First Horizon Corp (FHN) 2008 Q2 法說會逐字稿

Good day, and welcome to the First Horizon National Corporation second 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.

At this time all participants have been placed in a listen-only mode.

But the floor will be open for questions.

Mr.

Miller, you may begin.

Thank you, operator.

Please note that our press release and financial supplements as well as the slide presentation we'll use this morning are posted on the investor relations section of our website at www.FHNC..com.

Before we begin we need to inform you that this conference call contains forward-looking statements which may include guidance 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 10Q and 10K.

First Horizon National Corporation disclaims any obligation to update any statements that are made from time to time to reflect future events or developments.

In addition nonGAAP financial information may be noted in this conference call.

Also please remember that this webcast on our website is the only authorized record of this call.

This morning's speakers include: our CEO, Jerry Baker, our Chief Credit Officer, Greg Olivier, and our CFO, Bryan Jordan.

With that I will turn it over to Jerry.

Thank you, Dave, and good morning.

Given the turmoil in the market through yesterday, we determined that it was appropriate to release earnings earlier than planned, so we did that last evening rather than wait until Thursday.

As always on these calls we will discuss our strategic direction review our financial performance trends, and given the importance of providing clear direction regarding managing asset quality, Greg Olivier will review current quality asset trends.

At the end of our formal comments, Bryan, Greg, Dave and I will take your questions.

The market conditions including economic, credit and housing-related issues continued to impact our results, we see progress as we execute our refocused strategy and second quarter results were generally in line with expectations.

We did build additional reserves and earnings were a loss of $19 million.

Bryan and Greg will provide more detail, but let me first provide a brief strategic overview of the second quarter as shown on slide four.

During the quarter we bolstered our capital position by issuing $690 million in new common equity to better navigate through the persistent economic risks as we liquidate our national real estate portfolios.

With this added equity we should be able to avoid returning to the market for additional capital.

We contributed $610 million of this new capital to First Tennessee Bank, boosting its strength as well.

We also replaced the quarterly cash dividend with a stock dividend until the operating environment improves.

We reduced our balance sheet by nearly $2 billion over the quarter, driven by the wind down of our national businesses, and we expect roughly $4 billion of additional contraction by year end.

And as a result our capital ratios improved significantly in the second quarter and should continue to improve as the balance sheet shrinks.

We also entered into an agreement to divest our mortgage business other than in our Tennessee markets.

We are selling our origination and servicing platforms as well as $20 billion in servicing to MetLife.

The transaction should close during the third quarter and transition activities are progressing as planned.

We've also contracted to sell additional MSRs, which should reduce the total servicing portfolio to about $65 billion by the end of next quarter.

And by the end of the year, as a result of these transactions, we would expect our balance sheet and mortgage to decline further, driving the previously mentioned balance sheet contraction and freeing up capital.

We continue to wind down our national real estate lending businesses and, as a result, our national specialty lending real estate portfolio contracted by more than $400 million over the quarter.

We expect this portfolio to contract another $600 million or more by year end.

We are actively managing problem loans and, despite weakening housing market conditions and the strain on borrowers and consumers and the increased energy cost and the slower economy, our 2008 expectations for losses in our loan portfolios remain within the previously communicated range of $385 million to $485 million.

We continue to proactively and aggressively review our portfolios, recognize losses on nonperforming loans quickly.

And, when collateral dependent, write them down to net realizable value rather than reserving for them.

As a result on average nonperforming loans have been written down by about 20%, which is 40% below appraised value.

And, we also continue to ensure that we have adequate reserves for losses and therefore increased reserves this quarter by an additional $90 million, strengthening coverage to 2.6%.

While all these matter are being actively managed we have at the same time remained focused on our two core businesses, regional retail and commercial banking and capital markets.

These two businesses continue to show good trends, even as we prudently provide for loan losses.

Our capital markets organization continues to benefit from the rate environment and strong penetration of targeted financial institutions.

We are successfully managing through the challenges of the trust preferred market and there was no low this quarter, but we did elect to move our inventory of trust preferred loans from held for sale to held to maturity.

In our regional banking we sold our remaining out of Tennessee market branches, but we continued to invest in new branches in Nashville, Knoxville and Memphis.

As a result of these and other investments, our core regional banking franchise continues to gain customers in targeted segments.

Recent third party surveys indicate that we continue to gain customer share across most Tennessee metros as you can see on slide five.

However, June FDIC data will show a decline of roughly $5 billion in deposits due to our intensional reduction of high cost wholesale funding in the Memphis bank.

That's a result of our strategic decision to reduce national lending and not due to any real decline in our market share or core customer deposits.

Let me conclude on slide six with our priorities for the balance of 2008, which remain as we have communicated previously.

We are staying on plan to improve capital ratios and reduce balance sheet risk.

We are aggressively managing our asset quality problems, recognizing losses and maintaining the full engagement of our work out resources.

We are winding down our national real estate businesses.

We are eliminating infrastructure costs associated with liquidating those national businesses.

And we are maintaining our focus on building on our strong regional banking franchise and continuing to diversify our strong capital markets business.

Much has been done over the last 15 months and we have also strengthened our organization in key positions.

So as we announced last evening we have been developing my succession plan over the last several months and we are ready to execute that plan.

I believe we can move forward with great confidence as Bryan takes over as CEO in September and he and our team together execute our refocused strategy.

We have done a lot of heavy lifting, but today's First Horizon is far different, more stronger, better positioned company.

We still have work to do.

But I know that Mike Rose, the board, Bryan and I believe these efforts will pay offer.

With that, let me turn it over to Greg Olivier.

Greg?

Thanks, Jerry.

I'll begin with the asset quality overview on slide eight.

Charge-offs from the second quarter totaled $128 million.

Provision expense this quarter includes a reserve build of about $90 million, driven by great deterioration in the commercial loan portfolio and by higher loss severity rates in home equity, which offset favorable delinquency trends in that book.

This increased our coverage ratio to 2.59% and to 3.33% for our liquidating national specialty lending segment.

MPLs increased with new inflow in the second quarter about equal to inflows in the first quarter of 2008.

Perhaps most importantly our outlook for full year 2008 net charge-offs remains within the expected range of $385 million to $485 million which we outlined almost three months ago.

Turning to slide nine, we are actively managing the asset quality of our $22 billion loan portfolio which this slide shows by major category.

Our national specialty portfolios represent the lion's share of problems which we continue to attack.

We have remained aggressive in identifying problem loans, recognizing losses by writing down most nonperforming loans down to net realizable values and adding to our work out resources.

I'll walk through what we were doing and seeing in each of our portfolios starting with consumer.

On slide 10, here's an update of our discontinued one time closed portfolio which we continue to work down.

Commitments are down 35% and balances are down 25% from the first of the year.

This has been accomplished by putting resources in place to keep pace with the portfolio's performance, most importantly by adding experience to fully dedicated to remediation efforts.

Performing prime jumbo loans on which construction is complete and for which there's no secondary market are being moved to the balance sheet.

So far about $200 million of these loans have been taken to the permanent portfolio.

Second quarter losses were somewhat higher than expected, influenced by a focused efforts to clean up a pocket of problem loans in Florida.

Our 2008 OTC loss expectations remain well within the range previously communicated, but keep in mine that this a stress portfolio with potential for some variability given the size of some of the commitments.

Moving to home equity on slide 11, we continue to believe our portfolio is better than average in quality relative to the industry.

As a reminder this portfolio is 85% retail originated, 27% is in the state of Tennessee, 26% is first lean, 54% is 2005 or earlier vintage, and 45% are fixed-rate loans.

We did see an increase in losses during second quarter, so let me explain why on slide 12.

Delinquency trends in our home equity portfolio have seen -- have been favorable as total delinquency has decreased in every month since reaching its peak in February, down 18% in absolute delinquent dollars at June 30.

However, home equity losses for the quarter were larger than anticipated primarily due to two factors.

First, the delinquency peak in Q1 working its way to loss, and, second, from increased loss severity, particularly in the national footprint where home prices have fallen more and where we have less first lean product.

Additionally we modified loss recognition practices on certain accounts resulting in a one time $6 million increase in charge-offs in the month of May.

Losses were driven by home equity loans and high risk national markets, wholesale originated loans and high loan to value loans.

Going forward we have remodeled home equity loss expectations assuming 100% of our 150 to 180 day accounts, rolled the charge-offs so as to reflect the increased severity being observed.

Given these more conservative assumptions, revised modeling indicates that our home equities losses for 2008 could be roughly $20 million above the previous range that had been communicated.

Therefore we determined in it was necessary to incur provision expense in excess of charge-offs this quarter in order to maintain appropriate reserve level.

Given the rapidly evolving market we continue to refine our loss modeling.

While the number of moving factors makes prediction difficult the performance of our portfolio represents cumulative loss assumptions remained well within the range previously communicated.

Slide 13 is an update on our residential CRE our home build to finance portfolio.

As you will remember we discontinued our national home builder finance business in January, choosing to maintain that line of business only within our traditional regional bank.

National commitments and balances are down significantly.

We are on track of outstandings of about $1.5 billion in total and below $1 billion in the national home builder book by the end of 2008.

The home builder portfolio continues to deteriorate as MPLs increased the second quarter, although the absolute dollar increase was less than in the prior quarter.

Let me make a point here about the issue of interest reserves which continues to be a hot topic.

28% of our national residential CRE loans have interest reserves but these loans are not kept currently solely due to these reserves.

However we regularly review borrower conditions and loan covenants, placing loans on nonperforming status based on those factors.

Charge-offs in the total residential CRE book were within expectations during the second quarter and are expected to remain so through 2008.

Moving to slide 14, national markets continue to drive the majority of problem loans.

In the second quarter, we again conduct detailed portfolio reviews to insure grading keeps pace with weakening market conditions.

This let us to increase the loan loss reserve again this quarter while also continuing to write down FAS 114 loans to net realizable value.

On slide 15, the C&I and commercial real estate portfolios are feeling the effects of the poor economy.

We have seen continued loan great deterioration and early stage problems, but have had some success moving early stage problems out of the bank to alternative financing resources.

C&I and income precharge ops were at expected levels in Q2 and are expected to perform as forecast for the remainder of 2008.

Employees in the regional banking footprint continue to find business opportunities and support customer relationships, but an increased focus has been placed on credit risk management due to the broad weakening in the economy.

Throughout our loan portfolios we have reinforced problem asset identification protocol and processes, enhanced our remediation capabilities and continue to recognize losses aggressively.

As you can see on slide 16, substantially all of our impaired assets greater than $1 million are considered collateral dependent and written down to net realizable value, a percentage of appraised value net of disposition costs.

On average we've already written these loans down by about 20% below their precharge down balance and about 40% below appraised value.

We hold no reserves against collateral dependent FAS 114 loans as we have proactively recognized their expected loss content.

For this reason, reserves to NPL ratios for our institution are less meaningful than for institutions that do not follow this approach.

In the second quarter we also began to see an increase in early stage asset disposition activity as investors are beginning to engage in the process.

In summary on slide 17 we continue to believe that 2008 total charge-offs will fall within the previously communicated range of $385 million to $485 million, with moderately higher losses than expected in our home equity portfolio.

Now I'll turn the call over to Bryan who will discuss second quarter financial results.

Thank you, Greg, and good morning, everyone.

As highlighted on slide 19, earnings per share in the second quarter were a loss of $0.11 per share or $19 million.

Fees and net interest income excluding securities transaction grew as our net interest margin expanded 20 basis points.

Pretax income was a loss of $48 million.

Excluding provision, pretax income was a positive $172 million in the quarter, with our core businesses contributing the majority of that amount.

The provision decrease link quarter to $220 million.

Capital ratios improved significantly and tangible book value ended the quarter at $12.52.

Slide 20 shows that earnings were impacted by a handful of other significant items.

Our efficiency and restructuring initiatives resulted in $16 million of employee and other costs associated with exiting the national businesses, as well as a transfer cost of $10 million on mortgage servicing sales.

We expect $35 million to $50 million of similar charges in the second half of 2008, as the mortgage sale to MetLife and additional bulk servicing sales are completed.

Two other items deserve mention.

First, a positive impact.

We had a gain from the repurchase of $152 million of bank notes, and, second, we increased repurchase reserves for home equity and mortgage loans by $25 million.

Repurchase requests have risen, and although we are often successful in resolving those, higher repurchases are likely going forward.

Slide 21 shows our balance trends and outlook.

We reduced assets by almost $2 billion from March 31 to June 30.

Loans held for sale decreased, due primarily to our moving roughly $380 million of trust preferred loans, $330 million of prime jumbo mortgages and the unsold First Horizon bank loans into loans held to maturity.

Loans held to maturity declined as reductions in our wind down national portfolios more than offset and increases associated with held for sale loan transfers.

While MSRs increased in the quarter due to higher valuations driven by slower prepay speeds, this increase was offset by reductions in related servicing assets such as IOS and hedges and also by servicing sold this quarter.

We expect assets to decline by $3.5 million to $4.5 billion as a result of: continued contraction of real estate loans in our international specialty lending businesses; the MetLife transaction, including their purchase of $20 billion in servicing and related assets; continued bulk servicing sales; and the orderly liquidation of our remaining mortgage warehouse.

The net interest margin improved this quarter as a result of lower wholesale borrowing costs, the benefit of free funding resulting from our capital raise, and fewer interest reversals on nonaccrual construction loans.

Over the near term the margin will be influenced by the changing balance sheet dynamics associated with divestiture of mortgage assets, but should remain above first quarters level.

Longer term, the margin should be positively influenced by the reduction of lower margin business assets and the core bank's asset sensitivity position heading in a likely rising short-term rate environment.

Slide 22 highlights our capital ratios improved significantly during the second quarter, as our tangible common equity to tangible assets improved by 191 basis points to 7%, while tier one capital improved by 214 basis points to 10.4%.

These ratios should build further through the end of 2008.

All other things being equal $4 billion by year end 2008 of balance sheet shrinkage would improve our tangible common equity to tangible asset ratio by approximately 90 basis points.

As Jerry mentioned our capital position and balance sheet actions given us the ability to withstand significantly higher than expected credit losses should the economy significantly worsen.

This slide illustrates that assuming $4 billion of balance sheet shrinkage and no cash dividends and using broker preprovision estimates for the remainder of 2008, our tangible capital ratio would improve to about 8%, with $200 million of provisioning for credit losses in the seconds half of the year and tangible book value would remain essentially flat to second quarters $12.52.

At these levels we'd have a significant amount of excess capital based on any capital ratio used.

Now I'll move on to the highlights from our business segments.

Slide 23 shows that our regional banking total revenue increased 3% link quarter, reflecting our refocus on driving customer growth.

For instance, deposit fee income increased 10% sequentially.

The bank's net interest margin stabilized helped by slightly less competitive environment and targeted deposit rate adjustments.

Expenses were flat sequentially and declined year over year driven by ongoing efficiency efforts including the successful divestiture of our outside of Tennessee First Horizon Bank.

We recognize that more work is needed to further reduce our infrastructure costs.

Second quarter pretax provision -- pretax preprovision income increased sequentially to $62 million, although continued provisioning drove a pretax loss of $27 million for the quarter.

Slide 24 recaps performance in capital markets which had another good quarter.

Pretax income increased sequentially to $24 million.

Fixed income sales remain strong although reduced market volatility resulted in a decline from first quarters record levels.

Other products revenue improved primarily due to the valuation adjustments recognized on the trust preferred warehouse in the prior quarter.

Despite ongoing strong demand from our financial institution client base to raise capital through trust preferred issuances, investor demands for such products remained largely nonexistent.

Accordingly, during the second quarter we elected to move all of our trust preferred warehouse loans to held to maturity status.

These loans still held in raw loan form rather than securities are both geographically diverse and granular, representing approximately 40 individual bank and insurance issuers from around the country.

The transfer was an economically attractive position given favorable yields and the low comp market of roughly 10% we had already taken on these loans.

We are currently operating our full trust preferred business on a best efforts basis going forward.

We remain focused on managing the corresponding banking credit portfolio while still recognizing the value of this business overall.

We have approximately $1.3 billion of corresponding banking loans and we are focused on relationship customers with whom we have nonlending business.

Turning to mortgage on slide 25, pretax income for the second quarter was $69 million, an improvement in operating results from first quarter, which included $40 million benefit from accounting changes.

The improved results were driven by: higher gain on sale margins largely resulting from an increased mix of government loans; better than expected originations as ongoing low rates continues to drive refinance activity; flat expenses; and continued favorable net hedging performance.

We've also tried to give you a better view of the earnings composition of this segment.

Looking at the table in the bottom right, originations drove roughly $27 million of pretax income including production revenues, expenses as well as net interest income from our warehouse and small permanent loan portfolio.

Servicing produced $43 million of pretax income through servicing fees net of run-off, expenses and net interest income from [IOS] custodial balances and $3 million of our small portfolio of permanent mortgage loans.

As we complete the MetLife transaction we expect that revenues and expenses with origination will largely be eliminated.

While earnings from servicing and permanent loans will remain, but should decline naturally over time and as we sell servicing.

We expect assets in the mortgage business to decline another three to $4 billion over the remainder of the year.

In summary First Horizon has a refocus, well thought out viable business strategy in place.

We have made good head way in implementing needed changes and strengthening our position in the second quarter.

We are aggressively identifying, reserving for and charging down problem loans and our expectations for losses in 2008 remain within the range of our prior expectations.

We have a strong core business in regional banking and capital markets.

We are divesting our national mortgage business and reducing its balance sheet usage.

We are shrinking our national lending portfolios and mortgage business to further reduce the balance sheet.

We continue to focus on driving down expenses and being an increasingly efficient organization.

And finally we are improving our capital ratios and reducing balance sheet risk.

We still have work to do, but we are excited about the opportunities that lie ahead.

I'm honored to lead the continuing successful transformation of our company.

With our talented, hard working employees and experienced management team I'm confident that First Horizon will succeed in building a highly profitable, dominant regional franchise.

Thanks, and, operator, we'll now take questions.

Thank you, Mr.

Jordan.

The question and answer session will be conducted electronically.

(OPERATOR INSTRUCTIONS) We'll pause just a moment to assemble our roster.

Our first question comes from Steve Alexopoulos, JPMorgan.

Hey, good morning, everyone.

Hey.

Good morning.

First question, if we look at the $876 million of nonperformers, what portion of those have been written down to the net realizable value?

Steve, there's a schedule in the financial supplement that shows that, I think it's on page 31 -- I'm sorry, not 31 -- probably -- bear with me here -- our total -- I'm sorry, if you go to the slide presentation on slide 16 we show your -- the FAS 114 loans.

So it's about $370 million or so that are in the FAS 114 process.

The $334 million of those have been charged down to net realizable value.

The balance will have a reserve against them for what we think is the loss content.

The $334 million of the $876 million, in other words?

That's correct.

The balance -- so that's gets -- that's on the commercial side NPLs about $376 million.

And the balance of that is going to be OTC, and in the OTC portfolio we talk about our charge off policy I believe on the last page of the supplement.

At 90 days it goes to nonaccrual, we write them down to appraised value at that in time and then write them down further at 180 days.

Bryan, do you expect at this point to match provision to charge-offs the rest of the year or do you think at some point you might start using the reserve to cover losses?

We expect it to turn -- I'm not certain that it would be in the last half of this year.

As I said here today I think it would match -- at least match charge-offs over the remaining six months of this year.

We expect that to return -- to turn some time in 2009 as we reach the end of the life on the portfolios and home builder finance and one-time close.

Okay.

And then just final, do you expect the delinquency trends in home equity to continue to decline here near term?

I think that's a great question.

We keep watching that.

In fact I looked at the delinquency trends this morning through yesterday for the month of July and they are about flat to June.

So that's going to be heavily influenced by what happens with the economy.

We are pleased with the trends we've seen so far.

We are certainly hopeful they will continue, but time will tell.

Thanks, guys.

Thank you.

Our next question comes from Kevin Fitzsimmons, Sandler O'Neill.

Good morning, everyone.

Just looking at page 22 of the slide deck, you outline the capital ratios in your outlook that -- going through that you expect the capital ratios to strengthen.

Yet you have tangible book value per share really staying even.

And if you could just talk through that, is that just a matter of shrinking the balance sheet and essentially maybe your outlook for pretax, preprovision earnings just basically being an up to match the expected provisions and any restructuring charges that we would expect?

Thank you.

Yes.

Kevin, this is Bryan.

That's a mechanical thing.

What that reflects is the fact that share count will go up with the payment of our dividend in stock in the third quarter and the declaration in the fourth quarter.

All of that gets reflected in equity.

So all it's really doing -- all things being equal that number would go up based on the previous tax, preprovision earnings that we've used in this now $200 million reserve.

What's happening there though is share count goes up as you reflect the dividend paid in stock dividend form.

Okay.

Okay.

Can you also just comment on -- you noted the severity in home equity going up, if you can -- if you have the in here and I missed it I apologize, if you can go into what specific states you might be season more of that severity.

Thanks.

Yes, we talk in general in here about the national portfolio versus the regional bank, and on the bottom of slide 12, bottom right corner, you get a view on the severities we've experienced by quarter and can see in a national specialty we are approaching 100%.

So there's what cap I guess on how bad that can continue to get to influence our numbers.

In our modeling we tried to incorporate that in our role rate model assuming everything in 150 rolls to charge-off, it's simulating best possible in the roll rate model a pretty high severity rate level.

Our next question comes from Paul Miller, FBR Capital Markets.

Excuse me, I've got something in my throat.

Sorry about that.

Can you guys go through a little bit, because you guys made a lot of changes which I think are all very good.

But how do we look at your companies pretax preprovision going forward?

What is the core earnings power of your company as we stand today?

Because a big chunk of your mortgage banking and your servicing would go away.

Is there any other things that you are looking at to sell?

And the bottom line is, what do you think is your core pretax preprovisions on the businesses you are going to keep?

Well, this is Bryan, Paul.

And there are a lot of moving parts in, as you've highlighted.

You've highlighted a number of them.

The change in the mortgage business will certainly impact in the short run, particularly as the origination business goes away.

The servicing business will go away.

We will probably have, call it a $865 billion servicing portfolio at the end of August when the mortgage transaction is probably completed.

That will wind down over time.

You've got a fair amount of friction, I would call it, due to the higher level of nonperforming assets that with experience today.

Part of it is the net interest income that we are not earning, and part of it is the amount of infrastructure that we've appropriately built in credit and other areas of the organization to continue to work on, problem assets.

That will decline over time.

And then the other factor that's not factored in today is the build up in -- or, excuse me, the remaining benefit from the divestiture of the First Horizon bank branches, we continue to take costs out of that.

That coupled with the capital markets business and a bank business that did over $100 million in the quarter on a pretax preprovision basis coupled with our efficiency initiatives, the efforts we have in place to get more efficient in the organization as we continue to structure, I think give us a pretty solid foundation of the $100 million to $125 million range that we can achieve over the next several quarters as we work through these various initiatives.

And can you -- I mean, you might not want to do this but on the expenses, how much additional expenses per quarter are you spending on these work outs?

Well, just in terms of direct expenses, I think in the second quarter our foreclosed property expense was not quite double.

I think it went from $6 million to $10 million or $11 million, which you can see in the supplement.

And then the infrastructure costs probably run in the neighborhood of $2 million to $3 million a quarter to work through the process.

All of that should wind itself down, but right now it's a reasonable investment to maximize the management of the portfolio.

And we will go next to Tony Davis, Stifel Nicolaus.

Good morning, and congratulations, Bryan.

I just -- following up on that question, where are you right now in terms of run rate savings from the various initiatives as were sit here in the middle of the year?

We are -- as we sit here today we perceive more than the initial $175 million of run rate savings.

We have had an initiative ongoing since really the early part of this year to continue to reduce costs and infrastructure.

First, focus on the costs associated -- the centralized costs associated with supporting our mortgage business and the national businesses and how we wind that down as we wind those businesses down.

As we look at the infrastructure and support functions for our operations and credit and capital markets -- excuse me, and banking -- how we support the capital markets and banking businesses going forward, we think we've got additional opportunity to reduce costs and overhead.

And although we haven't tried to pin the tale on a target that's a strong area of focus for us and we've made a fair amount of progress in identifying those costs over the last several months.

I wonder, too, what was the impact, Bryan, on the margin this past quarter of the truck loan transfer?

That 20-point move was pretty significant.

It really had -- that didn't have any impact to speak of.

Those were in the margin last quarter and we are not accreting the 10% mark we have taken on those, so that had no impact on the margin.

The two big benefits were: one, the reduction and wholesale borrowing cost, lower cost of funds, coupled with margin management in the banking franchise, where I think our bankers did an outstanding job managing deposit pricing.

And then the third element would be about two to four basis points of improvement associated with the $690 million of capital that we raised.

Got you.

One final question, any comments here on Fannie Mae or Freddie Mac stock, exposures there and marks?

We don't have any Fannie Mae or Freddie Mac preferred stocks.

Our Fannie Mae/Freddie Mac securities are mortgage-backed pass through instruments for the most part.

I think 95% to 98%.

But we don't have any exposure to the preferred stocks.

And we will take our next question from Christopher Marinac, FIG Partners.

Thanks, good morning.

Bryan, I was curious if you could comment on the home equity portfolio from the perspective of the breakout of each years' vintage, and which year is worse, which year is better, if you can give color on that?

I am going to let Greg do it because he's better at it than I am.

Hey.

Good morning, Chris.

Yes.

Separating out home equity installment loans from home equity lines of credit.

Installment loans, vintage performance going back to 2000, there are some years that are lower, but it's fairly consistent around 1% or 1.5%, kind of that range for cumulative loss content.

You see the difference in our HELOC vintages and our peak year for losses at this point appears to be 2007, materially different from the other years.

You look at HELOCs exclusively kind of '05 to '08, we are looking at somewhere between 4% and 5% [team] loss on those four years combined.

And then separately, Bryan, on the low comp adjustments for the truck loans will any of that get accreted later?

I know it's not part of the earnings now, but will that come over the life of the loan.

At some point that will come back in and as you know those securities or loans typically have a five-year no call period, where probably at a minimum a half year into that, in some cases closer to a year.

The discount we've taken there as I mentioned earlier is roughly 10%.

Right now it's set up as a contra asset.

It's not sitting in our loan loss reserve, but essentially functions like a loan loss reserve in those securities, but at some point that will come back into earning but I suspect that to be down the road, Chris.

And we'll take our next question from Ken Zerbe, Morgan Stanley.

Great.

Thanks.

The -- I guess the first question I had just in terms of slide 10, your goals being the OTC construction loans down below $1 billion, given that you seem to be moving, I think you moved $200 million into permanent loans the second quarter, how much of that reduction to below $1 billion is going to come from sort of internal transfers as opposed to reducing the actual exposure?

Yes.

Good question.

We will -- we created basically a score card for you we included in the national specialty segment, the permanent mortgages associated with one-time close.

So we tend to be pretty transparent about those that reach final stage and we end up having to take you back to the health maturity portfolio.

We do anticipate the construction piece of that book to be $1 billion or below, certainly below $1 billion by the ends of the year.

We do anticipate that we will move a portion of permanence in there.

We moved $200 million so far.

The amount we have to move beyond that will vary based on market conditions, but we will keep track of that so every quarter will you see what the results of that effort is.

We are making a concerted effort internally and with -- and externally to encourage those permanent mortgages to move elsewhere through incentives, but sales staff into customers, because it's not our intent to create a massive permanent mortgage portfolio.

Ken, this is Bryan.

The score card Greg referred to is in the financial supplement which was also filed this morning, page 30, I think.

Keep in mind these are loans that have modified and got through the construction phase.

They are loans that have modified into the permanent phase and essentially could be looked at as a new first mortgage loan.

The issue with them is the lock up and in the jumbo market whether it's fixed or arm in that there's, it's not a salable product to date.

So as that changes we will be able to move them into the market, but for the time being it's a converted first permanent mortgage that has got to go on the balance sheet until we can find a market that opens up for them.

Okay.

That makes sense.

The second question I had was, maybe just more of a qualitative question, but how can we get comfortable or how are you guys comfortable with your NCO guidance remaining unchanged, given the sharp deterioration that we've seen in nonperforming assets this quarter?

Was that increase planned four in your guidance last quarter, or what's changing?

Because I think over the last several quarters we have seen sort of an increase in loss estimate or loss guidance, so I'm just wondering if that's going to change going forward.

Yes, it's a good question.

We certainly feel comfortable communicating through 2008 that we will be within that range.

I think we are all kind of acknowledging we will be in the upper half of in range based on what we are seeing.

But your question is what was in our heads when we came up with the estimate three or so months ago, we did anticipate further deterioration of residential decree.

We did anticipate the wind down impact of OTC.

We did anticipate, not as well as we should have, based on our comments this morning on home equity and where our loss expectations are in that portfolio.

But I think we are comfortable saying we are in that range.

I think it's fair to say we will be in the upper half of that range right now.

Ken, this is Bryan.

I will add to Greg's comment.

We will be the first to say we don't know what we don't know about where the economy is going to go and how things can play out from here.

But we believe we've got a head start on identifying and recognizing problem assets.

As you know we've been building reserves.

We've got approximately $575 million of reserves built on our existing portfolio.

Greg and his team and our line bankers have been very proactive in addressing problem assets, identifying them, making sure that we are getting them graded properly.

It's starting early on the resolution process.

So as we sit here today we expected some further deterioration.

We expect that over the course of the year, and as we analyze what we think the loss potential we still think, as Greg said, we can be in the range we discussed earlier.

Yes.

A couple more points on that.

With things like the one-time close portfolio it becomes smaller and smaller every month, therefore somewhat easier to predict and manage.

On the commercial side where you've seen deterioration more recently and it's sort of been a wave running through the portfolio starting with residential for your home builder and starting to impact income, CRE and C&I business.

In those type of loan there's more for successful work out strategy, you have a cash flow stream that you can work with, so you can work with a business that's being impacted for example by commodity prices and work to restructure, successfully rehabilitate that credit.

With a home builder it's a little more difficult.

If there's no appetite in the market and no financing for the appetite that might be there, there's far fewer resolution opportunities at rehabilitation opportunities.

So we expect the loss content and some of the nonperforming build that we've seen in the income, CRE and C&I less than we've seen in the CRE portfolio, if that makes sense.

And we'll go next to Heather Wolf, Merrill Lynch.

Hi.

Good morning.

Bryan, I know you said that the pop in the gain on sale margin was due to a better mix of governments.

But when I dug into it, it looks like a lot of it came from trading gains, and I'm wondering if you can kind of reconcile that for me.

There was a little bit in trading gains just due to rate movements.

And the other thing that I think is reflected in there is probably $6 million of gains associated with expiration of jumbo commitments.

But largely it was the benefit of having more government production a little north of 40% and tends to price a little bit better at the end of the day.

And does the higher mix of government impact the trading gains at all, or is that really just in like the OMSR portion of it?

It's mostly in the OMSR portion of it.

The trading gains is really the positioning P&L that our hedgers and traders at the mortgage company execute.

Okay.

And then just another question on the construction and one-time close portfolios, can you guys talk a little bit about the types of loss severity you are seeing for each of those portfolios and where you think those might go?

Sure, Heather, this is Greg.

I will point you to slide 16 again and look at the -- specifically at the bottom right, the charge down information.

We've begun to have some resolutions in second quarter when we talked about that the market becoming a little more active there.

And our resolutions are tending to come right at about what we've written these assets down to.

We'll have some smaller coverage in some cases and some additional incremental charge-offs and others but by and large coming about at the mark.

Most of the FAS 114 charge down accidents are residential CRE accounts.

So the marks we are taking, the 20% right down for the book and 40% or so 38% to appraisals are about what we are seeing thing clear at.

There's a lot of variability underneath that though, as you are aware.

It's the lands deal, it's far bigger hits than that.

If it's in a more stable market, it's far better than that, so some variability there.

On OTC we continue to be right in the high 20%s to 30% loss severity.

That continues to hold up pretty well.

And we'll go next to Tom Purcell, Viking Global Investors.

Hey, guys, just had a question on the earnings that that you talked about earlier.

Looking at the number, the $100 million to $125 million preprovision, I guess that gets me to you guys trading right now at about two times preprovision?

Yes.

All right.

Yes.

That's all I had.

I thought it was a good quarter.

Thanks.

Yes.

Thanks, Tom.

And we'll go next to Eric Wasserstrom, UBS.

Thanks.

I just wanted to circle back to asset quality for a moment.

I'm looking on page 27 of your supplement and I'm just trying to reconcile what I'm seeing here on the commercial C&I and the income CRE delinquency in NPL trends with the loss guidance, because it looks like those portfolio are starting to feel some pressure just in terms of -- it looks like in both cases NPLs are up 50% to 100%.

And yet the charge-offs are either flat or down in the period.

So two questions, one is could you explain what's occurring there in terms of the increase in NPLs versus the charge-off experience?

And, two, can you just reconcile that again with your go-forward charge-off guidance?

Sure, would be glad to.

What we saw beginning in probably fourth quarter, first quarter of '08 was an increase in our watch list accounts there.

So we started to see deterioration in the early part of the year.

Watch list balances have actually neutralized a bit since March.

March, April, May were relatively flat, slightly down in C&I.

What we saw was partially because of market deterioration, partially because of emphasis we get on getting home grades accurate, problems identified to kind of identification in first quarter end of the watch list, a bit of a neutral flow into watch from that point forward, but then a recognition, once we got a handle on watch lists problems would you have seen migration down to classified, which is driving more provision based on the factors associated with substandard and special mention accounts.

Again talking about income CRE and C&I there's more resolution opportunities.

A lot of these downgrades are being driven, some are being driven by instrumental weakness from covenant light deals done a couple of years ago, but a lot are being done due to commodity prices.

So we feel a lot will have the opportunity to recover and rehabilitate any time from the current condition.

In any event we think that the resolution plans will be more protracted as we work through those things.

So we think the impact on third and fourth quarter will be as we forecasted.

But as those numbers build there's more of an opportunity to miss somewhat on those portfolios.

But at this point we still feel good with those numbers.

Okay.

And just more specifically on the income CRE, obviously a lot of deterioration from year end.

Can you just discuss what's driving that?

Well, I think there's a couple of things driving it.

One is the retail side of the income CRE book has been impacted the most as you imagine because it's impacted by rooftops more than any other segment.

So we think that's been the primary stimulus there.

The other issue there is that the availability of permanent financing for income CRE properties has decreased with what's happening in the market, so there's more credit that gets to the ends of construction and it's an opportunity or the refinance opportunity's gone, the market -- the cap rates have increased, so the value of the property if you are looking into many permanent finance loan there has decreased, therefore the equity requirements increased and that's a struggle for some of the borrowers.

So it's driven primarily from what's happened in housing.

It's impacted mostly retail, but the -- what's gone on with permanent market income CRE has also impacted it.

We'll take our next question from Bob Patten, Morgan Keegan.

Good morning, everyone.

Congratulations, Jerry and Bryan.

Thank you.

Thanks, Bob.

Greg, the slide on 16, which you show the writedowns of net realizable value.

I just wanted to, one, say it's a good slide, but, two, wanted to talk about the loan sale market loan values are today and how you kind of tie that together.

Obviously, everybody is looking at NPAs growing on an absolute basis with very little activity going on in terms of loan sales.

What are you seeing in this market?

How aggressive can First Horizon start to get to mitigate that growth of the NPA number?

Obviously with your write down aggressively you could probably -- the question is do you expect further marks in the NPA based on current market pricing?

That's question number one.

Two, with the increase of fraud or home equity mortgage repurchase agreements and defaults, are you seeing fraud occurrences increase?

And then I guess just in general -- I'll stop there.

Go ahead.

Okay.

Making notes as quickly --

I started trying to do it just in my head and had to start writing thing down, Bob.

First of all on the charge down slide, I guess your question is really about the loan sale market.

We are starting to see more activity there.

So I think investors are starting to become a little more I guess both are meeting each other a bit, institutions are willing to take more of a hit to dispose of properties, investors are willing to pay incrementally more.

So you've seen bids increase from first quarter to second quarter.

And that gap between what you've written an asset down to and what an investor is willing to pay for it has narrowed, so I think that's what driving some of the activity.

We -- Bryan and I talk every week with our work out people and assess the viable of strategy for select loan sales where we think it makes some sense.

Bryan, I will let you comment, but I don't think we intend to vary dramatically from our strategy of using that as a selective method of disposing of a bulk of assets.

Yes.

As we sit here today I agree with exactly what Greg says.

Secondly, question on increased instance of fraud.

If the question's on the commercial side of things have not seen an increase in commercial fraud, it's more on the mortgage side I think, on home equity side.

Yes, if you look at the types of home equity that are having problems they tend to be more of the wholesale originator, which has more of an opportunity for misrepresentation, more of misstated income which has more of an opportunities for misrepresentation.

That really has not been more of an increase in that.

That's been a character risk of that book on an ongoing basis.

Alright.

Thank you.

And at this time I would like to turn the conference back over to Mr.

Baker for any additional or closing remarks.

Let me just conclude by congratulating Bryan, and thanking all of you for calling in and showing your interest.

I have great confidence in this team and our ability to go forward.

I believe we've made a lot of important changes, refocused, restructured ourselves.

And while I would always like to see the market be a better environment in which to operate, I can certainly feel good about the changes we've made, and I appreciate all your interest and attention this morning.

So thank you, and have a great day.

Thank you, and again that does conclude this calling.

We do thank you for your participation.

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