Summary
- First Citizens offered a different set of results from the typical bank in the fourth quarter, including little revenue growth and sequential pre-provision contraction.
- A slowing macro environment is leading to weaker demand for factoring, depressing loan growth, but funding costs remain attractive.
- Management could be too optimistic with its deposit beta and net interest margin guidance, but the bank offers good leverage (and profitability) to a stronger macro in 2024.
- I expect mid-teens pre-provision growth in 2023 and 6%-plus long-term core earnings growth (both above average), and I believe FCNCA shares are undervalued by 20% or more.
These are not easy times for banks focused more on commercial lending. The yield curve is increasingly inverted, net interest margin is near a peak, credit costs are going to rise, and loan demand is softening. As a primarily commercial bank, and one with sizable macro-sensitive businesses like factoring and equipment leasing, that’s not a great set-up for First Citizens BancShares ( FCNCA ), though the bank continues to benefit from profitable lending activities, good operating leverage, and enhanced scope of operations across the country.
First Citizen's stock is down about 6% since my last update , a little worse than average for similarly-sized banks. I do have concerns about First Citizens seeing a more pronounced slowdown in its lending activities, as well as higher credit and funding costs, but I believe it is poised for above-average pre-provision growth in FY’23, as well as above-average long-term core growth in the neighborhood of 6%, supporting a fair value 20% above today’s level.
A Different Mix Drives Different Results
First Citizens definitely didn’t post a typical bank earnings report for the fourth quarter, though it was a little more similar to Comerica ( CMA ) and other more commercial-focused banks. Investors should note that the nature of the business, including significant leasing income, necessitates some deviation from reported results, but management does a good job of laying these out and I generally follow those changes.
Revenue rose 24% year over year on an adjusted basis and about 1% quarter over quarter, weaker than the typical 4% sequential growth from comparable banks. Net interest income rose 30% yoy and about 1% qoq, which was likewise weaker than average (an average closer to 6%). Net interest margin rose 80bp yoy and fell 4bp qoq to 3.36%, while earning assets declined 2% yoy and rose 2% qoq.
As was the case for so many banks this quarter, fee-based income was not particularly strong – improving 10% year over year but only rising about 1% qoq.
Operating expenses rose about 6% yoy and a little more than 2% qoq on an adjusted basis. That was better than the average sequential increase of around 4%, and the banks adjusted efficiency ratio of 54.6% isn’t too far off its peer group average (around 52.6%). Pre-provision profits actually declined 1% sequentially, well below the norm for the sector this quarter.
Macro Hitting Growth, And Funding Costs Remain A Risk
First Citizens grew loans by less than 2% in the fourth quarter, which was weaker than the 3%-ish growth rate of peer banks, and while C&I lending has generally remained one of the stronger lending categories, First Citizens saw a 1% sequential decline. This is due to the nature of the bank’s business – First Citizens does meaningful business in factoring, essentially lending on accounts receivable. As business activity has begun to slow and as businesses aren’t under the same pressure to free up cash to expand inventories, this business has trailed off.
Business Capital lending has held up better, CRE lending was strong, and First Citizens also saw good activity in its rail business, with increased utilization and significantly improved renewal pricing.
Compared to other banks, First Citizens’ earning asset betas have been okay, but not extraordinary. Comerica, for instance, has a trailing cumulative loan beta over 60%, while First Citizens is a little above 33%. Again, these are different businesses, but the point stands that higher rates have had a relatively more muted impact on interest income.
At the same time, First Citizens has done well on the funding side of the business. Strong branch-based deposit gathering has been a strength of First Citizens for some time, and the cumulative deposit beta of 17% compares well to most of its comps/peers.
Management believes that beta will peak in the mid-20%’s, and part of their assumptions include 50bp worth of rate cuts in the second half of 2023. Predicting rates is far from easy, but I think there could be some risk here from higher funding costs, as I’m not as optimistic on rates and I think deposit betas could peak in the 30%’s. That said, loan growth in the mid-single-digits is not that aggressive, and the loan/deposit ratio is still below 80%, so First Citizens is far from the most stressed on this front.
The Outlook
In the short term, I see First Citizens as a bank with above-average sensitivity to the macro environment – more so even than Comerica or other commercial-oriented banks like Fifth Third ( FITB ) or KeyCorp ( KEY ). Specialty verticals/end-markets like aviation, energy, marine, and rail should remain healthy through 2023 and into 2024, but I do expect more weakness in factoring and I expect to see weaker trends (weaker demand and higher losses) in equipment leasing. If the U.S. economy sees a more gentle slowdown than expected, First Citizens should outperform, but likewise if the downturn is steeper, there is downside risk.
The macro situation is what it is, but management isn’t sitting still. Recognizing that branch-based banking and consumer banking is changing, management has acknowledged the need to improve its digital offerings, and I’d expect to see more investments in 2023/2024 (a modest risk to operating leverage).
All of that said, First Citizens is expecting further expansion in its interest margin through 2023 (rare for most peer banks) and strong mid-teens net interest income versus a median growth rate for its peers closer to 12%. Higher funding costs are a threat here, but assuming mid-single-digit opex growth is manageable, I expect mid-teens pre-provision profit growth in FY’23 versus low double-digit growth for the peer group.
Longer term, I expect 6% core long-term earnings growth from First Citizens. Between discounted core earnings, ROTCE-driven P/TBV (with a low-to-mid-teens ROTCE), and P/E (a 10x multiple on my FY’23 EPS estimate) I believe First Citizens ought to trade somewhere in the range of $930 to $975.
The Bottom Line
Although many shorter-cycle financial names have been rallying, that hasn’t translated into more market enthusiasm for more macro-sensitive banking names. I do think this can change as 2023 develops, particularly if the Fed signals it is done hiking rates and the macro outlook doesn’t dramatically deteriorate. While First Citizens isn’t the easiest bank to follow, I do think it offers better leverage (including better profitability) to specialty commercial lending than is reflected in the share price, and I think it’s a name for more adventurous investors to consider.
For further details see:
First Citizens BancShares Offers Quality And Value, But Also Macro Sensitivity