First Citizens BancShares, Inc. (FCNCA) Q2 2016 Earnings Report, Transcript and Summary

Good morning and welcome to CIT's second quarter 2016 earnings conference call. My name is Carrie and I will be your operator today. 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 a reminder, this conference call is being recorded. I would now like to turn the call over to Barbara Callahan, Head of Investor Relations. Please proceed, ma’am.

Thank you, Carrie. Good morning and welcome to CIT’s second quarter 2016 earnings conference call. Our call today will be hosted by Ellen Alemany, Chairwoman and CEO, and Carol Hayles, our CFO. After Ellen’s and Carol’s prepared remarks, we will have a question-and-answer session. Also joining us for the Q&A discussion is our Chief Risk Officer, Rob Rowe. [indiscernible] to others on the call, we ask that you limit yourself to one question and a follow-up and then return to the call queue if you 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 the business, please refer to our 2015 Form 10-K. Any references to non-GAAP financial measures are meant to provide meaningful insights and are reconciled with GAAP in our press release. Also as part of the call this morning, we will be referencing a presentation that is available on the Investor Relations section of our Web site at www.cit.com. Now, I’ll turn the call over to Ellen.

Thank you, Barbara. Good morning, everyone, and thank you for joining our second quarter 2016 earnings call. I would like to begin this morning by addressing the charge we took this quarter regarding Financial Freedom, the reverse mortgage servicing business which was part of the OneWest Bank acquisition, and has been reported as a discontinued operation since the closing of the transaction. Carol will go into the details. But, first, I want to express our disappointment with the developments in connection with our ongoing efforts to remediate the previously disclosed material weakness in Financial Freedom’s interest curtailment practices, which required this change. We have a new management team in place and they’re making good progress in implementing practices to strengthen the controls and procedures of this legacy business. We're also fully cooperating with the HUD OIG investigation which began in earnest shortly after the close of the acquisition. We remain committed to exiting from this business as we continue to execute on the plan we laid out in March. Despite the impact Financial Freedom had on our financial results this quarter, we made progress advancing our strategic goals. Let me give you a brief update on our progress. The Commercial Air separation remains our number one priority. As many of you saw, we filed the Form 10 at the end of June, which contained the audited financial statements, a significant milestone for both a spin or a sale, and we advanced to the second round of the bidding process in the case of a sale. We continue to pursue both tracks in order to ensure we maximize the value for our shareholders and we remain committed to completing the separation by the end of the year. We also signed a definitive agreement to sell the Canadian equipment and commercial finance business with Laurentian Bank and expect to close this transaction in the fourth quarter. Finally, if you recall, last quarter, we announced the exit from the international business air as it lacked connectivity with the rest of the business. After further review, given the size of the remaining business, we've decided to exit the US assets as well in order to maximize the value of the entire platform. Despite the challenges from a low interest rate environment and continued weak middle-market business activity, overall operating trends in our core businesses were solid this quarter. In commercial banking, overall assets were down 2%, reflecting our focus to improve returns in commercial finance. We’re finding good opportunities to strengthen our core franchises and delivered strong growth in Real Estate Finance and our equipment finance businesses. In commercial finance, we are complementing our industry expertise with a more full-service commercial bank by offering multiple products to our clients. As a result, we're migrating the portfolio to clients where we have the opportunity to provide credit, banking and deposit services. We sold almost $200 million in loans this quarter and have almost $500 million in held-for-sale. This has impacted their growth and we are staying disciplined in our strategy. In Direct Capital, our fintech business that fits within Business Capital, we're currently seeing more opportunities in the small business lending market due to the constraints and challenges of other online lenders. In small ticket equipment finance, new business volume has been strong even though the ELFA Monthly Leasing and Finance Index was down through the first half of the year. In capital equipment finance, our large ticket business, we're also seeing strong equipment financing activity in our direct end users channel which is generating solid opportunities to cross-sell products with the industry vertical platforms within commercial banking. In commercial services, factoring volume for the quarter was down when compared to a year ago, reflecting softer sales in the retail space, although we did see a pickup in June as we head into a seasonally stronger second half of the year. We continue to believe there is a tremendous opportunity within Business Capital to leverage our strong brand in both the direct and indirect market segments. We have over 110,000 small and mid-sized active customers in the equipment financing businesses and 40,000 in our factoring business and are mining our data to identify and go after opportunities to provide additional products and services. Turning to Real Estate Finance, new business volume was strong on both coasts as the disruption in the CMBS market is benefitting the balance sheet lenders. The pipeline continues to be strong and we're focused on prudent deal selection as well as maintaining pricing and structure discipline. Commercial banking deposits increased by 12%. Our commercial bankers are focused on bringing in deposits as part of the lending relationships. We have added performance goals and incentives to drive this initiative and we are seeing some traction. Assets were down in Consumer and Community Banking as the run-offs in the Legacy Consumer Mortgage portfolio outpaced growth in the mortgage lending business. In our rail business, lease renewal rates have continued to decline due to weakness in the energy and steel industries. The team is doing a great job proactively managing the portfolio through the cycle and successfully initiated a number of portfolio management activities this quarter to sell or scrap underperforming cars. The outlook for 2016 has not changed. And although we expect utilization to fall into the low 90s this year, we continued to expect this business to earn double-digit pretax returns. Our second priority is to improve profitability and return capital to shareholders. We continue to focus on our expense reduction program. Carol will provide you some more details on the quarter, but based on what we see today, we expect to be about a third through our $125 million target saves in 2016. However, as we have said, costs associated with our strategic initiatives will offset the savings in this year, so you will not see the benefit of our actions until 2017. We remain committed to achieving this initiative and will continue to update you on our progress. Finally, we remain committed to strong risk management. We completed our first CCAR submission, which was a private file in this year. Like many other first-time filers, we received a qualitative objection to our plan with approval to maintain our dividend and do a modest amount of share repurchases. We continue to work with the regulators regarding the capital actions requested in conjunction with the Commercial Air separation, which Carol will take you through in a little more detail. We remain disciplined in our credit risk management and continue to proactively manage our exposures. We increased our maritime reserve this quarter. We sold a few energy loans at or above their carry value and reduced our exposure to the oil and gas industry by about 12%. Outside these areas, we do not see any underlying trends at this time that would lead us to believe there are other areas of weakness in our loan book. As I mentioned, despite the challenges from a low interest rate environment and continued weak middle-market business activity, overall operating trends in our core businesses were solid this quarter. We are continuing to execute on the strategy to strengthen our core franchises and improve returns and remain committed to the strategy outlined in March to create a national middle market bank and maximize value for shareholders. With that, I will turn it over to Carol to provide more details on the quarter.

Thank you, Ellen. And good morning, everyone. During the second quarter, income from continuing operations was $181 million, up from $152 million in the prior quarter. However, including the $167 million loss in discontinued operations, net income was $14 million or $0.07 per share. The loss in discontinued operations includes a $163 million after-tax charge related to Financial Freedom reverse mortgage servicing operations acquired with OneWest. These operations service almost 90,000 reverse mortgages today, most of which are home equity conversion mortgages, otherwise known as HECM, that are administered by the Department of Housing and Urban Development and insured by the Federal Housing Administration. The FHA Insurance pays interest on the underlying loans post the maturity event, such as when a mortgagee passes away as long as the servicer complies with the guidelines issued by HUD. These guidelines are complex and include servicing milestones, which, if not met, may result in the servicer becoming liable for the interest post the missed milestone. We call this a curtailment event. We disclosed in our 2015 Form 10-K a material weakness in the internal controls over financial reporting related to the HECM interest curtailment retirement reserve, which is described on slide 19 in the presentation. We also previously disclosed the ongoing investigation by the Office of the Inspector General of HUD. We have invested significant time and resources reviewing the servicing guidelines, updating policies and procedures, improving operation, and ensuring we have the most current and comprehensive information with which to calculate the reserve and minimize additional exposure on future maturity events. Financial Freedom services a portfolio of loans for others with about $16 billion of unpaid principal balance, of which approximately $3 billion have matured. In addition, there’s approximately $4 billion of loans on which we have filed claims with HUD. As a result of the work we've done, we recorded a $230 million pretax charge, bringing the reserve to approximately $500 million on the approximately $7 billion of filed claims and loans in the foreclosure process. The reserve reflects our best estimate at this time, but our validation and analysis are continuing. As a result, it is possible that the reserve may change positively or negatively, including before we file our Form 10-Q. As Ellen indicated, we are very disappointed with these developments, but have made good progress implementing enhancements that strengthen the operations and controls and believe these actions will mitigate exposure on future maturity events on the remaining $13 billion of loans serviced. Turning to the results from continuing operations, financing and leasing assets decreased in the quarter as asset pay-offs and portfolio run-offs were partially offset by new originations. Slide three shows the key performance metrics and provides commentary on the outlook for the remainder of 2016. Net finance margins declined to 3.65% from its elevated level last quarter when it benefited from low maintenance and operating lease expenses and elevated collections in both air and rail. In the second quarter, maintenance and operating lease expenses in Commercial Air increased and rental income was lower, most notably in rail. We also had a 5 basis point benefit to net finance margins from an interest recovery in commercial finance. And interest expense was relatively flat. For the remainder of 2016, we continue to expect net finance margin to trend towards 3.5% as legacy consumer mortgages continued to run-off and we see the impact from lower rental revenue in rail. The provision for credit losses declined from $99 million to $28 million this quarter. Overall portfolio quality remains relatively stable. While we may experience quarterly variability in the credit provision, we expect the full year 2016 to be towards the high end of our target range of 25 to 50 basis point of average earning assets. This expectation incorporates our current outlook on energy and maritime loans. The level of net charge-offs improved to $41 million or $16 million excluding the impact of loans transferred to held-for-sale. And the provision also included a reserve build of approximately $10 million for the maritime portfolio. Including the principal loss discount on acquired loans, the allowance for loan losses in our commercial book was 183 basis points, down slightly from last quarter. Non-accrual loans decreased from the fourth quarter to $283 million as charge-offs and asset sales offset a modest level of inflows into non-accrual. Consistent with last quarter, energy non-accruals make up nearly half the balance. Details on our oil and gas exposure can be found on slide 16. Oil and gas loans were $832 million, representing 2.7% of total loans. Exposure is down from $945 million last quarter, driven by loan sales and pay-downs primarily related to lower rated loans with higher reserves. We now have about a 10.5% loss coverage against this portfolio, taking into account the purchase accounting mark and the allowance. We have completed the spring redetermination process, resulting in a 15% to 20% decrease in the average borrowing basis. If current market conditions persist, we think there could be an additional $75 million of energy-related non-accrual loans over the remainder of the year, with a corresponding increase to the provision of $15 million to $25 million. Taking into account this quarter’s activity, this outlook is relatively unchanged from the prior quarter. Moving to other income on slide eight, other income of $104 million reflect higher gains on sales and our leasing business and mark-to-market benefits of $9 million on the TRF and $5 million on investment securities. These benefits were partially offset by a $4 million goodwill impairment in business air, impairments related to portfolio management activity in rail and lower factoring commissions. Turning to expenses on slide ten, excluding intangible amortization and restructuring charges, our base operating expenses were $321 million, essentially flat with the prior quarter. Costs related to the integration of OneWest and the separation of Commercial Air rose by $7 million. The prior-quarter expenses included $15 million from elevated employee costs, most of which did not recur. Our FDIC insurance assessment increased by $4 million and we recorded an $8 million one-time expense related to prior-quarter OREO activity. We are making good progress on our initiatives to reduce costs by $125 million and remain on track to take out a third of these this year. For example, during the quarter, we closed two offices; and as a result of our integration efforts, sunset federal systems. We expect the base expenses, excluding cost of strategic initiatives, to remain around $300 million next quarter. However, as we said previously, costs associated with the strategic initiatives will ramp up in the second half of the year and more than offset these expense savings. We expect to close the sale of our Canadian equipment and corporate finance business in the fourth quarter and anticipate recording a modest gain. This exit will result in $16 million of annual cost saving. The sale of our equipment finance business in China, which incurred $12 million of annual costs, is also progressing, but at a slower pace given the complexities of that market and the current environment. The income tax provision was $94 million, representing a 34% tax rate for the quarter and 31% year-to-date. We continue to expect the effective tax rate in 2016 to be in the low 30% range and the cash tax rate to remain in the mid-to-high single digits. Turning to our business segments on slide 11. Commercial banking reported pretax income of $122 million, representing a pre-tax ROA of 2.4%, reflecting lower credit costs and lower operating expenses. The segment reported a pretax ROA of 1.6% year-to-date. Financing and leasing assets decreased 2%, driven by a decline in commercial finance, partially offset by strong originations in Real Estate Finance. Commercial finance assets decreased 6% due to prepayments and asset sales. As Ellen mentioned, we’re focused on clients with whom we can have a broad relationship across multiple products. This strategy caused us to pass on certain refinancings that occurred during the quarter. Portfolio yields were up 35 basis points and included a 27 basis point benefit from the interest recovery previously mentioned. Business Capital assets decreased 2% driven primarily by seasonal activity in the factoring business and portfolio yields rose slightly. Real Estate Finance assets grew 4%, given strong new business volumes. While competition remains strong, we believe spread have stabilized. The reduction in portfolio yields of 26 basis points was driven by lower purchase accretion on the acquired run-off portfolio. Turning to slide 12, Transportation Finance generated pretax income of $154 million and a pretax ROA of about 2.9%. Financing and leasing assets were unchanged with new aircraft and rail deliveries being offset by a run-off in the aerospace loan portfolio and, to a lesser extent, in maritime. In Commercial Air, we took deliveries of six aircraft from the order book and utilization of 100% with leases or lease commitments on all aircraft. Portfolio yield was negatively impacted by elevated operating lease and maintenance expenses and higher interest-bearing cash balances. Looking ahead, nearly $1 billion of aircraft are scheduled for delivery in the next 12 months, all of which have lease commitments. Rail assets grew 1%, driven by new deliveries from the order book, partially offset by portfolio sales. Rail utilization remained stable at 94%, reflecting portfolio management activity. Demand for crude, coal and steel cars continues to be soft. Therefore, we still expect utilization to move towards the low 90% range and rental rates to decline when the leases renew. Portfolio yields decrease 57 basis points, primarily driven by declining renewal rent in energy-related car types, which are coming off historic highs. Maritime assets decreased slightly to $1.6 billion and we further increased reserves against the drybulk exposures by approximately $10 million, given the continued weakness in this sector. Consumer and Community Banking, as shown on slide 13, generated pretax income of $17 million and a pretax ROA of 0.9%. Financing and leasing assets remained flat at $7.2 billion as new volume was offset by run-off in the legacy consumer mortgages. Turning to funding and capital, deposits were flat at almost $33 billion and funding costs were stable at 2.2%. Investment securities increased approximately $300 million as we deployed excess liquidity into HQLA securities with new investment yields around 1.8%. Given the current interest rate environment, we are being measured in our pace and level of growth in the investment portfolio. Our capital ratios remain strong with a common equity Tier 1 ratio of 13.4%, up 30 basis points from the prior quarter. As Ellen mentioned, we received a qualitative objection to our CCAR filing. While we have not yet received the detailed feedback, we recognize we have work to do to meet the standards of CCAR and have begun our mediation efforts. And providing us with feedback, the Federal Reserve did approve the continuation of our dividend and share repurchases of approximately $140 million, consistent with the level in 2015. The capital actions contemplated in the separation of Commercial Air were not part of the April CCAR submission, but were included in an amended plan that we submitted for the transaction that is currently under review. Given the separation is expected to result in a significant capital action, we do not contemplate executing any share buyback in advance of its completion. To wrap up, we’re disappointed in the developments around Financial Freedom and the impact it has had on our financial results. That said, we're pleased with the improvement in the underlying performance of the business given the current environment. And with that, I’ll turn the call back over to Carrie and we will take your questions.

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Mark DeVries of Barclays. Please go ahead.

Yeah. Thank you for the comments around CCARs. I had a follow-up. Do you have a sense yet given the qualitative objection to the plan what the reaction might be to the amended filing around capital returns in the event of the sale?

The amended return is a discrete capital action around the transaction. We’re in ongoing dialog with the Fed, so we can't make any specific comments around the protest, but we do look at it as a very separate event.

Okay. Will you wait for a reaction to them before deciding whether to go forward with the sale versus the spend?

I think there are a lot of factors that we’re going to consider in deciding which route to go. I don’t think we want to make any further comments. Obviously, economics are going to be a big part of that, but there will the other factors that we’ve talked about, the uncertainty of execution timing and things like that. So there’s a variety of factors that will come into play.

Okay, thank you.

Okay. Thanks, Mark.

Our next question comes from Arren Cyganovich of D.A. Davidson. Please go ahead.

Thanks. I was wondering if you could talk a little bit more about the commercial finance reduction in loans. I know you sold some. In some of those, you passed on some opportunity. I can understand that from like a terms perspective or something from the pricing aspect of it. But I'm not quite understanding why you pass up business where you actually know the credit well enough and you’re turning them down for other reasons.

The whole strategy on commercial finance is we’re now focused on risk-adjusted returns. So if we look overall of how commercial finance performed in the quarter, we had lower expenses. We had lower credit provisions. We grew our deposits. And new business volume increased from $1.5 billion to $2 billion. If we break that into components, in commercial banking, we’re focused on industry verticals and cross-selling our Business Capital products and then the rest of our commercial products to those customers. We had good momentum in healthcare and power in the quarter. Business Capital, we had good growth in the small ticket, large ticket and Direct Capital, which is our fintech business. We were down in commercial – in our factoring business, commercial services, but that’s seasonally adjusted and we’re going into the last two quarters of the year with good momentum. Those are typically our best quarters in that business. And then lastly, in our real estate business, we had good activity on both coasts. And we benefited a little from the CMBS issuance, but we’re focused on prudent deal selection, but maintaining pricing and structure. So this is all about improving our returns, risk-adjusted returns, which is why we're divesting some of these lower performing commercial loans.

Okay, thanks. And then in terms of the sale or spin, are you still contemplating the same equity allocation to the business, the $3.3 billion?

We haven't really changed our outlook on that. As we go through the process, that will get burned up. But there’s not really any change to what we said in the past there.

Okay. All right, thank you.

Thank you very much.

Our next question comes from Moshe Orenbuch of Credit Suisse. Please go ahead.

Great, thanks. I guess, is there anything that you can kind of tell us about how you sort of think about the capital distribution? For the moment, assuming that there's a sale of air, should we think about the Financial Freedom charge as something that would kind of reduce the beginning capital. Could you kind of walk us through the steps – the strategic steps you’re taking between now and that time and how that would affect that process?

Financial Freedom certainly has a negative impact on our capital, but we still have very strong capital ratios. And I’m not contemplating that that would impact the transaction at all. And really, we haven't changed our view on how we would effect capital distributions in a spin. We’re going to get the shares in a sale. We would look over time to be returning the capital. But really, as disappointing as this impact is, I don't see it affecting the capital distribution plan associated with the transaction.

Got it. And just as a follow-up, can you just talk a little bit about – you mentioned the lease rate decline and kind of utilization in rail and the outlook for 2016 hours. How does that play out? I know you don't want to have specific forecasts, but how does that play out kind of over the course of – into 2017?

So, Moshe, it’s Rob. The utilization rate, we have been a little bit predictive about what’s going to happen over the balance of the year. The lease rates have been coming down, as you can see, over the course – over the last 12 months and we would expect that condition would persist because in terms of the shale play, which is driving the energy sector in the US, the self-correcting process is going on. North American production is dropping, but it probably will continue to drop for the next 12 months or so. So as long as that is the underlying impact to the energy portfolio, we would expect these rates to continue to decline, consistent with the rate they’ve been declining.

Thanks, Rob.

Our next question comes from Chris Kotowski of Oppenheimer & Company. Please go ahead.

On Financial Freedom, I wonder if you can flush it out a bit more for us and convince us that we have our arms around the whole thing. Specifically, I guess I'm wondering, is the $500 million reserve against the $3 billion with maturity events or the whole $16 billion? And then, kind of I wonder, can you work us through an example on, say, $100,000 or $200,000 reverse mortgage? What are you on the hook for? What triggers you being on the hook for a payment and how do you quantify – how would you assess the risk on a typical mortgage?

Okay. We could spend all day talking about this. But let me try to give a response to this concisely. The $500 million reserve relates to two underlying portfolios. The $3 billion of mortgages that have hit a maturity event, but haven’t yet been filed, this claim, because they’re still in the foreclosure process. Plus the $4 billion that we have already filed claims on. So of the $16 billion, around $13 billion are with people who are still in the home. They have not hit the maturity event. We think the processes and controls that we have put in place will help mitigate any issues going forward around those loans when they hit a maturity event. For the loans that have hit the maturity event, but haven't yet been filed, to the extent, we haven't hit a curtailment event yet, we think our processes and controls are going to help mitigate any further risk. But for the 500, it’s kind of on just over $7 billion of loans. And that's how we think about the reserve going forward. With respect to where we end up incurring a liability, post the maturity event, there are a series of guidelines issued by HUD with which we have to comply in order for the FHA insurance to be valid. This is described a little bit in the presentation. If we miss one of those curtailment events, we may be liable for the interest post our missing of the event. So the insurance would cover the interest up to the event and then we could be liable post that. Since foreclosure process can take a while depending upon if and when you miss an event, that is the driver of the potential interest expense on our exposures. So that’s how we think about it. The team has done a lot of work on it, as you might imagine. We are feeling better about the controls and processes that we’ve put in place. I hope that helps. And certainly, if there were any other questions, we could talk about that offline later on.

Yeah. Just 500 against just interest seems like a gigantic number. But you’re not under any circumstance liable for the principal balance?

No, this relates to the interest in the foreclosure time period. I guess, one of the reasons it can take a long time, in some of the states, the foreclosure timeline can be quite a long time, right? New York, it can be six or seven years. So depending upon when the curtailment event hits, that's how it could be a larger number.

And then secondly, I have a question, when you file the Form 10 on C2 Aviation, what we saw in those financials was $6.9 billion of equity and $2 billion of borrowings. And then same as slide 18 from your March presentation, we saw about a 30% allocated capital. And I wonder if in a general way you can describe if there were a separation of the air business, would the going-forward financials look different from what we see in the Form 10 filings.

Yeah. That’s a good question. The Form 10 kind of reflects the historical funding and the including of parent investments and everything. So once we have a structure in place, the pro forma would show a debt and equity structure similar to what we had talked about in the past, which we’ve kind of said 30% equity funding, could end up a little bit more like peers [ph] which were in the 25% to 30% range. But that is just a reflection of the historical, not how it would look once separated, and that would eventually end up being presented in the pro forma financials.

Okay. So interest expense would be higher and, I guess, return on equity would be higher because the equity base would be lower.

Actually, the interest expense does reflect interest – so the parent net investment includes debt and equity. So the P&L does reflect interest expense on the inter-company funding. It might be helpful – if you have other questions, you can follow-up with IR to take you through those details.

Okay, thank you.

Okay. You’re welcome.

Our next question comes from Eric Wasserstrom of Guggenheim. Please go ahead.

Thanks very much. Carol, I just wanted to follow up again on the CCAR issue. Can you just help us understand what the various milestones are from here until – I guess, from here?

With respect to the amended submissions?

Correct.

Yeah. Well, it’s submitted and we’ll be having an ongoing dialog with the regulators with respect to both potential transactions and – I really can’t give you more color on the timeline or anything. But, in aggregate, we still feel we’re on track with respect to the transaction for this year.

Eric, it’s Rob. I just wanted to remind you and others that the CCAR filing, when we say qualitative, but there’s always the quantitative piece as well. And this time, as a private filing, they were not running – the Fed was not running its model on us, okay? And so, they did give us – the dividend and the share repurchases were consistent. So that was reflective of they know us, right? We’ve been a Fed bank for a long time, but they didn't run their models and they won’t run their models on us for the amended plan either.

Okay. And just as it relates to whatever remediation might exist for – on the qualitative objections, I think if you look at peers, some have incurred significant costs related to that and others very little. Is there anything in there that suggests to you that it will consume a lot of cost savings as it relates to this remediation process?

We’re certainly investing in our processes and have hired – have got help to take us through what we need to do. So this doesn’t change our commitment to the delivery of the cost reduction targets. So I think that is the key thing there.

Good. Thanks very much.

Thank you.

Our next question comes from Eric Beardsley of Goldman Sachs. Please go ahead.

Hi, thank you. I think you had mentioned that you’d expect to have 30% of the targeted $125 million of cost saves out this year. Can you just update us on where you stand now in terms of the $125 million as of 2Q?

One is, we established a project management office to manage both our investment and expense initiatives in the second quarter with a full-time dedicated executive to manage it. And as I mentioned earlier, we think we’re about a third of the way through the $125 million target saves in 2016.

Just wondering how far along are you as of 2Q in terms of dollars.

We’re pretty close to that. Certainly tracking – we made some good progress in the first half of the year.

Yep.

Okay. So how much should we see in the back half, I guess, just to get to that third?

As I said, we think we are running around $300 million a quarter at the moment.

[indiscernible] where does that end the year? Does it go to $300 million down to $290 million by the end of the year? Or are we kind of around this $300 million level for the rest of the year?

It’s around the $300 million. And, of course, because of the investments in the strategic initiatives, especially the separation of Commercial Air, which is causing quite an elevated level of expenses. I think that’s kind of the guidance we want to provide at the moment around expenses.

Okay. And then just secondly, as we look at the railcar leasing business, what percentage of the deliveries this year have leases in place? And, I guess, could you just walk us through how you go through the impairment process on railcars?

I’ll take the impairment question first, right? Railcars are long-lived assets, typically around 50 years or so. And many of our cars are fairly new. So when you’re doing an impairment process for accounting reasons, you look at the life of expected cash flows on the leases and compare that to the carrying value. So near-term headwinds really do not affect the carrying value of the cars. With respect to leasing…

So in terms of the deliveries, this year, railcars in total, we’re talking about half that have been pre-leased. As you know, the utilization rate overall has held up at 94%. But because we have that visibility is why we’ve been guiding – you can think about a 90% utilization rate overall.

Okay, great. And then, I guess, just lastly – and I don’t know if you're able to answer this – but as you have this amended plan with the Fed, do you think you'd be able to execute on whatever capital return you asked for in the case of a sale, almost coincident, shortly after the sale of aircraft leasing or would you have to wait until the next CCAR round, call it, third quarter of 2017?

I think we’ve submitted the plan and would expect to execute post the separation. I guess you realize that it is a significant capital action, right? To do coincidently with a separation, that would be hard given the size. And we will be thinking about that and how we execute the return, which could be either through repurchases, special dividend, the capital actions that you might expect with something of that size.

Okay, thank you.

Thank you.

Our next question comes from David Ho of Deutsche Bank. Please go ahead.

Good morning. I just wanted to follow-up on the aircraft forward order book. Following up on the impairment process, given the supply and demand dynamics in that business, would that be something you would have to visit upon the separation? And then, would that impact the sale at all?

No. If we separate the carrying values of our fleet, remain the same as the value of the order book. It is recognized as a commitment. I don’t see any need for impairments or anything like that upon delivery. Similar to rail, they’re both long-lived and we don't expect any long-term impairment. And I think the values of the aircraft, the lease rates are holding up, have been holding up, and don’t see any impact there. I don’t know, Rob, if you would have any other thoughts on that.

The demand for air travel has still been very good. The rate of growth has slowed a little bit from 6% to 5%, but it’s still very good. And the near-term deliveries are all on lease anyway. So we feel we’re in pretty good shape with that.

Okay, great. And separately, on the Financial Freedom, the capital impact, how does that impact the overall DTA outlook from a regulatory standpoint, future and current potential charges?

Our regulatory capital actually did increase this quarter, even post the charge. It does increase the NOL a little bit. But all in, the DTA impact on reg capital didn't change that much.

Okay, great. Thanks.

You’re welcome.

Our next question comes from Vincent Caintic of Macquarie. Please go ahead.

Thanks. And good morning, guys. You’ve achieved a lot strategically in this past quarter. And I just want to take a step back on the aerospace business. For the first round bids, were there any takeaways from that that you can share in terms of the demand and pricing? And then, when we think about the second round due in late August, kind of what are you looking for and any idea on how you prioritize kind of the speed of making decision and the execution of the close?

I would say that we really can’t comment on the first round of bids on the transaction. And we’re so committed to closing the transaction by year-end. We will take a variety of factors into making a decision on this transaction, including valuation, timing, certainty of execution, funding, and tax implications.

Okay, got it. Thanks. And then, looking beyond the separation, could you update us on your thoughts on what your plans are for kind of the overall asset size of the company post the separation of aerospace?

Sure. I think we’ve talked about this before, but we’re managing the business to attain attractive risk-adjusted returns. We’re not managing the company to a specific asset level. And that being said, the earliest we could potentially be separate anyway is 2018, given the current $50 billion average asset size over a four-quarter period. I also want to note that, given the recent commentary from Governor Tarullo and others, we may see some change in the qualitative standards for traditional banks with less than $250 billion in assets. So there may be change coming down there anyway. But we’re not managing to an asset size number.

Okay, got it. Thanks very much.

You’re welcome.

Our next question comes from Chris Brendler of Stifel. Please go ahead.

All right. Thanks. Good morning. Just wanted to talk about the factoring business in this quarter. I don’t know if I may have missed it, but looks like a pretty material deceleration. Can you just talk about the competitive conditions? Are you losing share in that business? Or is it just less demand for factoring services in this kind of environment and any strategic update on how you feel about this business long-term? Thanks.

Sure. Just to talk about the factoring business, it's a very seasonal business, you know a hockey stick where the – because of the amount of the amount of retail we do, the third and fourth quarter are our strongest quarters. The business has been relatively flat. We’re looking into some new – we’re doing more in the furniture sector, others sectors of the business. The other thing is, we have a tremendous customer base in our factoring business. And what we’re looking at, we have been already data mining those customers to sell other products to them. And so, factoring business continues to be a very good source of fee income business for us. We have good returns in the business. And we’re pleased with the business.

Okay. It just seems like the trend [indiscernible] revenues here are back to, like, 1999 levels and another step down this quarter. Is there pressure on commissions as well as volumes or is it more just macro conditions weighing on the volume outlook?

We’re in a relatively benign economic environment. And even though retail gets a lot of discussion, the truth is that the largest retailers are still performing fairly well and their balance sheets are better than they’ve ever been. And so, in that situation, when you think about it, our clients wouldn’t need us quite as much as when there’s more stressed conditions. So this is kind of consistent with what we’ve seen over cycles. But we’re definitely losing share in our view.

Okay, that’s helpful. Thank you. Second question, in the core middle-market finance business, so outside of the OneWest, just the core – when I think of CIT and their expertise in that middle-market finance business, where are you standing from a competitive and yield standpoint? It seemed like there was a lot of competition on pricing. Sort of last several years, you’ve seen compression of margin in some of your higher-yielding loans, refinance or run-off. Has that stabilized at this point? And any update on where we stand from a demand perspective? Thanks.

So the pricing has stabilized in the marketplace and it’s at a healthy level and it’s stronger than it was in the last cycle at this point – at this same equivalent point of the cycle. So from our standpoint, that’s what Ellen is referring to, risk-adjusted returns. And so, we do feel very good about the opportunities that we are seeing there.

Okay, thanks so much.

Our next question comes from Chris York of JMP Securities. Please go ahead.

Good morning. My question kind of follows up on the last one from Chris. I was hoping we could get your views on future new business volume in commercial banking. It appears the production in CRE was better than expected. So in addition to the effect from CMBS, have you seen any incremental opportunities from other banks that may be slowing originations from the regulator's guidance on CRE? And then lastly, what was the yield on new loans for CRE?

So CREs, linked-quarter growth was stronger than most would have expected. As you noted, the CMBS market is under a little bit of pressure. And so, when there’s less activity there, that means that some of the construction and reposition loans that are in our portfolio don't really go anywhere, right? So that’s good for us for a period of time. You can’t count on that forever, okay? So that’s something could last for another quarter or two, we don’t really know. I would say the pricing in the commercial real estate world has firmed because it has been dropping over a couple of year period of time, but it has firmed and we think those are good risk-adjusted returns overall. And then the volume itself was the same from the prior quarter.

And then second question here is – and forgive me if I missed it here. Any color on the pickup in maintenance and operating lease expense quarter-over-quarter, year-over-year? What caused that pickup? And was any of it one-time or due to retrofitting cars in rail? And then, how should we think about that going forward?

Yeah. So I can take that. The operating lease and maintenance expense was actually predominantly in air this quarter. And in air, it does tend to reflect – if you’re doing a re-marketing – there were a couple of planes this quarter, but otherwise not really any change in the underlying thing there. Just slightly elevated from that. And, of course, last quarter being low relative to trends. They get a little bit of variability in the air P&L based on that, but otherwise nothing really different. And I think, in rail, maintenance expenses and operating lease expenses reflect utilization. And so, that’s one of the reasons it’s important to keep the releasing going on. The costs are lower when the cars are leased. So that’s one of the reasons we’re very focused on utilization.

That’s helpful, Carol. Thank you.

All right. Thanks very much.

There are no further questions in the question queue. I will turn the call back over to management for any closing remarks.

Great. Thank you, Carrie. And thank you, everyone, for joining us this morning. If you have any follow-up questions, please feel free to contact me or any member of the Investor Relations team. You can find our contact information along with other information on CIT in the Investor Relations section of our Web site at www.cit.com. Thanks, again, for your time and have a great day.

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