First Horizon Now Well-Placed For The Longer Term

Summary

• First Horizon's deal for IBERIABANK is strategically sound and should provide multiple benefits including enhanced geographic diversification, market growth, improved deposit mix, and operating scale.
• With a relatively modest opex synergy target and little branch overlap, integration risk should be lower than for other mergers of equals in the banking sector.
• First Horizon is significantly boosting its scale but also making a deal that has strong strategic rationale outside of scale.
• First Horizon looks undervalued below $20.

I’ve written before that First Horizon (NYSE: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 (NASDAQ: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.

The Deal

About two weeks ago, First Horizon and Iberia announced a merger of equals that will see Iberia merge into First Horizon. Iberia shareholders will get just under 4.6 shares of First Horizon for each IBKC share, with First Horizon shareholders owning 56% of the combined company. Assuming the deal closes as expected in 2020 (and I see little risk of any regulatory obstacles), First Horizon’s CEO will serve as the CEO for the newly-combined banks, with Iberia’s CEO becoming the executive chairman.

At the time of the announcement this was effectively a zero-premium deal, similar to the completed Chemical Financial – TCF Financial (TCF) transaction. First Horizon will see about 5% initial tangible book value dilution, but the earnback is only a bit over two years and management expects mid-teens EPS accretion. The opex savings assumptions look modest at around of 25% of Iberia’s base expenses, and I’d note that there’s not much branch overlap – only about 10% of branches are within 2 miles of each, and that’s almost all in Florida.

A Necessary Deal, But Still A Good One

One of my core beliefs about the U.S. banking industry is that there are still far too many banks and branches and that the industry is likely to see significant consolidation over the next 10 to 20 years. I expect much of this to be driven by economies of scale, and particularly in the IT/technology area, as many of the largest banks in the country have IT budgets larger than the revenue base of most banks. Although IT and digital capabilities aren’t all there is to banking, I believe it will be harder and harder for smaller banks without a differentiated business model (like First Republic (FRC) and Bank OZK (OZK) ) to survive.

With that backdrop, I think First Horizon is making a strong strategic move – by acting early, I believe First Horizon is getting to make a deal that adds plenty of long-term value instead of acting out of desperation – in other words, a “deal of choice” rather than a “deal of need”.

With the deal, the new First Horizon will become the 21^th-largest bank by assets in the country, well behind #20 Huntington (HBAN), and a bit ahead of #22 Comerica (CMA) and about $5 billion ahead of Zions (ZION). The combined bank will have a presence in 11 states and a presence in 15 of the 20 largest metro areas of the Southeast U.S., including top-five deposit share in 12 of those markets. With an expected population growth rate of 4.5% in the new footprint, First Horizon will be serving a market growing comfortably above the expected national average (around 3.6%).

Obviously this deal will change First Horizon’s business mix. First Horizon doesn’t do much CRE lending (relatively rare for a bank of its size), but Iberia does and the combined entity will have more than 25% of its loans in CRE (an almost 80% increase from First Horizon’s current mix). C&I lending will correspondingly decrease as a part of the mix, though will still be close to 50% of total loans.

While deposits will change in terms of geographic mix (with major increases in Florida and Texas and the addition of Louisiana, among other markets), the quality will arguably increase, with Iberia adding some sticky non-interest-bearing deposits that will boost the NIB mix to over 26% (from a little over 20% now).

All told, First Horizon will significantly increase its presence in Florida and Texas through this deal, as well as adding exposure to Atlanta, Louisiana, and the Gulf Coast. First Horizon had an attractive base business in Tennessee and the Carolinas, but this is value-added diversification in my view. First Horizon will also have a chance to leverage its strong cost and capital discipline over a larger asset base – Iberia is by no means a badly-run bank, but First Horizon has done better historically on costs. I’d also note that Iberia has a pretty good credit track record, so I think the risk of “buying trouble” is low.

The Outlook

As I said, mergers of equals tend to have greater risks then more traditional whole bank acquisitions, as there are often culture clashes between the two organizations. Those clashes can be exacerbated when there are large-scale firings, and I think First Horizon’s more moderate cost savings projections reflect the lower level of branch overlap and the lower need for firings from redundancy.

I also want to note that First Horizon agreed shortly after the Iberia deal announcement to acquire 30 branches from SunTrust (STI). These branch sales are being done to secure approval for the BB&T (BBT) – SunTrust merger of equals, and First Horizon is getting a good price (a 3.4% deposit premium) for branches in attractive markets like Raleigh-Durham, NC.

I really don’t have any serious hesitations with this deal other than the normal integration risks that go with large M&A. The added geographical diversification is welcome, particularly with the expanded scale in Florida, Atlanta, and Texas, and I like the long-term cost leverage potential. Iberia does bring some energy lending into the mix (6% of its loans), but the credit quality there has been good and Iberia has generally had good underwriting results.

Factoring in the deal, my fair value for First Horizon moves to just over $20, and I am assuming long-term (years 6-10) core adjusted earnings growth of around 5%/year .

The Bottom Line

I thought both First Horizon and Iberia could be acquisition targets, and this deal doesn’t necessarily preclude an acquisition (or another merger of equals) further down the road. As is, I think this deal gives First Horizon the scale and staying power it will need for the long term, but also attractive opportunities in growing markets in the South/Southeast U.S.. With the shares more than 20% below my revised fair value, I think this is a name worth serious consideration.

Disclosure: I am/we are long BBT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.