UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

þ	Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2012

¨	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission File Number 001-33063

CITIZENS REPUBLIC BANCORP, INC.

(Exact name of Registrant as specified in its charter)


MICHIGAN		38-2378932
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

328 S. Saginaw Street, Flint, Michigan		48502
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (810) 766-7500

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Name of exchange on which registered

Common Stock, no par value

7.50% Trust Preferred Securities

(issued by Citizens Funding Trust I)

The NASDAQ Capital Market^®

New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

none

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þ

The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2012 was $679,082,450. For purposes of this computation, all officers, directors and 10% beneficial owners of the registrant are assumed to be affiliates. Such determination should not be deemed an admission that such officers, directors and beneficial owners are, in fact, affiliates of the registrant.

The number of shares outstanding of the registrant’s no par value common stock as of February 15, 2013 was 40,494,598.

DOCUMENTS INCORPORATED BY REFERENCE

None

CITIZENS REPUBLIC BANCORP, INC.

2012 Annual Report on Form 10-K

TABLE OF CONTENTS


		Page
PART I
Item 1.	Business		3
Item 1A.	Risk Factors		14
Item 1B.	Unresolved Staff Comments		27
Item 2.	Properties		27
Item 3.	Legal Proceedings		27
Item 4.	Mine Safety Disclosures		28

PART II
Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		29
Item 6.	Selected Financial Data		31
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		33
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk		74
Item 8.	Financial Statements and Supplementary Data		74
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		134
Item 9A.	Controls and Procedures		134
Item 9B.	Other Information		137

PART III
Item 10.	Directors, Executive Officers and Corporate Governance		137
Item 11.	Executive Compensation		142
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		174
Item 13.	Certain Relationships and Related Transactions, and Director Independence		177
Item 14.	Principal Accounting Fees and Services		177

PART IV
Item 15.	Exhibits and Financial Statement Schedules		179

SIGNATURES			180

EXHIBIT INDEX			182

PART I

ITEM 1.

BUSINESS

Unless the context indicates otherwise, all references in this Form 10-K to “Citizens,” the “Corporation,” “we,” or “our,” refer to Citizens Republic Bancorp, Inc. and its subsidiary. References to the “Holding Company” refer to Citizens Republic Bancorp, Inc. alone. Citizens’ common stock is traded on the NASDAQ (“NASDAQ”) Capital Market^® under the symbol “CRBC.” Citizens’ principal executive offices are located at 328 South Saginaw Street, Flint, Michigan 48502, and the telephone number is (810) 766-7500. Citizens maintains an internet website at www.citizensbanking.com where the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports are available without charge, as soon as reasonably practicable after Citizens files each such report with, or furnishes it to, the U.S. Securities and Exchange Commission (the “SEC”), which are also available at the SEC’s website www.sec.gov. The information on Citizens’ website does not constitute a part of this report. Investors may also contact Investor Relations at the corporate address listed above to receive copies of these reports without charge.

GENERAL

Citizens Republic Bancorp, Inc. was incorporated in the State of Michigan in 1980 with roots dating back to 1871. Citizens is a diversified banking and financial services company that is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). Citizens provides a full range of banking and financial services to individuals and businesses through its banking subsidiary, Citizens Bank (the “Bank”). These services include deposit products, loan products, and other consumer-oriented financial services such as safe deposit and night depository facilities, wealth management services and Automated Teller Machines (“ATMs”). Among the services designed specifically to meet the needs of businesses are various types of specialized financing, treasury management services, and transfer/collection facilities. Citizens is not dependent upon any single or limited number of customers, the loss of which would have a material adverse effect on Citizens. No material portion of the business is seasonal.

RECENT DEVELOPMENTS

On April 19, 2012, Citizens announced that, effective April 17, 2012, the Federal Reserve Bank of Chicago (FRBC) and the Michigan Office of Financial and Insurance Regulation (OFIR) terminated their written agreement with Citizens, and our subsidiary, Citizens Bank dated July 28, 2010.

The Written Agreement required the boards of directors of the Holding Company and the Bank to undertake various assessments and submit by specified dates in 2010 a number of plans acceptable to the FRBC and OFIR in connection with the following matters.

•

Allowance for Loan and Lease Losses

•

Compliance Committee

•

Staffing Plans

•

Credit Risk Management Practices

•

Credit Administration

•

Asset Improvement

•

Capital Plan

•

Liquidity Position Management

On September 13, 2012, Citizens and FirstMerit Corporation (“FirstMerit”) announced the signing of an agreement and plan of merger, dated as of September 12, 2012 under which FirstMerit would acquire Citizens in a stock-for-stock merger transaction (the “FirstMerit Merger”). Under the terms of the merger agreement, holders of Citizens common stock will receive 1.37 shares of FirstMerit common stock in exchange for each share of Citizens common stock.

Subject to receipt of requisite approvals, FirstMerit is also required to repay at closing Citizens’ approximately $355 million of TARP preferred stock, which includes $55 million of estimated deferred dividends, held by the U.S. Treasury. The merger has been unanimously approved by the Boards of Directors of both Citizens and FirstMerit and is subject to customary closing conditions, including receipt of regulatory approvals and approval by both companies’ shareholders. The transaction is expected to close in the second quarter of 2013.

On December 10, 2012, Citizens announced that it would resume interest payments on its outstanding junior subordinated debentures relating to its two trust preferred securities. Regularly scheduled quarterly interest payments were deferred in January 2010 although Citizens continued to accrue for the obligations. Payment on the variable rate junior subordinated debenture issued on June 26, 2003 due June 2033 (“2003 Debenture”) was made on December 26, 2012 for the 12 payments due or deferred plus interest and dividends on the associated trust preferred securities were made to holders of record on December 15, 2012. Payment on the 7.50% junior subordinated debentures issued on October 3, 2006 due September 2066 (the “2006 Debenture”) (NYSE: CTZ-PrA) along with dividends on the associated trust preferred securities will be made in March 2013. In the aggregate, Citizens’ accrued obligation for these deferred payments was approximately $12 million. Citizens intends to resume the regular quarterly interest payment schedule.

GEOGRAPHIC LOCATIONS

Citizens conducts operations through 219 offices and 248 ATM locations throughout Michigan, Wisconsin, and Ohio with 1,973 full-time equivalent employees as of December 31, 2012. In Michigan, the primary markets are concentrated in the Lower Peninsula, primarily in the Mid-Michigan and Southeast Michigan areas, with a small presence in the Upper Peninsula. In Wisconsin, the primary markets include the greater Green Bay Metropolitan area, the Fox Valley region which extends from Appleton to Oshkosh, suburban Milwaukee, and also rural markets in southern and northern Wisconsin. In Ohio, the primary market is the greater Cleveland area. All of Citizens’ assets are located in the United States.

PRINCIPAL SOURCES OF REVENUE

Citizens’ primary source of revenue is interest income. The table below shows the amount of total consolidated revenues resulting from interest and fees on loans, interest and dividends on investment securities, money market investments, FHLB and Federal Reserve stock, and noninterest income for each of the last three years:


(in thousands)	2012		2011		2010
Interest and fees on loans	$	293,782	$	312,746	$	390,587
Interest and dividends on investment securities, money market investments, FHLB and Federal Reserve stock		78,146		95,073		93,857
Noninterest income		92,320		95,257		94,659

Total revenues	$	464,248	$	503,076	$	579,103

Citizens’ revenue tends to be influenced by overall economic factors, including market interest rates, business spending, consumer confidence, and competitive conditions within the marketplace, as well as residential housing markets in the communities Citizens serves.

LINES OF BUSINESS

Citizens’ performance is monitored by an internal profitability measurement system that provides line of business results and key performance measures. Citizens operates along five major business lines: Regional Banking, Specialty Consumer, Specialty Commercial, Wealth Management, and Other. The Regional Banking, Specialty Consumer, and Specialty Commercial business lines are involved in lending activity. Lending involves credit risk which is controlled and monitored through active asset quality management, the use of lending standards, and thorough review of potential borrowers. Credit risk management is discussed in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the captions “Critical Accounting Policies,” “Loan Portfolio,” “Credit Risk Management,” “Nonperforming Assets,” “Allowance for Loan Losses,” and “Contractual Obligations and Off-Balance Sheet Arrangements” and under Notes 1, 3, 4, and 16 to the Consolidated Financial Statements.

Additional information regarding the business lines is incorporated herein by reference from “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Line of Business Results” and in Note 15 of the Consolidated Financial Statements.

COMPETITION

The financial services industry is highly competitive. Citizens Bank competes with other commercial banks, many of which are subsidiaries of other bank holding companies, for loans, deposits, trust accounts and other business on the basis of interest rates, fees, convenience and quality of service. Major competitors include commercial banks, community banks, savings associations and thrifts, finance companies, mortgage banking companies, brokerage firms, insurance companies, credit unions and other organizations.

Mergers between financial institutions and the expansion of financial institutions both within and outside of the primary Midwest banking markets have provided significant competitive pressure in those markets. In addition, the passage of Federal interstate banking legislation has expanded the banking market and heightened competitive forces. The effect of this legislation is further discussed under the caption “Supervision and Regulation.”

Many of Citizens’ offices are located in small cities and rural areas that have diverse economies and a mix of manufacturing, service, retail and agricultural businesses. In many of these localities, Citizens is the largest bank, which we believe is a competitive advantage. In other markets, Citizens’ competitors may enjoy a competitive advantage, including greater financial resources, more aggressive marketing campaigns, better brand recognition and more branch locations. On the lending side, competitors may be able to offer lower rates for loans, which could hamper Citizens’ ability to retain existing loans or attract new customers. On the deposit side, Citizens’ competitors may also offer higher interest rates, which could decrease Citizens’ ability to retain existing deposits or attract new deposits or require Citizens to increase its rates to attract deposits.

Other factors such as employee relations and environmental laws also impact Citizens’ competitiveness. Citizens maintains a favorable relationship with its employees and none of its employees are represented by a collective bargaining group.

SUPERVISION AND REGULATION

General

The banking industry is subject to extensive state and federal regulation which continues to undergo significant change. Proposals to change the laws and regulations governing the banking industry are frequently raised in Congress, in state legislatures, and before the various bank regulatory agencies. The likelihood and timing of any changes and the impact such changes might have on Citizens are impossible to determine with any certainty. A change in applicable laws or regulations, or a change in the way such

laws or regulations are interpreted by regulatory agencies or courts, may have a material impact on the business, operations and earnings of Citizens. Citizens expects that the financial services industry will remain heavily regulated and that additional laws or regulations may be adopted. The following discussion summarizes certain aspects of the banking laws and regulations that affect Citizens. To the extent that the following information describes statutory or regulatory provisions, it is qualified entirely by reference to the particular statutory or regulatory provision.

The Holding Company is a bank holding company registered with the Board of Governors of the Federal Reserve System (“FRB”) and is subject to regulation under the Bank Holding Company Act. The Bank Holding Company Act requires the FRB’s prior approval of an acquisition of assets or of ownership or control of voting shares of any bank or bank holding company if the acquisition would give the holder more than 10% of the voting shares of that bank or bank holding company. It also imposes restrictions, summarized below, on the assets or voting shares of non-banking companies that Citizens may acquire.

Under FRB policy, and as codified by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), a bank holding company is expected to serve as a source of financial strength to each of its subsidiary banks and to stand prepared to commit resources to support each of them. There are no specific quantitative rules on a holding company’s potential liability. If the Bank were to encounter financial difficulty, the FRB could invoke the doctrine and require a capital contribution from the Holding Company. In addition, and as a separate legal matter, a holding company is required to guarantee the capital plan of an undercapitalized subsidiary bank. See “Capital Adequacy and Prompt Corrective Action” below.

Citizens Bank is a state-chartered bank and is therefore subject to supervision, regulation and examination by the state banking regulator of the state in which it is chartered, the Michigan Office of Financial and Insurance Regulation. Citizens Bank is also subject to supervision and examination by the FRB because it is a member of the Federal Reserve System and by the Federal Deposit Insurance Corporation (“FDIC”), because the FDIC insures its deposits to the extent provided by law.

Payment of Dividends

There are various statutory restrictions on the ability of the Bank to pay dividends or make other payments to the Holding Company. The Bank is subject to dividend limits under the laws of Michigan. In addition, the Bank is a member bank of the Federal Reserve System, subject to the dividend limits of the FRB. The FRB allows a member bank to make dividends or other capital distributions in an amount not exceeding the current calendar year’s net income, plus retained net income of the preceding two years. Distributions in excess of this limit require prior approval of the FRB. FRB policy provides that, as a matter of prudent banking, a bank holding company generally should not maintain a rate of cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears to be consistent with the holding company’s capital needs, asset quality and overall financial condition.

On April 17, 2008, Citizens’ Board of Directors voted to suspend the common stock quarterly dividend. On January 28, 2010, Citizens announced that it was suspending the dividend payments on its trust preferred securities and on its fixed-rate cumulative perpetual preferred stock, Series A (the “TARP Preferred Stock”) with liquidation value of $300 million to the U.S. Department of the Treasury (“Treasury”) as part of the Treasury’s Capital Purchase Program. During 2011, two directors were elected to the Holding Company’s Board of Directors pursuant to the terms of the TARP Preferred Stock due to the Holding Company’s failure to pay dividends on the TARP Preferred Stock for six quarterly dividend periods. In December 2012, after consultation, and agreement with its primary regulator, Citizens announced it will resume interest payments on the outstanding junior subordinated debentures relating to our two trust preferred securities.

The Holding Company is unable to pay common stock dividends or engage in common stock repurchases until the TARP Preferred Stock dividend payments and payments deferred under our trust preferred securities are no longer in arrears. The accrued and unpaid TARP Preferred Stock dividends are scheduled to be paid just prior to completion of the FirstMerit Merger. Refer to “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity Risk Management” for additional information.

Capital Adequacy and Prompt Corrective Action

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) requires federal regulators to take prompt corrective action against any undercapitalized institution. FDICIA establishes five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Regulatory capital requirements for bank holding companies are evaluated using three capital measures: (i) risk-based capital expressed as a percentage of total risk-weighted assets, and (ii) Tier 1 risk-based capital expressed as a percentage of total risk-weighted assets, and (iii) leverage capital expressed as a percentage of total assets.

The following table presents the regulatory capital requirements for the five categories.

Well
Capitalized

Adequately
Capitalized

Under
Capitalized

Significantly
Under
Capitalized

Critically
Under
Capitalized

Total Capital to risk weighted assets ⁽¹⁾

< 8

< 6

Tier 1 Capital to risk weighted assets ⁽¹⁾

< 4

< 3

Tier 1 Leverage ⁽²⁾

< 4

< 3

Tangible equity to total assets

< 2

⁽¹⁾

Total Capital is comprised of Tier 1 Capital, a portion of the allowance for loan losses and qualifying subordinated debt. Tier 1 Capital is calculated as follows: total shareholders’ equity + trust preferred securities - goodwill - accumulated other comprehensive income (loss) - disallowed portion of deferred tax asset - other intangible assets.

⁽²⁾	Tier 1 Capital to quarterly average assets.

If the FDIC determines that an institution is in unsafe or unsound condition or that the institution has not corrected a less than satisfactory rating received in its last examination for asset quality, management, earnings or liquidity, an institution may be treated as if it were in the next lower capital category. A depository institution is generally prohibited from making capital distributions, including paying dividends, or paying management fees to a holding company if the institution would thereafter be undercapitalized. Institutions that are adequately but not well capitalized cannot accept, renew or rollover brokered deposits except with a waiver from the FDIC and are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew or rollover brokered deposits.

The banking regulatory agencies are permitted or, in certain cases, required to take certain actions with respect to institutions falling within one of the three undercapitalized categories. Depending on the level of an institution’s capital, the agencies’ corrective powers include, among other things:

•

prohibiting the payment of principal and interest on subordinated debt;

•

prohibiting the holding company from making distributions without prior regulatory approval;

•

placing limits on asset growth and restrictions on activities;

•

placing additional restrictions on transactions with affiliates;

•

restricting the interest rate the institution may pay on deposits;

•

prohibiting the institution from accepting deposits from correspondent banks; and

•

in the most severe cases, appointing a conservator or receiver for the institution.

A banking institution that is in any of the three undercapitalized categories is required to submit a capital restoration plan, and such a plan will not be accepted unless, among other things, the banking institution’s holding company guarantees the plan up to a certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in bankruptcy.

FDICIA also contains a variety of other provisions that may affect Citizens’ operations, including reporting requirements, regulatory standards for real estate lending, “truth in savings” provisions, and the requirement that a depository institution give 90 days prior notice to customers and regulatory authorities before closing any branch.

At December 31, 2012 and 2011, Citizens’ regulatory capital ratios were above “well capitalized” standards. Information concerning capital adequacy guidelines for the Holding Company and Citizens Bank including their regulatory capital position at December 31, 2012 and maintenance of minimum average reserve balances by the Bank with the FRB is incorporated herein by reference from “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the captions “Capital Resources” and “Liquidity Risk Management” and Note 18 to the Consolidated Financial Statements.

FDIC Insurance Assessments

The FDIC calculates deposit insurance based on a risk-based system that places a bank in one of four risk categories, principally on the basis of its capital level and an evaluation of the bank’s risk to the relevant deposit insurance fund, and bases premiums on the probability of loss to the FDIC with respect to each individual bank. Under the Federal Deposit Insurance Act, depository institutions such as Citizens’ subsidiary bank may not pay interest on indebtedness, if such interest is required to be paid out of net profits, or distribute any of its capital assets while it remains in default on any assessment due to the FDIC.

The calculation of the FDIC assessment includes the Financing Corporation (“FICO”) assessment. FICO was established to finance the Federal Savings and Loan Insurance Corporation resolution fund. All FDIC insured banks are required to pay into this resolution fund through the Deposit Insurance Fund (“DIF”).

In mid 2011, the FDIC Board implemented a rule that changed the assessment base from domestic deposits to average assets minus average tangible equity, adopted a new large-bank pricing assessment scheme, and set a target size for the Deposit Insurance Fund. The rule finalized a target size for the Deposit Insurance Fund at 2 percent of insured deposits. It also implemented a lower assessment rate schedule when the fund reaches 1.15 percent so that the average rate over time should be about 8.5 basis points of the assessment base and, in lieu of dividends, provides for a lower rate schedule when the reserve ratio reaches 2 percent and 2.5 percent. The rule, in aggregate, increased the share of assessments paid by large institutions and created a scorecard-based assessment system for banks with more than $10 billion in assets. The scorecards include financial measures that the FDIC believes are predictive of long-term performance.

Interstate Banking

Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Riegle-Neal Act”), as amended, a bank holding company may acquire banks in states other than its home state, subject to any state requirement that the bank has been organized and operating for a minimum period of time (not to exceed five years) and the requirement that the bank holding company not control, prior to or following the proposed acquisition, more than 10% of the total amount of deposits of insured depository institutions nationwide or, unless the acquisition is the bank holding company’s initial entry into the state, more than 30% of such deposits in the state, or such lesser or greater amount set by the state. The Riegle-Neal Act also authorizes banks to merge across state lines, thereby creating interstate branches. Banks are also permitted to acquire and to establish de novo branches in other states where authorized under the laws of those states.

Transactions with Affiliates

Transactions between the Bank and its affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. The affiliates of the Bank include any entity controlled by Citizens. Generally, Sections 23A and 23B (i) limit the extent to which the subsidiary banks may engage in “covered transactions” with any one affiliate to an amount equal to 10% of Citizens’ capital stock and surplus, and maintain an aggregate limit on all such transactions with affiliates to an amount equal to 20% of the bank’s capital stock and surplus, (ii) require that a bank’s extensions of credit to such affiliates be fully collateralized (with 100% to 130% collateral coverage, depending on the type of collateral), (iii) prohibit the bank from purchasing or

accepting as collateral from an affiliate any “low quality assets” (including nonperforming loans) and (iv) require that all “covered transactions” be on terms substantially the same, or at least as favorable, to the bank or its subsidiary as those provided to a non-affiliate. The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee and other types of similar transactions. The definition of “covered transactions” has been expanded by the Dodd-Frank Act and applicable regulations to include repurchase agreements with an affiliate, debt obligations issued as collateral for a loan or extension of credit, securities borrowing and lending transactions to the extent the transaction creates credit exposure to the Bank and derivative transactions. Additionally, covered transactions must now be secured at all times by collateral with a specified market value. Previously, a covered transaction only needed to be secured at the time of transaction with collateral of a specified market value.

Loans to Insiders

The Federal Reserve Act and related regulations impose specific restrictions on loans to directors, executive officers and principal stockholders of banks. Under Section 22(h) of the Federal Reserve Act and its implementing regulations, loans to a director, an executive officer or a principal shareholder of a bank, and some affiliated entities of any of the foregoing, may not exceed, together with all other outstanding loans to such person and affiliated entities, the bank’s loan-to-one-borrower limit. Loans in the aggregate to insiders and their related interests as a class may not exceed the bank’s unimpaired capital and unimpaired surplus. Section 22(h) and its implementing regulations also prohibit loans, above amounts prescribed by the appropriate federal banking agency to directors, executive officers and principal shareholders of a bank or bank holding company, and their respective affiliates, unless such loan is approved in advance by a majority of the board of directors of the bank with any “interested” director not participating in the voting. Section 22(h) generally requires that loans to directors, executive officers and principal shareholders be made on terms and underwriting standards substantially the same as offered in comparable transactions to other persons. Under the Dodd-Frank Act and applicable regulations, the types of extensions of credit covered by Section 22(h) have been expanded to include credit exposure to a person resulting from derivative transactions, repurchase agreements, reverse repurchase agreements, securities lending transactions and securities borrowing transactions.

Community Reinvestment Act

Under the Community Reinvestment Act (“CRA”) and related regulations, depository institutions have an affirmative obligation to assist in meeting the credit needs of their market areas, including low and moderate income areas, consistent with safe and sound banking practice. Depository institutions are periodically examined for compliance with CRA and are periodically assigned ratings in this regard. Banking regulators consider a depository institution’s CRA rating when reviewing applications to establish new branches, undertake new lines of business, and/or acquire part or all of another depository institution. An unsatisfactory rating can significantly delay or even prohibit regulatory approval of a proposed transaction by a bank holding company or its depository institution subsidiary.

Fair Lending and Consumer Laws

In addition to CRA, other federal and state laws regulate various lending and consumer aspects of the banking business. Governmental agencies, including the Department of Housing and Urban Development, the Federal Trade Commission and the Department of Justice, have become concerned that in some cases prospective borrowers experience unlawful discrimination in their efforts to obtain loans from depository and other lending institutions. These agencies have brought litigation against some depository institutions alleging discrimination against borrowers. Many of these suits have been settled, in some cases for material sums, short of a full trial.

These governmental agencies have clarified what they consider to be lending discrimination and have specified various factors that they will use to determine the existence of lending discrimination under the Equal Credit Opportunity Act and the Fair Housing Act. These factors include evidence that a lender discriminated on a prohibited basis, evidence that a lender treated applicants differently based on prohibited factors in the absence of evidence that the treatment was the result of prejudice or a conscious intention to discriminate, and evidence that a lender applied an otherwise neutral non-discriminatory policy uniformly to all applicants, but the practice had a discriminatory effect, unless the practice could be justified as a business necessity.

Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations. These laws, which include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, and the Fair Housing Act, require compliance by depository institutions with various disclosure requirements and requirements regulating the availability of funds after deposit or the making of certain loans to customers.

Gramm-Leach-Bliley Act of 1999

The Gramm-Leach-Bliley Act of 1999 (the “GLBA”) covers a broad range of issues, including a repeal of most of the restrictions on affiliations among depository institutions, securities firms and insurance companies. The following description summarizes some of its significant provisions.

The GLBA repealed sections 20 and 32 of the Glass-Steagall Act, thus permitting unrestricted affiliations between banks and securities firms. It also permits bank holding companies to elect to become financial holding companies. A financial holding company may engage in or acquire companies that engage in a broad range of financial services, including securities activities such as underwriting, dealing, investment, merchant banking, insurance underwriting, sales and brokerage activities. In order to become a financial holding company, the bank holding company and all of its affiliated depository institutions must be well capitalized, well-managed and have at least a satisfactory CRA rating. Citizens has determined not to become certified as a financial holding company but may reconsider this determination in the future.

The GLBA provides that the states continue to have the authority to regulate insurance activities, but prohibits the states in most instances from preventing or significantly interfering with the ability of a bank, directly or through an affiliate, to engage in insurance sales, solicitations or cross-marketing activities. Although the states generally must regulate bank insurance activities in a non-discriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in specific areas identified under the law. The federal bank regulatory agencies adopted insurance consumer protection regulations that apply to sales practices, solicitations, advertising and disclosures.

The GLBA repealed the broad exemption of banks from the definitions of “broker” and “dealer” for purposes of the Securities Exchange Act of 1934, as amended. It also identifies a set of specific activities, including traditional bank trust and fiduciary activities, in which a bank may engage without being deemed a “broker,” and a set of activities in which a bank may engage without being deemed a “dealer.” Additionally, the law makes conforming changes in the definitions of “broker” and “dealer” for purposes of the Investment Company Act of 1940, as amended, and the Investment Advisers Act of 1940, as amended.

The GLBA also contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, both at the inception of the customer relationship and on an annual basis, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. The law provides that, except for specific limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to “opt out” of such disclosure. An institution may not disclose to a non-affiliated third party, other than to a consumer reporting agency, customer account numbers or other similar account identifiers for marketing purposes. The GLBA also provides that the states may adopt customer privacy protections that are stricter than those contained in the GLBA.

Anti-Money Laundering and the USA Patriot Act of 2001

The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”) is designed to deny terrorists and criminals the ability to obtain access to the United States’ financial system and has significant implications for depository institutions, brokers, dealers, and other businesses involved in the transfer of money. The Patriot Act mandates that financial services companies implement policies and procedures with respect to additional measures designed to address the following matters: money laundering, terrorist financing, identifying and reporting suspicious activities and currency transactions, and currency crimes.

The Patriot Act also substantially broadened existing anti-money laundering legislation, imposed new compliance and due diligence obligations, created new crimes and penalties, and compelled the production of documents located both inside and outside the United States. The Treasury has issued a number of regulations that apply some of these requirements to financial institutions such as Citizens Bank. The regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing. Pursuant to the Patriot Act and the related regulations, Citizens has established anti-money laundering compliance and due diligence programs that include, among other things, the designation of a Bank Secrecy Act officer, employee training programs and an independent audit function to review and test the program.

EESA and Troubled Asset Relief Capital Purchase Program

In response to the financial crises affecting the financial markets and the banking system, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law and established the Troubled Asset Relief Program (“TARP”). On October 14, 2008, the Treasury announced the Capital Purchase Program (“CPP”) to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy. Under CPP, the Treasury made $250 billion of capital available to U.S. financial institutions in the form of senior preferred stock and warrants which qualify as Tier 1 capital. On December 12, 2008, Citizens issued $300.0 million of TARP Preferred Stock and a warrant to purchase 1,757,813 shares of its common stock at $25.60 per share to the Treasury as part of this program. The TARP Preferred Stock pays a cumulative dividend rate of 5 percent per annum for the first five years and will reset to a rate of 9 percent per annum after year five. The TARP Preferred Stock is callable after three years. Participating financial institutions were required to adopt the Treasury’s standard for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the CPP.

The Treasury has been given authority to promulgate regulations under the EESA. Any new regulations implemented by the Treasury under the EESA may be applied retroactively to recipients of TARP funding under the CPP. In addition, the U.S. government could pass new legislation which may have a similar effect in the future. In either case, any such new regulations or legislation may have the effect of imposing additional economic restrictions or obligations on Citizens under the TARP CPP, at least for as long as any of Citizens’ obligations under the CPP remain outstanding.

The Special Inspector General for the Troubled Asset Relief Program (“SIGTARP”) was established pursuant to Section 121 of the EESA, and has the duty among other things, to conduct, supervise, and coordinate audits and investigations of the purchase, management, and sale of assets by the Treasury under TARP and the CPP including the TARP Preferred Stock purchased from Citizens.

American Recovery and Reinvestment Act

The American Recovery and Reinvestment Act of 2009 (“ARRA”) was signed into law on February 17, 2009. ARRA includes a wide variety of programs intended to stimulate the economy. In addition, ARRA imposes executive compensation and expenditure limits on all TARP CPP recipients, such as Citizens, and expands the class of employees to whom the limits and restrictions apply. ARRA also provides the opportunity for additional repayment flexibility for existing TARP CPP recipients. The Treasury published interim final rules to implement the compensation and corporate governance provisions of the ARRA that became effective in 2009.

Among other things, ARRA prohibits the payment of bonuses, other incentive compensation and severance to certain of Citizens’ most highly paid employees (except in the form of restricted stock subject to specified limitations and conditions), and requires each TARP recipient to comply with certain other executive compensation related requirements. These provisions modify the executive compensation provisions that were included in the EESA, and in most instances apply retroactively for so long as any obligation arising from financial assistance provided to the recipient under TARP remains outstanding. The ARRA guidelines generally supersede the executive compensation and corporate governance standards for TARP recipients set forth in the EESA.

In addition, the ARRA directs the Secretary of the Treasury to review previously-paid bonuses, retention awards and other compensation paid to the senior executive officers and certain other highly-compensated employees of each TARP recipient to determine whether any such payments were excessive, inconsistent with the purposes of the ARRA or the TARP, or otherwise contrary to the public interest. If the Secretary determines that any such payments have been made by a TARP recipient, the Secretary will seek to negotiate with the TARP recipient and the subject employee for appropriate reimbursements to the U.S. government (not the TARP recipient) with respect to any such compensation or bonuses. The ARRA also permits the Secretary, subject to consultation with the appropriate federal banking agency, to allow a TARP recipient to repay any assistance previously provided to such TARP recipient under the TARP, without regard to whether the TARP recipient has replaced such funds from any source, and without regard to any waiting period. Any TARP recipient that repays its TARP assistance pursuant to this provision would no longer be subject to the executive compensation provisions under the ARRA.

Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank Act will likely result in dramatic changes across the financial regulatory system, some of which became effective immediately and some of which will not become effective until various future dates. Implementation of the Dodd-Frank Act will require many new rules to be made by various federal regulatory agencies over the next several years. Uncertainty remains until final rulemaking is complete as to the ultimate impact of the Dodd-Frank Act, which could have a material adverse impact either on the financial services industry as a whole, or on Citizens’ business, results of operations, and financial condition. Provisions in the legislation that affect deposit insurance assessments, payment of interest on demand deposits, and interchange fees could increase the costs associated with deposits and place limitations on certain revenues those deposits may generate.

Among other provisions affecting Citizens’ business, the Dodd-Frank Act:

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Changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible equity, eliminated the ceiling and the size of the Deposit Insurance Fund, and increased the floor applicable to the size of the DIF.

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Repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transactions and other accounts.

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Centralized responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau (“CFPB”), and giving it responsibility for implementing, examining and enforcing compliance with federal consumer protection laws.

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Provided that debit card interchange fees must be reasonable and proportional to the cost incurred by the issuer with respect to the transaction. This provision is known as the Durbin Amendment. The Board of Governors of the Federal Reserve System (“Federal Reserve Board”) adopted regulations setting the maximum permissible interchange fee as the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction, with an additional adjustment of up to one cent per transaction if the issuer implements certain fraud-prevention standards.

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Authorized the Federal Reserve Board to adopt enhanced supervision standards for, among others, bank holding companies with total consolidated assets of $50 billion or more (often referred to as “systemically important financial institutions” or “SIFI”), and authorized the Federal Reserve Board to establish such standards either on its own or upon the recommendations of the Financial Stability Oversight Council (“FSOC”), a new systemic risk oversight body created by Dodd-Frank. In April 2012, the Federal Reserve Board and FSOC issued final rules and

interpretative guidance establishing enhanced prudential standards responsive to these provisions for (i) risk-based capital requirements and leverage limits, (ii) stress testing of capital, (iii) liquidity requirements, (iv) overall risk management requirements, (v) resolution plan and credit exposure reporting and (vi) concentration/credit exposure limits (the “SIFI Rules”). The SIFI Rules address a wide, diverse array of regulatory areas, each of which is highly complex. Most of the SIFI Rules will not apply to Citizens for so long as its total consolidated assets remain below $50 billion. Two aspects of the SIFI Rules – requirements for annual stress testing of capital under one base and two stress scenarios and certain corporate governance provisions requiring, among other things, that each bank holding company establish a risk committee of its board of directors and that such committee include a “risk expert” – apply to bank holding companies with total consolidated assets of $10 billion or more.

The implications of the Dodd-Frank Act for Citizens’ will depend to a large extent on the manner in which rules adopted pursuant to the Dodd-Frank Act are implemented by the primary U.S. financial regulatory agencies as well as potential changes in market practices and structures in response to the requirements of the Dodd-Frank Act. Citizens continues to analyze the impact of rules adopted under the Dodd-Frank Act. However, the full impact will not be known until the rules, and other regulatory initiatives that overlap with the rules are implemented and their combined impacts can be understood.

Basel III

The United States is a member of the Basel Committee on Banking Supervision (the “Basel Committee”), that provides a forum for regular international cooperation on banking supervisory matters. The Basel Committee develops guidelines and supervisory standards in areas where they are considered desirable. In this regard, the Basel Committee is best known for its international standards on capital adequacy; the Core Principles for Effective Banking Supervision; and the Concordat on cross-border banking supervision.

In December 2010, the Basel Committee released its new framework for strengthening international capital and liquidity regulation, now officially identified as “Basel III.” In June 2011, a revised version of this framework was released. Basel III, when implemented by the U.S. banking agencies and fully phased-in, will require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity. The US Federal Reserve announced in December 2011 that it would implement substantially all of the Basel III rules. In November 2012, however, the US Federal Reserve, FDIC and Office of the Comptroller of the Currency announced that implementation of the capital requirements would be delayed indefinitely. Requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact Citizens’ operating results.

ECONOMIC FACTORS AND MONETARY POLICY

Citizens’ earnings and business are affected by the general economic and political conditions in the United States and abroad and by the monetary and fiscal policies of various federal regulatory authorities, including the Federal Reserve System. Citizens’ policy for addressing credit risk, the effect of the economy on credit risk in 2012, 2011, and 2010 and its potential effect on future periods is discussed in “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the captions “Critical Accounting Policies,” “Loan Portfolio,” “Credit Risk Management,” “Nonperforming Assets,” and “Allowance for Loan Losses” and incorporated herein by reference. Through open market securities transactions, variations in the Federal Funds rate and the establishment of reserve requirements, the Board of Governors of the Federal Reserve System exerts considerable influence on interest rates and the supply of money and credit. Citizens strives to manage the effects of interest rates through its asset/liability management process but the effect of fluctuating economic conditions and federal regulatory policies on Citizens’ future profitability cannot be predicted with any certainty. The effect of the economy and changes in interest rates on Citizens’ net interest margin and net interest income in 2012, 2011, and 2010 and their potential effect on future periods is discussed in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Net Interest Income” and is incorporated herein by reference. Citizens’ sensitivity to changes in interest rates and the potential effect of changes in interest rates on net interest income is presented in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Interest Rate Risk” and incorporated herein by reference.

ENVIRONMENTAL MATTERS

Citizens’ primary exposure to environmental risk is through lending activities and trust services. In each instance, policies and procedures are in place to mitigate environmental risk exposures. With respect to lending activities, Citizens requires environmental site assessments at the time of loan origination to confirm collateral quality on commercial real estate parcels posing higher than normal potential for environmental impact, as determined by reference to present and past uses of the subject property and adjacent sites. Environmental assessments are also mandated prior to any foreclosure activity involving non-residential real estate collateral. In the case of trust services, Citizens utilizes various types of environmental transaction screening to identify actual and potential risks arising from any proposed holding of non-residential real estate for trust accounts. Consequently, Citizens does not anticipate any material effect on capital expenditures, earnings or the competitive position of Citizens or its subsidiary with regard to compliance with federal, state or local environmental protection laws or regulations. Additional information is provided in “Item 3. Legal Proceedings.”

ITEM 1A.

RISK FACTORS

Unless otherwise noted or the context indicates otherwise, all references in this Item to “we,” “us,” or “our,” refer to Citizens and its subsidiary. An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that we believe affect us are described below. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are not aware of or focused on or currently deem immaterial may also impair business operations. This report is qualified in its entirety by these risk factors. If any of the following risks occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and shareholders could lose all or part of their investment.

Risks Related to Our Business

We face the risk that loan losses, including unanticipated loan losses due to changes in loan portfolios, fraud and economic factors, could exceed the allowance for loan losses and that additional increases in the allowance will be required. Additions to the allowance for loan losses would cause our operating results to decline and could have a negative impact on our capital and financial position.

Making loans is an essential element of our business, and there is a risk that customer loans will not be repaid. The risk of nonpayment is affected by a number of factors, including:

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the duration of the loan;

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credit risks of a particular borrower;

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changes in economic and industry conditions; and

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in the case of a collateralized loan, the potential inadequacy of the value of the collateral in the event of default, such as has resulted from the deterioration in commercial and residential real estate values.

We attempt to maintain an appropriate allowance for loan losses to provide for probable losses inherent in our loan portfolio. We periodically determine the amount of the allowance based on consideration of several factors including, among others, the ongoing review and grading of the loan portfolio, consideration of past loan loss experience as well as that of the banking industry, trends in past due and nonperforming loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, the size and diversity of individual credits, and other

qualitative and quantitative factors which could affect probable credit losses. We determine the amount of the allowance for loan losses by considering these factors and by using estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on our historical loss experience with additional qualitative factors for various issues, and estimates of necessary reserves for special situations that are unique to the measurement period such as anticipated problem loan resolution activities, along with consideration of current economic trends and conditions, all of which are susceptible to significant change and are inherently subjective. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance, could change significantly.

A significant portion of our loan portfolio is secured by commercial and residential real estate. These portfolios are comprised of borrowers primarily located in Michigan, Wisconsin, and Northern Ohio. While the overall economy continues to improve, the Michigan and Northern Ohio markets in particular were adversely affected by job losses, declines in real estate value, declines in home sale volumes, and declines in new home building during the recent recession. The credit performance of loans secured by commercial income producing properties were negatively affected by tenant losses and reduced rental rates, contributing to the decline in values associated with the income producing loan portfolio. We may suffer further losses in these segments if our efforts to limit losses through execution of prudent workout strategies are unsuccessful. Although we do not engage in subprime lending, the credit performance of the residential mortgage portfolio has been negatively impacted by borrowers’ loss of or reduction in, income.

Increased stress on borrowers’ cash flow due to job loss, reduced rental income, higher interest rates or other factors could lead to even higher payment delinquencies and defaults. Declines in real estate values could lead to higher loss severity. Although our most significant loan losses to date have been concentrated in our commercial real estate and residential mortgage loan portfolios, adverse economic conditions could negatively affect other portions of our loan portfolio.

There is no precise method of predicting loan losses, and therefore we always face the risk that charge-offs in future periods will exceed our allowance for loan losses or that additional increases in the allowance for loan losses will otherwise be required. Additions to the allowance for loan losses would cause operating results to decline in the period(s) in which such additions occur and could also have a material adverse impact on our capital and financial position.

Our core lending and other businesses have been adversely affected by the recent weakness in the national and regional economies in which we operate, particularly Michigan. Our ability to generate earnings and maintain regulatory capital ratios at acceptable levels at our Holding Company and the Bank depends substantially on developments in those economies. Also, our potential inability to comply with applicable laws, regulations and regulatory policies or standards due to the effects of these conditions on our results of operations and financial condition may result in heightened regulatory scrutiny and require us to take actions to protect depositors that are not in the best interests of our shareholders.

While the Michigan economy is showing improvement, economic growth has been slow. With historic weaknesses in the economy nationally and particularly in our primary markets, and the effect of this weakness on unemployment rates and the value of real estate collateralizing many of our loans, we have incurred substantial losses in previous years and our capital levels have been adversely affected. These effects have, in turn, hampered our ability to comply with various standards and policies of our various banking regulators which are intended primarily for the protection of depositors and the FDIC, not shareholders or holders of subordinated debt or trust preferred securities. Any failure to comply with laws, regulations, or regulatory policies or standards could also result in heightened regulatory scrutiny and in further sanctions by regulatory agencies (such as a memorandum of understanding, a written supervisory agreement or a cease and desist order), civil money penalties and/or reputation damage. Any of these consequences could restrict our ability to operate or expand our business, could require us to raise additional capital, sell assets or take other actions on terms that are not advantageous to us or our shareholders and could have a material adverse effect on our business, financial condition, results of operations, and stock price.

Our business may be adversely affected by the highly regulated environment in which we operate. Changes in applicable laws, regulations, and regulatory practices at either the federal or state level may result in the imposition of additional costs or restrict our ability to operate our business in the manner most beneficial to our shareholders.

The banking industry is heavily regulated, and such regulations are intended primarily for the protection of depositors and the federal deposit insurance funds, not shareholders or holders of subordinated debt or trust preferred securities. As a bank holding company, the Holding Company is subject to regulation by the FRB.

Citizens Bank is subject to federal regulation primarily by the FRB and is also subject to regulation by the OFIR. These regulations affect lending practices, capital structure, investment practices, dividend policy and growth. Citizens Bank also engages in providing investment management and insurance brokerage services, which industries are also heavily regulated on both a state and federal level.

Various legislative and regulatory initiatives have been introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any impending regulations, would have on our financial condition and results of operations. A change in statutes, regulations or regulatory policies applicable to us could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things, any of which could have a material effect on our business.

The Dodd-Frank Act has and will continue to significantly change bank regulatory structure and affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.

The new Bureau of Consumer Financial Protection, created pursuant to the Dodd-Frank Act, has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. Additionally, the Bureau of Consumer Financial Protection has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets.

Proposals for further regulation of the financial services industry are continually being introduced in the Congress of the United States of America. The agencies regulating the financial services industry also periodically adopt changes to their regulations. It is possible that additional legislative proposals may be adopted or regulatory changes may be made that would have an adverse effect on our business.

In addition, changes in laws, regulations and regulatory practices affecting the financial services industry, such as those relating to the Dodd-Frank Act and Basel III, among others, could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could also result in heightened regulatory scrutiny and in sanctions by regulatory agencies (such as a memorandum of understanding, a written supervisory agreement or a

cease and desist order), civil money penalties and/or reputation damage. Any of these consequences could restrict our ability to expand our business or could require us to raise additional capital or sell assets on terms that are not advantageous to us or our shareholders and could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, such violations may occur despite our best efforts.

While we attempt to manage the risk from changes in market interest rates, interest rate risk management techniques are not exact. In addition, we may not be able to economically hedge our interest rate risk. A rapid or substantial increase or decrease in interest rates could adversely affect our net interest income and results of operations.

Our ability to generate net income depends primarily upon our net interest income. Net interest income is income that remains after deducting, from total income generated by earning assets, the interest expense attributable to the acquisition of the funds required to support earning assets. Income from earning assets includes income from loans, investment securities and short-term investments. The amount of interest income is dependent on many factors including the volume of earning assets, the general level of interest rates, the dynamics of the change in interest rates and the levels of nonperforming loans. The cost of funds varies with the amount of funds necessary to support earning assets, the rates paid to attract and hold deposits, rates paid on borrowed funds and the levels of noninterest-bearing demand deposits and equity capital.

Different types of assets and liabilities may react differently, and at different times, to changes in market interest rates. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities. That means either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest earning assets, or vice versa. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets, an increase in market rates of interest could reduce our net interest income. Likewise, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could reduce net interest income. We are unable to predict changes in market interest rates which are affected by many factors beyond our control including inflation, recession, unemployment, money supply, domestic and international events and changes in the United States and other financial markets. Net interest income is not only affected by the level and direction of interest rates, but also by the shape of the yield curve, relationships between interest sensitive instruments and key driver rates, as well as balance sheet growth, client loan and deposit preferences and the timing of changes in these variables.

We attempt to manage risk from changes in market interest rates, in part, by controlling the mix of interest rate-sensitive assets and interest rate-sensitive liabilities. We continually review our interest rate risk position and modify our strategies based on projections to minimize the impact of future interest rate changes. We also use derivative financial instruments to modify our exposure to changes in interest rates. However, interest rate risk management techniques are not exact. A rapid increase or decrease in interest rates could adversely affect results of operations and financial performance.

The negative economic effects caused by terrorist attacks, cyber attacks, potential attacks and other destabilizing events would likely contribute to the deterioration of the quality of our loan portfolio and could reduce our customer base, our level of deposits, and demand for our financial products such as loans.

High inflation, natural disasters, acts of terrorism, cyber attacks, an escalation of hostilities or other international or domestic occurrences, and other factors could have a negative impact on the economy of the Upper Midwest regions in which we operate. An additional economic downturn in our markets would likely contribute to the deterioration of the quality of our loan portfolio by impacting the ability of our customers to repay loans, the value of the collateral securing loans, and may reduce the level of deposits in the Bank and the stability of our deposit funding sources. An additional economic downturn could also have a significant impact on the demand for our products and services. The cumulative effect of these matters on our results of operations and financial condition would likely be adverse and material.

If we are unable to continue to attract and retain core deposits, to obtain third party financing on favorable terms, or to have access to interbank or other liquidity sources (as a result of rating agency downgrades or other market factors), our cost of funds will increase, adversely affecting the ability to generate the funds necessary for lending operations, reducing net interest margin and negatively affecting results of operations.

The Bank derives liquidity through core deposit growth, maturity of money market investments, and maturity and sale of investment securities and loans. Additionally, the Bank has access to financial market borrowing sources on an unsecured, and a collateralized basis for both short-term and long-term purposes including, but not limited to, the Federal Reserve, Federal Home Loan Banks of which the Bank is a member, and other correspondent banks. If these funding sources are not sufficient or available, we may have to acquire funds through higher-cost sources.

Our credit ratings are important to our liquidity. Our credit rating was downgraded by various ratings services in the past. Any further reduction or anticipated reduction in our credit ratings could adversely affect our liquidity and competitive position, increase our borrowing costs, limit our access to the capital markets or trigger unfavorable contractual obligations.

Increased competition with other financial institutions or an adverse change in our relationship with a number of major customers could reduce our net interest margin and net income by decreasing the number and size of loans originated, the interest rates charged on these loans and the fees charged for services to customers.

The Bank faces substantial competition in originating commercial and consumer loans. This competition comes principally from other banks, savings institutions, mortgage banking companies and other lenders. Many of our competitors have competitive advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce our net income by decreasing the number and size of the loans that we originate and the interest rates we charge on these loans.

In attracting business and consumer deposits, we face substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many competitors enjoy advantages, including greater financial resources, more aggressive marketing campaigns, better brand recognition and more branch locations. These competitors may offer higher interest rates, which could decrease the deposits that we attract or require us to increase rates to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect our ability to generate the funds necessary for lending operations which could increase our cost of funds.

We also compete with non-bank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance companies and governmental organizations which may offer more favorable terms on deposits or investments. Some non-bank competitors are not subject to the same extensive regulations that govern banking operations. As a result, such non-bank competitors may have advantages over us in providing certain products and services. This competition may reduce or limit our margins on banking and non-banking services, reduce our market share and adversely affect our earnings and financial condition.

The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems.

Events such as significant adverse changes in the business climate, adverse action by a regulator, unanticipated changes in the competitive environment, and a decision to change our operations or dispose of an operating unit could have a negative effect on our goodwill or other intangible assets such that we may need to record an impairment charge, which could have a material adverse impact on our results of operations.

Under current accounting standards, goodwill and certain other intangible assets with indeterminate lives are assessed at least annually for impairment, or more frequently when impairment indicators are present. After evaluating goodwill and other intangible assets, we may determine that one or both are deemed to be impaired for accounting purposes. Deterioration in the outlook for credit quality, changes in the value of the loan or deposit portfolios, or increases in the discount rates could have a material impact on future goodwill impairment testing results. If we identify any impairment, it would be reflected as a charge to earnings in the period during which such impairment is identified and could have a material adverse effect on our results of operations.

If the FDIC raises the assessment rate charged to its insured financial institutions, our FDIC insurance premium may increase and this could have a negative effect on our expenses and results of operations.

Recent high levels of bank failures and temporary programs increasing deposit insurance limits dramatically increased resolution costs for the FDIC and depleted its deposit insurance fund. In order to maintain a strong funding position and restore reserve ratios for the deposit insurance fund, the FDIC increased assessment rates for all insured institutions in recent years. There can be no assurance that we will not be required to pay even higher FDIC insurance premiums than the recently increased levels, particularly if our assets increase to more than $10 billion, which may materially adversely affect our results of operations and financial condition.

We may not realize our deferred income tax assets and loss carryforwards.

The realization of our deferred income tax assets is dependent on generating future taxable income, executing tax planning strategies, and reversing existing taxable temporary differences. If a period of sustained losses were to occur, we may be required to recognize an allowance against all or part of our deferred tax asset, which would have a material adverse effect on our results of operations in the period in which such an allowance is recognized. In addition, under Section 382 of the Internal Revenue Code of 1986, as amended, if a change of ownership occurs with respect to a company with deferred income tax assets, that company’s use of the pre-change of ownership tax loss carryforwards as well as the ability to use certain unrealized built-in losses would be substantially limited. A change of ownership occurred under Section 382 as a result of the exchange offers of common stock for long-term debt in the third quarter of 2009. Generally, under Section 382, the yearly limitation on our ability to utilize such deductions will be equal to the product of the applicable long-term tax exempt rate and the sum of the values of our common stock and our TARP Preferred Stock immediately before the ownership change. Our ability to utilize deductions related to credit losses during the twelve-month period following such an ownership change would also be limited under Section 382, together with net operating loss carryforwards, to the extent that such deductions reflect a net loss that was “built-in” to our assets immediately prior to the ownership change.

Because the 2009 exchange offers triggered an ownership change, our ability to use the net operating loss carryforwards and certain built-in losses existing at the time of the deemed change in ownership to offset future income will be substantially limited. Therefore, we may suffer higher than anticipated tax expense, and consequently lower net income and cash flow, in future years. Moreover, any future change in ownership would further limit our ability to use our net operating loss carryforwards and certain built-in losses existing at the time of the future change in ownership.

Our stock price can be volatile.

Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:

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Actual or anticipated negative variations in quarterly results of operations;

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Negative recommendations by securities analysts;

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Poor operating and stock price performance of other companies that investors deem comparable to us;

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News reports relating to negative trends, concerns and other issues in the financial services industry or the economy in general;

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Negative perceptions in the marketplace regarding us and/or our competitors;

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New technology used, or services offered, by competitors;

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Adverse changes in interest rates;

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Adverse changes in the real estate market;

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Negative economic news;

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Adverse changes in government regulations; and

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Geopolitical conditions such as acts or threats of terrorism or military conflicts.

General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease regardless of operating results.

An investment in our common stock is not an insured deposit.

Our common stock is not a bank deposit and, therefore, is not insured against loss by the Federal Deposit Insurance Corporation, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you could lose some or all of your investment.

We may be adversely affected by the soundness of other financial institutions.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral we hold cannot be liquidated at prices sufficient to recover the full amount of the credit or derivative exposure due to us. Any such losses could have a material adverse effect on our financial condition and results of operations.

In order to maintain and strengthen our capital base or to repay outstanding obligations, we may need to raise additional capital in transactions that may be highly dilutive to our common shareholders. If such capital becomes needed, our failure to raise additional capital could have serious consequences for our business.

We regularly perform a variety of analyses on our assets and the impact of credit losses on our capital base, including the preparation of stress case scenarios. Due to economic conditions in the markets in which we operate and the challenges posed to our business, including those described in other Risk Factors, we may determine, based on these analyses, that we need to raise additional Tier 1 common equity to maintain and strengthen our capital base as the effects of these events impact our business over the coming months and years. We may also determine to raise equity capital to repay outstanding obligations, with unfavorable interest or dividend rates. Any potential capital raising transaction could be highly dilutive to our common shareholders. The market price of our common stock could decline as a result of the dilutive effect of the capital raising transactions we may enter into, or the perception that such transactions could occur.

In connection with the issuance of the TARP Preferred stock, we also issued a warrant to Treasury to purchase approximately 1.8 million additional shares of our common stock at an initial per share exercise price of $25.60, subject to adjustment, which expires ten years from the issuance date. Even if we were to redeem the TARP Preferred Stock, we may not fully retire this warrant and, therefore, this warrant may be exercised, in whole or part, prior to its expiration date. Furthermore, the terms of the warrant provide that, if we issue common stock or securities convertible or exercisable into, or exchangeable for, common stock at a price that is less than 90% of the market price of such shares on the last trading day preceding the date of the agreement to sell such shares, the number and the per share price of common stock to be purchased pursuant to the warrant will be adjusted pursuant to its terms. As part of our potential capital raising efforts, we could issue securities convertible into or exercisable for our common stock, which may trigger the anti-dilution provisions of the warrant issued to the Treasury. If we issue such securities and they are subsequently exercised, converted into or exchanged for common stock such transactions would have a further dilutive effect on other holders of our common stock.

Also, if we determine that we need to raise additional capital, our capital raising efforts may not be successful, or we may be required to raise additional capital on terms that are unfavorable to us. A failure to maintain capital above “well capitalized” levels could require us to further reduce the size of our business and would likely have serious negative consequences for our business.

We have agreements with derivative counterparties that contain a provision where if we fail to maintain our status as a well capitalized or adequately capitalized institution, then the counterparty could terminate the derivative positions and we would be required to settle our obligations under the agreements. A default under these agreements could have a material adverse effect on our business, results of operations and financial condition.

Our Holding Company may not have sufficient resources to make capital contributions to the Bank if required by bank regulatory agencies, or if we might otherwise wish to do so, in order to maintain the Bank’s capital ratios at acceptable levels.

Our Holding Company is required by banking regulation to act as a “source of strength” to the Bank. If the Bank incurs losses and regulatory capital levels at the Bank decline, our Holding Company may be required by the bank regulatory agencies to contribute additional capital to the Bank. As of December 31, 2012, the Holding Company’s cash resources totaled $81.8 million. We may not have sufficient funds at our Holding Company level to make required capital contributions to the Bank if the Bank incurs losses.

As a bank holding company that conducts substantially all of our operations through our operating subsidiary, the ability of our Holding Company to pay dividends, repurchase our shares or to repay our indebtedness depends upon the results of operations of our subsidiary and its ability to pay dividends to our Holding Company. Dividends paid by the subsidiary are subject to limits imposed by federal and state law.

The Holding Company is a separate and distinct legal entity from our operating subsidiary, the Bank, and it receives substantially all of its revenue from dividends from the Bank and sales of our securities to investors. Dividends from the Bank are an important source of funds to pay dividends on common stock and interest and principal on debt. Various federal and state laws and regulations limit the amount of dividends that our subsidiary may pay to the Holding Company. Also, our Holding Company’s right to participate in a distribution of assets upon the Bank’s liquidation or reorganization is subject to the prior claims of the Bank’s creditors. If we are unable to pay dividends to our Holding Company, we may not be able to service debt, pay obligations or, should we have the ability to do so in the future, pay dividends on common stock.

The Holding Company’s interest and preferred dividend payment obligations are approximately $20 million annually. There can be no assurance that the Holding Company’s cash resources will be sufficient to fulfill its obligations.

We could face unanticipated environmental liabilities or costs related to real property owned or acquired through foreclosure. Compliance with federal, state and local environmental laws and regulations, including those related to investigation and clean-up of contaminated sites, could have a negative effect on expenses and results of operations.

A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on results of operations.

We are party to various lawsuits. Litigation is subject to many uncertainties such that the expenses and ultimate exposure with respect to many of these matters cannot be ascertained.

From time to time, customers, shareholders and others make claims and take legal action against us and our directors. Whether these claims and legal actions are legitimate or unfounded, if such claims and legal actions are not resolved in our favor they may result in significant financial liability to us (directly or as a result of our indemnification obligations), adversely affect the market’s perception of us and our products and services and impact customer demand for our products and services. Any financial liability or reputation damage could have a material adverse effect on our business, financial condition and results of operations.

The financial services industry is undergoing rapid technological changes. If we are unable to adequately invest in and implement new technology-driven products and services, we may not be able to compete effectively, or the cost to provide products and services may increase significantly.

The financial services industry is undergoing rapid technological changes with frequent introduction of new technology-driven products and services. In addition to providing better customer service, the effective use of technology increases efficiency and enables financial service institutions to reduce costs. Our future success will depend, in part, upon our ability to address customer needs by using technology to provide products and services to enhance customer convenience, as well as to create additional operational efficiencies. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services, which could reduce our ability to effectively compete and, in turn, have a material adverse effect on our financial condition and results of operations.

The products and services offered by the banking industry and customer expectations regarding them are subject to change. We attempt to respond to perceived customer needs and expectations by offering new products and services, which are often costly to develop and market initially. A lack of market acceptance of these products and services would have a negative effect on our financial condition and results of operations.

From time to time, we implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly

in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services we may invest significant time and resources. We may not achieve initial timetables for the introduction and development of new lines of business and/or new products or services and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, results of operations and financial condition.

We may not be able to attract and retain skilled people. If we were to lose key employees, we may experience a disruption in our relationship with certain customers.

Our success depends, in large part, on our ability to attract and retain skilled people. Competition for the best people in most of our business activities can be intense, and we may not be able to hire sufficiently skilled people or to retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our markets, years of industry experience, and the difficulty of promptly finding qualified replacement personnel.

Many of our key employees have extensive customer relationships. Loss of a key employee with such customer relationships may lead to the loss of customers if they were to follow that employee to a competitor. While we believe that our relationship with our key producers is good, we cannot guarantee that all of our key personnel will remain with us.

The Standard & Poor’s downgrade in the U.S. government’s sovereign credit rating, and in the credit ratings of instruments issued, insured or guaranteed by certain related institutions, agencies and instrumentalities, creates risks to our net income, capital levels, financial condition and liquidity and causes uncertainties in general economic conditions that may adversely impact us.

In August 2011, Standard & Poor’s downgraded the United States long-term debt ratings and downgraded the credit ratings of certain long-term debt instruments issued by Fannie Mae and Freddie Mac and other U.S. government agencies linked to long-term U.S. debt. Instruments of this nature are key assets on the balance sheets of financial institutions, including Citizens. These downgrades could adversely affect the market value of such instruments, and could adversely impact our ability to obtain funding that is collateralized by affected instruments, as well as affecting the pricing of that funding when it is available. In addition, these downgrades could materially affect financial markets and economic conditions, which may affect our net income, financial condition and liquidity and result in future changes in capital requirements or our investment portfolio in response to management’s assessment of the related risk weightings. We cannot predict if, when or how these changes to the credit ratings will affect economic conditions. As a result, it is possible that these changes could result in a significant adverse impact to us, and could affect other risks to which we are subject.

New accounting or tax pronouncements or interpretations may be issued by the accounting profession, regulators or other government bodies which could change existing accounting methods. Changes in accounting methods could negatively impact our results of operations and financial condition.

Current accounting and tax rules, standards, policies, and interpretations influence the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time. Events that may not have a direct impact on us, such as the bankruptcy of major U.S. companies, have resulted in legislators, regulators, and authoritative bodies, such as the Financial Accounting Standards Board, the SEC, the Public Company Accounting Oversight Board, and various taxing authorities, responding by adopting and/or proposing substantive revision to laws, regulations, rules, standards, policies, and interpretations.

New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. A change in accounting standards may adversely affect reported financial condition and results of operations.

Our business continuity plans or data security systems could prove to be inadequate, resulting in a material interruption in, or disruption to, our business and a negative impact on our results of operations.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems, whether due to severe weather, natural disasters, cyber attack, acts of war or terrorism, criminal activity or other factors, could result in failures or disruptions in general ledger, deposit, loan, customer relationship management, and other systems. While we have disaster recovery and other policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our results of operations.

Our vendors could fail to fulfill their contractual obligations, resulting in a material interruption in, or disruption to, our business and a negative impact on our results of operations.

We have entered into subcontracts for the supply of current and future services, such as data processing, mortgage loan processing and servicing, and certain property management functions. These services must be available on a continuous and timely basis and be in compliance with any regulatory requirements. Failure to do so could substantially harm our business.

We often purchase services from vendors under agreements that typically can be terminated on a periodic basis. There can be no assurance, however, that vendors will be able to meet their obligations under these agreements or that we will be able to compel them to do so. Risks of relying on vendors include the following:

•

If an existing agreement expires or a certain service is discontinued by a vendor, then we may not be able to continue to offer our customers the same breadth of products and our operating results would likely suffer unless we are able to find an alternate supply of a similar service.

•

Agreements we may negotiate in the future may commit us to certain minimum spending obligations. It is possible we will not be able to create the market demand to meet such obligations.

•

If market demand for our products increases suddenly, our current vendors might not be able to fulfill our commercial needs, which would require us to seek new arrangements or new sources of supply, and may result in substantial delays in meeting market demand.

•

We may not be able to control or adequately monitor the quality of services we receive from our vendors. Poor quality services could damage our reputation with our customers.

Potential problems with vendors such as those discussed above could have a significant adverse effect on our business, lead to higher costs and damage our reputation with our customers and, in turn, have a material adverse effect on our financial condition and results of operations.

Our controls and procedures may fail or be circumvented which could have a material adverse effect on our business, results of operations and financial condition.

We regularly review and update our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.

Our articles of incorporation and bylaws as well as certain banking laws may have an anti-takeover effect.

Provisions of our articles of incorporation and bylaws and federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire our Holding Company, even if doing so would be perceived to be beneficial to shareholders. The combination of these provisions effectively inhibits a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.

Risks Relating to the FirstMerit Merger

We will be subject to contractual restrictions and business uncertainties while the FirstMerit merger is pending.

Our merger agreement with FirstMerit restricts us from operating our business other than in the ordinary course, and prohibits us from taking specified actions without FirstMerit’s consent until the merger occurs. These restrictions may prevent us from pursuing attractive business opportunities that may arise prior to the completion of the merger. In addition, uncertainty about the effect of the FirstMerit merger on our staff members and clients may have an adverse effect on our business. We may have difficulty retaining staff members while the merger is pending, as certain staff members may experience uncertainty about their future roles with FirstMerit. In addition, the uncertainty caused by the pending merger could cause our clients and business associates to seek to change their existing business relationships with us. These uncertainties may impair our ability to attract, retain, and motivate key personnel and retain and grow our client base until we complete the merger.

The merger is subject to certain closing conditions that, if not satisfied or waived, will result in the merger not being completed. Failure to complete the merger with FirstMerit could negatively affect our business or cause our stock price to decline.

The merger is subject to customary conditions to closing, including the receipt of required regulatory approvals and approval of the Citizens and FirstMerit shareholders. If any condition to the merger is not satisfied or waived, to the extent permitted by law, including the absence of any materially burdensome condition in the regulatory approvals, the merger will not be completed. In addition, FirstMerit or Citizens may terminate the merger agreement under certain circumstances even if the merger is approved by their shareholders, including but not limited to, if the merger has not been completed on or before June 12, 2013. If we do not complete the merger, the market price of our common stock may decline to the extent that the current market price reflects a market assumption that the merger will be completed. In addition, we would not realize any of the expected benefits of having completed the merger. If the merger is not completed, additional risks could materialize, which could materially and adversely affect the business, financial results, financial condition and stock prices of FirstMerit or Citizens.

If the merger is not completed, we will have incurred substantial expenses without realizing the expected benefits of the merger.

We have incurred substantial expenses in connection with the negotiation and signing of the merger agreement, the receipt of regulatory and shareholder approvals and in anticipation of the completion of the merger. If the merger is not completed, we would have to recognize these expenses without realizing the expected benefits of the merger.

The merger is subject to the receipt of consents and approvals from governmental entities that may impose conditions that could have an adverse effect on the combined company following the merger.

Before the merger may be completed, various approvals or consents must be obtained from regulatory authorities. These regulatory authorities, including the Federal Reserve and the Comptroller of the Currency may impose conditions on the completion of the merger or require changes to the terms of the

merger. Such conditions or changes could have the effect of delaying completion of the merger, giving FirstMerit the right to terminate the merger agreement or imposing additional costs on or limiting the revenues of the combined company following the merger, any of which might have an adverse effect on the combined company following the merger. The Comptroller of the Currency’s approval of the merger of FirstMerit Bank and Citizens Bank is a condition of the merger.

We cannot be sure of the market value of the merger consideration that our common shareholders will receive as a result of the announced merger with FirstMerit.

Upon completion of the merger, each share of our common stock will be converted into merger consideration consisting of 1.37 shares of FirstMerit common stock. The market value of the merger consideration will vary from the closing price of FirstMerit common stock on the date we announced the merger, on the date that the proxy statement/prospectus is mailed to our shareholders, on the date of the special meeting of our shareholders, on the date we complete the merger and thereafter. Stock price changes may result from a variety of factors, including general market and economic conditions, changes in our respective businesses, operations and prospects, and regulatory situation of FirstMerit and Citizens. Many of these factors are beyond our control. Any change in the market price of FirstMerit common stock prior to completion of the merger will affect the market value of the merger consideration that our shareholders will receive upon completion of the merger, and there will be no adjustment to the merger consideration for changes in the market price of either shares of FirstMerit common stock or shares of our common stock. Accordingly, at the time of the special meeting, our shareholders will not know or be able to calculate the market value of the merger consideration they would receive upon completion of the merger.

Further, the businesses of FirstMerit and Citizens differ in important respects and, accordingly, the results of operations of the combined company and the market price of the combined company’s shares of common stock may be affected by factors different from those currently affecting the independent results of operations of FirstMerit and Citizens.

We may fail to realize all of the anticipated benefits of the merger.

The success of the merger will depend, in part, on FirstMerit’s ability to realize anticipated benefits and cost savings from combining the businesses of FirstMerit and Citizens and to combine the businesses of FirstMerit and Citizens in a manner that permits growth opportunities and cost savings to be realized without materially disrupting the existing customer relationships of Citizens nor decreasing revenues due to loss of customers. However, to realize these anticipated benefits and cost savings, FirstMerit must successfully combine the business of FirstMerit and Citizens. If the combined company is not able to achieve these objectives, the anticipated benefits and cost savings of the merger may not be realized fully or at all or may take longer to realize than expected.

Citizens has operated and, until the completion of the merger, will continue to operate, independently. It is possible that the integration process could result in the loss of key employees who may then receive severance benefits, the disruption of each company’s ongoing business or inconsistencies in standards, controls, procedures and policies that adversely affect the combined company’s ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits of the merger. The anticipated cost savings from the merger are largely expected to derive from the absorption by FirstMerit of many of our back-office and other duplicative administrative functions. Integration efforts between the two companies will also divert significant management attention and resources that will not be available for normal operations. An inability to successfully market FirstMerit’s products to Citizens’ customer base could cause the earnings of the combined company to be less than anticipated. An expected benefit from the merger is an expected increase in the revenues of the combined company from anticipated sales of FirstMerit’s wide variety of financial products, and from increased lending out of the combined company’s larger capital base and legal lending limits. An inability to successfully market FirstMerit’s products to our customer base could cause the earnings of the combined company to be less than anticipated. Integration matters and the transition to FirstMerit could have an adverse effect on Citizens and FirstMerit during the pre-merger transition period, and on FirstMerit for an undetermined period after consummation of the merger.

The merger agreement limits our ability to pursue an alternative acquisition proposal and requires us to pay a termination fee of $37.5 million under limited circumstances relating to alternative acquisition proposals.

The merger agreement prohibits FirstMerit and Citizens from soliciting, initiating or encouraging certain alternative acquisition proposals with any third party, subject to exceptions set forth in the merger agreement. The merger agreement also provides for the payment by FirstMerit or Citizens of a termination fee in the amount of $37.5 million in the event that the other party terminates the merger agreement for certain reasons. These provisions might discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of Citizens from considering or proposing such an acquisition.

ITEM 1B.

UNRESOLVED STAFF COMMENTS

None

ITEM 2.

PROPERTIES

Citizens’ executive offices are located at 328 South Saginaw Street, Flint, Michigan in the main office building of Citizens Bank, the bank subsidiary. The bank subsidiary operates through 219 offices. Of these, 60 are leased and the remainder are owned and not subject to any material liens. Rent expense on the leased properties totaled $6.1 million in 2012. The banking offices are located in various communities throughout the states of Michigan and Wisconsin, and in parts of Ohio, and are used by all of Citizens’ business segments. At certain Citizens Bank locations a portion of the office buildings are leased to tenants.

ITEM 3.

LEGAL PROCEEDINGS

Citizens is party to a number of lawsuits incidental to its business. Although litigation is subject to many uncertainties and the ultimate exposure with respect to many of these matters cannot be ascertained, Citizens does not believe the ultimate outcome of these matters will have a material adverse effect on its financial condition or liquidity.

In the first quarter of 2012, putative class action litigation was filed against the Bank and the Corporation, in the United States District Court for the Eastern District of Michigan and in Genesee County Circuit Court in the State of Michigan, relating to the Bank’s practices in posting debit card transactions to customers’ deposit accounts. The class of plaintiffs, which purports to constitute substantially all of the Bank’s customers during the class period, alleges that the Bank improperly reordered debit card transactions from the highest amount to lowest amount before processing these transactions in order to generate unwarranted overdraft fees. Plaintiffs contend that the Bank should have processed such transactions in the chronological order they were authorized or from lowest to highest, and seek restitution for the fees they claim were wrongly charged as well as a declaratory judgment and attorney fees. The state court action was stayed, and the same lead plaintiff then filed suit in federal court. During the second quarter of 2012, the two federal cases were consolidated into one case pending in the United States District Court for the Eastern District of Michigan under the caption Jane Simpson, et al. v. Citizens Bank, U.S. District Court Case No. 2:12-cv-10267, while the state court action was dismissed. Citizens has filed a motion to dismiss the consolidated federal action, which motion is currently pending. This litigation is still in its early stages and there can be no assurance that the outcome will not be adverse to Citizens. However, based on the information currently known, Citizens does not believe the resolution of this litigation will have a material adverse effect on its results of operations, cash flows or financial condition.

Between September 17, 2012 and October 5, 2012, alleged shareholders of Citizens filed six purported class action lawsuit in the Circuit Court of Genesee County, Michigan, which have been consolidated as In re Citizens Republic Bancorp, Inc. Shareholder Litigation, Case No. 12-99027-CK (the “Lawsuit”). The consolidated complaint (the “Complaint”) names as defendants Citizens, each of the current members of Citizens’ board of directors and FirstMerit. It alleges that the director defendants breached their fiduciary duties by failing to obtain the best available price in connection with the merger, by not utilizing a proper process to evaluate the merger and by agreeing to protective devices that ensure that no entity other than FirstMerit will seek to acquire Citizens. The Complaint also alleges that FirstMerit and Citizens aided and abetted those alleged breaches of fiduciary duty. The Complaint seeks declaratory and injunctive relief to prevent the consummation of the merger, rescissory damages and other equitable relief. The defendants filed a motion to dismiss the Complaint.

On February 21, 2013, the plaintiffs and defendants entered into a memorandum of understanding (the “MOU”) setting forth their agreement in principle to settle the Lawsuit. While the defendants deny the allegations made in the Complaint, they have agreed to enter into the MOU to avoid the costs and disruptions of any further litigation and to permit the timely closing of the Merger. The MOU describes the terms that the parties have agreed to include in the final settlement agreement concerning the Complaint (the “Settlement Agreement”), subject to confirmatory discovery by the plaintiffs, and describes the actions that the parties will take or refrain from taking between the date of the MOU and the date that the Settlement Agreement is finally approved.

The MOU, among other things, provided that the Defendants would amend the joint proxy statement/prospectus filed on February 21, 2013, to include the supplemental disclosures contained in the MOU. The MOU also provides that the Settlement Agreement will include an injunction against proceedings in connection with the Complaint and any additional complaints concerning claims that will be covered by the Settlement Agreement. In addition, the MOU provides that the Settlement Agreement will include a release on behalf of the plaintiffs, along with other members of the class of Citizens’ shareholders certified for purposes of the Settlement Agreement, in favor of the defendants and their related parties from any claims that arose from or are related to the Merger. The Defendants have agreed to pay the plaintiffs’ attorneys’ fees and expenses as awarded by the court, subject to court approval of the Settlement Agreement and the consummation of the Merger.

We do not believe the costs associated with the Settlement Agreement or the MOU will have a material impact on Citizens’ financial condition, results of operations or liquidity.

From time to time, the Bank is notified by applicable environmental regulatory agencies, pursuant to state or federal environmental statutes or regulations, that they may be potentially responsible parties (“PRP”) for environmental contamination on or emanating from properties currently or formerly owned. Typically, exact costs of remediation of the contamination cannot be fully determined at the time of initial notification. While, as PRPs, the Bank is potentially liable for the costs of remediation, in most cases, a number of other PRPs have been identified as being jointly and severally liable for remediation costs. Additionally, in certain cases, statutory defenses to liability for remediation costs may be asserted based on the Bank’s status as a lending institution that acquired ownership of the contaminated property through foreclosure. Citizens is not presently aware of any environmental liabilities that pose a reasonable possibility of future material impact on its results of operations. It is Citizens’ policy to establish and accrue appropriate reserves for all such identified exposures during the accounting period in which a loss is deemed to be probable and the amount is determinable.

ITEM 4.

MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Holding Company’s common stock is traded on NASDAQ under the symbol “CRBC”. There were approximately 24,500 shareholders of the Holding Company’s common stock as of December 31, 2012, which includes record holders and individual participants in security position listings.

Information regarding the Holding Company’s high and low stock prices during each quarter of the last two fiscal years is set forth in the table below. The Holding Company is currently prohibited from paying cash dividends or repurchasing shares of common stock without the prior written consent of the U.S. Treasury and none have been paid during the last three years. Also, the Holding Company is unable to pay common stock dividends or engage in common stock repurchases until the TARP Preferred Stock dividend payments and payments deferred under our trust preferred securities are no longer in arrears. Restrictions on the Holding Company’s ability to pay dividends are described in “Item 1 Business – Supervision and Regulation” and such descriptions are incorporated herein by reference.


	Common Stock Price Range				Closing Price
	High		Low		Closing Price
2012
First quarter	$	15.75	$	11.40	$	15.61
Second quarter		17.47		14.55		17.13
Third quarter		20.98		16.80		19.35
Fourth quarter		19.74		16.92		18.97
Year		20.98		11.40		18.97
2011
First quarter⁽¹⁾	$	9.75	$	6.05	$	8.90
Second quarter⁽¹⁾		9.52		6.00		6.90
Third quarter		9.75		6.28		6.92
Fourth quarter		11.69		6.11		11.40
Year		11.69		6.00		11.40

⁽¹⁾	Prices retroactively adjusted to reflect the 1-for-10 reverse stock split effective after the close of trading on July 1, 2011.

In addition, the information under the caption “Equity Compensation Plan Information” under Item 12 of this Report is incorporated herein by reference.

Stock Performance Graph

The following graph summarizes the annual percentage change in the cumulative total shareholder return of the Holding Company’s common stock for the last five years compared with the Keefe, Bruyette & Woods Regional Banking Index (Ticker: KRX) and the S&P 500 Index (Ticker: SPX). The graph assumes the investment in Citizens’ common stock and each index was $100 on December 31, 2007 and the reinvestment of all dividends. The returns shown are not necessarily indicative of future performance.

LOGO


	2007		2008		2009		2010		2011		2012
CRBC	$	100.00	$	21.02	$	4.87	$	4.34	$	8.04	$	13.38
KRX		100.00		81.53		63.52		76.45		72.53		82.20
SPX		100.00		63.06		79.70		91.68		93.63		108.55

The information furnished under the heading “Stock Performance Graph” shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of that Section, and such information shall not be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended.

Issuer Purchases of Equity Securities


Period	Total Number of Shares Purchased ⁽¹⁾		Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares That May Yet Be Purchased Under The Plans or Programs ⁽²⁾
October 2012		1,952	$	19.23		—		124,115
November 2012		—		—		—		124,115
December 2012		—		—		—		124,115

Total		1,952	$	19.23		—		124,115

⁽¹⁾	Shares repurchased in connection with taxes due from employees as a result of the vesting of certain restricted share awards in accordance with the related grant agreements. These repurchases were not part of the repurchase program approved in October 2003.

⁽²⁾

In October 2003, the Board of Directors approved the repurchase of 300,000 shares of common stock from time to time in the market. There is no expiration date for the repurchase program. The repurchase of shares is generally prohibited, with certain exceptions, by the CPP Letter Agreement while Treasury continues to hold the related Series A Preferred Stock, by the terms of Citizens’ outstanding trust preferred securities, and is also subject to limitations that may be imposed by applicable securities laws and regulations and the rules of NASDAQ. The timing of the purchases and the number of shares to be bought at any one time also depend on market conditions and Citizens’ capital requirements. There can be no assurance that Citizens will repurchase the remaining shares authorized to be repurchased.

ITEM 6.

SELECTED FINANCIAL DATA

The selected financial data presented below is derived from Citizens’ audited consolidated financial statements and should be read in conjunction with its Consolidated Financial Statements for the years ended December 31, 2012, 2011, and 2010, and notes thereto and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included elsewhere in this Annual Report. Material events or changes that affect the comparability of information in the table are described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations “Significant Developments.”

Five Year Summary of Selected Financial Data



(in thousands, except per share amounts)	December 31, 2012			December 31, 2011			December 31, 2010			December 31, 2009			December 31, 2008
*For The Year*
Net interest income	$	300,772		$	313,110		$	329,064		$	310,449		$	343,039
Provision for loan losses		23,204			138,808			392,882			323,820			280,961
Noninterest income ⁽¹⁾		92,320			95,257			94,659			63,133			96,577
Noninterest expense ⁽²⁾		270,622			283,150			307,087			585,139			482,312
Income (loss) from continuing operations before income taxes		99,266			(13,591	)		(276,246	)		(535,377	)		(323,657	)
Income tax (benefit) provision from continuing operations ⁽³⁾		(273,009	)		(20,258	)		12,858			(29,633	)		70,970
Income (loss) from discontinued operations (after tax) ⁽⁴⁾		—			—			(3,821	)		(8,469	)		1,575
Net income (loss)		372,275			6,667			(292,925	)		(514,213	)		(393,052	)
Net income (loss) attributable to common shareholders ⁽⁵⁾		347,928			(16,318	)		(314,610	)		(533,990	)		(405,016	)
Cash dividends		—			—			—			—			21,959
Taxable equivalent adjustment		6,074			7,482			10,582			15,574			17,444

*Per Common Share Data ⁽⁶⁾*
Income (loss) from continuing operations:
Basic	$	8.61		$	(0.41	)	$	(7.89	)	$	(27.11	)	$	(43.20	)
Diluted		8.61			(0.41	)		(7.89	)		(27.11	)		(43.20	)
Income (loss) from discontinued operations:
Basic	$	—		$	—		$	(0.10	)	$	(0.44	)	$	0.17
Diluted		—			—			(0.10	)		(0.44	)		0.17
Net income (loss):
Basic	$	8.61		$	(0.41	)	$	(7.99	)	$	(27.55	)	$	(43.03	)
Diluted		8.61			(0.41	)		(7.99	)		(27.55	)		(43.03	)
Cash dividends		—			—			—			—			2.90
Common book value		26.62			18.24			18.47			26.85			105.97
Tangible book value (non-GAAP) ⁽⁷⁾		25.85			17.24			17.20			25.00			77.99
Tangible common book value (non-GAAP) ⁽⁸⁾		18.63			10.16			10.19			18.10			56.87
Shares outstanding, end of period ⁽⁹⁾		40,497,890			40,260,213			39,716,714			39,439,741			12,599,694
Market value, end of period		18.97			11.40			6.15			6.90			29.80

*At Year End*
Assets	$	9,586,683		$	9,462,849		$	9,965,645		$	11,595,670		$	12,724,678
Earning assets		8,453,513			8,680,995			9,302,825			10,864,446			11,655,879
Portfolio loans		5,258,976			5,529,535			6,216,602			7,787,905			8,963,175
Allowance for loan losses		110,439			172,726			296,031			338,940			252,938
Deposits		7,160,785			7,394,941			7,726,834			8,500,763			8,630,250
Long-term debt		850,910			854,185			1,032,689			1,512,987			2,193,066
Shareholders’ equity		1,370,505			1,019,537			1,011,731			1,331,036			1,601,321

*Average For The Year*
Assets	$	9,570,133		$	9,669,597		$	10,997,062		$	12,126,968		$	12,911,620
Earning assets		8,628,907			8,946,187			10,272,769			11,237,214			11,600,954
Portfolio loans		5,461,074			5,752,516			7,175,649			8,349,387			9,274,707
Allowance for loan losses		145,566			228,509			325,844			304,016			186,828
Deposits		7,315,842			7,582,742			8,282,629			8,509,676			8,351,683
Long-term debt		852,932			898,501			1,280,839			1,904,455			2,520,604
Shareholders’ equity		1,200,867			993,761			1,229,945			1,444,733			1,558,414

*Financial Ratios ⁽¹⁰⁾*
Return on average assets		3.89	%		0.07	%		(2.66	)%		(4.24	)%		(3.04	)%
Return on average shareholders’ equity		31.00			0.67			(23.82	)		(35.59	)		(25.22	)
Average shareholders’ equity / average assets		12.55			10.28			11.18			11.91			12.07
Dividend payout ratio		—			—			—			—			(5.59	)
Net interest margin (FTE) ⁽¹¹⁾		3.56			3.58			3.31			2.90			3.10
Efficiency ratio (non-GAAP) ⁽¹²⁾		65.75			63.05			67.73			74.21			62.61
Allowance for loan losses as a percent of portfolio loans		2.10			3.12			4.76			4.35			2.82
Allowance for loan losses as a percent of nonperforming loans ⁽¹³⁾		187.15			197.56			138.41			71.83			82.99
Allowance for loan losses as a percent of nonperforming assets ⁽¹³⁾		162.38			168.97			105.66			57.30			57.79
Nonperforming loans as a percent of portfolio loans ⁽¹³⁾		1.12			1.58			3.44			6.06			3.40
Nonperforming assets as a percent of portfolio loans plus ORAA ^(13)(14)		1.29			1.84			4.45			7.47			4.80
Nonperforming assets as a percent of total assets ⁽¹³⁾		0.71			1.08			2.81			5.10			3.44
Ratio of net charge-offs during period to average portfolio loans		1.57			4.56			6.07			2.85			2.04
Leverage ratio		9.95			8.45			7.71			9.21			9.66
Tier 1 capital ratio		15.71			13.51			12.11			12.52			12.21
Total capital ratio		16.97			14.84			13.51			13.93			14.49

⁽¹⁾

Noninterest income includes a fair-value adjustment on loans held for sale of $1.0 million, $1.8 million, $20.6 million, $20.1 million and $9.4 million in 2012, 2011, 2010, 2009, and 2008, respectively; a loss on investment securities of $1.3 million in 2011 and a gain on investment securities of $13.9 million in 2010; and a net loss on debt extinguishment of $15.9 million in 2009.

⁽²⁾

Noninterest expense includes fair-value adjustments on other real estate (“ORE”) properties of $0.2 million, $12.8 million, $13.4 million, $23.3 million and $8.1 million in 2012, 2011, 2010, 2009 and 2008, respectively and a goodwill impairment of $256.3 million and $178.1 million in 2009 and 2008, respectively.

⁽³⁾	Income tax provision (benefit) from continuing operations includes the increase in benefit for 2012, primarily the result of eliminating the valuation allowance against the deferred tax asset during the second quarter.

⁽⁴⁾	Citizens completed a stock purchase agreement in 2010 with Great Western Bank whereby Great Western Bank acquired all of the stock of Citizens’ wholly owned subsidiary, F&M, in exchange for $50.0 million in cash.

⁽⁵⁾

Net (loss) income attributable to common shareholders includes a non cash dividend to preferred shareholders of $24.3 million, $23.0 million, $21.7 million, and $19.8 million in 2012, 2011, 2010, and 2009, respectively, and a $0.2 dividend on redeemable preferred stock and a $11.7 million deemed dividend on convertible preferred stock in 2008.

⁽⁶⁾	Per common share data, as well as number of shares, were adjusted to reflect the 1 for 10 reverse stock split effective 7/1/11.

⁽⁷⁾	Tangible book value is an estimate of a company’s worth, if it was liquidated, to shareholders. The calculation using ending balances is as follows: (Shareholders’ equity-Goodwill-Intangible assets)/Common shares outstanding.

⁽⁸⁾	Tangible common book value is an estimate of a company’s worth, if it was liquidated, to common shareholders. The calculation using ending balances is as follows: (Shareholders’ equity-Preferred stock-Goodwill-Intangible assets)/Common shares outstanding.

⁽⁹⁾	Includes participating shares which are restricted stock units and restricted shares. On September 30, 2009 completed the settlement of its exchange for outstanding long term debt securities with a carrying value of $204.0 million.

⁽¹⁰⁾	Financial ratios are based upon continuing operations.

⁽¹¹⁾	Net interest margin includes taxable equivalent adjustments to interest income and is based on a tax rate of 35%.

⁽¹²⁾

Efficiency ratio (non-GAAP) is calculated as follows: (Noninterest expense-Losses on other real estate (“ORE”)-ORE expenses-Intangible amortization-Goodwill impairment-FDIC special assessment-(Gain)loss related to Visa USA shares-Restructuring and merger related expenses)/(Net interest income+Taxable equivalent adjustment+Total noninterest income-Investment securities gains(losses)).

⁽¹³⁾	Nonperforming loans/assets exclude troubled debt restructurings (TDRs) that are on an accrual status and performing in accordance with their modified terms.

⁽¹⁴⁾	Other real estate assets acquired (“ORAA”) include nonaccrual loans held for sale.

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following presents management’s discussion and analysis of Citizens’ financial condition and results of operations for each of the past three years and should be read in conjunction with the accompanying Consolidated Financial Statements and Notes. The discussion highlights the principal factors affecting earnings (loss) for the years 2012, 2011, and 2010 and the significant changes in balance sheet items from December 31, 2011 to December 31, 2012 and is intended to help the reader understand, from management’s perspective, the consolidated financial statements, notes to financial statements, and the accompanying tables, charts and financial statistics appearing elsewhere in this report. Where applicable, this discussion also reflects management’s insights regarding known events and trends that have or may reasonably be expected to have a material effect on Citizens’ operations and financial condition. All share and per share amounts have been adjusted to reflect the 1-for-10 reverse stock split that became effective July 1, 2011.

Forward–Looking Statements

Discussions and statements in this report that are not statements of historical fact, including without limitation statements that include terms such as “will,” “may,” “should,” “believe,” “expect,” “anticipate,” “estimate,” “project,” “intend,” and “plan,” and statements regarding Citizens’ future financial and operating results, plans, objectives, expectations and intentions, are forward-looking statements that involve risks and uncertainties, many of which are beyond Citizens’ control or are subject to change. No forward-looking statement is a guarantee of future performance and actual results could differ materially. Factors that could cause or contribute to such differences include, without limitation, risks and uncertainties detailed from time to time in Citizens’ filings with the SEC, including those listed in “Item 1A. Risk Factors” of this report.

Other factors not currently anticipated may also materially and adversely affect Citizens’ results of operations, cash flows, financial position, and prospects. There can be no assurance that future results will meet expectations. While Citizens believes that the forward-looking statements in this report are reasonable, the reader should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. Citizens does not undertake, and expressly disclaims any obligation to update or alter any statements, whether as a result of new information, future events or otherwise, except as may be required by applicable law.

OVERVIEW

Nature of Citizens’ Business

Citizens is a diversified banking and financial services company that provides a full range of banking, financial services and wealth management services to individuals and businesses through its subsidiary, Citizens Bank. Citizens conducts operations through 219 offices and 248 ATM locations throughout Michigan, Wisconsin, and Ohio. Citizens operates in five major business lines: Regional Banking, Specialty Consumer, Specialty Commercial, Wealth Management, and Other. Citizens’ performance is monitored by an internal profitability measurement system that provides line of business results as presented in “Line of Business Results” and Note 15 to the Consolidated Financial Statements, incorporated herein by reference.

Citizens’ primary source of revenue is net interest income, which is the difference between interest income on earning assets (such as loans and securities) and interest expense on liabilities (such as interest-bearing deposits and borrowings) used to fund those assets. Net interest income is affected by fluctuations in the amount and composition of earning assets and funding sources and in the yields earned and rates paid, respectively, on these assets and liabilities. Citizens’ measures the level of interest income relative to earning assets and interest bearing liabilities through two statistics—interest spread and net interest margin. The interest spread represents the difference between the taxable equivalent yields on earning assets and the rates paid for interest-bearing liabilities. The net interest margin is expressed as the percentage of taxable equivalent net interest income to average earning assets. Citizens’ sensitivity to changes in interest rates and the potential effect of changes in interest rates on net interest income is presented in more detail in “Interest Rate Risk”.

Proper management of the volume and composition of the Citizens’ earning assets and funding sources is essential for ensuring strong and consistent earnings performance, maintaining adequate liquidity and limiting exposure to risks caused by changing market conditions. Citizens’ investment securities portfolio is structured to provide a source of liquidity principally through the maturity of the securities held in the portfolio and to generate an income stream with relatively low levels of principal risk. Loans comprise the largest component of earning assets and are the highest yielding assets. Client deposits are the primary source of funding for earning assets while short-term debt and other managed sources of funds are utilized as market conditions and liquidity needs change.

Citizens monitors and manages its liquidity position so that funds will be available at a reasonable cost to meet client cash flow needs, while maintaining funds available for loan and investment opportunities as well as to service debt, invest in its subsidiary, finance business expansion, satisfy other operating requirements and take advantage of unforeseen opportunities. Citizens derives its liquidity through core deposit growth, maturity of money market investments, and maturity and sale of investment securities and loans. Citizens also has access to market borrowing sources for both short-term and long-term purposes.

Citizens’ other principal source of revenue is noninterest income, particularly fees and other revenue from financial services provided to customers. Citizens’ noninterest income includes service charges on deposit accounts, trust fees related to personal, institutional and employee benefit products and services, revenue related to loan products, including commercial loan fees and mortgage banking revenue, and fees for various other services, such as brokerage and investment services, ATM network use, and other financial services.

Performance Summary

An analysis of the major components of net income (loss) is presented below.

Three Year Summary of Net Income Components


	Year Ended December 31,
(in thousands)	2012			2011			2010
Interest income	$	371,928		$	407,819		$	484,444
Interest expense		71,156			94,709			155,380

Net interest income		300,772			313,110			329,064
Provision for loan losses		23,204			138,808			392,882
Noninterest income		92,320			95,257			94,659
Noninterest expense		270,622			283,150			307,087
Income tax (benefit) provision from continuing operations		(273,009	)		(20,258	)		12,858
Loss from discontinued operations (net of income tax)		—			—			(3,821	)

Net income (loss)		372,275			6,667			(292,925	)
Dividend on redeemable preferred stock		(24,347	)		(22,985	)		(21,685	)

Net income (loss) attributable to common shareholders	$	347,928		$	(16,318	)	$	(314,610	)

Pre-tax pre-provision profit (non-GAAP)⁽²⁾
Net income (loss) from continuing operations	$	372,275		$	6,667		$	(289,104	)
Income tax (benefit) provision from continuing operations		(273,009	)		(20,258	)		12,858
Provision for loan losses		23,204			138,808			392,882
Net (gains) losses on loans held for sale		984			(1,808	)		20,617
Merger-related expenses		5,008			—			—
Investment securities (gains) losses		—			1,336			(13,896	)
(Gains) losses on other real estate (ORE)		(214	)		12,768			13,438
Fair value adjustment on bank owned life insurance⁽¹⁾		(71	)		233			(67	)
Fair value adjustment on swaps⁽¹⁾		11			413			782

Pre-tax pre-provision profit (non-GAAP)	$	128,188		$	138,159		$	137,510

⁽¹⁾	Amounts contained in “Other Income” on Consolidated Statement of Operations.

⁽²⁾	Pre-tax pre-provision profit (non-GAAP) defined in “Use of Non-GAAP Financial Measures.”

Key factors behind the changes in results for 2012 compared with 2011 were:

•

The decrease in net interest income was primarily a result of a decrease of $317.3 million in average earning assets. Additionally, net interest margin dropped by two basis points to 3.56%. The decrease in average earning assets was primarily due to reductions in our loan portfolio, particularly in the commercial real estate business, as well as smaller decreases in the residential mortgage and direct consumer portfolios. These reductions were partially offset by substantial increases in the commercial and industrial and indirect portfolios, as well as investment securities. The decrease in net interest margin was primarily the result of the continued low interest rate environment, which has resulted in reduced yields on our earning assets. The negative effects on asset yields were almost fully offset by a more advantageous funding mix and reduced funding costs.

•

The decrease in the provision for loan losses in 2012 was primarily a result of the continuing improvement of the credit metrics within our business. During 2012, we experienced improvement in virtually every credit metric including delinquencies, non-performing assets, and charge offs.

•

Noninterest income dropped 3% compared to 2011 as clients changed their behavior relative to penalty fees and product choices. Additionally, we experienced a net loss in loans held for sale in 2012 while we recorded gains in 2011. The loss in 2012 was driven by a $2.7 million charge related to one commercial loan relationship in the loans held for sale portfolio.

•

The decrease in noninterest expense was the result of a reduction in credit related expenses including gains or losses on ORE, ORE expenses and other loan expense. These reductions were partially offset by increased employment and merger related costs.

•

The large increase in the income tax benefit was driven almost entirely by the elimination of our valuation allowance on the deferred tax asset.

•

Pre-tax pre-provision profit decreased approximately $10.0 million due largely to reduced net interest income discussed above.

SIGNIFICANT DEVELOPMENTS

Business Combination

On September 13, 2012, Citizens and FirstMerit Corporation (“FirstMerit”) announced the signing of a definitive agreement under which FirstMerit will acquire Citizens in a stock-for-stock merger transaction. Under the terms of the agreement, Citizens’ common shareholders will receive 1.37 shares of FirstMerit common stock in exchange for each share of Citizens’ common stock.

FirstMerit is also required to repay at closing Citizens’ approximately $355 million of TARP preferred stock, which includes $55 million of estimated deferred dividends, held by the U.S. Treasury. The merger has been unanimously approved by the Boards of Directors of both Citizens and FirstMerit and is subject to customary closing conditions, including receipt of regulatory approvals and approval by both companies’ shareholders. The transaction is expected to close in the second quarter of 2013.

Payments resumed on Trust Preferred Securities

On December 10, 2012, Citizens announced that it will resume interest payments on its outstanding junior subordinated debentures relating to its two trust preferred securities. Regularly scheduled quarterly interest payments were deferred in January 2010 although Citizens continued to accrue for the obligations. Payment on the variable rate junior subordinated debentures due June 2033 was made on December 26, 2012 for the 12 payments due or deferred plus interest and dividends on the associated trust preferred securities were made to holders of record on December 15, 2012. Payment on the 7.50% junior subordinated debentures due September 2066 (NYSE: CTZ-PrA) along with dividends on the associated trust preferred securities will be made in March 2013. In the aggregate, Citizens’ accrued obligation for these deferred payments as of December 31, 2012 was approximately $12 million. Citizens intends to resume the regular quarterly interest payment schedule.

Reversal of the Valuation Allowance on our Deferred Tax Asset

During 2012, Citizens recorded an income tax benefit of $273.0 million primarily the result of eliminating the valuation allowance against our deferred tax asset that had been established as of December 2008. Following Citizens’ quarterly review of the deferred tax asset at June 30, 2012, Citizens determined that the deferred tax asset valuation allowance was no longer necessary. As of December 31, 2012, the recorded balance of the net deferred tax asset was $272.9 million.

Termination of the Written Agreement with FRBC and OFIR

On July 28, 2010, Citizens and Citizens Bank entered into a written supervisory agreement with the FRBC and OFIR, their primary regulators. Effective April 17, 2012, the Federal Reserve Bank of Chicago and the Michigan Office of Financial and Insurance Regulation terminated the written agreement.

Reverse Stock Split

Citizens affected a 1-for-10 reverse stock split of its common stock effective after the close of trading on July 1, 2011. Citizens common stock began trading on a split adjusted basis on The NASDAQ Capital Market at the opening of trading on July 5, 2011.

Proportional adjustments were made to Citizens’ equity based plans as well as outstanding options, warrants and other securities entitling their holders to purchase or receive shares of Citizens common stock so that the reverse stock split did not materially affect any of the rights of holders of those securities.

Resolution of Problem Assets

In an effort to reduce overall problem asset levels, Citizens resolved $460.0 million of problem assets in the first quarter of 2011 and $466.2 million of problem assets in the fourth quarter of 2010 through a combination of bulk sales and individual workouts, recording a provision for loan losses of $88.7 million and $131.3 million and net charge-offs of $160.6 million and $159.3 million in the first quarter of 2011 and fourth quarter of 2010, respectively. These resolution efforts led to substantial decreases in the provision for loan losses in the second half of 2011, significantly reduced the outstanding amount of nonperforming loans and watchlist loans and improved the credit quality of our loan portfolio.

Discontinued Operations

On April 23, 2010, Citizens completed the sale of its wholly owned subsidiary, F&M Bank-Iowa (“F&M”) to Great Western Bank in exchange for $50.0 million in cash. The price represented approximately 25 times F&M’s average earnings and 1.10 times its tangible book value. The sale proceeds improved Citizens’ capital and liquidity positions in a manner that was non-dilutive to shareholders.

The financial condition and operating results for this subsidiary have been segregated from the financial condition and operating results of Citizens’ continuing operations throughout this report and, as such, are presented as a discontinued operation. While all prior periods have been revised retrospectively to align with this treatment, these changes do not affect Citizens’ reported consolidated financial condition or operating results for any of the prior periods.

Use of Non-GAAP Financial Measures

In addition to results presented in accordance with generally accepted accounting principles in the United States (“GAAP”), this report includes non-GAAP financial measures such as net interest margin, efficiency ratio, tangible equity to tangible assets ratio, tangible common equity to tangible assets ratio, Tier 1 common equity ratio and pre-tax pre-provision profit. Citizens believes these non-GAAP financial measures provide additional information that is useful to investors in understanding the underlying performance of Citizens, its business, and performance trends and, to a lesser degree, such measures may help facilitate performance comparisons with others in the banking industry. Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied and are not audited. Readers should be aware of these limitations and should be cautious as to their use of such measures. To mitigate these limitations, Citizens has procedures in place to ensure that these measures are calculated using the appropriate GAAP or regulatory components in their entirety and to ensure that Citizens’ performance is properly reflected to facilitate consistent period-to-period comparisons. Although Citizens believes the non-GAAP financial measures disclosed in this report enhance investors’ understanding of its business and performance, these non-GAAP measures should not be considered in isolation, or as a substitute for GAAP basis financial measures.

Net Interest Margin and Efficiency Ratio (non-GAAP financial measures)

In accordance with industry standards, certain designated net interest income amounts are presented on a taxable equivalent basis, including the calculation of net interest margin and the efficiency ratio. Citizens believes the presentation of net interest margin on a taxable equivalent basis using a 35% effective tax rate allows comparability of net interest margin with industry peers by eliminating the effect of the differences in portfolios attributable to the proportion represented by both taxable and tax-exempt investments. See “Item 6 Selected Financial Data,” the Non-GAAP Reconciliation Table, and the Average Balances/Net Interest Income/Average Rates Table later in this report for additional information.

Tangible Equity, Tangible Common Equity and Tier 1 Common Equity Ratios (non-GAAP financial measures)

Citizens believes the exclusion of goodwill and other intangible assets to create “tangible assets” and “tangible equity” facilitates the comparison of results for ongoing business operations. Citizens’ management internally assesses the company’s performance based, in part, on these non-GAAP financial measures. The tangible common equity ratio and Tier 1 common equity ratio have become a

focus of some investors and management believes that these ratios may assist investors in analyzing Citizens’ capital position absent the effects of intangible assets and preferred stock. Because tangible common equity and Tier 1 common equity are not formally defined by GAAP or codified in the federal banking regulations, these measures are considered to be non-GAAP financial measures. Because analysts and banking regulators may assess Citizens’ capital adequacy using tangible common equity and Tier 1 common equity, Citizens believes that it is useful to provide investors the ability to assess its capital adequacy on the same basis. Tier 1 common equity is often expressed as a percentage of net risk-weighted assets. Under the risk-based capital framework, a bank’s balance sheet assets and credit equivalent amounts of off-balance sheet items are assigned to one of four broad risk categories. The aggregated dollar amount in each category is then multiplied by the risk weight assigned to that category. The resulting weighted values from each of the four categories are added together and this sum is the risk-weighted assets total that, as adjusted, comprises the denominator of certain risk-based capital ratios. Tier 1 capital is then divided by this denominator (net risk-weighted assets) to determine the Tier 1 capital ratio. Adjustments are made to Tier 1 capital to arrive at Tier 1 common equity as shown in the Non-GAAP Reconciliation Table below. The amounts disclosed as net risk-weighted assets are calculated consistent with banking regulatory requirements.

Pre-tax Pre-Provision Profit (non-GAAP financial measure)

Pre-tax pre-provision profit (“PTPP”), as defined by Citizens’ management represents total revenue (total net interest income and noninterest income) excluding any securities gains/losses, fair value adjustments on loans held for sale, interest rate swaps, and bank owned life insurance, less noninterest expense excluding any goodwill impairment charges, credit writedowns, fair value adjustments, merger-related expenses, and special assessments. While certain of these items are an integral part of Citizens’ banking operations, in each case, the excluded items are items that management believes are particularly impacted by economic stress or significant changes in the credit cycle and are therefore likely to make it more difficult to understand our underlying performance trends and the ability of our banking operations to generate revenue. Net interest income, noninterest income and noninterest expense are all calculated in accordance with GAAP and are presented in the Consolidated Statements of Operations. While noninterest income and noninterest expense are adjusted for the specific items listed above in the calculation of PTPP, these adjustments represent the excluded items in their entirety for each period presented to better facilitate period-to-period comparisons.

Viewed together with Citizens’ GAAP results, PTPP provides management, investors, and others with a useful metric to evaluate and better understand trends in Citizens’ period-to-period earnings power and ability to generate capital to cover credit losses, in each case exclusive of the effects of the current and recent economic stress and the credit cycle. As recent results for the banking industry demonstrate, loan charge-offs, related credit provision, and credit writedowns can vary significantly from period to period, making a measure that helps isolate the impact of credit costs on profitability all the more important to investors. The “Credit Quality” section of this report discusses the quality of Citizens’ loan portfolio and the impact on Citizens’ earnings as reflected in the provision for loan losses.

A portion of the compensation awarded to Citizens’ Named Executive Officers and certain other management employees for their performance in 2011 and 2012 is measured against a PTPP performance target as Citizens believes that PTPP is a key measurement that helps keep revenue generation as a focus for its business and a particularly valuable measure during challenging credit cycles. Based on 2011 full year results, the total cash compensation award linked to PTPP was $0.8 million. Additionally, during 2011, approximately 186,500 shares of restricted stock were granted which have a two-year vesting period based partially on PTPP results and partially on net income. Based on 2012 full year results, the total potential cash compensation award linked to PTPP is $1.6 million, payable in early 2013. The grants are designed so that a portion of the compensation is based on net income while the remainder does not depend on management’s performance with regard to managing loan losses, securities impairments, merger related expenses, and other asset impairments.

Like all non-GAAP metrics, PTPP’s usefulness is inherently limited. Because Citizens’ calculation of PTPP may differ from the calculation of similar measures used by other bank holding companies, PTPP should be used to determine and evaluate period to period trends in Citizens’ performance and in

comparison to Citizens’ loan charge-offs, related credit provision, and credit writedowns, rather than in comparison to non-GAAP metrics used by other companies. In addition, investors should bear in mind that income tax expense (benefit), the provision for loan losses, and the other items excluded from revenues and expenses in the PTPP calculation are recurring and integral expenses to Citizens’ banking operations, and that these expenses will still accrue under GAAP, thereby reducing GAAP earnings and, ultimately, shareholders’ equity.

The following table displays the calculation for the past three years of these non-GAAP measures other than pre-tax pre-provision profit, the calculation of which is set forth in the “Performance Summary” section.

Non-GAAP Reconciliation


(in thousands)	2012			2011			2010
*Efficiency Ratio (non-GAAP)*
Net interest income (A)	$	300,772		$	313,110		$	329,064
Taxable equivalent adjustment (B)		6,074			7,482			10,582
Investment securities (losses) gains (C)		—			(1,336	)		13,896
Noninterest income (D)		92,320			95,257			94,659
Noninterest expense (E)		270,622			283,150			307,087
Losses on ORE and ORE Expenses (F)		1,045			17,090			18,408
Intangible amortization (G)		2,120			3,027			3,923
Merger related expenses (H)		5,008			—			—
*Efficiency ratio: (E-F-G-H)/(A+B-C+D) (non-GAAP)*		65.75	%		63.05	%		67.73	%
*Tangible Common Equity to Tangible Assets (non-GAAP)*
Total assets	$	9,586,683		$	9,462,849		$	9,965,645
Goodwill		(318,150	)		(318,150	)		(318,150	)
Other intangible assets		(5,308	)		(7,428	)		(10,454	)

Tangible assets (non-GAAP)	$	9,263,225		$	9,137,271		$	9,637,041

Total shareholders’ equity	$	1,370,505		$	1,019,537		$	1,011,731
Goodwill		(318,150	)		(318,150	)		(318,150	)
Other intangible assets		(5,308	)		(7,428	)		(10,454	)

Tangible equity (non-GAAP)	$	1,047,047		$	693,959		$	683,127

Tangible equity	$	1,047,047		$	693,959		$	683,127
Preferred stock		(292,473	)		(285,114	)		(278,300	)

Tangible common equity (non-GAAP)	$	754,574		$	408,845		$	404,827

*Tier 1 Common Equity (non-GAAP)*
Total shareholders’ equity	$	1,370,505		$	1,019,537		$	1,011,731
Qualifying capital securities and other adjustments		73,667			73,558			73,489
Goodwill		(318,150	)		(318,150	)		(318,150	)
Accumulated other comprehensive loss (income)		13,213			5,820			20,156
Disallowed deferred tax asset		(241,535	)		—			—
Other intangible assets		(5,308	)		(7,428	)		(10,454	)

Tier 1 capital (regulatory)	$	892,392		$	773,337		$	776,772

Tier 1 capital (regulatory)	$	892,392		$	773,337		$	776,772
Qualifying capital securities and other adjustments		(73,667	)		(73,558	)		(73,489	)
Preferred stock		(292,473	)		(285,114	)		(278,300	)

Total Tier 1 common equity (non-GAAP)	$	526,252		$	414,665		$	424,983

Net risk-weighted assets (regulatory)	$	5,695,254		$	5,723,333		$	6,416,792
Equity to assets		14.30	%		10.77	%		10.15	%
Tier 1 common equity (non-GAAP)		9.24			7.24			6.62
Tangible equity to tangible assets (non-GAAP)		11.30			7.59			7.09
Tangible common equity to tangible assets (non-GAAP)		8.15			4.47			4.20

RESULTS OF OPERATIONS

NET INTEREST INCOME

An analysis of net interest income, interest spread and net interest margin with average balances and related interest rates is presented below.


*Average Balances/Net Interest Income/Average Rates*

	2012								2011								2010
(in thousands)	Average Balance			Interest ⁽¹⁾		Average Rate ⁽²⁾			Average Balance			Interest ⁽¹⁾		Average Rate ⁽²⁾			Average Balance			Interest ⁽¹⁾		Average Rate ⁽²⁾
*Earning Assets*
Money market investments	$	251,169		$	626		0.25	%	$	340,482		$	840		0.25	%	$	605,217		$	1,501		0.25	%
Investment securities ⁽³⁾:
Taxable		2,573,740			63,912		2.48			2,444,539			79,281		3.24			1,901,195			72,545		3.82
Tax-exempt		207,726			8,711		6.45			250,098			10,800		6.64			366,044			16,035		6.74
FHLB and Federal Reserve stock		121,107			4,897		4.04			132,101			4,152		3.14			154,959			3,776		2.44
Portfolio loans ⁽⁴⁾:
Commercial and industrial		1,647,813			89,944		5.54			1,438,292			72,194		5.13			1,728,712			81,069		4.80
Commercial real estate		1,415,141			69,652		4.92			1,776,292			90,862		5.12			2,631,901			139,307		5.30
Residential mortgage		591,946			25,595		4.32			700,257			32,539		4.65			867,500			43,862		5.06
Direct consumer		884,745			51,490		5.82			981,396			59,273		6.04			1,133,691			68,794		6.07
Indirect consumer		921,429			56,639		6.15			856,279			56,947		6.65			813,845			55,629		6.84

Total portfolio loans		5,461,074			293,320		5.40			5,752,516			311,815		5.45			7,175,649			388,661		5.44
Loans held for sale ⁽⁴⁾		14,091			462		3.28			26,451			931		3.52			69,705			1,926		2.76

Total earning assets		8,628,907			371,928		4.38			8,946,187			407,819		4.64			10,272,769			484,444		4.82
*Nonearning Assets*
Cash and due from banks		143,639								142,721								163,203
Premises and equipment		93,953								101,009								107,382
Investment security fair value adjustment		54,149								44,712								54,451
Other nonearning assets		795,051								663,477								725,101
Assets of discontinued operations		—								—								108,615
Allowance for loan losses		(145,566	)							(228,509	)							(325,844	)

Total assets	$	9,570,133							$	9,669,597							$	11,105,677

*Interest-Bearing Liabilities*
Deposits:
Interest-bearing demand deposits	$	1,026,098		$	1,437		0.14		$	953,187		$	2,021		0.21		$	1,008,871		$	2,741		0.27
Savings deposits		2,639,803			5,901		0.22			2,636,422			9,315		0.35			2,561,596			15,785		0.62
Time deposits		1,902,397			30,121		1.58			2,489,703			45,991		1.85			3,405,281			80,000		2.35
Short-term borrowings		41,676			53		0.13			42,760			79		0.18			36,744			80		0.22
Long-term debt		852,932			33,644		3.94			898,501			37,303		4.15			1,280,839			56,774		4.43

Total interest-bearing liabilities		6,462,906			71,156		1.10			7,020,573			94,709		1.35			8,293,331			155,380		1.87
*Noninterest-Bearing Liabilities* *and Shareholders’ Equity*
Noninterest-bearing demand		1,747,544								1,503,430								1,306,881
Other liabilities		158,816								151,833								146,669
Liabilities of discontinued operations		—								—								128,851
Shareholders’ equity		1,200,867								993,761								1,229,945

Total liabilities and shareholders’ equity	$	9,570,133							$	9,669,597							$	11,105,677

*Interest Spread ⁽⁵⁾*				$	300,772		3.28	%				$	313,110		3.29	%				$	329,064		2.95	%

Contribution of noninterest bearing sources of funds							0.28								0.29								0.36

*Net Interest Margin ⁽⁵⁾⁽⁶⁾*							3.56	%							3.58	%							3.31	%

⁽¹⁾	Interest income is shown on actual basis and does not include taxable equivalent adjustments.

⁽²⁾	Average rates are presented on an annual basis and include taxable equivalent adjustments to interest income of $6.1 million, $7.5 million and $10.6 million for the years ended December 31, 2012, 2011 and 2010, respectively, based on a tax rate of 35%.

⁽³⁾	For presentation in this table, average balances and the corresponding average rates for investment securities are based upon historical cost, adjusted for amortization of premiums and accretion of discounts.

⁽⁴⁾	Nonaccrual loans are included in average balances for each applicable loan category.

⁽⁵⁾	The interest spread and net interest margin are presented on a tax-equivalent basis.

⁽⁶⁾	Because noninterest-bearing funding souces, demand deposits, other liabilities and shareholders’ equity also support earning assets, the net interest margin exceeds the interest spread.

2012 compared with 2011

The decrease in net interest margin was primarily the result of lower earning assets and the continued low interest rate environment, which resulted in a slightly reduced yield on our earning assets. The negative effects on asset yields were almost fully offset by a more advantageous funding mix and reduced funding costs. Average earning assets decreased $317.3 million. Additionally, net interest margin dropped by two basis points to 3.56%. The decrease in average earning assets was primarily due to reductions in our loan portfolio, particularly in the commercial real estate business, as well as smaller decreases in the residential mortgage and direct consumer portfolios. These reductions were partially offset by substantial increases in the commercial and industrial and indirect portfolios as well as investment securities.

2011 compared with 2010

The increase in net interest margin was primarily the result of declining deposit costs, reductions in high-cost funding, lower levels of nonperforming assets and a planned reduction in excess cash and money market investments, partially offset by lower investment securities yields. The decrease in net interest income was primarily the result of a decrease in average earning assets due to the effects of the accelerated problem asset resolution initiatives completed during the first half of 2011.

The table below shows changes in interest income, interest expense and net interest income due to volume and rate variances for major categories of earning assets and interest-bearing liabilities.

Analysis of Changes in Interest Income and Interest Expense


	2012 Compared to 2011									2011 Compared to 2010
	Net			Increase (Decrease) Due to Change in						Net			Increase (Decrease) Due to Change in
(in thousands)	Change⁽¹⁾			Rate ⁽²⁾			Volume⁽²⁾			Change⁽¹⁾			Rate ⁽²⁾			Volume⁽²⁾
*Interest Income on Earning Assets:*
Money market investments	$	(214	)	$	9		$	(223	)	$	(661	)	$	(8	)	$	(653	)
Investment securities:
Taxable		(15,369	)		(19,379	)		4,010			6,736			(11,957	)		18,693
Tax-exempt		(2,089	)		(304	)		(1,785	)		(5,235	)		(225	)		(5,010	)
FHLB and Federal Reserve stock		745			1,113			(368	)		376			987			(611	)
Loans:
Commercial and industrial		17,750			6,659			11,091			(8,875	)		5,420			(14,295	)
Commercial real estate		(21,210	)		(3,325	)		(17,885	)		(48,445	)		(4,536	)		(43,909	)
Residential mortgage loans		(6,944	)		(2,152	)		(4,792	)		(11,323	)		(3,349	)		(7,974	)
Direct consumer		(7,783	)		(2,101	)		(5,682	)		(9,521	)		(321	)		(9,200	)
Indirect consumer		(308	)		(4,476	)		4,168			1,318			(1,531	)		2,849

Total portfolio loans		(18,495	)		(5,395	)		(13,100	)		(76,846	)		(4,317	)		(72,529	)
Loans held for sale		(469	)		(60	)		(409	)		(995	)		427			(1,422	)

Total		(35,891	)		(24,016	)		(11,875	)		(76,625	)		(15,093	)		(61,532	)

*Interest Expense on Interest-Bearing Liabilities:*
Deposits:
Interest-bearing demand deposits		(583	)		(728	)		145			(720	)		(575	)		(145	)
Savings deposits		(3,414	)		(3,426	)		12			(6,470	)		(6,918	)		448
Time deposits		(15,870	)		(5,986	)		(9,884	)		(34,009	)		(15,060	)		(18,949	)
Short-term borrowings		(26	)		(24	)		(2	)		(1	)		(13	)		12
Long-term debt		(3,660	)		(1,816	)		(1,844	)		(19,471	)		(3,409	)		(16,062	)

Total		(23,553	)		(11,980	)		(11,573	)		(60,671	)		(25,975	)		(34,696	)

*Net Interest Income*	$	(12,338	)	$	(12,036	)	$	(302	)	$	(15,954	)	$	10,882		$	(26,836	)

⁽¹⁾	Changes are based on actual interest income and do not reflect taxable equivalent adjustments.

⁽²⁾	The change in interest not solely due to changes in volume or rates has been allocated in proportion to the absolute dollar amounts of the change in each.

2012 compared with 2011

The decrease in net interest income reflects rate and volume variances that are unfavorable in the aggregate. The unfavorable rate variance was primarily the result of the continued low interest rate environment, which has resulted in reduced yields on our earning assets. The negative effects on asset yields were partially offset by a more advantageous funding mix and reducing funding costs. The negative volume variance is the result of a lower level of average earning assets.

2011 compared with 2010

The decrease in net interest income reflects volume variances that were unfavorable in the aggregate and rate variances that were favorable in the aggregate. The unfavorable volume variance was primarily due to the reduction in the loan portfolios as a result of the accelerated problem asset resolution initiative, partially offset by an increase in the taxable investment securities portfolio and a decrease in time deposits and long term debt.

The favorable rate variance was primarily the result of borrowings repricing to lower rates as a result of lower market interest rates in 2011 and reduced deposit price competition, partially offset by lower reinvestment yields for investment securities and intensified price competition for commercial and industrial loans.

PROVISION FOR LOAN LOSSES

After determining what Citizens believes is an appropriate allowance for loan losses based on the inherent risk in the portfolio, the provision for loan losses is calculated each quarter as a result of the net effect of the quarterly change in the allowance for loan losses and the quarterly net charge-offs. The decreases in the provision for loan losses for 2012 compared with 2011 as well as 2011 to 2010 were primarily due to our focused efforts to improve asset quality, stabilized portfolio credit metrics and an overall decrease in loan balances. See “Critical Accounting Policies – Allowance for Loan Losses” and “Allowance for Loan Losses” for a discussion of the calculation of the allowance and the related methodology.

NONINTEREST INCOME

An analysis of the components of noninterest income is presented in the table below.

Noninterest Income


	Year Ended December 31,									$ Change						% Change
(dollars in thousands)	2012			2011			2010			2012-2011			2011-2010			2012-2011			2011-2010
Service charges on deposit accounts	$	37,308		$	39,268		$	40,336		$	(1,960	)	$	(1,068	)		(5.0	)%		(2.6	)%
Trust fees		14,601			15,103			15,603			(502	)		(500	)		(3.3	)		(3.2	)
Mortgage and other loan income		8,104			9,620			10,486			(1,516	)		(866	)		(15.8	)		(8.3	)
Brokerage and investment fees		6,055			5,072			4,579			983			493			19.4			10.8
Card-based and other nondeposit fees		17,507			17,167			15,916			340			1,251			2.0			7.9
(Losses) gains on loans held for sale		(984	)		1,808			(20,617	)		(2,792	)		22,425			(154.4	)		(108.8	)
Investment securities (losses) gains		—			(1,336	)		13,896			1,336			(15,232	)		(100.0	)		(109.6	)
Other		9,729			8,555			14,460			1,174			(5,905	)		13.7			(40.8	)

Total noninterest income	$	92,320		$	95,257		$	94,659		$	(2,937	)	$	598			(3.1	)		0.6

2012 compared with 2011

Noninterest income dropped 3.1% compared to 2011. We experienced a net loss on loans held for sale in 2012 while we recorded gains in 2011. The loss in 2012 was driven by a $2.7 million charge related to one commercial loan relationship in the category. Changes in the other noninterest items were largely offsetting. Service charges on deposit accounts were lower as clients changed their behavior relative to penalty fees and product choices. Mortgage and other loan income were down due to a decline in commercial letter of credit fees and derivative income, partially offset by increased mortgage origination volume. Brokerage and investment fees performed well due to increased focus to improve performance.

2011 compared with 2010

Noninterest income was essentially unchanged from last year, with gains on loans held for sale, offset by investment securities losses and lower other income. The gain on loans held for sale was offset by fewer writedowns to reflect fair value declines of the underlying collateral in 2011 compared to 2010. Citizens recorded net losses on investment securities compared to net gains in 2010 directly related to the sale of four CMOs during 2011 at a loss, and a gain on sale of securities in 2010 as part of Citizens’ capital strategy. The decline in other income reflects a decrease in interest rate swap income recognition and unrealized losses on deferred compensation plans.

NONINTEREST EXPENSE

An analysis of the components of noninterest expense is presented in the table below.

Noninterest Expense


	Year Ended December 31,							$ Change						% Change
(dollars in thousands)	2012			2011		2010		2012-2011			2011-2010			2012-2011			2011-2010
Salaries and employee benefits	$	132,850		$	123,514	$	126,384	$	9,336		$	(2,870	)		7.6	%		(2.3	)%
Occupancy		24,997			26,059		26,963		(1,062	)		(904	)		(4.1	)		(3.4	)
Professional services		13,772			9,331		10,550		4,441			(1,219	)		47.6			(11.6	)
Equipment		12,001			12,136		12,482		(135	)		(346	)		(1.1	)		(2.8	)
Data processing services		16,717			16,131		18,734		586			(2,603	)		3.6			(13.9	)
Advertising and public relations		5,904			5,848		6,530		56			(682	)		1.0			(10.4	)
Postage and delivery		4,456			4,543		4,571		(87	)		(28	)		(1.9	)		(0.6	)
Other loan expenses		13,224			16,007		20,311		(2,783	)		(4,304	)		(17.4	)		(21.2	)
(Gains) losses on other real estate (ORE)		(214	)		12,768		13,438		(12,982	)		(670	)		(101.7	)		(5.0	)
ORE expenses		1,259			4,322		4,970		(3,063	)		(648	)		(70.9	)		(13.0	)
Intangible asset amortization		2,120			3,027		3,923		(907	)		(896	)		(30.0	)		(22.8	)
Other		43,536			49,464		58,231		(5,928	)		(8,767	)		(12.0	)		(15.1	)

Total noninterest expense	$	270,622		$	283,150	$	307,087	$	(12,528	)	$	(23,937	)		(4.4	)		(7.8	)

2012 compared with 2011

The decrease in noninterest expense was the result of a substantial reduction in credit related expenses including reduced losses on ORE, ORE expenses and other loan expense. These expenses were lower in 2012 due to the continued improvement in our credit quality. These reductions were partially offset by increased salaries and benefits costs resulting from increased incentives due to better performance and a fuller staff compliment. The increase in professional services is related to our pending merger with FirstMerit.

2011 compared with 2010

The decrease in noninterest expense was the result of decreases in all noninterest expense categories, primarily lower other expenses, lower other loan expense, lower salaries and employee benefits, lower data processing services and lower professional services. The decline in other expenses was primarily related to reductions in FDIC insurance costs. Lower other loan expense was primarily the result of lower commercial and residential mortgage origination volume and foreclosure-related expenses. The decline in salaries and employee benefits, professional services and data processing services reflect the continued focus on improving efficiencies.

FDIC insurance premiums

In 2011, the FDIC implemented a rule that changed the assessment base from domestic deposits to average assets minus average tangible equity, adopted a new large-bank pricing assessment scheme, and set a target size for the Deposit Insurance Fund. The rule finalized a target size for the DIF at 2 percent of insured deposits. It also implemented a lower assessment rate schedule when the fund reaches 1.15 percent so that the average rate over time should be about 8.5 basis points of the assessment base and, in lieu of dividends, provides for a lower rate schedule when the reserve ratio reaches 2 percent and 2.5 percent. The rule, in aggregate, increased the share of assessments paid by large institutions and created a scorecard-based assessment system for banks with more than $10 billion in assets. The scorecards include financial measures that the FDIC believes are predictive of long-term performance. The new rule did not have a material effect on our results of operations and financial condition as assets were below $10 billion in 2012 and 2011.

FEDERAL AND STATE INCOME TAXES

Citizens recorded an income tax benefit of $273.0 million for 2012 compared with a tax benefit of $20.3 million for 2011 and a tax expense of $12.9 million in 2010. The tax benefit in 2012 was primarily the result of eliminating the valuation allowance against our deferred tax asset. The tax benefit in 2011 was primarily the result of recording a receivable due to the change in a tax election and changes in other components of income that are included in the calculation of the tax provision. The tax expense in 2010 was primarily the result of alternative minimum tax calculations.

In assessing whether or not some or all of our deferred tax assets are more likely than not to be realized in the future, we consider all available positive and negative evidence, including projected future taxable income, tax planning strategies and recent financial operations. Based on an evaluation of the then-available positive and negative evidence, Citizens determined it was appropriate to establish a full valuation allowance on our deferred tax asset as of December 31, 2008. At that time, and in subsequent quarters, negative evidence, including a recent cumulative history of operating losses, outweighed the positive evidence.

However, at June 30, 2012, the positive evidence outweighed the negative evidence and Citizens determined that a deferred tax asset valuation allowance was no longer necessary. The significant positive evidence in our analysis included: five consecutive quarters of profitability, termination of the written agreement with our primary regulators, improved capital levels, solid credit metrics, strong deposit mix, reduced regulatory risk, and a stabilizing economy.

The positive evidence continued through the remainder of 2012 including seven consecutive quarters of profitability, continued strong credit metrics, and other items noted above. As a result we continue to believe that the positive evidence outweighs the negative evidence and no valuation allowance is necessary at December 31, 2012.

During 2009, we incurred an ownership change within the meaning of Section 382 of the Internal Revenue Code. As a result, federal tax law places an annual limitation of approximately $17.7 million on the amount of certain loss carryforwards that may be used.

For further discussion of federal and state income taxes, see Note 13 to the Consolidated Financial Statements.

LINE OF BUSINESS RESULTS

Net income or loss by line of business is presented in the table below. A description of each business line, important financial performance data and the methodologies used to measure financial performance are presented in Note 15 to the Consolidated Financial Statements. Certain amounts have been revised retrospectively for discontinued operations.


(in thousands)	2012		2011			2010
Regional Banking	$	31,716	$	695		$	(4,904	)
Specialty Consumer		4,495		(4,831	)		(45,316	)
Specialty Commercial		47,062		(2,670	)		(98,847	)
Wealth Management		3,160		3,587			2,716
Other		285,842		9,886			(142,753	)

Net income (loss) from Continuing Operations	$	372,275	$	6,667		$	(289,104	)

2012 compared with 2011

Net income for Regional Banking increased primarily due to lower provision for loan losses, partially offset by lower net interest income and increased income tax expense. The decrease in the provision for loan losses reflected the results of our focused efforts to improve asset quality and stabilized portfolio credit metrics. The decrease in net interest income reflected the decline in loan balances. Income taxes increased due to the improvement in pre-tax earnings.

Specialty Consumer recorded net income in 2012, compared to a net loss in 2011 primarily due to lower provision for loan losses, which reflects the results of our focused efforts to improve asset quality, stabilized portfolio credit metrics as well as an overall decrease in loan balances.

Specialty Commercial recorded net income in 2012, compared to a net loss in 2011 primarily due to lower provision for loan losses and higher net interest income. The decrease in the provision for loan losses reflected the results of our focused efforts to improve asset quality and stabilized portfolio credit metrics. The increase in net interest income was directly related to an increase in commercial and industrial lending.

Net income for Wealth Management decreased primarily as a result of lower trust income due to a lower level of trust assets under administration.

Activities that are not directly attributable to one of the primary lines of business are included in the Other business line. Included in this category are the Holding Company; the shared services unit; Citizens’ treasury unit, including the securities portfolio, short-term borrowing and asset/liability management activities; inter-company eliminations; and the economic impact of certain assets, capital and support functions not specifically identifiable with the four primary lines of business. Net income for the Other line of business increased primarily as a result of lower income taxes as a result of the reversal of the deferred tax valuation allowance, partially offset by lower net interest income. Changes in income taxes reflect an allocation of 35% to all other lines of businesses in 2012 and 2011.

2011 compared with 2010

Regional Banking recorded net income in 2011, compared to a net loss in 2010 primarily due to lower provision for loan losses, partially offset by lower net interest income. The decrease in the provision for loan losses reflected the results of our focused efforts to improve asset quality and stabilized portfolio credit metrics as well as an overall decrease in loan balances. The decrease in net interest income reflected the decline in loan balances due to the resolution of problem assets.

Net losses for Specialty Consumer decreased primarily due to lower provision for loan losses and higher noninterest income due to credit writedowns in 2010 associated with the bulk sale of nonperforming residential mortgage loans.

Net losses for Specialty Commercial decreased primarily due to lower provision for loan losses and higher noninterest income, partially offset by lower net interest income. The decrease in the provision for loan losses reflected the results of our focused efforts to improve asset quality and stabilized portfolio credit metrics as well as an overall decrease in loan balances. The increase in noninterest income reflected fewer writedowns associated with loans held for sale. The decrease in net interest income reflected the decline in loan balances due to the resolution of problem assets.

Net income for Wealth Management increased primarily as a result of a decrease in noninterest expense relating to decreases in salaries and employee benefits expense and lower data processing expenses.

The Other line of business recorded net income for 2011, compared to a net loss in 2010 primarily as a result of higher net interest income, lower noninterest expense, lower discontinued operations and lower taxes. These improvements were partially offset by lower noninterest income. The increases in net interest income were primarily the result of the internal profitability methodology utilized at Citizens that insulates the other lines of business from interest-rate risk and assigns the risk to the asset/liability management function, which is a component of this segment. The decrease in noninterest expense was primarily the result of a decrease in FDIC insurance costs, as well as a continued focus on improving efficiencies. The 2010 loss on discontinued operations was directly related to the fair value adjustment related to the sale of F&M. The decrease in noninterest income was primarily the result of net gains on investment securities sales during 2010. Changes in income taxes reflect an allocation of 35% to all other lines of businesses in 2011 and 2010.

FINANCIAL CONDITION

TOTAL ASSETS

Total assets at December 31, 2012 were $9.6 billion, an increase of $123.8 million or 1.3% from December 31, 2011. The increase was due to the restoration of the deferred tax asset, and increases in investment securities, partially offset by a reduction in loan balances.

MONEY MARKET INVESTMENTS AND INVESTMENT SECURITIES

Objectives in managing the securities portfolio are driven by the dynamics of the balance sheet, including growth, maturity, management of interest rate risk and maximizing return. On October 6, 2008 the FRB announced that it would pay interest on required and excess reserve balances at rates close to the targeted federal funds rates. Citizens has chosen to utilize this program while adverse conditions exist in the credit markets. Securities are classified as available for sale or held to maturity and as of December 31, 2012, 58.1% of the securities in Citizens’ investment securities portfolio were classified as available for sale. A summary of investment securities balances is provided below.

Investment Securities


			December 31,
(in thousands)	2012		2011		2010
Securities available for sale, at fair value:
Federal agencies	$	—	$	—	$	5,557
Collaterized mortgage obligations		661,743		365,302		599,264
Mortgage-backed		933,143		823,852		1,259,131
State and municipal		102,436		123,308		183,584
Other		303		271		1,992

Total available for sale		1,697,625		1,312,733		2,049,528
Securities held to maturity, at amortized cost:
Collaterized mortgage obligations		283,264		350,160		—
Mortgage-backed		844,086		988,930		363,427
State and municipal		98,918		104,964		111,405

Total held to maturity		1,226,268		1,444,054		474,832

Total investment securities	$	2,923,893	$	2,756,787	$	2,524,360

Citizens maintained the risk profile of its investment securities portfolio during 2012 by increasing holdings of GNMA or agency-issued mortgage-backed securities and decreasing holdings of municipal and whole-loan mortgage-backed securities.

In June 2011 and December 2010, Citizens transferred certain mortgage-backed securities from the available for sale to the held to maturity category in accordance with Topic 320 “Investments-Debt and Equity Securities.” Management determined that it had both the ability to hold these investments to maturity and the positive intent to do so. The securities transferred in June 2011 had a total amortized cost of $924.6 million and a fair value of $943.1 million. The securities transferred in December 2010 had a total amortized cost of $179.2 million and a fair value of $181.8 million. The unrealized gain of $18.5 million in June 2011 and $2.6 million in December 2010 will be amortized over the remaining life of the securities as an adjustment of the yield, offset against the amortization of the unrealized gain maintained in accumulated other comprehensive income.

The collateralized mortgage obligations (“CMO”) sector includes securities where the underlying collateral consists of agency issued or whole loan mortgages. At December 31, 2012, the whole loan CMOs had a market value of $58.9 million with gross unrealized losses of $0.6 million. Citizens performs a thorough

credit review on a quarterly basis on the underlying mortgage collateral as well as the supporting credit enhancement and structure. The results of the December 31, 2012 credit review demonstrated continued strength and no material degradation to the holdings. Additionally, Citizens determined there is no other-than-temporary impairment on any security in the investment portfolio at December 31, 2012.

Maturities and average yields of investment securities are presented in the table below.

Maturity Distribution of Investment Securities Portfolio ⁽¹⁾


	Due Within					One to					Five to					After
	One Year					Five Years					Ten Years					Ten Years					Total
December 31, 2012			Avg.					Avg.					Avg.					Avg.					Avg.
*(in thousands)*	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
*Securities available for sale ⁽²⁾*
Collateralized mortgage obligations ⁽³⁾	$	80,155		2.63	%	$	580,049		2.07	%	$	1,539		4.33	%	$	—		—	%	$	661,743		2.14	%
Mortgage-backed⁽³⁾		20,225		4.10			854,637		3.15			42,066		3.22			16,215		3.22			933,143		3.18
State and municipal⁽⁴⁾		9,369		7.04			16,311		6.85			61,794		6.23			14,962		6.10			102,436		6.38
Other		—		—			—		—			—		—			303		4.57			303		4.57

Total available for sale	$	109,749		3.28		$	1,450,997		2.76		$	105,399		5.00		$	31,480		4.60		$	1,697,625		2.97

*Securities held to maturity ⁽²⁾*
Collateralized mortgage obligations ⁽³⁾	$	7,107		2.38	%	$	276,157		3.19	%	$	—		—	%	$	—		—	%	$	283,264		3.17	%
Mortgage-backed⁽³⁾		—		—			593,149		3.16			218,028		3.26			32,909		2.82			844,086		3.17
State and municipal⁽⁴⁾		4,489		4.25			21,202		4.04			55,962		4.11			17,265		4.10			98,918		4.10

Total held to maturity	$	11,596		3.11		$	890,508		3.19		$	273,990		3.43		$	50,174		3.26		$	1,226,268		3.25

⁽¹⁾	This table excludes stock holdings of the Federal Home Loan Bank and Federal Reserve.

⁽²⁾	Yields are based on amortized cost and are purchase yields.

⁽³⁾	Maturity distributions for collateralized mortgage obligations and mortgage-backed securities are based on estimated average lives.

⁽⁴⁾	Average yields on tax-exempt obligations have been computed on a tax equivalent basis, based on a 35% federal tax rate.

As of December 31, 2012, the estimated aggregate fair value of the investment securities portfolio was $109.2 million above amortized cost, consisting of gross unrealized gains of $109.9 million and gross unrealized losses of $0.7 million. Except for obligations of the U.S. Government and its agencies, no holdings of securities of any single issuer exceeded 10% of consolidated shareholders’ equity at December 31, 2012 or 2011. A summary of estimated fair values and unrealized gains and losses for the major components of the investment securities portfolio is provided in Note 2 to the Consolidated Financial Statements. Citizens’ policies with respect to the classification of investments in debt and equity securities are discussed in Note 1 to the Consolidated Financial Statements. During 2012, money market deposits decreased to $186.3 million from $313.6 million as funds were invested in higher yielding assets.

LOAN PORTFOLIO

Citizens primarily extends credit within its local markets in Michigan, Wisconsin, and Ohio. Citizens generally lends to consumers and small to mid-sized businesses and, consistent with its emphasis on relationship banking, most of these credits represent core, multi-relationship customers who also maintain deposit relationships and utilize other banking services such as treasury management. The loan portfolio is diversified by borrower and industry, with no concentration within a single industry segment that exceeds 10% of total portfolio loans. Citizens has minimal loans to foreign debtors. Citizens seeks to limit its credit risk by reviewing the aggregate outstanding commitments and loans to particular borrowers and industries. Citizens obtains and monitors collateral based on the nature of the credit and the risk assessment of the customer. See “Underwriting” for a discussion of Citizens’ underwriting policies and practices.

Loan balances by category for the past five years and an analysis of the maturity and interest rate sensitivity of commercial and industrial, and commercial real estate loans at December 31, 2012 are presented below.

Portfolio Loans ⁽¹⁾


(in thousands)	2012		2011		2010		2009		2008
Commercial and industrial	$	1,656,292	$	1,543,529	$	1,474,227	$	1,921,755	$	2,540,925
Commercial real estate		1,242,348		1,544,361		2,120,735		2,811,539		2,947,022

Total commercial		2,898,640		3,087,890		3,594,962		4,733,294		5,487,947
Residential mortgage		546,513		637,245		756,245		1,025,248		1,248,622
Direct consumer		844,240		933,314		1,045,530		1,224,182		1,406,070
Indirect consumer		969,583		871,086		819,865		805,181		820,536

Total	$	5,258,976	$	5,529,535	$	6,216,602	$	7,787,905	$	8,963,175

Portfolio Loan Maturities and Interest Rate Sensitivity


(in thousands)	Within One Year		One to Five Years		After Five Years		Total
Commercial and industrial	$	995,218	$	572,998	$	88,076	$	1,656,292
Commercial real estate		411,490		701,457		109,419		1,222,366
Real estate construction		5,686		6,951		7,345		19,982

Total commercial	$	1,412,394	$	1,281,406	$	204,840	$	2,898,640

Loans above:
With floating interest rates		596,170		742,553		112,900		1,451,623
With predetermined interest rates		816,224		538,853		91,940		1,447,017

Total	$	1,412,394	$	1,281,406	$	204,840	$	2,898,640

⁽¹⁾	Excludes mortgage loans held for sale

Increases in commercial and industrial, as well as indirect loans, in 2012 reflect our targeted lending efforts during the year. Decreases in the other categories of portfolio loans during 2012 reflect the paydowns as a result of normal client activity, and continuing efforts to improve the risk profile of Citizens.

Commercial and Industrial. The commercial and industrial loan portfolio includes a diverse group of loans to companies in a variety of businesses across many industries. The purpose of these loans varies from supporting seasonal working capital needs to term financing of equipment purchases. While some short-term loans may be made on an unsecured basis, the large majority are secured by the assets being financed with collateral margins consistent with Citizens’ loan underwriting guidelines. Commercial and industrial loans are evaluated for adequacy of repayment sources at the time of approval and are regularly reviewed for any possible deterioration in the ability of the borrower to repay on agreed terms. Credit risk in commercial and industrial loans arises due to fluctuations in borrowers’ financial condition, deterioration in collateral values, and changes in market conditions.

Commercial Real Estate. The majority of this portfolio consists of commercial real estate intermediate-term loans to developers and owners of commercial real estate for single and multiple family residential as well as multi-unit commercial properties. These loans are viewed first as cash-flow loans and secondarily as loans secured by real estate.

Commercial real estate loans are subject to underwriting standards and processes specific to the risks embedded in each of the geographic markets served by Citizens, primarily Michigan and Ohio. Management monitors commercial real estate loans based on sustainable cash flow, collateral, geography, and risk rating criteria. As a general rule, Citizens avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. Management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied “investment” real estate loans. At December 31, 2012, approximately 43% of commercial real estate loans were secured by owner-occupied properties.

Citizens proactively manages the credit performance of loans secured by commercial income producing properties. The value of loans in this portfolio have been negatively affected by tenant losses and reduced rental rates. While market conditions have stabilized, Citizens may suffer losses in these segments if market conditions deteriorate or do not continue to improve and efforts to limit these losses through execution of prudent workout strategies are unsuccessful.

Residential Mortgage Loans. The residential mortgage loan category is predominately comprised of single family owner-occupied residential properties primarily located in Michigan and Ohio. Residential mortgage loans are evaluated based on credit scores, debt-to-income ratios and loan-to-collateral value ratios.

Residential Mortgage Loan Balances By Category


	December 31,
(in thousands)	2012		2011
Fixed rate	$	170,289	$	203,318
Adjustable rate		375,232		430,802
Construction⁽¹⁾		992		3,125

Total	$	546,513	$	637,245

Residential Mortgage Loan Origination Volume


	December 31,
(in thousands)	2012		2011
Fixed rate	$	188,248	$	147,889
Adjustable rate		9,982		9,547
Construction⁽¹⁾		911		1,090

Total	$	199,141	$	158,526

⁽¹⁾	All construction mortgages are retained by Citizens in the residential mortgage portfolio.

In June 2008, Citizens entered into a master sales agreement to sell its residential mortgage originations to a third-party servicer at a fixed rate with no recourse. Under this agreement, Citizens sells more than 95% of new mortgage origination, resulting in minimal new loans being retained in the residential mortgage portfolio. During 2012, a total of $3.4 million in originated residential mortgage loans were returned to our portfolios since these loans had characteristics (other than loan amount or new construction) that made them non-compliant with the underwriting standards of government-sponsored entities (“GSE”) Federal National Mortgage Association (“FNMA”), Federal Home Loan Mortgage Corporation (“FHLMC”) and Government National Mortgage Association (“GNMA”). These loans were underwritten with compensating factors such as mortgage insurance, maximum debt to income ratios, maximum loan-to-value ratios and minimum credit scores which Citizens believes offset the additional risks.

Prior to June 2008, when Citizens sold its residential mortgage originations to several secondary market participants, it made various standard representations and warranties. The specific representations and warranties made by Citizens depended on the nature of the transaction and the requirements of the buyer. In the event of a breach of the representations and warranties, Citizens may be required to either repurchase the mortgage loans (generally at unpaid principal balance plus accrued interest) with the identified defects or indemnify the investor. Citizens repurchased $6.2 million and $2.2 million in 2012 and 2011, respectively, of loans pursuant to such provisions. Citizens recorded $6.4 million and $4.3 million in 2012 and 2011, respectively, in Other Expense on the Consolidated Statements of Operations related to repurchasing or indemnifying such loans.

Citizens proactively manages the residential loan portfolio, and in 2011 we started to experience stability with declining levels of delinquencies and nonaccrual loans. While delinquency rates continued to stabilize and drop slightly in 2012, non-accrual loans increased largely due to our adoption of new regulatory guidance relating to clients who filed for bankruptcy and have not reaffirmed the obligation. While real estate values continue to slowly recover, the extended time frame associated with the sale of repossessed residential properties continues to stress this asset category.

Direct Consumer. The direct consumer loan category includes home equity loans and direct installment loans to individuals used to purchase boats, recreational vehicles, automobiles, and other personal items. Home equity loans consist of revolving lines of credit and fixed rate loans to consumers that are secured by residential real estate. Credit risks for these types of loans are influenced by general economic conditions, the financial strength of individual borrowers, and the value of the loan collateral. Credit risk in the direct consumer loan portfolio arises from the borrowers potentially being unable to repay the loan on agreed terms, or by a shortfall in the collateral value in relation to the outstanding loan balance in the event of default and subsequent liquidation of collateral.

Citizens originates consumer loans utilizing a credit scoring model to supplement the underwriting process. To monitor and manage consumer loan risk, policies and underwriting guidelines are developed and modified as market conditions require. This monitoring activity, coupled with relatively small loan amounts spread across many individual borrowers, reduces risk. Additionally, trend and outlook reports are reviewed by management on a regular basis.

Indirect Consumer. The indirect consumer loan category includes indirect installment loans used by customers to purchase boats and recreational vehicles. Credit risks for these types of loans are influenced by general economic conditions, the characteristics of individual borrowers, and the value of loan collateral. Additionally, credit risk may include the dealer’s ability to collect proper customer information, and adhere to appropriate lending guidelines, including but not limited to, evaluating collateral value, accurately capturing property identification numbers, and following related documentation guidelines. Credit risk in the indirect consumer loan portfolio arises from a borrower’s potential inability to repay their loan and by a potential shortfall in the collateral value in relation to the outstanding loan balance in the event of default and subsequent liquidation of collateral. Credit risk is generally controlled by reviewing the creditworthiness of the borrowers as well as taking appropriate collateral and guaranty positions.

LOANS HELD FOR SALE

Loans that Citizens has the intent and ability to sell are classified as held for sale and are carried at the lower of cost or fair value, net of estimated costs to sell. Commercial loans held for sale are comprised primarily of loans identified for sale that are recorded at the lower of carrying amount or fair value based on appraisals of the underlying collateral, which are also subject to management adjustments based on current market conditions and recent sales activity. Fair value may also be measured using the present value of expected future cash flows discounted at an appropriate interest rate. Residential mortgage loans held for sale are comprised of loans originated for sale in the ordinary course of business and selected nonperforming residential mortgage loans. The fair value of residential mortgage loans originated for sale in the secondary market is based on purchase commitments or quoted prices for similar loans. The fair value of nonperforming residential mortgage loans is based on the fair value of the underlying collateral, net of estimated costs to sell, using market prices derived from indicative pricing models which utilize projected assumptions Citizens believes potential investors would make, broker price opinions or appraisals. Gains and losses on the sales of loans are determined using the specific identification method. Subsequent valuation adjustments to reflect current fair value, as well as gains and losses on disposal of these loans are charged to noninterest income as incurred.

Held for sale loans at December 31, 2012 totaled $10.7 million, a $0.3 million or 3% increase from December 31, 2011.

UNDERWRITING

Citizens’ Commercial Credit Policy and Underwriting Guidelines and Citizens’ Consumer Loan Credit Policy and Underwriting Guidelines (together, the “Underwriting Guidelines”) are written in a manner that is consistent with prudent banking practices and regulatory guidance applicable to each loan product. Citizens’ Underwriting Guidelines outline loan requirements and structuring parameters to determine the borrower’s financial capacity to repay under the terms of the loan and evaluate the collateral pledged to secure the loan and are designed to provide an adequate margin of safety for full collection of both principal and interest, within contractual terms. The Underwriting Guidelines provide the framework to determine that the borrower has the financial capacity to fully repay the loan, structurally mitigate credit risks, and monitor the loan’s credit performance over the term of the loan. Additionally, the Underwriting Guidelines are updated periodically in response to market and economic conditions and are reviewed by the Risk Management Committee of the Board as well as Citizens’ full Board of Directors.

The commercial Underwriting Guidelines outline product—and collateral-specific acceptable loan terms and conditions, including maximum loan to value ratios for real estate collateral, advance rates for non-real estate collateral, and debt service coverage. Acceptable credit management practices require that the borrower’s financial capacity to repay the loan be analyzed based on the most recent financial information as specified by the loan’s documented structure. It is Citizens’ general practice to obtain personal guarantees and underwrite the guarantor’s capacity to support the loan no less frequently than annually and more frequently if changes occur in the borrower’s capacity to repay or in general economic conditions that might affect the borrower. Citizens’ Underwriting Guidelines for non-owner occupied commercial real estate loans delineate maximum terms, amortizations and loan to value ratios as well as minimum equity investments and debt service coverage ratios based on property type. Generally, maximum loan terms are five years, maximum amortizations are 25 years, minimum equity requirements range from 10% to 25%, debt service coverage ratios range from 1.2 to 1.5 times and loan to value ratios range from 65% to 80%. Citizens’ Real Estate Appraisal and Environmental Policy specifies the Bank’s requirements for obtaining appraisals from licensed or certified appraisers to assess the value of the underlying collateral. New variable rate commercial loans are underwritten at fully indexed rates. Additionally, variable rate commercial loan underwriting includes stress tests of the borrower’s debt service capabilities with higher than existing interest rates and fluctuations in the underlying cash flows available for repayment.

The consumer Underwriting Guidelines outline product—and collateral-specific loan terms and conditions, including maximum debt ratios and advance rates based on the borrower’s credit score. Residential mortgage loans are evaluated based on credit scores, debt-to-income ratios, and loan to collateral value ratios. They are predominately originated in accordance with underwriting standards set forth by the government-sponsored entities FNMA, FHLMC and GNMA, which serve as the primary purchasers of loans sold in the secondary market by mortgage lenders. These underwriting standards generally require that the loans be collateralized by one-to-four family residential real estate. Automated underwriting engines deployed by a GSE are used to determine creditworthiness of the vast majority of borrowers. Maximum allowable loan-to-value (“LTV”)/combined loan-to-value (“CLTV”) on these loan products generally do not exceed 95% at origination. Citizens has not offered “no-doc/low doc” and “stated income/stated asset” loans since January 1, 2007 and does not have any of these loans in its residential mortgage portfolio. Sub-prime, initial teaser rate and negative amortization loans were originated on an exception basis prior to 2007 and have not been offered since January 1, 2007. At December 31, 2012 and 2011, the outstanding balance of these loans and the associated interest income was immaterial.

Direct consumer loans include home equity loans, and direct installment loans to individuals used to purchase boats, recreational vehicles, automobiles and other personal items. Underwriting guidelines for these loans are heavily influenced by statutory requirements, which include, but are not limited to, maximum loan-to-value ratios, credit scoring results, ability to service overall debt, and documentation requirements. Individual borrowers may be required to provide additional collateral or a satisfactory endorsement or guaranty from another person, depending on the creditworthiness of the borrower. Home equity loans consist of fully-indexed variable rate revolving lines of credit and fixed rate loans to consumers that are secured by residential real estate. Home equity loans are generally in a junior lien

position and are originated through Citizens’ branches with cumulative loan-to-value ratios generally at or less than 80% of appraised collateral value. As of December 31, 2012, Citizens’ home equity portfolio totaled $682.7 million, and had an average loan size of $35,851 with an average refreshed FICO score of 741. As of December 31, 2012, other direct installment loans totaled $161.5 million and had an average loan size of $19,497 with an average refreshed FICO score of 728.

Indirect consumer loans are originated through our centralized underwriting group that has established relationships with certain dealers which meet Citizens’ underwriting guidelines and adhere to prudent business practices. The dealers are evaluated on their creditworthiness and business practices with performance monitored on an annual basis. The dealers refer customers to the centralized underwriting group, which utilizes a credit scoring model to supplement the underwriting process, and then complete the loans utilizing Citizens’ loan documents. As of December 31, 2012, indirect consumer loans had an average loan size of $24,276 with an average refreshed FICO score of 742.

CREDIT RISK MANAGEMENT

Extending credit to businesses and consumers exposes Citizens to credit risk, which is the risk that the principal balance of a loan and any related interest will not be collected under the original underwriting terms due to the inability or unwillingness of the borrower to repay the loan. Citizens lending policies and underwriting guidelines, discussed above, are designed to maximize loan income within an acceptable level of risk. Credit risk is mitigated through a comprehensive system of internal controls, which includes adherence to conservative lending practices, underwriting guidelines, collateral monitoring, and oversight of financial performance. Credit risk associated with fluctuations in economic conditions is mitigated through portfolio diversification that limits exposure to any single industry or customer. Lending policies and guidelines are reviewed by credit administration and modified on an ongoing basis as conditions change and new credit products are offered. The commercial and industrial and commercial real estate credit administration policies include a two-tier loan rating system that incorporates probability of default and loss given default to estimate a borrower’s ability to repay and the strength of the collateral supporting their loan obligation. To strengthen and monitor loan structuring and collateral position, collateral field audits are regularly performed on those credits that have a significant reliance on accounts receivable and inventory. Additionally, a reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and nonperforming and potentially problematic loans. Citizens monitors its loans in an effort to proactively identify, manage, and mitigate any potential credit quality issues and losses.

The quality of Citizens’ loan portfolio is impacted by numerous factors, including the economic environment in the markets in which Citizens operates. Citizens carefully monitors its loans in an effort to identify and mitigate any potential credit quality issues and losses in a proactive manner. Citizens performs quarterly reviews of the non-watchlist commercial credit portfolio. This process seeks to validate each reviewed credit’s risk rating, underwriting structure and exposure management under current and stressed economic scenarios while strengthening these relationships and improving communication with these clients.

Citizens maintains an independent loan review department that reviews the quality, trends, collectability and collateral margins within the loan portfolio. The loan review department validates the credit risk profile on a regular basis by sampling loans using criteria such as loan size, delinquency status, loan officer coverage and other factors. This process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel. Results of these reviews are presented to management and to the Risk Committee of the Board of Directors.

As part of the overall credit underwriting and review process, Citizens carefully monitors commercial and industrial and commercial real estate credits that are current in terms of principal and interest payments but may deteriorate in quality as economic conditions change. Commercial relationship officers monitor their clients’ financial condition and initiate changes in loan ratings based on their findings. Loans that have migrated within the loan rating system to a level that requires increased oversight, at management’s discretion, are considered ‘watchlist’ loans (generally consistent with the regulatory definition of special mention, substandard, and doubtful loans) and include loans that are in accruing or nonperforming status.

Citizens utilizes the watchlist process as a proactive credit risk management practice to help mitigate the migration of commercial loans to nonperforming status and potential loss. Once a loan is placed on the watchlist, it is reviewed quarterly by the appropriate credit and market officers to assess cash flows, collateral valuations, guarantor liquidity, and other pertinent trends. During these reviews, action plans are developed to address emerging problem loans or to implement specific actions for alternatives to strengthen the credit and/or for removing the loans from the portfolio. Additionally, loans viewed as substandard or doubtful are transferred to Citizens’ special loans or small business workout groups and are subjected to an even higher level of monitoring and workout activity.

The following table illustrates the commercial loans on the watchlist that, while still accruing interest, may be at risk due to general economic conditions or changes in borrower’s financial status.

Commercial Watchlist

Accruing loans only


	December 31,
	2012					2011					2010
(in thousands)	$		% of Portfolio			$		% of Portfolio			$		% of Portfolio
Land hold	$	2,457		56.28	%	$	4,115		62.90	%	$	21,575		76.35	%
Land development		303		4.84			804		6.14			18,674		53.66
Construction		6,832		77.11			1,658		28.36			33,234		32.05
Income producing		196,685		28.51			259,971		28.45			444,450		37.96
Owner-occupied		94,940		17.81			112,756		18.63			196,915		25.15

Total commercial real estate		301,217		24.25			379,304		24.56			714,848		33.71
Commercial and industrial		136,207		8.22			227,487		14.74			347,180		23.55

Total	$	437,424		15.09		$	606,791		19.65		$	1,062,028		29.54

The decreases in watchlist credits were primarily due to a reduction in the level of new inflows, and continued emphasis on improving the risk profile through resolutions.

The following table illustrates loans where the contractual payment is 30 to 89 days past due and interest is still accruing. While these loans are actively worked to bring them current, past due loan trends may be a leading indicator of potential future nonperforming loans and charge-offs.

Delinquency Rates By Loan Portfolio

30 to 89 days past due


	December 31,
	2012					2011					2010
(in thousands)	$		% of Portfolio			$		% of Portfolio			$		% of Portfolio
Land hold	$	—		—	%	$	21		0.32	%	$	2,233		7.90	%
Land development		—		—			—		—			216		0.62
Construction		—		—			—		—			464		0.45
Income producing		1,470		0.21			2,508		0.27			20,643		1.76
Owner-occupied		695		0.13			2,345		0.39			14,705		1.88

Total commercial real estate		2,165		0.17			4,874		0.32			38,261		1.80
Commercial and industrial		1,949		0.12			2,454		0.16			9,058		0.61

Total commercial		4,114		0.14			7,328		0.24			47,319		1.32

Residential mortgage		7,641		1.40			9,544		1.50			15,389		2.03
Direct consumer		13,354		1.58			17,810		1.91			22,379		2.14
Indirect consumer		8,356		0.86			13,067		1.50			13,287		1.62

Total consumer		29,351		1.24			40,421		1.66			51,055		1.95

Total	$	33,465		0.64		$	47,749		0.86		$	98,374		1.58

The decreases in total delinquencies were primarily the result of continued emphasis on proactively managing and resolving delinquent commercial and consumer loans along with a more stable economic environment.

NONPERFORMING ASSETS

Loans are generally placed on nonaccrual status when there is substantial doubt regarding collection of principal or interest, in full, based on Citizens’ credit policies and practices or when principal or interest is past due in excess of 90 days. When a loan is placed on nonaccrual status, interest that is accrued but not collected is reversed and charged against income. Nonperforming assets are comprised of nonaccrual loans, loans past due over 90 days and still accruing interest, nonperforming loans held for sale, and other repossessed assets acquired. Although these assets have more than a normal risk of loss, they may not necessarily result in future losses. A five-year history of nonperforming assets is presented below. The nonperforming commercial loans in this table are also reviewed as part of the watchlist process.

Nonperforming Assets and Past Due Loans

December 31,

(in thousands)

2012

2011

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

CITIZENS REPUBLIC BANCORP, INC. 10-K