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Citizens Republic Bancorp Inc. (NASDAQ:CRBC)

Q2 2009 Earnings Call

July 24, 2009; 10:00 am ET


Cathy Nash - President and Chief Executive Officer

Charlie Christy - Chief Financial Officer

Mark Widawski - Chief Credit Officer

Marty Grunst - Treasurer

Kristine Brenner - Director of Investor Relations


Scott Siefers - Sandler O’Neill

Greg Ketron - CitiGroup

Terry McEvoy - Oppenheimer

Eileen Rooney- KBW


Good day everyone 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

Good morning and welcome to the Citizens Republic Bancorp second quarter conference call. This call is being recorded and a telephone replay will be available through July 31. This call is also being simulcast live on website where it will be archived for 90 days.

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

Citizens recently filed preliminary proxy materials and a registration statement on Form S-4 with the SEC. During today’s call, we will not be discussing either one of these filings in our prepared remarks, nor will we be able to address any questions related to them due to the applicable SEC restriction.

You may obtain these documents and related documents free of charge by visiting the SEC’s web site at or the Investor Relations page of our website You are encouraged to read these documents as they contain important information. The information conveyed on this call is not an offer of any Citizens securities for sale.

During this conference call statements that are not historical facts such as those regarding Citizens future financial and operating results, plans, objectives, expectations and intentions are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject risks and uncertainties, which include, but are not limited to those discussed in Citizens annual and quarterly reports filed with the SEC.

Forward-looking statements are not guarantees of future performance and actual results could differ materially. These forward-looking statements reflects management’s judgment as of today and we expressly disclaim any obligation to update or revise information contained in these statements in the future, except as required by applicable law.

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

Cathy Nash

Thank you, Kristine. I think your comments were longer than mine are going to be. Our second quarter results continue to reflect the economic stress that Michigan and the Midwest is experiencing. As most of you know, about 80% of our revenue comes from this state and since our last call we’ve had bankruptcies of both Chrysler and GM.

Over 20 major Tier-1 suppliers have filed for bankruptcy protection this year, Visteon, Metaldyne and Lear are being the most notable recent filings. Many other smaller suppliers have chosen to cease operations and liquidate.

We continue our aggressive management of our loan portfolio, which Mark will comment on in a few minutes. Additionally, we have undertaken a series of steps to further protect the company that may include capital raising activities. We have begun this work as a result of the analysis we’ve conducted on our own portfolio, but also because we see a protracted downturn in the states that we serve. Recovery will come to the Midwest; it will simply take longer than the rest of the country to arrive.

As the economic environment remains uncertain, we maybe impacted by that. Before we get into the details of our results, let me share with you some bright spots. These positive trends point the long term potential of our company and I’m proud of our team of bankers who continue to serve their communities and clients during difficult times.

As a leading SBA lender in Michigan, we’ve already closed over $20 million in SBA loans this year. Our branches are growing, we’ve added over 14,000 new clients year-to-date. In the second quarter alone we opened more than 30,000 new accounts compared to the first quarter, that’s an additional 1200 more consumer and business checking account.

We booked an additional 340 loans for consumer and business clients excluding mortgage and indirect. Since our incentive system does not pay for account opening, but for revenue, this is real growth. It’s also one of the reasons our incentive payouts are higher than the first quarter.

Our revenue work continues, as I said in the last quarters call we must seek opportunities to offset the loss of fee income from deposit accounts we’ve experienced from lower overdraft activity.

Adjusting our earnings credit rate, for example is worth about $600,000, simply having a sale on vacant safe deposit boxes, and that’s about $10,000. Some ideas are small but they add up. We’ve identified over 60 opportunities that have a run rate impact of more than a million dollars a year.

I will now turn the call over to Charlie Christy, our CFO who’ll take us through the details of our results. Charlie.

Charlie Christy

Thanks Cathy. Key financial highlights for the quarter include our net loss for the quarter was $347.4 million compared to the net loss from the previous quarter of $45.1 million and a net loss of $201.6 million from the second quarter 2008.

Our second quarter included a non-cash goodwill impairment charge of $266.5 million, which has no impact on our regulatory capital ratios or overall liquidity position. Key drivers for the quarter were increases in our non-performing loans, which impacted our net interest margin, provision expense at a $100 million, slight increase in our non-interest income, a the goodwill impairment charge in the special FDIC assessment of $5.6 million.

From a balance sheet perspective, total loans were down by $329 million from the first quarter. Total commercial loans which includes commercial real estate and C&I were down by $218 million, while our total consumer loans mortgage, direct and indirect were down by a $111 million. Total earning assets were down by $256 million due to decreases in the loan portfolio and decreases in the investment portfolio as maturing balances were not being fully invested.

Money market investments were up by $79 million from the previous quarter to $561 million. These balances are up $561 million from a year ago reflecting our focus on liquidity and maintaining the strong cash cushion.

The key driver behind the loan portfolio decreases is that we continue to see less demand from credit worthy borrowers, as this economic cycle continues to show its effects. Despite the slower loan demand, we approved a 178 million of new commercial loans, we renewed over 339 million of commercial loans and we approved over 210 million of consumer loans during the second quarter.

Total deposits were down $206 million from the first quarter. Core deposits continue to show a good growth with an increase of $120 million over the previous quarter. Core deposits increased $318 million or 7% over the second quarter of 2008. Time deposits were down $326 million. $266 million of that decrease was due to our plan reduction of our broker time deposits.

Moving on to our pretax, pre-provision, core operating earnings table included in our release is defined by us, this represents net income or loss excluding the income tax provision or benefit, provision for loan losses in any impairment charges or special assessment. These charges include items like goodwill, credit write-downs, fair value adjustments and FDIC special assessments.

During the second quarter of 2009, our pre-tax pre-provision operating earnings were $21.4 million, down $5.9 million from the previous quarter. The key drivers for the decrease included lower net interest income due to increases in non-performing loans and increased NIE from performance based incentive payments for frontline personnel and advertising.

Let’s review the components of the income statement. Net interest income was down $1.3 million from the first quarter and our net interest margin percentage was unchanged at 2.73%. Net interest income decrease was driven by the earning asset mix changing loans to money market investments, which while enhancing our liquidity position impacted our top line revenue.

Non-performing loan increases and continued deposit price competition were then partially offset by expanded commercial and consumer loans spreads.

Total net charge offs were $49.2 million, while our provision for loan loss was $100 million. Both were up from the first quarter. Consumer net charge-offs, which includes residential mortgage, home equity, direct consumer and indirect consumer loans were up $2.9 million to $13.1 million.

However, there is continued evidence that these portfolios are performing very well in this economy, total consumer delinquencies were $65.6 million, which is up slightly from the first quarter level of $61 million, while they are down from a year ago by $5.7 million.

C&I net charges-offs were down $1.2 million to $6.8 million, while commercial real estate net charge-offs were up $10.8 million to $29.3 million.

Total commercial loan delinquencies including C&I and CRE were down $74 million from the first quarter. Total non-performing loans were up $67 million from the first quarter. $39.7 million of that increase was related to commercial real estate and $18.7 million increase in residential mortgage loans.

The non-performing loan increase was the key driver behind the additional loan loss provision over the net charge offs of $50.7 million. Non-interest income for the quarter was up $1.7 million from the previous quarter to $21 million, key drivers for the increase include the lower losses on loans held for sale, slightly higher mortgage and other income, and slightly higher deposit service charges due to increases in our core deposits. These are partially offset by lower other incomes.

Non-interest expense for the quarter was $355.4 million, which includes the $266.5 million goodwill impairment charge in the $5.6 million special FDIC assessment. After adjusting for those two items, the NIE for the quarter was $83.4 million or $2.6 million higher than the previous quarter. As noted earlier that increase was primarily related to a higher performance based incentives and advertising.

Let’s discussed, the $265.5 million goodwill impairment charges; majority of our goodwill is created when we purchased Republic Bancorp back in 2006. If you remember the goodwill from that acquisition was approximately $727 million.

During the quarter we determined that we should conduct an interim analysis of our goodwill because of ongoing volatility in the financial industry, expected ongoing challenges in the economy, especially in Michigan, continued loan portfolio deterioration and the uncertain trickle down effect of recent bankruptcy filings in the automotive industry.

We updated our annual goodwill analysis, conducted discount and cash flow and pricing analysis to see if the fair value of the assets and liabilities in a different group succeeded their carrying values and determined that the regional banking portion of our goodwill was impaired.

It is a non-cash charge and it is not tax deductible. It has no impact on our tangible equity or regulatory capital ratios and it does not affect our liquidity and cash positions. After the charge we have $331 million of goodwill left on our books.

Capital adequacy and liquidity, our estimated Tier-1 capital was one of the highest amongst our peers at 11.83% and is $532 million above well capitalized minimums. Our estimated total capital at the end of the quarter was 13.93%, while our tangible common equity was at 5.09%.

We continue to maintain a strong liquidity position and stable funding base due to our on balance sheet liquidity sources. This is comprised of 73% of deposits, 16% long term debt, 10% equity and a very low level of short term liabilities at 1%.

Now, I will turn it over to Mark Widawski for a more insight into our credit quality. Mark.

Mark Widawski

Thank you Charlie, and good morning. Our second quarter net charge-offs, non performing loans and provision for loan losses increased as the economic environment, particularly in Michigan continued its negative trend.

Our non performing assets were up $54 million in the second quarter, primarily driven by continued stress in the commercial real estate and residential mortgage portfolios. Total commercial real estate NPLs increased by $40 million. This increase includes $10 million retail center loan. A $6 million charge was taken this quarter on the loan based on the current appraised value of the property.

Owner occupied real estate accounted for a $6 million of the increase reflecting softness in the manufacturing and transportation sectors. The $8 million increase in C&I, NPLs was primarily related to one loan. We have specifically reserved for this loan based on the appraised value of the collateral. We conservatively move loans to NPL status at 90 days past due. This is evidenced by the small and decreasing amount of our loans over 90 days delinquent and still accruing.

Residential mortgage NPLs were up $19 million in the second quarter. This increase is attributed to the loss mitigation efforts in our residential mortgage portfolio. The allowance for loan losses was $333 million at quarter end, up from $283 million in Q1. The increase reflects the higher level of NPLs continued deterioration in commercial real estate loans and the recession’s effects on the C&I and residential mortgage portfolios.

Each non-performing commercial loans cash flow and collateral position is reviewed quarterly to determine probable losses and the specific portion of the allowance for loan losses. This accounts for $69 million of the $333 million total allowance.

The remaining $264 million is the general risk associated allowance, which represents 177% of the remaining underlying nonperforming loans at the end of the quarter. Net charge-offs of $49 million were up from $37 million in the first quarter.

Fore relationships accounted for $22 million of the second quarter total. Three of the relationships were commercial real estate related. The largest charge-off totaled $7 million based on current appraisal of the borrowers income producing and owner occupied properties.

By contrast, in the first quarter the largest charge was under $3 million. The commercial watch list grew by $168 million in the second quarter. Second quarter past credit reviews of the C&I and income producing commercial real estate portfolios looked at over $1 billion in credit exposure. These reviews resulted in $140 million in downgrades that drove the increase in the watch list.

The purpose of the past credit reviews is to enhance our client interaction, obtain current financials and projections to validate our credit underwriting and risk ratings, as well as initiate structural changes to improve the bank’s position.

We proactively moved credit to watch status through the past credit review when we conclude that quarterly management and credit review of the client’s financial or collateral information is appropriate.

The $74 million quarterly improvement in total commercial delinquencies is due to a focused effort by our market teams to engage at our clients in advance of renewals and intervene early, should payment trends show signs of deterioration.

Charlie referred to our consumer loan portfolios performance faring well, given the climate of rising unemployment and the declining asset values. The indirect consumer loan portfolios delinquencies were flat with non-performers and charge offs down quarter-over-quarter.

This portfolio of primarily RV and marine loans is conservatively underwritten and well managed by an experienced team. The direct consumer loan portfolio is made up primarily of home equity loans, originated through our branch and banker teams.

Nonperforming loans in this segment were flat for the quarter. We continue to monitor our automotive industry related exposure conservatively, using a 25% auto related revenue threshold for clients directly dealing with the industry, and have included service and real estate related businesses within close proximity to auto plans in our reviews.

Our auto exposure declined to 8.14% of the portfolio, as clients continue de-leveraging their working capital positions. We were paid in full on our participation in GM’s senior secured revolving credit at the of the quarter. Our exposure to dealerships that received closure notices from Chrysler and GM is minimum. Cathy, back to you.

Cathy Nash

Thank you Mark. Our results for this quarter are not surprising, considering the environment in the Midwest and in Michigan in particular. Our bankers continue to do the right things to position us for the future, take care of our current clients and appropriately gain new ones.

This concludes our prepared remarks. Now we will open up the lines for questions.

Question-and-Answer Session


(Operator instructions) Your first question comes from Scott Siefers - Sandler O’Neill.

Scott Siefers - Sandler O’Neill

First; just a couple of credit related questions. I guess there’s been a lot of different focus on different metrics that people are looking at, especially this quarter. I wonder which of the metrics, on a credit basis are you guys placing the most emphasis on, as you look for signs of the additional detritions or turn, stabilization etc.. Early stage delinquencies, NPAs. Which are the ones that you guys are most focused on?

Mark Widawski

Scott, this is Mark. I’ll backup to our fast credit process, as a feeder to where we really want to get a feel for what’s happening out there in the individual credits and the portfolios. That process this past quarter resulted in downgrades that were similar to the first quarter, and gave us an opportunity to step in and do so some additional shoring up of our physicians with clients.

Our NPLs this quarter in terms of a slower increase, is another area that we would look at to give us some indication for the future. The early stage delinquency improvement that we saw this quarter was the result of a lot of effort and we are going to watch that closely to see if that’s something that continues.

Scott Siefers - Sandler O’Neill

Then, but additionally can you kind of characterize qualitatively how you guys felt about the paces of deterioration in the footprints specifically, since we had Chrysler and GM bankruptcies. Since then there has been the heavier kind of supplier focus as well. Just any qualitative thoughts?

Mark Widawski

We are very closely attuned to the supplier base issues. The GM and Chrysler events for us, in terms of the commercial and commercial real estate related side of it were not negative events in terms of any of our charges or delinquencies this past quarter.

The bankruptcies in the supply chain also were not events that effected us negatively in any of the categories. We have tried to manage exposure to auto suppliers that we believe were trending, as some of them ended up this past quarter in bankruptcy and I think they have done a good job actively managing that exposure.

Looking out into the future, we are going to continue to do that, the effect on the consumer portfolios of all of these events is something that is going to have to play out I think in the third and fourth and first quarter of next year.

Scott Siefers - Sandler O’Neill

I guess just one question as it relates to capital. I guess either Cathy or Charlie it’s probably best for you. Depending on the success you had with the offers that are outstanding. I guess you have applied for the Cap program, I guess.

How would you weigh, potentially converting some of your tarp shares in the [common] which I think would be up. They would convert I think around $1.50 a share which would be perhaps a more attractive price to the shareholder base, but by the same token would bring more of a permanence to the government ownership. How do you weigh those dynamics as you think about some of your capital alternatives?

Charlie Christy

We are pretty much prohibited to talk much about this at all, because we do have the proxy in S4 outstanding. All I would say is that, we look at all alternatives as key things that we want to consider, and we try to find as many ways in the future. If we need it, we’ll use it.

So, as far as whether we rank it high or low we are not ready to speak to that, but we will look at all of the alternatives and consider them and try to make sure we do the prudent thing for this company, and make sure we get through the financial crisis.


Your next question comes from Greg Ketron - CitiGroup.

Greg Ketron - CitiGroup

First; if I could start with margin, maybe Charlie for you margin was stable. Do you think we’ve seen the worst of the margin depression or how do you view those playing out for the rest of this year and the next year?

Marty Grunst

It’s Marty, let me talk about a little bit, I’ll stop sort of actually making a prediction, but let me talk through a couple of each of the more important trends and giving a little history on those. I can give you a little color around that.

The two positive drivers were loan spreads and loan pricing first, and deposit re-pricing. The loan pricing, we’ve gotten consistent list quarter-over-quarter out of that up till now and we are keeping that same process in place. That’s working very well for us.

On the deposit pricing front; if you look at the maturity distribution of our liabilities we’ve got a larger than normal amount of liabilities re-pricing in the third quarter and throughout the quarter, more than we have in the past couple of quarters and that has probably got 200 basis points or so of re-price down capability in it.

Then the other two negative trends that have been affecting the margin, and just not accrual outstandings. I think that trend you can see and that kind of speaks for itself. Loan volume is the other one, and again that’s the trend that you can kind of see the history of, it also speaks through itself.

But through that loan volume versus how much cash we’ve got on hand, $560 million of available cash is really more than would be necessary for us and I think that given the amount of liabilities re-pricing and the third quarter we will have better opportunities than we have had to manage that level going forward.

So, we can affect that negative carry, probably a little bit more opportunity there to do that. So, hopefully that helps Greg.

Greg Ketron - CitiGroup

Yes, that’s very helpful. Marty, do you anticipate the CD portfolio, where you had a pretty sizeable drop, that direction will continue as you work your way out or is that that more function of just that have the maturity this quarter?

Marty Grunst

The CD portfolio drop was almost entirely brokerage CDs where and we’ve got some that have calls embedded in them, or we own the call and give them what rates have done, I think those calls are pretty deep in the mind. So, we’ve exercised those calls and there is no reason of replace it given the liquidity position.

Again next quarter we have some more of that on the liability side where we can manage the brokerage CD book, and that’s a very nice level to be able to pull to manage the overall margin.

Greg Ketron - CitiGroup

The other question is on past dues; in light of the economic situation you had a very impressive improvement in the past few levels. I was just trying to get some color behind the scenes.

I think you alluded to the fact you have been working the past dues very hard, but there are some other factors that are entering into play to get that kind of improvement and does that probably into which you think maybe a pretty substantive drop in NPL inflows.

Mark Widawski

This is Mark. Well, I think that it’s something that we are going to be very cautious about going forward, given the state of the economy in Michigan. Our frontline folks and their credit partners are very attuned to trying to make sure that they get in front of real deteriorating situations as quickly as possible to try to shore up the credit side.

So, I hope that we can continue to do that. It was an excellent effort by our teams. In terms of translating it into how it’s related to the NPLs of this quarter. I think it did have an effect that we didn’t have as many administrative NPLs that ended up on the books of this quarter.

Greg Ketron - CitiGroup

And the drop that you saw this quarter carrying over into the third, do you think that that’s a favorable development.

Mark Widawski

Yes, I kind of think, I know where you are headed and we would just continue to show some caution in Michigan. I think as you know when you have the number of things that occurred in this second quarter, there is a legging factor that we properly haven’t even begun to feel as much of a trickle down as that may occur. Who knows, that’s anybody’s guess

So we were, we see the early stage things that seem positive, but we are cautious, because we know there’s a late factor due to the economic issues that have just recently been announced and that we are going through.


Your next question comes from Terry McEvoy - Oppenheimer.

Terry McEvoy - Oppenheimer

I know you really can’t talk specifically about actions that you are taking to increase capital, but could you give us a sense in terms of where you would like your overall capital levels to be and is there any sort of target looking at a few quarters, looking at a few years, just that we can get a sense for how much you need to raise, but just internally how you are looking at what needs to be the right level of capital.

Charlie Christy

Yes, this is Charlie. That’s a fair question and the hard part is really, trying to match that up to what you think the economic issues are going to be and how that’s going to impact our balance sheet.

So I would say that we are still very focused on doing whatever we need to do to maintain strong regulatory capital ratios. We do realize that eventually coming out of this we would want to make sure we have a decent tangible common equity.

So we are going to do the things that we need to do, but this is something that we are going to be in for a while and it’s hard to quantify what you would like, but again our focus is on the regulatory and as we come out of the financial crisis to have a decent tangible common.

Terry McEvoy - Oppenheimer

Then the one thing you can control in this environment is overall operating expenses, Cathy you are as lean as you can be right now. Is there any areas where you can cut to provide some improvement I guess to pre-tax, pre-provision earnings which would I guess help the capital scenario that Charlie just talked about?

Cathy Nash

Yes, good question Kerry, thank you. In the last few years, we have pulled about $54 million of expenses out of our run-rate. If you look from the Republic acquisition to now, we put two companies together totaling a little over 3000 FTEs and took another thousand of those FTEs out.

So, in the combination of two firms, we essentially reduced by 1 and this year-to-date we pulled another, almost $13 million and in addition to that out of our expense run rate, for example we announced that we were not doing a 401K match in this economic environment, with the challenges we face, that’s a prudent thing for management to do.

So, our goal is to cut our expenses in ways that make sense for our company for the long term, but don’t cut us to the bone in a short term. Because we are still growing our business; we are growing our clients; we are growing the number of accounts. We did $728 million of new loans in the second quarter [inaudible] and pricing parameters. So certainly we are looking at every opportunity to cut expenses, we just want to do it in a way that’s prudent for the long term.

Terry McEvoy - Oppenheimer

Just one last question. As you talked to the board and discussed capital and I will just be vague, how comfortable is the board with potentially having the US Government being a significant shareholder, potentially in Citizens Republic. Is there a level of comfort that if that is one of the strategies utilized, they would be comfortable with?

Charlie Christy

Well, this is Charlie. That’s an interesting question, obviously if we see the need to trigger the Cap; we applied for it as we said and if we see the need to trigger the Cap that could translate into some ownership level.

I think if we do not do other things that would drive that level either up or down. So, I think the board is comfortable with the capital strategy of building an arsenal, of having alternatives on the shelf that we can pull down to use when we see the need to use. If that does include utilizing Cap, then I think they are ready and willing to do what they need to do to make sure we get through the crisis period.


Your final question comes from Eileen Rooney - KBW.

Eileen Rooney- KBW

Most of my questions have already been answered, but maybe just follow-up on what you said Charlie about the level of capital you would want. You said a decent TCE ratio at cycle end. Could you just maybe quantify that a little bit for us?

Charlie Christy

Well, the only thing I would say that, years ago before the crisis occurred we always had like a 7%, 7.5% TCE. I think there are a lot of banks that were operation in between the 6% to 7% range and so I think eventually we do want to get back into that range because that’s I will call the historical kind of range that I gave you a little bit of dry powder if you wanted to do some other things down the road.

I think going forward its going to be a little tougher kind of perspective, because the key here is it is coming out of the financial crisis and being positioned to be a force in your market place.

When I mean by decent, you don’t want to have something where you are still begging and scratching and so on to kind of just get what you need. It’s hard to find exactly what it is, but you can look at some history though to give you some guidance.

Eileen Rooney- KBW

That’s great, and then just one more question on the capital plan and from a timing perspective, maybe give us a little bit of color when we should expect some of these exchanges. I know the shareholder meeting rather is August 20, but maybe just a little bit of color on the timing.

Charlie Christy

Eileen that’s really something we can’t really talk about unfortunately, but as things get announced we will make sure you see them.


It appears that we have no further questions in the queue at this time.

Cathy Nash

Thank you everyone. We appreciate your time this morning, as usual if you have follow-up questions you can contact Kristine Brenner, our Director of Investor Relations and she will be happy to guide you to the right person. Have a great day. Thank you.


This concludes today’s teleconference, you may disconnect at any time. Thank you and have a great day.

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