First Citizens BancShares, Inc. (FCNCA) Q3 2017 Earnings Report, Transcript and Summary

Good morning, and welcome to the CIT’s Third Quarter 2017 Earnings Conference Call. My name is Allison, and I will be your operator today. At this time, all participants will be in listen-only mode. There will be question-and-answer session later in the call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Barbara Callahan, Head of Investor Relations. Please proceed, ma’am.

Great, thank you, Allison. Good morning, and welcome to CIT’s third quarter 2017 earnings conference call. Our call today will be hosted by Ellen Alemany, Chairwoman and CEO; and John Fawcett, our CFO. After Ellen and John’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. As a courtesy to others on the call, we ask that you limit yourself to one question and one 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 2016 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 in the Investor Relations section of our website at www.cit.com. I’ll turn the call over to Ellen Alemany now. Thank you.

Thank you, Barbara. Welcome and thank you for joining the call. Let me start-off with an overview of our results for the quarter. We posted $220 million of net income or $1.61 per share. Excluding noteworthy items, we recorded $139 million of income from continuing operations or $1.02 per share. Both measures are up year-over-year and results were primarily driven by lower operating expenses and lower credit provision, which was partially offset by lower net finance revenue. Overall, the quarter provided evidence of continued progress on the strategic plan across a number of fronts. But like others in the industry, we did experience challenges with prepayments and loan growth, which affected our Commercial Finance business in particular. That said, we saw pockets of growth year-over-year in our Business Capital and Real Estate Finance units. Our strategic plan which is outlined on Slide 2 continues to be our roadmap for the transformation and I want to highlight a few important advances this quarter. Our operating expenses declined about 9% from a year ago, as we continue to simplify the organization. We reduced unsecured debt by another $800 million, which will improve funding costs. We completed the ASR and repurchased approximately $120 million of incremental common stock. We grew average investments by $800 million. Credit remains strong and we continued to improve our mix of deposits in particular at the Direct Bank. In addition to these efforts, earlier this month, we addressed another key legacy issues for the company, in reaching an agreement to sell the financial freedom reverse mortgage servicing business, as well as the portfolio of reverse mortgage loans. This transaction is expected to close in the second quarter of next year and we’ll allow us to ultimately exit this business. While the sale of the reverse mortgage loan portfolio will reduced our revenue stream, we believe selling these assets is in the best interest of the company, as it will reduced future risks and enable us to focus our attention and resources on our core businesses. The previously announced transaction to sell NACCO, the European Rail business continues to progress. This is our last ongoing overseas business and supports our efforts to simplify CIT. We’ve remain committed to the North American Rail business, and while we’ve continued to work through the current market cycle, the business generates good returns has attracted tax and capital benefits and is well managed. As we look across the commercial banking space, environment has clearly become more competitive in certain sectors and the structure of the deals has gotten more aggressive in middle-market lending. We have remain disciplined in our approach, as we compete for the business and our deep expertise across segments coupled with our products and service level is a compelling package that drives value for our clients. We’ve posted 8% growth year-over-year in our Business Capital unit and nearly 6% growth in real estate, when excluding the legacy run-off of portfolio. And we continued to advance our business initiatives across the board and plant seeds for the future by investing in talent and infrastructure that will support our plan. For example, we added nearly 20 client-facing professionals over the last quarter across six business teams dedicated to expanding our market presence in core areas. We added a team dedicated to aviation lending, which will help to expand our aerospace offering. We don’t have the industrial team in our equipment finance unit. And we have added capability in our Sponsor Finance business, as well as in the new Northbridge JV. We have also recently closed on several key deals in the Business Capital unit. The equipment finance business completed three manufacturing programs and the construction of material handling industries, as well as beginning a partnership with one of the largest technology integrators in the country. And a commercial services team has added several new clients in the factory unit. The real estate team recently added syndication capabilities to pursue additional avenues of growth. On the deposits front, the Direct Bank had very strong quarter with over 33,000 new accounts and strong growth in the non-maturity savings product of nearly $700 million. And OneWest Bank was just recognized for the second consecutive year, the best bank in California by Money Magazine on their annual best banks’ list. Overall, we made solid progress in the quarter and delivered on many facets on their plan. With that, let me turn it over to John for a more detailed accounting results.

Good morning, everyone, and thank you Ellen. Turning to our results on Page 3 of the presentation, GAAP net income for the quarter was $220 million or $1.61 per common share. Net income from continuing operations was $223 million or $1.64 per common share. On Page 4, you will see the financial results continued to be impacted by a number of noteworthy items, primarily related to our strategic transformation, most of which working in continuing operations this quarter. Noteworthy items included a $140 million benefit to the tax provision, resulting from strategic tax planning actions taking during the quarter to restructure an international legal entity. These actions generated capital tax losses and offset taxable gains from the Commercial Air sale and other activities, preserving approximately $400 million of our net operating loss carried-forward to offset future taxable income. The actions resulted in an increase to our deferred tax asset of $140 million an increased to disallowed deferred tax asset and regulatory capital by approximately $70 million. And updated slide describing the impact to our deferred tax asset from the sale of Commercial Air in the current quarter actions is on page 26 in the appendix of our earnings presentation. We continue to be opportunistic in reducing our funding costs. At the end of the quarter, we incurred an after tax charge of $33 million, as we tendered for $800 million of unsecured debt, utilizing excess liquidity at the holding company. In addition, earlier this month, we reached definitive agreement to sell financial freedom, our reverse mortgage servicing business and other reverse mortgage assets. The transaction includes mortgage servicing rights, related servicing assets and liabilities, as well as reverse mortgage loans and related secured borrowings or reported in discontinued operations. The transaction also includes approximately $900 million of reverse mortgage loans and other real estate owned, which are reported in continuing operations. We expect the transaction to close in the second quarter of 2018, following the approval of certain government agencies and the consent of investors related to the reverse mortgage servicing business. Due to the structure of the transaction, we’ve recognized after tax charges of $28 million this quarter, from the write down of certain loans and related assets that were priced at a discount to our carrying value, and anticipate a gain at closing for loans priced at a premium. On a pretax basis, the charges this quarter included $27 million in other non-interest income related to the write down of home equity conversion mortgage loans, Other Real Estate Owned and other mortgage related assets in continuing operations. In addition, the credit provision included $15 million charge-off for mortgage loans moved to held for sale, and we recognized a $4 million charge in discontinued operations related to the servicing liability. We currently anticipate recognizing a pretax gain in continuing operations at closing of approximately $25 million to $35 million net of transaction costs. However, the actual amount will depend on the timing of the closing and the performance of the portfolio prior to closing. The anticipated gain does not include any potential changes to our reserves. The transaction contains customary representations and warranties and certain indemnifications related to any potential loan defects and servicing deficiencies both of which are subject to certain caps and limitations. We will continue to analyze the adequacy of our reserves related to the indemnifications, as we move through the closing process and may have further adjustments if appropriate. As for the go forward earnings impact, the reverse mortgages that are being sold from continuing operations were significantly discounted and earned at an average yield of 9% to 10%, and there are no incremental direct operating costs associated with these loans. As a result, interest income reported in the run-off legacy consumer mortgage division in continuing operations will decline by about $20 million per quarter after the transaction costs. However, the sale of financial freedom and this mortgage portfolio is a significant step in simplifying CIT, enabling us to focus on our core franchises. With regard to the pending sale of our European Rail business, NACCO, the related operating lease equipment assets have been transferred into held for sale, requiring us to suspend depreciation on those assets, increasing net finance revenue by approximately $8 million per quarter. While the NACCO sale is progressing, anti-trust trust approvals in Europe are taking longer than expected and we now anticipate the closing to occur in the first quarter. As a result, we expect fourth quarter results to also benefit from this suspended depreciation. Details of all noteworthy items for the current, prior and year-ago quarters are listed on Page 20 of the presentation. Turning to Page 5, income from continuing operations, excluding noteworthy items was $139 million or $1.02 per common share this quarter. This is up from $126 million or $0.68 per common share last quarter and $109 million or $0.54 per share in the year ago quarter. I will now get into some further detail on our financial results for the quarter. Please note that in this discussion, I will be referring to our results from continuing operations, excluding noteworthy items unless otherwise noted. Turning to Page 6 of the presentation, net finance revenue was down $11 million from the prior quarter, while net finance margin increased 2 basis points. Compared to the year ago quarter, net finance revenue was down about $25 million, while the margin was down 5 basis points. I would like to point out a change we made to the net finance revenue trend chart on the top of Page 6. In the past, we separately highlighted the amount of purchase accounting accretion or PAA, on loans acquired from OneWest in net finance revenue. We are now highlighting PAA net of negative interest income on the indemnification asset, which represents a decline in expected cash flows from the loss agreement with the FDIC, and $3.9 billion of Covered Loans acquired from OneWest. In past quarters, this negative interest income was not as impactful and therefore not separately highlighted. As you can see, our core net finance revenue has been relatively stable over the past year, while the reduction has been driven by the impact of net purchase accounting accretion. Purchase accounting accretion has declined from $71 million in the year ago quarter to $61 million last quarter and $52 million in the current quarter, reflecting the run-off of the Legacy Consumer Mortgage division and high prepayments in Commercial Finance and Real Estate Finance. The negative interest income on the indemnification asset has increased to $14 million this quarter from $10 million last quarter and just $4 million in the year ago quarter, due to a decline in expected reimbursable losses under the loss share agreement from better than expected credit performance of covered loans. Next quarter, we expect a negative net interest income from the indemnification asset to increase to around $16 million and the negative yields will increase to about 45%. We expect the yields to remain negative but can increase or decrease as the indemnification asset amortizes over the remaining contract period, which expires in March of 2019. It is important to note that while the stronger credit performance reduces the yield on the indemnification asset, it increases the yield on covered loans, which has resulted in more purchase accounting accretion than originally expected. This improvement is also evidenced by the reclassification of approximately $300 million of purchase accounting discount from non-accretable to accretable since the acquisition. Turning to Page 7. Net finance margin increased by 2 basis points this quarter due to several factors. Growth in the investment securities portfolio and yield improvements on our loans resulting from an increase in LIBOR and the mix of assets added 18 basis points to the margin. We also had lower borrowing costs, driven by our funding mix. Offsetting these increases were lower net purchase accounting accretion and prepayment benefits, as well as lower net operating lease revenue from our Rail business. Rail renewal rates priced down on average 16% this quarter, reflecting the mix of cars renewing. We continue to expect leases to reprice down on average 20% to 30% for the next year, reflecting current market conditions and continued pressure from the tank car lease rates, which are coming off peak levels. We expect further reduction in our funding cost next quarter from the $800 million of unsecured debt we repurchased at the end of the quarter, which had an average coupon of 5.4%. This benefit will be partly offset by the reduction in interest income from excess liquidity that was used to fund the redemption, which had a weighted average yield of around 1.5%. Compared to the year ago quarter, the decline in net finance margin was primarily due to the same trends described above. In addition, lower deposit cost has improved the margin by 2 basis points, reflecting the growth in non-maturity deposits and reduction in higher cost, broker and commercial deposits. Turning to Page 8. Other non-interest income increased from prior and year ago quarters. Compared to last quarter, higher factor and commissions and gains on investments offset lower gains on the sale of loans and leases. The year ago quarter included a large mark-to-market charge on the total return swap while factoring commissions declined slightly as higher factoring volumes were offset by lower pricing. Turning to Page 9. Operating expenses before the amortization of intangibles were $268 million, down $18 million from the prior quarter and $26 million from the year-ago quarter. You may recall that last year’s – last quarter’s expenses were elevated by $8 million due to a non-restructuring severance and a nonrecurring charge related to the NACCO business. Absent those charges, operating expenses declined $10 million, reflecting lower FDIC insured and compensation related costs. Compared to the year-ago quarter, the decline in operating expenses was driven by lower compensation costs, professional fees and other business related expenses, primarily related to our cost reduction initiatives, partially offset by higher advertising and marketing costs related to our strategy to shift to non-maturity deposits. We continue to be on track with our cost savings target for 2018. Page 10 describes our consolidated average balance sheet, which includes discontinued operations. With the sale of Commercial Air, the only remaining items in discontinued operations relate to the Financial Freedom reverse mortgage servicing operations and Business Air. Adjusted for the noteworthy items highlighted toward the bottom of the page, average earning assets are down $1.5 billion from the prior quarter, reflecting the continued deployment of our cash. Average interest bearing deposits were down $2 billion while investments grew $800 million and deposits and unsecured debt declined. Turning to Page 11. We’ve provided more detail on average loans by division within Commercial and Consumer Banking. Commercial Banking’s average loans and leases have been relatively flat, with the reduction in Commercial Finance offset by growth in other divisions. While the reduction in Commercial Finance from a year ago was mostly due to our repositioning efforts and higher prepayments, new business volume was impacted this quarter by weaker activity and more aggressive structures in the middle market. Business Capital grew a little over 1% this quarter, with average growth across all businesses. But over the past year, this division has grown 8% with double-digit growth or near double-digit growth coming from Direct Capital, Capital Equipment Finance and Commercial Services. Real Estate Finance’s volumes were strong this quarter. But overall average assets remained relatively flat due to prepayments and the run-off of the legacy portfolio acquired through the OneWest acquisition. Compared to the year-ago quarter, the core portfolio has grown $250 million or almost 6%, while the legacy run-off portfolio, which is now approximately $730 million has declined by $160 million. North America Rail’s utilization remains around 95%, and assets are flat. As I mentioned last quarter, the remaining order book in North America is currently $100 million, which is expected to be delivered through 2018. The run-off of the Legacy Consumer Mortgage portfolio continues to be the driver of the reduction in average loans in Consumer Banking. Page 12 highlights the improvement in the composition of funding. Deposits are 78% of our total average funding, while unsecured borrowings declined to 11% from 22% a year ago, and FHLB advances increased modestly. Funding cost as a percentage of average earning assets have been relatively confident over the past year, and we continue to evaluate opportunities to reduce these costs. The loan and lease-to-deposit ratio of the company is 127% versus 120% last quarter, while the bank ratio increased modestly to 102% from 96% last quarter. Page 13 illustrates the deposit mix by type and channel. Our strategy is to reduce the amount of time deposits relative to non-maturity deposits as well as reduce broker deposits. As you can see on the top chart, while we have been increase in non-maturity deposits, the decrease this quarter in money market and sweeps accounts represents a reduction of higher-cost accounts in our broker and commercial channels, offset by an increase in our savings account. The lower chart illustrates the deposits by channel we can also see the progress we’re making reducing broker deposits. Average deposits in the Direct Bank or online channel increased by $500 million this quarter, reflecting a $700 million increase in savings accounts, offset by a reduction in time deposits. The overall cost increased modestly from prior quarter, reflecting an increase in the average savings account, savings rate offset by a reduction in higher cost broker and commercial deposits. Page 14 highlights our credit trends, which continue to reflect a favorable environment, and we’re seeing no substantive changes in overall trends. The credit provision was $15 million this quarter, up from $4 million last quarter, but still below the normalized run rate, reflecting stable charge-off levels and a decrease in reserves due to overall low loan balances. The decline in the credit provision from the year ago quarter, which was $45 million, reflects these trends as well as positive changes in credit quality. Non-accrual loans remain at 0.9% of total loans while the allowance for loan losses in Commercial Banking is 1.73%, down slightly from the prior quarter and relatively flat from the year ago quarter. Turning to capital on Page 15. The change in capital ratios are highlighted on the top chart. During the quarter, we took delivery of another 1.45 million shares related to the completion of the ASR, resulting in the aggregate repurchase of 10.7 million shares at $47.82 per share. Additionally, we repurchased $120 million of common stock, in line with our capital plan, representing 2.7 million shares at an average price of $44.82. These actions reduce the number of share from $135 million at the beginning of the quarter to $131 million at September 30. We still have $106 million of capital that can be executed in the first half next year under the existing capital plan. As we highlighted last quarter, we also increased our dividend by a $0.01 per share to $0.16 per share. Our capital position remains strong with the common equity Tier 1 ratio of 14%, down from prior quarter, reflecting higher risk-weighted assets. CET1 was relatively flat as the increase in earnings was offset by share repurchase, dividends and an increase in the disallowed tax asset I discussed earlier. While overall assets are down, risk-weighted assets increased $1.5 billion, reflecting a shift from cash, which carries a zero-risk waiting to investment securities and other assets, as well as seasonally higher on and off balance sheet factoring balances that carry a higher risk weighting. Adjusting for noteworthy items, our effective tax rate this quarter was 28%, benefiting from a true-up related to the mix of U.S. and international earnings, which reduced the year-to-date tax rate. Page 17 provides our current outlook for the next quarter. We expect net finance margin to drift closer to the middle of the range given its continued run-off of purchase accounting accretion and Rail headwinds. Also, while we expect the continued increase our investment securities book, the pace may be slower as the average increase of $800 million this quarter was above our expected run rate. We continue to expect the credit provision to be within the target range of 25 to 50 basis points of average earning assets. Operating expenses before restructuring costs are expected to be relatively flat next quarter, as further improvement in our cost save initiatives will be offset by investment expenditures, particularly in the information technology area. Finally, our year-to-date effective tax rate is 30%, and we expect this rate to return to a more normalized level next quarter. As Ellen mentioned, we will be back to you on our fourth quarter call within an update of our 2018 outlook. With respect to capital, as I mentioned last quarter, our capital plan submission targeted an 11% common equity Tier 1 ratio towards the end of 2018. Since that submission, we’ve announced at the sale of NACCO and Financial Freedom, further reduced our unsecured debt, and we’ll continue to work within the regulatory framework to return excess capital to our shareholders. In addition, we constantly evaluate opportunities to optimize our debt structure and are taking a comprehensive approach to address the impact from divestitures as well as other actions, including further reducing debt from excess liquidity and/or refinancing with lower-cost debt to improve the financial performance of the company. And with that, let me turn it back over to Ellen.

Thanks, John. To wrap up, we are pleased with the progress on the strategic plan and are dedicated to consistent execution on our five priorities. We remain committed to the 10% ROTCE target. However, given the pace of loan growth in certain areas and the divestiture of the reverse mortgage portfolio, we may experience some headwinds in achieving this target in 2018. There are many facets to the plan, and we feel confident with the ability to achieve our $150 million cost-reduction goal next year. In addition, we’re focused on optimizing our capital structure within the regulatory framework, improving our funding cost, growing our investment portfolio, remaining disciplined on risk management and maximizing the potential of our businesses. We are currently in the annual planning process and expect to share additional guidance on 2018 during our next earnings call in the first quarter. With that, let me turn it back to the operator for Q&A.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Ken Zerbe with Morgan Stanley. Please go ahead.

Great, thanks. Good morning. I guess just to start off, in terms of the operating lease yields, still coming down quite a bit. Do you guys see any kind of stability in the near future? Where could that bottom out? Just trying to see if there’s any stability there. Thanks.

Yes. Ken, its John. So it’s really a function of the cars that are actually coming off lease. We expect that we’re going to see a little bit more of a headwind going into 2018 because there’s a fair number of tank cars that are coming off lease. So if you don’t see any kind of move in the oil or more opportunity in the fields, you’d expect that to come down. I think we’re looking probably into 2019 before we see a more fulsome bottom. I think while the tank cars remain a particular challenge, I think as you go to some of the other cars, the more common cars, box cars, flat cars, auto tracks. That seems to have stabilized already. But the preponderance of the headwinds are, I think, going to be continued to be driven by what we’re seeing in tanks.

Got it, okay. That helps. And then just on the expense line, it came in a little bit better than what we were looking for. I’m glad you’re still committed to the $150 million. But it seems like some of the reduction, some of the improvement this quarter is driven by sort of core items, right, like FDIC insurance costs. Is that a fair statement? Because I guess I was under the impression that some – a little bit more the expense reductions coming from the volatile items or – I’m just wondering, like, this – how sustainable some of those core expense numbers are as it gets driven down? Am I thinking about that the right way?

I guess, yes and no. I mean – and the reality is that I’ve taken a very fresh look at this. I’m pretty comfortable with the $150 million. I think this becomes an area of continuous improvement. I don’t know that you ever get to the right place, and you just have to keep pushing. I think the plan that Ellen laid out back in March of 2016 articulated all the right levers, the bulk. If you look at our expenses, it’s pretty much like a bank. You got 50% of your cost are tied up in people cost. And so if you want to improve significantly, take people out of the process. There’s another 12% that’s tied up in hope’s technology and data, and that becomes an enabler to take people out. And so it’s necessary to make some investments that will depreciate over time to allow that to happen. But I think third big lever is around the notion of consultants, which I think there are a lot of them around here, and I think we’re making a concerted effort to build, retain institutional knowledge within the company and push the consultants out of the place. So there’s still a lot to do, but we are literally looking at every single line. I know this a little bit in the weeds, but in the past quarter, we took a look at a comprehensive review of our travel and expense policy, and that’s going to get rolled out in the current quarter. And again, its little things, but they will have a way of adding up. In terms of the arithmetic going forward, I know we’re committed to that 10 50, and there’s a bit of extra maybe stranded cost. So if you want to do easy arithmetic and want to get 10 40, you’d be targeting it about 2 60 a quarter going into 2018. We’re $268 million right now, so that feels pretty achievable to me.

Yes. Ken, this is Ellen. Just a couple more comments on expenses. So the FDIC insurance decline is really due to the lower assessment base and also just other factors that go into calculation because the credit improvements, we have lower criticized and classified portfolios and also improvements in our core earnings in Tier 1 affected this ratio. So we think that those changes are sustainable. We also – there’s so much with expenses you can squeeze, squeeze, squeeze and take out. But we’re really looking at really making fundamental structural changes to get expenses out. And I think we’re making good progress there. And headcount stands 6%. We just put in a new capacity-management program so that we could drive more efficiency with staffing levels. We’re starting to leverage robotics and artificial intelligence. We’re also rationalizing a lot of our technology applications, still working on real estate footprint. But I also want to note that even though our target is the 10 50, we’re still investing in our infrastructure, primarily risk and – risk infrastructure, growth initiatives. And so there’s going to be variabilities in that expense line going forward.

All right, great. I appreciate it, thank you.

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

Great, thanks. You did a pretty comprehensive job going through the kind of onetime notable items, but could you talk a little bit about the areas in which there’s going to be future impacts kind of to net finance revenue and when that happens like, for example, the NACCO suspended depreciation and the reverse mortgage assets? Like when do those come out? And is that part of what’s in your fourth quarter guidance or not? And so maybe kind of address that.

Yes. So – I mean, interestingly enough, I think we modeled NACCO to actually close on November 1. The anti-trust is not something we anticipated. Now we’re expecting it to close, call it, middle of the first quarter. I think we’d be happily surprised if it happens sooner. I think we’ll maintain the suspended depreciation until it’s actually closing. And so you can expect a full $8 million benefit in the fourth quarter and then whatever the partial benefit is in the first quarter, subject to the closing. I think the Financial Freedom, we are still pretty close to actually signing the contract. I think, we expect that that’ll close sometime in the second quarter, hopefully at the early end of the second quarter. Obviously, the big headwind is the $800 million what we characterize as a G3 portfolio, and that’s worth about $20 million a quarter. So if you are modeling this, I would say halfway through the middle of the second quarter and on out, so you lose 10.5 second quarter, another 20 20 in three and four.

Right. But none of that’s kind of contemplated in the margin guidance that you’ve got for the fourth quarter?

No.

Got it. Okay, thank you.

Our next question will come from Owen Lau of Oppenheimer. Please go ahead.

Thank you, good morning. Thank you for taking my question. I’m just wondering how much more cash can you move to investment securities? Because when I look at your balance sheet, you have $3.1 billion in your third quarter, down $2 billion. And you’re still maintaining at around $5.7 billion in investment securities portfolio. I’m just wondering how much more cash you can deploy maybe due high-yielding investment securities or pay down debt?

I think on a steady-state basis, we’d like to get to about 5% of average earning assets in terms of where cash is. I think if you look at other regional banks, regional banks have high-quality investment portfolios in the 18% to 20% range. I think over time, we’d aspire to get there. I think we have a lot of choices, different choices that we can make in terms of our excess liquidity. I think you saw one of them executed in the third quarter this year, where we kind of retire, across three debt stacks, 5.4% paper. So it’s not a straight line. I think we’re opportunistic in terms of when we’re going to deploy cash, where we’re going to deploy cash. I think given where tens have moved around, buying at 2 30 seems okay. But buying at 2 10 seems less okay. So I think it’s an exercise that we spend a lot of time looking at in terms of how to properly deploy the cash between investment portfolio and opportunistically restructuring debt.

Yes, thank you. That’s very helpful. Just one follow-up. High-level strategy question related to your middle market lending franchise and the railcar leasing franchise. And actually based on my math, the differential between the long yield adjusted for credit cost and the rental income yield came down from 5.5% in 2015 to around 2.3% this year. And given where we are in the interest rate cycle, where we are in the credit cycle and where we are in the railcar leasing cycle and also the excess capital you have, those are two very good business. But looking into like over the next two to three years, how would you position CIT and allocate your resources between these two good franchises? Thank you.

So this is Ellen, Owen. I would – I mean, just commenting, I mean, our core franchises in the future are our North American Rail business, our Business Capital, Commercial Finance and Real Estate Finance business and then Direct Capital. And we have hurdles set up for all of those businesses, and I would say that the growth is primarily going to be in those businesses going forward. I think the one business that we’re experiencing weakness in right now is the Commercial Finance business. And really, that’s a function of the aggressive structures, covenant light, record leverage in these deals now, and we’re really trying to stay disciplined. Although that being said, we have a pretty good pipeline in the business, and I think it’s going to really depend on conversion rates and prepayment levels in the fourth quarter there. Business Capital, we’re seeing a lot of strength right now in franchise, industrial, office imaging, material handling. We’re investing a lot. I’ve mentioned earlier, we added over 20 front-office people. Those are good return businesses, and we expect good growth in Business Capital going forward. Even our Capital Equipment Finance business was one of our stars for the quarter, where smaller businesses were making a large Capital Equipment purchases. And then Direct Capital, our fintech business where we’re processing transactions literally under 30 minutes. We’re seeing good demand from small businesses for Equipment Leasing in that space. So we’re going to just keep investing in these core businesses going forward. And as John spoke about with Rail earlier, I think we’re going to have softness in Rail and throughout 2018. And it’s really going to depend on growth in the industrial and manufacturing sectors for Rail to really make a turn, but we’re still making good returns on that business.

And the only thing I would add to on the Rail because, obviously, we get a lot of questions on the Rail franchise and I’m still relatively new here, but I took the time to actually go back and look at the kind of returns that this business has generated going back all the way down to 2012 and 2013. And this is a very long-cycle business, but when it’s at the top of its game, it’s quite an important franchise, and it’s a quite a good returning franchise. And I think, given the management team, given the quality of the cars, given the newness of the cars, given the mix and diversified nature of the portfolio, I think it’s well worth it to weather the storm to get through this cycle and see what’s on the other side of it.

Thank you. That’s very helpful.

Our next question will come from Arren Cyganovich of Citi. Please go ahead.

Thanks. If you could talk a little bit about – you mentioned the headwinds you’re seeing in the Commercial Finance business, but you’re also hiring a decent amount of folks in various verticals. Maybe just talk about your expectations for origination trends as you’re adding some new folks and kind of combating the pressures you’re seeing on the Commercial Finance business.

Sure. I mean, our – we’re – one, it’s – congratulations on your new role, by the way, Arren.

Thank you.

I would say that we’ve organized our business around our industry verticals. We think that, that’s our biggest competitive advantage. So the teams that we’re adding are really in material handling, construction equipment, industrial equipment. We just put on a new air team that will specialize in midrange aircraft. So we’re really growing in the areas where we think we’ll have the biggest growth in assets. And we’re also adding to our syndication capability, where we can play in larger transactions. And so that’s where the growth will be going forward.

I think last quarter, you indicated that you’d expected the year-end to grow around in the low single digits for average loan and leases. Has that changed since you had a higher loan growth prepayments again in the third quarter?

So, Arren, this is Rob. Yes, we did expect that. And as you can see, over the last year, Business Capital and Real Estate has had pretty good growth. Commercial Finance has not had that quite the same level of growth. The pipeline, as Ellen said, is pretty strong in Commercial Finance, but we’ve all been around the block a little bit, the markets are pretty frothy and there’s fairly loose structures out there, and so we will be prudent. So we don’t give too much of a caveat because we do see a pretty good pipeline. But this is just – we’re already a month into the fourth quarter. So you should expect growth in most of the business, but Commercial Finance is still building its pipeline.

Thanks. I appreciate that it’s always better to [indiscernible] for the sake of it, so we appreciate that. The last question I have is just on the tax rate. For the third quarter, the adjusted tax rate was around 20%, and I think you’re guiding towards kind of mid-30s longer term. I suppose – that looks like it added around $0.09 or so to the quarter. Why not – why is that not considered a more of a one-off from a tax perspective?

It’s essentially – it was essentially a year-to-date true-up in terms of the mix between international and domestic income. And I think as we’ve messaged, we don’t expect to stay in this ZIP Code, and we’ll probably get more to a 33%, 35% rate in the fourth quarter.

Got it. Okay, thank you.

You’re welcome.

[Operator Instructions] Our next question will come from James Fotheringham of Bank of Montreal. Please go ahead.

Thank you. Thanks for all the details regarding the current and expected impact from the Financial Freedom transaction. I was wondering, what do you anticipate will be the impact on purchase accounting accretion specifically and the PAA growth from the sale of the $900 million reverse mortgages in the second quarter of next year?

I don’t know that I have the specifics on that. What I would say is that in terms of remaining purchase accounting accretion, it is probably seven or eight. Let’s call it 7 50, 7 70 on the balance sheet. The vast majority of it in Consumer. The pace of runoff is probably 10% to 15% a year. On the Commercial side, it’s got a much shorter life. It’s probably $150 million or so of remaining purchase accounting accretion. And we expect that half of that will be gone over the course of the next 12 months. On the Financial Freedom, it’s – I guess it’s something you can probably follow up with IR after call, and we’ll get you that information.

If you look at Legacy Consumer Mortgage at about 60% of PAA and $900 million being about 20% of that 60%. Is it 12% hit to PAA a reasonable assumption? I know it’s a lot more complicated than that, I just don’t have access to the information to do a more refined analysis.

Yes, it is more complicated than that. It’s probably something better taken offline with Barb and the IR guys.

All right. If I can squeeze in one related question then. Was there any impact on the PAA this past quarter from the announced sale of the reverse mortgages?

No.

Thanks so much.

You’re welcome.

Ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Great. Thank you, everyone, for joining 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 website at www.cit.com. Thank you, again, for your time this morning, and have a great day.

That concludes today’s call. Thank you for participating. You may now disconnect your lines.