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Good morning, ladies and gentlemen. Welcome to the Fulton Financial second quarter results conference call. This call is being recorded.
I will now turn the call over to Jason Weber. Please go ahead, sir.
Thank you, Haley. Good morning, everyone. Thanks for joining us for Fulton Financial's conference call and webcast to discuss our earnings for the second quarter of 2018.
You host for today's conference call is Phil Wenger, Chairman and Chief Executive Officer of Fulton Financial Corporation. Joining the Phil Wenger is Mark McCollom, Senior Executive Vice President and Chief Financial Officer.
Our comments today will refer to the financial information and related slide presentation included with our earnings announcement, which we released at 4:30 PM yesterday afternoon.
These documents can be found on our website at fulton.com by clicking "Investor Relations," then on "News." The slides can also be found on the "Presentations" page relations under "Investor Relations" on our website.
On this call, representatives of Fulton may make forward-looking statements with respect to Fulton Financial's financial condition, results of operations and business.
These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors and actual results could differ materially.
Please refer to the Safe Harbor statements on forward-looking statements in our earnings release and slide two of today's presentation for additional information regarding these risks, uncertainties and other factors.
Fulton undertakes no obligation other than as required by law to update or revise any forward-looking statements.
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 Fulton's earnings announcement released yesterday and slides 11 and 12 of today's presentation 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.
Thanks, Jason. And good morning, everyone. Thank you for joining us. I have a few prepared remarks before our CFO, Mark McCollom, shares the details of our second quarter financial performance and discusses our 2018 outlook. When he concludes, we will open the phone lines for questions.
As you know, our second quarter results were impacted by loss arising from a single large commercial lending relationship, resulting from internal fraud at the borrower.
Excluding the loss, we were pleased with our financial performance for the quarter. Positives for the first quarter relative to the first quarter included a 4 basis point increase in our net interest margin, growth in non-interest income, a decline in non-interest expenses and an improvement in our credit quality.
Our pre-provision net revenue reached an all-time high, increasing approximately $11.3 million or 18.2% linked quarter and $10.5 million or 16.7% year-over-year.
Average loans increased 0.7% or $107 million linked quarter and 4.2% or $641 million year-over-year.
We had several items that created downward pressure on loan growth this quarter. Our line borrowings declined. We had several criticized and classified credits payoff and we had higher-than-normal prepayments, driven primarily by pricing pressure.
From a market perspective, our competition for loans appears as strong as it's ever been.
As a result, our loan growth has moderated this year relative to the prior two years, given our desire to remain disciplined on pricing and structure. Despite the slower-than-expected loan growth, we believe we can deliver a near double-digit growth in net interest income for the year as we continue to benefit from a rising rate environment.
Our average C&I loan portfolio increased 1.1% linked quarter and 2.7% year-over-year. Our growth, linked quarter, was spread across a broad range of industries and concentrated in our Pennsylvania and Maryland markets.
Our commercial leasing portfolio continues to be a nice growth story. The average commercial leasing portfolio increased 4.4% linked quarter and 13% year-over-year.
The residential mortgage portfolio increased 3.5% linked quarter and 18.6% year-over-year.
Growth was spread throughout our footprint linked quarter, but primarily in our Maryland and Virginia markets.
For the quarter, approximately 88% of the portfolio originations were adjustable-rate mortgages.
Our consumer portfolio increased 9% linked quarter and 14.8% year-over-year. Growth was in our indirect auto portfolio, primarily in our core Pennsylvania market. The portfolio is predominantly comprised of super-prime and prime credits.
Philadelphia presents a tremendous long-term growth opportunity for us. So, I wanted to give an update on our recent investments in that market.
If you recall, we hired a regional president and a team of commercial relationship managers in 2016. The team has developed a nice pipeline of opportunities and has generated over $120 million in net balances since 2017.
We opened a mortgage loan production office in May and received regulatory approval to open two full service branch offices. The branches are targeted to open in the fourth quarter of 2018.
Turning to credit quality, as I mentioned in my earlier comments, we incurred a loss arising from a single large commercial lending relationship, resulting from internal fraud at the borrower. Mark will provide some financial details in his prepared remarks. Absent the loss, overall asset quality improved linked quarter.
Our agricultural portfolio is an area we have been monitoring carefully over the last couple of years due to compressed commodity prices.
The portfolio saw a noticeable decrease in delinquencies in the second quarter, while net charge-offs were minimal.
Moving to fees, non-interest income growth was strong linked quarter, reflecting seasonal growth and higher volumes. We saw growth across most non-interest income categories.
Mortgage banking income increased linked quarter. Mortgage production improved and gain on sale spreads increased after two consecutive quarters of noticeable declines.
Turning to expenses, we saw a linked-quarter decline in our non-interest expenses. Our efficiency ratio was 63.3% which was within our stated goal of 60 to 65% and actually reached its lowest level since the second quarter of 2013.
We were pleased to see a decline in our efficiency ratio and we believe there are more opportunities to gain efficiencies. These opportunities exist as we continue to optimize our delivery channels, upgrade our origination and servicing platforms, consolidate our bank charters and exit our BSA/AML orders.
In May, we received regulatory approval to consolidate two of our subsidiary banks, FNB Bank and Swineford National Bank into our largest banking subsidiary, Fulton Bank. Consolidation is expected to be completed in the fourth quarter of 2018.
On the capital front, we paid quarterly common cash dividend of $0.12 per share. We did not repurchase any common stock during the quarter and we have approximately $31.5 million left in our current year repurchase program, which is authorized through December 31, 2018.
Turning to regulatory matters, during the fourth quarter of 2017, the BSA/AML consent orders issued to three of our subsidiary banks were terminated. With respect to the remaining BSA/AML consent orders, we are confident that we are progressing towards achieving a similar resolution.
At this point, I'd like to turn the call over to Mark McCollom to discuss our financial performance in more detail. Mark?
Thank you, Phil. And good morning, everyone.
Turning to our earnings, unless noted otherwise, the quarterly comparisons I will discuss are with the first quarter 2018.
Starting on slide four, earnings per diluted share this quarter were $0.20 on net income of $35.2 million.
During the quarter, we recorded a $36.8 million provision for credit losses related to a single large commercial relationship. This increase to our credit provision equates to approximately $0.16 per diluted share.
Now, I'm going to dive a little bit deeper into the components of our earnings and provide some additional color.
Moving to slide five, our net interest income was $156 million, an increase of $4.7 million linked quarter, driven by growing net interest margin, which expanded 4 basis points as well as modest balance sheet growth.
For net interest margin, we've seen our assets replace faster than our liabilities throughout the first half of the year. Our loan yields increased 13 basis points in the second quarter compared to the first quarter, whereas our deposit cost increased at a slower rate of 7 basis points.
The 25 basis point Fed rate increases in March and June of this year, coupled with the increases we've seen to our interest-bearing deposit rates have resulted in year-to-date deposit betas of approximately 21%.
These deposit betas will likely be higher for future rate increases; and as a result, we anticipate that deposit costs will increase at a faster rate than they have on a year-to-date basis so far, slowing down our net interest margin expansion.
I also want to remind everyone that our balance sheet remains asset sensitive as 42% of our loan portfolio is variable, 36% is adjustable and only 22% is fixed rate.
Growth in average loans linked quarter was $107 million for an annualized loan growth rate of 2.7%. Average deposits increased $97 million or the $2.5 million linked quarter annualized growth rate.
At the end of June, our commercial loan pipeline was approximately $120 million higher than it was at the end of March.
Turning to slide six, other than a significant provision for credit losses recorded for the noted commercial relationship, our credit performance in the second quarter was very strong.
Non-performing loans decreased $11 million to $124 million even after giving effect to $7 million added to the total for the noted commercial relationship.
Total delinquencies also improved by 1 basis point to 1.18%.
In the second quarter of 2018, we recorded a $33.1 million provision for credit losses. Approximately $36.8 million of this was for the aforementioned commercial relationship, which results in a negative credit provision being applied to the rest of our portfolio.
This is supported by the improving overall credit metrics just discussed as well as payoffs of certain larger loans with high-risk ratings that had allowance for credit loss allocations in prior periods.
The allowance for credit losses as a percent of loans decreased linked quarter from 1.07% from 1.12% at the end of the first quarter. However, the coverage of the allowance to non-performing loans increased during the quarter to 137% from 131% last quarter.
Annualized net charge-offs to average loans were 101 basis points for the quarter or $39.9 million. Of that amount, $33.9 million was for the previously referenced commercial relationship.
Adjusted for this, net charge-offs were 15 basis points or 5 basis points higher than the first quarter, but in line with our recent history.
Moving to slide seven, for the second quarter, our non-interest income, excluding securities gains, was $49.1 million, an increase of $3.2 million linked quarter. The increase was driven by commercial loan interest rate swap fees, which increased $1.1 million linked quarter.
As a reminder, our swap fees will continue to be impacted by future levels of commercial loan originations as well as interest rates in the shape of the yield curve.
We saw seasonal increases in both debit card and merchant fees. As Phil mentioned previously, mortgage banking income also showed a seasonal increase, while gains of sales of Small Business Administration loans also grew during the quarter.
Moving to slide eight, non-interest expenses were $133.3 million, a decrease of $3.3 million from the first quarter. Decreases were seen across most expense categories, but notably in professional fees, salaries and benefits expense and net occupancy expense, which is seasonally higher in the first quarter.
Income tax expense decreased $4 million linked quarter due to lower pretax income, driven by the higher provision for credit losses.
For the second quarter 2018, our effective tax rate was 9%, which is slightly below our guidance and is due to the fairly constant level of tax preference items applied to a lower pretax earnings level than what we assumed when setting that range.
Absent the credit loss for the commercial relationship, our effective tax rate for the quarter would've been 14.9%, driven by higher pretax income.
Our year-to-date effective tax rate is approximately 11%, which is at the low end of the range within our outlook.
Moving to slide nine, slide nine displays our profitability and capital levels over the past five quarters. Returns on assets and equity were lower for this quarter due to the credit provision for the previously discussed commercial relationship, which impacted our earnings.
Our tangible common equity ratio remains strong.
Slide ten provides a summary of our outlook for the year, which does have some changes from the outlook we provided on last quarter's call. Average annual loan and core deposit growth has been revised from a mid-single digit growth rate to a low-to-mid single-digit growth rate based on our results for the first six months of 2018 and our expectations for the remainder of the year.
While we believe a mid-single-digit growth rate is possible during the last two quarters on a linked quarter annualized basis, it will likely not be enough to make up for the slower growth we've experienced through the first six months of the year.
Asset quality has been revised simply to recognize that the provision for credit losses has always been impacted by factors other than loan growth, including asset quality measures, risk grading migration and results of our allowance allocation methodology
Non-interest income has been revised from a low-single-digit growth rate to a flat-to-low single-digit growth rate based on results for the first six months of 2018 and our expectations for the remainder of the year.
And finally, we are increasing our net interest margin guidance from an increase of 5 to 10 basis points to an increase of 7 to 12 basis points. This improved outlook expectation for our margin mitigates the lower outlook for earning asset growth.
And with that, we'll now turn the call over to the operator for questions.
[Operator Instructions]. And our first question comes from Frank Schiraldi of Sandler O'Neill. Your line is now open.
Good morning.
Hi, Frank.
Just a couple of questions. I wanted to first – just following up on loan growth, if you can talk about – Phil, talk about where the best opportunity for growth is. Do you think the driver in the back half of the year will be C&I, will it be resi? And then, if you could also just talk about where – in what bucket the growth came in originations in Philly. Is that mostly CRE?
We see growth, I think, in the second half really in all our portfolios. I think resi will continue to grow. I think installment loans, consumer loans will continue to grow. We believe C&I will pick up. And commercial real estate may be the toughest because that is where we're getting most of our payoffs and the pricing competition is really tough.
In Philadelphia, we're getting – our growth has been in both C&I and commercial real estate. Probably a little heavier on the commercial real estate side.
Okay. All right, thanks. And then, just maybe a question, probably for Mark, but in terms of the updated margin guidance, it seems like you are already sort of at that level, even at the midpoint of that level maybe where the margin came in in 2Q. And you noted still, remain asset sensitive. So, just wondering, what your thoughts for a margin impact from a given 25 basis point rate hike at this point?
Yeah, Frank. Good morning. Yeah, you're right. We are up 9 basis points so far year-to-date, year-over-year. And we did revise the guidance upwards. As you know, what's going to impact that, as much as anything, are deposit betas in the back half of the year. We had a deposit beta of 8% in the first quarter of the year. Our deposit beta in the second quarter of the year was 36%. So, year-to-date, that blends down to 21%. But as we have said all year, what we've expected is deposit betas would pick up as the year progresses. How much those pick up here in the third quarter, I think, will ultimately impact whether we see a couple more ticks of margin expansion, like we see in the last couple of quarters or whether that pulls things in line being a little bit more flat.
As you also know, in the third quarter is when we tend to see an influx of public deposits. So, from an overall deposit mix perspective, we just have a little bit higher percentage of some higher-cost money as well.
All right. Thank you.
Thank you. Our next question comes from the line of Chris McGratty of KBW. Your line is now open.
Hey, good morning, everybody.
Hey, Chris.
Hey. So, maybe a question on capital, given that the balance is not growing as fast as some of your peers and your ROI is still running in excess of that, you talked about the buyback on the prepared remarks, I guess, what's preventing you from either utilizing the rest of the buyback, given where valuation is? Or perhaps, even coming back for more?
Yeah. It's a great question, Chris. And I would say, as we go through the second half of the year and if we don't see growth pick up that we could be more inclined to start buying back. And we'll keep – the plan that we have in place runs through the end of the year and then we'll be looking at whether we want to put another one in place, which I'd be surprised if we wouldn't.
Okay, okay. And can you remind us on that point, the capital levels that your looking at most closely when evaluating that decision? Is it TCE? And if it's so, what level is kind of – where you guys are hoping to keep it above?
Hey, this is Mark. Our longer-term targets are 8.5% Tier 1 risk-based, 11.5% total risk-based. As you know, we're significantly above those levels today.
Gordon, great. And, Mark, if I got you, on the tax rate and tax am, I think the first half of the year, your quarterly tax am was around $1.6 million. It would suggest that – based on the tax rate year-to-date, it suggests, correct me if I'm wrong, that the tax rate would be higher in the back half of the year? And would the offset be that number going lower on the am expense? Maybe just walk us through those dynamics would be great.
We continue to be comfortable with the tax guidance, the previous tax guidance we have out there for effective rate for the year. And as far as the amortization and tax credit investments, I think you should expect to continue to see it, the back half of the year will be consistent with what you saw in the first half, about $1.6 million per quarter.
Okay, great. Thank you.
Thank you. Our next question comes from the line of Daniel Tamayo of Raymond James. Your line is now open.
Good morning, guys.
Good morning.
I was wondering if you could kind of just talk about some of the drivers of the increased loan yield in the second quarter. And also, I don't know if you gave the number of the payoffs in the commercial real estate portfolio.
First off, on the payoffs, we don't give a total number. But in the second quarter, they were about $100 million more than what we had been experiencing in the past. $20 million of the $100 million was non-accrued loans.
In terms of the second off of your question, in terms of the increase in loan yields, again, we have – 78% of our loan portfolio is either variable or adjustable. If you break that down further, of that 78%, 36% of that is tied to prime, 24% is tied to one-month LIBOR, 5% to six-month LIBOR and about 8.5%, 9% to one-year LIBOR.
So, as you've seen those rates go up, typically depending on when that variable rate loan resets, we usually see the full impact of that within about 30 days after the rate increase.
Okay, thank you. And then, on the deposit side, the Philadelphia branches that you'll be opening next quarter, are those expected to be a similar mix in terms of loan to deposit? Is it kind of a one-to-one in terms what you're running now or are you hoping to have more of a deposit generation capability in Philadelphia?
I think we are projecting that it will be similar. But, typically, you get some more loan growth ahead of the deposit growth. But we expect it to be similar to the rest of our footprint.
And then in terms of kind of keeping up with the deposit – with the long growth on the deposit side, any specials or programs you're running for time deposits or anything like that?
We really, since the first quarter, have been running a money market special.
Okay. That's all I have. Thank you.
Yes.
Thank you. Our next question comes from the line of Russell Gunther of D.A. Davidson. Your line is now open.
Hey, good morning, guys.
Good morning, Russell.
Good morning, Russell.
I appreciated the color on the loan growth guide for 2018. Just curious what you think the biggest potential headwinds out there are that would you keep from hitting that kind of mid-single digit annualized pace in the back half of this year?
Competition.
And that's primarily within the CRE or C&I as well?
It is in both. But CRE probably a little more than C&I just because you have a lot of – we have a lot of non-bank competition in CRE right now.
Okay, great. And then, just last one. Switching gears for me here, you guys mentioned the kind of overall improving credit performance in the quarter, touched on the commodities portfolio. As you look at the portfolio as a whole, are there any kind of pockets of weakness that have you concerned at this point in the cycle, be it an asset class or within your different geographies?
So, I would say, in general, no. We continue to watch our agricultural portfolio closely, although I think we did see some nice improvement this quarter. We continue to watch that pretty closely.
Got it. Sorry, just one last one here. With the kind of idiosyncratic credit event this quarter, would you guys undertake any sort of larger portfolio review within the loan book as a whole?
Yes, we've done that. And we're pretty confident that it was an isolated situation.
Very good. Okay, great. That's it from me. Thanks so much.
Thank you.
Thank you. [Operator Instructions]. Our next question comes from the line of Matthew Breese of Piper Jaffray. Your line is open.
Good morning, everybody.
Good morning, Matt.
Phil, I wanted to go back to your loan growth commentary. You noted commercial real estate is especially competitive. You noted some of the non-bank players. So, I guess, I want to get a sense anecdotally for how that is flowing through. Are you seeing lower spreads? Are you seeing relaxed credit and underwriting terms?
And then, as a follow-up to that, switching a bit to C&I, are your borrowers in that line of business behaving the way you thought they would post tax reform? And if not, what are you hearing from them?
So, first off, on CRE pricing, both of those items you mentioned, I'd say yes to. In addition to lower priced or lower rates, we're also seeing very long-term fixed rates. And we're seeing extended amortization. We recently saw a 10-year bullet loan.
And then – help me with the other part of your question.
The other part of the question was C&I, right?
Right.
If we were to, in our picture of the world, post tax reform, I think we would have pointed to C&I in borrowers potentially tapping lines of credit, growing their own businesses, and I wanted to get a sense for. Is that showing up? And if not, what are the –
I think that we've seen it so far, Matthew, is that our corporate deposits are being spent. So, they are running – there is pressure on our corporate deposits. The average balance per account is dropping. And I think that's the first step in this process. And so, the next step should be increased line borrowings.
Got it, okay. And maybe as a follow-up to that, if we are going to see a little bit less loan growth, is that going to be any change in strategy for the securities portfolio? Should we see some growth there as an offset?
No. This is Mark. Good morning, Matthew. I don't anticipate any change. Our general philosophy for the investment portfolio is not as much for earnings as is for liquidity. We are commercial bank that likes to take deposits and make loans. So, no, I don't anticipate any material changes to either mix or size of the investment portfolio over the next couple of quarters.
Okay. And then, on the reserve, over the past couple of years, it's come steadily down, slow, but surely, down to 1.07% of total loans this quarter. Where's the stabilizing point on that? And if you can give us any color in terms of your own thoughts on modeling on CECL, that would be helpful.
So, where that bottoms – it's a great question – I don't know that we have an answer to it. Our numbers are driven by our models, which are impacting – they're impacted by a number of factors, big factors, the migration of our risk gradings. And that continues to be positive.
And can you give any color or sense for you –
We're still working on CECL. I think we're making good progress. But I would say, it's still a little early for us to give you any kind of guidance on what the impact or provision would be.
Okay. Okay, that's all I had. Thank you very much.
All right. Thank you.
And 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.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. And you may all disconnect. Everyone, have a great day.