First Horizon National Corporation — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; comparative results are for the same 2017 periods unless noted. First Horizon is a regional bank and fixed-income business operating primarily in the southeastern United States. Results and balance-sheet comparisons were significantly affected by its November 2017 acquisition of Capital Bank Financial Corporation (CBF).
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $654.7 million | $322.2 million | $1.530 billion | $957.3 million |
| Net interest income | $305.7 million | $209.8 million | $917.8 million | $600.2 million |
| Net income | $274.7 million | $71.8 million | $455.7 million | $225.4 million |
| Net income available to common shareholders | $270.3 million | $67.3 million | $442.5 million | $212.2 million |
| Diluted EPS | $0.83 | $0.28 | $1.35 | $0.90 |
| Net interest margin | 3.44% | 3.19% | 3.47% | 3.06% |
- Revenue growth reflected higher net interest income, CBF-related balance growth and a $212.9 million pretax gain from selling the remaining Visa Class B shares. The Visa gain was recorded in Q3 and substantially boosted reported earnings.
- Net interest income rose 46% for the quarter and 53% year to date, supported by acquired loans and deposits, loan accretion and higher short-term rates. Q3 net interest spread was 3.12%, up from 2.96%.
- Noninterest expense rose 24% to $294.0 million for the quarter and 39% to $940.1 million year to date. Drivers included CBF-related costs, higher personnel expense and operating costs. Nine-month 2017 expense benefited from a $22.6 million mortgage repurchase and foreclosure provision reversal.
- Return on average assets was 2.72% in Q3 and 1.52% year to date; return on average common equity was 25.41% and 14.13%, respectively. These figures include the unusual Visa gain.
Balance sheet, credit, capital and liquidity
- At September 30, 2018, total assets were $40.6 billion, compared with $41.4 billion at year-end 2017. Loans were $27.35 billion versus $27.66 billion; deposits were $31.01 billion versus $30.62 billion.
- Total equity was $4.74 billion. Available-for-sale securities were $4.61 billion; accumulated other comprehensive loss widened to $437.6 million, largely reflecting unrealized securities losses as rates rose.
- Allowance for loan losses was $186.0 million, down from $189.6 million at year-end, or 0.68% of loans. Q3 annualized net charge-offs were 0.02%. Nonperforming loans were $146.4 million, and nonperforming assets were $177.8 million, or 0.63% under the filing’s measure. The NPL-to-loans ratio was 0.54%.
- Credit quality was described as strong overall, though consumer real estate delinquencies and nonperforming loans increased from year-end, and credit card and other net charge-offs were higher year over year. Management noted the C&I portfolio’s exposure to financial services: finance and insurance plus mortgage-company lending represented about 30% of C&I loans.
- Regulatory ratios at September 30 were 9.84% common equity tier 1, 10.86% tier 1, 12.02% total capital and 9.21% tier 1 leverage. The company and bank met well-capitalized thresholds.
- Liquidity indicators included $1.44 billion of cash and cash equivalents and $2.2 billion of available FHLB borrowing capacity. The loan-to-core-deposit ratio was 100%. Deposits were the primary funding source.
- For the first nine months, operating cash flow was negative $130.8 million, investing cash flow was positive $1.35 billion and financing cash flow was negative $1.22 billion; cash and cash equivalents declined $8.8 million. The filing attributes operating outflows in part to purchases of loans held for sale and financing outflows primarily to reduced short-term borrowings.
Changes, outlook and risks
- CBF contributed approximately $7.3 billion of acquired loans and $8.1 billion of deposits. Integration activities were substantially completed in Q2 2018; reported expenses included $82.1 million of CBF merger and integration costs for the first nine months.
- FHN sold approximately $120 million of acquired subprime auto loans because they did not fit its risk profile, and sold $55.5 million of trust preferred loans in Q3. It also divested two branches under commitments related to the CBF merger review.
- No specific earnings or revenue guidance is provided. Management expected asset quality to remain relatively stable near term if economic growth continued. It described the balance sheet as moderately asset-sensitive: simulated rate increases benefited projected net interest income, while declines and a flatter curve were adverse. Faster-than-assumed deposit-cost increases could reduce the benefit of rising rates. Fixed-income revenue was pressured by a flattening yield curve, expected rate increases and low market volatility.
- Legacy mortgage exposures remain uncertain. FHN had $32.8 million of liabilities for material litigation contingencies and estimated additional reasonably possible losses above recorded liabilities of zero to approximately $20 million; some matters could not be reasonably estimated. Separately, the mortgage repurchase and foreclosure liability was $32.5 million and the active pipeline was $10.0 million.
- A former subservicer demanded $43.5 million for servicing-related costs; FHN disputes the demand and had made no payment. Nationstar/Mr. Cooper also asserted indemnification claims that FHN could not estimate. The filing warns that ultimate losses on legacy matters could exceed recorded amounts.
- The Visa-related derivative liability was $34.2 million at quarter-end and remains linked to the timing and outcome of Visa covered litigation, despite the sale of the shares. FHN noted a preliminary settlement for one plaintiff class remained subject to court approval and other litigation remained unresolved.
- FHN was evaluating the upcoming credit-loss standard (CECL). It estimated adoption of the lease standard would add approximately $185 million of lease assets and $195 million of lease liabilities, with an estimated $3 million after-tax increase in retained earnings; these estimates could change.
Investor verification priorities
- Separate recurring earnings from the $212.9 million Visa gain and assess the Visa derivative’s exposure to settlement assumptions and timing.
- Review CBF integration costs, acquisition-related expense savings, loan accretion and the sustainability of net interest margin gains as deposit costs reprice.
- Track credit performance, especially consumer real estate delinquencies, credit card charge-offs, C&I financial-services concentrations and allowance coverage.
- Assess the adequacy of legacy mortgage reserves and the possible effects of pending litigation, servicing indemnities and other unquantified claims.
- Monitor capital and liquidity, including the effect of dividends and repurchases, securities valuation losses and short-term funding changes.