Fulton Financial Corporation — Q1 2017 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2017, compared with Q1 2016 where applicable. Fulton is a regional financial holding company operating through six bank subsidiaries and other subsidiaries, serving customers in Pennsylvania, Delaware, Maryland, New Jersey and Virginia.
Financial performance and condition
- Earnings: Net income was $43.4 million, up 13.4% from $38.3 million; diluted EPS was $0.25 versus $0.22. Cash dividends were $0.11 per share versus $0.09.
- Revenue and margins: Net interest income was $137.6 million, up 6.6%; on a fully taxable-equivalent basis, it rose 6.9% to $143.2 million. Net interest margin increased to 3.26% from 3.23%. Non-interest income was $46.7 million, up 8.2%; non-interest expense was $122.3 million, up 1.5%. The efficiency ratio improved to 64.76% from 68.33%.
- Profitability: Return on average assets was 0.92% versus 0.86%; return on average equity was 8.22% versus 7.47%; return on average tangible equity was 10.93% versus 10.07%. The effective tax rate was 24.1% versus 23.9%.
- Loans and credit: Loans, net of unearned income, were $15.0 billion at quarter-end, up 1.8% from December 31, 2016. The provision for credit losses increased to $4.8 million from $1.5 million, which management attributed largely to loan growth. Net charge-offs fell to $3.5 million from $6.9 million; annualized net charge-offs to average loans were 0.09% versus 0.20%. Non-performing assets were $143.4 million, or 0.75% of assets, compared with $148.1 million, or 0.82%, a year earlier. The allowance for credit losses was $172.6 million, or 1.15% of loans.
- Balance sheet and funding: Total assets were $19.2 billion, up 1.2% from year-end. Deposits were $15.1 billion, up 0.5%; shareholders’ equity was $2.15 billion. Total borrowings were $1.59 billion, up 8.2%, as long-term debt increased and short-term borrowings declined.
- Cash flow and liquidity: Operating activities provided $64.5 million; investing activities used $274.6 million, mainly reflecting loan growth and short-term investments; financing activities provided $185.1 million. Cash and due from banks decreased $24.9 million to $93.8 million. At quarter-end, Fulton reported $3.1 billion of additional FHLB borrowing capacity, $1.1 billion of federal funds line availability (with $54.4 million borrowed), and $1.2 billion of Discount Window availability with no borrowings.
- Capital: Fulton reported a 13.2% total capital ratio, 10.4% Tier 1 and common equity Tier 1 ratios, and a 9.0% Tier 1 leverage ratio. The company said it met fully phased-in minimum requirements, including conservation buffers; subsidiary banks exceeded the regulatory well-capitalized thresholds.
Material changes, outlook and commentary
- Management attributed higher earnings mainly to stronger net interest income and non-interest income, partly offset by higher credit-loss provision and operating expenses. Average interest-earning assets grew 6.4% year over year, principally through loan growth.
- Loan growth included commercial mortgages, commercial and industrial, residential mortgages and construction lending. Management cited improved customer sentiment, a more favorable economic outlook and additional commercial relationship managers.
- In March, Fulton issued $125 million of senior notes at a 3.60% fixed rate, maturing in 2022. Proceeds partly funded repayment of $100 million of 5.75% subordinated notes at maturity on May 1, 2017. Management estimated the transactions would reduce quarterly interest expense by approximately $300,000, with the full effect beginning in Q3 2017.
- No formal earnings or financial guidance is provided in the filing. Management cautioned that Q1 results are not necessarily indicative of full-year results. Its stated risk factors include economic and credit conditions, interest-rate and funding changes, competition, regulatory costs and restrictions, litigation, operational and cybersecurity risks, and the ability to execute growth plans.
Risks, contingencies and unusual items
- Regulatory matters: Fulton and its bank subsidiaries remained subject to consent orders related to identified BSA/AML program deficiencies. The company reported completing required retrospective reviews and continuing program enhancements; restrictions on certain expansion activities remain while the orders are in effect. Noncompliance could lead to further restrictions, fines or penalties.
- Fair-lending investigation: The Department of Justice expanded its investigation of potential lending discrimination to additional geographies and subsidiaries. Fulton said it was cooperating but could not reliably estimate the timing, resolution terms, potential penalties or remedial costs.
- Litigation: Fulton Bank is a defendant in the Agostino matter, in which plaintiffs allege liability connected to a customer’s alleged fraud and seek damages exceeding $11.3 million, plus other relief. The filing describes pending preliminary objections and says outcomes of proceedings may be unpredictable.
- Other exposures: Outstanding residential loan repurchase requests were approximately $543,000. Commitments to extend credit totaled $6.23 billion, with standby and commercial letters of credit of $357.3 million and $38.0 million, respectively. These off-balance-sheet commitments involve credit risk.
- Market and valuation risks: Available-for-sale securities had $53.1 million of gross unrealized losses at March 31, 2017; management attributed declines to interest rates rather than credit quality and said it did not expect to be required to sell before recovery. Auction-rate securities of $97.4 million are valued using a model that assumes market liquidity returns within five years. A single financial-institution equity holding represented 44.6% of the fair value of Fulton’s publicly traded financial-institution stock portfolio.
- Interest-rate sensitivity: The filing’s model estimated annual net interest income would increase 16.8% under a +300 basis-point shock and decrease 8.3% under a -100 basis-point shock. These are modeled scenarios, not forecasts; actual results may differ with customer behavior, competition and management actions.
Important facts for investors to verify
- Whether loan growth and the 3-basis-point year-over-year margin improvement continue, and how deposit and borrowing costs respond to rate changes.
- Whether credit quality remains stable, particularly in commercial and construction loans, and whether provision expense tracks portfolio growth and risk migration.
- Progress toward resolving the BSA/AML consent orders and DOJ fair-lending investigation, including any restrictions, remediation costs or financial penalties.
- Whether the estimated $300,000 quarterly interest-expense reduction from the debt refinancing is realized beginning in Q3 2017.
- Developments in the Agostino litigation, mortgage repurchase exposures, and the valuation and liquidity assumptions for auction-rate and other securities.
- The sustainability of fee-income growth, expense control and capital levels as Fulton pursues loan growth and its share-repurchase authorization.