FIRST HORIZON CORP quarterly report, Q3 FY2013

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First Horizon National Corporation (FHN) — Q3 2013 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2013. Unaudited consolidated results; comparison is with the corresponding 2012 period unless noted. FHN operates regional banking, capital markets, corporate and non-strategic businesses.

Financial performance and position

  • Q3 earnings: Net loss attributable to common shareholders was $107.5 million, or $0.45 per diluted share, versus net income of $25.8 million, or $0.10 per share. The quarter included a $200 million repurchase and foreclosure provision.
  • Nine-month earnings: Net loss available to common shareholders was $25.6 million, or $0.11 per share, compared with a $68.4 million loss, or $0.27 per share, in 2012.
  • Revenue and margin: Q3 total revenue was $309.3 million, down 8% from $337.0 million. Net interest income was $158.8 million, down 8%; net interest margin was 2.97%, versus 3.15%. Noninterest income was $150.5 million, down from $163.5 million. For nine months, revenue was $929.8 million versus approximately $1.04 billion; net interest income was $480.2 million versus $518.1 million.
  • Expenses and credit costs: Q3 noninterest expense rose 65% to $433.6 million, principally due to the $200 million mortgage repurchase provision. Provision for loan losses was $10 million versus $40 million. Nine-month noninterest expense declined 19% to $901.5 million, while loan-loss provision fell to $40 million from $63 million.
  • Cash flow: In the first nine months, operating activities provided $114.2 million, investing activities provided $1.56 billion, and financing activities used $1.76 billion. Cash and cash equivalents decreased $81.4 million to $1.02 billion.
  • Balance sheet and funding: Total assets were $24.19 billion, down from $25.74 billion a year earlier. Loans were $15.41 billion versus $16.52 billion; deposits were $16.28 billion versus $16.23 billion. Shareholders’ equity was $2.14 billion; total equity, including noncontrolling interest, was $2.43 billion.
  • Debt and liquidity: Term borrowings were $1.77 billion; federal funds purchased were $1.06 billion, repurchase-agreement liabilities $427 million, and other short-term borrowings $304 million. Management described core deposits, securities and access to Federal Reserve, FHLB and market funding as liquidity sources. The loans-to-core-deposits ratio was 96%, down from 102%.
  • Capital: FHN’s Tier 1 capital ratio was 13.26% and total capital ratio 15.59%; Tier 1 common ratio was 10.19%. Management stated FHN and its bank subsidiary qualified as well-capitalized. FHN issued $100 million of Series A preferred stock in Q1 2013, netting about $95.6 million.

Material changes versus the prior comparable period

  • The sharp Q3 earnings reversal principally reflected the new $200 million repurchase and foreclosure provision, alongside lower revenue. Lower loan-loss provision and reduced personnel and litigation-related expenses partly offset the effect.
  • Capital markets noninterest income declined 20% in Q3 and 19% year to date, as fixed-income revenue weakened amid less favorable markets, volatility and rising rates. Regional Banking Q3 pretax income increased to $75.8 million from $70.9 million; Capital Markets pretax income declined to $9.8 million from $21.0 million.
  • Average loans declined 5% in Q3, while average core deposits increased 5%. Total loans fell substantially year over year, reflecting mortgage-company lending declines and runoff of legacy portfolios.
  • Credit indicators were mixed: allowance for loan losses declined 9% to $255.7 million and Q3 net charge-offs fell to $16.2 million from $79.3 million. However, nonperforming assets including nonperforming loans held for sale rose to $482.0 million from $450.4 million; regulatory changes affecting second liens contributed to higher consumer real-estate nonperforming loans.
  • FHN acquired Mountain National Bank in June, adding approximately $452 million of assets before purchase adjustments, including $249 million of loans, and assuming about $362 million of deposits. Purchase accounting was provisional; the assets were acquired at a discount, with no FDIC loss-sharing agreement.

Outlook, management commentary, risks and unusual items

  • Outlook: Management expected net interest margin to remain under pressure in Q4 2013 and into 2014 due to historically low rates and continued pressure on loan yields. It expected asset-quality trends to be relatively stable through the remainder of 2013 and early 2014, subject to continued economic recovery; improvement in C&I credit was expected to slow. Management also said capital ratios should remain strong and above well-capitalized standards.
  • Mortgage repurchase exposure: FHN recorded a $200 million Q3 provision based on expanded loan information obtained in connection with a Fannie Mae resolution agreement. The filing describes the definitive agreement as entered in Q4 2013, after the reporting date; it resolves certain 2000–2008 Fannie Mae claims but excludes specified loans and obligations. The September 30 active claims and mortgage-insurance pipeline totaled $310.7 million. The filing reports a $293.7 million legacy mortgage repurchase liability in its rollforward and cites approximately $295.2 million of reserves in its discussion.
  • Mortgage servicing sale: FHN agreed in Q3 to sell substantially all remaining legacy mortgage servicing and related assets. Transfer was expected in the following months, subject to customary conditions. The agreement affected Q3 mortgage-servicing valuations and hedging results; substantially all first-lien MSR were expected to be derecognized upon completion.
  • Legal and regulatory contingencies: Established litigation liabilities for matters discussed were $21.1 million. For estimable matters, reasonably possible losses above recorded liabilities were estimated at zero to approximately $242 million; other matters, including an FHA-loan investigation and certain securitization claims, were not estimable. Management said the pending litigation was not expected to materially affect consolidated financial condition, but could materially affect results in a particular period.
  • Other material risks: Risks include mortgage repurchase and securitization litigation, FHA-insured loan investigation exposure, foreclosure-servicing costs and disputes with a former subservicer, rate and market sensitivity, housing and economic conditions, and regulatory changes. A subservicer sought $8.6 million for specified costs and $34.9 million for foreclosure-review expenditures; FHN disputed responsibility and had made no reimbursement.
  • Rate sensitivity: Management estimated a 10% favorable 12-month net interest income variance under an immediate +200 basis-point shock, and a 1.5% unfavorable variance under a curve-flattening scenario. These are model-based estimates, not forecasts.
  • Dividends and funding constraints: FHN paid a $0.05 common dividend in October and approved another $0.05 dividend for January 2014. The bank subsidiary’s calculated dividend capacity was negative $201.5 million, so dividends to FHN required prior regulatory approval.
  • Other notable items: Pension benefits were frozen effective year-end 2012, reducing pension expense. FHN repurchased $91.4 million of common shares during the first nine months of 2013 and paid $0.15 per common share in declared dividends during that period.

Important facts for investors to verify

  • Read the subsequent-event and repurchase disclosures for the timing, scope, exclusions and financial consequences of the Fannie Mae agreement, and reconcile the $293.7 million and $295.2 million reserve figures.
  • Track mortgage repurchase claims, Freddie Mac exposure, mortgage-insurance cancellations, the FHA investigation and the stated $0–$242 million range of reasonably possible litigation losses, including matters excluded from that range.
  • Confirm completion and proceeds of the legacy mortgage-servicing sale, the amount of MSR derecognized, and any resulting earnings or servicing-cost changes.
  • Assess whether margin pressure, falling loan balances and weaker capital-markets revenue are offset by deposit growth, expense control and credit improvement; monitor consumer real-estate nonperforming loans and charge-offs.
  • Review capital and liquidity, regulatory limits on subsidiary dividends, future share repurchases and dividends, and sensitivity to interest-rate, housing-market and regulatory developments.