First Horizon Corp (FHN) 2004 Q4 法說會逐字稿

Welcome to First Horizon National Corporation's fourth-quarter 2004 earnings conference call.

Today's call is being recorded.

In addition you can listen along simultaneously at www.shareholder.com/ftb/medialist.cfm.

Hosting the call today from First Horizon National is Ken Glass, Chairman and Chief Executive Officer, and Marty Mosby, Chief Financial Officer.

They are also joined by Mark Yates, Director of Investor Relations.

Before we begin, management has asked me to inform you this conference call contains forward-looking statements involving significant risks and uncertainties.

A number of factors could cause actual results to differ materially from those in forward-looking information.

Those factors are outlined in the recent earnings press release and more in the most current 10-Q and 10-K.

First Horizon National Corporation disclaims any obligation to update any forward-looking statements that are made from time to time to reflect future events or developments.

At this time all participants have been placed in a listen-only mode, and the floor will be open for your questions following management's comments.

Now it's my pleasure to turn the floor over to Mr. Ken Glass.

Please go ahead, sir.

Good morning to all of you, and thanks for joining the call.

As the operator stated, I have Marty and Mark here with me.

We appreciate all of you taking the interest in First Horizon, and we're pleased to be on the call to talk to you today.

Generally our performance in the fourth quarter of 2004 continued to reflect the impact of an unfavorable interest rate environment that we saw much of the second half of the year.

We started off the first half of 2004 in line with the goals we set for ourselves.

We set these goals based on the prevailing economic forecast going into the year; and while the market generally behaved according to our expectations initially, during the second half of the year unanticipated changes relative to interest rates occurred which presented some unique challenges.

We're not immune to these types of market disruptions, and our fourth-quarter earnings for mortgage and capital markets businesses reflect that interest rate environment.

While our performance was not insulated from these challenges in 2004, we were able to achieve some very important results while continuing to make significant investments for the future.

These achievements include average annual loan growth of 22 percent with positive momentum going into 2005; net growth of almost 15 percent in the number of relationship managers; and most recently the acquisition of the fixed income division of Spear Leeds & Kellogg.

We achieved a lot with our national expansion plans.

During 2004 we expanded in northern Virginia.

We are replicating this strategy in two additional markets today, Texas and Georgia, where we have approximately 30,000 customers in each market.

With this type of critical mass, we can implement our strategy of selling additional products to the existing customers.

This is evidenced by our penetration rate, and by that we mean the number of mortgage clients who have purchased multiple financial purchases has reached 35 percent.

Most importantly national retail and commercial banking contribution to pretax earnings more than doubled, reaching $216 million in 2004.

Also let me just say that our expansion is not limited to our banking business.

For example our capital markets group, FTN Financial, now operates in 15 states including most of the major money centers and just closed the acquisition of the fixed income business of Spear, Leeds & Kellogg's.

This greatly enhances our sales force, product offerings, and executional capabilities.

In addition, we are now part of MarketAxess and its leading platform for electronic trading of corporate bonds and certain other types of fixed income securities.

This is also a prestigious list of participants, which now includes FTN Financial.

Finally we continue to add talent across other parts of our business including investment banking and research.

Now I'd like to turn it over to Marty Mosby to go through the financial results in more detail, and I look forward to taking your questions afterwards.

Marty.

Thanks, Ken.

Let me reiterate Ken's greeting and thank all of you for joining us.

Looking at the fourth quarter, we reported earnings of 103 million or 81 cents diluted per share, compared to earnings of 118 million or 90 cents diluted earnings per share for the fourth quarter of 2003.

This quarter's earnings did include an adjustment of a little under $4 million for an other-than-temporary impairment loss on our Freddie Mac stock.

For the year 2004 we reported earnings of 454 million, or $3.54 diluted earnings per share, compared to earnings of 473 million or $3.62 diluted earnings per share for the year 2003.

Just a reminder, the adoption of SAB 105 impacted our earnings unfavorably by $8 million in the second quarter.

Return on average shareholders equity and return on average assets were 23.9 percent and 1.7 percent, respectively, for the year.

Before I detail the individual segments I want to discuss the overall business composition and business drivers that frame our current environment.

For the fourth quarter our pretax earnings were 121 million from the retail commercial banking, 82 percent of the total; 30 million from mortgage banking, which is down to 20 percent of the total; 10 million from capital markets, which was 7 percent of the total; and 14 million loss from corporate, which is a negative 9 percent of the total.

This composition is significantly different than our business in fourth quarter of last year 2003.

In last year's pretax earnings, 47 percent was from retail commercial banking; 37 percent was from mortgage banking; and 19 percent from capital markets.

Corporate had a negative drag of about 3 percent in last year's pretax earnings.

As we have disclosed or discussed over the last year, we expected the retail commercial bank and corporate earnings to rebound and offset the declines in mortgage earnings as asset quality improved, discretionary spending was reduced, and investment in our national cross-sell and expansion initiatives produced returns.

This has come true this year, as retail commercial banking pretax earnings grew $168 million; corporate earnings improved by $59 million; while mortgage banking earnings declined a little over $200 million this year.

However, at the same time fixed income was negatively affected by the unexpected market conditions, reducing capital markets earnings by $72 million.

Specific market conditions that affected this quarter were both positive and negative.

First the challenges.

We saw continued difficulties in fixed income sales as noted, lower revenue from structured finance transactions, compression in earnings from the lower mortgage originations margins, and increased mortgage hedging costs.

Conversely, several favorable developments exceeded our expectations, including our national expansion strategy and lower asset quality cost.

Now I'd like to take a quick look at each segment's performance.

As with last quarter we have furnished a financial supplement which includes a significant detail on each business segment.

The supplement is also available on our website at www.FirstHorizon.com.

The press release, the supplement, and our SEC filings include detailed information on the quarter, so I will only hit on a couple of the key points.

In our retail commercial banking segment pretax earnings were up from 87 million to 121 million.

Total revenue grew 12 percent or $36 million, while provision saw improvements of $3 million.

Non interest expense only increased 3 percent or $5 million, thus contributing to an improvement in the efficiency ratio for our retail commercial bank to 59 percent.

Net interest income showed a very strong increase of $36 million.

We saw total loan growth of 23 percent, reflecting the strength in our consumer lending, which has been particularly successful across our national footprint.

We are also benefiting from an improved market for commercial loan growth of 18 percent.

Additionally, while the retail commercial banks net interest margin has decreased 19 basis points since the fourth quarter of 2003, it has stabilized since the second quarter of 2004.

Deposit account balances grew 6 percent over last year's levels, which was unfavorably impacted by the impact of the Springdale divestiture, which represented approximately 3 percent of our deposit base last year.

We continue to be focused on the implementation of strategies to grow deposits, such as convenient hours, free checking, and targeted financial center expansions.

Merchant processing fees were 24 percent higher, while insurance premiums and commissions were 15 percent lower.

Fourth quarter this year included a $16 million securitization gain and a $3 million divestiture gain, while fourth quarter last year included a $22 million divestiture gain.

We improved penetration among our national customer base by increasing the number of clients with multiple financial services from 30 percent a year ago to 35 percent this quarter.

Revenues from national retail commercial banking activities increased from 34 percent in the fourth quarter of last year to 43 percent in the fourth quarter of this year with respect to our total retail commercial banking revenues.

As a result pretax earnings from this quarter from our national expansion initiatives doubled last year's fourth-quarter profitability levels, adding $35 million in additional earnings to this quarter alone.

Going forward retail commercial banking revenues should see year-over-year growth in the quarters ahead, driven by further penetration in our existing markets of Tennessee, and our national expansion strategy which includes Northern Virginia and our newer markets and other opportunities.

Based on expected economic conditions asset quality should remain stable at current levels.

Now moving on to mortgage banking segment.

Pretax earnings decreased $38 million to 30 million, due to the competitive pricing pressures, reduced impacts from servicing hedging, and increased impairment costs.

Net origination fees increased $3 million from a year ago, as mortgage origination volume increased 26 percent to $8 billion this quarter, compared to 6 billion a year ago.

Home purchase originations increased 34 percent and refinance volume increased 16 percent due to the quarter, mainly due to our sales force growth of 15 percent over the last year.

The competitive pricing and the market and interest rate volatility caused our margins to shrink compared to last year's fourth quarter.

However, pricing concessions did lessen in the fourth quarter from 26 basis points in the third quarter to 11 basis points this quarter.

Net servicing income declined 68 percent from last year.

The continued low interest rates led to an increase in amortization and impairment expense of $20 million.

The flattening of the yield curve and the increased use of option-based hedge instruments reduced total net hedge gains by $22 million.

Reflecting continued strategic progress, productivity improvement resulted in a 16 percent reduction of servicing cost per loan; and the mortgage servicing portfolio was 87 million on December 31, 2004, a 26 percent increase from 69 million on December 31 of 2003.

Looking ahead the competitive pricing environment could continue to negatively impact mortgage banking profitability.

However, servicing profitability should begin to improve.

Capital markets pretax earnings declined from 36 million to 10 million, primarily due to a challenging environment in the overall capital markets business.

Depository income decreased 39 percent, while nondepository income declined 21 percent, and other fees decreased 36 percent.

Noninterest expense decreased 18 percent compared to a year ago.

The challenges related to the stalemate in the long-term interest rates continued from third quarter for our fixed income business.

Factors attributable to the slight decrease in fixed income included inclement weather experienced in Memphis during the latter half of December and a drop in rates which pushed investors to the sidelines.

Noninterest expense on a sequential quarter was approximately 5 million higher, driven primarily by costs associated with the deferred compensation plan, and initial cost and preparation for our upcoming annual conference.

The deferred compensation plan, while increasing expenses by over $4 million this quarter, had a comparable impact on revenues and taxes, creating no net impact on corporate earnings.

Going forward revenues from fixed income security sales may remain subdued due to uncertainty in the investment community.

However, the addition of Spear, Leeds & Kellogg will give us additional revenue going forward.

Finally, the corporate segment had a $14 million pretax loss compared to a $5 million pretax loss last year.

The decrease in net interest income since last year was due to a temporary reduction in the investment portfolio, a decline in the earnings credit on allocated capital, and the repurchase of REMIC securities in 2003.

Before closing I want to turn your attention to our asset quality.

The ratio of allowance to total loans has declined from 1.15 percent at December 31, 2003, to 0.96 percent at the end of December 2004.

The primary driver of this decline was the improvement in the asset quality of both the consumer and commercial loan portfolios due to a favorable change in mix as well as a continued economic recovery.

The increase in the ratio of allowance to the net charge-offs has gone from 2.36 percent at December 31, 2003, to actually 3.75 percent at December 31, 2004.

This is an indication of how significant the change in our asset quality has been.

Throughout this time frame we have been consistently applying or loan loss allowance model and have continued to have provisioning in excess of charge-offs.

Now let me turn the call over to Ken for some concluding remarks.

I would like to summarize with a couple of comments about where we are going.

Looking at this year 2005, we will continue to evolve into a national company by expanding into select markets, leading with our mortgage product, and successfully cross selling other products such as home equity lines of credit, deposits, and credit cards.

As already mentioned our cross-sell penetration in 2004 was 35 percent, and we expect to continue an improvement in that during 2005.

We will grow our existing presence, enter into new markets, and increase our customer base during the course of this year.

This growth will be possible because of our people-driven strategy, enhanced by the consolidation in the industry, enabling us to add significant talent across all areas of our business.

Finally our earnings mix combined with the strong market position of our business segments and the continued execution of our national expansion strategies will over the long run produce high-performing results.

And we do expect to resume growth in 2005.

We will now entertain your questions.

(OPERATOR INSTRUCTIONS) Heather Wolf of Merrill Lynch.

A couple of questions.

First, in terms of the delivery margins, when you guys had preannounced in December, you had indicated that the trend in your delivery margin appeared positive compared to the third quarter.

But clearly it is down quite a bit.

Was that just miscommunicated?

Or was there a change late in the quarter?

Actually, one of the things that we were highlighting was if you look at the concessions or the servicing, the SRP, it actually went -- the concessions went down from 26 basis points to 11 basis points.

So if you look at the part that's related to pricing, we actually did see about a 15 basis point improvement in the pricing-related element of that margin.

When you start looking at the total margin, it was impacted mainly by the execution and the marketplace.

And that was a late development in December.

So some of that did erode.

So you went from 27 basis points in marketing gains and loss, to 7 basis points.

So that was a 20 basis point decline.

There was only a 10 basis point decline in total.

So some of the uncertainty and volatility in the marketplace was hurting the execution or the delivery of those loans, while the pricing in the market or the concessions actually saw a pretty significant improvement.

I see, okay.

Thank you.

Also, just curious what efforts are in place in your capital markets division to bring expenses down.

The expenses in our capital markets division is pretty much volume driven or income driven.

So almost all commission.

So you will see that expense go down.

We continue to build our capacity in that division or business line, and we will continue to do that.

So we don't see us pulling our overhead down at all.

Do you have any plans to shift your commission structure if revenues don't pick up anymore?

That commission structure automatically shifts with the revenue size.

I mean, the individual production of the individuals.

As well as the management bonus is totally driven by the bottom line.

Can you just repeat what you said about the change in the deferred compensation plan, and the impact?

Right, that plan is one that has been in place.

It allows the folks in that management team as well as the sales force to defer compensation into the future periods.

When you do that, you set the plan up; you then create hedging for that plan.

So what I was meaning was there is about -- it grosses up your expenses, because as their performance on that plan -- you know, stock market went well up in the fourth quarter, so the performance showed some increased expense, because of the liability that we have going forward.

The flip side of that is we have some revenue that is driven into the model, into the numbers we have here.

And there's a tax benefit that we then pick up.

So net to the bottom line there is no impact from the deferred compensation plan.

But from a quarterly perspective and when the market does well, it doesn't have some gross effects on some of the line items in the income statement.

Can you quantity the impact to the expense line and the revenue line?

Yes.

The expense line was impacted by about $4 million, so it represented the majority of the increase.

The revenue line was impacted by about $2.5 million.

And the rest is in the tax?

The rest is in the tax line.

That is correct.

And that is one of the reasons that tax rate actually did go down this quarter.

So you see the tax rate going down; you see about $2.5 million in extra revenues, which would be in that other revenue line.

So where we were talking about the trust preferred execution in the preannouncement, you would have seen a drop in those other fees related to the smaller revenue from our structured finance this quarter.

Then when you look at the expenses, the expenses would have been actually down or about flat with third quarter, slightly from where they were, once you adjust out deferred compensation.

Thank you very much.

Christopher Marinac of Fig Partners.

Can you talk about the expense level at the capital markets area?

I was I guess a little bit curious on why that did not fall sequentially.

Is there some additional investment there even before the new acquisition comes in?

Chris, as we were highlighting, the deferred compensation plan actually skewed the expenses higher in the fourth quarter.

That's a plan that is in place over years that they can push money into in order to defer their compensation current periods to future periods.

As that plan is set up we then -- depending on how the assets perform in that plan, that will impact the expense levels.

So as quarter actually you had about a $4 million impact related to the fact that those expenses, because the stock market did well, grossed those expenses up.

So that is all of that change, then?

Yes, yes.

So exclusive of that, there is no other change.

That was my question.

That is exactly right.

Again, that is offset in revenues and in tax benefits; so net to the bottom line there was no impact this quarter.

Got it.

I'm sorry for having you repeat that.

No problem.

Can you talk about the retail bank, in terms of what is the timing on seeing some real additions in Dallas and Atlanta, Seattle and maybe other markets you have, both on a retail as well as commercial front this year?

Chris, this is Ken, if I can talk;

I've had a bad cold all week.

So excuse me.

But we have hired a team of people to start the expansion in Texas.

We now have I think about a dozen individuals that we recruited from the competition there, that are getting ready to start integrating or penetrating that market from a retail commercial banking standpoint.

In Georgia we've done the same thing, with that same number of people.

We would like to have a small acquisition in the Atlanta market early this year to allow us to charter, so that we can actually branch in that market.

Then that would also give us the ability to go on across the Georgia line at the Tennessee line from our Chattanooga market.

Those will be the two markets we will concentrate on as far as potential full branch banking this year.

The other markets that we've mentioned in our presentations, there's 15 of them across the country, so another 12 or 13; and a total of 50 retro markets.

We will continue to add sales force and specialized, skilled people in those markets.

But we do not anticipate doing branching unless there is an opportunistic acquisition in one of those markets, and we are constantly looking for those.

Last question and then I'll go.

Do you have any goal in terms of the cross-selling ratio that you've given us in the past, in terms of the success you've already had?

What is the upside, whether it be longer term or more near term on that?

I think you will see gradual increase in that year by year.

The major penetration that we have created is 35 percent; has been without our retail commercial banking activities in those markets.

So that will definitely accelerate that penetration activity.

But again our mortgage customer base is very national; and we're going to tackle the retail commercial banking expansion region by region or metro by metro.

So that picks up customers in addition to the mortgage customer as well as increase our capability of bringing additional products into our mortgage customer base.

So I think will see a gradual -- you should not see a rapid jump in that.

Again, we have led with our lending products.

We are now following with our wealth management and investment, and now deposit products.

Great, thanks very much, guys.

Chris, the only other thing I might add is if you look at the number that Ken was talking about in penetration, that's not the only metric we are following.

Average revenue per household would be the other metric that we continue to see I think improvement in.

If you look at what we're doing in Tennessee, we're almost doing $1,000 per year in revenue per household.

With actual households that we have out in the national market today we're just over 350.

So, if you look at the opportunity, it's continue to move that number up.

In this last year, that number showed significant improvement as well.

Great.

Thanks, Marty.

Gary Townsend of Friedman, Billings and Ramsey.

Question has been answered though, and I thank you for your time.

I wish I had your voice this morning, Gary.

Hope you feel better, Ken.

Gary Tenner of SunTrust Robinson Humphrey.

A couple of questions.

First off, with regard to the securitization gains during the quarter, around $15 million.

It seems like that would have been a bit larger than even if the third quarter securitization had not occurred, it happened in the fourth quarter plus a little bit more.

Was it unusually large even beyond that?

Or is it -- trying to get a sense for what to expect going forward.

We did mention that the security gains were going to be larger this quarter.

To make sure I'm getting the right stance on how to answer the question though, we had said we were going to be somewhere around 10 to $12 million.

We ended up at 15 to 16.

So we were a little bit larger than what we had expected coming into the quarter.

What you would expect going forward is that this quarter's representation would be about double what we would typically do.

That's fine.

It seems even a little bit larger than that.

I was just trying to get a sense if it was even larger than -- I guess it was a little bit larger than what you had forecast anyway.

Okay.

That is fine, that answers the question.

Curious about kind of the atmosphere in Memphis as far as the banks that have been acquired, how things are going there, and whether you have been able to take advantage of any of those opportunities yet.

Yes, Gary, we have.

We have continued to be able to recruit very good people from those organizations.

We're seeing the penetration of the customer base continue to improve.

We believe that the big improvements will be midyear this year and later, as they change the names and change the customer statements etc.

But we are seeing pickup in that business, not only here in Memphis but across the state.

If you talk about Nashville, as well, because I know that is a market that you're trying to target more.

Any movement there as far as attracting folks as well?

Yes.

To give you a better feel for that, if you look at our -- we've recruited across the state about 65 people from those organizations, statewide.

In the middle Tennessee market we will close this year out it looks like -- or close last year out it looks like with about 185 basis point gain in the consumer share and a couple points gain in the business share.

So we're very pleased with what's going on in that middle Tennessee market.

Looking financially our contribution for that middle Tennessee market is going to be substantially increased this year as a result of the investment we've made for the last couple years.

What was that gain you said on the commercial share?

Commercial share is a couple points.

Okay.

So the big gain is in the consumer side right now.

No, consumer is a little bit less than what we gained in commercial. (multiple speakers)

Okay, 200 basis points in the commercial.

I'm sorry. (multiple speakers) Okay.

Finally, can you give us any sort of idea of a run rate of the revenues for Spears Leeds Kellogg?

I am not sure that that is any numbers that we've been able, or at least that I have been able to find.

I am just curious if you have any sense of that; or any sense of that you can actually provide us with.

We haven't really released any of Spear Leeds Kellogg's individual numbers.

What we are suggesting is that it would show an increase in revenues off of what the base is in the capital markets area.

So that will be incremental pickup.

But we haven't given out any of their specific numbers.

Thank you.

I would say at this point we integrated Spear, Leeds -- started that January 7 as we (ph) closed; the integration is well underway and moving very well.

We are very pleased with the way that has gone and continue to move.

That will be wrapped up very promptly too, it's gone so well.

David Honold, KBW Investments.

I had a question on the revenue and expense trends in mortgage banking; and I guess part and parcel of that is gain on sale margins.

Do you see better operating leverage around the corner?

Or what would be the catalyst for better revenue and expense trends there?

And also what your outlook is for stabilizing of the gain on sale margin?

The execution of the marketing gains and loss line have typically run, if you have looked, the last two quarters, 27 and 30 basis points.

That is a pretty good historical average.

So when you start looking at the return of the margins that we would see, we would expect to get back in that range going forward.

So as long as the pricing holds where it is, we get the rebound and that execution as the market volatility comes out.

That should be a pretty good boost in our margins as we go into the first quarter.

The other thing that you have is the hedging cost that is sitting over in the servicing standpoint.

If you looked at just hedge gains in general, they were $17 million in the third quarter; they dropped to $3 million, a little below 3.8, just below $4 million in the fourth quarter.

That was related to the increased cost of hedging.

The actual hedges are still very effective.

The correlation is working nicely.

But the cost because of the volatility in the marketplace has gone up, which has increased that hedging cost.

As soon as we can start to see that convexity and other issues that are now embedded in the numbers begin to lessen, we will begin to pick up that as well.

So that is another part of the leverage that we will begin to see as we go through next year.

In terms of the expense structure in place, sort of from an overhead or personnel standpoint you are comfortable where that is at this point?

Yes.

Again they have been containing to show profitability and productivity improvements on the servicing side; and again they are seeing their origination side still performing well in line with what we would expect, as commissions and incentives are moving with the volume that is being generated.

Great.

Just to follow up on the tax rate, in terms of the impact of the deferred comp issue that you already touched on.

Does that mean that we go back to a more normal sort of higher tax rate in the coming quarters; and that is sort of a onetime true-up in this quarter?

Yes.

Again that is all correlated to what is happening in the capital markets area.

So you would return to what's been a 32 or 33 percent tax rate.

So you'd see that come as we move forward.

But then we have had the other piece that's impacting the pretax over in capital markets.

Thank you.

Operator, we will have time for one more question.

Cory Shipman of the Stanford Group.

Actually ours have already been answered.

Thank you, Cory.

Operator, we want to thank you; and thanks, everyone, for again participating in our call this morning, and thank you for your questions.

And once again we appreciate your interest in First Horizon and I wish everyone a happy day.

That does conclude today's conference.

We do thank you for your participation.