FBK - FB Financial: Not Bad But Also Not Compelling

2023-10-18 11:53:43 ET

Summary

• FB Financial's third-quarter results were decent, but there are evident pressures on core revenue, including sluggish loan growth and rising deposit costs.
• FB Financial has above-average exposure to retail and office CRE, but location matters in real estate and Nashville's CRE market has held up well.
• Management is executing on "blocking and tackling" opportunities - repositioning the securities portfolio and launching a meaningful opex reduction program.
• There's nothing wrong with FB Financial today, but also nothing compelling or exceptional, and the valuation offers lackluster upside compared to many other regional banks.

Since my last update on the company , Tennessee-based FB Financial ( FBK ) has been a basically okay performer in the context of a battered regional bank market. Down about 25% since my last update, the company has done slightly better than regional banks in general, but not as good as names I preferred like Pinnacle Financial ( PNFP ).

At this point I find it hard to work up much enthusiasm for either a bullish or bearish call. There’s nothing wrong with FB Financial – many of the metrics are solidly around the middle of the pack – and I still like the company’s leverage to the attractive Tennessee banking market. On the other hand, the entire region is seeing intense competition and I don’t see a lot to argue that this is a must-own bank, though I do like the company’s efforts to reduce expenses and restructure its securities portfolio.

With a valuation that’s not that compelling compared to many regional banks today, I just don’t see the bullish argument here beyond a “regional banks will turn” sector call with perhaps the added kicker that the bank’s attractive footprint should drive an M&A premium.

Third Quarter Results Weren’t Bad, But Pressures Are Evident

On a core adjusted basis, FB’s third quarter results were fine. The company managed a core pre-provision beat and neither loan nor deposit performance were problematic.

Core revenue declined 8% from the year-ago period and 1% from the prior quarter, a 2% (or about $0.05/share) miss versus Street expectations. Net interest income fell 9% yoy and about 1% qoq on a fully-taxed equivalent basis, coming in about 1% (or $0.01/share) light. While net interest margin was better than expected (up 2bp to 3.42%), earnings assets shrunk more than expected at 2% qoq.

Core non-interest income (adjusted for securities losses, among other things) declined 2% yoy and 5% qoq, missing by about 9% or $0.04/share. Mortgage banking appears to have stabilized, with a 3% yoy and 2% qoq decline, as gain-on-sale margin improved 33bp to 2.75% but commitments continue to shrink (down 9% yoy and 7% qoq).

Core operating expenses declined 4% yoy and 2% qoq, beating expectations by about 6% and adding back more than $0.08/share. Pre-provision profits ( core ) declined almost 14% yoy and were flat sequentially, beating by about 4% or $0.03/share. Loan loss provision and taxes were both lower than expected. Tangible book value per share rose more than 9% and fell about 1% sequentially to $23.93.

Loan Declines Driven By Construction

End-of-period loans rose 2% yoy but fell slightly on a sequential basis (down about 1% on an average balance basis). C&I lending slipped 1.5% qoq, but the bigger driver was the 6.5% decline in construction lending. FB was previously over-exposed to construction (over 100% of capital) and has been working down that exposure. At the same time, commercial real estate lending rose more than 2% sequentially. It’s unclear to me how much of this can be tied to Nashville and other Tennessee metro areas continuing to grow better than national rates and how much can be tied to smaller banks filling in as larger banks pull away from CRE, but both are credible drivers.

Loan yields continue to improve, rising 138bp yoy and 20bp qoq to 6.54%.

On the credit side, management did see one large C&I credit deteriorate, driving a 22% qoq increase in non-performing assets. The non-performing asset ratio still isn’t too bad, though (0.71% vs. 0.59% in Q2’23), and charge-offs remain quite low.

As far as future problems go, the company does have meaningful exposure to both retail (around 5% of total loans) and office CRE (4% of total), as well as over 6% of C&I lending to the real estate and rental sector. I’m not too worried about the retail portfolio given retail occupancy rates in Tennessee. Likewise, while the bank’s skew toward lower-quality office is concerning (23% Class A, 41% Class B, and 11% Class C), occupancy remains okay (over 80%) and loan-to-value ratios are on the lower side (low 60%’s). Moreover, close to 60% of the portfolio is in Nashville, a comparatively healthy market. I do think higher reserving may be necessary here, but it’s not a problem area yet.

Like Most Other Things, Deposits And Funding Look “Okay”

I don’t have many concerns on the funding side either, and I think FB’s relatively clean funding profile helped spare it some grief during the drama in regional banks during the spring.

Deposits rose 6% yoy and fell about 2% qoq on an end-of-period basis, with non-interest-bearing deposits down 20.5% yoy and 2% qoq. Those numbers aren’t atypical (the sequential result for NIB deposits may end up looking relatively good), but a 22% NIB/deposit ratio isn’t all that special. Likewise, neither is the bank’s cost of interest-bearing deposits (up 27bp qoq to 3.33%) or total cost of deposits (up 20bp to 2.58%). The deposit beta (interest-bearing deposits) climbed to 58% this quarter, a bit high relative to peers.

Loans to deposits are a little higher than I’d like (at 91%), but I don’t expect significant near-term lending growth. I’d also note that FB has likely been held back on deposit growth by more aggressive competition in its region – banks like First Horizon ( FHN ) have been offering fairly aggressive rates on CDs lately, and management here has been more restrained.

Also relevant to funding, management has started restructuring its securities portfolio. The bank sold $77M in low-yielding (1.4%) securities this quarter, booking the losses and reinvesting in securities with an average yield of 6.4%. Further maneuvering in coming quarters seems more likely than not.

The Outlook

Maybe the best news out of the quarter was management’s announcement of a new expense initiative that is targeting $20M in savings for FY’24. With revenue likely to be under more pressure in 2024 (flattish to down net interest income and non-interest income), operating leverage is one of the few avenues to preserve pre-provision profits. The challenge here is going to be in balancing the short-term benefits of these cuts and the risk of handicapping the bank’s longer-term growth opportunities. Plenty of large banks are targeting Nashville, Memphis, and Knoxville, and if FB goes too far, they risk ultimately driving business to rivals.

As I said in the open, the biggest issue I have with FB is that there’s just not much that’s special about the story. Funding costs are higher than average, but higher loan yields compensate for this, and net interest margin is just a little better than average (about 20bp going into the quarter). The operating efficiency here is nothing special (but not bad), and likewise credit is fine but not exceptional. I do see some risks in the CRE/C&D portfolio, and I’d like to see more C&I lending, but that’s largely nitpicking. All told, return metrics (like ROTCE/ROTE) are a little worse than average, but you could argue that’s offset by better regional growth prospects.

I still believe that FB Financial can generate long-term core earnings growth in the neighborhood of 6%, driven by strong demographic and economic trends in its operating footprint. I likewise think that the bank can get back to double-digit ROTCE in a couple of years.

None of that drives a compelling fair value, though. My standard approaches (discounted core earnings, ROTCE-driven P/TBV, and P/E) get me to the low-to-mid-$30’s, but that’s about it. I’m using a 12.5x multiple on my ’23 EPS, and that’s below the long-term average (closer to 14.5x), but I think it’s early to be assuming normalization in sentiment/multiples.

The Bottom Line

Perhaps FB Financial will deliver more punch with its opex initiative than I expect, or maybe the bank will start gaining more share in attractive lending markets than I’m modeling. In any case, I don’t think there’s much wrong here apart from valuation. In a market where a lot of quality banks trade at a discount, though, I can’t really say that this is a must-own.

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