While I am generally bullish on financials, the continued macro uncertainty and, now, ratings downgrade in Europe has created an atmosphere of substantial risk for regional banks. In agreement with the Street, I rate both First Horizon National (FHN) and SunTrust (STI) a "hold".
From a multiples perspective, SunTrust is the cheaper of the two. It trades at 11.2x forward earnings while First Horizon trades at 13.5x forward earnings. With the much more fundamentally-strong Wells Fargo (WFC) trading at only 9.1x forward earnings, the two other financials could struggle to justify the premium.
At the third quarter earnings call, First Horizon's CEO, noted:
"Net income available to shareholders was $36 million, and earnings per share were $0.14 in the third quarter compared to the second quarter's net income of $20 million and EPS of $0.08. Core business net income was $94 million compared to $27 million in the second quarter. While third quarter's bottom line was solid, there were also some significant items. We executed nonperforming loan sales … approximating $150 million in net book value. Provision impact from loss on these sales was $36 million. We also sold some Visa shares in the third quarter as a -- for a securities gain of $35 million. Expenses related to our restructuring, repositioning and efficiency initiatives were $2 million, down from $17 million in the second quarter; and additionally, a previously announced divestiture resulted in an after-tax gain of about $5 million within discontinued ops".
Three key issues will determine where the stock price goes from here: de-risking away from mortgage put-backs, share repurchases, and turnaround success. On the first measure, I am anticipating a decline in mortgage provisions as requests are heading lower. On the second issue, management made the proper decision to target a $100M buyback despite investor disappointing. The market reaction from a more aggressive capital allocation plan would have contained the ability to reduce share count. With that said, as shares are currently trading below book value, buyback activity is one of the most accretive methods to drive ROE and EPS growth. On the third, the company benefits from not being deemed a systemic risk. Put differently, this means less regulatory.
Consensus estimates for First Horizon's EPS are that it will turn positive to $0.52 in 2011 and then grow by 26.9% and 33.3% in the following two years. Assuming a multiple of 15x and a conservative 2012 EPS of $0.62, the rough intrinsic value of the stock is $9.30, implying 7.1% upside. If the multiple to be 13x - ahead of the level that Wells Fargo is at - and 2012 EPS turns out to be 10.6% below consensus, the stock would fall by 11.6%. Accordingly, the "hold" on the Street is warranted.
The same goes for SunTrust, which has had 16 of the last 19 revisions to EPS go down for a net change of -3.7%. Recently, the bank has benefited from the elimination of TARP drag and the lower provisions arising from improving credit trends. One analyst is forecasting a 60% decline in mortgage put-back losses going forward to 4Q13. While investors are optimistic about expense reductions, I believe that the effort to cut $300M from overhead costs will be damaging to future effort in retaining talent. Financials are, for practical purposes, about trust and it is crucial that an atmosphere of confidence surrounds executives. High pay, as superficial as it may sound, is one major key to the puzzle.
Consensus estimates for SunTrust's EPS forecast that it will turn positive to $1.09 in 2011 and then grow by 69.7% and 44.3% in the following two years. Assuming a multiple of 15x and a conservative 2012 EPS of $1.71, the rough intrinsic value of the stock is $25.65, implying 23.3% upside. While this upside is attractive, it does not meet the threshold that I consider to call the investment a "value play".