Synovus Shares Finally Performing As Worst-Case Scenarios Roll Off

Having expressed some frustration in my last article at consistently recommending Synovus (SNV) only to see the shares underperform, the recent run of outperformance is a welcome change. Bank sector valuations are still low, but investors seem willing to do a little “risk on” investing in the sector, particularly where there have been outsized concerns about credit quality, reserves, and capital/dividends. It’s still much too early to declare an “all clear”, particularly as charge-offs usually peak about five to nine quarters after a recession starts, but with the economy recovering and the stimulus efforts seen to date, the worst-case credit scenarios are rolling out of models and valuations.

Synovus still has some things to prove to the Street, but I like management’s blended prioritization of operating efficiency and targeted loan growth across its Southern footprint. Low single-digit core earnings growth can still support a fair value near $30, and while there are some better return prospects elsewhere (including Citizens (CFG), First Horizon (FHN), and Zions (ZION)), the return potential here is still good enough to consider seriously.

A Sector-Typical Beat

Most banks are beating earnings expectations this quarter, and doing it through a combination of higher fee income, stable opex, and lower credit costs. Synovus is no different, though the double-digit sequential growth in pre-provision profits (a 10% beat) was a nice bonus as well.

Revenue fell slightly from the prior year’s level and rose almost 5% sequentially, beating expectations by about 4%. Net interest income was just shy of expectations, falling 6% yoy and staying flat sequentially, with a small (1bp) net interest margin miss, as NIM fell 59bp yoy and 3bp qoq. Like most banks, Synovus saw modestly higher balance sheet growth, both causing and helping to offset the NIM compression.

Core fee income jumped more than 27% yoy and 22% qoq, driving a 25% beat. Mortgage banking income tripling from the prior year (and rising one-third sequentially) was a major contributor.

Operating income rose 4% yoy and declined less than 3% qoq, basically matching expectations and driving a 250bp beat in efficiency ratio. Core adjusted pre-provision profits declined 5% yoy but rebounded 15% qoq, beating expectations by 10%. Provision expense was roughly half of what the Street expected, driving about $0.23/share of earnings upside.

Increasing Confidence On Credit Risk

I don’t want to give the impression that Synovus is a pristine credit story, because that’s not the case. At-risk exposure to COVID-19 is higher than average (I include senior living facilities, while Synovus management does not), while reserves are very slightly lower than average. Synovus has also historically operated with thinner-than-average capital buffers, which boosts earnings in the good times, but creates capital adequacy worries during the bad times.

Still, I believe the evolution of Synovus’s credit situation, as well as the ongoing improvements in the U.S. economy, is pushing the worst-case credit loss scenarios off the table. Non-performing loans increased 15% sequentially, and while there were increases in the core C&I portfolio, that shift was overwhelmingly driven by office CRE loans (a portfolio which now has a 1.2% NPL ratio). Non-performing asset ratios remain a little elevated (0.43% vs. 0.37% in Q2), but not troublingly so. Likewise, while charge-offs increased 17% qoq, the overall level of charge-offs remain low (0.28%), and I’m not seeing particularly troubling trends in the criticized loan figures.

Loan deferrals declined from a peak of around 13% to around 1% at quarter-end, with 2% of consumer loans on deferral and 0.5% of commercial loans (overwhelmingly hotel and restaurant loans). Of those loans that came off deferral, 94% returned to paying status.

Balancing Growth And Efficiency

Management has stepped up its attention to operating expenses during this downturn, and that should continue to serve the company well during the recovery. While loan growth is still weak, I do expect to see improvements at some point in 2021.

As the business transitions back to growth, management is going to be looking to focus on generating loan share growth in key Tier 1 markets like Atlanta and South Florida, as well as Tier 2 markets like Birmingham, Greenville, Charleston, and Tampa. Of course, that sounds fine … but there is going to be plenty of competition. Banks have been pouring into the Atlanta market over the last decade, and Synovus may have to fight harder than it expects. Likewise, regional rivals like First Horizon, Regions, South State (SSB), and Truist (TFC) aren’t going to just roll over and give up without a fight in those Tier 2 markets.

One less competitive source of upside is in the balance sheet. Synovus still has around $1.2 billion to $1.3 billion in higher-cost (1.75% on average) time deposits maturing over the next three quarters, and Synovus can improve its spread margin by either letting those deposits go away (using the excess liquidity it already has) or reupping them at significantly lower (100bp-plus) rates. Partly offsetting that will be fixed-rate securities and loans that mature/run off over the next couple of years, but it should still be a net positive for the company.

The Outlook

While the near-term earnings outlook is improving for Synovus, my long-term outlook hasn’t changed as much, and I’m still looking for medium-term (five years) core earnings to be roughly flat with 2019, with long-term growth around 2%. On a year-by-year basis, I expect a significant rebound next year continuing on into 2022 and 2023 and 2024. Synovus could return to double-digit ROTCE in 2021, and if not in 2021, then 2022.

The Bottom Line

Between discounted core earnings and ROTCE-driven P/TBV, I believe Synovus should trade around $30. While that doesn’t make Synovus the cheapest bank I follow, nor my first choice for new money, it does still make it a worthwhile name to consider today.

Disclosure: I am/we are long FHN, SNV. 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.