First Horizon Corp (FHN) 2007 Q4 法說會逐字稿

Welcome to the First Horizon National Corporation first quarter earnings conference call.

Today's call is being recorded.

In addition, you can listen simultaneously at www.fhnc.com at the Investor Relations link.

Hosting the call today for First Horizon National Corporation is Jerry Baker, Chief Executive Officer; and Bryan Jordan, Chief Financial Officer.

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

At this time, all participants have been placed in a listen-only mode, but the floor will be open for your questions.

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 details are provided 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 web cast on our website at www.fhnc.com is the only authorized record of this call.

With that, I will turn it over to our CEO, Jerry Baker.

Good morning, and thank you for joining the call.

I'm sure you have all seen our news release this morning regarding our fourth quarter earnings and our dividend reduction.

I will cover the dividend in a few minutes.

But I will begin with our reported earnings which were a loss of $1.97 per share in the fourth quarter.

This quarter's results reflect several significant changes net of some small gains.

They also reflect the continuing impact of challenges facing financial services companies as housing markets across the country continue to weaken, interest rates remain highly volatile, and we continue to face [illiquid] markets for credit-based products.

Brian will cover the detail in a few minutes and I will focus this morning on the actions we are taking as well as the core fundamental strengths we see in our businesses as we move forward.

The market environment continues to require definitive management actions across several areas; the adequacy of reserves for loan losses, maintenance of adequate capital and liquidity, elimination of unprofitable or low return businesses, and achieving meaningful cost reductions.

Accordingly, we have taken the following measures to improve performance.

First, as we announced in December, we conducted a comprehensive review of our residential construction portfolios including an assessment of our reserves.

As a result, we increased reserves by over $100 million in the fourth quarter, mainly reflecting inherent losses in our construction lending businesses related to deteriorating market conditions.

In contrast, our C&I and home equity portfolios continue to perform as expected.

We will, of course, continue to monitor all of our portfolios carefully.

Second, we completed the sale of 15 First Horizon bank branch locations in the fourth quarter generating a small gain.

We expect the sale of the remaining locations to be completed in the first quarter of this year.

Third, we are reducing our mortgage and national real estate exposure.

Despite our competitive advantages, we continue to downsize these businesses which we view as lower return and more volatile, and where we see market conditions remaining difficult into 2009.

As a result, we substantially reduced head count and costs in the fourth quarter.

We also sold $7.3 billion of mortgage servicing and believe that further reductions in the size of our servicing portfolio are warranted.

Accordingly, we recorded a $135 million reduction in the value of our mortgage servicing assets this quarter reflecting more emphasis on broker price discovery to determine marketable value in the current environment.

We also took other charges in response to the current difficult real estate marketing including writing off all of our $71 million mortgage goodwill and making some LOCOM adjustments in our warehouse.

After tightening underwriting significantly and reducing our sales force and cost of the fourth quarter, we are making further changes in our construction lending businesses.

We have eliminated wholesale one-time close and virtually all home builder lending and high risk national markets and will continue to reduce originations.

And in all markets we have refocused experienced resources to workout roles.

This should result in a $2 billion or more contraction in these portfolios by the end of 2008 freeing up capital and requiring less ongoing provisioning.

Fourth, we continue to approve our efficiency and productivity completing the initiatives that will achieve our $170 million annual target.

We will pursue significant additional cuts over 2008 as we shrink our national businesses.

As we acted throughout the quarter to improve performance and made adjustments to reflect current market conditions, the magnitude of negative impacts on our financials increased and our capital levels were diminished.

This constraint led us to one last meaningful decision, our decision to reduce our dividend from $0.45 per share to $0.20 per share.

We clearly understand the importance of our dividend to many shareholders and did not make this decision lightly.

As we considered the continued challenges we face in the current environment, we believe a lower dividend is in the long-term best interest of the Company and shareholders.

Combined with our actions to shrink our balance sheet and improve earnings, the reduced dividend should improve capital ratios and provide us additional flexibility during 2008 and into 2009 including the ability to make continued investments in growing our strong regional banking franchise.

The $0.20 dividend should reduce our payout ratio closer to our targeted 45% to 50% range, and as we focus on improving earnings in our capital position, this should provide the longer term flexibility to adjust the payout or repurchase shares.

While these changes aren't easy to make, our management team and employees together with the leadership of our board, have proactively moved to respond to changing market conditions.

At the same time, we are positioning the Company for improved 2008 results, better long term returns on capital, and a more stable business mix.

Now I will turn it over to Brian for his comments and be back with some closing thoughts before we take your questions.

Thank you, Jerry.

Good morning, everyone.

As Jerry said earlier, reported earnings were a loss of $1.97 per share in the fourth quarter.

There are a number of pieces to the results, which we've again tried to simplify to the extent possible with materials in our financial supplement providing detailed schedules to explain which line items and business segments these charges impact.

Dave and I will be available after the call to answer questions you may have.

I will begin with a run down of this quarter's significant items which we've summarized on page three of our financial supplement.

We incurred net charges of $27 million this quarter from restructuring, repositioning and efficiency initiative charges.

This amount includes $36 million in expenses from severance and technology projects and $7 million in servicing sale transaction costs, which were partially offset by a $16 million gain associated with the sale of 15 First Horizon bank branches.

All of these charges are recorded in our corporate segment.

There were four items that impacted the mortgage banking and national lending businesses including the following: Goodwill impairment of $71 million reflecting an updated valuation of the business based principally on strategic cash flow projections and mark-to-book values; Reduction of mortgage servicing asset carrying values of $135 million.

Lower of cost or market, or LOCOM, adjustments on non-conforming loans in our warehouse and other valuation reductions totaling $19 million; And finally, a legal settlement accrual of $5 million.

Other items include $56 million of accruals related to our proportionate share in Visa and its American Express and other outstanding litigation matters.

And there are a handful of smaller items that total roughly $4 million which are detailed on the summary page in the supplement.

With respect to asset quality, as pre-announced, we incurred $157 million in provision expense in the fourth quarter, significantly exceeding net charge-offs of $51 million.

As a result, reserves increased by $106 million over third quarter to $342 million at the end of the fourth quarter, or 1.55% of total loans outstanding.

Net charge-offs increased to 93 basis points in the fourth quarter from 57 basis points experienced in the third quarter driven primarily by one-time close and home builder loans in our national footprint.

Non-performing assets increased from 113 basis points last quarter to 166 basis points in the fourth quarter, also largely reflecting construction loan deterioration in the national markets.

We've again provided detailed disclosure by portfolio in our financial supplement this quarter.

As we disclosed in late December, the additional reserves primarily reflect higher inherent losses in segments of our national one-time close and home builder portfolios, which together represent $4.1 billion or about 19% of our total loan portfolio.

In home builder finance, we continue to see the greatest problems in weak national housing markets such as Florida, California, Arizona, Nevada, Virginia and Georgia where falling home prices are driving higher loss severities and where large supplies of unsold homes are pressuring builders and consumers.

Florida and California alone represent about 22% of our total $2.1 billion builder portfolio, but account for over 50% of our non-performers in this portfolio.

Our one-time close portfolio is also experiencing significant pressures in these national markets.

In addition, we've seen greater loss rates on product structures that we discontinued in 2006 and 2007 that had higher interest, excuse me, higher risk origination parameters and were structured as stated income and low documentation loans.

These loans represent approximately 24% of OTC commitments, but accounted for 75% of charge-offs in 2007.

Our non-construction loan portfolios, representing approximately 80% of total loans, continued to perform well in the fourth quarter.

In our home equity portfolio, delinquencies rose from 1.14% of loans 30 days past due in the third quarter to 1.36% in the fourth quarter reflecting general maturation of the portfolio and continued environmental pressures.

Annualized charge-offs increased 60 basis points in the fourth quarter from 33 basis points in the third quarter.

The increase was primarily driven by addressing a group of fraudulent loans in Virginia.

We attribute this portfolio's relatively good continued performance to our creditworthy borrowers, geographic diversity and high mix of retail originations.

In the C&I portfolio, which is mainly Tennessee based, non-performers improved from 32 basis points in the third quarter to 24 basis points in the fourth quarter.

And net charge-offs decreased, as well, to 20 basis points annualized in the fourth quarter.

Management continues to take actions to limit, identify and manage problem loans.

First, we are reducing our national real estate portfolio, significantly curtailing new originations, tightening underwriting, eliminating certain product structures and pulling back in higher risk national markets.

And as we've said, the relatively short life of these loans will also generate meaningful reductions in these portfolios over 2008.

Second, we are proactively identifying at problem assets through a more intensive watch list process and comprehensive portfolio reviews.

In the fourth quarter, these reviews touched substantially all loans in high risk markets and approximately 70% of the entire commercial real estate portfolio.

Third, we were ensuring adequacy of reserves.

In the fourth quarter we conducted a thorough review of our reserve methodology refining loss probabilities and severities in certain segments of our portfolio to reflect more recent historical losses and deteriorating conditions.

Finally, we are remediating problem assets by deploying additional workout resources including an enhanced central work out function.

We have brought in outside seasoned staff for selected new positions and have moved experienced relationship managers to work out roles.

Going forward, generally expect asset quality indicators and market conditions to weaken further in 2008, but also believe that we have moved aggressively to address problem loans.

Non-performers should continue to increase.

We currently expect provision expenses in the range of $50 million per quarter for 2008 and our reserve coverage of total loans to increase somewhat as our national portfolio shrinks.

Next, I will update you on our progress in executing our efficiency and productivity improvements.

We have completed roughly 50 individual projects that should drive $175 million of annual pre-tax benefits and there are a handful of remaining projects that could push the benefit a bit higher.

We estimate that approximately $150 million of these annual benefits were in the fourth quarter run rate, and that the remainder should be realized by the first quarter of 2008.

We completed the sale of 15 First Horizon branches in the fourth quarter resulting in the transfer of approximately $230 million in deposits and loans, both of which were classified in held for sale categories at the end of the third quarter.

We expect the sale of the remaining locations to occur in the first quarter of 2008.

In aggregate, we expect the divestitures to provide approximately $30 million in annual pre-tax improvements by the second quarter of 2008.

As we have done in the past, we continue to pursue opportunities to reduce our mortgage and national specialty lending businesses.

Since the middle of the third quarter, we have eliminated the bottom 50% of our retail sales force, reduced wholesale account executives, construction relationship managers, management and support staff, closed more than 60 offices and cut other back office costs such as IT.

We ended the fourth quarter with 4,000 employees in these businesses, 600 less than the end of the third quarter, and down more than 1,300 from a year ago.

We anticipate that these reductions will provide $40 million in annual pre-tax savings beginning in the first quarter.

Given the continued challenges and outlook for these businesses we will look for ways to reduce costs even further.

As a result of all of our efficiency and restructuring efforts, total full time equivalent employees declined 10% from the end of the third quarter and are down approximately 18% from a year ago.

We expect head count to decline further in 2008 as we become more efficient.

Total expenses in the fourth quarter excluding the $167 million of charges from significant items were approximately $390 million.

While exhibiting normal seasonal patterns, and impacted by variable commissions, we expect expenses to decline further in 2008.

We have again provided a detailed schedule on page five in the financial supplement to explain all of these charges and benefits.

Now I will discuss the highlights from each of our business lines beginning with mortgage.

Clearly, this was another disappointing quarter for our mortgage business as we recorded a pre-tax loss of $263 million.

As I've already mentioned, this loss was mainly driven by two larger items.

First, we recorded a goodwill impairment charge of $71 million writing off all of the goodwill in this business based upon market valuations.

Second, we recognized a $135 million reduction in the carrying value of retained servicing assets this quarter.

Each quarter we assess the model value of our servicing asset by comparing them to those of other mortgage companies, observable trades of servicing in the market and third party broker valuations.

Given the ongoing disruptions in the mortgage market, we adjusted our carrying values this quarter to be more in line with third party broker values.

In addition to these larger unusual items there also some persistent operational challenges in the business.

On the origination side, deliveries declined seasonally as expected to $5.5 billion in the fourth quarter, but pricing remains below historical levels.

Gain on sale margins were five basis points in the quarter, again, adversely impacted by significant spread widening on ARM and nonagency eligible production, although the impact was smaller than the third quarter as we have substantially reduced volumes in these products.

Margins were also negatively impacted by the aforementioned LOCOM adjustments.

On the servicing side of the business, run-off expenses decreased to $41 million in the fourth quarter, versus $49 million in the third quarter.

Net hedging performance was a loss of $18 million in the fourth quarter, significantly below last quarter's positive $22 million.

This quarter's loss was primarily driven by significant rate volatility in December and weaker market liquidity in certain hedging instruments.

In part, this increased transaction costs to maintain our targeted hedge profile.

Despite these challenges, servicing portfolio metrics continue to reflect our operational expertise and focus on prime and informing customers.

Servicing costs for loans remain at best-in-class levels and delinquencies, though increasing somewhat, are well below industry norms.

As of the end of the fourth quarter, 148 basis points of the portfolio was 90 days delinquent, up from 118 basis points last quarter.

Lastly, we completed two bulk servicing sales in December totaling $7.3 billion in unpaid principle balances.

This reduced servicing assets by approximately $120 million driving reduced utilization of capital by the business.

Going forward, we expect the mortgage business will remain challenging in the near term given current credit market conditions.

We believe the actions we have undertaken in recent quarters and our ongoing focus on discipline pricing management and cost control should position this business as well as possible for the current environment.

That being said, we also recognize that our work is not done here and we will continue to explore ways to further reduce our mortgage exposure.

Capital markets was a bright spot for us in the fourth quarter as our focus on maintaining a balanced business model was evident.

Pre-tax income increased sequentially from an $8 million loss in the third quarter to a $21 million profit in the fourth quarter.

Fixed income sales improved sharply as the Fed reduced rates and the yield curve steepened producing $77 million in revenues compared to $46 million in the third quarter.

Other product revenues improved from $16 million in the third quarter to $24 million in the fourth quarter, although still well below levels seen in prior quarters.

We completed a small pool trust preferred issuance this quarter of approximately $370 million and profitability was minimal.

Despite ongoing strong demand from our financial institution client base to raise capital through trust preferred issuances, investor demand for even high quality CDO product remains subdued.

We have temporarily adjusted this business accordingly and have managed our warehouse down to less than $400 million at year end.

Going forward, we expect our capital markets business to benefit from continued increased levels of fixed income activity.

Additionally, while we believe credit market illiquidity may continue to restrict our pooled trust preferred business over the near term we believe this business will recover in time.

We continue to be pleased with the performance of our First Tennessee bank franchise.

Customer and account trends remain strong as a result of our efforts to open new financial centers, increase marketing spending and intensify sales calls particularly in light of ongoing bank consolidation in our trade area.

As a result of these efforts, fee income in our regional banking business increased 3% sequentially and deposits grew as well.

We expect profitability to grow in the quarters ahead as we reap the benefits of continued investment in this business.

Turning to the total retail commercial banking segment, we recorded a pre-tax loss of $52 million in the fourth quarter driven mainly by the aforementioned increased provision expense associated with our national construction portfolios.

Deposits were flat and loans declined 2% sequentially over the third quarter primarily driven by First Horizon branch sales completed during the quarter.

Our real estate construction loan portfolios, mainly OTC and home builder, declined by a combined $227 million from the end of the third quarter to the end of the fourth quarter, and we expect a faster rate of contraction over the next few quarters.

The retail commercial banks net interest margin declined 17 basis points to 3.71% in the fourth quarter driven by additional non-accrual construction loans in our national markets and the impact of Fed rate cuts on deposit rates.

The corporate segment incurred net charges of $93 million this quarter associated with our various restructuring, repositioning and efficiency initiatives, the Visa litigation accrual and equity security losses.

Turning to our consolidated results, the tax provision this quarter was a credit of $146 million reflecting our normal statutory federal and state rates, permanent fixed credits of $6 million, and approximately $40 million of non-deductible goodwill impairment in the mortgage business.

Consolidated net interest margin declined from 2.87% last quarter to 2.77% in the fourth quarter.

The decrease largely resulted from increased wholesale funding costs tied to LIBOR, although we were able to leverage alternative short-term funding sources to mitigate some of this negative impact.

In general, every 30 basis points of sustained higher LIBOR rate relative to Fed funds costs us roughly $5 million pre-tax per quarter as more liabilities than assets are tied to LIBOR.

Going forward, we expect the margin to show some improvement given the prospects of a steeper yield curve and our overall liability sensitivity.

In addition, the reduction of lower margin businesses from the balance sheet including the First Horizon Bank and national consumer lending businesses should provide benefit as well.

While we have seen improvement in LIBOR rates in recent days, these benefits could be eroded by resumption of the LIBOR illiquidity premium experienced in the fourth quarter.

As Jerry indicated, capital ratios declined in the fourth quarter driven by the reported losses.

All ratios continue to be above well capitalized standards based on our estimates for the end of the fourth quarter, 6.0% for tangible common equity to risk weighted assets, 8.0% for tier one and 12.5% for total capital.

While these ratios are at or above our more conservative internal targets, we also recognize the need to build capital into 2008 to facilitate ongoing investments in our bank and provide cushions given market uncertainties.

A number of the actions we've outlined today do just that.

Reduction of our quarterly dividends saves roughly $130 million annually relative to our prior run rate.

Contraction of $2 billion or more in national real estate loans frees up roughly another $160 million of tier one capital, and the divestiture of remaining First Horizon banks should create another $40 million of tier one improvement.

In total, these three initiatives alone should improve our tier one capital position by roughly $330 million over the next year.

Combined with our strategic initiatives to improve core earnings, we expect capital ratios to improve during 2008.

With that, I will turn it back over to Jerry for some closing thoughts.

Thanks, Bryan.

This has been a challenging year for our Company.

But reflecting back on 2007 we have made major strategic changes while addressing complex market conditions.

We've taken significant charges and made difficult decisions and despite the challenges, our core business assets are strong.

The First Tennessee franchise continues to perform well.

We are building new financial centers, focusing on growing deposits and wealth management services, refining our targeted value propositions, and adding top talent to grow the bottom line of this business that has great potential.

Our capital markets division continues to be an important complementary business and its balanced model should continue to drive profitability improvement despite current CDO market pressures.

And we will continue to make further significant adjustments to our mortgage and related lending businesses including pursuing strategic alternatives to further reduce our exposure to these areas.

In short, the earnings power and potential of the Tennessee bank and capital markets businesses are strong and improving.

By focusing on our fundamental strength, our regional banking business, we are positioning the Company for improved 2008 results and better long-term returns on capital.

I'm sure no CEO wants to cut their Company's dividend.

At the same time, I believe that in these extraordinary times we need to build capital, improve liquidity and provide the flexibility for continued investments in our banking business.

We believe that we are making the right strategic adjustments, and we believe these changes will reward shareholders in the long term.

Now we will take your questions.

The question-and-answer session will be conducted electronically.

(OPERATOR INSTRUCTIONS) We'll pause for a moment to assemble today's roster.

We will go first to Steven Alexopoulos, JPMorgan.

Good morning, everyone.

Good morning, Steven.

Good morning.

Jerry, you commented that with the dividend cut, the payout ratio should in the 40% to 50% range.

What time frame are you thinking there?

Is that an '08 assumption?

Or next quarter?

That's our assumption for '08.

We believe that we should progress and be at that level as we move through the year.

Bryan, maybe could you just touch for a second on how you are thinking about the mortgage banking segment here?

You have had head count reductions.

A lot of moving pieces.

When do you expect that segment to actually become profitable again?

That's a good question.

The disruptions in the market seem to continue to persist.

You see improvement for a couple of months and then spreads widen out like they did towards the end of the year, especially in December.

We expect, as we sit here today, to continue to see a difficult operating environment for the mortgage business for the foreseeable future.

We don't expect significant recovery over 2008 and probably will persist into 2009.

Our hope is that we can reduce the -- if you pull it out a number of the one-time items in the business and look just at the operating results, you probably would have had in the neighborhood of a $40 million pre-tax operating loss in the business.

That pulls out the goodwill, the MSR valuations, (inaudible) et cetera.

So we are trying to drive that much closer to break even over the next couple of quarters, and as Jerry said in his comments, and as I said a couple different ways in my comments, that's a business that we are going to continue to address as aggressively as we can to reduce exposure to the volatility of the business, and to reduce the cost structure and the capital allocated in way that we drive greater profitability out of the business.

We will go next to Paul Miller, FBR Capital Markets.

Thank you very much.

You talked about having provisions of roughly $200 million, or a $50 million run rate if I'm correct throughout the year.

And you had $50 million, roughly, charge-offs in the fourth quarter alone.

Are you planning going forward to provision what you expect to charge-off and saying that do you expect charge-offs to be roughly in that $200 million range?

Yes, Paul.

This is Bryan.

Let me tell you a little bit of, put in context the fourth quarter.

We went through as we said a very detailed bottoms up analysis of our reserving methodologies.

We reviewed 70% of our commercial real estate portfolio, loan by loan.

We looked at all of the loans in our high risk markets and our construction portfolios.

And clearly we were trying to make sure that as we looked at these assets that we got them charged down to our realizable values and, our expected realizable values making as good an estimates as we can.

As we look into 2008 and as we sit here to date, we expect the credit quality will continue to deteriorate.

We expect that our loan portfolios will come down some as we reduce our exposure to our construction portfolios.

So in an absolute sense, just by covering charge-offs, reserve levels will build as a percentage of loans.

Now I'm not prepared today to say that we are going to limit our provisioning to whatever charge-offs are.

Our expectation is is that we will cover charge-offs and we will continue to evaluate the adequacy of the loss reserve in 2008 as events unfold.

Again, against the back drop we think credit quality in the total environment will continue to deteriorate and we will see how our portfolio performs in that context.

And then one other quick question on you talked about taking out $170 million of expenses.

What time frame would that take?

And what's a good run rate?

What's a good solid core run rate for the expenses for the Company?

The $175 million of expense commitments that we have already committed to, we've got about $150 million or so of that in our fourth quarter run rate.

Given the nature of our business, particularly capital markets and to some extent the mortgage business, it causes compensation expenses to fluctuate from period to period.

It makes it a little harder to get to a run rate.

Additionally, the first quarter is probably not a good benchmark because you have got a seasonal impacts of taxes and things like that flowing back in.

But our general expectation is once we complete the realization of the $175 million commitment, we realize the cost reductions associated with the First Horizon branch divestitures, and we realized the savings that we expect out of the mortgage initiatives that we have in place, that 2008 expenses will be significantly below 2007 expenses.

I would sort of benchmark a $390 million kind of run rate for the fourth quarter and I would expect it would decline from there going into 2008 given you have to factor in some effect of capital markets and seasonality and things of that nature.

We will go next to Christopher Marinac, FIG Partners.

Hey, Chris.

Good morning, Bryan.

How are you guys?

Good.

Jerry, too.

I want to ask about the tier one capital.

When you mentioned the $40 million from divestitures does that include the M&T sale that already happened or just the pending Atlanta sale?

Chris, that just includes the pending Atlanta and Texas sales, plus, whatever premium we get there, plus the benefit of freed up balance sheet relief of $240 million, $250 million of assets.

Okay.

Very good.

And my next question had to do with the loss rate going forward on home equity lines.

Is this rate a sort of sustainable pace for the quote, next quarter or two?

Yes, Chris, this is Bryan again.

We think that the tick up in loss rates is likely to be sustained for a period of time.

I talked a little bit about some of the -- we had a cleanup of some fraud loans and one of the divestitures, it accounted for maybe $700,000 or so in charge-offs, three or four basis points on an annualized basis.

But we are seeing a tick up in loss rates, particularly in the higher risk markets, the Californias and the Floridas, places like that.

We are seeing a slight tick up in our roll rates and delinquencies, i.e., from 30 to 60, to 60 to 90 days, in the 20% range higher probability of roll rates.

Our expectations today are that we are probably likely to be in more of a 55 to 65-basis-point range for the near term.

And that's just on home equity, correct?

Yes.

And then for other areas such as the home building losses and C&I, and et cetera, are there any other just general thoughts where those might be headed near term?

We have taken fairly significant losses, a big piece of the losses that we took in the current quarter were clearly driven by that.

In the supplement you can see the loss rates that we incurred.

We've built substantial reserves around those portfolios.

We expect some continued deterioration in terms of the real estate markets and that will probably drive further delinquency and probably tick up in non-performing assets.

But loss rates, we don't think, should go up significantly from where we are today.

We will go next to Heather Wolf, Merrill Lynch.

Good morning, Heather.

Hi, there.

Good morning.

Good morning.

Let's see, Bryan, one question on reserves.

I know you are saying that you're building reserves as a percentage of your loans.

Reserves as a percentage of non-performers is actually deteriorating a little bit and I think you said you expect higher non-performers going forward.

Can you talk about how you are managing toward that ratio?

Yes, yes.

When we look at the reserve to non-performing assets, we aren't really trying to build a ratio there.

What we are doing is we are looking at the content of loss in our non-performing loans.

So we -- as I tried to point out, we have gone through a very detailed review of our home builder, our commercial real estate portfolios, our one-time close portfolios.

If you step back from it, we have got about 6% of the construction portfolios on a non-accrual basis at the end of the year.

We have taken a pretty aggressive step in trying to identify problem assets, take charge-offs and evaluate the loss content in those.

So when we look at the reserve to the loan ratio, we really aren't trying to -- excuse me, loan to non-performing asset, we aren't trying to drive a specific ratio.

One of the reasons we expect it to build is not a significant additional surge in non-performing assets, but the very fact that non-performing assets inflows will continue while resolution will take a period of time until the housing market recovers.

The fact that we are seeing a slowdown in the ability to resolve problem assets in the current environment.

Okay.

And, Jerry, as you said, these are extraordinary times.

I know that in recent days we have seen one of your competitors in the mortgage industry look for some help through M&A.

Can you, I guess, address your view on First Horizon and whether or not you would seek a partner to help you through these times?

Absolutely, Heather.

As I think we tried to state in my comments for sure, we are looking at all kinds of alternatives which could include a partner in one form or another, including the sale of mortgage servicing assets.

We are mindful of the need to be profitable in that business in the short run, reducing our costs.

But we are certainly evaluating what would be appropriate options to deal with what I see as an issue in housing in the mortgage business through this year and certainly into next.

And would you consider a full sale at this point?

Well, it would certainly be something to look at based on whatever options, or whatever offers that might be there.

But I think that's sort of putting the cart before the horse.

We are clearly, though, looking at what our options are for a very strong franchise.

Okay, thank you very much.

You're welcome.

We will go next to Robert Patten, Morgan Keegan.

Mr.

Patten.

Good morning, guys.

Good morning, Bob.

Just so we can follow-up on Heather's question, reserve to NPAs, Bryan.

Can you just give us an idea of how aggressive you guys were at writing down credits when they go into NPAs so we can get a feel there?

Yes.

Take OTC as an example.

When we put an OTC loan into the non-accrual we take a charge-off to appraised value and then try take into account the estimated holding and selling costs around that asset.

So we are trying on the front end to take adequate charge to get these loans to what we believe is a most likely outcome in sales.

So we aren't trying to do it through a reserving methodology.

We are trying to make sure we get proactive in taking charge-offs.

I'm not sure that's responsive to your question, but --

Yes, I guess the question was 6% of construction lending.

The question is have we done enough and where do we go from here?

If you have taken that big chunk of your portfolio which is the high stress markets and written them down to what we believe our current costs, of course, if the market gets worse it will go down more.

I guess we are trying to figure out where you are?

Yes.

One way to put it in perspective, there is a chart that I think Dave put in the supplement.

The broad points that you might sort of help dimension the construction portfolios, and in broad terms in home builder and one-time close, somewhere between 20% and 25% of our exposure in those portfolios are in the higher risk markets like a Florida or a California.

And today 50% of our non-performing assets are in those markets.

So said another way, we -- the problems tend to be more concentrated in some of those higher risk markets.

And we have been fairly aggressive in identifying problems in those markets, we think, as we've spent a lot of time focused on them.

And so the flip side of that is that performance in other markets continues to be very good.

You aren't seeing the same kind of depreciation in real estate values that you are seeing in some concentrated markets.

So what's driving some of the problems today is more concentrated back up in real estate prices in some of the higher risk markets.

We are mindful of keeping an eye on it and focused on it.

And we expect that it's not a problem that's going to turn around in the next couple of quarters at real estate prices will remain soft across the country.

Most of the problem right now is concentrated in the higher risk markets.

I would just add, Bob, in those higher risk markets as we went through the end of the year, we essentially reviewed every loan.

And reserved and took actions as appropriate.

Okay, and another question, what can we expect, contribution from the Tennessee banking operations?

Are you going to break those out in terms of reporting going forward?

Bob, our intent is to break the Tennessee franchise out in the first quarter.

It really requires going back, not that you care about the mechanics, but it requires going back and restating all of our segment reporting.

But clearly we want to separate the Tennessee banking franchise from the real estate commercial bank which includes national real estate portfolios and home equity portfolios.

The Tennessee banking franchise continues to be very strong on an operating contribution business basis.

We are very pleased with the progress that we've made there.

We are continuing to invest in that franchise through advertising.

We have got new branches that we've started for opening in 2008.

So we intend to break that out and isolate it in 2008 so you can track it.

Bob, one thing to add, this is Dave.

We've also, in the supplement, in the retail commercial banking section, added some information on deposits and loans and net interest margins in our regional banking franchise which is mainly First Tennessee.

So that should give you guys some incremental information while we are also making those changes.

It gives you a sense of what the net interest margin is close to 500 basis points and so forth.

What was the contribution from the Tennessee banking operations for the fourth quarter?

It was in the $60 million to $65 million operating contribution range.

Okay.

And then last question, regulators, was there any regulatory pressure on the dividend cut?

No.

Okay.

Thank you, guys.

Yes, sir.

Thank you.

We will go next to Fred Cannon, KBW.

Hello, Fred.

Hi, good morning.

Good morning, sir.

Morning.

Thanks.

I wonder if you guys could walk us through a bit more on the one-time close product in particular.

Kind of what essentially went wrong on that product in terms of the structure of it and the loss content you're seeing.

If I remember correctly, historically, you have kind of implied that you thought that was a fairly safe product and would perform kind of like first mortgages and that isn't occurring and now it sounds like it's performing more in line with the national home builder portfolio.

And also was there any kind of break down in your risk management regarding that product?

This is Bryan, Fred.

The one-time close is a product, just sort of restate, is an individual construction loan for an individual borrower to build a home.

It's often made in a scenario where the home builder is -- it also includes sort of a takeout into a permanent structure.

The average loan size is about $435,000 or so.

Sort of the issues that we were seeing in the portfolio are largely driven by a couple of major factors.

In a lot of cases the portfolio had an all day structure, or an all day takeout.

A lot of the problems that we are seeing today are in products that we significantly curtailed in 2006 and into 2007.

For example, stated income products and other expanded approval products.

And we are seeing the greatest deterioration in those products.

You have got the overall slowdown in the real estate markets driving the ability of buyers to sell the home they are in, move into this one, a number of different factors from the economy affecting it.

But the biggest drivers in general have been the difficulty in the real estate markets and the fact that the unavailability of financing and the ability to sell some of those products.

Bryan, just to note, essentially the risk characteristics that created this issue were kind of all day stated income issues, and, secondly, you said essentially you would make this loan to an individual while he still had another mortgage on another property.

Therefore, it was essentially a second home loan to an individuals and that was another risk characteristic.

It wasn't always a second home loan.

It was intended to be a first and that was part of the approval where you would sell the existing home.

You'd move the equity over.

But clearly a stated product is more susceptible to misrepresentation and fraud.

And, Fred, you also had, those expanded guideline products tended to be more prevalent in some of the high risk markets.

So with the slowdown in some of those areas that sort of exacerbated the issues.

You are talking about my home state of California, I will bet.

That's one of them.

That would be one, Fred.

Just to follow up on that, now you guys are basically getting out of this business, it sounds like.

I was wondering if you evaluated actually just selling that portfolio and we were wondering if you could kind of give us an idea what you might be able to -- what discount you would have to sell that for today if you were going to get out of it that way?

We -- this is Bryan, Fred.

We have not pursued selling those portfolios.

We tend to believe that with the dislocation of the real estate markets that our ability to collect it and realize value through the aggressive administration processes that we've put in place is going to create more value than trying to liquidate it in a sale at this point.

So we really have not pursued that.

We'd much rather manage it ourselves and pay attention to the details.

We will go next to Alex Lopez, Portales Partners.

Good morning.

Good morning, Alex.

Actually, I have two questions.

First question with respect to your MSR evaluation, to what extent does your prepayment speed assumption take into consideration the, I guess, home price [depreciation] and I guess the credit crunch pressures faced by the borrower?

It is factored in -- we factored in our prepaid speed estimates a portion of the structural impediments to refinance in the current environment.

Given the falling rate environment that we have seen and the expectations for a falling rate environment, our prepaid speeds have been lessened a little bit by the fact that there are structural barriers that make it more difficult to refinance.

Okay.

My second question has to do with the consumer real estate portfolio.

What is, I guess, the geographic makeup of your consumer real estate portfolio with -- that have LTVs greater than 80%?

Alex, this is Dave.

You have in the analyst pack and in the materials Bryan referenced, we have breakouts of the consumer real estate portfolio by state, the LTV mix and giving you LTV and FICO grids.

But generally speaking, you have a third of the portfolio that is going to be in the state of Tennessee.

What's outside of Tennessee will be broadly diverse across the remainder of states, and I don't think the LTV mix will be biased in that regard.

Average LTV in that portfolio will be in the mid to high 70s.

Average FICO 730 plus on a refresh basis.

And so despite some of the challenges in the geographies that we have talked about, that portfolio seems to be performing relatively well.

We expect incremental pressure.

We will go next to Kevin Fitzsimmons, Sandler O'Neill.

Good morning, everyone.

Good morning, Kevin.

Jerry and Bryan, I was just wondering if you could address generally kind of -- you've touched on it a few times here this morning, but the commitment level going forward with the capital markets business and the mortgage business separately?

On mortgage, I have heard what you are say being the servicing side that you would be open to looking for alternatives, specifically maybe selling some mortgage servicing assets.

But can you talk more about the other side of mortgage?

If really we are looking at a continued very difficult environment going into 2009 and this business may continue to be operating at a loss in the near term, while I realize it may be difficult to sell that business, is there an option on the table to even close part or all of it down?

That's number one.

And number two, on the capital markets, Bryan, you always spoke about the capital markets business being a good source to securitize assets and get them off the balance sheet.

With the liquidity crunch we have now has your view on that business clanged?

I know in the near term we are having a nice bounce in fixed income activity, but just generally to get an update on your thoughts there?

Thanks.

A couple of different comments I'll make, and then Bryan can add his, as well.

I think in terms of the capital markets business, we have a good balanced operation there.

We have been -- I think we've tried to diversify that well.

The trust preferred business is certainly not something that we see coming back any time soon.

But I think we are optimistic that it will come back and we are pleased with its results and see continued results from capital markets throughout the rest of this year.

Capital markets, I think, we feel good about and I will let Bryan make comments when I'm done thinking about mortgage.

Mortgage is a business in which, yes, the future in terms of spreads, volumes and so forth are difficult.

I think making adjustments in our MSRs that give us perhaps a better opportunity as we think about selling some portion of our servicing portfolio was a good move, and we sold some servicing in the fourth quarter.

And we will continue to look for opportunities to do that.

You ask about origination.

We have a strong origination franchise.

We think we can get that business profitable, but at the same time I'm mindful of the need to make sure that we continue to reduce our exposure to that business.

There may be options as you suggest.

I don't have anything that I could specifically discuss.

We will certainly evaluate any and all options because I think we have a valuable franchise.

I'll add to Jerry's comments on the capital markets business.

I think we have a very good business.

It is well balanced in terms of the capital we've got allocated to the business.

We continue to produce very good returns in the business.

It's gone through a period of market volatility.

And capital markets business by their very nature have their ups and downs and what products are in favor and what products are out of favor.

But with the balance in the business we are pleased with the mix and we think it's a business that we can continue to grow in the near term and do it very profitably.

We will go next to Gary Tenner, SunTrust Robinson Humphrey.

Good morning.

Good morning.

Good morning, Gary.

Just a couple questions, of the $2 billion expected shrinkage of the home builder and one-time close portfolios in 2008, how much of that is home builder versus one-time close?

I can't recall what that number was?

How that breakout worked?

Yes.

The $2 billion is, really includes the decline in home equity lending as well.

And the numbers are about evenly split between home builder and one-time close, that they total about $1.5 billion.

In total that is about $700 million to $800 million in each of those portfolios, and then $500 million or so in our home equity portfolios.

Clearly, those are projections that we've talked about for a couple of quarters.

Given the continued disruption in the market, given our continued desire to reduce exposure for those products we are going to continue to be aggressive at looking for opportunities to reduce them further.

I would expect that those numbers to go up from there over the next couple of quarters as we continue to restrict product and continue to look aggressively to restrict the markets that we were in to just those with very low risk.

On that topic to the extent that you still have land exposure in the home builder portfolio, maybe you could remind us with that amount is?

I'm just curious how the construction of credit availability nationally would impact your ability to run off some more of those loans?

I still have -- I missed the first part -- exposure in what in the home builder portfolios?

The level of land exposure in the home builder portfolio, how does that impact your ability to do that?

Yes, yes.

Now I'm with you.

The home builder portfolio in total is a little over $2 billion.

About 25% or less of that is in the land, is in lands.

So call it less than $500 million.

$500 million to $600 million.

And the majority of that is going to be developed land as well.

We've consistently worked down the amount of land that we've had over the last year, really mitigating the exposure to raw land even as a piece of that, which will be in the low single-digits.

That concludes our question-and-answer session for today.

I will turn the conference back over to Mr.

Jerry Baker for additional or closing remark.

Let me just add by thanking you for joining us.

I'm not certainly delighted about some aspects of the marketplace, but I am pleased with the progress we are making, our ability to reposition our Company and particularly invest and grow in our Tennessee banking operation.

We look forward to the opportunity to speak with you next quarter and share with you our progress as we move through this year.

Thank you very much, and have a good rest of the day.

That concludes today's conference.

You may disconnect at this time.