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Like so many other banks, Tennessee’s First Horizon (FHN) committed ample sins during the housing boom, and the path of penance has been long and difficult. While there are still some financially significant potential liabilities left here, patient deep-value investors should give this small regional bank a serious look.

Q3 Was Not *That* Bad

It is hard to say that First Horizon had a good quarter, but the Street has seemingly been looking for problems here for a while. Consequently, it would be par for the course if the emphasis was on what was wrong with the quarter.

Still, First Horizon reported a 4% sequential increase in operating revenue, with a 2% increase in net interest income. In a banking environment where low rates and sluggish lending is hitting net interest margin, FHN saw the margin improve ever so slightly this quarter. First Horizon does not have the net interest margin of Wells Fargo (WFC) or regional rivals like BB&T (BBT) and SunTrust (STI), but it is solid compared to smaller banks like Regions Financial (RF).

While non-interest expense improvement was not actually as strong as it looked on a reported basis, the company is doing reasonably well in controlling employee costs. At the same time, the company's non-performing asset ratio is getting better quickly – improving about a full point from the second quarter.

What Will Happen With The Put-Backs?

One of the biggest issues with First Horizon is the overhang regarding how much the company will have to pay in making good on bad mortgages sold to those who securitized them. This quarter saw a sizable uptick in the cost of repurchases to government-sponsored entities, but still no private label requests. When it is all said and done, First Horizon will probably end up paying back about 1% of the nearly $70 billion in eligible loans; if that's accurate, the company is about two-thirds of the way through.

The private label issue is murkier, though. A worst-case scenario would probably cost around $500 million – a sum that would take a sizable bite out of the company's equity and tier 1 capital, but would be survivable. At this point, though, it looks like the ultimate cost will be lower – even though Wall Street seems to be pricing in a worst-case scenario.

Learning From The Past, Positioned From The Future

Not unlike Regions, Synovus (SNV), and BankcorpSouth (BXS), First Horizon got greedy and sloppy and paid a heavy price. At one point, First Horizon was heavily involved in national mortgage origination (through brokers) and national construction lending – meaning that a sizable majority of the company's loans were outside of its Tennessee operating geography. Since then, though, new management has been very active in disposing of high-risk assets and repositioning the bank for a more sustainable future.

At the same time, the bank has some attractive aspects. The company repaid its TARP funds, has initiated a buyback, and has an appealing deposit profile with a sizable non-interest bearing composition. As loan demand picks up, then, First Horizon should be able to underwrite some profitable lending business going forward.

The Bottom Line

First Horizon likely wants to expand outside of Tennessee, and acquisitions would be a logical approach. At the same time, it's an appealing sales candidate in its own right, as SunTrust, BB&T, and Fifth Third (FITB) could all make geographically and economically rational arguments for buying this bank.

In the meantime, not only is the bank trading at a discount to its tangible book value (a metric that is admittedly vulnerable to more putbacks), but it is trading at a significant discount to its likely future returns on equity. Yes, banking will not return to the greed-inflated returns seen in the height of the bubble for some time (if ever), but even just a low teens ROE would be more than enough to fuel a double in these shares from today's levels.

Source: First Horizon Getting No Benefit Of The Doubt