May 4th proved to be a rather dark and painful day for shareholders of First Horizon (NYSE:FHN). After news broke that it and TD Bank (TD) had mutually agreed to end their pending merger, shares of the enterprise plunged, closing down 33.2% at $10.06 per unit. This marks a significant departure from the roughly $25 per share that the company was going to be bought out for. More importantly, it is brought forth to investors’ minds the possibility that it, too, could be a victim of the current banking crisis that has spelled the end to multiple multi-billion-dollar financial institutions. Given the composition of the company’s deposits, it most certainly is not immune from a bank run. But when you factor in how stable its financial condition has been so far, as well as its exposure, a material deterioration in its fundamental condition seems quite unlikely.
A painful day
After days of speculation, May 4th was finally the day that news broke that First Horizon and TD Bank had agreed to terminate their merger agreement whereby TD Bank would have essentially absorbed First Horizon. According to the press release, this decision was not based on anything that was wrong with First Horizon. Rather, it was due to ongoing uncertainty regarding regulatory approvals that were necessary in order for the merger to go through. As part of this development, TD Bank plans to pay a $200 million termination fee to First Horizon, on top of an additional $25 million fee reimbursement as outlined by the original merger agreement.
Although it’s nice to see this cash come in, the market is clearly displeased by the development. The hope had been that TD Bank would absorb First Horizon and grant investors the rather lofty premium this would have entailed compared to the price that shares of the company were trading at before the deal was ever announced. In any normal environment, some downside would have been expected for FHN stock. But the amount of downside seen so far, representing a nearly 60% haircut from the original planned purchase price, indicates that investors are worried about the ability of First Horizon to remain afloat in the current environment.
The only significantly pressing issue revolves around the fact that about 45% of the $62.2 billion worth of deposits held at First Horizon are uninsured. That translates to roughly $28 billion in all and it could prove to be a problem for the company if those who use the bank come to believe that the company might be unstable. I would definitely acknowledge that this does elevate the risk for the business. The argument would be that, without the merger taking place, the company might be vulnerable on its own.
To be clear, First Horizon has experienced some decline in deposits during this banking crisis. At the end of the first quarter of the 2023 fiscal year, which covers the end of March, the company had $62.2 billion in deposits. But only one quarter earlier, it had $64.9 billion. Unfortunately, there’s no knowing whether the outflows the company ultimately saw would have been greater without the perceived protection of TD Bank. At the end of the day, this is something we can only speculate on. What we do know is that the banks that have been most impacted are those that had exposure, at least initially, to California and, to a degree, New York. This exposure initially involved venture capital, private equity, and early-stage enterprises. As I detailed in a prior article on First Horizon, the company does not have this kind of geographical exposure. The states that the company has the greatest exposure to are Texas, Florida, Louisiana, and North Carolina. For those worried about the overall deposit outflows, it is important to note that these actually began in the first quarter of the 2022 fiscal year. Rising interest rates caused consumers and companies to like elsewhere for yield. Plus, broader economic concerns likely lead to more individuals and businesses drawing down on their balances to cover costs.
Of course, a bank run can occur with any bank that has large uninsured deposits. Geographical and business-oriented exposure is not necessarily a limitation here. But as of the end of March of this year, it is worth noting that the company has held up quite well in many respects. It ended the quarter with tangible book value per share of $10.89. That’s up from the $10.46 reported one year earlier and stacks up nicely against the $10.23 per share that the company had at the end of the 2022 fiscal year. Even the overall book value per share of the company has been on the rise, hitting $14.11 compared to the $13.48 reported only one quarter earlier.
There are, of course, other important metrics that we should be paying attention to. Loans, for instance, came in at $59.05 billion. That’s up from the $58.10 billion that the company reported only three months earlier. Profitability metrics have shown some downside. But not much. Net interest income, as an example, dipped from $709 million in the fourth quarter of 2022 to $688 million in the first quarter of 2023. Total net revenue dropped from $882 million to $859 million. Even net income has held up reasonably well, dipping slightly from $258 million to $243 million.
One thing that is common about the banks that have collapsed is that they significantly ramped up their borrowings prior to this. These borrowings were often used to offset deposit outflows. On the other hand, they came with a downside that they required significantly higher interest payments than what depositors were comfortable accepting. The good news for shareholders of First Horizon is that the company did not report all that significant a rise in short term borrowings. At the end of the most recent quarter, this came out to $6.48 billion. This compares to the $2.51 billion that the company had only one quarter earlier.
Although a near tripling may sound like much, the nominal amount of short-term borrowings is quite small. Also at the end of the most recent quarter, the company seemed to have a great deal of liquidity on its books. Cash and cash equivalents, which include investment securities the company can sell, trading securities, and interest-bearing deposits with other banks, came out to $15.22 billion. This is up from the $14.51 billion that the company had three months earlier. This is not to say that all of this would be guaranteed to the company. Selling some of these securities right very well result in a haircut of sorts. But given the nature of the assets, a significant haircut seems unlikely. There could be some reduction in the value of the government agency issued mortgage-backed securities and collateralized mortgage applications that make up the majority of these investment securities.
From the data that’s currently available, First Horizon remains in solid shape. It absolutely could see its fundamental condition deteriorate from here if too many depositors Decide to bail on it. But given how sturdy the company is and how late we are in the downturn, I would argue that this is unlikely to transpire.