First Horizon Corp (FHN) 2008 Q1 法說會逐字稿

Good morning and thank you for joining our call.

Welcome to today's First Horizon National Corporation Q1, 2008 update conference call.

Just a reminder, today's call is being recorded.

It's now my pleasure to turn the conference over to Mr.

Dave Miller.

Please go ahead, sir.

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 webcast on our website is the only authorized record of this call.

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

Good morning, and thank you for joining our call.

As you have seen from our release this morning, our reported earnings were $8 million or $0.06 per share in the first quarter.

Impacted by a few favorable, unusual items, tough market dynamics and cost to increase our loan loss reserves.

Bryan will cover the details of the quarter.

But first, I would like to tell you what we are doing to navigate successfully through a very challenging industry and economic environment.

Against the backdrop of this difficult market, we continue to change course and to improve our financial position for the future.

Let's begin with asset quality.

Which is being severely impact by the softening economy, falling home prices, and limited credit availability.

In light of these unprecedented real estate market conditions, we are actively identifying and addressing problem loans.

Resulting in increased reserves.

During the first quarter, we continued to conduct extensive, detailed reviews of our commercial real estate and C&I portfolios.

We also reviewed our home equity and one-time closed lost models and determined that additional reserves were appropriate given greater loss rates in certain products and markets.

Through these efforts, we determined that additional provisioning and reserves were needed to reflect the current challenging market.

As a result, our loan loss reserves grew from 1.55% of total loans in fourth quarter to 2.20% this quarter.

We have not only been actively identifying problem loans but also are writing them down to realizable values, taking a weakening economy into account.

In fact, as Bryan will cover in more detail, these actions contributed to increase chargeoffs of approximately $100 million this quarter.

The bottom line is that asset quality is a big challenge.

But we believe we have a handle on the issues and we are hitting our problems head on.

We remain very committed to shrinking our balance sheet and freeing up capital.

As we previously discussed, we are winding down our national real estate portfolios.

During first quarter, we announced our decision to discontinue national construction lending and stop most consumer lending outside our bank footprint.

As a result, our portfolio of real estate construction loans contracted by over $300 million from the end of the fourth quarter to the end of the first quarter.

We are also committed to reducing our mortgage banking business significantly over 2008.

After selling more than $7 billion of servicing in the fourth quarter, we sold another $8 billion in first quarter and have a commitment to sell $9 billion more in the second quarter.

These bulk transactions along with a recently executed flow sale agreement should bring our servicing portfolio to approximately $90 billion by the end of second quarter.

On the origination side, we have eliminated virtually all non-GSE eligible product originations and continue to close unproductive offices.

Including 16 locations in first quarter.

We are pursuing additional near-term opportunities to further reduce both our servicing and origination platforms and concentrate more heavily on our Tennessee footprint.

We'll update you as progress is made.

We also recognize that in the current environment, a strong capital position and adequate liquidity are essential.

As of the end of the first quarter, all capital ratios remain above well capitalized levels and meet or exceed our own minimum guidelines.

But we believe it is prudent to build capital even further.

As we continue to downsize the balance sheet, we expect our capital ratios to increase over 2008 providing a cushion for potential additional weakening and asset quality.

We're also taking steps to improve liquidity.

We expect that reducing our balance sheet should lower our need for wholesale funding and we're focused on growing core deposit funding in our regional bank.

After considering our capital and liquidity position and other factors, the Board declared a quarterly dividend of $0.20 payable in July.

As we strengthen the balance sheet, address asset quality problems, and improve liquidity, we also continue to refocus our strategy on being a strong regional financial services company.

To reflect that new focus, we changed our segment disclosure this quarter to better highlight our two core businesses, our regional banking franchise in and around Tennessee and our capital markets business FTN Financial.

Our regional banking business continues to gain customers in our home banking markets with a particular emphasis on attracting economically valuable deposits.

In the near term, we're facing margin pressures in this segment from falling short-term rates but believe that that will subside in time if we don't fundamentally compete on price.

We also sold ten First Horizon bank branches in Texas during the quarter and expect the last locations in Atlanta to be divested by early may.

And in capital markets, fixed income sales benefited from the rate environment generating good profitability in first quarter and substantially overcoming higher provision in corresponding banking.

We expect the rest of 2008 will remain tough for financial services companies.

At the same time, we believe that we are doing the right thing to put this Company on solid footing.

And position us well for the future.

We are addressing problem loans and meaningfully increasing loan loss reserves to reflect portfolio and market weaknesses.

We're focused on reducing our balance sheet and lower return businesses such as mortgage which include our capital position.

We're taking steps to improve liquidity and we're refocusing on core businesses with competitive advantage, good earnings power, and returns on equity that should be 20% plus over the long-term.

We are confident that the more focused, less volatile, more efficient, more profitable First Horizon will ultimately reward shareholders.

Now, I'll turn it other to Bryan to review the details of the quarter and then we'll take your questions together.

Thank you, Jerry.

Good morning, everyone.

As Jerry said earlier, earnings per share were $0.06 in the first quarter including a number of significant items.

As in prior quarters, we have provided a summary of the significant items in our financial supplement on page four that explains which line items and business segment they impact.

Let me touch on some of the key ones.

First, we had a pretax gain of $96 million associated with our proportionate ownership interest in Visa.

In connection with the Visa IPO, a portion of our class V shares were redeemed in the first quarter.

Generating a pretax gain of $66 million.

We also reversed $30 million of a litigation accrual taken in the fourth quarter.

Our unredeemed shares of Visa are now carried at the historical cost basis of zero on our balance sheet.

Second, accounting changes in our mortgage banking segments had an aggregate $40 million pretax benefit during the first quarter.

On January 1, of this year, we adopted FAS 157 and FAS 159 which in combination with FAS 109 accelerated the timing of revenue recognition on mortgage loan commitments and loans in our warehouse.

This had the effect of accelerating gain on sale income on loans originated but not sold during the first quarter.

The related effect is that origination expenses are no longer treated as a contra revenue item through FAS 91, increasing our noninterest income and noninterest expense for underage by approximately $55 million this quarter.

Lastly, we incur net charges of $21 million this quarter from restructuring, repositioning and efficiency initiatives.

This amount includes employee severance and retention, facilities and other costs, primarily associated with divestiture of our remaining First Horizon bank branches in Texas and Georgia and the contraction of our national construction lending and mortgage operations.

Now, I'll spend a few minutes on our consolidated results beginning with asset quality.

Pressured by weakening housing markets and a slowing economy, our portfolio showed signs of further deterioration during the quarter.

Our wind down of national specialty lending portfolios continued to represent the greatest challenge.

Especially in one-time close and homebuilder finance.

Given deteriorating market conditions, as Jerry said, we've continued to be proactive in identifying problem loans and in writing them down to realizable value which include disposition costs and adjustments from market declines since the last appraisal.

To help you understand our processes better, we've included a summary on page 32 of our financial supplement highlighting both our processes and the enhancements we continue to make.

I think it is important to understand our credit metric and the context of our approach.

In our one-time close portfolio, we continue to take steps to actively identify problem loans through monthly portfolio reviews.

We look closely at the inherent risk and credits based on draw inactivity and borrower conditions.

Often classifying loans as non-accrual that are not yet delinquent.

When OTC loans are classified substandard, they are reappraised and charged down and charged down further as conditions warrant.

Let me give you an example.

We observed the draw activity on a construction project in California Sea.

Our investigations identified that the local city had placed a stop order on construction by this customer due to past due real estate taxes.

And additional liens have been placed on the properties.

Although the loan remained current due to interest reserve, the credit was classified substandard and a new appraisal ordered.

Following receipt and review of the appraisal, the loan was charged down to the estimated current realizable value.

Turning to our commercial loan portfolios, we continue to strengthen our processes in both commercial real estate and C&I so that reserves keep pace with evolving borrower and market conditions.

In the fourth quarter, relationship managers received additional training and tools to ensure timely identification of weakening credits and we introduced quarterly portfolio reviews conducted by senior credit officers to provide independent oversight.

In the first quarter, the portfolio review process was enhanced and expanded to include C&I credits related to the home building industry.

RMs also reviewed the assigned grade for all C&I and CRE loans resulting in further grade updates.

Identification of additional potential problem credits and increased provisions.

We view most of the nonaccrual commercial loans as collateral dependent and assess them using a fair value of collateral approach when a loan is classified nonaccrual, collateral values are assessed with third party appraisals, adjusted down for costs associated with asset disposal and for our estimate of any further deterioration since the most recent appraisal.

We then charge off the full difference between book value and our most likely estimate of net realizable value.

Here is an example from our homebuilder finance portfolio.

We have a residential builder in the southeast with several single family residential loans totaling $6.5 million.

Recent appraisals indicate aggregate value less estimated costs to complete of about $6 million.

Local market conditions are appreciably worse for more expensive homes while values for lower priced homes are relatively stable but have slow inventory turns.

For the lower priced homes, the price values were reduced by 20% to reflect weak market conditions and the likely extended 12 to 18 month absorption period.

Appraised values on the higher priced homes were lowered by 30%.

The resulting values will further reduce the costs and expenses of anticipated selling periods.

These included 6% broker fees, taxes and insurance, attorney's fees, appraisal fees and costs to complete.

As we used the fair value of collateral approach, we charged off the resulting loans down to roughly $4 million.

Turning to our home equity portfolio, higher loss severity trends continued in the first quarter, especially in markets like California where home prices have fallen meaningfully.

30 day delinquencies, however, rose only modestly from 1.48% at the end of the fourth quarter to 1.55% at the end of the first quarter and actually showed signs of stabilizing in February and March.

We continue to see that lost frequency remains principally driven by borrower life events such as job loss.

Certainly, home equity trends have softened.

We believe that our portfolio has held up because of its quality.

85% of the portfolio is retail originated.

Roughly 30% are in Tennessee where we typically have other relationships with the borrower.

Our average refresh FICO score is approximately 730.

26% are in a first lien position.

Two-thirds are full documentation and our utilization rate has held steady at about 53%.

In total, given persisting economic weaknesses, our active processes identified increased problem loans and chargeoffs this quarter that also necessitated additional reserves.

Chargeoffs increased to $99 million, much of which was due to our proactive efforts to recognize losses.

Nonperforming assets ratio increased from 166 basis points last quarter to 278 basis points at the end of the first quarter.

But we would attribute part of the increase to our active decision and would also note that most of our nonaccrual loans are charged down to appraised value or below.

Provision exceeding net chargeoffs by roughly $140 million during the first quarter.

Increasing our reserves to loans at 2.20% overall and 2.83% within our wind down national specialty lending segment.

You'll note that we added considerable detail on asset quality metrics by product and segment to our financial supplement this quarter.

The obvious question is where do we think credit costs go from here?

That is difficult to answer.

Last quarter, I shared with you our view that chargeoffs and provision costs would be in the range of $50 million a quarter.

We underestimated that.

As the economy worsened over the past 90 days and we remained proactive, losses increased, and further reserves were needed in the first quarter.

We can't tell you with certainty where those go from here.

But as we sit here today, our view is that the economy and the housing market will remain soft through 2008.

Given this, we expect that chargeoffs are likely to remain in the neighborhood of $100 million per quarter for the foreseeable future.

Provision costs will remain dependent on the need for additional reserves but are also likely to be in that $100 million quarterly range.

As Jerry indicated, all capital ratios are above well capitalized standards at quarter end and were at or above our own conservative minimum guidelines.

Tier one capital at 8.1%.

Total capital at 12.8%.

And tangible common equity at a risk weighted asset 6.1%.

Given the economic environment, we will continue to focus on improving our capital position by shrinking the balance sheet over 2008 since each $1 billion of assets we can reduce improves our tier one ratio by roughly 30 basis points.

Our consolidated net interest margin increased 4 basis points over fourth quarters 2.81% in the first quarter.

The reduction of short-term rates lowered wholesale borrowing costs and improved a net interest margin in mortgage, capital markets and corporate offsetting margin compression in the regional bank.

Going forward, we expect the margin to be relatively stable or perhaps show some improvement given a steeper yield curve and the reduction of lower margin businesses from the balance sheet.

We continue to make progress on our efficiency and restructuring initiatives as we have completed roughly 55 projects across the enterprise.

We estimate that approximately $175 million in annual pretax benefits from these projects are now in our run rate.

In addition, we completed the sale of ten First Horizon bank locations in Dallas in the first quarter.

We expect the remaining Atlanta locations and deposits to be sold in May.

In total, First Horizon bank divestitures should produce an aggregate $30 million in annual pretax operating improvement by the second quarter.

Roughly $10 million annualized of which was in our first quarter run rate.

We have, again, provided a detailed schedule in the financial supplement to explain the charges and benefits.

Now, I'll cover the highlights from each of our business segments.

As Jerry mentioned, we changed our segment disclosure this quarter to highlight our core businesses and allow investors better visibility into our wind down national business.

We've included a summary on page three of the financial supplement to describe the content of the new segment.

Regional banking continues to show strong fundamental customer trends as a result of efforts to increase marketing, spending, refined segmentation and improve relationship pricing with renewed focus on growing core deposits.

At the same time, we are enhancing our competitive advantage and convenience by opening eight new financial centers by year end.

Including a new middle Tennessee location this month.

Average core deposits excluding divestitures increased 2% linked quarter while loans remained flat sequentially.

However, net interest income declined as banks margin declined 35 basis points in the first quarter.

Primarily reflecting inelasticity of deposit rates through 175 basis points of fed rate cuts during the quarter.

Positively, expenses declined 6% linked quarter.

Primarily driven by our ongoing efficiency and restructuring efforts.

While regional banking had a pretax loss of $18 million in the first quarter driven largely by higher provision costs, profitability and growth should resume in this business when the need to build reserves abates.

The capital market segment which now includes correspondent banking had another good quarter producing $23 million in pretax income in the first quarter.

Fixed income sales improved sharply as the fed reduced rates and market volatility increased, producing a record $152 million in revenues compared to $77 million last quarter.

Other product revenue declined $45 million linked quarter, primarily driven by $36 million LOCOM adjustment to our full trust preferred warehouse as.

CDO spreads widened over the quarter.

Despite this, we believe the underlying collateral is of greater quality than current pricing reflects.

We continue to manage balance sheet usage in capital markets including our trading inventory and trust preferred warehouse.

Near-term profitability in this business should remain solid driven mainly by fixed income sales.

In the first quarter, we stopped most of the originations in our national specialty lending businesses driving approximately $100 million of contraction in their portfolios from fourth quarter end to first quarter end.

Despite continued funding of some existing homebuilder and one-time close commitments, we expect loans in this segment to be significantly lower by the end of year 2008.

Mortgage banking pretax income for the first quarter was $51 million, up from last quarter's loss of $254 million.

Excluding first quarter's $40 million accounting changes benefit, pretax income was approximately $11 million.

This quarter's results were primarily driven by four factors.

First, hedging performance improved from a loss last quarter to a positive $33 million in the first quarter.

Reduced portfolio convexity and fed funds rate changes both contributed to the improvement.

Second, net interest income increased $8 million linked quarter reflecting the larger warehouse and higher net interest margins.

Third, originations grew to $8 billion in the first quarter as lower rates drove periods of increased refinance activities.

And finally, gain on sale margins were negative 17 basis points in the first quarter.

Again, reflecting significant spread widening on nonconforming and agency arm production.

Regarding the servicing portfolio, we completed an $8 billion vault sale during the first quarter and have committed to sell another $9 billion in the second quarter.

Both sales were executed in line with book carrying values and together, they should free up approximately $30 million in tier one capital.

With a runoff rate of about 19% plus further bulk and flow sales, the servicing portfolio will continue to be reduced, freeing up capital and lowering hedge costs.

Corporate segment results for the first quarter reflect the net charges of $21 million from our restructuring, repositioning and efficiency initiatives and the $96 million of pretax benefits related to Visa.

Net interest income in the segment improved $8 million linked quarter reflecting a reduction in the unusually wide spread between LIBOR and fed funds and lower wholesale borrowing costs.

In conclusion, we continue to make progress on refocusing our Company.

And we're positioning ourselves to weather what is likely to be a difficult 2008.

We're actively identifying, providing for and charging down problem loans.

We're shrinking our national lending portfolios and mortgage banking businesses, contributing to improved capital and liquidity and finally, we have good core businesses in regional banking and capital markets.

With that, Jerry and I will be pleased to take any questions you may have.

Thank you.

(OPERATOR INSTRUCTIONS) Our first question today is from Steven Alexopolous with JPMorgan.

Good morning, guys.

Hey, Steve, good morning.

Good morning, Steve.

Bryan, I'm curious with the reserve doubling here over the past two quarters, why would you expect it not to continue to increase given the amount of pressure on the loan portfolio?

I'm referring to your comments to expect provision and net chargeoffs will be about equal the next couple of quarters.

Couple of factors in that.

One, and maybe foremost is with respect to the national lending portfolios, particularly the construction portfolios, homebuilder finance, one-time closed, and in the home equity portfolios, those are portfolios that we're not increasing at all.

Essentially, they're in a runoff mode.

We look at them and over time, have had the expectation as they decline, the reserves we set aside will be used for chargeoffs and as a result, won't necessitate the reprovisioning or rebuilding of reserves.

A total of those portfolios is roughly 9 billion to $10 billion as we sit here today.

Second, as Jerry and I both commented in the call, we've spent a tremendous amount of time looking at the portfolio, trying to factor in our expectations around the near term realizability of assets.

We've got new appraisals on a lot of properties.

We've done a top to bottom review of all of our one-time closed portfolios.

We've tried to make conservative assumptions about net realizable values.

We think we've built a fair amount of reserves for the portfolios as they stand today.

I use the example of our one-time close portfolio.

Typically, we're seeing severities on the one-time closed portfolio and the high 20s percent range.

If you take the existing portfolio and you look at the reserves, we have built for which is something like $118 million, a little over 6%, you've got reserves set out that sort of says you can have 25% or so of the portfolio default and you can incur 25% to 30% losses on that and still have adequate reserves.

So, we think as these portfolios liquidate, that's going to necessitate that reserves will come down over time.

They won't be replenished.

Very helpful.

Sure.

Just one other question.

Given how much mortgage banking seems to be losing next quarter -- each quarter, ex servicing, are you considering closure of the businesses, one of the strategic alternatives?

Steve, I guess that could always be an option but we believe we have a valuable franchise, good people that it has value over time and we'll continue to explore strategic options that can take advantage of those capabilities.

We will -- this is Bryan again, Steve.

We will continue to look at the productivity of various offices we have in the footprint and to the extent that we see opportunities to reduce the size and the footprint of the business and shrink it over time, as we said, for several quarters, we'll continue to do that as well.

Thanks, Steve.

Ultimately, not to carry this too long for your question but our focus is on Tennessee.

And ultimately, that's where we'll wind up and remain focused on this state and the surrounding market.

We'll go next to Paul Miller with FBR.

Yes, on the sale of the servicing rights, can you give us any color on what type of valuation and what type of multiple of servicing you got for those sales?

Paul, this is Bryan.

Good morning.

I can't recall off the top of my head the multiples.

What I can recall is we sold them right at book value.

Where we had them recorded based on the valuation adjustments that were factored into our valuation in the fourth quarter.

We sold them right on top of those valuations.

If you would like, I would ask Dave to follow-up with you with the exact multiples.

I would love to have that.

The other question I have is your 30 to 89 day past dues.

Do you know what type of growth that is?

Is that stabilizing or is it still growing?

Where are you at that point?

I guess it depends on the portfolio you're looking at.

We saw some stabilization in home equity lending.

In general, I would say that there is a slight increase in roll rates from 30 to 89 past due rates over the past three months.

And it is probably not stabilized yet.

Okay.

And the dividend.

With the current guidance of $100 million of provision that you guys have given, it is going to be hard to make money this year, we believe.

Is there any discussion of cutting that dividend farther to conserve capital?

We continue to believe that the dividend is important.

We certainly have a large retail shareholder base particularly here in tennessee that's important to us.

We see over the long-term, our ability to earn the dividend with the guidance or parameters we mentioned before, 45 to 50% payout over the long-term.

So, we'll continue to be mindful of our capital and our capital adequacy needs but at this point in time, as I stand here today, that would be our view.

Paul, this is Bryan.

What I would also add to that is if you go to the effort to pull out the unusual items in the quarter, and you sort of get back to the core operating run rate, even with $100 million of provision, that number depending on what you include and exclude is going to come out around the level of the dividend and as Jerry said, when you normalize our dividend -- excuse me, our provision levels over the long-term, especially getting back down over the long-term to a Tennessee-only portfolio which ought to drive on average 50 basis points or less than annual losses, you've got a lot of earnings pick up that comes from that.

We factor that in as Jerry said into our long-term view that we need to pay out around 50% of our earnings and dividends.

Our next question comes from Ken Zerbe with Morgan Stanley.

Thanks.

Can you just give a little more detail on the commercial loan deterioration you're seeing in regional banking?

Is that one or two large loans or a lot of smaller ones?

Is it focused on Tennessee?

And the second part of that question is does this new $100 million of provisions and chargeoffs relate predominantly to the national lending which is what I would expect or are you also look at increasing your loss expectations for your regional banking business as well?

Thanks.

Ken, this is Bryan.

Start with the Tennessee portfolio.

There were a couple of large chargeoffs that we took in the credits.

There are a couple of large specific credits we took chargeoffs in the quarter.

But also the provisioning was driven by our conservative and proactive look at essentially all of the C&I credits in our tennessee franchise making sure that we had an accurate view of those credits.

And a couple of examples, anecdotally where we have taken a loan and downgraded it where we've got very strong guarantor strength but we downgraded it based on the results of operations of the underlying commercial entities.

So, we're trying to take a conservative view of it and that's what really drove our reserve levels.

I think you come out at something like a 1.7% reserve level in our Tennessee franchise.

With respect to the losses going forward, the vast majority of that will come out of the national portfolios particularly we think the construction portfolios.

Homebuilder finance and one-time close.

Great.

Thank you.

You're welcome.

(OPERATOR INSTRUCTIONS) We'll go to Brian Forem with Goldman Sachs.

Hi, guys.

Good morning.

Good morning, Brian.

Is there any other opportunities to raise capital ratios, monetizing the rest of the Visa stake or selling other branches or anything like that that maybe would be in the balance sheet right now?

Yes.

There are those kinds of opportunities although those are -- the Visa IPO is a good example.

We've got a lot of inherent value in that.

But with the restrictions it happens over, I think it is a three-year period.

We don't have the ability or the technology to do that today.

But clearly, those opportunities exist.

As we've said, the biggest opportunity for us is to continue to reduce the size of the balance sheet, particularly the nonessential assets we think from a customer perspective.

So going back to our national lending portfolio, home equity construction, reducing the size of our servicing portfolio, and so those are the levers that we're working most immediately to pull to reduce the size of the overall balance sheet.

And then on the dividend again, I mean not to beat a dead horse, can you just remind us of exactly what the tests are around dividends versus profitability that you have to meet and any issues of the ability of the bank to dividend up to the holding Company?

Yes.

In general, and it is a little more technical than I can describe it but the bank has the ability to deal with an end up current year earnings plus prior year earnings.

I think we noted in our 10-K that we currently have a limitation on how much dividend capacity the bank has to the holding Company.

We have -- there is a fed statement out that talks about earnings and dividend levels and preference to earn the dividend.

We have adequate cash in the holding Company to pay the dividend for a period of time.

But as Jerry said earlier, the dividend is something that we consider with our Board on a quarterly basis and will continue to do so.

It will be influenced by how we view our capital ratios.

How we view our earnings capability over the long run.

And again, we think over the long run, based on what -- the returns we can create in the business, we're going to have the capability to pay out a fair amount of earnings over the next several years.

We'll take our next question today are from Kevin Fitzsimmons with Sandler O'Neill.

Good morning, Jerry and Bryan.

Good morning, Kevin.

I know there's been a few questions on the reserve and the expected losses but I just -- you mentioned in your comments, Bryan, I believe that you guys gave an estimate for future losses and obviously underestimated that and now going forward and establishing these reserves, was it more of just a loan by loan type of approach?

Was it a change in a macro assumption on what you had been expecting for housing or was it more just more of a widespread change of methodology and how you were determining your reserve and tweaking some of the assumptions, if you could just give us a little color on that?

Thanks.

Yes, Kevin, I think you hit really all three of the key underpinnings of what we've done here.

One, we did estimate and in our view, the economy is significantly softer today than it was 90 days ago.

That factored into our desire to go through and do a loan by loan review, engaging all of -- essentially all of our credit folks, all of our line folks and looking at credits.

And taking a real pragmatic and thorough look at the potential for loss in our portfolio.

And so as we look at it, we think that all of those things factor in and it is tough to tell if you get out in front of it or you get your hands around it because we're not certain, any more today about how the economy is going to look in the next 90 days but knowing what we know about the portfolio, knowing how we believe the economy is unfolding today, we've tried to build a substantial level of reserves and at 2.2%, we've got very substantial reserves set aside.

Kevin, this is Dave.

Also, I would remind you we added a page of pretty good amount of detail on our processes and really highlighted some of the enhancements that we continue to make this quarter.

It is on one of the latter pages in the supplement page 32 I guess.

Dave raises a good point.

You alluded to this, Kevin.

I probably ought to expand on it.

One thing we did is we made some process changes that drove chargeoffs.

Example is our one-time close portfolio where in the past, we would let a loan get to 120 days past due before we put it on nonaccrual and take writedowns as a matter of course.

We accelerated that to 90 days in the current quarter.

So, you're picking up four months of chargeoffs in the current quarter and the reserving impacts of that.

But in all of that kind of thing in an effort to at least get our hands around the problem be proactive in identifying it.

We'll take our next question today from Bob Patton with Morgan Keegan.

Most of my questions have been answered.

Bryan, we talked -- a couple of people asked about capital.

When you plug in the loss rates, on the doubled assumptions from the fourth quarter, I think everybody's models are going to drop below not paying the dividend.

I know there's going to be things that will happen during the year.

But I guess strategically, how confident can you guys be in capital?

Tier one declined this quarter when we thought it was going to go up.

And I'm just not clear how the capital is going to build.

Can you just one more time, go through this with us?

Well, the tier one ratio, I think ended up about 8.12 or 8.1%, something like that.

It was down just a tick or two from where it was at the end of the fourth quarter.

Our total capital ratios, our tangible capital risk weighted assets to date about 6.1%.

Relative to our Board guidelines, relative to well capitalized standards, we are far in excess of our well capitalized standards.

The dividend is going to be a function of capital levels.

It is going to be a function of earnings and it is going to be a function of where we think the economy is going and the impact of that on credit losses and our results over the long term.

So as we sit here today, it is impossible to tell you what's going to happen 90 days out or 180 days out as we evaluate capital.

But we think we've got adequate capital as we sit in this environment knowing what we know.

I would also say that the efforts we have in place to shrink the size of the balance sheet significantly increase our capital ratios.

We saw about $300 million of contraction in our construction portfolios.

I think the ratio is something like for every $1 billion we reduce the balance sheet, we improve our capital ratios by 30 basis points.

And we're -- we're working very diligently to reduce the size of the balance sheet and those actions will show up in our capital ratios as we work through the rest of this year.

Okay.

For the $300 million of contraction, how much was chargeoff and how much of actual attrition were runoff?

Well, the chargeoff number, I get Dave to confirm it later but in the aggregate if you said all of the chargeoffs related to the national portfolios, it would still be about 3 to 1 ratio.

So, and all of those chargeoffs were not in the national portfolios.

I think the number was about $60 million in chargeoffs in those portfolios.

So, we had $300 million runoff, $60 million of it was charged off.

Yes, that would be right.

A little over 60.

Our next question today are is from Jim Schutz with Sterne, Agee.

Good morning.

Good morning, Jim.

I don't want to beat a dead horse here but not withstanding your well capitalized posture at this time, have you internally considered any possibility for the need to raise additional capital as the year progresses?

And if so, would you prefer to issue common stock or another type of security?

Well, it would be naive of us not to consider all alternatives.

And we're always evaluating capital levels.

We're always evaluating what's going on in the marketplace.

And trying to make our best estimates.

So, although we have not made any firm decisions about what we would do, we're going to keep our options open and we'll evaluate those opportunities as things unfold.

Thank you.

Sure.

Moving on, we'll go next to Chris Marinac with FIG Partners.

I wanted to get some detail i fou would, about the level two and three securities that -- for the new accounting rules and how that shook out as you placed securities in various buckets?

I can't think of -- we don't have very much that gets in the fair value accounting.

The vast majority of what we have in capital markets ends up being a level one asset, I believe.

We don't have very much to get into level two or level three, Chris.

In fact, I can't think of anything right now off the top of my head of any significance.

Okay.

That's great.

Just a follow-up, on the other portion of securities, Bryan, how much is in trust preferred securities and things like that?

Were there any marks there?

I know it may have been washed out by other gains but curious how that may have played out with the change in the capital markets?

The only -- capital markets numbers included, we had about -- if you pull out the correspondence side of the business, which had some provisioning in that, it rolls into our capital markets business, the capital markets business fixed income sales of trading, full trust preferred business et cetera, et cetera did about $30 million pretax.

Embedded in that is a net LOCOM adjustment on there of $360 million inventory of full trust preferred assets of $24 million.

So, the business did $30 million after a $24 million LOCOM adjustment on full trust preferred.

We haven't really backed any new full adjust preferred assets.

That's inventory that's really been carried forward since the fourth quarter of this year.

It is still a soft market for CDOs.

We still think the collateral value is good and if you run the math on the yield to maturities with the reserves, we've got set aside on it, it's got very very attractive yields.

But we think that inventory is better than the marks and we think over time it will come back.

If you look at it in terms of the way we grade the loans, they're still very high graded from a credit perspective.

They would be in the top four or five grades of our risk rating system out of a say, 15 or 16 grade risk rating system.

So, the quality is good.

It is really just a mark based on interest rates and spreads.

Our next question today is from Kevin Reynolds with Janney Montgomery Scott.

Good morning, gentlemen.

Good morning, Kevin.

Golly, I hate to keep going over the same things over and over again but I would like to ask this question and see if you can answer it.

For several years, the concern has been that loan loss reserving maybe was blamed on the accountants but the reserves and provisioning practices were inadequate or potentially inadequate should the economy turn.

Now, the economy has turned.

We've got a national portfolio that seems to be deteriorating rapidly like right before our eyes.

In my calculation, I see the national portfolio or the $4 billion portfolio that is expected to run off is about 11% nonperformers right now combined.

And it seems, again, correct me if I'm wrong, it seems the $2 billion of runoff is sort of the hopeful runoff of the loans that can find another home would go find another home and you would be left with $2 billion of loans that might not be able to find another home.

Thus, there is actually more risk in the portfolio for potentially than it appears today.

How do we get confidence today that as we go forward, that you've got your arms around the credits, I mean last quarter we heard, we looked at every loan.

We regraded every loan.

We added reserves.

We think we got our arms around it.

Now we're hearing it again.

How do we get confidence in that for next quarter that we are not going to see the same kind of thing?

And I know it is a tough question to answer.

But I just feel like from where I'm sitting that needs to be asked.

Kevin, this is Bryan again.

Clearly, the loan loss reserve modeling in most environments is more art than it is science.

And when you get into these extreme loss environments like we seem to be in now, further out on the table per se, modeling becomes much more of an art and much less of a science.

And so we look -- we go through the model and we go through the build-up then we get the input of our internal credit folks.

We look at it from an accounting perspective.

We get the input of external auditors and regulators and others and we try to make our best estimates of what those reserves are.

But I'll go back to our one-time close portfolio.

You're absolutely right that over time, the good loans will most likely modify and go into the secondary market or something else or -- and you'll see more problem assets linger for awhile.

But as I said earlier, if you look in the aggregate, we've got about 6.49%, it's about $118 million of reserves set up on one-time close.

That essentially, based on the severities we've assumed and we've seen something in the low 20s depending on the market to the high 28, 29, 30% level in some of the more severe markets.

Let's say you take a midpoint of 25% severities, you can have something like 25% of that entire portfolio go into default and incur a 25% kind of loss rate.

So, I don't know -- what will prove out over time is what those real severities are.

But 25% seems pretty severe estimates in this environment as we see it today.

And if that -- but only time will tell.

Kevin, I may hitchhike on to Bryan's response.

Because I think this is important.

We believe that we need to continue to identify any problem loan and we've encouraged our relationship managers to be aggressive in doing that.

The sooner we recognize a potential problem, the better opportunity we have to work it out or get it corrected.

And so you've seen us really elevate the amount of aggressiveness if you will and in doing that throughout all of our relationship manager portfolios.

So, I think that is important to keep in mind in terms of staying in front of it.

And we've turned to any nonperforming loan into the -- what I would call our professional work out people who can maximize recovery and work through any problems on the back end.

So we're not originating any more of the portfolio.

So, how we manage those assets now, how we identify problem loans is important and I think that the team is fully focused on doing that.

And it is a reason why you've seen a big increase quarter over quarter.

Our next question today is from Keith Horowitz with Citi.

Good morning, guys.

Hey, Keith.

How are you?

I'm sorry.

I was a little late on the call.

So, if you said this already, I apologize.

But you talked a little bit about current appraisals.

Do you have any stats on what percent of the construction loans have current appraisals within the last three to six months?

Three to six months, most of them are going to be originated less than 12 months so it is going to be a fairly high percentage within a year.

Anything that is of a non -- substandard level, nonperforming, we've got current appraisals on those.

As I think Kevin or somebody pointed out earlier.

Got 11% or so that are nonperforming which we've got very recent appraisals on.

Given the nature of the construction portfolios and the fact that they generally have somewhere between a nine and a 15-month life, the appraisal process is fairly current.

On your breakout where you show your allowance for the national specialty lending, the allowance for the homebuilder portfolio nationally is 3.5%.

Right.

Chargeoffs were 7.5 in the first quarter and 4% in the fourth quarter.

Your allowance for nonperforming loans is 0.2, allowance chargeoffs is 0.5.

It seems like those reserves are a little bit light.

Why do you have comfort in that reserve?

Yes, well, this is true of the vast majority of our nonperforming assets.

And maybe we can't emphasize it enough.

If something is a nonperforming asset category, generally speaking, we have charged those down to net realizable values.

So, that means we've taken estimates of value whether it is appraisal on collateral, dependent loans or other measures and charged them down to what we believe are net realizable values.

Appraised value less holding selling cost.

In that homebuilder portfolio, those nonperforming assets have been charged down to net realizable value that are nonperforming today and we went through very detailed analysis in the fourth quarter and the first quarter so the reserve levels are really for what is the performing asset portion of that portfolio.

Moving on, we'll take our next question today from Fred Cannon with KBW.

Oh, thanks.

I wanted to ask about your unused home equity commitments.

Particularly from Bryan's comment, I'm kind of guessing you guys have about $7 billion of outstanding, unused commitments.

I wanted to see if you guys could talk about how you're managing those?

Whether you're cutting the lines to certain borrowers and do you have a reserve against that?

And I ask this because, as you try to wind down the portfolios, the home equity portfolio continues to grow in part, I would imagine because you have a fair amount of outstanding unused lines.

Fred, this is Bryan.

The national home equity portfolio is a mixture of lines and loans.

We've got about 4 billion to $5 billion, call it $4.5 billion of unused lines in the portfolio.

We have -- historically, we have managed lines and limits of lines based on appraised values, borrower performance, delinquency standards and so we're continuing to look at lines and where we have home home price depreciation, we're look at lines where we have borrower delinquency.

And where appropriate, we have the ability to reduce the level of those lines.

Are you actively doing that?

We've heard other national lenders such as Washington Mutual actively sending out letters and reducing lines.

Are you in that process today doing that in places where home prices have declined?

In a word, yes.

We're not doing it reflectively across the board.

But we're taking a thoughtful approach and looking at it.

Even more particularly, in Tennessee, where 30% of our home equity loans are really in the state of Tennessee.

But yes, in a word, we're look at those lines and we're being very proactive in how we address that.

Our next question is from [Howard Kaplan] with Columbia Management.

Good morning.

Could you address your funding requirements for the remainder of the year?

We have, over the past several quarters, we've addressed, we've had a fair amount of short-term funding roll-off.

We've put it into longer term sources.

We have a little bit of maturities in the back half of this year as we estimate available sources.

We've got more than adequate liquidity to address continued refundings of the balance sheet.

Particularly as we look at reducing the size of the aggregate balance sheet.

That has dollar for dollar reduction benefit and the need for wholesale funding.

So, we've got more than adequate liquidity to fund maturities over the next while.

We can take the next question, operator.

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

Hi, there.

Hey, Heather.

Bryan, just a clarification.

When you were talking about the reserves being able to withstand 25% probability of default and 25% loss severity, can you break that down into HELOC, one-time close and construction for us?

I didn't mean to -- maybe I got my language confused.

That's -- what I was talking about was specifically the one-time close portfolio.

Okay.

Can you give us some color around construction and home equity as well?

Well, construction, you've got about 3.5% reserve levels, home equity.

In total, you're going to be about a little between 1 and 1.5% reserves.

So, you can sort of back into that based on the severity.

I can get the calculator out and do the math later.

I hate to do it in my head.

I see what you're saying.

You're using 20% to 30% severity across the portfolios roughly?

No.

That's OTC.

Okay.

That's OTC.

It depends -- I think there is a page in the supplement, I think it is like 30 or 31 that shows you by state it takes home equity, show you by state the loss severities we've seen.

So, in the home equity portfolio if I recall correctly, the highest loss severities we've seen have been in the states of Virginia and Florida.

In that order.

But we show you the severities in the supplement by market by product so you can get a handle around that.

Okay.

And on the construction portfolio, are you thinking severities around the same level?

In terms of the one-time close, it depends on the market.

For all of the portfolios.

And even in the homebuilder side of it, it depends on the market.

In the middle part of the country, you're seeing lower severity of losses.

In parts of the country like California, Florida, you're seeing higher severities so we're trying to differentiate by market.

So, generally, we're thinking of something in the, depending on the portfolio in the 20% range 20% plus.

We do have a couple minutes remaining for questions.

We'll go next to John Noel with Barrington.

Hi, guys.

I was wondering on the reduction in the mortgage servicing rights that comes from the change in the valuation model inputs, you had a consolidated number of $258 million or $259 million, does that run its way through the income statement?

It does but it is offset by the impact of the hedge.

Part of that is going to be the MSR sale that we talked about, part of it is just going to be the change in the value of the MSR due to interest rates and there is going to be an offset to the hedge.

John, it is Dave.

If you want to call me, I can take through the geography on the P&L.

We'll go back to Bob Patten from Morgan Keegan with a follow-up question.

Hi, guys.

I am going through my notes and looking -- following-up on Steve's question on the mortgage company.

Obviously Jerry says there's value.

The first part of the strategic alternative is we're not going to shut it down because there is value there.

So, that flips you over to say what is the value and what is the value in this market and I'm just going to ask you guys outright, are you trying to sell the mortgage Company and if you did, for par, what would be the net impact of this Company in terms of capital freed up, in terms of earnings and the balance sheet shrinkage?

Well, Bob, there is value in it.

We have been looking and looking for strategic partners.

We think that certainly is an option.

And I do think that, if that were to occur, it would have -- the benefit of course is freeing up the warehouse from our mortgage portfolio of $4 billion on a monthly basis.

So, when you think about it in those terms, it has a big pickup to reducing the balance sheet.

We've talked about mortgage a fair amount over the last six to nine months.

And the one thing we've tried to convey is that we think that we need to get the business smaller.

We need to reduce the size of the servicing asset.

And we try to be careful not to take any options off the table.

And we're looking at strategic alternatives.

We're trying to manage our way through a difficult environment in the business.

But as Jerry said, we've got a good business.

It is a good management team.

And they have a very good platform but it is a big asset to our balance sheet and creates a lot of volatility.

The easiest way to do the math is you've probably got on the balance sheet, somewhere between 6 billion and $6.5 billion of assets associated with, call it $4 billion in the origination side and a couple billion or so in the servicing side.

And so pick your capital ratio that you want to work off of.

But if you work off of a tangible capital ratio and pick something between or say call it 6% to make it easy math, at $6 billion, you can free up $360 million in capital by reducing the size of that balance sheet.

Mr.

Patten, anything further?

No.

There are no further questions at this time.

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

Baker for concluding remarks.

Please go ahead, sir.

Thank you very much.

We appreciate everyone's interest in calling in.

We continue to stay focused on building our Tennessee bank and improving our shareholder value over time and we look forward to sharing with you over the coming quarters our progress in realizing that.

Thank you very much.