Fulton Financial Corp (FULT) 2014 Q2 法說會逐字稿

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

Thank you, Stephanie, and good morning, everyone. Thanks for joining us for our conference call and webcast to discuss earnings for the second quarter of 2014. Your host for today's conference call is Phil Wenger; and Phil is Chairman, President, and Chief Executive Officer of Fulton Financial. And joining him is Pat Barrett, Senior Executive Vice President and Chief Financial Officer.

Our comments today will refer to the financial information included with our earnings announcement which was released at 4:30 yesterday afternoon. These documents can be found on our website at 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 and are subject to risks, uncertainties and other factors, some of which are beyond Fulton's 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've included our safe Harbor statement on forward-looking statements and we refer you to this section and 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's Discussion and Analysis of Financial Condition and Results of Operations set forth in our filings with the SEC.

In discussing Fulton's performance, representatives of Fulton may refer to certain non-GAAP financial measures. Please refer to the supplemental financial information included with the earnings announcement we released yesterday for a reconciliation of those non-GAAP financial measures to the most comparable GAAP measures.

Now I would like to turn the call over to your host, Phil Wenger.

Thank you, Laura. Good morning, everyone, and thank you for joining us. After my prepared remarks, our Chief Financial Officer, Pat Barrett, will review our financials in detail. Then we will both respond to your questions.

We reported diluted per-share earnings of $0.21, down $0.01 from the first quarter and unchanged from the second quarter of last year. Our return on average assets came in at 0.94%, and our return on average tangible shareholder equity was 10.3%.

We were pleased to see a modest resumption of our loan growth. Linked quarter we grew ending loans by $106 million and average loans by $33 million. Our focus on quality earning asset growth continues. Commercial and small business loan pipelines increased linked quarter. That being said, our relationship managers tell us that pressure on loan pricing continues.

On the liability side of the balance sheet, we successfully implemented our promotional strategy to lock in longer-term CD funding to guard against rising rates. Average time deposit balances increased by 2.7%. We also saw our core deposits increase by 0.6% as a result of continued growth in core households.

As long as the current interest rate and competitive environment continues, our net interest margin is likely to undergo further pressure. But we feel we are well-positioned for margin expansion when interest rates rise, and Pat will provide more detail in his financial discussion.

Overall asset quality improved further this quarter. We saw decreases in nonperforming loans, non-accrual loans, classified and criticized loans, and in overall delinquency. Total nonperforming assets fell to 0.96%. That is the first time we have seen that number below 1% since the second quarter of 2008.

Our other income grew a very strong 14% linked quarter, excluding security gains. All business lines contributed to this overall lift. And these included mortgage banking, merchant services, deposit account related income, investment management and trust services, credit and debit card income, and cash management fees.

We are pleased with the $2.1 million increase linked quarter in residential mortgage income. Applications were up 34% over the first quarter at $387 million from $288 million. And loan closings were up 41% to $242 million from $171 million last quarter.

At quarter end, purchase money accounted for 71% of our closing volume, up from 60% last quarter. Loans in process stood at $192 million, up 25% from the $154 million at the end of the first quarter.

Total other expenses exceeded our prior guidance, due primarily to the acceleration of expenses associated with risk management and compliance matters.

During the quarter, we continued to aggressively build out our risk regulatory compliance and IT infrastructures. We believe we have made good progress. However, we have not attained a level of compliance that we and our regulators expect and require. Remaining deficiencies in our Bank Secrecy and PATRIOT Act anti-money-laundering functions resulted in a recent issuance of enforcement actions. Details surrounding these were reported in our Form 8-K filing with the SEC last Friday, July 18.

Since we knew these actions were a possibility, they were also discussed in our Form 10-K for 2013, and our 2014 first quarter 10-Q. How might the enforcement actions impact us? Expenses related to these ongoing regulatory and compliance initiatives will likely remain elevated in the next two quarters as we continue to accelerate our remediation work, and also continue our use of outside services.

It should be noted we have incurred significant costs since beginning of 2012, in connection with the work related to strengthening our BSA and AML compliance processes, as we directed additional resources to enhance this area.

We have increased our staffing levels from 13 at the beginning of 2012 to 41 people today, increasing the annual run rate of salaries from $830,000 to $3.6 million. We expect to reach a total of approximately 50 professionals by year end, adding another $600,000 to that annual run rate.

At this point, we are reasonably confident that the total of 50 people, once they are hired and fully productive, will enable us to effectively complete the buildout of our BSA/AML function. We have engaged consultants to help us evaluate and strengthen our BSA and AML compliance programs. That assistance continues today as we work to address various components of the BSA processes.

During this time we have expended approximately $9 million for this outside consulting assistance, and our current expectation is that we will incur approximately $4 million to $6 million more in outside consulting expenses over the remainder of 2014. We do expect expenses from outside consulting services related to BSA and AML to decrease by approximately $5 million in 2015.

While we have been incurring these higher expenses, at the same time we have been actively managing other expense areas. A number of actions have been taken to reduce expenses in areas unrelated to our compliance and risk management functions. Those actions will continue. Our Board, senior management team and all our team members continue to work diligently to ensure these regulatory expectations are met. As you can imagine, we are all very anxious to get these items resolved as soon as possible.

Looking at capital, we continue to deploy our capital to enhance shareholder value. During the first quarter we completed a 4 million share repurchase program, which brought the total number of shares bought back since the second quarter of 2012 to 14.1 million.

This quarter we announced a new program to repurchase up to 4 million shares or 2.1% of our stock through the end of this year. We will continue to actively manage our capital.

At this time, I would like to turn the call over to Pat Barrett for his financial discussion. When he concludes, we will respond to your questions. Pat?

Thank you, Phil, and good morning to everyone on the call. Unless I note otherwise, quarterly comparisons will be with the first quarter of 2014.

As Phil noted, earnings per diluted share this quarter were $0.21 on net income of $40 million, which represents a $2.1 million or 5.2% decrease in earnings compared to the prior period. Earnings per share was flat compared to the second quarter of 2013.

The decrease in earnings resulted from higher noninterest expense, lower net interest income, and an increase in the provision for loan losses, partially offset by gross in noninterest income.

Net interest income decreased $1.7 million or 1.3%, due mainly to the effect of a 6 basis point decline in our net interest margin. The impact of this decline was partially offset by an additional day in the quarter, which generated approximately $1.1 million of net interest income.

Average yields on interest-earning assets decreased 5 basis points. Average earning assets decreased $38 million or 0.2%, as a decline in average investment securities of $56 million was partially offset by an increase in average loan balances of $33 million.

After steady improvement in 2013, new loan origination yields have flattened out in 2014 to a second quarter level of just below 4%, while rates on maturing loans have continued to come down and are just over 4% at this point. This has closed the negative gap between maturities and new originations to less than 10 basis points.

The average cost of interest-bearing liabilities increased 2 basis points. This resulted from the success of time deposit promotions intended to lock in longer-term rates.

Average deposits increased $132 million or 1.1%, due to a $52 million increase in demand in savings accounts and an $80 million increase in time deposits. Growth and demand in savings accounts was the result of increases in personal and business account balance increases, partially offset by a seasonal decrease in municipal account balances.

The net interest margin of 3.41% was 1 basis point below the range we provided last quarter of 3.42% to 3.46%. This resulted from lower-than-expected interest recoveries on nonaccrual loans, lower loan fees, and lower investment in security yields. For the third quarter of 2014, we are expecting continued modest compression to arrange between 3.35% and 3.39%.

Provision for credit losses for the second quarter increased $1 million. While most of our credit metrics showed continued improvement, a single large credit exposure and the results of our alliance calculation indicated the need for a slightly higher position.

Total delinquencies decreased by $2 million due to a $6 million decrease in loans 90 days or more past due, partially offset by a $4 million increase in 30 to 90 day delinquencies. Total classified and criticized loans declined $23 million or 3%, while net charge-offs increased from $8 million to $9 million, for an annualized net charge-off rate of 28 basis points as compared to 26 basis points during the first quarter.

Our allowance to loans coverage ratio declined 5 basis points to 1.51% at June 30, 2014. Comparing second-quarter noninterest income, we saw a $5 million or 14% increase compared to the first quarter, excluding the impact of security gains. Mortgage banking income increased $2.1 million due to a $550,000 increase in mortgage sale gains as a result of higher volumes, and a $1.6 million decrease in amortization of mortgage servicing rights as prepayment rates slowed.

Other service charges and fees increased $1.6 million, including a $1.1 million seasonal increase in merchant fees. Service charges on deposits increased $841,000 or 7.2%, reversing a declining trend we have seen for the last three quarters. Net investment securities gains were $1.1 million, resulting from the sale of two pooled trust preferred securities that were previously written down.

Noninterest expenses increased $6.6 million or 6% to $116.2 million for the quarter, exceeding our estimated range of $111 million to $115 million, due to higher than expected outside services expense. The linked quarter increase was primarily the result of two drivers.

First, a $4.1 million or 7% increase in salaries and employee benefits, due mainly to increases in incentive compensation accruals, self-insured healthcare costs and stock compensation expense, partially offset by a seasonal decrease in payroll taxes.

Second, outside services increased $3.4 million or 90%. The majority of this increase was related to risk management and compliance initiatives, including accelerated efforts to enhance our programs for compliance. Partially offsetting these increases was a $2.1 million decrease in occupancy expense, as snow removal costs decreased and we realized the benefits of branch consolidations combined with a $1.1 million decrease in operating risk losses.

We remain committed to our stated goal of expense discipline and the buildout of our risk management and compliance processes. During the second quarter we achieved $2 million of quarterly savings as a result of our previously announced cost-saving initiatives, which helped to offset higher costs in risk management and compliance areas. While we have incurred higher than expected costs in these areas, these costs in large part reflected continuation and acceleration of previously planned initiatives.

Expenses will likely remain elevated for the remainder of 2014, particularly outside services and professional fees. I also want emphasize that there could be volatility from quarter to quarter due to the timing of services and work performed on various initiatives. And accordingly, we have framed our expense guidance in terms of the second half of the year.

Overall, our internal projections indicate that expenses for the remainder of 2014 will be in the range of $232 million to $238 million. As always and in addition to our projections of outside services and professional fees, run rates of certain other expenses such as other real estate owned and repossession expense and operating risk losses can experience volatility based on timing or events that can't always be reasonably predicted.

Moving to taxes. Our 25.4% effective income tax rate for the second quarter was equal to the rate in the first quarter. Consistent with our prior projections, we estimate that our annual effective tax rate will remain in the mid-20%s.

And concluding briefly on capital, our ratios remain very strong with estimated Tier 1 and total risk-based capital at 13.3% and 14.9% respectively. As Phil said, active capital management remains a key priority for us, one that we will continue going forward.

Thank you for your attention and for your continued interest in Fulton Financial Corporation. Now we will be glad to answer your questions.

(Operator Instructions) Chris McGratty, KBW Financial.

Pat, on your prepared remarks on the expenses, I just want to make sure I heard you. Once you get through the next two quarters, it was a $5 million annual reduction in just the professional services line. Is that the right way to think about it?

That is right. That was Phil that mentioned that, but I think that is the right way to think about it.

Okay. And I guess with other expense initiatives that are ongoing, how should we think about kind of confidence that the BSA issues are largely behind you by the end of this year? I mean have you -- are all the systems kind of invested already? And maybe you could speak to it maybe in terms of the efficiency ratio next year.

Chris, this is Phil, and we do have some technology initiatives to put into place over the next six months, and we are working actively on those. It is really going to be I think two phase. The first phase will be starting shortly and will have little impact from an expense standpoint.

Then the second phase would be next year, and its impact from an expense standpoint should not be substantial on a quarterly basis either. So we are, as we were last year at this time, we are reviewing all expense categories again, and everything is on the table. You know, our target has been on an efficiency ratio to be between 60% and 65%. And that is going to be our goal for next year, also.

Okay, so 60% to 65% with all of this investment is kind of the way to think about it next year. Okay.

On capital, you guys didn't buy stock in the second quarter. What are your limitations if any with the consent owner, and how aggressively can you buy stock kind of over the next couple quarters?

So, Chris, when we heard from the regulators regarding that purchase program, the $4 million shares that we announced, I think we had one or two days prior to the blackout beginning. And that is why we didn't repurchase any in the second quarter. We would have no restrictions as soon as the blackout ends this week.

All right, thank you.

Casey Haire, Jefferies.

Good morning, guys. Just wanted to follow up on Chris's comments on the expense relief. So if I'm hearing this correctly, so professional service gets $5 million of relief next year. And assuming that it runs is elevated in the second half, you are more or less expecting professional fees to run around $8 million or $9 million next year from the baseline of $13 million or $14 million. Is that correct?

No. First off, we are only talking about professional fees as they relate to outside services. The $9 million that we have expended to date that I mentioned, I would say half of that was in 2012, and half in 2013 and 2014.

So we are looking at outside services related to BSA this year, only this year, to be in the $8 million to $10 million range. And we think that number will be decreased by approximately $5 million for next year.

Okay. And then that comes down, and then the full-time employees that you hire add -- did you mentioned, Phil, was $600,000 of expense annually that would show up in the comp line?

That would be an additional $600,000 annually, yes, from where we are right now.

Okay. And then Phil, just -- I mean, I'm sorry, Pat -- to focus in on the comp line. You kind of ran through some of the ins and outs this quarter. It did seem a little surprising to see it up this much, with incentive comp kind of driving it in a quarter where EPS is down.

Can you just walk through some of the drivers and what might be, if anything, temporary this quarter?

Yes, this is Phil. On the incentive comp, in the first quarter as we outlined in our proxy information, the first -- the executive bonuses were reduced by 30% because of where we stood, but we had accrued for 100%.

So the first-quarter incentive comp was a much lower number because of that reversal, about $2.5 million. So the second quarter's is a accrual number that at the end of the year may or may not get adjusted again. Does that add some color to that?

Yes, that is helpful. Thank you. And then just lastly on the NIM guide, sounds like there is a little bit of pressure coming here. Just curious, is this all -- is the NIM guide predicated on assume all asset yield pressure, or are you expecting funding costs to rise as well?

I think it is a combination of both. So I think that the days of seeing declining funding costs are certainly behind us. We have enjoyed very flat funding costs for a number of quarters. You know, liquidity and liquidity preferences have remained pretty high. And I think that we are gearing up for a more competitive interest rate environment and focusing as always a great deal of our energy on our funding mix, and feel pretty good about testing the waters and being able to lock in $200 million, $225 million, of 3 to 5-year funding at the rates that we did this quarter.

Okay, and just new money yield on loan production these days versus that 4.21%?

I think we are in the 3.9%0 range, similar to last quarter.

Okay, thank you.

David Bishop, Drexel Hamilton.

The increase to the 50 professionals, those are -- I just want to confirm you are talking about full-time employees as you move forward for the BSA department?

That is correct.

Okay, great. And then shifting topics real quick in terms of the nature of loan growth, just curious if you can speak to some of the markets where you saw the pockets of loan growth this quarter?

So, a good question. We actually saw growth in all the states that we operate in, in both ending loan growth in each state, and we also saw upticks in pipelines in every area.

Got you. And then one follow-up in terms of the loan yields. Saw a little bit of a pop on the construction loan yields. Anything going on there in terms of firming up pricing, increasing spreads, that you are seeing in that segment?

I wouldn't necessarily say that we are seeing increasing spreads. That really can be impacted by one or two specific deals because of the size of the portfolio.

Great, thank you.

David Darst, Guggenheim Securities.

Phil, I think in the past couple quarters you talked about introducing some loan campaigns to stimulate growth. And I just wondered if you had any specifics kind of around the success, or do you expect it to be more successful with the pipeline growth?

Yes. So one of those is on the consumer side. And I would say that our consumer pipeline right now is as large as it has been in recent memory. We think that has been pretty successful. And then the other would be on the commercial real estate, and I think we are also seeing some success from that program.

Okay. Is commercial real estate one of the areas where you are seeing more of the competition, or is it in C&I?

Well, the most intense competition is in the C&I area. And I mean there is competition in every loan pricing category, but it is worse in the C&I area than the commercial real estate.

Okay. Then as you are working through the series of investments you've had over the past 18 months, you kind of -- the BSA part now, you have done stress testing, done your core system. Is any of the strength in the case to consolidate some of your subsidiary banks further?

Well, as I mentioned, we are looking at all our expenses, and I think everything is on the table. And that would be included in the everything category.

Do you have any way to frame what the cost saves could be from doing that?

You know, we are going to be looking at it very closely over the next quarter, and I think we would be able to frame that out for you before the end of the year.

Okay, great. Okay, thanks a lot.

Thank you.

Matthew Kelley, Sterne Agee.

Hi, this is actually Chris Jackson for Matthew Kelley. Just a couple of questions. Can you tell us what the utilization rate for C&I loans in the quarter was, and how does it compare to first quarter and the year-ago period?

I can. So our utilization rate was 37.7%. That is up slightly from first quarter when it was 37.2%. It is down. Second quarter of 2012, we were at 41.5%; second quarter of 2013 we were at 38.3%.

Okay, great. Thanks, and then just one follow-up. How low could you take the loan-loss reserve coverage ratio from the 1.49% at period end?

Well, we are still substantially ahead or higher than our peers. I think at the end of the first quarter, our peer average was somewhere around 1.20%. So I would expect that in the near term that it could continue to go down, but it is going to -- you know, where it ends up is just going to depend on so many different factors.

But what we see right now, I would expect in the next couple of quarters it would probably go down some.

Okay, great. Thanks. That's all I had.

(Operator Instructions) Matthew Keating, Barclays.

Good morning, thank you. So as it relates to the BSA and the strengthening of your compliance procedures, so that there's 50 incremental employees, what base is that off of? Like so how many employees do you have involved in BSA compliance before you start to make these investments?

So in 2011, I think we might have been at 8. At the beginning of 2012, we had 13.

Got you. Okay, that is helpful. Maybe you could just explain as you sort of strengthen these systems and procedures, so obviously you add people. But from a system standpoint, is this something you contract with a third-party outsource or is it more a system you have to build yourself? How does the investment in the systems actually work in practice? Thanks.

You know, it is a combination. So we would buy outside software and then we would tailor it to fit our specific framework.

Okay, understood. So at least the systems cost plateau, would you think they would plateau by the end of this year and then just stay in a run rate; and then some of the professional and outside services fees, as you mentioned, roll off? Is that the best way to think about some of these investments that you're making on the technology side?

Actually, the technology investments will be more in -- the costs will be more in 2015 than 2014. So we are putting in one system. We have started that now. You know, you don't start amortizing it until it is completely up and running, which probably will be by the end of the year. And then the second system, probably we will begin amortizing that in the June to September timeframe of next year.

Okay. And I guess just generally, we have seen a lot -- a few banks mention the need to sort of strengthen BSA compliance. Is it your feeling that regulators are taking a harder line on this issue? I mean certainly that is what everyone thinks, but maybe you could just talk about whether you were surprised by this level of investment that is required? Or do you think your peers are also facing similar type of reviews? Thanks.

Well, you know, if you would have asked me in early 2011, would we ever have this many people in our BSA area; I would have told you no way. But as we have been strengthening, we think it is now the appropriate number. So I guess you can interpret that answer any way you want to.

No, that is helpful. I appreciate all the color. Thank you.

Bob Ramsey, FBR Capital Markets.

Good morning, this is Travis Potts for Bob. I just wanted to clarify, I think you said you had $9 million to date. And I think you said that was related to the outside services. Do you have how much expenses you have incurred in total for the enhancements to your BSA/AML platform?

Yes, so just to go through those numbers again. We have -- outside services since 2012 have been $9 million to date. We are expecting another $4 million to $6 million. So that puts us at $14 million, $15 million on the outside services.

Our salaries will increase by -- from that same time period, our salaries will have increased another $3.5 million. And then we would expect not all of the outside services are going to go away next year; a good chunk of them. But I would expect another $2 million to $4 million of outside services next year.

So if you add it all up, it is going to be I would say between $20 million and $25 million.

Okay, thank you for the clarification. And then do you expect this enforcement order to sort of preclude you from any acquisition or any other growth activities?

Yes, I would, and we will get more clarification on that as we move through. But certainly in the short term, the answer is yes.

Okay, thank you.

And if I could just add, as we have been saying, we really did not anticipate being active in the acquisition area for at least the coming 12 months. I think we have been pretty clear in communicating that.

Right, thank you for the color.

Blair Blantley, BB&T Capital Markets.

I had a question about the loans to deposit ratio, and just kind of your thoughts (technical difficulty) around that. I had a question about the loan to deposit ration and kind of what your thoughts are around it being north of 100%, and any type of plans you may have to get it below that threshold.

So it is north of 100%, but barely north, and we are comfortable where we are. But we don't want to see large increases from where we are. So we try to manage between that 97% to 103%.

Okay. And do you expect to do any more types of deposit promotions going forward, similar to what you have done recently?

So our current strategy has been -- our most recent strategy has been to try to extend the duration of our deposit base. And we are going to selectively continue that strategy as we move forward.

Okay. And then one last question regarding service charges. Obviously, they have been on a downward trend. Is that purely customer behavior? Is there anything else going on there?

That would be primarily customer behavior. And hopefully, we have hit the bottom and we are going to start seeing growth again.

I would also add that just from a lot of those line items across our income statement and in fee income particularly, are a function of the amount of time people have to swipe and spend and invest. And the first quarter was more than just one day less. In our markets it was several days less because of weather.

So we're definitely seeing a rebound just because of the more of the fingers in the air normal type of run rate of quarter and activity, which is good to see.

Right, but they are still down 14% year-over-year. So are we closer to a bottom then, you think, with those year-over-year (multiple speakers) changes?

I think we are, yes.

Okay, thank you.

Frank Schiraldi, Sandler O'Neill.

Good morning. Just two questions. Just one, just wondering your thoughts, Phil, on the other subs that you may get some sort of enforcement agreement on BSA. Just wondering your thoughts on how good a handle you think you have on what those potential consent orders could entail in terms of expense.

Do you feel like that is very much baked into guidance here, or could we see potential tick-up if and when those are put in place?

So, we think it is baked in. You know, the function is a centralized function at the holding company. So we think that they will be similar if and when they occur, but you never know.

Right. Okay. And then just on -- sorry if I missed it, but just on loan growth, expectations going forward. I believe in the past, perhaps last call, you talked about maybe a 3% to 7% annualized loan growth expectation.

Is that still viable given what we have seen first half of the year? Should we maybe anticipate towards the lower end of that range, or what are your thoughts for the back half of the year here?

So we do think we, based on what we see today, that we can still get within that range. I would say there is a better chance that we will be at the lower end of the range than the higher end.

Got you. Okay, thank you.

Chris McGratty, KBW Financial.

Yes, just a follow-up Phil. In the past we have talked about your (inaudible) borrowing costing almost 5%. We are a couple years removed from those conversations, but presumably the penalty may be a little bit less. Is there any -- and your capital levels are building, right? Is there any discussion about whether to take them out and extend the duration that way?

Yes, Chris, most of that comes due in 2016 and 2017. And we are looking at that again, but there still are penalties. So I am not sure how it is going to work out, but there still are substantial penalties. We are taking a look at it. If it makes sense, we would definitely consider it. But I can't tell you positive either way right now.

Okay. And then one for Pat. The investment portfolio, how should we be thinking about the near-term size? Is it going to be used to fund loan growth or should it grow at all?

I think we would like to see it stay flat. We have had a tough time like everybody else finding yield that kind of meets what we are looking for. But I wouldn't expect to see it run in a material way.

All right, good deal. Thanks.

And with no further questions, I would like to turn the call back to Mr. Phil Wenger.

Well, thank you all for joining us today. We hope you'll be able to be with us when we discuss third-quarter results in October.

And this concludes our conference. Thank you for your participation.