Fulton Financial Corporation — Q3 2017 Form 10-Q
Business context and period: Regional financial holding company serving Pennsylvania, Delaware, Maryland, New Jersey and Virginia. This unaudited filing covers the three and nine months ended September 30, 2017; comparisons below are with the corresponding 2016 period unless otherwise noted.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income | $146.8 million | $130.6 million | $426.0 million | $388.5 million |
| Net interest margin, FTE | 3.27% | 3.14% | 3.27% | 3.19% |
| Net income | $48.9 million | $41.5 million | $137.8 million | $119.5 million |
| Diluted earnings per share | $0.28 | $0.24 | $0.78 | $0.69 |
| Non-interest income | $52.0 million | $48.1 million | $151.0 million | $137.4 million |
| Non-interest expense | $132.2 million | $119.8 million | $387.1 million | $361.9 million |
| Provision for credit losses | $5.1 million | $4.1 million | $16.6 million | $8.2 million |
Net income increased 17.9% in Q3 and 15.3% year to date. Return on average assets was 0.98% for Q3 and 0.95% year to date, versus 0.89% and 0.87%. The efficiency ratio improved to 64.3% for Q3 and 64.6% year to date, from 65.2% and 67.0%.
- Balance sheet at September 30: Total assets were $20.06 billion, up 5.9% from December 31, 2016. Loans, net of unearned income, were $15.49 billion, up 5.4%; deposits were $16.14 billion, up 7.5%.
- Funding and debt: Short-term borrowings were $298.8 million and long-term debt $1.04 billion. Total borrowings of $1.34 billion were down 9.1% from year-end 2016. The company issued $125 million of senior notes in March and repaid $100 million of subordinated notes at maturity in May.
- Liquidity and cash flow: Cash and due from banks were $99.8 million, with interest-bearing deposits at other banks of $582.8 million. For the first nine months, operating cash flow was $194.4 million, investing cash flow was negative $1.16 billion, and financing cash flow was positive $945.7 million. Cash and due from banks declined $19.0 million.
- Credit quality: The allowance for credit losses was $174.7 million, or 1.13% of loans, versus 1.17% at year-end. Nine-month net charge-offs were $13.2 million, or 0.12% of average loans annualized, compared with 0.14% in 2016; Q3 charge-offs were higher year over year at 0.14% versus 0.11%. Nonperforming assets were $147.0 million, 0.73% of assets, versus $150.1 million and 0.80% at September 2016.
- Capital: At September 30, total capital was 13.1%, Tier 1 capital 10.4%, common equity Tier 1 10.4%, and Tier 1 leverage 9.0%. The company reported meeting fully phased-in minimum capital requirements, including the conservation buffer; bank subsidiaries exceeded “well capitalized” thresholds.
Material changes and management commentary
- FTE net interest income rose 12.5% in Q3 and 9.8% year to date, driven mainly by growth in interest-earning assets and higher net interest margin. Average loans increased 8.3% in Q3 year over year; commercial and residential mortgage lending were key contributors.
- Higher deposit costs partly offset asset-yield improvement as interest rates rose. Q3 average deposit cost increased to 0.40% from 0.31% a year earlier.
- Non-interest income excluding securities gains declined 1.6% in Q3, largely because commercial loan interest-rate-swap fees and mortgage loan sale gains fell. Year to date, that measure increased 5.5%, supported by trust and mortgage servicing income.
- Investment securities gains were $4.6 million in Q3 and $7.1 million year to date, mainly from sales of financial institution common stocks. These gains were substantially above the comparable 2016 periods.
- Non-interest expense rose 10.3% in Q3 and 7.0% year to date. Drivers included compensation, technology and outside services, and tax-credit investment amortization. The amortization was classified as expense rather than income tax expense in 2017; management said this presentation change did not affect net income.
- The provision rose year over year, which management attributed mainly to loan growth and normal changes in portfolio risk characteristics; management described credit metrics as generally stable. The unallocated allowance was eliminated after methodology enhancements incorporated relevant factors into the allocation process.
Outlook, risks and unusual items
- The filing provides no specific earnings or financial guidance. Management cautions that nine-month results are not necessarily indicative of full-year results.
- Interest-rate sensitivity modeling estimated annual net interest income would increase 5.4% under a +100 basis-point shock, 10.6% under +200 basis points, and 15.5% under +300 basis points, and decline 8.1% under a -100 basis-point shock. These are model estimates subject to assumptions about rates, customer behavior, and balance-sheet changes.
- Three bank subsidiaries’ OCC BSA/AML consent orders were terminated on October 27, 2017. Other regulatory orders were described as remaining in effect; they restrict certain expansion activities, and noncompliance could lead to further restrictions, fines, or penalties.
- A Department of Justice fair-lending investigation, covering lending activity from 2009 onward and expanded to additional geographies and subsidiaries, remained unresolved. The company said it could not reliably estimate any potential settlement, penalties, or remedial costs.
- The Bank agreed to settle the Agostino litigation, which alleged more than $11.3 million in damages plus other relief. The insurer indicated it would reimburse the full settlement payment; effectiveness depended on court dismissal of the claims.
- Other disclosed risks include credit deterioration, interest-rate and funding pressures, regulatory and legal matters, operational and cyber risks, competition, and execution of growth plans. The filing reported no material change to previously disclosed risk factors.
Important facts for investors to verify
- Whether loan growth and improved net interest margin continue to outweigh rising deposit funding costs.
- Credit trends, especially commercial loan downgrades, construction-loan delinquencies, and the increase in Q3 annualized net charge-offs.
- How much earnings depend on securities gains and mortgage servicing valuation changes versus recurring fee income.
- Resolution and potential consequences of the fair-lending investigation, remaining BSA/AML orders, and the Agostino settlement’s court dismissal and insurance reimbursement.
- Liquidity and capital implications of continued loan growth, deposit mix changes, and regulatory requirements.