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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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Form 10-Q
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|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 001-31369
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CIT Group Inc.
(Exact name of Registrant as specified in its charter)
Delaware 65-1051192
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
1 CIT Drive, Livingston, New Jersey, 07039
(Address of Registrant's principal executive offices)
(973) 740-5000 (Registrant's telephone number)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer as
defined in Rule 12b-2 of the Securities Exchange Act of 1934. Yes |X| No |_|
As of July 31, 2003, there were 211,634,107 shares of the Registrant's
common stock outstanding.
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CIT GROUP INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Page
----
Part I--Financial Information:
Item 1 Consolidated Financial Statements (Unaudited)...................... 1
Consolidated Balance Sheets........................................ 1
Consolidated Statements of Income.................................. 2
Consolidated Statements of Stockholders' Equity.................... 3
Consolidated Statements of Cash Flows.............................. 4
Notes to Consolidated Financial Statements......................... 5-18
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations and Quantitative and
Qualitative Disclosure about Market Risk......................... 19-51
Item 4 Controls and Procedures............................................ 51
Part II--Other Information:
Item 1 Legal Proceedings.................................................. 52
Item 4 Submission of Matters to a Vote of Security Holders................ 52
Item 6 Exhibits and Reports on Form 8-K................................... 53
Signatures......................................................... 54
i
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
CIT GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Unaudited)
($ in millions, except share data)
June 30, December 31,
2003 2002
--------- ------------
ASSETS
Financing and leasing assets:
Finance receivables ............................... $28,413.6 $27,621.3
Reserve for credit losses ......................... (754.9) (760.8)
--------- ---------
Net finance receivables ........................... 27,658.7 26,860.5
Operating lease equipment, net .................... 7,560.0 6,704.6
Finance receivables held for sale ................. 1,210.0 1,213.4
Cash and cash equivalents ............................ 1,423.3 2,036.6
Goodwill, net ........................................ 389.8 384.4
Other assets ......................................... 4,942.9 4,732.9
--------- ---------
Total Assets ......................................... $43,184.7 $41,932.4
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Debt:
Commercial paper .................................. $ 4,576.7 $ 4,974.6
Variable-rate bank credit facilities .............. -- 2,118.0
Variable-rate senior notes ........................ 6,637.3 4,906.9
Fixed-rate senior notes ........................... 21,216.8 19,681.8
--------- ---------
Total debt ........................................... 32,430.8 31,681.3
Credit balances of factoring clients ................. 2,471.6 2,270.0
Accrued liabilities and payables ..................... 2,968.3 2,853.2
--------- ---------
Total Liabilities ................................. 37,870.7 36,804.5
--------- ---------
Commitments and Contingencies (Note 8)
Company-obligated mandatorily redeemable
preferred securities of subsidiary
trust holding solely debentures of the Company .... 256.4 257.2
Stockholders' Equity:
Preferred stock, $0.01 par value,
100,000,000 authorized; none issued ............. -- --
Common stock, $0.01 par value, 600,000,000
authorized; 211,634,107 issued and
outstanding ..................................... 2.1 2.1
Paid-in capital, net of deferred compensation
of $3.7 and $5.5 ................................ 10,677.8 10,676.2
Accumulated deficit ............................... (5,393.8) (5,606.9)
Accumulated other comprehensive loss .............. (228.5) (200.7)
--------- ---------
Total Stockholders' Equity ........................ 5,057.6 4,870.7
--------- ---------
Total Liabilities and Stockholders' Equity ........ $43,184.7 $41,932.4
========= =========
See Notes to Consolidated Financial Statements (Unaudited).
1
CIT GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
($ in millions, except per share data)
For the Quarter For the Six Months
Ended June 30, Ended June 30,
---------------- ------------------
2003 2002 2003 2002
---- ---- ---- ----
Finance income ..................................... $943.2 $ 1,021.9 $1,882.4 $ 2,128.6
Interest expense ................................... 331.1 370.2 677.8 718.5
------ --------- -------- ---------
Net finance income ................................. 612.1 651.7 1,204.6 1,410.1
Depreciation on operating lease equipment .......... 272.9 295.7 551.7 605.9
------ --------- -------- ---------
Net finance margin ................................. 339.2 356.0 652.9 804.2
Provision for credit losses ........................ 100.6 357.7 203.6 552.7
------ --------- -------- ---------
Net finance margin after provision for
credit losses ................................... 238.6 (1.7) 449.3 251.5
Other revenue ...................................... 217.6 246.1 453.1 478.2
------ --------- -------- ---------
Operating margin ................................... 456.2 244.4 902.4 729.7
------ --------- -------- ---------
Salaries and general operating expenses ............ 227.4 237.9 461.0 472.1
Interest expense - TCH ............................. -- 281.3 -- 586.3
Goodwill impairment ................................ -- 1,999.0 -- 6,511.7
------ --------- -------- ---------
Operating expenses ................................. 227.4 2,518.2 461.0 7,570.1
------ --------- -------- ---------
Income (loss) before provision for income taxes .... 228.8 (2,273.8) 441.4 (6,840.4)
(Provision) for income taxes ....................... (89.2) (121.3) (172.1) (171.7)
Minority interest in subsidiary trust holding solely
debentures of the Company, after tax ............ (2.7) (2.7) (5.4) (5.4)
------ --------- -------- ---------
Net income (loss) .................................. $136.9 $(2,397.8) $ 263.9 $(7,017.5)
====== ========= ======== =========
Net income (loss) per basic share .................. $ 0.65 $ (11.33) $ 1.25 $ (33.17)
====== ========= ======== =========
Net income (loss) per diluted share ................ $ 0.65 $ (11.33) $ 1.24 $ (33.17)
====== ========= ======== =========
Dividends per common share ......................... $ 0.12 $ -- $ 0.24 $ --
====== ========= ======== =========
Note: Per share calculations for the quarter and six months ended June 30, 2002
assume that common shares as a result of the July 2002 IPO (211.6 million) were
outstanding during those time periods.
See Notes to Consolidated Financial Statements (Unaudited).
2
CIT GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
($ in millions)
Accumulated
Other Total
Common Paid-in Accumulated Comprehensive Stockholders'
Stock Capital Deficit (Loss) Equity
------ ------- ----------- ------------- --------------
December 31, 2002 .......................... $2.1 $10,676.2 $(5,606.9) $(200.7) $4,870.7
Net income ................................. -- -- 127.0 -- 127.0
Foreign currency translation adjustments ... -- -- -- 9.0 9.0
Unrealized loss on equity and securitization
investments .............................. -- -- -- (11.2) (11.2)
Change in fair values of derivatives
qualifying as cash flow hedges ........... -- -- -- 25.7 25.7
--------
Total comprehensive income ................. -- -- -- -- 150.5
--------
Cash dividends ............................. -- -- (25.4) -- (25.4)
Restricted common stock grants ............. -- 0.8 -- -- 0.8
---- --------- --------- ------- --------
March 31, 2003 ............................. 2.1 10,677.0 (5,505.3) (177.2) 4,996.6
---- --------- --------- ------- --------
Net income ................................. -- -- 136.9 -- 136.9
Foreign currency translation adjustments ... -- -- -- (22.8) (22.8)
Unrealized gain on equity and securitization
investments .............................. -- -- -- 2.8 2.8
Minimum pension liability adjustment ....... -- -- -- (1.8) (1.8)
Change in fair values of derivatives
qualifying as cash flow hedges ........... -- -- -- (29.5) (29.5)
--------
Total comprehensive income ................. -- -- -- -- 85.6
--------
Cash dividends ............................. -- -- (25.4) -- (25.4)
Restricted common stock grants ............. -- 0.8 -- -- 0.8
---- --------- --------- ------- --------
June 30, 2003 .............................. $2.1 $10,677.8 $(5,393.8) $(228.5) $5,057.6
==== ========= ========= ======= ========
See Notes to Consolidated Financial Statements (Unaudited).
3
CIT GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
($ in millions)
For the Six Months
Ended June 30,
------------------
2003 2002
---- ----
Cash Flows From Operations
Net income (loss) .................................. $ 263.9 $(7,017.5)
Adjustments to reconcile net income (loss)
to net cash flows from operations:
Goodwill impairment ............................. -- 6,511.7
Provision for credit losses ..................... 203.6 552.7
Depreciation and amortization ................... 569.7 625.8
Provision for deferred federal
income taxes .................................. 150.3 92.8
Gains on equipment, receivable
and investment sales .......................... (119.3) (128.8)
Increase in other assets ........................ (201.8) (181.4)
Increase (decrease) in accrued
liabilities and payables ...................... 9.5 (269.6)
Other ........................................... (19.2) (6.3)
--------- ---------
Net cash flows provided by operations .............. 856.7 179.4
--------- ---------
Cash Flows From Investing Activities
Loans extended ..................................... (25,040.9) (23,435.1)
Collections on loans ............................... 21,180.1 20,488.8
Proceeds from asset and receivable sales ........... 3,859.9 6,753.2
Purchases of assets to be leased ................... (1,355.0) (1,028.2)
Net decrease in short-term factoring receivables ... (205.9) (1,272.2)
Purchase of finance receivable portfolios .......... (534.4) (26.0)
Purchase of investment securities .................. (6.6) (109.3)
Other .............................................. (41.2) 4.3
--------- ---------
Net cash flows (used for) provided by
investing activities ............................ (2,144.0) 1,375.5
--------- ---------
Cash Flows From Financing Activities
Proceeds from the issuance of variable
and fixed-rate notes ............................ 6,192.8 11,018.4
Repayments of variable and fixed-rate notes ........ (5,045.4) (4,415.3)
Net decrease in commercial paper ................... (397.9) (7,982.1)
Net capitalization from Tyco
and Tyco affiliates ............................. -- 672.7
Net repayments of non-recourse
leveraged lease debt ............................ (71.0) (119.3)
Cash dividends paid ................................ (50.8) --
--------- ---------
Net cash flows provided by (used for)
financing activities ............................ 627.7 (825.6)
--------- ---------
Net (decrease) increase in cash
and cash equivalents ............................ (659.6) 729.3
Exchange rate impact on cash ....................... 46.3 49.8
Cash and cash equivalents,
beginning of period ............................. 2,036.6 1,301.5
--------- ---------
Cash and cash equivalents,
end of period ................................... $ 1,423.3 $ 2,080.6
========= =========
Supplementary Cash Flow Disclosure
Interest paid ...................................... $ 811.5 $ 861.1
Federal, foreign, state and local
income taxes paid, net .......................... $ 40.6 $ 46.2
See Notes to Consolidated Financial Statements (Unaudited).
4
CIT GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1 -- Summary of Significant Accounting Policies
CIT Group Inc., a Delaware corporation ("we," "CIT" or the "Company"), is
a leading global source of financing and leasing capital for companies in a wide
variety of industries, including many of today's leading industries and emerging
businesses, offering vendor, equipment, commercial, factoring, consumer, and
structured financing capabilities. CIT operates primarily in North America, with
locations in Europe, Latin America, Australia and the Asia-Pacific region.
These financial statements, which have been prepared in accordance with
the instructions to Form 10-Q, do not include all of the information and note
disclosures required by accounting principles generally accepted in the United
States ("GAAP") and should be read in conjunction with the Company's Annual
Report on Form 10-K for the three-month transition period ended December 31,
2002. These financial statements have not been examined by independent
accountants in accordance with generally accepted auditing standards, but in the
opinion of management include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair statement of CIT's financial
position and results of operations. Certain period amounts have been
reclassified to conform to the current presentation.
On June 1, 2001, The CIT Group, Inc. was acquired by a wholly-owned
subsidiary of Tyco International Ltd. ("Tyco"), in a purchase business
combination recorded under the "push-down" method of accounting, resulting in a
new basis of accounting for the "successor" period beginning June 2, 2001. On
July 8, 2002, Tyco completed a sale of 100% of CIT's outstanding common stock in
an initial public offering ("IPO"). Immediately prior to the offering, CIT was
merged with its parent Tyco Capital Holding, Inc. ("TCH"), a company used to
acquire CIT. As a result, the historical financial results of TCH are included
in the historical consolidated CIT financial statements.
CIT consolidates entities in which it owns or controls more than fifty
percent of the voting shares. Entities that are twenty to fifty percent owned by
CIT are included in other assets and presented at the corresponding share of
equity plus loans and advances. Entities in which CIT owns less than twenty
percent of the voting shares, and over which the Company has no significant
influence, are included in other assets at cost, less declines in value that are
other than temporary. In accordance with Statement of Financial Accounting
Standards ("SFAS") No. 140, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishment of Liabilities", Qualifying Special Purpose Entities
utilized in securitizations are not consolidated. Interests in securitizations
are included in other assets. All significant inter-company transactions have
been eliminated.
The Company adopted FASB Interpretation No. 46 ("FIN 46") "Consolidation
of Variable Interest Entities" ("VIEs") on July 1, 2003 for VIEs existing before
February 1, 2003. FIN 46 addresses the identification of a VIE and the
consolidation of a VIE's assets, liabilities and results of operations in a
company's financial statements. VIEs are certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. FIN 46
requires the consolidation of a VIE by its primary beneficiary if the VIE does
not effectively distribute the economic risks and rewards of ownership among the
parties involved. The primary beneficiary is the entity that has the majority of
the economic risks and rewards of ownership of the VIE. VIEs for which CIT is
the primary beneficiary will be consolidated in the Company's financial
statements effective July 1, 2003. On February 1, 2003, CIT adopted FIN 46 for
VIEs acquired after January 31, 2003.
The FIN 46 potential impact to CIT is primarily related to three types of
transactions: 1) strategic vendor partner joint ventures, 2) securitizations,
and 3) selected financing and private equity transactions. Based on
interpretations of FIN 46 currently available, we believe the implementation of
this standard does not change the current equity method of accounting for our
strategic vendor partner joint ventures (see Note 7 - Related Party
Transactions). Securitization transactions outstanding at June 30, 2003 would
qualify as off-balance sheet transactions. The Company may structure certain
future securitization transactions, including factoring trade account
receivables transactions, as on-balance sheet financings. Certain VIEs acquired
primarily in conjunction with selected financing and/or private equity
transactions will be consolidated under FIN 46. The consolidation of these
entities will not have a significant impact on the Company's financial position
or results of operations. Due to the complexity of the new guidance and evolving
interpretations among accounting professionals, the Company will consider such
further guidance, if any, and assess the accounting and disclosure impact of FIN
46 on its VIEs.
5
CIT GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
For guarantees issued or modified subsequent to December 31, 2002,
liabilities are recognized at the estimated fair value of the obligation
undertaken at the inception of the guarantee.
CIT has elected to apply Accounting Principles Board Opinion 25 ("APB 25")
rather than the optional provisions of SFAS No. 123 "Accounting for Stock-Based
Compensation" ("SFAS 123"), as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure" in accounting for its
stock-based compensation plans. Under APB 25, CIT does not recognize
compensation expense on the issuance of its stock options because the option
terms are fixed and the exercise price equals the market price of the underlying
stock on the grant date. The following table presents the pro forma information
required by SFAS 123 as if CIT had accounted for stock options granted under the
fair value method of SFAS 123, as amended ($ in millions, except per share
data):
Six Months Ended June 30,
-------------------------
2003 2002
---- ----
Net income (loss) as reported ................... $263.9 $(7,017.5)
Stock-based compensation expense --
fair value method, after tax .................. 11.7 --
------ ---------
Pro forma net income (loss) ..................... $252.2 $(7,017.5)
====== =========
Basic earnings per share as reported ............ $ 1.25 $ (33.17)
====== =========
Basic earnings per share pro forma .............. $ 1.19 $ (33.17)
====== =========
Diluted earnings per share as reported .......... $ 1.24 $ (33.17)
====== =========
Diluted earnings per share pro forma ............ $ 1.19 $ (33.17)
====== =========
Note 2 -- Earnings Per Share
Basic earnings per share ("EPS") is computed by dividing net income by the
weighted-average number of common shares outstanding for the period. The diluted
EPS computation includes the potential impact of dilutive securities, including
stock options and restricted stock grants. The dilutive effect of stock options
is computed using the treasury stock method, which assumes the repurchase of
common shares by CIT at the average market price for the period. Options that do
not have a dilutive effect (because the exercise price is above the market
price) are not included in the denominator and averaged approximately 19.0
million and 18.2 million shares for the quarter and six months ended June 30,
2003.
The reconciliation of the numerator and denominator of basic EPS with that
of diluted EPS is presented for the quarter and six months ended June 30, 2003
and 2002. The denominator for the quarter and six months ended June 30, 2002 is
the number of shares upon completion of the July 2002 IPO ($ in millions, except
per share amounts, which are in whole dollars; share balances in thousands):
Income Shares Per Share (Loss) Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- --------- ----------- ------------- ---------
Quarter Ended June 30, 2003 Quarter Ended June 30, 2002
------------------------------------ -------------------------------------
Basic EPS:
Income available to common
stockholders ............ $136.9 211,588 $0.65 $(2,397.8) 211,573 $(11.33)
Effect of Dilutive Securities:
Restricted shares ......... -- 456 -- -- -- --
Stock options ............. -- 22 -- -- -- --
------ ------- ----- --------- ------- -------
Diluted EPS .................. $136.9 212,066 $0.65 $(2,397.8) 211,573 $(11.33)
====== ======= ===== ========= ======= =======
Six Months Ended June 30, 2003 Six Months Ended June 30, 2002
------------------------------------ -------------------------------------
Basic EPS:
Income available to common
stockholders ............ $263.9 211,581 $1.25 $(7,017.5) 211,573 $(33.17)
Effect of Dilutive Securities:
Restricted shares ......... 383 -- -- -- --
Stock options ............. -- 11 -- -- -- --
------ ------- ----- --------- ------- -------
Diluted EPS .................. $263.9 211,975 $1.24 $(7,017.5) 211,573 $(33.17)
====== ======= ===== ========= ======= =======
6
CIT GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
Note 3 -- Derivative Financial Instruments
The components of the adjustment to Accumulated Other Comprehensive Loss
for derivatives qualifying as hedges of future cash flows at December 31, 2002
and at June 30, 2003 are presented in the following table ($ in millions):
Adjustment of
Fair Value of Income Tax Net Unrealized
Derivatives Effects Loss
------------- ---------- --------------
Balance at December 31, 2002 ........ $(190.8) $(72.5) $(118.3)
Changes in values of derivatives
qualifying as cash flow hedges .... (6.2) (2.4) (3.8)
------- ------ -------
Balance at June 30, 2003 ............ $(197.0) $(74.9) $(122.1)
======= ====== =======
The unrealized loss as of June 30, 2003, presented in the preceding table,
primarily reflects our use of interest rate swaps to convert variable-rate debt
to fixed-rate debt, and lower market interest rates. For the quarter and six
months ended June 30, 2003, the ineffective portion of changes in the fair value
of cash flow hedges amounted to $0.1 million and $0.5 million, respectively, and
has been recorded as an increase to interest expense. Assuming no change in
interest rates, $52.0 million, net of tax, of Accumulated Other Comprehensive
Loss is expected to be reclassified to earnings over the next twelve months as
contractual cash payments are made. The Accumulated Other Comprehensive Loss
(along with the corresponding swap liability) will be adjusted as market
interest rates change over the remaining life of the swaps.
As part of managing the exposure to changes in market interest rates, CIT,
as an end-user, enters into various interest rate swap transactions, which are
transacted in over-the-counter markets with other financial institutions acting
as principal counter-parties. We use derivatives for hedging purposes only, and
do not enter into derivative financial instruments for trading or speculative
purposes. To ensure both appropriate use as a hedge and hedge accounting
treatment, derivatives entered into are designated according to a hedge
objective against a specific liability, including commercial paper or a
specifically underwritten debt issue. The notional amounts, rates, indices and
maturities of our derivatives are required to closely match the related terms of
our hedged liabilities. CIT exchanges variable-rate interest on certain debt
instruments for fixed-rate amounts. These interest rate swaps are designated as
cash flow hedges. We also exchange fixed-rate interest on certain of our debt
for variable-rate amounts. These interest rate swaps are designated as fair
value hedges.
The following table presents the notional principal amounts of interest
rate swaps by class and the corresponding hedged liability position at June 30,
2003 ($ in millions):
Notional Amount
--------------------------------
Interest Rate Swaps June 30, 2003 December 31, 2002 Comments
- ------------------- ------------- ----------------- --------
Floating to fixed-rate swaps -- Effectively converts the interest
cash flow hedges..................... $2,637.0 $3,280.5 rate on an equivalent amount
of commercial paper and variable-rate
notes to a fixed rate.
Fixed to floating-rate swaps -- Effectively converts the interest
fair value hedges.................... 6,521.3 4,489.8 rate on an equivalent amount of
-------- -------- fixed-rate notes to a variable rate.
Total interest rate swaps ............. $9,158.3 $7,770.3
======== ========
CIT also utilizes trusts as part of its ongoing securitization programs.
As part of these related activities, the Company enters into hedge transactions
with the trusts in order to protect the trusts against interest rate risk. CIT
insulates its associated risk by entering into substantially offsetting swap
transactions with third parties. The net effect is to protect the trusts and CIT
from interest rate risk. The notional amount of these swaps was $3.5 billion at
June 30, 2003.
CIT also utilizes foreign currency exchange forward contracts to hedge
currency risk underlying its net investments in foreign operations and cross
currency interest rate swaps to hedge both foreign currency and interest rate
risk underlying foreign debt. At June 30, 2003, CIT was party to foreign
currency exchange forward contracts with notional amounts totaling $2.4 billion
and maturities ranging from 2003 to 2006. CIT was also party to cross currency
interest rate swaps with notional amounts totaling $1.4 billion and maturities
ranging from 2003 to 2027.
7
CIT GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
Note 4 -- Business Segment Information
The current and prior period segment reporting has been modified to
reflect Equipment Finance and Capital Finance as separate segments. Previously,
these two strategic business units were combined as the Equipment Financing and
Leasing segment. This presentation is intended to facilitate the analysis of the
Company's results for users of the financial statements.
The selected financial information by business segment presented below is
based upon a fixed leverage ratio across business units and the allocation of
most corporate expenses. The business segments' operating margins and net income
for the six months ended June 30, 2003 include the allocation (from Corporate
and Other) of additional borrowing costs stemming from the 2002 disruption to
the Company's funding base and enhanced liquidity levels. These additional
borrowing and liquidity costs have had a greater impact in 2003 than in 2002 and
were included in Corporate and Other in 2002. Corporate and Other also included
the 2002 non-cash goodwill impairment charge.
During the quarter ended March 31, 2003, in order to better align
competencies, we transferred certain small business loans and leases, including
the small business lending unit, totaling $1,078.6 million from Equipment
Finance to Specialty Finance. Prior periods have not been restated to conform to
this current presentation ($ in millions).
Corporate
Specialty Equipment Capital Commercial Structured Total and
Finance Finance Finance Finance Finance Segments Other Consolidated
--------- --------- ------- ---------- ---------- -------- --------- ------------
For the quarter ended
June 30, 2003
Operating margin ............. $ 204.4 $ 35.8 $ 32.2 $ 131.3 $ 31.6 $ 435.3 $ 20.9 $ 456.2
Income taxes ................. 40.2 5.1 5.7 35.5 9.3 95.8 (6.6) 89.2
Operating earnings (loss) .... 63.0 7.9 9.1 55.6 14.7 150.3 (13.4) 136.9
At or for the six months ended
June 30, 2003
Operating margin ............. $ 394.9 $ 76.0 $ 61.1 $ 261.2 $ 59.9 $ 853.1 $ 49.3 $ 902.4
Income taxes ................. 73.6 11.9 10.6 70.1 17.1 183.3 (11.2) 172.1
Operating earnings (loss) .... 115.2 18.6 16.8 109.7 26.9 287.2 (23.3) 263.9
Total financing and leasing
assets ..................... 11,600.8 6,711.0 6,968.4 8,913.4 3,315.4 37,509.0 -- 37,509.0
Total managed assets ......... 18,137.4 10,530.9 6,968.4 8,913.4 3,315.4 47,865.5 -- 47,865.5
For the quarter ended
June 30, 2002
Operating margin ............. $ 220.0 $ 97.8 $ 45.7 $ 114.8 $ 33.1 $ 511.4 $ (267.0) $ 244.4
Income taxes ................. 51.5 18.7 9.1 30.1 10.7 120.1 1.2 121.3
Operating earnings (loss) .... 83.8 31.7 22.8 46.0 15.3 199.6 (2,597.4) (2,397.8)
At or for the six months ended
June 30, 2002
Operating margin ............. $ 476.1 $ 204.3 $ 88.7 $ 229.8 $ 66.4 $ 1,065.3 $ (335.6) $ 729.7
Income taxes ................. 112.7 43.4 16.3 60.9 19.9 253.2 (81.5) 171.7
Operating earnings (loss) .... 183.8 72.1 45.0 92.2 31.7 424.8 (7,442.3) (7,017.5)
Total financing and
leasing assets ............. 10,009.7 8,706.8 5,792.6 8,180.5 3,018.8 35,708.4 -- 35,708.4
Total managed assets ......... 17,319.4 13,365.0 5,792.6 8,180.5 3,018.8 47,676.3 -- 47,676.3
8
CIT GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
Note 5 -- Concentrations
The following table presents the geographic and industry compositions of
financing and leasing portfolio assets, based on the location and industry of
the customer, at June 30, 2003 and December 31, 2002 ($ in millions):
At June 30, 2003 At December 31, 2002
---------------- --------------------
Amount Percent Amount Percent
------ ------- -------- ---------
North America:
Northeast .................................... $ 7,576.9 20.2% $ 7,833.8 21.8%
West ......................................... 6,978.5 18.6% 6,223.8 17.4%
Midwest ...................................... 5,741.3 15.3% 5,748.3 16.0%
Southeast .................................... 5,168.9 13.8% 4,946.8 13.8%
Southwest .................................... 4,076.9 10.9% 3,691.9 10.3%
Canada ....................................... 1,907.7 5.1% 1,804.9 5.0%
--------- ----- --------- -----
Total North America ............................ 31,450.2 83.9% 30,249.5 84.3%
Other foreign .................................. 6,058.8 16.1% 5,625.2 15.7%
--------- ----- --------- -----
Total ........................................ $37,509.0 100.0% $35,874.7 100.0%
========= ===== ========= =====
At June 30, 2003 At December 31, 2002
----------------- --------------------
Amount Percent Amount Percent
------ ------- -------- ---------
Manufacturing(1) (no industry
greater than 3.2%) ........................... $ 7,590.8 20.3% $ 7,114.3 19.8%
Commercial Airlines ............................ 4,831.5 12.9% 4,570.3 12.7%
Retail(2) ...................................... 4,144.5 11.0% 4,053.6 11.3%
Transportation(3) .............................. 2,989.5 8.0% 2,703.9 7.5%
Service industries ............................. 2,520.3 6.7% 1,571.1 4.4%
Consumer based lending-- non-real estate(4) .... 2,087.9 5.6% 2,435.0 6.8%
Consumer based lending-- home mortgage ......... 1,897.1 5.1% 1,292.7 3.6%
Construction equipment ......................... 1,620.8 4.3% 1,712.7 4.8%
Communications(5) .............................. 1,432.2 3.8% 1,662.6 4.6%
Wholesaling .................................... 1,316.6 3.5% 1,305.2 3.6%
Automotive services ............................ 1,105.6 2.9% 1,138.8 3.2%
Other (no industry greater than 3.0%)(6) ....... 5,972.2 15.9% 6,314.5 17.7%
--------- ----- --------- -----
Total ........................................ $37,509.0 100.0% $35,874.7 100.0%
========= ===== ========= =====
- --------------------------------------------------------------------------------
(1) Includes manufacturers of textiles and apparel, industrial machinery and
equipment, electrical and electronic equipment and other.
(2) Includes retailers of apparel (4.3%) and general merchandise (3.3%).
(3) Includes rail, over-the-road trucking and business aircraft.
(4) Includes receivables from consumers for products in various industries
such as manufactured housing, recreational vehicles, marine and computers
and related equipment.
(5) Includes $624.4 million and $685.8 million of telecommunication related
assets at June 30, 2003 and December 31, 2002, respectively.
(6) Included in "Other" above are financing and leasing assets in the energy,
power and utilities sectors, which totaled $896.7 million, or 2.4% of
total financing and leasing assets at June 30, 2003. This amount includes
approximately $585 million in project financing and $262 million in rail
cars on lease.
9
CIT GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
Note 6 -- Accumulated Other Comprehensive Loss
The following table details the June 30, 2003 and December 31, 2002
components of accumulated other comprehensive loss, net of tax ($ in millions):
June 30, December 31,
2003 2002
-------- ------------
Changes in fair values of derivatives
qualifying as cash flow hedges .............. $(122.1) $(118.3)
Foreign currency translation
adjustments ................................. (89.4) (75.6)
Minimum pension liability adjustments ......... (22.3) (20.5)
Unrealized gain on equity and
securitization investments .................. 5.3 13.7
------- -------
Total accumulated other comprehensive loss .. $(228.5) $(200.7)
======= =======
Note 7 -- Related Party Transactions
CIT is a partner with Dell Computer Corporation ("De ll") in Dell
Financial Services L.P. ("DFS"), a joint venture that offers financ ing to Dell
customers. The joint venture provides Dell with financing and leasing
capabilities that are complementary to its product offerings and provides CIT
with a steady source of new financings. CIT acquired this relationship in
November 1999, and the current agreement extends until October 2005. CIT
regularly purchases finance receivables from DFS at a premium, portions of which
are typically securitized within 90 days of purchase from DFS. CIT has limited
recourse back to DFS on defaulted contracts. In accordance with the joint
venture agreement, net income generated by DFS as determined under U.S. GAAP is
allocated 70% to Dell and 30% to CIT, after CIT has recovered any cumulative
losses. The DFS board of directors voting representation is equally weighted
between designees of CIT and Dell and an independent director. Any losses
generated by DFS as determined under U.S. GAAP are allocated to CIT. DFS is not
consolidated in CIT's June 30, 2003 financial statements and is accounted for
under the equity method. At June 30, 2003, financing and leasing assets
originated by DFS and purchased by CIT (included in the CIT Consolidated Balance
Sheet) were $1.5 billion whereas securitized assets included in managed assets
were $1.9 billion. In addition to the owned and securitized assets acquired from
DFS, CIT's maximum exposure to loss with respect to activities of the joint
venture is approximately $273 million pretax at June 30, 2003, which is
comprised of the investment in and loans to the joint venture.
CIT also has a joint venture arrangement with Snap-on Incorporated
("Snap-on") that has a similar business purpose and model to the DFS arrangement
described above, including credit recourse on defaulted receivables. CIT
acquired this relationship in November 1999. The agreement with Snap-on extends
until January 2007. CIT and Snap-on have 50% ownership interests, 50% board of
directors representation and share income and losses equally. The Snap-on joint
venture is accounted for under the equity method and is not consolidated in
CIT's financial statements. As of June 30, 2003, the related financing and
leasing assets and securitized assets were $1.0 billion and $0.1 billion,
respectively. In addition to the owned and securitized assets purchased from the
Snap-on joint venture, CIT's maximum exposure to loss with respect to activities
of the joint venture is approximately $15 million pretax at June 30, 2003, which
is comprised of the investment in and loans to the joint venture.
Since December 2000, CIT has been a joint venture partner with Canadian
Imperial Bank of Commerce ("CIBC") in an entity that is engaged in asset-based
lending in Canada. Both CIT and CIBC have a 50% ownership interest in the joint
venture and share income and losses equally. This entity is not consolidated in
CIT's financial statements and is accounted for under the equity method. As of
June 30, 2003, CIT's maximum exposure to loss with respect to activities of the
joint venture is $127 million pretax, which is comprised of the investment in
and loans to the joint venture.
CIT invests in various trusts, partnerships, and limited liability
corporations established in conjunction with structured financing transactions
of equipment, power and infrastructure projects. CIT's interests in certain of
these entities were acquired by CIT in November 1999, and others were
subsequently entered into in the normal course of business. At June 30, 2003,
other assets included $34.0 million of investments in non-consolidated entities
relating to such transactions that are accounted for under the equity or cost
methods. This investment is CIT's maximum exposure to loss with respect to these
interests as of June 30, 2003.
10
CIT GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
As of June 30, 2002, certain subsidiaries of Tyco sold receivables
totaling $319.0 million to CIT in a factoring transaction. CIT has continued to
purchase receivables from Tyco in similar factoring transactions through June
30, 2003 on an arms-length basis.
While CIT was an indirect subsidiary of Tyco, certain of CIT's expenses,
such as third party consulting and legal fees, were paid by Tyco and billed to
CIT. The payables were satisfied in conjunction with the July 2002 IPO.
Note 8 -- Commitments and Contingencies
In the normal course of meeting the financing needs of its customers, CIT
enters into various credit-related commitments, including standby letters of
credit, which obligate CIT to pay the beneficiary of the letter of credit in the
event that a CIT client to which the letter of credit was issued does not meet
its related obligation to the beneficiary. These financial instruments generate
fees and involve, to varying degrees, elements of credit risk in excess of the
amounts recognized in the consolidated balance sheets. To minimize potential
credit risk, CIT generally requires collateral and other credit-related terms
and conditions from the customer. At the time credit-related commitments are
granted, the fair value of the underlying collateral and guarantees typically
approximates or exceeds the contractual amount of the commitment. In the event a
customer defaults on the underlying transaction, the maximum potential loss will
generally be limited to the contractual amount outstanding less the value of all
underlying collateral and guarantees.
Guarantees are issued primarily in conjunction with CIT's factoring
product, whereby CIT provides the client with credit protection for its trade
receivables without actually purchasing the receivables. The trade terms are
generally sixty days or less. The receivables are not purchased unless the
customer is unable to pay.
As of June 30, 2003, there were no outstanding liabilities for the fair
values relating to these credit-related commitments or guarantees, as amounts
are generally billed and collected on a monthly basis.
The accompanying table summarizes the contractual amounts of
credit-related commitments. The reduction in guarantees outstanding from
December 31, 2002 reflects the transition to on-balance sheet factoring
products, which are included in credit balances of factoring clients in the CIT
consolidated balance sheet ($ in millions).
At
December 31,
At June 30, 2003 2002
----------------------------------- ------------
Due to Expire
---------------------
Within After Total Total
One Year One Year Outstanding Outstanding
--------- -------- ----------- -----------
Unused commitments to extend credit:
Financing and leasing assets.......................... $1,212.1 $2,819.9 $4,032.0 $3,618.9
Letters of credit and acceptances:
Standby letters of credit............................. 511.0 16.3 527.3 519.8
Other letters of credit............................... 625.0 -- 625.0 583.3
Acceptances........................................... 12.1 -- 12.1 5.6
Guarantees.............................................. 69.0 -- 69.0 745.8
Venture capital fund and equity commitments............. 0.2 149.0 149.2 164.9
11
CIT GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
As of June 30, 2003, commitments to purchase commercial aircraft from both
Airbus Industrie and The Boeing Company totaled 68 units through 2007 at an
approximate value of $3.3 billion as detailed below ($ in billions):
Calendar Year: Amount Number
- -------------- ------ ------
2003 ................................... $0.3 8
2004 ................................... 0.8 16
2005 ................................... 1.2 27
2006 ................................... 0.9 16
2007 ................................... 0.1 1
---- ---
Total .................................. $3.3 68
==== ===
The order amounts are based on current appraised values in 2002 base
dollars and exclude CIT's options to purchase additional aircraft. Six of the
2003 units and five of the 2004 units have lease commitments in place.
Outstanding commitments to purchase equipment, other than the aircraft
detailed above, totaled $183.5 million at June 30, 2003. In addition, CIT is
party to a railcar sale-leaseback transaction under which it is obligated to pay
a remaining total of $495 million, including approximately $28 million per year
through 2010 and declining thereafter through 2024, which is expected to be more
than offset by CIT's re-lease of the assets, contingent on its ability to
maintain railcar usage.
CIT has guaranteed the public and private debt securities of a number of
its wholly-owned, consolidated subsidiaries, including those disclosed in Note
13 -- Summarized Financial Information of Subsidiaries. In the normal course of
business, various consolidated CIT subsidiaries have entered into other credit
agreements and certain derivative transactions with financial institutions,
which are guaranteed by CIT and included in the consolidated financial
statements. These transactions are generally used by CIT's subsidiaries outside
of the U.S. to allow the local subsidiary to borrow funds in local currencies.
In addition, CIT has guaranteed, on behalf of certain non-consolidated
subsidiaries, $9.5 million of third party debt, which is not reflected in the
consolidated balance sheet at June 30, 2003.
Note 9 -- Legal Proceedings
On April 10, 2003, a putative class action lawsuit, asserting claims under
the Securities Act of 1933, was filed in the United States District Court for
the Southern District of New York against CIT, its Chief Executive Officer and
its Chief Financial Officer. The lawsuit contains allegations that the
registration statement and prospectus prepared and filed in connection with the
IPO were materially false and misleading, principally with respect to the
adequacy of CIT's telecommunications-related loan loss reserves at the time. The
lawsuit purports to have been brought on behalf of all those who purchased CIT
common stock in or traceable to the IPO, and seeks, among other relief,
unspecified damages or rescission for those alleged class members who still hold
CIT stock and unspecified damages for other alleged class members. On June 25,
2003, by order of the United States District Court, the lawsuit was consolidated
with five other substantially similar suits, all of which had been filed after
April 10, 2003 and Glickenhaus & Co., a privately held investment firm, was
named lead plaintiff. One such suit named as defendants some of the underwriters
and former directors of CIT. In addition to the foregoing, two derivative suits
arising out of the same facts and circumstances have been brought against CIT
and some of its present and former directors.
CIT believes that the allegations in each of these actions are without
merit and that its disclosures were proper, complete and accurate. CIT intends
to vigorously defend itself against these actions.
In addition, in the ordinary course of business, there are various legal
proceedings pending against CIT. Management believes that the aggregate
liabilities, if any, arising from such actions, including the class action suit
above, will not have a material adverse effect on the consolidated financial
position, results of operations or liquidity of CIT.
12
CIT GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
Note 10 -- Acquisition by Tyco
The following table summarizes purchase accounting liabilities (pre-tax)
related to severance of employees and closing facilities that were recorded in
connection with the acquisition of CIT by Tyco, as well as utilization during
the current quarter ($ in millions):
Severance Facilities
-------------------- ------------------
Number of Number of Total
Employees Reserve Facilities Reserve Reserves
--------- ------- ---------- ------- --------
Balance at December 31, 2002 ................. 240 $17.2 22 $12.4 $29.6
Utilization - six months ended June 30, 2003.. (58) (10.1) (2) (3.6) (13.7)
--- ----- --- ----- -----
Balance at June 30, 2003 ..................... 182 $ 7.1 20 $ 8.8 $15.9
=== ===== === ===== =====
The reserves remaining at June 30, 2003 relate largely to the
restructuring of the European operations. The facility reserves relate primarily
to shortfalls in sublease transactions and will be utilized over the remaining
lease terms, generally between 3 and 7 years. Severance reserves also include
amounts payable within the next year to individuals who chose to receive
payments on a periodic basis.
Note 11-- Consolidating Financial Statements -- Tyco Capital Holdings (TCH)
The June 30, 2002 financial statements include the activity of TCH, which
was a wholly owned subsidiary of a Tyco affiliate and was the holding company
for the acquisition of CIT by Tyco. In its capacity as the acquisition holding
company, TCH's activity included an outstanding loan from and related interest
expense and prepayment penalties payable to an affiliate of Tyco. Immediately
prior to the IPO of CIT on July 8, 2002, the prior activity of TCH (accumulated
net deficit) was eliminated by means of a capital contribution from Tyco. As a
result, the consolidated financial statements of CIT were not impacted by TCH
subsequent to June 30, 2002.
($in millions) For the Quarter Ended June 30, 2002 For the Six Months Ended June 30, 2002
- -------------- ----------------------------------- --------------------------------------
CIT TCH Consolidated CIT TCH Consolidated
--- --- ------------ --- --- ------------
Finance Income ...................... $ 1,021.9 $ -- $1,021.9 $2,128.6 $ -- $2,128.6
Interest expense .................... 370.2 -- 370.2 718.5 -- 718.5
--------- ------- --------- --------- ------- ---------
Net finance income .................. 651.7 -- 651.7 1,410.1 -- 1,410.1
Depreciation on operating lease
equipment ........................ 295.7 -- 295.7 605.9 -- 605.9
--------- ------- --------- --------- ------- ---------
Net finance margin .................. 356.0 -- 356.0 804.2 -- 804.2
Provision for credit losses ......... 357.7 -- 357.7 552.7 -- 552.7
--------- ------- --------- --------- ------- ---------
Net finance margin after provision
for credit losses ................ (1.7) -- (1.7) 251.5 -- 251.5
Other revenue ....................... 246.1 -- 246.1 478.2 -- 478.2
--------- ------- --------- --------- ------- ---------
Operating margin .................... 244.4 -- 244.4 729.7 -- 729.7
--------- ------- --------- --------- ------- ---------
Salaries and general operating
expenses ........................ 230.4 7.5 237.9 457.3 14.8 472.1
Interest expense - TCH .............. -- 281.3 281.3 -- 586.3 586.3
Goodwill impairment ................. 1,999.0 -- 1,999.0 6,511.7 -- 6,511.7
--------- ------- --------- --------- ------- ---------
Operating expenses .................. 2,229.4 288.8 2,518.2 6,969.0 601.1 7,570.1
--------- ------- --------- --------- ------- ---------
(Loss) before provision for
income taxes ..................... (1,985.0) (288.8) (2,273.8) (6,239.3) (601.1) (6,840.4)
(Provision) for income taxes ........ (5.8) (115.5) (121.3) (104.2) (67.5) (171.7)
Minority interest in subsidiary trust
holding solely debentures of the
Company, after tax ............... (2.7) -- (2.7) (5.4) -- (5.4)
--------- ------- --------- --------- ------- ---------
Net (loss) .......................... $(1,993.5) $(404.3) $(2,397.8) $(6,348.9) $(668.6) $(7,017.5)
========= ======= ========= ========= ======= =========
13
CIT GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
Note 12 -- Accounting Change -- Goodwill
The Company periodically reviews and evaluates its goodwill and other
intangible assets for potential impairment. Effective October 1, 2001, the
Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS
142"), under which goodwill is no longer amortized but instead is assessed for
impairment at least annually. As part of the adoption, the Company allocated its
existing goodwill to each of its reporting units as of October 1, 2001. Under
the transition provisions of SFAS 142, there was no goodwill impairment as of
October 1, 2001.
During the quarter ended March 31, 2002, Tyco experienced disruptions to
its business surrounding its announced break-up plan, downgrades in its credit
ratings, and a significant decline in its market capitalization. As a result of
these events at Tyco, CIT also experienced credit downgrades and a disruption to
our funding base and ability to access capital markets. Further, market-based
information used in connection with our preliminary consideration of an initial
public offering for 100% of CIT indicated that CIT's book value exceeded its
estimated fair value as of March 31, 2002. As a result, management performed a
Step 1 SFAS 142 impairment analysis as of March 31, 2002 and concluded that an
impairment charge was warranted at that date.
Management's objective in performing the Step 1 SFAS 142 analysis was to
obtain relevant market-based data to calculate the fair value of each CIT
reporting unit as of March 31, 2002 based on each reporting unit's projected
earnings and market factors that would be used by market participants in
ascribing value to each of these reporting units in the planned separation of
CIT from Tyco. Management obtained relevant market data from our financial
advisors regarding the range of price to earnings multiples and market discounts
applicable to each reporting unit as of March 31, 2002 and applied this market
data to the individual reporting unit's projected annual earnings as of March
31, 2002 to calculate a fair value of each reporting unit. The fair values were
compared to the corresponding carrying value of each reporting unit at March 31,
2002, resulting in a $4.513 billion impairment charge as of March 31, 2002.
SFAS 142 requires a second step analysis whenever the reporting unit book
value exceeds its fair value. This analysis required us to determine the fair
value of each reporting unit's individual assets and liabilities to complete the
analysis of goodwill impairment as of March 31, 2002. During the quarter ended
June 30, 2002, we completed this analysis for each reporting unit and determined
that an additional Step 2 goodwill impairment charge of $132.0 million was
required based on reporting unit level valuation data.
Subsequent to March 31, 2002, CIT experienced further credit downgrades
and the business environment and other factors continued to negatively impact
the expected CIT IPO proceeds. As a result, management performed both a Step 1
and a Step 2 analysis as of June 30, 2002 in a manner consistent with the March
2002 process described above. This analysis was based upon market data from our
financial advisors regarding the individual reporting units, and other relevant
market data at June 30, 2002 and through the period immediately following the
IPO of the Company, including the total amount of IPO proceeds. This analysis
resulted in Step 1 and Step 2 incremental goodwill impairment charges of $1.719
billion and $148.0 million, respectively, as of June 30, 2002, which were
recorded during the June 30, 2002 quarter.
The changes in the carrying amount of goodwill for the six months ended
June 30, 2003 were as follows ($ in millions):
Specialty Equipment Capital Commercial Structured
Finance Finance Finance Finance Finance Total
--------- --------- ------- ---------- ---------- -----
Balance as of December 31, 2002 .... $14.0 $ -- $ -- $370.4 $ -- $384.4
Goodwill related to rail acquisition -- -- 5.4 -- -- 5.4
----- ---- ---- ------ ---- ------
Balance as of June 30, 2003 ........ $14.0 $ -- $5.4 $370.4 $ -- $389.8
===== ==== ==== ====== ==== ======
The $5.4 million increase to goodwill during the quarter ended June 30,
2003 relates to the acquisition of an approximate 75% interest in Flex Leasing
Corporation by Capital Finance on April 8, 2003. Flex, which is based in San
Francisco, California and was founded in 1996, leases approximately 7,200
general-purpose railcars, representing approximately $410.0 million in assets,
to railroads and shippers in the U.S. and Canada. The Flex results of operations
from the date of acquisition through June 30, 2003 are included in the CIT
consolidated results and are not significant. Minority interest related to the
Flex acquisition was $39.7 million at June 30, 2003 and is included in other
liabilities in the CIT consolidated balance sheet.
14
CIT GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
Other intangible assets, net, comprised primarily of proprietary computer
software and related transaction processes, totaled $14.3 million and $16.5
million at June 30, 2003 and December 31, 2002, respectively, and are included
in Other Assets on the Consolidated Balance Sheets. These assets are being
amortized over a five year period on a straight-line basis, resulting in an
annual amortization expense of $4.4 million.
Note 13 -- Summarized Financial Information of Subsidiaries
The following presents condensed consolidating financial information for
CIT Holdings LLC and Capita Corporation (formerly AT&T Capital Corporation). CIT
has guaranteed on a full and unconditional basis the existing registered debt
securities and certain other indebtedness of these subsidiaries. CIT has not
presented related financial statements or other information for these
subsidiaries on a stand-alone basis ($ in millions).
CIT
CONSOLIDATING CIT Capita Holdings Other
BALANCE SHEETS Group Inc. Corporation LLC Subsidiaries Eliminations Total
-------------- ---------- ----------- -------- ------------ ------------ -----
June 30, 2003
ASSETS
Net finance receivables ............ $ 1,530.4 $ 3,705.9 $ 1,045.9 $21,376.5 $ -- $27,658.7
Operating lease equipment, net ..... -- 637.9 164.3 6,757.8 -- 7,560.0
Finance receivables held for sale .. -- 47.8 117.1 1,045.1 -- 1,210.0
Cash and cash equivalents .......... 775.0 334.4 58.9 255.0 -- 1,423.3
Other assets ....................... 7,248.5 203.3 581.6 2,356.9 (5,057.6) 5,332.7
--------- --------- --------- --------- --------- ---------
Total Assets .................... $ 9,553.9 $ 4,929.3 $ 1,967.8 $31,791.3 $(5,057.6) $43,184.7
========= ========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Debt ............................... $28,679.5 $ 1,823.0 $ 1,807.5 $ 120.8 $ -- $32,430.8
Credit balances of factoring clients -- -- -- 2,471.6 -- 2,471.6
Other liabilities .................. (24,183.2) 2,526.4 (658.0) 25,283.1 -- 2,968.3
--------- --------- --------- --------- --------- ---------
Total Liabilities ............... 4,496.3 4,349.4 1,149.5 27,875.5 -- 37,870.7
Preferred securities ............... -- -- -- 256.4 -- 256.4
Equity ............................. 5,057.6 579.9 818.3 3,659.4 (5,057.6) 5,057.6
--------- --------- --------- --------- --------- ---------
Total Liabilities and
Stockholders' Equity ............ $ 9,553.9 $ 4,929.3 $ 1,967.8 $31,791.3 $(5,057.6) $43,184.7
========= ========= ========= ========= ========= =========
December 31, 2002
ASSETS
Net finance receivables ............ $ 633.5 $ 3,541.4 $ 935.7 $21,749.9 $ -- $26,860.5
Operating lease equipment, net ..... -- 734.6 157.1 5,812.9 -- 6,704.6
Finance receivables held for sale .. -- 159.1 62.8 991.5 -- 1,213.4
Cash and cash equivalents .......... 1,310.9 231.1 293.7 200.9 -- 2,036.6
Other assets ....................... 6,532.9 283.3 391.6 2,780.2 (4,870.7) 5,117.3
--------- --------- --------- --------- --------- ---------
Total Assets .................... $ 8,477.3 $ 4,949.5 $ 1,840.9 $31,535.4 $(4,870.7) $41,932.4
========= ========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Debt ............................... $27,760.7 $ 1,815.7 $ 2,116.8 $ (11.9) $ -- $31,681.3
Credit balances of factoring clients -- -- -- 2,270.0 -- 2,270.0
Other liabilities .................. (24,154.1) 2,551.5 (1,396.1) 25,851.9 -- 2,853.2
--------- --------- --------- --------- --------- ---------
Total Liabilities ............... 3,606.6 4,367.2 720.7 28,110.0 -- 36,804.5
Preferred securities ............... -- -- -- 257.2 -- 257.2
Equity ............................. 4,870.7 582.3 1,120.2 3,168.2 (4,870.7) 4,870.7
--------- --------- --------- --------- --------- ---------
Total Liabilities and
Stockholders' Equity ............ $ 8,477.3 $ 4,949.5 $ 1,840.9 $31,535.4 $(4,870.7) $41,932.4
========= ========= ========= ========= ========= =========
15
CIT GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
CIT
CONSOLIDATING CIT Capita Holdings Other
STATEMENT OF INCOME Group Inc. Corporation LLC Subsidiaries Eliminations Total
------------------- ---------- ----------- -------- ------------ ------------ -----
Six Months Ended June 30, 2003
Finance income ................................. $ 53.9 $ 399.9 $ 95.4 $1,333.2 $ -- $ 1,882.4
Interest expense ............................... 25.4 166.6 (7.3) 493.1 -- 677.8
---------- ------- ------ -------- ------- ---------
Net finance income ............................. 28.5 233.3 102.7 840.1 -- 1,204.6
Depreciation on operating
lease equipment ............................. -- 194.6 38.8 318.3 -- 551.7
---------- ------- ------ -------- ------- ---------
Net finance margin ............................. 28.5 38.7 63.9 521.8 -- 652.9
Provision for credit losses .................... 19.6 25.7 9.6 148.7 -- 203.6
---------- ------- ------ -------- ------- ---------
Net finance margin, after provision
for credit losses ........................... 8.9 13.0 54.3 373.1 -- 449.3
Equity in net income of subsidiaries ........... 270.7 -- -- -- (270.7) --
Other revenue .................................. 4.0 55.2 50.4 343.5 -- 453.1
--------- ------- ------ -------- ------- ---------
Operating margin ............................... 283.6 68.2 104.7 716.6 (270.7) 902.4
Operating expenses ............................. 24.7 68.2 59.2 308.9 -- 461.0
--------- ------- ------ -------- ------- ---------
Income (loss) before provision for
income taxes ................................ 258.9 -- 45.5 407.7 (270.7) 441.4
Benefit (provision) for income taxes ........... 5.0 (20.8) (22.1) (134.2) -- (172.1)
Minority interest, after tax ................... -- -- -- (5.4) -- (5.4)
--------- ------- ------ -------- ------- ---------
Net income (loss) .............................. $ 263.9 $ (20.8) $ 23.4 $ 268.1 $(270.7) $ 263.9
========= ======= ====== ======== ======= =========
Six Months Ended June 30, 2002
Finance income ................................. $ 112.6 $ 511.8 $115.4 $1,388.8 $ -- $2,128.6
Interest expense ............................... (17.8) 220.7 (6.8) 522.4 -- 718.5
--------- ------- ------ -------- ------- ---------
Net finance income ............................. 130.4 291.1 122.2 866.4 -- 1,410.1
Depreciation on operating
lease equipment ............................. -- 237.3 49.7 318.9 -- 605.9
--------- ------- ------ -------- ------- ---------
Net finance margin ............................. 130.4 53.8 72.5 547.5 -- 804.2
Provision for credit losses .................... 251.2 165.4 10.4 125.7 -- 552.7
--------- ------- ------ -------- ------- ---------
Net finance margin, after provision
for credit losses ........................... (120.8) (111.6) 62.1 421.8 -- 251.5
Equity in net income of subsidiaries ........... (398.2) -- -- -- 398.2 --
Other revenue .................................. 2.4 62.2 42.2 371.4 -- 478.2
--------- ------- ------ -------- ------- ---------
Operating margin ............................... (516.6) (49.4) 104.3 793.2 398.2 729.7
Operating expenses ............................. 6,546.2 81.9 31.8 910.2 -- 7,570.1
--------- ------- ------ -------- ------- ---------
Income (loss) before provision for
income taxes ................................ (7,062.8) (131.3) 72.5 (117.0) 398.2 (6,840.4)
Benefit (provision) for income taxes ........... 45.3 50.4 (37.4) (230.0) -- (171.7)
Minority interest, after tax ................... -- -- -- (5.4) -- (5.4)
--------- ------- ------ -------- ------- ---------
Net (loss) income .............................. $(7,017.5) $ (80.9) $ 35.1 $ (352.4) $ 398.2 $(7,017.5)
========= ======= ====== ======== ======= =========
16
CIT GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
CIT
CONSOLIDATING CIT Capita Holdings Other
STATEMENT OF CASH FLOWS Group Inc. Corporation LLC Subsidiaries Eliminations Total
----------------------- ---------- ----------- -------- ------------ ------------ -----
Six Months Ended June 30, 2003
Cash Flows From
Operating Activities:
Net cash flows provided by (used for)
operations .................................... $ (68.3) $ 602.3 $(130.1) $ 452.8 $ -- $ 856.7
-------- ------- ------- ------- ------- --------
Cash Flows From
Investing Activities:
Net decrease in financing and
leasing assets ................................ (914.8) (164.4) (203.0) (814.0) -- (2,096.2)
Decrease in inter-company loans
and investments ............................... (471.6) -- -- -- 471.6 --
Other ............................................ -- -- -- (47.8) -- (47.8)
-------- ------- ------- ------- ------- --------
Net cash flows (used for)
investing activities .......................... (1,386.4) (164.4) (203.0) (861.8) 471.6 (2,144.0)
-------- ------- ------- ------- ------- --------
Cash Flows From
Financing Activities:
Net increase (decrease) in debt .................. 918.8 7.3 (309.3) 61.7 -- 678.5
Inter-company financing .......................... -- (341.9) 407.6 405.9 (471.6) --
Cash dividends paid .............................. -- -- -- (50.8) -- (50.8)
-------- ------- ------- ------- ------- --------
Net cash flows provided by
(used for) financing activities ............... 918.8 (334.6) 98.3 416.8 (471.6) 627.7
-------- ------- ------- ------- ------- --------
Net increase (decrease) in cash and
cash equivalents .............................. (535.9) 103.3 (234.8) 7.8 -- (659.6)
Exchange rate impact on cash ..................... -- -- -- 46.3 -- 46.3
Cash and cash equivalents,
beginning of period ........................... 1,310.9 231.1 293.7 200.9 -- 2,036.6
-------- ------- ------- ------- ------- --------
Cash and cash equivalents,
end of period ................................. $ 775.0 $ 334.4 $ 58.9 $ 255.0 $ -- $1,423.3
======== ======= ======= ======= ======= ========
17
CIT GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
CIT
CONSOLIDATING CIT Capita Holdings Other
STATEMENT OF CASH FLOWS Group Inc. Corporation LLC Subsidiaries Eliminations Total
----------------------- ---------- ----------- -------- ------------ ------------ -----
Six Months Ended June 30, 2002
Cash Flows From
Operating Activities:
Net cash flows provided by (used for)
operations .................................. $ 384.3 $ 170.1 $(112.6) $(262.4) $ -- $ 179.4
-------- -------- ------- ------- ------- --------
Cash Flows From
Investing Activities:
Net increase in financing and
leasing assets .............................. 624.4 305.6 216.9 224.3 -- 1,371.2
Decrease in inter-company loans
and investments ............................. 127.3 -- -- -- (127.3) --
Other .......................................... -- -- -- 4.3 -- 4.3
-------- -------- ------- ------- ------- --------
Net cash flows provided
by (used for) investing activities .......... 751.7 305.6 216.9 228.6 (127.3) 1,375.5
-------- -------- ------- ------- ------- --------
Cash Flows From
Financing Activities:
Net increase (decrease) in debt ................ (255.9) (1,065.2) 129.1 366.4 -- (825.6)
Inter-company financing ........................ -- 505.7 (79.6) (553.4) 127.3 --
Cash dividends paid ............................ -- -- -- -- -- --
-------- -------- ------- ------- ------- --------
Net cash flows (used for) provided by
financing activities ........................ (255.9) (559.5) 49.5 (187.0) 127.3 (825.6)
-------- -------- ------- ------- ------- --------
Net increase (decrease) in cash and
cash equivalents ............................ 880.1 (83.8) 153.8 (220.8) -- 729.3
Exchange rate impact on cash ................... -- -- -- 49.8 -- 49.8
Cash and cash equivalents,
beginning of period ......................... 833.4 145.1 110.6 212.4 -- 1,301.5
-------- -------- ------- ------- ------- --------
Cash and cash equivalents,
end of period ............................... $1,713.5 $ 61.3 $ 264.4 $ 41.4 $ -- $2,080.6
======== ======== ======= ======= ======= ========
18
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations and Quantitative and Qualitative Disclosure about Market
Risk
Recent Developments
On July 23, 2003, we announced that Jeffrey M. Peek will become the
Company's President and Chief Operating Officer, as well as a member of the
Board of Directors, effective September 3, 2003. We also announced the creation
of an Office of the Chairman, effective September 3, 2003. The members of the
Office of the Chairman will be Albert R. Gamper, Jr., who will remain Chairman
and Chief Executive Officer, Mr. Peek, Thomas B. Hallman, who will serve as Vice
Chairman, Specialty Finance, Joseph M. Leone, who will serve as Vice Chairman
and Chief Financial Officer and Lawrence Marsiello, who will serve as Vice
Chairman and Chief Credit Officer.
On July 28, 2003, we announced that Vice Admiral John R. Ryan, President
of the State University of New York Maritime College, and William M. Freeman,
President of the Public Communications Group of Verizon Communications, have
joined CIT's Board of Directors. CIT's Board is now comprised of nine
independent members and Chief Executive Officer Albert R. Gamper, Jr., and will
expand to a total of eleven directors with the addition of Mr. Peek in
September.
Overview
The accompanying Consolidated Financial Statements include our
consolidated accounts. On July 8, 2002, our former parent, Tyco, completed a
sale of 100% of CIT's outstanding common stock in our IPO. Immediately prior to
the offering, our predecessor, CIT Group Inc., a Nevada corporation, was merged
with and into its parent, TCH, a Nevada corporation, and that combined entity
was further merged with and into CIT Group Inc. (Del), a Delaware corporation.
In connection with the reorganization, CIT Group Inc. (Del) was renamed CIT
Group Inc. As a result of the reorganization, CIT is the successor to CIT Group
Inc. (Nevada)'s business, operations and obligations and the financial results
of TCH are included in the consolidated CIT financial statements.
Prior to our IPO on July 8, 2002, the activity of TCH consisted primarily
of interest expense to an affiliate of Tyco, and the TCH accumulated net deficit
was relieved via a capital contribution from Tyco. The activity of TCH consisted
primarily of interest expense to an affiliate of Tyco during the period from
June 1, 2001 to June 30, 2002. TCH had no operations subsequent to June 30,
2002. Although the financial statements and notes thereto include the activity
of TCH in conformity with accounting principles generally accepted in the U.S.,
management believes that it is most meaningful to discuss our financial results
excluding TCH, due to its temporary status as a Tyco acquisition company with
respect to CIT. Therefore, throughout this section, in order to provide
comparability with current quarter and prospective results, prior period
comparisons exclude the results of TCH. Consolidating income statements for CIT,
TCH and CIT consolidated for the quarter and six months ended June 30, 2002 are
displayed in Item 1. Consolidating Financial Statements and Supplementary Data,
Note 12.
Following the acquisition by Tyco, we changed our fiscal year end from
December 31 to September 30, to conform to Tyco's fiscal year end. On November
5, 2002, the CIT Board of Directors approved the return to a calendar year end
effective December 31, 2002. As a result, the quarter ended June 30, 2003
constitutes the second quarter of our calendar 2003 results.
Key Business Initiatives and Trends
June 2003 is the fourth quarter closed since our return to public company
status. During the six months ended June 30, 2003, we have restored our funding
base as evidenced by the repayment in full of previously drawn bank lines, the
consistent access to both the commercial paper and term debt markets and the
significant lowering of our term debt quality spreads. The section that follows
sequences the events leading up to the funding base disruption and our eventual
IPO through to the current period.
In early to mid-2001, the e-commerce and telecommunications industry
downturns in the economy became evident. In light of this downturn, we
recognized impairment charges against earnings immediately prior to the
acquisition by Tyco, including equity interests related to e-commerce and
telecommunications.
19
After the June 2001 acquisition by Tyco, we broadened and accelerated
asset liquidation initiatives. Management also initiated further business line
consolidation and operating expense cost reductions, both in the corporate staff
areas and in the business units.
The targeted non-strategic business lines and products were sold or placed
in liquidation status, and we ceased originating new business in these areas.
Severance and other costs associated with these initiatives were identified in
plans that were approved by senior management. These costs plus any adjustments
to reduce the carrying values of the targeted assets to fair value were provided
for primarily through purchase accounting (Tyco's acquisition of CIT, with the
purchase accounting adjustments "pushed-down" to CIT's financial statements). In
support of these initiatives, Tyco provided nearly $900 million of additional
capital to CIT from June through December of 2001. We also decided to cease
making new venture capital investments and to run-off our existing venture
capital portfolio.
The balance of each of these non-strategic/liquidating portfolios are
presented in the following table ($ in millions):
Balance Balance
Outstanding at Outstanding at
Portfolio June 30, 2003(1) December 31, 2002(1)
-------- ---------------- --------------------
Manufactured housing .................. $ 605 $ 624
Franchise finance ..................... 173 322
Owner-operator trucking ............... 155 218
Recreational marine ................... 104 123
Recreational vehicle(2) ............... 46 34
Wholesale inventory finance ........... 2 18
------ ------
Sub total - liquidating portfolios .. 1,085 1,339
Venture capital ....................... 325 335
------ ------
Total ............................... $1,410 $1,674
====== ======
- --------------------------------------------------------------------------------
(1) On-balance sheet financing and leasing assets.
(2) The increase is due to repurchase of previously securitized receivables.
In early 2002, Tyco announced its break-up plan and intent to sell CIT.
Subsequent developments at Tyco prior to the separation of CIT resulted in
credit rating downgrades of Tyco and similar but more limited actions for CIT.
These rating actions caused significant disruption to our historical funding
base. As a result, the Company's access to the commercial paper market was
hindered, and the Company drew down on its existing backup lines of credit to
meet its financing requirements. Consequently, management focused primarily on
liquidity and capital as opposed to growth and profitability. Significant
initiatives were undertaken to fortify the Company's liquidity position, to
address bondholder protections, to re-access the commercial paper and term debt
markets and to strengthen our balance sheet.
In July 2002, Tyco sold 100% of CIT in our IPO, with the proceeds
(exclusive of overallotment proceeds) paid to our former parent. CIT received
approximately $250 million when the underwriters partially exercised the
overallotment option in our IPO.
Immediately following our IPO and complete separation from Tyco, our debt
credit ratings were upgraded by Standard & Poor's and Fitch. Shortly thereafter,
the Company commenced repayment of our drawn bank facilities, which facilitated
our re-entrance into the commercial paper markets. We re-launched our commercial
paper program, and achieved significant outstandings at market pricing levels,
maintaining backstop liquidity to fully cover all outstanding commercial paper.
During the quarter ended June 30, 2003, we fully paid down drawn bank credit
facilities.
Since our IPO, we have readily accessed the term markets, issuing an
aggregate $10.2 billion in term debt, comprised of $5.5 billion in fixed-rate
debt and $4.7 billion in floating-rate debt. These totals include $1.8 billion
issued through a retail note program, which was initiated in November 2002.
20
The events described resulted in an increased cost of funds due to our
borrowing spreads being higher than traditionally experienced. The following
table summarizes the trend in our quality spreads (interest rate cost over U.S.
Treasury rates) in relation to 5-year treasuries. Amounts are in basis points
and represent the average spread during the stated periods:
Three Months Ended Years Ended
------------------------------------ -------------------------------------------
June 30, March 31, December 31, September 30, September 30, December 31,
2003 2003 2002 2002 2001 2000
-------- --------- ------------ ------------- ------------- ------------
Average spread over
U.S. Treasuries .......... 152 215 302 313 147 154
The average spread over U.S. Treasuries for the month of July 2003
improved to 104 basis points. Separately, on July 29, 2003, we issued $750.0
million of 2-year senior floating rate notes at 43 basis points over LIBOR, a
significant improvement from prior period spread levels.
Additionally, the Company has been maintaining cash liquidity levels in
excess of our historical norms. Although our quality spreads have been trending
towards historical levels in recent months, management expects that margin and
earnings will continue to be negatively impacted for the foreseeable future, as
results will continue to reflect the higher cost of non-callable funding
executed during this period. A limited portion of our outstanding debt is
callable. Such debt is monitored to evaluate economic benefits to redemption.
As management was executing its plan to dispose of targeted assets while
improving liquidity and capital, the U.S. and world economies slowed
significantly. The slowing economy dampened demand for new borrowings from CIT,
which was reflected in lower loan origination levels and also leads to
compressed rental rates in the commerical aerospace sector. The economic
slowdown, in conjunction with our emphasis on liquidating or selling targeted
assets, and securitizing higher levels of assets to meet liquidity needs, caused
our on-balance sheet assets to decrease, which in turn led to lower levels of
net interest margin.
The poor economy also resulted in worsening borrower performance and lower
equipment values, leading to higher loss frequency and severity, which lowered
earnings. In response to increasing past due and non-performing loan levels,
management increased our balance sheet reserve for credit losses, even as
portfolio asset levels continued to decline. Our exposures to telecommunications
and Argentina were evaluated, with specific reserving actions taken in the year
ended September 30, 2002. These reserves were added to the balance sheet reserve
for credit losses and are separately identified and tracked in relationship to
the performance of the corresponding portfolios. These reserving actions were
consistent with our focus to strengthen our balance sheet.
Income Statement and Balance Sheet Analysis in Relation to Prior Year
The following table summarizes the impact of various items for the
respective reporting periods that affect the comparability of our financial
results under GAAP. We are presenting these items as a supplement to the GAAP
results to facilitate the comparability of results between periods. The adoption
of SFAS No. 142, "Goodwill and Other Intangible Assets" eliminated goodwill
amortization and introduced goodwill impairment charges. The impairment charge
in the period ended June 30, 2002 was a non-cash charge and did not impact our
tangible capital. The TCH results relate to a Tyco acquisition company that had
temporary status with respect to Tyco's acquisition of CIT. For these reasons,
we believe that this table, in addition to the GAAP results, aids in the
analysis of the significant trends in our business over the periods presented ($
in millions):
Quarter Ended Six Months Ended
June 30, June 30,
------------------ -----------------
2003 2002 2003 2002
---- ---- ---- ----
Net income (loss) -- GAAP basis.................. $136.9 $(2,397.8) $263.9 $(7,017.5)
Charges included in net income (loss):
Goodwill impairment ........................... -- 1,999.0 -- 6,511.7
TCH losses..................................... -- 404.3 -- 668.6
------ --------- ------ ---------
Net income -- before charges..................... $136.9 $ 5.5 $263.9 $ 162.8
====== ========= ====== =========
The increase in 2003 net income - before charges for both the quarter and
the six months ended June 30, 2003, was due primarily to the specific
telecommunication and Argentine reserving actions in 2002. Excluding these prior
year reserving actions, which totalled $148.8 million and $207.7 million after
tax for the quarter and the six months ended June 30, 2002, the comparisons
reflect lower current year interest margin, due to higher borrowing costs
resulting from the funding base disruption.
21
Managed assets totaled $47.9 billion at June 30, 2003, versus $46.4
billion at December 31, 2002 and $47.7 billion at June 30, 2002. Financing and
leasing portfolio assets totaled $37.5 billion at June 30, 2003, versus $35.9
billion at December 31, 2002, and $35.7 billion at June 30, 2002. The portfolio
growth for the current six month period was primarily in the Commercial Finance
segment, due to strong asset-based lending growth, and in the Capital Finance
segment, reflecting new aircraft deliveries and the acquisition of a rail
operating lease portfolio. Home equity receivables also grew in the Specialty
Finance segment.
Net Finance Margin
A comparison of finance income and net finance margin is set forth below
($ in millions):
Quarter Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2003 2002 2003 2002
---- ---- ---- ----
Finance income .......................... $ 943.2 $ 1,021.9 $ 1,882.4 $ 2,128.6
Interest expense ........................ 331.1 370.2 677.8 718.5
--------- --------- --------- ---------
Net finance income .................... 612.1 651.7 1,204.6 1,410.1
Depreciation on operating lease equipment 272.9 295.7 551.7 605.9
--------- --------- --------- ---------
Net finance margin .................... $ 339.2 $ 356.0 $ 652.9 $ 804.2
========= ========= ========= =========
Average earning assets ("AEA") .......... $35,700.0 $34,670.1 $35,194.8 $35,069.7
========= ========= ========= =========
As a % of AEA:
Finance income .......................... 10.57% 11.79% 10.70% 12.14%
Interest expense ........................ 3.71% 4.27% 3.85% 4.10%
--------- --------- --------- ---------
Net finance income .................... 6.86% 7.52% 6.85% 8.04%
Depreciation on operating lease equipment 3.06% 3.41% 3.14% 3.46%
--------- --------- --------- ---------
Net finance margin as a % of AEA ........ 3.80% 4.11% 3.71% 4.58%
========= ========= ========= =========
The debt quality spread factors discussed previously in the "Key Business
Initiatives and Trends" section adversely impacted interest margin in relation
to 2002 periods. Finance income reflected the decline in market interest rates
from June 2002. However, the corresponding decrease in our funding costs was in
part offset by the draw down of bank facilities to pay off commercial paper, the
issuance of term debt at wider credit spreads and higher levels of excess cash
maintained for liquidity purposes.
Finance income (interest on loans and lease rentals) for the quarter ended
June 30, 2003 decreased $78.7 million from the same quarter in 2002 and
decreased $246.2 million for the six months ended June 30, 2003 from the prior
year six months. AEA for the quarter and six months ended June 30, 2003
increased 3.0% and 0.4% from the prior year periods. However, the impact of
lower market interest rates more than offset the higher asset levels in the
finance income comparisons with 2002. This trend also reflected an 8.5% and
11.3% reduction in operating lease rentals primarily resulting from lower
rentals on the aerospace portfolio due to the commercial airline industry
downturn.
Interest expense as a percentage of AEA averaged 3.71% and 3.85% for the
quarter and six months ended June 30, 2003, compared to 4.27% and 4.10% for the
quarter and six months ended June 30, 2002, as the favorable impact of lower
market interest rates was partially offset by higher borrowing spreads. At June
30, 2003, CIT had $4.6 billion in outstanding commercial paper and drawn bank
facilities were fully repaid. At December 31, 2002 and June 30, 2002, commercial
paper outstanding was $5.0 billion and zero, respectively, while drawn
commercial bank lines were $2.1 billion and $8.5 billion, respectively.
22
The operating lease equipment portfolio was $7.6 billion at June 30, 2003,
compared to $6.7 billion at December 31, 2002 and $6.7 billion at June 30, 2002.
The following table summarizes by segment the total operating lease portfolio ($
in millions).
June 30, December 31, June 30,
Segment 2003 2002 2002
- ------- -------- ------------ --------
Capital Finance................ $5,783.2 $4,719.9 $4,262.4
Specialty Finance.............. 1,171.2 1,257.3 1,546.9
Equipment Finance.............. 504.0 668.3 818.6
Structured Finance............. 101.6 59.1 61.8
-------- -------- --------
Total.......................... $7,560.0 $6,704.6 $6,689.7
======== ======== ========
The table below summarizes operating lease margin as a percentage of
average operating lease equipment for the respective periods.
Quarter Ended Six Months Ended
June 30, June 30,
----------------- ----------------
2003 2002 2003 2002
---- ---- ---- ----
As a % of Average Operating
Lease Equipment:
Rental income....................... 20.8% 24.9% 21.6% 26.0%
Depreciation expense................ 14.9% 17.8% 15.7% 18.4%
---- ---- ---- ----
Operating lease margin............ 5.9% 7.1% 5.9% 7.6%
==== ==== ==== ====
The decline in depreciation expense for the quarter and six months ended
June 30, 2003 from the prior year periods reflects a greater proportion of
aircraft and rail assets with an average depreciable life of 25 and 40 years,
respectively, compared to smaller-ticket asset lives generally of 3 years in the
Specialty Finance and Equipment Finance portfolios.
Net Finance Margin After Provision for Credit Losses
The net finance margin after provision for credit losses (risk adjusted
interest margin) for the quarter and six months ended June 30, 2003 increased by
$240.3 million and $197.8 million to $238.6 million and $449.3 million from
$(1.7) million and $251.5 million for the comparable periods in 2002. These
amounts equated to risk adjusted margin of 2.67% and (0.02)% as a percentage of
AEA for the the quarters ended June 30, 2003 and 2002 and 2.55% and 1.43% for
the six months ended June 30, 2003 and 2002. These improved risk adjusted net
margin comparisons largely reflect the impact of specific reserving actions in
2002 relating to the telecommunications portfolio exposure and the economic
reforms instituted by the Argentine government. These reserving actions totalled
$240.0 million (2.77% as a percentage of AEA) for the quarter ended June 30,
2002 and $335.0 million (1.91% as a percentage of AEA) for the six months ended
June 30, 2002.
The positive impact on risk adjusted margin, before the benefit of
refinancing at better rates, due to fair value adjustments to mark receivables
and debt to market remaining from the Tyco acquisition was 13 and 40 basis
points for the quarter ended June 30, 2003 and 2002 and 16 and 42 basis points
for the six months ended June 30, 2003 and 2002.
At the date of the Tyco acquisition, we used discounted cash flow
projection analysis to estimate the fair value of our various liquidating
portfolios by modeling the portfolio revenues, credit costs, servicing costs and
other related expenses over the remaining lives of the portfolios. These
discounts are being accreted into income as the portfolios liquidate. The
positive impact on risk-adjusted margin due to purchase accounting fair value
adjustments related to the liquidating portfolios was two and seven basis points
for the quarters ended June 30, 2003 and 2002 and was three basis points and
seven basis point for the six months ended June 30, 2003 and 2002.
Other Revenue
Other revenue for the quarter ended June 30, 2003 decreased 11.6% to
$217.6 million from $246.1 million during the quarter ended June 30, 2002, and
for the six months ended June 30, 2003 decreased 5.2% to $453.1 million from
$478.2 million in the prior year period. Losses on venture capital investments
were recorded as
23
reductions to other revenue. Other revenue was 2.44% and 2.84% as a percentage
of AEA for the quarters ended June 30, 2003 and 2002 and 2.57% and 2.73% for the
six months ended June 30, 2003 and 2002. The components of other revenue are set
forth in the following table ($ in millions):
Quarter Ended Six Months Ended
June 30, June 30,
------------- ----------------
2003 2002 2003 2002
---- ---- ---- ----
Fees and other income ................... $134.6 $144.4 $279.3 $305.3
Factoring commissions ................... 44.8 42.0 91.7 79.5
Gains on securitizations ................ 33.8 57.1 64.5 91.8
Gains on sales of leasing equipment ..... 16.5 4.0 34.1 8.3
(Losses) on venture capital investments.. (12.1) (1.4) (16.5) (6.7)
------ ------ ------ ------
Total Other Revenue ..................... $217.6 $246.1 $453.1 $478.2
====== ====== ====== ======
The decline in total other revenue included higher venture capital losses
and lower securitization gains as the prior year included an unusually high
level of securitization activity due to the disruption to our historical funding
sources. Gains from the sales of leasing equipment were up primarily in the
Specialty Finance segment, reflecting end-of-lease equipment sales of
communication and other small-ticket equipment. The reduction in fees and other
income reflected write-downs of securitization retained interests due to high
prepayment activity principally in the consumer assets and a modest loss on the
sale of a portion of the Franchise portfolio.
The following table presents information regarding securitization gains
included in the table above ($ in millions):
Quarter Ended Six Months Ended
June 30, June 30,
--------------- ----------------
2003 2002 2003 2002
---- ---- ---- ----
Volume securitized(1) ........................ $1,652.5 $2,738.7 $2,889.9 $5,464.6
Gains ........................................ $ 33.8 $ 57.1 $ 64.5 $ 91.8
Gains as a percentage of volume securitized... 2.05% 2.08% 2.23% 1.68%
- --------------------------------------------------------------------------------
(1) Excludes short-term trade receivables securitized for liquidity purposes
at no gain.
The trend in the gains as a percentage of volume securitized for the six
months reflects the fact that the first quarter 2002 securitization volume was
securitized at lower gain percentages in comparison to first quarter 2003
largely due to asset mix. The greater volume securitized in 2002 was done
primarily to meet funding and liquidity needs.
The key assumptions used in measuring the retained interests at the date
of securitization for transactions completed during the six months ended June
30, 2003 were as follows:
Commercial Equipment Consumer
---------------------- --------
Specialty Equipment Home
Finance Finance Equity
--------- --------- --------
Weighted average prepayment speed ............ 29.80% 12.51% 24.40%
Weighted average expected credit losses ...... 0.46% 1.17% 0.90%
Weighted average discount rate ............... 11.88% 9.00% 13.00%
Weighted average life (in years) ............. 1.31 1.90 3.51
Key assumptions used in calculating the fair value of the retained
interests in securitized assets by product type at June 30, 2003 were as
follows:
Commercial Equipment Consumer
-------------------- -------------------------
Manufactured Recreational
Specialty Equipment Housing & Vehicle
Finance Finance Home Equity & Boat
------- ------- ----------- ------
Weighted average prepayment
speed ........................ 21.41% 12.09% 26.41% 18.15%
Weighted average expected
credit losses ................ 0.97% 1.90% 1.16% 0.82%
Weighted average
discount rate ................ 11.10% 10.31% 13.08% 14.31%
Weighted average life
(in years) ................... 1.15 1.44 3.07 3.12
24
Salaries and General Operating Expenses
The efficiency ratio and the ratio of salaries and general operating
expenses to average managed assets ("AMA") are two metrics that management uses
to monitor productivity and are set forth in the following table. The efficiency
ratio measures the level of expenses in relation to revenue earned, whereas the
AMA relationship measures the efficiency of expenses in relation to loans and
leases we collect and service represented by our managed asset base. The AMA is
used to better reflect the relationship of expenses recognized in the Statements
of Income with all applicable asset sources ($ in millions).
Quarter Ended Six Months Ended
June 30, June 30,
---------------- ----------------
2003 2002 2003 2002
---- ---- ---- ----
Efficiency ratio(1) ............ 40.8% 38.3% 41.7% 35.7%
Salaries and general operating
expenses as a percentage
of AMA(2) .................... 1.99% 2.02% 2.03% 1.97%
Salaries and general operating
expenses ..................... $227.4 $230.4 $461.0 $457.3
- --------------------------------------------------------------------------------
(1) Efficiency ratio is the ratio of salaries and general operating expenses
to operating margin, excluding the provision for credit losses.
(2) "AMA" means average managed assets, which is average earning assets plus
the average of finance receivables previously securitized and still
managed by us.
Salaries and general operating expenses for the quarter ended June 30,
2003 decreased 1.3% from the prior year quarter to $227.4 million and included
lower collection and repossession expenses and reduced costs associated with
securitization facilities. For the six months ended June 30, 2003 salaries and
general operating expenses increased 0.8% from the prior year period to $461.0
million. Personnel was 5,845, unchanged from the prior quarter and down from
5,935 at June 30, 2002.
The deterioration in efficiency ratios for the quarter and six months
ended June 30, 2003 to 40.8% and 41.7% from 38.3% and 35.7% for the comparable
periods of 2002 is the result of lower net finance margin in 2003. We continue
to target an efficiency ratio in the mid 30% area and an AMA ratio under 2.00%,
as we have the existing capacity to increase assets without significant
additional expense.
Expenses are monitored closely by business unit and corporate management
and are reviewed monthly with our senior management as to trends and forecasts.
To ensure overall project cost control, an approval and review procedure is in
place for major capital expenditures, such as computer equipment and software,
including post-implementation evaluations.
Provision for Credit Losses
The provision for credit losses was $100.6 million and $203.6 million for
the quarter and six months months ended June 30, 2003 versus $357.7 million and
$552.7 million for the same periods last year. The 2002 provisions included
specific reserving actions related to our telecommunications portfolio ($200.0
million) and the economic reforms instituted by the Argentine government that
resulted in the mandatory conversion of dollar-denominated receivables into the
peso ($135.0 million).
25
Our provision for credit losses and reserve for credit losses are
presented in the following table ($ in millions):
For the Quarter Ended For the Six Months Ended
--------------------- ------------------------
June 30, June 30, June 30, June 30,
2003 2002 2003 2002
-------- -------- -------- --------
Balance beginning of period .......................... $757.0 $554.9 $760.8 $496.4
------ ------ ------ ------
Provision for credit losses .......................... 100.6 117.7 203.6 217.7
Provision for credit losses -- telecommunications .... -- 200.0 -- 200.0
Provision for credit losses -- Argentine exposure .... -- 40.0 -- 135.0
Reserves relating to dispositions, acquisitions, other 5.7 22.3 13.2 (1.8)
------ ------ ------ ------
Additions to reserve for credit losses ............. 106.3 380.0 216.8 550.9
------ ------ ------ ------
Net credit losses:
Specialty Finance -- commercial ...................... 23.9 21.2 54.9 40.8
Equipment Finance .................................... 38.6 64.9 76.7 126.0
Capital Finance ...................................... -- -- 1.8 --
Commercial Finance ................................... 21.3 29.0 37.9 49.2
Structured Finance ................................... 8.6 -- 22.4 0.1
Specialty Finance -- consumer ........................ 16.0 10.9 29.0 22.3
------ ------ ------ ------
Total net credit losses ............................ 108.4 126.0 222.7 238.4
------ ------ ------ ------
Balance end of period ................................ $754.9 $808.9 $754.9 $808.9
====== ====== ====== ======
Reserve for credit losses as a percentage of finance
Receivables(1) ..................................... 2.66% 2.90%
====== ======
Reserve for credit losses as a percentage of past due
receivables (sixty days or more)(1) ................ 81.5% 78.5%
====== ======
- --------------------------------------------------------------------------------
(1) The reserve for credit losses excluding the impact of telecommunication
and Argentine reserves as a percentage of finance receivables was 1.78% at
June 30, 2003 and 1.75% at June 30, 2002. The reserve for credit losses
excluding the impact of telecommunication and Argentine reserves as a
percentage of past due receivables (sixty days or more) was 55.6% and
44.1% at June 30, 2003 and 2002, respectively.
The tables that follow detail net charge-offs for the quarters and six
months ended June 30, 2003 and June 30, 2002 by segment, both in amount and as a
percentage of average finance receivables on an annualized basis. In addition to
total amounts, net charge-offs relating to the liquidating and
telecommunications portfolios are presented to provide enhanced analysis ($ in
millions):
Quarter Ended June 30, 2003
---------------------------------------------------------
Before
Liquidating and Liquidating and
Total Telecommunications Telecommunications
----------------- ------------------ ------------------
Specialty Finance -- commercial................ $ 23.9 1.33% $ 23.9 1.33% $ -- --
Equipment Finance.............................. 38.6 2.51% 26.1 1.82% 12.5 12.00%
Capital Finance................................ -- -- -- -- -- --
Commercial Finance............................. 21.3 0.96% 18.6 0.84% 2.7 76.80%
Structured Finance............................. 8.6 1.18% -- -- 8.6 5.38%
------ ------ ------
Total Commercial Segments................... 92.4 1.40% 68.6 1.09% 23.8 8.87%
Specialty Finance -- consumer.................. 16.0 2.62% 9.9 2.43% 6.1 3.01%
------ ------ ------
Total....................................... $108.4 1.51% $ 78.5 1.17% $ 29.9 6.33%
====== ====== ======
26
Quarter Ended June 30, 2002
---------------------------------------------------------
Before
Liquidating and Liquidating and
Total Telecommunications Telecommunications
----------------- ------------------ ------------------
Specialty Finance -- commercial .. $ 21.2 1.36% $ 19.3 1.28% $ 1.9 4.59%
Equipment Finance ................ 64.9 3.14% 50.5 2.83% 14.4 5.10%
Capital Finance .................. -- -- -- -- -- --
Commercial Finance ............... 29.0 1.61% 29.0 1.61% -- --
Structured Finance ............... -- -- -- -- -- --
------ ------ ------
Total Commercial Segments ..... 115.1 1.78% 98.8 1.61% 16.3 5.03%
Specialty Finance -- consumer .... 10.9 1.86% 6.8 1.86% 4.1 1.88%
------ ------ ------
Total ........................ $126.0 1.79% $105.6 1.63% $ 20.4 3.75%
====== ====== ======
Six Months Ended June 30, 2003
---------------------------------------------------------
Before
Liquidating and Liquidating and
Total Telecommunications Telecommunications
----------------- ------------------ ------------------
Specialty Finance -- commercial .. $ 54.9 1.53% $ 54.5 1.52% $ 0.4 7.84%
Equipment Finance ................ 76.7 2.45% 55.8 1.92% 20.9 8.94%
Capital Finance .................. 1.8 0.29% 1.8 0.29% -- --
Commercial Finance ............... 37.9 0.88% 35.2 0.82% 2.7 37.24%
Structured Finance ............... 22.4 1.54% -- -- 22.4 6.84%
------ ------ ------
Total Commercial Segments ..... 193.7 1.48% 147.3 1.18% 46.4 8.08%
Specialty Finance -- consumer .... 29.0 2.53% 16.5 2.23% 12.5 3.05%
------ ------ ------
Total ......................... $222.7 1.56% $163.8 1.23% $ 58.9 5.99%
====== ====== ======
Six Months Ended June 30, 2002
---------------------------------------------------------
Before
Liquidating and Liquidating and
Total Telecommunications Telecommunications
----------------- ------------------ ------------------
Specialty Finance -- commercial .. $ 40.8 1.31% $ 36.1 1.19% $ 4.7 5.86%
Equipment Finance ................ 126.0 2.82% 82.9 2.14% 43.1 7.40%
Capital Finance .................. -- -- -- -- -- --
Commercial Finance ............... 49.2 1.40% 49.2 1.40% -- --
Structured Finance ............... 0.1 0.01% 0.1 0.01% -- --
------ ------ ------
Total Commercial Segments ..... 216.1 1.65% 168.3 1.39% 47.8 4.67%
Specialty Finance -- consumer .... 22.3 1.83% 12.5 1.41% 9.8 2.95%
------ ------ ------
Total ......................... $238.4 1.66% $180.8 1.39% $ 57.6 4.25%
====== ====== ======
Certain small business loans and leases were transferred from Equipment
Finance to Specialty Finance -- commercial during the March 2003 quarter (prior
period amounts have not been restated). Charge-offs related to the transferred
portfolios during the quarter and six months ended June 30, 2003 totaled $6.9
million and $18.0 million, respectively, versus $5.1 million and $8.8 million
during the quarter and six months ended June 30, 2002, respectively. Excluding
the impact of the transfers, charge-offs were down from the prior year periods
for both Equipment Finance and Specialty Finance -- commercial. The increase in
the Structured Finance segment relates entirely to charge-offs in the
telecommunications sector.
Reserve for Credit Losses
The reserve for credit losses was $754.9 million or 2.66% of finance
receivables at June 30, 2003 compared to $760.8 million (2.75%) at December 31,
2002 and $808.9 million (2.90%) at June 30, 2002. The decrease from both
December 31, 2002 and June 30, 2002 reflects telecommunication charge-offs which
were applied to the specific telecommunications reserve established in 2002,
partially offset by reserves associated with loan growth during the respective
periods. In 2002, we took two specific reserving actions. First, in light of the
continued deterioration in the telecommunications sector, particularly with
respect to our competitive local exchange carrier ("CLEC") portfolio, we added
$200.0 million to the reserve for credit losses as at June 30, 2002.
Additionally, as
27
a result of the Argentine government's action to convert dollar-denominated
loans to pesos, and continued weakness in the peso, we recorded a $135.0 million
provision ($95.0 million during the quarter ended March 31, 2002 and $40.0
million during the quarter ended June 30, 2002). The current balances for the
specific reserves are detailed below.
The following table presents the components of the reserve for credit
losses, both in amount and as a percentage of corresponding finance receivables
($ in millions):
At June 30, 2003 At December 31, 2002 At June 30, 2002
---------------- -------------------- -------------------
Amount % Amount % Amount %
------ ----- -------- ------- -------- -------
Finance receivables... $491.8 1.78% $472.2 1.77% $473.9 1.75%
Telecommunications 128.1 19.77%(1) 153.6 22.40%(1) 200.0 29.77(1)
Argentina ............ 135.0 80.36%(2) 135.0 73.11%(2) 135.0 75.00%(2)
------ ------ ------
Total ................ $754.9 2.66% $760.8 2.75% $808.9 2.90%
====== ====== ======
- --------------------------------------------------------------------------------
(1) Percentages of telecommunications portfolio finance receivables.
(2) Percentages of finance receivables in Argentina.
The reserve includes specific amounts relating to SFAS 114 impaired loans
(excluding telecommunications and Argentina) of $51.7 million at June 30, 2003,
compared to $52.9 million at December 31, 2002, and $153.0 million at June 30,
2002. Management continues to believe that the credit risk characteristics of
the portfolio are well diversified by geography, industry, borrower and
equipment type. Refer to "Concentrations" for more information.
The total telecommunications portfolio including the portion comprising
the CLEC exposure amounted to $647.9 million and $224.3 million at June 30,
2003, compared to $710.1 million and $262.3 million at December 31, 2002 and
$725.7 million and $288.3 million at June 30, 2002. Telecommunications net
charge-offs were $11.3 million and $25.1 million for the quarter and six months
ended June 30, 2003, respectively.
We established a $135 million reserve for Argentine exposure in the first
half of 2002 to reflect the geopolitical risks associated with collecting our
peso-based assets and repatriating them into U.S. dollars that resulted from the
Argentine government instituting certain economic reforms. When established, the
reserve was about two-thirds of our combined currency and credit exposure. We
have made progress in collecting these balances and the portfolio's underlying
credit profile continues to perform as expected. Discussions with the Argentine
government are ongoing and additional recovery efforts continue. Management
expects to seek resolution in the coming quarters and charge-offs are expected
to be recorded against the reserve as these activities are concluded. We
continue to believe that the reserve is adequate.
The consolidated reserve for credit losses is intended to provide for
losses inherent in the portfolio, which requires the application of estimates
and significant judgment as to the ultimate outcome of collection efforts and
realization of collateral, among other things. Therefore, changes in economic
conditions or other events affecting specific obligors or industries may
necessitate additions or reductions to the consolidated reserve for credit
losses.
28
Past Due and Non-Performing Assets
The following table sets forth certain information concerning our past due
(sixty days or more) and non-performing assets (finance receivables on
non-accrual status and assets received in satisfaction of loans) and the related
percentages of finance receivables at June 30, 2003, December 31, 2002 and June
30, 2002 ($ in millions):
At June 30, At December 31, At June 30,
2003 2002 2002
--------------- ---------------- ----------------
Finance receivables, past due 60 days or more:
Specialty Finance -- commercial............. $249.6 3.58% $ 182.9 3.07% $ 250.3 4.06%
Equipment Finance........................... 253.0 4.21% 359.3 4.88% 370.5 4.77%
Capital Finance............................. 99.2 8.37% 85.5 6.40% 36.8 2.40%
Commercial Finance.......................... 130.5 1.46% 172.3 2.14% 195.3 2.39%
Structured Finance.......................... 65.7 2.27% 67.6 2.31% 44.9 1.73%
------ -------- --------
Total Commercial Segments................... 798.0 3.07% 867.6 3.39% 897.8 3.42%
Specialty Finance-- consumer................ 128.1 5.26% 133.7 6.66% 132.4 7.81%
------ -------- --------
Total....................................... $926.1 3.26% $1,001.3 3.63% $1,030.2 3.69%
====== ======== ========
Non-performing assets:
Specialty Finance -- commercial............. $140.0 2.01% $ 98.2 1.65% $ 125.7 2.04%
Equipment Finance........................... 337.8 5.62% 403.5 5.48% 484.5 6.23%
Capital Finance............................. 83.1 7.01% 154.9 11.60% 25.5 1.67%
Commercial Finance.......................... 107.4 1.20% 136.2 1.69% 143.2 1.75%
Structured Finance.......................... 133.9 4.64% 151.6 5.19% 128.3 4.95%
------ -------- --------
Total Commercial Segments................... 802.2 3.09% 944.4 3.69% 907.2 3.46%
Specialty Finance -- consumer............... 139.0 5.70% 141.4 7.04% 145.4 8.58%
------ -------- --------
Total....................................... $941.2 3.31% $1,085.8 3.93% $1,052.6 3.77%
====== ======== ========
Non-accrual loans.............................. $804.6 $ 946.4 $ 878.9
Repossessed assets............................. 136.6 139.4 173.7
------ -------- --------
Total non-performing assets................. $941.2 $1,085.8 $1,052.6
====== ======== ========
Past due loans continued a declining trend, down $75.2 million from
December 31, 2002, ending the quarter at 3.26% of finance receivables, versus
3.93% and 3.77% at December 31, 2002 and June 30, 2002. The fluctuations in the
Equipment Finance and Specialty Finance -- commercial segments, reflect the
previously mentioned transfer of small business loans and leases from Equipment
Finance to Specialty Finance -- commercial. Past due accounts related to these
transferred portfolios approximated $74 million, $79 million and $61 million at
June 30, 2003, December 31, 2002 and June 30 2002, respectively. Excluding the
impact of the transferred accounts, past due accounts in Equipment Finance and
Specialty Finance -- commercial were below the prior two quarters. The
Commercial Finance decline from December 2002 was due to improvements in both
the Commercial Services (factoring) and Business Credit (asset-based lending)
units, while the continued increase in aerospace delinquency drove the Capital
Finance trend.
Similar to past due loans, non-performing assets declined for the third
consecutive quarter at June 30, 2003. Excluding the impact of the portfolio
transfers, the reduction for the quarter was primarily in factoring, the vendor
and small ticket commercial portfolios of Specialty Finance, as well as the
commercial aerospace portfolio, as aircraft securing United Airlines receivables
on non-accrual at December 31, 2002 were placed on short-term operating leases
and payments were received during the first quarter of 2003 to bring the account
to current status. This reduction was in part offset by the placement of Air
Canada assets on non-accrual status following its bankruptcy announcement.
29
Managed past due loans, which also include securitized loans, decreased to
3.20% of managed financial assets (managed assets less operating leases and
venture capital investments) at June 30, 2003 from 3.55% and 3.74% at December
31, 2002 and June 30, 2002, respectively, as shown in the table below ($ in
millions):
June 30, 2003 December 31, 2002 June 30, 2002
----------------- ----------------- ----------------
Managed Financial Assets, past due 60 days or more:
Specialty Finance -- commercial............. $ 318.5 2.88% $ 265.1 2.62% $ 331.7 3.15%
Equipment Finance........................... 395.5 3.94% 545.7 4.78% 680.6 5.42%
Capital Finance............................. 99.2 8.37% 85.5 6.40% 36.8 2.40%
Commercial Finance.......................... 130.5 1.46% 172.3 2.14% 195.3 2.39%
Structured Finance.......................... 65.7 2.27% 67.6 2.31% 44.9 1.73%
-------- -------- --------
Total Commercial............................ 1,009.4 2.96% 1,136.2 3.36% 1,289.3 3.65%
Specialty Finance -- consumer............... 268.4 4.55% 259.4 4.71% 230.8 4.39%
-------- -------- --------
Total....................................... $1,277.8 3.20% $1,395.6 3.55% $1,520.1 3.74%
======== ======== ========
The fluctuations in the Equipment Finance and Specialty Finance --
commercial segments, reflect the previously mentioned transfer of small business
loans and leases from Equipment Finance to Specialty Finance -- commercial. Past
due accounts related to these transferred portfolios approximated $74 million,
$79 million and $61 million at June 30, 2003, December 31, 2002 and June 30
2002, respectively.
In light of the continued general economic weakness, and the circumstances
surrounding particular sectors as discussed in "Concentrations", past due
finance receivables and non-performing assets may increase from the June 30,
2003 amounts.
Income Taxes
The effective tax rate was 39.0% for both the quarter and six months ended
June 30, 2003, and (5.3)% and (2.5)% for the respective prior year periods. The
provision for income taxes totaled $89.2 million and $121.3 million for the
quarters ended June 30, 2003 and 2002, respectively, and $172.1 million and
$171.7 million for the comparable prior year periods. The effective tax rate for
the prior year quarter and six months, excluding the impact of TCH and the
non-cash goodwill impairment charge, was 41.4% and 38.2%.
As of June 30, 2003, we had approximately $1,559.0 million of tax loss
carry-forwards, primarily related to U.S. federal and state jurisdictions. The
federal loss carryforwards expire at various dates through 2021. These loss
carry-forwards are available to offset current federal income tax liabilities,
subject to certain limitations.
In connection with the June 2001 acquisition by Tyco, our income tax
compliance, reporting and planning function was transferred to Tyco. Following
our 2002 IPO and separation from Tyco we have made strides in rebuilding our tax
functions, including hiring personnel, and rebuilding systems and processes.
Results by Business Segment
Our segment reporting has been modified and prior periods restated to
reflect Equipment Finance and Capital Finance as separate segments. Previously,
these two strategic business units were combined as the Equipment Financing and
Leasing segment. This presentation is intended to facilitate the analysis of our
results for our financial statement users.
30
The table that follows summarizes selected financial information by
business segment, based upon a fixed leverage ratio across business units and
the allocation of most corporate expenses ($ in millions):
Quarter Ended Six Months Ended
------------------------------- --------------------
June 30, March 31, June 30, June 30, June 30,
2002 2003 2002 2003 2002
-------- --------- -------- -------- --------
Net Income (Loss)
Specialty Finance .................... $ 63.0 $ 52.2 $ 83.8 $115.2 $ 183.8
Equipment Finance .................... 7.9 10.7 31.7 18.6 72.1
Capital Finance ...................... 9.1 7.7 22.8 16.8 45.0
Commercial Finance ................... 55.6 54.1 46.0 109.7 92.2
Structured Finance ................... 14.7 12.2 15.3 26.9 31.7
------ ------ --------- ------ ---------
Total Segments .................... 150.3 136.9 199.6 287.2 424.8
Corporate, including certain charges.. (13.4) (9.9) (2,597.4) (23.3) (7,442.3)
------ ------ --------- ------ ---------
Total .............................. $136.9 $127.0 $(2,397.8) $263.9 $(7,017.5)
====== ====== ========= ====== =========
Return on AEA
Specialty Finance .................... 2.07% 1.75% 3.12% 1.91% 3.22%
Equipment Finance .................... 0.46% 0.60% 1.35% 0.53% 1.44%
Capital Finance ...................... 0.54% 0.50% 1.59% 0.52% 1.63%
Commercial Finance ................... 3.44% 3.58% 3.20% 3.50% 3.57%
Structured Finance ................... 1.95% 1.63% 2.31% 1.79% 2.43%
Total Segments ..................... 1.70% 1.60% 2.33% 1.65% 2.45%
Corporate, including certain charges.. (0.17)% (0.13)% (25.33)% (0.15)% (38.65)%
Total .............................. 1.53% 1.47% (23.00)% 1.50% (36.20)%
Return on AEA for the business segments after Corporate and certain other
charges was 1.53% and 1.50% for the quarter and six months ended June 30, 2003
versus (23.00)% and (36.21)% for the comparable periods of 2002. The improvement
over the prior year was primarily the result of certain corporate charges
described below. On a segment basis, results reflect the dampened returns in
Capital Finance and Equipment Finance, continued strong performance by
Commercial Finance, reduced securitization gains in Specialty Finance and the
allocation to the segments of higher corporate borrowing costs in 2003 as
described below.
Corporate included the following items in the quarter and six months ended
June 30, 2002: (1) goodwill impairment of $1,999.0 million and $6,511.7 million,
(2) TCH expenses of $288.8 million ($404.3 million after tax) and $601.1 million
($668.6 million after tax), (3) specific loan loss reserves of $240.0 million
($148.8 million after tax) and $335.0 million ($207.7 million after tax)
relating to telecommunication exposures and economic reforms instituted by the
Argentine government which resulted in the mandatory conversion of
dollar-denominated receivables into pesos and (4) venture capital operating
losses of $9.8 million ($6.0 million after tax) and $23.5 million ($14.6 million
after tax). Corporate included $21.6 million ($13.2 million after tax) and $36.1
million ($22.1 million after tax) of venture capital operating losses in the
quarter and six months ended June 30, 2003. Excluding these items, unallocated
corporate expenses and funding costs after tax were $0.2 million and $39.3
million during the quarters ended June 30, 2003 and 2002 and were $1.3 million
and $39.7 million for the six months ended June 30, 2003 and 2002, respectively,
reflecting the change in borrowing cost allocation as explained below.
For the first six months of 2003, return on AEA was down across all
segments in relation to the 2002 period reflecting margin compression offset in
part by lower charge-offs from the year ago levels. The business segments' risk
adjusted margins for the quarter ended June 30, 2003 were further dampened by
the allocation (from Corporate) of additional borrowing costs stemming from the
2002 disruption to the Company's funding base and enhanced liquidity levels.
These additional costs have had a greater impact in 2003. The additional
borrowing and liquidity costs were included in Corporate in 2002.
The unfavorable variance in Equipment Finance reflected reduced returns in
construction and industrial, while Capital Finance included lower aerospace
profitability. In addition to lower risk adjusted margins, the Specialty Finance
comparisons with the prior year reflected higher levels of securitization
activity during the prior year done primarily for liquidity purposes.
31
During the quarter ended March 31, 2003, in order to better align
competencies, we transferred $1,078.6 million of certain small business loans
and leases, including the small business lending unit, from Equipment Finance to
Specialty Finance -- commercial. Prior periods have not been restated to conform
to this current presentation.
Financing and Leasing Assets
Owned financing and leasing portfolio assets totaled $37.5 billion at June
30, 2003, up from $35.9 billion at December 31, 2002. Managed assets, comprised
of owned financing and leasing assets and finance receivables previously
securitized that we continue to manage, totaled $47.9 billion at June 30, 2003,
up from $46.4 billion at December 31, 2002. Growth in our portfolio assets for
the six months ended June 30, 2003 was most notable in Capital Finance due to a
$410.0 million rail operating lease portfolio acquisition and new aircraft
deliveries, and in Commercial Finance due to the combination of strong
asset-based lending and factoring new business volumes. Growth was also strong
in Specialty Finance -- consumer, reflecting opportunistic home equity bulk
purchases. During the March 2003 quarter, certain asset portfolios totaling
approximately $1 billion were transferred from Equipment Finance to Specialty
Finance -- commercial. Excluding factoring, total origination volume was up from
2002 by 19% and 7% for the quarter and the six months. The favorable variances
were primarily driven by Business Credit and Specialty Finance.
As of June 30, 2003, the net investment in leveraged leases totaled $1.2
billion, or 4.3% of finance receivables. The major components of this amount are
as follows: commercial aerospace of $472 million, including $216 million of
tax-optimization leveraged leases, which generally have increased risk for
lessors in relation to conventional lease structures due to additional leverage
in the transactions; $309 million of project finance transactions, primarily in
the power and utility sector; and $230 million in rail transactions.
32
The managed assets of our business segments and the corresponding
strategic business units are presented in the following table ($ in millions):
At At Change
June 30, December 31, -------------------------
2003 2002 $ %
--------- ------------ --------- ---------
Specialty Finance:
Commercial:
Finance receivables(1) ............. $ 7,598.0 $ 6,722.4 $ 875.6 13.0%
Operating lease equipment, net ..... 1,171.2 1,257.3 (86.1) (6.8)%
--------- --------- ---------
Total commercial ................. 8,769.2 7,979.7 789.5 9.9%
--------- --------- ---------
Consumer:
Home equity ........................ 1,502.1 1,292.7 209.4 16.2%
Other .............................. 1,329.5 1,044.4 285.1 27.3%
--------- --------- ---------
Total consumer ................... 2,831.6 2,337.1 494.5 21.2%
--------- --------- ---------
Total Specialty Finance Segment .... 11,600.8 10,316.8 1,284.0 12.4%
--------- --------- ---------
Equipment Finance:
Finance receivables(1) ............. 6,207.0 7,476.9 (1,269.9) 17.0%
Operating lease equipment, net ..... 504.0 668.3 (164.3) (24.6)%
--------- --------- ---------
Total Equipment Finance Segment .... 6,711.0 8,145.2 (1,434.2) (17.6)%
--------- --------- ---------
Capital Finance:
Finance receivables ................ 1,185.2 1,335.8 (150.6) (11.3)%
Operating lease equipment, net ..... 5,783.2 4,719.9 1,063.3 22.5%
--------- --------- ---------
Total Capital Finance Segment .... 6,968.4 6,055.7 912.7 15.1%
--------- --------- ---------
Commercial Finance:
Commercial Services ................ 4,766.3 4,392.5 373.8 8.5%
Business Credit .................... 4,147.1 3,649.1 498.0 13.6%
--------- --------- ---------
Total Commercial Finance Segment.. 8,913.4 8,041.6 871.8 10.8%
--------- --------- ---------
Structured Finance:
Finance receivables ................ 2,888.4 2,920.9 (32.5) (1.1)
Operating lease equipment, net ..... 101.6 59.1 42.5 71.9%
--------- --------- ---------
Total Structured Finance Segment.. 2,990.0 2,980.0 10.0 0.3%
--------- --------- ---------
Equity investments(3) ................ 325.4 335.4 (10.0) (3.0)%
--------- --------- ---------
TOTAL FINANCING AND LEASING
PORTFOLIO ASSETS ................. 37,509.0 35,874.7 1,634.3 4.6%
--------- --------- ---------
Finance receivables securitized:
Equipment Finance .................... 3,819.9 3,936.2 (116.3) (3.0)%
Specialty Finance -- commercial ...... 3,473.9 3,377.4 96.5 2.9%
Specialty Finance -- consumer ........ 3,062.7 3,168.8 (106.1) (3.3)%
--------- --------- ---------
Total ............................ 10,356.5 10,482.4 (125.9) (1.2)%
--------- --------- ---------
TOTAL MANAGED ASSETS(2) .......... $47,865.5 $46,357.1 $ 1,508.4 3.3%
========= ========= =========
- --------------------------------------------------------------------------------
(1) During the quarter ended March 31, 2002, finance receivables totaling
$1,078.6 million were transferred from Equipment Finance to Specialty
Finance -- commercial, principally representing small business loans.
Prior periods have not been restated to conform to the current
presentation.
(2) Managed assets are comprised of financing and leasing assets (finance
receivables, finance receivables held for sale, operating leases and
equity investments) and finance receivables previously securitized that we
continue to manage.
(3) Included in other assets in the consolidated balance sheet.
33
Concentrations
Our ten largest financing and leasing asset accounts in the aggregate
represented 5.1% of our total financing and leasing assets at June 30, 2003
(with the largest account representing less than 1.0%) and 5.0% at December 31,
2002. All ten accounts at each period of time were commercial accounts and were
secured by equipment, accounts receivable or inventory.
Our strategic relationships with industry-leading equipment vendors are a
significant origination channel for our financing and leasing activities. These
vendor alliances include traditional vendor finance programs, joint ventures and
profit sharing structures. Our vendor programs with Dell, Snap-on and Avaya Inc.
are among our largest alliances. The joint venture agreements with Dell and
Snap-on extend until October 2005 and January 2007, respectively. The Avaya
agreement was recently extended through September 2006.
At June 30, 2003, our financing and leasing assets included $1,501
million, $1,046 million and $841 million related to the Dell, Snap-on and Avaya
programs, respectively. These amounts include receivables originated directly by
CIT as well as receivables purchased from joint venture entities. Securitized
assets included $1,878 million, $80 million and $743 million from the Dell,
Snap-on and Avaya origination sources, respectively, at June 30, 2003. Any
significant reduction in origination volumes from any of these alliances could
have a material impact on our asset levels. For additional information regarding
certain of our joint venture activities, see Note 7 -- Related Party
Transactions.
Geographic Composition
The following table summarizes state concentrations of 5.0% or greater and
foreign concentrations of 1.0% or greater of our owned financing and leasing
portfolio assets at June 30, 2003 and December 31, 2002. In each period, our
managed asset geographic composition did not differ significantly from our owned
asset geographic composition.
June 30, December 31,
2003 2002
-------- ------------
State
California ................................ 10.3% 9.8%
Texas ..................................... 7.6% 7.0%
New York .................................. 7.3% 7.9%
Total U.S. .................................. 78.8% 79.3%
Country
Canada .................................... 5.1% 5.0%
England ................................... 3.3% 3.2%
Australia ................................. 1.2% 1.3%
China ..................................... 1.2% 1.2%
Germany ................................... 1.1% 1.1%
France .................................... (1) 1.0%
Brazil .................................... (1) 1.1%
Total Outside U.S. .......................... 21.2% 20.7%
- --------------------------------------------------------------------------------
(1) The applicable balances are less than 1.0%.
Industry Composition
At June 30, 2003, our commercial aerospace portfolio in the Capital
Finance business unit consisted of financing and leasing assets of $4,479.2
million covering 203 aircraft. These loans had an average age of approximately 7
years (based on a dollar value weighted average). The portfolio was spread over
83 accounts, with the majority placed with major airlines around the world. The
commercial aerospace portfolio at December 31, 2002 was $4,072.8 million of
financing and leasing assets, which covered 194 aircraft spread over 78
accounts, with a weighted average age of approximately 7 years. The commercial
aircraft all comply with stage III noise regulations.
34
The following table summarizes the composition of the commercial aerospace
portfolio as of June 30, 2003 and December 31, 2002 ($ in millions):
At June 30, 2003 At December 31, 2002
--------------------- -------------------------
Net Number of Net Number of
Investment Planes Investment Planes
---------- -------- ---------- ---------
By Geography:
Europe ................. $1,930.9 62 $1,506.5 51
North America(1) ....... 1,060.9 76 1,042.2 75
Asia Pacific ........... 879.5 36 853.6 35
Latin America .......... 536.2 25 595.9 29
Africa/Middle East ..... 71.7 4 74.6 4
-------- --- -------- ---
Total ..................... $4,479.2 203 $4,072.8 194
======== === ======== ===
By Manufacturer:
Boeing ................. $2,607.9 140 $2,388.1 135
Airbus ................. 1,847.5 48 1,647.9 42
Other .................. 23.8 15 36.8 17
-------- --- -------- ---
Total ..................... $4,479.2 203 $4,072.8 194
======== === ======== ===
By Body Type(2):
Narrow ................. $3,218.7 152 $2,799.4 142
Intermediate ........... 865.4 18 859.2 17
Wide ................... 371.3 18 377.4 18
Other .................. 23.8 15 36.8 17
-------- --- -------- ---
Total ..................... $4,479.2 203 $4,072.8 194
======== === ======== ===
- --------------------------------------------------------------------------------
(1) Comprised of net investments in the U.S. and Canada of $871.6 million (70
aircraft) and $189.3 million (6 aircraft) at June 30, 2003 and $832.7
million (69 aircraft) and $209.5 million (6 aircraft) at December 31,
2002.
(2) Narrow body are single aisle design and consist primarily of Boeing 737
and 757 series and Airbus A320 series aircraft. Intermediate body are
smaller twin aisle design and consist primarily of Boeing 767 series and
Airbus A330 series aircraft. Wide body are large twin aisle design and
consist primarily of Boeing 747 and 777 series and McDonnell Douglas DC10
series aircraft.
As of June 30, 2003, operating leases represented approximately 83% of the
portfolio, with the remainder consisting of capital leases (including leveraged
leases) and loans. Tax-optimization leveraged leases, which generally have
increased risk for lessors in comparison to our other lease and leveraged lease
structures, were approximately $216 million at June 30, 2003. Total leveraged
leases, including the tax optimization structures described above, were $472
million or 11% of the aerospace portfolio at June 30, 2003. Of the 203 aircraft,
2 are off-lease, 1 of which has been remarketed with leases pending as of June
30, 2003.
The regional aircraft portfolio at June 30, 2003 consisted of 122 planes
and a net investment of $316.9 million, primarily in the Structured Finance
segment. The planes are primarily located in North America and Europe. Operating
leases accounted for about 31% of the portfolio at June 30, 2003, with the rest
being capital leases or loans. There are 5 aircraft in this portfolio that are
off-lease. At December 31, 2002, the regional aircraft portfolio consisted of
117 planes and a net investment of $344.0 million.
The following is a list of CIT's exposure to bankrupt carriers and the
current status of related aircraft.
o National Airways -- On November 6, 2002, National Airways, which was
operating in bankruptcy, announced that it would cease operations
effective November 6, 2002. We have repossessed our two narrow-body
Boeing 757 aircraft previously leased to National Airways, and
released one during the quarter and have a lease pending for the
second aircraft.
o UAL Corp. -- On December 9, 2002, UAL Corp., the parent of United
Airlines, announced its Chapter 11 bankruptcy filing. Under existing
agreements, United Airlines leases 4 CIT-owned narrow body aircraft
(2 Boeing 757 aircraft and 2 Boeing 737 aircraft) with a net book
value of $91.2 million. These leases were converted from single
investor capital leases to short-term operating leases during the
quarter ended March 31, 2003.
o Avianca Airlines -- Avianca Airlines filed voluntary petitions for
re-organization under Chapter 11 of the U.S. Bankruptcy Code on
Friday, March 21, 2003. Under existing agreements, CIT has operating
leases
35
with Avianca Airlines whereby it is the lessee of one MD 80 and one
Boeing 757 aircraft, both of which are in the process of being
restructured. Current net investment is $38.5 million.
o Air Canada -- Air Canada filed for protection from creditors on
April 1, 2003 under the Companies' Creditors Arrangement Act, the
Canadian reorganization law. CIT's exposure in aircraft to Air
Canada is approximately USD $52 million, primarily relating to one
Boeing 767 aircraft for which CIT has an investment in a leveraged
lease (not a tax-optimized structure), with a remaining term of six
years and a $16.0 million loan collateralized by eight Bombardier
Dash 8 aircraft. The loan is fully guaranteed by the Canadian
government. CIT had a second 767 aircraft that came off-lease on
June 1, 2003 and has been re-leased to another carrier.
Additionally, CIT holds Senior A tranche Enhanced Equipment Trust
Certificates (EETCs) with a fair value of $41.5 million issued by United
Airlines, which are debt instruments collateralized by aircraft operated by the
airline. In connection with United Airlines' filing under Chapter 11, CIT is a
co-arranger in a $1.2 billion secured revolving and term loan facility with a
commitment of $102.0 million. This debtor-in-possession facility, with an
outstanding balance of $32.3 million at June 30, 2003, is secured by, among
other collateral, previously unencumbered aircraft. Future revenues and aircraft
values could be impacted by the actions of the carriers, management's actions
with respect to re-marketing the aircraft, airline industry performance and
aircraft utilization.
The top five commercial aerospace exposures totaled $1,024.0 million at
June 30, 2003, the largest of which was $292.5 million. All are to carriers
outside of the U.S. and the top three of these exposures are to European
carriers. The largest exposure to a U.S. carrier at June 30, 2003 was $142.7
million.
Our aerospace assets include both operating leases and capital leases.
Management monitors economic conditions affecting equipment values, trends in
equipment values, and periodically obtains third party appraisals of commercial
aerospace equipment, which include projected rental rates. We adjust the
depreciation schedules of commercial aerospace equipment on operating leases or
residual values underlying capital leases, when required. Aerospace assets are
reviewed for impairment annually, or more often when events or circumstances
warrant. An aerospace asset is considered impaired when the expected
undiscounted cash flow over its expected remaining life is less than its book
value. Both historical information and current economic trends are factored into
the assumptions and analyses used when determining the expected undiscounted
cash flow. Included among these assumptions are the following:
o Lease terms
o Remaining life of the asset
o Lease rates supplied by independent appraisers
o Remarketing prospects
o Maintenance costs
An impairment loss is recognized if the asset book value exceeds the
estimated fair value determined under the aforementioned cash flow analysis.
There were no recorded impairment charges related to the commercial aerospace
assets during the quarter ended June 30, 2003, while $1.8 million was recorded
during the March 2003 quarter. Management remains comfortable with valuations of
the commercial aerospace portfolio. Utilization is good, demonstrating the
ability to place aircraft. However, these placements are at compressed rental
rates, which reflect current market conditions. Generally, leases are being
written for terms between three and five years.
Our telecommunications portfolio is included in "Communications" in the
industry composition table included in Note 7 to the Consolidated Financial
Statements. This portfolio totals approximately $647.9 million at June 30, 2003,
or approximately 1.7% of total financing and leasing assets. The portfolio
consists of 53 accounts with an average balance of approximately $12.2 million.
The 10 largest accounts in the portfolio aggregate $262.7 million with the
largest single account totaling $33.4 million. Non-performing accounts totaled
$94.2 million (10 accounts) or 14.5% of this portfolio. The telecommunications
portfolio includes CLECs, wireless and towers, with the largest group being CLEC
accounts, which totaled $224.3 million, or 34.6% of the telecommunications
portfolio, at June 30, 2003. At December 31, 2002, the portfolio totaled $710.1
million (approximately 2.0% of total financing and leasing assets) and consisted
of 52 accounts with an average balance of approximately $13.7 million. The 10
largest accounts in the portfolio aggregated $264.5 million with the largest
single account totaling $32.9 million. Non-performing accounts totaled $120.2
million (10 accounts) or 16.9% of this portfolio. Many of these CLEC accounts
are still in the process
36
of building out their networks and developing their customer bases. Our
telecommunications transactions are collateralized by the assets of the customer
(equipment, receivables, cash, etc.) and typically are also secured by a pledge
of the stock of non-public companies. Weak economic conditions and industry
overcapacity have driven down values in this sector. As discussed in "Provision
and Reserve for Credit Losses," $128.1 million of previously recorded reserves
remain for telecommunication exposures. As management continues to monitor and
work out the individual accounts in this portfolio, charge-offs will likely be
recorded against this reserve in subsequent periods. Weakness in this sector
could result in additional losses or require additional reserves.
The portfolio of direct and private fund venture capital equity
investments totaled $325.4 million at June 30, 2003 and $335.4 million at
December 31, 2002. At June 30, 2003, this portfolio was comprised of direct
investments of approximately $169.1 million in 49 companies and $156.3 million
in 52 private equity funds. Our direct investments totaled $188.8 million (57
companies) and our investment in private equity funds amounted to $146.6 million
(52 funds) as of December 31, 2002. These investments are principally in
emerging growth enterprises in selected industries, including industrial buyout,
information technology, life science and consumer products. In 2001, we ceased
making new venture capital investments beyond existing commitments, which
totaled approximately $144.3 million at June 30, 2003 and $164.9 million at
December 31, 2002. These commitments, which are mainly to private equity funds,
may or may not be drawn. Performance of both our direct investments and our fund
investments will depend upon the performance of the underlying companies, and
public and private market valuations of these companies. During the quarters
ended June 30, 2003 and 2002, we recognized losses of $12.1 million and $1.4
million and for the six months ended June 30, 2003 and 2002, losses totaled
$16.5 million and $6.7 million.
At June 30, 2003, we had approximately $168.1 million of loans and assets
outstanding to customers located or doing business in Argentina. During 2002,
the Argentine government instituted economic reforms, including the conversion
of certain dollar-denominated loans into pesos. Due to these actions and the
weakness of the peso, we established a reserve of $135.0 million during 2002.
The underlying portfolio continues to perform as to collection, but payments are
now in pesos. Collection efforts and discussions with the Argentine government
continue in order to maximize recovery efforts. Management expects to seek
resolution in the coming quarters and charge-offs are expected to be recorded
against the reserve as these activities are concluded.
Management strives to maximize the profitability of the operating lease
equipment portfolio by balancing equipment utilization levels with market rental
rates and lease terms. Substantially all such equipment was subject to lease
agreements throughout the first six months of 2003 and 2002. Total equipment not
subject to lease agreements was $293.9 million and $385.9 million at June 30,
2003 and December 31, 2002, respectively. The current weakness in the commercial
airline industry and the slower economy could further adversely impact both
rental and utilization rates prospectively.
See Note 5 -- Concentrations of Item 1. Consolidated Financial Statements
for further discussion on concentrations.
Other Assets
Other assets totaled $4.9 billion at June 30, 2003 and $4.7 billion at
December 31, 2002, as both the total balance and the underlying components were
essentially unchanged. Other assets primarily consisted of the following at June
30, 2003: securitization assets, including interest-only strips, retained
subordinated securities, cash reserve accounts and servicing assets of $1.4
billion, investments in and receivables from and related to non-consolidated
subsidiaries of $0.9 billion, accrued interest and receivables from derivative
counterparties of $0.8 billion, deposits on commercial aerospace flight
equipment of $0.3 billion, direct and private fund equity investments of $0.3
billion, repossessed assets of $0.1 billion, prepaid expenses of $0.1 billion
and investment in aerospace securities of $0.1 billion. The remaining balance
includes furniture and fixtures, miscellaneous receivables and other assets.
Goodwill and Other Intangible Assets Impairment and Amortization
The Company periodically reviews and evaluates its goodwill and other
intangible assets for potential impairment. Effective October 1, 2001, the
Company adopted SFAS 142, under which goodwill is no longer amortized but
instead is assessed for impairment at least annually. As part of the adoption,
the Company allocated its existing goodwill to each of our reporting units as of
October 1, 2001. Under the transition provisions of SFAS 142, there was no
goodwill impairment as of October 1, 2001.
37
During the quarter ended March 31, 2002, our former parent, Tyco,
experienced disruptions to its business surrounding its announced break-up plan,
downgrades in its credit ratings, and a significant decline in its market
capitalization. As a result of these events at Tyco, CIT also experienced credit
downgrades and a disruption to our funding base and ability to access capital
markets. Further, market-based information used in connection with our
preliminary consideration of an initial public offering for 100% of CIT
indicated that CIT's book value exceeded its estimated fair value as of March
31, 2002. As a result, management performed a Step 1 SFAS 142 impairment
analysis as of March 31, 2002 and concluded that an impairment charge was
warranted at that date.
Management's objective in performing the Step 1 SFAS 142 analysis was to
obtain relevant market-based data to calculate the fair value of each CIT
reporting unit as of March 31, 2002 based on each reporting unit's projected
earnings and market factors that would be used by market participants in
ascribing value to each of these reporting units in the planned separation of
CIT from Tyco. Management obtained relevant market data from our financial
advisors regarding the range of price to earnings multiples and market discounts
applicable to each reporting unit as of March 31, 2002 and applied this market
data to the individual reporting unit's projected annual earnings as of March
31, 2002 to calculate a fair value of each reporting unit. The fair values were
compared to the corresponding carrying value of each reporting unit at March 31,
2002, resulting in a $4.513 billion impairment charge as of March 31, 2002.
SFAS 142 requires a second step analysis whenever the reporting unit book
value exceeds its fair value. This analysis required us to determine the fair
value of each reporting unit's individual assets and liabilities to complete the
analysis of goodwill impairment as of March 31, 2002. During the quarter ended
June 30, 2002, we completed this analysis for each reporting unit and determined
that an additional Step 2 goodwill impairment charge of $132.0 million was
required based on reporting unit level valuation data.
Subsequent to March 31, 2002, CIT experienced further credit downgrades
and the business environment and other factors continued to negatively impact
the expected CIT IPO proceeds. As a result, we performed both a Step 1 and a
Step 2 analysis as of June 30, 2002 in a manner consistent with the March 2002
process described above. This analysis was based upon market data from our
financial advisors regarding the individual reporting units, and other relevant
market data at June 30, 2002 and through the period immediately following the
IPO of the Company, including the total amount of IPO proceeds. This analysis
resulted in Step 1 and Step 2 incremental goodwill impairment charges of $1.719
billion and $148.0 million, respectively, as of June 30, 2002, which were
recorded during the June 30, 2002 quarter.
The changes in the carrying amount of goodwill for the six months ended
June 30, 2003 were as follows ($ in millions):
Specialty Equipment Capital Commercial Structured
Finance Finance Finance Finance Finance Total
--------- --------- ------- ---------- ---------- -----
Balance as of December 31, 2002 ...... $ 14.0 $ -- $ -- $370.4 $ -- $384.4
Goodwill related to rail acquisition.. -- -- 5.4 -- -- 5.4
------ ---- ------ ------ ------ ------
Balance as of June 30, 2003 .......... $ 14.0 $ -- $ 5.4 $370.4 $ -- $389.8
====== ==== ====== ====== ====== ======
The $5.4 million increase to goodwill during the quarter ended June 30,
2003 relates to the acquisition of an approximate 75% interest in Flex Leasing
Corporation by Capital Finance on April 8, 2003. Flex, which is based in San
Francisco, California and was founded in 1996, leases approximately 7,200
general-purpose railcars, representing approximately $410.0 million in assets,
to railroads and shippers in the U.S. and Canada. The Flex results of operations
from the date of acquisition through June 30, 2003 are included in the CIT
consolidated results and are not significant. Minority interest related to the
Flex acquisition was $39.7 million at June 30, 2003 and is included in other
liabilities in the CIT consolidated balance sheet.
Results and Trends in Relation to the Prior Quarter
The following analysis is provided in addition to the year-over-prior year
period analysis in order to discuss trends in our business in the periods
subsequent to our July 2002 IPO.
38
Net income for the quarter ended June 30, 2003 was $136.9 million, or
$0.65 per diluted share, compared to $127.0 million, or $0.60 per diluted share
for the quarter ended March 31, 2003. The table that follows presents results
for the quarters ended June 30, 2003 and March 31, 2003, both in amount and as a
percentage of AEA ($ in millions):
Quarter ended Quarter ended
June 30, 2003 March 31, 2003
----------------------- ------------------
Amount % AEA Amount % AEA
------ ----- ------ -----
Finance income ..................................... $ 943.2 10.57% $ 939.2 10.86%
Interest expense ................................... 331.1 3.71% 346.7 4.01%
--------- ----- --------- -----
Net finance income ................................. 612.1 6.86% 592.5 6.85%
Depreciation on operating lease equipment .......... 272.9 3.06% 278.8 3.22%
--------- ----- --------- -----
Net finance margin ................................. 339.2 3.80% 313.7 3.63%
Provision for credit losses ........................ 100.6 1.13% 103.0 1.19%
--------- ----- --------- -----
Net finance margin after provision for credit losses 238.6 2.67% 210.7 2.44%
Other revenue ...................................... 217.6 2.44% 235.5 2.72%
--------- ----- --------- -----
Operating margin ................................... 456.2 5.11% 446.2 5.16%
Salaries and general operating expenses ............ 227.4 2.55% 233.6 2.70%
--------- ----- --------- -----
Income before provision for income taxes ........... 228.8 2.56% 212.6 2.46%
Provision for income taxes ......................... (89.2) (1.00)% (82.9) (0.96)%
Minority interest in subsidiary trust holding
solely debentures of the Company, after tax ..... (2.7) (0.03)% (2.7) (0.03)%
--------- ----- ---------
Net income ......................................... $ 136.9 1.53% $ 127.0 1.47%
========= ===== =========
Net income per share-- basic and diluted ........... $ 0.65 $ 0.60
========= =========
Average Earning Assets (AEA) ....................... $35,700.0 $34,600.6
========= =========
The increase in net income from the prior quarter reflected higher
interest margin, lower charge-offs and controlled expenses, partially off-set by
lower other revenue.
Net finance margin, at 3.80% of average earning assets for the current
quarter, increased from 3.63% during the prior quarter. The improvement
primarily reflects higher yield-related fees (9 basis points higher than last
quarter), reduced excess liquidity (4 basis points) and a shift in debt mix to
better match assets and liabilities (6 basis points). Although improving, our
funding costs are still higher than historical levels. The positive impact on
risk adjusted margin due to fair value adjustments to mark finance receivables
and debt to market remaining from the Tyco acquisition, before the benefit of
refinancing at better rates, declined to 13 basis points from 19 basis points
last quarter.
Operating lease equipment increased to $7,560.0 million from $6,831.4
million at March 31, 2003 primarily due to large-ticket equipment in the Capital
Finance unit. The aerospace portfolio increased by approximately $400 million
due to new fundings and the conversion of capital leases to operating leases.
The rail portfolio increased by approximately $400 million due to the current
quarter acquisition. The decline in depreciation expense for the quarter
reflects a greater proportion of aircraft and rail assets with an average
depreciable life of 25 and 40 years, compared to smaller ticket asset lives of 3
years. Our depreciable assets range from smaller-ticket, shorter-term leases
(e.g. computers) to larger-ticket, longer-term leases (e.g. commercial aircraft
and rail assets). Operating lease margin (rental income less depreciation
expense) as a percentage of average operating lease equipment was 5.9% during
the quarter ended June 30, 2003 versus 6.1% during the prior quarter, reflecting
continued pressure on aerospace rental rates.
Total net charge-offs during the quarter ended June 30, 2003 were $108.4
million (1.51%), including $11.3 million of telecommunication loan net
charge-offs, compared to $114.3 million (1.61%) during the quarter ended March
31, 2003. The tables that follow detail net charge-offs for the current and
prior quarters by segment, both in amount and as a percentage of average finance
receivables. In addition to total amounts, net charge-offs relating to the
liquidating and telecommunications portfolios are also presented to provide
enhanced analysis ($ in millions):
39
Net Charge-offs: Quarter Ended June 30, 2003
--------------------------------------------------------------
Before Liquidating and Liquidating and
Total Telecommunications Telecommunications
----------------- ---------------------- ------------------
Specialty Finance -- commercial.. $ 23.9 1.33% $23.9 1.33% $ -- --
Equipment Finance ............... 38.6 2.51% 26.1 1.82% 12.5 12.00%
Commercial Finance .............. 21.3 0.96% 18.6 0.84% 2.7 76.80%
Capital Finance ................. -- -- -- -- -- --
Structured Finance .............. 8.6 1.18% -- -- 8.6 5.38%
------ ----- -----
Total Commercial Segments ..... 92.4 1.40% 68.6 1.09% 23.8 8.87%
Specialty Finance -- consumer ... 16.0 2.62% 9.9 2.43% 6.1 3.01%
------ ----- -----
Total ......................... $108.4 1.51% $78.5 1.17% $29.9 6.33%
====== ===== =====
Net Charge-offs: Quarter Ended March 31, 2003
--------------------------------------------------------------
Before Liquidating and Liquidating and
Total Telecommunications Telecommunications
----------------- ---------------------- ------------------
Specialty Finance -- commercial.. $ 31.0 1.73% $30.6 1.76% $ 0.4 8.65%
Equipment Finance ............... 38.1 2.39% 29.7 2.02% 8.4 6.48%
Commercial Finance .............. 16.6 0.80% 16.6 0.80% -- --
Capital Finance ................. 1.8 0.55% 1.8 0.55% -- --
Structured Finance .............. 13.8 1.90% -- -- 13.8 8.23%
------ ----- -----
Total Commercial Segments ..... 101.3 1.55% 78.7 1.27% 22.6 7.48%
Specialty Finance -- consumer ... 13.0 2.36% 6.6 1.92% 6.4 3.09%
------ ----- -----
Total ......................... $114.3 1.61% $85.3 1.30% $29.0 5.70%
====== ===== =====
Total telecommunications and liquidating charge-offs were up $0.9 million
from last quarter. Charge-offs in the liquidating franchise and trucking
portfolios increased while telecommunication related charge-offs declined.
Before liquidating portfolio charge-offs and telecommunication charge-offs
covered by specific 2002 reserving actions, charge-offs were $78.5 million
(1.17% of average finance receivables) for the current quarter, down from $85.3
million (1.30%) last quarter. The improvement from last quarter primarily
reflects declines in both Specialty Finance -- commercial and Equipment Finance,
partially offset by higher Specialty Finance -- consumer charge-offs this
quarter, which included higher losses in home equity loans. The decline in
Specialty Finance -- commercial is due to lower charge-offs in the small
business loan and lease portfolios that were transferred from Equipment Finance
last quarter, while the Equipment Finance trend reflected lower charge-offs in
the construction and industrial equipment businesses.
For the quarter ended June 30, 2003, Other Revenue totaled $217.6 million,
down from $235.5 million for the quarter ended March 31, 2003, reflecting lower
fee income mainly in the Specialty Finance Segment and an increase in venture
capital investment losses due to the continued weak economic environment.
Securitization gains during the current quarter totaled $33.8 million, 14.8% of
pretax income, on volume of $1,653.0 million, compared to $30.7 million, 14.4%
of pretax income, on volume of $1,237.0 million during the prior quarter. The
components of Other Revenue are set forth in the following table ($ in
millions):
Quarter Ended
-------------------------
June 30, March 31,
2003 2003
-------- ---------
Fees and other income........................ $134.6 $144.7
Factoring commissions........................ 44.8 46.9
Gains on securitizations..................... 33.8 30.7
Gains on sales of leasing equipment.......... 16.5 17.6
Loss on venture capital investments.......... (12.1) (4.4)
------ ------
Total...................................... $217.6 $235.5
====== ======
The reduction of fees and other income reflected write-downs of
securitization retained interests. Salaries and general operating expenses were
$227.4 million for the current quarter, compared to $233.6 million reported for
the March 31, 2003 quarter. The decrease from last quarter included lower
repossession and collection expenses and reduced costs associated with
securitization facilities. Salaries and general operating expenses were 1.99% of
average managed assets during the quarter, versus 2.08% for the prior quarter
due to the combination of lower expenses and higher asset levels. The efficiency
ratio for the quarter (salaries and general operating expenses
40
divided by operating margin, excluding provision for credit losses) improved to
40.8% as compared to 42.5% in the prior quarter, reflecting lower operating
expenses and higher revenues. Headcount was unchanged at 5,845 at both June 30,
2003 and March 31, 2003.
Risk Management
We performed additional risk management procedures in 2002 and into 2003
in light of the factors discussed previously in the "Key Business Initiatives
and Trends" section. Our ongoing risk management activities, beyond these
special liquidity and capital measures, are described more fully in the sections
that follow. Our business activities involve various elements of risk. We
consider the principal types of risk to be credit risk (including credit,
collateral and equipment risk) and market risk (including interest rate, foreign
currency and liquidity risk.)
We consider the management of risk essential to conducting our commercial
and consumer businesses and to maintaining profitability. Accordingly, our risk
management systems and procedures are designed to identify and analyze risks, to
set appropriate policies and limits and to continually monitor these risks and
limits by means of reliable administrative and information systems and other
policies and programs.
We review and monitor credit exposures, both owned and managed, on an
ongoing basis to identify, as early as possible, those customers that may be
experiencing declining creditworthiness or financial difficulty, and
periodically evaluate our finance receivables across the entire organization. We
monitor concentrations by borrower, industry, geographic region and equipment
type, and we adjust limits as conditions warrant to minimize the risk of
substantial credit loss. We have maintained a standard practice of reviewing our
aerospace portfolio regularly and, in accordance with SFAS No. 13 and SFAS No.
144, we test for asset impairment based upon projected cash flows and relevant
market data, with any impairment in value charged to operating earnings. Given
the developments in the aerospace sector during 2002 and into 2003, performance,
profitability and residual values relating to aerospace assets were reviewed
more frequently with the Executive Credit Committee.
Our Asset Quality Review Committee is comprised of members of senior
management, including the Chief Risk Officer, the Chief Financial Officer, the
Controller and the Director of Credit Audit. Periodically, the Committee meets
with senior executives of our strategic business units and corporate credit risk
management group to review portfolio performance, including the status of
individual financing and leasing assets, owned and managed, to obligors with
higher risk profiles. In addition, this committee periodically meets with the
Chief Executive Officer of CIT to review overall credit risk, including
geographic, industry and customer concentrations, and the reserve for credit
losses.
Credit Risk Management
We have developed systems specifically designed to manage credit risk in
each of our business segments. We evaluate financing and leasing assets for
credit and collateral risk during the credit granting process and periodically
after the advancement of funds. The Corporate Credit Risk Management group,
which reports to the Chief Risk Officer, oversees and manages credit risk
throughout CIT. This group includes senior credit executives aligned with each
of the business units, as well as a senior executive with corporate-wide asset
recovery and workout responsibilities. In addition, our Executive Credit
Committee, which includes the Chief Executive Officer, the Chief Risk Officer,
members of the Corporate Credit Risk Management group and group Chief Executive
Officers, approves large transactions and transactions which are outside of
established target market definitions and risk acceptance criteria or which
exceed the strategic business units' credit authority. The Corporate Credit Risk
Management group also includes an independent credit audit function.
Each of our strategic business units has developed and implemented a
formal credit management process in accordance with formal uniform guidelines
established by the credit risk management group. These guidelines set forth risk
acceptance criteria for:
o acceptable maximum credit lines;
o selected target markets and products;
o creditworthiness of borrowers, including credit history, financial
condition, adequacy of cash flow, financial performance and quality
of management; and
o the type and value of underlying collateral and guarantees
(including recourse from dealers and manufacturers).
41
Compliance with established corporate policies and procedures and the
credit management processes at each strategic business unit are reviewed by the
credit audit group. The credit audit group examines adherence with established
credit policies and procedures and tests for inappropriate credit practices,
including whether potential problem accounts are being detected and reported on
a timely basis.
Commercial
The commercial credit management process (other than small ticket leasing
transactions) starts with the initial evaluation of credit risk and underlying
collateral at the time of origination and continues over the life of the finance
receivable or operating lease, including collecting past due balances and
liquidating underlying collateral.
Credit personnel review each potential borrower's financial condition,
results of operations, management, industry, customer base, operations,
collateral and other data, such as third party credit reports, to thoroughly
evaluate the customer's borrowing and repayment ability. Borrowers are graded
according to credit quality based upon our uniform credit grading system, which
considers both the borrower's financial condition and the underlying collateral.
Credit facilities are subject to approval within our overall credit approval and
underwriting guidelines and are issued commensurate with the credit evaluation
performed on each borrower.
Consumer and Small Ticket Leasing
For consumer transactions and small-ticket leasing transactions, we employ
proprietary automated credit scoring models by loan type that include both
customer demographics and credit bureau characteristics. The profiles emphasize,
among other things, occupancy status, length of residence, length of employment,
debt to income ratio (ratio of total installment debt and housing expenses to
gross monthly income), bank account references, credit bureau information and
combined loan to value ratio. The models are used to assess a potential
borrower's credit standing and repayment ability considering the value or
adequacy of property offered as collateral. Our credit criteria include reliance
on credit scores, including those based upon both our proprietary internal
credit scoring model and external credit bureau scoring, combined with judgment.
The credit scoring models are regularly reviewed for effectiveness utilizing
statistical tools.
We regularly evaluate the consumer loan portfolio and the small ticket
leasing portfolio using past due, vintage curve and other statistical tools to
analyze trends and credit performance by loan type, including analysis of
specific credit characteristics and other selected subsets of the portfolios.
Adjustments to credit scorecards and lending programs are made when deemed
appropriate. Individual underwriters are assigned credit authority based upon
their experience, performance and understanding of the underwriting policies and
procedures of our consumer and small-ticket leasing operations. A credit
approval hierarchy also exists to ensure that an underwriter with the
appropriate level of authority reviews all applications.
Equipment/Residual Risk Management
We have developed systems, processes and expertise to manage the equipment
and residual risk in our commercial segments. Our process consists of the
following: 1) setting residual value at deal inception; 2) systematic residual
reviews; and 3) monitoring of residual realizations. Reviews for impairment are
performed at least annually. Residual realizations, by business unit and
product, are reviewed as part of our ongoing financial and asset quality review,
both within the business units and by senior management.
Market Risk Management
Market risk is the risk of loss arising from changes in values of
financial instruments, including interest rate risk, foreign exchange risk,
derivative credit risk and liquidity risk. We engage in transactions in the
normal course of business that expose us to market risks. However, we maintain
what we believe are appropriate management practices and policies designed to
effectively mitigate such risks. The objectives of our market risk management
efforts are to preserve company value by hedging changes in future expected net
cash flows and to decrease the cost of capital. Strategies for managing market
risks associated with changes in interest rates and foreign exchange rates are
an integral part of the process, because those strategies affect our future
expected cash flows as well as our cost of capital.
42
Our Capital Committee sets policies, oversees and guides the interest rate
and currency risk management process, including the establishment and monitoring
of risk metrics, and ensures the implementation of those policies. Other risks
monitored by the Capital Committee include derivative credit risk and liquidity
risk. The Capital Committee meets periodically and includes the Chief Executive
Officer, the Chief Financial Officer, the Treasurer, and the Controller, with
business unit executives serving on a rotating basis.
Interest Rate and Foreign Exchange Risk Management
We offer a variety of financing products to our customers, including fixed
and floating-rate loans of various maturities and currency denominations, and a
variety of leases, including operating leases. Changes in market interest rates,
relationships between short-term and long-term market interest rates, or
relationships between different interest rate indices (i.e., basis risk) can
affect the interest rates charged on interest-earning assets differently than
the interest rates paid on interest-bearing liabilities, and can result in an
increase in interest expense relative to finance income. We measure our
asset/liability position in economic terms through duration measures and
sensitivity analysis, and we periodically measure the effect on earnings using
maturity gap analysis.
A matched asset/liability position is generally achieved through a
combination of financial instruments, including commercial paper, medium-term
notes, long-term debt, interest rate and currency swaps, foreign exchange
contracts, and through asset syndication and securitization. We do not speculate
on interest rates or foreign exchange rates, but rather seek to mitigate the
possible impact of such rate fluctuations encountered in the normal course of
business. This process is ongoing due to prepayments, refinancings and actual
payments varying from contractual terms, as well as other portfolio dynamics.
We periodically enter into structured financings (involving both the
issuance of debt and an interest rate swap with corresponding notional principal
amount and maturity) to manage liquidity and reduce interest rate risk at a
lower overall funding cost than could be achieved by solely issuing debt.
CIT uses derivatives for hedging purposes only, and does not enter into
derivative financial instruments for trading or speculative purposes. As part of
managing the exposure to changes in market interest rates, CIT, as an end-user,
enters into various interest rate swap transactions in the over-the-counter
markets, with other financial institutions acting as principal counterparties.
To ensure both appropriate use as a hedge and hedge accounting treatment, all
derivatives entered into are designated according to a hedge objective against a
specified liability, including long-term debt, bank credit facilities, and
commercial paper. CIT's primary hedge objectives include the conversion of
variable-rate liabilities to fixed rates, and the conversion of fixed-rate
liabilities to variable rates. The notional amounts, rates, indices and
maturities of CIT's derivatives are required to closely match the related terms
of CIT's hedged liabilities.
We target to match the basis of assets with that of our liabilities (i.e.
fixed rate assets funded with fixed rate liabilities and floating rate assets
funded with floating rate liabilities), while also targeting to preserve the
economic returns of our assets through duration matching. Interest rate swaps
are an effective means of achieving our target matched funding objectives by
converting debt to the desired basis and duration.
Interest rate swaps with notional principal amounts of $9.2 billion at
June 30, 2003 and $9.0 billion at March 31, 2003 were designated as hedges
against outstanding debt. The net increase in notional principal amounts of
interest rate swaps as of June 30, 2003 consisted of a $1,188.5 million increase
in fixed to floating-rate swaps (fair value hedges) and a $1,031.5 million
decrease in floating to fixed-rate swaps (cash flow hedges). The increase in
fair value hedges was due to the $500 million fixed rate note issued during the
quarter which was swapped to float, with the remaining increase due to retail
fixed issuances being swapped to float. The decline in the cash flow hedges is
the result of maturities during the quarter. In addition, CIT enters into hedge
transactions in conjunction with its securitization programs. See Note 3 to the
Consolidated Financial Statements for further details.
The following table summarizes the composition of our assets and
liabilities before and after swaps at June 30 and March 31, 2003:
Before Swaps After Swaps
-------------------------- -------------------------
Fixed Rate Floating Rate Fixed Rate Floating Rate
---------- ------------- ---------- -------------
June 30, 2003
Assets......................................... 52% 48% 52% 48%
Liabilities.................................... 65% 35% 53% 47%
March 31, 2003
Assets......................................... 51% 49% 51% 49%
Liabilities.................................... 62% 38% 55% 45%
43
A comparative analysis of the weighted average principal outstanding and
interest rates on our debt before and after the effect of interest rate swaps is
shown in the following table ($ in millions):
Quarter Ended June 30, 2003
-------------------------------------------------
Before Swaps After Swaps
---------------------- ---------------------
Commercial paper and variable rate senior notes and bank
credit facilities.................................. $12,030.2 1.90% $15,646.8 2.72%
Fixed rate senior and subordinated notes............. 20,284.9 6.13% 16,668.3 5.93%
--------- ---------
Composite............................................ $32,315.1 4.56% $32,315.1 4.37%
========= =========
Quarter Ended March 31, 2003
-------------------------------------------------
Before Swaps After Swaps
---------------------- ---------------------
Commercial paper and variable rate senior notes and bank
credit facilities.................................. $12,704.5 1.94% $14,751.9 2.80%
Fixed rate senior and subordinated notes............. 19,695.7 6.32% 17,648.3 6.10%
--------- ---------
Composite............................................ $32,400.2 4.61% $32,400.2 4.60%
========= =========
Quarter Ended June 30, 2002
-------------------------------------------------
Before Swaps After Swaps
---------------------- ---------------------
Commercial paper and variable rate senior notes and bank
credit facilities.................................. $16,056.8 2.25% $13,942.2 2.46%
Fixed rate senior and subordinated notes............. 17,822.6 6.08% 19,937.2 5.98%
--------- ---------
Composite............................................ $33,879.4 4.27% $33,879.4 4.53%
========= =========
Six Months Ended June 30, 2003
-------------------------------------------------
Before Swaps After Swaps
---------------------- ---------------------
Commercial paper and variable rate senior notes and bank
credit facilities.................................. $12,367.3 1.92% $15,159.1 2.75%
Fixed rate senior and subordinated notes............. 19,990.3 6.23% 17,198.5 6.02%
--------- ---------
Composite............................................ $32,357.6 4.58% $32,357.6 4.49%
========= =========
Six Months Ended June 30, 2002
-------------------------------------------------
Before Swaps After Swaps
---------------------- ---------------------
Commercial paper and variable rate senior notes and bank
credit facilities.................................. $17,678.4 2.19% $14,933.1 2.34%
Fixed rate senior and subordinated notes............. 16,827.5 5.85% 19,572.8 5.83%
--------- ---------
Composite............................................ $34,505.9 3.97% $34,505.9 4.32%
========= =========
The weighted average interest rates before swaps do not necessarily
reflect the interest expense that would have been incurred over the life of the
borrowings had we chosen to manage interest rate risk without the use of such
swaps. Derivatives are discussed further in Note 3 -- Derivative Financial
Instruments to the Consolidated Financial Statements.
We regularly monitor and simulate through computer modeling our degree of
interest rate sensitivity by measuring the re-pricing characteristics of
interest-sensitive assets, liabilities, and derivatives. The Capital Committee
reviews the results of this modeling periodically. The interest rate sensitivity
modeling techniques employed by us include the creation of prospective twelve
month "baseline" and "rate shocked" net interest income simulations.
At the date that interest rate sensitivity is modeled, "baseline" net
interest income is derived considering the current level of interest-sensitive
assets and related run-off (including both contractual repayment and historical
prepayment experience), the current level of interest-sensitive liabilities and
related maturities and the current level of derivatives. The "baseline"
simulation assumes that, over the next successive twelve months, market interest
rates (as of the date of simulation) are held constant and that no new loans or
leases are extended. Once the "baseline" net interest income is calculated,
market interest rates, which were previously held constant, are raised 100 basis
points instantaneously and parallel across the entire yield curve, and a "rate
shocked" simulation is run. Interest rate sensitivity is then measured as the
difference between calculated "baseline" and "rate shocked" net interest income.
44
An immediate hypothetical 100 basis point increase in the yield curve on
July 1, 2003 would have reduced net income by an estimated $15 million after tax
over the next twelve months, while a decrease in the yield curve would have
increased net income by a like amount. Although management believes that this
measure provides a meaningful estimate of our interest rate sensitivity, it does
not account for potential changes in the credit quality, size, composition and
prepayment characteristics of the balance sheet and other business developments
that could affect net income. Accordingly, no assurance can be given that actual
results would not differ materially from the potential outcome simulated by our
computer modeling. Further, it does not necessarily represent management's
current view of future market interest rate movements.
We also utilize foreign currency exchange forward contracts to hedge
currency risk underlying our net investments in foreign operations and cross
currency interest rate swaps to hedge both foreign currency and interest rate
risk underlying foreign debt. At June 30, 2003, CIT was party to foreign
currency exchange forward contracts with notional amounts totaling $2.4 billion
and maturities ranging from 2003 to 2006. CIT was also party to cross currency
interest rate swaps with notional amounts totaling $1.4 billion and maturities
ranging from 2003 to 2027. At March 31, 2003, CIT was party to foreign currency
exchange forward contracts with notional amounts totaling $2.7 billion. CIT was
also party to cross currency interest rate swaps with notional amounts totaling
$1.4 billion. At June 30, 2002, CIT was party to $3.4 billion in notional
principal amount of foreign currency exchange forward contracts and $2.0 billion
in notional principal amount of cross currency swaps that were designated as
currency-related debt hedges. Translation gains and losses of the underlying
foreign net investment, as well as offsetting derivative gains and losses on
designated hedges, are reflected in other comprehensive income in the
Consolidated Balance Sheet.
Derivative Risk Management
We enter into interest rate and currency swaps and foreign exchange
forward contracts as part of our overall market risk management practices. We
assess and manage the external and internal risks associated with these
derivative instruments in accordance with the overall operating goals
established by our Capital Committee. External risk is defined as those risks
outside of our direct control, including counterparty credit risk, liquidity
risk, systemic risk, legal risk and market risk. Internal risk relates to those
operational risks within the management oversight structure and includes actions
taken in contravention of CIT policy.
The primary external risk of derivative instruments is counterparty credit
exposure, which is defined as the ability of a counterparty to perform its
financial obligations under a derivative contract. We control the credit risk of
our derivative agreements through counterparty credit approvals, pre-established
exposure limits and monitoring procedures.
The Capital Committee approves each counterparty and establishes exposure
limits based on credit analysis and market value. All derivative agreements are
entered into with major money center financial institutions rated investment
grade by nationally recognized rating agencies, with the majority of our
counterparties rated "AA" or better. Credit exposures are measured based on the
market value of outstanding derivative instruments. Exposures are calculated for
each derivative contract to monitor counterparty credit exposure.
Liquidity Risk Management
Liquidity risk refers to the risk of CIT being unable to meet potential
cash outflows promptly and cost effectively. Factors that could cause such a
risk to arise might be a disruption of a securities market or other source of
funds. We actively manage and mitigate liquidity risk by maintaining diversified
sources of funding and committed alternate sources of funding. The primary
funding sources are commercial paper (U.S.), long-term debt (U.S. and
International) and asset-backed securities (U.S. and Canada). Included as part
of our securitization programs are committed asset-backed commercial paper
programs in the U.S. and Canada. We also maintain committed bank lines of credit
to provide backstop support of commercial paper borrowings and local bank lines
to support our international operations. Additional sources of liquidity are
loan and lease payments from customers, whole-loan asset sales and loan
syndications.
We also target and monitor certain liquidity metrics to ensure both a
balanced liability profile and adequate alternate liquidity availability. Among
the target ratios are maximum percentage of outstanding commercial paper to
total debt, minimum percentage of committed bank line coverage to outstanding
commercial paper and minimum percentage of alternate liquidity sources to
current cash obligations.
Liquidity
The commercial paper program closed the quarter at $4.6 billion, up
slightly from $4.5 billion at March 31, 2003. The drop in outstanding balance
from December corresponded with the emphasis on term funding during the quarter.
Our targeted program size remains at $5.0 billion and our goal is to maintain at
least 100% back-up liquidity.
45
During the quarter, previously drawn bank facilities were completely paid
down from $1.3 billion at March 31, 2003. At June 30, 2003, we had undrawn total
bank credit facilities of $6,270.0 million. Accordingly, backstop liquidity
coverage of outstanding commercial paper was in excess of 100% at June 30, 2003.
In April 2003, a $765.0 million undrawn facility expired and was not renewed.
Our remaining facilities include a $3,720.0 million facility, undrawn and
available, which expires March 2005, and two other facilities expiring during
October 2003.
In addition to the commercial paper markets, CIT accesses the unsecured
term debt markets. CIT maintains registration statements with the Securities and
Exchange Commission covering debt securities that it may sell in the future. At
June 30, 2003, we had $17.0 billion of registered, but unissued, debt securities
available under a shelf registration statement. Term-debt issued during the
quarter ended June 30, 2003 consisted of a $0.5 billion five-year, fixed-rate
global issue and $1.0 billion in variable-rate medium-term notes. In November
2002, we introduced a retail note program, in which we offer senior, unsecured
notes utilizing numerous broker-dealers for placement to retail accounts. During
the quarter, we issued $340.0 million under this program. As of June 30, 2003,
we had issued $1.8 billion of notes under this program having maturities of
between 2 and 10 years.
To further strengthen our funding capabilities, we maintain committed
asset backed facilities, which cover a range of assets from equipment to
consumer home equity receivables, and trade accounts receivable. While these
facilities are predominately in the U.S., we also maintain facilities for
Canadian domiciled assets. As of June 30, 2003, we had approximately $2.8
billion of availability in our committed asset-backed facilities and $2.6
billion of registered, but unissued, securities available under public shelf
registration statements relating to our asset-backed securitization program.
Securitization volume was $1.7 billion, compared to $1.2 billion last quarter.
Our credit ratings are shown for June 30, 2003, December 31, 2002 and June
30, 2002 in the following table:
At June 30, 2003 At December 31, 2002 At June 30, 2002
----------------------- ------------------------ -----------------------
Short Term Long Term Short Term Long Term Short Term Long Term
---------- --------- ---------- --------- ---------- ---------
Moody's........................ P-1 A2 P-1 A2 P-1 A2
Standard & Poor's.............. A-1 A A-1 A A-2 BBB+
Fitch.......................... F1 A F1 A F2 BBB
- --------------------------------------------------------------------------------
The credit ratings stated above are not a recommendation to buy, sell or hold
securities and may be subject to revision or withdrawal by the assigning rating
organization. Each rating should be evaluated independently of any other rating.
We have some material covenants within our legal documents that govern our
funding sources. The most significant covenant in CIT's indentures and credit
agreements is a negative pledge provision, which limits granting or permitting
liens on our assets, but provides for exceptions for certain ordinary course
liens needed to operate our business. Various credit agreements also contain a
minimum net worth test of $3.75 billion.
The following tables summarize various contractual obligations, selected
contractual cash receipts and contractual commitments as of June 30, 2003.
Projected proceeds from the sale of operating lease equipment, interest revenue
from finance receivables, debt interest expense and other items are excluded ($
in millions):
Payments and Collections by Period
-------------------------------------------------------------------------
Remaining After
Contractual Obligations Total 2003 2004 2005 2006 2006
- ----------------------- --------- --------- --------- --------- --------- ---------
Commercial Paper .................... $ 4,576.7 $ 4,576.7 $ -- $ -- $ -- $ --
Variable-rate term debt ............. 6,637.3 1,980.2 3,531.4 833.3 35.3 257.1
Fixed-rate term debt ................ 21,216.8 2,785.6 3,324.8 4,201.1 2,299.9 8,605.4
Lease rental expense ................ 188.2 32.1 46.6 37.9 27.0 44.6
--------- --------- --------- --------- --------- ---------
Total contractual obligations .... 32,619.0 9,374.6 6,902.8 5,072.3 2,362.2 8,907.1
--------- --------- --------- --------- --------- ---------
Finance receivables (1) ............. 28,413.6 7,955.1 4,554.8 4,141.2 2,542.8 9,219.7
Operating lease rental income ....... 3,171.7 642.9 860.4 550.5 339.4 778.5
Finance receivables held for sale (2) 1,210.0 1,210.0 -- -- -- --
Cash -- current balance ............. 1,423.3 1,423.3 -- -- -- --
--------- --------- --------- --------- --------- ---------
Total projected cash availability 34,218.6 11,231.3 5,415.2 4,691.7 2,882.2 9,998.2
--------- --------- --------- --------- --------- ---------
Net projected cash inflow (outflow) . $ 1,599.6 $ 1,856.7 $(1,487.6) $ (380.6) $ 520.0 $ 1,091.1
========= ========= ========= ========= ========= =========
- --------------------------------------------------------------------------------
(1) Based upon contractual cash flows; amount could differ due to prepayments,
charge-offs and other factors.
(2) Based upon management's intent to sell rather than contractual maturities
of underlying assets.
46
Commitment Expiration by Period
---------------------------------------------------------------
Remaining After
Contractual Commitments Total 2003 2004 2005 2006 2006
- ----------------------- --------- --------- -------- -------- -------- --------
Aircraft purchases......................... $3,286.0 $ 318.0 $ 788.0 $1,248.0 $ 840.0 $ 92.0
Credit extensions.......................... 4,032.0 1,212.1 859.5 713.5 555.4 691.5
Letters of credit.......................... 1,152.3 1,136.0 15.1 0.4 0.3 0.5
Sale-leaseback payments.................... 494.7 8.3 28.5 28.5 28.5 400.9
Manufacturer purchase commitments.......... 253.5 253.5 -- -- -- --
Venture capital fund and
equity commitments....................... 149.2 0.2 2.5 0.4 3.7 142.4
Guarantees................................. 69.0 69.0 -- -- -- --
Acceptances................................ 12.1 12.1 -- -- -- --
------- ------- -------- ------- -------- --------
Total Commitments.......................... $9,448.8 $3,009.2 $1,693.6 $1,990.8 $1,427.9 $1,327.3
======== ======== ======== ======== ======== ========
See the "-- Overview" and "-- Net Finance Margin" sections for information
regarding the impact of our liquidity and capitalization plan on results of
operations.
Capitalization
The following table presents information regarding our capital structure
($ in millions):
June 30, December 31,
2003 2002
--------- ---------
Commercial paper ................................. $ 4,576.7 $ 4,974.6
Bank credit facilities ........................... -- 2,118.0
Term debt ........................................ 27,854.1 24,588.7
Company-obligated mandatorily redeemable
preferred securities of subsidiary
trust holding solely debentures of the
Company ("Preferred Capital Securities") ....... 256.4 257.2
Stockholders' equity(1) .......................... 5,171.8 4,968.5
--------- ---------
Total capitalization ............................. 37,859.0 36,907.0
Goodwill ......................................... (389.8) (384.4)
--------- ---------
Total tangible capitalization .................... $37,469.2 $36,522.6
========= =========
Total tangible stockholders' equity .............. $ 4,782.0 $ 4,584.1
========= =========
Tangible stockholders' equity(1) and
Preferred Capital Securities to
managed assets ................................. 10.53% 10.44%
Total debt (excluding overnight deposits)
to tangible stockholders' equity(1)
and Preferred Capital Securities ............... 6.28x 6.22x
- --------------------------------------------------------------------------------
(1) Stockholders' equity for these calculations excludes accumulated other
comprehensive loss relating to derivative financial instruments and
unrealized gains on equity and securitization investments of $114.2
million and $97.8 million at June 30, 2003 and December 31, 2002,
respectively, as these losses and gains are not necessarily indicative of
amounts which will be realized.
The Company-obligated mandatorily redeemable preferred securities are
7.70% Preferred Capital Securities issued in 1997 by CIT Capital Trust I, a
wholly-owned subsidiary. CIT Capital Trust I invested the proceeds of that issue
in Junior Subordinated Debentures of CIT having identical rates and payment
dates.
See "Liquidity Risk Management" for discussion of risks impacting our
liquidity and capitalization.
Securitization and Joint Venture Activities
We utilize special purpose entities ("SPE's") and joint ventures in the
normal course of business to execute securitization transactions and conduct
business in key vendor relationships.
Securitization Transactions -- SPE's are used to achieve "true sale"
requirements for these transactions in accordance with SFAS No. 140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities." Pools of assets are originated or acquired and sold to SPE's,
which in turn issue debt securities to investors solely backed by asset pools.
Accordingly, CIT has no legal obligations to repay the securities in the event
of a default by the SPE. CIT retains the servicing rights and participates in
certain cash flows of the pools. The
47
present value of expected net cash flows that exceeds the estimated cost of
servicing is recorded in other assets as a "retained interest." Assets
securitized are shown in our managed assets and our capitalization ratios on
managed assets. Under the recently issued rules relating to consolidation and
SPE's, non-qualifying securitization entities will have to be consolidated.
Based on our preliminary analysis, we believe that all of our existing
asset-backed SPE structures meet the definition of a qualifying special purpose
entity ("QSPE") as defined by SFAS 140 and will therefore continue to qualify as
off-balance sheet transactions. As part of these related activities, the Company
enters into hedge transactions with the trusts (SPE) in order to protect the
trust against interest rate risk. CIT insulates its associated risk by entering
into offsetting swap transactions with third parties. The net effect is to
protect the trust and CIT from interest rate risk. The notional amount of these
swaps was $3.5 billion at June 30, 2003. During 2003, we successfully completed
a consent solicitation to amend the negative pledge provision in our 1994 debt
indenture. This action conforms the 1994 debt indenture to our other agreements
and provides flexibility in structuring our securitizations as accounting sales
or secured financings.
Joint Ventures -- We utilize joint ventures to conduct financing
activities with certain strategic vendor partners. Receivables are originated by
the joint venture and purchased by CIT. The vendor partner and CIT jointly own
these distinct legal entities, and there is no third-party debt involved. These
arrangements are accounted for using the equity method, with profits and losses
distributed according to the joint venture agreement. See related FIN 46,
"Consolidation of Variable Interest Entities" discussion in "Accounting and
Technical Pronouncements" and disclosure in Note 7 -- Related Party
Transactions.
Critical Accounting Policies
The preparation of financial statements in conformity with GAAP requires
management to use judgment in making estimates and assumptions that affect
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of income and expenses during the reporting period. The following accounting
policies include inherent risks and uncertainties related to judgments and
assumptions made by management. Management's estimates are based on the relevant
information available at the end of each period.
Investments -- Investments, for which the Company does not have the
ability to exercise significant influence and for which there is not a readily
determinable market value, the majority of which are venture capital equity
investments, are accounted for under the cost method. Management uses judgment
in determining when an unrealized loss is deemed to be other than temporary, in
which case such loss is charged to earnings. As of June 30, 2003, the balance of
venture capital equity investments was $325.4 million. A 10% fluctuation in
value of venture capital investments equates to $0.09 in earnings per share.
Charge-off of Finance Receivables -- Finance receivables are reviewed
periodically to determine the probability of loss. Charge-offs are taken after
substantial collection efforts are conducted, considering such factors as the
borrower's financial condition and the value of underlying collateral and
guarantees (including recourse to dealers and manufacturers).
Impaired Loans -- Loan impairment is defined as any shortfall between the
estimated value and the recorded investment in the loan, with the estimated
value determined using the fair value of the collateral and other cash flows, if
the loan is collateral dependent, or the present value of expected future cash
flows discounted at the loan's effective interest rate. The determination of
impairment involves management's judgement and the use of market and third party
estimates regarding collateral values. Valuations in the level of impaired loans
and corresponding impairment as defined under SFAS 114 affect the level of the
reserve for credit losses.
Reserve for Credit Losses -- Our consolidated reserve for credit losses is
periodically reviewed for adequacy based on portfolio collateral values and
credit quality indicators, including charge-off experience, levels of past due
loans and non-performing assets, evaluation of portfolio
diversification/concentration and economic conditions. We review finance
receivables periodically to determine the probability of loss, and record
charge-offs after considering such factors as delinquencies, the financial
condition of obligors, the value of underlying collateral, as well as third
party credit enhancements such as guarantees and recourse from manufacturers.
This information is reviewed formally on a quarterly basis with senior
management, including the CEO, CFO, Chief Risk Officer and Controller among
others, in conjunction with setting the reserve for credit losses.
The reserve for credit losses is set and recorded based on the development
of three key components (1) specific reserves for collateral dependent loans
which are impaired under SFAS 114, (2) reserves for estimated losses inherent in
the portfolio based upon historical and projected credit trends and, (3) general
reserves for
48
estimation risk. The process involves the use of estimates and a high degree of
management judgement. As of June 30, 2003, the reserve for credit losses was
$754.9 million or 2.66% of finance receivables and 81.5% of past due
receivables. A $10.0 million change in the reserve for credit losses equates to
the following variances: 4 basis points (0.04%) in the percentage of reserves to
finance receivables; 108 basis points (1.08%) in the percentage of reserves to
past due receivables and $0.03 in earnings per share.
Retained Interests in Securitizations -- Significant financial
assumptions, including loan pool credit losses, prepayment speeds and discount
rates, are utilized to determine the fair values of retained interests, both at
the date of the securitization and in the subsequent quarterly valuations of
retained interests. Any resulting losses, representing the excess of carrying
value over estimated fair value, are recorded against current earnings. However,
unrealized gains are reflected in stockholders' equity as part of other
comprehensive income.
Lease Residual Values -- Operating lease equipment is carried at cost less
accumulated depreciation and is depreciated to estimated residual value using
the straight-line method over the lease term or projected economic life of the
asset. Direct financing leases are recorded at the aggregated future minimum
lease payments plus estimated residual values less unearned finance income. We
generally bear greater risk in operating lease transactions (versus finance
lease transactions) as the duration of an operating lease is shorter relative to
the equipment useful life. Management performs periodic reviews of the estimated
residual values, with non-temporary impairment recognized in the current period.
As of June 30, 2003, our direct financing lease residual balance was $2,448.0
million and our operating lease equipment balance was $7,560.0 million. A 10
basis points (0.1%) fluctuation in the total of these amounts equates to $0.03
in earnings per share.
Goodwill -- CIT adopted SFAS No. 142, "Goodwill and Other Intangible
Assets," effective October 1, 2001, the beginning of CIT's fiscal 2002. The
Company determined at October 1, 2001 that there was no impact of adopting this
new standard under the transition provisions of SFAS No. 142. Since adoption,
goodwill is no longer amortized, but instead will be assessed for impairment at
least annually. During this assessment, management relies on a number of factors
including operating results, business plans, economic projections, anticipated
future cash flows, and market place data. See "-- Goodwill and Other Intangible
Assets Amortization" for a discussion of our impairment analysis. Goodwill was
$389.8 million at June 30, 2003. A 10% fluctuation in the value of goodwill
equates to $0.18 in earnings per share.
Accounting and Technical Pronouncements
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure." This pronouncement
amends SFAS No. 123 to provide alternative methods of transition for an entity
that voluntarily changes to the fair value-based method of accounting for
stock-based compensation. SFAS No. 148 also expands the disclosure requirements
with respect to stock-based compensation. CIT does not intend to change to the
fair value method of accounting. The required expanded disclosure is included in
the June 30, 2003 financial statements and notes thereto.
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN 45 requires a guarantor to recognize, at the
inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing certain guarantees. The expanded disclosure requirements
are required for financial statements ending after December 15, 2002, while the
liability recognition provisions are applicable to all guarantee obligations
modified or issued after December 31, 2002. The liability recognition provision
and expanded disclosure are included in our June 30, 2003 financial statements
and notes thereto.
In January 2003, the FASB issued FIN 46, which requires the consolidation
of VIEs by their primary beneficiaries if they do not effectively disperse the
risks among the parties involved. VIEs are certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. The
primary beneficiary is the entity that has the majority of the economic risks
and rewards of ownership of the VIE. See Note 1 -- Summary of Significant
Accounting Policies for additional information regarding the implementation of
FIN 46.
The FIN 46 potential impact to CIT is primarily related to three types of
transactions: 1) strategic vendor partner joint ventures, 2) securitizations,
and 3) selected financing and private equity transactions. Based on
interpretations of FIN 46 currently available, we believe the implementation of
this standard will not change the current equity method of accounting for our
strategic vendor partner joint ventures (see Note 7 - Related Party
49
Transactions). Our securitization transactions outstanding at June 30, 2003 will
continue to qualify as off-balance sheet transactions. The Company may structure
certain future securitization transactions, including factoring trade account
receivables transactions, as on-balance sheet financings. Certain VIEs acquired
primarily in conjunction with selected financing and/or private equity
transactions will be consolidated under FIN 46. However, we anticipate that the
consolidation of these entities will not have a significant impact on our
financial position or results of operations. Due to the complexity of the new
guidance and evolving interpretations among accounting professionals, the
Company will consider such further guidance, if any, and assess the accounting
and disclosure impact of FIN 46 on its VIEs.
In April 2003, the FASB issued SFAS No. 149 "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." This pronouncement amends and
clarifies financial accounting and reporting for certain derivative instruments,
including certain derivative instruments embedded in other contracts. This
pronouncement is effective for all contracts entered into or modified after June
30, 2003. The implementation of SFAS No. 149 is not expected to have a
significant impact on our financial position or results of operations.
In May 2003, the FASB issued SFAS No. 150 "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." This
pronouncement establishes standards for classifying and measuring certain
financial instruments as a liability (or an asset in some circumstances). This
pronouncement will require CIT to display the "Company obligated mandatorily
redeemable preferred securities of subsidiary trust holding solely debentures of
the Company" within the liability section on the face of the consolidated
balance sheet and show the related expense, with interest expense on a pre-tax
basis. There will be no impact to net income upon adoption. This pronouncement
is effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. Prior period restatement is not permitted.
Statistical Data
The following table presents components of net income as a percent of AEA,
along with other selected financial data ($ in millions):
Six Months Ended
June 30,
------------------------
2003 2002
---------- ----------
Finance income..................................... 10.70% 12.14%
Interest expense................................... 3.85% 4.10%
--------- ---------
Net finance income............................... 6.85% 8.04%
Depreciation on operating lease equipment.......... 3.14% 3.46%
--------- ---------
Net finance margin............................... 3.71% 4.58%
Provision for credit losses........................ 1.16% 3.15%
--------- ---------
Net finance margin, after provision
for credit losses................................ 2.55% 1.43%
Other revenue...................................... 2.58% 2.73%
--------- ---------
Operating margin................................... 5.13% 4.16%
--------- ---------
Salaries and general operating expenses............ 2.62% 2.69%
Goodwill impairment................................ -- 37.14%
Interest expense-- TCH............................. -- 3.34%
--------- ---------
Operating expenses................................. 2.62% 43.17%
--------- ---------
Income (loss) before income taxes.................. 2.51% (39.01)%
Provision for income taxes......................... (0.98)% (0.98)%
Minority interest in subsidiary trust
holding solely debentures of the Company......... (0.03)% (0.03)%
--------- ---------
Net income (loss)................................ 1.50% (40.02)%
========= =========
Average earning assets............................. $35,194.8 $35,069.7
========= =========
Forward-Looking Statements
Certain statements contained in this document are "forward-looking
statements" within the meaning of the U.S. Private Securities Litigation Reform
Act of 1995. All statements contained herein that are not clearly historical in
nature are forward-looking and the words "anticipate," "believe," "expect,"
"estimate" and similar expressions are generally intended to identify
forward-looking statements. Any forward-looking statements
50
contained herein, in press releases, written statements or other documents filed
with the Securities and Exchange Commission or in communications and discussions
with investors and analysts in the normal course of business through meetings,
webcasts, phone calls and conference calls, concerning our operations, economic
performance and financial condition are subject to known and unknown risks,
uncertainties and contingencies. Forward-looking statements are included, for
example, in the discussions about:
o our liquidity risk management,
o our credit risk management,
o our asset/liability risk management,
o our capital, leverage and credit ratings,
o our operational and legal risks,
o our commitments to extend credit or purchase equipment, and
o how we may be affected by legal proceedings.
All forward-looking statements involve risks and uncertainties, many of
which are beyond our control, which may cause actual results, performance or
achievements to differ materially from anticipated results, performance or
achievements. Also, forward-looking statements are based upon management's
estimates of fair values and of future costs, using currently available
information. Therefore, actual results may differ materially from those
expressed or implied in those statements. Factors that could cause such
differences include, but are not limited to:
o risks of economic slowdown, downturn or recession,
o industry cycles and trends,
o risks inherent in changes in market interest rates and quality
spreads,
o funding opportunities and borrowing costs,
o changes in funding markets, including commercial paper, term debt
and the asset-backed securitization markets,
o uncertainties associated with risk management, including credit,
prepayment, asset/liability, interest rate and currency risks,
o adequacy of reserves for credit losses,
o risks associated with the value and recoverability of leased
equipment and lease residual values,
o changes in laws or regulations governing our business and
operations,
o changes in competitive factors, and
o future acquisitions and dispositions of businesses or asset
portfolios.
Item 4. Controls and Procedures
Within 90 days before filing this report, the Company evaluated the
effectiveness of the design and operation of its disclosure controls and
procedures. The Company's disclosure controls and procedures are designed to
ensure that the information that the Company must disclose in its reports filed
under the Securities Exchange Act of 1934 is communicated and processed in a
timely manner. Albert R. Gamper, Jr., Chairman, President and Chief Executive
Officer, and Joseph M. Leone, Executive Vice President and Chief Financial
Officer, participated in this evaluation.
Based on this evaluation, Messrs. Gamper and Leone concluded that, as of
the date of their evaluation, the Company's disclosure controls and procedures
were effective, except as noted in the next paragraph. Since the date of the
evaluation described above, there have not been any significant changes in the
Company's internal controls or in other factors that could significantly affect
those controls.
During our fiscal 2002 financial reporting process, management, with the
Company's independent accountants, identified a deficiency in our tax financial
reporting process relating to the calculation of deferred tax assets and
liabilities which constitutes a "Reportable Condition" under standards
established by the American Institute of Certified Public Accountants.
Management believes that this matter has not had any material impact on our
financial statements. Management has established a project plan and has
completed the design of processes and controls to address this deficiency. The
development phase is ongoing and includes process and control refinements. The
project initiatives have recently been expanded to include historic tax basis
data gathering and quality control review. The significant aspects of this
project will be completed in 2003.
51
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On April 10, 2003, a putative class action lawsuit, asserting claims under
the Securities Act of 1933, was filed in the United States District Court for
the Southern District of New York against CIT, its Chief Executive Officer and
its Chief Financial Officer. The lawsuit contains allegations that the
registration statement and prospectus prepared and filed in connection with the
IPO were materially false and misleading, principally with respect to the
adequacy of CIT's telecommunications-related loan loss reserves at the time. The
lawsuit purports to have been brought on behalf of all those who purchased CIT
common stock in or traceable to the IPO, and seeks, among other relief,
unspecified damages or rescission for those alleged class members who still hold
CIT stock and unspecified damages for other alleged class members. On June 25,
2003, by order of the United States District Court, the lawsuit was consolidated
with five other substantially similar suits, all of which had been filed after
April 10, 2003, and Glickenhaus & Co., a privately held investment firm, was
named lead plaintiff. One such suit named as defendants some of the underwriters
and former directors of CIT . In addition to the foregoing, two derivative suits
arising out of the same facts and circumstances have been brought against CIT
and some of its present and former directors.
CIT believes that the allegations in each of these actions are without
merit and that its disclosures were proper, complete and accurate. CIT intends
to vigorously defend itself against these actions.
In addition, in the ordinary course of business, there are various legal
proceedings pending against CIT. Management believes that the aggregate
liabilities, if any, arising from such actions, including the class action suit
above, will not have a material adverse effect on the consolidated financial
position, results of operations or liquidity of CIT.
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of stockholders was held on May 28, 2003. The following
table includes individuals, comprising all of the directors of CIT, who were
elected to the Board of Directors, each with the number of votes shown, to serve
until the next annual meeting of stockholders, or until succeeded by another
qualified director who has been elected, along with all other proposals and vote
tallies:
Proposal Votes
No. Description Votes For Withheld/Against Abstain
-------- ----------- --------- ---------------- -------
1. Election of Directors:
Albert R. Gamper, Jr. 196,782,961 1,198,123
John S. Chen 190,869,332 7,111,762
William A. Farlinger 197,120,871 860,213
Hon. Thomas H. Kean 190,863,183 7,117,901
Edward J. Kelly, III 197,128,024 853,060
Marianne Miller Parrs 197,127,577 853,507
Peter J. Tobin 197,123,820 857,264
Lois M. Van Deusen 190,858,972 7,122,112
2. Ratification of Independent Accountants 196,216,650 2,794,485 26,904
3. Approval of Long-Term Equity Compensation
Plan, as amended 151,489,348 24,589,543 1,159,828
4. Approval of Annual Bonus Plan 180,013,473 17,880,963 1,143,603
5. Approval of Employee Stock Purchase Plan 173,967,572 2,158,457 1,112,690
Note: Proposals 3 and 5 required specific voting instructions from the
beneficial owners pursuant to NYSE requirements.
52
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 Second Restated Certificate of Incorporation of the Company.
3.2 Amended and Restated By-laws of the Company.
4.1 Indenture dated as of August 26, 2002 by and among CIT Group
Inc., Bank One Trust Company, N.A., as Trustee and Bank One
NA, London Branch, as London Paying Agent and London
Calculation Agent, for the issuance of unsecured and
unsubordinated debt securities (incorporated by reference to
Exhibit 4.18 to Form 10-K filed by CIT on February 26, 2003).
10.1 Employment Agreement for Jeffrey M. Peek, dated as of July 22,
2003.
10.2 Amendment to Employment Agreement for Albert R. Gamper, Jr.,
dated as of July 22, 2003.
12.1 CIT Group Inc. and Subsidiaries Computation of Earnings to
Fixed Charges.
31.1 Certification of Albert R. Gamper, Jr. pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Joseph M. Leone pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Albert R. Gamper, Jr. pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Joseph M. Leone pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) Reports on Form 8-K
Current Report on Form 8-K dated March 25, 2003, reporting the
financing relationship of CIT with Avianca Airlines.
Current Report on Form 8-K dated April 3, 2003, reporting the
financing relationship of CIT with Air Canada.
Current Report on Form 8-K dated April 10, 2003, reporting
that a punitive class action lawsuit, asserting claims under
the Securities Act of 1933, was filed in the United States
District Court for the Southern District of New York, against
CIT, its Chief Executive Officer and its Chief Financial
Officer.
Current Report on Form 8-K dated April 24, 2003, reporting the
financial results of CIT as of and for the quarter ended March
31, 2003.
53
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CIT GROUP INC.
By: /s/ Joseph M. Leone
.................................................
Joseph M. Leone
Executive Vice President, Chief Financial Officer
and Principal Accounting Officer
August 12, 2003
54