Unassociated Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q


xQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended March 31, 2007
 
or
 
 o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 

Commission File Number: 0-16471

First Citizens BancShares, Inc

(Exact name of Registrant as specified in its charter)

Delaware
56-1528994
(State or other jurisdiction of
(I.R.S. Employer Identification Number)
incorporation or organization)
 
   
4300 Six Forks Road, Raleigh, North Carolina
27609
(Address of principle executive offices)
(Zip code)

(919) 716-7000

(Registrant’s telephone number, including area code)


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 twelve 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 ninety days.
Yes x     No o
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of ‘accelerated filer and large accelerated filer’ in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer x     Accelerated filer   o   Non-accelerated filer   o.             
 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  o    No x
 


Class A Common Stock—$1 Par Value—8,756,778 shares
Class B Common Stock—$1 Par Value—1,677,675 shares

(Number of shares outstanding, by class, as of May 4, 2007)



INDEX

   
 Page(s)
PART I.
FINANCIAL INFORMATION
 
     
Item 1.
Financial Statements (Unaudited)
 
     
 
Consolidated Balance Sheets at March 31, 2007, December 31, 2006
 
 
and March 31, 2006
3
     
 
Consolidated Statements of Income for the three-month
 
 
periods ended March 31, 2007, and March 31, 2006
4
     
 
Consolidated Statements of Changes in Shareholders’ Equity for the
 
 
three-month periods ended March 31, 2007, and March 31, 2006
5
     
 
Consolidated Statements of Cash Flows for the three-month
 
 
periods ended March 31, 2007, and March 31, 2006
6
     
 
Notes to Consolidated Financial Statements
7-9
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and
 
 
Results of Operations
10-25
     
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
26
     
Item 4.
Controls and Procedures
26
     
     
     
PART II.OTHER INFORMATION
     
Item 6.
Exhibits.
26





PART I
Item 1. Financial Statements (Unaudited)

Consolidated Balance Sheets
             
First Citizens BancShares, Inc. and Subsidiaries
             
               
   
March 31*
 
December 31#
 
March 31*
 
   
2007
 
2006
 
2006
 
Assets
 
(thousands, except share data)
 
Cash and due from banks
 
$
847,202
 
$
1,010,984
 
$
805,757
 
Overnight investments
   
799,848
   
348,597
   
748,918
 
Investment securities available for sale
   
2,934,995
   
3,001,890
   
2,396,001
 
Investment securities held to maturity
   
96,803
   
219,158
   
500,961
 
Loans and leases
   
10,221,578
   
10,239,551
   
9,810,088
 
Less allowance for loan and lease losses
   
132,640
   
132,004
   
130,222
 
Net loans and leases
   
10,088,938
   
10,107,547
   
9,679,866
 
Premises and equipment
   
726,041
   
702,926
   
657,141
 
Income earned not collected
   
74,648
   
71,562
   
55,680
 
Goodwill
   
102,625
   
102,625
   
102,735
 
Other intangible assets
   
7,427
   
8,000
   
9,732
 
Other assets
   
175,251
   
156,408
   
138,419
 
Total assets
 
$
15,853,778
 
$
15,729,697
 
$
15,095,210
 
                     
Liabilities
                   
Deposits:
                   
Noninterest-bearing
 
$
2,701,786
 
$
2,682,997
 
$
2,733,885
 
Interest-bearing
   
10,020,746
   
10,060,327
   
9,778,672
 
Total deposits
   
12,722,532
   
12,743,324
   
12,512,557
 
Short-term borrowings
   
1,245,025
   
1,150,847
   
850,566
 
Long-term obligations
   
405,356
   
401,198
   
408,954
 
Other liabilities
   
138,538
   
123,509
   
119,767
 
Total liabilities
   
14,511,451
   
14,418,878
   
13,891,844
 
Shareholders' Equity
                   
Common stock:
                 
Class A - $1 par value (8,756,778 shares issued for all periods)
   
8,757
   
8,757
   
8,757
 
Class B - $1 par value (1,677,675 shares issued for all periods)
   
1,678
   
1,678
   
1,678
 
Surplus
   
143,766
   
143,766
   
143,766
 
Retained earnings
   
1,175,449
   
1,148,372
   
1,054,793
 
Accumulated other comprehensive income (loss)
   
12,677
   
8,246
   
(5,628
)
Total shareholders' equity
   
1,342,327
   
1,310,819
   
1,203,366
 
Total liabilities and shareholders' equity
 
$
15,853,778
 
$
15,729,697
 
$
15,095,210
 

* Unaudited
     
# Derived from the 2006 Annual Report on Form 10-K.
     
See accompanying Notes to Consolidated Financial Statements.
   



3



Consolidated Statements of Income
         
First Citizens BancShares, Inc. and Subsidiaries
         
   
Three Months Ended March 31
 
   
2007
 
2006
 
Interest income
 
(thousands, except share and per share data)
 
Loans and leases
 
$
175,024
 
$
159,205
 
Investment securities:
             
U. S. Government
   
32,744
   
24,285
 
State, county and municipal
   
58
   
61
 
Other
   
774
   
711
 
Total investment securities interest and dividend income
   
33,576
   
25,057
 
Overnight investments
   
7,461
   
5,739
 
Total interest income
   
216,061
   
190,001
 
Interest expense
             
Deposits
   
80,011
   
57,742
 
Short-term borrowings
   
12,682
   
6,992
 
Long-term obligations
   
6,755
   
7,449
 
Total interest expense
   
99,448
   
72,183
 
Net interest income
   
116,613
   
117,818
 
Provision for credit losses
   
3,532
   
6,737
 
Net interest income after provision for credit losses
   
113,081
   
111,081
 
Noninterest income
             
Cardholder and merchant services income
   
22,377
   
18,428
 
Service charges on deposit accounts
   
17,157
   
18,206
 
Commission-based income
   
9,264
   
7,872
 
Fees from processing services
   
8,187
   
6,909
 
Trust and asset management fees
   
6,078
   
5,178
 
ATM income
   
1,587
   
2,532
 
Mortgage income
   
2,374
   
1,372
 
Other service charges and fees
   
3,770
   
4,123
 
Securities losses
   
-
   
(186
)
Other
   
409
   
1,315
 
Total noninterest income
   
71,202
   
65,749
 
Noninterest expense
         
Salaries and wages
   
59,189
   
56,543
 
Employee benefits
   
13,177
   
13,943
 
Occupancy expense
   
13,855
   
12,875
 
Equipment expense
   
13,772
   
12,664
 
Other
   
39,197
   
35,687
 
Total noninterest expense
   
139,190
   
131,712
 
Income before income taxes
   
45,093
   
45,118
 
Income taxes
   
16,109
   
16,461
 
Net income
 
$
28,984
 
$
28,657
 
Average shares outstanding
   
10,434,453
   
10,434,453
 
Net income per share
 
$
2.78
 
$
2.75
 
See accompanying Notes to Consolidated Financial Statements.
             

4



Consolidated Statements of Changes in Shareholders' Equity
                 
First Citizens BancShares, Inc. and Subsidiaries
                         
                   
Accumulated
     
 
 
Class A
 
Class B
         
Other
 
Total
 
 
 
Common
 
Common
     
Retained
 
Comprehensive
 
Shareholders'
 
   
Stock
 
Stock
 
Surplus
 
Earnings
 
Income (loss)
 
Equity
 
   
(thousands, except share data)
Balance at December 31, 2005
 
$
8,757
 
$
1,678
 
$
143,766
 
$
1,029,005
 
$
(2,147
)
$
1,181,059
 
Comprehensive income:
                                     
Net income
   
-
   
-
   
-
   
28,657
   
-
   
28,657
 
Unrealized securities losses arising during
                                     
period, net of deferred taxes
   
-
   
-
   
-
   
-
   
(3,481
)
 
(3,481
)
Total comprehensive income
   
-
   
-
   
-
   
28,657
   
(3,481
)
 
25,176
 
Cash dividends
                        
(2,869
)
       
(2,869
)
Balance at March 31, 2006
 
$
8,757
 
$
1,678
 
$
143,766
 
$
1,054,793
 
$
(5,628
)
$
1,203,366
 
                                       
Balance at December 31, 2006
 
$
8,757
 
$
1,678
 
$
143,766
 
$
1,148,372
 
$
8,246
 
$
1,310,819
 
Adjustment resulting from adoption of
                                     
FASB Interpretation No. 48
                     
962
         
962
 
Comprehensive income:
                                     
Net income
   
-
   
-
   
-
   
28,984
   
-
   
28,984
 
Unrealized securities gains arising during
                                     
period, net of deferred taxes
   
-
   
-
   
-
   
-
   
4,722
   
4,722
 
Change in unrecognized loss on cash flow
                                     
hedge, net of deferred taxes
                                   
(291
)
 
(291
)
Total comprehensive income
   
-
   
-
   
-
   
28,984
   
4,431
   
33,415
 
Cash dividends
   
-
   
-
   
-
   
(2,869
)
 
-
   
(2,869
)
Balance at March 31, 2007
 
$
8,757
 
$
1,678
 
$
143,766
 
$
1,175,449
 
$
12,677
 
$
1,342,327
 
See accompanying Notes to Consolidated Financial Statements.
                             

5



Consolidated Statements of Cash Flows
         
First Citizens BancShares, Inc. and Subsidiaries
         
           
   
Three months ended
 
   
2007
 
2006
 
   
(thousands)
 
OPERATING ACTIVITIES
         
Net income
 
$
28,984
 
$
28,657
 
Adjustments to reconcile net income to cash
             
provided by operating activities:
             
Amortization of intangibles
   
573
   
586
 
Provision for credit losses
   
3,532
   
6,737
 
Deferred tax benefit
   
(2,654
)
 
(5,104
)
Change in current taxes payable
   
15,058
   
19,172
 
Depreciation
   
12,678
   
11,603
 
Change in accrued interest payable
   
(907
)
 
1,800
 
Change in income earned not collected
   
(3,086
)
 
(801
)
Securities losses
   
-
   
186
 
Origination of loans held for sale
   
(118,184
)
 
(84,096
)
Proceeds from sale of loans
   
128,448
   
123,165
 
Gain on sale of loans
   
(467
)
 
274
 
Net amortization of premiums and discounts
   
(1,208
)
 
(1,140
)
Net change in other assets
   
(19,162
)
 
(1,697
)
Net change in other liabilities
   
1,335
   
2,335
 
Net cash provided by operating activities
   
44,940
   
101,677
 
INVESTING ACTIVITIES
             
Net change in loans outstanding
   
5,494
   
(211,799
)
Purchases of investment securities held to maturity
   
-
   
(1,066
)
Purchases of investment securities available for sale
   
(309,431
)
 
(161,631
)
Proceeds from maturities of investment securities held to maturity
   
122,355
   
137,741
 
Proceeds from maturities of investment securities available for sale
   
385,229
   
52,753
 
Net change in overnight investments
   
(451,251
)
 
(267,906
)
Dispositions of premises and equipment
   
505
   
2,779
 
Additions to premises and equipment
   
(32,140
)
 
(32,054
)
Net cash used by investing activities
   
(279,239
)
 
(481,183
)
FINANCING ACTIVITIES
             
Net change in time deposits
   
(17,073
)
 
278,962
 
Net change in demand and other interest-bearing deposits
   
(3,719
)
 
59,737
 
Net change in short-term borrowings
   
94,178
   
71,505
 
Cash dividends paid
   
(2,869
)
 
(2,869
)
Net cash provided by financing activities
   
70,517
   
407,335
 
Change in cash and due from banks
   
(163,782
)
 
27,829
 
Cash and due from banks at beginning of period
   
1,010,984
   
777,928
 
Cash and due from banks at end of period
 
$
847,202
 
$
805,757
 
CASH PAYMENTS FOR:
             
Interest
 
$
98,541
 
$
73,982
 
Income taxes
   
3,562
   
25,352
 
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Unrealized securities gains (losses)
 
$
7,695
 
$
(5,711
)
See accompanying Notes to Consolidated Financial Statements.
             


6


Notes to Consolidated Financial Statements
(Dollars in thousands, except per share amounts)

Note A
Accounting Policies
 
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements.
 
In the opinion of management, the consolidated financial statements contain all material adjustments necessary to present fairly the financial position of First Citizens BancShares, Inc. as of and for each of the periods presented, and all such adjustments are of a normal recurring nature. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates.
 
These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the 2006 First Citizens BancShares, Inc. Form 10-K. Certain amounts for prior periods have been reclassified to conform with statement presentations for 2007. However, the reclassifications have no effect on shareholders’ equity or net income as previously reported.



Note B
Operating Segments
 
BancShares conducts its banking operations through its two wholly-owned subsidiaries, First-Citizens Bank & Trust Company (FCB) and IronStone Bank (ISB). Although FCB and ISB offer similar products and services to customers, each entity operates in distinct geographic markets and each entity operates under a separate charter. The financial results and trends of ISB reflect the impact of the de novo nature of its growth.
 
FCB is a mature banking institution that operates under a state bank charter from its branch network in North Carolina, Virginia, West Virginia, Maryland and Tennessee. ISB began operations in 1997 and currently operates in Georgia, Florida, Texas, Arizona, California, New Mexico, Colorado, Oregon and Washington under a federal thrift charter.
 
In the aggregate, FCB and its consolidated subsidiaries, which are integral to its branch operation, and ISB account for more than 90 percent of consolidated assets, revenues and net income. Other includes activities of the parent company and Neuse, Incorporated, a subsidiary that owns real property used in the banking operation. For 2006, other also includes American Guaranty Insurance Corporation, a property insurance company that was sold January 1, 2007.
 
The adjustments in the accompanying tables represent the elimination of the impact of certain inter-company transactions. The adjustments to interest income and interest expense neutralize the earnings and cost of inter-company borrowings. The adjustments to noninterest income and noninterest expense reflect the elimination of management fees and other services fees paid by one company to another within BancShares’ consolidated group.
 

7




   
March 31, 2007
 
   
ISB
 
FCB
 
Other
 
Total
 
Adjustments
 
Consolidated
 
       
Interest income
 
$
33,808
 
$
180,291
 
$
9,851
 
$
223,950
 
$
(7,889
)
$
216,061
 
Interest expense
   
17,935
   
76,123
   
13,279
   
107,337
   
(7,889
)
 
99,448
 
Net interest income
   
15,873
   
104,168
   
(3,428
)
 
116,613
   
-
   
116,613
 
Provision for credit losses
   
318
   
3,214
   
-
   
3,532
   
-
   
3,532
 
Net interest income after provision
   
15,555
   
100,954
   
(3,428
)
 
113,081
   
-
   
113,081
 
for credit losses
                                     
Noninterest income
   
3,201
   
70,598
   
(127
)
 
73,672
   
(2,470
)
 
71,202
 
Noninterest expense
   
19,105
   
122,436
   
119
   
141,660
   
(2,470
)
 
139,190
 
Income (loss) before income taxes
   
(349
)
 
49,116
   
(3,674
)
 
45,093
   
-
   
45,093
 
Income taxes
   
(83
)
 
17,463
   
(1,271
)
 
16,109
   
-
   
16,109
 
Net income (loss)
 
$
(266
)
$
31,653
 
$
(2,403
)
$
28,984
 
$
-
 
$
28,984
 
At March 31, 2007:
                                     
Total assets
 
$
2,225,229
 
$
13,359,371
 
$
2,438,870
 
$
18,023,470
 
$
(2,169,692
)
$
15,853,778
 
Loans and leases
   
1,881,368
   
8,340,210
   
-
   
10,221,578
   
-
   
10,221,578
 
Allowance for loan and lease losses
   
22,580
   
110,060
   
-
   
132,640
   
-
   
132,640
 
Deposits
   
1,826,095
   
10,935,271
   
-
   
12,761,366
   
(38,834
)
 
12,722,532
 
                                       
 
 
March 31, 2006 
 
   
ISB
 
 
FCB
 
 
Other
 
 
Total
 
 
Adjustments
 
 
Consolidated
 
                                       
Interest income
 
$
28,595
 
$
161,433
 
$
5,390
 
$
195,418
 
$
(5,417
)
$
190,001
 
Interest expense
   
12,347
   
55,071
   
10,182
   
77,600
   
(5,417
)
 
72,183
 
Net interest income
   
16,248
   
106,362
   
(4,792
)
 
117,818
   
-
   
117,818
 
Provision for credit losses
   
966
   
5,771
   
-
   
6,737
   
-
   
6,737
 
Net interest income after provision
   
15,282
   
100,591
   
(4,792
)
 
111,081
   
-
   
111,081
 
for credit losses
                                     
Noninterest income
   
2,544
   
64,612
   
543
   
67,699
   
(1,950
)
 
65,749
 
Noninterest expense
   
17,992
   
115,115
   
555
   
133,662
   
(1,950
)
 
131,712
 
Income (loss) before income taxes
   
(166
)
 
50,088
   
(4,804
)
 
45,118
   
-
   
45,118
 
Income taxes
   
(19
)
 
18,147
   
(1,667
)
 
16,461
   
-
   
16,461
 
Net income (loss)
 
$
(147
)
$
31,941
 
$
(3,137
)
$
28,657
 
$
-
 
$
28,657
 
At March 31, 2006:
                                     
Total assets
 
$
1,945,156
 
$
13,003,924
 
$
2,070,063
 
$
17,019,143
 
$
(1,923,933
)
$
15,095,210
 
Loans and leases
   
1,719,046
   
8,091,042
   
-
   
9,810,088
   
-
   
9,810,088
 
Allowance for loan and lease losses
   
20,268
   
109,954
   
-
   
130,222
   
-
   
130,222
 
Deposits
   
1,576,990
   
11,002,133
   
-
   
12,579,123
   
(66,566
)
 
12,512,557
 

8



Note C
Employee Benefits



BancShares recognized pension expense totaling $2,625 and $3,690, respectively, in the three-month periods ended March 31, 2007 and 2006. Pension expense is included as a component of employee benefit expense.

   
Three month periods ended March 31,
 
Components of Net Periodic Benefit Cost
 
2007
 
2006
 
Service cost
 
$
4,235
 
$
4,128
 
Interest cost
   
5,250
   
4,885
 
Expected return on assets
   
(7,442
)
 
(6,423
)
Amortization of prior service cost
   
59
   
66
 
Amortization of net actuarial loss
   
523
   
1,034
 
Total net periodic benefit cost
 
$
2,625
 
$
3,690
 


The expected long-term rate of return on plan assets for 2007 is 8.50 percent, and the assumed discount rate is 5.75 percent.





Note D
Income Taxes

BancShares and its subsidiaries file a consolidated federal income tax return. BancShares and its subsidiaries each file separate state income tax returns except where unitary filing is required. BancShares and its subsidiaries are generally no longer subject to federal, state or local income tax examinations for years before 2002.

BancShares adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), on January 1, 2007. As a result of the implementation of FIN 48, BancShares recognized a decrease in the liability for uncertain tax positions of $962, which was accounted for as an increase to the January 1, 2007 balance of retained earnings.

The total amount of uncertain tax positions at the date of adoption of FIN 48 was $1,700. The total amount of uncertain tax positions that, if recognized, would affect the effective tax rate at the date of adoption of FIN 48 was $500. BancShares recognizes accrued interest and penalties related to uncertain tax positions in tax expense. At the date of adoption of FIN 48, BancShares had recognized approximately $700 for the payment of interest and penalties. BancShares is not aware of any positions for which it is reasonably possible that the total amounts of uncertain tax positions will significantly increase or decrease within the next twelve months.



9



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 
INTRODUCTION
 
Management's discussion and analysis of earnings and related financial data are presented to assist in understanding the financial condition and results of operations of First Citizens BancShares, Inc. and Subsidiaries (BancShares). This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and related notes presented within this report. Intercompany accounts and transactions have been eliminated. Although certain amounts for prior years have been reclassified to conform to statement presentations for 2007, the reclassifications have no effect on shareholders' equity or net income as previously reported.
 
OVERVIEW
 
BancShares is a financial holding company with two wholly owned banking subsidiaries: First-Citizens Bank & Trust Company (FCB), a North Carolina-chartered bank, and IronStone Bank (ISB), a federally-chartered thrift institution. FCB operates branches in North Carolina, Virginia, West Virginia, Maryland and Tennessee. ISB operates in Georgia, Florida, Texas, New Mexico, Arizona, California, Oregon, Washington and Colorado. ISB has announced plans to expand into Oklahoma City, Oklahoma; Kansas City, Missouri; Kansas City, Kansas; and Dallas, Texas.
 
BancShares’ earnings and cash flows are derived primarily from the commercial banking activities conducted by its banking subsidiaries. These activities include commercial and consumer lending, deposit and cash management products, cardholder, merchant, wealth management services as well as various other products and services typically offered by commercial banks. FCB and ISB gather interest-bearing and noninterest-bearing deposits from retail and commercial customers. BancShares and its subsidiaries also secure funding through various non-deposit sources. We invest the liquidity generated from these funding sources in various types of interest-earning assets such as loans and leases, investment securities and overnight investments. We also invest in bank premises, furniture and equipment used to conduct the subsidiaries’ commercial banking business.
 
Various external factors influence customer demand for our loan, lease and deposit products. In an effort to stimulate and control the rate of growth of economic activity, monetary actions by the Federal Reserve are significant to the interest rate environment in which we operate. At any point in time, both the existing level and anticipated movement of interest rates have a profound impact on customer demand for our products, our pricing of those products and on our profitability.
 
In addition to the interest rate environment, the general strength of the economy influences demand as well as the quality and collectibility of our loan and lease portfolio. External economic indicators such as consumer bankruptcy rates and business debt service capacity closely follow trends in the economic cycle. Demand for our deposit and cash management products is highly dependent on interest rates and, to some extent, the volatility of alternative investment markets.
 
Although we are unable to control the external factors that influence our business, through the utilization of various liquidity, interest rate and credit risk management tools, we seek to minimize the potentially adverse risks of unforeseen and unfavorable economic trends and take advantage of favorable economic conditions when appropriate.

10



Financial institutions frequently focus their strategic and operating emphasis on maximizing profitability, and therefore measure their relative success by reference to profitability measures such as return on average assets or return on average shareholders’ equity. BancShares’ profitability measures have historically compared unfavorably to the returns of similar-sized financial holding companies. We have historically placed significant emphasis upon asset quality, balance sheet liquidity and capital conservation, even when those priorities may be detrimental to short-term profitability.
 
Based on our organization’s strengths and competitive position within the financial services industry, we believe opportunities for significant growth and expansion exist. We operate in diverse and growing geographic markets and believe that through competitive products and superior customer service, we can increase our business volumes and profitability. In recent years, we have focused our efforts on customers who own their own businesses, medical and other professionals and individuals who are financially active.
 
We seek to increase fee income in areas such as merchant processing, working capital finance, insurance, cash management, wealth management and private banking services. We also focus on opportunities to generate income by providing processing services to other banks.
 
We attempt to mitigate certain of the risks that can endanger our profitability and growth prospects. While we are attentive to all areas of risk, economic risk is especially problematic due to the lack of control and the potential material impact upon our financial results. Specific economic risks include recession, rapid movements in interest rates, changes in the yield curve and significant shifts in inflation expectations. Compared to our larger competitors, our relatively small asset size and limited capital resources create a level of economic risk that requires constant and focused management attention.
 
PERFORMANCE SUMMARY
 
BancShares realized an increase in earnings during the first quarter of 2007 compared to the first quarter of 2006. Consolidated net income during the first quarter of 2007 was $29.0 million, compared to $28.7 million earned during the corresponding period of 2006. The annualized return on average assets was 0.75 percent during the first quarter of 2007, compared to 0.79 percent during the same period of 2006. The annualized return on average equity was 8.88 percent during 2007, compared to 9.72 percent during the same period of 2006. Net income per share during the first quarter of 2007 totaled $2.78, compared to $2.75 during the first quarter of 2006, a 1.1 percent increase.
 
The $327,000 or 1.1 percent earnings increase resulted from higher noninterest revenue, lower net charge-offs and a lower effective tax rate, partially offset by increased levels of noninterest expense and a marginal reduction in net interest income.


11



Financial Summary
                 
Table 1
 
                       
   
2007
 
2006
 
   
First
 
Fourth
 
Third
 
Second
 
First
 
 
 
Quarter
 
Quarter
 
Quarter
 
Quarter
 
Quarter
 
Summary of Operations
 
(thousands, except share data and ratios)
 
Interest income
 
$
216,061
 
$
218,102
 
$
214,650
 
$
202,499
 
$
190,001
 
Interest expense
   
99,448
   
101,215
   
96,773
   
83,566
   
72,183
 
Net interest income
   
116,613
   
116,887
   
117,877
   
118,933
   
117,818
 
Provision for credit losses
   
3,532
   
7,383
   
3,813
   
2,973
   
6,737
 
Net interest income after provision
                               
for credit losses
   
113,081
   
109,504
   
114,064
   
115,960
   
111,081
 
Noninterest income
   
71,202
   
71,381
   
72,605
   
69,609
   
65,749
 
Noninterest expense
   
139,190
   
132,223
   
134,865
   
135,207
   
131,712
 
Income before income taxes
   
45,093
   
48,662
   
51,804
   
50,362
   
45,118
 
Income taxes
   
16,109
   
15,467
   
18,877
   
18,650
   
16,461
 
Net income
 
$
28,984
 
$
33,195
 
$
32,927
 
$
31,712
 
$
28,657
 
Net interest income-taxable equivalent
 
$
117,056
 
$
117,394
 
$
118,345
 
$
119,351
 
$
118,226
 
Selected Quarterly Averages
                               
Total assets
 
$
15,572,613
 
$
15,628,835
 
$
15,477,992
 
$
15,322,373
 
$
14,699,290
 
Investment securities
   
3,092,261
   
3,176,845
   
3,072,113
   
2,964,308
   
2,896,711
 
Loans and leases
   
10,198,638
   
10,133,502
   
10,075,016
   
9,924,208
   
9,705,443
 
Interest-earning assets
   
13,876,402
   
13,951,134
   
13,820,610
   
13,522,235
   
13,129,313
 
Deposits
   
12,502,206
   
12,601,708
   
12,571,525
   
12,440,125
   
12,192,664
 
Interest-bearing liabilities
   
11,557,940
   
11,601,752
   
11,485,378
   
11,156,821
   
10,794,420
 
Long-term obligations
   
408,277
   
424,597
   
500,564
   
466,259
   
408,946
 
Shareholders' equity
 
$
1,323,244
 
$
1,292,771
 
$
1,254,551
 
$
1,219,835
 
$
1,196,174
 
Shares outstanding
   
10,434,453
   
10,434,453
   
10,434,453
   
10,434,453
   
10,434,453
 
Selected Quarter-End Balances
                               
Total assets
 
$
15,853,778
 
$
15,729,697
 
$
15,633,597
 
$
15,530,846
 
$
15,099,564
 
Investment securities
   
3,031,798
   
3,221,048
   
3,118,025
   
3,024,780
   
2,896,962
 
Loans and leases
   
10,221,578
   
10,239,551
   
10,129,423
   
10,029,045
   
9,810,088
 
Interest-earning assets
   
14,053,224
   
13,809,196
   
13,818,528
   
13,685,530
   
13,455,968
 
Deposits
   
12,722,532
   
12,743,324
   
12,681,150
   
12,717,219
   
12,512,557
 
Interest-bearing liabilities
   
11,671,127
   
11,612,372
   
11,510,073
   
11,395,473
   
11,038,192
 
Long-term obligations
   
405,356
   
401,198
   
424,351
   
527,478
   
408,954
 
Shareholders' equity
 
$
1,342,327
 
$
1,310,819
 
$
1,276,608
 
$
1,232,933
 
$
1,207,720
 
Shares outstanding
   
10,434,453
   
10,434,453
   
10,434,453
   
10,434,453
   
10,434,453
 
Profitability Ratios (averages)
                               
Rate of return (annualized) on:
                               
Total assets
   
0.75
%
 
0.84
%
 
0.84
%
 
0.84
%
 
0.79
 
Shareholders' equity
   
8.88
   
10.19
   
10.41
   
10.43
   
9.72
 
Dividend payout ratio
   
9.89
   
8.65
   
8.70
   
9.05
   
10.00
 
Liquidity and Capital Ratios (averages)
                               
Loans and leases to deposits
   
81.57
%
 
80.41
%
 
80.14
%
 
79.78
%
 
79.60
 
Shareholders' equity to total assets
   
8.50
   
8.27
   
8.11
   
7.96
   
8.14
 
Time certificates of $100,000 or more to
                               
total deposits
   
16.60
   
16.17
   
15.74
   
15.04
   
14.44
 
Per Share of Stock
                               
Net income
 
$
2.78
 
$
3.18
 
$
3.16
 
$
3.04
 
$
2.75
 
Cash dividends
   
0.275
   
0.275
   
0.275
   
0.275
   
0.275
 
Book value at period end
   
128.64
   
125.62
   
122.35
   
118.16
   
115.74
 
Tangible book value at period end
   
118.10
   
115.02
   
111.68
   
107.44
   
104.97
 



12


INTEREST-EARNING ASSETS
 
Interest-earning assets include loans and leases, investment securities and overnight investments, all of which reflect varying interest rates based on the risk level and maturity of the underlying asset. Riskier investments typically carry a higher interest rate, but expose the investor to potentially higher levels of default. We have historically focused on maintaining high asset quality, which results in a loan and lease portfolio subjected to strenuous underwriting and monitoring procedures. Our investment securities portfolio includes high-quality assets, primarily United States Treasury and government agency securities. Generally, the investment securities portfolio grows and shrinks based on loan, lease and deposit trends. When deposit growth exceeds loan and lease demand, we invest excess funds in the securities portfolio. Conversely, when loan and lease demand exceeds deposit growth, we use proceeds from maturing securities to fund loan and lease demand. Overnight investments are selectively made with other financial institutions that are within our risk tolerance.
 
During the first quarter of 2007, interest-earning assets averaged $13.87 billion, an increase of $747.1 million or 5.7 percent from the first quarter of 2006. This increase reflects growth in both the loan and investment securities portfolios.
 
Loans and Leases. At March 31, 2007 and 2006, loans and leases totaled $10.22 billion and $9.81 billion, respectively. The $411.5 million or 4.2 percent growth from March 31, 2006 to March 31, 2007 resulted from growth within the commercial mortgage and commercial and industrial loan portfolios.
 
Commercial real estate loans totaled $3.74 billion at March 31, 2007, representing 36.6 percent of total loans and leases. This represents an increase of $209.7 million or 5.9 percent since March 31, 2006. Although demand for commercial real estate financing remains stable for owner-occupied medical and professional facilities, competition for this type of high-quality lending continues to be strong. A large percentage of our commercial mortgage portfolio is secured by owner-occupied facilities, rather than investment property. These loans are underwritten based primarily upon the cash flow from the operation of the business rather than the value of the real estate collateral.
 
Commercial and industrial loans equaled $1.51 billion or 14.8 percent of total loans and leases outstanding. These loans have increased $184.6 million or 13.9 percent since March 31, 2006. Healthy customer demand and franchise expansion have supported the growth of these loans.
 
At March 31, 2007, revolving mortgage loans totaled $1.30 billion at March 31, 2007, representing 12.7 percent of total loans outstanding. This component of the loan and lease portfolio has declined slightly compared to March 31, 2006, reflecting continued migration of customers to closed-end fixed-rate lending alternatives. This trend results from the yield curve inversion, which has caused the short-term rate on variable mortgage products to exceed those offered on longer-term fixed-rate products.
 
Residential mortgage loans totaled $1.02 billion or 10.0 percent of total loans at March 31, 2007, an increase of $41.4 million or 4.2 percent since March 31, 2006. Growth has been caused primarily by loans within the medical customer base.  
 
Our continuing expansion into new markets has allowed us to mitigate our historic exposure to geographic concentration in North Carolina and Virginia. As we continue to expand into new markets, we have endeavored to ensure that rigorous centralized underwriting and monitoring controls are functioning effectively. We will continue to place emphasis upon maintaining strong lending standards in new markets.
 
We anticipate growth in commercial mortgage and commercial and industrial loans in 2007, as our expansion into new markets translates into modestly higher levels of loan and lease demand among our business customers. Our continued expansion will likewise continue to diversify risks resulting from regional concentrations. All growth projections are subject to change as a result of economic deterioration or improvement, competitive forces and other external factors.


13



Loans and Leases
                 
Table 2
 
                       
   
2007
 
2006
 
   
First
 
Fourth
 
Third
 
Second
 
First
 
   
Quarter
 
Quarter
 
Quarter
 
Quarter
 
Quarter
 
Real estate:
 
(thousands)
 
Construction and land development
 
$
779,718
 
$
783,680
 
$
833,505
 
$
822,687
 
$
821,477
 
Commercial mortgage
   
3,739,948
   
3,725,752
   
3,626,600
   
3,591,372
   
3,530,296
 
Residential mortgage
   
1,020,945
   
1,025,235
   
1,040,202
   
1,007,616
   
979,572
 
Revolving mortgage
   
1,301,311
   
1,326,403
   
1,331,055
   
1,368,584
   
1,359,483
 
Other mortgage
   
157,576
   
165,223
   
167,238
   
172,322
   
173,819
 
Total real estate loans
   
6,999,498
   
7,026,293
   
6,998,600
   
6,962,581
   
6,864,647
 
Commercial and industrial
   
1,510,754
   
1,493,326
   
1,448,554
   
1,417,341
   
1,326,182
 
Consumer
   
1,345,631
   
1,360,524
   
1,331,597
   
1,330,852
   
1,312,790
 
Lease financing
   
302,581
   
294,366
   
284,230
   
259,253
   
246,544
 
Other
   
63,114
   
65,042
   
66,442
   
59,018
   
59,925
 
Total loans and leases
   
10,221,578
   
10,239,551
   
10,129,423
   
10,029,045
   
9,810,088
 
Less allowance for loan and lease losses
   
132,640
   
132,004
   
131,652
   
130,532
   
130,222
 
Net loans and leases
 
$
10,088,938
 
$
10,107,547
 
$
9,997,771
 
$
9,898,513
 
$
9,679,866
 


Investment Securities. Investment securities available for sale equaled $2.93 billion at March 31, 2007, compared to $2.40 billion at March 31, 2006. The $539.0 million or 22.5 percent increase resulted from deposit and short-term borrowings growth that exceeded loan and lease demand and the reinvestment of proceeds from maturing held-to-maturity securities into newly purchased securities classified as available-for- sale. Available-for-sale securities are reported at their aggregate fair value. Investment securities held to maturity totaled $96.8 million at March 31, 2007, compared to $501.0 million at March 31, 2006. Securities that are classified as held-to-maturity reflect BancShares’ ability and positive intent to hold those investments until maturity. Table 3 presents detailed information relating to the investment securities portfolio.
 
Income on Interest-Earning Assets. Interest income amounted to $216.1 million during the first quarter of 2007, a $26.1 million or 13.7 percent increase from the first quarter of 2006. Improved yields and growth in the volume of interest-earning assets caused the increase in interest income when compared to the same period of 2006. The taxable-equivalent yield on interest-earning assets for the first quarter of 2007 equaled 6.31 percent, compared to 5.87 percent for the corresponding period of 2006.
 
Loan interest income for the first quarter of 2007 was $175.0 million, an increase of $15.8 million or 9.9 percent from the first quarter of 2006, the combined result of balance sheet growth and higher yields. The taxable-equivalent yield on the loan portfolio was 6.96 percent during the first quarter of 2007, up 30 basis points from the same period of 2006. The higher loan yields resulted from new loans originated at current market rates and repricing of outstanding variable-rate loans. Average loans increased $493.2 million or 5.1 percent from 2006 to 2007.
 
Interest income earned on the investment securities portfolio amounted to $33.6 million during the first quarter of 2007 and $25.1 million during the same period of 2006, an increase of $8.5 million or 34.0 percent. This increase in income is the result of improved yields and higher average volume. The taxable-equivalent yield increased 89 basis points from 3.48 percent in the first quarter of 2006 to 4.37 percent in the first quarter of 2007 due to higher market rates. Average investment securities increased $195.6 million from $2.90 billion during the first quarter of 2006 to $3.09 billion during the first quarter of 2007. Maturing securities not needed to fund loan and lease growth were reinvested in higher-yielding securities.
 
Interest income from overnight investments amounted to $7.5 million during the first quarter of 2007, an increase of $1.7 million from the $5.7 million earned during the first quarter of 2006, the combined result of a 75 basis point yield increase and $58.3 million growth in average overnight investments.


14



Investment Securities
 
 
         
 
             
Table 3
 
 
                                 
 
 
March 31, 2007
 
March 31, 2006
 
           
Average
 
Taxable
         
Average
 
Taxable
 
       
Fair
 
Maturity
 
Equivalent
     
Fair
 
Maturity
 
Equivalent
 
   
Cost
 
Value
 
(Yrs./Mos.)
 
Yield
 
Cost
 
Value
 
(Yrs./Mos.)
 
Yield
 
   
(thousands)
 
Investment securities available for sale:
                             
U. S. Government:
                                 
Within one year
 
$
1,522,251
 
$
1,515,123
   
0/6
   
4.06
%
$
1,284,299
 
$
1,264,371
   
0/5
   
3.16
%
One to five years
   
1,267,976
   
1,268,807
   
1/7
   
4.92
   
1,009,952
   
997,206
   
1/7
   
4.10
 
Five to ten years
   
6,335
   
6,139
   
6/4
   
4.88
   
1,852
   
1,788
   
7/3
   
4.99
 
Over ten years
   
71,151
   
70,047
   
27/5
   
5.45
   
55,963
   
54,198
   
27/11
   
5.28
 
Total
   
2,867,713
   
2,860,116
   
1/0
   
5.45
   
2,352,066
   
2,317,563
   
1/7
   
3.62
 
State, county and municipal:
                                                 
Within one year
   
871
   
870
   
0/3
   
3.02
   
1,076
   
1,074
   
0/3
   
2.37
 
One to five years
   
2,726
   
2,692
   
2/6
   
3.97
   
2,872
   
2,823
   
2/5
   
3.54
 
Five to ten years
   
470
   
476
   
5/11
   
4.90
   
1,114
   
1,104
   
6/1
   
4.65
 
Over ten years
   
211
   
211
   
24/4
   
3.46
   
145
   
145
   
26/8
   
3.01
 
Total
   
4,278
   
4,249
   
3/6
   
3.86
   
5,207
   
5,145
   
3/5
   
3.52
 
Other
                                                 
Over ten years
   
9,566
   
10,039
   
11/2
   
10.66
   
11,740
   
11,740
   
11/8
   
11.09
 
Total
   
9,566
   
10,039
   
11/2
   
10.66
   
11,740
   
11,740
   
11/8
   
11.09
 
Equity securities
   
34,297
   
60,591
               
36,081
   
61,553
             
Total investment securities
                                                 
available for sale
 
$
2,915,854
 
$
2,934,995
             
$
2,405,094
 
$
2,396,001
             
Investment securities held to maturity:
                                     
U. S. Government:
                                                 
Within one year
 
$
88,294
 
$
87,889
   
0/4
   
3.71
%
$
398,692
 
$
395,491
   
0/7
   
3.12
%
One to five years
   
3
   
3
   
2/11
   
8.00
   
91,589
   
90,213
   
1/4
   
3.71
 
Five to ten years
   
1,175
   
1,165
   
9/11
   
5.71
   
15
   
13
   
9/10
   
5.22
Over ten years
   
5,500
   
5,502
   
10/1
   
5.59
   
8,841
   
8,834
   
11/7
   
5.59
 
Total
   
94,972
   
94,559
   
1/0
   
3.85
   
499,137
   
494,551
   
0/11
   
3.27
 
Within one year
   
-
   
-
           
-
   
-
         
One to five years
   
149
   
154
   
4/1
   
5.88
   
147
   
154
   
4/1
   
5.88
 
Over ten years
   
1,432
   
1,548
   
12/1
   
6.02
   
1,427
   
1,553
   
12/1
   
6.02
 
Total
   
1,581
   
1,702
   
10/3
   
6.01
   
1,574
   
1,707
   
11/3
   
6.01
 
Other
                                                 
Within one year
   
-
   
-
           
-
   
-
         
One to five years
   
250
   
250
   
1/4
   
3.25
   
250
   
250
   
3/4
   
7.75
 
Five to ten years
   
-
   
-
               
-
   
-
             
Total
   
250
   
250
   
1/4
   
3.25
   
250
   
250
   
3/4
   
7.75
 
Total investment securities
                                             
held to maturity
   
96,803
   
96,511
   
1/0
   
3.88
   
500,961
   
496,508
   
0/11
   
3.28
 
Total investment securities
 
$
3,012,657
 
$
3,031,506
             
$
2,906,055
 
$
2,892,509
             

Average maturity assumes callable securities mature on their earliest call date; yields are based on amortized cost; yields related to securities that are exempt from federal and/or state income taxes are stated on a taxable-equivalent basis assuming statutory rates of 35% for federal income tax purposes and 6.9% for state income taxes for all periods.


15


INTEREST-BEARING LIABILITIES
 
Interest-bearing liabilities include our interest-bearing deposits as well as short-term borrowings and long-term obligations. Deposits represent our primary funding source, although we also utilize non-deposit borrowings to stabilize our liquidity base and, in some cases, to fulfill commercial customer requirements for cash management services. Certain of our long-term borrowings also provide capital strength under existing guidelines established by the Federal Reserve Bank and other banking regulators.
 
Deposits. At March 31, 2007, total deposits equaled $12.72 billion, an increase of $210.0 million or 1.7 percent over March 31, 2006. Average interest-bearing deposits were $9.95 billion during the first quarter of 2007, an increase of $347.6 million or 3.6 percent from the first quarter of 2006. Average time deposits increased $427.2 million or 9.1 percent to $5.11 billion from the first quarter of 2006 to the same period of 2007. During the first quarter of 2007, money market accounts averaged $2.77 billion, compared to $2.66 billion in the first quarter of 2006. Partially offsetting these increases, average balances of both Checking With Interest and savings accounts declined marginally.
 
We attribute the growth of time deposits to the higher interest rate environment, and expect that the mix of time deposit balances within interest-bearing deposits will continue to increase throughout much of 2007 due to generally higher market rates than those paid on existing accounts. Competition for deposit business in our market areas is extremely intense. While we have access to non-deposit borrowing sources, we prefer to fund loan and lease demand with traditional bank deposits. Therefore, generating acceptable levels of deposit growth is a critical challenge for us, particularly during periods of strong loan and lease demand.
 
Short-term Borrowings. At March 31, 2007, short-term borrowings totaled $1.25 billion compared to $850.6 million at March 31, 2006. For the quarters ended March 31, 2007 and 2006, short-term borrowings averaged $1.20 billion and $784.7 million, respectively. The growth in short-term borrowings was the result of significantly higher customer demand for our commercial master note and overnight repurchase obligation products, key offerings within our cash management suite of products.
 
Expense on Interest-Bearing Liabilities. Interest expense amounted to $99.4 million during the first quarter of 2007, a $27.3 million or 37.8 percent increase from the first quarter of 2006. The higher interest expense was the result of higher rates and higher average volume. The rate on average interest-bearing liabilities equaled 3.49 percent during the first quarter of 2007, a 78 basis point increase in the aggregate blended rate on interest-bearing liabilities as compared to the first quarter of 2006. Average interest-bearing liabilities increased $763.5 million or 7.1 percent from first quarter of 2006 to the first quarter of 2007.

 
NET INTEREST INCOME
 
Net interest income totaled $116.6 million during the first quarter of 2007, a decrease of $1.2 million or 1.0 percent from the first quarter of 2006. The taxable-equivalent net yield on interest-earning assets equaled 3.42 percent for the first quarter of 2007, compared to the 3.65 percent achieved for the first quarter of 2006. This 23 basis point reduction primarily resulted from the unfavorable impact of the flat yield curve which has persisted since the first quarter of 2006.
 
Net interest income during the first quarter of 2007 was $274,000 less than the $116.9 million recognized during the fourth quarter of 2006. However, the taxable-equivalent net yield on interest-earning assets improved slightly from the 3.34 percent recorded during the fourth quarter of 2006.
 
Our asset/liability management strategy continues to focus on maintaining high levels of balance sheet liquidity and managing our interest rate risk. We maintain portfolios of interest-earning assets and interest-bearing liabilities with maturities or repricing characteristics that will protect against wide interest rate fluctuations, thereby limiting, to the extent possible, the ultimate interest rate exposure.



16



Consolidated Taxable Equivalent Rate/Volume Variance Analysis - First Quarter
             
                                   
Table 4
 
                                       
   
2007
 
2006
 
Increase (decrease) due to:
 
   
 
 
Interest
 
 
 
 
 
Interest
 
 
 
 
 
 
 
 
 
 
 
Average
 
Income/
 
Yield/
 
Average
 
Income/
 
Yield/
 
 
 
Yield/
 
Total
 
(thousands)
 
Balance
 
Expense
 
Rate
 
Balance
 
Expense
 
Rate
 
Volume
 
Rate
 
Change
 
Assets
 
(thousands)
Loans and leases
 
$
10,198,638
 
$