UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20459
FORM 10-Q
(Mark One)
For the quarterly period ended March 31, 2004,
or
For the transition period from to
Commission File No. 0-10587
FULTON FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
One Penn Square, P.O. Box 4887
Lancaster, Pennsylvania
(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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
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 – 116,418,000 shares outstanding as of April 30, 2004.
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2004
INDEX
Description
Financial Statements (Unaudited):
(a) Consolidated Balance Sheets - March 31, 2004 and December 31, 2003
(b) Consolidated Statements of Income - Three months ended March 31, 2004 and 2003
(c) Consolidated Statements of Shareholders’ Equity - Three months ended March 31, 2004 and 2003
(d) Consolidated Statements of Cash Flows - Three months ended March 31, 2004 and 2003
(e) Notes to Consolidated Financial Statements – March 31, 2004
Quantitative and Qualitative Disclosures about Market Risk
Controls and Procedures
PART II.OTHER INFORMATION
Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities
Exhibits and Reports on Form 8-K
Signatures
Exhibit Index
Certifications
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Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Dollars in thousands, except per-share data)
March 31
2004
ASSETS
Cash and due from banks
Interest-bearing deposits with other banks
Mortgage loans held for sale
Investment securities:
Held to maturity (Fair value: $22,703 in 2004 and $23,739 in 2003)
Available for sale
Loans, net of unearned income
Less: Allowance for loan losses
Net Loans
Premises and equipment
Accrued interest receivable
Goodwill
Other assets
Total Assets
LIABILITIES
Deposits:
Noninterest-bearing
Interest-bearing
Total Deposits
Short-term borrowings:
Federal funds purchased
Other short-term borrowings
Total Short-Term Borrowings
Accrued interest payable
Other liabilities
Federal Home Loan Bank Advances and long-term debt
Total Liabilities
SHAREHOLDERS’ EQUITY
Common stock, $2.50 par value, 400.0 million shares authorized, 113.8 million shares issued
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income
Treasury stock (5.5 million shares in 2004 and 2003)
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
See Notes to Consolidated Financial Statements
3
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended
INTEREST INCOME
Loans, including fees
Taxable
Tax-exempt
Dividends
Other interest income
Total Interest Income
INTEREST EXPENSE
Deposits
Short-term borrowings
Long-term debt
Total Interest Expense
Net Interest Income
PROVISION FOR LOAN LOSSES
Net Interest Income After Provision for Loan Losses
OTHER INCOME
Investment management and trust services
Service charges on deposit accounts
Other service charges and fees
Mortgage banking income
Investment securities gains
Other
Total Other Income
OTHER EXPENSES
Salaries and employee benefits
Net occupancy expense
Equipment expense
Data processing
Advertising
Intangible amortization
Total Other Expenses
Income Before Income Taxes
INCOME TAXES
Net Income
PER-SHARE DATA:
Net income (basic)
Net income (diluted)
Cash dividends
4
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2004 AND 2003
Number of
Shares
Outstanding
Additional
Paid-In
Capital
Retained
Earnings
Accumulated
Comprehensive
Income (Loss)
Treasury
Stock
Balance at December 31, 2003
Comprehensive Income:
Other - unrealized gain on securities (net of $4.3 million tax effect)
Less - reclassification adjustment for gains included in net income (net of $2.0 million tax expense)
Total comprehensive income
Stock issued
Acquisition of treasury stock
Cash dividends - $0.160 per share
Balance at March 31, 2004
Balance at December 31, 2002
Other - unrealized loss on securities (net of $3.2 million tax effect)
Less - reclassification adjustment for gains included in net income (net of $780,000 tax expense)
Stock dividend - 5%
Cash dividends - $0.143 per share
Balance at March 31, 2003
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CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses
Depreciation and amortization of premises and equipment
Net amortization of investment security premiums
Net decrease (increase) in mortgage loans held for sale
Amortization of intangible assets
Decrease in accrued interest receivable
(Increase) decrease in other assets
Increase (decrease) in accrued interest payable
Increase in other liabilities
Total adjustments
Net cash provided by operating activities
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale
Proceeds from maturities of securities held to maturity
Proceeds from maturities of securities available for sale
Purchase of securities held to maturity
Purchase of securities available for sale
Decrease (increase) in short-term investments
Net (increase) decrease in loans
Net cash paid for acquisitions
Net purchase of premises and equipment
Net cash provided by investing activities
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand and savings deposits
Net decrease in time deposits
Increase (decrease) in long-term debt
Decrease in short-term borrowings
Dividends paid
Net proceeds from issuance of common stock
Net cash used in financing activities
Net Increase in Cash and Due From Banks
Cash and Due From Banks at Beginning of Period
Cash and Due From Banks at End of Period
Supplemental Disclosures of Cash Flow Information
Cash paid during period for:
Interest
Income taxes
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A – Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles 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 generally accepted accounting principles for complete financial statements. 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, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.
NOTE B – Net Income Per Share
The Corporation’s basic net income per share is calculated as net income divided by the weighted average number of shares outstanding. For diluted net income per share, net income is divided by the weighted average number of 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 solely of outstanding stock options.
A reconciliation of the weighted average shares outstanding used to calculate basic net income per share and diluted net income per share follows:
Weighted average shares outstanding (basic)
Impact of common stock equivalents
Weighted average shares outstanding (diluted)
NOTE C – Stock Dividend
The Corporation declared a 5% stock dividend on April 22, 2004, which will be paid on June 4, 2004 to shareholders of record on May 14, 2004. Since the market price of the Corporation’s stock will not adjust as a result of the stock dividend until subsequent to the filing of these financial statements, the stock dividend has not been recorded in shareholders’ equity and share and per-share information has not been restated. The following table provides share and per-share amounts reflecting the impact of the stock dividend:
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As Reported:
Net Income (Basic)
Net Income (Diluted)
Ending Shares Outstanding (at March 31)
Pro-Forma:
NOTE D – Disclosures about Segments of an Enterprise and Related Information
The Corporation does not have any operating segments which require disclosure of additional information. While the Corporation owns twelve separate banks, each engages in similar activities, provides similar products and services, and operates in the same general geographical area. The Corporation’s non-banking activities are immaterial and, therefore, separate information has not been disclosed.
NOTE E – Stock-Based Compensation
In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” (Statement 148). Statement 148 clarifies the accounting for options issued in prior periods when a company elects to transition from Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) accounting to Statement 123, “Accounting for Stock-Based Compensation” (Statement 123) accounting. It also requires additional disclosures with respect to accounting for stock-based compensation. Finally, Statement No. 148 amends Accounting Principles Board Opinion No. 28, “Interim Financial Reporting,” to require disclosure about those effects in interim financial information.
The Corporation has elected to continue application of APB 25 and related interpretations in accounting for its stock-based employee compensation plans and, accordingly, no compensation expense is reflected in net income. Had compensation cost for these plans been recorded consistent with the fair value provisions of Statements 123 and 148, the Corporation’s net income and net income per share would have been reduced to the following pro-forma amounts:
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(In thousands except
per-share data)
Net income as reported
Stock based employee compensation expense under the fair value method, net of tax
Pro-forma net income
Net income per share (basic)
Pro-forma net income per share
Net income per share (diluted)
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. 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. The Pension Plan has been closed to new participants, but existing participants continue to accrue benefits according to the terms of the plan. The Corporation expects to contribute approximately $2.6 million to the Pension Plan in 2004.
The Corporation currently provides medical and life insurance benefits to retired full-time employees who were employees of the Corporation prior to January 1, 1998. Full-time employees may become eligible for these discretionary benefits if they reach retirement while working for the Corporation. Benefits are based on a graduated scale for years of service after attaining the age of 40.
The net periodic benefit cost for the Corporation’s Pension Plan and Post-Retirement Plan, as determined by consulting actuaries, consisted of the following components for the quarters ended March 31:
Service cost
Interest cost
Expected return on plan assets
Net amortization and deferral
Net periodic benefit cost
NOTE G – New Accounting Standards
Variable Interest Entities: In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities – An Interpretation of ARB No. 51”, which was revised in December 2003 (FIN-46). FIN-46 provides guidance on when to consolidate certain Variable Interest Entities (VIE’s) in the financial statements of the Corporation. VIE’s are entities in which equity investors do not have a controlling financial interest or do not have sufficient equity at risk for the entity to finance activities without additional financial support from other parties. Under FIN-46, a company must consolidate a VIE if the company has a variable interest that will absorb a majority of the VIE’s losses, if they occur, and/or receive a majority of the VIE’s residual returns, if they occur.
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The provisions of FIN-46 which relate to the Corporation’s investments in low and moderate income partnerships (LIH Investments) were effective as of December 31, 2003 for LIH Investments made by the Corporation after January 31, 2003 and March 31, 2004 for all other partnerships. Based on its review, the Corporation concluded that none of its LIH Investments met the criteria for consolidation and, as such, did not consolidate any LIH Investments as of March 31, 2004 or December 31, 2003.
LIH Investments continue to be amortized under the effective interest method over the life of the Federal income tax credits generated as a result of such investments, generally ten years. At March 31, 2004 and 2003, the Corporation’s LIH Investments totaled $43.9 million and $40.0 million, respectively. The net income tax benefit associated with these investments was $1.1 million and $1.0 million for the quarters ended March 31, 2004 and 2003, respectively.
Accounting for Certain Loans or Debt Securities Acquired in a Transfer: In December 2003, the Accounting Standards Executive Committee issued Statement of Position 03-3 (SOP 03-3), “Accounting for Certain Loans or Debt Securities Acquired in a Transfer”. SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer, including business combinations, if those differences are attributable, at least in part, to credit quality.
SOP 03-3 is effective for loans or debt securities acquired in fiscal years beginning after December 15, 2004. The Corporation intends to adopt the provisions of SOP 03-3 effective January 1, 2005, and does not expect the initial implementation to have a material effect on the Corporation’s consolidated financial statements.
Application of Accounting Principles to Loan Commitments. In March 2004, the SEC staff issued Staff Accounting Bulletin No. 105 (SAB 105), “Application of Accounting Principles to Loan Commitments”. SAB 105 provides specific guidance on fair value measurement of mortgage loan commitments that are accounted for as derivatives. SAB 105 must be applied to mortgage loan commitments that are accounted for as derivatives entered into after March 31, 2004. The Corporation does not expect SAB 105 to have a material effect on its consolidated financial statements.
NOTE H – Reclassifications
Certain amounts in the 2003 consolidated financial statements and notes have been reclassified to conform to the 2004 presentation.
NOTE I – Acquisition of Resource Bankshares Corporation
On April 1, 2004, the Corporation completed its acquisition of Resource Bankshares Corporation (Resource), of Virginia Beach, Virginia. Resource was an $885 million financial holding company whose primary subsidiary was Resource Bank, which operates six community banking offices in Newport News, Chesapeake, Herndon, Virginia Beach, and Richmond, VA and 14 loan production and residential mortgage offices in Virginia, North Carolina, Maryland and Florida.
Under the terms of the merger agreement, each of the approximately 6.1 million shares of Resource’s common stock was exchanged for 1.4667 shares of the Corporation’s common stock. In addition, each of the options to acquire Resource’s stock was converted to options to purchase the Corporation’s stock. As a result of the acquisition, Resource was merged into the Corporation and Resource Bank became a wholly owned subsidiary.
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The acquisition is being accounted for as a purchase. Purchase accounting requires the Corporation to allocate the total purchase price of the acquisition to the assets acquired and liabilities assumed, based on their respective fair values at the acquisition date, with any remaining acquisition cost being recorded as goodwill. Resulting goodwill balances are then subject to an impairment review on at least an annual basis. The results of Resource’s operations will be included in the Corporation’s financial statements prospectively from the date of the acquisition.
The total purchase price of approximately $200 million includes the value (based on the price as of the announcement date) of the Corporation’s stock issued, Resource options converted, and certain acquisition related costs. The carrying value of the net assets of Resource as of April 1, 2004 was approximately $60 million and, accordingly, the purchase price exceeds the carrying value of the net assets by $140 million. The total purchase price will be allocated to the net assets acquired, based on fair market values. The Corporation expects to record a core deposit intangible asset and goodwill as a result of the acquisition accounting. The Corporation is in the process of completing its fair value analysis and will determine the allocation of the purchase price to the fair value of net assets acquired and goodwill during the second quarter of 2004.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Management’s Discussion) concerns Fulton Financial Corporation (the Corporation), a financial holding company incorporated under the laws of the Commonwealth of Pennsylvania in 1982, and its wholly-owned subsidiaries. This discussion and analysis should be read in conjunction with the consolidated financial statements and other financial information presented in this report.
FORWARD-LOOKING STATEMENTS
The Corporation has made, and may continue to make, certain forward-looking statements with respect to its acquisition and growth strategies, management of net interest income and margin, the ability to realize gains on equity investments, allowance and provision for loan losses, expected levels of certain non-interest expenses and the liquidity position of the Corporation and Parent Company. The Corporation cautions that these forward-looking statements are subject to various assumptions, risks and uncertainties. Because of the possibility of changes in these assumptions, risks and uncertainties, actual results could differ materially from forward-looking statements.
In addition to the factors identified herein, the following could cause actual results to differ materially from such forward-looking statements: pricing pressures on loan and deposit products, actions of bank and non-bank competitors, changes in local and national economic conditions, changes in regulatory requirements and regulatory oversight of the Corporation, actions of the Federal Reserve Board (FRB) and the Corporation’s success in merger and acquisition integration.
The Corporation’s forward-looking statements are relevant only as of the date on which such statements are made. By making any forward-looking statements, the Corporation assumes no duty to update them to reflect new, changing or unanticipated events or circumstances.
RESULTS OF OPERATIONS
Overview
As a financial institution with a focus on traditional banking activities, Fulton Financial Corporation generates the majority of its revenue through net interest income, or the difference between interest income earned on loans and investments and interest paid on deposits and borrowings. Growth in net interest income is dependent upon balance sheet growth and maintaining or increasing the net interest margin, which is net interest income as a percentage of average interest-earning assets. The Corporation also generates revenue through fees earned on the various services and products offered to its customers and through sales of assets, such as loans or investments. Offsetting these revenue sources are provisions for credit losses on loans, administrative expenses and income taxes.
The Corporation’s net income for the first quarter of 2004 increased $1.8 million, or 5.3%, from $34.0 million in 2003 to $35.8 million in 2004. Diluted net income per share increased $0.01, or 3.1%, from $0.32 per share in 2003 to $0.33 per share in 2004. In 2004, the Corporation realized annualized returns on average assets of 1.49% and average equity of 15.18%.
The increase in net income compared to the first quarter of 2003 resulted from a $7.3 million increase in net interest income, a $3.6 million increase in investment securities gains and a $1.1 million decrease in the provision for loan losses, offset by a $3.0 million decrease in other income, primarily mortgage banking income, and a $6.6 million increase in other expenses. Net interest income growth resulted from increases in average earning assets, largely due to the acquisition of Premier Bank in the third quarter of 2003. While the net interest margin decreased compared to the first quarter of 2003, it has increased in each of the last two calendar quarters.
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The following summarizes some of the more significant factors that influenced the Corporation’s first quarter 2004 results.
Interest Rates - Short-term interest rates remained low throughout the first quarter of 2004, with the overnight borrowing rate, or Federal funds rate, and the prime lending rate at 1.00% and 4.00%, respectively, both historic lows. Over the past year, the low short-term interest rates had a negative impact on the Corporation’s net interest income and net interest margin, as reducing the rates paid on deposits became exceedingly difficult. As a result, average rates on earning assets decreased more than the average rates paid on liabilities, and the net interest margin and net interest income both decreased in 2004 compared to 2003.
Longer-term interest rates, including residential mortgage rates, while remaining relatively low during 2004, were higher than the historic lows reached during 2003. Lower long-term interest rates continued to affect the Corporation’s deposit mix as funds from maturing time deposits were deposited in core demand and savings accounts as customers were reluctant to lock into the relatively low rates being offered on time deposit products.
If the current interest rate environment continues, the Corporation will be challenged to maintain and grow its net interest margin and to increase net interest income. Most of the Corporation’s balance sheet has repriced to current rates, however, and management does not expect further significant erosion of the net interest margin if rates remain low. In such an environment, however, growth in net interest income will be more reliant on growth in balances than changes in rates. In a rising rate environment, the Corporation expects improvements in net interest income, as discussed in the “Market Risk” section of Management’s Discussion. Increasing long-term rates, however, tend to have a detrimental impact on mortgage loan origination volumes and related gains on sales of mortgage loans.
Earning Assets - The Corporation experienced significant earning asset growth due to the acquisition of Premier Bank (Premier) in August 2003 and the purchase of a $165 million agricultural loan portfoilo in December 2003, as well as internal growth.
Asset Quality - Asset quality refers to the underlying credit characteristics of borrowers and the likelihood that defaults on contractual payments will result in charge-offs of account balances. Asset quality is generally a function of economic conditions, but can be managed through conservative underwriting and sound collection policies and procedures.
The Corporation continues to maintain excellent asset quality, attributable to its credit culture and underwriting policies. Asset quality measures such as non-performing assets to total assets and net charge-offs to average loans improved in comparison to 2003, resulting in a lower provision for loan losses in the first quarter of 2004. While overall asset quality has remained strong, deterioration in quality of one or several significant accounts could have a detrimental impact and result in losses that may not be foreseeable based on current information. In addition, rising interest rates could increase the total payments of borrowers and could have a negative impact on their ability to pay according to the terms of their loans.
Equity Markets - During much of the first quarter of 2004, equity markets in general remained strong and, specifically, bank stocks showed very strong valuations. This resulted in decisions to sell certain securities, which allowed additional gains to be realized.
Gains on sales of equities have been a recurring component of the Corporation’s earnings for many years. The contribution of these gains to earnings in the first quarter of 2004, however, exceeded the first quarter of 2003 due to the aforementioned improving values. If equity markets do not continue to perform, this component of earnings could contract.
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Acquisitions - During 2003, the Corporation completed two acquisitions. In August, Premier Bank of Doylestown, Pennsylvania became a wholly-owned subsidiary and strengthened the Corporation’s presence in eastern Pennsylvania markets. In December, the Corporation acquired approximately $165 million of agricultural loans in Central Pennsylvania and Delaware. Both acquisitions strengthen the Corporation’s core banking franchise and contributed to balance sheet and earnings growth in 2004 compared to 2003.
On April 1, 2004, the Corporation completed its acquisition of Resource Bankshares Corporation, located in Virginia Beach, Virginia. This is the Corporation’s first acquisition in Virginia, allowing it to enter a new geographic market.
Acquisitions have long been a supplement to the Corporation’s internal growth. These recent acquisitions provide opportunity for additional growth as they will allow the Corporation’s existing products and services to be sold in new markets. The Corporation’s acquisition strategy focuses on high growth areas with strong market demographics and targets organizations that have a comparable corporate culture, strong performance and good asset quality, among other factors. Under its “super-community” banking philosophy, acquired organizations generally retain their status as separate legal entities, unless consolidation with an existing affiliate bank is practical. Back office functions are generally consolidated to maximize efficiencies.
Merger and acquisition activity in the financial services industry has become very competitive and the prices paid for certain acquisitions have increased recently. While the Corporation has been an active acquirer, management is committed to basing its pricing on rational economic models. Management will continue to focus on generating growth in the most cost-effective manner.
Net interest income increased $7.3 million, from $75.6 million in 2003 to $83.0 million in 2004. This increase was due primarily to average balance growth, with total earnings assets increasing 16.6%, and was offset by the impact of the low interest rate environment. The Corporation’s average prime lending rate decreased from 4.25% in the first quarter of 2003 to 4.00% in the first quarter of 2004 as a result of FRB actions. This reduction in an already low interest rate environment negatively impacted the Corporation’s net interest margin as average yields on earning-assets decreased further than the average cost of deposits.
The average yield on earning assets decreased 70 basis points (a 12.1 % decline) during the period while the cost of interest-bearing liabilities decreased 55 basis points (a 24.6% decline). This resulted in a 27 basis point decrease in net interest margin compared to the same period in 2003. The Corporation continues to manage its asset/liability position and interest rate risk through the methods discussed in the “Market Risk” section of Management’s Discussion.
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The following table provides a comparative average balance sheet and net interest income analysis for the first quarter of 2004 as compared to the same period in 2003 (dollars in thousands):
Average
Balance
Yield/
Rate (1)
Interest-earning assets:
Loans and leases
Taxable investment securities
Tax-exempt investment securitites
Equity securities
Total investment securities
Short-term investments
Total interest-earning assets
Noninterest-earning assets:
LIABILITIES AND EQUITY
Interest-bearing liabilities:
Demand deposits
Savings deposits
Time deposits
Total interest-bearing deposits
Total interest-bearing liabilities
Noninterest-bearing liabilities:
Shareholders’ equity
Net interest income
Net interest margin (FTE)
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The following table summarizes the changes in interest income and expense due to changes in average balances (volume) and changes in rates:
2004 vs. 2003
Increase (decrease) due
To change in
Interest income on:
Tax-exempt investment securities
Interest expense on:
Interest income increased $3.8 million, or 3.4%, mainly as a result of the growth in average balances. Total interest earning assets increased 16.6%, resulting in an $18.1 million increase in interest income. This increase was partially offset by the 70 basis point decrease in average yields on earning assets, which accounted for a $14.4 million decline in interest income.
Average interest-earning assets increased in both the loan and investment categories. The Corporation’s average loan portfolio increased $841.0 million, or 15.7% ($521.9 million, or 9.9%, without Premier). The following summarizes the growth in average loans by category:
Commercial - industrial, financial and agricultural
Real estate - commercial mortgage
Real estate - residential mortgage
Real estate - home equity
Consumer and other
Total
Loan growth was particularly strong in the commercial and commercial mortgage categories. Even factoring out the loans added by the Premier acquisition and the agricultural loan portfolio purchase, these categories grew in excess of 8.0%. The significant reduction in residential mortgage loan balances was due to customer refinance activity that occurred over the past year. The Corporation generally sells newly originated fixed rate mortgages in the secondary market to promote liquidity and manage interest rate risk. Home equity loans increased significantly due to promotional efforts and customers using home equity loans as a cost-effective refinance alternative. Consumer loans decreased, reflecting customers’ repayment of these loans with tax-advantaged residential mortgage or home equity loans
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The average yield on loans during 2004 was 5.75%, a 71 basis point, or 11.0%, decline from 2003. This reflects the 25 basis point reduction in the Corporation’s average prime lending rate, as well as higher than normal prepayments received on fixed rate commercial and commercial mortgage loans.
Average investment securities increased $476.6 million, or 20.4% ($256.8 million, or 11.0%, without Premier), as the growth in deposits and borrowings exceeded loan growth. The Corporation used the excess funds to purchase investment securities, particularly mortgage-backed securities.
The average yield on investment securities declined 63 basis points from 4.24% in 2003 to 3.61% in 2004. This 17.4% decrease was due to both the relatively short maturity of the portfolio as well as prepayments experienced on mortgage-backed securities.
Interest expense decreased $3.6 million, or 10.3%, to $31.0 million in 2004 from $34.5 million in 2003, mainly as a result of the 55 basis point decrease in the cost of total interest-bearing liabilities. This decrease was partially offset by a $2.6 million increase in interest expense due to average balance growth. The cost of interest-bearing deposits declined 24.5%, from 2.24% in 2003 to 1.69% in 2004. This reduction was due to both the impact of declining short-term interest rates and the continuing shift in the composition of deposits from higher-rate time deposits to lower-rate demand and savings deposits. Customers continued to exhibit an unwillingness to invest in certificates of deposit at the rates available, instead keeping their funds in demand and savings products.
The following table summarizes the growth in average deposits by category:
Noninterest-bearing demand
Interest-bearing demand
Savings and money market
The acquisition of Premier added $391.4 million to the total average balance of deposits in 2004. If those balances were factored out, the deposit categories would show the following increases (decreases) – noninterest-bearing demand, 14.2%, interest-bearing demand, 10.3%, savings and money market, 9.2%, and time deposits, (11.1)%.
Other borrowings increased significantly from 2003. Average short-term borrowings increased $733.8 million, or 120.0%, to $1.3 billion in 2004, while average long-term debt increased $29.1 million, or 5.4%, to $570.1 million in 2004. The increase in short-term borrowings resulted primarily from certain limited strategies to manage the Corporation’s gap position and to take advantage of low wholesale funding rates. In addition, customer cash management accounts, which are included in short-term borrowings, grew $87.5 million, or 29.1%, to reach $387.6 million in 2004.
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Provision and Allowance for Loan Losses
The following table summarizes loans outstanding (net of unearned income) as of the dates shown:
December 31
2003
Commercial - industrial and financial
Commercial - agricultural
Real estate - construction
Consumer
Leasing and other
Total Loans
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The following table summarizes the activity in the Corporation’s allowance for loan losses:
Loans outstanding at end of period (net of unearned)
Daily average balance of loans and leases
Balance at beginning of period
Loans charged-off:
Commercial, financial and agricultural
Real estate - mortgage
Total loans charged-off
Recoveries of loans previously charged-off:
Total recoveries
Net loans charged-off
Balance at end of period
Net charge-offs to average loans (annualized)
Allowance for loan losses to loans outstanding
The following table summarizes the Corporation’s non-performing assets as of the indicated dates:
Non-accrual loans
Loans 90 days past due and accruing
Other real estate owned (OREO)
Total non-performing assets
Non-accrual loans/Total loans
Non-performing assets/Total assets
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The provision for loan losses for the first quarter of 2004 totaled $1.7 million, a decrease of $1.1 million, or 38.6%, from the same period in 2003. Net charge-offs totaled $1.1 million, or 0.08% of average loans on an annualized basis, during the first quarter of 2004, a $1.8 million improvement over the $3.0 million, or 0.22%, in net charge-offs for the first quarter of 2003. Non-performing assets decreased to $30.7 million, or 0.32% of total assets, at March 31, 2004, from $37.1 million, or 0.44% of total assets, at March 31, 2003.
Management believes that the allowance balance of $78.3 million at March 31, 2004 is sufficient to cover losses inherent in the loan portfolio on that date and is appropriate based on applicable accounting standards.
Other Income
The following table details the components of other income:
Investment management and Trust Services
Other income for the quarter ended March 31, 2004 was $32.2 million, an increase of $578,000, or 1.8%, over the comparable period in 2003. Excluding investment securities gains, which increased from $2.2 million in 2003 to $5.8 million in 2004, other income decreased $3.0 million, or 10.3%.
This decrease was attributable to the $3.9 million, or 65.5%, decrease in mortgage banking income. While the national monthly average for fixed rate mortgage loans decreased from 5.96% in the first quarter of 2003 to 5.74% in the first quarter of 2004, volumes were lower than in 2003 due to the existence of significantly lower rates during the second quarter of 2003 which realized the majority of the recent refinance volume. Mortgage loan originations decreased from $258.8 million in 2003 to $116.2 million in 2004. In order to limit interest rate risk, the Corporation generally sells the qualifying fixed rate mortgage loans it originates, resulting in gains.
Investment securities gains increased $3.6 million, or 161.5%. Investment securities gains during the first quarter of 2004 consisted of realized gains of $4.8 million on the sale of equity securities and $1.0 million on the sale of available for sale debt securities. Investment securities gains during the first quarter of 2003 consisted of realized gains of $2.2 million on the sale of equity securities and $3.2 million on the sale of available for sale debt securities. The gains in 2003 were offset by $3.2 million of losses recognized for equity securities exhibiting other than temporary impairment.
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Other Expenses
The following table details the components of other expenses:
Total other expenses for the first quarter of 2004 were $62.5 million, representing an increase of $6.6 million, or 11.8% from 2003 ($3.7 million, or 6.6%, excluding Premier).
Salaries and employee benefits increased $3.6 million, or 10.9% ($2.4 million, or 7.2%, excluding Premier), in comparison to the first quarter of 2003. The salary expense component increased $2.3 million, or 8.6%, driven by normal salary increases for existing employees as well as the addition of the Premier employees. The employee benefits component of the expense increased $1.3 million, or 22.5%, due mainly to rising healthcare and retirement plan expenses.
Net occupancy expense increased $438,000, or 8.6% ($172,000, or 3.4%, excluding Premier), over the first quarter of 2003. Equipment expense decreased $39,000, or 1.5%, due to a reduction in depreciation expense as certain equipment became fully depreciated during 2003. The 1.6% decrease in data processing expense was due to favorable renegotiations of certain contracts for data processing services.
Advertising expense increased $296,000, or 24.0% ($224,000, or 18.2%, excluding Premier), mainly due to the timing of promotional campaigns and expenditures. The $632,000 increase in intangible amortization was due to the Premier and agriculture loan portfolio acquisitions.
Other expense increased $1.7 million, or 16.1% ($760,000, or 7.3%, excluding Premier), to $12.0 million in 2004.
Income Taxes
Income tax expense for the first quarter of 2004 was $15.1 million, a $604,000, or 4.2%, increase from $14.5 million in 2003. The Corporation’s effective tax rate was approximately 29.7% in 2004 as compared to 29.9% in 2003. The effective rate is lower than the federal statutory rate of 35% due mainly to investments in tax-free municipal securities and federal tax credits from investments in low and moderate income housing partnerships.
FINANCIAL CONDITION
Total assets of the Corporation decreased $147.1 million, or 1.5%, to $9.6 billion at March 31, 2004, compared to $9.8 billion at December 31, 2003. Investment securities decreased $213.3 million, or 7.3%, as the Corporation chose not to reinvest proceeds from maturities, except where required for pledging purposes. Loans outstanding, net of unearned income, increased $57.1 million, or 0.9%, during the period. Commercial loans, commercial mortgages and home equity loans each increased slightly, offset by declines in residential mortgage, consumer and other loans.
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Cash and due from banks decreased $7.4 million, or 2.5%, during the period. Due to the nature of these accounts, daily balances can fluctuate up or down in the normal course of business.
Deposits increased $32.4 million, or 0.5%, from December 31, 2003. Noninterest-bearing deposits increased $66.0 million, or 5.2%, while interest-bearing deposits decreased $33.7 million, or 0.6%. Customers continued to hesitate to invest in time deposits in this low interest rate environment, as reflected in a $33.4 million decrease in time deposits.
Short-term borrowings, which consist mainly of Federal funds purchased, other short-term borrowings and customer cash management accounts, decreased $214.2 million, or 15.3%, during the first quarter of 2004. Federal funds purchased and other short-term borrowings decreased $212.5 million, or 21.5%, as the proceeds from maturing investment securities were used to repay these borrowings. Long-term debt increased slightly by $3.2 million, or 1.0%.
Capital Resources
Total shareholders’ equity increased $21.5 million, or 2.3%, during the first three months of 2004. Increases due to net income of $35.8 million, $2.3 million in stock issuances and $4.2 million in unrealized gains on securities were offset by $17.3 million in cash dividends to shareholders and $3.5 million in stock repurchases.
The Corporation has a stock repurchase plan that was originally approved by the Board of Directors in December 2002 and is currently scheduled to terminate in June 2004. During the first quarter of 2004, 163,000 shares were purchased under this plan. As of March 31, 2004, there are approximately 4.8 million authorized shares remaining.
The Corporation and its subsidiary banks are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain actions by regulators that could have a material effect on the Corporation’s financial statements. The regulations require that banks maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk weighted assets (as defined), and Tier I capital to average assets (as defined). As of March 31, 2004, the Corporation and each of its bank subsidiaries met the minimum requirements. In addition, the Corporation and each of its bank subsidiaries’ capital ratios exceeded the amounts required to be considered “well-capitalized” as defined in the regulations. The following table summarizes the Corporation’s capital ratios in comparison to regulatory requirements as of March 31:
Adequacy
Well-
Capitalized
Total Capital (to risk Weighted Assets)
Tier I Capital (to Risk Weighted Assets)
Tier I Capital (to Average Assets)
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Liquidity
The Corporation must maintain a sufficient level of liquid assets to meet the cash needs of its customers, who, as depositors, may want to withdraw funds or who, as borrowers, need credit availability. Liquidity is provided on a continuous basis through scheduled and unscheduled principal and interest payments on outstanding loans and investments and through the availability of deposits and borrowings. In addition, the Corporation can borrow on a secured basis from the Federal Home Loan Bank to meet short-term liquidity needs.
The Corporation’s sources and uses of cash were discussed in general terms in the net interest income section of Management’s Discussion. The Consolidated Statements of Cash Flows provide additional information. The Corporation generated $45.9 million in cash from operating activities during the first quarter of 2004, mainly due to net income. Investing activities resulted in a net cash inflow of $158.5 million, compared to a net cash inflow of $42.9 million in 2003, as prepayments of loans and mortgage-backed securities exceeded originations and purchases during both periods. Finally, financing activities resulted in a net outflow of $197.1 million as excess funds were used to pay down borrowings.
Liquidity must also be managed at the Fulton Financial Corporation Parent Company level. For safety and soundness reasons, banking regulations limit the amount of cash that can be transferred from subsidiary banks to the Parent Company in the form of loans and dividends. Generally, these limitations are based on the subsidiary banks’ regulatory capital levels and their net income. The Parent Company has historically been able to meet its cash needs through normal, allowable dividends and loans. If additional cash needs arise that cannot be met through dividends and loans, the Parent Company may need to investigate alternative liquidity sources, including stock or debt issuances.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the exposure to economic loss that arises from changes in the values of certain financial instruments. The types of market risk exposures generally faced by financial institutions include interest rate risk, equity market price risk, foreign currency risk and commodity price risk. Due to the nature of its operations, only equity market price risk and interest rate risk are significant to the Corporation.
Equity Market Price Risk
Equity market price risk is the risk that changes in the values of equity investments could have a material impact on the financial position or results of operations of the Corporation. The Corporation’s equity investments consist primarily of common stocks of publicly traded financial institutions (cost basis of approximately $75.5 million and fair value of $87.2 million at March 31, 2004). The Corporation’s financial institutions stock portfolio had gross unrealized gains of approximately $12.8 million at March 31, 2004.
Although the carrying value of equity investments accounted for less than 1.0% of the Corporation’s total assets, the unrealized gains on the portfolio represent a potential source of revenue. The Corporation has a history of periodically realizing gains from this portfolio and, if values were to decline significantly, this revenue source could be lost.
Management continuously monitors the fair value of its equity investments and evaluates current market conditions and operating results of the companies. Periodic sale and purchase decisions are made based on this monitoring process. None of the Corporation’s equity securities are classified as trading. Future cash flows from these investments are not provided in the table on page 25 as such investments do not have maturity dates.
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The Corporation evaluates, based on current accounting guidance, whether any decreases in values of its equity investments constitute “other than temporary” impairment that would require a write-down through a charge to earnings. Based on the results of such evaluations, no charges were recorded during the first quarter of 2004. Write-downs of $3.3 million were recorded during calendar year 2003. Subsequent to these write-downs, the values of these securities improved and $1.9 million of realized gains were recognized upon sale while those remaining in the Corporation’s portfolio have increased in value by $1.3 million. Additional impairment charges may be necessary depending upon the performance of the equity markets in general and the performance of individual investments held by the Corporation.
In addition to its equity portfolio, the Corporation’s investment management and trust services revenue could be impacted by fluctuations in the securities markets. A portion of the Corporation’s trust revenue is based on the value of the underlying investment portfolios. If securities markets contract, the Corporation’s revenue could be negatively impacted. In addition, the ability of the Corporation to sell its equities brokerage services is dependent, in part, upon consumers’ level of confidence in the outlook for rising securities prices.
Interest Rate Risk
Interest rate risk creates exposure in two primary areas. First, changes in rates have an impact on the Corporation’s liquidity position and could affect its ability to meet obligations and continue to grow. Second, movements in interest rates can create fluctuations in the Corporation’s net income and changes in the economic value of its equity.
The Corporation employs various management techniques to minimize its exposure to interest rate risk. An Asset/Liability Management Committee (ALCO), consisting of key financial and senior management personnel, meets on a weekly basis. The ALCO is responsible for reviewing the interest rate sensitivity position of the Corporation, approving asset and liability management policies, and overseeing the formulation and implementation of strategies regarding balance sheet positions and earnings. The primary goal of asset/liability management is to address the liquidity and net income risks noted above.
The following table provides information about the Corporation’s interest rate sensitive financial instruments. The table provides expected cash flows and weighted average rates for each significant interest rate sensitive financial instrument, by expected maturity period. None of the Corporation’s financial instruments are classified as trading (dollars in thousands).
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Estimated
Fair Value
Fixed rate loans (1)
Average rate
Floating rate loans (1)
Fixed rate investments (1)(2)
Floating rate investments (1)(2)
Other interest-earning assets
Fixed rate deposits (3)
Floating rate deposits (4)
Fixed rate borrowings (5)
Floating rate borrowings (6)
Assumptions:
The preceding table and discussion addressed the liquidity implications of interest rate risk and focused on expected contractual cash flows from financial instruments. Expected maturities, however, do not necessarily estimate the net interest income impact of interest rate changes. Certain financial instruments, such as adjustable rate loans, have repricing periods that differ from expected cash flows.
The Corporation uses three complementary methods to measure and manage interest rate risk. They are static gap analysis, simulation of earnings, and estimates of economic value of equity. Using these measurements in tandem provides a reasonably comprehensive summary of the magnitude of interest rate risk in the Corporation, level of risk as time evolves, and exposure to changes in interest rate relationships.
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Static gap provides a measurement of repricing risk in the Corporation’s balance sheet as of a point in time. This measurement is accomplished through stratification of the Corporation’s assets and liabilities into predetermined repricing periods. The assets and liabilities in each of these periods are summed and compared for mismatches within that maturity segment. Core deposits having noncontractual maturities are placed into repricing periods based upon historical balance performance. Repricing for mortgage loans held and for mortgage-backed securities includes the effect of expected cash flows. Estimated prepayment effects are applied to these balances based upon industry projections for prepayment speeds. The Corporation’s policy limits the cumulative 6-month gap to plus or minus 15% of total earning assets. The cumulative 6-month gap as of March 31, 2004 was 0.93.
Simulation of net interest income and of net income is performed for the next twelve-month period. A variety of interest rate scenarios are used to measure the effects of sudden and gradual movements upward and downward in the yield curve. These results are compared to the results obtained in a flat or unchanged interest rate scenario. Simulation of earnings is used primarily to measure the Corporation’s short-term earnings exposure to rate movements. The Corporation’s policy limits the potential exposure of net interest income to 10% of the base case net interest income for every 100 basis point “shock” in interest rates. A “shock’ is an immediate upward or downward movement of interest rates across the yield curve based upon changes in the prime rate. The following table summarizes the expected impact of interest rate shocks on net interest income:
Rate Shock
Annual change
in net interest
income
+300bp
+200bp
+100bp
-100bp
Economic value of equity estimates the discounted present value of asset cash flows and liability cash flows. Discount rates are based upon market prices for like assets and liabilities. Upward and downward shocks of interest rates are used to determine the comparative effect of such interest rate movements relative to the unchanged environment. This measurement tool is used primarily to evaluate the longer-term re-pricing risks and options in the Corporation’s balance sheet. A policy limit of 10% of economic equity may be at risk for every 100 basis point “shock” movement in interest rates. The following table summarizes the expected impact of interest rate shocks on economic value of equity.
Change in
economic value
of equity
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Item 4. Controls and Procedures
The Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this quarterly report, the Corporation’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in Corporation reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
There have been no changes in our internal control over financial reporting during the fiscal quarter covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II — OTHER INFORMATION
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
Period
Total number
of shares
purchased
price paid
per share
Total number of shares
purchased as part of a
publicly announced plan
or program
Maximum number of
shares that may yet be
purchased under the
plan or program
1/1/04 - 1/31/04
2/1/04 - 2/29/04
3/1/04 - 3/31/04
The Corporation has one publicly announced stock repurchase plan originally approved by the Board of Directors in December 2002 to repurchase 3.2 million shares through June 2003. In June 2003, the Board approved an extension of the program to repurchase the approximately 2.0 million remaining authorized shares through December 31, 2003. In September 2003 when approximately 900,000 authorized shares were remaining to be repurchased, the Board extended the plan through June 2004 and authorized an additional 4.9 million shares to be repurchased through that date. During 2004, no stock repurchases were made outside the plan and all were made under the guidelines of Rule 10b-18 issued in November 2003 and in compliance with Regulation M.
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Item 6. Exhibits and Reports on Form 8-K
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FULTON FINANCIAL CORPORATION AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: May 7, 2004
/s/ Rufus A. Fulton, Jr.
Rufus A. Fulton, Jr.
Chairman and Chief Executive Officer
/s/ Charles J. Nugent
Charles J. Nugent
Senior Executive Vice President and
Chief Financial Officer
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EXHIBIT INDEX
Exhibits Required Pursuant
to Item 601 of Regulation S-K
3. Articles of incorporation, as amended and restated, and Bylaws of Fulton Financial Corporation as amended - Incorporated by reference from Exhibit 3 of the Fulton Financial Corporation Quarterly Report on Form 10-Q for the quarter ended March 31, 1999.
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