First Horizon National Corporation — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 30, 2010. Unaudited consolidated results. First Horizon is a bank holding company whose principal businesses include regional banking and capital markets, alongside portfolios being wound down in its non-strategic segment. Financial amounts below are in U.S. dollars; “million” and “billion” are used for readability.
Financial performance and condition
| Metric | Q2 2010 | Comparable period / context |
|---|---|---|
| Total revenue (net interest income plus noninterest income) | $430.1 million | $483.3 million in Q2 2009, down about 11% |
| Net interest income | $182.1 million | $199.1 million in Q2 2009 |
| Net interest margin | 3.19% | 3.05% in Q2 2009 |
| Provision for loan losses | $70.0 million | $260.0 million in Q2 2009 |
| Noninterest income | $248.0 million | $284.2 million in Q2 2009 |
| Noninterest expense | $341.8 million | $402.5 million in Q2 2009 |
| Net income attributable to common shareholders | $2.7 million; diluted EPS $0.01 | Net loss of $123.2 million; diluted loss per share $0.54 in Q2 2009 |
| Six-month net income (loss) available to common shareholders | Loss of $25.0 million; diluted loss per share $0.11 | Loss of $206.0 million; diluted loss per share $0.91 in first half 2009 |
| Net charge-offs | $132.8 million; 3.10% annualized of average loans | $239.4 million; 4.77% in Q2 2009 |
Q2 earnings improved primarily because loan-loss provision fell, expenses declined, and mortgage banking income rose. Lower net interest income reflected balance-sheet and loan contraction. Capital markets revenue fell as unusually favorable 2009 fixed-income conditions normalized; this more than offset some of the mortgage banking improvement.
- Balance sheet at June 30: Total assets were $26.3 billion versus $28.8 billion a year earlier. Loans, net of unearned income, were $17.2 billion versus $19.6 billion; net loans after allowance were $16.4 billion.
- Credit reserves and problem assets: Allowance for loan losses was $781.3 million, or 4.55% of loans, compared with $961.5 million, or 4.91%, at June 30, 2009. Nonperforming loans were $790.5 million versus $1.127 billion; nonperforming assets were $899.8 million versus $1.233 billion. Improvement largely reflected the wind-down of construction portfolios, while some commercial and permanent mortgage credit indicators worsened.
- Liquidity and funding: Cash and cash equivalents were $967.8 million. Deposits totaled $15.2 billion, up from $15.0 billion at June 30, 2009. Long-term debt was $2.93 billion, down from $3.24 billion. Over the first six months, operating cash flow was negative $517.1 million, investing cash flow was positive $1.321 billion, and financing cash flow was negative $755.1 million; cash and cash equivalents increased $49.2 million.
- Capital: Total equity was $3.29 billion. First Horizon’s Tier 1 capital ratio was 16.80% and total capital ratio 21.34%; First Tennessee Bank’s ratios were 16.39% and 20.78%, respectively. Management said both met capital adequacy requirements and the bank qualified as well capitalized.
Material changes and notable items
- First-half provision for loan losses declined to $175.0 million from $560.0 million. The reduced provision reflected portfolio runoff and some stabilization, but did not eliminate continued weakness in selected loan categories.
- Mortgage banking income increased to $63.3 million in Q2 from $15.5 million a year earlier, including $44.1 million of positive net hedge gains versus $6.2 million. Mortgage servicing rights fell to $201.7 million from $337.1 million a year earlier, including valuation effects and portfolio changes.
- Capital markets noninterest income decreased to $100.9 million from $179.4 million; fixed-income sales revenue declined to $91.8 million from $170.1 million. Related lower variable compensation helped reduce expenses.
- The mortgage banking repurchase and foreclosure provision rose to $56.0 million in Q2 from $29.1 million. The related reserve reached $164.6 million, versus $76.9 million a year earlier. The active repurchase-request and mortgage-insurance cancellation pipeline was $411.1 million at June 30, 2010, versus $177.5 million a year earlier.
- Adoption of revised variable-interest-entity accounting led to consolidation of certain mortgage securitization trusts and restricted presentation of related assets and liabilities. It reduced opening retained earnings by approximately $10.6 million.
- First Horizon closed its FTN Equity Capital Markets research business in February 2010 after a planned sale failed to close. First-half discontinued operations included a $6.9 million net loss; the closure involved a $3.3 million pretax goodwill impairment and other exit costs.
Outlook, management commentary, and risks
- Management expected net interest margin to remain somewhat stable over the next few periods, assuming interest rates remain near historical lows. It expected asset quality and provision expense to improve during the remainder of 2010 if current trends continued, but noted possible near-term charge-off volatility.
- Management described the rest of 2010 as challenging. Weak loan demand, prolonged economic weakness, unemployment, housing-market conditions, and commercial real estate stress could pressure revenue and raise credit, foreclosure, and repurchase costs. Bank-related and trust-preferred loans were also identified as vulnerable.
- Mortgage representations-and-warranties exposure remains a significant uncertainty. Management’s reserve estimates depend on claims, mortgage-insurance cancellations, rescissions, loss severity, and the performance of loans sold; actual outcomes could differ materially.
- FHN disclosed SEC staff Wells notices to two subsidiaries and individuals concerning alleged assistance to former customer Sentinel Management Group; there had been no material developments since the prior quarterly report. A shareholder derivative lawsuit filed in Q2 names the company as a nominal defendant; management said it intends to defend the claims.
- Management said pending litigation outcomes are difficult to predict and could materially affect results in a particular period, although it did not expect pending matters to materially adversely affect consolidated financial condition based on then-current knowledge.
- The company recognized a $288 million net deferred tax asset without a valuation allowance. Management considered its three-year cumulative loss position significant negative evidence but concluded other factors supported realization; that conclusion could change if future losses exceed expectations.
- The Dodd-Frank Act, enacted July 21, 2010, was identified as a source of uncertainty, with potential for increased compliance and deposit-insurance costs, revenue or margin pressure, and changes to consumer finance and capital rules. FHN noted that roughly $300 million of trust-preferred securities would be excluded from Tier 1 capital after a phase-out period.
- FTBNA’s available dividend capacity was negative $305 million at June 30, 2010; it could not pay common dividends to FHN without prior regulatory approval. The board declared a 1.6567% stock dividend for distribution in October and said it would consider a cash dividend when earnings and other conditions improved, subject to restrictions.
Important facts for investors to verify
- Whether the $164.6 million mortgage repurchase and foreclosure reserve adequately reflects the expanding $411.1 million claims and mortgage-insurance cancellation pipeline, and how these exposures develop.
- Whether credit quality continues to improve, especially in income-producing commercial real estate, permanent mortgages, and bank-related/trust-preferred commercial loans; assess charge-offs alongside the declining loan base and allowance.
- How sustainable Q2 earnings are after separating lower credit provision and expense from volatile mortgage servicing hedge gains and normalized capital markets revenue.
- Whether the $288 million deferred tax asset is ultimately realizable and whether future losses would require a valuation allowance.
- How regulatory changes, including Dodd-Frank and restrictions on subsidiary dividends, affect costs, capital, liquidity, and shareholder distributions.
- Review the full filing for details of legal proceedings, loan-sale recourse and servicing obligations, and valuation assumptions for mortgage servicing rights and other fair-value assets.