Fulton Financial Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Fulton is a financial holding company with six bank subsidiaries serving Pennsylvania, Delaware, Maryland, New Jersey and Virginia. Unless stated otherwise, financial amounts below are in U.S. dollars.
Financial performance and condition
| Metric | Q1 2018 | Prior comparable period or change |
|---|---|---|
| Net interest income | $151.3 million | Up 10.0% from Q1 2017 |
| Net interest margin, FTE | 3.35% | Up 9 basis points from 3.26% |
| Non-interest income | $45.9 million | $45.9 million excluding securities gains, up 0.6%; reported total down 1.7% |
| Non-interest expense | $136.7 million | Up 11.8% |
| Net income | $49.5 million | Up 14.1% from $43.4 million |
| Diluted earnings per share | $0.28 | Up $0.03 |
| Effective tax rate | 12.5% | 24.1% in Q1 2017 |
| Operating cash flow | $71.8 million provided | $69.8 million provided |
Average loans rose 5.4% year over year to $15.7 billion, while average deposits rose 3.6% to $15.4 billion. At quarter-end, total assets were $19.9 billion, down 0.4% from December 31, 2017; loans, net of unearned income, were $15.7 billion. Deposits fell 2.0% to $15.5 billion, while total borrowings increased 13.3% to $1.88 billion, including a 51.9% rise in short-term borrowings. Shareholders’ equity was $2.24 billion.
Net cash used in financing activities was $116.7 million, and cash and due from banks ended at $100.2 million. Fulton reported $3.8 billion of additional FHLB borrowing capacity, $1.0 billion of aggregate federal funds line availability with $400 million drawn, and $490.3 million of Discount Window availability with no borrowings. Regulatory capital ratios exceeded fully phased-in minimums: total capital 13.2%, Tier 1 10.6%, common equity Tier 1 10.6%, and Tier 1 leverage 9.2%.
Credit indicators were broadly stable to improved year over year: non-performing assets were 0.73% of assets versus 0.75%; total delinquency was 1.19% versus 1.23%. Net charge-offs were 0.10% of average loans, slightly higher than 0.09%. The allowance for credit losses was $176.0 million, including $12.8 million reserved for unfunded commitments; the latter rose from $6.2 million, largely due to a single customer relationship.
Material changes and drivers
- Higher loan balances and asset yields, including repricing after Federal Reserve rate increases, supported earnings and margin. Higher deposit and short-term borrowing costs partly offset the benefit. The Tax Act reduced reported FTE asset yields and margin by an estimated 6 basis points.
- The Tax Act’s reduction of the federal corporate tax rate from 35% to 21% materially lowered tax expense. Management estimated that, absent the statutory rate reduction, Q1 2018 tax expense and effective rate would have been approximately $12.9 million and 22.8%.
- Expense growth outpaced fee-income growth. Salaries and benefits rose $6.5 million; outside services rose $2.6 million; professional fees rose $2.1 million; data processing and software rose $1.5 million; and FDIC insurance expense rose $0.9 million. Management cited staffing and compensation, consulting and technology initiatives, higher legal expenses, and higher insurance assessments after the largest bank subsidiary exceeded $10 billion in assets.
- Other comprehensive loss was $27.1 million, primarily reflecting unrealized securities losses as interest rates rose. Accumulated other comprehensive loss increased to $67.2 million.
- Quarter-end deposits declined $320.4 million, reflecting seasonal municipal deposit decreases and customer funds shifting toward short-term promissory notes. Short-term borrowings rose $320.3 million.
Outlook, risks and unusual items
The filing provides no specific earnings or revenue guidance. Management cautions that quarterly results are not necessarily indicative of full-year results. Its interest-rate simulation estimated annual net interest income would increase 4.5% under a 100-basis-point upward shock, 9.0% under +200 basis points, and 13.1% under +300 basis points; a 100-basis-point downward shock was estimated to reduce it 7.62%. These are model estimates and depend on assumptions, including customer behavior and balance-sheet repricing.
Fulton and three bank subsidiaries remain subject to certain BSA/AML regulatory enforcement orders and related activity restrictions; the OCC terminated its 2014 orders for three bank subsidiaries in October 2017. A Department of Justice fair-lending investigation, expanded in 2016 to cover additional geographies and subsidiaries, remained unresolved; the company said it could not reliably estimate potential settlement, penalties or remedial costs. Management did not expect pending legal matters, individually or collectively, to materially affect financial condition, while noting an unfavorable resolution could materially affect results in a particular period.
Other risks include credit quality and loan losses, rate and liquidity movements, deposit competition and funding costs, regulatory compliance, litigation and investigations, loan repurchase or indemnification exposure, and operational and cybersecurity risks. The company reported $6.42 billion of commitments to extend credit and $362.5 million of standby and commercial letters of credit. It also disclosed a $58.4 million unpaid balance of non-prime loans sold under a program requiring repurchase if loans become delinquent within three years; no loss reserve was recorded for these loans at quarter-end.
Adopted accounting standards generally had no material financial-statement impact. Fulton adopted the stranded-tax-effects standard early and reclassified $7.1 million from accumulated other comprehensive income to retained earnings. It was evaluating the expected-credit-loss standard (CECL), scheduled for adoption in 2020, and said the impact could be significantly influenced by portfolio characteristics and economic conditions.
Key facts for investors to verify
- Whether loan growth and higher asset yields can continue to offset rising deposit and borrowing costs, and whether the margin holds up under changing rates.
- Whether expense increases—particularly compensation, technology, outside services and legal costs—moderate, given the efficiency ratio rose to 67.5% from 64.2%.
- Whether the increase in short-term borrowings and the decline in deposits are temporary or indicate a sustained shift in funding mix and cost.
- Trends in the unfunded-commitment reserve, criticized and classified loans, non-performing assets and charge-offs, including the exposure tied to one customer relationship.
- Developments and potential costs or business restrictions from the remaining BSA/AML orders and DOJ fair-lending investigation.
- The effects of securities valuation losses, rate sensitivity, CECL adoption and the non-prime mortgage repurchase exposure.