First Horizon's Long Road Back

MEMPHIS ( TheStreet) -- As is fitting for a company headquartered in a town known for the blues, First Horizon National Corp. ( FHN) is standing at the crossroads.

The bank, whose assets total nearly $26 billion, reported its first quarterly profit in more than two years in mid-July but Wall Street is skeptical that it's out of the woods just yet.

Of the 27 analysts currently covering the stock, 18 have a hold rating. And while the median analysts' 12-month price target for the shares is $14, implying upside of more than 15% from current levels, the stock was sitting at a 52-week high of $15.86 as recently as mid-April.

The question is whether or not that pullback is emblematic of the broad weakness in the bank stocks due to financial reform and other well-documented headwinds since that time, or does it represent real skepticism about First Horizon's post-crisis prospects? The answer, as it so often is, seems to be a little bit of both.

Management's stance, unsurprisingly, is that the bank is ready to rise up and meet the challenges of the new world of banking. CFO William 'BJ' Losch says the First Horizon's relatively new leadership team is far from exhausted coming out of the crisis; rather, they're just getting started.

"We're certainly tired, but kind of energized about where we are for the future," Losch said in a recent interview with TheStreet. "We just returned to profitability this quarter Q2 and so we feel like we turned the corner on credit and we think our challenges now are much more exciting; which are how do we drive returns, how do we drive profitability, how do we get incremental growth above and beyond what everybody else has?"

The questions Losch poses are ones facing the entire banking industry, which has indicated topline growth will be a challenge in the post-FinReg/CARD Act business environment, especially if the economy doesn't cooperate. First Horizon has made a conscious decision to hunker down and concentrate on strengthening its presence in Tennessee while continuing to whittle away bad loans and it seems to be working so far, but doubters still exist.

Bob Phillips, managing partner and co-founder of Indianapolis-based Spectrum Management Group, a wealth management services firm owned by Raymond James Financial ( RJF), is underweight in the financial sector and does not see the value in First Horizon shares right now.

"I don't know where the growth comes from to be honest," Phillips says.

First, a little backstory. First Horizon essentially cut off its left arm to save its whole self by agreeing early in the crisis to sell its mortgage origination and servicing business outside of Tennessee to MetLife Bank, a subsidiary of MetLife ( MET), in June 2008. The bank no longer originates mortgage loans outside of Tennessee.

The company originally began selling branches located outside of its home state in late 2007 -- giving priority to its in-state bank subsidiary First Tennessee Bank, with 180 branches even then -- and it's toiled throughout the crisis to get out from under troubled home equity and construction and industrial loans, a task that continues to this day. That said, it did make it through the crisis and there are more bright spots than blemishes on its balance sheet these days.

New management gets plenty of credit for the bank's survival. Longtime CEO Jerry Baker announced his retirement in 2008, naming Bryan Jordan, the former CFO at First Horizon (and previous finance head at Regions Financial ( RF)) to succeed him in September of that year. Losch himself started at the company in early 2009, after his predecessor employer, Wachovia, was acquired by Wells Fargo ( WFC), where he was the CFO for Wachovia's main banking subsidiary.
William 'BJ' Losch
William 'BJ' Losch, First Horizon's chief financial officer.

But while the surprise second-quarter profit was attributable to improved credit costs as the bank's loan loss provision fell for a fifth straight quarter, First Horizon wasn't able to release any reserves, like many institutions did in the second quarter.

Nonperforming loans totaled $790.5 million at quarter's end, and the bank said its commercial real estate income loan portfolio continues to show stress. Another issue is its bailout tab. First Horizon accepted $866 million in funding from the U.S. Treasury's Troubled Asset Relief Program, and despite some speculation about paying it back earlier this year, it's yet to do so.

The decision by Keefe, Bruyette & Woods to lower its rating on the stock in the wake of the second-quarter report illustrates the conflict that seems to be holding the shares back. The firm likes the bank's long-term prospects, and said it views it as one of the best capitalized banks in the Southeast U.S. with a strong management team that "will one day turn its excess capital into additional EPS power," but it still cut its assessment to "market perform," trimmed its 12-month price target to $14, and lowered earnings estimates for 2010 and 2011.

CFO Losch says First Horizon is much more focused on returns and profitability as opposed to growth right now. The bank has set long-term targets for a 15% to 20% return on equity; a return on assets between 1.25% to 1.45% and a tangible common equity to tangible asset ratio between 6% and 7%, according to company presentation materials. It expects to achieve those goals with a continued focus on efficiency.

"If you look back over the last several years for us and for the industry, everybody was growing their earnings per share or P/E multiple through growth. That dynamic certainly has shifted," Losch says.

He continued: "Theoretically, if you're focusing your company on driving returns, you could have low or no growth and still have high returns on equity year in and year out by being efficient, by driving revenue per FTE full-time employee, by taking costs out of the organization and so on. We've had that mindset for 12-18 months. I think that foundation of thought is going to serve us well."

Sandler O'Neill analyst Kevin Fitzsimmons thinks First Horizon is on its way to changing investor perception so it will be seen as belonging to "the camp of strong, profitable, capital-rich regional names positioned to be consolidators over the next few years," he told clients in a recent note.

"We think First Horizon's achievement of a headline profit in the second quarter is notable in that it highlights the underlying progress made by management in the long-term overhaul of the company's balance sheet, business mix/franchise, and core earnings power," Fitzsimmons said. He rates First Horizon at buy.

But how exactly does First Horizon plan to silence the naysayers?

The bank's move to bring it all back home and grab market share in Tennessee looks like a sound one. First Horizon has the ability to take market share from its small community bank competitiors by simply hiring more bankers and acquiring their client relationships.

CFO Losch also believes there are growth opportunities in the Tennessee economy.

"We're seeing it in our corporate segment, with larger companies that are sitting on a lot of cash and have the opportunity to start to take share in their own industry and so we're seeing some good pipeline and opportunities there," Losch says.

He specifically mentioned the commercial real estate sector.

"We only have 10% of our portfolio in that, but we're seeing very well documented, well priced, well structured deals with a lot of equity put in by the developer that we think are great opportunities for us going forward."

Listen to Losch's thoughts on the outlook for the Tennessee economy.

Spectrum Management's Phillips isn't buying it just yet.

"The real estate market is going to be a tough place to do business for the next several years. How do they become a commercial lender? How do they tend to replace real estate loans as they run off or are written off to generate future profitability?," he says. "How long will it take this company to generate a profit and have a dividend again and have stable cash flow? I'm just not sure it's far enough along to warrant investing in it."

First Horizon's other engine for growth may end up being M&A -- both within and outside of its home state, CFO Losch says. While the regional bank cannot make a move until it returns X amount of taxpayer money to the government; even without TARP, First Horizon is one of the best capitalized banks in the country. It raised $660 million through a common stock offering in the spring of 2008, and its Tier 1 capital ratio stood at 16.77% as of June 30, up from 15.55% a year earlier.

FIG Partners, an Atlanta-based investment firm that provides research on financial companies, gives First Horizon kudos for keeping excess capital on the books and thinks an eventual deal is a real possibility. The firm lifted its rating on the stock to "outperform" following the second-quarter report.

"While management is cautious about economic uncertainty and lingering credit workouts (albeit at an improved loss pace), FHN is in a strong position for both organic EPS results and improved returns as well as strategic growth via acquisitions," FIG told clients. "The company appears to be in zero hurry to use its excess tangible capital, which we think investors should appreciate."

First Horizon's Losch also thinks bank consolidation is in the offing, citing the "confluence"of factors like "financial reform, slow growth in the economy, limited opportunities, and structural changes in the industry."

"We feel very well positioned to put our capital to work that way as well," he said.

Listen to more on First Horizon's M&A plans.

But in the near term, Losch and others acknowledge that it will be a tough slog for the regional bank.

"Although the second quarter's return to profitability demonstrates the significant progress made by this management team, uncertainty surrounding near-term growth outlook, as well as earnings headwinds from mortgage repurchases keeps us on the sidelines for now," writes Bob Patten, an analyst who covers regional banks at Morgan Keegan, a unit of Regions Financial.

Patten thinks the stock will need a catalyst to make a strong move higher, listing "some form of capital deployment, either in the form of an acquisition or a reinstatement of the cash dividend (after repaying TARP)," as an example.

So while everyone seems to agree the bank looks solid over the long haul, the stock, which is already down nearly 13% year-to-date, may be stuck at the crossroads for a while longer before it's able to follow the company in one direction or the other.

-- Written by Laurie Kulikowski in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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