First Horizon National Corporation (FHN) — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014; filed August 7, 2014. FHN operates regional banking, capital markets, corporate, and non-strategic businesses. Financial statements are unaudited.
Financial performance and position
| Metric | Q2 2014 | Comparable period |
|---|---|---|
| Total revenue | $283.7 million | $302.7 million in Q2 2013 |
| Net interest income | $156.8 million | $160.0 million in Q2 2013 |
| Net interest margin | 2.97% | 2.96% in Q2 2013 |
| Provision for loan losses | $5.0 million | $15.0 million in Q2 2013 |
| Noninterest expense | $165.3 million | $227.4 million in Q2 2013 |
| Net income available to common shareholders | $76.8 million; diluted EPS $0.32 | $40.8 million; diluted EPS $0.17 in Q2 2013 |
- First-half results: Revenue was $581.8 million versus $620.5 million; net income available to common shareholders was $121.6 million versus $81.8 million. Diluted EPS was $0.51 versus $0.34.
- Cash flow: For the six months, operating activities provided $385.5 million, investing activities used $106.9 million, and financing activities used $13.4 million. Cash and cash equivalents ended at $1.093 billion, up $265.2 million from year-end 2013.
- Balance sheet at June 30: Assets were $24.22 billion; loans, net of allowance, were $15.55 billion; deposits were $16.16 billion; total liabilities were $21.60 billion; and total equity was $2.63 billion.
- Funding and capital: Term borrowings were $1.50 billion. Tier 1 capital ratio was 14.19%, total capital ratio 15.94%, and Tier 1 common ratio 11.14%. FHN reported it exceeded well-capitalized thresholds.
- Credit quality: Allowance for loan losses was $243.6 million, or 1.54% of loans, versus $261.9 million and 1.62% a year earlier. Nonperforming assets were $339.6 million versus $432.6 million; quarterly net charge-offs were $8.6 million versus $18.3 million.
Material changes versus prior periods
- Q2 common earnings rose substantially even as revenue declined 6%. Lower loan-loss provision and lower expenses more than offset weaker revenue.
- The quarter’s expense decline was heavily affected by a $47.1 million insurance recovery related to the settled Sentinel litigation: $38.6 million reduced litigation expense and $8.5 million reduced legal and professional fees. This is a significant nonrecurring benefit to the comparison.
- Capital markets revenue fell 31% year over year in Q2, reflecting low rates, low market volatility, and uncertainty around Federal Reserve policy. FHN cited lower fixed-income activity and variable compensation.
- Mortgage servicing income changed materially after the sale of substantially all legacy servicing, largely completed in Q1 2014. Mortgage servicing rights fell to $3.2 million from $113.9 million a year earlier. Q2 mortgage banking income nevertheless benefited from an $8.2 million positive fair-value adjustment on mortgage warehouse loans.
- Period-end loans were $15.80 billion, down from $16.20 billion a year earlier; deposits were $16.16 billion, down from $17.01 billion. The loan portfolio’s decline reflected runoff of legacy portfolios and lower mortgage-company lending, partly offset by commercial growth.
- Asset quality improved overall, but credit card and other consumer credit showed pressure: 30-plus-day delinquencies rose to 1.39% from 1.00%, and quarterly annualized net charge-offs rose to 3.35% from 2.22% for that portfolio.
Outlook, risks, contingencies, and unusual items
- Management expected net interest margin to remain under pressure in 2014 amid historically low rates and pressure on loan yields. It described the low-rate environment as a continuing challenge to margin expansion. No specific earnings or revenue guidance was provided.
- Management expected asset quality to be relatively stable for the rest of 2014, conditional on continued economic recovery. It anticipated continued runoff of legacy consumer real estate and permanent mortgage portfolios, with possible short-term variability in commercial credit trends.
- Interest-rate modeling estimated that a 200-basis-point rate increase would favorably affect next-12-month net interest income by about 10% versus the base case; a flattening yield curve was estimated to reduce it by about 1.3%. These are model scenarios, not forecasts. Declining-rate shock scenarios were not performed because rates were already very low.
- Material litigation liabilities totaled $11.9 million. FHN estimated reasonably possible losses above established liabilities could range from zero to approximately $115 million. Separately, the accrued legacy mortgage repurchase and foreclosure liability was $141.6 million at June 30, 2014.
- The DOJ and HUD investigation into certain FHA-insured originations remained unresolved; FHN had recorded no liability and could not estimate a loss range. The filing also describes mortgage-securitization investor suits, repurchase and insurance-related exposures, and a dispute with a former subservicer over $8.6 million of charges and $34.9 million of foreclosure-review expenditures sought for reimbursement.
- FHN agreed to buy 13 Tennessee bank branches, expected to close in the second half of 2014 subject to regulatory approval and customary conditions. The transaction would add approximately $660 million of deposits at a stated 3.32% premium near closing and an immaterial amount of loans.
- FHN reported a $4.4 million first-half loss on extinguishment of debt associated with the collapse of two HELOC securitization trusts, and a $2.0 million fair-value loss on a venture-capital investment in Q2. First-half restructuring charges were $6.4 million, including $4.6 million of lease-abandonment costs.
- The filing states that the board approved a $0.05 per common share dividend payable October 1, 2014. A new $100 million share-repurchase authorization had no purchases through June 30.
Important facts for investors to verify
- How much of the earnings improvement persists after excluding the $47.1 million Sentinel-related recovery and other unusual fair-value or transaction items.
- Whether capital markets revenue stabilizes and whether reduced mortgage servicing income can be offset by recurring fee businesses.
- Trends in net interest margin, loan and deposit balances, and dependence on short-term borrowings as legacy assets run off.
- Credit-card delinquencies and charge-offs, consumer real-estate performance, and the adequacy of the loan-loss allowance.
- Developments in mortgage repurchase exposures, the FHA investigation, securitization litigation, and the possible-loss range; confirm that the separate $141.6 million repurchase accrual is not conflated with litigation liabilities.
- Regulatory approval, closing terms, and integration effects of the proposed branch acquisition, as well as capital and liquidity implications of future dividends or repurchases.