- Due to the high level of loan loss reserves, the provision expense will likely remain subdued in the remainder of the year.
- Cost-saving initiatives will likely reduce non-interest expenses this year.
- The federal stimulus will likely drive deposit growth, which will boost relatively low-yielding earning assets.
- The year-end target price suggests a small upside from the current market price. Moreover, the company is offering a low dividend yield.
The earnings of Synovus Financial Corp. (NYSE: NYSE:SNV) will likely trend upwards this year because of cost savings from initiatives under the Synovus Forward program. Moreover, the provision expense will likely remain subdued in the year ahead because of the high level of loan loss reserves. Further, earning asset growth will likely support the bottom line. Overall, I'm expecting Synovus to report earnings of $2.95 per share in the last three quarters of 2021, taking full-year earnings to $4.14 per share, up 80% year-over-year. The December 2021 target price suggests a limited upside from the current market price. As a result, I'm adopting a neutral rating on Synovus Financial.
Provision Expense Likely to Remain Subdued in the Year Ahead
After significant provisioning last year, Synovus Financial released some of its provisions in the first quarter of 2021. As the allowance level is currently quite high relative to net charge-offs, I'm expecting the provision expense to remain below normal in the year ahead. Allowances made up 1.58% of total loans at the end of March. In comparison, net charge-offs made up 0.21% of average loans in the first quarter, as mentioned in the first quarter’s investor presentation. This meant that allowances were more than seven times the net charge-offs.
Meanwhile, the credit risk appears manageable, with the only area of concern being loans to hotel borrowers. Synovus has material exposure to the hotel industry, which made up 3.8% of total loans at the end of last quarter, as mentioned in the presentation. Considering these factors, I'm expecting Synovus to report a provision expense of $11 million in 2021, as opposed to a provision expense of $355 million in 2020.
Savings from Synovus Forward Appear to be on Track
Synovus Financial’s non-interest expense declined in the first quarter because of benefits from initiatives taken under the Synovus Forward program and headcount reduction. As mentioned in the investor presentation, Synovus reduced the headcount by 72 people due to the voluntary retirement scheme and branch closures. The company closed 13 branches in 2020 and plans to close four more branches in the second quarter of 2021. As mentioned in the presentation, the management believes that the company is on track for $175 million of cost savings by the end of 2022. Considering these factors, I'm expecting the non-interest expense to decline by 11% year-over-year in 2021.
Relatively Low Yielding Earning Asset Growth to Counter Margin Compression
The federal stimulus and economic recovery will likely continue to boost deposit growth in the year ahead. However, loan growth will likely be unable to match deposit growth. This is because both consumer and commercial customers are currently holding excess cash that will diminish the demand for credit. As mentioned in the first quarter's conference call, the average checking account balance for commercial clients has increased by 40% year-over-year while the average checking balance for consumer accounts has increased by 25% year-over-year.
Moreover, the upcoming forgiveness of phase one Paycheck Protection Program (“PPP”) loans will constrain the loan growth. As mentioned in the presentation, PPP phase one loans totaled $1.5 billion at the end of March, representing 3.9% of total loans. Due to the mismatch between deposit growth and loan growth, I am expecting the company to park excess funds in earning assets with lower yields than loans.
The management mentioned in the conference call that it expects loans to increase by 2% to 4% in 2021, excluding the impact of PPP. Considering these factors, I'm expecting loans to increase by 0.1%, earning assets to increase by 13.3%, and deposits to increase by 4.5% year-over-year in 2021. The following table shows my balance sheet estimates.
Mostly because of the shift in asset mix towards lower-yielding assets, I'm expecting the average earning asset yield to decline further in the year ahead. Moreover, the reinvestment of maturing loans at lower rates will likely reduce the average portfolio yield.
On the other hand, the maturity of costly time deposits will lift the net interest margin. Time deposits made up 11.8% of total deposits in the first quarter, according to details given in the first quarter’s earnings release. Moreover, as mentioned in the presentation, these time deposits carried a high rate of 0.89%. Assuming Synovus can replace half of the time deposit portfolio with deposits carrying rates that are 50 basis points lower, the company can reduce its deposit cost by three basis points.
Considering the anticipated balance sheet growth, the pressure on yield, and the opportunity to reduce the deposit cost, I'm expecting the net interest income to decline by 3.2% year-over-year in 2021.
Expecting Full-Year Earnings of $4.14 per Share
Cost savings from initiatives and a reduction in the provision expense will likely drive earnings this year. Moreover, the growth of lower-yielding earning assets will likely support the bottom line. On the other hand, pressure on the net interest margin will likely drag earnings. Moreover, the mortgage income will likely decline because of stable to rising interest rates that will disincentivize the refinance activity. The management mentioned in the conference call that it expects mortgage revenues to decline to pre-pandemic levels over the next few quarters.
Considering these factors, I'm expecting Synovus Financial to report earnings of $2.95 per share in the last three quarters of 2021, taking full-year earnings to $4.14 per share, up 80% year-over-year. The following table shows my income statement estimates.
Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic and new variants.
Small Price Upside Warrants a Neutral Rating
Synovus Financial is offering a dividend yield of 2.7%, assuming the company maintains its quarterly dividend at the current level of $0.33 per share. The earnings and dividend estimates suggest a payout ratio of 32% for 2021, which is higher than the average payout ratio of 29% from 2016 to 2019. Therefore, I’m not expecting an increase in the dividend this year despite the positive earnings outlook.
I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Synovus Financial. The stock has traded at an average P/TB ratio of 1.54 in the past, as shown below.
Multiplying the average P/TB multiple with the forecast tangible book value per share of $29.5 gives a target price of $45.6 for the end of 2021. This price target implies a 5.9% downside from the May 5 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
The stock has traded at an average P/E ratio of around 14.4x in the past, as shown below.
Multiplying the average P/E multiple with the forecast earnings per share of $4.14 gives a target price of $59.6 for the end of 2021. This price target implies a 23.2% upside from the May 5 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
Equally weighting the target prices from the two valuation methods gives a combined target price of $52.6, which implies an 8.6% upside from the current market price. Adding the forward dividend yield gives a total expected return of 11.4%. Hence, I’m adopting a neutral rating on Synovus Financial.
The company’s earnings are likely to grow on the back of cost savings and provision expense reduction. Unfortunately, the stock is trading at a level that leaves only a small and unattractive upside to the year-end target price. I would consider investing in Synovus Financial only if its price dipped by more than 5% from the current level.
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