Fulton Financial Corporation — Q2 2013 Form 10-Q
Business context and period: Fulton Financial Corporation is a Pennsylvania financial holding company. This unaudited filing covers the three and six months ended June 30, 2013; comparisons are with the corresponding 2012 periods unless noted.
Financial performance and position
- Q2 earnings: Net income was $40.6 million, up 1.7%; diluted EPS was $0.21 versus $0.20. Pretax income rose 0.9% to $53.8 million.
- First-half earnings: Net income was $79.8 million, up 2.3%; diluted EPS was $0.41 versus $0.39. Pretax income was $104.7 million, down 0.2%.
- Net interest: Q2 net interest income was $132.1 million, down 4.0%; first-half net interest income was $261.7 million, down 5.3%. FTE net interest margin contracted 26 basis points to 3.52% in Q2 and 27 basis points to 3.54% for the first half. Lower asset yields outweighed reduced funding costs.
- Other income and expenses: Q2 non-interest income declined 1.9% to $52.3 million; first-half income declined 5.1% to $99.6 million, including lower mortgage banking and foreign currency processing income, partly offset by securities gains. Non-interest expense rose 4.5% to $117.1 million in Q2 and 2.4% to $228.1 million in the first half, driven partly by compliance, risk-management and core-system conversion costs.
- Credit quality: Q2 provision for credit losses was $13.5 million, down 47.1%; first-half provision was $28.5 million, down 46.7%. First-half net charge-offs were $36.3 million versus $74.4 million. Non-performing assets were $210.2 million, or 1.23% of assets, versus $266.3 million, or 1.63%, at June 30, 2012. The allowance for credit losses was $217.6 million, 1.72% of loans.
- Balance sheet at June 30: Assets totaled $17.02 billion, up 3.0% from December 31, 2012. Loans, net of unearned income, were $12.65 billion, up 4.1%; deposits were $12.26 billion, down 1.8%. Short-term borrowings increased 86.6% to $1.62 billion, including $550 million of short-term FHLB advances; long-term debt was $889.2 million. Shareholders’ equity was $2.03 billion, down 2.5%.
- Cash flow and liquidity: First-half operating cash flow was $142.4 million; investing activities used $616.9 million and financing activities provided $438.2 million. Cash and due from banks ended at $219.9 million. The company reported $1.5 billion of additional FHLB borrowing capacity, $1.6 billion of Federal funds line availability (with $780.5 million outstanding), and $1.9 billion of Discount Window availability. Regulatory capital ratios were 14.9% total capital, 13.0% Tier 1 risk-based capital and 10.6% Tier 1 leverage.
- Returns and distributions: Q2 return on average assets was 0.97% and return on average equity 7.89%. The quarterly dividend was $0.08 per share. The company repurchased 6.4 million shares for $71.3 million during the first half.
Material changes versus comparable periods
- Loan growth supported by commercial lending, commercial mortgages, home equity and residential mortgages; average loans rose 4.7% in Q2 and 3.5% in the first half year over year.
- Net interest margin declined as yields on interest-earning assets fell faster than funding costs. Time deposits declined while noninterest-bearing and demand-and-savings balances increased on average; period-end deposits nevertheless fell.
- Credit indicators improved overall, with lower non-performing assets, criticized commercial loans and net charge-offs. Residential mortgage net charge-offs increased in the first half.
- Available-for-sale securities moved from a $41.5 million net unrealized gain at year-end 2012 to an $18.3 million net unrealized loss at June 30, 2013, mainly reflecting rising interest rates. Accumulated other comprehensive loss was $32.5 million.
- Equity declined amid share repurchases, dividends and securities-related unrealized losses, partly offset by net income.
Outlook, commentary, risks and unusual items
- No quantified full-year earnings or revenue guidance is provided. Management said 2013 core-processing conversion costs were expected to total approximately $3.0 million, compared with $980,000 in 2012, and full implementation was expected to increase annual expenses by approximately $3 million. Three of six subsidiary banks had converted by June 30; the other three were expected to convert in Q3 2013.
- Management cited ongoing low interest rates, competition, regulatory compliance and risk-management costs, credit quality, real estate conditions, securities valuations, operational risks and Basel III implementation as factors that could affect results. The company believed its then-current capital levels would meet fully phased-in Basel III minimums, including conservation buffers.
- A July 31, 2013 court ruling vacated parts of the Federal Reserve’s debit-card interchange fee and network rules, subject to a stay. The company warned that a possible reduction in permissible interchange fees could reduce future debit-card income.
- Other notable items included $5.3 million of first-half investment securities gains; a $2.0 million reversal of the mortgage-servicing-rights valuation allowance; and first-half sales of non-accrual loans associated with $11.9 million of charge-offs.
- About $152.6 million of auction-rate securities remained illiquid and Level 3 valued; management’s valuation assumed market liquidity would return within five years. The company reported that the securities were current on interest payments and that it did not expect to be forced to sell before recovery.
- Management stated that pending ordinary-course litigation was not expected to have a material adverse effect, while noting litigation outcomes are uncertain. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether margin compression continues and whether loan growth can offset lower asset yields and deposit or borrowing funding shifts.
- Whether credit-quality improvements persist, particularly for commercial real estate and residential mortgage exposures, and whether allowance levels remain adequate.
- The valuation, liquidity assumptions and potential credit exposure of auction-rate and financial-institution securities, alongside the effect of rising rates on securities and equity.
- Actual core-system conversion costs, completion timing and recurring expense impact; also track regulatory and compliance spending.
- Potential effects of debit interchange rule changes on fee income, as well as the company’s elevated short-term borrowing and its funding mix.
- Capital and liquidity capacity, including progress toward Basel III requirements and the remaining share-repurchase authorization.