FIRST CITIZENS BANCSHARES INC annual report, FY2010

Business Context and Reporting Period

First Citizens BancShares, Inc. is a bank holding company whose principal subsidiaries were First-Citizens Bank & Trust Company and IronStone Bank. At December 31, 2010, the company operated 435 offices across multiple states and Washington, D.C. This Form 10-K covers the fiscal year ended December 31, 2010, with fourth-quarter information included. On January 7, 2011, IronStone Bank merged into First-Citizens Bank, and its branches continued under the IronStone Bank name.

During 2010, First-Citizens Bank completed FDIC-assisted acquisitions of First Regional Bank and Sun American Bank, adding 20 branches, approximately $1.55 billion of loans and approximately $1.71 billion of deposits at acquisition-date recorded amounts. These transactions included FDIC loss-share protection.

Key Financial Metrics

Metric	2010	2009	Change
Net income	$193.0 million	$116.3 million	Up 65.9%
Earnings per share	$18.50	$11.15	Up $7.35
Net interest income	$774.2 million	$510.5 million	Up 51.7%
Provision for loan and lease losses	$143.5 million	$79.4 million	Up $64.2 million
Noninterest income	$406.2 million	$403.5 million	Up 0.7%
Noninterest expense	$733.4 million	$651.5 million	Up 12.6%
Return on average assets	0.93%	0.66%	Up 27 basis points
Return on average equity	11.54%	7.94%	Up 360 basis points
Taxable-equivalent net yield on interest-earning assets	4.22%	3.25%	Up 97 basis points

All dollar amounts above are as reported; the filing generally presents financial statement amounts in thousands. Pretax income was $303.6 million and income tax expense was $110.5 million, producing a 36.4% effective tax rate.

• Total assets increased to $20.81 billion from $18.47 billion.
• Total deposits increased 15.0% to $17.64 billion, including strong organic growth but significant runoff of deposits assumed in the 2010 acquisitions.
• Total loans and leases increased 5.2% to $13.49 billion. FDIC-covered loans rose to $2.01 billion from $1.17 billion, while noncovered loans declined modestly to $11.48 billion.
• Investment securities increased 54.0% to $4.51 billion, reflecting excess liquidity and weak loan demand.
• Shareholders’ equity increased to $1.73 billion from $1.56 billion; book value per share was $166.08 and tangible book value per share was $155.30.
• Net cash provided by operating activities was $146.7 million, compared with $168.1 million in 2009. Investing activities used $129.6 million and financing activities used $37.2 million.

Debt, Liquidity and Capital

• Short-term borrowings were $546.6 million, down from $642.4 million. Long-term obligations were $809.9 million, compared with $797.4 million.
• Long-term obligations included $265.0 million of trust preferred securities and related junior subordinated debentures, subordinated debt, Federal Home Loan Bank borrowings and debt associated with a securitization.
• Immediately available balance-sheet liquidity was approximately $2.73 billion at year-end, compared with $1.32 billion at year-end 2009. The company also reported access to approximately $1.32 billion of secured Federal Home Loan Bank borrowing capacity and $550.0 million of unfunded borrowings through various sources.
• BancShares reported a 14.86% Tier 1 risk-based capital ratio, 16.95% total risk-based capital ratio and 9.18% leverage ratio. First-Citizens Bank remained well-capitalized.
• The company paid $12.5 million of cash dividends in 2010, or $1.20 per share. A quarterly dividend of $0.30 per share was declared for payment in April 2011.

Material Changes Versus the Prior Comparable Period

• Net income rose primarily because of higher net interest income from balance-sheet growth, acquired loans and accelerated accretion of acquisition-related fair-value discounts.
• Net interest income included $145.4 million of discount accretion in 2010, principally from large unscheduled payments and payoffs of acquired loans. No comparable accretion was recorded in 2009.
• Acquisition gains increased to $136.0 million from $104.4 million. The 2010 gains consisted of $107.7 million from First Regional and $27.8 million from Sun American Bank.
• Credit costs increased. Net charge-offs were $88.7 million versus $64.7 million, although noncovered net charge-offs declined to $49.6 million from $64.7 million. The increase was driven by $39.1 million of charge-offs on FDIC-covered loans acquired in 2010 and 2009.
• Nonperforming assets increased to $560.1 million from $374.3 million. Of the 2010 total, $363.5 million was covered by FDIC loss-share agreements and $196.7 million was not covered.
• Noninterest income excluding acquisition-related items and FDIC receivable adjustments increased approximately 7.0%. Cardholder and merchant services and wealth-management revenue improved, while deposit service charges declined following Regulation E changes affecting overdraft fees.
• Noninterest expense increased $81.9 million, including $61.9 million of costs associated with acquired branches, collection activity, foreclosure-related expenses and other acquisition integration costs.
• Effective January 1, 2010, new consolidation guidance required the company to consolidate a previously securitized revolving mortgage loan structure, increasing loans by approximately $97.3 million, debt by $86.9 million and beginning retained earnings by $4.9 million.

Fourth-Quarter Performance

Fourth-quarter 2010 net income was $30.1 million, or $2.88 per share, compared with $19.0 million, or $1.82 per share, in the fourth quarter of 2009. Net interest income increased 60.4% to $228.4 million, supported by $66.2 million of fair-value discount accretion. The fourth-quarter provision was $34.9 million, while noninterest income declined 36.6% to $51.7 million because of a $29.1 million net charge related to adjustments to the FDIC receivable. Noninterest expense increased 16.4% to $201.8 million.

Guidance, Outlook, Risks and Unusual Items

• Management expected non-acquisition loan growth to remain modest in 2011 because of weak demand and customer deleveraging.
• Management anticipated higher credit costs in 2011 on acquired loans because of elevated nonperforming assets and weaker acquired portfolios. Losses recoverable under FDIC agreements would generally generate corresponding noninterest income.
• Management expected some moderation of credit costs on noncovered loans as economic conditions stabilized, but noted continued exposure to unemployment, declining real-estate values, weak loan demand and borrower defaults.
• Future net interest income may be volatile because the timing of acquired-loan payoffs and fair-value discount accretion is unpredictable.
• Management believed additional FDIC-assisted acquisition opportunities could arise during 2011. The filing states that the principal financial constraint on additional transactions was maintaining adequate leverage capital.
• On January 21, 2011, First-Citizens Bank acquired substantially all assets and assumed most liabilities of United Western Bank in an FDIC-assisted transaction. The acquired institution reported approximately $993.1 million of loans and $1.6 billion of deposits before fair-value adjustments. The filing states that valuation was incomplete at filing date.
• United Western’s former parent, United Western and related directors subsequently sued the FDIC and other parties regarding the receivership. BancShares and First-Citizens Bank were not named, but the filing states that the effect of the litigation was unclear.
• The FDIC receivable was $623.3 million at year-end. The company had resubmitted certain loss-share reimbursement filings because of inaccuracies, and the FDIC had temporarily suspended certain payments pending review. The company reported $53.4 million received in February 2011 and expected an additional $77.2 million in March 2011.
• Dodd-Frank will phase out the inclusion of $265.0 million of trust preferred securities in Tier 1 capital beginning in 2013 and eliminate it by 2015. Management’s pro forma analysis indicated that BancShares would remain well-capitalized after full exclusion under then-current guidelines.
• Debit-card interchange revenue was expected to decline materially in 2011 because of Dodd-Frank-related regulations. FDIC insurance assessments, regulatory costs, competition, interest-rate changes and operational risks could also pressure earnings.
• Loss-share reimbursements are subject to FDIC review and may be delayed or disallowed for noncompliance. First Regional also had a projected $67.2 million true-up payment to the FDIC under its loss-share agreement; estimates were subject to change.

Most Important Facts to Verify

• Separate recurring operating performance from the $136.0 million of acquisition gains, $145.4 million of discount accretion and other FDIC-related accounting adjustments.
• Reconcile the growth and subsequent runoff of deposits acquired from First Regional and Sun American Bank.
• Monitor nonperforming assets, allowance coverage and credit costs, distinguishing FDIC-covered exposures from noncovered loans.
• Review the collectibility, timing and regulatory approval of the $623.3 million FDIC receivable and pending reimbursement claims.
• Assess the effect of the United Western acquisition, its incomplete purchase accounting and related litigation on 2011 results and liquidity.
• Evaluate the effect of Dodd-Frank on debit-card revenue, deposit costs, regulatory expenses and capital treatment of trust preferred securities.
• Confirm the sustainability of earnings excluding acquisition-related items and the unpredictable accretion of acquired-loan fair-value discounts.
• Review contractual obligations of $19.17 billion, loan commitments of $5.36 billion, standby letters of credit of $70.8 million and mortgage-loan recourse exposure of approximately $253.3 million.