FULTP - Fulton Financial Could Use More Core Growth Leverage

Summary

• Fulton Financial came up a little short on revenue and pre-provision profits in the fourth quarter, though rate and operating leverage weren't bad.
• Organic loan growth looked quite weak, but Fulton is standing out more on deposit beta as funding costs remain low.
• A long-term core earnings growth rate in the 5% to 6% range can support a high-teens fair value, but 2023 could be a challenging year for organic growth.

It’s still early in the fourth quarter reporting cycle, but so far the bank sector is not having the easiest time. The main drivers aren’t all that surprising to me – I’ve been writing about the threats presented by rising deposit betas, weaker operating leverage, and slowing loan demand for some time, but it seems as though the Street is taking it more seriously now.

Fulton Financial ( FULT ) came up short on fourth quarter results and 2023 guidance, although the bank is actually performing well with respect to its deposit beta. Leveraging the Prudential Bancorp deal will be an important driver in 2023, as will the health of the economy in the Philadelphia region, but this remains a bank that has something to prove to the Street where operating leverage and organic growth are concerned.

These shares have fallen about 10% since my last update , more or less matching regional bank peers. I do think the shares are likely undervalued here, but with a challenging 2023 ahead and not a lot of clear positives to tie a bullish thesis to, I can’t really muster that much enthusiasm today.

Lackluster Results To Close The Year

Fulton’s fourth quarter results weren’t a disaster, but they were disappointing relative to sell-side expectations, and pre-provision operating performance was likewise lackluster.

Revenue rose 22% year over year and 2% quarter over quarter, and it’s worth noting that these results include Prudential from roughly the start of November. Revenue came up modestly (about 1%) short of expectations. Net interest income rose 36% yoy and about 5% qoq, with the bank benefiting both from some growth in reported earning assets (up 0.4% qoq) and a stronger net interest margin (up 15bp qoq to 3.69%).

Fee income fell 15% yoy and 8% qoq, with core commercial fees down 11% qoq and core consumer fees down 9% qoq. Weak mortgage banking (down 71% yoy and 43% qoq) also didn’t matter. Commercial fees were pressured by weaker revenue in capital markets (down 35% qoq), while consumer fees were pressured by weaker overdraft fees (down 25%).

Adjusted operating expenses rose 8% yoy and almost 3% qoq, with Fulton seeing a slight worsening in efficiency ratio on a sequential basis (from 59.2% to 59.5%). Pre-provision profits jumped 51% from the year-ago period, but only improved by 1% from the prior quarter.

Softer Balance Sheet Trends, But Deposit Costs And Credit Are Bright Spots

Fulton reported that net loans (adjusted for PPP) rose more than 12% yoy and about 3% qoq in the fourth quarter. Management didn’t offer insight into organic growth trends, but looking at where Prudential loans were trending earlier in the year, it’s possible that there was minimal organic growth – if Prudential’s loan balances held steady from its last fillings, Fulton’s growth would have been pretty flat.

As reported, though, 6% sequential growth in C&I lending was better than the flattish results seen by smaller U.S. banks in the fourth quarter (though keep in mind that by the standards of Fed reporting, “smaller” just means not one of the 20 largest banks).

Yields continue to improve with higher rates, though, as average loan yields jumped from 3.47% last year and 4.21% in the third quarter to 4.80% this quarter. Given the structure of Fulton’s loans and where we are in the rate cycle, there could still be some further upside to loan yields, particularly if Fulton can grow the C&I book relative to mortgages.

On the deposit side, 4% yoy and 3% qoq attrition in deposits was disappointing and likely worse than average. Non-interest-bearing deposits declined 5% qoq on an end-of-period basis and 3% on an average balance basis, and Fulton’s ratio of non-interest-bearing deposits to total deposits is still pretty good at around 34%.

I’m also impressed with the bank’s comparatively low deposit beta. Deposit costs rose 25bp qoq to 0.43% (with interest-bearing deposit costs up 37bp to 0.65%), and that is likely to hold up as a good number relative to many banks. Likewise, I calculate a cumulative beta for interest-bearing deposits of 12% and about 7.5% for total deposits, and that’s likely to be well on the low end of the curve, particularly as betas are likely to peak above 30% for many banks.

Charge-offs did pick up in the quarter, with a net charge-off ratio of 0.23 versus 0.01 in the prior quarter, but the non-performing loan ratio (0.85% versus 0.98% in Q3’22) and non-performing asset ratio (0.66% versus 0.76% in Q3’22) are both holding at fairly healthy levels. I do expect credit costs to continue rising across the sector, but Fulton seems to be fine at this point.

The Outlook

This year is going to be a more challenging one for banks, and Fulton will have to really focus on “blocking and tackling” in this environment. Deposit costs are holding up well, but increased attrition from customers seeking out higher rates remains a risk. I likewise believe loan growth will be more challenging in the near term. Integrating Prudential can drive some value creation, but the Street really needs to see more organic momentum here.

I’m looking for mid-term core earnings growth of around 6% from 2022’s level and longer-term core earnings growth in the 5% to 6% range. I do see opportunities to gain share in the metro Philly area, as well as opportunities to grow in New Jersey and Maryland, and I’ll be curious if Fulton can leverage relatively attractive funding costs to gain some share from non-bank lenders in commercial lending.

Between discounted cash flow, ROTCE-driven P/TBV, and P/E, I believe Fulton shares can trade in the high teens, even with a lackluster fourth quarter and initial guidance for 2023.

The Bottom Line

If a fair value in the $18 to $19 range is indeed reasonable for Fulton, the shares do offer some worthwhile upside. My issue has never really been price/value with Fulton, but rather the company’s ability to generate attractive organic loan growth and operating leverage and complement this with value-creating deals in a regional that isn’t particularly attractive to most bank investors. I could see some bargain-hunting boosting Fulton shares as the reaction to the quarter and 2023 guidance fade, but I want to see a little more in the reported operating results before getting more bullish.

For further details see: