10-Q 1 fult331201410q.htm 10-Q FULT 3.31.2014 10Q

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20459 

FORM 10-Q

(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2014, or

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to              

Commission File No. 0-10587
FULTON FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter) 
PENNSYLVANIA
 
23-2195389
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
One Penn Square, P.O. Box 4887, Lancaster, Pennsylvania
 
17604
(Address of principal executive offices)
 
(Zip Code)

(717) 291-2411
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
ý
  
Accelerated filer
 
¨
Non-accelerated filer
 
¨
  
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý

APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Common Stock, $2.50 Par Value – 188,969,000 shares outstanding as of April 30, 2014.



FULTON FINANCIAL CORPORATION
FORM 10-Q FOR THE THREE MONTHS ENDED MARCH 31, 2014
INDEX
 
Description
 
Page
 
 
 
 
PART I. FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
(a)
Consolidated Balance Sheets - March 31, 2014 and December 31, 2013
 
 
 
 
(b)
 
 
 
 
(c)
 
 
 
 
(d)
 
 
 
 
(e)
 
 
 
 
(f)
 
 
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2




Item 1. Financial Statements
 
FULTON FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS 
 
(in thousands, except per-share data)
 
March 31,
2014
 
December 31,
2013
 
(unaudited)
 
ASSETS
 
 
 
Cash and due from banks
$
260,389

 
$
218,540

Interest-bearing deposits with other banks
225,428

 
163,988

Federal Reserve Bank and Federal Home Loan Bank stock
81,634

 
84,173

Loans held for sale
24,417

 
21,351

Available for sale investment securities
2,501,198

 
2,568,434

Loans, net of unearned income
12,733,792

 
12,782,220

Less: Allowance for loan losses
(197,089
)
 
(202,780
)
Net Loans
12,536,703

 
12,579,440

Premises and equipment
225,647

 
226,021

Accrued interest receivable
43,376

 
44,037

Goodwill and intangible assets
532,747

 
533,076

Other assets
480,350

 
495,574

Total Assets
$
16,911,889

 
$
16,934,634

LIABILITIES
 
 
 
Deposits:
 
 
 
Noninterest-bearing
$
3,359,900

 
$
3,283,172

Interest-bearing
9,310,017

 
9,208,014

Total Deposits
12,669,917

 
12,491,186

Short-term borrowings:
 
 
 
Federal funds purchased
361,098

 
582,436

Other short-term borrowings
708,586

 
676,193

Total Short-Term Borrowings
1,069,684

 
1,258,629

Accrued interest payable
16,972

 
15,218

Other liabilities
213,136

 
222,830

Federal Home Loan Bank advances and long-term debt
883,461

 
883,584

Total Liabilities
14,853,170

 
14,871,447

SHAREHOLDERS’ EQUITY
 
 
 
Common stock, $2.50 par value, 600 million shares authorized, 217.9 million shares issued in 2014 and 217.8 million shares issued in 2013
544,821

 
544,568

Additional paid-in capital
1,434,546

 
1,432,974

Retained earnings
490,517

 
463,843

Accumulated other comprehensive loss
(21,889
)
 
(37,341
)
Treasury stock, at cost, 29.1 million shares in 2014 and 25.2 million shares in 2013
(389,276
)
 
(340,857
)
Total Shareholders’ Equity
2,058,719

 
2,063,187

Total Liabilities and Shareholders’ Equity
$
16,911,889

 
$
16,934,634

 
 
 
 
See Notes to Consolidated Financial Statements
 
 
 
 

3


FULTON FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
 
(in thousands, except per-share data)
Three months ended March 31
 
2014
 
2013
INTEREST INCOME
 
 
 
Loans, including fees
$
131,830

 
$
134,130

Investment securities:
 
 
 
Taxable
13,266

 
13,397

Tax-exempt
2,348

 
2,481

Dividends
332

 
390

Loans held for sale
134

 
495

Other interest income
882

 
429

Total Interest Income
148,792

 
151,322

INTEREST EXPENSE
 
 
 
Deposits
7,896

 
10,401

Short-term borrowings
633

 
509

Long-term debt
10,698

 
10,768

Total Interest Expense
19,227

 
21,678

Net Interest Income
129,565

 
129,644

Provision for credit losses
2,500

 
15,000

Net Interest Income After Provision for Credit Losses
127,065

 
114,644

NON-INTEREST INCOME
 
 
 
Service charges on deposit accounts
11,711

 
14,111

Investment management and trust services
10,958

 
10,096

Other service charges and fees
8,927

 
8,510

Mortgage banking income
3,605

 
8,173

Other
3,305

 
3,896

Investment securities gains, net

 
2,473

Total Non-Interest Income
38,506

 
47,259

NON-INTEREST EXPENSE
 
 
 
Salaries and employee benefits
59,566

 
61,212

Net occupancy expense
13,603

 
11,844

Other outside services
3,812

 
2,860

Data processing
3,796

 
3,903

Equipment expense
3,602

 
3,908

Software
2,925

 
2,748

Professional fees
2,904

 
3,047

FDIC insurance expense
2,689

 
2,847

Operating risk loss
1,828

 
1,766

Marketing
1,584

 
1,872

Other real estate owned and repossession expense
983

 
2,854

Intangible amortization
315

 
534

Other
11,947

 
11,541

Total Non-Interest Expense
109,554

 
110,936

Income Before Income Taxes
56,017

 
50,967

Income taxes
14,234

 
11,740

Net Income
$
41,783

 
$
39,227

 
 
 
 
PER SHARE:
 
 
 
Net Income (Basic)
$
0.22

 
$
0.20

Net Income (Diluted)
0.22

 
0.20

Cash Dividends
0.08

 
0.08

See Notes to Consolidated Financial Statements
 
 
 

4


FULTON FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
 
(in thousands)
 
Three months ended March 31
 
2014
 
2013
 
 
Net Income
$
41,783

 
$
39,227

Other Comprehensive Income (Loss), net of tax:
 
 
 
Unrealized gain on securities
13,933

 
125

Reclassification adjustment for postretirement amendment gains and securities gains included in net income
(944
)
 
(1,608
)
Non-credit related unrealized gain on other-than-temporarily impaired debt securities
189

 
1,083

Unrealized gain on derivative financial instruments
34

 
34

Unrecognized pension and postretirement income
2,144

 

Amortization of net unrecognized pension and postretirement items
96

 
328

Other Comprehensive Income (Loss)
15,452

 
(38
)
Total Comprehensive Income
$
57,235

 
$
39,189

 
 
 
 
See Notes to Consolidated Financial Statements
 
 
 


5


FULTON FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2014 AND 2013
 
(in thousands, except per-share data)
 
Common Stock
 
 
 
Retained
Earnings
 
 
 
Treasury
Stock
 
Total
 
Shares
Outstanding
 
Amount
 
Additional Paid-in
Capital
 
Accumulated
Other Comprehensive
Income (Loss)
 
 
 
Balance at December 31, 2013
192,652

 
$
544,568

 
$
1,432,974

 
$
463,843

 
$
(37,341
)
 
$
(340,857
)
 
$
2,063,187

Net income

 

 

 
41,783

 

 

 
41,783

Other comprehensive income (loss)

 

 

 

 
15,452

 

 
15,452

Stock issued, including related tax benefits
198

 
253

 
539

 

 

 
1,385

 
2,177

Stock-based compensation awards

 

 
1,033

 

 

 

 
1,033

Acquisition of treasury stock
(4,000
)
 
 
 
 
 
 
 
 
 
(49,804
)
 
(49,804
)
Common stock cash dividends - $0.08 per share

 

 

 
(15,109
)
 

 

 
(15,109
)
Balance at March 31, 2014
188,850

 
$
544,821

 
$
1,434,546

 
$
490,517

 
$
(21,889
)
 
$
(389,276
)
 
$
2,058,719

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2012
199,225

 
$
542,093

 
$
1,426,267

 
$
363,937

 
$
5,675

 
$
(256,316
)
 
$
2,081,656

Net income

 

 

 
39,227

 

 

 
39,227

Other comprehensive income (loss)

 

 

 

 
(38
)
 

 
(38
)
Stock issued, including related tax benefits
297

 
393

 
196

 

 

 
2,146

 
2,735

Stock-based compensation awards

 

 
847

 

 

 

 
847

Acquisition of treasury stock
(4,246
)
 
 
 
 
 
 
 
 
 
(47,046
)
 
(47,046
)
Common stock cash dividends - $0.08 per share

 

 

 
(15,618
)
 

 

 
(15,618
)
Balance at March 31, 2013
195,276

 
$
542,486

 
$
1,427,310

 
$
387,546

 
$
5,637

 
$
(301,216
)
 
$
2,061,763

 
 
 
 
 
 
 
 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 

6


FULTON FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
(in thousands)
 
Three months ended March 31
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net Income
$
41,783

 
$
39,227

Adjustments to reconcile net income to net cash provided by operating activities:

 

Provision for credit losses
2,500

 
15,000

Depreciation and amortization of premises and equipment
6,629

 
6,171

Net amortization of investment securities premiums
1,435

 
3,846

Investment securities gains, net

 
(2,473
)
Net (increase) decrease in loans held for sale
(3,066
)
 
4,854

Amortization of intangible assets
315

 
534

Stock-based compensation
1,033

 
847

Excess tax benefits from stock-based compensation
(25
)
 
(88
)
Decrease (increase) in accrued interest receivable
661

 
(1,699
)
Decrease in other assets
7,271

 
7,074

Increase in accrued interest payable
1,754

 
2,063

Increase (decrease) in other liabilities
182

 
(11,713
)
Total adjustments
18,689

 
24,416

Net cash provided by operating activities
60,472

 
63,643

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Proceeds from sales of securities available for sale
12,548

 
56,896

Proceeds from maturities of securities held to maturity

 
35

Proceeds from maturities of securities available for sale
79,045

 
199,910

Purchase of securities available for sale
(11,700
)
 
(334,660
)
(Increase) decrease in short-term investments
(58,901
)
 
73,275

Net decrease (increase) in loans
40,017

 
(249,229
)
Net purchases of premises and equipment
(6,255
)
 
(5,202
)
Net cash provided by (used in) investing activities
54,754

 
(258,975
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Net increase in demand and savings deposits
94,093

 
19,339

Net increase (decrease) in time deposits
84,638

 
(115,042
)
(Decrease) increase in short-term borrowings
(188,945
)
 
258,567

Repayments of long-term debt
(123
)
 
(5,042
)
Net proceeds from issuance of common stock
2,152

 
2,647

Excess tax benefits from stock-based compensation
25

 
88

Dividends paid
(15,413
)
 

Acquisition of treasury stock
(49,804
)
 
(47,046
)
Net cash (used in) provided by financing activities
(73,377
)
 
113,511

Net Increase (Decrease) in Cash and Due From Banks
41,849

 
(81,821
)
Cash and Due From Banks at Beginning of Period
218,540

 
256,300

Cash and Due From Banks at End of Period
$
260,389

 
$
174,479

Supplemental Disclosures of Cash Flow Information:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
17,473

 
$
19,615

Income taxes
631

 
5,086

See Notes to Consolidated Financial Statements
 
 
 
 

7


FULTON FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
NOTE A – Basis of Presentation
The accompanying unaudited consolidated financial statements of Fulton Financial Corporation (the Corporation) have been prepared in conformity with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts of assets and liabilities as of the date of the financial statements as well as revenues and expenses during the period. Actual results could differ from those estimates. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. The Corporation evaluates subsequent events through the filing date of this Form 10-Q with the Securities and Exchange Commission (SEC).

NOTE B – Net Income Per Share
Basic net income per share is calculated as net income divided by the weighted average number of shares outstanding.
Diluted net income per share is calculated as net income divided by the weighted average number of shares outstanding plus the incremental number of shares added as a result of converting common stock equivalents, calculated using the treasury stock method. The Corporation’s common stock equivalents consist of outstanding stock options and restricted stock.
A reconciliation of weighted average shares outstanding used to calculate basic net income per share and diluted net income per share follows:
 
Three months ended March 31
 
2014
 
2013
 
(in thousands)
Weighted average shares outstanding (basic)
189,467

 
196,299

Effect of dilutive securities
1,022

 
918

Weighted average shares outstanding (diluted)
190,489

 
197,217

For the three months ended March 31, 2014 and March 31, 2013, 3.1 million and 3.7 million shares issuable under stock options, respectively, were excluded from the diluted net income per share computation as their effect would have been anti-dilutive.


8


NOTE C – Accumulated Other Comprehensive Income (Loss)
The following table presents changes in other comprehensive income (loss): 
 
Before-Tax Amount
 
Tax Effect
 
Net of Tax Amount
 
(in thousands)
Three months ended March 31, 2014
 
 
 
 
 
Unrealized gain (loss) on securities
$
21,435

 
$
(7,502
)
 
$
13,933

Reclassification adjustment for postretirement gains included in net income (1)
(1,452
)
 
508

 
(944
)
Non-credit related unrealized gains (losses) on other-than-temporarily impaired debt securities
291

 
(102
)
 
189

Unrealized gain on derivative financial instruments
52

 
(18
)
 
34

Unrecognized pension and postretirement income
3,291

 
(1,147
)
 
2,144

Amortization of net unrecognized pension and postretirement items (1)
149

 
(53
)
 
96

Total Other Comprehensive Income (Loss)
$
23,766

 
$
(8,314
)
 
$
15,452

Three months ended March 31, 2013
 
 
 
 
 
Unrealized gain (loss) on securities
$
192

 
$
(67
)
 
$
125

Reclassification adjustment for securities gains included in net income (2)
(2,473
)
 
865

 
(1,608
)
Non-credit related unrealized gains (losses) on other-than-temporarily impaired debt securities
1,666

 
(583
)
 
1,083

Unrealized gain on derivative financial instruments
54

 
(20
)
 
34

Amortization of net unrecognized pension and postretirement items (1)
505

 
(177
)
 
328

Total Other Comprehensive Income (Loss)
$
(56
)
 
$
18

 
$
(38
)

(1)
Amounts reclassified out of accumulated other comprehensive income. Before-tax amounts included within "Salaries and employee benefits" on the consolidated statements of income. See Note H, "Employee Benefit Plans," for additional details.
(2)
Amounts reclassified out of accumulated other comprehensive income. Before-tax amounts included within "Investment securities gains, net" on the consolidated statements of income. See Note D, "Investment Securities," for additional details.

The following table presents changes in each component of accumulated other comprehensive income (loss), net of tax: 
 
Unrealized Gains (Losses) on Investment Securities Not Other-Than-Temporarily Impaired
 
Unrealized Non-Credit Gains (Losses) on Other-Than-Temporarily Impaired Debt Securities
 
Unrealized Effective Portions of Losses on Forward-Starting Interest Rate Swaps
 
Unrecognized Pension and Postretirement Plan Income (Costs)
 
Total
 
(in thousands)
Three months ended March 31, 2014
 
 
 
 
 
 
 
 
 
Balance at December 31, 2013
$
(27,510
)
 
$
1,652

 
$
(2,682
)
 
$
(8,801
)
 
$
(37,341
)
Other comprehensive income (loss) before reclassifications
13,933

 
189

 

 
2,144

 
16,266

Amounts reclassified from accumulated other comprehensive income (loss)

 

 
34

 
(848
)
 
(814
)
Balance at March 31, 2014
$
(13,577
)
 
$
1,841

 
$
(2,648
)
 
$
(7,505
)
 
$
(21,889
)
Three months ended March 31, 2013

 

 
 
 

 

Balance at December 31, 2012
$
26,361

 
$
613

 
$
(2,818
)
 
$
(18,481
)
 
$
5,675

Other comprehensive income (loss) before reclassifications
125

 
1,083

 

 

 
1,208

Amounts reclassified from accumulated other comprehensive income (loss)
(1,608
)
 

 
34

 
328

 
(1,246
)
Balance at March 31, 2013
$
24,878

 
$
1,696

 
$
(2,784
)
 
$
(18,153
)
 
$
5,637



9


NOTE D – Investment Securities
The following table presents the amortized cost and estimated fair values of investment securities, which were all classified as available for sale:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
(in thousands)
March 31, 2014
 
 
 
 
 
 
 
Equity securities
$
34,231

 
$
11,524

 
$
(21
)
 
$
45,734

U.S. Government securities
526

 

 

 
526

U.S. Government sponsored agency securities
275

 
6

 
(1
)
 
280

State and municipal securities
278,019

 
7,190

 
(1,756
)
 
283,453

Corporate debt securities
100,348

 
6,292

 
(6,088
)
 
100,552

Collateralized mortgage obligations
1,031,968

 
7,638

 
(32,869
)
 
1,006,737

Mortgage-backed securities
914,502

 
13,582

 
(11,881
)
 
916,203

Auction rate securities
159,379

 
2

 
(11,668
)
 
147,713

 
$
2,519,248

 
$
46,234

 
$
(64,284
)
 
$
2,501,198

 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
(in thousands)
December 31, 2013
 
 
 
 
 
 
 
Equity securities
$
33,922

 
$
12,355

 
$
(76
)
 
$
46,201

U.S. Government securities
525

 

 

 
525

U.S. Government sponsored agency securities
720

 
7

 
(1
)
 
726

State and municipal securities
281,810

 
6,483

 
(3,444
)
 
284,849

Corporate debt securities
100,468

 
5,685

 
(7,404
)
 
98,749

Collateralized mortgage obligations
1,069,138

 
8,036

 
(44,776
)
 
1,032,398

Mortgage-backed securities
949,328

 
13,881

 
(17,497
)
 
945,712

Auction rate securities
172,299

 
234

 
(13,259
)
 
159,274

 
$
2,608,210

 
$
46,681

 
$
(86,457
)
 
$
2,568,434

Securities carried at $1.8 billion as of March 31, 2014 and $1.7 billion as of December 31, 2013 were pledged as collateral to secure public and trust deposits and customer repurchase agreements.
Equity securities include common stocks of financial institutions ($39.8 million at March 31, 2014 and $40.6 million at December 31, 2013) and other equity investments ($5.9 million at March 31, 2014 and $5.6 million at December 31, 2013).
As of March 31, 2014, the financial institutions stock portfolio had a cost basis of $28.5 million and a fair value of $39.8 million, including an investment in a single financial institution with a cost basis of $20.0 million and a fair value of $27.9 million. The fair value of this investment accounted for 70.1% of the fair value of the Corporation's investments in the common stocks of publicly traded financial institutions. No other investment within the financial institutions stock portfolio exceeded 5% of the portfolio's fair value.

10


The amortized cost and estimated fair values of debt securities as of March 31, 2014, by contractual maturity, are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
Amortized
Cost
 
Estimated
Fair Value
 
(in thousands)
Due in one year or less
 
$
30,424

 
$
30,517

Due from one year to five years
 
67,544

 
71,350

Due from five years to ten years
 
199,377

 
203,240

Due after ten years
 
241,202

 
227,417

 
 
538,547

 
532,524

Mortgage-backed securities
 
914,502

 
916,203

Collateralized mortgage obligations
 
1,031,968

 
1,006,737

 
 
$
2,485,017

 
$
2,455,464

There were no losses recognized for the other-than-temporary impairment of investments during the three months ended March 31, 2014 and 2013. The following table presents information related to the gross realized gains and losses on the sales of equity and debt securities:
 
Gross
Realized
Gains
 
Gross
Realized
Losses
 
Net Gains
Three months ended March 31, 2014
(in thousands)
Equity securities
$
1

 
$

 
$
1

Debt securities
322

 
(323
)
 
(1
)
Total
$
323

 
$
(323
)
 
$

Three months ended March 31, 2013
 
 
 
 
 
Equity securities
$
1,139

 
$

 
$
1,139

Debt securities
1,334

 

 
1,334

Total
$
2,473

 
$

 
$
2,473

The following table presents a summary of the cumulative credit related other-than-temporary impairment charges, recognized as components of earnings, for debt securities held by the Corporation at March 31, 2014 and 2013:
 
Three months ended March 31
 
2014
 
2013
 
(in thousands)
Balance of cumulative credit losses on debt securities, beginning of period
$
(20,691
)
 
$
(23,079
)
Reductions for increases in cash flows expected to be collected that are recognized over the remaining life of the security
4

 

Balance of cumulative credit losses on debt securities, end of period
$
(20,687
)
 
$
(23,079
)

11


The following table presents the gross unrealized losses and estimated fair values of investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2014:
 
Less than 12 months
 
12 months or longer
 
Total
 
Estimated
Fair Value
 
Unrealized
Losses
 
Estimated
Fair Value
 
Unrealized
Losses
 
Estimated
Fair Value
 
Unrealized
Losses
 
(in thousands)
U.S. Government sponsored agency securities
$

 
$

 
$
50

 
$
(1
)
 
$
50

 
$
(1
)
State and municipal securities
50,286

 
(1,510
)
 
3,996

 
(246
)
 
54,282

 
(1,756
)
Corporate debt securities
3,939

 
(58
)
 
38,804

 
(6,030
)
 
42,743

 
(6,088
)
Collateralized mortgage obligations
416,584

 
(13,921
)
 
313,758

 
(18,948
)
 
730,342

 
(32,869
)
Mortgage-backed securities
621,165

 
(11,881
)
 

 

 
621,165

 
(11,881
)
Auction rate securities

 

 
147,619

 
(11,668
)
 
147,619

 
(11,668
)
Total debt securities
1,091,974

 
(27,370
)
 
504,227

 
(36,893
)
 
1,596,201

 
(64,263
)
Equity securities
3

 
(1
)
 
118

 
(20
)
 
121

 
(21
)
 
$
1,091,977

 
$
(27,371
)
 
$
504,345

 
$
(36,913
)
 
$
1,596,322

 
$
(64,284
)
The Corporation’s collateralized mortgage obligations and mortgage-backed securities have contractual terms that generally do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because the decline in market value of these securities is attributable to changes in interest rates and not credit quality, and because the Corporation does not have the intent to sell and does not believe it will more likely than not be required to sell any of these securities prior to a recovery of their fair value to amortized cost, the Corporation does not consider these investments to be other-than-temporarily impaired as of March 31, 2014.
The unrealized holding losses on auction rate securities, or auction rate certificates (ARCs), are attributable to liquidity issues resulting from the failure of periodic auctions. The Corporation had previously purchased ARCs for investment management and trust customers as short-term investments with fair values that could be derived based on periodic auctions under normal market conditions. During 2008 and 2009, the Corporation purchased ARCs from these customers due to the failure of these periodic auctions, which made these previously short-term investments illiquid.
As of March 31, 2014, approximately $143 million, or 97%, of the ARCs were rated above investment grade, with approximately $6 million, or 4%, AAA rated and $103 million, or 70%, AA rated. Approximately $4 million, or 3%, of ARCs were either not rated or rated below investment grade by at least one ratings agency. Of this amount, approximately $3 million, or 59%, of the student loans underlying these ARCs have principal payments which are guaranteed by the federal government. In total, approximately $146 million, or 99%, of the student loans underlying the ARCs have principal payments that are guaranteed by the federal government.
During the first quarter of 2014, the Corporation sold ARCs with a total book value of $11.9 million, with no gain or loss upon sale. As of March 31, 2014, all ARCs were current and making scheduled interest payments. Based on management’s evaluations, ARCs with a fair value of $147.7 million were not subject to any other-than-temporary impairment charges as of March 31, 2014. The Corporation does not have the intent to sell and does not believe it will more likely than not be required to sell any of these securities prior to a recovery of their fair value to amortized cost, which may be at maturity.
For its investments in equity securities, particularly its investments in stocks of financial institutions, management evaluates the near-term prospects of the issuers in relation to the severity and duration of the impairment. Based on that evaluation and the Corporation’s ability and intent to hold those investments for a reasonable period of time sufficient for a recovery of fair value, the Corporation does not consider those investments with unrealized holding losses as of March 31, 2014 to be other-than-temporarily impaired.

12


The majority of the Corporation's available for sale corporate debt securities are issued by financial institutions. The following table presents the amortized cost and estimated fair value of corporate debt securities:
 
March 31, 2014
 
December 31, 2013
 
Amortized
cost
 
Estimated
fair value
 
Amortized
cost
 
Estimated
fair value
 
(in thousands)
Single-issuer trust preferred securities
$
47,502

 
$
41,879

 
$
47,481

 
$
40,531

Subordinated debt
47,436

 
50,429

 
47,405

 
50,327

Pooled trust preferred securities
2,825

 
5,659

 
2,997

 
5,306

Corporate debt securities issued by financial institutions
97,763

 
97,967

 
97,883

 
96,164

Other corporate debt securities
2,585

 
2,585

 
2,585

 
2,585

Available for sale corporate debt securities
$
100,348

 
$
100,552

 
$
100,468

 
$
98,749


The Corporation’s investments in single-issuer trust preferred securities had an unrealized loss of $5.6 million at March 31, 2014. The Corporation did not record any other-than-temporary impairment charges for single-issuer trust preferred securities during the three months ended March 31, 2014 or 2013. Six of the Corporation's 22 single-issuer trust preferred securities were rated below investment grade by at least one ratings agency, with an amortized cost of $13.5 million and an estimated fair value of $11.7 million at March 31, 2014. All of the single-issuer trust preferred securities rated below investment grade were rated BB or Ba. Three single-issuer trust preferred securities with an amortized cost of $4.7 million and an estimated fair value of $3.8 million at March 31, 2014 were not rated by any ratings agency.
As of March 31, 2014, all eight of the Corporation's pooled trust preferred securities, with an amortized cost of $2.8 million and an estimated fair value of $5.7 million, were rated below investment grade by at least one ratings agency, with ratings ranging from C to Ca. The class of securities held by the Corporation was below the most senior tranche, with the Corporation’s interests being subordinate to other investors in the pool. The Corporation determines the fair value of pooled trust preferred securities based on quotes provided by third-party brokers.
The amortized cost of pooled trust preferred securities is the purchase price of the securities, net of cumulative credit related other-than-temporary impairment charges, determined using an expected cash flows model. The most significant input to the expected cash flows model is the expected payment deferral rate for each pooled trust preferred security. The Corporation evaluates the financial metrics, such as capital ratios and non-performing assets ratios, of the individual financial institution issuers that comprise each pooled trust preferred security to estimate its expected deferral rate.
Based on management’s evaluations, corporate debt securities with a fair value of $100.6 million were not subject to any additional other-than-temporary impairment charges as of March 31, 2014. The Corporation does not have the intent to sell and does not believe it will more likely than not be required to sell any of these securities prior to a recovery of their fair value to amortized cost, which may be at maturity.
As mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), in December 2013, five regulatory bodies issued final rulings (Final Rules) implementing certain prohibitions and restrictions on the ability of a banking entity and non-bank financial company supervised by the Federal Reserve Board to engage in proprietary trading and have certain ownership interests in, or relationships with, a "covered fund" (the so-called "Volcker Rule"). The Final Rules generally treat as a covered fund any entity that would be an investment company under the Investment Company Act of 1940 (1940 Act) but for the application of the exemptions from SEC registration set forth in Section 3(c)(1) (fewer than 100 beneficial owners) or Section 3(c)(7) (qualified purchasers) of the 1940 Act. The Final Rules also require regulated entities to establish an internal compliance program that is consistent with the extent to which it engages in activities covered by the Volcker Rule, which must include making regular reports about those activities to regulators. Although the Final Rules provide some tiering of compliance and reporting obligations based on size, the fundamental prohibitions of the Volcker Rule apply to banking entities of any size, including the Corporation. Banking entities have until July 21, 2015 to conform their activities and investments to the requirements of the Final Rules. While the Corporation does not engage in proprietary trading or in any other activities prohibited by the Final Rules, the Corporation will continue to evaluate whether any of its investments that fall within the definition of a "covered fund" and would need to be disposed of by July 21, 2015. However, based on the Corporation's evaluation to date, it does not currently expect the Final Rules will have a material effect on its business, financial condition or results of operations.


13


NOTE E – Loans and Allowance for Credit Losses

Loans, Net of Unearned Income
Loans, net of unearned income are summarized as follows:
 
March 31, 2014
 
December 31, 2013
 
(in thousands)
Real-estate - commercial mortgage
$
5,137,454

 
$
5,101,922

Commercial - industrial, financial and agricultural
3,574,130

 
3,628,420

Real-estate - home equity
1,740,496

 
1,764,197

Real-estate - residential mortgage
1,331,465

 
1,337,380

Real-estate - construction
584,217

 
573,672

Consumer
270,021

 
283,124

Leasing and other
103,192

 
99,256

Overdrafts
3,034

 
4,045

Loans, gross of unearned income
12,744,009

 
12,792,016

Unearned income
(10,217
)
 
(9,796
)
Loans, net of unearned income
$
12,733,792

 
$
12,782,220


Allowance for Credit Losses
The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments. The allowance for loan losses represents management’s estimate of incurred losses in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The reserve for unfunded lending commitments represents management’s estimate of incurred losses in its unfunded loan commitments and is recorded in other liabilities on the consolidated balance sheet. The allowance for credit losses is increased by charges to expense, through the provision for credit losses, and decreased by charge-offs, net of recoveries.
The Corporation’s allowance for credit losses includes: (1) specific allowances allocated to loans evaluated for impairment under the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) Section 310-10-35; and (2) allowances calculated for pools of loans measured for impairment under FASB ASC Subtopic 450-20.
The Corporation segments its loan portfolio by general loan type, or "portfolio segments," as presented in the table under the heading, "Loans, Net of Unearned Income," above. Certain portfolio segments are further disaggregated and evaluated collectively for impairment based on "class segments," which are largely based on the type of collateral underlying each loan. For commercial loans, class segments include loans secured by collateral and unsecured loans. Construction loan class segments include loans secured by commercial real estate, loans to commercial borrowers secured by residential real estate and loans to individuals secured by residential real estate. Consumer loan class segments include direct consumer installment loans and indirect automobile loans.
The following table presents the components of the allowance for credit losses:
 
March 31,
2014
 
December 31,
2013
 
(in thousands)
Allowance for loan losses
$
197,089

 
$
202,780

Reserve for unfunded lending commitments
1,917

 
2,137

Allowance for credit losses
$
199,006

 
$
204,917


14


The following table presents the activity in the allowance for credit losses:
 
Three months ended March 31
 
2014
 
2013
 
(in thousands)
Balance at beginning of period
$
204,917

 
$
225,439

Loans charged off
(10,268
)
 
(22,106
)
Recoveries of loans previously charged off
1,857

 
3,194

Net loans charged off
(8,411
)
 
(18,912
)
Provision for credit losses
2,500

 
15,000

Balance at end of period
$
199,006

 
$
221,527


The following table presents the activity in the allowance for loan losses by portfolio segment:
 
Real Estate -
Commercial
Mortgage
 
Commercial -
Industrial,
Financial and
Agricultural
 
Real Estate -
Home
Equity
 
Real Estate -
Residential
Mortgage
 
Real Estate -
Construction
 
Consumer
 
Leasing
and other
and
overdrafts
 
Unallocated
 
Total
 
(in thousands)
Three months ended March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2013
$
55,659

 
$
50,330

 
$
28,222

 
$
33,082

 
$
12,649

 
$
3,260

 
$
3,370

 
$
16,208

 
$
202,780

Loans charged off
(1,386
)
 
(5,125
)
 
(1,651
)
 
(846
)
 
(214
)
 
(751
)
 
(295
)
 

 
(10,268
)
Recoveries of loans previously charged off
44

 
744

 
356

 
116

 
224

 
209

 
164

 

 
1,857

Net loans charged off
(1,342
)
 
(4,381
)
 
(1,295
)
 
(730
)
 
10

 
(542
)
 
(131
)
 

 
(8,411
)
Provision for loan losses (1)
(560
)
 
4,614

 
5,533

 
977

 
(2,817
)
 
606

 
(1,228
)
 
(4,405
)
 
2,720

Balance at March 31, 2014
$
53,757

 
$
50,563

 
$
32,460

 
$
33,329

 
$
9,842

 
$
3,324

 
$
2,011

 
$
11,803

 
$
197,089

Three months ended March 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2012
$
62,928

 
$
60,205

 
$
22,776

 
$
34,536

 
$
17,287

 
$
2,367

 
$
2,752

 
$
21,052

 
$
223,903

Loans charged off
(4,133
)
 
(9,502
)
 
(2,404
)
 
(3,050
)
 
(1,986
)
 
(550
)
 
(481
)
 

 
(22,106
)
Recoveries of loans previously charged off
1,064

 
379

 
331

 
81

 
671

 
506

 
162

 

 
3,194

Net loans charged off
(3,069
)
 
(9,123
)
 
(2,073
)
 
(2,969
)
 
(1,315
)
 
(44
)
 
(319
)
 

 
(18,912
)
Provision for loan losses (1)
4,126

 
5,590

 
2,998

 
1,917

 
32

 
(37
)
 
354

 
70

 
15,050

Balance at March 31, 2013
$
63,985

 
$
56,672

 
$
23,701

 
$
33,484

 
$
16,004

 
$
2,286

 
$
2,787

 
$
21,122

 
$
220,041


(1)
The provision for loan losses excluded a $220,000 decrease in the reserve for unfunded lending commitments for the three months ended March 31, 2014 and excluded a $50,000 decrease in the reserve for unfunded lending commitments for the three months ended March 31, 2013. The total provision for credit losses, comprised of allocations for both funded and unfunded loans, was $2.5 million for the three months ended March 31, 2014 and $15.0 million for the three months ended March 31, 2013.

15


The following table presents loans, net of unearned income and their related allowance for loan losses, by portfolio segment:
 
Real Estate -
Commercial
Mortgage
 
Commercial -
Industrial,
Financial and
Agricultural
 
Real Estate -
Home
Equity
 
Real Estate -
Residential
Mortgage
 
Real Estate -
Construction
 
Consumer
 
Leasing
and other
and
overdrafts
 
Unallocated
(1)
 
Total
 
(in thousands)
Allowance for loan losses at March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Measured for impairment under FASB ASC Subtopic 450-20
$
37,363

 
$
36,859

 
$
22,969

 
$
11,618

 
$
7,256

 
$
3,309

 
$
2,011

 
$
11,803

 
$
133,188

Evaluated for impairment under FASB ASC Section 310-10-35
16,394

 
13,704

 
9,491

 
21,711

 
2,586

 
15

 

 
N/A

 
63,901

 
$
53,757

 
$
50,563

 
$
32,460

 
$
33,329

 
$
9,842

 
$
3,324

 
$
2,011

 
$
11,803

 
$
197,089

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans, net of unearned income at March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Measured for impairment under FASB ASC Subtopic 450-20
$
5,075,556

 
$
3,528,857

 
$
1,726,342

 
$
1,279,783

 
$
555,852

 
$
270,004

 
$
96,009

 
N/A

 
$
12,532,403

Evaluated for impairment under FASB ASC Section 310-10-35
61,898

 
45,273

 
14,154

 
51,682

 
28,365

 
17

 

 
N/A

 
201,389

 
$
5,137,454

 
$
3,574,130

 
$
1,740,496

 
$
1,331,465

 
$
584,217

 
$
270,021

 
$
96,009

 
N/A

 
$
12,733,792

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses at March 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Measured for impairment under FASB ASC Subtopic 450-20
$
40,920

 
$
38,988

 
$
14,947

 
$
10,075

 
$
8,838

 
$
2,271

 
$
2,758

 
$
21,122

 
$
139,919

Evaluated for impairment under FASB ASC Section 310-10-35
23,065

 
17,684

 
8,754

 
23,409

 
7,166

 
15

 
29

 
N/A

 
80,122

 
$
63,985

 
$
56,672

 
$
23,701

 
$
33,484

 
$
16,004

 
$
2,286

 
$
2,787

 
$
21,122

 
$
220,041

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans, net of unearned income at March 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Measured for impairment under FASB ASC Subtopic 450-20
$
4,646,355

 
$
3,591,753

 
$
1,675,577

 
$
1,247,976

 
$
554,757

 
$
309,120

 
$
89,195

 
N/A

 
$
12,114,733

Evaluated for impairment under FASB ASC Section 310-10-35
83,575

 
66,730

 
13,869

 
55,478

 
42,840

 
18

 
45

 
N/A

 
262,555

 
$
4,729,930

 
$
3,658,483

 
$
1,689,446

 
$
1,303,454

 
$
597,597

 
$
309,138

 
$
89,240

 
N/A

 
$
12,377,288

 
(1)
The unallocated allowance, which was approximately 6% and 10% of the total allowance for credit losses as of March 31, 2014 and March 31, 2013, respectively, was, in the opinion of management, reasonable and appropriate given that the estimates used in the allocation process are inherently imprecise.
N/A – Not applicable.
In March 2013, the Corporation sold $9.9 million of non-accrual commercial mortgage, commercial and construction loans to an investor, resulting in a total increase to charge-offs of $5.2 million during the three months ended March 31, 2013, as detailed in the following table.
 
Real Estate - Commercial mortgage
 
Commercial - industrial, financial and agricultural
 
Real Estate - Construction
 
Total
 
(in thousands)
Unpaid principal balance of loans sold
$
7,690

 
$
4,730

 
$
740

 
$
13,160

Charge-offs prior to sale
(2,420
)
 
(710
)
 
(150
)
 
(3,280
)
Net recorded investment in loans sold
5,270

 
4,020

 
590

 
9,880

Proceeds from sale, net of selling expenses
2,770

 
1,730

 
140

 
4,640

Total charge-off upon sale
$
(2,500
)
 
$
(2,290
)
 
$
(450
)
 
$
(5,240
)
 
 
 
 
 
 
 
 
Existing allocation for credit losses on sold loans
$
(2,870
)
 
$
(1,960
)
 
$
(300
)
 
$
(5,130
)

Impaired Loans
A loan is considered to be impaired if it is probable that all amounts will not be collected according to the contractual terms of the loan agreement. Impaired loans consist of all loans on non-accrual status and accruing troubled debt restructurings (TDRs). An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. Impaired loans to borrowers with total outstanding commitments greater than $1.0 million are evaluated individually for impairment. Impaired loans to borrowers with total outstanding commitments less than $1.0 million are pooled and measured for impairment collectively. All loans evaluated for impairment under FASB ASC Section 310-10-35 are measured for losses on a quarterly basis. As of March 31, 2014 and December 31, 2013, substantially all of the Corporation’s individually evaluated impaired loans with total outstanding balances greater than $1.0 million were measured based on the estimated fair value of each loan’s collateral. Collateral

16


could be in the form of real estate, in the case of impaired commercial mortgages and construction loans, or business assets, such as accounts receivable or inventory, in the case of commercial and industrial loans. Commercial and industrial loans may also be secured by real property.
As of March 31, 2014 and 2013, approximately 79% and 73%, respectively, of impaired loans with principal balances greater than $1.0 million, whose primary collateral is real estate, were measured at estimated fair value using state certified third-party appraisals that had been updated within the preceding 12 months.
When updated certified appraisals are not obtained for loans to commercial borrowers evaluated for impairment under FASB ASC Section 310-10-35 that are secured by real estate, fair values are estimated based on the original appraisal values, as long as the original appraisal indicated a strong loan-to-value position and, in the opinion of the Corporation's internal loan evaluation staff, there has not been a significant deterioration in the collateral value since the original appraisal was performed. Original appraisals are typically used only when the estimated collateral value, as adjusted appropriately for the age of the appraisal, results in a current loan-to-value ratio that is lower than the Corporation's loan-to-value requirements for new loans, generally less than 70%.
The following table presents total impaired loans by class segment:
 
March 31, 2014
 
December 31, 2013
 
Unpaid
Principal
Balance
 
Recorded
Investment
 
Related
Allowance
 
Unpaid
Principal
Balance
 
Recorded
Investment
 
Related
Allowance
 
(in thousands)
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
 
Real estate - commercial mortgage
$
27,433

 
$
23,491

 
$

 
$
28,892

 
$
24,494

 
$

Commercial - secured
23,862

 
20,867

 

 
23,890

 
21,383

 

Real estate - home equity
399

 
300

 

 
399

 
300

 

Real estate - residential mortgage
317

 
317

 

 

 

 

Construction - commercial residential
26,475

 
20,705

 

 
18,943

 
13,740

 

Construction - commercial
2,992

 
1,962

 

 
2,996

 
1,976

 

 
81,478

 
67,642

 

 
75,120

 
61,893

 

With a related allowance recorded:
 
 
 

 

 

 

Real estate - commercial mortgage
47,010

 
38,407

 
16,394

 
43,282

 
35,830

 
14,444

Commercial - secured
36,309

 
23,765

 
13,232

 
34,267

 
22,324

 
13,315

Commercial - unsecured
693

 
641

 
472

 
1,113

 
1,048

 
752

Real estate - home equity
19,420

 
13,854

 
9,491

 
20,383

 
14,337

 
9,059

Real estate - residential mortgage
61,733

 
51,365

 
21,711

 
63,682

 
51,097

 
21,745

Construction - commercial residential
15,753

 
4,963

 
2,212

 
25,769

 
14,579

 
3,493

Construction - commercial
481

 
191

 
76

 
485

 
195

 
77

Construction - other
718

 
544

 
298

 
719

 
548

 
301

Consumer - direct
15

 
15

 
13

 
11

 
11

 
10

Consumer - indirect
15

 
2

 
2

 
2

 
2

 
2

 
182,147

 
133,747

 
63,901

 
189,713

 
139,971

 
63,198

Total
$
263,625

 
$
201,389

 
$
63,901

 
$
264,833

 
$
201,864

 
$
63,198

As of March 31, 2014 and December 31, 2013, there were $67.6 million and $61.9 million, respectively, of impaired loans that did not have a related allowance for loan loss. The estimated fair values of the collateral for these loans exceeded their carrying amount, or they were previously charged down to collateral values. Accordingly, no specific valuation allowance was considered to be necessary.

17


The following table presents average impaired loans by class segment:
 
Three months ended March 31
 
2014
 
2013
 
Average
Recorded
Investment
 
Interest
Income
Recognized (1)
 
Average
Recorded
Investment
 
Interest
Income
Recognized (1)
 
(in thousands)
With no related allowance recorded:
 
 
 
 
 
 
 
Real estate - commercial mortgage
$
23,993

 
$
86

 
$
32,140

 
$
160

Commercial - secured
21,125

 
35

 
31,413

 
34

Commercial - unsecured

 

 
66

 

Real estate - home equity
300

 

 
205

 
1

Real estate - residential mortgage
159

 
1

 
991

 
12

Construction - commercial residential
17,223

 
60

 
22,650

 
63

Construction - commercial
1,969

 

 
4,979

 
2

 
64,769

 
182

 
92,444

 
272

With a related allowance recorded:
 
 
 
 
 
 
 
Real estate - commercial mortgage
37,119

 
132

 
54,464

 
221

Commercial - secured
23,045

 
38

 
35,864

 
43

Commercial - unsecured
845

 
1

 
1,743

 
2

Real estate - home equity
14,096

 
20

 
13,301

 
16

Real estate - residential mortgage
51,231

 
294

 
53,797

 
339

Construction - commercial residential
9,771

 
35

 
11,496

 
42

Construction - commercial
193

 

 
2,758

 
3

Construction - other
546

 

 
533

 
1

Consumer - direct
13

 

 
24

 

Consumer - indirect
2

 

 

 

Leasing and other and overdrafts

 

 
28

 

 
136,861

 
520

 
174,008

 
667

Total
$
201,630

 
$
702

 
$
266,452

 
$
939

 
 
 
 
 
 
 
 
(1)
All impaired loans, excluding accruing TDRs, were non-accrual loans. Interest income recognized for the three months ended March 31, 2014 and 2013 represents amounts earned on accruing TDRs.


18


Credit Quality Indicators and Non-performing Assets
The following table presents internal credit risk ratings for commercial - secured loans, commercial - unsecured loans, commercial mortgages, construction - commercial residential loans and construction - commercial loans:
 
Pass
 
Special Mention
 
Substandard or Lower
 
Total
 
March 31, 2014
 
December 31, 2013
 
March 31, 2014
 
December 31, 2013
 
March 31, 2014
 
December 31, 2013
 
March 31, 2014
 
December 31, 2013
 
(dollars in thousands)
Real estate - commercial mortgage
$
4,833,982

 
$
4,763,987

 
$
122,929

 
$
141,013

 
$
180,543

 
$
196,922

 
$
5,137,454

 
$
5,101,922

Commercial - secured
3,109,539

 
3,167,168

 
137,176

 
111,613

 
128,326

 
125,382

 
3,375,041

 
3,404,163

Commercial -unsecured
183,734

 
209,836

 
10,369

 
11,666

 
4,986

 
2,755

 
199,089

 
224,257

Total commercial - industrial, financial and agricultural
3,293,273

 
3,377,004

 
147,545

 
123,279

 
133,312

 
128,137

 
3,574,130

 
3,628,420

Construction - commercial residential
153,495

 
146,041

 
29,556

 
31,522

 
46,490

 
57,806

 
229,541

 
235,369

Construction - commercial
274,037

 
258,441

 
2,915

 
2,932

 
6,144

 
8,124

 
283,096

 
269,497

Total construction (excluding Construction - other)
427,532

 
404,482

 
32,471

 
34,454

 
52,634

 
65,930

 
512,637

 
504,866

 
$
8,554,787

 
$
8,545,473

 
$
302,945

 
$
298,746

 
$
366,489

 
$
390,989

 
$
9,224,221

 
$
9,235,208

% of Total
92.7
%
 
92.6
%
 
3.3
%
 
3.2
%
 
4.0
%
 
4.2
%
 
100.0
%
 
100.0
%

The following is a summary of the Corporation's internal risk rating categories:
Pass: These loans do not currently pose undue credit risk and can range from the highest to average quality, depending on the degree of potential risk.
Special Mention: These loans constitute an undue and unwarranted credit risk, but not to a point of justifying a classification of substandard. Loans in this category are currently acceptable, but are nevertheless potentially weak.
Substandard or Lower: These loans are inadequately protected by current sound worth and paying capacity of the borrower. There exists a well-defined weakness or weaknesses that jeopardize the normal repayment of the debt.

The Corporation believes that internal risk ratings are the most relevant credit quality indicator for the class segments presented above. The migration of loans through the various internal risk rating categories is a significant component of the allowance for credit loss methodology, which bases the probability of default on this migration. Assigning risk ratings involves judgment. Risk ratings are initially assigned to loans by loan officers and are reviewed on a regular basis by credit administration staff. The Corporation's loan review officers provide a separate assessment of risk rating accuracy. Ratings may be changed based on the ongoing monitoring procedures performed by loan officers or credit administration staff, or if specific loan review activities identify a deterioration or an improvement in the loan. The risk rating process allows management to identify riskier credits in a timely manner and to allocate resources to managing troubled accounts.

The Corporation does not assign internal risk ratings to smaller balance, homogeneous loans, such as home equity, residential mortgage, consumer, leasing and other and construction loans to individuals secured by residential real estate. For these loans, the most relevant credit quality indicator is delinquency status. The migration of these loans through the various delinquency status categories is a significant component of the allowance for credit losses methodology, which bases the probability of default on this migration.


19


The following table presents a summary of delinquency and non-performing status for home equity, residential mortgages, construction loans to individuals and consumer, leasing and other loans by class segment:
 
Performing
 
Delinquent (1)
 
Non-performing (2)
 
Total
 
March 31, 2014
 
December 31, 2013
 
March 31, 2014
 
December 31, 2013
 
March 31, 2014
 
December 31, 2013
 
March 31, 2014
 
December 31, 2013
 
(dollars in thousands)
Real estate - home equity
$
1,711,430

 
$
1,731,185

 
$
11,978

 
$
16,029

 
$
17,088

 
$
16,983

 
$
1,740,496

 
$
1,764,197

Real estate - residential mortgage
1,281,854

 
1,282,754

 
20,306

 
23,279

 
29,305

 
31,347

 
1,331,465

 
1,337,380

Construction - other
70,096

 
68,258

 
940

 

 
544

 
548

 
71,580

 
68,806

Consumer - direct
116,748

 
126,666

 
3,634

 
3,586

 
2,872

 
2,391

 
123,254

 
132,643

Consumer - indirect
144,220

 
147,017

 
2,420

 
3,312

 
127

 
152

 
146,767

 
150,481

Total consumer
260,968

 
273,683

 
6,054

 
6,898

 
2,999

 
2,543

 
270,021

 
283,124

Leasing and other and overdrafts
95,141

 
92,876

 
794

 
581

 
74

 
48

 
96,009

 
93,505

 
$
3,419,489

 
$
3,448,756

 
$
40,072

 
$
46,787

 
$
50,010

 
$
51,469

 
$
3,509,571

 
$
3,547,012

% of Total
97.4
%

97.2
%

1.2
%

1.3
%

1.4
%

1.5
%

100.0
%

100.0
%

(1)
Includes all accruing loans 31 days to 89 days past due.
(2)
Includes all accruing loans 90 days or more past due and all non-accrual loans.
The following table presents non-performing assets:
 
March 31,
2014
 
December 31,
2013
 
(in thousands)
Non-accrual loans
$
133,705

 
$
133,753

Accruing loans greater than 90 days past due
21,225

 
20,524

Total non-performing loans
154,930

 
154,277

Other real estate owned (OREO)
15,300

 
15,052

Total non-performing assets
$
170,230

 
$
169,329

The following table presents TDRs, by class segment:
 
March 31,
2014
 
December 31,
2013
 
(in thousands)
Real-estate - residential mortgage
$
30,363

 
$
28,815

Real-estate - commercial mortgage
19,514

 
19,758

Construction - commercial residential
8,430

 
10,117

Commercial - secured
6,674

 
7,933

Real estate - home equity
2,606

 
1,365

Commercial - unsecured
81

 
112

Consumer - direct
15

 
11

Consumer - indirect
1

 

Total accruing TDRs
67,684

 
68,111

Non-accrual TDRs (1)
27,487

 
30,209

Total TDRs
$
95,171

 
$
98,320

 
(1)
Included within non-accrual loans in the preceding table detailing non-performing assets.

As of March 31, 2014 and December 31, 2013, there were $5.2 million and $9.6 million, respectively, of commitments to lend additional funds to borrowers whose loans were modified under TDRs.


20


The following table presents TDRs, by class segment, as of March 31, 2014 and 2013 that were modified during the three months ended March 31, 2014 and 2013:
 
Three months ended March 31
 
2014
 
2013
 
Number of Loans
 
Recorded Investment
 
Number of Loans
 
Recorded Investment
 
(dollars in thousands)
Real estate - commercial mortgage
7
 
$
7,470

 
5
 
$
2,652

Real estate - residential mortgage
6
 
706

 
28
 
3,966

Construction - commercial residential
1
 
548

 
2
 
628

Real estate - home equity
10
 
529

 
17
 
1,180

Consumer - direct
4
 
4

 
 

Consumer - indirect
3
 
1

 
 

Commercial - secured
 

 
5
 
457

Commercial - unsecured
 

 
1
 
15

 
31
 
$
9,258

 
58
 
$
8,898


The following table presents TDRs, by class segment, as of March 31, 2014 and 2013 that were modified within the previous 12 months and had a post-modification payment default during the three months ended March 31, 2014 and 2013. The Corporation defines a payment default as a single missed payment.
 
Three months ended March 31
 
2014
 
2013
 
Number of Loans
 
Recorded Investment
 
Number of Loans
 
Recorded Investment
 
(dollars in thousands)
Real estate - residential mortgage
12
 
$
2,522

 
31
 
$
5,849

Real estate - home equity
14
 
1,432

 
20
 
1,233

Construction - commercial residential
1
 
619

 
4
 
1,308

Real estate - commercial mortgage
3
 
126

 
12
 
6,893

Commercial - secured
1
 
11

 
6
 
708

Construction - commercial
 

 
1
 
930

 
31
 
$
4,710

 
74
 
$
16,921



21


The following table presents past due status and non-accrual loans by portfolio segment and class segment:
 
March 31, 2014
 
31-59
Days Past
Due
 
60-89
Days Past
Due
 
≥ 90 Days
Past Due
and
Accruing
 
Non-
accrual
 
Total ≥ 90
Days
 
Total Past
Due
 
Current
 
Total
 
(in thousands)
Real estate - commercial mortgage
$
13,290

 
$
4,633

 
$
3,492

 
$
42,384

 
$
45,876

 
$
63,799

 
$
5,073,655

 
$
5,137,454

Commercial - secured
9,370

 
1,886

 
308

 
37,958

 
38,266

 
49,522

 
3,325,519

 
3,375,041

Commercial - unsecured
304

 
275

 
4

 
560

 
564

 
1,143

 
197,946

 
199,089

Total commercial - industrial, financial and agricultural
9,674

 
2,161

 
312

 
38,518

 
38,830

 
50,665

 
3,523,465

 
3,574,130

Real estate - home equity
9,347

 
2,631

 
5,540

 
11,548

 
17,088

 
29,066

 
1,711,430

 
1,740,496

Real estate - residential mortgage
14,682

 
5,624

 
7,986

 
21,319

 
29,305

 
49,611

 
1,281,854

 
1,331,465

Construction - commercial residential
1,352

 
228

 
796

 
17,238

 
18,034

 
19,614

 
209,927

 
229,541

Construction - commercial

 

 
27

 
2,153

 
2,180

 
2,180

 
280,916

 
283,096

Construction - other
940

 

 

 
544

 
544

 
1,484

 
70,096

 
71,580

Total real estate - construction
2,292

 
228

 
823

 
19,935

 
20,758

 
23,278

 
560,939

 
584,217

Consumer - direct
2,495

 
1,139

 
2,872

 

 
2,872

 
6,506

 
116,748

 
123,254

Consumer - indirect
1,960

 
460

 
126

 
1

 
127

 
2,547

 
144,220

 
146,767

Total consumer
4,455

 
1,599

 
2,998

 
1

 
2,999

 
9,053

 
260,968

 
270,021

Leasing and other and overdrafts
331

 
463

 
74

 

 
74

 
868

 
95,141

 
96,009

 
$
54,071

 
$
17,339

 
$
21,225

 
$
133,705

 
$
154,930

 
$
226,340

 
$
12,507,452

 
$
12,733,792

 
December 31, 2013
 
31-59
Days Past
Due
 
60-89
Days Past
Due
 
≥ 90 Days
Past Due
and
Accruing
 
Non-
accrual
 
Total ≥ 90
Days
 
Total Past
Due
 
Current
 
Total
 
(in thousands)
Real estate - commercial mortgage
$
15,474

 
$
4,009

 
$
3,502

 
$
40,566

 
$
44,068

 
$
63,551

 
$
5,038,371

 
$
5,101,922

Commercial - secured
8,916

 
1,365

 
1,311

 
35,774

 
37,085

 
47,366

 
3,356,797

 
3,404,163

Commercial - unsecured
332

 
125

 

 
936

 
936

 
1,393

 
222,864

 
224,257

Total commercial - industrial, financial and agricultural
9,248

 
1,490

 
1,311

 
36,710

 
38,021

 
48,759

 
3,579,661

 
3,628,420

Real estate - home equity
13,555

 
2,474

 
3,711

 
13,272

 
16,983

 
33,012

 
1,731,185

 
1,764,197

Real estate - residential mortgage
16,969

 
6,310

 
9,065

 
22,282

 
31,347

 
54,626

 
1,282,754

 
1,337,380

Construction - commercial residential

 
645

 
346

 
18,202

 
18,548

 
19,193

 
216,176

 
235,369

Construction - commercial
14

 

 

 
2,171

 
2,171

 
2,185

 
267,312

 
269,497

Construction - other

 

 

 
548

 
548

 
548

 
68,258

 
68,806

Total real estate - construction
14

 
645

 
346

 
20,921

 
21,267

 
21,926

 
551,746

 
573,672

Consumer - direct
2,091

 
1,495

 
2,391

 

 
2,391

 
5,977

 
126,666

 
132,643

Consumer - indirect
2,864

 
448

 
150

 
2

 
152

 
3,464

 
147,017

 
150,481

Total consumer
4,955

 
1,943

 
2,541

 
2

 
2,543

 
9,441

 
273,683

 
283,124

Leasing and other and overdrafts
559

 
22

 
48

 

 
48

 
629

 
92,876

 
93,505

 
$
60,774

 
$
16,893

 
$
20,524

 
$
133,753

 
$
154,277

 
$
231,944

 
$
12,550,276

 
$
12,782,220



22


NOTE F – Mortgage Servicing Rights
The following table summarizes the changes in mortgage servicing rights (MSRs), which are included in other assets on the consolidated balance sheets:
 
Three months ended
March 31
 
2014
 
2013
 
(in thousands)
Amortized cost:
 
 
 
Balance at beginning of period
$
42,452

 
$
39,737

Originations of mortgage servicing rights
1,115

 
4,227

Amortization
(1,899
)
 
(2,958
)
Balance at end of period
$
41,668

 
$
41,006

 
 
 
 
Valuation allowance
$

 
$
(3,680
)
 
 
 
 
Net MSRs at end of period
$
41,668

 
37,326

MSRs represent the economic value of existing contractual rights to service mortgage loans that have been sold. Accordingly, actual and expected prepayments of the underlying mortgage loans can impact the value of MSRs.
The Corporation estimates the fair value of its MSRs by discounting the estimated cash flows from servicing income, net of expense, over the expected life of the underlying loans at a discount rate commensurate with the risk associated with these assets. Expected life is based on the contractual terms of the loans, as adjusted for prepayment projections.
As of March 31, 2014, the estimated fair value of MSRs was $48.2 million, which exceeded their book value. Therefore, no increase to the valuation allowance was necessary during the three months ended March 31, 2014.

NOTE G – Stock-Based Compensation
The fair value of equity awards granted to employees is recognized as compensation expense over the period during which employees are required to provide service in exchange for such awards. The Corporation grants equity awards to employees, consisting of stock options and restricted stock, under its Amended and Restated Equity and Cash Incentive Compensation Plan (Employee Option Plan). In addition, employees may purchase stock under the Corporation’s Employee Stock Purchase Plan.
The Corporation also grants restricted stock to non-employee members of the board of directors under its 2011 Directors’ Equity Participation Plan (Directors’ Plan). Under the Directors’ Plan, the Corporation can grant equity awards to non-employee holding company and subsidiary bank directors in the form of stock options, restricted stock or common stock.
The following table presents compensation expense and the related tax benefits for equity awards recognized in the consolidated statements of income:
 
Three months ended March 31
 
2014
 
2013
 
(in thousands)
Stock-based compensation expense
$
1,033

 
$
847

Tax benefit
(263
)
 
(224
)
Stock-based compensation expense, net of tax
$
770

 
$
623


Stock option fair values are estimated through the use of the Black-Scholes valuation methodology as of the date of grant. Stock options carry terms of up to ten years. The fair value of restricted stock is based on the trading price of the Corporation’s stock on the date of grant. Restricted stock awards earn dividends during the vesting period, which are forfeitable if the awards do not vest. Equity awards issued under the Employee Option Plan have historically been granted annually and become fully vested over or after a three year vesting period. Equity awards under the Directors' Plan generally vest immediately upon grant. Certain events, as defined in the Employee Option Plan and the Directors' Plan, result in the acceleration of the vesting of equity awards. As of March 31, 2014, the Employee Option Plan had 11.0 million shares reserved for future grants through 2023. As of March 31, 2014, the Directors’ Plan had 438,000 shares reserved for future grants through 2021.

23


On April 1, 2014, the Corporation granted approximately 389,000 performance based restricted stock units (PSUs), 289,000 stock options and 96,000 restricted stock units (RSUs) under its Employee Option Plan. The fair value of RSUs and a majority of PSUs are based on the trading price of the Corporation's stock on the date of grant. The fair value of certain PSUs are estimated through the use of the Monte Carlo valuation methodology as of the date of grant. RSUs become fully vested over or after a three year vesting period, however, certain events, as defined in the Employee Option Plan, can result in the acceleration of the vesting of RSUs. RSUs and PSUs earn dividends during the vesting period, which are forfeitable if the awards do not vest. The amount of PSUs that vest is variable based on the achievement of Corporate and individual performance measures, as defined in each grantees' award agreement. As such, the fair value of PSUs, which is recognized as compensation expense over the period during which employees are required to provide service in exchange for such awards, may vary, based on the expectations for actual performance relative to defined performance measures.

NOTE H – Employee Benefit Plans
The Corporation maintains a defined benefit pension plan (Pension Plan) for certain employees, which was curtailed effective January 1, 2008. Contributions to the Pension Plan are actuarially determined and funded annually, if required. Pension Plan assets are invested in: money markets; fixed income securities, including corporate bonds, U.S. Treasury securities and common trust funds; and equity securities, including common stocks and common stock mutual funds.
The net periodic benefit cost for the Corporation’s Pension Plan, as determined by consulting actuaries, consisted of the following components:
 
Three months ended
March 31
 
2014
 
2013
 
(in thousands)
Service cost (1)
$
92

 
$
51

Interest cost
853

 
772

Expected return on plan assets
(811
)
 
(800
)
Net amortization and deferral
244

 
596

Net periodic benefit cost
$
378

 
$
619

 
(1)
The Pension Plan service cost recorded for the three months ended March 31, 2014 and 2013, respectively, was related to administrative costs associated with the plan and was not due to the accrual of additional participant benefits.
The Corporation currently provides medical and life insurance benefits under a postretirement benefits plan (Postretirement Plan) to certain retired full-time employees who were employees of the Corporation prior to January 1, 1998.
Effective February 1, 2014, the Corporation amended the Postretirement Plan, making all active full-time employees ineligible for benefits under this plan. As a result of this amendment, the Corporation recorded a $1.5 million gain in 2014, as determined by consulting actuaries and included as a component of salaries and employee benefits on the consolidated statements of income. The gain resulted from the recognition of the remaining pre-curtailment prior service cost as of December 31, 2013. In addition, this amendment resulted in a $3.3 million decrease in the accumulated postretirement benefit obligation and a corresponding increase in unrecognized prior service cost credits.

24


The net periodic benefit cost of the Corporation’s Postretirement Plan as determined by consulting actuaries, consisted of the following components, excluding the impact of the $1.5 million gain:
 
Three months ended
March 31
 
2014
 
2013
 
(in thousands)
Service cost
$
15

 
$
57

Interest cost
61

 
81

Expected return on plan assets

 

Net accretion and deferral
(95
)
 
(91
)
Net periodic benefit (income) cost
$
(19
)
 
$
47


(1)
As a result of the plan amendment, additional participant benefits are not accrued under the Postretirement Plan after February 1, 2014. Service costs recorded after the effective date of the amendment represent administrative costs associated with the plan.
The Corporation recognizes the funded status of its Pension Plan and Postretirement Plan on the consolidated balance sheets and recognizes the change in that funded status through other comprehensive income.

NOTE I – Derivative Financial Instruments
The Corporation manages its exposure to certain interest rate and foreign currency risks through the use of derivatives. None of the Corporation's outstanding derivative contracts are designated as hedges and none are entered into for speculative purposes. Derivative instruments are carried at fair value, with changes in fair values recognized in earnings as components of non-interest income and non-interest expense on the consolidated statements of income.
Derivative contracts create counterparty credit risk with both the Corporation's customers and with institutional derivative counterparties. The Corporation manages credit risk through its credit approval processes, monitoring procedures and obtaining adequate collateral, when appropriate.
Mortgage Banking Derivatives
In connection with its mortgage banking activities, the Corporation enters into commitments to originate certain fixed rate residential mortgage loans for customers, also referred to as interest rate locks. In addition, the Corporation enters into forward commitments for the future sales or purchases of mortgage-backed securities to or from third-party counterparties to hedge the effect of changes in interest rates on the values of both the interest rate locks and mortgage loans held for sale. Forward sales commitments may also be in the form of commitments to sell individual mortgage loans or interest rate locks at a fixed price at a future date. The amount necessary to settle each interest rate lock is based on the price that secondary market investors would pay for loans with similar characteristics, including interest rate and term, as of the date fair value is measured. Gross derivative assets and liabilities are recorded within other assets and other liabilities, respectively, on the consolidated balance sheets, with changes in fair values during the period recorded within mortgage banking income on the consolidated statements of income.
Interest Rate Swaps
The Corporation enters into interest rate swaps with certain qualifying commercial loan customers to meet their interest rate risk management needs. The Corporation simultaneously enters into interest rate swaps with dealer counterparties, with identical notional amounts and terms. The net result of these interest rate swaps is that the customer pays a fixed rate of interest and the Corporation receives a floating rate. These interest rate swaps are derivative financial instruments that are recorded at their fair values within other assets and liabilities on the consolidated balance sheets. Changes in fair value during the period are recorded within other non-interest expense on the consolidated statements of income.
Foreign Exchange Contracts
The Corporation enters into foreign exchange contracts to accommodate the needs of its customers. Foreign exchange contracts are commitments to buy or sell foreign currency on a future date at a contractual price. The Corporation offsets its foreign exchange contract exposure with customers by entering into contracts with third-party correspondent financial institutions to mitigate its exposure to fluctuations in foreign currency exchange rates. The Corporation also holds certain amounts of foreign currency with international correspondent banks. The Corporation's policy limits the total net foreign currency open positions, which includes all outstanding contracts and foreign account balances, to $500,000. Gross derivative assets and liabilities are recorded within other assets and other liabilities, respectively, on the consolidated balance sheets, with changes in fair values during the period recorded within other service charges and fees on the consolidated statements of income.

25


The following table presents a summary of the notional amounts and fair values of derivative financial instruments:
 
March 31, 2014
 
December 31, 2013
 
Notional
Amount
 
Asset
(Liability)
Fair Value
 
Notional
Amount
 
Asset
(Liability)
Fair Value
 
(in thousands)
Interest Rate Locks with Customers
 
 
 
 
 
 
 
Positive fair values
$
91,145

 
$
1,202

 
$
75,217

 
$
867

Negative fair values
1,258

 
(5
)
 
11,393

 
(59
)
Net interest rate locks with customers

 
1,197

 

 
808

Forward Commitments
 
 
 
 
 
 
 
Positive fair values
4,904

 
2

 
87,904

 
1,263

Negative fair values
95,750

 
(242
)
 
2,373

 
(5
)
Net forward commitments
 
 
(240
)
 
 
 
1,258

Interest Rate Swaps with Customers
 
 
 
 
 
 
 
Positive fair values
228,588

 
4,955

 
111,899

 
2,105

Negative fair values
81,163

 
(1,638
)
 
105,673

 
(2,993
)
Net interest rate swaps with customers
 
 
3,317

 
 
 
(888
)
Interest Rate Swaps with Dealer Counterparties
 
 
 
 
 
 
 
Positive fair values
81,163

 
1,638

 
105,673

 
2,993

Negative fair values
228,588

 
(4,955
)
 
111,899

 
(2,105
)
Net interest rate swaps with dealer counterparties
 
 
(3,317
)
 
 
 
888

Foreign Exchange Contracts with Customers
 
 
 
 
 
 
 
Positive fair values
9,927

 
56

 
2,150

 
24

Negative fair values
9,965

 
(183
)
 
12,775

 
(343
)
Net foreign exchange contracts with customers
 
 
(127
)
 
 
 
(319
)
Foreign Exchange Contracts with Correspondent Banks
 
 
 
 
 
 
 
Positive fair values
15,036

 
198

 
17,348

 
498

Negative fair values
4,466

 
(16
)
 
5,872

 
(48
)
Net foreign exchange contracts with correspondent banks
 
 
182

 
 
 
450

Net derivative fair value asset
 
 
$
1,012

 
 
 
$
2,197


The following table presents a summary of the fair value gains and losses on derivative financial instruments:
 
Three months ended
March 31
 
2014
 
2013
 
(in thousands)
Interest rate locks with customers
$
389

 
$
(2,538
)
Forward commitments
(1,498
)
 
428

Interest rate swaps with customers
4,205

 
(408
)
Interest rate swaps with dealer counterparties
(4,205
)
 
408

Foreign exchange contracts with customers
192

 
460

Foreign exchange contracts with correspondent banks
(268
)
 
418

Net fair value losses on derivative financial instruments
$
(1,185
)
 
$
(1,232
)


26


NOTE J – Balance Sheet Offsetting
Certain financial assets and liabilities may be eligible for offset on the consolidated balance sheets as they are subject to master netting arrangements or similar agreements. The Corporation elects to not offset assets and liabilities subject to such arrangements on the consolidated financial statements.
The Corporation is a party to interest rate swap transactions with financial institution counterparties and customers, disclosed in detail within Note I, "Derivative Financial Instruments." Under these agreements, the Corporation has the right to net settle multiple contracts with the same counterparty in the event of default on, or termination of, any one contract. Cash collateral is posted by the party with a net liability position in accordance with contract thresholds and can be used to settle the fair value of the interest rate swap agreements in the event of default.
Beginning in the first quarter of 2014, the Corporation is also a party to foreign currency exchange contracts with financial institution counterparties, under which the Corporation has the right to net settle multiple contracts with the same counterparty in the event of default on, or termination of, any one contract. As with interest rate swap contracts, cash collateral is posted by the party with a net liability position in accordance with contract thresholds and can be used to settle the fair value of the interest rate swap agreements in the event of default. For additional details, see Note I, "Derivative Financial Instruments."
The Corporation also enters into agreements with customers in which it sells securities subject to an obligation to repurchase the same or similar securities, referred to as repurchase agreements. Under these agreements, the Corporation may transfer legal control over the assets but still maintain effective control through agreements that both entitle and obligate the Corporation to repurchase the assets. Therefore, repurchase agreements are reported as secured borrowings, classified within short-term borrowings on the consolidated balance sheets, while the securities underlying the repurchase agreements remain classified with investment securities on the consolidated balance sheets. The Corporation has no intention of setting off these amounts, therefore, these repurchase agreements are not eligible for offset.

The following table presents the Corporation's financial instruments that are eligible for offset, and the effects of offsetting, on the consolidated balance sheets:
 
Gross Amounts
 
Gross Amounts Not Offset
 
 
 
Recognized
 
 on the Consolidated
 
 
 
on the
 
Balance Sheets
 
 
 
Consolidated
 
Financial
 
Cash
 
Net
 
Balance Sheets
 
Instruments (1)
 
Collateral (2)
 
Amount
 
(in thousands)
March 31, 2014
 
 
 
 
 
 
 
Interest rate swap derivative assets
$
6,593

 
$
(1,830
)
 
$

 
$
4,763

Foreign exchange derivative assets with correspondent banks
198

 
(16
)
 

 
182

Total
$
6,791

 
$
(1,846
)
 
$

 
$
4,945

 
 
 
 
 
 
 
 
Interest rate swap derivative liabilities
$
6,593

 
$
(1,830
)
 
$
(3,870
)
 
$
893

Foreign exchange derivative liabilities with correspondent banks
16

 
(16
)
 

 

Total
$
6,609

 
$
(1,846
)
 
$
(3,870
)
 
$
893

 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
Interest rate swap derivative assets
$
5,098

 
$
(2,104
)
 
$

 
$
2,994

 
 
 
 
 
 
 
 
Interest rate swap derivative liabilities
$
5,098

 
$
(2,104
)
 
$
(730
)
 
$
2,264


(1)
For interest rate swap and foreign exchange derivative assets, amounts represent any derivative liability fair values that could be offset in the event of counterparty or customer default. For interest rate swap and foreign exchange derivative liabilities, amounts represent any derivative asset fair values that could be offset in the event of counterparty or customer default.
(2)
Amounts represent cash collateral posted on interest rate swap transactions with financial institution counterparties. Interest rate swaps with customers are collateralized by the underlying loans to those borrowers.
  
NOTE K – Commitments and Contingencies
Commitments
The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.
Those financial instruments include commitments to extend credit and letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized on the Corporation’s consolidated balance sheets. Exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the outstanding amount of those instruments.

27


The outstanding amounts of commitments to extend credit and letters of credit were as follows:
 
March 31,
2014
 
December 31, 2013
 
(in thousands)
Commitments to extend credit
$
4,258,552

 
$
4,379,578

Standby letters of credit
387,424

 
391,445

Commercial letters of credit
35,404

 
36,344

The Corporation records a reserve for unfunded lending commitments, which represents management’s estimate of losses associated with unused commitments to extend credit. See Note E, "Loans and Allowance for Credit Losses," for additional details.
Residential Lending
Residential mortgages are originated and sold by the Corporation and consist primarily of conforming, prime loans sold to government sponsored agencies, such as the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). The Corporation also sells a portion of prime loans to non-government sponsored agency investors.
The Corporation provides customary representations and warranties to investors that specify, among other things, that the loans have been underwritten to the standards established by the investor. The Corporation may be required to repurchase a loan or reimburse the investor for a credit loss incurred on a loan if it is determined that the representations and warranties have not been met. Such repurchases or reimbursements generally result from an underwriting or documentation deficiency. As of March 31, 2014 and December 31, 2013, total outstanding repurchase requests totaled $543,000 and $8.8 million, respectively. During the three months ended March 31, 2014, the Corporation entered into a settlement agreement with a secondary market investor. Under this agreement, the Corporation agreed to pay this investor $4.5 million to settle all outstanding and potential future repurchase requests under a series of specified loan purchase agreements with that secondary market investor. The result of this settlement was a reduction to outstanding repurchase requests of $7.5 million and a reduction to reserves for repurchases of $5.1 million, resulting in a $600,000 reduction of operating risk loss on the consolidated statements of income during the first quarter of 2014.
From 2000 to 2011, the Corporation sold loans to the Federal Home Loan Bank (FHLB) under its Mortgage Partnership Finance Program (MPF Program). No loans were sold under this program during the three months ended March 31, 2014 or during 2013 or 2012. The Corporation provided a "credit enhancement" for residential mortgage loans sold under the MPF Program whereby it would assume credit losses in excess of a defined "First Loss Account" (FLA) balance, up to specified amounts. The FLA is funded by the FHLB based on a percentage of the outstanding principal balance of loans sold. As of March 31, 2014, the unpaid principal balance of loans sold under the MPF Program was approximately $175 million. As of March 31, 2014 and December 31, 2013, the reserve for estimated credit losses related to loans sold under the MPF Program was $3.2 million and $3.6 million, respectively. Required reserves are calculated based on delinquency status and estimated loss rates established through the Corporation's existing allowance for credit losses methodology.
As of March 31, 2014 and December 31, 2013, the total reserve for losses on residential mortgage loans sold was $3.6 million and $8.6 million, respectively, including both reserves for credit losses under the MPF Program and reserves for representation and warranty exposures. Management believes that the reserves recorded as of March 31, 2014 are adequate. However, declines in collateral values, the identification of additional loans to be repurchased, or a deterioration in the credit quality of loans sold under the MPF Program could necessitate additional reserves in the future.
Other Contingencies
The Corporation and its subsidiaries are involved in various legal proceedings in the ordinary course of business of the Corporation. The Corporation periodically evaluates the possible impact of pending litigation matters based on, among other factors, the advice of counsel, available insurance coverage and recorded liabilities and reserves for probable legal liabilities and costs. In addition, from time to time, the Corporation is the subject of investigations or other forms of regulatory or governmental inquiry covering a range of possible issues and, in some cases, these may be part of similar reviews of the specified activities of other industry participants. These inquiries could lead to administrative, civil or criminal proceedings, and could possibly result in fines, penalties, restitution or the need to alter the Corporation’s business practices, and cause the Corporation to incur additional costs. The Corporation’s practice is to cooperate fully with regulatory and governmental investigations.

NOTE L – Fair Value Option
FASB ASC Subtopic 825-10 permits entities to measure many financial instruments and certain other items at fair value and requires certain disclosures for amounts for which the fair value option is applied. The Corporation has elected to measure mortgage loans held for sale at fair value to more accurately reflect the financial results of its mortgage banking activities in its consolidated

28


financial statements. Derivative financial instruments related to these activities are also recorded at fair value, as noted within Note I, "Derivative Financial Instruments." The Corporation determines fair value for its mortgage loans held for sale based on the price that secondary market investors would pay for loans with similar characteristics, including interest rate and term, as of the date fair value is measured. Changes in fair values during the period are recorded as components of mortgage banking income on the consolidated statements of income. Interest income earned on mortgage loans held for sale is recorded within interest income on the consolidated statements of income.
The following table presents a summary of the Corporation’s mortgage loans held for sale:
 
March 31,
2014
 
December 31,
2013
 
(in thousands)
Cost
$
23,941

 
$
21,172

Fair value
24,417

 
21,351

During the three months ended March 31, 2014, the Corporation recorded gains related to changes in fair values of mortgage loans held for sale of $297,000 and $699,000, respectively.

NOTE M – Fair Value Measurements
FASB ASC Topic 820 establishes a fair value hierarchy for the inputs to valuation techniques used to measure assets and liabilities at fair value using the following three categories (from highest to lowest priority):
Level 1 – Inputs that represent quoted prices for identical instruments in active markets.
Level 2 – Inputs that represent quoted prices for similar instruments in active markets, or quoted prices for identical instruments in non-active markets. Also includes valuation techniques whose inputs are derived principally from observable market data other than quoted prices, such as interest rates or other market-corroborated means.
Level 3 – Inputs that are largely unobservable, as little or no market data exists for the instrument being valued.
The Corporation has categorized all assets and liabilities measured at fair value on both a recurring and nonrecurring basis into the above three levels.
The following tables present summaries of the Corporation’s assets and liabilities measured at fair value on a recurring basis and reported on the consolidated balance sheets:
 
March 31, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Mortgage loans held for sale
$

 
$
24,417

 
$

 
$
24,417

Available for sale investment securities:
 
 
 
 
 
 
 
Equity securities
45,734

 

 

 
45,734

U.S. Government securities

 
526

 

 
526

U.S. Government sponsored agency securities

 
280

 

 
280

State and municipal securities

 
283,453

 

 
283,453

Corporate debt securities

 
91,073

 
9,479

 
100,552

Collateralized mortgage obligations

 
1,006,737

 

 
1,006,737

Mortgage-backed securities

 
916,203

 

 
916,203

Auction rate securities

 

 
147,713

 
147,713

Total available for sale investments
45,734

 
2,298,272

 
157,192

 
2,501,198

Other assets
15,943

 
7,798

 

 
23,741

Total assets
$
61,677

 
$
2,330,487

 
$
157,192

 
$
2,549,356

Other liabilities
$
15,886

 
$
6,841

 
$

 
$
22,727


29


 
December 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Mortgage loans held for sale
$

 
$
21,351

 
$

 
$
21,351

Available for sale investment securities:
 
 
 
 
 
 
 
Equity securities
46,201

 

 

 
46,201

U.S. Government securities

 
525

 

 
525

U.S. Government sponsored agency securities

 
726

 

 
726

State and municipal securities

 
284,849

 

 
284,849

Corporate debt securities

 
89,662

 
9,087

 
98,749

Collateralized mortgage obligations

 
1,032,398

 

 
1,032,398

Mortgage-backed securities

 
945,712

 

 
945,712

Auction rate securities

 

 
159,274

 
159,274

Total available for sale investments
46,201

 
2,353,872

 
168,361

 
2,568,434

Other assets
15,779

 
7,227

 

 
23,006

Total assets
$
61,980

 
$
2,382,450

 
$
168,361

 
$
2,612,791

Other liabilities
$
15,648

 
$
5,161

 
$

 
$
20,809

The valuation techniques used to measure fair value for the items in the preceding tables are as follows:
Mortgage loans held for sale – This category consists of mortgage loans held for sale that the Corporation has elected to measure at fair value. Fair values as of March 31, 2014 and December 31, 2013 were measured based on the price that secondary market investors were offering for loans with similar characteristics.
Available for sale investment securities – Included within this asset category are both equity and debt securities. Level 2 available for sale debt securities are valued by a third-party pricing service commonly used in the banking industry. The pricing service uses pricing models that vary based on asset class and incorporate available market information, including quoted prices of investment securities with similar characteristics. Because many fixed income securities do not trade on a daily basis, pricing models use available information, as applicable, through processes such as benchmark yield curves, benchmarking of like securities, sector groupings, and matrix pricing.
Standard market inputs include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data, including market research publications. For certain security types, additional inputs may be used, or some of the standard market inputs may not be applicable.

Management tests the values provided by the pricing service by obtaining securities prices from an alternative third-party source and comparing the results. This test is done for approximately 75% of the securities valued by the pricing service. Generally, differences by security in excess of 5% are researched to reconcile the difference.
Equity securities – Equity securities consist of stocks of financial institutions ($39.8 million at March 31, 2014 and $40.6 million at December 31, 2013) and other equity investments ($5.9 million at March 31, 2014 and $5.6 million at December 31, 2013). These Level 1 investments are measured at fair value based on quoted prices for identical securities in active markets.
U.S. Government securities/U.S. Government sponsored agency securities/State and municipal securities/Collateralized mortgage obligations/Mortgage-backed securities – These debt securities are classified as Level 2 investments. Fair values are determined by a third-party pricing service, as detailed above.
Corporate debt securities – This category consists of subordinated debt issued by financial institutions ($50.4 million at March 31, 2014 and $50.3 million at December 31, 2013), single-issuer trust preferred securities issued by financial institutions ($41.9 million at March 31, 2014 and $40.5 million at December 31, 2013), pooled trust preferred securities issued by financial institutions ($5.7 million at March 31, 2014 and $5.3 million at December 31, 2013) and other corporate debt issued by non-financial institutions ($2.6 million at March 31, 2014 and December 31, 2013).
Level 2 investments include the Corporation’s subordinated debt, other corporate debt issued by non-financial institutions and $38.1 million and $36.7 million of single-issuer trust preferred securities held at March 31, 2014

30


and December 31, 2013, respectively. The fair values for these corporate debt securities are determined by a third-party pricing service, as detailed above.
Level 3 investments include the Corporation’s investments in pooled trust preferred securities and certain single-issuer trust preferred securities ($3.8 million at March 31, 2014 and December 31, 2013). The fair values of these securities were determined based on quotes provided by third-party brokers who determined fair values based predominantly on internal valuation models which were not indicative prices or binding offers. The Corporation’s third-party pricing service cannot derive fair values for these securities primarily due to inactive markets for similar investments. Level 3 values are tested by management primarily through trend analysis, by comparing current values to those reported at the end of the preceding calendar quarter, and determining if they are reasonable based on price and spread movements for this asset class.
Auction rate securities – Due to their illiquidity, ARCs are classified as Level 3 investments and are valued through the use of an expected cash flows model prepared by a third-party valuation expert. The assumptions used in preparing the expected cash flows model include estimates for coupon rates, time to maturity and market rates of return. The most significant unobservable input to the expected cash flows model is an assumed return to market liquidity sometime within the next five years. If the assumed return to market liquidity was lengthened beyond the next five years, this would result in a decrease in the fair value of these ARCs. The Corporation believes that the trusts underlying the ARCs will self-liquidate as student loans are repaid. Level 3 values are tested by management through the performance of a trend analysis of the market price and discount rate. Changes in the price and discount rates are compared to changes in market data, including bond ratings, parity ratios, balances and delinquency levels.
Other assets – Included within this category are the following:
Level 1 assets include mutual funds that are held in trust for employee deferred compensation plans ($15.7 million at March 31, 2014 and $15.3 million at December 31, 2013) and the fair value of foreign currency exchange contracts ($257,000 at March 31, 2014 and $522,000 at December 31, 2013). The mutual funds and foreign exchange prices used to measure these items at fair value are based on quoted prices for identical instruments in active markets.
Level 2 assets include the fair value of mortgage banking derivatives in the form of interest rate locks and forward commitments with secondary market investors ($1.2 million at March 31, 2014 and $2.1 million at December 31, 2013) and the fair value of interest rate swaps ($6.6 million at March 31, 2014 and $5.1 million at December 31, 2013). The fair values of the Corporation’s interest rate locks, forward commitments and interest rate swaps represent the amounts that would be required to settle the derivative financial instruments at the balance sheet date. See Note I, "Derivative Financial Instruments," for additional information.
Other liabilities – Included within this category are the following:
Level 1 liabilities include employee deferred compensation liabilities which represent amounts due to employees under deferred compensation plans ($15.7 million at March 31, 2014 and $15.3 million at December 31, 2013) and the fair value of foreign currency exchange contracts ($199,000 at March 31, 2014 and $391,000 at December 31, 2013). The fair value of these liabilities are determined in the same manner as the related assets, as described under the heading "Other assets" above.
Level 2 liabilities include the fair value of mortgage banking derivatives in the form of interest rate locks and forward commitments with secondary market investors ($247,000 at March 31, 2014 and $64,000 at December 31, 2013) and the fair value of interest rate swaps ($6.6 million at March 31, 2014 and $5.1 million at December 31, 2013). The fair values of these liabilities are determined in the same manner as the related assets, as described under the heading "Other assets" above.

31


The following table presents the changes in the Corporation’s available for sale investment securities measured at fair value on a recurring basis using unobservable inputs (Level 3):
 
Three months ended March 31, 2014
 
Pooled Trust
Preferred
Securities
 
Single-issuer
Trust Preferred
Securities
 
ARCs
 
(in thousands)
Balance at December 31, 2013
$
5,306

 
$
3,781

 
$
159,274

Sales

 

 
(11,912
)
Unrealized adjustment to fair value (1)
521

 
38

 
124

Settlements - calls
(172
)
 

 

Discount accretion (2)
4

 
1

 
227

Balance at March 31, 2014
$
5,659

 
$
3,820

 
$
147,713

 
 
 
 
 
 
 
Three months ended March 31, 2013
Balance at December 31, 2012
$
6,927

 
$
3,360

 
$
149,339

Unrealized adjustment to fair value (1)
1,429

 
7

 
5,360

Settlements - calls

 

 
(342
)
Discount accretion (2)

 
3

 
282

Balance at March 31, 2013
$
8,356

 
$
3,370

 
$
154,639


(1)
Pooled trust preferred securities, single-issuer trust preferred securities and ARCs are classified as available for sale investment securities; as such, the unrealized adjustment to fair value was recorded as an unrealized holding gain and included as a component of available for sale investment securities on the consolidated balance sheets.
(2)
Included as a component of net interest income on the consolidated statements of income.

Certain financial assets are not measured at fair value on an ongoing basis, but are subject to fair value measurement in certain circumstances, such as upon their acquisition or when there is evidence of impairment. The following table presents the Corporation’s financial assets measured at fair value on a nonrecurring basis and reported on the Corporation’s consolidated balance sheets:
 
March 31, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Net loans
$

 
$

 
$
137,488

 
$
137,488

Other financial assets

 

 
56,968

 
56,968

Total assets
$

 
$

 
$
194,456

 
$
194,456

 
December 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Net loans
$

 
$

 
$
138,666

 
$
138,666

Other financial assets

 

 
57,504

 
57,504

Total assets
$

 
$

 
$
196,170

 
$
196,170

The valuation techniques used to measure fair value for the items in the table above are as follows:
Net loans – This category consists of loans that were evaluated for impairment under FASB ASC Section 310-10-35 and have been classified as Level 3 assets. The amount shown is the balance of impaired loans, net of the related allowance for loan losses. See Note E, "Loans and Allowance for Credit Losses," for additional details.
Other financial assets – This category includes OREO ($15.3 million at March 31, 2014 and $15.1 million at December 31, 2013) and MSRs ($41.7 million at March 31, 2014 and $42.5 million at December 31, 2013), both classified as Level 3 assets.

32


Fair values for OREO were based on estimated selling prices less estimated selling costs for similar assets in active markets.
MSRs are initially recorded at fair value upon the sale of residential mortgage loans to secondary market investors. MSRs are amortized as a reduction to servicing income over the estimated lives of the underlying loans. MSRs are stratified and evaluated for impairment by comparing each stratum's carrying amount to its estimated fair value. Fair values are determined at the end of each quarter through a discounted cash flows valuation performed by a third-party valuation expert. Significant inputs to the valuation included expected net servicing income, the discount rate and the expected life of the underlying loans. Expected life is based on the contractual terms of the loans, as adjusted for prepayment projections. The weighted average annual constant prepayment rate and the weighted average discount rate used in the March 31, 2014 valuation were 11.2% and 9.1%, respectively. Management tests the reasonableness of the significant inputs to the third-party valuation in comparison to market data.
As required by FASB ASC Section 825-10-50, the following table details the book values and estimated fair values of the Corporation’s financial instruments as of March 31, 2014 and December 31, 2013. In addition, a general description of the methods and assumptions used to estimate such fair values is also provided.
Fair values of financial instruments are significantly affected by the assumptions used, principally the timing of future cash flows and discount rates. Because assumptions are inherently subjective in nature, the estimated fair values cannot be substantiated by comparison to independent market quotes and, in many cases, the estimated fair values could not necessarily be realized in an immediate sale or settlement of the instrument. The aggregate fair value amounts presented do not necessarily represent management’s estimate of the underlying value of the Corporation.
 
March 31, 2014
 
December 31, 2013
 
Book Value
 
Estimated
Fair Value
 
Book Value
 
Estimated
Fair Value
 
(in thousands)
FINANCIAL ASSETS
 
 
 
 
 
 
 
Cash and due from banks
$
260,389

 
$
260,389

 
$
218,540

 
$
218,540

Interest-bearing deposits with other banks
225,428

 
225,428

 
163,988

 
163,988

Federal Reserve Bank and Federal Home Loan Bank stock
81,634

 
81,634

 
84,173

 
84,173

Loans held for sale (1)
24,417

 
24,417

 
21,351

 
21,351

Available for sale investment securities (1)
2,501,198

 
2,501,198

 
2,568,434

 
2,568,434

Loans, net of unearned income (1)
12,733,792

 
12,628,983

 
12,782,220

 
12,688,774

Accrued interest receivable
43,376

 
43,376

 
44,037

 
44,037

Other financial assets (1)
149,453

 
149,453

 
146,933

 
146,933

FINANCIAL LIABILITIES
 
 
 
 
 
 
 
Demand and savings deposits
$
9,667,357

 
$
9,667,357

 
$
9,573,264

 
$
9,573,264

Time deposits
3,002,560

 
3,011,698

 
2,917,922

 
2,927,374

Short-term borrowings
1,069,684

 
1,069,684

 
1,258,629

 
1,258,629

Accrued interest payable
16,972

 
16,972

 
15,218

 
15,218

Other financial liabilities (1)
133,848

 
133,848

 
124,440

 
124,440

FHLB advances and long-term debt
883,461

 
881,197

 
883,584

 
875,984

 
(1)
These financial instruments, or certain financial instruments within these categories, are measured at fair value on the Corporation’s consolidated balance sheets. Descriptions of the fair value determinations for these financial instruments are disclosed above.
For short-term financial instruments, defined as those with remaining maturities of 90 days or less, and excluding those recorded at fair value on the Corporation’s consolidated balance sheets, book value was considered to be a reasonable estimate of fair value.
The following instruments are predominantly short-term:
Assets
  
Liabilities
Cash and due from banks
  
Demand and savings deposits
Interest bearing deposits
  
Short-term borrowings
Accrued interest receivable
  
Accrued interest payable


33


Federal Reserve Bank and FHLB stock represent restricted investments and are carried at cost on the consolidated balance sheets.
Fair values for loans and time deposits were estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers and similar deposits would be issued to customers for the same remaining maturities. Fair values estimated in this manner do not fully incorporate an exit price approach to fair value, as defined in FASB ASC Topic 820.
The fair values of FHLB advances and long-term debt were estimated by discounting the remaining contractual cash flows using a rate at which the Corporation could issue debt with similar remaining maturities as of the balance sheet date. These borrowings would be categorized within Level 2 liabilities under FASB ASC Topic 820.

NOTE N – Common Stock Repurchase Plan
In October 2013, the Corporation announced that its board of directors had approved a share repurchase program pursuant to which the Corporation was authorized to repurchase up to four million shares, or approximately 2.1% of its outstanding shares, through March 2014. During the first quarter of 2014, the Corporation repurchased 4.0 million shares under this repurchase plan at an average cost of $12.45 per share, completing this repurchase program on February 19, 2014.

NOTE O – New Accounting Standard
In April 2014, the FASB issued ASC Update 2014-08, "Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity." ASC Update 2014-08 changes the criteria for reporting discontinued operations, including a change in the definition of what constitutes the disposal of a component and additional disclosure requirements. ASC Update 2014-08 is effective for disposals that occur within annual periods beginning after December 15, 2014. For the Corporation, this standards update is effective with its March 31, 2015 quarterly report on Form 10-Q. The adoption of ASC Update 2014-08 is not expected to have an impact on the Corporation's consolidated financial statements.

NOTE P – Reclassifications

Certain amounts in the 2013 consolidated financial statements and notes have been reclassified to conform to the 2014 presentation.

34


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Management’s Discussion) relates to Fulton Financial Corporation (the Corporation), a financial holding company registered under the Bank Holding Company Act of 1956 and incorporated under the laws of the Commonwealth of Pennsylvania in 1982, and its wholly owned subsidiaries. Management’s Discussion should be read in conjunction with the consolidated financial statements and notes presented in this report.

FORWARD-LOOKING STATEMENTS

The Corporation has made, and may continue to make, certain forward-looking statements with respect to its financial condition and results of operations. Do not unduly rely on forward-looking statements. Forward-looking statements can be identified by the use of words such as "may," "should," "will," "could," "estimates," "predicts," "potential," "continue," "anticipates," "believes," "plans," "expects," "future," "intends" and similar expressions which are intended to identify forward-looking statements.          

These forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties, some of which are beyond the Corporation's control and ability to predict, that could cause actual results to differ materially from those expressed in the forward-looking statements. The Corporation undertakes no obligation, other than as required by law, to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Many factors could affect future financial results including, without limitation: 
the impact of adverse changes in the economy and real estate markets, including protracted periods of low-growth and sluggish loan demand;
increases in non-performing assets, which may require the Corporation to increase the allowance for credit losses, charge-off loans and incur elevated collection and carrying costs related to such non-performing assets;
the effect of market interest rates, particularly a continuing period of low market interest rates, and relative balances of rate-sensitive assets to rate-sensitive liabilities, on net interest margin and net interest income;
capital and liquidity strategies, including the expected impact of the capital and liquidity requirements imposed by the final U.S. Basel III Capital Rules;
investment securities gains and losses, including other-than-temporary declines in the value of securities which may result in charges to earnings;
non-interest income growth, including the impact of potential regulatory changes;
the impact of increased regulatory scrutiny of the banking industry;
the increasing time and expense associated with regulatory compliance and risk management;
the uncertainty and lack of clear regulatory guidance associated with the delay in implementing many of the regulations mandated by the Dodd-Frank Act;
operational risk, i.e. the risk of loss resulting from human error, inadequate or failed internal processes and systems, outsourcing arrangements, compliance and legal risk and external events;
the level of non-interest expenses, including salaries and employee benefits expenses, operating risk losses, amortization of intangible assets and goodwill impairment; and
the effect of competition on rates of deposit and loan growth and net interest margin.


RESULTS OF OPERATIONS
Overview and Summary Financial Results
Fulton Financial Corporation is a financial holding company comprised of six wholly owned banking subsidiaries which provide a full range of retail and commercial financial services in Pennsylvania, Delaware, Maryland, New Jersey and Virginia. The Corporation generates the majority of its revenue through net interest income, or the difference between interest earned on loans and investments and interest paid on deposits and borrowings. Growth in net interest income is dependent upon balance sheet growth and/or maintaining or increasing the net interest margin, which is net interest income (fully taxable-equivalent, or FTE) as a percentage of average interest-earning assets. The Corporation also generates revenue through fees earned on the various services and products offered to its customers and through gains on sales of assets, such as loans, investments, lines of business or properties. Offsetting these revenue sources are provisions for credit losses on loans, non-interest expenses and income taxes.

35


The following table presents a summary of the Corporation’s earnings and selected performance ratios:
 
As of or for the
Three months ended
March 31
 
2014
 
2013
Income before income taxes (in thousands)
$
56,017

 
$
50,967

Net income (in thousands)
$
41,783

 
$
39,227

Diluted net income per share
$
0.22

 
$
0.20

Return on average assets
1.01
%
 
0.96
%
Return on average equity
8.21
%
 
7.67
%
Net interest margin (1)
3.47
%
 
3.55
%
Non-performing assets to total assets
1.01
%
 
1.39
%
Annualized net charge-offs to average loans
0.26
%
 
0.62
%
 
(1)
Presented on an FTE basis, using a 35% Federal tax rate and statutory interest expense disallowances. See also the “Net Interest Income” section of Management’s Discussion.
Income before income taxes for the first quarter of 2014 increased $5.1 million, or 9.9%, compared to the first quarter of 2013. The Corporation's results for the three months ended March 31, 2014 in comparison to the same period in 2013 were most significantly impacted by improved asset quality, resulting in a decrease in the provision for credit losses, lower non-interest income due to a decline in mortgage banking income and service charges on deposit accounts and an increase in income tax expense.
Following is a summary of these and other noteworthy items for the first quarter of 2014:
Asset Quality - For the three months ended March 31, 2014, the Corporation's provision for credit losses decreased $12.5 million, or 83.3%, in comparison to the same period in 2013. This decrease was due to an overall improvement in asset quality.
Non-performing loans decreased $53.7 million, or 25.7%, since March 31, 2013. The total past due rate was 1.78% as of March 31, 2014, compared to 2.30% as of March 31, 2013. Annualized net charge-offs to average loans outstanding were 0.26% for the first quarter of 2014, compared to 0.62% for the first quarter of 2013.
Net Interest Income and Net Interest Margin - For the three months ended March 31, 2014, net interest income was essentially unchanged, decreasing $79,000 in comparison to the same period in 2013. Net interest income for the first three months of 2014 was negatively impacted by net interest margin compression as yields on interest-earning assets declined more significantly than the cost of interest-bearing liabilities. The net interest margin for the first quarter of 2014 decreased 8 basis points, or 2.3%, in comparison to the first quarter of 2013.
The impact of the net interest margin compression was offset by growth in interest-earning assets, which increased $352.2 million, or 2.3%, in comparison to the first quarter of 2013, mainly due to a $505.1 million, or 4.1%, increase in average loans. The increase in average loans for the three months ended March 31, 2014 in comparison to the first quarter of 2013 was due to increases in commercial mortgages, home equity loans and residential mortgages.
Non-interest Income - For the three months ended March 31, 2014, non-interest income, excluding investment securities gains, decreased $6.3 million, or 14.0%, in comparison to the same period in 2013. This decrease in non-interest income was primarily due to a decrease in mortgage banking income as a result of lower gains on sales of residential mortgages due to lower refinancing volumes. Also contributing to the decrease in non-interest income was a decline in service charges on deposits, particularly a $2.2 million, or 29.0%, decrease in overdraft fee income.
Non-interest Expense - For the three months ended March 31, 2014, non-interest expense decreased $1.4 million, or 1.2%, in comparison to the same period in 2013. This decrease was driven by a $1.9 million decrease in other real estate owned (OREO) and repossession expense, due to improved asset quality, and a $1.6 million decrease in salaries and employee benefits, primarily due to lower incentive compensation expense. These decreases were partially offset by a $1.8 million increase in occupancy expense primarily due to higher snow removal costs and a $952,000 increase in other outside services.
During the first quarter of 2014, the Corporation implemented a series of initiatives intended to reduce non-interest expenses by approximately $8 million annually. These initiatives resulted in implementation expenses, net of associated gains, of $980,000

36


and expense reductions of $1.0 million during the first quarter of 2014, resulting in a minimal net impact on total expenses for the first quarter of 2014.

The following table presents a summary of the Corporation's 2014 cost saving initiatives:
 
Three months ended March 31, 2014
 

 
Implementation Expenses (Gains)
 
Expense Reductions
 
Estimated Expense Reductions for the Year Ending December 31, 2014
 
(in thousands)
Branch consolidations
$
2,080

 
$

 
$
(2,400
)
Subsidiary bank management reductions and other employee compensation and benefit reductions
(1,100
)
 
(1,020
)
 
(4,550
)
 
$
980

 
$
(1,020
)
 
$
(6,950
)
Branch consolidations - Represents the consolidation of 13 branches, which resulted in the transfer of deposits, employees and other branch resources to existing branch locations. During the first quarter of 2014, $2.1 million of expenses, consisting mainly of lease termination costs and the write-off of leasehold improvements, were incurred as a result of the branch consolidation.
Subsidiary bank management reductions and other employee compensation and benefit reductions - Represents the streamlining of subsidiary bank management structures through the elimination of five subsidiary bank divisional executive positions, in addition to the impact of changes to certain employee benefits plans, most notably an amendment to the Corporation's postretirement benefits plan (Postretirement Plan). During the first quarter of 2014, these initiatives resulted in $1.1 million of gains, net of severance expense, and $1.0 million of cost savings due primarily to lower salaries and employee benefits expense.

Regulatory Compliance and Risk Management Matters - Virtually every aspect of the Corporation’s operations is subject to extensive regulation, and in recent years, a combination of financial reform legislation and heightened scrutiny by banking regulators have significantly increased expectations regarding what constitutes an effective risk and compliance management infrastructure. Bank regulators are scrutinizing banks through longer and more extensive bank examinations in both the safety and soundness and compliance areas. As previously disclosed in the Corporation's filings with the Securities and Exchange Commission, including in Item 1A, Risk Factors, of the Corporation’s most recent Annual Report on Form 10-K, the time and expense associated with regulatory compliance and risk management efforts continues to increase.

To keep pace with these heightened expectations in the compliance area, over the past several years, the Corporation, which provides compliance program services for all of the Corporation's banking subsidiaries, has devoted substantial resources to improving its risk management framework and regulatory compliance programs, including those designed to comply with the requirements of the Bank Secrecy Act, the USA Patriot Act and related anti-money laundering regulations (collectively, the “BSA Requirements”). Although the Corporation has made substantial progress in strengthening its risk management and regulatory compliance programs, the pace of this progress has not been consistent with current regulatory expectations, and continuing deficiencies in compliance program elements related to the BSA Requirements have been identified at the Corporation’s banking subsidiaries, and at the Corporation.

As a result, management anticipates that certain banking subsidiaries and the Corporation will consent to the issuance by Federal banking authorities of formal enforcement orders ("Enforcement Orders") requiring those entities to remedy the identified deficiencies and take other actions to strengthen their compliance programs related to the BSA Requirements, and potentially other areas. The Enforcement Orders, or any failure by the banking subsidiaries or the Corporation to comply with the Enforcement Orders, could result in the imposition of material restrictions on the activities of the Corporation or its banking subsidiaries or the assessment of fines or penalties.

As previously disclosed, management accelerated its efforts to resolve the identified deficiencies and to enhance the compliance and risk management functions at the Corporation and its banking subsidiaries, and these efforts will continue. As an example of the importance that the Corporation's Board of Directors places on these efforts, in March 2014, the Board reduced the amount of the annual cash incentive award paid to the Corporation's executive officers for performance during 2013 under the Corporation's Amended and Restated Equity and Cash Incentive Compensation Plan. The Board exercised its discretion to reduce awards under the Plan to provide tangible evidence of the importance the Board of Directors attaches to the need to strengthen the Corporation's

37


risk and regulatory compliance management infrastructures and to reinforce the critical importance of accelerating completion of that work to build stronger and sustainable regulatory compliance and risk management processes that will support the Corporation's strategic growth objectives.

Although management is not able to predict with certainty the outcome of these matters or the costs associated with compliance with the Enforcement Orders, the Enforcement Orders could materially affect the Corporation's business, financial condition or results of operations in future periods. Compliance with the Enforcement Orders could potentially require additional expenditures for salaries and benefits of additional personnel, outside professional services, such as consulting and legal, and for enhancing or acquiring operating systems to strengthen and support the Corporation's compliance and risk management infrastructures.



38


Quarter Ended March 31, 2014 compared to the Quarter Ended March 31, 2013
Net Interest Income
FTE net interest income decreased $69,000 to $133.8 million in the first quarter of 2014, from $133.9 million in the first quarter of 2013. This decrease was primarily due to an 8 basis point, or 2.3%, decrease in the net interest margin, to 3.47% for the first quarter of 2014 from 3.55% for the first quarter of 2013. The following table provides a comparative average balance sheet and net interest income analysis for the first quarter of 2014 as compared to the same period in 2013. Interest income and yields are presented on an FTE basis, using a 35% Federal tax rate and statutory interest expense disallowances. The discussion following this table is based on these FTE amounts. All dollar amounts are in thousands.
 
Three months ended March 31
 
2014
 
2013
ASSETS
Average
Balance
 
Interest (1)
 
Yield/
Rate
 
Average
Balance
 
Interest (1)
 
Yield/
Rate
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans, net of unearned income (2)
$
12,762,357

 
$
134,749

 
4.28
%
 
$
12,257,280

 
$
136,948

 
4.53
%
Taxable investment securities (3)
2,257,773

 
13,266

 
2.35

 
2,421,178

 
13,397

 
2.22

Tax-exempt investment securities (3)
279,278

 
3,613

 
5.17

 
292,118

 
3,814

 
5.22

Equity securities (3)
33,922

 
429

 
5.11

 
44,371

 
510

 
4.64

Total investment securities
2,570,973

 
17,308

 
2.70

 
2,757,667

 
17,721

 
2.57

Loans held for sale
13,426

 
134

 
4.00

 
47,885

 
495

 
4.14

Other interest-earning assets
258,803

 
882

 
1.36

 
190,576

 
429

 
0.90

Total interest-earning assets
15,605,559

 
153,073

 
3.97
%
 
15,253,408

 
155,593

 
4.13
%
Noninterest-earning assets:

 

 

 

 

 

Cash and due from banks
199,641

 

 

 
202,507

 

 

Premises and equipment
226,295

 

 

 
226,466

 

 

Other assets
1,032,071

 

 

 
1,071,440

 

 

Less: Allowance for loan losses
(203,201
)
 

 

 
(227,858
)
 

 

Total Assets
$
16,860,365

 

 

 
$
16,525,963

 

 

LIABILITIES AND EQUITY
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:

 

 

 

 

 

Demand deposits
$
2,945,211

 
$
909

 
0.13
%
 
$
2,705,835

 
$
877

 
0.13
%
Savings deposits
3,351,871

 
1,035

 
0.13

 
3,334,305

 
1,023

 
0.12

Time deposits
2,932,456

 
5,952

 
0.82

 
3,321,309

 
8,501

 
1.04

Total interest-bearing deposits
9,229,538

 
7,896

 
0.35

 
9,361,449

 
10,401

 
0.45

Short-term borrowings
1,208,953

 
633

 
0.21

 
1,032,122

 
509

 
0.20

Federal Home Loan Bank advances and long-term debt
883,532

 
10,698

 
4.88

 
891,173

 
10,768

 
4.87

Total interest-bearing liabilities
11,322,023

 
19,227

 
0.69
%
 
11,284,744

 
21,678

 
0.78
%
Noninterest-bearing liabilities:

 

 

 

 

 

Demand deposits
3,243,424

 

 

 
2,968,777

 

 

Other
232,004

 

 

 
198,944

 

 

Total Liabilities
14,797,451

 

 

 
14,452,465

 

 
 
Shareholders’ equity
2,062,914

 

 

 
2,073,498

 

 

Total Liabilities and Shareholders’ Equity
$
16,860,365

 

 

 
$
16,525,963

 

 

Net interest income/net interest margin (FTE)
 
 
133,846

 
3.47
%
 
 
 
133,915

 
3.55
%
Tax equivalent adjustment
 
 
(4,281
)
 
 
 
 
 
(4,271
)
 
 
Net interest income
 
 
$
129,565

 
 
 
 
 
$
129,644

 
 
(1)
Includes dividends earned on equity securities.
(2)
Includes non-performing loans.
(3)
Balances include amortized historical cost for available for sale securities; the related unrealized holding gains (losses) are included in other assets.

39


The following table summarizes the changes in FTE interest income and interest expense resulting from changes in average balances (volume) and changes in rates for the three months ended March 31:
 
2014 vs. 2013
Increase (decrease) due
to change in
 
Volume
 
Rate
 
Net
 
(in thousands)
Interest income on:
 
 
 
 
 
Loans, net of unearned income
$
5,513

 
$
(7,712
)
 
$
(2,199
)
Taxable investment securities
(898
)
 
767

 
(131
)
Tax-exempt investment securities
(166
)
 
(35
)
 
(201
)
Equity securities
(129
)
 
48

 
(81
)
Loans held for sale
(344
)
 
(17
)
 
(361
)
Other interest-earning assets
185

 
268

 
453

Total interest income
$
4,161

 
$
(6,681
)
 
$
(2,520
)
Interest expense on:
 
 
 
 
 
Demand deposits
$
75

 
$
(43
)
 
$
32

Savings deposits
5

 
7

 
12

Time deposits
(920
)
 
(1,629
)
 
(2,549
)
Short-term borrowings
91

 
33

 
124

FHLB advances and long-term debt
(93
)
 
23

 
(70
)
Total interest expense
$
(842
)
 
$
(1,609
)
 
$
(2,451
)
Note: Changes which are partially attributable to both volume and rate are allocated to the volume and rate components presented above based on the percentage of direct changes that are attributable to each component.
As summarized above, a 16 basis point, or 3.9%, decrease in yields on average interest-earnings assets resulted in a $6.7 million decrease in FTE interest income, partially offset by a $4.2 million increase in FTE interest income as a result of an $352.2 million, or 2.3%, increase in average interest-earning assets.
Average investments decreased $186.7 million, or 6.8%, as portfolio cash flows were not fully reinvested. The average yield on investments increased 13 basis points, or 5.1%, to 2.70% in the first quarter of 2014 from 2.57% in the first quarter of 2013. A $2.5 million, or 60.5%, decrease in net premium amortization on mortgage-backed securities and collateralized mortgage obligations had a 15 basis point positive impact on the overall change in portfolio yield. The positive impact of the net decrease in premium amortization was partially offset by the reinvestment of cash flows and purchases of mortgage-backed securities and collateralized mortgage obligations at yields that were lower than the overall portfolio yield.
Average loans and average FTE yields, by type, are summarized in the following table:
 
March 31, 2014
 
March 31, 2013
 
Increase (Decrease) in Balance
 
Balance
 
Yield
 
Balance
 
Yield
 
$
 
%
 
(dollars in thousands)
Real estate – commercial mortgage
$
5,085,128

 
4.44
%
 
$
4,666,494

 
4.84
%
 
$
418,634

 
9.0
%
Commercial – industrial, financial and agricultural
3,637,075

 
4.03

 
3,662,566

 
4.24

 
(25,491
)
 
(0.7
)
Real estate – home equity
1,755,346

 
4.18

 
1,662,173

 
4.30

 
93,173

 
5.6

Real estate – residential mortgage
1,336,323

 
3.99

 
1,283,168

 
4.25

 
53,155

 
4.1

Real estate – construction
576,346

 
4.08

 
591,338

 
4.11

 
(14,992
)
 
(2.5
)
Consumer
274,910

 
4.82

 
305,480

 
5.00

 
(30,570
)
 
(10.0
)
Leasing and other
97,229

 
9.79

 
86,061

 
8.59

 
11,168

 
13.0

Total
$
12,762,357

 
4.28
%
 
$
12,257,280

 
4.53
%
 
$
505,077

 
4.1
%



40


Average loans increased $505.1 million, or 4.1%, compared to the first quarter of 2013. The growth in commercial mortgages was driven by a combination of loans to new customers and increased borrowings from existing customers. The average yield on loans decreased 25 basis points, or 5.5%, to 4.28% in 2014 from 4.53% in 2013. The decrease in average yields on loans was attributable to repayments of higher-yielding loans, continued refinancing activity, the renegotiation of certain existing loans to commercial borrowers to eliminate interest rate floors and new loan production at lower rates.
Average other interest-earning assets increased $68.2 million, or 35.8%, primarily due to an increase in average interest-bearing deposits with other banks. The average yield on other interest-earning assets increased 46 basis points, or 51.1%, due to increases in dividends from Federal Home Loan Bank (FHLB) stock. As of March 31, 2014, the Corporation held $55.3 million of FHLB stock.
Interest expense decreased $2.5 million, or 11.3%, to $19.2 million in the first quarter of 2014 from $21.7 million in the first quarter of 2013. Interest expense decreased $1.6 million due to a 9 basis point, or 11.5%, decrease in the average cost of total interest-bearing liabilities. While total interest-bearing liabilities increased $37.3 million, or 0.3%, the change in the overall funding mix resulted in an additional $842,000 decrease in interest expense. A decrease in higher cost time deposits was more than offset by increases in interest-bearing demand deposits and short-term borrowings. However, the cost of these funding sources is significantly lower, resulting in the interest expense decrease.
Average deposits and average interest rates, by type, are summarized in the following table:
 
March 31, 2014
 
March 31, 2013
 
Increase (Decrease) in Balance
 
Balance
 
Rate
 
Balance
 
Rate
 
$
 
%
 
(dollars in thousands)
Noninterest-bearing demand
$
3,243,424

 
%
 
$
2,968,777

 
%
 
$
274,647

 
9.3
%
Interest-bearing demand
2,945,211

 
0.13

 
2,705,835

 
0.13

 
239,376

 
8.8

Savings
3,351,871

 
0.13

 
3,334,305

 
0.12

 
17,566

 
0.5

Total demand and savings
9,540,506

 
0.08

 
9,008,917

 
0.09

 
531,589

 
5.9

Time deposits
2,932,456

 
0.82

 
3,321,309

 
1.04

 
(388,853
)
 
(11.7
)
Total deposits
$
12,472,962

 
0.26
%
 
$
12,330,226

 
0.34
%
 
$
142,736

 
1.2
%
The $531.6 million, or 5.9%, increase in total demand and savings accounts was primarily due to a $238.4 million, or 5.5%, increase in personal account balances and a $260.5 million, or 8.8%, increase in business account balances. The $388.9 million, or 11.7%, decrease in time deposits was primarily due to a decrease in time deposits occurring in accounts with balances less than $100,000.
The average cost of interest-bearing deposits decreased 10 basis points, or 22.2%, to 0.35% in 2014 from 0.45% in 2013, primarily due to a decrease in higher cost time deposits and an increase in lower cost interest-bearing savings and demand balances as a percentage of total interest-bearing deposits, to 68.2% in the first quarter of 2014 from 64.5% in 2013. During the first quarter of 2014, excluding early redemptions, $537.1 million of time deposits matured at a weighted average rate of 0.50%, while approximately $709.5 million of time deposits were issued at a weighted average rate of 0.83%.

41


Average borrowings and interest rates, by type, are summarized in the following table:
 
March 31, 2014
 
March 31, 2013
 
Increase (Decrease) in Balance
 
Balance
 
Rate
 
Balance
 
Rate
 
$
 
%
 
(dollars in thousands)
Short-term borrowings:
 
 
 
 
 
 
 
 
 
 
 
Customer repurchase agreements
$
187,362

 
0.11
%
 
$
165,109

 
0.11
%
 
$
22,253

 
13.5
 %
Customer short-term promissory notes
102,000

 
0.06

 
112,041

 
0.04

 
(10,041
)
 
(9.0
)
Total short-term customer funding
289,362

 
0.09

 
277,150

 
0.08

 
12,212

 
4.4

Federal funds purchased
416,230

 
0.21

 
709,779

 
0.24

 
(293,549
)
 
(41.4
)
Short-term FHLB advances (1)
503,361

 
0.28

 
45,193

 
0.27

 
458,168

 
N/M

Total short-term borrowings
1,208,953

 
0.21

 
1,032,122

 
0.20

 
176,831

 
17.1

Long-term debt:

 
 
 

 
 
 

 

FHLB advances
513,790

 
4.14

 
521,699

 
4.13

 
(7,909
)
 
(1.5
)
Other long-term debt
369,742

 
5.90

 
369,474

 
5.90

 
268

 
0.1

Total long-term debt
883,532

 
4.88

 
891,173

 
4.87

 
(7,641
)
 
(0.9
)
Total borrowings
$
2,092,485

 
2.20
%
 
$
1,923,295

 
2.38
%
 
$
169,190

 
8.8
 %
 
 
 
 
 
 
 
 
 
 
 
 
(1) Represents FHLB advances with an original maturity term of less than one year.
N/M - Not meaningful.
Total short-term borrowings increased $176.8 million, or 17.1%, primarily due to increases in short-term FHLB advances, partially offset by a reduction in Federal funds purchased. The increase in short-term borrowings was driven by the growth in average loans exceeding the increase in average deposits. The $7.6 million decrease in long-term debt was due to the repayment of FHLB advances, which were not replaced with new long-term borrowings.
The average cost of total borrowings decreased 18 basis points, or 7.6%, to 2.20% in 2014 from 2.38% in 2013, primarily due to the weighted average cost impact of an increase in lower cost short-term borrowings, which were 57.8% of total borrowings in 2014 and 53.6% in 2013.

Provision for Credit Losses
The provision for credit losses was $2.5 million for the first quarter of 2014, a decrease of $12.5 million, or 83.3%, from the first quarter of 2013 due to improvements in asset quality, as shown by a reduction in non-performing loans and overall delinquency rates.
The provision for credit losses is recognized as an expense in the consolidated statements of income and is the amount necessary to adjust the allowance for credit losses to its appropriate balance, as determined through the Corporation's allowance methodology. The Corporation determines the appropriate level of the allowance for credit losses based on many quantitative and qualitative factors, including, but not limited to: the size and composition of the loan portfolio, changes in risk ratings, changes in collateral values, delinquency levels, historical losses and economic conditions. See the "Financial Condition" section of Management's Discussion under the heading "Provision for Credit Losses and Allowance for Credit Losses" for details related to the Corporation's allowance and provision for credit losses.


42


Non-Interest Income
The following table presents the components of non-interest income:
 
Three months ended March 31
 
Increase (decrease)
 
2014
 
2013
 
$
 
%
 
(dollars in thousands)
Service Charges on deposit accounts:
 
 
 
 
 
 
 
Overdraft fees
$
5,297

 
$
7,461

 
$
(2,164
)
 
(29.0
)%
Cash management fees
3,105

 
2,832

 
273

 
9.6

Other
3,309

 
3,818

 
(509
)
 
(13.3
)
         Total service charges on deposit accounts
11,711

 
14,111

 
(2,400
)
 
(17.0
)
Investment management and trust services
10,958

 
10,096

 
862

 
8.5

Other service charges and fees:
 
 
 
 
 
 
 
Merchant fees
2,723

 
3,074

 
(351
)
 
(11.4
)
Debit card income
2,210

 
2,084

 
126

 
6.0

Letter of credit fees
1,101

 
1,234

 
(133
)
 
(10.8
)
Commercial swap fees
1,013

 
287

 
726

 
253.0

Other
1,880

 
1,831

 
49

 
2.7

        Total other service charges and fees
8,927

 
8,510

 
417

 
4.9

Mortgage banking income:
 
 
 
 
 
 
 
Gain on sales of mortgage loans
2,422

 
8,338

 
(5,916
)
 
(71.0
)
Mortgage servicing income
1,183

 
(165
)
 
1,348

 
     N/M
        Total mortgage banking income
3,605

 
8,173

 
(4,568
)
 
(55.9
)
Credit card income
2,171

 
2,171

 

 

Other income
1,134

 
1,725

 
(591
)
 
(34.3
)
        Total, excluding investment securities gains
38,506

 
44,786

 
(6,280
)
 
(14.0
)
Investment securities gains

 
2,473

 
(2,473
)
 
              Total
$
38,506

 
$
47,259

 
$
(8,753
)
 
(18.5
)%

N/M - Not meaningful.
The $2.2 million, or 29.0%, decrease in overdraft fee income included a $1.4 million decrease in fees assessed on personal accounts and a $764,000 decrease in fees assessed on commercial accounts. The overall decline in these fees resulted from a reduction in the number of overdraft items paid.
The $862,000, or 8.5%, increase in investment management and trust services income was due to a $713,000, or 16.8%, increase in brokerage revenue and a $149,000, or 2.6%, increase in trust commissions. These increases resulted from new trust business sales, improved market conditions that increased the values of existing assets under management and additional recurring revenue generated through the brokerage business due to growth in new accounts.
Commercial swap fees increased $726,000, or 253.0%, due to the current interest rate environment and the Corporation's continued roll out of the product. For additional details see Note I, "Derivative Financial Instruments" in the notes to consolidated financial statements.
Gains on sales of mortgage loans decreased $5.9 million, or 71.0%, due to a $322.1 million, or 62.7%, decrease in new loan commitments and an 22.1% decrease in pricing spreads compared to the first quarter of 2013. Both decreases resulted from an increase in mortgage interest rates in the second half of 2013. The decline in new loan commitments was mainly in refinancing volumes, which represented approximately 33% of new loan commitments in 2014 compared to 63% during 2013.
Mortgage servicing income, which includes fees earned for servicing sold residential mortgage loans net of the amortization of MSRs, increased $1.3 million in comparison to the first quarter of 2013, primarily due to a $1.1 million decrease in MSR amortization as prepayments slowed due to increases in mortgage rates.

43


Non-Interest Expense
The following table presents the components of non-interest expense:
 
Three months ended March 31
 
Increase (decrease)
 
2014
 
2013
 
$
 
%
 
(dollars in thousands)
Salaries and employee benefits
$
59,566

 
$
61,212

 
$
(1,646
)
 
(2.7
)%
Net occupancy expense
13,603

 
11,844

 
1,759

 
14.9

Other outside services
3,812

 
2,860

 
952

 
33.3

Data processing
3,796

 
3,903

 
(107
)
 
(2.7
)
Equipment expense
3,602

 
3,908

 
(306
)
 
(7.8
)
Software
2,925

 
2,748

 
177

 
6.4

Professional fees
2,904

 
3,047

 
(143
)
 
(4.7
)
FDIC insurance expense
2,689

 
2,847

 
(158
)
 
(5.5
)
Operating risk loss
1,828

 
1,766

 
62

 
3.5

Telecommunications
1,819

 
1,804

 
15

 
0.8

Marketing
1,584

 
1,872

 
(288
)
 
(15.4
)
Postage
1,260

 
1,264

 
(4
)
 
(0.3
)
Supplies
1,065

 
1,196

 
(131
)
 
(11.0
)
Other real estate owned (OREO) and repossession expense
983

 
2,854

 
(1,871
)
 
(65.6
)
Intangible amortization
315

 
534

 
(219
)
 
(41.0
)
Other
7,803

 
7,277

 
526

 
7.2

Total
$
109,554

 
$
110,936

 
$
(1,382
)
 
(1.2
)%
Salaries and employee benefits decreased $1.6 million, or 2.7%, due to a $205,000, or 0.4%, increase in salaries and a $1.9 million, or 17.7%, decrease in employee benefits. The increase in salaries was caused by normal merit increases and an increase in average full-time equivalent employees, partially offset by a decrease in incentive compensation. Average full-time equivalent employees were 3,590 for the three months ended March 31, 2014 as compared to 3,570 for the same period in 2013. The decrease in employee benefits was primarily due to the Corporation's cost savings initiatives, which included the elimination and reduction of certain employee benefit plans, most notably a decrease in profit sharing contributions and an amendment to the Postretirement Benefits Plan. For additional information related to the amendment to the postretirement plan, see Note H, "Employee Benefit Plans" in the notes to consolidated financial statements.
Net occupancy expense increased $1.8 million, or 14.9%, primarily due to snow removal costs in 2014. Other outside services increased $952,000, or 33.3%, due to increases related to IT initiatives and consulting expense, incurred primarily for risk management and regulatory compliance initiatives.
OREO and repossession expense decreased $1.9 million, or 65.6%, primarily due to an increase in net gains on sales of properties and a decrease in valuation provisions, which reflect the continued improvement in overall asset quality.
The $526,000, or 7.2%, increase in other expense included $1.5 million of lease termination costs associated with the Corporation's consolidation of 13 branches in the first quarter of 2014, partially offset by a decrease in lending related expenses. For a summary of the impact of cost savings initiatives implemented during the first quarter of 2014, see the "Overview and Summary Financial Results" section of Management's Discussion.
Income Taxes
Income tax expense for the first quarter of 2014 was $14.2 million, a $2.5 million, or 21.2%, increase from $11.7 million for the first quarter of 2013.
The Corporation’s effective tax rate was 25.4% in 2014, as compared to 23.0% in 2013. The effective rate is generally lower than the Federal statutory rate of 35% due to investments in tax-free municipal securities and credits earned from investments in partnerships that generate tax credits under various federal programs. The increase in the effective tax rate in comparison to the first quarter of 2013 was primarily due to a $982,000 ($638,000, net of federal tax) reduction in the valuation allowance for certain state deferred tax assets recognized through a credit to income tax expense recognized in the first quarter of 2013, along with a higher level of pre-tax income for the first quarter of 2014.

44


FINANCIAL CONDITION
The table below presents condensed consolidated ending balance sheets for the Corporation.
 
 
 
Increase (decrease)
 
March 31, 2014
 
December 31, 2013
 
$
 
%
 
(dollars in thousands)
Assets
 
 
 
 
 
 
 
Cash and due from banks
$
260,389

 
$
218,540

 
$
41,849

 
19.1
 %
Other interest-earning assets
307,062

 
248,161

 
58,901

 
23.7

Loans held for sale
24,417

 
21,351

 
3,066

 
14.4

Investment securities
2,501,198

 
2,568,434

 
(67,236
)
 
(2.6
)
Loans, net of allowance
12,536,703

 
12,579,440

 
(42,737
)
 
(0.3
)
Premises and equipment
225,647

 
226,021

 
(374
)
 
(0.2
)
Goodwill and intangible assets
532,747

 
533,076

 
(329
)
 
(0.1
)
Other assets
523,726

 
539,611

 
(15,885
)
 
(2.9
)
Total Assets
$
16,911,889

 
$
16,934,634

 
$
(22,745
)
 
(0.1
)%
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
 
Deposits
$
12,669,917

 
$
12,491,186

 
$
178,731

 
1.4
 %
Short-term borrowings
1,069,684

 
1,258,629

 
(188,945
)
 
(15.0
)
Long-term debt
883,461

 
883,584

 
(123
)
 

Other liabilities
230,108

 
238,048

 
(7,940
)
 
(3.3
)
Total Liabilities
14,853,170

 
14,871,447

 
(18,277
)
 
(0.1
)
Total Shareholders’ Equity
2,058,719

 
2,063,187

 
(4,468
)
 
(0.2
)
Total Liabilities and Shareholders’ Equity
$
16,911,889

 
$
16,934,634

 
$
(22,745
)
 
(0.1
)%
Other interest-earning assets
The $58.9 million, or 23.7%, increase in other interest-earning assets was due to an increase in interest-bearing deposits with other banks.
Investment Securities
The following table presents the carrying amount of investment securities:
 
 
 
Increase (decrease)
 
March 31, 2014
 
December 31, 2013
 
$
 
%
 
(dollars in thousands)
U.S. Government securities
$
526

 
$
525

 
1

 
0.2
 %
U.S. Government sponsored agency securities
280

 
726

 
(446
)
 
(61.4
)%
State and municipal securities
283,453

 
284,849

 
(1,396
)
 
(0.5
)%
Corporate debt securities
100,552

 
98,749

 
1,803

 
1.8
 %
Collateralized mortgage obligations
1,006,737

 
1,032,398

 
(25,661
)
 
(2.5
)%
Mortgage-backed securities
916,203

 
945,712

 
(29,509
)
 
(3.1
)%
Auction rate securities
147,713

 
159,274

 
(11,561
)
 
(7.3
)%
Total debt securities
2,455,464

 
2,522,233

 
(66,769
)
 
(2.6
)%
Equity securities
45,734

 
46,201

 
(467
)
 
(1.0
)%
Total
$
2,501,198

 
$
2,568,434

 
$
(67,236
)
 
(2.6
)%
Total investment securities decreased $67.2 million, or 2.6%, in comparison to December 31, 2013 due primarily to a decrease in mortgage-backed securities, collateralized mortgage obligations and auction rate securities (ARCs). The decreases in mortgage-backed securities and collateralized mortgage obligations were primarily due to the Corporation not fully reinvesting portfolio cash flows. As in the prior year, portfolio cash flows that were reinvested during the first three months of 2014 were used to

45


purchase collateralized mortgage obligations and mortgage-backed securities with average lives of approximately five years to provide for more structured cash flows, thereby limiting price and extension risk in a rising interest rate environment. The decrease in ARCs was primarily due to the sale of ARCs during the first quarter of 2014 with a total book value of $11.9 million, with no gain or loss upon sale.
The net pre-tax unrealized loss on available for sale investment securities was $18.1 million as of March 31, 2014, compared to $39.8 million as of December 31, 2013. The $21.7 million increase in the unrealized loss was due to a decrease in market interest rates, which caused the fair values of collateralized mortgage obligations and mortgage-backed securities to increase. See additional details regarding investment security price risk within Item 7A, "Quantitative and Qualitative Disclosures About Market Risk."
Loans, net of unearned income
The following table presents ending balances of loans outstanding, net of unearned income:
 
 
 
 
 
Increase (decrease)
 
March 31,
2014
 
December 31,
2013
 
$
 
%
 
(in thousands)
 
 
Real-estate – commercial mortgage
$
5,137,454

 
$
5,101,922

 
$
35,532

 
0.7
 %
Commercial – industrial, financial and agricultural
3,574,130

 
3,628,420

 
(54,290
)
 
(1.5
)
Real-estate – home equity
1,740,496

 
1,764,197

 
(23,701
)
 
(1.3
)
Real-estate – residential mortgage
1,331,465

 
1,337,380

 
(5,915
)
 
(0.4
)
Real-estate – construction
584,217

 
573,672

 
10,545

 
1.8

Consumer
270,021

 
283,124

 
(13,103
)
 
(4.6
)
Leasing and other
96,009

 
93,505

 
2,504

 
2.7

Loans, net of unearned income
$
12,733,792

 
$
12,782,220

 
$
(48,428
)
 
(0.4
)%
The Corporation does not have a concentration of credit risk with any single borrower, industry or geographical location within its footprint. The maximum total lending commitment to an individual borrower was $39.0 million as of March 31, 2014, which is below the Corporation's maximum lending limit. As of March 31, 2014, the Corporation had 60 relationships with total borrowing commitments between $20.0 million and $39.0 million.

Approximately $5.7 billion, or 44.9%, of the loan portfolio was in commercial mortgage and construction loans as of March 31, 2014. The performance of these loans can be adversely impacted by fluctuations in real estate values. The Corporation limits its maximum non-owner occupied commercial real estate exposure to $28.0 million to any one borrower, and limits its exposure to any one development project to $15.0 million.
Construction loans include loans to commercial borrowers secured by residential real estate, loans to commercial borrowers secured by commercial real estate and other construction loans, which represent loans to individuals secured by residential real estate. The following table presents outstanding construction loans and their delinquency rates by these class segments:
 
March 31, 2014
 
December 31, 2013
 
$
 
Delinquency Rate (1)
 
% of Total
 
$
 
Delinquency Rate (1)
 
% of Total
 
(dollars in thousands)
Commercial
$
283,096

 
0.8
%
 
48.4
%
 
$
269,497

 
0.8
%
 
47.0
%
Commercial - residential
229,541

 
8.5

 
39.3

 
235,369

 
8.2

 
41.0

Other
71,580

 
2.1

 
12.3

 
68,806

 
0.8

 
12.0

Total Real estate - construction
$
584,217

 
4.0
%
 
100.0
%
 
$
573,672

 
3.8
%
 
100.0
%

(1)
Represents all accruing loans 31 days or more past due and non-accrual loans as a percentage of total loans within each class segment.

Construction loans increased $10.5 million, or 1.8%, in comparison to December 31, 2013. Geographically, the increase in construction loans was in the Delaware ($7.4 million, or 19.2%) and Virginia ($3.0 million, or 3.2%) markets.
The $54.3 million, or 1.5%, decrease in commercial loans was due to a decrease in the Pennsylvania ($61.8 million, or 2.3%) market, partially offset by an increase in the New Jersey ($10.1 million, or 2.0%) market.

46



The following table summarizes the percentage of loans, by industry, of the Corporation's commercial loan portfolio:
 
March 31,
2014
 
December 31, 2013
Services
19.1
%
 
19.2
%
Manufacturing
12.8

 
13.5

Retail
11.1

 
11.0

Construction
10.1

 
10.0

Wholesale
9.9

 
9.7

Health care
7.9

 
8.1

Real estate (1)
7.4

 
7.0

Agriculture
5.0

 
5.8

Arts and entertainment
3.2

 
2.7

Transportation
2.3

 
2.5

Financial services
1.7

 
1.6

Other
9.5

 
8.9

 
100.0
%
 
100.0
%
(1)
Includes borrowers engaged in the business of: renting, leasing or managing real estate for others; selling and/or buying real estate for others; and appraising real estate.
Commercial loans and commercial mortgage loans also include shared national credits, which are participations in loans or loan commitments of at least $20 million that are shared by three or more banks. Below is a summary of the Corporation's outstanding purchased shared national credits:
 
March 31, 2014
 
December 31, 2013
 
(dollars in thousands)
Commercial - industrial, financial and agricultural
$
117,481

 
$
129,840

Real estate - commercial mortgage
135,199

 
87,868

 
$
252,680

 
$
217,708

Total shared national credits increased $35.0 million, or 16.1%, in comparison to December 31, 2013. The Corporation's shared national credits are to borrowers located in its geographical markets and the increase was due to normal lending activities consistent with the Corporation's underwriting policies. As of March 31, 2014 and December 31, 2013, none of the shared national credits were past due.
Home equity loans decreased $23.7 million, or 1.3%, due to decreases in new originations as a result of certain home equity promotions that occurred through 2013. Geographically, the decrease was primarily in the Pennsylvania ($20.1 million, or 1.9%) market.
Consumer loans decreased $13.1 million, or 4.6%, due to decreases in both direct consumer loans ($9.4 million, or 0.7%) and indirect automobile loans ($3.7 million, or 2.5%).

47


Provision for Credit Losses and Allowance for Credit Losses
The following table presents the activity in the allowance for credit losses:
 
Three months ended
March 31
 
2014
 
2013
 
(dollars in thousands)
Average balance of loans, net of unearned income
$
12,762,357

 
$
12,257,280

 
 
 
 
Balance of allowance for credit losses at beginning of period
$
204,917

 
$
225,439

Loans charged off:

 

Commercial – industrial, financial and agricultural
5,125

 
9,502

Real estate – home equity
1,651

 
2,404

Real estate – commercial mortgage
1,386

 
4,133

Real estate – residential mortgage
846

 
3,050

Consumer
751

 
550

Real estate – construction
214

 
1,986

Leasing and other
295

 
481

Total loans charged off
10,268

 
22,106

Recoveries of loans previously charged off:
 
 
 
Commercial – industrial, financial and agricultural
744

 
379

Real estate – home equity
356

 
331

Real estate – commercial mortgage
44

 
1,064

Real estate – residential mortgage
116

 
81

Consumer
209

 
506

Real estate – construction
224

 
671

Leasing and other
164

 
162

Total recoveries
1,857

 
3,194

Net loans charged off
8,411

 
18,912

Provision for credit losses
2,500

 
15,000

Balance of allowance for credit losses at end of period
$
199,006

 
$
221,527

 
 
 
 
Net charge-offs to average loans (annualized)
0.26
%
 
0.62
%
The following table presents the components of the allowance for credit losses:
 
March 31,
2014
 
December 31,
2013
 
(dollars in thousands)
Allowance for loan losses
$
197,089

 
$
202,780

Reserve for unfunded lending commitments
1,917

 
2,137

Allowance for credit losses
$
199,006

 
$
204,917

 
 
 
 
Allowance for credit losses to loans outstanding
1.56
%
 
1.60
%
For the three months ended March 31, 2014, the Corporation's provision for credit losses decreased $12.5 million, or 83.3%, in comparison to the same period in 2013. The decrease in the provision for credit losses was due to improvements in credit quality, as shown by a reduction in non-performing loans and overall delinquency.
Net charge-offs decreased $10.5 million, or 55.5%, to $8.4 million for the first quarter of 2014, compared to $18.9 million for the first quarter of 2013. The decrease in net charge-offs was primarily due to a $4.7 million, or 52.0%, decrease in commercial loan net charge-offs, a $2.2 million, or 75.4%, decrease in residential mortgage net charge-offs and a $1.7 million, or 56.3%, decrease in commercial mortgage net charge-offs. Of the $8.4 million of net charge-offs recorded in the first quarter of 2014, 73.1% were for loans originated in Pennsylvania and 23.7% were for loans originated in New Jersey.

48


The following table summarizes non-performing assets as of the indicated dates:
 
March 31, 2014
 
March 31, 2013
 
December 31,
2013
 
(dollars in thousands)
Non-accrual loans
$
133,705

 
$
179,334

 
$
133,753

Loans 90 days past due and accruing
21,225

 
29,325

 
20,524

Total non-performing loans
154,930

 
208,659

 
154,277

Other real estate owned (OREO)
15,300

 
23,820

 
15,052

Total non-performing assets
$
170,230

 
$
232,479

 
$
169,329

Non-accrual loans to total loans
1.05
%
 
1.45
%
 
1.05
%
Non-performing assets to total assets
1.01
%
 
1.39
%
 
1.00
%
Allowance for credit losses to non-performing loans
128.45
%
 
106.17
%
 
132.82
%

The following table presents accruing loans whose terms have been modified under troubled debt restructurings (TDRs), by type, as of the indicated dates:
 
March 31, 2014
 
March 31, 2013
 
December 31, 2013
 
(in thousands)
Real estate – residential mortgage
$
30,363

 
$
33,095

 
$
28,815

Real estate – commercial mortgage
19,514

 
28,421

 
19,758

Real estate – construction
8,430

 
11,125

 
10,117

Commercial – industrial, financial and agricultural
6,755

 
9,031

 
8,045

Real estate - home equity
2,606

 
1,537

 
1,365

Consumer
16

 
12

 
11

Total accruing TDRs
67,684

 
83,221

 
68,111

Non-accrual TDRs (1)
27,487

 
33,215

 
30,209

Total TDRs
$
95,171

 
$
116,436

 
$
98,320

(1) Included with non-accrual loans in the preceding table.

TDRs modified during the first three months of 2014 and still outstanding as of March 31, 2014 totaled $9.3 million. During the first three months of 2014, $4.7 million of TDRs that were modified within the previous 12 months had a payment default, which the Corporation defines as a single missed scheduled payment, subsequent to modification.
The following table presents the changes in non-accrual loans for the three months ended March 31, 2014:
 
Commercial -
Industrial,
Financial and
Agricultural
 
Real Estate -
Commercial
Mortgage
 
Real Estate -
Construction
 
Real Estate -
Residential
Mortgage
 
Real Estate -
Home
Equity
 
Consumer
 
Leasing
 
Total
 
(in thousands)
Balance of non-accrual loans as of December 31, 2013
$
36,710

 
$
40,566

 
$
20,921

 
$
22,282

 
$
13,272

 
$
2

 
$

 
$
133,753

Additions
10,507

 
7,583

 
483

 
3,587

 
2,370

 
755

 

 
25,285

Payments
(2,914
)
 
(4,281
)
 
(1,255
)
 
(327
)
 
(531
)
 
(5
)
 

 
(9,313
)
Charge-offs
(5,125
)
 
(1,386
)
 
(214
)
 
(846
)
 
(1,651
)
 
(751
)
 

 
(9,973
)
Transfers to accrual status

 
(54
)
 

 
(1,839
)
 
(1,403
)
 

 

 
(3,296
)
Transfers to OREO
(660
)
 
(44
)
 

 
(1,538
)
 
(509
)
 

 

 
(2,751
)
Balance of non-accrual loans as of March 31, 2014
$
38,518

 
$
42,384

 
$
19,935

 
$
21,319

 
$
11,548

 
$
1

 
$

 
$
133,705


Non-accrual loans decreased $45.6 million, or 25.4%, in comparison to March 31, 2013 and $48,000 in comparison to December 31, 2013. Total non-accrual additions for the three months ended March 31, 2014 were $25.3 million, compared to additions for the three months ended March 31, 2013 of $45.3 million.

49


The following table summarizes non-performing loans, by type, as of the indicated dates:
 
March 31, 2014
 
March 31, 2013
 
December 31,
2013
 
(in thousands)
Commercial – industrial, financial and agricultural
$
38,830

 
$
61,113

 
$
38,021

Real estate – commercial mortgage
45,876

 
58,805

 
44,068

Real estate – residential mortgage
29,305

 
36,361

 
31,347

Real estate – construction
20,758

 
31,919

 
21,267

Real estate – home equity
17,088

 
17,468

 
16,983

Consumer
2,999

 
2,782

 
2,543

Leasing
74

 
211

 
48

Total non-performing loans
$
154,930

 
$
208,659

 
$
154,277


Non-performing commercial loans decreased $22.3 million, or 36.5%, in comparison to March 31, 2013. Geographically, the decrease occurred primarily in the Pennsylvania ($16.4 million, or 38.0%) and Maryland ($2.2 million, or 57.2%) markets.
Non-performing commercial mortgages decreased $12.9 million, or 22.0%, in comparison to March 31, 2013. Geographically, the decrease was primarily in the Virginia ($10.8 million, or 85.5%) market.
Non-performing construction loans decreased $11.2 million, or 35.0%, in comparison to March 31, 2013. Geographically, the decrease occurred primarily in the New Jersey ($6.3 million, or 57.4%), Virginia ($2.4 million, or 82.2%) and Maryland ($1.6 million, or 29.5%) markets.
Non-performing residential mortgages decreased $7.1 million, or 19.4%, in comparison to March 31, 2013. Geographically, the decrease was primarily in the Virginia ($2.7 million, or 27.5%), Pennsylvania ($2.4 million, or 18.5%) and New Jersey ($1.3 million, or 14.6%) markets.
The following table summarizes the Corporation’s OREO, by property type, as of the indicated dates:
 
March 31, 2014
 
March 31, 2013
 
December 31,
2013
 
(in thousands)
Residential properties
$
8,026

 
$
6,286

 
$
7,052

Commercial properties
5,412

 
14,775

 
5,586

Undeveloped land
1,862

 
2,759

 
2,414

Total OREO
$
15,300

 
$
23,820

 
$
15,052

The Corporation's ability to identify potential problem loans in a timely manner is important to maintaining an adequate allowance for credit losses. For commercial loans, commercial mortgages and construction loans to commercial borrowers, an internal risk rating process is used to monitor credit quality. For a description of the Corporation's risk ratings, see Note E, "Loans and Allowance for Credit Losses," in the Notes to Consolidated Financial Statements. The evaluation of credit risk for residential mortgages, home equity loans, construction loans to individuals, consumer loans and lease receivables is based on aggregate payment history, through the monitoring of delinquency levels and trends.

50


Total internally risk rated loans were $9.2 billion as of March 31, 2014 and December 31, 2013. The following table presents internal risk ratings for commercial loans, commercial mortgages and construction loans to commercial borrowers with internal risk ratings of Special Mention (considered criticized loans) or Substandard or lower (considered classified loans), by class segment:
 
Special Mention
 
Increase (decrease)
 
Substandard or lower
 
Increase (decrease)
 
Total Criticized and Classified Loans
 
March 31, 2014
 
December 31, 2013
 
$
 
%
 
March 31, 2014
 
December 31, 2013
 
$
 
%
 
March 31, 2014
 
December 31, 2013
 
(dollars in thousands)
Real estate - commercial mortgage
$
122,929

 
$
141,013

 
$
(18,084
)
 
(12.8
)%
 
$
180,543

 
$
196,922

 
$
(16,379
)
 
(8.3
)%
 
$
303,472

 
$
337,935

Commercial - secured
137,176

 
111,613

 
25,563

 
22.9

 
128,326

 
125,382

 
2,944

 
2.3

 
265,502

 
236,995

Commercial -unsecured
10,369

 
11,666

 
(1,297
)
 
(11.1
)
 
4,986

 
2,755

 
2,231

 
81.0

 
15,355

 
14,421

Total Commercial - industrial, financial and agricultural
147,545

 
123,279

 
24,266

 
19.7

 
133,312

 
128,137

 
5,175

 
4.0

 
280,857

 
251,416

Construction - commercial residential
29,556

 
31,522

 
(1,966
)
 
(6.2
)
 
46,490

 
57,806

 
(11,316
)
 
(19.6
)
 
76,046

 
89,328

Construction - commercial
2,915

 
2,932

 
(17
)
 
(0.6
)
 
6,144

 
8,124

 
(1,980
)
 
(24.4
)
 
9,059

 
11,056

Total real estate - construction (excluding construction - other)
32,471

 
34,454

 
(1,983
)
 
(5.8
)
 
52,634

 
65,930

 
(13,296
)
 
(20.2
)
 
85,105

 
100,384

Total
$
302,945

 
$
298,746

 
$
4,199

 
1.4
 %
 
$
366,489

 
$
390,989

 
$
(24,500
)
 
(6.3
)%
 
$
669,434

 
$
689,735

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
% of total loans
3.3
%
 
3.2
%
 
 
 
 
 
4.0
%
 
4.2
%
 
 
 
 
 
7.3
%
 
7.4
%
As of March 31, 2014, total loans with risk ratings of Substandard or lower decreased $24.5 million, or 6.3%, in comparison to December 31, 2013 and $138.9 million, or 27.5%, in comparison to March 31, 2013. Special Mention loans increased $4.2 million, or 1.4%, in comparison to December 31, 2013 and decreased $51.0 million, or 14.4%, in comparison to March 31, 2013.
The following table summarizes loan delinquency rates, by type, as of the dates indicated:
 
March 31, 2014

March 31, 2013
 
December 31, 2013
 
31-89
Days
 
≥ 90 Days (1)
 
Total
 
31-89
Days
 
≥ 90 Days (1)
 
Total
 
31-89
Days
 
≥ 90 Days (1)
 
Total
Real estate – commercial mortgage
0.35
%
 
0.89
%
 
1.24
%
 
0.39
%
 
1.25
%
 
1.64
%
 
0.38
%
 
0.87
%
 
1.25
%
Commercial – industrial, financial and agricultural
0.33
%
 
1.09
%
 
1.42
%
 
0.35
%
 
1.67
%
 
2.02
%
 
0.30
%
 
1.04
%
 
1.34
%
Real estate – construction
0.43
%
 
3.55
%
 
3.98
%
 
0.17
%
 
5.34
%
 
5.51
%
 
0.11
%
 
3.71
%
 
3.82
%
Real estate – residential mortgage
1.53
%
 
2.20
%
 
3.73
%
 
2.07
%
 
2.79
%
 
4.86
%
 
1.74
%
 
2.34
%
 
4.08
%
Real estate – home equity
0.69
%
 
0.98
%
 
1.67
%
 
0.69
%
 
1.03
%
 
1.72
%
 
0.91
%
 
0.96
%
 
1.87
%
Consumer, leasing and other
1.87
%
 
0.84
%
 
2.71
%
 
1.38
%
 
0.75
%
 
2.13
%
 
1.99
%
 
0.68
%
 
2.67
%
Total
0.56
%
 
1.22
%
 
1.78
%
 
0.62
%
 
1.68
%
 
2.30
%
 
0.61
%
 
1.20
%
 
1.81
%
Total dollars (in thousands)
$
71,410

 
$
154,930

 
$
226,340

 
$
76,373

 
$
208,659

 
$
285,032

 
$
77,667

 
$
154,277

 
$
231,944

 
(1)
Includes non-accrual loans.
The Corporation believes that the allowance for credit losses of $199.0 million as of March 31, 2014 is sufficient to cover incurred losses in both the loan portfolio and the unfunded lending commitments as of that date and is appropriate based on applicable accounting standards.
Other Assets
Other assets decreased $15.9 million, or 2.9%, in comparison to December 31, 2013 due primarily to a decrease in net deferred tax assets that resulted primarily from a decrease in unrealized losses on available for sale investment securities.

51


Deposits and Borrowings
The following table presents ending deposits, by type:
 
 
 
 
 
Increase
 
March 31, 2014
 
December 31, 2013
 
$
 
%
 
(dollars in thousands)
Noninterest-bearing demand
$
3,359,900

 
$
3,283,172

 
$
76,728

 
2.3
%
Interest-bearing demand
2,960,577

 
2,945,210

 
15,367

 
0.5

Savings
3,346,880

 
3,344,882

 
1,998

 
0.1

Total demand and savings
9,667,357

 
9,573,264

 
94,093

 
1.0

Time deposits
3,002,560

 
2,917,922

 
84,638

 
2.9

Total deposits
$
12,669,917

 
$
12,491,186

 
$
178,731

 
1.4
%
Non-interest bearing demand deposits increased $76.7 million, or 2.3%, due primarily to a $46.0 million, or 6.5%, increase in personal account balances and a $16.8 million, or 0.7%, increase in business account balances.
Interest-bearing demand accounts increased $15.4 million, or 0.5%, due to an increase in personal account balances. The $2.0 million, or 0.1%, increase in savings account balances was due to a $66.0 million, or 3.1%, increase in personal account balances, partially offset by a $38.5 million, or 8.1%, seasonal decrease in municipal account balances and a $25.5 million, or 3.4%, decrease in business account balances. The $84.6 million, or 2.9%, increase in time deposits was in accounts with balances less than $100,000.
The following table summarizes the changes in ending borrowings, by type:
 
 
 
Increase (decrease)
 
March 31, 2014
 
December 31, 2013
 
$
 
%
 
(dollars in thousands)
Short-term borrowings:
 
 
 
 
 
 
 
Customer repurchase agreements
$
220,426

 
$
175,621

 
44,805

 
25.5
 %
Customer short-term promissory notes
88,160

 
100,572

 
(12,412
)
 
(12.3
)
Total short-term customer funding
308,586

 
276,193

 
32,393

 
11.7

Federal funds purchased
361,098

 
582,436

 
(221,338
)
 
(38.0
)
Short-term FHLB advances (1)
400,000

 
400,000

 

 

Total short-term borrowings
1,069,684

 
1,258,629

 
(188,945
)
 
(15.0
)
Long-term debt:
 
 
 
 
 
 
 
FHLB advances
513,732

 
513,854

 
(122
)
 

Other long-term debt
369,729

 
369,730

 
(1
)
 

Total long-term debt
883,461

 
883,584

 
(123
)
 

Total borrowings
$
1,953,145

 
$
2,142,213

 
(189,068
)
 
(8.8
)%
 
 
 
 
 
 
 
 
(1) Represents FHLB advances with an original maturity term of less than one year.
The $188.9 million decrease in total short-term borrowings was primarily the result of a $178.7 million increase in deposits.
Other liabilities
Other liabilities decreased $7.9 million, or 3.3%, in comparison to December 31, 2013. As of December 31, 2013, the Corporation had $6.2 million of investment securities purchases executed prior to December 31, 2013, that had not settled at the end of the year. The Corporation had no such payables outstanding as of March 31, 2014. Also contributing to the decrease in other liabilities was a reduction in reserves associated with the potential repurchase of previously sold residential mortgages.

52


Shareholders' Equity
Total shareholders’ equity decreased $4.5 million, or 0.2%, during the first three months of 2014. The decrease was due primarily to $49.8 million of stock repurchases and $15.1 million of dividends on shares outstanding, partially offset by $41.8 million of net income and a $14.1 million decrease in after-tax unrealized holding losses on available for sale investment securities.
In October 2013, the Corporation announced that its board of directors had approved a share repurchase program pursuant to which the Corporation was authorized to repurchase up to four million shares, or approximately 2.1% of its outstanding shares, through March 2014. During the first quarter of 2014, the Corporation repurchased 4.0 million shares at an average cost of $12.45 per share, completing this repurchase program on February 19, 2014.
Bank holding companies are required to comply with the Federal Reserve Board’s risk-based capital guidelines, which require a minimum ratio of total capital to risk-weighted assets of 8.00%. At least half of the total capital is required to be Tier 1 capital. In addition to the risk-based capital guidelines, the Federal Reserve Board has adopted a minimum leverage capital ratio under which a bank holding company must maintain a level of Tier 1 capital to average total consolidated assets of at least 3.00% in the case of a bank holding company which has the highest regulatory examination rating and is not contemplating significant growth or expansion. For all other bank holding companies, the minimum ratio of Tier 1 capital to total assets is 4.00%. Depository institutions are required to comply with similar capital guidelines issued by their primary federal regulator. Bank holding companies and depository institutions with supervisory, financial, operational, or managerial weaknesses, as well as those that are anticipating or experiencing significant growth, are expected to maintain capital ratios well above the minimum levels. Moreover, higher capital ratios may be required for any bank holding company and depository institution if warranted by its particular circumstances or risk profile. In all cases, bank holding companies and depository institutions should hold capital commensurate with the level and nature of the risks, including the volume and severity of problem loans, to which they are exposed.
The Basel Committee on Banking Supervision (Basel) is a committee of central banks and bank regulators from major industrialized countries that develops broad policy guidelines for use by each country’s regulators with the purpose of ensuring that financial institutions have adequate capital given the risk levels of assets and off-balance sheet financial instruments. In December 2010, Basel released frameworks for strengthening international capital and liquidity regulations, referred to as Basel III. In July 2013, the Federal Reserve Board approved final rules (the "U.S. Basel III Capital Rules") establishing a new comprehensive capital framework for U.S. banking organizations and implementing the Basel Committee on Banking Supervision's December 2010 framework for strengthening international capital standards. The U.S. Basel III Capital Rules substantially revise the risk-based capital requirements applicable to bank holding companies and depository institutions.
As of March 31, 2014, the Corporation and each of its bank subsidiaries met the minimum requirements. In addition, each of the Corporation’s bank subsidiaries’ capital ratios exceeded the amounts required to be considered "well capitalized" as defined in the regulations.
The following table summarizes the Corporation’s capital ratios in comparison to regulatory requirements:
 
March 31, 2014
 
December 31,
2013
 
Regulatory
Minimum
for Capital
Adequacy
Total Capital (to Risk-Weighted Assets)
15.0
%
 
15.0
%
 
8.0
%
Tier I Capital (to Risk-Weighted Assets)
13.1
%
 
13.1
%
 
4.0
%
Tier I Capital (to Average Assets)
10.5
%
 
10.6
%
 
4.0
%
The new minimum regulatory capital requirements established by the U.S. Basel III Capital Rules are effective for the Corporation beginning on January 1, 2015, and become fully phased in on January 1, 2019.
When fully phased in, the U.S. Basel III Capital Rules will require the Corporation and its bank subsidiaries to:
Meet a new minimum Common Equity Tier 1 capital ratio of 4.50% of risk-weighted assets and a Tier 1 capital ratio of 6.00% of risk-weighted assets;
Continue to require the current minimum Total capital ratio of 8.00% of risk-weighted assets and the minimum Tier 1 leverage capital ratio of 4.00% of average assets;
Maintain a "capital conservation buffer" of 2.50% above the minimum risk-based capital requirements, which must be maintained to avoid restrictions on capital distributions and certain discretionary bonus payments; and

53


Comply with a revised definition of capital to improve the ability of regulatory capital instruments to absorb losses as a result of which certain non-qualifying capital instruments, including cumulative preferred stock and trust preferred securities, will be excluded as a component of Tier 1 capital for institutions of the Corporation's size.
The U.S. Basel III Capital Rules use a standardized approach for risk weightings that expand the risk-weightings for assets and off balance sheet exposures from the current 0%, 20%, 50% and 100% categories to a much larger and more risk-sensitive number of categories, depending on the nature of the assets and resulting in higher risk weights for a variety of asset categories.
As of March 31, 2014, the Corporation believes its current capital levels would meet the fully-phased in minimum capital requirements, including capital conservation buffer, as prescribed in the U.S. Basel III Capital Rules.
Liquidity
The Corporation must maintain a sufficient level of liquid assets to meet the cash needs of its customers who, as depositors, may want to withdraw funds or who, as borrowers, need credit availability. Liquidity is provided on a continuous basis through scheduled and unscheduled principal and interest payments on outstanding loans and investments and through the availability of deposits and borrowings. The Corporation also maintains secondary sources that provide liquidity on a secured and unsecured basis to meet short-term and long-term needs.

The Corporation maintains liquidity sources in the form of demand and savings deposits, time deposits, repurchase agreements and short-term promissory notes. The Corporation can access additional liquidity from these sources, if necessary, by increasing interest rates. The positive impact to liquidity resulting from higher interest rates could have a detrimental impact on the net interest margin and net income if rates on interest-earning assets do not have a corresponding increase.
Borrowing availability with the FHLB and Federal Reserve Bank, along with Federal funds lines at various correspondent banks, provides the Corporation with additional liquidity.
Each of the Corporation’s subsidiary banks is a member of the FHLB and has access to FHLB overnight and term credit facilities. As of March 31, 2014, the Corporation had $913.7 million of short and long-term advances outstanding from the FHLB with an additional borrowing capacity of approximately $1.7 billion under these facilities. Advances from the FHLB are secured by FHLB stock, qualifying residential mortgages, investments and other assets.
As of March 31, 2014, the Corporation had aggregate availability under Federal funds lines of $1.6 billion, with $361.1 million of that amount outstanding. A combination of commercial real estate loans, commercial loans and securities are pledged to the Federal Reserve Bank of Philadelphia to provide access to Federal Reserve Bank Discount Window borrowings. As of March 31, 2014, the Corporation had $2.2 billion of collateralized borrowing availability at the Discount Window, and no outstanding borrowings.
Liquidity must also be managed at the Fulton Financial Corporation parent company level. For safety and soundness reasons, banking regulations limit the amount of cash that can be transferred from subsidiary banks to the parent company in the form of loans and dividends. Generally, these limitations are based on the subsidiary banks’ regulatory capital levels and their net income. Management continues to monitor the liquidity and capital needs of the parent company and will implement appropriate strategies, as necessary, to remain adequately capitalized and to meet its cash needs.
The Corporation’s sources and uses of funds were discussed in general terms in the net interest income section of Management’s Discussion. The consolidated statements of cash flows provide additional information. The Corporation’s operating activities during the first three months of 2014 generated $60.5 million of cash, mainly due to net income, as adjusted for non-cash expenses, most notably depreciation and amortization of premises and equipment and a net decrease in other assets. Cash provided by investing activities was $54.8 million, due mainly to proceeds from the maturities and sales of investment securities, partially offset by an increase in short-term investments and purchases of investment securities. Net cash used by financing activities was $73.4 million due to a net decrease in short-term borrowings, acquisitions of treasury stock and dividends paid on common shares, partially offset by an increase in deposits.


54


Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the exposure to economic loss that arises from changes in the values of certain financial instruments. The types of market risk exposures generally faced by financial institutions include interest rate risk, equity market price risk, debt security market price risk, foreign currency risk and commodity price risk. Due to the nature of its operations, only equity market price risk, debt security market price risk and interest rate risk are materially significant to the Corporation.
Equity Market Price Risk
Equity market price risk is the risk that changes in the values of equity investments could have a material impact on the financial position or results of operations of the Corporation. As of March 31, 2014, equity investments consisted of $39.8 million of common stocks of publicly traded financial institutions, and $5.9 million of other equity investments.
The equity investments most susceptible to equity market price risk are the financial institutions stocks, which had a cost basis of approximately $28.5 million and a fair value of $39.8 million at March 31, 2014, including an investment in a single financial institution with a cost basis of $20.0 million and a fair value of $27.9 million. The fair value of this investment accounted for 70.1% of the fair value of the common stocks of publicly traded financial institutions. No other investment within the financial institutions stock portfolio exceeded 5% of the portfolio's fair value. In total, the financial institutions stock portfolio had gross unrealized gains of $11.3 million and gross unrealized losses of $14,000 as of March 31, 2014.
Management continuously monitors the fair value of its equity investments and evaluates current market conditions and operating results of the issuers. Periodic sale and purchase decisions are made based on this monitoring process. None of the Corporation’s equity securities are classified as trading.
In addition to its equity portfolio, investment management and trust services income may be impacted by fluctuations in the equity markets. A portion of this revenue is based on the value of the underlying investment portfolios, many of which include equity investments. If the values of those investment portfolios decrease, whether due to factors influencing U.S. equity markets in general or otherwise, the Corporation’s revenue would be negatively impacted. In addition, the Corporation’s ability to sell its brokerage services in the future will be dependent, in part, upon consumers’ level of confidence in financial markets.

Debt Security Market Price Risk
Debt security market price risk is the risk that changes in the values of debt securities, unrelated to interest rate changes, could have a material impact on the financial position or results of operations of the Corporation. The Corporation’s debt security investments consist primarily of U.S. government sponsored agency issued mortgage-backed securities and collateralized mortgage obligations, state and municipal securities, U.S. government debt securities, auction rate securities and corporate debt securities. All of the Corporation's investments in mortgage-backed securities and collateralized mortgage obligations have principal payments that are guaranteed by U.S. government sponsored agencies.
Municipal Securities
As of March 31, 2014, the Corporation had $283.5 million of securities issued by various municipalities. Ongoing uncertainty with respect to the financial strength of municipal bond insurers places much greater emphasis on the underlying strength of issuers. Continued pressure on local tax revenues of issuers due to adverse economic conditions could have an adverse impact on the underlying credit quality of issuers. The Corporation evaluates existing and potential holdings primarily based on the creditworthiness of the issuing municipality and then, to a lesser extent, on any underlying credit enhancement. Municipal securities can be supported by the general obligation of the issuing municipality, allowing the securities to be repaid by any means available to the issuing municipality. As of March 31, 2014, approximately 95% of municipal securities were supported by the general obligation of corresponding municipalities. Approximately 84% of these securities were school district issuances, which are also supported by the states of the issuing municipalities.

55


Auction Rate Certificates
As of March 31, 2014, the Corporation’s investments in student loan auction rate certificates (ARCs), had a cost basis of $159.4 million and a fair value of $147.7 million.
ARCs are long-term securities that were structured to allow their sale in periodic auctions, resulting in both the treatment of ARCs as short-term instruments in normal market conditions and fair values that could be derived based on periodic auction prices. However, beginning in 2008, market auctions for these securities began to fail due to an insufficient number of buyers, resulting in an illiquid market. This illiquidity has resulted in recent market prices that represent forced liquidations or distressed sales and do not provide an accurate basis for fair value. Therefore, as of March 31, 2014, the fair values of the ARCs were derived using significant unobservable inputs based on an expected cash flows model which produced fair values which were materially different from those that would be expected from settlement of these investments in the illiquid market that presently exists. The expected cash flows model, prepared by a third-party valuation expert, produced fair values which assumed a return to market liquidity sometime within the next five years. The Corporation believes that the trusts underlying the ARCs will self-liquidate as student loans are repaid.
The credit quality of the underlying debt associated with ARCs is also a factor in the determination of their estimated fair value. As of March 31, 2014, approximately $143 million, or 97%, of the ARCs were rated above investment grade, with approximately $6 million, or 4%, AAA rated and $103 million, or 70%, AA rated. Approximately $4 million, or 3%, of ARCs were either not rated or rated below investment grade by at least one ratings agency. Of this amount, approximately $3 million, or 59%, of the student loans underlying these ARCs have principal payments which are guaranteed by the federal government. In total, approximately $146 million, or 99%, of the student loans underlying the ARCs have principal payments which are guaranteed by the federal government. As of March 31, 2014, all ARCs were current and making scheduled interest payments.

Corporate Debt Securities
The Corporation holds corporate debt securities in the form of pooled trust preferred securities, single-issuer trust preferred securities and subordinated debt issued by financial institutions, as presented in the following table:
 
March 31, 2014
 
Amortized
cost
 
Estimated
fair value
 
(in thousands)
Single-issuer trust preferred securities
$
47,502

 
$
41,879

Subordinated debt
47,436

 
50,429

Pooled trust preferred securities
2,825

 
5,659

Corporate debt securities issued by financial institutions
$
97,763

 
$
97,967


The fair values for pooled trust preferred securities and certain single-issuer trust preferred securities were based on quotes provided by third-party brokers who determined fair values based predominantly on internal valuation models which were not indicative prices or binding offers.

The Corporation’s investments in single-issuer trust preferred securities had an unrealized loss of $5.6 million at March 31, 2014. The Corporation did not record any other-than-temporary impairment charges for single-issuer trust preferred securities during the three months ended March 31, 2014 or 2013. Six of the Corporation's 22 single-issuer trust preferred securities were rated below investment grade by at least one ratings agency, with an amortized cost of $13.5 million and an estimated fair value of $11.7 million as of March 31, 2014. All of the single-issuer trust preferred securities rated below investment grade were rated BB or Ba. Single-issuer trust preferred securities with an amortized cost of $4.7 million and an estimated fair value of $3.8 million at March 31, 2014 were not rated by any ratings agency.
As of March 31, 2014, all eight of the Corporation's pooled trust preferred securities with an amortized cost of $2.8 million and an estimated fair value of $5.7 million, were rated below investment grade by at least one ratings agency, with ratings ranging from C to Ca. The class of securities held by the Corporation was below the most senior tranche, with the Corporation’s interests being subordinate to other investors in the pool.
The amortized cost of pooled trust preferred securities is the purchase price of the securities, net of cumulative credit related other-than-temporary impairment charges, determined using an expected cash flows model. The most significant input to the expected cash flows model was the expected payment deferral rate for each pooled trust preferred security. The Corporation evaluates the financial metrics, such as capital ratios and non-performing asset ratios, of the individual financial institution issuers that comprise each pooled trust preferred security to estimate its expected deferral rate.

56


See Note D, "Investment Securities," in the Notes to Consolidated Financial Statements for further discussion related to other-than-temporary impairment evaluations for debt securities and Note L, "Fair Value Measurements," in the Notes to Consolidated Financial Statements for further discussion related to the fair values of debt securities.

Interest Rate Risk, Asset/Liability Management and Liquidity
Interest rate risk creates exposure in two primary areas. First, changes in rates have an impact on the Corporation’s liquidity position and could affect its ability to meet obligations and continue to grow. Second, movements in interest rates can create fluctuations in the Corporation’s net interest income and changes in the economic value of its equity.
The Corporation employs various management techniques to minimize its exposure to interest rate risk. An Asset/Liability Management Committee (ALCO), consisting of key financial and senior management personnel, meets on a regular basis. The ALCO is responsible for reviewing the interest rate sensitivity and liquidity positions of the Corporation, approving asset and liability management policies, and overseeing the formulation and implementation of strategies regarding balance sheet positions.
From a liquidity standpoint, the Corporation must maintain a sufficient level of liquid assets to meet the cash needs of its customers, who, as depositors, may want to withdraw funds or who, as borrowers, need credit availability. Liquidity is provided on a continuous basis through scheduled and unscheduled principal and interest payments on outstanding loans and investments and through the availability of deposits and borrowings. The Corporation also maintains secondary sources that provide liquidity on a secured and unsecured basis to meet short-term and long-term needs.




57


The following table provides information about the Corporation’s interest rate sensitive financial instruments as of March 31, 2014. The table presents expected cash flows and weighted average rates for each of the Corporation's significant interest rate sensitive financial instruments, by expected maturity period. None of the Corporation’s financial instruments are classified as trading. All dollar amounts are in thousands.
 
Expected Maturity Period
 
 
 
Estimated
 
Year 1
 
Year 2
 
Year 3
 
Year 4
 
Year 5
 
Beyond
 
Total
 
Fair Value
Fixed rate loans (1)
$
1,038,502

 
$
481,227

 
$
358,523

 
$
347,552

 
$
223,835

 
$
688,435

 
$
3,138,074

 
$
3,124,133

Average rate
3.91
%
 
4.61
%
 
4.53
%
 
4.75
%
 
4.67
%
 
4.07
%
 
4.27
%
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Floating rate loans (1) (2)
2,225,044

 
1,429,523

 
1,158,476

 
987,825

 
1,383,239

 
2,408,577

 
9,592,684

 
9,501,816

Average rate
3.97
%
 
4.04
%
 
4.06
%
 
4.06
%
 
3.88
%
 
4.05
%
 
4.01
%
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate investments (3)
388,713

 
311,708

 
258,563

 
235,944

 
188,809

 
889,731

 
2,273,468

 
2,260,056

Average rate
2.52
%
 
2.65
%
 
2.61
%
 
2.73
%
 
2.74
%
 
2.89
%
 
2.73
%
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Floating rate investments (3)

 
37

 
165,171

 
4,984

 
49

 
41,616

 
211,857

 
195,716

Average rate
%
 
1.31
%
 
2.17
%
 
0.92
%
 
1.95
%
 
1.46
%
 
2.00
%
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other interest-earning assets (4)
249,845

 

 

 

 

 
81,634

 
331,479

 
329,892

Average rate
0.70
%
 
%
 
%
 
%
 
%
 
3.32
%
 
1.34
%
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
3,902,104

 
$
2,222,495

 
$
1,940,733

 
$
1,576,305

 
$
1,795,932

 
$
4,109,993

 
$
15,547,562

 
$
15,411,613

Average rate
3.60
%
 
3.97
%
 
3.80
%
 
4.01
%
 
3.86
%
 
3.76
%
 
3.79
%
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate deposits (5)
$
1,470,035

 
$
541,514

 
$
260,248

 
$
92,264

 
$
209,043

 
$
27,072

 
$
2,600,176

 
$
2,613,586

Average rate
0.63
%
 
1.27
%
 
1.23
%
 
1.40
%
 
2.05
%
 
1.81
%
 
0.97
%
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Floating rate deposits (6)
4,766,812

 
714,981

 
379,458

 
355,369

 
334,556

 
158,665

 
6,709,841

 
6,705,569

Average rate
0.14
%
 
0.10
%
 
0.09
%
 
0.09
%
 
0.09
%
 
0.12
%
 
0.13
%
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate borrowings (7)
52,418

 
100,742

 
451,582

 
100,516

 
668

 
161,039

 
866,965

 
871,586

Average rate
3.20
%
 
5.34
%
 
4.21
%
 
5.74
%
 
4.65
%
 
6.18
%
 
4.82
%
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Floating rate borrowings (8)
1,069,684

 

 

 

 

 
16,496

 
1,086,180

 
1,079,295

Average rate
0.20
%
 
%
 
%
 
%
 
%
 
2.36
%
 
0.23
%
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
7,358,949

 
$
1,357,237

 
$
1,091,288

 
$
548,149

 
$
544,267

 
$
363,272

 
$
11,263,162

 
$
11,270,036

Average rate
0.27
%
 
0.96
%
 
2.07
%
 
1.34
%
 
0.85
%
 
3.04
%
 
0.70
%
 

 
(1)
Amounts are based on contractual payments and maturities, adjusted for expected prepayments. Excludes $3.0 million of overdraft deposit balances.
(2)
Line of credit amounts are based on historical cash flows, with an average life of approximately 5 years.
(3)
Amounts are based on contractual maturities; adjusted for expected prepayments on mortgage-backed securities and collateralized mortgage obligations and expected calls on agency and municipal securities. Excludes equity securities as such investments do not have maturity dates.
(4)
Excludes Federal Reserve Bank and FHLB stock as such restricted investments do not have maturity dates.
(5)
Amounts are based on contractual maturities of time deposits.
(6)
Estimated based on history of deposit flows.
(7)
Amounts are based on contractual maturities of debt instruments, adjusted for possible calls. Amounts also include junior subordinated deferrable interest debentures.
(8)
Amounts include Federal Funds purchased, short-term promissory notes and securities sold under agreements to repurchase, which mature in less than 90 days, in addition to junior subordinated deferrable interest debentures.
The preceding table and discussion addressed the liquidity implications of interest rate risk and focused on expected cash flows from financial instruments. Expected maturities, however, do not necessarily reflect the net interest impact of interest rate changes. Certain financial instruments, such as adjustable rate loans, have repricing periods that differ from expected cash flows periods.
Included within the $9.6 billion of floating rate loans above are $3.7 billion of loans, or 38.4% of the total, that float with the prime interest rate, $1.7 billion, or 18.1%, of loans that float with other interest rates, primarily the London Interbank Offered Rate (LIBOR), and $4.2 billion, or 43.5%, of adjustable rate loans. The $4.2 billion of adjustable rate loans include loans that are fixed rate instruments for a certain period of time, and then convert to floating rates.


58


The following table presents the percentage of adjustable rate loans, at March 31, 2014, stratified by the period until their next repricing:
 
Percent of Total
Adjustable Rate
Loans
One year
29.4%
Two years
17.6
Three years
15.3
Four years
15.3
Five years
12.8
Greater than five years
9.6
The Corporation uses three complementary methods to measure and manage interest rate risk. They are static gap analysis, simulation of net interest income, and estimates of economic value of equity. Using these measurements in tandem provides a reasonably comprehensive summary of the magnitude of the Corporation's interest rate risk, level of risk as time evolves, and exposure to changes in interest rates.
Static gap provides a measurement of repricing risk in the Corporation’s balance sheet as of a point in time. This measurement is accomplished through stratification of the Corporation’s assets and liabilities into repricing periods. The sum of assets and liabilities in each of these periods are compared for mismatches within that maturity segment. Core deposits having no contractual maturities are placed into repricing periods based upon historical balance performance. Repricing for mortgage loans, mortgage-backed securities and collateralized mortgage obligations is based upon industry projections for prepayment speeds. The Corporation’s policy limits the cumulative six-month ratio of rate sensitive assets to rate sensitive liabilities (RSA/RSL) to a range of 0.85 to 1.15. As of March 31, 2014, the cumulative six-month ratio of RSA/RSL was 1.10.
Simulation of net interest income is performed for the next twelve-month period. A variety of interest rate scenarios are used to measure the effects of sudden and gradual movements upward and downward in the yield curve. These results are compared to the results obtained in a flat or unchanged interest rate scenario. Simulation of net interest income is used primarily to measure the Corporation’s short-term earnings exposure to rate movements. The Corporation’s policy limits the potential exposure of net interest income, in a non-parallel instantaneous shock, to 10% of the base case net interest income for a 100 basis point shock in interest rates, 15% for a 200 basis point shock and 20% for a 300 basis point shock. A "shock" is an immediate upward or downward movement of interest rates. The shocks do not take into account changes in customer behavior that could result in changes to mix and/or volumes in the balance sheet, nor do they account for competitive pricing over the forward 12-month period.
The following table summarizes the expected impact of interest rate shocks on net interest income (due to the current level of interest rates, the 200 and 300 basis point downward shock scenarios are not shown):
Rate Shock (1)
 
Annual change
in net interest income
 
% Change
+300 bp
 
+ $ 47.1 million
 
   +9.0%
+200 bp
 
+ $ 27.9 million
 
+5.4
+100 bp
 
+ $ 9.7 million
 
+1.9
–100 bp
 
– $ 20.2 million
 
–3.9
 
(1)
These results include the effect of implicit and explicit floors that limit further reduction in interest rates.

Economic value of equity estimates the discounted present value of asset cash flows and liability cash flows. Discount rates are based upon market prices for like assets and liabilities. Upward and downward shocks of interest rates are used to determine the comparative effect of such interest rate movements relative to the unchanged environment. This measurement tool is used primarily to evaluate the longer-term repricing risks and options in the Corporation’s balance sheet. The Corporation's policy limits the economic value of equity that may be at risk, in a non-parallel instantaneous shock, to 10% of the base case economic value of equity for a 100 basis point shock in interest rates, 20% for a 200 basis point shock and 30% for a 300 basis point shock. As of March 31, 2014, the Corporation was within policy limits for every 100 basis point shock.

59


Item 4. Controls and Procedures
The Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures pursuant to Rule 13a-15, promulgated under the Securities Exchange Act of 1934 (the "Exchange Act"). Based upon that evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this quarterly report, the Corporation’s disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in Corporation reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
There have been no changes in the Corporation’s internal control over financial reporting during the fiscal quarter covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.


60


PART II – OTHER INFORMATION

Item 1. Legal Proceedings
The Corporation and its subsidiaries are involved in various legal proceedings in the ordinary course of business of the Corporation. The Corporation periodically evaluates the possible impact of pending litigation matters based on, among other factors, the advice of counsel, available insurance coverage and recorded liabilities and reserves for probable legal liabilities and costs. In addition, from time to time, the Corporation is the subject of investigations or other forms of regulatory or governmental inquiry covering a range of possible issues and, in some cases, these may be part of similar reviews of the specified activities of other industry participants. These inquiries could lead to administrative, civil or criminal proceedings, and could possibly result in fines, penalties, restitution or the need to alter the Corporation’s business practices, and cause the Corporation to incur additional costs. The Corporation’s practice is to cooperate fully with regulatory and governmental investigations.
As of the date of this report, the Corporation believes that any liabilities, individually or in the aggregate, which may result from the final outcomes of pending proceedings will not have a material adverse effect on the financial position, the operating results and/or the liquidity of the Corporation. However, legal proceedings are often unpredictable, and the actual results of such proceedings cannot be determined with certainty.

Item 1A. Risk Factors

The discussion under the heading “Regulatory Compliance and Risk Management Matters” contained in Part I, Item 2 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) of this Quarterly Report on Form 10-Q, supplements and modifies the discussion of the risk factor “The supervision and regulation to which the Corporation is subject is increasing and can be a competitive disadvantage; the Corporation may incur fines, penalties and other negative consequences from regulatory violations, including inadvertent or unintentional violations” as set forth in Part I, Item 1A of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2013. There have been no other material changes to the risk factors as previously disclosed in Part I, Item 1A of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2013.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table presents the Corporation's monthly repurchases of its common stock during the first quarter of 2014:
Period
 
Total Number of Shares Purchased
 
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
January 1, 2014 to January 31, 2014
 
684,800

 
$12.66
 
684,800

 
3,315,200

February 1, 2014 to February 28, 2014
 
3,315,200

 
$12.41
 
3,315,200

 

March 1, 2014 to March 31, 2014
 

 
 

 


On October 22, 2013, the Corporation announced that its board of directors had approved a share repurchase program pursuant to which the Corporation was authorized to repurchase up to four million shares, or approximately 2.1% of its outstanding shares, through March 2014. As of March 31, 2014, 4.0 million shares were repurchased, completing this repurchase program. No stock repurchases were made outside the program and all repurchases were made in accordance with the guidelines of Rule 10b-18 and in compliance with Regulation M.

Item 3. Defaults Upon Senior Securities
Not applicable.

Item 4. Mine Safety Disclosures
Not applicable.


61


Item 5. Other Information
Not applicable.

Item 6. Exhibits
See Exhibit Index for a list of the exhibits required by Item 601 of Regulation S-K and filed as part of this report.

62




FULTON FINANCIAL CORPORATION AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
FULTON FINANCIAL CORPORATION
 
 
 
 
 
 
 
Date:
 
May 12, 2014
 
/s/ E. Philip Wenger
 
 
 
 
E. Philip Wenger
 
 
 
 
Chairman, Chief Executive Officer and President
 
 
 
 
 
Date:
 
May 12, 2014
 
/s/ Patrick S. Barrett
 
 
 
 
Patrick S. Barrett
 
 
 
 
Senior Executive Vice President and
 
 
 
 
Chief Financial Officer


63


EXHIBIT INDEX
Exhibits Required Pursuant
to Item 601 of Regulation S-K
 
 
 
 
 
3.1
  
Articles of Incorporation, as amended and restated, of Fulton Financial Corporation– Incorporated by reference to Exhibit 3.1 of the Fulton Financial Corporation Current Report on Form 8-K dated June 24, 2011.
 
 
 
 
3.2
  
Bylaws of Fulton Financial Corporation as amended – Incorporated by reference to Exhibit 3.1 of the Fulton Financial Corporation Current Report on Form 8-K dated September 18, 2008.
 
 
 
 
31.1
  
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
31.2
  
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
32.1
  
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
32.2
  
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
 
101
 
Financial statements from the Quarterly Report on Form 10-Q of Fulton Financial Corporation for the quarter ended March 31, 2014, filed on May 12, 2014, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income (iv) the Consolidated Statements of Shareholders' Equity, (v) the Consolidated Statement of Cash Flows and (vi) the Notes to Consolidated Financial Statements - filed herewith.
 
 
 
 


64