Citizens Republic Bancorp, Inc. Q1 2009 Earnings Call Transcript

| About: Citizens Republic (CRBC)

Citizens Republic Bancorp, Inc (NASDAQ:CRBC)

Q1 2009 Earnings Call

April 24, 2009 10:00 am ET


Cathy Nash - President and CEO

Charlie Christy - EVP and CFO

Mark Widawski - EVP and CCO

Marty Grunst - SVP and Treasurer

Kristine Brenner - Director of IR


Scott Siefers - Sandler O'Neill

Terry McEvoy - Oppenheimer & Co. Inc.

Jason O'Donnell - Boenning & Scattergood Inc.


Good day and welcome to today's program. (Operator Instructions) It is now my pleasure to turn the conference over to Kristine Brenner. Please go ahead, ma'am.

Kristine Brenner

Welcome to the Citizens Republic Bancorp first quarter conference call. This call is being recorded and a telephone replay will be available through May 1st. This call is also being simulcast live on our website where it will be archived for 90 days.

I have with me Cathy Nash, President and Chief Executive Officer; Charlie Christy, our CFO; and Mark Widawski our Chief Credit Officer who all have comments to share with you this morning. Marty Grunst, our Treasurer is also here to answer questions. After management concludes their prepared remarks, we will open the line up for questions from research analysts.

Before we begin, I would like to point out that during this conference call statements maybe made that are not historical facts. These forward-looking statements involve risks and uncertainties, which include but are not limited to those discussed in Citizens filings with the SEC.

Forward-looking statements are not guarantees of future performance and actual results could differ materially from those contained in the forward-looking information. These forward-looking statements reflect management’s judgment as of today and we expressly disclaim any obligation to update and/or revise information contained in these statements in the future.

Now I’ll turn the call over to our President and Chief Executive Officer, Cathy Nash. Cathy?

Cathy Nash

Thank you, Kristine. Good morning and thank you for joining us on our call today. Our first quarter results are reflective of both the economic times and our footprint, as well as results of work we have done to strengthen the balance sheet. As I am sure you've heard on most banks earnings call, the environment is not any better than it was in 2008 and in fact it's worsened in many cases.

To ensure our ability to remain confident in our future and ultimately to return to profitability, we have increased loan loss reserve and enhanced our liquidity. Loan commitments are up without lowering any of our credit quality standards, and we are very pleased to have been named the "SBA Lender of the Year" in Michigan. This recognition by the US small business administration reflects our commitment to serve our clients.

Our liquidity position remained strong and we continue to hold excess short-term assets. We grew deposits for the sixth consecutive quarter without resorting to paying the high rates that we have seen by some of the competitors in our markets.

Despite all the good work we are doing some facts remain out of our control all of which are driven by the economic cycle we are in. Our FDIC expenses are up and will continue to increase. Our cost of carrying real estate for longer periods of time is up. Foreclosure expenses are up. We see lower fee income from service charges on deposit accounts and from our trust and brokerage units.

While I am clearly not pleased to announce the loss, I think the work we have done and are continuing to do position us well to move through this protected downturn. Our headcount is down 234 FTE from the same time last year, about a 10% decrease.

In total our salaries and benefits decreased from last quarter by $3.3 million. We have actively reduced incentive payouts and delayed other payments to save another $1.5 million this year. We will seek to continue opportunities to save money and examine every viable opportunity.

We are actively seeking new revenue opportunities to offset the loss of some of the fee income this year. That effort is being lead by Tom Shafer, our Director of Regional Banking. We are actively engaged in our strategic planning process. The outcome of that work is very simple.

We need to focus on being the good, retail and business bank that we've always been. We need to direct our talent, resources and support around those core income producing activities. I have asked Charlie Christy whom I think most of you know and Judi Klawinski, our Director of Client Segmentation and Delivery to lead our efforts, and I am very pleased with the progress they have made so far.

Now Charlie, would you please take us through the financial results.

Charlie Christy

Thanks Cathy. Key financial highlights for the quarter include our net loss for the quarter was $45.1 million, better than the previous quarter by a $150.2 million, but worse than the first quarter of 2008 by $56.2 million.

Our net loss attributable to common shareholders was $49.3 million after incorporating the $4.1 million dividend to the preferred shareholders. When comparing our results to the fourth quarter of 2008, there were a number of key drivers that should be noted.

The fourth quarter included a non-cash valuation allowance of a $155.7 million against our preferred tax assets, which increased the fourth quarter income tax expense $136.6 million. Provision for loan losses were less by $54.5 million, and net charge-offs were down by $44.3 million.

Net interest income was down by $8.7 million. Our non-interest income was better by $3.5 million and our non-interest expense was worse by $2.2 million. I will spend a little more time on this later on. From an average balance sheet perspective, total loans were down by $359 million from the fourth quarter. Total commercial loans, commercial real estate and C&I were down by $267 million, while our total consumer loans mortgage direct and indirect were down by $92 million.

On the other hand total earning assets were up by $90 million due to increases of $456 million of money market investments and securities. Money market investments were up by $304 million to $426 million. So, if you do the math, loans that use to earn well above 5% when replace with more liquid assets earning nearly 25 basis points. That mix changes one of the key drivers behind our net interest income decrease in previous quarter.

Key drivers of the loan decreases were related to a number of factors, if you recall during the third quarter of 2008. We focused on enhancing our liquidity position. We created a bank way of process that focused on enhancing our pricing spreads and funding base, emphasize full relationship banking and reduce capital intensive credit-only businesses.

Those initiative, which still exists further strengthen our balance sheet, as they preserve capital, enhance returns on risk adjusted capital and align to changes in loan outstandings with funding, liquidity and profitability objectives.

As a result of these initiatives, we have a solid core deposit base currently maintain high levels of untapped liquidity, pay down the majority of our short-term funding and amount flush with liquidity. However, not quest to enhance liquidity. We also impact on our commercial loan pipelines and momentum, which resulted in the higher decrease in our first quarter loan outstandings than we anticipated.

Our increased focus on loss mitigation activity specifically in evaluating and visiting certain past loan clients also impact our loan pipeline momentum. We have recognized the need to balance pricing, funding, credit and loss mitigation activity and we have already put in place strategies and incentives to build back our loan pipelines and eventually our desired loan growth.

We continue to see less demand and less credit worthy borrowers, as this economic downturn continues to show it effects. Despite the slower low demand, we approved over 160 million of new commercials loans. We renewed over 275 million of commercial loans and we approved over 180 million of consumer loans during the first quarter.

Total deposits were up $119 million from the third quarter primarily driven by an increase of $130 million in core deposits, while we experienced a $5 million increase on our customer time deposits and a $16 million decrease in our brokered time deposits.

We continue to see many successes from our action plans initiated during 2008. These include a continued focus on driving household retention and expansion, stealing market share and gaining deeper share of wallets and a continued focus on training on full relationship banking in our commercial business lines.

Moving onto our pre-tax pre-provision core operating earnings table included in our release. As defined by management this represents net income or loss excluding the income tax provisional benefit, provision for loan losses and any impairment charges caused by this economic cycle. These charges include items like goodwill, credit write-downs and fair value adjustments.

During the first quarter of 2009, our pre-tax pre-provision earnings were $27.3 million, down $10.7 million from the fourth quarter. For the past four quarters our pre-tax pre-provision earnings were over $145 million. As we have noted before, our focus is to drive the action plans that preserve capital and enhance our liquidity position even at the expense of short-term earnings.

At the same time our goal is to maintain a strong PPP through the implementation of revenue enhancing and cost containment strategies, those have not stopped. The key driver for the decrease was a reduction in net interest income.

Let’s review the key components of the income statement. Net interest income was down $8.7 million for the fourth quarter and net interest margin percentage was down by 30 basis points to 2.73%. These decreases were primarily driven by the earning asset mix changed loans to money market investments, which while enhancing our liquidity position impact our top line revenue.

Non-performing loan increases and continued deposit price competition, partially offset by expand in commercial and consumer loans risk. Deposit rates fell much less than usual after the fourth quarter primarily changes and when rates finally started to decrease they occurred later in the first quarter.

Total charge-offs were $36.7 million, while our provision for loan loss was $64 million. Both were down significantly from the fourth quarter. Consumer net charge-offs, which includes residential mortgage, home equity, direct consumer and indirect consumer loans were down $3 million to $10.2 million.

As continued evidence that these portfolios are performing very well in this economy, consumer total dollar delinquencies were $61 million, which is down $22.5 million from the fourth quarter down $7.5 million from the first quarter a year ago.

C&I charges-offs were down 13.9% to $8 million, while commercial real estate charge-offs were down $27.4 million to $18.5 million. Total commercial loan delinquencies including C&I and CRE were down $26.9 million from the fourth quarter. So, the non-performing loans were up $122.6 million from the fourth quarter. $98.5 million of that increase was related to commercial real estate $73.4 million and residential real estate $25.1 million.

C&I and direct consumer made up the remaining $25 million of non-performing increases. The non-performing increase was the key driver behind the additional loan loss provision over net charge-offs of $27.3 million.

Non-interest income for the quarter was up $3.5 million from the previous quarters $19.2 million. Key drivers for the increase included $4.8 million income sling between the fourth quarter and this quarter from swap income recognition due to changes in related credit spreads.

The fourth quarter was a $2.4 million loss while this quarter was a $2.4 million gain. These are related to the FAS 157 rules. $1.3 million from higher mortgage income then offset by $1.4 million increase in deposit service charges and $900,000 in lower trust and brokerage fees.

Non-interest expense for the quarter was $80.8 million or $2.2 million higher than the fourth quarter. Key drivers for the increase included $6.8 million in higher ORE expenses, $1.8 million in higher FDIC charges, offset by $3.3 million of lower salaries and benefits and $3 million of lower other losses.

One interesting bit of trivia is that are FTEs are now down to 2,175. That was a level of FTEs of Citizens before the merger with Republic. At the beginning of 2006 Republic had over 1,000 FTEs. That is evidence that we are focused on cost containment and efficiency.

Income taxes were better than the fourth quarter by $103 million. This was due to the $155 million valuation allowance we established on our net preferred tax assets in the fourth quarter, which was comprised of $136 million income tax expense and $19.1 million reduction recognized through the OCI or other comprehensive income, component of our equity.

As a reminder, the valuation allowance will remain available to offset future taxable income over the next 20 years. As we have positive future earnings, we will be able to reduce the future tax expense by the valuation allowance and will eventually be able to write-off the remaining amount, the unused allowance when profits become evident. This also enhances future regulatory capital and tangible capital levels.

Capital adequacy and liquidity, our estimated Tier 1 capitals one of the highest amongst our peers at 12.2%, and is $589 million above well capitalized minimums. Our estimated total capital at the end of quarter was 14.2%. Our intangible common equity was 5.5.

We continue to maintain a strong liquidity position and stable funding base due to our on balance sheet liquidity sources. This is comprised of 70% of deposits, 16% long-term debt, 12% equity and a very low level of short-term liabilities at 2%.

I'll turn it over to Mark, now for more insight in our credit quality.

Mark Widawski

Thank you, Charlie and good morning. In the first quarter total nonperforming loans and the allowance for loan losses both increased due to the continued economic deterioration challenging us. As Charlie mentioned, nonperforming loans increased $123 million. Primarily due to further stress in the commercial and residential real estate secured portfolios.

Last quarter we saw increases in delinquencies for income producing, owner occupied and C&I asset classes. These increases migrated into NPLs and were the primary drivers of the $38 million, $35 million and $19 million increases in income producing, owner occupied and C&I respectively.

New commercial real estate nonperforming loans reflect softness in apartment, retail and leisure markets. As a result we have expanded our past credit review process to include a review of income producing exposure with a focus on retail related properties. $17 million of the $19 million increase in C&I NPLs was attributable to one credit, and we have specifically reserve for this loan based on the supporting real estate collateral.

Residential mortgage NPLs were up $25 million. The primary reason for the increase was due to a higher frequency of delinquent loans moving to NPL, due to economic and employment conditions. Approximately $11 million of the increase was due to a recent foreclosure moratorium.

We conservatively move loans to NPL status at 90 days past due. This was evidenced by the small and decreasing amount of our loans over 90 days delinquent and still accruing. The allowance for loan losses was $283 million at quarter end up from $255 million at year end 2008.

At quarter end the allowance for loan losses was 66% of non-performing loans. Our portfolio is heavily weighted towards commercial and real estate secured loans. In the event of default, the liquidation and NPL carrying times associated with these asset classes is longer than in consumer direct and indirect classes.

Each nonperforming commercial loans cash flow and collateral position is reviewed quarterly to determine probable losses and the specific portion of the allowance for loan losses, which accounted for $47 million of the $283 million total allowance. The remaining $236 million is the general risk associated allowance which represents 150% of nonperforming loans at the end of the quarter.

Charlie noted that our net charge-offs of $37 million were down from $81 million in the fourth quarter. The largest first quarter charge-off was less than $3 million. This compares with the fourth quarter where poor relationships accounted for $57 million of the $81 million total. Land development was the only asset class showing an increase in net charge-offs and we continue to view this asset classes extremely distressed, and mark land development loans based on current appraised liquidation values.

The commercial watch list grew by $131 million in the first quarter. First quarter past credit reviews of the automotive and major exposure portfolios looked at $510 million in exposure. You may recall these initiatives involve our market teams meeting with clients, obtaining updated financials and projections to validate underwriting and risk ratings under current market conditions.

These reviews resulted in $90 million in downgrades that drove the increase in the watch list. Additionally, the first quarter watch process reviewed $571 million in exposures. Downgrades totaled $93 million down from a $137 million in the fourth quarter. Transfers to our workout groups totaled a $136 million in the first quarter, up from $68 million in the fourth quarter to ensure the stress credits are monitored closely and managed appropriately.

We continue to monitor our automotive industry related exposure closely, as evidenced by the past credit review initiative for the segment. We have conservatively used a 25% auto-related revenue threshold for our clients directly dealing with the industry. And have include service and real estate related businesses within close proximity to auto plans in our reviews.

Our auto exposure declined to 8.4% of the total portfolio, as clients managed their working capital down to match production cuts. We are utilizing the automotive expertise of our asset based lending team to assist clients tap to participate in the treasuries Auto Supplier Support Program.

In the first quarter we transferred $47 million in auto related credits to ABL to enhance working capital collateral management. In response to GM's extended summer work shutdown announcement earlier this week, we will be contacting our GM clients to assess the impact on their cash flow and develop an appropriate action plan.

To watch and past credit review processes are critical to the early identification of issues, which are key to adjusting credit underwriting and mitigating potential loss given default.

Back to you, Cathy.

Cathy Nash

Thanks Mark. Before we open it up for questions, I would like to briefly mention our rationale for suspending qualitative guidance. Like many other financial institutions, we found that the practice we are trying to forecast in these uncertain economic times is, to put it modally extremely difficult.

We remain confident in our future and as I mentioned, I am very pleased with the steps, we have taken to-date to ensure our ultimate return to profitability.

At this time, we’d like to open up the line for questions.

Question-and-Answer session


(Operator instructions) We'll take our first question from the side of Scott Siefers with Sandler O'Neill.

Scott Siefers - Sandler O'Neill

Let's say, I guess the first question, I had was just on, there was something to drill down a bit more into the fair value write-downs on the loans out for sale and then more specifically I guess on the OREO write-downs. One if you could, maybe just add a little color and distinguishing between maybe initial marks on the OREO versus ongoing ones and then just generally, are the write-downs in OREO are those a result of continued declines in housing values or is it also, having to keep and maintain that real estate longer above and if possible, where we do expect that line to go in coming quarters.

Charlie Christy

Right. So, we did have held for sale write-downs and OREO. So, the held for sale write-downs obviously, the majority of those related to updated appraisals and things like that and making sure we mark those to the right market values. On the OREO properties, pretty much doing the same thing, but Marty a few more things you can add to that.

Marty Grunst

Yeah. No, it’s a result of current appraisals they are primarily commercial properties as appose to residential. And we have seen continued stress in our valuations and the properties that are in that portfolio.

Scott Siefers - Sandler O'Neill

Okay. And then I guess since there are more commercial, any specific industries are concentration in there?

Mark Widawski

At this point it’s primarily the land and land development pieces that are there and we update the appraisals on a 12 to 18 month basis in that portfolio and as they come in, we're seeing softness, but it's not a decline from where we are a change from where we saw in previous quarters.

Scott Siefers - Sandler O'Neill

Okay, perfect we still on the mostly residential related though it sounds like?

Marty Grunst

You mean residential development, right?

Scott Siefers - Sandler O'Neill


Mark Widawski


Scott Siefers - Sandler O'Neill

Okay. And then if I get switch gears over to the margin just to in the decline. Charlie you addressed, the kind of the funding dynamics in the first quarter to a certain extent. Would your [bias] for the margin before to rebound, we've heard a couple of companies that saw some sort of sphere contraction in the first quarter suggest that the direction should be up. I guess I would be curious as to how much valuation you thinking you could recapture just as the funds that you've got are able to be deployed in a more efficient fashion?

Marty Grunst

It's Marty. Let me help you out with that. If you look at the trends on deposit pricing within the quarter, normally you'd see the deposit rates react pretty quickly to the prime drops we saw at the end of the fourth. That really didn't happen until the end of the first quarter and actually continued a little bit into April.

So if you look at the timing of the margin within the quarter. The margin for the month of March was actually 19 basis points higher than the margin for the month of January. So I think that should give you a pretty good idea of how that kind of play out for us.

Scott Siefers - Sandler O'Neill

Okay. And then this might be getting I guess too granular, but can you give us a sense for where the March margin was relative to the total first quarter margin?

Marty Grunst

Certainly fairly north of it.


We'll take our next question from the side of Terry McEvoy with Oppenheimer.

Terry McEvoy - Oppenheimer & Co. Inc.

Charlie, just a question on capital, ended the first quarter your TC at 5.5 and it was north of seven just two quarters ago. And as I just plug into my model a similar loss in the second quarter we're getting close to 5% without talking about just the directions of net income. How low could that go before you would need to address that issue?

Charlie Christy

Well, obviously our first and foremost focus is really on our regulatory capital ratios, which are very strong when compared to our peers and we continue to implement actions that will help mitigate future losses and also help maintain those ratios. We are also focused on activities that help maintain and enhance our PPP overtime.

So again that's going to hopefully help and slow down any deterioration of the capital levels especially the regulatory in these periods. And then third, let's remember that our tangible common equity was impacted by the differed tax allowance taken in the fourth quarter, which was an accounting entry and accounting entry is significantly impacted by 80-90 basis points.

So when, we do return to profitability and the key is we need to get through this financial crisis. We will have the ability to write that asset back up and by the time we get to that further period out that should be a lot larger balance because we will be able to continue to have net operating losses that will grow through that. So that will have a big trigger that's down the road once we get back to profitability we'll have it come back.

So for us to put in we'll call it short-term activities and action plans in order to just focus on trying to bolster the TCE does not make sense to us at this time.

Terry McEvoy - Oppenheimer & Co. Inc.

Looking at the mortgage banking line this quarter, a little below what I might have expected given what the industry is seeing in some of your peers. Can you just remind us the changes that have happened from when you bought, acquired Republic Bankcorp and I believe you outsourced some of that business by some of the events that you have taken? Is that may be limited some of the outside in terms of mortgage banking revenue and then second part would you expect that number to increase in the second and the third quarter just as pipelines potentially grow?

Charlie Christy

Yes, that’s a good question. When we did merge with Republic we first did move our business to their servicing system. We eventually moved off their servicing system and moved back to PHH, both with our underwriting and processing and servicing. So we are plugged into that environment, therefore we're going to be sending 90% plus of our originations into the secondary market.

We are seeing some growth in that, we are in markets that are little bit tighter than others when it comes to loan demand and so we are not seeing as much as we might see in other states. Cathy, do you want add something?

Cathy Nash

Yes. The piece I would add to it Terry is, one of the strategic moves behind moving to PHH was when the market was down because we don't have the backroom underwriting and production facilities. It limits us and it quite frankly helps us in a down cycle, because you just simply can't cut your way out of it. But it does limit you when the cycle comes back and you have more opportunity, because you balance out what you pay PHH for the upside and the downside. We felt strategically in our markets, that was the best move for us and I have been very pleased with that so far.

Our production level has been up, but as Charlie mentioned, 90% plus of it goes through PHH and is sold in the secondary market and that is part of our strategy.


We'll take our next question from the side of Jason O'Donnell with Boenning Scattergood.

Jason O'Donnell - Boenning & Scattergood Inc.

Just a couple of quick questions here. In terms of the deposit gathering, looks like you have a nice quarter and Charlie touched on that, I believe. I am wondering how much of that in your view is a function of, kind of reduced competition in the market versus just a general flight to safety on the part of consumers?

Cathy Nash

I would say there's some of each and plus a third factor that I'll mention. There is disruption in our markets and one of our strategies is to take advantage of that. A lot of our competitors had their heads down trying to solve all the issues, and we're solving our issues too. But we want to keep our line bankers focused on our clients and our opportunities in our markets.

Yes, there has been a bit of way to safety I think arriving tied with all if you will. But I had a third piece for us and that is, we are actively growing our client base. And just in the second quarter we are net up a 141 new clients within the consumer bank alone. And well that might not sound like some big bank terms and in our company that's a pretty big number, it’s a nice move for us and a reversal of some trend.

So, one of the things I’m very pleased about and quite optimistic about is our line banker’s ability to bring new deposit clients into the bank that's a long-term good way to fund ourselves, keeps our lines of short-term funding and grows our client base in our relationship. So, I think, yes, to the first two questions, but also to our line bankers, who are bringing new clients and.

Jason O'Donnell - Boenning & Scattergood Inc.

Okay. Great and in terms of sticking to that themes you got, potentially here to increase deposits and you got increasing liquidity it's look like I’m wondering, what your intentions are going forward, so we see continuation of pay downs on debt or should we see the securities portfolio kind of be the place for those funds will move to. Can you just give us some color on your expectations in the second quarter?

Charlie Christy

Probably our objective is to focus on growing high quality loans to the greatest extent we can, and that's going to be the best way to employee some of the excess liquidity. So, in terms of our priority list that certainly at the top. To the extent, but that doesn't materialize to the level we would like to see it. I think we’d next look to the liability side.

Cathy Nash

And Jason as I mentioned we see disruption in our markets that not only help us from a deposit gathering in a client growth side it helps us from loan gathering side as well. We put a lot of emphasis on our [FDA] growth and as I think we mentioned in our press release we've been named the FDA lender of the year. That's a great opportunity and absolutely fits within the sweet spot of our client base. So, we're actively out in the market seeking new opportunities, when many folks aren’t.

Mark Widawski

And it certainly does represent a margin opportunity.

Jason O'Donnell - Boenning & Scattergood Inc.

Okay, great. And then just finally housekeeping item, in terms of this pending one-times FDIC assessments coming down the pie, we have clarity on the size of this charge in the second quarter, you guys intend to take the entire charge in the second quarter or you're going to [clear] it over the second and third quarter up until payment.

Marty Grunst

No, we planned on taking the full amount in the second quarter.

Cathy Nash

Thank you. And with that we will conclude our call today. Thank you all and have a great day.


And this concludes your conference for today. Thank you for you participation. Have a great day.

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