Tuesday, April 03, 2007

Calls of Note Part 4

- Merrill Lynch notes First Horizon National (NYSE:FHN) is the most exposed to deteriorating consumer credit among the mid- and small-cap banks. It has material exposure to the highest risk loan categories. Also, low capital, low reserves and high dividend payout ratio give it little flexibility.

MLCO sees meaningful downside to FHN's shares as their three-pronged valuation methodology (sum-of-the-parts, target P/E and DCF) suggests a theoretical fair value of $31, suggesting 23% downside. Their '07 and '08 estimates are 5% and 11% below consensus respectively, and they view risks skewed to the downside.

The firm is most concerned that on balance sheet credits originated through the retail bank will deteriorate. FHN's residential real estate book is already showing signs of strain. Firm expects further deterioration, given elevated growth and exposure. They also expect deterioration in industry-wide residential construction loans, and FHN is very exposed.

There is also material EPS risk embedded in the mortgage origination unit. The recourse provision for early payment defaults (EPDs) related to sub-prime and/or Alt-A exposure is likely to increase. Moreover, recent issues in these two loan categories could drive a material slowdown in top-line growth. Maintains Sell.

Notablecalls: The stock took a pretty bad hit yesterday, following a warning from MTB. MLCO's comments do nothing to please the bulls, so more downside in store for FHN. Should the stock open down more than a pt, I would not be surprised to see a quick bounce.

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