FIRST HORIZON CORP quarterly report, Q2 FY2013

First Horizon National Corporation — Q2 2013 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2013. Unaudited consolidated results. Unless otherwise stated, dollar amounts are in millions.

Business context

First Horizon operates regional banking, capital markets, corporate and non-strategic businesses. On June 7, its bank acquired substantially all assets and liabilities of Mountain National Bank (MNB), adding approximately $451 million of assets, including $249 million of loans, and assuming $362 million of deposits. The acquisition was from the FDIC, at a discount to book value, with no loss-sharing agreement; purchase accounting remained provisional.

Financial results and position

Metric	Q2 2013	Q2 2012	Six months 2013	Six months 2012
Net interest income	$160.0	$172.7	$321.4	$344.6
Noninterest income	$142.6	$158.9	$299.1	$361.3
Provision for loan losses	$15.0	$15.0	$30.0	$23.0
Noninterest expense	$227.4	$527.2	$467.9	$849.2
Net income (loss) attributable to common shareholders	$40.8	$(124.8)	$81.8	$(94.2)
Diluted earnings (loss) per share	$0.17	$(0.50)	$0.34	$(0.38)

Q2 total revenue was $302.7 million, down 9% year over year. The filing attributes the decline chiefly to lower capital-markets, mortgage-banking and securities-gain income, and lower net interest income.
Net interest margin was 2.96%, down from 3.16%. Management said margin would likely remain under pressure in 2013 given low reinvestment rates and portfolio runoff.
Q2 expense fell 57%, principally because the prior-year quarter included a $250 million repurchase and foreclosure provision. No such provision was recorded in Q2 2013. Lower litigation-related expense and personnel costs also contributed.
At June 30, total assets were $25.13 billion; total loans were $16.20 billion and net loans $15.94 billion. Total deposits were $17.01 billion, total liabilities $22.59 billion, and total equity $2.55 billion.
Cash and cash equivalents were $1.04 billion; interest-bearing cash was $344 million and securities purchased under resale agreements were $602 million. Six-month operating cash flow was $88.2 million, investing cash flow $596.1 million, financing cash flow $(753.7) million, and cash decreased $69.4 million.
Term borrowings were $1.80 billion. Federal funds purchased were $1.14 billion, repurchase-agreement liabilities $434 million, and other short-term borrowings $447 million. These categories are presented separately in the balance sheet.
The allowance for loan losses was $261.9 million, or 1.62% of loans, versus $321.1 million, or 1.98%, a year earlier. Q2 net charge-offs were $18.3 million versus $40.0 million; nonperforming assets were $506.7 million and the reported NPA ratio was 2.25%.
FHN’s Tier 1 capital ratio was 13.26%, total capital ratio 15.53%, and Tier 1 common ratio 10.37%. Management said FHN and its bank subsidiary qualified as well-capitalized.

Material changes versus comparable periods

Profitability returned to positive territory, primarily because the unusually large 2012 mortgage repurchase provision and certain litigation expenses did not recur at comparable levels—not because revenue grew.
Capital-markets fixed-income revenue was $58.5 million in Q2, down from $68.4 million, amid market volatility and rising rates late in the quarter. Six-month capital-markets income declined 18%.
Mortgage-banking income fell to $5.6 million from $9.9 million. Q2 included a $2.5 million negative mortgage-warehouse valuation adjustment; servicing fees also declined with the runoff of the servicing portfolio.
Loans were broadly flat year over year, while deposits increased to $17.01 billion from $16.12 billion. The filing notes that MNB contributed deposits and that customer balances shifted toward interest-bearing accounts following expiration of unlimited FDIC coverage for certain noninterest-bearing accounts.
Reported consumer-real-estate nonperforming loans rose, in part because new third-party information led FHN to place certain second liens on nonaccrual. Management said the information did not materially increase the allowance because probable losses had been considered previously.
FHN issued $100 million of Series A preferred stock in January 2013 and repurchased $81.2 million of common stock in the first half. A $40 million prepaid variable share-repurchase arrangement was reflected in equity and regulatory capital at quarter-end; the related shares were expected to be delivered in Q3.

Outlook, risks, contingencies and unusual items

Management expected asset-quality trends to be stable to slightly improving in 2013, conditional on continued economic recovery. It expected slower improvement in commercial and income-CRE credit trends and continued runoff of legacy consumer portfolios.
Management identified low interest rates as a continuing constraint on margin. Its rate-sensitivity scenario estimated a favorable 11% change in 12-month net interest income under an immediate 200-basis-point rate increase; a yield-curve-flattening scenario estimated a 1.6% unfavorable change. These are model scenarios, not forecasts.
The legacy mortgage repurchase and foreclosure liability was $122.7 million, down from $360.5 million a year earlier. The active repurchase/other-claims and mortgage-insurance cancellation pipeline totaled $234.7 million. FHN reported $61.1 million of Q2 net realized repurchase and make-whole losses.
Separate from that reserve, established liabilities for the litigation matters discussed in the filing totaled $20.9 million. For certain estimable cases, including specified mortgage-securitization suits, reasonably possible losses in excess of established liabilities could range from zero to approximately $227 million. Several other matters were not estimable; management said outcomes and timing were uncertain.
DOJ and HUD provided preliminary findings in an ongoing investigation of certain FHA-insured loans. No claim or demand had been made, no liability was established, and FHN could not estimate a loss range. The filing notes potential enhanced damages under applicable statutes.
FHN disclosed disputed subservicer demands for $8.6 million of costs and $34.9 million of foreclosure-review expenditures; it had made no reimbursement and said it would defend against the claims. It also described potential additional servicing, foreclosure, litigation and regulatory costs.
The MNB purchase-price allocation and loan classifications were provisional. FHN expected to substantially complete the allocation by year-end 2013 and planned to reassess certain acquired loans for purchased-credit-impaired classification in Q3.
FHN said its bank subsidiary could not pay dividends to the parent or preferred shareholders without prior regulatory approval, citing negative dividend capacity under applicable rules. The parent’s liquidity and shareholder dividends therefore depend partly on subsidiary cash flows and regulatory restrictions.

Important facts for investors to verify

Whether revenue and net interest margin stabilize, given declines in net interest income, capital-markets revenue and mortgage-banking income.
Whether credit quality improves after the second-lien nonaccrual reclassification, and how nonperforming loans, charge-offs and the allowance develop.
Whether the $122.7 million mortgage repurchase reserve adequately reflects future GSE claims, actual loss severity and the $234.7 million pipeline.
Developments in mortgage-securitization litigation, the FHA investigation, and disputed foreclosure-servicing demands, including exposure beyond established liabilities.
Completion and final valuation of the MNB acquisition, including any changes to goodwill, acquired-loan values or purchased-credit-impaired classifications.
Regulatory capital, funding and dividend capacity, and the effect of the planned share delivery under the prepaid repurchase arrangement.