First Citizens Stock: Good Start With Transformative Acquisition

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For several years now, investors owning the shares of banks undertaking large mergers have had to wait a while to see the benefits, as the market has taken a “wait and see” approach that has meant underperformance relative to benchmarks until the synergies start showing up. so far, First Citizens Bancshares‘ (NASDAQ:FCNCA) (“First Citizens”) merger with CIT is working out well, and the stock has been outperforming on good core operating profits, with early evidence of cost synergies and above-average lending growth.

Up about 15% since my last update, First Citizens has outperformed the regional banking sector by close to 15%, as well as outperforming other commercial-driven growth banks like East West Bancorp (EWBC), Pinnacle Financial (PNFP), Signature (SBNY), or SVB Financial (SIVB). I have some concerns about a weaker macroeconomic environment in 2023 and higher deposit costs, but I’m still expecting high single-digit normalized core growth from this bank, and that continues to support an attractive return in a still-out-of-favor sector.

Looking Back At Third Quarter Results

First Citizens isn’t particularly well-followed, so comparing the results to sell-side estimates is a little less informative than it might otherwise be. Even so, results were comfortably ahead of expectations despite higher provisioning, as First Citizens benefitted from good core performance trends.

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

Revenue rose 10% sequentially, which is fairly representative for the period. Net interest income rose almost 14% qoq, which was better than average, as was the 36bp quarter-over-quarter improvement in net interest margin (to 3.4%). Fee income was up 2% on a core basis, with some underlying growth in service fees and rental income.

Core expenses rose 2% qoq, driving a 430bp sequential improvement in efficiency ratio to 53.3%. First Citizens outperformed on operating leverage, but then I would expect it to given the cost synergies it is supposed to be realizing now. At 53.3%, First Citizens’ expense ratio compares pretty well to most of its peers, though Pinnacle’s 47% and Signature’s 31% are impressive in their own right.

Pre-provision profits rose more than 21% sequentially, a stronger-than-average result in a quarter when many banks managed double-digit sequential growth. Tangible book value per share did decline sequentially (by 2.4%), with the bank suffering mark-to-market losses in its securities portfolio (a common occurrence).

Healthy Growth, But Mind The Macro

The new First Citizens is built first and foremost to be a strong commercial lender, taking advantage of multiple industry verticals, strong demand for equipment financing, and some of the more specialized financing needs that small-to-mid-sized businesses have. Results in the third quarter were strong in that regard.

Overall loans rose 3% sequentially, basically keeping pace with its peers while outgrowing the banking sector (as per Fed H.8 data). Growth was balanced, with over 3% growth in C&I and CRE lending, as well as nearly 4% growth in mortgages. C&I growth was helped by demand in verticals like energy, healthcare, and tech, and I was impressed that First Citizens saw stronger-than-average CRE lending growth. Mortgage growth was driven primarily by retaining more origination.

Yield improved nicely 57bp on a sequential basis. Credit quality was fine. There was an expected uptick from pre-CIT credit levels (non-performing loans up 15bp as a percentage of total loans, allowances for loan losses up 70bp to 1.26%), but nothing beyond expectation that I consider notable.

Deposits declined 2% sequentially, which was a little worse than average. Non-interest-bearing deposits were almost flat sequentially, though, and that was a little better than average. The cost of interest-bearing deposits rose 24bp to 50bp, about half the rise of its comp group, and while total deposit costs rose 17bp qoq, it’s still comparatively good at 0.35%.

What happens next is more debatable. Management guided to slower loan growth, which while a little disappointing, seems realistic in the context of a weakening macro environment and greater caution among commercial borrowers. Mid-single-digit growth in 2023 would be a bit light, but management could be baking in some conservatism here.

Thus far First Citizens’ deposit beta (the rate at which deposit costs rise relative to underlying interest rate levels) compares well to its peers. Management is guiding to a 25% full-cycle deposit beta, and I think that could be a little too optimistic. I’m expecting higher betas through this next phase of the cycle (that’s been my call all year long), and I think 30%-plus is more likely, though I expect First Citizens to do better than average on this metric. A key question is loan growth – if loan growth remains more moderate, First Citizens won’t have the same funding pressure requiring it to go into the market for higher-cost deposits.

The Outlook

Not much has changed about my outlook for First Citizens, though recent results have been strong and I’ve tweaked my 2022 and 2023 estimates some, but that’s largely been driven by the share buyback that the company launched earlier this year; management indicated that if 2023 goes as expected, another sizable buyback could happen next year. Long term, I’m still expecting core earnings growth in the mid-to-high single-digits as the bank leverages its enhanced national commercial specialty lending capabilities and continues to leverage growth in its home markets in the Mid-Atlantic/Southeast region.

The Bottom Line

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

It probably shouldn’t be surprising that after outperforming its peer group, First Citizens doesn’t seem to offer the same upside as many other beaten-down bank stocks. I believe some of this reflects the “lower-hanging fruit” of more certain operating leverage as First Citizens reaps merger-based synergies, but some of it could also be due to the company’s stronger specialty lending business. In either case, I think First Citizens remains a good bank to consider, but there are certainly some names out there trading at even bigger discounts to fair value.

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