Why did First Citizens' earnings decline in 2007?

Net income fell $17.9 million, driven by a $12.7 million rise in the provision for credit losses (including $8.3 million tied to Working Capital Finance losses), an $43.6 million increase in noninterest expense from branch expansion, and a 13 basis point compression in the net interest yield. Higher noninterest income of $24.1 million only partly offset these pressures.

Is the IronStone Bank expansion a risk for shareholders?

Yes. ISB lost $7.7 million in 2007 after a $2.2 million profit in 2006, has cumulative losses of $34.7 million since inception, and management indicated it will likely remain unprofitable in 2008. BancShares has infused $304 million of capital into ISB since 1997, and that funding depends on dividends from FCB, which is the company's primary earnings engine.

How strong is the bank's capital and can it sustain its dividend?

Capital is strong, with a holding company Tier 1 risk-based ratio of 13.02% against a 4% minimum and a total capital ratio of 15.36%. The annual dividend of $1.10 per share consumed roughly 10.6% of 2007 earnings, so the payout is well covered. The company also has $956 million of dividend capacity at FCB, though only $461 million can be paid without jeopardizing its well-capitalized status.

What credit quality issues should investors monitor?

Nonperforming assets were a low 0.18% of loans and other real estate at year-end, but early 2008 saw $23.1 million of residential construction loans move to nonaccrual status due to weaker borrower cash flow and collateral values. Loans to medical and dental professionals represent 20.6% of the portfolio, a single-industry concentration above the 10% level for any other sector, and the company increased its unallocated loan loss reserve to 8.0% of the total allowance.

What is the outlook for net interest margin and loan growth in 2008?

Management expects asset yields to decline in 2008 following Federal Reserve rate cuts totaling 125 basis points in early 2008, with the company's liability-sensitive balance sheet potentially benefiting over time but offset by intense competition for deposits. Management anticipates moderate growth in commercial mortgage and commercial and industrial loans, but warns that economic instability could curb both loan demand and lender support for debt levels.

FCNCA 10-K FY2007 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed February 28, 2008. Cited figures are marked; the original filing is the authoritative source.

First Citizens BancShares (FCNCA) reported 2007 net income of $108.6 million^a, down 14.1% from $126.5 million in 2006, with diluted EPS falling to $10.41 from $12.12.

The decline was driven by a 60.6% jump in the provision for credit losses to $33.6 million^b, an 8.2% rise in noninterest expense to $574.7 million, and a net interest margin that compressed 13 basis points to 3.41%. Return on average equity fell to 7.92% from 10.19%, and return on assets to 0.68% from 0.83%. Net interest income was nearly flat at $480.3 million, up only 0.8%, as a flat yield curve and aggressive loan and deposit pricing offset balance sheet growth.

The filing also highlights a split performance profile between the two banking subsidiaries. First-Citizens Bank & Trust (FCB), the mature North Carolina franchise, earned $125.2 million^c, while the de novo IronStone Bank (ISB), focused on high-growth Sun Belt and western markets, posted a $7.7 million loss, and management expects ISB to remain unprofitable in 2008. Credit quality remains strong on a historical basis, with nonperforming assets at 0.18% of loans and other real estate, but management flagged $23.1 million of residential construction loans placed on nonaccrual in early 2008 and increased its unallocated reserve to 8.0% of the total allowance.

The company also disclosed a significant deficiency in Working Capital Finance lending that was remediated by year-end, and ongoing patent litigation with DataTreasury. Capital and liquidity remain conservative. Tier 1 risk-based capital was 13.02%^d and the Tier 1 leverage ratio 9.63% at the holding company, and both banks are well capitalized.

Shareholders' equity rose to $1.44 billion, with book value per share of $138.12. The Board declared a quarterly dividend of 27.5 cents, unchanged at $1.10 annually, which represents a payout ratio near 10.6% of earnings. Investors should weigh the stable, well-capitalized core bank against slowing earnings momentum, margin pressure, ISB's continuing losses, and rising credit risk as the 2008 economic outlook deteriorated.

02—Key points

Key Highlights

Net income fell 14.1% to $108.6 million in 2007 from $126.5 million in 2006; diluted EPS declined to $10.41 from $12.12.
Provision for credit losses rose 60.6% to $33.6 million, with net charge-offs increasing to 0.27% of average loans from 0.18%.
Net interest income grew only 0.8% to $480.3 million as the net interest yield fell 13 basis points to 3.41% amid a flat yield curve and competitive pricing.
Noninterest income increased 8.9% to $295.5 million, led by cardholder and merchant services ($97.1 million, up 12.7%) and wealth management fees (up 16.8%).
IronStone Bank (ISB) lost $7.7 million in 2007 and management expects continued losses in 2008 as it expands into new markets such as Dallas, Oklahoma City and Kansas City.
Capital remains strong: Tier 1 risk-based ratio of 13.02%, Tier 1 leverage of 9.63%, and both banks are well capitalized; book value rose to $138.12 per share.
Early 2008 brought $23.1 million of residential construction loans placed on nonaccrual, and the unallocated allowance rose to 8.0% of total allowance for credit losses.

03—Questions

Frequently Asked Questions

Why did First Citizens' earnings decline in 2007?
Net income fell $17.9 million, driven by a $12.7 million rise in the provision for credit losses (including $8.3 million tied to Working Capital Finance losses), an $43.6 million increase in noninterest expense from branch expansion, and a 13 basis point compression in the net interest yield. Higher noninterest income of $24.1 million only partly offset these pressures.
Is the IronStone Bank expansion a risk for shareholders?
Yes. ISB lost $7.7 million in 2007 after a $2.2 million profit in 2006, has cumulative losses of $34.7 million since inception, and management indicated it will likely remain unprofitable in 2008. BancShares has infused $304 million of capital into ISB since 1997, and that funding depends on dividends from FCB, which is the company's primary earnings engine.
How strong is the bank's capital and can it sustain its dividend?
Capital is strong, with a holding company Tier 1 risk-based ratio of 13.02% against a 4% minimum and a total capital ratio of 15.36%. The annual dividend of $1.10 per share consumed roughly 10.6% of 2007 earnings, so the payout is well covered. The company also has $956 million of dividend capacity at FCB, though only $461 million can be paid without jeopardizing its well-capitalized status.
What credit quality issues should investors monitor?
Nonperforming assets were a low 0.18% of loans and other real estate at year-end, but early 2008 saw $23.1 million of residential construction loans move to nonaccrual status due to weaker borrower cash flow and collateral values. Loans to medical and dental professionals represent 20.6% of the portfolio, a single-industry concentration above the 10% level for any other sector, and the company increased its unallocated loan loss reserve to 8.0% of the total allowance.
What is the outlook for net interest margin and loan growth in 2008?
Management expects asset yields to decline in 2008 following Federal Reserve rate cuts totaling 125 basis points in early 2008, with the company's liability-sensitive balance sheet potentially benefiting over time but offset by intense competition for deposits. Management anticipates moderate growth in commercial mortgage and commercial and industrial loans, but warns that economic instability could curb both loan demand and lender support for debt levels.

04—Continue

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