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Dear Stockholders:
Once again, I find myself writing this letter to you as Chief Executive Officer of TCF Financial Corporation. As you know, I retired from this role on December 31, 2005; however, with the unprecedented financial crisis and the retirement of Lynn Nagorske, the Board of Directors asked me to return on July 26, 2008 as your CEO. It is an honor to be back.
The 2008 year for the financial services sector was highlighted with news of subprime lending, multi-billion dollar credit losses, collateralized debt obligations and financial derivatives which negatively impacted the industry as a whole. In addition, many recent mergers and acquisitions rapidly deteriorated in value for the purchaser and their stockholders.
TCF did not engage in the activities that have created so many problems in the financial industry. TCF has not made subprime, teaser rate, Option ARM, broker-purchased, out of market, low documentation and other risky mortgages. TCF has not participated in junk bonds, collateralized debt obligations, asset-backed commercial paper, structured investment vehicles, or other off-balance-sheet programs. TCF has no auto or credit card portfolios, and does not have any derivative contracts. TCF has never owned Fannie Mae or Freddie Mac preferred stock, trust preferred securities or bank owned life insurance. Over 99 percent of TCF loans and leases are secured.
While TCF did not participate in any of these types of activities, we were not immune to the effects of these devastating headlines, the reduction in home values and the general state of the economy, as evidenced by a 24 percent decline in our stock price.
Let me assure you, TCF's fundamentals remain strong with conservative and secured loan growth, well-managed expense control, and an excellent, large and growing customer base. We continue to stand by our conservative philosophy of banking which has produced high performance measures for many years. In fact, our banking model has proven to be far superior to the failed models of our larger competitors. With the commitment of our dedicated employees, I expect to see continued growth and success.
A look at 2008:
TCF earned $129 million and diluted earnings per common share was $1.01. Although we were disappointed in these results, we remained profitable during an economic crisis not seen for several decades - a proclamation many financial institutions today cannot make. TCF's return on average assets was.79 percent and return on average common equity was 11.46 percent. TCF continues to rank as one of the highest performing banks in the country, topping U.S. Banker's "Best of the Biggest" list in 2008. TCF's net interest margin was 3.91 percent, a decrease of only 3 basis points. We continue to be better than the average of the Top 50 Banks by approximately 50 basis points, despite competitive deposit pricing pressure. TCF was able to increase its dividend to $1.00 per share in 2008, which was the 17th consecutive year we increased the dividend. Due to TCF's participation in the U.S. Treasury's Capital Purchase Program (more on this later), TCF will not be able to increase its dividend without regulatory approval and other regulatory limits on TCF's ability to pay dividends are possible. However, TCF intends to continue to pay its dividend in future periods subject to maintaining solid profits and strong capital. TCF's Tier 1 risk-based capital was $1.5 billion, or 11.79 percent of risk-weighted assets and total risk-based capital was $1.8 billion, or 14.65 percent of risk-weighted assets. TCF's tangible common equity ratio was 5.93 percent.
The main concern of regulators, stock analysts and stockholders in 2008 was capital and liquidity. TCF remains a solidly capitalized bank. At December 31, 2008, TCF was $577 million over the stated regulatory well-capitalized requirement due in part to $115 million of trust preferred securities issued on August 19 - which naysayers said we could not accomplish - and proceeds of a $361.2 million investment in TCF by the U.S. Department of the Treasury on November 14.
TCF has a strong retail deposit franchise with $10.2 billion in deposits (none of our deposits are brokered deposits), an increase of 7 percent for the year, which provides ample liquidity for the bank. In addition to deposits, TCF has a variety of borrowing sources available for overnight and long-term funding, including $2.3 billion in secured borrowing capacity at the Federal Home Loan Bank of Des Moines for short- and long-term funding, $1 billion in unsecured and uncommitted available lines for overnight and short-term (up to six months) funding, and $616 million of secured borrowing capacity at the Federal Reserve discount window for overnight and short-term (up to three months) funding. In addition, TCF can issue up to $329 million of FDIC guaranteed senior unsecured debt until October 31, 2009.
Over the past year, much has been written about credit losses and write-downs of home equity and residential mortgage portfolios due to subprime lending and other nontraditional mortgage-related programs. Again, TCF has not engaged in the activities that have created so many problems in the financial industry, such as subprime lending or offering loans originated with teaser rates. Any change in payments on TCF's variable-rate consumer home equity portfolio (27 percent of the total portfolio) is tied to the prime rate and not to any arbitrary provisions in mortgage documents.
In 2008, TCF's consumer home equity delinquencies and net charge-offs increased significantly from the prior year. Most of the increase was attributable to the industry's subprime lending crisis that led to record foreclosures and an oversupply of homes held for sale led by a housing bubble created by mistakes in monetary policy. This, in turn, led to lower home values and increased credit losses for TCF. It is important to recognize, however, that at year-end, 98 percent of our consumer loan customers were current on their loan payments to TCF. The vast depreciation in home values across the country - a direct link to the subprime market - in combination with adverse life events such as divorce, sickness, and especially loss of job have increased the frequency and the severity of delinquency incidents. As a result, TCF is now taking greater losses on these loans, although our losses remain less than most of TCF's peers and are still manageable.
TCF has also seen increases in delinquencies and charge-offs in our other portfolios. Commercial non-performing assets (mostly residential development related) increased 131 percent and net charge-offs increased. In a proactive move to manage this growing concern, we incorporated some management changes and expanded the credit quality functional group now headed by Tim Bailey, Vice Chairman of TCF Bank® and a longtime employee with considerable expertise in commercial workouts.
TCF's leasing and equipment finance business also experienced a modest increase in net charge-offs in 2008. However, this portfolio continues to be very profitable, well-diversified and well-managed.
The provision for credit losses in total for 2008 was $192 million compared to $57 million last year. At December 31, 2008, TCF's allowance for loan and lease losses totaled $172.4 million, or 1.29 percent of loans and leases, an increase of $91.5 million from $80.9 million, or .66 percent of loans and leases, at December 31, 2007.
To paraphrase one of the greatest businessmen and philosophers of our time, Warren Buffet, "We simply attempt to be fearful when others are bold and to be bold when others are fearful." In a year when many of our competitors and outside producers such as brokers and other financial service companies discontinued lending, we felt it was an opportunity for growth in our loans, leases and deposits.
TCF's loan and lease portfolio experienced strong growth in 2008, totaling $13.3 billion at the end of the year, up 8 percent over the prior year.
Consumer home equity loans grew 5 percent and totaled $6.8 billion at year-end despite continued declines in home values. During 2008, TCF funded $1.1 billion of new home equity loans. These new loans have thus far recorded low delinquencies and minimal charge-offs of less than 3 basis points. We are pleased with these results and attribute the good performance to our conservative underwriting standards in addition to the mitigated risk of lower home values.
Commercial loans increased 12 percent in 2008 and totaled $3.5 billion at year-end. During the year we saw REITs, conduits and other non-bank sources leave our markets, which led to a substantial decline in prepayments. This also allowed us to further strengthen our credit underwriting guidelines and improve yields and terms on all of our commercial lending products. Commercial business loans decreased 9.2 percent for the year as we saw a slowdown in retail, manufacturing and construction concurrent with the slowing economy.
TCF's leasing and equipment finance business grew 18.1 percent. This $2.5 billion portfolio is well-diversified by equipment type and geography, and grew nicely in all active segments. Our leasing and equipment finance operation is now the 34th largest in the United States, and is the 17th largest bank-affiliated leasing company in the United States. Winthrop Resources Corporation grew its portfolio $52.8 million, or 19 percent, in 2008 - a positive trend which will favorably impact future periods. Leasing and Equipment Finance continues to be one of the largest profit centers at TCF.
In 2008, TCF created a new subsidiary called TCF Inventory Finance, Inc., specializing in the inventory floorplan finance business in the United States and Canada with an initial focus on the consumer electronics and household appliance industries. We have hired 38 employees, established policies and procedures, implemented a core operating system and commenced operations in December 2008.
On the other side of the balance sheet, TCF's deposits totaled a record $10.2 billion as of December 31, 2008. During the year, as competition for certificates of deposits and higher cost deposits intensified, TCF introduced Power Savings and TCF Power Money MarketSM products to cross-sell and retain customers. As of December 31, 2008, Power Savings totaled $281.9 million and TCF Power Money Market totaled $118.7 million. In the last half of the year, TCF successfully promoted three high value new checking account premium campaigns to attract new customers: free gas card, free grocery card and free cash card. As a result, TCF's gross new checking accounts grew by 21 percent in the last two quarters of 2008. Our emphasis in 2009 will be to grow deposits and look for new products and premiums to introduce into the market.
In 2008, TCF opened 11 branches including five traditional branches and six supermarket branches. We also closed and consolidated 16 branches, including 12 Colorado supermarket branches, into nearby branches to improve operating efficiencies. TCF relocated three branches and remodeled 23 branches during the year.
TCF has minimal plans for branch expansion in 2009, unless additional opportunities arise with our two supermarket partners. We intend to continue our relocation and remodel programs during the year, and will look for good values on land for future branch growth.
One of the challenging areas for TCF in 2008 was deposit fee income, which I attribute to the slowing economy. Banking fees and service charges decreased 2.6 percent from 2007 primarily due to a decline in volume as customers have become especially careful in managing their personal accounts via online and telephone banking.
Card revenues continued their growth momentum and increased 4.2 percent to $103.1 million in 2008. TCF continues to be the 12th largest Visa® debit card issuer in the United States.
Leasing and equipment finance revenues totaled $55.5 million, down 6.2 percent, from 2007. In 2008, we saw a decrease in operating lease revenues as a result of maturing leases as well as a decrease in sales-type lease revenue as more lessees chose to continue leasing their equipment.
During the first quarter of 2008, Visa completed its initial public offering (IPO) and as part of the IPO, Visa redeemed a portion of the shares held by Visa U.S.A. members for cash. TCF received $8.3 million from this redemption and recorded a gain. TCF had 308,219 shares of Visa Class B at year-end. However, these shares are subject to dilution as Visa concludes certain litigation.
TCF's income tax expense was $76.7 million for 2008, or 37.3 percent of pre-tax income, which included a $2.2 million increase in income tax expense and a $2.8 million increase in deferred income taxes related to changes in state tax laws, primarily in Minnesota.
TCF was very efficient in managing expenses in 2008. While I look at 2008 as one of the most difficult and challenging times for the financial industry, I also saw an opportunity for TCF to place a stronger emphasis on its core businesses of deposit gathering and loan production. As a result, necessary actions were made to improve efficiencies including discontinued sales of investments and insurance products, closure of Education Finance, refocus on the consumer home equity loan business, scaling back of our non-branch based consumer lending unit and reorganization of Business Banking under our retail division. Unfortunately, these decisions were made at the cost of a number of long-term and loyal employees. I applaud those employees that have assumed additional duties as a result of the restructuring and look to all employees to continue to find ways to contribute to the bottom line while carefully monitoring expenses. My senior management team did not receive a bonus for the year 2008 and I did not take a salary or a bonus in 2008. Even during these difficult times, TCF is committed to the ongoing professional development of its employees and continues to recognize and motivate hard working individuals through job promotions, incentive compensation, tuition reimbursement and other reward programs. We strongly believe that maintaining an experienced and motivated team creates a competitive advantage and is crucial to enhancing stockholder value.
In 2008, TCF continued to support the communities in which we serve, both financially and through volunteerism. During 2008, TCF and its employees contributed over $3 million to charitable organizations in human services, education, community development, and the arts. In addition, numerous TCF employees generously gave their time by volunteering and providing leadership to local nonprofit organizations.
Also in 2008, TCF's performance under the Community Reinvestment Act over the last several years was evaluated which resulted in TCF receiving the highest possible rating of "Outstanding" on overall performance. We are very proud of the outstanding rating. TCF and its employees continue to express a commitment to make a difference for people in need and for the communities we serve, and we have an ongoing focus on organizations that have TCF employee involvement.
I am happy to close the 2008 chapter of this book and am optimistic about TCF's future. As I look forward to 2009, I am confident I have the right staff in the right positions to weather the financial storm, which may get worse before it gets better. The nature of the economy is one we have never before experienced; however, I believe we can endure and tackle the challenges that lie ahead.
To be successful in 2009, we must:
Continue growth momentum in loans, leases and deposits. With fewer competitors in the market on both the deposit side and the lending side, now is an opportune time to capture deposit customers through premium campaigns, new products and cross-sell initiatives while lending to creditworthy customers. Deposit gathering and loan production are the bread and butter of TCF, and a high priority for our entire management team in 2009. Checking account growth is the key to deposit fee income growth. Carefully monitor credit quality and proactively work with customers to remedy delinquencies and mitigate foreclosures and charge-offs. I expect delinquencies and charge-offs to stabilize during the year as a good portion of the loans on our books will have been originated in 2008 and 2009 - when home values have tended to stabilize and industry credit standards have been further tightened. Credit quality will largely depend on the viability of the U.S. economy. Use capital wisely. In 2008, TCF participated in the U.S. Treasury Department's Capital Purchase Program under the Emergency Economic Stabilization Act of 2008 and received proceeds of $361.2 million in exchange for 361,172 shares of senior perpetual preferred stock of TCF and a warrant to purchase 3.2 million shares of TCF common stock. The investment by the U.S. Treasury requires TCF to pay non-tax deductible cumulative dividends equal to 5 percent for the first five years and 9 percent thereafter. We felt the transaction was an inexpensive form of raising capital, even though TCF was already solidly capitalized. In order to fulfill the intent - as we now see it - of the government investment, we will need to lever this capital into good loans to creditworthy customers. In the first 45 days following receipt of these funds, TCF originated over $490 million of loans and leases, and completed 762 loan modifications and extensions on over $117 million of consumer home equity loans to help these customers avoid home foreclosures. In 2009, we intend to continue these activities. Additionally, this capital will allow us to fund the new inventory finance business. Continue to review and control expenses. In this difficult operating environment, it is important to focus on expense control and in 2009, it will be a team effort of all TCF employees. We will continue to identify areas within our states and backroom offices to improve processes and efficiencies. We must focus on the areas we can control and comply with regulations and tax laws in the most cost-effective manner. Continue our longstanding commitment to strong corporate governance. In 2008, TCF eliminated the classified board structure and all directors will stand annually for election by stockholders once their current term expires. In addition, because our customers and stockholders entrust us with their money and confidential information, our management practices demand high standards of ethics. Reputation for honesty and integrity continues to rank at the top of our priorities. TCF's management and staff did not engage in the activities driven by the imprudence and greed so commonly shown by Wall Street and many of our banking competitors.
From my perspective, the significant risks to our business strategy are as follows:
Economic conditions, including the value of residential and commercial real estate, increasing bankruptcies with the potential negative consequences of pending "cramdown" provisions, and rising unemployment, are major risks for all banks, including TCF. In the current state of the economy, the Federal and most state governments cannot fund their spending initiatives. Increasing taxes on businesses, including TCF, or individuals to fill the spending gaps in an attempt to balance their budgets is a risk on multiple fronts to TCF. Managing interest rate risk due to the changing yield curve and overall levels of interest rates continues to be very challenging. Potential reductions in our borrowing capacity at the Federal Home Loan Bank or the Federal discount window for any reason would reduce our liquidity and could prohibit growth or force higher deposit costs. Growing deposits reduces this risk. Changes in customer behavior from the slowing economy and advances in technology could further impact fee revenue.
New banks in the market, such as former brokerage firms and other large financial service conglomerates, have shown some irrational behavior in their certificate of deposit pricing. Continued competitive deposit pressure could impact deposit costs. Pending litigation against Visa could further impact card revenues as merchants seek to reduce or eliminate their card interchange expenses. Growth expectations of our new inventory finance business may not be achieved. This new line of business for TCF must be able to solidify business relationships with manufacturers and dealers - a key part to its success. Regulatory issues and the related compliance burden continue to increase and impact expense. To keep abreast and in compliance with all of the laws and regulations, a growing amount of time and dollars are being spent. The political impact of the outrageous behavior of many of our largest competitors and of Wall Street, and the public's perception concerning TARP (Trouble Asset Relief Program) funds raises the risks of future Congressional actions.
TCF has prudently managed these types of risks in the past and we believe we are adequately prepared to manage them in the future.
In closing, I would like to reaffirm our commitment to TCF's conservative corporate philosophy that was developed during the savings and loan crisis in the late 1980s. Today our corporate philosophy is being tested like never before as consumer confidence and spending are down and unemployment is on the rise. I am proud we have held tight to our principles and I believe TCF can remain profitable even during these very difficult times. In fact, these difficult times may bring new growth opportunities to TCF.
We continue to have a mutuality of interest with our stockholders and will always evaluate opportunities to deliver stockholder value. Our senior management and board of directors own over 9 million shares, or 7 percent of TCF stock. Eighty-four percent of our match-eligible employees participate in TCF's Employees Stock Purchase Plan, which at year-end held over 7.7 million shares.
I would like to thank the board of directors for their continued dedication, wise counsel and support of TCF. It was very much appreciated in 2008. Recently, director Peter Scherer notified the board that he has chosen not to continue to serve. In addition, director Rodney Burwell has reached retirement age and is leaving the board. We appreciate the exceptional leadership and guidance they provided us over the years. With these changes come opportunities to welcome new members to the board and I take great pleasure in introducing Barry Winslow and Theodore Bigos as our newest board members. Barry brings a long history of banking experience and we welcome his insights to assist TCF in our continued growth and success. Ted has an entrepreneurial drive and spirit that closely matches ours and brings a history of successful business management experience to the board.
I would also like to take this time to recognize Lynn Nagorske for the tremendous contributions he has made to TCF. Lynn joined TCF in 1986 and held many high-level positions. His analytical approach to opportunities was invaluable and led us in creating new and profitable businesses while developing cost-effective processes within the organization. Thank you, Lynn, for all that you have done. I, along with members of the TCF Team, wish you happiness.
During these tumultuous times, TCF remains a safe and sound financial institution due in large part to our dedicated staff of nearly 8,000 employees. I would like to give a special thanks to our employees for their hard work and efforts during the year. Their exceptional abilities, commitment and energy make everything happen at TCF. I am proud of the TCF Team and its accomplishments.
Thank you for your continued support and investment in TCF.
William A. Cooper
Chairman and Chief Executive Officer
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