Fulton Financial: Margin & Loan Growth Outlook Remains Rosy

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helen89

Earnings of Fulton Financial Corporation (NASDAQ:FULT) will likely be flattish this year before growing strongly next year. Mid-single-digit loan growth will likely support earnings in the coming quarters. Further, the large balance of variable-rate loans will enable the margin to quickly benefit from the rising rate environment. Overall, I’m expecting Fulton Financial to report earnings of $1.66 per share for 2022 and $1.88 per share for 2023. Compared to my last report on the company, I’ve slightly increased my earnings estimate for next year as I’ve raised my margin estimate. Next year’s target price suggests a significant upside from the current market price. Therefore, I’m maintaining a buy rating on Fulton Financial Corporation.

High Borrowing Costs, Runoffs to Pressurize Loan Growth

Fulton Financial Corporation’s loan portfolio grew by 4% in the third quarter of 2022 (16.2% annualized), in line with expectations. The growth was mostly attributed to the acquisition of Prudential Bancorp. Loan growth will likely return to an annualized mid-single-digit range in the coming quarters as high borrowing costs will diminish credit demand. Further, the management mentioned in the conference call that residential loan growth will significantly decelerate going forward because application volumes have already dropped by 35% quarter-on-quarter during the third quarter of 2022.

Moreover, some of Prudential Bancorp’s borrowers may pay down and leave following the acquisition, which is quite natural. Runoffs, pay downs, and streamlining of the acquired loan portfolio happens quite frequently in M&A transactions.

As more than 60% of total loans are in the commercial real estate and commercial and industrial segments, the PMI and coincident indices are appropriate gauges of credit demand. As shown below, the PMI indices are in the expansionary territory, which bodes well for loan growth.

Chart
Data by YCharts

Additionally, the coincident index shows that the pace of economic activity is satisfactory.

Chart
Data by YCharts

Considering these factors, I’m expecting the loan portfolio to grow by 2% in the last quarter of 2022 and 4% in 2023. Compared to my last report on Fulton Financial, I haven’t changed my loan growth estimates much.

Meanwhile, I’m expecting other balance sheet items to grow mostly in line with loans. The following table shows my balance sheet estimates.

FY18FY19FY20FY21FY22EFY23E
Financial Position
Net Loans16,00416,67418,62318,07619,81720,622
Growth of Net Loans2.6%4.2%11.7%(2.9)%9.6%4.1%
Other Earning Assets3,0563,2915,2445,7284,4264,606
Deposits16,37617,39420,83921,57321,59022,467
Borrowings and Sub-Debt1,7471,7651,9261,0381,4391,497
Common equity2,2482,3422,4242,5202,2172,413
Book Value Per Share ($)12.714.014.915.413.114.3
Tangible BVPS ($)9.710.811.612.19.811.0

Source: SEC Filings, Author’s Estimates

(In USD million unless otherwise specified)

Margin Expansion to Slow Down After Third Quarter’s Jump

The net interest margin surged by 50 basis points in the third quarter of 2022, which was higher than my expectations. It was also higher than what was implied by the results of the management’s interest rate sensitivity analysis given in the second quarter’s 10-Q filing. According to the management’s analysis, a 200-basis points hike in interest rates could boost the net interest income by 11.4% over twelve months.

Part of the extraordinary margin expansion during the third quarter was attributable to the management’s ability to restrain deposit costs as market interest rates rose. This restraint is unsustainable unless Fulton Financial wants to lose its deposit customers to other banks. Therefore, the deposit cost is bound to surge with a twang in the fourth quarter of 2022. As mentioned in the conference call, the management also expects to see higher deposit betas in future quarters compared to what has been observed so far in the ongoing rate cycle.

The loan yield will counter the effect of the rising deposit cost on the margin. Around $8 billion worth of loans were variable at the end of September 2022, out of a total loan balance of $19.5 billion, as mentioned in the conference call. As almost half the book is comprised of variable-rate loans, the portfolio’s rate sensitivity is likely to be high in the coming quarters. Additionally, another $4.9 billion worth of loans are adjustable (however, there is not enough information on how soon these loans can reprice).

The margin will also benefit from loan additions. The blended yield for new assets is currently around 5%, as mentioned in the conference call. This is much higher than the average portfolio yield of 4.21% during the third quarter, as mentioned in the earnings release.

Considering these factors, I’m expecting the margin to increase by five basis points in this fourth quarter of 2022 and another five basis points in the first quarter of 2023 before plateauing.

Expecting Flattish Earnings for 2022, Decent Growth for 2023

The anticipated loan growth and margin expansion will support earnings through the end of 2023. On the other hand, inflation-driven growth in operating expenses will restrict earnings growth. Further, there are still some merger-related expenses remaining because, as mentioned in the conference call, the conversion of Prudential Bancorp’s system is scheduled for November 2022.

Meanwhile, I’m expecting the provisioning for loan losses to return to a normal level this quarter. I’m expecting the net provision expense to make up around 0.21% of total loans (annualized) in every quarter till the end of 2023, which is in line with the average for 2017 to 2019.

Overall, I’m expecting Fulton Financial to report earnings of $1.66 per share for 2022, up by just 2% year-over-year. For 2023, I’m expecting earnings to grow by 13% to $1.88 per share. The following table shows my income statement estimates.

FY18FY19FY20FY21FY22EFY23E
Income Statement
Net interest income630648629664779932
Provision for loan losses473377(15)2544
Non-interest income196216229274229230
Non-interest expense546568579618637681
Net income – Common Sh.208226176265275318
EPS – Diluted ($)1.181.351.081.621.661.88

Source: SEC Filings, Earnings Releases, Author’s Estimates

(In USD million unless otherwise specified)

My updated 2022 earnings estimate is almost unchanged from the earnings estimate of $1.68 per share I gave in my last report on Fulton Financial. However, I have increased my earnings estimate for 2023 because I’ve increased my margin estimate following the third quarter’s surprising margin expansion.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to inflation, and consequently the timing and magnitude of interest rate hikes. Further, a stronger or longer-than-anticipated recession can increase the provisioning for expected loan losses beyond my estimates.

Next Year’s Target Price Suggests a High Upside

Fulton Financial has a long-standing tradition of increasing its dividend every year. Therefore, I’m expecting the company to increase its quarterly dividend by $0.01 per share to $0.16 per share in the first quarter of 2023. I’m also expecting special dividends of $0.08 per share for the last quarter of both 2022 and 2023. The earnings and dividend estimates suggest a payout ratio of 38% for 2023, which is below the five-year average of 45%. Based on my dividend estimate, Fulton Financial is offering a forward dividend yield of 4.3%.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Fulton Financial. The stock has traded at an average P/TB ratio of 1.42 in the past, as shown below.

FY18FY19FY20FY21Average
T. Book Value per Share ($)9.710.811.612.1
Average Market Price ($)17.416.512.016.1
Historical P/TB1.79x1.53x1.03x1.33x1.42x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/TB multiple with the forecast tangible book value per share of $11.0 gives a target price of $15.6 for the end of 2023. This price target implies a 6.6% downside from the October 20 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

P/TB Multiple1.22x1.32x1.42x1.52x1.62x
TBVPS – Dec 2023 ($)11.011.011.011.011.0
Target Price ($)13.414.515.616.717.8
Market Price ($)16.716.716.716.716.7
Upside/(Downside)(19.7)%(13.1)%(6.6)%0.0%6.6%
Source: Author’s Estimates

The stock has traded at an average P/E ratio of around 12.0x in the past, as shown below.

FY18FY19FY20FY21Average
Earnings per Share ($)1.181.351.081.62
Average Market Price ($)17.416.512.016.1
Historical P/E14.7x12.2x11.1x9.9x12.0x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/E multiple with the forecast earnings per share of $1.88 gives a target price of $22.6 for the end of 2022. This price target implies a 35.3% upside from the October 20 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

P/E Multiple10.0x11.0x12.0x13.0x14.0x
EPS 2023 ($)1.881.881.881.881.88
Target Price ($)18.820.722.624.526.3
Market Price ($)16.716.716.716.716.7
Upside/(Downside)12.8%24.0%35.3%46.6%57.9%
Source: Author’s Estimates

Equally weighting the target prices from the two valuation methods gives a combined target price of $19.1, which implies a 14.4% upside from the current market price. Adding the forward dividend yield gives a total expected return of 18.5%. Hence, I’m adopting a buy rating on Fulton Financial Corporation.



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