First Horizon Corp (FHN) 2007 Q1 法說會逐字稿

Welcome to the First Horizon National Corporation's first-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 Jerry Baker, Chief Executive Officer, and Marty Mosby, Chief Financial Officer.

They are also joined by Dave Miller, the Director of Investor Relations for First Horizon.

(OPERATOR INSTRUCTIONS).

Mr.

Miller, you may begin.

Thank you, operator.

Before we begin, we need 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.

In addition, non-GAAP financial information may be noted in this conference call.

A reconciliation of that non-GAAP information to comparable GAAP information will be provided as needed in the Investor Relations area of the Company's website at www.fhnc.com.

Listeners are encouraged to review any such reconciliations after this call.

Also, please remember that this audio webcast on our website at www.fhnc.com is the only authorized record of this call.

Now I would like to turn it over to our CEO Jerry Baker.

Thanks, Dave, and good morning.

I'm excited about serving as the Chief Executive Officer of First Horizon National Corporation, and I appreciate this first of many opportunities to share our progress with you.

Today Marty and I would like to update you on our strategy, share the results from the first quarter and talk about what we are changing to improve the Company going forward.

Before I get into the details of the quarter, I want to be clear about our strategic vision, which is to expand our banking franchise nationwide with relationship management in target markets and niche customer segments.

We will focus on building our core franchise in Tennessee and continue to export that expertise by adding banking specialists in key national markets.

Our Mortgage and Capital Markets businesses will remain important levers in this banking expansion.

As we invest in our Retail/Commercial Banking businesses, we grow our base of predictable earnings and reduce our volatility related to interest rates.

Now let's get into the details of the quarter.

Our reported earnings this quarter were $71 million or $0.55 per share, lower-than-expected as a result of some industrywide disruptions related to the softening housing market.

I will get into those in just a moment, but first let me tell you how we advanced towards the strategic goal I just outlined.

Within our Tennessee footprint, we opened three more financial centers during the first quarter, bringing us to a total of 36 new financial centers over the last four years, nearly a 10% increase in our delivery system.

That expansion, along with growth in our sales force and our leading value proposition, allowed us to continue gaining market share and produce solid financial results.

In the first quarter, targeted consumer households and business relationships were both up 6% over the same period last year, each significantly better than the market.

We continued to be the leader in Tennessee, but we think we can do even more given consolidation in the market.

To that end, our plans for the next couple of years call for an increased focus on expanding our Tennessee market position, opening another 10 to 15 locations per year.

Nationally we are expanding by adding banking specialists in our full-service markets instead of branches.

And we just -- we did just that in first quarter.

As a result of this and our ongoing focus on cross-sell, our banking product penetration grew another 1% in first quarter.

Now 45% of our national customers have purchased one or more of our banking products, and 14% have a deposit relationship with us.

In total, our national deposit balances have grown to $1.6 billion, an 18% increase over first quarter 2006.

Going forward, you will see us add more specialists in middle market, small business, private client banking and construction lending in other key markets around the country.

Let me go back to the specifics of our earnings this quarter.

While we certainly experienced the expected seasonal decline of approximately $12 million from fourth quarter to first quarter, we were also hit by some unexpected disruptions in the business environment.

We have anticipated that the yield curve would remain inverted, but had not counted on the volatility within the quarter that created an addition of negative impact of $15 million in hedging in our business, in our Mortgage business.

There is a cost of hedging against big losses or gains in MSR values, and this quarter we experienced the net largest hedge cost since 2001.

Certainly the softening housing market had a negative effect on our real estate related banking businesses, reducing pretax income by approximately $8 million over fourth quarter.

Volume growth and pricing remains soft for consumer lending products as consumers continued to shift debt from floating to fixed rate products.

And our construction lending business experienced less volume growth, reduced pricing spreads and an increase in provision as we proactively managed deteriorating credits early in their cycle.

Despite this deterioration in our construction businesses, our overall asset quality position remains within expected ranges.

Although we experienced higher charge-offs, as we work through problem loans identified in previous periods, nonperforming assets decreased to 56 basis points this quarter.

Since NPAs are a good leading indicator, we believe that charge-offs are still likely to remain at historical norms for the year.

I would also note that provision against -- again exceeded our charge-offs this quarter as you would expect in a softening economy.

Within the industry, fears of accelerating weakness in the subprime market created turmoil within the secondary markets and further reduced the number of homebuyers in the market.

This spilled over into our Capital Markets business, adversely impacting the anticipated market execution of this quarter's pooled trust preferred transaction.

The environment has certainly been a challenge for everybody, and I don't believe we can count on or expect the current environment to improve anytime soon.

So here is what we are doing in the short-term.

First, we are maintaining our focus on asset quality.

As the housing market showed signs of slowing last year, we tightened guidelines in both our consumer and construction-lending businesses.

We will remain disciplined, managing problem assets and resisting the temptation to chase high-risk growth.

Secondly, we are working hard to return mortgage to historical levels of profitability through our strategy of building our prime retail origination business.

We are focused on improving the productivity of our existing originators but also on adding new ones.

We continued to recruit aggressively in the midst of market consolidation, and as a result of our total mortgage sales force was up nearly 50 producers in first quarter as compared to year-end.

We are beginning to benefit from these efforts and also from a pickup in refinance activity as our current pipeline has risen to its highest level in almost two years.

In an effort to better focus on our core strategy in mortgage of acquiring target customers from cross-sell, we have determined that some things just don't fit.

One of those things is nonprime.

And so we have made the decision to no longer underwrite, process and fund nonprime loans, resulting in our exiting the wholesale piece of that business.

Our nonprime business represents less than 2% of our mortgage loan production.

We have done a good job of keeping repurchases to a reasonable level, and we have adequate reserves to cover estimated remaining losses on any past loan sales.

However, reduced investor appetite for this product has diminished gain on sale margins drastically.

Therefore, we think the market risk in nonprime no longer justifies the modest potential rewards and believe it is better to service retail customer needs and referral sources through broker relationships.

While I am on the subject of nonprime, I feel compelled to talk about Alt-A for a minute.

Despite reports from some in the industry, we have not seen the subprime turmoil create a major adverse impact to our Alt-A business.

In the first quarter, Alt-A represented 20% of our first lien production, down from 32% a year earlier.

Importantly, our Alt-A business has prime type credit characteristics, despite the nonstandard loan structures, having an average FICO of over 715.

The majority of our Alt-A production is securitized and to date, based on historical execution levels, no residuals.

Our credit support structures had been retained.

We have not seen any material repurchase activity from these loans, and we continue to see our Alt-A securities price appropriately.

Finally, we continue the evolution of FTN Financial into a balanced broker-dealer.

The sale of products other than fixed income accounted for 48% of its total product revenue in the first quarter, and we anticipate continued strong performance going forward.

Also, we made regulatory and operational preparations to establish a physical presence in Asia in order to take advantage of foreign client demand for US fixed income securities.

We expect to open our Capital Markets office in Hong Kong during second quarter and expect to open Tokyo later this year.

I will turn it over to Marty now to go over the details of the quarter with you, and I will be back to wrap it up after he is done.

Marty?

Thanks, Jerry, and good morning, everyone.

As Jerry discussed, we reported earnings per share of $0.55 this quarter, a decline of $0.05 from the $0.60 reported in the fourth quarter.

I am going to discuss our business line results in detail, but first I would like to offer some topline thoughts on the quarter.

We had two favorable items that partially offset the seasonal and environmental impact that occurred during the quarter.

First, we received approval from regulatory authorities on a plan to merge our mortgage company into our bank in an effort to become more efficient and enhance the use of our national bank charter in our Mortgage Lending business.

This produced a tax benefit of $7 million this quarter from the adjustment of our deferred taxes to the expected tax rate of the combined entity and will also create additional operational benefits going forward.

Second, we realized $10 million of security gains in our corporate segment as we reduced the size of our investment portfolio and expectation of growth in loans and a rebound in the size of our mortgage warehouse.

As you know, seasonality has a distinct impact on our businesses.

Declines in mortgage production and consumer deposit fees, as well as increases in personnel expenses, had an approximately $12 million negative impact on pretax income in the first quarter as compared to the fourth quarter.

Typically these impacts are significantly reduced heading into the second quarter.

Now let's turn to the business segment highlights for the quarter.

I will begin with the Retail/Commercial Bank.

The Retail/Commercial Bank showed continued momentum and product growth as deposits grew 5% year-over-year and also grow on a sequential basis.

We continue to see solid increases in both retail and business deposits from our Tennessee franchise and also further positive benefits from cross-selling nationally.

Loans also increased sequentially and rose 5% year-over-year as continued robust C&I lending growth offset a reduction in the growth rates of our consumer and construction business lines.

Deposit fees grew 4% as compared with the first quarter of 2006, reflecting our continued growth of business and consumer transaction accounts and pricing increases implemented in 2006.

The net interest margin in the Retail/Commercial Bank was 4.1% this quarter, down 5 basis points from the previous quarter.

This six-digit decrease was mainly driven by the continued shift from floating to fixed-rate consumer loans caused by the inverted yield curve and pricing pressure in our construction lending business and a contracting housing market.

This compression was somewhat offset by margin expansion in our Tennessee franchise where we actually widened deposit spreads in the first quarter as market conditions permitted.

Results in the bank continue to reflect our heightened focus on containing expense growth.

As you may recall, first quarter of 2006 included $16 million of unusual expenses related to coin inventory valuations, consolidation of offices, early retirement and incremental technology costs.

If you look at bank expenses on a GAAP basis, this quarter showed good improvement over a year ago.

If you exclude those unusual items from last quarter, on a non-GAAP basis, expenses in first quarter of 2007 were relatively flat as compared to a year ago, even including about $3 million in investments in new financial centers.

Our long-term goal is to reach an efficiency ratio in the mid '60s within the bank and a level which is consistent with our peers.

Despite the product growth and continued attention on efficiency, the Retail/Commercial Bank's pretax income declined from $109 million in the fourth quarter to $100 million in the first quarter.

There were three main drivers of the sequential decrease which offset areas of growth.

The first was certainly seasonality, which drove an expected increase of $2 million in personnel expense and a $4 million decrease in deposit fees.

Secondly, revenues from consumer loan sales and securitizations decreased from $14 million in the fourth quarter to $9 million in the first quarter as we experienced lower execution margins driven by secondary market unrest.

Thirdly, provision expenses increased $5 million this quarter compared to fourth quarter.

As expected, asset quality continued to deteriorate companywide but remained better than historical averages.

In contrast to the increase in provisioning, our nonperforming asset ratio actually declined 2 basis points in the first quarter as continued low levels in our consumer and commercial loan portfolios offset an expected increase in our Construction business, and we accelerated addressing previously identified problem loans.

This acceleration caused what we believe is a temporary spike in our charge-offs, which rose to 48 basis points in the first quarter, driven mainly by a few C&I loans in our traditional banking market and residential real estate construction loans.

In spite of this rise, we still provision in excess of net charge-offs again this quarter.

This increased our allowance to total loan ratio from 98 basis points in the fourth quarter to 99 basis points this quarter, and we still expect asset quality to be solid for the full year of 2007 with net charge-offs averaging between 30 and 40 basis points for the year.

A key driver of the increase in provision in the first quarter was the addition of certain construction loans to our watchlist.

As we had anticipated, the underlying condition of the housing market continued to soften in the first quarter as inventories rose, the financial condition of some borrowers deteriorated and past speculators worked their way out of the market.

This weakening was most evident in Florida, California and Texas.

As this occurred, we worked to proactively move a number of loans in our homebuilder and onetime closed portfolios to the watchlist, engaging both our relationship managers and credit support staff in working through these problems.

Historically this process has produced better than 67% improvement through payments or upgrades in such loans.

Importantly, we had also made a number of underwriting changes beginning in late 2005 in our OTC business to reduce the potential for speculation, including raising FICO scores, eliminating certain products and adding other income verification steps.

We believe the combination of these changes, our aggressive watchlist process and our strong credit infrastructure will limit losses and slow the need for further provision increases to support this business.

And, in spite of the environment, we expect outstandings to grow in 2007 as our offices continue to mature.

Going forward, as we reap the benefits of investments in Tennessee and build out our National Specialty businesses, we believe our deposit and loan growth should improve and that margins should show only modest compression.

And with continued management of expenses and a reduction of seasonal impacts, sequential growth in the Retail/Commercial Bank's pretax income should resume in the second quarter.

Now let's turn to Mortgage.

The seasonal and environmental impacts created an $11 million pretax loss for the first quarter, despite the benefits from the rightsizing actions taken in the third and fourth quarters.

Net servicing income experienced their greatest impact this quarter, declining from $12 million in the fourth quarter to $3 million in the first quarter.

The key driver of this quarter's decline was a $15 million increase in net hedging costs caused by interest rate volatility, fluctuations in MSR values and continued higher costs to hedge under an inverted yield curve.

While difficult to predict, we believe this level of hedging cost is unlikely to repeat the remainder of this year.

Our experience shows that our hedging capabilities benchmark well with quarterly net costs averaging 2 basis points of our standing servicing balances.

Net interest income decreased from $21 million in the fourth quarter to $17 million in the first quarter, driven by seasonally lower escrow balances and a decline in warehouse spreads.

Originations declined only 2% from fourth quarter to $6.3 billion in the first quarter.

This compares to a MBA forecasted drop of 4%.

As we maintain our historical focus on prime fixed-rate conventional performing loans, we largely offset the normal seasonal drop in originations.

Furthermore, we ended first quarter with a pipeline of $4 billion.

This is our largest level since the second quarter of 2005.

Prime margins, which include our Alt-A production, were 98 basis points this quarter, within our expected range and comparable to both fourth quarter and our historical average.

Despite current industry uncertainty that may impact Alt-A executions, we expect our firm gain on sale margin to remain near historical averages.

As we move into the second quarter of 2007, our mortgage segment should resume turning a profit as originations improve, hedging losses diminish and expense growth is limited primarily -- is limited to primarily variable commissions.

In Capital Markets fixed-income revenues remained flat from fourth quarter at $46 million in the first quarter.

As long-term interest rates rose during the first half of the quarter and then fell during the second half, our fixed-income customers curtailed their purchase of securities as they awaited further clarity over the direction of rates.

Revenues from other products remained solid, but declined $7 million from fourth quarter as the pooled trust preferred transaction this quarter was smaller than in previous quarters at approximately $900 million and then market execution of this transaction was unfavorably impacted by industrywide disruption.

Going forward, we believe other products sales should increase over this quarter's level, although we have said it before, they will remain subject to quarterly fluctuations in timing and bill size.

Overall we expect profitability in Capital Markets to improve sequentially in second quarter and for the full year 2007.

In the corporate segment, we deleveraged our balance sheet during the first quarter, selling approximately $500 million of securities and reducing our wholesale funding accordingly.

In the process, we did realize a $10 million security gain in the first quarter.

Deferred compensation expenses and associated revenue both declined in the first quarter as compared to the fourth-quarter levels as equity markets retreated.

Our balance sheet remains relatively neutral and continues to show improvement.

This is highlighted as our deposit growth and loan growth rates have converged, and our loan to core deposit ratio has declined begin, decreasing from 157% in the fourth quarter to 156% this quarter.

The corporate managed margin was relatively flat at 2.84% in first quarter versus 2.86% in the fourth quarter as compression in the bank's margin was partially offset by business mix and the downside securities portfolio.

Our corporate effective tax rate was 21% this quarter, favorably impacted by the planned consolidation of the mortgage company into the national bank.

At the current level of earnings, our normalized tax rate should be approximately 30%.

Lastly, I would note that we have added further disclosure to our financial supplement this quarter.

Given the recent speculation around trends in Alt-A mortgage production, we felt it was appropriate to highlight the declining mix and our strong credit characteristics in this product segment.

We have also added new disclosure on our consumer loan originations to our press release tables.

We believe our focus on strong underwriting standards, high FICO borrowers, geographic diversity, rigorous oversight and practice of ensuring high LTV loans will allow us to maintain solid asset quality in this portfolio relative to the industry.

Now I would like to turn it back over to Jerry for some closing thoughts.

Thank you, Marty.

As we look out across the rest of the year, we expect the environment to remain difficult.

We are not planning for the yield curve to improve, and we are not anticipating a major recovery in the housing market.

We do believe, however, that several of the impacts we had felt in the first quarter are likely to display, namely seasonality, hedging costs and transactional execution.

I believe that this Company must resume earnings growth from current levels no matter how difficult the environment.

But we have also learned that the nature of today's marketplace makes it challenging to forecast precise numbers.

So I do not plan to provide specific earnings guidance.

Instead, let me tell you what my objective is.

My goal is to improve quarterly earnings over the remainder of 2007 toward a quarterly run-rate of $0.70.

This management team has set its sights on exceeding this level; however, given the current headwinds and constantly evolving market disruptions, this could become more challenging in the months ahead.

I believe that this goal is realistic, but I also believe we're going to have to do a few things differently to make it happen.

First, we must fine-tune our strategies to maximize earnings and reduce interest rate sensitivity.

Let me share some of these things with you.

As I said earlier, we will be devoting more resources to our Tennessee market.

We think that there is plenty of room for growth in our homestate, and we know the timeframe to turn a new location to profitability is much shorter where we have strong brand awareness and acceptance.

So, in this difficult earnings environment for two of our business lines, we will not open any new national markets with full-service locations.

Instead, we will build out Tennessee and add banking specialists to the national markets.

We like this approach because the return on investment is enhanced, and it also allows us to grow banking businesses that build deposits and non real estate lending.

The goal in mortgage will be to further leverage the customer acquisition and cross-sell potential of this business.

Our future -- our focus will be on increasing retail, prime originations, by growing the sales force through recruiting and targeted acquisitions, and improving its productivity through dedicated sales management.

To this end, we still expect to acquire about $22 billion in annual production capacity this year with the first of two to three deals this year likely to come in the second quarter.

Capital Markets will continue to evolve as we expand other products further and add international offices in Hong Kong and Tokyo.

Secondly, we must accelerate our progress in becoming a more efficient company.

In light of the added challenges we experienced in the first quarter, the management team has taken a fresh look at efficiencies and is being more aggressive in its approach.

As we told you in January, we set a target of $40 million in efficiencies for this year.

If you remember, we took actions in the fourth quarter to reduce costs in Mortgage and Capital Markets, better aligning those businesses with their respective markets.

That produced about $5 million of benefit in the first quarter.

We have also established a procurement relationship and began outsourcing a number of backoffice jobs.

We will see the positive lift from these actions beginning in second quarter and beyond.

Based upon our progress to date, I feel comfortable we will achieve our $40 million target.

However, I believe that we need to take our productivity and efficiency initiatives to to the next level.

And so we intend to move more aggressively to restructure our Company beginning in the second quarter.

In this effort, we are using both internal and external resources to systematically review how we can reduce costs and be more productive.

While also maintaining or enhancing employee value.

As a result, we will be consolidating functional areas, reducing management to staff ratios, closing unprofitable locations, exiting noncore businesses like nonprime, refinancing portions of our capital and likely much more.

We are still sizing both the costs and benefits of these further initiatives.

While we expect to incur onetime charges, primarily in the second and third quarters in order to execute on these opportunities, we anticipate that 2007 and long-term benefits will be significant.

We see the total benefit of these further efforts amounting to at least another $50 million of annualized savings and our run-rate by the end of this year, over and above the $40 million inefficiencies we currently expect to achieve.

Combined with the efficiencies we achieved last year, we will have created about $140 million of improvements, which is roughly 8% of our annual expense base.

Of course, any of the specific expectations Marty and I have discussed this morning for our businesses would exclude these onetime charges.

Before I close, as you saw from our announcement last Friday, we have appointed Bryan Jordan as our new Chief Financial Officer.

Bryan has absolutely the right mix of skills, experience and strategic perspective that will add tremendous value to our already strong management team.

I know that Bryan is looking forward to getting ramped up quickly on our business so that he can hit the ground running when he starts at the beginning of May.

One of his priorities will be spending time with the investment community, and I know many of you already know him well.

Of course, this means that this will be Marty's last call as CFO of First Horizon.

I would like to personally thank him for his years of service and dedication.

Through his leadership, we have been able to build a financially sound business that has become well-known by the investment community as open and transparent.

We're thrilled that Marty is remaining in our family.

In closing, as I reflect back on my first 80 days as CEO, I have been pleased with the team's willingness to make changes.

We have more work to do, but we are determined to be successful.

Thanks for listening.

Now we will take your questions.

(OPERATOR INSTRUCTIONS).

Jason Goldberg, Lehman Brothers.

Just so I understand you guys correctly, I guess your, and i realize there's tons of risks and uncertainties in the statement, but you expect to kind of be at $0.70 earnings run-rate by the end of this year?

That is right, Jason.

Okay.

And then secondly -- and I'm sorry if I missed it -- did you quantify the size of the onetime charges that you would expect?

No, we're still putting that together, pulling it together.

I think, as you might expect, I have an idea about that, but Mercer Oliver Wyman is helping us with the team internally, and I want to make sure we have sized it properly.

And I also want to have Bryan get a chance to get his arms around it as well.

I would expect that within 60 days, maybe shorter, we will be able to give some specific guidance on that.

Okay.

And then I guess in the release you pointed to a net positive impact from a third-party settlement in I guess expenses this quarter.

Can you quantify that?

Yes, it was relatively small, about $3 million or so, and I think, Marty, you might want to add something to that as well.

Yes, what I wanted to highlight was that $3 million was in other expenses.

If you looked at the trend of other expenses, another thing that we cited in just the conference call script that we just talked about was the reduction in deferred expenses.

That number had gone up in the fourth quarter because the market performance, and as the market retreated in the first quarter, you actually saw that number drop by about 7 to $8 million.

So a lot of the variance that you're seeing in other expenses is related to other things besides this particular settlement, which was, as Jerry said, relatively small at around $3 million.

Okay.

And then just lastly, can you maybe just give more color in terms of what is going on in the trust preferred market in terms of I guess deals being smaller than expected and pricing being not as good as expected in terms of your -- and your thoughts kind of looking out in terms of improvement?

We said consistently that our deals if you look at all of our other products are going to be timing related, size related, and this quarter what we saw was as there were disruptions in the marketplace, the size of the trust preferred, which had been running about $1.5 billion, dropped to just $900 million.

The pipeline still is relatively strong.

So it will be somewhere in that $1 billion to $1.5 billion kind of range.

That is where we have been over the last four or five quarters.

We are just on the lower end of that range this quarter.

With the disruptions that were in the marketplace and the execution, we were successful in completing the deal, which I think was a great testimony to our market share and our position in the market out there.

We did execute.

As we worked through that process, we would have had a little less in the overall profitability just related to that as well.

So those things are disruptions that will come in and out as you go from one quarter to the next.

Our other products are about $7 million lower this quarter, and we should expect to see that rebound with the pipeline that we have in place back towards what we saw between the fourth and somewhere in last year's numbers.

So we feel very confident we will continue to see growth in those revenue sources.

Fred Cannon, KBW.

One question on the servicing hedge in terms of volatility hitting you guys this quarter.

We did not see that same effect at the other large mortgage services, Washington Mutual and Wells Fargo this quarter.

I was wondering if your MSR hedge had more susceptibility or more sensitivity to volatility than others in the industry?

We might in the way that we use options and swaps, the way we have structured ours, to try to limit the direction of rates.

As you have seen over the last year, we have had less losses as the direction rates have shipped, and we have been fairly efficient holding our net losses to around between 5 to $10 million.

This quarter we did see a market change in what they call the [VOL] factor, which is the volatility that the market is anticipating going forward.

That did have an adjustment on our hedge performance this quarter and did take that cost up from a $5 million number to a $15 million more at 20.

So we would not expect -- those are onetime adjustments that you go through in any given quarter.

We would expect as we roll forward that it would be much more like what we have had in the prior quarters related to our very efficient hedging performance.

It is Dave.

I would also had add that if you benchmark our hedging losses over a period of time against other companies, if you look at it as a percentage of our MSR values or as a percentage of UPBs, I would I think compare pretty favorably over a longer period of time too.

I guess the question, Marty, to follow-on is, should we think -- should we track volatility as perhaps an indicator of the hedge performance that we could expect in any one quarter?

I think that would be a decent indicator that in quarters where volatility was narrowing significantly, we could have an impact like we had this quarter.

When volatilities widen back out, then we would potentially see some benefit.

And I just had a general question for Jerry given it is his first quarter.

Jerry, you did a good job I think helping us think about where you are looking forward to vis-a-vis EPS and some of your goals.

I wanted to see if you would be willing to address your thoughts on profitability?

I know it is the first quarter, but I think the ROA at First Horizon was 74 basis points, ROE was under 12, and I believe the efficiency ratio was around 77%.

These are kind of at the very low end of peer profitability levels.

I was wondering if you could address what you would like to see in your new role the bank to achieve and what kind of timeframe you would like to see those profitability levels move back up in line with peers?

Well, my goal is to make sure we are focused on executing the strategy.

As you know, we have changed our strategy to really focus on Tennessee where I think we can be far more effective.

You will see us be far more aggressive in this state in terms of adding banking specialists and opening new branches.

And that does not produce instant results, but I'm confident by the end of the year you will see us improving our earnings within our banking business.

In our Mortgage business, I think we will see that turnaround as we move through the end of the year, and while I was in a way a proponent of us having a small role in the subprime business, it is important that we exit it in terms of the wholesale business, and that will improve our profitability I think measurably as we move through the balance of this year in the Mortgage business.

Efficiencies, as you I think made a comment about, are extremely important.

We have not been an efficient organization, and we are intending to be at the midpoint of the industry as we begin next year.

And this management team is absolutely committed to do that.

We have assembled the resources to make sure we are focused on it.

I have the commitment throughout the organization that we will do that.

And we will track it on a weekly and monthly basis.

So I'm very confident that we can be an efficient organization by the end of the year.

If I stay focused on strategy and I make sure we are an efficient organization, I am confident that our profitability will improve, and we will -- you will see and the industry will see that we will continue to move up in terms of both return on investment and other measures as well.

Eric Wasserstrom, UBS.

Just a couple of points of clarification.

The first is, Marty, I am afraid I did not follow all of the commentary on why the charge-off event in this quarter was like a particular onetime spike.

Could you just walk through that once again?

Yes.

What I was trying to parallel was a couple of things.

One is, if you looked at the charge-off number, it increased by $13 million from last quarter.

However, when you look at what we had -- we increased in provisioning, it was only $5 million, which reflects the fact that we had a majority of those charge-offs already provided for.

The other factor that then kind of confirms that is, if you look at our nonperforming assets, they actually dropped 2 basis points or about $5 million from fourth quarter to first quarter.

So we had nonperformers moving down.

We had charge-off moving up, but we did not have the increased provision in the same amount that we increased the net charge-offs increase.

So a lot of those were loans that we had already provided for last year as we worked through those particular issues, and this quarter just coincidentally there were a number of them that got finished out.

And just on that issue of the MPAs, I mean they are down slightly, but they are still running at north of $130 million roughly I think.

I'm just unclear why that points to a 30 to 40 basis point charge-off ratio for the year.

If you look at the nonperforming loans, they are down $9 million.

So, as you go through the workout process, what you're typically kind of doing is working through your nonperformers, and then they worked down into foreclosed properties.

So your nonperforming assets were only down $4 million, but there was a shift from nonperforming loans to foreclosed properties, of which all of the loss content has already been taken out of your foreclosed properties.

So again, it is just the steps or the progression through the workout process that we are seeing reflected in this quarter.

If you looked at the charge-offs from our consumer portfolio, they remain down at around 30 basis points.

If you looked at the source of where we saw the increase in the net charge-offs, it was a 48 basis point really coming from commercial and industrial loans in our traditional markets that were very specifically related to issues loan by loan type of things that were happening.

So when you look at going forward, without the next level of kind of loan issues out there, already having worked through a lot of what we saw, we feel like there is a good chance that that commercial and industrial charge-off number will come back down, and then we will see the stability that we have seen in the consumer side with less of those particular issues in the commercial industrial play into a lower net charge-off ratio next quarter.

Christopher Marinac, FIG Partners.

Jerry, you had mentioned that with the removal of the nonprime mortgage business, that things would improve measurably.

If we just looked this last quarter for example and if you were not in the nonprime business, would it simply be that $2 million swing, or is there more of a profit swing than would have happened in the first quarter?

I just want to reconcile that.

If I outline Mortgage Banking profitability, what you would see is the biggest shift between last quarter and this quarter is going to be the impact of what you had in your hedging costs.

So actually, if you added that hedging cost, that $15 million back, we actually were earning a little bit more than what we had in the fourth quarter, even though seasonably this is a weaker quarter on deliveries.

If you look at the nonprime side, nonprime being able to move to the broker model, taking out the funding and the underwriting and the processing costs that we would have had this quarter, would add on a quarterly basis a couple of million dollars.

So you would see that benefit as you begin to move forward, and then you will begin to recognize the benefit of being able to get the fees off of the broker product that we are selling.

So it will turn it from a loss to a gain by being able to redesign the business that we are in right now.

And that business has been costing us on a run-rate basis operationally 2 or $3 million a quarter.

We exit that business, and you really get the benefit of it turning around from a minus a couple of million dollars to neutral to positive going forward.

Okay.

And the broker fees that you mentioned, Marty or Jerry, those are separate from 2 or 3 million, or that is included in that loss, that swing?

It would be separate.

It would be on top of it.

(multiple speakers)

So you save the 2 or 3, plus you get the additional fees?

That is right.

What would those fees be just from basis points, or how should we think of those?

Normally we would expect 50 basis points to 100 basis points of fee income as we refer those out to brokers on a brokered out basis.

Would you do the same amount of volume with brokers, or would you do more under this model?

For now I would say we will do our current amount of volume.

That would be on the retail side.

On the wholesale side, you would see some contraction because you would not have those channels anymore.

Okay.

And then just one point of clarification on some of the cost savings in general, do any of these initiatives impact some of your newer markets, whether that be Seattle, Atlanta, DC?

No, they don't impact our banking markets per se.

Where we see the opportunity is fear in our corporate structure and in consolidating duplicative functions which have existed for a long period of time, improving the ratio of management to staff.

There is plenty of opportunity for us to get benefit there.

In our bank markets that you mentioned, we're going to continue to add specialists in those markets.

While we're not going to add brick and mortar, we will certainly add banking specialists to continue to develop those markets for us in the middle market, small-business lending and private client areas.

Gary Tenner, STRH.

Marty, I wonder if you could talk a little more just to the sort of tangible benefits of building the Mortgage business into the bank that you alluded to earlier?

Right.

What we talked about there was, as you noticed this quarter, we had the tax benefit of being able to go from the tax rate that we would have had just in the mortgage company to the consolidated overall tax rate of the bank.

Going forward, we will have the benefit continuing of not having again getting the benefit incrementally of that tax lowering.

We also will get operational benefit as we execute on finishing the consolidation.

There is less regulatory -- there are not as many legal entities now, the consolidation operationally, so there is some backoffice and kind of corporate governance things that you can save some money on as you consolidate into one entity.

Okay.

And then just to follow-up on the question earlier regarding credit, and expectation for the losses, I wonder if you could just give some more color into some of your hotter markets and what you are seeing, whether it be Phoenix, etc.

just in terms of the health of the construction markets in those locations?

If you look at our particular markets across the country, really the ones that we're seeing that are slowing down are California, Texas and Florida.

The rest of the markets have a fairly healthy momentum to them, and we feel like they are still performing as expected.

So just those three areas, which is where we are seeing the magnitude really of any slowdown there.

Gary Townsend, Friedman Billings Ramsey.

Marty, I was wondering would FAS 157 be helpful to your mortgage hedging operations, and have you been considering moving to that on an early basis?

If you will remember last year, we actually went to fair market accounting on the mortgage hedging.

So, from the hedging side of what we have done mortgage servicing wise, we feel like we've got a fairly efficient way of being able to do that.

Again, there will be things that will happen in the marketplace that can cause disruptions favorably and unfavorably.

I mean we have had positives as well as negatives, and they will fluctuate from quarter to quarter.

But we have been able to minimize that.

We have been able to be able to have very tight correlations between when rates move up and down, so we have been a very good hedger of the direction of rates.

Every now and then there will be one of these other kind of ancillary variables that will change that can create a hit.

But again, $15 million in the overall scheme of things, when you look at how we have done over time, is pretty small relative to what we have been able to see in the marketplace.

So the new accounting guidance is not particularly impactful for you?

No, I don't think so because already it has gone to fair market accounting on the hedging side.

Marty or rather Jerry, in your other earlier remarks, you talked to -- you really reaffirmed the national interest that the Company has but the focus is now Tennessee.

Can you just speak to that and help reconcile the seeming contradiction?

Well, the fact is that I'm very concerned or interested as you might expect on making sure that we have revenue and earnings growth.

This state is an extremely great opportunity for us.

Consolidation going on in the banking business, particularly in this state, puts it up to the very top of my list of opportunities.

And so the fact is that a branch that we opened or an investment we make in any of our newer banking markets takes far longer to get profitable results than if we invest those dollars here.

So, over the next two to three years, we want to put our dollars here.

But that does not mean that we don't want to grow in the new markets that we are in Virginia and Maryland and Texas and Georgia.

We don't believe that we need grow more brick and mortar there.

We believe we can first add more banking specialists.

We have also not spent I think the marketing dollars that we could spend to create greater brand awareness in those markets.

So more specialists, the greater level of marketing in those states or in those markets will produce results for us as well.

But we continue to add banking specialists in our nonbank markets in terms of small-business lenders, middle market lenders.

So we will continue to have a national focus with relationship management but in targeted areas, markets that we believe we have the greatest opportunity to be successful in.

David Stumpf, A.G.

Edwards.

A couple of follow-up questions I guess.

Marty, you had mentioned some additions to the watchlist I guess from the construction portfolio that was partly a driver of the additions to reserve.

Can you at least in a general sense size that for us in terms of what that watchlist is and how much larger it has gotten?

Yes, I mean if you start looking at the general direction we have seen again, some Texas, California and Florida as being the primary regions where we have begun to see some deterioration in the sense of slowing in the activity.

We have seen any of the speculations in the market begin to push its way out.

And so that has enabled us to continue to look at what we're doing.

If you look at their loans today, we have got about 4% of their loans on watchlist.

That is where we are at.

Still 96% of them are still performing very well.

What we're looking at is that typically we have got 70% of those to improve.

So we have been able to work through those loans, been able to see improvement as we have been able either to work through the deal and get them back upgraded or get them sold off our balance sheet.

So the watchlist process is just something that we can do by looking at it three or four stages before it becomes a real problem asset, and it gives us the greatest opportunity to be proactive in working it out.

Okay.

In the fee income area, insurance fees were down pretty significantly from a year ago.

Are those agency-based insurance fees, or is that related to insurance sales to the Mortgage company?

What exactly is the main driver of that, and what is the explanation for the big decline?

Right.

Actually those are agency fees.

It is down from a year ago only in the fact that we had a divestiture of an agency.

We had several years ago bought an agency in Nashville which had an office that was up in Kentucky, which was in an area where we did not have any other presence.

So last year we actually divested of that office, and that is the representative of the decline that you are seeing from last year.

Okay.

One more.

The deferred in that other -- that nice breakdown of other income and expenses that you provide, which I do appreciate, I think you touched on this, Marty, but I still am confused.

What is deferred compensation that is actually in other income and explain again why it is down so much?

Okay.

I actually have to correlate for you two different schedules.

If you will look at the other income and other expense table, on other income you will see deferred compensation drop from $8 million to $1 million.

Okay?

When you look down in other expenses, if you flip over to actually where we show the corporate segment numbers, what you will see is in the corporate segment we will actually show you deferred compensation expense.

Deferred compensation expense dropped from $10 million to $2 million, so it is an $8 million drop between fourth quarter and first quarter.

If you look at the fourth quarter, also included in that was we had talked about last quarter about $6 million from two issues that created losses for us.

So you had the ACH loss that we had, and we also had the employee fraud loss.

Those were two things that were included in that $19 million.

So if you adjust out the $6 million from last time, you would have had $13 million in other expenses.

If you add you will say the $3 million related to the settlement that we got this quarter, you would have $8 million.

The difference between those two, that $5 million, is basically built into the $8 million reduction in deferred compensation expense.

The reason deferred compensation expense goes up and down is that we have a program that allows our employees to defer some of their income into a fund.

Once it is in that fund, it still ends up in our income and expense line, but they are offsetting each other.

We have got it hedged so that when the market does well, you have expenses that go up that just reflect the returns that our employees are getting on their funds that they have put into these different instruments.

And on the topside, we have got revenues that then pay for the returns that those employees are getting.

What you saw in the first quarter was that the market performance was markedly lower than what you saw in the fourth quarter when the stock market was going up very strongly.

So that is why you saw a correlation between those expenses and revenues going up very strongly in the fourth quarter and being very low in the first quarter.

Bob Patten, Morgan Keegan.

I guess I just wanted to follow-up with Jerry's comments on efficiency.

I would like to know how he is -- he wants to get down to the midpoint of peers.

I guess how are you going to measure that?

Is that going to be on each business separately?

An example would be the bank is at 61% efficiency ratio now.

The midpoint is 57.

So by year-end should we see the bank only at 57?

That would be correct.

We are going to peg each to their respective industries and target the midpoint for them.

Okay.

So will you guys come out when you -- and Bryan is onboard -- and you look at your plans, come out with some measurable targets that the street can look at and see how you are achieving your progress?

I think that would be reasonable.

Okay.

And then I guess just on volatility, with your business mix in this environment, Jerry, how are you going to take the volatility out of this mix?

Keep growing our banking businesses.

But it is not growing.

Well, I think you will see it certainly growing within the state of Tennessee, and we can continue to grow more in Tennessee.

When you look at banking overall, you are certainly going to have some impact from our construction, particularly our consumer businesses as they are tied to the Mortgage and the Real Estate business.

But our banking business in Tennessee both in deposits and loans is growing, and I expect that to continue to grow, and it is really the reason why we want to focus on this state.

That concludes our question-and-answer session.

I would like to turn the conference back over to Mr.

Baker for any additional remarks.

Well, the only additional remarks I have is maybe to reinforce or repeat again that we have enjoyed having Marty in his role.

He has been a valuable contributor to our Company, and I know he will continue to do that as he moves out to Capital Markets.

And I know you will miss the conversations with him that you have had over time and his friendship.

But we do appreciate all that he has done for us, and I thank you for your interest in our Company, and we appreciate you continuing to watch our progress as we move through this year.

Thank you very much.

Thank you, everyone.

That does conclude today's conference.

You may now disconnect.