F.N.B. Seeing Signs Of Improving Loan Demand, But Execution Still Needs To Improve

Summary

• F.N.B. managed to post a decent beat relative to Street expectations for pre-provision profits, and the improved loan growth and conservative-looking guidance were likewise welcome.
• The announcement of the Howard Bancorp acquisition has led to questions on the premium paid, the real need for the deal, and whether management can hit their post-deal goals.
• Mid-single-digit growth can support a double-digit long-term annualized return, but F.N.B.'s business is still heavily reliant on mature markets where growth could be more challenging absent ongoing share gains.

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Bank stocks have been on quite the rollercoaster since my last article on Pittsburgh’s F.N.B. (NYSE:FNB), and while the stock has fared better than most in its peer group (and has outperformed regional banks by about five points), the barely-positive low single-digit total return since then is certainly not inspiring.

How F.N.B. management intends to pursue growth remains a key point of contention around the stock. The market isn’t overly impressed with a bank where so much of the business skews to slower-growing markets like Pittsburgh, Baltimore, and Cleveland, and likewise wasn’t too impressed with the recent acquisition of a small bank in Baltimore at a generous premium. The shares do continue to look undervalued on a mid-single-digit core earnings growth rate, but I feel that the market needs more visibility to better profitability and/or growth before a significant rerating is likely.

Modest Outperformance In The Second Quarter

There haven’t been all that many blockbuster earnings results among regional banks, or at least outside the growth bank group, and F.N.B. was no exception, with a core earnings beat of $0.02/share, albeit with a modest 4% beat on the pre-provision line.

Revenue increased slightly on a year-over-year basis, and more than 1% quarter over quarter, good for a small beat versus the Street. Net interest income declined slightly yoy and rose about 2% qoq on an FTE basis, beating expectations by more than 2%, as the net interest margin was only slightly weaker than expected (down 5bp qoq to 2.70% versus 2.73%) and earning assets (up 3% qoq) were stronger than expected. Core fee income rose more than 2% yoy and declined about 1% qoq, but still came in a little better than expected.

Expenses rose 2% yoy and fell 3% qoq, basically as expected, with the efficiency ratio coming in about 40bp better than expected with the small revenue beat. Adjusted core pre-provision profits declined 2% yoy and rose 8% qoq, beating the Street by 4%, but adding only $0.01/share to earnings. Lower provisioning expense contributed the rest, and also helped offset higher taxes in the quarter.

Tangible book value per share improved 2% qoq, beating expectations by a little less than 1% and coming in a little short of the 4% or so sequential growth that some solid banks have managed.

Signs Of Loan Growth Are Welcome …

Like many banks, F.N.B. reported a modest sequential decline in end-of-period loans (down about 2%), as PPP loans weighed on comps. Adjusted for PPP loans, though, there was modest growth (up 2% qoq), with 3% growth in C&I lending and 5% growth in residential loans, as lending activity picked up later in the quarter and drove stronger end-of-periods comps relative to average balances.

Not all that many banks have managed to show meaningful organic growth in both commercial and consumer lending, and management did confirm that commercial line utilization remains near historic lows, as companies are by and large in good shape with respect to cash and access to the capital markets. Management also called out Pittsburgh and the Carolinas as areas of better loan growth, with the latter not really coming as much of a surprise to me.

Guidance and commentary was a bit odd… management maintained its guidance for mid-single-digit ex-PPP loan growth for the year, which is maybe a bit conservative, but the commentary sounded more bullish, or at least with respect to the bank seeing “significant” opportunities on the commercial lending side. It also seems that management is not counting on meaningful improvement in commercial line utilization in the second half, though many other banks have said they think utilization rates have bottomed and/or are already improving.

All in all, I’d say there’s a basis for being “cautiously optimistic” that the next two quarters could offer some beat-and-raise upside on stronger loan growth.

… But A New M&A Announcement Wasn't

While somewhat better than expected loan performance and bullish notes on loan growth were welcome, I don’t think the same applies to the announcement of F.N.B.’s acquisition of Howard Bancorp (HBMD), as the shares traded down modestly (around 4%) on that news.

Another deal to expand the bank’s presence in Baltimore isn’t necessarily a bad thing, but the premium paid – 1.6x tangible book and 10.3% on core deposits – seems quite high for a sub-scale bank with unimpressive margins and growth. Management believes they can strip half of the costs out, and did point to the fact that Baltimore has been a strong market for the company, but that just as easily raises the question of why the bank needed to pay a premium to grow in a market where it was already taking share.

Making matters worse, or at least more controversial, is that the last deal F.N.B. did, the Yadkin deal about four and a half years ago, didn’t go particularly well. There was a lot of personnel turnover after that deal, more than expected loan run-off, and lower than projected overall returns, and that came despite what has remained a pretty healthy banking market in the Carolinas.

As a result, this is at best a “show me” story as to the value to be garnered from Howard Bancorp, and with F.N.B. having a history of running with relatively thin capital ratios, it amplifies the scrutiny.

The Outlook

Core markets like Pittsburgh, Baltimore, and Cleveland wouldn’t seem to offer particularly attractive core growth, but there is still at least share growth potential outside Pittsburgh (at #3 in a market where the top three have 50%+ share, I’m not bullish on there being abundant share growth opportunities).

There should also be more growth opportunities in the markets of North Carolina and South Carolina, but those markets have been getting more and more competitive, with larger banks like Bank of America (BAC), Fifth Third (FITB), and PNC (PNC) stepping up their activities, as well as smaller growth-oriented banks like Pinnacle Financial (PNFP).

I’m looking for core long-term earnings growth in the neighborhood of 5%, settling down into the high-3%s/low-4%s after 2023. I’m also expecting pro forma ROTCE of around 12.5% in ’22. In the short-term, I think F.N.B. should trade closer to $12.50-$13, and I do see a path for double-digit share price appreciation, but management is going to have to execute on both growth and margins.

The Bottom Line

I guess F.N.B. has technically outperformed other banks since my last update, so that’s not terrible. Likewise, while I would like to see more improvement in core growth markets like Charlotte and RDU, the pandemic clearly has had an impact. I do believe, though, this is a stock where improved execution can drive meaningful re-rating and investors willing to take the risk of buying in ahead of that could well enjoy a double-digit longer-term annualized return as a result.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.