Fulton Financial Management Discusses Q4 2012 Results - Earnings Call Transcript

Jan.16.13 | About: Fulton Financial (FULT)

Fulton Financial (NASDAQ:FULT)

Q4 2012 Earnings Call

January 16, 2013 10:00 am ET

Executives

Laura Wakeley

E. Philip Wenger - Chairman, Chief Executive Officer, President, Member of Executive Committee and Ex-Officio Member of Risk Management Committee

Charles J. Nugent - Chief Financial Officer and Senior Executive Vice President

Analysts

Bob Ramsey - FBR Capital Markets & Co., Research Division

Collyn Bement Gilbert - Stifel, Nicolaus & Co., Inc., Research Division

Jason A. O’Donnell - Merion Capital Group

Frank Schiraldi - Sandler O'Neill + Partners, L.P., Research Division

Nicholas Karzon

Christopher McGratty - Keefe, Bruyette, & Woods, Inc., Research Division

Casey Haire - Jefferies & Company, Inc., Research Division

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

David Darst - Guggenheim Securities, LLC, Research Division

Russell Gunther - BofA Merrill Lynch, Research Division

Matthew J. Keating - Barclays Capital, Research Division

Aaron C. Brann - Stifel, Nicolaus & Co., Inc., Research Division

Operator

Good morning, ladies and gentlemen. Welcome to the Fulton Financial Corporation Fourth Quarter Earnings Conference Call. This call is being recorded. I would now like to turn the call over to Laura Wakeley, Senior Vice President of Corporate Communications.

Laura Wakeley

Thank you. Good morning, and thank you, all, for joining us for Fulton Financial's conference call and webcast to discuss our earnings for the fourth quarter and year-end 2012. Your host for today's conference call is Phil Wenger, Chairman, President and Chief Executive Officer of Fulton Financial. As you may recall, Phil assumed this new role on January 1, following the retirement of our former Chairman and CEO, Scott Smith. Joining Phil on today's call is Charlie Nugent, Senior Executive Vice President and Chief Financial Officer.

Our comments today will refer to the financial information included with our earnings announcement, which we released at 4:30 yesterday afternoon. These documents can be found on our website at fult.com by clicking on Investor Relations and then on News.

On this call, representatives of Fulton may make forward-looking statements with respect to Fulton's financial condition, results of operations and business. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond Fulton's control and difficult to predict and which could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. Fulton undertakes no obligation, other than required by law, to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

In our earnings release, we've included our Safe Harbor statement on forward-looking statements. We refer you to this section and we incorporate it into today's presentation. For a more complete discussion of certain risks and uncertainties affecting Fulton, please see the sections entitled Risk Factors and Management Discussion and Analysis of Financial Condition and Results of Operation set forth in Fulton's filings with the SEC.

Now I'd like to turn the call over to your host, Phil Wenger.

E. Philip Wenger

Thank you, Laura. Good morning, everyone, and thank you for joining us. I'm pleased to be hosting this call for the first time. I look forward to working with you in the future. I'd like to begin with a few introductory remarks about both 2012 and the fourth quarter. When I conclude, Charlie will provide some additional color on the financials. Then we will be happy to take your questions.

We were pleased with our progress in 2012 and are optimistic about 2013. Our proven relationship, banking strategy, dedicated people and commitment to superior customer service provide the building blocks for our future success.

Diluted earnings per share came in at $0.80, up 9.6% year-over-year. Return on average assets increased to almost 1%. We saw a good improvement in our asset quality, along with a significant decrease in the provision expense. We deployed capital to buy back a portion of our stock. And we increased the quarterly cash dividend twice during the year. We were able to grow both retail and small business relationships, leading to a strong year-over-year growth in core deposits.

Along with our successes, 3 areas presented challenges in 2012: achieving our desired level of quality earning asset growth; protecting our net interest margin and keeping expenses in check in light of regulations.

Looking at the fourth quarter, diluted net earnings came in at $0.20, a slight decrease from the $0.21 we earned in the third quarter.

During the quarter, we were pleased to see strong loan growth and continued credit quality improvements.

Based on year-end balances, our loan portfolio increased 2% linked quarter, a rate of growth we have not seen since the third quarter of 2008. While we will work hard to maintain that rate of growth in 2013, doing so will require continued improvement in the economy.

C&I loans increased by 3% during the quarter. Consumer and home equity loans grew 2.3% in the same period. It's encouraging to see the consumers beginning to borrow again. We have been aggressively promoting home equity lines and loans for the last several months and will continue to do so.

Total loan commitments grew by 19%, although overall line utilization declined last quarter from 42.5% to 42%. Commercial line of credit balances did increase by $11 million as contributing to our overall loan growth. The market for new and commercial relationships remains competitive. However, our overall loan pipeline remains strong, and we expect current credit activity to continue into the first quarter.

In the residential mortgage area, where we have seen high activity levels all year, linked quarter applications fell slightly while closed loans increased during the same period. The fourth quarter purchase-refinance mix was 31% purchase and 69% refinancing. Our current pipeline is $462 million, 75% of which is refinancing. The pipeline going into the fourth quarter was $535 million. We normally do see a seasonal decline over the holidays.

Regarding asset quality, improvement continues with reductions in overall delinquency, nonperforming assets and in the level of problem loans. Problem loans, which include credits rated lower than at past rating, declined by $85 million or 7% this quarter. We've made no major changes in our strategy of problem asset reductions, adhering to our consistent approach of work out, exit and note or asset sales where appropriate.

The generation of new nonaccrual loans was $55 million this quarter, up from $39 million last quarter. However, $14 million of the increase was related to implementation of recent regulatory guidance regarding the treatment of home equity and residential mortgage loans to borrowers that have received a discharge under Chapter 7 of the Bankruptcy Code, regardless of their payment history. There was no underlying change in the credit quality of these loans. These borrowers were making and continued to make payments on their loans. However, the regulatory guidance required us to recognize them as nonaccrual loans and write them down to fair value, which we did in the fourth quarter.

Our total charge-offs were $27 million. $4 million was related to the Chapter 7 bankruptcies. And given the continued improvement in asset quality, we reduced the provision from $23 million to $17.5 million linked quarter. The loan loss reserve declined from 1.97% of loans to 1.86%. We would expect to see further improvement in credit quality in 2013, barring any unexpected economic setbacks.

Given our New Jersey presence, I want to provide some comments about Hurricane Sandy. While we do not have a branch presence in any of the 3 hardest-hit counties, this storm had considerable impact along portions of the coast, including lengthy power outages, which affected our branch operations. As you may know, we included a subsequent event footnote in our third quarter 10-Q that stated we were in the process of assessing the potential financial impact that may result from Hurricane Sandy's effect on the local economy and the corporation's customers. And based on our further analysis, we do not believe the storm will have a material impact on the corporation's results of operations or financial condition. We saw a short-term increase in delinquency from storm-impacted customers. However, as of year end, New Jersey delinquency is almost back to where it was at the end of the third quarter. We also had some fee waivers and loss of activity due to branch closures, but again, not to a level of materiality.

On the liability side of the balance sheet, core deposit growth was up strongly for the year and modestly in the fourth quarter as we continued to focus on core deposit growth throughout the year. We had success attracting new core checking accounts with our company-wide Kindle e-reader campaigns in the second and fourth quarters. Fulfillment of those Kindle offers in the fourth quarter did cause an increase in marketing expenses.

We also experienced elevated expenses in other areas during the quarter, some of which are nonrecurring, that Charlie will discuss more specifically in his comments.

We've studied the potential impact of the exploration of the Transaction Account Guarantee, or TAG program, and expect the impact to be minimal on potential deposit outflows and funding costs. We also will be studying the recently released 800-page qualified mortgage and qualified residential mortgage proposals from the Consumer Financial Protection Bureau to assess what, if any impact, the proposals may have on our residential mortgage operations when they go into effect in January of 2014.

At year end, we divested ourselves of the Global Exchange Group. We no longer believe that this division strategy was consistent with our focused customer relationship strategy and our Mid-Atlantic footprint. We used the proceeds of this transaction and other short-term borrowings to pay down higher-cost FHLB advances, incurring a prepayment penalty that offset the gain from the sale.

In closing, we are positioned to further improve our performance as we enter 2013. If the economy continues to expand and consumer and business confidence increases, we would expect to see higher loan growth, further improvement in asset quality, further reductions in the provision for credit losses. We believe our greatest challenge will be of managing the continued pressure on the net interest margin in this persistently low rate environment.

As I said in our earnings release, our primary strategic focus is on quality earning asset growth. In keeping with that focus, our 2013 affiliate and departmental business plans placed tactical priority not only on loan growth, but also on core deposit and noninterest income growth. As our goals are achieved and as we generate additional capital from ongoing profitable operations, we will deploy it in the best interest of our shareholders. While the merger and acquisition front has been rather quiet, we do remain open to the right opportunities for acquisitive growth.

And finally, in keeping with our desire to deploy capital prudently, we began the year by announcing an up to 8 million share repurchase program through June 30.

Thank you for your attention, for your continued interest in our company, and before we respond to your questions, Charlie will review fourth quarter financial highlights. Charlie?

Charles J. Nugent

Okay. Thank you, Phil, and good morning, everyone. Thank you for joining us today. As Phil mentioned, we reported net income of $0.20 per share for the fourth quarter, a decline of $0.01 from the third quarter. Net income decreased 3% to $40.2 million in the fourth quarter from $41.6 million in the third quarter.

My comments are based on comparisons of this quarter's results to the third quarter. The reduction in our net income resulted from a decrease in net interest income and an increase in noninterest expenses. This reduction was partially offset by a decrease in provision for credit losses and an increase in noninterest income.

As Phil mentioned, the after-tax gain on the sale of Global Exchange was virtually offset by the after-tax impact of the Federal Home Loan Bank prepayment penalty. Net interest income decreased $3.7 million, or 2.7%, primarily as a result of a 9 basis point decline in our net interest margin.

Average earning assets remained essentially unchanged. Average yields on earning assets decreased 14 basis points, while average cost of interest-bearing liabilities only decreased 5 basis points.

A portion of the net interest margin decrease was due to a decline in the benefit from early calls and redemptions of trust preferred and auction rate securities. This benefit totaled $1.4 million in the third quarter compared to only $370,000 in the fourth quarter, accounting for 3 basis points of the margin compression.

Our projections indicate that we will likely experience a similar level of margin compression in the range of 5 basis points in the first quarter of 2013.

Other income for the fourth quarter increased $1.2 million or 2.3%, excluding the impact of security gains and the gain on the sale of Global Exchange. The improvement was due to the increase in mortgage banking income, resulting from a $2.1 million impairment charge with mortgage servicing rights that we recognized in the third quarter. This increase was partially offset by a decrease in other income from life insurance investments.

Operating expenses increased $3.6 million, or 3.2%, excluding the Federal Home Loan Bank advance prepayment penalty. Marketing expenses grew $1.9 million, mainly due to the timing of promotional campaigns. State taxes increased $1.5 million due to reversals of reserves in the third quarter, resulting from the expiration of the statute of limitations as well as changes in the risk level of certain positions.

Operating risk loss increased $1.2 million due to additional provisions for losses on potential loan repurchase obligations. These increases were partially offset by a $1.5 million decrease in outside services.

Our internal projections indicate that our total other expenses should be in the range of $111 million to $114 million in the first quarter of 2013. However, certain expenses such as other real estate-owned expenses and repossession expenses, mortgage repurchase losses and operating risk loss can experience volatility based on timing or events that cannot always be reasonably predicted. Such volatility could result in expense levels being higher or lower than projected.

Thank you for your attention and for your continued interest in Fulton Financial Corporation. Now we'll be glad to answer your questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first to Bob Ramsey from FBR.

Bob Ramsey - FBR Capital Markets & Co., Research Division

I was curious with the net interest margin. Was there any impact this quarter from accelerated premium amortization on mortgage-backed securities or was that not a factor this quarter?

E. Philip Wenger

Yes, that's always a factor, Bob. It went from -- in the third quarter, it was $4.6 million and it went up to $4,740,000 this quarter. So it is a factor. It's a high level and it grew third to fourth quarter.

Bob Ramsey - FBR Capital Markets & Co., Research Division

Right. And as you all sort of look forward, is the expectation that prepayment activity and accelerated premium amortization will remain elevated?

E. Philip Wenger

It's hard to guess. It's going to be -- it depends a lot on refinancing activity. Our guess is it would remain about where it is now or down slightly. That's our guess. And that's going to depend on refinancings that we can. We don't know exactly what they're going to be in the quarter.

Bob Ramsey - FBR Capital Markets & Co., Research Division

Sure, okay. And to be sure I understood your margin outlook clearly, I think you said you expect something in the range of 5 basis points down next quarter from 3.65% this -- is that a fair synopsis?

E. Philip Wenger

Yes, that's fair, Bob. That's our estimate and there are a lot of guesses that go in there, but that's...

Bob Ramsey - FBR Capital Markets & Co., Research Division

Fair enough. As we sort of move forward through 2013, assuming the world remains as it looks today, do you think that, that level of pace, you stay in that ballpark or do we get further down the road to more of the higher-yielding assets? Have they already sort of moved off? Does the pace of compression abate a bit?

Charles J. Nugent

We're still going to have compression, we think, given where interest rates are. But loan growth and the fact that the premium amortization and the mortgage-backs can have a big effect on that, that can really change. We also have -- for the rest of the year, we have $2.3 billion in CDs maturing this year. The weighted average yield on that is 85 basis points. During the fourth quarter, we were able to keep CDs. We're putting CDs on at a weighted average yield of 37 basis points. So that's $11.5 million in give there if you go from 85 basis points to 35. So there's a lot of things go into that margin, but we think there's going to be compression, but we don't think it's going to be significant.

Bob Ramsey - FBR Capital Markets & Co., Research Division

Okay. And just roughly what is the timing of the CD maturities? Is it early in the year, later in the year?

Charles J. Nugent

It's even throughout the year. And the first quarter is a little bit less than it usually is. In the first quarter, it's -- I think it's $585 million and -- $585 million are maturing. The weighted average yield is 65 basis points. And the second quarter, it's about 96 basis points. But it -- there's good there, there's an opportunity to reduce our cost of deposits.

Bob Ramsey - FBR Capital Markets & Co., Research Division

Okay. And then last question and I'll back out. But you took a big hit in the yield on taxable investment securities this quarter. I know you highlighted some of the pieces that are in there. I mean, as you look forward from 2.35%, is that sort of a good base point to sort of start projecting forward? And then where are you all purchasing new securities in the market today? Sort of where is that 2.35% trending towards if 2.35% is the right starting point?

Charles J. Nugent

I would think the municipal security yield's going to continue to go down, but I don't think they'll go down a lot. And we'd buy -- we're still buying securities. One, average were down $140 million, and the -- more cash flows from the mortgage-backed portfolios was about $135 million during the quarter. And during the quarter, we continued to buy securities and it was primarily short mortgage-backed securities. And we bought some municipals. They were advanced [ph] good for a year and then we bought primarily municipal securities that were short.

Bob Ramsey - FBR Capital Markets & Co., Research Division

In the mortgage-backed, so you're buying? Are they yielding sub-2% or what's sort of roughly the yield you would get at the margin?

Charles J. Nugent

Yes, the mortgage-backs we've been buying, the average yield was 1.37% in the quarter and the average length was [indiscernible] years. So the yields are extremely low on our volume. The cash flow's coming off. The yield on those are about at 3.50% so that's part of the compression in that net interest margin.

Bob Ramsey - FBR Capital Markets & Co., Research Division

That's helpful. How much more do you have on the portfolio like in the portfolio that has got yields around that 3.50%? Sort of I'm just kind of curious. So, obviously, I can see what the average yield is, but how big are the tails at the high end anyway?

Charles J. Nugent

I would think, this would be my guess, the higher yields are the 3.50%, 3.60%. Most of the other ones have already paid off. But there will be some in there that would have higher growth.

Operator

[Operator Instructions] We'll go next to Collyn Gilbert from Stifel, Nicolaus.

Collyn Bement Gilbert - Stifel, Nicolaus & Co., Inc., Research Division

So just a question on your comment about the strategic focus this year in terms of interest earning asset growth -- quality interest earning asset growth. Would you say that, that's a slight change from what maybe the objective would've been going into 2012? Or how should we frame that?

Charles J. Nugent

We know -- Collyn, that's a good question. I think historically, we went through a time period, '02 to '06, where our primary growth, our focus was on growth and it was really external focus. And then I think we went through a period, '07 through '11, where we were more internally focused, working on credit issues and working up to some -- just becoming stronger as an organization internally. And so now moving forward, I think the strategy has shifted some and I think we are much more balanced. But I think we are -- in general, our focus started to shift in the April-to-June time frame last year, and we're starting to see the benefits from that shifting. And I think we'll continue that into '13.

Collyn Bement Gilbert - Stifel, Nicolaus & Co., Inc., Research Division

Okay. So when you're -- in terms of the loan growth that maybe we'll start to see, is that a function of your originators just extending their retail a little bit more? Is that a function of you're seeing more stuff come to loan committee? I'm just trying to sort of understand what would drive this pickup in potential loan growth.

Charles J. Nugent

Well, I think it's multifaceted. I do think that we are in some areas gaining market share. Our lenders are going a good job of that. I think we have seen increased activity from existing customers which helps. We're seeing increased activity from the consumer which helps. So the market-share part, we're going to continue to push. The activity from our existing customers is still going to depend a lot on what happens in the economy as we move forward in '13. And to some degree, we've been in this same position in the last couple of years and we get this slowdown in May. So we're -- I mean, we're not 100% certain that what we see now will continue, but we do feel better than we have in the past.

Collyn Bement Gilbert - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And in terms of quantifying, is there any kind of sort of target you can kind of give us or thoughts you can give us as to how much asset growth -- earning asset growth you could potentially see in 2013? Let's assume that the trend -- let's assume you know what you know today and under the current scenario because I know we don't know the future, but under as things stand today, as we assume this environment continues throughout the rest of the year, what kind of growth rate do you think you could see?

Charles J. Nugent

Yes, well, again, that's tough. I think we are encouraged on what we see could happen in the first quarter. And then as we go into the summer, we tend to see seasonal slowdowns and then it picks up again in the fall. So I'm not necessarily sure I would take that 2% and annualize that and say that's what we can do for the year, but our goal is to have more growth than we've had the last couple of years. So I would say somewhere between that 0 and 8%.

Collyn Bement Gilbert - Stifel, Nicolaus & Co., Inc., Research Division

Okay, okay. And then just one final question. You mentioned in your opening comments again that you would expect to improve performance this year. And I guess given the environment and if we think about the margin pressure, I mean, are you kind of looking at it and saying, "We're going to do whatever we can to try keep that 1% ROA" or should we assume that profitability profile is going to decline? I guess, what I'm saying is to me, it seems hard that the performance as measured by profitability would actually accelerate this year, but do you think it can?

Charles J. Nugent

Well, we certainly want to earn more money this year than we did last year. I don't like you to think that it's not going to be a battle. Margin compression is going to be difficult to offset. And loan growth will help that tremendously. We still think we have a little credit leverage, some credit leverage to take where -- as that continues to improve. So it's going to be a battle, but we think we're positioned pretty well.

Operator

We'll take our next question from Jason O'Donnell of Merion Capital Group.

Jason A. O’Donnell - Merion Capital Group

Just to revisit the loan growth question again, can you just maybe give us some color regarding which market or markets were responsible disproportionately for driving that growth? I'm especially interested in how much of the growth is coming out of the New Jersey market just given the impact of the hurricane.

Charles J. Nugent

So good question, Jason. As we look across our markets, we had nice growth in Pennsylvania, Maryland, Delaware and Virginia. We did not have any growth in New Jersey. So that is the one area that has continued to lag. We think -- well, they have -- they do have a nice backlog in New Jersey. And we are more optimistic for some growth in that area as we move into '13.

Jason A. O’Donnell - Merion Capital Group

Okay. Okay, that's helpful. And then, Phil, with respect to the nonaccrual formation figures that you referenced, just excluding the $14 million impact related to regulatory changes, can you give us some sense of which loan categories have been driving the bulk of your more recent credit stress?

E. Philip Wenger

Jason, it's really been mixed, I would say, across construction, C&I, commercial real estate. And then on the consumer side, those portfolios are not quite as large. But there is a small portion of it comes from the consumer side. But I'd say it was spread pretty evenly between the other 3.

Jason A. O’Donnell - Merion Capital Group

Okay, okay. And then I guess my final question is, you all incurred roughly $10 million, I believe, in OREO and repossession expense from the year for 2012. Your OREO balance is I think down linked quarter to somewhere around $26 million. As we think about normalized EPS for Fulton, I'm wondering kind of what you might consider like a normalized run rate for OREO and repo expense when that time comes.

E. Philip Wenger

Normalized at this point, I think, is still difficult for us to say. We do believe we can have that number lower in '13. To what degree, I would hesitate to give you any guidance.

Operator

We'll go next to Frank Schiraldi from Sandler O'Neill.

Frank Schiraldi - Sandler O'Neill + Partners, L.P., Research Division

A couple of questions that I still had here that haven't been asked. Charlie, you mentioned the expected range for, I guess, core expenses or at least the expense base for 1Q is $111 million to $114 million, which is I believe the same range you gave for the 4Q. And I'm just wondering if you drilled down a bit specifically into marketing expenses, given the Kindle promotion that Phil mentioned in the previous quarter. Just wondering if those marketing -- that increase in marketing expenses sequentially into 4Q could potentially come back out in 1Q?

Charles J. Nugent

Yes. Frank, we had mentioned that in the, I think, second and fourth quarter we had big deposit promotions related to the Kindle and we didn't in the third quarter. So the third quarter was extremely low in terms of marketing expenses. We look at our run rate if our marketing is right around where it was for the fourth quarter.

Frank Schiraldi - Sandler O'Neill + Partners, L.P., Research Division

Got you. Okay. And then I wonder if you could maybe talk a little bit more about expectations in the expense base for 2013 in regards to looking forward -- I know it's hard to do, but looking forward beyond the first quarter, do you sort of expect that you may be able to keep the expense base flattish from here in the coming year? Or maybe looking at it another way, do you believe you can hold the efficiency ratio flattish with the fourth quarter? Just any more color you can give would be great.

Charles J. Nugent

Frank, I think we've always been good at controlling cost and usually our efficiency ratio is always in the first quartile when we compare ourselves to peer group. We would expect to stay there. But -- just expenses between the third and fourth quarter, we went from $110 million to $116 million. And it's hard to come up with a run rate anymore because in the fourth quarter, we had some expenses related to mortgage putbacks and it was relatively high, it was $1.3 million. And in the third quarter it was only $300,000, and other quarters it's 0. So it's kind of hard to project that -- that run rate because of the economy and the way things are right now. But we'll do our best.

Frank Schiraldi - Sandler O'Neill + Partners, L.P., Research Division

Okay. And then I wanted to ask on the tremendous deposit growth in terms of the demand accounts growth sequentially. Is that an aberration at all, something in there that would be more seasonal in nature or could we expect to see growth in that range, perhaps not to that degree in the coming year? And also, just wondered if you continue to have room, Charlie, to reduce deposit costs across the board just outside of CDs?

Charles J. Nugent

Outside of CDs, it would be hard. We moved back all of our NOW, Super NOW money market savings rate. It's a pretty low rate. I guess we could, but I don't think it would be a tremendous difference. But in regard to non-interest bearing DDA growth, it was 4% linked quarter; to annualize that, it would be 16%. But if you go back a year, the growth has been 15% on an average balance year-to-year. And most of it is in -- I don't know if it helps, but it was up on average $357 million between years. And $302 million of that was business and the rest was personal. And we've also had good growth in the NOW, and Super NOW and that's been primarily personal. So I think we've been doing a good job at growing households, and I think also balances are increasing too, so.

E. Philip Wenger

Yes. So Frank, just in general, we have been focused, as Charlie mentioned, on growing households, small business and retail. And I think it's paid in the formation of those demand deposit accounts. And that focus that we have on growing households and core deposits will continue throughout '13.

Frank Schiraldi - Sandler O'Neill + Partners, L.P., Research Division

Okay. Great. And then just as we're looking at -- now once you're looking at 2013, of course, we're starting to look at 2014 as well. And then just wondering if you could talk a little bit about, at least on the borrowing side, any borrowings? I know you had the $20 million that you repaid in December, but anything else rolling off within the next 24 months that might be sizable and reduce those costs?

E. Philip Wenger

Frank, not a lot. In the first quarter we have $5 million of Federal Home Loan Bank advances that's maturing in [indiscernible], but it will help but not a lot. But, you're right, we have a lot of Federal Home Loan Bank advances that are $524 million and the average life is down 4 years and yield's at $415 million. We look at that constantly and we have outside investment bankers look at it constantly, too, to see what we can do about that. But I wouldn't think any significant changes because the prepayment penalties are so significant, it's hard to earn back that prepayment penalty. So I would look at it constantly, but I wouldn't think there's going to be anything significant.

Operator

We'll take our next question from Craig Siegenthaler of Credit Suisse.

Nicholas Karzon

This is actually Nick Karzon standing in for Craig this morning. I guess, first, just a question on the capital return and with the $8 million buyback, is the right way to think about that kind of a $3 million catch-up from the remaining -- remainder of the repurchase authorization in the second half of 2012? And the second part of that is kind of, what's the rate that we should think about going forward in terms of the buyback potential?

E. Philip Wenger

So just to be clear, Nick, it's 8 million shares, not $8 million. And 3 million of it, I think it would be appropriate to say that 3 million is a 3 million that we didn't -- weren't able to do in the fourth quarter of this year. So as we work our way through the program and get closer to June 30, we're going to -- we will reevaluate our capital position and what's happening with our growth rates and all sorts of things. And we'll determine at that point if there will be additional repurchases through the balance of the year.

Nicholas Karzon

And then, I guess, just a second question, following up on the comment around the lower healthcare costs, I'm not sure -- I guess, a sequential decline in salaries and employment benefits. Is that something that is recurring, a structural change in plans or is that kind of a onetime and you would expect that to kind of re-rate higher looking out into next year?

Charles J. Nugent

Yes. You're right, it's down $750,000 linked quarter. But it depends on our healthcare costs. And our cost for employees has dropped from the third quarter of $6,700 to $6,100. But I think it's being driven primarily by claims. We're self-funded for the healthcare.

Nicholas Karzon

Okay. So nothing structural has changed there?

Charles J. Nugent

No, no. It's just the experience, right.

Operator

We'll go next to Chris McGratty of KBW.

Christopher McGratty - Keefe, Bruyette, & Woods, Inc., Research Division

Maybe I'll ask the buyback question a little bit differently. The 8 million shares that you've got, I mean, is it possible based on, I guess, how much your stock trades in the black outs that you could complete the whole thing in the first 6 months? I know it expires June 30. Is that kind of what we should be expecting that you guys are more aggressive in the first half given your limited ability in Q4?

E. Philip Wenger

Chris, our goal in the last program was to buy it all back. Things happened that prohibit us from doing that. So our goal would be to do that, but who knows what could happen throughout the first 6 months that could prohibit us from actively repurchasing. But it's our goal. We wouldn't put it in place if we didn't have the goal to complete it.

Christopher McGratty - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. Great. On new loan production, I think your weighted average yield on your loan book was off about by 10 basis points of 4.68. Can you comment on where new loans are being put on it in terms of yield, because I'm wondering if there's a convergence point at some point in future quarters?

E. Philip Wenger

Yes. So in the commercial side, fixed rates are in the low-4s, if we go out that's by -- a 5-year rate would be in the low-4s. If we go a little longer on amortization it might be mid-4s. On the consumer side we're probably in the high-3s. Our prime rate here is 3.25%. In a small business loan we try to get its floating, some increment over prime. And on the residential side, 15-year loans right now are 2.875% and 30-year are 3.375%.

Christopher McGratty - Keefe, Bruyette, & Woods, Inc., Research Division

Great. Last question, in terms of the overall size of the investment portfolio, with presumably a better growth outlook from the loan side, how should we think, Charlie, about just the size of the securities book over the next 2 quarters?

Charles J. Nugent

Chris, it depends a lot on economic conditions, but investments are about 17% of our balance sheet. We think we could take it down to 12% and meet all the liquidity and pledging requirements and -- that's about $845 million, that could come down. A lot is going to depend on interest rates what we think rates are going to do in economic conditions, but there is room to move that down. And then that would really help if we could replace those investments with loans in terms of margins.

Christopher McGratty - Keefe, Bruyette, & Woods, Inc., Research Division

So earning assets not necessarily wouldn't change. But is that 12% achievable over the next couple of years or is that kind of a 3- to 5- year plan?

Charles J. Nugent

Well, it depends on municipal deposit growth. It depends on liquidity requirements. But I think we can do that.

Operator

We'll go next to Casey Haire of Jefferies.

Casey Haire - Jefferies & Company, Inc., Research Division

Could you talk a little bit about the M&A environment? It seems like it's loosening up. Recently a smaller Virginia bank announced its exploring alternatives. I'm just wondering what you're seeing in your footprint and what your appetite is as we move into 2013?

E. Philip Wenger

Well, I would say that, in general, the activity is similar to what it's been in the past. And we would consider looking at the proper, strategic opportunity that would come along.

Casey Haire - Jefferies & Company, Inc., Research Division

Okay. I mean, could you give us just an update in terms of what your preference is by geography, asset size and a reminder on accretion targets, acceptable levels of tangible book value dilution?

E. Philip Wenger

Well, I'll start that and then I'll let Charlie finish on some of the metrics. But I think we've indicated that we would -- from an asset size, we're looking at $300 million to $2.5 billion. We would be looking at opportunities that fill in our existing footprint. So we operate in 56 counties in our 5-state marketplace. And in 8 of those 56 counties, our market share position's either first, second or third. So we want to look at opportunities that would increase our market share position in places we currently are at, but would like more market share. So they exist in Virginia, they exist in Maryland. Those opportunities exist in Virginia, Maryland, Delaware, Pennsylvania and New Jersey.

Casey Haire - Jefferies & Company, Inc., Research Division

Okay. And then just one last one, switching to credit quality, and apologies if I missed this. But the construction charge-off rates are higher but construction came down meaningfully lower, was there a big recovery in there or is this -- or can that line turn the corner and we can expect that line to run much lower than what's been pretty much a 5% average since 2011?

E. Philip Wenger

So there was not a large recovery. And we just had a better experience. And we're hopeful that, that will continue into 2013.

Operator

We'll go next to Matthew Kelley of Sterne Agee.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

Just going back to the mortgage-backed securities book. What is the total dollar amount of unamortized premium left in the books at year end?

E. Philip Wenger

Just give me a minute there, Matt.

Laura Wakeley

Do you have another question, Matt?

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

Yes. The follow-up question would be what were your gain on sale margins in the fourth quarter in the mortgage business and what do you think those can do in the quarter ahead and the year ahead? And the third would be -- tax rate going forward?

E. Philip Wenger

Well, our mortgage margins in the fourth quarter were strong. They were over 2%. And going into January, we have not seen a reduction yet. But we do anticipate, as we move through the year, that those margins will pull back some.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

Okay. Got you. And then the...

E. Philip Wenger

I'm sorry, on the premium on the mortgage-backed securities $36.6 million. And the average premium value will be just at 1 02.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

1 02, okay. And any change in the tax rate we should be using, still around 27% to 28%, is that right?

E. Philip Wenger

Yes, 28%, 29% I would think.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

28%, 29%, okay. All right, got you. Okay, and then have you -- at what point here, with top line revenues being so difficult, do you consider maybe a more or a new round of cost cutting or branch consolidations and closures just to kind of manage the expense side of the business given the fact that if you added low-single-digit loan growth, margin continues to come down, that revenue line is flat, at best, as it is for many banks. I mean, at what point do you think about new round of cost cutting?

E. Philip Wenger

So that's a good question. And we look at costs all the time and we'll continue to. I don't -- to put a cost-cutting program in place prior to the completion of our core conversion, we think it would be difficult. So I don't -- we would anticipate that would be completed sometime in the third quarter. And so I don't see any kind of program going into place prior to that.

Matthew Brandon Kelley - Sterne Agee & Leach Inc., Research Division

Okay. All right. And again that -- the change in the core processing, there's no net savings there, right, it keeps you about flat?

E. Philip Wenger

There's actually -- in 2013, the onetime costs are going to be about $3.6 million, onetime cost. Then the incremental increase in our ongoing expenses for '13 are going to be -- because of the timing of when it all is implemented, somewhere between $1 million and $1.5 million. And then as we go into '14, there will be an additional, probably, $2 million to $2.5 million increase during that incremental increase.

Operator

We'll take our next question from David Darst of Guggenheim Securities.

David Darst - Guggenheim Securities, LLC, Research Division

Charlie, I'm not sure I quite follow your reasoning for not buying back any stock in the fourth quarter.

Charles J. Nugent

David, we were negotiating the sale of Global. And in doing that, we didn't know what the gain or loss would be. And we thought that was something that -- we couldn't buy back stock until we fully disclosed the sale and the sale price.

David Darst - Guggenheim Securities, LLC, Research Division

Okay. And so what are the parameters around the first half of the year that we should be thinking about?

Charles J. Nugent

For example, in the first quarter, we won't start thinking about buying stock back until Friday. We can do it all on February. And then usually when we -- not usually, what we do is when we find out the second, the first 2 months earnings in the quarter, as soon as we know that, we stop buying back the stock until we -- 3 days after we announce earnings. And so it should give us about almost 30 days, business days to buy back. And last time I looked, David, we could buy back 273,000 shares a day, if we wanted to, based on the previous trading volume over the last couple of weeks. Now in a block, we can do a block trade that would be bigger than that. We have the ability, given nothing comes up like Global, we would be able to buy those shares back in the first quarter. That'll be depending on also the price, what our share price is now.

David Darst - Guggenheim Securities, LLC, Research Division

Right. Okay. And then, I guess, you could use the language quality earning asset growth. But it sounds like over time, you want to reduce the size of securities portfolio. Do you have the flexibility to maybe add or grow the residential mortgage portfolio or is that maybe your intention to balance out the margin compression and try and hold your net interest income flat?

E. Philip Wenger

Right now, David, we've had periods where we've held some 10- and 15-year residential mortgages. Right now we're holding $10 million a month of 10-year mortgages.

David Darst - Guggenheim Securities, LLC, Research Division

And then you expect that to continue?

E. Philip Wenger

Well, we expect that to continue, I would say, through the first quarter.

David Darst - Guggenheim Securities, LLC, Research Division

Okay. Great. And then I guess you're trying to ultimately hold net interest income flat or up for the year?

E. Philip Wenger

Boy, that would be great. We would love to do that. It's going to take some continued loan growth to be able to achieve it.

Operator

We'll go next to Russell Gunther of Bank of America Merrill Lynch.

Russell Gunther - BofA Merrill Lynch, Research Division

A quick follow-up question on the expenses relating to the core processing change, you said $3.6 million onetime cost. Did you mention, or if you could, the timing of that expected implementation?

E. Philip Wenger

Well, I think we had $600,000 in the fourth quarter of '12. And then they'll be spread out, primarily, I would say first and second quarter. And then they'll be some moving into the third quarter.

Russell Gunther - BofA Merrill Lynch, Research Division

Okay. And so that would be considered in your guided range of $111 million to $114 million for 1Q?

E. Philip Wenger

Yes.

Russell Gunther - BofA Merrill Lynch, Research Division

Okay. And then the incremental increase of $1 million to $1.5 million, again, that's in the back half of 2013?

E. Philip Wenger

That's correct. That would be partial, partial third and then fourth quarter. Well, it will build second, third, fourth quarter.

Russell Gunther - BofA Merrill Lynch, Research Division

Got it. And then I appreciate the color on the charge-off activity in the quarter with regard to home equity. Adjusting for that the charge-offs were down modestly from 3Q. Could you give us a sense for your outlook and expectations for improvement in 2013?

E. Philip Wenger

Well, again, it's -- ultimately, what happens is tough to say, but we do expect charge-offs to continue to decrease in the '13.

Russell Gunther - BofA Merrill Lynch, Research Division

From an adjusted, call it, 24...

E. Philip Wenger

From an adjusted, yes.

Russell Gunther - BofA Merrill Lynch, Research Division

Okay. And then you did mention briefly your expectation for some credit leverage left to take. So as you think about the provision going forward, how should we think about the -- how are you, I guess, sizing up credit leverage, where could the reserve go by the end of the year or how should we be thinking about that?

E. Philip Wenger

Well, that's a $1 million question. And I can't -- I don't know. We do think there is room for it to come down some more. And how much more is really going to depend on what happens to the economy and what happens to our portfolio.

Russell Gunther - BofA Merrill Lynch, Research Division

Do you have a target level that you're comfortable with?

E. Philip Wenger

I would say it's still too early to give any guidance as to ultimate targets.

Russell Gunther - BofA Merrill Lynch, Research Division

Okay. But maybe in terms of the magnitude of bullishness this quarter, maybe somewhat outsize relative to what we could expect going forward barring a material improvement on the credit quality outlook.

E. Philip Wenger

I think the answer to that is yes.

Russell Gunther - BofA Merrill Lynch, Research Division

Okay. And then last question would be, you talked about the shift in strategy from an external focus in '02 to '06 and more internally focused '07 through last year. But does this shift that you began to experience in April and June, how much, I guess from a purely internal focus a little more externally, to what extent does that incorporate M&A? Is that what you would characterize as a part of that shift?

E. Philip Wenger

Well, I was really speaking about our internal growth within our current operations. So on the M&A side, I'd say that there is -- over time, since the depth of the problem, I'd say, back in '08 and '09 I'd say there was little focus on M&A. And as we move forward, there is more than there was then. But we want to be disciplined as we go forward and we want to get the right opportunities.

Operator

[Operator Instructions] We'll go to Matthew Keating of Barclays.

Matthew J. Keating - Barclays Capital, Research Division

My question relates to your fee income. Obviously, one of the strongest contributors to growth in '12 was the mortgage banking business. And I appreciate the color on the pipeline decelerating around the holidays in the fourth quarter. It looks like your pipeline at the end of '12 was $462 million and that compared to a pipeline at the end of '11 of around $320 million or so. So I'm just wondering what are you budgeting for, in terms of general trends in the mortgage banking side in '13, can revenues at least maintain the levels we saw in '12 or are you budgeting for us somewhat of a precipitous decline? Or how are you looking at that line item?

E. Philip Wenger

Well, I don't think we really share what we're budgeting. Our backlog going into '13 is stronger than it was going into '12. But there was an awful lot of activity through the entire year. I think it would be incredibly challenging to be able to produce the same level that we did in '12. I think, nationally, the national realtors are predicting somewhere between a 15% and 20% decline in mortgage activity for the year.

Matthew J. Keating - Barclays Capital, Research Division

So is there any expense leverage to the extent that revenues in the mortgage banking area do decline partially in '13? Is there any cost takeout potential on the expense side or it doesn't seem like expenses really ramped that aggressively on the growth this year? I'm just wondering if vice versa you could see some benefit on the cost side?

E. Philip Wenger

On the expense side, we would see benefit, yes.

Operator

We'll go next to Aaron Brann of Stifel, Nicolaus.

Aaron C. Brann - Stifel, Nicolaus & Co., Inc., Research Division

This is Aaron with a follow-up lesson for Collyn. First question, I just want to clarify your comments about interest earning asset growth. It sounded as though you were targeting loan growth, maybe at mid-single digits if I take the midpoint of the range you talked about, but you're also looking to scale down your securities book. What is the net effect of that? What does that look like for earning asset growth for the year? Are we talking 1% to 2% or closer to that mid-single digit?

Charles J. Nugent

Aaron, this is Charlie. I think I misled you if I said it was our plan to move down the security book. I said we could to let it fund loan growth, but a lot of it is going to depend on economic conditions, our interest sensitivity position, and what we think interest rates are going to do before we move that down. We can move it down, but this is going to depend on a lot of different things whether we do or not.

Aaron C. Brann - Stifel, Nicolaus & Co., Inc., Research Division

Okay. I appreciate the clarification.

Charles J. Nugent

I'm sorry if I misspoke there.

Aaron C. Brann - Stifel, Nicolaus & Co., Inc., Research Division

That's fine. Secondly, looking at your delinquency table in the press release, it looks like the residential delinquencies increased quarter-over-quarter pretty sharply. Is any of that due to the effects of Hurricane Sandy or where are you going to attribute that increase to?

E. Philip Wenger

We had some increase on both consumer and the mortgage delinquency. All but $1 million of the total increase in those 2 categories was directly associated with the $14 million of home equity and mortgages that were paying us, but had been just discharged through the bankruptcy proceedings.

Operator

At this time, there are no further questions. I would now like to turn the call over to Mr. Phil Wenger.

E. Philip Wenger

I'd like to end this call by thanking everyone for joining us today. We hope you will be able to be with us when we discuss first quarter results on Wednesday, April 17.

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