FULTON FINANCIAL CORP quarterly report, Q2 FY2012

Full document

Fulton Financial Corporation — Q2 2012 Form 10-Q

Reporting period: Three and six months ended June 30, 2012. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions where appropriate.

Business context and reporting period

Fulton Financial is a Pennsylvania-based bank holding company. The filing reports unaudited consolidated results. Management cautions that interim results are not necessarily indicative of full-year results.

Financial performance and position

  • Q2 earnings: Net income was $39.9 million, up 9.6% from $36.4 million in Q2 2011; diluted EPS was $0.20 versus $0.18. Six-month net income was $78.0 million, up 11.2%, with diluted EPS of $0.39 versus $0.35.
  • Revenue and margins: Q2 net interest income was $137.5 million, down 2.2%; six-month net interest income was $276.2 million, down 1.4%. Net interest margin (FTE) was 3.78% in Q2 versus 3.95% a year earlier, and 3.81% for the half versus 3.93%. Non-interest income rose 16.6% in Q2 to $53.4 million and 15.1% for the half to $105.0 million, led by mortgage banking.
  • Expenses and credit provision: Q2 non-interest expense increased 11.2% to $112.1 million; first-half expense rose 10.5% to $222.9 million. Provision for credit losses declined 29.2% in Q2 to $25.5 million and 27.7% for the half to $53.5 million.
  • Credit quality: Q2 net charge-offs were $46.3 million, up from $38.5 million a year earlier; the annualized ratio to average loans increased to 1.55% from 1.30%. For the first half, net charge-offs fell to $74.4 million from $80.9 million. At June 30, non-performing assets were $266.3 million, or 1.63% of assets, compared with $348.3 million, or 2.18%, a year earlier. The allowance for credit losses was $237.3 million, equal to 101.43% of non-performing loans.
  • Balance sheet and funding: Total assets were $16.34 billion, down slightly from year-end 2011. Loans were $11.98 billion, approximately flat; available-for-sale securities were $2.86 billion, up 7.1% from year-end. Deposits were $12.23 billion, down 2.3%; short-term borrowings rose 56.1% to $931.7 million, while FHLB advances and long-term debt fell 12.6% to $908.8 million.
  • Capital and liquidity: Shareholders’ equity was $2.04 billion. Capital ratios at June 30 included total capital of 15.4%, Tier 1 risk-based capital of 13.2%, Tier 1 leverage of 10.6%, and tangible common equity to risk-weighted assets of 11.8%. Management said the company and its bank subsidiaries met applicable minimums, and subsidiary banks exceeded “well capitalized” thresholds. The company reported $817.6 million of additional FHLB borrowing capacity and $1.2 billion of collateralized Federal Reserve Discount Window availability, with no Discount Window borrowings outstanding.
  • Cash flows, first half: Operating activities provided $135.6 million; investing activities used $72.6 million; financing activities used $112.8 million. Cash and due from banks declined $49.8 million to $242.8 million.

Material changes versus prior comparable periods

  • Net income improved despite lower net interest income and margin; stronger mortgage banking income and lower credit-loss provision contributed, while operating expenses increased.
  • Mortgage banking income increased 84.2% in Q2 and 84.1% for the first half, primarily from greater refinancing activity, higher loan commitments, and improved pricing spreads.
  • Credit indicators improved year over year, including lower non-performing assets and overall delinquency. However, Q2 net charge-offs increased, including losses associated with a loan sale.
  • Deposit mix shifted away from time deposits toward demand and savings accounts. Average interest-bearing deposit costs declined, but asset yields fell faster, compressing net interest margin.
  • Shareholders’ equity increased 2.4% from year-end 2011, despite lower accumulated unrealized gains on available-for-sale securities.

Outlook, risks, contingencies, and unusual items

  • Outlook: The filing provides no specific earnings or revenue guidance. Management cited slow economic growth and weak loan demand, a continuing low-rate environment, and anticipated volatility in other-real-estate-owned expenses while working through non-performing assets. It also noted that actual results may differ materially from forward-looking statements.
  • Interest-rate sensitivity: The company’s modeled 12-month net interest income increased 1.5% under a 100-basis-point rate increase and declined 3.1% under a 100-basis-point decrease. Management stated that economic-value-of-equity exposures were within policy limits.
  • Loan sale and credit costs: In June, Fulton sold loans with $60.0 million unpaid principal balance for net proceeds of $22.9 million. After prior charge-offs, the recorded investment sold was $44.1 million, with a further $21.2 million charge-off on sale; management said existing reserves covered the loss without additional provision.
  • Mortgage-related contingencies: The reserve for losses on residential loans sold was $4.1 million, including exposure under the FHLB Mortgage Partnership Finance program and representations and warranties. Outstanding repurchase requests were approximately $4.7 million. Management said reserves were adequate but noted further losses could require additional reserves.
  • Investment risk: Auction-rate securities had $238.4 million amortized cost and $203.3 million fair value, with valuation dependent on an assumed return to market liquidity within five years. All were current and paying interest at June 30. On August 6, 2012, securities with $48.0 million par value were called at par, and $1.1 million of unaccreted discount was recognized as interest income. Certain trust-preferred securities were below investment grade or valued using significant unobservable inputs.
  • Other items: In June the board authorized repurchases of up to 5 million shares through December 31, 2012; none had been repurchased by June 30. On July 31, Fulton agreed to buy $12.7 million of another financial institution’s stock, with a further $6.4 million purchase conditional on regulatory approval. Management did not expect pending litigation to have a material adverse effect, while noting litigation outcomes are uncertain.
  • Regulation and controls: Management believed current capital would meet proposed U.S. Basel III requirements as then proposed. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported for the quarter.

Most important facts for investors to verify

  1. Whether credit-quality improvement continues after accounting for loan sales, and whether elevated net charge-offs or commercial real estate exposures require further provision.
  2. Whether net interest margin stabilizes as asset yields, deposit costs, funding mix, and interest rates change.
  3. Whether mortgage banking gains remain strong if refinancing volumes or pricing spreads decline, and whether mortgage repurchase or FHLB program losses increase.
  4. Whether auction-rate and financial-institution securities recover value as assumed, particularly given illiquidity and unobservable valuation inputs.
  5. How deposit outflows, increased short-term borrowings, planned share repurchases, and regulatory capital changes affect liquidity and capital flexibility.