FHN - First Horizon: 7.5% Dividend Yield For 87 Cents On The Dollar With The Preferreds

2023-07-12 08:01:30 ET

Summary

• First Horizon has seen its shares drop by 50% since the start of 2023 due to the March banking panic.
• Despite the crisis, the company has maintained a high dividend payout, but questions remain about its ability to continue this in light of dual misses on revenue and earnings.
• The preferreds currently offer a 7.5% yield on cost and are trading at a double-digit discount to their par value.

First Horizon ( FHN ) forms one of the high-profile tickers of the March 2023 banking panic. The Memphis, Tennessee-based financial holding company is down 50% since the start of the year with continued fears around the health of US regional banking keeping the bulls away and maintaining pressure on common shares that are now trading hands at a 7.77x forward price to earnings multiple. This is around 30% lower than its 5-year average multiple of 11.1x and around 12% lower than its peer group median. In view of shareholders here is the maintenance of a dividend payout that has been pushed to its highest level since the 2020 pandemic crash. Crucially, with the commons still trading at such a marked discount to their historical trend, the banking crisis is yet to come to a concrete end.

First Horizon last declared a quarterly cash dividend of $0.15 per share , in line with its prior payout and for a 5% annualized forward yield. The big question is whether the company will be able to maintain the dividend against a more volatile macroeconomic environment. Bond fund manager PIMCO is preparing for a "harder landing" of the US economy with some economists firming around the possibility of the US falling into recession early next year. I like the preferreds here but also don't foresee a near-term situation in which the current quarterly dividend is suspended. Hence, the play here is based on your broad appetite for risk and time frame.

The Series E Preferreds

First Horizon 6.50% Depositary Shares ( FHN.PE ) each represent a fractional interest in a share of the non-cumulative Series E perpetual preferred stock. These are currently swapping hands for $21.68 per share, a roughly 13% discount to their $25 par value or around 87 cents on the dollar. These only started trading in the summer of 2020 when First Horizon sold 6,000,000 depository shares to raise $172.5 million . Crucially, these pay out a fixed $1.625 annual coupon for a 7.5% yield on cost, 250 basis points more than the common share dividend yield.

There are a few points to like here. Firstly, with these trading at a discount to par, their yield to their 10th of October 2025 call date stands at 13.52%. These are perpetual, hence there is no guarantee that First Horizon will redeem at par in just over two years. In this sense, this yield to call represents an upper rate of return from what's a fundamentally stable and safe security. Preferreds are in some ways half fixed income and half equity, hence, a double-digit rate of return forms an attractive risk and reward profile.

The Series E is down 10.65% on a total return basis over the last 1-year versus a loss of 41.8% for the commons. However, over the last 3 years and the preferreds are sporting a 3.4% gain against a profit of 54% for the commons. This performance dichotomy highlights the core difference between both securities, the commons form the better bet on a potential recovery of regional banking sentiment whilst the preferreds would enable a more defensive stock portfolio stance.

The Commons In 2023 And Beyond

First Horizon realized fiscal 2023 first-quarter revenue of $859 million , up 21.5% over its year-ago comp and a miss by $12.36 million on consensus estimates. This came against investor expectations of regional banking flight to the safety of the four systematically important banks JPMorgan Chase ( JPM ), Wells Fargo ( WFC ), Bank of America ( BAC ), and Citi ( C ). First Horizon Bank reported total deposits of $62.2 billion , a sequential decrease of $2.7 billion, around 4%, over the fourth quarter. This was also a 16% year-over-year decline as demand deposit accounts and other noninterest-bearing deposits came under pressure. Whilst ten consecutive rate hikes have meant an expansion of rates chargeable on interest-bearing assets, it's also sparked more competition from deposits which when aggregated with the regional banking turbulence is likely set to see deposits remain under some pressure.

The market is currently pricing in a 92.4% chance of a rate hike at the upcoming July 26th FOMC meeting, a move that will further pull up what was a total deposit cost of 111 basis points during the first quarter. This was up 42 basis points over the fourth quarter. First Horizon brought in net interest income of $688 million, a 3% decrease over its fourth quarter on the back of higher funding costs set against higher loan rates. This drove adjusted earnings of $0.45 per share, a miss of $0.02 on consensus estimates. However, the company is currently swapping hands at a 12.58% premium to tangible book value per share of $10.89 as of the end of the first quarter. This more traditional metric for undervaluation does not scream buy as financials look set to remain somewhat disrupted in the near term. I think these would be in play on a future broad recovery of regional bank stocks if fears around deposit flight to SIBs prove to be pessimistic through 2023 and the crisis reaches a definitive end.

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