Business Context and Reporting Period
First Citizens BancShares, Inc. is a financial holding company headquartered in Raleigh, North Carolina. It provides commercial banking, consumer lending, deposit and treasury services, cardholder and merchant services, wealth management, insurance and processing services through First-Citizens Bank & Trust Company. The company operated as one reportable segment after the January 7, 2011 merger of IronStone Bank into First-Citizens Bank.
This unaudited Form 10-Q covers the three and six months ended June 30, 2011, with comparisons to the corresponding 2010 periods. Dollar amounts are in thousands except per-share data and ratios.
Key Financial Metrics
| Metric | Three months ended June 30, 2011 | Three months ended June 30, 2010 | Six months ended June 30, 2011 | Six months ended June 30, 2010 |
|---|---|---|---|---|
| Interest income | $245.6 million | $217.4 million | $490.8 million | $418.1 million |
| Net interest income | $207.4 million | $164.9 million | $411.4 million | $315.9 million |
| Provision for loan and lease losses | $54.0 million | $31.8 million | $98.4 million | $48.8 million |
| Noninterest income | $66.6 million | $92.6 million | $197.7 million | $304.6 million |
| Noninterest expense | $187.5 million | $181.8 million | $377.5 million | $354.7 million |
| Net income | $21.3 million | $28.6 million | $84.0 million | $135.2 million |
| Net income per share | $2.04 | $2.74 | $8.05 | $12.96 |
The taxable-equivalent net yield on interest-earning assets was 4.46% in the second quarter and 4.41% for the first six months, compared with 3.54% for both comparable 2010 periods. Annualized return on average assets was 0.41% for the quarter and 0.80% year to date; annualized return on average equity was 4.74% and 9.53%, respectively.
- Total assets were $21.02 billion at June 30, 2011, compared with $20.81 billion at December 31, 2010 and $21.11 billion at June 30, 2010.
- Total loans and leases were $13.93 billion, including $2.40 billion covered by FDIC loss-share agreements and $11.53 billion not covered by those agreements.
- Total deposits were $17.66 billion. Short-term borrowings were $655.8 million and long-term obligations were $792.7 million.
- Shareholders’ equity was $1.81 billion, up from $1.73 billion at December 31, 2010. The company repurchased 37,688 Class B shares for approximately $7.6 million and paid $6.3 million of dividends during the first six months.
- The allowance for loan and lease losses was $250.1 million, including $180.6 million for noncovered loans and $69.4 million for covered loans.
- Net cash provided by operating activities was $462.2 million. Investing activities provided $1.66 billion, largely reflecting $974.0 million of net cash received from acquisitions and securities activity. Financing activities used $2.04 billion, primarily because of deposit and borrowing reductions.
- Immediately available balance-sheet liquidity was approximately $1.78 billion at June 30, 2011. The company reported access to approximately $1.50 billion of additional secured borrowings and $400.0 million of contingent unsecured borrowing capacity.
- Capital ratios remained strong: Tier 1 risk-based capital was 15.38%, total risk-based capital was 17.27%, and Tier 1 leverage capital was 9.50%. Management stated that First-Citizens Bank remained well-capitalized.
Material Changes Versus Prior Comparable Period
- Second-quarter net income declined 25.5% from $28.6 million to $21.3 million; first-half net income declined 37.9% from $135.2 million to $84.0 million.
- Net interest income increased 25.8% in the quarter and 30.2% year to date, driven by balance-sheet growth, lower funding costs and substantial accretion of acquired-loan discounts.
- Loan-discount accretion was $71.1 million in the second quarter and $122.8 million for the first six months, including $43.7 million and $73.0 million, respectively, related to post-acquisition events and unscheduled payments. Management warned that this income is unpredictable and may create future volatility.
- Provision expense more than doubled year to date, primarily because of post-acquisition deterioration in covered loans. Covered-loan provision was $41.2 million in the quarter and $73.8 million year to date.
- Noninterest income fell $26.0 million in the quarter and $106.8 million year to date. The decline reflected lower acquisition gains and unfavorable adjustments to the FDIC loss-share receivable. Acquisition gains were $65.0 million in the first half of 2011 versus $136.0 million in the first half of 2010.
- Noninterest expense increased 3.1% in the quarter and 6.4% year to date, due to higher personnel, technology, processing, foreclosure and loan-collection costs.
- Nonperforming assets increased to $689.2 million, or 4.9% of loans, leases and other real estate, from $560.1 million, or 3.7%, at June 30, 2010. Approximately $479.8 million was covered by FDIC loss-share agreements; noncovered nonperforming assets were $209.4 million.
- Noncovered loans increased $136.5 million during the second quarter but remained below the June 30, 2010 level. Consumer loans declined substantially year over year, while commercial mortgage and revolving mortgage balances increased.
Guidance, Outlook, Risks and Unusual Items
- Management expects non-acquisition loan growth to remain limited for the next several quarters because of weak loan demand and customer deleveraging. Loan projections remain sensitive to economic conditions.
- The January 2011 acquisition of United Western Bank generated a preliminary $65.0 million bargain-purchase gain and added approximately $759.4 million of covered loans, $1.60 billion of deposits and $336.9 million of short-term borrowings. Acquisition-date fair values and the related gain remain subject to revision for one year.
- On July 8, 2011, after quarter-end, First-Citizens Bank acquired substantially all assets and most liabilities of Colorado Capital Bank. Reported settlement amounts included $540.3 million of loans, $607.1 million of deposits and $103.5 million of cash received from the FDIC; fair-value calculations were incomplete at filing.
- United Western loss-share agreements provide substantial FDIC protection but include a potential estimated true-up payment of approximately $11.4 million in 2021. Reimbursements are subject to FDIC oversight and may be delayed or disallowed for noncompliance.
- Management identified significant exposure to real estate lending, medical and dental borrowers, weak regional economies, declining collateral values, credit deterioration, liquidity pressure and interest-rate changes.
- The company expects debit-card interchange revenue to decline following October 1, 2011 regulatory changes, with estimated fee reductions of approximately $3.0 million in the fourth quarter of 2011 and $13.0 million in 2012. Additional overdraft-fee changes were expected to reduce annual fees by approximately $1.8 million.
- Dodd-Frank requirements will phase out the inclusion of $265.0 million of trust-preferred securities in Tier 1 capital beginning in 2013, although management stated the company would remain well-capitalized under the modeled impacts.
- Interest-rate simulations indicated that net interest income could increase by 8.1% to 15.7% under modeled rising-rate scenarios, but management noted that deposit migration and other factors could reduce the benefit.
- Legal proceedings include litigation brought by former United Western parties against the FDIC and others. The filing states that the potential impact on First-Citizens Bank or acquired assets is unclear, although the company was not named as a defendant.
Investor Verification Items
- Verify the sustainability of net interest income after the unusually high acquired-loan discount accretion subsides.
- Assess trends in covered and noncovered nonperforming assets, charge-offs, delinquencies and allowance adequacy.
- Review the assumptions supporting the $522.5 million FDIC loss-share receivable and the estimated $11.4 million United Western true-up payment.
- Confirm the final fair values, acquisition gain and capital and liquidity effects of the Colorado Capital Bank acquisition.
- Monitor deposit attrition in acquired markets and the decline in immediately available liquidity from $2.73 billion at December 31, 2010 to $1.78 billion at June 30, 2011.
- Quantify the effects of debit-card interchange and overdraft-fee regulations on future noninterest income.
- Evaluate the impact of the Dodd-Frank phase-out of trust-preferred capital and future regulatory requirements.