Fulton Financial: A Complete Review Before Earnings

Here's a deep dive into Fulton Financial's soundness, profitability, and growth to prepare for the company's second-quarter earnings results this week.

Jul 21, 2014 at 9:57AM

Over the next month, banks will be releasing results for the second quarter. In advance of these releases, let's take a moment to review the state of some of these banks as of the end of Q1.

Fulton Financial Company Website

Today we'll look at Fulton Financial Corporation (NASDAQ:FULT), a $16.9 billion bank holding company headquartered in Lancaster, Pennsylvania, which reports earnings this Tuesday, July 21. You can find information on other banks at my Motley Fool article feed, available here. All data in this analysis was sourced from the FDIC's Quarterly Banking Profile and S&P Capital IQ.

When I evaluate banks, I follow a model made famous by former Wachovia CEO John Medlin: soundness, profitability, and growth. As investors, we then look at valuation and the potential for investment after gaining a better understanding for each bank.

Soundness refers to the bank's asset quality. Generally speaking, this means loans. If a bank makes loans that are never repaid, that bank will fail, and fail quickly. The best banks put risk management first, ensuring that shareholder capital is protected if a portfolio of loans turns sour.

To measure this, we'll look at both non-performing assets and Fulton Financial Corp.'s provision for loan and lease losses. A simplified definition of non-performing assets is loans or other assets that have fallen seriously delinquent or are in foreclosure.

The provision for loan and lease losses is a reserve of money that the bank pulls out of its income each quarter to guard against future losses in the loan portfolio. Banks are required by regulation to maintain certain levels of reserves, but within that, management has plenty of wiggle room to over- or under-reserve. Over-reserving increases protection but hurts net income; under-reserving increases risk but keeps net income high.


Fulton Financial's NPA trend. Source: BankRegData.com.

For the quarter ending on March 31, Fulton Financial Corp. had 1% non-performing assets as a percentage of total assets. The FDIC reports that banks with total assets greater than $10 billion on average had 1.5% non-performing assets as a percentage of total assets.

Fulton reserved $2.5 million for the first quarter, which represented 1.5% of operating revenue. That compares with 5% for the $10 billion-plus peer group, according to the FDIC.

Since the second quarter of 2011, Fulton and its subsidiaries have literally halved the total level of non-performing loans. This trend continued in the first quarter of this year, and I expect it to continue in Q2's numbers.

Another facet of soundness is compliance with all legal and regulatory requirements. Last week, regulators issued enforcement orders against three of Fulton's subsidiary banks. These subsidiaries failed to fully comply with Bank Secrecy Act and Anti-Money Laundering requirements. I don't see too much risk to shareholders based on the consent order released last week. However, it is worth noting as an indication of management's focus (or perhaps, lack thereof) on these business-critical compliance issues.

After establishing an understanding of a bank's risk culture and soundness, next we can focus on profitability. Any investment in a business is an investment in that company's future earnings, so profitability is a particularly important consideration for any bank investor.

The first question, perhaps most obviously, is if the bank actually generates a profit at all. According to data from the FDIC, 7.3% of U.S. banks failed to generate a profit at all in the first quarter. That's one in every 14 banks!

For Fulton Financial, the first calendar quarter of 2014 fortunately wasn't that bad. The company generated total net revenues of $168.1 million for the quarter -- that's total interest income plus non-interest income minus interest expense.

FULT Return on Equity (TTM) Chart

FULT Return on Equity (TTM) data by YCharts

Over the past 12 months, Fulton has generated $678 million in total net revenue. Of that revenue, 77% was attributable to net interest income, the difference between interest earned on loans and paid out to depositors. The remaining 23% was through fees, trading, or other non-interest revenue sources.

The bank was able to turn a profit margin of 24% on that revenue.

For the first quarter, the company reported return on equity of 8.1%. Of the banks covered in this series of articles, the average return on equity was 8.9%. The FDIC reports that the average ROE for U.S. banks with total assets greater than $10 billion was 9.1%.

In the bank's letter to shareholders reporting the first quarter's results, Philip Wenger, the company's chairman and CEO, cited the harsh weather this past January and February as being particularly challenging in Fulton's footprint in the Northeastern United States. The company deferred two major marketing campaigns until March in an effort to produce better results on those campaigns.

Fulton Financial Footprint Company Website

Fulton's subsidiaries and footprint. Source: Company website.

The company also completed a major cost-cutting initiative in the first quarter -- consolidating 14 branches, adjusting some employee benefits, and thinning out middle management. These changes are expected to save $7 million through the rest of 2014.

The company's profitability was more or less on level with the average of the bank's peer set, and with the extra marketing push as the weather thawed, coupled with the more efficient branch and management structure, I expect the company's profitability to improve in the second quarter.

Leverage is a double-edged sword for banks and could easily fit into either the soundness or profitability categories. We'll call it a subset of both and discuss it here.

Leverage is just part of the game with banks, so if you're a conservative investor who really focuses on conservative capital structures, the banking industry may not be the best place for your money. Adding leverage is an easy way to juice return on equity, which is, generally speaking, a good thing. The bank increases assets and thus earnings, while maintaining a lower capital level.

The result is a higher numerator, a constant denominator, and a larger return-on-equity number. The math does the heavy lifting for you.

On the flip side, too much leverage can put the bank on thin ice if the loan portfolio takes a turn for the worse. A stronger equity base protects the bank from bankruptcy and bailouts, two outcomes that are both politically charged and downright terrible for shareholders.

Banks use all kinds of esoteric and overly complex accounting methods to determine leverage. We'll keep it simple here with an old-fashioned assets-to-equity ratio. The lower the number, the less levered (and more conservative) the bank.

FULT Assets To Shareholder Equity (Quarterly) Chart

FULT Assets To Shareholder Equity (Quarterly) data by YCharts

Fulton's assets to equity ratio comes in at 8.2. The average of the 62 banks analyzed in this series of articles was 9.1. The company's below-average return on equity is largely correlated to this conservative leverage position.

Growth and valuation
Fulton Financial Corp. saw its revenues change by 2.4% over the past 12 months. That compares with the 5.74% average of the 62 banks analyzed.

This change in revenue corresponded with a 2.4% change in net income over the same period. The peer set averaged 14.1%.

Fifty-four precent of all U.S. banks saw year-over-year earnings growth in the first quarter. In the case of Fulton Financial and its subsidiaries, the cold winter really hindered Q1 growth. That said, with the marketing push mentioned previously, it stands to reason that the company will report a much stronger second quarter.

Moving now to valuation, Fulton Financial Corp. traded at a forward price-to-earnings ratio of 14.0, according to data form S&P Capital IQ. That compares with the peer set average of 16.7 times.

Fulton Financial Corp.'s market cap is, at the time of this writing, 1.5 times its tangible book value. The peer set average was 1.9.

FULT Price to Tangible Book Value Chart

FULT Price to Tangible Book Value data by YCharts

Many investors use a general rule of thumb of buying a bank stock when the price-to-tangible book value is less than 0.5 and selling when it rises above 2. For me, that method is just way too oversimplified.

It sometimes makes sense to pay a premium for a bank stock that places a high value on credit culture and asset quality. These banks will survive and prosper while others fall by the wayside. That security can be worth a premium. Likewise, a bank that relies heavily on leverage to achieve above-average return on equity may not be worth the price, even if price-to-tangible book value is low. That risk may not justify even a healthy discount in price.


Based on the factors we've discussed here -- soundness, profitability, and growth -- Fulton Financial Corp. appears undervalued. The bank's soundness is acceptable, and profitability is strong and improving. The company has conservative leverage and trades at a healthy discount to peer average tangible book value.

Fulton Financial seems to be on the rise. I expect Q2 earnings to continue the trend.

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Jay Jenkins and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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