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Citizens Republic Bancorp, Inc (NASDAQ:CRBC)

Q2 2011 Earnings Call

July 29, 2011 10:00 am ET

Executives

Lisa McNeely - Chief Financial Officer and Executive Vice President

Brian Boike - Senior Vice President, Treasurer, Senior Vice President of Citizens Bank and Treasurer of Citizens Bank

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.

John Barber - Keefe, Bruyette, & Woods, Inc.

Terence McEvoy - Oppenheimer & Co. Inc.

Jason O’Donnell - Boenning and Scattergood, Inc.

Operator

Good day, and welcome to the Citizens Republic Bancorp Second Quarter Conference Call. [Operator Instructions] And it is now my pleasure to hand the call over to Kristine Brenner. Please go ahead.

Kristine Brenner

Thank you and good morning. Welcome to the Citizens Republic Bancorp Second Quarter Conference Call. This call is being recorded and will be archived for 90 days on the Investor Relations page on our website, www.citizensbanking.com.

The format of our call today will be Cathy Nash, President and Chief Executive Officer, providing highlights for the quarter; Lisa McNeely, Chief Financial Officer; and Mark Widawski, Chief Credit Officer, will provide details of the quarter. Cathy Nash will share some concluding remarks, then we'll open the line up for questions from research analysts. And Brian Boike, our Treasurer, is also here to answer questions.

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 Office, Cathy Nash.

Cathleen Nash

Thank you, Kristine. We are very pleased to announce our return to profitability this quarter. Our net income of $18.5 million or $0.46 per common share, included a $10 million income tax benefit. Pretax pre-provision results remain solid at $33 million, driven by a strong net interest margin of 3.56%. Additionally, our credit trends remain positive. Our near term delinquencies remained low at 1% of total loans. Total nonperforming assets decreased for the 7th consecutive quarter, and the new commercial inflows to NPL were less than $25 million. Last quarter inflows were $29 million.

Inflows haven't been this low since 2006, which is truly a reflection of our team's hard work. We recorded an $18 million provision for loan losses while our allowance for loan losses remained very strong at 3.7% of total loans and 167% of nonperforming loans.

I'll turn it over to Lisa and Mark to talk through the quarter in more detail, and then I'll wrap up the call. Lisa?

Lisa McNeely

Thanks, Cathy. As Cathy mentioned, we reported net income for the quarter of $18.5 million driven by improving credit trends, steady pretax pre-provision profits and a unique tax item. Pretax pre-provision profits remained strong at $33 million. The result of our intense focus on preserving fee income from services, managing expenses and optimizing net interest margin through product pricing discipline and balance sheet management.

Net interest margin increased 3 basis points over last quarter to 3.56%. Compared to the second quarter of last year, margin increased 21 basis points. This increase was primarily driven by strategies that focused on lowering funding cost and reducing levels of nonperforming loans. These efforts were partially offset by the effect of replacing declining performing loan balances with lower yielding investment securities and money market investments. Going forward, we expect our margin to remain stable.

Noninterest income was $23 million for the second quarter, essentially unchanged from the first quarter, and improved from the second quarter of last year. The improvement was caused by the net impact of gains and losses from sales of loans held for sale and investment securities.

Service and product-related fee income categories were stable, as a result of the efforts put forth by our branch bankers to proactively reach out to clients and ensure their product choices best meet their financial needs.

Noninterest expense was $69 million, which is a decrease of $12 million from the first quarter and a decrease of $8 million from the second quarter of last year. These decreases were primarily driven due to lower valuation write-downs on other real estate and lower credit-related workout cost.

Provision expense was $18 million for the quarter, which is a decline of 80% from last quarter. The lower provision expense reflects our improved credit metrics, and the result of our asset quality improvement initiatives. Going forward, our provision expense and reserve levels will reflect the reduced risk in our portfolios.

We recorded a $10 million income tax benefit this quarter. An unusual circumstance created the tax benefit. Year-to-date, we had an increase in the value of our available-for-sale securities portfolio, operating losses for tax purposes and a full valuation reserve on our DTA.

Taking a look at our balance sheet trends. Total loans at quarter end were $5.6 billion. This represents a modest decline from the first quarter of $77 million, which is the slowest pace of decline in over 11 quarters. The decline resulted from planned reductions in both our commercial and real estate -- residential real estate portfolios and resolutions of problem assets. The C&I portfolio was essentially flat, due to a meaningful increase in lending opportunities as a result of the hard work by our bankers across all of the C&I lending channels. The indirect portfolio grew by $46 million over the first quarter, which represents a second consecutive quarter of growth and an increase of 7% in balances over the second quarter of 2010.

Origination activity seasonally peaks mid-year in this business. We have been expanding geographically with a disciplined approach, and we are winning business as a result of our long-term commitment to our existing dealers. The improving loan pipelines we discussed last quarter resulted in an increase of loan closings during the second quarter. We approved and renewed $134 million in consumer loans and $337 million in commercial loans during the second quarter. In total, this was an increase of 30% over last quarter. High fine momentum continues to build in C&I and indirect and branch originated consumer loans, which will continue to help mitigate the effects of reducing our real estate loan concentrations.

We continue to focus on relationship banking, quality client service and new client acquisition. Our new client acquisition rate is 9% annually. With these efforts, we have a very stable core deposit base, $5 billion at the end of June, which is flat compared to last quarter, and up 4% from the second quarter of last year. This will fund future loan growth.

Time deposits decreased 8% from the first quarter to $2.4 billion, resulting from our planned initiative to reduce our reliance on single service, high-cost retail CD balances. We've been successful in referring these balances to our investment center or other products, which better meet both the bank's goals and the client's needs.

As you can see from the table in our release, all of our key capital ratios improved this quarter, reflecting our positive results. Capital ratios remain well above the regulatory minimums. Our capital ratios will be further enhanced as we expect to continue to report positive results.

We recognized a significant value of the deferred tax asset, hence [ph] For our common shareholders. As we have said in the past, the reversal of the valuation allowance would be based on facts and circumstances that primarily focus on sustained profitability. The rules on when a valuation allowance on a deferred tax asset should be reversed are open to interpretation. So we will continue to do both our own research on this issue and monitor how others interpret the guidance.

I will turn it over to Mark now for more insight into our credit.

Mark Widawski

Thank you, Lisa, and good morning. I am pleased to report continued improvement and positive trends in our credit performance for the second quarter. The sustained execution of our problem asset resolution initiatives over the past 2 years has resulted in lower levels of nonperforming commercial loan inflows, reduced and stabilized near-term delinquencies, material reductions in NPA and OREO levels and lower charge-offs and provision expense.

Commercial inflows to NPL totaled $24 million for the quarter, marking the second consecutive quarter of inflow below $30 million, and substantially below the 2010 average orderly inflow of $102 million.

Our accelerated resolution initiative successfully executed during the previous 2 quarters materially stemmed commercial NPL formation in 2011.

Furthermore, we saw fewer residential mortgage loans flow into NPL during the quarter. As a result, NPLs remained essentially flat in this portfolio. In total, consumer nonaccrual loans increased by $1.3 million and remain at stable, manageable levels.

Loans 30 to 89 days past due represented 1% or less of total loans for the second consecutive quarter. Commercial near-term delinquencies were essentially flat to the linked quarter, while consumer delinquencies exhibited the expected seasonal uptick increasing by $4.9 million.

NPAs were down 19% from the first quarter, the 7th consecutive quarterly decline as Cathy referenced. Our continued aggressive approach to problem commercial real estate and C&I resolutions continued during the quarter, employing traditional strategies rather than larger bulk sales efforts.

Consistent with last quarter, our largest commercial NPL is $6 million, with 8 loans between $1 million and $6 million. We successfully completed within our targeted price range the pooled sale of non-performing small business assets that were moved to held for sale in the first quarter. This transaction was part of the 63% reduction in non-performing held for sale loans for the quarter.

Our focused efforts on reducing OREO resulted in a 23% reduction from the first quarter's level. First quarter 2011 and fourth quarter 2010 elevated charge-off levels reflected the accelerated resolution initiative actions, including 2 commercial bulk sales.

Second quarter net charge-offs of $35 million were well below these levels, but also 50% lower than charge-offs in the second quarter of last year. The largest commercial charge-off during the quarter, was $3.9 million on an out-of-market land loan in line with our strategy to reduce our investment commercial real estate concentrations.

Due to our improved portfolio performance, the provision expense declined this quarter, coming in at approximately 51% of our net charge-offs. While the provision was down, we actually improved our allowance coverage percentages of both non-performing loans and assets. The allowance represents a very strong 167% of NPLs and 3.7% of total loans.

As we've discussed in the past, indirect and asset-based lending portfolios are targeted for growth. Our indirect marine and RV portfolio has performed very well throughout this credit cycle, and our expansion efforts are reflected in that portfolio's $46 million quarterly increase in balances. As Lisa mentioned, we have grown this portfolio by expanding our geographic reach to contiguous states, while maintaining our credit underwriting standards. This is a seasonal business where origination activity peaks in the second or third quarter. However, our team has done an exceptional job expanding our base and building on our recognized long-term commitment to this business.

Competition for high-quality C&I loans continues to be fierce, primarily from a pricing perspective. Nevertheless, our balances in that asset class were nearly flat to the first quarter due to strong origination activity in our asset-based lending unit and increased bookings from our [indiscernible] core commercial banking teams. Our demonstrated asset-based lending competency affords us the ability to book assets with enhanced yields, while maintaining strict credit standards. Cathy back to you.

Cathleen Nash

Thanks, Mark. As you heard from Lisa and Mark, we are quite pleased with the results we've achieved and the trends we see. Throughout this cycle, our bankers have focused on growing clients and revenue. And as a result, we have a very solid core operating franchise. We have a demonstrated expertise in C&I, asset-based and indirect lending. Our team's growing pipelines reflect their success in executing the growth strategies we've put in place to reflect our strengths in these businesses.

Our strategy as we look forward into next year is: to prudently and profitably rebuild our loan book, replacing the earning assets that we've lost over the last few years as we've reduced the size of and risk in our balance sheet; to maintain margin with a continued focus on core deposits, disciplined pricing and an efficient balance sheet; to ensure that our loan loss reserve appropriately reflects the reduced risk in our portfolios and adequately supports our growth initiatives; to report consistent profitability, as we look forward into next year, consistent profitability will continue to strengthen capital ratios and should allow us to recognize the value of our deferred tax asset on our balance sheet, we will continue to evaluate appropriate timing on the payment of our Treasury and preferred dividends, as well as TARP repayment options; and finally, to continue to provide top-tier client service as a core competency.

With those final comments, we're happy to open the line up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Looks like our first question will come from the site of Jason O'Donnell with Boenning and Scattergood.

Jason O’Donnell - Boenning and Scattergood, Inc.

I wanted to follow up on the rate of commercial NPA formation. How granular have your new commercial problems been recently? And I'm wondering what was the trend, if you can give it to us by month during the quarter?

Mark Widawski

Jason, it's Mark. The trend, because of our accelerated efforts, has been toward a very granular inflow into NPL. The trend, I don't have by quarter, but let me give you the -- by month. Let me give you the quarterly watched trend in terms of increase and decreases. The watch list totals were down $37 million for the quarter. And if you go back for the entire year, our watch list is down $342 million. And if you look at that in the 10-Q, we do break out our classification of adversely rated credits. And what you'll see is, since the beginning of the year, we're down $455 million in terms of classified and criticized assets. And that $455 million decrease is 87% of the total decrease in the commercial portfolio. So what we focused on is reducing the risk levels and taking the largest sized assets and prioritizing them for resolution. So I think we're getting very granular in terms of the inflows. We've identified the larger deals that need to be dealt with, and we've got plans around them for resolution.

Jason O’Donnell - Boenning and Scattergood, Inc.

Okay. Great that's helpful. And then on the -- with respect to the non-performing inflows figure, do you track that as well on the consumer side?

Mark Widawski

Yes, we do. And for the quarter, we didn't see a large number of units increase. It was in line with our expectations and basically, about the same average size that we've seen previously.

Jason O’Donnell - Boenning and Scattergood, Inc.

Okay. Great. And with respect to total delinquencies being impacted by a seasonal increase in consumer delinquencies, can you just remind us what types of consumer loans are being affected? And what the nature of the seasonality is?

Mark Widawski

Right. We don't have a credit card portfolio, so you can take that, kind of, out of the mix. The first quarter is traditionally a good quarter for consumer delinquencies. And our consumer credit management teams did put a good amount of additional effort and thought into moving aggressively to protect the second quarter seasonal increase through additional touches of clients. But what you find in the second quarter is it's very difficult to overcome that seasonal low in the first quarter. So we didn't have a large increase there either in number of units. But it was hard to get at that base, simply because it tends to be a quarter were payments slowdown on the consumer side. It's primarily in our direct consumer business, our indirect delinquents, near-term delinquencies, as well as NPA inflows have continued to be the very minimal.

Jason O’Donnell - Boenning and Scattergood, Inc.

Okay. Great. And then what's your outlook going forward or at least in the back half of the year for OREO expense? I know it's not entirely a fair question, but in terms of accounting for the outlook for both maintenance expense and valuation adjustments, do you feel like the second quarter is a good run rate?

Mark Widawski

Jason, we're going to continue to focus on moving OREO as quickly as we possibly can off the books and evaluate each property versus the forecast in terms of cost carry of that property to make a determination as to whether or not we should be moving those.

Jason O’Donnell - Boenning and Scattergood, Inc.

Okay. And maybe this is a question for Lisa, on the operating and the noninterest expense side, are there any one-time issues in there that we should be aware of outside of the valuation write-downs, et cetera?

Lisa McNeely

No, we've actually done a pretty good job of managing our expenses and we feel like we're at a pretty efficient level. And we feel pretty good about most of the categories as we ran through the expenses this quarter. So as you mentioned, there will be some movement from time to time on workout cost and, Mark, kind of address that as we evaluate moving OREO property faster and things like that.

Operator

And it looks like our next question will come from the site of Terry McEvoy with Oppenheimer.

Terence McEvoy - Oppenheimer & Co. Inc.

Just a question on capital. Second quarter profitability, a quarter ahead of your expectations and a pretty nice bottom line. Because of the capital build and the profitability, is any sort of common equity or capital raise off the table? And probably the next time you'd think about capital in terms of raising capital, is that would you think in connection with repaying the TARP preferred?

Cathleen Nash

Yes, Terry, that's exactly right. As we've said consistently, we've worked closely with our regulators through the written agreement we've been under regarding our capital plans and their approving of our capital plans as we work through the work -- in the last couple of quarters. And consistently as we have said, that we would not seek to go into the markets until we we're ready to do something around TARP. And even at that level, we obviously are going to seek to do these things that are as shareholder-friendly as possibly we can. So we don't anticipate anything, unless we see the right time to do it as part of TARP.

Terence McEvoy - Oppenheimer & Co. Inc.

And any further tax benefits like we saw in the second quarter expected going forward?

Lisa McNeely

The -- as we do our tax planning, we feel pretty confident that we're -- that's a onetime, I wouldn't want to necessarily one time because they're -- as the portfolio changes, as far as the available-for-sale, we actually may see that come down a little bit. So -- and maybe a little bit of reversal of that $10 million actually, Terry.

Cathleen Nash

Yes, Terry, if you looked and go back to Lisa's comments, we did find ourselves in a kind of a unique crossroads that led to that tax benefit, and it's a bit of a guesstimate to know how much of it will kind of have to pullback in. But it's not the whole $10 million, and we learn more about taxes, I personally learned more about taxes in the last quarter, than I ever wanted to know. But we would've ideally not like to have taken that in this quarter, just have a perfectly crystal clean quarter for everybody without that $10 million on the top of it, but that's just not the way it works out sometimes.

Terence McEvoy - Oppenheimer & Co. Inc.

So you learned a lot more about recapturing the DTA in the coming quarters?

Cathleen Nash

Absolutely. That's for sure.

Terence McEvoy - Oppenheimer & Co. Inc.

Okay. And then just one last question. The C&I rates or yields kind of jumped up noticeably quarter-over-quarter. What kind of happened in that part of the portfolio in the second quarter?

Brian Boike

Terry, this is Brian. We -- at the end of the first quarter disposed of a lot of non-performing loans. And what you're seeing is the full quarter benefit of those activities.

Terence McEvoy - Oppenheimer & Co. Inc.

So if you backed out the noise in the first quarter, could you just talk about C&I yields? What happened in the second quarter?

Brian Boike

You would have seen them remain relatively flat, absent the reduction in non-performing loans.

Operator

And our next question will come from the site of John Barber with KBW.

John Barber - Keefe, Bruyette, & Woods, Inc.

Your credit quality has been dramatically improving ever since 2009 and I realize that, that's the result of a lot of hard work and dedicating a large amount of resource to fixing credit. But I'm just curious could you talk about how you're starting to shift -- gears more towards the growth phase? Are you having less frequent credit meetings? Are you shifting people from your workout group back towards lending again?

Cathleen Nash

Well, our Chief Credit Officer would say that there isn't a coincidence to him starting his new job in 2009, and the dramatic improvement you mentioned, John. But I'll let him make those comments. So we have focused on adding revenue producers into the company, as well as looking at the folks who are doing loan workout. We've had some natural attrition in that group. But quite frankly, we are not in any huge rush to say let's do reductions there, that doesn't make sense for us. These are folks who have done a fabulous job over the last couple of years, and we have plenty of need within our company for folks who can do good work. Some will shift toward revenue production. But that does -- boy, we've got to get everybody there, we're pretty comfortable with the track we're on. In terms of your question around, are we having fewer meetings? We're a bank, of course, we're not having fewer meetings. But what it does mean is that what we've got left to work through, we can move a little quicker with a lot more attention. When you move over $900 million through a pipeline in 2 quarters, it frees up some resources to focus, and that's what we want those folks to do. And I'll turn it over to Mark to add to those comments.

Mark Widawski

I got to echo the comments Cathy made about the efforts throughout this whole cycle, that all of our teams have put into improving the asset quality, they've truly done a fabulous job. Where we're seeing some of the initial growth because the sales cycle is a little longer and tends to be a bit more transactionally focused, is in our asset based lending unit. It is something that distinguishes us from our competition, I firmly believe. And we do get a little bit larger -- average loan size out of those folks. So as we look at a unit production basis, we will see, hopefully, some benefit of that. Our healthcare group has a very strong pipeline and is focused on a segment of the market that I believe makes sense today. And our core bankers have truly gotten back into the sales cycle, front-end loaded that, such that over the next couple of quarters, we're going to start to see the benefits from that as well. So we have dedicated some resources over the last 2 quarters to the core banking franchise. Some of those have come out of either real estate areas or special loans areas. So, yes, we are making sure that we give people the right opportunities to continue to move us down the path towards growth here.

Cathleen Nash

Yes, but that said, we will not abandon our discipline of having past credit meetings and taking samplings of our portfolio and analyzing them. That's the way you stay on top of credit, and the way you continue discipline within your bankers and your bankers' daily activities in managing their portfolios. And we believe that's a best practice that we won't give up on.

Mark Widawski

Culturally, I think we're at a very good point in terms of the credit market balance.

Cathleen Nash

Agree.

John Barber - Keefe, Bruyette, & Woods, Inc.

Thanks. And do you have the dollar amount of the valuation allowance against the DTA as of the second quarter?

Lisa McNeely

I don't have that right with me, John. I can -- I know at the end of the first quarter was about $315 million. So I apologize, I don't have that number off the top of my head.

John Barber - Keefe, Bruyette, & Woods, Inc.

That's okay. And we talked a little bit about how your returning to profitability and the implications that has for recapturing the DTA, but could you give us maybe some more comments on the amount you expect to get back and the timing? Thanks.

Cathleen Nash

Well, I'd like all of it as soon as I can. But obviously, there's a lot of gray around this, John, and I guess, one of the, I mean, positives is other banks are going to be in a position to harvest theirs. Meaning they've had more quarters of profitability than we've had. Clearly, sustainable profitability is the -- kind of the key area that we have to demonstrate. So it will actually be a benefit for us as we watch what other companies are doing. This is really around an accounting issue. And what their accounting teams are saying and what guidance their getting from their firms. We obviously are very focused on it with our own accounting firm. And we're doing a lot of analysis around what our options are. So more to come as we continue to see that profitability. But please rest assured that this is a big one for us, and we want it back and not just the opt it to our common shareholder but the harvesting, the benefit of it, the actual cash value benefit of it over time is important as well.

Operator

It looks like we do have another question. It comes from the side of Brett Scheiner with FBR Capital Markets.

Brett Scheiner - FBR Capital Markets & Co.

Congratulations on the quarter, and the credit progress, my questions have been answered.

Operator

And it appears we have no other questions in queue.

Cathleen Nash

Thank you. We appreciate every one being on the call today. As always, if you have follow ups, please let us know, and we'll talk to you in a quarter. Thank you.

Operator

And this does conclude today's teleconference. Thank you for your participation. You may disconnect at any time.

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