First Citizens Bancshares Inc (FCNCA) Q4 2020 Earnings Call Transcript

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First Citizens Bancshares Inc (FCNCA 1.04%)
Q4 2020 Earnings Call
Jan 27, 2021, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the First Citizens BancShares Q4 Earnings Conference Call. [Operator Instructions]. As a reminder, today's conference is being recorded.

I would now like to introduce host of this conference call, Mr. Tom Heath, Director of Investor Relations. You may begin.

Thomas Heath -- Director of Investor Relations

Thank you, Angie. Good morning and thank you so much for joining us. It is my pleasure to introduce our Chairman and Chief Executive Officer, Frank Holding, as well as our Chief Financial Officer, Craig Nix, who will provide an overview of our results, after which, we will be happy to take any questions you may have. We are also pleased to have several other members of the team with us as well, including our Chief Risk Officer, Lorie Rupp; our Chief Credit Officer, Jim Bryan; our Treasurer, Tom Eklund; our Chief Accounting Officer, Robert Holly; our Head of Analysis and M&A, Elliot Howard; and lastly, Bryan Paul of Risk and Data Analytics.

Our remarks today will reference an earnings presentation that is available at firstcitizens.com/earningspresentation. I should note that statements made during the call and statements included in the presentation materials may be forward-looking statements and the factors that could cause actual results to differ materially from those statements are listed in the earnings press release, the presentation materials and the company's SEC filings.

And if any non-GAAP financial measures will be discussed on the call or are included in the presentation materials, that reconciliations of those measures to the comparable GAAP measures are available in the presentation materials which are posted on the website.

And with that, I'm going to hand it over to Frank.

Frank B. Holding -- Chairman and Chief Executive Officer

Thank you, Tom, and good morning everybody. We appreciate you joining us. As you've seen, despite the challenging environment, we've had a very good fourth quarter and a full year 2020. This all translated into record earnings for First Citizens, our performance was broad-based and I'm exceptionally proud of our team for their hard work and the efforts they have made to see our clients and communities through this challenging period.

I'll let Craig Nix, our CFO, walk you through our financial performance in more detail, but before I do, I want to make a couple of high-level comments. First, it's very clear to me that the investments we made in recent years in both people and technology have paid off handsomely. Testament to that fact, is that in this tough environment, we've not skipped a beat and I believe our significant activity in PPP demonstrates just one example of the power of our people and the underlying franchise. The team is hard at work on round two of PPP now as we plan to continue to help our clients navigate these tough times.

Second, as you know, we announced a transformational partnership with CIT this past October. And while we spent many months on the planning and carefully understanding the opportunity, since that time we've been -- we've had even more time with the CIT team. As of today, I can tell you that we're even more excited about this opportunity, given the quality of the combined team and our underlying capabilities as a combined entity.

On Page 3 of the investor deck, we provide an update of our activities surrounding our planned merger with CIT. Drawing from both organizations, we've established core merger and integration planning teams to promote a coordinated approach to enterprise issues, drive executions and aid key decisions. We filed key regulatory applications in December 2020. We have scheduled a shareholder meeting to approve the merger in February. Subject to regulatory and shareholder approval, we are targeting legal close at the beginning of the second quarter. We formed an Integration Management Office to provide governance structure and facilitate reporting. As we move forward, we will be finalizing organizational and personnel decisions, as well as completion of our Business Unit Integration plans. We continue to plan operational conversion in 2022.

Both First Citizens and CIT have been active in M&A and are experienced in this process and understand its importance. Consequently, we're going to great lengths to do it carefully and to do it right. We remain confident that we will accomplish just that.

I'd like to close by thanking our employees for their steadfast commitment to their customers through a very challenging year. And with that, I'll turn it over to Craig for a closer look at our results, and then we will take your questions. Craig?

Craig L. Nix -- Chief Financial Officer

Thank you Frank and good morning everyone. As I'm sure you're aware, we released our fourth quarter earnings yesterday, along with the press release and investor deck. I will touch on our significant fourth quarter and full-year financial highlights in my comments today.

As Frank mentioned in his comments, we are very pleased to report a strong fourth quarter, as well as full year results. Pages 4 and 5 of the investor deck provides our earnings highlights for the fourth quarter and for the year ended 2020. During the fourth quarter, we earned $133.4 million, an increase of 31% over the fourth quarter of 2019. Earnings translated into a return on average assets of 1.11% and a return on average equity of 14.02%. EPS was up 42.3%, reflecting the positive impact of higher earnings and our earlier share repurchases.

I will touch on some of the drivers behind our fourth quarter results on the ensuing pages, but the increase in quarter-over-quarter earnings was primarily driven by a 29.3% increase in pre-provision net revenue. Credit quality remained strong with comparable quarter net charge-offs declining from 14 basis point to 7 basis point.

For the full year 2020, we are earned $477.7 million, which translated into a return on average assets of 1.07% and a return on average equity of 12.96%. Earnings for the full year were up 4.4%, while EPS was up 15.7%, again reflecting the positive impact of higher earnings and of share repurchases.

Similar to the quarterly results, pre-provision net revenue growth was the primary driver behind improved year-over-year earnings, but the impact was partially blunted by $36.1 million reserve build related to uncertainty around COVID-19.

On Page 6, we take a look at net interest income and net interest margin. As we stated at the end of the third quarter, while we expected net interest margin to continue to decline, we expected it to decline at a much more modest pace. This is what happened as net interest margin declined by 4 basis points on a linked quarter basis, compared to a 41 basis points drop between the first and second quarter. While the margin did decline during the quarter, net interest income was up by just over $5 million, driven primarily by acceleration of SBA-PPP interest income as loan forgiveness has picked up.

I won't cover Page 7 in detail, but the page rolls forward the drivers behind our margin change for the linked quarters and for the comparable quarters. Before I leave margin, a few points I would like to make. We have ample liquidity on the balance sheet and see that potentially going up due to strong core deposit growth. And while our liquidity is strong, this does present margin pressure as we keep increased levels of cash at the Fed and the reinvestment opportunity is challenging, given the low interest rate environment.

We were prudently opportunistic throughout the quarter, reinvesting cash flows and selling securities for gains to offset some of the margin pressure, but for the most part have retained a conservative posture with this liquidity. Our thinking here is that we'd see opportunities when we combine our balance sheet to CIT, hopefully during the second quarter. So at this point, we believe there is value in being conservative with our liquidity.

As for the margin, looking forward, we expect deposit costs to continue to decline, but they will not fall much further. So most of the benefit of lower deposit costs has already been realized.

We expect that SBA-PPP interest net income will continue to be a positive contributor to net interest margin and net interest income, but that it's impact will largely be offset by excess liquidity and lower earning asset yields.

If you turn to Page 8, we will take a look at non-interest income. In general, each of our fee income producing businesses did well and they remain very important to our customer relationship offering. Wealth management, card, merchant and mortgage, all had good quarters and while deposit fees have not yet rebounded to pre-COVID levels, they continue to rebound during the quarter.

If you turn to Page 9, we'll take a look at our non-interest expense. We did see a slight uptick relative to the third quarter. So I want to give you a bit of color of some of the more significant factors that threw us off of our run rate. First, revenue producing lines of business finished out the year strong, resulting in higher incentive expense.

Second, building repairs and maintenance that were delayed in the second and third quarters due to COVID were incurred and paid during the fourth quarter.

And, finally, foreclosure expense was up related to losses on the sale of two OREO properties during the quarter.

Given the lumpy nature of these expenses, we did not expect fourth quarter to be reflective of our non-interest expense run rate moving forward. All in, our key ratio in the fourth quarter was 64.28%, well within an acceptable range for us, given both our operating strategy and the low interest rate environment.

Page 10 provides a snapshot of the balance sheet. I will discuss loans and deposits in the next couple of pages, but I would like to point out a few things here. First, total assets grew by over 25% during the year, finishing the year at just under $50 billion. Asset growth was funded by strong organic core deposit growth and our loan-to-deposit ratio ex-PPP ended the year at 71.5%. Second thing I'd point out is the tangible book value per share, a measure that we pay close attention to, ended the year at over $357 per share, up 18.9% on a year-over-year basis.

Page 11 provides a snapshot of our loan composition and growth. For the year, loans were up 13.5%. Stripping out both PPP and the impact of acquisitions, growth was 4.9%, which we were pleased with, particularly, given the current operating backdrop. During the fourth quarter, loans were slightly down by 0.6%, but if you look ex-PPP paydowns, loans grew at an annualized rate of 7.9% indicative of loan activity picking up. Most of the loan growth for both the linked quarter and the year-over-year period was driven by owner-occupied commercial real estate loans.

Going to Page 12, we wanted to give you a few comments on PPP. We are pleased that we helped our clients secure a meaningful amount of PPP loans. A vast majority of the loans went to small businesses. As of year-end, we had received applications for forgiveness totaling to over 43% of the original loan amount into almost 34% of the number of loans. We have received approximately 23% of the original loan amount from the SBA. We are actively managing the forgiveness process and expect activity to continue to be meaningful during the first quarter. In addition, we will see more funding coming in the form of PPP round two. Overall, the program has been very impactful to the business community, and has been one more way for us to affirm to our clients the true value of our focus on relationship banking.

Pages 13 through 15 summarize our credit quality and allowance for credit losses trends. Good credit quality trends continued for both the fourth quarter and for the full year. Net charge-offs were 7 basis points for the quarter and 8 basis points for the year. NPAs have been relatively stable throughout the year. They did spike during the first quarter of the year, but this was a function of both CECL accounting for PCI loan pools, as well as a bucket of acquired loans we classified as PCD. We did not take any further COVID-related reserve in the fourth quarter but had taken $36.1 million in total during the first and second quarters of the year. Overall, the allowance for credit losses is 0.74% of loans ex-PPP representing 9.25 times annual net charge-offs on a loan book with an average life of approximately four years.

Turning to Page 16, I want to briefly touch on deposits. Total deposits grew at an annualized rate of 11.1% during the fourth quarter and by 26.1% on a year-over-year basis. Adjusting for acquisitions and estimated PPP deposits, deposits grew by almost 23% organically on a year-over-year basis. Our deposit base continues to be generated from our core relationship-oriented clientele. Non-interest-bearing deposits grew by over $5 billion during the year or by over 39% and stood at 41.5% of total deposits as of year-end.

We continue to attribute our strong core deposit growth to many factors, including day-to-day focus on relationship banking, a flight to quality in challenging economic times, lower consumer spending and consequently higher deposit balances, and commercial and business customers holding more cash in their deposit accounts due to economic uncertainty.

Page 17 shows that deposits continue to make up the bulk of our funding. The only real change of note in our funding profile since 2019, is that we did opportunistically add some subordinated debt during the first quarter to round out our capital stack and to support earning asset growth. Of note is that our cost of interest bearing deposits decreased by 5 basis points during the quarter and by 27 basis points since the first quarter. Our overall cost of deposits declined by 18 points since the first quarter and by 3 basis points on a linked quarter basis and stood at 10 basis points at year-end. We expect this may fall to mid-to-upper single-digits next year, so not much more room to fall from here.

On Page 18, we give you a quick snapshot of the capital ratios and their evolution since the end of 2019. All of our capital ratios are healthy and well within both regulatory and internal guidelines. I will call out that our Tier 1 leverage ratio has been most impacted by the asset growth we have experienced this year, particularly as a result of the SBA-PPP loan program. The actual Tier 1 leverage ratio was 7.86% at year-end but ex-PPP would have been 8.45%. We are comfortable operating at our current capital levels.

Finally, on Page 19, we wanted to give you a general outlook on the first quarter. While we expect net interest margin to decline, we think the worst of it is behind us. We expect that net interest income will decrease slightly on a linked quarter basis due to the impact of lower earning asset yields more than offsetting the acceleration of PPP interest income, loan growth and lower deposit costs.

Fee income-generating businesses continue to do well and should hold their trend, but it remains dependent on the continuance of the economic recovery. We are expecting a slight uptick in net charge-offs, primarily because they are currently at such historically low levels and the temporary impacts of economic stimulus could subside. But overall, we do not expect credit quality trends to change significantly. They should remain relatively consistent and continue to be a source of strength.

Non-interest expense should return to normalized levels as the benefit of converting acquired bank are realized. We expect loan growth ex-PPP to be low-to-mid single-digits, and we expect to see continued deposit growth in the same range.

To close, our focus in the first quarter will be, one, integration of First Citizens and CIT. Two, continued organic growth and profitability. Three, maintaining discipline on credit quality, customer selection and retention. And, four, maintaining prudent expense control.

Thank you all for joining us today. I will now open it up for Q&A.

Questions and Answers:

Operator

[Operator Instructions] Your first question comes from the line of Brian Foran with Autonomous.

Brian Foran -- Autonomous Research -- Analyst

Hi, good morning. Maybe one to start, when you announced the CIT deal, you put up an illustrative $70 per share in 2022. I know it's only been three months or so since then. But I wonder if you could just kind of talk anything that's going better or worse than you expected relative to those original assumptions, and especially maybe in the context of the deposit growth and credit quality performance? Is there anything that's kind of maybe trending a little better than that $70 originally assumed?

Craig L. Nix -- Chief Financial Officer

Okay. Craig Nix here. We have not updated those pro formas and we're going to -- and we will be doing that here soon. We do acknowledge that the economic outlook in general has improved since we established our original marks and established those pro formas. We are also encouraged with CITs fourth quarter results. We did create our marks and assumptions based on the best information we had at the time in the fall of last year. And again, we plan to establish final marks at transaction close, and we'll consider the facts and circumstances at that time. But right now we're not ready to provide additional guidance, but we are -- I can tell you we are encouraged. Our eyes are on the ball in integrating CIT. And we don't think, things have gotten any worse.

Brian Foran -- Autonomous Research -- Analyst

And maybe one follow up or maybe a separate question really. Probably the most common question I get on your stock is because you have a little bit of an unusual set up and I hesitate to call it, things that could be shareholder-friendly because ultimately a stock that goes up and outperforms over time is the ultimate shareholder-friendly set up, and you guys have certainly delivered on that. So the existing set up has served you well over time. But maybe if I call it like shareholder-broadening and things like the Class A, Class B, the level to dividend, index inclusion, all the things that would go in that bucket, I wonder if you could just share your outlook, what things are under consideration, and anything that's not on the table or not subject to change over time. Just, if you think about the next two or three years, what could that shareholder-broadening transition look like?

Frank B. Holding -- Chairman and Chief Executive Officer

Brian, this is Frank Holding, CEO. I think in terms of shareholder-broadening, we look forward to having a much broader shareholder base with our friends, with combining with our friends at CIT. If you're asking a question about, are we planning something that would change our share class structure A to B, we have no plans for that. But thank you for your compliment on our total shareholder returns. I believe we have done a reasonable job there and thank you for that recognition. You asked a -- a part of your question also was about dividend. And I would say we have a long history of having a very modest dividend. And while we demonstrate that we move it nominally occasionally, I think we have no intention of changing our path from having a modest dividend.

Brian Foran -- Autonomous Research -- Analyst

Great, thank you for taking the questions.

Operator

[Operator Instructions] We do have a follow-up question from Brian Foran with Autonomous.

Brian Foran -- Autonomous Research -- Analyst

I figured we'd just make it a fireside chat. I guess, one other question I get a lot is on your owner-occupied CRE. I mean, certainly your ability to grow core loans right now is a pretty nice differentiator. I think, maybe it's not always as clear to people the differences in the owner-occupied CRE book you have and even sometimes I kind of scratch my head on some of the opportunities you might be finding now. I wonder if you could just talk about, as you look at the recent owner-occupied CRE growth over the past three, six, nine months and help us understand a little bit where that opportunity is coming from and what makes it different than the typical retail or hotel or whatever that might be a little bit COVID concerning right now.

Craig L. Nix -- Chief Financial Officer

I'm going to ask Jim Bryan, our Chief Credit Officer to address that question.

Jim Bryan -- Chief Credit Officer

Thank you, Craig. We have had nice growth this past year in that category and our focus is on small business, medical, professional activities and owner-occupied as compared to non-owner occupied, obviously, as that credit -- the business cash flow repays the credit. So it's supporting the housing of the business that, that business needs to operate. We continue to see opportunity in that area across all sectors of -- including our medical and professional activity, small business, primarily outside of that restaurant COVID-impacted category. And a lot of that has to do with consolidation within the industry, merger and acquisition that creates opportunity for us.

If that -- if you want to rephrase the question where -- if I haven't answered properly, if you want to ask an additional question, I'd be glad to help.

Brian Foran -- Autonomous Research -- Analyst

No, I think that's helpful. And I guess maybe to follow on, I mean, is it -- if I think about that kind of stereotypical medical property that is the owner-occupied CRE or a piece of it, is it about growth in the market right now or is it about gaining market share or new geographies? I mean, where are you finding the incremental growth in that portfolio?

Jim Bryan -- Chief Credit Officer

I think it's a little bit of both because we are seeing that growth both in our -- what we would consider our legacy footprint of North Carolina, South Carolina, Virginia, and also in our other markets as well. So it's a combination of gaining new clients along with growth within our existing client base, where they continue to expand and grow. And so those opportunities are on both sides of the ledger.

Brian Foran -- Autonomous Research -- Analyst

And I don't know if this is for Craig or Frank, but maybe on capital. I think you put out a 9.5% CET1 at deal close, if I remember and I think that might be even fully loaded merger costs, so it might even been a little conservative. I guess, on the one hand, earnings for both you and CIT are coming in pretty good, maybe that CET1 ratio -- the marks might improve, so maybe that CET1 ratio come higher, but you did reference the Tier 1 leverage being a little depressed right now by PPP, by cash on the balance sheet. As we think about post-deal close, which one do you think will be the limiting factor, number one? And then number two, when you do reemerge into an excess capital position, how do you think about the relative attractiveness of maybe a buyback versus maybe another deal or other uses of capital? So I guess what's the limiting factor, post the deal close, and then whenever you get back into an excess position, what's kind of the waterfall of priorities?

Craig L. Nix -- Chief Financial Officer

Sure. A very good question. With respect to both CET1 and leverage, we really don't see either as a limiting factor. We are comfortable operating within those ranges or within that level. It falls within our ranges. So we're comfortable operating there, and we do see both rebounding nicely as we start with the earnings stream of the combined company starts to kick in. So we have no concerns operating at those levels. With respect to acquisitions and repurchases, our first priority in 2021 will be to integrate CIT. So you wouldn't see, certainly, anything in that -- activity in that right away, but we certainly see in a long -- our long-term strategy is to be opportunistic with M&A opportunities, and that would include buying back our own stock.

Brian Foran -- Autonomous Research -- Analyst

If I could sneak one last one in, your non-interest bearing deposit, your domestic growth this year was pretty phenomenal on the order of 50% year-over-year. And I'm assuming PPP played a part in that, maybe some companies getting cash and not fully using it yet. I wonder if you kind of have any thoughts on the stickiness of those non-interest-bearing deposits going forward and once you get fully past PPP, any kind of insights you have into how much of that might stick around, or could you actually continue to grow from these levels.

Craig L. Nix -- Chief Financial Officer

Tom Eklund, our Treasurer will address that question.

Tom Eklund -- Treasurer

Yeah, I think you mentioned PPP growth. When we look at the PPP program, we initially had $3 billion in growth, resulting from the PPP program. However, when looking at by the end of the year, using sort of a watermark approach on that, those balances were down to about $1 billion. So of the $9 billion we grew for the year, about $1 billion came from that PPP program. When looking at it another way, of that $9 billion total deposit growth, we did see $2.5 billion of that coming from new clients with -- that was not clients with us going into 2020. So I think it's a little bit of both. We're seeing both existing clients, going back to Craig's point earlier, holding more cash on their balance sheet, which resulted in about $6.5 billion of the growth and then $2.5 billion, which was a very strong year for us where we were able to capitalize on some opportunities and add new clients as well on top of that.

Brian Foran -- Autonomous Research -- Analyst

That's great, thank you for taking all my questions.

Operator

Our final question comes from the line of Moshe Orenbuch with Credit Suisse.

Moshe Orenbuch -- Credit Suisse -- Analyst

Great, thanks. And maybe you could just expand a little on one of the points that you raised about the liquidity. And, yeah, how do you see it actually working in terms of the deploying your excess liquidity into CITs book? Like what's the process? How long will it take? I assume that you'll have to, at some point, get rid of some of the funding that they've got on the assets. I mean, can you just talk through like what that will look like [Technical Issues] from the second quarter on?

Tom Eklund -- Treasurer

Yeah, sure, this is Tom Eklund again. I think the way we were thinking about it is, I think we've been very clear on sort of from a business perspective. We're not looking to make any changes there. We're excited about the opportunities from the direct bank and some of the broader client footprint that CIT brings to the table. However, obviously, when looking at the balance sheet, assuming we can accomplish the deal structure as proposed, the waterfall for us really starts with looking at some of the senior debt opportunity, some of the non-core sort of funding thesis and see what we can do there to replay with ideally with the low cost deposits.

I mean, we mentioned, we're at 10 basis points total deposit cost for the year. So obviously that provides potential synergistic opportunities for us in the future as we're able to reposition that. The maturity schedule of those mean that not all that comes in early, it's something that will be phased in over time as we start looking at those -- that instruments come up for maturity.

Moshe Orenbuch -- Credit Suisse -- Analyst

Thank you.

Operator

I would now like to turn the conference to Mr. Tom Heath for any additional or closing remarks.

Thomas Heath -- Director of Investor Relations

Angie, that's all. We're good and thank you very much. Thank you all for joining us.

Operator

[Operator Closing Remarks]

Duration: 33 minutes

Call participants:

Thomas Heath -- Director of Investor Relations

Frank B. Holding -- Chairman and Chief Executive Officer

Craig L. Nix -- Chief Financial Officer

Jim Bryan -- Chief Credit Officer

Tom Eklund -- Treasurer

Brian Foran -- Autonomous Research -- Analyst

Moshe Orenbuch -- Credit Suisse -- Analyst

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