The North Carolina-based First Citizens BancShares (FCNCA 0.28%) made a big move when it acquired most of the assets and liabilities of SVB Financial, which collapsed in March and was seized by regulators.
The deal was immensely accretive to First Citizens' tangible book value or net worth, as well as the bank's earnings, leading to a huge jump in the bank's share price since completing the deal.
While there are inherent risks that First Citizens faces as it works to integrate and stabilize the SVB businesses it acquired, I think the stock could have a lot of room to run over the long term. Here's why.
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Staying conservative
A big near-term challenge for the management team at First Citizens will be stabilizing the start-up and venture capital business that SVB had built into a powerhouse over the last several decades. However, SVB failed partly because that business came into hard times during the high-interest rate environment.
SVB banked one of every two venture-backed start-ups in the U.S., which fueled a lot of its noninterest-bearing (NIB) deposits, those the bank pays no interest on. But the high-rate environment and broader market conditions in the tech space brought venture capital investment to more or less of a standstill, so SVB stopped seeing the massive deposit inflows it saw during the years right after the pandemic. Then to make matters worse, client cash burn accelerated, which is why the bank saw roughly $47 billion of NIB deposit outflows in 2022.
Since First Citizens acquired SVB, it has seen SVB deposits decline by about $12 billion due to clients leaving the bank and deposits moving to off-balance sheet arrangements, as clients seek more yield on their money. However, between April 14 and May 5, SVB deposits stabilized, which is a good sign for First Citizens.
Now, if the Fed ends its rate-hiking campaign soon and First Citizens can convince former SVB clients that they can offer a similar level of service as SVB did prior to its demise, then deposits could certainly rebound from here, especially if VC investment resumes at some point.
But even if it doesn't, First Citizens is still modeling for as much as $8 billion more of SVB deposit outflows into its 2023 earnings projections. I think that's a reasonable number considering the bank lost $47 billion in 2022 and that there are not likely to be any jumbo rate hikes moving forward. First Citizens also has a ton of liquidity it can tap, including a $70 billion line of credit from the Federal Deposit Insurance Corporation (FDIC), which gives the bank enough total liquidity to cover 198% of uninsured deposits.
A great capital position
The SVB deal also significantly boosted SVB's regulatory capital ratios. The bank's common equity tier 1 (CET1) capital ratio, which looks at a bank's core capital expressed as a percentage of its risk-weighted assets, jumped from 10.08% before the deal to 12.53%.
First Citizens' regulatory requirement for the CET1 is only 7% and management currently has an internal buffer of 9% to 10%, giving it a tremendous amount of excess capital. Even if you back out all of the bank's unrealized bond losses from the CET1 ratio, a change most bank management teams are expecting regulators to eventually make, First Citizens would still have an 11.4% CET1 ratio.
However, keep in mind that as part of the deal, the FDIC agreed to cover a portion of losses incurred on SVB loans, which is a big reason First Citizens' capital ratios are so high right now. Management also said it plans to keep these ratios elevated this year and in 2024, but it's still a great position to be in given that regulators are expected to make changes to regulatory capital requirements.
There are risks but also a nice margin of safety
Given what SVB's business just went through, there are certainly risks when you think about deposit outflows and whether or not First Citizens can continue to run SVB's venture and start-up business successfully.
But First Citizens executed a terrific deal with the FDIC that gave it a significant purchase discount on the assets, access to liquidity, and a loss-sharing agreement. The deal grew First Citizens' tangible book value per share, which bank stocks trade relative to, from roughly $590 before the deal to $1,180 after, which is the kind of accretion that you never see in bank deals.
I also do still think that start-up and venture capital deposits and loans will continue to be profitable businesses once everything settles down. Once First Citizens gets a better handle on this business, it can right-size its balance sheet, get rid of more expensive funding, and then ideally start to buy back stock, given its capital position. With First Citizens still only trading right around tangible book value, I like the setup.
