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Good morning, ladies and gentlemen, and welcome to the Fulton Financial's Second Quarter 2021 Results Conference Call. [Operator Instructions] As a reminder, this conference call may be recorded.
I would now like to turn the conference over to your host, Mr. Matt Jozwiak, Director of Investor Relations.
Good morning, and thanks for joining us for Fulton Financial's conference call and webcast to discuss our earnings for the second quarter of 2021. Your host for today's conference call is Phil Wenger, Chairman and Chief Executive Officer. Joining Phil are Curt Myers, President and Chief Operating Officer; and Mark McCollom, Chief Financial Officer.
Our comments today will refer to the financial information and related slide presentation included with our earnings announcements, which we released yesterday afternoon. These documents can be found on our website at fult.com by clicking on Investor Relations and then on News. The slides can also be found on the Presentations page under our Investor Relations website.
On this call, representatives 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 on 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 in Slides 10 and 11 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.
Well, thanks, Matt. Good morning, everyone. I'll begin today's call by making a few high-level remarks about our performance for the quarter and factors affecting the markets we serve. And then Curt will discuss our business performance, and Mark will share the details of our financial performance. And after that, we will answer any questions you may have.
Fulton's performance continued to be solid in the second quarter of 2021 following our record-setting earnings per share of $0.43 in the first quarter our second quarter earnings per share of $0.38 tied our previous record high. And we saw growth in certain segments of our business, as Curt and Mark will discuss, and asset quality remains stable.
The economy and the markets we serve are showing improvement. Unemployment is in decline and the communities are reopening. In fact, as of July 4, the governments in the 5 states in which we operate have lifted mask requirements for everyone. As the economy continues to open and business activity moves closer to normal, we are increasingly optimistic about the future.
In recent months, we have seen several mergers and acquisitions in and around our market. Fulton has taken a look at a few of these opportunities, and we remain interested in supporting our growth through M&A. We will continue to evaluate future opportunities to identify those which would be a good fit for our strategy and our community-oriented style of banking.
As always, we remain focused on our shareholders and will remain disciplined on pricing. To the end of the second quarter, we have not repurchased any shares under the $75 million share repurchase authorization approved by the Board in February, but we continue to assess share repurchase opportunities.
Throughout the past year, I've referenced the challenges brought about by COVID-19. I'm extremely proud of how our entire team adapted to these challenges. Through their efforts, we were able to support our customers through the most challenging of times. Now more than a year after the pandemic began, we are pleased to see more people becoming fully vaccinated, our communities reopening and life starting to return to some sense of normalcy.
Given this improvement, we are now looking forward to bringing more of our own team back to on-site work in early September. While some employees will be permanently remote, most will return to some level of on-site or hybrid work. The ability to connect an in-person strengthens relationships and our culture, which, quite frankly, sustained us during the pandemic and allowed us to continue to focus on our customers.
Now, I'll turn things over to Curt to discuss our financial performance.
Well, thank you, Phil, and good morning. As Phil noted, our second quarter performance produced solid results, and I'd like to share some detail on several key areas. Loan growth for the quarter was approximately $170 million or about 4% annualized, excluding the impact of PPP loan forgiveness and originations. We benefited from the diversity of our business model as strong loan growth from residential mortgage lending offset declines in our commercial business.
First, let me talk about the PPP program. PPP originations for Wave 3 ended up at $750 million beyond our original expectations, with $60 million originated in the second quarter and $690 million originated in the first quarter. Our average Wave 3 processing fee was 4.5%, which was also well above what we had originally anticipated.
While the PPP program has ended for new originations, we continue to focus on loan forgiveness needs of our small business customers. In the second quarter, we processed $639 million of PPP forgiveness request and have remaining Wave 1 and 2 outstanding balances of approximately $360 million. In total, we have $1.1 billion in outstanding PPP loans as of June 30 and $35 million in processing fees yet to be earned.
Turning to commercial loans. Commercial real estate showed modest growth, while other commercial categories declined, resulting in an overall decline in the commercial balances of $127 million on a linked quarter basis. When excluding PPP loans, we continue to experience commercial loan headwinds due to persistent low line utilization and prepayment activity. Our commercial loan pipeline is down linked quarter, but consistent with year-end levels. In recent weeks, we have experienced growth in the pipeline, consistent with all of our markets reopening. We remain cautiously optimistic that commercial loan demand will improve as business activity and customer confidence increase.
In consumer lending, our loan balances grew $284 million or 5.8% linked quarter on an ending balance basis. This growth was driven primarily by residential mortgages. As noted in prior quarters, our asset-sensitive balance sheet provides room to continue growing this segment of high-quality in-market residential mortgage loans. Overall, we anticipate loan origination levels to continue at a rate that is adequate to support the annual net interest income guidance in our outlook.
Turning to deposits. Growth for the quarter was modest; however, total deposit balances are up $4.3 billion or 25% since pre-pandemic levels. During the quarter, we continued to actively manage our deposit costs down, and we are encouraged by the work of our team and the loyalty of our customer base. Our total cost of deposits for the quarter was down to 15 basis points.
Moving on to fee income. Wealth Management, Commercial Banking and Consumer Banking fee-based businesses all delivered growth in revenue on a linked quarter and year-over-year basis.
Our Wealth Management business continues to perform very well. During the quarter, we purchased a small investment advisory firm, which helps support the growth of our Wealth business. Our assets under management and administration grew to $13.7 billion at quarter end, up from $13.1 billion last quarter and $11.1 billion at the end of the second quarter of 2020. These trends drove record quarterly Wealth Management income for the third quarter in a row.
Turning to mortgage banking business. Originations were $875 million for the quarter, an increase of 22% from the first quarter. However, a significant decline in gain on sale spreads combined with continuing to hold an elevated amount of loans on the balance sheet led to an overall decline in mortgage banking revenue linked quarter.
In addition, the decline in longer-term rates also led to a $2 million increase to our mortgage servicing rights valuation allowance, further reducing overall mortgage banking income. Overall, the mortgage banking business remains strong as we continue to experience solid origination activity and opportunities to either sell or conforming loans in the secondary market or increase our balance sheet with this product.
Purchase activity represents approximately 60% of total originations and has steadily increased in recent quarters. The mortgage pipeline sits at $620 million, remaining more than 2x our pre-pandemic levels. Capital markets revenue, which are primarily commercial loan interest rate swap fees declined in the second quarter. This decline was partially driven by our willingness to provide longer-term balance sheet fixed rates. We expect swap revenue to return to more historical levels as we move forward. However, this is dependent on customer preferences, commercial loan demand and interest rate expectations.
Moving to credit. Asset quality remains stable. Delinquency remains low. Nonperforming loans were flat linked quarter and remained relatively stable. This is prior to the beginning of the pandemic. Net charge-offs were $6.9 million or 15 basis points for the quarter, this compares to $6.2 million or 13 basis points of net charge-offs in the first quarter.
On Slide 13, we have again provided updated loan deferral trends through June 30, 2021. Commercial deferrals further declined to approximately $122 million and stand at 0.9% of the commercial portfolio. Consumer loans on deferral and forbearance also declined and are now at $57 million or 1.1% of the consumer loan portfolio.
In previous calls, we noted selected industries, we believe, may be at more risk due to COVID-19. Slide 15 provides an updated summary of these selected industries. Overall, our credit outlook remains cautiously optimistic for the remainder of 2021. And as a result, we have further reduced our 2021 provision for credit loss outlook.
Now, I'll turn the call over to Mark to discuss our financial results in more detail.
Thank you, Curt, and good morning to everyone on the call. Unless I note otherwise, the quarterly comparisons I will discuss are with the first quarter of 2021.
Starting on Slide 3. Earnings per diluted share of this quarter were $0.38, while net income available to common shareholders was $62.4 million. This represents a decline of $0.05 per share versus the first quarter of 2021. Our second quarter performance included a slightly lower net interest income as well as lower noninterest income, offset by negative provision expense and lower operating expenses, which I'll cover in more detail later in my comments.
Moving to Slide 4. Our net interest income was $162 million, a $2 million decline linked quarter, mainly due to less fees earned on PPP loans forgiven during the second quarter as compared to the first quarter. Forgiveness for the quarter was $639 million, and this represents only Waves 1 and 2. Wave 3 is not expected to begin requesting forgiveness until late in the third quarter and into the fourth quarter of 2021. The latest wave of PPP loans also have a larger average fee, 4.5%, due to a smaller average loan size for this wave of funding.
As of June 30, we have approximately $35 million of PPP loan fees yet to be recognized, $4 million coming from the 2020 originations and $31 million from our first and second quarter originations this year.
Turning to the investment portfolio. We selectively redeployed some of our excess cash into mortgage-backed securities and short-term money market instruments. As a result, investments grew $308 million during the second quarter.
As Curt noted, we saw deposits grow by approximately $90 million on an ending balance basis, and our cost of deposits for the quarter was only 15 basis points, a decline of 3 basis points linked quarter. We would expect our deposit cost to still migrate moderately lower in future quarters as we have approximately $660 million of CDs maturing over the next few quarters at a cost of approximately 80 basis points, which is significantly higher than current market replacement costs. Our average loan-to-deposit ratio declined during the quarter from 89.9% in the first quarter to 86.9% in the second quarter.
As I discussed last quarter, Fulton completed a balance sheet restructuring, which reduced our interest rate risk and improved several of our performance metrics going forward. This restructuring was fully reflected in the second quarter and is incorporated into the updated guidance I will provide at the end of my remarks.
Our net interest margin for the second quarter was 2.73% versus 2.79% in the first quarter. The 6 basis point decline linked quarter was largely a result from lower PPP loan fee recognition as well as additional cash on our balance sheet.
Turning to credit. On Slide 5, our second quarter provision for credit losses was a negative $3.5 million versus a negative $5.5 million for the first quarter and a positive $20 million a year ago. Compared to the year ago period, the initial impact of COVID had a significant impact on our allowance for credit losses in the first half of 2020. But as the economic outlook continues to improve, the amount required in our allowance for credit losses has declined. As always, this could change in future periods based on new loan origination volumes, loan mix, net charge-off activity and the economic projections.
Slide 5 also shows our normal quarterly credit metrics. Our allowance for credit losses, excluding PPP loans, has declined 14 basis points since the end of last year and currently stands at 1.46%.
Moving to Slide 6. Noninterest income, excluding securities gains, was $52 million, down $10 million from last quarter and down $1 million from a year ago. Our fee-based revenues showed modest increases in wealth management, commercial banking and consumer banking, but were outweighed by a decline in mortgage banking revenues. Mortgage banking revenues were impacted by a decline in gain on sale spreads of 114 basis points linked quarter, down to 1.85% after spending much of the past year at approximately 3%.
We also elected to portfolio about $230 million of salable mortgages onto our balance sheet thus far this year. This has impacted our short-term mortgage banking revenues, but may provide a significant long-term benefit to net interest income versus the purchase of investment securities.
Lastly, our MSR asset was $36 million on the balance sheet at June 30. This balance is net of a $6.5 million mortgage servicing rights valuation allowance. As Curt noted, during the quarter, we recorded an addition to the valuation allowance of $2.2 million due to a decline in longer-term interest rates. Wealth Management revenues were $17.6 million for the quarter, an increase of 1.7% from the first quarter and an increase of 31% from the prior year.
Moving to Slide 7. Noninterest expenses were approximately $141 million in the second quarter, down $38 million linked quarter. This decline was largely due to $32 million of debt extinguishment costs we recorded in the first quarter related to our balance sheet restructuring. Excluding those items, our remaining expenses declined approximately $5 million, primarily due to lower salaries and benefits expenses compared to the prior quarter. This was due to lower bonus accruals, the full quarter impact of our cost reductions and the absence of a onetime COVID bonus paid to frontline personnel in the first quarter of 2021. We also saw seasonal declines in occupancy expense of approximately $1.5 million.
Our effective tax rate was 16% for the quarter, consistent with the first quarter. Slide 8 gives you more detail on our capital ratios. As of June 30, 2021, we maintained strong cushions over the regulatory minimums, and our bank and parent company liquidity remain very strong.
On Slide 9, we provide our updated guidance for 2021. We expect our net interest income to be in the range of $640 million to $660 million. We expect our provision for credit losses to be in the range of $10 million to $20 million. We expect our noninterest income to be in the range of $220 million to $230 million. And we expect operating expenses, excluding charges related to the balance sheet restructuring, to be in the range of $560 million to $570 million for the year.
Lastly, we are aware that many of you look at pre-provision net revenue, or PPNR, as a key metric to assess the profitability of core operations. We also know that many of you calculate this metric differently. We've included our version of this metric in the financial tables of our press release.
We would also like to point out a couple of additional items to consider as you assess our PPNR results. First, our PPs earned have declined $7.5 million from the first quarter to the second quarter. Also, MSR valuation allowance adjustments resulted in an $8.3 million swing from a $6.1 million decrease in the valuation allowance in the first quarter to a $2.2 million increase to the valuation allowance in the second quarter. When considering these additional items, we believe our PPNR has shown marked improvement from the first quarter to the second quarter as a result of our first quarter balance sheet restructuring, earning asset growth and better cost containment.
With that, I'll now turn the call over to the operator for questions. Ashley?
[Operator Instructions] And your first question comes from Frank Schiraldi with Piper Sandler.
Good morning. Just wondered, I realized that there hasn't been any change to NII guide. Just wondering about some of the moving parts there. And I wondered if you could talk a little bit about outlook for loan growth and within that commercial loan growth in the back half of the year?
Yes, Frank, for the NII guide, there is -- as you've seen so far this year, we've recognized $19.5 billion and $11.5 billion in PPP fees in the first 2 quarters of the year. We still have $35 million to go -- and the timing of that, I mean, we have our own estimates as to when that will be recognized, which may differ from yours. But we would anticipate to possibly see a slight decrease in PPP fees in the third quarter and then have that step back up again in the fourth quarter just based on the timing of this third wave of PPP recognition.
And then we've seen results now through the first half of the year. We would expect business results to improve in the back half of the year, and Curt can give you more color on that.
Yes, Frank, we look at originations -- commercial originations in the first 2 quarters. They were pretty consistent. The second quarter, we saw elevated prepayment activities. So I think the growth, as we look forward, would be based on what prepayment activity is. The pipelines have been building over the last 6 weeks. And as things reopen and business activity increases, we do think pipelines will continue to grow. So we think we have more momentum in the second half. I think the growth will depend though on those prepayment factors.
Just as an additional information, car dealers. Our floor plan portfolio linked quarter was down $70 million because car dealers can't get cars. So floor plans are not as utilized as they were. So things like that can provide us some momentum in the second half.
Okay. And then you mentioned, Phil, you've looked at some of the deals in terms of M&A that have taken place in the market, is it fair to say that you feel you can more actively pursue deals in the back half of the year, given your confidence level now on the macro environment? And I wondered if you could just remind us of what's sort of too small in terms of asset size to pursue in terms of whole bank deals? Thanks.
Yes. I mean, I think we'll be as active as there are opportunities, Frank. And I think they will continue in the second half of the year. We'd like to be looking at banks over $1 billion. But wouldn't be impossible that we could look at something smaller that was really strategically positioned well within our footprint.
Your next question comes from Daniel Tamayo with Raymond James.
Good morning, guys. If I could dig into the NII from the NIM side a little bit. What is your assumption for excess cash levels? It sounds like they increased again in the second quarter. What is your assumption for those levels within the guidance for the rest of the year?
In our guidance is that they tick up a little bit again during the third quarter because that's when we tend to see our [muni] business at its high watermark for the year and then coming back down a little bit in the back half. But candidly, we don't see much decline in the excess cash levels because I think as an industry, we've been wrong as an industry as to deposit levels. And deposit levels continue to stick around longer than we anticipate. So we're -- while we'd like to run with a lower level of cash than we currently have, I think the expectation is going to remain elevated certainly through the end of the year.
Okay. And then switching over to fee income, I heard the comment you made about the interest rate swaps within capital market income going back to normal. What kind of environment do you need for that? Do you need rates to go up from here or do you think this level of swaps would be kind of the run rate, assuming we don't get an interest in rates or even without that, you think that this was a depressed level in the second quarter?
Yes. Dan, it's Curt. Just a little more color there. The second quarter was a light quarter for us. We were putting more fixed rate loans on the balance sheet. We are continuing to offer that. It really comes down to loan origination mix and larger deal mix and types of loans. So we do think linked quarter as we look at the third quarter will be stronger. And again, just to remind you, we're coming off the high watermark. I think we did $16.8 million in last year, which was our best year ever from that. We do expect it to moderate from there. But again, the second quarter was light.
Your next question comes from Russell Gunther with D.A. Davidson.
I wanted to -- just a follow-up on expense comments earlier, see if I caught this right. So you guys have done a really nice job keeping a lid on that and the recent initiatives. Could you just remind us of those previously announced, are they fully in the run rate now as of the second quarter or is there more to come?
Yes, they are fully in the run rate. But remember, Russell, when we announced that $25 million, we did say that we were going to invest a portion of that into some of our digital technology initiatives. So if you look at our income statement, you can see on the category for data processing and software, you can see the first 2 quarters of this year, that's been running anywhere from $1 million to $2 million higher per quarter than what our run rate was in the prior year. So that's going to be the one offset to those cost savings. But other than that, yes, you should expect them to be fully in the run rate.
Okay. That's helpful, Mark. And then I guess as you look out and start thinking about 2022, do you contemplate additional initiatives to continue to keep a tight lid on expenses? Are there opportunities to do something similar going forward?
I think there will be constant reinvestment in our franchise, but I don't anticipate there being investment in the franchise that's going to change the trajectory of our expense levels. I would expect at this point that there would be nominal increases in certain categories, but nothing materially off the run rate that you've seen.
Okay. That's great. And then just switching gears, Phil, you touched on the buyback a bit in prepared remarks and with the discussion around M&A. I mean, how should we think about you guys being active or not with repurchases? Is it more a hope to land a deal and so we shouldn't expect to see it in the market or how are you guys contemplating that?
I'd say, Russell, it would be driven more by the price of our stock. So we do think we have enough capital to do a deal and buyback, but we want to do both of them at the right price.
Okay. Understood. And then just a reminder as to sort of what that price to tangible book multiple or earn back is for repurchases for you guys?
Yes. So if you look at kind of current levels for us right now, that ends up being a TBV dilution earn back of about 2.2 to 2.5 years, if you're kind of in the mid-15s right now, which is fairly attractive relative to certain M&A transactions, so it would be kind of equivalent to buying a bank that's kind of in that more $120 to $130 a tangible book well.
Your next question comes from Erik Zwick with Boenning and Scattergood.
First question, I guess for Mark, maybe on your comments about the gain on sale margins declining for the residential mortgage. I think you said from kind of the 3% range down to about 185 or so. Now, curious, is that largely just market dynamics? Or has there just been a change with you holding more of those loans on your balance sheet and what you're putting into the secondary market. Curious what's impacted that? And then I guess second part would just be, do you think those gain on sale margins settle out here in this range? Or is there more downward pressure as we move through the year?
Yes. Yes. I think it's more been -- I mean while we have shifted the mix a little bit in terms of our originations, have shifted a little bit from last quarter. They're about 49% purchase, 51% refi to this quarter, they were 60% purchase, 40% refi. So there's been a little bit of a shift in terms of product type, but I would say it's more just a demand of our product has driven down gain on sale margins.
And if you look back to where we were sort of first quarter of '20 and earlier, so going back to pre-pandemic, you had a 4- or 5-quarter stretch there. Our gain on sales spreads were fairly tightly banded between about 135 basis points and 155 basis points. We would expect and our original expectations internally, was that it was going to migrate back to that by the end of the year. I think things came down a little bit more quickly than we anticipated in the second quarter. But I think where we're going to end up by the end of the year is still going to be in line with our expectations for spreads.
That's great detail. And then the second question for me. Phil, I believe in your prepared remarks, you mentioned that you're bringing more of your workforce back to the office starting in September, but there'll still be a component works remotely. Curious what that ultimate kind of percentage of employees that will work remotely will be kind of compared to pre-pandemic levels? And how that makes you think about your real estate needs going forward over the mid- to long term?
Yes. So pre-pandemic, I'd say we had a few people who worked remotely. As we are moving forward, I'd say 6% to 10% of our staff will be fully remote. A big chunk will be hybrid. So we will be looking at all our real estate. And I would suspect over time it would decrease.
[Operator Instructions] And your next question comes from Matthew Breese with Stephens Inc.
I was hoping for a little bit of more detail on the interest rate sensitive loan portfolio. So last quarter, you provided that, I think you had $12.6 billion of loans, either tied to prime or LIBOR. How much of that is subject to floors where you wouldn't benefit from higher rates until rate hike 2 or 3? And maybe talk a little bit about the last rate cycle, where we really didn't see loan yields inflect until the second or third hike along the way? Any differences this time you expect?
Yes. So Matt, we have about $2.5 billion of loans that are currently at their floors. We have total loans with floors, its about $4.8 billion, but we have bill loans that are below their floors. So your question really gets to if there's a rate increase, would we need to see 2 before rate impact? The answer is really no on that. We would see sort of the full reset of that with rate increases.
Okay. So we wouldn't see the same delays last time?
We would not.
And then the other question I had is residential loans continue to drive a big portion of the recent loan growth. Balances there up to 19% of total loans. At what point do we start to see you take your foot off the gas pedal where exposure is enough and where you sell more of the production versus retaining?
Yes. So we continue to be asset sensitive one of the more assets that banks -- that we track in our peer group. So we think there's still room to continue putting high-quality customer-based mortgages on our balance sheet. We have, based on our current origination levels, I mean, I think there's capacity to at least through the balance of this year to continue to do that.
And your trade-off is that again, right now, if you're -- year-to-date, we've taken $230 million of production that we haven't sold. We just said in the second quarter, our average gain on sale spread was 185 basis points. So there's a real short-term impact right there about $3.5 million to $4 million in mortgage banking gains. When you put those loans on your books, you have a Year 1 reserve that you have to put on one of those residential loans under CECL.
But then if you assume that those loans are going to stick around on your books for 5 or 7 years, then there's going to be a very material positive impact to your NII, having those mortgages on the books versus say, the alternative right now with that $1.4 billion, $1.5 billion of cash we have and deploying that into MBS, let's just say, versus those residential mortgages.
Okay. And could you talk a bit about the securities portfolio outlook for the balance of the year?
Yes. I think I would expect it to stay pretty range bound from where we ended up in the second quarter. We did -- I mean a lot of that depends on, obviously, where the 10-year goes. And the last couple of days, it's been going the opposite direction.
But we -- as I said in my prepared comments, we selectively redeploy some of that excess cash in MBS as longer term rates went up. We'll continue to be opportunistic to maybe put some of it there. But we don't want to extend duration too much in the investment portfolio, because investment portfolio is primarily there as a liquidity tool. And ultimately, we want that excess cash balance to be redeployed into loans as opposed to investment securities.
Last one from me. As I exclude commercial swap fees, the other commercial fee income line item, so merchant, card income, cash management, other commercial banking, all really quarters, up sequentially. What were the drivers behind those type of fee income improvements?
I would just point to increased business activity and underlying transactional activity as well as effectively managing earnings credit that would offset any of those fees in -- on the treasury business. But we're seeing increased activity in business in all those categories.
Do you feel like these kinds of levels are sustainable or levels you can grow off of from here?
Yes. We expect them to continue to grow. We'll see what pace they grow and it really be tied to kind of underlying business activity of our customers, but we do anticipate then continuing to grow.
At this time, there are no further questions. I will hand the call back for closing remarks.
Well, thanks to everyone, again, for joining us today. We hope you'll be able to be with us when we discuss third quarter results in October.
That concludes today's conference. Thank you for your participation. You may now disconnect.