Fulton Financial Corporation — Q2 2010 Form 10-Q
Business context and period. Fulton Financial is a Pennsylvania-based financial holding company. This unaudited report covers the three and six months ended June 30, 2010; comparisons are with the same periods in 2009 unless noted. Dollar figures below are in millions except per-share data.
Financial results and position
| Metric | Q2 2010 | Q2 2009 | First half 2010 | First half 2009 |
|---|---|---|---|---|
| Net interest income | $139.2 | $127.9 | $277.7 | $252.1 |
| Net interest margin, FTE | 3.76% | 3.43% | 3.77% | 3.44% |
| Provision for loan losses | $40.0 | $50.0 | $80.0 | $100.0 |
| Net income | $31.7 | $13.1 | $59.2 | $26.2 |
| Net income available to common shareholders | $26.6 | $8.1 | $49.0 | $16.1 |
| Diluted earnings per share | $0.14 | $0.05 | $0.27 | $0.09 |
- Revenue, margins and expenses. Q2 FTE net interest income rose 8.6%, as funding-cost reductions more than offset lower interest income; the net interest margin gained 33 basis points. Q2 other income was $44.0 million, down 3.1%, including lower mortgage-sale gains. Other expenses fell 7.1% to $100.2 million, partly reflecting the prior-year FDIC special assessment. First-half other income declined 11.8% to $81.4 million, including a $1.3 million net securities loss; expenses declined 6.9% to $199.4 million.
- Loans and credit. Loans net of unearned income were $11.94 billion at June 30, down slightly from $11.97 billion at year-end 2009. Commercial mortgage and residential mortgage balances increased, while construction lending contracted. The allowance for loan losses was $272.0 million; total allowance for credit losses, including unfunded commitments, was $280.4 million, or 2.35% of loans. First-half net charge-offs were $57.2 million, equivalent to 0.96% of average loans on an annualized basis.
- Asset quality. Non-performing assets rose to $342.6 million, or 2.06% of total assets, from $305.0 million at year-end 2009 and $292.2 million a year earlier. Non-performing loans were $316.9 million; growth in commercial mortgage and commercial loan problem credits was partly offset by lower construction non-performers. The filing also reports $57.7 million of modified troubled loans that were current on modified terms and excluded from non-accrual loans.
- Balance sheet, funding and liquidity. Total assets were $16.63 billion, essentially unchanged from year-end. Deposits increased to $12.35 billion; short-term borrowings fell to $458.3 million from $868.9 million, and FHLB advances and long-term debt declined to $1.37 billion from $1.54 billion. Cash and due from banks was $268.4 million, with a further $433.7 million in interest-bearing deposits at other banks. First-half operating cash flow was $150.5 million; investing activities used $37.5 million and financing activities used $129.1 million.
- Capital. Shareholders’ equity increased to $2.23 billion, supported by a May common-stock offering that raised $226.3 million net. At June 30, regulatory capital ratios were 16.8% total capital, 14.3% Tier I risk-based capital and 11.3% Tier I leverage. Excluding the Treasury preferred stock, the respective pro forma ratios were 13.8%, 11.3% and 8.9%.
Material changes and unusual items
- On May 5, 2010, Fulton issued 21.8 million common shares, raising $226.3 million net. The funds were temporarily held in short-term assets pending approval to redeem Treasury-held Series A preferred stock.
- On July 14, 2010, after quarter-end, the company redeemed all 376,500 preferred shares for $379.6 million, including $3.1 million of dividends. The $5.5 million preferred-stock discount was to reduce third-quarter net income available to common shareholders. Treasury still held warrants for up to 5.5 million common shares; Fulton said it intended to repurchase them at a negotiated price.
- First-half impairment charges on securities were $8.5 million, mainly $7.1 million on pooled trust preferred securities. The company held $276.5 million of illiquid student-loan auction-rate securities (ARCs), valued using a model; all were current on interest payments, and 88% of underlying student-loan principal was federally guaranteed, according to the filing.
- Commitments to extend credit were $3.88 billion, with $516.1 million of standby letters of credit and $36.1 million of commercial letters of credit. Potential repurchases of previously sold mortgage loans remain subject to uncertainty; management considered recorded reserves adequate but warned that further collateral declines or additional identified loans could require more reserves.
Outlook, commentary and risks
- The filing provides no numerical earnings or revenue guidance. Management said results for the interim periods are not necessarily indicative of full-year results.
- Management attributed improved earnings chiefly to lower funding costs, reduced loan-loss provisioning and lower FDIC expense. It also noted that mortgage refinance activity and related loan-sale gains had declined substantially.
- Credit risks include continued weak economic conditions, falling or weak real-estate values, rising commercial mortgage and commercial loan problem credits, and estimates used in collateral valuations and loss reserves. Commercial mortgage and construction loans represented approximately 43.7% of the loan portfolio.
- Market and funding risks include interest-rate changes, securities valuation and liquidity, and potential further impairments. ARCs and some trust preferred securities rely on significant unobservable valuation inputs. The modeled impact of a 100-basis-point rate increase was a 2.7% increase in annual net interest income; a 100-basis-point decline was estimated to reduce it by 0.3% under the filing’s rate-floor assumptions.
- Management identified possible future effects from Dodd-Frank implementation, including changes to capital, consumer-protection, governance, risk-management and deposit-insurance requirements. It said the impact could not yet be determined. FDIC premium increases and regulatory changes could adversely affect earnings.
Important facts for investors to verify
- Whether elevated non-performing assets—especially commercial mortgage and commercial loan exposures—and related charge-offs stabilize, and whether the $280.4 million credit-loss allowance remains adequate.
- How much of reported earnings improvement is repeatable after the lower funding-cost benefit, reduced provision, and prior-year FDIC and ARC-related charges.
- Whether ARC and trust preferred security valuations, assumptions, and future impairment exposure change, and whether liquidity in these holdings improves.
- The effect of the July preferred-stock redemption on capital, earnings per common share and funding costs, and the eventual price and terms of any Treasury warrant repurchase.
- Whether mortgage repurchase claims, unfunded lending commitments, regulatory reforms and FDIC assessments result in additional expenses or capital needs.