Fulton Financial Corporation (FULT) Q2 2013 Earnings Report, Transcript and Summary

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 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 in 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's Discussion and Analysis of Financial Condition and 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. 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…

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…

[Operator Instructions] And we'll take our first question from Bob Ramsey with FBR. Thomas Frick - FBR Capital Markets & Co., Research Division: 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?

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 - FBR Capital Markets & Co., Research Division: 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?

Well, it's, I would say, primarily a function of not having specials. Thomas Frick - FBR Capital Markets & Co., Research Division: 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?

Phil?

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 - FBR Capital Markets & Co., Research Division: 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.

[indiscernible]

Oh, I'm sorry, the margin went up. Thomas Frick - FBR Capital Markets & Co., Research Division: Oh, the margin went up, you said?

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

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

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?

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.

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.

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

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.

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?

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.

We'll take our next question from Frank Schiraldi with Sandler O'Neill. Frank Schiraldi - Sandler O'Neill + Partners, L.P., Research Division: 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?

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 - Sandler O'Neill + Partners, L.P., Research Division: 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?

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 - Sandler O'Neill + Partners, L.P., Research Division: 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?

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 - Sandler O'Neill + Partners, L.P., Research Division: Okay. But it's still, I guess, just as volatile in terms of quarter-to-quarter?

It can be, yes. Frank Schiraldi - Sandler O'Neill + Partners, L.P., Research Division: 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?

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.

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 - Sandler O'Neill + Partners, L.P., Research Division: 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?

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

[Operator Instructions] And we'll take our next question from Chris McGratty with KBW. Christopher McGratty - Keefe, Bruyette, & Woods, Inc., Research Division: 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.

Yes, we look -- we'll talk about that at the September board meeting. Christopher McGratty - Keefe, Bruyette, & Woods, Inc., Research Division: 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?

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 - Keefe, Bruyette, & Woods, Inc., Research Division: 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?

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.

We'll take our next lesson from Nicholas Karzon with Crédit Suisse. Nicholas Karzon - Crédit Suisse AG, Research Division: 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?

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 - Crédit Suisse AG, Research Division: 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?

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 - Crédit Suisse AG, Research Division: 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.

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 - Crédit Suisse AG, Research Division: 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.

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.

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.