FIRST HORIZON CORP quarterly report, Q3 FY2012

First Horizon National Corporation — Q3 2012 Form 10-Q

Business context and period. First Horizon is a regional banking and capital-markets company, operating primarily through First Tennessee and FTN Financial. This unaudited filing covers the quarter and nine months ended September 30, 2012; comparisons are with the same 2011 periods.

Financial performance and condition

Metric	Q3 2012	Q3 2011	Nine months 2012	Nine months 2011
Total revenue	$337.0 million	$397.2 million	$1.043 billion	$1.127 billion
Net interest income	$173.5 million	$176.3 million	$518.1 million	$522.0 million
Provision for loan losses	$40.0 million	$32.0 million	$63.0 million	$34.0 million
Noninterest expense	$263.2 million	$322.7 million	$1.112 billion	$981.0 million
Net income (loss) available to common shareholders	$25.8 million	$36.1 million	$(68.4) million	$96.3 million
Diluted EPS available to common shareholders	$0.10	$0.14	$(0.27)	$0.37

• Q3 net interest margin was 3.15%, down from 3.23%. Management expected it to remain flat or decline slightly in Q4, citing historically low rates and pressure on reinvestment yields.
• At September 30, total assets were $25.74 billion; loans before allowance were $16.52 billion and net loans $16.24 billion. Deposits were $16.23 billion. Cash and cash equivalents were $885.7 million.
• The allowance for loan losses was $281.7 million, down from $449.6 million a year earlier. Nonperforming assets were $450.4 million versus $582.6 million; the nonperforming-loan ratio was 1.85% versus 2.55%.
• Nine-month cash flows: operating activities provided $112.4 million, investing activities used $339.8 million, and financing activities provided $284.8 million. Cash and cash equivalents increased $57.4 million to $885.7 million.
• Term borrowings were $2.26 billion; other short-term borrowings were $857.0 million, and federal funds purchased and repurchase-agreement liabilities were $1.79 billion. Shareholders’ equity was $2.24 billion; total equity including noncontrolling interest was $2.53 billion.
• Regulatory capital ratios at September 30: Tier 1 capital 13.15%, total capital 15.99%, and Tier 1 common 10.69%. The company reported that it and its bank subsidiary qualified as well-capitalized.

Material changes versus comparable periods

• Q3 revenue declined 15%, largely because 2011 included a $35.1 million Visa-share gain and capital-markets revenue weakened. Net interest income also slipped, as lower asset yields outweighed lower deposit costs and loan growth.
• Q3 expense fell 18%, primarily because no repurchase-and-foreclosure provision was recorded in the quarter, compared with $52.8 million in Q3 2011. For the first nine months, however, that provision rose to $299.3 million from $114.6 million and drove much of the increase in total expense and the year-to-date loss.
• Q3 loan-loss provision increased to $40 million, including about $30 million attributed to new regulatory guidance on secured loans discharged in bankruptcy. The guidance also drove approximately $40 million of Q3 charge-offs; many affected loans were current when classified as nonperforming.
• Capital-markets and regional-banking performance weakened in Q3. For the nine-month period, capital-markets pretax income improved, but the non-strategic segment’s pretax loss widened substantially, principally reflecting the mortgage repurchase provision.
• Mortgage servicing rights declined to $120.5 million from $150.8 million a year earlier, and the serviced mortgage balance was about $20 billion versus $25 billion.

Outlook, risks, contingencies, and unusual items

• Management anticipated continued, but slower, asset-quality improvement if economic conditions remained stable or improved. It cautioned that housing weakness, unemployment, low rates, and borrower conditions could weigh on credit costs and loan demand.
• In October 2012, FHN announced a voluntary severance program and estimated Q4 2012 restructuring charges of $20–$25 million, largely severance costs.
• The mortgage repurchase liability was $293.5 million at September 30, up from $171.4 million a year earlier. The active repurchase and mortgage-insurance pipeline was $446.3 million. Management said the remaining liability was expected to cover projected GSE losses absent significant changes in GSE practices or outcomes; estimates remain sensitive to claims, loss severities, and review practices.
• Mortgage-securitization investor lawsuits remain a material uncertainty. The filing estimated reasonably possible litigation losses in excess of established liabilities of up to approximately $90 million for certain estimable matters; some securitization claims were excluded because the company could not estimate a range. Separately, $29 million of litigation liabilities had been established. A potential insurance recovery tied to the Sentinel settlement was not considered probable.
• The former mortgage subservicer sought $8.9 million for certain costs and $34.8 million for foreclosure-review expenses; FHN disputed responsibility. Management also described ongoing foreclosure-process scrutiny and possible additional operating, legal, and servicing costs.
• FHN reported a net deferred tax asset of approximately $250 million and concluded realization was more likely than not, while maintaining an $8 million valuation allowance for certain state tax-loss carryforwards.
• FHN stated that its bank subsidiary could not pay dividends to FHN or preferred shareholders without prior regulatory approval, given its regulatory dividend capacity. The company paid a $0.01-per-share dividend in October and approved another $0.01 dividend for January 2013.
• Other risks cited include regulatory changes, including proposed Basel III-related capital rules, interest-rate and market exposure, mortgage servicing and foreclosure requirements, and possible changes in GSE repurchase practices.

Most important facts for investors to verify

• Whether the $293.5 million mortgage repurchase reserve proves sufficient as claims and GSE review practices evolve, and how pipeline resolutions compare with new claims.
• How much of the Q3 consumer credit deterioration reflects the bankruptcy-related regulatory guidance versus underlying borrower performance.
• Whether net interest margin stabilizes as management anticipated, given low rates and pressure on reinvestment yields.
• The potential financial range and timing of mortgage-securitization litigation and subservicer disputes, including matters for which FHN could not estimate a loss range.
• Capital, liquidity, and dividend flexibility, including the impact of regulatory requirements and the bank subsidiary’s restricted dividend capacity.