Business context and reporting period
Fulton Financial Corporation is a Pennsylvania-based financial holding company providing consumer and commercial banking services. This unaudited Form 10-Q covers the three and nine months ended September 30, 2012; comparisons are with the corresponding 2011 periods unless otherwise noted. Balance-sheet comparisons are with December 31, 2011. Amounts below are in millions except per-share data and ratios.
Financial results and condition
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net interest income | $135.9 | $141.5 | $412.1 | $421.7 |
| Provision for credit losses | $23.0 | $31.0 | $76.5 | $105.0 |
| Non-interest income | $52.0 | $48.1 | $157.0 | $139.4 |
| Non-interest expense | $110.0 | $105.9 | $332.9 | $307.6 |
| Income before income taxes | $54.8 | $52.8 | $159.8 | $148.5 |
| Net income | $41.6 | $39.3 | $119.6 | $109.5 |
| Diluted earnings per share | $0.21 | $0.20 | $0.60 | $0.55 |
| Net interest margin, FTE | 3.74% | 3.93% | 3.79% | 3.93% |
Third-quarter pretax income rose 3.9%; nine-month pretax income rose 7.6%. Revenue from mortgage banking helped offset lower net interest income. The nine-month effective tax rate was 25.1%, versus 26.2% a year earlier.
- Balance sheet: Total assets were $16.27 billion, down 0.6% from year-end 2011. Net loans were $11.93 billion, down 0.3%; available-for-sale securities were $2.79 billion, up 4.4%.
- Deposits and debt: Deposits totaled $12.60 billion, up 0.6%; demand and savings deposits increased $510.5 million while time deposits declined $435.0 million. Short-term borrowings were $487.0 million and FHLB advances and long-term debt were $908.6 million, down from $597.0 million and $1.04 billion, respectively, at year-end.
- Credit: The allowance for credit losses was $235.3 million, or 1.97% of loans, compared with $258.2 million at year-end. Nine-month net charge-offs were $99.4 million; annualized net charge-offs were 1.11% of average loans, versus 1.25% in 2011. Nonperforming assets were $242.0 million, or 1.49% of assets, down from $317.3 million and 1.94% at year-end.
- Capital and liquidity: Shareholders’ equity was $2.06 billion. At September 30, total capital/risk-weighted assets was 15.7%, Tier 1/risk-weighted assets 13.4%, and Tier 1 leverage 10.7%. The company reported $806.5 million of additional FHLB borrowing capacity and $1.8 billion of Discount Window borrowing availability, with no Discount Window borrowings outstanding.
- Cash flow: For the first nine months, operating activities provided $193.8 million, investing activities used $47.8 million, and financing activities used $221.4 million. Cash and due from banks ended at $217.2 million, down $75.4 million from year-end.
Material changes and management commentary
- Net interest margin contracted as yields on earning assets fell more than funding costs. Management said the low-rate environment and pressure on margins were expected to continue through the remainder of 2012.
- Mortgage banking income increased 63.4% for the first nine months, driven by refinancing activity, higher loan commitments and improved sale pricing. The company also recorded a $2.1 million MSR impairment charge in Q3 as forecast mortgage prepayments increased.
- Non-interest expense increased 8.2% for the first nine months. Key increases included salaries and benefits, consulting and other outside services, operating risk losses, and OREO valuation expense. Compliance and risk-management consulting contributed to higher outside-service costs.
- Management attributed improved credit indicators partly to fewer non-accrual loan additions and loan sales, including $44.1 million of non-accrual commercial, construction and commercial mortgage loans sold in June. The sale generated $21.2 million of charge-offs, covered by existing allowances. Non-accrual loan additions were about $131 million in the first nine months, versus about $212 million in 2011.
- The company repurchased about 2.1 million shares for $20.4 million in Q3 under a program authorizing up to 5 million shares through December 31, 2012; about 2.9 million shares remained authorized at quarter-end.
Outlook, risks and contingencies
The filing provides no formal earnings or revenue guidance. Management identified economic and real-estate conditions, credit quality, interest rates and net interest margin, deposit and loan growth, securities values, expenses, regulation, capital and liquidity as factors that could affect results. It cautioned that forward-looking statements are subject to risks and actual results may differ.
Notable exposures include $160.1 million of auction-rate securities valued using Level 3 assumptions, including an assumed return to market liquidity within five years; management reported that all were current on interest payments. Mortgage-loan repurchase requests were approximately $5.9 million, and reserves for mortgage-sale exposures were $4.6 million. The company also recorded $3.0 million of reserves in the first nine months for expected losses under an FHLB mortgage credit-enhancement program. Management said pending litigation was not expected to have a material adverse effect, while noting that outcomes are uncertain. Hurricane Sandy caused no significant company property damage, but the company was still assessing potential effects on customers and the local economy. In October, it completed an additional $6.4 million investment in a financial institution, bringing its ownership to approximately 7.2%.
Important facts for investors to verify
- Whether margin pressure continues and whether mortgage banking gains remain strong as refinancing activity changes.
- Whether credit-quality improvements persist apart from the effect of loan sales, and how charge-offs, delinquencies, TDRs and allowance adequacy evolve.
- The valuation assumptions and liquidity outlook for auction-rate and other Level 3 securities, as well as any further impairment needs.
- Potential additional mortgage repurchases or credit-enhancement losses, including adequacy of recorded reserves.
- Actual effects of higher compliance, consulting and operating-risk costs, and the eventual impact of Hurricane Sandy on borrowers.
- Progress on share repurchases, capital requirements and available liquidity facilities.