Business context and reporting period
First Horizon National Corporation (FHN), the parent of First Tennessee and FTN Financial, filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2011. Its principal businesses are regional banking and fixed-income capital markets, alongside corporate and wind-down non-strategic operations. FHN sold Msaver during the quarter; sales of First Horizon Insurance and Highland closed in the second quarter.
Financial performance and condition
Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenue (net interest income plus noninterest income) | $397.2 | $428.8 | $1,126.8 | $1,276.2 |
| Net interest income | $176.3 | $186.1 | $522.0 | $548.6 |
| Provision for loan losses | $32.0 | $50.0 | $34.0 | $225.0 |
| Noninterest income | $220.9 | $242.7 | $604.8 | $727.6 |
| Noninterest expense | $322.7 | $341.5 | $981.0 | $1,013.5 |
| Net income | $39.0 | $33.7 | $104.8 | $44.3 |
| Net income available to common shareholders | $36.1 | $15.9 | $96.3 | $(9.1) |
| Diluted EPS available to common shareholders | $0.14 | $0.07 | $0.37 | $(0.04) |
- Margins and returns: Consolidated net interest margin was 3.23% in both Q3 periods; net interest spread rose to 3.03% from 3.01%. Q3 return on average assets was 0.62% versus 0.52%, and return on average common equity was 5.90% versus 2.86%.
- Balance sheet at September 30, 2011: Assets were $25.57 billion, loans net of allowance were $15.79 billion, deposits were $15.70 billion, and total equity was $2.74 billion. At September 30, 2010, these were $25.38 billion, $16.34 billion, $14.98 billion, and $3.31 billion, respectively. The allowance for loan losses was $449.6 million, down from $719.9 million.
- Capital and funding: FHN’s Tier 1 capital ratio was 14.44% (17.34% a year earlier), total capital ratio 18.21% (21.97%), and Tier 1 common ratio 11.95% (10.43%; non-GAAP). Management reported FHN and its bank subsidiary above well-capitalized thresholds. The loans-to-core-deposits ratio improved to 103% from 113%.
- Cash flow and liquidity: For the nine months, operating cash flow was negative $36.0 million, investing cash flow was positive $256.5 million, and financing cash flow was positive $70.1 million. Cash and cash equivalents increased $290.5 million to $1.06 billion. Management cited a general objective of maintaining excess liquidity equivalent to at least 15% of assets.
- Debt: Term borrowings were $2.51 billion, versus $2.81 billion a year earlier. Other short-term borrowings and commercial paper were $622.0 million, versus $193.4 million. FHN repaid or matured $661.0 million of term borrowings during the first nine months.
Changes versus the prior comparable period
- Q3 common earnings improved, principally because loan-loss provision fell by $18.0 million and noninterest expense declined 6%. However, total revenue fell 7%, as mortgage banking and capital markets income declined; $35.1 million of gains from Visa Class B share sales partly offset the decreases.
- For the first nine months, common earnings improved from a loss to $96.3 million. Lower loan-loss provision and the absence of $44.8 million in CPP preferred dividends paid in 2010 were important factors. Revenue declined 12%, including lower mortgage banking and capital markets income.
- Credit indicators improved overall: nonperforming assets declined to $582.6 million from $919.2 million, and the nonperforming-assets ratio fell to 3.02% from 5.00%. The allowance-to-loans ratio declined to 2.77% from 4.22%. Permanent-mortgage charge-offs rose sharply in Q3, partly due to the bulk sale of mostly nonperforming loans.
- Loans declined year over year while deposits increased. FHN attributed loan contraction largely to the run-off of non-strategic portfolios and weak demand; average C&I balances grew.
Outlook, commentary, risks and unusual items
- Management expected net interest margin to decline slightly over the next few quarters, citing historically low rates and pressure on securities reinvestment yields. It expected asset-quality trends to remain favorable through the remainder of 2011 and into 2012 if economic conditions remained stable or improved, while noting possible near-term volatility.
- Q3 loan sales generated approximately $36 million of losses included in loan-loss provision, including a $29.8 million loss on a permanent-mortgage sale and $6.0 million on commercial loan sales. The allowance reduction also reflected portfolio shrinkage and improving credit assessments; it should not be read as evidence that all credit risks have passed.
- The $35.1 million Visa share-sale gain lifted Q3 noninterest income. The Msaver sale generated a $5.7 million after-tax gain. FHN recorded a $36.7 million expense in Q2 for a Sentinel-related litigation settlement of $38.5 million; it is pursuing insurance recovery, which insurers dispute.
- Legacy mortgage exposure remains significant. The repurchase and foreclosure liability was $171.4 million; the active repurchase pipeline, including unresolved mortgage-insurance cancellation notices, was $417.9 million. FHN reported that it could not estimate potential losses on investor lawsuits involving proprietary securitizations; four pending suits related to approximately $1.1 billion of original certificate purchases. No liability had been recorded for those claims at quarter-end.
- Other legal and operational uncertainties include an M&T arbitration over HELOCs, SEC Wells notices concerning a Sentinel transaction, foreclosure-process reviews and possible servicing costs, and a new debit-transaction sequencing class action for which FHN had not established a liability. Management said it could not estimate losses for several of these matters.
- Management identified weak housing and commercial real estate conditions, unemployment, mortgage repurchase claims, low interest rates, regulatory changes, and European financial uncertainty as risks. The company estimated that debit interchange rules could reduce annual revenue by $15–$20 million, with some mitigation expected from fees and product changes. New mortgage subservicing fees were expected to increase by approximately $3–$4 million per quarter, partly offset by improved loss-mitigation results.
- On October 17, 2011, FHN announced a separate $100 million share-purchase authority, subject to market conditions, capital needs, and regulatory restrictions. It also reported a $0.01-per-share dividend payable January 1, 2012. Management stated that future dividends depend on capital, liquidity, operating results, and regulatory approval; the bank could not pay common dividends to FHN without prior regulatory approval at quarter-end.
Most important facts for investors to verify
- Whether lower credit provisions and declining nonperforming assets persist, and how much improvement reflects portfolio run-off, loan sales, or underlying borrower performance.
- Whether the $449.6 million loan-loss allowance remains adequate, particularly for residential real estate, commercial real estate, trust-preferred loans, and restructured loans.
- How repurchase claims, PMI cancellations, proprietary-securitization lawsuits, and servicing or foreclosure reviews affect future losses beyond the $171.4 million recorded liability.
- Whether core earnings can withstand weaker mortgage banking and capital markets revenue, low-rate pressure on net interest margin, and added servicing and regulatory costs.
- Capital and liquidity trends, including the lower year-over-year regulatory capital ratios, increased short-term borrowings, and regulatory limits on bank-to-parent dividends.