Fulton Financial Corporation — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; unaudited consolidated results. Fulton is a financial holding company with six banking subsidiaries serving Pennsylvania, Delaware, Maryland, New Jersey and Virginia.
Financial results and position
| Metric | Q1 2014 / Mar. 31, 2014 | Comparable period / prior date |
|---|---|---|
| Net income | $41.8 million | $39.2 million in Q1 2013 |
| Diluted earnings per share | $0.22 | $0.20 in Q1 2013 |
| Net interest income | $129.6 million | $129.6 million in Q1 2013 |
| Net interest margin, FTE | 3.47% | 3.55% in Q1 2013 |
| Provision for credit losses | $2.5 million | $15.0 million in Q1 2013 |
| Non-interest income | $38.5 million | $47.3 million in Q1 2013 |
| Non-interest expense | $109.6 million | $110.9 million in Q1 2013 |
| Operating cash flow | $60.5 million | $63.6 million in Q1 2013 |
| Total assets | $16.912 billion | $16.935 billion at Dec. 31, 2013 |
| Deposits | $12.670 billion | $12.491 billion at Dec. 31, 2013 |
| Net loans, before allowance | $12.734 billion | $12.782 billion at Dec. 31, 2013 |
| Total borrowings | $1.953 billion | $2.142 billion at Dec. 31, 2013 |
Income before taxes rose 9.9% year over year. Return on average assets was 1.01% and return on average equity was 8.21%, compared with 0.96% and 7.67%, respectively, in Q1 2013. The effective tax rate increased to 25.4% from 23.0%.
Annualized net charge-offs were 0.26% of average loans, down from 0.62% in Q1 2013. Non-performing assets were $170.2 million, or 1.01% of assets, versus $232.5 million, or 1.39%, a year earlier. The allowance for credit losses was $199.0 million, equal to 1.56% of loans and 128.45% of non-performing loans.
At March 31, total capital to risk-weighted assets was 15.0%, Tier 1 capital to risk-weighted assets 13.1%, and Tier 1 leverage 10.5%. Management reported that the Corporation and its bank subsidiaries met applicable minimum capital requirements; bank subsidiaries exceeded “well capitalized” thresholds. Liquidity included approximately $1.7 billion of additional FHLB borrowing capacity, $1.6 billion of Federal funds line availability (with $361.1 million outstanding), and $2.2 billion of Discount Window borrowing availability, with no Discount Window borrowings.
Material changes and management commentary
- Credit costs improved: provision expense fell $12.5 million year over year, and net charge-offs declined 55.5% to $8.4 million.
- Net interest income was nearly flat despite a 8-basis-point margin decline. Average interest-earning assets increased 2.3%, including average loans up 4.1%; lower asset yields were partly offset by reduced funding costs.
- Non-interest income excluding securities gains fell 14.0%. Mortgage banking income declined 55.9%, mainly because higher mortgage rates reduced refinancing volumes and loan-sale gains. Deposit service charges decreased 17.0%, including a 29.0% decline in overdraft fees.
- Non-interest expense declined 1.2%. Lower salaries and OREO costs were partly offset by higher occupancy and outside-service costs, including consulting for compliance and risk-management initiatives.
- Management began initiatives intended to reduce annual expenses by approximately $8 million. The filing estimates $6.95 million of 2014 expense reductions; 13 branch consolidations generated $2.1 million of first-quarter costs. First-quarter implementation expenses and gains were $980,000, alongside $1.0 million in expense reductions.
- The Corporation repurchased 4.0 million shares for $49.8 million, averaging $12.45 per share, completing its authorized repurchase program. The quarterly dividend was $0.08 per share.
Outlook, risks, contingencies and unusual items
- Regulatory compliance: Management reported continuing deficiencies in Bank Secrecy Act-related compliance program elements and anticipated that the Corporation and certain banking subsidiaries would consent to formal federal enforcement orders. Orders could impose business restrictions, fines or penalties and require additional personnel, consulting, legal and systems spending. Management could not predict the outcome or costs and warned of potential material effects on future results.
- Credit and concentration risks: Commercial mortgage and construction loans represented approximately 44.9% of the loan portfolio. Real-estate value declines or renewed deterioration in borrowers’ credit could increase losses and provisions. Construction delinquency was 4.0% overall, with 8.5% for commercial-residential construction loans.
- Investment valuation and liquidity: Auction rate securities had a $147.7 million fair value and remained illiquid; their valuation assumed a return to market liquidity within five years. Management said all were current and making scheduled interest payments and that 99% of underlying student-loan principal was federally guaranteed. Corporate debt holdings also included below-investment-grade and unrated securities.
- Mortgage repurchase exposure: A first-quarter settlement required a $4.5 million payment to resolve specified outstanding and potential future investor repurchase requests. It reduced repurchase reserves by $5.1 million and produced a $600,000 reduction in operating risk loss. Outstanding repurchase requests were $543,000 at quarter-end. Management cautioned that additional reserves may be needed if collateral or loan quality deteriorates or further repurchases are identified.
- Other notable items: An amendment to the postretirement plan generated a $1.5 million gain in Q1. The filing provides no earnings or revenue guidance; it states that first-quarter results are not necessarily indicative of full-year results. Risks also include low interest rates, weak loan demand, regulatory costs, market-sensitive securities and competition.
Investor verification priorities
- Track the issuance, scope and compliance costs of the anticipated BSA-related enforcement orders, including any restrictions, penalties or remediation deadlines.
- Assess whether improving credit trends persist, especially in commercial real estate and construction, and whether the allowance remains adequate as criticized loans and delinquencies change.
- Monitor net interest margin and fee-income trends, particularly mortgage banking and overdraft fees, against management’s expense-reduction plans.
- Review the assumptions and potential liquidity exposure underlying auction rate securities and other Level 3 investment valuations.
- Verify subsequent mortgage repurchase claims, reserve adequacy, and the realized savings and implementation costs of branch and workforce initiatives.