First Horizon Corp (FHN) 2005 Q2 法說會逐字稿

Good day everyone and welcome to this First Horizon National Corporation second quarter earnings conference call.

Today's call is being recorded.

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

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

They are also joined today 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 moored in the most recent 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, but the floor will be open for your questions following managements comments.

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

Please go ahead, sir.

Thank you operator, and I want to wish all of you a good morning, and I want to thank you for joining the call.

But first let me apologize for any inconvenience that the shift in our earnings release timing may have caused you.

I'm glad you were able to receive the notification that we distributed Friday afternoon and adjusted your plans accordingly.

We felt it was important to make this change in the release date due to the potential confusion regarding what impacts the recent increase in mortgage volumes would have on our current and near term earnings.

While the increased activity that we and others have experienced will have a favorable impact on our earnings next quarter, we did not realize a benefit in the second quarter.

Actually this increase in production activity created a net unfavorable impact this quarter, since increased impairment expense proceeds the revenues that are in our pipeline that won't be realized until the third quarter.

Therefore we felt it was important to report our earnings to you as soon as possible to address any apparent misperceptions that might exist.

I'd like to add here that accelerating our release date is not our normal practice.

However, we felt that this response was warranted given the unusual circumstances.

In considering our performance for the second quarter, the impact of the timing issue on the mortgage banking earnings is temporary and should be disregarded when evaluating our performance.

Our company continues to produce strong fundamentals while the quarterly earnings were unfavorably impacted by this increase impairment and the flatter yield curve.

This flatter yield curve narrowed the spreads on the capital markets inventories and the mortgage warehouse loans as well as continued to suppress the demand for fixed-income securities.

The progression and success of our strategies and our strong fundamentals are evident in our second quarter report.

Total revenues this quarter grew 10% annualized on a sequential quarter basis and were up 3% over last year.

Year to date return on equity remained above 20%.

The retail commercial bank continued its outstanding loan growth and deposit growth while maintaining strong credit quality.

This segment now represents 77% of our consolidated earnings.

That's up from 59% for the second quarter of last year.

Commercial loans grew 31%.

Consumer loans grew 11%.

Deposits grew 12%.

As a result of these growth rates the retail commercial bank experienced growth in both net interest income and fee income over last year totaling a 17% growth in revenues.

Continued growth in our mortgage sales force -- or our total mortgage sales force now includes almost 2,000 retail relationship managers.

Enabling our home purchase originations to grow 28%.

This is double the anticipated national growth rate of 14% in the home purchase mortgages.

FTN financials revenue other than fixed income experienced double digit growth over the second quarter of 2004.

All of this and more that I haven't mentioned adds up to our strategies being on track.

Yes, current conditions are difficult and in response to the current conditions we're implementing some specific earnings enhancements that are not dependent on any changes in the interest rate environment or customer growth.

And I'll have more to say about these improvements in just a moment.

Right now I'll turn it over to Marty to discuss the details of the second quarter results.

Thanks -- thanks, Ken.

Second quarter 2005 earnings per share came in at $0.80 which is down from last year's second quarter earnings of $0.92 and last quarters $0.85.

While the pattern of earnings over the last 2 quarters is not exactly what we expected, we were $0.05 favorable to market expectations in the first quarter.

And are $0.07 unfavorable in the second quarter.

The underlying trends continue to make us optimistic on the momentum we are building going into the second half of 2005.

As Ken mentioned a primary driver of this quarter's drop in earnings as compared to the first quarter was the impact that the acceleration and prepayment activity had on impairment expense.

Mortgage impairment, net of hedge gains increased by $9 million over first quarter levels.

As many of you may remember, last year at this time, FAB 105 was adapted by the entire industry.

As a result the timing of expenses versus revenues related to increased production activity has become somewhat disconnected.

Impairment reflects the market's expectation given current market conditions of future payments over the life of the loans and actual payments in excess of past expected payoffs.

Now let me read that to you again, because that's pretty important given that impairment went up $9 million this year.

Impairment reflects the markets expectation given current market conditions of future payoffs over the life of the loans and actual payoffs in excess of past expected payoffs.

On the other hand increases in production are not realized into earnings until the volume goes through the pipeline, is warehoused for approximately 40 days, and then is delivered into the market.

The pipeline and warehouse at quarter end, increased $1.3 billion over the prior quarter end and will create more earnings in the third quarter than was lost in the second quarter due to increased impairment expense.

The drop in the longer term interest rates this quarter not only precipitated an increase in production activity, but also flattened the yield curve substantially.

This flattening of the yield curve impacted our capital markets inventory and mortgage warehouse spread this quarter by approximately 90 basis points and 20 basis points respectively.

These variances reduced net interest income by $7 million this quarter.

The demand for fixed income fell even further during the quarter due to the change in interest rate environment.

Creating a drop in fixed income revenues of 12 million this quarter as compared to the first quarter.

These two impacts from today's flatter-year-old curve environment, reduced second quarter pre-tax earnings by an estimated $12 million.

At this point we aren't assuming that these earnings will return in the short-term.

Therefore we have begun to execute on specific earnings enhancements as Ken mentioned earlier and we'll give some details later.

These earnings enhancements will offset the potential continued loss of these earnings in the second half of this year.

I also wanted to give you more of the financial trends which demonstrate the continued strategic progress and underlying momentum that our business lines are currently producing as Ken stated in his earlier comments.

First the retail commercial bank continues to produce strong growth over the prior year.

Second quarter pre-tax earnings grew 17% in the retail commercial bank.

Even after a $5 million write off of net capitalized expenses related to increased HELOC pre payments.

Loan growth was 20% while deposit growth was 12% over last year.

Net charge offs and non-performing asset ratios have improved by 7 basis points and 15 basis points respectively since second quarter last year.

Moving on to mortgage banking.

As a result of 20% growth in mortgage banking's total sales force and a continued strong housing market, home purchase volume increased 28% over the second quarter of last year.

Doubling the anticipated national origination market growth of 14%.

While capital markets fixed income revenues have dropped since the prior quarter and prior year, capital markets other product revenues increased to $49 million this quarter.

A 10% increase over second quarter 2004 and a significant increase over first quarter.

These strategic initiatives in each of our three business lines have and will continue to provide for long term earnings growth.

The continued execution of our strategic initiatives, the implementation of earnings enhancements and the realization of earnings in the current mortgage pipeline should enable earnings per share growth to resume this year.

As we have discussed over the years, and was highlighted in the second quarter, a flatter yield curve could unfavorably impact our earnings.

We will continue to monitor these trends in the current environment, and will adapt our business plans accordingly.

Now I'd like to turn it back over to Ken for some additional comments.

Thank you, Marty.

Now let me address our plans for operating in the current environment.

While the yield curve flattened as the second quarter progressed, we began to identify and to implement several earning enhancement initiatives.

For example we have begun to distribute more of our mortgage volume through FTN Financial.

Additionally we are consolidating operating staff functions within and between our business lines and have reduced the level of discretionary expenses.

The expected impact of our current initiatives will be sufficient to offset the potential ongoing loss of earnings at the level experienced in the second quarter of $12 million as Marty described in his comments, which is due to today's flatter yield curve.

This will not hinder our strategic momentum.

Now before I go to questions, let me reiterate that while this quarter's reported results are not what we or the market anticipated, the value created by the increase in mortgage activity will be recognized in the third quarter.

So even though the anticipated yield curve for the second half of 2005 is much flatter than at the beginning of this year, our current business plans result in resumed earnings per share growth this year.

These plans are based on the current interest rate environment, achieving the benefits of the earnings enhancements I have discussed, and recognition of the value from the refinancing activities generated in the second quarter.

This concludes our prepared remarks, and now we'll take your questions.

[OPERATOR INSTRUCTIONS] We'll take our first question from Heather Wolf with Merrill Lynch.

Hi, good morning.

Good morning, Heather.

Just a couple of questions, first, Marty, point of clarification, the 12 million takes into account the -- the hedge losses as well as the reduced warehouse revenue.

Can you just break that down for me again.

Yes, if you look at it the impairment cost -- if you look at the supplement you'll see it went from 10.4 million in the first quarter to $23.5 million in the second quarter.

That was a $13 million increase in impairment costs.

If you look at the hedge results, as you would expect, your hedge gain increased from the first to the second quarter offsetting some of that impairment.

That would then be -- was $3 million -- a little more than $3 million of hedge gains in the first quarter.

Second quarter was 7.3 so you end up with a positive $4 million coming out of the hedge result.

If you net those two out, that's the $9 million that we discussed early on as the net impact of increased refinancing activity on impairment costs this quarter.

So that's -- you kind of -- that's puts a fence around that, that is the initial impact of the refinancing activities picking up which everybody saw in the statistics that was beginning to show up there in the -- in the industry numbers.

Yes.

If you then look at -- what we're saying is if you go into the next quarter the pipeline increase of about 1.1 billion and the warehouse increase of a couple hundred million dollars would then generate value that would more than offset the $9 million that we lost this quarter going into the third quarter.

So you got to put that kind of on a separate area.

In other words move that up.

That's one issue.

The second issue that we talked about was the flattening of the yield curve which happened as we went through the second quarter.

As we came in the second quarter interest rates were beginning to -- actually long term rates continue (ph) move up.

As we then went to May and June you saw it precipitously drop.

As that occurred that flattened the yield curve and had an impact on three things, capital markets inventory spreads, warehouse loan spreads, and fixed income demand, or demand for fixed-income securities.

So if you look at those three things in total.

The impact of those issues would be about $12 million on this particular quarter.

What we're saying in addressing about that is as that occurred, and was generally not anticipated in the market, we had a bigger than expected impact from the yield curve, and then that's when we got busy looking at earnings enhancements, and we began to roll out in the third and fourth quarters to help replace the earnings from those three sources that we didn't think would improve, or weren't going to count on improving in the second half of the year:

I see, so your 9 million is separate from the 12 million.

The 9 million you think will come back.

The 12 million you're not counting on coming back.

That's correct.

And how we're looking at that is replacing it through those earnings enhancements.

Can you address the expenses in the retail bank, why they ticked up this quarter, and whether or not any of your earnings enhancements are going to help contain those?

Yes, if you look at the expenses in the bank this quarter, what you would see is one, there's an impact on the revenue side.

So let's address the revenue side and then we'll kind of roll down to the expense side.

If you look at the revenues, we would have had about $8 million more in revenues as compared to the prior quarter.

If you just look at the supplement on two line items.

What you'll see is the gain on sale of loans which we have always talked about will fluctuate, this quarter it was $8 million, when last quarter it was $11 million.

The other thing you'll see is miscellaneous revenue which has very consistently been in the 18 to $19 million range.

This quarter was $14 million.

The impact related to that line item was what we had highlighted in the press release and in the comment of the prepayment impact having on HELOCs.

So we had a write down of net capitalized expenses of $5 million this quarter that impacted the miscellaneous revenue line.

So when you start adjusting your revenues by that $8 million, you would then see that your revenue and expense growth would look much more in line with what we would have thought was going to happen as we went through the quarter.

So the biggest driver of your expenses is related to what is happening on the revenue side in the bank.

Because we are expanding our sales forces, we're investing in our national strategy.

We're investing in Tennessee for the consolidation opportunity that we have.

So as we've able to do that in the first half of the year we did see expenses going up but we're seeing a corresponding increase in the revenue side.

To answer your question, as we go forward, what we would see is that yes, the expense -- or containment or expense initiatives that we're putting out there related to the earnings enhancement would help us to see us mitigate some of that incremental growth that we have seen in the retail commercial bank.

So it will help the retail commercial bank even though when you look at the real impacts of the flatter yield curve they are outside of the retail commercial banking segment.

So we have strategies and growth initiatives that we have in the bank that we want to continue to take advantage of that are generating revenue as we've gone forward.

Okay.

Then just a couple quick follow-ups on the lost revenue items that you mentioned.

The 5.2 million in prepayments on the HELOCs.

It sounds to me like there was an assumption that was off there, can you talk a little bit more about why that happened and what you are doing going forward to make sure that doesn't happen again?

It wasn't really that there was an assumption that went wrong, as much as it is just now as we're putting HELOCs into our held for sale account and we're looking at marketing those and pushing those into the marketplace, as there's prepayments on the HELOCs that are in that portfolio, you have to then write down -- because there's a low common adjustment on any loan that's held for sale -- or any asset that's held for sale.

So as those assets are being pulled out through to consolidation or refinancing activity, you are going to have a hit as you are writing down the asset that you put on the books at origination so there is not anything that was done wrong originally it's just that the activity has gone up considerably this quarter.

If you looked at the held for sale, we had a CPR or prepayment rate that was up around 40% for this particular quarter, and that's an annualized rate.

So that would be higher than what we would anticipate in a normal environment.

Okay.

And then just one last question.

I'm guessing you guys knew about this issue -- ahead of Friday afternoon when you issued the press release, how come you guys didn't preannounce before the quarter end which is when you've pre announced in the past?

This is Ken.

We didn't do that because we felt that our operating earnings as we stated in the press release is very close to our expectations once you adjust for this impairment number.

And this thing progressed as we went through the quarter so we're right at quarter end we were close to announcing the earnings.

Everyone knew about the mortgage activities, but it became obvious they had different impressions about its financial impact on us.

And everyone knew about the yield curve as it moved.

Those were facts that were evident in the marketplace so that's why we didn't feel like there was a need to preannounce.

Okay.

Thanks very much.

Thank you Heather.

We'll move to our next question with Gary Tenner with SunTrust Robinson-Humphrey.

Thanks, a question on the capital market segment, I would have thought and I thought the -- or the path was to unwind some of the training inventory as it bumped up in the first quarter with SLK coming over and yet that number actually increased somewhat first quarter to second quarter.

Can you talk about that a little bit.

Right.

There's two issues there that we talked about going into the second quarter, and -- and one -- the reason I bring this up, Gary, is one is math because of what's happened in the yield curve.

The -- basically 100 basis points flattening in the yield curve that occurred in the second half of the second quarter, drew down the spread that we were getting on the actual inventory position at capital markets.

So we're looking at the capital markets inventories, and net interest income while we were anticipating a $3 million improvement.

We achieved that improvement due to the SLK integration and being able to be more efficient in the delivery of their products.

On the backside what we had was that spread in the market went down more than the advantage that we got from the benefit in the actual inventories.

So we are still seeing activities.

We are still seeing the level of the inventory be higher than what we anticipated, but generally the benefits that we were going to get this quarter we did achieve, and again, that is related to activities -- the level of the inventories related to activities that the SLK acquisition is still having.

Did you have anything further Mr. Tenner.

No.

Thank you very much.

Thank you.

We'll go now to Christopher Marinac with FIG Partners.

I wanted to ask about the slow but sure increase in the reserves from the dollar standpoint.

Can you give us some color on what you are thinking on that and should we expect more of that increase in the future?

I'm sorry repeat your question, Chris.

The growth of the reserves for loan losses will that continue in the future in terms of absolute dollar and then do you have any thought about the percentage of loans or coverage.

Right.

If you look at what we have been providing over net charge off's.

In the last couple of quarters we've actually expanded that.

If you look at prior year 2004, it was a million or two per quarter that we were billing with provision over charge offs.

If you look at what we've done, we have now expanded that about $5 million per quarter, so we will continue to provide over net charge offs.

That will continue as loan growth continues to be robust to widen out as it has been doing in the first half of this year.

So we continue to think and believe that we would build the provision at 5 million or more per quarter as we go forward.

Okay.

Can you give us some more color on the growth of deposits both initially in your other non-Virginia markets in terms of new cities, as well as sort of other metrics you think are relevant?

If you look at deposit growth we have done very well in Tennessee by gaining market share.

The middle Tennessee strategy is paying dividends at this point so we have been looking at -- this is our time of year when we go to the Board and look at our annual market share increases and we -- I think last year, Ken, we had two to three times more market share than we would have in a normal year.

Gains.

So the acceleration of the market share gains that we've had here in Tennessee with the middle Tennessee strategy and the consolidation that's going on has been very favorable for deposits.

So I would say if you are looking at the growth that we have seen, two-thirds of it is coming from the opportunity we've had here.

The other third is incrementally through products that we're now pushing out and through de novo in those other markets.

What we are seeing is that the national strategy has seen an increase in their growth rates and the amount of volume that they have been able to attract in the financial center forwards.

So we have been accumulating deposits in northern Virginia, that pace we're probably a little more than $100 million in deposits out there now.

That pace is continuing but the big impact that we're seeing nationally now is cross selling to our existing mortgage customers through financial center forwards and other initiatives.

Great.

Last question is, is the cross sell ratio now pushing higher than 35% or what would that be?

It is sitting right now around 37% of our customer base -- mortgage customer base.

And that compares to like 33 or 34?

Yes, you are right. 33 or 34 this time last year.

Okay.

Great thank you.

Thank you.

We'll go now to David Honold with KBW.

Could you comment on first, the other expense line it looked a little bit elevated this quarter.

Is there anything in there?

There is, the interesting thing, and I have had to explain this internally until I'm -- every schedule I had I've had to separate it out.

It's kind of interesting that when you do an issuance of preferred stock, that's not a net interest income number, that's an expense number because you are dividending it.

So $3.5 million of that increase is related to the issuance of the preferred stock.

The other increase that you would see is that there were some advertising increase in the first and second quarter due to us ramping up in Tennessee to take advantage of the marketplace consolidation and market share gains that we were building there, so that was a planned roll-out that we had that was in that number.

Okay.

And then just to follow up on the net interest margin in terms of mitigating the compression we have seen, what types of movements could you make on the balance sheet to offset that going forward.

Actually if you look at -- it's a good question, and what I would ask you to look at is net interest income has been growing.

That's the first thing you need to look at.

Net interest income is growing very nicely, and that's related to the product growth that we've had.

Our net interest margin compression, if you look at the net interest margin in the bank it's flat from last year to this year, so the bank margin's performance is much better, and that's really where you are looking at pricing and all of the initiatives that you are talking about.

We have been looking and been very successful in lagging our deposit rates as the Feds run rates have been going up, we have been competing with the market competitive pricing forces on the loan side and making sure that we're trying to minimize that and build our relationships and work off our value relationship value equation as much as we can.

That's helped us to maintain that retail commercial banking margin.

If you look at the impact on the margin from last year, even this quarter it's all related to inventory accounts.

Like if you take the mortgage warehouse, the spread of the mortgage warehouse dropped that 20-basis points, and the warehouse increased.

So as the warehouse increases in size and the margin contracts, you still have generally good net interest income growth but you are looking at the margin compression, again, that's a ratio affect.

And it's really driven by those inventory accounts being the capital markets, inventories, and the mortgage warehouse inventories.

While that doesn't have an impact on net interest income as much, it can have a pretty dramatic impact on the net interest margin.

You don't really have to look at initiatives that offset that as much as you have to be able to understand the drivers and the mix shifts that are creating that change in the ratio.

Great, thanks.

Thank you.

We'll move now to Gary Townsend with FBR.

Good morning, gentlemen, how are you?

Hello, Gary we're doing well and I hope you are.

Thank you for asking.

I am.

I would like to ask about the deposit growth and what you are doing to change the mix in a more favorable way that would be less dependent on CD's and more transaction oriented?

The -- one thing you need to be able to separate out, when you are looking at CDs -- our large CDs is where we utilize our access to the market through FTN Financial and the relationships that we have on the street to build our purchase money because it helps from a liquidity standpoint.

So you really have to separate out that large CD as a source, because we don't even count that, we're looking at core deposits and we're looking at interest bearing core deposits, and that's really the base of funding that we're getting through our distribution channels.

A lot of the reports get skewed because these CDs that we do get through our channels and relationship with financial institutions, and we do use that as a primary source of our purchase money gets kind of conglomerated in and then that looks like it's very reliant.

Our growth and ability to grow money market savings and checking has been really rather good, so that's been the primary source of growth that we have had in those core deposit balances.

Even adjusting for that, it seems to me your cost of funding is a bit steep.

Am I misunderstanding it or--?

We -- our cost of funds could be higher, because nationally what we're doing is that we're looking at the availability of funds into these new markets, financial center fours and being able to look at -- being able to offer those incremental markets, what would be more like a money market in a sense of a market -- national market rate so that is a way for us to go out and attract incremental build relationships, track incremental funding, and get that product within the array of cross-sale products that we're doing in the additional markets outside of Tennessee.

And secondly, commercial loan growth was strong, can you describe just what you are seeing with respect to either the pipeline or customer utilization?

We have seen strong pipeline and customer realization.

Tennessee market is doing very well in the commercial lending side as well as what we have been able to build in our construction lending in our national mortgage -- our home loan infrastructure.

So those two -- and that's builder financing and one time close products that we offer our customers there.

Thank you.

Thank you, Gary.

And we have time for one final question that comes from John Balkind with Fox-Pitt.

Thank you it is Brian Harvey for John Balkind.

Can you discuss the change in the other fees in the capital markets?

What's driving that increase?

I think it went from about 33 million up to about 49 this quarter.

Yes.

We've had loan sales, which you would imagine at this point of the cycle is a product that our customers would desire, plus community banks are having stronger loan growth, needing a funding source, our capital assets group is able to go out there and help them facilitate that process.

The other thing is our equity research has been growing as well as our investment banking.

So we have been able to introduce some new products on the investment banking side that have helped to raise our other product revenues, and there's a couple of more that will roll out here in the second half of this year.

Okay.

Was there any large transactions in this quarter.

Not -- not necessarily, no.

Okay.

Thank you.

Oh, let me clarify that, not any larger than normal.

We would have our pool trust preferred issuance that would happen every quarter that has been about the same size as previous quarters so the increase wasn't driven by a large transaction, but we do have that particular transaction that everybody has talked about.

And we have seen historically.

That concludes our time and our questions.

I want to thank you for your questions and thank you for the interest in our company.

And everyone have a great day.

Thank you that concludes today's conference.

Thank you for joining.