Business Context and Reporting Period
First Citizens BancShares, Inc., a Delaware financial holding company headquartered in Raleigh, North Carolina, operates primarily through First-Citizens Bank & Trust Company. The bank provides commercial and consumer lending, deposits, treasury services, cardholder and merchant services, wealth management, mortgage and insurance services. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2013; comparisons are primarily with the corresponding 2012 periods and December 31, 2012.
Key Financial Metrics
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net interest income | $179.5 million | $215.4 million | $384.4 million | $436.4 million |
| Noninterest income | $65.0 million | $57.3 million | $122.5 million | $104.2 million |
| Noninterest expense | $188.6 million | $194.8 million | $382.9 million | $378.1 million |
| Net income | $43.9 million | $37.6 million | $99.5 million | $73.1 million |
| Net income per share | $4.56 | $3.66 | $10.34 | $7.11 |
| Taxable-equivalent net yield on interest-earning assets | 3.74% | 4.58% | 4.04% | 4.69% |
| Return on average assets | 0.83% | 0.71% | 0.95% | 0.70% |
| Return on average equity | 9.13% | 7.93% | 10.55% | 7.79% |
- Provision for loan and lease losses was a credit of $13.2 million in Q2 and $31.8 million for the first six months, versus expense of $29.7 million and $60.4 million, respectively, in the comparable 2012 periods.
- Total assets were $21.31 billion at June 30, 2013, compared with $21.28 billion at December 31, 2012 and $21.33 billion at June 30, 2012.
- Total loans and leases were $13.10 billion, including $11.66 billion of originated loans and $1.44 billion of acquired loans. The allowance for loan and lease losses was $258.3 million, or approximately 1.97% of total loans and leases.
- Total deposits were $18.02 billion. Short-term borrowings were $581.9 million and long-term obligations were $443.3 million.
- Shareholders’ equity was $1.94 billion. Tier 1 risk-based, total risk-based and leverage capital ratios were 14.91%, 16.41% and 9.68%, respectively; management stated that BancShares and its bank subsidiary remained well-capitalized.
- Operating cash flow for the first six months was $147.3 million, compared with $170.7 million in 2012. Investing activities used $182.1 million and financing activities used $62.3 million, resulting in a $97.1 million decrease in cash and due from banks to $542.6 million.
- Free liquidity was $3.68 billion at June 30, 2013, including cash, overnight investments and unpledged available-for-sale securities. The company also reported $1.15 billion of additional FHLB borrowing capacity and $550 million of contingent unsecured borrowing access.
Material Changes Versus Prior Comparable Period
- Profitability improved despite lower spread income. Q2 net income increased 16.8% and six-month net income increased 36.1%, driven primarily by lower credit-loss provisions, higher noninterest income and lower Q2 operating expenses.
- Net interest income declined. Q2 net interest income fell 16.7% and six-month net interest income fell 11.9%. Lower asset yields, lower average loan balances and the runoff of acquired loans outweighed lower funding costs.
- Credit trends improved. Nonperforming assets declined to $237.8 million, or 1.8% of loans, leases and other real estate, from $507.6 million, or 3.7%, at June 30, 2012. Total troubled debt restructurings declined to $277.6 million from $308.0 million.
- Loan mix continued to change. Originated loans increased 1.7% year over year to $11.66 billion, while acquired loans declined 27.8% to $1.44 billion. Commercial mortgage balances grew, while revolving mortgage, consumer and acquired loan balances declined.
- Noninterest income increased. Six-month noninterest income rose 17.5%, reflecting a $5.5 million net gain from selling processing-service relationships, improved mortgage income and stronger cardholder and merchant services. Processing-service fees declined 33.8% and are expected to remain lower.
- Expense trends were mixed. Q2 noninterest expense decreased 3.2%, mainly from lower foreclosure costs. Six-month expense increased 1.3%, reflecting higher employee benefits, pension costs, processing fees and technology-related costs.
- Tax expense increased. The effective tax rate was 36.6% in Q2 2013 versus 22.1% in Q2 2012, and 36.2% for the first six months versus 28.4%. The prior-year rate benefited from a $6.4 million state tax audit credit.
- Accumulated other comprehensive loss worsened. AOCI increased from an $82.1 million loss at year-end 2012 to a $100.2 million loss, primarily because of lower unrealized gains on available-for-sale securities.
Guidance, Outlook, Commentary, Risks and Unusual Items
- Management expects originated loan growth to remain sluggish for the remainder of 2013 because economic conditions remain uncertain, although loan demand improved during Q2.
- Low interest rates and competitive pricing continue to pressure asset yields and margins. Acquired-loan discount accretion was $52.0 million in Q2 and $131.9 million year to date; management expects accretion to remain volatile and generally decline as acquired balances run off.
- FDIC-assisted transactions remain a significant source of earnings volatility. The FDIC receivable was $158.0 million, including $71.4 million expected from future reimbursements and $86.7 million expected to be recovered through prospective amortization. The payable for estimated FDIC clawback obligations was $101.7 million.
- Management enhanced its allowance methodology during Q2, reallocating reserves among loan classes and moving $7.4 million of the reserve for unfunded commitments into the allowance. Management stated that the methodology change had no material overall impact on the allowance.
- The company began a core technology and process modernization program expected to continue through 2016, with total costs estimated to exceed $100 million. Equipment, depreciation, maintenance and occupancy costs are expected to increase.
- Key credit risks include economic weakness, declining real estate values, concentrations in real-estate-secured lending and medical-related borrowers, and junior-lien revolving mortgage loans. Approximately 66% of the $2.12 billion revolving mortgage portfolio was secured by junior liens.
- Loss-share reimbursements are subject to FDIC review, contractual requirements and differing interpretations. Delays, disallowances or losses occurring after loss-share periods could adversely affect results.
- Trust preferred securities qualifying as Tier 1 capital will be phased out under regulatory requirements by 2016. Even excluding these securities, management reported a Tier 1 common equity ratio of 14.23% at June 30, 2013.
- Other unusual items include the processing-relationship sale, $1.4 million of related fixed-asset writedowns, significant provision reversals on acquired loans and a $6.4 million prior-year tax benefit. No goodwill impairment was recorded, although the company noted that a sustained stock price below book value could trigger future testing.
- Management reported that pending litigation was not expected to have a material effect. The SBA advised during Q2 that it would no longer pursue a claim relating to certain FDIC loss-share proceeds.
Investor Verification Checklist
- Verify the sustainability of earnings excluding acquired-loan accretion, FDIC-related adjustments, provision reversals and the processing-service sale.
- Track net interest margin and asset yields as acquired loans continue to decline and low-rate conditions persist.
- Review originated-loan credit quality, junior-lien exposure, collateral values, nonaccrual loans and the adequacy of the $258.3 million allowance.
- Assess the timing and collectability of the $158.0 million FDIC receivable and potential exposure to the $101.7 million clawback payable.
- Monitor the implementation cost and execution risk of the technology modernization program, expected to exceed $100 million through 2016.
- Evaluate deposit retention, liquidity availability and funding costs as time deposits decline and loan demand changes.
- Confirm the capital impact of Basel III, the phase-out of trust preferred securities and the 2015 maturity-related reduction of subordinated debt in Tier 2 capital.