TD - First Horizon: Strong Capital Position And Growth Prospects

2023-12-19 14:03:10 ET

Summary

• First Horizon is focusing on independent growth after the termination of its merger with TD Bank.
• The bank is expected to experience lower deposit costs in Q4, leading to potential revenue improvement.
• First Horizon's strong capital position and strategic location in the Southeastern region offer flexibility and growth potential.

Thesis

Following the termination of the merger between First Horizon Corporation ( FHN ) and The Toronto-Dominion Bank ( TD ), First Horizon is now focusing on operating independently. The bank is back on track for independent growth in some of the most robust US markets. First Horizon's strong capital foundation is advantageous, and there is potential for share buybacks to recommence in 2024. The recent deposit campaign has successfully attracted new customers and opened up lending opportunities, although, without a similar initiative, the balance sheet gains in 2024 may be limited. The top-line revenue is expected to improve as the promotional pricing that boosted recent deposit growth phases out. However, the shares have been under extreme pressure since the cancellation of the deal, and any additional setbacks in credit quality could once more have a negative impact on the stock in the near term.

Q4 Outlook

First Horizon is among the few banks expected to experience lower deposit costs in the fourth quarter. This is because $6 billion in deposits acquired in May are set to reprice, mostly in December. These deposits, which currently bear a 5.25% interest rate, will be repriced at either 4.25% or 4.9% for those adding funds. Although there is a shift from non-interest-bearing to interest-bearing deposits, the pressure from this shift is diminishing. First Horizon's revenue may see an improvement due to an expansion in the net interest margin and overall balance sheet growth. A full quarter of higher interest rates and reduced funding costs could have a positive impact. Deposit expenses are also decreasing after two-quarters of promotional rates linked to a specific campaign. However, this reduction in promotional rates could slow down balance sheet growth. With a CET1 ratio of 11.1% in the third quarter and anticipated improvement in the fourth quarter, the bank maintains a strong capital position. I expect the management to make announcements regarding share buybacks for 2024 at the end of Q4.

Capital Cushion Offers Flexibility

First Horizon is undergoing a transformation as it repositions itself as an independent entity following the cancellation of its merger with Canada's Toronto Dominion Bank ((TD)). However, the bank's strong capital position, with a CET1 ratio of 11.1%, and its strategic location in the rapidly growing Southeastern region, make it well-positioned for future growth.

First Horizon's robust CET1 ratio distinguishes it from its peers, many of which are scaling back their growth efforts to bolster their capital reserves. With a CET1 ratio of 11.1%, First Horizon has the flexibility to expand its loan portfolio and potentially consider share repurchases in 2024, although buybacks are currently on hold due to economic uncertainties. In the longer term, the bank aims for a CET1 ratio in the range of 9.5% to 10.5%. At the midpoint of this range, the bank holds approximately $800 million in excess capital. Even after adjusting for unrealized losses in securities, the bank maintains a strong capital position at 9.3%.

Potential for Growth in New Markets

First Horizon is well-positioned to benefit from the economic growth driven by the increasing population in its Southeastern markets. Operating in regions with higher growth potential, such as Miami, Nashville, and Raleigh, North Carolina, the bank has an opportunity to achieve stronger gains on its balance sheet. With a strong capital position and recent initiatives like the deposit campaign, it appears that the bank is refocusing on growth. Previously, First Horizon expanded its branch network in the Southeast through a merger of equals with Iberiabank and the acquisition of branches from the former SunTrust. These additions included branches across the Gulf Coast from Texas to Florida, as well as in North Carolina, Georgia, and Arkansas.

Valuation

The previously expected sale to TD Bank was initially viewed positively by shareholders; however, the cancellation of the deal resulted from TD's inability to secure timely regulatory approval, driven by concerns related to anti-money laundering practices. First Horizon's valuation has weakened compared to its industry peers after the TD Bank merger fell through. Currently, its stock is trading at a FWD Price/Book ratio of 0.95x, while the median for its peers is 1.2x. This reflects market concerns about potential revenue challenges in the upcoming year. Moreover, there may be cost pressures due to the resumption of technology investments that were postponed during the merger approval process. The significant loan loss in the third quarter has also raised doubts about the quality of the bank's assets. Therefore, although the valuation appears attractive at the moment, I recommend staying cautious and assign a hold rating to the stock for now.

Conclusion

After the merger between First Horizon Corporation and The Toronto-Dominion Bank fell through, First Horizon is now refocusing on its independent operations. A robust CET1 capital ratio of 11.1% gives it the flexibility to grow its loan portfolio and consider share repurchases in 2024 despite the current economic uncertainties. Furthermore, its strategic presence in high-growth Southeastern markets, like Miami, Nashville, and Raleigh, positions the bank for potential balance sheet improvements. However, since the deal's cancellation, the stock has faced significant pressure, and I believe any further credit quality issues could negatively impact the stock in the short term. Hence, I remain cautious for now and assign a hold rating to the stock for now.

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