First Horizon Executing Well; The Next Step Is Up To The Regulators (NYSE:FHN)

It has taken a little longer than shareholders would have preferred, but First Horizon (NYSE:FHN) is starting to show real evidence of the promised benefits from its merger with IBERIABANK back in 2020. Unlike many, if not most, large-scale bank transactions, it looks as though First Horizon may actually be exceeding initial revenue and expense synergy targets, and that’s coming in handy now that fee-generating businesses like fixed income trading and mortgage banking are struggling.

The key to First Horizon’s valuation remains the approval and closure of the pending acquisition proposal from Toronto-Dominion Bank (TD) (“TD”). I continue to expect that the deal will ultimately be concluded, but regulatory clearances are taking a while – it took 13 months for Bank of Montreal (BMO) to get approval to acquire Bank of the West, 16 months for Umpqua (UMPQ) and Columbia (COLB) to get final approval for their merger, and 19 months for New York Community Bancorp (NYCB) and Flagstar, and we’re “only” 11 months distant from the initial deal announcement for TD and First Horizon.

Were the deal to fall apart, there would definitely be downside risk for First Horizon shareholders. With mortgage banking and fixed income trading unlikely to be strong in the near term and more challenging lending markets, I don’t think First Horizon would find particularly positive sentiment, though there is a solid core to support valuation.

Good Spread Performance And Operating Leverage In The Fourth Quarter

First Horizon executed relatively well in the fourth quarter, though it was far from a perfect set of results. Numbers are presented on an adjusted basis and will vary a bit from reported results.

Revenue rose about 18% year over year and 4.5% quarter over quarter, just topping expectations (and beating my own expectations by a bit more). Net interest income rose almost 42% yoy and 7% qoq, with strong net interest margin improvement (up 147bp yoy and 40bp qoq to 3.89%) offsetting weak earning asset performance (down more than 4%, and with Texas Capital Bancshares (TCBI) one of the weakest results of the banks I’ve examined this earnings cycle).

Fee-based income fell 30% yoy and over 4% qoq, with fixed income trading results down 24% qoq and mortgage banking down 56%. In both cases these are cyclical shifts in the markets driving weaker results, though the fixed income performance here was softer than for the giant trading banks (Bank of America (BAC), et al).

Operating expenses declined more than 3% yoy and rose about 3% qoq, with the efficiency ratio coming in below 52% – a marked improvement from the mid-60%’s before the IBERIABANK deal and the 70%-plus results from roughly a decade ago. Management tagged cost synergies from the deal at $200M in the quarter, suggesting around 10% outperformance relative to management’s initial expectations.

Pre-provision profits rose 56% yoy and 6% qoq, and First Horizon did a little better than I’d expected here, helped by that operating leverage.

Mixed Balance Sheet Trends, But A Respectable Funding Position

First Horizon’s roughly 1% end-of-period loan growth was not all that impressive compared to comparable banks this quarter, including better than 2% growth from Regions (RF) and Synovus (SNV) and better than 3% growth from Truist (TFC).

Core C&I lending was up about 2% in the quarter, with management calling out healthy asset-backed lending and Florida and Tennessee markets. Given generally positive commentary from other banks operating in the Carolinas, though, it does make me wonder if First Horizon is seeing more competitive pressures here; I know Pinnacle (PNFP) has grabbed several loan officers from First Horizon and banks like F.N.B. (FNB) are likewise pushing hard for growth in the region.

Yields do continue to improve nicely, with overall loan yields up 167bp yoy and 77bp qoq to 5.12%, commercial loan yields up 203bp yoy and 93bp qoq to 5.4%, and core C&I yields up 77bp qoq to 5.12%.

Credit is okay. While non-performing loan balances did increase 8% qoq, they’re pretty stable as a percentage of loans relative to the year-ago and quarter-ago levels, and C&I loans are doing better than the company average. Charge-offs have ticked up, up 10bp qoq to 0.18%, with C&I charge-offs up 13bp to 0.27%, but it’s not an area of real concern yet.

First Horizon’s deposit performance is somewhat mixed. While the bank is seeing greater deposit outflows than I’d like, including a 9% qoq drop in non-interest-bearing deposit balances, overall costs are under control. Total deposit costs rose 62bp yoy and 44bp qoq to 0.69%, pretty good relative to other midcap banks, and First Horizon’s cumulative deposit beta of 15% is still low (anything below 20% is pretty good at this point).

The Outlook

Management isn’t giving guidance, so modeling involves more guesswork than usual, and I’m largely “borrowing” guidance from banks of similar size in similar markets. I do think that First Horizon may avoid a year-over-year decline in earnings in 2024, and I continue to believe that the bank can generate better than 5% long-term core earnings growth if it has to go it alone.

Valuation is still driven by the standing acquisition offer from TD, and I do expect deal approval and closure later in 2023. Were the deal to collapse, I could see the shares trading below $20 given a sluggish growth outlook, peaking net interest margins, and challenged fee-generating businesses, but I do think the long-term fundamental value is above $20.

The Bottom Line

Given that the shares trade within 3% of the adjusted deal value (the consideration from TD is rising now that the initial targeted close date has been exceeded), I don’t think investors necessarily need to hang around to try and wring every last dollar from this one. Frankly, the risk of the deal collapsing relative to the gains from holding to close seem skewed to the downside, and while I do still have a positive all-in view of the company, I think there are better uses of cash and I intend to sell my own shares now that we’re in a new tax year.