FIRST CITIZENS BANCSHARES INC quarterly report, Q2 FY2012

First Citizens BancShares, Inc. — 10-Q Summary

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 filing covers the unaudited three- and six-month periods ended June 30, 2012, compared primarily with the corresponding 2011 periods. At June 30, 2012, the bank operated 421 branches across multiple states and the District of Columbia. Results remain significantly influenced by six FDIC-assisted transactions completed from 2009 through 2011 and related loss-share agreements.

Key financial metrics

Metric	Three months ended June 30, 2012	Three months ended June 30, 2011	Six months ended June 30, 2012	Six months ended June 30, 2011
Net interest income	$215.4 million	$207.4 million	$436.4 million	$411.4 million
Provision for loan losses	$29.7 million	$54.0 million	$60.4 million	$98.4 million
Noninterest income	$57.3 million	$66.6 million	$104.2 million	$196.2 million
Noninterest expense	$194.8 million	$187.5 million	$378.1 million	$377.5 million
Net income	$37.6 million	$21.3 million	$73.1 million	$83.1 million
Net income per share	$3.66	$2.04	$7.11	$7.96

Total assets were $21.24 billion at June 30, 2012, versus $20.88 billion at December 31, 2011 and $21.02 billion at June 30, 2011.
Total deposits were $17.80 billion, up 1.3% from December 31, 2011 and 0.8% from June 30, 2011.
Total loans and leases were $13.46 billion, down from $13.94 billion at December 31, 2011 and $13.93 billion at June 30, 2011. Covered loans declined to $2.00 billion from $2.36 billion and $2.40 billion, respectively.
Investment securities available for sale increased to $4.63 billion from $4.06 billion at December 31, 2011 and $4.01 billion at June 30, 2011.
Cash and due from banks were $571.0 million, supplemented by $984.5 million of overnight investments.
Long-term obligations were $644.7 million; short-term borrowings were $700.3 million.
Shareholders’ equity was $1.93 billion, compared with $1.86 billion at December 31, 2011 and $1.81 billion at June 30, 2011.
Taxable-equivalent net yield on interest-earning assets was 4.58% for the second quarter and 4.69% year to date, compared with 4.46% and 4.41%, respectively, in 2011.
Return on average assets and equity was 0.71% and 7.80% in the second quarter, and 0.69% and 7.70% year to date.
Six-month operating cash flow was $362.8 million, compared with $462.2 million in 2011. Investing activities used $637.5 million, primarily reflecting purchases of investment securities; financing activities provided $254.9 million.
Capital ratios remained strong: Tier 1 risk-based capital was 15.97%, total risk-based capital was 17.66%, and Tier 1 leverage was 10.21%.

Material changes versus the prior comparable period

Second-quarter net income rose 76% to $37.6 million, primarily because of higher net interest income and lower loan-loss provisions.
Year-to-date net income declined 12% because 2011 included a $63.5 million acquisition gain from the United Western transaction; no acquisition gains were recorded in 2012. Management stated that the 2011 gain had an after-tax impact of approximately $38.6 million.
Net interest income increased 3.9% in the second quarter and 6.1% year to date. Lower funding costs were partially offset by lower interest income and declining loan balances.
Noninterest income declined $9.4 million in the second quarter and $92.0 million year to date. Drivers included lower debit-card interchange revenue, lower service charges and mortgage income, larger negative adjustments to the FDIC receivable, and the absence of the 2011 acquisition gain.
Cardholder and merchant services income fell 19.1% in the second quarter to $24.7 million following federally mandated debit-card interchange fee limits.
Noninterest expense increased 3.9% in the second quarter, principally because foreclosure-related expense rose to $15.8 million from $3.7 million. Six-month expense was broadly stable year over year.
The effective tax rate fell to 22.1% for the quarter and 28.4% year to date, partly because of a $6.4 million benefit from favorable state tax audits for 2008–2010, net of additional federal taxes.
Nonperforming assets declined to $507.6 million, or 3.72% of loans, leases and other real estate, from $553.8 million at December 31, 2011. Covered nonperforming assets were $388.8 million and noncovered nonperforming assets were $118.9 million.
The allowance for loan and lease losses increased to $272.9 million from $250.1 million at June 30, 2011. The noncovered allowance was $185.1 million, or 1.62% of noncovered loans.

Outlook, management commentary, risks and unusual items

Management expects noncovered loan growth to remain limited for the next several quarters because of weak demand and continued customer deleveraging. Investment-security yields are expected to remain low until the Federal Reserve raises benchmark rates.
Future net interest income may be volatile because $60.9 million of second-quarter and $125.8 million of year-to-date interest income arose from discount accretion on acquired loans. Unscheduled repayments and changes in estimated cash flows can accelerate or reduce this income.
Debit-card interchange limits are expected to continue reducing cardholder and merchant services income during 2012. Processing-services revenue is expected to decline in late 2012 and 2013 because of client-bank attrition and system conversions.
Credit risks include weak economic conditions, declining real-estate values, exposure to junior-lien revolving mortgages, commercial real-estate concentrations, and a concentration of medical, dental and related borrowers. Approximately two-thirds of the revolving mortgage portfolio was secured by junior liens.
Total troubled debt restructurings were $308.0 million at June 30, 2012, including $226.7 million performing under modified terms. Management selectively modifies loans for customers facing liquidity challenges.
The FDIC loss-share receivable was $314.0 million. It included estimated reimbursements of $253.5 million for projected covered losses and expenses, plus amounts expected from prospective accretion, offset by estimated clawback payments. Reimbursements remain subject to FDIC review, contractual conditions and timing.
First Citizens received claims from the Small Business Administration seeking a share of certain FDIC payments related to Temecula Valley Bank loans. The company disputes the claims and cannot determine the outcome or potential loss.
Management disclosed a material weakness in internal control over financial reporting relating to accounting and reporting for acquired loans and the FDIC receivable. Remediation includes an external consulting engagement, additional staff, enhanced reviews and conversion of acquired loans to an automated system, anticipated to be substantially completed by December 31, 2012.
On July 31, 2012, the company redeemed $150.0 million of trust preferred securities, reducing long-term borrowings by $154.6 million and creating a $3.6 million third-quarter prepayment penalty. It also repaid $21.6 million of debt related to a 2005 revolving-mortgage securitization on July 15, 2012.
After the July redemption, management estimated Tier 1 leverage at 9.50%, Tier 1 risk-based capital at 14.85% and total risk-based capital at 16.54%. Remaining trust preferred securities will be phased out of Tier 1 capital beginning in 2013.
Immediate rate increases of 200 and 300 basis points were estimated to increase net interest income by 1.8% and 0.6%, respectively; a 400-basis-point increase was estimated to reduce it by 3.0%.

Most important facts for investors to verify

Progress and effectiveness of remediation for the material weakness, including completion of acquired-loan system conversions.
Realization, timing and potential clawbacks of the $314.0 million FDIC receivable, including the unresolved SBA claims.
Sustainability of earnings excluding acquisition gains, FDIC-related adjustments, tax benefits and acquired-loan discount accretion.
Trends in noncovered delinquencies, charge-offs, impaired loans, troubled debt restructurings and real-estate collateral values.
Impact of debit-card interchange restrictions and anticipated processing-services revenue declines.
Deposit retention, liquidity availability and funding costs as economic conditions improve and assumed FDIC-related deposits continue to run off.
Capital effects of the July 2012 redemption and the scheduled phase-out of remaining trust preferred securities and subordinated debt from regulatory capital.
Potential additional allowance requirements or losses not reimbursable under FDIC loss-share agreements.