Following First Horizon National Corp.’s (FHN) announcement that it expects to incur a huge charge for beefing up its mortgage repurchase reserves in the second quarter, Fitch ratings downgraded the issuer-default rating (:IDR) of the company and its lead bank, First Tennessee Bank, N.A. yesterday. Also, the agency has put the rating on a negative watch.
Long-term IDR of First Horizon as well as First Tennessee Bank now stands at 'BBB,' down from the previous rating of 'BBB+.'
Rationale Behind the Downgrade
The ratings downgrade from Fitch comes after First Horizon revealed that it would take a pre-tax charge of $250 million for mortgage repurchases in the second quarter. The company will boost its mortgage repurchases reserve to meet repurchase demands from two government-sponsored entities (GSEs), Fannie Mae and Freddie Mac.
The amount significantly outstrips the prior three-quarter average of $50 million. It is also well ahead of the rating agency’s expectations. The hefty charge would likely result in the company reporting a loss for the full year 2012. However, the agency noted that even without such charges the company’s profit has been low for the recent quarters as compared to its peers who are rated similarly.
Within a short period, the rating agency will review all the ratings of First Horizon. Its ability to reinstate profitability measures will be of key importance in such a review. Private label put-back risk will also be a crucial factor in the review.
Notably, at the end of the first quarter, First Horizon’s reserves stood at $161 million. For meeting repurchase activity in the second quarter, around $60 million is expected to be realized by First Horizon as losses. Therefore, at the end of the second quarter, the company’s mortgage repurchase reserve is likely to stand at $351 million.
We believe the rating downgrade will adversely affect its position with respect to its credit worthiness. Also, First Horizon’s mortgage repurchase expense will continue to remain an overhang in the quarters ahead.
As a matter of fact, though the company sold its mortgage origination and servicing platforms in 2008, it still bears the liability for the conforming conventional mortgage loans purchased by the GSEs from First Horizon which were originated over many years till 2008. Hence, concern regarding this exposure remains.
Earlier in June, PNC Financial Services Group Inc. (PNC) also announced that it will boost its residential mortgage repurchase reserves by around $350 million in the second quarter of 2012. The decision stemmed from the company’s experience of recently elevated levels of GSE-related repurchase demands. The mortgages were mostly originated by National City Corp., which was acquired in 2009.
Moreover, for First Horizon, shrinking revenue base, low interest rate environment and regulatory issues amidst a protracted economic recovery will continue to serve as headwinds. Yet, cost containment efforts, solid capital position and share buyback activities are viewed positively by the investors.
First Horizon shares maintain a Zacks #3 Rank, which translates into a short-term Hold recommendation. Considering the fundamentals, we also maintain our long-term Neutral rating on the stock.Read the Full Research Report on FHN
More From Zacks.com