UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended March 31, 2006
or
Commission File Number: 0-16471
First Citizens BancShares, Inc
(Exact name of Registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
(919) 716-7000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days. Yes x No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. Se definition of “accelerated filer and large accelerated filer: in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Class A Common Stock—$1 Par Value—8,756,778 shares
Class B Common Stock—$1 Par Value—1,677,675 shares
(Number of shares outstanding, by class, as of May 5, 2006)
INDEX
PART I
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets
First Citizens BancShares, Inc. and Subsidiaries
(thousands, except share data)
Assets
Cash and due from banks
Overnight investments
Investment securities available for sale
Investment securities held to maturity
Loans and leases
Less allowance for loan and lease losses
Net loans and leases
Premises and equipment
Income earned not collected
Other assets
Total assets
Liabilities
Deposits:
Noninterest-bearing
Interest-bearing
Total deposits
Short-term borrowings
Long-term obligations
Other liabilities
Total liabilities
Shareholders’ Equity
Common stock:
Class A - $1 par value (8,756,778 shares issued for all periods)
Class B - $1 par value (1,677,675 shares issued for all periods)
Surplus
Retained earnings
Accumulated other comprehensive income (loss)
Total shareholders’ equity
Total liabilities and shareholders’ equity
See accompanying Notes to Consolidated Financial Statements.
Consolidated Statements of Income
(thousands, except share and per share data; unaudited)
Interest income
Investment securities:
U. S. Government
State, county and municipal
Dividends
Total investment securities interest and dividend income
Total interest income
Interest expense
Deposits
Total interest expense
Net interest income
Provision for credit losses
Net interest income after provision for credit losses
Noninterest income
Service charges on deposit accounts
Cardholder and merchant services income
Trust and asset management fees
Fees from processing services
Commission income
ATM income
Mortgage income
Other service charges and fees
Securities losses
Other
Total noninterest income
Noninterest expense
Salaries and wages
Employee benefits
Occupancy expense
Equipment expense
Total noninterest expense
Income before income taxes
Income taxes
Net income
Other comprehensive loss net of taxes
Unrealized securities losses arising during period
Less: reclassified adjustment for losses included in net income
Other comprehensive loss
Comprehensive income
Average shares outstanding
Net income per share
Consolidated Statements of Changes in Shareholders’ Equity
(thousands, except share data, unaudited)
Balance at December 31, 2004
Unrealized securities losses, net of deferred taxes
Cash dividends
Balance at March 31, 2005
Balance at December 31, 2005
Balance at March 31, 2006
Consolidated Statements of Cash Flows
OPERATING ACTIVITIES
Adjustments to reconcile net income to cash provided by operating activities:
Amortization of intangibles
Deferred tax (benefit) expense
Change in current taxes payable
Depreciation
Change in accrued interest payable
Change in income earned not collected
Origination of loans held for sale
Proceeds from sale of loans held for sale
Loss (gain) on loans held for sale
Net amortization of premiums and discounts
Net change in other assets
Net change in other liabilities
Net cash provided by operating activities
INVESTING ACTIVITIES
Net change in loans and leases outstanding
Purchases of investment securities held to maturity
Purchases of investment securities available for sale
Proceeds from maturities of investment securities held to maturity
Proceeds from maturities of investment securities available for sale
Net change in overnight investments
Dispositions of premises and equipment
Additions to premises and equipment
Purchase of branch, net of cash acquired
Net cash used by investing activities
FINANCING ACTIVITIES
Net change in time deposits
Net change in demand and other interest-bearing deposits
Net change in short-term borrowings
Cash dividends paid
Net cash provided by financing activities
Change in cash and due from banks
Cash and due from banks at beginning of period
Cash and due from banks at end of period
CASH PAYMENTS FOR:
Interest
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Unrealized securities losses
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)
Note A
Accounting Policies
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements.
In the opinion of management, the consolidated financial statements contain all material adjustments necessary to present fairly the financial position of First Citizens BancShares, Inc. as of and for each of the periods presented, and all such adjustments are of a normal recurring nature. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates.
These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the 2005 First Citizens BancShares, Inc. Annual Report, which is incorporated by reference on Form 10-K. Certain amounts for prior periods have been reclassified to conform with statement presentations for 2006. However, the reclassifications have no effect on shareholders’ equity or net income as previously reported.
Note B
Operating Segments
BancShares conducts its banking operations through its two wholly-owned subsidiaries, First-Citizens Bank & Trust Company (FCB) and IronStone Bank (ISB). Although FCB and ISB offer similar products and services to customers, each entity operates in distinct geographic markets and each entity operates under a separate charter. Additionally, the financial results and trends of ISB reflect the de novo nature of its growth.
FCB is a mature banking institution that operates from a single charter from its branch network in North Carolina, Virginia, West Virginia, Maryland and Tennessee. ISB began operations in 1997 and currently operates in Georgia, Florida, Texas, Arizona, California, New Mexico, Colorado, Oregon and Washington under a federal thrift charter.
In the aggregate, FCB and its consolidated subsidiaries, which are integral to its branch operation, and ISB account for more than 90 percent of consolidated assets, revenues and net income. Other includes activities of the parent company, Neuse, Incorporated, a subsidiary that owns real property used in the banking operation and American Guaranty Insurance Corporation, a property insurance company.
The adjustments in the accompanying tables represent the elimination of the impact of certain inter-company transactions. The adjustments to interest income and interest expense neutralize the earnings and cost of inter-company borrowings. The adjustments to noninterest income and noninterest expense reflect the elimination of management fees and other services fees paid by one company to another within BancShares’ consolidated group.
Provision for loan and lease losses
Net interest income after provision for loan and lease losses
Income (loss) before income taxes
Net income (loss)
At March 31, 2006:
Allowance for loan and lease losses
At March 31, 2005:
Note C
Employee Benefits
BancShares recognized pension expense totaling $3,690 and $3,735, respectively, in the three-month periods ended March 31, 2006 and 2005. Pension expense is included as a component of employee benefit expense.
Components of Net Periodic Benefit Cost
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Recognized net actuarial loss
Net periodic benefit cost
The expected long-term rate of return on plan assets for 2006 is 8.50 percent.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
INTRODUCTION
Management’s discussion and analysis of earnings and related financial data are presented to assist in understanding the financial condition and results of operations of First Citizens BancShares, Inc. and Subsidiaries (BancShares). BancShares is a financial holding company with two wholly owned banking subsidiaries: First-Citizens Bank & Trust Company (FCB), a North Carolina-chartered bank, and IronStone Bank (ISB), a federally-chartered thrift institution. FCB operates branches in North Carolina, Virginia, West Virginia, Maryland and Tennessee. ISB operates in Georgia, Florida, Texas, New Mexico, Arizona, California, Oregon, Washington and Colorado.
This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and related notes presented within this report. Intercompany accounts and transactions have been eliminated. Although certain amounts for prior years have been reclassified to conform to statement presentations for 2006, the reclassifications have no effect on shareholders’ equity or net income as previously reported.
SUMMARY
BancShares’ earnings and cash flows are derived primarily from the commercial banking activities conducted by its banking subsidiaries. These activities include commercial and consumer lending, deposit and cash management products, cardholder, merchant, wealth management services as well as various other products and services typically offered by commercial banks. FCB and ISB gather interest-bearing and noninterest-bearing deposits from retail and commercial customers. BancShares and its subsidiaries also secure supplemental short-term and long-term funding through various non-deposit sources. We invest the liquidity generated from these funding sources in various types of interest-earning assets such as loans and leases, investment securities and overnight investments. We also invest in bank premises, furniture and equipment used in the subsidiaries’ commercial banking business.
Various external factors influence customer demand for our loan, lease and deposit products. The general strength of the economy influences loan and lease demand as well as the quality and collectibility of our loan and lease portfolio. External economic indicators such as consumer bankruptcy rates and business debt service capacity closely follow trends in the economic cycle. In an effort to stimulate and control the rate of growth of economic activity, monetary actions by the Federal Reserve are significant to the interest rate environment in which we operate. At any point in time, both the existing level and anticipated movement of interest rates have a profound impact on customer demand for our products, our pricing of those products and on our profitability.
Financial institutions frequently focus their strategic and operating emphasis on maximizing profitability and therefore measure their relative success by reference to profitability measures such as return on average assets or return on average shareholders’ equity. BancShares’ profitability measures have historically compared unfavorably to the returns of similar-sized financial holding companies. We have historically placed significant emphasis upon asset quality, balance sheet liquidity and capital conservation, even when those priorities may be detrimental to short-term profitability.
Based on our organization’s strengths and competitive position within the financial services industry, we believe opportunities for significant growth and expansion exist. We operate in diverse and growing geographic markets and believe that through competitive products and superior customer service, we can increase our business volumes and profitability. In recent years, we have focused our efforts on customers who own their own businesses, medical and other professionals and individuals who are financially active. Among all of our customers, we seek to increase fee income in areas such as merchant processing, working capital finance, insurance, cash management, wealth management and private banking services. We also focus on opportunities to generate income by providing processing services to other banks.
We attempt to mitigate certain of the risks that can endanger our profitability and growth prospects. These risks generally fall into categories of economic, industry systemic, competitive and regulatory. While we are attentive to all areas of risk, economic risk is especially problematic due to the lack of control and the potential material impact upon our financial results. Specific economic risks include recession, rapid movements in interest rates and significant changes in inflation expectations. Compared to our larger competitors, our relatively small
Financial Summary
Table 1
(thousands, except per share data and ratios)
First
Quarter
Third
Summary of Operations
Net interest income-taxable equivalent
Selected Quarterly Averages
Investment securities
Interest-earning assets
Interest-bearing liabilities
Shareholders’ equity
Shares outstanding
Selected Quarter-End Balances
Profitability Ratios (averages)
Rate of return (annualized) on:
Dividend payout ratio
Liquidity and Capital Ratios (averages)
Loans to deposits
Shareholders’ equity to total assets
Time certificates of $100,000 or more to total deposits
Per Share of Stock
Book value at period end
Tangible book value at period end
asset size and limited capital resources create a level of economic risk that requires significant and constant management attention.
Detailed information regarding the components of net income and other key financial data over the most recent five quarters is provided in Table 1. Table 4 provides information on net interest income. Table 5 provides information related to asset quality.
Net income. BancShares realized an increase in earnings during the first quarter of 2006 compared to the first quarter of 2005. Consolidated net income during the first quarter of 2006 was $28.7 million, compared to $25.0 million earned during the corresponding period of 2005. The $3.7 million or 14.6 percent increase resulted from higher revenue, partially offset by increased levels of noninterest expense and provision for credit losses.
Net income per share during the first quarter of 2006 totaled $2.75, compared to $2.40 during the first quarter of 2005, a 14.6 percent increase. Return on average assets was 0.79 percent for the first quarter of 2006 and 0.76 percent for the first quarter of 2005. Return on average equity for the first quarter of 2006 was 9.75 percent compared to 9.26 percent during the first quarter of 2005.
ISB reported a net loss of $147,000 during the first quarter of 2006, compared to a net loss of $1.2 million during the first quarter of 2005. The improvement in the first quarter operating results reflects the impact of significantly higher levels of net interest income and reduced provision for credit losses arising from less robust loan growth. As ISB’s offices continue to mature, we anticipate continued improvements over 2005 earnings. However, ISB’s net yield on interest-earning assets remains under pressure due to competitive loan and deposit pricing.
Shareholders’ Equity. BancShares continues to exceed minimum regulatory capital standards, and the banking subsidiaries remain well-capitalized. However, the continued de novo growth has required BancShares to infuse significant amounts of capital into ISB to support its rapidly expanding balance sheet. BancShares infused $15.0 million into ISB during the first quarter of 2006. Since ISB was formed in 1997, BancShares has provided $265.0 million in capital. Losses incurred since ISB’s inception total $29.4 million. Based on plans for further growth and expansion, BancShares will infuse an additional $15 million into ISB during the remainder of 2006. BancShares’ prospective capacity to provide capital to support the growth and expansion of ISB is highly dependent upon FCB’s ability to return capital through dividends to BancShares.
INTEREST-EARNING ASSETS
Interest-earning assets include loans, investment securities and overnight investments, all of which reflect varying interest rates based on the risk level and maturity of the underlying asset. Riskier investments typically carry a higher interest rate, but expose the investor to potentially higher levels of default. We have historically focused on maintaining high asset quality, which results in a loan and lease portfolio subjected to strenuous underwriting and monitoring procedures. Our investment securities portfolio includes high-quality assets, primarily United States Treasury and government agency securities. Generally, the investment securities portfolio grows and shrinks based on loan, lease and deposit trends. When deposit growth exceeds loan and lease demand, we invest excess funds in the securities portfolio. Conversely, when loan and lease demand exceeds deposit growth, we use proceeds from maturing securities to fund loan and lease demand. Overnight investments are selectively made with other financial institutions that are within our risk tolerance.
During the first quarter of 2006, interest-earning assets averaged $13.13 billion, an increase of $1.20 billion or 10.1 percent from the first quarter of 2005. This increase resulted primarily from growth in investment securities, primarily funded by deposit growth.
Loans and Leases. At March 31, 2006 and 2005, loans and leases totaled $9.81 billion and $9.40 billion, respectively. The $405.3 million or 4.3 percent growth from March 31, 2005 to March 31, 2006 resulted from growth within the commercial and industrial and construction and land development portfolios.
At March 31, 2006, commercial and industrial loans equaled $1.33 billion or 13.5 percent of total loans and leases outstanding. These loans have increased $352.4 million or 36.2 percent since March 31, 2005. Construction and land development loans totaled $821.5 million or 8.4 percent of total loans at March 31, 2006, an increase of $183.8 million or 28.8 percent since March 31, 2005. Customer demand and ISB franchise expansion have supported the growth of both loan categories.
Outstanding Loans and Leases by Type
Table 2
(thousands)
Real estate:
Construction and land development
Commercial mortgage
Residential mortgage
Revolving mortgage
Other mortgage
Total real estate loans
Commercial and industrial
Consumer
Lease financing
Total loans and leases
Commercial real estate loans totaled $3.53 billion at March 31, 2006, representing 36.0 percent of total loans. This represents an increase of $148.7 million or 4.4 percent since March 31, 2005. Demand for commercial real estate loans continues to be healthy, particularly at ISB. A large percentage of our commercial mortgage portfolio is secured by owner-occupied facilities, rather than investment property. These loans are underwritten based primarily upon the cash flow from the operation of the business rather than the value of the real estate collateral.
Revolving mortgage loans totaled $1.36 billion at March 31, 2006, representing 13.9 percent of total loans outstanding. This component of the loan portfolio has decreased $302.3 million or 18.2 percent since March 31, 2005. During the second quarter of 2005, we completed a securitization and sale of $256.2 million of revolving mortgage loans. This transaction reduced our mix of revolving loans secured by real estate and generated additional liquidity for other loan types.
Our continuing expansion into new markets has allowed us to mitigate our historic exposure to geographic concentration in North Carolina and Virginia. As we continue to expand into new markets, we have endeavored to ensure that rigorous centralized underwriting and monitoring controls are functioning effectively. We will continue to place emphasis upon maintaining strong lending standards in new markets.
We maintain a well-diversified loan and lease portfolio, and seek to avoid the risk associated with large concentrations within specific industries. Over the past several years, we have aggressively sought opportunities to provide financial services to businesses associated with and professionals within the medical community. Due to strong growth within this industry, our loans for offices and clinics of medical doctors increased to $1.32 billion as of March 31, 2006, which represents 13.75 percent of total loans and leases outstanding. Except for this single concentration, no other industry represented more than 10 percent of total loans and leases outstanding at March 31, 2006.
We anticipate growth in commercial mortgage and commercial and industrial loans in 2005, as our expansion into new markets translates into higher levels of loan demand among our business customers. Our continued expansion will likewise continue to diversify risks resulting from regional concentrations. All growth projections are subject to change as a result of economic deterioration or improvement, competitive forces and other external factors.
Investment Securities
Table 3
Investment securities available for sale:
U. S. Government:
Within one year
One to five years
Five to ten years
Ten to twenty years
Over twenty years
Total
State, county and municipal:
Over ten years
Equity securities
Total investment securities available for sale
Investment securities held to maturity:
Total investment securities held to maturity
Total investment securities
Average maturity assumes callable securities mature on their earliest call date; yields are based on amortized cost; yields related to securities that are exempt from federal and/or state income taxes are stated on a taxable-equivalent basis assuming statutory rates of 35% for federal income tax purposes and 6.9% for state income taxes for all periods.
Investment Securities. Investment securities available for sale equaled $2.40 billion at March 31, 2006, compared to $1.34 billion at March 31, 2005. The $1.06 billion increase in investment securities available for sale from March 31, 2005 resulted from deposit and short-term borrowings growth that exceeded loan demand and the continued migration of investments from the held to maturity portfolio. Available-for-sale securities are reported at their aggregate fair value. Investment securities held to maturity totaled $501.0 million at March 31, 2006, compared to $850.8 million at March 31, 2005. Securities that are classified as held to maturity reflect BancShares’ ability and positive intent to hold those investments until maturity. Table 3 presents detailed information relating to the investment securities portfolio.
Income on Interest-Earning Assets. Interest income amounted to $190.0 million during the first quarter of 2006, a $41.8 million or 28.2 percent increase from the first quarter of 2005. Higher yields and higher average volume caused the increase in interest income when compared to the same period of 2005. The taxable-equivalent yield on interest-earning assets for the first quarter of 2006 was 5.87 percent, compared to 5.04 percent for the corresponding period of 2005.
Loan interest income for the first quarter of 2006 was $159.2 million, an increase of $26.9 million or 20.3 percent from the first quarter of 2005, the result of higher average balances and higher yields. The taxable-equivalent yield on the loan portfolio was 6.66 percent during the first quarter of 2006, compared to 5.74 percent during the same period of 2005. The higher loan yields resulted from new loans originated at current market rates and repricing of outstanding variable-rate loans. Average loans increased $348.0 million or 3.7 percent from 2005 to 2006.
Interest income earned on the investment securities portfolio amounted to $25.1 million during the first quarter of 2006 and $12.9 million during the same period of 2005, an increase of $12.2 million or 94.2 percent. This increase in income is the result of higher average volume and increased yields. Average investment securities increased $824.4 million from $2.07 billion during the first quarter of 2005 to $2.90 billion during the first quarter of 2006. Maturing securities not needed to fund loan and lease growth were reinvested in higher-yielding securities. The taxable-equivalent yield increased 95 basis points from 2.53 percent in the first quarter of 2005 to 3.48 percent in the first quarter of 2006 due to higher market rates.
Interest income from overnight investments was $5.7 million during the first quarter of 2006, an increase of $2.7 million from the $3.0 million earned during the first quarter of 2005, the combined result of a 198 basis point increase in the earned yield and $27.9 million growth in average overnight investments.
INTEREST-BEARING LIABILITIES
Interest-bearing liabilities include our interest-bearing deposits as well as short-term borrowings and long-term obligations. Deposits are our primary funding source, although we also utilize non-deposit borrowings to stabilize our liquidity base and, in some cases, to fulfill commercial customer requirements for cash management services. Certain of our long-term borrowings also provide capital strength under existing guidelines established by the Federal Reserve Bank and other banking regulators.
At March 31, 2006 and 2005, interest-bearing liabilities totaled $11.04 billion and $9.82 billion, respectively. During the first quarter of 2006, interest-bearing liabilities averaged $10.79 billion, an increase of $1.15 billion or 12.0 percent from the first quarter of 2005. This increase primarily resulted from higher levels of time deposits and master notes.
Deposits At March 31, 2006, total deposits were $12.51 billion, an increase of $883.2 million or 7.6 percent over March 31, 2005. Deposits at ISB increased by $339.3 million or 27.4 percent from March 31, 2005 to March 31, 2006.
Average interest-bearing deposits were $9.60 billion during the first quarter of 2006, an increase of $691.5 million or 7.8 percent from the first quarter of 2005. Average time deposits increased $691.0 million or 17.3 percent to $4.68 billion from the first quarter of 2005 to the same period of 2006. Partially offsetting this increase, average savings accounts decreased $57.3 million or 7.7 percent.
Consolidated Taxable Equivalent Rate/Volume Variance Analysis - First Quarter
Table 4
Total interest-earning assets
Interest-bearing deposits:
Checking With Interest
Savings
Money market accounts
Time deposits
Total interest-bearing deposits
Federal funds purchased
Repurchase agreements
Master notes
Other short-term borrowings
Total interest-bearing liabilities
Interest rate spread
Net interest income and net yield on interest-earning assets
Average loan and lease balances include nonaccrual loans and leases. Yields related to loans, leases and securities exempt from both federal and state income taxes, federal income taxes only, or state income taxes only are stated on a taxable-equivalent basis assuming a statutory federal income tax rate of 35% and state income tax rate of 6.90% for each period. The taxable-equivalent adjustment was $408 for 2006 and $347 for 2005.
We attribute the growth of time deposits to the higher interest rate environment, and expect that the mix of time deposit balances within interest-bearing deposits will increase as market rates continue to move higher. Competition for deposit business in our market areas is extremely intense. While we have access to non-deposit borrowing sources, we prefer to fund loan demand with traditional bank deposits. Therefore, generating acceptable levels of deposit growth is a critical challenge for us, particularly during periods of strong loan demand.
Short-term Borrowings At March 31, 2006, short-term borrowings totaled $850.6 million compared to $465.0 million at March 31, 2005. For the quarters ended March 31, 2006 and 2005, short-term borrowings averaged $784.7 million and $445.5 million, respectively. The growth in short-term borrowings was primarily the result of significantly higher customer demand for our commercial master note product.
Long-Term Obligations. At March 31, 2006 and 2005, long-term obligations totaled $408.9 million and $285.7 million, respectively, an increase of $123.3 million or 43.2 percent.
Long-term obligations at March 31, 2006 include $125.0 million in 5.125 percent subordinated notes payable issued by FCB during 2005. The notes mature in 2015 and are redeemable, subject to regulatory approval, at any time based on specific redemption provisions and qualify as tier 2 regulatory capital.
Long-term obligations includes $257.8 million in junior subordinated debentures representing obligations to two equity method subsidiaries, FCB/NC Capital Trust I and FCB/NC Capital Trust II. Under regulatory standards, these trust preferred capital securities qualify as Tier 1capital for BancShares. The $150.0 million in trust preferred capital securities issued by FCB/NC Capital Trust I mature in 2028 and may be redeemed in whole or in part at a declining premium after March 1, 2008. The $100.0 million in trust preferred capital securities issued by FCB/NC Capital Trust II mature in 2031 and may be redeemed in whole or in part at par after October 31, 2006. Although no definitive action has been directed by the board of directors, given current interest rates, it is likely that the trust preferred capital securities issued by FCB/NC Capital Trust II will be redeemed during the fourth quarter of 2006.
Expense on Interest-Bearing Liabilities. Interest expense amounted to $72.2 million during the first quarter of 2006, a $29.6 million or 69.5 percent increase from the first quarter of 2005. The higher interest expense was the result of higher rates and higher average volume. The rate on average interest-bearing liabilities was 2.71 percent, a 92 basis point increase in the aggregate blended rate on interest-bearing liabilities as compared to the first quarter of 2005.
NET INTEREST INCOME
Net interest income totaled $117.8 million during the first quarter of 2006, an increase of $12.2 million or 11.5 percent from the first quarter of 2005. The taxable-equivalent net yield on interest-earning assets was 3.65 percent for the first quarter of 2006, compared to the 3.60 percent achieved for the first quarter of 2005.
Our asset/liability management strategy continues to focus on maintaining high levels of balance sheet liquidity and managing our interest rate risk. We maintain portfolios of interest-earning assets and interest-bearing liabilities with maturities or repricing characteristics that will protect against wide interest rate fluctuations, thereby limiting, to the extent possible, the ultimate interest rate exposure. We do not use interest rate swaps, floors, collars or other derivative financial instruments to attempt to hedge our interest rate sensitivity and interest rate risk. Due to customer preference for fixed-rate commercial loans and surges in shorter-term deposit balances, our interest-sensitivity position has shifted over the last several quarters to a virtually neutral position, whereby short-term interest sensitive assets and liabilities are roughly equivalent. Based upon recent trends, it appears that the interest-sensitivity position will migrate to being liability- sensitive within the next twelve months by the end of 2006. A liability sensitive position typically creates a situation where rising interest rates cause a reduction in the net yield on interest-earning assets.
ASSET QUALITY
The maintenance of excellent asset quality is one of our primary areas of focus. We have historically dedicated significant resources to ensuring we are prudent in decisions to extend credit and in the monitoring of asset quality on an ongoing basis.
Nonperforming assets. At March 31, 2006, BancShares’ nonperforming assets amounted to $21.4 million or 0.22 percent of loans and leases plus foreclosed properties, compared to $22.9 million at March 31, 2005. Management views these levels of nonperforming assets as evidence of strong asset quality. Management continues to closely monitor nonperforming assets, taking necessary actions to minimize potential exposure.
Allowance for Credit Losses. At March 31, 2006, the allowance for credit losses totaled $137.1 million or 1.40 percent of total loans and leases, compared to 1.41 percent at March 31, 2005. The $4.5 million increase was needed to support new loan growth and specific impaired loans. The allowance for credit losses includes the allowance for loan and lease losses and the liability for unfunded credit commitments. We continuously analyze the growth and risk characteristics of the total loan and lease portfolio under current economic conditions in order to evaluate the adequacy of the allowance. Such factors as the financial condition of borrowers, fair market value of collateral and other considerations are recognized in estimating probable credit losses.
The provision for credit losses charged to operations during the first quarter of 2006 was $6.7 million, compared to $5.3 million during the first quarter of 2005. The $1.4 million increase in the provision for credit losses during 2006 resulted primarily from higher net charge offs. Net charge-offs during the first quarter of 2006 were $5.4 million compared to $3.5 million during the first quarter of 2005, primarily due to losses incurred on a single relationship. On an annualized basis, net charge-offs represent 0.22 percent of average loans and leases during the first quarter of 2006 compared to 0.15 percent in the first quarter of 2005. Table 5 provides details concerning the allowance and provision for credit losses during the past five quarters.
Summary of Loan and Lease Loss Experience and Risk Elements
Table 5
(thousands, except ratios)
Allowance for credit losses at beginning of period
Adjustment for sale of loans
Net charge-offs:
Charge-offs
Recoveries
Net charge-offs
Allowance for credit losses at end of period
Allowance for credit losses includes:
Liability for unfunded credit commitments
Historical Statistics
Average loans and leases
Loans and leases at period-end
Risk Elements
Nonaccrual loans and leases
Other real estate
Total nonperforming assets
Accruing loans and leases 90 days or more past due
Ratios
Net charge-offs (annualized) to average total loans and leases
Percent of total loans and leases at period-end:
Allowance for credit losses
Nonperforming assets to total loans and leases plus other real estate
Management considers the established allowance adequate to absorb estimated probable losses that relate to loans and leases outstanding at March 31, 2006, although future additions may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for credit losses. Such agencies may require the recognition of adjustments to the allowance based on their judgments of information available to them at the time of their examination.
NONINTEREST INCOME
The growth of noninterest income is essential to our ability to sustain adequate levels of profitability. The primary sources of noninterest income are service charges on deposit accounts, cardholder and merchant services income, various types of commission-based income, fees from processing services and various types of revenues derived from wealth management services.
During the first three months of 2006, noninterest income was $65.7 million, compared to $61.2 million during the same period of 2005. The $4.5 million or 7.4 percent increase was primarily due to improvements in cardholder and merchant services income, commission income and trust and asset management fees.
Service charges on deposit accounts generated $18.2 million and $18.7 million for the first quarter of 2006 and 2005, respectively. The $487,000 or 2.6 percent decrease was primarily due to lower commercial service charges, the result of higher interest rates, which reduce service charge income earned on commercial analysis accounts.
Cardholder and merchant services income increased $2.2 million or 13.4 percent to $18.4 million during the first quarter. This increase resulted from higher merchant discount income due to higher merchant transaction volume, and higher interchange income, the result of growth in cardholder transaction volume.
Within commission income, fees generated by broker-dealer activities increased $1.1 million as a result of strong sales growth. Commission income generated by insurance agency activities and working capital finance also improved when compared to 2005.
Trust and asset management fees improved $690,000 or 15.4 percent to $5.2 million during the first quarter of 2006 due to new sales activity and favorable results from accounts that generate fees based on asset values. Fees from processing services totaled $6.9 million in the first quarter of 2006 and $6.2 million in the first quarter of 2005. The $689,000 or 11.1 percent increase was primarily the result of increased volume.
NONINTEREST EXPENSE
The primary components of noninterest expense are salaries and related employee benefit costs, occupancy costs related to branch offices and support facilities, and equipment costs related to branch offices and technology.
Noninterest expense equaled $131.7 million for the first three months of 2006, a $10.4 million or 8.5 percent increase over the $121.3 million recorded during the same period of 2005. As a result of its continued growth and expansion, ISB’s noninterest expense increased from $15.5 million for the first quarter of 2005 to $18.0 million in 2006, a $2.5 million or 16.1 percent increase.
Salaries and wages increased $4.8 million or 9.3 percent during the first quarter of 2006 when compared to the same period of 2005. The increase resulted from workforce expansions both as a result of new branch offices and headcount additions in several support functions, merit increases and higher incentive payments. Employee benefits expense totaled $13.9 million for the first three months of 2006, an increase of $1.4 million. This 11.4 percent increase was the result of higher health insurance costs.
Occupancy expense was $12.9 million during the first quarter of 2006 and $11.4 million during the first quarter of 2005. The $1.4 million or 12.6 percent increase resulted from higher building depreciation, rent expense and occupancy costs arising from branch expansion.
Other expenses increased $2.5 million or 7.6 percent from the first quarter of 2005 to the first quarter of 2006. This increase includes a $1.6 million increase in card processing costs and smaller increases among costs related to our cardholder reward program, courier expenses, and external computer processing expense.
INCOME TAXES
BancShares continually monitors and evaluates the potential impact of current events on the estimates used to establish income tax expenses and income tax liabilities. On a periodic basis, we evaluate our income tax positions based on current tax law, positions taken by various tax auditors within the jurisdictions that BancShares is required to file income tax returns as well as potential or pending audits or assessments by such tax auditors.
Income tax expense amounted to $16.5 million during the three months ended March 31, 2006, compared to $15.2 million during the same period of 2005. The 8.1 percent increase in income tax expense was primarily the result of higher pre-tax income. The effective tax rates for these periods were 36.5 percent and 37.8 percent, respectively.
LIQUIDITY
BancShares has historically maintained a strong focus on liquidity, and our deposit base represents our primary liquidity source. Through our deposit pricing strategies, we have the ability to stimulate or curtail deposit growth. BancShares also maintains additional sources for borrowed funds through federal funds lines of credit and other borrowing facilities. At March 31, 2006, BancShares had access to $480.0 million in unfunded borrowings through its correspondent bank network.
Once we have generated the needed liquidity and satisfied our loan and lease demand, residual liquidity is invested in overnight and longer-term investment products. Investment securities available for sale provide immediate liquidity as needed. In addition, investment securities held to maturity provide an ongoing liquidity source based on the scheduled maturity dates of the securities.
SHAREHOLDERS’ EQUITY AND CAPITAL ADEQUACY
BancShares maintains an adequate capital position and exceeds all minimum regulatory capital requirements. At March 31, 2006 and 2005, the leverage capital ratios of BancShares were 9.23 percent and 9.39 percent, respectively, surpassing the minimum level of 3 percent. As a percentage of risk-adjusted assets, BancShares’ Tier 1 capital ratios were 12.52 percent at March 31, 2006 and 12.15 percent at March 31, 2005. The minimum ratio allowed is 4 percent of risk-adjusted assets. The total risk-adjusted capital ratios were 15.03 percent at March 31, 2006 and 13.49 percent as of March 31, 2005. The minimum total capital ratio is 8 percent. BancShares and each of its subsidiary banks exceed the capital standards established by their respective regulatory agencies.
SEGMENT REPORTING
BancShares conducts its banking operations through its two banking subsidiaries, FCB and ISB. Although FCB and ISB offer similar products and services to customers, each entity operates in distinct geographic markets and has separate management groups. We monitor growth and financial results in these institutions separately and, within each institution, by geographic segregation.
Although FCB has grown through acquisition in certain of its markets, throughout its history much of its expansion has been accomplished on a de novo basis. However, because of FCB’s size, market share and maturity as well as the current modest expansion of its branch network, the costs associated with de novo branching are not material to FCB’s financial performance. Since it first opened in 1997, ISB has followed a similar business model for growth and expansion. Yet, due to the magnitude of the number of branch offices that have yet to attain sufficient size for profitability, the financial results and trends of ISB are significantly affected by its current and continuing growth. Each new market ISB enters creates additional operating costs that are typically not fully offset by operating revenues until the third year after initial opening. ISB’s rapid growth in new markets in recent years has continued to adversely impact its financial performance.
IronStone Bank. At March 31, 2006, ISB operated 54 branches in Florida, Georgia, Texas, New Mexico, Arizona, California, Oregon, Washington and Colorado, compared to 48 branches at March 31, 2005. ISB continues to focus on markets with favorable growth prospects. Our business model for these new markets has two pivotal requirements. First, we are recruiting and hiring experienced bankers who are established in the markets we are entering and who are focused on strong asset quality and delivering high quality customer service. Second, we are occupying attractive branch facilities located in areas conducive to attracting medical and professional customers. While these are costly goals, we believe that they are critical to establishing a solid foundation for future success in these new markets.
ISB’s total assets were $1.95 billion at March 31, 2006 compared to $1.59 billion at March 31, 2005, an increase of $357.6 million or 22.5 percent. Net interest income increased $2.3 million or 16.1 percent during the first quarter of 2006, the result of balance sheet growth and an improved net yield on interest-earning assets.
The provision for credit losses decreased $656,000 during the first quarter of 2006 due to lower net charge offs and slower loan and lease growth. Net charge-offs decreased from $277,000 in the first quarter of 2005 to $141,000 in the first quarter of 2006. On an annualized basis, the ratio of current quarter net charge-offs to average loans and leases outstanding equaled 0.10 percent.
ISB’s noninterest income increased $1.2 million or 85.0 percent during the first quarter of 2006 as cardholder and merchant services income increased $824,000 and factoring commissions increased $327,000. These increases were partially offset by lower mortgage income.
Noninterest expense increased $2.5 million or 16.1 percent during the first quarter of 2006, versus the same period of 2005. Personnel costs increased $768,000 or 9.5 percent, while occupancy expense was up $573,000 or 22.0 percent. Other expense equaled $4.9 million during the first quarter of 2006 compared to $3.9 million during the first quarter of 2005. This increase was the result of higher general operating expenses, such as credit card processing, service fee expense and recording fees. Noninterest expenses will continue to grow as compared to 2005 levels.
ISB recorded a net loss of $147,000 during the first quarter of 2006, compared to net loss of $1.2 million recorded during the same period of 2005. This represents a favorable variance of $1.0 million. ISB continues to evaluate expansion opportunities. As growth continues, ISB will incur incremental operating costs, particularly in the areas of personnel and occupancy. As a result of the de novo status of much of the ISB franchise and plans for continued expansion, ISB’s net losses will likely extend into the foreseeable future.
First-Citizens Bank & Trust Company. At March 31, 2006, FCB operated 339 branches in North Carolina, Virginia, West Virginia, Maryland and Tennessee, compared to 340 branches at March 31, 2005.
FCB’s total assets increased from $11.87 billion at March 31, 2005 to $13.00 billion at March 31, 2006, an increase of $1.14 billion or 9.6 percent, the result of strong growth in investment securities, primarily funded by deposit growth. FCB’s net interest income increased $10.0 million or 10.4 percent during 2006, due both to an improved net yield and higher balances of interest-earning assets.
The provision for credit losses increased $2.1 million due to higher net charge offs. Net charge-offs increased $2.0 million or 62.9 percent. FCB’s noninterest income increased $3.4 million or 5.5 percent during the first quarter of 2006, primarily the result of higher cardholder and merchant services income and commission-based income. Noninterest expense increased $8.1 million or 7.5 percent during 2006, caused principally by higher personnel costs.
FCB recorded net income of $31.9 million during the first quarter of 2006 compared to $29.3 million during the same period of 2005. This represents a $2.6 million or 8.9 percent increase in net income.
CURRENT ACCOUNTING AND REGULATORY ISSUES
In November 2003, the Emerging Issues Task Force (“EITF”) issued EITF Issue No. 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (“EITF 03- 01”). In September 2004, the Financial Accounting Standards Board (FASB) issued a FASB Staff Position (FSP EITF 03-1-b). In November 2005, the FASB issued FSP FAS 115-1 and FAS 124-1. Collectively, these documents consider when an investment is considered impaired, what disclosures are appropriate for impairment losses, and what disclosures are appropriate for unrealized losses that have not been recognized as other-than-temporary impairments. The new disclosure requirements are effective for reporting periods beginning after December 15. 2005.
In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154 (SFAS 154), “Accounting Changes and Error Corrections”, which replaces prior accounting guidance related to accounting changes and error corrections. SFAS 154 changes the requirements for the accounting for and reporting of a change in an accounting principle. SFAS 154 requires retrospective application for voluntary changes in an accounting principle unless it is impracticable to do so. SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. We adopted SFAS 154 on January 1, 2006. There will be no material impact on our consolidated financial statements.
Management is not aware of any current recommendations by regulatory authorities that, if implemented, would have or would be reasonably likely to have a material effect on liquidity, capital ratios or results of operations.
FORWARD-LOOKING STATEMENTS
Statements in this Report and exhibits relating to plans, strategies, economic performance and trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts, may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed in our Annual Report on Form 10-K and in other documents filed by us from time to time with the Securities and Exchange Commission.
Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “forecasts,” “projects,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of BancShares’ management about future events.
Factors that could influence the accuracy of those forward-looking statements include, but are not limited to, the financial success or changing strategies of our customers, customer acceptance of our services, products and fee structure, the competitive nature of the financial services industry, our ability to compete effectively against other financial institutions in our banking markets, actions of government regulators, the level of market interest rates and our ability to manage our interest rate risk, changes in general economic conditions particularly changes that affect our loan and lease portfolio, the abilities of our borrowers to repay their loans and leases, and the values of collateral, and other developments or changes in our business that we do not expect.
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We have no obligation to update these forward-looking statements.
Market risk is the potential economic loss resulting from changes in market prices and interest rates. This risk can either result in diminished current fair values of financial instruments or reduced net interest income in future periods. As of March 31, 2006, BancShares’ market risk profile has not changed significantly from December 31, 2005. Changes in fair value that result from movement in market rates cannot be predicted with any degree of certainty. Therefore, the impact that future changes in market rates will have on the fair values of financial instruments is uncertain.
BancShares’ management, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of BancShares’ disclosure controls and procedures in accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (Exchange Act). Based on their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, BancShares’ disclosure controls and procedures were effective in enabling it to record, process, summarize and report in a timely manner the information required to be disclosed in reports it files under the Exchange Act.
No change in BancShares’ internal control over financial reporting occurred during the first quarter of 2006 that had materially affected, or is reasonably likely to materially affect, BancShares’ internal control over financial reporting.
PART II
In addition to information discussed in this report, our Annual Report on Form 10-K for the year ended December 31, 2005 identifies and discusses various risk factors that could materially affect our business, financial condition or future results. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may adversely affect our business, financial condition or operating results.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
FIRST CITIZENS BANCSHARES, INC.
(Registrant)
/s/ Kenneth A. Black