First Horizon National Corporation — Q1 2014 Form 10-Q
Business context and reporting period. First Horizon National Corporation (FHN), a regional banking and capital-markets company, reported unaudited results for the three months ended March 31, 2014. Comparisons below are with Q1 2013 unless stated otherwise. Amounts are in U.S. dollars.
Financial performance and condition
| Metric | Q1 2014 / March 31, 2014 | Comparable period |
|---|---|---|
| Total revenue | $298.1 million | $317.8 million, Q1 2013 |
| Net interest income | $152.4 million | $161.4 million, Q1 2013 |
| Net interest margin | 2.88% | 2.95%, Q1 2013 |
| Noninterest income | $145.7 million | $156.4 million, Q1 2013 |
| Provision for loan losses | $10.0 million | $15.0 million, Q1 2013 |
| Noninterest expense | $220.2 million | $240.5 million, Q1 2013 |
| Net income | $49.2 million; $44.9 million available to common shareholders | $45.0 million; $41.0 million available to common shareholders, Q1 2013 |
| Diluted earnings per share | $0.19 | $0.17, Q1 2013 |
| Cash flow | Operating $333.2 million; investing $131.2 million; financing use $220.1 million; cash and cash equivalents increased $244.2 million | Cash and cash equivalents decreased $64.6 million, Q1 2013 |
| Total assets | $23.94 billion | $24.80 billion, March 31, 2013 |
| Loans, net of allowance | $14.87 billion | $15.62 billion, March 31, 2013 |
| Deposits | $16.67 billion | $16.20 billion, March 31, 2013 |
| Term borrowings | $1.51 billion | $2.20 billion, March 31, 2013 |
| Regulatory capital | Tier 1 capital ratio 14.26%; Tier 1 common ratio 11.10% | 13.56% and 10.64%, respectively, March 31, 2013 |
- Profitability improved despite lower revenue: pre-tax income rose to $67.9 million from $62.3 million. Lower expenses and loan-loss provision more than offset weaker revenue. Return on average assets was 0.83% and return on average common equity was 8.48%, versus 0.73% and 7.48%, respectively.
- Revenue fell 6%, primarily reflecting weaker capital-markets activity and lower net interest income. Capital-markets income declined 28% to $56.8 million. Net interest income declined 6%, reflecting loan runoff and lower mortgage-company lending; deposit pricing improvements partly offset the pressure.
- Expense fell 8%, with personnel expense down 14%, partly offset by higher occupancy, legal and professional, and advertising costs. Q1 included $5.7 million of restructuring charges, including $4.6 million for lease abandonment.
- Credit indicators were mixed. The allowance for loan losses declined 7% year over year to $247.2 million, or 1.64% of loans. Net charge-offs fell 38% to $16.6 million, and the annualized net charge-off ratio improved to 0.45% from 0.67%. Portfolio nonperforming loans were $240.9 million, or 1.59% of loans; total nonperforming assets, including held-for-sale loans, were $345.5 million, with the NPA ratio rising to 1.87% from 1.81%.
- Consumer real-estate nonperforming loans increased year over year, in part because FHN placed second liens on nonaccrual when third-party data showed the senior lien was seriously delinquent or restructured. FHN reported approximately $67 million of such loans. Residential real estate secured 39% of total loans.
- Liquidity included $1.07 billion of cash and cash equivalents and $685.5 million of interest-bearing cash. Average core deposits increased 1% year over year to $16.0 billion. The loans-to-core-deposits ratio was 93%, compared with 99% in Q1 2013. Management generally seeks excess liquidity of at least 15% of assets.
Material changes, outlook, risks and unusual items
- FHN sold substantially all of its remaining legacy mortgage servicing in stages, with transfers substantially completed in Q1 2014. It recorded $20.1 million of servicing fees associated with the sales; mortgage servicing rights fell to $4.7 million from $109.1 million a year earlier. The servicing business and related revenues are expected to be significantly smaller going forward.
- FHN entered definitive resolution agreements with Fannie Mae in Q4 2013 and Freddie Mac in Q1 2014, resolving certain legacy mortgage repurchase obligations. It retains obligations for specified excluded defects and certain mortgage-insurance matters. The legacy mortgage repurchase and foreclosure liability was $145.1 million, down from $183.8 million a year earlier.
- After quarter-end, on April 29, 2014, FHN agreed to pay $110 million to settle FHFA litigation concerning mortgage-backed securities purchased by Fannie Mae and Freddie Mac. FHN had recorded a reserve at March 31, and insurance was available for part of the settlement. Management said the settlement was not expected to materially affect Q2 earnings.
- At quarter-end, established liabilities for material litigation contingencies totaled $121.5 million, including the FHFA matter. FHN estimated reasonably possible future losses beyond established liabilities of up to approximately $113 million. A separate DOJ/HUD investigation into FHA-insured lending could result in enhanced damages; FHN had recorded no liability and could not estimate a loss range.
- Other unusual Q1 items included a $5.6 million gain on sale of a cost-method investment, a $4.4 million debt-extinguishment loss and a $2.0 million loss associated with securitization deconsolidation. These items affected noninterest income.
- Management expected asset-quality trends to be relatively stable in 2014, subject to continued economic recovery, and expected the pace of C&I improvement to remain slow. FHN said net interest margin would remain under pressure in a historically low-rate environment. Its modeled 12-month net interest income effect of a 200-basis-point rate increase was a favorable 10.8% versus base; a yield-curve flattening scenario indicated a 1.4% decline.
- Management said capital ratios were expected to remain well above current well-capitalized standards. FHN reported that fully phased-in Basel III rules were estimated to reduce its March 31, 2014 common equity Tier 1 ratio by approximately 30 basis points; the rules were scheduled to begin applying January 1, 2015.
- FHN’s bank subsidiary could not pay dividends to its parent or preferred shareholders without prior regulatory approval under the applicable retained-income limit. FHN declared a common dividend of $0.05 per share payable July 1, 2014, and a preferred dividend payable July 10, 2014.
Important facts for investors to verify
- Whether revenue and net interest margin stabilize as loan balances run off and capital-markets conditions change; monitor core loan growth, deposit pricing and segment results.
- Whether consumer real-estate credit performance improves, especially second liens and HELOCs entering repayment; track nonperforming loans, charge-offs, and reserve adequacy.
- The remaining financial exposure from mortgage repurchase obligations, FH-branded securitization litigation, the FHA investigation, and disputes with former servicers; compare outcomes with recorded reserves and the disclosed possible-loss range.
- The sustainability of earnings after mortgage-servicing sale fees, securities gains, investment-sale gains and other unusual items, and the continuing impact of restructuring and litigation expenses.
- Liquidity and capital distributions, including subsidiary dividend restrictions, capital requirements and the effect of Basel III implementation.