Letter to Stockholders
It is hard to believe that it has been 30 years since I first took over as Chief Executive Officer at TCF. As I begin my final year leading the bank, I often look back and find myself amazed at all the exceptional things this company has accomplished. We were the first to launch totally free checking, completed several acquisitions and stock splits, acquired new businesses, started businesses from scratch, repositioned the balance sheet and successfully completed significant business model changes while reducing balance sheet credit risk to meet a changing regulatory landscape. These events laid the groundwork for the success we had in 2014 and have helped us bring the future of TCF into focus.
A Look at 2014
2014 was a very good year for us despite continued headwinds as the economy showed little, if any, improvement until late in the year and interest rates remained at historic lows. We earned net income of $174.2 million, or 94 cents per share, up 14.8 percent and 14.6 percent, respectively, from 2013. Return on average tangible common equity increased from 9.58 percent to 10.08 percent during the year, while tangible book value per share increased 10.1 percent to $9.72. We maintained an industry-leading net interest margin in 2014 of 4.61 percent, over 100 basis points greater than our peer average. Our stock price closed the year at $15.89 with a three-year total stockholder return of 61.02 percent.
A significant factor in our success in 2014 was our loan and lease origination engine. We originated $13.5 billion of loans and leases in 2014, up 12.2 percent from 2013. As a result, total assets now consist of 85 percent loans and leases. These originations have largely been driven by our national lending businesses, including Leasing and Equipment Finance, Inventory Finance, Gateway One Lending & Finance and our national junior lien mortgage business. We recognized several years ago that the banking industry and regulatory environment in America were evolving. To compete, we needed to not only succeed in our footprint businesses, such as branch banking, retail lending and commercial lending, but we needed to be successful lending nationally as well. As a result, we developed a unique mix of lending platforms that have allowed us to generate originations at an extremely efficient level.
Our loan origination capacity is significant for a number of reasons. First, it creates revenue through interest income as our unique portfolio mix allows us to put high-yielding, high-quality earning assets on our balance sheet. Second, within our lending platforms, we have a niche lending strategy which allows our portfolio to be well diversified by type of credit, geography, industry, product and collateral type. Finally, our core loan sale capability allows us to reduce risk by actively managing loan concentrations as well as generating gains on sales and servicing fees.
Given the growth of our national lending platforms, investors, rating agencies and regulators have all expressed concern about the future credit quality of these businesses. We believe our experienced management teams and effective risk mitigation strategies within these businesses provide for consistent performance moving forward.
We entered the inventory finance business in 2008 and it is led by a management team that averages over 30 years of experience specifically in this industry. Business is generated through program relationships with strong manufacturers, primarily in the powersports, lawn and garden, appliances and electronics, and marine industries. We finance the inventory shipped to the retail dealers of the manufacturers. Not only do we have the inventory as collateral, but we underwrite each dealer’s credit and generally have agreements with manufacturers to reallocate repossessed inventory at no loss to us. These loans turn very quickly with an estimated weighted average life of four months.
Inventory finance has been our best performing business in terms of losses, even during the recession. Net charge-offs in 2014 were 0.04 percent while peak losses since the business began were 0.17 percent in 2010. This is a high credit quality business because it has multiple sources of credit support, including the credit of the retailer, the value of the collateral and the arrangements with the manufacturers. In addition, credit risk is spread across more than 9,600 active dealers in all 50 states and Canada.
Auto financing, on the other hand, is a newer business which we have been in for three years. We acquired the business with a fully developed origination and servicing platform, as well as a seasoned management team averaging 25 years of experience in auto finance. Net charge-offs in 2014 were 0.66 percent. As the portfolio is still maturing, losses may continue to slowly increase and are expected to stabilize around 75 basis points. The biggest risks in the auto business are a weak economy and falling auto values. We mitigate these risks by selling our lower FICO originations and consistently underwriting with a focus on all aspects of the transaction, including credit, stability and ability to pay. The current average FICO of the portfolio loans is 724.
Our most seasoned national lending business is Leasing and Equipment Finance, which we have been in since 1997 with the acquisition of Winthrop Resources Corporation, our high-tech leasing company. Winthrop, TCF’s highest ROA business, is able to mitigate risk by financing business-essential equipment through high credit quality borrowers. Our other leasing business, TCF Equipment Finance, is well diversified in select segments such as specialty vehicles, manufacturing, medical, construction and technology. Together, these businesses are well diversified by equipment type and geography with an average loan size of just $74 thousand. These businesses had net charge-offs of only 0.10 percent in 2014 and are both run by very experienced management teams.
Our legacy lending businesses, commercial and retail lending, have also added national lending components in recent years. As part of our commercial business, we started TCF Capital Funding, an asset-based and cash flow lending business, in 2012. Similar to our other businesses, TCF Capital Funding is run by a very experienced management team, which we recruited as a group, and has seen no charge-offs since its inception. Risks are mitigated by secured lending and diverse collateral types. While we are letting our legacy first residential mortgage portfolio run off, we are originating high-quality junior lien mortgages to high FICO borrowers across the United States. Risks are mitigated through the portfolio’s strong loan-to-value and debt-to-income ratios as well as quarterly loan sales to manage concentration risk. This portfolio had no net charge-offs in 2014, nearly no delinquencies and a current average FICO of 742.
In late 2014, we further mitigated the balance sheet credit risk of our legacy retail portfolio by selling $405.9 million of consumer troubled debt restructurings (“TDRs”) which resulted in a $23.1 million pre-tax charge. We expect to recover this loss in less than three years through reduced net charge-offs, lower expenses and increased margin created by redeploying funds into higher yielding assets. We also expect to see a quicker reduction of non-performing assets moving forward as the TDR sale will help to reduce inflows into non-performing assets. Our remaining accruing TDR consumer portfolio totaled $111.9 million with reserves of 23 percent at December 31, 2014.
We created these TDRs by rewriting mortgage loans at lower interest rates for troubled borrowers, helping to keep thousands of TCF customers in their homes. This program, of which we are very proud, was a huge success benefiting both TCF and our customers. This portfolio sale allows us to diversify further away from our legacy consumer real estate portfolio, while providing a fresh start as we move into 2015.
A Look Ahead
Executing on the investments we have made in the business over the past few years has brought the future into focus at TCF. We are no longer a bank which simply gathers deposits and makes loans in our footprint. As we look ahead, we are now a company that uses our high-quality deposit base to fund loan and lease originations not only in our markets, but also through unique and diverse national lending platforms. This strategy, with a focus on strong enterprise risk management, will carry us into 2015 and beyond.
With the overhang of our legacy consumer real estate portfolio decreased due to the TDR sale, I am excited to begin 2015. A key area where the TDR sale will help us in 2015 is through a reduction in regulatory and operational costs. During the first quarter of 2014, we consolidated 46 underperforming branches to further improve efficiencies as branch traffic has slowed due to increased use of online and mobile banking. Expense efficiencies will continue to be a key focus in 2015.
We fund our asset growth primarily with low-cost, core deposits. This is a key part of our strategy we expect to continue in 2015 and beyond. Average total deposits have increased for 17 consecutive quarters at TCF and had an average interest cost of just 0.26 percent in 2014. All in all, the total cost for us to acquire deposits is our fee income less interest and operating expenses, which was 1.71 percent in 2014, lower than a five-year FHLB borrowing rate. In addition, 89 percent of our deposits are FDIC-insured, making them very sticky even in an economic downturn. We have a track record of being able to raise deposits as needed to fund our ongoing loan and lease originations.
For us to continue to attract high-quality deposits, we must remain competitive from a product and service standpoint. We have made several enhancements and will continue to do so moving forward. These have included image-enabled ATMs, upgrades to our online and mobile channels and participation in Apple PayTM. We also began offering first lien mortgages again in the branches on a correspondent basis. We are reviewing additional product and service opportunities, including offering auto loans in the branches, credit cards, and additional online and mobile upgrades. These efforts are aimed at creating new and enhanced touch points with customers to ensure a long relationship with the bank.
Banking regulation will continue to be a focus in 2015. While it is too early to predict the impact of new rules, we have been proactive in taking steps to align our products with industry best practices. We were one of the first banks to adopt deposit account disclosures based on the Pew Charitable Trust Model and eliminated high-to-low sort order years ago. In addition, the diversification of our revenue away from banking fees will help to minimize the impact we see from future regulatory changes related to fees. With the increase in gains on loan sales and servicing revenue, banking fees made up just 53 percent of total non-interest income in 2014, down from 80 percent just five years ago.
Everyone is also anxiously waiting to see what happens with interest rates in 2015. We are well positioned for a rising rate environment. Approximately 80 percent of our assets are variable/adjustable rate or short/medium duration fixed rate. This means that a large portion of our asset base will re-price as rates rise. In addition, 64 percent of our deposits are low or no interest cost. Our low-cost deposit base becomes much more valuable in a rising rate environment. We believe we are set to become a more profitable bank through a higher net interest margin when rates rise.
Finally, enterprise risk management has been a key focus for us. This function has grown significantly over the past year and will continue to grow as we move into 2015. The goal of enterprise risk management is to ensure we are managing all risks of the company, including credit risk, in a prudent and responsible manner, especially given the ever-changing regulatory landscape. I am very pleased with the enhancements we have made in this area.
I want to thank Barry Winslow and Earl Stratton who both announced their retirements over the past year. Barry joined TCF in 1987 and most recently served as Vice Chairman of Corporate Development. Earl joined TCF in 1985 and most recently held the role of Chief Operations Officer. Both have played an extremely influential role in TCF’s success over the past 30 years. They are great friends and will be missed.
I also want to thank our Board of Directors for their guidance over the past year. I especially want to thank Ray Barton who will retire from the Board on April 22, 2015. Ray has served on the Board since 2011 and we appreciate the leadership he has provided during his tenure.
Finally, I want to thank our employees for their hard work during another challenging year. This is the group that makes our company great. I appreciate their dedication and willingness to do whatever it takes to put the customer first, as well as their contributions in the community. For example, I am proud to say that TCF and its employees generously contributed over $3 million to charitable organizations in 2014. In addition, we have been committed to building a financially stronger community through our financial education program.
I am very fortunate to have had the opportunity to lead TCF for the last 30 years. I have enjoyed working closely with our Board of Directors, employees, various constituents and stockholders. I am proud of how far we have come as a company, especially through some very challenging times. While it will be difficult to walk away as CEO at the end of the year, I am comforted by the exceptionally strong management team we have in place, the best I’ve ever worked with. I look forward to continuing to work with this group as Chairman of the Board through 2017. The future is bright and in focus for TCF.
William A. Cooper
Chairman and Chief Executive Officer
Chairman and Chief Executive Officer