Fulton Financial Corporation — Q3 2016 Form 10-Q
Business context and reporting period. Fulton Financial is a financial holding company with six bank subsidiaries serving Pennsylvania, Delaware, Maryland, New Jersey and Virginia. This unaudited filing covers the three and nine months ended September 30, 2016; balance-sheet comparisons are with December 31, 2015.
Financial performance and condition
- Q3 earnings: Net income was $41.5 million, up 21.1% from $34.3 million a year earlier. Diluted EPS was $0.24 versus $0.20. For the first nine months, net income was $119.5 million, up 7.7%, and diluted EPS was $0.69 versus $0.63.
- Revenue and margin: Q3 net interest income was $130.6 million, up 3.9%; fully taxable-equivalent (FTE) net interest income rose 4.2% to $135.8 million. Q3 FTE net interest margin was 3.14%, down 4 basis points year over year. Nine-month FTE net interest income increased 4.6% to $403.7 million, while margin declined 3 basis points to 3.19%. Noninterest income was $48.1 million in Q3 and $137.4 million year to date; excluding securities gains, it rose 11.9% and 6.8%, respectively, from 2015.
- Expenses and profitability: Q3 noninterest expense was $119.8 million, down 4.0% as reported, but up 0.5% excluding the prior-year trust-preferred redemption loss. Nine-month expense was $361.9 million, essentially flat. Q3 return on average assets was 0.89%, return on average equity 7.78%, and efficiency ratio 65.16% (non-GAAP). The nine-month figures were 0.87%, 7.64%, and 67.01%, respectively.
- Loans, deposits and balance sheet: Total assets were $18.70 billion, up 4.4% from year-end 2015. Loans, net of unearned income, were $14.39 billion, up 4.0%; growth was led by commercial mortgages (+6.5%) and residential mortgages (+12.1%). Deposits were $14.95 billion, up 5.8%, with demand and savings balances increasing and time deposits declining. Shareholders’ equity was $2.13 billion, up 4.3%.
- Credit quality: The provision for credit losses was $4.1 million in Q3 versus $1.0 million in Q3 2015; nine-month provision was $8.2 million versus a $0.5 million release in 2015. The allowance for credit losses was $165.2 million, or 1.15% of loans, compared with $171.4 million and 1.24% at year-end. Nonperforming assets were $150.1 million, 0.80% of assets, down from $155.9 million and 0.87% at year-end. Q3 annualized net charge-offs increased to 0.11% of average loans from 0.03% a year earlier; the nine-month rate improved to 0.14% from 0.16%.
- Debt, liquidity and capital: Short-term borrowings were $264.0 million, down from $497.7 million at year-end; long-term debt was $965.3 million, up from $949.5 million. The company reported $143.8 million of operating cash flow for the first nine months, $698.8 million used in investing activities and $540.3 million provided by financing activities. It reported $2.6 billion of additional FHLB borrowing capacity, $1.1 billion available under federal funds lines (with $8.4 million borrowed), and $1.3 billion of Discount Window availability with no borrowings. September 30 regulatory capital ratios included 13.2% total capital, 10.4% Tier 1 and common equity Tier 1, and 9.1% Tier 1 leverage; the company said it met fully phased-in minimums including buffers.
Material changes and management outlook
- Management attributed higher net interest income chiefly to loan and other interest-earning asset growth; lower asset yields and modest margin compression partly offset that growth. Average loans rose 6.3% year over year in Q3.
- Higher Q3 noninterest income excluding securities gains reflected commercial loan swap fees and mortgage loan sale gains. Nine-month securities gains fell to $1.0 million from $8.3 million.
- Mortgage servicing rights were impaired by $1.3 million in Q3 and $3.0 million year to date, reducing mortgage banking income. Q3 2015 included a $5.6 million loss on redemption of trust-preferred securities, making reported expense comparisons more favorable in 2016.
- The 2016 outlook was unchanged for mid- to high-single-digit annual growth in average loans and deposits and noninterest income excluding securities gains, and low- to mid-single-digit noninterest expense growth excluding the prior-year TruPS loss. Management’s revised margin outlook anticipated low-single-digit quarterly compression absent further market rate increases.
Risks, contingencies and unusual items
- The company and bank subsidiaries remained subject to regulatory BSA/AML enforcement orders requiring remediation and, while in effect, restricting certain expansion activities. Noncompliance could prompt further restrictions, fines or penalties.
- The Department of Justice expanded its fair-lending investigation in Q3 to additional geographies and subsidiaries, including mortgage lending under the Fulton Mortgage Company brand. The company said it could not estimate the timing, resolution terms or potential costs; enforcement could restrict expansion or other activities.
- Fulton Bank was a defendant in litigation related to an alleged Ponzi scheme. Plaintiffs sought more than $11.3 million, plus other damages and costs; the case was remanded to Pennsylvania state court in October 2016. Management said pending proceedings were not expected to have a material adverse effect on financial condition, while noting an unfavorable resolution could materially affect a particular period.
- Other areas to monitor include loan growth and credit losses, interest-rate sensitivity, deposit pricing and liquidity, securities valuations (including illiquid auction-rate securities), and mortgage repurchase or representation-and-warranty exposure.
Most important facts for investors to verify
- Whether loan growth, deposit mix and FTE margin trends support earnings growth as funding costs and market rates change.
- Whether the higher Q3 net charge-offs and credit provision remain consistent with stable-to-improving credit metrics, and whether allowance coverage remains adequate.
- Progress and potential financial or operating consequences of the BSA/AML orders and expanded fair-lending investigation.
- Any material developments in the Agostino litigation and mortgage repurchase or representation-and-warranty exposures.
- Whether 2016 guidance remains achievable, particularly the expected margin compression, expense growth and noninterest-income growth.