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Dear Stockholders:
2011 was one of the most challenging years I've experienced in my 39 years in the banking industry. For the past couple of years, we have all believed that the "next year" will be the year everything turns around. This has not proven to be the case as economic issues such as high unemployment and deflated home values have shown minimal improvement. Also, legislation such as the Dodd-Frank Act, is negatively impacting revenues. In addition, record low interest rates are impacting the margin. All in all, the banking industry is changing and it will be those banks that can adapt and stay ahead of the curve that will come out ahead.
2012 will be a year in which we pro-actively build and invest in TCF's future, regardless of the state of the economy. An evolution is already taking place at TCF that will position us to take advantage of new marketplace opportunities and be successful in the changing banking environment. We are now focused on growing our diversified regional and national lending businesses funded by a regional, core deposit platform. We have implemented a new functional management structure that will better support this growth strategy.
Despite this evolution of TCF, we are committed to staying true to the conservative banking philosophy that has made TCF the successful and profitable company it is today. This year marked TCF's 21st consecutive year of profitability. Our commitment to convenience, conservative underwriting, and secured and diversified loan and lease portfolios are just part of the philosophy that has been the foundation of our company for so many years. I believe that applying this philosophy to the changing banking environment will allow us to stay ahead of the curve and make TCF a premier investment choice.
A Look at 2011
Throughout 2011, we continued to see the same economic problems that have affected us since the financial crisis began. It is important to remember that the current financial crisis we are experiencing was largely the result of the risky lending practices demonstrated by many of our peers. TCF is not entirely blameless for some of the problems we have experienced. For example, we should have foreseen the burst of the rapidly expanding housing bubble. However, we did not engage in many of the risky activities used by other financial institutions.
As a result of the continued implementation of legislative and regulatory requirements, TCF again spent a significant amount of time and money, not only on compliance, but researching and implementing various new strategies to allow us to be successful in the new banking environment. Considerations of strategic shift include the following:
Durbin Amendment Impact TCF spent a great deal of effort with its legal challenge of the constitutionality of the Durbin Amendment and its impact on debit card interchange. While we ultimately decided to drop our lawsuit, we felt that it highlighted many key areas of concern in the Durbin Amendment that proved to be a factor in the Federal Reserve's final rule allowing for banks to receive more than double the interchange compared to their initial proposed rule. That being said, the Durbin Amendment will still cost TCF approximately $60 million per year in lost interchange revenue. We have to look to recover this lost revenue where we can.
Asset Growth and Diversification As a result of competition from large national banks in our markets, it has become more difficult for regional banks to continue to add high-quality loans and leases within a regional footprint. To be successful, regional banks must be able to make loans on a national platform. As a result, over the last several years TCF has begun shifting its lending focus toward its already successful national niche lending programs. These national platforms include equipment finance, inventory finance, mortgage lending and now auto finance. In 2011, TCF announced an agreement to provide inventory financing to the dealers of Bombardier Recreational Products, Inc. (BRP) in the U.S. and Canada as well as an acquisition of Gateway One Lending & Finance, Inc. (Gateway One), an indirect auto finance company headquartered in California. While these new programs will result in additional operational risks, I am confident that with the extensive due diligence completed, their experienced management teams, and TCF's successful track record of integrating and operating national specialty finance programs, we will be able to manage these risks. These high-quality, secured lending programs will provide TCF with an avenue for growth in 2012. These new programs will be a great complement to our current specialty finance portfolio and accretive to our business, all while staying true to our conservative lending philosophy.
Functionally Organized Management Structure As a result of the evolution taking place at TCF, it was necessary to reevaluate the responsibilities of our experienced executive management team to more efficiently manage and implement strategies moving forward. Our new functionally organized management structure will allow us to better manage our four key initiatives: 1) Enterprise Risk Management, 2) Lending, 3) Funding and 4) Corporate Development. This structure is well suited to both protect and increase shareholder value into the future.
TCF continued its consistency of profitability in 2011, earning $109.4 million, down 28 percent from 2010. Diluted earnings per common share was $.71. These results remain below TCF's historical performance while we continue to operate in a difficult economic and regulatory environment. With the continued evolution of TCF and a slowly improving economy, I look forward to improving these results.
TCF's net interest margin was 3.99 percent for the full year of 2011, down 16 basis points from the full year of 2010. In 2011, we continued to take actions to increase the asset sensitivity of the balance sheet, such as changing the mix of fixed- and variable-rate loans, in anticipation of rising interest rates. Despite recent guidance from the Federal Reserve suggesting rates will likely not rise until late 2014, rates will eventually rise and we will be ready to take advantage when they do. In the meantime, with our increased focus on national specialty finance programs, we have laid the groundwork for significant growth in our higher-yielding portfolios. Overall, TCF's net interest margin continues to be strong when compared to the Top 50 Banks.
On March 15, 2011, TCF raised gross proceeds of $230 million through a public common stock offering of 15,081,968 shares. As we have done in the past, we chose to take advantage of market conditions and raised the capital when we could. This additional capital allowed us to pay off our senior unsecured notes and continue the growth of our very successful specialty finance businesses. TCF's capital management strategy is prudent and provides flexibility to take advantage of balance sheet opportunities.
With TCF's annual dividend rate of $.20 per share in 2011, TCF has paid a common stock dividend 95 consecutive quarters. When capital accumulation from earnings exceeds capital required for asset growth and risk parameters permit, TCF will raise its dividend. We actively review these factors on a quarterly basis as returning capital to our stockholders remains an important part of how we deliver value.
TCF is financially strong and remains a safe and sound bank. We are solidly capitalized and have ample liquidity to conduct business. TCF's tangible realized common equity, which we feel is the most important capital metric, was $1.6 billion, or 8.42 percent of tangible assets at December 31, 2011. We continue to exceed all well-capitalized requirements as defined by the regulatory agencies. At December 31, 2011, TCF had $647.3 million of total risk-based capital in excess of the stated well-capitalized requirement. We also anticipate exceeding the minimum standards under the Basel III capital guidelines.
At December 31, 2011, TCF's stock price closed at $10.32 per share, down from $14.81 per share on December 31, 2010. Several key factors weighed heavily on stock prices across the industry in 2011, including regulatory uncertainty such as the Durbin Amendment and macroeconomic concerns including depressed home values, elevated unemployment and the European debt crisis. Until the economy shows more consistent signs of improvement, pressure on the stock price may continue.
Retail Banking
TCF's Retail Banking division consists of branch banking and retail lending. In branch banking, our focus has been on growing low-cost deposits to fund both our regional and national lending programs. Similar to 2010, we have recently spent a significant amount of time developing products that can help increase the level of convenience for our customers in the ever-changing competitive environment. Deposit balances totaled $12.2 billion at year-end, up 5.3 percent from 2010.
We are committed to providing our customers with the most convenient products possible, including the launch of free TCF Mobile Banking in early 2011. Our recent product changes have increased the simplicity and convenience to our customers with the intention of also increasing profitability for the bank, however, changes to our deposit account products are still evolving. We are currently evaluating additional ideas and expect to make further enhancements in 2012.
Retail lending loan balances totaled $6.9 billion at year-end, down 3.7 percent from 2010. With the continued depressed home values and a more competitive environment for borrowers who meet TCF's underwriting criteria, we have reduced the consumer real estate portfolio and made investments in other higher-yielding asset categories. Despite the current economic conditions, TCF continued to fund new consumer real estate loans to credit-worthy customers during 2011. The new loans have performed well with low delinquencies and minimal charge-offs. We expect to have more opportunities to add loans in this portfolio as home values stabilize.
Wholesale Banking
TCF's Wholesale Banking division consists of commercial banking and specialty finance (TCF Equipment Finance, Winthrop Resources Corporation, TCF Inventory Finance and Gateway One). Loan balances decreased 5.4 percent in our commercial portfolio, which totaled $3.4 billion at year-end, largely due to higher levels of payments exceeding increased new origination volume. Demand for commercial loans has remained somewhat tempered by the sluggish economy but we are seeing some signs of growing demand. We saw many of our peers being much more competitive from a pricing perspective on the commercial deals that were available during the year. As a result of our various avenues for asset growth in specialty finance, we have not been forced to compete for deals with substandard pricing. Overall, our commercial portfolio is performing well in the current economic environment largely as a result of our conservative underwriting philosophy and our commitment to relationship banking with long-term customers.
Loan and lease balances in specialty finance decreased 4.5 percent to $3.8 billion at year-end. In specialty finance, home to TCF's highest yielding loans and leases, we were able to minimize concentration risk by diversifying our businesses by industry, transaction size, geography and collateral type. We continue to emphasize specialty finance as a key vehicle for asset growth because of our proven expertise in acquiring, integrating and operating these national niche businesses.
TCF's leasing and equipment finance business balances decreased by.4 percent from 2010 as past portfolio purchases continue to run off. Excluding this run-off activity, the core portfolio continues to grow as balances increased 6 percent from 2010. Our $3.1 billion leasing and equipment finance portfolio is well-diversified by equipment type, transaction size and geography. Our leasing and equipment finance operation, which is comprised of TCF Equipment Finance and Winthrop Resources Corporation, is the 28th largest in the U.S. and the 13th largest bank-affiliated leasing company in the U.S. Despite the overall decrease in leasing and equipment finance balances, 2011 originations were up 19.2 percent from 2010. Future growth opportunities are strong as we have an uninstalled backlog of $455.3 million at year-end. The portfolio is currently yielding 6 percent.
TCF Inventory Finance, Inc. (TCFIF) continues to be a business where we are seeing opportunity for growth. TCFIF ended the year with a portfolio balance of $625 million, down 21.2 percent from 2010, at an average yield of 7.19 percent. The portfolio decrease during the year was largely due to the termination of a lawn and garden program and the transitioning of an electronics and appliance program to a servicing-only program. Following the entrance into the powersports industry in 2010 with the acquisition of Arctic Cat® Canadian powersports equipment floorplan programs, TCF built on its powersports market share in 2011 through an agreement with BRP to finance BRP's Ski-Doo®, Sea-Doo® and Can-Am® dealers across the U.S. and Canada. The BRP agreement has the potential for approximately $600 million in average net receivables when the program matures. In addition, TCFIF entered the recreation vehicle and marine products industries in 2011 through agreements with Jayco, Inc. and Alumacraft Boat Co. in 2011.
TCFIF, which TCF started in 2008, is now becoming a significant player in the inventory finance marketplace. TCFIF has proven that it can provide excellent service and financing for some of the largest manufacturers in their respective industries. Our proven track record is now resonating with some of the smaller manufacturers as well. Our increased presence and credibility in the market will only help as we continue to grow this profitable business for TCF. We are continuing to pursue future programs as well as renew contracts with existing manufacturers in a very competitive market.
In November 2011, TCF acquired Gateway One Lending & Finance. Gateway One originates and services primarily used retail auto loans acquired from over 3,400 franchised and independent dealers across the country. The acquisition of Gateway One was another step toward the further diversification of TCF by growing high-quality assets with strong risk-adjusted returns through national specialty finance lending programs in the second largest consumer finance market in the U.S. The lower cost of funding that TCF provides will allow Gateway One to reach more dealers and compete for higher quality loans. The experienced management team from Gateway One, along with the TCF's proven track record of integrating and operating these types of businesses, make this acquisition an ideal fit.
At December 31, 2011, Gateway One had managed assets totaling $437.7 million and loan balances of $3.6 million. We expect to see asset balances ramp up throughout 2012 with start-up expenses in the near-term. Gateway One will be an important component of TCF's 2012 success.
Credit Quality
While we started to see some stabilization, credit losses continued to be a challenge for TCF in 2011 and impacted TCF's results. Net charge-offs decreased only 2 percent, or 2 basis points, in 2011. Overall, credit metrics showed some improvement from peak 2010 levels, but until we see unemployment decline and home values start to recover, credit costs are likely to remain elevated.
Non-performing assets declined steadily throughout 2011, down $53.1 million, or 10.9 percent, from 2010 and have now decreased five consecutive quarters. This decline in non-performing assets is primarily due to decreases in commercial and leasing and equipment finance non-accrual loans and leases.
Despite the continued economic stress on unemployment and home values, we saw some stabilization in consumer real estate delinquencies. To help our customers avoid home foreclosure, TCF has continued its program of providing loan modifications which are accounted for as troubled debt restructurings (TDRs). The TDRs extend payment dates, reduce interest rates and/or reduce payment amounts for a term of up to five years. These TDRs are underwritten individually. Our goal is to extend these TDRs to customers who can make a payment and truly want to stay in their homes.
At December 31, 2011, TCF held $433.1 million of accruing modified consumer TDRs, up 28.4 percent from 2010, with a weighted average interest rate of 3.7 percent. The TDR reserves are based on the present value of expected cash flows, or 13.5 percent, with a fourth quarter annualized net charge-off rate of 6.5 percent. To date, these TDRs are performing as expected and have proven to be an effective way to help mitigate losses.
TCF's Wholesale Banking division saw some credit stabilization throughout 2011. Commercial net charge-offs and provision tend to be lumpy as credits are worked out, especially in this challenging workout environment. Overall, our specialty finance loans and leases continue to perform very well. We continue to closely monitor our wholesale customers, and in particular, those customers in distressed industries and geographies. Our relationship banking strategy provided us with the ability to effectively work out many distressed loans. Wholesale Banking continues to be a very profitable, well-managed and highly diversified segment.
Real estate owned properties decreased throughout 2011. This was an encouraging sign as the length of time in the foreclosure process continues to be lengthy. At December 31, 2011, TCF owned 465 consumer real estate properties and 33 commercial real estate properties, compared with 520 and 28 properties, respectively, at December 31, 2010.
At December 31, 2011, TCF's allowance for loan and lease losses totaled $255.7 million, or 1.81 percent of loans and leases, a decrease of $10.1 million from December 31, 2010. The decrease in allowance for loan and lease losses was primarily due to charge-offs of commercial loans during the first quarter of 2011 that had previously been specifically reserved for. TCF's provision for credit losses of $200.8 million decreased 15.1 percent from last year.
Overall, we saw some good signs of credit stabilization in 2011, not the least of which was the consistent decline in non-performing assets. That being said, we still experienced elevated levels of credit losses and delinquencies due to the persistent economic conditions. We are encouraged by the trends and feel we are on the right track, but ultimate success will only occur when the economy gets back on track.
Revenue
TCF's total revenue in 2011 was $1.1 billion, down 8 percent from last year with net interest income remaining flat and non-interest income decreasing 17 percent.
Banking fees and service charges declined 20 percent from 2010 primarily due to the full annual impact in 2011 of Regulation E, the opt-in regulations regarding ATM transactions and one-time debit card transactions that became effective in August 2010. While I feel TCF did a good job educating customers on opt-in, this regulation still had a sizeable impact on overdraft revenue in 2011. The full impact is now built in and the opt-in initiative is largely behind us. The fee revenue lost to Regulation E was partially offset by the implementation of monthly maintenance fees for retail customers not meeting certain account criteria. In late 2011, we implemented the new fee waiver criteria which included a minimum of 15 qualifying transactions per month to waive the monthly maintenance fee. This product is different than many of our competitors. Instead of requiring a high minimum balance, we are just asking that our customers simply use their account.
TCF's card revenue of $96.1 million in 2011 was down 13 percent from 2010, which was attributable to the implementation of the Durbin Amendment in October 2011. The impact of the Durbin Amendment in the fourth quarter of 2011 resulted in decreased revenue of $14.7 million.
Leasing and equipment finance continued to be an important revenue source for TCF in 2011. These revenues totaled $89.2 million, which remained flat compared with 2010.
Expenses
TCF's operating expenses were again very well controlled in 2011. We continued to streamline our business processes and operations to make them as efficient as possible. Our new functionally organized management structure will provide more opportunities for TCF to improve efficiencies and reduce operating expenses moving forward. During the third quarter of 2011, TCF discontinued its debit card reward program as a result of the implementation of the Durbin Amendment. We continue to look for additional expense savings opportunities as a way to help contribute to the bottom line in the challenging economic and regulatory environment.
Non-Interest expense totaled $764.5 million in 2011, up slightly from 2010. We saw increased FDIC insurance expenses related to changes in the rate calculations for banks over $10 billion in total assets, which were implemented in April 2011. Foreclosed real estate and repossessed asset expenses also increased in 2011 primarily due to valuation writedowns on commercial real estate.
Even during this difficult operating environment, TCF remains 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.
TCF also continues to support the communities in which we serve, both financially and through volunteerism. During 2011, TCF and its employees contributed nearly $2.8 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. TCF and its employees continue to express a commitment to make a difference for people in need and for the communities we serve.
Keys to Success in 2012
In 2011, TCF laid the groundwork for success in 2012. We have taken proactive steps to position ourselves for success in the future. This process will continue into 2012. While 2011 was a transition year for TCF, 2012 will be a building and investing year. Below are some of the keys to success for TCF in 2012:
Execute strategy of growing assets through national lending programs. TCF made significant investments in this strategy in late 2011 with the addition of BRP's inventory finance program and the acquisition of the Gateway One auto lending business. In 2012, we will need to successfully integrate these businesses to take advantage of the growth prospects they provide. Our new management structure will make this process much more efficient. We must also continue to look for additional asset growth opportunities in specialty finance. Our proven track record and increased credibility in the industry will benefit us with this initiative.
Implement company-wide, revenue-producing and expense reduction strategies. We must successfully implement various revenue-producing and expense reduction strategies throughout the company. Revenue-producing strategies could include new deposit account products and features as well as revenues related to TCF's new specialty finance programs. The implementation of new deposit account products will be influenced by the competitive landscape as a whole. Expense reductions will likely come from various productivity enhancements. As the economy improves, there will also be opportunities to reduce credit costs, such as foreclosed real estate expenses.
Carefully monitor credit quality. It will be important for TCF to stay true to our conservative lending philosophy. We are a secured and diversified lender with conservative underwriting and this will continue going forward. We will continue to extend loan modifications to qualified borrowers and work through commercial real estate non-performing assets in this challenging environment. In 2012, we expect to see continued declines in non-performing assets through sales of real estate owned, paydowns and loans returning to accrual status based on performance. We also expect delinquencies and charge-offs to remain elevated in the near-term due to the sluggish economy. Despite our efforts, we will need to see significant improvement in the economy to see more substantial improvement in credit quality.
Demonstrate strong enterprise risk management. In today's regulatory environment, a strong enterprise risk management program is essential. At TCF, we have enhanced our program under our new management structure. It will be important to appropriately manage our risks and maintain clear and open communication with our regulators.
Use capital wisely. TCF is solidly capitalized. We will continue to be good stewards of our stockholders' capital and think in terms of the best long-term interest of the company. It will be important that we prudently monitor our capital position to ensure we are in a position to take advantage of various balance sheet opportunities. Prudent capital management, which includes making wise investment decisions, is a top priority as well as staying cognizant of maintaining a strong liquidity position for unanticipated situations.
Monitor corporate development opportunities. Under the new functionally organized management structure, corporate development will be key. With this evolution of TCF comes the need for an executive presence to oversee corporate development issues on both the asset and liability sides of the balance sheet, as well as evaluate potential new business lines. In 2012, we must actively monitor and be ready to act on these opportunities that will increase stockholder value.
Continue our longstanding commitment to strong corporate governance. Our customers and stockholders entrust us with their money and confidential information and therefore, our management practices demand the highest of standards. Reputation for honesty and integrity continues to rank at the top of our priorities.
Risks to Our Business Strategy
Congressional and regulatory actions continue to produce a cloud of uncertainty over the banking industry. While the Durbin Amendment has been implemented, uncertainty continues as Congress has introduced a bill to repeal it while the retailers have filed a lawsuit stating the Federal Reserve did not reduce debit card interchange enough.
The economic climate remains a major risk for all banks, including TCF. Unemployment and depressed home and commercial real estate values reduce consumer spending and loan demand, which impacts the ability of banks to generate fee income and earn interest on new loans.
The competitive landscape in the banking industry is changing. With banks exploring various ways to recover lost revenue, trends may emerge with the types of fees charged going forward. Fee strategies may be impacted by the changes we make as well as the ensuing public perception. We already saw this in 2011 when public outcry caused Bank of America to back off of their plan to charge a debit card usage fee.
With the current economy and TCF's changing product structure, customer behavior is still an unknown and could impact future fee revenue. We spent time researching, testing and piloting our various product changes but it generally takes an extended period of time to fully understand how customer behavior will respond in the long run. This will be the case with any additional changes we make. We will monitor how our customers respond and react accordingly.
Managing interest-rate risk and the continued low levels of interest rates with an eye toward the possibility of rapidly increasing inflation continues to be a challenge.
Potential reductions in our borrowing capacity because of restrictions put on the Federal Home Loan Banks or the Federal Reserve Discount Window could reduce our liquidity and inhibit growth or force higher deposit costs. Growing core deposits reduces this risk.
Growth expectations of our new specialty finance businesses may not be achieved. While we have the track record and experience to successfully operate national specialty finance businesses, the ability to retain existing business relationships and attract new customers is challenging in the current competitive environment. We will also have to work to mitigate the integration and operational risks associated with these new businesses.
In Closing
Despite the troubled economy and legislative and regulatory environment, TCF has continued to be a profitable and successful bank. Our conservative philosophy and hard work have made us the bank we are today and this will not change. The business strategies around this philosophy and hard work are evolving to allow us to stay ahead of the curve in the newly forming banking environment. Given the new wave of regulations, it is not likely banks will ever be as profitable as they once were. But this will not stop us from positioning ourselves to continue to be successful and profitable as times change.
I am confident and excited about the direction we are heading. Once our new specialty finance programs fully take off in the second half of 2012, I think we will be in a great position for growth and success. My role at TCF has been and will continue to be to maintain and increase stockholder value.
We continue to have a mutuality of interest with our stockholders. Our senior management and board of directors own over 6.8 million shares, or 4.3 percent of TCF stock. Eighty percent of our match-eligible employees participate in TCF's Employees Stock Purchase Plan, which at year-end held over 8.2 million shares.
I would like to take a moment to thank our board of directors for their hard work and guidance. I am very proud of this group. I especially want to thank Ralph Strangis and Luella Goldberg, who decided to leave the board in early 2012. Ralph and Luella have each served on TCF's board of directors for 20-plus years and have provided invaluable contributions to TCF and our stockholders during their tenure. We appreciate the exceptional leadership and guidance they have provided over the years.
With these changes come opportunities to welcome new members to the board. During the past year, we welcomed Jim Ramstad to the board of directors. Jim brought with him a wealth of knowledge and experience in the political arena from his nine terms as a Minnesota Congressman in the U.S. House of Representatives. In addition, Tom Jasper and Craig Dahl were also added to the board of directors at the beginning of 2012. Tom has previously served as TCF's Chief Financial Officer and has now assumed the role of Vice Chairman of Funding, Operations and Finance. Craig was previously Executive Vice President overseeing TCF's specialty finance division and will now take over as Vice Chairman of Lending. I am excited about these new additions to the board and welcome their insights and counsel.
I would also like to give a special thank you to all of our employees for all of their hard work during another challenging year. Without their hard work and dedication, TCF would not be able to provide a high level of convenience and service to our customers and the returns to our stockholders. I am proud of our team and the accomplishments we have achieved in 2011 and I look forward to a successful 2012.
Thank you for your continued support and investment in TCF.
William A. Cooper
Chairman and Chief Executive Officer
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