First Horizon Leveraging Rate Sensitivity, Credit Quality, And M&A Synergy Ahead Of The Expected TD Bank Deal Close

It helps to have powerful friends, and in the case of First Horizon (NYSE:FHN), increased confidence in the likelihood of Toronto-Dominion Bank (TD) closing its deal for First Horizon has helped First Horizon outperform in what has been a poor year for regional banks (and banking in general). At the same time, First Horizon hasn’t hurt its standalone credentials (should the deal somehow fall apart) with signs of improved execution over the last few quarters.

I believe TD Bank will get the final go-ahead from regulators to close its acquisition of First Horizon over the next three months or so, and I think there’s a reasonable chance that the close will be after the November 27 deadline that triggers additional payments to shareholders. While the current spread between today's price and the deal price doesn't promise a scintillating return, it's not bad for investors who don’t have more pressing ideas today.

 

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 First Horizon Leveraging Rate Sensitivity, Credit Quality, And M&A Synergy Ahead Of The Expected TD Bank Deal Close

TD Bank Sees The Potential And Strategy Value In First Horizon, And Pays Up To Get It

 

Strategic acquisitions are interesting on multiple levels, not the least of which to me as an analyst and model-builder is how strategic buyers perceive and value target companies. I’ve been bullish on First Horizon (FHN) for some time, even with ongoing execution challenges and risks, but even I was surprised to see the premium that Toronto-Dominion Bank (TD) (“TD Bank”) was willing to pay for these shares.

As a First Horizon shareholder, I can’t say that TD Bank is shortchanging me. If anything, First Horizon did a good job of securing not only a good price for what First Horizon should be worth on a standalone basis, but also a piece of the strategic value of First Horizon to TD Bank as a way to extend this bank’s presence across the faster-growing Southeast United States. Although there are some regulatory risks to the deal closing, and closing on time, I believe shareholders are getting a fair price and should likely keep an eye on the door for an exit.

 

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TD Bank Sees The Potential And Strategy Value In First Horizon, And Pays Up To Get It

The Frustrating Wait For Positive Differentiation From First Horizon Goes On

 

The bull thesis on First Horizon (FHN) has centered around the ideas that management has learned important lessons from mistakes of the past and that, coupled with the leverage and synergy opportunities provided by the Iberiabank deal, the bank was about to set out on a new path of better growth and higher returns.

It’s premature to call this an impromptu rendition of Waiting for Godot, but it’s getting harder to make the “the turnaround is coming, and things are going to get better” argument stick after ongoing performance that’s really rather more “okay” than “good” (or better). With that, the shares have modestly trailed the regional bank group since my last update, while other bank stocks I like including Citizens (CFG), Key (KEY), Synovus (SNV), and Zions (ZION) have all done noticeably better.

First Horizon shares still look undervalued and priced for a double-digit return, not to mention well-leveraged to the upside, but valuation alone doesn’t move stocks and these shares really need to see a marked improvement in performance. As a shareholder myself, I have to admit that my patience is wearing thin, particularly with other banks offering similar upside and showing more operational upside.

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The Frustrating Wait For Positive Differentiation From First Horizon Goes On

First Horizon Undervalued, But Really Needs To Show Differentiated Growth To Re-Rate

 

I said that First Horizon (FHN) was a "show me" story back in February of this year (after fourth quarter results), and unfortunately the company really hasn't come through with any substantial evidence of differentiated growth - upside has largely come from areas like reserve releases, which is common in the sector these days. While the long-term story, including synergies from the Iberiabank deal, attractive fee-generating businesses, and an attractive geographical footprint, is still in place, "potential" isn't going to move the shares.

Up about 15% since my last update, First Horizon has basically tracked the regional bank index since then. That's good enough, I suppose, but I want to see reasons to raise estimates on the back of differentiated (positively differentiated) performance. Even so, 4% core growth can still support a fair value close to $20, as can the mid-14%'s ROTCE I expect for 2022. If First Horizon can make that turn and live up to its potential, this could be a big winner, but investors should also recognize the risk that the bank never does differentiate itself from a growth or return perspective.

 

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First Horizon Undervalued, But Really Needs To Show Differentiated Growth To Re-Rate

First Horizon Still Undervalued With Wall Street In Show Me Mode

The market's shift to a risk-on position toward banks has helped a number of riskier bank stocks (or bank stocks perceived as riskier), and First Horizon (FHN) has benefited, rising a little more than 30% since my last update - good enough for a modest beat relative to its larger peer group, but not good enough to match other regional competitors like Pinnacle (PNFP) and Regions (RF). Over that time, expectations for '21 have definitely improved, but First Horizon still doesn't seem to be getting full credit for its growth and profitability improvement potential.

Admittedly, investing in "potential" always carries risk, but if you wait to see that potential become reality, you typically miss most of the market-beating performance potential. To that end, while First Horizon absolutely still needs to prove that they can achieve above-average growth in a highly competitive market and at least peer-average profitability, management has already made progress on its underwriting, and I believe the annualized total return potential here is still comfortably in the double digits, making First Horizon still very much a name worth buying/owning.

 

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First Horizon Still Undervalued With Wall Street In Show Me Mode

Messy Initial Results Should Not Obscure The Long-Term Value At First Horizon

Investors like clean beat-and-raise quarters, and they didn’t get that from First Horizon (FHN) this quarter. The first couple of quarters after large mergers are often messy, so no real surprise there, but the underlying guidance for weaker core net interest margin wasn’t welcome in a quarter where “stabilization” has been the overall theme. Likewise, First Horizon’s credit quality remains a negative talking point and the core profitability is still not impressive.

None of this should really be a surprise, but the Street wants what it wants, and stocks get sold off when it doesn’t get it. On a core basis, nothing has changed for me with respect to modeling, my bullish drivers, or my bearish concerns. First Horizon management has a lot to prove – they have to prove they’ve learned their lessons on credit/underwriting quality and they must prove that this newly-enlarged bank can be more than a middle-of-the-road performer where profitability is concerned. My position is that they will prove this over time, and that the shares can deliver a mid-teens annualized return from here, but investors are going to have to be patient with this one.

 

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Messy Initial Results Should Not Obscure The Long-Term Value At First Horizon

First Horizon Sounding A Little Better On Credit, With Integration Opportunities Ahead

Wall Street can pivot from problem to problem almost instantaneously, but for now at least it looks as though analysts and investors are in a calmer place with respect to bank credit risk, and have instead turned more toward issues like weak revenue growth prospects and limited operating leverage possibilities across the space. That may actually be a benefit for First Horizon (FHN), as I still see some legitimate questions on credit, but I believe the integration and synergies from the Iberia deal will boost the near-term growth opportunities.

Organic revenue growth is going to be a challenge for almost every bank over the next few years, but First Horizon does at least have an expanded franchise in some of the fastest-growing areas of the country, not to mention a healthy counter-cyclical capital markets business and an expanded mortgage banking operation. The pandemic and recession are likely to stretch the timeline for realizing the hoped-for synergies from the Iberia deal, and I’m still concerned about credit, but all in all I think First Horizon is in good shape, and between above-average upside and a high dividend yield (obviously the two are linked), I like this stock for more risk-tolerant investors.

 

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First Horizon Sounding A Little Better On Credit, With Integration Opportunities Ahead

First Horizon Leveraging Trading To Offset Weaker Core Banking

I turned more cautious on First Horizon (FHN) after the first quarter, as I liked the long-term opportunity but had some concerns about nearer-term risks around reserve levels and credit performance in the combined First Horizon and Iberia loan books. Since then, the shares have done pretty well as the Street has gotten more comfortable with the idea that the worst-case scenarios for the pandemic-driven recession are unlikely to materialize, and the shares have outperformed other comparable banks like Regions (RF) and Synovus (SNV).

I do still have some lingering concerns about the bank's reserves and the risk of a bigger hit from credit losses. It's also pretty clear that First Horizon, really, will need to make the most of its opportunities in fixed income trading and in merger-driven synergies to offset the pressures on the core banking franchise from low rates and weaker loan demand. All of that said, the discount to tangible book and my long-term estimate of core earnings is just too low and I still believe First Horizon is poised for above-average long-term returns.

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First Horizon Leveraging Trading To Offset Weaker Core Banking

Credit Worries Loom Large For First Horizon

First Horizon (FHN) has been a notable laggard this year compared to peer regional banks, and I believe at least some of that is due to outsized worries about the loan portfolio of the bank it is acquiring – IBERIABANK’s (IBKC) 5% loan exposure to energy isn’t looking very attractive now, and there are valid concerns over how much reserving will be needed for those loans. On top of that, First Horizon has its own challenges with its loan book, including loans to franchisees and other hospitality/consumer discretionary businesses.

First Horizon’s capital is not as strong as I’d like, and I expect further reserving will be necessary (particularly in the case of Iberia’s book). On the other hand, management’s economic assumptions don’t appear at all heroic, and businesses like the fixed income trading will help generate pre-provision profits through this downturn. First Horizon is definitely a higher-risk call now, and I can understand why investors may want to stay away for the time being.

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Credit Worries Loom Large For First Horizon

First Horizon Continuing To Deliver Good Results Ahead Of A Transformative Merger

With good countercyclical opportunities like the trading business and mortgage warehouse lending, First Horizon (FHN) is doing pretty well at a more challenging point in the banking cycle. Loan growth prospects aren’t looking quite so exciting into 2020, but First Horizon seems to be doing more than holding its own, and the impending merger with IBERIABANK (IBKC) should unlock meaningful operating leverage down the line.

I liked First Horizon last quarter and after the IBERIABANK merger announcement, and the shares have been outperforming. I still like them now, with upside to the $19-$20 range and greater long-term opportunities from the IBERIABANK deal.

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First Horizon Continuing To Deliver Good Results Ahead Of A Transformative Merger

First Horizon Now Well-Placed For The Longer Term

I’ve written before that First Horizon (FHN) has some under-appreciated counter-cyclical drivers that should help it navigate a likely-to-be tough 2020 better than its peers, but First Horizon management has since taken a major step toward shoring up its long-term future. Not only does the merger of equals with IBERIABANK (IBKC) (“Iberia”) look attractive on its own merits, but it should give First Horizon much-needed scale and an even more attractive long-term operating footprint.

I liked First Horizon before and the Iberia deal makes the outlook even better in my view. While mergers of equals are riskier from an integration perspective, I think First Horizon is going about this the right way and the long-term potential makes the risks worth taking. I’m not really big on “top picks”, but I definitely think First Horizon is a name to consider below the high teens.

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First Horizon Now Well-Placed For The Longer Term

First Horizon Shares Weaker On A Less Distinguished Third Quarter

First Horizon (FHN) still doesn't seem to be getting its due, but arguing with the market only gets you so far in the short term. Although the shares had done slightly better than the peer group going into the quarter, a sell-off on the earnings report has pulled the relative performance back to the peer group.

I continue to believe that First Horizon has some useful near-term offsets to spread pressure, including a counter-cyclical trading business and cost leverage, and I like the long-term ramifications of a management team that is keenly focused on out-earning its cost of capital in all parts of the business. These shares could languish without beat-and-raise quarters, but I believe they trade at a double-digit discount to fair value and offer appeal for more patient investors.

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First Horizon Shares Weaker On A Less Distinguished Third Quarter

Strong Trading Drives A Healthy Beat At First Horizon

In a quarter where I believe a lot of regional banks will continue to report “okay, but not great” earnings, First Horizon’s (FHN) second quarter earnings certainly stand out. While some will discount the importance of a beat driven by the bank’s bond trading operations, there were some other underlying positives including good expense control and solid deposit cost control.

I think First Horizon may be a little better-positioned for upcoming rate cuts than commonly believed, and I continue to believe the shares are relatively attractive on a valuation basis.

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Strong Trading Drives A Healthy Beat At First Horizon

A Recent Rally Has Soaked Up South State Bank's Undervaluation As It Repositions

I was a little surprised to see South State Bank (SSB) outperform so well since my last article – up more than 25%, beating regional banks by about 5% overall and a more direct set of peers by about 10%. While I thought the shares were undervalued on a longer-term basis, the Street isn’t famous for taking a longer-term perspective, particularly when near-term earnings growth potential is more limited by the bank’s ongoing restructuring efforts. Still, with many large regional banks announcing plans to expand into the U.S. Southeast, and the bank close to the end of that repositioning process, I suspect this outperformance could be due in part to expectations that a regional bank may look to M&A to accelerate its expansion plans.

I do think South State could make an attractive buyout candidate; while the loan-to-deposit rate isn’t perfect, the bank has an attractive core deposit franchise in attractive growth markets like Charleston, SC, and Charlotte and Raleigh, NC. While a bank like U.S. Bancorp (USB) could offer as much as a 20% premium in a cash deal and still see some accretion, South State’s valuation isn’t exactly cheap on a stand-alone basis. Much as I like the long-term story at South State, with a lot of smaller banks offering 10%-20%-plus discounts to fair value today, it’s hard to call this a must-buy at this price.

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A Recent Rally Has Soaked Up South State Bank's Undervaluation As It Repositions

First Horizon Seeing Ongoing Challenges In The Core Business

With some turbulence in the core business, rising competitive challenges in its core markets and a comparatively large short interest, First Horizon (FHN) is a more controversial stock than you might initially assume. Management has laid out its case for leveraging its specialty lending franchise to gain share in key growth markets like the Carolinas and Florida while also driving higher efficiency through its “bonefish” restructuring efforts. But the fact remains that spreads are still challenging and competition is still rising.

I believe that sentiment skews negative on First Horizon and that if the company can stabilize and improve, there could be decent rewards here for shareholders. The guide-down for NIM and ROTCE don’t help the case, but a long-term core earnings growth rate around 4% can still support fair value close to $18.

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First Horizon Seeing Ongoing Challenges In The Core Business

The Rate Cycle Weighing More Heavily On Comerica

As one of the most asset-sensitive banks that I follow, Comerica (CMA) has a lot to lose from a flattening yield curve that is seeing deposit costs rise while LIBOR-based loan yield grow looks more restrained. Capital and credit quality are still above-average, but average loan growth in the face of rising spread pressure is a tough combination and pre-provision growth is likely to decelerate into the mid-single digits and exit the year in the low single-digits (and possibly stay there a little while).

I’ve felt similarly about Comerica and Citigroup (C) over the past year, insofar as I don’t really love either business, but at the right price there can be some opportunity. At this point, though, I’m concerned about Comerica’s vulnerability to sooner-than-expected rate cuts and its lackluster loan growth and I think it will be harder to answer the “why should I own Comerica?” question positively as core operating income growth stalls and capital returns moderate.

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The Rate Cycle Weighing More Heavily On Comerica

M&T Bank Doing Fine, But Also As Expected

Buying quality can be a frustrating exercise, as M&T Bank (MTB) shares have shown over the last couple of years. Fairly regarded as a conservatively-run, high-quality bank, M&T Bank’s share price performance hasn’t really stood out as exceptional over the last year or two. I do believe there could be more separation from the pack when the economy slows further, though, and there’s another reckoning as to which banks did the best job of managing their credit exposures. As is, the shares look somewhat undervalued, more so in terms of the multiple to tangible book than on a discounted earnings basis, but JPMorgan (JPM), PNC (PNC), BB&T (BBT), and U.S. Bancorp (USB) offer similar or better prospective returns.

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M&T Bank Doing Fine, But Also As Expected

SunTrust Offering A Strong Story Going Into 2019

Both SunTrust (STI) and BB&T Corp. (BBT) seem to have a lot working for them going into 2019, including improving cost leverage from digital investments, stronger-than-average loan growth in relatively attractive regional markets, and strong deposit franchises anchored by long-term leadership in those same markets. And probably not so surprisingly, they’re both priced for things going relatively well.

With what appears to be somewhat limited capacity to fund attractively priced loan growth and the likelihood of higher provisioning expense in the coming years, SunTrust’s earnings growth potential looks lackluster (in the low single digits), but the company pays a good dividend, could have some upside/outperformance potential in the numbers, and the shares are still undervalued, even if not so much so as other Southeast banks like Regions Financial Corp. (RF), First Horizon National Corp. (FHN), or Synovus Financial Corp. (SNV).

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SunTrust Offering A Strong Story Going Into 2019

First Horizon Underperforming On Lackluster Numbers

I can’t say that I’m all that surprised that First Horizon’s (FHN) last two quarters have come in below expectations, leading the shares to underperform its regional bank peers by around 5% on average (including underperforming the likes of Bank of America (BAC), Wells Fargo (WFC), SunTrust (STI), Regions (RF), and Pinnacle (PNFP) ). I’d written back in July that I thought the long-term potential I saw was tempered by a tougher near-term outlook, and that has come to pass as loans, spread, and fee income have come in lower than expected.

I’d call my opinion on First Horizon today “positive, with an asterisk”. I believe First Horizon is a well-run bank on a basic level, and I think the strategy that has driven significant in-market growth in Tennessee over the last five years can be successfully applied elsewhere (namely the Carolinas and Florida). I also believe there are opportunities to grow its multi-faceted national specialty lending platforms. The “but” is that management has already laid out fairly ambitious expectations, and First Horizon is trying to grow in some of the most intensely competitive markets in the country. I do believe these shares are undervalued now, but more and more “show me” burden is falling on management’s shoulders.

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First Horizon Underperforming On Lackluster Numbers

Playing M&A Bingo With BB&T

When an historically acquisitive bank signals that they’re reading to start considering M&A again, I don’t think it’s much of a stretch to start speculating on the sort of target(s) the company might have in mind. In the case of BB&T (BBT), while management has certainly laid out a case for worthwhile organic growth by focusing on its core strengths in business and consumer lending, the company has also laid out a clear set of criteria for future M&A, and I believe management would like to make a significant deal (or two) to vault the company over the $250 billion asset level.

Deal or not, I believe BB&T shares are modestly undervalued today. While there are certainly other options in BB&T’s size range worth considering (including PNC (PNC)), I believe mid-single-digit growth can support an attractive return at today’s price.

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Playing M&A Bingo With BB&T