Description

History

First Citizens (FCNCA) is the largest family-controlled bank in the United States with ~$110bn of assets and is now a Top 20 bank. FCNCA primarily operates through a 600+ branch network in 22 states primarily concentrated in North Carolina (headquarters), South Carolina, Virginia, and California (via the recent CIT merger). Founded in 1898, FCNCA has been controlled by descendants of the Robert P Holding family since the 1920’s. Today, the third generation is in charge, with Frank B Holding Jr (age 61) acting as CEO since 2008. He has sat on the FCNCA board for 30 years.

Management

The various Holding Family members own 23% of the company, equating to ~$2.5bn of stock (Frank Holding Jr. owns ~11%). They are well aligned from an economic perspective, as well as having at-risk compensation tied to value generative KPIs like TBV/share growth + cumulative dividends over rolling 3 year periods. Salaries are modest relative to peers and there are no annual cash bonuses for senior management. The Holding-related family members continue to exercise control of the company through Class B shares with 16:1 voting rights.

“I would be remiss if I didn't touch on how our strategy, culture and financial goals all really become one. We revisit our goals each year. But in short, it revolves around our people and customers, delivering our best to each other. When we do it right, it's a win-win for all. And while we pay attention to all the metrics indicative of how we're performing, in its simplest form, we focus on growing tangible book value and we watch it with vigilance.” – Frank B Holding (July 29, 2020)

What is there to like about FCNCA:

1.  Solid deposit base

• FCNCA is the 4th largest bank by deposits in both North Carolina and South Carolina. Over 80% of deposits come from their branch networks with ~56% being non-interest and checking/accounts

• Management expects to maintain a historical full-cycle deposit beta of ~25%

• Experienced a 14% deposit beta in 2022 (a period where the Fed funds rate increased 425bps), expect a 22% beta by end of Q1’23

2.  History of accretive mergers (not overpaying for growth/scale)

• In the prior decade FCNCA also completed nearly 25 other acquisitions – a mixture of FDIC rescues and traditional acquisitions. Most have continued to strengthen branch density in the core Southeast markets and were done at accretive multiples (FCNCA has virtually nil goodwill).

• The Largest acquisition was CIT, which was an all-stock merger completed at a fraction of TBV and closed after an extended review process in January 2022. The low original purchase price, a 1.2 year period from announcement until close, and an improving economic backdrop resulted in the CIT merger being nearly 40% accretive to TBVPS. In addition to significant cost synergies of ~$250m, this combined CIT’s attractive commercial lending book (including their differentiated Rail leasing, factoring, and equipment leasing portfolios) with FCNA’s lower cost deposit base.

3.  Conservative Culture is ingrained in the company DNA

• Low charge off volatility – compounding may not be as high as some high octane banks, but is less likely to be interrupted (or worse, experience catastrophic failure).

• Unlike most banks, continued to compound capital through the GFC period with TBV/share increasing at a 9% CAGR from 2004 to the end of 2021. This is nearly double the growth in TBV achieved by average regional bank. Importantly, FCNCA was even profitable in 2008. Annual charges off never rose above 65bps during the 2006-2010 period.

• FCNCA has chosen to run with lower than optimal leverage:

  1. CET1 of 10.1% (vs. 9-10% company target range)

  2. Tier 1 Risk-based Capital of 11.1%%

  3. Total Risk-based Capital ratio of 13.2%

  4. Loan/Deposit Ratio of 79%

• Family owns lots of stock – run it conservatively because their wealth is much more important than their paychecks.

• FCNCA only lends to companies that keep their operating deposits with them (leading to lower losses and also allows them to cross sell higher ROA services in exchange for attractive lending rates). FCNCA also likes to lend to lower risk end-markets like Dental/healthcare related organizations.

• Low dividend payout – self healing/less reflexivity risk if capital needed to be raised in the event of higher loan losses

Why Does the Opportunity Exist?

Shares have moderately traded off after the Q4 earnings print due to several factors:

1.   Management pulled 2023 EPS guidance given on the prior Q3 call of $95-100 (suggested 2023 now expected to come closer to the lower end of that range)

• Some concern around the bank’s ability to maintain NIMs as rates continue to rise (COF may continue to rise and inverted yield curve hurts spreads)

2.   Concern around potential charge offs in the CRE loan portfolio

•  FCNCA has ~1/3 of its loan portfolio allocated to CRE. In Q3, they took some higher than normal NPL provisions in their office portfolio.

• More specifically, Office CRE Loans are a small % of the loan portfolio ($2.6bn or 3.1% of loan book / ~31% of common equity). They are not originating any new office loans going forward and the at-risk office exposure has been appropriately provisioned based on the latest information as of Q4.

• The philosophy around CRE at FCNCA is more conservative than meets the eye – 60% of CRE loans are to owner occupied CRE. These types of CRE have considerably lower charger off rates and higher recoveries due to them being more akin to C&I loans (backed by the cash flow of the tenant rather than the collateral value). Furthermore, LTVs on the portfolio are low which would aid recoveries in any default scenario.

• Allowance for credit losses are still multiples higher than recent charges (1.35% ACL vs. <15bps net charge offs in each of the prior 3 quarters and guidance of 20-30bps for 2023).

3.  After retiring just over 9% of shares in 2H ’22, FCNCA paused their buyback until 2H’23 to build additional capital. While this back-half loaded buyback cadence is identical to 2022, it does take a large buyer out of the market for the next few months.

The Benefit from Fixed Rate Loan Repricing may be overlooked - FCNCA is still benefiting from the rapid rise in interest rates. FCNCA has a moderately higher mix of fixed rate/longer duration loans than peers (~55% fixed, with fixed rate loans having a higher duration than the overall portfolio). This means that it did not benefit as much in the prior year as some banks. Many of their fixed rate loans in their consumer business are still priced just below 4%, so as they mature/reprice to current rates of 5.5-6% (or possible higher as rates have moved up over the last month), FCNCA will pick up additional yield (and likely NIM expansion). Management currently anticipates only very modest NIM expansion during 2023, but this repricing dynamic should help offset any deposit base repricing pressure. As the current book matures and reprices at higher rates, FCNCA will see an outsized benefit going forward on NII relative to peers.

Finally, I have also seen recent insider buying from the CEO. Frank Holding purchased $737k of stock in the days following the Q4 earnings release. The timing of insider purchases have typically been good.

Return Expectations

Shares currently trade at 1.3x Q4’22 TBV of  $572/share (1.2x TBV ex-AOCI of ~$50/share). I believe $90 of EPS in 2023 is achievable equating to an 8.3x Fwd. P/E. Assuming buybacks in the second half of the year are completed at the current trading price, TBV will end the year at ~$640 or 1.16x (~$695 ex-AOCI or ~1.07x). Based on historical ROEs and well-timed returns of capital via buybacks, I believe FCNCA can continue to compound at a 12-14% rate for the next 5 years. The optionality of further multiple expansion to ~1.5x TBV or ~10x P/E increases IRR’s solidly into the mid-to-high teens. This would still be a discount to other well run regional bank peers with strong deposit franchises and underwriting cultures.

While this may not be the highest octane bank to own, it is one with a higher degree of certainty and lower “left tail” risk.

Alternatively, FCNCA trades at 5.2x P/PPNR (has historically traded at ~8x, which is where it would trade if NII were to fall 20% from current levels). This is also attractive relative to most regional peers.

Risks

• Typical bank risks – underwriting, leverage, liquidity, reflexivity, regulatory changes

• Positive interest rate shock – could lead to some NIM compression from the 45% fixed rate loan portfolio

  • Flat yield curve continues making it harder to generate spread (FCNCA expects some steepening of the curve in the 2H of 2023 in their guidance)

• Deposit betas coming in hotter than management expectations or an inability to attract fresh core/non-interest bearing deposits as expected (pressuring COF/NIMs)

• Persistent wage inflation offsets some of the still to be achieved CIT synergies

Disclaimer: The information contained herein reflects the views of the author as of the date of publication. These views are subject to change without notice at any time subsequent to the date of issue. The author has an economic interest in the price movement of the securities discussed in this presentation, but the author’s economic interest is subject to change without notice. All information provided in this presentation is for informational purposes only and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any data presented. In addition, there can be no guarantee that any projection, forecast or opinion in this presentation will be realized. All trade names, trademarks, service marks, and logos herein are the property of their respective owners who retain all proprietary rights over their use. This presentation is confidential and may not be reproduced without prior written permission from the author.

Catalyst

• Proving out limited charge offs necessary in CRE book

• Resumption of buybacks in 2H 2023

• Continued accretion in TBV/share

• Further Wall Street coverage – even with a $11bn mkt cap, there is still limited sell-side coverage (4 analysts) due the closely held nature of FCNCA prior to the CIT merger. The company did not begin conference calls until mid 2020.