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Citizens Republic Bancorp, Inc (NASDAQ:CRBC)

Q4 2010 Earnings Call

January 28, 2011 10:00 am ET

Executives

Lisa McNeely - Chief Financial Officer and Executive Vice President

Mark Widawski - Chief Credit Officer, Executive Vice President, Chief Credit Officer of Citizens Bank and Executive Vice President of Citizens Bank

Kristine Brenner - Director of Investor Relations

Cathleen Nash - Chief Executive Officer, President, Director, Chief Executive Officer of Citizens Bank and President of Citizens Bank

Analysts

Brett Scheiner - FBR Capital Markets & Co.

Eileen Rooney - Keefe, Bruyette, & Woods, Inc.

Terence McEvoy - Oppenheimer & Co. Inc.

Operator

Good day, everyone, and welcome to the Fourth Quarter Conference Call. [Operator Instructions] It is now my pleasure to turn the conference over to Ms. Kristine Brenner. Please go ahead.

Kristine Brenner

Thank you, and good morning. Welcome to the Citizens Republic Bancorp Fourth Quarter Conference Call. This call is being recorded and a telephone replay will be available through February 4th. This call is also being simulcast live on our website, citizensbanking.com, where it will be archived for 90 days.

I have with me Cathy Nash, President and Chief Executive Officer; Lisa McNeely, Chief Financial Officer; and Mark Widawski, Chief Credit Officer, who all have comments to share with you this morning. Brian Boike, 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.

During this conference call, statements may be made that are not historical facts such as those regarding Citizens' future financial and operating results, plans, objectives, expectations and intentions. Such forward-looking statements are subject to 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 reflect management's judgment as of today, and we expressly disclaim any obligation to update or revise information contained in these statements in the future.

Now, I'd like to turn the call over to our President and Chief Executive Officer, Cathy Nash. Cathy?

Cathleen Nash

Thank you, Kristine. Last quarter, we said we were going to aggressively pursue resolution of problem assets in our portfolio. We anticipated doing the bulk of that work over two quarters. Our fourth quarter results reflect the significant progress we've made as we resolved $466 million of problem assets in the quarter with charges of $159 million. Some other key facts for your consideration: our 30-89-day delinquencies are at their lowest level in four years; our watch list declined 25% in a year; non-performing assets are down 52% in the same timeframe; net interest margin expanded by 10 basis points to 3.42% this quarter and it's up 41 basis points on a year-to-date basis compared to last year.

Non-interest income reflected our strong efforts around Reg E implementation, as well as increases in key fee income categories during the past year. Lastly, we continue to maintain strong expense management while adding sales positions in the fourth quarter. Our pretax pre-provision profit came in at $32 million for the quarter.

I'll let Lisa and Mark talk about the details of the quarter, and I'll finish up with some concluding remarks. Lisa?

Lisa McNeely

Thanks, Cathy. The net loss for the quarter was $106 million, which is an increase over last quarter's net loss of $62 million. Increased provision expense reflecting our accelerated work in resolving problem assets was the primary reason for the increased loss over the prior quarter. Provision expense was a $131 million for the quarter compared to net charge-offs of $159 million. As we discussed last quarter, we expected to record about a year's worth of charge-offs over a couple of quarters as we executed our problem asset resolution plan. As you can see, we are about halfway there. We maintained a strong reserve position at the end of the year in anticipation of the remaining work to be completed in the first quarter of 2011.

You may have noticed, we added a table that's normally on our 10-Q to our press release on Page 7, which shows the allocation of the allowance between specific and risk allocated. As we completed the sales of NPLs that have specific reserves associated with them, the allowance was reduced accordingly. The risk-allocated allowance is driven by quantitative historical-looking models. As the risk profile of the portfolio improves, refracting resolution and the watch list, the level of reserves will trend downward.

This quarter, we bolstered the model-driven portion $29.5 million in anticipation of problem assets we have targeted for resolution. You can see this on the new table in the line titled Incremental Risk Allocated Allowance, CRE. The level of our reserves at the end of the fourth quarter are positioned to address the pending resolutions of problem assets to the first quarter. Our quantitative model was driven from historical data. With improving credit quality trends, the model will reflect a justifiable lower risk allocated reserve. Our reserve levels also reflect our conservative and prudent view of the markets we are in.

As we work through the continued resolution of problem assets, we expect the level of reserves to trend downward, reflecting the improving trends in non-performing assets, delinquent and watch list loans. Net interest margin was 3.42% for the fourth quarter, 10 basis points better than the third quarter. The increase was primarily the result of declining deposit cost. Margin was also positively impact by reduced cost of carrying non-performing loans and the repricing of fixed rate funding to lower rates. The increase was partially offset by lower reinvestment rates in our investment and loan portfolios. Going forward, we expect margin to improve slightly as a result of reduced cost related to carrying non-performing loans and reduction in non-balance sheet liquidity.

Non-interest income was $24 million for the fourth quarter, a decrease of $2 million over the third quarter. The third quarter benefited from two events that did not repeat in the fourth quarter. We received interest from previous year's tax returns and unrealized gains on deferred compensation plans in the third quarter. Service charges were lower in the fourth quarter as customer transaction volume was lower. We also recognized losses related to the problem asset resolution plan from the disposition of loans held for sale.

We had positive trends in the fourth quarter from improved sales efforts by our bankers and mortgage trust and brokerage. Year-to-date, operating non-interest income improved $2.5 million compared to last year, reflecting the consistent focus of our bankers to improve revenue-generating fee income opportunities through the services we offer our clients. We expect some contraction non-interest income in the future as we face regulatory headwinds, just like other banks.

Non-interest expense was $77 million, a $2 million increase from the third quarter. The increase was primarily the result of seasonally higher other expenses and other loan expenses, which were partially offset by a decrease in losses on other real estate. As we further reduce the level of problem assets, we will also reduce the expenses associated with maintaining them, so we expect lower levels toward the end of the year.

Taking a look at our balance sheet trends. Our total average earning assets of $9.8 million were down $296 million, primarily due to decreases in loan and held-for-sale portfolios compared to last quarter. At quarter end, total loans of $6.2 billion were down $671 million from the third quarter. All our portfolio's decline was the result of pay downs, charge-offs, normal client activity and continued weak demand from credit-worthy borrowers. Year-to-date, our consumer loan production was $511 million, which reflects an increase in indirect volume and lower demand in Home Equity. Year-to-date, new and renewed commercial loan production totaled $1.3 billion.

Core deposits of $4.9 billion were stable compared with the third quarter. TD [time deposit] balances totaled $2.9 billion, which were managed down $299 million from the third quarter. The decrease was primarily the result of planned reductions in broker deposits and single-service retail TD clients.

We continue to maintain strong liquidity positions with substantial liquid assets and unsecured borrowing capacity. Citizens' funding base is very stable, with 78% of the base supported by deposits. Citizens' loan-to-deposit ratio is 81% at December 31, 2010, compared to 92% a year ago, which reflects our stable deposit base and a challenge of a contracting loan portfolio. Short-term liquid assets as of December 31 were $409 million.

Our capital levels remain strong. Total capital was 13.5% and Tier 1 capital was 12.11%. All of our capital ratios remain above well-capitalized standards.

We recognize and understand that non-regulatory capital ratios such as TCE are negatively impacted by our problem asset resolution plan. If you evaluate the strength of our company based on TCE, also consider the eventual reduction of our reserve to loans as our risk profile and concentrations improve in our portfolio. In addition, after consistent quarters of sustained profitability, we anticipate the return of our deferred tax asset, which will have an immediate positive impact on capital ratios. At December 31, 2010, the DTA allowance was $293 million.

The applicable accounting rules are based upon facts and circumstances present at the time and therefore, we are hesitant to give guidance as to the timing, the exact amount or reversal of the DTA allowance. The goals of the accelerated problem asset resolution plan were to get us back to sustained profitability quicker and significantly improve our overall credit profile. Our plan is working, and we will continue to manage our capital for the long-term value of the company.

Before I turn it over to Mark, let me recap three key points. First, we are halfway through our plans to aggressively move a year's worth of charge-offs over two quarters and improve our credit quality. We expect the provision for the first quarter to be less than the fourth quarter. Second, by the time we get to the third quarter this year, we expect the level of reserves for loan losses to reflect the lower level of inflows into NPA in a more orderly disposition. Third, core earnings from margin, fee income and effective cost management have been and will continue to be stable. Last, capital will be used in the short term to achieve our goals for the long term.

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

Mark Widawski

Thanks, Lisa, and good morning. During the first three quarters of 2010, our consumer and special loans workout teams resolved $475 million of our most adversely rated loans. Our intense commercial real estate asset quality improvement efforts prior to the fourth quarter focused on finding orderly paths to problem asset resolution that resulted in asset value realizations above distressed asset pricing. However, this approach faced market headwinds of elongating resolution periods and exposure to unfavorable valuation trends.

Our accelerated problem asset resolution plan produced fourth quarter reductions totaling $466 million, nearly equaling the total achieved in the first three quarters. Through our special loans team's outstanding efforts, $335 million of the fourth quarter resolutions were executed through third-party or short sales that provided significantly better pricing than comparable distressed valuations.

Commercial, non-performing and held-for-sale loans totaling $122 million were moved in a bulk sale, and we completed the $9 million residential mortgage bulk sale that we announced in the third quarter. Our accelerated problem asset resolution plan began with a loan level review of the assets managed by our special loans group. Loans with the greatest uncertainty regarding the sustainability of project and guarantor cash flow support or with exposure to deteriorating valuations were selected for accelerated resolution.

Where potential holding periods were extended, the loans became bulk sale candidates. During the third quarter, the special loans officers continued to pursue synergistic opportunities on $30 million of the bulk sale candidates and executed more favorable resolutions than the indicative pricing from the pool data. We will adhere to our approach of balancing enhanced value through short and third-party individual resolutions with accelerated disposition afforded by bulk asset dispositions as we execute the final phase of the accelerated plan in the first quarter.

Fourth quarter charge-offs of $159 million associated with our asset quality improvement efforts represent an overall 35% severity to book. As Lisa indicated, we are looking to complete our acceleration plan in the first quarter and are approximately halfway through our plan. Our problem asset management resolution strategies affected our NPA inflow totals in the fourth quarter. Approximately $20 million in loans were not extended and moved to NPA status as part of the resolution plan. Net of these activities, the NPA inflows of $90 million for the quarter was slightly below the third quarter inflows.

During our fourth quarter watch review process, downgrade activity was at the lowest level we have seen in over two years. Risk-rating downgrades to more adversely rated status provide an indication of potential future NPA formation. Cathy highlighted the beneficial results of our acceleration effort on the total loan portfolio's near-term delinquencies, notable watch list and significant NPL reductions. Reduced 30-89-day delinquencies should lead to lower NPL formation and with lower NPLs, lower future charge-offs

Looking at the results in detail by asset class, our land and construction portfolios, the investment commercial real estate segment is under the highest level of stress throughout the credit cycle. Those portfolios were reduced 47% year-over-year, representing now just 6% of the total loan portfolio. New originations in these segments have been confined to owner-occupied related construction projects for over two years.

The income-producing segment of the investment commercial real estate asset class is down 24% year-over-year. The assets in this segment faced continued valuation pressure and accordingly, comprised approximately three quarters of our fourth quarter problem asset resolutions. This led to a 26% improvement in the 30-89-day delinquencies, 15% reduction in watch list totals and 49% reduction in NPLs in this segment year-over-year.

C&I and owner-occupied loans were down 22% year-over-year. Credit quality improvements in the segment included a 27% reduction in near-term delinquency percentage, a 25% reduction in watch list totals and a 40% reduction in NPLs year-over-year. Our commercial line utilization percentage was down 3% in the quarter due to normal seasonal auto industry-related activity and exiting of stress situations where utilization rates tend to be higher.

Competition for high-quality C&I clients continues to be fierce. We have expanded our core banking lending teams to focus on small- and middle-market businesses, and our asset-based lending group's pipeline is increasing. We intend to grow the C&I and owner-occupied segments through a service-oriented, relationship-driven approach in our markets and selected ABL transactions. The direct and indirect consumer segments continue to produce stable credit metrics. 30-89 day delinquencies were up slightly over the linked quarter in normal seasonal pattern but down over the previous year end. Normal NPLs and charge-offs for the segments were both down on quarterly and yearly comparisons.

As we have noted throughout this credit cycle, our indirect Marine and RV portfolio has been a solid performer. Over the past two years, we have expanded our indirect origination activity to states contiguous to our footprint, and the portfolio is now less than 50% concentrated in Michigan. We will continue to build on this success through further geographic expansion in 2011.

Our consumer credit team successfully executed two bulk sales of non-performing residential mortgage assets last year. The fourth quarter sale of primarily single-family properties was priced at 43%, resulting in a $4 million gain on the sale.

Last year's sale activity significantly reduced our inventory of late-stage foreclosures. This will slow our individual loan work-through velocity and as seen in this quarter, lead to an increase in the asset classes NPLs. The asset class will continue to be managed as they runoff portfolio with opportunistic dispositions.

The goals of our accelerated problem asset resolution effort are on track to be achieved in the first quarter. We look to substantially improve our overall credit profile over a relatively short period of time, enhance the transparency on our asset quality, reduce the risk of potential future losses and improve the stability of future earnings. By significantly upgrading our credit quality, we will be positioned for growth.

Cathy, back to you.

Cathleen Nash

Thank you, Mark. Our turnaround efforts and all the work we've done over the last several years have positioned our company to transition our focus to growth opportunities. Having said that, I'd like to take a minute to recognize the hard work and efforts on behalf of all of our employees that made this happen and their continued hard work that will position us appropriately. We have a very solid core-operating franchise, which is evident in our consistent ability to attract new clients, particularly in this challenging economic environment.

During 2010, we added over 30,000 new clients. We've maintained steady levels of core deposits. And although we continue to see weak loan demand in our markets and increased competition for credit-worthy clients, we renewed and improved over $1.8 billion of loans in the year. We still have some work to do in 2011 with a focus in the first quarter to complete our plan of problem asset resolution. But we've positioned ourselves to be able to report sustainable profits later in the year.

With those comments, we'll now take questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Brett Scheiner with FBR Capital.

Brett Scheiner - FBR Capital Markets & Co.

One, 3Q profitability, are you assuming that, that's due to reserve release or do you think pretax will actually exceed charge-offs in the third quarter?

Lisa McNeely

We are planning on not replenishing the reserve levels as we work through our charge-offs, Brett. So we won't need to be restoring reserves to levels to the extent that it won't match the level of charge-offs. So charge-offs will be reduced by the time we get to that point in time.

Brett Scheiner - FBR Capital Markets & Co.

On the bulk sales, did you take that paper, meaning do you have any residual risk there?

Mark Widawski

We don't have residual risk on that stuff beyond looking at a very short-term period here that will be up in January with regard to providing additional documentation to the buyer, and we're on track for that.

Brett Scheiner - FBR Capital Markets & Co.

On NPA inflows. Even backing out the $20 million that came from this aggressive work through, there's still $90 million. Do you think that will slow materially between now and this third quarter profitability you're forecasting?

Mark Widawski

Yes. What we saw this quarter was not unexpected. Referring back to the resolution plan, we do a loan level review and we do a loan level review for forecasting charge-offs, NPL and future watch list additions. So what we saw was in line with where we thought it would be. And we think that the work that we're doing around resolving the most adversely classified credits will slow that inflow.

Operator

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

Terence McEvoy - Oppenheimer & Co. Inc.

As you discussed your fourth quarter results and the impact on your balance sheet with your regulators, are they still comfortable with your outlook, the scenarios that you talk about in your plans? And I guess more directly, are you feeling any pressure to raise capital or do you think the next capital raise will really be centered around when you repay TARP?

Cathleen Nash

Certainly, to execute our plan and review our results with our regulators is important part of what we do, and they have indicated their comfort with our plan and our execution of that plan. In terms of raising capital, I'm going to give you a little bit of a qualify, I don't have a crystal ball, but our credit indicators continue to point all in the right direction. And we feel that the problem asset resolution work we've done in the fourth quarter and the reductions we see in watch list and expect to see this quarter will drive those credit numbers to the point that we are very confident and comfortable with where we're sitting. So with that said, we would look at some point to do a TARP repayment, but we don't see that to be a short-term necessary, "oh my gosh, we have to run down this road." And we would explore every option available for us working with Treasury, which we talk to regularly on at least quarterly basis to explore those opportunities in a way that is as limiting in its dilution of our shareholders as possible. That's the key priority for us.

Terence McEvoy - Oppenheimer & Co. Inc.

And the DTA. I think you said in early December at a conference that you were meeting with auditors, accountants to discuss that. And it doesn't sound like you have any more clarity on that, on the DTA, that would help us in terms of the timing about when that will come back into regulatory capital. Is that correct?

Cathleen Nash

Yes, that is true. We've said to our auditors on a path to do a couple of things to do a deep dive and really understand what the scenarios would have to be and what judgments have to be made to begin to put that back on the book. Obviously, getting it back to profitability is the first one. Second, we've also undertaken some examination of others as they begin to put their DTA back on the books and what circumstances their auditors are letting them do that. So I wish, Terry, I had a lot more information around that. I don't yet. Although that I will tell you while we are conservative in many things in this company, we will very aggressive in pursuing our DTA in getting it back.

Terence McEvoy - Oppenheimer & Co. Inc.

You say that you're halfway through this kind of problem asset workout plan. And so should I look at the $250 million of charge-offs in the third and the fourth quarter and say, okay, that's the 50% number I should look at and then kind of double that looking out over the next few quarters? I'm just trying to financially reckon with or take into consideration that 50% comment and how that's going to impact charge-offs and provisioning in the first quarter and the second quarter.

Lisa McNeely

The first quarter will resemble the fourth quarter in terms of charge-offs and problem asset resolution. We don't anticipate the reserve level to be replenished to a level that it was in the fourth quarter.

Operator

And we'll take our next question from Eileen Rooney with KBW.

Eileen Rooney - Keefe, Bruyette, & Woods, Inc.

I had a question on what you're expecting in the first quarter. Should we assume that you'll have -- I guess can you give us any color on the amount of bulk sales that you expect in the first quarter and will it be a similar mix of non performers and watch list-type credits?

Mark Widawski

The issue around sizing the bulk sale is, I think, we're doing it differently than many people do it. We are looking at it from that loan-level perspective. And given our teams in the field, the opportunity to beat our estimate and then ultimately, the indicative pricing that we receive on a potential pool of assets that we deliver for analysis by KBW, our underwriter, on the last quarter's pool, for example. So it totally depends on the ability to execute at the Street level as to what the size of the bulk sale will be. If we can't get it done individually to move it faster, it will fall into the bulk sale by default.

Cathleen Nash

Well, and I think to add to that, Eileen, I think Mark noted in his comments that the special loan officers, we took about $30 million out of the bulk sale the we had slated in the pool because they got us better deals compared to where we thought we'd get in the bulk sale. So that is absolutely our preferred strategy. Bulk sale is our least preferred strategy because it takes the highest hit to us. So I think we are a little different from others where we don't simply say, "Well, this is the number and everybody go do something else while we pursue a bulk sale." We want the bulk sales to be as small as possible. And I think we demonstrated that in the fourth quarter.

Eileen Rooney - Keefe, Bruyette, & Woods, Inc.

So the charge-off guidance that you've been giving and what you're giving for the first quarter, is that consistent with if you did it as a complete bulk sale? Is that sort of a worse case? Or is there a possibility that, that charge off could actually be lower if you pursue other avenues?

Lisa McNeely

We're anticipating similar execution in the first quarter as to what we had in the first [sic] quarter. So as Mark said, we're moving down parallel paths and our expectation is that we will be as successful as we were in the fourth quarter in moving things out through Street-level disposition to -- they're kind of mirror-image quarters, if you will.

Cathleen Nash

I think the one caveat that we would not be expecting to reload provision, but we would expect to see similar levels of problem assets worked out with probably similar charge-off levels but not increasing reserves as a result.

Eileen Rooney - Keefe, Bruyette, & Woods, Inc.

So by not increasing reserves, you would expect the reserve to decline more than the amount of your specifically allocated reserves?

Lisa McNeely

Eileen, if you look at that Page 7, the table on Page 7. There is a line item that I pointed out in my comments that relates to an amount that we bolstered the risk allocated reserve, about $29.5 million as we looked at the activities of the first quarter. So if you think about our reserve fell in the fourth quarter by $30 million, we bolstered back again.

Eileen Rooney - Keefe, Bruyette, & Woods, Inc.

Back $29 million?

Lisa McNeely

Yes.

Eileen Rooney - Keefe, Bruyette, & Woods, Inc.

And then just a question on the DTA. I know you're still working on it, but I just want to understand -- my impression of bringing it back on is that it's the same as when it went off. It's sort of an all or nothing and that there really isn't an incremental bringing it back on. Is that what you're weighing, whether or not you actually will be able to bring it on at all?

Cathleen Nash

No. No. We feel quite strongly about that. Keeping in mind, obviously, that we did some trigger of Section 382 when we did our debt exchange, a year and a half ago now. We anticipate bringing the full amount back on. Our real question is, our understanding of it from our accountant side that is not a you get it all in one quarter but we expect that it will be, if you will, parceled out, as we regain our sustained profitability. Our question is how much and how quickly, not if or not if. We don't have any question that we can get it back. The question is how much of it over what period of time and how quickly we can do that.

Eileen Rooney - Keefe, Bruyette, & Woods, Inc.

And that's true also on a GAAP basis and versus the regulatory capital ratios? I understand that those can be brought back in pieces. But on a GAAP basis, it's also, incrementally, you can bring it back in?

Cathleen Nash

We believe so, Eileen, and we're clearly looking at that. But others that we've seen start to move down this road have had that approach. So we've got a little bit of time to get our heads around this, but that is our belief right now, yes.

Operator

And there are no further questions in queue.

Cathleen Nash

Thank you. We appreciate everyone's time on the phone with us. If you have additional questions, please feel free to contact us directly.

Operator

This does conclude today's teleconference. You may now disconnect and enjoy the rest of your day.

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