Investment Thesis

Headquartered in Pittsburgh, Pennsylvania, F.N.B. Corporation (FNB) is a diversified financial holding company for First National Bank of Pennsylvania. FNB provides a wide range of financial services across the Atlantic seaboard through its 350+ bank branches. FNB has four main reported business segments: (1) Community Banking, (2) Wealth Management, (3) Insurance, and (4) Consumer Finance. With over $37 billion in assets and a leading deposit market share position in multiple MSAs located throughout its six state footprint, FNB is a force to be reckoned with.

While FNB is currently trading at a discount to peers, due to lower capital levels versus peers, I would look toward its sound credit policy and sustainable 7%+ dividend yield for reasons to invest today. FNB has a near sterling credit track record that I think should lead to greater earnings stability through this recession and could regain some of the multiple degradation over the past 3 years.

My current bullishness is built on the current valuation gap that I think should narrow over the next year driving outperformance and better risk adjusted returns. FNB has historically had a management team that is focused on credit first and growth second. While that might be frustrating in times of economic prosperity, it should serve the bank well for economic downturns like today.

ChartData by YCharts

As one can see from the chart above, FNB typically trades at near 2.0x price to tangible book value in good economic times. Given that we are in a recession, I would guess that valuation should be closer to 1.25x per share. Should FNB trade back up to that range (the 1.25x), it would mark a 48% upside in share price along with the 7% dividend yield – setting the stage for 55% upside return potential.

Revenue Outlook

Since the beginning of the pandemic to the end of the second quarter, FNB had originated $2.6 billion in PPP loans aided by its internal digital operating platform. Management touched on this success during the second quarter call, in particular, FNB had the ability to filter and support requests more efficiently providing better service especially compared to large bank competitors. As a result, roughly 20% of all processed and approved applications were from non-bank customers. From management’s commentary, it sounded like PPP started as a means to support existing clients but should open the door to call on these new customers in the near future.

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When looking at second quarter results, it’s clear that average loans jumped significantly (+$2.8 billion) or 12.5% from last year, primarily due to PPP loans. However, net interest income of $231.1 million was down from the first quarter as the reported net interest margin (NIM) decreased by 26 basis points to 2.88%. The decrease was driven by sizable loan yield compression from the tough interest rate environment and the addition of low yielding PPP loans.

The other part of overall revenue, fee income, saved the quarter, in my mind. Second quarter core noninterest income was up $9.1 million relative to the first quarter. Mortgage banking operations drove most of this, along with some capital markets activity.

Source: SEC Filings and Author’s Estimates

While overall loans are likely to come down with the forgiveness of PPP related loans, I do believe that FNB set the stage to capture some historically non-bank clients due to their superior service. I am modeling the mortgage business to continue to perform well in the third quarter, but tapering off a little as we wrap up the year. I believe the NIM is near its cycle floor since loan years are already low and deposit costs only have a little more room to budge.

Solid Credit History

In the second quarter, the provision for credit losses totaled $30.2 million. This compares to $47.8 million seen in the first quarter. The additional $17.1 million was driven by CECL oriented/mandated reserves and not necessarily credit degradation.

While the market has long known FNB as being a relative credit safe haven, the most recent press release provides further proof:

As of September 15, 2020, F.N.B. reported second deferrals were $434M, or 1.8% of total loans and leases vs. $2.4B, or 10.3% of total loans and leases in deferral as of June 30, 2020.

This nearly 82% reduction in loan deferrals from the end of the second quarter should set the stage for a very limited loan loss provision in the fourth quarter. I say the fourth quarter because there are still some loans in deferral (i.e. the $434 million mentioned). I believe management will want to further increase the reserve to mitigate any potential future net charge-offs (NCOs). However, once the third quarter is in the books, I think the market will appreciate how strong FNB’s credit profile truly is relative to peers.

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Source: SEC Filings

If I had to guess, most of the remaining deferrals are driven by longer hotel loans. While FNB has not historically been a hotel-lending bank, they have acquired some hotel loans through out of market acquisitions over the past decade. In my mind, these hotel loans should be rather limited in nature and could actually be sold at a discount to another lender.

Source: SEC Filings and Author’s Estimates

While I was a little skeptical of FNB’s deferrals at the end of the second quarter, since it was higher than average, the most recent update should have provided a catalyst for share to work their way higher. I think future provisioning, fourth quarter specifically, will be a little higher than pre-COVID-19 levels, but something like $20 million per quarter is much more acceptable given the solid credit operating in a volatile economic world.

Concluding Thoughts

While I might be a little too optimistic in terms of the overall timing of PPP loan forgiveness and the strength of mortgage related fee income, my investment thesis is predicated on sound credit quality juxtaposed the valuation gap.

While FNB just let the market know that most of its deferrals are resolved, I am a little surprised shares didn’t have a gap upward from the release. It is very clear that FNB could use a little more capital to become more in line with peers, however, if the bank’s credit is sound – why would the market demand more capital? The most recent deferral update indicated that nearly all potentially bad loans have been resolved and are now paying again. This should actually help drive more net income and build reserves faster.

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My provisioning estimates and timing could be off a little too, however, I am nowhere near having to trim the dividend or raise capital. Based on the deferral press release, in my mind, this bank should be trading at a slight premium to peers – which would be closer to 1.1x to 1.25x price to tangible book value.

Source: SEC Filings and Author’s Estimates

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any 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.



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