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First Citizens BancShares, inc (NASDAQ:FCNCA)
Q2 2021 Earnings Call
Aug 3, 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 First Citizens BancShares Second Quarter Earnings Conference Call. [Operator Instructions]

I would now like to introduce host of today's conference Ms. Deanna Hart, Senior Vice President of Investor Relations. You may begin.

Deanna Hart -- Senior Vice President Of Investor Relations

Thank you, Myra. Good morning, and thank you for joining us today. It is my pleasure to introduce our Chairman and Chief Executive Officer, Frank Holding; as well as our Chief Financial Officer, Craig Nix. Frank and Craig will provide an overview of our second quarter 2021 results and will be referencing our investor presentation, which you can find on our Investor Relations website. We are pleased to have several other members of our leadership team here with us today, who will be available for questions if needed. After the presentation, we'll be happy to take questions you may have. As we have not closed the transaction with CIT Group, we will be speaking today on First Citizens BancShares stand-alone performance only. We will also provide an update on our planned merger with CIT.

Our comments will include forward-looking statements, which are subject to risks and uncertainties that may cause our results to differ materially from expectations. These risks are outlined for your review on Page two of the presentation. We will also reference non-GAAP financial measures within the presentation. Reconciliations of these measures against comparable GAAP measures are available in the appendix.

With that, I'll hand it over to Frank.

Frank B. Holding, Jr. -- Chairman And Chief Executive Officer

Thank you, Deanna, and good morning to everyone. We appreciate all of you joining us today and your interest in our company. As you can imagine, we've spent the first half of 2021 focused on our upcoming merger with CIT. I'm pleased with the progress of both teams to prepare us for legal close and integration of our companies. We remain excited about our merger with CIT and look forward to capitalizing on the expertise of our companies to deliver value to our shareholders and stakeholders. Subject to Fed approval and customary closing conditions, we expect to close the merger during the third quarter. In addition to merger and integration planning, our team has executed on a number of financial and strategic objectives that we laid out in our 2021 strategic plan. One key area of focus is expanding our customer relationship model to improve our customers' experience.

We've made good progress leveraging data to provide our bankers a comprehensive view of our customers allowing us to better serve their financial needs. In the digital space, we recently expanded the functionality of our consumer banking platform and are in the process of upgrading our commercial online platform. While serving customers has been a big focus, we're also focused on talent development and retention of our associates. The objective here is to ensure that we attract, retain and develop associates to create a high-performing, sustainable company that will meet the strategic, financial and operational goals of the combined organization. We have continued to focus on organic loan and deposit growth both of which have been positive contributors to our success in 2021.

Excluding the impact of SBA-PPP, we grew loans by four percent on an annualized basis since December and achieved an annualized growth rate during the second quarter of seven percent. Additionally, deposit growth has remained strong at an annualized rate of 23% since the year-end. Our focus on operational efficiency has continued as we expand and enhance our revenue-generating lines of business while continuing to maintain prudent expense control. We are pleased with our progress to date and optimistic that we can meet our strategic and financial goals for 2021, while remaining focused on the merger with CIT.

With that, I'll turn it over to Craig for a closer look at our financial results, and then we'll open the line for questions.

Craig L. Nix -- Chief Financial Officer

Thank you, Frank, and good morning, everyone. Starting on Page three of the investor presentation, I will cover our second quarter earnings highlights. We achieved another quarter of strong earnings. Net income totaled $152.8 million, an increase of $5.5 million over the linked quarter and a slight decline from the second quarter of 2020. We are pleased to announce that earnings translated into a return on average assets of 1.13% and a return on average equity of 14.64%. Net income per common share was $15.09, up from $14.53 in the first quarter and $14.74 in the comparable quarter a year ago. Pre-provision net revenue narrowly declined compared to the first quarter. The most significant factor causing the decline was related to higher personnel costs associated with merit increases, which took effect at the beginning of the quarter.

Mortgage servicing rights impairments negatively affected noninterest income. Otherwise, our revenue-producing lines of businesses posted another good quarter. Net interest income was a bright spot during the quarter, increasing by $6.7 million over the linked quarter, which was mostly attributable to opportunistically putting some of our excess liquidity to work in the investment portfolio, increasing the portfolio balance and improving the yield. We continued to experience strong credit quality and low net charge-offs during the second quarter. In addition, macroeconomic factors continued to improve, resulting in a further reserve release. As a result, the benefit from provision for credit losses increased from $11 million during the first quarter to $19.6 million during the second quarter. To date, as macroeconomic factors have improved and we have sustained good credit quality, we have released $35.3 million in reserves compared to a reserve build of $36.1 million during the first half of last year related to the uncertainty surrounding COVID-19.

Compared to the second quarter of 2020, provision -- pre-provision net revenue declined by $32.2 million or by 15.2%. Solid core net revenue growth was more than offset by a $52.9 million decline in the fair market value adjustment on marketable equity securities. As a reminder, during the first quarter of last year, given what we saw at severe dislocation in the bank equity market where many banks were trading below 1 times tangible book value, we opportunistically bulked up our bank equity portfolio. During the second quarter of last year, these bank equity prices rebounded, and we sold the bulk of the securities for realized gains and experienced improvement in the fair market value of the portfolio that remained. This resulted in a positive fair market value adjustment during the second quarter of last year totaling $64.6 million.

During the current quarter, the fair market value improved by $11.7 million resulting in the [$52 point-million] decline. The fair market value adjustment decline was partially offset by lower provision for credit losses, higher core noninterest income and higher net interest income, resulting in a minimal decline in net income for the comparable quarters. On Pages four and 5, I will cover trends in net interest income and net interest margin. After experiencing a decline in net interest income during the first quarter compared to the fourth quarter, net interest income increased during the current quarter as we opportunistically put some of our excess liquidity to work in the investment portfolio increasing the average balance by $777 million and the yield by eight basis points.

Net interest income grew by $9.1 million over the comparable quarter in 2020 due to lower rates paid on interest-bearing deposits as well as increased interest and fee income on SBA-PPP loans, both only partially offset by a decline in yield on earning assets. While we were pleased with the increase in the absolute level of net interest income during the quarter, as expected, net interest margin declined by 12 basis points from the linked quarter. As we discussed last quarter, given the significant increase in deposits, which continued during the second quarter and the pending merger with CIT, we continue to operate with liquidity above normal operating ranges, which puts downward pressure on our net interest margin. Excess liquidity negatively impacted the change in margin from the first quarter by 13 basis points.

Therefore, compared to prior quarters, the rate environment had a minimal positive impact on margins, primarily lower deposit costs and higher investment yield, while asset mix was the primary factor contributing to the decline in margin. As we mentioned last quarter, loans continue to come on the books at rates lower than maturing loans. This has put downward pressure on margin in recent quarters, but did moderate during the second quarter as rates on new business and commercial loans increased by approximately 25 basis points. In fact, the yield on loans ex-PPP did not change compared to the first quarter. We expect that net interest margin will continue to be a headwind throughout the remainder of 2021, but that the decline will continue to moderate in the coming quarters as it did in the second quarter. Turning to Page six.

I will cover noninterest income, which totaled $134.2 million during the second quarter. Noninterest income declined about $2.5 million compared to the linked quarter. The most significant factor in the decline was a decrease in mortgage income, which was primarily the result of mortgage servicing rights impairment in the second quarter versus mortgage servicing rights impairment recapture in the first quarter. This occurred as mortgage rates after increasing in the first quarter decreased in the second quarter. We did opportunistically sell securities during the quarter for a gain of $15.8 million, an increase of $6.6 million over the linked quarter. Outside of mortgage income, we had a good quarter from a core noninterest income standpoint. Cardholder services income increased due to higher sales volumes.

Wealth and merchant services had good quarters with income remaining fairly consistent with the first quarter. Noninterest income declined $31.3 million when compared to the second quarter of 2020 due primarily to the $52.9 million decline in fair market value adjustments on marketable equity securities that I discussed earlier. Core noninterest income grew over the comparable quarter in 2020 by $20 million as wealth management income, cardholder and merchant services income and deposit-related fees all increased offsetting a decline in mortgage income. For the remainder of 2021, we expect continued strength in the areas that have performed well so far this year, including wealth, card and merchant. We expect mortgage volume to decline as refinance activity slows, but the decline will be somewhat offset by service charges returning closer to pre-pandemic levels.

The punchline here is that we expect core noninterest income in the third and fourth quarters to be in the $109 million to $110 million range, so fairly consistent with the second quarter isolating for mortgage servicing rights impairment. Turning to Page 7. I will cover noninterest expense. Noninterest expense increased by $5.7 million over the linked quarter, primarily as a result of merit increases effective at the beginning of the second quarter. Other expenses were generally in line with their normal quarterly trend. Noninterest expense increased by $9.9 million over the comparable quarter in 2020, also primarily driven by higher personnel expense. We remain pleased with the level of expenses and the year-over-year decline in our efficiency ratio. We expect core noninterest expense ex-merger-related costs to remain in line with the recent run rate.

Turning to Page eight. We provide balance sheet highlights and key ratios. I will cover the significant components of the balance sheet on the subsequent slides. On Page 9, I'll cover loan growth for the linked quarter and year-over-year periods. During the linked quarter, we saw a solid pickup in loan growth with the largest category in owner-occupied commercial real estate loans, which was more than offset by forgiveness of a large portion of our PPP loans. Ex-PPP loans grew organically at an annualized rate of seven percent during the second quarter. The story was similar on a year-to-date basis, the total loans relatively stable as PPP forgiveness almost completely offset a 5.1% increase in organic loans. Overall, we were pleased with organic loan growth during the first half of the year and expect organic loan balances to continue to grow during the second half of the year in the mid-single-digit percentage range.

The ultimate level of loan growth will ultimately be dependent on continued economic expansion in our markets. Turning to Pages 10 and 11. I will cover our credit quality trends and allowance for credit losses. Credit continues to perform well as we experienced further improvement in the economy. As indicated by a historically low net charge-off ratio of three basis points during the second quarter and a nonperforming asset ratio of 0.74%, the lowest ratio over the past five linked quarters and the lowest level since the second quarter of 2019. Given these trends and improvement in the macroeconomic factors, we have recognized a credit provision benefit of $30.6 million through the first two quarters of this year compared to a reserve build of $36.1 million during the same period last year related to uncertainties surrounding the pandemic.

Our allowance ratio ex-PPP loans declined from 0.69% in the first quarter to 0.61% in the second, covering net charge-offs during the quarter by 20.33 times and covering average net charge-off over the last five quarters 11.3 times. These coverage ratios compare to a loan book with an average life of approximately four years. We are now operating with an allowance ratio approximating where it was when we adopted CECL on January 1, 2020, or looking at it another way near the pre-pandemic level. While we saw no significant portfolio deterioration during the worst of the pandemic, we will continue to monitor industry risks associated with the impact that additional outbreaks may have on our loan portfolio performance.

We remain comfortable with our allowance level. And while we do not expect that net charge-offs will remain at these historically low levels, we have seen little indication that charge-offs going forward will have a significant impact on the level of our allowance. Moving on to Pages 12 and 13. I will cover deposit trends and our funding mix. We continue to experience strong deposit growth during the second quarter with demand deposits and checking with interest accounts leading the way. Deposits grew at an annualized rate of 9.2% since the end of the first quarter and by 16.7% on a year-over-year basis. Our balance sheet continues to be funded predominantly by core deposits with deposits representing over 96% of our funding base at the end of the quarter. We are pleased that most of our deposit growth has occurred in core checking accounts.

And at the end of the second quarter, noninterest-bearing deposits accounted for approximately 43% of our total deposits. Total deposit costs ended the quarter at seven basis points, which was down one basis point from the first quarter and down 11 basis points from the same quarter a year ago. Looking forward, while our go-to-market strategy will continue to stress core deposit growth, we do expect growth to begin to moderate as the effect of government stimulus subsides and customers put their cash to use. Turning to Page 14. Our capital position remains strong and ratios are above or within target ranges. As of the end of the second quarter, our CET1 ratio was 11.14%, and our total risk-based capital ratio was 14.15%. The majority of the growth in our risk-based capital ratios was attributable to strong earnings during the first half of the year, partially offset by growth in total risk-weighted assets.

As we noted in prior quarters, our Tier one leverage ratio continues to be impacted by significant asset growth, both from government stimulus and organic deposit growth but it remains above internal thresholds, and we are comfortable with the current level. Turning to Page 15. I will close out by providing an update on our merger with CIT. As Frank mentioned in the opening, we continue to be excited about this merger. Our collective teams remain connected and have positioned us well for legal close and the ultimate integration of the company. Since our last call, we received approval of our application from the FDIC and are currently awaiting approval from the Federal Reserve. We continue to be in communication with the Fed and are positive that an approval of our application is forthcoming.

There are no outstanding information requests with respect to our application. It is also our understanding that there are no concerns that may impact ultimate approval. Completion of the merger remains subject to Fed approval and customary closing conditions. We expect closing to occur during this quarter. Both companies have worked hard to develop initial business unit integration plans, which include key system decisions and recommendations. Once we move past legal close, we will review and finalize these integration plans and time lines. Key system conversions are slated to begin in the first quarter of 2022. When we announced this merger, we stated that it was financially compelling and that it would create a premier nationwide commercial and consumer bank with enhanced scale to drive growth, improve profitability and enhance shareholder value.

We believe this remains the case, and our collective teams are excited about the opportunities that lie ahead for the combined company. Last October, we shared with you estimated day one accounting marks and financial projections based on our merger due diligence. Our plan is to provide you an update as soon as practical following legal close. I can tell you that both companies are well positioned financially for this merger, and the conditions have improved since October, particularly with respect to credit quality. Specifically, we are pleased with the trends in credit quality that CIT has reported this year and the impact they have had on the allowance for credit losses. Again, more to come as soon as practical after legal close with respect to day one accounting marks and financial projections.

This concludes my comments. Thank you all for joining us today. I will now open it up for Q and A.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from Kevin Fitzsimmons. Your line is open. Please go ahead.

Kevin Fitzsimmons -- D.A. Davidson & Co., Research Division -- Analyst

Hey guys. It's Kevin Fitzsimmons, D.A. Davidson. [Phonetic]. Appreciate all the detailed updates. One area I wanted to drill in a little deeper into was loan growth. So ex-PPP looked like a pretty healthy seven percent growth linked quarter, as you said, Craig, and given the outlook for mid-single digit. Just curious if you can drill down a little further in terms of what is really driving the growth and what the headwinds are? We've heard quite a bit about elevated paydowns and payoffs and line utilization not quite being there on the C&I side. And you all are in a lot of different markets. So I'm curious what you're seeing in terms of the Southeast or some of your other metro markets you're in throughout the country? Thanks.

Craig L. Nix -- Chief Financial Officer

Thanks for the question, Kevin. I would say just from a quantitative standpoint, the growth has come in commercial real estate loans and primarily owner occupied. We've also seen some growth in residential mortgage loans. We put some products out there for -- such as home improvement loans, and this has fueled some of that growth. I think that we're very pleased with the seven percent annualized growth during the quarter, and we really attribute that to those new products, number one. But number two, we were very proactive during the pandemic in reaching out to our customers. And we think this has paid dividends with new opportunities for loans as the economy has improved. And the headwinds that we would anticipate in the future may be related to if there are further outbreaks or things of that nature. But we see opportunities to grow our loans at similar rates as we go forward, assuming the economy continues to open up and expand.

Kevin Fitzsimmons -- D.A. Davidson & Co., Research Division -- Analyst

Okay. Great. Also, given what you mentioned about the margin that I think all banks are facing this issue, this drag from excess liquidity, and you guys mentioned that you put some of that to work in securities. So I'm just curious how high you would continue taking the securities portfolio just on a stand-alone basis in trying to fight off some of that yield pressure from the excess liquidity? Thanks.

Craig L. Nix -- Chief Financial Officer

Well, I don't really have a bright line in terms of the size of the investment portfolio. I can tell you that at the end of the first quarter, we huddled up, and we decided -- we put a goal out there to put close to $1 billion to work there to optimize our yield on earning assets moving out of cash and into investments. We remain diligent to add to that portfolio moving forward. As you know, we're running around 15% of our earning assets and cash right now. We're normally at four percent. So there's certainly a cost to that. And part of the way to mitigate that outside of loan growth is to opportunistically add to the investment portfolio where it makes sense. So that strategy -- we foresee that strategy continuing throughout the remainder of the year.

Kevin Fitzsimmons -- D.A. Davidson & Co., Research Division -- Analyst

Okay. And just one last one. I appreciate those comments on the CIT merger. So if I'm reading it correctly, just between the lines, it sounds like where the message is there's no big issue or obstacle that's stopping it. It's just you're in communication. It's just a matter of letting the process play out and getting legal close, correct?

Craig L. Nix -- Chief Financial Officer

That's correct, Kevin.

Kevin Fitzsimmons -- D.A. Davidson & Co., Research Division -- Analyst

Okay. Thanks guys.

Craig L. Nix -- Chief Financial Officer

Thank you.

Operator

Our next question comes from the line of Brady Gailey. Your line is now open, please go ahead.

Brady Gailey -- Keefe, Bruyette, & Woods, Inc., Research Division -- Analyst

Hey. Thank you, good morning guys. So maybe one more on loan growth, great loan growth this quarter. I hear you on the guidance of mid-single digits. What do you think loan growth will look like as a combined company with CIT? A lot of times, when you go through a big acquisition, loan balances can be somewhat flat or maybe even shrink a little bit before they kind of normalize out and then start to grow from there. So how do you think about the dynamics of organic core loan growth with CIT in the mix?

Craig L. Nix -- Chief Financial Officer

We would maintain the mid-single-digit growth expectation there. But obviously, I'm stating the obvious here, but it really does depend on to the extent the economy keeps opening up, but our expectations would be mid-single-digit percentage growth combined.

Brady Gailey -- Keefe, Bruyette, & Woods, Inc., Research Division -- Analyst

Okay. All right. Great. And then when you think about, you guys have historically been pretty active buying back your stock. I know it's been a little problematic just with the CIT deal pending. But assuming that will close soon, what are your thoughts on the buyback? I mean if you look at the stock, it's trading at about 1.5 times pro forma tangible book value per share, which is pretty attractive relative to your profitability profile. So how do you think about the buyback from here?

Craig L. Nix -- Chief Financial Officer

We acknowledge that the price is attractive. I will tell you, our first priority will be integrating CIT. But as we combine the companies and build capital, we definitely plan to opportunistically resume our share repurchase program.

Brady Gailey -- Keefe, Bruyette, & Woods, Inc., Research Division -- Analyst

Okay. And then, Craig, you mentioned how you're going to be updating and disclosing kind of where the deal marks shook out after legal close. I know a lot has changed today versus mid-October. The world seems to be doing better than what we had all -- were thinking back then. So to me, it seems like the deal-related marks are going to come down. So I know you can't talk about specifics, but maybe just talk about what impact that could have on forward tangible book value and earnings? Like obviously, if the marks go down, you think that would be a positive tangible book value per share. But then is there any real EPS impact maybe from lower accretable yield? I mean, just talk about the dynamics that could be in consideration there?

Craig L. Nix -- Chief Financial Officer

Well, I will talk qualitatively about that, number one, certainly, are encouraged by the credit quality trends, which will bode well for where the credit mark may be compared to where it was in October. That's as of today, things could change between now and closing. So that movement is generally positive. From an EPS perspective, I know that we came out with EPS guidance in October of last year. I really don't see much movement there, based on just what we know as of today either. So I think the financial dynamics behind this, obviously, with a lower credit mark, we would come into it with higher capital. But I think that the financial dynamics are even more compelling than they were in October. So we expect good news there, but we shall see upon legal close where those things shake out.

Brady Gailey -- Keefe, Bruyette, & Woods, Inc., Research Division -- Analyst

Got it. And then finally for me, CIT has a lot of really expensive holding company debt. And I know that's a big opportunity for additional EPS accretion kind of beyond what you guys laid out in October. You have two options. You can either just let that debt mature over time, or you can kind of bite the bullet and go ahead and take care of that debt upfront. Any idea which way you're leaning as far as what you're going to do with all that rather expensive holding company debt with CIT?

Craig L. Nix -- Chief Financial Officer

Well, as you know, we're going to mark that debt to market. So we'll get the benefit of current market rates. I can tell you with great certainty that our eye is on that constantly. We mark that debt-to-market and are now doing a cost-benefit analysis of that. And that decision will be made post legal day one close.

Brady Gailey -- Keefe, Bruyette, & Woods, Inc., Research Division -- Analyst

Okay. Great. Thanks for [Indecipherable] guys.

Craig L. Nix -- Chief Financial Officer

Thank you.

Operator

Our next question comes from the line of Christopher Marina. Your line is open, please go ahead.

Christopher Marina -- [Phonetic] -- Analyst

Thanks. Good morning. -I had two follow-up questions. On the commercial loan growth side, it's noticeable that the lines of credit from the FDIC disclosures have expanded, particularly at CIT, but it's also at First Citizens side. What does it take borrowers to kind of draw on those lines? Do you see signals coming that they'll be more active with that? The lines themselves have expanded, which I see as a positive as well.

James S. Bryan -- Executive Vice President And Chief Credit Policy Officer

This is Jim Bryan. I think the activity on the lines of credit for First Citizens are really driven by our focus on C&I activity. We have historically not been a C&I lender, and we began that journey prior to COVID, but we have been able to continue with that and have picked up some nice opportunities. I don't see a negative in line advance. I think it's more active participation in the market and the rebuild of activity with our C&I clients.

Christopher Marina -- [Phonetic] -- Analyst

Okay. Great. That's helpful. And then just a quick back other question on the capital levels, pro forma capital. I presume it's stronger now than it was when you announced the acquisition in mid-October. Do you have a sense of kind of how low you can take the capital ratios once the merger is closed?

Craig L. Nix -- Chief Financial Officer

Well, we came out with -- and I'll focus on CET1. We came out with a pro forma in October of around 9.5%. That has -- that number will come in higher than that. I'm not going to talk about a specific number, but it will be higher for the reasons we discussed earlier around credit quality primarily and good earnings by both companies. In terms of how low we're willing to take it, I think our operating range for CET1 is nine percent to 11%, and we would -- in an environment where there's economic uncertainty, we might operate at the higher end of that range in a better business environment, maybe down toward the lower end of that range. But how low we're willing to take capital, obviously, is -- we have to consider regulatory limits. But we believe that we will be well within our range on CET1 at that time. And as we build capital, again, as we combine the companies, I think we'll have opportunities to repurchase shares.

Christopher Marina -- [Phonetic] -- Analyst

Great. Thank you, Craig. I appreciated that.

Craig L. Nix -- Chief Financial Officer

Thank you.

Operator

And I'm not showing any further questions at this time. I'd like to turn the call back over to our host for any closing remarks.

Deanna Hart -- Senior Vice President Of Investor Relations

Great. Thank you, and thank you, everyone, for joining this morning. As always, we are appreciative of your ongoing interest in our company. If you have any further questions or need additional information, please feel free to reach out. I hope everyone has a great day.

Operator

[Operator Closing Remarks]

Duration: 36 minutes

Call participants:

Deanna Hart -- Senior Vice President Of Investor Relations

Frank B. Holding, Jr. -- Chairman And Chief Executive Officer

Craig L. Nix -- Chief Financial Officer

James S. Bryan -- Executive Vice President And Chief Credit Policy Officer

Kevin Fitzsimmons -- D.A. Davidson & Co., Research Division -- Analyst

Brady Gailey -- Keefe, Bruyette, & Woods, Inc., Research Division -- Analyst

Christopher Marina -- [Phonetic] -- Analyst

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