Fulton Financial Corporation
Q3 2013 Earnings Call Transcript

Published: 23 Oct 2013

[Operator:]

Good morning, ladies and gentlemen. Welcome to the Fulton Financial Corporation's Third Quarter Earnings Call. This call is being recorded. I would now like to turn the call over to Laura Wakeley, Senior Vice President of Corporate Communications. Please go ahead.

[Laura Wakeley:]

Thank you, and good morning, everyone. Thanks for joining us for today's conference call and webcast to discuss our earnings for the third quarter of 2013. Your host for today's call is Phil Wenger, Chairman, President and Chief Executive Officer of Fulton Financial. And joining Phil 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, and good morning, everyone. We are pleased to have you join us. I will briefly touch on the highlights this quarter, and Charlie will review the financial details. Then we will both be happy to take your questions. We reported diluted per share earnings of $0.21, unchanged from the second quarter and from the same period last year. Our return on average assets for the quarter came in at 0.93%, and our return on tangible equity was 10.69%. We were pleased to see loans grow by $200 million or 1.6%, representing the fourth consecutive quarter of strong growth. On an ending balance basis, our loan portfolio has grown by approximately $652 million or 5.4% since December 2012. Our largest increase this quarter came in the commercial mortgage category followed by home equity and residential mortgages. The Pipeline has been strong throughout 2013. And the strength of our current pipeline provide a foundation for continued earning asset growth, although it has weakened slightly going into the fourth quarter. Of our $200 million loan growth, $80 million came from Pennsylvania, $38 million from Maryland, $31 million from Virginia, $30 million from New Jersey and $21 million from Delaware. 53% of our growth came from new customers and 47% from existing customers. Asset quality has been consistently improving. This quarter was no exception. We experienced a decrease in nonperforming loans of $21 million or 11%, which gave us the opportunity to lower the provision by $4 million to $9.5 million for the quarter. Total loan delinquency decreased $23 million from $275 million, or 2.18% of total loans at the end of last quarter to $252 million or 1.97% as of September 30. This is the lowest level of loan delinquency we have seen since the first quarter of 2008. Nonperforming assets also fell to $186 million from $210 million, partly due to a $16.4 million of loan sales as well as a decrease in new noncore loans. We are particularly pleased to report that the $22 million inflow into nonaccruals this quarter, down from $38 million last quarter, is the lowest we have seen since before the economic downturn. Our residential mortgage activity was as expected, impacted by higher rates. We closed 1,848 loans this quarter, compared to 2,148 last quarter. For September 30, our mortgage pipeline stood at $200 million, down from $368 million at the end of the second quarter. 63% of that total was purchase, 37% refinancing. The third quarter also saw the completion of our $8 million -- 8 million share stock repurchase program. Since we began repurchasing our stock in the third quarter of 2012, we have bought back a total of 10 million shares at an average cost of $11 per share. We also completed our 3-year conversion project to a new core processing system. Each of the conversions went very smoothly with virtually no adverse impact on our customer base. While this particular project is successfully behind us, our investment in technology throughout all of our delivery channels remains an ongoing commitment. Pressure on our net interest margin continued this quarter, but to a less extent than in prior quarters. Total interest-earning asset yields decreased at a faster pace than the cost of total interest-bearing liabilities. However, our margin decreased by only 3 basis points on a normalized basis, and Charlie will give you more details on the margin in his comments. The slowdown in residential mortgage banking and resulting lower sales gains impacted our noninterest income. There was also a pressure on service charges and deposit account-related revenue this quarter. Generally, our noninterest income line has held up well throughout 2013 despite a number of regulatory changes. The bright spot has been our investment management trust services income, which is up about 9% year-over-year. Other expenses fell slightly linked quarter and near the middle of the range we gave you on our last call. As we have emphasized, expense line items can and will be volatile. Outside services and professional fees remain elevated. Like many of our peers, we have engaged outside assistance in the areas of stress testing, new mortgage rules, Bank Secrecy Act and compliance among others. We remain intent on building out our risk management compliance and technology infrastructures in order to position us for future growth and to proactively meet higher levels of regulatory expectations. In addition, we recently undertook a comprehensive review of our expense structure and have identified a number of areas for cost reduction. These reductions are intended to control expenses throughout the corporation. I'm not prepared to discuss specifics at this time, but plan to do so as these decisions are implemented. So to summarize the quarter in light of our corporate objectives, we were pleased with our reported EPS, our loan growth, the improvement in our asset quality and our ability to manage the net interest margin. One of our priorities is to continue to deploy capital prudently. Yesterday, we announced a new share repurchase program of up to 4 million shares or 2.1% of our stock through March 31, 2014. These shares will be repurchased in the open market at prevailing prices as permitted by security laws and other legal requirements and subject to market conditions. At this point, I would like to turn the call over to Charlie to review the financial details. Then we will both be happy to respond to your questions. Charlie?

[Charles J. Nugent:]

Okay. Thank you, Phil, and good morning, everyone. Thank you for joining us today. As Phil mentioned, for the third quarter, we reported net income of $0.21 per share, which is the same as the second quarter. Net income decreased 1.6% to $39.9 million in the third quarter from $40.6 million in the second quarter. My comments are based on comparisons of this quarter's results to the second quarter. Reduction in net income resulted from the decline in noninterest income, conceding the combined impact of an increase in net interest income and decreases in the provision for credit losses and noninterest expenses. Net interest income increased $468,000 or approximately 0.5%. This improvement resulted from growth in -- interest-earning assets, an additional day in the third quarter and a $394,000 decrease in premium amortization on mortgage-backed securities and collateralized mortgage obligations. These improvements were partially offset by $1.8 million decrease in interest income received from recoveries and calls on debt securities from the second to the third quarter. Our net interest margin declined 7 basis points to 3.45%, as compared to 3.52% in the second quarter. The second quarter net interest margin would have been 3.48%, excluding interest recoveries and calls on debt securities. A normalized decrease was approximately 3 basis points. Average interest-earning assets grew $239 million or 1.5%. The average yield on interest-earning assets decreased 11 basis points, while the average cost of interest-bearing liabilities declined 4 basis points. The average yield on new loans originated during the third quarter was approximately 11 basis points higher than on loans originated in the second quarter. Average deposits increased $186 million or 1.5%, net effect of the $290 million increase in demand and savings account balances and a $104 million decrease in time deposits. The growth in demand and savings accounts reflected a seasonal increase in the municipal accounts, as well as increases in business accounts. Our projections forecast at core margin compression will continue in the fourth quarter, with a net interest margin expected to be in the range of 3.39% to 3.44%. Noninterest income for the second quarter increased $4.7 million or 9.6%, excluding the impact of security gains. Mortgage banking income decrease $3.9 million or 35%, mortgage sale gains declining $4.2 million or 49% and mortgage servicing income increasing $347,000 with [indiscernible]. The impact of higher long-term interest rates resulted in the 41% decline in new loan commitments and a 24-basis point decrease in spreads. The increase in servicing income resulted from a $550,000 decline in the amortization of mortgage servicing rights as prepayments slowed. This is partially offset by a $300,000 decrease in MSR valuation allowance reversals, which totaled $1.7 million in the third quarter, as compared to $2 million in the second quarter. Service charges on deposits decreased $713,000 or 4.9%, as overdraft fees declined $432,000 and other deposit service charges declined $312,000. In the third quarter, net security gains were $2.6 million, as compared to $2.9 million in the second quarter. During the third quarter, realized gains included $2.1 million on sales of bank stocks and $500,000 on sales of debt securities. The bank stock portfolio had $8.3 million of net unrealized gains at the end of the third quarter, and we will continue to realize gains when considered appropriate. Noninterest expense decreased $525,000 or 0.4%. Loan repurchase losses grew by $1.9 million. And this increase, however, was more than offset by $584,000 decrease in state taxes, a $490,000 reduction in other real estate expenses, and a $1 million decline in lending-related expenses. Other outside service expenses decreased $267,000 or 5%, due mainly to the timing of consulting engagements related to regulatory compliance and risk management activities. As Phil mentioned, during the quarter, the final 3 of our 6 subsidiary banks converted to our new core processing systems. Total implementation expenses related to these conversions were approximately $1.6 million, as compared to $1.2 million in the second quarter and $340,000 in the first quarter. These expenses in the third quarter were included in other outside services, marketing, salaries and benefits and other expenses. Our internal projections indicate that our total noninterest expenses should be in the range of $114 million to $118 million for the fourth quarter. However, certain expenses such as other real estate owned, 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 longer than projections. Our effective income tax rate was 25.7% in the third quarter, as compared to $24.5 million (sic) [24.5%] in the second quarter. Our projections indicate that our annual effective tax rate will be in the range of 24% to 26%. Quarterly rates will vary based on the timing of credits and deductions in the level of pretax income. Okay. Thank you for your attention and for your continued interest in Fulton Financial Corporation. And now, we will be glad to answer your questions.

[E. Philip Wenger:]

Before I end today's call -- I'm sorry. Questions?

[Operator:]

[Operator Instructions] And we'll take our first question from Casey Haire with Jefferies.

[Casey Haire:]

So quick question on the provision outlook, it seems like credit migration trends are fair -- favorable, and loan growth remains positive, but wheezing a little bit. Is it safe to say that provision can run at this low level going forward?

[E. Philip Wenger:]

From what we see right now, Casey, I think it is fair to say that, yes. It certainly would be subject to change, but that's what we see right now.

[Casey Haire:]

Okay. And the loan loss reserve ratio at 1 7, I know it's mix dependent, but I mean, is it safe to say you're not going to let that go below precrisis levels?

[E. Philip Wenger:]

Well, definitely not below precrisis levels, which were too low. So I think we were under 1 at one point, very close to 1. So I don't anticipate we will get that low. We do think that it has room to come down.

[Casey Haire:]

Okay. And then just switching to mortgage banking. X the MSR write-up that the run rate was pretty much cut in half this quarter. Is that the right way to think about that line going forward? Or is there room for more MSR write-ups in the future?

[E. Philip Wenger:]

The ongoing MSRs are stronger than they were prior, but I don't think we'll have more write-ups on MSRs.

[Operator:]

We'll take our next question from Bob Ramsey with FBR.

[Bob Ramsey:]

I probably missed it, Charlie, but did you give sort of an expected range for fee income in the fourth quarter?

[Charles J. Nugent:]

No, we didn't.

[Bob Ramsey:]

Okay. Any way to think about it either in total or at least how you're thinking about the mortgage banking line, excluding MSR write-ups sort of what's going on with the origination side of business?

[E. Philip Wenger:]

Well, our backlog -- our pipeline going into the fourth quarter is lower than what it was going into the third quarter.

[Bob Ramsey:]

Okay. And I guess, the pipeline, you all gave these numbers as down 45-ish percent. I mean, is that a good proxy for what's going to happen to origination income? Have margins stabilized, do you think?

[E. Philip Wenger:]

Well, Bob, like we say every quarter, these -- the mortgage numbers change really quickly depending on rates. But we have seen a refinancing activity continue to drop off. So I'm trying to -- yes, the pipeline going into the quarter was at $200 million. And going into the third quarter, it was $368 million.

[Bob Ramsey:]

Okay. Shifting to loan growth, you guys obviously had really, really tremendous commercial real estate growth this quarter. Just curious if there's anything unusual, if there's any area of CRE that seems to be growing faster than others, or sort of what some of the qualitative thoughts are around the commercial loan growth you guys had this quarter?

[E. Philip Wenger:]

The commercial mortgage growth, Bob, so much of that is just timing. And I'd say we had 3 or 4 larger deals that happened to settle in the quarter to drive that. The same thing can happen on the C&I side. You will get a couple of large deals to drive that also, but I don't think anything outside of that.

[Bob Ramsey:]

Okay. Is it -- I guess, if I sort of look over the last year, maybe it's from some of timing or the strong quarters and weak quarters but you think it's -- that it's reasonable to expect total loan growth will continue to be in kind of a mid- to high-single-digit range as we go forward on an annualized basis or year-over-year basis?

[E. Philip Wenger:]

I think for this year, at this point, I'd say we're looking in between the 6 and probably 7.5. And just based on what we see right now, I'd say we think that could be possible again next year.

[Operator:]

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

[Frank Schiraldi:]

Just a couple of questions. First, on expenses. It seems like some of these expense builds are certainly behind you. And Phil, you even talked about some potential saves up and coming, which sounds like maybe next year. Just wondering if your thoughts on efficiencies, do you believe that you could see the efficiency ratio drop back down to say the 60% level or even below as we go through 2014 as we close out 2014?

[E. Philip Wenger:]

So yes, it's a great question. I don't see us going under a 60%, and between -- I'd say based on what we know right now, Frank, we're looking at 60% to 65% range, could go a little higher.

[Frank Schiraldi:]

Okay. All right. That's helpful. And then wondering, if you could just talk a little bit about timing on -- Charlie, I believe, is set to retire at the end of this year and if you can give us some sense of how the search is going and any possible timing around an announcement.

[E. Philip Wenger:]

So we have identified a candidate that we are pleased with, and we will be anticipating making an announcement very soon.

[Frank Schiraldi:]

Okay, great. And, I mean, could -- would you say or could you say, is it external or internal? Or is it something you wouldn't want to comment on?

[E. Philip Wenger:]

It is external.

[Operator:]

We'll take our next question from Christopher McGratty with KBW.

[John Barber:]

This is John Barber filling in for Chris. The taxable security yields were down about 29 basis points versus last quarter. I was just wondering what drove that. And do you still expect security yields to inflect this quarter in the fourth quarter?

[E. Philip Wenger:]

The big thing was the interest recoveries that we mentioned [indiscernible]. The additional interest related to the calls on [indiscernible]. It's funny, the yield on -- we're projecting it [indiscernible] and we're putting on -- securities that we're buying or yields [indiscernible]. I think you could see we buy securities that [indiscernible].

[John Barber:]

Okay. And I'm just wondering, now that the systems conversion is behind you, what are some on the kind of the new capabilities that offers you maybe that you can't do before?

[E. Philip Wenger:]

Well, it gives the line a much better view, 360 view of our customer. And it also now gives us the capability to enhance a lot of our other technology systems throughout the company, tying into that core processing system, giving us a much better data across all different kinds of lines. But we do need to continue to invest in some technology to get that accomplished.

[John Barber:]

And just the last one I had. Has your appetite for M&A changed now that this systems conversion is behind you? And also, how does the upcoming stress test impact your impact to pursue deals or deploy capital?

[E. Philip Wenger:]

So I would say, in general, we are still internally focused. We still have technology initiatives we want to get accomplished. We're still building out some risk management areas, and we have the stress test coming up. We're getting ready for the new qualified mortgage rules. So we still have a lot to accomplish internally.

[Operator:]

[Operator Instructions] We'll take our next question from Nicholas Karzon with Crédit Suisse.

[Nicholas Karzon:]

I guess, just to start on the fee income side on the decline in the service charges on deposit accounts, I think you noted that there was a pretty significant drop-off in overdraft fees. I was wondering if there's been a change in your product offering, or is there something that you're seeing more so on the consumer behavior side?

[E. Philip Wenger:]

I would say it's almost all on the consumer behavior side. And we've seen this trend consistently now over the last 18 months.

[Nicholas Karzon:]

Okay. And I guess, moving to -- I think you noted in your release that there was an increase in the mortgage repurchase provision this quarter. And some of your peers have added reserves following a change in the scope of the -- further GSE reviews. And is this something that you've seen as well? And can you kind of give us some thoughts on the drivers there?

[E. Philip Wenger:]

Our mortgage repurchase reserve is -- has been driven more by mortgages we're getting back from privately held companies, as compared from the GSEs.

[Nicholas Karzon:]

Okay. And then kind of lastly, on the loan growth side, we've seen a lot of strong CRE growth this quarter. But we've been hearing some commentary that life insurance companies are starting to take share, given their ability to fund some longer-term loans. And I was wondering if you've seen any impact on that, and just kind of in general, kind of commentary on the pricing environment that you're seeing in kind of commercial real estate and C&I.

[E. Philip Wenger:]

Yes, so in general, I would say we have not seen a lot of competition on -- from the life insurance companies. And because in general, we're -- we tend to be at a lower end. I think they're getting back in. I'm hearing that, but I don't think they're down really to the markets that we're playing in yet. They had gotten there, precrisis. They were doing a lot smaller deals, but we haven't seen them back in our space yet.

[Operator:]

And we'll take our next question from Matthew Keating with Barclays.

[Matthew J. Keating:]

I know you mentioned that you don't expect, I guess, MSR rights to be a big part of your revenue stream next quarter after having a benefit the past couple of quarters. But can you just update us on where sort of your valuation allowance for MSR stood at the end of the third quarter?

[E. Philip Wenger:]

The valuation allowance is 0. And when we book [indiscernible] when we think of our valuations, we don't write them up to market value. But we do write them down for impairment and [indiscernible] down 2.7 million, and that has been reversed in the last 2 quarters.

[Charles J. Nugent:]

1.7 million this quarter and [indiscernible].

[Matthew J. Keating:]

Okay. That's helpful. And I guess on the M&A front, understanding there's some near-term issues you want to kind of get through before you look towards that. But if we look out maybe towards the middle part of 2014 or later, do you expect a pickup in M&A activity maybe more broadly in your footprint? And if Fulton would be interested, maybe you could outline a few of geographies that might make sense to add to the franchise.

[E. Philip Wenger:]

So, yes. I mean, it's really hard to say what's going to be happening out there. We keep saying at some point we expect things to pick up. But just in general, in our 5-state footprint, we have physical locations in 54 counties. And in 12 of those 54 counties, we have a market share position that's either 1 through 5. And we'd like to increase those areas. So ultimately, we have a lot of places within our existing footprint to -- where we want to grow. And I think over time, some of that's going to be through acquisition. Those areas exist in all 5 states that we operate in.

[Matthew J. Keating:]

All right. Thanks. All the rest of my questions have been addressed. Thanks, very much. And Charlie, good luck to until I speak to you after your retirement.

[E. Philip Wenger:]

So, before I end today's call, I would like to recognize Charlie Nugent and thank him for his 2 decades of service to our company. And, as I mentioned earlier in the call, Charlie will retire on December 31, so this is his last earnings call. I'm sure you know from working with Charlie, has tremendous understanding of financial service industry. He's been instrumental in helping to guide our company over the years, and we'll certainly miss him. I also wanted to thank you all for joining us today. We hope you will be able to be with us when we discuss fourth quarter and year end 2013 results in January.

[Operator:]

This does conclude today's presentation. Thank you for your participation.