Fulton Financial Corporation — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Fulton is a financial holding company with six banking subsidiaries serving Pennsylvania, Delaware, Maryland, New Jersey and Virginia. Unaudited results are not necessarily indicative of full-year performance.
Financial performance
- Q2 earnings: Net income was $39.8 million, up 8.4% from $36.7 million; diluted EPS was $0.23 versus $0.21. For the first half, net income was $78.0 million, up 1.7%, and diluted EPS was $0.45 versus $0.43.
- Interest income and margin: Q2 net interest income was $128.9 million, up 4.9%; fully taxable-equivalent (FTE) net interest income rose 5.1% to $133.9 million. Q2 net interest margin was 3.20%, unchanged year over year. First-half FTE net interest income increased 4.8% to $267.9 million; margin edged down to 3.22% from 3.24%.
- Other income and expenses: Q2 noninterest income was $46.1 million, down slightly from $46.5 million, as lower securities gains and mortgage banking income offset fee growth. Excluding securities gains, noninterest income increased 4.5%. Noninterest expense rose 2.8% to $121.6 million, driven mainly by salaries and benefits. The efficiency ratio improved to 67.59% from 68.94%.
- Credit costs and asset quality: Q2 provision for credit losses was $2.5 million versus $2.2 million; first-half provision was $4.0 million versus a $1.5 million credit in 2015. Q2 annualized net charge-offs declined to 0.10% from 0.38%; nonperforming assets were $139.7 million, or 0.76% of assets, versus $162.3 million, or 0.93%, a year earlier. The allowance for credit losses was $165.1 million, 1.17% of loans.
- Cash flow: First-half operating cash flow was $74.1 million, investing cash outflow was $447.0 million, and financing cash inflow was $356.4 million. Cash and due from banks declined $16.5 million to $84.6 million. Investing outflows principally reflected loan growth and short-term investments.
Financial position, funding and capital
- Total assets were $18.48 billion at June 30, up 3.2% from year-end 2015. Net loans were $14.0 billion, up 2.4%; deposits were $14.29 billion, up 1.1%.
- Total borrowings were $1.69 billion, up 16.6% from year-end. Short-term borrowings increased 45.1% to $722.2 million, including $449.2 million of federal funds purchased. Long-term debt was $965.6 million. Shareholders’ equity totaled $2.11 billion.
- Management reported $2.8 billion of additional FHLB borrowing capacity, $1.1 billion of federal funds line availability (with $449.2 million drawn), and $1.3 billion of discount-window availability with no borrowings. These sources support liquidity, but increased reliance on short-term funding is a point to monitor.
- Regulatory capital ratios included total capital of 13.1%, Tier 1 capital of 10.3%, Common Equity Tier 1 of 10.3%, and Tier 1 leverage of 9.0%. The filing states the company met fully phased-in Basel III minimums, including capital conservation buffers; subsidiary banks exceeded “well capitalized” thresholds.
Material changes and unusual items
- Loan growth and higher average earning assets drove interest-income growth, while loan yields declined amid refinancing and lower-rate new production. A shift toward lower-cost deposits and prior debt refinancing helped reduce interest expense.
- Q2 mortgage banking income included a $1.7 million MSR impairment charge; reported mortgage servicing income was negative $543,000. MSRs were $38.2 million net at quarter-end.
- Securities gains fell to $76,000 in Q2 from $2.4 million in Q2 2015; first-half gains were $1.0 million versus $6.6 million. First-half comprehensive income also benefited from $29.7 million of other comprehensive income, primarily unrealized securities gains.
- The allowance for loan losses declined to $162.5 million from $169.1 million at year-end, while nonperforming loans and nonperforming assets also declined. However, “special mention” commercial and real estate loans rose to $258.8 million from $218.9 million at year-end.
Outlook, risks and contingencies
- 2016 outlook: Management maintained expectations for mid- to high-single-digit annual growth in average loans and deposits and in noninterest income excluding securities gains; low- to mid-single-digit noninterest expense growth; and provision expense driven primarily by loan growth. The company revised its margin outlook: absent further market rate increases, it expects low-single-digit quarterly net interest margin compression.
- Regulatory matters: The company and bank subsidiaries remain subject to 2014–2015 BSA/AML consent orders requiring program improvements and, in some cases, retrospective reviews. Orders restrict certain expansion activity; noncompliance could lead to additional restrictions, fines or penalties. A Department of Justice fair-lending investigation of the largest bank subsidiary was ongoing.
- Litigation and lending exposures: A lawsuit involving 58 plaintiffs alleges the bank failed to detect activity associated with an alleged Ponzi scheme and seeks damages exceeding $11.3 million, plus other relief. The company said pending matters were not expected to materially adversely affect financial condition, while noting outcomes are unpredictable. Commitments to extend credit totaled $5.90 billion; standby letters of credit were $362.5 million.
- Other risks: Management cited sensitivity to interest rates, liquidity and funding costs, credit deterioration, regulatory compliance, litigation, operational and cybersecurity risks, and future adoption of the expected-credit-loss accounting standard (CECL). Interest-rate modeling estimated net interest income increases of 4.3%, 9.43% and 14.1% under +100, +200 and +300 basis-point shocks, respectively, and a 3.0% decline under a −100 bp shock.
Important facts for investors to verify
- Whether loan growth, deposit funding and increased short-term borrowings remain sustainable without pressuring liquidity or margins.
- Trends in net interest margin, deposit pricing, loan yields and the company’s revised outlook for quarterly margin compression.
- Credit quality, especially rising special-mention balances, commercial real-estate exposure, charge-offs and allowance adequacy.
- Progress and costs under the BSA/AML consent orders, and potential outcomes of the fair-lending investigation and pending lawsuit.
- Whether mortgage servicing asset values, securities valuations and reported gains remain sensitive to prepayments, market liquidity and interest rates.