First Horizon National Corporation (FHN) — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; unaudited. Comparisons are primarily with the same periods in 2018, or with December 31, 2018 for balance-sheet measures. FHN provides regional banking, wealth management and fixed-income services, principally in the southeastern United States.
Financial results and key metrics
- Revenue and earnings: Q2 revenue was $461.6 million, up 5% year over year. Net income was $113.7 million; net income available to common shareholders was $109.3 million, or $0.35 per diluted share, versus $81.6 million and $0.25 per diluted share in Q2 2018. For the first half, common earnings were $208.4 million, or $0.66 per diluted share, versus $172.2 million and $0.52 per diluted share.
- Interest income and margins: Q2 net interest income was $303.6 million, down 2%; net interest margin was 3.34%, down 19 basis points from 3.53%. Higher deposit costs were the principal pressure, partly offset by loan growth and higher loan accretion. First-half net interest income was $598.1 million, down 2%, and margin was 3.32%, down 16 basis points.
- Fee income and expenses: Q2 noninterest income rose to $158.0 million from $127.5 million, led by fixed-income revenue of $66.4 million versus $37.7 million. Noninterest expense fell 10% to $300.4 million, reflecting lower acquisition/integration costs, cost reductions and an $8.3 million litigation-related expense reversal. First-half noninterest expense declined 8% to $596.5 million.
- Credit costs and asset quality: Q2 loan-loss provision was $13.0 million versus none in Q2 2018; first-half provision was $22.0 million versus a $1.0 million credit. Management attributed the increase mainly to commercial loan growth and specific commercial credit reserves. Allowance for loan losses was $192.7 million, up from $180.4 million at year-end, or 0.65% of loans versus 0.66%. Nonperforming loans increased to $204.6 million from $147.7 million; nonperforming assets rose to $225.7 million from $175.5 million. Q2 net charge-offs were 0.07% of loans.
- Balance sheet and funding: Total assets were $42.2 billion, up from $40.8 billion at year-end. Loans were $29.7 billion, up 8%; deposits were $32.3 billion, down from $32.7 billion. Period-end short-term borrowings increased to approximately $2.9 billion from $1.5 billion; term borrowings were $1.2 billion. Shareholders’ equity was $4.9 billion.
- Cash flow: For the first half, operating activities provided $347.3 million, investing activities used $1.10 billion, and financing activities provided $595.7 million. Cash and cash equivalents decreased $155.6 million to $1.25 billion. Investing outflows were driven principally by loan growth; financing inflows included higher short-term borrowings, partly offset by deposit outflows, share repurchases and dividends.
- Capital and liquidity: FHN’s CET1, Tier 1, total capital and Tier 1 leverage ratios were 9.25%, 10.24%, 11.34% and 9.05%, respectively, down from 9.77%, 10.80%, 11.94% and 9.09% at year-end. The company reported that FHN and its bank subsidiary remained above well-capitalized thresholds and the applicable capital conservation buffer. Available Federal Home Loan Bank borrowing capacity was $4.8 billion. The loan-to-core-deposit ratio was 97%, versus 100% at year-end.
- Shareholder returns: FHN repurchased approximately $105.7 million of shares in the first half and declared common dividends of $0.14 per share each quarter, compared with $0.12 in the comparable 2018 quarter.
Material changes and management commentary
- Improved earnings reflected stronger fixed-income and other fee income and lower expenses, partly offset by lower net interest income and higher credit provisioning. Fixed-income results benefited from falling rates and expectations for rates to remain flat or decline; associated variable compensation also increased.
- Average loans and deposits grew year over year, but period-end deposits declined from December 2018 as market-indexed and noninterest-bearing balances fell. Commercial and industrial loans grew strongly, including mortgage warehouse lending.
- Management described asset-quality trends as broadly stable and expected them to remain relatively stable in the near term if economic conditions remained stable. It noted that C&I credit metrics could be volatile because of individual large credits, while remaining non-strategic consumer and permanent mortgage portfolios were expected to run off.
- Beginning in Q1, FHN launched company-wide efficiency efforts intended to improve profitability and fund technology and revenue-producing investments. First-half restructuring/repositioning charges were $30.8 million; Q2 charges were $18.7 million. Q2 also included $9.1 million of rebranding-related expenses. Management provided no specific earnings or revenue guidance.
- The July 2019 Federal Reserve rate cut was expected to compress net interest margin in the second half, though management noted it could modestly support economic activity. Interest-rate sensitivity analysis estimated favorable 12-month net interest income changes of 0.8% to 4.9% for upward rate shocks of 25 to 200 basis points and unfavorable changes for downward shocks. These are modeled scenarios, not forecasts; deposit pricing and mix assumptions materially affect results.
Risks, contingencies and unusual items
- Credit and concentration risk: Residential real estate represented 21% of loans. Finance/insurance and mortgage-company lending together represented 34% of C&I loans. One mortgage warehouse relationship was partially charged off by $4.0 million and placed on nonaccrual in Q2.
- Legacy mortgage and litigation exposures: FHN reported $24.5 million of liabilities for specified litigation loss contingencies, while stating it could not estimate material reasonably possible losses beyond established liabilities. It settled a mortgage-securitization lawsuit in Q2; payment was expected in Q3 and was expected to reduce those liabilities significantly. The separate repurchase/foreclosure liability was $17.5 million, down from $32.3 million at year-end, including a $12.6 million settlement payment during the first half.
- Other legal matters: FHN is a defendant in a putative class action alleging GSE bond price fixing and is responding to a Florida attorney general information demand. The company could not determine whether material loss was probable or estimate a loss range. It also disclosed unresolved mortgage-related indemnification claims, including claims involving its former subservicer.
- Accounting and market risks: FHN was preparing to adopt CECL, effective in 2020, and said the impact could be material but could not yet be reasonably estimated. LIBOR’s anticipated cessation after 2021 could affect floating-rate instruments and hedge accounting; the financial impact was not yet predictable.
- Other notable changes: Adoption of the new lease standard added approximately $185 million of lease assets and $204 million of lease liabilities at January 1, 2019. In April, FHN sold a subsidiary acquired with Capital Bank, removing approximately $25 million of subprime consumer loans from loans held for sale.
Important facts for investors to verify
- Whether commercial credit deterioration and higher nonperforming loans remain concentrated in a small number of relationships, and how provisioning evolves as loans grow.
- Whether deposit costs, deposit mix and interest-rate changes continue to pressure net interest margin and funding needs.
- How much of the expense decline is sustainable after lower acquisition costs and the Q2 litigation reversal, and whether efficiency initiatives deliver offsetting savings to restructuring and rebranding charges.
- The final payment and liability release from the settled mortgage litigation, and developments in GSE bond, mortgage indemnification and servicing matters.
- The eventual CECL adoption impact, LIBOR transition exposure, and capital and liquidity levels as loan growth and short-term borrowings change.