FIRST HORIZON CORP quarterly report, Q2 FY2016

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Business context and reporting period

First Horizon National Corporation (FHN), a regional banking and fixed-income company, filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2016. Comparisons are with the corresponding 2015 periods unless stated otherwise. Amounts below are in U.S. dollars.

Financial highlights

  • Revenue and earnings: Q2 revenue was $321.8 million, up 8%. Net income was $60.9 million; net income available to common shareholders was $56.5 million, or $0.24 diluted EPS, versus $50.6 million and $0.22. For the first half, revenue was $628.2 million, up 8%; common earnings were $104.4 million, or $0.44 diluted EPS, versus a $26.2 million common loss, or $0.11 per share.
  • Net interest income and margin: Q2 net interest income rose 6% to $176.3 million; net interest margin was 2.92%, unchanged. First-half net interest income rose 8% to $348.3 million and margin increased to 2.90% from 2.83%. Growth in commercial lending, the prior Federal Reserve rate increase, lower long-term funding costs, and a larger securities portfolio supported results.
  • Expenses and credit costs: Q2 noninterest expense increased 4% to $226.8 million; first-half expense fell 24% to $453.7 million. Provision for loan losses was $4.0 million in Q2 versus $2.0 million, and $7.0 million for each first-half period.
  • Balance sheet and funding: June 30 assets were $27.5 billion, loans $18.6 billion, deposits $20.6 billion, and total equity $2.7 billion. Compared with June 30, 2015, assets, loans, and deposits increased from $25.2 billion, $16.9 billion, and $18.7 billion, respectively. Cash and cash equivalents were $1.2 billion. Term borrowings were $1.1 billion, down from $1.6 billion a year earlier.
  • Cash flows: In the first half, operating activities used $21.3 million and investing activities used $640.7 million, while financing activities provided $836.9 million. Cash and cash equivalents increased $174.9 million to $1.2 billion, with financing inflows supported by deposit growth and increased short-term borrowings.
  • Asset quality: The allowance for loan losses was $199.8 million, or 1.07% of loans, versus $221.4 million, or 1.31%, a year earlier. Nonperforming assets were $198.9 million versus $238.5 million; nonperforming loans were 0.95% of loans versus 1.20%. Annualized net charge-offs were 0.19% versus 0.21%.
  • Capital and returns: FHN’s Common Equity Tier 1, Tier 1, and total capital ratios were 10.05%, 11.28%, and 12.39%, respectively, versus 10.41%, 11.98%, and 14.00% a year earlier. Management said FHN and its bank subsidiary remained well-capitalized. Q2 return on average common equity was 10.04% and return on average assets 0.91%.

Material changes versus the prior comparable period

  • Higher fixed-income revenue and net interest income supported revenue growth. Fixed-income product revenue rose 48% in Q2 to $69.3 million, benefiting from market and rate volatility and an expanded distribution platform.
  • First-half earnings improved substantially from the 2015 loss, mainly because 2015 included a $162.5 million DOJ/HUD-related charge. First-half 2016 also benefited from a $31.4 million reversal of mortgage repurchase and foreclosure provision following settlements of claims.
  • Q2 expenses nevertheless rose: litigation and regulatory accruals were $26.0 million in the quarter, and higher fixed-income compensation and other costs more than offset the mortgage-provision reversal. First-half 2016 litigation and regulatory expense was $25.5 million.
  • Loans and deposits expanded, including from the 2015 TrustAtlantic acquisition and regional-bank commercial growth. Consumer real estate and legacy non-strategic portfolios continued to run off.

Outlook, commentary, risks and unusual items

  • Management expected asset-quality trends to remain relatively stable in the near term if slow economic growth continued; it noted possible short-term variability in commercial credit and continued runoff of legacy consumer portfolios. No specific earnings or revenue guidance was provided.
  • FHN’s balance sheet was positioned to benefit from rising short-term rates, but management described margin expansion in a low-rate environment as challenging. Its June 30 simulation estimated a 5.3% favorable 12-month net interest income variance under an immediate 100-basis-point rate increase; a 25-basis-point decrease implied a 2.0% unfavorable variance. These are modeled scenarios, not forecasts.
  • Legacy mortgage and legal exposures remain significant. At June 30, established liabilities for loss-contingency matters totaled $40.4 million, with estimated reasonably possible losses above established liabilities ranging from zero to approximately $73 million. Separately, the mortgage repurchase and foreclosure reserve was reported as approximately $68 million; the active claims pipeline was $63.1 million. Outcomes and timing remain uncertain.
  • FHN disclosed a disputed $43.5 million demand from a former mortgage subservicer and continuing investor, indemnification, and regulatory inquiries relating to legacy mortgage activities. Management said it could not reliably determine the outcome of various matters. A separate potential insurance recovery of up to the policy limit of $75 million related to the prior DOJ/HUD settlement was reasonably possible but not considered probable.
  • FHN signed an agreement to buy approximately $0.6 billion of restaurant-franchise loans from GE Capital, expected to close in Q3 2016; management expected the transaction to be immediately accretive to EPS. FHN also expected to contribute approximately $165 million to its qualified pension plan in Q3.
  • FTBNA’s dividend capacity without prior regulatory approval was negative $189.2 million at June 30; regulatory approval was required for subsidiary dividends to FHN. FHN reported receiving OCC approvals for specified 2016 subsidiary dividends. Future shareholder dividends remain subject to capital, liquidity, operating results, and regulatory restrictions.

Most important facts for investors to verify

  • Whether the improvement in earnings persists after excluding the $31.4 million mortgage-reserve reversal and comparing against the prior-year DOJ/HUD charge.
  • Subsequent updates to legacy mortgage litigation, repurchase reserves and pipeline, including the basis for the filing’s approximately $68 million reserve disclosure.
  • Loan growth, credit performance, and concentration exposure: finance and insurance plus mortgage-company loans made up 40% of C&I loans; residential real estate was 27% of total loans.
  • Trends in net interest margin and deposit funding costs, and the sensitivity of results to actual rate and yield-curve changes versus modeled scenarios.
  • Regulatory capital ratios, subsidiary dividend approvals, the planned pension contribution, and the closing and realized earnings effect of the GE Capital loan purchase.