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TCF Financial Corporation (TCB - Analyst Report) reported third quarter 2012 net income of 19 cents per share, marginally beating the Zacks Consensus Estimate by 2 cents. However, results compared unfavorably with net income of 20 cents in the prior quarter.

Including after-tax charge of $20.6 million or 13 cents per share, based on the impact of the implementation of the clarifying regulatory guidance, net income stood at $9.3 million or 6 cents per share.

Improved net interest income coupled with reduced non-interest expenses were the positives for the quarter. Moreover, continued positive impact of the balance sheet repositioning in the prior quarter added fuel to fire. Yet, lower non-interest income and deteriorating credit quality were the dampeners.

Performance in Detail

TCF Financial reported total revenue of $332 million in the quarter, up 0.3% sequentially, attributable to higher interest income, partially offset by lower non-interest income. Moreover, the results outshined the Zacks Consensus Estimate of $299.0 million.

Net interest income climbed 1.2% sequentially to $200.6 million. The augmentation was driven by higher average balance of auto finance loans, partly offset by seasonally lower average balance of inventory finance loans. Moreover, decline in interest expense due to the redemption of $115 million of Trust Preferred securities during the quarter acted as a positive. Net interest margin was 4.85%, contracting 1 basis point (bp) sequentially.

Non-interest income came in at $112.1 million, down 0.7% sequentially. The decrease was primarily attributable to reduced banking fees and service charges coupled with lower card revenues.

TCF Financial reported non-interest expenses of $196.8 million, down 3.1% sequentially from $203 million. Reduced deposit account premiums and decline in foreclosed real estate and repossessed asset expenses led to decrease in expenses.

Evaluation of Credit Quality

With the increased level of non-performing assets in the quarter, due to the adoption of clarifying bankruptcy-related regulatory guidance, which led to rise in consumer real estate non-accrual loans, credit quality deteriorated on the whole.

Provisions for credit losses climbed 77.9% sequentially to $96.3 million, owing to increased provision expense on commercial loans and additional provision recorded for consumer real estate loans associated with the adoption of clarifying bankruptcy-related regulatory guidance.

Net loan and lease charge-offs were $104.5 million in the quarter, up 132.8% sequentially. The rise compared to the prior period was mainly attributable to the upsurge in commercial real estate net charge-offs. This includes the additional net charge-offs of $43.9 million related to the implementation of bankruptcy-related regulatory guidance.

Moreover, non-accrual loans and leases climbed 30% sequentially to $421.8 million, driven by a rise in consumer non-accrual loans due to the adoption of clarifying bankruptcy-related regulatory guidance. However, allowance for loan and lease losses declined to $264.8 million, down 3.4% sequentially.

Capital Position

As of September 30, 2012, the company’s total risk-based capital was $1.9 billion, or 12.96% of risk-weighted assets, down from $2.0 billion, or 14.80% of risk-weighted assets at the end of 2011. Tier 1 risk-based capital was $1.5 billion, or 10.40%, down from $1.7 billion, or 12.67% of risk-weighted assets as of December 31, 2011.

The tier 1 leverage ratio surged to 8.66% from 8.64% in the prior quarter, while tier 1 common capital ratio declined to 9.17% from 9.26% in the last quarter.

As of September 30, 2012, total deposits grew 3.9% sequentially and 12.5% year over year to $13.6 billion. Period end loans and leases were $15.2 billion slightly up sequentially and 6.1% year over year.

Dividend Update

Concurrent with the press release, TCF Financial declared a quarterly cash dividend of 5 cents per common share. The dividend will be paid on November 30, 2012 to stockholders of record as on November 15, 2012.

Peer Performance

Among TCF Financial’s peers, Commerce Bancshares, Inc. (CBSH - Analyst Report) reported third quarter 2012 earnings of 75 cents per share, lagging the Zacks Consensus Estimate by 2 cents. This compares unfavorably with the prior quarter’s earnings of 80 cents per share, but favorably with the year-ago quarter’s earnings of 72 cents.

The sequential improvement was due to higher non-interest income and a decrease in operating expenses, partially offset by a lower net interest income. Moreover, credit quality and capital ratios continued to show improvements.

Our Viewpoint

In March 2012, TCF Financial repositioned its balance sheet with the prepayment of $3.6 billion of long-term debt. Moreover, it sold $1.9 billion of mortgage-backed securities. The restructuring of the balance sheet has reduced interest rate risk of the company and is expected to be more accretive to net interest margin in the coming quarters.

We expect the company to maintain its superior position in the market based on its positive approach to market conditions and improving net interest income. Moreover, a healthy capital position is indicative of the company’s robust standing. Additionally, reduced operating expenses reflect prudent expense management. However, the regulatory reforms might affect the company’s near-term results to some extent.

TCF Financial currently retains its Zacks #3 Rank, which translates to a short-term Hold rating.

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