First Citizens Stock: off to a good start with a transformative acquisition

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For several years, investors holding shares of banks undergoing major mergers have had to wait a while to see the benefits, as the market has adopted a wait-and-see approach that has resulted in underperformance relative to benchmarks until the synergies begin. to show up. So far, First Citizens Bancshares‘ (NASDAQ: FCNCA) (“First Citizens”) The merger with CIT is working well, and the stock has outperformed on strong core operating profits, with early signs of cost synergies and above-average loan growth.

Up about 15% since my last update, First Citizens has outperformed the regional banking sector by almost 15%, as well as other commercially oriented growth banks like Bancorp East-West (EWBC), Pinnacle Financial (PNFP), Signature (SBNY), or SVB Financial (SIVB). I have some concerns about a weaker macro environment in 2023 and higher deposit costs, but I still expect normalized high single-digit core growth from this bank, and that continues to support attractive performance in a country still at a disadvantage in the sector.

Review of third quarter results

First Citizens isn’t particularly well-followed, so comparing results to sell-side estimates is a bit less informative than it might otherwise be. Even so, results far exceeded expectations despite higher provisioning as First Citizens benefited from good core performance trends.

Investors should note that I will generally only discuss quarterly comparisons, as the inclusion of CIT significantly skews year-ago comparisons.

Sales increased by 10% sequentially, which is fairly representative of the period. Net interest income increased nearly 14% quarter-on-quarter, above average, as did the 36 bps quarter-over-quarter improvement in net interest margin (at 3.4%). Commission income increased 2% on a basic basis, with some underlying growth in service fees and rental income.

Core expenses increased 2% QoQ, driving a 430 bps sequential improvement in the efficiency ratio to 53.3%. First Citizens outperformed on operating leverage, but I would expect it to do so given the cost synergies it is expected to achieve now. At 53.3%, First Citizens’ spend ratio compares fairly well to most of its peers, though Pinnacle’s 47% and Signature’s 31% are impressive in themselves.

Earnings before provision rose more than 21% sequentially, an above-average result in a quarter when many banks achieved double-digit sequential growth. Tangible book value per share declined sequentially (by 2.4%) as the bank suffered market value losses in its securities portfolio (a common occurrence).

Healthy growth, but watch out for the macro

The new First Citizens is designed first and foremost to be a strong commercial lender, leveraging multiple verticals, strong demand for equipment financing and some of the more specialized financing needs of small and medium-sized businesses. Third quarter results were strong in this regard.

Overall, lending was up 3% sequentially, essentially keeping pace with its peers while outpacing the banking sector (according to Fed H.8 data). Growth was balanced, with growth of more than 3% in C&I and CRE loans, as well as growth of almost 4% in mortgage loans. C&I growth was helped by demand in verticals such as energy, healthcare and technology, and I was impressed that First Citizens saw stronger than average CRE loan growth. Mortgage growth was driven primarily by continued higher issuance.

Yield improved significantly by 57 basis points on a sequential basis. Credit quality was good. There was an expected uptick from pre-CIT credit levels (non-performing loans up 15bps as a percentage of total loans, loan loss provisions up 70bps to 1.26%), but nothing beyond expectations that I consider notable.

Deposits were down 2% sequentially, which was a little worse than average. However, non-interest bearing deposits were nearly flat sequentially, and that was a bit better than average. The cost of interest-bearing deposits rose 24 bps to 50 bps, about half the rise of its peer group, and while the total cost of deposits rose 17 bps quarter-on-quarter, it is still relatively good at 0.35%.

What follows is more debatable. Management is guided by slower loan growth, which, while a little disappointing, appears realistic in the context of a weakened macro environment and greater caution among commercial borrowers. Mid-single-digit growth in 2023 would be a little light, but management could be conservative here.

So far, First Citizens’ deposit beta (the rate at which deposit costs increase relative to underlying interest rate levels) compares well to its peers. Management is moving towards a full cycle deposit beta of 25%, and I think that might be a bit too optimistic. I expect higher betas during this next phase of the cycle (that’s been my call all year), and I think 30%+ is more likely, although I expect that the First Citizens do better than average on this metric. A key issue is loan growth – if loan growth remains more subdued, First Citizens will not have the same funding pressure forcing it to enter the higher cost deposit market.

Perspectives

Not much has changed in my outlook for First Citizens, although recent results have been strong and I have slightly changed my estimates for 2022 and 2023, but that is largely due to the share buyback the company has launched over early this year; management has indicated that if 2023 goes according to plan, another major buyout could take place next year. Long term, I still expect mid- to high-digit core earnings growth as the bank leverages its enhanced domestic specialty commercial lending capabilities and continues to leverage growth in its domestic markets in the mid-Atlantic and southeast region.

The essential

Between discounted baseline earnings and multiple driven approaches, I think First Citizens remains undervalued. Long-term discounted baseline earnings (including estimated earnings of $1.8 billion in 2026) support a double-digit annualized total return from here, while a ROTCE-based P/TBV approach and a P/E approach (using a 10x forward multiple) gives me a fair value around $960.

It probably shouldn’t come as a surprise that after outperforming its peer group, First Citizens doesn’t seem to offer the same edge as many other battered banking stocks. I think part of this reflects the “low hanging fruit” of more certain operating leverage as First Citizens reaps merger-based synergies, but part could also be due to the increased business of specialized loan from the company. Either way, I think First Citizens remains a good bank to consider, but there are certainly names trading at even deeper discounts to fair value.