The line between “patient, long-term investor” and “wrong” can be fuzzy in the best of times and is sometimes only visible in hindsight. That’s something to keep in mind with Synovus (SNV), as these shares are down about 30% from the time of the announcement of the FCB deal and have just not worked as a long call. Although I had said back at the time of the deal that, “Synovus is likely to be sitting in the doghouse for a while now”, and “the overhang from the deal announcement will likely last a while”, this is rather more than I had in mind.
I do believe there is a good bank here with better-than-average growth potential, but management’s decision to increase spending in 2020 to take advantage of disruptions and opportunities in its operating footprint (particularly, but not exclusively, the Truist Financial Corp. (TFC) deal) is not what investors wanted to hear. I believe the shares are undervalued on a mid-single digit long-term core growth rate, but this is a stock that really needs some beat-and-raise quarters to boost sentiment.
A Mixed Quarter, But Weakness Where It Counted
Synovus didn’t have a poor quarter, but weakness at the core pre-provision profit line and core net income lines were not welcome developments, nor was the guidance for substantially higher opex spending in 2020.
Revenue rose 34% yoy and declined slightly on a qoq basis, just barely beating expectations for the quarter. Net interest income declined 0.5% qoq (with the acquisition, year-over-year comparisons don’t tell you much), beating by more than 1% on a better net interest margin (down 28bp yoy, up 23bp qoq, 10bp better than expected). Some of that spread improvement was offset by weaker balance sheet growth, as earning assets rose 0.5% qoq, missing expectations by about 1%. Fee income rose almost 1% qoq, coming in about 2% better than expected.
Adjusted core operating expenses rose 2.5% qoq, missing expectations by about 4%. Core pre-provision profits fell 3% qoq, missing expectations by about 1% ($2 million). Provisioning was more or less in line with expectations, but a higher effective tax rate sapped more of the momentum, leading to a 4% miss at the core net income line.
Stable Credit And A Little Loan Outperformance
One area of positive differentiation for Synovus this quarter was in loan growth; while earning asset growth came in lower than expected, Synovus was one of the relatively few banks to post a beat in loan growth. Loans rose a little less than 1% in average balance terms, with 0.5% growth in commercial loans and about 2% growth in consumer loans. Loan yield pressure was on the better side of average, with average loan yields declining 18bp yoy and 18bp qoq.
Deposits rose only 0.4% qoq, though non-interest-bearing deposits were stronger with more than 3% qoq growth. Synovus did fairly well in terms of funding costs, with interest-bearing deposit costs rising 54bp yoy but falling 16bp qoq, and total deposit costs rising 19bp yoy and 13bp qoq. Synovus’s deposit mix is about average, as is its cost structure; while the loan/deposit ratio is okay as is, it doesn’t really give the bank the flexibility to be more aggressive on deposit pricing, particularly with management targeting above-average loan growth in 2020 and beyond. That said, there’s still some leverage in 2020 from the repricing of CDs.
Credit quality seems fine, which should be more of a positive driver for Synovus given the worries that FCB’s more aggressive Florida property loan book would go sour. I suppose this is one of those perennial bear arguments that will remain in play until the cycle is over, as bears can rebut the positive experience to date with “just wait…”. Non-performing loans were down 12% qoq, and the CRE portfolio is holding up particularly well, with only a small percentage (0.05%) of those loans classified as non-performing. The criticized loan tally also ticked down sequentially.
Spending Money To Make Money
Synovus’s guidance for 4-7% loan growth in 2020 was better than expected, and I’m expecting growth to be on the lower end of that range. There are opportunities in areas like Atlanta, but banks like Pinnacle Financial Partners (PNFP) are targeting them too, and Truist may not lose as much business, as its rivals seem to be counting on it to lose. I’d also note some other risks to the loan growth outlook – namely, that new construction investments appear to be shrinking and C&I lending could prove vulnerable to an election year slowdown in corporate growth spending.
Management also guided to a bigger CECL impact than previously expected, though I think this is more of an issue of how the sell-side was modeling this impact. The bigger issue, though, is with operating expenses. In an environment where spread revenue growth is going to be pressured (management is looking for 0-3% growth), the Street doesn’t want to hear about 3-5% growth in opex, even if it is meant to build the business, take advantage of opportunities in markets like Atlanta, and drive long-term growth.
The spending guidance hits my expectations for 2020, but I do think earnings will bounce back in 2021 and grow for a time at a good mid- to high-single digit rate. Longer term, I still believe Synovus can grow core earnings at a mid-single digit rate, and given the underlying growth in markets like Georgia and Florida, that shouldn’t be a particularly aggressive or high bar. Discounting those earnings back and applying other valuation approaches like ROTCE-driven P/TBV, my fair value range goes from $42.50-44.50 to $40.50-43.50.
The hangover from the FCB deal has been worse than I expected, even though the underlying performance of the acquired assets has been fine (arguably better than expected, and certainly better than feared). That said, expectations have continued to come down, and management hasn’t been able to put in a solid floor to expectations and build from there. Hopefully, there will be more stability in terms of performance versus expectations in 2020, as sentiment is still quite weak for these shares.
Disclosure: I am/we are long TFC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.