Description

First Citizens Bank is merging with CIT in an all stock transaction whereby CIT will receive .062 shares of First Citizens shares. 

In the conference call on Friday reviewing the transaction, FCNCA and CIT targeted $1.13bn in earnings on 16mm shares or $70.50 per share of earnings. They're also targeting $470 in tangible book value pro forma for the merger.  I highly recommend reviewing the slide deck and transcript from Friday's call reviewing the transaction.

The current price represents 6.2x proforma earnings and 94% of tangible book value. When the merger is complete, the bank will be one of the largest 20 banks in the country with compelling franchises in numerous business lines as well as an advantaged deposit funding structure.  Financials are currently out of favor, with prices ranging from 8-12x earnings.  In two years, proforma for the merger, FCNCA is likely to have $70+ in EPS. If the company trades at 8x, 10x, 12x EPS, the upside potential for CIT shareholders ranges from 12%, 24%, 35% annualized. I find this -- a low P/E bargain in an out of favor sector with a savvy buyer -- quite compelling. 

The earnings and book value accretion are high, but upon examination seem reasonable.  The cost cuts in the merger are expected to be approximately 10% of the combined company which is par for the course in bank mergers. Management is targeting 50% of the cost savings by 2021 and 100% by 2022.

As far as book value accretion, CIT is being acquired at a $2.5 billion discount to their tangible book value. Provided CIT has adequately reserved for its losses, this is reasonable. The market, of course, was skeptical of this which is why CIT traded for such a large discount to book value.  However, on the call, FCNCA discussed the extensive due diligence they performed on the loan book and franchises, and I am going to give them the benefit of the doubt.

FCNCA has a demonstrably powerful track record in M&A in the banking industry, having successfully digested a number of sizable acquisitions in the past decade. From 2004 to 2019, the bank has compounded tangible book value per share at a rate of 8.1%. I suggest turning to page 20 of the 10k for a review of their performance. In the past five years, net income has increased from 210mm to 457mm, assets have increased from 31bn to 37bn, shareholder equity is up from $2.8bn  to 3.5bn.  At the same time, over this five year period, the company has reduced share count from 12mm to 11.1mm. Losses have remained under 1% in recent years, and the bank is well reserved.

FCNCA has a competitively advantaged deposit franchise costing in aggregate an extremely low 13bp. CIT has $45 billion in deposits, and is currently paying 1.2% for their deposits.  If First Citizens is able to lower CIT’s cost of funding, which seems reasonable, there’s about $450 million in interest expense savings or over $30 pretax per share.  The $70 EPS target offered by management in their Friday presentation does not include any benefits from changing the liability structure of CIT.  

The family behind First Citizens Bank owns $1 billion in stock.  Salaries are reasonable, and there’s evidence that they are terrific managers with a very long-term view. They control the company through super voting B shares. This is unusual, but provides a further advantage as the bankers are likely to act like owners rather than managers.

CIT has a compelling set of lending franchises. The fact that CIT is willing to do an all stock transaction at such a large discount to book value may attract another suitor willing to pay a higher price as the potential for tangible book and earnings accretion outlined on the call on Friday is mouth-watering.

There is risk of a deal-break, but given the advantageous pricing, the long lead time for the deal, and the fact that it's friendly, I think this is low.  The longer term risk is that CIT and/or FCNCA have properly reserved for loan losses. I believe this is not the case as both banks are well run, but am still doing work on this front. Also, there is macroeconomic risk that applies to all banks. Loan losses have been suppressed to fiscal stimulus and low rates, and the losses may be increasing in the years ahead. Also, spread based lending businesses may be under pressure due to a flat yield curve that remains so for many years to come.  However, at the current price of 6.2x pro forma EPS and 92% of pro forma tangible book value, or 54% of CIT’s current tangible book value for a bank that’s now in play, I think investors have a substantial margin of safety protecting against loss.

Catalyst

Competition of merger in 1H 2021

Emergence of another suitor for CIT