Fulton Financial Corporation
Q2 2013 Earnings Call Transcript

Published: 24 Jul 2013

[Operator:]

Good morning, ladies and gentlemen. Welcome to the Fulton Financial second quarter earnings conference call. This call is being recorded. I would now like to turn the call over to Laura Wakeley, Senior Vice President of Corporate Communications.

[Laura Wakeley:]

Good morning, and thank you for joining us for Fulton Financial Corporation's conference call and webcast to discuss our earnings for the second quarter of 2013. Your host for today's conference call is Phil Wenger, Chairman, President and Chief Executive Officer of Fulton Financial. And joining him is Charlie Nugent, Senior Executive Vice President and Chief Financial Officer. Our comments today will refer to the financial information included with our earnings announcement, which we released at 4

[E. Philip Wenger:]

Thank you, Laura. Good morning, everyone. Good to have you with us. I'd like to give you my thoughts on the quarter before Charlie reviews the financial highlights. When he concludes, we will be happy to take your questions. My remarks will focus on our performance relative to our corporate priorities. First of those is our earnings per share growth. We reported diluted earnings per share of $0.21 for the quarter, up $0.01 or 5% linked quarter and in comparison to the second quarter of last year. We increased our return on average assets by 1 basis point, 0.97%, and our return on tangible equity from 10.43% to 10.75%. You should know we have been deploying capital through periodic dividend increases, business lining investment and by repurchasing our shares in the open market at prevailing prices as permitted by security laws and other legal requirements, subject to market conditions. We extended our $8 million share repurchase program on June 18. Thus far, we have repurchased 6.4 million shares at an average cost of $11.11, leaving 1.6 million still available for repurchase up until September 30, 2013. While the loan growth contributed to our increase in net interest income and to our EPS growth this quarter, we were pleased to produce average loan growth of 2.2% or $271 million linked quarter. This was the third consecutive quarter of solid growth. Half of our portfolio growth came from existing relationships, half from new relationships. We had loan demand across all loan types with particularly good activity in C&I and commercial real estate. Of our $271 million loan growth, Pennsylvania provided $193 million, up 2.6%; New Jersey $24 million, up 1.1%; Maryland $11 million, up 0.6%; Virginia $22 million, up 2.2%; and Delaware $21 million, up 5%. Our current loan pipeline remains relatively strong, except that commitments scheduled to close in the next 90 days are on par with where we stood at the beginning of the second quarter. Along with our loan growth, which contributed to our net interest income and earnings per share growth this quarter, we saw further improvement in our asset quality. As a result, we reduced the provision by $1.5 million or 10%. We experienced a reduction in total loan delinquency of $10 million, from $285 million or 2.3% of total loans at the end of last quarter to $275 million or 2.18% as of June 30. Nonperforming assets declined to $210 million from $232 million, due in part to a $15.4 million reduction or nonperforming loan sale. Despite improved asset yields on new loans and lower funding costs, we experienced further margin compression in the quarter. Deposit costs fell 4 basis points as average non-interest-bearing demand deposits increased 5% linked quarter, while time deposits decreased by about the same amount. And Charlie will provide more details in his comments. The residential mortgage business also performed well during the quarter. Applications stood at $678 million at the end of the quarter compared to $701 million at the end of the first quarter. We closed 2,148 loans in the second quarter compared to 2,618 loans in the first quarter, with the rising interest rates and demand has slowed. Purchase activity increased from 37% to 52% of closed loans during the quarter, which was expected as rates increased and refinancing activity decreased. As we look into the third quarter for the mortgage business and assuming interest rates remain stable, we believe a decrease in net mortgage sale gains of up to 35% could be offset by lower amortization of mortgage servicing rights, an increase in our net investment portfolio interest income and lower costs. Another positive development this quarter was the over 10% linked quarter increase in noninterest income. We saw good linked quarter growth in branch and deposit account-related revenue along with an increase in investment management and trust services income. Other expenses were elevated this quarter, exceeding the range we provided in our last call. Expenses will likely remain elevated in the third quarter, and Charlie will provide more detail. I want to touch on our capital position relative to the recently released Basel III requirements. As we have stated and shown in our investor presentations, our capital ratios are currently well in excess of final Basel requirements. I'm also pleased to report that our core conversion project is progressing well, attribute to our people, their expertise, months of planning and extensive employee training. We have completed converting The Columbia Bank, Fulton Bank of New Jersey and LaFayette Ambassador Bank. Swineford National Bank, FNB and Fulton Bank are scheduled for completion by the end of August. To sum up the quarter, the exception of expenses, we performed well against our corporate objectives, earnings per share growth, quality loan growth, asset quality improvement, spread management, core deposit growth, return on assets and return on equity. With respect to expenses as we have reported, we've experienced overall increases over the past 18 months related to our core conversion, regulatory compliance, risk management and other technology upgrades. We view these as important and investments that will better position the company for the future. Now I will turn the call over to Charlie for his financial discussion, and then we will be happy to respond to your questions. Charlie?

[Charles J. Nugent:]

Yes. Thank you, Phil, and good morning, everyone. As Phil mentioned, we reported net income of $0.21 per share for the second quarter, which is a $0.01 or 5% improvement from the first quarter. Net income increased 3.5% to $40.6 million in the second quarter from $39.2 million in the first quarter. My comments are based on comparisons of this quarter's results to the first quarter. The improvement in our net income resulted from increases in both net interest income and noninterest income and a decrease in the provision for credit losses. These improvements were partially offset by higher noninterest expenses and income tax expense. Net interest Income increased $2.4 million or 1.9%. This improvement was aided by a $1.5 million increase in interest recoveries and calls on debt securities and an $819,000 decrease in premium amortization on mortgage-backed securities and collateralized mortgage obligations as prepayments slowed. 1 more day in the quarter also generated an additional $1.1 million of net interest income. Our net interest margin declined 3 basis points to 3.52%. The decline would have been 7 basis points to 3.48% excluding the increased interest recoveries and the calls on debt securities. Average interest-earning assets grew $275 million or 2%. Average yields on interest-earning assets decreased 6 basis points, while average cost of interest-bearing liabilities declined 4 basis points. The average yield on new loans generated during the second quarter was approximately 15 basis points higher than loans originated in the first quarter. Our projections forecast at our core margin compression will continue in the third quarter of 2013, with a net interest margin expected to be in the range of 3.40% to 3.45%. Noninterest income for the second quarter increased $4.7 million or 10.4% excluding the impact of security gains. Mortgage banking income increased $2.8 million or 35% with mortgage sale gains growing $339,000 or 4%, mainly due to higher spreads. Mortgage servicing income increased $2.5 million. In the second quarter, we reversed $2 million in the valuation allowance on mortgage servicing assets as the value of the portfolio improved with increasing rates. In addition, amortization decreased $380,000 as prepayments slowed. Service charges on deposits and other service charges and fees experienced a seasonal increase in comparison to the first quarter. In the second quarter, net security gains were $2.9 million as compared to $2.5 million in the first quarter. During the quarter, realized gains included $1.8 million on the sale of debt securities and $1.1 million on the sale of bank stocks. Net security gains are consisted almost entirely of a single trust preferred security that was previously written down but experienced recent recovery in value. Our bank stock portfolio had $6.6 million of unrealized gains at June 30, and we will continue to realize gains when we consider appropriate. Noninterest expense increased $6.2 million or 5.6%. Total salaries and benefits expenses grew $2.3 million or 3.7%. Salaries increased $1.7 million due to normal increases and growth in staffing levels. Stock compensation expense increased $1.5 million as a result of the annual grant of stock awards. These increases were partially offset by a seasonal decrease in payroll taxes. Our other outside services expenses increased $2.5 million or 86% due mainly to the timing of consulting engagements related to regulatory compliance and risk management activities. As Phil mentioned, during the second quarter, 3 of our 6 subsidiary banks converted to our new core processing system. Total implementation expenses related to these conversions were approximately $1.2 million as compared to $340,000 in the first quarter. These expenses in the second quarter were included in our other outside services, marketing, salaries and benefits and other expenses. We expect to incur $1.4 million in implementation expenses when the 3 remaining banks convert in the third quarter. The conversions also contributed to a $606,000 increase in data processing expenses and a $346,000 increase in software expenses. Our internal projections indicate that our total noninterest expenses should be the range of $114 million to $118 million for the third quarter of 2013. However, certain expenses such as other real estate and repossession expenses, mortgage repurchase losses, operating risk loss and outside services can experience volatility based on timing or events that cannot always be reasonably predicted. Such volatility could result in expense levels being higher or lower than projected. Our effective income tax rate was 24.5% in the second quarter as compared to 23% in the first quarter. Our projections indicate that our annual effective tax rate will be in the range of 24% to 26%, and quarterly rates will vary based on the timing of credits and deductions and the level of pretax income. Thank you for your attention and for your continued interest in Fulton Financial Corporation. Now we'll be glad to answer your questions.

[Operator:]

[Operator Instructions] And we'll take our first question from Bob Ramsey with FBR.

[Thomas Frick:]

This is actually Tom for Bob. I just wanted to touch on your -- your loan balances, again, were very strong with the growth this quarter, and especially your HELOC balances have been increasing nicely over the last several quarters, up 4.2% this quarter, and that seems counter to the trend that we're seeing in the fed data. And it gets down about 8% year-over-year. Can you talk a little bit about what you're seeing there in terms of the trends?

[E. Philip Wenger:]

Well, we did -- we are running a special on HELOCs in the quarter, and I think that helped us quite a bit. And I do think we are seeing some slowdown now in that activity.

[Thomas Frick:]

Again, is that a function of just no longer running specials and less demand as a result? Or do you think that's just lower demand overall?

[E. Philip Wenger:]

Well, it's, I would say, primarily a function of not having specials.

[Thomas Frick:]

Got you. Okay. And then kind of switching gears on the expense line, the $2.5 million increase you experienced on outside service related to the regulatory compliance, I mean, can you kind of expand on exactly what that was? And is that going to be kind of a recurring expense going forward or maybe once a year?

[Charles J. Nugent:]

Phil?

[E. Philip Wenger:]

Well, I will first say that I think it will be -- it can and probably will be volatile. So we're looking at all our processes within the company. The new regulatory environment and the new regulations in general are driving costs up in that area. And I think we are trying to examine throughout the company whether it's on a compliance side or the commercial loan processing side, how we can drive costs out through improving our processes.

[Thomas Frick:]

Okay, great. And then final question, and I'll hop back out. But obviously, mortgage banking was strong this quarter. A lot of that has to do with the MSR markup. Can you tell me what your gain on sale margin was this quarter and actually, what the change in origination volumes were as well?

[Charles J. Nugent:]

Yes, the margin was -- in the second quarter was 1.71%, and it was down from 1.62% from the first quarter. So that was a 6% decrease in spread, and the volume dropped 4%, it went from $514 million in the first quarter to $491,000 in the second quarter.

[E. Philip Wenger:]

[indiscernible]

[Charles J. Nugent:]

Oh, I'm sorry, the margin went up.

[Thomas Frick:]

Oh, the margin went up, you said?

[Charles J. Nugent:]

Yes, I'm sorry. Went from 1.62% to 1.71%.

[Operator:]

We'll take our next question from Casey Haire with Jefferies.

[Casey Haire:]

Question on the NIM guide. I'm a little surprised to hear not as the -- not a little bit better just given probably better reinvestment risk, reinvestment rates in the securities book and presumably better repricing risk in the CRE book. I'm just curious, what -- is loan pricing competition getting worse? What's sort of driving the pressure here?

[Charles J. Nugent:]

Well, Casey, we expect continued pressure, but we expect less. I think you can -- I hope you can tell that from the guidance, but the reinvestment rate in the investment portfolio is getting closer. It's coming off at a 2.74%. That's what it came off in the second quarter. And the reinvestment rate has gone from -- for the mortgage backs and CMOs that we bought, have gone from about 1.70% to 2.40%, 2.45%. So that's helping. Also, the -- as you mentioned in the script that our loan rate of new loans being put on were up 15 basis points, but there's still a big differential between -- it's getting closer, but the loans coming off -- were coming off at a 4.41%, and loans were going on with 3.64%. So I mean, there's still going to be a little compression in our minds nonetheless.

[E. Philip Wenger:]

Casey, just to add to that, there still is pressure because the assets that are running off are at a higher rate than what we're putting on. But just to give you an example, a year ago, the loans that were running off were yielding 110 basis points more than the loans we are putting on. And now that differential is down to 60 basis points. The same kind of phenomena is happening on the investment side, and they are getting actually very close to being the same rate. So we're going to continue to have pressure, but it is easing some.

[Casey Haire:]

Okay. The NIM guide, does it contemplate any further easing on the funding costs in the CD book?

[E. Philip Wenger:]

Yes, it does. The -- when we did our projections, we were assuming that -- and this is very accurate. We were thinking in the third quarter, we had $660 million of CDs rolling off at average cost -- weighted average cost of 87 basis points, and we were holding those in the second quarter at about 35. So we expect funding costs to continue to go down.

[Casey Haire:]

Okay. And then just switching to expenses, obviously, kind of a lot of moving parts here with the conversion and the system upgrade. And appreciate why there can be some elevated expense run rate going in the third quarter. But I was just curious, what kind of efficiencies can we expect once you get the charters consolidated and the system upgrade? Like what kind of run rate, what kind of -- how much leverage can we get from that 115 [ph] to 118 [ph] beyond third quarter?

[E. Philip Wenger:]

Well, I -- just to clarify one point, Charlie, we have not made any statement that we are consolidating our charters. So we are looking at everything in the company, but we have not made any statements that charters will be consolidated. Our efficiency ratio has gone up, and long term, our goal is to be in the first quartile of our peers from an efficiency standpoint. And we have been for years. We've moved through the second quarter, and when we get through some of these things that we're going through right now, our goal will be moved to be -- to move back to the first quartile.

[Operator:]

We'll take our next question from Frank Schiraldi with Sandler O'Neill.

[Frank Schiraldi:]

Just a couple of questions. First, on premium amortization in the securities book, I wonder if you could talk a little bit about -- just given where rates have gone, you're thinking that if this sort of yield curve environment holds up through the next quarter that we could see perhaps additional significant reduction in this quarterly amortization rate? And is that baked into margin expectations?

[E. Philip Wenger:]

That is right. The premium amortization's going down. In the first quarter, it was $4.1 million, and the second quarter, it was $3.3 million. And it went down quite a bit in May because the tenure rate went up to -- it went from a 1.63% low, and then it started going up to, I think, it's 2.57% today. I mean, that's going to result in continued reduction in that premium amortization, and that's baked into our numbers.

[Frank Schiraldi:]

Is there any way to, I mean, just sort of normalize that? Or is that too difficult to do to think about what those levels could be going forward?

[Charles J. Nugent:]

I think if you go back, maybe 18 months ago, it was 1.80% a quarter, 1.8% a quarter compared to 3.3% now.

[Frank Schiraldi:]

Got you. Okay. And then just going back to expenses, I wondered maybe -- if you could just the consulting costs or the increasing consulting costs in the quarter, do you look at that as more of a timing issue? Or is it likely in your minds that we would see similar levels next quarter and in the coming quarters?

[E. Philip Wenger:]

Yes, partly, Frank. It's -- it is partly timing, and I think that it's possible it could go down. I think we did accelerate a few things that we were working on just trying to accelerate all these processes that we're looking at. So over time, we think it's going to go down.

[Frank Schiraldi:]

Okay. But it's still, I guess, just as volatile in terms of quarter-to-quarter?

[E. Philip Wenger:]

It can be, yes.

[Frank Schiraldi:]

And then finally, on expenses, just the completion of the core processing change over, I guess, the NIM in the third quarter, I think Charlie had said $1.4 million in the third quarter should be the result of that. And those are sort of onetime fees, so we should expect that to just -- that $1.4 million to flow out for 4Q, all else equal?

[Charles J. Nugent:]

Yes, I would think -- yes, I think in the fourth quarter, you'd have a significant reduction in that. That would be most -- so we did -- have completed all the conversions, and most of the implementation costs will be behind us.

[E. Philip Wenger:]

And then just to be clear, Frank, our recurring costs are due to lump sum. So I think the net effect for the quarter should be down, but the net will not be the full $1.4 million because we have some increases then in recurring costs.

[Frank Schiraldi:]

And have you -- I believe you've given an annualized cost for that recurring cost going forward. Is that around $1 million or so or maybe a bit higher annually?

[E. Philip Wenger:]

Well, I think that's about the quarterly. The annual is about $3.4 million.

[Operator:]

[Operator Instructions] And we'll take our next question from Chris McGratty with KBW.

[Christopher McGratty:]

So I just wonder if I could start with the buyback real quick. You guys mentioned in your prepared remarks that you have about $1.6 million left on the current authorization. So I wonder if there's any conversations or update on -- after September 30, thoughts on additional buyback authorization.

[E. Philip Wenger:]

Yes, we look -- we'll talk about that at the September board meeting.

[Christopher McGratty:]

Okay. And then so, last call, you mentioned that the priority list was the core conversion and then a greater focus on M&A. After the progress you guys had this quarter and with the end in sight next quarters, have you guys started looking more at M&A? Is -- any change in that thought process or updates on that front?

[E. Philip Wenger:]

Well, we are very pleased with how the quarter is progressing, and so we feel much better. And I mean, there is not a whole lot of discussion out there right now on M&A, but as we get through it, I think our interest will increase.

[Christopher McGratty:]

Okay. And then just one last one for me. On -- in terms of rates, can you guys remind us how much your loan portfolio is fixed for versus variable [ph], and also maybe what part of the curve you guys have the most exposure to?

[E. Philip Wenger:]

The part of the curve we have the most exposure to is mature, and we have $3.9 billion of our loans repriced based on prime. There is $1.8 billion that repriced based on LIBOR, and there's another $3.9 billion that repriced based on -- they were adjustable over 5-year period, and most of that -- I'd say 50% of that's in the first 2 years.

[Operator:]

We'll take our next lesson from Nicholas Karzon with Crédit Suisse.

[Nicholas Karzon:]

I guess to start, it looks like the securities portfolio took a step up at the end of the second quarter. And I was wondering how we should think about balances there going forward with the kind of the deposit environment that we're in?

[Charles J. Nugent:]

Yes, we were down on average $22 million, but point to point we were up $103 million, and a lot of that had to do with the spike in rates. And when the rates went up, we tried to take advantage of that and buy some securities. Going forward, I -- the reinvestment of the cash flow is -- probably won't be as high as it was in the past due to our good loan demand. So we're happy to see that.

[Nicholas Karzon:]

Got it. And on the trust on investment management revenue, I guess in the past, it's taken a step down 3Q versus 2Q. Is this driven by tax planning and advising revenue that's a kind of a 2Q event? And should we expect similar seasonality this year?

[E. Philip Wenger:]

I think in general, it would be because a lot of people are on vacation in the summertime. And so a lot of the increases have been on the brokerage side, and it just tends to slow down in July and August.

[Nicholas Karzon:]

Got it. And one final question. I think you reduced your guidance kind of on the effective tax rate going forward, from 25% to 27%, to 24% to 26%. And I'm wondering what drove the change there and also if you can give us the dollar amount of any perpetual benefits that you receive on the tax side.

[Charles J. Nugent:]

The -- we've had some deferred tax assets. We had valuations against that, and that was on state taxes. And we reduced the valuations, and so that helped move up the rate. And the -- we have a very low effective tax rate. A lot of that's driven by the municipal securities. It -- we have about $280 million. Also, we have a lot of credits related to low-income housing and certain market tax rates when you support housing in certain areas. So that's the primary reason. The 2 primary reasons for that -- the low tax rate is tax credits and then municipal portfolio.

[Nicholas Karzon:]

And then I guess just if you can provide any color in terms of capital deployment, I guess, with the -- with your plan at the end of the first quarter to complete the 8 million share repurchase in the first half. You extended that into the third quarter. I just kind of wonder if you can give any color on the decision there and what drove that.

[E. Philip Wenger:]

Well, as far as not completing it during the quarter, we -- when we're repurchasing stock, we try to do it in a way that does not affect the market price. And during the last 10 days of the quarter, I don't know if you picked this up or not, but during the last 10 -- not at the quarter but the last 10 days before our blackout period started, the volume in our stock dropped off quite a bit as the -- I think the average volume during that period was 260,000 shares a day less than it had been. And we really felt like if we would have gone into the market at that time, it would artificially drove the price up. And that's what we try to avoid. That is the primary reason why the 8 million was not completed, and our goal is to try to complete it this quarter.

[Operator:]

And with no further questions, I'd like to turn the call back over to Phil Wenger for any additional or closing remarks.

[E. Philip Wenger:]

I'd like to end this call by thanking everyone for joining us today. We hope you will be able to be with us when we discuss third quarter results in October. Thank you.

[Operator:]

This concludes today's conference. Thank you for your participation.