Fitch Affirms First Horizon National Corporation's IDR at 'BBB-'; Outlook Remains Stable
The rating action follows a periodic review of the midtier regional banking group, which includes BankUnited Inc. (BKU), BOK Financial Corp. (BOKF), Cathay General Bancorp (CATY), East West Bancorp (EWBC), First Republic Bank (FRC), First Horizon National Corp. (FHN), First National of Nebraska Inc. (FNNI), Fulton Financial Corp. (FULT), Hilltop Holdings, Inc. (HTH), Synovus Financial Corp. (SNV), TCF Financial Corp. (TCB), Trustmark Corp. (TRMK), UMB Financial Corp. (UMBF) and Wintrust Financial Corp. (WTFC).
Company-specific rating rationales for the other banks are published separately, and for further discussion of the midtier regional bank sector in general, refer to the special report titled 'US Banks: Midtier Regional Bank Periodic Review,' to be published shortly.
KEY RATING DRIVERS
VRs, IDRs AND SENIOR UNSECURED DEBT
The affirmation of FHN's IDR and VR is driven by the entity's good capital profile, strong banking franchise, and niche capital markets business that caters to smaller, community bank-sized financial institutions. Fitch views FTN Financial (FTN) favorably as it provides good levels of noninterest income and revenue diversity, while assuming low levels of market risk. Today's rating action is also supported by the resolution of significant litigation risk through its 2Q'15 mortgage settlement. Fitch's ratings also incorporate the expectation that FHN will continue working through its nonstrategic assets with manageable credit losses going forward.
At Dec. 31, 2015, FHN reported Basel III Common Equity Tier 1 capital of 10.45% and Tangible Common Equity of 7.82%, both relatively in line with peer medians. Fitch anticipates that capital will continue to come down over time but expects management to maintain sufficient levels of capital relative to its risk profile. FHN is targeting a long-term CET1 target of 8% to 9%, which Fitch views as reasonable relative to the company's current risk profile
Additionally, FHN's deposit gathering capabilities within its core footprint remains strong, accounting for the best deposit market share in the state of Tennessee with 13.7% of total deposits. FHN's strong deposit franchise has translated into lower than peer deposit costs.
Loans within the nonstrategic portfolio totalled $2.0bn through 4Q'15, accounting for a still sizeable 11% of total loans, though down considerably from its peak. Fitch recognizes management's ability to work through the nonstrategic portfolio without outsized credit losses over recent periods. Consolidated NCOs over the last 10 quarters have averaged a manageable 29bps. Fitch expects that nonstrategic balances will continue to decline over time.
FHN has announced various legal settlements associated with its nonstrategic loan portfolio and business line over the past two years. Fitch views the legal settlements as credit positive, removing some of the risk created by its national mortgage lending platform, which has since been discontinued. Moreover, Even with the various one-time settlement charges, the company's capital profile remained good. Fitch believes that much of FHN's legal overhang is now behind it, which should aid in the company generating more consistent earnings as legal costs diminish, resulting in a credit positive over time.
FHN's core business operations include First Tennessee Bank National Association (FTBNA) and FTN, the company's capital markets division. Both FTBNA and FTN continue to perform well and in line with Fitch's expectations. Return on average assets (ROAA) for FTBNA over the last three years has averaged 1.42%. FTN has also been accretive to earnings even as average daily revenue (ADR) for the line has remained well below management's stated long-term target of $1.0 million to $1.5 million.
Despite an expectation that earnings volatility will be less over the near term given the resolution of a significant amount of litigation risk, Fitch considers the company's current level of earnings to be a rating constraint over the near term. Even with solid earnings performance out of its core business lines, overall company earnings lag the peer median due to the presence of the nonstrategic loan book and corporate activities.
Further constraining the company's rating over the near term are elevated levels of nonperforming assets (NPAs). Fitch-calculated NPAs through 3Q'15 totalled 2.50% of loans and other real estate owned (OREO), above the peer average of around 1.50%. Large balances of restructured residential loans originated out of the company's former national lending platform account for the majority of the NPAs. Restructured residential loans are generally difficult to remove from the balance sheet, which is why Fitch expects FHN's NPA ratio to remain elevated relative to peers over the near-to-intermediate time horizon.
FHN continues to exhibit solid liquidity and funding. As mentioned, FHN's funding primarily consists of its large, in foot-print non-interest-bearing deposit base, accounting for nearly 30% of total deposits at 3Q15. FHN also has access to multiple sources of secured borrowing, such as the FHLB. These sources were modestly used at 3Q15 and still have adequate capacity.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
FHN and its operating companies' subordinated debt is notched one level below its VR of 'bbb-' for loss severity. FHN's preferred stock is notched five levels below its VR, two times for loss severity and three times for non-performance. These ratings are in accordance with Fitch's criteria and assessment of the instruments non-performance and loss severity risk profiles.
LONG- AND SHORT-TERM DEPOSIT RATINGS
The uninsured deposit ratings of FHN are rated one notch higher than FHN's IDR and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default.
HOLDING COMPANY
FHN's IDR and VR are equalized with those of its operating company (FTBNA), reflecting its role as the bank holding company, which is mandated in the U.S. to act as a source of strength for its bank subsidiaries. Ratings are also equalized reflecting the very close correlation between holding company and subsidiary failure and default probabilities.
SUPPORT RATING AND SUPPORT RATING FLOOR
FHN has a Support Rating of '5' and Support Rating Floor of 'NF'. In Fitch's view, FHN is not systemically important and therefore, the probability of support is unlikely. IDRs and VRs do not incorporate any support.
RATING SENSITIVITIES
VRs, IDRs AND SENIOR UNSECURED DEBT
Fitch believes there is limited downside risk to FHN's ratings given the company's strong franchise in key operating markets.
While FHN's NPAs are likely to remain elevated relative to peers due to high balances of restructured residential mortgage loans, positive rating momentum could occur if FHN's other credit metrics, namely credit losses and delinquencies, perform better than peers as the credit environment worsens.
Furthermore, higher and more consistent earnings can also lead to positive rating action. Given the company's asset sensitivity, FHN's balance sheet is well positioned for a rising rate environment and may generate higher relative earnings than peers. This is mainly due to 70% of total assets are set to reprice within one year and 67% of total loans are variable rate.
Conversely, negative rating action may occur in the event of material asset quality deterioration. Fitch notes that over the next 24 months 37% of FHN's home equity lines of credit (HELOC) balances still in the draw period are set to convert to fully amortizing loans, which present repayment risk. Though these maturing balances account for just 3% of total loans, Fitch will continue to closely monitor their performance. Should performance of maturing HELOCs materially decline once in repayment, negative rating action could be taken.
Similarly, negative rating action could occur in the event capital is aggressively managed down given management's long-term capital expectations. Fitch views aggressive capital management at FHN unlikely.
Fitch notes that today's ratings action incorporates the view that FHN will be active in the merger and acquisition (M&A) space going forward as the company pursues expansion into neighbouring states and select metropolitan areas that management deem appropriate and in line with FHN's business model. Fitch would analyse any individual transaction for its strategic and financial implications, which may lead to rating changes.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings for FHN and its operating companies' subordinated debt and preferred stock are sensitive to any change to FHN's VR.
LONG- AND SHORT-TERM DEPOSIT RATINGS
The long- and short-term deposit ratings are sensitive to any change to FHN's long- and short-term IDR.
HOLDING COMPANY
Should FHN's holding company begin to exhibit signs of weakness, demonstrate trouble accessing the capital markets, or have inadequate cash flow coverage to meet near-term obligations, there is the potential that Fitch could notch the holding company IDR and VR from the ratings of the operating companies.
SUPPORT RATING AND SUPPORT RATING FLOOR
Since FHN's Support and Support Rating Floors are '5' and 'NF', respectively, there is limited likelihood that these ratings will change over the foreseeable future.
Fitch affirms the following ratings:
First Horizon National Corporation
--Long-term IDR at 'BBB-'; Outlook Stable;
--Viability at 'bbb-';
--Short-term IDR at 'F3';
--Senior Unsecured at 'BBB-';
--Preferred Stock at 'B';
--Support at '5';
--Support Floor at 'NF'.
First Tennessee Bank, N.A.
--Long-term IDR at 'BBB-'; Outlook Stable;
--Viability at 'bbb-';
--Short-term IDR at 'F3';
--Long-term Deposits at 'BBB';
--Short-term Deposits at 'F3';
--Senior Unsecured at 'BBB-';
--Subordinated Debt at 'BB+';
--Preferred Stock at 'B';
--Support at '5';
--Support Floor at 'NF.
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