Citizens Republic Bancorp, Inc Management Discusses Q2 2012 Results - Earnings Call Transcript

| About: Citizens Republic (CRBC)

Citizens Republic Bancorp, Inc (NASDAQ:CRBC)

Q2 2012 Earnings Call

July 27, 2012 10:00 am ET

Executives

Kristine D. Brenner - Director of Investor Relations

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

Lisa T. McNeely - Chief Financial Officer, Executive Vice President, Chief Financial Officer of Citizens Bank and Executive Vice President of Citizens Bank

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

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

Analysts

Terence J. McEvoy - Oppenheimer & Co. Inc., Research Division

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

Operator

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

Kristine D. Brenner

Thank you. Good morning, and 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 the 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'll turn the call over to our President and Chief Executive Officer, Cathy Nash. Cathy?

Cathleen H. Nash

Thank you, Kristine. We are very pleased to report another quarter of strong results that reflect our continued success in executing on key strategic initiatives. We achieved another important milestone this quarter with the reversal of the valuation against our deferred tax asset or DTA. We were able to restore the DTA due to the strong financial condition of our bank and expectations that we will be able to fully utilize the asset in the future.

Net income attributable to common shareholders for the second quarter was $297 million or $7.35 per share, which includes the $277 million tax benefit from restoring the DTA. Excluding that tax benefit, we reported continued solid results with net income of $20 million or $0.50 per share for the quarter and pretax pre-provisioned profit of $32 million.

Our continued improvements in credit quality metrics led to reduced credit cost again this quarter with provision expense dropping by 37% compared to last quarter. Net interest margin expanded 4 basis points compared to last quarter, reflecting our success in executing our strategic balance sheet initiatives. And Lisa will talk more about that in just a moment.

Core deposit balances increased 9% over last year and continued to represent an important component of our total funding. Core deposits now fund 56% of our balance sheet compared to 42% 2.5 years ago. Time deposits are down 24% from last year as we continue to strategically reduce high cost, single service and broker time deposits.

Our strategic focus on C&I and consumer lending led to another quarter of growth in these lines of business. Today, C&I and consumer loans make up 64% of our loan portfolio, up from 62% last quarter and 57% a year ago. Compared to the second quarter of last year, C&I balances have increased 27%, and Indirect portfolio balances are up over 6%.

As anticipated, income-producing commercial real estate and residential mortgage loan balances continued to decline. Now I'll turn the call over to Lisa and Mark to talk through the details -- the quarter in more detail for you. Lisa?

Lisa T. McNeely

Thanks, Cathy. As Cathy mentioned, we reported net income attributable to common shareholders for the quarter of $297 million, which includes a $277 million tax benefit from eliminating the valuation allowance against our deferred tax asset. Provision expense was $5 million in the second quarter, reflecting continued improvement in our credit metrics. The allowance as a percentage of the portfolio loans was 2.47% at the end of the quarter. With continued improvement in the risk profile of our loan portfolio, we would expect this ratio to gradually move into closer alignment with our peers throughout the remainder of the year.

Net interest margin was 3.6% in the second quarter, up 4 basis points compared to last quarter and the second quarter of last year. In this environment of low interest rates and increased competition for quality earning assets, we have expected the net interest income and margin to be pressured. This quarter, and for the last several quarters, we have been successful in executing balance sheet strategies to mitigate that pressure.

The balance sheet tactics we've utilized included emphasis on growing low-cost core deposits, reducing reliance on wholesale and other high-cost funding, carefully managing deposit pricing through a relationship pricing strategy, restructuring long-term debt to reduce cost while extending maturity and remaining diligent on loan pricing. Our overall cost of funds was down 8 basis points compared to last quarter and 30 basis points compared to the second quarter of 2011.

We continue to work diligently to offset the negative impact of regulation on our fee income by focusing on services and products that help support a stable base of fee income. Our bankers work with our clients to ensure their needs are matched with our competitively priced products. Service charges and card-based fees were seasonally higher this quarter compared to the first quarter. Those increases were offset by a reduction in net gains on loans held for sale and unrealized gains on deferred compensation. The change in deferred compensation is matched by an offset in change in noninterest expense.

Noninterest expense continues to benefit from reduced credit-related cost with our improving credit profile. We also continued to conscientiously manage expenses. Total noninterest expense was down slightly from last quarter while -- primarily due to seasonally lower compensation and occupancy as expenses.

We recorded a $277 million tax benefit related to the elimination of the valuation allowance against our deferred tax assets. This was a result of our continued strong financial performance and reduced risk profile. We do not expect to recognize any income taxes until the first quarter of 2013 as the remaining deferred tax asset valuation allowance is expected to offset income tax from the third and fourth quarters.

Taking a look at our balance sheet trends, total portfolio loans at quarter end were unchanged from last quarter at $5.5 billion. Growth in C&I and Indirect loan balances was offset by anticipated reductions in real estate based loan categories.

C&I loan portfolio balances increased 3% compared to last quarter and, as Cathy mentioned, are up 27% compared to the second quarter of last year. Year-to-date, our C&I portfolio has grown at 22% annualized rate. This growth reflects our continued focus, lending initiatives and areas of our expertise. Even though the continued extreme low interest rate environment has accelerated prepayments in our Indirect loans, our Indirect portfolio increased 6%. Year-to-date, our Indirect portfolio has grown at a 12% annualized rate.

Reductions in our commercial real estate and residential mortgage portfolios were the result of our portfolio rebalancing and concentration management strategies.

Our investment securities portfolio decreased $91 million or 3% at the end of June compared to last quarter end. Our portfolio remains high quality with about 90% government and agency securities. Although core deposits were flat compared to last quarter at $5.4 billion, the mix improved with increases in non-interest-bearing deposits and a decrease in interest-bearing deposits. This contributed to the increase in net interest margin that I mentioned earlier.

Our bankers continue to focus on relationship banking, providing high-quality client service and acquiring new clients. Our most important customer service score, measured as a percentage of clients likely to recommend Citizens Bank, continues to increase and has consistently ranked higher than the industry average. We are growing the number of new clients by 10% annually. Growing and retaining client relationships will continue to support earnings going forward.

Time deposits decreased 9% from the first quarter, reflecting further reductions in single service, high-cost retail CD balances and the continued runoff of broker time deposits. Since we started this focus in early 2011, we've reduced the amount of single service CD balances over 38%.

Regulatory capital ratios increased approximately 100 basis points over last quarter, while restoring the deferred tax asset had a meaningful impact on our capital levels this quarter, posting another quarter of consistent results, also organically contributed to the increase. I'll turn it over to Mark now for more insight into credit.

Mark W. Widawski

Thank you, Lisa, and good morning. As Cathy and Lisa mentioned, our credit metrics showed further improvement, resulting in a reduction in the quarterly provision. Total portfolio 30- to 89-day delinquencies fell to 59 basis points from 72 basis points in March, representing the fourth consecutive quarter of improving performance.

Total consumer delinquencies declined from last quarter's normal seasonal low point and were 47 basis points better than the seasonally comparable June 2011 results, evidencing the improvement of credit conditions in our markets.

Residential mortgage delinquencies were up 163,000 or 7 basis points from the seasonally low first quarter. However, they were down to 3.8 million or 32 basis points from year-earlier levels. Commercial delinquencies were down significantly, both in linked quarter and prior-year comparisons.

Nonperforming loans were 1.53% of total loans. Problem asset formation has stabilized at significantly lower levels following steadily improving market conditions.

Commercial NPL inflows of $24 million include a single $14 million ABL relationship that is in liquidation. Absent that inflow, new commercial NPL inflow was flat to the first quarter, and there were no other new NPLs greater than $1.5 million. The balance of the new ABL nonperformer was $10.5 million at quarter end and is now under $7 million. We expect that the liquidation will result in full payment.

Consumer NPL levels increased by $3.5 million from the prior quarter as residential mortgage NPLs continue to be impacted by protracted foreclosure timelines. New consumer NPL inflows, which totaled $24 million this quarter, continue to be aggressively evaluated and written down in conjunction with the more conservative loss recognition parameters instituted in the first quarter.

Our early problem resolution and asset disposition strategy led to a $3 million reduction in other repossessed assets and a $2.4 million reduction in nonperforming held for sale loans. As we have noted in prior calls, the benefit of this approach is reflected in the continued reduction in our quarterly ORE expenses.

Net charge-offs of $22 million were down $6 million from the first quarter and represented 1.62% of the total portfolio. Total net C&I charges were up $2.2 million, offsetting the quarterly reduction in CRE asset class charge-offs. The C&I increase was directly related to one substandard agricultural loan, where prompt resolution was preferable to an extended potentially costly liquidation scenario. All other C&I charge-offs were under $500,000.

Consumer net charge-offs totaled $11 million for the quarter. Excluding the $7 million related to the more conservative loss recognition policies in the first quarter and the bulk sale activity in the third quarter of 2011, the second quarter consumer net charge-offs were consistent with the levels we have seen over the last several quarters.

We continue to see a decline in our commercial watch credit balances, which at 17% of total commercial loans are at the lowest level since June of 2008. Our higher risk base capital combined with the lower levels of adversely rated loans produced a bank level classified asset ratio of 27.2% at quarter end.

The continued improvement in credit metrics and stabilized lower levels of problem asset formation provided the foundation for the lower provision expense. The allowance remains strong at 2.47% of loans and 145% of NPAs. As Cathy mentioned, our C&I book is up 27% over last year. Our core and corporate groups continue to grow their pipelines, and both teams hit their first half loan origination goals.

Our Indirect lending business continued strong results. The second quarter new bookings were up 28% over the prior year, with originations from new states associated with our concentric expansion strategy accounting for 16% of the increased volume. The Indirect portfolio's margin was down due to an increase in prepayment activity that Lisa mentioned.

Total loans at the end of June were essentially flat to March as the C&I and Indirect portfolio increases were offset by our planned reduction in CRE and residential mortgage loans. Cathy, back to you.

Cathleen H. Nash

Thank you, Mark. Obviously, restoring our deferred tax asset was a significant event for us this quarter. But just as important, our consistent operating results reflect our continued success in carrying out our strategic initiatives, which remain unchanged. Lending activity increased with strong production and pipeline growth. Our strong core deposits helped mitigate the margin pressure we expected. Positive credit trends continued, allowing for lower provision expense, and we continue to receive service scores from clients that are above industry average.

We continue to organically grow our strong capital position through earnings. This quarter, we added 101 basis points to Tier 1 common with about 1/3 of that coming from organic growth. We continue to have discussions with our regulators regarding when we will catch up on our trust, preferred and TARP dividends, as well as timing around repaying TARP. Our patience has allowed us to add $145 million to Tier 1 common equity in the past 5 quarters.

With those final comments, Clint, we'll open up the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first to the side of Jason O'Donnell [ph] with Marion Research [ph].

Unknown Analyst

Mark, can you just give us a little more detail around the $14 million C&I loan that migrated to nonperforming this quarter? I'm wondering what industry that business operates in and how comfortable you are with the current reserve against it at this point.

Mark W. Widawski

Yes, Jason. It's in the steel industry. It is a shared national credit. It is in liquidation. At this point, between working assets and fixed asset liquidation, we don't have the reserve against that and expect that we'll get that resolved this quarter in total.

Unknown Analyst

Okay, great. And then I apologize if I missed it, but can you tell us how much the level of consumer NPA formation or the level of inflows on the consumer side of the portfolio was this quarter?

Mark W. Widawski

Yes. The new inflows totaled $24 million, and the net increase was $3.5 million.

Unknown Analyst

Net increase from the last quarter?

Mark W. Widawski

Yes.

Unknown Analyst

Okay, great. And I guess maybe Cathy or maybe Mark, this is for you. In terms of the C&I portfolio and the growth that you're seeing, obviously, some strong growth. I'm just curious how much is coming out of the sort of the ABL class portfolios specifically versus sort of more traditional C&I lending.

Mark W. Widawski

Sure. As I mentioned, the core and our corporate commercial bankers did hit their production goals in a very tough environment this quarter and for the 6 months. So we're really encouraged by that. We've mentioned in the past that we used our CBBF, Citizens Bank Business Finance group, which is the asset-based lending folks, as well as some of our leverage and non-leverage participation business, to bridge that gap over the past year or so. And we've seen a flip to more organic lending in our communities taking over that growth factor. So this past quarter, we have definitely seen a change in that. Cathy?

Cathleen H. Nash

Yes, Jason. I would add, I think we've seen -- we have some nice economic stability in our region. And I think our core banking, our core C&I lending group has seen some benefits of that. The pipeline looked pretty good. The loan numbers that we've delivered within the risk parameters that were comfortable with are there. We think there's a lot of competition around price. And we're willing to look at price, but we don't want to do anything that would be stupid. So I'm really pleased with where the quarter ended and the mix that we've got.

Unknown Analyst

Okay, that's helpful. And then finally, just a housekeeping item on the tax benefit, the income tax benefit assumed this quarter. Is the entire $277 million benefit tied to the valuation allowance reversal or is there a small portion that's related to normal tax provisioning?

Lisa T. McNeely

That's correct. There's 2 parts though. Obviously, the largest is related to the valuation, and then there's the tax effect for the entire year.

Unknown Analyst

Okay. And how much is the smaller portion?

Lisa T. McNeely

I believe it's about $13 million.

Operator

We'll go next to the side of Terry McEvoy with Oppenheimer.

Terence J. McEvoy - Oppenheimer & Co. Inc., Research Division

Just, Lisa, when you were talking about the loan loss provision in Q2, you said something about, going forward, it would look something closer to peer levels? Were you talking about the provision? And could you just kind of repeat what you were getting at there?

Lisa T. McNeely

Right. I was really talking about the allowance for loan loss to loans. Today, we're about 2.47%, and we observed our peers closer to a 2% level. So as we look through our migration models that we utilize, we see that our reserve levels will come down because of the approved credit that we have. So we'll gradually align more towards that 2% range.

Terence J. McEvoy - Oppenheimer & Co. Inc., Research Division

And then, Cathy, just in your conversation with customers throughout the second quarter, was there any noticeable change in terms of their just overall outlook given some of the macro concerns that have emerged over the last few months? And do you see that having an impact on your business in the second half of this year?

Cathleen H. Nash

That's a great question, Terry. And I would say, yes, and I give that as a guarded answer. I think there is a great uncertainty around the elections coming up. I think the Supreme Court vote around health care caused concern as small business owners particularly have to think about the impact of those increased costs of providing coverage or paying the penalty if they choose not to. I think it feels a little different than a year ago, where we had an economic scenario around the entire borrowing base of the United States government. But the resulting feeling of uncertainty, I think, are reinvigorated maybe is the word to use. This quarter feels a lot like a -- the same quarter a year ago but for different reasons. I think there is a little bit of uncertainty and cautiousness within our customer base and our prospects. Now that said, we have good pipelines and we're really pleased with the amount that we see in our pipeline. So I think business is moving forward, but I would not want to paint that picture that they don't have concerns.

Terence J. McEvoy - Oppenheimer & Co. Inc., Research Division

And just one last question in terms of the TARP redemption. Could you just go through some of the issues that are being discussed with the regulators? And then ultimately, what would you like to see happen? Is it to essentially maintain the same share count as you continue to just organically grow capital, and that enables you to finally redeem TARP?

Cathleen H. Nash

So, a good question, Terry, and thank you. When we think about TARP, we have said all along, we want to repay TARP. We believe that is our obligation to do so at the lending terms in which it was given to us. We want to do that in a shareholder-friendly way, and we think patience has been the right approach for us. As I mentioned in my comments, in the last 5 quarters, we've added $145 million to Tier 1 common by being patient, and we think that's been the right approach. Now that said, certainly, Treasury has indicated publicly that they are interested in having this program move forward and maybe end quicker. That's certainly within their right, and they have been executing on some strategies to do that. We've not been included in those strategies. So our discussion with our regulators is around, again, we continue to believe patience is the right approach for us. It's 5% money. We have time to think about that. We have -- every quarter, we continue to organically add to our capital. That makes sense for us. So doing it in a shareholder-friendly way is important. If Treasury were to make other choices and consider putting us in a public auction, that's perfectly fine with us. It doesn't change our overall view of the program or our overall view with protecting our shareholders in looking to repay.

Operator

And we'll go next to the side of John Barber with KBW.

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

Mark, you mentioned the $14 million ABL and floated to nonaccrual status that was a syndicated credit. I guess how big is the SNC portfolio? And also, when was that credit added to the books?

Mark W. Widawski

John, we got in that deal a little over a year ago, and the portfolio from a SNC perspective is one that we did consciously grow, both on an ABL basis and a non-ABL basis. Early last year, it was more ABL-focused and then became less so as the yields on those deals became less attractive to us. We do have parameters around how -- what percentage of risk-based capital we will dedicate to any bucket within our Shared National Credit or club participation book. And we -- I think they're pretty conservative parameters. So we've grown that book over the year to about a $400 million balance, and most of that would be in either ABL or the CBBF managed portfolio.

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

Okay. And, Lisa, you talked about some of these strategies you've enacted to stay in the margin. Could you just give us a little more detail on your outlook for the second half of the year?

Lisa T. McNeely

Yes, John. We are very pleased with the way our bankers are addressing our clients with relationship pricing strategy that we have. We don't see a lot more opportunity on the deposit side. We don't have a lot of maturities on the CD portfolio. It's pretty stable as far as maturities, pretty even flow each month. And we are conscious to stay sort of in the middle of the pack around our market pricing, and so I don't see a lot more opportunity over the next coming quarters. And again, we see reinvestment rates on the asset side pretty tough in this environment. So it's going to be a battle to continue to maintain where we are.

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

Okay. And on the tax rate, you expected to return to more normalized levels in '13. Could you give us an estimated range of what that would be?

Lisa T. McNeely

Yes. So typically, I think a range in the low 30s. Maybe we might get a little bit of benefit to more than that, but I think that's probably a good place to be, is in the low 30s. Maybe just a tad below that.

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

All right. And then just looking at the risk profile of the bank, it seems like you guys have a lot of flexibility, upstream capital. I guess how are you thinking about the regulatory capital ratios, longer term? And what type of buffer to the minimums are you comfortable with?

Lisa T. McNeely

Go ahead, Brian.

Brian D. J. Boike

Sure. Hi, John, this is Brian. We've certainly spent some time talking about that recently with the MPRs that were put out. And I think the regulatory guidance says you need a buffer of 250 basis points over the minimums. It would certainly be prudent to maintain an additional buffer over that, especially given the inclusion of OCI and the regulatory capital ratios, if indeed that is how the final rules are written. So I don't think we're ready to announce what our strategy there in terms of additional buffer is going to be, if we ever do, but that's something we're actively thinking about.

Cathleen H. Nash

And regard your question about upstreaming, John, you're right. We have an awful lot sitting down at the bank. And part of what we're thinking about with our regulators is when is the right time for us to upstream and when it's the right time for us to catch up on both our TruPS and our TARP dividends. We consider catching up on dividends not necessarily to be linked to the timing of repaying our TARP. We would be hesitant to send a signal that, oh, we've caught up on dividends so therefore, you should assume the next thing is. So we want to be very careful we don't send any unintentional signals. But we agree, we've got plenty of cash at the bank level that supports the holding company, and the time will be right to upstream that and catch up when the time is right.

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

That's very helpful. And last one is how much cash do you have at the holding company right now?

Mark W. Widawski

$60 million.

Cathleen H. Nash

Thank you for your questions and participation in this quarter's call. It was another positive quarter for our bank, and we've demonstrated our continued success in executing the strategies we've set forth. We're going to continue our focus on top line revenue and improving our shareholder value. And we thank you for joining us and have a great weekend.

Operator

This concludes today's conference. You may disconnect at any time.

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