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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended March 31, 2004
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from_________________to_______________________________
Commission file Number 000-10535
CITIZENS BANKING CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2378932
- ---------------------------------------- ---------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
328 S. Saginaw St., Flint, Michigan 48502
- ---------------------------------------- ---------------------
(Address of principal executive offices) (Zip Code)
(810) 766-7500
--------------------------------------------------
(Registrant's telephone number, including area code)
None
---------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
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 12 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 90 days
X Yes ____ No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
X Yes ____ No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at April 30, 2004
-------------------------- -----------------------------
Common Stock, No Par Value 43,338,745 Shares
CITIZENS BANKING CORPORATION
Index to Form 10-Q
Page
----
PART I - FINANCIAL INFORMATION
Item 1 - Consolidated Financial Statements..................................................................... 3
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................................. 13
Item 3. - Quantitative and Qualitative Disclosures about Market Risk........................................... 29
Item 4. - Controls and Procedures.............................................................................. 29
PART II - OTHER INFORMATION
Item 2 - Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities..................... 30
Item 6 - Exhibits and Reports on Form 8-K...................................................................... 30
SIGNATURES.......................................................................................................... 31
EXHIBIT INDEX....................................................................................................... 32
2
PART I - FINANCIAL INFORMATION
ITEM 1 - CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
MARCH 31, December 31,
(in thousands) 2004 2003
- -------------- ----------- -------------
(UNAUDITED) (Note 1)
ASSETS
Cash and due from banks $ 156,220 $ 182,545
Interest-bearing deposits with banks 1,253 2,223
Investment Securities:
Available-for-Sale:
U.S. Treasury and federal agency securities 1,500,376 1,452,582
State and municipal securities 432,869 437,003
Other securities 76,065 75,616
Held-to-maturity:
State and municipal securities (fair value of $30,172 and $19,913, respectively) 30,104 19,857
----------- -------------
Total investment securities 2,039,414 1,985,058
Mortgage loans held for sale 37,205 44,677
Loans:
Commercial 2,796,580 2,885,868
Real estate construction 179,353 192,759
Real estate mortgage 396,010 402,910
Consumer 1,827,968 1,764,165
----------- -------------
Total loans 5,199,911 5,245,702
Less: Allowance for loan losses (123,703) (123,545)
----------- -------------
Net loans 5,076,208 5,122,157
Premises and equipment 116,531 112,784
Goodwill 54,785 54,785
Other intangible assets 16,207 16,932
Bank owned life insurance 80,896 80,461
Other assets 113,702 109,448
----------- -------------
TOTAL ASSETS $ 7,692,421 $ 7,711,070
=========== =============
LIABILITIES
Noninterest-bearing deposits $ 891,342 $ 882,429
Interest-bearing deposits 4,569,590 4,559,838
----------- -------------
Total deposits 5,460,932 5,442,267
Federal funds purchased and securities sold
under agreements to repurchase 542,206 588,593
Other short-term borrowings 17,169 43,077
Other liabilities 76,843 65,112
Long-term debt 941,089 936,859
----------- -------------
Total liabilities 7,038,239 7,075,908
SHAREHOLDERS' EQUITY
Preferred stock - no par value -- --
Common stock - no par value 100,982 100,314
Retained earnings 517,143 512,045
Accumulated other comprehensive income 36,057 22,803
----------- -------------
Total shareholders' equity 654,182 635,162
----------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 7,692,421 $ 7,711,070
=========== =============
See notes to consolidated financial statements.
3
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
Three Months Ended
March 31,
(in thousands, except per share amounts) 2004 2003
- ---------------------------------------- ---------- --------
INTEREST INCOME
Interest and fees on loans $ 73,706 $ 84,504
Interest and dividends on investment securities:
Taxable 15,442 14,434
Tax-exempt 5,244 5,184
Money market investments 2 87
---------- --------
Total interest income 94,394 104,209
---------- --------
INTEREST EXPENSE
Deposits 16,451 25,037
Short-term borrowings 1,272 620
Long-term debt 8,343 7,046
---------- --------
Total interest expense 26,066 32,703
---------- --------
NET INTEREST INCOME 68,328 71,506
Provision for loan losses 7,000 18,992
---------- --------
Net interest income after provision for loan losses 61,328 52,514
---------- --------
NONINTEREST INCOME
Service charges on deposit accounts 8,042 6,590
Trust fees 4,310 4,220
Mortgage and other loan income 2,256 5,154
Brokerage and investment fees 1,782 1,768
Bankcard fees 783 735
Investment securities gains -- 48
Other 5,339 4,772
---------- --------
Total noninterest income 22,512 23,287
---------- --------
NONINTEREST EXPENSE
Salaries and employee benefits 31,939 30,112
Occupancy 5,342 4,695
Equipment 3,642 4,169
Professional services 3,928 3,708
Data processing services 3,646 3,316
Advertising and public relations 2,145 2,049
Postage and delivery 1,556 1,678
Telephone 1,534 1,175
Other loan fees 1,129 1,142
Stationery and supplies 842 895
Other 4,831 3,642
---------- --------
Total noninterest expense 60,534 56,581
---------- --------
INCOME BEFORE INCOME TAXES 23,306 19,220
Income tax provision 5,863 4,162
---------- --------
NET INCOME $ 17,443 $ 15,058
========== ========
NET INCOME PER SHARE:
Basic 0.40 0.35
Diluted 0.40 0.34
CASH DIVIDENDS DECLARED PER SHARE 0.285 0.285
AVERAGE SHARES OUTSTANDING:
Basic 43,315 43,505
Diluted 43,860 43,748
See notes to consolidated financial statements.
4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
Accumulated
Other
Common Retained Comprehensive
(in thousands except per share amounts) Stock Earnings Income Total
- --------------------------------------- --------- -------- -------------- ---------
BALANCE - MARCH 31, 2003 $ 103,314 $498,173 $ 38,887 $ 640,374
Comprehensive income:
Net income 13,214 13,214
Other comprehensive income:
Net unrealized loss on securities available-for-sale,
net of tax effect of $(258) (479)
Less: Reclassification adjustment for net gains included
in net income, net of tax effect of $4 (7) (486)
-------------- ---------
Total comprehensive income 12,728
Exercise of stock options, net of shares purchased 1,428 1,428
Shares acquired for retirement (3,051) (3,051)
Net change in deferred compensation, net of tax effect 32 32
Cash dividends - $0.285 per share (12,343) (12,343)
--------- -------- -------------- ---------
BALANCE - JUNE 30, 2003 101,723 499,044 38,401 639,168
Comprehensive income:
Net income 19,605 19,605
Other comprehensive income:
Net unrealized loss on securities available-for-sale,
net of tax effect of $(5,974) (11,095)
Less: Reclassification adjustment for net gains included
in net income, net of tax effect of $15 (27)
Net change in unrealized gain on cash flow hedges 122 (11,000)
-------------- ---------
Total comprehensive income 8,605
Exercise of stock options, net of shares purchased 622 622
Shares acquired for retirement (1,951) (1,951)
Net change in deferred compensation, net of tax effect 31 31
Cash dividends - $0.285 per share (12,331) (12,331)
--------- -------- -------------- ---------
BALANCE - SEPTEMBER 30, 2003 100,425 506,318 27,401 634,144
Comprehensive income:
Net income 18,074 18,074
Other comprehensive income:
Net unrealized loss on securities available-for-sale,
net of tax effect of $(2,784) (5,171)
Less: Reclassification adjustment for net gains included
in net income, net of tax effect of $1 (1)
Net change in unrealized gain on cash flow hedges, net of
tax effect of $280 398
Minimum pension liability, net of tax effect of $95 176 (4,598)
-------------- ---------
Total comprehensive income 13,476
Tax benefit on non-qualified stock options 2,500 2,500
Exercise of stock options, net of shares purchased 2,293 2,293
Shares acquired for retirement (5,144) (5,144)
Net change in deferred compensation, net of tax effect 240 240
Cash dividends - $0.285 per share (12,347) (12,347)
--------- -------- -------------- ---------
BALANCE - DECEMBER 31, 2003 100,314 512,045 22,803 635,162
Comprehensive income:
Net income 17,443 17,443
Other comprehensive income:
Net unrealized gain on securities available-for-sale,
net of tax effect of $7,227 13,422
Net change in unrealized loss on cash flow hedges, net of
tax effect of $(90) (168) 13,254
-------------- ---------
Total comprehensive income 30,697
Exercise of stock options, net of shares purchased 4,015 4,015
Shares acquired for retirement (3,387) (3,387)
Net change in deferred compensation, net of tax effect 40 40
Cash dividends - $0.285 per share (12,345) (12,345)
--------- -------- -------------- ---------
BALANCE - MARCH 31, 2004 $ 100,982 $517,143 $ 36,057 $ 654,182
========= ======== ============== =========
See notes to consolidated financial statements.
5
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
Three Months Ended
March 31,
(in thousands) 2004 2003(1)
- -------------- ---------- ---------
OPERATING ACTIVITIES:
Net income $ 17,443 $ 15,058
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 7,000 18,992
Depreciation 3,041 3,576
Amortization of intangibles 725 725
Net amortization on investment securities 2,767 813
Investment securities gains -- (48)
Loans originated for sale (61,885) (269,120)
Proceeds from sales of mortgage loans held for sale 70,378 305,152
Net gains from loan sales (1,021) (3,397)
Stock-based compensation -- 200
Amortization of stock-based compensation expense 40 47
Other 3,951 16,614
---------- ---------
Net cash provided by operating activities 42,439 88,612
INVESTING ACTIVITIES:
Net decrease in money market investments 970 70,273
Securities available-for-sale:
Proceeds from sales 5,001 48
Proceeds from maturities 104,315 94,787
Purchases (135,545) (496,670)
Purchases of securities held-to-maturity (10,245) --
Net decrease in loans 38,949 113,884
Net increase in premises and equipment (6,788) (889)
---------- ---------
Net cash used in investing activities (3,343) (218,567)
FINANCING ACTIVITIES:
Net increase (decrease) in demand and savings deposits 75,619 (375)
Net decrease in time deposits (56,954) (124,804)
Net increase (decrease) in short-term borrowings (72,295) 171,102
Proceeds from issuance of long-term debt -- 149,558
Principal reductions in long-term debt (74) (56)
Cash dividends paid (12,345) (12,455)
Proceeds from stock options exercised 4,015 1,991
Shares acquired for retirement (3,387) (11,177)
---------- ---------
Net cash provided by (used in) financing activities (65,421) 173,784
---------- ---------
Net increase (decrease) in cash and due from banks (26,325) 43,829
Cash and due from banks at beginning of period 182,545 171,864
---------- ---------
Cash and due from banks at end of period $ 156,220 $ 215,693
========== =========
See notes to consolidated financial statements.
(1) Certain amounts have been reclassified to conform with current year
presentation.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Citizens Banking
Corporation ("Citizens") have been prepared in accordance with accounting
principles generally accepted in the United States ("GAAP") for interim
financial information and the instructions for Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
notes required by GAAP for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the
three month period ended March 31, 2004 are not necessarily indicative of the
results that may be expected for the year ended December 31, 2004. The balance
sheet at December 31, 2003 has been derived from the audited financial
statements at that date but does not include all of the information and
footnotes required by GAAP for complete financial statements. For further
information, refer to the consolidated financial statements and footnotes
thereto included in Citizens' 2003 Annual Report on Form 10-K.
STOCK-BASED COMPENSATION: Citizens' stock-based compensation plans are accounted
for based on the intrinsic value method set forth in Accounting Principles Board
("APB") Opinion 25, Accounting for Stock Issued to Employees, and related
interpretations. Compensation expense for employee stock options is generally
not recognized if the exercise price of the option equals or exceeds the fair
value of the stock on the date of grant. Compensation expense for restricted
share awards is ratably recognized over the period of service, usually the
restricted period, based on the fair value of the stock on the date of grant.
The following table illustrates the effect on net income and earnings per share
if Citizens had applied the fair value recognition provisions of Statement of
Financial Accounting Standards ("SFAS") 123, Accounting for Stock-Based
Compensation, to its stock option awards.
Three Months Ended
March 31,
(in thousands, except per share amounts) 2004 2003
---------- --------
Net income, as reported $ 17,443 $ 15,058
Less pro forma expense related to options granted (615) (556)
---------- --------
Pro forma net income $ 16,828 $ 14,502
========== ========
Net income per share:
Basic - as reported $ 0.40 $ 0.35
Basic - pro forma 0.39 0.33
Diluted - as reported 0.40 0.34
Diluted - pro forma 0.38 0.33
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS: In
December 2003, the FASB issued a revised SFAS 132, Employers' Disclosures about
Pensions and Other Postretirement Benefits - an amendment of SFAS 87,88, and 106
which revises employers' disclosures about pension plans and other
postretirement benefit plans. SFAS 132 does not change the measurement or
recognition of those plans required by SFAS 87, Employers' Accounting for
Pensions, SFAS 88, Employers' Accounting for Settlements and Curtailments of
Defined Benefit Pension Plans and for Termination Benefits, and SFAS 106,
Employers' Accounting for Postretirement Benefits Other Than Pensions. SFAS 132,
as revised, retains the disclosure requirements contained in the original SFAS
132, which it replaces. Additional disclosures, however, have been added to
those in the original SFAS 132 about the assets, obligations, cash flows, and
net periodic benefit cost of defined benefit pension plans and other defined
benefit postretirement plans. The required information should be provided
separately for pension plans and for other postretirement benefit plans. In
addition, SFAS 132 requires interim period disclosure of the components of net
period benefit cost and contributions if significantly different from previously
reported amounts - see Note 7 to the Consolidated Financial Statements in this
report. The new disclosures required by SFAS 132 became effective for Citizens
as of December 31, 2003 and do not impact our results of operations, financial
position, or liquidity.
7
ACCOUNTING AND DISCLOSURE REQUIREMENTS RELATED TO THE MEDICARE PRESCRIPTION
DRUG, IMPROVEMENT AND MODERNIZATION ACT OF 2003: In January 2004, The FASB
issued FASB Staff Position ("FSP"), "Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003," subsequently revised in April 2004. The FSP permits sponsors of
postretirement healthcare plans that provide prescription drug benefits to
elect a one-time deferral of accounting for the effects of the Medicare
Prescription Drug, Improvement and Modernization Act of 2003 ("Act") and
requires certain disclosures pending further consideration of the underlying
accounting issues. The Act provides a federal subsidy to companies which sponsor
postretirement benefit plans that provide prescription drug benefits. The FSP is
effective for financial statements of interim or annual periods ending after
December 7, 2003. Citizens is in the process of analyzing the impact the Act
will have on its employee benefit plans. Citizens has elected to defer
accounting for the effects of this new legislation until the specific
authoritative guidance is issued. The FASB plans to issue authoritative guidance
on the accounting for the subsidy in the second quarter of 2004, which could
require Citizens to modify its postretirement disclosures. Citizens anticipates
its benefits cost by 2006, or as early as guidance is issued, will be somewhat
lower as a result of the new medicare provision, however, the adoption of this
standard is not expected to have a material impact on results of operations,
financial position or liquidity.
NOTE 3. BUSINESS RESTRUCTURING AND SPECIAL CHARGE
In the third quarter of 2002, Citizens recorded a special charge of $13.8
million ($9.0 million after-tax) for restructuring, impairment and other costs
associated with the reorganization of Citizens' consumer, commercial and wealth
management lines of business. The reorganization was the result of a detailed
review of Citizens' consumer banking, commercial banking and wealth management
areas by key members of management with assistance from industry consultants.
This review revealed opportunities for process change, staff reassignment,
reporting structure changes, branch closures, expense reduction and business
growth. As a result of the reorganization, Citizens displaced 134 employees.
Displaced employees were offered severance packages and outplacement assistance.
Twelve banking offices were closed in the fourth quarter of 2002 and six
additional offices were closed during the second quarter of 2003.
The following provides details on the remaining liability from the special
charge as of March 31, 2004.
Reserve 2004 Reserve
Balance ------------ Balance
December 31, Cash Payment March 31,
(in thousands) 2003 Reductions 2004
- -------------- ------------ ------------ ---------
Employee benefits and severance $ 325 $ (51) $ 274
Professional fees 9 (5) 4
Facilities and lease impairment 276 (8) 268
------------ ------------ ---------
Total $ 610 $ (64) $ 546
============ ============ =========
NOTE 4. OTHER INTANGIBLE ASSETS
Citizens' other intangible assets as of March 31, 2004, December 31, 2003 and
March 31, 2003 are shown in the table below.
MARCH 31, December 31, March 31,
(in thousands) 2004 2003 2003
- -------------- --------- ------------ ------------
Core deposit intangibles $ 28,989 $ 28,989 $ 28,989
Accumulated amortization 12,783 12,058 9,885
--------- ------------ ------------
Net core deposit intangibles 16,206 16,931 19,104
Minimum pension liability 1 1 33
--------- ------------ ------------
Total other intangibles $ 16,207 $ 16,932 $ 19,137
========= ============ ============
The estimated annual amortization expense for core deposit intangibles for each
of the next five years is $2.9 million.
8
NOTE 5. LINES OF BUSINESS INFORMATION
Citizens is managed along the following business lines: Commercial Banking,
Consumer Banking, Wealth Management, and Other. In 2003, Citizens allocated its
core deposit intangible and the related amortization to the Commercial Banking
and Consumer Banking business lines. The core deposit intangible and the related
amortization was previously recorded in the Other business line. Prior period
information has been restated to reflect this change. In the third quarter of
2003, Citizens also reallocated the investment security portfolio held in our
mortgage company from Consumer Banking to Treasury, which is a component of
Other. The effect on net income for the prior periods presented was not material
to the segments and they were not restated. In the first quarter of 2004,
Citizens transferred the Credit Administration function from Other to Commercial
Banking. Prior year amounts were restated to reflect this change. Selected line
of business segment information, as adjusted, for the three month period ended
March 31, 2004 and 2003 is provided below. There are no significant intersegment
revenues.
Commercial Consumer Wealth
(in thousands) Banking Banking Management Other Total
- -------------- ---------- --------- ----------- --------- ----------
EARNINGS SUMMARY - THREE MONTHS ENDED MARCH 31, 2004
Net interest income (taxable equivalent) $ 28,988 $ 37,621 $ 189 $ 4,892 $ 71,690
Provision for loan losses 4,989 2,014 (3) -- 7,000
--------- --------- ----------- --------- ----------
Net interest income after provision 23,999 35,607 192 4,892 64,690
Noninterest income 3,522 12,428 5,497 1,065 22,512
Noninterest expense 17,079 32,316 5,642 5,497 60,534
--------- --------- ----------- --------- ----------
Income before income taxes 10,442 15,719 47 460 26,668
Income tax expense (taxable equivalent) 3,677 5,506 16 26 9,225
--------- --------- ----------- --------- ----------
Net income $ 6,765 $ 10,213 $ 31 $ 434 $ 17,443
========= ========= =========== ========= ==========
Average Assets (in millions) $ 2,851 $ 2,368 $ 17 $ 2,404 $ 7,640
========= ========= =========== ========= ==========
EARNINGS SUMMARY - THREE MONTHS ENDED MARCH 31, 2003(1)
Net interest income (taxable equivalent) $ 34,733 $ 35,856 $ 43 $ 4,350 $ 74,982
Provision for loan losses 15,611 3,416 -- (35) 18,992
--------- --------- ----------- --------- ----------
Net interest income after provision 19,122 32,440 43 4,385 55,990
Noninterest income 4,338 12,549 5,195 1,205 23,287
Noninterest expense 14,741 33,057 4,534 4,249 56,581
--------- --------- ----------- --------- ----------
Income before income taxes 8,719 11,932 704 1,341 22,696
Income tax expense (taxable equivalent) 3,052 4,176 246 164 7,638
--------- --------- ----------- --------- ----------
Net income $ 5,667 $ 7,756 $ 458 $ 1,177 $ 15,058
========= ========= =========== ========= ==========
Average Assets (in millions) $ 3,211 $ 2,584 $ 3 $ 1,656 $ 7,454
========= ========= =========== ========= ==========
(1) Certain amounts have been reclassified to conform to current year
presentation.
NOTE 6. LONG-TERM DEBT
The components of long-term debt as of March 31, 2004, December 31, 2003 and
March 31, 2003 are presented below.
MARCH 31, December 31, March 31,
(in thousands) 2004 2003 2003
- --------------- --------- ------------ ---------
Federal Home Loan Bank advances $ 787,869 $ 787,930 $ 624,094
Subordinated debt:
Notes maturing February 2013 127,365 123,061 126,304
Deferrable interest debenture maturing June 2033 25,774 25,774 --
Other borrowed funds 81 94 163
Total long-term debt $ 941,089 $ 936,859 $ 750,561
9
NOTE 7. PENSION BENEFIT COST
The components of pension expense for the three month periods ended March 31,
2004 and March 31, 2003 are presented below.
Three Months Ended
March 31,
(in thousands) 2004 2003
- -------------- ------------- --------------
DEFINED BENEFIT PENSION PLANS
Service cost $ 1,148 $ 1,099
Interest cost 1,299 1,361
Expected return on plan assets (1,770) (1,975)
Amortization of unrecognized:
Net transition asset (3) (2)
Prior service cost 58 55
Net actuarial loss 169 16
------------- --------------
Net pension cost $ 901 $ 554
============= ==============
Citizens previously disclosed in Note 13 to the Consolidated Financial
Statements in its Annual Report on Form 10-K for the year ended December 31,
2003, that it expected to contribute approximately $0.5 million to its pension
plans in 2004. As of March 31, 2004, $0.1 million of contributions have been
made. Citizens still anticipates that $0.5 million of contributions will be made
in 2004.
NOTE 8. DERIVATIVES AND HEDGING ACTIVITIES
SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," as
amended by SFAS 138 and SFAS 149, "Accounting for Certain Derivative Instruments
and Certain Hedging Activities," (collectively referred to as "SFAS 133")
establish accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. All derivatives, whether designated in hedging relationships
or not, are required to be recorded on the balance sheet at fair value.
Citizens designates its derivatives based upon criteria established by SFAS 133.
For a derivative designated as a fair value hedge, the derivative is recorded at
fair value on the consolidated balance sheet. Any difference between the fair
value change of the hedge versus the fair value change of the hedged item is
considered to be the "ineffective" portion of the hedge. The ineffectiveness of
the hedge is recorded in current earnings. For a derivative designated as a cash
flow hedge, the effective portion of the derivative's gain or loss is initially
reported as a component of accumulated other comprehensive income (loss) and
subsequently reclassified into earnings when the hedged exposure affects
earnings.
Citizens may use derivative instruments to hedge the variability in interest
payments or protect the value of certain assets and liabilities recorded in its
balance sheet from changes in interest rates. Citizens uses interest rate
contracts such as interest rate swaps to manage its interest rate risk. These
contracts are designated as hedges of specific assets or liabilities. The net
interest receivable or payable on swaps is accrued and recognized as an
adjustment to the interest income or expense of the hedged asset or liability.
The following table summarizes the derivative financial instruments held or
issued by Citizens.
10
DERIVATIVE FINANCIAL INSTRUMENTS:
MARCH 31, 2004 December 31, 2003
---------------------- ---------------------
NOTIONAL FAIR Notional Fair
(dollars in thousands) AMOUNT VALUE Amount Value
- ------------------------------- ---------- --------- ---------- --------
Interest rate swaps $ 177,000 $ 4,139 $ 190,000 $ 499
Interest rate lock commitments 44,596 252 14,683 109
Forward mortgage loan contracts 52,000 (142) 29,000 (161)
---------- --------- ---------- -------
TOTAL $ 273,596 $ 4,249 $ 233,683 $ 447
========== ========= ========== =======
DERIVATIVE CLASSIFICATIONS AND HEDGING RELATIONSHIPS:
MARCH 31, 2004 December 31, 2003
---------------------- ---------------------
NOTIONAL FAIR Notional Fair
(dollars in thousands) AMOUNT VALUE Amount Value
- --------------------------------------------- ---------- --------- ---------- --------
Derivatives Designated as Cash Flow Hedges:
Hedging commercial loans $ 25,000 $ 585 $ 25,000 $ 339
Derivatives Designated as Fair Value Hedges:
Hedging time deposits 25,000 138 40,000 31
Hedging long-term debt 125,000 3,416 125,000 129
Derivatives Not Designated as Hedges:
Customer initiated swaps 2,000 -- -- --
---------- --------- ---------- --------
TOTAL $ 177,000 $ 4,139 $ 190,000 $ 499
========== ========= ========== ========
NOTE 9. EARNINGS PER SHARE
Net income per share is computed based on the weighted-average number of shares
outstanding, including the dilutive effect of stock options, as follows:
Three Months Ended
March 31,
(in thousands, except per share amounts) 2004 2003
- ---------------------------------------- --------- ---------
NUMERATOR:
Basic and dilutive earnings per share -- net income available to shareholders $ 17,443 $ 15,058
========= =========
DENOMINATOR:
Basic earnings per share -- weighted average shares 43,315 43,505
Effect of dilutive securities -- potential conversion of employee stock
options 545 243
--------- ---------
Diluted earnings per share -- adjusted weighted-average shares and assumed
conversions 43,860 43,748
========= =========
BASIC EARNINGS PER SHARE $ 0.40 $ 0.35
========= =========
DILUTED EARNINGS PER SHARE $ 0.40 $ 0.34
========= =========
During the first quarter of 2004, employees exercised stock options to acquire
202,965 shares at an average exercise price of $19.78 per share.
11
NOTE 10. COMMITMENTS, CONTINGENT LIABILITIES AND GUARANTEES
The Consolidated Financial statements do not reflect various loan commitments
(unfunded loans and unused lines of credit) and letters of credit originated in
the normal course of business. Loan commitments are made to accommodate the
financial needs of clients. Generally, new loan commitments do not extend beyond
90 days and unused lines of credit are reviewed at least annually. Financial
standby letters of credit guarantee future payment of client financial
obligations to third parties. They are issued primarily for services provided.
Performance standby letters of credit are irrevocable guarantees to make payment
in the event a specified third party fails to perform under a nonfinancial
contractual obligation. Commercial letters of credit facilitate the shipment of
goods or enable clients to access public bond financing. Standby letters of
credit arrangements generally expire within one year and have essentially the
same level of credit risk as extending loans to clients and are subject to
Citizens' normal credit policies. Inasmuch as these arrangements generally have
fixed expiration dates or other termination clauses, most expire unfunded and do
not necessarily represent future liquidity requirements. Collateral is obtained
based on management's assessment of the client and may include receivables,
inventories, real property and equipment.
Amounts available to clients under loan commitments and standby letters of
credit follow:
MARCH 31, December 31,
(in thousands) 2004 2003
- -------------------------------------- ------------ ---------------
LOAN COMMITMENTS AND LETTERS OF CREDIT:
Commitments to extend credit $ 1,700,755 $ 1,593,426
Financial standby letters of credit 39,930 42,086
Performance standby letters of credit 6,326 6,782
Commercial letters of credit 194,086 183,665
------------ ---------------
$ 1,941,097 $ 1,825,959
============ ===============
NOTE 11. ACCUMULATED OTHER COMPREHENSIVE INCOME
The components of accumulated other comprehensive income, net of tax, for the
three month period ended March 31, 2004 and 2003 are presented below.
Three Months Ended
March 31,
(in thousands) 2004 2003
- --------------------------------------------------------------------------------------------- -------- --------
Balance at beginning of period $ 22,803 $ 42,646
Net unrealized gain (loss) on securities for the quarter, net of tax effect of $7,227 in 2004
and $(2,007) in 2003 13,422 (3,728)
Less: Reclassification adjustment for net gains included in net income for the quarter,
net of tax effect of $17 in 2003 -- (31)
Net change in unrealized loss on cash flow hedges, net of tax effect of $(90) (168) --
-------- --------
Accumulated other comprehensive income, net of tax $ 36,057 $ 38,887
======== ========
12
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FIVE-QUARTER SUMMARY OF SELECTED FINANCIAL INFORMATION
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
FOR THE QUARTER ENDED
--------------------------------------------------------------
MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
2004 2003 2003 2003 2003
-------- ------------ ------------- --------- ---------
SUMMARY OF OPERATIONS (THOUSANDS)
Interest income $ 94,394 $ 97,398 $ 99,687 $104,683 $104,209
Net interest income 68,328 70,678 71,154 72,920 71,506
Provision for loan losses 7,000 8,020 10,300 25,650 18,992
Noninterest income 22,512 21,631 25,054 24,847 23,287
Noninterest expense 60,534 60,446 59,600 56,361 56,581
Income tax provision 5,863 5,769 6,703 2,542 4,162
Net income 17,443 18,074 19,605 13,214 15,058
Cash dividends 12,345 12,347 12,331 12,343 12,455
PER COMMON SHARE DATA
Basic net income $ 0.40 $ 0.42 $ 0.45 $ 0.30 $ 0.35
Diluted net income 0.40 0.41 0.45 0.30 0.34
Cash dividends 0.285 0.285 0.285 0.285 0.285
Market value (end of period) 32.63 32.72 26.41 27.01 23.62
Book value (end of period) 15.09 14.69 14.67 14.77 14.79
AT PERIOD END (MILLIONS)
Assets $ 7,692 $ 7,711 $ 7,787 $ 7,789 $ 7,768
Portfolio Loans (1) 5,200 5,246 5,226 5,287 5,303
Deposits 5,461 5,442 5,482 5,660 5,812
Shareholders' equity 654 635 634 639 640
AVERAGE FOR THE QUARTER (MILLIONS)
Assets $ 7,640 $ 7,697 $ 7,812 $ 7,809 $ 7,454
Portfolio Loans (1) 5,191 5,220 5,183 5,253 5,343
Deposits 5,474 5,481 5,610 5,723 5,853
Shareholders' equity 644 626 620 639 643
RATIOS (ANNUALIZED)
Return on average assets 0.92% 0.93% 1.00% 0.68% 0.82%
Return on average shareholders' equity 10.89 11.45 12.55 8.29 9.50
Net interest margin (FTE) 4.01 4.07 4.03 4.17 4.33
Efficiency ratio 64.26 63.16 59.90 55.74 57.58
Net loans charged off to average loans 0.53 0.59 0.80 0.92 1.20
Allowance for loan losses as a percent of loans 2.38 2.36 2.36 2.33 2.07
Nonperforming assets to loans plus ORAA (end of period) 1.20 1.47 1.74 1.82 1.76
Nonperforming assets to total assets (end of period) 0.81 1.00 1.17 1.24 1.20
Average equity to average assets 8.43 8.13 7.94 8.18 8.63
Leverage ratio 7.79 7.45 7.25 7.20 7.21
Tier 1 capital ratio 10.31 9.80 9.64 9.55 9.15
Total capital ratio 13.77 13.23 13.07 13.10 12.59
(1) Balances exclude mortgage loans held for sale.
13
INTRODUCTION
The following commentary presents management's discussion and analysis of
Citizens Banking Corporation's financial condition and results of operations for
the three month period ended March 31, 2004. It should be read in conjunction
with the unaudited Consolidated Financial Statements and Notes included
elsewhere in this report and the audited Consolidated Financial Statements and
Notes contained in our 2003 Annual Report on Form 10-K. In addition, the
following discussion and analysis should be read together with "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
contained in our 2003 Annual Report on Form 10-K, which contains important
additional information that is necessary to understand our Company and its
financial condition and results of operations for the period covered by this
report. Unless the context indicates otherwise, all references in the discussion
to "Citizens," the "Company," "our," "us" and "we" refer to Citizens Banking
Corporation and its subsidiaries.
FORWARD - LOOKING STATEMENTS
Discussions in this report that are not statements of historical fact (including
statements that include terms such as "may," "should," "believe," "expect,"
"anticipate," "estimate," "intend," and "plan") are forward-looking statements
that involve risks and uncertainties, and our actual future results could
materially differ from those discussed. Factors that could cause or contribute
to such differences include, without limitation, risks and uncertainties
detailed from time to time in our filings with the Securities and Exchange
Commission, as well as the following.
- We face the risk that loan losses, including unanticipated loan
losses due to changes in our loan portfolios, fraud and economic
factors, will exceed our allowance for loan losses and that
additional increases in the allowance will be required. Additions to
the allowance would cause net income to decline and could have a
negative impact on our capital.
- While we attempt to manage the risk from changes in market interest
rates, interest rate risk management techniques are not exact. In
addition, we may not be able to economically hedge our interest rate
risk. A rapid or substantial increase or decrease in interest rates
could adversely affect our net interest income and results of
operations.
- An economic downturn, and the negative economic effects caused by
terrorist attacks, potential attacks and other destabilizing events,
would likely contribute to the deterioration of the quality of our
loan portfolio and could reduce our customer base, our level of
deposits, and demand for financial products such as loans.
- If we are unable to continue to attract core deposits, our cost of
funds will increase, adversely affecting our ability to generate the
funds necessary for lending operations, reducing our net interest
margin and negatively affecting our results of operations.
- Increased competition with other financial institutions could reduce
our net income by decreasing the number and size of loans that we
originate, the interest rates we may charge on these loans and the
fees we are able to charge for services to our customers.
- The financial services industry is undergoing rapid technological
changes. If we are unable to adequately invest in and implement new
technology-driven products and services, we may not be able to
compete effectively, or our cost to provide products and services
may increase significantly.
- Our business may be adversely affected by the highly regulated
environment in which we operate. Changes in banking or tax laws,
regulations and regulatory practices at either the federal or state
level may adversely affect us, including our ability to offer new
products and services, obtain financing, dividend funds to our
parent company, attract deposits, make loans and leases and achieve
satisfactory spreads, and may also result in the imposition of
additional costs on us.
- The products and services offered by the banking industry and
customer expectations regarding them are subject to change. We
attempt to respond to perceived customer needs and expectations by
offering new products and services, such as our new wealth
management capabilities, which are often costly to develop and
market initially. A lack of market acceptance of these products and
services would have a negative effect on our results of operations.
In addition, our potential inability to successfully expand our
Oakland County operations would have a negative effect on our
results of operations.
- New accounting pronouncements may be issued by the accounting
profession, regulators or other government bodies which could change
our existing accounting methods. Changes in accounting methods could
negatively impact our results of operations and capital.
14
- We could face unanticipated environmental liabilities or costs
related to both real property that we own or that we acquire through
foreclosure. Compliance with federal, state and local environmental
laws and regulations, including those related to investigation and
clean-up of contaminated sites, may increase our capital costs and
operating expenses.
- As a bank holding company that conducts substantially all of its
operations through its subsidiaries, the ability of the parent
company to pay dividends, repurchase its shares or to repay its
indebtedness depends upon the results of operations of its
subsidiaries and their ability to pay dividends to the parent
company. Dividends paid by these subsidiaries are subject to limits
imposed by federal and state law.
Other factors not currently anticipated by management may also materially and
adversely affect our results of operations. There can be no assurance that
future results will meet expectations. While we believe that our forward-looking
statements are reasonable, you should not place undue reliance on any
forward-looking statement. In addition, these statements speak only as of the
date made. We do not undertake, and expressly disclaim any obligation, to update
or alter our forward-looking statements whether as a result of new information,
future events or otherwise, except as required by applicable law.
CRITICAL ACCOUNTING POLICIES
Citizens' Consolidated Financial Statements are prepared in accordance with
accounting principles generally accepted in the United States and follow general
practices within the industries in which we operate. Application of these
principles requires management to make estimates, assumptions, and judgments
that affect the amounts reported in the financial statements and accompanying
notes. These estimates, assumptions and judgments are based on information
available as of the date of the financial statements; accordingly, as this
information changes, the financial statements could reflect different estimates,
assumptions and judgments. Certain policies inherently have a greater reliance
on the use of estimates, assumptions, and judgments and as such, have a greater
possibility of producing results that could be materially different than
originally reported. Based on the valuation techniques used and the sensitivity
of financial statement amounts to the methods, assumptions and estimates
underlying those amounts, management has identified the determination of the
allowance for loan losses and the benefit obligation and net periodic pension
expense for our employee pension and postretirement benefit plans to be the
accounting areas that require the most subjective or complex judgments, and,
therefore, are the most likely to vary materially as new information becomes
available. Our significant accounting policies are more fully described in Note
1 to the audited Consolidated Financial Statements contained in our 2003 Annual
Report on Form 10-K and the more significant assumptions and estimates made by
management are more fully described in "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Critical Accounting Policies" in
our 2003 Annual Report on Form 10-K. There have been no material changes to
those policies or the estimates made pursuant to those policies during the most
recent quarter.
SALE OF SUBSIDIARY BANK
On April 2, 2004 Citizens announced the signing of a definitive agreement to
sell its subsidiary - Citizens Bank-Illinois, N.A. ("Illinois Bank") - to
Metropolitan Bank Group, Inc., of Chicago, Illinois in a cash transaction valued
at $26,250,000. The Illinois Bank has three locations with $187 million of
assets, $84 million of loans and $166 million of deposits as of March 31, 2004.
The sale is expected to close in the third quarter of 2004, subject to
regulatory approval. Citizens expects to realize a gain on the sale of
approximately $12 million during the quarter in which the transaction closes,
and anticipates re-deploying the proceeds into one or more strategic
alternatives to achieve an equal or somewhat greater return. As a result, the
sale is anticipated to have a neutral to slightly positive impact on future
earnings per share.
RESULTS OF OPERATIONS
EARNINGS SUMMARY
Citizens earned net income of $17,443,000, or $0.40, per diluted share for the
three months ended March 31, 2004, compared with $15,058,000, or $0.34 per
diluted share, for the same quarter of 2003. The improvement in net income for
the three months ended March 31, 2004 compared to the same period in 2003 was
due to a lower provision for loan losses partially offset by lower net interest
income and noninterest income, and higher noninterest expense. Returns on
average assets and average equity for the quarter were 0.92% and 10.89%,
respectively, compared with 0.82% and 9.50%, respectively, in 2003.
The provision for loan losses declined to $7.0 million in the first quarter of
2004 compared with $19.0 million in the first quarter of 2003. The large loan
loss provision for the first quarter of 2003 was due primarily to an
unanticipated credit-related charge-off of $11.5 million recognized in that
quarter on a single commercial credit in which collateral value was materially
overstated (based on borrowing base reports falsified by the borrower). The
lower loan loss provision in 2004 also reflects a decline in nonperforming
assets, lower consumer and mortgage loan net charge-offs and fewer risk rating
downgrades within the commercial loan portfolio.
15
NET INTEREST INCOME AND NET INTEREST MARGIN
An analysis of net interest income, interest spread and net interest margin with
average balances and related interest rates for the three months ended March 31,
2004 and 2003 is presented below.
AVERAGE BALANCES/NET INTEREST INCOME/AVERAGE RATES
2004 2003
---------------------------------- ---------------------------------
Three Months Ended March 31 AVERAGE AVERAGE Average Average
(in thousands) BALANCE INTEREST(1) RATE(2) Balance Interest(1) Rate(2)
- --------------------------- ----------- ----------- ------- ---------- ---------- -------
EARNING ASSETS
Money market investments:
Federal funds sold $ -- $ -- --% $ 29,171 $ 84 1.16%
Other 1,977 2 0.48 1,898 3 0.66
Investment securities (3):
Taxable 1,528,829 15,442 4.04 1,061,281 14,434 5.44
Tax-exempt 421,589 5,244 7.65 405,524 5,184 7.87
Mortgage loans held for sale 37,307 441 4.73 138,275 2,022 5.85
Loans:
Commercial 2,920,584 38,701 5.40 3,256,707 46,214 5.84
Real estate mortgage 491,028 7,147 5.82 587,692 9,313 6.34
Direct consumer 1,040,543 14,750 5.70 857,422 14,633 6.92
Indirect consumer 739,210 12,667 6.89 640,807 12,322 7.80
----------- ----------- ---------- ----------
Total earning assets(3) 7,181,067 94,394 5.47 6,978,777 104,209 6.23
NONEARNING ASSETS
Cash and due from banks 160,763 171,491
Bank premises and equipment 114,145 116,264
Investment security fair value adjustment 47,041 64,090
Other nonearning assets 262,892 238,294
Allowance for loan losses (125,637) (114,692)
----------- ----------
Total assets $ 7,640,271 $7,454,224
=========== ==========
INTEREST-BEARING LIABILITIES
Deposits:
Interest-bearing demand $ 1,358,556 $ 2,471 0.73 1,314,615 3,710 1.14
Savings deposits 1,288,269 1,662 0.52 1,369,434 2,910 0.86
Time deposits 1,955,036 12,318 2.53 2,316,693 18,417 3.22
Short-term borrowings 508,252 1,272 1.00 214,786 620 1.17
Long-term debt 938,677 8,343 3.57 690,122 7,046 4.13
----------- ----------- ---------- ----------
Total interest-bearing liabilities 6,048,790 26,066 1.73 5,905,650 32,703 2.24
----------- ----------
NONINTEREST-BEARING LIABILITIES AND
SHAREHOLDERS' EQUITY
Noninterest-bearing demand 872,200 851,929
Other liabilities 75,116 53,284
Shareholders' equity 644,165 643,361
----------- ----------
Total liabilities and shareholders' equity $ 7,640,271 $7,454,224
=========== ==========
INTEREST SPREAD $ 68,328 3.74% $ 71,506 3.99%
=========== ==========
Contribution of net noninterest bearing sources of funds 0.27 0.34
------ ----
NET INTEREST INCOME AS A PERCENT OF EARNING ASSETS 4.01% 4.33%
(1) Interest income shown on actual basis and does not include taxable
equivalent adjustments.
(2) Average rates are presented on an annual basis and include taxable
equivalent adjustments to interest income of $3,362,000 and 3,476,000
for the three months ended March 31, 2004 and 2003, respectively, based on
a tax rate of 35%.
(3) For presentation in this table, average balances and the corresponding
average rates for investment securities are based upon historical for
amortization of premiums and accretion of discounts.
16
The decrease in net interest margin from the first quarter of 2003 was due to
declines in yields on all earning asset categories as a result of the lower
interest rate environment as well as a mix shift in earning assets from loans to
lower yielding securities. The decrease in earning asset yields from the first
quarter of 2003 was partially offset by a 44 basis point decline in funding
costs as the cost of all funding sources declined in the lower interest rate
environment.
Net interest income decreased $3.2 million to $68.3 million in the first quarter
of 2004 compared with $71.5 in the first quarter of 2003 as the aforementioned
decline in the net interest margin more than offset a $202 million increase in
average earning assets. Earning assets increased due to the full quarter effect
of the $500 million expansion of the investment portfolio which began near the
end of the first quarter of 2003. Citizens anticipates its net interest income
in the second quarter of 2004 to be comparable with the first quarter of 2004
and expects net interest income to grow during the second half of 2004 due to a
higher volume of earning assets.
The table below shows the effect of changes in average balances ("volume") and
market rates of interest ("rate") on interest income, interest expense and net
interest income for major categories of earning assets and interest-bearing
liabilities.
ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE
2004 Compared with 2003
----------------------------------
Increase (Decrease)
Due to Change in
Three Months Ended March 31, Net ----------------------
(in thousands) Change(1) Rate (2) Volume (2)
- --------------------------------- --------- -------- ----------
INTEREST INCOME
Money market investments $ (85) $ (1) $ (84)
Investment securities:
Taxable 1,008 (4,319) 5,327
Tax-exempt 60 (141) 201
Mortgage loans held for sale (1,581) (328) (1,253)
Loans:
Commercial (7,513) (3,387) (4,126)
Real estate (2,166) (717) (1,449)
Direct consumer 117 (1,942) 2,059
Indirect consumer 345 (1,413) 1,758
-------- -------- --------
Total (9,815) (12,248) 2,433
-------- -------- --------
INTEREST EXPENSE
Deposits:
Demand (1,239) (1,359) 120
Savings (1,248) (1,032) (216)
Time (6,099) (3,517) (2,582)
Short-term borrowings 652 (93) 745
Long-term debt 1,297 (1,000) 2,297
-------- -------- --------
Total (6,637) (7,001) 364
-------- -------- --------
NET INTEREST INCOME $ (3,178) $ (5,247) $ 2,069
======== ======== ========
(1) Changes are based on actual interest income and do not reflect taxable
equivalent adjustments.
(2) Changes not solely due to changes in volume or rates have been allocated
in proportion to the absolute dollar amounts of the change in each.
The decrease in net interest income in the first quarter of 2004 reflected
unfavorable rate-related variances, partially offset by favorable volume-related
variances. Favorable volume-related variances in the investment securities
portfolio are attributable to the 2003 portfolio expansion program, and
favorable volume variances in the direct and indirect consumer loan portfolios
are due to loan growth. The favorable variances were partially offset by lower
volumes of commercial and mortgage loans, and mortgage loans held for sale.
Commercial loan volumes declined due to lower demand for commercial credit, high
repayment activity and continued reduction of exposure on credits not meeting
our risk parameters. Mortgage loan volumes declined due to continued refinance
and repayment activity and our strategy to sell most new mortgage loan
production into the secondary market. Favorable volume variances from lower
deposit levels, primarily time deposits, were offset by unfavorable volume
variances in short-term borrowings and long term debt. The unfavorable
rate-related variances were due to lower yields on all asset categories as fixed
rate loans and investment securities portfolios continued to reprice lower
throughout 2003 and into the first quarter of 2004 due to the extended low
interest rate environment. Lower yields on earning assets were only partially
offset by lower funding costs. While the cost of all funding categories declined
in the first
17
quarter of 2004 compared with the same period of the prior year, interest
expense on such interest-bearing funds declined less than interest income on
earning assets. Interest expense declined less than interest income as more
earning assets than interest-bearing liabilities matured or repriced in the
twelve month period ended March 31, 2004. In addition, the cost of certain
interest-bearing demand and savings deposits declined less than the decrease in
earning asset yields as the cost of these funds approached practical lower
limits.
NONINTEREST INCOME
Noninterest income for the quarter was $22.5 million, a decrease of $0.8 million
or 3.3% compared with the first quarter of 2003. The decrease reflects a decline
in mortgage income from a lower volume of mortgage loan originations and sales,
partially offset by increases in deposit service charges, trust fees and other
noninterest income. An analysis of the sources of noninterest income during the
three months ended March 31, 2004 and 2003 is summarized in the table below.
Three Months Ended
NONINTEREST INCOME March 31, Change in 2004
-------------------- -----------------
(in thousands) 2004 2003 Amount Percent
- ----------------------------------- -------- -------- ------- -------
Service charges on deposit accounts $ 8,042 $ 6,590 $ 1,452 22.0%
Trust fees 4,310 4,220 90 2.1
Mortgage and other loan income 2,256 5,154 (2,898) (56.2)
Brokerage and investment fees 1,782 1,768 14 0.8
Bankcard fees 783 735 48 6.5
Investment securities gains -- 48 (48) N/M
Other, net 5,339 4,772 567 11.9
-------- -------- -------
Total noninterest income $ 22,512 $ 23,287 $ (775) (3.3)
======== ======== =======
N/M - Not Meaningful
Deposit service charges increased due to higher overdraft fee income, a result
of initiatives implemented throughout 2003. These initiatives included increased
overdraft fees, a new overdraft monitoring system and fewer waived fees.
Trust fees increased as total trust assets under administration grew $395
million to $2.873 billion at March 31, 2004 compared with $2.478 billion at
March 31, 2003. The increases in both trust fees and trust assets under
administration were due to stronger financial markets and Citizens' new sales
process implemented in January 2004, which is focused on relationship management
and new business development strategies. On average, trust assets under
administration were up $435 million in the first three months of 2004 compared
to the same period in 2003.
Mortgage income decreased as mortgage origination volume decreased $244 million
to $107 million due to lower refinance activity, and consequently, mortgage loan
sales declined $235 million to $70 million. The majority of all new mortgage
loan originations along with the related servicing are sold in the secondary
market.
Other noninterest income increased due to gains from the sale of former branch
and other bank premises in the first quarter of 2004. Citizens anticipates
noninterest income in the second quarter of 2004 to be slightly higher than the
first quarter level and expects noninterest income to increase in the second
half of the year due to higher deposit service charges, mortgage income, trust
fees and brokerage and investment fees.
18
NONINTEREST EXPENSE
Noninterest expense for the quarter was $60.5 million, an increase of $3.9
million compared to the first quarter of 2003. The increase was due to higher
salaries and employee benefits, occupancy expense, data processing services,
professional services and other noninterest expense, partially offset by lower
equipment expense. An analysis of the components of noninterest expense during
the three months ended March 31, 2004 and 2003 is summarized in the table below.
Three Months Ended
NONINTEREST EXPENSE March 31, Change in 2004
-------------------- -------------------
(in thousands) 2004 2003 Amount Percent
- -------------------------------- -------- -------- -------- -------
Salaries and employee benefits $ 31,939 $ 30,112 $ 1,827 6.1%
Occupancy 5,342 4,695 647 13.8
Equipment 3,642 4,169 (527) (12.6)
Professional services 3,928 3,708 220 5.9
Data processing services 3,646 3,316 330 10.0
Advertising and public relations 2,145 2,049 96 4.7
Postage and delivery 1,556 1,678 (122) (7.3)
Telephone 1,534 1,175 359 30.6
Other loan fees 1,129 1,142 (13) (1.1)
Stationery and supplies 842 895 (53) (5.9)
Other, net 4,831 3,642 1,189 32.6
-------- -------- -------- -----
Total noninterest expense $ 60,534 $ 56,581 $ 3,953 7.0
======== ======== ======== =====
Salaries and employee benefits increased due to higher salaries and
recruiting-related incentives in Oakland County of $0.7 million and $0.6
million, respectively, and higher severance costs of $0.4 million. Normal merit
and other compensation increases were largely offset by decreases resulting from
a lower level of staff. Citizens had 2,302 full time equivalent employees at
March 31, 2004, down from 2,415 at March 31, 2003.
Occupancy expense increased as a result of three factors. Building rent and
other costs increased $0.2 million due to the January 2004 opening of a new
branch and administrative office in Oakland County, the first location in
connection with the expansion initiative. Building repair increased $0.2 million
due to a change in Citizens' capitalization policy during the fourth quarter of
2003 incorporating higher capitalization thresholds on new expenditures. Other
occupancy costs increased $0.2 million due to higher maintenance, energy and
real estate tax expenses.
Equipment expense decreased $0.5 million while telephone expense increased $0.4
million due to reclassification of data transmission costs from equipment
expense to telephone expense in connection with a new services contract.
Professional services expense increased $0.2 million or 5.9% during the first
quarter compared to the same quarter a year ago due in part to higher audit
costs related to implementation of new control evaluation procedures to comply
with section 404 of the Sarbanes-Oxley Act.
Data processing services increased due to processing costs related to the fourth
quarter 2003 system implementation of the new trust and investment accounting
systems and operations with SEI Investments and retirement services record
keeping systems and operations with EPIC Advisors, Inc.
The major factors contributing to the increase in other noninterest expense were
higher non-credit related losses of $0.5 million as a result of a loss recovery
and an unusually low level of such losses in the first quarter of the prior
year, increased travel and training costs of $0.2 million, and higher state
taxes of $0.2 million. Noninterest expense in the second quarter of 2004 is
anticipated to remain comparable to the first quarter level, and increase
slightly in the second half of 2004 due to additional costs related to new
locations in Oakland County.
INCOME TAXES
Income tax provision was $5.9 million in the first quarter of 2004 compared with
an income tax provision of $4.2 million during the same period in 2003. The
effective tax rate, computed by dividing the provision for income taxes by
income before taxes, was 25.2% for the first quarter of 2004 and 21.7% for the
same period of 2003. The effective tax rate is lower than the statutory tax rate
due to tax-exempt interest and noninterest income and, to a lesser extent, other
permanent income tax differences. The effective tax rate increased in the first
quarter of 2004 compared to the same quarter of 2003 due to a higher ratio of
taxable income to total income, attributable to the lower provision for loan
losses.
19
LINES OF BUSINESS RESULTS
We monitor our financial performance using an internal profitability measurement
system, which provides line of business results and key performance measures.
Our business line results are divided into four major business segments:
Commercial Banking, Consumer Banking, Wealth Management and Other. For
additional information about each line of business, see Note 20 to the
Consolidated Financial Statements of our 2003 Annual Report on Form 10-K and
Note 5 to the unaudited Consolidated Financial Statements in this report. A
summary of net income by each business line is presented below.
Three Months Ended
March 31,
(in thousands) 2004 2003
- ------------------ -------- --------
Commercial Banking $ 6,765 $ 5,667
Consumer Banking 10,213 7,756
Wealth Management 31 458
Other 434 1,177
-------- --------
Net income $ 17,443 $ 15,058
======== ========
COMMERCIAL BANKING
The increase in net income in the three month period ended March 31, 2004 was
attributable to a decrease in the provision for loan losses, largely offset by
declines in net interest income and noninterest income and higher operating
expenses. The significant decline in the loan loss provision was due to lower
net charge-offs, fewer commercial loan risk rating downgrades and improving
non-performing asset levels. Net loan charge-offs in Commercial Banking declined
to $4.6 million in the first quarter of 2004 compared with $12.5 million in the
same period of 2003 due to a single credit charge-off of $11.5 million in 2003.
Net interest income declined in the three month period ended March 31, 2004 as a
result of lower average commercial loan balances due to lower demand for
commercial credit, high repayment activity and continued reduction of exposure
on credits not meeting our risk parameters. The decline in loans occurred in
most markets with the exception of Southeast Michigan, including Oakland County,
which experienced moderate growth. Noninterest income declined due to lower
deposit service charges and cash management fees as certain commercial account
relationships were transferred from Commercial Banking to Consumer Banking
beginning in the second quarter of 2003, based upon the client's assigned
office. Noninterest expense increased primarily due to higher compensation costs
as a result of an increase in commercial banking staff, lower deferred
origination-related compensation and higher recruiting-related incentives in
Oakland County and other markets.
CONSUMER BANKING
The increase in net income for the three months ended March 31, 2004 was due to
an increase in net interest income, a lower provision for loan losses and lower
noninterest expense. Net interest income increased due to a lower cost of funds
as a result of the low interest rate environment and higher loan volumes from
growth in home equity and indirect consumer loans. The decrease in the provision
for loan losses reflected a reduced level of net loan charge-offs. Noninterest
income was essentially flat compared with 2003. A decline in mortgage income
from lower refinance activity was offset by an increase in deposit service
charges from higher overdraft fee income and additional account relationships
transferred from Commercial Banking, and $0.6 million in gains from the sale of
former branch and other bank premises. Noninterest expense declined slightly as
increased advertising expense was more than offset by lower compensation,
equipment and other expenses.
WEALTH MANAGEMENT
The decline in net income for the three month period ended March 31, 2004 was
due to an increase in noninterest expense partially offset by increases in
noninterest income and net interest income. Noninterest expense increased due to
higher incentive-based compensation and increased data processing and
professional services costs related to implementation of the new trust and
investment accounting systems and operations with SEI Investments and retirement
services recordkeeping systems and operations with EPIC Advisors, Inc.
Noninterest income increased due to higher trust and brokerage fees.
OTHER
Net income in the three month period ended March 31, 2004 declined due to higher
noninterest expense and lower noninterest income, partially offset by increased
net interest income. Net interest income increased as a result of higher average
balances on investment securities due to the expansion of the investment
portfolio beginning near the end of the first quarter of 2003. Noninterest
expense increased due to higher non-credit related losses as a result of a loss
recovery and an unusually low level of such losses in the prior year period,
increased professional services expense, higher state taxes and lower allocated
costs to the other lines of business.
20
FINANCIAL CONDITION
Citizens' total assets at March 31, 2004 were $7.692 billion, a decrease of $19
million or 0.2% compared with December 31, 2003. Total assets declined due to a
decrease in portfolio loans and mortgage loans held for sale, offset in part by
higher investment securities balances. Portfolio loans decreased $45.8 million
or 0.9% compared with December 31, 2003. The decline in loans reflected a
decrease in commercial and mortgage loans, partially offset by higher consumer
loans. Total deposits at March 31, 2004 increased $18.7 million or 0.3% compared
with December 31, 2003 as both interest-bearing and noninterest-bearing deposits
increased.
INVESTMENT SECURITIES AND MONEY MARKET INVESTMENTS
Total average investments, including money market investments, comprised 27.2%
of average earning assets during the first three months of 2004 compared with
21.5% for the same period of 2003, a $454.5 million increase from the prior year
average levels. The increase was due to purchases of securities beginning in
March 2003, when Citizens implemented an investment portfolio expansion plan to
help offset the effect on net interest income of weak loan demand. In accordance
with the plan, we purchased approximately $500 million of mortgage backed
securities and collateralized mortgage obligations with average lives of three
to five years and an average duration of two to four years, resulting in
interest spreads of up to 250 basis points over funding sources. The purchases
were funded with cash flow from loan repayments, runoff of investments and
short- and medium-term borrowings.
PORTFOLIO LOANS
Portfolio loans decreased $45.8 million or 0.9% at March 31, 2004 compared with
December 31, 2003. Commercial loans declined $89.3 million compared with
December 31, 2003 due to lower demand for commercial credit, high repayment
activity and continued reduction of exposure on credits not meeting our risk
parameters. The decline occurred in most of our markets, with the exception of
Southeast Michigan including Oakland County, which experienced moderate growth.
Consumer loans, excluding mortgage loans, increased $63.8 million compared with
December 31, 2003. Home equity loans increased $64.3 million due to the success
of two first quarter promotional campaigns while indirect and other direct loan
balances remained relatively flat. Mortgage loans declined $6.9 million
compared with December 31, 2003. Mortgage loans declined due to continued loan
refinance and repayment activity and our strategy to sell most new mortgage loan
production into the secondary market. Average total portfolio loans declined by
$152 million, or 2.8%, for the first quarter of 2004 compared to the same period
in 2003 due to declines in commercial and mortgage loans, partially offset by
increases in direct and indirect consumer loans.
Growth in consumer loans is anticipated to continue during the remainder of 2004
led by strong growth in home equity loans and more moderate growth in indirect
loans, primarily marine and recreational vehicle loans, consistent with the
trend in consumer loan growth over the past twelve months. Mortgage loans are
expected to continue to decline due to normal refinance and repayment activity
combined with our strategy to sell most new mortgage loan production. The
decline in commercial loans experienced during the first quarter of 2004 is
anticipated to moderate during the second quarter as growth in our Oakland
County market begins to offset declines in other markets. Commercial loans are
anticipated to increase during the second half of the year due to higher demand
and stronger sales efforts with growth expected in Oakland County and other
markets.
At March 31, 2004 and 2003, $46.8 million and $125.5 million, respectively, of
residential real estate loans originated and subsequently sold in the secondary
market were being serviced by Citizens. Capitalized servicing rights relating to
the serviced loans were fully amortized in June 2003 and were $0.2 million at
March 31, 2003.
MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale were $37.2 million at March 31, 2004, down $7.5
million compared with December 31, 2003 and $90.9 million from March 31, 2003.
These balances generally track the level of originations, as we sell most of our
new residential mortgage loan production into the secondary market due to the
low interest rate environment. Closed mortgage volume declined to $107 million
compared with $351 million in the first quarter of 2003 as mortgage rates moved
higher and slowed refinance activity early in the first quarter of 2004. Average
mortgage loans held for sale during the first three months of 2004 comprised
0.5% of average earning assets compared with 2.0% during the same period in
2003. Mortgage loans held for sale are accounted for on the lower of cost or
market basis.
21
PROVISION AND ALLOWANCE FOR LOAN LOSSES
A summary of loan loss experience during the three months ended March 31, 2004
and 2003 is provided below.
Three Months Ended
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES March 31,
------------------------
(in thousands) 2004 2003
- -------------- ---------- ----------
Allowance for loan losses - beginning of period $ 123,545 $ 106,777
Provision for loan losses 7,000 18,992
Charge-offs:
Commercial 5,703 14,133
Commercial real estate 1,151 955
Small business 218 264
---------- ----------
Total commercial 7,072 15,352
Real estate mortgage 193 625
Consumer - Direct 1,630 1,748
Consumer - Indirect 1,891 2,511
---------- ----------
Total charge-offs 10,786 20,236
---------- ----------
Recoveries:
Commercial 2,332 2,032
Commercial real estate 432 465
Small business 17 362
---------- ----------
Total commercial 2,781 2,859
Real estate mortgage 13 1
Consumer - Direct 438 439
Consumer - Indirect 712 863
---------- ----------
Total recoveries 3,944 4,162
---------- ----------
Net charge-offs 6,842 16,074
---------- ----------
Allowance for loan losses - end of period $ 123,703 $ 109,695
========== ==========
Portfolio loans outstanding at period end (1) $5,199,911 $5,302,603
Average portfolio loans outstanding during period (1) 5,191,364 5,342,628
Allowance for loan losses as a percentage of portfolio loans 2.38% 2.07%
Ratio of net charge-offs during period to average portfolio loans (annualized) 0.53 1.20
Loan loss coverage (allowance as a multiple of net charge-offs, annualized) 4.5x 1.7x
- -----------------
(1) Balances exclude mortgage loans held for sale.
Net charge-offs declined to $6.8 million in the first quarter of 2004 compared
with $16.1 million in the same quarter a year ago. The significant decline in
net charge-offs compared with the first quarter of the prior year is largely due
to an $11.5 million charge-off on a single commercial credit in the first
quarter of 2003. Net charge-offs on mortgage loans declined due to a $0.6
million charge-off in connection with the sale of $2.8 million of nonperforming
residential mortgage loans at a discount in March 2003.
The provision for loan losses declined to $7.0 million compared with $19.0
million in the same quarter of 2003. The decline in the provision for loan
losses reflects the lower level of net charge-offs, a reduction in nonperforming
assets and fewer risk rating downgrades on commercial credits during the
quarter. Citizens expects both net charge-offs and provision expense to be lower
in the second quarter than in the first quarter of 2004 due to anticipated lower
commercial loan net charge-offs.
The allowance for loan losses represents our estimate of probable losses
inherent in the loan portfolio. The allowance is based on ongoing quarterly
assessments and is maintained at a level management considers to be adequate to
absorb probable loan losses identified with specific customer relationships and
for probable losses believed to be inherent in the loan portfolio that have not
been specifically identified. Our evaluation process is inherently subjective as
it requires estimates that may be susceptible to significant change and have the
potential to materially affect net income. Default frequency, internal risk
ratings, expected future cash collections, loss recovery rates, and general
economic factors, among other things, are considered in this evaluation, as are
the size and diversity of individual large credits. While we continue to enhance
our loan
22
loss allocation model and risk rating process, we have not substantively changed
our overall approach in the determination of the allowance for loan losses in
2004 from 2003. Our methodology for measuring the adequacy of the allowance
relies on several key elements, which include specific allowances for identified
problem loans, a formula-based risk-allocated allowance for the remainder of the
portfolio and an unallocated allowance. This methodology is discussed in our
2003 Annual Report on Form 10-K.
The allowance for loan losses totaled $123.7 million or 2.38% of loans at March
31, 2004, consistent with the December 31, 2003 level of $123.5 million or 2.36%
of loans. At March 31, 2004, the allowance allocated to specific commercial and
commercial real estate credits was $20.0 million compared with $18.3 million at
December 31, 2003. The increase is primarily attributable to an allowance
established to cover a potential downgrade of a specific portfolio of
agricultural credits located in our Southwest Wisconsin market region.
Criticized and classified credits (i.e., those internally risk rated 7 - special
mention, 8 - substandard or 9 - doubtful) subject to specific reserves were
essentially unchanged at $66.8 million at March 31, 2004 compared with $66.7
million at December 31, 2003.
The total formula risk-allocated allowance was $85.0 million at March 31, 2004,
down from $89.5 million at December 31, 2003. The amount allocated to commercial
and commercial real estate loans, including construction loans, decreased to
$64.4 million at March 31, 2004 from $69.7 million at December 31, 2003. The
decrease reflected a lower level of nonperforming assets in these categories.
The risk-allocated allowance for residential real estate loans increased to $5.1
million at March 31, 2004 compared with $4.7 million at December 31, 2003,
reflecting a higher loss allocation factor applied to the mortgage portfolio.
The risk-allocated allowance for consumer loans, excluding mortgage loans,
increased to $15.5 million at March 31, 2004 compared with $15.1 million at
December 31, 2003. The increase in the risk-allocated allowance for consumer
loans was due to growth in home equity loans.
The unallocated allowance increased to $18.7 million at March 31, 2004, from
$15.7 million at December 31, 2003. The unallocated portion of the allowance is
maintained to address the uncertainty relating to factors affecting the
determination of probable losses inherent in the loan portfolio that may not
have yet manifested themselves in our specific allowances or in the historical
loss factors used to determine the formula allowances, such as geographic
expansion, the possible imprecision of internal risk-ratings within the
portfolios, continued weak general economic and business conditions and changes
in the composition of our portfolio.
The amount of the provision for loan losses is based on our review of the
historical credit loss experience and such factors that, in our judgment,
deserve consideration under existing economic conditions in estimating probable
credit losses. While we consider the allowance for loan losses to be adequate
based on information currently available, future adjustments to the allowance
may be necessary due to changes in economic conditions, delinquencies or loss
rates. The methods we use to determine the provision for loan losses and the
factors we consider are described in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in our 2003 Annual Report on Form
10-K.
23
NONPERFORMING ASSETS
Nonperforming assets are comprised of nonaccrual loans, loans with restructured
terms and repossessed assets, primarily real estate. Although these assets have
more than a normal risk of loss, they will not necessarily result in a higher
level of losses in the future. The table below provides a summary of
nonperforming assets as of March 31, 2004, December 31, 2003 and March 31, 2003.
NONPERFORMING ASSETS
MARCH 31, December 31, March 31,
(in thousands) 2004 2003 2003
- -------------- ------- ------- -------
Nonperforming Loans
Nonaccrual Commercial:
Commercial $24,359 $37,171 $49,275
Commercial real estate 15,310 16,385 20,433
Small business 2,052 1,603 1,459
------- ------- -------
Total commercial 41,721 55,159 71,167
Nonaccrual Consumer:
Direct 3,471 3,177 3,416
Indirect 1,087 1,247 1,646
------- ------- -------
Total consumer 4,558 4,424 5,062
Nonaccrual Mortgage 8,286 9,161 7,878
------- ------- -------
Total nonaccrual loans 54,565 68,744 84,107
Loans 90 days past due and still accruing 201 345 990
Restructured loans 52 -- --
------- ------- -------
Total nonperforming loans 54,818 69,089 85,097
Other Repossessed Assets Acquired (ORAA) 7,592 7,943 8,226
------- ------- -------
Total nonperforming assets $62,410 $77,032 $93,323
======= ======= =======
Nonperforming assets as a percent of portfolio loans plus ORAA (1) 1.20% 1.47% 1.76%
Nonperforming assets as a percent of total assets 0.81 1.00 1.20
Allowance for loan loss as a percent of nonperforming loans 225.66 178.82 128.91
Allowance for loan loss as a percent of nonperforming assets 198.21 160.38 117.54
(1) Portfolio loans exclude mortgage loans held for sale.
The level of nonperforming commercial loans at March 31, 2004 declined as
Citizens sold one of its two largest nonperforming assets and received a
significant cash payment on the other during the first quarter of 2004, reducing
nonperforming assets by a total of $8.4 million on these two credits alone. In
addition, exposures on various other nonperforming assets were reduced,
recovered, or paid current by the borrower. Changes in nonperforming loans are
reflected in the allowance for loan losses through specific and risk allocated
allowances. As of March 31, 2004, the total allocated allowance for nonaccrual
commercial loans was approximately $5.6 million compared with $7.6 million at
December 31, 2003.
In addition to loans classified as nonperforming, we carefully monitor other
credits that are current in terms of principal and interest payments but which
we believe may deteriorate in quality if economic conditions change. As of March
31, 2004, such loans amounted to $183.5 million, or 3.5% of total portfolio
loans, compared with $189.8 million, or 3.6%, of total portfolio loans as of
December 31, 2003. These loans are primarily commercial and commercial real
estate loans made in the normal course of business and do not represent a
concentration in any one industry or geographic location.
24
Some of our nonperforming loans included in the nonperforming loan table above
are considered to be impaired. Total loans considered impaired and their related
reserve balances at March 31, 2004 and 2003 as well as their effect on interest
income for the first quarter of 2004 and 2003 follows:
IMPAIRED LOAN INFORMATION Valuation Reserve
-----------------
(in thousands) 2004 2003 2004 2003
- -------------- ------- ------- ------- -------
Balances - March 31,
Impaired loans with valuation reserve $45,500 $48,744 $16,413 $16,318
Impaired loans with no valuation reserve 21,750 37,937 -- --
------- ------- ------- -------
Total impaired loans $67,250 $86,681 $16,413 $16,318
======= ======= ======= =======
Impaired loans on nonaccrual basis $41,772 $71,167 $ 4,217 $ 9,411
Impaired loans on accrual basis 25,478 15,514 12,196 6,907
------- ------- ------- -------
Total impaired loans $67,250 $86,681 $16,413 $16,318
======= ======= ======= =======
Average balance for the quarter $69,479 $81,597
Interest income recognized for the quarter 292 161
Cash collected applied to outstanding principal 438 696
DEPOSITS
Total deposits increased $19 million or 0.3% to $5.461 billion at March 31, 2004
compared with $5.442 billion at December 31, 2003, as a result of several
deposit promotional campaigns during the first quarter. However, average
deposits declined $379 million, or 6.5%, in the first three months of 2004
compared to the same period in 2003 due to a lower level of time deposits, and
to a lesser extent, lower savings deposits, reflecting our less aggressive
pricing posture during the low interest rate environment.
We gather deposits primarily within our local markets and have not traditionally
relied on brokered or out of market purchased deposits for any significant
portion of our funding. At March 31, 2004, we had approximately $145 million in
brokered deposits, down from $159 million at December 31, 2003. We will continue
to evaluate the use of alternative funding sources such as brokered deposits as
funding needs change. In addition to brokered deposits, we had approximately
$492 million of time deposits greater than $100,000, up $32 million compared
with December 31, 2003. Time deposits greater than $100,000 consist of
commercial, consumer and public fund deposits derived almost exclusively from
our local markets. We continue to promote relationship driven core deposit
growth and stability through focused marketing efforts and competitive pricing
strategies.
BORROWED FUNDS
Short-term borrowings are comprised primarily of federal funds purchased,
securities sold under agreements to repurchase, other bank borrowings, FHLB
advances and Treasury Tax and Loan notes. As of March 31, 2004, short-term
borrowed funds totaled $559.4 million, a decrease of $72.3 million or 11.4%
compared with December 31, 2003. For the three months ending March 31, 2004,
average short-term borrowed funds totaled $508.3 million, an increase of $293.5
million, or 136.6% from the same period of 2003. The increased short-term
borrowings provided funding to support expansion of the investment portfolio,
which commenced in the first quarter of 2003, and to a lesser extent partially
offset a decrease in average deposits.
Long-term debt consists almost entirely of advances from the Federal Home Loan
Bank ("FHLB") to our subsidiary banks, and subordinated notes issued by our
holding company parent. Average long-term debt totaled $938.7 million for the
first three months of 2004, an increase of $248.6 million or 36.0% compared with
the same period in 2003. The increases resulted from the issuance of $125
million of subordinated debt in the first quarter of 2003, $25 million of junior
subordinated debentures in the second quarter of 2003, and increases in FHLB
advances. The $125 million of subordinated debt and the $25 million of junior
subordinated debentures qualify as Tier II and Tier I capital, respectively, for
regulatory risk-based capital purposes and were issued to improve liquidity and
risk-based capital ratios. The increase in FHLB advances provided funding to
support the expansion of the investment portfolio and the decline in deposits
during 2003. For further information on the two subordinated debt issuances,
refer to Note 12 to the Consolidated Financial Statements in our 2003 Annual
Report on Form 10-K.
25
CAPITAL RESOURCES
Citizens continues to maintain a strong capital position, which supports our
current needs and provides a sound foundation to support further expansion. Our
regulatory capital ratios are consistently at or above the "well capitalized"
standards and all of our bank subsidiaries have sufficient capital to maintain a
well capitalized designation. Our capital ratios as of March 31, 2004, December
31, 2003 and March 31, 2003 are presented below.
CAPITAL RATIOS Regulatory
Minimum For
"Well MARCH 31, December 31, March 31,
Capitalized" 2004 2003 2003
------------ -------- ----------- --------
Risk based capital:
Tier I 6.0% 10.3% 9.8% 9.2%
Total capital 10.0 13.8 13.2 12.6
Tier I leverage 5.0 7.8 7.5 7.2
Shareholders' equity at March 31, 2004 was $654.2 million, compared with $635.2
million at December 31, 2003 and $640.4 million as of March 31, 2003. Book value
per common share at March 31, 2004, December 31, 2003 and March 31, 2003 was
$15.09, $14.69 and $14.79, respectively. We declared and paid cash dividends of
$0.285 per share in the first quarter of 2004, the same as we declared and paid
in the first quarter of 2003. Shareholders' equity increased as net income
exceeded cash dividends and the capital requirements of our share repurchase
program. During the first quarter of 2004, we purchased a total of 101,800
shares for $3.4 million. Information regarding the Company's share repurchase
program is set forth later in this report under Part II, Item 2 "Changes in
Securities, Use of Proceeds and Issuer Purchases of Equity Securities."
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
Our contractual obligations and off-balance sheet arrangements are described in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" contained in our 2003 Annual Report on Form 10-K. In the first
quarter of 2004, we entered into long term leases on new branch and
administrative offices in Oakland County with minimum annual lease commitments
of approximately $1.0 million and total lease commitments over the life of the
contracts of approximately $10.4 million under the non-cancelable operating
leases for these facilities. Except for these new leases and as described
elsewhere in this Report on Form 10-Q, there have been no material changes to
those obligations or arrangements outside the ordinary course of business during
the most recent quarter.
LIQUIDITY AND DEBT CAPACITY
We monitor and manage our liquidity position so that funds will be available at
a reasonable cost to meet financial commitments, to finance business expansion
and to take advantage of unforeseen opportunities. We manage the liquidity of
our parent company to pay dividends to shareholders, service debt, invest in
subsidiaries and to satisfy other operating requirements. We manage the
liquidity of our subsidiary banks to meet client cash flow needs while
maintaining funds available for loan and investment opportunities.
Our subsidiary banks derive liquidity primarily through core deposit growth,
maturity of money market investments, and maturity and sale of investment
securities and loans. Additionally, our subsidiary banks have access to market
borrowing sources on an unsecured, as well as a collateralized basis, for both
short-term and long-term purposes including, but not limited to, the Federal
Reserve and Federal Home Loan Banks where the subsidiary banks are members.
The primary sources of liquidity for the parent company are dividends and
returns on investment in its subsidiaries. Each of our banking subsidiaries is
subject to dividend limits under the laws of the state in which it is chartered
and, as a member bank of the Federal Reserve System, is subject to the dividend
limits of the Federal Reserve Board. The Federal Reserve Board allows a member
bank to make dividends or other capital distributions in an amount not exceeding
the current calendar year's net income, plus retained net income of the
preceding two years. Distributions in excess of this limit require prior
approval of the Federal Reserve Board. At March 31, 2004, the banking
subsidiaries could distribute to Citizens approximately $35.5 million in
dividends without regulatory approval.
26
An additional source of liquidity is the ability of our parent company to borrow
funds on both a short-term and long-term basis. Our parent company maintains a
$50 million short-term revolving credit facility with two unaffiliated banks. As
of March 31, 2004, we had no outstanding balance under this credit facility. The
current facility will mature in August 2004 and is expected to be renewed at
that time. The credit agreement also requires Citizens to maintain certain
financial covenants related to asset quality and capital levels. We were in full
compliance with all debt covenants as of March 31, 2004.
Downgrades in the first quarter of 2003 by FitchRatings and Standard & Poor's
Rating Service of our long-term credit rating to BBB from BBB+ due to asset
quality deterioration and increased nonperforming assets have not and are not
expected to materially affect our liquidity position. Our short-term credit
rating remained unchanged at F2 and A-2, respectively. Separately, in the second
quarter of 2003, Moody's Investors Service affirmed our outstanding ratings of
Baa-1 (long term) and P-2 (short term), after their review for a possible
downgrade. We believe that our capital position provides enough financial
flexibility to deal with a degree of additional credit deterioration, if such
were to occur.
Our Oakland County branch expansion plan will pose a challenge to liquidity as
both the capital investment and loan growth will require incremental funding. We
anticipate that through a combination of wholesale funding and deposit
generation of both the new Oakland County branches and the existing branch
network, we will be able to fund all aspects of the expansion plan. In addition,
the announced sale of the Illinois Bank that is expected to close in the third
quarter of 2004, is anticipated to have a neutral to slightly positive impact on
liquidity.
We also have contingent letter of credit commitments that may impact liquidity.
Since many of these commitments historically have expired without being drawn
upon, the total amount of these commitments does not necessarily represent our
future cash requirements in connection with them. Further information on these
commitments is presented in Note 10 to the Consolidated Financial Statements in
this report. We have sufficient liquidity and capital resources to meet
presently known short and long-term cash flow requirements.
INTEREST RATE RISK
Interest rate risk arises when the repricing structures of our assets and
liabilities differ significantly. Interest rate risk can result from a mismatch
in the timing of the repricing of assets and liabilities, option risk which can
alter the expected timing of repricing of certain assets or liabilities, or
basis risk. Basis risk occurs when assets and liabilities reprice at the same
time but based on different market rates, and when those market rates change by
different amounts. Many assets and liabilities contain embedded options which
allow customers, and entities associated with our investments and wholesale
funding, the opportunity to prepay loans or securities prior to maturity, or to
withdraw or reprice deposits or other funding instruments prior to maturity. Our
Asset / Liability Committee (ALCO) monitors asset, liability, and
off-balance-sheet portfolios to ensure comprehensive management of interest rate
risk. The Asset / Liability management process includes monitoring contractual
and expected repricing of assets and liabilities as well as forecasting earnings
under different interest rate scenarios and balance sheet structures with the
objective of insulating net interest income from large swings attributable to
changes in market interest rates. Our static interest rate sensitivity, commonly
referred to as repricing "GAP," as of March 31, 2004 and 2003 is illustrated in
the table on the following page.
27
INTEREST RATE SENSITIVITY TOTAL
1-90 91-180 181-365 WITHIN 1-5 Over
(dollars in millions) Days Days Days 1 YEAR Years 5 Years Total
- ------------------------------------------------ --------- -------- -------- -------- -------- -------- --------
MARCH 31, 2004
RATE SENSITIVE ASSETS (1)
Portfolio loans (2) $ 2,502.2 $ 257.9 $ 454.0 $3,214.1 $1,726.0 $ 259.8 $5,199.9
Mortgage loans held for sale 37.2 -- -- 37.2 -- -- 37.2
Investment securities 177.0 97.8 296.6 571.4 946.1 521.9 2,039.4
Short-term investments 1.3 -- -- 1.3 -- -- 1.3
--------- -------- -------- -------- -------- -------- --------
Total $ 2,717.7 $ 355.7 $ 750.6 $3,824.0 $2,672.1 $ 781.7 $7,277.8
========= ======== ======== ======== ======== ======== ========
RATE SENSITIVE LIABILITIES
Deposits (3) $ 1,261.1 $ 579.5 $ 755.5 $2,596.1 $1,744.0 $ 229.5 $4,569.6
Other interest bearing liabilities 559.6 25.0 120.8 705.4 358.8 436.3 1,500.5
--------- -------- -------- -------- -------- -------- --------
Total $ 1,820.7 $ 604.5 $ 876.3 $3,301.5 $2,102.8 $ 665.8 $6,070.1
========= ======== ======== ======== ======== ======== ========
Period GAP (4) $ 897.0 $ (248.8) $ (125.7) $ 522.5 $ 569.3 $ 115.9 $1,207.7
Cumulative GAP 897.0 648.2 522.5 1,091.8 1,207.7
Cumulative GAP to Total Assets 11.66% 8.43% 6.79% 6.79% 14.19% 15.70% 15.70%
Multiple of Rate Sensitive Assets to Liabilities 1.49 0.59 0.86 1.16 1.27 1.17 1.20
MARCH 31, 2003
RATE SENSITIVE ASSETS (1)
Portfolio loans (2) $ 2,597.8 $ 162.0 $ 334.8 $3,094.6 $1,564.9 $ 643.1 $5,302.6
Mortgage loans held for sale 128.1 -- -- 128.1 -- -- 128.1
Investment securities 170.4 128.4 260.7 559.5 704.2 588.9 1,852.6
Short-term investments 1.1 -- -- 1.1 -- -- 1.1
--------- -------- -------- -------- -------- -------- --------
Total $ 2,897.4 $ 290.4 $ 595.5 $3,783.3 $2,269.1 $1,232.0 $7,284.4
========= ======== ======== ======== ======== ======== ========
RATE SENSITIVE LIABILITIES
Deposits (3) $ 650.7 $ 562.3 $ 905.7 $2,118.7 $2,255.8 $ 567.5 $4,942.0
Other interest bearing liabilities 598.5 0.1 0.4 599.0 210.5 414.5 1,224.0
--------- -------- -------- -------- -------- -------- --------
Total $ 1,249.2 $ 562.4 $ 906.1 $2,717.7 $2,466.3 $ 982.0 $6,166.0
========= ======== ======== ======== ======== ======== ========
Period GAP (4) $ 1,648.2 $ (272.0) $ (310.6) $1,065.6 $ (197.2) $ 250.0 $1,118.4
Cumulative GAP 1,648.2 1,376.2 1,065.6 868.4 1,118.4
Cumulative GAP to Total Assets 21.23% 17.72% 13.72% 13.72% 11.18% 14.40% 14.40%
Multiple of Rate Sensitive Assets to Liabilities 2.32 0.52 0.66 1.39 0.92 1.25 1.18
(1) Incorporates prepayment projections for certain assets which may shorten
the time frame for repricing or maturity compared to contractual runoff.
(2) Balances exclude mortgage loans held for sale.
(3) Includes interest bearing savings and demand deposits of $1.170 billion and
$715 million in 2004 and 2003, respectively, in the less than one year
category, and $1.441 billion and $1.981 billion, respectively in the over
one year category, based on historical trends for these noncontractual
maturity deposit types, which reflects industry standards.
(4) GAP is the excess of rate sensitive assets (liabilities).
As shown in the table above, as of March 31, 2004, rate sensitive assets
repricing within one year exceeded rate sensitive liabilities repricing within
one year by $522.5 million, compared with $1.066 billion as of March 31, 2003.
These results suggest an interest rate risk position which is not significantly
mismatched; however, embedded options can change the repricing characteristics
of assets, liabilities, and off-balance sheet hedges thereby changing the
repricing position from that outlined above. Further, basis risk is not captured
by repricing gap analysis. Because of these limitations, we use income
simulation modeling to evaluate the impact of market interest rate changes on
the company's net interest income.
28
We may, from time-to-time, use derivative contracts to help manage or hedge our
exposure to interest rate risk and to market value risk in conjunction with our
mortgage banking operations. We currently use interest rate swaps, mortgage loan
commitments and forward mortgage loan sales. Interest rate swaps are contracts
with a third party (the "counter-party") to exchange interest payment streams
based upon an assumed principal amount (the "notional amount"). The notional
amount is not advanced from the counter-party. Swap contracts are carried at
fair value on the consolidated balance sheet with the fair value representing
the net present value of expected future cash receipts or payments based on
market interest rates as of the balance sheet date. The fair values of the
contracts change daily as market interest rates change. Further discussion of
derivative instruments is included in Notes 1 and 18 to the Consolidated
Financial Statements in our 2003 Annual Report on Form 10-K and in Note 8 to the
Consolidated Financial Statements presented in this report.
Holding residential mortgage loans for sale and committing to fund residential
mortgage loan applications at specific rates exposes us to market value risk
caused by changes in interest rates during the period from rate commitment
issuance until sale. To minimize this risk, we enter into mandatory forward
commitments to sell residential mortgage loans at the time a rate commitment is
issued. These mandatory forward commitments and the related commitments to fund
residential mortgage loan applications at specific rates are considered
derivatives under SFAS 133. Our practice to hedge our market value risk with
mandatory forward commitments has been effective and has not generated any
material gains or losses. As of March 31, 2004, we had forward commitments to
sell mortgage loans of $52 million.
We performed simulations as of March 31, 2004 to evaluate the impact of market
rate changes on net interest income over the following 12 months assuming
limited changes to balance sheet levels over that time period. If market
interest rates were to increase immediately by 100 or 200 basis points (a
parallel and immediate shift along the yield curve) net interest income is
expected to be lower by 0.5% and 1.6%, respectively, of what it would be if
rates were to remain at March 31, 2004 levels. An immediate 50 basis point
parallel decline in market rates is expected to reduce net interest income over
the following 12 months by 1.3% of what it would be if rates remain constant
over the entire time period at March 31, 2004 levels. Net interest income is not
only affected by the level and direction of interest rates, but also by the
shape of the yield curve, pricing spreads in relation to market rates, balance
sheet growth, the mix of different types of assets or liabilities, and the
timing of changes in these variables. A flattening of the curve would exacerbate
the negative impact on net interest income. Scenarios different from those
outlined above, whether different by only timing, level, or a combination of
these or other factors, could produce different results.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There has been no material change in the information concerning quantitative and
qualitative disclosures about market risk contained in Item 7A of Citizens' 2003
Annual Report on Form 10-K, except as set forth in Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Interest Rate Risk.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of its management,
including its Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934.
Based upon that evaluation, the Company's Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective to cause the material information required to be disclosed by the
Company in the reports that it files or submits under the Securities Exchange
Act of 1934 to be recorded, processed, summarized and reported within the time
periods specified in the Commission's rules and forms. No changes in the
Company's internal control over financial reporting occurred during the quarter
ended March 31, 2004 that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
29
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Total Number of Maximum Number of
Shares Purchased as Shares that May Yet
Part of Publicly Be Purchased Under
Total Number of Average Price Paid Announced Plans or The Plans or Programs
Period Shares Purchased Per Share Programs (a)
- -------------- ---------------- ------------------ -------------------- ----------------------
January 2004 15,000 $32.93 15,000 3,239,600
February 2004 35,000 33.21 35,000 3,204,600
March 2004 51,800 33.41 51,800 3,152,800
------- ------ -------
Total 101,800 $33.27 101,800 3,152,800
(a) In October 2001, our Board of Directors approved the repurchase of up
to 3,000,000 shares of our common stock from time to time in the market and in
October 2003, the Board approved the repurchase of an additional 3,000,000
shares. There is no expiration date for the repurchase program. As of March 31,
2004, a total of 2,847,200 shares of common stock had been repurchased at an
average price of $28.46 pursuant to this program. The purchase of our shares is
subject to limitations that may be imposed by applicable securities laws and
regulations and the rules of the Nasdaq Stock Market. The timing of the
purchases and the number of shares to be bought at any one time depend on market
conditions and our capital requirements. There can be no assurance that we will
repurchase the remaining shares authorized to be repurchased, or that any
additional repurchases will be authorized by our Board of Directors.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of
the Securities Exchange Act
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of
the Securities Exchange Act
32.1 Certification pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) of
the Securities Exchange Act
(b) Report on Form 8-K
A report on Form 8-K, dated January 15, 2004, was filed under Items 7 and
12 on January 15, 2004, announcing Citizens' results of operations for the
three and twelve month periods ended December 31, 2003. The information was
considered furnished, rather than filed. No financial statements were filed
with this report.
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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.
CITIZENS BANKING CORPORATION
Date: May 7, 2004 By /s/ Charles D. Christy
------------------------------------
Charles D. Christy
Chief Financial Officer
(Principal Financial Officer and
duly authorized officer)
/s/ Daniel E. Bekemeier
------------------------------------
Daniel E. Bekemeier
Chief Accounting Officer
(Principal Accounting Officer)
31
10-Q EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -------------------------------------------------------------------
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
of the Securities Exchange Act of 1934
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
of the Securities Exchange Act of 1934
32.1 Certification pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b)
of the Securities Exchange Act of 1934
32