INTRODUCTION
Management's discussion and analysis of earnings and related financial data are presented to assist in understanding the financial condition and results of operations of First Citizens BancShares, Inc. and Subsidiaries (BancShares). This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and related notes presented within this report. Intercompany accounts and transactions have been eliminated. Although certain amounts for prior years have been reclassified to conform to statement presentations for 2012, the reclassifications have no material effect on shareholders' equity or net income as previously reported. Unless otherwise noted, the terms we, us and BancShares refer to the consolidated financial position and consolidated results of operations for BancShares. BancShares is a financial holding company headquartered in Raleigh, North Carolina that offers full-service banking through its wholly-owned banking subsidiary, First-Citizens Bank & Trust Company (FCB), a North Carolina-chartered bank. Prior to 2011, BancShares operated through two wholly-owned subsidiaries, First-Citizens Bank & Trust Company (FCB) and IronStone Bank (ISB). On January 7, 2011, ISB was merged into FCB. FCB is a state-chartered bank organized under the laws of the state of North Carolina and ISB was a federally-charted thrift institution. As of June 30, 2012, FCB operated 421 branches in North Carolina, Virginia, West Virginia, Maryland, Tennessee, Washington, California, Florida, Georgia, Texas, Arizona, New Mexico, Oregon, Colorado, Oklahoma, Kansas, Missouri and Washington, DC. While our growth has historically been achieved primarily through de novo activities, since mid-2009 BancShares has participated in six FDIC-assisted transactions involving failed financial institutions. These transactions have had a significant impact on BancShares' financial condition and results of operations in subsequent periods.
FDIC-ASSISTED TRANSACTIONS
FDIC-assisted transactions provided significant growth opportunities for BancShares during 2011, 2010, and 2009. These transactions allowed us to increase our presence in markets in which we presently operate, and to expand our banking presence to contiguous markets. Additionally, purchase discounts and fair value adjustments on acquired assets and assumed liabilities resulted in significant acquisition gains recorded at the time of each acquisition. All of the FDIC-assisted transactions include loss share agreements which protect us from a substantial portion of the credit and asset quality risk that we would otherwise incur.
Acquisition accounting and issues affecting comparability of financial statements. As estimated exposures related to the acquired assets covered by the loss share agreements change based on post-acquisition events, our adherence to accounting principles generally accepted in the United States of America (US GAAP) and accounting policy elections that we have made affect the comparability of our current results of operations to earlier periods. Several of the key issues affecting comparability are as follows:
• When post acquisition events suggest that the amount of cash flows we will ultimately receive for a loan covered by a loss share agreement is less than originally expected:

?          An allowance for loan and lease losses is established for the
           post-acquisition exposure that has emerged with a corresponding charge
           to provision for loan and lease losses;


?          If the expected loss is projected to occur during the relevant loss
           share period, the receivable from the FDIC is adjusted to reflect the
           indemnified portion of the post-acquisition exposure with a
           corresponding increase to noninterest income;


•    When post acquisition events suggest that the amount of cash flows we will
     ultimately receive for a loan covered under a loss share agreement is
     greater than originally expected:


?          Any allowance for loan and lease losses that was previously
           established for post-acquisition exposure is reversed with a
           corresponding reduction to provision for loan and lease losses; if no
           allowance was established in earlier periods, the amount of the
           improvement in the cash flow projection results in a reclassification
           from the nonaccretable difference created at the acquisition date to
           an accretable yield; the newly-identified accretable yield is accreted
           into income over the remaining life of the loan as a credit to
           interest income;

?          The receivable from the FDIC is adjusted immediately for reversals of
           previously recognized impairment and prospectively for
           reclassifications from non-accretable difference to reflect the
           indemnified portion of the post-acquisition change in exposure; a
           corresponding reduction in noninterest income is also recorded
           immediately for reversals of previously established allowances or over
           the shorter of the remaining life of the related loan or loss share
           agreement;


•    When actual payments received on loans are greater than initial estimates,
     large nonrecurring discount accretion may be recognized during a specific
     period; discount accretion is recognized as an increase to interest income.


•    Adjustments to the FDIC receivable resulting from changes in estimated loan
     cash flows are based on the reimbursement provision of the applicable loss
     share agreement with the FDIC. Adjustments to the FDIC receivable partially
     offset the adjustment to the covered loan carrying value, but the rate of
     the change to the FDIC receivable relative to the change in the covered loan
     carrying value is not constant. The loss share agreements establish
     reimbursement rates for losses incurred within certain ranges. In some loss
     share agreements, higher loss estimates result in higher reimbursement
     rates, while in other loss share agreements, higher loss estimates trigger a
     reduction in the reimbursement rates. In addition, some of the loss share
     agreements include clawback provisions that require the purchaser to remit a
     payment to the FDIC in the event that the aggregate amount of losses is less
     than a loss estimate established by the FDIC. The adjustments to the FDIC
     receivable based on changes in loss estimates are measured based on the
     actual reimbursement rates and consider the impact of changes in the
     projected clawback payment. Table 2 provides details on the various
     reimbursement rates for each loss share agreement.

Balance sheet impact. Table 1 provides information regarding the six FDIC-assisted transactions consummated during 2011, 2010 and 2009. Adjustments to acquisition date fair values are subject to change for one year following the closing date of each respective acquisition. No adjustments were made to previously reported fair values during the first six months of 2012.

FDIC-ASSISTED TRANSACTIONS
                                                                         Table 1
                                                                                Fair value of
                                                                                            Short-term        Long-term
                                                                            Deposits        borrowings       obligations         Gains on
           Entity            Date of  transaction     Loans  acquired        assumed         assumed           assumed         acquisition
                                                                                           (thousands)
Colorado Capital Bank (CCB)      July 8, 2011       $         320,789     $   606,501     $     15,212     $           -     $       86,943
United Western Bank (United
Western)                       January 21, 2011               759,351       1,604,858          336,853           207,627             63,474
Sun American Bank (SAB)         March 5, 2010                 290,891         420,012           42,533            40,082             27,777
First Regional Bank (First
Regional)                      January 29, 2010             1,260,249       1,287,719          361,876                 -            107,738
Venture Bank (VB)             September 11, 2009              456,995         709,091                -            55,618             48,000
Temecula Valley Bank (TVB)      July 17, 2009                 855,583         965,431           79,096                 -             56,400
Total                                               $       3,943,858     $ 5,593,612     $    835,570     $     303,327     $      390,332

US GAAP permits acquired loans to be accounted for in designated pools based on common risk characteristics. For all CCB loans and for United Western residential mortgage loans, we assigned loans to pools based on various factors including loan type, collateral type and performance status. When loans are pooled, improvements in some loans within a pool may offset deterioration in other loans within the same pool resulting in less volatility in net interest income and provision for loan and lease losses. The CCB loans had a fair value of $320.8 million at the acquisition date; the residential mortgage loans acquired from United Western had a fair value of $223.1 million at the acquisition date. All other acquired loans are not assigned to loan pools and are being accounted for at the individual loan level. The non-pool election for the majority of our acquired loans could potentially accentuate volatility in net interest income and the provision for loan and lease losses.
Income statement impact. The six FDIC-assisted transactions created acquisition gains recognized at the time of the respective transaction. No acquisition gains were recorded for the six-month period ended June 30, 2012, and acquisition gains of $63.5 were recorded for the corresponding period of 2011 relating to the United Western transaction. Additionally, the acquired loans, assumed deposits and assumed borrowings originated by the six banks have affected net interest income, provision for loan and lease losses and noninterest income. Increases to noninterest expense have resulted from incremental staffing and facility costs for the branch locations resulting from the FDIC-assisted transactions. Various fair value discounts and premiums that were previously recorded are being accreted and amortized into income over the life of the underlying asset or liability.

During the three-month period ended June 30, 2012, total provision for loan losses related to acquired loans equaled $18.7 million compared to $41.2 million during the same period of 2011. Total provision for loan losses related to acquired loans for the six-month period ended June 30, 2012, decreased by $45.5 million from the same period of 2011. The decrease in the provision for covered loan losses in 2012 is the result of lower charge-offs and reduced post-acquisition deterioration on acquired loans.
During the three-month period ended June 30, 2012, total discount accretion for loans for which a fair value discount had been recorded, equaled $60.9 million compared to $71.1 million during the same period of 2011. Discount accretion on acquired loans equaled $125.8 million for the six-month period ended June 30, 2012, compared to $122.8 million during the same period of 2011.
Accretion income is generated by recognizing accretable yield over the estimated life of acquired loans. Accretable yield is the difference in the expected cash flows and the present value of those expected cash flows. The amount of accretable yield related to the loans can change if the estimated cash flows expected to be collected changes subsequent to the initial estimates. Further, the recognition of accretion income can be accelerated in the event of large unscheduled repayments, loan payoffs, other loan settlements for amounts in excess of original estimates, and various other post-acquisition events. Due to the many factors that can influence the amount of accretion income recognized in a given period, this component of net interest income is not easily predictable for future periods and impacts the comparability of interest income, net interest income, and overall results of operations.
Unscheduled prepayments and post-acquisition deterioration of covered loans also result in adjustments to the FDIC receivable for changes in the estimated amount that would be covered under the respective loss share agreement. During the three- and six-month periods ended June 30, 2012, the adjustment to the FDIC receivable resulting from large unscheduled payments and other favorable changes in covered assets exceeded the amount of the adjustment for post-acquisition deterioration, resulting in a net reduction to the FDIC receivable and a net charge of $14.1 million and $40.9 million respectively to noninterest income compared to a net reduction in the receivable and a corresponding reduction in noninterest income of $13.7 million and $24.1 million during the same periods of 2011.
The various terms of each loss share agreement and the components of the resulting FDIC receivable is provided in Table 2 below. The table includes the estimated fair value of the FDIC receivable at the respective acquisition dates of each FDIC-assisted transaction as well as the carrying value of the FDIC receivable for each transaction at June 30, 2012. Additionally, the portion of the carrying value of the receivable that relates to accretable yield from improvements in acquired loan cash flows subsequent to acquisition is provided for each loss share agreement. This component of the FDIC receivable will be recognized as a reduction to noninterest income over the shorter of the remaining life of the associated receivables or the related loss share agreement. The fair value of the FDIC receivable at the respective acquisition dates and the carrying value as of June 30, 2012, include estimated obligations to the FDIC under any applicable clawback provisions.
As of June 30, 2012, the FDIC receivable includes $253.5 million of estimated reimbursements from the FDIC resulting from $316.9 million in projected losses and expenses. The FDIC receivable also includes $168.0 million that we expect to recover through prospective accretion of discounts, net of estimated clawback payments totaling $109.6 million we expect to owe to the FDIC at the expiration of the loss share agreements.
The timing of expected losses on covered assets is monitored by management to ensure the losses will occur during the respective loss share terms. If losses are projected to occur outside of the related loss share term, the FDIC receivable will be adjusted for those losses. As of June 30, 2012, no adjustments have been recorded for losses projected to occur out side of the loss share term.

Table 2
LOSS SHARE PROVISIONS AND RECEIVABLE FROM FDIC
                                                 FDIC receivable
                                                                              Receivable related
  Entity/Loss                         Fair value at       Carrying value at   to accretable yield
    ranges      Reimbursement rate   acquisition date       June 30, 2012     as of June 30, 2012
                                              (dollars in thousands)
TVB - combined
losses                             $          103,558   $            77,132   $          34,230
Losses up to
$193,262                0%
Losses between
$193,262 and
$464,000               80%
Losses above
$464,000               95%
No clawback
provision
applies
VB - combined
losses                                        138,963                24,431               8,063
Losses up to
$235,000               80%
Losses above
$235,000               95%
No clawback
provision
applies
First Regional
- combined
losses                                        378,695                34,613              24,527
Losses up to
$41,815                 0%
Losses between
$41,815 and
$1,017,000             80%
Losses above
$1,017,000             95%
Clawback
provisions
apply
SAB - combined
losses                                         89,734                41,895              37,687
Losses up to
$99,000                80%
Losses above
$99,000                95%
Clawback
provisions
apply
United Western
Non-single
family
residential
losses
Losses up to
$111,517               80%                    112,672                28,401              21,139
Losses between
$111,517 and
$227,032               30%
Losses above
$227,032               80%
Single family
residential
losses
Losses up to
$32,489                80%                     24,781                18,113                 201
Losses
between$32,489
and $57,653             0%
Losses above
$57,653                80%
Clawback
provisions
apply
CCB - combined
losses                                        155,070                89,393              34,294
Losses up to
$230,991               80%
Losses between
$230,991 and
$285,947                0%
Losses above
$285,947               80%
Clawback
provisions
apply
Total                              $        1,003,473   $           313,978   $         160,141

EXECUTIVE OVERVIEW AND PERFORMANCE SUMMARY
BancShares' earnings and cash flows are primarily derived from our commercial banking activities. We offer commercial and consumer loans, deposit and treasury services products, cardholder and merchant services, wealth management services as well as various other products and services typically offered by commercial banks. We gather deposits from retail and commercial customers and also secure funding through various non-deposit sources. We invest the liquidity generated from these funding sources in interest-earning assets including loans and leases, investment securities and overnight investments. We also invest in the bank premises, furniture and equipment used to conduct our commercial banking business.
Various external factors influence the focus of our business efforts. Due to unprecedented asset quality challenges, capital shortages and global recessionary conditions, the U.S. banking industry experienced serious financial challenges beginning in 2008, and, to varying degrees, those pressures have continued into the second quarter of 2012. During this period of industry-wide turmoil, we have elected to participate in FDIC-assisted transactions involving distressed financial institutions. Participation in FDIC-assisted transactions has created opportunities to increase our business volumes in existing markets and to expand our banking presence to adjacent markets that we deem demographically attractive. For each of the six FDIC-assisted transactions that we have completed as of June 30, 2012, loss share agreements protect us from a substantial portion of the asset quality risk that we would otherwise incur. Additionally, purchase discounts and fair value adjustments on acquired assets and assumed liabilities have resulted in significant acquisition gains that have provided a substantial portion of the equity required to fund the transactions. Despite the recognition of significant acquisition gains in 2011, 2010 and 2009, our core earnings have been adversely affected by tight interest margins, newly imposed restrictions on our ability to collect certain fees from our customers, and a relatively high level of difficulty for businesses and consumers to meet their debt service obligations. Other customers continue to repay existing debt or defer new borrowings due to lingering economic uncertainty, resulting in continuing soft demand for loan products.
Real estate demand in many of our markets remains weak, resulting in continued depressed real estate prices that have adversely affected collateral values for many borrowers. In an effort to assist customers experiencing financial difficulty, we have selectively agreed to modify existing loan terms to provide relief to customers who are experiencing liquidity challenges or other circumstances that could affect their ability to meet debt obligations. These efforts have resulted in an increase in troubled debt restructurings during 2012 and 2011. The majority of the modifications we provide are to customers that are currently performing under existing terms, but may be unable to do so in the near future without a modification.
The demand for our deposit and treasury services products has been adversely influenced by extraordinarily low interest rates, but favorably by the instability in alternative investment markets. Our balance sheet liquidity position remains strong despite our participation in FDIC-assisted transactions and the liquidity management challenge resulting from significant attrition of deposits assumed.
Ongoing economic weakness continues to have a significant impact on virtually all financial institutions in the United States. Beyond the profitability pressures resulting from a weak economy, financial institutions continue to face challenges resulting from legislative and governmental efforts to stabilize the financial services industry and provide consumer protection. In addition to the various actions previously enacted by governmental agencies and the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), further changes will occur likely leading to higher capital requirements and additional compliance costs for the banking industry.

One of the provisions of the Dodd-Frank Act required the Federal Reserve to adopt rules regarding the interchange fees that may be charged by banks for electronic debit transactions. The final rules required that interchange rates be reduced to the promulgated limits outlined in the regulations beginning October 2011. As a result of the interchange limits, our cardholder and merchant services income declined significantly and will continue to be adversely affected throughout 2012.

The Dodd-Frank Act also contained provisions that will gradually eliminate our ability to include our outstanding trust preferred securities as equity for capital adequacy purposes. Due to the pending elimination of those securities from our capital calculations and the cost of those borrowings, we elected to redeem $150.0 million of our trust preferred securities during July 2012. BancShares' consolidated net income during the second quarter of 2012 equaled $37.6 million, an increase of $16.3 million from the $21.3 million earned during the corresponding period of 2011. The annualized return on average assets and equity amounted to 0.71 percent and 7.80 percent respectively, during the second quarter of 2012, compared to 0.42 percent and 4.94 percent during the same period of 2011. Net income per share during the second quarter of 2012 totaled $3.66, compared to $2.04 during the second quarter of 2011.

For the six-month period ending June 30, 2012, net income amounted to $73.1 million compared to $83.1 million earned during the same period of 2011. Return on assets and equity during 2012 equaled 0.69 percent and 7.70 percent respectively, down from 0.79 percent and 9.43 percent during the six-month period ended June 30, 2011. Net income per share equaled $7.11 during the first six months of 2012 compared to $7.96 in the first six months of 2011. The decrease in net income in 2012 was due primarily to the gain on the United Western FDIC-assisted transaction in the first quarter of 2011 with an after-tax impact of $38.6 million or $3.70 per share. No acquisition gains were recorded in 2012. The absence of acquisition gains in 2012 was partially offset by higher net interest income and reductions in the provision for loan and lease losses. Net interest income increased $8.1 million from $207.4 million in the second quarter of 2011 to $215.4 million in 2012. This increase is the result of relatively stable loan interest income combined with lower funding costs for interest-bearing liabilities. The taxable-equivalent net yield on interest-earning assets increased by 12 basis points from 4.46 percent in the second quarter 2011 to 4.58 percent in 2012 due to the favorable impact of slightly higher yields on acquired loans and lower rates on interest-bearing liabilities.
Year-to-date net interest income increased $25.0 million, or 6.1 percent during 2012. The net yield on interest-earning assets was 4.69 percent during the six-month period ended June 30, 2012, compared to 4.41 percent for the same period of 2011. For both the second quarter and year-to-date periods, the impact of accreted loan discounts resulting from large unscheduled prepayments on acquired loans significantly impacted the taxable-equivalent net yield on interest-earning assets. Since large unscheduled prepayments are unpredictable, the yield on interest-earning assets may decline in future periods. The provision for loan and lease losses recorded during the second quarter of 2012 equaled $29.7 million, compared to $54.0 million during the second quarter of 2011. During the first six months of 2012, the provision for loan and lease losses equaled $60.4 million, a decrease of $38.0 million or 38.6 percent from the same period of 2011. For both the three- and six-month periods, the decrease was caused by lower post-acquisition deterioration of acquired loans covered by loss share agreements with the FDIC. To the extent deterioration is covered by a loss share agreement, there is a corresponding adjustment to the FDIC receivable with an offset to noninterest income for the covered portion at the appropriate indemnification rate.
Noninterest income decreased $9.4 million in the second quarter of 2012 when compared to the second quarter of 2011 resulting from reductions in income from cardholder and merchant services, service charges and fees, and mortgage banking. For the six-month period ended June 30, 2012, noninterest income decreased $92.0 million from the comparable period of 2011. This decrease was primarily the result of $63.5 million in acquisition gains recorded in 2011, adjustments to the FDIC receivable for assets covered by loss share agreements and lower cardholder and merchant services income.
Noninterest expense increased $7.3 million or 3.9 percent in the second quarter of 2012 and $618,000 for the six-month period ended June 30, 2012, when compared to the same period in 2011. The increase was due to higher salary expenses and foreclosure-related expenses partially offset by lower other noninterest expense items, including card loyalty program expenses and external processing fees. Income tax expense for the second quarter of 2012 includes the recognition of a $6.4 million benefit resulting from the favorable outcome of state tax audits for the period 2008-2010, net of additional federal taxes.

SELECTED QUARTERLY DATA                                                                                                               Table 3
                                       2012                                         2011                                 Six Months Ended June 30
. . .