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Edited Transcript of CIT earnings conference call or presentation 24-Jul-18 12:00pm GMT

Q2 2018 CIT Group Inc Earnings Call

NEW YORK Jul 24, 2018 (Thomson StreetEvents) -- Edited Transcript of CIT Group Inc earnings conference call or presentation Tuesday, July 24, 2018 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Barbara A. Callahan

CIT Group Inc. - Senior VP & Head of IR

* Ellen R. Alemany

CIT Group Inc. - Chairwoman & CEO

* John J. Fawcett

CIT Group Inc. - Executive VP & CFO

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Conference Call Participants

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* Arren Saul Cyganovich

Citigroup Inc, Research Division - VP & Senior Analyst

* Christoph M. Kotowski

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* Derek Russell Hewett

BofA Merrill Lynch, Research Division - VP

* Donald James Fandetti

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Eric Edmund Wasserstrom

UBS Investment Bank, Research Division - MD & Consumer Finance Analyst

* Moshe Ari Orenbuch

Crédit Suisse AG, Research Division - MD and Equity Research Analyst

* Scott Jean Valentin

Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst

* Vincent Albert Caintic

Stephens Inc., Research Division - MD and Senior Specialty Finance Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to CIT's Second Quarter 2018 Earnings Conference Call. My name is Keith, and I will be your operator today. (Operator Instructions) .

As a reminder, this conference call is being recorded.

And now I'd like to turn the call over to Barbara Callahan, Head of Investor Relations. Please proceed, ma'am.

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Barbara A. Callahan, CIT Group Inc. - Senior VP & Head of IR [2]

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Thank you, Keith. Good morning, and welcome to CIT's Second Quarter 2018 Earnings Conference Call. Our call today will be hosted by Ellen Alemany, Chairwoman and CEO; and John Fawcett, our CFO. After Ellen and John's prepared remarks, we will have a question-and-answer session. (Operator Instructions) .

Elements of this call are forward looking in nature and may involve risks, uncertainties and contingencies that may cause actual results to differ materially from those anticipated. Any forward-looking statements relate only to the time and date of this call. We disclaim any duty to update these statements based on new information, future events or otherwise. For information about risk factors relating to the business, please refer to our 2017 Form 10-K.

Any references to non-GAAP financial measures are meant to provide meaningful insights and are reconciled with GAAP in your press release.

Also, as part of the call this morning, we will be referencing a presentation that is available on the Investor Relations section of our website at www.cit.com.

Now I'll turn the call over to Ellen Alemany.

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Ellen R. Alemany, CIT Group Inc. - Chairwoman & CEO [3]

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Thank you, Barbara. Good morning, and thank you for joining the call. I'll start with an overview of results and then provide some updates on our strategic plan.

We posted net income available to common shareholders of $117 million in the second quarter or $0.94 per diluted share, and income from continuing operations, excluding noteworthy items, of $125 million or $1 per diluted share.

Results reflect continued progress on the strategic plan, including lower operating expenses, advances in optimizing the capital structure and growth in our core businesses despite some highly competitive markets.

Additionally, we completed the sale of the reverse mortgage business and related loan portfolio as well as outsourced the forward mortgage servicing operations. These actions further simplify and strengthen CIT by exiting noncore operations and driving greater efficiency in our go-forward mortgage business.

John will walk you through a more detailed account of financial results shortly. But first, I want to touch on a few key elements of our plan, which are on Slide 2.

Origination volume was strong across the board, up about 30% year-over-year, which demonstrates the progress we are making in the marketplace by adding expertise to key business verticals and delivering value for our customers. This volume was somewhat offset by an elevated level of prepayments in the Commercial Finance and Real Estate Finance divisions, and that affected core asset growth, which was up about 1%.

Business Capital had another very strong quarter with core loans and leases up 8% year-over-year and 2% quarter-over-quarter. Small business confidence is strong, and we are well positioned to help our customers grow their business. Our technology, industry expertise and knowledge of residual values gives us a strong position in the equipment finance market. Most recently, we announced that our leading FlexAbility digital platform is now integrated with a key software product in the Office Imaging space, which will enable dealers and their customers to have a completely automated experience when leasing equipment. Factoring volume is also up year-over-year, driven by increases in the technology sector.

Origination volume was up 24% versus the prior year in the Commercial Finance division, largely from the aviation, health care and energy verticals. The CIT Northbridge JV has also started to gain traction. Our pipeline of transactions in Commercial Finance continues to be strong. At the same time, we remain disciplined in our approach to this market, which has seen aggressive leverage levels and structures.

Likewise, our Real Estate Finance business continues to be competitive but also experienced a higher level of prepayments. The industry overall is seeing some softening, and we are being prudent in picking our spots.

In Rail, we have seen an uptick in railcar loadings, fueled by some improvement in the industrial sector. There's still a surplus of equipment, but our team has been successful in increasing the utilization of our North America Rail fleet over the past several quarters to 98%, which is up 350 basis points from last year and 100 basis points from last quarter.

The NACCO transaction continues to progress and is expected to close by the second half of this year.

We continue to advance our strategic business initiatives and build on our core strengths in small business and the middle market.

Operating expenses decreased 9% in the second quarter compared to a year ago, and we remain committed to achieving our expense target for the year. We posted total average deposit growth in the quarter of $900 million compared to the prior quarter as we strategically decreased brokered deposits and grew customer deposits at the direct bank. The cornerstone of our deposit growth is the direct bank, which had another strong quarter and added $1.5 billion of average deposits and 20,000 new customers. The new money market account has been a key contributor to deposit growth as we offer consumers additional savings options with a competitive value proposition.

We continue to make strides in optimizing the capital structure and creating value for shareholders. We purchased 680 million of common shares in the quarter and plan to return up to $750 million of additional capital as we advance our plan. We also recently announced a 56% per share increase in our common stock dividend to $0.25.

As we previously disclosed, with the passage of the Regulatory Relief legislation, CIT is no longer subject to the DFAST or CCAR processes. Our capital planning and risk management practices will continue to be reviewed through the regular supervisory process, and we are committed to maintaining strong capital planning and risk practices while also working to reach our target capital levels.

And lastly, our credit reserves remain strong.

With that, let me turn it to our CFO, John.

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John J. Fawcett, CIT Group Inc. - Executive VP & CFO [4]

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Thank you, Ellen, and good morning, everyone. Turning to our results on Page 3 of the presentation.

We posted GAAP net income for the quarter of $117 million or $0.94 per common share.

Page 4 highlights income from continuing operations, excluding noteworthy items, which was $125 million or $1 per common share this quarter, up from $97 million or $0.74 per common share last quarter and down modestly from $126 million or $0.68 per common share in the year-ago quarter.

Earnings per common share increases also reflect the decline in the average number of diluted common shares outstanding to 125 million from 132 million last quarter and 184 million in the year-ago quarter.

The increase in net income from prior quarter reflects lower operating expenses and a lower, more normal credit provision. The current quarter also included a $9.4 million preferred stock dividend. The year-ago quarter benefited from an unusually low credit provision and no preferred dividend, which was offset by higher operating expenses and a higher tax rate.

We posted strong new business activity in the second quarter in almost all of our businesses. And our average core portfolio grew 1% from the prior quarter despite high prepayments in Commercial Finance and Real Estate Finance. Total average loans and leases were modestly lower, reflecting the sale of the reverse mortgage portfolio and continued runoff of the Legacy Consumer Mortgage book.

As shown on Page 5 of the presentation, we had a number of noteworthy items resulting from our strategic initiatives that offset one another but impacted continuing and discontinued operations a bit differently. The sale of the Financial Freedom servicing business included an after-tax loss of $14 million in discontinued operations from additional reserves and transaction costs, while continuing operations included a $22 million after-tax benefit from the sale of reverse mortgages related to the Financial Freedom transaction.

We also incurred debt extinguishment cost of $14 million after tax from our liability management actions and a $6 million after-tax benefit from suspended depreciation related to the pending NACCO disposition, which we expect to close later this year.

I will now go into further detail on our financial results for the quarter. Please note that in this discussion, I will refer to our results from continuing operations, excluding noteworthy items, unless otherwise noted.

Turning to Page 6 of the presentation. Net finance revenue was relatively flat from the prior quarter, while net finance margin declined by 8 basis points. Compared to the year-ago quarter, net finance revenue was down $23 million and the margin declined 15 basis points. The flat net finance revenue compared to the prior quarter reflects higher income on our loans, leases and investments, which was offset by a higher interest expense.

Net purchase accounting accretion was unchanged from last quarter as a $2 million decline in accretion in our Real Estate Finance division was offset by a decrease in negative interest income on the indemnification assets in Consumer Banking. We continue to see a reduction in purchase accounting accretion as the portfolios run off. We now have approximately $665 million in total purchase accounting accretion remaining, of which almost $590 million relates to Legacy Consumer Mortgage portfolio, which runs off at about 10% to 15% annually. The remaining $75 million relates to Commercial Finance and Real Estate Finance, and we are forecasting 40% to 50% of it to accrete over the next 4 quarters.

Turning to Page 7. Although net finance revenue was flat, net finance margin declined by 8 basis points compared to the prior quarter to 3.29%, which was partially driven by a change in the mix of average earning assets. Deposit rates increased this quarter, reducing margin by 10 basis points, reflecting upward market trends and strong growth in our direct bank's money market savings product as we got ahead of some of our projected funding needs in the second half of the year.

Higher borrowing cost reduced margin by 8 basis points. About half of the increase was due to an increase in FHLB costs, most of which was rate driven, and the rest was mostly due to a full quarter impact of the Tier 2 qualifying subordinated debt issued in March.

The yields on our loans and investments benefited from higher interest rates, which contributed about 13 basis points to the overall margin. However, this was offset by about 5 basis points from a higher level of average interest-bearing cash during the quarter resulting from the timing of our liability management and capital actions as well as the sale of the reverse mortgage portfolio.

This quarter, Rail yields benefited from a customer prepayment.

In addition to the trends I just described, the decline in net finance margin from the year-ago quarter also reflected lower net purchase accounting accretion, other prepayment benefits and Rail yields.

Turning to Page 8. Other noninterest income was relatively flat when compared to the prior quarter. Compared to last year, other noninterest income was up significantly, reflecting income from BOLI, which has been relatively consistent at $7 million over the past 2 quarters, and gains on derivative activity, which is more episodic. As I noted in the last couple of quarters, other noninterest income included elevated activity related to the reverse mortgage portfolio that was sold on May 31. This quarter included $5 million in other revenues, while we recognized $7 million last quarter. Other noninterest income in the quarter also included a $6 million benefit from a release of reserves related to the OneWest acquisition.

Fee income was relatively flat to the prior quarter and down from the year-ago quarter resulting from lower capital markets fees, which can be uneven throughout the year.

Factoring commissions were down in the second quarter, reflecting seasonally lower volumes. Compared to a year ago, factoring commissions were relatively flat, reflecting increasing volumes, primarily from the technology sector, offset by lower pricing from a continued shift in the mix of services provided.

Gain on sale of leasing equipment, predominantly from our portfolio management activities in Rail, has remained relatively flat when compared to the prior and year-ago quarters.

Turning to Page 9. Operating expenses decreased from the prior quarter, reflecting lower compensation cost and professional fees. In addition, the current quarter benefited from a $5 million reversal of an international tax-related reserve. Compared to a year ago, operating expenses declined, primarily reflecting lower professional fees and insurance costs as well as the reversal of the international tax-related reserve that was originally recorded in the year-ago quarter. We remain on track to achieve our 2018 annual operating expense target of $1,050,000,000. As a reminder, this excludes intangibles and restructuring costs.

We expect operating expenses to continue to decline in the second half of the year, with much of the reduction resulting from lower compensation and benefits costs.

Page 10 describes our consolidated average balance sheet. This page demonstrates the progress we have made over the past year, repositioning our cash to build out the investment portfolio, reducing wholesale funded debt and returning significant capital to our shareholders.

Compared to the prior quarter, average earning assets were up almost $1 billion, reflecting higher interest-bearing cash related to the timing of our liability management and capital actions over the past 2 quarters as well as the sale of the reverse mortgage portfolio on May 31, which also reduced average loans.

The increase in liabilities reflects deposit growth and a full quarter impact from the liability management actions. These actions included the issuance of $400 million of Tier 2 qualifying subordinated debt and $1 billion of senior unsecured debt in March and the redemption of nearly $900 million of senior unsecured debt in April, which allowed us to extend our overall debt maturities at a modest incremental cost and improve the efficiency of our capital structure.

The decline in equity reflects our stock repurchases of approximately $680 million and a $22 million reduction from unrealized losses in our investment securities book that runs through OCI.

Page 11 provides more detail on average loans and leases by division. As I mentioned earlier, we saw strong origination volumes this quarter in most of our businesses, which resulted in 1% average growth in our core portfolios despite high prepayments in Commercial Finance and Real Estate Finance. Commercial Banking's average loans and leases were flat compared to the prior quarter, reflecting strong growth in Business Capital, offset by a reduction in Real Estate Finance and Commercial Finance. Compared to the year-ago quarter, Commercial Banking grew 3%, driven by Business Capital, Commercial Finance and Rail, partially offset by a reduction in Real Estate Finance.

The middle market continues to be challenging, and we remain disciplined in a highly competitive environment while finding opportunities where we can grow. In Commercial Finance, average loans and leases were down 1% this quarter. Compared to the year-ago quarter, average loans and leases were up 2%. Origination volumes were up significantly from the prior and year-ago quarters, but spreads remained pressured and prepayments increased as borrowers are taking advantage of tighter spreads by refinancing. We continue to find opportunities with strong origination volumes in the health care and energy verticals. In addition, asset-based originations remain over 50% of total new business volume, driven by our re-entry into aviation finance and our repositioning efforts.

Real Estate Finance was down 2% this quarter, excluding the legacy non-SFR portfolio runoff, reflecting lower volumes and higher prepayments. As I mentioned last quarter, the market has become more competitive as CMBS and debt funds are more active. As a result, we are seeing spreads compressing and more aggressive debt structures, including the incentive for borrowers to refinance. We are remaining disciplined in our new business originations and continue to pick our spots amid the market conditions.

North American Rail assets were up modestly as new deliveries were offset by depreciation. We are seeing some momentum in the industrial sector, and rail loadings are up. The general surplus of equipment across North America has improved from last year but remains high at 17%. The Rail team has been successful in increasing utilization in the current environment, which grew to 98% this quarter.

Overall lease rates repriced down 17% this quarter, reflecting the persistent surplus of equipment and the mix of cars renewing. We are seeing improvement in renewal rates on certain freight cars such as boxcars, cement and sand cars, mill gondolas and plastics. In addition, tank car markets have overall stabilized with opportunities developing in Canada from pipeline capacity constraints, in Mexico for refined products and for retrofitted tank cars servicing multiple markets.

That said, we continue to expect leases to reprice down on average 20% to 30% through 2019, driven by continued pressure from tank car lease rates, which are renewing at a faster pace and at rates that are down from peak levels.

Business Capital grew 2% compared to the prior quarter with growth across all of our equipment lending businesses. Origination volume was strong, up 17% from last quarter, and small business optimism remains high. We continue to gain momentum across all our platforms from the investments we made in our sales force as well as the technology that differentiates us in this space. Pricing has remained relatively constant as the leases and loans are predominantly fixed rate and it is more difficult to pass along rate increases in this industry. As a result, the increase in funding cost has put pressure on the margins, but we have recently increased lending rates in select markets.

In Consumer Banking, growth in our Other Consumer Banking businesses was more than offset by the runoff of the Legacy Consumer Mortgage portfolio and the sale of the reverse mortgages. Average loans in the core mortgage lending business increased by over $300 million or 13% this quarter from the continued strong originations in the retail and correspondent lending channels, and we continue to experience an increase in loans from our SBA lending platform.

In all our businesses, we continue to be selective and disciplined in the face of current competitive market conditions, emphasizing opportunities to build upon our expertise and seek to grow in areas that are not overheated.

Page 12 highlights our average funding mix. Compared to the prior quarter, total borrowed funds and deposits increased while the overall mix remained stable. Funding cost as a percent of average earning assets increased this quarter by 18 basis points. As I mentioned, higher deposit cost contributed 10 basis points, while our debt actions in March and higher Federal Home Loan Bank costs added 8 basis points to our borrowing costs.

Page 13 illustrates the deposit mix by type and channel. Quarter-over-quarter, our average deposits increased approximately $900 million to $31 billion, reflecting growth in our online channel of $1.5 billion or 12%, primarily offset by a reduction in brokered and commercial deposits. We've been growing our non-maturity deposits in conjunction with our strategy to optimize deposit costs while working within our risk management discipline.

The cost of our deposits increased 14 basis points this quarter.

The beta on total deposits in the current quarter was approximately 40%, resulting in a cumulative beta over the past year of approximately 30% and 15% since the first rate hike of the current tightening cycle in December of 2015. Actual betas in this tightening cycle have been generally lower than modeled due to a lack of market pressure, disciplined pricing in our retail savings and runoff of our higher-cost brokered deposits and high-cost CDs. Growth in our money market savings product contributed to the high beta this quarter, and we expect the trailing 12-month betas to continue to ramp up to around 40% to 50% by the end of the year.

Page 14 highlights our credit trends. Credit metrics remained stable, and our results reflected a more normal provision. The credit provision this quarter was $33 million compared to $69 million last quarter and only $4 million in the year-ago quarter. The current quarter's provision was in line with our near-term outlook of $30 million to $40 million, while the prior quarter included a $22 million charge-off of a single commercial exposure that was episodic in nature and a higher level of reserves, primarily within the Commercial Finance division.

The year-ago quarter's credit provision was unusually low and well below our normal run rate. This quarter's provision reflected 21 basis points on net charge-offs, below our near-term outlook guidance, and remains within cycle lows in most of our businesses. The provision also included an increase in reserves resulting from a higher level of nonaccrual loans within Commercial Finance, where changes in nonaccrual have some variability and have been running at historically low levels.

I would also point out that we are not seeing an overall deterioration in the credit environment, and new business origination continues to come in at better risk ratings than the overall risk rating of the performing portfolio.

Turning to capital on Page 15. Our capital levels remained strong, and we ended the quarter with a Common Equity Tier 1 ratio of 13.2%, down 120 basis points from the end of last year. We are committed to returning capital to shareholders and reducing our Common Equity Tier 1 ratio to our target level of 10% to 11% in the medium term.

As Ellen mentioned, with the recent passage of the Regulatory Relief legislation, we are no longer a SIFI bank. And even though we are no longer subject to DFAST and CCAR, our target capital levels and capital planning process will continue to reflect our desire to maintain a sound risk management framework, which will be reviewed through the regulatory supervision process.

We ended the quarter with 116 million common shares outstanding. In the second quarter, we returned $680 million of common equity through the tender and open market repurchases, bringing our total share repurchase in the first half of the year to $875 million, representing 16.2 million shares at an average repurchase price of $54.14 per share.

We increased our dividend last week by 56% per share to $0.25. If you recall, we raised our dividend in the third quarter of last year as well, resulting in a 67% cumulative per-share dividend increase over the past year.

In addition to the dividend increase, our board has authorized a capital return of up to $750 million, and we intend to return sufficient capital by the end of this year to achieve our guidance of a Common Equity Tier 1 ratio of 11.5% to 12%.

So far in the third quarter through Friday, July 20, we repurchased $105 million in common shares at an average price of $51.82 per share. We remain committed to achieving the upper end of our Common Equity Tier 1 ratio of 10% to 11% in 2019, and we'll continue to review options to return capital as efficiently and as prudently as possible while working within the confines of the supervisory review process.

Page 16 highlights our key performance metrics, both on a reported basis as well as excluding noteworthy items.

Our effective tax rate, excluding discrete items, was 27%, consistent with our updated guidance of 26% to 28%. Our return on tangible common equity, excluding noteworthy items, was 8.6%. And if you normalize for the preferred dividend being semiannual, our return on tangible common equity would have been 8.9%.

Before I turn it back to Ellen, I wanted to give you some thoughts on the third quarter outlook, which is on Page 17.

We expect total average earning assets to be relatively flat with low single-digit quarterly growth in our core portfolios, mostly offset by the runoff of the Legacy Consumer Mortgage portfolio and the full quarter impact from the sale of the reverse mortgage portfolio.

We expect net finance margin to be relatively flat and remain in the middle of the 2018 target range, driven by a reduction from the sale of the reverse mortgages, which included 2 months of activity in the current quarter and Rail repricing, offset by the impact of net impact of higher interest rates.

We expect operating expenses to trend down as we achieve our $1,050 million target for the year.

We continue to expect net charge-offs to be within the annual target range of 35 to 45 basis points.

And we expect the effective tax rate before the impact of discrete items to be 26% to 28%, and we continue to work through the impacts of state tax changes.

With that, let me turn it back over to Ellen.

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Ellen R. Alemany, CIT Group Inc. - Chairwoman & CEO [5]

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Thanks, John.

I want to reiterate our commitment to our return on tangible common equity goals.

As previously mentioned, we are targeting 9.5% to 10% return on tangible common equity at the end of this year and 11% to 12% over the medium term.

In closing, we are delivering steady progress on our plan to maximize the potential of our core businesses, enhance our operational efficiency, optimize our funding costs, optimize our capital structure and maintain strong risk management.

With that, we're happy to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And this morning's first question comes from Moshe Orenbuch with Crédit Suisse.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [2]

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I guess looking at the margin walk that you talked about, you've kind of alluded to some of the pieces of this, but I'm hoping you can kind of pull it together for us because essentially, I mean, this is a company that we've kind of been told was asset sensitive and yet you've got an 18 basis point hit to margins as a result of higher interest rates in the quarter. I mean, it seems like -- it seems high, and you talked about, like I said, some of the pieces, but can you kind of flesh out what it -- what will take to get to the point of actually demonstrating that asset sensitivity? Or is it the fact that pressure on yields has just offset that?

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John J. Fawcett, CIT Group Inc. - Executive VP & CFO [3]

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Yes. So Moshe, this is John. So I'll take a crack at this. I think a lot of it is competition in the space and change in mix of business. I think as you well know also, there's a lot of puts and takes that worked their way through the net finance revenue line in terms of the indemnification asset, the drag that creates; the runoff of the purchase accounting accretion, which is half of what it was last year. I think the other thing that's kind of out there a little bit is in terms of lease maintenance. And so as you start to see some of the cars come out of storage and you see our utilization go up, that drives a little bit of lease maintenance. And so as we take cars out, there's a higher volume of remarketing, pulling cars from storage and sending the cars into service. And so that's also a part of it. The other element of it that's probably unique a little bit to this quarter is, is that the elevated level of cash, which I think we were probably overly circumspective in the capital actions and probably impacted net interest margin in a disproportionate way. And then as I mentioned, the other 2 big drivers are this -- were the subordinated debt. So we had the full quarter of a 6 1/8% coupon work their way through on $400 million. And then, of course, we've had great success with the build-out of the money market in our online bank, and that was an off-rate of 1.85% that probably launched in late February but ran through part of the first quarter and all of the second quarter. So hopefully, that gives you a little bit more color in terms of what's going on.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [4]

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Right, okay. And you talked about the lease rates being down kind of still 20% to 30% on renewal. Can you talk about the percentage of the book that's renewing in '18 and how that changes in '19? And when do you think that number could be closer to where that will be more of a wash?

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John J. Fawcett, CIT Group Inc. - Executive VP & CFO [5]

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Yes. So this is a question of the pig and the python. And so I think as -- and you have to break the book into almost 2 pieces. So you've got kind of -- or the way I look at it is you have the freight and infrastructure book and you have the tank cars. And so kind of in broad strokes, 35% of what's repricing in '18 is tank-related cars, and that starts to trend down. '19 is probably sub-30%, '20 is sub-25% and '21 is sub-20%. So it continues to work its way through. I think on the tank side, to the extent that oil stabilizes at $70 or continues to move higher, that mode bodes well in terms of the rates that we can reprice at. Similarly, it also depends on the vintages of the cars that are coming off lease. And so you're starting to see a convergence of high leased cars and the tank space coming off at the same time that lease rates on tanks are starting to modestly move. I think the other thing, too, is in terms of utilization in the Rail business. I think you have to go back to probably '15 before you'd ever see a 1% increase quarter-on-quarter in terms of utilization and in terms of other kind of bright lights on the horizon. Something as probably out of favor as coal cars in the last year has gone from mid-80s utilization to mid-90s utilization. So it feels like there's a lot of things that are going on in the Rail space that are potentially good. But again, we're still going to have to work through the challenges we face in the tank space.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [6]

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Right. But just about how long do you think that takes till...

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John J. Fawcett, CIT Group Inc. - Executive VP & CFO [7]

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I think certainly through '19. And then '20, it starts to see a turn. But again, a lot of this has to do with the mix of cars. A lot of it has to do with infrastructure. And look, if Trump were able to do the same thing for infrastructure, as he's been talking about, as what he did with tax reform, I think that would potentially be a fairly decent lift. So we'll just have to see how it plays out.

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Operator [8]

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And the next question comes from Eric Wasserstrom with UBS.

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Eric Edmund Wasserstrom, UBS Investment Bank, Research Division - MD & Consumer Finance Analyst [9]

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I'm afraid my question is also on net interest margin, and I'm looking at Page 7 of the slide deck, which has the margin walk from the first to second quarter. And I'm just sort of contemplating these same categories from second to third, in line with the guidance. And I guess where I'm struggling is if we look at the left side, for example, the cash and investment income, and assume that the balance sheet is largely flat, then maybe there's a couple of benefits of -- a couple of basis points of benefit there, but the continued increase in deposit costs along the lines of the beta that you suggested would suggest that there's still going to be this pressure. And so I'm just wondering how all of that reconciles to a flat quarter-over-quarter net finance margin.

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John J. Fawcett, CIT Group Inc. - Executive VP & CFO [10]

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Yes. So on the left-hand side, in my call script, I alluded to the fact that we've started to introduce some pricing. We'll have to see how that goes in the Business Capital space. It largely becomes also a question of the pace of prepayments. I mean, very highly -- very high levels of prepayments in the second quarter. So if that abates a little bit, there's probably some good news there. Spot cash is already down, and we expect that we'll become a little bit more efficient on the balance sheet given that we're not going to have a tender to work through. On the right-hand side, in terms of borrowing costs, you'd expect some moderation, at least in the debt space. But on the deposit costs, depending upon the timing of subsequent Fed actions, that should be modestly flattish. So I think we're pretty comfortable with our range of 3.20% to 3.40% in terms of net finance margin, in the middle part of that range.

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Eric Edmund Wasserstrom, UBS Investment Bank, Research Division - MD & Consumer Finance Analyst [11]

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And then maybe if I could just ask one follow-up on the costs. The -- what -- I know that you mentioned that it's compensation and benefits that is the primary driver from the script. But can you give us a sense of within the organization where that cost leverage is emanating from? Because I also see these very strong hiring announcements. So I'm just trying to put the 2 and 2 together.

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John J. Fawcett, CIT Group Inc. - Executive VP & CFO [12]

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Yes. Oh, I'm sorry.

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Ellen R. Alemany, CIT Group Inc. - Chairwoman & CEO [13]

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Yes, so I'll just take this, John. So we are still committed to the $1.050 billion at year-end. And a lot of the cost declines are coming from really compensation costs, lower professional fees. We also have a lot of digitization efforts going across the business, which is resulting in a lot more operational efficiency. And I would add that with the passage of the Regulatory Relief legislation, there is some potential for further expense reduction. And what we're doing is we're rebalancing using some of these cost saves to make investments in the business and then otherwise just giving the cost saves back. So it's a little bit of rebalancing here.

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Operator [14]

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And the next question comes from Donald Fandetti with Wells Fargo.

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Donald James Fandetti, Wells Fargo Securities, LLC, Research Division - Senior Analyst [15]

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John, can you talk a little bit more about credit? The non-accruals, as you mentioned, were up. And if you think about last quarter, you had the episodic event in commercial. I guess 2-part question. One, is there any particular industry that drove the non-accruals? And then how are you thinking about credit, generally speaking, going forward? It seems like maybe it's softening a little bit in the commercial side.

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John J. Fawcett, CIT Group Inc. - Executive VP & CFO [16]

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Yes. So the increase in non-accruals was not due to any specific industry or common theme. So again, kind of episodic. The increases in reserves were primarily related to Commercial Finance, where non-accruals have some variability. And again, non-accruals and charge-offs aren't demonstrating any particular pockets or challenge. I mean, if you look at the top of the house, across most of the metrics, net charge-offs as a percent of average loans is at 21 basis points. When you look across the last 5 quarters, that's a low point for us in terms of low being good. The provision against average loans if you -- second quarter of '17 was ridiculously low, and the first quarter had that challenge of the episodic one credit going bad. But 45 basis points is very consistent with third and fourth quarter. If you look at nonperforming loans-to-end-of-period loans, again, kind of still below 1%, and you don't see any trends breaking out there. And then we feel pretty good about our allowance. So across the book of business, there's nothing out there that causes any particular challenges. And then as I said in the call script, the new business origination continues to come at better risk ratings than the overall risk rating of the performing portfolio. So at this point, we feel pretty good about where we are in the credit cycle.

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Operator [17]

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And the next question comes from Chris Kotowski with Oppenheimer & Co.

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Christoph M. Kotowski, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [18]

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I'm wondering in terms of the capital returns if you can say -- you indicated you were in the market that you're -- did $106 million, I believe you said, so far. Should we expect you to complete your authorization in the open market or through additional tenders?

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John J. Fawcett, CIT Group Inc. - Executive VP & CFO [19]

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Yes. So everything is on the table. I mean, the reality is if you do the arithmetic between when we started at $105 million, it feels like we could do the whole thing in the open market and get through the return. But we look at everything all the time, and so all these regular options are there in terms of an ASR, open market repurchase and a tender. I wouldn't expect that you're going to see any kind of a special cash dividend, but we're going to continue to march to deliver the target 11.5%, 12% by the end of the year. And I think if you do the arithmetic, we started the year at, call it, 14.5%. We're, at half year, at 13.2%, so it's 120, 130 basis points. And we're targeting 11.5% to 12%, which is another 120 to 170 basis points. So it feels like across the course of the year, we're going to have delivered between 250 and 300 basis points of reduced Common Equity Tier 1. And if you do the arithmetic, you can kind of discern that the bulk of the $750 million that was authorized by the board is very much front-loaded to get to those targets at year-end.

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Christoph M. Kotowski, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [20]

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Right, okay. And then just going back to the non-accruals. I mean, they increased a little over $50 million. Was it multiple loans? Or was it a couple of big relationships?

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John J. Fawcett, CIT Group Inc. - Executive VP & CFO [21]

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It's not -- it's multiple loans. It's not a single credit at all. And it's different industries. There's literally no correlation between any of the loans that have moved into nonaccrual.

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Operator [22]

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And the next question comes from Scott Valentin with Compass Point.

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Scott Jean Valentin, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [23]

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Just, John, I think you said earlier in the prepared remarks about the -- this quarter's deposit growth there were some initiatives in the second half. And maybe you guys were kind of prefunding, if I heard you correct. Was there anything specific you had planned for the second half in terms of assets?

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John J. Fawcett, CIT Group Inc. - Executive VP & CFO [24]

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No, no. It's steady as she goes. And by the way, welcome, Scott.

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Scott Jean Valentin, Compass Point Research & Trading, LLC, Research Division - MD & Research Analyst [25]

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And then just on the capital return, now that you guys are no longer SIFI, just wondering, in terms -- SIFI was a pretty structured process in terms of submissions and timing, things like that. I assume there's a lot more flexibility now going forward with regard to capital return requests. In other words, you guys can finish the current capital return. You can just go back and request additional and, if you still see fit, to return capital. There's no specific timeframes or any kind of, I guess, structured calendar in terms of requesting capital?

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John J. Fawcett, CIT Group Inc. - Executive VP & CFO [26]

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Yes. I...

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Ellen R. Alemany, CIT Group Inc. - Chairwoman & CEO [27]

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Yes. I mean, I think that's right, Scott. But that being said, I think the regulators have also made it clear that -- to make sure that our capital planning and risk management practices, they'll be continued to be reviewed through the regular supervisory process. And we've got to be prudent in our requests, et cetera, but...

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John J. Fawcett, CIT Group Inc. - Executive VP & CFO [28]

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And the only thing I would add is, look, the laws are out there. They have to be converted into regulation, and they have to be applied for supervision. I think a lot of people are under the impression that there's open season on capital, but the reality is that CCAR may be gone, but capital playing, as Ellen said, remains alive and well. It's still subject to supervisory oversight. And there are specific rules in terms of S.R.O. 904, and there are others in place still governing payment of dividends. And so we expect to continue to work very closely with the Federal Reserve in terms of what our ability is to return capital and the pacing and timing at which that would happen.

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Operator [29]

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And the next question comes from Vincent Caintic with Stephens.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD and Senior Specialty Finance Analyst [30]

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A couple of questions or 2 questions on the railcar business. So first, you alluded to the yields this quarter being supported by a prepayment. I'm just wondering what the yield would have been without the prepayment. And then secondly, so the 98% utilization rate, so a great number after having dipped into the low 90s. Just kind of wondering how sustainable that is. And particularly, when you think about pricing versus utilization, where do you think that can go?

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John J. Fawcett, CIT Group Inc. - Executive VP & CFO [31]

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Yes, I -- Barb will probably get back to you on the impact of the prepayment. It was kind of a modest number in the overall scheme of things. On the infrastructure side, in the freight car, it feels like we're in a pretty good place in terms of renewals against car lease rates. And so maybe there's potentially a little bit of upside there. Again, it depends on what happens in the broader market. And on tanks, it's just going to run its course. So I don't know that there's much more visibility that I can give you in terms of what I said before. I think it all still kind of holds true. It's wait and see. I think there are glimmers of hope on the horizon, but 1 quarter doesn't necessarily make a trend. I think oil prices have to sustain themselves, the infrastructure has to keep going, there's got to be a buoyant economy to kind of support some of the flow. But there are a lot of good signs in terms of loadings being up, and I think loadings are up. You'd have to go back to '14 or '15 to see the pace of loadings that we're seeing right now, so.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD and Senior Specialty Finance Analyst [32]

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Okay, got it. Helpful. Great. And then separate but maybe a little bit related question. If you can discuss the prepayment activity a little bit more. Just wondering, so the prepayment activity was high just generally in the second quarter. Is that something that you -- I don't know whether it's competition in commercial or in the real estate business or other things, but do you expect the prepayment activity to be elevated going forward? And is it something where, say, rising rates is a driver for that and we should kind of [tight it too]?

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Ellen R. Alemany, CIT Group Inc. - Chairwoman & CEO [33]

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Vince, this is Ellen. It's really hard to predict the prepayment rate. We had a lot of prepayment rates at -- in the last quarter of last year. It was a little lighter this past quarter. But it's really just a combination of the debt funds out there. That's been a challenge for us and for many other institutions. And it's also -- it's been an erosion of the deal structures in the marketplace, and we're really staying firm on the credit side of the business. So I would say that we'll just see how it goes. But otherwise, the business volume is as strong as I've ever seen it in terms of the new volumes that we're writing, but it's really hard to predict the prepayment activity.

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Operator [34]

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And the next question comes from Arren Cyganovich with Citi.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [35]

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So the return on tangible equity continues to improve but are somewhat below peers' largely, I think, because of the higher cost of deposit funding compared to other banks. What's your thoughts on maybe improving that? Or do you need to actually sell to somebody else or now acquire cheaper deposits to make returns more comparable with other banks'? Your thoughts on M&A there.

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Ellen R. Alemany, CIT Group Inc. - Chairwoman & CEO [36]

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I mean, I think it's just, it's continued execution against the plan. So it's a whole combination of factors that we're going at it, which is the revenue momentum we have in the business, continuous improvement on the operating expense line, et cetera. And it's just -- it's basically just quarter-over-quarter progress. So we're having a lot of success running off the brokered CD deposits and growing the direct bank deposits. But it's going to be a combination of all these factors that is going to drive the improvement on the return on tangible common equity and maybe some -- we're aggressively looking for some portfolio purchases in the market, et cetera, that may help, but it's just going at it every quarter.

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John J. Fawcett, CIT Group Inc. - Executive VP & CFO [37]

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Yes. And I would just add that look, we remain committed to the return on tangible common equity walk that's kind of out there. So fourth quarter '19, 9.5%, 10%, and then targeting 11% to 12% return on tangible common equity in the medium term. And so there's a lot of leverage here at work, and I would say we're working them all and remain committed to deliver against the commitments we've made.

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Operator [38]

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(Operator Instructions) And the next question comes from Derek Hewett with Bank of America Merrill Lynch.

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Derek Russell Hewett, BofA Merrill Lynch, Research Division - VP [39]

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Ellen or -- and John, could you discuss opportunities to further improve operating expense? I don't think the $1.050 billion guidance in 2018 contemplated the change in SIFI status.

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Ellen R. Alemany, CIT Group Inc. - Chairwoman & CEO [40]

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No, it didn't. This is Ellen. It didn't. But what we are doing is really balancing future investment with the expense saves. So over the past 18 months, we've been investing in a lot of new front-office origination capabilities, whether it's material handling, logistics expertise, air, et cetera, and also investing in technology in the company. But on the other hand, on the expense side, where, I would say, lower professional fees, lower compensation cost, we're doing all the, you would call, expense and layers exercise, looking at locations. So there's still a lot of expense initiatives in the works. We will, with the passage of the Regulatory Relief, have potential to take out some more expenses. There's just -- for example, we won't have to do resolution planning anymore. We won't have to do certain reports that are required for DFAST or CCAR. We won't be subject to some of the Federal Reserve Bank supervisory assessments. But as I said, we're looking at how we rebalance and put some investment in the business and then do some cost takeouts. But we'll probably come out with some guidance later on this year after we reach our $1.050 billion target of kind of the future expense number after that.

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Derek Russell Hewett, BofA Merrill Lynch, Research Division - VP [41]

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Okay, great. And then what percentage of the North American Rail portfolio is currently housed in CIT Bank? And are there additional opportunities to move the portfolio that's financed outside of the bank into the bank at this point?

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Ellen R. Alemany, CIT Group Inc. - Chairwoman & CEO [42]

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Well, roughly, I think half of the Rail portfolio is in the bank today. The other half is up at the holding company. And then after the sale of NACCO, we'll reduce the Rail in half up at the holding company level. And then as we continue to grow the bank, we'll be able to put more Rail assets into the bank.

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Operator [43]

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And as there are no more questions at the present time, I would like to turn the call to management for any closing comments.

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Barbara A. Callahan, CIT Group Inc. - Senior VP & Head of IR [44]

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So thank you, everyone, for joining this morning. And if you have any follow-up questions, please feel free to contact me or any member of the Investor Relations team. You can find our contact information, along with other information, on the Investor Relations section of our website at cit.com. Thanks again for your time, and have a great day.

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Operator [45]

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That concludes today's call. Thank you for participating.