Thoughts & Comments
Still Bullish On Synovus
The company's recent offering severely limits risk, but also some potential upside. Why we're still positive.

Thomas Brown  ( about me )
Posted 06/04/2010

Next, an update on Synovus Financial (SNV), a name we’ve talked about glowingly here before, that continues to be a large position in the portfolios we manage. The company made some moves a few weeks back that, in my view, materially changed its investment appeal. The good news is that the risk in the stock has been substantially reduced. The less-good news: so, alas, has some of the potential upside. My bottom line: I’m still a fan. Synovus remains a major position for us.

I’ll get to the details in a moment. First, though, a broad comment about the investment environment, which has been, shall we say, unsettled for the better part of the last month.  Market watchers have come up with all kinds of culprits for the weakness, from the Greek crisis to investor jitters following the “flash crash” on May 6. I don’t buy it. Rather, I believe stocks are simply experiencing the sort of normal correction one would expect following a non-stop, 80%, 15-month rise. With one caveat: the financials in particular face new uncertainty in the form of the semi-irrational financial reform bill that’s working its way through Congress. But even the financial reform bill doesn’t pose a serious new negative to the group, in my opinion.  

So if this correction hasn’t ended yet, I believe it will soon, and without much further erosion in valuations. I believe the bull market will resume shortly, as the U.S. economy moves from recovery to outright expansion.

(If you’re a market timer and disagree with my view of the market, you might as well stop reading now. But if you believe, as I do, that the U.S. economy will continue to expand, by all means stay with me, since Synovus will likely be a strong investment performer in the scenario we both have in mind.) 

Recall that the investment case for Synovus is familiar and simple to understand.  The company made too many residential construction loans during the housing boom and, once the bubble burst, its credit expenses soared. By now, Synovus has lost money for seven quarters in a row, and will likely lose money for one or two quarters before things get back to normal. But in the meantime, leading indicators of credit quality have markedly improved and credit costs have begun to decline. By my reckoning, Synovus can return to profitability by the fourth quarter.

Yet, at 0.9 times tangible book value and 7 times normalized earnings, the stock trades as if Synovus is still on life support. If you take the company’s credit indicators at face value (and I can’t imagine a reason why anyone shouldn’t), you should simply own the stock and watch it rise as fundamentals continue to improve. That’s essentially the strategy we’ve followed, on our way to becoming one of the company’s biggest shareholders.  

Now, to those recent events at Synovus that altered the stock’s potential risk and reward. As I’ve said before, Synovus comes with two main investment risks. First, credit might not improve as we expected, or might even get worse. That’s not happening—more in a minute.

But the second risk was that the company might choose (or be forced) to bolster its balance sheet by raising fresh equity, and thus dilute existing holders.  

There, things haven’t gone as well as we might have hoped. On April 28, Synovus raised $1 billion via the sale of common stock and equity units. Frankly, I can’t say I was pleased when I saw the size of the deal; it was quite a bit more than I thought the company needed to raise. The dilution was substantial, and has somewhat reduced (but far from eliminated) the returns long-term Synovus holders stand to earn. The remaining upside is nonetheless considerable, in my view.

And in the meantime, no one should have any questions anymore about the company’s capital ratios or the strength of its balance sheet. Post-deal, Synovus’s Tier 1 capital ratio is now 13.7%, its total capital ratio is 17.2%, and its Tier 1 common ratio is 10.0%. Those are of course very strong numbers. 

Meanwhile, the other investment risk, credit quality, continues to diminish. Synovus is now clearly on the path to profitability, as credit expenses continue to decline from levels that, at their peak, were fully 14 times normal. (See Chart 1).

In all, then, the risk in the stock has been greatly diminished—as has the potential reward. Back in March, before the equity raise, I thought Synovus would eventually trade at 15 times an earnings power I estimated to be 75 cents per share, for a price target of $9. Now, with the added shares, Synovus’s earnings power is more like 40 cents to 44 cents per share. Using the same target multiple, I get to a target of $6. That’s still more than a double—and at vastly reduced risk.  

And, as I say, the credit picture continues to improve. I spoke recently with Kevin Howard, Synovus’ chief credit officer, and came away from the chat with more confidence than ever in my credit forecast.  Here’s an update on the key credit indicators I discussed here in March. Notably, all of them are improving! 

1.       Exposure to the biggest problem areas continue to fall. Recall that Synovus’ biggest credit problems, both in frequency and severity, have been in its residential construction loan portfolio in general, and in metro Atlanta in particular.  Chart 2 shows that the performing loans left in this portfolio continue to decline at a rapid pace.

2.       The rate of new nonperforming loans continues to slow. The level of new nonperformers is the single best leading indicator of future credit costs. Chart 3 shows that new nonaccrual loans have fallen at Synovus for the past four consecutive quarters. In March, we expected new nonaccrual loans for the first quarter would come to $620 million. In fact, they were just $531 million. Back in March we expected new nonaccruals for the second quarter would be $500 million. Now we’re expecting $475 million.  We continue to expect new nonaccrual loans to fall to around $300 million by the fourth quarter. That would be low enough for Synovus to actually report a profit!

3.       The loss content of new nonaccrual loans is declining.  New nonaccrual loans have an inherently lower loss content than earlier nonaccruals, primarily because their underlying collateral is stronger. In particular, many (even most) of the earlier nonaccruals were secured by land. More recent nonaccruals, by contrast, are secured by properties that are generating some level of cash.

4.       Nonaccrual loan upgrades are trending higher. At Synovus (and industry-wide), Commercial & Industrial credit quality is improving as the economy improves, so that an increasing number of loans are being upgraded from nonaccrual. (Table 1). We expect this to continue, and for loan upgrades to become an increasingly important part of the reduction in nonaccruals at many banks in the coming quarters, including Synovus.

5.       Nonperforming assets have started to decline. Chart 4 shows Synovus’ nonperforming assets over the last nine quarters.  We expect the company will report its first decline in nonperforming assets in the second quarter.

6.       The level of net chargeoffs is declining.  Synovus’ quarterly new chargeoffs (Chart 5) have declined for two consecutive quarters. We expect the decline to continue. Why? Three reasons: 1) the inflow of new nonperforming loans is falling, 2) the loss content of new nonperforming loans should fall, as well, and 3) the company has already taken extensive writedowns (like, 49%) on its existing nonperformers. While the quarterly level of chargeoffs will be lumpy, the overall decline will likely proceed much faster than consensus expectations for the next six quarters.

7.       The loan loss provision is coming down. The items listed above will all help determine the one number most critical to the timing of Synovus’s return to profitability: the loan loss provision. Chart 6 shows that the company’s quarterly loan loss provision has declined for the previous four quarters. This is a pattern we expect to not only continue, but to accelerate.

8.       Problem-asset disposition has accelerated. Synovus disposed of $271 million of problem assets in the first quarter, better than our estimate of $225 million. But the “realization ratio” was only 43% compared with our estimate of 53%.  Sales activity and realization rates picked up late in the first quarter, and that has continued.  We expect the company to exceed its goal of $600 million in problem-asset disposition in the first half of 2010 (Chart 7) and the realization rate in the second quarter is likely to be higher than it was in the first. 


A lot has happened at Synovus since we last wrote about the company in March: it has reported another quarter of credit improvement and has completed a sizable capital raise.  The capital raise has had the effect of reducing both potential risk and reward in the stock in my view. The speed of credit improvement, meanwhile, will likely hasten price recovery in the stock.  

At its current price, the potential reward in Synovus seems compelling to me, particularly when weighed against the now vastly reduced risk. Credit is improving—and as that process continues, earnings will follow. The stock’s valuation should recover steadily, all of which suggests a potentially doubling in Synovus’ stock price over the next two-three years.

What do you think? Let me know!


  Add your comment



Joe V Posted On 6/4/2010 9:22:16 AM

I admire your loyalty more than your logic. I'm afraid the old model for banks that made Ken Lewis, George A. Schaefer, Jr, and so many others look like geniuses is gone. Banks were a solid investment when they paid a handsome dividend and used their inflated stock prices [2 to 3 times book] for acquisitions. Remember the brags of 100+ years of increased dividends? Without a dividend, tech companies, health care, etc. offer far more growth than the hope that banks will prosper. Banks need an expanding economy and low interest rates and those two items are contradictions.

DLB Posted On 6/4/2010 10:26:16 AM

Right you are Joe V. In general banking is a boring business that prospered during the long credit boom. With much less need for credit (and a lack of qualified borrowers) now and in the future, there is way too much capacity. Now they will have a tough time achieving decent returns on capital. Possibly a WFC or a JPM may do OK as they have a much broader array of products. But a plain Jane regional bank like Synovus, no way. Tom's right that the stock may move up somewhat the next couple of years as the credit costs fall. But lets not forget much higher FDIC premiums for a half dozen years (at least) and a wildly tougher regulatory outlook after the fiasco of the last decade.

Confused in Georgia Posted On 6/4/2010 10:34:59 AM

Tom, how can you say that the dilution (which is HUGE) "somewhat" limits the upside???? Synovus started this mess with 330 million shares and will end it (assuming yet no more stock is issued) with 900-950 million shares. They gave away 2/3 of the company to get out of the ditch. 2/3 !!! The stock was $12 before the mess (adjusted for TSS spin). At best it goes back to $4-5 (1/3 of the old peak factoring in the 2/3 dilution). I don't get your optimism. The company has been shattered. Management credibilty is very weak. They are on life support for a reason. The company is dying.

Confused in Georgia Posted On 6/4/2010 10:41:35 AM

One more thing.....15x Earnings????? What justifies that??? This franchise is severely weakened, they've merged all the banks into 1 bank which vastly changes the DNA of the company, they still have to pay back TARP and the government is limiting what banks can do going forward - capping fees, capping exposure to real estate, higher FDIC fees, etc. Why would any regional bank support a 15x P/E in that environment??? The $0.40 cents earnings power is about right down from $1.00+ they earned as a bank stand alone before this. Your PE assumption is wrong. 10-11x earnings is about right for banking coming out of this mess. Multiples will be nowhere close to the 15x PE's banks enjoyed during Nirvana days when all was grand. This industry will be handcuffed by Obama as punishment for putting America through this (Aside - no one ever blames the borrower who greedily overextended, it is always someone else's fault). $0.40 in earnings x 10-11 PE = $4+ stock not $6 like you think now and NOWHERE near the $9 you thought a few months ago.

Mike Durante Posted On 6/4/2010 2:02:36 PM

Correct analysis. A normal quarterly loss provision is closer to $20 million versus the declining $300 million in 1Q10. That's a 10 to 1 reversion to normal. One might argue the tie to "normal", but I would argue either current management gets there in step with other banks or gets acquired by a management team that will. Either way, the proper way to look at the stock is not the rear view. The bank's pre-tax earnings power therefore approaches $1 per share. That's a current market value of <3x. In addition, the company has more cash and equivalents than market value plus debt. So, this means it trades at no deposit premium whatsoever. Synovus is "tasty" take-over target, which will be a major "leg" in a long-tailed bank stock recovery over the next several years. A relatively "tame' deposit premium, values the franchise at $9.

Colonel Sanders Posted On 6/4/2010 2:07:27 PM

Amen to Confused in Georgia. Assuming "normalized" earnings is already something of a stretch. To put a 15X multiple on normalized earnings is even crazier. And how about some sort of time value discount to get to normalized earnings. Won't that take 2 years? How about a 10% annual discount, or 20% total. And SNV will be much different coming out. Prior to the crisis, it was a decentralized regional bank with lots of growth coming from variable rate construction loans in a relatively high-rate environment (i.e. 4-5% Fed funds). In the future, we will likely have low-ish interest rates and minimal real estate appreciation. On top of that, most banks have survived this crisis, despite the FDIC seizures, so there will remain a lot of competition for a shrunken pie of loan and deposits. Where is SNV going to actually get its growth to support a 15X PE multiple? The answer is nowhere. 12X multiple max and probably more like 9-10X.

Joe V Posted On 6/4/2010 3:05:06 PM

Lots of failing banks are being proffered by the FDIC for free with a share the hurt kicker . It's a buyer's market and no one will be chasing Synovus anytime soon. Synovus said it all when they scuttled shareholders to raise capital. Wonder how many insiders are snapping up this great buy? Wasn't Durante a comedian from another era?

Doubly Confused Posted On 6/4/2010 3:55:36 PM

I agree with Confused in Georgia. The dilution is absolutely killing the bank. To make matters even worse, the senior management team was awarded stock grants that will even further dilute the existing shareholders (and this is the exact same management team that got them in the mess in the first place - I mean why would you want to give this group any incentive to stick around??). Even more confusing is the selection of the CEO heir apparent who is the guy who as I understand it led the charge into Atlanta real estate lending. What was a great bank and a great story has been slowly eroded by cronyism and simple hubris.

kashy Posted On 6/5/2010 8:47:15 AM

All you guys are idiots. You can't see the big pictutre about how much trouble the world is in. I challenge anyone of you fool's to see who can generate a better return over the next 60 days. Synovus is over-vauled and Tom Brown continues to wear rose colored glasses. If you jackasses can't read the tea leaves - then stay long and blindly follow Tom and his lemmings. If you had any sense though, you would rake in profits like i'm doing on the long side. What do you say, Tom, think you take an amatuer here in a stock picking contest? I am convinced I would smoke you.

kashy Posted On 6/5/2010 8:48:15 AM

correction - make profits like i am doing on the short side.....

John Tschohl Posted On 6/7/2010 11:14:16 AM

Tom Thanks. I love your detailed reports. I will buy some more stock. I like betting against the market.

synovus please Posted On 6/7/2010 3:55:00 PM

thanks for the update tom, definitely appreciated

jrallen81 Posted On 6/7/2010 11:57:52 PM

for what it's worth, the new President (Kessel Stalling) did not lead the charge into risky lending in atlanta. He was the CEO of a bank acquired by Bank of North Georgia (synovus sub). Also, Confused, with the caveat that I was horrified by the dilution as well - it's not like they gave away the 2/3 of the company for nothing - capital raises were at 4 and 2.75, most recently, and at a higher price earlier.

bankman Posted On 6/8/2010 9:10:51 AM

confused and doubly confused, great points. Tom, 2 questions here: 1) why was management not replaced? and how can you invest with this SAME management team? 2) what is your downside case? Their metrics are "looking" better becasue the economy/unemployment/home values are not in freefall anymore...what if we see some further deterioration there? What's the stock worth in that case?

confused in georgia Posted On 6/10/2010 10:18:34 AM

regarding JRAllens post about Kessel not leading the charge into RE in attention to what is happening....SNV is spinning Kessel as the annointed one. He ran Riverside Bank in Cobb County that John Williams (Huge RE developer) had essentially bought and recapitalized. They grew Riverside aggressively and then sold it to SNV for top, top dollar. SNV even had to go in and mysteriously raise the price for Riverside (in my mind simply because Blanchard "had to have" Kessel). Now SNV is spinning the Riverside story that it was "clean" and didn't have the RE exposure of all their other ATL banks that were merged together into Bank of North Georgia in 2006. The Riverside deal closed in 2006. Atlanta's RE bubble popped in 2008. Riverside grew very fast and you're (and SNV) are telling us Kessel had nothing to do with SNV's Atlanta RE exposure? Riverside grew very fast in ATLANTA and somehow did all that by MISSING the RE buildup and problems? GIVE ME A BREAK. I'm willing to be that if Riverside had never been bought and if Riverside was a stand alone bank that Riverside would have failed by now like so many other, fast growing, young, aggressive ATL banks. We'll never know. SNV has lost their ass in ATL and Kessel has been running SNV's ATL bank since 2006. I'm certainly not saying he is to blame. He's not. But he had a role. Its a moot point. He's annointed. He'll be running the bank in a year. We'll see if they can spin him as the savior.

CREDIT GURU Posted On 6/14/2010 4:59:54 PM

When will they be able to be free of the Florida panhandle and southeast Georgia islands problems???
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