The much-feared phrase "rising interest rates" tends to be the brain-dead default explanation favored by many business journalists when a stock inexplicably heads south on a given day, but today that shadowy fear became very real for regional banking company First Tennessee National Corp.(NYSE: FTN).
Last night, the Memphis-based company announced that an expected continued rise in interest rates will negatively impact the firm's mortgage business this year, resulting in lower than expected Q1 and full-year 2000 earnings. In response, First Tennessee's share price came falling down like a house of cards with the stock losing more than 25% of its value this morning.
Combing through the numbers, First Tennessee is now forecasting Q1 EPS between $0.28 and $0.31 (including an estimated $5 million loss from mortgage securities held for sale), lower than last year's $0.40 and below the First Call mean estimate of $0.41. For the year, EPS is seen growing 8% to 10% from the newly restated 1999 result of $1.85, down from the 13% growth forecasted from the previously reported 1999 earnings base of $1.91. An accounting change for mortgage loans held for sale in Q4 was the reason for the 1999 restatement.
The mortgage business is more of a revenue river than a revenue stream for First Tennessee's fee-heavy business model, representing 57% of total non-interest income in 1999. In fact, mortgage banking income has topped the firm's net interest income from plain-vanilla banking activities by an average of 6% over the past two years as well. First Tennessee makes money from mortgages in several ways, from origination to securitization to servicing. But despite operating what is considered by many to be a low-cost operation, interest rate flux can buffet all of these income-producing opportunities.
Investors following First Tennessee over the past year have gotten a glimpse of how rising rates can knock the mortgage business around. From a recent high of $183 million in Q4 of 1998, quarterly mortgage banking income sank to $141 million by Q4 of 1999. Over the same span, 30-year fixed rate mortgage contract rates moved up from 6.9% to 7.8%, according to figures from the Mortgage Bankers Association of America (MBAA). With the MBAA currently forecasting mortgage rates to hit 8.5% before the end of this year, lower quarterly mortgage banking income for First Tennessee was a given in 2000.
Why this effect wasn't factored properly in First Tennessee's market valuation before today is an interesting question. Yesterday, the company was trading at 12 times non-restated trailing earnings -- a premium to the trailing P/E ratios of comparable asset-sized banks Compass Bancshares(Nasdaq: CBSS) and M&T Bank(NYSE: MTB) -- despite the mortgage-related risk. With today's share price drop and restatement, the trailing P/E's of all three banks are almost exactly the same. Considering the different risk profiles and value drivers of the three, deciding whether this multiple parity is justified or not is the first question investors looking at First Tennessee today should address.
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