First Horizon National Corporation — Q3 2015 Form 10-Q
Business context and period. The filing covers the quarter and nine months ended September 30, 2015, with comparisons to the corresponding 2014 periods. First Horizon operates regional banking and fixed-income businesses, alongside corporate activities and a wind-down non-strategic portfolio. Amounts below are in U.S. dollars; financial figures are rounded to millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Consolidated revenue | $288.7m | $317.4m | $872.2m | $899.1m |
| Net interest income | $163.6m | $159.5m | $487.1m | $468.7m |
| Net interest margin | 2.85% | 2.97% | 2.84% | 2.94% |
| Provision for loan losses | $1.0m | $6.0m | $8.0m | $21.0m |
| Net income | $63.3m | $50.5m | $45.9m | $182.4m |
| Net income available to common shareholders | $58.8m | $46.1m | $32.6m | $169.2m |
| Diluted earnings per share | $0.25 | $0.19 | $0.14 | $0.71 |
- Quarterly comparison: Net income available to common shareholders rose 27.6% year over year. Higher net interest income, lower loan-loss provision and lower expenses more than offset reduced noninterest income.
- Year-to-date comparison: Common earnings fell sharply, primarily because of litigation and regulatory charges and lower noninterest income; higher net interest income and lower loan-loss provision partly offset the impact.
- Expense and earnings quality: Noninterest expense was $215.4m in Q3 versus $244.0m a year earlier, but $810.1m for the nine months versus $625.2m. Q3 pretax income was $72.2m versus $67.3m; nine-month pretax income was $54.1m versus $252.9m.
- Cash flow, nine months: Operating activities provided $212.6m versus $590.6m in 2014; investing activities provided $421.8m versus using $124.4m; financing activities used $592.0m versus $384.4m. Cash and cash equivalents ended at $1.114bn, up $42.5m during the period.
Balance sheet, funding and capital
- At September 30, 2015, total assets were $25.39bn, deposits $18.87bn, loans net of unearned income $16.73bn, and net loans after allowance $16.51bn. Compared with September 30, 2014, assets, deposits and gross loans increased from $23.98bn, $16.14bn and $15.81bn, respectively.
- Interest-bearing cash was $596.7m, in addition to $1.114bn of cash and cash equivalents. Management reported average core deposits of $18.5bn in Q3, up 20% year over year, and a loans-to-core-deposits ratio of 89%, versus 102%.
- Term borrowings were $1.34bn, down from $1.49bn a year earlier and $1.88bn at year-end 2014. Total liabilities were $22.81bn; total equity was $2.58bn.
- Regulatory capital ratios at September 30 were 10.71% common equity Tier 1, 12.11% Tier 1 and 13.38% total capital. Management said FHN and its bank subsidiary remained above well-capitalized thresholds. The reported Tier 1 ratio was 14.47% a year earlier; comparisons are affected by Basel III implementation and the redemption of trust preferred securities.
Credit quality and key changes
- The allowance for loan losses was $210.8m, 1.26% of loans, versus $238.6m and 1.51% a year earlier. Nonperforming loans were $184.0m, down 14%; nonperforming assets were $217.2m versus $256.9m. Annualized net charge-offs were 0.28% of average loans, unchanged year over year.
- Commercial and CRE lending grew; average loans rose 6% year over year in Q3. Consumer real estate and permanent mortgage balances continued to run off. Residential real estate represented 32% of total loans, and finance and insurance plus mortgage-company lending made up 36% of C&I loans.
- Credit metrics were not uniformly stronger: permanent mortgage nonperforming loans rose to 7.30% of that portfolio from 5.93%, and its annualized net charge-off rate rose to 0.67% from 0.25%. CRE delinquencies also increased, although CRE nonperforming loans declined.
- Total portfolio troubled debt restructurings were $304.7m, down from $346.0m a year earlier; associated reserves were $51.2m. Held-for-sale TDRs added $72.6m.
Outlook, risks and unusual items
- Outlook: Management expected asset quality to remain relatively stable in the near term, conditional on continued economic recovery; it expected legacy consumer real estate and permanent mortgage portfolios to keep winding down. No formal earnings or revenue guidance was provided in the filing text.
- Margin and rates: Management cautioned that net interest margin could remain under pressure from excess cash balances, competitive loan pricing, low rates, and higher long-term funding costs. Its September 30 simulation estimated 12-month net interest income increases of 2.4%, 3.7%, 6.3% and 11.5% under instantaneous rate increases of 25, 50, 100 and 200 basis points, respectively, assuming a flat balance sheet; a flattening yield curve scenario reduced NII by 1.4%. These are model scenarios, not forecasts.
- Litigation and regulatory charges: First-quarter 2015 included a $162.5m charge for the $212.5m DOJ/HUD settlement concerning FHA-insured mortgage origination. Q3 included an $11.6m arbitration charge, recognized after the company learned of the award on October 30. Nine-month litigation and regulatory expense was $173.4m. At quarter-end, material litigation contingency liabilities totaled $17.1m; management estimated reasonably possible losses beyond established liabilities could range from zero to approximately $70m, subject to substantial uncertainty.
- Legacy mortgage exposure: The established repurchase and foreclosure liability was $114.8m, and the active repurchase/related-claims pipeline was $173.2m. FHN continued to face investor lawsuits involving legacy mortgage securitizations and disputes with former servicers. The company also paid $212.5m in the FHA settlement and was pursuing insurance coverage with a stated aggregate policy limit of $75m; insurers disputed or reserved their coverage positions.
- Other events: TrustAtlantic’s approximately $95m acquisition closed October 2, 2015. In October, FHN issued $500m of 3.50% senior notes due 2020, expecting to use proceeds and cash to retire $500m of 5.375% notes due December 2015. A $5.8m gain resulted from redeeming junior subordinated debt and related trust preferred securities in Q3. An $8.3m retiree medical plan curtailment gain also benefited Q3 expenses.
- Dividend and funding constraints: FTBNA’s calculated dividend capacity was negative $250.2m at quarter-end, so dividends required prior regulatory approval. The bank received OCC approval to pay FHN $325m in Q3 2015. Management stated future parent-company dividends depend on earnings, capital and liquidity needs, regulatory restrictions, and subsidiary cash distributions.
Important facts for investors to verify
- Reconcile the Q3 earnings improvement with the much lower nine-month earnings, particularly the DOJ/HUD settlement, arbitration charge, mortgage banking comparisons and other litigation accruals.
- Review the composition, aging and possible outcomes of the $173.2m legacy mortgage claims pipeline, the $114.8m reserve, and the estimated additional litigation loss range of up to approximately $70m.
- Assess the durability of loan and deposit growth, the effect of excess cash and competitive pricing on NIM, and management’s modeled sensitivity to rate and yield-curve changes.
- Examine credit trends by portfolio, especially permanent mortgage delinquencies and losses, CRE delinquencies, financial-services concentrations, and borrower-fraud exposure.
- Confirm the capital-ratio effects of Basel III, trust preferred redemption and the TrustAtlantic acquisition, and assess the practical implications of bank-level dividend restrictions for parent liquidity and shareholder distributions.