First Horizon Corp (FHN) 2006 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 simultaneously at www.shareholder.com/fhnc, at the presentation link.

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 Jerry Baker, Chief Operating Officer, and Dave Miller, the Director of Investor Relations for First Horizon.

Before we begin, management has asked me to inform you that 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, but the floor will be open for questions.

Sir, you may begin.

Thank you, operator, and good morning to everyone and welcome to our call.

This quarter, we reported earnings of $67 million, or $0.53 per share.

As indicated in our August 29th announcement, these results include a charge for the estimated settlement cost of a lawsuit, which reduced this quarter's pretax income by approximately $21 million.

Our third-quarter results in no way diminish my confidence in our core strategy.

First Horizon has a unique organic growth strategy that leverages our national mortgage franchise to successfully expand our retail commercial banking business in key markets across the country.

By combining these businesses with FTN Financial's national reputation and capabilities in the capital markets, we have a business mix designed to produce strong long-term earnings growth.

Fueled by a culture focused on employee and customer value, First Horizon has been a leading performer in our category for more than two decades.

I'm convinced that our vision of organically creating a national financial services organization and recruiting high-performing, experienced talent will allow us to continue to outperform the industry over the long term.

In the third quarter, we continue to see positive evidence of our strategy at work in a number of areas across our company.

Let me start with the retail commercial bank, which continues its growth with year-over-year deposit growth of 9% and loan growth of 15%.

One driver of this growth is our ability to gain market share in Tennessee.

For example, our business customers in Tennessee grew at an annualized rate of 7% year to date as a result of our emphasis on service and convenience.

This value is being validated by outside sources.

In fact, a recent survey conducted by Greenwich & Associates indicates we lead the business market in customer loyalty, with a seven-point advantage over the next-closest competitor, as measured by the likelihood to refer category.

Another key proof of our success is our national expansion, where our full-service banking operations outside Tennessee are producing targeted results.

Our first expansion market, northern Virginia, is performing well.

We have nine full-service financial centers and over $190 million in deposits.

More importantly, we're breaking even on a direct contribution basis and revenues are growing at a double-digit annual pace.

During third quarter, we also entered the Baltimore market with three new locations, bringing our total national full-service offices to 31, across four markets.

This continued expansion, along with a steady cross-selling in our mortgage service and customer base has resulted in a 20% increase in national banking customers as of the third quarter, compared to the same quarter a year ago.

Additionally, we've been able to continue our cross-selling momentum, increasing the penetration of those customers to 31%.

Our efforts to increase the sale of deposit products are bearing fruit, as 19% of new mortgage customers purchased a deposit product in the third quarter.

This is up from last quarter's level.

As a result, in the third quarter, we added about 1.6 million in deposits on new accounts per business day.

We now have over $1 billion in deposits outside of Tennessee from the combined success of our customer cross-sell, full-service banking markets and middle market expansion.

Despite a slowing housing market, our construction lending business continues to show growth, with average loans outstanding in the third quarter up 37% over third quarter of last year.

We've been able to benefit from the further maturation of our offices and growth of our sales force.

Importantly, this distribution system is weighted toward non-coastal, midsize markets across the country, diminishing our exposure to areas experiencing the greatest real estate slowdowns.

And, finally, asset quality in the bank remains strong, reflecting geographic diversity, granularity in the individual credits, industries and risk rates, as well as our history of a strong credit practice.

In addition to the growth in our retail commercial bank, we're also making strategic progress in our capital markets business, by growing the sales of products other than fixed income.

Fees associated with those products were up 38% year-over-year, reaching $57 million.

Driving the increase this quarter was another large full trust preferred transaction, which reflected continuing strong new issue supplied and the refinancing of a previous transaction.

As we had anticipated when we made our August announcement, tough market conditions had a significant impact on our mortgage segment, where pretax earnings decreased $34 million from second quarter due to lower marketing margins, lower production and higher hedging cost.

Earnings were further impacted by the previously mentioned $21 million lawsuit settlement charge.

At this stage of the mortgage cycle, we're focused on cost cutting and growing our sales force in order to return this segment to profitability as soon as possible.

To that end, we are in the process of reducing our origination support structure by approximately 300 FTEs and making further reductions in discretionary spending.

As a result of these efforts, we believe that we will get $2 million in savings in the fourth quarter and 10 million in savings in 2007.

The good news in mortgage is that we have been able to grow our sales force in a down market.

This quarter, we've added 28 new producers from our second quarter level, reversing the downward trend experienced over the first two quarters of the year.

Also, plans are underway to downsize our mortgage servicing portfolio and by selling non-strategic servicing, representing approximately 10% of our portfolio.

This reduces the use of the balance sheet by our mortgage business and mitigates future exposure to changes in servicing values, without adversely impacting our national cross-selling efforts.

We expect to complete this sale in the fourth quarter.

Finally, on the corporate level, we continue to make progress on our corporate-wide earnings enhancements.

We're on track to achieve our original target of $80 million in cost savings and new revenue generation for the year.

This quarter, we again realized $10 million of ongoing benefits from the utilization of the gain from selling our merchant business, and also achieved $11 million in efficiencies from initiatives enacted throughout the year.

Now, I'll turn it over to Marty and he will go over the details of the quarter with you, and I'll be back with some closing thoughts, and then we'll take your questions.

Thanks, Ken.

This quarter's earnings were unfavorably impacted by the settlement accrual of a class-action lawsuit, as well as decline in mortgage operating earnings.

As a result, we reported earnings per share of $0.53, as compared to $0.82 for the second quarter of this year.

Let me give you some further context around our financial performance.

As announced in August, First Horizon reached an agreement in principle to settle a class-action lawsuit in order to avoid the risk and costs associated with ongoing litigation.

In connection with this settlement, we accrued a pretax charge to earnings of $21 million for the third quarter.

Separately, mortgage banking operating earnings were also unfavorably impacted by lower gain on sale margins, a narrower spread on mortgage warehouse volume, higher hedging cost and a further contraction in the mortgage origination market.

As a result, mortgage banking pretax earnings, excluding the impact of legal settlement, experienced a $34 million decline from the second quarter.

Let me give you a breakdown of these impacts.

First, the disruptions in the secondary market related to an unanticipated 68 basis point drop in the 10-year treasury and the inversion in the yield curve this quarter significantly reduced the gain on sale margins for mortgage deliveries.

After improving to 122 basis points last quarter, gain on sale margins declined to 83 basis points this quarter.

This 39-basis point unfavorable swing reduced mortgage origination revenues by over $25 million.

Second, the inverted interest rate environment has also narrowed the spread on mortgage warehouse loans and increased the cost to hedge mortgage servicing rights.

As a result, this quarter's mortgage earnings were unfavorably impacted by another $4 million.

Lastly, the mortgage origination market continues to contract.

As a result of this drop in the market, First Horizon's mortgage originations declined by 15% this quarter, as compared to second quarter, to $6 billion in the third quarter.

This reduction in production unfavorably impacted mortgage deliveries this quarter and pretax earnings by an additional $5 million, although this was mitigated by higher servicing earnings driven by lower runoff.

Now let's take a look at the impact of these issues on the mortgage business operations specifically.

With the aforementioned issues, as well as the accrual related to the settlement of the class-action lawsuit, mortgage banking had a pretax loss of $26 million this quarter.

Next quarter, the elimination of the impact from the class-action lawsuit and initial improvements in productivity measures should return mortgage banking earnings to approximately breakeven.

Although the first quarter will be impacted by the normal seasonal declines in home purchase volume, mortgage banking is expected to become profitable again in 2007, as a continuation of productivity initiatives, rationalized with our fixed costs to the clear market demand and growth in our mortgage sales force return.

Now, let's turn our focus to the retail commercial bank and capital markets, which continued to make solid financial and operational progress this quarter.

First, retail commercial banking metrics continued to reflect strong growth.

As Ken already noted, loan and deposit growth from the third quarter of 2005 to the third quarter of 2006 increased 15% and 9%, respectively.

Sequentially, total loan growth in the retail commercial bank sold at 5% on an annualized basis, as consumer lending activities were reduced due to rising interest rates, a drop in mortgage originations and continued consolidation of debt by consumers into first mortgages.

The good news is that as a result of the slowdown in consumer lending, this quarter's deposit growth rate of 6% exceeded the growth in loans.

And, importantly, on a corporate level, the loan to core deposit ratio this quarter remained relatively flat to last quarter, at 163%.

Efficiencies within the retail commercial bank continued to build, as reflected in the efficiency ratio of the retail commercial bank improving 60 basis points over the last 12 months to 59.6% this quarter.

For example, this year, we have consolidated our loan operations, closed a processing center and deployed new technology that reduces system cost in our back office.

The retail commercial bank's net [interest] margin fell six basis points this quarter, from 4.27% in the second quarter to 4.21% in the third quarter.

This sequential contraction was related to the repositioning of our deposit pricing, as this cycle of Fed rate increases, which began in 2004, apparently was coming to an end.

Over the last two years, First Tennessee Bank had been very successful in lagging the increases in deposit rates relative to the overall increase in the market and the competition.

As a result, our retail commercial bank's net interest margin had remained relatively constant, despite the flattening in the yield curve and competitive pricing pressures.

This adjustment places us within our historical pricing range relative to our peers.

While asset quality ratios reflect the natural migration from historically low levels over the last couple of years, overall asset quality remains relatively strong.

This quarter's provisioning exceeded net charge-offs, increasing our allowance in loan ratio from 92 basis points to 94 basis points.

This increase in coverage was related to our expectation that overall economic growth is beginning to slow and the addition of a few loans to our watch list.

This represented approximately $4 million in additional provisioning.

In total, the retail commercial bank experienced 5% year-over-year growth and 9% annualized sequential quarter growth.

This slowing growth rate, which is a bit lower than previous quarters, was a result of slowing consumer lending activities, repositioning deposit pricing and increasing allowance coverage.

We expect these issues will continue to impact the fourth quarter, but should dissipate as we enter 2007.

Let me take a second to outline those.

First, as I mentioned before, consumer lending growth has slowed, as consumers continue to consolidate debt.

Also, the incremental growth of our national expansion initiatives are unfavorably impacted by a contraction in mortgage origination activities.

The market demand has also significantly shifted from the more-profitable HELOC product to fixed rate installment loans.

As the mortgage market stabilizes and our mortgage sales force growth returns, cross-sell opportunities should increase.

Also, the transition to fixed-rate installment lending should begin to stabilize.

Additionally, the incremental impact from repositioning deposit pricing and increasing the allowance coverage creates approximately $7 million in increased cost this quarter.

While this impact will more than likely remain in our base, the natural growth in our retail commercial bank's earnings will begin to reduce the significance of this impact on our overall earnings growth.

Going forward, the growth in the retail commercial bank is expected to return to double digits over the next couple of quarters.

Turning to capital markets, our business continues to succeed in generating revenues from new products beyond our traditional core fixed-income business, producing a solid 57 million in revenues this quarter.

This represented a 38% increase over last year's levels.

This quarter, other revenues in capital markets were almost 60% of the total fee income for this segment.

Going forward, we generally expect continuing strong performance in other product revenues over the next several quarters.

However, we could see some quarterly variability in these revenues because of the impact of market conditions on the size and timing of transactions in several of these businesses.

Although fixed income has yet to rebound, capital markets' profits have begun to show significant improvement.

Compared to the third quarter of last year, capital markets pretax earnings have improved $11 million, to 14 million this quarter.

This momentum is expected to continue.

The corporate segment improved $4 million over its second quarter level as 9 million of security gains were experienced this quarter.

First, we sold our MasterCard IPO stock for $5 million.

Secondly, we experienced a venture capital gain of $4 million this quarter, related to one of our investments being taken public.

Growth in expenses offset $4 million in this quarter's benefit in security gains and resulted from a $2 million writeoff of the holding company investment, venture capital commissions and project-related expenses.

The corporate effective tax rate declined to 28% this quarter.

The audits of several tax years were settled during the quarter, which resulted in approximately a 2% decrease in the corporate effective tax rate.

Incremental deferred compensation expenses, which are embedded in our business segment pretax earnings, also lowered our tax rate by an additional 1% this quarter.

While macro issues, including an inverted yield curve, will continue to impact overall earnings growth into next quarter, our strategy has positioned our three business segments for growth in 2007.

We believe, as the interest rate environment stabilizes, we would expect to see an even stronger result.

We look forward to sharing our progress with you next quarter.

Thank you, Marty.

In conclusion, let me remind you of the fundamental strengths of First Horizon.

We have a unique strategy of growing organically.

We have a proven track record of above-industry growth in our retail commercial bank, driven by our success in Tennessee, as well as our national expansion efforts.

FTN Financial has done an excellent job of developing and distributing other products to its national customer base, building a significant quarterly revenue stream from scratch in just a few years.

This helps us reduce the cyclical impact of our fixed-income business.

Mortgage has been and will continue to be a double-digit growth business over the long term and also provides us with an important strategic national growth platform.

In the short term, we are focused on achieving additional efficiencies to improve the performance in this unit.

The management team is committed to executing this strategy, and I believe, over the long haul, it will produce strong earnings growth and shareholder returns, as it has over the last two decades.

In the short term, investors will be rewarded by an attractive dividend yield, which is among the best in the industry.

Thank you, and now we'll be glad to take your questions.

Thank you. [OPERATOR INSTRUCTIONS].

We'll go first to Fred Cannon with KBW.

Thanks.

I wanted to just ask Marty, on the improvement that you were discussing in mortgage banking, when I look at the mortgage banking income in the loss, I'm assuming, that's where the class-action expense was, I believe.

Is that correct?

That is correct, yes.

And then if I back that out of the third quarter, you still have a modest loss of I think about 3 or $4 million?

That's correct.

And then you expect to be breakeven in the fourth quarter, according to your comments, I believe.

I was wondering how you expected to achieve that.

Is it improved gain on sale margins?

We do know the volumes of mortgages will probably be down in the fourth quarter, seasonally, or is it on the expense side?

It would be on both of those accounts.

One, we are going through a process we talked about, of pulling down our FTEs by about 300.

That will be accomplished -- we've already started that and it will be accomplished as we go through about two-thirds of it as we finish October, so expenses will be a part of the equation.

And then if you look at our gain on sale margins, they were up 83 basis points this quarter.

We would expect those to improve somewhat as we went in the fourth quarter, but not markedly.

Have you seen any improvement quarter to date, or any signals of some improvement?

We have, and if you looked at the late results that we had in the quarter, it would be closer to around 90 basis points.

Oh, okay, great.

One other question, if you don't mind.

On the retail loan book, which did decline like quarter, we saw both residential real estate loans tail off a bit and the growth rate on retail real estate construction has slowed significantly from its very rapid pace.

Wouldn't -- given kind of the current environment in US mortgage, the slowdown in home price appreciation, slowdown in housing activity we're seeing in many markets, is there any reason to think that that should pick up again, or should we kind of expect the retail side of loans to continue to tail off for a while as prepayments exceed new originations?

I think what we should expect there, and what we've seen, is that it will kind of stay -- sustain its level at this point.

What we'll start to see, as we go into next year, with the growth in the mortgage sales force, we'll begin to see those activity levels increase our cross-sell opportunities once again.

We've also started in Tennessee focusing on the consumer lending again, and some more, so increasing our focus there.

When you look at this part of the cycle we would expect commercial lending, as you're seeing this quarter, to continue to be the largest source of growth in our loan portfolio, which is related to our consolidation and getting the market share gains here in Tennessee, as well as our continued expansion nationwide.

So those are some positives that we're seeing on the commercial side.

But we wouldn't expect commercial construction to continue to expand, should we, I mean, given the slowdown in construction we're seeing nationally?

What we're seeing there is that the growth in the sales force and the adding of new markets that we're doing each year enables us to continue to have momentum there that, while we won't see 33% with a sequential growth rate in that category this quarter, that will probably begin to slow somewhat, but still seeing very strong growth in that category, because we're gaining market share, we're adding experienced salespeople in markets across the country.

And, also, we have less exposure to some of the coastal markets, some of the other markets in the middle part of the country is where we have a greater market share.

Fred, this is Ken.

We're still a very small player in that commercial real estate market, and as we've expanded our offices over the last few years, we have a lot of growth opportunity just with the network -- growth that we've had this year continuing to be in the market at our most recent market share, as opposed to a market share position where we were a year or two ago, even though that market will slow down.

Thank you.

We'll go next to Gary Tenner with SunTrust Robinson-Humphrey.

Thanks, and good morning.

Good morning, Gary.

I had a question, Ken.

You had mentioned, I think early in the call, you made some positive comments regarding business deposits in Tennessee.

Taking a look at the FDIC data, the year-over-year data to June 30, your statewide deposit market share declined pretty markedly, by about two percentage points and was down in absolute dollars.

I wonder if you could talk about what you're seeing within the state, especially as you've made some, I guess, attempts to be a little more aggressive in middle Tennessee.

Sure, and Marty's got the detail on that, so he's dying to answer the question.

Well, as always, you're on top of it.

It came out, what, yesterday, I think is when the [paper] came out?

Those numbers are actually reflective of our escrow balances and our purchase money here in Tennessee.

So if you back those numbers out, which we do every year -- so we look at it, we adjust for anything that's happening in our purchase funds department to get to what our core relationships are.

If you adjust that out, we would have a 50 basis point increase in our market share, which would reflect what we've been able to accomplish through the consolidation this last year.

So it's just the way that the numbers get tallied up and they include the corporate headquarters here in Memphis in those numbers.

Okay, thank you.

We'll go next to [Alex Lopez] with Portales Partners.

Good morning.

Good morning.

Good morning.

I was wondering if you could provide some color on the loans that were added to the watch list this past quarter?

Sure.

Those loans that were added to watch list were basically builder-financed loans across the country.

We're taking a very proactive approach in making sure that in the markets where there's slowing activity and growing inventory that we use our watch list to make sure there's an action plan to take for if they get into trouble.

And so we're being very proactive at identifying those loans that we need special attention to make sure they don't become an issue.

We historically in that group of loans that go through that watch list return approximately 90% of those upgraded as opposed to downgrades, and that's a very good ratio for us and we would anticipate that to be the case here.

Okay, again, sorry if I missed it, do you have any, I guess, geographic guidance on this?

Or was it any particular regions or --?

No, they're not.

They're spread -- I think they're in, like -- there's probably eight to 10 of those loans.

The largest one is about 12 million and most of them are significantly lower, but they're spread across the nation in the various markets.

Okay, thank you.

I would like to add -- is the line open for me?

I would like to add that one of the positive things about our construction real estate lending is that it is very geographically spread.

We have no concentration in any one market anywhere, coastal or non-coastal, and they're very small credits relative to the size you would expect to see from other large commercial real estate credits.

We'll go next to Bob Patten with Morgan Keegan.

Good morning, guys.

Good morning, Bob.

Marty, can you just kind of give a little color around the gains and charges, the VC gains, the holding company investment and also, Marty, if you could just give us an update on what your outlook is?

You talked about how you think the pressure will dissipate as you move through the fourth quarter in a variety of different businesses, so I'd like to sort of understand how you think that that's going to work out.

Okay.

If you looked at the gains, we talked about the lawsuit, obviously, which was $21.3 million, and the accrual for that this quarter.

That was in the mortgage banking segment and it was also in our other expense line, so when you start looking at those other expenses.

Our MasterCard IPO stock sale was $4.7 million.

Our venture capital gain was $4.1 million.

Those were in security gains, which you would see totaling $8.8 million.

Related to that, if you looked at our expenses in our corporate segment, something that we highlighted in the transcript, which I think is important, is that we had about a $4 million increase in expenses in our corporate segment.

That was related to, one, a holding company investment that we wrote off of $2 million this quarter.

We also had the commissions related to the venture capital gain embedded in that and then some project expenses that were unusual and one-time in nature in that sense.

So, about $4 million of those expenses were related to things that would naturally go against the $8.8 million in security gains.

The other thing that I was going to highlight is that if you looked at our expense run rate this quarter, you would need to adjust out the impact of our deferred compensation.

It had a larger-than-usual impact as you compared second quarter to third quarter.

It was about a $14 million swing when you start looking at the expenses, and if you start looking at some of the business lines, you would also want to make sure that you adjusted that out.

So while we're looking at second quarter expenses running into the expenses in the third quarter, that impact actually shows up in incentives and salaries, so that is one of the things that I also wanted to highlight.

While it has no impact on the bottom line, it does have an impact on the trends when you look at your expense trends.

Well, Marty, just the other part of the question was how you expect things to dissipate.

What's your call on the rate outlook in terms of how you're managing your balance sheet?

Right.

And, also, what is the number around that incentive number to come out?

You're talking about the incentive number that was in our corporate expenses?

You said it was sort of a one-time number that has to be adjusted going into the fourth quarter, in terms of trends.

Okay, if you're looking at deferred compensation or are you talking about the incentives related to the venture capital.

The deferred comp you just talked about.

Okay, deferred comp that was in this quarter was, let's see here, I think about $8.2 million.

So that would be the number you would back out of the compensation for this quarter.

And if you look at the number in the prior quarter, it actually reduced the number in the prior quarter by about $6 million.

And it's really just related to what happens in the stock market as some of our employees put their money in these deferred compensation plans, as the stock market does well, you have the revenue go up, which offsets the expenses related to the deferred compensation plan.

So it ends up in our other revenue line and it ends up in our employee compensation line.

Okay, and then just your rate outlook, Marty.

Yes, if you look at what we said in our outlook for the fourth quarter and going into 2007, is that as we go into the fourth quarter, what we would expect is that we're seeing a continued inversion in the yield curve.

We came in, averaged about 35 basis points last quarter.

We came into the quarter somewhere around 65 basis points of inversion.

Right now, we're at the 45 to 50 basis points of inversion.

For every 10 basis points of flattening or inversion in the yield curve.

That impacts us negatively by a penny or two of earnings.

So, if you start looking at the progression, that obviously would have an impact as we went into the fourth quarter.

Seasonally, you start to see some of the mortgage numbers, just in originations and things like that, beginning to slow.

We still believe mortgage would be break even as we go through, going into the fourth quarter, and that they would return to profitability next year as you get your production levels and your support staff to the right level, given the capacity that's out in the marketplace.

When you look at cap markets, like we talked about, their other fee income continued to show good progress year-over-year.

When you start looking at it sequentially, we have had some very good activity in our pooled trust preferred transactions.

We've been running abut 1.5 billion compared to typically about $1 billion.

Some of that's related to the refinancing activity that we are beginning to see now.

While we believe that that would stay at a higher level, to say that we're going to continue to see the 1.5 billion, we would have to kind of watch from quarter to quarter.

We still see good trends there, but transactionally, again, like we talked about, there will be some lumpiness related to cap markets, but, in general, we're seeing progress there.

What we're seeing on the bank side is somewhat of a slowing [interimly], as we adjusted our deposit pricing this quarter and we adjusted our provisioning higher.

But then as we go forward, what we should start seeing is, again, those things having less of an impact as they just are embedded in the base and we return to double-digit growth in the retail commercial bank next year.

So, we're basically saying, as we move into next quarter, impact from the yield curve, other issues, basically keep us pretty much at the same level as we move forward, and then we resume our growth as we move into the whole part of 2007, with the typical seasonal impacts in the first quarter.

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

Hi, good morning.

Good morning, Chris.

I was curious, I guess, on your thoughts kind of bigger picture about capital markets the next several years.

Is there anything on a secular basis that would make you less interested in the business in general, or do you still think there are some long-term reasons to keep the investments you have there?

I think there's very definite long-term reasons to keep that.

It gives us a strategic advantage both in delivering our mortgage product.

It advantages them.

Our capital markets business also, they've been able to diversify their revenue away from the fixed income.

The fixed-income business will return, not to the levels that we experienced in '03, '04, but will return once the outlook for the rates get more certain among the investors and the loan growth slows in the banking business.

So we feel it's a very good strategic mix and we're committed to continue to strategically address the issues in that.

I don't see anything in the marketplace that would cause us not to produce very acceptable returns long term in that business ,and the further integration of that into our capital raising in the bank and the mortgage product delivery to the markets is very good.

Okay, great, and then I guess just to follow up on the loan side, would you anticipate a slowdown on the construction side in the real estate, and then also, is there any more color on sort of why the acceleration on the commercial, the C&I, this quarter?

Yes, we do expect, and are seeing, a slowdown in the commercial real estate market.

However, again, we've added how many offices?

We've probably got 20-something offices we've added and a significant number of sales force in that.

We've got now over 400 people in our build or finance and construction real estate lending nationwide.

It has grown substantially over the last few years, have added relationships that are now coming on the book with very good builders, but they're not the nationwide builders that you may be reading about on the front page.

They're builders with individual net worth outside of those properties and builders that have been through cycles.

We feel very comfortable with our underwriting there.

Since we've been growing that capability or capacity over the last couple of years, even as the market slows, we expect to show some growth -- not the growth we've been showing, but we'll be able to show some growth.

Even though there are housing markets -- and those are the ones you read about ton the front page -- that have slowed down tremendously, or even declining, there are still others that have very good housing demand in it and inventories are well below the demand in the marketplace.

So the absorption rates are good and we're able to continue to lend in those markets.

I'm sorry, I'm going to ask you what the other part of your question was -- I think you had two parts to your question.

Sir, I apologize, but if you could, please press star, one, on your phone for me again, please.

Your line is open.

Thank you, sir.

Yes, Ken, I was just asking more on the C&I front in terms of just the acceleration there?

Deceleration there?

Acceleration.

Commercial loans, regular commercial loans.

That's going to be what we're seeing here in Tennessee, where we've been able to gain market share.

We've been able to make a lot of headway with our commercial customers and relationships we've had here.

We also have been able to be able to expand some of our middle market lending, which has been very positive as well.

Okay, good, thank you very much.

We'll take our final question from Heather Wolf with Merrill Lynch.

Hi, good morning.

Good morning, Heather.

Just a few questions for you.

Marty, it looks like you guys added about $800 million of securities and finance by debt and CDs.

What was happening there?

Basically, all we were doing there, Heather, is we had held our investment portfolio down over the last three to four years as mortgage has been at a higher level.

As we've seen the runoff in the mortgage warehouse, we naturally make a tradeoff between where the investment portfolio is and what amount of warehouse we have.

So as the warehouse has dropped down to around $3 billion, it had been running up in excess of $4 billion, we basically went in and replaced that volume with investment portfolio this quarter.

Okay, and I assume that was for liquidity purposes, because it doesn't look like you had much of a spread on that.

We did pick up a spread.

We picked up about 50 to 60 basis points of spread related to that.

We also picked and actually put on -- had a very good time, just coincidentally, as we made that decision, with seeing the mortgage warehouse drop to a lower level.

So we did end up with a spread on that, as we would typically expect and that's kind of how we've been managing the balance sheet to manage the size overall.

Okay, and that comes through your corporate and other division?

It does, yes.

Okay, and what would you say is a sustainable tax rate going forward?

Right, sustainable tax rate, we talked about that in the transcript in that we had about two percentage points related to the impact of finalizing or clearing a couple of years in past tax returns.

So as those were finalized then we had a benefit this quarter of just over $2 million.

If you look at the 1% related to deferred comp, that's just the tax benefit that comes from the hedging of the deferred comp expenses that I talked about earlier.

So that is an impact to this quarter.

It lowers the rate but doesn't have any impact on the bottom line of the company as a whole.

So when you start looking at that, 31% is typically the number we have talked about in the past and that's pretty close to what you should be looking at.

Okay, and with the sale of the MSR portfolio, what are you estimating tangible common equity to assets at for the end of the year?

We really look at it from a risk-weighted asset, instead of just the total assets.

And what we would see is that we could see some improvement there as we do some with the mortgage servicing rights, but it won't be a market improvement in that ratio.

Okay, and then one last question.

In the mortgage division, can you give us a sense for what portion -- or maybe this is in here and I've missed it -- what portion of your expenses are variable?

Related to?

In the mortgage bank.

If you look at the salaries and expenses at the mortgage company, what you would see is once you take out -- and this is one of the things you have to kind of work on, because the salaries and benefits is going to be where you get the variability.

When you look at the number, 108.2, you have to adjust out 3.4 for the deferred comp numbers.

When you do that, that puts you at 104.8 for the quarter.

The 109.7 from the prior quarter you would adjust the 2.5, so you would add to that because it was a reduction in the prior quarter.

That's 12.5.

So when you start looking at salaries and benefits on a comparable basis, you would see a 7% drop in salaries and benefits.

That would relate to deliveries dropping about 12%.

So when you start looking at that, you could kind of correlate those two together and get a better feel for the variability of those expenses.

Now, as you start to move forward, we'll begin to pull some of the fixed cost out from the support areas, so that will now change not just the embedded variability, but also now reducing some of those fixed costs, as well, to rationalize to the new level that's out in the marketplace.

Okay, that's very helpful.

Thank you so much.

Thank you.

This does conclude our question and answer session for today.

I'd like to turn the conference over to Ken Glass for any closing or additional comments.

I would like to close by reiterating that we have strong growth in our retail commercial bank.

Capital markets continues to reposition our income streams there to provide growth in the other than fixed income and the mortgage we will be concentrating on cost cutting and growing that sales force to address the level of the market that we see today and going forward.

Continue to have confidence in our strategies and I want to thank all of you for your continued interest in First Horizon, and I hope you have a great day.

This does conclude today's conference.

We do thank you for your participation.

You may disconnect at this time.