First Horizon National Corporation — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. First Horizon operates regional banking and fixed income businesses, alongside corporate and non-strategic portfolios. Unless stated otherwise, financial amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income | $209.8 million | $185.2 million | $600.2 million | $533.5 million |
| Noninterest income | $112.4 million | $148.5 million | $357.0 million | $428.4 million |
| Noninterest expense | $236.9 million | $233.6 million | $677.0 million | $687.3 million |
| Net income | $71.8 million | $67.6 million | $225.4 million | $180.8 million |
| Net income available to common shareholders | $67.3 million | $63.2 million | $212.2 million | $167.6 million |
| Diluted EPS | $0.28 | $0.27 | $0.90 | $0.71 |
- Total revenue was $322.2 million for Q3 and $957.3 million year to date. Net interest margin rose to 3.19% for Q3 and 3.06% year to date, from 2.96% and 2.92%, respectively, in 2016.
- Income tax expense was $13.6 million for Q3 and $57.9 million year to date; effective tax rates were approximately 16% and 20%, versus 30% and 31% in 2016. The reduction chiefly reflected reversal of a valuation allowance related to a federal capital-loss carryforward.
- At September 30, total assets were $29.6 billion, loans net of unearned income were $20.2 billion, deposits were $22.1 billion, and total equity was $2.9 billion. Compared with December 31, 2016, loans grew about 3%, assets about 4%, and deposits declined about 3%.
- Allowance for loan losses was $194.9 million, down from $202.1 million at year-end; nonperforming assets were $140.2 million, down from $164.6 million. The allowance was 0.97% of loans and 1.56 times nonperforming loans. No consolidated loan-loss provision was recorded in Q3; the nine-month provision was a $3.0 million credit.
- Cash and cash equivalents were $1.09 billion at quarter-end, with an additional $604.3 million of interest-bearing cash. Nine-month operating cash flow was negative $305.4 million, investing cash flow negative $266.4 million, and financing cash flow positive $621.8 million. Cash and cash equivalents increased $50.0 million.
- Period-end short-term borrowings were $2.74 billion across federal funds purchased, repurchase agreements, trading liabilities, and other short-term borrowings; other short-term borrowings alone rose to $1.64 billion from $83.2 million at year-end. Term borrowings were $1.06 billion. Management reported $1.4 billion of available FHLB borrowing capacity.
- FHN’s September 30 regulatory ratios were 10.04% common equity Tier 1, 11.20% Tier 1, 12.18% total capital, and 9.60% leverage. The filing states that FHN and its bank subsidiary met well-capitalized standards.
Material changes and notable items
- Higher market rates and regional-bank loan growth lifted net interest income 13% in both the quarter and year-to-date periods. Loan growth was concentrated in commercial lending; average loans rose 6% year over year in Q3.
- Noninterest income declined 24% in Q3 and 17% year to date, principally due to weaker fixed income revenue amid rate increases, a flatter yield curve, and low market volatility. Fixed income pre-tax income fell to $8.7 million in Q3 from $15.1 million, and to $18.1 million year to date from $44.7 million.
- Q3 results included a $14.3 million loss on repurchase of equity securities previously included in a financing transaction, $8.2 million of acquisition and integration expenses, and higher legal loss accruals. Acquisition-related expenses were $14.6 million for the first nine months.
- Expense fell 2% year to date, helped by lower legal loss accruals, personnel costs, and legal fees, partly offset by acquisition costs. Mortgage repurchase provision reversals were $22.6 million year to date, compared with $31.6 million in 2016.
- Regional Banking pre-tax income increased to $114.7 million in Q3 and $329.7 million year to date. Coastal Securities was acquired in April for approximately $131 million cash; the acquisition added $45.0 million of goodwill. FHN also announced a planned Capital Bank Financial acquisition, valued at approximately $2.2 billion at announcement, including about $411 million cash and FHN shares expected to represent approximately 29% of post-merger common shares. Closing was expected in Q4 2017, subject to regulatory and customary conditions.
Outlook, risks, and contingencies
- Management expected near-term asset quality to remain relatively stable if modest economic growth continued. It noted potential variability in commercial credit and risks to commercial real estate from oversupply, weaker property values, or economic uncertainty.
- Management said a continued rise in short-term rates could support net interest margin; a flattening yield curve could pressure it. On a static-balance-sheet simulation, a 100-basis-point rate increase was estimated to improve 12-month net interest income by 4.1%, while a 100-basis-point decrease was not disclosed; the filing gives estimates of a 1.5% decline for a 25-basis-point decrease and 4.4% for a 50-basis-point decrease. These are modeled scenarios, not forecasts.
- Capital Bank integration and execution, market conditions affecting fixed income trading, funding costs and deposit behavior, credit concentrations, and legacy mortgage exposures are material uncertainties. FHN disclosed finance and insurance plus mortgage-company lending equal to 37% of its C&I portfolio.
- Legacy mortgage repurchase and foreclosure liability was $33.9 million at September 30, down from $66.0 million at year-end. The active claims pipeline was $52.9 million. Separately, established liabilities for material litigation matters totaled $8.8 million; estimated reasonably possible losses beyond established liabilities ranged from zero to approximately $52 million. Management cautioned outcomes could exceed these estimates.
- FHN disputed a $43.5 million demand from a former mortgage subservicer and, after quarter-end, received indemnification claims from Nationstar/Mr. Cooper; the filing says the potential exposure for the Nationstar matter could not be estimated. FHN also described investor and underwriter claims concerning legacy securitizations. Possible recovery of up to $75 million under insurance policies related to a prior $212.5 million FHA settlement was a gain contingency; a material gain was not considered probable.
- FHN stated its dividend capacity at the bank subsidiary was restricted and that OCC approval was required for dividends to the parent. The filing also noted tax reform could reduce the value of deferred tax assets if enacted.
Important facts for investors to verify
- Whether the Capital Bank transaction closed on the expected terms and schedule, and its eventual integration costs, synergies, dilution, and capital impact.
- Whether net interest income growth can offset fixed income revenue weakness and higher deposit and wholesale funding costs.
- Trends in commercial credit quality, mortgage-company and financial-sector concentration, and non-strategic consumer portfolios.
- Changes in litigation, indemnification, and mortgage repurchase exposures, including the unquantified Nationstar claims and legacy subservicer demand.
- Regulatory approval and capacity for future bank-to-parent dividends, capital ratios after acquisitions, and liquidity as short-term borrowings increase.
- How much of earnings growth reflects recurring operating performance versus the lower effective tax rate, provision credits, and other unusual items.