Early horizon leveraging rate sensitivity and M&A synergy

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J. Michael Jones

It helps to have powerful friends, and in the case of first horizon (NYSE: FHN), increased confidence in the probability of Toronto-Dominion Bank (TD) closing its deal for First Horizon helped First Horizon is outperforming in a bad year for regional banks (and banks in general). At the same time, First Horizon hasn’t hurt its standalone credentials (should the deal somehow fall apart) with signs of improving execution in recent quarters. .

I believe TD Bank will get the final green light from regulators to complete its acquisition of First Horizon within the next three months or so, and I believe there is a reasonable chance that the closing will occur after the deadline. of November 27 which triggers an additional $0.65. / split payment. That suggests about $1.60/share upside from here (or about 6%) – not a scintillating return, but not bad for investors who don’t have more pressing ideas today.

Not a perfect neighborhood, but not bad either

I’ve been critical of First Horizon’s management in the past, and thought the company needed to show better execution, especially when it came to harvesting synergies from the IBKC deal. With third quarter results in hand, there are signs of progress, but there is still room for significant improvement should the bank go it alone.

Adjusted core revenue was up 11% year over year and 15% quarter over quarter, beating expectations by about 3%. It should be noted that many sell-side analysts take a less rigorous approach with modeling and tracking stocks as M&A deadlines approach, so I take some of the sell-side models for First Horizon with a coarser grain salt these days.

Core net interest income was up 35% year-on-year and 22% quarter-on-quarter as the bank’s above-average asset sensitivity really kicks in. 2.41% a year ago and 2.74% a quarter ago. Higher average loan yields (4.35% versus 3.47% a year ago and 3.57% a quarter ago) have clearly helped, and I expect First Horizon to become better than the average here once all quarterly reports are available.

Core fee income was down 32% yoy and 4% qoq, with bond income down 52% yoy and 10% qoq on a 14% qoq decline average daily trading earnings. I expected trading to be weaker this year given the rate cycle, but I admit to being a bit disappointed that the company hasn’t held up a bit better. First Horizon also experienced a substantial decline in Mortgage and Securities Banking revenue (down 74% YoY and 59% YoY), which is also what I had previously expected given the slowdown in the mortgage market and the exit of the bank from the securities sector.

Core operating expenses were down 8% YoY and up 1% QoQ as the bank sees fairly strong core operating leverage as synergies from the IBKC deal begin to materialize . Basic adjusted profit before provision increased 42% year-on-year and 37% quarter-on-quarter. Tangible book value decreased 11% year-on-year and 5% quarter-on-quarter, due to mark-to-market adjustments to the company’s securities portfolio.

Mixed loan performance and funding is a watchdog

First Horizon recorded average loan growth of 2% from the previous quarter, which on the face of it is unremarkable next to the growth of more than 3% reported for “small” banks according to Fed data H.8 (note that “small” means “not the 20 largest nationally chartered banks in the United States” in this case). Likewise with the 1% growth in commercial loans at a time when C&I loan activity was strong (up 4% q/q for the small banking group).

The adjusted results were somewhat better; Excluding the impact of PPP loans and warehouse mortgages, average loan growth climbs to 4%, with C&I loan growth of 4%. Whether this is the right way to look at it or not is up to investors; the warehouse mortgage has long been an integral part of First Horizon’s business, so I wouldn’t ignore it. That said, 4% growth in underlying non-warehouse lending isn’t a bad result, and First Horizon provided the strength I expected to see in areas such as asset-based lending and franchises.

Credit quality is, unsurprisingly, quite good now. I didn’t see anything in the numbers that concerned me, and I note that the credit quality in the commercial portfolio looks pretty good right now.

I’m less happy with what First Horizon brought in with the repositories. On an average balance basis, deposits were down 8% year-on-year and 5% quarter-on-quarter, significantly worse than the flat performance of the broader peer group. The performance of non-interest bearing deposits was also weak, down 4% quarter-on-quarter. Deposit costs jumped 15 basis points from 10 basis points last quarter (and 11 basis points last year) to 25 basis points, including a 24 basis point year-over-year increase and 25 basis points quarter-on-quarter in interest-bearing deposit costs.

Still, it’s not all bad news for First Horizon here. Optimizing the deposit base was part of management’s plans after IBKC, and while it’s a stretch to compare First Horizon to the big banks (and I haven’t had time to go through all the reports from the regional banks to date), I would note that ANC (PNC) and American bank (USB) saw a worse increase in their interest-bearing deposit costs, while Wells Fargo (WFC) did better (up just 16 bps qoq). I’m still concerned that deposit betas will be higher than expected throughout this cycle, and that First Horizon’s loan to deposit ratio will increase, but so far it seems to be under control, although I would have liked see a stronger result in non-custody of interest-bearing deposits.

Perspectives

For at least the next three months, I think the closing of TD Bank’s acquisition of First Horizon is more important than the underlying financials. Although there has been a lot of “noise” around this deal (including a US senator trying to defeat the deal on accusations of “aggressive sales practices” by TD Bank), I believe that the deal will be approved, and First Horizon’s management expects the transaction to close during TD’s first quarter of fiscal year 2023 (which runs from November 1, 2022 through January 31, 2023). 2023).

If the deal is not completed by Nov. 27, First Horizon shareholders will receive additional consideration of $0.65/share. I believe that TD Bank is fully prepared to complete the transaction as soon as final regulatory approvals have been obtained, so whether the transaction will close before this deadline is not really up to TD Bank management. .

Should the deal fall apart, I continue to believe that First Horizon would deliver long-term mid-single-digit core earnings growth, supporting a standalone fair value in the low $20s.

The essential

Whether or not these stocks are worth holding today depends a lot on the alternatives available to investors. A return of around 6% over three months (assuming the deal can be closed within the time frame projected by management) isn’t bad, but it also carries the risk that the closing of the deal will be further delayed or she completely collapses. While the market’s reaction to a deal meltdown would be ugly in the short term, First Horizon still has its merits, including what appears to be a better recent execution trend that should serve investors well in a solitary outcome.

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