FIRST HORIZON CORP quarterly report, Q2 FY2012

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First Horizon National Corporation — Q2 2012 Form 10-Q

Reporting period: Three and six months ended June 30, 2012. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless noted. Comparisons are with the corresponding 2011 period or, for balance-sheet figures, June 30, 2011 or December 31, 2011 as indicated.

Business context and results

First Horizon operated through regional banking, capital markets, corporate, and non-strategic segments. The non-strategic segment included legacy mortgage and other businesses being wound down. The most consequential Q2 development was a revised estimate of legacy mortgage repurchase obligations to Fannie Mae and Freddie Mac.

  • Q2 revenue: $331.6 million, down from $360.5 million. Net interest income was nearly unchanged at $172.7 million; noninterest income declined to $158.9 million from $187.6 million.
  • Q2 earnings: Net loss available to common shareholders was $124.8 million, or $0.50 per diluted share, versus net income of $20.0 million, or $0.08 per diluted share, in Q2 2011. The pretax loss was $210.6 million.
  • First half: Revenue was $706.0 million; net loss available to common shareholders was $94.2 million, or $0.38 per diluted share, compared with net income of $60.2 million, or $0.23 per diluted share, in first-half 2011.
  • Net interest margin: 3.16% in Q2, compared with 3.20% a year earlier. Management attributed pressure mainly to lower reinvestment yields, partly offset by lower deposit costs.
  • Cash flow, first half: Operating cash use was $311.3 million and investing cash use was $108.6 million; financing provided $448.1 million. Cash and cash equivalents increased $28.2 million to $856.4 million.

Financial position, capital, and asset quality

  • At June 30, 2012: Total assets were $25.49 billion; deposits were $16.12 billion; total equity was $2.51 billion, including $2.22 billion attributable to First Horizon shareholders. Total loans, net of unearned income, were $16.19 billion, with an allowance for loan losses of $321.1 million.
  • Borrowings: Term borrowings were $2.29 billion. Other short-term borrowings were $1.09 billion, up from $172.6 million at year-end 2011; management cited increased FHLB borrowing amid deposit fluctuations and higher mortgage-company lending near quarter-end.
  • Regulatory capital: First Horizon’s Tier 1 capital ratio was 13.12%, total capital ratio 15.97%, and Tier 1 common ratio 10.65%. The company and its bank subsidiary reported capital above the then-applicable well-capitalized standards.
  • Credit trends: Nonperforming assets declined to $466.9 million from $747.9 million a year earlier; the nonperforming-assets ratio fell to 2.32% from 4.09%. Net charge-offs for Q2 were $40.0 million versus $66.0 million. The allowance-to-loans ratio declined to 1.98% from 3.26%.
  • Management described broad loan-portfolio improvement, but noted continued stress in some commercial real estate and bank-related borrowers. Residential real estate represented 41% of total loans; loans to mortgage companies totaled $1.3 billion.

Material changes and unusual items

  • Mortgage repurchase provision: Q2 expense was $250.0 million, compared with $24.6 million in Q2 2011; first-half expense was $299.3 million versus $61.8 million. First Horizon said new information from Fannie Mae, including data on loans no longer serviced by the company and expected future claim selections, led it to revise its estimate. The repurchase and foreclosure liability was $362.5 million at June 30, 2012, compared with $171.9 million a year earlier.
  • Mortgage banking: Q2 income fell to $9.9 million from $32.1 million, reflecting lower net hedging results and servicing fees. The serviced mortgage portfolio was approximately $21 billion, down from $26 billion a year earlier; MSR carrying value was $129.3 million.
  • Other income and expenses: Q2 included a $5.1 million gain on sale of a venture capital investment and a $22.0 million legal and regulatory loss accrual. The prior-year quarter included a $36.7 million litigation settlement accrual in capital markets.
  • Capital return: The share repurchase authorization was increased to $200 million in April. First Horizon had repurchased $125.5 million under the program by June 30. The company paid a $0.01-per-share dividend in July and approved another $0.01 dividend for October.

Outlook, risks, and contingencies

  • Management expected net interest margin to remain flat or decline slightly in the second half of 2012, citing historically low rates and continued pressure on reinvestment yields. It expected asset-quality improvement to continue if economic conditions remained stable or improved, while cautioning that the pace could slow.
  • The company said its June 30 mortgage repurchase reserve was expected to cover current pending and projected GSE claims unless repurchase practices or outcomes changed significantly. The estimate depends on claim volumes, loss severities, rescission rates, GSE review practices, housing conditions, and other assumptions.
  • For specified litigation matters, First Horizon reported $22 million of established liabilities and estimated reasonably possible future losses in excess of those liabilities of zero to approximately $93 million where estimable. It said outcomes and timing were uncertain. Separate mortgage-securitization investor suits involved certificates with approximately $1.1 billion in original purchase amounts; the company had not recorded a liability for those investor claims.
  • Additional risks include foreclosure servicing changes and related costs, regulatory and capital-rule changes, economic and housing-market weakness, low interest rates, and possible indirect effects from European financial-market disruption. First Horizon said it could not predict certain foreclosure-review costs or the outcome of demands by its former subservicer.
  • FTBNA’s dividend capacity was reported as negative $332.0 million under applicable regulatory calculations; it could not pay dividends to its parent or preferred shareholders without prior regulatory approval.

Important facts for investors to verify

  • Whether the $362.5 million mortgage repurchase liability adequately reflects current and projected Fannie Mae and Freddie Mac claims, and how claim trends compare with the assumptions used.
  • Developments in mortgage-securitization litigation, the reported $0–$93 million range of possible additional losses for specified matters, and any claims not included in that range.
  • Whether underlying credit improvement continues as the allowance declines, especially in commercial real estate, residential real estate, and bank-related lending.
  • The sustainability of capital and liquidity, including short-term borrowing growth, dividend restrictions at FTBNA, and the impact of share repurchases on equity and capital ratios.
  • Whether mortgage servicing income, interest-rate hedging results, and net interest margin stabilize in the low-rate environment.