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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, 2005
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 29, 2005
- -------------------------- -----------------------------
Common Stock, No Par Value 43,174,192 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......................................... 14
Item 3 - Quantitative and Qualitative Disclosures about Market Risk........ 31
Item 4 - Controls and Procedures........................................... 31
PART II - OTHER INFORMATION
Item 2 -Unregistered Sales of Equity Securities and Use of Proceeds........ 32
Item 6 -Exhibits........................................................... 32
SIGNATURES...................................................................... 33
EXHIBIT INDEX................................................................... 34
2
PART I - FINANCIAL INFORMATION
ITEM 1 - CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
MARCH 31, December 31, March 31,
(in thousands) 2005 2004 2004
- ----------------------------------------------------------------------------- ----------- ----------- -----------
(Unaudited) (Note 1) (Unaudited)
ASSETS
Cash and due from banks $ 145,707 $ 153,474 $ 156,220
Interest-bearing deposits with banks 1,596 1,769 1,253
Investment Securities:
Available-for-sale:
U.S. Treasury and federal agency securities 1,377,766 1,348,199 1,500,376
State and municipal securities 386,515 395,878 432,869
Other securities 68,983 70,447 76,065
Held-to-maturity:
State and municipal securities (fair value of $58,622, $54,749
and $30,172, respectively) 58,942 54,035 30,104
----------- ----------- -----------
Total investment securities 1,892,206 1,868,559 2,039,414
Mortgage loans held for sale 34,627 28,038 33,155
Loans:
Commercial 1,626,541 1,633,698 1,615,758
Commercial real estate 1,313,825 1,255,913 1,280,672
Residential mortgage loans 495,953 508,234 479,563
Direct consumer 1,173,234 1,169,618 1,084,277
Indirect consumer 820,289 825,902 743,691
----------- ----------- -----------
Total loans 5,429,842 5,393,365 5,203,961
Less: Allowance for loan losses (120,945) (122,184) (123,703)
----------- ----------- -----------
Net loans 5,308,897 5,271,181 5,080,258
Premises and equipment 121,107 117,944 116,531
Goodwill 54,527 54,527 54,785
Other intangible assets 13,307 14,033 16,207
Bank owned life insurance 83,072 82,613 80,896
Other assets 121,690 113,895 113,702
----------- ----------- -----------
TOTAL ASSETS $ 7,776,736 $ 7,706,033 $ 7,692,421
=========== =========== ===========
LIABILITIES
Noninterest-bearing deposits $ 891,849 $ 898,820 $ 891,342
Interest-bearing demand deposits 1,106,744 1,150,332 1,332,396
Savings deposits 1,578,058 1,638,295 1,334,244
Time deposits 1,712,883 1,612,313 1,902,950
----------- ----------- -----------
Total deposits 5,289,534 5,299,760 5,460,932
Federal funds purchased and securities sold
under agreements to repurchase 853,926 671,660 542,206
Other short-term borrowings 6,157 53,114 17,169
Other liabilities 79,656 77,276 76,843
Long-term debt 901,875 949,921 941,089
----------- ----------- -----------
Total liabilities 7,131,148 7,051,731 7,038,239
SHAREHOLDERS' EQUITY
Preferred stock - no par value --- --- ---
Common stock - no par value 94,966 97,180 100,982
Retained earnings 546,882 539,128 517,143
Accumulated other comprehensive income 3,740 17,994 36,057
----------- ----------- -----------
Total shareholders' equity 645,588 654,302 654,182
----------- ----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 7,776,736 $ 7,706,033 $ 7,692,421
=========== =========== ===========
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) 2005 2004
- ------------------------------------------------------- ------- -------
INTEREST INCOME
Interest and fees on loans $79,272 $73,706
Interest and dividends on investment securities:
Taxable 14,688 15,442
Tax-exempt 5,197 5,244
Money market investments 9 2
------- -------
Total interest income 99,166 94,394
------- -------
INTEREST EXPENSE
Deposits 18,071 16,451
Short-term borrowings 4,441 1,272
Long-term debt 8,421 8,343
------- -------
Total interest expense 30,933 26,066
------- -------
NET INTEREST INCOME 68,233 68,328
Provision for loan losses 3,000 7,000
------- -------
Net interest income after provision for loan losses 65,233 61,328
------- -------
NONINTEREST INCOME
Service charges on deposit accounts 8,287 8,042
Trust fees 4,412 4,310
Mortgage and other loan income 2,360 2,256
Brokerage and investment fees 1,599 1,782
Bankcard fees 840 783
Other 4,957 5,339
------- -------
Total fees and other income 22,455 22,512
Investment securities gains 6 ---
------- -------
Total noninterest income 22,461 22,512
NONINTEREST EXPENSE
Salaries and employee benefits 33,351 31,939
Occupancy 5,560 5,342
Professional services 4,199 3,928
Equipment 3,301 3,642
Data processing services 3,369 3,646
Advertising and public relations 1,746 2,145
Postage and delivery 1,590 1,556
Telephone 1,441 1,534
Other loan fees 375 1,129
Stationery and supplies 919 842
Intangible asset amortization 725 725
Other 4,025 4,106
------- -------
Total noninterest expense 60,601 60,534
------- -------
INCOME BEFORE INCOME TAXES 27,093 23,306
Income tax provision 7,013 5,863
------- -------
NET INCOME $20,080 $17,443
======= =======
NET INCOME PER SHARE:
Basic $ 0.46 $ 0.40
Diluted 0.46 0.40
CASH DIVIDENDS DECLARED PER SHARE 0.285 0.285
AVERAGE SHARES OUTSTANDING:
Basic 43,224 43,315
Diluted 43,646 43,860
See notes to consolidated financial statements.
4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
Accumulated
Other
Common Retained Comprehensive
(in thousands, except per share amounts) Stock Earnings Income (Loss) Total
- --------------------------------------------------------------- --------- --------- ------------- ---------
BALANCE - MARCH 31, 2004 $100,982 $517,143 $ 36,057 $654,182
Comprehensive income:
Net income 18,722 18,722
Other comprehensive income:
Net unrealized gain/(loss) on securities available-for-sale,
net of tax effect of ($17,356) (32,232)
Less: Reclassification adjustment for net losses included
in net income, net of tax effect of $719 1,334
Net change in unrealized gain/(loss) on qualifying cash flow
hedges, net of tax effect of ($175) (325)
------------
Other comprehensive income total (31,223)
--------
Total comprehensive income (12,501)
Exercise of stock options, net of shares purchased 477 477
Tax benefit on non-qualified stock options 1,045 1,045
Net change in deferred compensation, net of tax effect 71 71
Cash dividends - $0.285 per share (12,284) (12,284)
Shares acquired for retirement (3,242) (3,242)
-------- -------- ------------ --------
BALANCE - JUNE 30, 2004 99,333 523,581 4,834 627,748
Comprehensive income:
Net income 19,646 19,646
Other comprehensive income:
Net unrealized gain/(loss) on securities available-for-sale,
net of tax effect of $8,944 16,610
Less: Reclassification adjustment for net gains included
in net income, net of tax effect of ($187) (347)
Net change in unrealized gain/(loss) on qualifying cash flow
hedges, net of tax effect of ($83) (155)
------------
Other comprehensive income total 16,108
--------
Total comprehensive income 35,754
Exercise of stock options, net of shares purchased 1,662 1,662
Tax benefit on non-qualified stock options 325 325
Net change in deferred compensation, net of tax effect 46 46
Cash dividends - $0.285 per share (12,331) (12,331)
Shares acquired for retirement (3,484) (3,484)
-------- -------- ------------ --------
BALANCE - SEPTEMBER 30, 2004 97,882 530,896 20,942 649,720
Comprehensive income:
Net income 20,286 20,286
Other comprehensive income:
Net unrealized gain/(loss) on securities available-for-sale,
net of tax effect of ($1,945) (3,613)
Less: Reclassification adjustment for net gains included
in net income, net of tax effect of ($4) (7)
Net change in unrealized gain/(loss) on qualifying cash flow
hedges, net of tax effect of $311 578
Minimum pension liability, net of tax effect of $51 94
------------
Other comprehensive income total (2,948)
--------
Total comprehensive income 17,338
Exercise of stock options, net of shares purchased 2,113 2,113
Net change in deferred compensation, net of tax effect 36 36
Recognition of stock-based compensation 272 272
Cash dividends - $0.285 per share (12,326) (12,326)
Shares acquired for retirement (2,851) (2,851)
-------- -------- ------------ --------
BALANCE - DECEMBER 31, 2004 97,180 539,128 17,994 654,302
Comprehensive income:
Net income 20,080 20,080
Other comprehensive income:
Net unrealized gain/(loss) on securities available-for-sale,
net of tax effect of ($8,223) (15,271)
Less: Reclassification adjustment for net gains included
in net income, net of tax effect of ($2) (4)
Net change in unrealized gain/(loss) on qualifying cash flow
hedges, net of tax effect of $549 1,021
------------
Other comprehensive income total (14,254)
--------
Total comprehensive income 5,826
Exercise of stock options, net of shares purchased 374 374
Net change in deferred compensation, net of tax effect 30 30
Cash dividends - $0.285 per share (12,326) (12,326)
Shares acquired for retirement (2,618) (2,618)
-------- -------- ------------ --------
BALANCE - MARCH 31, 2005 $ 94,966 $546,882 $ 3,740 $645,588
-------- -------- ------------ --------
See notes to consolidated financial statements.
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
THREE MONTHS ENDED
MARCH 31,
(in thousands) 2005 2004
- ------------------------------------------------------------ --------- ---------
OPERATING ACTIVITIES:
Net income $ 20,080 $ 17,443
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 3,000 7,000
Depreciation and amortization 2,953 3,041
Amortization of goodwill and other intangibles 725 725
Net amortization on investment securities 1,455 2,767
Investment securities (gains) losses (6) ---
Loans originated for sale (92,262) (91,580)
Proceeds from sales of mortgage loans held for sale 87,120 102,007
Net gains from loan sales (1,447) (1,021)
Stock-based compensation 30 40
Other 370 4,102
--------- ---------
Net cash provided by operating activities 22,018 44,524
INVESTING ACTIVITIES:
Net decrease in money market investments 173 819
Securities available-for-sale:
Proceeds from sales --- 5,001
Proceeds from maturities and payments 116,207 104,315
Purchases (159,892) (135,545)
Securities held-to-maturity:
Purchases (4,911) (10,245)
Net (increase) decrease in loans and leases (40,716) 37,015
Net increase in properties and equipment (6,116) (6,788)
--------- ---------
Net cash used by investing activities (95,255) (5,428)
FINANCING ACTIVITIES:
Net (decrease) increase in demand and savings deposits (110,795) 75,619
Net increase (decrease) in time deposits 100,570 (56,954)
Net increase (decrease) in short-term borrowings 135,309 (72,295)
Proceeds from issuance of long-term debt 25,000 ---
Principal reductions in long-term debt (70,044) (74)
Cash dividends paid (12,326) (12,345)
Proceeds from stock options exercised 374 4,015
Shares acquired for retirement (2,618) (3,387)
--------- ---------
Net cash provided (used) by financing activities 65,470 (65,421)
--------- ---------
Net decrease in cash and due from banks (7,767) (26,325)
Cash and due from banks at beginning of period 153,474 182,545
--------- ---------
Cash and due from banks at end of period $ 145,707 $ 156,220
========= =========
See notes to consolidated financial statements.
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 months ended March 31, 2005 are not necessarily indicative of the results
that may be expected for the year ended December 31, 2005. The balance sheet at
December 31, 2004 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'
2004 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) 2005 2004
- ------------------------------------------------- ---------- ----------
Net income, as reported $ 20,080 $ 17,443
Less pro forma expense related to options granted (505) (615)
---------- ----------
Pro forma net income $ 19,575 $ 16,828
========== ==========
Net income per share:
Basic - as reported $ 0.46 $ 0.40
Basic - pro forma 0.45 0.39
Diluted - as reported 0.46 0.40
Diluted - pro forma 0.45 0.38
The Corporation expects to adopt the provisions of SFAS No. 123R, "Share-Based
Payment (Revised 2004)," on January 1, 2006. Among other things, SFAS 123R
eliminates the ability to account for stock-based compensation using APB 25 and
requires that such transactions be recognized as compensation cost in the income
statement based on their fair values on the date of the grant. The Corporation
will transition to fair value based accounting for stock-based compensation
using a modified version of prospective application ("modified prospective
application"). Under modified prospective application, as it is applicable to
the Corporation, SFAS 123R applies to new awards and to awards modified,
repurchased, or cancelled after December 31, 2005. Additionally, compensation
cost for the portion of awards for which the requisite service has not been
rendered (generally referring to non-vested awards) that are outstanding as of
January 1, 2006 must be recognized as the remaining requisite service is
rendered during the period of and/or the periods after the adoption of SFAS
123R. The attribution of compensation cost for those earlier awards will be
based on the same method and on the same grant-date fair values previously
determined for the pro forma disclosures required for companies that did not
adopt the fair value accounting method for stock-based employee compensation.
Based on the stock-based compensation awards outstanding as of March 31, 2005
for which the requisite service is not expected to be fully rendered prior to
January 1, 2006, the Corporation expects to recognize additional pre-tax,
quarterly compensation cost of approximately $0.7 million beginning in the first
quarter of 2006 as a result of the adoption of SFAS 123R. Future levels of
compensation cost recognized related to stock-based compensation awards
(including the aforementioned expected costs during the period of adoption) may
be impacted by new awards and/or modifications, repurchases and cancellations of
existing awards.
7
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS
FASB INTERPRETATION NO. 47, "ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT
OBLIGATIONS" (FIN 47) - ISSUED MARCH 2005 FIN 47 is an interpretation of FASB
Statement 143, Asset Retirement Obligations, which was issued in June 2001. The
FASB issued FIN 47 to address diverse accounting practices that have developed
with regard to the timing of liability recognition for legal obligations
associated with the retirement of a tangible long-lived asset in which the
timing or method of settlement are conditional on a future event that may or may
not be within the control of the entity. According to FIN 47, uncertainty about
the timing or method of settlement of a conditional asset retirement obligation
should be factored into the measurement of the liability when sufficient
information exists. FIN 47 also clarifies when an entity would have sufficient
information to reasonably estimate the fair value of an asset retirement
obligation. The new interpretation is not expected to have a material impact on
Citizens' financial condition, results of operations, or liquidity.
FSP 46(R)-5 - "IMPLICIT VARIABLE INTERESTS UNDER FASB INTERPRETATION NO. 46"
(FIN 46R-REVISED DECEMBER 2003), "CONSOLIDATION OF VARIABLE INTERESTS ENTITIES"
- - ISSUED MARCH 3, 2005 The FSP requires a reporting enterprise to consider
whether it holds an implicit variable interest in a variable interest entity
(VIE) or potential VIE. The determination of whether an implicit variable
interest exists should be based on whether the reporting enterprise may absorb
variability of the VIE or potential VIE. The guidance in the FSP should be
applied in the first reporting period beginning after March 3, 2005 in
accordance with the transition provisions in FIN 46R. The new interpretation is
not expected to have a material impact on Citizens' financial condition, results
of operations, or liquidity.
SFAS NO. 123R, "SHARE-BASED PAYMENT (REVISED 2004)." SFAS 123R establishes
standards for the accounting for transactions in which an entity (i) exchanges
its equity instruments for goods or services, or (ii) incurs liabilities in
exchange for goods or services that are based on the fair value of the entity's
equity instruments or that may be settled by the issuance of the equity
instruments. SFAS 123R eliminates the ability to account for stock-based
compensation using APB 25 and requires that such transactions be recognized as
compensation cost in the income statement based on their fair values on the date
of the grant. SFAS 123R was to be effective for the Corporation on July 1, 2005;
however, the required implementation date was recently delayed until January 1,
2006 as a result of the SEC's adoption of a new rule that amends the compliance
dates for this standard. Based on the stock-based compensation awards
outstanding as of March 31, 2005 for which the requisite service is not expected
to be fully rendered prior to January 1, 2006, the Corporation expects to
recognize additional pre-tax, quarterly compensation cost of approximately $0.7
million beginning in the first quarter of 2006 as a result of the adoption of
SFAS 123R.
EMERGING ISSUES TASK FORCE ISSUES
EMERGING ISSUES TASK FORCE (EITF) ISSUE 03-1, "THE MEANING OF
OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO CERTAIN INVESTMENTS."
EITF 03-1 provides guidance for determining when an investment is considered
impaired, whether impairment is other-than-temporary, and measurement of an
impairment loss. FASB issued FSP 03-1-1 in September, 2004, which delayed the
effective date for measurement and recognition guidance contained in paragraphs
10-20. Citizens continues to evaluate the impact of EITF 03-1. The amount of
other-than-temporary impairment to be recognized, if any, will be dependent on
management's intent and ability to hold investments until anticipated recovery,
changes in interest rates, and the finalization of the proposed guidance by the
FASB. At March 31, 2005, gross unrealized losses on securities were $21.0
million as compared to $6.3 million at December 31, 2004.
AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS STATEMENTS OF POSITION
SOP NO. 03-3, "ACCOUNTING FOR CERTAIN LOANS OR DEBT SECURITIES ACQUIRED IN A
TRANSFER." SOP 03-3 requires acquired loans, including debt securities, to be
recorded at the amount of the purchaser's initial investment and prohibits
carrying over valuation allowances from the seller for those
individually-evaluated loans that have evidence of deterioration in credit
quality since origination, and it is probable all contractual cash flows on the
loan will be unable to be collected. SOP 03-3 also requires the excess of all
undiscounted cash flows expected to be collected at acquisition over the
purchaser's initial investment to be recognized as interest income on a
level-yield basis over the life of the loan. Subsequent increases in cash flows
expected to be collected are recognized prospectively through an adjustment of
the loan's yield over its remaining life, while subsequent decreases are
recognized as impairment. Loans carried at fair value, mortgage loans held for
sale, and loans to borrowers in good standing under revolving credit agreements
are excluded from the scope of SOP 03-3. The guidance is effective for loans
acquired in fiscal years beginning after December 15, 2004. The Corporation did
not acquire any assets subject to SOP No. 03-3 during the first quarter of 2005.
8
NOTE 3. INVESTMENT SECURITIES
The amortized cost, estimated fair value and gross unrealized gains and losses
of investment securities follow:
MARCH 31, 2005 DECEMBER 31, 2004
---------------------------------------- ---------------------------------------
ESTIMATED GROSS UNREALIZED ESTIMATED GROSS UNREALIZED
AMORTIZED FAIR ---------------- AMORTIZED FAIR ----------------
(in thousands) COST VALUE GAINS LOSSES COST VALUE GAINS LOSSES
- ---------------------------- ---------- ---------- ------- ------- ---------- ---------- ------- -------
AVAILABLE FOR SALE:
U.S. Treasury $ --- $ --- $ --- $ --- $ --- $ --- $ --- $ ---
Federal agencies:
Mortgage-backed 1,073,758 1,059,520 2,066 16,304 1,057,401 1,056,207 4,245 5,439
Other 318,836 318,246 2,883 3,473 287,044 291,991 5,269 322
State and municipal 368,105 386,515 19,007 597 372,602 395,878 23,628 352
Mortgage and asset-backed 526 527 1 --- 2,633 2,669 37 1
Other 68,380 68,456 78 2 67,685 67,779 96 2
---------- ---------- ------- ------- ---------- ---------- ------- ------
Total available for sale $1,829,605 $1,833,264 $24,035 $20,376 $1,787,365 $1,814,524 $33,275 $6,116
========== ========== ======= ======= ========== ========== ======= ======
HELD TO MATURITY:
State and municipal 58,942 58,622 338 658 54,035 54,749 849 135
---------- ---------- ------- ------- ---------- ---------- ------- ------
Total held to maturity $ 58,942 $ 58,622 $ 338 $ 658 $ 54,035 $ 54,749 $ 849 $ 135
========== ========== ======= ======= ========== ========== ======= ======
NOTE 4. OTHER INTANGIBLE ASSETS
Citizens' other intangible assets as of March 31, 2005, December 31, 2004 and
March 31, 2004 are shown in the table below.
MARCH 31, December 31, March 31,
(in thousands) 2005 2004 2004
- ------------------------------ --------- ------------ ---------
Core deposit intangibles $ 28,989 $ 28,989 $ 28,989
Accumulated amortization 15,682 14,957 12,783
--------- ------------ ---------
Net core deposit intangibles 13,307 14,032 16,206
Minimum pension liability --- 1 1
--------- ------------ ---------
Total other intangibles $ 13,307 $ 14,033 $ 16,207
========= ============ =========
The estimated annual amortization expense for core deposit intangibles is $2.9
million in each of the next four years and $1.6 million for the fifth year.
NOTE 5. LINES OF BUSINESS INFORMATION
Citizens is managed along the following business lines: Commercial Banking,
Consumer Banking, Wealth Management, and Other. During the first quarter of
2005, Citizens implemented a new intercompany cost allocation system, which
utilizes improved unit cost and statistical information for assigning
operational costs from the Other business line to Commercial Banking, Consumer
Banking, and Wealth Management. The implementation of this system included
changes to the methodology used to allocate costs among lines of business. Prior
period information has been restated to reflect this change. Selected line of
business segment information, as adjusted, for the three months ended March 31,
2005 and 2004 is provided below. There are no significant intersegment revenues.
9
LINE OF BUSINESS INFORMATION
Commercial Consumer Wealth
(in thousands) Banking Banking Mgmt Other Total
- ------------------------------------------------------- ---------- -------- ------- ------ -------
EARNINGS SUMMARY - THREE MONTHS ENDED MARCH 31, 2005
Net interest income (taxable equivalent) $ 28,643 $ 37,307 $ 216 $5,420 $71,586
Provision for loan losses 1,753 1,248 (1) --- 3,000
---------- -------- ------- ------ -------
Net interest income after provision 26,890 36,059 217 5,420 68,586
Noninterest income 3,058 11,778 6,007 1,618 22,461
Noninterest expense 18,104 32,918 5,530 4,049 60,601
---------- -------- ------- ------ -------
Income before income taxes 11,844 14,919 694 2,989 30,446
Income tax expense (taxable equivalent) 4,181 5,221 246 718 10,366
---------- -------- ------- ------ -------
Net income $ 7,663 $ 9,698 $ 448 $2,271 $20,080
========== ======== ======= ====== =======
AVERAGE ASSETS (IN MILLIONS) $ 2,858 $ 2,568 $ 22 $2,280 $ 7,728
========== ======== ======= ====== =======
EARNINGS SUMMARY - THREE MONTHS ENDED MARCH 31, 2004(1)
Net interest income (taxable equivalent) $ 28,898 $ 37,686 $ 189 $4,917 $71,690
Provision for loan losses 4,878 2,125 (3) --- 7,000
---------- -------- ------- ------ -------
Net interest income after provision 24,020 35,561 192 4,917 64,690
Noninterest income 3,496 12,453 5,497 1,066 22,512
Noninterest expense 17,311 33,115 6,008 4,100 60,534
---------- -------- ------- ------ -------
Income before income taxes 10,205 14,899 (319) 1,883 26,668
Income tax expense (taxable equivalent) 3,572 5,215 (111) 549 9,225
---------- -------- ------- ------ -------
Net income $ 6,633 $ 9,684 $ (208) $1,334 $17,443
========== ======== ======= ====== =======
AVERAGE ASSETS (IN MILLIONS) $ 2,844 $ 2,380 $ 17 $2,399 $ 7,640
========== ======== ======= ====== =======
(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, 2005, December 31, 2004 and
March 31, 2004 are presented below.
MARCH 31, December 31, March 31,
(in thousands) 2005 2004 2004
- ---------------------------------------------------- --------- ------------ ---------
Federal Home Loan Bank advances $ 755,131 $ 800,161 $ 787,869
Subordinated debt:
Notes maturing February 2013 120,948 123,948 127,365
Deferrable interest debenture maturing June 2033 25,774 25,774 25,774
Other borrowed funds 22 38 81
--------- ------------ ---------
Total long-term debt $ 901,875 $ 949,921 $ 941,089
========= ============ =========
10
NOTE 7. PENSION BENEFIT COST
The components of pension expense for the three months ended March 31, 2005 and
March 31, 2004 are presented below.
Three Months Ended
March 31,
(in thousands) 2005 2004
- ------------------------------ ------- --------
DEFINED BENEFIT PENSION PLANS
Service cost $ 1,198 $ 1,148
Interest cost 1,311 1,299
Expected return on plan assets (1,757) (1,770)
Amortization of unrecognized:
Net transition asset (1) (3)
Prior service cost 49 58
Net actuarial loss 301 169
------- -------
Net pension cost $ 1,101 $ 901
======= =======
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,
2004, that it expected to contribute approximately $0.5 million to the
nonqualified supplemental benefit plans during 2005. As of March 31, 2005, $0.1
million of contributions have been made. Citizens anticipates that an additional
$0.4 million of contributions will be made during the next three quarters of
2005. Returns from the financial markets affect current and future
contributions.
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.
11
DERIVATIVE FINANCIAL INSTRUMENTS:
MARCH 31, 2005 December 31, 2004
----------------- -----------------
NOTIONAL FAIR Notional Fair
(dollars in thousands) AMOUNT VALUE Amount Value
- -------------------------------------------------- -------- ------- -------- -------
Received fixed Swaps $215,000 $(5,426) $185,000 $(1,134)
Pay Fixed Swaps 124,000 2,264 104,000 693
Customer initiated swaps and corresponding offsets 146,674 --- 142,674 ---
Interest rate lock commitments 28,825 186 17,165 108
Forward mortgage loan contracts 44,000 426 58,000 (68)
-------- ------- -------- -------
TOTAL $558,499 $(2,550) $506,839 $ (401)
======== ======= ======== =======
DERIVATIVE CLASSIFICATIONS AND HEDGING RELATIONSHIPS:
MARCH 31, 2005 December 31, 2004
----------------- -----------------
NOTIONAL FAIR Notional Fair
(dollars in thousands) AMOUNT VALUE Amount Value
- -------------------------------------------- -------- ------- -------- -------
Derivatives Designated as Cash Flow Hedges:
Hedging repurchase agreements $124,000 $ 2,264 $104,000 $ 693
Derivatives Designated as Fair Value Hedges:
Hedging time deposits 90,000 (1,677) 60,000 (456)
Hedging long-term debt 125,000 (3,749) 125,000 (678)
Derivatives Not Designated as Hedges:
Customer initiated swaps 146,674 --- 142,674 ---
-------- ------- -------- ---=--
TOTAL $485,674 $(3,162) $431,674 $ (441)
======== ======= ======== ======
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) 2005 2004
- ------------------------------------------------------- ------- -------
NUMERATOR:
Basic and dilutive earnings per share -- net income
available to common shareholders $20,080 $17,443
======= =======
DENOMINATOR:
Basic earnings per share -- weighted average shares 43,224 43,315
Effect of dilutive securities -- potential conversion
of employee stock options 422 545
------- -------
Diluted earnings per share -- adjusted weighted-average
shares and assumed conversions 43,646 43,860
======= =======
BASIC EARNINGS PER SHARE $ 0.46 $ 0.40
======= =======
DILUTED EARNINGS PER SHARE $ 0.46 $ 0.40
======= =======
During the first quarter of 2005, employees exercised stock options to acquire
19,264 shares at an average exercise price of $19.43 per share.
12
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
180 days prior to being funded and unused lines of credit are reviewed on a
regular basis. Financial standby letters of credit guarantee future payment of
client financial obligations to third parties. They are issued primarily for
goods and services provided. Performance standby letters of credit are
irrevocable guarantees to various beneficiaries for the performance of
contractual obligations of the Corporation's clients. Commercial letters of
credit may facilitate the shipment of goods and may also include direct pay
letters of credit which afford our clients access to the public financing
market. 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 have fixed expiration dates, most expire unfunded and do not
necessarily represent future liquidity requirements. Appropriate 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) 2005 2004
- --------------------------------------- ---------- ------------
LOAN COMMITMENTS AND LETTERS OF CREDIT:
Commitments to extend credit $1,559,931 $ 1,769,968
Financial standby letters of credit 42,322 41,356
Performance standby letters of credit 6,212 6,198
Commercial letters of credit 226,921 207,460
---------- ------------
$1,835,386 $ 2,024,982
========== ============
At March 31, 2005 and December 31, 2004, a liability of $2.6 million and $2.8
million, respectively, has been recorded for possible losses on commitments to
extend credit. In accordance with FIN 45, at March 31, 2005 and December 31,
2004 a liability of $0.2 million and $0.8 million, respectively, has been
recorded representing the value of the guarantee obligations associated with
certain letters of credit.
NOTE 11. ACCUMULATED OTHER COMPREHENSIVE INCOME
The components of accumulated other comprehensive income, net of tax, for the
three month period ended March 31, 2005 and 2004 are presented below.
Three Months Ended
March 31,
-------------------
(in thousands) 2005 2004
- ------------------------------------------------------------------------------ -------- --------
Balance at beginning of period $ 17,994 $ 22,803
Net unrealized (loss) gain on securities for the quarter, net of tax effect of
$(8,223) in 2005 and $7,227 in 2004 (15,271) 13,422
Less: Reclassification adjustment for net (gains) losses included in net
income for the quarter, net of tax effect of $(2) in 2005 (4) ---
Net change in unrealized gain (loss) on cash flow hedges for the quarter, net
of tax effect of $549 in 2005 and $(90) in 2004 1,021 (168)
-------- --------
Accumulated other comprehensive income, net of tax $ 3,740 $ 36,057
======== ========
13
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SELECTED QUARTERLY INFORMATION
CITIZENS BANKING CORPORATION AND SUBSIDIARIES
FOR THE QUARTER ENDED
------------------------------------------------------------
MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
2005 2004 2004 2004 2004
- ---------------------------------------------------------- --------- ------------ ------------- -------- ---------
SUMMARY OF OPERATIONS (THOUSANDS)
Interest income $ 99,166 $ 97,170 $ 96,029 $ 95,375 $94,394
Net interest income 68,233 68,480 69,301 69,218 68,328
Provision for loan losses 3,000 4,609 4,985 4,500 7,000
Total fees and other income 22,455 23,644 34,548 24,856 22,512
Investment securities gains (losses) 6 10 534 (2,053) ---
Noninterest expense 60,601 61,117 78,973 62,143 60,534
Income tax provision 7,013 6,122 779 6,656 5,863
Net income 20,080 20,286 19,646 18,722 17,443
Taxable equivalent adjustment 3,353 3,324 3,350 3,356 3,362
Cash dividends 12,326 12,326 12,331 12,284 12,345
PER COMMON SHARE DATA
Basic net income $ 0.46 $ 0.47 $ 0.46 $ 0.43 $ 0.40
Diluted net income 0.46 0.46 0.45 0.43 0.40
Cash dividends 0.285 0.285 0.285 0.285 0.285
Market value (end of period) 29.36 34.35 32.57 31.05 32.63
Book value (end of period) 14.95 15.13 15.03 14.51 15.09
AT PERIOD END (MILLIONS)
Assets $ 7,777 $ 7,706 $ 7,659 $ 7,748 $ 7,692
Total loans including held for sale 5,464 5,421 5,319 5,327 5,237
Deposits 5,290 5,300 5,267 5,361 5,461
Shareholders' equity 646 654 650 628 654
AVERAGE FOR THE QUARTER (MILLIONS)
Assets $ 7,728 $ 7,661 $ 7,669 $ 7,769 $ 7,640
Total loans including held for sale 5,424 5,337 5,289 5,312 5,229
Deposits 5,349 5,258 5,336 5,435 5,474
Shareholders' equity 649 649 637 628 644
RATIOS (ANNUALIZED)
Return on average assets 1.05% 1.05% 1.02% 0.97% 0.92%
Return on average shareholders' equity 12.54 12.43 12.27 12.00 10.89
Net interest margin (FTE)(1) 3.96 3.97 4.02 3.98 4.01
Efficiency ratio (2) 64.44 64.21 63.86 63.78 64.26
Net loans charged off to average portfolio loans 0.32 0.34 0.38 0.34 0.53
Allowance for loan losses to portfolio loans 2.23 2.27 2.30 2.34 2.38
Nonperforming assets to portfolio loans plus ORAA (end of 0.80 0.94 0.99 1.10 1.20
Nonperforming assets to total assets (end of period) 0.56 0.66 0.68 0.75 0.81
Average equity to average assets 8.40 8.48 8.31 8.08 8.43
Leverage ratio 7.83 7.84 7.71 7.52 7.61
Tier 1 capital ratio 9.97 9.96 10.18 10.00 10.07
Total capital ratio 13.32 13.32 13.61 13.42 13.53
(1) Net interest margin is presented on an annual basis, includes taxable
equivalent adjustments to interest income and is based on a tax rate of 35%.
(2) Efficiency Ratio = Noninterest expense/(Net interest income + Taxable
equivalent adjustment + Total fees and other income). It measures how
efficiently a bank spends its revenues. The fourth quarter 2004 excludes a
special charge recovery of $0.2 million and the third quarter 2004 excludes
the gain on the of the Illinois Bank subsidiary of $11.7 million and a
prepayment penalty on FHLB advances of $18.0 million.
The efficiency ratio for the fourth and third quarters of 2004 would equal
64.03% and 73.67%, respectively, if these items were included in the
calculation
14
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, 2005. 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 the Corporation's 2004 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 Citizens' 2004 Annual Report on Form 10-K, which
contains important additional information that is necessary to understand the
Corporation and its financial condition and results of operations for the
periods covered by this report. Unless the context indicates otherwise, all
references in the discussion to "Citizens" or the "Corporation" refer to
Citizens Banking Corporation and its subsidiaries. References to the "Holding
Company" refer solely to Citizens Banking Corporation.
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 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 the Holding Company's filings with the Securities and Exchange
Commission, as well as the following.
- Citizens faces the risk that loan losses, including unanticipated
loan losses due to changes in loan portfolios, fraud and economic
factors, will exceed the 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 capital and financial position.
- While Citizens attempts to manage the risk from changes in market
interest rates, interest rate risk management techniques are not
exact. In addition, Citizens may not be able to economically hedge
its interest rate risk. A rapid or substantial increase or decrease
in interest rates could adversely affect 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 the
loan portfolio and could reduce Citizens' customer base, its level
of deposits, and demand for financial products such as loans.
- If Citizens is unable to continue to attract core deposits or to
continue to obtain third party financing on favorable terms, its
cost of funds will increase, adversely affecting the ability to
generate the funds necessary for lending operations, reducing net
interest margin and negatively affecting results of operations.
- Increased competition with other financial institutions or an
adverse change in Citizens' relationship with a number of major
customers could reduce Citizens' net interest margin and net income
by decreasing the number and size of loans originated, the interest
rates charged on these loans and the fees charged for services to
customers. If Citizens were to lend to customers who are less likely
to pay in order to maintain historical origination levels, it may
not be able to maintain current loan quality levels.
- Citizens is a party to various lawsuits incidental to its business.
Litigation is subject to many uncertainties such that the expenses
and ultimate exposure with respect to many of these matters cannot
be ascertained.
- The financial services industry is undergoing rapid technological
changes. If Citizens is unable to adequately invest in and implement
new technology-driven products and services, it may not be able to
compete effectively, or the cost to provide products and services
may increase significantly.
- Citizens' business may be adversely affected by the highly regulated
environment in which it operates. Changes in banking or tax laws,
regulations and regulatory practices at either the federal or state
level may adversely affect the Corporation, including its ability to
offer new products and services, obtain financing, dividend funds
from the subsidiaries to the Holding Company, attract deposits, make
loans and leases and achieve satisfactory spreads, and may also
result in the imposition of additional costs.
- The products and services offered by the banking industry and
customer expectations regarding them are subject to change. Citizens
attempts to respond to perceived customer needs and expectations by
offering new products and services, such as new wealth management
capabilities, which are often costly to develop and market
initially. A
15
lack of market acceptance of these products and services would have
a negative effect on Citizens' results of operations.
- New accounting pronouncements may be issued by the accounting
profession, regulators or other government bodies which could change
existing accounting methods. Changes in accounting methods could
negatively impact Citizens' results of operations and financial
position.
- Citizens' business continuity plans or data security systems could
prove to be inadequate, resulting in a material interruption in or
disruption to Citizens' business and a negative impact on the
results of operations.
- Citizens' vendors could fail to fulfill their contractual
obligations, resulting in a material interruption in, or disruption
to, its business and a negative impact on its results of operations.
- Citizens potential inability to integrate acquired operations or
complete any restructuring could have a negative effect on Citizens'
expenses and results of operations.
- Citizens could face unanticipated environmental liabilities or costs
related to real property owned or acquired through foreclosure.
Compliance with federal, state and local environmental laws and
regulations, including those related to investigation and clean-up
of contaminated sites, could have a negative effect on Citizens'
expenses and results of operations.
- As a bank holding company that conducts substantially all of its
operations through its subsidiaries, the ability of the Holding
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 Holding
Company. Dividends paid by these subsidiaries are subject to limits
imposed by federal and state law.
Other factors not currently anticipated may also materially and adversely affect
Citizens' results of operations and financial position. There can be no
assurance that future results will meet expectations. While the Corporation
believes that the forward-looking statements in this Report are reasonable, the
reader should not place undue reliance on any forward-looking statement. In
addition, these statements speak only as of the date made. Citizens does not
undertake, and expressly disclaims any obligation, to update or alter any
statements whether as a result of new information, future events or otherwise,
except as may be required by applicable law.
CRITICAL ACCOUNTING POLICIES
Citizens' Consolidated Financial Statements are prepared in accordance with
accounting principles generally accepted in the United States ("GAAP") and
follow general practices within the industry in which the Corporation operates.
Application of these principles requires management to make estimates,
assumptions, and complex 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. Actual results
could differ significantly from those estimates. 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. Estimates that are particularly
susceptible to significant change include the determination of the allowance for
loan losses, the benefit obligation and net periodic pension expense for
employee pension and postretirement benefit plans, derivative financial
instruments and hedging activities, and income taxes. Citizens believes that
these estimates and the related policies discussed below are important to the
portrayal of the Corporation's financial condition and results. Therefore,
management considers them to be critical accounting policies and discusses them
directly with the Audit Committee of the Board of Directors. Citizens'
significant accounting policies are more fully described in Note 1 to the
audited Consolidated Financial Statements contained in the Corporation's 2004
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 the Corporation's 2004 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.
16
RESULTS OF OPERATIONS
SUMMARY
Citizens earned net income of $20.1 million or $0.46 per diluted share for the
three months ended March 31, 2005, compared with $17.4 million or $0.40 per
diluted share for the same quarter of 2004 and $20.3 million or $0.46 per
diluted share for the fourth quarter of 2004. This represents an increase of
$2.7 million or 15.1% compared with the first quarter of 2004 and a decrease of
$0.2 million or 1.0% from the fourth quarter of 2004. Annualized returns on
average assets and average equity for the first quarter of 2005 were 1.05% and
12.54%, respectively, compared with 0.92% and 10.89% for the first quarter of
2004 and 1.05% and 12.43% for the fourth quarter of 2004.
Results of the first quarter of 2005 reflect continued improvement in credit
quality, growth in commercial loans, seasonal activity in consumer loans, and
minimal compression in the net interest margin. Net interest income, noninterest
income, and noninterest expense for the quarter remained essentially unchanged
from the same quarter last year. On a linked quarter basis, net interest income
was relatively unchanged, total fees and other income was lower by $1.2 million,
offset by lower provision for loan losses and lower noninterest expense of $0.5
million. The provision for loan losses decreased $4.0 million compared with the
first quarter of 2004 and $1.6 million from the fourth quarter of 2004 due to a
lower level of net charge-offs and reductions in the level of specific reserves.
Citizens' total assets at March 31, 2005 were $7.8 billion, an increase of $70.7
million or 0.9% from December 31, 2004 and an increase of $84.3 million or 1.1%
compared with March 31, 2004. These increases were due to growth in total
portfolio loans, and were partially offset by a decline in the investment
portfolio. Portfolio loans increased $36.5 million or 0.7% compared with
December 31, 2004 and $225.9 million or 4.3% compared with March 31, 2004 as
both consumer and commercial loans increased from the end of the first quarter
of 2004 despite the $78.5 million reduction attributable to the Illinois Bank
sale.
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,
2005 and 2004 is presented below.
17
AVERAGE BALANCES/NET INTEREST INCOME/AVERAGE RATES
2005 2004
---------------------------------- ----------------------------------
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 $ 1,799 $ 9 2.01% $ 1,977 $ 2 0.48%
Investment securities (3):
Taxable 1,435,683 14,688 4.09 1,528,829 15,442 4.04
Tax-exempt 420,931 5,197 7.60 421,589 5,244 7.65
Mortgage loans held for sale 25,169 430 6.83 32,001 378 4.73
Portfolio Loans (4):
Commercial 1,615,304 21,842 5.62 1,620,679 19,397 4.94
Commercial real estate 1,291,629 19,358 6.08 1,299,904 19,304 5.97
Residential mortgage loans 504,097 6,813 5.41 496,336 7,210 5.81
Direct consumer 1,167,894 17,363 6.03 1,040,542 14,750 5.70
Indirect consumer 820,291 13,466 6.66 739,210 12,667 6.89
----------- ----------- ---------- ---------
Total portfolio loans 5,399,215 78,842 5.96 5,196,671 73,328 5.71
----------- ----------- ---------- ---------
Total earning assets (3) 7,282,797 99,166 5.68 7,181,067 94,394 5.47
NONEARNING ASSETS
Cash and due from banks 158,195 160,763
Bank premises and equipment 120,902 114,145
Investment security fair value adjustment 18,974 47,041
Other nonearning assets 268,861 262,892
Allowance for loan losses (121,267) (125,637)
----------- ----------
Total assets $ 7,728,462 $7,640,271
=========== ==========
INTEREST-BEARING LIABILITIES
Deposits:
Interest-bearing demand $ 1,153,239 $ 2,001 0.70 $1,358,556 $ 2,471 0.73
Savings deposits 1,626,232 5,092 1.27 1,288,269 1,662 0.52
Time deposits 1,662,673 10,977 2.68 1,955,036 12,318 2.53
Short-term borrowings 717,971 4,441 2.51 508,252 1,272 1.01
Long-term debt 927,497 8,422 3.67 938,677 8,343 3.57
----------- ----------- ---------- ---------
Total interest-bearing liabilities 6,087,612 30,933 2.06 6,048,790 26,066 1.73
NONINTEREST-BEARING LIABILITIES AND
SHAREHOLDERS' EQUITY
Noninterest-bearing demand 906,615 872,205
Other liabilities 84,766 75,111
Shareholders' equity 649,469 644,165
----------- ----------
Total liabilities and shareholders' equity $ 7,728,462 $7,640,271
=========== ==========
NET INTEREST INCOME $ 68,233 $ 68,328
=========== =========
INTEREST SPREAD (5) 3.62% 3.74%
Contribution of noninterest bearing sources of funds 0.34 0.27
---- ----
NET INTEREST MARGIN (5)(6) 3.96% 4.01%
==== ====
(1) Interest income is 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 $3.4 million and $3.4 million
for the three months ended 2005 and 2004, 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 cost,
adjusted for amortization of premiums and accretion of discounts.
(4) Nonaccrual loans are included in average balances for each applicable loan
category.
(5) The interest spread and net interest margin are presented on a
tax-equivalent basis.
(6) Because noninterest-bearing funding sources, demand deposits, other
liabilities and shareholders' equity also support earning assets, the net
interest margin exceeds the interest spread.
18
Net interest income was $68.2 million in the first quarter of 2005 compared with
$68.3 million in the same quarter of 2004. The slight decrease compared with the
first quarter of 2004 resulted from a lower net interest margin of five basis
points. Most of the margin compression was offset by growth in earning assets of
$101.7 million, with an expansion of the direct and indirect consumer loan
portfolios outweighing a reduction in the size of the investment portfolio and
the impact of the sale of the Illinois Bank.
Net interest margin decreased to 3.96% in the first quarter of 2005 compared
with 4.01% in the first quarter of 2004. The decrease in the net interest margin
resulted from a more competitive environment and increases in the cost of funds
outpacing increases in asset yields, which were slowed by residential mortgage
loan yield declines and commercial loan pricing spread declines as Citizens
continues to underwrite higher quality commercial loans with normal spreads
replacing lower quality commercial loans with higher spreads. Increases in
liability yields were due to growth in higher yielding deposit product balances
and a higher cost of short term borrowing as the Federal Reserve continues to
raise short term interest rates.
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
2005 COMPARED WITH 2004
-----------------------------
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 $ 7 $ 7 $ ---
Investment securities:
Taxable (754) 197 (951)
Tax-exempt (47) (39) (8)
Mortgage loans held for sale 52 144 (92)
Loans:
Commercial 2,445 2,514 (69)
Commercial real estate 54 228 (174)
Residential mortgage loans (397) (508) 111
Direct consumer 2,613 857 1,756
Indirect consumer 799 (436) 1,235
-------- ------- --------
Total portfolio loans 5,514 2,655 2,859
-------- ------- --------
Total 4,772 2,964 1,808
-------- ------- --------
INTEREST EXPENSE:
Deposits:
Interest-bearing demand (470) (88) (382)
Savings 3,430 2,901 529
Time (1,341) 661 (2,002)
Short-term borrowings 3,169 2,479 690
Long-term debt 79 203 (124)
-------- ------- --------
Total 4,867 6,156 (1,289)
-------- ------- --------
NET INTEREST INCOME $ (95) $(3,192) $ 3,097
======== ======= ========
(1)Changes are based on actual interest income and do not reflect taxable
equivalent adjustments.
(2)The change in interest not solely due to changes in volume or rates has been
allocated in proportion to the absolute dollar amounts of the change in each.
The decrease in net interest income for the three months ended March 31, 2005
compared with the same period of 2004 reflects rate variances which were
generally unfavorable and volume variances which were generally favorable
despite the impact of the sale of the Illinois Bank in August 2004.
Unfavorable volume variances in the investment portfolio were the result of the
Illinois Bank sale. Unfavorable volume variances in the commercial and
commercial real estate portfolios were the result of the Illinois Bank sale,
partially offset by growth during the most recent two quarters. In the
residential mortgage and direct consumer loan portfolios, organic growth
19
more than offset the Illinois Bank sale impact. Growth in savings deposits and
short-term borrowings partially offset declines in interest-bearing demand,
time deposits, and long-term debt.
Favorable rate variances were driven by short term market rate increases in most
asset categories. For tax-exempt securities, residential mortgage, and indirect
consumer loans, yields on maturing balances were higher than yields on new
volume due to continued low long-term interest rates, which resulted in slightly
lower portfolio yields. Unfavorable rate variances occurred in all liability
categories with the exception of interest-bearing demand, which saw a small
favorable rate variance. These unfavorable rate variances were the result of
increases in market interest rates.
In the second quarter of 2005, Citizens anticipates net interest income will be
consistent with or slightly higher than the first quarter of 2005 as a result of
more days in the quarter and continued loan growth, partially offset by
anticipated margin compression.
NONINTEREST INCOME
Noninterest income for the first quarter of 2005 remained essentially unchanged
from the first quarter of 2004 at $22.5 million. Increases in deposit service
charges, trust fees, and mortgage fees were offset by decreases in brokerage and
investment fees and other income. An analysis of the sources of noninterest
income during the three months ended March 31, 2005 and 2004 is summarized in
the table below.
NONINTEREST INCOME
Three Months
Ended
March 31, Change in 2005
---------------- ---------------
(dollars in thousands) 2005 2004 Amount Percent
- ----------------------------------- ------- ------- ------ -------
Service charges on deposit accounts $ 8,287 $ 8,042 $ 245 3.1%
Trust fees 4,412 4,310 102 2.4
Mortgage and other loan income 2,360 2,256 104 4.6
Brokerage and investment fees 1,599 1,782 (183) (10.3)
Bankcard fees 840 783 57 7.3
Investment securities gains 6 --- 6 NM
Other 4,957 5,339 (383) (7.2)
------- ------- -----
TOTAL NONINTEREST INCOME $22,461 $22,512 $ (51) (0.2)
======= ======= =====
N/M - Not Meaningful
Deposit service charges for the first quarter of 2005 increased $0.2 million or
3.1% to $8.3 million compared with the first quarter of 2004. The increase was
the result of initiatives implemented over the last seven quarters which
improved fee waiver management and slight increases in certain fees.
Trust fees increased $0.1 million or 2.4% to $4.4 million in the first quarter
of 2005 compared with the first quarter of 2004 due to Citizens' sales
management processes implemented during the first quarter of 2004 that focused
on relationship management and new business development strategies. Total trust
assets under administration decreased $268.3 million to $2.6 billion at March
31, 2005 compared with March 31, 2004. The decline in trust assets from March
31, 2004 was due to the reduction of a large institutional relationship in the
second and fourth quarters of 2004 and the exit of unprofitable custody assets
related to three relationships in the second quarter of 2004 and the first
quarter of 2005.
Mortgage and other loan income increased $0.1 million or 4.6% to $2.4 million in
the first quarter of 2005 compared with the first quarter of 2004, reflecting an
improvement in the execution of the secondary market sales.
Brokerage and investment fees decreased $0.2 million or 10.3% to $1.6 million in
the first quarter of 2005 compared with the first quarter of 2004 due to lower
annuity sales.
Other noninterest income decreased $0.4 million or 7.2% to $5.0 million for the
first quarter of 2005 compared with the first quarter of 2004 due to gains
recognized upon the sale of a former branch and other bank premises in the first
quarter of 2004.
Citizens anticipates total noninterest income in the second quarter will be
consistent with or slightly lower than the first quarter of 2005 due to lower
mortgage activity and anticipated seasonal improvement in service charges.
20
NONINTEREST EXPENSE
Noninterest expense was essentially unchanged at $60.6 million in the first
quarter of 2005 compared with $60.5 million in the first quarter of 2004. An
analysis of the components of noninterest expense during the three months ended
March 31, 2005 and 2004 is summarized in the table below.
NONINTEREST EXPENSE
Three Months
Ended
March 31, Change in 2005
---------------- -----------------
(dollars in thousands) 2005 2004 Amount Percent
- -------------------------------- ------- ------- ------- -------
Salaries and employee benefits $33,351 $31,939 $ 1,411 4.4%
Occupancy 5,560 5,342 218 4.1
Professional services 4,199 3,928 271 6.9
Equipment 3,301 3,642 (341) (9.4)
Data processing services 3,369 3,646 (277) (7.6)
Advertising and public relations 1,746 2,145 (399) (18.6)
Postage and delivery 1,590 1,556 34 2.2
Telephone 1,441 1,534 (93) (6.0)
Other loan fees 375 1,129 (754) (66.8)
Stationery and supplies 919 842 76 9.1
Intangible asset amortization 725 725 --- 0.0
Other 4,025 4,106 (80) (2.0)
------- ------- -------
TOTAL NONINTEREST EXPENSE $60,601 $60,534 $ 67 0.1
======= ======= =======
Salaries and employee benefits increased $1.4 million or 4.4% to $33.4 million
in the first quarter of 2005 compared with the first quarter of 2004. Despite
recognizing $0.9 million in severance, salary costs continued to decline in the
first quarter of 2005 as a result of reduced headcount. However, incentive
expense increased during the current quarter due to the realignment of incentive
compensation programs. Employee benefits increased due to higher retirement
benefit costs and payroll taxes. Citizens had 2,175 full time equivalent
employees at March 31, 2005, down from 2,302 at March 31, 2004.
Occupancy costs increased $0.2 million or 4.1% to $5.6 million in the first
quarter of 2005 compared with the first quarter of 2004. This increase was
largely due to building rent and other expenses related to the opening of new
branches and regional hubs in Southeast Michigan throughout 2004.
Professional services expense increased $0.3 million or 6.9% to $4.2 million in
the first quarter of 2005 compared with the first quarter of 2004. This increase
was a result of expenses related to work performed in 2005 to complete the
evaluation, documentation, and testing of internal controls and issuance of the
related reports to comply with Sarbanes-Oxley Section 404.
Equipment related costs decreased $0.3 million or 9.4% to $3.3 million for the
first quarter of 2005 compared with the first quarter of 2004. This decrease was
the result of lower equipment depreciation expense associated with the first
quarter of 2004 change in Citizens' capitalization policy, along with reductions
in software maintenance costs and spending on non-capital equipment.
Data processing services decreased $0.3 million or 7.6% to $3.4 million for the
first quarter of 2005 compared with the first quarter of 2004 due to contract
savings negotiated in the third quarter of 2004 with Citizens' core processing
provider.
Advertising and public relations expense decreased $0.4 million or 18.6% to $1.7
million in the first quarter of 2005 compared with the first quarter of 2004.
This decrease was largely due to advertising and marketing expenses incurred
during the first quarter of 2004 to support Citizens' Southeast Michigan
initiative.
Other loan fee expense decreased $0.8 million or 66.8% to $0.4 million for the
first quarter of 2005 compared with the first quarter of 2004. This decrease was
largely the result of lower provisioning to fund the reserve for unused
commitments, due to improved credit quality and higher line utilization in the
first quarter of 2005, as well as lower loan processing costs.
Other noninterest expenses, which include postage and delivery, telephone,
stationery and supplies, intangible asset amortization, and other, were
essentially unchanged at $8.7 million for the first quarter of 2005 compared
with $8.8 million in the first quarter of 2004.
21
Citizens anticipates that noninterest expenses for the second quarter will be
lower than the first quarter of 2005 due to anticipated reductions in benefits,
incentives, and other expenses.
INCOME TAXES
Income tax provision was $7.0 million in the first quarter of 2005 compared with
an income tax provision of $5.9 million during the same period in 2004. The
effective tax rate, computed by dividing the provision for income taxes by
income before taxes, was 25.9% for the first quarter of 2005 and 25.2% for the
same period of 2004. The effective tax rate is lower than the statutory rate due
to tax-exempt interest and other permanent income tax differences. The effective
tax rate increased slightly in the first quarter of 2005 compared to the same
quarter of 2004 due to a higher ratio of taxable income to total income.
LINES OF BUSINESS RESULTS
Citizens monitors financial performance using an internal profitability
measurement system, which provides line of business results and key performance
measures. 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 the Corporation's 2004 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) 2005 2004
- ------------- ------- --------
Commercial Banking $ 7,663 $ 6,633
Consumer Banking 9,698 9,684
Wealth Management 448 (208)
Other 2,271 1,334
------- --------
Net Income $20,080 $ 17,443
======= ========
COMMERCIAL BANKING
The increase in net income for the three month period ended March 31, 2005 was
due to a decrease in the provision for loan losses, partially offset by declines
in net interest income and noninterest income and higher noninterest expenses.
The reduction in the provision for loan losses reflects a decrease in the level
of net charge-offs as well as a reduction in the level of specific reserves. Net
interest income declined in the three month period ended March 31, 2005 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 Citizens' risk parameters partially offset by higher
deposits. The decline in loans occurred in most markets with the exception of
Southeast Michigan, which experienced strong growth. Noninterest income declined
due to lower deposit service charges due to the rising rate environment, which
resulted in higher customer earnings credits against commercial deposit service
charges based on commercial deposit balances, and line of credit fees related to
a change in accounting methodology. Noninterest expense increased due to higher
incentive compensation, employee benefits and professional service fees,
partially offset by lower deferred origination-related compensation, advertising
and promotion, and loan fees.
CONSUMER BANKING
The slight increase in net income for the three months ended March 31, 2005
compared to the same period of the prior year was due to a reduction in
noninterest expense and provision for loan losses. The improvement in
noninterest expense and provision was mitigated by a decline in net interest
income and noninterest income. Net interest income was lower as a result of a
mortgage mix shift, causing some compression in margin that was mostly offset by
growth in home equity and indirect products. Noninterest income was lower for
the period ended March 31, 2005 compared with the first quarter of 2004 due to
gains recognized upon the sale of former branch and other bank premises in the
first quarter of 2004. Noninterest expense improved due to Citizens' continued
focus on expense management.
WEALTH MANAGEMENT
The increase in net income for the three month period ended March 31, 2005 was
due to an increase in net interest income and noninterest income and a decline
in noninterest expense. Noninterest income increased due to higher trust fees,
brokerage fees, a performance-related penalty of $0.3 million received from a
third party vendor, and the amortization of an upfront payment received from a
third party vendor. Trust fees increased due to Citizens' sales management
processes implemented during the first quarter of 2004 that focused on
relationship management and new business development
22
strategies. Brokerage income increased due to more business being referred-to
financial consultants in Wealth Management from licensed personal bankers in
Consumer Banking. Noninterest expense declined due to lower incentive
compensation and professional services costs partially offset by a litigation
settlement related to a trust account. The first quarter of 2004 included costs
related to the implementation of the trust and investment accounting systems and
operations with SEI Investments and the conversion of retirement services
recordkeeping systems and operations to EPIC Advisors, Inc.
OTHER
Net income increased for the three month period ended March 31, 2005 as a result
of higher net interest income and noninterest income, as well as a slight
decrease in noninterest expense. Net interest income grew as a result of an
increase in earning assets and a mix shift among liabilities from categories
with a higher funding credit rates to ones with lower funding credit rates. The
increase in noninterest income was due to higher payouts received from bank
owned life insurance policies and a preference payment on Citizens' membership
interest in the PULSE ATM network.
FINANCIAL CONDITION
Citizens' total assets at March 31, 2005 were $7.8 billion, an increase of $70.7
million or 0.9% from December 31, 2004 and an increase of $84.3 million or 1.1%
compared with March 31, 2004. These increases were due to growth in total
portfolio loans, which were partially offset by declines in the investment
portfolio. Total deposits were $5.3 billion at March 31, 2005, essentially
unchanged from December 31, 2004 and a decrease of $171.4 million or 3.1%
compared with March 31, 2004. After considering the $155.3 million reduction in
deposits as a result of the Illinois Bank sale, the decline in deposits since
the first quarter of 2004 occurred largely within time deposits, reflecting
Citizens' less aggressive pricing posture during the low interest rate
environment. Additionally, Citizens experienced a shift of customer deposits
from interest-bearing demand and time deposits to promotional rate savings
products throughout the year.
INVESTMENT SECURITIES AND MONEY MARKET INVESTMENTS
Total average investments, including money market investments, comprised 25.5%
of average earning assets during the first three months of 2005 compared with
26.0% for the fourth quarter of 2004 and 27.2% for the first three months of
2004. The decrease from both periods of 2004 was primarily a result of the sale
of the Illinois Bank in the third quarter of 2004.
PORTFOLIO LOANS
Portfolio loans increased $36.5 million or 0.7% compared with December 31, 2004
and $225.9 million or 4.3% compared with March 31, 2004 as both consumer and
commercial loans increased from the end of the first quarter of 2004 despite the
$78.5 million reduction at the date of the Illinois Bank sale.
Consumer loans, excluding mortgage loans, increased $165.6 million or 9.1% at
March 31, 2005 compared with March 31, 2004 due to a well executed sales process
and a number of successful sales campaigns. Total consumer loans, excluding
mortgage loans, remained essentially unchanged from December 31, 2004 due to
increased competition in home equity rates within our markets and seasonality in
the indirect portfolio. Since March 31, 2004, direct consumer loans increased
$89.0 million or 8.2% and indirect loans increased $76.6 million or 10.3% due to
growth in the recreational vehicle and marine segments from continued emphasis
on service and maintaining strong relationships with existing dealers.
Portfolio mortgage loans were $496.0 million at March 31, 2005, a decrease of
$12.3 million or 2.4% from December 31, 2004 and an increase of $16.4 million or
3.4% compared with March 31, 2004. The increase in the mortgage portfolio from
the end of the first quarter of 2004 occurred due to slower refinance activity.
Citizens continues to sell most new fixed rate production into the secondary
market and to hold most new ARM volume. Closed mortgage loan volume declined to
$108.5 million in the first quarter of 2005 compared with $132.9 million in the
fourth quarter of 2004. The decrease in the mortgage portfolio from the end of
the fourth quarter of 2004 was due to seasonally reduced activity in
construction financing.
Commercial and commercial real estate loans at March 31, 2005 increased $50.8
million or 1.8% from December 31, 2004 and $43.9 million or 1.5% compared with
March 31, 2004. The increases were a result of continued strong growth in the
Southeast Michigan market, increased focus on the sales management process and
several new relationships in key Michigan and Wisconsin markets, which were
partially offset by a continued reduction of exposure on credits not meeting
Citizens' risk parameters.
At March 31, 2005 and 2004, $46.9 million and $46.8 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.
23
MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale were $34.6 million at March 31, 2005, up $6.6
million or 23.5% compared with December 31, 2004 and $1.5 million or 4.4% higher
compared with March 31, 2004. These balances generally track the level of
originations, as Citizens sells most fixed rate new residential mortgage loan
production into the secondary market due to the long-term interest rate risk.
Closed mortgage loan volume was $109 million in the first quarter of 2005
compared with $107 million in the first quarter of 2004. New mortgage loan
production was spurred during the first quarter of 2005 by a strong refinance
market as a result of the low interest rate environment. Average mortgage loans
held for sale during the first three months of 2005 comprised 0.3% of average
earning assets compared with 0.4% during the same period of 2004. Mortgage loans
held for sale are accounted for on the lower of cost or market basis.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
A summary of loan loss experience during the three months ended March 31, 2005
and 2004 is provided below.
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
Three Months Ended
March 31,
-----------------------
(in thousands) 2005 2004
- -------------- ---------- ----------
Allowance for loan losses - beginning of period $ 122,184 $ 123,545
Provision for loan losses 3,000 7,000
Charge-offs:
Commercial 2,463 5,921
Commercial real estate 678 1,151
---------- ----------
Total commercial 3,141 7,072
Residential mortgage 324 193
Direct consumer 1,424 1,629
Indirect consumer 2,236 1,892
---------- ----------
Total charge-offs 7,125 10,786
---------- ----------
Recoveries:
Commercial 1,162 2,350
Commercial real estate 707 432
---------- ----------
Total commercial 1,869 2,782
Residential mortgage --- 13
Direct consumer 343 437
Indirect consumer 674 712
---------- ----------
Total recoveries 2,886 3,944
---------- ----------
Net charge-offs 4,239 6,842
---------- ----------
Allowance for loan losses - end of period $ 120,945 $ 123,703
========== ==========
Portfolio loans outstanding at period end (1) $5,429,842 $5,203,961
Average portfolio loans outstanding during period (1) 5,399,215 5,196,671
Allowance for loan losses as a percentage of portfolio loans 2.23% 2.38%
Ratio of net charge-offs during period to average portfolio loans (annualized) 0.32 0.53
(1) Balances exclude mortgage loans held for sale.
Net charge-offs decreased to $4.2 million or 0.32% of average portfolio loans in
the first quarter of 2005 compared with $6.8 million or 0.53% of average
portfolio loans in the first quarter of 2004. The reduction in net charge-offs
was primarily in the commercial portfolio, reflecting the ongoing, aggressive
efforts to address problematic credits.
The provision for loan losses decreased to $3.0 million in the first quarter of
2005 compared with $7.0 million in the first quarter of 2004. The reduction in
the provision for loan losses reflects a decrease in the level of net
charge-offs as well as a reduction in the level of specific reserves.
24
The allowance for loan losses represents management's estimate of an amount
adequate to provide for probable credit losses inherent in the loan portfolio as
of the balance sheet date. To assess the adequacy of the allowance for loan
losses, an allocation methodology is applied that focuses on changes in the size
and character of the loan portfolio, changes in the levels of impaired or other
nonperforming loans, the risk inherent in specific loans, concentrations of
loans to specific borrowers or industries, existing economic conditions,
underlying collateral, historical losses on each portfolio category and other
qualitative and quantitative factors which could affect probable credit losses.
The evaluation process is inherently subjective, as it requires estimates that
may be susceptible to significant change and have the potential to affect net
income materially. While Citizens continues to enhance its loan loss allocation
model and risk rating process, it has not substantially changed its overall
approach in the determination of the allowance for loan losses in 2005. The
Corporation's 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 a general valuation allowance that reflects the Corporation's
evaluation of a number of other risk factors discussed below. This methodology
is discussed in "Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations" in Citizens' 2004 Annual Report on Form
10-K.
The allowance for loan losses totaled $120.9 million or 2.23% of loans at March
31, 2005, a decrease of $1.2 million and $2.8 million from December 31, 2004 and
March 31, 2004 respectively. At March 31, 2005, the allowance allocated to
specific commercial and commercial real estate credits was $14.3 million
compared with $15.3 million at December 31, 2004. The decrease was attributable
to a number of the underlying credits being repaid. Criticized and classified
credits subject to specific reserves were $38.1 million as of March 31, 2005
compared with $35.0 million at December 31, 2004.
The total formula risk allocated allowance was relatively unchanged at $84.0
million as of March 31, 2005, compared with $84.6 million at December 31, 2004.
The amount allocated to commercial and commercial real estate loans, including
construction loans, increased to $61.4 million at March 31, 2005 compared with
$59.2 million at December 31, 2004 due to increased balances in the loan
portfolio. The risk allocated allowance for residential real estate loans
decreased to $5.8 million at March 31, 2005 compared with $6.2 million at
December 31, 2004, reflecting a lower loss allocation factor applied to the
mortgage portfolio. The risk allocated allowance for consumer loans, excluding
mortgage loans, decreased to $16.7 million at March 31, 2005 compared with $19.2
million at December 31, 2004, reflecting a lower loss allocation factor.
The general valuation allowances remained relatively flat at $22.7 million at
March 31, 2005, compared with $22.3 million at December 31, 2004. The general
valuation allowances portion of the allowance is maintained to address the
uncertainty relating to factors affecting the determination of potential losses
inherent in the loan portfolio that may not have yet manifested themselves in
the Corporation's 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, uncertainties related to interpreting
the Corporation's internal underwriting guidelines, illegal activities by
customers, and changes in the composition of the Corporation's portfolio. The
increase in the general valuation allowances resulted from additional
uncertainty in the small business and home equity portfolios.
The amount of the provision for loan losses is based on the Corporation's review
of the historical credit loss experience and such factors that, in Citizens
judgment, deserve consideration under existing economic conditions in estimating
potential credit losses. While the Corporation considers 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.
Based on current business trends and continued improvement in nonperforming
loans and the overall risk in the loan portfolio, Citizens anticipates net
charge-offs and provision expense in the second quarter will be consistent with
the first quarter of 2005.
25
NONPERFORMING ASSETS
Nonperforming assets are comprised of nonaccrual loans, loans with restructured
terms and repossessed assets that are mostly real estate related. 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, 2005, December 31, 2004 and March 31, 2004.
NONPERFORMING ASSETS
MARCH 31, December 31, March 31,
(in thousands) 2005 2004 2004
- -------------- --------- ------------ ---------
Nonperforming Loans
Nonaccrual Commercial:
Commercial $12,991 $13,774 $26,411
Commercial real estate 11,004 14,464 15,310
------- ------- -------
Total commercial 23,995 28,238 41,721
Nonaccrual Consumer:
Direct 3,474 3,518 3,471
Indirect 1,025 2,420 1,087
------- ------- -------
Total consumer 4,499 5,938 4,558
Nonaccrual Mortgage: 8,099 8,643 8,286
------- ------- -------
Total nonaccrual loans 36,593 42,819 54,565
Loans 90 days past due and still accruing 11 40 201
Restructured loans 42 42 52
------- ------- -------
Total nonperforming loans 36,646 42,901 54,818
Other Repossessed Assets Acquired (ORAA) 7,118 7,946 7,592
------- ------- -------
Total nonperforming assets $43,764 $50,847 $62,410
======= ======= =======
Nonperforming assets as a percent of portfolio loans plus ORAA (1) 0.80% 0.94% 1.20%
Nonperforming assets as a percent of total assets 0.56 0.66 0.81
Allowance for loan loss as a percent of nonperforming loans 330.04 284.80 225.66
Allowance for loan loss as a percent of nonperforming assets 276.36 240.30 198.21
(1) Portfolio loans exclude mortgage loans held for sale.
Nonperforming assets totaled $43.8 million at March 31, 2005, a decrease of $7.1
million or 13.9% compared with December 31, 2004 and a decrease of $18.6 million
or 29.9% compared with March 31, 2004. Nonperforming assets at March 31, 2005
represented 0.80% of portfolio loans plus other repossessed assets acquired
compared with 0.94% at December 31, 2004 and 1.20% at March 31, 2004. Loans
added to the commercial nonperforming loan category decreased to $11.2 million
in the first quarter of 2005 compared with $11.7 million in the first quarter of
2004 and $18.4 million in the fourth quarter of 2004 while loans removed from
that category totaled $15.4 million for the first quarter of 2005 compared with
$25.1 million in the first quarter of 2004 and $18.9 million in the fourth
quarter of 2004.
In addition to loans classified as nonperforming, the Corporation carefully
monitors other credits that are current in terms of principal and interest
payments but that the Corporation believes may deteriorate in quality if
economic conditions change. As of March 31, 2005, such loans amounted to $167.4
million, or 3.2% of total portfolio loans, compared with $155.6 million, or 2.9%
of total portfolio loans as December 31, 2004 and 4.2% of total portfolio loans
as of March 31, 2004. These loans are mostly 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.
26
Some of the Corporation's nonperforming loans included in the nonperforming loan
table above are considered to be impaired. A loan is considered impaired when
Citizens determines that it is probable that all the principal and interest due
under the loan may not be collected. In most instances, impairment is measured
based on the fair value of the underlying collateral. Impairment may also be
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate. The Corporation maintains a valuation
allowance for impaired loans as a part of the specific allocated allowance.
Total loans considered impaired and their related reserve balances at March 31,
2005, December 31, 2004 and March 31, 2004 as well as their effect on interest
income for the first quarter of 2005 and 2004 and fourth quarter of 2004
follows:
IMPAIRED LOAN INFORMATION
Balances Valuation Reserve
------------------------------------ -----------------------------------
MARCH 31, December 31, March 31, MARCH 31, December 31, March 31,
(in thousands) 2005 2004 2004 2005 2004 2004
- -------------- ----------- ------------ --------- --------- ------------ ---------
Balances -
Impaired loans with valuation reserve $ 32,774 $ 27,118 $ 45,500 $ 13,478 $ 12,405 $ 16,413
Impaired loans with no valuation reserve 14,447 14,529 21,750 --- --- ---
-------- -------- -------- -------- -------- --------
Total impaired loans $ 47,221 $ 41,647 $ 67,250 $ 13,478 $ 12,405 $ 16,413
======== ======== ======== ======== ======== ========
Impaired loans on nonaccrual basis $ 23,995 $ 28,238 $ 41,772 $ 3,959 $ 6,372 $ 4,558
Impaired loans on accrual basis 23,226 13,409 25,478 9,519 6,033 11,855
-------- -------- -------- -------- -------- --------
Total impaired loans $ 47,221 $ 41,647 $ 67,250 $ 13,478 $ 12,405 $ 16,413
======== ======== ======== ======== ======== ========
Average balance for the quarter $ 44,434 $ 45,021 $ 69,479
Interest income recognized for the quarter 266 238 292
Cash collected applied to outstanding principal 458 498 438
DEPOSITS
Total deposits were $5.3 billion at March 31, 2005, essentially unchanged from
December 31, 2004 and decreased $171.4 million or 3.1% compared with March 31,
2004. After considering the $155.3 million reduction in deposits as a result of
the Illinois Bank sale, the decline in deposits since the first quarter of 2004
occurred largely within time deposits, reflecting Citizens' less aggressive
pricing posture during the low interest rate environment. Additionally, Citizens
experienced a shift of customer deposits from interest-bearing demand and time
deposits to promotional rate savings products throughout the year. Core
deposits, which exclude time deposits, totaled $3.6 billion at March 31, 2005,
essentially unchanged from March 31, 2004 and representing a decrease of $110.8
million or 3.0% from December 31, 2004. The decrease in core deposits from the
end of the fourth quarter of 2004 is largely the result of a decline in
interest-bearing checking and promotional savings products as the higher rate
environment is prompting clients to migrate their funds into time deposits with
higher yields and to promotional rate products within the market. Time deposits
totaled $1.7 billion at March 31, 2005, representing an increase of $100.6
million or 6.2% from December 31, 2004 and decrease of $190.1 million or 10.0%
compared with March 31, 2004.
Citizens gathers deposits primarily within local markets and have not
traditionally relied on brokered or out of market purchased deposits for any
significant portion of funding. At March 31, 2005, Citizens had approximately
$153 million in brokered deposits, compared to $165 million at December 31, 2004
and $145 million at March 31, 2004. Citizens will continue to evaluate the use
of alternative funding sources such as brokered deposits as funding needs
change. In addition to brokered deposits, at March 31, 2005 Citizens had
approximately $639 million of time deposits greater than $100,000, compared to
$650 million at December 31, 2004 and $492 million at March 31, 2004. Time
deposits greater than $100,000 consist of commercial, consumer and public fund
deposits derived almost exclusively from local markets. In order to avoid use of
these higher cost funding alternatives, Citizens continues to promote
relationship-based core deposit growth and stability through focused marketing
efforts and competitive pricing strategies.
BORROWED FUNDS
Short-term borrowings are comprised 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, 2005, short-term borrowings totaled
$860.1 million, an increase of $135.3 million or 18.7% compared with December
31, 2004 and an increase of $300.7 million or 53.8% compared with March 31,
2004. For the three months ended March 31, 2005, average short-term borrowed
funds totaled $717.9 million, an increase of $209.7 million, or 41.3% from the
same period of 2004. The increase in short-term borrowings provided funding to
support growth in portfolio loans and partially offset a decrease in average
deposits.
27
Long-term debt consists almost entirely of advances from the FHLB to our
subsidiary banks, and subordinated notes issued by our Holding Company. Average
long-term debt for the first three months of 2005 was $927.5 million, a decrease
of $11.2 million or 1.2% compared with the same period in 2004, and a decrease
of $19.1 million or 2.0% compared to the fourth quarter of 2004.
CAPITAL RESOURCES
Citizens continues to maintain a strong capital position, which supports current
needs and provides a sound foundation to support further expansion. The
Corporation's regulatory capital ratios are consistently at or above the
"well-capitalized" standards and all bank subsidiaries have sufficient capital
to maintain a well capitalized designation. The Corporation's capital ratios as
of March 31, 2005, December 31, 2004 and March 31, 2004 are presented below.
CAPITAL RATIOS
Regulatory Minimum
------------------
"Well- MARCH 31, December 31, March 31,
Capitalized" 2005 2004 2004
------------------ --------- ------------ ---------
Risk based:
Tier 1 capital 6.00% 9.97% 9.96% 10.07%
Total capital 10.00 13.32 13.32 13.53
Tier 1 leverage 5.00 7.83 7.84 7.61
Shareholders' equity at March 31, 2005 was $645.6 million, compared with $654.3
million at December 31, 2004 and $654.2 million as of March 31, 2004. Book value
per common share at March 31, 2005, December 31, 2004 and March 31, 2004 was
$14.95, $15.13 and $15.09, respectively. Citizens declared and paid cash
dividends of $0.285 per share in the first quarter of 2005, the same as in the
first quarter of 2004. During the first quarter of 2005, the Holding Company
repurchased a total of 86,000 shares for $2.6 million. Information regarding the
Corporation's share repurchase program is set forth later in this report under
Part II, Item 2 "Unregistered Sales of Equity Securities and Use of Proceeds."
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
Contractual obligations and off-balance sheet arrangements are described in
"Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations" contained in the Corporation's 2004 Annual Report on Form
10-K. 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
Citizens monitors and manages its 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. Citizens
manages the liquidity of its Holding Company to pay dividends to shareholders,
to service debt, to invest in subsidiaries, and to satisfy other operating
requirements. It also manages the liquidity of its subsidiary banks to meet
client cash flow needs while maintaining funds available for loan and investment
opportunities.
Citizens' subsidiary banks derive liquidity through core deposit growth,
maturity of money market investments, and maturity and sale of investment
securities and loans. Additionally, its subsidiary banks have access to
financial 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 Holding Company are dividends from and
returns on investments in its subsidiaries. Each of the banking subsidiaries are
subject to dividend limits under the laws of the state in which they are
chartered and, as member banks of the Federal Reserve System, are 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
regulatory approval. As of April 1, 2005, the subsidiary banks are able to pay
dividends of $74.0 million to the Holding Company without prior regulatory
approval.
An additional source of liquidity is the ability of the Holding Company to
borrow funds on both a short-term and long-term basis. The Holding Company
maintains a $60 million short-term revolving credit facility with three
unaffiliated banks. As of March 31, 2005, there was no outstanding balance under
this credit facility. The current facility will mature in August 2005 and is
expected to be renewed at that time on substantially the same terms. The credit
agreement also requires Citizens
28
to maintain certain covenants including covenants related to asset quality and
capital levels. The Corporation was in full compliance with all debt covenants
as of March 31, 2005.
Citizens' Southeast Michigan branch expansion plan will pose a challenge to
liquidity as both the capital investment and loan growth will require
incremental funding. Management anticipates that through a combination of
wholesale funding and deposit generation from both the new Southeast Michigan
branches and the existing branch network, the Corporation will be able to fund
all aspects of the expansion plan. In addition, the combined effect of the third
quarter 2004 sale of the Illinois Bank, the prepayment of FHLB advances, and the
replacement of the prepaid advances with lower rate borrowings had a neutral
impact on liquidity.
Citizens also has contingent letter of credit commitments that may impact
liquidity. Since many of these commitments have historically expired without
being drawn upon, the total amount of these commitments does not necessarily
represent the Corporation's 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. Citizens has sufficient
liquidity and capital resources to meet presently known short-term and long-term
cash flow requirements.
Wholesale funding represents an important source of liquidity to the
Corporation, and credit ratings affect the availability and cost of this
funding. Citizens' credit ratings were reviewed and affirmed by Moody's Investor
Service on January 27, 2005. On April 21, 2005, Dominion Bond Rating Service
(DBRS) assigned ratings to Citizens of R-2 (high) for short-term instruments,
BBB (high) for issuer and senior debt and BBB for subordinated debt. DBRS
defines short-term debt rated R-2 (high) to be at the upper end of its adequate
credit quality classification. Long-term debt rated BBB is defined as adequate
credit quality. Long-term debt categories are denoted by the subcategories
"high" and "low". The absence of a "high" or "low" designation indicates the
rating is in the "middle" of the category. Credit ratings relate to the
Corporation's ability to issue long-term debt and should not be viewed as an
indication of future stock performance.
INTEREST RATE RISK
Interest rate risk arises when there is a mismatch in the timing of the
repricing of assets and liabilities, typically as a result of option risk, which
can alter the expected timing of repricing of certain assets or liabilities, or
basis risk. Many assets and liabilities contain embedded options which allow
customers, and entities associated with Citizens' investments and wholesale
funding, to prepay loans or securities prior to maturity, or to withdraw or
reprice deposits or other funding instruments prior to maturity. Basis risk
occurs when assets and liabilities reprice at the same time but based on
different market rates, and those market rates have changed by different
amounts. Asset, liability, and off-balance sheet portfolios are monitored 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. Citizens' static interest rate sensitivity (GAP) as of March 31, 2005 and
2004 is presented in the following table.
29
INTEREST RATE SENSITIVITY
TOTAL
0 - 3 4 - 6 7 - 12 WITHIN 1 - 5 Over
(dollars in millions) Months Months Months 1 YEAR Years 5 Years Total
- --------------------- --------- ------- ------- --------- --------- -------- ---------
MARCH 31, 2005
RATE SENSITIVE ASSETS(1)
Portfolio loans (2) $ 2,626.3 $ 217.7 $ 364.2 $ 3,208.2 $ 1,868.9 $ 352.7 $ 5,429.8
Mortgage loans held for sale 34.6 --- --- 34.6 --- --- 34.6
Investment securities 65.6 38.2 86.1 189.9 1,147.4 554.9 1,892.2
Short-term investments 1.6 --- --- 1.6 --- --- 1.6
--------- ------- ------- --------- --------- -------- ---------
Total $ 2,728.1 $ 255.9 $ 450.3 $ 3,434.3 $ 3,016.3 $ 907.6 $ 7,358.2
========= ======= ======= ========= ========= ======== =========
RATE SENSITIVE LIABILITIES
Deposits (3) $ 1,891.9 $ 244.9 $ 397.3 $ 2,534.1 $ 1,077.7 $ 785.9 $ 4,397.7
Other interest bearing liabilities 1,002.2 --- 0.7 1,002.9 579.3 179.8 1,762.0
--------- ------- ------- --------- --------- -------- ---------
Total $ 2,894.1 $ 244.9 $ 398.0 $ 3,537.0 $ 1,657.0 $ 965.7 $ 6,159.7
========= ======= ======= ========= ========= ======== =========
Derivatives $ 44.0 $(135.0) $ --- $ (91.0) $ (104.0) $ 195.0 $ ---
========= ======= ======= ========= ========= ======== =========
Period GAP (4) $ (122.0) $(124.0) $ 52.3 $ (193.7) $ 1,255.3 $ 136.9 $ 1,198.5
Cumulative GAP (122.0) (246.0) (193.7) 1,061.6 1,198.5
MARCH 31, 2004
RATE SENSITIVE ASSETS(1)
Portfolio loans (2) $ 2,506.2 $ 257.9 $ 454.0 $ 3,218.1 $ 1,726.0 $ 259.8 $ 5,203.9
Mortgage loans held for sale 33.2 --- --- 33.2 --- --- 33.2
Investment securities 177.0 97.8 296.6 571.4 946.1 521.9 2,039.4
Short-term investments 2.1 --- --- 2.1 --- --- 2.1
--------- ------- ------- --------- --------- -------- ---------
Total $ 2,718.5 $ 355.7 $ 750.6 $ 3,824.8 $ 2,672.1 $ 781.7 $ 7,278.6
========= ======= ======= ========= ========= ======== =========
RATE SENSITIVE LIABILITIES
Deposits (3) $ 1,261.1 $ 579.6 $ 755.4 $ 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 $ 604.6 $ 876.2 $ 3,301.5 $ 2,102.8 $ 665.8 $ 6,070.1
========= ======= ======= ========= ========= ======== =========
Derivatives $ (50.0) $(125.0) $ --- $ (175.0) $ 25.0 $ 150.0 $ ---
========= ======= ======= ========= ========= ======== =========
Period GAP (4) $ 847.8 $(373.9) $(125.6) $ 348.3 $ 594.3 $ 265.9 $ 1,208.5
Cumulative GAP 847.8 473.9 348.3 942.6 1,208.5
(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 without contractual
maturities of $1.5 billion in the less than one year category and $1.2
billion in the over one year category as of March 31, 2005. The same
amounts as of March 31, 2004 were $1.2 billion and $1.4 billion,
respectively. These amounts reflect management's assumptions regarding
deposit repricing behavior and tenor.
(4) GAP is the excess of rate sensitive assets (liabilities).
As shown, as of March 31, 2005 rate sensitive liabilities repricing within one
year exceeded rate sensitive assets repricing within one year by $193.7 million
or 2.6% of total assets, compared to rate sensitive assets repricing within one
year exceeding rate sensitive liabilities repricing within one year by $348.3
million or 4.8% of total assets as of March 31, 2004. These results suggest an
interest rate risk position which is not significantly mismatched. GAP analysis
is limited in its ability to measure interest rate sensitivity, as 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.
Since no single risk measurement approach satisfies all management objectives, a
combination of techniques is used, including income simulation, repricing gap
analysis, and economic value of equity analysis.
From time-to-time, derivative contracts are used to help manage or hedge
exposure to interest rate risk and market value risk in conjunction with
mortgage banking operations. These currently include interest rate swaps 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
30
value of expected future cash receipts and 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.
Holding residential mortgage loans for sale and committing to fund residential
mortgage loan applications at specific rates exposes Citizens to market value
risk caused by changes in interest rates during the period from rate commitment
issuance until sale. To minimize this risk, Citizens enters into mandatory
forward commitments to sell residential mortgage loans at the time a rate
commitment is issued. These mandatory forward commitments are considered
derivatives under SFAS 133. The practice of hedging market value risk with
mandatory forward commitments has been effective and has not generated any
material gains or losses. As of March 31, 2005, Citizens had forward commitments
to sell mortgage loans of $44.0 million. Further discussion of derivative
instruments is included in Note 8 to the Consolidated Financial Statements.
Citizens uses income simulation modeling as its principal interest rate risk
measurement technique. Key assumptions in the model include prepayment speeds on
various loan and investment assets to determine customers' ability to pay on
loans prior to the principal or due date or maturity date, cash flows and
maturities of financial instruments, changes in market conditions, loan and
deposit volumes, pricing, client preferences, and Citizens' financial capital
plans. These assumptions are inherently uncertain, subject to fluctuation and
revision in a dynamic environment and, as a result, the model cannot precisely
estimate net interest income nor exactly predict the impact of higher or lower
interest rates on net interest income. Actual results will differ from simulated
results due to timing, magnitude, and frequency of balance sheet component and
interest rate changes, and differences in client behavior, market conditions and
management strategies, among other factors.
Simulations were performed as of March 31, 2005 to evaluate the impact of market
rate changes on net interest income over the following 12 months assuming
expected levels of balance sheet growth 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 would be
expected to decline by 0.6% and 1.9%, respectively, from what it would be if
rates were to remain at March 31, 2005 levels. An immediate 100 basis point
parallel decline in market rates would be expected to reduce net interest income
over the following 12 months by 0.9% from what it would be if rates remain
constant over the entire time period at March 31, 2005 levels. These results
represent little change from prior year results. 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 yield 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 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' 2004
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
DISCLOSURE CONTROLS AND PROCEDURES
Management is responsible for establishing and maintaining effective disclosure
controls and procedures, as defined under Rule 13a-15 of the Securities Exchange
Act of 1934, that are designed to cause the material information required to be
disclosed by Citizens in the reports it files or submits under the Securities
Exchange Act of 1934 to be recorded, processed, summarized, and reported to the
extent applicable within the time periods required by the Securities and
Exchange Commission's rules and forms. In designing and evaluating the
disclosure controls and procedures, management recognized that a control system,
no matter how well designed and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Because
of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, with a company have been detected.
As of the end of the period covered by this report, Citizens performed an
evaluation under the supervision and with the participation of management,
including the Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of its disclosure controls and
procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the disclosure controls and procedures were effective at the
reasonable assurance level.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
No changes were made to the Corporation's internal control over financial
reporting (as defined in Rule 13a-15 under the Securities Exchange Act of 1934)
during the last fiscal quarter that materially affected, or are reasonably
likely to materially affect, the Corporation's internal control over financial
reporting.
31
PART II - OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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 2005 --- --- --- 2,850,200
February 2005 15,000 31.28 15,000 2,835,200
March 2005 71,000 30.27 71,000 2,764,200
------ ------ ------ ---------
Total 86,000 30.45 86,000 2,764,200
====== ====== ====== =========
(a) In October 2003, the Board of Directors approved the repurchase of 3,000,000
shares of common stock from time to time in the market. There is no expiration
date for the repurchase program. As of March 31, 2005, 2,764,200 shares remain
to be purchased under this program. The purchase of 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
Citizens' capital requirements. There can be no assurance that Citizens will
repurchase the remaining shares authorized to be repurchased, or that any
additional repurchases will be authorized by the Board of Directors.
ITEM 6. EXHIBITS
10.19 * 2005 Management Incentive Plan
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
* Portions of this exhibit have been omitted pursuant to Citizens' request to
the Secretary of the Securities and Exchange Commission for confidential
treatment pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as
amended.
32
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 6, 2005 By /s/ Charles D. Christy
----------------------------------------
Charles D. Christy
Chief Financial Officer
(Principal Financial Officer, Principal
Accounting Officer and duly authorized
officer)
33
10-Q EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.19 * 2005 Management Incentive Plan
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
32.2 Certification pursuant to 18 U.S.C. Section 1350 and Rule
13a-14(b) of the Securities Exchange Act
* Portions of this exhibit have been omitted pursuant to Citizens' request to
the Secretary of the Securities and Exchange Commission for confidential
treatment pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as
amended.
34