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Fulton Financial (NASDAQ:FULT)

Q1 2012 Earnings Call

April 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

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

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

Analysts

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

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

Nick Karzon

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

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

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

Russell Gunther - BofA Merrill Lynch, Research Division

David Darst - Guggenheim Securities, LLC, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Fulton Financial Corporation Announces First Quarter Earning Conference Call. Today's call is being recorded. I will now turn the call over to Ms. Laura J. Wakeley, Senior Vice President. Please go ahead, Ms. Wakeley.

Laura Wakeley

Great. Thank you. Good morning, everyone, and thank you for joining us for our conference call and webcast to discuss Fulton Financial Corporation's earnings for the first quarter of 2012. Your host for today's call is Scott Smith, 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 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 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 of the release and we've incorporated the statement into today's presentation. For a more complete discussion of certain risks and uncertainties affecting Fulton, please see the section entitled, Risk Factors and Management's Discussion and Analysis of Financial Condition and Results of Operations set forth in Fulton's filings with the SEC. Now I'd like to turn the call over to your host, Scott Smith.

R. Scott Smith

Good morning, and thank you, Laura, and thank you, all for joining us. I'd like to begin with a few prepared remarks about our first quarter performance, then Phil Wenger will discuss credit and Charlie Nugent will cover the financial details. When we conclude, we'll be happy to respond to your questions.

On previous calls and investor presentations, we've discussed our corporate priorities. They include growth and earnings per share, increasing our return on assets, managing the net interest margin, leveraging market opportunities, steadily improving our asset quality, lowering our credit costs and building and deploying capital effectively. I would like to look at each one of these areas more closely in the context of our first quarter performance.

Diluted earnings per share for the first quarter came in at $0.19, up 5.6% from the $0.18 we reported last quarter and almost 12% improvement over the first quarter of 2011. These results give us a good start on 2012, a year that we hope will be marked by steadily improving business and economic conditions in all of our markets. In addition to growing earnings per share this quarter, we increased our return on assets. A key focus is the effective management of our balance sheet. We continue to work to maximize loan yields in a difficult competitive environment, while at the same time, utilizing our branch network to attract lower-cost funding. Maximizing our asset yields without assuming undue risks while controlling deposit costs enabled us to expand our net interest margins.

In the release, you saw that we had a significant increase in linked quarter noninterest income, mainly due to continued strong mortgage activity and related sales gains. Our Investment, Management and Trust Services area also contributed to our growth in other income. Thanks to our very stable core deposit base and loyal customers, we remain highly liquid. We are aggressively working to deploy deposits back into our communities to creditworthy borrowers. However, while overall credit demand has been steady, it cannot be characterized as robust. The decline in our deposit balances this quarter was confined to our more costly municipal and time deposits, contributing to the net interest margin expansion I touched on earlier.

Another factor pertaining to our margin expansion this quarter was the deceleration in the pace of premium amortization on mortgage-backed securities, although that overall level still remains elevated. We experienced good first quarter commercial and personal household account growth as a result of sector-specific marketing and promotional efforts. We just concluded a new personal checking account promotion campaign, and we will be carefully monitoring the retention and expansion of those new relationships in coming quarters. We believe our expanded base of low-cost deposits is one of our key strategic resources.

Total average loan growth for the quarter was up, and as you know, we compete in what has been and remain very good markets and we are hearing anecdotal comments from our business customers that business conditions are gradually improving. That improvement, however, has not yet produced the traction we need to achieve our desired levels of loan growth and net interest income.

Looking at our credit metrics, we were encouraged to see another drop in the provision and in our overall delinquency this quarter. We also saw our construction books stabilize after significant previous declines, and Phil will give you the credit details.

Turning to capital, we were pleased to see an increase in our return on tangible equity, linked quarter. As our capital position continues to strengthen, the board regularly considers opportunities to deploy that capital. Recognizing importance of dividends to many of our shareholders, we have increased our dividend several times and most recently, last month, bringing our dividend yield to approximately 2.7%. We are also deploying capital back into our franchise with new and updated branches in new and existing markets and with the core conversion of our data processing platform that we discussed last call. The board periodically evaluates other potential uses of capital, including strategic acquisition opportunities and stock repurchases. The consolidation of our 2 New Jersey banks continues to go very smoothly. Our Garden State customers were already very familiar with the Fulton Bank way of doing business and with our reputation for delivering a superior customer experience. In addition, we are better able to leverage marketing and promotional dollars in New Jersey as a result of this consolidation.

To sum up the quarter, we continued to show improved performance in a slowly improving economy. We believe there's a great deal of pent-up consumer and business demand that will fuel higher credit demand as the recovery improves overall confidence and our company is very well positioned for that future.

Last month, I announced that I will retire at the end of this year after over 40 years in the industry. At the same time, the board announced that Phil Wenger will be taking the reins of the company, working alongside an extremely capable senior management team. Thanks to a highly developed and effective management succession program, you can expect the transition to Phil's leadership to occur smoothly and seamlessly. He is an outstanding banker who I had the pleasure of hiring in our management training program in the late '70s when I first came to Fulton. And he is personally committed to our strategy, core -- culture, core values and corporate success. I can think of no one more qualified to lead this organization in the future.

So Phil, congratulations and I look forward to working with you for the remainder of the year, and would you please give us your comments on credit at this time?

E. Philip Wenger

Thanks, Scott, and thanks also for your kind words. I'm grateful for your support and for the support I receive from our management team and all our employees. I'm truly looking forward to great success for Fulton's customers, shareholders and employees.

As I mentioned in our press release, we were pleased again to see general improvement in our credit metrics for the quarter. Overall delinquency declined to the lowest it has been at quarter end since the second quarter of 2008. Emerging delinquencies, those accounts under 90 days past due, were also at 2008 levels. We were able to reduce nonperforming loans, and our inflow of nonaccrual loans was lower than early 2008 amounts as well.

While the pace of nonperforming asset reductions is still modest, we are continuing to make progress. As you saw on our press release, we reduced our loan loss provision to $28 million from $30 million last quarter as a result of the gradual improvement in our credit metrics. Now let me give you some specifics. My comments are linked quarter unless I indicate otherwise.

With regard to delinquencies, as you saw on the chart on Page 4 of the earnings release, we saw a 19 basis point or $24 million decrease in overall delinquency. 31- to 89-day delinquencies decreased to 18 basis points. 90-day and over delinquencies declined by 1 basis point. Delinquent loans outstandings declined in all loan types with the exception of residential. The increase to the commercial loan delinquency rate as noted in the press release is the result of a decline in commercial loan outstandings, which I will comment on in a minute. Overall, we were pleased with our quarter-end delinquency levels.

Nonperforming loans are the lowest they have been since the first quarter of 2010. We had a moderate reduction to our nonaccrual loans, which declined from $258 million to $249 million. Our inflows into nonaccrual loans were $37 million, a reduction from $67 million last quarter and a considerable reduction from the levels we have seen over the last several years. The inflows to nonaccrual loans were across all loan types, through payments received, payoffs, as well as charge-offs and transfers to ORE, we achieved a $9 million reduction. Nonperforming loans as recorded in our press release include both nonaccrual loans, as well as loans 90 days delinquent and accruing. The $9 million reduction in nonaccrual loans was partially offset by a $6.5 million increase to 90-day accruing loans, the majority of which were in residential mortgages. ORE increased slightly from $31 million to $34 million, driven primarily by the addition of 3 New Jersey commercial properties, upon which we have been working to foreclose for nearly 2 years.

Net charge-offs were $28 million or 0.94% of average loans on an annualized basis, as compared to $40.6 million or 1.3% of average loans in the fourth quarter of 2011 and 1.42% for the first quarter of 2011. To remind everyone, last quarter, we sold the portfolio of nonperforming residential mortgages that resulted in an additional $17 million of charge-offs at year end. This quarter, we provided $28 million to our allowance for credit losses, maintained the allowance at 2.16% of loans and increased the coverage of our non-performing loans slightly from 90.1% last quarter to 90.9% this quarter.

We regularly discuss construction loan balances, so let me provide you with an update. Pending balances in the construction loan category increased by $32 million. This is the first time since we have been discussing our construction book in detail with you that we have seen an increase. We saw a modest increase in residential construction activity among our building -- builder clients who are reacting to increased housing demand in certain markets. We also saw both our owner-occupied, as well as residential construction mortgage business increase slightly. We would not expect significant increases in this loan type, however, if construction activity accelerates, our outstandings will adjust accordingly.

Troubled debt restructurings increased slightly from $99 million to $103 million. Of this total, $71 million or 69% are accruing loans versus $66 million or 67% last quarter. The $4 million increase to TDRs was primarily driven by a construction loan that was restructured to reflect the actual market conditions.

Now moving to loan demand and activity. We continued to experience modest loan demand, although most of our markets report increased pipelines versus the fourth quarter of 2011. As I mentioned earlier, the decline in our ending commercial loan balances drove the slight increase to delinquency in that category. The reduction in commercial loans includes a decline in line usage of nearly $60 million, driven primarily by lower credit needs among our commercial and industrial borrowers who continue to conserve cash.

Our average balances reflect moderate growth, and this quarter, our average balance growth was the highest it's been in 2 years. The $53 million increase in average total loans was driven by a $71 million or 7% increase in residential mortgages, $63 million or 1.4% increase in commercial mortgages. Partially offsetting this growth were a $52 million or 1.4% decrease in commercial loans and a $32 million decrease in home equity and consumer loans. We are seeing improved conditions and sentiments in all of our markets. New Jersey remains our most challenged market, although recent unemployment data for New Jersey reflects a greater rate of improvement than what is happening in our other 4 states.

Now in our residential mortgage business. Activity continues to be strong. Applications increased to $812 million versus $398 million last quarter. Application volume is up 28% over prior quarter and 92% over the first quarter of 2011. Although the majority of those applications, 69% are refinanced, we did see a slight shift towards purchase in our pipeline for March, which is now 65% refinanced. Last quarter, our pipeline was 72% refinanced. Our current pipeline totals $458 million versus $321 million last quarter, $161 million in the first quarter of 2011.

So to summarize, we achieved moderate improvement again in our credit metrics. We were particularly pleased with delinquency reductions, as well as lower nonaccrual additions. Average loan balance growth increased this quarter, and with a gradually improving economy, our seasoned teams are working hard to take advantage of market opportunities.

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 $0.19 per share for the first quarter, an increase of $0.01 or 6% from the fourth quarter. Net income also improved 6% to $38 million in the first quarter. Unless otherwise noted, comparisons are of this quarter's results to the fourth quarter of 2011.

The growth in our net income resulted primarily from an increase in other income and a decrease in the provision percent of losses. These improvements were offset by lower investment security gains and increases in other expenses. Net interest income increased slightly, this increase resulted from our earning asset growth and a 4 basis point expansion in our net interest margin to 3.85% in the first quarter from 3.81% in the fourth quarter. This improvement was offset by the impact of having 1 less day in the first quarter.

Prepayments on mortgage-backed securities and the resulting accelerated amortization of premiums decreased approximately $800,000 or 17%. However, premium amortization is still at an elevated level. Funding cost decreased further than asset yields, the average yield in the first quarter was 4.61%, a 2 basis point decline from 4.63% in the fourth quarter. Loan yields declined 6 basis points to 4.94% in the first quarter from 5% in the fourth quarter. Investment security yields saw a 3 basis point increase to 3.36% in the first quarter. This increase was due to the lower premium amortization in the mortgage-backed securities.

The cost in interest-bearing liabilities declined 8 basis points to 0.99% in the first quarter. The cost of interest-bearing deposits declined 6 basis points to 0.67% in the first quarter. A portion of the reduction in core deposits cost was related to municipal products. Time deposit costs decreased 7 basis points to 1.36% in the first quarter. We had $764 million of time deposits mature at a weighted average rate of 0.99%, while we put on $699 million of certificates of deposits that were issued at a rate of 0.47%.

In the second quarter, $699 million of time deposits are scheduled to mature at a rate of 0.89%. In addition, we had $50 million of advances from the Federal Home Loan Bank scheduled to mature in the second quarter at an average rate of 2.53%, and we do not expect to renew those advances.

Average earning assets grew $52 million or 0.3%. The growth in average assets resulted from the $53 million increase in average loans that Phil discussed and the $104 million or 3.8% increase in average investments. These increases were offset by $105 million decline in short-term other interest-earning assets. Average deposits decreased $220 million with demand and savings deposits declining $88 million or 1% and time deposits decreasing $132 million or 2% [ph]. Savings Deposits decreased $125 million or 4%, almost entirely in municipal accounts, largely driven by a reduction in rates paid on those accounts.

Interest bearing demand deposits were essentially unchanged in total with increases in business accounts being offset by declines in municipal accounts. Non-interest-bearing demand deposits increased $36 million or 1.4%, almost entirely in personal accounts due to the promotional efforts that Scott referred to. Other income for the first quarter increased $5.1 million or 11% excluding the impact of security gains. Mortgage banking income increased $3.8 million or 62% as a result of 66% increase in new loan commitments to $660 million for the quarter and a slight improvement in spreads driven by persistent low interest rates. Service charges on deposits decreased $435,000, including $109,000 or 1% reduction in overdraft fees, a $282,000 or 6% reduction in deposit service charges and a slight decrease in cash management fees.

The overdraft fee decline reflected a seasonal decrease offset by the impact of increasing charge in the first quarter. The decline in deposit service charges included a reduction in check image fee income, which was a new fee instituted in September of 2011, as well as a reduction in certain non-core fee categories. Other service charges and fees decreased $229,000 or 2%, mainly due to seasonal decreases in certain fee types. These types included merchant fees and debit card fees. Trust income grew $650,000 or 7%, including increases in both trust commissions and brokerage fees, both due to the strength of the equity markets. The $1.3 million increase in other income reflects gains on the disposition of 2 branch properties and 1 operations facility.

Operating expenses increased $1.9 million or 1.7% to $110.7 million for the first quarter. Without some of the non-reoccurring type items that I will go through, our operating expenses would have been approximately $106 million in the quarter. However, going forward, I'd still expect a core run rate of $107 million to $108 million, reflecting the impact of our core systems conversion plan and increasing compliance expectations. Salaries and benefits increased $2.3 million or 3.9%, the increase resulted primarily from a seasonal $1.7 million increase in payroll taxes and a $930,000 dollar increase in health insurance costs. These were partially offset by the effect of $610,000 of severance costs incurred in the fourth quarter.

Operating risk loss increased $2.3 million during the quarter. A $2.6 million charge is recorded to increase our reserve for potential losses related to residential mortgage loans sold, primarily due to exposure to one specific investor program. Under this program, we've provided a credit enhancement for residential mortgages sold, whereby we were responsible for credit losses above the final levels up to specific amounts. As of March 31, the unpaid principal balance of loans sold under the program was approximately $290 million and during the first quarter, credit losses under the program were projected to exceed the defined levels and as a result, we recorded a reserve for those expected credit losses in the first quarter.

Partially offsetting these increases were some reductions in other expense categories. In the fourth quarter of 2011, we incurred $1.8 million of non-reoccurring expenses related to the merger of our New Jersey banks. $1.1 million of these expenses were in marketing with the remaining expenses in the other expense category. ORE and repossession expenses also showed improvements decreasing $640,000 or 18%, as cost decreased $400,000 and net losses declined $240,000. Finally, other expenses for the fourth quarter also showed a $760,000 decrease in loss on property sales.

Okay, thank you for your attention and for your continued interest in Fulton Financial Corporation. Now we will be glad to answer your questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go to Frank Schiraldi of Sandler O'Neill.

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

I wondered -- first question on capital, following CCAR results for the larger banks, do you guys feel like you have a better sense of where Fulton is on the capital front in terms of what is excess capital on the balance sheet and where you want to be, say on a TCE basis?

R. Scott Smith

We -- Frank, this is Scott. Yes, we do. We're not completely there yet, but there's certainly some important information that came out of all of that, and we continue to stress our company and have ongoing discussions with the Fed about those stress tests and I think that provided some more guidance. But we're not ready to make specific statements about what's excess and what's not.

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

Okay. And you talked about a potential for capital return. You mentioned repurchases. I'm just wondering if your thinking on that has changed at all and then how you would rank buybacks against acquisitions and reinvestments of the franchise in terms of use of capital.

R. Scott Smith

Well, that would depend on the opportunity at hand, Frank. So it's hard to say one over the other. But obviously, if we think we have a good management team and if we have an opportunity to expand and put that capital to use and an acquisition is there and is available and is at the right price, then it's a better use of capital to invest it in the future for shareholders. But having said that, we haven't seen any lately. So we'll see how things develop over the summer.

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

Okay. I guess I'll ask another way, is the stock repurchase program -- we've seen 1 or 2 of your competitors announce them. Is that something that is potentially could be announced ahead of the next round of stress tests with the Fed? Or are buybacks something you probably want to wait until after that's completed until 2013?

R. Scott Smith

Frank, as I mentioned earlier, we're in ongoing discussions with the Fed. We continue to update our stress test based on what we learned in the CCAR exercise, and I can't give you a timing of when something might get to the point where we're ready to move or not, so -- and it depends on how the economy goes over the summer. I'm hoping for a good May this year. We've had 2 bad Mays in a row, but this year, let's hope we get a nice pickup in the economy this summer and then that can have an impact. So it's difficult and really impossible for me to tell you when we might consider a buyback because when we do, then we'll do it and announce it. But until we get to that point, it would be misleading for me to try to give you more specific direction.

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

Okay. And then, just finally, I just wanted to ask a question on the margin. Given balance sheet growth, is there more opportunity to reduce yields on some of the municipal accounts and then allow more of that higher-yielding product to run off the balance sheet in 2Q?

R. Scott Smith

Yes, Frank, we've been doing that constantly. A lot of the municipal accounts are bid, and the rates are locked in for a certain period of time. And we evaluate that constantly and are looking at those, trying to properly price those products when the commitment expires.

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

Okay. Do you have any numbers at hand in terms of the municipal accounts that left in the quarter where those were on a pricing basis before they left?

R. Scott Smith

Not on a pricing basis, no.

Operator

And we'll move on to our next question from Bob Ramsey of FBR.

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

I was hoping along the same lines, could you sort of talk about your margin outlook from here and whether you expect net interest income will sort of stay around at the same level that we're at or it may be possible to grow it?

R. Scott Smith

Bob, I can tell you everything about the first quarter. Second quarter and out, my crystal ball's a little foggy. But what I can tell you, we gave you numbers about the CD repricing, and our CDs are coming off to the $699 million repricing. They're coming off at 89 basis points probably on 50 basis points. I -- and we have the Federal Home Loan Bank advances repricing, so the cost of funds is going to continue to go down and the loan yields are under a little pressure. We would think, based on the past, they could be down 6 basis points. And then the investments are hard to judge because a lot of it relates to the prepayments on the mortgage-backed securities and we don't know what -- we project, we think we project something out, but I can't tell you that because we'd be getting -- in late May and June, we're just making guesses. But I would think we're going to see some margin pressure if you plug all these things together.

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

Okay. And then I appreciate the expense guidance that you gave earlier in the call. Just to clarify though, is that $107 million or $108 million, is that a good run rate to the rest of the year or is that just this coming quarter?

R. Scott Smith

We did it when we -- I think we gave you the run rates at the last conference call and maybe we're saying $106 million or $107 million for the first quarter, $107 million or $108 million for the second and up to $109 million for the third and $110 million for the fourth. We can tell you what the run rate is, but in this environment, it is just hard. There's so many unusual things happening. It's hard -- that's when we'd tell you the run rate is, but there's just a lot of unusual things that happen that affect that.

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

Okay. And I guess in terms of these unusual items, you highlighted the losses on the credit enhancement on the loans sold. How do you sort of think about -- to what degree I guess is that fully captured this quarter? Or are there situations where you could have further losses down the road? Is it dictated by home prices or what are kind of the moving pieces there?

R. Scott Smith

We think it's a pretty good portfolio, there was a portfolio loan, so we generated and went to the Federal Home Loan Bank and the FICO scores were high, the 726, loan to value was 74, very similar to the residential mortgages that we keep, the other one you saw, the Freddie Mac and Fannie Mae. We don't know, we'll do an evaluation at the end of the quarter, similar to the evaluation we do on our loan portfolio and then come up to see if we need another reserve. That would increase or maybe even decrease it. We'll do that at the end of the second quarter.

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

Okay. And would home prices be the biggest driver of kind of what that outcome looks like or are there other significant factors in figuring out what losses could be?

R. Scott Smith

I think it would similar factors that we can see in the regular loan portfolio. There would be delinquency doing that portfolio so ...

Operator

And next, we have Craig Siegenthaler of Credit Suisse.

Nick Karzon

This is actually Nick Karzon for Craig's team. Just a quick question on OREO, it looks like the OREO balance stepped up, but the OREO-related expenses declined a little bit. Can you give us some color on this trend going forward?

E. Philip Wenger

Yes, this is Phil. Those expenses are very lumpy and very difficult to project. So overall, our balances increased slightly, I don't think the -- that amount of increase is really going to have any kind of impact on what those ORE expenses are, a lot of it depends on timing of taxes and valuations.

Nick Karzon

Okay. And I guess just as a second question. On the securities portfolio, there's a pretty big step up quarter-over-quarter, and I was wondering if this is kind of a good run rate level going forward?

E. Philip Wenger

Nick, we look at that securities portfolio every day, every hour and we had sold some securities at $97 million at the end of the fourth quarter and they didn't settle. So when they settle, we had to replace those securities when the proceeds came in. We were also -- we had a lot, relatively a lot in short-term earning assets, so we mentioned they went down $105 million. And we bought some additional securities because of heavy cash flows coming in, and we expect those cash flows to continue. And then at the end of the first quarter in March, the 10-year rates spiked and has effect on mortgage-backed securities. They went up to 2.32%, 2.25% at the end of the quarter and the tenure rate today is, I think, 1.95%. So those rates spiked so we took advantage and we bought some more securities thinking that it was a good rate and we're going to have heavy cash flows in the future. So it turned out to be a good move for us, but what we do in our securities portfolio has been based on our ATCO [ph] position, but we look looking at it constantly. We have a lot of good people looking at that and doing a good job with that.

Operator

And we have Rick Weiss with Janney Montgomery Scott for the next question.

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

I guess speaking of your ATCO [ph], are you still asset sensitive?

R. Scott Smith

We are. The asset sensitivity, that 6-month gap is at 1.05% Rick, so we're still positive in that 6-month gap and then when we do our interest rate shocks, you know, 100 basis point increase in rates parallel shift to increase our net interest income by 1% so about $5 million, 200 basis point increase would then increase to $23 million or 4%. We think we're still asset-sensitive.

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

I wanted to talk more about the loan growth or lack thereof. For color there, what's happening with respect to competition and how are you pricing your loans compared to some of the others in the market?

E. Philip Wenger

Rick, Phil Wenger. And competition on C&I loans pricing is extremely competitive, and we're trying to be as competitive as we can.

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

I guess how do you look at it? Is it worth like cutting rates in order to keep customers or does your policy generally let it go then that the pricing is just irrational?

E. Philip Wenger

Rick, when we price our loans, we look at overall customer profitability so there are situations where we believe that it makes sense to make sure we don't lose the account and there are situations where we're probably not as aggressive. And that -- so we would look at the combination of profitability of the customer and the perceived risk that we see in the deal.

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

Is there more competition coming from banks that are smaller or the large banks coming into.

E. Philip Wenger

On the C&I side, it's everyone right now.

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

Okay. And I'm guessing like there's really not that much new business, it's more banks are taking more -- trying to get market share from others?

E. Philip Wenger

That would be correct.

Operator

And we'll move next to Collyn Gilbert of Stifel, Nicolaus.

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

Could you -- and if you guys had said this in the beginning of the call, I apologize, but the sustainability of mortgage banking, do you think that the volumes can -- continues through the second quarter? Or was it more of an anomaly just on the way things are being priced in the first quarter?

E. Philip Wenger

Hi Collyn, this is Phil Wenger. It's -- it changes quickly, so it's really hard to even predict out for a whole quarter. But at the end -- to start the quarter, we still have very strong backlog, and in the early stages of the quarter, we see demand holding up and it is shifting somewhat from refinance to purchase. But it can change really quickly.

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

Okay, okay. Okay, so from a strategic standpoint, is there anything that -- do you want to try to build that up and I'm just trying to think about this as it sort of aligns with net interest income. I mean it doesn't look like there's going to be much movement on the NII side, so just wondering if you would manage to find a business a little bit more aggressively?

E. Philip Wenger

Yes, I think, when we -- as we in the past year really have looked at adds to staff, especially on the revenue generating side, we've been doing it in our investment management and trust, especially brokerage. We've been doing it with C&I teams anytime we can, and we're doing it with mortgage originators so we do continue to invest in this product line.

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

Okay, okay. And then on the reserve front, are you guys in a position yet where you feel as if you can give some sort of reserve target?

E. Philip Wenger

I would say, at this point, no. I think we have some really good signs specifically with our 30- and 60-day delinquencies. Our inflows have dropped substantially. But the last 2 years, I think everyone was feeling good this time of year and we had a slowdown, so -- in the May timeframe, so we are still cautious.

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

Okay, okay. And then also, just on the, I think you may be mentioned it in the intro comments that I might have missed. The growth in construction, you're following some homebuilding activity, is that correct? And is that sustainable or maybe could you talk a little bit more about what's going on there?

E. Philip Wenger

Well, I think that the comments would be similar to what I just had. We are seeing some signs in certain markets to some increased homebuilding. It's -- we're still being cautious on that sustainability of that.

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

Okay. And is it markets in Pennsylvania or is it along the shorelines? Are these track developments, are these kind of smaller fill-in developments?

E. Philip Wenger

I would say Central Pennsylvania would be the strongest area that we have right now in residential construction.

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

Okay. And do you know what the average sales size or selling price is for these homes. I mean, is it in the $200,000 range, $400,000 range?

E. Philip Wenger

Well, I would say, for the most part, it's under $300,000.

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

Okay. And then just one final sort of big picture question. I know, Charlie, you love it when we ask you to predict and you don't like to do that, but there's obviously a strategy that you guys employ to sort of manage the financial performance and I know, Scott, you, in the past, you've kind of talked about ROA. I mean, it’s sort of you look at that business today in the market and the dynamics going on, what are you managing to? I mean, what's the kind of the financial metric that you guys are really looking to drive performance on?

R. Scott Smith

Well, this is Scott, Collyn. We continue to be ROA focused as we build capital and think about that. We're looking a lot more towards ROE as well, but I think we have to be disciplined through this environment to be focused on managing the assets that we're comfortable with the risk parameters around them as opposed to expanding our appetite for risk. We still, as Phil and I both have mentioned, we still have this issue with, "Is this economy really fixed this time and is it going to continue? Or are we going to have a relapse?" And if it's fixed, our rates going up as I think one Fed President thinks in the fall or are they going to wait until, you know, 2015 as some others think. So I think we're going to try to manage the assets that we're comfortable growing. We're going to aggressively go after those assets in terms of what now seems to be market share as opposed to growth. But hopefully, as I said earlier, we get a good May this time and we didn't get May in February. We've got a nice start on the spring. The weather gave us, I think, some help there. We'll see if that continues. If it does, then I think you'll see some nice growth in assets and the return on them as well and we won't have assets we were sorry we booked because we were chasing yield in a time when the risk of doing that was at least too great for us. So continue the basics, getting market share, managing risk effectively and being in a position to really take advantage of whatever credit opportunities that are out there for us

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

Okay, that's very helpful. And I don't want to take up too much more time. Just one final thing on that note. How does M&A fit into that? I know you've talked about in the past, but as it sounds to me, like you want to just manage the assets you currently have. Maybe taking on M&A isn't necessarily a top priority right now?

R. Scott Smith

Well, frankly, there are not a lot of opportunities and most have been, as I've said in the past, stress situations where, again, when we looked at the asset base we would have been acquiring, we were hesitant about why we would want to book those assets. But having said that, you never know what phone call I'll get this afternoon and if it's a very strategic opportunity for us both from a geographic and quality company, we're going to be looking at it. But to date, we haven't seen any of those.

Operator

And we have Mac Hodgson of SunTrust Robinson Humphrey with our next question.

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

Some questions for Charlie. Charlie, on the expense side you mentioned core first quarter expenses of $106 million, which I think excludes the $2.6 million contingent liability. What else are you backing out to get to the $106 million?

Charles J. Nugent

Mac, the other big thing was our health care costs. We're up $930,000 higher than we think would be a normal run rate because of some unusual medical expenses of some of our employees. And also, the rest were -- if you take those 2, that's $3.5 million and [indiscernible] went through it, they picked up another $500,000. So they were thinking the unusual in there and that's a subjective call. They were thinking it was about $4 million.

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

Okay, great. And then on your expense outlook again, I know you touched on this earlier, just want to be sure I understand. The $107 million to $108 million run rate is through the rest of the year and does that incorporate [indiscernible]?

Charles J. Nugent

That's just the second quarter we were talking that was and then as we go forward, it'll increase maybe to around $109 million in the third quarter and $110 million in the fourth quarter. It's being driven by -- we're getting a lot of new regulations and a lot more to come. And we're hiring more compliance people and that's a tough one to judge how much that's going to be, how much more we're going to have to add because we don't know all the regulations yet and the conversion as we go forward. We're adding additional things, servers and new systems to support our big conversion, so it's kind of hard to estimate. And in these volatile times, you can be hit by unusual things. Some of them are good and some of them bad. So it's kind of hard to estimate, but that's what we think.

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

Okay. Okay, that's helpful. And you made a comment on overdraft charges. I think you said seasonally lower in the first quarter. Then I think you said that was offset by an increase, and I didn't quite catch what you said.

Charles J. Nugent

We've put increase through in the first quarter. We did have a small increase in our overdraft fees that went into effect January 1.

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

Okay. And Charlie, on the bond portfolio, I think you mentioned with the tenure going up, you guys bought some bonds earlier this month. How much did you buy?

Charles J. Nugent

In the quarter, we bought $585 million. And let me give you the exact number. Yes, $585 million and it was some -- we had sold some in the fourth quarter and they didn't sit on the cash didn't come in in the first quarter so we reinvested that and we took the opportunity of -- we were having heavy cash flows coming off the portfolio because of short -- because of low rates and so we bought $585 million in total.

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

And have you bought some already in April, is that what you're implying about the...

Charles J. Nugent

There's not a -- I don't know what we did in April. I do know, but it was $585 million in the first quarter.

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

Okay, okay. And now short-term borrowings did go up, so did you fund any of that for short-term borrowings?

Charles J. Nugent

Some. Yes, that funds went up and that we were, when we bought those, it was sort of a prepurchase. We know we're going to have heavy cash flows. We thought the rates were good because I had spiked 40 basis points and we took advantage of that.

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

And Phil, on -- just a quick credit question I think following the fourth quarter when you had the elevated provision in charge-offs whether to sell those mortgage loans. I had considered the core provision to be in the $25 million in the fourth quarter. So I was a little surprised to see the provision go up from that level and especially kind of given your commentary on lower, nonaccrual inflows and lower delinquencies, is there anything unusual in the provision expense this quarter that kind of led to that?

E. Philip Wenger

I don't think there was anything unusual where we had a $828 million of charge-offs. You know, we just weren't ready to really release provision, Mac. So that's how our formula worked out. We wanted to maintain our coverage, and we maintained our provision. And we think we have some really encouraging signs. But as I mentioned earlier, I think we're just being somewhat cautious in that we've been here the last 2 years and we've seen slowdowns and so that's where we ended up.

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

Okay, okay. And then just one last one and you may have touched on this, Phil, but the decline in commercial loans in the quarter, what was the reason for that?

E. Philip Wenger

We had a $60 million decline in line usage, so most of it was in our line usage in our small businesses. Still, we do not see a whole lot of increased activity there.

Operator

And our next question will come from Russell Gunther of Bank of America Merrill Lynch.

Russell Gunther - BofA Merrill Lynch, Research Division

Just wanted a quick follow-up on credit. You guys gave a lot of good color, very helpful. With regard to the NPL inflows that you did see, I know down significantly this quarter, but what's the cost? What's causing the prime credits to continue to move in maybe geographically, what the breakdown might be and then as a follow-up, what's your expectation is for NPL inflows to kind of remain at this more benign level going forward?

E. Philip Wenger

It's Phil, I'll take a stab at that. First off, I'd say New Jersey continues to be the area where we have the largest inflows. And $16 million came in from New Jersey. So that's our largest area. It's still general economic conditions that cause those inflows and you know we are very encouraged by the trend in our 30- and 60-day delinquencies because that is, I think, a real indicator of what's going to happen. But other than that and other than general economic conditions, I think it's really difficult to say what's going to happen in the future.

Russell Gunther - BofA Merrill Lynch, Research Division

Okay. And then just kind of piggybacking on that, given your kind of cautious comments on the macro outlook do you think there's enough momentum to be able to significantly reduce nonaccruals from here our non-performing loan levels from here in the near term?

E. Philip Wenger

It's just really hard to say, but we're working very hard to reduce those numbers. We're looking at all the options that we have to reduce the amount of nonaccrual loans, and we're just going to keep working at it. We want to lower them as much as we can.

Russell Gunther - BofA Merrill Lynch, Research Division

Got you. And then -- nice improvement on charge-offs. Just kind of rounding out the credit quality questions here. With the improvement in the early-stage delinquencies, your expectations to kind of for charge-offs to remain around current levels and any increased confidence and perhaps returning to providing below charge-offs going forward.

R. Scott Smith

That's again a really tough -- first off, charge-offs can be extremely lumpy. If something comes along and something large that you didn't anticipate, and I would hate to give any kind of guidance on that because it's just really tough.

Russell Gunther - BofA Merrill Lynch, Research Division

Okay. And then just switching gears quickly on -- I believe you'd mentioned potentially introducing some new pricing initiatives in this current quarter. You mentioned overdraft. Was there anything else that was new maybe on the retail side and perhaps any different new products estimated annual impact?

R. Scott Smith

There were no other new fees. And what was the other question?

Russell Gunther - BofA Merrill Lynch, Research Division

Any future plans to introduce new products to generate additional fee income?

R. Scott Smith

At this point, I would say no. Our goal is to increase accounts, households and accounts. We're working very hard to increase core households and by doing that, we think we can increase the fees that are generating.

Russell Gunther - BofA Merrill Lynch, Research Division

Okay, great. And then just last one on flow and demand in your core Pennsylvania market. You heard from one of your larger peers, Monday, that in Pennsylvania there's some decent loan demand and prices are holding up from a pricing and structure perspective. Is this something that you're seeing similarly? And they also commented that in Philadelphia or downtown Philadelphia, the pricing and structure has weakened a little bit. Are you seeing this anecdotally as well? Or some general color on your primary Pennsylvania markets on demand and pricing perspective.

R. Scott Smith

Well, first off, I would say that our demand in Central Pennsylvania is probably a little stronger than in most of our areas. We're not really in the city of Philadelphia, so I would not be able to comment to that regard. But pricing on C&I loans, I think, is just as competitive in Pennsylvania as it is in any other market that we're in.

Operator

And next we have David Darst of Guggenheim Securities.

David Darst - Guggenheim Securities, LLC, Research Division

Phil, were you surprised in the increase in the residential NPLs this quarter following the sale that you had in the fourth quarter?

E. Philip Wenger

David, as I mentioned, probably not specifically, but we did have some -- our 90-day accruing loans were up, I think, $6.5 million, which really was the increase you're talking about. And we -- those are all loans that we do not expect to end up as being nonaccrual loans, non-accrued loan. So they were not nonperforming because they were over 90 days, but we're in the process of getting those out of that category. So I think that's really what drove that.

David Darst - Guggenheim Securities, LLC, Research Division

Okay. And then with the $60 million of construction NPLs, could you give us the makeup of what's residential, fully completed and to be marketed this spring and what's -- what the mix is of commercial?

E. Philip Wenger

If you give me a second, I might be able to give you the mix between commercial and residential. I don't think I couldn't tell you what's completed -- but 1 second. I don't know if you have any other questions in the interim.

David Darst - Guggenheim Securities, LLC, Research Division

No. I think you've covered everything else, thank you.

E. Philip Wenger

I would say I don't have that number, David, but most of our construction, nonperforming is commercial. But I don't have the breakout.

David Darst - Guggenheim Securities, LLC, Research Division

Is that a group of loans you think you can work out over the next 6 months or will that take a longer period as well?

Charles J. Nugent

Well, our goal would be to work out by next month. We're working hard to get rid of all of them through the best option that is available to us, so the timing is really hard to say.

Operator

And it does appear at this time, we did not have any further questions. I would like to turn the conference back to our speakers for any additional or closing remarks.

R. Scott Smith

Hello, this is Scott Smith, and I would like to end the call by thanking everyone for joining us today. We hope you have been able to be with us again in the second quarter or when we do the second quarter on Wednesday, July 18. We'll talk to you then if not, sooner. Have a good day.

Operator

Again, that does conclude today's conference call. We'd like to thank you for your participation.

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