Synovus Hit Hard On Concerns Over Core Growth Drivers (NYSE:SNV)

Synovus (NYSE:SNV) had been making real progress in changing investors’ minds that the company really had made changes for the better and that the bank was on much better footing for long-term growth. Between a more efficient cost structure, improved underwriting, and new growth drivers (both in and outside of core banking), there were solid reasons for a stronger growth outlook. Then came the Fed rate hike cycle and a third quarter report that included guidance suggesting that the good times aren’t going to last.

Synovus shares are down about 25% since my last update, far worse than the average regional bank over that period. I believe that this is an overreaction, but I also believe that there is still significant uncertainty around how far the Fed will go, what the impact of these rate hikes will be on the economy, and how well Synovus will stave off intensifying competition in its core Southeastern markets. I do believe that Synovus is priced for attractive long-term returns now, but I also think investors may have to wait a bit for the clouds to clear over this sector.

A Strong Core Beat On Rate Leverage

Like so many other banks, Synovus posted strong results on the back of better-than-expected rate sensitivity and ongoing growth in earning assets.

Revenue rose 17% year over year and 11% quarter over quarter, beating by over 2%. Net interest income rose an impressive 24% yoy and 12% qoq, beating by about 2% (or about $0.06/share), with net interest margin rising 48bp yoy and 27bp qoq to 3.49%, more or less in line with expectations. Fee income, (which fell 9% yoy and rose 4% qoq on an adjusted basis), was a bit below expectations, but that has been commonplace with bank earnings reports.

Core operating costs rose 10% yoy and 3% qoq, more or less matching expectations (but beating on an efficiency ratio basis given the revenue beat). Pre-provision profits rose 25% yoy and 20% qoq, beating by close to 4% (or a little over $0.05/share). While many banks have been reporting higher-than-expected provisioning expenses this quarter, Synovus was basically in-line here.

Tangible book value per share declined 24% yoy and 10% qoq due to valuation adjustments on the securities portfolio. Ex-AOCI, tangible book per share would have been up close to 12% year over year.

Guidance Was The “But”

Synovus’s third quarter was fine relative to expectations, and the company likewise did alright on loan growth and funding (more on this later). Guidance is where the problems come in.

Management guided to higher revenue growth (15%-16% versus 11%-plus) and higher loan growth (11% versus 8%-plus), but also higher expense growth (7% to 8% versus 6%). Management also warned that the third quarter was likely to be a near-term peak for net interest margin, and the bank increased its expectation for full-cycle deposit beta from 30% to 35%-40%.

I think it’s the last part of guidance that is creating the most concern – the warning that increasing funding costs could start chewing up the bank’s leverage to higher rates. This isn’t a change relative to my expectations – I warned at the start of the year that deposit betas were likely to be higher than expected for this next phase of the cycle – and I think Synovus is being prudent with its guidance, but I think the bank is getting punished for taking a more conservative outlook when other banks are taking more optimistic outlooks (incorrectly, in my view).

Decent Lending Growth, But Watch Funding

Synovus reported sequential loan growth of a little more than 3% – more or less in line with what “smaller” commercial banks produced in the third quarter (“smaller”, as per Fed H.8 data, basically means “not a top-20 bank by assets”). Core C&I lending rose about 2% sequentially, which was a little soft, but overall loan yields were strong and credit quality remains good at this point in the cycle.

Deposits were flat yoy and down 3% qoq on an end-of-period basis, with non-interest-bearing deposits down a little more than 3% quarter over quarter. Deposit costs more than doubled sequentially, but 38bp is not bad overall for deposit costs. The loan/deposit ratio is rather high at 89%, though, and Synovus had previously warned investors that it would likely have to seek out other sources of funding for loan growth, including brokered deposits and debt.

I do think that this environment of higher funding costs will make execution on Synovus’s growth initiatives even more important. Fee-generating business opportunities like MAAST (banking as a service) and specialty commercial lending verticals (finance/insurance, tech, and healthcare) are important potential contributors, particularly in an environment where management may have to get more choosy with its loan underwriting given higher funding costs.

The Outlook

I’ve pulled some earnings forward into 2022 on the stronger/faster realization of rate leverage, but my core earnings assumptions haven’t changed all that much, as the core underlying operating performance hasn’t deviated too far from my expectations.

I do see risks to 2023 and 2024, but mostly from the macro environment. The Fed is moving aggressively to curb inflation and it remains to be seen how much further they will go, not to mention the impact that will have on the economy (and, by extension, loan demand and credit quality). I do still see double-digit pre-provision earnings growth in FY’23, and I’m in the high-single-digits for FY’24, but I do acknowledge risk to that outlook (and the Street certainly doesn’t seem to be pricing that in).

Longer term, I’m still looking for around 4% to 6% core earnings growth from Synovus (6% from pre-COVID 2019 core earnings).

The Bottom Line

Sentiment is clearly weak for bank stocks now, and given the aggressive rate cycle we’re in, that sentiment may linger for several more quarters – at least until it looks like the Fed is prepared to ease off. I do think that Synovus is undervalued today, and I do think the shares should trade in the $50’s on the basis of its long-term drivers and earnings potential, but these shares may well not work until at least the second half of 2023 given the macro risks and sentiment headwinds.