First Horizon Corp (FHN) 2005 Q3 法說會逐字稿

Welcome to First Horizon National Corporation's third-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're also joined by Mark Gates, 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.

After the prepared remarks instructions will be given on how to signal if you have a question.

At this time, I would like to turn the call over to Mr. Ken Glass.

Please go ahead sir.

Thank you, operator.

I want to wish all of you good morning and welcome you to our call.

As you have seen from the press release, third-quarter earnings per share were $0.90, up both from last year's third quarter of $0.89 and the $0.80 we reported in the second quarter this year.

Return on equity was 21%, continuing to be one of the highest among the top 30 U.S. banks.

This quarter's earnings reflected two significant improvements which we discussed with you during the second-quarter earnings call.

One is the realization of $12 million in income from the delivery of a larger mortgage pipeline created at the end of the second quarter.

This increased pipeline was due to a drop in the mortgage rates, which also triggered a $9 million increase in impairment, net of hedge gains, recorded in the second quarter.

The other earnings enhancement was the realization of approximately $10 million from the efficiencies and revenue improvements we mentioned to you during our second-quarter call.

These improvements, plus the continued growth in our businesses, were partially offset by the increasing negative impact to our fixed income business and asset spreads due to the continued flattening of the yield curve, and reduced mortgage -- reduced margins from our mortgage originations.

Additionally, there were two unusual items included in this quarter's earnings -- an $8 million settlement from an insurance company which increased revenues, and a $7 million charge from the estimated impact from the Katrina and Rita hurricanes.

I would like to take a moment at this time to express our concerns for the people of the Gulf Coast whose lives have been turned upside down by these hurricanes.

We have business operations in that area and so we know how devastating this tragedy has been, and we have tried to help our customers and employees recover.

And I know many of you also have family, friends and business associates impacted.

There are a number of areas where we continue to demonstrate strategic progress.

These actions are adding to profitability and will increasingly do so in the future.

This quarter our Retail/Commercial Banking's pre-tax earnings grew 20% from the third quarter of 2004.

This growth was derived from our national expansion and our Tennessee franchise.

Over the last year, the penetration of our mortgage customer base with banking products has increased from 32 to 37%.

We have added specialized relationship managers in our national mortgage offices, creating eight new homebuilder finance markets and nine new small-business lending markets over last year.

In Tennessee, our strategies of expanding our presence in Middle Tennessee, extending hours at our financial centers and capitalizing on the merger activities of our competitors are all factors contributing to our business growth.

As a result, commercial loans in our Tennessee market have increased 20% and total deposit accounts have grown by 15%.

In our mortgage business, home purchase originations are growing faster than the national market.

We remain focused on home purchase originations and continue to recruit talented relationship managers.

Since last year, we have grown our mortgage servicing portfolio by 15% to $94 billion.

We have also reduced our annual cost of servicing per loan by 9%, from $57 to $52.

Combined, this will continue to provide a profitable base of servicing, which will help hedge against declining production earnings as refinancing activity slows.

Within our Capital Markets business, revenues continue to reflect strong diversification, as revenues related to fees from other than fixed income grew 26% and is now a higher percentage of revenue than fees from fixed income.

As this quarter's results show, First Horizon has returned to earnings growth.

Looking forward, there are some important factors to consider as we enter the fourth quarter.

First and foremost, strategic progress will continue.

Secondly, the timing benefit to the Mortgage Banking earnings realized this quarter will most likely not be repeated.

Thirdly, we will continue our emphasis on earning enhancements.

The combination of these factors without further deterioration of the current operating environment should produce earnings growth in the fourth quarter over fourth quarter of 2004.

Now I would like to turn it over to Marty to discuss the details of the third-quarter results, after which I will make some additional comments before I take your questions.

Marty?

Thanks, Ken.

This quarter's earnings per share did increase over last year's third quarter, and the third quarter of 2004 included $20 million of security gains in lieu of loan sale gains, which were only $9 million in the third quarter of 2005.

Additionally, provision has increased from $10 million in the third quarter last year to $23 million in the third quarter this year.

This highlights significant impacts that our strategic growth initiatives and earnings enhancements are having on our underlying earnings.

Also, as Ken has already stated, this quarter's earnings momentum was produced even as the operating environment continued to worsen.

The spread between the 10-year treasury and the Fed Funds rate declined from an average of 182 basis points in the first quarter of this year to 120 basis points in the second quarter, to 76 basis points in the third quarter.

This flattening yield curve has been unfavorably impacting spreads on the Mortgage warehouse and Capital Markets inventories, and the demand for fixed income products.

This quarter's earnings also absorbed the unfavorable impact from lower mortgage origination margins.

While First Horizon's corporate net interest margin widened by 3 basis points compared to second quarter, the spread on the Mortgage warehouse continued to narrow.

The Mortgage warehouse spread narrowed 33 basis points this quarter, unfavorably impacting net interest income by $4 million.

Capital Markets spreads, which also had been compressing recently due to the flatter yield curve, reversed this trend this quarter and improved its margin by 17 basis points.

The demand for fixed income products has remained subdued.

The uncertainty surrounding the current level of longer-term interest rates has kept portfolio managers on the sidelines as these rates stubbornly continued to trade at the lower-end of the anticipated trading range.

This quarter, fixed income revenues declined 16%, or $8 million from second-quarter levels.

In addition to the lower spreads on Mortgage warehouse and less demand for fixed income, mortgage origination margins compressed below (ph) historical averages this quarter.

The mortgage origination margin fell from 98 basis points last quarter to 89 basis points this quarter, reducing mortgage income by $11 million this quarter.

While these unfavorable impacts continued this quarter, earnings enhancements and strategic growth initiatives provided enough incremental earnings to resume growth.

I wanted to highlight the performance of the Retail/Commercial bank which supported this earnings growth.

As Ken has already said the Retail/Commercial bank grew its pre-tax earnings $20 million, or 20% over the third quarter of 2004.

Some of the improvements that we experienced in our Retail/Commercial bank Ken already highlighted, but additionally, the efficiency ratio improved by 200 basis points this quarter, as much of the expense savings were achieved within the banking business.

Asset quality is solid, as net charge-offs and nonperforming asset ratios improved this quarter.

The Retail/Commercial bank's net interest margin continued to rank well among our peers.

This quarter's 4.26% has only declined three basis points since last year.

Core deposits experienced double-digit growth for the third straight quarter compared to prior year.

This growth in deposits has been accomplished while we have been lagging our deposit rates relative to the increase in the Fed Funds rate.

A review of available data on the top 30 U.S. banks showed that through the second quarter, our core deposit rates had increased 187 basis points compared to a 210 basis point increase on average for the top 30 U.S. banks, and a 194 basis point increase in the Fed Fund rate.

Loan growth continued to be strong, with 18% growth over the third quarter of last year.

Over the last 12 months, First Horizon has increased its loan portfolio by approximately $2.9 billion.

Sources of loan growth are diversified across product types and geographic regions. 44%, or 1.1 billion of this loan growth has been originated through our traditional First Tennessee banking franchise, which experienced 13% growth over last year's third quarter.

The national expansion strategy grew loans 1.4 billion, or 18%.

This growth was broadly distributed, with no more than 15% coming from any one market outside of Tennessee.

One of the businesses which is benefiting from national expansion, as well as a good housing market, is construction lending.

Construction lending consists of both consumer and commercial loan types, which are two very distinct businesses.

In the consumer area, we have become one of the top lenders in the U.S. in onetime close construction to permanent financing.

These loans are originated by retail relationship managers and wholesale representatives.

First Horizon does not retain these credits, as they are underwritten according to investor guidelines and delivered to the secondary market after construction.

By doing so, this portfolio in effect has takeouts for its production, and has experienced less than 1 basis point of charge-offs since 1998.

In the homebuilder finance and commercial real estate field, substantial growth has been achieved by recruiting experienced bankers from other national and regional banks.

In addition, we have been making loans selectively to many of the top builders, investors and developers on relationship bases, retaining these customers for ongoing business, including deposit generation and cash management opportunities.

Over the past few years we attribute the rapid growth in this business to a plan that is gaining traction and providing substantial increased earnings while maintaining the Company's pricing, risk acceptance and credit administration strengths, rather than growing by taking greater risk or easing credit standards.

In conclusion, earnings began to growth this quarter as compared to previous years' comparisons, and this momentum is expected to continue into the fourth quarter.

Thanks for your attention to this detailed analysis of our current performance.

And, Ken, I would like to turn it back over to you now.

Thank you, Marty.

Well, in June we laid out a plan on how First Horizon is addressing the unfavorable impacts from the current operating environment.

We have executed on this plan, and despite the continuing flattening of the yield curve, First Horizon's third-quarter earnings rebounded from the second-quarter level and were up over last year's earnings level.

As I have already said, the continued flattening of the yield curve remains challenging.

To meet this challenge, we have identified additional efficiency initiatives that concentrate on consolidation and standardization of processes occurring within our business lines.

When completed, these efficiencies are expected to generate approximately $50 million in savings next year.

These include specific business line initiatives, consolidation and standardization of enterprise-wide functions, and the completion of several technology projects.

Based on today's environment, the achievement of the additional earnings enhancements, and the continued successful execution of our core strategies, First Horizon will continue to build earnings momentum into 2006.

Thank you, and we will now take your questions.

(OPERATOR INSTRUCTIONS).

Christopher Marinac, FIG Partners.

I wanted to ask a little bit about the servicing impairment or, I guess, lack thereof.

Can you give us some more color on sort of what we should be expecting there in the future?

Chris, what we are always looking at, again, is going to be what happens in that side of the occasion versus what is happening in the origination side.

So, you always have to kind of keep that in perspective.

One is that we knew impairment was going to start to go down as rates began to get some lift -- mortgage rates.

As that happened towards the end, second half of the third quarter, what we have experienced was that that impairment did basically go away.

And that is what you would expect as you saw that increase in rates.

Just like in the end of the second quarter when rates had dropped, impairment cost went up; as rates went up, impairment costs went down.

The other side of that is if you look at the origination margins and you look at the secondary marketing gains, the disruption that happened in interest rates there, we did see some compression which we talked about in the origination margins.

So, you do have moving pieces on both sides of the equation.

But generally, rising interest rates will push your impairment costs down pretty significantly.

The growth of CDs on the balance sheet versus other core deposits -- should we expect to see that kind of continue, or is there any sort of new campaigns on various deposits we should be aware of?

When you're talking about CDs, I want to make sure that you're looking at CDs under 100,000.

Is that what you are focused on?

I'm looking at both actually.

CDs over 100,000, or the large CDs, are what we are using to, again, incrementally fund the balance sheet when we have loan growth in excess of what we're putting on the books for core deposit growth.

That is an access to the market that we have.

It is a good funding source.

We have been able to continue to build capacity by being able to go out and get access to those funds.

So, that is the way that we are in the market each day raising funds.

When you're looking at our core deposits, looking at what we are seeing in savings, transactions and CDs under 100,000, those growth rates are pretty consistent.

And that's going to be rolled out as we continue to build our national penetration of deposits, as we're continuing to take advantage of the opportunities here in the Tennessee market.

So, that is really tied into our core deposit strategies that are based on our strategies and initiatives in our business line.

Chris, obviously, history has shown that as rates go up, the consumer moves back into the CD market.

That's where banks tend to do their pricing to grow deposits.

We are starting to see a little bit of that in the markets, and I think that will get more so as we move up the rate curve.

Last question.

Can you just talk more about some of the additions in terms of staffing that you have been able to have in both Atlanta and D.C. on the retail side, retail and commercial?

In Atlanta we completed the bank acquisition this past quarter.

And we already had a cadre, I think, of 25 mid 20s to add to that banking acquisition.

And we have been able to continue to acquire experienced people out of that market, and we're very, very excited about it.

I think your second region was the Maryland or the Virginia area, the Virginia market.

The Virginia market, we have continued to add to our staffing in that much the same way.

We opened our seventh branch earlier this year, and we continue to staff in those branches and with our specialized banking.

Our major emphasis lately has been to add small-business relationship managers, which is your commercial lenders.

Do you have any details on the either headcount or maybe just producers in either market?

We sure do.

I don't have it here in front of me.

I would be glad to get that to you.

Jackie Reeves, Ryan Beck.

Could you just maybe discuss a little bit more about the way you look at the servicings -- I was telling on the last question -- and what the odds of seeing a large recapture might be?

We have taken permanent impairment, Jackie, as we have gone through this process.

So, a large recapture is not something that we would -- we have talked about that as we have gone through this cycle.

We have been very diligent on the fact that anything that we didn't have in the portfolio, as it got paid off, we weren't sitting there taking a lot of temporary impairment and building up a big reserve.

So, what we would be looking at is more of what value would build in the servicing portfolio in your market versus what you'd have on the books.

So, it would not come through a big recovery out of a temporary impairment reserve.

If anything, we would see the servicing values increase faster than what we would see the book value increase.

And, Jackie, what we'd realize out of that is less amortization relative to our MSR value than others that write up their servicing.

Terrific.

And then, could you just give us a little bit more clarity if we're talking about the loan volume, and it was broad-based?

I guess that's just across the entire country.

Were there any specific areas of strength that you could identify or give us some more color on?

It is very granular in the sense that we have got probably 40-something states covered in the markets that we've got across the country.

We're in 50 metro areas.

And so, that's what we were basically getting at is from a geographic standpoint, we're not picking any pockets and we're not concentrated in any particular area.

Also in the product mix that I think is very important to highlight is that if you look at what we have seen in the past, the HELOC growth has been one of the primary sources of growth.

If you see that actually starting to now continue to grow but not at the rapid pace it was at -- we're seeing good C&I growth; we're seeing good, like I talked about, one-time close; we're seeing good homebuilder finance; we're seeing good commercial real estate.

So, across the categories that we would expect to see growth, we're seeing almost all of those categories provide growth for the loan portfolio instead of being so reliant on one particular product.

Terrific.

Just lastly, on the fixed income side, obviously, with the challenges that business faced in general, are there any things or any items that you're working on to further improve the margins in that area?

Yes, Jackie.

I'm sorry;

I keep calling you Jackie, Cathy (ph).

I apologize.

Yes, we continue to work on the overhead cost of our fixed income business, and we are making good progress there.

Obviously, it would take a tremendous amount of progress to offset the loss of revenue.

We continue to expand our customer base and we continue to expand the product offering to that customer base.

And I can tell you I'm very happy with the work that that management team has done in expanding the product offering to that same customer base.

Is that product offering expansion beyond the (indiscernible)?

Yes, definitely.

You will see it in the structured finance business that we do for those depository institutions.

Investment banking would be another one that we've been able to expand.

The other two things, Jackie, that I would point out is -- one, the other thing is if you look at the net interest income, net interest income is a drag on the current margin today when you look at the efficiency ratio because of the flatness of the yield curve.

Actually it's producing a negative net interest income.

And that is because what you would typically have is the cost of carry on the yield curve that would produce a positive -- would offset the hedging costs.

And we're very stringent on the sense that we don't take any market position out at Capital Markets.

So, the drag that we're getting out of net interest income today with the very flat yield curve creates a pressure on the efficiency ratio that in a typical market you're not going to have.

They are looking at -- and if you look at this quarter -- ways to begin to look at other ways to hedge.

In other words, what we do to create as clean a hedge as we can -- and especially with the steep yield curve you can get away with this -- is use the cash market for all of your hedging vehicles.

What we're now doing is looking at how can we go off balance sheet and begin to utilize some of the off-balance sheet instruments in order to hedge the inventories -- therefore, reducing that cost of carry that we would have.

And you're seeing some of that benefit this quarter add to their drag on net interest margin lesson that we talked about and highlighted earlier.

The other thing that we are continuing to do is look at our fixed costs, and we are continuing to make improvements in those costs as well.

However, this is a business that you want to continue to make sure that you have got the infrastructure in place so that when the market does turn, you're able to take advantage of that.

And that has always been what we have been able to do in the past.

So, as the market comes back, we don't want to cut the infrastructure down to a level that we're not in a position to be able to take advantage of that.

So, we are doing several things in a sense to try to ration that fixed cost to an appropriate level, but we're also very interested and focused on the fact that we don't want to go so far that we don't prepare for the market that's going to be there next year or the year after, when we do have capacity to generate a lot of earnings.

Joe Stieven, Stieven Capital Advisors.

Just a couple of questions.

A couple of my first ones were answered already.

When you look at your construction portfolio and the great growth that you guys are having, where do you sort of think that will end up a year or two years from now as sort of a percentage of things?

That's question number one.

And then question number two is your provision in the quarter was, obviously, elevated, but your charge-offs remain relatively good still.

Now, you did talk about your Hurricane Katrina provision, but can you just give us a couple of thoughts on the provisioning going forward?

That's it, guys.

Good quarter.

Joe, the percentage -- your first question; if you would repeat that for me on the percentage.

How big on a percentage basis could the construction portfolio grow to, you sort of think, over time?

If you look at the provision question first, we talked about last year that the provision was going to begin to increase because of the loan growth that we have had.

Again, this isn't tied to asset quality issues because like you said, net charge-offs and nonperformers continued to improve this quarter.

But we were getting to a level where we wanted to make sure that we were putting the allowance out there, that we were looking at the loan growth that we had.

And we have been, again, providing over what we have had in net charge-offs.

But we wanted to make sure that as we began to come out of what we know is the best of times today, that we were making sure that our allowance was adequate for whenever that turn in the economy was to happen down the road.

So, this was a very planned movement.

It was a part of what our core earnings would have to over come.

And we have been able to do that over the last year.

And it's strictly off of our loan loss bridle (ph) that does it by loan category, by FICO and the consumer.

And we're following that model and followed it up and down in the cycle.

It has been a very good model for us and we believe that it will continue to be a good disciplined way.

Obviously, as you create loan growth, you're going to provide for the coverage ratio -- or not the coverage ratio, but the coverage for the expected losses that you're underwriting to.

The other thing that you asked was the construction portfolio.

And while it is growing, again, very strongly now, we realize that that's really two-pronged.

One is the expansion that we have been able to build with our sales force, as well as a good housing market.

So, just like Mortgage and Capital Markets when they were in their peak environment represented a higher percentage, especially of if you look at incremental growth today, that is the case for construction lending at this point of the cycle.

This is a part of the cycle where they do very well.

That is added to the success we've been able to have to recruit.

So, we don't see the percentage continuing to increase at the pace it has been at, but that over the next 12 to 18 months you'll see that begin to level out as we go through the strategy.

Heather Wolf, Merrill Lynch.

Just a few questions for you.

First of all, can you discuss the roughly $6 million increase quarter-over-quarter in your other other revenue?

If you look at the other other revenues for the total corporate, that $6 million is going to be tied to the settlement with the insurance company that we had.

So, that's where that revenue would have shown up, is in that category.

Okay, let's see.

Secondly, can you discuss the trend in other other fees in your Mortgage bank?

Is that largely due to appraisal fees and whatnot, and how sustainable is that number?

And that other fees will move with when you're looking at origination fees, so you will begin to see those -- again, we had a good origination quarter given the activity that picked up at the end of the second quarter.

So, you would have seen a pickup in other fees that would have paralleled the increase in origination activity.

So, as we stated, we wouldn't expect all of that to hold over into the fourth quarter because of now we're back to a pipeline that's back to normal and run rates in the refinancing activities that are more sustainable that we're going into the fourth quarter with.

I apologize;

I got on the call late, so I'm guessing you may have mentioned some of this stuff.

Also, can you address -- it looks like the sales force in your Mortgage division has peaked out and it's starting to retrench a little bit.

Is that due to your own corporate actions, or is that due to people picking folks off from you?

We have begun to take a little bit of a break in the third quarter, but we're continuing to show growth and continuing to still look at how to expand that sales force.

There will be particular markets that we're going in.

But there is -- again, we're in a market where we are turning over sales to people.

We're in a market where you have -- starting to see some contraction in the overall activity levels.

Last year, for instance, we were able to grow our sales force when we saw a good, in a sense, underneath that turnover, in a sense of the producers we were getting in versus those that were just deciding to get out.

So, we haven't seen really any significant impact from improvement out of what we have; it's just the flow in and out that we're going to see each quarter.

Overall, we should still see growth there.

Gary Tenner, SunTrust Robinson-Humphrey.

I wonder if you could break out on the Capital Markets business the fixed income between depository and nondepository fees?

The nondepository was a little bit larger than the depository, but they were pretty close to each other, as they have been in the prior quarters.

And what we were looking at was the fixed income, both depository and nondepository, have been moving pretty close in the same.

The trends have been similar, where as we looked at it in the past, we had had the assumption before this cycle that the nondepository might act differently than the depository because of liquidity issues in the banks across the country.

That really hasn't played out.

And it gets kind of confusing -- and these were leases -- when we're talking about nondepository and depository.

We wanted to focus on the strategy of fixed income versus other products, because those two are the real big pieces.

And those will have different cyclical and trending issues.

So, going forward you won't be reporting those separately anymore?

Right.

We think that basically they act pretty close together, so we wanted to highlight fixed income versus other and just clean that up, versus talking about that so much in the press release.

Can you also just give us a little more insight into the size of your potential exposure, I guess, on the Gulf Coast from the hurricanes?

We are diligently trying to determine that exposure.

And, obviously, everything you do today has to be an estimate, because you don't know how the insurance companies are going to react or how much black mold there's going to be.

And the employment factor is going to -- reemployment factor is going to be very important.

We have limited exposure to the Coast, and I will get Marty to give you the details, but our exposure basically comes in two portfolios.

One is in the consumer lending through the second mortgage and home equity lines and home equity credits.

And then the third would be the servicing -- I mean the second would be the servicing portfolio.

Let me address the servicing portfolio and I'll ask Marty to give you the details on the other portfolios.

The servicing portfolio exposure in that market is less than one-half of 1 percent.

So, it's pretty insignificant to us.

And the loss that we took in the third quarter, $3 million of it was attributed to that servicing portfolio.

Marty, why don't you cover the credit port (ph) side?

In the credit side, we looked at the direct hit areas, because those are the areas that we believe could potentially act differently than what we've seen in the past.

We have been through, as other banks have, these hurricane situations in the past.

And we haven't seen the portfolios act significantly different than what they did prior to those, because the insurance came in and did the things that they were supposed to do and backstopped whatever damage that there could have been.

If you look at the direct hit area, we have had $60 million in loans.

We took an additional provision this quarter of $3.8 million and we've got $1.3 million in existing reserves.

So, today we would have a little over $5 million of reserves against that $60 million of exposed loans in that direct hit area.

That is roughly 8.5% of that loan portfolio.

Gary, thank you.

There are no further questions, so we will call this call to an end.

And I want to end by thanking all of you for your interest in First Horizon and wish you a happy day.

That does conclude today's conference.

Again, thank you for your participation.