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Fulton Financial (NASDAQ:FULT)

Q4 2011 Earnings Call

January 18, 2012 10:00 am ET

Executives

Laura Wakeley -

R. Scott Smith - Chairman, Chief Executive Officer, Member of Executive Committee and Ex-officio Member of Risk Management Committee

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

E. Philip Wenger - President, Chief Operating Officer, Director, Member of Executive Committee and Ex-officio Member of Risk Management Committee

Analysts

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

Craig Siegenthaler - Crédit Suisse AG, Research Division

Mac Hodgson - SunTrust Robinson Humphrey, Inc., Research Division

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

Mike I. Shafir - Sterne Agee & Leach Inc., Research Division

Blair C. Brantley - BB&T Capital Markets, Research Division

Matthew T. Clark - Keefe, Bruyette, & Woods, Inc., Research Division

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

Richard D. Weiss - Janney Montgomery Scott LLC, Research Division

Operator

Good morning, ladies and gentlemen. Welcome to the Fulton Financial Year End 2011 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. Please go ahead.

Laura Wakeley

Thanks, Diana. Good morning, and thank you all for joining us for Fulton Financial Corporation's conference call and webcast to discuss our earnings for the fourth quarter and year end of 2011. Your host for today's conference call is Scott Smith. Scott is Chairman and Chief Executive Officer of Fulton Financial. Joining him are Phil Wenger, President and Chief Operating Officer; and 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 conditions, results of operation 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 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, and we refer you to this message in the earnings release and incorporate it into this presentation. For a more complete discussion of certain risks and uncertainties affecting Fulton, please see the sections entitled Risk Factors and Management's Discussion and Analysis of financial conditions and results of operations set forth in Fulton's filings with the SEC.

Now we'd like to turn the call over to your host, Scott Smith.

R. Scott Smith

Thank you, Laura, and good morning, everyone, and thank you for joining us. I have a few remarks about the fourth quarter and the year, and then the Phil Wenger will discuss credit. Charlie Nugent will discuss our financial performance. And then we will be happy to take your questions.

We were encouraged by our progress in 2011, but there's more to be accomplished. Diluted earnings per share were up 24% for the year. Our commitment to credit quality improvements enabled us to reduce the provision by $25 million. We saw strong average core deposit growth of over 11%, and much of that growth came from small business sector. These low-cost funds helped us expand our net interest margin by 10 basis points, despite pressure on earning asset yields.

Since there is little clarity about capital requirements, we made ROA improvement a management priority. Our efforts to maximize balance sheet resources paid off, as we improved our return on assets by 12 basis points.

Although it did not happen as rapidly as we would have liked, we saw continued improvement in our credit metrics. Other income increased due to stable residential mortgage activity and despite regulatory restrictions on revenue.

We saw a modest increase in year-over-year expenses that enabled us to maintain our strong efficiency ratio. Our progress combined with confidence in our capital levels also allowed us to increase the cash dividend to shareholders. Knowing how important dividends are for many of our shareholders, this was particularly gratifying in light of the confidence and patience they have exhibited over the last few years.

Now I want to direct our attention specifically to the fourth quarter. This was a somewhat mixed quarter and one that presented a number of challenges. While there were positives, there were also some headwinds. In a more normal environment, the impact of these headwinds would have been mitigated, but since the pace of economic growth and particularly credit demand is still not that brisk, we reported diluted net earnings per share of $0.18, down 10% from the $0.20 we made in the third quarter.

On the credit front, Phil will give you more details. This quarter we sold at $35 million worth of nonperforming residential mortgages and nonperforming home equity loans. The transaction improved our overall credit metrics but also resulted in a charge to the allowance. After study, we concluded that the sale would enable us to more efficiently devote our resources to resolving our remaining nonperforming loans in 2012.

We were encouraged to see some moderate loan growth that, if annualized, would be over 1%. As you know, over the last several quarters, our growth in various loan categories has been repeatedly offset by a reduction in our construction book. Last quarter was no exception.

Although the pace of the decline continues to slow, we're also pleased with the meaningful decrease in our overall delinquency. The 4 factors that largely accounted for earnings decrease during the quarter were an increase in operating expenses, the October 1st implementation of new debit interchange restrictions, compression of our net interest margin and our decision to keep newly originated 10- and 15-year residential mortgages in our portfolio. As a result of this mortgage decision and as to be expected, our sale gains were lower for the quarter.

In October, we combined our 2 New Jersey banks into the Fulton Bank of New Jersey. The consolidation went very smoothly, and our New Jersey team is pleased to be meeting the financial needs of our Garden State customers under the recognized and respected Fulton name.

Onetime conversion and marketing cost to bring the quarter -- to bring the 2 banks together were incurred in the fourth quarter. Now that the merger is complete, marketing dollars can be invested into revenue supporting and new household-creating core deposit promotional campaigns. And since these advertising dollars no longer need to be spread over the 2 banks, we can market more efficiently throughout the state.

On the noninterest income, we are all aware of not only the unintended consequences of the Durbin interchange amendment but also of the negative impact on the industry fee income. And as we said in the previous calls, our goal was to mitigate the impact of lost Durbin-related revenues. We also explained that the introduction of fee increases to do that would be somewhat contingent on the competitive environment because we did not want to jeopardize customer relationships.

Core household retention and growth is important because we believe our base of low-cost funding will be of significant value when credit demand increases.

So while we implemented a number of fee changes in the last half of 2011, the full impact of these changes is dependent upon customer usage patterns. And the ability to further -- to make further -- to implement further changes is dependent on the competitive environment.

Net interest margin compression was a significant challenge this quarter and was a key factor in our linked quarter decline in income. Although overall funding cost continued to decrease, the decline could not offset the more rapid decrease in earning asset yields due to the drop in mortgage rates. The drop caused an increase in mortgage-backed security prepayments and an acceleration of the premiums on those securities.

While we know that the new year will bring with it new challenges and opportunities, we remain committed to the corporate priorities that accounted for our improved 2011 performance. Those priorities are to continue to focus on ROA improvement, closely monitor our net interest margin, leverage market opportunities to increase market share, provide a superior customer experience, deploy our capital prudently and continue to reduce our credit costs. As we manage through these multiple priorities, we hope 2012 will be a year of faster economic expansion, which will enable us to provide improving financial results.

Since the key to creating satisfied shareholders is retaining and creating satisfied customers by providing superior customer sales and service, we are embarking on a major project to better equip team members to deliver greater value to customers.

We have renewed our partnership with Fiserv to upgrade our core banking system from the current application to Fiserv's signature application. The benefits that this new platform will bring to our team members and customers are significant. Staff members will eventually have a 360-degree view of each customer that will help them to better understand and recommend solutions to meet customer financial needs. The new application will also provide an enhanced customer relationship management solution to aid in our new business development efforts.

When fully operational, our customer sales and support will be more effective and efficient. We have planned for this upgrade for some time and are excited about the new opportunities for customer satisfaction that it presents. While there will be costs associated with this project over the next 2 years, we believe these expenditures will equip -- better equip us to fulfill our customer promise to care, listen, understand and deliver.

In closing, I want to gratefully acknowledge the efforts of our 3,800 staff members who positively and enthusiastically deliver a superior experience to our customers every day. Their teamwork, along with their unwavering commitment to customer service, has created and will continue to create value for our shareholders.

Thank you for your attention. After Phil and Charlie give you additional details of our performance, we'll be available for your questions. Phil?

E. Philip Wenger

Thanks, Scott, and good morning, everyone. As we discussed in our earnings release, we were pleased to see improvements in our credit results this quarter. These results reflect the ongoing efforts we have made and will continue to make in reducing our problem assets.

As you saw in our earnings release, we sold $35 million of nonperforming residential loans to an investor. This sale, combined the efforts we have made to resolve troubled loans, resulted in further improvement in our credit metrics, which allowed us to reduce our loan loss provision by $1 million for the fourth quarter, from $31 million to $30 million.

Our charge-offs were up from last quarter, which I will cover in detail in a moment. Our coverage of nonperforming loans increased, even with a $10.6 million release in the allowance for credit losses.

Let me give you a few comments on the loan sale, which was detailed in our earnings release. As we entered the fourth quarter, we assessed market conditions and decided the timing was right to undertake the sale. We have periodically evaluated the sale strategy as part of our ongoing efforts to reduce problem loans. This past quarter, we made the decision that the pricing on residential nonperforming loans, combined with the elimination of the cost to work out these loans, made this sale an appropriate strategy. We estimate that each of these loans costs approximately $10,000 to collect, excluding personnel costs. Still, it allows us to eliminate these expenses as well as redeploy resources to other workout and collection efforts. We did not sell the entire nonperforming residential portfolio. Through our cost benefit analysis, we determined that the market pricing was not acceptable in the assets we retained.

Now let me give you some specifics on asset quality. My comments will be linked quarter unless I indicate otherwise. First with regard to delinquency, as you saw on the chart on Page 5 of the earnings release, we saw a 32 basis point or $35 million decrease in overall delinquency. 31- to 89-day delinquencies decreased 10 basis points. 90-day and over delinquencies declined by 22 basis points. Delinquency declined in commercial, commercial mortgage, residential and home equity loans. Construction delinquency increased by $10 million. One residential development loan for $9 million located in our Maryland market contributed significantly to the construction delinquency increase. This loan has been moved to nonaccrual. Overall, delinquency is the lowest it has been since the first quarter of 2009.

Nonperforming assets and nonperforming loans are the lowest they have been also since the first quarter of 2010. Additions to nonaccruals were $66 million this quarter versus $52 million last quarter. Through the sale of residential loans and the continued effort to resolve nonaccrual loans of all types, we were able to reduce nonperforming loans from $311 million to $287 million.

Within our nonperforming loans, increases to both commercial mortgage and construction loans types were offset by reductions to residential and commercial loans. The increase to commercial mortgage nonperforming loans of $10.8 million was the result of the addition of several loans, all under $2 million. A number of these were in our New Jersey market where real estate conditions continue to be challenging.

The construction nonperforming increase of $8.4 million was driven by the residential development account in Maryland that I mentioned earlier. Other real estate owned declined by $6.6 million, with sales of several commercial investment projects and a residential development loan.

Net charge-offs were $40.6 million or 1.36% of average loans on an annualized basis, as compared to $30.8 million or 1.04% of average loans in the third quarter of 2011 and 1.65% for the fourth quarter of 2010. This quarter we charged off $17 million associated with the loan sale. While our charge-offs exceeded our $30 million provision, the loan at sale eliminated $35 million of exposure to nonperforming loans. The allowance for credit losses declined from $269 million to $258 million. However, nonperforming loan coverage increased from 87% to 90%, and our allowance is 2.16% of loans.

We regularly discuss construction loan balances, so let me provide you with an update. Average balances in the construction loan category declined by $27 million. This decline was driven primarily by commercial construction loans that were converted to permanent mortgages, as well as by charge-offs. As we have mentioned, we do not see this loan type growing by any meaningful amount, though the housing and overall commercial real estate markets show greater stabilization.

Troubled debt restructurings declined to $99 million from $117 million. Of this total, $66 million or 67% are accruing loans versus $68 million or 58% last quarter. Residential TDRs declined $15 million driven by the loan sale, and commercial TDRs declined $3 million.

Now moving to loan demand and activity. Loan demand remains modest, although average outstandings increased by $39 million. Line usage remained flat with last quarter at 44%. We are replacing our normal runoff as well as construction loan reductions through new loan generation. New loan originations for the year were $1,710,000,000 as compared to $1,640,000,000 in 2010. This increase is being driven by our teams of seasoned relationship managers taking advantage of market opportunities.

General market conditions remain stable in Pennsylvania, Maryland, Northern Delaware and Virginia. Conditions remain challenging in New Jersey.

With regard to mortgage activity, applications were down from the third quarter at $635 million as compared to $712 million. Closings increased to $503 million from $374 million in the third quarter. The pipeline has declined to $321 million from $396 million at the start of last quarter. 72% of the pipeline is refinancing activity.

So in summary, we achieved a reduction to problem loan levels and incremental improvements to our credit metrics that position us well for the coming year.

Now I will turn the discussion over to Charlie Nugent for his comments. Charlie?

Charles J. Nugent

Okay. Thank you, Phil, and good morning, everyone. Thank you for joining us today. As Scott mentioned, we reported net income of $0.18 per share for the fourth quarter, a decrease of $0.02 or 10% from the third quarter. For the year, net income per share was $0.73, a 24% improvement over 2010. Unless otherwise noted, comparisons are of this quarter's results to the third quarter of 2011.

Net income was $36.1 million in the fourth quarter as compared to $39.3 million for the third quarter, a $3.2 million or 8% decrease. The decline in our net income resulted primarily from both lower net interest income and other income and an increase in other expenses. These items were offset by increases in investment security gains, a lower provision for credit losses and a decrease in income taxes. Net interest income decreased $3 million or 2%, mainly due to a 12-basis-point decline in the net interest margin. The net interest margin declined to 3.81% in the fourth quarter from 3.93% in the third quarter. Net interest income and margin was negatively impacted by prepayments on mortgage-backed securities and the resulting accelerated amortization of premiums, which increased $2.9 million in comparison to the third quarter. This increase in amortization equates to approximately 8 basis points.

For the year, our net interest margin increased 10 basis points to 3.90% as compared to 3.8% in 2010. The cost of our interest-bearing liabilities decreased 1.07% from 1.12% in the third quarter. The cost of interest-bearing deposits declined to 73 basis points in the fourth quarter from 78 basis points in the third quarter.

During the fourth quarter, $811 million of time deposits matured at a weighted average rate of 88 basis points, while $761 million of certificates of deposit were issued at a rate of 51 basis points. In the first quarter of 2012, $738 million of time deposits are scheduled to mature at a rate of 1.02%. In addition, $102 million of advances from the Federal Home Loan Bank are scheduled to mature in the first quarter of 2012 at an average rate of 2.86%.

The positive effect of the lower cost of funds was more than offset by a 17-basis-point decrease in the yield on average earning assets, which was 4.63% in the fourth quarter as compared to 4.80% in the third quarter. Investment security yields declined to 3.33% in the fourth quarter from 3.92% in the third quarter, primarily due to the increase in premium amortization. The yield on average loans decreased only 7 basis points to 5% in the fourth quarter from 5.07% in the third quarter.

Average interest earning assets increased $140 million or 1%. Average investments increased $103 million or 3.9%, while ending balances decreased $97 million or 3.5%.

During the fourth quarter, payoffs in maturities and investment securities exceeded purchases. We continuously monitor our portfolio holdings and current investment alternatives in making purchaser to sale decisions.

Average total loans increased $39 million or 0.3%. Increases in commercial mortgages and residential mortgages were partially offset by decreases in commercial loans and construction loans. Average deposits increased $97 million with a $237 million or 3% increase in demand and savings deposits, being partially offset by $140 million or 3% decrease in time deposits.

Noninterest-bearing demand deposits increased $63 million or 2.5%, almost entirely in business accounts. Interest-bearing demand deposits increased $38 million or 2% in both personal and business accounts, and savings deposits increased $137 million or 4%, almost entirely in municipal accounts.

Our other income for the fourth quarter decreased $3.3 million or 7% excluding the impact of security gains and losses. Service charges on deposits increased $113,000 or 0.7%. And included in this category are overdraft fees, which decreased $314,000 due to 3 fewer business days in the quarter. Other service charges grew $575,000 or 14.5%.

Other service charges and fees decreased $1.7 million or 13.8%. Included in this category is debit card income, which decreased $2.4 million or 52% as a result of the regulatory change in interchange rates. Also included in the category are merchant fees, which grew $541,000 or 22%.

Mortgage banking income decreased $1.7 million or 22%. Mortgage sale gains decreased $1.1 million or 16% as a result of a 30% decrease in new loan originations, partially offset by an improvement in spreads. The remaining decrease resulted from a $672,000 increase in the amortization of mortgage servicing rights due to prepayments on our existing servicing portfolio.

During the fourth quarter of 2011, certain 10- to 15-year residential mortgages were held in our portfolio rather than being sold in the secondary market. Had these loans been sold, an additional $1.4 million of mortgage sale gains would have been recognized during the fourth quarter.

For the year ended December 31, excluding the impact of security gains, other income increased $1.5 million or 1% in comparison to 2010. In the fourth quarter, total net security gains were at $3.1 million, a $3.5 million increase over net security losses of $443,000 in the third quarter.

During the quarter, realized gains on sales of $3.7 million were partially offset by $636,000 of other than temporary impairment charges on bank stocks. During the fourth quarter, we took advantage of market conditions and sold certain debt securities that had higher prepayment rates than expected.

Operating expenses increased $3 million or 3% in comparison to the third quarter. Approximately $1.6 million of this increase resulted from expenses related to the merger of the corporation's New Jersey banks during the fourth quarter. Of this amount, $890,000 was in marketing expense and $660,000 was in other expense. Salaries and benefits decreased $839,000 or 1.4%. Stock compensation expense declined $1.6 million, mainly due to accelerated vesting in the third quarter. This decrease was partially offset by a $523,000 increase in severance expenses.

FDIC insurance expense decreased $1 million due to actually insurance cost being lower than accrued. The core FDIC insurance expense is approximately $3.2 million. Marketing expenses increased $1.1 million or 58%, mainly as a result of the bank merger in New Jersey.

ORE and repossession expenses include foreclosure expenses and net losses or gains on the sales of other real estate owned. The $1 million or 40% increase was mainly due to a $1.2 million increase in net losses, which were approximately $980,000 during the fourth quarter, as compared to $260,000 of net gains during the third quarter. Prior to the fourth quarter of 2011, gains on ORE sales were included in other income. All periods have been restated to reflect the new presentation.

Other increases in expenses included $797,000 of losses on sales of certain branch properties and $750,000 of outside service costs.

For the year ended December 31, other expenses increased $1.2 million [ph] or 2% in comparison to 2010.

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 take our first question from Mac Hodgson with SunTrust Robinson Humphrey.

Mac Hodgson - SunTrust Robinson Humphrey, Inc., Research Division

Charlie, I wanted to hit on the net interest margin. It ended up coming in a decent amount lower than you had indicated on the third quarter call. Could you give us some color of kind of when the pressure started? Was it late in the quarter that you saw more prepayments?

Charles J. Nugent

Yes. We didn't know what our prepayments on the mortgage-backed securities would be in October when we had the conference call, and the total cash flows off the mortgage backs and the CMOs in the third quarter were $112 million. And what they turned out to be in the fourth quarter were $180 million. They were 60% higher than we thought. When we did our modeling, we expected a 15% increase, around a 15% increase. And that was based on the mortgage applications to refinancing that we see here at our mortgage company and also our review of the rates. And the prepayments were a lot more than we thought, looking at the rates. And I think part of it, Mac, is we have some 20-year mortgage-backed securities, and even though the 20-year rate didn’t go down that much, in the our opinion, that would trigger all this refinancing, it seems like a lot of people move from the 20-year to the 15-year or the 10-year rate. So that from -- I'm sorry, from a 20-year mortgage to a 15- or 10-year mortgage.

Mac Hodgson - SunTrust Robinson Humphrey, Inc., Research Division

And how do you expect this trend to play out going forward? I mean, do you expect continued pressure?

Charles J. Nugent

A lot of it is a guess, an estimate based on what mortgage rates are doing nationally and also -- and what mortgage rates are doing nationally and where people have their mortgage and what the rate is. So it's kind of hard to guess.

Mac Hodgson - SunTrust Robinson Humphrey, Inc., Research Division

Okay. On the liability cost...

Charles J. Nugent

Is that all right? I mean, is that [indiscernible] color on that?

Mac Hodgson - SunTrust Robinson Humphrey, Inc., Research Division

It would be helpful to get a little bit more thought on where you guys were thinking things would go, but I understand.

Charles J. Nugent

We were thinking -- in the third quarter, we knew it was $112 million. When we did our estimates, we do our projections. We were thinking it would increase to $125 million to $130 million, so about 16%. In reality, it increased to $180 million. And that's our -- we didn't know what the October cash flows were until the end of October. And then we -- when we do our projections, we estimate based on the rates and the applications we see.

Mac Hodgson - SunTrust Robinson Humphrey, Inc., Research Division

Are you going to estimate that it's going to increase from here?

Charles J. Nugent

What's going to increase?

Mac Hodgson - SunTrust Robinson Humphrey, Inc., Research Division

The prepayments.

Charles J. Nugent

In January, February, I wouldn't think they would, but in March, it could because rates are going down again. And then it's just -- it's a hard thing to estimate.

Mac Hodgson - SunTrust Robinson Humphrey, Inc., Research Division

And then on the funding costs, you’ve given some color on CD rates and rate pricing. But I think this may have been asked in prior calls. But the yield on your time deposits is 1.43%, which is considerably higher than the stuff that's been maturing and then kind of repricing it down. So is there a lot of long-term CDs that are in there?

Charles J. Nugent

There are not a lot of long-term CDs in there, but they have a lot higher rates.

Mac Hodgson - SunTrust Robinson Humphrey, Inc., Research Division

So I'm just curious because you gave $811 million matured at 88 basis points. You’ve got $738 million maturing at basically 1%. What in there is considerably higher than that, that gives you to the 143? And when does that stuff mature?

Charles J. Nugent

In the next quarter -- in the second quarter, it's -- and it's further out. In the third quarter, there's $555 million that mature at 1.22%. And then when you look at the fourth quarter scheduled maturities, there is $268 million in a -- at 2.34%. But it won't turn out to be 2.34% because we’ll constantly have CDs rolling out to that period.

Mac Hodgson - SunTrust Robinson Humphrey, Inc., Research Division

And what's the average term of your CDs?

Charles J. Nugent

Oh, I don't know what the average is. When we did our investor presentations, we tried -- we had a lot of questions on the CDs and so -- and the margins, so we tried to show by quarter how the CDs were rolling off and what their rates are. And it looks unusual because longer out, you have higher rates, but that's because the 6 months or 3 months haven't rolled off into that category yet. But that gives you an indication that there's still a lot of longer-term CDs out there at higher rates.

Operator

We'll take our next question from Robert Ramsey with FBR.

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

I was wondering if you could share maybe a little more information about the premium securities where you had amortization this quarter. What was maybe the average premium paid on some of those securities? And then what do you have left in the book maybe that's a higher premium security? Were these securities bought at 102 or 105 or 108 or where?

Charles J. Nugent

Yes, the total premiums, Bob, we have were about $35 million, and it's on the CMOs and the mortgage-backed that total about $1.9 billion. So the average premium we paid is 1.9% on average. And we don't like paying premiums, but rates have been falling. So if you want to buy mortgage-backed securities, we have to pay a premium. And I would think that our highest rates will be 103, maybe touching on 104, depending on when we bought them.

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

Okay. That's -- and then with the securities that you all are, I guess, in the market buying today, kind of where is the yield on MBS that you're buying? And are you today in the market still paying kind of that 102 up to 103 sort of range? Or is there something different than what you put on the…

Charles J. Nugent

What we've been doing recently is we've been buying the 10-year mortgage backs, and the premium on those would be at the 103 or 104. But we don't think there will be significant prepayments on those and -- or extension risk because they amortize over 10 years. But the rates -- the coupon of those rates are probably about 3 1/8, so rates would have to go down. I never thought they were going to go down like they have, but they would have to go down 75 basis points under that, I would think, for them to prepay. We feel safe with those, but I don't think we'd have the compression we had.

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

Sure. Sure. Okay, that's helpful. With -- I guess if I shift over to the fee income, obviously, we saw all the expected impact of Durbin this quarter. I guess I was a little surprised that you all weren't able to offset a little more of that. Could you sort of talk about where you all are in that process and maybe looking forward if you think the ability is there to recapture some of those lost fees?

E. Philip Wenger

Yes. This is Phil. Bob, I think we indicated in the third quarter that we had -- we thought we had fees in place to recoup about 50%, and of Durbin, I think that's held. We do have some additional increases that went into place in the first quarter that we think will, on an annual basis, give us another $2.25 million to $2.5 million on an annual basis. And then we had identified some other things that we thought we could do, and I would say given the pressures in the industry right now that we're probably going to put those off at least for the foreseeable future. So we still think annually on Durbin, we're losing somewhere between $8.5 million and $9 million. And with our January increases, we think we're going to be able to recoup on an annual basis $6.5 million to $7 million.

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

Okay. I guess, maybe then while I'm confused is if the annual loss is $8.5 million to $9 million, then quarterly, it's a little over 2. And you all seem to be down this quarter by that full amount, right? I mean, didn’t you all say you were down about $2.4 million related largely to the debit [indiscernible] fees?

E. Philip Wenger

Well, that was specifically just the debit card, which would -- which I think would be in line.

Charles J. Nugent

Yes, and the other things on that would be the mortgage sale gains were down $1.1 million on other income. And we also had the mortgage servicing rights because of higher prepayments on the servicing portfolio. That was down 57%. That was down $600,000. So in that, we are down $3.3 million, 7%, but it's outside -- the 3 big things are the debit card, as Phil said, mortgage sale gains and the mortgage servicing rights.

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

Okay. And then I guess maybe if I shift over to credit, you all mentioned in your introductory comments that you'll continue to make efforts to reduce problem assets. Are you all considering further loan sales at this stage? Or are you happy with where things are?

E. Philip Wenger

We've been looking at bulk loan sales probably for 3 years, and we just decided to sell $35 million. We'll continue to look at that every quarter. And I can't tell you that it will ever happen again, but it could happen. It really depends on so many different things, including how quickly we're moving assets through our own efforts, the prices that we can get in a bulk sale, and so it's really hard to say.

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

Okay. And as you think about that decision or the decision you all made this quarter, I know you all highlighted 2 collection calls to about $10,000 per loan post personnel costs. And instead, you all sold these loans at about $0.50 on the dollar. I mean, is it just sort of looking at what the expected recovery is net of cost versus what you can get today? Or I mean, sort of what are the factors in that decision because the sales price seemed a little expensive? Obviously, I don't know the loan level detail of what you sold though.

E. Philip Wenger

Yes. We look at a lot of different things. There are a lot of different factors, whether -- how our workloads are and our workout area has an impact. We're trying not to add costs from an expense -- from a personnel standpoint. That $10,000 does not include any personnel costs, so we were able to eliminate 165 loans that we don't have to sell through our own efforts. And it's really hard to put a dollar amount on that, but we felt as though it was the proper move to make right now.

Laura Wakeley

And Bob, I think we're going to see if we can move to the next person in the queue, since we have quite a number of people asking questions. But if you'd like to come back on, that would be wonderful at the end. But we do need to move on to the next person.

Operator

And we'll take our next question from Craig Siegenthaler with Crédit Suisse.

Craig Siegenthaler - Crédit Suisse AG, Research Division

Just first on the OREO, I just wondered what are your plans kind of going forward in terms of other real estate owned disposition activity. I'm just trying to think about the OREO expense line item and noninterest expenses.

E. Philip Wenger

Yes. The OREO expense really, we found, it really fluctuates quarter-to-quarter. Third quarter was -- it wasn't bad. Fourth quarter, we had a number. We're trying to sell all our real estate and our nonperforming loans as best we can, and we're going to continue to be as aggressive as we can.

Craig Siegenthaler - Crédit Suisse AG, Research Division

Got it. Okay. And then on -- and just in terms of loan growth, your trends were a little different than some of your competitors and certainly the industry in terms of lower C&I growth and other classes. Is this more of a function of a smaller case target in terms of who you're targeting for loan growth? Is it more of a function in terms of your geography of Pennsylvania, New Jersey, Maryland? What's kind of the -- what do you think is the driver there versus industry growth in C&I?

R. Scott Smith

This is Scott, and I've been reading some of that this morning. Wall Street Journal talks about loan growth. And from what I can see, trying to look at some of the national numbers, there's some geographic issues. I think there's more -- the auto industry is picking up, and I think there's some lending going on to all that's related to that in the Midwest. And I think a lot of the loan growth is happening in the mid-cap to large companies, which is not part of our market. But having said that, I don't have data in front of me that shows all of that. But our sense is that the small business sector is still hesitant about leveraging up there, although there's some anecdotally more positive attitudes out there than there's been. Phil, do you have anything to add to that?

E. Philip Wenger

No. I think it's hitting the small business sector, the one that we're really strong in. It's -- that demand pickup is hitting that sector a little later than it is the larger corporations. But in general, I think we feel better about loan demand, and really across the board, I think our pipelines are a little stronger in almost every region that we operate in right now.

Craig Siegenthaler - Crédit Suisse AG, Research Division

So given kind of the demand you're seeing and your expected runoff, you would probably expect -- given things kind of remain stable in terms of the economy, that C&I loan growth, that rate would actually improve in 2012 versus what we're seeing here?

R. Scott Smith

We can't forecast that. We'll see how it unfolds. There's just so many factors that impact that. Sitting here in January, it's hard to know what loan demand's going to be in July. So we're hopeful that, that will happen. I would say watch the economic numbers and the confidence indicators from the small business area that come out from time to time, and you'll get a sense of where that's going. And I think we'll get our share of it. But to predict what loan demand's going to be even in March at this point in time, it's hard to do.

Operator

We'll move next to Frank Schiraldi with Sandler O'Neill.

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

Just a couple of questions. I wondered on expenses. You guys mentioned that a couple of items in the quarter were of a nonrecurring basis, especially the merger costs of putting the 2 affiliates together. I'm just wondering if you can maybe update us with your thoughts, Charlie, on a good run rate from here. I think in the past you've talked about maybe $104 million, $105 million for total noninterest expense.

Charles J. Nugent

Thanks for asking me to make a prediction, Frank. We've always been saying the run rate's $104 million to $104,500,000. It's kind of hard to get it by quarter, but the operating expenses for the year were $416 million. Divide that by 4, it comes out to $104 million. But it's kind of hard to get it by quarter. You know what I mean? And this quarter, we had -- it was $109 million, but if you're asking for a run rate, I would think our expenses are going to go up because of a core conversion and because of a lot of compliance costs. I would think it's going to be in the range -- the first quarter will be -- I'm glad you asked. I can't guarantee this, but we were thinking about $106 million to $107 million in the first quarter, and maybe in the fourth quarter, it will be $109 million to $110 million. And I'm embarrassed because I always say $104 million to $104,500,000. But there are always things that -- it's kind of -- overall it came out, I think. But like marketing, I know our marketing people will be within their budget. I know what it is, but it varies by quarter. And when we had the merger, we spent an extra $1.1 million in the quarter related to that. And there's always -- there's timing differences on a lot of things. We've been trying to sell branches in New Jersey that were closed. We sold them, but we took an $800,000 loss. So that's in the fourth quarter. Outside services, we budget under $2 million a quarter, but this quarter, it turned out to be $2.6 million. So there's an extra $600,000 there. The ORE cost is -- they're going all over the place. Sometimes it's a gain. Sometimes it's a loss. But thanks for asking me. I'd say $106 million to $107 million in the first quarter and, the fourth quarter, between $109 million and $110 million. But it's -- I think we know -- and we're pretty good at controlling costs, and we know what they're going to be, but it's kind of hard to get them exactly in what quarter they're going to be.

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

Got you. And then the total merger, what you would consider merger costs including marketing but also other expense in the quarter. Was that -- did I hear it right? Was that $1.6 million?

Charles J. Nugent

Yes, that's exactly right.

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

Okay. And then just my last question was on the loan sale on the quarter. Just wondered if maybe, Phil, you can give us a little more color on the loans. Were they -- was this old resource vintage?

E. Philip Wenger

Some were, Frank. Not all. 16% of the sale, I think, would go back to the old resource vintage. And then the balance were residential properties that are nonperforming throughout our entire footprint.

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

Okay. So the -- so a majority then was still -- was prime residential loans? Is that fair?

E. Philip Wenger

Yes, well. I don't know what your definition of prime is. They were nonperforming, and there were some seconds that were sold also. Okay.

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

I'm just trying to get a sense for -- were the LTVs -- to start out with, were there anything outside of the norm or…

E. Philip Wenger

I would say on average, they were a little higher. I mean what -- in the residential mortgage portfolio, what moves to nonperforming in general are your higher LTVs.

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

Right. No, that makes sense. I'm just wondering -- just doing the math, it seems to me that if there are sort of maybe 80%, 85% LTVs, something like that. And then just given the haircut that you took, it seems like they've -- these loan values could have been -- could be looked at as these values were down 40% or 50%, but that, I wouldn't think, would be true unless there was something different about these loans. Or was it just the opportunity to get them off the books and...

E. Philip Wenger

Well, it was a combination of a number of things, Frank. It was an opportunity, we thought. It is really hard when you have -- in general when residential mortgages move to nonperforming, the maintenance of them tends to start declining, sometimes at a very -- a rapid pace. So it really varies from property to property.

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

Okay. And I don't want to dwell on it because I know it’s not big numbers…

Operator

We'll move next to Matthew Clark with KBW.

Matthew T. Clark - Keefe, Bruyette, & Woods, Inc., Research Division

On the reserving side of things, if you x out the reserves that were tied those loans sold, it looks like you still bumped up reserves on a dollar basis, a couple of million bucks. Just trying to get a sense for your view on building or a leasing from here given your outlook.

E. Philip Wenger

Yes, Matt, I would just say that last year at this time, I think we felt better about our credit than we did at the beginning of the prior year, and right now, we feel better than we did 12 months ago. So -- yes, but again, it changes. These things can change quickly and -- but I don't want to sound too optimistic, but in general, we feel better. The 30- and 60-day delinquencies are down, which is always a good sign, and so we'll see as we go forward.

Matthew T. Clark - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And then on the loans sold, can you give us the number of actual loans sold?

E. Philip Wenger

165.

Matthew T. Clark - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And those -- your nonperformers and 90 days plus in that category, I think, have been very, very range bound in that $40 million to $50 million write-up range, I think, dating back to '09. I guess getting back to that prior question about what was unique and different about these resi mortgages, I assume that exposure or that concentration of maybe higher than average LTV-type credits was isolated into that nonperforming bucket and have been there for the most part during this time. Or is there some other portion of the resi mortgage portfolio that you are concerned about?

E. Philip Wenger

I would say that the statement you made is pretty accurate, yes.

Matthew T. Clark - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. Okay, and then just on M&A, any update there? Most are, I think, hoping for a pickup in M&A this year, but just trying to get a sense for any chatter that you might be dealing with in each of your markets.

R. Scott Smith

This is Scott. I would say it's been relatively quiet. There are still some stressed banks out there from time to time that look around a little bit. My sense is that we're 6 to 9 months from any significant pickup in M&A activity, and that would assume that bank stocks recover and the economy is recovering nicely. I think most banks that are still here feel like they're going to survive all of this, and they're looking for better pricing and for -- sellers and buyers are looking, I think, for a little more confidence in credit and where it's going. But that's just my opinion.

Operator

We'll take our next question from Rick Weiss with Janney.

Richard D. Weiss - Janney Montgomery Scott LLC, Research Division

It looks as if you guys are still generating a lot of cash and not that many places to put it. Is that correct? It's hard to tell without a cash flow statement.

E. Philip Wenger

That's great. You're right, Rick, and...

Richard D. Weiss - Janney Montgomery Scott LLC, Research Division

Okay. And so does it make sense to just increase or start doing buybacks again or increase the dividend? Or do you prefer just to keep the cash in case -- suggesting M&A does pick up later this year?

E. Philip Wenger

Well, Rick, as you know, we did increase the dividend 3 times last year, and we continue to look at all of that. And as you also know the larger banks are completing their discussions with regulators and with their revised stress testing. I'm hearing that the FDIC has issued some information about their stress testing. The OCC will be shortly. So I think we need to get a little further down the road in regulators and capital requirements before we get too carried away with impacting the capital significantly. But we do believe we are very well capitalized and suspect there will be an opportunity to do some more of that as those guidelines become clearer. My hope is that by midyear we’ll have much more clarity than we have now. We'll see how that all goes. And then we'll, quarter-by-quarter, consider our position and both from where we need to be capitalized and then what opportunities present themselves. But we still don't have, I don't think, enough clarity from regulators to begin doing significant changes to the capital.

Operator

We'll take our next question from Mike Shafir with Sterne Agee.

Mike I. Shafir - Sterne Agee & Leach Inc., Research Division

I was just wondering, can we just review for a minute the CDs that are rolling off in the first quarter at $738 million? What was the current cost? And what are they being replaced with? And what cost?

Charles J. Nugent

Yes, we can do that. Mike, in the fourth quarter -- do you want the fourth quarter numbers? Or what would you like?

Mike I. Shafir - Sterne Agee & Leach Inc., Research Division

Fourth quarter.

Charles J. Nugent

In the fourth quarter, yes, we had $811 million of time deposits mature, and the weighted average rate was 88 basis points. And we put on -- either they rolled over or we put on new CDs. It totaled $761 million and we put them on -- the weighted average rate was 51 basis points. So our cost of funds went down. And then in the first quarter of 2012, we have $738 million of time deposits maturing, and the rate is 1.02%. So I would think we could retain most of those at 50 basis points.

Mike I. Shafir - Sterne Agee & Leach Inc., Research Division

And then on the borrowings side, it's $102 million that's repricing in the first quarter at 2.86%. And what were you guys asking about in terms of the term on that?

Charles J. Nugent

What -- as Rick said, we’re building a lot of cash. The cash we're building, we're going to pay off those advances. We don't need...

Mike I. Shafir - Sterne Agee & Leach Inc., Research Division

Okay. So you're not replacing them at all?

Charles J. Nugent

No. So they'll be paid off at -- just out of cash.

Mike I. Shafir - Sterne Agee & Leach Inc., Research Division

Okay. And then just on the tax rate, as we think about that moving toward, are we still kind of 26% to 27%?

Charles J. Nugent

I would think so. I would think so, Mike. Oh, wait a minute. I'm getting an indication not. But yes, as earnings go up, the marginal rate goes up. But we still have an awful lot of credits related to -- we have municipal bonds or tax rate, so about $300 million of those. And then we also have a lot of credits related to our low-income housing investments that we continue to make, and it will keep our tax rate low. But the marginal rate is -- additional incomes generated is on a 35%. I'm hearing a range, scared to do any predictions, but 27% to 29% effective tax rate. What it is now, and that depends on our income level because the top dollars are getting put -- the additional dollars that come in would come on at 35%.

Operator

And we'll take our next question from Collyn Gilbert with the Stifel, Nicolaus.

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

A question I guess for Phil or Charlie. What is the yield differential in your CRE book from what's rolling off to what you're originating?

Charles J. Nugent

We should have that shortly.

E. Philip Wenger

We're looking, Collyn.

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

Okay. While you're looking, Phil -- oh, so on the CRE book and then also on the C&I book. I was curious to get the yield differential on both of those books. And then also along those lines, just trying to understand how you're able to get that residential mortgage growth that you're getting, maybe how you’re pricing that. I mean when you're competing with the GSEs, I just -- I struggle with how any bank can actually book competitively a conforming loan. So what's -- how are you getting that?

Charles J. Nugent

Well, we generate a lot of residential mortgages through our branch system and our existing customers. I think a lot of our people, a lot of our customers just come to us because of service, not just the rate. But the rates on those are -- the 20-year rate's 3.75. And the rates are still good. 15 is 3.25, and the 10 year's 3 1/8. Some might drop a little bit. But they're competitive rates based on the Fannie Mae and Freddie Mac rates, and we can keep them just as the same as [ph] we sell them.

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

Okay. So you're getting a good -- or you're competing on the rate then on that front, okay.

Charles J. Nugent

Yes. And it's hard to believe that, that's a good rate, but if we go out and -- somebody mentioned you go out and buy mortgage-backed securities, you get 175 or 165. It's better to keep these even though you're giving up a gain of 1.3%. I think it's better to keep these than buying mortgage-backed, especially when you have to buy the -- paying the premium, too.

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

Yes. Okay. Okay, and then just a question, do you guys have an all-in cost projection for this platform expansion?

E. Philip Wenger

We have estimates, Collyn. We believe that in this year there will be approximately $3 million of costs, most of which will be in the last 6 months of the year. And then starting in 2013, our total IT costs, the run rate will increase by $3 million a year.

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

Okay. As you think about tying in, Scott, to your goals for ROA improvement -- and maybe this is a kind of question for you, too, Charlie, is that you don't want to give guidance on the expense side. I mean, how do you think about this additional cost burden but yet still trying to improve that ROA, do you look at it from maybe having an efficiency goal in place? I mean, I guess I'm asking -- the short question is where -- how will you finance this expansion? Will find areas to cut costs in other capacities? I mean, how do you continue to improve profitability and manage that efficiency ratio when you've got additional costs coming on to the business?

R. Scott Smith

You're talking about the conversion cost, Collyn?

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

Yes.

R. Scott Smith

Well, our expectation is that there could be a short-term bump for us on that, but our expectation is that the new system will provide us a much better ability to service and sell customers so that we're expecting revenue gains as we implement it throughout the banks. So we'll be watching that, and we'll be watching other costs and may have to hold back some other things to absorb this, depending on, frankly, on loan growth. If we get a pickup in the economy and we get some boost from that, which as you know we're well positioned to do, then I think we could absorb more of it that way. But we may have to hold back some other expenditures if we get in an environment where we have very little loan growth and it inhibits our ability to absorb it.

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

Okay. So if we think about, again, Scott, kind of the big picture ROA improvement, I mean, so do you sort of see as you look at your business the real driver to that is going to come more from loan growth rather than opportunities to cut expenses further or really meaningfully grow the revenue side? I guess, when I say revenue, I mean fee revenue. Or credit cost reduction, is that -- that reduction on potential credit cost, I mean, I would think that, that number alone could be a big driver. But we haven't seen it yet, so I'm just trying to think about how you're thinking about it.

R. Scott Smith

Well, as Phil talked about, we're little more optimistic than we were this time last year. And if you look at the potential for changes in earnings, there -- a lot of them are around credit, both on the problem side and on growth in loans. So if we get a combination of both of those, that's good news to us. If we just get a reduced credit cost, that's going to help earnings. But if we get both, then I think we've got some nice opportunity. But that depends on the economy as -- because we just can't go against that too significantly. So we'll see how it unfolds. I think you have to be careful about projecting too much growth in the economy this year. But I think we and most people feel better about that than we did this time last year. But we've been fooled before. And May is going to come again this year, and we're going to see if May does what it's done to us the last 2 years.

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

Okay. Okay, that was it. Did -- were you able to find the yield differential? Yes?

E. Philip Wenger

Collyn, I can't answer your question directly. But I can tell you that the C&I yield at -- in the month of December of '10, the total portfolio was yielding 487. And in '11, in the month of December, it yielded 467, though we had a 20 basis point decrease in yield over a 12-month period.

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

And that was C&I?

E. Philip Wenger

That was C&I. And CRE in December of '11 was 566 and December ‘12, 533 -- I'm sorry.

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

So 566, '10 and '11.

E. Philip Wenger

Yes, '10 and '11.

Operator

We'll take our next question from Blair Brantley with BB&T Capital Markets.

Blair C. Brantley - BB&T Capital Markets, Research Division

Just a quick question. Most of mine have been answered. Do you have the updated criticized loans and classified loan balances? Or minimum -- kind of what the trends are versus last quarter?

Charles J. Nugent

They'll be in the disclosures of our K. Don't have them in front of us.

Blair C. Brantley - BB&T Capital Markets, Research Division

You can't give us a sense of the trends or anything there, because they have actually -- they've been getting a little bit lower each quarter.

Charles J. Nugent

Yes. They will be lower.

Operator

And we'll move on to Mac Hodgson with SunTrust Robinson Humphrey.

Mac Hodgson - SunTrust Robinson Humphrey, Inc., Research Division

You actually just answered my follow-up.

Operator

And moving on to Robert Ramsey, FBR.

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

Just wanted to clarify, when you gave the expense guidance, does that include OREO expense? Or is that exclusive of OREO expense?

Charles J. Nugent

That's based on what we think it will be, but that's just a guess. I mean, that can change. That's the problem. We have a run rate that we feel comfortable with based on what we're seeing now, but things can change, and it includes the OREO expense.

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

Okay. That's helpful. And then just real quick on the provision line, and it looks like you all had about $5 million of provision this quarter related to the loan sale. And so if I kind of take that out, is that the right way to think about is that you had $25 million of provision in the quarter for everything other than the loan sale?

Charles J. Nugent

I think if you look at the numbers that we released, that would be accurate.

Operator

And we'll take our next question from Mike Shafir with Sterne Agee.

Mike I. Shafir - Sterne Agee & Leach Inc., Research Division

I just have a quick follow-up. The expense guidance in terms of that kind of $106 million to $110 million throughout the course of the year, gradually increasing, does that include the current initiative on technology?

Charles J. Nugent

It does. And that's the reason for that bump from the $104 million we've been saying, the $104 million, $106 million -- $106 million, $107 million for the first quarter and maybe $109 million or $110 million in the fourth quarter. We build them up. It’s in there.

Operator

We'll move on to a follow-up from Collyn Gilbert.

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

Sorry, just a quick question. As you think about the sale of your residential nonperforming loans, how does the -- Obama's proposal here to do this large refinancing program affect that?

E. Philip Wenger

I would say it had absolutely no impact to our decisions.

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

So going -- I mean if, let's say, this plan does get pushed through and there's a big refinancing of all the high LTV stuff, you would still continue to pursue these loan sales, even if it meant you could sort of right-size some of these mortgages?

E. Philip Wenger

We'll see how that impacts our portfolio. I think I would say the bulk of what we sold will be -- I don't think this program would have an impact on where those mortgages were in the process, but it should help with our nonperformers going forward.

Operator

And we have no further questions.

R. Scott Smith

I would like to end the call then by thanking everyone for joining us today, and we hope you'll be able to be with us as we discuss first quarter on Wednesday, April 18, 2012. Talk to you then.

Operator

Ladies and gentlemen, this does conclude today's conference call. We appreciate your participation. You may now disconnect.

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