Letter to Stockholders
It is no secret that the past few years have been very challenging for TCF and the banking industry as a whole. Banks have had to work through the deepest recession since the Great Depression, which included stressed home values and elevated unemployment, as well as many regulatory and legislative changes. We took an approach that we believe better positions TCF for the future and made 2012 a “Building and Investing” year.
TCF was proactive in taking several key steps to enhance its business model and better prepare for the future. TCF expanded its national lending platforms, repositioned its balance sheet and brought back its free checking product to consumers. We recognize that the banking world has undergone a permanent change in many regards and we are committed to taking the necessary steps to ensure TCF’s long-term success.
The building and investing we did in 2012 was just the first step in accomplishing our goals as an organization. We now look for 2013 to be an “Execution and Results” year. With the actions taken in 2012, I am optimistic that 2013 will be a year in which we increase the value of our organization.
A Look at 2012
TCF has always relied on a diversified approach to generating its revenue. Given the recent regulatory and legislative changes, this diversified approach is more important than ever as deposit accounts may never be as profitable for banks as they have been in the past. Instead of looking to increase revenue simply by imposing new fees on our retail customers, TCF chose to build a better way by taking a broader, company-wide approach to increasing overall revenue and making the company a more diverse and powerful revenue-producing machine.
• Expansion of National Lending Platforms National lending platforms have been a part of TCF’s business model since it acquired Winthrop Resources Corporation (Winthrop) in 1997. Since then, TCF started an equipment finance company in 1999, added TCF Inventory Finance in 2008 and expanded into indirect auto finance in 2011. With limited asset growth opportunities for regional banks within their footprints today, TCF made a concerted effort to make the national lending platforms a more substantial part of its loan and lease portfolio.
In late 2011, TCF announced an agreement for TCF Inventory Finance to provide inventory financing to the dealers of Bombardier Recreational Products, Inc. (BRP) in the U.S. and Canada adding approximately 1,200 dealers to its already growing footprint. The acquisition of Gateway One Lending & Finance, Inc. (Gateway One), an indirect auto finance company, completed in late November 2011, added an additional consumer lending channel to our organization. In addition, TCF announced in March 2012 the creation of TCF Capital Funding, a new commercial banking division specializing in asset-based and cash flow lending to smaller middle market companies across the U.S. As a result of these key additions, TCF’s loan and lease portfolio grew 9 percent in 2012.
The emphasis on national lending platforms has had a significant impact on lending as a whole at TCF. Instead of having to rely on growing commercial and consumer loans regionally in a very competitive pricing environment, we now have the ability to be more selective given our asset growth and diversification opportunities through national lending platforms.
• Balance Sheet Repositioning In March 2012, TCF repositioned its balance sheet by prepaying $3.6 billion of long-term debt and selling $1.9 billion of mortgage-backed securities. While this action resulted in a one-time, net after-tax charge of $295.8 million, the elimination of higher cost, longer term debt has had the beneficial impacts we expected. We now have a more flexible funding structure which better supports TCF’s strategic focus on growth in shorter duration assets. The balance sheet repositioning also had a positive impact on TCF’s net interest margin which was 4.65 percent in 2012, up 66 basis points from 2011. The increase has primarily been driven by the elimination of higher cost, long-term debt and the growth in our higher yielding national lending businesses. We believe that TCF is positioned to continue to have one of the highest net interest margins in the industry. We have also reduced our mark-to-market risk on securities and net interest income at risk, which should better position us when interest rates eventually rise.
• Deposit Acquisition TCF acquired $778 million of deposits from Prudential Bank & Trust, FSB in June 2012. The deposit acquisition has provided a diversified and stable portfolio of deposit funding from accounts located throughout the U.S.
• Capital Actions TCF took several actions to improve its capital position during the year including the issuances of $110 million of 6.25 percent subordinated notes, $172.5 million of 7.50 percent Series A Non-Cumulative Perpetual Preferred Stock and $100 million of 6.45 percent Series B Non-Cumulative Perpetual Preferred Stock. The funds raised through these capital offerings are being used to support current and future asset growth opportunities, including the growth in our national lending businesses. The capital issuances enabled TCF to redeem its $115 million of 10.75 percent trust preferred securities, which would have been phased out from qualifying as Tier 1 capital over time.
• Return of Free Checking TCF, like many large banks, eliminated its free checking product following the implementation of the Durbin Amendment in October 2011, which limits debit card interchange revenue. After listening to its customers and employees, TCF decided to return to what made it so successful for so many years — free checking. Since the return of free checking, TCF has seen a steady increase in new account production and a decrease in account attrition. TCF customers and employees are happy to have one of the most competitive checking accounts in the country — TCF Free CheckingSM.
For the first time in 22 years, TCF incurred a net loss in 2012 of $218.5 million, or $1.37 per diluted share. This loss was the result of the $295.8 million net after-tax charge related to the balance sheet repositioning. While TCF prides itself on being a profitable bank and providing a strong return to shareholders, completing the balance sheet repositioning in 2012 was the right thing to do for the company and our stockholders.
TCF remains solidly capitalized with ample liquidity to conduct business. The capital raising activities completed during the year have enhanced our ability to grow the balance sheet. At December 31, 2012, TCF had $1.6 billion of Tier 1 capital, or 11.09 percent of total risk-weighted assets.
TCF paid dividends totaling $.20 per share in 2012 and has now paid a dividend in 98 consecutive quarters. When capital accumulation from earnings exceeds capital required for asset growth and risk parameters permit, TCF expects to raise the dividend. Returning capital to stockholders remains an important part of how we deliver value.
At December 31, 2012, TCF’s stock price closed at $12.15 per share, up from $10.32 per share on December 31, 2011. We believe that credit quality remained the main issue impacting the stock price throughout the year. As we continue to execute on our strategies and home values improve, we expect the stock price will improve over time.
TCF’s Lending division consists of retail lending, commercial banking and the national lending businesses (TCF Equipment Finance, Winthrop, TCF Inventory Finance and Gateway One). Total loan and lease balances of $15.4 billion at December 31, 2012 increased $1.3 billion, or 9 percent from a year ago, primarily due to strong growth in TCF Inventory Finance and Gateway One, as well as increased originations across most lending platforms. The emphasis on national lending has led to increased diversity throughout the lending portfolio — a portfolio that is now 43 percent consumer real estate, 35 percent national lending and 22 percent commercial.
Loan and lease balances in TCF’s national lending businesses increased 41 percent to $5.3 billion at December 31, 2012. With experienced management teams and strong asset diversification by industry, transaction size, geography and collateral type, the national lending businesses not only originate the highest yielding assets at TCF, but also deliver the best credit quality.
The most significant asset growth during the year came from TCF Inventory Finance. Largely due to the floorplan financing agreement with BRP, portfolio balances totaled $1.6 billion at year-end, up 150.9 percent. TCF Inventory Finance is well-diversified with loans spread across powersports, lawn and garden, consumer electronics and appliances, recreation vehicle, and marine product industries. This portfolio has a high average yield (6.20 percent in 2012), while maintaining credit quality that is among the best of TCF’s lending businesses.
TCF Inventory Finance now has agreements with many industry-leading manufacturers including BRP, The Toro Company and Arctic Cat, Inc. These relationships, along with its seasoned and experienced management team, have given TCF Inventory Finance strong credibility and made it a significant player in the inventory finance marketplace. We believe TCF Inventory Finance will continue to be a key contributor to the TCF story as we pursue additional programs in 2013.
TCF began originating high quality indirect auto loans following the acquisition of Gateway One in November 2011. Gateway One finished 2012 with loan balances of $552.8 million and an average yield of 6.06 percent. Gateway One also has managed assets, which includes portfolio loans, loans held for sale and loans sold and serviced for others, of $1.3 billion. After joining TCF with 3,200 dealer relationships in 30 states, Gateway One now has nearly 6,200 dealer relationships in 43 states.
Throughout 2012, TCF has successfully integrated Gateway One into TCF. In addition to the strong on-balance sheet growth at Gateway One, we have also executed on our strategy of selling a portion of the originations each quarter to generate additional revenue. In 2012, TCF realized gains of $22.1 million as a result of the sales of these auto loans, which we continue to service. We expect Gateway One will continue to provide disciplined growth in 2013.
TCF’s leasing and equipment finance businesses, which include TCF Equipment Finance and Winthrop, ended the year with balances of $3.2 billion, an increase of 1.8 percent from last year. The increase was largely due to core portfolio originations exceeding the run-off from acquired portfolios dating back to 2009. This business is the 29th largest equipment finance/leasing company in the U.S. and 14th largest bank-affiliated leasing company in the U.S.
Consumer real estate loans decreased 3.2 percent during the year to $6.7 billion. The sluggish economy and low home values continued to dilute the market of borrowers meeting TCF’s underwriting criteria. With our balance sheet diversification, TCF is able to be more selective with its consumer real estate portfolio. We are focused on identifying areas within this portfolio where the risk-adjusted returns are better than those of the first lien consumer real estate loans. TCF has identified an opportunity to do this in high quality junior lien originations on a national level. In order to manage our concentration in this portfolio, we began selling pools of these assets in the fourth quarter of 2012.
Commercial loan balances decreased 1.3 percent in 2012, to $3.4 billion. Commercial loan demand has begun to rebound in many of our markets; however, pricing and terms are very competitive. Again, with growth opportunities in national lending, we have been able to be selective in commercial deals while maintaining strong relationships with our current customers. In March 2012, we added TCF Capital Funding, a new commercial banking division specializing in asset-based and cash flow lending, which has become a nice complement to our current commercial business. TCF brought aboard an experienced team to run the business and provide a new channel of commercial lending.
At the beginning of 2012, TCF created a functionally organized management structure with a focus on the interdependency of Lending and Funding. The role of Funding is to provide diverse funding sources based on the needs of the Lending division. This collaboration and focus has increased the overall efficiency and effectiveness of our funding initiatives.
As a result of the balance sheet repositioning, we have improved our funding flexibility. Deposit balances totaled $14.1 billion at year-end, up 15.2 percent from last year. This increase includes the Prudential Bank & Trust deposit acquisition, the return of free checking and various certificate of deposit and savings programs initiated during the year. Through TCF’s extensive branch network of nearly 430 branches, TCF has been able to raise deposits.
In addition to deposit funding sources, TCF had $2.6 billion in unused, secured borrowing capacity at the Federal Home Loan Bank of Des Moines and $525 million in unused, secured borrowing capacity at the Federal Reserve. TCF has also issued preferred stock and subordinated debt in 2012 to help fund future asset growth and is actively identifying alternative funding sources that may be beneficial in the future, such as developing securitization capabilities.
To execute on our asset growth strategy moving forward, TCF needs to have diversified funding sources and flexibility in place to take advantage of marketplace opportunities. With the actions taken in 2012 and the management structure in place, we are well-positioned to meet our goals in 2013.
In 2012, TCF worked to further diversify its revenue sources. TCF, as a result of its large deposit account base, has long been regarded as having a strong fee-based revenue stream. With the implementation of Regulation E in 2010 and the Durbin Amendment in 2011, TCF has moved toward becoming more of a spread-based business through its balance sheet repositioning and emphasis on national lending.
TCF’s total revenue was $1.3 billion in 2012, up 11 percent from 2011. Net interest income increased 11.5 percent while non-interest income increased 10.3 percent. The reduction in long-term debt and the growth in the higher yielding national lending businesses have allowed TCF to create additional net interest income.
Banking fees and service charges decreased 18.9 percent in 2012 due to the impact of regulatory changes and a reduced checking account base resulting from the impact of product changes made in 2011. Now that free checking is back at TCF, we have recently seen increases in gross account production, decreases in attrition and reduced premium expense to open accounts. It will take some time to restore our checking account base and make up the lost maintenance fee revenue, but with the return of free checking, we are optimistic we can meet this goal in 2013.
While leasing and equipment finance revenue of $92.7 million, up 4 percent in 2012, continues to be a key revenue source for TCF, we introduced additional core revenue sources during the year with the gains from the sales of auto loans and consumer real estate loans. We expect these loan sales to remain core sources of revenue in 2013.
Card revenue in 2012 totaled $52.6 million, a 45.3 percent decline from 2011 due to the full year impact of the Durbin Amendment, which went into effect in October 2011. Increased net interest income resulting from the balance sheet repositioning as well as new core revenue sources, including the gains from the sales of loans, have and are expected to continue to play a significant role in replacing this lost revenue.
Credit quality was again the most significant headwind for TCF in 2012. Recovery from the financial crisis has taken longer than expected, but progress is being made. Despite a persistent, sluggish economy, we saw improvements in several leading indicators throughout the year, including consumer delinquencies and commercial classified assets. In 2012, we were able to work through many of our challenges and believe we have positioned ourselves for a better 2013.
Credit quality in 2012 was impacted by the implementation of clarifying regulatory guidance requiring consumer loans discharged in a Chapter 7 bankruptcy to be reported as non-accrual loans and written down to the estimated collateral value, less cost to sell, regardless of delinquency status. The guidance has resulted in an additional $49.3 million of consumer net charge-offs and $117.7 million of consumer loans being classified as non-accrual. While this regulatory accounting guidance had a significant impact on TCF’s credit metrics, it had no impact on the underlying credit risk profile of the portfolio. In fact, 87.5 percent of the non-accrual assets associated with the regulatory accounting guidance were less than 60 days past due as of December 31, 2012.
Provision for loan and lease losses in 2012 increased $46.6 million, or 23.2 percent, from 2011 primarily due to regulatory Chapter 7 bankruptcy guidance and the aggressive management of commercial credit issues. Net charge-offs of 1.54 percent were also impacted by the regulatory guidance and increased 9 basis points. Excluding the regulatory guidance, net charge-offs decreased 12 percent from 2011.
Non-performing assets, which includes non-accrual loans and leases and other real estate owned, increased 10 percent in 2012 including the impact of the regulatory Chapter 7 bankruptcy guidance which resulted in additional loans being classified as non-accrual. Excluding this impact, non-performing assets showed a moderate decline of $74.4 million during the year. Other real estate owned totaled $97 million at year-end, a decrease of $37.9 million from 2011. At December 31, 2012, TCF owned 639 consumer real estate properties and 21 commercial properties, compared with 723 and 35 properties, respectively, at December 31, 2011.
The leading indicator of consumer real estate credit quality, over 60-day delinquencies, showed steady improvement throughout the year. At year-end, 1.38 percent of consumer real estate loans were over 60-days delinquent, down 25 basis points from 2011. Performing classified assets, the leading indicator for commercial, also saw significant improvement in 2012, decreasing $106 million to $224 million at December 31, 2012. Meanwhile, the national lending businesses continue to perform with very strong credit metrics including low delinquencies and charge-offs.
While there is still work to be done, we are encouraged by the trends we have seen during 2012. Home values, which are a significant factor in consumer credit quality because they impact both the willingness of the customer to make payments and the charge we recognize should they default, started to recover in many markets and we were able to work through many of the problems in the commercial portfolio in 2012.
TCF’s non-interest expense totaled $1.4 billion in 2012, including a $550.7 million loss on termination of debt related to the balance sheet repositioning. Excluding this charge, non-interest expense increased $47.4 million, or 6.2 percent from 2011.
Compensation and benefits expense increased 12.9 percent during the year due to the ramp-up of our revenue-producing national lending businesses, particularly TCF Inventory Finance and Gateway One.
On a combined basis, advertising, marketing and deposit account premium expense declined 23.3 percent in 2012 due to the change in marketing strategy as a result of the return to free checking, which dramatically decreased the need to offer premiums to open accounts.
In early 2013, TCF entered into an agreement with the Office of the Comptroller of the Currency (OCC) related to previously disclosed deficiencies in its Bank Secrecy Act/Anti-Money Laundering (BSA/AML) compliance program. As a result, TCF agreed to payment of a civil money penalty and reported a charge to earnings of $10 million, or 6 cents per common share, in the fourth quarter of 2012 for this penalty. We believe that this settlement, along with comprehensive changes TCF has made to strengthen our BSA/AML compliance program, is a significant step towards a satisfactory resolution of the July 2010 BSA-related consent order with the OCC.
TCF takes pride in providing monetary and volunteer support to the communities in which we operate. During 2012, TCF and its employees contributed over $2.7 million to charitable organizations in human services, education, community development and the arts. TCF employees from across the company gave their time by volunteering and serving in leadership roles at local non-profit organizations. TCF and its employees are committed to doing our part to make a difference in the communities we serve.
Keys to Success in 2013
After building and investing throughout 2012, it will be important to execute on our strategies and deliver results in 2013. I believe we have the right pieces in place to make this happen. Below are some keys to success in 2013:
• Improve credit quality. The most important area of improvement for TCF in 2013 is in credit quality. We believe rebounding home values in many markets and a slowly improving economy will improve the outlook in consumer real estate. Initiatives to aggressively address commercial credit issues in 2012 will continue into 2013. The overall loan and lease portfolio is expected to benefit as the national lending portfolio, with its already strong credit metrics, becomes a larger part of TCF’s asset mix. We need to be laser-focused on continuing to improve credit quality in 2013.
• Make investments in enterprise risk management. In today’s banking world, having strong enterprise risk management is more important than ever. We are actively making investments in our enterprise risk management programs to ensure TCF manages its risk prudently and is in compliance with all banking regulations.
• Continue strong, high quality, diversified loan and lease growth. TCF’s strategy of growing loans through its national lending businesses has proven to be a very successful strategy in 2012. In 2013, we need to continue to execute on this strategy while adhering to our conservative underwriting philosophy.
• Build customer base through core products. In 2012, TCF began the process of rejuvenating its checking account base with the reintroduction of free checking. In 2013, we need to utilize this product to build the customer base and also introduce new products that fit the needs of our customers.
• Increase revenue while controlling expenses. 2012 saw the on-boarding of the BRP program in TCF Inventory Finance and the expansion of the Gateway One team which resulted in increased compensation expenses. In 2013, we expect to be positioned to leverage the investments in these new businesses and grow the revenues while increasing revenue diversification.
• Maintain strong capital management. TCF must continue to monitor our capital position to ensure we are ready for unanticipated situations and to take advantage of marketplace opportunities as they arise. TCF is a solidly capitalized institution and takes great pride in appropriately utilizing our stockholders’ capital for the long-term success of the company.
• Continue to maintain strong and diverse sources of funding and liquidity. TCF holds appropriate levels of on-balance sheet liquidity consisting of cash held at the Federal Reserve and unencumbered marketable securities. TCF’s funding sources are diverse and include a large core depositor base. In addition, TCF maintains access to secured funding sources and must continue to explore new sources of liquidity to enable loan and lease growth, such as auto finance, as necessary.
• Emphasize good corporate governance. Our customers and stockholders entrust us with their money and confidential information, and therefore our management practices demand high standards. A reputation for honesty and integrity continues to rank at the top of our priorities.
Risks to Our Business Strategy
• The economic environment remains a risk for all banks. While the economy appears to be slowly improving, we are not out of the woods yet. Until unemployment drops and home values return to higher levels, banks will be challenged to improve their performance.
• Managing interest-rate risk given the continued depressed interest rates with an eye toward the possibility of rapidly increasing rates in the future continues to be a risk management focus.
• The competitive landscape in the banking industry remains unsettled. TCF chose to expand its auto finance and inventory finance businesses, as well as to bring back its free checking product in 2012 while other banks are looking at other strategic options. The profitability of banks can be impacted by both the strategic decisions made by other banks as well as the public perception of the industry as a whole.
• TCF takes great pride in listening to and understanding its customer base. That said, there is always some level of uncertainty regarding consumer behavior when product or service changes are made. We will continue monitoring consumer behavior as we evaluate existing products and introduce new products so that they fit the needs of our customers.
• SUPERVALU®, TCF’s supermarket partner and operator of grocery store chains Cub® Foods in Minnesota and Jewel-Osco® in Chicago, recently announced a definitive agreement to sell five of its grocery chains, including Jewel-Osco, to an investment group led by Cerberus Capital Management. Cub Foods was not part of the transaction. With this acquisition, TCF will seek to work closely with the buyer to determine how the Jewel-Osco chain will partner with TCF going forward. TCF maintains a strong relationship with both Cub Foods and Jewel-Osco and we continue to believe that the partnership provides significant value for both parties.
• Growth of our national lending businesses is challenging in a competitive environment. While we have the track record and experience to successfully operate these businesses, it will be important to stay focused on our customers’ needs and compete on price, structure, terms and service every day.
• Congressional and regulatory actions continue to create uncertainty in the banking industry. The potential rule-making of enforcement actions from the Consumer Financial Protection Bureau could have a significant impact on the entire industry, including TCF. The unpredictability of future actions leads to uncertainty within the banking industry.
TCF made great progress in 2012 positioning the company for success moving into 2013. We recognized the challenges facing the company and have taken proactive steps to address them. It is now up to us to execute on our initiatives and increase stockholder value. I am confident that we have the right team and the strategy in place to achieve this goal. While this has certainly been a challenging few years for TCF, I feel good about where we are going.
We continue to have an alignment with our stockholders as our senior management and board of directors own over 6.7 million shares, or 4.1 percent of TCF stock. 81.3 percent of our eligible employees participate in the TCF Employees Stock Purchase Plan, which at year-end held over 8.5 million shares.
I would like to take a moment to thank our board of directors for their hard work and counsel. I am very proud of this group. I appreciate the exceptional leadership and guidance they have provided over the years and I look forward to working with them as we enter 2013.
I would also like to give a special thank you to all of our employees. This has been a very busy year focused on building and investing at every level of the bank. It is because of their hard work and dedication that I am optimistic about the future. I am proud of our team and the achievements in 2012 and expect the same level of effort in 2013 as we execute on our strategies.
Thank you for your continued support and investment in TCF.
William A. Cooper
Chairman and Chief Executive Officer