extensive and pervasive regulation throughout the United States and in various other countries, and recent initiatives to impose new legal restrictions and requirements on certain financial institutions may materially and adversely affect our profitability and our ability to grow and compete effectively.
As a result of the recent crisis in the financial services industry, the President, Congress, state legislatures and various federal and state regulators, as well as governmental authorities outside the United States, have recently put forward numerous proposals to regulate, restrict and tax the activities of certain financial institutions, and these proposals, if adopted, could significantly affect our ability to conduct certain of our businesses, including some of our material businesses, in a cost-effective manner. Some of these proposals would place restrictions on the type of activities in which certain financial institutions are permitted to engage and on the size of certain financial institutions, while others would subject certain financial institutions to stricter and more conservative capital, leverage, liquidity and risk management standards, and these proposals could significantly increase our costs and limit our growth opportunities. Furthermore, other proposed legislation and regulation would impose additional taxes on certain financial institutions. For example, the Obama administration has proposed a Financial Crisis Responsibility Fee to be levied on certain large banks and financial institutions, on the basis of their liabilities, in order to recover projected losses by the US Government under the Troubled Asset Relief Program (TARP), in which we participated. As currently proposed, this fee would be approximately fifteen basis points, or 0.15%, of an amount calculated by subtracting a covered institutions Tier 1 capital and FDIC-assessed deposits from such institutions total assets and would remain in effect for at least ten years. The key features of the fee, including the rate, the nature and scope of the liabilities or other items on which it would be applied and its duration, have not been fully determined and are subject to change, and thus we are unable to predict the impact that this or any similar proposal that has been or may be made will have on our business. In addition, numerous regulators have proposed heightened standards for and increased scrutiny of the compensation practices of financial institutions, and the Federal Reserve Board has issued a proposal on incentive compensation policies to ensure that they do not encourage excessive risk-taking. Among other things, these compensation-related proposals could affect a subject companys ability to attract and retain highly valued employees. The various legislative and regulatory proposals relating to financial institutions that are currently pending or may yet be introduced may not apply to all our competitors, and if adopted they could adversely affect our ability to compete effectively and could significantly impair our profitability and growth opportunities.
Our business may be adversely affected if we do not successfully implement our project to transform our compliance, risk management, finance, treasury, operations, and other areas of our business to meet the standards of a bank holding company.
Our business may be adversely affected if we do not successfully implement our project to transform our compliance, risk management, finance, treasury, operations, and other areas of our business to meet the standards of a bank holding company.
When we became a bank holding company and converted our Utah industrial bank to a Utah state bank, we analyzed our business to identify areas that require improved policies and procedures to meet the regulatory requirements and standards for banks and bank holding companies, including but not limited to compliance, risk management, finance, treasury, and operations. We developed and we are implementing project plans to improve policies, procedures, and systems in the areas identified. Our new business model is based on the assumption that we will be able to make this transition in a reasonable amount of time. We are currently subject to the Written Agreement, which, among other things, requires us to develop plans to enhance corporate governance, including increasing resources in audit, risk management and control functions, correct weaknesses in credit risk management, review and revise, as appropriate, the consolidated allowance for loan and lease losses methodology, and develop capital and liquidity plans. If we have not identified all of the required improvements, particularly in our control functions, or if we are unsuccessful in implementing the policies, procedures, and systems that have been identified, or if we do not implement the policies, procedures, and systems quickly enough, we could be subject to a variety of formal and informal enforcement actions that could result in the imposition of certain restrictions on our business, or preclude us from making acquisitions, and such actions could impair our ability to execute our business plan and have a material adverse effect on our business, results of operations, or financial position.
Risks Related to the Operation of Our Businesses
We may be additionally negatively affected by credit risk exposures and our reserves for credit losses, including the related non-accretable fair value discount component of the fresh start adjustments, may prove inadequate.
Our business depends on the creditworthiness of our customers and their ability to fulfill their obligations to us. We maintain a consolidated reserve for credit losses on finance receivables that reflects managements judgment of losses inherent in the portfolio. We periodically review our consolidated reserve for adequacy considering economic conditions and trends, collateral values and credit quality indicators, including past charge-off experience and levels of past due loans, past due loan migration trends, and non-performing assets. During 2009, losses were significantly more severe than in 2008, and more severe than in prior economic downturns, due to an increase in the proportion of unsecured cash flow loans versus asset based loans in our corporate finance segment, the limited ability of borrowers to restructure their liabilities or their business, and reduced values of the collateral underlying the loans.
Our consolidated reserve for credit losses, and the related non-accretable fair value discount component of the fresh start adjustments, may prove inadequate and we cannot assure that it will be adequate over time to cover credit losses in our portfolio because of adverse changes in the economy or events adversely affecting specific customers, industries or markets. The current economic environment is dynamic and the credit-worthiness of our customers and the value of collateral underlying our receivables have declined significantly and may continue to decline significantly over the near future. Our reserves may not keep pace with changes in the credit-worthiness of our customers or collateral values. If the credit quality of our customer base continues to materially decline, if the risk profile of a market, industry, or group of customers changes significantly, or if the markets for accounts receivable, equipment, real estate, or other collateral deteriorates significantly, any or all of which would adversely affect the adequacy of our reserves for credit losses, it could have a material adverse effect on our business, results of operations, and financial position.
In addition to customer credit risk associated with loans and leases, we are exposed to other forms of credit risk, including counterparties to our derivative transactions, loan sales, syndications and equipment purchases. These counterparties include other financial institutions, manufacturers and our customers. If our credit underwriting processes or credit risk judgments fail to adequately identify or assess such risks, or if the credit quality of our derivative counterparties, customers, manufacturers, or other parties with which we conduct business materially deteriorates, we may be exposed to credit risk related losses that may negatively impact our financial condition, results of operations or cash flows.
Uncertainties related to our business may result in the loss of or decreased business with customers.
Our business depends upon our customers believing that we will be able to provide a wide range of quality products on a timely basis to our customers. Our ability to provide our products on a reliable and timely basis affects our ability to attract new customers. Many of our customers rely upon our products to provide them with the working capital necessary to operate their business or to fund capital improvements that allow them to maintain or expand their business. In many instances, these funding requirements are time sensitive. If our customers are uncertain as to our ability to continue to provide them with funding on a timely basis or to provide the same breadth and quality of products, we may be unable to attract new customers and we may experience lower business or a loss of business with our existing customers.
We may not be able to achieve adequate consideration for the disposition of assets or businesses.
As part of our strategy and business plan, we may consider a number of measures designed to manage our liquidity position, including potential asset sales. There can be no assurance that we will be successful in completing all or any of these transactions, because there may not be a sufficient number of buyers willing to enter into a transaction, we may not receive sufficient consideration for such assets, the process of selling assets may take too long to be a significant source of liquidity, or lenders or noteholders with consent rights may not approve a sale of assets. These transactions, if completed, may reduce the size of our business and it is not currently part of our long-term strategy to replace the volume associated with these businesses. From time to time, we also receive inquiries from third parties regarding our potential interest in disposing of other types of assets, such as student lending and other commercial finance or vendor finance assets, which we may or may not choose to pursue.
Prices for assets were depressed due to market conditions starting in the second half of 2007 and continuing to today. In addition, potential purchasers may be unwilling to pay an amount equal to the face value of a loan or lease if the purchaser is concerned about the quality of the Companys credit underwriting. Further, some potential purchasers will intentionally submit bids with purchase prices below the face value of a loan or lease if the purchaser suspects that the seller is distressed and cannot afford to negotiate the price. There is no assurance that we will receive adequate consideration for any asset or business dispositions. Certain dispositions in 2008 and 2009 resulted in the Company recognizing significant losses. As a result, our future disposition of businesses or asset portfolios could have a material adverse effect on our business, financial condition and results of operations.
We are prohibited from paying dividends on our common stock.
Under the terms of the Written Agreement, we are prohibited from declaring dividends on our common stock without prior written approval of the Federal Reserve Bank of New York. In addition, under the terms of the Expansion Credit Facility and the new second lien notes, we are prohibited from declaring dividends on our common stock until such indebtedness is repaid. We have suspended the payment of dividends on our common stock. We cannot determine when, if ever, we will be able to pay dividends on our common stock in the future.
Uncertainties related to our business, as well as the corporate governance best practices that we initiated under the TARP Capital Purchase Program, may create a distraction for employees and may otherwise materially adversely affect our ability to retain existing employees and/or attract new employees.
Our future results of operations will depend in part upon our ability to retain existing highly skilled and qualified employees and to attract new employees. Failure to continue to attract and retain such individuals could materially adversely affect our ability to compete. Uncertainties about the future prospects and viability of our business are impacting and are likely to continue to impact our ability to attract and retain key management, technical and other personnel, and are creating a distraction for existing employees. If we are significantly limited or unable to attract and retain key personnel, or if we lose a significant number of key employees, or if employees continue to be distracted due to the uncertainties about the future prospects and viability of our business, it could have a material adverse effect on our ability to successfully operate our business or to meet our operations, risk management, compliance, regulatory, and financial reporting requirements.
On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (the Act) was signed into law. The Act includes an amendment and restatement of Section 111 of the EESA that significantly expands and strengthens executive compensation restrictions applicable to entities, including CIT, which participate in TARP. The Act also includes a number of other requirements, including but not limited to implementing a say-on-pay policy that allows for an annual non-binding shareholder vote on executive compensation and a policy related to the approval of excessive or luxury expenditures, as identified by the United States Department of the Treasury, including corporate aircraft, office and facility renovations, entertainment and holiday parties and other activities or events that are not reasonable expenditures for staff development, performance incentives or similar measures in the ordinary course of business. Although no obligation of CIT arising from TARP financial assistance remains outstanding, we are continuing to apply the corporate governance best practices that we initiated under the TARP Capital Purchase Program, which could have a material adverse effect on our ability to recruit and retain individuals with the experience and skill necessary to manage successfully our business through its current difficulties and during the long term.
We may not be able to realize our entire investment in the equipment we lease.
The realization of equipment values (residual values) during the life and at the end of the term of a lease is an important element in the leasing business. At the inception of each lease, we record a residual value for the leased equipment based on our estimate of the future value of the equipment at the expected disposition date. Internal equipment management specialists, as well as external consultants, determine residual values.
A decrease in the market value of leased equipment at a rate greater than the rate we projected, whether due to rapid technological or economic obsolescence, unusual wear and tear on the equipment, excessive use of the equipment, recession or other adverse economic conditions, or other factors, would adversely affect the current or the residual values of such equipment. Further, certain equipment residual values, including commercial aerospace residuals, are dependent on the manufacturers or vendors warranties, reputation and other factors, including market liquidity. In addition, we may not realize the full market value of equipment if we are required to sell it to meet liquidity needs or for other reasons outside of the ordinary course of business. Consequently, there can be no assurance that we will realize our estimated residual values for equipment.
The degree of residual realization risk varies by transaction type. Capital leases bear the least risk because contractual payments cover approximately 90% of the equipments cost at the inception of the lease. Operating leases have a higher degree of risk because a smaller percentage of the equipments value is covered by contractual cash flows at lease inception. Leveraged leases bear the highest level of risk as third parties have a priority claim on equipment cash flows. A significant portion of our leasing portfolios are comprised of operating leases, and a portion is comprised of leveraged leases, both of which increase our residual realization risk.
We and our subsidiaries are party to various financing arrangements, commercial contracts and other arrangements that under certain circumstances give, or in some cases may give, the counterparty the ability to exercise rights and remedies under such arrangements which, if exercised, may have material adverse consequences.
We and our subsidiaries are party to various financing arrangements, commercial contracts and other arrangements that give, or in some cases may give, the counterparty the ability to exercise rights and remedies upon the occurrence of a material adverse effect or material adverse change (or similar event), certain insolvency events, a default under certain specified other obligations or a failure to comply with certain financial covenants. Deteriorations in our business and that of certain of our subsidiaries may make it more likely that counterparties will seek to exercise rights and remedies under these arrangements. The counterparty could have the ability, depending on the arrangement, to, among other things, require early repayment of amounts owed by us or our subsidiaries and in some cases payment of penalty amounts. In these cases, we intend to enter into discussions with the counterparties where appropriate to seek a waiver under, or amendment of, the arrangements to avoid or minimize any potential adverse consequences.
We cannot assure you that we will be successful in avoiding or minimizing the adverse consequences which may, individually or collectively, have a material adverse effect on our ability to successfully restructure our business and on our consolidated financial position and results of operations. If we are unsuccessful in avoiding or minimizing the adverse consequences discussed above, such consequences could have a material adverse effect on our business, results of operations, and financial position.
Adverse or volatile market conditions could continue to negatively impact fees and other income.
In 2005, we began pursuing strategies to leverage our expanded asset generation capability and diversify our revenue base in order to generate higher levels of syndication and participation income, advisory fees, servicing fees and other types of fee income to increase other income as a percentage of total revenue. These revenue streams are dependent on market conditions and, therefore, have been more volatile than interest on loans and rentals on leased equipment. Current market conditions, including lower liquidity levels in the syndication market and our strategy to manage our growth due to our own funding constraints, have significantly reduced our syndication activity, and have resulted in significantly lower fee income. In addition, if other lenders become concerned about our ability to meet our obligations on a syndicated transaction, it may become more difficult for us to syndicate transactions that we originate or to participate in syndicated transactions originated by others. If we are unable to sell or syndicate a transaction after it is originated, we will end up holding a larger portion of the transaction and assuming greater underwriting risk than we originally intended, which could increase our capital and liquidity requirements to support our business or expose us to the risk of valuation allowances for assets held for sale. In addition, we also generate significant fee income from our factoring business. If our clients become concerned about our liquidity position and our ability to provide these services going forward and reduce their amount of business with us, this could further negatively impact our fee income and have a material adverse effect on our business. Continued disruption to the capital markets or the failure of our initiatives to produce increased asset and revenue levels could adversely affect our financial position and results of operations.
Investment in and revenues from our foreign operations are subject to various risks and requirements associated with transacting business in foreign countries.
An economic recession or downturn, increased competition, or business disruption associated with the political or regulatory environments in the international markets in which we operate could adversely affect us.
In addition, while we generally hedged our translation and transaction exposures, in the past, most of our hedging transactions were terminated by our counterparties as a result of our bankruptcy proceedings. If we are unable to replace our hedging transactions, foreign currency exchange rate fluctuations could have a material adverse effect on our investment in international operations and the level of international revenues that we generate from international financing and leasing transactions. Reported results from our operations in foreign countries may fluctuate from period to period due to exchange rate movements in relation to the U.S. dollar, particularly exchange rate movements in the Canadian dollar, which is our largest non-U.S. exposure.
Foreign countries have various compliance requirements for financial statement audits and tax filings, which are required to obtain and maintain licenses to transact business. If we are unable to properly complete and file our statutory audit reports or tax filings, regulators or tax authorities in the applicable jurisdiction may restrict our ability to do business.
We may be adversely affected by significant changes in interest rates.
Historically, we generally employed a matched funding approach to managing our interest rate risk, including matching the repricing characteristics of our assets with our liabilities. In many instances, we implemented our matched funding strategy through the use of interest rate swaps and other derivatives, most of which were terminated by our counterparties as a result of our bankruptcy proceedings. In addition, the restructuring resulted in the conversion of our debt to U.S. Dollar, fixed rate liabilities. The restructuring and the derivative terminations left us in an asset sensitive position as our assets will reprice faster than our liabilities. Therefore, any significant decrease in market interest rates may result in a decrease in net interest margins. Likewise our non U.S. Dollar denominated debt was converted to U.S. Dollars resulting in foreign currency transactional and translational exposures. Our transactional exposures may result in income statement losses should related foreign currencies depreciate relative to the U.S. Dollar and our equity account may be similarly impacted as a result of foreign currency movements. During the second half of 2007 and all of 2008 and 2009, credit spreads for almost all financial institutions, and particularly our credit spreads, widened dramatically and made it highly uneconomical for us to borrow in the unsecured debt markets to fund loans to our customers. In addition, the widening of our credit spreads relative to the credit spreads of many of our competitors has placed us at a competitive disadvantage and made it more difficult to maintain our interest margins. If we are unable to obtain funding, either in the capital markets or through bank deposits, at an economical rate that is competitive with other banks and lenders, we will be operating at a competitive disadvantage and it may have a material adverse effect on our business, financial condition, and results of operations.
We may be adversely affected by further deterioration in economic conditions that is general or specific to industries, products or geographic areas.
Prolonged economic weakness, or other adverse economic or financial developments in the U.S. or global economies or affecting specific industries, geographic locations and/or products, would likely further impact credit quality as borrowers may fail to meet their debt payment obligations, particularly customers with highly leveraged loans. Adverse economic conditions have and could further result in declines in collateral values, which also decreases our ability to fund against collateral. Accordingly, higher credit and collateral related losses could impact our financial position or operating results.
Our business has already been materially weakened by the recent credit crisis. A continued downturn in certain industries may result in reduced demand for products that we finance in that industry or negatively impact collection and asset recovery efforts. Decreased demand for the products of various manufacturing customers due to the recent recession may adversely affect their ability to repay their loans and leases with us. Similarly, a decrease in the level of airline passenger traffic due to the recent recession or other fears or a decline in railroad shipping volumes due to recession may adversely affect our aerospace or rail businesses, the value of our aircraft and rail assets and the ability of our lessees to make lease payments.
Competition from both traditional competitors and new market entrants may adversely affect our market share, profitability, and returns.
Our markets are highly competitive and are characterized by competitive factors that vary based upon product and geographic region. We have a wide variety of competitors that include captive and independent finance companies, commercial banks and thrift institutions, industrial banks, community banks, leasing companies, hedge funds, insurance companies, mortgage companies, manufacturers and vendors.
We compete primarily on the basis of pricing, terms and structure. If we are unable to match our competitors terms, we could lose market share. Should we match competitors terms, it is possible that we could experience margin compression and/or increased losses. We also may be unable to match competitors terms as a result of our current or future financial condition.
Item 1B. Unresolved Staff Comments
There are no unresolved SEC staff comments.
Item 2. Properties
CIT operates in the United States, Canada, Europe, Latin America, Australia and the Asia-Pacific region. CIT occupies approximately 1.6 million square feet of office space, the majority of which is leased. In conjunction with our strategic and business planning, we are analyzing the adequacy and necessity of all office space.
Item 3. Legal Proceedings
SECURITIES CLASS ACTION
In July and August 2008, putative class action lawsuits were filed in the United States District Court for the Southern District of New York (the New York District Court) on behalf of CITs pre-reorganization stockholders against CIT, its former Chief Executive Officer and its Chief Financial Officer. In August 2008, a putative class action lawsuit was filed in the New York District Court by a holder of CIT-PrZ equity units against CIT, its former CEO, CFO and former Controller and members of its current and former Board of Directors. In May 2009, the Court consolidated these three shareholder actions into a single action and appointed Pensioenfonds Horeca & Catering as Lead Plaintiff to represent the proposed class, which consists of all acquirers of CIT common stock and PrZ preferred stock from December 12, 2006 through March 5, 2008, who allegedly were damaged, including acquirers of CIT-PrZ preferred stock pursuant to the October 17, 2007 offering of such preferred stock.
In July 2009, the Lead Plaintiff filed a consolidated amended complaint alleging violations of the Securities Exchange Act of 1934 (1934 Act) and the Securities Act of 1933 (1933 Act). Specifically, it is alleged that the Company, its former CEO, CFO, former Controller, and a former Vice Chairman violated Section 10(b) of the 1934 Act by allegedly making false and misleading statements and omissions regarding CITs subprime home lending and student lending businesses. The allegations relating to the Companys student lending businesses are based upon the assertion that the Company failed to account in its financial statements or, in the case of the preferred stockholders, its registration statement and prospectus, for private loans to students of a helicopter pilot training school, which it is alleged were highly unlikely to be repaid and should have been written off. The allegations relating to the Companys home lending business are based on the assertion that the Company failed to fully disclose the risks in the Companys portfolio of subprime mortgage loans. The Lead Plaintiff also alleges that the Company, its former CEO, CFO and former Controller and those current and former Directors of the Company who signed the registration statement in connection with the October 2007 CIT-PrZ preferred offering violated the 1933 Act by making false and misleading statements concerning the Companys student lending business as described above.
Pursuant to a Notice of Dismissal filed on November 24, 2009, CIT Group Inc. was dismissed as a defendant from the consolidated securities action. The action will continue as to the remaining defendants and CITs obligation to defend such defendants continues. Plaintiffs seek, among other relief, unspecified damages and interest. CIT believes the allegations in these complaints are without merit.
In September 2008, a shareholder derivative lawsuit was filed in the New York District Court on behalf of CIT against its former CEO and current and former members of its Board of Directors, alleging defendants breached their fiduciary duties to CIT and abused the trust placed in them by wasting, diverting and misappropriating CITs corporate assets (the Lookkin Action). Also in September 2008, a similar shareholder derivative action was filed in New York County Supreme Court against CITs former CEO, CFO and current and former members of its Board of Directors (the Singh Action). The Lookkin Action and the Singh Action have been dismissed as a consequence of CITs bankruptcy case.
PILOT TRAINING SCHOOL BANKRUPTCY
In February 2008, a helicopter pilot training school (the Pilot School) filed for bankruptcy and ceased operating. Student Loan Xpress, Inc. (SLX), a subsidiary of CIT engaged in the student lending business, had originated private (non-government guaranteed) loans to approximately 2,600 students of the Pilot School, which totaled approximately $196.8 million in principal and accrued interest. SLX ceased originating new loans to students of this school in September 2007, but a majority of SLXs student borrowers had not completed their training when the school ceased operations.
After the Pilot School filed for bankruptcy and ceased operations, SLX voluntarily placed those students who were attending school at the time of the closure in grace such that no payments under their loans have been required to be made and no interest on their loans has been accruing. Multiple lawsuits, including putative class action lawsuits and collective actions, have been filed against SLX and other lenders alleging, among other things, violations of state consumer protection laws. SLX participated in a mediation with several class counsels and the parties have reached an agreement pursuant to which a nationwide class of students who were in attendance at the Pilot School when it closed will be formed for the purposes of settlement only, and their claims against SLX will be resolved. In November, 2009, the United States District Court for the Middle District of Florida preliminarily approved the proposed settlement agreement and fixed February 13, 2010 as the deadline for class members to object to, or request exclusion from, the class. Nearly 2,200 students of the Pilot School are included in the settlement. Borrowers and/or co-signors under approximately 3% of these loans have objected to the settlement and borrowers and/or co-signors under approximately 5% of these loans have opted out of the settlement.
The court also fixed March 22, 2010 as the hearing date to consider final approval of the settlement. The value of the Pilot School student loans have been written down to estimated fair market value in connection with the Companys post-bankruptcy implementation of Fresh Start Accounting. SLX also completed a settlement of a mass action commenced by students in Georgia, which is binding upon 37 SLX borrowers. The Attorneys General of several states also engaged in a review of the impact of the Pilot Schools closure on the student borrowers and any possible role of SLX. SLX cooperated in the review and has reached agreement with twelve state Attorneys General, pursuant to which, among other things, the Attorneys General support the class settlement that has been preliminarily approved by the court.
NOTEHOLDER ACTIONS CONCERNING $3 BILLION CREDIT FACILITY
In September 2009, three noteholders filed a derivative action in the Delaware Chancery Court (the Delaware Action) against two directors of CIT Group Funding Company of Delaware, LLC (Delaware Funding), alleging that the directors breached their fiduciary duties to CIT Funding by allowing CIT Funding to guaranty and grant liens upon its assets in connection with the $3 billion financing facility entered into by the Company in July 2009 (the Credit Facility).
On the same date, a group of noteholders, including the plaintiffs in the Delaware Action, commenced an action in the United States District Court for the Southern District of New York against Delaware Funding and many of the lenders involved in the Funding Facility. Plaintiffs brought the action on behalf of themselves and a purported class of all holders or owners of notes issued by Delaware Funding. Plaintiffs asserted the Credit Facility constituted a fraudulent transfer under New York law, and accordingly should be annulled.
These cases were dismissed with prejudice on or about December 10, 2009.
VENDOR FINANCE BILLING AND INVOICING INVESTIGATION
In the second quarter of 2007, the office of the United States Attorney for the Central District of California requested that CIT produce the billing and invoicing histories for a portfolio of customer accounts that CIT purchased from a third-party vendor. The request was made in connection with an ongoing investigation being conducted by federal authorities into billing practices involving that portfolio. Certain state authorities, including California, have been conducting a parallel investigation. The investigations are being conducted under the Federal False Claims Act and its state law equivalents. CIT is cooperating with these investigations, and substantial progress has been made towards a resolution of the investigations. Based on the facts known to date, CIT believes these matters will not have a material adverse effect on its financial statements or results of operations.
On January 8, 2010, Snap-on Incorporated and Snap-on Credit LLC (Snap-on) filed a Demand for Arbitration alleging that CIT retained certain monies owed to Snap-on in connection with a joint venture between CIT and Snap-on that was terminated on July 16, 2009. Snap-on is alleging that CIT improperly underpaid Snap-on during the course of the joint venture, primarily related to the purchase by CIT of receivables originated and serviced by the joint venture, and is alleging damages of approximately $115 million. On January 29, 2010, CIT filed its Answering Statement and Counterclaim, denying Snap-ons allegations on the grounds that the claims are untimely, improperly initiated, or otherwise barred. CIT also alleges that Snap-on wrongfully withheld payment of proceeds due to CIT from the receivables serviced by Snap-on on behalf of CIT. CIT is claiming damages in excess of $110 million. CIT believes that Snap-ons allegations are largely without merit.
RESERVE FUND INVESTMENT
At December 31, 2009, the Company had a remaining principal balance invested in the Reserve Primary Fund (the Reserve Fund), a money market fund, of $48.4 million, which was reduced to $8.1 million after January 2010 cash distributions. In November 2009, the U.S. District Court issued an Order, on application made by the SEC, requiring distribution of the Reserve Funds remaining assets, including $3.5 billion the Reserve Fund had placed in a reserve to pay liabilities and costs associated with lawsuits and regulatory actions. It is estimated by the Reserve Fund that investors will recover 99% of their investment. As of December 31, 2009, the Company reduced its accrued pretax charge to $6.6 million from $18 million.
In addition, there are various legal proceedings and government investigations against or including CIT, which have arisen in the ordinary course of business. While the outcomes of the ordinary course legal proceedings and the related activities are not certain, based on present assessments, management does not believe that they will have a material adverse effect.
Item 5. Market for Registrants Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities
On November 1, 2009, CIT Group Inc. and CIT Group Funding Company of Delaware LLC (Delaware Funding and together with the Company, the Debtors) filed voluntary petitions for relief under Chapter 11 of the U.S. Bankruptcy Code (the Bankruptcy Code) in the United States Bankruptcy Court for the Southern District of New York (the Court). The Debtors emerged from Chapter 11 of the Bankruptcy Code on December 10, 2009 (the Effective Date or Emergence Date). On the Effective Date, all of the outstanding common stock (Predecessor Common Stock) and all other outstanding equity securities of CIT, including all options and warrants, were cancelled pursuant to the terms of the plan of reorganization and CIT issued 200 million shares of new common stock (Successor Common Stock) to unsecured holders of debt subject to the bankruptcy proceedings. Because the value of one share of Successor Common Stock bears no relation to the value of one share of Predecessor Common Stock (a new equity value was established upon emergence) the following discussions contain information regarding Successor Common Stock.
Market Information Successor Common Stock trades on the New York Stock Exchange (NYSE) under the symbol CIT. The stock began trading on the NYSE on December 10, 2009, in conjunction with our emergence from Chapter 11 proceedings.
From November 3, 2009 through the Effective Date, shares of Predecessor Common Stock of CIT traded on the OTC Bulletin Board under the symbol CITGQ. Before November 1, 2009, Predecessor Common Stock traded on the NYSE under the symbol CIT.
The following tables set forth the high and low reported closing prices for Successor and Predecessor Common Stock.
Successor Common Stock
* For 2009, through December 9.
Holders of Common Stock As of February 26, 2010, there were 58,157 beneficial owners of Successor Common Stock.
Dividends We did not declare or pay any common stock dividends on the shares of Successor Common Stock issued in December 2009. The terms of our Credit Facility and Expansion Credit Facility restrict the payment of dividends on shares of common stock, and we do not anticipate paying any such dividends at this time. During the 2009 first quarter, a $0.02 dividend per share of Predecessor Common Stock was paid. The Board suspended further dividend payments during the second quarter.
Securities Authorized for Issuance Under Equity Compensation Plans All equity compensation plans in effect during 2009 prior to our Chapter 11 proceedings were approved by our shareholders. Equity awards with respect to these plans were cancelled upon emergence from bankruptcy. Our equity compensation plans in effect following the Effective Date were approved by the Court and do not require shareholder approval. Equity awards associated with these plans are presented in the following table.
We had no other equity compensation plans that were not approved by the Court or by shareholders. For further information on our equity compensation plans, including the weighted average exercise price, see Item 8. Financial Statements and Supplementary Data, Note 19 Retirement, Other Postretirement and Other Benefit Plans.
Issuer Purchases of Equity Securities No purchases of equity securities were made during the fourth quarter and there were no shares that may yet be purchased under any repurchase plans or programs.
Unregistered Sales of Equity Securities On the Effective Date of our Plan of Reorganization, we provided for 600,000,000 shares of authorized Successor Common Stock, par value $0.01 per share, of which 200,000,000 shares of Successor Common Stock were issued on the Effective Date, and 100,000,000 shares of authorized new preferred stock, par value $0.01 per share, of which no shares were issued on the Effective Date. We reserved 10,526,316 shares of Successor Common Stock for future issuance under the Amended and Restated CIT Group Inc. Long-Term Incentive Plan.
Based on the Confirmation Order, the Company relied on Section 1145(a)(1) of the United States Bankruptcy Code to exempt from the registration requirements of the Securities Act of 1933, as amended, the issuance of the new securities.
Shareholder Return The following graph shows the cumulative total shareholder return for Successor Common Stock during the period from December 10, 2009 to December 31, 2009. Five year historical data is not presented since we emerged from bankruptcy on December 10, 2009 and the stock performance of CIT is not comparable to the performance of Predecessor Common Stock. The chart also shows the cumulative returns of the S&P 500 Index and S&P Banks Index for the same period. The comparison assumes $100 was invested on December 10, 2009 (the date our new common stock began trading on the NYSE). Each of the indices shown assumes that all dividends paid were reinvested.
CIT STOCK PERFORMANCE DATA
*2009 returns based on opening prices December 10, 2009, the effective date of the Companys plan of reorganization through year-end. The opening prices were: CIT: $27.00, S&P 500: 1098.69, and S&P Banks: 124.73.
Tax Attribute Preservation Provision
In order to preserve valuable tax attributes following emergence from bankruptcy, restrictions were included in our Articles of Incorporation on transfers of Successor Common Stock (the Tax Attribute Preservation Provision). During the Restriction Period (as defined in our Certificate of Incorporation), unless approved by the Board, any attempted transfer of Successor Common Stock is prohibited and void to the extent that, as a result of such transfer (or any series of transfers) of either (i) any person or group of persons shall become a five-percent shareholder of the Company (as defined in Treasury Regulation Section 1.382-2T(g)) or (ii) the ownership interest of any five-percent shareholder shall be increased.
Notwithstanding the foregoing, nothing in the Tax Attribute Preservation Provision shall prevent a person from transferring New Common Stock to a new or existing public group of the Company, as defined in Treasury Regulation Section 1.382-2T(f)(13) or any successor regulation. The restrictions described above (the Restriction Period) commenced on the December 2, 2009 Confirmation Date and will remain in effect until the earlier of (a) 45 days after the second anniversary of the Confirmation Date, and (b) the date that the Board determines that (1) the consummation of the Plan did not satisfy the requirements of section 382(1)(5) of the Internal Revenue Code or treatment under that section is not in the best interests of the Company, (2) an ownership change, as defined under the Internal Revenue Code, would not result in a substantial limitation on the ability to use otherwise available tax attributes, or (3) no significant value attributable to such tax benefits would be preserved by continuing the transfer restrictions.
Item 6. Selected Financial Data
The following table sets forth selected consolidated financial information regarding our results of operations, balance sheets and certain ratios. As detailed in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations, upon emergence from bankruptcy on December 10, 2009, CIT adopted fresh start accounting, which results in data subsequent to adoption not being comparable to data in periods prior to emergence. Therefore, balances for CIT at December 31, 2009 are presented separately. Data for the year ended December 2009 and at or for the years ended December 2008, 2007, 2006 and 2005 represent amounts for Predecessor CIT. Predecessor CIT presents the operations of the home lending business as a discontinued operation. (See Item 8, Note 1 (Discontinued Operation) for data pertaining to discontinued operation.) The data presented below is explained further in, and should be read in conjunction with, Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and Item 7A. Quantitative and Qualitative Disclosures about Market Risk and Item 8. Financial Statements and Supplementary Data.
The following table presents Predecessor CITs individual components of net interest revenue and operating lease margins. It is followed by a second table that disaggregates changes in net interest revenue and operating lease margin to either the change in average balances (Volume) or the change in average rates (Rate). There is no impact from accretion or amortization of fresh start accounting adjustments in 2009.
Average Balances(1) and Associated Income for the year ended: (dollars in millions)
The table below disaggregates Predecessor CITs year-over-year changes (2009 versus 2008 and 2008 versus 2007) in net interest revenue as presented in the preceding tables between volume (level of lending or borrowing) and rate (rates charged customers or incurred on borrowings). Factors contributing to the lower rates in 2009 and 2008 include the overall drop in market interest rates and lower asset yields due to lower market rates. The Companys lending rates declined further than borrowing rates due to increase in our borrowing spreads (over Libor) due to market dislocation, our distressed circumstances and higher costs for maintaining liquidity. See Net Finance Revenue section for further discussion.
Changes in Net Interest Income (dollars in millions)
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
CIT Group Inc. is a bank holding company that provides financing and leasing capital principally for small business and middle market companies worldwide. We serve a wide variety of industries and offer vendor, equipment, commercial and structured financing products, as well as factoring and management advisory services. CIT is the parent of CIT Bank, a state-chartered bank in Utah. We operate primarily in North America, with locations in Europe, Latin America, Australia and the Asia-Pacific region. CIT has been providing financial solutions to its clients since its formation in 1908 and became a bank holding company (BHC) in December 2008. A more detailed description of the Company is located in Part I Item 1- Business Overview.
On November 1, 2009, CIT Group Inc. and CIT Group Funding Company of Delaware LLC (Delaware Funding, and together with CIT, the Debtors) filed voluntary petitions for relief under Chapter 11 of the U.S. Bankruptcy Code (the Bankruptcy Code) in the United States Bankruptcy Court for the Southern District of New York (the Court). The Debtors emerged from bankruptcy December 10, 2009 (the Effective Date or Emergence Date) pursuant to the Modified Second Amended Prepackaged Reorganization Plan of Debtors (the Plan of Reorganization).
As detailed in Note 2, the consolidated financial statements include the effects of adopting fresh start accounting upon emergence from bankruptcy, as required by accounting principles generally accepted in the United States of America (U.S. GAAP). The fair value of assets, liabilities and equity were derived by applying market information at the Emergence Date to account balances at December 31, 2009, unless those account balances were originated subsequent to December 10, 2009, in which case fair values were assigned based on origination value, or if the basis of accounting applicable to the balances was fair value, then fair value was determined using market information at December 31, 2009. As a result of emergence from bankruptcy, CIT became a new reporting entity for accounting purposes, with a new capital structure, a new basis in its assets and liabilities and no retained earnings or accumulated comprehensive income. We evaluated transaction activity between the Emergence Date and year end 2009 and concluded an accounting convenience date of December 31, 2009 was appropriate.
As the consolidated financial statements as of and for the years ended December 31, 2008 and 2007 are not impacted by any changes from fresh start accounting, the 2009 financial statements are not comparable to prior period financial statements. Historical financial statements of Predecessor CIT will be presented separately from CIT results in this and future filings.
We refer to CIT Group Inc. prior to the Emergence Date as Predecessor CIT or the predecessor and on and after the Emergence Date as Successor CIT or the successor or CIT. All references include subsidiaries of Successor CIT or Predecessor CIT, unless otherwise indicated or the context requires otherwise.
Managements Discussion and Analysis of Financial Condition and Results of Operations and Quantitative and Qualitative Disclosures about Market Risk contain financial terms that are relevant to our business and a glossary of key terms we use in our business is in Part I Item 1 Business Section.
Our financial information is presented separately for continuing operations and our home lending business discontinued operation. See Discontinued Operation and Note 1 in Item 8- Financial Statements and Supplementary Data for further information. Our disclosures contain certain non-GAAP financial measures. See Non-GAAP Financial Measurements for reconciliation of these to comparable GAAP measures.
BACKGROUND AND RESTRUCTURING
CIT historically funded its businesses with unsecured debt and, to a lesser extent, secured borrowings, both on and off balance sheet. In 2007 and 2008, the disruption in the global credit markets restricted our access to cost efficient funding. We embarked on a strategy to change our funding model by becoming a BHC. We received approval to become a BHC in December 2008 and converted our Utah industrial bank to a Utah State Bank, but we did not realize important benefits we hoped to achieve. Failure to obtain these benefits, coupled with deteriorating loan portfolio credit performance, accelerating client line draw activity and debt rating downgrades, exacerbated an already strained liquidity situation and culminated with CIT Group Inc, the parent company, and one non-operating subsidiary, Delaware Funding, filing prepackaged voluntary petitions for relief under the Bankruptcy Code on November 1, 2009. On December 31, 2008, we issued $2.3 billion of preferred stock and a warrant to purchase our predecessor common stock to the U.S. Treasury as a participant in the TARP Capital Purchase Program. In conjunction with the bankruptcy, we issued contingent value rights (CVRs) to the U.S. Treasury in exchange for the preferred stock and warrant previously issued, which were cancelled. We emerged from bankruptcy on December 10, 2009. The CVRs expired without any value on February 8, 2010.
The restructuring strengthened our liquidity and capital, but did not address our long-term funding model. Debt levels were reduced by approximately $10.4 billion, and principal repayments on the $23.2 billion new second lien notes we issued do not start until 2013, relieving near-term funding stress. All predecessor common stock and preferred stock were cancelled, and 200 million shares of successor common stock were issued to eligible debt holders.
With the recapitalization and changes to our Board of Directors essentially completed, as well as the appointment of John A. Thain as Chairman and Chief Executive Officer on February 8, 2010, we are developing strategic and business plans focused on optimizing our business and creating a viable long-term funding model. The Board and CEO are currently conducting a search for a Chief Financial Officer, a Chief Risk Officer, and certain other senior executives. While the new Board and management team refine our strategy and business plan, we continue to transition to a smaller company focused on serving small and mid-sized commercial businesses with CIT Bank as part of our business and funding model.
During the summer and fall of 2009, the Company and its Board of Directors, in consultation with its advisors, developed an overall business reorganization strategy focused on creating a sustainable and profitable company by bolstering our financial strength and enhancing our funding model.
Our objectives with respect to improving financial strength include:
Our objectives with respect to enhancing our business model include:
We developed a three-phased plan and have made significant progress executing this plan as discussed below:
Phase 1 Addressed Liquidity Challenges
On July 15, 2009, we determined that some of the benefits we hoped to achieve by becoming a BHC would not be realized. We experienced higher draws by our customers on loan financing commitments, which accelerated the weakening of our liquidity position.
On July 20, 2009, we entered into the $3 billion Credit Facility with Barclays Bank PLC and other lenders, largely existing bondholders. The Credit Facility was secured by substantially all of the Companys unencumbered assets. The Company drew $2 billion under the Credit Facility on July 20th and the balance on August 4th. The Credit Facility allowed us to conduct business in the ordinary course, while working to develop and adopt a restructuring plan by October 1, 2009.
Also on July 20, 2009, we commenced a cash tender offer for outstanding floating rate senior notes due August 17, 2009 (the August 17 Notes). On August 3rd, the Company amended the terms of the offer to purchase any and all of the August 17 Notes for $875 for each $1,000 principal amount tendered as total consideration. The offer was consummated for approximately 58% of the outstanding principal amount with the balance repaid at par.
On October 28, 2009, we amended and restated the Credit Facility to expand the commitments by $4.5 billion (the Expansion Credit Facility). The Expansion Credit Facility is secured by substantially the same assets as the Credit Facility, plus any additional collateral which becomes available as a result of repayment of certain refinanced indebtedness. At year-end, the Company had drawn the full $4.5 billion. The first lien term loans are subject to a fair value collateral coverage covenant (based on accounting valuation methodology) of 2.5x the outstanding loan balance tested quarterly and upon the financing, disposition or release of certain collateral. As of December 31, 2009, the coverage ratio was 2.9x. See Note 9 Long-term Borrowings for detail.
On October 30, 2009, we secured an incremental $1 billion committed line of credit as a backup facility to ensure liquidity during the execution of our recapitalization. This line of credit was not utilized and expired on December 31, 2009.
On February 9, 2010, the Company voluntarily prepaid $750 million principal amount of the $7.5 billion first lien term loans under the Credit Facility and the Expansion Credit Facility, using available cash. The prepayment was applied pro-rata across both facilities. The prepayment was subject to a 2% payment premium ($15 million).
Phase 2 Recapitalized the Balance Sheet
We commenced our Reorganization Plan on October 1, 2009. Under the Plan, which was approved by the Board of Directors and by a Steering Committee of bondholders, CIT Group Inc. and Delaware Funding launched exchange offers for certain unsecured notes with a concurrent debt holder solicitation to approve a prepackaged plan of reorganization. Consummation of the exchange offer was conditioned upon satisfying certain liquidity and leverage conditions. Approval of the prepackaged Plan of Reorganization required votes by each class in favor from at least two-thirds of principal amount voting, and over half of the number of voters.
The bondholder votes were overwhelmingly supportive of the prepackaged Plan of Reorganization. All classes voted to accept the Plan with votes substantially exceeding required thresholds. Over 80% in principal amount of Predecessor CITs eligible debt voted, and over 90% in principal amount supported the Plan. Approximately 90% of the number of debt holders who voted, both large and small, cast affirmative votes for the Plan. The voting conditions to consummate the exchange offer were not satisfied.
On November 1, our then Board of Directors proceeded with the voluntary prepackaged bankruptcy filing for Predecessor CIT and Delaware Funding. Due to the overwhelming support from debt holders, we requested and received a quick confirmation from the Bankruptcy Court of the plan on December 8, 2009. CIT consummated the Plan and emerged from bankruptcy on December 10, 2009.
The Companys operating subsidiaries were not part of the filing and continued to conduct business. Pursuit of the reorganization was reviewed with the Companys primary regulators.
Significant results of consummation of the Plan included:
See Note 2 Fresh Start Accounting for additional information.
The Expansion Credit Facility and new second lien notes issued under the Plan of Reorganization include a cash sweep provision that is designed to accelerate the repayment of such debt using cash in excess of certain thresholds generated from asset collections. The Plan called for corporate governance changes that resulted in significant change in the composition of the Board of Directors.
Phase 3 Execute Strategic Business Plan
Following confirmation of the Plan of Reorganization, significant changes were made to our Board of Directors. Seven new members were recommended by large debt holders, reviewed and approved by the Nominating and Governance Committee, approved by the Federal Reserve Bank of New York, and appointed by the Board. Two incumbent members resigned and five incumbent members, who have served for several years, continue to serve as Directors. On January 21, 2010, one of the new members notified CIT that he was resigning as a director effective immediately due to short-term health issues and that position remains vacant. On February 8, 2010, John A. Thain became the Companys Chairman and Chief Executive Officer, replacing our former CEO, who resigned effective January 15, 2010. The Board and CEO are currently conducting a search for a Chief Financial Officer, a Chief Risk Officer, and certain other senior executives.
We believe our improved capital and liquidity afford us the time and resources required to execute the balance of our strategy, including refinement of our business model, identification of strategic options for select businesses or portfolios, efficiency enhancements and implementation of a long term funding strategy, which we currently expect will be a bank-centric model. We believe we have emerged from bankruptcy with the BHC as a source of strength for CIT Bank.
Subject to the new management team and reconstituted Board of Directors continuing to develop and refine our business strategy, the Company intends to continue to pursue its strategy of transferring most bank-like business lending operations, or platforms, to CIT Bank and to have future originations by those businesses occur in the Bank, subject to approval by our regulators. The benefit of conducting these businesses in CIT Bank is to enhance their profitability by funding them with more cost-effective and stable funding sources. Corporate finance, small business lending, vendor finance and possibly trade finance are the business platforms we currently believe are most suitable to operate in CIT Bank, although this could change.
If these platforms are transferred, the legacy portfolios will remain in current non-bank subsidiaries and will be managed to maximize returns. We will use cash generated from interest and principal payments on such legacy portfolios to reduce high-cost holding company indebtedness. Non-transferred businesses will be evaluated to maximize long term value. As the new model is reviewed, we plan to maintain conservative new business volumes, with a return to growth in core businesses as the Company and economy recover. In the long term, the Company will need to further diversify its funding base by accessing capital markets, either at the holding company or CIT Bank, and by adding commercial and retail deposits at CIT Bank, subject to regulatory approval.
As described in Risk Factors, the Company must obtain regulatory approval in order to transfer any of its business platforms into CIT Bank or to establish or acquire any retail branch network and as such, there are risks to the successful development of a bank funding model. If the Company is unsuccessful in obtaining approval to transfer platforms into CIT Bank or to establish or acquire retail branch network, we would continue to constrain new business volumes and pursue alternative paths to maximize franchise value, including developing alternative funding sources, the potential sale or joint venture of businesses, and/or portfolio liquidations. These actions would be accompanied by reductions in operating expenses in order to maintain profitability.
CIT expects to remain focused on providing financing solutions to small and medium size businesses, a market sector that remains relatively underserved by both large national banks and smaller regional and local banks. We believe that the opportunities in this market will be compelling in the future as many independent financing companies did not survive the current economic downturn and few banks have the focused sales, underwriting and operational know-how required to serve this specialized market sector. We believe that a streamlined business model, combined with stable and competitive funding, would position us to return to profitability, depending on economic conditions.
EMERGENCE FROM BANKRUPTCY
Reorganization items are expenses directly attributed to our reorganization and include the impact of debt exchanges and discharges, professional fees, financing fees, and other costs. Reorganization items, net totaled $10.3 billion (benefit to capital) primarily consisting of the following:
Fresh Start Accounting
The Company emerged from bankruptcy on December 10, 2009. In accordance with U.S. GAAP, the Company adopted fresh start accounting and adjusted historical carrying values of assets and liabilities to fair values at the Emergence Date. Simultaneously, the Company determined the fair value of equity. The Company selected a Convenience Date of December 31, 2009. As a result, fresh start accounting adjustments are reflected in the balance sheet at December 31, 2009 and in the statement of operations for the year ended December 31, 2009. There is no statement of operations for the period between December 10 and December 31, 2009 and accretion and amortization of fresh start accounting adjustments will begin in 2010.
In applying fresh start accounting, management performed a two-step valuation process. First, the Company re-measured all tangible and intangible assets and all liabilities, other than deferred taxes, at fair value. Deferred tax values were determined in conformity with accounting requirements for income taxes. The resulting net asset value totaled $8.2 billion. Second, management separately calculated a reorganization equity value of $8.4 billion by applying generally accepted valuation methodologies. The excess of reorganization equity value over the fair value of net assets of $239 million was recorded as goodwill.
Reorganization equity value represents the Companys estimate of the amount a willing buyer would pay for CITs net assets immediately after the reorganization. This amount was determined by CIT management with assistance from an independent financial advisor, who developed the reorganization equity value using a combination of three measurement methodologies. First, expected future free cash flows of the business, after emergence from Chapter 11, were discounted at rates reflecting perceived business and financial risks (the discounted cash flows or DCF). Second, market book value multiples for peer companies were compiled. Third, book value multiples in recent merger and/or acquisition transactions for companies in similar industries were also compiled. The three results were combined to arrive at the final equity valuation.
The impacts on the 2009 balance sheet, prospective impacts on the statement of operations and impacts to the comparability of credit and other financial metrics to prior periods are discussed below. See Note 2 Fresh Start Accounting for detailed information on valuation assumptions, determination of reorganization equity value and reorganization value, and reorganization and fresh start accounting adjustments.
Loans with publicly available market information were valued based upon such market data. Finance receivables without publicly available market data were valued by applying a discount rate to each assets expected cash flows. To determine the discount rate, loans and lease receivables were first aggregated into logical groupings based on the nature and structure of the lending arrangement and the borrowers business characteristics, geographic location and credit quality; an aggregate level discount rate was then derived for each loan grouping based on a risk free index rate plus a spread for credit risk, duration, liquidity and other factors as determined by management. Where appropriate at the individual loan or lease receivable level, additional adjustments were made to the discount rate based on the borrowers industry.
For finance receivables which are not considered impaired and for which cash flows were evaluated based on contractual terms, the discount will be accretable to earnings in future periods. This discount will be accreted using the effective interest method as a yield adjustment over the remaining lives and will be recorded in Interest Income. If the finance receivable is prepaid, the remaining accretable balance will be recognized in Interest Income. If the finance receivable is sold, the remaining discount will be considered in the resulting gain or loss. If the finance receivable is subsequently classified as non-accrual, the accretion of the discount may cease.
Capitalized loan origination costs, loan acquisition premiums and other similar items, that were previously amortized over the life of the related assets, were written off.
For finance receivables which are considered impaired or for which the cash flows were evaluated based on expected cash flows, that are less than contractual cash flows, there will be an accretable and a non-accretable discount. The non-accretable discount effectively serves as a reserve against future credit losses on the individual receivables so valued. The non-accretable discount reflects the present value of the difference between the excess of cash flows contractually required to be paid and expected cash flows (i.e. credit component). The non-accretable discount is recorded as a reduction to finance receivables and will be a reduction to future charge-offs or will be reclassified to accretable discount should expected cash flows improve. The accretable discount will be accreted using the effective interest method as a yield adjustment over the remaining lives and will be recorded in Interest Income. Finance receivables which are on non-accrual will not accrete the accretable discount until the account returns to performing status. See Financing and Leasing Assets section for detail of adjustments by segment.
Allowance for loan losses
As a result of fresh start accounting, the allowance for loan losses at December 31, 2009 was eliminated and effectively recharacterized as either non-accretable or accretable discounts. For Successor CIT, a provision for loan losses will be recorded in the future for both estimated losses on loans originated subsequent to the Emergence Date and additional losses, if any, required on loans existing at the Emergence Date.
Reporting of net charge-offs and non-accrual balances will be impacted in future periods. We expect that prospective charge-offs in the near term will be lower than historical levels because losses on loans existing at the Emergence Date will be allocated to non-accretable and accretable discount. To the extent the loss is in excess of the discount, the difference will be reported as a charge-off.
Non-accrual loans as of December 31, 2009 are reported net of fresh start accounting discounts. Non-accrual reporting and accounting for loans originated subsequent to emergence will continue in accordance with historical reporting.
Operating Lease Equipment
A discount was recorded to net operating lease equipment to record the equipment at its fair value. This adjustment will reduce depreciation expense over the remaining useful lives of the respective equipment on a straight line basis.
An intangible asset of $225 million was recorded for net above and below market lease contracts. These adjustments (net) will be amortized thereby lowering rental income (a component of Other Income) over the remaining lives of the lease agreements on a straight line basis.
Other assets were reduced to estimated fair value. This adjustment included a discount on a receivable from Goldman Sachs International (GSI) in conjunction with a secured borrowing facility and write-offs of deferred debt underwriting costs and deferred charges. The discount on the GSI receivable will be accreted into Other Income over the expected payout of the receivable.
Goodwill of $239 million was recorded to reflect the excess of reorganization equity value over the fair value of tangible and identifiable intangible assets, net of liabilities.
On November 1, 2009, the debt subject to the Plan was written down to the principal amount due by writing off any remaining unamortized debt discounts and hedge accounting adjustments. During the bankruptcy period from November 1, 2009 to December 10, 2009, we did not record any contractual interest expense on debt subject to the Plan. All debt, including debt issued in conjunction with the Plan, was adjusted to fair value. The fair value discount lowered debt balances and will be amortized, thereby increasing interest expense over the lives of the respective debt. This amount was offset by write-offs, related to capitalized amounts of debt not discharged in the Plan of Reorganization.
Deposits were adjusted to fair value. The related fair value premium will be amortized as a yield adjustment over the respective lives of the deposits and reflected as a reduction in interest expense.
Deferred income taxes were determined in conformity with relevant accounting requirements. Deferred tax assets, net of valuation allowance related to fresh start accounting adjustments and were attributable to selected foreign jurisdictions.
Other liabilities were increased to estimated fair value, which relates primarily to a liability recorded for valuation of unfavorable forward order commitments to purchase aircraft partially offset by lower deferred tax liabilities. When the assets are ultimately purchased, the cost basis of the asset will be reduced by the amount of this liability.
Through the combination of reorganization adjustments and fresh start accounting, all Predecessor equity was eliminated and the fair value of the new equity of CIT was determined to be $8.4 billion. The equity value was based on our financial projections using various valuation methods, including (1) a comparison to market values and ratios of comparable companies; (2) a review of merger and acquisition transactions in our industry; and (3) a calculation of the present value of expected future cash flows i.e. discounted cash flow analysis. The realization of such equity value is dependent upon future trading values of comparable companies, future financial results compared to those in our projections, as well as certain other assumptions. There can be no assurance that the projections will be achieved or that the assumptions will be realized. The excess equity value over the fair value of tangible and identifiable intangible assets, net of liabilities, has been reflected as goodwill.
Summary of Fresh Start Accounting
The following table presents fresh start accounting adjustments by balance sheet caption:
Estimated fresh start accounting adjustments accretion and amortization is presented below:
Estimated Accretion / (Amortization) of Fresh Start Accounting Adjustments (dollars in millions)
All estimates, assumptions, valuations, appraisals and financial projections, including the fair value adjustments, fair value accretion rates, the financial projections, the reorganization value and reorganization equity value, are inherently subject to significant uncertainties beyond our control. Accordingly, there can be no assurance that the estimates, assumptions, valuations, appraisals and the financial projections will be realized and actual results could vary materially.
PERFORMANCE MEASUREMENTS, OBJECTIVES AND EXPECTATIONS
With our emergence from bankruptcy, management is focusing on performance improvement and will utilize various measurements to track progress. The following chart reflects key performance indicators we use currently:
2010 Priorities and Performance Expectations
While 2008 was a transformational year, during which we transitioned our charter from an independent diversified finance company to a Bank Holding Company and broadened the powers of CIT Bank from a Utah industrial bank to a full charter Utah state bank, we were unsuccessful in realizing the important benefits of that transformation. As a result, the Company experienced liquidity pressure in 2009 that ultimately resulted in CIT Group Inc. and Delaware Funding reorganizing in November to December 2009 through a pre-packaged bankruptcy. The reorganization materially reduced our debt balances, significantly increased our liquidity runway, improved our capital ratios and positioned the Company for a return to profitability in the future.
With the recapitalization and changes to the composition of the Board of Directors essentially completed, as well as a new CEO appointed, we have set out the following primary objectives for 2010:
CIT expects to return to profitability in 2010 after the impact of Fresh Start Accounting (FSA), which will provide a significant level of non-cash operating income. FSA adjustments will result in significantly higher yields on loans and leases reflecting accretion revenue related to the net accretable discount.
Excluding FSA, the Company believes performance will improve somewhat in 2010 but not to profitability as we work through the lingering effects of the reorganization, including high cost debt that pressures finance margin, and our credit quality remains weak based on expectations that economic conditions, while improving, will remain weak. Key performance drivers and financial assumptions for 2010 are likely to include:
BANK HOLDING COMPANY AND CIT BANK
The Company and CIT Bank are each subject to various regulatory capital requirements set by the Federal Reserve Board and the FDIC, respectively. CIT committed to its regulators to maintain a 13% Total Capital Ratio at the BHC. Failure to meet minimum capital requirements can result in regulators taking certain mandatory, or in some circumstances discretionary, actions (including requiring CIT to divest CIT Bank or CIT Bank becoming subject to FDIC conservatorship or receivership) that could have a material adverse effect on the Company.
During 2009, Predecessor CITs Total Capital Ratio fell below 13%. Consummation of our Plan of Reorganization in December improved our capital levels such that post emergence CITs Total Capital ratio is above the required level. Notwithstanding our improved capital ratios, the Company remains subject to regulatory actions described below.
Cease and Desist Orders
On July 16, 2009, the FDIC and the Utah Department of Financial Institutions (the UDFI) each issued a Cease and Desist Order to CIT Bank (together, the Orders). The Orders were in connection with the diminished liquidity of Predecessor CIT and not reflective of any financial conditions of CIT Bank. The Orders have not had an adverse impact on CIT Bank. CIT Bank, without admitting or denying any allegations made by the FDIC and UDFI, consented and agreed to issuances of the Orders.
Each of the Orders directs CIT Bank to take certain affirmative actions, including among other things, ensuring that it does not allow any extension of credit to CIT or any other affiliate of CIT Bank or engage in any covered transaction, declare or pay any dividends or other payments representing reductions in capital, or increase the amount of Brokered Deposits above the $5.527 billion outstanding at July 16, 2009, without the prior written consent of the FDIC and the UDFI. Since the receipt of the Orders, the Company chose to limit new corporate loan originations by CIT Bank. On August 14, 2009, CIT Bank provided to the FDIC and the UDFI a contingency plan that ensures the continuous and satisfactory servicing of Bank loans if CIT is unable to perform such servicing.
CIT entered into a Written Agreement, dated August 12, 2009 (the Written Agreement), with the Federal Reserve Bank of New York (the FRBNY). The Written Agreement requires regular reporting to the FRBNY, the submission of plans related to corporate governance, credit risk management, capital, liquidity and funds management, the Companys business and the review and revision, as appropriate, of the Companys consolidated allowances for loan and lease losses methodology. Prior written approval by the FRBNY is required for payment of dividends and distributions, incurrence of debt, other than in the ordinary course of business, prepayment of debt and the purchase or redemption of stock. The Written Agreement also requires notifying the FRBNY prior to the appointment of new directors or senior executive officers, and imposes restrictions on indemnifications and severance payments. Each of the new directors that were appointed by the Board of Directors subsequent to our emergence from bankruptcy and the appointment of John A. Thain, our new Chairman and CEO, were reviewed with the FRBNY.
The Board of Directors appointed a Special Compliance Committee to monitor and coordinate compliance with the Written Agreement. We submitted a capital plan and a liquidity plan on August 27, 2009, a credit risk management plan on October 8, 2009 and a corporate governance plan and a business plan on October 26, 2009, as required by the Written Agreement. Our liquidity, governance and credit risk management plans were updated and submitted to the FRBNY on January 29, 2010. The Company is continuing to provide periodic reports to the FRBNY as required by the Written Agreement. The Written Agreement has not been affected by the consummation of the Plan.
Metrics as of and for the year ending December 31, 2009
At December 31, 2009, CITs consolidated Tier 1 and Total Capital Ratios (after reorganization and fresh start accounting adjustments) were each 14.2%, improved from 9.4% and 13.1% at December 31, 2008. We reduced consolidated risk-weighted assets to $55.2 billion from $79.4 billion at December 31, 2008, reflecting constrained new business volumes and fresh start accounting.
At December 31, 2009, CIT Banks total assets were $9.1 billion, up from $3.5 billion at December 31, 2008. Deposits totaled $5.2 billion, up from $2.9 billion at December 31, 2008. The increase in assets resulted from the transfer of government guaranteed student loans and accrued interest totaling $5.7 billion during 2009 pursuant to an exemption from Section 23A of the Federal Reserve Act. In consideration for this asset transfer, the bank assumed $3.5 billion of related debt, mostly conduit financing, and paid approximately $1.6 billion of cash to CIT Group Inc. For the year ended December 31, 2009, the bank recorded net income of $0.1 billion (prior to fresh start accounting adjustments of $0.4 billion), and total capital ended at $1.7 billion. CIT Banks Tier 1 and Total Capital Ratios (after fresh start accounting) were each 45.9% at December 31, 2009, improved from 22.2% and 23.5%, respectively, at December 31, 2008.
2009 CONSOLIDATED FINANCIAL PERFORMANCE REVIEW
CITs 2009 results reflect the impact of filing voluntary petitions for relief under the Bankruptcy Code and emergence therefrom, including fresh start accounting and reorganization adjustments, liquidity constraints that have curtailed lending and contributed to high borrowing costs, poor credit performance and the weak economic environment that heightened credit costs. When combined, these and other factors contributed to CITs net loss of $3.8 million, $0.01 per share (based on shares of Predecessor Common Stock) for the year. Excluding reorganization and fresh start accounting adjustments, the net loss was $4.1 billion.
Interest margin contracted reflecting higher costs associated with secured borrowing transactions, lower asset levels, as well as losses on derivatives terminated and derivatives which no longer qualified for hedge accounting, and termination fees on existing borrowing facilities.
The weak economic environment negatively impacted our credit performance. Non-accrual accounts and charge-offs trended up, resulting in a significantly increased provision for credit losses.
Salaries and general operating expenses were down in 2009, consistent with the smaller asset base, but were partially offset by higher professional fees associated with reorganization initiatives.
The following present certain noteworthy items and the quarter in which they arose:
NET FINANCE REVENUE
Net Finance Revenue (dollars in millions)
The following tables present managements view of consolidated margin and includes the net interest spread we make on loans and equipment we lease, in dollars and as a percent of average earning assets. There is no impact from accretion or amortization of fresh start accounting adjustments in 2009. Accretion and amortization of fresh start accounting adjustments will begin in 2010 and various components of net finance revenue will be impacted. See Emergence from Bankruptcy for related discussion.
Factors contributing to the decreases in net finance revenue in dollars and as a percent of average earning assets included higher funding costs due to market dislocation and CITs distressed circumstance, lower asset yields due to lower general market rates, lower asset levels and higher costs for maintaining liquidity.
The year over year variances in net finance revenue percentages are summarized in the table below:
Change in Net Finance Revenue as a % of AEA
Net finance revenue continued to reflect the declining asset base as well as increased borrowing costs. Although market interest rates declined and remained low from 2007 through 2009, the decline in benchmark rates was offset by CITs higher funding spreads. Our borrowing spreads over benchmark rates increased significantly, reflecting credit downgrades due to operating losses and portfolio deterioration, which effectively restricted our access to lower cost unsecured debt markets and limited us to utilizing only secured lending markets.
A decline in the net finance revenue percentage was due to incrementally higher borrowing costs associated with secured borrowings, including the Credit Facility and Expansion Facility. Our plan, going forward, is to utilize excess cash, new secured financings and asset sale proceeds to repay high cost debt. In February 2010, we repaid $750 million of the Credit Facility and Expansion Credit Facility from available cash. The 2009 margin was negatively affected by lower operating lease margins, maintaining cash balances, losses related to the unwinding of terminated swaps, joint venture related activities, and higher non-accrual loans.
Net finance revenue in 2008 decreased 20% versus 2007 on constrained growth in average earning assets, as the Company controlled growth to maintain liquidity. In addition to higher funding costs, other negative factors included lower asset yields and high liquidity costs. As a percentage of average earning assets, net revenue decreased in 2008 primarily due to the cost of increased liquidity and widening of CITs borrowing spreads over benchmark rates, coupled with higher non-accrual loans and compressed operating lease margins.
Net finance revenue for our commercial segments and corporate and other (including the cost of increased liquidity and other unallocated treasury costs) as a percentage of average earning assets declined to 1.01% in the current year from 2.34%. See Results by Business Segment Corporate and Other for more information.
Net Operating Lease Revenue as a % of Average Operating Leases (AOL) (dollars in millions)
Net operating lease revenue for 2009 of $758 million was down 8% as the relatively strong performance of the commercial aerospace portfolio was offset by decreased rentals in rail. Rail lease and utilization rates are under pressure as carriers and shippers reduce their fleets and return cars to us. At December 31, 2009, our entire commercial aircraft portfolio was leased while rail utilization decreased to 90% from 95%. In aerospace, 90% of the new aircraft to be delivered from our 2010 order book has been placed on lease. See Concentrations Operating Leases for additional information.
The 2008 decrease in net operating lease revenue as a percentage of average operating lease assets reflects lower lease rates primarily in rail and write downs to certain residual balances. See Concentrations Operating Leases for additional information.
Credit performance throughout 2009 continued to be impacted negatively by ongoing economic weakness globally. Nonaccrual loans and charge-offs increased significantly, particularly in the commercial real estate, printing, publishing, energy, lodging, leisure and small business lending sectors. Our Corporate Finance cash flow loan portfolio was most severely impacted. As a result, we had a higher provision for loan losses and increased our allowance for loan losses significantly from 2008 levels.
Before fresh start accounting, the December 31, 2009 allowance for loan losses totaled $1,786.2 million, up significantly from $1,096.2 million at December 31, 2008. As a percent of finance receivables, before fresh start accounting, the allowance increased to 4.34% more than doubling from 2.06 % at last year-end. As a result of adopting fresh start accounting, the allowance for loan losses at December 31, 2009 was eliminated in its entirety and effectively recorded as discounts on loans as part of the fair value of finance receivables. A portion of the discount attributable to embedded credit losses, is recorded as non-accretable discount and will be utilized as such losses occur. Prospectively, the allowance for loan losses will be established for loans recorded subsequent to the Emergence Date, and for any further credit deterioration in excess of the fair value discounts recorded for loans on balance sheet at the Emergence Date.
The allowance for loan losses is intended to provide for losses inherent in the portfolio based on estimates of the ultimate outcome of collection efforts, realization of collateral values, and other pertinent factors such as estimation risk related to performance in prospective periods. We may make adjustments to the allowance depending on general economic conditions and specific industry weakness or trends in our portfolio credit metrics, including non-accrual loans and charge-off levels and realization rates on collateral.
Our allowance for loan losses includes three components: (1) specific reserves for impaired loans, (2) reserves for estimated losses inherent in non-impaired loans based on historic loss experience and our estimates of projected loss levels and (3) a qualitative adjustment to the reserve for economic risks, industry and geographic concentrations and other factors. Our historic policy was to recognize losses through charge-offs when there was loss certainty after considering the borrowers financial condition and underlying collateral and guarantees and the finalization of collection activities. In the third quarter of 2009, we accelerated charge-offs on loans for which we had previously provided specific reserves. As a result, this acceleration had no material impact on the provision for credit losses. This acceleration resulted from refinements to our policy following an analysis conducted pursuant to the Written Agreement with the FRBNY, reflecting the view that losses on impaired loans should be recognized as charge-offs prior to finalization of collection activities. Approximately $500 million in accelerated charge-offs were taken, principally on Corporate Finance loans that were specifically reserved as of June 30, 2009, or would have been specifically reserved during the third quarter under our prior practice.
See Risk Factors for additional disclosure on our allowance for loan losses.
The following table presents detail on our allowance for loan losses including charge-offs and recoveries:
Reserve and Provision for Credit Losses (dollars in millions)
(1) Represents reserve as a percentage before fresh start accounting.
Overall credit metrics weakened. Net charge-offs increased largely reflecting the deterioration from the slow economy, high unemployment and constrained market liquidity. This impact was most notable in specific industries within Corporate Finance.
Corporate Finance continues to be our business most severely impacted by the weak economic environment due to a higher proportion of leveraged cash flow loans and exposure to industries dependent on discretionary business and consumer spending.
We have experienced credit losses well in excess of the rates that we predicted in our modeling, particularly in our exposures to the print, media, gaming, commercial real estate, small business lending and energy industries. In 2009, approximately 43% of our commercial credit losses were in these sectors, while these industries constituted only about 10% of our overall loan portfolio. We have put limits and more stringent underwriting criteria in place for lending to these industries and for lending based solely on cash flow. Underwriting changes include lower advance rates, significantly lower leverage thresholds, tighter financial covenants and shorter maturities. We ceased extending credit to the commercial real estate sector in 2007.
Transportation Finance had a minimal level of charge-offs in 2009, all related to Business Air loans. While no charge-offs were taken in our commercial airline portfolio, the commercial airline industry remains under pressure and this could cause future non-accruals and/or charge-offs. Credit risks in the commercial air portfolio are mitigated by the value of the collateral we lend against and the fact that the large majority of our portfolio is operating leases, which gives us greater flexibility if our lessees experience financial deterioration.
Trade Finance net charge-offs and non-accrual loans increased as the weak economic environment with high unemployment and more constrained consumer spending continued to negatively impact retailers and suppliers. However, given our deep and long tenured experience in the trade finance business and the relatively short term nature of the receivables, the overall credit performance in this segment was in line with expectations given the depth of the economic downturn. Proactive management of our exposure and obtaining additional collateral where possible on problem accounts helped minimize the impact of the downturn.
Vendor Finance charge-offs were higher in 2009. Given our focus on smaller balance transactions with broad industry and geographic diversification, and the essential nature of the equipment we lend and lease against in this segment, the impact of the macro economic slowdown, although significant, has been less severe in Vendor Finance than in Corporate Finance. Sector specific weakness was experienced in print, industrial and franchise.
Consumer charge-offs were up slightly due to the continued seasoning and run off of these portfolios, principally student lending. Management anticipates that performance will continue to weaken as the student loan portfolio seasons and a higher proportion of loans enter the repayment period. The large majority of our student loan portfolio is 97% guaranteed by the U.S. government thereby mitigating our ultimate credit risk.
The following table presents charge-off by business segment. See Results by Business Segment for additional information.
Net Charge-offs (charge-offs net of recoveries) as a Percentage of Average Finance Receivables (dollars in millions)
Non-accrual loans, prior to fresh start accounting, virtually doubled from 2008, with the majority of increase in Corporate Finance. This increase was primarily in the following sectors: communication, media, entertainment, energy, infrastructure, commercial real estate and small business lending. The increase in Vendor Finance was primarily in Europe.
In response to the weak credit environment and performance, a centralized Problem Loan Management group was created to manage problem loans across all business segments, with a strong focus on Corporate Finance. Centralizing this group creates increased specialization, efficiencies and effectiveness to maximize recoveries.
The tables below present information on non-performing loans:
Non-accrual, Restructured and Past Due Loans at December 31 (dollars in millions)
Non-accruing Loans as a Percentage of Finance Receivables at December 31 (dollars in millions)
See Non-GAAP Financial Measurements for more information.
Forgone Interest on Non-accrual Loans (dollars in millions)
In 2009, we continued to experience negative performance by borrowers in our portfolio from the prolonged recessionary economic environment globally. Corporate Finance led or participated in a significant number of leveraged cash flow loans in industries such as media, entertainment and other industrial sectors that are impacted by economic weakness caused by lower consumer spending. Trade Finance clients and retailers remained challenged by reduced consumer demand resulting from high unemployment levels. Vendor Finances broad customer base, domestically and globally, continues to face difficult business conditions. Transportation Finance expects the weak U.S. economic environment to negatively impact railcar leasing.
We anticipate that this weak environment will persist throughout 2010. High levels of credit losses historically extend beyond the end of recessionary periods. Our ability to minimize credit costs going forward is dependent on the adequacy of the level of discounts against finance receivables and the performance of accounts currently accruing that have lower fresh start accounting discounts. Additionally, our continuous improvement to risk management and monitoring processes and the efficacy of our workout efforts are important elements of our loss mitigation strategy.
Future reporting of net charge-offs and non-accrual loans will be impacted by fresh start accounting. Prospective charge-off levels will be lower than would have been reported on a historical basis due to the discount applied to loans in fresh start accounting. On non-accrual loans, a significant portion of the discount is non-accretable, which will mitigate charge-offs that would have been reported on a historical basis. To the extent charge offs are in excess of the non-accretable discount, the difference will be reported as a current period charge-off. Charge-offs on loans originated subsequent to emergence will be reflected in earnings. Non-accrual loan levels will be impacted as loan balances have been recorded at fair value which lowered the balances.
The following table summarizes accretable and non-accretable discounts on finance receivables resulting from fresh start accounting:
Fresh Start Accounting Discount on Loans/Finance Receivables (dollars in millions)
Cross Border Transactions
Cross-border transactions reflect monetary claims on borrowers domiciled in foreign countries and primarily include cash deposited with foreign banks and receivables from residents of a foreign country, reduced by amounts funded in the same currency and recorded in the same office. The following table includes all countries that we have cross-border claims of 0.75% or greater of total consolidated assets at December 31, 2009:
Cross-border Outstandings at December 31 (dollars in millions)
Other Income (dollars in millions)
Other income reflected continuing weak capital markets and our liquidity constraints. Other income was down reflecting lower business originations, loan sales completed at discounts, minimal syndication fees and impairment charges on investments and retained interests. We recognized a charge related to a derivative in conjunction with the reduction in the size of the Goldman Sachs lending facility (the GSI Facility).
Rental income on operating leases decreased in Vendor Finance on lower asset balances and remained relatively flat in Transportation Finance, but at compressed rates. See Net Finance Revenues and Financing and Leasing Assets Results by Business Segment and Concentrations Operating Leases for additional information.
Factoring commissions were lower as an increase in commission rates was offset by lower volume. Volume was down 26% during 2009 due to credit management, clients concerns regarding our reorganization and a weak retail environment.
Change in estimated fair value TARP warrant liability relates to the prospective adoption of the accounting standard on Contracts in Entitys Own Stock effective January 1, 2009. Management determined that the warrant issued to the U.S. Treasury in conjunction with the TARP program no longer qualified as equity and should be accounted for as a derivative liability. The reduction in the fair value of the warrant liability was primarily due to the reduction in the Companys stock price from January 1, 2009 through May 12, 2009 at which time the shareholders approved the issuance of common stock.
Fees and commissions are comprised of asset management, agent and advisory fees, servicing fees, including securitization-related servicing fees, accretion and impairments, fair value adjustments on non-qualifying hedge derivatives, as well as income from joint ventures.
Gains on sales of leasing equipment were down primarily reflecting fewer commercial aircraft and railcar sales. Sales were completed at amounts close to book value. The increase in 2008 reflected higher gains on sales of commercial aircraft.
Gains (losses) on securitizations declined reflecting the increased use of on-balance sheet secured financing.
Gains on portfolio dispositions were $4.2 million in 2008 reflecting limited activity. 2007 strategic asset sales included our U.S. Construction business, the Companys 30% ownership interest in Dell Financial Services and our U.S. Systems Leasing portfolio.
Investment (losses) gains primarily reflect impairment charges on equity investments, partially offset by a recovery relating to an investment in a money market fund.
Valuation allowance for assets held for sale related to the sale of Corporate Finance loans and Transportation Finance aircraft. 2008 amounts primarily related to the sale of $4.6 billion of Corporate Finance asset-based loans and related commitments ($1.4 billion of loans and $3.2 billion of commitments). The 2007 valuation adjustment of $22.5 million related to an energy plant.
(Losses) gains on loan sales and syndication fees primarily reflect losses on sales of $1.1 billion of receivables, which mostly consisted of syndicated loans. Commercial loan sales and syndication volume was $4.7 billion in 2008 versus $6.1 billion in the prior year. The decreases in volumes reflected market illiquidity with lower demand for syndications and receivable sales, and our focus on limiting new business.
Change in GSI facility derivative fair value represents a charge for a change in the fair value of the GSI facility derivative financial instrument, relating to our downsizing of the facility. See Notes 9 and 10 for additional information.
Other Expenses (dollars in millions)
Depreciation on operating leases is recognized on owned equipment over the lease term or projected economic life of the asset. See Net Finance Revenues and Financing and Leasing Assets Results by Business Segment and Concentrations Operating Leases for additional information.
Salaries and general operating expenses declined as we focused on efficiency improvements, which contributed to the $281.1 million (22%) reduction in Salaries and general operating expenses, exclusive of professional fees associated with reorganization plan. The decrease reflects reduced salaries and benefits due to lower headcount. The headcount reductions were largely due to restructuring activities reflected in the provision for severance and real estate exit activities.
Goodwill and intangible assets impairment charges relate to Corporate Finance and Trade Finance pretax goodwill impairment charges of $567.6 million and a pretax intangible asset impairment charge of $124.8 million. Goodwill and intangible asset impairment charges in 2008 primarily relate to Vendor Finance.
Gains (losses) on debt and debt-related derivative extinguishments includes a pre-tax gain of $67.8 million recognized on our August 17 notes tender and the pre-tax gain of $139.4 million (net of costs to unwind related hedges) from the repurchase of $471 million of senior unsecured notes. The 2008 balance includes gains of approximately $216 million primarily relating to extinguishment of $490 million in debt related to our equity unit exchange (gain of $99 million) and the extinguishment of $360 million in Euro and Sterling denominated senior unsecured notes (gain of $110 million), in part offset by losses of $148 million due to the discontinuation of hedge accounting for interest rate swaps hedging our commercial paper. The 2007 loss on early extinguishments of debt reflects the call of $1.5 billion in high coupon debt and preferred capital securities in the first quarter of 2007. These securities were refinanced with securities that qualified for a higher level of capital at a lower cost of funds.
Income Tax Data for the years ended December 31 (dollars in millions)
The overall tax benefit for 2009 was driven by the recognition of a net deferred tax asset related to fresh start accounting write-downs of assets primarily in international jurisdictions. The tax benefit was not impacted by fresh start adjustments in the U.S. or reorganization items (largely cancellation of indebtedness income) due to the Company's valuation allowance position and net operating loss carry forwards. The provision for taxes prior to fresh start accounting and reorganization items reflected earnings in international operations. Benefits were not recognized on U.S. losses due to our existing NOL carry forward position.
The 2008 tax benefit for continuing operations equated to a 41.3% effective tax rate, compared with 27.5% in 2007. The increase in the effective tax rate related primarily to tax benefits on losses at higher U.S. statutory rates and decreases in uncertain tax liabilities.
Excluding discrete tax items, the 2008 annual effective tax rate for continuing operations was approximately 38.1%, reflecting the disproportionate amount of loss tax-effected at higher U.S. statutory tax rates. CITs effective tax rate differs from the U.S. federal tax rate of 35% primarily due to state and local income taxes, international results taxed at lower rates, the vaulation allowance and permanent differences between book and tax treatment of certain items.
Included in the 2008 tax benefit for continuing operations was $31.6 million in net tax expense reductions comprised primarily of a $58.6 million net decrease in liabilities related to uncertain tax positions in accordance with ASC 740, Accounting for Uncertainty in Income Taxes, offset by a valuation allowance for separate state NOL.
Certain significant, discrete items in 2008 (the loss on asset-backed lending commitments and the loss on swaps hedging commercial paper program that became inactive) were taxed at higher U.S. statutory tax rates than our global effective tax rate applied to other items of ordinary income and expense. The combined tax benefit related to these items amounted to $98.3 million. In 2007, significant, unusual items (the loss on extinguishment of debt, gain on sale of CITs interest in the Dell joint venture, write-off of capitalized expenses related to a terminated capital raising initiative, and gains on sales of portfolios) were separately taxed at U.S. statutory rates and the combined tax related to these items amounted to $138.5 million.
Included in the 2007 income tax from continuing operations is $52.2 million in net tax expense reductions comprised of a New York State law change, deferred tax adjustments primarily associated with foreign affiliates, and a net decrease in liabilities related to uncertain tax positions. These tax benefits were partially offset by an increase to the valuation allowance for state NOL and capital loss carryovers anticipated to expire unutilized.
The 2008 tax benefit related to discontinued operations was $509.2 million. The lower effective tax rate in 2008 related to discontinued operations is largely due to a $559.5 million valuation allowance related to net operating losses from the loss on disposal of the home lending business.
See Note 18 Income Taxes for additional information.
In June 2008, management contractually agreed to sell the home lending business, including the home mortgage and manufactured housing portfolios and the related servicing operations. The sale of assets closed in July 2008 and we transferred servicing in February 2009. Related summarized financial information is shown in Note 1 Discontinued Operation, in Item 8. Financial Statements and Supplementary Data.
FINANCING AND LEASING ASSETS
The following table presents our financing and leasing assets by segment. The balances in 2009 after fresh start accounting reflect finance receivables and operating lease equipment at fair value. Balances before fresh start accounting represent book value prior to related adjustments. See Emergence from Bankruptcy section for further discussion.
Owned and Securitized Asset Composition (dollars in millions)
Before fresh start accounting, trends in 2009 reflect lower assets due to our management of liquidity and limiting of funding to key customers and relationships. Origination volume in our commercial businesses, excluding factoring, was $7.0 billion, down from $17.2 billion in 2008 and well below the $28.8 billion during 2007. This decline in volume lowered assets in Corporate Finance and Vendor Finance. Vendor Finance asset declines were partially offset by assets purchased from previously off-balance sheet joint ventures and securitizations, including approximately $2.4 billion in 2008, which was more efficient under bank holding company capital guidelines. Transportation Finance assets increased from prior years due to scheduled commercial aircraft deliveries, all of which were leased. Trade Finance asset levels declined; volume was $31.0 billion, well below volume levels of $42.2 billion in 2008 and $45.0 billion in 2007.The consumer segment ceased originating new student loans in 2008. See Results by Business Segment for further commentary.
Assets held for sale is comprised largely of asset based loans in Canada, and was up from December 2008, but well below prior year levels due to minimal Corporate Finance syndication activity and Vendor Finance securitizations.
Equity investments primarily reflect positions taken as enhancements to loan transactions. In limited instances, a unit of Corporate Finance invested directly in marketable instruments.
See Non-GAAP Financial Measurements for reconciliation of owned and securitized assets.
Owned and Securitized Assets Rollforward (dollars in millions)
Total Business Volumes (excluding factoring, dollars in millions)
The decreases in origination volume in our commercial businesses reflect weak economic conditions and the balancing of liquidity with customer needs. The consumer decline resulted from our decision to cease originating private student loans in 2007 and government-guaranteed student loans in 2008.
Syndications and Receivables Sales (excluding factoring, dollars in millions)
Due to market illiquidity and our focus on limiting new business, sales and syndication activities were sharply reduced except for sales of Corporate Finance loans done for liquidity purposes. 2008 includes a sale of $1.4 billion of asset-based lending receivables sold in Corporate Finance. The purchasers assumed related funding commitments of $3.2 billion. During 2007, we sold our $2.6 billion U.S. construction portfolio.
RISK WEIGHTED ASSETS
As a BHC, the primary measurement of capital adequacy is based upon risk-weighted asset ratios in accordance with quantitative measures of capital adequacy established by the Federal Reserve. Under these guidelines, certain commitments and off-balance sheet transactions are provided asset equivalent weightings, and together with on-balance sheet assets, are divided into risk categories, each of which is assigned a risk weighting ranging from 0% (U.S. Treasury Bonds) to 100% (consumer and commercial loans). The reconciliation of balance sheet assets to risk-weighted assets at December 31, 2009 and 2008 is presented below:
Risk Weighted Assets (dollars in millions)
See Note 14 Regulatory Capital for more information.
RESULTS BY BUSINESS SEGMENT
See Note 24 - Business Segment Information for additional details.
The following are performance trends prior to fresh start accounting:
Certain expenses are not allocated to operating segments. These are reported in Corporate and Other and consist primarily of the following: (1) certain funding costs, as the segment results reflect debt transfer pricing that matches assets (as of the origination date) with liabilities from an interest rate and maturity perspective; (2) provision for severance and facilities exit charges; (3) certain tax provisions and benefits; (4) a portion of credit loss provisioning in excess of amounts recorded in the segments, primarily reflecting qualitative determination of estimation risk; (5) dividends on preferred securities, as segment risk adjusted returns are based on the allocation of common equity; and (6) reorganization adjustments largely related to debt realized restructuring in bankruptcy.
Corporate Finance consists of units that focus on specific industry sectors, such as commercial and industrial (C&I), communications, media and entertainment (CM&E), healthcare, small business lending, and energy. Revenue is generated primarily from interest earned on loans, supplemented by fees collected on other services provided.
Corporate Finance results were negatively affected by significantly higher credit costs as portfolio credit performance worsened and we increased the provision for credit losses. Diminished earnings expectations for Corporate Finance, triggered by the poor credit performance and liquidity constraints, resulted in goodwill and intangible impairment charges in the second quarter. Other income includes losses on receivables sold at a discount.
Transportation Finance leases primarily commercial aircraft to airline companies globally and rail equipment to North American operators, and provides other financing to these customers as well as those in the defense sector. Revenue is generated from rents collected on leased assets, and to a lesser extent from interest on loans, fees and gains from assets sold.
Transportation results reflect continued good performance in aerospace, a softening in rail and overall lower gains on equipment sales.
Trade Finance provides factoring, receivable and collection management products, and secured financing to businesses that operate in several industries, including apparel, textile, furniture, home furnishings and consumer electronics. Although primarily U.S.-based, Trade Finance also conducts international business in Asia, Latin America and Europe. Revenue is generated from commissions earned on factoring activities, interest on loans and other fees for services rendered.
(1) AEA is lower than AFR as it is reduced by the average credit balances for factoring clients.
Trade Finance results reflect impairment charges for goodwill and intangible assets. Trade Finance was impacted significantly by our weakened financial condition and reorganization. In the months preceding and during CITs bankruptcy, clients were concerned about CITs ability to perform, which resulted in minimal new business, client terminations and a reduction in volume from clients that did not terminate. Client concerns in the months before the bankruptcy also triggered an increase in draws against unfunded commitments, which resulted in a significant reduction in credit balances due to factoring clients. Certain clients switched to deferred purchase contracts in which the receivables pertaining to these contracts are not owned by CIT, resulting in lower receivable balances. Following CITs exit from bankruptcy, clients with annual factored volume in excess of $1 billion have returned to doing business with us.
Vendor Finance offers vendor programs to manufacturers and distributors serving end user customers in the information technology, office products and telecommunications equipment markets. We offer global financial solutions for the acquisition or use of diversified asset types across multiple industries. Vendor Finance earns revenues from interest on loans, rents on leases and fees and other revenue from leasing activities.
Vendor Finance results reflect the challenging global economic conditions which caused lower volumes, diminished margins, weak fee generation and high credit costs. In order to mitigate these factors, we increased our pricing and exited marginally profitable accounts.
Our Consumer assets and results include student lending and other principally unsecured consumer loans. The student loan portfolio is running off as we ceased offering government-guaranteed loans in 2008 and private loans during 2007. During 2009, we transferred $5.7 billion of U.S. government-guaranteed student loans to the Bank.
Consumer operating losses for the past three years reflect high credit costs and low finance revenue. The 2007 results reflect a goodwill and intangible assets impairment charge on the student lending business and higher provisioning for charge-offs of other unsecured consumer loans.
Corporate and Other
Corporate and other expense is comprised primarily of expenses not allocated to segments including certain interest expense, a portion of the provision for credit losses, provisions for severance and facilities exit activities (see Expense section for detail) and certain corporate overhead expenses.