Fulton 2Q19 Report

FULT: Strong Fee Income Leads to Better-Than-Expected 2Q19 Results; Reducing EPS Estimates Slightly on Declining Rate Environment; Reducing Target Price, Reaffirming Neutral Rating.

2Q19 Results:

Fulton reported 2Q19 net income of $59.8 million or $0.35 per share, up 5.5% compared to the $56.7 million or $0.33 in 1Q19. Reported 2Q19 results exceeded our $0.33 estimate by $0.02, and the $0.34 Street consensus estimate by a penny. Higher-than-anticipated non-interest income, primarily commercial banking and mortgage banking income, coupled with a slightly lower-than-expected effective tax rate, were the main drivers of the out-performance versus expectations.

• Gross loans held for investment grew 0.7% sequentially, falling shy of the 1.2% growth we had projected. The sequential quarter advance was led by the residential mortgage category, which rose $138.1 million or 6.0% linked-quarter, accounting for roughly 130.0% of loan growth in the quarter. The CRE segment also contributed substantially, rising $69.3 million or 1.1% sequentially, while the consumer segment added $19.3 million or 4.5%. Offsetting some of this growth were declines of $64.3 million or 1.5% in C&I loans and $26.5 million or 1.9% in home equity loans. Average loans held-for-investment for 2Q19 grew at a slightly faster pace than period-end loans, rising 0.8% compared to 1Q19, with the residential mortgage, CRE, and consumer categories leading the way.
• Deposits advanced $10.9 million or 0.1% compared to 1Q19. Non-interest bearing accounts declined $28.6 million from the prior quarter, and interest bearing core deposit accounts declined $92.2 million. Meanwhile, time and brokered deposits, increased $131.7 million or 4.4%. Non-interest bearing deposits dropped to 25.8% of total deposits from 26.0% at March 31, 2019, while time and brokered deposits increased to 19.2% of deposits, up from 18.4%.
• Net interest income climbed 0.8% linked-quarter, as a 1.2% rise in average earning assets was partially offset by 5 bps of NIM compression to 3.44% (on a fully-tax equivalent basis). The average yield on loans climbed 4 bps linked-quarters, leading to a 2 bps hike in average earning asset yields. However, the average cost of interest bearing deposits rose 7 bps sequentially, while short-term borrowing costs jumped 13 bps, leading to an 8 bps increase in the average cost of interest bearing liabilities.
• Core non-interest income grew $7.5 million or 16.0% sequentially to $54.1 million. Much of the increase represents a rebound from seasonal drops experienced in the prior quarter, as items such as consumer card income, overdraft fees and merchant & commercial card income all advanced noticeably in 2Q19 compared to 1Q19. In addition, SBA loan income and commercial loan interest rate swap fees also rose considerably. Meanwhile, wealth management fees climbed a modest $0.9 million or 6.9% sequentially and mortgage banking income jumped $1.8 million or 38.2% from the prior quarter.
• Non-interest expenses increased $6.3 million or 4.6% compared to 1Q19. Much of the rise was driven by higher charter consolidation expenses, which were $5.1 million in 2Q19, $3.6 million more than in 1Q19. This included $2.5 million of the $2.9 million growth in outside services expense, as well as $1.6 million in salaries and benefits expenses, which were up $1.2 million in total compared to 1Q19. A rise of $1.6 million in occupancy expenses, offset partially by a $1.0 million reduction in professional services, was the other major contributor to the expense increase for the quarter.
• Fulton recorded an income tax expense of $9.9 million in 2Q19, down $0.6 million compared to 1Q19. This translates to a 14.2% effective tax rate versus the 15.6% rate in the prior quarter. We had projected a similar 15.6% effective tax rate for the quarter, but the rate recorded was still within the 14.0% to 16.0% effective tax rate range anticipated by management.
• The 2Q19 loan loss provision was $5.0 million, down $0.1 million or 1.5% from the $5.1 million recorded in 1Q19. The company recorded a net recovery of prior charge-offs of $1.5 million or (0.04)% of average loans compared to 0.10% in 1Q19. Meanwhile, NPLs/Loans edged up to 0.90% from the 0.85% posted in the prior quarter. As a result, the allowance for loan losses slipped to 120% of NPLs versus 123% at March 31, 2019.
• Tangible book value per share rose 2.3% to $10.63 at June 30, 2018 from $10.39 at March 31, 2019, while the TCE ratio declined to 8.54% from 8.64%. Fulton’s regulatory capital ratios saw modest decreases, as the leverage ratio slipped 3 bps sequentially to 8.89% and the total risk-based capital ratio slid to 12.42% from 12.63%. In any case, the regulatory ratios remain well above the minimums required to be considered “well-capitalized”.
• The company’s repurchase program was more active in 2Q19 than in the prior quarter. Fulton repurchased $58 million of common stock in 2Q19 compared to $5.9 million during the previous quarter. This leaves approximately $48 million in the $100 million share repurchase authorization Fulton’s Board approved in March that will expire on December 31, 2019.

Earnings Estimates:

Loan growth came in a bit below our expectations in 2Q19. Management explains that an increase in loan payoffs of roughly $50 million held loan growth back, but even adding this back in, growth still came up short of the 1.2% rise we projected. Management maintaining its low- to mid-single digit loan growth guidance for the year. We have adjusted our projections down slightly, but our full year growth projection of 4.1% remains within the guidance range. Similarly, we have slightly reduced our forecast on the deposit side to 2.9% growth for the full year, but this also falls within the same guidance range.

The biggest change in our projections should be no surprise. Around 1Q19 earnings announcements, expectations for one or more additional Fed rate hikes in 2019 were still alive (if just barely). Now, there seems to be a near certainty in the market for two or more rate cuts in 2019. Consequently, our NIM projections have changed. Fulton’s NIM contracted 5 bps in 2Q19 and we see additional NIM compression of 2-3 bps per quarter for the remainder of the year. Management reduced NIM guidance for a full year 2019 NIM increase of 4-7 bps from the 3.40% recorded in 2018 to an increase of 2-5 bps. We now see net interest income of $664.4 million in 2019, down from our prior $677.7 million projection, but still a 5.4% increase from 2018. We are forecasting net interest income growth at a more modest 1.6% pace in 2020.

The other significant change in our model is in non-interest income, which performed much better than we anticipated in 2Q19. We are now projecting growth of roughly 5.9% in core non-interest income in 2019, up from our prior 3.0% projection, and 3.7% in 2020. On the non-interest expense front, we are modeling growth of 3.8% in 2019 and 1.8% in 2020. The 2019 expense growth includes approximately $11.0 million in charter consolidation expenses, an increase from the $9.0 million in our prior model. We have reduced the effective tax rate in our model to 14.8% going forward, down from the 15.6% rate we had been using and between the rates recorded in 1Q19 and 2Q19. This still falls within management’s guidance range of 14%-16%.

After making the adjustments above, we are slightly adjusting our 2019 estimate to $1.41 from $1.37. We are reducing our 2020 EPS estimate to $1.29 from $1.31. We are still including in our 2020 estimate a very unscientifically-derived $25 million increment to the loan loss provision in 1Q20 to account for the implementation of CECL, meant more as a reminder of the rapid approach of CECL implementation than an accurate reflection of the expected impact. The incremental loan loss provision causes a reduction of roughly $0.13 to FULT’s 2020 EPS. Thus, our new 2020 estimate excluding this incremental charge is now $1.42, down from the prior $1.44 estimate. We are also reducing our 2021 EPS estimate to $1.41 from $1.46.

Valuation:

Fulton stock is currently valued at 153.5% of tangible book value and 11.8x trailing twelve months EPS. Both of these multiples are relatively close to the peer median valuations of 162.7% of TBV and 11.5x TTM EPS. Our longer-term outlook for Fulton remains largely unchanged. With the last BSA/AML order terminated and the consolidation of all the subsidiary banks underway, Fulton will have greater flexibility in deploying capital. We are reducing the multiple we use to value FULT stock to 12.0x forward EPS, down from the 13.0x EPS multiple we used previously, reflecting current peer multiples. Applied to our $1.42 EPS estimate for the next four quarter (2Q19-1Q20, excluding the impact of the incremental CECL provision), this provides a $17.00 price target, down $1.00 from our prior target. Our target suggests a gain of roughly 3.7% from the current price. Coupled with the stock’s 3.17% dividend yield, this leads to a 6.9% total return. Consequently, we are reaffirming our Neutral rating on shares of FULT.