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Fulton Financial 10-Q 2011 Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20459
FORM 10-Q
(Mark One)
For the quarterly period ended March 31, 2011, or
For the transition period from to Commission File No. 0-10587
FULTON FINANCIAL CORPORATION (Exact name of registrant as specified in its charter)
(717) 291-2411 (Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock, $2.50 Par Value – 199,263,000 shares outstanding as of April 29, 2011.
Table of ContentsFULTON FINANCIAL CORPORATION FORM 10-Q FOR THE THREE MONTHS ENDED MARCH 31, 2011 INDEX
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Table of ContentsItem 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(in thousands, except per-share data)
See Notes to Consolidated Financial Statements
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Table of ContentsFULTON FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(in thousands, except per-share data)
See Notes to Consolidated Financial Statements
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Table of ContentsCONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (UNAUDITED) THREE MONTHS ENDED MARCH 31, 2011 AND 2010
See Notes to Consolidated Financial Statements
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Table of ContentsCONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
See Notes to Consolidated Financial Statements
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Table of ContentsFULTON FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A – Basis of Presentation The accompanying unaudited consolidated financial statements of Fulton Financial Corporation (the Corporation) have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts of assets and liabilities as of the date of the financial statements as well as revenues and expenses during the period. Actual results could differ from those estimates. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011. The Corporation evaluates subsequent events through the date of filing with the Securities and Exchange Commission (SEC). NOTE B – Net Income Per Common Share and Other Comprehensive Income The Corporation’s basic net income per common share is calculated as net income available to common shareholders divided by the weighted average number of common shares outstanding. Net income available to common shareholders is calculated as net income less accrued dividends and discount accretion related to preferred stock. For diluted net income per common share, net income available to common shareholders is divided by the weighted average number of common shares outstanding plus the incremental number of shares added as a result of converting common stock equivalents, calculated using the treasury stock method. The Corporation’s common stock equivalents consist of outstanding stock options, restricted stock and common stock warrants. As of March 31, 2011, there were no outstanding common stock warrants. A reconciliation of weighted average common shares outstanding used to calculate basic net income per common share and diluted net income per common share follows.
As of March 31, 2011, 4.6 million stock options were excluded from the diluted net income per share computation as their effect would have been anti-dilutive. As of March 31, 2010, 5.6 million stock options and a 5.5 million share common stock warrant were excluded from the diluted net income per share computation as their effects would have been anti-dilutive.
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Table of ContentsThe following table presents the components of other comprehensive income:
NOTE C – Investment Securities The following tables present the amortized cost and estimated fair values of investment securities:
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Table of Contents
Available for sale equity securities include restricted investment securities issued by the Federal Home Loan Bank (FHLB) and the Federal Reserve Bank totaling $92.6 million and $96.4 million as of March 31, 2011 and December 31, 2010, respectively. The amortized cost and estimated fair values of debt securities as of March 31, 2011, by contractual maturity, are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
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Table of ContentsThe following table presents information related to the Corporation’s gains and losses on the sales of equity and debt securities, and losses recognized for the other-than-temporary impairment of investments:
The $297,000 and $824,000 of other-than-temporary impairment charges for equity securities during the three months ended March 31, 2011 and 2010, respectively, were for investments in stocks of financial institutions. Other-than-temporary impairment charges related to financial institution stocks were due to the severity and duration of the declines in fair values of certain bank stock holdings, in conjunction with management’s assessment of the near-term prospects of each specific issuer. As of March 31, 2011, after other-than-temporary impairment charges, the financial institutions stock portfolio had a cost basis of $31.3 million and a fair value of $35.1 million. The $994,000 and $4.2 million of credit related other-than-temporary impairment charges for debt securities during the three months ended March 31, 2011 and 2010, respectively, were for investments in pooled trust preferred securities issued by financial institutions. Other-than-temporary impairment charges related to pooled trust preferred securities were determined based on an expected cash flows model. The following table presents a summary of the cumulative credit related other-than-temporary impairment charges, recognized as components of earnings, for pooled trust preferred securities still held by the Corporation:
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Table of ContentsThe following table presents the gross unrealized losses and estimated fair values of investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2011:
For its investments in equity securities, most notably its investments in stocks of financial institutions, management evaluates the near-term prospects of the issuers in relation to the severity and duration of the impairment. Based on that evaluation and the Corporation’s ability and intent to hold those investments for a reasonable period of time sufficient for a recovery of fair value, the Corporation does not consider those investments with unrealized holding losses as of March 31, 2011 to be other-than-temporarily impaired. The unrealized holding losses on investments in student loan auction rate securities, also known as auction rate certificates (ARCs), are attributable to liquidity issues resulting from the failure of periodic auctions. Fulton Financial Advisors (FFA), the investment management and trust division of the Corporation’s Fulton Bank, N.A. subsidiary, held ARCs for some of its customers’ accounts. FFA had previously sold ARCs to customers as short-term investments with fair values that could be derived based on periodic auctions under normal market conditions. During 2008 and 2009, the Corporation purchased ARCs from customers due to the failure of these periodic auctions, which made these previously short-term investments illiquid. As of March 31, 2011, approximately $206 million, or 81%, of the ARCs were rated above investment grade, with approximately $156 million, or 61%, AAA rated. Approximately $50 million, or 20%, of ARCs were rated below investment grade by at least one ratings agency or not rated. Of this amount, approximately $30 million, or 59%, of the student loans underlying the ARCs have principal payments which are guaranteed by the Federal government. In total, approximately $226 million, or 88%, of the student loans underlying the ARCs have principal payments which are guaranteed by the Federal government. As of March 31, 2011, all ARCs were current and making scheduled interest payments. Because the Corporation does not have the intent to sell and does not believe it will more likely than not be required to sell any of these securities prior to a recovery of their fair value to amortized cost, the Corporation does not consider these investments to be other-than-temporarily impaired as of March 31, 2011. The Corporation’s collateralized mortgage obligations and mortgage-backed securities have contractual terms that generally do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because the decline in market value of these securities is attributable to changes in interest rates and not credit quality, and because the Corporation does not have the intent to sell and does not believe it will more likely than not be required to sell any of these securities prior to a recovery of their fair value to amortized cost, the Corporation does not consider those investments to be other-than-temporarily impaired as of March 31, 2011.
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Table of ContentsThe following table presents the amortized cost and estimated fair values of corporate debt securities:
The Corporation’s investments in single-issuer trust preferred securities had an unrealized loss of $6.3 million at March 31, 2011. The Corporation did not record any other-than-temporary impairment charges for single-issuer trust preferred securities during the three months ended March 31, 2011 or 2010, respectively. The Corporation held 13 single-issuer trust preferred securities that were rated below investment grade by at least one ratings agency, with an amortized cost of $40.1 million and an estimated fair value of $39.7 million at March 31, 2011. The majority of the single-issuer trust preferred securities rated below investment grade were rated BB or Baa. Single-issuer trust preferred securities with an amortized cost of $10.3 million and an estimated fair value of $8.1 million at March 31, 2011, were not rated by any ratings agency. The Corporation holds ten pooled trust preferred securities. As of March 31, 2011, nine of these securities, with an amortized cost of $6.4 million and an estimated fair value of $4.1 million, were rated below investment grade by at least one ratings agency, with ratings ranging from C to Ca. For each of the nine pooled trust preferred securities rated below investment grade, the class of securities held by the Corporation is below the most senior tranche, with the Corporation’s interests being subordinate to other investors in the pool. The Corporation determines the fair value of pooled trust preferred securities based on quotes provided by third-party brokers. The amortized cost of pooled trust preferred securities is the purchase price of the securities, net of cumulative credit related other-than-temporary impairment charges, determined using an expected cash flows model. The most significant input to the expected cash flows model was the expected payment deferral rate for each pooled trust preferred security. The Corporation evaluates the financial metrics, such as capital ratios and non-performing asset ratios, of the individual financial institution issuers that comprise each pooled trust preferred security to estimate its expected deferral rate. The actual weighted average cumulative defaults and deferrals as a percentage of original collateral were approximately 39% as of March 31, 2011. The discounted cash flow modeling for pooled trust preferred securities held by the Corporation as of March 31, 2011 assumed, on average, an additional 16% expected deferral rate. Based on management’s evaluations, corporate debt securities with a fair value of $129.1 million were not subject to any additional other-than-temporary impairment charges as of March 31, 2011. The Corporation does not have the intent to sell and does not believe it will more likely than not be required to sell any of these securities prior to a recovery of their fair value to amortized cost, which may be maturity.
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Table of ContentsNOTE D – Loans and Allowance for Credit Losses Loans, net of unearned income Loans, net of unearned income are summarized as follows:
Allowance for Credit Losses Effective December 31, 2010, the Corporation adopted the provisions of the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) Update 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” (ASC Update 2010-20), for period end disclosures related to the credit quality of loans. Effective March 31, 2011, the Corporation adopted certain additional disclosure requirements of ASC Update 2010-20 related to credit quality activity during a reporting period, or for the three months ended March 31, 2011 for the Corporation. The development of the Corporation’s allowance for loan losses is based first, on a segmentation of its loan portfolio by general loan type, or “portfolio segments,” as presented in the preceding table. Certain portfolio segments are further disaggregated and evaluated collectively for impairment based on “class segments,” which are largely based on the type of collateral underlying each loan. For commercial loans, class segments include loans secured by collateral and unsecured loans. Construction loan class segments include loans secured by commercial real estate and loans secured by residential real estate. Consumer loan class segments are based on collateral types and include direct consumer installment loans and indirect automobile loans. The following table presents the components of the allowance for credit losses:
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Table of ContentsThe following table presents the activity in the allowance for credit losses for the three months ended March 31:
The following table presents the activity in the allowance for loan losses for the three months ended March 31, 2011, by portfolio segment. Also presented below are loans, net of unearned income and their related allowance for loan losses, by portfolio segment as of March 31, 2011 and December 31, 2010:
N/A – Not applicable Impaired Loans A loan evaluated individually for impairment is considered to be impaired if the Corporation believes it is probable that all amounts will not be collected according to the contractual terms of the loan agreement.
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Table of ContentsThe Corporation uses an internal risk rating process for its commercial loans, commercial mortgages and construction loans, consisting of nine general classifications ranging from “excellent” to “loss.” Generally, all non-accrual commercial loans, commercial mortgages and construction loans with risk ratings of “substandard” or lower are individually reviewed for impairment under FASB ASC Section 310-10-35. Certain accruing commercial loans, commercial mortgages and construction loans are also reviewed individually for impairment if the Corporation believes they meet the definition of impaired. An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. As of March 31, 2011 and December 31, 2010, substantially all of the Corporation’s impaired loans were measured based on the estimated fair value of each loan’s collateral. Collateral could be in the form of real estate in the case of impaired commercial mortgages and construction loans, or business assets, such as accounts receivable or inventory, in the case of commercial loans. Commercial loans may also be secured by real property. As of March 31, 2011 and December 31, 2010, respectively, approximately 57% and 52% of impaired loans with principal balances greater than $1 million, whose primary collateral is real estate, were measured at estimated fair value using certified third-party appraisals that had been updated within the preceding 12 months. The following table presents total impaired loans by class segment:
As of March 31, 2011 and December 31, 2010 there were $121.0 million and $138.3 million, respectively, of impaired loans that did not have a related allowance for loan loss. The estimated fair values of the collateral for these loans exceeded the carrying amount of the loans and, accordingly, no specific valuation allowance was considered to be necessary. For 2010, the total average recorded investment in impaired loans was approximately $772.3 million. The Corporation generally applies all payments received on non-accruing impaired loans to principal until such time as the principal is paid off, after which time any additional payments received are recognized as interest income. For 2010, the Corporation recognized interest income of approximately $27.4 million on impaired loans.
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Table of ContentsCredit Quality Indicators and Non-performing Assets The following table presents a summary of delinquency and non-performing status by portfolio segment and class segment:
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Table of ContentsThe following table presents non-performing assets:
The following table presents loans whose terms were modified under troubled debt restructurings:
As of March 31, 2011 and December 31, 2010, there were $2.7 million and $1.6 million, respectively, of commitments to lend additional funds to borrowers whose loans were modified under troubled debt restructurings.
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Table of ContentsThe following table presents past due status and non-accrual loans by portfolio segment and class segment:
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Table of ContentsNOTE E – Stock-Based Compensation The fair value of equity awards granted to employees is recognized as compensation expense over the period during which employees are required to provide service in exchange for such awards. The Corporation grants equity awards to employees, consisting of stock options and restricted stock, under its Stock Option and Compensation Plan (Option Plan). In addition, employees may purchase stock under the Corporation’s Employee Stock Purchase Plan. The following table presents compensation expense and the related tax benefits for equity awards recognized in the consolidated statements of income:
Stock option exercise prices are equal to the fair value of the Corporation’s stock on the date of grant, and carry terms of up to ten years. Restricted stock fair values are equal to the average trading price of the Corporation’s stock on the date of grant. Restricted stock awards earn dividends during the vesting period, which are forfeitable if the awards do not vest. Stock options and restricted stock are typically granted annually on July 1st and become fully vested over or after a three-year vesting period. Certain events, as defined in the Option Plan, result in the acceleration of the vesting of both stock options and restricted stock. As of March 31, 2011, the Option Plan had 13.0 million shares reserved for future grants through 2013. NOTE F – Employee Benefit Plans The Corporation maintains a defined benefit pension plan (Pension Plan) for certain employees. Contributions to the Pension Plan are actuarially determined and funded annually, if required. Pension Plan assets are invested in: money markets; fixed income securities, including corporate bonds, U.S. Treasury securities and common trust funds; and equity securities, including common stocks and common stock mutual funds. Effective January 1, 2008, the Pension Plan was curtailed. The Corporation currently provides medical and life insurance benefits under a postretirement benefits plan (Postretirement Plan) to certain retired full-time employees who were employees of the Corporation prior to January 1, 1998. Certain full-time employees may become eligible for these discretionary benefits if they reach retirement age while working for the Corporation. The Corporation recognizes the funded status of its Pension Plan and Postretirement Plan on the consolidated balance sheets and recognizes the changes in that funded status through other comprehensive income.
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Table of ContentsThe net periodic benefit cost for the Corporation’s Pension Plan and Postretirement Plan, as determined by consulting actuaries, consisted of the following components for the three months ended March 31:
NOTE G – Derivative Financial Instruments In connection with its mortgage banking activities, the Corporation enters into commitments to originate fixed-rate residential mortgage loans for customers, also referred to as interest rate locks. In addition, the Corporation enters into forward commitments for the future sale or purchase of mortgage-backed securities to or from third-party investors to hedge the effect of changes in interest rates on the values of both the interest rate locks and mortgage loans held for sale. Forward sales commitments may also be in the form of commitments to sell individual mortgage loans at a fixed price on a future date. Both the interest rate locks and the forward commitments are accounted for as derivative financial instruments and are carried at fair value, determined as the amount that would be necessary to settle each derivative financial instrument at the balance sheet date. The amount necessary to settle each interest rate lock is based on the price that secondary market investors would pay for loans with similar characteristics, including interest rate and term, as of the date fair value is measured. Gross derivative assets and liabilities are recorded within other assets and other liabilities, respectively, on the consolidated balance sheets. The following table presents a summary of the notional amounts and fair values of derivative financial instruments recorded on the consolidated balance sheets, none of which have been designated as hedging instruments:
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Table of ContentsThe following table presents a summary of the fair value gains and losses on derivative financial instruments for the three months ended March 31:
Fair value gains and losses represent the changes in the fair values of derivative financial instruments during the period and are recognized on the consolidated statements of income as components of mortgage banking income. The other components of mortgage banking income are gains and losses on sales of mortgage loans, gains and losses on the settlement of forward commitments, and net servicing income. Total mortgage banking income, including fair value adjustments on derivative financial instruments, was $5.5 million and $4.1 million for the three months ended March 31, 2011 and 2010, respectively. NOTE H – Commitments and Contingencies Commitments The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Those financial instruments include commitments to extend credit and letters of credit, which involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized on the Corporation’s consolidated balance sheets. Exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the outstanding amount of those instruments. The outstanding amounts of commitments to extend credit and letters of credit were as follows:
The Corporation records a reserve for unfunded lending commitments, which represents management’s estimate of losses associated with unused commitments to extend credit on loans impaired under FASB ASC Section 310-10-35. See Note D, “Loans and Allowance for Credit Losses” for additional details. Residential Lending Residential mortgages are originated and sold by the Corporation through Fulton Mortgage Company, which operates as a division of each of the Corporation’s subsidiary banks. The loans originated and sold are predominantly “prime” loans that conform to published standards of government sponsored agencies. Prior to 2008, the Corporation’s former Resource Bank subsidiary operated a national wholesale mortgage lending operation which originated and sold non-prime loans from the time the Corporation acquired Resource Bank in 2004 through 2007. Beginning in 2007, Resource Bank experienced an increase in requests from secondary market purchasers to repurchase non-prime loans sold to those investors. These repurchase requests resulted in the Corporation recording charges representing the write-downs that were necessary to reduce the loan balances to their estimated net realizable values, based on valuations of the underlying properties, as adjusted for market factors and other considerations. Many of the loans the Corporation repurchased were delinquent and were settled through foreclosure and sale of the underlying collateral.
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Table of ContentsAs of March 31, 2011, the reserve for losses on the potential repurchase of loans with principal balances totaling approximately $3.3 million was $2.4 million. As of December 31, 2010, the reserve for losses on the potential repurchase of loans with principal balances totaling approximately $8.1 million was $3.3 million. Management believes that the reserves recorded as of March 31, 2011 are adequate for the known potential repurchases. However, continued declines in collateral values or the identification of additional loans to be repurchased could necessitate additional reserves in the future. Other Contingencies From time to time, the Corporation and its subsidiary banks may be defendants in legal proceedings relating to the conduct of their business. Most of such legal proceedings are a normal part of the banking business and, in management’s opinion, the financial position and results of operations and cash flows of the Corporation would not be affected materially by the outcome of such legal proceedings. NOTE I – Fair Value Option FASB ASC Subtopic 825-10 permits entities to measure many financial instruments and certain other items at fair value and requires certain disclosures for amounts for which the fair value option is applied. The Corporation has elected to measure mortgage loans held for sale at fair value to more accurately reflect the financial performance of its mortgage banking activities in its consolidated financial statements. Derivative financial instruments related to these activities are also recorded at fair value, as noted within Note G, “Derivative Financial Instruments.” The Corporation determines fair value for its mortgage loans held for sale based on the price that secondary market investors would pay for loans with similar characteristics, including interest rate and term, as of the date fair value is measured. Changes in fair value during the period are recorded as components of mortgage banking income on the consolidated statements of income. Interest income earned on mortgage loans held for sale is recorded within interest income on the consolidated statements of income. The following table presents a summary of the Corporation’s mortgage loans held for sale:
During the three months ended March 31, 2011 and 2010, the Corporation recorded gains related to changes in fair values of mortgage loans held for sale of $1.2 million and $391,000, respectively. NOTE J – Fair Value Measurements FASB ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into the following three categories (from highest to lowest priority):
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