It was all too common during the bubble years that began almost a decade ago to see quality community or regional banks de-prioritize their traditional businesses to reach for the fool’s gold offered by riskier lending. Very few of those stories had happy endings, and many ended like First Horizon National (NYSE:FHN), where the bank saw significant lending losses, putbacks, and the need to raise fresh capital to stay in business.

Now things are settling down and getting back closer to normal. First Horizon has retrenched around its core operations and is looking to reduce its non-strategic lending activity, while also looking to make the most of its sizable market share in Tennessee. The only real drawback to the story, aside from the risk of higher putbacks, is the fact that valuation already anticipates quite a lot of improvement.

Expenses Driving The Story
Looking back to April's first quarter earnings, First Horizon had a pretty mixed performance. While the 13% year-on-year decline in operating revenue was pretty startling compared to peers, the 1% sequential decline was pretty consistent with the sector. Net interest income declined more than most (down 6% and 5%), as the company saw a 14bp sequential decline in net interest margin due in large part to less lending to mortgage banking companies. Relative to its peer group average of about 3.5%, First Horizon's sub-3% NIM was poor. Where First Horizon did well was in its expense control. Expenses fell 13% and 6%, and that supported a double-digit sequential increase in pre-provision net revenue.

SEE: How To Decode A Company’s Earnings Reports

Transitions Blurs The Numbers A Bit
First Horizon has historically had a large “non-strategic” lending business, and reducing this business is a stated goal of management. To that end, the reported numbers on the company's lending don't necessarily reflect the full story.

Loans did decline on a reported basis, which would seem to lump First Horizon in with other regional banks like Regions (NYSE:RF) and SunTrust (NYSE:STI) in terms of uninspiring lending growth. Part of the decline was due to the reductions in non-strategic lending and a large sequential decline in lending to mortgage companies, though, and that masked underlying growth trends in its core regional lending activity.

Still Trying To Clean Up Past Messes
First Horizon is in much better shape with respect to its capital and “core operations”, but it's not completely out of the woods.

During the lending bubble First Horizon originated about $27 billion in Alt-A and Jumbo securitized loans, and putback losses have dogged the company as a result. Now First Horizon has gone some time without increasing its repurchase provision, and request from Fannie/Freddie declined more than one-fifth on a sequential basis. What's more, recission rates have been stable and statues of limitations are starting to come into play. Even so, there is the risk that higher actual losses here could add turbulence to the story.

Likewise, the company's non-performing asset ratio and net charge-off ratio are higher than for many of its peers. The levels are broadly consistent with what sell-side analysts have already factored into their models, but it's worth noting that First Horizon still has some cleaning up to do.

SEE: 7 Designations For The Sell Side

The Bottom Line
If First Horizon is committed to reemphasizing its regional banking operations, that should be a good thing on balance for the stock. The capital markets business will always be more volatile, but that too is a known risk.

If I have any real concern with First Horizon now, it may be that the bank is returning such a high level of capital to shareholders. It's not that I'm concerned about higher-than-expected losses from the loan book or putbacks, but rather that the bank isn't building capital with which to grow. While First Horizon is the second-largest bank in Tennessee (just a bit behind Regions and well ahead of SunTrust and Bank of America (NYSE:BAC), it has barely any presence in Georgia and a small presence in Mississippi. Then again, a relatively focused business may not be so bad on balance – it would certainly simplify a deal if a company like U.S. Bancorp (NYSE:USB) or Fifth Third (Nasdaq:FITB) wanted to expand their presence in Tennessee.

I'm a little concerned that my 12% long-term ROE target is ambitious for First Horizon. Yes, this bank routinely logged pre-crisis ROE's in the 20%'s, but this is a new world for banks. In any case, even with a 12% target, First Horizon carries a fair value of about $10. Other metrics like return on tangible common equity, return on tangible assets, and capital-adjusted ROE suggest that the stock is within about 5% to 10% of fair value today. All in all, that means First Horizon is a decent enough hold (particularly if you believe management can continue to cut expenses), but not a compelling buy today.

At the time of writing, Stephen D. Simpson did not own shares of any of the companies mentioned in this article.

Related Articles
  1. Economics

    Lessons Learned From the Banking Crisis

    There are lessons to be learned on how to handle severe financial downturns, and while the Fed is learning, politicians may not be.
  2. Credit & Loans

    The Evolution Of Banking

    Banks are a part of ancient history. Find out how this system of money management developed into what we know today.
  3. Personal Finance

    The Rise And Fall Of The Shadow Banking System

    We look at the evolution, failure and fallout from the shadow banking system.
  4. Options & Futures

    Profiting In Bear And Bull Markets

    There are many ways to profit in both bear and bull markets. The key to success is using the tools for each market to their full advantage.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Europe Financials

    Learn about the iShares MSCI Europe Financials fund, which invests in numerous European financial industries, such as banks, insurance and real estate.
  6. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares Morningstar Small-Cap Value

    Find out about the Shares Morningstar Small-Cap Value ETF, and learn detailed information about this exchange-traded fund that focuses on small-cap equities.
  8. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  9. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  4. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  5. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  6. Net Present Value - NPV

    The difference between the present values of cash inflows and ...
RELATED FAQS
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  2. What is the difference between a Debit Order and a Standard Order in a bank reconciliation?

    While both debit orders and standard orders represent recurring transactions that must be considered in bank reconciliations, ... Read Full Answer >>
  3. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  4. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  5. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  6. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!