First Horizon National Corporation — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; interim financial statements are unaudited. Comparisons are with Q1 2011 unless otherwise noted. First Horizon’s principal businesses are regional banking and fixed-income capital markets; its non-strategic segment includes legacy businesses and portfolios being wound down. Dollar amounts below are in U.S. dollars.
Financial performance
| Metric | Q1 2012 | Q1 2011 | Change and context |
|---|---|---|---|
| Total revenue | $374.4 million | $369.1 million | Up $5.3 million, led by capital markets |
| Net interest income | $171.9 million | $172.8 million | Nearly flat |
| Net interest margin | 3.12% | 3.22% | Down 10 basis points |
| Provision for loan losses | $8.0 million | $1.0 million | Higher despite improvement in several credit indicators |
| Noninterest income | $202.4 million | $196.3 million | Capital markets gains offset lower mortgage and deposit fees |
| Noninterest expense | $322.0 million | $313.8 million | Higher personnel and repurchase/foreclosure costs |
| Net income | $33.4 million | $43.0 million | Common-shareholder income was $30.5 million versus $40.2 million |
| Diluted earnings per share | $0.12 | $0.15 | Lower year over year |
| Operating cash flow | $(162.3) million | $(224.8) million | Negative in both periods |
Financial position, capital and liquidity
- At March 31, 2012, total assets were $25.7 billion, total deposits $16.9 billion, loans before allowance $16.0 billion, and total equity $2.7 billion. Total assets were $24.4 billion at March 31, 2011.
- Cash and cash equivalents were $964 million; interest-bearing cash was $761 million, reported separately. The quarter ended with cash and cash equivalents up $136.1 million, supported by $722.2 million of deposit growth and partly offset by operating and investing cash uses.
- Term borrowings were $2.34 billion at quarter-end. Federal funds purchased and repurchase-agreement liabilities totaled $1.80 billion; other short-term borrowings were $181.6 million.
- FHN’s Tier 1 capital ratio was 14.36%, total regulatory capital ratio 17.84%, and non-GAAP Tier 1 common ratio 11.86%. Management said capital remained well above regulatory “well-capitalized” thresholds.
- FHN repurchased $46.6 million of common stock in Q1, including $44.5 million under its buyback program, and declared a $0.01-per-share dividend.
Material changes and credit quality
- Capital markets noninterest income increased to $106.7 million from $90.1 million, reflecting stronger fixed-income trading activity and more favorable market conditions. Segment pretax income rose to $32.2 million from $22.0 million.
- Mortgage banking income fell to $23.3 million from $27.7 million. Mortgage originations declined 54% to $51.3 million, and the serviced first-lien portfolio declined 18.5% to $20.0 billion.
- Deposit transactions and cash-management income declined $3.5 million; management cited the Durbin Amendment’s effect on interchange fees. Regional banking pretax income improved to $74.5 million from $65.7 million, while the non-strategic segment’s pretax loss widened to $44.3 million from $25.1 million.
- The allowance for loan losses was $346.0 million, down 41% from $589.1 million a year earlier; allowance-to-loans ratio declined to 2.17% from 3.69%. Net charge-offs fell to $46.3 million from $76.7 million.
- Nonperforming assets declined to $527.1 million from $819.0 million, and the nonperforming-assets ratio fell to 2.66% from 4.55%. Consumer real-estate nonperforming loans increased, in part because $27.5 million of second liens were classified as nonaccrual following regulatory guidance.
- Portfolio risks remain concentrated in residential real-estate lending: 42% of total loans were secured by residential real estate. Bank-related and trust-preferred loans totaled about $0.6 billion; the filing says weaker financial institutions in this exposure remained under stress.
- Troubled debt restructurings in portfolio loans totaled $303.3 million, up from $285.1 million; related reserves were $49.9 million. Management attributed the increase to modifications intended to prevent foreclosure and mitigate losses.
Outlook, risks and unusual items
- Management expected net interest margin to remain flat or decline slightly in 2012, citing historically low interest rates and pressure on reinvestment yields. It expected credit quality to continue improving if economic conditions remained stable or improved, while noting that the pace of improvement could slow.
- The mortgage repurchase and foreclosure liability was $163.3 million at March 31, 2012. Q1 provision expense was $49.3 million and net realized losses were $53.3 million. The active mortgage-claim pipeline, including mortgage-insurance cancellation notices, was $380.3 million, mostly related to GSE claims. These balances are estimates and outcomes could differ.
- FHN faced mortgage-securitization litigation in which investors claimed purchases of $1.1 billion of certificates; the related cases were at an early stage. FHN had not accrued a liability for these investor claims or for potential repurchases arising from alleged breaches in its proprietary securitizations. The filing describes significant uncertainty about possible outcomes and losses.
- Other disclosed exposures include a potential loss range up to approximately $70 million in a VA-loan guarantee qui tam matter and up to approximately $16 million in a branch-sale arbitration. Management said litigation contingencies were not expected to materially affect consolidated financial condition, but could affect results in a particular period.
- Mortgage-servicing and foreclosure practices remain subject to regulatory scrutiny. FHN disclosed disputed reimbursement demands from a former subservicer of $5.8 million for tax-service contracts and approximately $7.4 million for foreclosure-review costs; FHN disputed responsibility. Additional costs were not estimable.
- FHN reported a net deferred tax asset of approximately $154 million and concluded it was more likely than not to be realized, while identifying its cumulative three-year loss position as significant negative evidence. This judgment depends on expected future taxable income.
- After quarter-end, FHN announced that its common-stock buyback authorization was increased from $100 million to $200 million and extended through January 2013, subject to market conditions. FTBNA had regulatory restrictions on paying dividends to FHN without prior approval; an OCC-approved $100 million dividend was paid to FHN on April 17, 2012.
Important facts for investors to verify
- Whether revenue and capital-markets performance can offset margin pressure, lower mortgage activity, and increased personnel and repurchase-related costs.
- Whether credit-quality improvement continues and whether reserve levels remain adequate as portfolio composition and economic conditions change.
- The development of mortgage repurchase claims, GSE and mortgage-insurance disputes, securitization litigation, and the adequacy of the $163.3 million reserve.
- Whether the $154 million deferred tax asset is realized as projected, given the cumulative-loss history and dependence on future taxable income.
- Capital, liquidity, regulatory dividend restrictions, and the effect of the expanded share-repurchase program on those resources.