First Horizon Corporation

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

First Horizon Corporation is a regional bank holding company primarily operating in the southeastern United States. It offers a range of financial products and services to consumers, businesses, and corporations through its banking subsidiaries and affiliated companies.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview and Moat Assessment

First Horizon (FHN) is a regional bank primarily operating in the southeastern United States, providing financial services to diverse clients. FHN’s primary revenue sources are net interest income, fees and commissions, and trading revenue. Net interest income is derived from the difference between interest earned on loans and securities and interest paid on deposits and borrowings. Fees and commissions come from banking activities such as mortgage origination, wealth management, and brokerage. Trading income results from trading fixed income securities, equities, and other instruments. While FHN has a stable customer base and is well-regarded, its economic moat is narrow.

Here’s a breakdown of why it gets a 2/5 moat rating:

  1. Limited Pricing Power: As a regional bank, FHN’s pricing power is limited due to significant competition from larger national banks, local community banks, and credit unions. While it serves specific geographic markets, it’s subject to pressure on deposit and lending rates based on competitive offers.
  2. Modest Switching Costs: While customers have certain switching costs, such as closing accounts, setting up direct deposits, and so on, these are relatively low and easily overcome if a competing bank offers a more attractive value proposition. This limits FHN’s ability to retain a customer base long term if competitors offer significantly better rates or services.
  3. Lack of Scale Advantage: Although scale benefits some banks, FHN’s size is not necessarily enough to generate significant cost advantages over its competitors. Many of the costs in banking are fixed and spread across the customer base and branches. Although FHN’s size and infrastructure can be an advantage over newer community banks, larger banks would have a clear advantage due to greater scale.

Legitimate Risks and Resilience

  1. Interest Rate Risk: FHN’s profitability is heavily dependent on the interest rate environment. Changes in interest rates can affect net interest margins and the bank’s overall profitability. Particularly, if interest rates rise too fast, it might create pressure on loan defaults, negatively impacting the asset quality and the cost of credit. While FHN is taking steps to improve liquidity and manage its balance sheet, this remains a significant risk.
  2. Credit Risk: The bank faces the risk of borrowers defaulting on loans, especially during economic downturns. As mentioned in the latest quarterly reports, loan balances are a significant portion of their assets. A downturn can cause defaults, which could cause significant losses for FHN. They did mention the implementation of new risk modeling strategies.
  3. Competition: FHN operates in a highly competitive industry with a large number of competitors, both nationally and locally. The ease of customer switching makes it harder to retain deposits and therefore margins can be compressed further.
  4. Regulatory Changes: The banking industry is heavily regulated. Changes in laws, rules, and other federal regulations can affect the way that FHN does business. Such modifications, including potential increases in capital reserve requirements, can increase costs and reduce profitability.
  5. Cybersecurity: As a technology-focused industry, banking faces increased cyber risks and the possibility of internal and external breaches that can affect the security and integrity of operations as well as cause financial damages.

FHN’s business resilience, however, can be attributed to:

  • Strong customer base: FHN has a long history in certain regions and established customer relationships
  • Diversification: FHN has also expanded its portfolio of products and services, which enables the business to rely on a variety of sources of revenues and reduce risk.
  • Experienced Management: FHN’s executive and management team has demonstrated the capabilities of effective handling of a diverse range of situations, including acquisitions, expansions, and recessions.

Financial Analysis

The current financial position of FHN is a bit concerning with the 2023 financial year seeing reduced profits. Here’s a more detailed breakdown:

  1. Income Statement Analysis:

    • Net Interest Income: Net Interest Income for the most recent quarter is $996 million, compared to $1,031 million for the same quarter previous year which shows a decrease. This shows that rising interest rates are impacting both earnings and funding costs.
    • Net Noninterest income: This metric was -33 million versus $179 million last year showing that its performance in management fees, banking services, mortgage origination, and trading was way down in the past quarter.
    • Net Income Attributable to Common Shareholders: For the past quarter, net income available to common shareholders is $155 million, compared to $381 million in the same quarter of 2023.
    • EPS: FHN’s EPS numbers have also declined from $1.28 last year to $0.23.
    • Full-Year 2022 Overview: Net interest income increased to $5.7 billion in 2022 up from $4.5 billion in 2021. This jump was heavily affected by an increased rate of loan growth and higher yields. The increase in total noninterest income was modest. However, the total noninterest income figures were affected by an increase in provision for credit losses to $379 million from the $555 million in 2021. The year’s EPS were down at $1.93 in 2022 from the $2.17 in 2021.

  2. Balance Sheet Analysis:

  • Asset Quality: The overall quality of assets is a mixed bag. The total loan portfolio has grown but provisions for credit losses have increased as well.
  • Liquidity: The company currently holds approximately 67 billion in deposits.
  • Capital Adequacy: The Common Equity Tier 1 (CET1) ratio for the bank was 11.7%. Although this ratio has decreased significantly from 12.24% last quarter. Management has stated they are working on strategies to improve their regulatory capital ratios.

Understandability Rating: 3/5

FHN’s business model is fairly straightforward: it’s a traditional banking model. However, there are some nuances including derivative contracts, complex regulatory capital rules, and how the merger with TD will affect the bank that can make analysis more complicated. These factors contribute to a rating of 3:

  • The core business of banking is simple: taking deposits and providing loans.
  • Understanding the factors that influence profitability and risk requires analysis of financial statements and their footnotes which may not be easy for most people
  • Some of the factors influencing earnings such as derivatives, securitization of debts, credit losses, and valuation methodology can be a little complicated.

Balance Sheet Health Rating: 3/5

FHN’s balance sheet health is moderate. Here’s why a rating of 3 out of 5 is applicable:

  • Strengths:
    • FHN has a strong base of customer deposits, which provides a very stable source of funds.
    • They also have a variety of sources of funding such as short-term debt, government borrowing and other borrowings.
  • Weaknesses:
    • FHN’s capital adequacy is an area of some concern, with its CET1 ratio below the minimum requirement, and this might hamper FHN’s growth in the short term.
    • The recent mergers of banks in the sector have given rise to concerns and a significant increase in the size and complexity of balance sheets. In the event of a recession, the balance sheets will shrink, and the effect on bank profitability will be significant.
    • Loan concentration in Florida, Carolina and Tennessee is a considerable source of risk for the business.

Recent Concerns and Management Commentary

The management has addressed concerns over their deteriorating metrics in their latest call. Here are some key topics and management answers:

  • TD Bank Merger: Management expects that by completing the transaction with TD Bank, they will be able to improve several metrics including their capital and CET1 ratios. The expected closing is in Q1 2025.
  • Share Performance: Management said they were not pleased with the recent sell-offs on the bank shares. They also expressed confidence that current values have been depressed due to the uncertainties surrounding the economic environment. The management plans to address that through share buybacks.
  • Interest Rates: Management said that they have seen some relief on interest rates and are expecting them to level off in the short term. They are still wary of any new change in interest rate and the effects of it on the bank’s profitability.
  • Asset Quality: Management said they are closely monitoring the asset quality of the bank. They reported that their new risk modelling process has made it easier to spot changes earlier on. They also mentioned they are building up provision for credit losses.
  • Guidance: Management has reaffirmed guidance in its latest call. They expect net income to be in between 1.45 to 1.50, ROAA at 1.15 and ROATCE at 15%. These estimates exclude the effects of the TD merger.
  • Deposit Pricing: The company has stated that deposit pricing seems to be in a healthy position with only minimal change.
  • Mortgage Banking: Management has said that they expect mortgage banking to stay volatile and they expect margins to stay under pressure.

Overall, it seems as if management is taking proactive steps to mitigate its risks and achieve their set goals, but significant uncertainty still remains.

Conclusion

In conclusion, while First Horizon has been able to generate steady returns and a diversified portfolio of offerings, its profitability is vulnerable to certain economic factors and competitive forces. FHN is not an ideal investment choice at its current valuations as a “forever” stock, but rather a stock that might have short-term upside. While the bank tries to protect itself with new financial instruments and improved risk management, it is still dependent on many external factors which remain outside the control of management.