FCNCA - It's Early But The SVB Deal Still Looks Like A Winner For First Citizens BancShares

2023-10-11 15:03:20 ET

Summary

• First Citizens is still in the early days of stabilizing and integrating the former Silicon Valley Bank, and investors will likely be closely watching the SVB deposit numbers in Q3'23.
• SVB provides a virtually unique growth opportunity for First Citizens; not only was it a leader in banking to emerging tech-driven companies, but it also complements the deposit-hungry CIT operations.
• It's too soon to say whether the VCs, equity funds, and client companies who pulled their deposits and drove the collapse of SVB will come back to the bank.
• Assuming that SVB's core franchise value remains intact and that First Citizens can drive the synergies I expect, 6%-plus long-term core earnings growth is attainable, suggesting meaningful undervaluation today.

This isn’t the easiest operating environment for banks, and particularly not for those with sizable commercial lending operations. As businesses have turned cautious, commercial loan (C&I) demand has dried up and credit losses are likely to increase from here, even if the U.S. avoids a recession in 2024. On top of that, the sharp increase in interest rates has driven deposit costs substantially higher and many banks have already completed substantial cost-saving initiatives. With all of that, company-specific drivers are more important than before.

That works to First Citizens BancShares’ (FCNCA) (FCNCB) advantage, as when it comes to company-specific drivers, First Citizens has a doozy in the ongoing integration of SVB and the potential down the line to leverage this bank’s almost-unique positioning in financing emerging business (and particularly tech/innovation-driven businesses). While there are still integration and operational risks with the SVB deal, not to mention risks for commercial-heavy banks in general, First Citizens is an old hand at integrating deals and I see relatively few risks beyond the possibility of permanent impairment to SVB’s reputation (hard to measure at this point).

While First Citizens has done quite well this year, up about 55% since my last update , I don’t think it’s done yet. Core growth in the mid-single-digits isn’t a humble estimate, but I think First Citizens can get there and that suggests 20% or better undervaluation for what I believe to be a well-run, high-quality bank that now has a legitimate growth angle as well.

Watch For Deposit Retention And Surplus Capital Deployment

One of my key watch items going into third quarter reporting is the extent to which the SVB business has stabilized after Silicon Valley Bank collapsed earlier this year on a deposit run. This run was driven primarily by large losses on the company’s securities portfolio, with venture capital funds and other equity funds advising their clients to pull out their deposits before the solvency situation forced the closure of the bank and the potential freezing of those deposits.

First Citizens exited the last quarter with around $41B in SVB deposits and looking at how VC funding has developed since the last report, and considering management’s guidance for deposit performance relative to VC funding, I think there could be another 6%-8% sequential outflow in deposits, with likely still some left for the fourth quarter.

At the same time, I expect to see further increases in deposit costs. First Citizens is more or less average when it comes to non-interest-bearing deposits as a percentage of deposits, and I do think we’re past the worst of the NIB outflows, but managing deposits costs and deposit flows is still a key watch item, particularly as First Citizens has been willing to pay up for retail deposits – as of this writing, the bank is still offering a 5% 11-month CD (keep in mind, competition for deposits in North Carolina has been pretty stiff).

I also want to see what the company has been able to do in terms of redeploying the surplus liquidity it got with the SVB deal. This surplus liquidity has spiked First Citizens’ asset sensitivity (to over 9%, well ahead of Zions (ZION) and First Hawaiian (FHB) in the 5%’s), and while that’s not a terrible thing as rates continue to head higher, deploying that liquidity effectively into new loans will take time – First Citizens has never been the sort of bank to grow loans just because it can. With that, I do see a risk that the bank carries under-earning assets a little while longer, weighing on net interest income, net interest margin, and pre-provision profits.

Leveraging The SVB Opportunity Is The Key Long-Term Driver

The real key to First Citizens’ long-term success is the extent to which it can not only shore up SVB’s business, but continue to build on its legacy as the leading banker to the emerging innovation economy. There’s a good track record here with CIT and “letting CIT be CIT” post-merger, but it remains to be seen just how much reputational damage has been done to SVB and whether or not VCs will come back and direct their portfolio companies toward First Citizens.

Even with the risk of long-term damage (with companies like JPMorgan (JPM) trying to fill at least some of the breech), the deal makes sense on several levels.

Looking back at the large CIT deal, First Citizens was motivated to do this deal not just for opportunistic short-term accretion, but because the bank felt it needed to actively improve its capabilities and offerings for larger commercial customers. First Citizens has long had a very good franchise with smaller business customers, but as those customers grew, both customer and bank found that they were outgrowing First Citizens’ capabilities. Acquiring CIT pretty much addressed that issue.

SVB addresses different issues and opportunities. SVB has long enjoyed a strong franchise with early-stage tech-driven companies and the VC and equity funds that support them. That supported the growth of a large, lucrative capital call lending business (were losses are exceptionally rare across the sector), as well as lending franchises to the companies themselves, the executives of the start-ups and VC/equity funds (private banking, where JPMorgan’s First Republic has also been strong), and to/for private equity buyouts. None of these were sizable businesses under the former First Citizens umbrella, and I think they are high-potential opportunities given the company’s long track record in lending to small and middle-market businesses.

SVB is also complementary in a meaningful way. One of the issues with the CIT business model is that while it generates substantial loan and lease opportunities, it doesn’t generate enough deposits to fund them. That was problematic for CIT in its standalone days, as it left the company vulnerable to the vagaries of brokered deposits and other higher-cost (and volatile) sources of funding.

SVB had the opposite problem. Tech companies, and emerging tech companies in particular, aren’t exactly known for being big borrowers and SVB was generating 8x to 10x deposits to loans from its core business customers. That in turn led the company to purchase large amounts of securities; when rates shot higher, the value of those securities dropped and the unrealized losses crushed the company’s solvency numbers.

Provided that the SVB deposit franchise stabilizes (which I believe it will), the deposit-rich nature of the SVB franchise should be a great complement to the deposit-needy nature of the CIT commercial lending franchise. That should allow for less volatility in underwriting and better deposit costs and net interest margins over time.

The Outlook

Rates are likely not done heading higher (there will likely be one more Fed hike before cuts in 2024), and that will create more repricing opportunities for First Citizens’ assets. On the flip side, I expect softer demand for loans in general, as recent Fed data suggests minimal year-over-year loan growth in recent weeks across the banking system (and no real growth in C&I lending). This will create some challenges for First Citizens when it comes to deploying excess liquidity, but it also means that First Citizens can be more selective about when, where, and how it competes for deposits (it can afford to let some excess liquidity leave).

I’m expecting First Citizens to see a modest decline in lending (1% to 2% qoq) and I’m likewise expecting around a quarter-point of NIM pressure. I do also think that NIMs could likely disappoint across the banking sector this quarter, so call this another “watch item”. Again, though, I think the pace of deposit outflow in the SVB business is likely the key number that many analysts and investors will be watching.

I believe the SVB business is not only salvageable but still a significant growth driver for years to come. With that, I think First Citizens can see high single-digit to low double-digit core earnings growth in FY’24 and FY’25 as it leverages accretion from the acquisition and then leverages the underlying growth opportunities in SVB’s core markets. I’m looking for long-term organic core growth of over 6% and that’s admittedly aggressive, but I think it’s attainable, particularly as and if it can leverage the SVB client base into longer-term customers for CIT’s offerings.

Discounted core earnings gives me a fair value around $1,660, and a forward EPS multiple of 9.9x (consistent with what I use for large cap banks and arguably too low given the stronger growth profile) gives me a fair value of almost $1,690 on my FY’23 EPS estimate. ROTCE-driven P/TBV produces an even higher target, with a 12% forward ROTCE (arguably too low) supporting a 1.45x multiple and a fair value near $1,820.

The Bottom Line

There are risks here – the SVB integration may not go well, SVB may be irreparably damaged, and/or First Citizens may struggle to successfully manage what is a very different business model. I think those risks are offset by a long operating track record, including a record of successfully integrating many different banks, and I think the current difficult environment for banks will pass in time. If that 6% core growth estimate is at least in the ballpark, I think First Citizens is undervalued today, potentially meaningfully so, and well worth a look.

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