Why First Horizon Is a Compelling Example of Will Power

First Horizon National (FHN) in Memphis, Tenn., is a lesson in patience for executives and investors everywhere as it slowly puts its mortgage woes in the past while pursuing incremental revenue opportunities.

The company has taken its lumps in the past year as it resolved mortgage-related issues with Fannie Mae, Freddie Mac and the Federal Housing Finance Agency. Bryan Jordan, the $24 billion-asset company's chairman and chief executive, acknowledges that there are still lingering mortgage problems but prefers to highlight growth initiatives that include a recent branch deal in Tennessee and a commercial lending push into Houston.

"I think we've made substantial progress" with mortgage issues, Jordan said in a recent interview. "We have some additional work to do, but the passage of time helps to resolve things. … Below the surface the vast majority of what we've been doing has involved building the banking franchise and our fixed-income business to position ourselves for the long term."

It will take some time before those efforts trickle down to the bottom line, and investors must tolerate some fits and starts as management works through the remaining mortgage mess, industry observers say. The company's stock rose 12.7% last year, though it underperformed the KBW Bank Stock index, which increased by 30%. Its first-quarter earnings rose 9.5% from a year earlier, to $44.9 million, as lower expenses offset an 8% decline in revenue.

First Horizon "is a stock that definitely needs some patience," says Matt Olney, an analyst at Stephens. "This is a bank that has struggled to grow revenue more than most banks in recent years."

Jordan, who inherited a slew of mortgage issues when he became CEO in 2008, is making strides to line up revenue opportunities. A large part of his efforts have involved finding markets similar to those in Tennessee — Raleigh, N.C.; Richmond, Va.; Jacksonville, Fla.; and Charleston, S.C. — to target middle-market and wealth management clients.

While management is relatively mum on its progress in those markets, analysts note that the recent decision to buy 13 branches and $660 million in deposits from Bank of America (BAC) in several middle and east Tennessee markets indicates that the company feels good about its prospects.

The branch deal will lower the company's loan-to-deposit ratio to 85% from 89%, says Chris Marinac, an analyst at FIG Partners. "Most bankers desire a higher" ratio, he says. "This can only be interpreted that First Horizon plans to expand loans and desires additional core funding."

The branch deal "provides liquidity to fund loan growth" in Tennessee and elsewhere, Jordan says, adding that First Horizon is open to doing more deals. (The company bought a failed bank, Mountain National Bank in Sevierville, Tenn., a year ago.)

"We're trying to take measured and thoughtful steps to build the franchise while being disciplined in the way that we approach it," Jordan said. "We think these deals are additive, and we'll be open to looking for more."

It is unlikely First Horizon would pursue an acquisition in Houston, where it opened a lending office in April. Jordan made it clear that such a deal would deplete an inordinate amount of capital to target retail customers, given the high number of branches required to adequately cover that metropolitan market.

Finding good lenders to staff a new office makes more sense, he argues.

"If you get the right kind of people you can build traction" in commercial lending, he said, adding that First Horizon also had some existing clients in Houston where it will initially focus on the energy sector. "It is possible to have the right products to make that market attractive to us."

A big question mark in Houston, which is much bigger than most of First Horizon's other markets, involves how the company will compete with the area's largest banks.

"It remains to be seen what takes place in Houston, though they have found [employees] there that make them comfortable," Marinac says.

"Houston is competitive but it is healthy," Olney says. "The [loan] pricing is aggressive, but most companies we talk to tell us that they still get some decent pricing and pretty good terms and conditions there."

Perhaps First Horizon's dedication to new markets and its openness to acquisitions indicate increased confidence about its mortgage exposure, industry observers say. Still, it could take another year or two before management can declare that all of those issues are resolved, providing another reason why investors must remain patient.

"Still, the range of outcomes is tolerable," Olney says, noting that any remaining exposure is tied to private mortgages. "Their retained earnings are solid, and their ability to build capital is getting better."

Another cause for patience involves the company's balance sheet. First Horizon is very asset sensitive; nearly two-thirds of its loans have floating rates. Its net interest margin shrank 10 basis points in the first quarter from a quarter earlier, to 2.88%.

Management projects that interest income could increase by $34 million, or 5.5%, from current levels, should long-term rates rise by 100 basis points. "That is a big change … even if it doesn't happen until 2017," Marinac says. "But a lot of people believe the Fed will act quickly when they start to raise rates."

Some industry observers, including Olney, hold out hope that First Horizon — Tennessee's biggest bank — will eventually sell itself, but they admit it could take time before regulators let a bigger bank pursue a target that large. They point to the lengthy delays and regulatory scrutiny M&T Bank (MTB) has received in its quest to buy the $38 billion-asset Hudson City Bancorp (HCBK).

Again, investors who expect a big pay day from a sale must be willing to play a waiting game.

"They also have to fully address the balance sheet and get over the hump with mortgages," Olney says. "Once regulators start to approve mergers of that size or give larger acquirers the green light, First Horizon would be an interesting candidate, though it is too early to say who might be interested."

"I think the regulatory environment is not conducive to big acquisitions as regulators show their might," Marinac says. "I don't think it is permissible today, but I think Bryan and his board are extremely shareholder friendly and would do the right thing."