Business Context and Reporting Period
First Citizens BancShares, Inc. is a financial holding company headquartered in Raleigh, North Carolina, operating through First-Citizens Bank & Trust Company. The bank operated 416 branches across 18 states and Washington, D.C. as of September 30, 2012. The unaudited Form 10-Q covers the three and nine months ended September 30, 2012, with comparisons to September 30, 2011 and December 31, 2011.
Results remain significantly influenced by six FDIC-assisted acquisitions completed from 2009 through 2011, including acquired loans, FDIC loss-share agreements, discount accretion and related accounting estimates.
Financial Performance and Position
| Metric | Third quarter 2012 | Nine months 2012 | Comparable period |
|---|---|---|---|
| Net interest income | $215.4 million | $651.7 million | $217.2 million and $628.5 million |
| Provision for loan and lease losses | $17.6 million | $78.0 million | $44.6 million and $143.0 million |
| Noninterest income | $51.8 million | $156.1 million | $162.9 million and $359.1 million |
| Noninterest expense | $190.1 million | $568.2 million | $203.8 million and $581.3 million |
| Net income | $39.5 million | $112.6 million | $81.4 million and $164.5 million |
| Net income per share | $3.85 | $10.96 | $7.86 and $15.81 |
| Net interest yield, taxable equivalent | 4.51% | 4.63% | 4.60% and 4.47% |
| Return on average assets | 0.75% | 0.72% | 1.53% and 1.04% |
| Return on average equity | 8.08% | 7.89% | 17.65% and 12.29% |
Amounts are in thousands or millions as presented in the filing. The comparable-period columns represent the third quarter and nine months ended September 30, 2011, respectively.
- Total assets were $21.17 billion at September 30, 2012, versus $20.88 billion at December 31, 2011 and $21.02 billion at September 30, 2011.
- Total deposits were $17.89 billion, including $4.90 billion of noninterest-bearing deposits. Shareholders’ equity was $1.97 billion.
- Total loans and leases were $13.35 billion, consisting of $1.90 billion covered by FDIC loss-share agreements and $11.46 billion not covered by those agreements.
- Investment securities available for sale increased to $5.01 billion from $4.06 billion at December 31, 2011.
- The allowance for loan and lease losses was $276.6 million, including $90.5 million for covered loans and $186.0 million for noncovered loans.
- Operating cash flow was $219.7 million for the first nine months, compared with $340.9 million in 2011. Investing activities used $344.9 million, while financing activities provided $140.5 million. Cash and due from banks ended at $606.1 million.
- Long-term obligations declined to $472.2 million from $687.6 million at December 31, 2011, principally following the redemption of $150.0 million of trust preferred securities and repayment of other obligations.
- Capital remained strong: the Tier 1 risk-based, total risk-based and leverage ratios were 15.08%, 16.76% and 9.67%, respectively. Management stated that BancShares and FCB remained well-capitalized.
Material Changes Versus the Prior Comparable Period
- Third-quarter net income decreased $41.9 million, or approximately 51%, primarily because third-quarter 2011 included an $86.9 million acquisition gain. Nine-month net income declined $51.9 million, principally because 2011 included $150.4 million of acquisition gains.
- Net interest income decreased 0.8% in the third quarter but increased 3.7% year to date. Lower loan balances and lower investment-security yields pressured quarterly results, while lower deposit and borrowing costs supported year-to-date performance.
- The provision for loan losses decreased 60.5% in the third quarter and 45.5% for the first nine months, primarily due to lower post-acquisition deterioration and improved cash-flow projections for covered loans.
- Noninterest income fell $111.1 million in the quarter and $203.0 million year to date. In addition to the absence of acquisition gains, cardholder and merchant services income declined because of debit-card interchange-fee limits, and FDIC receivable adjustments reduced noninterest income by $16.9 million in the quarter and $57.8 million year to date.
- Noninterest expense decreased 6.7% in the third quarter and 2.3% year to date, despite higher employee-benefit and foreclosure-related costs. The quarter included a $3.6 million premium for early redemption of trust preferred securities.
- Nonperforming assets declined to $379.4 million, or 2.81% of loans, leases and other real estate, from $560.6 million, or 3.90%, at September 30, 2011. The reduction in covered nonperforming assets was partly attributable to converting certain acquired loans to an automated accounting system, which allowed some previously nonaccrual loans to accrete yield.
Outlook, Commentary, Risks and Unusual Items
- Management expects noncovered loan growth to remain sluggish for the next several quarters because of weak loan demand and competitive pricing.
- Investment-security yields were expected to remain low until the Federal Reserve raised benchmark rates. Management reported that a 200-, 300- or 400-basis-point rate increase would increase projected 24-month net interest income by 3.1%, 4.3% or 5.2%, respectively.
- Acquired-loan discount accretion was $67.6 million in the third quarter and $193.4 million for the first nine months. Management cautioned that accretion is difficult to predict and will decline as acquired loans run off, although repayments and revised cash-flow estimates may create volatility.
- The company implemented an automated acquired-loan accounting system for loans from the Temecula Valley Bank and Venture Bank transactions during the third quarter. Management expected the remaining two FDIC-assisted portfolios to be substantially converted by December 31, 2012.
- A material weakness in internal control over financial reporting remained outstanding, relating to accounting and reporting for acquired loans and the FDIC receivable. Disclosure controls were therefore concluded to be ineffective as of September 30, 2012. Management had engaged an external firm, added staff and implemented enhanced reconciliations and review procedures.
- Trust preferred securities remaining in Tier 1 capital totaled $93.5 million and were scheduled to be phased out in $31.2 million annual increments beginning in 2013. Management stated that the company would remain well-capitalized under the disclosed scenarios.
- Key credit risks include weak economic conditions, declining real-estate values, junior-lien exposure, concentrations in medical and dental-related borrowers, and potential additional losses on noncovered loans. Approximately two-thirds of the revolving mortgage portfolio was secured by junior liens.
- FDIC loss-share reimbursements are subject to contractual terms, FDIC oversight and possible clawbacks. The FDIC receivable was $243.9 million, including estimated reimbursements and prospective accretion, offset by estimated clawback obligations.
- First Citizens disclosed an unresolved dispute with the Small Business Administration regarding claims to amounts paid or payable by the FDIC on certain SBA-guaranteed loans. The company could not estimate any potential loss.
- Unused commitments were $5.68 billion, standby letters of credit were $62.2 million and the reserve for mortgage-loan repurchase exposure was $3.3 million. Management stated that other litigation was not expected to have a material effect, but certain claims remain unresolved.
- Goodwill of $102.6 million passed the annual impairment test during the quarter. Management noted that a sustained decline in the stock price relative to book value could result in a future impairment charge.
Important Facts for Investors to Verify
- Whether the remaining acquired-loan system conversions and remediation of the material internal-control weakness were completed as planned.
- The sustainability of earnings after excluding acquisition gains, acquired-loan discount accretion and favorable tax items.
- Future trends in noncovered delinquencies, charge-offs, nonperforming assets, troubled debt restructurings and the allowance for loan losses.
- The collectability and timing of the $243.9 million FDIC receivable, including loss-share eligibility, expiration dates and clawback exposure.
- The effect of debit-card interchange restrictions, continued low interest rates and declining acquired-loan balances on recurring revenue and margins.
- The impact of trust-preferred-security phase-out and Basel III implementation on capital ratios, funding costs and acquisition capacity.
- The outcome of the SBA claims, legal proceedings and any potential mortgage repurchase obligations.