Business Context and Reporting Period
First Citizens BancShares, Inc. is a financial holding company headquartered in Raleigh, North Carolina, operating primarily through First-Citizens Bank & Trust Company. The unaudited Form 10-Q covers the three and nine months ended September 30, 2011, with comparisons to the corresponding 2010 periods. IronStone Bank was merged into First-Citizens Bank on January 7, 2011, leaving BancShares with one reportable segment.
The company completed FDIC-assisted acquisitions of United Western Bank in January 2011 and Colorado Capital Bank in July 2011. These transactions increased covered loans, deposits and acquisition-related income but also affect comparability through fair-value accretion, FDIC loss-share accounting and integration costs.
Key Financial Metrics
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Interest income | $252.2 million | $278.6 million | $743.0 million | $696.8 million |
| Net interest income | $217.2 million | $229.9 million | $628.5 million | $545.8 million |
| Provision for loan losses | $44.6 million | $59.9 million | $143.0 million | $108.6 million |
| Noninterest income | $163.7 million | $50.0 million | $360.0 million | $354.5 million |
| Noninterest expense | $203.8 million | $176.9 million | $581.3 million | $531.6 million |
| Net income | $81.9 million | $27.7 million | $165.0 million | $163.0 million |
| Net income per share | $7.91 | $2.66 | $15.85 | $15.62 |
| Net yield on interest-earning assets | 4.60% | 4.93% | 4.47% | 4.02% |
| Return on average assets | 1.55% | 0.52% | 1.04% | 1.05% |
| Return on average equity | 17.95% | 6.46% | 12.34% | 13.17% |
At September 30, 2011, total assets were $21.02 billion, total loans and leases were $14.16 billion, deposits were $17.66 billion, shareholders’ equity was $1.87 billion and total liabilities were $19.14 billion. Cash and due from banks totaled $539.3 million, overnight investments totaled $410.0 million and available-for-sale securities totaled $3.99 billion.
Debt included $600.4 million of short-term borrowings and $744.8 million of long-term obligations. Immediately available balance-sheet liquidity, net of pledged amounts, was approximately $1.47 billion. The company also reported access to $892.4 million of additional secured borrowings and $400.0 million of contingent unsecured borrowing capacity.
Capital remained strong: the Tier 1 risk-based capital ratio was 15.46%, total risk-based capital was 17.33% and the leverage capital ratio was 9.83%. Management stated that BancShares and First-Citizens Bank remained well-capitalized.
Nine-month cash provided by operating activities was $581.3 million. Investing activities provided $2.28 billion, primarily reflecting $1.15 billion of net cash received from acquisitions and investment-security maturities. Financing activities used $2.78 billion, largely because of deposit reductions, debt repayments and common-stock repurchases. Cash and due from banks increased by $79.2 million during the period.
Material Changes Versus Prior Comparable Period
- Third-quarter net income increased by $54.2 million, or approximately 196%, primarily because of the $87.8 million Colorado Capital Bank acquisition gain.
- Nine-month net income increased only $2.0 million because higher acquisition gains and net interest income were substantially offset by higher personnel, foreclosure, collection and technology expenses and greater loan-loss provision.
- Nine-month net interest income increased $82.7 million, or 15.2%, helped by $192.6 million of acquired-loan discount accretion versus $100.3 million in 2010. Third-quarter net interest income declined 5.5% because discount accretion fell to $69.8 million from $88.1 million.
- The provision for loan and lease losses rose 31.7% for the nine-month period, to $143.0 million, primarily because of post-acquisition deterioration in covered loans. The allowance increased to $254.2 million from $227.8 million at year-end 2010.
- Nonperforming assets rose to $739.9 million, or approximately 5.2% of loans and leases plus other real estate, from $560.1 million at December 31, 2010. Of the September 30 balance, $545.3 million was covered by FDIC loss-share agreements.
- Total loans and leases increased to $14.16 billion from $13.49 billion at year-end 2010, primarily due to the United Western and Colorado Capital acquisitions. Noncovered loans increased modestly, while consumer and residential mortgage balances declined.
- Total deposits were broadly stable versus year-end but declined from September 2010. Deposits assumed in the acquisitions experienced substantial runoff, including approximately $1.8 billion of United Western deposits.
- Noninterest expense increased 15.3% in the third quarter and 9.4% year to date, reflecting acquisition-related staffing, technology, foreclosure and collection costs.
Guidance, Outlook, Commentary and Risks
- Management expects non-acquisition loan growth to remain limited for several quarters because of weak loan demand, deleveraging and economic uncertainty, although commercial loan balances showed modest recent improvement.
- Acquired-loan discount accretion is inherently volatile and may decline or accelerate based on prepayments, payoffs, settlements and changes in expected cash flows. Management stated that future accretion and net interest income are not readily predictable.
- Debit-card interchange-fee limits effective October 2011 were expected to reduce cardholder and merchant-services income by approximately $2.0 million in the fourth quarter of 2011 and $13.0 million in 2012. Additional overdraft-related changes were expected to reduce annual fees by approximately $1.8 million.
- Management projected potential FDIC true-up payments of approximately $11.8 million for United Western and $16.3 million for Colorado Capital Bank in 2021. Loss-share reimbursements remain subject to FDIC review, contractual thresholds and possible clawback provisions.
- Current projections indicated Colorado Capital Bank covered-asset losses of approximately $219.4 million. Losses above specified thresholds may receive no FDIC reimbursement until higher thresholds are exceeded.
- The company reported $277.7 million of troubled debt restructurings at September 30, 2011, including $159.4 million covered and $118.3 million not covered by loss-share agreements.
- Key risks include weak economic and real-estate conditions, borrower defaults, concentrations in real-estate and medical-related lending, FDIC reimbursement and acquisition-integration risk, interest-rate sensitivity, liquidity pressure, regulatory changes, litigation, operational and technology risks, and valuation uncertainty in the allowance, goodwill and FDIC receivable.
- The Dodd-Frank Act is expected to phase out $265.0 million of trust-preferred securities from Tier 1 capital between 2013 and 2015. Management stated that the company would remain well-capitalized under the disclosed pro forma scenarios.
- The filing reports no material change in market-risk exposure from December 31, 2010. A modeled immediate 200-basis-point rate increase would reduce the market value of equity to approximately 7.9%, while rate-ramp scenarios indicated a potential 4.8% to 8.2% increase in net interest income, subject to customer deposit migration assumptions.
Important Facts for Investors to Verify
- Separate recurring operating earnings from the $151.3 million of acquisition gains recognized in the first nine months of 2011.
- Assess the sustainability of net interest income excluding unpredictable acquired-loan discount accretion.
- Review covered and noncovered nonperforming assets, charge-offs, troubled debt restructurings and allowance adequacy.
- Monitor deposit attrition in acquired markets and the reduction in immediately available liquidity to approximately $1.47 billion.
- Evaluate the timing, thresholds and potential clawback or true-up obligations under FDIC loss-share agreements.
- Quantify the effect of debit-card interchange regulation, overdraft changes and other regulatory actions on fee income.
- Consider the future effect of trust-preferred capital phaseout and the company’s ability to fund growth or additional acquisitions.
- Review acquisition fair-value estimates, goodwill impairment assumptions, FDIC-receivable valuations and pending litigation because these estimates may change.