First Citizens Bank: The Bank Buyers

Sector

Financial Services

Background

Bill Nygren and Alex Fitch are partners at Oakmark Funds. We cover the basics of investing in banks, why First Citizens plays an important role in the banking system despite being relatively unknown, and how it is adapting its acquisition strategy to today's economic environment.

Cover

Date

June 7, 2023

Episode Number

114

Business Breakdown: First Citizens Bank

First Citizens Bank, a 125-year-old institution headquartered in North Carolina, stands out as a unique player in the U.S. banking sector. With over $200 billion in assets and 550 branches, it ranks as the 16th largest bank in the U.S. Despite its size, it remains relatively unknown compared to Wall Street giants like JPMorgan or Bank of America, largely due to its low-profile approach, including never hosting public conference calls or investor meetings until recently. This analysis delves into the key dynamics of First Citizens’ business model, emphasizing its distinctive capital allocation strategy, conservative risk management, and exceptional deposit franchise. The breakdown follows a detailed examination of its financials, revenue and cost drivers, capital intensity, and a Hamilton’s 7 Powers analysis, concluding with market context and valuation insights.

Background / Overview

First Citizens Bank, founded in 1898, began as a community bank in North Carolina, focusing on serving wealthy individuals and small businesses. It has been family-run for three generations, with the Holding family maintaining significant ownership (24% of shares, 40% voting control). Frank Holding, CEO since 2008, has overseen a transformative period, accelerating the bank’s growth through acquisitions, particularly FDIC-assisted takeovers of failed banks. The bank operates a “plain vanilla” banking model, emphasizing deposit gathering and conservative lending, without engaging in capital markets or investment banking activities common among larger peers.

The bank’s history is marked by steady organic growth in its Carolina stronghold, where it holds the #4 market share, and strategic expansion via acquisitions. Over the last 15 years, First Citizens has completed 27 acquisitions, with 17 being FDIC-assisted takeovers, generating approximately $1 billion in bargain purchase gains. Notable recent deals include the 2020 acquisition of CIT Group and the 2023 acquisition of Silicon Valley Bank (SVB) from FDIC receivership, which doubled its tangible book value per share.

Ownership / Fundraising / Recent Valuation

The Holding family’s ownership (24% of shares, 40% voting control via Class B super-voting shares) aligns management with long-term shareholder interests. Frank Holding, his sister Hope (Vice Chairman), and brother-in-law Peter Bristow (President) are deeply involved, ensuring a stewardship mindset. The bank has not raised significant external capital recently, relying instead on organic growth and capital-efficient acquisitions. The CIT acquisition was an all-stock deal, and the SVB deal required no upfront capital, highlighting First Citizens’ ability to grow without diluting equity.

Post-SVB acquisition, the stock trades just above 1x tangible book value ($1,250 per share, up from $570 pre-SVB). Private market transactions for high-quality regional banks typically occur at ~2x tangible book value, suggesting undervaluation. The Class B shares, with super-voting rights, trade at a 10% discount to Class A shares due to lower liquidity, presenting an opportunity for long-term investors.

Key Products / Services / Value Proposition

First Citizens operates a straightforward banking model with two core activities:

1. Deposit Gathering: The bank attracts low-cost, sticky deposits through exceptional customer service and long-standing relationships, particularly in the Carolinas. Its deposit costs are significantly below the industry average, enabling a competitive funding advantage.
2. Lending: The bank focuses on conservative lending to wealthy individuals, small businesses, and middle-market firms. Loan types include consumer loans, small business loans, middle-market lending (via CIT), railcar and equipment financing, and capital call lending (via SVB). Lending prioritizes relationship-driven, specialized loans over commoditized, price-sensitive ones.

Value Proposition:

• Sticky Deposits: Long-term relationships and a strong regional brand ensure depositors remain loyal, even in high-rate environments, minimizing funding costs.
• Conservative Lending: Low loan losses and high credit quality maintain profitability through economic cycles.
• Acquisition Expertise: A core competency in integrating FDIC-assisted takeovers, generating bargain purchase gains and expanding market presence.

Segments and Revenue Model

First Citizens operates primarily as a single-segment bank, with revenue derived from net interest income (the spread between interest earned on loans/investments and interest paid on deposits). Unlike larger banks, it avoids non-interest income from capital markets or fees, focusing solely on traditional banking.

Revenue Model:

• Net Interest Income: Generated by lending at higher rates than deposit costs. For example, lending at 150 basis points above treasuries while paying depositors 150 basis points below treasuries yields a net interest margin (NIM). Post-SVB, the bank is asset-sensitive, benefiting from higher interest rates.
• Bargain Purchase Gains: Non-recurring gains from acquiring failed banks at a discount to book value (~$1 billion historically).

Revenue Drivers:

• Deposit Cost Advantage: Low-cost deposits (below industry average) enable a wider NIM.
• Loan Yield: Specialized, high-yield loans (e.g., CIT’s middle-market lending, SVB’s capital call lending) boost revenue, while conservative consumer loans ensure stability.
• Acquisition Synergies: Cost reductions (20-25% of target cost base) and asset redeployment (liquidating low-yield assets) enhance earnings post-acquisition.

Splits and Mix

• Geographic Mix: ~33% of deposits from the Carolinas, with California now a significant contributor post-SVB. Other regions include states entered via acquisitions.
• Customer Mix: Wealthy individuals, small businesses (e.g., dentists, doctors), middle-market firms, and PE/VC funds (via SVB’s capital call lending).
• Product Mix: Diversified loan book with consumer/small business loans, middle-market lending, equipment financing, and capital call lending. Deposits are primarily retail, with some commercial deposits from SVB.
• End-Market Mix: Exposure to real estate (consumer mortgages), healthcare (doctors), retail (factoring via CIT), railcar leasing, and venture capital (via SVB).

Mix Shifts:

• Post-CIT (2020), the bank shifted toward higher-yield middle-market lending, reducing reliance on low-yield consumer loans.
• Post-SVB (2023), the loan book diversified further with capital call lending and winery financing, though deposit retention remains uncertain.

KPIs

• Return on Equity (ROE): High single-digit ROE through the 2008 financial crisis, compared to peers’ losses. Post-CIT, ROE likely exceeds 10%.
• Tangible Book Value per Share: Grew from $570 to $1,250 post-SVB, compounding at a mid-teens rate over 20 years.
• Net Interest Margin (NIM): Expanded post-higher interest rates, driven by low-cost deposits and asset sensitivity.
• Loan Losses: Historically low, with charge-offs during the financial crisis below peers’ good-year averages.
• Deposit Retention: Critical post-SVB, with $41 billion of SVB deposits remaining (down from $171 billion).

Acceleration/Deceleration:

• Revenue and earnings accelerated post-CIT (+50% EPS accretion) and SVB (doubled tangible book value).
• Deposit retention is a potential deceleration risk if SVB deposits continue to run off.

Headline Financials

Long-Term Financial Trends:

• Revenue: Grew at a mid-teens CAGR, driven by organic deposit growth and acquisitions.
• EBITDA Margin: Expanded through cost synergies (20-25% cost reductions in acquired banks) and operating leverage from low-cost deposits.
• FCF: High due to minimal capex (branch network maintenance) and capital-efficient acquisitions.

Value Chain Position

First Citizens operates midstream in the banking value chain, between depositors (upstream) and borrowers (downstream). Its primary activities include:

• Inbound Logistics: Gathering deposits through branches and relationships.
• Operations: Underwriting loans, managing liquidity, and integrating acquisitions.
• Outbound Logistics: Disbursing loans and providing banking services.
• Marketing/Sales: Relationship-driven customer service, leveraging brand and regional presence.
• Service: High-touch support to ensure deposit stickiness.

Go-to-Market (GTM) Strategy:

• Retail Banking: Personalized service in branches, targeting wealthy individuals and small businesses.
• Specialized Lending: Relationship-driven loans (e.g., CIT’s equipment financing, SVB’s capital call lending) with expertise-based differentiation.
• Acquisition Integration: Rapid integration of failed banks, leveraging FDIC processes to minimize disruption.

Competitive Advantage:

• Deposit Franchise: Low-cost, sticky deposits reduce funding costs.
• Acquisition Expertise: Unique ability to bid on and integrate FDIC-assisted takeovers.
• Conservative Risk Management: Low loan losses and diversified loan book ensure stability.

Customers and Suppliers

• Customers: Wealthy individuals, small businesses (e.g., dentists, doctors), middle-market firms, PE/VC funds, and niche sectors (e.g., wineries via SVB).
• Suppliers: Depositors (providing capital), FDIC (for acquisition opportunities), and technology vendors (for banking systems).

Pricing

• Deposits: Priced below industry averages (e.g., 150 basis points below T-bills), reflecting stickiness and brand strength.
• Loans: Priced at a premium for specialized lending (e.g., 150 basis points above treasuries for mortgages), with conservative consumer loans at lower yields.
• Contract Structure: Deposits have daily withdrawal rights (liquidity risk), while loans (e.g., 30-year mortgages) are long-term, creating asset-liability mismatch. SVB’s capital call loans are short-term and low-risk.
• Pricing Drivers: Brand, customer relationships, and mission-criticality (e.g., tailored services for dentists) enable premium pricing on loans. Deposit pricing reflects low price sensitivity due to loyalty.

Bottoms-Up Drivers

Revenue Model & Drivers

How First Citizens Makes $1 of Revenue:

• Net Interest Income: Earns a spread between loan yields and deposit costs. For example, lending $1 million at 5% (150 basis points above treasuries) while paying 3.5% on deposits (150 basis points below treasuries) generates $15,000 in net interest income.
• Bargain Purchase Gains: Acquiring failed banks at a discount (e.g., SVB loans at a discount) generates non-recurring gains.

Revenue Drivers:

• Price: Loan yields driven by specialization (e.g., CIT’s high-yield loans) and relationship-based pricing. Deposit costs remain low due to brand and loyalty.
• Volume: Deposit growth from organic branch expansion and acquisitions (e.g., SVB’s $41 billion in deposits). Loan volume grows via acquisitions and up-tiering to creditworthy borrowers.
• Mix: Shift toward high-yield loans (post-CIT/SVB) increases revenue per dollar of assets.
• Industry Fundamentals: Higher interest rates boost NIM for asset-sensitive banks like First Citizens.

Revenue Mix:

• Consumer/Small Business Loans: Stable, low-yield, high volume.
• Middle-Market/Specialized Lending: High-yield, moderate volume, high margin.
• Capital Call Lending: High-yield, low-loss, growing post-SVB.

Cost Structure & Drivers

Cost Structure:

• Variable Costs: Deposit interest (3.5% on $900,000 in deposits yields $31,500 in costs), transaction processing, and branch operations (~100 basis points of assets, or $10,000 on $1 million).
• Fixed Costs: Branch network maintenance, employee salaries, technology systems, and regulatory compliance.
• Acquisition Costs: Integration expenses (e.g., employee retention packages, system upgrades) offset by synergies (20-25% cost reductions).

Cost Drivers:

• Operating Leverage: Fixed costs (branches, technology) spread over a larger asset base post-acquisitions, improving margins.
• Economies of Scale: Larger size reduces per-unit costs for compliance, technology, and administration.
• Inflation: Labor and technology costs may rise, but low deposit costs mitigate impact.

EBITDA Margin:

• Pre-tax margin example: $50,000 (interest income) - $31,500 (deposit interest) - $10,000 (operating expenses) = $8,500 (8.5% margin on $1 million assets).
• Post-acquisition synergies (e.g., CIT’s cost reductions) boosted margins, with further upside from SVB integration.

FCF Drivers

• Net Income: Driven by NIM expansion and acquisition synergies. Post-CIT EPS rose from $50 to $75.
• Capex: Low, primarily for branch maintenance and technology upgrades. Banking is capital-light compared to industrial firms.
• Net Working Capital (NWC): Minimal, as banking involves liquid assets (deposits, loans). Cash conversion cycle is short due to daily deposit liquidity.
• FCF: High due to low capex and strong earnings growth. Excess capital (300 basis points above regulatory minimums) supports dividends or buybacks.

Capital Deployment

• M&A: 27 acquisitions in 15 years, including 17 FDIC-assisted takeovers. SVB required no upfront capital, showcasing capital efficiency.
• Organic Growth: Branch expansion in adjacent geographies.
• Capital Return: Excess capital (post-SVB) supports potential dividends or buybacks, aligning with Oakmark’s philosophy of returning capital when growth opportunities are limited.

Market, Competitive Landscape, Strategy

Market Size and Growth

• Market Size: U.S. banking market exceeds $20 trillion in assets, with regional banks (top 25) holding ~$5 trillion.
• Growth: Driven by GDP growth (2-3% real), inflation (2-3%), and deposit/loan growth (~4-5% annually). Higher interest rates boost NIM for asset-sensitive banks.
• First Citizens’ Market: Focused on Carolinas (33% of deposits), California (post-SVB), and other U.S. regions. Specialized lending (e.g., railcar, capital call) targets niche markets.

Market Structure

• Competitors: ~3,000 U.S. banks, down from 14,000 in 1980, reflecting consolidation. The market is fragmented, with top 10 banks holding ~50% of assets and regionals like First Citizens competing for the rest.
• Minimum Efficient Scale (MES): Larger MES favors consolidation, as small banks require higher risk to achieve similar ROE. First Citizens benefits from economies of scale (550 branches, $200B assets).
• Industry Cycle: Post-2023 banking crisis (SVB, First Republic), focus shifted from credit risk to liquidity and duration risk, benefiting diversified, well-capitalized banks.

Competitive Positioning

• Positioning: First Citizens targets relationship-driven, high-service banking for wealthy individuals, small businesses, and niche sectors, avoiding commoditized lending.
• Market Share: #4 in Carolinas, top 15 nationally. SVB acquisition expanded its California presence.
• Relative Growth: Outpacing market growth via acquisitions (mid-teens tangible book value CAGR vs. ~5% industry asset growth).

Hamilton’s 7 Powers Analysis

1. Economies of Scale: Strong. Larger asset base ($200B) spreads fixed costs (branches, compliance), enabling higher ROE than smaller banks. MES favors consolidation, and First Citizens’ size provides a moat.
2. Network Effects: Weak. Banking lacks flywheel effects, as deposits and loans are not inherently networked.
3. Branding: Moderate. Strong regional brand in Carolinas drives sticky deposits, but national brand is less prominent.
4. Counter-Positioning: Strong. FDIC-assisted takeover expertise is a unique business model, difficult for peers to replicate due to experience and risk aversion.
5. Cornered Resource: Moderate. Holding family’s ownership and long-term stewardship provide strategic alignment, but not a proprietary resource.
6. Process Power: Strong. Streamlined acquisition integration (e.g., SVB’s relationship manager retention) and conservative risk management differentiate operations.
7. Switching Costs: Moderate. Sticky deposits due to relationships and service quality create moderate switching costs, though less pronounced in commercial lending.

Key Moat: Counter-positioning via FDIC acquisition expertise and economies of scale from a large, diversified asset base.

Competitive Forces (Porter’s Five Forces)

1. New Entrants: Low threat. High barriers (capital, regulation, brand, deposit stickiness) deter new banks. First Citizens’ acquisition expertise further raises the bar.
2. Threat of Substitutes: Moderate. Non-bank lenders (e.g., fintechs) compete in lending, but sticky deposits and relationship-driven banking limit substitution.
3. Supplier Power: Low. Depositors (suppliers of capital) have limited power due to First Citizens’ low-cost, sticky deposit base. FDIC provides acquisition opportunities.
4. Buyer Power: Moderate. Borrowers in commoditized lending have price sensitivity, but relationship-driven clients (e.g., dentists, PE funds) prioritize service over price.
5. Industry Rivalry: High. Fragmented market with ~3,000 banks creates competition, but First Citizens’ niche focus and acquisition strategy reduce direct rivalry.

Strategic Logic

• Acquisition-Driven Growth: FDIC takeovers provide capital-efficient growth, with SVB adding $700+ to tangible book value per share.
• Economies of Scale: Larger size enhances operating leverage, reducing per-unit costs.
• Risk Management: Conservative lending and diversified loan book mitigate credit risk, while SVB’s loss-sharing agreement and liquidity buffers address liquidity/duration risks.
• Potential M&A: As the 16th largest bank, First Citizens can pursue mergers of equals or additional FDIC takeovers without hitting the 10% deposit market share regulatory cap.

Valuation

• Current Valuation: Stock trades at ~1x tangible book value ($1,250 per share), compared to ~2x for high-quality regional peers in private transactions.
• Rules of Thumb:
• P/E vs. ROE: A bank earning 10% ROE should trade at ~10x earnings. First Citizens’ high single-digit to low double-digit ROE suggests fair value at 10-12x earnings.
• Deposit Premium: High-quality deposit franchises command 7-10% premiums, implying ~2x tangible book value.
• Upside: If SVB deposits are retained/grown, earnings power could justify a 2x tangible book value multiple, doubling the stock price.
• Risks: Key man risk (Frank Holding’s succession), SVB deposit runoff, and regulatory changes could cap upside.

Key Dynamics and Unique Aspects

1. FDIC Acquisition Expertise:
• First Citizens’ core competency in FDIC-assisted takeovers is unparalleled, with 17 deals generating ~$1 billion in bargain purchase gains. This counter-positioning moat allows capital-efficient growth, as seen in the SVB deal (no upfront capital, $700+ tangible book value accretion).
• The bank’s “muscle memory” in bidding, integrating, and retaining relationships (e.g., SVB’s winery business manager) sets it apart from peers, who lack the experience or risk appetite for such deals.
2. Low-Cost, Sticky Deposit Franchise:
• The bank’s 125-year regional presence and relationship-driven service create a sticky deposit base, with costs significantly below industry averages. This enables a wider NIM, even in high-rate environments, and supports conservative lending without sacrificing ROE.
• Unlike SVB’s volatile tech deposits, First Citizens’ generational relationships ensure stability, a critical advantage in a post-2023 banking crisis world.
3. Conservative Risk Management:
• Low loan losses (below peers’ good 2008 charge-offs) and diversified loan book (consumer, middle-market, capital call lending) mitigate credit risk.
• Post-SVB, liquidity buffers ($35 billion term loan, 100% deposit coverage) and capital buffers (300 basis points above regulatory minimums) address liquidity and duration risks, making First Citizens resilient to rate volatility.
4. Family Ownership and Long-Term Focus:
• The Holding family’s 24% ownership and 40% voting control align management with shareholders, fostering decisive, long-term capital allocation (e.g., SVB acquisition despite short-term risks).
• This ownership structure contrasts with hired CEOs’ risk aversion, enabling bold moves like FDIC takeovers.
5. Capital Efficiency:
• Acquisitions like SVB require minimal capital, preserving equity and boosting ROE. Cost synergies (20-25% reductions) and asset redeployment (liquidating low-yield assets) enhance earnings power.
• Excess capital supports potential dividends/buybacks, aligning with shareholder-friendly capital allocation.

Conclusion

First Citizens Bank’s business model is a masterclass in balancing conservative banking with opportunistic growth. Its low-cost, sticky deposit franchise, conservative lending, and FDIC acquisition expertise create a defensible moat, enabling mid-teens tangible book value growth over two decades. The SVB acquisition, doubling tangible book value to $1,250 per share, underscores its capital-efficient growth strategy. Financially, the bank delivers high single-digit to low double-digit ROE, strong FCF, and expanding margins, driven by operating leverage and acquisition synergies. Despite risks (SVB deposit runoff, key man risk), its 1x tangible book value valuation suggests significant upside, potentially doubling if SVB deposits are retained. In a fragmented, competitive banking market, First Citizens’ unique dynamics—rooted in family ownership, risk discipline, and acquisition prowess—position it as a standout compounder.

The good explanations sought here stem from understanding the causal relationships behind First Citizens’ success: sticky deposits lower funding costs, enabling conservative yet profitable lending; acquisition expertise drives capital-efficient growth; and family ownership ensures long-term, decisive capital allocation. These dynamics, grounded in clear, testable mechanisms, make First Citizens a compelling case study in banking excellence.