Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20459

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2010, or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                     

Commission File No. 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

(Registrant's telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   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 Exchange Act).    Yes  ¨    No  x

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

Common Stock, $2.50 Par Value – 176,606,000 shares outstanding as of April 30, 2010.

 

 

 


Table of Contents

FULTON FINANCIAL CORPORATION

FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2010

INDEX

 

Description

           

Page

PART I. FINANCIAL INFORMATION
Item 1.   Financial Statements (Unaudited):      
(a)   Consolidated Balance Sheets - March 31, 2010 and December 31, 2009       3
(b)   Consolidated Statements of Income - Three ended March 31, 2010 and 2009       4
(c)   Consolidated Statements of Shareholders’ Equity and Comprehensive Income - Three months ended March 31, 2010 and 2009       5
(d)   Consolidated Statements of Cash Flows - Three months ended March 31, 2010 and 2009       6
(e)   Notes to Consolidated Financial Statements       7
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations       24
Item 3.   Quantitative and Qualitative Disclosures about Market Risk       40
Item 4.   Controls and Procedures       46
PART II. OTHER INFORMATION
Item 1.   Legal Proceedings       47
Item 1A.   Risk Factors       47
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds       47
Item 3.   Defaults Upon Senior Securities       47
Item 4.   Reserved       47
Item 5.   Other Information       47
Item 6.   Exhibits       47
Signatures       48
Exhibit Index    49
Certifications    50

 

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Table of Contents
Item 1. Financial Statements

FULTON FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands, except per-share data)

 

     March 31
2010
(unaudited)
    December 31
2009
 

ASSETS

    

Cash and due from banks

   $ 276,200      $ 284,508   

Interest-bearing deposits with other banks

     7,842        16,591   

Loans held for sale

     53,798        85,384   

Investment securities:

    

Held to maturity (estimated fair value of $8,254 in 2010 and $8,797 in 2009)

     8,159        8,700   

Available for sale

     3,095,469        3,258,386   

Loans, net of unearned income

     11,964,840        11,972,424   

Less: Allowance for loan losses

     (264,915     (256,698
                

Net Loans

     11,699,925        11,715,726   
                

Premises and equipment

     204,149        204,203   

Accrued interest receivable

     58,689        58,515   

Goodwill

     535,149        534,862   

Intangible assets

     16,388        17,701   

Other assets

     455,755        451,059   
                

Total Assets

   $ 16,411,523      $ 16,635,635   
                

LIABILITIES

    

Deposits:

    

Noninterest-bearing

   $ 2,038,199      $ 2,012,837   

Interest-bearing

     10,118,256        10,085,077   
                

Total Deposits

     12,156,455        12,097,914   
                

Short-term borrowings:

    

Federal funds purchased

     162,040        378,067   

Other short-term borrowings

     462,610        490,873   
                

Total Short-Term Borrowings

     624,650        868,940   
                

Accrued interest payable

     49,247        46,596   

Other liabilities

     170,578        144,930   

Federal Home Loan Bank advances and long-term debt

     1,440,755        1,540,773   
                

Total Liabilities

     14,441,685        14,699,153   
                

SHAREHOLDERS’ EQUITY

    

Preferred stock, $1,000 par value, 376,500 shares authorized and outstanding

     370,649        370,290   

Common stock, $2.50 par value, 600 million shares authorized, 193.1 million shares issued in 2010 and 193.0 million shares issued in 2009

     482,676        482,491   

Additional paid-in capital

     1,257,875        1,257,730   

Retained earnings

     89,120        71,999   

Accumulated other comprehensive income:

    

Unrealized gains on investment securities not other-than-temporarily impaired

     36,649        24,975   

Unrealized non-credit related losses on other-than-temporarily impaired debt securities

     (5,741     (8,349

Unrecognized pension and postretirement plan costs

     (5,924     (5,942

Unamortized effective portions of losses on forward-starting interest rate swaps

     (3,192     (3,226
                

Accumulated other comprehensive income

     21,792        7,458   

Treasury stock, 16.5 million shares in 2010 and 16.6 million shares in 2009, at cost

     (252,274     (253,486
                

Total Shareholders’ Equity

     1,969,838        1,936,482   
                

Total Liabilities and Shareholders’ Equity

   $ 16,411,523      $ 16,635,635   
                

See Notes to Consolidated Financial Statements

 

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FULTON FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(in thousands, except per-share data)

 

     Three Months Ended
March 31
 
     2010     2009  

INTEREST INCOME

    

Loans, including fees

   $ 157,534      $ 162,314   

Investment securities:

    

Taxable

     28,149        26,849   

Tax-exempt

     3,595        4,476   

Dividends

     729        617   

Loans held for sale

     556        1,261   

Other interest income

     25        50   
                

Total Interest Income

     190,588        195,567   

INTEREST EXPENSE

    

Deposits

     33,738        49,896   

Short-term borrowings

     549        1,436   

Long-term debt

     17,792        20,119   
                

Total Interest Expense

     52,079        71,451   
                

Net Interest Income

     138,509        124,116   

Provision for loan losses

     40,000        50,000   
                

Net Interest Income After Provision for Loan Losses

     98,509        74,116   

OTHER INCOME

    

Service charges on deposit accounts

     14,267        14,894   

Other service charges and fees

     9,372        8,354   

Investment management and trust services

     8,088        7,903   

Gains on sales of mortgage loans

     3,364        8,591   

Other

     4,599        4,253   

Total other-than-temporary impairment losses

     (5,251     (5,856

Less: Portion of loss recognized in other comprehensive income (before taxes)

     274        2,816   
                

Net other-than-temporary impairment losses

     (4,977     (3,040

Net gains on sales of investment securities

     2,754        5,959   
                

Net investment securities gains (losses)

     (2,223     2,919   
                

Total Other Income

     37,467        46,914   

OTHER EXPENSES

    

Salaries and employee benefits

     52,345        55,304   

Net occupancy expense

     11,650        11,023   

FDIC insurance expense

     4,954        4,288   

Equipment expense

     3,091        3,079   

Data processing

     2,624        3,072   

Professional fees

     2,546        2,228   

Telecommunications

     2,270        2,163   

Marketing

     1,830        2,571   

Intangible amortization

     1,314        1,463   

Operating risk loss

     511        6,201   

Other

     16,094        14,980   
                

Total Other Expenses

     99,229        106,372   
                

Income Before Income Taxes

     36,747        14,658   

Income taxes

     9,267        1,573   
                

Net Income

     27,480        13,085   

Preferred stock dividends and discount accretion

     (5,065     (5,031
                

Net Income Available to Common Shareholders

   $ 22,415      $ 8,054   
                

PER COMMON SHARE:

    

Net income (basic)

   $ 0.13      $ 0.05   

Net income (diluted)

     0.13        0.05   

Cash dividends

     0.03        0.03   

See Notes to Consolidated Financial Statements

 

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FULTON FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (UNAUDITED)

THREE MONTHS ENDED MARCH 31, 2010 AND 2009

 

     Preferred
Stock
  Common Stock   Additional
Paid-in
Capital
    Retained
Earnings
    Accumulated
Other

Comprehensive
Income (Loss)
    Treasury
Stock
    Total  
    Shares
Outstanding
  Amount          
  (in thousands)  

Balance at December 31, 2009

  $ 370,290   176,364   $ 482,491   $ 1,257,730      $ 71,999      $ 7,458      $ (253,486   $ 1,936,482   

Comprehensive income:

               

Net income

            27,480            27,480   

Other comprehensive income

              14,334          14,334   
                     

Total comprehensive income

                  41,814   
                     

Stock issued, including related tax benefits

    145     185     (148         1,212        1,249   

Stock-based compensation awards

          293              293   

Preferred stock discount accretion

    359           (359         0   

Preferred stock cash dividends

            (4,706         (4,706

Common stock cash dividends - $0.03 per share

            (5,294         (5,294
                                                       

Balance at March 31, 2010

  $ 370,649   176,509   $ 482,676   $ 1,257,875      $ 89,120      $ 21,792      $ (252,274   $ 1,969,838   
                                                       

Balance at December 31, 2008

  $ 368,944   175,044   $ 480,978   $ 1,260,947      $ 31,075      $ (17,907   $ (264,390   $ 1,859,647   

Cumulative effect of FSP FAS 115-2 and FAS 124-2 adoption (net of $3.4 million tax effect)

            6,298        (6,298       0   

Comprehensive income:

               

Net income

            13,085            13,085   

Other comprehensive loss

              (7,313       (7,313
                     

Total comprehensive income

                  5,772   
                     

Stock issued, including related tax benefits

    463     234     (2,348         5,625        3,511   

Stock-based compensation awards

          380              380   

Preferred stock discount accretion

    326           (326         0   

Preferred stock cash dividends

            (2,719         (2,719

Common stock cash dividends - $0.03 per share

            (5,270         (5,270
                                                       

Balance at March 31, 2009

  $ 369,270   175,507   $ 481,212   $ 1,258,979      $ 42,143      $ (31,518   $ (258,765   $ 1,861,321   
                                                       

See Notes to Consolidated Financial Statements

 

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FULTON FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)

 

     Three Months Ended
March 31
 
     2010     2009  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net Income

   $ 27,480      $ 13,085   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Provision for loan losses

     40,000        50,000   

Depreciation and amortization of premises and equipment

     5,163        4,912   

Net amortization of investment securities premiums

     802        116   

Investment securities losses (gains)

     2,223        (2,919

Net decrease (increase) in loans held for sale

     31,586        (6,193

Amortization of intangible assets

     1,314        1,463   

Stock-based compensation

     293        380   

Increase in accrued interest receivable

     (174     (803

Decrease (increase) in other assets

     4,200        (12,926

Increase in accrued interest payable

     2,651        13,013   

Increase in other liabilities

     6,368        19,041   
                

Total adjustments

     94,426        66,084   
                

Net cash provided by operating activities

     121,906        79,169   
                

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Proceeds from sales of securities available for sale

     89,647        162,363   

Proceeds from maturities of securities held to maturity

     117        983   

Proceeds from maturities of securities available for sale

     167,992        152,432   

Purchase of securities held to maturity

     (84     (922

Purchase of securities available for sale

     (76,296     (731,005

Decrease in short-term investments

     8,749        7,381   

Net (increase) decrease in loans

     (20,715     3,510   

Net purchases of premises and equipment

     (5,109     (7,750
                

Net cash provided by (used in) investing activities

     164,301        (413,008
                

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Net increase in demand and savings deposits

     214,562        247,253   

Net (decrease) increase in time deposits

     (156,021     614,813   

Additions to long-term debt

     45,000        0   

Repayments of long-term debt

     (145,018     (1,199

Decrease in short-term borrowings

     (244,290     (567,296

Dividends paid

     (9,997     (28,976

Net proceeds from issuance of stock

     1,249        3,511   
                

Net cash (used in) provided by financing activities

     (294,515     268,106   
                

Net Decrease in Cash and Due From Banks

     (8,308     (65,733

Cash and Due From Banks at Beginning of Year

     284,508        331,164   
                

Cash and Due From Banks at End of Period

   $ 276,200      $ 265,431   
                

Supplemental Disclosures of Cash Flow Information

    

Cash paid during the period for:

    

Interest

   $ 49,428      $ 58,438   

Income taxes

     37        54   

See Notes to Consolidated Financial Statements

 

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FULTON FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE A – Basis of Presentation

The accompanying unaudited consolidated financial statements of Fulton Financial Corporation (the Corporation) have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts of assets and liabilities as of the date of the financial statements as well as revenues and expenses during the period. Actual results could differ from those estimates. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. The Corporation evaluates subsequent events through the date of filing with the Securities and Exchange Commission (SEC).

NOTE B – Net Income Per Common Share and Other Comprehensive Income (Loss)

The Corporation’s basic net income per common share is calculated as net income available to common shareholders divided by the weighted average number of common shares outstanding. Net income available to common shareholders is calculated as net income less accrued dividends and discount accretion related to preferred stock.

For diluted net income per common share, net income available to common shareholders is divided by the weighted average number of common shares outstanding plus the incremental number of shares added as a result of converting common stock equivalents, calculated using the treasury stock method. The Corporation’s common stock equivalents consist of outstanding stock options, restricted stock and common stock warrants.

A reconciliation of weighted average common shares outstanding used to calculate basic net income per common share and diluted net income per common share follows.

 

     Three months ended
March 31
     2010    2009
     (in thousands)

Weighted average shares outstanding (basic)

   176,174    175,315

Effect of dilutive securities

   507    233
         

Weighted average shares outstanding (diluted)

   176,681    175,548
         

Stock options and common stock warrants excluded from the diluted net income per share computation as their effect would have been anti-dilutive

   11,115    11,818
         

 

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The following table presents the components of other comprehensive income (loss):

 

     Three months ended  
     March 31  
     2010     2009  
     (in thousands)  

Unrealized gain (loss) on securities (net of $7.0 million and $2.0 million tax effect in 2010 and 2009, respectively)

   $ 12,927      $ (3,789

Non-credit related unrealized loss on other-than-temporarily impaired debt securities (net of $49,000 and $985,000 tax effect, respectively)

     (91     (1,831

Unrealized gain on derivative financial instruments (net of $18,000 tax effect in 2010 and 2009) (1)

     34        34   

Amortization of unrecognized pension and postretirement costs (net of $10,000 and $92,000 tax effect in 2010 and 2009, respectively)

     19        170   

Reclassification adjustment for securities losses (gains) included in net income (net of $778,000 tax benefit in 2010 and $1.0 million tax expense in 2009)

     1,445        (1,897
                

Other comprehensive income (loss)

   $ 14,334      $ (7,313
                

 

(1) Amounts represent the amortization of the effective portions of losses on forward-starting interest rate swaps, designated as cash flow hedges and entered into in prior years in connection with the issuance of fixed-rate debt. The total amount recorded as a reduction to accumulated other comprehensive income upon settlement of these derivatives is being amortized to interest expense over the life of the related securities using the effective interest method. The amount of net losses in accumulated other comprehensive income that will be reclassified into earnings during the next twelve months is expected to be approximately $135,000.

NOTE C – Investment Securities

The following tables present the amortized cost and estimated fair values of investment securities:

 

Held to Maturity at March 31, 2010

   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Estimated
Fair
Value
          
          
     (in thousands)

U.S. Government sponsored agency securities

   $ 6,289    $ 4    $ 0      $ 6,293

State and municipal securities

     503      0      0        503

Mortgage-backed securities

     1,367      91      0        1,458
                            
   $ 8,159    $ 95    $ 0      $ 8,254
                            

Available for Sale at March 31, 2010

                    

Equity securities

   $ 140,102    $ 3,791    $ (1,836   $ 142,057

U.S. Government securities

     1,325      0      0        1,325

U.S. Government sponsored agency securities

     71,462      703      (4     72,161

State and municipal securities

     378,691      8,704      (48     387,347

Corporate debt securities

     149,935      1,157      (28,161     122,931

Collateralized mortgage obligations

     1,093,867      30,849      (414     1,124,302

Mortgage-backed securities

     920,196      37,104      (87     957,213

Auction rate securities

     292,341      2,673      (6,881     288,133
                            
   $ 3,047,919    $ 84,981    $ (37,431   $ 3,095,469
                            

 

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Held to Maturity at December 31, 2009

   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair
Value
     (in thousands)

U.S. Government sponsored agency securities

   $ 6,713    $ 7    $ 0    $ 6,720

State and municipal securities

     503      0      0      503

Mortgage-backed securities

     1,484      90      0      1,574
                           
   $ 8,700    $ 97    $ 0    $ 8,797
                           

 

Available for Sale at December 31, 2009

                    

Equity securities

   $ 142,531    $ 2,758    $ (4,919   $ 140,370

U.S. Government securities

     1,325      0      0        1,325

U.S. Government sponsored agency securities

     91,079      905      (28     91,956

State and municipal securities

     406,011      9,819      (57     415,773

Corporate debt securities

     154,029      424      (37,714     116,739

Collateralized mortgage obligations

     1,102,169      25,631      (4,804     1,122,996

Mortgage-backed securities

     1,043,518      36,948      (442     1,080,024

Auction rate securities

     292,145      3,227      (6,169     289,203
                            
   $ 3,232,807    $ 79,712    $ (54,133   $ 3,258,386
                            

The amortized cost and estimated fair value of debt securities as of March 31, 2010, by contractual maturity, are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

     Held to Maturity    Available for Sale
     Amortized
Cost
   Estimated
Fair
Value
   Amortized
Cost
   Estimated
Fair Value
     (in thousands)

Due in one year or less

   $ 6,446    $ 6,450    $ 60,096    $ 60,715

Due from one year to five years

     346      346      191,911      195,954

Due from five years to ten years

     0      0      93,561      94,257

Due after ten years

     0      0      548,186      520,971
                           
     6,792      6,796      893,754      871,897

Collateralized mortgage obligations

     0      0      1,093,867      1,124,302

Mortgage-backed securities

     1,367      1,458      920,196      957,213
                           
   $ 8,159    $ 8,254    $ 2,907,817    $ 2,953,412
                           

 

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The following table presents information related to the Corporation’s gains and losses on the sales of equity and debt securities, and losses recognized for the other-than-temporary impairment of investments:

 

     Gross
Realized
Gains
   Gross
Realized
Losses
    Other-than-
temporary
Impairment
Losses
    Net
Gains
(Losses)
 
     (in thousands)  

Three months ended March 31, 2010:

         

Equity securities

   $ 836    $ 0      $ (824   $ 12   

Debt securities

     1,923      (5     (4,153     (2,235
                               

Total

   $ 2,759    $ (5   $ (4,977   $ (2,223
                               

Three months ended March 31, 2009:

         

Equity securities

   $ 112    $ (216   $ (1,062   $ (1,166

Debt securities

     6,171      (108     (1,978     4,085   
                               

Total

   $ 6,283    $ (324   $ (3,040   $ 2,919   
                               

The following table presents a summary of other-than-temporary impairment charges recorded by the Corporation, by investment security type:

 

     Three Months
Ended March 31
     2010    2009
     (in thousands)

Financial institution stocks

   $ 824    $ 956

Mutual funds

     0      106
             

Total equity securities charges

     824      1,062
             

Debt securities - pooled trust preferred securities

     4,153      1,978
             

Total other-than-temporary impairment charges

   $ 4,977    $ 3,040
             

The $824,000 of other-than-temporary impairment charges related to financial institution stocks during the three months ended March 31, 2010 was due to the increasing severity and duration of the decline in fair values of certain bank stock holdings, in conjunction with management’s assessment of the near-term prospects of each specific issuer. As of March 31, 2010, after other-than-temporary impairment charges, the financial institutions stock portfolio had a cost basis of $31.4 million and a fair value of $33.3 million.

In April 2009, the Financial Accounting Standards Board (FASB) issued Staff Position No. 115-2 and 124-2, “Recognition and Presentation of Other-than-Temporary Impairments” (FSP FAS 115-2), codified within the FASB Accounting Standards Codification (FASB ASC) as Subtopic 320-10. During the year ended December 31, 2008, the Corporation recorded other-than-temporary impairment charges for pooled trust preferred securities of $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.

During the three months ended March 31, 2010, the Corporation recorded $4.2 million of other-than-temporary impairment losses for pooled trust preferred securities based on an expected cash flows model.

 

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The following table presents a summary of the cumulative credit related other-than-temporary impairment charges, recognized as components of earnings, for securities still held by the Corporation at March 31:

 

     Three months ended
March 31,
 
     2010     2009  
     (in thousands)  

Balance of cumulative credit losses on pooled trust preferred securities, beginning of period (1)

   $ (15,612   $ (6,142

Additions for credit losses recorded which were not previously recognized as components of earnings

     (4,153     (1,978
                

Ending balance of cumulative credit losses on pooled trust preferred securities, end of period

   $ (19,765   $ (8,120
                

 

(1) Cumulative credit losses of $6.1 million at January 1, 2009 represent the other-than-temporary impairment charges recorded during the year ended December 31, 2008 for pooled trust preferred securities, net of the Corporation’s cumulative effect adjustment upon adoption of FSP FAS 115-2.

The following table presents the gross unrealized losses and estimated fair values of investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2010:

 

     Less Than 12 months     12 Months or Longer     Total  
      Estimated
Fair Value
   Unrealized
Losses
    Estimated
Fair Value
   Unrealized
Losses
    Estimated
Fair Value
   Unrealized
Losses
 
               
     (in thousands)  

U.S. Government sponsored agency securities

   $ 0    $ 0      $ 529    $ (4   $ 529    $ (4

State and municipal securities

     4,025      (40     397      (8     4,422      (48

Corporate debt securities

     5,558      (6,542     77,583      (21,619     83,141      (28,161

Collateralized mortgage obligations

     44,577      (414     0      0        44,577      (414

Mortgage-backed securities

     22,607      (87     0      0        22,607      (87

Auction rate securities

     28,570      (741     171,512      (6,140     200,082      (6,881
                                             

Total debt securities

     105,337      (7,824     250,021      (27,771     355,358      (35,595

Equity securities

     8,653      (1,261     3,012      (575     11,665      (1,836
                                             
   $ 113,990    $ (9,085   $ 253,033    $ (28,346   $ 367,023    $ (37,431
                                             

For its investments in equity securities, most notably its investments in stocks of financial institutions, management evaluates the near-term prospects of the issuers in relation to the severity and duration of the impairment. Based on that evaluation and the Corporation’s ability and intent to hold those investments for a reasonable period of time sufficient for a recovery of fair value, the Corporation does not consider those investments with unrealized holding losses as of March 31, 2010 to be other-than-temporarily impaired.

The unrealized holding losses on investments in student loan auction rate securities, also known as auction rate certificates (ARCs), are attributable to liquidity issues resulting from the failure of periodic auctions. Fulton Financial Advisors (FFA), the investment management and trust division of the Corporation’s Fulton Bank, N.A. subsidiary, held ARCs for some of its customers’ accounts. FFA had previously sold ARCs to customers as short-term investments with fair values that could be derived based on periodic auctions under normal market conditions. During 2008 and 2009, the Corporation purchased ARCs from customers due to the failure of these periodic auctions, which made these previously short-term investments illiquid.

As of March 31, 2010, approximately $260 million, or 90%, of the ARCs were rated above investment grade, with approximately $187 million, or 65%, AAA rated by at least one ratings agency. Approximately $30 million, or 10%, of ARCs are rated below investment grade by at least one ratings agency. Of this amount, approximately $17 million, or 57%, of the student loans underlying the ARCs have principal payments which are guaranteed by the Federal government. In total, approximately $255 million, or 88%, of the student loans

 

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underlying the ARCs have principal payments which are guaranteed by the Federal government. At March 31, 2010, all ARCs were current and making scheduled interest payments. Because the Corporation does not have the intent to sell and does not believe it will more likely than not be required to sell any of these securities prior to a recovery of their fair value to amortized cost, the Corporation does not consider these investments to be other-than-temporarily impaired as of March 31, 2010.

The Corporation’s mortgage-backed securities and collateralized mortgage obligations have contractual terms that generally do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because the decline in market value of these securities is attributable to changes in interest rates and not credit quality, and because the Corporation does not have the intent to sell and does not believe it will more likely than not be required to sell any of these securities prior to a recovery of their fair value to amortized cost, the Corporation does not consider those investments to be other-than-temporarily impaired as of March 31, 2010.

The following table presents the amortized cost and estimated fair values of corporate debt securities:

 

     March 31, 2010    December 31, 2009
     Amortized
cost
   Estimated
fair value
   Amortized
cost
   Estimated
fair value
     (in thousands)

Single-issuer trust preferred securities

   $ 95,500    $ 80,691    $ 95,481    $ 75,811

Subordinated debt

     34,913      34,113      34,886      32,722

Pooled trust preferred securities

     16,295      4,900      20,435      4,979
                           

Corporate debt securities issued by financial institutions

     146,708      119,704      150,802      113,512

Other corporate debt securities

     3,227      3,227      3,227      3,227
                           

Available for sale corporate debt securities

   $ 149,935    $ 122,931    $ 154,029    $ 116,739
                           

The Corporation’s investments in single-issuer trust preferred securities had an unrealized loss of $14.8 million as of March 31, 2010. The Corporation did not record any other-than-temporary impairment charges for single-issuer trust preferred securities in the first quarter of 2010 or 2009. The Corporation holds 11 single-issuer trust preferred securities that are rated below investment grade by at least one ratings agency, with an amortized cost of $37.1 million and an estimated fair value of $33.2 million as of March 31, 2010. 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 $7.1 million as of March 31, 2010, 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. See Note I, “Fair Value Measurements”, for additional details.

The Corporation holds ten pooled trust preferred securities. Nine of these securities, with an amortized cost of $15.4 million and an estimated fair value of $4.3 million, are rated below investment grade by at least one ratings agency, with ratings ranging from C to Ca. For each of the nine pooled trust preferred securities rated below investment grade, the class of securities held by the Corporation is below the most senior tranche, with the Corporation’s interests being subordinate to other investors in the pool. The Corporation determines the fair value of pooled trust preferred securities based on quotes provided by third party brokers.

The amortized cost of pooled trust preferred securities is the purchase price of the securities, net of cumulative credit related other-than-temporary impairment charges, determined using an expected cash flows model. The most significant input to the expected cash flows model was the expected payment deferral rate for each pooled trust preferred security. The Corporation evaluates the financial metrics, such as capital ratios and non-performing asset ratios, of the individual financial institution issuers that comprise each pooled trust preferred security to estimate its expected deferral rate. The actual weighted average cumulative defaults and deferrals as a percentage of original collateral were approximately 27% as of March 31, 2010. The discounted cash flow modeling for pooled trust preferred securities held by the Corporation as of March 31, 2010 assumed an additional 12% expected deferral rate.

 

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Based on management’s other-than-temporary impairment evaluations, and because the Corporation does not have the intent to sell and does not believe it will more likely than not be required to sell any of these securities prior to a recovery of their fair value to amortized cost, which may be maturity, corporate debt securities with a fair value of $122.9 million were not considered to be other-than-temporarily impaired as of March 31, 2010.

NOTE D – Stock-Based Compensation

The fair value of equity awards granted to employees is recognized as compensation expense over the period during which employees are required to provide service in exchange for such awards. The Corporation grants equity awards to employees, consisting of stock options and restricted stock, under its Stock Option and Compensation Plans (Option Plans). In addition, employees may purchase stock under the Corporation’s Employee Stock Purchase Plan.

The following table presents compensation expense and the related tax benefits for equity awards recognized in the consolidated statements of income:

 

     Three months ended
March 31
 
     2010     2009  
     (in thousands)  

Stock-based compensation expense

   $ 293      $ 380   

Tax benefit

     (62     (38
                

Stock-based compensation expense, net of tax

   $ 231      $ 342   
                

Under the Option Plans, stock options and restricted stock are granted to key employees. Stock option exercise prices are equal to the fair value of the Corporation’s stock on the date of grant, and carry terms of up to ten years. Restricted stock fair values are equal to the average trading price of the Corporation’s stock on the date of grant. Restricted stock awards earn dividends during the vesting period, which are forfeitable if the awards do not vest. Stock options and restricted stock are typically granted annually on July 1st and become fully vested over or after a three-year vesting period. Certain events as defined in the Option Plans result in the acceleration of the vesting of both stock options and restricted stock. As of March 31, 2010, the Option Plans had 13.2 million shares reserved for future grants through 2013.

In connection with the Corporation’s participation in the U.S. Treasury Department’s (UST) Capital Purchase Program (CPP) component of the Troubled Asset Relief Program, the 2009 restricted stock granted to certain key employees is subject to the requirements and limitations contained in the Emergency Economic Stabilization Act of 2008, as amended, and related regulations. Among other things, the 2009 restricted stock grants to these key employees provide that they may not fully vest until the Corporation’s participation in the CPP ends. None of the key employees who received 2009 restricted stock grants subject to the CPP vesting restrictions received 2009 stock option awards.

NOTE E – Employee Benefit Plans

The Corporation maintains a defined benefit pension plan (Pension Plan) for certain employees. Contributions to the Pension Plan are actuarially determined and funded annually, if required. Pension Plan assets are invested in: money markets; fixed income securities, including corporate bonds, U.S. Treasury securities and common trust funds; and equity securities, including common stocks and common stock mutual funds. In 2007, the Corporation curtailed the Pension Plan, discontinuing the accrual of benefits for all existing participants effective January 1, 2008.

 

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The Corporation currently provides medical and life insurance benefits under a postretirement benefits plan (Postretirement Plan) to certain retired full-time employees who were employees of the Corporation prior to January 1, 1998. Certain full-time employees may become eligible for these discretionary benefits if they reach retirement age while working for the Corporation.

The Corporation recognizes the funded status of its Pension Plan and Postretirement Plan on the consolidated balance sheets and recognizes the changes in that funded status through other comprehensive income.

The net periodic benefit cost for the Corporation’s Pension Plan and Postretirement Plan, as determined by consulting actuaries, consisted of the following components for the three months ended March 31:

 

     Pension Plan     Postretirement Plan  
     2010     2009     2010     2009  
     (in thousands)  

Service cost (1)

   $ 26      $ 37      $ 50      $ 106   

Interest cost

     842        819        110        166   

Expected return on plan assets

     (802     (722     (1     (1

Net amortization (accretion) and deferral

     119        262        (91     0   
                                

Net periodic benefit cost

   $ 185      $ 396      $ 68      $ 271   
                                

 

(1) Pension Plan service cost for the three months ended March 31, 2010 and 2009 was related to administrative costs associated with the plan and was not due to the accrual of additional participant benefits as the plan was curtailed in 2007.

NOTE F – Derivative Financial Instruments

In connection with its mortgage banking activities, the Corporation enters into commitments to originate fixed-rate residential mortgage loans for customers, also referred to as interest rate locks. In addition, the Corporation enters into forward commitments for the future sale or purchase of mortgage-backed securities to or from third-party investors to hedge the effect of changes in interest rates on the value of the interest rate locks. Forward sales commitments may also be in the form of commitments to sell individual mortgage loans at a fixed price on a future date. Both the interest rate locks and the forward commitments are accounted for as derivatives and carried at fair value, determined as the amount that would be necessary to settle each derivative financial instrument at the end of the period. Gross derivative assets and liabilities are recorded within other assets and other liabilities on the consolidated balance sheets, with changes in fair value during the period recorded within gains on sales of mortgage loans on the consolidated statements of income.

 

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The following table presents a summary of the notional amounts and fair values of derivative financial instruments recorded on the consolidated balance sheets, none of which have been designated as hedging instruments:

 

     March 31, 2010     December 31, 2009  
      Notional
Amount
   Asset
(Liability)
Fair Value
    Notional
Amount
   Asset
(Liability)
Fair Value
 
     (in thousands)  

Interest Rate Locks with Customers:

          

Positive fair values

   $ 120,285    $ 975      $ 58,165    $ 534   

Negative fair values

     66,006      (364     106,921      (945
                      

Net Interest Rate Locks with Customers

        611           (411

Forward Commitments:

          

Positive fair values

     194,486      101        232,310      1,819   

Negative fair values

     32,094      (115     59,432      (535
                      

Net Forward Commitments

        (14        1,284   
                      
      $ 597         $ 873   
                      

The following table presents a summary of the fair value gains and losses on derivative financial instruments for the three months ended March 31:

 

     Fair Value Gains (Losses)      
     2010     2009    

Statements of Income Classification

     (in thousands)      

Interest rate locks with customers

   $ 1,022      $ 3,963      Gains on sales of mortgage loans

Forward commitments

     (1,298     (2,128   Gains on sales of mortgage loans

Interest rate swaps

     0        (18   Other expense
                  
   $ (276   $ 1,817     
                  

NOTE G – Commitments and Contingencies

Commitments

The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Those financial instruments include commitments to extend credit and letters of credit, which involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized on the Corporation’s consolidated balance sheets. Exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the outstanding amount of those instruments.

The outstanding amounts of commitments to extend credit and letters of credit were as follows:

 

      March  31,
2010
   December 31,
2009
     
     (in thousands)

Commitments to extend credit

   $ 3,882,214    $ 4,479,546

Standby letters of credit

     541,620      551,064

Commercial letters of credit

     30,113      37,726

The Corporation records a reserve for unfunded lending commitments which represents management’s estimate of losses associated with unused commitments to extend credit on loans impaired under FASB

 

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ASC Section 310-10-35. As of March 31, 2010 and December 31, 2009, the reserve for unfunded lending commitments, included in other liabilities on the consolidated balance sheets, was $4.3 million and $855,000, respectively.

Residential Lending

Residential mortgages are originated and sold by the Corporation through Fulton Mortgage Company, which operates as a division of each of the Corporation’s subsidiary banks. The loans originated and sold are predominantly “prime” loans that conform to published standards of government sponsored agencies. Prior to 2008, the Corporation’s former Resource Bank subsidiary operated a national wholesale mortgage lending operation which originated and sold significant volumes of non-prime loans from the time the Corporation acquired Resource Bank in 2004 through 2007.

Beginning in 2007, Resource Bank experienced an increase in requests from secondary market purchasers to repurchase non-prime loans sold to those investors. These repurchase requests resulted in the Corporation recording charges representing the write-downs that were necessary to reduce the loan balances to their estimated net realizable values, based on valuations of the underlying properties, as adjusted for market factors and other considerations. Many of the loans the Corporation repurchased were delinquent and were settled through foreclosure and sale of the underlying collateral.

The following table presents a summary of the approximate principal balances and related reserves/write-downs recognized on the Corporation’s consolidated balance sheets, by general category:

 

     March 31, 2010     December 31, 2009  
     Principal    Reserves/
Write-downs
    Principal    Reserves/
Write-downs
 
     (in thousands)  

Outstanding repurchase requests (1) (2)

   $ 7,800    $ (3,740   $ 6,130    $ (3,750

No repurchase request received – sold loans with identified potential misrepresentations of borrower information (1) (2)

     3,650      (1,260     3,650      (1,260

Repurchased loans (3)

     5,120      (500     5,580      (870

Foreclosed real estate (OREO) (4)

     7,830      0        9,140      0   
                      

Total reserves/write-downs

   $ (5,500      $ (5,880
                      

 

(1) Principal balances had not been repurchased and, therefore, are not included on the consolidated balance sheets as of March 31, 2010 and December 31, 2009.
(2) Reserve balance included as a component of other liabilities on the consolidated balance sheets as of March 31, 2010 and December 31, 2009.
(3) Principal balances, net of write-downs, are included as a component of loans, net of unearned income on the consolidated balance sheets as of March 31, 2010 and December 31, 2009.
(4) OREO is written down to its estimated fair value upon transfer from loans receivable.

Management believes that the reserves recorded as of March 31, 2010 are adequate for the known potential repurchases. However, continued declines in collateral values or the identification of additional loans to be repurchased could necessitate additional reserves in the future.

NOTE H – Fair Value Option

FASB ASC Subtopic 825-10 permits entities to measure many financial instruments and certain other items at fair value and requires certain disclosures for amounts for which the fair value option is applied.

The Corporation elected to measure mortgage loans held for sale at fair value to more accurately reflect the financial performance of its mortgage banking activities in its consolidated financial statements. Derivative financial instruments related to these activities are also recorded at fair value, as noted within Note F, “Derivative Financial Instruments”. The Corporation determines fair value for its mortgage loans held for sale based on the price that secondary market investors would pay for loans with similar characteristics, including interest rate and term, as of the date fair value is measured. Changes in fair value during the period

 

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are recorded as components of gains on sales of mortgage loans on the consolidated statements of income. Interest income earned on mortgage loans held for sale is recorded within interest income on the consolidated statements of income.

The following table presents a summary of the Corporation’s fair value elections for mortgage loans held for sale:

 

     March 31,
2010
   December 31,
2009
     (in thousands)

Cost (1)

   $ 52,649    $ 78,819

Fair value

     53,798      79,577
             

Fair value adjustment

     1,149      758
             

 

(1) Cost basis of mortgage loans held for sale represents the unpaid principal balance.

NOTE I – Fair Value Measurements

FASB ASC Topic 820 Fair Value Measurements

FASB ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into the following three categories (from highest to lowest priority):

 

   

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 on both a recurring and nonrecurring basis into the above three levels.

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 were effective for the Corporation on March 31, 2010. The Corporation did not record any transfers of assets or liabilities between the Level 1 and Level 2 fair value categories during the three months ended March 31, 2010.

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 this provision of ASC Update 2010-06 is not expected to materially impact the Corporation’s fair value measurement disclosures.

 

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Items Measured at Fair Value on a Recurring Basis

The Corporation’s assets and liabilities measured at fair value on a recurring basis and reported on the consolidated balance sheets were as follows:

 

     March 31, 2010
      Level 1    Level 2    Level 3    Total
     (in thousands)

Mortgage loans held for sale

   $ 0    $ 53,798    $ 0    $ 53,798

Available for sale investment securities:

           

Equity securities

     42,061      0      0      42,061

U.S. Government securities

     0      1,325      0      1,325

U.S. Government sponsored agency securities

     0      72,161      0      72,161

State and municipal securities

     0      387,347      0      387,347

Corporate debt securities

     0      110,895      12,036      122,931

Collateralized mortgage obligations

     0      1,124,302      0      1,124,302

Mortgage-backed securities

     0      957,213      0      957,213

Auction rate securities

     0      0      288,133      288,133
                           

Total available for sale investments

     42,061      2,653,243      300,169      2,995,473

Other financial assets

     13,842      1,076      0      14,918
                           

Total assets

   $ 55,903    $ 2,708,117    $ 300,169    $ 3,064,189
                           

Other financial liabilities

   $ 13,842    $ 479    $ 0    $ 14,321
                           

 

     December 31, 2009
      Level 1    Level 2    Level 3    Total
     (in thousands)

Mortgage loans held for sale

   $ 0    $ 79,577    $ 0    $ 79,577

Available for sale investment securities:

           

Equity securities

     41,256      0      0      41,256

U.S. Government securities

     0      1,325      0      1,325

U.S. Government sponsored agency securities

     0      91,956      0      91,956

State and municipal securities

     0      415,773      0      415,773

Corporate debt securities

     0      104,779      11,960      116,739

Collateralized mortgage obligations

     0      1,122,996      0      1,122,996

Mortgage-backed securities

     0      1,080,024      0      1,080,024

Auction rate securities

     0      0      289,203      289,203
                           

Total available for sale investments

     41,256      2,816,853      301,163      3,159,272

Other financial assets

     13,882      2,353      0      16,235
                           

Total assets

   $ 55,138    $ 2,898,783    $ 301,163    $ 3,255,084
                           

Other financial liabilities

   $ 13,882    $ 1,480    $ 0    $ 15,362
                           

The valuation techniques used to measure fair value for the items in the tables above are as follows:

 

   

Mortgage loans held for sale – This category consists of mortgage loans held for sale that the Corporation has elected to measure at fair value. Fair values as of March 31, 2010 and December 31, 2009 were measured as the price that secondary market investors were offering for loans with similar characteristics.

 

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Available for sale investment securities – Included within this asset category are both equity and debt securities:

 

   

Equity securities – Equity securities consist of stocks of financial institutions ($33.3 million at March 31, 2010 and $32.3 million at December 31, 2009) and mutual fund and other equity investments ($8.8 million at March 31, 2010 and $9.0 million at December 31, 2009). These Level 1 investments are measured at fair value based on quoted prices for identical securities in active markets. Restricted equity securities issued by the Federal Home Loan Bank (FHLB) and Federal Reserve Bank ($100.0 million at March 31, 2010 and $99.1 million at December 31, 2009) have been excluded from the above table.

 

   

U.S. Government securities/U.S. Government sponsored agency securities/State and municipal securities/Collateralized mortgage obligations/Mortgage-backed securities – These debt securities are classified as Level 2 investments. Fair values are determined by a third-party pricing service using both quoted prices for similar assets, when available, and model-based valuation techniques that derive fair value based on market-corroborated data, such as instruments with similar prepayment speeds and default interest rates. The pricing data and market quotes the Corporation obtains from outside sources are reviewed internally for reasonableness.

 

   

Corporate debt securities – This category consists of subordinated debt issued by financial institutions ($34.1 million at March 31, 2010 and $32.7 million at December 31, 2009), single-issuer trust preferred securities issued by financial institutions ($80.7 million at March 31, 2010 and $75.8 million at December 31, 2009), pooled trust preferred securities issued by financial institutions ($4.9 million at March 31, 2010 and $5.0 million at December 31, 2009) and other corporate debt issued by non-financial institutions ($3.2 million at March 31, 2010 and December 31, 2009).

Classified as Level 2 investments are the subordinated debt, other corporate debt issued by non-financial institutions and $73.6 million and $68.8 million of single-issuer trust preferred securities held at March 31, 2010 and December 31, 2009, respectively. These corporate debt securities are measured at fair value by a third-party pricing service using both quoted prices for similar assets, when available, and model-based valuation techniques that derive fair value based on market-corroborated data, such as instruments with similar prepayment speeds and default interest rates. As with the debt securities described above, an active market presently exists for securities similar to these corporate debt security holdings.

Classified as Level 3 assets are the Corporation’s investments in pooled trust preferred securities and certain single-issuer trust preferred securities ($7.1 million at March 31, 2010 and $7.0 million at December 31, 2009). The fair values of these securities were determined 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 Corporation’s third-party pricing service cannot derive fair values for these securities primarily due to inactive market transactions for similar investments.

 

   

Auction rate securities – Due to their illiquidity, ARCs are classified as Level 3 investments and are valued through the use of an expected cash flows model prepared by a third-party valuation expert. The assumptions used in preparing the expected cash flows model include estimates for coupon rates, time to maturity and market rates of return. The expected cash flows model the Corporation obtains from outside sources is reviewed internally for reasonableness.

 

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Other financial assets – Included within this asset category are: Level 1 assets, consisting of mutual funds that are held in trust for employee deferred compensation plans and measured at fair value based on quoted prices for identical securities in active markets; and Level 2 assets representing the fair value of mortgage banking derivatives in the form of interest rate locks and forward commitments with secondary market investors. The fair value of the Corporation’s interest rate locks and forward commitments are determined as the amount that would be required to settle each derivative financial instrument at the balance sheet date. See Note F, “Derivative Financial Instruments”, for additional information.

 

   

Other financial liabilities – Included within this category are: Level 1 employee deferred compensation liabilities which represent amounts due to employees under the deferred compensation plans described under the heading “Other financial assets” above and Level 2 mortgage banking derivatives, described under the heading “Other financial assets” above.

The following tables present the changes in the Corporation’s assets and liabilities measured at fair value on a recurring basis using unobservable inputs (Level 3) for the three months ended March 31, 2010 and 2009:

 

     Available for Sale Investment Securities     Other  Financial
Liabilities –
ARC Financial
Guarantee (1)
 
      Pooled Trust
Preferred
Securities
    Single-issuer
Trust Preferred
Securities
    ARC
Investments
   
     (in thousands)  

Balance, December 31, 2009

   $ 4,979      $ 6,981      $ 289,203      $ 0   

Realized adjustment to fair value (2)

     (4,153     0        0        0   

Unrealized adjustment to fair value (3)

     4,079        154        (1,266     0   

Redemptions

     0        0        (1,140     0   

(Premium amortization)/Discount accretion (4)

     (5     1        1,336        0   
                                

Balance, March 31, 2010

   $ 4,900      $ 7,136      $ 288,133      $ 0   
                                

Balance, December 31, 2008

   $ 15,381      $ 7,544      $ 195,900      $ (8,653

Purchases (5)

     0        0        9,642        877   

Realized adjustment to fair value (2)

     (1,978     0        0        (6,158

Unrealized adjustment to fair value (3)

     (2,711     (1,252     (2,665     0   

Redemptions

     0        0        (89     0   

Discount accretion (4)

     0        2        790        0   
                                

Balance, March 31, 2009

   $ 10,692      $ 6,294      $ 203,578      $ (13,934
                                

 

(1) In 2008, the Corporation offered to purchase illiquid ARCs from customers. The estimated fair value of the guarantee was determined based on the difference between the fair value of the underlying ARCs and their estimated purchase price. During 2009, the Corporation completed the repurchase of all eligible ARCs and, as of December 31, 2009, there were no longer any ARCs still held by customers that the Corporation had agreed to purchase.
(2) For pooled trust preferred securities, realized adjustments to fair value represent credit related other-than-temporary impairment charges that were recorded as a reduction to investment securities gains on the consolidated statements of income.
(3) Pooled trust preferred securities, single-issuer trust preferred securities, and ARCs are classified as available for sale investment securities; as such, the unrealized adjustment to fair value was recorded as an unrealized holding gain (loss) and included as a component of available for sale investment securities on the consolidated balance sheet.
(4) Included as a component of net interest income on the consolidated statements of income.
(5) For ARCs, amount represents investments acquired from customers, less an adjustment to fair value upon purchase. For the ARC financial guarantee, amount represents the reversal of the guarantee liability due to the purchase of ARCs from customers.

 

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Items Measured at Fair Value on a Nonrecurring Basis

Certain financial assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value measurement in certain circumstances, such as upon their acquisition or when there is evidence of impairment.

The Corporation’s assets measured at fair value on a nonrecurring basis and reported on the Corporation’s consolidated balance sheets were as follows:

 

     March 31, 2010
     Level 1    Level 2    Level 3    Total
     (in thousands)

Net loans

   $ 0    $ 344    $ 669,033    $ 669,377

Other financial assets

     0      26,228      23,516      49,744
                           

Total assets

   $ 0    $ 26,572    $ 692,549    $ 719,121
                           

Reserve for unfunded commitments

   $ 0    $ 0    $ 4,339    $ 4,339
                           

 

     December 31, 2009
     Level 1    Level 2    Level 3    Total
     (in thousands)

Loans held for sale

   $ 0    $ 5,807    $ 0    $ 5,807

Net loans

     0      0      642,853      642,853

Other financial assets

     0      23,309      22,498      45,807
                           

Total assets

   $ 0    $ 29,116    $ 665,351    $ 694,467
                           

Reserve for unfunded commitments

   $ 0    $ 0    $ 855    $ 855
                           

The valuation techniques used to measure fair value for the items in the tables above are as follows:

 

   

Loans held for sale – This category consists of floating rate residential mortgage construction loans which are measured at the lower of aggregate cost or fair value. Fair value was measured as the prices that secondary market investors were offering for loans with similar characteristics.

 

   

Net loans – This category consists of residential mortgage loans and home equity loans that were previously sold and repurchased from secondary market investors during the first quarter of 2010 and have been classified as Level 2 assets. Upon repurchase, these loans were written down to the appraised value of their underlying collateral, less estimated selling costs. See Note G, “Commitments and Contingencies” for additional information.

This category also consists of commercial loans, commercial mortgage loans and construction loans which were considered to be impaired under FASB ASC Section 310-10-35 and have been classified as Level 3 assets. Impaired loans are measured at fair value based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or at the loan’s observable market price or fair value of its collateral, if the loan is collateral dependent. An allowance for loan losses is allocated to an impaired loan if its carrying value exceeds its estimated fair value. The amount shown is the balance of impaired loans, net of the related allowance for loan losses.

 

   

Other financial assets – This category includes other real estate owned. Fair values for these Level 2 assets were based on estimated selling prices less estimated selling costs for similar assets in active markets.

 

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Classified as Level 3 assets above are mortgage servicing rights (MSRs), which are initially recorded at fair value upon the sale of residential mortgage loans, which the Corporation continues to service, to secondary market investors. MSRs are amortized as a reduction to servicing income over the estimated lives of the underlying loans. MSRs are evaluated quarterly for impairment, by comparing the carrying amount to estimated fair value. Fair value is determined at the end of each quarter through a discounted cash flows valuation. Significant inputs to the valuation include expected net servicing income, the discount rate and the expected life of the underlying loans.

 

   

Reserve for unfunded commitments – This liability represents the reserve associated with unused commitments to extend credit on loans which are impaired under FASB ASC Section 310-10-35, and included as Level 3 assets under the heading, “Net loans” above. The fair value of the reserve for unfunded commitments is determined based on the results of the measurement of impaired loans. As such, this liability is classified as a Level 3 item.

FASB ASC Section 825-10-50 Fair Values of Financial Instruments

The following table details the book values and estimated fair values of the Corporation's financial instruments as of March 31, 2010 and December 31, 2009. A general description of the methods and assumptions used to estimate such fair values is also provided.

Fair values of financial instruments are significantly affected by assumptions used, principally the timing of future cash flows and discount rates. Because assumptions are inherently subjective in nature, the estimated fair values cannot be substantiated by comparison to independent market quotes and, in many cases, the estimated fair values could not necessarily be realized in an immediate sale or settlement of the instrument. Further, certain financial instruments and all non-financial instruments not measured at fair value on the Corporation’s consolidated balance sheets are excluded. For financial instruments listed below which are not measured at fair value on the Corporation’s consolidated balance sheets, the aggregate fair value amounts presented do not necessarily represent management's estimate of the underlying value of the Corporation.

 

     March 31, 2010    December 31, 2009

FINANCIAL ASSETS

   Book Value    Estimated
Fair Value
   Book Value    Estimated
Fair Value
           
     (in thousands)

Cash and due from banks

   $ 276,200    $ 276,200    $ 284,508    $ 284,508

Interest-bearing deposits with other banks

     7,842      7,842      16,591      16,791

Loans held for sale (1)

     53,798      53,798      85,384      85,384

Securities held to maturity

     8,159      8,254      8,700      8,797

Securities available for sale (1)

     3,095,469      3,095,469      3,258,386      3,258,386

Loans, net of unearned income (1)

     11,964,840      11,953,559      11,972,424      11,972,109

Accrued interest receivable

     58,689      58,689      58,515      58,515

Other financial assets (1)

     129,085      129,085      128,374      128,374

FINANCIAL LIABILITIES

                   

Demand and savings deposits

   $ 6,998,611    $ 6,998,611    $ 6,784,050    $ 6,784,050

Time deposits (1)

     5,157,844      5,200,366      5,313,864      5,349,237

Short-term borrowings

     624,650      624,650      868,940      868,940

Accrued interest payable

     49,247      49,247      46,596      46,596

Other financial liabilities (1)

     56,293      56,293      53,267      53,267

Federal Home Loan Bank advances and long-term debt

     1,440,755      1,377,153      1,540,773      1,474,082

 

(1) Description of fair value determinations for these financial instruments, or certain financial instruments within these categories, measured at fair value on the Corporation’s consolidated balance sheets, are detailed under the heading, “FASB ASC Topic 820 Fair Value Measurements” above.

 

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For short-term financial instruments, defined as those with remaining maturities of 90 days or less and excluding those recorded at fair value and reported above under the heading, “FASB ASC Topic 820 Fair Value Measurements”, the carrying amount was considered to be a reasonable estimate of fair value. The following instruments are predominantly short-term:

 

Assets

  

Liabilities

Cash and due from banks    Demand and savings deposits
Interest bearing deposits    Short-term borrowings
Federal funds sold    Accrued interest payable
Accrued interest receivable    Other financial liabilities

For those components of the above-listed financial instruments with remaining maturities greater than 90 days, fair values were determined by discounting contractual cash flows using rates which could be earned for assets with similar remaining maturities and, in the case of liabilities, rates at which the liabilities with similar remaining maturities could be issued as of the balance sheet date.

The estimated fair values of securities held to maturity as of March 31, 2010 and December 31, 2009 were based on quoted market prices, broker quotes or dealer quotes.

For short-term loans and variable rate loans that reprice within 90 days, the carrying value was considered to be a reasonable estimate of fair value. For other types of loans and time deposits, fair value was estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

The fair value of FHLB advances and long-term debt was estimated by discounting the remaining contractual cash flows using a rate at which the Corporation could issue debt with a similar remaining maturity as of the balance sheet date. The fair values of commitments to extend credit and standby letters of credit, included within other financial liabilities above, are estimated to equal their carrying amounts.

NOTE J – Reclassifications

Certain amounts in the 2009 consolidated financial statements and notes have been reclassified to conform to the 2010 presentation.

NOTE K – Subsequent Event

On May 5, 2010, the Corporation issued 21.8 million shares of its common stock, in an underwritten public offering, for total proceeds of $226.7 million, net of underwriting discounts and commissions. The underwriter has a 30-day option to purchase up to an additional 3.3 million shares at $10.40 per share.

The Corporation intends to use the net proceeds from this offering, together with other funds, to redeem all of the Series A Preferred Stock that it issued to the UST as part of the Troubled Asset Relief Program at such time as its banking regulators authorize and the UST formally approves.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Management’s Discussion) concerns Fulton Financial Corporation (the Corporation), a financial holding company registered under the Bank Holding Company Act and incorporated under the laws of the Commonwealth of Pennsylvania in 1982, and its wholly owned subsidiaries. Management’s discussion should be read in conjunction with the consolidated financial statements and notes 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 conditions 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 Federal Deposit Insurance Corporation 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 or a decline in loans originated; 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. Do not unduly rely on forward-looking statements. Forward-looking statements can be identified by the use of words such as “may,” “should,” “will,” “could,” “estimates,” “predicts,” “potential,” “continue,” “anticipates,” “believes,” “plans,” “expects,” “future” and “intends” and similar expressions which are intended to identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond the Corporation’s control and difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. The Corporation undertakes no obligation, other than as required by law, to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

RESULTS OF OPERATIONS

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, or FTE) 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.

 

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The following table presents a summary of the Corporation’s earnings and selected performance ratios:

 

     As of or for the
Three months ended
March 31
 
     2010     2009  

Net income available to common shareholders (in thousands)

   $ 22,415      $ 8,054   

Income before income taxes (in thousands)

   $ 36,747      $ 14,658   

Diluted net income per share (1)

   $ 0.13      $ 0.05   

Return on average assets

     0.68     0.33

Return on average common equity (2)

     5.73     2.18

Return on average tangible common equity (3)

     9.13     3.88

Net interest margin (4)

     3.78     3.45

Non-performing assets to total assets

     1.90     1.63

Net charge-offs to average loans (annualized)

     0.95     1.00

 

(1) Net income available to common shareholders divided by diluted weighted average common shares outstanding.
(2) Net income available to common shareholders, divided by average common shareholders’ equity.
(3) Net income available to common shareholders, adjusted for intangible asset amortization (net of tax), divided by average common shareholders’ equity, excluding goodwill and intangible assets.
(4) Presented on a fully taxable-equivalent basis, using a 35% Federal tax rate and statutory interest expense disallowances. See also the “Net Interest Income” section of Management’s Discussion.

The Corporation’s income before income taxes for the first quarter of 2010 increased $22.1 million, or 150.7%, from the same period in 2009. The increase was primarily due to the following significant items:

Increases in income before income taxes:

 

   

Increase in net interest income of $14.4 million, or 11.6%. The increase in net interest income was due to a 33 basis point, or 9.6%, increase in the net interest margin, from 3.45% in the first quarter of 2009 to 3.78% in the first quarter of 2010. The increase in net interest margin was primarily due to a significant decline in funding costs, partially offset by a decrease in interest-earning asset yields.

 

   

Decrease in the provision for loan losses of $10.0 million, or 20.0%. During the first quarter of 2010, the increase in the allowance allocation needs for impaired loans slowed in comparison to the first quarter of 2009, primarily due to a stabilization in collateral values for impaired commercial mortgages and improved expected cash flow forecasts for commercial customers. These factors, in conjunction with a modest decrease in net charge-offs from $30.1 million in the first quarter of 2009 to $28.3 million in the first quarter of 2010, contributed to a decrease in the provision for loan losses.

 

   

A $6.2 million decrease in contingent losses associated with the Corporation’s guarantee to purchase illiquid student loan auction rate securities, also known as auction rate certificates (ARCs). Fulton Financial Advisors (FFA), the investment management and trust division of the Corporation’s Fulton Bank, N.A. subsidiary, held ARCs for some of its customers’ accounts. FFA had previously sold ARCs to customers as short-term investments with fair values that could be derived based on periodic auctions under normal market conditions.

During 2008 and 2009, the Corporation purchased ARCs from customers due to the failure of these periodic auctions, making these previously short-term investments illiquid. During the first quarter of 2009, the Corporation recorded a pre-tax charge, recorded as a component of operating risk loss on the consolidated statement of income, of $6.2 million, which represented contingent losses related to guarantees to purchase ARCs held by customers. As of December 31, 2009, the Corporation had purchased all remaining ARCs held by customers, and therefore, recorded no such charges in the first quarter of 2010.

 

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Decreases in income before income taxes:

 

   

A $5.2 million decrease in gains on sales of mortgage loans. During the first quarter of 2009, low interest rates on residential mortgages resulted in a significant increase in residential mortgage refinances and an increase in the Corporation’s volumes of residential mortgage sales. The decrease in gains on sales of mortgage loans in the first quarter of 2010 was a result of a decrease in refinance volumes.

 

   

A $5.1 million decrease in net gains on sales of investment securities, from a gain of $2.9 million in the first quarter of 2009 to a net loss of $2.2 million in the first quarter of 2010. The decrease in gains on sales of investment securities was primarily due to a $4.1 million decrease in net gains on sales of debt securities and a $2.2 million increase in other-than-temporary impairment charges related to pooled trust preferred securities issued by financial institutions. During the first quarter of 2009, the Corporation recorded $6.0 million of net gains on sales of debt securities, primarily collateralized mortgage obligations, compared to $1.9 million of net gains on sales of debt securities in the first quarter of 2010.

 

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Quarter Ended March 31, 2010 compared to the Quarter Ended March 31, 2009

Net Interest Income

The following table provides a comparative average balance sheet and net interest income analysis for the first quarter of 2010 as compared to the same period in 2009. Interest income and yields are presented on an FTE basis, using a 35% Federal tax rate and statutory interest expense disallowances. The discussion following this table is based on these FTE amounts. All dollar amounts are in thousands.

 

     Three months ended March 31  
     2010     2009  

ASSETS

   Average
Balance
    Interest
(1)
    Yield/
Rate
    Average
Balance
    Interest
(1)
    Yield/
Rate
 
            

Interest-earning assets:

            

Loans, net of unearned income (2)

   $ 11,971,786      $ 159,424      5.39   $ 12,041,286      $ 163,753      5.51

Taxable investment securities (3)

     2,663,127        28,149      4.23        2,212,639        26,849      4.86   

Tax-exempt investment securities (3)

     387,971        5,531      5.70        503,265        6,887      5.47   

Equity securities (3)

     141,896        809      2.29        137,308        774      2.28   
                                            

Total investment securities

     3,192,994        34,489      4.33        2,853,212        34,510      4.84   

Loans held for sale

     42,938        556      5.18        104,467        1,261      4.83   

Other interest-earning assets

     10,793        25      0.95        16,934        50      1.19   
                                            

Total interest-earning assets

     15,218,511        194,494      5.17     15,015,899        199,574      5.38

Noninterest-earning assets:

            

Cash and due from banks

     263,147            317,928       

Premises and equipment

     203,584            202,875       

Other assets

     1,086,635            924,755       

Less: Allowance for loan losses

     (273,426         (187,183    
                        

Total Assets

   $ 16,498,451          $ 16,274,274       
                        

LIABILITIES AND EQUITY

                                    

Interest-bearing liabilities:

            

Demand deposits

   $ 1,981,653      $ 1,840      0.38   $ 1,754,003      $ 1,776      0.41

Savings deposits

     2,847,427        5,201      0.74        2,058,021        4,353      0.86   

Time deposits

     5,202,975        26,697      2.08        5,432,676        43,767      3.27   
                                            

Total interest-bearing deposits

     10,032,055        33,738      1.36        9,244,700        49,896      2.19   

Short-term borrowings

     871,981        549      0.25        1,517,064        1,436      0.38   

FHLB advances and long-term debt

     1,484,236        17,792      4.86        1,787,493        20,119      4.55   
                                            

Total interest-bearing liabilities

     12,388,272        52,079      1.70     12,549,257        71,451      2.31

Noninterest-bearing liabilities:

            

Demand deposits

     1,973,146            1,657,658       

Other

     180,528            201,449       
                        

Total Liabilities

     14,541,946            14,408,364       

Shareholders' equity

     1,956,505            1,865,910       
                        

Total Liabilities and Shareholders' Equity

   $ 16,498,451          $ 16,274,274       
            
                        

Net interest income/net interest margin (FTE)

       142,415      3.78       128,123      3.45
                    

Tax equivalent adjustment

       (3,906         (4,007  
                        

Net interest income

     $ 138,509          $ 124,116     
                        

 

(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.

 

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The following table summarizes the changes in FTE interest income and expense due to changes in average balances (volume) and changes in rates:

 

     2010 vs. 2009
Increase (decrease) due
to change in
 
     Volume     Rate     Net  
     (in thousands)  

Interest income on:

      

Loans, net of unearned income

   $ (939   $ (3,390   $ (4,329

Taxable investment securities

     5,011        (3,711     1,300   

Tax-exempt investment securities

     (1,630     274        (1,356

Equity securities

     29        6        35   

Loans held for sale

     (790     85        (705

Other interest-earning assets

     (16     (9     (25
                        

Total interest income

   $ 1,665      $ (6,745   $ (5,080
                        

Interest expense on:

      

Demand deposits

   $ 219      $ (155   $ 64   

Savings deposits

     1,502        (654     848   

Time deposits

     (1,781     (15,289     (17,070

Short-term borrowings

     (480     (407     (887

FHLB advances and long-term debt

     (3,601     1,274        (2,327
                        

Total interest expense

   $ (4,141   $ (15,231   $ (19,372
                        

Interest income decreased $5.1 million, or 2.5%. A 21 basis point, or 3.9%, decrease in average yields resulted in a $6.7 million decrease in interest income, which was partially offset by a $1.7 million increase in interest income attributable to a $202.6 million, or 1.3%, increase in average interest-earning assets. Average investments increased $339.8 million, or 11.9%, while average loans decreased $69.5 million, or 0.6%.

Average loans, by type, are summarized in the following table:

 

      Three months ended
March 31
   Increase (decrease)  
     2010    2009    $     %  
     (dollars in thousands)  

Real estate – commercial mortgage

   $ 4,306,270    $ 4,048,847    $ 257,423      6.4

Commercial – industrial, financial and agricultural

     3,686,405      3,655,970      30,435      0.8   

Real estate – home equity

     1,640,912      1,698,599      (57,687   (3.4

Real estate – construction

     962,175      1,229,841      (267,666   (21.8

Real estate – residential mortgage

     940,652      957,556      (16,904   (1.8

Consumer

     362,212      360,919      1,293      0.4   

Leasing and other

     73,160      89,554      (16,394   (18.3
                            

Total

   $ 11,971,786    $ 12,041,286    $ (69,500   (0.6 %) 
                            

Despite sluggish economic conditions, the Corporation experienced growth in both its commercial mortgage ($257.4 million, or 6.4%) and commercial loan ($30.4 million, or 0.8%) portfolios. Geographically, the growth in commercial mortgages was mainly attributable to the Corporation’s Pennsylvania ($176.2 million, or 8.5%, increase) and Maryland ($50.7 million, or 15.1%, increase) markets. The commercial loan growth was partially due to the lack of alternative funding sources, such as the secondary market or private placements. Commercial loan growth was primarily in the Pennsylvania ($85.8 million, or 3.6%) and New Jersey ($18.4 million, or 3.3%) markets, partially offset by declines in the Maryland ($49.3 million, or 11.8%) and Virginia ($25.3 million, or 8.3%) markets.

 

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The $267.7 million, or 21.8%, decrease in construction loans was primarily due to efforts to decrease credit exposure in this portfolio. Geographically, the decline was throughout all of the Corporation’s markets, with decreases in Maryland ($95.2 million, or 28.2%), New Jersey ($64.4 million, or 27.0%), Virginia ($59.4 million, or 19.8%) and Pennsylvania ($46.4 million, or 13.8%). The decrease in home equity loans was due to higher residential mortgage refinances that were driven by low interest rates.

The average yield on loans decreased 12 basis points, or 2.2%, from 5.51% in 2009 to 5.39% in 2010. The average prime rate was 3.25% for the first quarter of 2010 and 2009. The decrease in average yields on loans was attributable to declining average rates on fixed and adjustable rate loans which, unlike floating rate loans, have a lagged repricing effect.

Average investments increased $339.8 million, or 11.9%, due largely to increases in collateralized mortgage obligations and ARCs. In late 2009, the Corporation purchased high-quality U.S. government agency-backed collateralized mortgage obligations with funds generated from an increase in deposits combined with a decrease in loans. The increase in ARCs was related to purchases of those securities from customers during 2009. The average yield on investments decreased 51 basis points, or 10.5%, from 4.84% in 2009 to 4.33% in 2010, as the reinvestment of cash flows and incremental purchases were at yields that were lower than the overall portfolio yield.

The $5.1 million decrease in interest income was offset by a decrease in interest expense of $19.4 million, or 27.1%, to $52.1 million in the first quarter of 2010 from $71.5 million in the same period in 2009. Interest expense decreased $15.2 million as a result of a 61 basis point, or 26.4%, decrease in the average cost of interest-bearing liabilities. Interest expense decreased an additional $4.1 million, attributable to a $161.0 million, or 1.3%, decline in average interest-bearing liabilities.

The following table summarizes the changes in average deposits, by type:

 

      Three months ended
March 31
   Increase (decrease)  
     2010    2009    $     %  
     (dollars in thousands)  

Noninterest-bearing demand

   $ 1,973,146    $ 1,657,658    $ 315,488      19.0

Interest-bearing demand

     1,981,653      1,754,003      227,650      13.0   

Savings

     2,847,427      2,058,021      789,406      38.4   
                            

Total demand and savings

     6,802,226      5,469,682      1,332,544      24.4   

Time deposits

     5,202,975      5,432,676      (229,701   (4.2
                            

Total deposits

   $ 12,005,201    $ 10,902,358    $ 1,102,843      10.1
                            

The Corporation experienced an increase in noninterest-bearing and interest-bearing demand and savings accounts of $1.3 billion, or 24.4%. The increase in noninterest-bearing demand accounts was primarily in business accounts, the increase in interest-bearing demand accounts was primarily in personal accounts and the increase in savings accounts was in personal, business and governmental accounts. The growth in business accounts was due, in part, to businesses being required to keep higher balances on hand to offset service fees, as well as a migration from the Corporation’s cash management products due to low interest rates.

The decrease in time deposits was due to a $322.9 million, or 95.8%, decrease in brokered certificates of deposit, offset by a $93.2 million, or 1.8%, increase in customer certificates of deposit. The decrease in brokered certificates of deposit resulted from the significant growth in customer funding. The increase in customer certificates of deposits was in accounts with original maturity terms greater than one year and jumbo certificates of deposit, offset by a decline in accounts with original maturity terms less than one year. The growth in longer-term certificates of deposit was due to the Corporation’s continuing focus on building customer relationships, while at the same time extending funding maturities at reasonable rates over a longer time horizon.

 

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The average cost of interest-bearing deposits decreased 83 basis points, or 37.9%, from 2.19% in 2009 to 1.36% in 2010 primarily due to the maturities of higher-rate certificates of deposit. The average cost of certificates of deposit decreased 119 basis points, or 36.4%.

As average deposits increased, short-term and long-term borrowings decreased, as summarized in the following table:

 

     Three months ended
March 31
   Increase (decrease)  
     2010    2009    $     %  
     (dollars in thousands)  

Short-term borrowings:

          

Customer short-term promissory notes

   $ 223,439    $ 337,069    $ (113,630   (33.7 )% 

Customer repurchase agreements

     248,982      246,429      2,553      1.0   
                            

Total short-term customer funding

     472,421      583,498      (111,077   (19.0

Federal funds purchased

     399,560      792,001      (392,441   (49.6

Federal Reserve Bank borrowings

     0      138,222      (138,222   (100.0

Other short-term borrowings

     0      3,343      (3,343   (100.0
                            

Total other short-term borrowings

     399,560      933,566      (534,006   (57.2
                            

Total short-term borrowings

     871,981      1,517,064      (645,083   (42.5
                            

Long-term debt:

          

FHLB advances

     1,100,893      1,404,275      (303,382   (21.6

Other long-term debt

     383,343      383,218      125      0.0   
                            

Total long-term debt

     1,484,236      1,787,493      (303,257   (17.0
                            

Total

   $ 2,356,217    $ 3,304,557    $ (948,340   (28.7 )% 
                            

The $111.1 million net decrease in short-term customer funding was due to customers transferring funds from the cash management program to deposits due to the low interest rate environment. The decrease in long-term debt was due to maturities of Federal Home Loan Bank (FHLB) advances, which were generally not replaced with new advances.

 

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Provision for Loan Losses and Allowance for Credit Losses

The following table presents the activity in the allowance for credit losses:

 

     Three months ended
March 31
 
     2010     2009  
     (dollars in thousands)  

Loans, net of unearned income outstanding at end of period

   $ 11,964,840      $ 12,009,060   
                

Daily average balance of loans, net of unearned income

   $ 11,971,786      $ 12,041,286   
                

Balance of allowance for credit losses at beginning of period

   $ 257,553      $ 180,137   

Loans charged off:

    

Real estate – construction

     20,553        12,242   

Commercial – industrial, agricultural and financial

     2,981        10,622   

Real estate – commercial mortgage

     2,344        3,960   

Real estate – residential mortgage and home equity

     1,391        1,937   

Consumer

     2,078        2,076   

Leasing and other

     645        946   
                

Total loans charged off

     29,992        31,783   
                

Recoveries of loans previously charged off:

    

Real estate – construction

     315        112   

Commercial – industrial, agricultural and financial

     436        904   

Real estate – commercial mortgage

     128        10   

Real estate – residential mortgage and home equity

     1        1   

Consumer

     552        429   

Leasing and other

     261        253   
                

Total recoveries

     1,693        1,709   
                

Net loans charged off

     28,299        30,074   

Provision for loan losses

     40,000        50,000   
                

Balance of allowance for credit losses at end of period

   $ 269,254      $ 200,063   
                

Components of Allowance for Credit Losses:

    

Allowance for loan losses

   $ 264,915      $ 192,410   

Reserve for unfunded lending commitments

     4,339        7,653   
                

Allowance for credit losses

   $ 269,254      $ 200,063   
                

Selected Ratios:

    

Net charge-offs to average loans (annualized)

     0.95     1.00

Allowance for credit losses to loans outstanding

     2.25     1.67

Allowance for loan losses to loans outstanding

     2.21     1.60

The provision for loan losses was $40.0 million for the first quarter of 2010, a decrease of $10.0 million, or 20.0%, over the same period in 2009. A decrease in net charge-offs, the stabilization of non-performing loans, and a slowing in the pace of specific loan loss allocations needed for impaired loans all contributed to the decrease in the provision for loan losses.

Net charge-offs decreased $1.8 million, or 5.9%, to $28.3 million for the first quarter of 2010 compared to $30.1 million for the first quarter of 2009. Annualized net charge-offs to average loans decreased 5 basis points, or 5.0%, to 95 basis points for the first quarter of 2010. The $1.8 million decrease in net charge-offs was primarily due to decreases in commercial loan net charge-offs ($7.2 million, or 73.8%), commercial mortgage net charge-offs ($1.7 million, or 43.9%) and residential mortgage and home equity net charge-offs ($546,000, or 28.2%), offset by an increase in construction loan net charge-offs ($8.1 million, or 66.8%).

 

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Of the $28.3 million of net charge-offs recorded in the first quarter of 2010, 32.2% were in Virginia, 29.5% in Maryland, 19.1% in New Jersey, and 18.6% in Pennsylvania. During the first quarter of 2010, there were six individual charge-offs which exceeded $1.0 million, totaling $17.0 million, which were for businesses that were negatively impacted by the downturn in residential and commercial real estate.

The following table summarizes the Corporation’s non-performing assets as of the indicated dates:

 

     March 31
2010
    March 31
2009
    December 31
2009
 
     (dollars in thousands)  

Non-accrual loans

   $ 242,423      $ 198,765      $ 238,360   

Loans 90 days past due and accruing

     43,603        47,284        43,359   
                        

Total non-performing loans

     286,026        246,049        281,719   

Other real estate owned (OREO)

     26,228        23,189        23,309   
                        

Total non-performing assets

   $ 312,254      $ 269,238      $ 305,028   
                        

Non-accrual loans to total loans

     2.03     1.66     1.99

Non-performing assets to total assets

     1.90     1.63     1.83

Allowance for credit losses to non-performing loans

     94.14     81.31     91.42

Non-performing assets to tangible common shareholders’ equity and allowance for credit losses

     23.71     23.71     24.00

Excluded from the summary of non-performing assets above were $51.4 million of loans whose terms were modified under troubled debt restructurings and were current under their modified terms at March 31, 2010. These troubled debt restructurings included $27.0 million of residential mortgages, $16.7 million of commercial mortgages, $4.8 million of construction loans and $2.6 million of commercial loans.

The following table summarizes the Corporation’s non-performing loans, by type, as of the indicated dates:

 

     March 31
2010
   March 31
2009
   December 31
2009
     (in thousands)

Real estate – construction

   $ 79,527    $ 93,425    $ 92,841

Commercial – industrial, agricultural and financial

     78,365      50,493      69,604

Real estate – commercial mortgage

     70,565      59,899      61,052

Real estate – residential mortgage and home equity

     42,302      31,365      45,748

Consumer

     15,086      10,316      12,319

Leasing

     181      551      155
                    

Total non-performing loans

   $ 286,026    $ 246,049    $ 281,719
                    

Non-performing loans increased to $286.0 million at March 31, 2010, from $246.0 million at March 31, 2009. The $40.0 million, or 16.2%, increase in non-performing loans in comparison to March 31, 2009 was primarily due to a $27.9 million, or 55.2%, increase in non-performing commercial loans, a $10.9 million, or 34.9%, increase in non-performing residential mortgage and home equity loans and a $10.7 million, or 17.8%, increase in non-performing commercial mortgages, offset by a $13.9 million, or 14.9%, decrease in non-performing construction loans.

The $27.9 million increase in non-performing commercial loans was a result of prolonged weak economic conditions continuing to put stress on business customers. Geographically, the increases were as follows: $17.6 million, or 91.3%, in the Pennsylvania market, $4.2 million, or 98.0%, in the Maryland market, $3.1 million, or 28.0%, in the Virginia market and $2.6 million, or 16.7%, in the New Jersey market.

 

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The $10.9 million increase in non-performing residential mortgage and home equity loans was primarily due to increases in the New Jersey ($4.7 million, or 110.7%) and Pennsylvania ($4.3 million, or 73.6%) markets. The $10.7 million increase in non-performing commercial mortgages was due to increases in the New Jersey ($13.8 million, or 58.7%) and Pennsylvania ($3.9 million, or 18.3%) markets, offset by a decrease in the Maryland ($8.1 million, or 82.0%) market.

The $13.9 million decrease in non-performing construction loans was due to the $20.2 million of net charge-offs recorded during the first quarter of 2010, partially offset by increases to non-performing construction loans, primarily in the Pennsylvania market.

The $26.2 million of OREO at March 31, 2010 included $19.4 million of residential properties and $6.8 million of commercial properties. The residential properties included $7.8 million of foreclosed repurchased residential mortgage loans, as discussed in Note G, “Commitments and Contingencies” in the Notes to Consolidated Financial Statements.

The following table summarizes loan delinquency rates, by type, as of March 31:

 

     2010     2009  
     30-60
Days
    > 90 Days     Total     30-60
Days
    > 90 Days     Total  

Real estate – construction

     2.19     8.49     10.68     1.12     7.65     8.77

Commercial – industrial, agricultural and financial

     0.71        2.13        2.84        0.67        1.59        2.26   

Real estate – commercial mortgage

     1.36        1.62        2.98        0.61        1.27        1.88   

Real estate – residential mortgage

     3.58        4.51        8.09        4.08        3.56        7.64   

Consumer, home equity, leasing and other

     0.95        0.74        1.69        0.77        0.51        1.28   
                                                

Total

     1.33     2.39     3.72     0.98     2.05     3.03
                                                

Total dollars (in thousands)

   $ 159,632      $ 286,528      $ 446,160      $ 117,715      $ 247,755      $ 365,470   
                                                

In comparison to the first quarter of 2009, the Corporation experienced an increase in delinquency rates across all loan categories. Delinquency rates at December 31, 2009 were 1.09% in the 30 to 60 days past due category and 2.36% in the greater than 90 days category.

The increase in construction loan delinquency percentages was due to a decrease in the construction loan portfolio as total delinquency slightly decreased in dollars. During the past year, the delinquencies on commercial loans and commercial mortgages have increased, a by-product of slow consumer demand that continues to place stress on businesses.

 

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Table of Contents

The following table presents ending balances of loans outstanding, net of unearned income:

 

     March 31
2010
   March 31
2009
   December 31
2009
     (in thousands)

Real-estate – commercial mortgage

   $ 4,322,774    $ 4,068,342    $ 4,292,300

Commercial – industrial, agricultural and financial

     3,684,903      3,653,503      3,699,198

Real-estate – home equity

     1,638,179      1,673,613      1,644,260

Real-estate – residential mortgage

     951,381      947,837      921,741

Real-estate – construction

     937,279      1,205,256      978,267

Consumer

     361,681      378,851      360,698

Leasing and other

     68,643      81,658      75,960
                    

Loans, net of unearned income

   $ 11,964,840    $ 12,009,060    $ 11,972,424
                    

Approximately $5.3 billion, or 44.0%, of the Corporation’s loan portfolio was in commercial mortgage and construction loans at March 31, 2010. The Corporation does not have a concentration of credit risk with any single borrower, industry or geographical location. However, the performance of real estate markets in general has adversely impacted the performance of these loans.

Commercial loans comprise 30.8% of the total loan portfolio. The credit quality of these loans has been impacted by generally poor economic conditions as businesses continue to struggle for growth as a result of reduced consumer spending.

Approximately $2.6 billion, or 21.6%, of the Corporation’s loan portfolio was in residential mortgage and home equity loans at March 31, 2010. Recent years deterioration in residential real estate values in some geographic areas, most notably in portions of Maryland, New Jersey and Virginia, and generally poor economic conditions have resulted in increases in non-performing loans and negatively impacted the overall credit quality of the portfolio.

Management believes that the allowance for credit losses of $269.3 million at March 31, 2010 is sufficient to cover losses inherent in both the loan portfolio and the unfunded lending commitments as of that date and is appropriate based on applicable accounting standards.

 

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Table of Contents

Other Income

The following table presents the components of other income:

 

     Three months ended
March 31
   Increase (decrease)  
   2010     2009    $     %  
   (dollars in thousands)  

Overdraft fees

   $ 8,884      $ 8,442    $ 442      5.2

Cash management fees

     2,277        3,203      (926   (28.9

Other

     3,106        3,249      (143   (4.4
                             

Service charges on deposit accounts

     14,267        14,894      (627   (4.2

Debit card income

     2,953        2,440      513      21.0   

Merchant fees

     1,824        1,626      198      12.2   

Foreign exchange income

     1,938        1,283      655      51.1   

Letter of credit fees

     1,239        1,534      (295   (19.2

Other

     1,418        1,471      (53   (3.6
                             

Other service charges and fees

     9,372        8,354      1,018      12.2   

Investment management and trust services

     8,088        7,903      185      2.3   

Gains on sales of mortgage loans

     3,364        8,591      (5,227   (60.8

Credit card income

     1,451        1,187      264      22.2   

Gains on sales of OREO

     464        161      303      188.2   

Other

     2,684        2,905      (221   (7.6
                             

Total, excluding investment securities gains (losses)

     39,690        43,995      (4,305   (9.8

Investment securities gains (losses)

     (2,223     2,919      (5,142   (176.2
                             

Total

   $ 37,467      $ 46,914    $ (9,447   (20.1 )% 
                             

The $627,000, or 4.2%, decrease in service charges on deposit accounts was due primarily to a $926,000, or 28.9%, decrease in cash management fees, due to customers transferring funds from the cash management program to deposits due to the low interest rate environment, offset by an increase of $442,000, or 5.2%, in overdraft fees due to an increase in volume.

The $1.0 million, or 12.2%, increase in other service charges was primarily due to a $513,000, or 21.0%, increase in debit card fees, as a result of increasing transaction volumes and a $655,000, or 51.1%, increase in foreign currency processing revenue, also due to an increase in transaction volumes.

Gains on sales of mortgage loans decreased $5.2 million, or 60.8%, due to a decrease in the volume of loans sold. Total loans sold in the first quarter of 2010 were $199.6 million, compared to $572.6 million in the first quarter of 2009. The $373.0 million, or 65.1%, decrease in volume was mainly due to lower refinance activity as interest rates were higher in the first quarter of 2010. For the three months ended March 31, 2010, 55% of loans originated for sale were refinances, compared to 84% for the same period in 2009.

The $264,000, or 22.2%, increase in credit card income was due to an increase in new relationships, which generate fees under a joint marketing agreement with an independent third party. The $303,000, or 188.2%, increase in gains on sales of OREO was due to an increase in the number of properties sold.

Investment securities losses of $2.2 million for the first quarter of 2010 included $2.8 million of net gains on the sales of securities, offset by $5.0 million of other-than-temporary impairment charges. The Corporation recorded $4.2 million of other-than-temporary impairment charges for pooled trust preferred securities issued by financial institutions and $824,000 of other-than-temporary impairment charges for certain financial institution stocks. The $2.9 million of investment securities gains for the first quarter of 2009 was due primarily to $6.0 million of net gains on the sales of securities, primarily collateralized mortgage obligations, partially offset by $2.0 million of other-than-temporary impairment charges for

 

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Table of Contents

debt securities issued by financial institution, $956,000 of other-than-temporary impairment charges for certain financial institutions stocks and $106,000 of other-than-temporary impairment charges for other equity securities. 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:

 

     Three months ended
March 31
   Increase (decrease)  
     2010    2009    $     %  
     (dollars in thousands)  

Salaries and employee benefits

   $ 52,345    $ 55,304    $ (2,959   (5.4 )% 

Net occupancy expense

     11,650      11,023      627      5.7   

FDIC insurance expense

     4,954      4,288      666      15.5   

Equipment expense

     3,091      3,079      12      0.4   

Data processing

     2,624      3,072      (448   (14.6

Professional fees

     2,546      2,228      318      14.3   

Telecommunications

     2,270      2,163      107      4.9   

Marketing

     1,830      2,571      (741   (28.8

Supplies

     1,329      1,281      48      3.7   

Intangible amortization

     1,314      1,463      (149   (10.2

Postage

     1,305      1,384      (79   (5.7

OREO expense

     1,661      1,316      345      26.2   

Operating risk loss

     511      6,201      (5,690   (91.8

Other

     11,799      10,999      800      7.3   
                            

Total

   $ 99,229    $ 106,372    $ (7,143   (6.7 )% 
                            

Salaries and employee benefits decreased $3.0 million, or 5.4%, with salaries decreasing $1.7 million, or 3.8%, and employee benefits decreasing $1.3 million, or 11.5%. The decrease in salaries was primarily due to an $841,000 decrease in incentive compensation expense, in addition to a decrease in average full-time equivalent employees from 3,640 in the first quarter of 2009 to 3,530 in the first quarter of 2010, largely due to the consolidation of The Columbia Bank’s back office functions in 2009.

The $1.3 million decrease in employee benefits was primarily due to a $792,000 decrease in healthcare costs as claims decreased as a result of higher deductibles in 2010 and $749,000 of severance expense recorded in the first quarter of 2009 for the consolidation of The Columbia Bank’s back office functions.

The $627,000, or 5.7%, increase in net occupancy expense was primarily due to higher snow removal and utilities costs. The $666,000, or 15.5%, increase in FDIC insurance expense was due to an increase in assessment rates and growth in insured deposits. The $448,000, or 14.6%, decrease in data processing expense was primarily due to the conversion of The Columbia Bank’s back office systems in the third quarter of 2009. The $318,000, or 14.3%, increase in professional fees was due to an increase in regulatory fees and an increase in legal fees related to collection and workout efforts for non-performing loans. The $741,000, or 28.8%, decrease in marketing expenses was due to an effort to reduce discretionary spending and the timing of promotional campaigns. The $345,000, or 26.2%, increase in OREO expense was primarily due to an increase in loss provisions and losses on disposition.

The $5.7 million decrease in operating risk loss was a result of a $6.2 million charge recorded in the first quarter of 2009 related to the Corporation’s commitment to purchase illiquid ARCs from customer accounts. The Corporation did not record any charges related to this guarantee in 2010 as all remaining customer ARCs were purchased during 2009.

 

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The $800,000, or 7.3%, increase in other expenses was primarily due a to $754,000 increase in costs associated with the repossession of foreclosed assets and a $492,000 increase in student loan lender expense. These increases were partially offset by a $166,000 decrease in outside services and a $164,000 decrease in travel, meals and entertainment expenses, all as a result of efforts by the Corporation to reduce discretionary spending.

Income Taxes

Income tax expense for the first quarter of 2010 was $9.3 million, a $7.7 million, or 489.1%, increase from $1.6 million in 2009. The increase was primarily due to the increase in income before income taxes.

The Corporation’s effective tax rate was 25.2% in 2010, as compared to 10.7% in 2009. The effective rate is generally lower than the Federal statutory rate of 35% due to investments in tax-free municipal securities and Federal tax credits earned from investments in low and moderate-income housing partnerships. The effective rate for the first quarter of 2010 is higher than the same period in 2009 due to non-taxable income and tax credits having a smaller impact on the effective tax rate due to the higher level of income before income taxes.

FINANCIAL CONDITION

Total assets decreased $224.1 million, or 1.3%, to $16.4 billion at March 31, 2010, compared to $16.6 billion at December 31, 2009.

Investment securities decreased $163.5 million, or 5.0%. In late 2009, the Corporation purchased collateralized mortgage obligations with funds generated from an increase in deposits, combined with a decrease in loans. During the first quarter of 2010, some of the proceeds from maturities of investment securities were used to reduce Federal funds purchased and FHLB advances.

The Corporation experienced a $7.6 million, or 0.1%, decrease in loans, net of unearned income. Construction loans decreased $41.0 million, or 4.2%, due to paydowns on existing loans and $20.2 million of net charge-offs recorded in the first three months of 2010. Commercial loans decreased $14.3 million, or 0.4%, due to continued weak economic conditions. Offsetting these decreases was a $30.5 million, or 0.7%, increase in commercial mortgages and a $29.6 million, or 3.2%, increase in residential mortgages. Residential mortgages increased as certain 10 and 15 year mortgages originated in the first quarter of 2010 were held in portfolio rather than being sold in the secondary market.

Loans held for sale decreased $31.6 million, or 37.0%, due to a decrease in the volume of loans originated for sale. The decrease in originations was primarily due to an increase in residential mortgage interest rates during the first quarter of 2010.

Deposits increased $58.5 million, or 0.5%, due an increase in demand and savings deposits of $214.6 million, or 3.2%, offset by a decrease in time deposits of $156.0 million, or 2.9%. The increase in demand and savings accounts was in business and personal accounts. The growth in business accounts 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 Corporation’s cash management products due to the current low rates. The decrease in time deposits was due to a decrease in customer demand for time deposits.

Short-term borrowings decreased $244.3 million, or 28.1%, due to a $216.0 million, or 57.1%, decrease in Federal funds purchased. The decrease in short-term borrowings largely resulted from proceeds received from maturing investment securities which were not reinvested. Long-term borrowings decreased $100.0 million, or 6.5%, due to a $100.1 million, or 8.6%, decrease in FHLB advances.

Other liabilities increased $25.6 million, or 17.7%, due to an $11.6 million increase in equity commitments payable on low and moderate-income housing partnership investments, an $8.1 million increase in accrued taxes, due to an increase in income before taxes, and a $3.5 million increase in the reserve for unfunded loan commitments.

 

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Capital Resources

Total shareholders’ equity increased $33.4 million, or 1.7%, during the first three months of 2010. The increase was due to $27.5 million of net income and a $12.8 million increase in net holding gains on investment securities, offset by $10.0 million in dividends on common and preferred shares outstanding.

The Corporation and its subsidiary banks are subject to various regulatory capital requirements administered by banking regulators. Failure to meet minimum capital requirements can initiate certain actions by regulators that could have a material effect on the Corporation’s consolidated financial statements. The regulations require that banks maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk weighted assets (as defined), and Tier I capital to average assets (as defined). As of March 31, 2010, the Corporation and each of its bank subsidiaries met the minimum requirements. In addition, each of the Corporation’s bank subsidiaries’ capital ratios exceeded the amounts required to be considered “well capitalized” as defined in the regulations.

The following table summarizes the Corporation’s capital ratios in comparison to regulatory requirements:

 

     March 31
2010
    December 31
2009
    Regulatory
Minimum
Capital
Adequacy
 

Total Capital (to Risk Weighted Assets)

   15.1   14.7   8.0

Tier I Capital (to Risk Weighted Assets)

   12.2   11.9   4.0

Tier I Capital (to Average Assets)

   9.8   9.7   3.0

Tangible common equity to tangible assets (1)

   6.6   6.3  

Tangible common equity to risk weighted assets (2)

   8.2   7.8  

 

(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.

In connection with the Emergency Economic Stabilization Act of 2008 (EESA), the U.S. Treasury Department (UST) initiated a Capital Purchase Program (CPP) which allowed for qualifying financial institutions to issue preferred stock to the UST, subject to certain terms and conditions. The EESA was initially 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.

In December 2008, the Corporation voluntarily participated in the CPP by issuing $376.5 million of fixed rate cumulative perpetual preferred stock, and warrants to purchase 5.5 million of the Corporation's common stock, to the UST. The preferred stock pays a compounding cumulative dividend at a rate of 5.0% for the first five years and 9.0% thereafter.

The $376.5 million par value of the preferred stock is included in regulatory capital. Pro-forma regulatory capital ratios, excluding this amount would be as follows:

 

     March 31
2010
    December 31
2009
    Regulatory
Minimum
Capital
Adequacy
 

Total Capital (to Risk Weighted Assets)

   12.1   11.8   8.0

Tier I Capital (to Risk Weighted Assets)

   9.3   9.0   4.0

Tier I Capital (to Average Assets)

   7.4   7.3   3.0

 

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On May 5, 2010, the Corporation issued 21.8 million shares of its common stock, in an underwritten public offering, for total proceeds of $226.7 million, net of underwriting discounts and commissions. The underwriter has a 30-day option to purchase up to an additional 3.3 million shares at $10.40 per share.

The Corporation intends to use the net proceeds from this offering, together with other funds, to redeem all of the Series A Preferred Stock that it issued to the UST as part of the Troubled Asset Relief Program at such time as its banking regulators authorize and the UST formally approves.

Liquidity

The Corporation must maintain a sufficient level of liquid assets to meet the cash needs of its customers, who, as depositors, may want to withdraw funds or who, as borrowers, need credit availability. Liquidity is provided on a continuous basis through scheduled and unscheduled principal and interest payments on outstanding loans and investments and through the availability of deposits and borrowings. The Corporation also maintains secondary sources that provide liquidity on a secured and unsecured basis to meet short-term needs. 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. Management continues to monitor the liquidity and capital needs of the parent company and will implement appropriate strategies, as necessary, to remain adequately capitalized and to meet its cash needs.

The Corporation’s sources and uses of cash were discussed in general terms in the net interest income section of Management’s Discussion. The consolidated statements of cash flows provide additional information. The Corporation’s operating activities during the first quarter of 2010 generated $121.9 million of cash, mainly due to net income, as adjusted for non-cash expenses, most notably the provision for loan losses and the net decrease in loans held for sale. Cash flows provided by investing activities were $164.3 million, due to proceeds from the sales and maturities of available for sale securities exceeding purchases of available for sale securities. Net cash outflows from financing activities were $294.5 million, primarily due to a net decrease in short-term borrowings and long-term debt repayments exceeding a net increase in deposits.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk is the exposure to economic loss that arises from changes in the values of certain financial instruments. The types of market risk exposures generally faced by financial institutions include interest rate risk, equity market price risk, 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. The Corporation’s equity investments consisted of $100.0 million of Federal Home Loan Bank (FHLB) and Federal Reserve Bank stock, $33.3 million of stocks of publicly traded financial institutions, and $8.8 million of money market mutual funds and other equity investments. The equity investments most susceptible to equity market price risk are the financial institutions stocks, which had a cost basis of approximately $31.4 million and fair value of $33.3 million at March 31, 2010. Gross unrealized gains in this portfolio were $3.7 million, and gross unrealized losses were $1.8 million.

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 $824,000 for specific financial institution stocks that were deemed to exhibit other-than-temporary impairment in value during the three months ended March 31, 2010. Additional impairment charges may be necessary in the future depending upon the performance of the equity markets in general and the performance of the individual investments held by the Corporation. See Note C, “Investment Securities”, in the Notes to Consolidated Financial Statements for additional details.

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 Corporation’s equity securities are classified as trading. Future cash flows from these investments are not provided in the table on page 43 as such investments do not have maturity dates.

Another source of equity market price risk is the Corporation’s 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 other’s 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 Corporation’s 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 Corporation’s investment management and trust services income may 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 Corporation’s revenue would be negatively impacted. In addition, the Corporation’s ability to sell its brokerage services in the future will be dependent, in part, upon consumers’ level of confidence in the outlook for rising securities prices.

 

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Debt Security Market 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 Corporation’s debt security investments 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 Corporation’s investments in auction rate certificates and corporate debt securities are susceptible to market price risk.

Auction Rate Certificates

The Corporation’s debt securities include investments in student loan auction rate securities, also known as auction rate certificates (ARCs) with a cost basis of $292.3 million and fair value of $288.1 million, or 1.8% of total assets at March 31, 2010.

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, at March 31, 2010, the fair value of ARCs were derived using significant unobservable inputs based on an expected cash flow model which produced fair values that 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 ARCs is also a factor in the determination of their estimated fair value. As of March 31, 2010, approximately $260 million, or 90%, of the ARCs were rated above investment grade, with approximately $187 million, or 65%, AAA rated by at least one ratings agency. Approximately $30 million, or 10%, of ARCs are rated below investment grade by at least one ratings agency. Of this amount, approximately $17 million, or 57%, of the student loans underlying the ARCs have principal payments which are guaranteed by the Federal government. In total, approximately $255 million, or 88%, of the student loans underlying the ARCs have principal payments which are guaranteed by the Federal government. All ARCs were current and making scheduled interest payments. At March 31, 2010, the risk of changes in the estimated fair values of ARCs due to deterioration in the credit quality of their underlying debt instruments was 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:

 

     March 31, 2010
     Amortized
cost
   Estimated fair
value
     (in thousands)

Single-issuer trust preferred securities

   $ 95,500    $ 80,691

Subordinated debt

     34,913      34,113

Pooled trust preferred securities

     16,295      4,900
             

Total corporate debt securities issued by financial institutions

   $ 146,708    $ 119,704
             

 

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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 Corporation’s investments in single-issuer trust preferred securities had an unrealized loss of $14.8 million as of March 31, 2010. The Corporation did not record any other-than-temporary impairment charges for single-issuer trust preferred securities during the three months ended March 31, 2010. The Corporation holds 11 single-issuer trust preferred securities that are rated below investment grade by at least one ratings agency, with an amortized cost of $37.1 million and an estimated fair value of $33.2 million as of March 31, 2010. 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 $7.1 million as of March 31, 2010, 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. See Note I, “Fair Value Measurements”, in the Notes to Consolidated Financial Statements for additional details.

During the three months ended March 31, 2010, the Corporation recorded $4.2 million of other-than-temporary impairment losses for pooled trust preferred securities, based on an expected cash flows model. The Corporation holds ten pooled trust preferred securities. Nine of these securities, with an amortized cost of $15.4 million and an estimated fair value of $4.3 million, are rated below investment grade by at least one ratings agency, with ratings ranging from C to Ca. For each of the nine pooled trust preferred securities rated below investment grade, the class of securities held by the Corporation is below the most senior tranche, with the Corporation’s interests being subordinate to other investors in the pool.

The amortized cost of pooled trust preferred securities is the purchase price of the securities, net of cumulative credit related other-than-temporary impairment charges, determined using an expected cash flows model. The most significant input to the expected cash flows model was the expected payment deferral rate for each pooled trust preferred security. The Corporation evaluates the financial metrics, such as capital ratios and non-performing asset ratios, of the individual financial institution issuers that comprise each pooled trust preferred security to estimate its expected deferral rate. The actual weighted average cumulative defaults and deferrals as a percentage of original collateral were approximately 27% as of March 31, 2010. The discounted cash flow modeling for pooled trust preferred securities held by the Corporation assumed an additional 12% expected weighted average deferral rate as of March 31, 2010.

Additional impairment charges for debt securities 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 Corporation’s other-than-temporary impairment evaluations for debt securities and Note I, “Fair Value Measurements”, in the Notes to Consolidated Financial Statements for further discussion related to debt securities’ fair values.

Interest Rate Risk

Interest rate risk creates exposure in two primary areas. First, changes in rates have an impact on the Corporation’s liquidity position and could affect its ability to meet obligations and continue to grow. Second, movements in interest rates can create fluctuations in the Corporation’s net income and changes in the economic value of its equity.

The Corporation employs various management techniques to minimize its exposure to interest rate risk. An Asset/Liability Management Committee (ALCO), consisting of key financial and senior management personnel, meets on a 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.

 

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The following table provides information about the Corporation’s interest rate sensitive financial instruments. The table presents expected cash flows and weighted average rates for each significant interest rate sensitive financial instrument, by expected maturity period. None of the Corporation’s financial instruments are classified as trading. All dollar amounts are in thousands.

 

    Expected Maturity Period           Estimated
Fair Value
    Year 1     Year 2     Year 3     Year 4     Year 5     Beyond     Total    

Fixed rate loans (1)

  $ 1,050,395      $ 512,322      $ 411,700      $ 342,260      $ 273,378      $ 633,853      $ 3,223,908      $ 3,252,832

Average rate

    4.81     6.50     6.45     6.37     6.53     5.96     5.83  

Floating rate loans (1) (2)

    2,156,549        1,108,156        891,937        817,354        1,723,117        2,034,845        8,731,958        8,691,753

Average rate

    4.81     5.12     5.13     4.96     4.47     5.60     5.01  

Fixed rate investments (3)

    582,362        477,723        333,999        254,471        173,615        727,093        2,549,263        2,617,311

Average rate

    4.41     4.62     4.66     4.69     4.65     4.31     4.50  

Floating rate investments (3)

    0        500        292,341        101        207        73,563        366,712        344,260

Average rate

    0     4.11     4.34     1.18     1.65     2.52     3.98  

Other interest-earning assets

    61,640        0        0        0        0        0        61,640        61,640

Average rate

    3.71     0     0     0     0     0     3.71  
                                                             

Total

  $ 3,850,946      $ 2,098,701      $ 1,929,977      $ 1,414,186      $ 2,170,317      $ 3,469,354      $ 14,933,481      $ 14,967,796

Average rate

    4.73     5.34     5.21     5.26     4.74     5.33     5.07  
                                                             

Fixed rate deposits (4)

  $ 3,207,407      $ 793,347      $ 378,381      $ 126,148      $ 54,037      $ 12,381      $ 4,571,701      $ 4,614,223

Average rate

    1.78     2.48     3.26     3.36     2.86     2.69     2.09  

Floating rate deposits (5)

    3,244,455        181,996        179,470        170,904        172,847        1,596,883        5,546,555        5,546,555

Average rate

    0.84     0.55     0.55     0.52     0.53     0.34     0.66  

Fixed rate borrowings (6)

    411,750        87,824        30,815