UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2009,
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number: 0-10587
FULTON FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
PENNSYLVANIA | 23-2195389 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
One Penn Square, P. O. Box 4887, Lancaster, Pennsylvania | 17604 | |
(Address of principal executive offices) | (Zip Code) |
(717) 291-2411
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
Name of exchange on which registered | |
Common Stock, $2.50 par value |
The NASDAQ Stock Market, LLC |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
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 ¨ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check One):
Large accelerated filed x Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of the voting Common Stock held by non-affiliates of the registrant, based on the average bid and asked prices on June 30, 2009, the last business day of the registrants most recently completed second fiscal quarter, was approximately $878.9 million. The number of shares of the registrants Common Stock outstanding on January 31, 2010 was 176,455,000.
Portions of the Definitive Proxy Statement of the Registrant for the Annual Meeting of Shareholders to be held on April 30, 2010 are incorporated by reference in Part III.
Description |
Page | |||
PART I |
||||
Item 1. |
3 | |||
Item 1A. |
9 | |||
Item 1B. |
12 | |||
Item 2. |
13 | |||
Item 3. |
13 | |||
Item 4. |
13 | |||
PART II |
||||
Item 5. |
14 | |||
Item 6. |
16 | |||
Item 7. |
Managements Discussion and Analysis of Financial Condition and Results of Operations |
17 | ||
Item 7A. |
42 | |||
Item 8. |
Financial Statements and Supplementary Data: |
|||
50 | ||||
51 | ||||
Consolidated Statements of Shareholders Equity and Comprehensive Income (Loss) |
52 | |||
53 | ||||
54 | ||||
Management Report On Internal Control Over Financial Reporting |
97 | |||
98 | ||||
99 | ||||
Item 9. |
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
100 | ||
Item 9A. |
100 | |||
Item 9B. |
100 | |||
PART III |
||||
Item 10. |
101 | |||
Item 11. |
101 | |||
Item 12. |
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
101 | ||
Item 13. |
Certain Relationships and Related Transactions, and Director Independence |
101 | ||
Item 14. |
101 | |||
PART IV |
||||
Item 15. |
102 | |||
105 | ||||
107 |
2
PART I
Item 1. | Business |
General
Fulton Financial Corporation (the Corporation) was incorporated under the laws of Pennsylvania on February 8, 1982 and became a bank holding company through the acquisition of all of the outstanding stock of Fulton Bank on June 30, 1982. In 2000, the Corporation became a financial holding company as defined in the Gramm-Leach-Bliley Act (GLB Act), which allowed the Corporation to expand its financial services activities under its holding company structure (See Competition and Supervision and Regulation). The Corporation directly owns 100% of the common stock of eight community banks and twelve non-bank entities. As of December 31, 2009, the Corporation had approximately 3,560 full-time equivalent employees.
The common stock of Fulton Financial Corporation is listed for quotation on the Global Select Market of The NASDAQ Stock Market under the symbol FULT. The Corporations internet address is www.fult.com. Electronic copies of the Corporations 2009 Annual Report on Form 10-K are available free of charge by visiting Investor Relations on www.fult.com. Electronic copies of quarterly reports on Form 10-Q and current reports on Form 8-K are also available at this internet address. These reports are posted as soon as reasonably practicable after they are electronically filed with the Securities and Exchange Commission (SEC).
Bank and Financial Services Subsidiaries
The Corporations eight subsidiary banks are located primarily in suburban or semi-rural geographical markets throughout a five state region (Pennsylvania, Delaware, Maryland, New Jersey and Virginia). Pursuant to its super-community banking strategy, the Corporation operates the banks autonomously to maximize the advantage of community banking and service to its customers. Where appropriate, operations are centralized through common platforms and back-office functions; however, decision-making generally remains with the local bank management. The Corporation is committed to a decentralized operating philosophy; however, in some markets and in certain circumstances, merging subsidiaries creates operating and marketing efficiencies by leveraging existing brand awareness over a larger geographic area. In 2009, the former Peoples Bank of Elkton subsidiary and the former Hagerstown Trust Company subsidiary merged with The Columbia Bank to consolidate the Corporations Maryland franchise.
The Corporations subsidiary banks are located in areas that are home to a wide range of manufacturing, distribution, health care and other service companies. The Corporation and its banks are not dependent upon one or a few customers or any one industry, and the loss of any single customer or a few customers would not have a material adverse impact on any of the subsidiary banks.
Each of the subsidiary banks offers a full range of consumer and commercial banking products and services in its local market area. Personal banking services include various checking account and savings deposit products, certificates of deposit and individual retirement accounts. The subsidiary banks offer a variety of consumer lending products to creditworthy customers in their market areas. Secured loan products include home equity loans and lines of credit, which are underwritten based on loan-to-value limits specified in the lending policy. Subsidiary banks also offer a variety of fixed and variable-rate products, including construction loans and jumbo loans. Residential mortgages are offered through Fulton Mortgage Company, which operates as a division of each subsidiary bank. Consumer loan products also include automobile loans, automobile and equipment leases, personal lines of credit, credit cards and checking account overdraft protection.
Commercial banking services are provided to small and medium sized businesses (generally with sales of less than $100 million) in the subsidiary banks market areas. The maximum total lending commitment to an individual borrower was $33.0 million as of December 31, 2009, which is below the Corporations regulatory lending limit. Commercial lending options include commercial, financial, agricultural and real estate loans. Floating, adjustable and fixed rate loans are provided, with floating and adjustable rate loans generally tied to an index such as the Prime Rate or the London Interbank Offering Rate. The Corporations commercial lending policy encourages relationship banking and provides strict guidelines related to customer creditworthiness and collateral requirements. In addition, equipment leasing, credit cards, letters of credit, cash management services and traditional deposit products are offered to commercial customers.
The Corporation also offers investment management, trust, brokerage, insurance and investment advisory services to consumer and commercial banking customers in the market areas serviced by the subsidiary banks.
3
In October 2009, the Corporations investment management and trust services subsidiary, Fulton Financial Advisors, N.A., became an operating subsidiary of Fulton Bank. Concurrently with this transaction, Fulton Bank converted its Pennsylvania state charter to a national charter, thereby becoming Fulton Bank, N.A.
The Corporations subsidiary banks deliver their products and services through traditional branch banking, with a network of full service branch offices. Electronic delivery channels include a network of automated teller machines, telephone banking and online banking. The variety of available delivery channels allows customers to access their account information and perform certain transactions, such as transferring funds and paying bills, at virtually any hour of the day.
The following table provides certain information for the Corporations banking subsidiaries as of December 31, 2009.
Subsidiary |
Main Office Location |
Total Assets |
Total Deposits |
Branches (1) | ||||||
(dollars in millions) | ||||||||||
Fulton Bank, N.A. |
Lancaster, PA | $ | 8,368 | $ | 5,643 | 105 | ||||
The Bank |
Woodbury, NJ | 2,092 | 1,720 | 50 | ||||||
The Columbia Bank |
Columbia, MD | 2,229 | 1,707 | 40 | ||||||
Lafayette Ambassador Bank |
Easton, PA | 1,443 | 1,136 | 24 | ||||||
Skylands Community Bank |
Hackettstown, NJ | 1,324 | 1,049 | 27 | ||||||
Delaware National Bank |
Georgetown, DE | 486 | 351 | 12 | ||||||
FNB Bank, N.A. |
Danville, PA | 402 | 312 | 10 | ||||||
Swineford National Bank |
Hummels Wharf, PA | 314 | 249 | 7 | ||||||
275 | ||||||||||
(1) | Remote service facilities (mainly stand-alone automated teller machines) are excluded. See additional information in Item 2. Properties. |
Non-Bank Subsidiaries
The Corporation owns 100% of the common stock of six non-bank subsidiaries which are consolidated for financial reporting purposes: (i) Fulton Reinsurance Company, LTD, which engages in the business of reinsuring credit life and accident and health insurance directly related to extensions of credit by the banking subsidiaries of the Corporation; (ii) Fulton Financial Realty Company, which holds title to or leases certain properties upon which Corporation branch offices and other facilities are located; (iii) Central Pennsylvania Financial Corp., which owns certain limited partnership interests in partnerships invested in low and moderate income housing projects; (iv) FFC Management, Inc., which owns certain investment securities and other passive investments; (v) FFC Penn Square, Inc. which owns trust preferred securities issued by a subsidiary of Fulton Bank, N.A; and (vi) Fulton Insurance Services Group, Inc., which engages in the sale of various life insurance products.
The Corporation owns 100% of the common stock of six non-bank subsidiaries which are not consolidated for financial reporting purposes. The following table provides information for these non-bank subsidiaries, whose sole assets consist of junior subordinated deferrable interest debentures issued by the Corporation, as of December 31, 2009 (total assets in thousands):
Subsidiary |
State of Incorporation |
Total Assets | |||
Fulton Capital Trust I |
Pennsylvania | $ | 154,640 | ||
SVB Bald Eagle Statutory Trust I |
Connecticut | 4,124 | |||
Columbia Bancorp Statutory Trust |
Delaware | 6,186 | |||
Columbia Bancorp Statutory Trust II |
Delaware | 4,124 | |||
Columbia Bancorp Statutory Trust III |
Delaware | 6,186 | |||
PBI Capital Trust |
Delaware | 10,310 |
Competition
The banking and financial services industries are highly competitive. Within its geographical region, the Corporations subsidiaries face direct competition from other commercial banks, varying in size from local community banks to larger regional and national
4
banks, credit unions and non-bank entities. With the growth in electronic commerce and distribution channels, the banks also face competition from banks that do not have a physical presence in the Corporations geographical markets.
The industry is also highly competitive due to the GLB Act. Under the GLB Act, banks, insurance companies or securities firms may affiliate under a financial holding company structure, allowing expansion into non-banking financial services activities that were previously restricted. These include a full range of banking, securities and insurance activities, including securities and insurance underwriting, issuing and selling annuities and merchant banking activities. While the Corporation does not currently engage in all of these activities, the ability to do so without separate approval from the Federal Reserve Board (FRB) enhances the ability of the Corporation and financial holding companies in general to compete more effectively in all areas of financial services.
As a result of the GLB Act, there is a great deal of competition for customers that were traditionally served by the banking industry. While the GLB Act increased competition, it also provided opportunities for the Corporation to expand its financial services offerings. The Corporation competes through the variety of products that it offers and the quality of service that it provides to its customers. However, there is no guarantee that these efforts will insulate the Corporation from competitive pressure, which could impact its pricing decisions for loans, deposits and other services and could ultimately impact financial results.
Market Share
Although there are many ways to assess the size and strength of banks, deposit market share continues to be an important industry statistic. This publicly available information is compiled, as of June 30th of each year, by the Federal Deposit Insurance Corporation (FDIC). The Corporations banks maintain branch offices in 53 counties across five states. In 11 of these counties, the Corporation ranked in the top three in deposit market share (based on deposits as of June 30, 2009). The following table summarizes information about the counties in which the Corporation has branch offices and its market position in each county.
No. of Financial Institutions |
Deposit Market Share (June 30, 2009) |
||||||||||||||
County |
State | Population (2009 Est.) |
Banking Subsidiary |
Banks/ Thrifts |
Credit Unions |
Rank | % | ||||||||
Lancaster |
PA | 504,000 | Fulton Bank, N.A. | 18 | 13 | 1 | 20.6 | % | |||||||
Berks |
PA | 408,000 | Fulton Bank, N.A. | 20 | 11 | 9 | 4.1 | % | |||||||
Bucks |
PA | 625,000 | Fulton Bank, N.A. | 36 | 16 | 17 | 2.1 | % | |||||||
Centre |
PA | 146,000 | Fulton Bank, N.A. | 16 | 4 | 16 | 1.5 | % | |||||||
Chester |
PA | 497,000 | Fulton Bank, N.A. | 40 | 5 | 14 | 1.9 | % | |||||||
Columbia |
PA | 65,000 | FNB Bank, N.A. | 6 | | 5 | 5.1 | % | |||||||
Cumberland |
PA | 231,000 | Fulton Bank, N.A. | 21 | 5 | 15 | 1.5 | % | |||||||
Dauphin |
PA | 257,000 | Fulton Bank, N.A. | 17 | 9 | 6 | 4.1 | % | |||||||
Delaware |
PA | 555,000 | Fulton Bank, N.A. | 42 | 14 | 38 | 0.2 | % | |||||||
Lebanon |
PA | 130,000 | Fulton Bank, N.A. | 10 | 2 | 1 | 28.8 | % | |||||||
Lehigh |
PA | 343,000 | Lafayette Ambassador Bank | 19 | 13 | 7 | 3.9 | % | |||||||
Lycoming |
PA | 116,000 | FNB Bank, N.A. | 11 | 10 | 13 | 1.0 | % | |||||||
Montgomery |
PA | 779,000 | Fulton Bank | 50 | 23 | 24 | 0.3 | % | |||||||
Montour |
PA | 18,000 | FNB Bank, N.A. | 4 | 3 | 1 | 32.7 | % | |||||||
Northampton |
PA | 299,000 | Lafayette Ambassador Bank | 17 | 13 | 3 | 15.2 | % | |||||||
Northumberland |
PA | 90,000 | Swineford National Bank | 18 | 3 | 14 | 1.8 | % | |||||||
FNB Bank, N.A. | 8 | 5.0 | % | ||||||||||||
Schuylkill |
PA | 147,000 | Fulton Bank, N.A. | 20 | 4 | 10 | 3.5 | % | |||||||
Snyder |
PA | 38,000 | Swineford National Bank | 8 | | 1 | 32.5 | % |
5
No. of Financial Institutions |
Deposit Market Share (June 30, 2009) |
||||||||||||||
County |
State | Population (2009 Est.) |
Banking Subsidiary |
Banks/ Thrifts |
Credit Unions |
Rank | % | ||||||||
Union |
PA | 44,000 | Swineford National Bank | 8 | 1 | 6 | 6.0 | % | |||||||
York |
PA | 430,000 | Fulton Bank, N.A. | 16 | 14 | 5 | 9.3 | % | |||||||
New Castle |
DE | 534,000 | Delaware National Bank | 30 | 20 | 24 | 0.1 | % | |||||||
Sussex |
DE | 190,000 | Delaware National Bank | 15 | 4 | 5 | 0.8 | % | |||||||
Anne Arundel |
MD | 515,000 | The Columbia Bank | 32 | 7 | 27 | 0.2 | % | |||||||
Baltimore |
MD | 794,000 | The Columbia Bank | 44 | 22 | 22 | 0.9 | % | |||||||
Baltimore City |
MD | 635,000 | The Columbia Bank | 39 | 13 | 17 | 0.4 | % | |||||||
Cecil |
MD | 102,000 | The Columbia Bank | 7 | 3 | 3 | 11.9 | % | |||||||
Frederick |
MD | 229,000 | The Columbia Bank | 17 | 2 | 13 | 1.1 | % | |||||||
Howard |
MD | 278,000 | The Columbia Bank | 21 | 3 | 2 | 13.4 | % | |||||||
Montgomery |
MD | 939,000 | The Columbia Bank | 38 | 21 | 31 | 0.3 | % | |||||||
Prince Georges |
MD | 827,000 | The Columbia Bank | 23 | 19 | 16 | 1.4 | % | |||||||
Washington |
MD | 148,000 | The Columbia Bank | 13 | 3 | 2 | 21.8 | % | |||||||
Atlantic |
NJ | 273,000 | The Bank | 15 | 6 | 14 | 1.3 | % | |||||||
Burlington |
NJ | 448,000 | The Bank | 23 | 10 | 21 | 0.3 | % | |||||||
Camden |
NJ | 515,000 | The Bank | 21 | 7 | 10 | 2.0 | % | |||||||
Cumberland |
NJ | 157,000 | The Bank | 12 | 4 | 10 | 2.1 | % | |||||||
Gloucester |
NJ | 292,000 | The Bank | 22 | 4 | 2 | 14.8 | % | |||||||
Hunterdon |
NJ | 130,000 | Skylands Community Bank | 15 | 3 | 12 | 2.7 | % | |||||||
Mercer |
NJ | 367,000 | The Bank | 27 | 18 | 21 | 0.6 | % | |||||||
Middlesex |
NJ | 794,000 | Skylands Community Bank | 46 | 25 | 38 | 0.3 | % | |||||||
Monmouth |
NJ | 644,000 | The Bank | 27 | 9 | 24 | 0.6 | % | |||||||
Morris |
NJ | 491,000 | Skylands Community Bank | 31 | 9 | 15 | 1.4 | % | |||||||
Ocean |
NJ | 573,000 | The Bank | 23 | 6 | 16 | 0.8 | % | |||||||
Salem |
NJ | 66,000 | The Bank | 8 | 4 | 1 | 25.9 | % | |||||||
Somerset |
NJ | 328,000 | Skylands Community Bank | 28 | 7 | 8 | 2.8 | % | |||||||
Sussex |
NJ | 152,000 | Skylands Community Bank | 12 | 1 | 11 | 0.7 | % | |||||||
Warren |
NJ | 110,000 | Skylands Community Bank | 13 | 2 | 2 | 12.7 | % | |||||||
Chesapeake |
VA | 221,000 | Fulton Bank, N.A. | 14 | 7 | 12 | 2.0 | % | |||||||
Fairfax |
VA | 1,019,000 | Fulton Bank, N.A. | 39 | 15 | 32 | 0.1 | % | |||||||
Henrico |
VA | 295,000 | Fulton Bank, N.A. | 23 | 13 | 27 | 0.1 | % | |||||||
Manassas |
VA | 36,000 | Fulton Bank, N.A. | 14 | 1 | 10 | 1.5 | % | |||||||
Newport News |
VA | 181,000 | Fulton Bank, N.A. | 12 | 7 | 15 | 0.6 | % | |||||||
Richmond City |
VA | 198,000 | Fulton Bank, N.A. | 15 | 11 | 16 | 0.3 | % | |||||||
Virginia Beach |
VA | 435,000 | Fulton Bank, N.A. | 15 | 8 | 11 | 2.2 | % |
Supervision and Regulation
The Corporation operates in an industry that is subject to various laws and regulations that are enforced by a number of Federal and state agencies. Changes in these laws and regulations, including interpretation and enforcement activities, could impact the cost of operating in the financial services industry, limit or expand permissible activities or affect competition among banks and other financial institutions.
6
The following discussion summarizes the current regulatory environment for financial holding companies and banks, including a summary of the more significant laws and regulations.
Regulators The Corporation is a registered financial holding company, and its subsidiary banks are depository institutions whose deposits are insured by the FDIC. The Corporation and its subsidiaries are subject to various regulations and examinations by regulatory authorities. The following table summarizes the charter types and primary regulators for each of the Corporations subsidiary banks.
Subsidiary |
Charter | Primary Regulator(s) | ||
Fulton Bank, N.A. |
National | OCC (1) | ||
The Bank |
NJ | NJ/FDIC | ||
The Columbia Bank |
MD | MD/FDIC | ||
Lafayette Ambassador Bank |
PA | PA/FRB | ||
Skylands Community Bank |
NJ | NJ/FDIC | ||
Delaware National Bank |
National | OCC | ||
FNB Bank, N.A. |
National | OCC | ||
Swineford National Bank |
National | OCC | ||
Fulton Financial (Parent Company) |
N/A | FRB |
(1) | Office of the Comptroller of the Currency. Fulton Bank, N.A. became an OCC-regulated bank in October 2009. |
Federal statutes that apply to the Corporation and its subsidiaries include the GLB Act, the Bank Holding Company Act (BHCA), the Federal Reserve Act and the Federal Deposit Insurance Act, among others. In general, these statutes and related interpretations establish the eligible business activities of the Corporation, certain acquisition and merger restrictions, limitations on intercompany transactions such as loans and dividends and capital adequacy requirements, among other statutes and regulations.
The Corporation is subject to regulation and examination by the FRB, and is required to file periodic reports and to provide additional information that the FRB may require. In addition, the FRB must approve certain proposed changes in organizational structure or other business activities before they occur. The BHCA imposes certain restrictions upon the Corporation regarding the acquisition of substantially all of the assets of or direct or indirect ownership or control of any bank for which it is not already the majority owner.
Capital Requirements There are a number of restrictions on financial and bank holding companies and FDIC-insured depository subsidiaries that are designed to minimize potential loss to depositors and the FDIC insurance funds. If an FDIC-insured depository subsidiary is undercapitalized, the bank holding company is required to ensure (subject to certain limits) the subsidiarys compliance with the terms of any capital restoration plan filed with its appropriate banking agency. Also, a bank holding company is required to serve as a source of financial strength to its depository institution subsidiaries and to commit resources to support such institutions in circumstances where it might not do so absent such policy. Under the BHCA, the FRB has the authority to require a bank holding company to terminate any activity or to relinquish control of a non-bank subsidiary upon the FRBs determination that such activity or control constitutes a serious risk to the financial soundness and stability of a depository institution subsidiary of the bank holding company.
Bank holding companies are required to comply with the FRBs risk-based capital guidelines that require a minimum ratio of total capital to risk-weighted assets of 8%. At least half of the total capital is required to be Tier 1 capital. In addition to the risk-based capital guidelines, the FRB has adopted a minimum leverage capital ratio under which a bank holding company must maintain a level of Tier 1 capital to average total consolidated assets of at least 3% in the case of a bank holding company which has the highest regulatory examination rating and is not contemplating significant growth or expansion. All other bank holding companies are expected to maintain a leverage capital ratio of at least 1% to 2% above the stated minimum.
Dividends and Loans from Subsidiary Banks There are also various restrictions on the extent to which the Corporation and its non-bank subsidiaries can receive loans from its banking subsidiaries. In general, these restrictions require that such loans be secured by designated amounts of specified collateral and are limited, as to any one of the Corporation or its non-bank subsidiaries, to 10% of the lending banks regulatory capital (20% in the aggregate to all such entities).
The Corporation is also limited in the amount of dividends that it may receive from its subsidiary banks. Dividend limitations vary, depending on the subsidiary banks charter and whether or not it is a member of the Federal Reserve System. Generally, subsidiaries
7
are prohibited from paying dividends when doing so would cause them to fall below the regulatory minimum capital levels. Additionally, limits may exist on paying dividends in excess of net income for specified periods. See Note J Regulatory Matters in the Notes to Consolidated Financial Statements for additional information regarding regulatory capital and dividend and loan limitations.
Federal Deposit Insurance Substantially all of the deposits of the Corporations subsidiary banks are insured up to the applicable limits by the Bank Insurance Fund (BIF) of the FDIC, generally up to $100,000 per insured depositor and up to $250,000 for retirement accounts. Effective October 3, 2008 with the enactment of the Emergency Economic Stabilization Act of 2008 (EESA), the $100,000 insurance limit was increased to $250,000 through December 31, 2009. See additional discussion of the EESA under Regulatory Developments. In May 2009, the FDIC extended the $250,000 insurance limit through December 31, 2013, however, the insurance limit on individual retirement accounts and other certain retirement accounts will remain at $250,000 per depositor.
The subsidiary banks pay deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC for BIF member institutions. The FDIC has established a risk-based assessment system under which institutions are classified and pay premiums according to their perceived risk to the Federal deposit insurance funds. The FDIC is not required to charge deposit insurance premiums when the ratio of deposit insurance reserves to insured deposits is maintained above specified levels. For the period from 1997 through 2006, the Corporations subsidiary banks (based on the FDICs classification system) did not pay any premiums as the BIF was sufficiently funded. However, in 2006, legislation was passed reforming the bank deposit insurance system. The reform act allowed the FDIC to raise the minimum reserve ratio and allowed eligible insured institutions an initial one-time credit to be used against premiums due. During 2007, 2008 and 2009, the Corporations subsidiary banks were assessed insurance premiums, which were partially offset by each affiliates one-time credit. The Corporations one-time credits expired in the first quarter of 2009.
During the second quarter of 2009, the FDIC imposed a special assessment of 5 basis points on total bank subsidiary assets less total bank subsidiary tier one capital, resulting in a one-time pre-tax charge of $7.9 million for the Corporation. In November 2009, the FDIC issued a ruling requiring financial institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. As of December 31, 2009, the balance of prepaid FDIC assessments included in other assets on the Corporations consolidated balance sheet was $66.0 million.
USA Patriot Act Anti-terrorism legislation enacted under the USA Patriot Act of 2001 (Patriot Act) expanded the scope of anti-money laundering laws and regulations and imposed significant new compliance obligations for financial institutions, including the Corporations subsidiary banks. These regulations include obligations to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.
Failure to comply with the Patriot Acts requirements could have serious legal, financial and reputational consequences. The Corporation has adopted appropriate policies, procedures and controls to address compliance with the Patriot Act and will continue to revise and update its policies, procedures and controls to reflect required changes.
Sarbanes-Oxley Act of 2002 The Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley), which was signed into law in July 2002, impacts all companies with securities registered under the Securities Exchange Act of 1934, including the Corporation. Sarbanes-Oxley created new requirements in the areas of corporate governance and financial disclosure including, among other things, (i) increased responsibility for Chief Executive Officers and Chief Financial Officers with respect to the content of filings with the SEC; (ii) enhanced requirements for audit committees, including independence and disclosure of expertise; (iii) enhanced requirements for auditor independence and the types of non-audit services that auditors can provide; (iv) accelerated filing requirements for SEC reports; (v) disclosure of a code of ethics; (vi) increased disclosure and reporting obligations for companies, their directors and their executive officers; and (vii) new and increased civil and criminal penalties for violations of securities laws. Many of the provisions became effective immediately, while others became effective as a result of rulemaking procedures delegated by Sarbanes-Oxley to the SEC.
Section 404 of Sarbanes-Oxley requires management to issue a report on the effectiveness of its internal controls over financial reporting. In addition, the Corporations independent registered public accountants are required to issue an opinion on the effectiveness of the Corporations internal control over financial reporting. These reports can be found in Item 8, Financial Statements and Supplementary Data. Certifications of the Chief Executive Officer and the Chief Financial Officer as required by Sarbanes-Oxley and the resulting SEC rules can be found in the Signatures and Exhibits sections.
Regulatory Developments On October 3, 2008 the EESA, also known as the Troubled Asset Relief Program (TARP), was enacted. In connection with the EESA, the U.S. Treasury Department (UST) initiated a Capital Purchase Program (CPP), which allowed for
8
qualifying financial institutions to issue preferred stock to the UST, subject to certain limitations and terms. The EESA was developed to attract broad participation by strong financial institutions, to stabilize the financial system and increase lending to benefit the national economy and citizens of the U.S.
On December 23, 2008, the Corporation entered into a Securities Purchase Agreement with the UST pursuant to which the Corporation sold to the UST, for an aggregate purchase price of $376.5 million, 376,500 shares of preferred stock and warrants to purchase up to 5.5 million shares of common stock of the Corporation. The preferred stock ranks senior to the Corporations common shares and pays a compounding cumulative dividend at a rate of 5% per year for the first five years, and 9% per year thereafter. The preferred stock is non-voting, other than class voting rights on matters that could adversely affect the preferred stock. The UST may also transfer the preferred stock to a third-party at any time. The Corporations preferred stock is included as a component of Tier 1 capital in accordance with regulatory capital requirements.
As a condition of its participation in the CPP, and as long as the preferred stock issued to the UST is outstanding, without the consent of the UST, common stock repurchases are currently limited to purchases in connection with the administration of any employee benefit plan, consistent with past practices, including purchases to offset share dilution in connection with any such plans until December 2011 or until the UST no longer owns any of the Corporations preferred shares issued under the CPP. In addition, the Corporation is prohibited from paying any dividend with respect to shares of common stock or repurchasing or redeeming any shares of the Corporations common shares in any quarter unless all accrued and unpaid dividends are paid on the preferred stock for all past dividend periods (including the latest completed dividend period), subject to certain limited exceptions. In addition, without the consent of the UST, the Corporation is prohibited from declaring or paying any cash dividends on common shares in excess of $0.15 per share, which was the last quarterly cash dividend per share declared prior to October 14, 2008. The Corporation is also restricted in the amounts and types of compensation it may pay to certain of its executives as a result of its participation in the CPP.
See also Note M, Stock-based Compensation Plans and Shareholders Equity in the Notes to Consolidated Financial Statements for additional details related to the Corporations participation in the CPP.
Item 1A. | Risk Factors |
An investment in the Corporations common stock involves certain risks, including, among others, the risks described below. In addition to the other information contained in this report, you should carefully consider the following risk factors.
Changes in interest rates may have an adverse effect on the Corporations net income or loss.
The Corporation is affected by fiscal and monetary policies of the Federal government, including those of the Federal Reserve Board (FRB), which regulates the national money supply in order to manage recessionary and inflationary pressures. Among the techniques available to the FRB are engaging in open market transactions of U.S. Government securities, changing the discount rate and changing reserve requirements against bank deposits. The use of these techniques may also affect interest rates charged on loans and paid on deposits.
Net interest income is the most significant component of the Corporations net income, accounting for approximately 76% of total revenues in 2009. The narrowing of interest rate spreads, the difference between interest rates earned on loans and investments and interest rates paid on deposits and borrowings, could adversely affect the Corporations net interest income and financial condition. Regional and local economic conditions as well as fiscal and monetary policies of the Federal government, including those of the FRB, may affect prevailing interest rates. The Corporation cannot predict or control changes in interest rates.
The severity and duration of the economic downturn and the composition of the Corporations loan portfolio could impact the level of loan charge-offs and the provision for loan losses and may affect the Corporations net income or loss.
National, regional, and local economic conditions could impact the loan portfolios of the Corporations subsidiary banks. For example, an increase in unemployment, a decrease in real estate values or increases in interest rates, as well as other factors, could weaken the economies of the communities the Corporation serves. Weakness in the market areas served by the Corporations subsidiary banks could depress its earnings and consequently its financial condition because:
| borrowers may not be able to repay their loans; |
| the value of the collateral securing the Corporations loans to borrowers may decline; and |
| the quality of the Corporations loan portfolio may decline. |
9
Any of these scenarios could require the Corporation to charge-off a higher percentage of its loans and/or increase its provision for loan losses, which would negatively impact its results of operations.
In addition, the amount of the Corporations provision for loan losses and the percentage of loans it is required to charge-off may be impacted by the overall risk composition of the loan portfolio. In 2009, the Corporations provision for loan losses was $190.0 million. While the Corporation believes that its allowance for loan losses as of December 31, 2009 is sufficient to cover losses inherent in the loan portfolio on that date, the Corporation may be required to increase its loan loss provision or charge-off a higher percentage of loans due to changes in the risk characteristics of the loan portfolio, thereby negatively impacting its results of operations.
Price fluctuations in securities markets, as well as other market events, such as a disruption in credit and other markets and the abnormal functioning of markets for securities, could have an impact on the Corporations results of operations.
As of December 31, 2009, the Corporations equity investments consisted of Federal Home Loan Bank (FHLB) and Federal Reserve Bank stock ($99.1 million), common stocks of publicly traded financial institutions ($32.3 million), and money market mutual funds and other equity investments ($9.0 million). The value of the securities in the Corporations equity portfolio may be affected by a number of factors, including factors that impact the performance of the U.S. securities market in general and specific risks associated with the financial institution sector. Historically, gains on sales of stocks of other financial institutions had been a recurring component of the Corporations earnings. However, general economic conditions and uncertainty surrounding the financial institution sector as a whole has impacted the value of these securities. Further declines in bank stock values could result in additional other-than-temporary impairment charges.
As of December 31, 2009, the Corporation had $113.5 million of corporate debt securities issued by financial institutions. As with stocks of financial institutions, continued declines in the values of these securities, combined with adverse changes in the expected cash flows from these investments, could result in additional other-than-temporary impairment charges.
The Corporations investment management and trust division, Fulton Financial Advisors, previously held student loan auction rate securities, also known as auction rate certificates (ARCs), for some of its customers accounts. From the second quarter of 2008 through 2009, the Corporation purchased illiquid ARCs from customers of Fulton Financial Advisors. Total ARCs included in the Corporations investment securities at December 31, 2009 were $289.2 million.
The Corporations investment management and trust services income could also be impacted by fluctuations in the securities markets. A portion of this revenue is based on the value of the underlying investment portfolios. If the values of those investment portfolios decrease, whether due to factors influencing U.S. securities markets in general, or otherwise, the Corporations revenue could be negatively impacted. In addition, the Corporations ability to sell its brokerage services is dependent, in part, upon consumers level of confidence in securities markets.
If the goodwill that the Corporation has recorded in connection with its acquisitions becomes impaired, it could have a negative impact on the Corporations results of operations.
The Corporation has historically supplemented its internal growth with strategic acquisitions of banks, branches and other financial services companies. If the purchase price of an acquired company exceeds the fair value of the companys net assets, the excess is carried on the acquirers balance sheet as goodwill. Companies must evaluate goodwill for impairment at least annually. Write-downs of the amount of any impairment, if necessary, are to be charged to earnings in the period in which the impairment occurs. During 2008, the Corporation recorded a $90.0 million goodwill impairment charge. Based on its annual goodwill impairment test, the Corporation determined that no impairment charge was necessary in 2009. As of December 31, 2009, the Corporation had $534.9 million of goodwill on its consolidated balance sheet. There can be no assurance that future evaluations of goodwill will not result in additional impairment charges.
Difficult conditions in the capital markets and the economy generally may materially adversely affect the Corporations business and results of operations.
The Corporations results of operations and financial condition are affected by conditions in the capital markets and the economy generally. The capital and credit markets have been experiencing extreme volatility and disruption in recent years. The volatility and disruption in these markets have produced downward pressure on stock prices of, and credit availability to, certain companies without regard to those companies underlying financial strength.
10
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (EESA) was enacted. Pursuant to the EESA, the U.S. Treasury (UST) was authorized to, among other things, deploy up to $750 billion into the financial system. On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (ARRA) was enacted. The Federal Government, the Federal Reserve and other governmental and regulatory bodies have taken or are considering taking other actions in response to the financial crisis. Such actions, although intended to aid the financial markets, and continued volatility in the markets could materially and adversely affect the Corporations business, financial condition and results of operations, or the trading price of the Corporations common stock.
Concerns over the availability and cost of credit and the decline in the U.S. real estate market also contributed to increased volatility in the capital and credit markets and diminished expectations for the economy. These factors precipitated the economic slowdown, and may have a continuing adverse effect on the Corporation.
Included among the potential adverse effects of the current economic downturn on the Corporation are the following:
| A prolonged economic downturn, especially one affecting the Corporations geographic market areas, could reduce the Corporations customer deposits and demand for financial products, such as loans. The Corporations success depends significantly upon the growth in population, income levels, deposits and housing starts in its geographic markets. Unlike large national institutions, the Corporation is not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies and geographic locations. If the communities in which the Corporation operates do not grow, or if prevailing economic conditions locally or nationally are unfavorable, its business could be adversely affected. |
Negative developments in the financial industry and the credit markets may subject the Corporation to additional regulation. Negative developments in the financial industry and the domestic and international credit markets, and the impact of legislation in response to those developments, may negatively impact the Corporations operations and financial performance. The Corporation and its subsidiaries are subject to regulations and examinations by various regulatory authorities. In addition, the Corporation is subject to certain restrictions associated with its participation in the CPP, including its ability to increase dividends, repurchase common stock or preferred stock and access the equity capital market.
The potential exists for new Federal or state laws and regulations regarding lending and funding practices, capital requirements, deposit insurance premiums, other bank-focused special assessments and liquidity standards, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations, which may result in the issuance of formal enforcement orders.
| The Corporations future growth and liquidity needs may require the Corporation to raise additional capital in the future, but that capital may not be available when it is needed or may be available at an excessive cost. The Corporation is required by regulatory authorities to maintain adequate levels of capital to support its operations. The Corporation anticipates that current capital levels will satisfy regulatory requirements for the foreseeable future. |
On December 23, 2008, the Corporation issued $376.5 million of preferred stock and warrants to purchase 5.5 million shares of the Corporations common stock to the UST. The Corporation may at some point choose to raise additional capital to support its continued growth or to redeem the preferred stock issued under the CPP. The Corporations ability to raise additional capital will depend, in part, on conditions in the capital markets at that time, which are outside of the Corporations control. Accordingly, the Corporation may be unable to raise additional capital, if and when needed, on terms acceptable to the Corporation, or at all. If the Corporation cannot raise additional capital when needed, its ability to further expand operations through internal growth and acquisitions could be materially impacted. In addition, future issuances of equity securities could dilute the interests of existing shareholders and could cause a decline in the Corporations stock price.
In addition to primary sources of liquidity in the form of principal and interest payments on outstanding loans and investments and deposits, the Corporation maintains secondary sources that provide it with additional liquidity. These secondary sources include secured and unsecured borrowings from sources such as the Federal Reserve Bank and FHLB and third-party commercial banks. The Corporations strong liquidity position was further enhanced by its participation in the CPP and it believes that it is well positioned to withstand current market conditions. However, market liquidity conditions have been negatively impacted by disruptions in the capital markets and such disruptions could, in the future, have a negative impact on secondary sources of liquidity.
11
The competition the Corporation faces is significant and may reduce the Corporations customer base and negatively impact the Corporations results of operations.
There is significant competition among commercial banks in the market areas served by the Corporations subsidiary banks. In addition, as a result of the deregulation of the financial industry, the Corporations subsidiary banks also compete with other providers of financial services such as savings and loan associations, credit unions, consumer finance companies, securities firms, insurance companies, commercial finance and leasing companies, the mutual funds industry, full service brokerage firms and discount brokerage firms, some of which are subject to less extensive regulations than the Corporation is with respect to the products and services they provide. Some of the Corporations competitors, including certain super-regional and national bank holding companies that have made acquisitions in its market area, have greater resources than the Corporation has and, as such, may have higher lending limits and may offer other services not offered by the Corporation.
The Corporation also experiences competition from a variety of institutions outside its market areas. Some of these institutions conduct business primarily over the internet and may thus be able to realize certain cost savings and offer products and services at more favorable rates and with greater convenience to the customer.
Competition may adversely affect the rates the Corporation pays on deposits and charges on loans, thereby potentially adversely affecting the Corporations profitability. The Corporations profitability depends upon its continued ability to successfully compete in the market areas it serves while achieving its objectives.
The supervision and regulation to which the Corporation is subject can be a competitive disadvantage.
The Corporation is a registered financial holding company, and its subsidiary banks are depository institutions whose deposits are insured by the Federal Deposit Insurance Corporation (FDIC). The Corporation is extensively regulated under Federal and state banking laws and regulations that are intended primarily for the protection of depositors, Federal deposit insurance funds and the banking system as a whole. In general, these laws and regulations establish: the eligible business activities for the Corporation; certain acquisition and merger restrictions; limitations on intercompany transactions such as loans and dividends; capital adequacy requirements; requirements for anti-money laundering programs and other compliance matters, among other regulations. Compliance with these statutes and regulations is important to the Corporations ability to engage in new activities and to consummate additional acquisitions. In addition, the Corporation is subject to changes in Federal and state tax laws as well as changes in banking and credit regulations, accounting principles and governmental economic and monetary policies. While these statutes and regulations are generally designed to minimize potential loss to depositors and the FDIC insurance funds, they do not eliminate risk, and compliance with such statutes and regulations increases the Corporations expense, requires managements attention and can be a disadvantage from a competitive standpoint with respect to non-regulated competitors.
Federal and state banking regulators also possess broad powers to take supervisory actions, as they deem appropriate. These supervisory actions may result in higher capital requirements, higher insurance premiums and limitations on the Corporations activities that could have a material adverse effect on its business and profitability.
Item 1B. | Unresolved Staff Comments |
None.
12
Item 2. | Properties |
The following table summarizes the Corporations branch properties, by subsidiary bank, as of December 31, 2009. Remote service facilities (mainly stand-alone automated teller machines) are excluded.
Subsidiary Bank |
Owned | Leased | Total Branches | |||
Fulton Bank, N.A. |
36 | 69 | 105 | |||
The Bank |
33 | 17 | 50 | |||
The Columbia Bank |
9 | 31 | 40 | |||
Lafayette Ambassador Bank |
7 | 17 | 24 | |||
Skylands Community Bank |
7 | 20 | 27 | |||
Delaware National Bank |
9 | 3 | 12 | |||
FNB Bank, N.A. |
8 | 2 | 10 | |||
Swineford National Bank |
5 | 2 | 7 | |||
Total |
114 | 161 | 275 | |||
The following table summarizes the Corporations other significant administrative properties. Banking subsidiaries also maintain administrative offices at their respective main banking branches, which are included within the preceding table.
Entity |
Property |
Location |
Owned/ | |||
Fulton Bank, N.A./Fulton Financial Corporation | Corporate Headquarters | Lancaster, PA | (1) | |||
Fulton Financial Corporation | Operations Center | East Petersburg, PA | Owned | |||
Fulton Bank, N.A. | Operations Center | Mantua, NJ | Owned | |||
Lafayette Ambassador Bank | Operations Center | Bethlehem, PA | Owned |
(1) | Includes approximately 100,000 square feet which is owned by an independent third-party who financed the construction through a loan from Fulton Bank. The Corporation is leasing this space from the third-party in an arrangement accounted for as a capital lease. The lease term expires in 2027. The Corporation owns the remainder of the Corporate Headquarters location. This property also includes a Fulton Bank, N.A. branch, which is included in the preceding table. |
Item 3. | Legal Proceedings |
There are no legal proceedings pending against Fulton Financial Corporation or any of its subsidiaries which are expected to have a material impact upon the financial position and/or the operating results of the Corporation.
Item 4. | Reserved |
No matters were submitted to a vote of security holders of Fulton Financial Corporation during the fourth quarter of 2009.
13
PART II
Item 5. | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Common Stock
As of December 31, 2009, the Corporation had 176.4 million shares of $2.50 par value common stock outstanding held by approximately 49,000 holders of record. The common stock of the Corporation is traded on the Global Select Market of The NASDAQ Stock Market under the symbol FULT.
The following table presents the quarterly high and low prices of the Corporations common stock and per common share cash dividends declared for each of the quarterly periods in 2009 and 2008.
Price Range | Per Common Share | ||||||||
High | Low | Dividend | |||||||
2009 |
|||||||||
First Quarter |
$ | 10.05 | $ | 5.09 | $ | 0.03 | |||
Second Quarter |
7.93 | 4.75 | 0.03 | ||||||
Third Quarter |
8.00 | 4.72 | 0.03 | ||||||
Fourth Quarter |
9.00 | 6.77 | 0.03 | ||||||
2008 |
|||||||||
First Quarter |
$ | 13.69 | $ | 9.83 | $ | 0.15 | |||
Second Quarter |
13.66 | 10.03 | 0.15 | ||||||
Third Quarter |
17.00 | 7.35 | 0.15 | ||||||
Fourth Quarter |
13.04 | 7.89 | 0.15 |
The Corporation is limited in its ability to pay dividends on common shares as a result of its participation in the U.S. Treasury Departments Capital Purchase Program. See Note M, Stock-based Compensation Plans and Shareholders Equity of the Notes to Consolidated Financial Statements in Item 8, Financial Statement and Supplementary Data for additional details.
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information about options outstanding under the Corporations 2004 Stock Option and Compensation Plan as of December 31, 2009:
Plan Category |
Number of securities to be issued upon exercise of outstanding options, warrants and rights |
Weighted-average exercise price of outstanding options, warrants and rights |
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in first column) | ||||
Equity compensation plans approved by security holders |
7,011,368 | $ | 12.79 | 13,125,687 | |||
Equity compensation plans not approved by security holders |
| | | ||||
Total |
7,011,368 | $ | 12.79 | 13,125,687 | |||
14
Performance Graph
The graph below shows cumulative investment returns to shareholders based on the assumptions that (A) an investment of $100.00 was made on December 31, 2004, in each of the following: (i) Fulton Financial Corporation common stock; (ii) the stock of all U. S. companies traded on The NASDAQ Stock Market and (iii) common stock of the performance peer group approved by the Board of Directors on September 21, 2004 consisting of bank and financial holding companies located throughout the United States with assets between $6-20 billion which were not a party to a merger agreement as of the end of the period and (B) all dividends were reinvested in such securities over the past five years. The graph is not indicative of future price performance.
The graph below is furnished under this Part II, Item 5 of this Form 10-K and shall not be deemed to be soliciting material or to be filed with the Commission or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the Exchange Act of 1934, as amended.
(1) | A listing of the Fulton Financial Peer Group is located under the heading Compensation Discussion and Analysis within the Corporations 2010 Proxy Statement. |
Year Ending December 31 | ||||||||||||||||||
Index |
2004 | 2005 | 2006 | 2007 | 2008 | 2009 | ||||||||||||
Fulton Financial Corporation |
$ | 100.00 | $ | 97.51 | $ | 100.67 | $ | 70.62 | $ | 63.81 | $ | 58.89 | ||||||
NASDAQ Composite |
100.00 | 101.37 | 111.03 | 121.92 | 72.49 | 104.31 | ||||||||||||
Fulton Financial 2009 Peer Group |
100.00 | 98.83 | 107.90 | 89.34 | 80.83 | 69.99 |
Issuer Purchases of Equity Securities
Not Applicable.
15
Item 6. | Selected Financial Data |
5-YEAR CONSOLIDATED SUMMARY OF FINANCIAL RESULTS
(dollars in thousands, except per-share data)
2009 | 2008 | 2007 | 2006 | 2005 | ||||||||||||||||
SUMMARY OF OPERATIONS |
||||||||||||||||||||
Interest income |
$ | 786,467 | $ | 867,494 | $ | 939,577 | $ | 864,507 | $ | 625,767 | ||||||||||
Interest expense |
265,513 | 343,346 | 450,833 | 378,944 | 213,219 | |||||||||||||||
Net interest income |
520,954 | 524,148 | 488,744 | 485,563 | 412,548 | |||||||||||||||
Provision for loan losses |
190,020 | 119,626 | 15,063 | 3,498 | 3,120 | |||||||||||||||
Investment securities gains (losses), net |
1,079 | (58,241 | ) | 1,740 | 7,439 | 6,625 | ||||||||||||||
Other income |
171,677 | 155,387 | 146,284 | 142,436 | 137,673 | |||||||||||||||
Gain on sale of credit card portfolio |
| 13,910 | | | | |||||||||||||||
Other expenses |
414,358 | 406,625 | 405,455 | 365,991 | 316,291 | |||||||||||||||
Goodwill impairment |
| 90,000 | | | | |||||||||||||||
Income before income taxes |
89,332 | 18,953 | 216,250 | 265,949 | 237,435 | |||||||||||||||
Income taxes |
15,408 | 24,570 | 63,532 | 80,422 | 71,361 | |||||||||||||||
Net income (loss) |
73,924 | (5,617 | ) | 152,718 | 185,527 | 166,074 | ||||||||||||||
Preferred stock dividends and discount accretion |
(20,169 | ) | (463 | ) | | | | |||||||||||||
Net income (loss) available to common shareholders |
$ | 53,755 | $ | (6,080 | ) | $ | 152,718 | $ | 185,527 | $ | 166,074 | |||||||||
PER COMMON SHARE (1) |
||||||||||||||||||||
Net income (loss) (basic) |
$ | 0.31 | $ | (0.03 | ) | $ | 0.88 | $ | 1.07 | $ | 1.01 | |||||||||
Net income (loss) (diluted) |
0.31 | (0.03 | ) | 0.88 | 1.06 | 1.00 | ||||||||||||||
Cash dividends |
0.120 | 0.600 | 0.598 | 0.581 | 0.540 | |||||||||||||||
RATIOS |
||||||||||||||||||||
Return on average assets |
0.45 | % | (0.04 | %) | 1.01 | % | 1.30 | % | 1.41 | % | ||||||||||
Return on average common shareholders equity |
3.54 | (0.38 | ) | 9.98 | 12.84 | 13.24 | ||||||||||||||
Return on average common shareholders equity tangible (2) |
5.96 | 9.33 | 18.16 | 23.87 | 20.28 | |||||||||||||||
Net interest margin |
3.52 | 3.70 | 3.66 | 3.82 | 3.93 | |||||||||||||||
Efficiency ratio |
57.70 | 56.31 | 61.20 | 56.00 | 55.50 | |||||||||||||||
Ending tangible common equity to tangible assets |
6.30 | 5.97 | 6.03 | 5.98 | 6.98 | |||||||||||||||
Dividend payout ratio |
38.70 | N/M | 68.00 | 54.80 | 54.00 | |||||||||||||||
PERIOD-END BALANCES |
||||||||||||||||||||
Total assets |
$ | 16,635,635 | $ | 16,185,106 | $ | 15,923,098 | $ | 14,918,964 | $ | 12,401,555 | ||||||||||
Investment securities |
3,267,086 | 2,724,841 | 3,153,552 | 2,878,238 | 2,562,145 | |||||||||||||||
Loans, net of unearned income |
11,972,424 | 12,042,620 | 11,204,424 | 10,374,323 | 8,424,728 | |||||||||||||||
Deposits |
12,097,914 | 10,551,916 | 10,105,445 | 10,232,469 | 8,804,839 | |||||||||||||||
Federal Home Loan Bank advances and long-term debt |
1,540,773 | 1,787,797 | 1,642,133 | 1,304,148 | 860,345 | |||||||||||||||
Shareholders equity |
1,936,482 | 1,859,647 | 1,574,920 | 1,516,310 | 1,282,971 | |||||||||||||||
AVERAGE BALANCES |
||||||||||||||||||||
Total assets |
$ | 16,480,673 | $ | 15,976,871 | $ | 15,090,458 | $ | 14,297,681 | $ | 11,781,485 | ||||||||||
Investment securities |
3,137,708 | 2,924,340 | 2,843,478 | 2,869,862 | 2,498,538 | |||||||||||||||
Loans, net of unearned income |
11,975,899 | 11,595,243 | 10,736,566 | 9,892,082 | 7,981,604 | |||||||||||||||
Deposits |
11,637,125 | 10,016,528 | 10,222,594 | 9,955,247 | 8,364,435 | |||||||||||||||
Federal Home Loan Bank advances and long-term debt |
1,712,630 | 1,822,115 | 1,579,527 | 1,069,868 | 839,694 | |||||||||||||||
Shareholders equity |
1,889,561 | 1,609,828 | 1,530,613 | 1,444,793 | 1,254,476 |
N/M Not meaningful.
(1) | Adjusted for stock dividends and stock splits. |
(2) | Net income (loss), as adjusted for intangible amortization (net of tax) and goodwill impairment charges, divided by average common shareholders equity, net of goodwill and intangible assets. |
16
Item 7. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
Managements Discussion and Analysis of Financial Condition and Results of Operations (Managements Discussion) concerns Fulton Financial Corporation (the Corporation), a financial holding company registered under the Bank Holding Company Act and incorporated under the laws of the Commonwealth of Pennsylvania in 1982, and its wholly owned subsidiaries. Managements Discussion 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 financial condition and results of operations. Many factors could affect future financial results, including without limitation: asset quality and the impact of adverse changes in the economy and in credit or other markets and resulting effects on credit risk and asset values; acquisition and growth strategies; market risk; changes or adverse developments in economic, political, or regulatory conditions; a continuation or worsening of the current disruption in credit and other markets, including the lack of or reduced access to, and the abnormal functioning of, markets for mortgages and other asset-backed securities and for commercial paper and other short-term borrowings; changes in the levels of FDIC deposit insurance premiums and assessments; the effect of competition and interest rates on net interest margin and net interest income; investment strategy and income growth; investment securities gains and losses; declines in the value of securities which may result in charges to earnings; changes in rates of deposit and loan growth; balances of risk-sensitive assets to risk-sensitive liabilities; salaries and employee benefits and other expenses; amortization of intangible assets; goodwill impairment; capital and liquidity strategies and other financial and business matters for future periods. 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, actual results could differ materially from forward-looking statements. The Corporation undertakes no obligations to update or revise any forward-looking statements.
OVERVIEW
Net income available to common shareholders increased $59.8 million, from a net loss available to common shareholders of $6.1 million in 2008 to net income available to common shareholders of $53.8 million, or $0.31 per diluted common share in 2009. The key themes that characterized the Corporations performance in 2009 were significant deposit growth, growth in non-interest income, effective expense management and, most notably, managing credit quality in the recent, challenging economic environment.
The Corporation grew ending deposits by $1.5 billion, or 14.7%, in 2009, with $1.3 billion of this growth in non-interest and interest-bearing demand and savings accounts. This growth was partially a by-product of prolonged weak economic conditions, as consumers reduced their investments in debt and equity securities while spending less and saving more. The increase in deposits also resulted in a reduction in wholesale funding. The increase in deposits and the resulting changes in its funding mix had a positive impact on net interest margin, in addition to an improvement in the Corporations market share throughout its five-state footprint. In addition, the Corporation was able to position itself to assist creditworthy borrowers in the event of more robust consumer spending and business expansion in 2010.
Growth in non-interest income and tight expense control enabled the Corporation to enhance its net income growth, despite the significant credit quality challenges faced in 2009. The growth in non-interest income in 2009 was mostly attributable to increases in gains on sales of mortgage loans, which were driven by historically low interest rates and Federal government first-time homebuyer incentives. Continued growth in non-interest income in 2010 may be impacted by residential mortgage interest rates, which have a direct impact on the level of mortgage sale gains, and legislative activity, which will affect the fees that can be charged to customers for services such as overdrafts.
Despite the challenging economic environment, the Corporation was able to effectively manage its non-interest expenses. Excluding the $90.0 million goodwill impairment charge recorded in 2008, the Corporation was able to keep 2009 non-interest expenses essentially flat in comparison to the prior year. Reductions in discretionary spending and a decrease in charges for losses on auction rate securities offset increases in FDIC insurance assessments and expenses related to the collection and workout of problem loans.
Credit quality presented the greatest challenge to the Corporation in 2009. The provision for loan losses increased $70.4 million, or 58.8%, to $190.0 million for 2009. The significant increase in the provision for loan losses was related to the increase in non-performing loans and net charge-offs, which required additions to the allowance for credit losses to meet allocation needs. The
17
Corporation began to see stabilization in credit quality metrics during the second half of 2009, as the rate of increase in non-performing assets slowed. As a result, provisioning levels were reduced slightly during the second half of the year.
While there is still much uncertainty about the economic outlook and the potential effects on credit quality in 2010, the Corporation believes that it took the appropriate steps to manage its exposures as of December 31, 2009 and continues to actively monitor its portfolio for signs of further deterioration.
The Corporation has maintained strong capital and liquidity positions throughout 2009. Despite the challenges faced in 2009, the Corporation has the potential for future earnings growth in the event of an economic rebound. The timing and extent of a recovery will depend largely on customers confidence in the economy, which will strengthen demand for loans and other products and services the Corporation offers.
Summary Financial Results
The Corporation generates the majority of its revenue through net interest income, or the difference between interest earned on loans and investments and interest paid on deposits and borrowings. Growth in net interest income is dependent upon balance sheet growth and/or maintaining or increasing the net interest margin, which is net interest income (fully taxable-equivalent) 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, investments, or properties. Offsetting these revenue sources are provisions for credit losses on loans, operating expenses and income taxes.
The following table presents a summary of the Corporations earnings and selected performance ratios:
2009 | 2008 | |||||||
Net income (loss) available to common shareholders (in thousands) |
$ | 53,755 | $ | (6,080 | ) | |||
Diluted net income (loss) per common share (1) |
$ | 0.31 | $ | (0.03 | ) | |||
Return on average assets |
0.45 | % | (0.04 | %) | ||||
Return on average common shareholders equity (2) |
3.54 | % | (0.38 | %) | ||||
Return on average common shareholders equity (tangible) (3) |
5.96 | % | 9.33 | % | ||||
Net interest margin (4) |
3.52 | % | 3.70 | % | ||||
Non-performing assets to total assets |
1.83 | % | 1.35 | % |
(1) | Calculated as net income (loss) available to common shareholders divided by diluted weighted average common shares outstanding. |
(2) | Calculated as net income (loss), divided by average common shareholders equity. |
(3) | Calculated as net income (loss), adjusted for intangible amortization (net of tax) and goodwill impairment charges, divided by average common shareholders equity, excluding goodwill and intangible assets. |
(4) | Presented on a fully taxable-equivalent (FTE) basis, using a 35% Federal tax rate and statutory interest expense disallowances. See also Net Interest Income section of Managements Discussion. |
18
Net income (loss) available to common shareholders increased $59.8 million in 2009, largely due to a number of significant items. These significant items, and their impact on net income (loss) available to common shareholders, are presented in the following table:
2009 | 2008 | |||||||||||||||||||||||
Pre-tax (Expense)/ Income |
After-tax (Expense)/ Income |
Diluted EPS Impact |
Pre-tax (Expense) /Income |
After-tax (Expense) /Income |
Diluted EPS Impact |
|||||||||||||||||||
(in thousands, except per share amounts) | ||||||||||||||||||||||||
Preferred stock dividends and discount accretion |
$ | (20,169 | ) | $ | (20,169 | ) | $ | (0.11 | ) | $ | (463 | ) | $ | (463 | ) | $ | | |||||||
FDIC insurance expense |
(26,579 | ) | (17,276 | ) | (0.10 | ) | (4,562 | ) | (2,965 | ) | (0.02 | ) | ||||||||||||
Investment securities sale gains |
14,480 | 9,412 | 0.05 | 7,095 | 4,612 | 0.03 | ||||||||||||||||||
Other-than-temporary impairment of securities |
(13,401 | ) | (8,711 | ) | (0.05 | ) | (65,336 | ) | (42,468 | ) | (0.24 | ) | ||||||||||||
Guarantee related to purchase of customer auction rate securities |
(6,237 | ) | (4,054 | ) | (0.02 | ) | (19,810 | ) | (12,877 | ) | (0.07 | ) | ||||||||||||
Goodwill impairment |
| | | (90,000 | ) | (90,000 | ) | (0.52 | ) | |||||||||||||||
Gain on sale of credit card portfolio |
| | | 13,910 | 9,042 | 0.05 | ||||||||||||||||||
Total |
$ | (51,906 | ) | (40,798 | ) | (0.23 | ) | $ | (159,166 | ) | (135,119 | ) | (0.77 | ) | ||||||||||
Net income (loss) available to common shareholders |
53,755 | 0.31 | (6,080 | ) | (0.03 | ) | ||||||||||||||||||
Adjusted net income available to common shareholders |
$ | 94,553 | $ | 0.54 | $ | 129,039 | $ | 0.74 | ||||||||||||||||
Note: | Adjusted net income available to common shareholders is a non-Generally Accepted Accounting Principles (GAAP) measure. This measure is presented as it is useful for comparing information and assessing trends in the Corporations results of operations. This measure should not be considered a substitute for GAAP basis measures nor should it be viewed as a substitute for operating results determined in accordance with GAAP, nor is it necessarily comparable to non-GAAP performance measures which may be presented by other companies. The Corporation strongly encourages a review of Managements Discussion in its entirety. |
Adjusted net income available to common shareholders decreased $34.5 million, or 26.7% primarily due to a $70.4 million ($45.8 million after-tax) increase in the provision for loan losses, offset by a $12.3 million ($8.0 million after-tax) increase in gains on sales of mortgage loans. The increase in the provision for loan losses was due to an increase in net loans charged off and an increase in non performing loans, which resulted in additional allocations to the allowance for credit losses. The increase in gains on sales of mortgage loans was the result of an increase in the volume of loans sold, due to historically low interest rates for residential mortgages in 2009.
Additional information regarding the significant items presented in the preceding table can be found in the Results of Operations section of Managements Discussion.
19
RESULTS OF OPERATIONS
Net Interest Income
Net interest income is the most significant component of the Corporations net income. The Corporation manages the risk associated with changes in interest rates through the techniques described in the Market Risk section of Managements Discussion. Net interest income decreased $3.2 million, or 0.6%, to $521.0 million in 2009, as a result of an 18 basis point decrease in the net interest margin, partially offset by the impact of balance sheet growth.
The following table provides a comparative average balance sheet and net interest income analysis for 2009 compared to 2008 and 2007. Interest income and yields are presented on a fully taxable-equivalent (FTE) basis, using a 35% Federal tax rate and statutory interest expense disallowances. The discussion following this table is based on these tax-equivalent amounts.
2009 | 2008 | 2007 | |||||||||||||||||||||||||||||||
(dollars in thousands) |
Average Balance |
Interest (1) | Yield/ Rate |
Average Balance |
Interest (1) | Yield/ Rate |
Average Balance |
Interest (1) | Yield/ Rate |
||||||||||||||||||||||||
ASSETS |
|||||||||||||||||||||||||||||||||
Interest-earning assets: |
|||||||||||||||||||||||||||||||||
Loans, net of unearned income (2) |
$ | 11,975,899 | $ | 655,384 | 5.47 | % | $ | 11,595,243 | $ | 732,533 | 6.32 | % | $ | 10,736,566 | $ | 805,881 | 7.51 | % | |||||||||||||||
Taxable inv. securities (3) |
2,548,810 | 112,945 | 4.43 | 2,228,204 | 110,220 | 4.95 | 2,157,325 | 99,621 | 4.62 | ||||||||||||||||||||||||
Tax-exempt inv. securities (3) |
451,828 | 25,180 | 5.57 | 512,920 | 27,904 | 5.44 | 496,820 | 25,856 | 5.20 | ||||||||||||||||||||||||
Equity securities (3) |
137,070 | 2,917 | 2.13 | 183,216 | 6,520 | 3.56 | 189,333 | 9,073 | 4.79 | ||||||||||||||||||||||||
Total investment securities |
3,137,708 | 141,042 | 4.50 | 2,924,340 | 144,644 | 4.95 | 2,843,478 | 134,550 | 4.73 | ||||||||||||||||||||||||
Loans held for sale |
105,067 | 5,390 | 5.13 | 93,085 | 5,701 | 6.12 | 166,437 | 11,501 | 6.91 | ||||||||||||||||||||||||
Other interest-earning assets |
21,255 | 196 | 0.92 | 21,503 | 586 | 2.71 | 33,015 | 1,630 | 4.90 | ||||||||||||||||||||||||
Total interest-earning assets |
15,239,929 | 802,012 | 5.27 | 14,634,171 | 883,464 | 6.04 | 13,779,496 | 953,562 | 6.93 | ||||||||||||||||||||||||
Noninterest-earning assets: |
|||||||||||||||||||||||||||||||||
Cash and due from banks |
305,410 | 318,524 | 329,814 | ||||||||||||||||||||||||||||||
Premises and equipment |
203,865 | 197,967 | 190,910 | ||||||||||||||||||||||||||||||
Other assets (3) |
952,597 | 951,270 | 899,292 | ||||||||||||||||||||||||||||||
Less: Allowance for loan losses |
(221,128 | ) | (125,061 | ) | (109,054 | ) | |||||||||||||||||||||||||||
Total Assets |
$ | 16,480,673 | $ | 15,976,871 | $ | 15,090,458 | |||||||||||||||||||||||||||
LIABILITIES AND SHAREHOLDERS EQUITY |
|||||||||||||||||||||||||||||||||
Interest-bearing liabilities: |
|||||||||||||||||||||||||||||||||
Demand deposits |
$ | 1,857,081 | $ | 7,995 | 0.43 | % | $ | 1,714,029 | $ | 13,168 | 0.77 | % | $ | 1,696,624 | $ | 28,331 | 1.67 | % | |||||||||||||||
Savings deposits |
2,425,864 | 19,487 | 0.80 | 2,152,158 | 28,520 | 1.32 | 2,258,113 | 53,312 | 2.36 | ||||||||||||||||||||||||
Time deposits |
5,507,090 | 153,344 | 2.78 | 4,502,399 | 170,426 | 3.79 | 4,553,994 | 212,752 | 4.67 | ||||||||||||||||||||||||
Total interest-bearing deposits |
9,790,035 | 180,826 | 1.85 | 8,368,586 | 212,114 | 2.53 | 8,508,731 | 294,395 | 3.46 | ||||||||||||||||||||||||
Short-term borrowings |
1,043,279 | 3,777 | 0.36 | 2,336,526 | 50,091 | 2.12 | 1,574,495 | 73,983 | 4.66 | ||||||||||||||||||||||||
Long-term debt |
1,712,630 | 80,910 | 4.72 | 1,822,115 | 81,141 | 4.45 | 1,579,527 | 82,455 | 5.22 | ||||||||||||||||||||||||
Total interest-bearing liabilities |
12,545,944 | 265,513 | 2.12 | 12,527,227 | 343,346 | 2.74 | 11,662,753 | 450,833 | 3.86 | ||||||||||||||||||||||||
Noninterest-bearing liabilities: |
|||||||||||||||||||||||||||||||||
Demand deposits |
1,847,090 | 1,647,942 | 1,713,863 | ||||||||||||||||||||||||||||||
Other |
198,078 | 191,874 | 183,229 | ||||||||||||||||||||||||||||||
Total Liabilities |
14,591,112 | 14,367,043 | 13,559,845 | ||||||||||||||||||||||||||||||
Shareholders equity |
1,889,561 | 1,609,828 | 1,530,613 | ||||||||||||||||||||||||||||||
Total Liabs. and Equity |
$ | 16,480,673 | $ | 15,976,871 | $ | 15,090,458 | |||||||||||||||||||||||||||
Net interest income/net interest margin (FTE) |
536,499 | 3.52 | % | 540,118 | 3.70 | % | 502,729 | 3.66 | % | ||||||||||||||||||||||||
Tax equivalent adjustment |
(15,545 | ) | (15,970 | ) | (13,985 | ) | |||||||||||||||||||||||||||
Net interest income |
$ | 520,954 | $ | 524,148 | $ | 488,744 | |||||||||||||||||||||||||||
(1) | Includes dividends earned on equity securities. |
(2) | Includes non-performing loans. |
(3) | Balances include amortized historical cost for available for sale securities. The related unrealized holding gains (losses) are included in other assets. |
20
The following table sets forth a summary of changes in FTE interest income and expense resulting from changes in average balances (volumes) and changes in rates:
2009 vs. 2008 Increase (decrease) due To change in |
2008 vs. 2007 Increase (decrease) due To change in |
|||||||||||||||||||||||
Volume | Rate | Net | Volume | Rate | Net | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Interest income on: |
||||||||||||||||||||||||
Loans and leases |
$ | 23,414 | $ | (100,563 | ) | $ | (77,149 | ) | $ | 61,027 | $ | (134,375 | ) | $ | (73,348 | ) | ||||||||
Taxable investment securities |
12,787 | (10,062 | ) | 2,725 | 4,588 | 6,011 | 10,599 | |||||||||||||||||
Tax-exempt investment securities |
(3,391 | ) | 667 | (2,724 | ) | 854 | 1,194 | 2,048 | ||||||||||||||||
Equity securities |
(1,388 | ) | (2,215 | ) | (3,603 | ) | (285 | ) | (2,268 | ) | (2,553 | ) | ||||||||||||
Loans held for sale |
681 | (992 | ) | (311 | ) | (4,610 | ) | (1,190 | ) | (5,800 | ) | |||||||||||||
Other interest-earning assets |
(7 | ) | (383 | ) | (390 | ) | (457 | ) | (587 | ) | (1,044 | ) | ||||||||||||
Total interest-earning assets |
$ | 32,096 | $ | (113,548 | ) | $ | (81,452 | ) | $ | 61,117 | $ | (131,215 | ) | $ | (70,098 | ) | ||||||||
Interest expense on: |
||||||||||||||||||||||||
Demand deposits |
$ | 1,022 | $ | (6,195 | ) | $ | (5,173 | ) | $ | 288 | $ | (15,451 | ) | $ | (15,163 | ) | ||||||||
Savings deposits |
3,202 | (12,235 | ) | (9,033 | ) | (2,375 | ) | (22,417 | ) | (24,792 | ) | |||||||||||||
Time deposits |
33,428 | (50,510 | ) | (17,082 | ) | (2,384 | ) | (39,942 | ) | (42,326 | ) | |||||||||||||
Short-term borrowings |
(18,535 | ) | (27,779 | ) | (46,314 | ) | 26,332 | (50,224 | ) | (23,892 | ) | |||||||||||||
Long-term debt |
(5,023 | ) | 4,792 | (231 | ) | 11,713 | (13,027 | ) | (1,314 | ) | ||||||||||||||
Total interest-bearing liabilities |
$ | 14,094 | $ | (91,927 | ) | $ | (77,833 | ) | $ | 33,574 | $ | (141,061 | ) | $ | (107,487 | ) | ||||||||
Note: Changes which are partially attributable to rate and volume are allocated based on the proportion of the direct changes attributable to rate and volume.
2009 vs. 2008
Interest income decreased $81.5 million, or 9.2%. A 77 basis point decrease in average rates resulted in a $113.5 million decrease in interest income, which was partially offset by a $32.1 million increase in interest income realized from a $605.8 million, or 4.1%, increase in average balances.
Contributing to the increase in average interest-earning assets was a $380.7 million, or 3.3%, increase in average loans. During 2009, overall loan growth was slowed as a result of weak economic conditions. Also affecting loan growth was the Corporations efforts to reduce credit exposure in certain sectors. The following table presents growth in average loans, by type:
Increase (decrease) | |||||||||||||
2009 | 2008 | $ | % | ||||||||||
(dollars in thousands) | |||||||||||||
Real estate - commercial mortgage |
$ | 4,135,486 | $ | 3,747,240 | $ | 388,246 | 10.4 | % | |||||
Commercial - industrial, financial and agricultural |
3,673,654 | 3,525,629 | 148,025 | 4.2 | |||||||||
Real estate - home equity |
1,665,834 | 1,597,207 | 68,627 | 4.3 | |||||||||
Real estate - construction |
1,111,863 | 1,320,418 | (208,555 | ) | (15.8 | ) | |||||||
Real estate - residential mortgage |
938,187 | 918,658 | 19,529 | 2.1 | |||||||||
Consumer |
368,651 | 399,281 | (30,630 | ) | (7.7 | ) | |||||||
Leasing and other |
82,224 | 86,810 | (4,586 | ) | (5.3 | ) | |||||||
Total |
$ | 11,975,899 | $ | 11,595,243 | $ | 380,656 | 3.3 | % | |||||
The growth in average loans was primarily due to increases in commercial mortgages, commercial loans and home equity loans, offset by a decrease in construction loans. Geographically, the increase in commercial mortgages was mainly attributable to increases within the Corporations Pennsylvania ($207.3 million, or 10.7%), New Jersey ($80.8 million, or 7.3%) and Maryland ($73.8 million, or 26.1%) markets. The increase in commercial loans was mostly attributable to an increase within the Corporations Pennsylvania market of $134.3 million, or 6.0%. The $68.6 million, or 4.3%, increase in home equity loans was in home equity lines of credit, offset by a decrease in collateralized home equity loans.
21
Offsetting the above increases was a $208.6 million, or 15.8%, decrease in construction loans, due to both a lower level of new and existing residential housing developments and the Corporations efforts to reduce its credit exposure in this sector, particularly within its Maryland and Virginia markets. Geographically, the decrease was attributable to decreases in the Corporations Maryland ($100.7 million, or 25.5%), Virginia ($48.1 million, or 14.7%), New Jersey ($27.7 million, or 11.3%) and Pennsylvania ($26.6 million, or 8.1%) markets.
The average yield on loans during 2009 of 5.47% represented an 85 basis point, or 13.4%, decrease in comparison to 2008. The decrease in the average yield on loans reflected a lower average rate environment, as illustrated by a lower average prime rate in 2009 (3.25%) as compared to 2008 (5.12%). The decrease in average yields was not as pronounced as the decrease in the average prime rate as fixed and adjustable rate loans, unlike floating rate loans, have a lagged repricing effect during periods of declining interest rates.
Average investments increased $213.4 million, or 7.3%, primarily due to a $181.1 million increase in student loan auction rate securities, also known as auction rate certificates (ARCs). The Corporations investment management and trust division, Fulton Financial Advisors, held ARCs for some of its customers accounts. ARCs are structured to allow for their sale in periodic auctions, with fair values that could be derived based on periodic auctions under normal market conditions. Beginning in the second quarter of 2008 and continuing throughout 2009, the Corporation began purchasing customer ARCs due to the failure of these periodic auctions, making these previously short-term investments illiquid.
The average yield on investment securities decreased 45 basis points, or 9.1%, from 4.95% in 2008 to 4.50% in 2009 as current year purchases were at yields that were lower than the overall portfolio yield. Investment yields were also adversely impacted by the reduction, or in some cases the suspension of, dividends on equities, particularly financial institution stocks and FHLB stocks. The $181.1 million increase in ARCs resulted in a seven basis point decrease in average yield.
The $81.5 million decrease in interest income was largely offset by a decrease in interest expense of $77.8 million, or 22.7%, to $265.5 million in 2009 from $343.3 million in 2008. Interest expense decreased $91.9 million as a result of a 62 basis point, or 22.6%, decrease in the average cost of total interest-bearing liabilities. This decrease was partially offset by an increase in interest expense of $14.1 million caused by an increase in average interest-bearing liabilities.
The following table summarizes the change in average deposits, by type:
Increase | ||||||||||||
2009 | 2008 | $ | % | |||||||||
(dollars in thousands) | ||||||||||||
Noninterest-bearing demand |
$ | 1,847,090 | $ | 1,647,942 | $ | 199,148 | 12.1 | % | ||||
Interest-bearing demand |
1,857,081 | 1,714,029 | 143,052 | 8.3 | ||||||||
Savings/money market |
2,425,864 | 2,152,158 | 273,706 | 12.7 | ||||||||
Time deposits |
5,507,090 | 4,502,399 | 1,004,691 | 22.3 | ||||||||
Total |
$ | 11,637,125 | $ | 10,016,528 | $ | 1,620,597 | 16.2 | % | ||||
The Corporation experienced a net increase in average noninterest-bearing and interest-bearing demand and savings accounts of $615.9 million, or 11.2%. The increase in noninterest-bearing accounts was in business accounts, while the increase in interest-bearing demand and savings accounts was in governmental, business and personal accounts. The growth in business account balances was due, in part, to businesses being required to keep higher balances on hand to offset service fees, as well as a movement from the Corporations cash management products due to low interest rates. The increase in personal account balances was the result of a reduction in customer spending, in addition to the impact of decreased consumer confidence in equity and debt markets, resulting in a shift to deposits. The trends that impacted personal deposit growth in 2009 may reverse in 2010 if economic conditions improve.
The $1.0 billion increase in time deposits occurred primarily in retail customer certificates of deposits. This increase was due to active promotion in the fourth quarter of 2008 and the beginning of 2009. These average deposit increases were used to reduce the Corporations short and long-term borrowings.
22
The following table summarizes the changes in average borrowings, by type:
Increase (decrease) | |||||||||||||
2009 | 2008 | $ | % | ||||||||||
(dollars in thousands) | |||||||||||||
Short-term borrowings: |
|||||||||||||
Federal funds purchased |
$ | 453,268 | $ | 1,328,888 | $ | (875,620 | ) | (65.9 | %) | ||||
Customer short-term promissory notes |
287,231 | 454,473 | (167,242 | ) | (36.8 | ) | |||||||
Customer repurchase agreements |
254,662 | 227,130 | 27,532 | 12.1 | |||||||||
Federal Reserve Bank borrowings |
46,137 | | 46,137 | N/M | |||||||||
FHLB overnight repurchase agreements |
| 303,224 | (303,224 | ) | N/M | ||||||||
Other short-term borrowings |
1,981 | 22,811 | (20,830 | ) | (91.3 | ) | |||||||
Total short-term borrowings |
1,043,279 | 2,336,526 | (1,293,247 | ) | (55.3 | ) | |||||||
Long-term debt: |
|||||||||||||
FHLB Advances |
1,329,482 | 1,439,197 | (109,715 | ) | (7.6 | ) | |||||||
Other long-term debt |
383,148 | 382,918 | 230 | 0.1 | |||||||||
Total long-term debt |
1,712,630 | 1,822,115 | (109,485 | ) | (6.0 | ) | |||||||
Total borrowings |
$ | 2,755,909 | $ | 4,158,641 | $ | (1,402,732 | ) | (33.7 | %) | ||||
N/M Not meaningful.
The $1.3 billion, or 55.3%, decrease in short-term borrowings was mainly due to an $875.6 million decrease in Federal funds purchased and a $303.2 million decrease in Federal Home Loan Bank (FHLB) overnight repurchase agreements, both a result of the increase in deposits. Also contributing to the decrease in short-term borrowings was a $139.7 million decrease in short-term customer funding due to customers transferring funds from the cash management program to deposits due to the low interest rate environment. The $109.5 million, or 6.0%, decrease in long-term debt was due to maturities of FHLB advances.
2008 vs. 2007
FTE net interest income increased $37.4 million, or 7.4%, from $502.7 million in 2007 to $540.1 million in 2008, due to an increase in average interest-earning assets and a four basis point increase in net interest margin.
Interest income decreased $70.1 million, or 7.4%, due to a $131.2 million decrease related to changes in interest rates. During 2008, the average rates on interest-earning assets decreased 89 basis points, or 12.8%, in comparison to 2007. The decline in interest income due to changes in rates was partially offset by a $61.1 million increase in interest income realized from growth in average interest-earning assets of $854.7 million, or 6.2%.
The increase in average interest-earning assets was almost entirely due to loan growth. Average loans increased by $858.7 million, or 8.0%, to $11.6 billion in 2008. The growth in average loans was primarily due to increases in commercial mortgages and commercial loans. Commercial mortgages increased $424.5 million, or 12.8%, due primarily to increases in floating and adjustable rate loan products. Commercial loans increased $322.8 million, or 10.0%, due primarily to increases in floating and adjustable rate loans and partially due to increases in fixed rate loan products.
Residential mortgages increased $167.2 million, or 22.2%, due primarily to growth in traditional adjustable rate mortgages. Home equity loans increased $142.6 million, or 9.8%, due to an increase in home equity lines of credit, due to the introduction of a new blended fixed/floating rate loan product in late 2007 and an increase in line of credit usage for existing borrowings.
Offsetting the above increases were a $107.1 million, or 21.2%, decrease in consumer loans and a $92.0 million, or 6.6%, decrease in construction loans. The decrease in consumer loans was due primarily to the Corporations sale of its approximately $87 million credit card portfolio in April 2008 and a decrease in the indirect automobile loan portfolio. The decrease in construction loans was primarily due to a decrease in floating rate commercial construction loans.
23
The average yield on loans during 2008 of 6.32% represented a 119 basis point, or 15.8%, decrease in comparison to 2007. The decrease in the average yield on loans reflected a lower average rate environment, as illustrated by a lower average prime rate in 2008 (5.12%) as compared to 2007 (8.03%).
Average loans held for sale decreased $73.4 million, or 44.1%, as a result of a $466.4 million, or 32.9%, decrease in the volume of loans originated for sale. The decrease in volumes of loans originated for sale was mainly due to the Corporations exit from the national wholesale mortgage business in the second half of 2007.
Average investments increased $80.9 million, or 2.8%. In late 2007, the Corporation pre-purchased investments, based on the expected cash flows to be generated from maturing securities over an approximate six-month period. The result of this pre-purchase was a higher average investment balance for 2008. Also contributing to the increase was the sale of approximately $250 million of lower-yielding investment securities during the first quarter of 2007, which lowered the balance of average investment securities for 2007.
The average yield on investment securities increased 22 basis points from 4.73% in 2007 to 4.95% in 2008. The increase in yield was due to the systematic reinvestment of normal portfolio cash flows, primarily from shorter-duration, lower-yielding mortgage-backed securities, into a combination of higher-yielding mortgage-backed pass-through securities, U.S. government issued collateralized mortgage obligations and longer-term municipal securities.
Interest expense decreased $107.5 million, or 23.8%, to $343.3 million in 2008 from $450.8 million in 2007. Interest expense decreased $141.1 million due to a 112 basis point, or 29.0%, decrease in the average cost of total interest-bearing liabilities. This decrease was partially offset by an increase in interest expense of $33.6 million caused by an $864.5 million, or 7.4%, increase in average interest-bearing liabilities.
Average deposits decreased $206.1 million, or 2.0%. The Corporation experienced a net decrease in noninterest-bearing and interest-bearing demand and savings accounts of $154.5 million, or 2.7%, primarily due to personal accounts. Time deposits decreased $51.6 million, or 1.1%, due to a $137.2 million decrease in brokered certificates of deposit, offset by an $85.6 million increase in customer certificates of deposit.
Short-term borrowings increased $762.0 million, or 48.4%, due to a $520.5 million increase in Federal funds purchased and a $213.5 million increase in FHLB overnight repurchase agreements. Long-term debt increased $242.6 million, or 15.4%, due to a $227.1 million, or 18.7%, increase in FHLB advances as longer-term rates were locked and durations were extended to manage interest rate risk. The total increase in borrowings of $1.0 billion was principally employed to support overall balance sheet growth.
Provision and Allowance for Credit Losses
The Corporation accounts for the credit risk associated with lending activities through its allowance for credit losses and provision for loan losses. The provision is the expense recognized on the consolidated statements of operations to adjust the allowance to its proper balance, as determined through the application of the Corporations allowance methodology procedures. These procedures include the evaluation of the risk characteristics of the portfolio and documentation in accordance with the Securities and Exchange Commissions (SEC) Staff Accounting Bulletin No. 102, Selected Loan Loss Allowance Methodology and Documentation Issues (SAB 102). See the Critical Accounting Policies section of Managements Discussion for a discussion of the Corporations allowance for credit loss evaluation methodology.
24
A summary of the Corporations loan loss experience follows:
2009 | 2008 | 2007 | 2006 | 2005 | ||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||
Loans, net of unearned income outstanding at end of year |
$ | 11,972,424 | $ | 12,042,620 | $ | 11,204,424 | $ | 10,374,323 | $ | 8,424,728 | ||||||||||
Daily average balance of loans, net of unearned income |
$ | 11,975,899 | $ | 11,595,243 | $ | 10,736,566 | $ | 9,892,082 | $ | 7,981,604 | ||||||||||
Balance of allowance for credit losses at beginning of year |
$ | 180,137 | $ | 112,209 | $ | 106,884 | $ | 92,847 | $ | 89,627 | ||||||||||
Loans charged off: |
||||||||||||||||||||
Real estate construction |
44,909 | 14,891 | | | | |||||||||||||||
Commercial industrial, financial and agricultural |
34,761 | 18,592 | 6,796 | 3,013 | 4,095 | |||||||||||||||
Real estate commercial mortgage |
15,530 | 7,516 | 851 | 155 | 158 | |||||||||||||||
Real estate residential mortgage and home equity |
7,056 | 5,868 | 355 | 274 | 309 | |||||||||||||||
Consumer |
10,770 | 5,188 | 3,678 | 3,138 | 3,436 | |||||||||||||||
Leasing and other |
6,048 | 4,804 | 2,059 | 389 | 206 | |||||||||||||||
Total loans charged off |
119,074 | 56,859 | 13,739 | 6,969 | 8,204 | |||||||||||||||
Recoveries of loans previously charged off: |
||||||||||||||||||||
Real estate construction |
1,194 | 17 | | | | |||||||||||||||
Commercial financial and agricultural |
1,679 | 1,795 | 1,664 | 2,863 | 2,705 | |||||||||||||||
Real estate commercial mortgage |
536 | 286 | 34 | 210 | 960 | |||||||||||||||
Real estate residential mortgage and home equity |
150 | 143 | 144 | 58 | 285 | |||||||||||||||
Consumer |
1,678 | 1,487 | 1,246 | 1,289 | 1,169 | |||||||||||||||
Leasing and other |
1,233 | 1,433 | 913 | 97 | 77 | |||||||||||||||
Total recoveries |
6,470 | 5,161 | 4,001 | 4,517 | 5,196 | |||||||||||||||
Net loans charged off |
112,604 | 51,698 | 9,738 | 2,452 | 3,008 | |||||||||||||||
Provision for loan losses |
190,020 | 119,626 | 15,063 | 3,498 | 3,120 | |||||||||||||||
Allowance of purchased entities |
| | | 12,991 | 3,108 | |||||||||||||||
Balance at end of year |
$ | 257,553 | $ | 180,137 | $ | 112,209 | $ | 106,884 | $ | 92,847 | ||||||||||
Components of Allowance for Credit Losses: |
||||||||||||||||||||
Allowance for loan losses |
$ | 256,698 | $ | 173,946 | $ | 107,547 | $ | 106,884 | $ | 92,847 | ||||||||||
Reserve for unfunded lending commitments (1) |
855 | 6,191 | 4,662 | | | |||||||||||||||
Allowance for credit losses |
$ | 257,553 | $ | 180,137 | $ | 112,209 | $ | 106,884 | $ | 92,847 | ||||||||||
Selected Asset Quality Ratios: |
||||||||||||||||||||
Net charge-offs to average loans |
0.94 | % | 0.45 | % | 0.09 | % | 0.02 | % | 0.04 | % | ||||||||||
Allowance for loan losses to loans outstanding |
2.14 | % | 1.44 | % | 0.96 | % | 1.03 | % | 1.10 | % | ||||||||||
Allowance for credit losses to loans outstanding |
2.15 | % | 1.50 | % | 1.00 | % | 1.03 | % | 1.10 | % | ||||||||||
Non-performing assets (2) to total assets |
1.83 | % | 1.35 | % | 0.76 | % | 0.39 | % | 0.38 | % | ||||||||||
Non-performing assets to total loans and OREO |
2.54 | % | 1.82 | % | 1.08 | % | 0.56 | % | 0.57 | % | ||||||||||
Non-accrual loans to total loans |
1.99 | % | 1.34 | % | 0.68 | % | 0.32 | % | 0.43 | % | ||||||||||
Allowance for credit losses to non-performing loans |
91.42 | % | 91.38 | % | 105.93 | % | 198.87 | % | 203.74 | % | ||||||||||
Non-performing assets to tangible common shareholders equity and allowance for credit losses |
24.00 | % | 19.68 | % | 11.40 | % | 6.03 | % | 5.14 | % |
(1) | Reserve for unfunded lending commitments transferred to other liabilities as of December 31, 2007. Prior periods were not reclassified. |
(2) | Includes accruing loans past due 90 days or more. |
The Corporations provision for loan losses for 2009 totaled $190.0 million, a $70.4 million, or 58.8%, increase from the $119.6 million provision for loan losses in 2008. The increase in the provision for loan losses was due to the $60.9 million, or 117.8%, increase net loans charged off, an $84.6 million, or 42.9%, increase in non-performing loans and an increase in delinquency rates, all of which resulted in additional allocations to the allowance for credit losses.
25
The $60.9 million increase in net charge-offs was primarily due to increases in construction loan net charge-offs ($28.8 million), commercial loan net charge-offs ($16.3 million), commercial mortgage net charge-offs ($7.8 million) and consumer loan net charge-offs ($5.4 million).
Of the $112.6 million of net charge-offs recorded in 2009, 27.7% were for loans originated by the Corporations banks in Maryland, 27.1% in New Jersey, 21.9% in Virginia and 21.1% in Pennsylvania. During 2009, individual charge-offs of $1.0 million or greater totaled approximately $44 million, of which approximately $28 million were for residential construction or land development loans, approximately $10 million were for commercial loans, approximately $4 million were for commercial mortgages and approximately $2 million was related to a lease of commercial equipment. For 2008, individual charge-offs of $1.0 million or greater totaled approximately $26 million, of which approximately $17 million were for residential construction or land development loans, approximately $6 million were for commercial loans and approximately $3 million was related to a lease of commercial equipment.
The following table presents the aggregate amount of non-accrual and past due loans and other real estate owned (1):
December 31 | |||||||||||||||
2009 | 2008 | 2007 | 2006 | 2005 | |||||||||||
(in thousands) | |||||||||||||||
Non-accrual loans (1) (2) (3) |
$ | 238,360 | $ | 161,962 | $ | 76,150 | $ | 33,113 | $ | 36,560 | |||||
Accruing loans past due 90 days or more |
43,359 | 35,177 | 29,782 | 20,632 | 9,012 | ||||||||||
Total non-performing loans |
281,719 | 197,139 | 105,932 | 53,745 | 45,572 | ||||||||||
Other real estate owned (OREO) |
23,309 | 21,855 | 14,934 | 4,103 | 2,072 | ||||||||||
Total non-performing assets |
$ | 305,028 | $ | 218,994 | $ | 120,866 | $ | 57,848 | $ | 47,644 | |||||
(1) | In 2009, the total interest income that would have been recorded if non-accrual loans had been current in accordance with their original terms was approximately $19.0 million. The amount of interest income on non-accrual loans that was included in 2009 income was approximately $1.6 million. |
(2) | Accrual of interest is generally discontinued when a loan becomes 90 days past due as to principal and interest. When interest accruals are discontinued, interest credited to income is reversed. Non-accrual loans are restored to accrual status when all delinquent principal and interest becomes current or the loan is considered secured and in the process of collection. Certain loans, primarily adequately collateralized mortgage loans, may continue to accrue interest after reaching 90 days past due. |
(3) | Excluded from the amounts presented as of December 31, 2009 were $653.4 million in loans where possible credit problems of borrowers have caused management to have doubts as to the ability of such borrowers to comply with the present loan repayment terms. These loans were reviewed for impairment under the Financial Accounting Standards Boards Accounting Standards Codification Section 310-10-35, but continue to pay according to their contractual terms and are, therefore, not included in non-performing loans. Non-accrual loans include $116.4 million of impaired loans. |
Excluded from the summary of non-performing assets above were $41.1 million of loans whose terms were modified under a troubled debt restructuring and were current under their modified terms at December 31, 2009. These troubled debt restructurings include $24.6 million of residential mortgages and $16.5 million of commercial loans.
The following table summarizes the Corporations non-performing loans, by type, as of the indicated dates:
December 31 | |||||||||||||||
2009 | 2008 | 2007 | 2006 | 2005 | |||||||||||
(in thousands) | |||||||||||||||
Real estate construction |
$ | 92,841 | $ | 80,083 | $ | 30,927 | $ | 13,385 | $ | 374 | |||||
Commercial industrial, agricultural and financial |
69,604 | 40,294 | 27,715 | 21,706 | 25,585 | ||||||||||
Real estate commercial mortgage |
61,052 | 41,745 | 14,515 | 8,776 | 9,853 | ||||||||||
Real estate residential mortgage and home equity |
45,748 | 26,304 | 25,774 | 7,085 | 7,384 | ||||||||||
Consumer |
12,319 | 8,374 | 4,741 | 2,793 | 2,287 | ||||||||||
Leasing |
155 | 339 | 2,260 | | 89 | ||||||||||
Total non-performing loans |
$ | 281,719 | $ | 197,139 | $ | 105,932 | $ | 53,745 | $ | 45,572 | |||||
Non-performing loans increased $84.6 million, or 42.9%, to $281.7 million as of December 31, 2009. In late 2008, the Corporation experienced a significant increase in non-performing construction loans, primarily in its Maryland and Virginia
26
markets. During 2009, prolonged weak economic conditions resulted in an increase in the level of non-performing loans within the Corporations commercial and commercial mortgage loan portfolios, primarily in its Pennsylvania and New Jersey markets, while the rate of growth in the non-performing construction loans in the Corporations Maryland and Virginia markets slowed.
In 2009, non-performing commercial loans increased $29.3 million, or 72.7%, with $14.4 million of the increase in Pennsylvania, $7.8 million in Virginia and $5.5 million in Maryland. Non-performing commercial mortgages increased $19.3 million, or 46.2%, with $14.7 million of the increase in New Jersey and $3.7 million in Pennsylvania. Non-performing residential mortgage and home equity loans increased $19.4 million, or 73.9%, with increases spread throughout the Corporations geographical markets. Non-performing construction loans increased $12.8 million, or 15.9%, with $9.1 million of the increase in Maryland, $7.8 million in Pennsylvania, and $3.9 million in New Jersey, offset by a $8.1 million decrease in Virginia.
The $23.3 million balance of OREO as of December 31, 2009 included $14.0 million of residential properties, $5.6 of commercial properties and $2.8 million of undeveloped residential land.
The following table summarizes loan delinquency rates, by type, as of the indicated dates:
December 31, 2009 | December 31, 2008 | |||||||||||||||||
30-60 Days |
> 90 Days |
Total | 30-60 Days |
> 90 Days |
Total | |||||||||||||
Real estate construction |
0.70 | % | 9.43 | % | 10.13 | % | 2.06 | % | 6.15 | % | 8.21 | % | ||||||
Commercial industrial, agricultural and financial |
0.63 | 1.88 | 2.51 | 0.56 | 1.08 | 1.65 | ||||||||||||
Real estate commercial mortgage |
0.91 | 1.42 | 2.33 | 0.74 | 1.03 | 1.78 | ||||||||||||
Real estate residential mortgage |
4.12 | 5.10 | 9.22 | 4.14 | 2.97 | 7.11 | ||||||||||||
Consumer, home equity, leasing and other |
1.12 | 0.60 | 1.72 | 0.82 | 0.41 | 1.23 | ||||||||||||
Total |
1.09 | % | 2.36 | % | 3.44 | % | 1.11 | % | 1.64 | % | 2.74 | % |
The following table summarizes the allocation of the allowance for loan losses by loan type:
December 31 | ||||||||||||||||||||||||||||||
2009 | 2008 | 2007 | 2006 | 2005 | ||||||||||||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||||||||
Allow- ance |
% of Loans In Each Category |
Allow- ance |
% of Loans In Each Category |
Allow- ance |
% of Loans in Each Category |
Allow- ance |
% of Loans in Each Category |
Allow- ance |
% of Loans in Each Category |
|||||||||||||||||||||
Comml financial & agricultural |
$ | 96,901 | 30.9 | % | $ | 66,147 | 30.2 | % | $ | 53,194 | 30.6 | % | $ | 52,942 | 28.6 | % | $ | 52,379 | 28.2 | % | ||||||||||
Real estate construction |
67,388 | 8.2 | 32,917 | 10.5 | 1,174 | 12.2 | 1,383 | 13.9 | 1,773 | 10.1 | ||||||||||||||||||||
Real estate commercial mortgage |
32,257 | 35.9 | 42,402 | 33.4 | 31,542 | 31.0 | 34,606 | 30.9 | 14,690 | 33.6 | ||||||||||||||||||||
Real estate residential mortgage |
13,704 | 21.4 | 7,158 | 22.1 | 2,868 | 21.0 | 1,208 | 20.7 | 1,139 | 21.0 | ||||||||||||||||||||
Consumer, leasing & other |
13,620 | 3.6 | 8,167 | 3.8 | 8,142 | 5.2 | 6,475 | 5.9 | 7,935 | 7.1 | ||||||||||||||||||||
Unallocated |
32,828 | | 17,155 | | 10,627 | | 10,270 | | 14,931 | | ||||||||||||||||||||
Total |
$ | 256,698 | 100.0 | % | $ | 173,946 | 100.0 | % | $ | 107,547 | 100.0 | % | $ | 106,884 | 100.0 | % | $ | 92,847 | 100.0 | % | ||||||||||
The provision for loan losses is determined by the allowance allocation process, whereby an estimated need is allocated to impaired loans, as defined by the Financial Accounting Standards Boards Accounting Standards Codification (FASB ASC) Section 310-10-35,
27
or to pools of loans under FASB ASC Subtopic 450-20. The allocation is based on risk factors, collateral levels, economic conditions and other relevant factors, as appropriate. The Corporation also maintains an unallocated allowance for factors or conditions that exist at the balance sheet date, but are not specifically identifiable. Management believes such an unallocated allowance, which was approximately 13% as of December 31, 2009, is reasonable and appropriate as the estimates used in the allocation process are inherently imprecise. See additional disclosures in Note A, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements and Critical Accounting Policies, in Managements Discussion. Management believes that the allowance for loan losses balance of $256.7 million as of December 31, 2009 is sufficient to cover losses inherent in the loan portfolio on that date and is appropriate based on applicable accounting standards.
Other Income and Expenses
2009 vs. 2008
Other Income
The following table presents the components of other income for the past two years:
Increase (decrease) | ||||||||||||||
2009 | 2008 | $ | % | |||||||||||
(dollars in thousands) | ||||||||||||||
Overdraft fees |
$ | 35,964 | $ | 35,324 | $ | 640 | 1.8 | % | ||||||
Cash management fees |
11,399 | 13,274 | (1,875 | ) | (14.1 | ) | ||||||||
Other |
13,087 | 13,042 | 45 | 0.3 | ||||||||||
Service charges on deposit accounts |
60,450 | 61,640 | (1,190 | ) | (1.9 | ) | ||||||||
Debit card income |
11,094 | 9,803 | 1,291 | 13.2 | ||||||||||
Merchant fees |
7,476 | 7,608 | (132 | ) | (1.7 | ) | ||||||||
Foreign exchange income |
6,573 | 6,726 | (153 | ) | (2.3 | ) | ||||||||
Letter of credit fees |
6,387 | 6,009 | 378 | 6.3 | ||||||||||
Other |
5,791 | 6,101 | (310 | ) | (5.1 | ) | ||||||||
Other service charges and fees |
37,321 | 36,247 | 1,074 | 3.0 | ||||||||||
Investment management and trust services |
32,076 | 32,734 | (658 | ) | (2.0 | ) | ||||||||
Gains on sales of mortgage loans |
22,644 | 10,332 | 12,312 | 119.2 | ||||||||||
Credit card income |
5,472 | 3,587 | 1,885 | 52.6 | ||||||||||
Gains on sales of OREO |
1,925 | 679 | 1,246 | 183.5 | ||||||||||
Other income |
11,789 | 10,168 | 1,621 | 15.9 | ||||||||||
Total, excluding gain on sale of credit card portfolio and investment securities gains (losses) |
171,677 | 155,387 | 16,290 | 10.5 | ||||||||||
Gain on sale of credit card portfolio |
| 13,910 | (13,910 | ) | N/M | |||||||||
Investment securities gains (losses) |
1,079 | (58,241 | ) | 59,320 | N/M | |||||||||
Total |
$ | 172,756 | $ | 111,056 | $ | 61,700 | 55.6 | % | ||||||
N/M Not Meaningful.
The $1.2 million, or 1.9%, decrease in service charges on deposit accounts was due to a $1.9 million, or 14.1%, decrease in cash management fees, as customers transferred funds from the cash management program to deposits due to the low interest rate environment, offset by a $640,000, or 1.8%, increase in overdraft fees.
The $1.1 million, or 3.0%, increase in other service charges and fees was primarily due to a $1.3 million, or 13.2%, increase in debit card fees as transaction volumes increased.
The $12.3 million, or 119.2%, increase in gains on sales of mortgage loans resulted from an increase in the volume of loans sold from $648.1 million in 2008 to $2.1 billion in 2009. The $1.5 billion, or 229.0%, increase in loans sold was mainly due to an increase in refinance activity, as mortgage rates dropped to historic lows. Refinances accounted for approximately 70% of sales volumes in 2009, compared to approximately 43% in 2008.
28
Credit card income includes fees earned for each new account opened and a percentage of revenue earned on both new accounts and accounts sold, under an agreement entered into with the purchaser of the Corporations credit card portfolio. The $1.9 million, or 52.6%, increase in credit card income was primarily due to twelve months of revenue being earned in 2009 compared to less than nine months earned during 2008, as the agreement with the credit card purchaser was executed during the second quarter of 2008.
The $1.2 million, or 183.5%, increase in gains on sales of OREO was due to an increase in the number of properties sold in 2009. The $1.6 million, or 15.9%, increase in other income was primarily due to a $1.0 million mortgage servicing rights impairment charge in 2008, which was recorded as a decrease to mortgage servicing income.
Investment securities gains of $1.1 million for 2009 included $14.5 million of net gains on the sales of debt securities, primarily collateralized mortgage obligations, offset by other-than-temporary impairment charges of $13.4 million. During 2009, the Corporation recorded $9.5 million of other-than-temporary impairment charges for pooled trust preferred securities issued by financial institutions and $3.8 million of other-than-temporary impairment charges for financial institutions stocks. The $58.2 million of investment securities losses for 2008 were primarily a result of $43.1 million of other-than-temporary impairment charges for financial institutions stocks and $15.8 million of other-than-temporary impairment charges for pooled trust preferred securities issued by financial institutions. See Note C, Investment Securities in the Notes to Consolidated Financial Statements for additional details.
Other Expenses
The following table presents the components of other expenses for each of the past two years:
Increase (decrease) | |||||||||||||
2009 | 2008 | $ | % | ||||||||||
(dollars in thousands) | |||||||||||||
Salaries and employee benefits |
$ | 218,812 | $ | 213,557 | $ | 5,255 | 2.5 | % | |||||
Net occupancy expense |
42,040 | 42,239 | (199 | ) | (0.5 | ) | |||||||
FDIC insurance premiums |
26,579 | 4,562 | 22,017 | 482.6 | |||||||||
Equipment expense |
12,820 | 13,332 | (512 | ) | (3.8 | ) | |||||||
Data processing |
11,328 | 12,813 | (1,485 | ) | (11.6 | ) | |||||||
Professional fees |
9,099 | 7,618 | 1,481 | 19.4 | |||||||||
Marketing |
8,915 | 13,267 | (4,352 | ) | (32.8 | ) | |||||||
Telecommunications |
8,608 | 8,172 | 436 | 5.3 | |||||||||
Operating risk loss |
7,550 | 24,308 | (16,758 | ) | (68.9 | ) | |||||||
Intangible amortization |
5,747 | 7,162 | (1,415 | ) | (19.8 | ) | |||||||
OREO expenses |
5,694 | 5,580 | 114 | 2.0 | |||||||||
Supplies |
5,637 | 5,773 | (136 | ) | (2.4 | ) | |||||||
Postage |
5,292 | 5,474 | (182 | ) | (3.3 | ) | |||||||
Other |
46,237 | 42,768 | 3,469 | 8.1 | |||||||||
Total, excluding goodwill impairment |
$ | 414,358 | $ | 406,625 | $ | 7,733 | 1.9 | % | |||||
Goodwill impairment |
| 90,000 | (90,000 | ) | N/M | ||||||||
Total |
$ | 414,358 | $ | 496,625 | $ | (82,267 | ) | (16.6 | %) | ||||
N/M Not Meaningful.
Salaries and employee benefits increased $5.3 million, or 2.5%, with salaries increasing $2.4 million, or 1.4%, and benefits increasing $2.9 million, or 7.5%.
The increase in salaries was due to a $2.2 million increase in incentive compensation expense for subsidiary bank management. Although merit increases were suspended as of March 2009, the remaining increase in salary expense reflects the 2009 impact of merit increases granted prior to the salary freeze. These increases were partially offset by a reduction in average full-time equivalent employees from 3,660 in 2008 to 3,600 in 2009.
The increase in employee benefits was primarily due to a $1.8 million, or 9.2%, increase in healthcare costs as claims increased, a $1.9 million increase in defined benefit pension plan expense due to a lower return on plan assets and $1.1 million in severance expense primarily related to the consolidation of back office functions at the Corporations Columbia Bank subsidiary. These increases were
29
offset by a $970,000 decrease in accruals for compensated absences and a $602,000 decrease in postretirement plan expense due to a reduction in benefits covered.
The $22.0 million, or 482.6%, increase in FDIC insurance expense was due to a $7.9 million special assessment in 2009, in addition to an increase in assessment rates, which were effective January 1, 2009. Gross FDIC insurance premiums for 2009, excluding the special assessment, were $18.8 million before applying $114,000 of one-time credits. For 2008, gross FDIC insurance premiums were $7.0 million, before applying $2.4 million of one-time credits.
In November 2009, the FDIC issued a ruling requiring financial institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. As a result, the Corporation pre-paid $70.2 million of FDIC insurance assessments in the fourth quarter of 2009, $18.3 million of which represented the estimated FDIC insurance assessments for 2010.
The $1.5 million, or 11.6%, decrease in data processing expense was primarily due to savings realized from the consolidation of back office functions at the Corporations Columbia Bank subsidiary, as well as reductions in costs for certain renegotiated vendor contracts. The $1.5 million, or 19.4%, increase in professional fees was primarily due to increased legal costs associated with the collection and workout efforts for non-performing loans. The $4.4 million, or 32.8%, decrease in marketing expenses was due to an effort to reduce discretionary spending and the timing of promotional campaigns. The $1.4 million, or 19.8%, decrease in intangible amortization was realized mainly in core deposit intangible assets, which are amortized on an accelerated basis, with lower expense in later years.
The $16.8 million, or 68.9%, decrease in operating risk loss was due to a $13.6 million reduction in charges related to the Corporations commitment to purchase ARCs from customer accounts and a $2.9 million decrease in losses on the actual and potential repurchase of residential mortgage and home equity loans previously sold in the secondary market. See Note O, Commitments and Contingencies in the Notes to Consolidated Financial Statements for additional details.
The $3.5 million, or 8.1%, increase in other expenses included a $2.7 million increase in loan collection and workout costs, a $1.9 million increase in student loan lender expense, and the impact of a $1.4 million reversal of litigation reserves in 2008 associated with the Corporations share of indemnification liabilities with Visa Inc. (Visa). These increases in other expenses were offset by decreases of $1.7 million in consulting fees, due primarily to certain information technology initiatives in 2008 that did not recur in 2009, and a $1.1 million decrease in travel and entertainment expense, due to efforts to reduce discretionary spending.
2008 vs. 2007
Other Income
Other income decreased $37.0 million, or 25.0%. In 2008, the Corporation had $58.2 million of investment securities losses, compared to investment securities gains of $1.7 million in 2007. Excluding investment securities gains (losses), other income increased $23.0 million, or 15.7%.
Service charges on deposit accounts increased $15.1 million, or 32.6%, primarily due to an increase in overdraft fees of $13.0 million, or 58.1%, and an increase in cash management fees of $1.7 million, or 15.1%. The increase in overdraft fees was mainly due to a new overdraft program that was introduced in November 2007. The increase in cash management fees was due to increased sales during 2007, resulting in a higher revenue stream in 2008.
Other service charges and fees increased $4.1 million, or 12.7%, due to a $2.4 million, or 56.8%, increase in foreign currency processing revenue, due primarily to an increase in volume, a $1.1 million, or 12.5%, increase in debit card fees, also due to increased volumes, and a $658,000, or 12.5%, increase in letter of credit fees.
Investment management and trust services income decreased $5.9 million, or 15.3%, primarily due to a $4.9 million, or 38.2%, decrease in brokerage revenue. During 2008, the Corporation began transitioning its brokerage business from a transaction-based model to a relationship model, which generates fees based on the values of assets under management rather than transaction volume. This transition had a negative impact on brokerage revenue due to expected business disruptions. The negative performance of equity markets also contributed to the decrease in investment management and trust services income.
30
Gains on sales of mortgage loans decreased $4.0 million, or 27.7%, due to lower sales volumes. Total loans sold were $648.1 million in 2008 and $1.3 billion in 2007, mainly due to the exit from the national wholesale residential mortgage business in 2007. Credit card income of $3.6 million was related to income earned subsequent to the Corporations April 2008 credit card portfolio sale.
Other income decreased $3.8 million, or 26.1%, primarily due to a $2.1 million gain related to the resolution of litigation and the sale of certain assets between the Corporation and an unaffiliated bank and a $700,000 gain related to the redemption of a partnership interest, both recorded in 2007. In 2008, the Corporation recorded a $1.0 million mortgage servicing rights impairment charge as a reduction to servicing income.
Investment securities losses of $58.2 million for 2008 were primarily due to other-than-temporary impairment charges of $43.1 million related to financial institution stocks, $20.7 million related to debt securities and $1.5 million for other equity securities. In addition, the Corporation recorded a $2.7 million loss related to the write-off of a collateralized mortgage obligation that was delivered as collateral for interest rate swaps with a failed financial institution. These impairment charges were offset by $4.8 million in gains from the redemption of Class B shares in connection with Visas initial public offering and gains on the sale of MasterCard, Incorporated shares, in addition to net gains of $2.9 million and $2.1 million on the sale of equity securities and debt securities, respectively.
Other Expenses
Other expenses increased $91.2 million, or 22.5%, due primarily to a $90.0 million goodwill impairment charge recorded in 2008. Salaries and employee benefits decreased $4.0 million, or 1.8%, with salaries decreasing $1.1 million, or 0.6%, and benefits decreasing $2.9 million, or 7.1%.
The decrease in salaries was due to staff reductions that were made as part of a corporate-wide workforce management and centralization initiative that began in 2007 and a decrease in stock-based compensation, offset by normal merit increases. Average full-time equivalent employees decreased from 3,840 in 2007 to 3,660 in 2008.
Employee benefits decreased $2.9 million, or 7.1%, due to a $2.0 million reduction associated with the curtailment of the Corporations defined benefit pension plan and a net decrease in expenses for the Corporations retirement plans as a result of changes in contribution formulas in 2008. Also contributing to the decrease was a reduction in severance expenses.
Net occupancy expense increased $2.3 million, or 5.7%. The increase was due to additional expenses related to rental, maintenance, utility and depreciation of real property as a result of growth in the branch network during 2008 in comparison to 2007. The Corporation added 5 full service branches to its network in both 2008 and 2007.
Operating risk loss decreased $2.9 million, or 10.7%, due to a $22.8 million decrease in losses on the actual and potential repurchase of residential mortgage and home equity loans, offset by $19.8 million of charges, recorded in 2008, related to the Corporations guarantee to purchase ARCs from customer accounts.
Equipment expense decreased $560,000, or 4.0%, and intangible amortization decreased $1.2 million, or 14.1%. The decreases in equipment expense and intangible amortization were due to both equipment and intangible assets becoming fully depreciated and amortized during 2008. Marketing expenses increased $1.9 million, or 17.1%, due to deposit promotional campaigns, new branch promotions and customer service initiatives undertaken during 2008.
FDIC insurance expense increased $2.8 million, or 152.3%, due to the expiration of one-time credits and an increase in insured deposits. In 2008, gross FDIC insurance premiums were $7.0 million, reduced by $2.4 million of one-time credits. In 2007, gross FDIC insurance premiums were $6.7 million, reduced by $4.9 million of one-time credits.
Other expenses increased $2.2 million, or 4.9%, due to a $5.2 million increase in costs associated with the maintenance and disposition of foreclosed real estate and a $2.9 million increase in consulting fees, primarily associated with new information technology initiatives. Offsetting these increases was a $2.9 million decrease in other expenses due to the reversal of litigation reserves associated with the Corporations share of indemnification liabilities with Visa, which were no longer necessary as a result of Visas initial public offering in 2008, and a $2.7 million decrease in state taxes due to the consolidation of certain subsidiary banks in 2007 and 2008.
31
Income Taxes
Income tax expense for 2009 was $15.4 million, a decrease of $9.2 million, or 37.3%, from 2008. Income tax expense for 2008 decreased $39.0 million, or 61.3% from 2007. The Corporations effective tax rate (income taxes divided by income before income taxes) was 17.2%, 129.6% and 29.4% in 2009, 2008 and 2007, respectively. The effective tax rate for 2008 was significantly impacted by the $90.0 million goodwill impairment charge, which is not deductible for income tax purposes. Excluding the impact of the goodwill charge, the Corporations effective tax rate for 2008 was 22.6%. The decline in the effective tax rate over the past three years resulted from non-taxable income and credits, which have been fairly consistent amounts over the three-year period, having a more significant impact on the effective tax rate calculation as income before income taxes has decreased.
The Corporations effective tax rates are generally lower than the 35% Federal statutory rate due to investments in tax-free municipal securities and Federal tax credits earned from investments in low and moderate-income housing partnerships (LIH Investments). Net credits associated with LIH investments were $4.7 million, $3.9 million and $3.7 million in 2009, 2008 and 2007, respectively.
For additional information regarding income taxes, see Note K, Income Taxes, in the Notes to Consolidated Financial Statements.
FINANCIAL CONDITION
The table below presents condensed consolidated ending balance sheets for the Corporation.
December 31 | Increase (decrease) | ||||||||||||
2009 | 2008 | $ | % | ||||||||||
(dollars in thousands) | |||||||||||||
Assets: |
|||||||||||||
Cash and due from banks |
$ | 284,508 | $ | 331,164 | $ | (46,656 | ) | (14.1 | %) | ||||
Other earning assets |
101,975 | 117,550 | (15,575 | ) | (13.2 | ) | |||||||
Investment securities |
3,267,086 | 2,724,841 | 542,245 | 19.9 | |||||||||
Loans, net of allowance |
11,715,726 | 11,868,674 | (152,948 | ) | (1.3 | ) | |||||||
Premises and equipment |
204,203 | 202,657 | 1,546 | 0.8 | |||||||||
Goodwill and intangible assets |
552,563 | 557,833 | (5,270 | ) | (0.9 | ) | |||||||
Other assets |
509,574 | 382,387 | 127,187 | 33.3 | |||||||||
Total Assets |
$ | 16,635,635 | $ | 16,185,106 | $ | 450,529 | 2.8 | % | |||||
Liabilities and Shareholders Equity: |
|||||||||||||
Deposits |
$ | 12,097,914 | $ | 10,551,916 | $ | 1,545,998 | 14.7 | % | |||||
Short-term borrowings |
868,940 | 1,762,770 | (893,830 | ) | (50.7 | ) | |||||||
Long-term debt |
1,540,773 | 1,787,797 | (247,024 | ) | (13.8 | ) | |||||||
Other liabilities |
191,526 | 222,976 | (31,450 | ) | (14.1 | ) | |||||||
Total Liabilities |
14,699,153 | 14,325,459 | 373,694 | 2.6 | |||||||||
Shareholders equity |
1,936,482 | 1,859,647 | 76,835 | 4.1 | |||||||||
Total Liabilities and Shareholders Equity |
$ | 16,635,635 | $ | 16,185,106 | $ | 450,529 | 2.8 | % | |||||
Total assets increased $450.5 million, or 2.8%, to $16.6 billion as of December 31, 2009, from $16.2 billion as of December 31, 2008. Total investments increased $542.2 million, or 19.9%, offset by a decrease in loans, net of the allowance for loan losses, of $152.9 million, or 1.3%. Total liabilities increased $373.7 million, or 2.6%, due to a $1.5 billion, or 14.7%, increase in deposits, offset by a $1.1 billion, or 32.1%, decrease in short and long-term borrowings.
The changes in the Corporations balance sheet from December 31, 2008 to December 31, 2009 were mainly a result of changes in funding mix, combined with weaker loan demand. Funds generated by significant deposit growth were used to reduce wholesale funding in the form of both short-term borrowings and long-term debt. Excess funds were used to purchase additional investment
32
securities, in the absence of loan demand. The discussion that follows provides more details on the changes in specific balance sheet line items.
Loans
The following table presents loans outstanding, by type, as of the dates shown:
December 31 | ||||||||||||||||||||
2009 | 2008 | 2007 | 2006 | 2005 | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
Real-estate commercial mortgage |
$ | 4,292,300 | $ | 4,016,700 | $ | 3,480,958 | $ | 3,202,706 | $ | 2,831,405 | ||||||||||
Commercial industrial, financial and agricultural |
3,699,198 | 3,635,544 | 3,427,085 | 2,965,186 | 2,375,669 | |||||||||||||||
Real-estate home equity |
1,644,260 | 1,695,398 | 1,501,231 | 1,455,439 | 1,205,523 | |||||||||||||||
Real-estate construction |
978,267 | 1,269,330 | 1,366,923 | 1,440,180 | 851,555 | |||||||||||||||
Real-estate residential mortgage |
921,741 | 972,797 | 848,901 | 696,568 | 567,629 | |||||||||||||||
Consumer |
360,698 | 365,692 | 500,708 | 523,066 | 520,098 | |||||||||||||||
Leasing and other |
83,675 | 97,687 | 89,383 | 100,711 | 79,738 | |||||||||||||||
Gross loans |
11,980,139 | 12,053,148 | 11,215,189 | 10,383,856 | 8,431,617 | |||||||||||||||
Unearned income |
(7,715 | ) | (10,528 | ) | (10,765 | ) | (9,533 | ) | (6,889 | ) | ||||||||||
Loans, net of unearned income |
$ | 11,972,424 | $ | 12,042,620 | $ | 11,204,424 | $ | 10,374,323 | $ | 8,424,728 | ||||||||||
Total loans, net of unearned income, decreased $70.2 million, or 0.6%, mainly due to a combination of lower demand and continuing efforts to manage credit exposures. Construction loans decreased $291.1 million, or 22.9%, due to efforts by the Corporation to reduce credit exposure in this sector, particularly in its Maryland and Virginia markets. Also contributing to the decrease were $44.9 million in construction loan charge-offs during 2009. Home equity loans decreased $51.1 million, or 3.0%, and residential mortgages decreased $51.1 million, or 5.2%, both due to refinance activity generated by low interest rates. Offsetting these decreases was a $275.6 million, or 6.9%, increase in commercial mortgages, of which $200.4 million was attributable to increases in commercial mortgages generated in the Corporations Pennsylvania market, and a $63.7 million, or 1.8%, increase in commercial loans.
Approximately $5.3 billion, or 44.0%, of the Corporations loan portfolio was in commercial mortgage and construction loans as of December 31, 2009. The Corporation does not have a concentration of credit risk with any single borrower, industry or geographical location. The performance of real estate markets and general economic conditions adversely impacted the performance of these loans throughout 2009, most significantly construction loans to residential housing developers in the Corporations Maryland and Virginia markets. Construction loans outstanding in Virginia and Maryland at December 31, 2009 were $250.3 million and $242.8 million, respectively.
33
Investment Securities
The following table presents the carrying amount of investment securities held to maturity (HTM) and available for sale (AFS) as of the dates shown:
December 31 | |||||||||||||||||||||||||||
2009 | 2008 | 2007 | |||||||||||||||||||||||||
HTM | AFS | Total | HTM | AFS | Total | HTM | AFS | Total | |||||||||||||||||||
(in thousands) | |||||||||||||||||||||||||||
U.S. Government securities |
$ | | $ | 1,325 | $ | 1,325 | $ | | $ | 14,628 | $ | 14,628 | $ | | $ | 14,536 | $ | 14,536 | |||||||||
U.S. Government sponsored agency securities |
6,713 | 91,956 | 98,669 | 6,782 | 77,002 | 83,784 | 6,478 | 202,523 | 209,001 | ||||||||||||||||||
State and municipal |
503 | 415,773 | 416,276 | 825 | 523,536 | 524,361 | 1,120 | 521,538 | 522,658 | ||||||||||||||||||
Corporate debt securities |
| 116,739 | 116,739 | 25 | 119,894 | 119,919 | 25 | 165,982 | 166,007 | ||||||||||||||||||
Collateralized mortgage obligations |
| 1,122,996 | 1,122,996 | | 504,193 | 504,193 | | 594,775 | 594,775 | ||||||||||||||||||
Mortgage-backed securities |
1,484 | 1,080,024 | 1,081,508 | 2,004 | 1,141,351 | 1,143,355 | 2,662 | 1,452,188 | 1,454,850 | ||||||||||||||||||
Auction rate securities |
| 289,203 | 289,203 | | 195,900 | 195,900 | | | | ||||||||||||||||||
Total debt securities |
8,700 | 3,118,016 | 3,126,716 | 9,636 | 2,576,504 | 2,586,140 | 10,285 | 2,951,542 | 2,961,827 | ||||||||||||||||||
Equity securities |
| 140,370 | 140,370 | | 138,701 | 138,701 | | 191,725 | 191,725 | ||||||||||||||||||
Total |
$ | 8,700 | $ | 3,258,386 | $ | 3,267,086 | $ | 9,636 | $ | 2,715,205 | $ | 2,724,841 | $ | 10,285 | $ | 3,143,267 | $ | 3,153,552 | |||||||||
Total investment securities increased $542.2 million, or 19.9%, to $3.3 billion at December 31, 2009. During 2009, the Corporation purchased investments with funds generated from the increase in deposits combined with the decrease in loans. In addition, the Corporation invested the funds received from the issuance of preferred stock to the United States Treasury Department in December 2008. Finally, increases in investments were also due to the purchase of $104.4 million of ARCs from customers during 2009.
The Corporation classified 99.7% of its investment portfolio as available for sale as of December 31, 2009 and, as such, these investments were recorded at their estimated fair values. The net unrealized gain on available for sale investment securities at December 31, 2009 was $25.6 million, compared to a net unrealized loss of $3.9 million as of December 31, 2008, as a result of the decrease in market interest rates on collateralized mortgage obligations and mortgage-backed securities in 2009.
Other Assets
Cash and due from banks decreased $46.7 million, or 14.1%. Because of the daily fluctuations that result in the normal course of business, cash is more appropriately analyzed in terms of average balances. On an average balance basis for the month of December, cash and due from banks increased $22.6 million, or 7.4%, from $306.1 million in 2008 to $328.7 million in 2009.
Other earning assets decreased $15.6 million, or 13.2%, primarily due to a $10.5 million, or 10.9%, decrease in loans held for sale. Premises and equipment increased $1.5 million, or 0.8%, to $204.2 million. The increase reflects additions primarily for the construction of new branch facilities, offset by depreciation and the sales of branch and office facilities during 2009. Goodwill and intangible assets decreased $5.3 million, or 0.9%, due to the amortization of intangible assets.
Other assets increased $127.2 million, or 33.3%, to $509.6 million. Prepaid FDIC assessments increased $66.0 million as assessments for 2010 through 2012 were paid in the fourth quarter of 2009. Also contributing to the increase in other assets were a $29.0 million increase in LIH investments and a $15.0 million increase in mortgage servicing rights as mortgage loans sold with servicing retained increased in 2009.
Deposits and Borrowings
Deposits increased $1.5 billion, or 14.7%, to $12.1 billion as of December 31, 2009. During 2009, total non-interest and interest bearing demand and savings deposits increased $1.3 billion, or 24.4%, and time deposits increased $215.7 million, or 4.2%. The increase in demand and savings accounts was in personal, business and, to a lesser degree, governmental accounts. The increase in personal accounts was primarily due to a reduction in consumer spending, in addition to the impact of decreased consumer confidence in equity and debt markets, both as a result of weak economic conditions. The increase in business and governmental accounts was due, in part, to businesses transferring funds from the Corporations cash management products due to low interest rates. The increase in time deposits resulted from a $541.0 million, or 11.4%, increase in customer certificates of deposit, offset by a $325.3 million, or
34
95.0%, decrease in brokered certificates of deposit. The increase in customer certificates of deposit was due to active promotion in the beginning of 2009.
Short-term borrowings decreased $893.8 million, or 50.7%, primarily in Federal Funds purchased ($769.6 million decrease) and short-term customer funding ($121.7 million decrease). Federal funds purchased declined as a result of deposit growth, while short-term customer funding decreased as customers transferred funds from the cash management program to deposits due to the low interest rate environment. Long-term debt decreased $247.0 million, or 13.8%, as a result of the maturity of FHLB advances.
Other Liabilities
Other liabilities decreased $31.5 million, or 14.1%. The decrease was primarily attributable to a $21.0 million decrease in dividends payable to common shareholders, as the quarterly dividend rate was $0.15 per share in the fourth quarter of 2008 and $0.03 per share in the fourth quarter of 2009. Also contributing to the decrease was an $8.7 million reduction in financial guarantee liabilities related to commitments to purchase ARCs from customers, a $7.7 million decrease in amounts payable for security purchases executed prior to year-end, but not settled until after year-end and a $7.1 million decrease in accrued interest payable. These increases were partially offset by a $14.6 million increase in equity commitments payable on LIH investments.
Shareholders Equity
Total shareholders equity increased $76.8 million, or 4.1%, to $1.9 billion, or 11.6% of total assets as of December 31, 2009. The increase was due to $73.9 million of net income, a $29.0 million increase in net holding gains on investment securities, $7.4 million of stock issuances and a $5.6 million increase in unrecognized pension and postretirement plan costs, offset by $38.0 million of dividends on common and preferred shares outstanding.
On December 23, 2008, the Corporation entered into a Securities Purchase Agreement with the U.S. Treasury Department (UST) pursuant to which the Corporation sold to the UST, for an aggregate purchase price of $376.5 million, 376,500 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (preferred stock), par value $1,000 per share, and warrants to purchase up to 5.5 million shares of common stock, par value $2.50 per share. As a condition under the CPP, without the consent of the UST, the Corporations share repurchases are limited to purchases in connection with the administration of any employee benefit plan, including purchases to offset share dilution in connection with any such plans. This restriction is effective until December 2011 or until the UST no longer owns any of the Corporations preferred shares issued under the CPP. The Corporations preferred stock is included as a component of Tier 1 capital in accordance with regulatory capital requirements.
The preferred stock ranks senior to the Corporations common shares and pays a compounding cumulative dividend at a rate of 5% per year for the first five years, and 9% per year thereafter. Dividends are payable quarterly on February 15th, May 15th, August 15th and November 15th. The Corporation is prohibited from paying any dividend with respect to shares of common stock or repurchasing or redeeming any shares of the Corporations common shares in any quarter unless all accrued and unpaid dividends are paid on the preferred stock for all past dividend periods (including the latest completed dividend period), subject to certain limited exceptions. In addition, without the consent of the UST, the Corporation is prohibited from declaring or paying any cash dividends on common shares in excess of $0.15 per share, which was the last quarterly cash dividend per share declared prior to October 14, 2008. The Corporation is also restricted in the amounts and types of compensation it may pay to certain executives as a result of its participation in the CPP. The preferred stock is non-voting, other than class voting rights on matters that could adversely affect the preferred stock. The UST may transfer the preferred stock to a third-party at any time. The 5.5 million of common stock warrants issued to the UST have a term of 10 years and are exercisable at any time, in whole or in part, at an exercise price of $10.25 per share (subject to certain anti-dilution adjustments).
The $376.5 million of proceeds was allocated to the preferred stock and the warrants based on their relative fair values at issuance ($368.9 million was allocated to the preferred stock and $7.6 million to the warrants). The difference between the initial value allocated to the preferred stock of approximately $368.9 million and the liquidation value of $376.5 million will be charged to retained earnings over the first five years of the contract as an adjustment to the dividend yield using the effective yield method. During 2009, total accretion of the difference between the preferred stocks initial value and its liquidation value was $1.3 million.
The Corporation and its subsidiary banks are subject to regulatory capital requirements administered by various banking regulators. Failure to meet minimum capital requirements can initiate certain actions by regulators that could have a material effect on the Corporations 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 December
35
31, 2009, the Corporation and each of its bank subsidiaries met the minimum capital requirements. In addition, all of the Corporations bank subsidiaries capital ratios exceeded the amounts required to be considered well capitalized as defined in the regulations. See also Note J, Regulatory Matters, in the Notes to Consolidated Financial Statements.
The following table summarizes the Corporations capital ratios in comparison to regulatory requirements at December 31:
2009 | 2008 | Regulatory Minimum for Capital Adequacy |
|||||||
Total Capital (to Risk Weighted Assets) |
14.7 | % | 14.3 | % | 8.0 | % | |||
Tier I Capital (to Risk Weighted Assets) |
11.9 | % | 11.5 | % | 4.0 | % | |||
Tier I Capital (to Average Assets) |
9.7 | % | 9.6 | % | 3.0 | % | |||
Tangible common equity to tangible assets (1) |
6.3 | % | 6.0 | % | |||||
Tangible common equity to risk weighted assets (2) |
7.8 | % | 7.2 | % |
(1) | Ending common shareholders equity, excluding goodwill and intangible assets, divided by ending assets, excluding goodwill and intangible assets. |
(2) | Ending common shareholders equity, excluding goodwill and intangible assets, divided by risk-weighted assets. |
Pro-forma regulatory capital ratios, excluding the $376.5 million of preferred stock issued under the CPP, would be as follows at December 31:
2009 | 2008 | Regulatory Minimum for Capital Adequacy |
|||||||
Total Capital (to Risk Weighted Assets) |
11.8 | % | 11.4 | % | 8.0 | % | |||
Tier I Capital (to Risk Weighted Assets) |
9.0 | % | 8.6 | % | 4.0 | % | |||
Tier I Capital (to Average Assets) |
7.3 | % | 7.2 | % | 3.0 | % |
Contractual Obligations and Off-Balance Sheet Arrangements
The Corporation has various financial obligations that require future cash payments. These obligations include the payment of liabilities recorded on the Corporations consolidated balance sheet as well as contractual obligations for purchased services or for operating leases.
36
The following table summarizes significant contractual obligations to third parties, by type, that were fixed and determinable as of December 31, 2009:
Payments Due In | |||||||||||||||
One Year or Less |
One to Three Years |
Three to Five Years |
Over Five Years |
Total | |||||||||||
(in thousands) | |||||||||||||||
Deposits with no stated maturity (1) |
$ | 6,784,050 | $ | | $ | | $ | | $ | 6,784,050 | |||||
Time deposits (2) |
4,030,551 | 1,089,996 | 153,779 | 39,538 | 5,313,864 | ||||||||||
Short-term borrowings (3) |
868,940 | | | | 868,940 | ||||||||||
Long-term debt (3) |
468,851 | 195,921 | 11,990 | 864,011 | 1,540,773 | ||||||||||
Operating leases (4) |
13,004 | 22,267 | 15,610 | 47,123 | 98,004 | ||||||||||
Purchase obligations (5) |
18,057 | 22,156 | 2,611 | | 42,824 | ||||||||||
Uncertain tax positions (6) |
5,325 | | | | 5,325 |
(1) | Includes demand deposits and savings accounts, which can be withdrawn by customers at any time. |
(2) | See additional information regarding time deposits in Note H, Deposits, in the Notes to Consolidated Financial Statements. |
(3) | See additional information regarding borrowings in Note I, Short-Term Borrowings and Long-Term Debt, in the Notes to Consolidated Financial Statements. |
(4) | See additional information regarding operating leases in Note N, Leases, in the Notes to Consolidated Financial Statements. |
(5) | Includes information technology, telecommunication and data processing outsourcing contracts. Variable obligations, such as those based on transaction volumes, are not included. |
(6) | Includes accrued interest. See additional information related to uncertain tax positions in Note K, Income Taxes in the Notes to Consolidated Financial Statements. |
In addition to the contractual obligations listed in the preceding table, 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. These financial instruments include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit and interest rate risk that are not recognized on the consolidated balance sheets. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments issued to guarantee the financial or performance obligation of a customer to a third-party. Commitments and standby letters of credit do not necessarily represent future cash needs as they may expire without being drawn.
The following table presents the Corporations commitments to extend credit and letters of credit as of December 31, 2009 (in thousands):
Commercial mortgage and construction |
$ | 329,159 | |
Home equity |
891,570 | ||
Commercial and other |
3,258,817 | ||
Total commitments to extend credit |
$ | 4,479,546 | |
Standby letters of credit |
$ | 551,064 | |
Commercial letters of credit |
37,662 | ||
Total letters of credit |
$ | 588,726 | |
37
CRITICAL ACCOUNTING POLICIES
The following is a summary of those accounting policies that the Corporation considers to be most important to the portrayal of its financial condition and results of operations, as they require managements most difficult judgments as a result of the need to make estimates about the effects of matters that are inherently uncertain.
Fair Value Measurements The disclosure of fair value measurements is required by FASB ASC Topic 820, which 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):
| Level 1 Inputs that represent quoted prices for identical instruments in active markets. |
| Level 2 Inputs that represent quoted prices for similar instruments in active markets, or quoted prices for identical instruments in non-active markets. Also includes valuation techniques whose inputs are derived principally from observable market data other than quoted prices, such as interest rates or other market-corroborated means. |
| Level 3 Inputs that are largely unobservable, as little or no market data exists for the instrument being valued. |
The Corporation has categorized all assets and liabilities measured at fair value both on a recurring and nonrecurring basis into the above three levels. See Note P, Fair Value Measurements in the Notes to Consolidated Financial Statements for the disclosures required by FASB ASC Topic 820.
The determination of fair value for assets and liabilities categorized as Level 3 items involves a great deal of subjectivity due to the use of unobservable inputs. In addition, determining when a market is no longer active and placing little or no reliance on distressed market prices requires the use of managements judgment. The need for greater management judgment in determining fair values for Level 3 assets and liabilities has further been heightened by the current challenging economic conditions, which have resulted in significant volatility in the fair values of certain investment securities.
The Corporation engages third-party valuation experts to assist in valuing most available-for-sale investment securities measured at fair value on a recurring basis which are classified as Level 2 or Level 3 items. The pricing data and market quotes the Corporation obtains from outside sources are reviewed internally for reasonableness.
Allowance for Credit Losses The allowance for loan losses represents managements estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The reserve for unfunded lending commitments represents managements estimate of losses inherent in its unfunded loan commitments and is recorded in other liabilities on the consolidated balance sheet. The allowance for credit losses is increased by charges to expense, through the provision for loan losses, and decreased by charge-offs, net of recoveries. Managements periodic evaluation of the adequacy of the allowance for credit losses is based on the Corporations past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrowers ability to repay, the estimated fair value of underlying collateral and current economic conditions, among other considerations. Management believes that the allowance for loan losses and the reserve for unfunded lending commitments are adequate as of the balance sheet date, however, future changes to the allowance or reserve may be necessary based on changes in any of these factors.
The allowance for loan losses consists of two components specific allowances allocated to individually impaired loans, as required by FASB ASC Section 310-10-35, and allowances calculated for pools of loans under FASB ASC Subtopic 450-20. Impaired loans represent loans for which the Corporation believes it is probable that all amounts will not be collected according to the contractual terms of the loan agreement.
The 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. Internal credit ratings are reviewed in connection with the Corporations ongoing allowance allocation process. Larger balance 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. A loan with a substandard credit rating is inadequately protected by sound worth and paying capacity of the borrower or by the collateral pledged, if any. In addition, there exists a well-defined weakness or weaknesses that jeopardize the normal repayment of the debt. Collection of principal may be collateral-intensive. A distinct possibility exists that some loss may be sustained if deficiencies are not corrected.
Loans that are determined to be impaired are measured based on the present value of expected future cash flows discounted at the loans effective interest rate, or at the loans observable market price or at the fair value of the collateral if the loan is collateral dependent. The fair value of collateral is generally based on appraisals, discounted to represent expected sale prices. An allowance for loan losses is allocated to an impaired loan if its carrying value exceeds its estimated fair value. In addition, a reserve for unfunded lending commitments is allocated for impaired loans with unused commitments to extend credit.
38
All loans not individually reviewed for impairment under FASB ASC Section 310-10-35 are evaluated under FASB ASC Subtopic 450-20. Loans are segmented into groups with similar characteristics and an allowance for loan losses is allocated to each segment based on quantitative factors, such as recent loss history, and qualitative factors, such as economic conditions and trends. In general, these loans include residential mortgages and home equity loans, consumer loans, installment loans, smaller balance commercial loans and mortgages and lease receivables. Large balance commercial loans, commercial mortgages and construction loans with internal credit ratings of satisfactory minus or special mention are also evaluated under FASB ASC Subtopic 450-20. Since these loans have somewhat higher risk characteristics compared to other loans evaluated under FASB ASC Subtopic 450-20, they are segregated into separate pools for evaluation purposes. Loans rated special mention represent potentially weak loans or assets presenting an unwarranted credit risk, but less risky than substandard assets. Loans rated satisfactory minus generally involve borrowers that may lack experience, depth or credit history. Borrowers may display marginal financial condition and financial trends that are unestablished or may be negative, however, the Corporation has an optimistic view of their future collectibility.
The allocation of the allowance for credit losses is reviewed to evaluate its appropriateness in relation to the overall risk profile of the loan portfolio. The Corporation considers risk factors such as: local and national economic conditions; trends in delinquencies and non-accrual loans; the diversity of borrower industry types; and the composition of the portfolio by loan type. An unallocated allowance is maintained for factors and conditions that exist at the balance sheet date, but are not specifically identifiable, and to recognize the inherent imprecision in estimating and measuring loss exposure.
Loans and lease financing receivables deemed to be a loss are written off through a charge against the allowance for credit losses. Closed-end consumer loans are generally charged off when they become 120 days past due (180 days for open-end consumer loans) if they are not adequately secured by real estate. All other loans are evaluated for possible charge-off when it is probable that the balance will not be collected, based on the ability of the borrower to pay and the value of the underlying collateral. Recoveries of loans previously charged off are recorded as increases to the allowance for loan losses. Past due status is determined based on contractual due dates for loan payments.
Prior to 2009, loans reviewed for impairment under FASB ASC Section 310-10-35 also included large balance commercial loans and commercial mortgages that were rated satisfactory minus or special mention. In 2009, the Corporation revised its allocation methodology to evaluate loans with these internal risk ratings under FASB ASC Subtopic 450-20, as documented above. The methodology was changed to more properly align internal risk ratings with the likelihood of impairment.
This change in allocation methodology did not result in a change in the Corporations overall allowance for credit losses balance, or in a change to the unallocated allowance, but rather resulted in a re-categorization of the allowance for loan losses from the allowance allocated to impaired loans under FASB ASC Section 310-10-35 to the allowance allocated to loans evaluated under FASB ASC Subtopic 450-20. This change in methodology did result in a significant decrease in the reserve for unfunded lending commitments, which is based solely on unfunded commitments related to impaired loans. Such loans included satisfactory minus and special mention loans in years prior to 2009. As of December 31, 2009, the reserve for unfunded lending commitments was $855,000, as compared to $6.2 million as of December 31, 2008.
Lease financing receivables include both open and closed end leases for the purchase of vehicles and equipment. Residual values are set at the inception of the lease and are reviewed periodically for impairment. If the impairment is considered to be other-than-temporary, the resulting reduction in the net investment in the lease is recognized as a loss in the period when impairment occurs.
Business Combinations and Intangible Assets The Corporation accounts for all business acquisitions using the purchase method of accounting. Purchase accounting requires the purchase price to be allocated to the estimated fair values of the assets acquired and liabilities assumed, including certain intangible assets that must be recognized. Typically, this allocation results in the purchase price exceeding the fair value of net assets acquired, which is recorded as goodwill.
Goodwill is not amortized to expense, but is evaluated at least annually for impairment. The Corporation completes its annual goodwill impairment test as of October 31st of each year. The Corporation tests for impairment by first allocating its goodwill and other assets and liabilities, as necessary, to defined reporting units. A fair value is then determined for each reporting unit. If the fair values of the reporting units exceed their book values, no write-down of the recorded goodwill is necessary. If the fair values are less than the book values, an additional valuation procedure is necessary to assess the proper carrying value of the goodwill. In 2008, the Corporation recorded a $90.0 million goodwill impairment charge due to one of its defined reporting units failing the annual impairment test and based on the additional valuation procedures performed. The Corporation determined that no impairment write-offs were necessary
39
in 2009. For additional details related to the Corporations 2009 goodwill impairment test, see Note F, Goodwill and Intangible Assets in the Notes to Consolidated Financial Statements.
Reporting unit valuation is inherently subjective, with a number of factors based on assumptions and management judgments. Among these are future growth rates for the reporting units, selection of comparable market transactions, discount rates and earnings capitalization rates. Changes in assumptions and results due to economic conditions, industry factors and reporting unit performance and cash flow projections could result in different assessments of the fair values of reporting units and could result in impairment charges.
If an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount, an interim impairment test is required. Such events may include adverse changes in legal factors or in the business climate, adverse actions by a regulator, unauthorized competition, the loss of key employees, or similar events.
Intangible assets are amortized over their estimated lives. Some intangible assets have indefinite lives and are, therefore, not amortized. All intangible assets must be evaluated for impairment if certain events occur. Any impairment write-downs are recognized as expense on the consolidated statements of operations.
Income Taxes The provision for income taxes is based upon income before income taxes, adjusted for the effect of certain tax-exempt income and non-deductible expenses. In addition, certain items of income and expense are reported in different periods for financial reporting and tax return purposes. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the applicable enacted marginal tax rate.
The Corporation must also evaluate the likelihood that deferred tax assets will be recovered from future taxable income. If any such assets are more likely than not to not be recovered, a valuation allowance must be recognized. The Corporation recorded a valuation allowance of $7.9 million as of December 31, 2009 for certain state net operating losses that are not expected to be recovered. The assessment of the carrying value of deferred tax assets is based on certain assumptions, changes in which could have a material impact on the Corporations consolidated financial statements.
The Corporation accounts for uncertain tax positions by applying a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Recognition and measurement of tax positions is based on managements evaluations of relevant tax code and appropriate industry information about audit proceedings for comparable positions at other organizations. Virtually all of the Corporations unrecognized tax benefits are for positions that are taken on an annual basis on state tax returns. Increases to unrecognized tax benefits will occur as a result of accruing for the nonrecognition of the position for the current year. Decreases will occur as a result of the lapsing of the statute of limitations for the oldest outstanding year which includes the position.
See also Note K, Income Taxes, in the Notes to Consolidated Financial Statements.
Recent Accounting Pronouncements
In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assets an amendment of FASB Statement No. 140 (Statement 166). Statement 166, or ASC Update 2009-16, amends the accounting for transfers of financial assets. Among its amendments to FASB Statement 140, it eliminates the concept of qualifying special-purpose entities, requires additional criteria to be met in order for the transfer of portions of financial assets to qualify for sale treatment, and expands the legal isolation criteria. Statement 166 is effective for a reporting entitys first annual reporting period that begins after November 15, 2009, or January 1, 2010 for the Corporation. The adoption of Statement 166 will not have a material impact on its consolidated financial statements.
In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R) (Statement 167). Statement 167 amends the criteria for determining the primary beneficiary of, and the entity required to consolidate, a variable interest entity. Statement 167, or ASC Update 2009-17, is effective for a reporting entitys first annual reporting period that begins after November 15, 2009, or January 1, 2010 for the Corporation. The adoption of Statement 167 will not have a material impact on its consolidated financial statements.
40
In January 2010, the FASB issued ASC Update No. 2010-06, Improving Disclosures About Fair Value Measurements (ASC Update 2010-06). ASC Update 2010-06 requires companies to disclose, and provide the reasons for, all transfers of assets and liabilities between the Level 1 and 2 fair value categories. ASC Update 2010-06 also clarifies that companies should disclose fair value measurement disclosures for classes of assets and liabilities which are subsets of line items within the balance sheet, if necessary. In addition, ASC Update 2010-06 provides additional clarification related to disclosures about the fair value techniques and inputs for assets and liabilities classified within Level 2 or 3 categories. The disclosure requirements prescribed by ASC Update No. 2010-06 are effective for fiscal years beginning after December 15, 2009, and for interim periods within those fiscal years, or March 31, 2010 for the Corporation. ASC Update 2010-06 also requires companies to reconcile changes in Level 3 assets and liabilities by separately providing information about Level 3 purchases, sales, issuances and settlements on a gross basis. This provision of ASC Update 2010-06 is effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years, or March 31, 2011 for the Corporation. The adoption of ASC Update 2010-06 is not expected to materially impact the Corporations fair value measurement disclosures.
41
Item 7A. | 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, debt security market price risk, foreign currency risk and commodity price risk. Due to the nature of its operations, only equity market price risk, debt security 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. As of December 31, 2009, the Corporations equity investments consisted of FHLB and Federal Reserve Bank stock ($99.1 million), common stocks of publicly traded financial institutions ($32.3 million), and money market mutual funds and other equity investments ($9.0 million). The equity investments most susceptible to equity market price risk are the financial institutions stocks, which had an adjusted cost basis of $34.5 million and a fair value of $32.3 million as of December 31, 2009. Gross unrealized gains and gross unrealized losses in this portfolio were approximately $2.7 million and $4.9 million as of December 31, 2009, respectively.
The Corporation has evaluated whether any unrealized losses on individual equity investments constituted other-than-temporary impairment, which would require a write-down through a charge to earnings. Based on the results of such evaluations, the Corporation recorded write-downs of $3.8 million in 2009, $43.1 million in 2008, and $117,000 in 2007 for financial institutions stocks which were deemed to exhibit other-than-temporary impairment in value. In 2009, the Corporation also recorded a $106,000 other-than-temporary impairment charge for a mutual fund investment. In 2008, the Corporation recorded other-than-temporary impairment charges of $1.2 million and $357,000 for a mutual fund investment and other government agency-sponsored stocks, respectively. Additional impairment charges may be necessary depending upon the performance of the equity markets in general and the performance of the individual investments held by the Corporation. See also Note C, Investment Securities, in the Notes to Consolidated Financial Statements.
Management continuously monitors the fair value of its equity investments and evaluates current market conditions and operating results of the issuers. Periodic sale and purchase decisions are made based on this monitoring process. None of the Corporations equity securities are classified as trading. Future cash flows from these investments are not provided in the table on page 48 as such investments do not have maturity dates.
Another source of equity market price risk is the Corporations investment in FHLB stock, which the Corporation is required to own in order to borrow funds from the FHLB. FHLBs obtain funding primarily through the issuance of consolidated obligations of the Federal Home Loan Bank system. The U.S. government does not guarantee these obligations, and each of the FHLB banks is, generally, jointly and severally liable for repayment of each others debt. The FHLB system has experienced financial stress, and some of the regional banks within the FHLB system have suspended or reduced their dividends, or eliminated the ability of members to redeem capital stock. The Corporations FHLB stock and its ability to obtain FHLB funds could be adversely impacted if the financial health of the FHLB system worsens.
In addition to its equity portfolio, the Corporations investment management and trust services revenue is impacted by fluctuations in the securities markets. A portion of the Corporations trust and brokerage revenue is based on the value of the underlying investment portfolios. If the values of those investment portfolios decrease, whether due to factors influencing U.S. securities markets in general, or otherwise, the Corporations revenue would be negatively impacted. In addition, the Corporations ability to sell its brokerage services is dependent, in part, upon consumers level of confidence in equity markets.
Debt Security Price Risk
Debt security market price risk is the risk that changes in the values of debt securities could have a material impact on the financial position or results of operations of the Corporation. The Corporations debt securities consist primarily of mortgage-backed securities and collateralized mortgage obligations whose principal payments are guaranteed by U.S. government sponsored agencies, state and municipal securities, U.S. government sponsored and U.S. government debt securities, auction rate certificates and corporate debt securities. The Corporations investments in auction rate certificates and corporate debt securities have significant debt security price risk.
Auction rate certificates
As of December 31, 2009, the Corporations investments in student loan auction rate securities, also known as auction rate certificates (ARCs), had a cost basis of $292.1 million and a fair value of $289.2 million, or 1.7% of total assets.
42
ARCs are long-term securities structured to allow their sale in periodic auctions, resulting in both the treatment of ARCs as short-term instruments in normal market conditions and fair values that could be derived based on periodic auction prices. However, beginning in 2008, market auctions for these securities began to fail due to an insufficient number of buyers, resulting in an illiquid market. This illiquidity has resulted in recent market prices that represent forced liquidations or distressed sales and do not provide an accurate basis for fair value. Therefore, as of December 31, 2009, the fair value of the ARCs held by the Corporation were derived using significant unobservable inputs based on an expected cash flow model which produced fair values which were materially different from those that would be expected from settlement of these investments in the illiquid market that presently exists. The expected cash flow model produced fair values which assumed a return to market liquidity sometime within the next three years.
The credit quality of the underlying debt associated with the ARCs is also a factor in the determination of their estimated fair value. As of December 31, 2009, approximately $250 million, or 86%, of the ARCs held by the Corporation were rated above investment grade, with approximately $187 million, or 65%, AAA rated by at least one ratings agency. Approximately $40 million, or 14%, of ARCs were rated below investment grade by at least one ratings agency. Of this amount, approximately $22 million, or 57%, of the student loans underlying the ARCs have principal payments which are guaranteed by the Federal government. In total, approximately $257 million, or 89%, of the student loans underlying the ARCs have principal payments which are guaranteed by the Federal government. At December 31, 2009, all ARCs held by the Corporation were current and making schedule interest payments. Therefore the risk of changes in the estimated fair values of ARCs due to deterioration in the credit quality of their underlying debt is not significant.
Corporate Debt Securities
The Corporation holds corporate debt securities in the form of pooled trust preferred securities, single-issuer trust preferred securities and subordinated debt issued by financial institutions, as presented in the following table:
December 31, 2009 | ||||||
Amortized cost |
Estimated fair value | |||||
(in thousands) | ||||||
Single-issuer trust preferred securities |
$ | 95,481 | $ | 75,811 | ||
Subordinated debt |
34,886 | 32,722 | ||||
Pooled trust preferred securities |
20,435 | 4,979 | ||||
Total corporate debt securities issued by financial institutions |
$ | 150,802 | $ | 113,512 | ||
Historically, the Corporation determined the fair value of these securities based on prices received from third-party brokers and pricing agencies who determined fair values using both quoted prices for similar assets, when available, and model-based valuation techniques that derived fair value based on market-corroborated data, such as instruments with similar prepayment speeds and default interest rates.
The fair values for pooled trust preferred securities and certain single-issuer trust preferred securities were based on quotes provided by third-party brokers who determined fair values based predominantly on internal valuation models which were not indicative prices or binding offers.
The Corporations investments in single-issuer trust preferred securities had an unrealized loss of $19.7 million as of December 31, 2009. 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 $38.1 million and an estimated fair value of $31.2 million as of December 31, 2009. 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 $10.2 million and an estimated fair value of $7.0 million as of December 31, 2009, were not rated by any ratings agency and, due to inactive or limited trading activity, were classified as Level 3 assets under FASB ASC Topic 820.
In April 2009, the FASB issued Staff Position No. 115-2 and 124-2, Recognition and Presentation of Other-than-Temporary Impairments (FSP FAS 115-2). FSP FAS 115-2, codified within FASB ASC Subtopic 320-10, amends other-than-temporary impairment guidance for debt securities and expands disclosure requirements for other-than-temporarily impaired debt and equity securities.
43
In 2009, the Corporation recorded $9.5 million of other-than-temporary impairment charges related to investments in pooled trust preferred securities issued by financial institutions. These other-than-temporary impairment charges were based on the credit losses, as determined through present value modeling of expected cash flows. In addition, in 2009, the Corporation recorded $5.2 million ($3.4 million, net of tax) of non-credit related write-downs to fair value as a component of other comprehensive loss.
During 2008, the Corporation recorded other-than-temporary impairment charges for pooled trust preferred securities totaling $15.8 million. Upon adoption of FSP FAS 115-2, the Corporation determined that $9.7 million of those other-than-temporary impairment charges were non-credit related. As such, a $6.3 million (net of $3.4 million of taxes) increase to retained earnings and a corresponding decrease to accumulated other comprehensive income was recorded as the cumulative effect of adopting FSP FAS 115-2 as of January 1, 2009. Because previously recognized other-than-temporary impairment charges were reversed through equity rather than earnings, $8.7 million of the $9.5 million other-than-temporary impairment charges for certain pooled trust preferred securities recorded during 2009 were also presented as other-than-temporary impairment charges on the Corporations statements of operations for the year ended December 31, 2008.
As noted above, the Corporation has recorded significant other-than-temporary impairment charges related to its investments in pooled trust preferred securities issued by financial institutions in 2009 and 2008. As of December 31, 2009, the Corporation held ten pooled trust preferred securities. Nine of these securities, with an amortized cost of $19.5 million and an estimated fair value of $4.4 million, were rated below investment grade by at least one ratings agency, with ratings ranging from C to Caa. For each of the nine pooled trust preferred securities held by the Corporation, the class of securities held is below the most senior tranche, with the Corporations interests being subordinate to other investors in the pool.
The amortized cost of pooled trust preferred securities is the purchase price of the securities, net of credit related other-than-temporary impairment charges, determined using an expected cash flows analysis. 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 comprises 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 26% as of December 31, 2009. The expected weighted average deferral rate assumed in the discounted cash flow modeling for pooled trust preferred securities held by the Corporation as of December 31, 2009 was approximately 13%.
Additional impairment charges for corporate debt securities issued by financial institutions may be necessary in the future depending upon the performance of the individual investments held by the Corporation.
See Note C, Investment Securities, in the Notes to Consolidated Financial Statements for further discussion related to the Corporations other-than-temporary impairment evaluations for debt securities and see Note P, Fair Value Measurements, in the Notes to Consolidated Financial Statements for further discussion related to the fair values of debt securities.
Interest Rate Risk, Asset/Liability Management and Liquidity
Interest rate risk creates exposure in two primary areas. First, changes in rates have an impact on the Corporations liquidity position and could affect its ability to meet obligations and continue to grow. Second, movements in interest rates can create fluctuations in the Corporations net interest 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 periodic 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.
From a liquidity standpoint, 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. The Corporation also maintains secondary sources that provide liquidity on a secured and unsecured basis to meet short-term and long-term needs.
The consolidated statements of cash flows provide details related to the Corporations sources and uses of cash. The Corporation generated $182.6 million in cash from operating activities during 2009, mainly due to net income, as adjusted for non-cash charges such as the provision for loan losses. Investing activities resulted in a net cash outflow of $582.9 million in 2009 due to the purchase of
44
investment securities exceeding the proceeds from sales and maturities of investments. Financing activities resulted in net cash proceeds of $353.7 million in 2009, primarily due to increases in deposits exceeding net repayments of short and long-term borrowings and dividends on common and preferred stock.
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 meets its cash needs through dividends and loans from subsidiary banks, and through external borrowings, if necessary. Management regularly monitors the liquidity and capital needs of the Parent Company and will implement appropriate strategies, as necessary, to remain well capitalized and to meet its cash needs.
As of December 31, 2009, liquid assets (defined as cash and due from banks, short-term investments, Federal funds sold, mortgages available for sale, securities available for sale, and non-mortgage-backed securities held to maturity due in one year or less) totaled $3.6 billion, or 21.8% of total assets, as compared to $3.1 billion, or 19.4% of total assets, as of December 31, 2008.
45
The following tables present the expected maturities of investment securities as of December 31, 2009 and the weighted average yields of such securities (calculated based on historical cost):
HELD TO MATURITY (at amortized cost)
MATURING | ||||||||||||||||||||||||
Within One Year | After One But Within Five Years |
After Five But Within Ten Years |
After Ten Years | |||||||||||||||||||||
Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | |||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
U.S. Government sponsored agency securities |
$ | | | % | $ | 6,713 | 0.50 | % | $ | | | % | $ | | | % | ||||||||
State and municipal (1) |
157 | 4.88 | 346 | 5.41 | | | | | ||||||||||||||||
Total |
$ | 157 | 4.88 | % | $ | 7,059 | 0.74 | % | $ | | | $ | | | ||||||||||
Mortgage-backed securities (2) |
$ | 1,484 | 5.67 | % | ||||||||||||||||||||
AVAILABLE FOR SALE (at estimated fair value) | ||||||||||||||||||||||||
MATURING | ||||||||||||||||||||||||
Within One Year | After One But Within Five Years |
After Five But Within Ten Years |
After Ten Years | |||||||||||||||||||||
Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | |||||||||||||||||
(dollars in thousands) | ||||||||||||||||||||||||
U.S. Government securities |
$ | 1,325 | 0.05 | % | $ | | | % | $ | | | % | $ | | | % | ||||||||
U.S. Government sponsored agency securities (3) |
9,043 | 4.36 | 66,808 | 3.09 | 15,863 | 4.88 | 242 | 2.73 | ||||||||||||||||
State and municipal (1) |
50,016 | 4.66 | 171,613 | 5.10 | 38,788 | 5.95 | 155,356 | 6.68 | ||||||||||||||||