Tennessee bank's sale a cautionary tale on out-of-market lending

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Franklin Financial’s loan book looks a lot like a case of Jekyll and Hyde.

The $4.2 billion-asset company has a highly regarded commercial real estate business in middle Tennessee that caught the eye of FB Financial in Nashville, Tenn., which agreed on Tuesday to buy the company for $611 million.

Executives at the $6.1 billion-asset FB Financial were far less excited about Franklin’s corporate and health care books, which feature a large amount of out-of-market loans. The plan is to purge those loans — $430 million, including $137 million in shared national credits — as soon as possible even though doing so will cost FB Financial about $10 million in revenue.

“The corporate book is not aligned with our philosophy as it does not generally involve local customers or financial sponsors,” James Gordon, FB Financial’s chief financial officer, said during a Tuesday conference call to discuss the deal. “We will not be putting that onto our balance sheet.”

Franklin’s foray into shared national credits had begun to cause concern among some analysts. Criticized and classified loans at the company surged by more than 50% during the first nine months of 2019, and Franklin had to charge off a $9.7 million shared national credit to a health care company.

So Franklin’s pending sale to FB Financial, while generally well received, embodies for some a cautionary tale of the risks banks face when they stretch beyond their core markets to book more loans and boost profit.

“We do like this deal, but it is a reminder of how challenging it can be to go outside your comfort zone,” said Andrew Gibbs, an analyst at Mercer Capital in Nashville.

J. Myers Jones, formerly Franklin’s chief credit officer, succeeded Richard Herrington as CEO last March, shortly before the health care borrower went into default. Jones reduced the size of Franklin’s corporate and health care portfolios by 16%, shedding $84 million in loans during the second half of 2019.

Still, 9.1% of the loans left in those portfolios, or roughly $39 million, are criticized or classified.

Against that backdrop, some analysts began looking at Franklin as a likely seller.

"It was our top takeout idea for 2020,” said Tyler Stafford, an analyst at Stephens. He wrote in a recent note to clients that Jones's efforts to clean up its credit helped position the company to be sold.

Conversations between the Nashville-area companies began early in the fourth quarter and quickly “picked up steam,” Christopher Holmes, FB Financial’s president and CEO, said during Wednesday’s call.

The deal, expected to close in the third quarter, priced Franklin at 150% of its tangible book value. FB Financial plans to cut about 30% of Franklin’s annual noninterest expenses, including the closing of seven branches.

FB Financial executives touted opportunities in the growing and economically vibrant Nashville market, adding that the scale gained from the acquisition will make their company more efficient and competitive.

“We're thrilled with the strategic nature of this deal and we're also elated with the financial impact,” Holmes said. “At the core, Franklin … is an incredibly strong group of relationship managers that epitomize our definition of everything community bankers should be.”

Holmes said FB Financial plans to implement some of Franklin’s monitoring practices for residential construction loans. The seller’s chief credit officer will also have a senior role at FB Financial after the deal closes.

FB Financial also outlined changes it will make to the liability side of Franklin’s balance sheet. While Franklin has increased retail deposits by 11% since the end of 2018, they still make up just 53% of total deposits.

A portion of the proceeds from the loan sales will be used to pay down noncore funding such as wholesale funds and brokered CDs.

Those moves make sense for FB Financial over the long run, industry observers said.

“I think that’s the right strategy,” Gibbs said. “The risk reduction definitely outweighs what they give up in revenue.”

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