| CITIZENS BANKING CORP ITEM 1A RISK FACTORS Unless the context indicates otherwise, all references in this Item to “we,” “us,” or “our,” refer to Citizens Banking Corporation and its subsidiaries |
| An investment in our common stock is subject to risks inherent to our business |
| The material risks and uncertainties that we believe affect us are described below |
| The risks and uncertainties described below (in bold) are not the only ones we face |
| Additional risks and uncertainties that we are not aware of or focused on or currently deems immaterial may also impair business operations |
| This report is qualified in its entirety by these risk factors |
| If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected |
| If this were to happen, the value of our common stock could decline significantly, and shareholders could lose all or part of their investment |
| We face the risk that loan losses, including unanticipated loan losses due to changes in loan portfolios, fraud and economic factors, will exceed the allowance for loan losses and that additional increases in the allowance will be required which would cause our net income to decline and could have a negative impact on our capital and financial position |
| Making loans is an essential element of our business, and we recognize there is a risk that customer loans will not be repaid |
| The risk of nonpayment is affected by a number of factors, including: • the duration of the loan; • credit risks of a particular borrower; • changes in economic and industry conditions; and • in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral |
| We attempt to maintain an appropriate allowance for loan losses to provide for potential losses in our loan portfolio |
| We periodically determine the amount of the allowance based on consideration of several factors including the ongoing review and grading of the loan portfolio, consideration of past loan loss experience as well as that of the banking industry, trends in past due and nonperforming loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, the size and diversity of individual large credits, and other qualitative and quantitative factors which could affect probable credit losses |
| We determine the amount of the allowance for loan losses by considering 12 _________________________________________________________________ [57]Table of Contents these factors and by using estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on our historical loss experience as well as that of the banking industry with additional qualitative factors for various issues, and allocation of reserves for special situations that are unique to the measurement period with consideration of current economic trends and conditions, all of which are susceptible to significant change |
| Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly |
| There is no precise method of predicting loan losses, and therefore we always face the risk that charge-offs in future periods will exceed our allowance for loan losses and that additional increases in the allowance for loan losses will be required |
| Additions to the allowance for loan losses would cause net income to decline in the period(s) in which such additions occur and could also have a material adverse impact on capital and financial position |
| While we attempt to manage the risk from changes in market interest rates, interest rate risk management techniques are not exact |
| In addition, we may not be able to economically hedge our interest rate risk |
| A rapid or substantial increase or decrease in interest rates could adversely affect our net interest income and results of operations |
| Our net income depends primarily upon our net interest income |
| Net interest income is income that remains after deducting, from total income generated by earning assets, the interest expense attributable to the acquisition of the funds required to support earning assets |
| Income from earning assets includes income from loans, investment securities and short-term investments |
| The amount of interest income is dependent on many factors including the volume of earning assets, the general level of interest rates, the dynamics of the change in interest rates and the levels of non-performing loans |
| The cost of funds varies with the amount of funds necessary to support earning assets, the rates paid to attract and hold deposits, rates paid on borrowed funds and the levels of non-interest-bearing demand deposits and equity capital |
| Different types of assets and liabilities may react differently, and at different times, to changes in market interest rates |
| We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities |
| That means either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest earning assets, or vice versa |
| When interest-bearing liabilities mature or reprice more quickly than interest-earning assets, an increase in market rates of interest could reduce our net interest income |
| We are unable to predict changes in market interest rates which are affected by many factors beyond our control including inflation, recession, unemployment, money supply, domestic and international events and changes in the United States and other financial markets |
| As of December 31, 2005, we were a liability-sensitive financial institution (liabilities repricing within one year exceeded assets repricing within one year) |
| Net interest income is not only affected by the level and direction of interest rates, but also by the shape of the yield curve, relationships between interest sensitive instruments and key driver rates, as well as balance sheet growth, client loan and deposit preferences and the timing of changes in these variables |
| We attempt to manage risk from changes in market interest rates, in part, by controlling the mix of interest rate-sensitive assets and interest rate-sensitive liabilities |
| We continually review our interest rate risk position and modify our strategies based on projections to minimize the impact of future interest rate changes |
| We also use derivative financial instruments to modify our exposure to changes in interest rates |
| Holding residential mortgage loans for sale and committing to fund residential mortgage loan applications at specific rates may pose interest rate risk during the period from loan funding until sale |
| To minimize this risk, we enter into mandatory forward commitments to sell residential mortgage loans |
| However, interest rate risk management techniques are not exact |
| A rapid increase or decrease in interest rates could adversely affect results of operations and financial performance |
| An economic downturn, and the negative economic effects caused by terrorist attacks, potential attacks and other destabilizing events, would likely contribute to the deterioration of the quality of our loan portfolio and could reduce our customer base, level of deposits, and demand for financial products such as loans |
| High inflation, natural disasters, acts of terrorism, an escalation of hostilities or other international or domestic occurrences, increased unemployment, changes in securities markets and other factors could have a negative impact on the economy of the Upper Midwest regions in which we operate |
| A sustained economic downturn in our markets would likely contribute to the deterioration of the quality of our loan portfolio by impacting the ability of our customers to repay loans, the value of the collateral securing loans, and may reduce the level of deposits in our banking subsidiaries and the stability of our deposit 13 _________________________________________________________________ [58]Table of Contents funding sources |
| A sustained economic downturn could also have a significant impact on the demand for our products and services |
| The cumulative effect of these matters on our results of operations and financial condition would likely be adverse and could be material |
| If we are unable to continue to attract core deposits or continue to obtain third party financing on favorable terms, our cost of funds will increase, adversely affecting the ability to generate the funds necessary for lending operations, reducing net interest margin and negatively affecting results of operations |
| Our subsidiary banks derive liquidity through core deposit growth, maturity of money market investments, and maturity and sale of investment securities and loans |
| Additionally, our subsidiary banks have access to financial market borrowing sources on an unsecured, as well as collateralized basis, for both short-term and long-term purposes including, but not limited to, the Federal Reserve and Federal Home Loan Banks of which the subsidiary banks are members |
| If these funding sources are not sufficient, we may have to acquire funds through higher-cost sources |
| Our credit ratings were reviewed and affirmed by Moody’s Investor Service on January 27, 2005 and Dominion Bond Rating Service assigned ratings to us on April 21, 2005 |
| Wholesale funding represents an important source of liquidity to us, and credit ratings affect the availability and cost of this funding |
| We currently have the ability to borrow funds on both a short-term and long-term basis as an additional source of liquidity |
| Our Holding Company maintains a dlra75 million short-term revolving credit facility with four unaffiliated banks |
| As of December 31, 2005, there was no outstanding balance on this credit facility |
| If our ratings were downgraded, our ability to borrow funds at favorable rates may be negatively impacted and could adversely affect our results of operations and financial condition |
| Increased competition with other financial institutions or an adverse change in our relationship with a number of major customers could reduce our net interest margin and net income by decreasing the number and size of loans originated, the interest rates charged on these loans and the fees charged for services to customers |
| If we lend to customers who are less likely to pay in order to maintain historical origination levels, we may not be able to maintain current loan quality levels |
| Our banking subsidiaries face substantial competition in originating commercial and consumer loans |
| This competition comes principally from other banks, savings institutions, mortgage banking companies and other lenders |
| Many of our competitors have competitive advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs |
| This competition could reduce our net income by decreasing the number and size of the loans that we originate and the interest rates we charge on these loans |
| In attracting business and consumer deposits, we face substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds |
| Many competitors enjoy advantages, including greater financial resources, more aggressive marketing campaigns and better brand recognition and more branch locations |
| These competitors may offer higher interest rates, which could decrease the deposits that we attract or require us to increase rates to retain existing deposits or attract new deposits |
| Increased deposit competition could adversely affect our ability to generate the funds necessary for lending operations which could increase our cost of funds |
| We also compete with non-bank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance companies and governmental organizations which may offer more favorable terms |
| Some non-bank competitors are not subject to the same extensive regulations that govern banking operations |
| As a result, such non-bank competitors may have advantages over us in providing certain products and services |
| This competition may reduce or limit our margins on banking and non-banking services, reduce our market share and adversely affect our earnings and financial condition |
| The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation |
| Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking |
| Also, technology has lowered barriers to 14 _________________________________________________________________ [59]Table of Contents entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems |
| We are party to various lawsuits incidental to our business |
| Litigation is subject to many uncertainties such that the expenses and ultimate exposure with respect to many of these matters cannot be ascertained |
| From time to time, customers make claims and take legal action pertaining to our performance of fiduciary responsibilities |
| Whether customer claims and legal action are founded or unfounded, if such claims and legal actions are not resolved in our favor they may result in significant financial liability and/or adversely affect the market perception of us and our products and services as well as impact customer demand for those products and services |
| Any financial liability or reputation damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations |
| The financial services industry is undergoing rapid technological changes |
| If we are unable to adequately invest in and implement new technology-driven products and services, we may not be able to compete effectively, or the cost to provide products and services may increase significantly |
| The financial services industry is undergoing rapid technological changes with frequent introduction of new technology-driven products and services |
| In addition to better serving customers, the effective use of technology increases efficiency and enables financial service institutions to reduce costs |
| Our future success will depend, in part, upon our ability to address the customer needs by using technology to provide products and services to enhance customer convenience, as well as to create additional operational efficiencies |
| Many of our competitors have substantially greater resources to invest in technological improvements |
| We may not be able to effectively implement new technology-driven products and services, which could reduce our ability to effectively compete and, in turn, have a material adverse effect on our financial condition and results of operations |
| Our business may be adversely affected by the highly regulated environment in which we operate |
| We may be adversely affected by changes in banking or tax laws, regulations, and regulatory practices at either the federal or state level |
| Such changes would affect our ability to offer new products and services, obtain financing, pay dividends from the subsidiaries to the Holding Company, attract deposits, make loans and leases at satisfactory spreads |
| Such changes may also result in the imposition of additional costs |
| The banking industry is heavily regulated, and such regulations are intended primarily for the protection of depositors and the federal deposit insurance funds, not shareholders or holders of subordinated debt |
| As a bank holding company, our Holding Company is subject to regulation by the Federal Reserve Board |
| Our bank subsidiaries each have their own federal regulator (the Federal Reserve Board or the OCC) and are also subject to regulation by the state banking departments of the state in which they are chartered |
| These regulations affect lending practices, capital structure, investment practices, dividend policy and growth |
| In addition, we have non-bank operating subsidiaries from which we derive income |
| Certain of these non-bank subsidiaries engage in providing investment management and insurance brokerage services, which industries are also heavily regulated on both a state and federal level |
| In addition, changes in laws, regulations and regulatory practices affecting the financial services industry could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things |
| Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations |
| While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur |
| The products and services offered by the banking industry and customer expectations regarding them are subject to change |
| We attempt to respond to perceived customer needs and expectations by offering new products and services, which are often costly to develop and market initially |
| A lack of market acceptance of these products and services would have a negative effect on financial condition and results of operations |
| From time to time, we implement new lines of business or offer new products and services within existing lines of business |
| There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed |
| In developing and marketing new lines of business and/or new products and services we may invest 15 _________________________________________________________________ [60]Table of Contents significant time and resources |
| We may not achieve initial timetables for the introduction and development of new lines of business and/or new products or services and price and profitability targets may not prove feasible |
| External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service |
| Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls |
| Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on business, results of operations and financial condition |
| New accounting or tax pronouncements or interpretations may be issued by the accounting profession, regulators or other government bodies which could change existing accounting methods |
| Changes in accounting methods could negatively impact our results of operations and financial position |
| Current accounting and tax rules, standards, policies, and interpretations influence the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures |
| These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time |
| Events that may not have a direct impact on us, such as the bankruptcy of major US companies, have resulted in legislators, regulators, and authoritative bodies, such as the Financial Accounting Standards Board, the Securities and Exchange Commission, the Public Company Accounting Oversight Board, and various taxing authorities responding by adopting and/or proposing substantive revision to laws, regulations, rules, standards, policies, and interpretations |
| New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future |
| A change in accounting standards may adversely affect reported financial condition and results of operations |
| Our business continuity plans or data security systems could prove to be inadequate, resulting in a material interruption in, or disruption to, our business and a negative impact on the results of operations |
| We rely heavily on communications and information systems to conduct our business |
| Any failure, interruption or breach in security of these systems, whether due to severe weather, natural disasters, acts of war or terrorism, criminal activity or other factors, could result in failures or disruptions in general ledger, deposit, loan, customer relationship management, and other systems |
| While we have disaster recovery and other policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed |
| The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our results of operations |
| Our vendors could fail to fulfill their contractual obligations, resulting in a material interruption in, or disruption to, our business and a negative impact on our results of operations |
| We have entered into subcontracts for the supply of current and future services, such as data processing and certain property management functions |
| These services must be available on a continuous and timely basis and be in compliance with any regulatory requirements |
| Failure to do so could substantially harm our business |
| We often purchase services from vendors under agreements that typically can be terminated on a periodic basis |
| There can be no assurance, however, that vendors will be able to meet their obligations under these agreements or that we will be able to compel them to do so |
| • If an existing agreement expires or a certain service is discontinued by a vendor, then we may not be able to continue to offer our customers the same breadth of products and our operating results would likely suffer unless we are able to find an alternate supply of a similar service |
| • Agreements we may negotiate in the future may commit us to certain minimum spending obligations |
| It is possible we will not be able to create the market demand to meet such obligations |
| • If market demand for our products increase suddenly, our current vendors might not be able to fulfill our commercial needs, which would require us to seek new arrangements or new sources of supply, and may result in substantial delays in meeting market demand |
| • We may not be able to control or adequately monitor the quality of services we receive from our vendors |
| Poor quality services could damage our reputation with our customers |
| 16 _________________________________________________________________ [61]Table of Contents Potential problems with vendors such as those discussed above could have a significant adverse effect on our business, lead to higher costs and damage our reputation with our customers and, in turn, have a material adverse effect on our financial condition and results of operations |
| Our potential inability to integrate acquired operations could have a negative effect on our expenses and results of operations |
| In the past, we have grown through strategic acquisitions and we may engage in strategic acquisitions in the future to strengthen and expand our operating and marketing capabilities |
| The full benefits of these acquisitions, however, require integration of administrative, financial, sales, lending, collections, marketing approaches, and personnel |
| If we are unable to successfully integrate these acquisitions, we may not realize the benefits of the acquisitions, and our financial results may be negatively affected |
| A completed acquisition may adversely affect our financial condition and results of operations, including our capital requirements and the accounting treatment of these acquisitions |
| Completed acquisitions may also lead to significant unexpected liabilities after the consummation of these acquisitions |
| We could face unanticipated environmental liabilities or costs related to real property owned or acquired through foreclosure |
| Compliance with federal, state and local environmental laws and regulations, including those related to investigation and clean-up of contaminated sites, could have a negative effect on expenses and results of operations |
| A significant portion of our loan portfolio is secured by real property |
| In doing so, there is a risk that hazardous or toxic substances could be found on these properties |
| If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage |
| Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property |
| In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability |
| Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards |
| The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on results of operations |
| As a bank holding company that conducts substantially all of our operations through our subsidiaries, the ability of the Holding Company to pay dividends, repurchase our shares or to repay our indebtedness depends upon the results of operations of our subsidiaries and their ability to pay dividends to the Holding Company |
| Dividends paid by these subsidiaries are subject to limits imposed by federal and state law |
| The Holding Company is a separate and distinct legal entity from our subsidiaries and it receives substantially all of its revenue from dividends from its subsidiaries |
| These dividends are the principal source of funds to pay dividends on common stock and interest and principal on debt |
| Various federal and/or state laws and regulations limit the amount of dividends that our bank subsidiaries and certain non-bank subsidiaries may pay to the Holding Company |
| Also, the Holding Company’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors |
| In the event its subsidiaries are unable to pay dividends to the Holding Company, the Holding Company may not be able to service debt, pay obligations or pay dividends on common stock |
| Our controls and procedures may fail or be circumvented which could have a material adverse effect on our business, results of operations and financial condition |
| We regularly review and update our internal controls, disclosure controls and procedures, and corporate governance policies and procedures |
| Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met |
| Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition |
| 17 _________________________________________________________________ [62]Table of Contents Our articles of incorporation, bylaws and shareholder rights agreement as well as certain banking laws may have an anti-takeover effect |
| Provisions of our articles of incorporation and bylaws, federal banking laws, including regulatory approval requirements, and the rights agreement, dated May 23, 2000, between the Holding Company and Citizens Bank, as rights agent, could make it more difficult for a third party to acquire the Holding Company, even if doing so would be perceived to be beneficial to shareholders |
| The combination of these provisions effectively inhibits a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock |