First Horizon Corporation (FHN) — Q3 2020 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2020. On July 1, First Horizon completed its merger-of-equals with IBERIABANK Corporation (IBKC), issuing approximately 243 million common shares and preferred stock in a transaction valued at $2.5 billion. On July 17, the bank acquired 30 Truist branches. Results include acquired operations only after each closing date; year-over-year comparisons therefore are not on a like-for-like basis.
Financial performance and position
- Q3 earnings and revenue: Net income was $539.0 million; net income available to common shareholders was $523.3 million, or $0.95 per diluted share, versus $109.5 million, or $0.35 per diluted share, in Q3 2019. Total revenue (net interest income plus noninterest income) was $1.36 billion, compared with $472.4 million.
- Interest income and margin: Net interest income rose 77% to $532.4 million, mainly reflecting the merger, branch acquisition, deposit pricing and PPP lending. Net interest margin declined to 2.84% from 3.21%, as lower market rates and higher excess cash pressured yields.
- Fees and expenses: Noninterest income was $822.9 million, including a preliminary $532.2 million non-taxable purchase accounting gain and higher fixed-income and mortgage banking income. Noninterest expense increased 90% to $587.0 million; it included $116 million of merger and acquisition-related costs and higher personnel expense.
- Credit costs and asset quality: Q3 provision for credit losses was $227.0 million versus $14.4 million a year earlier. The September 30 allowance for loan and lease losses was $988.1 million, or 1.65% of loans, versus $200.3 million and 0.64% at year-end 2019. Nonperforming loans and leases were 0.75% of loans, compared with 0.52% at year-end; the allowance covered nonperforming loans 2.21 times, versus 1.24 times.
- Nine-month results: Net income available to common shareholders was $587.7 million, or $1.50 per diluted share, versus $317.9 million, or $1.00 per diluted share. Net interest income was $1.14 billion; provision for credit losses was $502.4 million; noninterest income was $1.20 billion; and noninterest expense was $1.21 billion.
- Cash flow: For the nine months, operating activities used $272.9 million, investing activities used $3.45 billion, and financing activities provided $4.12 billion. Cash and cash equivalents ended the period at $1.67 billion, up from $1.27 billion at the start of the year.
- Balance sheet and funding: Total assets were $83.0 billion, loans and leases $59.7 billion, and deposits $68.4 billion at September 30. Short-term borrowings were $2.14 billion and term borrowings $2.16 billion. The company reported $8.14 billion in total equity.
- Capital and liquidity: FHN’s regulatory CET1, Tier 1, total capital and Tier 1 leverage ratios were 9.21%, 10.25%, 12.05% and 8.25%, respectively. Management said FHN and the bank met well-capitalized standards and the capital conservation buffer. Available Federal Home Loan Bank borrowing capacity was $14.3 billion.
Material changes versus comparable periods
- Reported asset, loan, deposit and revenue growth chiefly reflects the IBKC merger and Truist branch acquisition; acquired assets and liabilities were recorded at estimated fair value.
- The merger generated a preliminary $532.2 million purchase accounting gain, materially boosting reported earnings and reducing the effective tax rate to approximately 0.4% in Q3. The gain is nonrecurring and non-taxable.
- Credit provision rose sharply due to CECL adoption, acquired non-purchased-credit-deteriorated loans, and the deterioration in COVID-19-related economic forecasts. CECL adoption reduced retained earnings by $96.1 million at January 1, 2020.
- Net interest margin fell year over year despite higher net interest income, reflecting a larger earning-asset base but lower rates and higher excess cash. Fixed-income revenue also benefited from market volatility.
Outlook, management commentary and risks
- The filing provides no specific earnings or revenue guidance. Management said results remain exposed to the uncertain duration and effects of COVID-19, including unemployment, borrower repayment capacity, loan migration, charge-offs and reserve needs. Deferrals and government support may delay visibility into underlying credit stress.
- FHN held $4.2 billion of PPP loans, which are SBA-guaranteed and considered to have no credit risk. The company anticipated approximately $60 million of net lender fees and expected substantially all eligible forgiven balances to be repaid by the end of 2021.
- Credit exposures include residential real estate (21% of loans) and finance/insurance borrowers plus mortgage-company lending (26% of C&I loans). Management highlighted potential COVID-19 pressure on hospitality and retail commercial real estate, energy, restaurants and other stressed industries.
- Integration execution, realization of merger synergies, provisional acquisition valuations and related costs are significant uncertainties. The preliminary IBKC purchase-price allocation remained subject to change; Truist acquisition valuations were also provisional.
- Other risks include low rates and LIBOR transition, market volatility, and legacy pre-2009 mortgage indemnification and servicing claims. Management could not estimate a reasonably possible loss range for certain material matters. The repurchase and foreclosure liability was $15.9 million; aggregate liabilities for other identified loss-contingency matters were $1.3 million.
- Management’s 12-month static-balance-sheet sensitivity estimated net interest income would increase 1.9% under a 25-basis-point rate rise and 10.7% under a 200-basis-point rise, and decline 2.3% under a 25-basis-point decline, assuming rates do not fall below zero. These are modeled scenarios, not forecasts.
Important facts for investors to verify
- How much of reported earnings and return metrics depends on the one-time $532.2 million purchase accounting gain, and what are normalized results excluding it?
- How are acquired loan fair values, provisional purchase accounting estimates and merger integration costs changing as valuations and integration progress?
- Are CECL reserves adequate as deferrals expire and economic conditions, delinquencies, criticized loans and charge-offs evolve?
- What is the repayment and forgiveness timing for PPP loans, and when will the related deferred fees be recognized?
- How will lower rates, excess liquidity and LIBOR transition affect net interest margin and funding costs?
- What are the progress and potential financial exposure from legacy mortgage claims and other litigation, for which some loss ranges cannot be estimated?