Tennessee banker faces difficult test after credit quality slips

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Franklin Financial Network in Tennessee embodies the banking industry's challenge to improve margins and manage risk.

Commercial lending, including dealings in shared national credits and health care loans, have helped Franklin expand its net interest margin by 30 basis points this year, to 3% on Sept. 30. The $3.8 billion-asset company's third-quarter profit rose by 8% from a year earlier, to $11.3 million.

At the same time, substandard and special mention loans jumped by nearly 30%, to $83.3 million at Sept. 30. Franklin also finished charging off nearly all of a $9.7 million shared national credit to a health care company.

The challenge of keeping more loans from going bad belongs to J. Myers Jones, who succeeded Richard Herrington as CEO in March, about three weeks before Franklin learned that the health care credit had gone into default. Jones had been Franklin's chief credit officer.

Jones has spent recent months reducing Franklin's exposure to shared national credits, brokered deposits and other noncore relationships as part of a plan to "unlock the value of the core bank.” The question is whether he can successfully do that while continuing to increase, or at least shore up, Franklin's net interest margin and profits.

For those reasons, Jones is one of American Banker's community bank CEOs to watch in the new year.

Efforts to reach Jones were unsuccessful.

Franklin, for its part, never shied away from its exposure to shared national credits, noting in its 2018 annual report that “our reduced control over the monitoring and management of these relationships … could lead to increased risk of loss.”

Still, the company has been reducing that exposure; outstanding balances tied to shared national credits fell by 42% between the end of 2018 and the third quarter, totaling $144 million on Sept. 30. The same can be said of brokered deposits, which fell by 26% over the first nine months of 2019, to $589 million.

Total assets fell by 10% over the first three quarters of 2019.

Franklin will likely focus more on local markets, including affluent Williamson County, where it has the top deposit market share, to offset decrease in SNCs and brokered deposits. The county, which is outside Nashville, has a median family income of $109,000, according to the Census Bureau.

Credit quality will be a focus for those who cover Franklin.

Though nonperforming loans represent 0.08% of total assets — an improvement after the big charge-off — special mention and substandard loans remain elevated.

Special mention loans, while performing, have potential weaknesses that merit close attention. Substandard loans are also current but are inadequately protected by the current net worth and paying capacity of the borrower or the loan's collateral.

Franklin's commercial portfolio largely consists of relatively new loans, Laurie Havener Hunsicker, an analyst at Compass Point, cautioned in a note to clients shortly after Franklin reported third-quarter results. "We are watching the health care loan book. ... It appears that this portfolio has a substandard rate of [about] 11%."

Regulatory filings and published reports indicate that Franklin charged off a loan to Nobils Health, which filed for bankruptcy protection and closed its corporate headquarters in Houston in October. The health care company had a $82.5 million credit facility that was underwritten by BBVA Compass Bank. Franklin charged off $7.5 million in July and another $1.7 million in October.

Investors, for now, seem more encouraged by the margin expansion and increased earnings. The company's shares have increased by 21% since July.

Other industry observers said Franklin's pullback shouldn't be viewed as a rebuke for shared national credits.

“Any regional or super-regional community bank that doesn’t look to expand their market in digitally efficient ways like shared national credits might be looking less attractive in the medium term,” said Sultan Meghji, CEO at Neocova, a core provider in St. Louis.

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