Fulton Financial Corporation — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; comparisons are primarily with 2016. The filing was signed March 1, 2018. Fulton is a regional financial holding company operating six community banks across Pennsylvania, Delaware, Maryland, New Jersey and Virginia.
Financial performance and position
- Earnings: Net income was $171.8 million, up 6.3% from $161.6 million. Diluted EPS rose 5.4% to $0.98. Return on average assets was 0.88%; return on average equity was 7.83%.
- Revenue and margins: GAAP net interest income increased 10.5% to $575.4 million. Net interest margin improved 10 basis points to 3.28%. Non-interest income was $208.0 million, including $9.1 million of net securities gains; excluding securities gains, it grew 6.0% to $198.9 million. The efficiency ratio improved to 64.5% from 67.2%.
- Credit costs and quality: Provision for credit losses rose to $23.3 million from $13.2 million; net charge-offs increased to $18.5 million, or 0.12% of average loans, from $13.3 million, or 0.09%. Non-performing assets were $144.6 million, 0.72% of total assets, versus $144.5 million, or 0.76%, a year earlier. Allowance for credit losses was $176.1 million, including $6.2 million for unfunded commitments.
- Growth and funding: Year-end assets were $20.0 billion, up 5.8%; loans were $15.8 billion, up 7.3%; deposits were $15.8 billion, up 5.2%. Average loans grew 7.8% and average deposits 6.1%. The year-end loan-to-deposit ratio increased to 99.8% from 97.9%.
- Debt and liquidity: At year-end, short-term borrowings were $617.5 million and FHLB advances and long-term debt were $1.038 billion. Cash and due from banks was $108.3 million. Operating cash flow was $258.8 million; investing activities used $1.166 billion, mainly reflecting loan growth, while financing activities provided $897.1 million, mainly from deposit growth. Fulton reported $3.6 billion of additional FHLB borrowing capacity and $1.2 billion of federal funds lines, of which $220 million was drawn.
- Capital: Corporation total capital ratio was 13.0%, Tier 1 risk-based ratio 10.4%, CET1 ratio 10.4%, and Tier 1 leverage ratio 8.9%. The Corporation and its bank subsidiaries met applicable Basel III capital requirements; bank subsidiaries were reported as well capitalized.
- Shareholder returns: Cash dividends were $0.47 per share for 2017, versus $0.41 in 2016. The board authorized up to $50 million in repurchases through December 31, 2018; $18.5 million had been used under the program by year-end.
Material changes versus 2016
- Net interest income benefited from loan and earning-asset growth and a 13-basis-point increase in earning-asset yields; higher deposit costs partly offset the benefit.
- Provision expense increased $10.1 million, driven mainly by portfolio growth and a $3.5 million increase in the reserve for unfunded lending commitments related to one financially stressed relationship.
- Non-interest expense rose 7.4% to $525.6 million. Drivers included salaries, outside services, state taxes, FDIC insurance and $11.0 million of tax-credit-investment amortization newly classified as expense. A $3.4 million write-off of technology project costs also contributed.
- The Tax Act reduced the federal corporate tax rate to 21% beginning in 2018. Fulton recorded a $15.6 million fourth-quarter charge to remeasure deferred taxes. The reported effective tax rate was 26.7%, versus 22.4%; excluding that charge, management said the 2017 rate would have been about 20.1%.
- Net securities gains increased to $9.1 million from $2.6 million, including $13.6 million of gains on financial-institution stocks, partly offset by about $4.5 million of losses from investment-portfolio repositioning. Non-interest income also included a $5.1 million net gain on settlement of litigation.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no formal numerical earnings or revenue guidance. Management expected the lower corporate tax rate to reduce the effective tax rate in 2018, with the level of tax-credit investment amortization and related credits affecting the outcome. The company anticipated additional Federal Reserve rate increases; its year-end sensitivity model estimated net interest income would rise 5.2% under an immediate 100-basis-point increase and decline 8.0% under a 100-basis-point decrease. These are modeled scenarios, not guidance.
- Business and bank consolidation: Fulton is moving toward a customer-segment-focused model and plans a multi-year effort to consolidate its six bank subsidiaries into one, subject to regulatory approval and progress on compliance remediation. Timing and expected savings are uncertain.
- BSA/AML enforcement: The Corporation and three bank subsidiaries had regulatory enforcement orders requiring improvements to their BSA/AML program and, in some cases, retrospective reviews. The OCC terminated its orders against Fulton Bank, N.A., FNB Bank, N.A. and Swineford National Bank in October 2017; the filing describes other orders as remaining in effect and provides no assurance about when they will end. Orders can restrict expansion and entail further costs or penalties.
- Fair-lending investigation: The Department of Justice investigation concerning potential lending discrimination on the basis of race and national origin had expanded to Fulton and three additional bank subsidiaries. Fulton was cooperating but could not estimate the timing, resolution terms, potential penalties or remedial costs.
- Credit and funding risks: Commercial, commercial-mortgage and construction lending represented about 74% of the loan portfolio. Commercial real estate and construction concentrations, rising criticized loans, a 99.8% loan-to-deposit ratio, and rate-sensitive municipal deposits—about 13% of deposits—are important risks. Management also identified competition, interest-rate sensitivity and liquidity access as potential constraints.
- Other contingencies and valuation risks: Loan-sale representations and warranties may require repurchases or reimbursements; outstanding residential repurchase requests were approximately $543,000. Student-loan auction-rate securities had $98.7 million fair value, based on Level 3 assumptions that market liquidity would return within five years. Total TDRs were $95.4 million, including $66.4 million accruing.
- Accounting and controls: Fulton intended to adopt the expected-credit-loss (CECL) standard in 2020 and was still evaluating its impact. Management and the independent auditor concluded internal control over financial reporting was effective at year-end; the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Progress toward release of all remaining BSA/AML enforcement orders, ongoing compliance spending and any continuing restrictions on acquisitions or branching.
- Status and potential financial or operational consequences of the DOJ fair-lending investigation and any related remedial actions.
- Loan performance trends, especially commercial, commercial real estate and construction exposures; criticized-loan growth; and whether allowance levels keep pace with loan growth and charge-offs.
- Deposit retention and funding costs as rates change, given the high loan-to-deposit ratio and municipal-deposit exposure.
- Actual 2018 effective tax rate and earnings effect of the Tax Act, including tax-credit-investment expense and credits.
- Execution costs, regulatory approvals and expected benefits of the multi-year bank consolidation and business-model transition.
- Assumptions supporting Level 3 asset valuations, particularly the auction-rate securities liquidity timeline, and the eventual effect of CECL on reserves and capital.