First Citizens BancShares, Inc. (FCNCA) Q4 2010 Earnings Report, Transcript and Summary

Good morning. And welcome to the CIT Fourth Quarter 2010 Earnings Conference Call. My name is Eric, and I will be your operator today. Participating in today's call are John Thain, Chairman and Chief Executive Officer; Scott Parker, Chief Financial Officer; and Ken Brause, Head of Investor Relations. [Operator Instructions] I would now like to turn your call over to Ken Brause. Please proceed, sir.

Thank you, Eric. And good morning, everyone. Welcome to CIT's year-end 2010 earnings conference call. Our call today is hosted by John Thain, our Chairman and CEO; and Scott Parker, our CFO. Following our formal remarks, we will have a Q&A session. We do ask that you limit yourself to one question and a follow-up, and then return to the queue if you do have additional questions. We will do our best to answer as many questions as possible in the time we have this morning. 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 our business, please refer to our 2009 Form 10-K that was filed with the SEC in March of last year. Any references to certain non-GAAP financial measures are meant to provide meaningful insights and are reconciled with GAAP in the press release. And for more information on CIT, please visit the Investor Relations section of our website www.cit.com. I'd like to now turn the call over to John Thain.

Thank you, Ken. Good morning, everyone. And thank you all for being on our call this morning. I'd like to make some opening comments and then I'll turn it over to Scott. I am pleased with our progress that we made in 2010. We completed the build out of our senior management team. We sold over $5 billion of non-core assets. We repaid over $7 billion of high-cost debt, including $4.5 billion of first-lien debt and we refinanced the remaining $3 billion of first-lien debt. We repaid $2.1 billion of Series B debt, the last piece was actually done in January. And we started the process of dealing with the Series A debt with $500 million. We also raised nearly $3 billion of new secured financing at attractive rates, and we established CIT Bank as a major originator of assets. We originated $1.2 billion of commitments in CIT Bank over the course of the year. Just in the fourth quarter alone, CIT Bank originated $675 million of commitments, including almost all of our U.S. Corporate Finance new originations. We've made progress on our regulatory relationships. We have built out our risk management functions, our internal audit functions, our loan review functions and our compliance functions. And we have made meaningful progress on our written agreement, although there is still much we need to do on the written agreement. We've been effective in bringing our costs down, and I'm pleased with the growth that we've seen in our new volume. We originated $4.5 billion of new volume over the course of the year. But importantly, we originated $1.5 billion of new volume in the fourth quarter and we've seen consecutive quarter-over-quarter growth in our new originations. Our credit portfolio had stabilized, and Scott will cover that in more detail. So as I look forward into 2011, I want to share some of our priorities for this year. First, we will substantially satisfy the remaining open items in the Fed written agreement. Second, we will continue to expand the role of CIT Bank, both in terms of adding assets and diversifying its funding base. Third, we will focus on growth in our four core businesses, both domestically and internationally. And as I mentioned, the trend is positive across our businesses. We will make significant progress in refinancing the Series A debt, and that's what’s going to be our focus on the debt side. We will continue to strengthen our risk management functions, our compliance, our internal audit and our loan review functions. And we will continue to actively manage our expenses. So that will be our focus for this year. And now, let me turn it over to Scott to give you some more details on the fourth quarter and 2010.

Thank you, John. Good morning. While the fourth quarter results were impacted by several AUMs, the restructuring charge, debt prepayments and a favorable tax settlement, the underlying trends of increased business activity, lower borrowing costs and stabilizing credit quality continued. This morning, I will review the consolidated quarterly results, touch on the segment highlights, funding progress and then comment on fresh-start accounting. All of my comparisons will be to the restated figures that were provided in the press release today. On the fourth quarter, we reported $75 million of net income, $0.37 a share, bringing the full year results to $517 million or $2.58. Book value per share ended the year at $44.48, up from about $42 in the beginning of the year. Capitals have still remain strong. Our Tier 1 capital ratio is over 19%. And as you recall, we have only common equity in our capital structure. Let me talk about some specifics. Finance and leasing assets declined $2.2 billion sequentially. About $1.9 billion in the Commercial portfolio and $300 million in the liquidating student loan book. With respect to the Commercial portfolio, we had total committed volume of about $2 billion, we funded $1.5 billion of new lending and leasing volume, an increase of over 40% from the third quarter. The improvement was broad-based and it was an increases in three of the four commercial segments in both the U.S. and non-U.S. businesses. And importantly, over half of our U.S. lending volume was originated and funded by CIT Bank. Funded volume, while up, is still being more than offset by portfolio collections and asset sales, which were $2 billion and $1.2 billion, respectively. Factoring volume was fairly stable, with third quarter at $7 billion while trade receivables decreased seasonally. Debt finance revenues fell $58 million sequentially, a decrease. So let me explain. About 1/3 of the decline relates to portfolio contraction. The average earning assets fell $2.5 billion, an amount greater than the drop in period end balances since the vendor consumer portfolio sale occurred at the end of last quarter. The remainder of the decline is largely rate-driven, was reported an economic debt finance margins, each falling approximately 40 basis points sequentially. Reported margin went from 3.44% to 3.04%, while economic margins, which are adjusted to exclude FSA impacts and debt prepayment fees, went from 95 basis points to 56 basis points. Focusing on the economic margin, the decline was largely asset-related driven by the timing of aircraft redeployment and lower renewal rents on the rail business, the sale of high-yielding higher risk assets in Vendor Finance and a higher average cash balance. Excluding the impacts of FSA and prepayment fees, our average borrowing rate improved slightly as the benefit we received from paying off high-cost debt was partially offset by higher securitized debt cost. We prepaid $1.4 billion, as John mentioned, of the 10.25% Series B Notes during the fourth quarter, with a 3.5% prepayment fee or $49 million, up from the $29 million in the third quarter. The prepayment penalty on the second-lien debt drops to 2% in January. So the prepayment costs on the $750 million Series B Notes and $500 million, 7% Series A Notes we retired in January will have a smaller prepayment fee. That said, the Series A Notes were marked at a discount in FSA and are currently carried at values ranging from $0.88 on the 2017s to $0.94 on the 2013 maturities. Prepayment of these notes will result in accelerated recognition of the discount based on a level-yield methodology. Over the year, we have made considerable progress selling non-core assets, as John mentioned, paying down high-cost debt. And while the sales were strategic, in many cases, they include high-yielding assets such as small ticket consumer-oriented receivables in Vendor Finance. We also carried significant cash liquidity, which combined with our portfolio of low yielding government-guaranteed student loans, became a larger part of total assets. These items, along with fresh-start accounting and debt prepayment costs, have significantly impacted margins. However, our new business economics are attractive. Yields on new volume remain high, and we can fund new business competitively. For example, margins on corporate loans originated in CIT Bank averaged over 300 basis points in the fourth quarter and margins on conduit funded Vendor Finance originations averaged over 500 basis points. Additionally, lease margins on recent aircraft deliveries funded by ECA and bank financing should generate double-digit ROEs. These originations account for less than 10% of the total portfolio today. But as volume increases, the portfolio turns and CIT Bank grows, margins should widen over time to a level commensurate with our risk-adjusted return expectations. On Other Income, we have $224 million was down from the third quarter due to reduced gain on sales. We sold about $1.2 billion of assets in the fourth quarter bringing the year-to-date total over $5 billion, as John mentioned. In the fourth quarter, we sold about $800 million of Corporate Finance loans, including some small business loans, $200 million of transportation assets and roughly $100 million each of private student loans and vendor assets. The average gain on sale was about 5%, lower than the 8% gain on sales from early in the year since the private student loans and small business loans were slow at a slight below book value. Recoveries on pre-FSA charge-offs were again very strong at $69 million. Factoring commissions were fairly stable and fees and other income declined due to some asset impairments. As John mentioned, credit quality continues to stabilize. Reported are post-FSA and net charge-offs increased $79 million as we recognized impairments on assets transferred to held for sale and refined our charge-off practices. These items added roughly $40 million each to our fourth quarter charge-offs. The refinements included accelerating delinquency-based loss recognition on small ticket loans and corporate and Vendor Finance. Our non-accrual loans were down 20% sequentially, with a big improvement in Corporate Finance where we sold or worked out roughly $400 million of problem loans and in Transportation Finance, where we recovered book value on a large loan we put on non-accrual in the first quarter. New inflows on non-accrual, an important leading indicator, continue to decline on both the pre- and post-FSA basis. While the allowance for loan losses decreased slightly, its coverage increased to 1.7% of loans. In terms of the reserve composition, specific reserves increase due to certain energy and other pre-emergence loans in Corporate Finance. While non-specific reserves decreased, reflecting transferred to held for sale and overall contraction of the small ticket portfolios. We also continue to establish reserves for newly originated assets. The non-accretable discount decreased $193 million sequentially to $372 million, reflecting the application of pre-FSA charge-offs against the discount, asset sales and prepayments. Combining the on-book balance sheet allowance and the remaining non-accretable discount, we have nearly $800 million or about 3% coverage against the $26 billion of pre-FSA loans. To wrap up on credit, we've made a lot of progress in 2010. We've improved our risk governance and tightened our credit underwriting standards, we refined our credit collection and charge-off practices, and we significantly reduced high-risk exposures and concentrations. Switching to operating expenses. Excluding the $32 million restructuring charge related to office consolidations, operating expenses were down slightly to $218 million, reflecting lower employee cost. We ended the year with roughly 3,800 employees, down 12% from a year ago. And finally on taxes, the fourth quarter benefit included favorable settlements of prior year international tax positions. Outside of that, the provision approximated our 32% effective tax rate for the year driven by taxes on international earnings and U.S. valuation allowances. I'd like to move on to the business segments. I'd like to note that all of our segments were profitable for the fourth quarter. First, with Corporate Finance. Income declined as increasing credit provisioning reduced gains and lower assets more than offset operating expense reductions and strong recoveries on pre-emergence charge-offs. Finance and leasing assets fell 14% due to sales and increased prepayments as we remain focused on working out and selling non-performing loans. Fourth quarter new business activity was strong, with funded volume up 57%. New commitments doubling and a number of agency roles exceeding the first three quarters combined. Credit costs rose due in part to refinements in charge-off practices in Small Business Lending. But overall, portfolio quality improved with non-accruals falling 18% sequentially. The Transportation Finance earnings decreased from the third quarter, which benefited from strong gains on sales. Aircraft utilization remained strong, and we had further improvement in rail. All 2011 new aircraft deliveries and about 90% of the planes with expiring leases are placed. The eight planes return from a bankrupt carrier have all been released. However, the timing of redeployment and the associated costs with that impacted fourth quarter margins. In rail, market rents are improving but renewal rates remained below expiring rates, leading to some margin compression. We continue to manage through this phase of the cycle by keeping cars rolling and leases short. On Trade Finance, a return to profitability after being burdened by high funding and credit costs early on the year. Factoring volume was flat sequentially, with seasonal run-off offset by volume from new and returning customers. Our commission rates remained solid but were down slightly, reflecting the improvement in the retail credit environment. And we are seeing improvement in the portfolio quality with charge-offs and non-accruals decreasing from the third quarter. Finally, on Vendor Finance. The results reflect our portfolio streamlining efforts as average earning assets fell 15% and yields reflected our transition away from consumer-oriented assets. New business volume grew 8% sequentially and new business yields remain double-digit. Moreover, we expanded our partner base by signing over 100 new reseller agreements in the fourth quarter. We are working to restore our local funding capabilities in Latin America, Europe and Asia and continue to work towards moving the U.S. vendor platform into CIT Bank. Charge-offs increased due to the recognition of credit impairments on assets, transferred to held for sale and the acceleration of delinquency-based losses. On the provision for credit loss, it reflected the lower receivable balances. New business volume continues to grow, but portfolio rebalancing will remain a headwind in 2011. Now I'd like to turn to funding. Cash was essentially unchanged at about $11 billion as proceeds from portfolio collections and sales were used to pay down $1.4 billion of Series B Notes in the fourth quarter. Last month, we completed the redemption of the remaining Series B Notes and $500 million of the Series A Notes due on 2013. While bank liquidity remained strong, we did issue over $100 million of brokered CDs in the fourth quarter and found the market was very receptive at competitive rates. We continue to fund new aircraft deliveries in the secured debt market and are working with our banks to renew and improve the terms on our current conduit facilities. We are also actively evaluating liability management strategies to address the remaining high-cost debt at the parent and to grow and diversify the funding at CIT Bank. Now I'd like to have a few remarks on fresh-start accounting. Fresh-start accounting accretion added nearly $1.5 billion to pretax earnings in 2010, with all about $100 million benefiting finance margins that went to Other Income. This exceeded our expectations with the biggest driver being the accelerated loan repayments on asset sales during 2010. We also accelerated debt repayments in 2010, but both the term loan and the Series B debt was marked at a slight premium, so the net accretion impact was a modest benefit. As we look forward, we expect the asset accretion to decline significantly. Additionally, prepayments on Series A debt will result in FSA costs as the debt is carried at a discount to par. In summary, we continue to make progress on our strategic priorities that John mentioned and you can see evidence of that progress in our results. We've had some noise in the numbers this year but are encouraged by the underlying trends, particularly with respect to the increasing new business volume. With that, I'll turn it back over to Eric and open it up for questions.

[Operator Instructions] Your first question comes from the line of Matthew Kelley with Morgan Stanley.

So just wondering if you can give us a little more color on your long-term funding strategy? What portion you think at this point might be in the form of deposits? What portion of the long-term debt could fill in securitizations?

I'll start with that. I don't think we're going to be terribly precise about that, other than to say, it will be a mix of funding sources with an increasing percentage from deposits, particularly in CIT Bank. We will continue to do securitizations and to use the assets to fund our business as we have been. And we're going to focus on repaying significant portion of the Series A debt. And that mix will change, but we're not going to be more precise than that.

Then just one follow-up from me. I'm not sure if you're able to give us any more color on the discussions you're having with the Fed or the FDIC on the cease and desist at this point? But if you can, great.

Well, you have to separate those two things. So the Fed is the written agreement and the cease and desist is the FDIC. And we have discussions with each of them about each topic. The cease and desist is much more specific as it relates to CIT Bank. And it puts a certain restrictions on CIT Bank, primarily in a number of brokered deposits that it has. And we are having discussions with the FDIC about getting that lifted. The written agreement with the Fed is much more extensive and requires a lot more effort on our part to satisfy a lot of the items, and that's an ongoing work in progress.

Your next question comes from the line of Don Fandetti with Citigroup.

John, I wanted to sort of dig in a little bit more on sort of these regulatory issues, and I think you've been sort of quoted as saying it's a two-year process. Are you feeling incrementally better? Are you making progress to where you feel like some relief is in sight? Can you just give us a little more detail on sort of how you're feeling about the regulatory issues?

Sure. I would continue to say -- I wouldn't change the view that it's a two-year process or a multi-year process. As I said in my comments, I think we will be able to satisfy substantially all of the Fed’s written agreement items this year in 2011, that will take all of 2011. And then at that point, there is both an ongoing process with the Fed. So they do come up with more items as they do their ongoing review. And also, one of the other elements that's important to them is the sustainability of our processes. So even as we fix things, we then have to demonstrate that they're not only fixed but sustainable. So I would expect that 2011 is spent fixing substantially all of their items, and then we'll have to see kind of what point they're willing to lift the written agreement, which will depend a little bit on their comfort level with not only the corrections and repairs but also the sustainability.

The next question comes from the line of Moshe Orenbuch with Crédit Suisse. Moshe Orenbuch - Crédit Suisse AG: Scott or John, could you talk a little bit about the pace of the movement in the FSA adjustments? You did say it declined significantly in 2011? And then I’ve got a follow-up question.

Yes. Well I think, as you can see from the tables and we talked about in 2010, the accretion was an accelerated pace mainly because of the portfolio changes in asset sales and prepayments of assets. So I think in 2011, our expectation is to, as part of the 10-K similar to last year, be able to lay out our expectation for contractual run out. And then based on that, you have to make assumptions, which we don't have right now with respect to what that prepayment speed maybe in 2011 versus 2010, but we'll lay out the contractual obligations and how we think it's going to lay out. And then the second piece, as we mentioned, is really around the Series A debt. So the Series A debt will depend on the amount and timing of those payments and the impact of the discount on the debt that would flow through the P&L. Moshe Orenbuch - Crédit Suisse AG: Just kind of as a follow-up, you alluded to some liability management techniques and I'm wondering if you could kind of just expand on that a little bit?

Well there's, as John mentioned, we know kind of the key issue on regards to the Series A debt. And so I think we're in discussions, it's about $20 billion, so it's a large amount. It's not going to be solved by one activity. So I think it's going to be combination of some payments. It's going to be a combination of kind of seeing what different alternatives are out there for different types of debt. And those are things we'll continue to look at given what the marketplace is.

Your next question comes from the line of Sameer Gokhale with KBW. Sameer Gokhale - Keefe, Bruyette, & Woods, Inc.: Scott, in terms of the economic margin, you gave us some color on that. But do you have handy with you, can you walk us through the 39 basis point change and talk about, let's say, specific categories and say okay, x basis points related to each categories? Do you have like a walk through like that handy, by any chance?

In regard -- yes, I don't know if I want to get into specifics. But I would say about -- in regards to, I talked about a lot of it was driven by our asset mix. So I'd say about half of that was driven by kind of the aircraft redeployments and the lower rental rates in the Rail business and about half of that was in the kind of the sale of these high-yielding higher-risk assets that we have in Vendor that kind of have been offsetting the positive aspects of these high-cost to debt paydown. Sameer Gokhale - Keefe, Bruyette, & Woods, Inc.: But would you expect the margin, the economic margin, to improve from here on out? Now that -- having reached a steady-state given that you've completed the asset sales of some of these high-yielding assets? And do we expect growth from here on out in the economic margin?

We do expect growth. As I mentioned, some of the business we're putting on at the year end. You saw that the ramp up in the third and the fourth quarter on volume that kind of needs some time to mature and maturate, the funded versus the committed piece. And so, I think what you'll see is that, that will start to come through and become a bigger part of our portfolio. And at 10% of our book it’s just very hard to see that through because of the magnitude of the pre-emergence assets. So the trajectory of that, we expect to move forward and move up. The steepness of that trajectory, I think, is really dependent on some of the other activities that played through with the portfolio. Sameer Gokhale - Keefe, Bruyette, & Woods, Inc.: And just in terms of your taxes, I was curious for next year, what should we be modeling in from a tax rate perspective?

Well, I think, I would say that's a difficult kind of question. But I think 2010 at the kind of 30%-plus expected, or effective, tax rate is the best information we have at this time.

Your next question comes from the line of Brad Ball with Evercore.

Scott, I think you mentioned that about half of your new volume was done in the bank. Can you explain why you didn't do all of it there? And also, can you give us an update on what you're seeing on the sort of loan demand side in small and middle market in the Corporate Finance business?

Yes. So I think to answer that question, you got two pieces of why more is not in the bank? One, as you know, Vendor Finance in the U.S., we fund that through a conduit and until it moves into the bank. So that's a significant portion of the U.S. volume that's not in the bank. The second piece is in Corporate Finance, we have a couple of different business units. So we have a Canadian portfolio that's reported into the Corporate Finance. We also have the Small Business Lending portfolio that's in Corporate Finance numbers that are reported. If you strip those out, above 75%, 80% of the core Corporate Finance assets were done in the bank. And the delta between not having 100% of those in there is we look at some agency positions that we wanted to retain, and due to affiliate transaction rules, we were not able to put those into the bank. But we thought the economics and the leadership position on those transactions made sense to kind of retain those at the parent company.

And then just one quick follow-up. Can you give us a sense, Scott, as to when the asset shrinkage will begin to subside? Sort of when the level of loan, new loan production will overtake the declines in assets? And do you have any significant asset sales slotted for 2011?

Well, I wish I had a conclusive answer for that. I think a lot of it has to do with kind of the continued market environment. I would say that in the fourth quarter, at $1.5 billion of volume, we're starting to get to a point where that will, if that trend continues, will offset the portfolio contraction, which is the normal run-off of the assets. But that assumes that an overall shrinkage, it really depends on asset sales and prepayments that we cannot, at this point, kind of forecast that far out. And our hope would be is sometime mid-2011 or the second half of 2011, that the new volume coming on offsets the portfolio contraction. With respect to the planned asset sales, you kind of see in our press release, we do have assets that are held for sale. And the expectation would be is that during 2011, that those assets would be sold. And we may look at additional portfolios as we're looking at kind of profitability, we're looking at risk profiles, as well as some of our platforms that may not have the scale or the risk profile that we would like to have. There could be additional asset sales.

Your next question comes from the line of Henry Coffey with Sterne Agee. Henry Coffey - Sterne Agee & Leach Inc.: As you start to look at 2011 and consider some sort of improvement within your [ph], what is the real benefit from that? Or what really happens when they hand you the whole production and let you let go?

I think a lot of it is having us get to the types of policies and procedures that a bank holding company should have. And so, there isn't some instantaneous change, either in terms of our business or our processes. We will continue to be a bank holding company. We will continue to be under the Fed as well as the FDIC and Utah's oversight. And I think that it will simply be that we are now substantially complying with the obligations of a bank holding company. And I don't think it changes anything in particular in terms of how we conduct our business, other than we will be doing it in a way consistent with a well-managed bank holding company. Henry Coffey - Sterne Agee & Leach Inc.: You're already a well-run company. You're just trying to earn the privilege of being described as a well-run bank holding company. But it doesn't add to your liquidity or your loan generation capacity, it just adds to the durability of what you're doing? Is that the way to think about it?

Well, I think the way to think about it is, it puts us in compliance with the Fed’s standards for bank holding companies. But you're right, it doesn't change our liquidity and it doesn't change our asset generation capability. Henry Coffey - Sterne Agee & Leach Inc.: And then, as you look to 2011, what are the benchmarks that you're going to use, besides you had a really successful year? And at what point do you have to deal with whether this company stays independent or sells to another bank? And I'll just get off the phone and listen.

Well, we certainly believe that we have a successful business model. And there's no reason for us to think that we can't remain a successful independent company. Henry Coffey - Sterne Agee & Leach Inc.: So what kind of benchmarks are you looking at?

Look, no different than the benchmarks you would expect, revenue growth, earnings, profitability, increasing shareholder value.

Your next question comes from the line of Mike Taiano with Sandler O'Neill. Michael Taiano - Sandler O’Neill & Partners: A set of questions on the refinement in your charge-off practices. Just could you give us a little bit more color on that? Was that driven by the bank regulators? And I guess if you could maybe give us a sense of how much of an impact that had on charge-offs in the quarter?

As you know, Lisa Polsky and Rob Rowe kind of came on around the June time frame. And as part of all of the efforts to improve, kind of, the risk and credit practices within CIT, these are just the manifestation of all that work. A lot of the policy refinements are based on using analytics and evaluation of both kind of the trends that are going on, the loss severities of different portfolios, on the delinquency based items that I talked about. As you would be familiar with kind of consumer banks, some of the smaller ticket items, there's a point at which a time to charge-off, and we've been looking at those and refining the timeline at which an account would be charged off. And those kind of came through in the fourth quarter. So I think, again, it's just continued refinement and support for making the appropriate credit decisions. So as I talked about a little bit in my remarks, those kind of refinements and policy enhancements represented about $40 million of the charge-off in the fourth quarter. Michael Taiano - Sandler O’Neill & Partners: And do you think that's sort of just a one-time item? Or do you think that's going to continue into future quarters?

Well, with the policy changes, a lot of it has to do with the role of the assets, right. So if we brought in the days to charge-off, it's really a matter of how our portfolio rolls, right. So if we charged off in one of our portfolios now at 150 days, it's based on how many accounts kind of hit that trigger. And so, I think those will be -- with some of the things that we pointed out on non-accrual, the decreases there and new additions as those kind of slow down as delinquencies improved, you would expect that the charge-offs related to these policy enhancements would reduce. Michael Taiano - Sandler O’Neill & Partners: And then just one last thing, could you just repeat. You had mentioned the yields on new business volume, I think the 300 basis points and 500 basis points, is that the yields or the spreads?

That's the spread. I apologize. So I think on the Corporate Finance side, as you know, the spread is the one component and yield related fees by having the agency roles, as well as potential for syndication fees and others, will enhance the yield on the Corporate Finance loans.

Your next question comes from the line of John Stilmar with SunTrust.

My first question is a follow-up on Corporate Finance. As your -- deal velocity is certainly picking up. Can you talk to me a little bit more about structure other than the spreads that you referenced before, but the structure of the types of transactions that you're doing? You talked about the marginal originations being of better credit quality and lower risk. Can you provide at least a little bit more of context or anecdotal evidence to how the -- the materiality of that statement?

You know what, I think it's, I try to break it down into two components. One is, as we talk about in previous quarters, in Corporate Finance where we are rebalancing the portfolio between a, more of kind of balanced mix between asset-based lending as well as cash-flow lending. And I think, so on that side, that will change the risk dynamics. And each one has its unique kind of risk/return elements based on an asset-based loan tends to be as more secure and you have advance against receivables and inventory. On the cash flow, I think it really comes down to the discipline in regards to kind of debt leverage within the transactions, the kind of terms and conditions that, as you know, in the last couple of years, the whole covenant kind of discussions. So we're really kind of focused on what is the debt multiples, the structure of the deals and also playing in industries that we feel we have good understanding of the dynamics of those. And I think some of the things that you see kind of come out in regards to some of those deals in the healthcare arena as well as kind of our traditional C&I loans. So I think it's a little bit of making sure we stick to the guidelines and the risk profiles that we think are representative of a loss risk-adjusted return that we're willing to accept.

And then my other question, as you highlighted and rightfully point out that Series A Note repayment or the restructuring of Series A Notes. Is one of the items that you're going to be pushing for a greater ability to encumber assets, for instance, like the transportation assets, which might be better financed through a structured market? And how should we be thinking about that as a benefit or an opportunity in 2011?

Do you mean Series A? You mean the encumbrances on the Series A second lien that would inhibit potentially securitized transactions?

Correct.

Yes. Well, as I think we talked about in the third quarter, I think we have plenty of assets that are not encumbered via our second-lien debt that we can use to continue to find attractive secured financing. But yes, it is an item that we would look to as we'd like to have over time, more flexibility, which means that we need to kind of focus on some strategies for the second-lien debt.

Your next question comes from the line of Mike Turner with Compass Point.

Just had a question on your expenses. It looks like your expenses are running lower than I had initially expected along on a cost basis. As far as the comp and benefits, were there any onetime items? Or was that really a kind of solid run rate going forward? And then also on the professional fees, it looks like they've jumped up, I don't know if there was any noise in there as well?

I think there is, I wouldn't say any significant kind of one-timers in the expense base. And as we've talked about that we'd like to be in the $220 million to $230 million range. A lot of that has to do with, as John mentioned, kind of the continued investment that we want to make in building the infrastructure for the bank holding company and also putting improvement in our systems and technology. So that piece is something that the fourth quarter may be a little bit lower than prior expectation for the first quarter just because there's a lot of employee-related costs in the first couple of quarters of the year. But I would say that with respect to the professional fees, as the team kind of came in, in the second half of the year, as John mentioned, we had a lot of activities that we leveraged some external firms to help us accelerate our progress. For myself, we did a lot of work with Lisa with respect to economic capital for the end of the year that we used some senior outside advisers on that. We had work that helped in risk area around our re-grading and kind of risk analytics side. So I think there was a lot of kind of professional fees to help us kind of accelerate things. And John and I are very keen on making sure that, that line in particular kind of diminishes in 2011 significantly. And so we are actively kind of monitoring what those fees are. But it was really just to make sure that we could make the progress in 2010 that we wanted and that will spill over in lower costs next year. But I think the benefits of all those activities you're seeing and will see in the future financials.

The one element that you might keep in mind as you're modeling our compensation expenses going forward is we did use RSUs this year, and that RSU expense will get amortized over the next three years. And I would expect that to continue as we go into 2011.

And just another follow-up, I think you touched on this a lot, as far as a master refinancing or you really described it as really a series of steps. What do you see as the highlights or the key points to attaining maybe an investment-grade rating? What you need to have -- do you view the bank holding company’s status and the lifting of the written agreement as a key point in order to do that? What are you -- maybe some highlights as far as that strategy?

Are you talking specific to the ratings?

Yes, I mean, I didn't know. If you grew Internet deposits and did a number of steps, do you think you could get an investment-grade rating without having the written agreements lifted? Or are those things mutually exclusive?

Yes, I don't know if I could say it per se whether there is kind of a link or that they are mutually exclusive. But I think what we're focused on that I think will be important for our ratings would be a lot of the things we talked about this morning was to continue to diversify our funding sources, both within CIT Bank and, in general, with the parent company with respect to the liability management as well as secured debt. I think it's continued profitability and business volume. I think it's making improvements and improving the infrastructure that we have in place, which will then lead to John's point around kind of the regulatory expectations of us to the bank holding company is important. And I think those are kind of the key things. It's our funding kind of model. It's our continued business growth and profitability, and also getting the improvement on the bank holding company infrastructure.

I would also say, if you just look at our pure credit metrics, if you look at our capital position, our earnings power, our cash position, our ratings are substantially lower than where they should be anyway. And so, I think part of it is just the history and part of it is just time. And it's just going to take time for the rating agencies to catch up to where we are.

[Operator Instructions] Your next question comes from the line of Bruce Harting with Barclays Capital.

Scott, what is your goal for how much Series A would be outstanding at year end 2011? And just as part of the debt question, is the accretable discount on long-term borrowings all against the Series A or is it pro rata across the various debt that you have? And just wondering, I'm looking at, the only place where I see the cost of funds breakdown is in the average balance table, and it looks like long-term borrowings are roughly flat over the last year despite hanging down some of the higher-cost debt. So any benchmark you might be able to give us for year-end 2011 on that number in conjunction with where you might see the Series A outstanding? And then last sort of add-on here from last, the margin of 300 basis points on new loans, that's relative to what cost of funds exactly? And then last thing, I guess for John, isn't acquisition prior to satisfying all of the Fed and FDIC issues a possibility if you got their permission?

Well, Bruce, maybe we might have ask you to kind of come back. So I guess you want me to forecast out. I think the first one is forecast out where I'd like to the Series A to be at the end of 2011? I probably don't want to go out on record with that right now based on not forecasting that. But I think we want to make a lot of progress in the Series A with respect to kind of dealing with both the size as well as the structure of that. And so, I think a lot of that's going to be based on cash generation by the business, the capital market's access that we can have and the size of the capital markets with respect to new debt offerings around that. I think the second question that you had was around the margins or the spreads in regards to Corporate Finance and what's the cost of funds that we're using for those? You could probably follow up with Ken and team afterwards. But I think we're using kind of the bank funding CD rate, which compared to the spreads on the Corporate Finance loans kind of get to that 300 basis points. I think the third question would be, as you said, was the average balances and what the expectations for the interest expense in 2011. So the numbers that you have there kind of on a post-FSA basis and you also have a lot of the fees running through that line. So I think one of things that, as we get into 2011, because of all the significant activities with respect to 2010, assuming that the transactions we do or any debt finances we do in 2011 are below the 7% Series A, that balance, that average, kind of, long-term borrowing cost should go down.

And then your last question, any acquisition that we were to contemplate would require the Fed, the FDIC and the Utah State approval, no matter where we are in the written agreement process.

Ladies and gentlemen, this concludes our Q&A session. Thank you for participating in today's call. You may now disconnect.

Thank you, Operator.