Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 3Q17 Earnings Update
Prev. Ed: 2Q17 Earnings Update, Sep 1, 2017
Brokers’ Recommendations: Neutral: 63.6% (7 firms); Positive: 36.4% (4); Negative: 0.0% (0) Prev. Ed.: 6; 4; 0
Brokers’ Target Price: $20.94 (↑$0.73 from the last edition, 11 firms) Brokers’ Avg. Exp. Return: 5.4%
Note: A Flash Update on 3Q17 Earnings was done on Oct 13, 2017.
Note: We do not have access to the report from broker having the Sell recommendation on the stock.
Portfolio Manager Executive Summary
Incorporated in 1968, First Horizon National Corporation (FHN) is a financial services company based in Memphis, TN. It is the parent company of First Tennessee Bank and FTN Financial.
Trend of Broker Opinions: Broker sentiment on the stock remains skewed towards the neutral side with 63.6% of the firms in the Digest group rating the stock neutral and 36.4% rating it positive. Target prices provided by the firms range from a low of $19.00 to a high of $23.00 per share. The average came in at $20.94, implying a positive return of 5.4%.
Chief Investment Considerations:
§ Inorganic growth opportunities
§ Strong capital position
§ Improving credit quality
§ Ability to return capital to its shareholders
§ Loan growth
§ Low Regulatory Issues
§ Rising interest rate environment
§ Gradual ease in pressure on net interest margin
Neutral or equivalent outlook – Seven firms or 63.6%: According to these firms, First Horizon’s inorganic growth strategy along with improving interest income will support revenues. The company’s plan to return excess capital to shareholders in the coming period indicates strong balance sheet position. However, legacy mortgage issues and lower quality non-strategic assets may hinder growth going forward. Given the concerns related to the company’s potential exposure to private label securitization losses, the neutral firms expect the upside potential to be constrained in the near term.
Positive or equivalent outlook – Four firms or 36.4%: According to these firms, First Horizon remains well positioned for growth supported by a focused management lineup, improving asset quality and investment in technological enhancement. Further, the firms expect the company to benefit from its improving operating trends, and growing market share and loans. Management has positioned the company well to absorb credit weakness, prepared it to take advantage of opportunities in its core market and benefit from a recovering economy. Also, the company is expected to break even on its non-strategic business after successive run-offs in the prior quarters. Additionally, its solid fundamentals and capital deployment activities continue to be positives. Also, the recent interest rate hikes by the Fed is likely to ease the pressure on net interest margin.
December 1, 2017
Overview
Formerly known as First Tennessee National Corporation, First Horizon National Corporation is a financial services company based in Memphis, TN which was incorporated in 1968. The company began as a small community bank chartered in 1864. It is the holding company for First Tennessee Bank and FTN Financial. First Tennessee Bank offers deposit products, loans, investments, insurance, financial planning, trusts, asset management and cash management services in Tennessee. FTN Financial provides capital markets and investment banking services. As of Sep 30, 2017, First Horizon had $29.6 billion in total assets, $20.2 billion in loans net of unearned income and $22.1 billion in deposits.
In April 2017, FTN Financial, a division of First Tennessee Bank, completed the acquisition of Houston-based financial company, Coastal Securities. First Tennessee Bank is a subsidiary of First Horizon. The $160-million deal was signed in October 2016, for payment in cash, based on the book/market value of acquired net assets at closing. The deal was immediately accretive to First Horizon’s earnings per share, return on tangible common equity and return on assets.
The company has four business segments: regional banking, capital markets, corporate and non-strategic.
§ The Regional Banking segment offers financial products and services, including traditional lending and deposit taking, to retail and commercial customers in Tennessee and surrounding markets. Regional banking provides investments, financial planning, trust services and asset management, credit card, cash management and first-lien mortgage originations within the Tennessee footprint. Additionally, the regional banking segment includes correspondent banking, which provides credit, depository and additional banking-related services to other financial institutions.
§ The Fixed Income segment consists of fixed income sales, trading and strategies for institutional clients in the U.S. and abroad, loan sales, portfolio advisory and derivative sales.
§ The Corporate segment consists of gains from the extinguishment of debt, unallocated corporate expenses, subordinated debt issuances and preferred stock expenses, bank-owned life insurance, unallocated interest income associated with excess equity, net impact of raising incremental capital, revenues and deferred compensation plans expenses, funds management, low-income housing investment activities and various charges related to restructuring, repositioning and efficiency.
§ The Non-strategic segment includes the wind-down of national consumer lending activities, legacy mortgage banking elements including servicing fees, and associated ancillary revenues and expenses related to these businesses. It also consists of the wind-down trust preferred loan portfolio and exited businesses along with related restructuring, repositioning and efficiency charges.
Its website is: http://www.firsthorizon.com/
The key positives and negatives as identified by the analysts are addressed below:
Key Positive Arguments / Key Negative Arguments§ First Horizon has executed several strategic repositioning efforts to improve long-term profitability.
§ Increasing revenue base with rising interest income.
§ The company possesses a unique combination of credit leverage and capital strength.
§ Significant efforts recognized in reducing risk and de-leveraging balance sheet.
§ Excess capital could be deployed through acquisitions, buybacks or eventual growth in the balance sheet.
§ Rising interest rates to benefit the company. / § Slow rate of economic growth might impact loan demand.
§ Above average mortgage repurchase exposure weighs on profitability.
§ Uncertainty surrounding the impact of mortgage repurchase activity (specifically the private label exposure) is a challenge for First Horizon.
Note: First Horizon operates on a calendar year basis.
December 1, 2017
Long-Term Growth
First Horizon has implemented several strategic repositioning measures to improve long-term profitability. It was one of the first banks to address its credit problems in this cycle. Prior to 2008, the company focused on a national lending strategy that included a construction lending business and a mortgage origination and servicing platform. The company’s exposure to national mortgage and construction lending made a severe impact on the company, leading to its exit from these business lines and focus on its core Tennessee banking franchise.
In 2008, First Horizon sold much of the mortgage business to MetLife and put the legacy national lending portfolio into run-off. As the portfolio was wound down, the company should have deployed excess capital to execute a deal in and around the nine states that border the bank’s core franchise, improving long-term profitability. Management remains committed to enhance productivity and efficiency levels in the long run.
Overall, the firms believe that with the Southeast having ample distressed bank acquisition opportunities, M&A could be a catalyst for First Horizon’s earnings growth, given the option to leverage a very strong capital position. Although the company has been inactive for several years on the M&A front, the Troubled Asset Relief Program (TARP) repayment and the subsequent renewal of cash dividend proved to be an inflection point. Management is interested in Federal Deposit Insurance Corporation (FDIC)-assisted deals and others, provided they match its risk profile.
The company is grappling with some issues, particularly in its national mortgage and construction lending businesses. The firms support the strategic decisions, which were made in late 2007, to exit these business lines and focus on growing its core Tennessee banking franchise. As the non-strategic businesses continue to wind down, the company will be able to reallocate the capital that was associated with these businesses into its core markets. This should improve the long-term growth outlook. The firms expect additional challenges in the medium term as the macro credit environment remains a headwind.
First Horizon reiterated its long-term targets. The company expects net charge-off ratio in a range of 0.20-0.60%. Also, it continues to anticipate Tier 1 Common Ratio within 8-9%.
NIM is expected in a range of 3.25-3.50%. Further, fee income, as a percentage of revenues, is anticipated within 30-40% range. Also, it expects long-term efficiency ratio in the range of 60-65%.
Additionally, Return on Tangible Common Equity (ROTCE) is expected to trend above 15%, while long-term Return on Assets (ROA) is projected in the range of 1.1-1.3%.
December 1, 2017
Target Price/Valuation
Provided below is a summary of valuations and ratings as compiled by Zacks Research Digest:
Rating DistributionPositive / 36.4%↓
Neutral / 63.6%↑
Negative / 0.0%
Average Target Price / $20.94↑
Maximum Upside from Current Price / 15.8%
Minimum Upside from Current Price / -4.3%
Upside from Current Price / 5.4%
Digest High / $23.00↑
Digest Low / $19.00
Number of Analysts with Target Price/Total / 11/11
Risks to the target price include, but are not limited to, extended subdued fixed income trading revenues, credit deterioration related to its commercial real estate and home equity portfolios, lower-than-expected capital markets income, increasing competition in its core Tennessee footprint, weakening economic conditions, interest rate volatility, credit risk and materially increased regulatory requirements or costs.
Recent Events
On Dec 1, 2017, First Horizon completed the stock-cash acquisition deal with Charlotte, N.C.-based Capital Bank Financial Corp., under which the former acquired the latter for a total value of $2.2 billion. The combined entity forms the fourth largest regional bank in the Southeast. Notably, the deal was announced in May 2017.
Terms of the Deal
Per the deal, each common shareholder of Capital Bank will get cash or stock equivalent to 1.750 of First Horizon shares and $7.90 in cash for every Capital Bank share held, subject to certain conditions. The deal has been agreed upon 80% stock and 20% cash. Specifically, Capital Bank shareholders, in total, will own about 29% of First Horizon’s common shares and $411 million in cash.
First Horizon, with $30 billion in assets, and Capital Bank, with $10 billion in assets, created the combined entity with $40 billion in assets, $32 billion in deposits and $27 billion in loans. The high potential market in North Carolina, along with the strong relationships that Capital Bank has built in the area, seems to have prompted First Horizon to opt for the acquisition. The deal certainly fortifies First Horizon’s footprint in the Southeast, with about 350 branches in Tennessee, North Carolina, South Carolina, Florida, Mississippi, Georgia, Texas and Virginia.
According to the terms of the deal, First Horizon will maintain its First Tennessee bank brand in Tennessee, while the Capital Bank name will be used for branches outside Tennessee.
On Nov 17, 2017, First Horizon and Capital Bank Financial agreed to sell two branches of Capital Bank in Greene County to Apex Bank. Notably, First Horizon entered into a $2.2-billion stock-cash deal to acquire Capital Bank in May 2017. The combined entity will form the fourth-largest regional bank in the Southeast.
Terms of the Deal
Tennessee-based Apex Bank will absorb deposits worth approximately $34 million and $2.5 million in loans from the two branches. The branches were already included in First Horizon’s agreement with the United States Department of Justice and the Board of Governors of the Federal Reserve System. Notably, the agreement was signed during the customary review of the pending merger between First Horizon and Capital Bank Financial.
Apex Bank will retain all existing branch employees after acquiring the two branches. The company has assets worth $517 million and 11 branches. Notably, the spin-off deal awaits closing of the First Horizon and Capital Bank merger, certain customary regulatory approvals to Apex Bank along with customary closing conditions.
On Oct 13, 2017, First Horizon announced 3Q17 results. Adjusted earnings per share of 32 cents surpassed the Zacks Consensus Estimate by 6.7%. Further, it came above the year-ago quarter’s figure of 27 cents.
Results reflected improvement in net interest income and loans. Also, no provision for loan losses supported the results. Further, improved capital position acted as a tailwind.
The reported earnings include impacts relating to legal matters, acquisition-related expenses and repurchase of equity securities previously included in a financing transaction. Earnings also include a positive effect from tax rate adjustment.
Net income available to common shareholders for the quarter was approximately $67.3 million, up 7% from the prior-year period.
Segment wise, quarterly net income at Regional Banking jumped 13% year over year to $73.4 million. Net income for Fixed Income segment amounted to $5.7 million, down 40% from the prior-year quarter. Also, the Non-Strategic segment recorded net income of $5.8 million, up 34% from the year-ago period. However, Corporate segment reported net loss of $13.1 million against a net loss of $11.3 million in the prior-year quarter.
Revenues
Total revenues in 3Q17 came in at $322.2 million, down 3% year over year (y/y).
Net interest income (NII) was $209.8 million, up 13% y/y. The rise was mainly due to higher interest income partially offset by rise in interest expenses.
Net interest margin (NIM) was 3.19%, up 23 basis points (bps) compared with 2.96% in the previous year quarter.
Non-interest income of $112.4 million was down 24% y/y. The decrease was primarily due to lower income in the Fixed Income segment and decline in insurance income.
Quarterly Business Segments
Regional Banking: The segment reported total revenues of $273.7 million, up 7% y/y. NII was $209.3 million, increasing 10% y/y. Non-interest income came in roughly at $64.4 million, down 1% y/y.
Fixed Income: The segment reported total revenues of approximately $61.8 million, down 17% y/y. NII came in at $6 million, increasing significantly y/y. Non-interest income was $55.8 million, down 23% y/y.
Corporate: The segment reported negative revenues of $23.5 million compared with negative revenues of $13.1 million in the year-ago quarter. Net interest expenses amounted to $14 million, compared with $18.2 million in the previous-year quarter. Negative non-interest income of $9.5 million was reported in the quarter compared with an income of $5.1 million in the prior-year quarter.