Fulton Financial Corp (FULT) 2013 Q2 法說會逐字稿

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.

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 4.30 yesterday afternoon. These documents can be found on our website at www.FULT.com by clicking on investor relations and then on news.

On this call, representatives of Fulton may make forward-looking statements with respect to Fulton's financial condition, results of operation, and business. These forward-looking statements are not guarantees of future performance but are subject to risks, uncertainties, and other factors, some of which are beyond Fultons' control and difficult to predict and which could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. Fulton undertakes no obligation other than required by law to update or revise any forward-looking statements whether as a result of new information, future events, or otherwise. In our earnings release, we have included our safe harbor statement on forward-looking statements, and we refer you to this section of the release and we incorporate it into today's presentation. For a more complete discussion of certain risks and uncertainties affecting Fulton, please see the sections entitled risk factors and management discussion and analysis of financial condition and the results of operations set forth in Fulton's filings with the SEC. Now, I'd like to turn the call over to your host, Phil Wenger.

Thank you, Laura. Good morning, everyone. It's 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. The first of those is earnings-per-share growth. We reported diluted earnings per share of $0.21 for the quarter, up $0.01 [in the quarter], 5% linked quarter and in comparison to the second quarter last year. We increased our return on average assets by 1 basis point to 0.97 and our return on tangible equity from 10.43% to 10.75%.

As you know, we have been deploying capital through periodic dividend increases, business line reinvestment, 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 of 2013. The quality loan growth contributed to our increase in net interest income and to our EPS growth this quarter. And, 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. 50% of our portfolio growth came from existing relationships, 50% 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. Accepted 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 $210 million -- 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 the quarter. Deposit costs fell 4 basis points as average non-interest-bearing demand deposits increased 5% linked quarter while timed 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 in the first quarter. With the rising interest rates, 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 sales 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 cost. Another positive development this quarter was the over 10% linked-quarter increase in non-interest 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. A tribute 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, with the exception of expenses, we performed well against all our corporate objectives; earnings-per-share growth, quality loan growth, asset quality improvement, spread management, or 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 necessary investments that will better position the Company for the future. Now, we'll turn the call over to Charlie for his financial discussion, and then we will be happy to respond to your questions. Charlie?

Thank you, Phil. 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 non-interest income and a decrease in the provision for credit losses. These improvements were partially offset by higher non-interest 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. One 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 the 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 that our core margin compression will continue in the third quarter of 2013 with the net interest margin expected to be in the range of 3.4% to 3.45%. Non-interest 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 sales 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 of 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. Debt security gains consisted almost entirely of a single trust preferred security that was previously written down but experienced a 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 it appropriate. Non-interest 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 service 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, three of our six 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 other outside services, marketing salaries and benefits, and other expenses. We expect to incur $1.4 million in implementation expenses when the three 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 non-interest expenses should be in 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 Instructions)

Bob Ramsey, FBR.

This is Tom for Bob. Just wanted to touch on -- your loan balances again were very strong with the growth this quarter and especially you're HELOC balances have increased 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. I think it's down about 8% year over year. Can you talk a little bit about what you're seeing there in terms of trends?

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

Okay. 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?

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

Got you. Okay. And then, switching gears, on the expense line, the $2.5 million increase you experienced in outside services related to regulatory compliance. Can you expand on exactly what that was? And, is that going to be a recurring expense going forward? Or, maybe once a year?

Well, I will first say that I think it will be -- it can and probably will be volatile. So, we are 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 the compliance side or the commercial loan processing side, how we can drive costs out through improving our processes.

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?

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.

The margin.

I'm sorry. The margin went up.

The margin went up, you said?

Yes. I'm sorry. It went from 1.62% to 1.71%.

Okay. Great. Thanks. That's all I had.

Casey Haire, Jefferies.

Question on the NIM guide. I'm a little surprised to hear not as-- 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, is loan pricing competition getting worse? What's driving the pressure here?

Casey, we expect continued pressure, but we expect less. 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 came off in the second quarter, and the reinvestment rate is going from for the mortgage-backs and CMOs that we bought have gone from about a 1.70% to 2.40%, 2.45% so that's helping. Also, as we mentioned in the script, 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 4.41% and loans [going on] were 3.64%. So, there's still going to be a little compression in our minds -- but less.

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 that pressure, but it is easing some.

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

Yes. It does. When we did our projections, we were assuming that -- and this usually 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.

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

Well, just to clarify one point, Charlie, we have not made any statement that we are consolidating 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.

Okay. Thanks for taking the questions.

Frank Schiraldi, Sandler O'Neill.

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

That is, Frank. The premium amortization has gone down. In the first quarter, it was $4.1 million. The second quarter, it was $3.3 million, and it went down quite a bit in May because the 10-year rate went up to -- it went from a 1.63%, a low, and then it started going up to -- I think it is 2.57% today. That's going to result in continued reduction in that premium amortization, and that's baked into our numbers.

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

I think if you go back maybe 18 months ago, it was 1.8% a quarter, 1.8% a quarter.

1.8%?

Compared to 3.3% now.

Okay. Got you. Okay. And then, just going back to expenses. I wondered maybe if you could -- the consulting costs or the increase in 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?

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

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

It can be, yes.

And then, finally on expenses, just the completion of the core processing changeover. 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 one-time fees. So, we should expect that $1.4 million to flow out for 4Q? All else equal?

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

Okay. Great.

And then, just to be clear, Frank, our recurring costs do go up some. So, I think the net effect fourth quarter should be down, but the net will not be the full $1.4 million because we have some increases then in recurring costs.

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

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

$3.4 million? Okay. Great. Thank you.

(Operator Instructions)

Chris McGratty, KBW.

Mike [Freedo] stepping on for Chris. I was wondering if I can start with the buyback real quick. You mentioned in your prepared remarks that you have about $1.6 million left on the current authorization. I was wondering if there was any conversations or updates on after September 30 thoughts on an additional buyback authorization?

We'll talk about that at the September board meeting.

Okay. And then, so last call, you mentioned that the priority list was the core conversion and then greater focus on M&A. After the progress you had this quarter and what the [end in sight] next quarter is, have you started looking more at M&A? Any change in that thought process or updates on that front?

Well, we are very pleased with how the core is progressing. So, we feel much better. And, 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.

Okay. And, one last one from me. In terms of rates, can you remind us how much of your loan portfolio is fixed versus variable? And also, maybe what part of the curve you have the most exposure to? Thanks.

The part of the curve we had the most exposure to is mature. And, we have $3.9 billion of our loans repriced based on prime. There's $1.8 billion that repriced based on LIBOR. And, there's another [$3.9 billion] that repriced based on -- at they're adjustable over a five-year period, and most of that -- I would say 50% of that is in the first two years.

Okay. Great. Thanks for taking my questions.

Nicholas Karzon, Credit Suisse.

I guess -- it looks like the securities portfolio takes a step up at the end of the second quarter. I was wondering how we should think about balances there going forward? With the deposit environment that we're in?

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, the reinvestment of the cash flow flows 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.

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

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.

Got it. Thanks. And, one final question. I think you reduced your guidance 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?

We've had some deferred tax assets. We had valuations against that, and it was on state taxes, and we reduced the valuations. And so, that helped move up the rate. We have a very low effective tax rate. A lot of that is driven by the municipal securities. 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 two primary reasons for that would be -- the low tax rate is tax credits and the municipal portfolio.

Thanks. And then, I guess just if you could provide any color in terms of capital deployment? I guess with the 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. Just wondering if you can give any color on the decision there, and what drove that?

Well, as far as not completing it during the quarter -- 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 -- not of the quarter, but the last 10 days before our blackout period started, the volume in our stock dropped off quite a bit as 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 have artificially drove the price up. And, that's what we tried 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.

Thanks. Really appreciate the color this morning.

Thank you.

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

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.

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