Letter to Stockholders
TCF’s focus in 2013 was to execute on the investments we made in 2012 and position the company to capitalize on opportunities as we head into 2014. The recent financial crisis significantly impacted TCF, as well as the banking industry as a whole. Elevated unemployment levels and depressed home values led to industry-wide credit concerns while regulatory changes, such as the Durbin Amendment, have changed how banks like TCF generate revenue. Over the past two years, TCF has been aggressive in addressing the various challenges facing the current banking environment and began to see positive results in 2013.
Beginning in late 2011 and continuing throughout 2012, TCF took a “building and investing” approach to the business. We started by expanding our national lending platforms with TCF Inventory Finance, Inc.’s agreement with Bombardier Recreational Products, Inc. (BRP); the acquisition of Gateway One Lending & Finance, LLC (Gateway One), an indirect auto finance company; and the creation of TCF Capital Funding, an asset-based and cash flow lending business. TCF also repositioned its balance sheet creating a more flexible funding structure. On the deposit side, TCF completed a diversified and stable deposit acquisition from Prudential Bank & Trust, FSB while also responding to our customers’ feedback by returning to our free checking product. Finally, TCF improved its capital position in 2012 through issuances of preferred stock, subordinated debt and the redemption of its trust preferred securities.
This restructuring has clearly been a success. Continuing low interest rates have demonstrated the wisdom of our strategy. TCF’s 2013 net interest margin of 4.68 percent is now one of the strongest in the banking business, 125 basis points higher than our peer average.
With these 2012 investments providing a sound foundation for the organization, we looked to deliver solid returns to our stockholders by successfully executing on the strategies behind these investments. In the beginning of 2013, we established two overarching strategies to leverage the investments made in the prior year: 1) maintain our strong pre-tax pre-provision return on average assets and 2) reduce the credit-related costs associated with our in-footprint consumer and commercial lending businesses. I am proud to say that our team has executed on these strategies and the results have been very positive. In order to maintain our strong pre-tax pre-provision return on average assets, we needed to diversify our revenue sources and reduce our cost of funding.
We were able to accomplish this by enhancing and increasing our loan sales in auto finance and consumer real estate. Due to strong originations, loan growth has continued despite these loan sales. Total checking accounts have grown 5.9 percent since the return to free checking. Most importantly, credit quality has steadily improved throughout the year as provisions for loan and lease losses decreased while we also drove down non-accrual loans and other real estate owned in our consumer and commercial lending businesses. In addition, our auto, inventory finance and leasing and equipment finance businesses continued their strong credit performance.
We believe the successful execution of our strategies has put us in a great position to take advantage of rising opportunities in 2014 and beyond. As we move forward, we look for further improvements in credit quality driven by continued trends in home values and unemployment, new product and service offerings to our retail customers and a focus on leveraging the expense base as we bring our newer national lending businesses to scale.
In addition to these successes, I am equally proud of TCF’s continued investments and contributions made within the communities we serve. Our focus on social responsibility takes many forms including donations to charitable organizations through the TCF Foundation, employee volunteer hours, enhancing education opportunities by supporting local charter schools, helping customers stay in their homes through loan modifications, and a commitment to financially stronger communities with our new financial literacy programs. These initiatives are important to us and we look forward to continuing to positively impact our communities in the future.
Throughout my career, the largest banks have always operated with a competitive advantage over mid-size and smaller banks as a result of lower capital and liquidity requirements due to economies of scale as well as lower borrowing costs. With new regulations, this is changing. The largest banks now have increased capital and liquidity requirements and additional regulatory costs. The “too big to fail” era for the largest banks appears to be over. We believe the $10 billion to $50 billion asset size for banks, in which TCF is positioned, has become the “sweet spot” of banking. TCF is large enough to utilize economies of scale while operating in an environment where big banks no longer enjoy the same competitive advantages. Coupled with the recent investments TCF has made, this provides an outlook that our stockholders can be excited about. We aren’t where we want to be yet, but we believe we are well on our way to making TCF the bank it needs to be to deliver lasting stockholder value.
A Look at 2013
Following several key investments in 2012, TCF spent significant time and effort in 2013 integrating these investments and executing on our strategies. The results we began to see during the year have shown that the investments and hard work are paying off.
Economic factors played a significant role during the year. On the positive side, home values and unemployment continued to improve. On the negative side, we saw a change in customer behavior that resulted in lower transaction volumes and higher account balances, ultimately impacting banking fee revenue.
TCF continued to make key investments in regulatory initiatives such as enterprise risk management and Bank Secrecy Act (BSA) compliance. TCF hired a new Chief Risk Officer in August whose risk management and leadership experience have already made a meaningful impact throughout TCF as we look to adopt risk management best practices in all aspects of the organization. TCF also hired a new Chief Credit Officer in December whose expertise in credit policy, underwriting and administration will have a positive influence on the organization as we position the platform for the future.
A key focus for TCF over the past several years has been resolving the BSA-related consent order we signed with the Office of the Comptroller of the Currency (OCC) in July 2010. Since signing the consent order, TCF has made significant enhancements to its BSA compliance program, including the hiring of an experienced BSA Officer and expanded BSA staffing; improving risk-assessment, customer identification and due diligence processes; improving internal controls; enhancing training; and updating and improving BSA-related transaction screening systems. As a result of these efforts, TCF announced in December that the OCC had lifted its consent order. We feel that TCF now has a best-in-class BSA program which will benefit the company moving forward.
TCF returned to profitability in 2013 earning $132.6 million, or $.82 per diluted share. For the first time in 22 years, TCF incurred a net loss in 2012 of $218.5 million, or $1.37 per diluted share, as a result of the $295.8 million net after-tax charge related to the balance sheet repositioning. TCF also delivered a strong pre-tax pre-provision profit return on average assets in 2013 of 1.98 percent.
TCF remains solidly capitalized with ample liquidity to grow the business. At December 31, 2013, TCF had $1.8 billion of Tier 1 capital, or 11.41 percent of total risk-weighted assets. Tangible realized common equity to tangible assets increased to 8.18 percent.
TCF paid dividends totaling $.20 per share in 2013 and has now paid a dividend in 102 consecutive quarters. When capital accumulation from earnings exceeds capital required for asset growth and risk parameters permit, TCF hopes to increase the dividend. Returning capital to stockholders continues to be a core function of how we deliver stockholder value.
At December 31, 2013, TCF’s stock price closed at $16.25 per share, up from $12.15 per share on December 31, 2012. Since December 31, 2011, TCF’s stock price has increased 57.5 percent. This material increase in our stock price over the past two years demonstrates the investments TCF has made in the business and its successful execution of the strategies leveraging those investments.
TCF’s Lending portfolios consist of 48 percent retail loans (consumer real estate and auto finance) and 52 percent wholesale loans and leases (commercial, leasing and equipment finance and inventory finance). This nearly even mix between retail and wholesale is ideal for TCF as it demonstrates strong diversification across our loan and lease products. Prior to the increased competition for loans and leases within our branch footprint states, particularly in commercial, TCF invested in a unique blend of national lending platforms with experienced management teams. These platforms have allowed us to generate organic growth on a national basis without having to focus on asset generation in the more competitive environments or take on additional credit risk within our markets.
Total loans and leases of $15.8 billion at December 31, 2013, was an increase of 2.7 percent from the prior year. Loan and lease originations also increased 12.4 percent to $12.1 billion in 2013 compared to 2012, primarily due to opportunities in our national lending platforms.
This increase in total loan and lease balances occurred despite $1.6 billion of core sales of consumer real estate and auto finance loans in 2013, up 123.1 percent from similar loan sales in 2012. Excluding these loan sales, total loans and leases grew 8.1 percent in 2013. The loan sales have been a core revenue source for TCF since 2012 while also allowing us to actively manage concentration risk within the portfolios. This model gives us the capacity to generate additional earning asset growth in the future by controlling the volume of loans we sell.
TCF’s largest growth engine in 2013 was Gateway One, an indirect auto loan business acquired in November 2011. Gateway One finished 2013 with loan balances of $1.2 billion, up 124.2 percent from 2012, with an average yield of 4.84 percent. Despite a very competitive environment, loan originations increased 61.5 percent in 2013 to $1.9 billion. In addition, TCF managed concentration risk and generated additional revenue by selling $795.3 million of auto loans in 2013.
Gateway One is led by an experienced management team and now has nearly 8,500 dealer relationships in 45 states. Following a successful integration in 2012, Gateway One has become a key piece of the disciplined growth story at TCF. The portfolio is made up primarily of used auto loans and is well diversified by geography. Credit quality remains strong and the portfolio continues to perform. We are excited about the future growth opportunities with Gateway One.
TCF Inventory Finance balances totaled $1.7 billion at December 31, 2013, up 6.2 percent from the prior year. The loan portfolio has a high average yield of 6.03 percent and has maintained very strong credit quality metrics. TCF entered the inventory finance business in 2008 and now has a well-diversified portfolio with loans in the powersports, lawn and garden, electronics and appliance, recreational vehicle, marine and specialty vehicle markets.
The inventory finance business is unique in the banking industry given its steep barriers to entry including industry expertise. TCF Inventory Finance’s experienced management team and customer service focus have resulted in relationships with several industry-leading manufacturers including BRP, The Toro Company and Arctic Cat, Inc. Celebrating its five-year anniversary in 2013, TCF Inventory Finance continued its focus on customer service while strengthening its relationships with its manufacturers. We continue to look at opportunities to add additional programs and expect to continue to grow the business going forward.
TCF’s leasing and equipment finance businesses continue to be a key part of the TCF lending story. Leasing and equipment finance ended the year with total balances of $3.4 billion, which represents 7.2 percent year-over-year asset growth, driven by continued growth in originations. Portfolio performance during 2013 was exceptional with the leasing and equipment finance provision for credit losses at .03 percent of average earning assets.
The leasing and equipment finance businesses consider investment in information technology to be a strategic differentiator. As such, the businesses implemented a number of system enhancements throughout the year. For example, TCF Equipment Finance received a 2013 Equipment Leasing and Finance Association Operations and Technology Excellence Award for its development and implementation of its “End of Lease Cycle” system which provides dynamic workflow processes for all lease end of term activity. TCF’s leasing and equipment finance businesses represent the 30th largest equipment finance/leasing company in the U.S. and the 15th largest bank-affiliated leasing company.
Consumer real estate loans decreased 5 percent during the year to $6.3 billion. Given the reduction in borrowers meeting TCF’s underwriting criteria and the competition for those that do, TCF’s focus in the consumer real estate portfolio has been on high-quality junior liens originated on a national level. These loans are made to high-FICO borrowers which has resulted in pristine credit quality within the portfolio. TCF has been actively managing the concentration risk in this portfolio by selling a portion of the originations on a quarterly basis. TCF’s home equity line of credit portfolio totaled $2.3 billion at December 31, 2013 with only 10.2 percent reaching maturity or draw period end prior to 2021.
With increased competition in our banking footprint, commercial loan balances declined 7.5 percent during the year to $3.1 billion. We continued to see strong originations in 2013 of $1.6 billion; however, competition in the marketplace has led to elevated levels of prepayments. While TCF has focused on maintaining strong relationships with our current customers, the growth opportunities in our national lending businesses have given us the luxury of selectively choosing commercial loans based on pricing and risk. In March 2012, TCF started TCF Capital Funding, a commercial banking division specializing in asset-based and cash flow lending. This business has been integrated and has met expectations through 2013. Similar to our other businesses, TCF Capital Funding is led by an experienced management team. This business has brought an additional layer of diversity to our loan and lease portfolio.
TCF’s Funding segment provides diverse funding sources to support the growth of our Lending businesses. The Funding segment utilizes a “switches and dials” approach which gives us the ability to generate deposits in a specific product or market through targeted rates or marketing initiatives. This provides greater flexibility in generating appropriate funding.
TCF’s primary funding source is its large low-cost deposit base. Deposit balances totaled $14.4 billion at December 31, 2013, up 2.7 percent from 2012, with an average cost of 26 basis points, down 5 basis points from last year. TCF made several key investments in the deposit side of the bank in 2012 including a $778 million deposit acquisition and the return to free checking. These have both proved to be beneficial in 2013 as we have a more diverse deposit base and have seen 5.9 percent checking account growth since the return to free checking. Also in 2013, TCF placed an emphasis on improving the customer experience through the introduction and upgrades of mobile apps, upgrades to web account openings and online banking, and improved online bill pay. While we will continue to make enhancements to the customer experience, we are now in position to begin introducing new products and services that fit the wants and needs of our customers.
Additional funding sources at TCF include $2.2 billion in unused, secured borrowing capacity at the Federal Home Loan Bank of Des Moines and $201 million in unused, secured borrowing capacity at the Federal Reserve. In 2012, TCF issued preferred stock and subordinated debt which it is using to support asset growth. In addition, we are actively reviewing alternative funding sources such as auto loan securitization.
TCF’s Funding and Lending segments work in close partnership to ensure appropriate funding is generated in a timely manner to meet TCF’s asset growth needs. While TCF continues to enhance and diversify its funding capabilities, we have the structure, processes and flexibility to meet our organizational goals.
TCF invested in several revenue diversification initiatives in 2012 and saw the results in 2013. Total revenue in 2013 was $1.2 billion, down 5 percent from 2012. Excluding the gain on securities from the balance sheet repositioning in 2012, total revenue would have increased 1.1 percent in 2013. As regulatory changes such as Regulation E and the Durbin Amendment impacted banking revenue, TCF took action by repositioning its balance sheet and generating revenue through core loan sales. The balance sheet repositioning has resulted in TCF having one of the highest net interest margins in the industry. TCF’s net interest margin in 2013 was 4.68 percent, up from 4.65 percent in 2012, overcoming the impact of two years of yield compression due to the continued low interest rate environment. TCF also sold $1.6 billion of loans from its auto and consumer real estate businesses for a pre-tax gain of $51.4 million in 2013. This was a revenue source TCF did not have two years ago.
Banking fees and service charges totaled $241.2 million in 2013, a decrease of 5.3 percent year-over-year. The decline was primarily due to a change in customer behavior in which transaction volumes have decreased and average balances have increased. This has been partially offset by an increase in checking accounts due to decreased attrition as a result of the return to free checking. Customer behavior remains an uncertainty moving forward, but we are confident that we can continue to grow the deposit base through our improved customer experience and new product and service initiatives.
Card revenue in 2013 totaled $51.9 million, a 1.4 percent decrease from 2012, and remains significantly below historical levels given the implementation of the Durbin Amendment in 2011. During 2013, the Durbin Amendment debate resurfaced as the Federal Reserve appealed a U.S. District judge’s ruling that the Federal Reserve’s original rule did not cap debit card interchange fees low enough. This creates further uncertainty surrounding interchange; however, TCF’s recent initiatives to diversify its revenue sources have reduced its reliance on card revenue. We will keep a close eye on this issue in 2014.
With these various revenue sources, along with leasing and equipment finance revenue which totaled $92 million in 2013, TCF has a much more diverse revenue base than in past years and less concentration in any one area. We will continue to explore additional revenue opportunities in 2014 and beyond.
After seeing positive signs in 2012, TCF’s credit recovery story really took hold in 2013. Reduced unemployment levels, improving home values and work-outs of problem loans have led to consistent credit improvements within our loan and lease portfolio.
Net charge-offs of .81 percent in 2013 declined 73 basis points from 2012 as home values in our markets showed steady improvement. As a result, provision for loan and lease losses in 2013 totaled $118.4 million, a decrease of 52.2 percent from 2012.
TCF made great strides in reducing its levels of non-accrual loans and leases and other real estate owned during the year. Non-accrual loans and leases declined 27 percent to $277 million. The decrease was impacted by a non-accrual policy change for consumer real estate loans which resulted in an additional $48.6 million of loans moving from over 60-day delinquency to non-accrual status in the third quarter of 2013, partially offset by a $40.5 million sale of non-accrual loans during the second quarter of 2013. Other real estate owned of $68.9 million was down 29 percent from 2012, partially due to a portfolio sale of 184 consumer properties during the first quarter of 2013.
Over 60-day delinquencies, the leading credit indicator for TCF’s consumer real estate portfolio, showed significant improvement during the year with a decrease of 98 basis points to .40 percent. The decrease was impacted by the previously mentioned non-accrual policy change for consumer real estate loans. The leading credit indicator on the commercial side, accruing classified assets, showed similar improvement with a decrease of 30.7 percent to $156.3 million. Meanwhile, TCF’s national lending businesses continue to produce superb credit metrics and meet expectations.
We are pleased with the overall credit improvement we saw in 2013. TCF’s credit recovery has taken longer than many other banks, but has positioned us as one of the few banks that still has further credit leverage. Our national lending businesses have demonstrated the strongest credit quality and are becoming a larger portion of the portfolio. As the economy continues to improve, I am optimistic that we can maintain strong credit quality.
TCF’s total non-interest expense was $845.3 million in 2013, down 38 percent from 2012. Excluding the $550.7 million loss on termination of debt related to the balance sheet repositioning in 2012, non-interest expense increased 4.1 percent in 2013.
Throughout 2012 and 2013, TCF’s expenses grew as a result of increased compensation related to the growth of our national lending businesses, particularly Gateway One and TCF Inventory Finance, as well as elevated regulatory compliance costs associated with the Bank Secrecy Act, stress testing and other initiatives. Compensation and employee benefits expense increased 9 percent in 2013. Compensation in these businesses will remain elevated as we bring them to scale. Meanwhile, foreclosed real estate expense declined 32.4 percent in 2013 to $28 million as a result of improved credit quality and improving home values.
With the strong improvements in credit quality during the year, expense control has become the biggest headwind for TCF as we move into 2014 and beyond. We are laser-focused on addressing this issue. TCF’s goal is to leverage its level of non-interest expense as a percent of average assets from 4.62 percent in 2013 toward 4.00 percent. This will not be an easy task, but there are key steps we can take to achieve this goal. First is continued asset growth as we bring Gateway One to scale. Second are additional reductions in foreclosed real estate expenses as credit quality further improves. Lastly, reviewing and implementing expense reductions will improve efficiencies company-wide. In early 2014, TCF will close nearly 50 branches, many of which are located in supermarkets, which will improve the overall efficiencies of our branch network. While brick and mortar branches remain vital to our business model, traffic in these branches has declined as more customers are utilizing mobile and online banking services. As a result, it is even more important today for us to look at opportunities to make our branch network more efficient for the organization.
TCF feels it is very important to provide monetary and volunteer support to the communities in which we serve. In 2013, TCF and its employees generously contributed over $2.4 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 community.
In addition, TCF supports 20 Minnesota charter schools serving 8,500 students. These strong academic charter schools provide a quality educational opportunity to all, including disadvantaged children. We are proud to support these schools that make such a meaningful difference in the lives of children in our community.
Keys to Future Success
The building and investing in 2012 and the execution in 2013 have positioned us well for the future, but there is more hard work that needs to be done to achieve our goals. Our primary goal as we head into 2014 and beyond is to achieve a return on average assets of 1.25 percent. TCF’s return on average assets in 2013 was .87 percent, up 37 basis points from 2012, excluding the balance sheet repositioning. We are where we need to be on the revenue side of the bank, but we still have a ways to go on the expense side and with the provision. Below are some keys to achieving this goal and other future initiatives:
- Increase revenue while controlling expenses. A focus will continue to be placed on identifying additional sources of revenue while managing expenses by improving business efficiencies.
- Consistent high quality, diversified loan and lease originations. TCF’s recent investments in our national lending platforms have given us the opportunity to generate consistent loan and lease originations while adhering to our conservative underwriting philosophy. We will continue to look for additional asset-generation opportunities.
- Continue to improve the customer experience. TCF expects to further improve the branch customer experience in 2014 through product, service and branding enhancements along with channel optimization initiatives in branch, ATM, online and mobile platforms.
- Continued improvements in credit quality. 2013 was a good year for TCF in terms of improving credit quality. Now we need to ensure that we are able to continue the trends we have seen into 2014. We believe that economic improvement, such as increases in home values, as well as growth in our strong credit quality national lending businesses and a conservative underwriting philosophy will help us achieve this goal.
- Further enhance enterprise risk management. The investments made in our enterprise risk management program in 2013 are already paying off. TCF’s new Chief Risk Officer is making great strides in further enhancing the program. Enterprise risk management will continue to be a company-wide priority.
- Maintain strong capital management. We believe that maintaining a strong capital position will ensure that we are prepared for all marketplace situations and are able to take advantage of marketplace opportunities. We continue to operate in excess of Basel III capital requirements.
- Ensure strong and diverse sources of liquidity. TCF’s funding sources are diverse and include a large core depositor base. Sufficient levels of liquidity are also available, consisting of cash held at the Federal Reserve and unencumbered marketable securities. While maintaining these sources, TCF will continue to explore additional avenues to add further diversity, which will help to ensure that TCF is prepared for future growth opportunities.
- 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
TCF is committed to strong risk management practices that meet our risk appetite and tolerance. TCF’s enterprise risk management program looks to minimize the risks that affect our business.
- TCF’s loan and lease growth is coming primarily from our national lending businesses. TCF has experienced management teams with track records of success in these businesses, but we must grow cautiously while actively managing risk.
- Managing interest rate risk given the possibility of rising rates in the future is a focus of TCF. We are currently well positioned for a rising rate environment as 76 percent of our assets are variable rate or short/medium duration fixed rate. In addition, 71 percent of TCF’s deposits are low or no interest cost with an average balance of $10.3 billion and an average cost of 5 basis points during the fourth quarter of 2013.
- Uncertainty continues to surround the regulatory environment. In particular, the Federal Reserve’s appeal of a judge’s ruling on the Durbin Amendment is still outstanding and the potential impact of the Consumer Financial Protection Bureau on the banking industry is still unknown. TCF will continue to participate in open and effective communication with our regulators.
- Economic risk is still a concern. While unemployment and home values have shown consistent improvement throughout the year, we continue to monitor the economy in our markets and prepare for potential challenges in the future.
- TCF takes great pride in listening to and understanding our customer base; however, customer behavior can change for a number of reasons. In 2013, we saw such changes as declining transaction volumes and increasing average balances. We need to be cognizant of these potential changes and the impact they may have on the business.
TCF lost a great man in 2013 with the passing of former Chief Executive Officer Lynn Nagorske. Lynn’s contributions to TCF and to the community were significant both during his 22 years with TCF and after his retirement. Lynn will forever be remembered for his contributions to TCF, but his passion for his family, his faith and his community will be remembered by those who knew him best. He will be missed.
I would like to thank our Board of Directors for their guidance and dedication. This group has provided exceptional leadership through a challenging banking environment. I especially want to thank Jerry Schwalbach, who has decided to retire from the Board. Jerry has been on the Board since 1999 and has served as Lead Director and Chair of both the Audit and Risk Committees. We appreciate the wealth of valuable leadership and counsel he has provided over the years.
Finally, I would also like to thank our team of employees. They have had much to digest over the past two years and have done a terrific job executing on our strategies and being a liaison between TCF and our customers.
We have operated and continue to operate in one of the most challenging banking environments in history. At TCF, we have had to make difficult decisions. We also had to make significant changes to our business model. As I stand here today, I am proud of the investments we have made over the past two years. We are a much different looking bank than we were prior to the crisis, but I also feel we are now a much stronger and well-rounded bank. I am excited about the team we have in place and opportunities that lie ahead. We believe we are in the sweet spot of banking — just where we want to be.
Thank you for your continued support and investment in TCF.
William A. Cooper
Chairman and Chief Executive Officer
Chairman and Chief Executive Officer