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Good day, ladies and gentlemen, and welcome to the Fulton Financial Second Quarter 2019 Results Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time [Operator Instructions]. As a reminder, this conference call maybe recorded.
I would now like to introduce your host of today's conference, Mr. Jason Weber. Sir, you may begin.
Thank you, Daniel and good morning. Thanks for joining us for Fulton Financial's conference call and webcast to discuss our earnings for the second quarter of 2019. Your host for today's conference call is Phil Wenger, Chairman and Chief Executive Officer of Fulton Financial Corporation. Joining 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 p.m. yesterday afternoon. These documents can be found on our Web site at www.fult.com by clicking on Investor Relations, then on News. The slides can also be found on the Presentations page under Investor Relations on our Web site.
On this call, representative of Fulton may make forward-looking statements with respect to Fulton'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 statement and forward-looking statements in our earnings release and on Slide 2 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'd like to turn the call over to your host, Phil Wenger.
Thanks, Jason, and good morning, everyone. Thank you for joining us today. I have a few prepared remarks before our CFO, Mark McCollom, share the details of our second quarter financial performance and discuss our 2019 outlook. When he concludes, we will open the phone line for questions.
Before I talk briefly about our second quarter performance, I want to highlight two important milestones we hit during the quarter. First, we consolidated our subsidiary bank, Fulton Bank in New Jersey, into our largest banking subsidiary Fulton Bank. And second, our remaining BSA/AML consent order was terminated, paving the way to finalize our strategic priority of consolidating all of our subsidiary banks into Fulton Bank. We plan on consolidating our remaining two subsidiary banks in September. Together achieving these milestones will not only help unify our brand, but also facilitate growth, going forward.
Now, I'd like to talk about our second quarter performance. Overall, we were pleased with our results, which were driven by strong fee income and continued growth in our consumer business. Our consumer business, we continued to see strong growth in our residential mortgage and indirect auto portfolios. Our residential mortgage portfolio has a balanced mix of -- in footprint, fixed and adjustable-rate mortgages with a weighted average borrowing credit score of approximately 750. And our indirect auto portfolio was comprised of inputs grant programs with a weighted-average borrower credit score of approximately 795.
Our commercial business continues to be impacted by an extremely competitive lending landscape. And we are seeing competition from banks, small and large, as well as non-bank lenders. Our commercial pipeline remains strong. So we are cautiously optimistic about our growth prospects for the remainder of the year.
Turning to credit. Overall asset quality continues to be relatively stable, despite a modest uptick in non-performing loans linked quarter. We believe the uptick in non-performing loans is not suggestive of a broader portfolio or macro trends. Our provision for credit losses was down slightly linked quarter and we also had net recoveries during the quarter.
Moving to fees. Non-interest income growth was strong linked quarter and year-over-year, reflecting seasonal growth, higher volumes, and continued sales efforts. We saw growth across most non-interest income categories. Mortgage banking income increased linked quarter and year-over-year on both improving spreads and higher originations. As rates moved down during the quarter, we did see a nice pickup in refinance activity in June.
Our investment management trust services income grew at a nice page linked quarter and year-over-year due to both overall market performance and our continued asset gathering focus. Brokerage revenue increased 16.5% year-over-year and continues to be one of our fastest growing segments in the business. The increase also reflects the acquisition of a small wealth management business in the first quarter. Our commercial loan interest rate swap income was up linked quarter and year-over-year on increased volumes and larger deals.
Turning to expenses. We saw a linked quarter increase on non-interest expenses, which was expected due to approximately $5.1 million in charter consolidation expense. Excluding those expenses, charter consolidation expenses, the efficiency ratio for the second quarter would have been 51.9%, which is lowest since the first quarter of 2013.
On the capital front, we paid a quarterly common dividend of $0.13 per share in the second quarter. We repurchased approximately $58 million of common stock during the second quarter. We had approximately $48 million left in our current share repurchase program, which is authorized through December 31, 2019.
At this point, I'd like to turn the call over to Mark McCollom to discuss our financial performance in more detail.
Thank you, Phil and good morning everyone. Turning to our earnings, unless noted otherwise, quarterly comparisons I will discuss with the first quarter of 2019.
Starting on Slide 4. Earnings per diluted share this quarter were $0.35 on net income of $59.8 million, an increase of $0.02 or 6.1% from the first quarter of 2019 and an increase of $0.15 or 75% from the second quarter 2018. As you may recall, during the second of 2018, we recorded $36.8 million provision for credit losses related to a customer fraud on a single large commercial relationship. I will now dive a bit deeper into the components of our earnings and provide you with some additional color.
Moving Slide 5. Our net interest income was $164.5 million, an increase of $1.2 million linked quarter, driven mainly by an increase in interest earning assets and an additional day of interest accruals during the quarter, partially offset by the impact of 5 basis point decrease in our net interest margin. In the second quarter, we saw our cost of funds increase at higher rate than our yields on interesting assets, reversing the trends we've seen in preceding course. In prior quarters, increases in the fed funds rate drove increases in our earning asset yields, while increases in the cost of funds lagged.
In the second quarter of 2019, yields on earning assets increased 2 basis points, while our cost of funds increased 6 basis points. Loan yields increased 4 basis points, while the cost of interest bearing deposits increased 7 basis points. Everyone is aware of the volatility in interest rates we saw during the second quarter. And that the likelihood of rate decreases in the second half of 2019 appears to be high at this point.
I would note that some of the impact of declining rates is already reflected in our second quarter results as approximately $7 billion of our loans are tied to various points in the LIBOR curve, and this curve declined sharply during the second quarter. I will provide more color on our net interest margin during our outlook discussion at the end of my comments. Growth in average loans linked quarter was $122 million for an annualized loan growth rate of 3%. Average deposits increased $100 million or 2.5% linked quarter annualized.
Turning to Slide 6. Our credit performance in the second quarter was mixed, but overall relatively stable. We had net recoveries of $1.5 million for the quarter as compared to net charge-offs of $4.1 million in the first quarter of 2019. Non-performing loans increased $9 million to $148 million. Non-performing loans as a percentage of total loans increased 90 basis points at the end of the second quarter as compared to 85 basis points at the end of the first quarter.
The provision for credit losses for the second quarter of 2019 was $5 million, slightly lower than the first quarter. The provision was $28.1 million lower than the second quarter of last year, which was driven by the aforementioned commercial relationship. The allowance for credit losses as a percent of loans increased linked quarter to 1.08% from 1.05% at the end of the first quarter. However, the coverage of the allowance to non-performing loans decreased to 120% from 123% last quarter.
Moving to Slide 7. We had a very strong quarter with respect to fees as our non-interest income, excluding security gains, grew $7.5 million or 16% linked quarter. Some of this increase was attributable to seasonality, particularly in consumer card income and overdraft fees, as well as merchant and commercial card income. Mortgage banking income increased $1.8 million or 38%, driven by increases in the volume of sold loans, as well as improvements in spreads. Increases were also realized in commercial loan interest rate swap fees and also in SBA loan sale gains, which are included in other commercial banking income on our income statement.
Moving to Slide 8. Non-interest expenses were $144.2 million, an increase of $6.3 million from the first quarter. Included in non-interest expense in the second quarter were expenses related to charter consolidation activities totaling $5.1 million with $1.6 million of this total in salary and benefit expense, $2.7 million in other outside services and the remainder in various expense categories. This compares to total charter consolidation costs of $1.5 million in the first quarter of 2019, which were primarily reported in other outside services. Excluding these charter consolidation costs from both periods, expenses would have increased $2.7 million or 2%. And our efficiency ratio for the second quarter would have been 61.9% as compared to 64.2% in the quarter.
Salaries and employee benefit increased $1.2 million, or 1.6% as the aforementioned charter consolidation costs and increases resulting from normal merit increases during the quarter were partially offset by lower health insurance expense due to favorable claims experience. Increases were also seen in net occupancy expense, data processing and software, as well as marketing expense. Professional fees decreased compared to the first quarter of 2019. For the second quarter of 2019, our effective tax rate was 14.2%, which is a decrease from the first quarter of 2019.
Moving to Slide 9. Slide 9 displays our profitability and capital levels over the past five quarters. Returns on assets and equity were higher this quarter due to net income growth. Our tangible common equity ratio remained strong.
Lastly, we have included our guidance for the remainder of 2019 on Slide 10. This is unchanged from what we've provided last quarter except for net interest income and margin, as well as our non-interest outlook. For net interest margin, we were pleased to start off the year with margin expansion in the first quarter stronger than we have guided. However, the outlook for near-term rate decreases and the significantly flatter yield curve have caused us to be more tempered in our outlook for the balance of the year. Therefore, we are now expecting our net interest margin to increase 2 to 5 basis points for the full year 2019 versus our full year 2018 net interest margin, which was 3.4%.
We are also tempering our outlook for net interest income to a mid single-digit growth rate for the full year 2019. Our non-interest income based on our year-to-date results through June and our expectations for the remainder of the year, we are changing our outlook for a mid single-digit growth rate for non-interest income for the full year 2019.
And with that, I'll now turn the call over to the operator for questions. Denial, could you help please?
Thank you [Operator Instructions]. Our first question comes from Chris McGratty with KBW. Your line is now open.
Mark, maybe I'd start with a margin question for you. The updated guidance, what does that assume? Is that assuming the forward curve, or maybe timing of rate cuts?
Yes, we had assumed, if you recall, Chris, going back, we had assumed in our guidance at the beginning of the year that there would be two rate increases. We've now revised that that in this revised guidance we're assuming two 25 basis point decreases, one in July, one in September, is in this refresh items.
And on the loan growth comment, so you talked about cautious optimism for the back half of the year. Looking at the source of growth in the first half, it continues to be more biased towards resi mortgage. Could you speak to either conversations you're having with your borrowers and maybe the source of growth in the back half of the year? Or should we be expecting more of the growth will be resi-loaded? Thanks.
So, our pipelines to continue to grow, Chris. We were -- our second quarter growth was, again, hampered by large payoffs. We did have a $15 million increase linked quarter in payoffs, about half of that actually was criticized and classified loans. So, going forward, I think we see the growth to be a little more mixed than it was in the second quarter. So we do expect to see continued growth on the consumer side but we also expect to see C&I pickup.
And maybe a question on expenses. Just so I'm clear, the guide for the year, is that off of the reported number of 5.46 last year, or are there any other adjustments that you, given the charter consolidation and the branch charges, that will be excluding from that starting point?
It was also reported number for last year and then excluding charter consolidation cost for this year.
And year-to-date, those -- I don't have metrics in terms of, Mark, the charter consolidation cost have been how much?
Yes, year-to-date, we're at 6.6. I would expect last quarter we had given guidance that that number will be about $9 million. I think that number is going to be closer to $11 million to $11.5 million, Chris. And that is principally due to, as we've dug a little bit deeper, we think there's going to be a little bit of expense savings but that's going to require some upfront costs. And there's also going to be a very small write off on the intangible asset as well.
So an additional $5 million in the back half of the year. But the guide is, the 5.46 ex-middle of 9 bucks, okay…
Chris, most of that should be in the third quarter.
Third quarter, yes.
And maybe last one on capital, given the progress you made in the BSA? Could you offer updated thoughts on acquisition. Obviously, bank stocks have been little bit out of favor. But any conversation you might be having and strategy would be appreciated. Thanks.
So, we continue to be interested in looking at acquisitions but we're also committed to remaining disciplined in that approach. So, we'll see. We want to make strategic acquisitions inside our footprint that enhances our market share. And so as those opportunities come available, we'll be active. But again, we will stay disciplined.
Thank you. And our next question comes from Frank Schiraldi with Sandler O'Neill. Your line is now open.
Good morning. Just a follow-up on the NIM, Mark, just based on your comments and the number of rate cuts you guys have now baked into expectations. Just back the envelope, I'm thinking about -- I'm trying to quantify what a given 25 basis point rate cut might be worth to you guys in bps in margin. Is it -- how do you think about it? Is it fair to say 2 to 3 basis points as perhaps comes off the margin for every -- for 25 basis point cut, is that fair? Or just hoping to try and quantify that further?
Frank, I always hesitate to talk about in basis points, because there're so many levers. We have -- obviously, some of our loans are tied to LIBOR where we've already seen some of those decreases. We have $5.4 billion of loans either prime, which would reset depending on where we are in the cycle. We've got -- throughout the year, we got $800 million, so $1.1 billion of deposits that are also indexed and would reset immediately.
And then the big question, I think not just us but the entire industry is facing is that, what do we do now with the back book or deposits when we're now all the sudden really in whipsaws here and going from the possibility of rate increases to rate decreases. And we're looking at that very thoughtfully right now. But I think as a starting point, I think your number is not a bad place to start, but where its end up is going to depend on how much we can pull those levers ultimately.
And I mean is the thinking at this point, when you get a rate cut that you try immediately to pass some of that onto depositors and see what results you get in terms of attrition. Is it more of a wait and see approach? How to think about that?
I wouldn't say it's a wait and see approach, because we've already again -- I mean, some of the impacts, we have $5.5 billion of loans tied to one month LIBOR. And what's happened to one month LIBOR during the second quarter, right? So, some of the reason for the change in our guidance is because of that impact. So, we've been looking at that impact and addressing it currently.
And then just as it pertains to buybacks. In the past, you talked about buybacks depending upon growth opportunities. And sounds like you guys have strong pipelines but there's also significant competition out there. So just wondering how you guys are thinking about given how you see the environment currently. How you're thinking about buybacks in the back half of the year? Do you think you could be as aggressive as things stand now as you were in the second quarter, or what's the thinking there?
I think that we believe that we'll continue to be as aggressive as we've been in the second quarter.
Thank you. And our next question comes from Austin Nicholas with Stephens. Your line is now open.
Maybe just taking a look at the occupancy expense, I think it was little bit higher than maybe I was looking for. Can you maybe just provide us some guidance on where we should see that number trending? I know you closed some branches in the first quarter also have opened a few. So maybe if we weigh those two things, how we should think about that number as we look forward?
Yes, sure. I think second quarter had some discrete items related to timing of invoices and those sorts of things. I would expect for the guide, going forward, look at maybe the prior four quarters and maybe just increase that a little bit, to account for net square footage increase across platform. But I think going back to something that's just a little bit above where we were in the prior four quarters would be the guide.
So, they're not going to be a huge meaningful I guess cost saves from the branch closures that already happened I guess net it with the openings since that kind of there just that...
Yes, correct. Remember, we obviously opened four branches. And so the net impacts would have been not the large five, five that we've opened.
And then just on the FDIC insurance. Is that a good run rate here, or is that going to be reevaluated a little, given more assets under the $10 billion charter?
No, I think that's a reasonable run rate for now.
And then maybe just broader picture on the balance sheet positioning, you've reduced your asset sensitive position a bit over the last several quarters. Can you maybe talk about how you're positioning for interest rates just on the balance sheet as a whole and maybe anything you're doing on the securities book?
Yes, I mean, we have been taking very mild steps to expand duration, which obviously helps us when we're asset sensitive overall book to bring that back to a more neutral posture. We are also evaluating opportunities where, and again in small measured ways where, when you have the curve flattening the way it does, it creates opportunities that you might have, small pockets of your wholesale portion of your balance sheet that's actually at close to zero or negative carry. So, in cases where that exists we'll be opportunistic to take those off and either just shrink in a very small amount on the wholesale book or takes some off and then replace at higher spread.
And then maybe just one last one on, I know you mentioned $7 billion of loans tied to somewhere on the LIBOR core curve. But I guess more, specifically, maybe what percentage of that is tied to 30 day? And then on the -- maybe just the deposit side, can you maybe provide for us the level of deposits that are just indexed to short-term 30 day rates?
So we have about $5.5 billion tied to one month LIBOR. We have $1.2 billion, $1.3 billion tied to one year LIBOR. But those will actually reset over the next year as those reset days come do. And then we have another $300 million tied to five year LIBOR, same thing which will reset during our next reset date but aren't the commercial loans that are resetting. And the on the liability side, really what we have is -- again, it's going to fluctuate throughout the year with our municipal deposit book, but it's going to be between $800 million and $1.1 billion that are indexed municipal rates.
Thank you. And our next question comes from Joe Gladue with Alden securities. Your line is now open.
Just one more question, I guess, on net interest margin more on the deposit side. As interest rates have gone up, we've seen a shift in the mix of deposits from non-interest and other core deposits into brokered and CDs. Just wondering if in your guidance, you assume any with interest rates, Fed rate cuts now, you see any change in that trend and move back to core deposits at all, or is any of that assumed?
No. We did assume that our long term rates, the guidance we've previously given that holds intact. We have tweaked our mix a little bit but the overall growth rate on deposits how we expect to remain the same.
Thank you [Operator Instructions]. Our next question comes from Russell Gunther with D.A. Davidson. Your line is now open.
A quick follow up on the margin. So embedded in the guidance beyond the funding that's tied to fed funds. Are you guys assuming an ability to reduce deposit costs?
Yes. So we are assuming that, again, some of that existing book that we are going to be testing, learning adjusting. But there is an assumption certainly as rates decline that we're going to be opportunistic about that.
And then switching to the expenses. So I hear you on the update on the charter consolidation. We're now looking for a total of 11 to 11.5. You also mentioned though some related cost saves. So, could you quantify for us what the net impact would be? So gross upfront, the 11, 11.5? What would be net out from it related saves?
I think we'd said in prior quarter, Russell, that most of the costs, I mean, we've been operating as one bank for a long time within our back office. So while there will be some advisory board consolidations and very small savings there. But I mean I would put the total savings from our charter consolidation, so part of our cost savings to be $1 million or less.
And then onto the asset quality side, I hear you on the unchanged guidance there as we think about the provision, going forward. But could you just give us an update on your ag portfolio and what's embedded in that stable asset quality outlook?
So, I would say that our ag portfolio has stabilized. And so we don't see it really having a major impact on our asset quality, going forward.
And then just last one for me. On the commercial loan growth, you guys mentioned feeling better about the back half of the year with the pipeline there. Could you just give us a sense for geographic or regional pockets of strength in that pipeline?
So, our strongest area in regards to the pipeline right now is Maryland. And that probably be followed by Pennsylvania, and then Virginia and New Jersey.
Thank you. And our next question comes from Matthew Breese with Piper Jaffray. Your line is now open.
First, I wanted to just hone in on non-interesting income, the increase in fees this quarter. A lot of different items there that all moved your way, a lot of which you noted was seasonal. And so, thinking about the $7.5 million quarterly increase. If you had to gauge how much was seasonal and therefore subject to volatility or reduction. How much would you say that was versus what's should be included on a run rate basis?
Well, just to be clear, that seasonality that we're talking about really applies to the first quarter. So, I don't think there is much effect for the remaining two quarters based on seasonality.
And then maybe we can hone in on some of the items that were more profitable this quarter, such as swap fees, merchant card income, just a ramp higher in terms of run rate, or like the $6.5 million from merchant card, the $3.5 million from commercial swap fees. Are those figures we should expect at least in the near-term through year-end?
Yes, definitely on the merchant side. The swap side can be a little volatile based on volumes but given our backlog right now, we feel comfortable that they'll hold.
And then, Phil, just going back to your initial comments, I mean, it sounds like the loan growth environment just remains super competitive. And I wanted to get a sense for how that competition looks, if you're losing loans or you're losing them in terms of rate and structure, or is it duration. And then if you are losing loans, do you feel like your competitors are just taking lower levels of profits? Or are they actually putting, at this point in the cycle, credit risk on the books?
I think the answer to every one of those is yes. So, rate, terms, which would include duration. I think folks are taking less profit and I also think they're taking on more risk.
And then thinking about your forward rate outlook and the potential for lower costs. Are you yet seeing the opportunities to lower deposit costs are there green shoots showing up on that front? And if so, could you just give us an idea of what those products are? Are they the longer duration CDs, or are you getting to the point where you can reduce money markets rates and short duration products?
I'll comment on two fronts there, Matt. One, we are seeing opportunities now to do so. And when you look to -- when you first started to see signs of rates changing, it was really in the promotional money market rates. And it was first really the online banks really started to lower their rates. And I think that that allow a lot of the other brick and mortar competitors to follow suit.
On a go forward basis, we are looking at all categories of deposit rates. And selectively, again, it was testing and evaluating if that changes attrition rates or new acquisition rates to lower them. So, the answer to your question is yes. We are seeing opportunities across the board to do so.
And then just balancing that versus the NIM outlook. First quarter was a pretty high mark, 3.49, NIM were down 5 bps this quarter. I understand it can still be up year-over-year. But if we do circle into a fed cutting environment, is it likely that the NIM is peaked for this interest rate cycle?
That's hard to say. Again, we're all talking about a rate decrease. We're seeing the first rate -- actual rate cut yet, right? So we need to see how many. We need to see what customer psychology is around those rate cuts and as some of the initial testing that we're able to do on deposits, whether that doesn't materially change our new acquisition rates and change our attrition rates then we might be able to do more. So I think it's early to answer that question, but it's something we're very focused on.
Just my last one. CECL is very close, at this point. And I would love any updated commentary there. I think we're all anxious to hear where the pro forma allowance and go forward provision, how those items will look. Can you provide any updated commentary and thoughts there?
We are providing any commentary in terms of disclosure and any financial forecast yet for what that number will be. We are very far long and have had a team of people working really hard for the past year plus on this. And we have had some third-party consultants signed to help us with pieces of that, and they are gone at this point. So, our internal team is just finalizing things. And you can expect over the next six months once we get in a position that we're ready to announce something in advance of the adoption date, we'll do so.
Just curious the consultants are out versus the initial expectations. Should we expect CECL to be worse or better than what the industry had thought going to it?
Well, I think what I've seen from the largest banks that have reported is that there is still a very wide variance even for what would appear on the surface to be relatively similar books of business, right. So, we are being cautious in terms of any numbers that we share with folks. And so we have had ample time to really stress it. There are, as you I'm sure well aware, there are a lot of levers in that standard. And we just want to make sure that we've done sufficient stress testing around each of those levers before we're in a position to put out what our estimate would be.
Thank you. And I am not showing any further questions, at this time. I'd now like to turn the call back over to Phil Wenger for any closing remarks.
Well, thank you all for joining us today. We hope you will be up with us when we discuss third quarter results in October.
Ladies and gentleman, thank you for participating in today's conference. This concludes today's program and you may all disconnect. Everyone, have a wonderful day.