First Horizon National Corporation — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010; comparisons are with the corresponding 2009 periods unless stated otherwise. The registrant is First Horizon National Corporation.
Business context and financial results
First Horizon operates regional banking, capital markets, corporate and non-strategic businesses. Its strategy included shrinking legacy mortgage, construction lending and other non-strategic portfolios while emphasizing regional banking and capital markets.
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net interest income | $186.1 million | $190.9 million | $548.6 million | $586.6 million |
| Provision for loan losses | $50.0 million | $185.0 million | $225.0 million | $745.0 million |
| Noninterest income | $248.2 million | $302.1 million | $744.7 million | $1,008.6 million |
| Noninterest expense | $347.6 million | $348.2 million | $1,032.3 million | $1,181.5 million |
| Net income (loss) | $33.7 million | $(35.0) million | $44.3 million | $(205.6) million |
| Net income (loss) available to common shareholders | $15.9 million | $(52.9) million | $(9.1) million | $(258.8) million |
| Diluted EPS available to common shareholders | $0.07 | $(0.23) | $(0.04) | $(1.12) |
Q3 total revenue was $434.4 million, down 12% year over year. Consolidated net interest margin improved to 3.23% from 3.14%; average earning assets fell 5% to $23.0 billion. The filing reports Q3 return on average assets of 0.52% and return on average common equity of 2.86%, versus negative 0.52% and negative 9.02%, respectively, in Q3 2009.
Financial position, credit and liquidity
- Balance sheet at September 30: assets were $25.4 billion, down from $26.5 billion a year earlier; loans net of unearned income were $17.1 billion, versus $18.5 billion; net loans were $16.3 billion. Deposits were $15.0 billion, compared with $14.2 billion. Total equity was $3.3 billion.
- Allowance and credit quality: allowance for loan losses was $719.9 million, or 4.22% of loans, compared with $944.8 million and 5.10% a year earlier. Q3 net charge-offs were $111.4 million; the annualized net charge-off ratio declined to 2.63% from 4.24%. Nonperforming assets declined to $919.2 million from $1.22 billion, but nonperforming commercial and permanent-mortgage loans increased in some portfolios. Troubled debt restructurings rose to $253.7 million from $67.6 million.
- Funding and cash flows: cash and cash equivalents were $934.2 million at quarter-end. For the nine months, operating cash flow was $137.8 million, investing cash flow was $1.14 billion and financing cash flow was negative $1.26 billion; cash increased $15.6 million. Long-term debt was $2.81 billion, down from $3.08 billion a year earlier. Short-term borrowings and commercial paper were $193.4 million, down from $1.74 billion.
- Regulatory capital: FHN reported a 17.34% Tier 1 capital ratio and 21.97% total capital ratio at September 30, 2010. Management said FHN and its bank subsidiary met capital adequacy requirements and were well capitalized.
Changes versus prior period and unusual items
- Q3 earnings improved substantially, mainly because loan-loss provision expense fell $135.0 million. Nine-month common-shareholder losses also narrowed significantly, though the company remained loss-making on that basis.
- Revenue weakened: capital markets income declined as unusually favorable 2009 fixed-income markets normalized; mortgage banking income and servicing fees fell with the smaller servicing portfolio; deposit-related fees were affected by overdraft policy changes and Regulation E.
- Repurchase and foreclosure provision reached $48.7 million in Q3, up $24.6 million year over year. The repurchase and foreclosure reserve was $177.6 million, versus $63.9 million a year earlier. The active repurchase and mortgage-insurance cancellation pipeline was $469.0 million at quarter-end.
- FHN exited its institutional equity research business in February 2010 after a contracted sale failed to close. The exit included a $3.3 million goodwill impairment and other closure costs; discontinued operations produced a $6.9 million loss for the first nine months.
- Adoption of revised variable-interest-entity accounting consolidated additional mortgage trusts. It reduced opening retained earnings by approximately $10.6 million and brought related restricted loans and borrowings onto the balance sheet.
Outlook, risks and contingencies
- Management expected asset-quality trends to improve through the remainder of 2010 if current performance continued, and expected Q4 loan-loss provision to be relatively stable. It cautioned that trust-preferred and bank-related commercial loans could deteriorate, and that income-producing commercial real estate could remain stressed, with net charge-offs potentially increasing in 2011. These are management expectations, not formal earnings guidance.
- Management identified weak loan demand, low interest rates, housing and commercial-property conditions, unemployment, regulatory change, and mortgage repurchase claims as important uncertainties. It said the three-year cumulative loss position was negative evidence for deferred-tax-asset realization, but concluded the $294 million net deferred tax asset was more likely than not to be realized.
- Mortgage matters include GSE repurchase and make-whole claims, mortgage-insurance cancellations, and three investor lawsuits alleging deficiencies in securitization offering documents. FHN said it could not estimate a probable loss or range for those lawsuits and had established no reserve for that exposure. A separate $28.9 million unpaid-principal-balance branch-sale repurchase dispute was in arbitration; only an immaterial reserve was recorded.
- Foreclosure-practice reviews were ongoing at the subservicer; potential delays, costs and legal or compliance effects were not estimable, and no reserve was established. FHN also disclosed SEC Wells notices concerning alleged conduct related to Sentinel Management Group; no material developments had occurred since its prior quarterly filing.
- The Dodd-Frank Act and potential U.S. implementation of Basel III could increase compliance costs and capital or liquidity requirements. FHN said U.S. effects were not yet known. Its bank subsidiary could not pay common dividends to the parent without regulatory approval; the parent declared a stock dividend for January 2011. The CPP also restricts common cash dividends and share repurchases.
Most important facts for investors to verify
- Whether the sharp decline in loan-loss provisions and charge-offs is sustainable, especially given rising problem loans in certain commercial and mortgage categories.
- How the $469.0 million repurchase and PMI-cancellation pipeline develops, whether the $177.6 million reserve is adequate, and whether securitization litigation results in estimable exposure.
- Whether the $294 million deferred tax asset is ultimately realizable and how future taxable income supports that assessment.
- Progress and costs from subservicer foreclosure reviews, regulatory changes, and any resulting delays or liabilities.
- Core deposit trends, loan demand, capital and liquidity requirements, and the timing or feasibility of any future cash dividend.
All figures are reported amounts; the filing states interim results are not necessarily indicative of future performance.