Jeff Peek - Chairman and Chief Executive Officer
Joe Leone - Vice Chairman and Chief Financial Officer
Alex Mason - President and Chief Operating Officer
Ken Brause - Executive Vice President of Investor Relations
Chris Brendler - Stifel Nicolaus
Eric Wasserstrom - UBS
Bruce Harding - Lehman Brothers
Moshe Orenbuch - Credit Suisse
Sameer Gokhale - KBW
Howard Shapiro - Fox-Pitt
Ryan O'Connell - Citigroup
Louise Pitts - Goldman Sachs
CIT Group Inc. (CIT) Q2 2008 Earnings Call July 17, 2008 9:00 AM ET
Good morning, ladies and gentlemen, and welcome to the CIT's Second Quarter 2008, Earnings Call. My name is Carrisa and I will be your operator today.
Participating in today's call from the company are Jeff Peek, Chairman and Chief Executive Officer; Joe Leone, Vice Chairman and Chief Financial Officer; Alex Mason, President and Chief Operating Officer; and Ken Brause, Executive Vice President of Investor Relations.
At this time, all participants are in a listen-only mode. There will be a question-and-answer session later in the call. (Operator Instructions). As reminder, this conference is being recorded for reply purposes.
I’d now like to turn the call over to Mr. Ken Brause, Executive Vice-President of Investor Relations. Please proceed, sir.
Ken Brause – Executive Vice President of Investor Relations
Thank you, Carrisa, and good morning everyone. Welcome to the CIT's second quarter earnings call.
Let me mention two items before we get started today. First, following our formal remarks, we will have a Q&A session. We ask that you limit yourselves to one question and then return to the queue if you additional question, we'll do our best to answer as many questions as possible in the allotted time.
Second, elements of this call are forward-looking in nature and may involve risks, uncertainties, and contingencies that may cause actual results to differ materially from those anticipated. Any forward-looking statements relate only to the time and date of this call. We disclaim any duty to update these statements based on new information, future events or otherwise. For information about risk factors relating to the business, please see refer to our SEC reports. Any references to certain non-GAAP financial measures are meant to provide meaningful insight and are reconciled with GAAP and the financial tables accompanying the press release. For more information on CIT, please visit the Investor Relations section of our website at www.cit.com.
With that, it's my pleasure to hand the call over to Jeff Peek, our Chairman and CEO.
Jeff Peek - Chairman and Chief Executive Officer
Thanks Ken and good morning everybody. Welcome to our second quarter earnings call. I’m joined this morning by Joe Leone, our Vice Chairman and CFO; and Alex Mason, our new President and Chief Operating Officer.
Before I update you on a number of strategic issues and the results for the quarter, I’m going to ask to Alex to say a few words about why he joined CIT and his first month hear. Then Joe will take you through the quarter and provide you with more detail on our liquidity and capital position. And then finally, we’ll be delighted to take your questions.
Now, as I’m sure you have read, Alex joined us last month as President and Chief Operating Officer and has responsibility for all of our operating business units. He has a long and distinguish career in financial services including leadership positions at Bankers Trust and Deutsche Bank and most recently at Mercantile Bank at Baltimore. I think, he is a terrific addition to CIT, and as quickly become an important contributor to the senior leadership. Alex?
Alex Mason - President and Chief Operating Officer
Thanks Jeff. It has been only a matter of a few short weeks since my arrival, but I will tell you, I’ve already been struck by the tremendous collegiality of the environment and the quality and focuses of people.
A number of folks both inside and outside the firm have asked me, and I think quite appropriately, why CIT and why now? I thought, it might be useful this morning to talk for a couple of minutes about why I came. In the interest of keeping this short and relatively simple, I have distilled my reasons down to four.
The first is that I really do have an affection for the commercial and corporate finance businesses. As some choose to remind me I have been in this business over 30 years. In that time I have created businesses, I have built businesses and I have run businesses all in the corporate finance field. I haven’t touched and felt every business in the CIT mix, but I think I bring enough experience to add to value and to help manage those business. So I am very excited in this respect.
Secondly, I believe in franchise values. I believe that the core franchises here are in very good order, they have been managed well and over a long period of time. And I believe that franchise value inures to the benefit of both the employees and the shareholders. All the folks who have contributed to the creation of these franchises have much to be proud of. They are strong and endeavoring and very much part of the reason why I am here.
Thirdly, I believe in relationships. One of the things I found interesting as I did my diligence on CIT was the strength of the relationships that CIT has created with its clients across all its core businesses. As you know, we live in a world where most financial products are highly commoditized. The point of differentiation frankly is the service one provides to clients and the relationship one builds overtime with clients by way of that service. The point of which a relationship becomes most valuable is when one side or the other faces challenges. I think many of you have seen in the troubled times that we have been in, the strength and enduring nature of the client relationships that CIT has forged.
And last and most importantly, I believe in the plan. Needless to say Jeff and I have had occasion to talk about this at some length. I also met with virtually all of our Directors before I joined. I believe in the direction that the firm is taking, I believe, actually, that I arrived at something of an inflection point which is probably worth spending another minute on.
Despite the challenges, I believe CIT has been doing a lot right on a number of different fronts. Obviously, liquidity has been and will continue to be job one. But the firm now has established a strong track record of moving aggressively on the liquidity front and extending our liquidity timeline in the face of continued disruptions in the credit markets continues to be among our highest priorities.
I think the sale of the home lending portfolio is a major event. Many of our competitors will be forced to deal with enormous continued pressures on their balance sheets, their earnings and their management's time until this housing cycle is complete. CIT can now put home lending in the rear view mirror and focus again on the business at hand. I won't suggest that all our challenges are about to disappear. But I think my arrival will mark the point at which our mission becomes more about rebuilding our access to capital markets and growing our franchises again. I know that is where everybody here wants to be. Thank you, Jeff.
Jeff Peek - Chairman and Chief Executive Officer
Thanks Alex. And I could not agree with you more and share your enthusiasm about the opportunities for CIT. We have a great franchise with meeting market positions and deep customer relationships. In my opinion, the breadth and depth of our experience in the commercial finance sector is unmatched.
Now let's turn our attention to the second quarter. It was a respectable quarter during which we demonstrated solid execution on a number of well-timed actions. And let me review those steps.
We have substantially improved our liquidity position since April 1st through several transactions that represent over $10 billion of incremental liquidity and that gives us visibility into our maturities into 2010. The sale of home lending, which closed last week, cash received, assets and liabilities transferred and all risk from this volatile asset class removed was a watershed event for CIT in its strategic evolution to a pure commercial finance franchise.
Our remaining consumer exposure, student lending is 90% government-guaranteed loans, and consequently, represents minimal credit risk to CIT. Our commercial credit experience remains well within our expectations as we made further progress in reducing the level of unfunded commitment. While we do see some pockets of weakness across our loan book, there has been no broad based deterioration. We are appropriately capitalized despite the loss on the sale of home lending with a pro forma tangible equity to manage the asset ratio of 9% above our 8.5% target. This ratio would be well over 10% if we excluded the guaranteed student loan portfolio and we expect to begin building capital through retained earnings going forward from today.
We have market leading franchises in the commercial middle market. That's why we have been around for 100 years. Given the backdrop of a weakening economy, current market dynamics and our own funding costs, I believe the second quarter results of these businesses are quite respectable with particularly strong performance by transportation finance and solid results in both corporate finance and trade finance.
Now let me turn your attention to the issues of liquidity and funding. We made meaningful progress executing against our initiatives to increase liquidity through asset sales and financing. After withdrawing the bank lines in March, we outlined our plans to return to a more normal funding model. We said we wanting to shrink the balance sheet and specifically mentioned the target of managed commercial assets in the 50 to $60 billion range. At quarter end, our managed commercial assets were $59 billion having sold about 3 billion of loans, airplanes and other assets during the quarter while strategically managing our growth and these asset sales have been at around book value. But we think that our ability to not only get these transactions done in the current market but to do so at these prices continues to demonstrate the quality of our portfolio.
We also said we wanted to secure additional liquidity including some form of funding partnership. Since then, we have raised and/or secured over $7 billion in new funding including the capital raise in April, the secured BCA Aircraft facility we announced today and other asset backed financings we did during the quarter as well as the $3 billion long term funding arrangement we put in place with Goldman Sachs and we received proceeds of over $3 billion from asset sales including the 1.7 billion from the home lending sale, bringing the increase -- the overall increase in liquidity to well over $10 billion. And we said we would consider business dispositions and of course the sale of our home lending business, which was not in our initial plan puts us considerably ahead of our liquidity projections. We will continue to look for opportunities to dispose of non-core assets at attractive and appropriate values.
Now I know many of you are curious about the status of the rail business. As you know, we have been considering various strategic option for this very attractive franchise. We have run a very comprehensive and competitive analytical process. Given the considerable progress we have made with regard to liquidity and asset sales we continue to explore a full range of alternatives for rail. It would be inappropriate to comment in anymore detail at this late stage of our process. We will update you when there is something to report.
Now moving on to operating results. The business environment has not only remained difficult but perhaps become even more challenging. Accordingly, we still have a tail of two cities for CIT in the second quarter. Our market leading commercial finance businesses which continue to progress and our liquidating consumer businesses, student lending, which remains and home lending, which is now divested and accounted for as a discontinued operation in the current and prior periods. I would like to share a few highlights with you for each of our commercial franchises during the second quarter.
First transportation finance. We had another terrific quarter. Return on equity over 20%. We have a young and importantly and fuel efficient aerospace fleet and we continue to see good demand for our plane. Our delivery book is committed with leases into 2010 and we have been successful at selling planes. Nearly 700 million of those sales have closed year-to-date and more are under contract or Memorandum of Understanding, MoU. We think these asset sales in the plane suite are a positive for liquidity, for risk management, and for fleet composition.
Credit in the aerospace leasing business remains excellent and we have had no exposure to any of the US airlines that have recently stopped operating. Rail, it had a strong quarter as well. Overall utilization rose to 96% this quarter as we saw continued good demand for several of our car types. Higher gas prices continue to make rail a more attractive strategic alternative to trucking, it's major competitor. Now we will say the rail team performed very well this quarter, staying focused on the business amidst our strategic review.
Trade Finance, let's talk about that. Trade Finance remains a steady performer, return on equity of around 13%. I will say the weaker economy is having an impact on volume, which are down and we did see some margin compressor. In this difficult retail environment we are clearly playing defense and while our credit metrics have weakened we have dodged many bullets and continue to be successful in anticipating problem and proactively taking actions to mitigate potential losses.
We certainly have a track record here of successfully managing through prior cycles and I will reiterate again our talented I think the executive team in this business is at managing credit risks.
Let’s move on to Corporate Finance. I think corporate finance again, was masterful in managing their franchise in a difficult market. Earning about a 10% return on equity before liquidity related item, while the syndication and asset sales markets remained challenged, we are getting deals done for our clients including arranging senior secured loans for CHF industry, Alcon Entertainment, and the Edmonton Oilers, a hockey team. As well as advising on the sales of Physicians Endoscopy and PBM Graphics.
And importantly, we continue to build our pipeline of financing, many of which are now originated by CIT Bank. We think that it is very important, crucial, to be open for business helping our clients achieve their goals.
Vendor finance, our vendor finance results were disappointment again this quarter and we are very focused on this business. It continues to be impacted by the dislocation in the capital market, which is resulted in some impairment charges that relate to both current and past periods. A lack of sale and securitization income and increase funding costs given the lag and re-pricing assets in this portfolio are also affecting profitability negatively. We certainly have a plan in place to get the results in this business back in line with expectations. We are focusing our resources on the highest margin customers and segment, we are increasing pricing and continue our cost reduction program across vendor.
In our opinion vendor finance is the core CIT franchise, with some of the leading global companies as business partners. And I’m confident that we will get this back to double-digit returns on equity.
So overall stepping back, looking at our core go-forward businesses our commercial results are good in the current environment. We are providing customers with the financing that they need and we remain disciplined and focused on enhancing our valuable middle market franchise. We will right-size the organization to carry an expense base that is sized appropriately for current market opportunities and our book of business. And we will continue to keep our line of communication open with our customers, our employees, the rating agencies and key stake holders like all of you, to make sure everyone understand the considerable progress that we have made in our ultimate destination.
Now let me ask Joe to review our liquidity position and financial results in greater detail. Joe?
Joe Leone - Vice Chairman and Chief Financial Officer
Thank you, Jeff. Good morning everyone. Welcome to the call. Jeff’s review was very comprehensive, let me try to give you my view of where things sit from the first quarter and the progress we have made and I will try to interject how I feel about the environment we are in versus the last 20 years that I have been in this business.
I think we made tremendous strides in the quarter on the balance sheet. And this is the most difficult operating environment I have ever seen. As Jeff said, we raised equity capital, that was well-timed early in the quarter and it gave us strategic options. Clearly the home lending sale as Alex mentioned is a key part of the overall strategy of execution in the second quarter.
Our liquidity run rate has been extended in a very robust way. The cash position is strong. Capital is strong as it was last quarter despite the write-ins and our loss reserves had been strengthened. And all of that as Jeff described, we are doing that while continuing to service our clients.
Let me get you grounded in the financials by detailing some of the impact current market conditions have had on our results, the impact of home lending action on the financial reporting and performance metrics. And then an update on liquidity which has been my primary focus.
Starting with the financials, income from continuing operations was negatively impacted by items related to liquidity action and some restructuring costs. If I put an EPS around those items which I will detail it’s about $0.10 to $0.12 a share. First, is the negative carry on the very large cash balance we've had since we drew down the bank lines in March. We had more than $7 billion of cash on hand and that cost about $15 million pre-tax on the negative carry. And that’s just the cost of doing business today. We understand that.
We also had $9 million of net pre-tax losses on the receivables sold for liquidity purposes that Jeff described corporate finance. The corporate finance team did a terrific job in execution, it's not only enhanced our cash, it enhanced our contingent liquidity, because we reduced the potential draws on unfunded commitments related to those loans.
We are renegotiating, renewing and terming out some of our committed securitization conduits. We had some noise in the first quarter on that and that continued into Q2. The new facilities, the new term outs are being priced at current market rates and that is resulting in impairments in retained interest. This quarter we had about $20 million $0.04 a share of impairments on these terms outs, both in Canada and the US.
The quarter's results were also impacted by our exit from the consumer business. For example, we recorded about a $17 million restructuring charge most of which covers the closing of student lending originations which we did in April and some to cover corporate down-sizing.
And in home lending again a very important transaction to us, particularly with regard to our forward strategic emphasis and strategy, we closed the sale, moved that business into discontinued ops and we exited business risk. But we have work to do here. The sale result in $49 million of pre-tax falling back to corporate. Stranded costs, if you well. 5 to 6 million of that is indirect sales and general and administration expenses previously allocated to that segment. We need to eliminate that. And roughly 44 million or 43 million of interest expense is now going to be covered by the rest of the operation.
Let me explain that. We sold home lending at a discounts book for the cash we received did not pay down all the allocated debt. Give you some round numbers, we had 10 billion of home lending assets funded with $9 billion of debt and a billion of equity. About 6 billion of that debt will go away from the assumption of debt by the buyer, 4.5 billion and our expected pay downs of debt with the cash we received is a 1.8 billion. That leaves about 3 billion of debt with little cash current tax benefits and that now becomes part of our operation. So we're going to have some drag to work through and we're committed to finding ways to work through that and reducing the costs of that, higher cost debt and excess liquidity.
Key operating metrics of continue operations. Let's start with net finance revenue margin. It increased sequentially six basis points. Some of that was due to deleveraging in the quarter with the equity raise about 5 basis points. Higher rentals and transportation finance by several basis points. The difference in timing on the rate resets that happened during the quarter that was helpful and those factors more than offset the negative carry on a cash position and increase non-accrual costs.
As I looked to the second half of the year, we will have some more pressure as we refinance low cost debt with higher cost debt, and we are very focused on pricing that through in our new origination particularly in our lending areas with pricing and structures have improved significantly over the prior year.
Non-spread revenue pressured in the marketplace particularly in syndications. The value of our operating lease equipments held up and we had gains on equipment sales in both air and rail.
Receivable sales and syndications are more difficult and therefore profits were down this quarter from sale activities. Additionally, many of the deals we do today in the lending book are being structured as club deals and the accounting requires fees to be deferred and amortized overtime. So, we have the similar or better deal economics but income comes in overtime rather than up fronts. Our deferred fees have more than doubled in the last year.
Factory and commissions were down; Jeff described some of the market environment we are encountering there. Some of that is seasonal, receivables were down, some of it reflects volume reductions due to seasonality and the economy. And some of it reflects lower rates as we dialed back on volumes to riskier credits.
Credit quality very much on your mind and ours came in about where we expected it to. Charges-off declined sequentially, but forward indicators increased with the softening economy. Most of the increases in the forward markers were incorporate finance and trade finance. Couple of words on that, Jeff covered a little of this. Retailers are weak. We have a leadership position. So we are not immune to the trends. We have exposure to retailers. I will reiterate what Jeff said, the trade finance team, whom I have known for 20 years has done a tremendous job just as they did in 2001 of staying ahead of the curve and managing down credits therefore exposures to weak credits.
In corporate finance, we had an increase. The majority was in a handful of names across several industries energy, entertainment, and real estate. Delinquencies were up more than non-performing and corporate finance. Let me explain that. Last quarter, you heard me talk about approximately $90 million energy account [home line] that we put non-accrual. In the second quarter it technically became past due, so we went on our past due less. If you think about that, we put up loans on non-accrual before they are contractually delinquent that’s our conservative accounting policy.
Having said that, we fully expect that loan to be brought current in the current quarter. On another note related to credit our workout team once again did a great job in selling in asset before closed on. If you recall about year ago, we spoke about waste energy plant that we charged off. This quarter our workout team brought in $10 million in cash proceeds by selling that asset.
On the reserving front, we increase loss reserves by $59 million in the quarter and that’s even despite assets going down $3 billion. So, our total loan loss reserve ratio improved to 147 basis points, 162 basis points of the exclude guaranteed student loan and the dedicated FAS 144 reserves. Of the 60 million or so of increase in reserves 36 million relates to commercial and 23 million relate to consumer principally the private student loan book.
Operating expenses were up sequentially, a little disappointing, but are down 33 million from a year ago. We had some reversals in Q1 of incentive accruals, without that sequential expenses were down as staff and expenses control efforts more than offset some of the higher costs we are seeing in professional fees and covering annual employ raises which took effect in March.
We had 300 head count reduction in Q2 and we have met our initial objective of 100 million of annualized expense out of the base this year. With some 7 to 8 million of this benefit on a quarterly basis not yet reflected in quarterly results. We are very focused on expanding efficiency initiatives and further right-sizing the company after assets sales.
Some comments on income taxes. And I’ll try to clarify what’s going on. It’s a complicated formula with discontinued operations. We had an effective tax rate of approximately 30% on continuing operations that was a bit higher than we expected. We had higher state and local income taxes this quarter. We did report a tax benefit on the home lending loss. Having said that we limited the benefit we booked, the 435 million which is only 17% of the pretax loss.
As we look forward into 2008 and beyond, we expect our effective tax rate on continuing operations to be in the 20% area and that depends on the jurisdiction of where the income is earned. How fast the NOL benefits accrue back to us will depend on income generation levels and geographic mix. What I mean by that is we need US income.
Funding, I’m very proud of the team and the overall company on what we’ve accomplished here. As you said to me we have one of the most experienced and best treasury teams in the industry. And I agree with you. I’m proud of the flexibility and tenacity of the reorganization overall has shown in managing through this market. Jeff told you, we generated over 10 billion of liquidity outside the unsecured debt markets since drawing on our bank loans that’s without access to the unsecured debt market. And that was through the items that Jeff mentioned. And that liquidity not only enables us to meet client needs, we actually improved our standings in middle market commercial lending weak tables.
Getting to some details we ended the quarter about 7.5 billion of available cash. Despite paying of $5.5 billion of debt and we did opportunistically buyback some debt of our own this quarter. We’ve reduced portfolio of assets by $3 billion and executed vendor equipment securitizations in a very difficult market. CIT Bank has been successful. It has deployed its cash into middle market corporate lending origination about a $1 billion year-to-date.
You often ask me about availability under securitization facilities we have about $2.2 billion available and we have generated over $5 billion of liquidity that’s not in our June ending cash number. Home lending sale that’s about an additional $1.5 billion that we’ve received in July; we will receive another $100 million towards the end of the year early ’09 when we transfer the servicing operation.
With regard to the Goldman's facility, we will start funding the facility in the second half of the year, most probably with corporate finance to start. And we expect to be at full utilization by year end. Jeff mentioned, we also recently entered into a secured aircraft financing facility in July. I have been talking to you for about four months that we are working on it. Well it signed. In aggregate we expect to fund about a $1.5 billion of Airbus new deliveries over the next 18 months including about $350 million in July of ’08. Well we are unable to disclose specific terms, it is long-term financing. It’s competitive in rate and advanced rate.
Our cash and liquidity generating projections exceed our forward 12 months of unsecured term debt maturities of about 10 billion and 4 billion of bank lines. Having 12 months or more confirmed liquidity available to meet that obligation continues to be our operating objective. And our base liquidity plan which we stress test as well is based on the following assumption. No unsecured debt access. No secured debt issuance beyond the existing commitment. Flat asset levels with portfolio inflows used to finance new business. And remember the portfolio inflows that we have are significant, about $1 billion a month exclusive of factoring. So that always presents us with another liquidity option.
On commitments, we made significant progress as I mentioned earlier by selling about 3 billion of commitments and today, we have about 4.5 billion of unfunded and available commercial loan commitment at the end of the second quarter and that’s down from about 9 or 10 billion at year end.
Customer behavior to date has been not abnormal in any significant way with regard to line utilization. Beyond the baseline liquidity plan, liquidity, liquidity, liquidity, we are currently analyzing other asset sales, secured financing involving vendor, middle market, consumer and transportation. We are mindful of the encumbrance limits or guidelines or thoughts. But today on the commercial finance side we're about 20% encumbrance. We feel we have ample capacity to continue to execute additional secured financing. We will have further asset sales, in addition to the home lending sales we sold -- we're syndicated $2.5 billion of assets this quarter on the commercial side. We have another 400 million of commercial aircraft in asset held for sale and that is moving forward.
Finally, after deploying it’s $1 billion of cash CIT bank intends to growth deposit in a measured way and utilize the proceeds to continue to originate corporate finance loans. Bottom line, we are tracking to our cash forecast, we look at them daily, our liquidity position in length of runway has improved significantly from our forecast 3 months ago. Our controls, our analytics over liquidity and cash have never been stronger in my 20 years in the company.
Though we are confident that we have more than 12 months liquidity and our planned actions for the second half of 2008, will extend our runway into 2010. And I think we’ve been successful in executing what we told you we would do over the last six months. And we are securing liquidity outside of capital market is essential to weathering the storm. Our primary objective is to return to the unsecured markets as soon as practical we pay our bank lines and stabilize our debt rates.
Again, I want to thank all CIT employees for your support of the liquidity initiatives we’ve put in place and executed on in the second quarter. And you needed to do that and help us out as you run your business. And I want to thank our investors for your interest and support.
In terms of liquidity one last thought. We are not stopping where we are in terms of initiatives. The organization is extremely energized, I think you have heard it from Alex and Jeff to continue to improve liquidity, but there is a balancing act. We have to balance the liquidity needs with customer relationships and franchise strengths with an eye towards longer term profitability enhancement.
With that, I will turn over the call or turn the call back to Carrisa our operator to open up the Q&A lines.
(Operator Instructions). And your first question comes from the line of Chris Brendler of Stifel Nicolaus. Please proceed.
Hi, good morning.
Congratulations on the progress this quarter. I guess, the first question is the obvious one. Can you just give us a little more detail on the commercial finance book? How big was the size of that one loan that moved from NPA into delinquency, the sequential jump is alarming, but I just want to get more comfort on the trend on how you feel of the trend and also what do you think the ultimate loss content? Is there expected to see more reserve building in commercial financial this quarter or corporate finance this quarter. I didn’t -- I hope that’s a good sign not a bad sign. Give me a little more color if you can?
Yeah Chris, something we spend a lot of time on. The loan that went on non-accrual last quarter that went on to delinquent this quarter was approximately 85 to $90 million. That was a big part of the delinquency increase. Clearly we look closely at the loss content on anything that goes into non-performing and have our FAS 114 impairment tests. And as we went through those loans, we increased the reserves accordingly for FAS 114 impairment and those loans essentially were in corporate finance and somewhat in trade finance. I would say that as we look at the loss content of some of the loans that went on non-accrual, we are encouraged by few things. The underlying value of the enterprise and the fact that we are in a senior secured position and there is a significant amount of subordinated mezzanine debt and equity below us. As we look forward clearly credit cost are going to go higher. We have been saying that for years and unfortunately we are right now. We are coming off all time lows. But I think the 50 to 60 basis points we had in Q2 was a good number. The increase in non-accruals will probably push that up a bit, but as we've looked at the non-accrual loans and loss content we feel comfortable with the second half of the year in terms of reasonable charge-offs levels.
Okay. The followup question will be on liquidity. Give me a little more -- I don’t think you addressed this in your comment or prepared remarks, what's going on the deposits in the banks I think they were down. Shouldn’t those be growing any -- I guess target on how much -- how could we even grow the bank. And then your encumbrance of 20%, can you still get it at 30% with your current mix of assets I think we talked about 30 in the past is that still the right numbers that gives you a little more cushion. And then a final liquidity thought from the text of the release it says that you can get through ‘09 with some additional progress and I think from your color on this call it sounds like you fell like you are almost there. And, I think that maturity is scheduled to second half of '09 definitely helps you there its not very big, but just give me more color and comfort that you feel very comfortable that you're not going to need unsecured debt until 2010 it sound like from this release.
I can't answer that question, Chris. You're only allowed one question. I am kidding. First on deposits in the bank -- I'm not going to remember all the parts of the question. Somebody will have to help me here.
That's okay -- we will do it. Deposits in the bank, why are they going down? Good reason for that, we had initially in the bank, the home lending loan. And when we sold the portfolio, and last year and then again the big sale this year, we took those loans out of the bank and sold them. That left the bank with a lot of negative arbitrage cash, negative carry on cash. So the governor on the deposits has been getting assets in there and we have worked with the regulators since late '07 into early '08 to begin to book commercial loan originations in the bank. So that’s come down, but we are very close to reigniting the origination of deposits and we actually over the last few weeks did a little test marketing and raised some deposits to see what the demand was what the rates look like et cetera. That’s the deposit. Now so help me out on the other part.
Encumbrance is sort of a -- it’s not a sign, it’s an art. And the reason why we are focused on commercial is that for the ongoing business enterprise will be and is. And clearly I think a 20% -- I have heard a banker tell us we came into this market mess, whatever you call it, with a very responsible balance sheet in terms of encumbrance. We had very little commercial finance assets encumbered when we came in. But we're now at 20%, that number will go higher with the facilities we put in place. But my thinking Glen's thinking as we think about it, somewhere in the 30 to 35% area, is tolerable. More important we have got to look at the amount of unencumbered assets we have against unsecured debt, because we want to make sure the unsecured debt has more assets than there is debt. So that’s a second answer.
On 2010, I will repeat what I said. Chris, we're going to look at this and report it sort of in 12months out. We do that with our board. We show them -- obviously we show them something beyond, but we think its reasonable, prudent for us at least -- we have to at least look at 12 months. And I often say to my team people think in 12 month terms. It is hard to think with the next 15 months. No a good reason but it’s a practical way of looking at the numbers. Yes we feel we have done a lot that really is extended to the horizon, maybe beyond the second quarter of 2009 and we have no I repeat no additional or we have no unsecured debt issuance in our base plan and for that matter we don’t have any new secured facilities that we don’t have commitments on in our base plan. So we are felling pretty good about liquidity, but we are going to continue to work on it. I think we should move on.
Great. Thank you.
Again your next question comes from the line of Eric Wasserstrom of UBS. Please proceed.
Thanks. Just a couple of points of clarification. Joe just back to this cash position, did you say, you mentioned some statistics about how much your cash position exceeded your upcoming liabilities. Can you just repeat those for me?
Well, what I said was that between the cash we sit on, $7.4 billion, and the cash we have coming in, in July, which is principally on home lending and somewhat on aircraft sales and on top of that the $3 billion of facilities in Goldman that we have totally available to us, that our liquidity forecast 12 months forward exceeds our debt maturities by not in significant amount, that’s what I think I said.
Okay, great. And then on the just to get back to Chris question on the credit deterioration, I think you guys have often pointed to 80 to 85 basis points as where you consider to be a normalized loss experiences. Is there any thing that would change that at this stage?
Well I think we’ve said that is a normal charge-off rate through the cycle or we’ve also talked about stress testing of portfolio in a deep recession and we come out with on an 120 basis points or so. But I don’t want to leave with the 120 we are thinking as we see the portfolio as we see the market that we have today, we are still thinking about the 70 to 80 basis point area.
I think Eric I would just add to that. With the divestiture of home lending, we feel so much better about the credit outlook for us going forward and as we said in our remarks the commercial book is performing within our expectations and as you saw we had a reserved billed which we think is prudent just given all the uncertainty in the economy.
Thanks so much.
Your next question comes from the line of Bruce Harding of Lehman Brothers. Please proceed.
On the securitization side, Joe you all sound more like you are back to your normal sales, congratulations on the home equity sale by the way. But in terms of securitization as a percentage of total funding when it was at its peak and the markets were operating normally, what would that number have been? And on a go forward basis, can you, assuming that doesn’t back to any normalcy or attractive funding cost, is the funding strategy going forward would just go without that? And specific to vendor, how much of the decline in the ROE there is really due to the lack of securitization funding and as opposed to other issues going on within that and when do you think that segment would be sort of rallying back to better returns as it was in the past? Thanks.
Yeah, good question, multipart question. Again, you guys are getting us here. Help me out on the answers or the order of the questions. I say first, if you look back to 2004, 2005, 2006 when the market was robust, we overweighted unsecured financing and underweighted secured financing and one we wanted to have secured financing facilities because diversification is important. But through the unsecured economics were much better than the secured economics. I would say we were probably 90/10 unsecured to secured. That helps us now, because as I said before when we came into the market, MORASS that's began last year, we had a lot of dry powder in terms of unencumbered assets. So, I don’t think we will go back to 10 as we think about it now Bruce, I think 10 would be on the low side as we see the model and the markets developing over the years. I think the secured financing would be more in the 30% area.
As to vendor, we did do a vendor finance securitization in both Canada in the US. Clearly the costs were more expensive than the conduit financing we had in place and therein lies the reason to the impairment. We still have conduits of capability, availability and we do have conduits that needs to be renewed and re-negotiated. So, I continue to see pressure on the funding costs from -- when you look at it, you see how could it have been that way. The costs were like LIBOR plus 20 to 30 previously that were coming just like in credit where we are coming off all time lows, on funding we are coming off all time lows. And, I’m not expecting it to get back there. But the funding model, I will just say this, one more reason the funding model and vendor finance is an issue that we are looking at. It’s the loan side is not as elastic as the financing side, it’s a little bit more main streets and Wall Street. On the flip side, corporate finance really reprice the marketplace along with our cost of funds.
So, as Jeff said we are looking at where we make our money , are there relationships which are marginal where we can’t make money, and what the operating cost base needs to be in that business.
Hope I covered it all Bruce?
You did Joe. Just in your prepared remarks, a clarification, you said the new facilities and new term out are being priced out at and then I missed when you said requiring an impact on your residuals?
And just could you clarify is that done now, there is…?
Yeah, we are terming them out at market rate is what I said. And I think if you will – I can't remember the exact rate in the US conduit. I know the advance rate was 83% for 500 million. I think the all-in fixed cost was five and three quarters to six. I can’t remember the LIBOR spread, but it was probably LIBOR plus 2 to 2.50, but I’m just guessing there. IR will confirm that.
Your next question comes from the line of Moshe Orenbuch of Credit Suisse. Please proceed.
Thanks. Given the significant amount of cash and liquidity that you talked about in the – you did buyback some debt in the quarter. Could you talk a little bit about how much debt you bought back? What the effective yield on the debt that you have got outstanding is that would be maturing in the next couple of quarters? How you think about whether to buy it back going forward?
Moshe, it's something we still are early on in the analysis. But if I remember right on the bank line draw call on March 20th whatever we drew the lines, we got that question. I said absolutely we are not buying back debt. And the reason for that was several, but including, we had to get a good insight into our liquidity picture before we did that. With the initiatives in Q2, we became more and more comfortable that our bonds were not trading correctly and that we were holding or ex-growing or holding liquidity for those ultimate maturities anyway. So a lot of our -- we have found it difficult to find a lot of our bonds that we were looking for. But having said that, it was several 100 million dollars that we bought back. I don’t remember the effect of cost, but we do have debt maturing in the second half of the year that is relatively cheap.
As I mentioned before, we have got the bank lines and that's probably LIBOR plus 50 to 60 and we have some floaters that are probably LIBOR plus 10 to LIBOR plus 30. So they have got low cost. Having said that, to the extent we are sitting on excess liquidity, there is a negative carry on that so we continue to look at what's the appropriate cash position to have and what's the appropriate approach to buying in early or paying off early anything in front of us. I would say we look at it in a relatively short time horizon. We are not looking buy out 10 year forward debt. We are looking at what do we have in our liquidity plan and should we that sooner or rather than later. Hopefully that’s our promotion.
Your next question comes from the line of Sameer Gokhale of KBW. Please proceed.
Hi, good morning. Clearly you have taken some pretty positive steps in terms of bolstering your liquidity and your -- seem to do well along that process. But I have to say would be announcement of the sale of your mortgage business, it's not that I was expecting the company to get formal upgrades in your credit rating, but it did seem like the tone from the rating agencies remain pretty cautious specifically as it relates to capital levels and I know you have talked about higher capital levels are adequate. But is there any update on your discussion with the rating agency? What specifically are they looking for in terms of capital levels? And then just another quick note in terms of your strategic partnerships, you have signed the agreement with Goldman. Are you still actively looking for other strategic partners and how far along the process are you there? Thank you.
Yeah Sameer, I think in reverse order we are divided with the Goldman partnership and we continue to have discussions with others particularly as we bolstered our liquidity and given more clarity to what we think the new CIT is going to look like. So the answer to that would be, yes I think each of these discussions tends to take its own unique profiles, so it's not that we have a template that we are trying to force counterparties into, but we have several discussions going on in terms of securitized funding that we think are promising on that. I think in terms of our discussions with the rating agencies, they are ongoing and I guess what I would say in response to your question is I think its' been a long time since we saw an upbeat rating agency report on a financial services company. But our view is that capital levels are going to go up overtime in the business and that’s why we are at over 9% even though our historically target has been 8.5.
Okay. Thank you
Your next question comes from the line of Howard Shapiro of Fox-Pitt. Please proceed.
Thank you. And I just I know you don’t want to talk about the rail business but I am trying to understand the economic decision here. You are well ahead in terms of your efforts to build your liquidity, the utilization rate is 96%, it's strong alternative to other forms of transportation right now, credit is very strong. At this point, why would you even considering selling it?
I think it's just a question -- I just -- I’ll stand by the statement we had out. I think all I would say is you have a nice job of summarizing the reasons why we think it's a very valuable franchise.
Okay. And if I can just squeeze one other one in. On the $3 billion in financing that you kind of have stranded from the--or debt that you have stranded from the sale of the home lending portfolio. Is there anything you can do to defuse it? Are you working on any way to kind of defuse that cost?
Howard, it's Joe. I would say we are looking at that in combination of how much excess liquidity we should carry at all times. So, if we carry 7, 8, $9 billion in the second quarter that may be higher than the threshold that we would carry going forward and that’s how we are looking to attack it.
Okay, perfect. Thanks.
Your next question comes from the line of Ryan O'Connell of Citigroup. Please proceed.
Hi, good morning. Joe, could you maybe provide a little bit more color on the renewals of the asset backed conduits? You have about I think 1.5 billion that was going to come up for renewal this quarter -- Q2 sorry and about 6 billion that's coming up for renewal in the Q3? So just in terms of availability, what sort of advanced rates, pricing, to the extent you can?
Yeah, it's that conduits. I think of it in sort of three buckets. We have equipment and vendor finance and I think that’s the one you are referring to, which has a nearer term maturity and we have student lending, which has sort of a fourth quarter maturity and then we have our factoring facility which has a January maturity. I would say a couple of things, one advanced rates are coming down and I think that one of the benchmarks I can give you is when we did the equipment finance public securitization in the US, which by the way the cost is LIBOR plus 274. I think have Bruce ask that question. The advanced rates a year or two ago was 87%, the advanced rate in the public markets when we did it two months ago was 83%. I think that the conduit advanced rate is going to be somewhere in that area code and that’s down. It's down from I think it's the high 80s or the low 90s.
Clearly the costs are going higher. I mentioned that some of these facilities are priced below LIBOR plus 50 and clearly when you look at a market comp and I just mentioned to you LIBOR plus 274, we know the cost will go higher. I think the first discussion we will have with the renewal with you is the one on equipment because that’s we are furthest along and working on right now, and actually JP Morgan is the lead on that, there is four or five banks in it, and we have been talking to them about a month on the facility and are we going to attack. We should get the closure on that facility in the near year term. Then we will take the other maturities as they come. I think on the factoring, which is at the back end of the year, it's a 1.5 billion facility. I say it's one of the safest facility for the banks that they probably have in the world because the factoring receivables are over collateralized in the 60 days receivables. So I am hoping that the pricing sort of reflects the safety of that and then we have the student loan maturities and that asset class has been difficult in the securitization market. So we may be looking to renew that at a lower amount. So that’s the status. It's clearly a work stream that's very much under focused and I think the first -- just summing up, the first specific you will hear from us is on equipment. Okay Ryan.
You are welcome.
Thanks it’s a busy morning for everybody with a number of companies reporting, so I think we will have one more question before we close.
Our final question will come from the line of [Joseph Shatt] of Goldman Sachs. Please proceed.
Yeah, hi good morning. It's actually Louise Pitts here. Good morning guys. Thanks for the color. I just wanted to push a little bit, you thought that your bought back was more short term than longer term. Can you give us anymore detail on that and do you have any plans to continue to buy back that at discount? And then my second is actually on the dividend policy with respect to your plans for the dividend on an ongoing basis relative to capital and liquidity?
I think just in brief, in reverse order, the dividend at this point is -- historically we have got a pay out ratio at some place between 15% and 20% and we think the dime a quarter kind of fits is within that range when we look at the prospective earnings power of the company on an intermediate term, long term basis. So we are pretty comfortable with that. I think on the buyback that as Joe said, we kept it on a relatively short term go forward. We look for maturities that were within our liquidity horizon if that’s the way to look at it. We talked about 12 months being kind of the liquidity, 12 month plus stretching it out to 18 into 2010. So, we’ve been looking for debt that we could buyback at a discount that was maturing within 12 months and actually we haven’t found too many people we wanted to sell it to at less than par. But we are not going way out, Louise, in terms of looking for the out years in terms of maturities.
And can you give us any guidance on how much of the discount that probably you have averaged out in the debt buyback?
Not too much. It hasn’t been significant. Frankly we have been looking a lot and we haven’t really gotten much done.
I think based upon the comments I gave you in the financial statements, you will be able come to a pretty reasonable estimate of it.
Okay, great. Thanks.
Alright. Just before, we close I just would like to reiterate a couple of our key messages. We do think that our core commercial finance businesses are doing well and retain quite a bit of value. We closed on the sale of home lending and we were delighted that we closed on the week in which we did, but we have removed any and all risks from that asset class. As we said to you, we think commercial credit, our credit experience on the commercial book continues to perform well within our expectations. We have made quite a bit of progress on securing liquidity with clear visibility into repaying our maturities leading into 2010. We think the capital that we’ve got right now is appropriate and we do continue to originate new business in support of our customers. We will continue to focus on improving the efficiency and profitability of our core commercial franchises. And I want to echo Joe's remarks and I want to thank all of our employees for their dedication and hard work and helping us manage through this challenging time and, I also want to thank all our investors both on the equity as well as the fixed income side for your support of the value of the CIT franchise, and I know that will be recognized and rewarded in the future.
As always, Ken Brause and the Investor Relations team are available to answer any questions that we did not cover today or any follow up in terms of our one question for analyst policy. Thanks very much for your time and attention.
Thank you for participating in today’s call. You may now disconnect. Good day.