Fulton Financial Corporation — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013; unaudited consolidated results. Fulton is a Pennsylvania-based financial holding company. Comparisons below are to Q3 or the first nine months of 2012, or to December 31, 2012 for balance-sheet changes.
Financial performance and condition
| Metric | Q3 2013 | Nine months 2013 | Comparison / context |
|---|---|---|---|
| Net income | $39.9 million | $119.8 million | Q3: $41.6 million; nine months: $119.6 million in 2012 |
| Diluted EPS | $0.21 | $0.61 | 2012: $0.21 and $0.60, respectively |
| Net interest income | $132.5 million | $394.2 million | Down 2.5% and 4.3%, respectively |
| Net interest margin (FTE) | 3.45% | 3.51% | Down 29 and 28 basis points, respectively |
| Return on average assets / equity | 0.93% / 7.81% | 0.95% / 7.79% | Q3 2012: 1.02% / 8.03% |
| Provision for credit losses | $9.5 million | $38.0 million | Down 58.7% and 50.3%, respectively |
| Non-interest income | $47.4 million | $146.9 million | Excluding securities gains, down 13.8% and 9.8% |
| Non-interest expense | $116.6 million | $344.7 million | Up 6.0% and 3.6% |
| Operating cash flow | — | $224.6 million | Investing cash outflow $665.2 million; financing inflow $447.3 million |
- Balance sheet at September 30: Total assets were $17.05 billion, up 3.1% from year-end 2012. Loans, net of unearned income, were $12.78 billion, up 5.2%; deposits were $12.72 billion, up 1.9%.
- Funding and debt: Short-term borrowings increased 38.0% from year-end to $1.20 billion; long-term debt was $889.1 million. Management said additional short-term funding helped cover loan growth exceeding deposit growth.
- Credit quality: Nonperforming assets were $186.5 million, or 1.09% of assets, versus $237.2 million and 1.43% at year-end 2012. Net charge-offs were $14.3 million in Q3 and $50.6 million year to date; annualized ratios were 0.45% and 0.54%. The allowance for credit losses was $212.8 million, 1.67% of loans and 126.48% of nonperforming loans.
- Capital and liquidity: Reported capital ratios were 14.8% total capital, 12.9% Tier 1 risk-based capital and 10.4% Tier 1 leverage. The company and bank subsidiaries met minimum requirements; subsidiaries exceeded “well capitalized” thresholds. Available capacity included approximately $1.6 billion of additional FHLB borrowing, $1.6 billion under Federal funds lines, and $2.0 billion at the Federal Reserve Discount Window; no Discount Window borrowings were outstanding.
Material changes and drivers
- Lower asset yields outweighed growth in average interest-earning assets and reduced funding costs. FTE asset yields fell 45 basis points in both Q3 and year-to-date comparisons; average loans rose 6.8% in Q3 and 4.6% year to date.
- Asset quality improved: year-to-date net charge-offs fell from $99.4 million to $50.6 million, and nonperforming assets declined. The lower credit-loss provision supported earnings.
- Fee income excluding securities gains weakened, principally because higher mortgage rates reduced refinancing and mortgage-sale gains, overdraft fees declined, and the Global Exchange division had been sold in December 2012. Trust and investment management revenue increased.
- Operating expenses rose amid regulatory compliance and risk-management work and a core processing system conversion completed in Q3. Conversion costs were $3.1 million year to date; management expects the system to add about $3 million in annual expenses.
- Shareholders’ equity fell 2.5% from year-end, reflecting $90.9 million of repurchases, dividends and a $46.5 million after-tax decline in accumulated other comprehensive income, partly offset by net income. An additional authorization to repurchase up to 4.0 million shares through March 31, 2014 was announced after quarter-end.
Outlook, risks and unusual items
- No specific earnings or revenue guidance is provided. Management noted that it may take actions to reduce ongoing operating costs to offset some or all increased compliance and risk-management costs.
- Regulatory compliance: The filing identifies deficiencies involving Flood Disaster Protection Act, Bank Secrecy Act and anti-money-laundering compliance. Management said remediation is being accelerated, but progress may not meet regulatory expectations. The company disclosed increased risk of enforcement action, which could require further remediation and lead to activity restrictions, fines or penalties and materially higher costs.
- Interest-rate exposure: Management’s modeled 12-month net interest income rises 1.7% under a 100-basis-point rate increase and falls 3.5% under a 100-basis-point decrease. The filing warns that results depend on assumptions and do not fully reflect future customer behavior or competitive pricing.
- Credit and real estate: Commercial mortgage and construction loans together represented 44.1% of the loan portfolio. Deterioration in real estate values or borrower performance could increase credit losses. TDRs totaled $100.7 million; $21.4 million of TDRs modified within the prior 12 months had subsequently defaulted during the first nine months.
- Securities and valuation: Available-for-sale securities had a $31.8 million net unrealized loss at quarter-end, versus a $41.5 million gain at year-end 2012, primarily associated with rising interest rates. Auction-rate securities were illiquid, valued using Level 3 assumptions, and had a $154.5 million fair value against $172.1 million cost. A single financial-institution stock investment accounted for 71.1% of the publicly traded financial-institution stock portfolio’s fair value.
- Unusual items: Q3 included $2.6 million of net securities gains and a $1.7 million reversal of the mortgage-servicing-rights valuation allowance. Year-to-date securities gains were $8.0 million. These items, together with lower credit provisions, partly offset margin compression, lower mortgage activity and higher expenses.
- Residential mortgage sale representations-and-warranties and Mortgage Partnership Finance exposures had total reserves of $7.8 million. Management considered reserves adequate but noted that weaker collateral values, additional repurchases or deteriorating credit could require more. The company said pending ordinary-course litigation was not expected to have a material adverse effect, while acknowledging that outcomes are uncertain.
Important facts for investors to verify
- Whether net interest margin pressure continues and whether loan growth can be funded without sustained reliance on higher short-term borrowings.
- Trends in nonperforming loans, charge-offs, criticized loans, TDR defaults and the adequacy of the credit-loss allowance.
- Progress and costs of compliance remediation, and whether regulators impose enforcement actions, restrictions or penalties.
- Performance and valuation assumptions for illiquid auction-rate securities, financial-institution investments and mortgage servicing rights.
- Actual recurring expense impact of the core system conversion and whether cost-reduction actions offset compliance and technology spending.
- Execution and capital effects of the post-quarter authorization to repurchase up to 4.0 million shares, alongside Basel III implementation requirements.