First Horizon National Corporation (FHN) — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014; comparative periods are 2013. Unaudited consolidated results. Unless noted, financial amounts below are in millions.
Business context and financial performance
FHN operates regional banking, capital markets, corporate and non-strategic businesses. Regional banking provides consumer and commercial banking services, primarily in Tennessee and selected markets; capital markets focuses on fixed-income services. The non-strategic segment includes legacy businesses being wound down.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $317.4 | $309.3 | $899.1 | $929.8 |
| Net interest income | $159.5 | $158.8 | $468.7 | $480.2 |
| Net interest margin | 2.97% | 2.97% | 2.94% | 2.96% |
| Provision for loan losses | $6.0 | $10.0 | $21.0 | $40.0 |
| Noninterest expense | $246.2 | $433.6 | $631.7 | $901.5 |
| Net income (loss) | $49.7 | $(103.0) | $180.2 | $(12.8) |
| Net income (loss) available to common shareholders | $45.3 | $(107.5) | $167.0 | $(25.6) |
| Diluted EPS | $0.19 | $(0.45) | $0.70 | $(0.11) |
Q3 revenue improved 3%, mainly on a $39.7 million gain from selling held-for-sale mortgage loans, partly offset by weaker capital markets revenue. Nine-month revenue declined 3%, reflecting lower capital markets revenue and net interest income. Expenses fell sharply year over year, largely because Q3 2013 included a $200 million mortgage repurchase provision; lower compensation and other costs also contributed. Q3 2014 included $35.4 million of net litigation and regulatory expense after insurance-related reversals.
Balance sheet, cash flow, capital and asset quality
- At September 30, 2014: assets were $24.0 billion; loans, net of allowance, were $15.6 billion; deposits were $16.1 billion; total equity was $2.6 billion. Year-earlier assets were $23.9 billion, net loans $15.2 billion and deposits $16.3 billion.
- Liquidity and funding: cash and cash equivalents were $909.7 million, versus $1.025 billion a year earlier. For the nine months, operating cash flow was $585.6 million, investing cash flow was $(129.2) million, financing cash flow was $(374.5) million, and cash increased $81.8 million. Term borrowings were $1.49 billion; deposits declined by $591.2 million in financing cash flows while short-term borrowings increased.
- Profitability and capital: quarterly return on average assets was 0.83% and return on average common equity was 7.99%. FHN’s Tier 1 capital ratio was 14.47%, compared with 13.28% a year earlier; its Tier 1 common ratio was 11.40%, compared with 10.21%. Management said capital remained well above current well-capitalized standards.
- Credit quality: allowance for loan losses was $238.6 million, down from $255.7 million; allowance-to-loans was 1.51%, versus 1.66%. Nonperforming assets were $256.9 million, down from $404.0 million; nonperforming loans were 1.35% of loans, versus 1.87%. Quarterly net charge-offs were $11.0 million, compared with $16.2 million.
- Portfolio concentrations and watch items: residential real estate represented 36% of loans. Finance and insurance plus mortgage-company lending represented 33% of C&I loans. Credit card and other delinquencies rose to 1.44% from 1.11%; management cited higher first-half delinquencies and charge-offs in that portfolio.
Material changes, outlook and unusual items
- Average loans grew 1% year over year in Q3, with commercial growth more than offsetting runoff in consumer real estate and permanent mortgages. Average core deposits declined 4% in Q3; management attributed the decline partly to reduced Promontory insured deposits.
- Capital markets revenue declined: fixed-income revenue was $41.2 million in Q3, down from $54.4 million, amid low rates, low volatility and uncertainty around Federal Reserve policy. Management said NIM would likely remain under pressure through the rest of 2014 as low rates constrain loan yields.
- Management expected asset quality to remain relatively stable through the remainder of 2014 and early 2015, conditional on continued economic recovery. It expected legacy consumer real estate and permanent mortgage portfolios to continue running off.
- Mortgage servicing sales substantially reduced the owned servicing portfolio: owned first-lien servicing was $110 million at quarter-end, compared with $13.8 billion a year earlier. Q3 mortgage loan sales generated the $39.7 million gain noted above; first-quarter servicing sales also included about $20 million of previously unrecognized servicing fees.
- Legacy mortgage repurchase and foreclosure liability was reported as $125.5 million in the rollforward at September 30, down from $293.7 million a year earlier. The filing separately cites $126.2 million of accrued repurchase exposure; investors should reconcile the reported measures and scope. The active repurchase pipeline was $184.5 million.
- Material legal exposure remains. Established liabilities for material loss contingency matters totaled $56.3 million; estimated reasonably possible losses above established liabilities ranged from zero to approximately $118 million. FHN could not estimate a reasonably possible loss range for certain mortgage-related matters. The FHA-insured loan investigation could result in claims with enhanced damages; outcome and excess exposure were not estimable.
- Subsequent events: a 13-branch Tennessee acquisition closed October 17, 2014, involving approximately $440 million of deposits. On October 21, FHN agreed to acquire TrustAtlantic Financial for estimated consideration of approximately $80 million; closing was expected in the first half of 2015, subject to approvals and other conditions.
- FHN paid a $0.05 per-share common dividend in October and approved another $0.05 dividend for January 2015. Its $100 million share repurchase authority had $76.0 million remaining at September 30. FTBNA’s available dividend capacity was negative $31.4 million, so subsidiary dividends to FHN required regulatory approval.
Important facts for investors to verify
- Whether the mortgage-sale gain and lower legacy provisions are repeatable, and how results perform excluding these unusual items.
- Reconciliation and adequacy of the $125.5 million repurchase liability, the separately stated $126.2 million accrued exposure, and the $184.5 million active pipeline.
- Developments in the FHA investigation, mortgage-securitization litigation and other legal matters, including the potential for losses beyond established accruals.
- Trends in credit card delinquencies and charge-offs, residential real estate concentrations, and loans to financial and mortgage companies.
- Deposit trends, short-term borrowing reliance, regulatory limits on subsidiary dividends, and the company’s ability to maintain liquidity and capital as acquisitions proceed.
- Execution, regulatory approval and integration of the branch purchase and proposed TrustAtlantic acquisition; also monitor NIM under persistent low rates and changing balance-sheet mix.