First Horizon Corp (FHN) 2006 Q1 法說會逐字稿

Welcome to First Horizon National Corporation's first-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 by Jerry Baker, Chief Operating Officer, and Mark Yates, Director of Investor Relations.

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

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

Those factors are outlined in the recent earnings press release and more in the most 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.

Sir, you may begin.

Thank you.

Good morning, and I want to thank all of you for joining us today to discuss our first-quarter earnings.

Our reported earnings for the first quarter are $1.67; and I wish I could stop right there an move on, but I must go on to say that this includes the impacts from a gain on the sale of discontinued operations; the cumulative effect of accounting changes; and several transactions that (technical difficulty) expense in this quarter.

Let me give you my overview of the first quarter.

The Retail/Commercial Bank continued to show its growth in loans and deposits well above the market growth rates.

The two drivers of this excellent growth were the success of our national expansion and our ability to take market share in Tennessee.

Capital Markets also showed growth in earnings over fourth quarter through an increase in fixed-income sales and continued growth in other products, including equity research, investment banking, and structured finance.

The one business that presented the biggest challenge was Mortgage Banking.

That industry experienced a decline in originations of 20%, while First Horizon home loans held its decline to 14%.

Also, we incurred an increased level of net hedge losses.

We are off to an excellent start on our efficiency efforts.

We told you that $50 million was our target for the year, and in the first quarter we realized $9 million of that amount, and we are on plan to achieve our target for the year.

The merchant divestiture was a major transaction that will benefit us throughout this year and going forward.

It is the most significant of the numerous unusual items occurring this quarter.

On March 1, we sold our merchant credit card processing business for an after-tax net gain of $208 million.

Currently, First Horizon entered into an accelerated stock buyback agreement for 4 million shares to offset the earnings per share impact from the loss of the merchant business.

This buyback, in combination with our actions taken in utilizing the additional proceeds from the merchant divestiture, is expected to produce more than $30 million in pretax earnings in 2006.

The most significant of these actions was the restructuring of approximately $2.3 billion of investment securities.

Although the restructuring resulted in an $81 million expense this quarter, the yield pickup will generate more than $20 million in additional net interest income this year, while maintaining the expected average life and characteristics of the portfolio.

Also, the adoption of two new accounting standards and a change in accounting interpretation affected this quarter.

These, along with all the other actions are shown in the table in the press release, and Marty will talk about them in more detail a little later.

The Retail/Commercial Bank continued its earnings growth trend of approximately 20% since the first quarter of last year.

The major drivers of this growth were a 24% increase in loans, 11% increase in deposits, and our efficiency gains.

Let me take a minute and talk more about what is behind this growth.

Over the last year, we have added 100 banking specialists to our mortgage offices nationwide.

As a result, cross-selling of banking products to our Mortgage Banking customers continues to rise.

We now have 230,000 households who have purchased two or more products from us.

That is a cross-sell penetration of 39% of our national mortgage customer base, which is up from 38% at year-end.

In March, 14% of our customers who took out a new mortgage opened a deposit account.

That is compared to 2% one year ago.

On the other hand, in mortgage the origination market contains to be increasingly competitive, as the industrywide production is contracting.

Also, the nonprime mortgage investors' appetite has shifted to the higher-quality segments of the nonprime market, creating more competition and lower margins.

In response, we have adapted our pricing, lowered our fixed cost, and adjusted our underwriting standards.

In recent transactions we have begun to show improved profitability.

But we're still managing to increase our market share.

Compared to last year, First Horizon's originations only declined 10% compared to 17% in the mortgage industry.

We accomplished this favorable relative performance while producing an origination margin of 97 basis points, which we believe is well above the industry.

Capital Markets experienced pickup in fixed income demand this quarter.

Sequentially, fixed income was up 14% compared to the fourth quarter of 2005.

While fixed-income revenues remain 20% below last year's first quarter, Capital Markets' other product revenues have grown 32% as compared to the first quarter of 2005, and are up 15% from fourth-quarter levels.

While strategic progress continues to be positive, the environment, as anticipated, remained challenging during the first quarter.

As you know, one of the major impacts of the environment was the additional flattening of the yield curve by 31 basis points since fourth-quarter 2005 and 164 basis points from a year ago.

Also, the consumer market continues its shift to fixed-rate installment loans from variable-rate HELOCs.

Fixed-rate installment loans have narrower spreads and receive lower margins when securitized or sold into the market.

As we have highlighted over the past few quarters, we continue to improve efficiencies and enhance earnings in order to mitigate the challenging operating environment.

As I have mentioned, we are well on our way to achieving our targeted efficiency results for the year.

We have generated $9 million in efficiency gains.

Compared to our base results for the fourth quarter, these savings resulted in more than 100 basis points improvement in the Retail/Commercial Banking efficiency ratio; a quarterly reduction of $1 million in overhead costs in the mortgage company; and a 300 basis points improvement in the Capital Markets efficiency ratio.

We have another 20 initiatives that when implemented will have a positive impact throughout the remainder of this year, allowing us to achieve our target of $50 million for the year.

Now I will hand it Ever to Marty to go through the financial performance in more detail, and then I will be back with some closing thoughts.

Thanks, Ken, and good morning.

Our first-quarter reported earnings per share was $1.67.

Before discontinued operations and the cumulative effect of accounting changes, the reported earnings per share drops to $0.03.

As you can obviously tell from these two distinctly different reported earnings, First Horizon's performance in the first quarter was impacted by several items, which included the already announced merchant credit card divestiture; transactions through which the incremental capital provided by that divestiture were utilized; various other transactions which should improve future performance; and the adoption of a couple of accounting changes.

Let me start and give you a better sense of how these transactions impacted our financial performance.

First, those items included in our pretax income from continuing operations.

As Ken mentioned earlier, we repositioned approximately $2.3 billion of our investment portfolio.

The average investment yield on the securities sold was about 4.4% and the new reinvestment yields average 5.6%.

This 120 basis point pickup will create more than $20 million in additional net interest income this year.

In total, losses from this sale and the sale of no-balance HELOCs equaled $94 million this quarter.

These sales will contribute approximately $25 million of additional net interest income for the remainder of 2006.

This quarter's results were also unfavorably impacted as two of our businesses adapted to changes in their respective markets.

This quarter, some of our nonprime investors changed their investment criteria and began to put back additional loans to us.

In response, we adapted to their new standards.

However, this resulted in an unexpected higher level of foreclosure losses and other expenses of $13 million this quarter.

In normal quarters, these expenses have been more like $2 million.

Given the changes we have implemented, we believe we will return to historical expense levels in the upcoming quarters.

We have also been rolling out a collectible coins strategy through a relationship we had developed with the U.S. Mint.

Over the last 18 months, First Horizon developed delivery channels and built up inventories to begin execution of this strategic initiative.

Unexpectedly, the leadership of the U.S.

Mint recently changed and their support for this strategy has diminished.

We have adapted our strategy to realign our delivery channels and have devalued our packaging inventory to reflect the current outlook.

This resulted in a $9 million of additional expense in this quarter.

Several transactions were implemented this quarter to enhance our ongoing efficiency initiatives.

These actions included closing mortgage branches and an operations processing center; consolidating some other operations; incurring incremental expenditures on technology designed to improve productivity; as well as retirement, severance, and retention costs.

In total, these initiatives added $11 million of expense this quarter, but should generate $14 million in savings for the rest of the year.

As did many other companies in the industry, First Horizon also re-designated two swaps which were (technical difficulty) our trust preferred debt issuances from shortcut method of hedge accounting to longhaul method of hedge accounting.

This change in interpretation on the application of the shortcut method for hedge accounting created an unfavorable mark-to-market expense this quarter of $16 million.

The adoption of FASB 123(R) increased expenses in continuing operations by $3 million this quarter, as well as its impact and the cumulative effect of change in accounting principles.

Finally, income from continuing operations was unfavorably impacted by $3 million due to the reclassification of presale operations of our merchant processing business to income from discontinued operations.

In total, these items unfavorably impacted pretax income from continuing operations by approximately $147 million, lowering this reported earnings to $0.03 as the income from merchant processing, including this quarter's divestiture gain, has been classified as income from discontinued operations.

The next category of items for those in income from discontinued operations I would like to highlight.

On March 1, we sold our merchant processing business for an after-tax net gain of $208 million.

In addition, approximately $1 million of additional pretax expenses associated with the transaction and the $3 million in presale operations of the merchant processing business previously discussed are included in after-tax income from discontinued operations.

The last impact or category of items in this quarter's reported results are those in cumulative effect of change in accounting principles.

We had two.

We adopted FASB number 123(R), share-based payment and basically stock option expensing, in this quarter resulting in a cumulative effect adjustment of $1 million in after-tax income.

We also adopted FASB number 156, which is accounting for servicing of financial assets, resulting in a cumulative effect adjustment of $300,000 in after-tax income.

Both of these were favorable or positive adjustments.

I know for those of you who have to model this quarter there will be some additional work and work that you have already spent, I think, some of last night working on.

The net benefits, though, that we have been able to accrue through this, I think will be worth the extra effort and thus position us well for future financial performance.

We also accomplished several fundamental initiatives this quarter that enhance our capital and funding positions.

First, we issue $250 million of 10-year subordinated debt.

This incremental capital will help fund the balance sheet growth we are continuing to experience.

Secondly, we executed an on balance sheet securitization this quarter.

These loans are identified separately as real estate loans pledged against other collateralized borrowings.

These loans have their own secured funding and should be excluded from our loan to deposit ratio.

Additionally, and a side note, our book value has been steadily increasing.

Over the last year, book value has grown 14% as it has increased $2.37 to $19.36.

Following the conference call and over the next couple of weeks, Mark and I will be available to answer any of your questions.

I know you'll probably have numerous questions as you digest this information.

Thanks for your patience, and I look forward to hearing from you.

Ken, I can turn it back over to you now.

Okay.

Thank you, Marty.

It is great that our core strategies continue to evolve as planned, especially in the light of the fact that the operating and competitive environments have tightened further, which hurt our first-quarter earnings.

Looking ahead, second quarter's earnings will be benefited as the first quarter's unfavorable impact from seasonality goes away.

Additionally, earnings throughout the remainder of the year should be positively impacted by continued growth in the Retail/Commercial Bank and the incremental benefit of earnings enhancements, including the benefits from the utilization of the merchant sale and other unusual items that we have previously discussed.

Additionally, Capital Markets is positioned to continue its recent growth.

On the other hand, there are a couple of things that I highlighted earlier that should have an unfavorable -- or could have an unfavorable impact.

These include the potential of a more negative mortgage market and any further flattening in the yield curve.

So, assuming a stable operating environment, the continued execution of our strategies, combined with the actions taken in the first quarter, and the continued implementation of our efficiency initiatives, earnings per share for the remainder of the year should exceed that of last year's.

Finally, I am excited to tell you we were named to Fortune's Best Places to Work for the ninth year in a row; and we have been recognized again by Working Mother and AARP as one of the best places to work in the country; and named one of the 100 Best Corporate Citizens by Business Ethics Magazine.

These awards are a testament to our culture and our team at First Horizon, which gives us a distinct competitive advantage.

I am very proud of these recognitions and the hard work and dedication seen in all areas of our organization.

I want to thank you for your attention to these details, and we will now take your questions.

(OPERATOR INSTRUCTIONS) Jason Goldberg of Lehman Brothers.

It would be helpful -- I mean, what do you think you guys earned this quarter?

Well, let me -- what happened -- the way I view the quarter, Jason, is that we pretty much came out in the Retail/Commercial Bank where we expected to with the growth.

Continued growth very much in line with what we had been seeing.

Capital Markets started showing growth, which we anticipated.

And mortgage fell short of our expectations.

Where they fell short was the net hedging loss.

Then I think you -- each of us have to take a couple of items and figure out how to classify them.

One would be the loss we took on the subprime or the nonprime dents and scratches, as we call them here.

The kickbacks that we got from the investors for those.

We had reserved for those that we think we will get going forward based on an increased level that we saw in the first quarter.

That amount, that $13.2 million I think is an exact number, represents a reserve as well for going forward for amounts above our normal level that runs around about 2 to $2.5 million a quarter.

Then in the gain on sale, our gain on sale was very similar to our tracking that we have tracked in the past.

We had a credit card gain in that, that we disclosed this quarter, which we do not normally sell every quarter.

We had a gain on sale on credit card last year.

These are the one product only customer base that builds up over a period of time.

This portfolio, a third of it was in held for sale, left over from the sale we did last year.

The other came out of our non held for sale and represented the agent bank credit card portfolio generated from our merchant credit card business.

So since that business -- we sold the origination business -- or the business that originated those credit cards for us, we divested ourself with those.

But that kept our gain on sale for credit card -- I mean, for loans very similar to our previous levels.

Now, going forward, the thing that we are trying to set forth is the change in the consumer loan mix from HELOCs to -- or variable-rate loans, to fixed-rate loans, reduces our potential for gain on sale.

So we don't anticipate going forward that we would have as much gain on sale on loan sales as we have been reporting.

It is not a significant number.

I think is about $5 million a quarter that we would forecast to be less than the trend that we have been running for the last five quarters.

Those are the major items that really, I think, you have to look at, at how we perform.

We consider the 13, the onetime -- the $13 million loss that we took on the subprime as a onetime unusual item.

We think we have totally cleaned that up and we won't see that kind of level going forward.

So when we look at it, we fell basically short by approximately the additional amount of about $20 million of hedge losses; and we made a little bit of that up with some Capital Markets being slightly above our plan and the Retail/Commercial Bank being right on plan.

Okay.

Then in your comment in the release that EPS and the range over the year should grow over the prior year, does that mean each of the next three quarters should be above what they were in the year-ago quarter?

Yes.

Then too, when we think about that, should we look at EPS from continuing ops or EPS before the cumulative effect change in accounting principle?

I will take that one, Ken.

In the sense that basically you would be looking at diluted EPS, you would not look at the EPS from continuing operations, because in the past numbers it excluded the merchant earnings.

We have been able to, through utilizing the capital generated out of this transaction, we have been able to go out and do the share buyback.

So the share buyback would be the initiative or transaction related to replacing that earnings.

So that would not be our base that we would be growing off of.

It would be comparing to the diluted earnings line.

Super, thank you.

Christopher Marinac of FIG Partners.

I wanted to ask about the dip in NII or net interest income at the Retail Bank.

How much of that was related to just a shorter quarter?

Chris, let me make -- it was difficult for us to hear you.

I think you asked about the dip in NII in the Retail Bank and how much of that related to this quarter?

Right.

That is affected, like you're saying, by the shorter days.

Some of that is offset as you look at NII, if you adjust the NII down in corporate.

So that would be an impact.

You would have seen growth in the Retail/Commercial Banking if you exclude things that happened this quarter.

So sequentially you would have been higher than where you were in the fourth quarter.

Would it be fair to expect that that noise is not in existence next quarter?

Yes.

Okay.

Then on the mortgage business, were you surprised that the overall spread on the margins on delivery were not lower?

No, we were not.

It hit slightly below what we expected at the 97 basis points.

That was for two reasons.

One is that the subprime margins did further tighten.

We don't -- only a small -- I guess about 4% or 5% of our volume is subprime or nonprime, but those continue to tighten industrywide as they did for us.

The second thing was the March margins came in a little lower than we expected, as we finalized the last set of deliveries.

So we were expecting slightly better than the 97 basis points.

We have been running 98, 99 and that is about -- we were expecting about 100.

It hit pretty close to that.

But Ken, you don't think it gets worse than that here in the next two quarters?

It could.

We are not anticipating that because we took a pretty significant concession as you could see in the first quarter.

We have been able to manage it at that level for four quarters, I guess.

We have been in the high 90s, and prior to that we were 120.

Chris, we have indicated that over the last couple of years, that our margin has been superior to others in the industry.

That is the way we manage our business.

We give up some volume for that.

But also when you look at others, I think one of the things that you might be seeing is that nonprime makes up about 20% of total originations.

We only have about 5% in our originations of nonprime.

So as that margin has continued to tighten and gotten very tight, you might see more people declining.

More peers with greater declines in their margin.

Great.

Last question is, as we all know, that there has been an increase in commercial real estate and construction on your balance sheet for many quarters.

Do you have any thoughts or perspectives on these proposed guidelines that are surfacing from regulatory agencies?

Sure, I think the proposed regulations require you to look very carefully and diligently at your concentration, and as compared to standards in the industry.

Let me just tell you that our levels of concentration do not exceed the industry.

We're very much in line with the peers once you take the onetime close out of that category and put it where it belongs, and that is in retail.

Because those are the loans to the homeowner, to the home buyer.

They're not loans to builders or developers.

Once you do that, we are very much in line.

The requirements as we understand them, and I have had quite a bit of conversation with the regulators on it, are just indicating how you manage those portfolios.

I think our controls over the underwriting and the ongoing management of our commercial real estate business, as well as retail real estate lending, will be viewed as very strong.

Great.

The amount of onetime close, approximately how much?

About $1.3 billion as what we had.

Was it $1.3 billion?

Yes, just a little over $1 billion.

Great, thanks very much guys.

Heather Wolf of Merrill Lynch.

Okay, I guess just following up on the question on delivery margins, it looks like your disclosure has changed a little bit this quarter.

Can you give us a feel for what those concessions on trading gain and losses were relative to last quarter?

Yes.

If you look at concessions, concessions were about 15 to 20 basis points worse.

If you look at trading gains, they were fairly consistent.

You would have seen a little bit higher, which we were a little lower last quarter; so we were back about the average of 25 basis points.

If you look at the other side of that, it would be how the concessions were offset, were in the rise in interest rates created a bigger value in the servicing OMSR values.

So that was where the offset was from the concessions side.

So that is really how we ended up at the same place that we were basically in the fourth quarter.

Okay, and I think this is a follow-on.

But can you sort of in plain English walk through the change that you guys made in the counting and disclosure for MSR valuations?

Yes, I can.

Actually, glad you brought that up, Heather, because with 156 and the change in that accounting, there are a lot of different things we had to use to do in other hedging to try to make sure that we were hedging from a LOCOM or a GAAP standard, versus what we're now being able to do, which would be fair market accounting.

So what it does is it clarifies that into really three distinct lines.

One is change in MSR value runoff, which would have been what you're used to seeing as impairment or amortization, the largest part of that being your scheduled amortization.

That is going to be purely what is run off in the portfolio and how much of the value went with it as you saw it.

That is going to be directly offset in the amount of originations that you have in any given quarter.

So the balance or the natural hedge that we would have talked about in the past is going to be that first line, change in MSR value runoff, versus what we would see in the production side in origination income.

So you can see that as you go through the different parts of the cycle through the year.

Seasonality.

Lower numbers in the first quarter; it picks up as you go forward.

That is again reflective of what is happening on the originations side.

The next two lines are very critical in the sense that it tells you now with 156, you get rid of all these buckets and all these different types of hedge reporting in the way that we have looked at it.

And you get right to two things.

What is the change in MSR value due to other things besides runoff?

Be it interest rate changes, expectation changes, anything that is in the marketplace that drives the value of your MSR, versus what are the hedges that are intended to hedge against that; and how are they performing?

One of the things you're hearing a lot about when you look at a lot of the other mortgages companies reporting, mortgage companies and banks, they are talking about their hedge performance this quarter.

These two lines actually give you a very good reflection of what that means.

If you look at the prior four quarters, the net between the change in MSR value and the MSR hedging gains was a positive approximately $20 million or better.

If you look at this quarter, the net between those two was actually a minus-$2 million.

So when we were talking about earnings in the mortgage business, that was what provided a lot of the pressure.

That is going to be related to a flattening of the yield curve.

That is going to be related to change in mortgage rate and LIBOR rate spreads and a change in VOL, in the sense of what the volatility that is embedded in those hedges is.

All of those things create basis shift when you start looking at your hedges versus the performance of the MSRs.

That shift in the marketplace did impact us this quarter, as it did other mortgage companies.

So when you look at that, that was one of the unfavorable impacts that came through the earnings during this quarter.

Is there anything in the marketplace that makes you think that some of those trends will be shifting?

It seems to me that our curve is getting a little bit steeper, but VOL is definitely increasing.

Right.

If you look at rolling forward, what you believe is really two things.

One is, you don't get shocks that occur in the marketplace like I just talked about.

Once they're done, it doesn't recreate another negative.

It just creates a negative within that quarter.

So when you're looking at going forward, you would see some improvement here.

The other thing is, I have not really been able to get the verification on this in general, but when you look at 156, I think that in general you have a lot of repositioning, a lot of activity that typically would happen.

However in this book, they knew new accounting was coming, and it didn't happen till the end of the quarter.

So as you are sitting there working through the process, you're having to look at how your hedging is doing.

You're having to also anticipate a completely different accounting standard in the way you're going to hedge.

Because the instruments that we used before 156 and the ones we are going to use after 156 are completely different.

They will be more effective and efficient as we go forward.

So there is also a pickup going forward, from being able to use 156 accounting, which you're not been having to kind of work with this LOCOM, versus just being able to say -- now I have completely fair value accounting.

Positives and negatives.

You can work both ways.

You don't have 100 different pools and stratifications.

You pull it together.

You've got one portfolio, one MSR, one big hedge position, and you can make it much more efficient going forward.

So I think there is some disruption as we go through the quarter just in general related to the change in accounting that was happening at the very end of the quarter.

Okay, great.

I just have a couple more questions.

Also in the mortgage division, it seems like your expenses went up quite a bit given the drop in originations.

I'm guessing some of that was the subprime.

That is correct.

Okay, but even if you exclude subprime, they were up quite a bit given the decline.

Right, you had other onetime, in a sense that we talked about, closings.

So I mean there's other onetime expenses that is embedded, not just the subprime issue.

He means office closings and consolidations.

I backed all that out, and it seems like still seems like it was up quite a bit.

No color there on what might be driving that?

There was another issue that we highlighted in cap markets, which we have in our deferred compensation plans for our sales forces primarily, where they can take some of their earnings and put it into these plans.

What happens in those is that as they invest their money -- it is their money that they put in them -- we then hedge that by then buying a similar investment that they are then asking for.

It grosses up revenues and expenses.

With the market performing well this quarter, one of the things that we were highlighting, like in cap markets, same type of deal, if you look at their sequential growth over last year's numbers, almost all of it was embedded in the performance.

That is offset in revenues, it's offset in expenses.

There was a similar number I think of about 3 to $4 million in the mortgage company that was also in cap markets.

That had nothing to do with, again, operations as much as it had to do just with revenue and expense number that offsets each other.

So I think that is another item that is embedded in those trends that could be affecting what you're looking at.

Okay.

If I can, just one sort of final big picture question.

It seems to me that you guys sold, I think, a high returning business for a very good gain.

It feels like this quarter you have spent that gain on a lot of cleanup and sort of fixing the organization.

Can you talk a little bit about your thought process behind that and maybe why you have decided to sort of spent on kind of cleaning up the organization?

Yes, Heather.

I don't know that I agree with your choice of terms.

But I think the table and our disclosure that we made in the release and the comments we have already made today makes it very clear that the gain from -- the $208 million gain that we got from the merchant business was used in mostly two things.

One was the stock buyback, which totally offset the loss of that income.

Secondly, we used a little over $100 million.

That left us over $100 million. $81 million of that was used to restructure an investment portfolio which gives us good returns.

You have seen that across the industry, and you have seen others this quarter announce that.

That is a typical thing that retail commercial banks do when the interest rates move.

That is a good return on that item.

We measure everything we did against a stock buyback.

If it did not exceed the stock buyback, then we bought back stock.

Okay?

So everything we did exceeded stock buyback, with a couple that we mentioned to you.

The cleanup the dents and scratches in the nonprime area.

And the -- is there another one?

A couple of the minor ones, very minor things.

Taking the zero-balance HELOCs off the balance sheet, selling those loans, allowed us to take off a FAS 91 that is amortized against our entire home equity portfolio, over the life of that home equity portfolio.

So it reduces our cost going forward by a return better than we would have gotten with a stock buyback.

So there's a few items in there that -- like the one I mentioned and there may be another 1 or 2 or $3 million.

But we do not view that as a cleanup at all.

Those items were transactions that occurred in the first quarter, needed to be taken in the first quarter.

And they allowed for future performance to be improved.

So you know, if there was the direction in strategy such as U.S.

Mint that we could go in, we could make some proactive decisions given change in the environment, it allowed us to be able to do that.

Then, I guess, Heather, just finishing up on your question, when you were talking about the noninterest expense, if you look at fourth quarter to first quarter, it was a $10 million increase.

We have talked about $11 million; it was related to the foreclosure expenses and other expenses, and the nonprime.

We talked about the other incentives in the sense of the dollars that we spent related to deferred compensation plans that are basically just returns versus expenses.

So you take that 3 to $4 million out.

You take out what we would have in onetime in the sense of branch closings and consolidations.

That gets you to about another 4 or $5 million.

All of that would have pulled down expenses relative to the fourth quarter.

By the time we finished I think we would be lower than where we were in the first quarter as well.

So it would be considerably down from where we were in the third quarter.

There are -- just seasonally, there is a lag between what we have in production and then what we have actually in the revenue.

So as you are building the pipeline and activities going through the quarter, there is that same kind of lag as you're doing that in the first quarter.

So as we are looking at that, I think that is another piece of the element that we just need to be aware of.

The other thing that happens between first and fourth quarters in all of our businesses is that our highly commissioned sales forces go back into FICO, where we start incurring those taxes.

That is about I think a $4 million additional expense to us in the first quarter, spread across all of our business.

In the first quarter relative to the fourth quarter.

That is correct.

So that is spread across each of the businesses too.

That is some of what we talk about when we say there's some seasonality negative in the first quarter versus fourth quarter.

That and the normal drop in your mortgage activities during the winter months.

That's all very helpful.

Thank you for the time.

Kevin Fitzsimmons of Sandler O'Neill.

I have got just two questions.

Number one, it's kind of Jason's questions but asked a different way.

Can you just clarify your statement about meeting the EPS or beating the EPS of last year?

What do you consider -- what are you considering the base?

What is the EPS from last year that you're using, you are considering?

Then, in that context, what you're considering as the number for this quarter for that comparison, number one.

Number two, Marty, maybe if you can just -- this might cut down on a lot of follow-on calls afterwards, but it would help me a lot I think if you could -- those 10 items that add up to the 147 that are listed on the release, if you can just really quickly run down and say which line item on the actual regular income statement they all fall into it.

It would just clarify it a lot in terms of where to pull them out of.

Thanks.

If you look at the base of our diluted EPS, I think on page 2 of the supplement, we give the different layers, which from an accounting standpoint, we have to report these because you have discontinued operations from the merchant.

So that kind of facilitates that.

The accounting changes are pretty minimal.

So they are not -- don't have a significant impact.

But the diluted EPS number is really the line that is what we will be gauging against, which in the second quarter of last year was $0.77; third quarter of last year it was $0.87; fourth quarter of last year it was $0.81.

Those are the comparable numbers.

Again, it was a long [time], maybe too windy explanation in the sense of we have to report EPS from continuing operations, which really only excludes the merchant earnings that we had last year.

But that is not really a comparable number, because you had the same shares last year that we had during that quarter.

You don't go back and say, well, you have a share buyback related to not having those operations and then get the credit for that.

Or else you would have a comparable type number to what you have in diluted EPS.

So you would add back the merchant earnings from last year.

That gets you to diluted EPS.

That is generally I think the flowthrough that we would be looking at as we compared to last year.

Does that help, Kevin?

Yes, so basically on page 2, what is stated there is diluted EPS; for those quarters in '05 we use that.

That is correct.

That is what we --

That is exactly right.

Okay, great.

Marty, I don't know if that is something you can quickly -- that second question I had.

Yes, I think it is relatively straight (multiple speakers).

Most of them.

There were a couple that -- just to be absolutely clear where they are.

Right, I think to be just completely clear, I won't be able to like put you down to the -- I mean, I can basically just say off the cuff what's expenses and revenues and those types of things.

Okay.

Most of these will fall in some of the other expenses, so you will get some of that.

Investment portfolio restructuring, you've got $80 million (multiple speakers) that is.

There's $300,000 that's in the -- would be in employee expenses.

Sale of no-balance HELOCs is an expense; it would be in other expenses.

Incremental nonprime losses that is going to be in foreclosure expenses and other expenses.

Coin inventory devaluation, that is going to be in some of your other expenses.

You are going to have closing retail offices, consolidation of operations.

A lot of that is going to flow through what you have in your depreciation expenses, as well as some of that will flow through what you would have in early retirement, severance, and retention costs would be up in your employee expenses.

Incremental technology would be in operations.

The hedge accounting treatment again would flow through I think in either -- other expenses, down in that line item.

Stock-based compensation cost, that is going to be in our employee costs.

Then the negative impact from the merchant sale is going to be a revenue net expense; so that is going to be in a lot of different line items.

So that is generally where they are at.

What we try to do is to provide the numbers by the segments, so you can be very clear on which segment they impacted.

Because most folks are now looking at us through the segment look.

So what you can do is, knowing what is our revenues and what is our expenses, you can adjust your income statements for each of those different segments.

That is really what we were trying to steer people towards.

It's a little cleaner look at it versus some of these being spread amongst so many different line items.

Great, that's very helpful.

Thank you.

Could you also just add, give me a little color on the securities that you did purchase to replace the ones you sold?

The yield does seem high, and I was just wondering generally what kind of securities you did replace them with.

We replaced them with very similar products that we had before, which are -- generally our forte is the CMO PAC bonds.

Some agency bonds.

Some mortgage pass-throughs.

But generally we are talking about very straightforward CMO PAC bonds that have very tight duration parameters.

We have expected life of somewhere around 3.5 to 4.5 years.

That is typically what we have been putting on the books.

So as Ken mentioned in his statements we were not changing the characteristics, duration, anything in the portfolio.

So it was basically a move from what we had in the portfolio to our current yield on a similar type bond.

What we also -- one of the questions I have had just in the sense of kind of going through it, anticipating maybe some people would be looking at, well, why did you replace the investment portfolio?

For liquidity and for what we do in our public funds, we need to replace it, because we use those as collateral.

So it is an important vehicle for us to have on the balance sheet.

We have minimized or have actually managed that category down to about as small a portfolio as we can have given what we need for our relationships across -- our commercial relationships that need the securities for collateral.

Okay, great guys.

Thank you.

Gary Tenner of SunTrust Robinson Humphrey.

Just a couple questions.

I wonder if you could expand on the commentary in the press release regarding credit cost.

You mentioned kind of gradual trend away from lower charge-offs.

Certainly there was a little bit of an increase in NPAs, which you talk a little bit about, about subprime.

I was just hoping you could expand on what you are seeing in the national construction and real estate portfolio.

If you look our asset quality numbers, the uptick that we saw really is related to a larger portfolio.

Really are there two things.

The growth in the portfolio, which we have been able to see.

And if you look at our ratios compared to where we were a year ago, we have nonperforming asset ratio of 37 basis points today; last year it was 38 basis points.

We have got nonperforming loan ratio 23 basis points; it was 23 basis points last year.

So if you look at the asset quality in general, what we basically said in the asset quality section, so that there is going to be some general gradual trend towards more normal level of asset quality in the sense of what you would expect to see in any of our delinquencies or nonperforming loans.

Fourth quarter was just the best quarter.

If you looked at that same nonperforming asset ratio in the fourth quarter, it was 33 basis points, down from 35 in the third quarter.

So it there is going to be fluctuation.

Fourth quarter was really abnormally low relative to what we think is our just general trend that we would be on.

If you look at the nonperforming assets, the two sources that we had this quarter, one was the nonprime loans going into the mortgage side.

On the bank side, those were just normal types of issues here in Tennessee.

It wasn't anything that popped up on the national front, as much as it was just relationships that we have had for years, and the movement in and out of that portfolio.

So a lot of it is due to the growth we have been able to see.

Ratios are very constant.

We have seen a very natural progression in the portfolio that we would expect to see as we return over time very gradually to more normal levels.

In terms of what you are hearing from your folks out in the field, are there any markets that you're particularly more or less concerned about right now, versus a quarter ago or six months ago?

Any markets less concerned about from a credit --?

Yes, well, more or less concerned about, frankly.

Yes, from a credit perspective, that you would be wanting to pull back in a little bit from what you have been doing there.

Well, we have seen and looked at different markets.

We look use our indexes to value debt.

There has not been anything that we have seen that we are overbuilding or the indexes would tell us we have to pull back significantly.

We have tightened controls in a few.

But there, again, there is not any markets that are standing out at us right now that really -- that we feel like show any real possible or potential signs of being too overbuilt or contraction.

Jerry, you might mention a couple of the --.

I would add that we watch our portfolio on a customer by customer basis, and look at maybe their new starts, their inventory, the risk associated in that market.

We would be adjusting credit levels and outstandings on a customer by customer basis in every market around the country based on that local market situation.

All right, thank you.

Gary Townsend of Friedman, Billings, Ramsey.

My questions have been answered.

Thank you.

Okay, that complete our questions, and again, I want to thank you for attending the conference and your interest in First Horizon.

I hope you have a great day.

That concludes today's conference call.

You may disconnect at this time.