First Horizon Corp (FHN) 2005 Q4 法說會逐字稿

Welcome to First Horizon National Corporation fourth quarter earnings conference call.

Today's call is being recorded.

In addition you can listen along simultaneously at www.shareholder.com/SHMC/media+list.cfm.

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

And Martin 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 risk and uncertainties.

A number of factors that 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 but the floor will be open for questions. (OPERATOR INSTRUCTIONS) At this time I will turn the call over to your host.

Please go ahead sirs.

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

Earlier we indicated that as long as there was no further deterioration in the operating environment, our earnings growth would resume in the second half of 2005.

Well we all know that the operating environment did deteriorate, but I am pleased to say that we did deliver growth, 5% for the fourth quarter and more importantly 3% for the second half of the year.

Fourth quarter earnings were $0.85 after the cumulative effect of a change in accounting principles of $0.02 compared to $0.81 in the fourth quarter of last year and $1.75 for the second half of 2005 compared to $1.70 for the second half of 2004.

This growth in the face of a yield curve headwinds negatively affecting our capital markets and mortgage banking businesses shows the strength of our retail commercial banking and national expansion strategies along with our efficiency initiatives.

Let me put this into context.

Since the Fed started raising rates in the third quarter 2004, the yield curve as represented by the spread of the 10-year Treasury rate and the Fed funds rate has flattened every quarter falling from 358 basis points in the second quarter of 2004 to an average of 50 basis points in the fourth quarter of 2005 to its current level of approximately 10 basis points.

From an earnings perspective, we are a dynamic company; depending on the overall market conditions our earnings contribution from segment to segment may vary.

In this rate environment our earnings contribution has shifted from our business of mortgage and capital markets banking to retail commercial banking which made up 83% of our fourth quarter earnings.

This quarter's trends continue to display the successful execution of our long-term strategy.

Some highlights demonstrating our continued strategic success are, fourth quarter pretax earnings in the retail commercial banking continue to experience double-digit growth at 16% over last year.

We continue to leverage our leading market position in Tennessee by expanding our sales force, adding new financial centers in Nashville and aggressively marketing to customers of merging banks.

This effort produced 75 basis points of marketshare gain in 2005 in both the consumer and business markets.

Our national expansion strategy continues to gain momentum.

The cross-sell penetration of our mortgage customers who have purchased additional banking products increased another full percentage point to 38% in the fourth quarter.

Additionally, as we expand our deposit taking capabilities nationally, deposit growth from these areas continue to build momentum.

Our home purchase originations grew more than 10% faster than the national market last year as the size of our sales force increased by over 200, representing a 9% increase.

Our mortgage servicing portfolio profitability continues to improve.

The servicing cost for loan has declined 9% and impairment costs have subsided.

Finally, capital markets, other product revenues including investment banking and equity research continues to grow as FTN Financial introduces new products to the market.

Additionally, fixed income revenues equal their production from the previous quarter for the first time since the Fed began to increase rates which we view as a potential sign of stabilization.

This obviously would exclude the first quarter of 2005 when the impact of the Spear, Leeds & Kellogg acquisition increased fixed income revenues.

With that, let me turn it over to Marty to discuss the details of the quarter.

And then I will come back and talk about 2006 and then we will take your questions.

Thanks, Ken, and before I highlight a few items in this quarter I would like to take some time to apologize for the delay in getting our earnings release and supplement out to you yesterday.

We had the best intentions of getting you the information earlier so you would have a chance to digest the details before our call this morning.

However, it has been a while since we released in the afternoon and due to technical delays it took much longer than expected for the information to pass through the distribution channels.

I am truly sorry for any inconvenience this might have caused you.

Hopefully you are able to get the information earlier than if we had released this morning but next time we will adjust in order to make sure you can get the information even sooner.

Now moving on to this quarter's results.

This quarter we adopted FIN 47 which is accounting for conditional asset retirement obligations.

The accounting change requires companies to accrue for the liability related to asbestos removal and became effective on December 31st with a cumulative effect adjustment.

As a result net income was decreased by $3.1 million which was recorded in the retail commercial bank this quarter.

Thus our reported earnings per share of $0.85 or $0.87 before the cumulative effect of this accounting change.

Periodically we evaluate the markets we serve to determine if they are still strategic to our overall plans.

This quarter a $7 million gain resulted from the sale of three financial centers in a nonstrategic Tennessee market.

Additionally, you might have heard in the industry news bankruptcy laws changed in October having a significant impact on several consumer lenders.

This quarter's results included an acceleration of households declaring bankruptcy in order to benefit from the old laws before they changed.

The impact on our credit card and home equity net charge-offs was an increase of approximately $2 million this quarter.

We do not anticipate that this impact will continue into the future quarters.

As you will remember two large hurricanes Rita and Katrina, hit the Southeast and Gulf Coast during third quarter Q3 '05.

As a result in third quarter we increased loan loss reserves for the consumer and credit card portfolios to cover an estimated $3.8 million in additional projected credit losses.

Additionally, we set aside 3.5 million for impairment in the servicing portfolio.

Our experience has been that the insurance industry has performed well and any losses incurred have been within our estimated ranges.

Thus the performance of the portfolios in the affected areas has been as expected and we believe that the reserves created in the third quarter continue to be adequate.

One of the fundamental ratios that the market has been very focused on throughout 2005 has been the net interest margin.

After the acquisition of Spear, Leeds & Kellogg in the first quarter of 2005 our net interest margin declined 45 basis points due to the associated increase of their assets.

We have discussed the driving impacts or net interest margin contraction throughout the year.

However, the eventual proof is in the performance.

Since first quarter First Horizon's corporate net interest margin has stabilized only experiencing 6 basis points of compression.

More importantly the retail commercial banks net interest margin has remained very strong at 4.19% and has only narrowed 10 basis points in total over the last year.

Our balance sheet remains GAAP neutral with incremental loan growth matched against like maturity deposits and purchase funds.

The primary impact that the yield curve environment has had on our balance sheet is the narrowing of the spread on our mortgage warehouse.

As the Fed funds rate is approaching the 10-year Treasury, the spread on the warehouse continues to contract.

We average approximately $4 billion in the mortgage warehouse, thus every 10 basis points of compression creates $1 million less in net interest income per quarter.

Another fundamental highlight is that our asset quality continues to be strong.

Even with the increase in bankruptcy net charge-offs in the consumer portfolio, our net charge-off rate remained relatively low at 22 basis points this quarter.

This reflects the sound asset quality foundation and customer relationship strategies embedded in the loan growth we have been experiencing.

Before I turn it back over to Ken I would like to take a minute to outline some unusual items that could impact our first quarter.

The transition into the first quarter has always been difficult for the market to forecast.

There are several seasonal trends which typically lower our earnings a couple of cents between the fourth and first quarters.

For example home purchases slow over the holidays and into the winter months leaving mortgage production and first quarter deliveries at their lowest point in the first quarter.

First quarter 2006 could have several other items which could make the reported numbers even more difficult to predict than normal.

There are at least two items that you should be aware of as we go into the first quarter.

Adding to the complexity of the first quarter will be the adoption of FASB 123R.

Currently we estimate the impact of this accounting change to range between $0.07 and $0.10 in 2006.

We will be restating the prior year's earnings for the impact of this change as well.

Also, there is another potential accounting change that could be adopted in the first quarter.

Fair value accounting for mortgage servicing rights might be finalized in the first quarter of 2006 with early adoption available beginning in that quarter.

This accounting change could permit mark-to-market accounting for our servicing mortgage servicing rights.

The adoption of this change if elected would be presented as a cumulative effect.

Thanks for your attention to these details.

We will further discuss the impact of these matters when we release first quarter earnings in April.

Thank you Marty.

As we look at 2006 we are encouraged about the opportunities we see in our businesses, in the progress that we have been making on our earning enhancements.

In considering the outlook for 2006 there are several points that must be considered.

First, during 2005 our quarterly earnings level was relatively constant despite the ever-growing and favorable impact from the flatter yield curve.

This was the case because our business growth, coupled with our earnings enhancements, enabled us to replace the earnings loss from the flattening yield curve.

Second, for 2006 we are doubling the level of earning enhancements we achieved in the third and fourth quarters of 2005.

Third, retail commercial banking earnings should maintain the double-digit growth as we continue the successful execution of our national and our Tennessee expansion strategies.

Fourth, our mortgage banking earnings should only show a slight decline from 2005 since we have a 9% larger origination sales force as we begin the year, and a planned increase of an additional 8% this year.

Also, we have a servicing business which provides a natural hedge to a decline in the origination business, which is 10% larger than a year ago.

And a servicing cost that is 9% lower.

Fifth, after stabilizing in the fourth quarter capital markets earnings are expected to begin to grow again in 2006.

Other product revenues are expected to continue strong growth this year as we continue to expand investment banking activities and introduce additional new products.

Also the demand for fixed income products could experience somewhat of a rebound once the Fed is finished raising rates.

In summary, our increased level of earning enhancements should offset most of the impact from the further expected flattening of the yield curve allowing our strategic earnings growth to be more reflected on the bottom line and when the yield curve stops flattening our growth will accelerate.

With that I want to thank you and we will take questions.

(OPERATOR INSTRUCTIONS).

We will take our first question from Gary Tenner with SunTrust Robinson Humphrey.

Ken, I think you just mentioned at the tail end here the earnings enhancements as far as doubling what has been done in the second half of '05 as you go into 2006.

Can you go into a little more detail on some of the things that you have planned in 2006 on that side?

Sure.

And let me start by stating it is more than a plan.

These enhancements are well under the way of being executed.

We have got a lot of benefit coming from investments we have made over the last several years.

I ask you to recall that we made substantial investments in our infrastructure and retail commercial bank when we were generating a lot of income from the mortgage banking business in '01, '02 and '03 and in early '04.

And a lot of that -- a lot of the benefits we are getting are implementation of some of the technology investments we made.

The Check 21 we have an advanced check processing technology and with the implementation of that we are now eliminating the extra check processing center that we have located in East Tennessee.

So we are moving to one check processing center.

We have been busy over the last couple years installing some very sophisticated consumer loan technology, both the front-end system and the operations system.

So we are getting consolidation of our multiple consumer loan platforms into one.

We are consolidating several of our consumer loan operations.

We had five went light weight early last year or before last year; we had five different consumer loan operations going between our Dallas, our national operations and Memphis.

We have consolidated some of the technology functions that exist between Dallas and Memphis, Tennessee.

We have three or four call centers.

We have upgraded the technology in those call centers and have eliminated one or two of those call centers for significant savings.

As you can imagine to get $50 million we have got a huge array of things.

Those are the ones that would make up the large single bulk of the dollars.

Just I guess specifically to the processing center that you mentioned, when is that scheduled to be closed down and what is the incremental expense savings on it?

That center will be closed down I think sometime this first quarter, and that will be a couple million dollars.

A couple million dollars per quarter?

No, for the year.

The year.

Okay.

The largest single -- I think the largest single effort we have will be $6 million on an annual basis.

And that is the consumer loan platforms and operations.

So rest of them range individually less than a $6 million level.

The $6 million is almost 12% of the total.

And one follow-up question, wonder if you could just comment on the progress you are making in terms of converting First Horizon mortgage offices into deposit accepting offices and/or fuller branch type of offices.

Sure.

We are very much on track with that.

And that would be where we move financial center threes to financial center fours.

And we have got a regular schedule of which ones of those we will do in each timeframe and we are right on that schedule.

I don't have here in front of me the exact number, but I would be glad to get that to you and we generally share that in our analyst presentations as to how much movement we make each quarter but that is going very well.

We will take our next question from Kevin Reynolds with the Stanford Group.

I have got a couple of questions as you know, a couple of things that have been on my mind for a little while.

The loan-to-deposit ratio in the retail banking segment, there is still a wide gap.

And as I calculate loans are up or average loans are up about 18% year-over-year and then deposit growth strong at 14 or so, 14 to 15% but still lagging behind.

What are the plans and maybe how should we think about this, how long is the time horizon where the deposit growth starts to really catch up with the loan growth and you can shrink that gap a bit between loans and deposits in the banking segment?

Well Kevin a couple of things to look at there is one -- as we entered '05 that gap was up around 16 or 17%.

So over this year we have actually narrowed the gap from that number down to earlier in the year it was closer to 7 to 8%.

In the second half of this year it has been closer to 4%.

So we made tremendous strides in being able to begin the rollout as we have been doing the financial center threes, the financial center fours, our deposit taking capabilities on a nationwide basis.

Today we have over one-half billion dollars in deposit related to customers outside of Tennessee.

So we are seeing good progress in our ability to do that.

We are looking at a continuing to evaluate securitization and how much we would like to keep on the books or retain out of the originations that we are producing.

The gap of 4% that we are at today we can fund, we are continuing to be able to leverage the marketplace.

We are matching both from a liquidity standpoint as well as a rate sensitivity standpoint anything that we are having to fill on the purchase money side.

And we felt very comfortable with, as loan-to-deposit ratio is increasing there is other secondary ratios that we are managing holding flat in order to maintain the liquidity position that we have today.

We have a very strong contingency plan that has been reviewed by rating agencies or regulators and we have got great marks on what we have there.

From just a pure earnings perspective, however, if the Fed were to stop soon and there is still some debate on that, but for the sake of argument let's say it happens and the curve steepened back up as you were suggesting it might at some point in the future, Ken, I guess we know it will at some point in the future.

Does this gap between loans and deposits to the retail bank in your mind, does that then become actually a positive for you from a margin perspective?

Or have you been so successful that kind of match funding and maintaining neutrality that it won't really have any impact.

Two things Kevin.

One is if you look at what we talked about and we are very adamant is that we are match funding this loan growth.

So there isn't any play on what happens in interest rates and that hasn't impacted our retail commercial bank net interest margin.

So, no that part of the balance sheet will continue to be pretty much solidified.

There is not an impact from the interest rate environment or the yield curve on the spread between our loans and deposits.

I want to make sure that we also clarify one of the things that you said which we were not foreshadowing that the yield curve was going to start steepening nor were we really talking about that or conditioning our earnings around that particular statement.

All we were saying is that once the yield curve stops deteriorating, we have had deterioration in the yield curve steepness every quarter since the third quarter of 2004.

And what we are looking for and what we would expect is that at some point that deterioration just stops.

And as that deterioration stops then the strategic growth and earnings enhancement will begin to be able to show through to the bottom line results and the growth that we've talked about.

Understood.

And I guess one last question given the strength of loan growth and then particularly my understanding that you have had a lot of success in construction lending outside the state of Tennessee which is helping to fuel that growth, what are the reserve implications as we go forward?

You know we've talked about this with you for many, many quarters now; help me again to get comfortable with the level of reserves, how you arrive at that number, what the regulators would be saying versus what the accountants might be saying about potential risk out there particularly in say a construction portfolio.

If you look at the provisioning and look at how we have been doing that, we have been saying for a long time that the mix of loans has changed.

And what we have seen since we were back in '01 where we were at that higher level to where we're at today, the mix change has made up 80% of that shift in our coverage.

So we have stayed very true to the model that we had.

That has been what we have continued to apply to the loan growth that we have got.

And you look at what we have had is that consumer lending in the home equity -- which has the collateral behind it -- just requires less provisioning.

What we're now seeing is equaling out this commercial loan growth.

So what we have seen is a stabilization and actually we have been fluctuating in the 90 to 95 basis point coverage range for a while now and we feel like it is going to kind of sit there and continue at that level given the mix of growth that we see going forward.

Heather Wolf with Merrill Lynch.

Let's see my first question was on the increase in the thirty-day delinquencies I believe it was.

Was that hurricane related or bankruptcy related?

No, obviously there would be some hurricane related.

Our hurricane portfolio today is running about twice what the other portfolio is.

In other words, we are about a little less than 1%, and if you put the hurricane loans on there they run at around 2% which is what we were expecting as we went through this process.

But they are very small --

Very small part of the portfolio.

The other thing Heather is that if you look at the 90 days they are just fluctuations in particular quarters, some seasonal impact.

If you look at the size of the portfolio the ratio as compared to the overall portfolios remain relatively constant and even the level is constant if you compare back to where we were a year ago.

So there are going to be natural fluctuations as we go through this from quarter-to-quarter.

But generally what we have seen is that the ratio to the loan portfolio has been relatively flat and if you compare back to the seasonally the same quarter last year, we are at the same level that we were last year.

Great.

And then I noticed in the gain on sale margin that the concessions that you're offering this quarter increased.

Can you talk a little bit about that trend?

We have seen pricing pressure in the marketplace.

We did see our overall margins though improve this quarter so that was a favorable.

We were at 98 basis points and so that was one of the things that we were talking about last quarter, is that that number had been under pressure mainly because of the market that we were delivering into which pushed our marketing gains and losses down last quarter.

So we returned to a more normal line there.

On the other side we saw more pricing concessions that we did see in the marketplace.

We have been holding our margins relative to the market that is out there and we did see because interest rates were higher that the value of the servicing or the OMSRs was a little bit higher this quarter.

So all in all it was a good performance on our margin, we did see a little more pricing competition.

And can you refresh our memories on what kind of a market equates to very strong trading gains and losses?

It is not a particular market.

It is really the day-to-day fluctuations as you originate the loans you need to deliver them into the marketplace.

So it is a combination of many factors.

There is not one particular factor that is good or bad.

The only one that you can say is generally almost always positive is if you had a very slight decline, as you go forward through a quarter, that is a general trend that can produce a favorable results and did in earlier quarters back in '03.

And then one last question on the earnings enhancement, I know that you had mentioned that you expect sort of the double impact of that in 2006.

But if I look at the efficiency ratio in your retail bank which I suspect is where a lot of those are coming in, you are still hovering on a core basis at about 60%.

I'm curious if you can tell us what amount of enhancement you have seen thus far and what you think you'll see in '06?

Heather, we were in somewhere around an average of $0.04 a quarter for the last half of '05 out of the efficiencies. $0.03 to $0.06.

So second half of the year this year in '06 that will double our $50 million run rate -- I mean our $50 million on an annualized basis will double what we experienced on an annualized basis for the second half.

Some of those efficiencies are in the bank; some of them are in the mortgage company and some of them are in the corporate functions.

And the reduction in capital markets fixed costs (technical difficulty) would be favorable.

But Heather if you look at the bank's efficiency ratio as compared to the second quarter when we began talking about these efficiency numbers, it has gone from 62% to 59%.

And if you compare the last year it went from 61 to 59.

So we have been making progress over the last two quarters and we would continue to see that progress in efficiency ratio as we go into next year.

Christopher Marinac with FIG Partners.

I wanted to ask a couple of particular questions on the servicing piece, and Marty I'm curious if you think that the hedge gains or losses, is there anyway to sort of predict those going forward?

One of the impacts of a flatter yield curve is that there is some additional cost in hedging your servicing portfolio.

So what we have seen is that in general, we would expect that number to be relatively neutral unless there was a lot of prepays or refinancing activity.

So as we were going to go forward we would expect that that number would continue to be relatively neutral to our earnings.

And fairly close to the levels that we have seen here in the third and fourth quarters which again are inflated costs because of where the yield curve is at this point.

So where we would see a negative $4 million in third quarter or $4 million here in the fourth quarter from total hedge gains that number typically would be relatively flat.

But because of the yield curve shape today we have a little bit of cost going through that.

Now to that point what is the likelihood that the prepays stay high, that your overall amortization expense just stays high because of where rates are?

Amortization expense hasn't fluctuated very much because it is really tied -- it doesn't get tied so much to the prepayment number as it just is the size of the portfolio.

Your impairment costs are really where you see a lot of the impact from the prepayments.

And what we have seen in the last two quarters is impairment costs have been relatively zero.

I guess on the production side given the staffing increases that have gone on as you buildout the footprint would production levels this year be down significantly, down a little bit, mainly sort of feel for production this year.

Chris, as we stated earlier we expect production to be down slightly.

The market forecast is somewhere around 15 to 20% decline in mortgage originations.

We are able to produce a better origination rate than the national market, and we have increased -- with the increase of our sales force should offset that substantially.

Great.

And I guess last question Ken, can you give us any perspective in terms of how large you would like to see Atlanta and DC be?

Maybe that's a two or three year question, not a couple of quarters, but just looking out.

In two to three years we think each of those metro area -- a metro area that we have expanded into so you take Virginia, the Fairfax Virginia, you take Atlanta, you take the Dallas-Fort Worth market -- would be at least $1 billion in three years.

And that is mostly organic if not all?

That is all organic; well you might -- in Atlanta we started with 100 million, we bought a bank to get a charter for $100 million.

So it is organic.

Very good.

Thank you.

We will take our final question from Gary Townsend with Friedman, Billings, Ramsey.

I have been a little distracted.

I'm sorry if you have covered this already but --

Hello?

We last Gary.

My apologies.

One moment.

Mr. Townsend please continue with your question.

Forgive me.

I seemed to have dropped off there.

Just if you could quickly cover again, if you haven't already, your interest rate outlook for the rest of the year, the number of rate increases and when?

In our forecast we would think that there would be one more rate increase to 4.5% on the Fed funds side.

And then after that it would expect to slow down.

Slow down to zero?

Yes.

That we wouldn't see anymore for the rest of the year.

Thank you.

Thank you.

Thank you everyone and you all have a good day and we appreciate your continued interest in our organization.

Ladies and gentlemen, this does conclude the First Horizon National Corporation conference call.

At this time you may now disconnect and have a great day.