First Citizens 1Q2007 Earnings: Sliding on an Inverted Slope

Implications: First Citizens BancShares Inc. issued its first quarter earnings release, reporting a 1% increase in quarterly earnings and EPS over 1Q2006. Non interest income was up, net charge offs were down, and taxes were down to compensate for lower net interest income and higher non interest expenses. Return on average assets and return on equity fell from the prior year's levels. Total assets reached $15.9 billion, up slightly from YE2006 and about $750 mm from a year earlier.

Analysis: First Citizens could be the poster bank for being earnings-challenged with the current yield curve. The bank relies heavily on net interest income, which accounts for about 62.5% of total income. Several conditions make it very difficult for earnings to improve in a meaningful way.

1. Its interest income earning capacity is eroding, especially since net charge offs were reduced, not increased as many other banks reported for their 1st quarter. Generating new loan growth at above average margins is a tedious process. Without a reversion to a normal yield curve, the net interest margin is not likely to expand.

2. Also troubling is the growth rate in non interest expense at +5.7%, outpacing the growth in non interest income by $2 million for the quarter. Compensation, equipment and occupancy expenses were all up, accounting for 63% of the increase. These types of expenses are usually hard to reduce without a cost cutting program.

3. The bank's net chargeoffs are very low compared to peer banks. The bank either has very pristine loans on the books, which will not offer help on the net interest margin or it is waiting to move delinquent loans into a classified status which would increase loan loss rates. Time will tell, but maintaining a low loss rate is exceptional. If anything, a buyer likes to see a clean loan portfolio.

4. First Citizens is a solid M & A target for a large bank wanting to expand into the First Citizens' footprint in the Southeast.