Damaged Merger Arb, Regional Financial institution Storm


First Horizon Corp (FHN) ($5.3B market capitalization) is a reasonably vanilla regional financial institution serving a steadiness of each industrial and shopper clients in 12 states all through the demographically fascinating southeastern United States.  In contrast to different troubled banks, their clientele is much less chunky, much less scorching cash, much less return motivated.  First Horizon does not have buyer focus in asset managers, funding funds, tech start-ups or a big wealth administration apply the place deposits are much less operational in nature.  It is only a boring center American financial institution with a historical past of above common, low-to-mid teenagers ROE. 

Again in early 2022, First Horizon agreed to be purchased out by TD Financial institution (TD) for $25/share plus a small ticking charge, nevertheless on 5/4, the 2 banks mutually agreed to terminate the merger as a result of regulatory approval timing uncertainty.  It was later reported by the WSJ that the OCC had considerations about TD Financial institution’s anti-money laundering insurance policies and blocked the deal.  The merger arb unfold had already widened forward of the termination signaling the market was extremely skeptical of this deal going via, however shares tanked anyhow as merger arb holders are promoting shares at a time when there are few enthusiastic patrons of regional financial institution shares to match the liquidity.  As of this writing, shares commerce round $9.60, lower than half of the place TD was ready to take it out.

The present banking disaster is completely different than 2008, there’s much less concern concerning the final recoverability of securities on financial institution steadiness sheets (AAA CDOs for instance, weren’t AAA, however there is not that query with company MBS), fairly the market is extra frightened concerning the mark-to-market losses in financial institution held-to-maturity (“HTM”) portfolios if banks are compelled to promote securities to fulfill deposit outflows.  First Horizon’s use of HTM accounting is comparatively small (simply 12% of the securities portfolio), deposits (which totaled $61B as of three/31) massive and small must flee in mass earlier than the financial institution would wish to realizes losses of their HTM portfolio.

As specified within the merger settlement, TD paid First Horizon a $200MM break charge and $25MM in merger expense reimbursement.  TD additionally purchased $494MM of Sequence G most popular inventory on the time of the merger announcement, which was used to fund retention bonuses for First Horizon’s folks, that tranche mechanically converts to frequent inventory with the deal breaking on the $25 deal worth.  Each changes assist enhance their capital. 

What might FHN be value as soon as all of the clouds clear?  Previous to 2022, First Horizon traded round ~1.5x tangible frequent fairness.

If we incorporate the mark-to-market losses on the HTM portfolio, the termination charge and expense reimbursement, and the conversion of the Class G most popular, I get the beneath:

There are few extra banks that I am kicking round, be happy to say some that you just like within the remark part, however FHN appears unfairly punished.  I doubt it might be buying and selling right here in the event that they by no means got here to an settlement with TD, related however bigger peer Areas Monetary (RF) trades for 1.5x tangible fairness.

Different ideas:

  • Previous to the termination, some rumors have been floating round that TD was searching for a worth lower as a result of market circumstances, however First Horizon administration acknowledged on their investor name that TD by no means broached the topic.
  • The TD-FHN merger occurred as a result of an unsolicited provide, the financial institution wasn’t working a sale course of, so it’s unlikely FHN will get scooped up by one other bidder within the close to time period, but additionally means the board and administration take their fiduciary accountability critically and would contemplate different bidders.
  • Period of the funding portfolio is simply 5.2 years, every quarter that passes a number of the losses will flip as par is realized.  The Federal Reserve additionally seems to be completed mountain climbing which ought to put a flooring on the securities portfolio losses.

Disclosure: I personal shares of FHN


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