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Fulton Financial (NASDAQ:FULT)

Q3 2012 Earnings Call

October 17, 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

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

Nicholas Karzon

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

Thomas Frick - FBR Capital Markets & Co., Research Division

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

David Darst - Guggenheim Securities, LLC, Research Division

Russell Gunther - BofA Merrill Lynch, Research Division

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

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

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

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

Matthew J. Keating - Barclays Capital, Research Division

Operator

Good morning, ladies and gentlemen. Welcome to the Fulton Financial Corporation Announces Third Quarter Earnings Call. This call is being recorded. I would like to now turn the conference over to Ms. Laura Wakeley, Senior Vice President of Corporate Communications. You may begin.

Laura Wakeley

Thank you. Good morning, and thank you, all, for joining us today for our conference call and webcast to discuss earnings for the third quarter of 2012. Your host for today's conference call's 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 that was 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 Financial's -- Fulton's financial condition, results of operations and business. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond Fulton's control and difficult to predict and which could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements. Fulton undertakes no obligation, other than required by law, to update or revise any of the 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 section of the earnings release and we incorporated into today's presentation. For a more complete discussion of certain risks and uncertainties affecting Fulton, please see the sections entitled Risk Factors and Management Discussion and Analysis of Financial Condition and Results of Operation set forth in Fulton's filings with the SEC.

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

R. Scott Smith

Thank you, Laura, and good morning, everyone. It's good to have you with us. After my remarks, Phil Wenger will discuss the loan portfolio and market conditions, and then Charlie Nugent will cover the financial details. Then we'll be happy to respond to your questions.

As this is my last conference call before I retire at year end and turn the reins over to Phil and his team, I'm pleased to tell you that we continue to execute our corporate strategy and business plans very effectively while positioning the company for the future. I look forward to my continuing role as a director of the corporation.

I'm also pleased to report we had a good third quarter. We saw a continuation on a number of positive trends that I will review with you. We reported diluted earnings per share of $0.21, a 5% increase over the second quarter.

As we stated in previous calls and in our investor presentations, return on assets is a key priority for us. We made progress on that benchmark, ending the quarter with an ROA in excess of 1%. As you may recall from our last call, our goal for ROA is significantly higher than where we are now.

The foundation for further improvement is found in all our affiliate banks as asset quality and loan demand improves, particularly at the Fulton Bank of New Jersey and the Columbia Bank, who have greater upside potential.

Another positive story this quarter was the solid improvement in our overall credit quality. Phil will cover those details in a moment. Because of this nice improvement, we were able to further reduce our provision for credit losses. We believe that lower credit cost and subsequent reductions in the provision provide a good foundation for future earnings growth. Of course, stronger credit demand leading to more rapid earning asset growth would be helpful as well.

We remain highly liquid and are working to profitably deploy our increasing core deposit base back into the communities we serve through quality loans. While some of the growth in core deposits this quarter was in municipal accounts, a significant portion with -- also came from new business customer acquisition. That indicates to us that we are effectively executing our marketing share goals.

A portion also came from growth in existing customer accounts. Our market research, along with unsolicited customer feedback and internal survey, tell us that customers value our brand of personal professional banking. Strategically, we believe that our superior customer experience is an important competitive differentiator.

Total noninterest income was a significant contributor to our third quarter results, due to continued strong residential mortgage activity. Moreover, we saw a reduction in expenses linked quarter, and Charlie will provide more color on expense management, one of our strongest core competencies over the years, as seen in our efficiency ratio compared to peers.

As you know, spread management in this rate environment is a challenge. I think we did a good job of limiting margin compression during the quarter. However, there are challenges ahead and -- that Charlie will address also in more detail.

The metric we've not talked about a great deal over the past several years is return on equity. With our strong capital position, we realize the importance of deploying it both prudently and profitably. Currently, we are deploying capital in 3 of the 4 ways available to us. We are reinvesting back into our branch network and profitable business lines, as well as improving our technology and systems infrastructure. We are implementing our stock repurchase program announced last quarter, and we are returning capital to shareholders by raising our cash dividend to $0.08 per share, bringing the yield to over 3%. With the right opportunities, we will once again acquire banks, seeking to realign -- to align with our core values and customer relationship strategy.

In regard to our 5 million share repurchase program announced back in June, during the quarter, we bought back 2.1 million shares at an average cost of $9.63 per share. The share repurchase program authorization continues through the end of this year. We may make additional open market purchases under the program from time to time as permitted by securities laws and other legal requirements and subject to our assessment of the market conditions and other factors. In summary, it's been a good quarter and a good year thus far.

This time, I'd like to turn the call over to Phil to share some details on asset quality, our loan portfolio and market conditions. Phil?

E. Philip Wenger

Thanks, Scott. In my comments today, I will be providing you with information on our credit quality and loan demand. First, with regard to credit quality, our trend of overall improvement continued this quarter. Total delinquency, nonperforming assets and charge-offs were all reduced. We also saw a reduction in the level of problem accounts, primarily from payments and payoffs. Our provision for credit losses was reduced from $25.5 million to $23 million.

Regarding loan demand, we are seeing improvement in the level of activity in several of our markets. While capital spending levels are not yet robust, a number of our markets are reporting increased pipelines. Overall, we are quite pleased with our results.

Now let me give you the details. First, on credit quality, overall delinquency declined to the lowest it has been at the quarter end since the end of 2008 at 2.58% of loans, or $308 million. Emergency delinquency -- excuse me, emerging delinquencies, those accounts under 90 days past due, declined from 0.86% of loans to 0.8%. Commercial loan delinquencies declined. Consumer, leasing and home equity delinquency increased slightly. This is not unexpected, given the elevated unemployment level in several of our markets, most notably, New Jersey.

Nonperforming assets declined by $24 million from $266 million to $242 million. Within this category, nonaccrual loans declined by $18 million. 90-day delinquent loans declined by $3 million, and the ORE declined by $3 million. We added $39 million in new nonaccruals this quarter versus $55 million in the second quarter of 2012. In addition, we were able to resolve, through payments and charge-offs, $54 million, which, when combined with a $3 million transfer to ORE, drove the improvement in nonaccrual loans.

Additions to nonaccruals year-to-date total $131 million versus $212 million for the same period last year. We were also able to reduce our exposure to criticized and classified assets by nearly $100 million, bringing our total reduction to problem assets since this time last year to just over $350 million.

Given these metrics, we were able to reduce our loan loss provision from $25.5 million to $23 million for the quarter. Our year-to-date provision of $76.5 million is $28.5 million lower than our provision to the first 9 months of 2011 and $43.5 million lower than the same period for 2010.

We have a reserve modeling approach that takes into account both our portfolio performance as well as the general economic environment. And while we are feeling better about the business climate, some of the economic data we utilize does not yet fully support a sustained recovery.

The allowance to nonperforming loans ratio increased to 111% from 101% at the end of the second quarter 2012. So our allowance stands at 1.97% of loans, down slightly from 1.98% last quarter.

Total net charge-offs were $25 million, or 0.84% of average loans, on an annualized basis as compared to $46 million, or 1.55% of average loans, in the second quarter of 2012. As a reminder, we sold a $44 million pool of nonperforming loans last quarter, which resulted in higher charge-offs for that period.

Troubled debt restructuring decreased slightly from $109 million to $106 million. Of this total, $85 million, or 80%, are accruing loans versus $81 million, or 75%, last quarter. The $3 million decrease in TDRs was driven by payments and payoffs within this pool of loans.

So to summarize our asset quality, we are pleased with our results and the direction in which we continue to move. Obviously, there are items, such as borrower fatigue and persistent economic challenges, which can still impact our overall results. However, we remain confident that general improvement should continue.

Now moving to loan demand and activity. Our ending loan balances decreased by just under 1/2 of 1%, or $50 million. However, when factoring in the purposeful reduction in problem loans through charge-offs and paydowns, our balances were even with last quarter.

Our commercial pipelines also remain fairly even with last quarter, but are up 20% over the same period last year. In the small business sector, we continue to face lackluster demand in a business climate in which borrowers are tentative about spending and will likely be so until conditions change.

Borrowing usage is down $38 million versus last quarter. However, we are replacing runoff, including the reductions in nonperforming loans with good quality new loans, resulting from our consistent calling and prospecting activities.

Certain segments of our portfolio are showing growth, and in particular, the automobile -- the automotive sector, where floor plan usage has increased. And in a number of our markets, customer sentiment has improved. There are signs that pipeline activity is picking up with closings expected to increase the fourth quarter.

We have seen increased opportunities this quarter in New Jersey, despite the economic challenges we've mentioned in that state. Further, we are seeing good success in the opportunities our lending teams are generating throughout our footprint, particularly in Pennsylvania and Delaware.

Mortgage lending activity continued to be robust during the third quarter. We did make the decision to hold additional mortgage loans in the portfolio. We are holding all 10-year loans and up to $15 million per month of 15-year loans, which has resulted in a net growth of $30 million in our residential loan outstandings.

Applications are strong and increased to $840 million -- $849 million versus $824 million in the second quarter and $712 million in the third quarter of 2011. Purchases comprised 42% of our closed loans, level with last quarter.

The mortgage pipeline has shifted to an increasing portion of refinance activity. This trend continued this quarter with 75% of the current pipeline from refinancing. Our current pipeline is $535 million versus $520 million last quarter.

So to summarize, we made good progress again this quarter in our credit metrics. Loan outstandings, outside of intentional runoff, are holding steady, and mortgage activity continues to be a highlight.

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 $0.21 per share for the third quarter, an improvement of $0.01, or 5%, from the second quarter. Net income increased 4% to $41.6 million in the third quarter from $39.9 million in the second quarter. As always, unless otherwise noted, comparisons are of this quarter's results to the second quarter.

The growth in our net income resulted primarily from a decrease in the provision for credit losses and a decline in other expenses. These improvements were partially offset by a lower net interest income and lower security gains.

Net interest income decreased $1.6 million, or 1%, primarily as a result of a decrease in both interest earning assets and the net interest margin. This decline was partially offset by the impact of

1 additional day in the third quarter. Our net interest margin declined 4 basis points to 3.74% in the third quarter from 3.78% in the second quarter.

Yields on interest earning assets decreased 6 basis points to 4.42% in the third quarter from 4.48% in the second quarter. Our costs of interest-bearing liabilities decreased 3 basis points to 0.90% in the third quarter from 0.93% in the second quarter. The decline in the yield on assets was driven by both investment securities and loans, with investment yields decreasing 12 basis points and loan yields increasing 6 basis points.

Increase prepayments on mortgage-backed securities resulted in amortization of premiums increasing approximately $600,000 compared to the second quarter. This was offset by an increase of approximately $700,000 of accretion on calls of both trust preferred securities and auction rate securities.

The total accretion related to redemptions was $1.4 million in the third quarter and $700,000 in the second quarter. This added 20 basis points to the yield on investments and 3 basis points to the net interest margin in the third quarter.

Yields on loans decreased 6 basis points from 4.85% in the second quarter to 4.79% in the third quarter. Low interest rates and competition continues to place downward pressure on loan yields.

The costs of interest-bearing deposits declined 5 basis points to 5.7% in the third quarter. This decline was driven primarily by the 7-basis-point decrease in time deposit costs.

$754 million of time deposits matured at a weighted average yield of 0.94%, while $655 million of time deposits were issued at a rate of 0.39%. In the fourth quarter of this year, $726 million of time deposits are scheduled to mature at a rate of 1.05%.

Our projections indicate that we will experience a similar level of compression of the net interest margin in the fourth quarter, and that's from the, we said, 3.74% for the quarter. But if you adjust for that -- the accretion related to the redemptions, the margin would've been 3.71%.

Average total in our interest-earning assets decreased $158 million, or 1%. Average investments declined $136 million, or 4.6%, and average loans declined $46 million, or 4/10 of 1%. Ending loan balances also decreased by approximately the same amount, as Phil discussed.

Average deposits increased $228 million with a $362 million, or 4.3%, increase in demand and savings deposits being partially offset by $134 million, or 3.5%, decline in time deposits. Noninterest-bearing demand deposits increased $167 million or 6.3%, almost entirely in businesses accounts, due in part to our focus on acquiring small business relationships. Interest-bearing demand deposits increased $123 million, or 5%, almost entirely attributable to municipal accounts and seasonal tax collections. Savings deposits grew $71 million, or 2.2%, with the increase evenly split among personal, business and municipal accounts.

Other income for the third quarter increased $136,000, or 3/10 of 1%, excluding the impact of security gains. Mortgage banking income decreased $549,000, or 4.9%. A $1.9 million, or 17.6%, increase in mortgage sale gains was offset by a $2.5 million decrease in net servicing income. Mortgage sale gains increased as a result of a 4% increase in loan commitments to $682 million at a 13% improvement in spreads. The growth in volume was driven by persistent low interest rates throughout the quarter, which increased even further at the end of the quarter.

The decline in net servicing income resulted primarily from a $2.1 million impairment charge on mortgage servicing rights. Mortgage prepayments are expected to increase as a result of lower rates and the Federal Reserve's quantitative easing plan, which resulted in the decline in the fair value of our mortgage servicing rates. The $1.2 million increase in the other noninterest income category was related to investments in corporate-owned life insurance, which are not expected to recur.

In the third quarter, net security gains were only $42,000 as compared to $1.5 million in the second quarter. Net security gains during the second quarter were almost entirely realized gains on bank stock sales.

Operating expenses decreased $2.1 million, or 1.9%, to $110 million for the third quarter. Our efficiency ratio improved to 56.9% in the third quarter as compared to 57.6% in the second quarter. Our efficiency ratio has historically have been much lower than our peers and the largest banks, and we expect this to continue.

Salaries and benefits increased $2.1 million, or 3.4%, due to a combination of normal merit increases, an additional day in the third quarter as compared to the second and an increase in health insurance cost. Staff additions were also made primarily to support residential lending activities, retail banking and compliance.

Other outside service expense increased $520,000, or 11.6%, as we continue to incur elevated consulting fees related to risk management and compliance efforts. A total of $2.3 million was incurred in the third quarter, and we currently project $1.6 million remaining likely to be incurred in the fourth quarter.

Equipment expense increased $631,000, or 20%, due to a certain vendor rebates earned in the second quarter and additional depreciation expense related to hardware upgrades.

ORE and repossession expenses were $727,000, or 26%, lower. Net losses incurred on sales of properties, or for valuation adjustments, accounted for most of this decrease. Operating risk loss decreased $651,000, or 32%, during the third quarter as losses related to repurchase obligations for mortgage loans sold declined approximately $430,000.

Marketing cost declined $1.9 million. This decrease resulted primarily from a significant promotion that occurred in the second quarter. We expect this expense category will increase in the fourth quarter.

The other category of noninterest expense decreased $2 million, or 14.5%. This decrease resulted largely from reversals of reserves for state tax positions due to the expiration of the statute of limitations, as well as changes in the risk level of certain positions.

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

Okay. Thank you for 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 take our first question from Frank Schiraldi of Sandler O'Neill.

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

Just a few quick questions, if I could. I wanted to ask, first, Scott, on buybacks. You obviously continue to build capital. You bought back 2 million shares, 2.1 million shares in the quarter. Is that a decent run rate, do you think, for what to expect going forward, say, if the economic environment doesn't really change and then, let's say, sort of similar to current stock prices?

R. Scott Smith

Well, I guess the answer to that is yes, if nothing changes, but obviously, things will. So as I mentioned in my comments, we'll be watching the price. We'll be watching the expectation about the economy. And we have certain legal restrictions of how many shares we can buy back in any 1 day and all those kind of things. So we did what we did and I wouldn't expect huge changes in our attitude, but market conditions change everyday.

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

Okay, fair enough. And then is there any reason not to believe that you -- I know that the program ends December 31. But is there a reason to believe that you wouldn't go ahead and, say, if things sort of remain similar again, continue this sort of buyback progression next year as well with a new program?

R. Scott Smith

Well, that's a board decision, and the board will continue to discuss our capital position on a meeting-by-meeting basis. And when we have an announcement, we'll make it.

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

Okay. The loan growth, you talked about the pipeline going forward being a bit stronger. Is that approved deals in the hopper too that are stronger? I'm just trying to get a sense if the modest contraction we saw in the quarter is representative of what we might expect going forward in terms of loan balances.

E. Philip Wenger

Frank, this is Phil. And when we talk about our pipeline, that is all approved loans. So we're seeing a bit more activity in certain areas. And Pennsylvania and Delaware have been showing a little more strength, and we're getting some more activity or opportunities in the state of New Jersey.

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

Okay. So things have certainly picked up from this time last quarter then?

E. Philip Wenger

Yes. Well, I think our pipeline is -- are stronger, as we said. We did have a reduction in line borrowings during the quarter, $38 million. So that could have some seasonal changes to it also.

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

Okay, great. Then just finally, I wanted to turn to expenses. And I had missed one thing that you had said, Charlie, during your comments. There was something that was $1.6 million going forward. I think it had been $3 million this quarter. Can you just run through that quickly again?

Charles J. Nugent

Yes. Frank, we had incurred about $2.3 million in the third quarter related to elevated consulting fees related to risk management and compliance efforts. And we currently project that, that $2.3 million will drop to $1.6 million in the fourth quarter.

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

Is there any way to extend that out? Is that a tail that should dissipate further in 2013?

Charles J. Nugent

We would expect it to continue to drop.

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

Okay. And just correct me if I'm wrong. I thought you had given a range of total noninterest expense of $111 million to $114 million for the fourth quarter, is that right?

Charles J. Nugent

That's right.

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

Okay, okay. And then -- I'm sorry. Just real quickly on something you had mentioned on the margin, Charlie. I thought you had said that, linked quarter, you expect the margin -- you expect similar compression to what we saw from 2Q. And then given the moving parts, I'm a little unsure of what that exactly means. Is that -- I know 3.71% is sort of a better normalized margin without the accretion in the quarter. So are you saying maybe 4 basis points off of that number is what you're talking about when you're saying similar compression?

Charles J. Nugent

I think, Frank, we were talking about similar compression off the 3.71%. We went from 3.78% to a normalized of 3.71%, 7 basis points. We would expect -- our projections are saying that we'll have similar margin compression in the fourth quarter.

Operator

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

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

Just a follow-up. I think, Phil, you may have said it or Scott. But surrounding the reserve methodology, you had said that there is economic data that you're utilizing that goes into your allowance methodology. What is that, specifically, the metrics that you're looking at?

E. Philip Wenger

Well, we look at a number of different metrics, but it would include unemployment and...

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

In your region or a national level or?

E. Philip Wenger

Only in our region, yes. Asset prices would be another. And we did have a couple of states that had unemployment actually ticked up during the month. We'll look at -- that's fine. No, go ahead.

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

If you were to -- I mean, as you look at your methodology, is it skewed more towards the economic data versus the trends that you're seeing in the portfolio? Is it split evenly? Or how do those -- how do you sort of apply the weightings?

E. Philip Wenger

It would be skewed more towards the trend in our portfolio.

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

Okay. So as you look at your portfolio trends and, obviously, taking into consideration the economic data, I mean, it's -- do you see a level to which you can draw this reserve down? I know I ask it every quarter, and I think it just one of some -- some of the trends that we're seeing at some other banks, where they had guided to a higher level and then, boom, the next quarter they really dropped the reserve. So it seems to me -- as you look at your metrics and, as you said, all the credit metrics are improving, your reserve coverage is 100%, it seems like you should be in a position now where you could really start to drop that reserve. But I'm just trying to...

E. Philip Wenger

I would -- I think we expect the provision to -- the way things are right now, to continue to decrease. To have a big decrease without a corresponding improvement in those economic data within our marketplace, I think, would be difficult.

R. Scott Smith

We're not a boom company, Collyn.

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

Well, no. That's what I'm getting at. Is it just your defensive sort of measured approach to the way you run the business? Or are you just going to see a more gradual bleed of the provision, where -- but yet the metrics could suggest you could move at a more rapid clip than you are?

E. Philip Wenger

We'll be prudent, but it depends. A lot of good things could happen if we get this fiscal cliff resolved, and we might see some really nice activity. But we're just going to hang in there right now.

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

Okay, okay. And is there anything -- any of the new nonaccruals that have come onto the portfolio this year, how do those nonaccruals differ from what's in the legacy portfolio, from either size, type of loan, structure, geography, or is it pretty similar? Is the newer roll-ins pretty similar to what the legacy portfolio looks like?

E. Philip Wenger

Well, first off, I would say the average size of what's rolling in is smaller than what it's been in the past. There's more coming from the state of New Jersey. There's less construction. I would say they would be the 3 things that might be a little different.

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

Okay. Would you say that the credit quality of what's rolling in, in general, or the risk profile, is better than what the legacy portfolio looks like?

E. Philip Wenger

Boy, that's tough. I don't know that I'd be prepared to answer that right now.

Operator

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

Nicholas Karzon

This is actually Nick Karzon standing in for Craig this morning. I guess, first question, can you give us a little -- some idea in terms of what the new money yield is on the residential mortgage loans that you're holding?

Charles J. Nugent

I probably can give you a range. I would say between 2.75% and 3%, maybe 3.25%.

Nicholas Karzon

And then, I guess, second question was folks looking at the tax rate. And I think that you had previously guided to a moderately higher tax rate, kind of in the 25% or 26%, 27% range. And it was a little lower again this quarter. Is there a fixed tax credit here that we should be thinking about? Or kind of what's the rate that we should think going forward?

Charles J. Nugent

Our normalized rate's about 27%, where obviously as income goes up, our margin tax rates higher so that's going up. During the quarter, we mentioned that we had some gains on corporate and life insurance that's not taxable, and that moved our effects to break down, I think, 24.9%. So that was the primary reason.

Nicholas Karzon

And I guess, just one last one, if I can. Can you give us some color in terms of commercial loan demand, I guess, by geography and by segment, if possible?

R. Scott Smith

Well, the one segment that I'd say we are seeing more strength than others would be the automotive. As far as geography, well, first off, we're also seeing some strength on the owner occupied CRE side. And then geography, Delaware is giving us good opportunities right now, as is New Jersey and Pennsylvania and Southeastern Pennsylvania, specifically. And then we're -- but this is -- these are market share opportunities, not necessarily new projects for our customers.

Operator

And our next question comes from Casey Haire at Jefferies.

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

Just a follow-up on credit quality. I'm just trying to get a little bit more color as to why some of the losses are a little sticky, actually up quarter-to-quarter, if you back out the bulk sale last quarter. If you just give us a little more color on that. Nonaccrual inflows are down, and real estate seems to be stabilizing, yet the loss rates seem to be a little stickier.

R. Scott Smith

Well, I don't think they were up quarter-to-quarter. I think they were actually pretty -- charge-offs would have been pretty flat, would have been flat. So we're trying to continue to be as aggressive as we can.

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

Okay. And then Charlie, on the expense guide of $111 million to $114 million, the principal offsets or pressure, if you will, versus third quarter is higher marketing, as well as the tax benefit does not recur going forward. Correct?

Charles J. Nugent

That's right. That's right, Casey. And the marketing, it's not even quarter-to-quarter it's based on our promotions. We had a big promotion in the second quarter and relatively low promotions in the third quarter. That's going to go back up in the fourth quarter. The other thing that's related to -- reserve positions, related to state taxes, you always see it going down in the third quarter because the statute of limitations related to review and return is over so we reduced that. And then we also -- we look at all our risk positions, and we've moved them down a little bit.

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

Okay. And then just one more on capital, if I may. Just wondering, on the M&A environment, are you guys hearing anymore increased chatter, given what's obviously a pretty challenging operating environment? And then, also, we're hearing stuff that regulators are actually pretty down on M&A and comments by Trulia [ph] last week, just very down on banks using M&A to get bigger. Just wondering if you're hearing anything on that front?

R. Scott Smith

Not a lot. This is Scott. I wouldn't say -- there's always some discussions here and there, but I wouldn't say -- I wouldn't call it an increase in or a trend -- an increasing trend at this point in time. And regulators are being very cautious about everything, so I'm not surprised to hear that one of them might comment on that. But I don't have any sense that the attitude's changed dramatically since last quarter. I think we're all on a very cautious mode. And I think a lot of -- there's still a big difference in opinion between buyers and sellers as to what are banks worth.

Operator

And our next question comes from Bob Ramsey, FBR.

Thomas Frick - FBR Capital Markets & Co., Research Division

This is actually Tom Frick for Bob. I just had one question. So it sounds like your NIM guidance is for contraction of somewhere in the range of 6 to 8 basis points. Is there any more room to reprice deposits to fight some of that compression? I know you talked about CD repricing that's available to you. Is there any other room to reprice deposits down?

R. Scott Smith

Yes, you're right. The primary way to move deposits down are in the CDs. We have $726 million coming due. The rates -- the weighted average rate on that is 105%. We should keep them at below 40 basis points. That's one opportunity. And we're looking at all our quarter rates, constantly looking at them all the time and, in particular, the rates we pay on municipal accounts.

Thomas Frick - FBR Capital Markets & Co., Research Division

Okay, great. And then on the tax rate, you guys might have mentioned this, but we were kind of expecting a number in the kind of 27% and 28% range. What's a good rate to you going forward now?

R. Scott Smith

It's 27%. 27%, 28% is good.

Thomas Frick - FBR Capital Markets & Co., Research Division

Got you. And then finally, on mortgage banking, what was the gain on sale margin for loans sold in the secondary market?

R. Scott Smith

Our margin did go up, and it was 1.87%.

Operator

And our next question comes from Chris McGratty of KBW.

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

Just -- I wanted to make sure I got the margin right. So the 3.74% less the 3 basis points gets you to 3.71%. Are you suggesting 4 basis points off of that number or is it the 7 basis points?

Charles J. Nugent

We're thinking 7.

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

So 3.66% -- 3.64%, excuse me?

Charles J. Nugent

Yes, in that range. It's difficult to project because it's going to go down.

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

That's fine. I just wanted to make sure I got it right. On the margin, you guys do still have some trust preferred. You do have some officially borrowings. Has -- and I asked this question last quarter. Has your mentality or thought process changed at all about looking at these kind of more expensive funding sources to help protect the margin?

Charles J. Nugent

We look at it all the time, talk to different investment bankers about it but, the trust preferred, it's 30 year plus -- and it's at 6.92%. We could replace it right now. And that's sort of -- and that's total capital. It's not -- it doesn't apply to Tier 1, but we need a bucket in that total capital category. The Basel is 8.5% is supposed to be like common capital to risk weighted average assets certainly. And 10.5% of the total, we think that fits in nicely. And I think before we would buy back the trust preferred, this is my opinion, we buy back common stock first because it would give us a better benefit, I think, and the common stocks are higher cost capital to us.

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

Okay. Just one final question on the balance sheet. How should I think about the size of the investment portfolio?

Charles J. Nugent

We mentioned it was down $136 million on average for the quarter. And right now, we don't like the risk reward. We don't like the premiums we pay on the securities we usually buy, and we don't like the yields. And that can change, but that's how we feel now.

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

Okay. And how much premium amortization is on the books related to the MBS booked?

Charles J. Nugent

I'm not sure. I'm not sure what it is.

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

All right. I will follow up after.

Charles J. Nugent

Chris, hang on, and I'll give it to you. But I don't have it on the tip of my tongue but I'll mention it to you. Sorry.

Operator

And our next question comes from David Darst, Guggenheim Partners.

David Darst - Guggenheim Securities, LLC, Research Division

You said a lot of your deposit growth this quarter is coming from new business customers. Is that also stimulating your loan pipeline? And are you writing loans, writing more lines that sure yet to be drawn?

R. Scott Smith

Well, the growth in those deposits, David, has come from small business acquisition. So that is in the short term not where we're seeing our loan opportunities. We're hopeful over time that those businesses will be a little more aggressive as far as expansion is concerned, but I don't think that's necessary too. We did see line borrowings go down, it's about $38 million, and usage dropped by over a full percentage point.

David Darst - Guggenheim Securities, LLC, Research Division

Okay. And then just maybe more on your marketing strategy and sort of marketing spending you had in the second quarter, how much you're expecting for the fourth. Is it more retail media focused? Or is there anything unique or a strategic -- that you're trying to channel those dollars into?

R. Scott Smith

It's primarily a retail core deposit promotion that we did in the second quarter that was pretty successful, and we are going to be doing it in the fourth quarter again.

David Darst - Guggenheim Securities, LLC, Research Division

Okay, got it. And is that -- I mean, is that, I guess, the best usage of funds, given the inflow of deposits that you're seeing now and the use of deposits?

R. Scott Smith

Well, it is -- I mean, we -- from a strategic standpoint, we believe strongly in growing core households and core deposits and obtaining new customers, and that's really what the whole promotion is geared towards. And then those new accounts help us grow fee income, and I think that's evident in a lot of our fee income categories.

David Darst - Guggenheim Securities, LLC, Research Division

Is any of that supporting your mortgage banking effort?

R. Scott Smith

It does to a smaller degree. And hopefully, our mortgage banking effort impacts our increase in core deposits also. I think it works both ways.

Charles J. Nugent

Could I get back to -- this is Charlie. Could I get back to Chris? Chris, the unamortized premium on our books related to mortgage-backed securities and CMOs, it's $41.1 million. And if you take that as a premium to our book value on those securities, it's $102 million. It's an even $102 million.

Operator

And our next question comes from Russell Gunther of Bank of America.

Russell Gunther - BofA Merrill Lynch, Research Division

Just appreciate the color on the non-interest expense side. I wanted to follow up. I believe you guys are going to be undertaking a systems upgrade either later in the fourth quarter or 2013. Could you give us a sense for whether or not any portion of that is in that $111 million to $114 million guidance and what that associated cost might be?

Charles J. Nugent

Yes. So regarding the core conversion, total onetime expenses are going to be $3.9 million, of which $1.3 million is in '12 and the balance will be in '13. Most of that will be in the fourth quarter, yes, so that would be in that.

Russell Gunther - BofA Merrill Lynch, Research Division

Okay, I appreciate that. And then I guess, just turning back to comments on the M&A front, if you could just give us a sense for whether or not the conversations have picked up and if where your dialogue is centered. I believe you have a targeted asset range maybe in the $300 million to $2.5 billion in terms of what you might look at. Is there any -- is the conversation around some of the smaller banks or just general thoughts on what you're seeing?

R. Scott Smith

This is Scott. There hasn't been a lot of conversations. And as I said earlier there, I don't -- I wouldn't say there's an increase in noise. There's some folks that have, that are kind of investigating the market, if you will, and I think just kind of preliminary discussions maybe. But the pricing and where the stocks are right now, there just isn't a lot happening quite frankly.

Russell Gunther - BofA Merrill Lynch, Research Division

Okay. And then in terms of where you would look within your footprint, assuming those conversations do pick up, do you have a geographical preference for where you might want to [indiscernible]

R. Scott Smith

Well, I think our preference is to stay in footprint. We have a lot of places where additional critical mass would help our profitability in those markets. But as you know, it's opportunistic, so to say we want to be this market and then we announce 2 weeks later we're in that market. You have to look at what's available and what opportunities we have. We have an ideal situation and we keep to ourselves, but, frankly, very seldom do you get an acquisition in the exact market that you've named as your highest priority. It's just they happen and those -- that's the size range. But we consider smaller or larger than that, if it's very strategic, and it puts us where we want to be in the market. So that's a vague answer, I know. But until a bank is for sale, you really don't know what's going to be possible.

Russell Gunther - BofA Merrill Lynch, Research Division

No, understood and appreciate your thoughts on that. Just lastly, on the credit quality front, you mentioned the challenges to the Columbia Bank and Fulton Bank of New Jersey but that there's certainly upside there as things begin to improve. Could you give us your outlook on the credit quality front for those 2 banks and when we might expect to see improvement that would flow through?

R. Scott Smith

First off, we're seeing -- I think we're seeing improvement in credit from all our banks. And we just, I think, mentioned New Jersey and Maryland because they're probably the 2 that we have the most potential to have increased credit quality.

Operator

And our next question comes from Rick Weiss of Janney.

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

I think most of my questions were answered but let me just flesh out a little bit with the loan growth. What is competition like? Is there any volume out there and you're seeing more aggressive competitors? Or is it weak demand? How do you see the landscape?

R. Scott Smith

Well, demand, Rick, has been fairly weak. So for the most part, we're all out trying to pick up market share. And it is extremely competitive, especially on the C&I side, but it's also become competitive on consumer and CRE. Pricing is extremely competitive.

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

Is it competitive as well in terms of besides the pricing with regard to underwriting standards?

R. Scott Smith

Yes. There has been more competitiveness in underwriting standards, but I would say that change is to a much lesser degree than pricing.

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

Okay. Would you say is it more competitive today than it was 6 months ago, the pricing competition?

R. Scott Smith

I would say -- I mean, I don't think there's been a lot of change from second quarter to third quarter. But from -- if you go back to third quarter of last year compared to third quarter of this year, I think it's definitely more competitive.

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

Okay. And then on the deposit growth. Is that -- and I know it's coming a lot from the commercial accounts. Is this from new commercial customers or existing ones that are, I guess, putting more deposits into your bank?

R. Scott Smith

Well, we are growing small business customers, and I think most of the growth has come in that small business category.

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

Has this ever happened before where you're growing the commercial customers in deposits rather than lending?

Charles J. Nugent

Well, it's been happening for the last 18 months, and we do anticipate a point in time when those small business customers that are growing deposits will start growing loans. But I don't think we're there yet.

R. Scott Smith

Rick, this is Scott. We've been doing a lot on branding the last several years and even during the difficult times maintained our efforts to brand the bank as a community bank with community banking philosophy. And I think some of that's paying off. And there are some -- typically, over the year -- over my long 10 year, typically, you've got an account because they wanted a loan and they bid it around, and whoever got the loan got the account. So we have seen over the last couple of years, people just saying, "I want a new bank." And we've been fortunate to pick up, I think, more than our share of that. And I think some of it has to do with the branding and some of it has to do with our style of banking. And there's more appeal to particularly small business to a community bank brand than there are other brands.

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

So then, it's almost like a matter of time whenever business conditions improve and [indiscernible]

R. Scott Smith

Yes, one would think, Rick. Yes.

Operator

And our next question comes from Mac Hodgson of SunTrust Robinson Humphrey.

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

So to clarify, did you say that criticized and classified loans were down $100 million in the quarter?

Charles J. Nugent

Assets. Criticized and classified assets were down $100 million in the quarter, $60 million were in more loans, $40 million were actually on the investment portfolio.

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

Okay, got you. And then just one quick one on -- just on expenses. I just want to get your thoughts more on efficiency. You've obviously got revenue pressures from the net interest margin and a lack of growth. And you've got expense headwinds, given the regulatory compliance environment and your conversion. It seems like you run the risk of losing your efficiency advantage. I mean, you've talked about how you've run an efficient operation. Just want to get your thoughts on the need for an expense initiative to be more aggressive on the expense side to offset some of these headwinds.

R. Scott Smith

This is Scott. We are confident that we will maintain our relative position as far as efficiency is concerned. And we have been involved with this lien process engineering for, help me folks, 5 or 6 years -- 5 years. And that's resulted in 7-figure savings every year, so we will continue to do those kinds of things. And as we go through our core conversion, we'll be looking at a lot of systems again and with a finer toothed comb and looking at ways that we can become more efficient. The technology and infrastructure that we're investing in will help us become more efficient. So we have been -- we've had a culture of this for many years. So to expect us to find this $100 million that we can save in expenses out of nowhere is probably not realistic because we've been, I think, very good at managing that on an ongoing basis. So we'll continue to be more efficient. And as our systems improve, I think we'll maintain our relative position.

Charles J. Nugent

This is Charlie. Just a little comment was everybody's under the same pressure and related to a slow economy and loan growth. Everybody is under the pressure of margin compression because of low interest rates. We can grow at a lower cost than other people. And I would expect our efficiency ratio to always be where it is, and that's at the top of our peer group.

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

Yes. I think where I was kind of going is we're starting to see a lot of banks either consolidate branches or announce more programs in response to the environment. And Scott, I know you talked about it's kind of a culture thing for you guys. I was just curious if things are bad enough to where that might change.

R. Scott Smith

Well, if things are bad enough, you have to react. So we'll see if it gets there. But I think we don't expect things to get that bad, and I think we just -- we'll keep doing what we've been doing. And if we need to do something drastic, then we will, but my expectation is that will not be necessary.

Operator

Our next call comes from Matthew Kelley of Sterne Agee.

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

Just wondering if you can just follow up on the loan commentary, just talk about where you're seeing yields on new commercial real estate loans, high-quality office industrial type collateral, 5- to 10-year fixed rate type pricing. Where is that today?

R. Scott Smith

Fixed rates on CRE for the most part, we're trying to stay 5 years on our fixed rates and maybe in the 4s.

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

Okay. Low, mid? I mean...

R. Scott Smith

That depends on the deal. And I'd say they are -- some are low, some are mid and some are high 4s.

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

Okay. And then in the auto business, the floor plan lending. Where are those yields? And how big is that portfolio, if you guys can remind us that?

Charles J. Nugent

Most of that would be floating rate, and it would be tied to -- I would say that they would probably be in the 3s, probably low 3s, and the total of that portfolio is $117 million.

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

Okay. And then the construction portfolio, where do you see that stabilizing in terms of total size? It still came down in a pretty good clip sequentially, around $600 million. Where do you see that headed?

R. Scott Smith

That has really been fluctuating quarter-to-quarter, so that could really vary. And it could drop a little, but it could go up. I think we're really close to a stabilized level.

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

Okay. And then just switching gears to the MSR valuation. Can you just give us a sense of the assumptions that changed, how you're carrying that now and just expectation for additional MSR write-downs going forward? I assume that's secured at a level that you're more comfortable just given Q3 and the lower environment, where is it carried and what changed and what's going to happen going forward?

R. Scott Smith

MSRs are about $37 million, and we have valuation reserves against that of about $3 million. We think we're conservative in measuring prepayment speeds and we have extremely high prepayment speeds factored in there. And unless prepayments increase significantly, I don't we'd have any more impairment charges on that.

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

How much did your assumptions change from Q2 to 3Q, just fair cost the charge?

R. Scott Smith

A lot of it is prepayment speeds by type of mortgage, and it's the actual prepayments speeds on the mortgages where seeing.

Operator

Our next question comes from Blair Brantley of BB&T Capital Markets.

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

I just had a follow-up question on the M&A aspects. Are you guys looking at any more fee income acquisitions at this point, kind of given where spreads and revenues are being pressured? And if so, what area?

R. Scott Smith

We would be open to that. We have not aggressively pursued that, but would certainly listen with interest if one became available. But I wouldn't say it's eminent.

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

Is there some area you would focus on, if you did pursue something, certain lines of businesses, maybe?

R. Scott Smith

Well, we have a good wealth management business, and we like that business. So that might be one. And then there are others that might be unique kinds of businesses that we feel like we could understand and manage the risk. We'd prefer, frankly, to do bank acquisitions, but we'll see what else is out there.

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

Okay. And then on the dividend front. Is there a certain payout ratio, where you're comfortable with and obviously in the face of stress testing next year? Is there any kind of target that you may have, given kind of where you've increased dividends so far?

R. Scott Smith

I think we're in the 30% to 40% range right now, but that could change with our comfort level about the economy and our capital position. But we feel good there now. But at one point in time, we were at 50%. And we get back to more normal times, we may get back there again. But right now, I think that's [indiscernible].

Operator

And our next question comes from Matthew Keating of Barclays.

Matthew J. Keating - Barclays Capital, Research Division

I had a question, I was hoping you could comment on your normalized ROA goal of 1.3% to 1.5%. In the current sort of environment, I know in the past you've mentioned that many of your individual bank subsidiaries are currently operating close to and, in some cases, above that range. Could you talk about sort of a timeline for achieving that goal and just in general, whether you think it's possible if the current extended low rate environment persists through say the middle of 2015, for example?

Charles J. Nugent

It's obviously going to be very tough with that, but we do have credit leverage available to us. And you folks keep asking us when we're going to spend that reserve, and I think we have some opportunity there. If margins stay where they are and interest rates stay where they are, it's going to prolong that. But if you look at the credit costs in the 2 banks we referred to and they get back to more normal, that will help considerably. But we're not going to set the world on fire if we get no loan growth and margin keeps compressing and we have all these headwinds. But I think we feel, right now, like things are going to get better but gradually. And so -- and people forget that the Fed -- when the Fed puts out its announcement about interest rates, it precedes that with "if our forecast is correct." So they're not telling you that interest rates are going to stay low until 2015. They're just saying, based on the crystal ball right now, that's what it looks like. But we fix this fiscal cliff and a few other things happen, we could be there this time next year. So we know we have the capacity to do it, but we can't do it with all the headwinds that are there today or we'd be there. But I think our history would indicate that we can get to that range, and we're still shooting for it. But the timing is anybody's guess.

Operator

And there are no further questions at this time. I'd like to turn the conference back over to Mr. Scott Smith and Phil Wenger for additional or closing remarks.

R. Scott Smith

Well, thanks again for joining us today. After 40 years in the banking industry and experiencing its many rewards and challenges, it's hard for me to believe that this is my final discussion with you. There's been one constant over the last 4 decades that has made the rewards more satisfying and the tough times a bit easier: It's the people I've worked with and the relationships I've enjoyed with them. That includes all of you. Our goal has always been and always will be to tell you the facts about our performance so you can represent us as accurately as possible to your colleagues and to current and potential investors. And of course, that won't change. I want to thank you for your support and input over the years. And don't forget, I'll continue to read your research reports as closely after I retire as I do today. I am, however, pleased that Phil will be taking your questions in the future. And now Phil will give you details on our next call.

E. Philip Wenger

Well, thank you, Scott, and thank you for your many years of service to Fulton Financial and for your leadership and mentoring to me and all of our team. I would like to end this call by thanking everyone for joining us today. We hope you will be able to be with us when we discuss fourth quarter and year-end results on Wednesday, January 16.

Operator

This concludes today's presentation. Thank you for joining and have a nice day.

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