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FULTON FINANCIAL CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Management's Discussion and Analysis of Financial Condition and Results of Operations (Management's Discussion) relates to 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 condition and results of operations. Many factors could affect future financial results including, without limitation: the impact of adverse changes in the economy and real estate markets; increases in non-performing assets which may reduce the level of the earning assets and require the Corporation to increase the allowance for credit losses, charge-off loans and incur elevated collection and carrying costs related to such non-performing assets; acquisition and growth strategies; market risk; changes or adverse developments in political or regulatory conditions; a disruption in or abnormal functioning of credit and other markets, including the lack of or reduced access to markets for mortgages and other asset-backed securities and for commercial paper and other short-term borrowings; changes in the levels of, or methodology for determining, FDIC deposit insurance premiums and assessments; the effect of competition and interest rates on net interest margin and net interest income; investment strategy and other 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; relative balances of rate-sensitive assets to rate-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," "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 and uncertainties, some of which are beyond the Corporation's control and ability to predict, that could cause actual results to differ materially from those expressed 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. 34-------------------------------------------------------------------------------- Table of Contents The following table presents a summary of the Corporation's earnings and selected performance ratios: As of or for the As of or for the Three months ended Six months ended June 30 June 30 2011 2010 2011 2010 Net income available to common shareholders (in thousands) $ 36,385 $ 26,616 $ 70,170 $ 49,031 Income before income taxes (in thousands) $ 49,539 $ 42,965 $ 95,699 $ 79,712 Diluted net income per share (1) $ 0.18 $ 0.14 $ 0.35 $ 0.27 Return on average assets 0.91 % 0.77 % 0.88 % 0.72 % Return on average common equity (2) 7.53 % 6.06 % 7.38 % 5.90 % Return on average tangible common equity (3) 10.71 % 9.10 % 10.54 % 9.11 % Net interest margin (4) 3.95 % 3.76 % 3.93 % 3.77 % Non-performing assets to total assets 2.18 % 2.06 % 2.18 % 2.06 % Net charge-offs to average loans (annualized) 1.30 % 0.97 % 1.36 % 0.96 % (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, as adjusted for intangible asset amortization (net of tax), divided by average common shareholders' equity, net of goodwill and intangible assets. (4) Presented on an FTE 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 second quarter of 2011 increased $6.6 million, or 15.3%, from the same period in 2010. Income before income taxes for the first half of 2011 increased $16.0 million, or 20.1%, in comparison to the first half of 2010. The increase was primarily due to the following significant items: • Increase in other income, excluding investment securities gains (losses), of $3.7 million, or 8.4%, and $7.1 million, or 8.4%, for the three and six months ended June 30, 2011, respectively. During the three and six months ended June 30, 2011, the Corporation experienced growth in a number of other income categories, including mortgage banking income and investment management and trust services. The increase in mortgage banking income was due to an increase in the spread on loans sold, while the improvement in investment management and trust services income resulted from improved market conditions and the Corporation's focus on increasing recurring revenues in the brokerage business. Also contributing to the growth in other income were increased debit card fees, merchant fees and foreign currency processing revenues, all resulting from higher transaction volumes. The Corporation was able to achieve growth in other income while controlling discretionary spending. Other expenses increased $1.4 million, or 1.4%, and $2.9 million, or 1.4%, for the three and six months ended June 30, 2011, respectively. • Decrease in the provision for credit losses of $4.0 million, or 10.0%, and $6.0 million, or 7.5%, for the three and six months ended June 30, 2011, respectively. Non-performing loans and overall delinquencies decreased as of June 30, 2011 in comparison to June 30, 2010, which are positive indicators of improving asset quality. Net charge-offs increased for both the quarter and first half of 2011 in comparison to the same periods in 2010. Charge-offs typically occur after losses are recognized through the provision for credit losses, which establish the appropriate allowance allocation levels. • Increase in net interest income of $1.5 million, or 1.1%, and $2.5 million, or 0.9%, for the three and six months ended June 30, 2011, respectively. The increases in net interest income for the three and six months ended June 30, 2011 were a result of increase in the net interest margin. For the second quarter of 2011, the net interest margin increased 19 basis points, or 5.1%, in comparison to the second quarter of 2010. For the first half of 2011, the net interest margin increased 16 basis points, or 4.2%, 35 -------------------------------------------------------------------------------- Table of Contents in comparison to the first half of 2010. These increases in net interest margin were a result of decreased funding costs due to the repricing of time deposits and long-term debt, in addition to a change in the funding mix to lower cost demand and savings deposits. The increases in net interest margin were partially offset by decreases in average interest-earning assets. Quarter Ended June 30, 2011 compared to the Quarter Ended June 30, 2010 Net Interest Income FTE net interest income increased $1.6 million, or 1.1%, from $143.0 million in the second quarter of 2011 to $144.6 million in the second quarter of 2011. This increase was the net result of a $12.6 million decrease in FTE interest income and a $14.2 million decrease in interest expense. Net interest margin increased 19 basis points, or 5.1%, from 3.76% for the second quarter of 2010 to 3.95% for the second quarter of 2011. The increase in net interest margin was a result of a 41 basis point, or 25.6%, decrease in funding costs, partially offset by a 15 basis point, or 3.0%, decrease in yields on interest-earning assets. 36 -------------------------------------------------------------------------------- Table of Contents The following table provides a comparative average balance sheet and net interest income analysis for the second quarter of 2011 as compared to the same period in 2010. 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 June 30 2011 2010 Average Yield/ Average Yield/ ASSETS Balance Interest (1) Rate Balance Interest (1) Rate Interest-earning assets: Loans, net of unearned income (2) $ 11,883,019 $ 151,974 5.13 % $ 11,959,176 $ 159,632 5.35 % Taxable investment securities (3) 2,141,307 20,749 3.88 2,386,695 25,146 4.22 Tax-exempt investment securities (3) 343,214 4,840 5.64 355,186 5,152 5.80 Equity securities (3) 128,258 775 2.42 140,271 733 2.09 Total investment securities 2,612,779 26,364 4.04 2,882,152 31,031 4.31 Loans held for sale 36,793 492 5.34 59,412 667 4.49 Other interest-earning assets 163,548 101 0.25 366,200 231 0.25 Total interest-earning assets 14,696,139 178,931 4.88 % 15,266,940 191,561 5.03 % Noninterest-earning assets: Cash and due from banks 278,393 261,576 Premises and equipment 207,141 203,928 Other assets 1,098,116 1,102,587 Less: Allowance for loan losses (273,593 ) (275,209 ) Total Assets $ 16,006,196 $ 16,559,822 LIABILITIES AND EQUITY Interest-bearing liabilities: Demand deposits $ 2,352,961 $ 1,371 0.23 % $ 2,019,605 $ 1,840 0.37 % Savings deposits 3,356,361 3,258 0.39 3,090,857 5,388 0.70 Time deposits 4,353,352 17,146 1.58 5,120,648 24,591 1.93 Total interest-bearing deposits 10,062,674 21,775 0.87 10,231,110 31,819 1.25 Short-term borrowings 455,831 168 0.15 512,583 390 0.30 FHLB advances and long-term debt 1,025,637 12,347 4.82 1,403,410 16,313 4.66 Total interest-bearing liabilities 11,544,142 34,290 1.19 % 12,147,103 48,522 1.60 % Noninterest-bearing liabilities: Demand deposits 2,362,614 2,079,674 Other 162,202 199,778 Total Liabilities 14,068,958 14,426,555 Shareholders' equity 1,937,238 2,133,267 Total Liabilities and Shareholders' Equity $ 16,006,196 $ 16,559,822 Net interest income/net interest margin (FTE) 144,641 3.95 % 143,039 3.76 % Tax equivalent adjustment (3,996 ) (3,881 ) Net interest income $ 140,645 $ 139,158 (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. 37 -------------------------------------------------------------------------------- Table of Contents The following table summarizes the changes in FTE interest income and interest expense due to changes in average balances (volume) and changes in rates: 2011 vs. 2010 Increase (decrease) due to change in Volume Rate Net (in thousands) Interest income on: Loans, net of unearned income $ (1,011 ) $ (6,647 ) $ (7,658 ) Taxable investment securities (2,466 ) (1,931 ) (4,397 ) Tax-exempt investment securities (171 ) (141 ) (312 ) Equity securities (67 ) 109 42 Loans held for sale (285 ) 110 (175 ) Other interest-earning assets (125 ) (5 ) (130 ) Total interest income $ (4,125 ) $ (8,505 ) $(12,630 ) Interest expense on: Demand deposits $ 269 $ (738 ) $ (469 ) Savings deposits 430 (2,560 ) (2,130 ) Time deposits (3,384 ) (4,061 ) (7,445 ) Short-term borrowings (41 ) (181 ) (222 ) FHLB advances and long-term debt (4,499 ) 533 (3,966 ) Total interest expense $ (7,225 ) $ (7,007 ) $(14,232 ) FTE interest income decreased $12.6 million, or 6.6%. A 15 basis point, or 3.0%, decrease in average yields resulted in an $8.5 million decrease in interest income. The remaining $4.1 million decrease was due to a $570.8 million, or 3.7%, decrease in average interest-earning assets. Average loans, by type, are summarized in the following table: Three months ended June 30 Increase (decrease) 2011 2010 $ % (dollars in thousands) Real estate - commercial mortgage $ 4,430,046 $ 4,319,540 $ 110,506 2.6 % Commercial - industrial, financial and agricultural 3,689,877 3,686,442 3,435 0.1 Real estate - home equity 1,623,438 1,638,260 (14,822 ) (0.9 ) Real estate - residential mortgage 1,023,471 972,129 51,342 5.3 Real estate - construction 712,638 909,836 (197,198 ) (21.7 ) Consumer 332,960 362,883 (29,923 ) (8.2 ) Leasing and other 70,589 70,086 503 0.7 Total $ 11,883,019 $ 11,959,176 $ (76,157 ) (0.6 %) Geographically, the $110.5 million, or 2.6%, increase in commercial mortgages was largely due to increases in the Corporation's Pennsylvania market of $94.1 million, or 4.2%. The $51.3 million, or 5.3%, increase in residential mortgages was a result of the Corporation's retention in portfolio of certain 10 and 15 year fixed rate mortgages and certain adjustable rate mortgages to partially mitigate the impact of decreases in average interest-earning assets. The $197.2 million, or 21.7%, decrease in construction loans was primarily due to efforts to reduce credit exposure in this portfolio as payoffs exceeded new loan originations in recent quarters. Geographically, the decline in construction loans was primarily in the Corporation's Maryland ($80.8 million, or 38.7%), Virginia ($72.8 million, or 32.1%) and New Jersey ($47.4 million, or 29.0%) markets. 38 -------------------------------------------------------------------------------- Table of Contents The $29.9 million, or 8.2%, decrease in consumer loans occurred throughout all of the Corporation's markets, with $19.7 million of the decrease related to direct consumer loans and $10.2 million of the decrease attributable to the indirect automobile loan portfolio. The average yield on loans decreased 22 basis points, or 4.1%, from 5.35% in 2010 to 5.13% in 2011, despite the average prime rate remaining at 3.25% for the second quarters of both 2011 and 2010. The decrease in average yields on loans was attributable to repayments of higher-yielding loans and declining average rates on fixed and adjustable rate loans which, unlike floating rate loans, have a lagged repricing effect. In addition, approximately one-third of the floating rate portfolio is based on an index other than prime, such as the one-month London Interbank Offering Rate, or LIBOR, which decreased on average for the second quarter of 2011 in comparison the second quarter of 2010. Average investments decreased $269.4 million, or 9.3%, due largely to sales and maturities of mortgage-backed securities and collateralized mortgage obligations. During the second quarter of 2011, proceeds from the sales and maturities of securities were not fully reinvested into the portfolio because current rates on many investment options were not attractive. The average yield on investments decreased 27 basis points, or 6.3%, from 4.31% in 2010 to 4.04% in 2011, as the reinvestment of cash flows and incremental purchases of taxable investment securities were at yields lower than the overall portfolio yield. Other interest-earning assets, consisting of interest-bearing deposits with other banks, decreased $202.7 million, or 55.3%. During the second quarter of 2010, the Corporation invested $226.3 million of proceeds received in connection with a May 2010 common stock offering in short-term funds, prior to the redemption of its outstanding preferred stock in July 2010. Interest expense decreased $14.2 million, or 29.3%, to $34.3 million in the second quarter of 2011 from $48.5 million in the second quarter of 2010. Interest expense decreased $7.2 million as a result of a $603.0 million, or 5.0%, decline in average interest-bearing liabilities. Interest expense decreased an additional $7.0 million as a result of a 41 basis point, or 25.6%, decrease in the average cost of interest-bearing liabilities. Average deposits, by type, are summarized in the following table: Three months ended June 30 Increase (decrease) 2011 2010 $ % (dollars in thousands) Noninterest-bearing demand $ 2,362,614 $ 2,079,674 $ 282,940 13.6 % Interest-bearing demand 2,352,961 2,019,605 333,356 16.5 Savings 3,356,361 3,090,857 265,504 8.6 Total demand and savings 8,071,936 7,190,136 881,800 12.3 Time deposits 4,353,352 5,120,648 (767,296 ) (15.0 ) Total deposits $ 12,425,288 $ 12,310,784 $ 114,504 0.9 % Total demand and savings accounts increased $881.8 million, or 12.3%. The increase in noninterest-bearing account balances was primarily due to a $218.4 million, or 15.2%, increase in business account balances due, in part, to businesses maintaining higher balances to offset service fees, as well as a migration away from the Corporation's cash management products due to low interest rates. The increase in interest-bearing demand and savings account balances was due to a $374.7 million, or 34.0%, increase in municipal account balances and a $266.4 million, or 8.6%, increase in personal account balances. The increase in municipal account balances was largely due to attractive interest rates for insured deposit products relative to alternatives. The increase in personal account balances was largely due to customers' migration away from certificates of deposit, as well as the Corporation's promotional efforts with a focus on building customer relationships. 39-------------------------------------------------------------------------------- Table of Contents The decrease in time deposits was almost entirely due to customer certificates of deposit, which decreased $761.6 million, or 14.9%, with the remaining $5.7 million decrease in brokered certificates of deposit. The decrease in customer certificates of deposit was in accounts with original maturity terms of less than two years ($759.9 million, or 23.3%) and jumbo certificates of deposit ($194.7 million, or 46.4%), partially offset by an increase in account balances with original maturity terms greater than two years ($193.0 million, or 13.5%). As noted above, the decrease in customer certificates of deposit was largely due to customers migrating funds to interest-bearing savings and demand accounts in the current low interest rate environment. The average cost of interest-bearing deposits decreased 38 basis points, or 30.4%, from 1.25% in 2010 to 0.87% in 2011 due to a reduction in rates paid on all categories of deposits, and the repricing of time deposits. During the second quarter of 2011, approximately $906 million of time deposits matured at a weighted average rate of 1.47%, while approximately $825 million of time deposits were issued at a weighted average rate of 0.80%. The following table summarizes changes in average short-term and long-term borrowings, by type: Three months ended June 30 Increase (decrease) 2011 2010 $ % (dollars in thousands) Short-term borrowings: Customer repurchase agreements $ 217,657 $ 263,533 $ (45,876 ) (17.4 %) Customer short-term promissory notes 171,958 207,100 (35,142 ) (17.0 ) Total short-term customer funding 389,615 470,633 (81,018 ) (17.2 ) Federal funds purchased 66,216 41,950 24,266 57.8 Total short-term borrowings 455,831 512,583 (56,752 ) (11.1 ) Long-term debt: FHLB advances 641,851 1,020,134 (378,283 ) (37.1 ) Other long-term debt 383,786 383,276 510 0.1 Total long-term debt 1,025,637 1,403,410 (377,773 ) (26.9 ) Total $ 1,481,468 $ 1,915,993 $ (434,525 ) (22.7 %) The $81.0 million, or 17.2%, decrease in short-term customer funding was primarily due to customers transferring funds from the cash management program to deposit products due to the low interest rate environment. The $378.3 million decrease in Federal Home Loan Bank (FHLB) advances was due to maturities, which were not replaced with new advances. 40-------------------------------------------------------------------------------- Table of Contents Provision for Credit Losses and Allowance for Credit Losses The following table presents the activity in the allowance for credit losses: Three months ended June 30, 2011 2010 (dollars in thousands) Loans, net of unearned income outstanding at end of period $ 11,852,491 $ 11,943,384 Daily average balance of loans, net of unearned income $ 11,833,019 $ 11,959,176 Balance of allowance for credit losses at beginning of period $ 271,156 $ 269,254 Loans charged off: Commercial - industrial, financial and agricultural 15,406 13,390 Real estate - residential mortgage 7,707 1,880 Real estate - construction 7,468 9,299 Real estate - commercial mortgage 7,074 3,915 Consumer and home equity 2,331 2,438 Leasing and other 689 610 Total loans charged off 40,675 31,532 Recoveries of loans previously charged off: Commercial - industrial, financial and agricultural 1,003 1,157 Real estate - residential mortgage 190 3 Real estate - construction 79 581 Real estate - commercial mortgage 191 157 Consumer and home equity 435 488 Leasing and other 254 269 Total recoveries 2,152 2,655 Net loans charged off 38,523 28,877 Provision for credit losses 36,000 40,000 Balance of allowance for credit losses at end of period $ 268,633 $ 280,377 Components of the Allowance for Credit Losses: Allowance for loan losses $ 266,683 $ 272,042 Reserve for unfunded lending commitments 1,950 8,335 Allowance for credit losses $ 268,633 $ 280,377 Selected Ratios: Net charge-offs to average loans (annualized) 1.30 % 0.97 % Allowance for credit losses to loans outstanding 2.27 % 2.35 % The provision for credit losses was $36.0 million for the second quarter of 2011, a decrease of $4.0 million, or 10.0%, from the second quarter of 2010. The decrease in the provision for credit losses was due to the continuing improvement in the Corporation's credit quality metrics, including a reduction in the level of non-performing assets and overall delinquency. Net charge-offs increased $9.6 million, or 33.4%, to $38.5 million for the second quarter of 2011 compared to $28.9 million for the second quarter of 2010. The increase in net charge-offs was primarily due to increases in residential mortgage net charge-offs ($5.6 million, or 300.5%), commercial mortgage net charge-offs ($3.1 million, or 83.2%) and commercial loan net charge-offs ($2.2 million, or 17.7%), partially offset by a decline in construction loan net charge-offs ($1.3 million, or 15.2%). Of the $38.5 million of net charge-offs recorded in the second quarter of 2011, 38.0% were for loans originated by the Corporation's banks in New Jersey, 28.9% in Pennsylvania, 19.3% in Virginia and 9.3% in Maryland. Charge-offs for the second quarter of 2011 included one $6.7 million commercial loan charge-off, with no additional individual charge-offs that exceeded $1.0 million. 41-------------------------------------------------------------------------------- Table of Contents The following table summarizes the Corporation's non-performing assets as of the indicated dates: June 30, June 30, December 31, 2011 2010 2010 (dollars in thousands) Non-accrual loans $ 274,973 $ 263,227 $ 280,688 Loans 90 days past due and accruing 35,869 53,707 48,084 Total non-performing loans 310,842 316,934 328,772 Other real estate owned (OREO) 37,493 25,681 32,959 Total non-performing assets $ 348,335 $ 342,615 $ 361,731 Non-accrual loans to total loans 2.32 % 2.20 % 2.35 % Non-performing assets to total assets 2.18 % 2.06 % 2.22 % Allowance for credit losses to non-performing loans 86.42 % 88.47 % 83.80 % Non-performing assets to tangible common shareholders' equity and allowance for credit losses 20.78 % 21.54 % 22.50 % The following table summarizes the Corporation's non-performing loans, by type, as of the indicated dates: June 30, June 30, December 31, 2011 2010 2010 (in thousands) Real estate - commercial mortgage $ 102,724 $ 101,378 $ 93,720 Commercial - industrial, financial and agricultural 94,855 77,587 87,455 Real estate - construction 58,381 79,122 84,616 Real estate - residential mortgage 43,200 45,639 50,412 Real estate - home equity 9,440 11,090 10,188 Consumer 2,090 2,025 2,154 Leasing 152 93 227 Total non-performing loans $ 310,842 $ 316,934 $ 328,772 Non-performing loans decreased to $310.8 million at June 30, 2011, from $316.9 million at June 30, 2010. The $6.1 million, or 1.9%, decrease was due to a $20.7 million, or 26.2%, decrease in non-performing construction loans and a $2.4 million, or 5.3%, decrease in non-performing residential mortgages, partially offset by a $17.3 million, or 22.3%, increase in non-performing commercial loans. The $20.7 million decrease in non-performing construction loans was due to $57.9 million of charge-offs recorded since June 30, 2010, partially offset by additions to non-performing construction loans. Geographically, the decrease in non-performing construction loans was in the Corporation's Maryland ($17.1 million, or 50.2%) and Pennsylvania ($7.2 million, or 58.8%) markets, partially offset by an increase in the Virginia ($3.7 million, or 20.1%) market. The $17.3 million increase in non-performing commercial loans was primarily due to a $16.5 million, or 42.1%, increase in the Corporation's Pennsylvania market, mostly due to the addition of two non-accrual accounts during the second quarter of 2011. 42 -------------------------------------------------------------------------------- Table of Contents The following table presents accruing loans whose terms have been modified under troubled debt restructurings (TDRs), by type, as of the indicated dates: June 30, June 30, December 31, 2011 2010 2010 (in thousands) Real estate - residential mortgage $ 37,006 $ 32,009 $ 37,826 Real estate - commercial mortgage 30,735 16,205 18,778 Real estate - construction 5,589 6,165 5,440 Commercial - industrial, financial and agricultural 3,055 4,314 5,502 Consumer and home equity 258 266 263 Total accruing TDRs $ 76,643 $ 58,959 $ 67,809 The following table summarizes the Corporation's OREO, by property type, as of the indicated dates: June 30, June 30, December 31, 2011 2010 2010 (in thousands) Commercial properties $ 17,033 $ 7,950 $ 15,916 Residential properties 15,881 15,181 12,635 Undeveloped land 4,579 2,550 4,408 Total OREO $ 37,493 $ 25,681 $ 32,959 The following table summarizes loan delinquency rates, by type, as of June 30: 2011 2010 31-89 ³ 90 31-89 ³ 90 Days Days (1) Total Days Days (1) Total Real estate - commercial mortgage 0.57 % 2.32 % 2.89 % 0.81 % 2.34 % 3.15 % Commercial - industrial, financial and agricultural 0.54 2.58 3.12 0.46 2.12 2.58 Real estate - construction 0.62 8.56 9.18 1.07 8.86 9.93 Real estate - residential mortgage 3.37 4.22 7.59 3.65 4.63 8.28 Real estate - home equity 0.74 0.58 1.32 0.83 0.68 1.51 Consumer, leasing and other 1.22 0.56 1.78 1.37 0.49 1.86 Total 0.85 % 2.63 % 3.48 % 0.98 % 2.65 % 3.63 % Total dollars (in thousands) $ 101,213 $ 310,842 $ 412,055 $ 116,772 $ 316,934 $ 433,706 (1) Includes non-accrual loans. The decrease in delinquency rates since the second quarter of 2010 was primarily in loans 31-89 days past due across all loan types, partially offset by an increase in commercial loans greater than 90 days past due. 43-------------------------------------------------------------------------------- Table of Contents The following table presents ending balances of loans outstanding, net of unearned income: June 30, June 30, December 31, 2011 2010 2010 (in thousands) Real-estate - commercial mortgage $ 4,443,025 $ 4,330,630 $ 4,375,980 Commercial - industrial, financial and agricultural 3,678,858 3,664,603 3,704,384 Real-estate - home equity 1,626,545 1,637,171 1,641,777 Real-estate - residential mortgage 1,023,646 985,345 995,990 Real-estate - construction 681,588 893,305 801,185 Consumer 330,965 368,631 350,161 Leasing and other 67,864 63,699 63,830 Loans, net of unearned income $ 11,852,491 $ 11,943,384 $ 11,933,307 Approximately $5.1 billion, or 43.2%, of the Corporation's loan portfolio was in commercial mortgage and construction loans at June 30, 2011. The Corporation did not have a concentration of credit risk with any single borrower, industry or geographical location. However, the performance of real estate markets and general economic conditions adversely impacted the performance of these loans. From 2008 to 2010, the Corporation experienced significant increases in non-performing construction loans and commercial mortgages as a result of weak economic conditions. In comparison to December 31, 2010, non-performing construction loans decreased $26.2 million, or 31.0%, to $58.4 million as of June 30, 2011 as charge-offs and paydowns of certain non-performing construction loans exceeded additions during the first half of 2011. The Corporation continues to reduce its exposure to residential housing development construction loans, most notably in its New Jersey, Virginia and Maryland markets. In comparison to December 31, 2010, non-performing commercial mortgages increased $9.0 million, or 9.6%, to $102.7 million as of June 30, 2011. During the first half of 2011, economic conditions, although slowly improving, continued to place stress on the credit quality of the commercial mortgage portfolio. Commercial loans comprised 31.0% of the total loan portfolio. As with commercial mortgages, the credit quality of these loans has been impacted by general economic conditions, as businesses continued to struggle for growth as a result of reduced consumer spending. Approximately $2.7 billion, or 22.4%, of the Corporation's loan portfolio was in residential mortgage and home equity loans at June 30, 2011. The significant deterioration in residential real estate values in prior years, particularly in portions of New Jersey, Virginia and Maryland, and general economic conditions, resulted in increases in non-performing loans and negatively impacted the overall credit quality of the portfolio. However, as with the commercial loan portfolio, the Corporation experienced a slight decrease in non-performing asset levels during the second quarter of 2011. Effective April 1, 2011, the Corporation changed its allowance for credit loss methodology. This change in allowance methodology did not impact the total allowance for credit losses. See Note D, "Loans and Allowance for Credit Losses" in the Notes to Consolidated Financial Statements for additional details. The Corporation believes that the allowance for credit losses of $268.6 million as of June 30, 2011 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. 44-------------------------------------------------------------------------------- Table of Contents Other Income The following table presents the components of other income: Three months ended June 30 Increase (decrease) 2011 2010 $ % (dollars in thousands) Overdraft fees $ 8,029 $ 9,618 $ (1,589 ) (16.5 )% Cash management fees 2,677 2,514 163 6.5 Other 3,626 3,350 276 8.2 Service charges on deposit accounts 14,332 15,482 (1,150 ) (7.4 ) Debit card income 4,610 4,085 525 12.9 Merchant fees 2,516 2,123 393 18.5 Foreign currency processing income 2,374 1,964 410 20.9 Letter of credit fees 1,271 1,463 (192 ) (13.1 ) Other 1,938 1,834 104 5.7 Other service charges and fees 12,709 11,469 1,240 10.8 Investment management and trust services 9,638 8,655 983 11.4 Mortgage banking income 6,049 3,899 2,150 55.1 Credit card income 1,826 1,442 384 26.6 Gains on sales of OREO 1,593 762 831 109.1 Other 1,560 2,299 (739 ) (32.1 ) Total, excluding investment securities gains (losses) 47,707 44,008 3,699 8.4 Investment securities gains (losses) (335 ) 904 (1,239 ) N/M Total $ 47,372 $ 44,912 $ 2,460 5.5 % N/M - Not meaningful. The $1.6 million, or 16.5%, decrease in overdraft fees was a result of changes in regulations that took effect in August 2010, which require customers to affirmatively consent to the payment of certain types of overdrafts. Increases in debit card income ($525,000, or 12.9%), merchant fees ($393,000, or 18.5%), and foreign currency processing revenues ($410,000, or 20.9%) all resulted from higher transaction volumes. The Federal Reserve recently issued revised pricing guidelines regarding interchange income on certain debit card transactions which must be implemented by October 2011, as required under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"). These revised pricing guidelines are higher than those in the original proposal, but are significantly lower than current rates. Under the revised pricing guidelines, the $4.6 million of debit card income earned by the Corporation during the second quarter of 2011 would have been approximately $2.2 million less. The $983,000, or 11.4%, increase in investment management and trust services income was due to a $509,000, or 15.7%, increase in brokerage revenue, due both to an improvement in the market values of assets under management and the Corporation's expanded focus on generating recurring revenues in the brokerage business. Trust commissions increased $474,000, or 8.7%, primarily due to improved market conditions. The $2.2 million, or 55.1%, increase in mortgage banking income was due to an improvement in the spreads on loans sold, partially offset by a $39.1 million, or 14.4%, decrease in the volume of loans sold. 45-------------------------------------------------------------------------------- Table of Contents The $384,000, or 26.6%, increase in credit card income was due to an increase in new card applications, higher average balances and an increase in the volume of transactions on credit cards previously originated, which generate fees under a joint marketing agreement with an independent third-party. Gains on sales of OREO increased $831,000, or 109.1%. Combined with net losses on sales of OREO of $580,000, recorded within other expenses, net gains on sales were $1.0 million, compared to a net gain of $257,000 for the second quarter of 2010. The $739,000, or 32.1%, decrease in other income was due to an increase in insurance claims experienced by the Corporation's reinsurance subsidiary, which engages in the business of reinsuring credit life and accident and health insurance directly related to extensions of credit by the Corporation's banking subsidiaries. Also contributing to the decrease was a $202,000 decrease in gains on sales of branch assets. The $335,000 of investment securities losses for the second quarter of 2011 included $58,000 of net gains on the sales of securities, more than offset by $393,000 of other-than-temporary impairment charges. The Corporation recorded $359,000 million of other-than-temporary impairment charges for pooled trust preferred securities issued by financial institutions and $34,000 of other-than-temporary impairment charges related to stocks of financial institutions. See Note C, "Investment Securities," in the Notes to Consolidated Financial Statements for additional details. Investment securities gains of $904,000 for the second quarter of 2010 included $4.4 million of net gains on the sales of securities partially offset by $3.5 million of other-than-temporary impairment charges. During the second quarter of 2010, the Corporation recorded $3.0 million of other-than-temporary impairment charges for pooled trust preferred securities issued by financial institutions and $509,000 of other-than-temporary impairment charges for certain stocks of financial institutions. Other Expenses The following table presents the components of other expenses: Three months ended June 30 Increase (decrease) 2011 2010 $ % (dollars in thousands) Salaries and employee benefits $ 56,070 $ 54,654 $ 1,416 2.6 % Net occupancy expense 10,874 10,519 355 3.4 Equipment expense 3,377 2,663 714 26.8 FDIC insurance expense 3,264 5,136 (1,872 ) (36.4 ) Data processing 3,214 3,311 (97 ) (2.9 ) Professional fees 3,102 3,035 67 2.2 OREO and repossession expense 2,575 1,876 699 37.3 Telecommunications 2,020 2,086 (66 ) (3.2 ) Software 1,972 1,706 266 15.6 Marketing 1,863 2,271 (408 ) (18.0 ) Supplies 1,416 1,369 47 3.4 Postage 1,288 1,455 (167 ) (11.5 ) Intangible amortization 1,172 1,341 (169 ) (12.6 ) Other 10,271 9,683 588 6.1 Total $ 102,478 $ 101,105 $ 1,373 1.4 % Salaries and employee benefits increased $1.4 million, or 2.6%, with salaries increasing $1.8 million, or 4.1%, and employee benefits decreasing $395,000, or 3.9%. The increase in salaries was primarily due to a $521,000 increase in incentive compensation, a $236,000 increase in stock-based compensation expense and normal merit increases. 46 -------------------------------------------------------------------------------- Table of Contents The decrease in employee benefits was primarily due to a decrease in healthcare costs, partially offset by an increase in severance costs. The $714,000, or 26.8%, increase in equipment expense was due to higher depreciation expense, primarily related to the addition of assets supporting the Corporation's technology infrastructure, and increased maintenance costs. The $1.9 million, or 36.4%, decrease in FDIC insurance expense was due to a change in the assessment base, which, effective April 1, 2011 was based on total average assets minus average tangible equity, compared to average domestic deposits for the second quarter of 2010. This change accounted for approximately $1.5 million of the decrease, with the remaining decrease due to the Corporation opting out of the Transaction Account Guarantee program on July 1, 2010. OREO and repossession expense increased $699,000, or 37.3%. OREO and repossession expense is expected to be volatile as the Corporation continues to work through repossessed real estate. The $408,000, or 18.0%, decrease in marketing expense was primarily due to the timing of promotional campaigns. The $588,000, or 6.1%, increase in other expenses included a $315,000 increase in provisions for debit card rewards points earned, a $170,000 increase in state franchise taxes and an increase in information technology consulting costs. These increases in other expenses were partially offset by a $500,000 decrease in reserves associated with the potential repurchase of previously sold residential mortgage and home equity loans recorded during the second quarter of 2011 as the Corporation's exposure to future repurchases was reduced as a result of entering into a settlement agreement with a secondary market investor. Income Taxes Income tax expense for the second quarter of 2011 was $13.2 million, a $1.9 million, or 16.6%, increase from $11.3 million for the second quarter of 2010. The increase was primarily due to the increase in income before income taxes. The Corporation's effective tax rate was 26.6% in 2011, as compared to 26.3% in 2010. 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. Six Months Ended June 30, 2011 compared to the Six Months Ended June 30, 2010 Net Interest Income FTE net interest income increased $2.7 million, or 1.0%, from $285.5 million in the first half of 2010 to $288.2 million in the first half of 2011. This was the net result of a $27.5 million decrease in FTE interest income and a $30.2 million decrease in interest expense. Net interest margin increased 16 basis points, or 4.2%, from 3.77% for the first half of 2010 to 3.93% for the first half of 2011. The increase in net interest margin was a result of a 44 basis point, or 26.7%, decrease in funding costs, partially offset by a 21 basis point, or 4.1%, decrease in yields on interest-earning assets. 47 -------------------------------------------------------------------------------- Table of Contents The following table provides a comparative average balance sheet and net interest income analysis for the first half of 2011 as compared to the same period in 2010. 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. Six months ended June 30 2011 2010 Average Yield/ Average Yield/ ASSETS Balance Interest (1) Rate Balance Interest (1) Rate Interest-earning assets: Loans, net of unearned income (2) $ 11,902,124 $ 303,660 5.14 % $ 11,965,446 $ 319,056 5.37 % Taxable investment securities (3) 2,235,789 42,556 3.81 2,524,149 53,295 4.23 Tax-exempt investment securities (3) 343,832 9,725 5.66 371,488 10,683 5.75 Equity securities (3) 130,537 1,527 2.35 141,079 1,542 2.19 Total investment securities 2,710,158 53,808 3.97 3,036,716 65,520 4.32 Loans held for sale 41,082 992 4.83 51,220 1,223 4.77 Other interest-earning assets 115,233 134 0.23 189,479 256 0.27 Total interest-earning assets 14,768,597 358,594 4.89 % 15,242,861 386,055 5.10 % Noninterest-earning assets: Cash and due from banks 269,444 262,357 Premises and equipment 207,263 203,757 Other assets 1,100,319 1,094,653 Less: Allowance for loan losses (277,782 ) (274,322 ) Total Assets $ 16,067,841 $ 16,529,306 LIABILITIES AND EQUITY Interest-bearing liabilities: Demand deposits $ 2,337,615 $ 2,807 0.24 % $ 2,000,734 $ 3,680 0.37 % Savings deposits 3,319,778 6,616 0.40 2,969,814 10,589 0.72 Time deposits 4,442,446 35,638 1.62 5,161,583 51,288 2.00 Total interest-bearing deposits 10,099,839 45,061 0.90 10,132,131 65,557 1.30 Short-term borrowings 538,786 422 0.16 691,289 939 0.27 FHLB advances and long-term debt 1,043,481 24,938 4.80 1,443,600 34,105 4.75 Total interest-bearing liabilities 11,682,106 70,421 1.21 % 12,267,020 100,601 1.65 % Noninterest-bearing liabilities: Demand deposits 2,300,750 2,026,705 Other 166,541 190,207 Total Liabilities 14,149,397 14,483,932 Shareholders' equity 1,918,444 2,045,374 Total Liabilities and Shareholders' Equity $ 16,067,841 $ 16,529,306 Net interest income/net interest margin (FTE) 288,173 3.93 % 285,454 3.77 % Tax equivalent adjustment (7,965 ) (7,787 ) Net interest income $ 280,208 $ 277,667 (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. 48 -------------------------------------------------------------------------------- Table of Contents The following table summarizes the changes in FTE interest income and expense for the first half of 2011 due to changes in average balances (volume) and changes in rates: 2011 vs. 2010 Increase (decrease) due to change in Volume Rate Net (in thousands) Interest income on: Loans, net of unearned income $ (1,744 ) $ (13,652 ) $ (15,396 ) Taxable investment securities (5,748 ) (4,991 ) (10,739 ) Tax-exempt investment securities (799 ) (159 ) (958 ) Equity securities (119 ) 103 (16 ) Loans held for sale (247 ) 16 (231 ) Other interest-earning assets (90 ) (31 ) (121 ) Total interest income $ (8,747 ) $ (18,714 ) $(27,461 ) Interest expense on: Demand deposits $ 550 $ (1,423 ) $ (873 ) Savings deposits 1,132 (5,105 ) (3,973 ) Time deposits (6,569 ) (9,081 ) (15,650 ) Short-term borrowings (178 ) (339 ) (517 ) FHLB advances and long-term debt (9,489 ) 322 (9,167 ) Total interest expense $ (14,554 ) $ (15,626 ) $ (30,180 ) Interest income decreased $27.5 million, or 7.1%. A 21 basis point, or 4.1%, decrease in average yields resulted in an $18.7 million decrease in interest income. The remaining $8.7 million decrease was due to a $474.3 million, or 3.1%, decrease in average interest-earning assets. Average loans, by type, are summarized in the following table: Six months ended June 30 Increase (decrease) 2011 2010 $ % (dollars in thousands) Real estate - commercial mortgage $ 4,407,683 $ 4,312,942 $ 94,741 2.2 % Commercial - industrial, financial and agricultural 3,698,430 3,686,425 12,005 0.3 Real estate - home equity 1,625,980 1,639,579 (13,599 ) (0.8 ) Real estate - residential mortgage 1,020,471 956,478 63,993 6.7 Real estate - construction 745,912 935,861 (189,949 ) (20.3 ) Consumer 337,080 362,549 (25,469 ) (7.0 ) Leasing and other 66,568 71,612 (5,044 ) (7.0 ) Total $ 11,902,124 $ 11,965,446 $ (63,322 ) (0.5 %) Geographically, the $94.7 million, or 2.2%, increase in commercial mortgages was attributable to the Corporation's Pennsylvania ($66.7 million, or 3.0%), New Jersey ($13.5 million, or 1.1%), Maryland ($7.5 million, or 1.9%) and Virginia ($4.1 million, or 1.2%) markets. The $64.0 million, or 6.7%, increase in residential mortgages was largely due to the Corporation's retention in portfolio of certain 10 and 15 year fixed rate mortgages and certain adjustable rate mortgages to partially mitigate the impact of decreases in average interest-earning assets. 49-------------------------------------------------------------------------------- Table of Contents The $189.9 million, or 20.3%, decrease in construction loans was primarily due to efforts to decrease credit exposure in this portfolio. Geographically, the decline was attributable to the Maryland ($90.5 million, or 40.1%), Virginia ($70.2 million, or 30.1%) and New Jersey ($47.5 million, or 28.2%) markets, partially offset by an increase in the Pennsylvania ($12.6 million, or 4.3%) market. The $25.5 million, or 7.0%, decrease in consumer loans occurred throughout most of the Corporation's markets, with $15.6 million of the decrease related to direct consumer loans and $9.9 million of the decrease attributable to the indirect automobile loan portfolio. The average yield on loans decreased 23 basis points, or 4.3%, from 5.37% in 2010 to 5.14% in 2011, despite the average prime rate remaining at 3.25% for the first half of both 2011 and 2010. The decrease in average yields on loans was attributable to repayments of higher-yielding loans and declining average rates on fixed and adjustable rate loans which, unlike floating rate loans, have a lagged repricing effect. In addition, approximately one-third of the floating rate portfolio is based on an index other than prime, such as the one-month LIBOR, which decreased on average for the first half of 2011 in comparison the first half of 2010. Average investments decreased $326.6 million, or 10.8%, due largely to sales and maturities of mortgage-backed securities and collateralized mortgage obligations, in addition to maturities of other debt securities. During the first half of 2011, proceeds from the sales and maturities of securities were not fully reinvested into the portfolio because current rates on many investment options were not attractive. The average yield on investments decreased 35 basis points, or 8.1%, from 4.32% in 2010 to 3.97% in 2011, as the reinvestment of cash flows and incremental purchases of taxable investment securities were at yields lower than the overall portfolio yield. Interest expense decreased $30.2 million, or 30.0%, to $70.4 million in the first half of 2011 from $100.6 million in the first half of 2010. Interest expense decreased $15.6 million as a result of a 44 basis point, or 26.7%, decrease in the average cost of interest-bearing liabilities. Interest expense decreased an additional $14.6 million as a result of a $584.9 million, or 4.8%, decline in average interest-bearing liabilities. The following table summarizes the changes in average deposits, by type: Six months ended June 30 Increase (decrease) 2011 2010 $ % (dollars in thousands) Noninterest-bearing demand $ 2,300,750 $ 2,026,705 $ 274,045 13.5 % Interest-bearing demand 2,337,615 2,000,734 336,881 16.8 Savings 3,319,778 2,969,814 349,964 11.8 Total demand and savings 7,958,143 6,997,253 960,890 13.7 Time deposits 4,442,446 5,161,583 (719,137 ) (13.9 ) Total deposits $ 12,400,589 $ 12,158,836 $ 241,753 2.0 % The $274.0 million, or 13.5%, increase in noninterest-bearing accounts was primarily due to a $219.5 million, or 15.8%, increase in business account balances due, in part, to businesses maintaining higher balances to offset service fees, as well as a migration from the Corporation's cash management products due to low interest rates. The $686.8 million, or 13.8%, increase in interest-bearing demand and savings accounts was due to a $392.7 million, or 37.4%, increase in municipal account balances and a $333.2 million, or 11.1%, increase in personal account balances. The increase in municipal account balances was largely due to attractive interest rates for insured deposit products relative to alternatives. The increase in personal accounts was largely due to a decrease in customer certificates of deposit as well as the Corporation's promotional efforts with a focus on building customer relationships. The decrease in time deposits was almost entirely due to customer certificates of deposit, which decreased $712.0 million, or 13.8%, with the remaining $7.1 million decrease in brokered certificates of deposit. 50-------------------------------------------------------------------------------- Table of Contents The decrease in customer certificates of deposit was in accounts with original maturity terms of less than two years ($804.7 million, or 23.9%), and jumbo certificates of deposit ($175.5 million, or 42.9%), partially offset by an increase in account balances with original maturity terms greater than two years ($34.4 million, or 1.2%). As noted above, the decrease in customer certificates of deposit was largely due to customers migrating funds to interest-bearing savings and demand accounts in the current low rate environment. The average cost of interest-bearing deposits decreased 40 basis points, or 30.8%, from 1.30% in 2010 to 0.90% in 2011 due to a reduction in rates paid on all categories of deposits and the repricing of certificates of deposit. The following table summarizes changes in average short-term and long-term borrowings, by type: Six months ended June 30 Increase (decrease) 2011 2010 $ % (dollars in thousands) Short-term borrowings: Customer repurchase agreements $ 215,307 $ 256,298 $ (40,991 ) (16.0 %) Customer short-term promissory notes 181,121 215,224 (34,103 ) (15.8 ) Total short-term customer funding 396,428 471,522 (75,094 ) (15.9 ) Federal funds purchased 142,358 219,767 (77,409 ) (35.2 ) Total short-term borrowings 538,786 691,289 (152,503 ) (22.1 ) Long-term debt: FHLB advances 659,781 1,060,290 (400,509 ) (37.8 ) Other long-term debt 383,700 383,310 390 0.1 Total long-term debt 1,043,481 1,443,600 (400,119 ) (27.7 ) Total $ 1,582,267 $ 2,134,889 $ (552,622 ) (25.9 %) The $75.1 million decrease in short-term customer funding resulted from customers transferring funds from the cash management program to deposits due to the low interest rate environment. The decrease in Federal funds purchased was due to increases in non-interest and interest bearing demand and savings accounts, combined with the decreases in investments and loans, the result of which was a reduced funding need for the Corporation. The $400.5 million decrease in FHLB advances was due to maturities, which were generally not replaced with new advances. 51 -------------------------------------------------------------------------------- Table of Contents Provision for Loan Losses and Allowance for Credit Losses The following table presents the activity in the allowance for credit losses: Six months ended June 30 2011 2010 (dollars in thousands) Loans, net of unearned income outstanding at end of period $ 11,852,491 $ 11,943,384 Daily average balance of loans, net of unearned income $ 11,902,124 $ 11,965,446 Balance of allowance for credit losses at beginning of period $ 275,498 $ 257,553 Loans charged off: Commercial - industrial, financial and agricultural 28,742 16,371 Real estate - construction 21,362 29,852 Real estate - commercial mortgage 17,121 6,259 Real estate - residential mortgage 12,703 3,271 Consumer and home equity 5,090 4,516 Leasing and other 1,186 1,255 Total loans charged off 86,204 61,524 Recoveries of loans previously charged off: Commercial - industrial, agricultural and financial 1,394 1,593 Real estate - construction 642 896 Real estate - commercial mortgage 1,726 285 Real estate - residential mortgage 234 4 Consumer and home equity 745 1,040 Leasing and other 598 530 Total recoveries 5,339 4,348 Net loans charged off 80,865 57,176 Provision for loan losses 74,000 80,000 Balance of allowance for credit losses at end of period $ 268,633 $ 280,377 Net charge-offs to average loans (annualized) 1.36 % 0.96 % The provision for loan losses was $74.0 million for the first half of 2011, a decrease of $6.0 million, or 7.5%, over the same period in 2010. The decrease in the provision for credit losses was due to the continuing improvement in the Corporation's credit quality metrics, including a reduction in the level of non-performing assets and overall delinquency. Net charge-offs increased $23.7 million, or 41.4%, to $80.9 million for the first half of 2011 compared to $57.2 million for the first half of 2010. Annualized net charge-offs to average loans increased 40 basis points, or 41.7%, to 1.36% for the first half of 2011. The $23.7 million increase in net charge-offs was primarily due to increases in commercial loan net charge-offs ($12.6 million, or 85.1%), commercial mortgage net charge-offs ($9.4 million, or 157.7%) and residential mortgage net charge-offs ($9.2 million, 281.7%), partially offset by a decrease in construction loan net charge-offs ($8.2 million, or 28.4%). Of the $80.9 million of net charge-offs recorded in the first half of 2011, 31.2% were in New Jersey, 24.8% in Virginia, 21.8% Pennsylvania and 19.8% in Maryland. During the first half of 2011, there were 13 individual charge-offs which exceeded $1.0 million, totaling $29.2 million, of which $16.1 million were commercial loans, $6.4 million were construction loans, $5.5 million were commercial mortgages and $1.3 million was for a residential mortgage. 52-------------------------------------------------------------------------------- Table of Contents Other Income The following table presents the components of other income: Six months ended June 30 Increase (decrease) 2011 2010 $ % (dollars in thousands) Overdraft fees $ 15,600 $ 18,502 $ (2,902 ) (15.7 %) Cash management fees 5,127 4,791 336 7.0 Other 6,910 6,456 454 7.0 Service charges on deposit accounts 27,637 29,749 (2,112 ) (7.1 ) Debit card income 8,814 7,619 1,195 15.7 Merchant fees 4,663 3,947 716 18.1 Foreign currency processing income 4,571 3,902 669 17.1 Letter of credit fees 2,526 2,702 (176 ) (6.5 ) Other 3,617 3,464 153 4.4 Other service charges and fees 24,191 21,634 2,557 11.8 Investment management and trust services 18,842 16,743 2,099 12.5 Mortgage banking income 11,512 8,048 3,464 43.0 Credit card income 3,422 2,893 529 18.3 Gains on sales of OREO 2,292 1,226 1,066 86.9 Other 3,686 4,198 (512 ) (12.2 ) Total, excluding investment securities gains (losses) 91,582 84,491 7,091 8.4 Investment securities gains (losses) 1,950 (1,319 ) 3,269 N/M Total $ 93,532 $ 83,172 $ 10,360 12.5 % N/M - Not meaningful. The $2.9 million, or 15.7%, decrease in overdraft fees was a result of changes in regulations that took effect in August 2010, which require customers to affirmatively consent to the payment of certain types of overdrafts. Increases in debit card income ($1.2 million, or 15.7%), merchant fees ($716,000, or 18.1%), and foreign currency processing revenues ($669,000, or 17.1%) all resulted from higher transaction volumes. The $2.1 million, or 12.5%, increase in investment management and trust services income was due to a $1.3 million, or 22.1%, increase in brokerage revenue and a $769,000, or 7.2%, increase in trust commissions. The increase in brokerage revenue resulted from both an improvement in the market values of assets under management and the Corporation's expanded focus on generating recurring revenues in the brokerage business. The $3.5 million, or 43.0%, increase in mortgage banking income was primarily due to an improvement in the spreads on loans sold and partially due to a $35.1 million, or 7.0%, increase in the volume of loans sold, which was driven by higher refinance activity in the first half of 2011 compared to the first half of 2010. The $529,000, or 18.3%, increase in credit card income was due to an increase in new card applications, higher average balances and an increase in the volume of transactions on credit cards previously originated, which generate fees under a joint marketing agreement with an independent third-party. Gains on sales of OREO increased $1.1 million, or 86.9%. Combined with net losses on sales of OREO of $744,000, recorded within other expenses, net gains on sales were $1.5 million, compared to a net gain of $219,000 for the first half of 2010. 53 -------------------------------------------------------------------------------- Table of Contents The $512,000, or 12.2%, decrease in other income was due to an increase in insurance claims experienced by the Corporation's reinsurance subsidiary and a $178,000 decrease in gains on sales of branch assets. Investment securities gains of $2.0 million for the first half of 2011 included $3.6 million of net gains on the sales of securities, offset by $1.7 million of other-than-temporary impairment charges. The Corporation recorded $1.4 million of other-than-temporary impairment charges for pooled trust preferred securities issued by financial institutions and $331,000 of other-than-temporary impairment charges for certain financial institution stocks. The $1.3 million of investment securities losses for the first half of 2010 resulted from $7.2 million of net gains on the sales of securities, which were more than offset by $7.1 million of other-than-temporary impairment charges for debt securities issued by financial institutions and $1.3 million of other-than-temporary impairment charges for certain financial institution stocks. 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: Six months ended June 30 Increase (decrease) 2011 2010 $ % (dollars in thousands) Salaries and employee benefits $ 110,378 $ 106,999 $ 3,379 3.2 % Net occupancy expense 22,240 22,169 71 0.3 FDIC insurance expense 8,018 10,090 (2,072 ) (20.5 ) Data processing 6,586 6,728 (142 ) (2.1 ) Equipment expense 6,509 5,754 755 13.1 Professional fees 5,951 5,581 370 6.6 Marketing 4,699 4,101 598 14.6 OREO and repossession expense 4,545 4,556 (11 ) (0.2 ) Telecommunications 4,192 4,356 (164 ) (3.8 ) Software 4,004 3,320 684 20.6 Supplies 2,791 2,698 93 3.4 Postage 2,694 2,760 (66 ) (2.4 ) Intangible amortization 2,350 2,655 (305 ) (11.5 ) Other 19,084 19,360 (276 ) (1.4 ) Total $ 204,041 $ 201,127 $ 2,914 1.4 % Salaries and employee benefits increased $3.4 million, or 3.2%, with salaries increasing $4.2 million, or 4.8%, and employee benefits decreasing $829,000, or 4.2%. The increase in salaries was due to the ending of a 12-month freeze on merit increases in March 2010, normal merit increases, a $1.2 million increase in incentive compensation and a $490,000 increase in stock-based compensation expense. The $829,000 decrease in employee benefits was primarily due to a decrease in healthcare costs, partially offset by an increase in severance costs. The $2.1 million, or 20.5%, decrease in FDIC insurance expense was due to a change in the assessment base, which, effective April 1, 2011 was based on total average assets minus average tangible equity, compared to average domestic deposits for the first half of 2010. This change accounted for $1.5 million of the decrease, with the remaining decrease mostly due to the Corporation opting out of the Transaction Account Guarantee program on July 1, 2010. The $755,000, or 13.1%, increase in equipment expense was due to higher depreciation expense, primarily related to the addition of assets supporting the Corporation's information technology infrastructure, and 54-------------------------------------------------------------------------------- Table of Contents increased maintenance costs. The $370,000, or 6.6%, increase in professional fees was primarily due to an increase in legal fees associated with the collection and workout efforts for non-performing loans. The $598,000, or 14.6%, increase in marketing expense was primarily due to the timing of promotional campaigns. The $305,000, or 11.5%, decrease in intangible amortization was primarily due to a decrease in core deposit intangibles amortization. The $684,000, or 20.6%, increase in software expense was due to increased maintenance costs, mainly due to desktop software upgrades for virtually all employees. The $276,000, or 1.4%, decrease in other expenses was due to a $1.4 million decrease in reserves associated with the potential repurchase of previously sold residential mortgage and home equity loans recorded during the first half of 2011 as the Corporation's exposure to future repurchases was reduced as a result of entering into settlement agreements with certain secondary market investors. This decrease was partially offset by a $695,000 increase in provisions for debit card rewards points earned and an increase in information technology consulting costs. Income Taxes Income tax expense for the first half of 2011 was $25.5 million, a $5.0 million, or 24.2%, increase from $20.6 million in 2010. The increase was primarily due to the increase in income before income taxes. The Corporation's effective tax rate was 26.7% in 2011, as compared to 25.8% in 2010. 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 half of 2011 is higher than the same period in 2010 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 $308.1 million, or 1.9%, to $16.0 billion at June 30, 2011 from $16.3 billion at December 31, 2010. Investment securities decreased $198.4 million, or 6.9%. During the first half of 2011, proceeds from the sales and maturities of collateralized mortgage obligations and mortgage-backed securities were not fully reinvested in the investment portfolio due to few attractive investment options in the current rate environment. The Corporation experienced an $80.8 million, or 0.7%, decrease in loans, net of unearned income. Construction loans decreased $119.6 million, or 14.9%, due to paydowns on existing loans exceeding new originations. Also contributing to the decrease in loans was a $25.5 million, or 0.7%, decrease in commercial loans, a $19.2 million, or 5.5%, decrease in consumer loans and a $15.2 million, or 0.9%, decrease in home equity loans, all a by-product of continued weak demand. Offsetting these decreases was a $67.0 million, or 1.5%, increase in commercial mortgages and a $27.7 million, or 2.8%, increase in residential mortgages. Commercial mortgage growth has been throughout the Corporation's footprint. Residential mortgages increased as certain 10 and 15 year fixed rate mortgages and certain adjustable rate mortgages are being held in portfolio rather than sold in the secondary market. Other assets decreased $171.7 million, or 27.3%, primarily due to $142.9 million of investment security sales that had not settled as of December 31, 2010 and a $20.2 million decrease in net deferred Federal taxes, mainly a result of an increase in unrealized gains on the Corporation's investment portfolio. Deposits decreased $125.7 million, or 1.0%, due to a decrease in time deposits of $354.8 million, or 7.7%, partially offset by an increase in demand and savings deposits of $229.1 million, or 3.0%. The increase in demand and saving accounts was due to a $200.9 million, or 8.3%, increase in business account balances and a $43.0 million, or 3.1%, increase in municipal account balances, partially offset by a $25.7 million, or 0.7%, decrease in personal account balances. 55 -------------------------------------------------------------------------------- Table of Contents Short-term borrowings decreased $127.5 million, or 18.9%, mainly in Federal funds purchased, which decreased $101.7 million, or 38.0%. The decrease in short-term borrowings largely resulted from the Corporation's overall liquidity position, which was enhanced by a decrease in investments and loans. Long-term debt decreased $93.9 million, or 8.4%, as a result of FHLB advance maturities, which were not replaced. Other liabilities decreased $30.1 million, or 16.8%, primarily due to $26.4 million of investment security purchases that had not settled as of December 31, 2010. Capital Resources Total shareholders' equity increased $72.9 million, or 3.9%, during the first half of 2011. The increase was due to $70.2 million of net income and a $17.7 million increase in holding gains on available for sale investment securities, partially offset by $18.0 million of dividends on common shares outstanding. As a result of the continued growth in earnings, the Corporation increased its dividend to common shareholders to $0.05 cents per share for the second quarter of 2011, a two cent, or 66.7%, increase in comparison to the second quarter of 2010. For the first half of 2011, the Corporation's $0.09 cent dividend per common share represented a 50.0% increase in comparison to the $0.06 cent dividend per common share for the same period in 2010. 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 June 30, 2011, 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, where applicable: Regulatory Minimum June 30 December 31 Capital 2011 2010 Adequacy Total Capital (to Risk-Weighted Assets) 14.8 % 14.2 % 8.0 % Tier I Capital (to Risk-Weighted Assets) 12.3 % 11.6 % 4.0 % Tier I Capital (to Average Assets) 9.9 % 9.4 % 4.0 % Tangible common equity to tangible assets (1) 9.1 % 8.5 % N/A Tangible common equity to risk weighted assets (2) 11.3 % 10.5 % N/A (1) Ending common shareholders' equity, net of goodwill and intangible assets, divided by ending assets, net of goodwill and intangible assets. (2) Ending common shareholders' equity, net of goodwill and intangible assets, divided by risk-weighted assets. N/A - Not applicable. The Basel Committee on Banking Supervision (Basel) is a committee of central banks and bank regulators from major industrialized countries that develops broad policy guidelines for use by each country's regulators with the purpose of ensuring that financial institutions have adequate capital given the risk levels of assets and off-balance sheet financial instruments. In December, 2010, Basel released a framework for strengthening international capital and liquidity regulation, referred to as Basel III. Basel III includes defined minimum capital ratios, which must be met 56-------------------------------------------------------------------------------- Table of Contents when implementation occurs on January 1, 2013. An additional "capital conservation buffer" will be phased-in beginning January 1, 2016 and, when fully phased-in three years later, the minimum ratios will be 2.5% higher. Fully phased-in capital standards under Basel III will require banks to maintain more capital than the minimum levels required under current regulatory capital standards. The U.S. banking regulators have not yet proposed regulations implementing Basel III, but are expected to do so in the near future. As of June 30, 2011, the Corporation met the fully phased-in minimum capital ratios required for each of the capital measures included in Basel III. 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 half of 2011 generated $204.9 million of cash, mainly due to net income, as adjusted for non-cash expenses, most notably the provision for credit losses, and a decrease in loans held for sale and other assets. Cash flows provided by investing activities were $238.8 million, due mainly to proceeds from the maturities and sales of investment securities, partially offset by purchases of investment securities and a net increase in short-term investments. Net cash used in financing activities was $358.0 million as a net decrease in time deposits and repayments of short-term borrowings and long-term debt exceeded cash inflows from demand and savings deposits increases. 57 -------------------------------------------------------------------------------- Table of Contents |