By all accounts, Fulton Financial Corp. in Lancaster, Pa., had a respectable third quarter, reporting a 14% increase in net income from the previous quarter, to $48.3 million.
Yet within two days of its Oct. 17 earnings announcement, three analysts downgraded the $14.9 billion-asset company's stock, pointing to a pessimistic outlook for the banking industry in general.
Performing well now is not enough to comfort analysts about what lies ahead. At least 35 banks had higher revenue and income in their last reported quarter compared to the preceding quarter, but got downgraded by two or more analysts anyway, according to data from StarMine Corp., a San Francisco firm that tracks earnings and analyst recommendations for 567 commercial banks.
Analysts blame mainly a difficult operating environment, as an inverted yield curve and intense competition for loans and deposits continue to cut net interest margins.
"Most of the management teams - even with the companies that had good numbers - are talking down the next couple of quarters, due to both net interest margin issues and credit issues," said Mark Fitzgibbon, the director of research at Sandler O'Neill & Partners LP.
"I think analysts are looking past the current quarter and making more conservative assumptions about the future," he said.
Mr. Fitzgibbon said valuation is another common trigger behind the downgrades of companies with good earnings.
He said that is more apt to be a factor lately, because bank stocks have rallied over the past several months. He pointed out that the Standard & Poor's Corp. Bank Index has risen about 9% since the end of June and the Nasdaq Bank Index 7%.
StarMine found that another 46 companies that had increases in revenue and income were given a lone downgrade, including Sterling Bancshares Inc. in Houston and Susquehanna Bancshares Inc. in Lititz, Pa.
Sterling's third-quarter income of $11.7 million - which it reported Tuesday - rose 4% from the previous quarter and 35% from a year earlier.
Sandler O'Neill analyst Brad Milsaps downgraded the company to "hold" from "buy" Wednesday, even though he called it "one of the most attractive banking franchises in Texas" and said he expected double-digit growth in its earnings per share next year. He cited valuation and greater-than-expected margin contraction of 11 basis points from the previous quarter, to 4.87%.
"Continued pressure on the company's net interest margin will make it difficult for the shares to outperform over the near term," Mr. Milsaps wrote.
Matthew Schultheis, an analyst at Ferris, Baker Watts Inc., said valuation was the sole reason he downgraded Susquehanna to "neutral" from "buy" on Wednesday, a day after it reported that income jumped 31% from the second quarter and 42% from a year earlier. His target price is $26 a share; it was trading at $25.13 late Friday.
Drew K. Hostetter, Susquehanna's chief financial officer, said that though he was pleased with the company's third-quarter results, he understands why analysts are "less bullish" on the industry.
"Banks are going to have a difficult time," he said. "Every banker will tell you, it's tough to improve the net interest margin right now."
R. Scott Smith Jr., Fulton's chairman, president, and chief executive officer, took the downgrades of his company in stride.
"Our job is to grind out the earnings," Mr. Smith said. "Wall Street will take care of itself."
Three analysts who had rated Fulton's stock "buy" or "outperform" lowered it to the equivalent of "hold."
All spoke highly of the company, citing strong management, solid loan growth, and stellar asset quality. But they said its net interest margin of 3.85% - which shrank by 5 basis points from the second quarter and 7 from a year earlier - is likely to continue contracting.
"Up until this quarter Fulton had unbelievable consistency in its net interest margin," said Cohen & Co.'s Andrew W. Stapp, one of the analysts who downgraded the company.
Mr. Stapp said the "biggest negative surprise" at Fulton is that the margin would have dropped even more steeply in the third quarter if it had not been bolstered by $3.3 million in interest recovered on nonperforming loans.
"When you dig through the numbers, the core compression is really 13 basis points, compared to the previous quarter," he said.
That also factored into downgrades from Wilson L. Smith of Boenning & Scattergood Inc. and Richard D. Weiss of Janney Montgomery Scott LLC. Mr. Smith said he expects consumers to continue shifting their money into higher-yielding certificates of deposit in the fourth quarter, further shaving Fulton's margin.
Still, he said Fulton remains "at the top of my list" of banking companies.
"We believe Fulton has some of the best management of any of the banks we cover, and they have one of the lowest-risk balance sheets in the business," Mr. Smith said. "However, with the yield curve the way it is and the outlook for net income increases in the next 12 months, we frankly couldn't justify keeping the 'outperform' rating."
Fulton made $10.3 billion of loans during the third quarter, a 25% jump from a year earlier. It attributed half of that growth to Columbia Bank in Maryland, which it bought in February. The other half came from an increase in commercial mortgages, commercial loans, and construction loans.
That impressed analysts, but not enough to stave off the downgrades.
"A lot of banks I cover haven't been able to get the kind of loan growth Fulton gets," Mr. Smith said. "That's what has allowed me to keep it at 'outperform' for as long as I did."
Company executives echoed much of the industry in their Oct. 17 earnings conference call, lamenting the fierce competition for loans and the increased cost of funding loan growth as core deposits move into CDs.
"The competitive environment will continue to create headwinds for both balance-sheet and fee income growth," Fulton's Mr. Smith said during the call.
Mr. Weiss, who downgraded the company to "neutral," said he thought it had a "decent" quarter but that it faces tougher times ahead, with margin pressure unlikely to abate.
"The downgrade doesn't mean sell," he said. "If you own it, it's a quality company, and I would continue to own it."
Collyn B. Gilbert, an analyst at BankAtlantic Bancorp Inc.'s Ryan Beck & Co. Inc., kept her "outperform" rating on Fulton. She said she has "faith" that it can improve performance by increasing fee revenue at its 15 subsidiary banks.
"I think they need to leverage their affiliate network more," she said.
Ms. Gilbert said she considered downgrading Fulton but decided against it. She did lower her price target by $1, to $18, along with her earnings-per-share estimates.
"It's not going to be a home run, but I think your downside is protected," she said of Fulton's stock, which was trading at $16.06 late Friday.
