First Horizon National Corporation (FHN) — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. FHN operates regional banking, fixed income, corporate, and non-strategic businesses. Unless noted, amounts below are in millions of dollars.
Financial performance and condition
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $333.7 | $288.7 | $961.9 | $872.2 |
| Net interest income | $185.2 | $163.6 | $533.5 | $487.1 |
| Noninterest income | $148.5 | $125.1 | $428.4 | $385.1 |
| Provision for loan losses | $4.0 | $1.0 | $11.0 | $8.0 |
| Noninterest expense | $233.6 | $215.4 | $687.3 | $810.1 |
| Net income | $67.6 | $63.3 | $180.8 | $45.9 |
| Net income available to common shareholders | $63.2 | $58.8 | $167.6 | $32.6 |
| Diluted EPS | $0.27 | $0.25 | $0.71 | $0.14 |
- Net interest margin was 2.96% in Q3, up from 2.85%; the nine-month margin was 2.92%, versus 2.84%. Management attributed improvement to loan growth, the prior December Fed rate increase, lower long-term funding costs, and lower excess cash balances.
- At September 30, total assets were $28.4 billion, loans $19.6 billion, deposits $21.6 billion, and total equity $2.7 billion. Loans rose from $16.7 billion a year earlier, driven mainly by commercial growth, the 2015 TrustAtlantic acquisition, and the GE Capital loan purchase.
- Cash and cash equivalents were $1.16 billion. For the nine months, operating cash flow was negative $259.6 million and investing cash flow negative $1.55 billion; financing cash flow was positive $1.94 billion, principally reflecting deposit growth and increased short-term borrowings. A $165 million qualified pension contribution was a major operating cash use.
- Term borrowings were $1.07 billion, down from $1.34 billion a year earlier. Other short-term borrowings were $792.7 million, versus $99.9 million a year earlier. Period-end deposits increased from $18.9 billion to $21.6 billion.
- FHN’s Common Equity Tier 1, Tier 1, total capital, and Tier 1 leverage ratios were 9.81%, 11.03%, 12.09%, and 9.52%, respectively. Ratios declined year over year, largely as risk-weighted assets grew; management said FHN and its bank subsidiary remained well-capitalized.
- Credit quality improved overall: nonperforming assets were $173.5 million versus $217.2 million; nonperforming loans were 0.78% of loans versus 1.10%; and annualized net charge-offs were 0.05% versus 0.28%. The allowance was $201.6 million, or 1.03% of loans, compared with $210.8 million, or 1.26%.
Material changes and drivers
- Q3 revenue rose 16% year over year, while nine-month revenue rose 10%. Higher net interest income and fixed income product revenue were the principal drivers. Fixed income product revenue increased 37% in Q3 and 30% year to date, reflecting stronger market conditions, particularly in agency and mortgage products.
- Q3 noninterest expense increased 8%, largely due to personnel costs, including higher fixed-income variable compensation and regional-bank hiring and retention costs. Nine-month expense fell 15%, primarily because 2015 included substantial DOJ/HUD-related legal accruals.
- FHN reversed $31.6 million of mortgage repurchase and foreclosure provision in the first nine months of 2016, mainly following settlements of repurchase claims. This materially benefited year-to-date expense and earnings.
- FHN acquired $537.4 million unpaid principal balance of GE Capital restaurant-franchise loans in September 2016, establishing a franchise-finance specialty business. After quarter-end, FTN Financial announced a proposed approximately $160 million cash acquisition of Coastal Securities, expected to close in early 2017 subject to approvals and other conditions.
Outlook, risks, contingencies, and unusual items
- Management gave no specific earnings guidance. It expected near-term asset-quality trends to remain relatively stable if modest economic growth continues. Its interest-rate sensitivity analysis estimated a favorable 4.8% change in next-12-month net interest income for an instantaneous 100-basis-point rate increase, and an unfavorable 2.1% change for a 25-basis-point decrease. These are modeled scenarios, not forecasts.
- Management noted that low rates constrain margin expansion; future NIM depends partly on Fed actions and balances of interest-bearing cash and trading inventory. It also cited economic, housing, yield-curve, competitive, regulatory, and technology uncertainties.
- FHN recorded $39.9 million of liabilities for material litigation contingencies. It estimated reasonably possible losses beyond established liabilities for material matters could range from zero to approximately $70 million. A former mortgage subservicer separately demanded $43.5 million; FHN disputes the demand and has made no payment.
- The legacy mortgage repurchase and foreclosure liability was $67.6 million, down from $115.5 million a year earlier. The related active claims pipeline was $52.1 million versus $173.2 million. Estimates remain uncertain; FHN disclosed limited visibility into some legacy loan performance after servicing transfers.
- FHN had a proposed settlement in a debit-card overdraft sequencing class action, subject to court approval. A separate potential insurance recovery connected with the 2015 $212.5 million DOJ/HUD settlement is reasonably possible but not considered probable by management.
- FHN said it expected to adopt CECL under ASU 2016-13 in 2020 and noted the resulting allowance could be larger than under the incurred-loss method, with the effect dependent on portfolio and economic conditions. Adoption of ASU 2016-09 was estimated to increase 2017 tax expense by $1–$2 million.
- FTBNA’s dividend capacity without prior regulatory approval was negative $156.2 million at quarter-end. It received OCC approval for specified 2016 dividends to FHN; parent-company liquidity depends substantially on subsidiary dividends and regulatory restrictions.
Most important facts for investors to verify
- Whether improved earnings are repeatable without the $31.6 million mortgage-provision reversal and unusually high 2015 legal expenses.
- Loan-growth quality and concentration: financial-services-related borrowers represented 39% of C&I loans; loans to mortgage companies were $2.5 billion, and FHN added the GE franchise portfolio.
- Trends in nonperforming and potential-problem assets, charge-offs, and the allowance as commercial lending expands and legacy consumer portfolios run off.
- Development of legacy mortgage claims, the $67.6 million reserve, the $52.1 million active pipeline, and the disclosed possible litigation-loss range.
- Funding mix, the increase in short-term borrowings, regulatory limits on bank-to-parent dividends, and capital ratios as risk-weighted assets grow.
- Coastal Securities acquisition approvals, closing conditions, and final purchase price and integration impact.