Fulton Financial Corporation — 2011 Q2 Form 10-Q
Business context and period. Regional bank holding company; results cover the three and six months ended June 30, 2011, compared with the same 2010 periods. Balance-sheet comparisons are primarily with December 31, 2010. Unaudited interim results are not necessarily indicative of full-year results.
Key financial metrics
Dollar amounts below are in millions except per-share data and ratios.
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Net interest income | $140.6 | $139.2 | $280.2 | $277.7 |
| Net interest income, FTE | $144.6 | $143.0 | $288.2 | $285.5 |
| Net interest margin, FTE | 3.95% | 3.76% | 3.93% | 3.77% |
| Provision for credit losses | $36.0 | $40.0 | $74.0 | $80.0 |
| Other income | $47.4 | $44.9 | $93.5 | $83.2 |
| Other expenses | $102.5 | $101.1 | $204.0 | $201.1 |
| Net income | $36.4 | $31.7 | $70.2 | $59.2 |
| Diluted earnings per share | $0.18 | $0.14 | $0.35 | $0.27 |
- Q2 income before tax rose 15.3% to $49.5 million; first-half income before tax rose 20.1% to $95.7 million. Net income increased 14.8% and 18.6%, respectively. Common earnings comparisons also reflect preferred dividends and discount accretion in 2010, but none in 2011.
- Average net interest margin improved as funding costs fell faster than asset yields. Q2 average funding cost declined 41 basis points, while the average yield on earning assets fell 15 basis points. First-half funding cost declined 44 basis points versus a 21-basis-point decrease in asset yield.
- At June 30, total assets were $16.0 billion, down 1.9% from year-end; loans net of allowance were $11.6 billion, down 0.6%. Deposits were $12.3 billion, down 1.0%. Shareholders’ equity was $1.95 billion, up 3.9%.
- Allowance for loan losses was $266.7 million; including the unfunded-commitment reserve, total allowance for credit losses was $268.6 million, or 2.27% of loans. First-half net charge-offs were $80.9 million, annualized at 1.36% of average loans, versus 0.96% a year earlier.
- Cash and due from banks were $284.7 million; interest-bearing deposits with other banks were $125.0 million. First-half operating cash flow was $204.9 million, investing cash flow was $238.8 million, and financing cash flow was negative $358.0 million. Cash and due from banks increased $85.7 million during the period.
- Short-term borrowings were $546.6 million and FHLB advances and long-term debt were $1.03 billion. Regulatory capital ratios at June 30: total risk-based capital 14.8%, Tier 1 risk-based capital 12.3%, and Tier 1 leverage 9.9%. The company and bank subsidiaries met applicable minimums; bank subsidiaries exceeded “well capitalized” thresholds.
Material changes versus comparable periods
- Net interest income rose modestly despite lower interest income, as interest expense fell more sharply. Lower deposit pricing, a shift toward demand and savings deposits, and repayments of higher-cost FHLB advances supported the margin.
- Other income excluding securities gains increased 8.4% in both the quarter and first half. Mortgage banking and investment-management/trust income grew; higher transaction volumes lifted debit-card, merchant, and foreign-currency fees. Deposit service charges declined, including lower overdraft fees following regulatory changes.
- Provision expense declined, while net charge-offs increased: first-half net charge-offs rose 41.4% year over year. Nonperforming loans declined to $310.8 million from $316.9 million at June 2010, but nonperforming assets rose to $348.3 million from $342.6 million. Construction nonperforming loans improved, while commercial nonperforming loans increased.
- Construction loans fell 14.9% from year-end, reflecting paydowns exceeding originations and efforts to reduce exposure. Commercial mortgages and residential mortgages increased. Deposits shifted away from time deposits toward demand and savings accounts.
- Common dividends rose to $0.05 per share in Q2 from $0.03 a year earlier; first-half dividends were $0.09 per share versus $0.06.
Outlook, risks, contingencies, and unusual items
- No specific earnings or financial guidance is provided. Management cautions that interim results may not predict full-year results. Forward-looking risks include economic and real-estate weakness, credit deterioration, interest-rate and margin changes, funding-market disruption, regulatory developments, competition, and capital or liquidity needs.
- Effective April 1, the company revised its credit-loss allowance methodology, including more frequent impaired-loan evaluations, updated real-estate appraisals, and more granular pooled-loan analysis. The change shifted allocations among loan categories but did not change the total allowance; management considered the allowance adequate.
- Investment risks include $255.1 million of illiquid student-loan auction-rate securities (ARCs), classified as Level 3. About 80% were rated investment grade or better and 89% of underlying student-loan principal was federally guaranteed; all were current on scheduled interest. Fair value relies on an expected-cash-flow model and assumes a return to market liquidity within three years. The portfolio also includes below-investment-grade pooled trust preferred securities; first-half impairment charges on those securities were $1.4 million.
- The Dodd-Frank debit interchange pricing rules scheduled for implementation by October 2011 could reduce quarterly debit-card income: management estimated Q2 income of $4.6 million would have been approximately $2.2 million lower under the revised pricing guidelines.
- Mortgage repurchase reserves were $1.4 million, down from $3.3 million at year-end, following settlements with secondary-market investors. Management believes the reserve is adequate for known exposure but says further collateral declines or newly identified repurchases could require additional reserves.
- Commitments to extend credit were $3.85 billion; standby and commercial letters of credit totaled approximately $490 million. Management does not expect pending ordinary-course litigation to materially adversely affect financial position, results, or liquidity, but notes litigation outcomes are uncertain.
- Interest-rate sensitivity analysis indicated estimated annual net interest income increases of 1.8%, 5.7%, and 10.0% for upward shocks of 100, 200, and 300 basis points, respectively, and a 1.4% decrease for a 100-basis-point downward shock. These are modeled estimates, not guidance.
Most important facts for investors to verify
- Whether higher net interest margin can persist as asset yields continue to decline and deposits reprice.
- Whether rising net charge-offs, commercial-loan problem credits, and real-estate exposures result in further credit costs despite lower reported nonperforming loans.
- The valuation assumptions, liquidity prospects, ratings, and potential impairment exposure for ARCs and trust preferred securities.
- The earnings effect of debit interchange pricing changes and the sustainability of mortgage-banking and fee-income growth.
- The adequacy of mortgage repurchase reserves, the status of settlements, and any material developments in litigation or off-balance-sheet commitments.