First Horizon Stock: Outperforming While Waiting To Be Acquired (NYSE:FHN)

We have begun our earnings season coverage of the many regional banks that we follow. One such bank that we have not discussed in many quarters is First Horizon Corporation (NYSE:FHN). Based out of Tennessee, First Horizon Banks operate in 12 states across the southern U.S. About a year ago, The Toronto-Dominion Bank (TD) made a bid to acquire the company and the stock has traded in a tight range since then, which also translates to a stretched valuation by most standards we examine given the premium associated with an acquisition.

We believe the banks really give a solid picture of where the economy is heading. So far, we would conclude that all banks are preparing for a mild recession, as evidenced by the significant increase in loan loss provisions. We would also argue that banks are very healthy here, with strong net interest margins and broader increased loan activity, while the competition for customer deposits has increased dramatically. We have made a lot of money in the bank stocks, as in late summer and early fall of 2022 we pushed our members to start buying financials.

While not all of the stocks in the space have been in rally mode, for about three months, they largely have rallied off the lows, taking a breather the last few weeks. The higher rates are boosting margins and net interest income per loan. Loan demand is robust. Despite a shaky outlook the next few quarters for the economy, we believe banks, and especially those that are more regionally focused, will enjoy tailwinds on the back return of higher interest rates.

Banks are now well-positioned for growth over the next few year, and we think TD bank is picking up a quality operation in FHN, a bank stock that pays a 2.5% dividend yield and is growing in the southern U.S. The bank just reported its Q4 earnings, and it shows their loan growth and that asset quality is improving. Let us discuss the just-reported earnings.

Q4 2022 performance relatively strong

First Horizon Corporation’s headline numbers were relatively strong in the quarter. First Horizon Corporation reported Q4 2022 growth on both the top and bottom lines. There was top line growth of 18.4% to $882 million, just about in line with consensus estimates. The strong increase in revenues year-over-year was offset somewhat by an increase in loan loss provisions from last year, like we have seen with many banks. There was strong net interest income. Overall, the bank reported net income of $304 million for the quarter compared to net income of $270 million for the quarter a year ago, rising 13%. On a per share basis, this was $0.51 this quarter, up from $0.48 last year. While there was higher expenses and loan loss provisions, there was strong growth in loans.

Loans grow, but deposits decline

Like a number of competitors, we saw that loans are up from a year ago, but deposits dipped. Growth in loans and deposits is key for any bank to see growth long-term. Total assets are $78.9 billion, which rose from $20.8 billion to start the quarter. Total loans were up. Overall, period-end loans and leases for First Horizon were $58.1 billion, which increased $0.7 billion from third quarter 2022, reflecting a 1% increase in commercial loans and a 3% increase in consumer loans.

But deposits are becoming harder to come by as banks compete. Period-end deposits were $63.5 billion, which decreased $2.5 billion. This decrease was a result of a $2.3 billion decrease in noninterest-bearing deposits, and a $0.2 billion decrease in interest-bearing deposits.

Margins widened despite a higher cost of funds

So, the cost of funds is on the rise as banks have to pay more on deposits. The cost of funds was nearly doubled from last quarter. Cost of funds rose 44 basis points from a year ago. But net interest margin widened to 3.89% versus 2.42% a year ago. This is because the increase in the average yields increased more than the cost of funds increased.

Keep in mind that new loans are going out at a higher rate. Margins also widened 40 basis points from 3.49% in the sequential Q3. We predict margins will remain well over 3.5% in coming quarters. We see both the cost of funds and the yield on the loan portfolio both continuing to increase in 2023. Net interest income was $709 million, an increase of $47 million or 7% from the sequential quarter, and up 42% from a year ago.

Return metrics are strong

You have to keep an eye on return metrics as well to understand the direction a bank is moving. In our coverage thus far, there has been mixed performance on return metrics. First Horizon has strong return metrics. The return on average assets and return on average equity are key measures of efficiency. The return on average assets actually expanded to 1.35% from 1.02% a year ago, while the return on average equity expanded to 14.4% from 11.3%. The bank also became more efficient versus a year ago, with the efficiency ratio improving to 57.07% from 70.88% a year ago.

Asset quality metrics

When we consider that First Horizon Corporation is being bought out, TD is acquiring a bank with strong trends in the asset quality metrics here. We expect this will continue as rates rise further and new loans are made at higher rates, but are mindful that a stronger than expected recession could lead to more delinquencies. As we mentioned before, the loan loss provisions were increased, so that weighed some on performance, but the allowance for credit losses to loans ratio was 1.33%, a slight increase from 1.31% in the sequential quarter, but down from 1.34% a year ago. The nonperforming loans ratio ticked up slightly to 0.54% from 0.51% in Q3, and 0.50% a year ago, but overall these are strong numbers.

Final thoughts

The acquisition of First Horizon Corporation by TD is slated to close in H1 2023, and we think TD is getting a quality set of assets in this bank. While the stock of FHN has crept up to highs, it has been range bound since the acquisition was announced. Overall this was a good quarter for First Horizon Corporation, despite mixed reports from regional banks as a whole. Loan growth is a strength, as are margins.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.