FNB - F.N.B. Corp Generating Good Spread And Operating Leverage In An Increasingly Challenging Market

Summary

• F.N.B. exceeded top and bottom line expectations in the fourth quarter, with strong net interest income growth and good operating leverage driving a $0.04/share pre-provision beat.
• F.N.B.'s cumulative deposit beta is comfortably low and better than most peers, and with modest expectations for loan growth in 2023, the bank shouldn't need to overpay for funding.
• Growth markets like North and South Carolina can support years of healthy growth, but improved customer service/satisfaction may be needed to withstand intense in-market competition.
• Long-term core earnings growth, as well as nearer-term ROTCE and EPS, can support a fair value around $16.

Pittsburgh’s F.N.B. Corporation ( FNB ) (“FNB”) continues to execute well in an increasingly challenging environment. While acquisitions do muddy the waters a bit where comparable numbers are concerned, the reality is that the bank delivered both better-than-expected rate leverage and operating leverage in the fourth quarter and the set up for 2023 looks relatively positive.

F.N.B.’s progress continues to go undervalued in my view. The shares have basically tracked regional bank peers since my last update , but I would argue that the bank’s performance deserves more than that. I do expect more challenging circumstances over the next two years, with weaker loan growth and higher funding costs, but core growth in the neighborhood of 6% can support a fair value above $16 today, making this a name worth consideration ahead of a rally in bank stocks once the Fed eases up.

Solid Fourth Quarter Results, If Not So Easy To Benchmark

The inclusion of the Howard Bancorp and UB Bancorp acquisitions in 2022 do impact the comparability of F.N.B.’s results, but I would say core results were still better than expected. I was particularly encouraged by the well-controlled funding costs and positive operating leverage, both of which have emerged as more problematic talking points with many bank earnings reports this quarter.

Revenue rose more than 37% year over year and almost 10% quarter over quarter, but again, comparability is skewed by the M&A activities. Still, relative to sell-side expectations, revenue came in about 4% better than expected (or around $0.04/share better).

Net interest income rose 50% yoy and almost 13% qoq, a solid beat of around $0.03/share, with net interest margin up almost 100bp yoy and 34bp qoq to 3.53%. Earning assets grew almost 2% qoq. Fee-based income fell more than 2% qoq, but was still around the expected level. Within this category, trust income declined 2% qoq and capital markets income rose 4%, while mortgage banking remains very weak (down 47% qoq).

Core operating expenses rose about 8% yoy and more than 1% qoq, coming in better than expected and with an impressive 47.1% efficiency ratio. Pre-provision profits (on an adjusted core basis) rose almost 81% yoy and 18% qoq, beating expectations by more than $0.04/share. FNB gave some of this back with higher provisioning, but still beat expectations at the bottom line by about $0.02.

Funding Costs Remain Well-Controlled, But Peak Spreads Are Nevertheless In Sight

At this point in the cycle, most banks aren’t going to see all that much improvement from additional rate hikes (the market is expecting 50bp more of Fed tightening) as deposit costs are going to increase at a faster rate than loan yields for most banks. While this is broadly true for FNB as well, they’re better positioned than most.

By my calculation, F.N.B. exited the quarter with a cumulative deposit beta of 13% (management’s calculation was 16%). Either way, FNB is on the low end of the curve where deposit beta is concerned, with most banks in the 20%’s or 30’s. FNB exited the quarter with a loan/deposit ratio of 87%, which isn’t ideal, but a good mix of non-interest-bearing deposits (34% of total deposits) and some “dry powder” in the form of $1.3B in deposits with other banks and $7.2B in securities on the balance sheet.

Loans grew 5% on a reported end-of-period basis and over 3% on an average balance basis. If management disclosed organic loan growth in the conference call I must have missed it, but some back-of-the-envelope “guesstimation” based on UB Bancorp’s last reported quarter would lead me to think that F.N.B.’s organic loan growth rate was something in the neighborhood of 2.5% qoq, not exceptional relative to peer banks, but not problematic either.

Management did disclose, though, that commercial loan pipelines were down about 10% to 15%, and that's consistent with what other banks have been reporting. While it's certainly possible to generate stronger loan growth, it’s worth wondering what compromises faster-growing banks may be making with respect to credit quality or loan terms at this point in the cycle, as many banks have reported that “quality” borrowers have largely stepped to the sidelines.

F.N.B. management guided to mid-single-digit loan growth for 2023, and while that will put a damper on net interest income growth (likely to be in the low single-digits on a sequential basis in FY’23), it does also mitigate some of the need to pay up aggressively for deposits in order to fund loan growth.

Looking at credit, F.N.B. saw a jump in net charge-offs (from 0.04% to 0.16%), but absolute levels of non-performing loans and assets don’t look troubling at present. I do expect credit costs to increase in 2023 (higher provisioning and losses), but that’s just a normal part of the cycle at this point, and I believe F.N.B. is still in a relatively strong credit position.

The Outlook

Given wage pressures and higher FDIC insurance costs, I do expect some erosion in operating efficiency from here, but FNB should still have a comparatively strong efficiency ratio. Likewise, I think there’s still a little spread leverage left in the model (until around mid-year). I do expect that to be the peak, though, and I expect core earnings to decline modestly in FY’24 before rebounding in FY’25. Over the longer term, I expect core earnings growth from F.N.B. in the 6% range, and the bank has shown that it can effectively leverage organic and M&A growth strategies to gain share in attractive markets in North and South Carolina.

Competition remains a risk (as seemingly everybody wants to operate in the Southeast U.S.), and I’d like to see a higher Net Promoter Score here (a measure of customer satisfaction). Over time, motivated employees and satisfied customers are an invaluable component of competing effectively in contested banking markets.

Between discounted core earnings, ROTCE-driven P/TBV, and P/E, I believe FNB shares should trade closer to $16 today.

The Bottom Line

Sentiment remains a real challenge for bank stocks, particularly with the sector at or near peak margins for the cycle. I expect that it will take the Fed signaling an end to further rate hikes (or at least shared anticipation of that event) to really shift sentiment, so there's a risk of these shares continuing to drift. For more patient investors, though, I do see enough value to at least make this name worthy of due diligence.

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