NEW YORK (TheStreet) -- First Horizon National Corp. (FHN) continues to work through its legacy mortgage mess, but when short-term interest rates eventually begin to rise, the company should see a major improvement in earnings, according to Credit Suisse analyst Nick Karzon.
First Horizon of Memphis, Tenn., had $24.2 billion in total assets as of Sept. 30, with 170 branches in Tennessee, as well as 21 FTN Financial Group offices in the U.S. and Hong Kong.
Before the housing crisis that began during 2007 and crested during 2008, First Horizon had developed a national mortgage business, which included the purchase of newly originated loans from community banks, and the packaging of loans into mortgage-backed securities (MBS).
The company in 2008 sold its national mortgage lending platform and closed its national consumer lending operations, while changing its strategy to focusing on its traditional markets in Tennessee.
The company reported a third-quarter net loss to common shareholders of $107.5 million, or 45 cents a share, compared to earnings of $40.8 million, or 17 cents a share, the previous quarter, and $25.8 million, or 10 cents a share, a year earlier. The third-quarter loss was driven by a $200 million provision for mortgage repurchases reserves, following a settlement of mortgage putback claims with Fannie Mae (FNMA).
First Horizon's mortgage putback reserves totaled $293 million as of Sept. 30.
Karzon expects First Horizon to make further settlements with the Department of Housing and Urban Development over loans insured by the Federal Housing Administration, as well as settling private label MBS loss claims, which will include a settlement with the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac (FMCC).
"While significant uncertainty remains, we estimate these could result in $390M in pre-tax losses over the next 12-18 months (although timing remains uncertain). In order to offset the capital impact, we believe FHN is likely to sell its Visa (V) Class B shares (currently held at $0), which would provide a $92M pre-tax offset (using the current conversion rate)," Karzon wrote in a note to clients on Friday.
First Horizon reported a tangible common equity ratio of 9.69% as of Sept. 30.
"We estimate future settlements and [a] Visa share sale will have a net negative impact of ~95bps to FHN's Tier 1 Common ratio and ~$0.78 to [tangible book value per share]," according to Karzon. Under Credit Suisse's estimate loss scenario, First Horizon's estimated Basel III Tier 1 common equity ratio would remain "toward the high end of FHN's targeted range of 8-9% with our loss estimates," he wrote.
Leaving aside the third-quarter loss, First Horizon reported returns on average common equity ROE) ranging from 7.20% to 7.48% over the previous three quarters. The company's goal in the current short-term environment is to bring its ROE to a range of 8% to 12% in the "low rate environment." The company's long-term ROE target is 15% to 20%, which "would require a normal interest rate environment," according to Karzon.
Most of the media coverage of Federal Reserve economic stimulus policy centers around the expected "tapering" of the central bank's "QE3" purchases of long-term bonds, which have been running at a net $85 billion each month since September 2008. The incredible expansion of the central bank's balance sheet is meant to hold long-term interest rates down. The market yield on 10-year U.S. Treasury bonds was 2.77% Friday morning, increasing from 1.70% at the end of April, as investors have anticipated a curtailment of Fed bond buying.