First Horizon Corp (FHN) 2009 Q2 法說會逐字稿

Welcome to First Horizon National Corporation's 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 your questions.

Mr.

Miller you may begin.

Thank you, operator.

Good morning.

Please note that our press release and financial supplement as well as the slide presentation we will use this morning are posted on the Investor Relations section of our website at www.FHNC.com.

Before we begin I 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 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 is noted in this conference call.

A reconciliation of that non-GAAP information to comparable GAAP information is provided in the appendix of the slide presentation available on our website.

Listeners are encouraged to review the reconciliations after this call.

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

This mornings speakers include our CEO Bryan Jordan; our Chief Credit Officer Greg Olivier; and our CFO BJ Losch.

With that I will turn it over to Bryan.

Thank you, Dave.

Good morning, everyone, and welcome to our call.

Second quarter results were noisy, but our core businesses and credit were in line with expectations.

Despite a challenging environment, First Horizon's team made significant progress on key initiatives to further strengthen our Company and improve our profit potential.

As summarized on slide three.

The flattening trend in our problem loans continued as MBAs declined 2% link quarter and charge offs met expectations.

This is the first drop in MPAs since the third quarter of 2007.

We continue to believe we are ahead of the curve on credit having proactively attacked our problematic national construction portfolios, and applied the same rigorous practices to our input print portfolios.

Unless the economy significantly worsens from here, we think our MPAs, charge offs and reserves will peak over the next few quarters, a critical step in returning to profitability.

We continue to shrink our balance sheet and improve liquidity through a combination of winding down our high risk national loan portfolios and strengthening our customer deposit base.

Our net interest margins multiquarter down trend was reversed with the margin up 16 basis points to 3.05%.

We expect further margin improvement in the second half of 2009 as we continue our emphasis on loan and deposit pricing discipline building customer deposits and winding down our national businesses.

Our core businesses performed well.

Regional bankings pretax, preprovision earnings increased 24% link quarter while capital markets achieved another very strong quarter.

It is a pretax, preprovision earning is up 13%.

Finally we maintained capital ratios among the strongest in the industry, with Tier 1 improving to 15.4%, Tier 1 common to 9.5%, and tangible common equity to tangible assets to 7.3%.

Let me spend a moment on capital.

Slide four shows an updated internal stress test analysis using assumption similar to those applied in May's public supervisory capital assessment program.

We have applied the median two year loan loss rates under the more adverse scenario as reported for the 19 S-CAP banks.

Additionally, we made some simplifying assumptions that include broker preprovision earnings estimates, a shrinking balance sheet and loan loss reserves of 2% at year-end 2010.

As you can see, even in an adverse economic environment where we experienced higher than anticipated losses, our capital ratios would be significantly above well capitalized standards with Tier 1 common at 8.5% and Tier 1 at 14.5%.

Given this strength you may be wondering about First Horizon's ongoing participation in the capital purchase program.

While we believe our MPAs, charge offs and reserves will peak over the next few quarters, economic conditions are soft.

So we would like improved clarity around the economic outlook.

Also CPP funds are a relatively inexpensive source of capital.

We are therefore not in a rush to repay TARP but intend to work with our regulators to repay the funds at a prudent time as the economy stabilizes and credit trends improve.

Turning back to second quarter results, slide five provides the financial highlights.

We reported a loss of $0.58 per share for the quarter, as BJ will detail in a few minutes there are a number of moving pieces.

This includes a dividend on the CPP preferred as well as a modest loan los reserve increase of $20 million.

Pretax, preprovision income on a consolidated basis was $79 million as stronger performance from our core regional banking and capital markets businesses was mitigated by negative impacts from winding down our national specialty business, lower hedging results in mortgage banking, actions taken to further derisk our balance sheet, and the FDIC special assessment.

Clearly performance in our wind down national businesses has been volatile in the past few quarters.

We expect they will continue to be somewhat unpredictable going forward as they are liquidated and we are working aggressively to dampen those effects.

As we see some light at the end of the tunnel on credit quality and our balance sheet remains one of the strongest in the industry, we are increasingly turning our attention to driving long-term earnings power.

With that in mind, we focused on making our core businesses more efficient and productive.

In our regional bank we streamline processes by shortening loan approval times, streamlining infrastructure to better serve our customers.

Loan and deposit pricing has also been an emphasis, in capital markets we have made targeted sales force additions and reduced fixed costs so that this business can generate solid returns even when the economic environment changes.

We have also been doing a fair bit of work around key financial and performance drivers.

We have highlighted several of our key metrics here and BJ will cover those in more detail later in the call.

With the analysis we have done, and the core businesses we have, I think that our new, more focused First Horizon can generate 15 to 20% ROEs in a normalized environment assuming tangible common equity to tangible assets of 6 to 7%.

We know however, that we have got a lot of work to do to get there.

Now, I will turn it over to Greg to discuss asset quality trends and I will be back to help take your questions.

Greg?

Thanks, Brian.

I will begin my comments on slide seven with an overview of the quarter.

As a general statement results continue to be as expected.

We still feel we are approaching peak levels of charge offs and loan loss reserves and in fact, expect lower charge off and lower aggregate reserve levels in the back half of this year.

Keep in mind, however, that these comments are based on our expectation of a continued incremental economic deterioration.

If an unexpected significant acceleration in the rate of economic deterioration should occur, our results may be materially different.

Charge offs were in line with expectations at $239 million or an annualized 4.77% of loans increasing modestly over last quarter.

MPAs continue their flattening trend, negative commercial grade migration slowed and the problematic wind down portfolios continued to shrink all of which led to a decrease in provision expense of $40 million to $260 million.

We had a small reserve build of $20 million as we expect incremental deterioration and our C&I income pre portfolios and the permanent mortgage portfolio continues to deteriorate.

Lastly, I would note that 90 day plus delinquent loans declined $68 million over last quarter as we had anticipated.

As you may recall we burdened ourself with an unusual level of administrative delinquencies last quarter and those issues have been resolved.

Slide eight gives more detail on MPAs which were down for the first time since first quarter 2007.

The decline was a modest 2% and we feel it is an important milestone on the way to normalizing the performance of our portfolio, and serves as evidence of our proactive approach to managing credit quality.

NPLs decreased 1% and inflows slowed while the rate of disposition improved somewhat.

Inflows from our commercial portfolio tended to be real estate related including both RES, CRE and income exposures.

ORE management has been a focus over the past several quarters over which time we have consolidated the management of the majority of our ORE under a single team.

We continue to have success disposing of individual assets at or around carrying values.

We also executed a handful of bulk sales at a loss in Q2.

This allowed us to manage the age of our ROE inventory and was in recognition of the impact decreasing appraised values are having on our regimented valuation adjustment process.

Valuation adjustments, the process of regularly marketing our ORE inventory to market accounted for over half of our foreclosure expense in the second quarter.

Our strong capital position enables us to appropriately manage our MPAs and we will continue to selectively and prudently pursue ways to accelerate improved asset quality metrics.

It is also worth noting that the downward migration of commercial loans continued its slowing trend this quarter which translates into a smaller increase in required reserves.

Now I will cover the key trends in each portfolio starting with C&I on slide nine.

Charge offs in our C&I portfolio were $27 million down incrementally from the $30 million in first quarter.

Losses in general were small, as approximately 60% of our C&I charge offs were less than $1 million.

While charge offs were not concentrated in any particular portfolio subsegment, industries that are seeing elevated levels of stress include construction-related businesses, retail trade, and banking.

As a reminder our trust preferred and other bank loans are housed in C&I portfolio and total about $800 million.

Trust preferred borrowers include banks and insurance companies, they have solid capital levels and several of them have received TARP.

This quarter we had one additional bank elected for interest on a trust preferred loan that we hold, bringing the number of trust preferred loans on interest deferral to three.

These three loans totaled $22.5 million.

Due to continued stress on the trust preferred loan portfolio we have increased reserves accordingly.

Delinquencies in NPL rates in the C&I portfolio remain manageable owing to good borrower relationships in our predominantly Tennessee footprint.

Economic conditions are softening here as they are everywhere and thus we expect performance trends in this book to deteriorate incrementally over the balance of the year.

That said, we have been aggressive in reviewing credits in this portfolio with regular ongoing reviews to ensure accurate loan grading.

We have also increased reserves to 3.4% of loans.

Turning to income pre on slide 10, outstanding balances stood at $1.9 billion at quarter end, the majority of which is managed by our regional bank.

Charge offs were $31 million in second quarter up from $17 million in the last quarter.

In contrast to C&I losses 68% of the charge offs in this portfolio exceeded $1 million and were driven by a handful of relationships.

Both the geography and collateral types land retail and mixed use projects varied.

We expect continued deterioration in the income pre portfolio as vacancy increase, cap rates increase and permanent market financing remains illusive.

Our reserves in this portfolio stood at 5.77% at quarter end.

As we said before, loans in this book were underwritten to our balance sheet standards and in contrast to CMBS debt our relationship loans almost always include personal guarantees and debt right sizing provisions, maturities do tend to be shorter than CMBS debt however so we are proactively working with our borrowers to improve the bank's position on upcoming renewals.

Moving to slide 11, our home equity portfolio has a balance of $7.4 billion with a declining $4.7 billion in our national markets and $2.7 billion in our core Tennessee market.

30 day delinquencies increased 11 basis points to 2.12% from last quarter mainly driven by our national markets.

Rising unemployment seems to be the most meaningful driver of although we have been pleasantly surprised by the modest degree of uptick.

You will also note that our performance continues to run much better than the industry due to our strong borrowers and underwriting, 85% of these loans were retail originated and have an average refreshed FICO of 730.

As you can see from the graph on the lower left hand corner of slide 11, borrowers are able to refinance out of our portfolio.

Prepay speeds and the wide down national book continue to be higher than a few quarters ago.

A final point on home equity.

The majority of our current charge offs are coming from the vintage years 2005 through 2007.

In analyzing our loss curve, losses tend to peak between 24 and 48 months suggesting that the underlying natural charge off emergence period for the largest origination vintages should be nearing their peaks, notwithstanding further deterioration and economic conditions.

We still expect the consumer economy to remain stressed, however the offsetting impact of the vintage dynamics-- given the offsetting impact of vintage dynamics we expect the charge offs will remain near the current run rate in the second half of 2009.

Compared to a prior view they would tend to increase.

Our cumulative loss views for this portfolio remain consistent with prior expectations.

Slide 12 is an update on our national construction in our per mortgage portfolio which continue to drive disproportionate percentage of our problem loans.

The RES CRE wind down remains on track as balances dropped another $100 million in the quarter to $579 million.

Charge offs in this quarter were $34 million down $4 million from first quarter.

Reserves remained relatively flat.

The national RES CRE commitments are now down 70%, 70% since the wind down began in January 2008.

One-time close balances ended second quarter at $558 million down $215 million link quarter.

OTC commitments are now down 79% since the wind down began.

Charge offs totaled $51 million up from $47 million in first quarter as expected.

We expect that OTC charge offs will decrease in the second half of the year as this portfolio wanes.

Likewise since we hold reserves for the observable inherent loss in this portfolio, reserve levels should continue to decrease for this book.

Note that we did increase our estimate of remaining inherent loss this quarter and adjusted reserves accordingly.

Between the national specialty and mortgage segments our permanent mortgage totals $1.1 billion.

It is a heterogenous pool of loans that contain a mix of high quality permanent mortgages from our core bank, prime performing mortgages from our warehouse, OTC loans that were taken to the balance sheet.

Scratch and dent loans from the warehouse and some loans repurchased from investors, as a result performance varies dramatically within this portfolio.

Permanent mortgage charge offs were $22 million in the second quarter driven by performance deterioration, increased loss severities and the depletion of available low com marks on a portion of this book.

We have increased reserves to 8.9%.

I will wrap up on slide 13.

Here is a look at our updated charge with directional trend arrows which we have shown you in the past two quarters.

We have adjusted the format somewhat in an attempt to make our expectations for the balance of the year clearer.

To summarize our performance relative to expectations in the first half of the year charge off trends were generally as expected across all portfolios and somewhat lower than expected in RES CRE.

Our expectations regarding the required level of reserve were low however, as C&I and income CRE reserve levels were increased and not held constant as anticipated.

Our expectation for the second half of the year is that both charge off and reserve levels are expected to decline in the aggregate relative to second quarter results.

We have a slightly more favorable view on the home equity portfolio than we did at the outset of the year but a more negative on C&I as we expect to incrementally build reserve and on income CRE as we expect both higher reserves on higher charge offs.

The thesis for these expectations is that we expect the economic environment to remain challenging well into 2010 with unemployment rising and home prices falling further.

With that I will turn it over to BJ who will discuss the national results.

Thanks, Greg.

And if everybody will flip to slide 15, we will start with an overview of this quarters consolidated income statement.

And as Bryan mentioned we reported a loss of $0.58 per common share while provision expense declined $40 million link quarter, and NII was stable, significantly lower mortgage results drove lower pretax preprovision income of $79 million.

This masks some really encouraging signs that we see in our core businesses and in fact, the next slide, slide 16 shows that in our core business segments which are regional banking, capital markets and corporate, pretax preprovision earnings improved to $131 million up $23 million from 1Q '09.

I will touch on some of the highlights of the core businesses in in few minutes.

The wide wind down businesses however, posted a pretax preprovision loss of $52 million compared to first quarters positive $79 million.

If you look at the column on the right, on this slide, it shows some of the significant revenue and expense impacts by each segment.

So I will touch on some of the more meaningful ones which will include a number of actions that we took dispose of problem assets and mitigate future exposures in those wind down businesses.

First, you can see at the bottom the accrual for the special FDIC assessment totaled $13 million across all of our segments.

Next, as we have done on loan loss reserve, we also proactively addressed credit related aspects of our wind down businesses this quarter that impact revenue and expense lines, repurchase expenses were $29 million, and our mortgage business as we increased those reserves to address repurchase activity as industry delinquency rise.

We also recorded a $12 million reduction to income associated with home equity repurchases.

And in the repurchase area, we have assembled a strong cross functional team of experienced professionals to address and resolve requests from legacy originations going forward.

And we had about $8 million in reinsurance reserve adjustment for our legacy mortgage reinsurance business based on higher loss projections although we have not yet actually paid any losses to date.

Third, we incurred $22 million of foreclosure costs this quarter, that Greg mentioned up from $10 million in 1Q '09, including some losses associated with more aggressive dispositions while most of our foreclosure sales continue to incur in line with those carrying values.

This quarter we did execute a bulk sale transaction that resulted in the disposition of about 100 properties at an incremental loss to book of about $5 million.

Finally, mortgage hedge revenue results while still positive were much lower than the outsize results in 1Q due to a more volatile rate environment and a smaller MSR book.

I would also note that in Q2 '09 we reviewed cost allocation and funds transfer pricing views to determine segment performance, and as a result of this review, some of those methodologies were revised.

So, for comparability, segment history has been revised as well to reflect those changes.

And although the review impacted segment, across segments the consolidated representation of financials was not affected.

So if you turn to page 17, to review some of our key financial drivers beginning with the balance sheet.

We are pleased again with the progress and managing down our national assets, growing core deposits, and improving the loan to core deposit ratio that will ultimately improve and continue to improve our funding mix.

Our assets were reduced by about $2.5 billion in the second quarter as we sold mortgage servicing and continued to liquidate those national loan books.

On the funding side, core deposits were a positive up 2% from last quarter even as we transferred approximately $300 million in escrow balances with the sale of that $13 billion of national mortgage servicing.

What offset this decline from the escrow balances was solid customer trends and early success expanding share of wallet in our private banking and wealth management client business and that drove a meaningful increase in deposits in our regional bank.

Combined with balance sheet reductions, good core deposit trends allowed us to retire $700 million in debt at maturity, reduce our cap utilization by $1.1 billion, and maintain no utilization of our federal home loan bank borrowing capability.

As a result of asset reductions and good deposit trends, our loan to core deposit ratio dropped from 149% to 140 link quarter, and is down 27 points from a year ago.

Going forward, we expect another $0.5 billion to $1 billion of balance sheet reduction throughout the rest of '09, with continued core deposit growth, and a declining loan to deposit ratio into the mid to low 130s leading to a Company that is ultimately smaller but more profitable.

Flipping to slide 18, our net interest margin was a real bright spot this quarter, improving 16 basis points to 3.05%.

We benefited from reduced deposit funding costs as promotional money market savings balances repriced at materially lower rates.

We also experienced improved spreads on new and renewed loans although lack of significant loan demand here muted that benefit so far.

And lastly, we have experienced continued slowing in the drag from nonaccruals that are, as our national businesses wind down.

As we have talked about before, going forward, pricing is a major focus for us.

And our margin is likely to expand modestly throughout 2009 as pricing improves and we wind down our lower margin national businesses although volatility and LIBOR makes the magnitude of impact tough to size with much precision.

Long-term, we think the net interest margin for our business is 3.50% to 3.75%, and that is achievable for the core franchise.

And of course to get all the way there, we need credit head winds to abate and interest rates to rise from their current low levels.

Moving on to the next key driver, fee income to total revenue on slide 19, the fee income is a percentage to total revenue was 60% in the second quarter, down a bit from last quarter but still very strong.

Our capital markets businesses continues to be be the main driver of our fee income and our distribution base firm remains well positioned to take advantage of the continued favorable fixed income market conditions.

While fixed income fees softened modestly in the second quarter after a previous quarters record, they remained very strong by historical standards.

Fees in our banking business rebounded seasonally but remained relatively soft as weak consumer confidence drives lower overdrafts, debit card purchases and wealth management fees.

Our national businesses drove significantly lower fees as previous quarters outsized mortgage hedge gains were not repeated in Q2 as rates rose.

Increased volatility caused repositioning of the hedge book and we had a 25% smaller servicing portfolio via the sale of $13 billion of MSR.

Although the hedging profile remains predisposed to modest gains given the steepness of the current yield curve, volatile rates will continue to make results difficult to predict.

I'd also remind you that fees were impacted this quarter by the addition to the home equity repurchase reserve of about $12 million which is a contra revenue.

As our net interest margin improves and capital markets production normalizes our fee income mix will come down from the 60% which should remain strong relative to the industry at roughly 40 to 50%.

Turning to page 20, expenses declined 1% link quarter to $412 million as we saw increased costs in our national businesses that we previously discussed, and the FDIC assessment while maintaining focus on reducing expenses across all of our businesses.

Capital markets expense decreased primarily due to our reduced rate of incentive provisioning and decreased production levels.

As I talked about earlier, much of the increased cost in our wind down national businesses is cyclical in nature as we move to address repurchases in these businesses as well as ORE.

Total head count declined in the second quarter as we focused on efficiency initiatives across the enterprise.

We are in the process of implementing a number of initiatives to get at what we call here bad costs, things that don't significantly impact customers or revenue.

For example, we are closing a number of teller only branches since our full service branches have more convenient hours and services.

We have also been able to restructure our consumer lending processes as Bryan talked about, streamlining infrastructure but also dramatically cutting loan origination time for the customer.

And we are beginning to experience the first opportunities to reduce resources assigned to liquidating our national portfolios.

Driven by some of the significant expense items and lower mortgage revenue our consolidated efficiency ratio remained elevated in the second quarter at 84%.

Going forward, we expect our revenue improvement and cost reduction efforts to push this down into the lower 60s over the long term.

Now I will just spend a few minutes on highlights from our core business segments and remember we did adjust some allocation methodologies this quarter that impacted segment numbers but we revised that history to reflect those changes.

So if you turn to regional banking on slide 21, pretax preprovision earnings here were up 24% link quarter to $38 million.

Provision costs in this business also declined significantly link quarter, as delinquency trends in the consumer portfolio stabilized and grade migration continued to moderate in the commercial books.

Underlying customer trends in this business remain solid and very encouraging.

The net interest margin improved 21 basis points, as deposit promo rates from the fall rolled off and we maintained a significant, a significant number of those balances at much lower rates.

You will note that we did a nice job retaining these balances through the repricing the portfolio.

Deposits were up 1% link quarter, as downward seasonal impacts from tax season were offset by solid growth primarily in our private banking and wealth business.

Average loans on the other hand, were down 3% link quarter as we proactively manage watch list credits, and there was soft demand for new loans.

New commercial loan demand in particular is as subdued as we have seen in quite some period of time.

Revenues increased $8 million link quarter on the strength of improved NII and a seasonal rebound in fees although those deposit fees remained soft.

Lastly, expenses were flat in the bank as improvements in the run rate were muted by elevated environmental costs, particularly related to credit, and the portion of the FDIC assessment that was allocated to the bank.

If you flip to slide 22, a bit on our capital markets business, which had another strong quarter was $100 million in pretax, preprovision earnings up from the $89 million that we saw in the first quarter.

Continues to perform very well in the favorable environment, and we benefit from our strong distribution capabilities.

Our average daily fixed income revenue remained well above normal at about $2.7 million a day again driven by our product capabilities across agencies, mortgages, treasuries and corporates.

Total return clients continue to drive over about half of our sales, consistent with our experience over the last few quarters.

Our balance sheet usage remains flat from last quarter and well below prior year levels with trading inventory just under $1 billion.

Given the fairly modest use of the balance sheet, and the lower risk profile, you can see why we like this business, it drives good returns from relatively little use of capital.

Capital market expenses were positively impacted in the second quarter by relatively lower production and by a reduced rate of incentive provisioning that resulted in improved operating leverage.

Going forward, we expect the fixed income business to remain strong particularly if economic conditions remain poor and liquidity is tight.

As always however the magnitude and duration of continued benefit from unusual market conditions is difficult to predict in this business.

So let me wrap up a little bit on slide 23 and summarize.

As we refocus on our regional banking and capital markets businesses, there's increasing evidence of strength and opportunities going forward in these businesses.

And with each passing quarter, we have also increased clarity around our credit quality issues as MPAs flatten and higher risk portfolios shrink.

And given our strong capital position and headway in dealing with problematic credits are increasingly turning our attention to the future although we surely know the challenges aren't over.

If you turn to page 24, we believe that driving long-term returns of profitability are key focus for us going forward.

And we believe that our strategic actions over the past year to refocus our Company and leverage the competitive advantages in our core businesses will lead to good long-term earnings power when this credit cycle ends.

When this occurs, we believe that 15 to 20% returns to shareholders are achievable and we have also defined the key financial drivers that will lead us there, and we are rigorously managing execution around those.

We are working on integrating all of our executive reporting our scorecards down through the organization, and our incentive plans to align with these key metrics that will drive them.

The net interest margin, we think substantial improvement can be made over current levels, as our national wholesale funded businesses are reduced, credit head winds abate, core deposit growth continues, and wider lending spreads persist leading to better risk adjusted margins.

With our capital markets franchise and solid deposit in wealth management businesses we should be able to maintain a mix of fee income that is well above average.

So clearly below current levels if market conditions return to normal and our efficiency ratio is elevated today in part due to cyclical costs related to asset quality.

Over time, we should be able to eliminate the remaining infrastructure costs associated with the wind down mortgage and national lending businesses, which are meaningful today.

But, we also know we have some structural work to do.

Through a focused internal effort involving all parts of our Company we have identified significant costs we can eliminate the next 18 months driving down our overall efficiency ratio.

Over the past several quarters and again this quarter our management team and employees have delivered on our commitments.

Whether that has been shrinking our balance sheet, tackling problem credits, improving liquidity or providing top rank customer service we have done what we said we would do and we are equally committed to returning this Company not only to profitability but to the kind of returns that will meaningfully reward shareholders over the long term.

Thanks and with that we would be happy to take your questions.

(Operator Instructions) We will pause for a moment to give everyone the opportunity to signal.

We will take our first question from Craig Siegenthaler from Credit Suisse.

Question for Bryan.

Maybe you can help me on some of the high level trends, just looking at the decline in nonperforming assets and nonperforming loans this quarter.

In your view was the first quarter the cyclical peak in both MPAs and NPLs or is there potential for a double peak in the second half?

Craig, this is Bryan, thank you and good morning.

We are not, we think we have gotten close to the peak.

We are not in a position to say we can call the top because we don't know how the economy is going to play out the next couple of quarters.

But if we haven't erased it we think we are very, very close to it and we don't expect based on what we have indicated around charge offs, and allowance levels in in the second half we don't expect significant increases from here.

So there's a good chance we have gotten very close to the top.

Got it.

Maybe I can kind of ask this question a different way to kind of get at what I am looking for but in your guidance slide on 13, basically First Horizon expects looks like reserves to decline and net charge offs to decline in the second half of this year but your guidance actually change on the commercial side where now you are expecting to build reserves.

Is First Horizon's overall forecast for declining (inaudible) and reserves is it more modest now in terms of the magnitude than it was in the first quarter or should we not really read into that?

It may be slightly better modest but it is not a significant change in our outlook, and I think, the pieces are going move from time to time, but I don't think they have changed significantly.

Our outlook is very similar to the way it was 30 days ago, the way it was 90 days ago.

We feel very confident that our asset quality trends are on track and as we discussed a minute ago I think you can infer from the trends, excuse me and charge offs and allowance that MPAs would follow a similar path.

Thanks.

Then I just had one question on your OTC one time close loan portfolio.

It looks like delinquencies picked up again to about 8%, pretty high level, and I am thinking with 64% of the portfolio now NPL, how much potential is there for this portfolio to move into NPL?

Craig, this is Greg.

I think we are, we have got an awful lot of the portfolio in nonperforming now, the ratio analysis on any portfolio and wind down starts to get distorted when there's very little accruing loans left.

So I think what you are seeing in the volatility around delinquency is exactly that.

Actually intraquarter it was at one point down.

So it is pretty volatile right now because it is, there's few accruing assets left, and they're -- some are of a large size.

So it bounces around a bit.

Great.

Thanks for taking my questions.

Sure thing.

Our next question comes from Bob Patten with Morgan Keegan.

Hey, guys.

A couple of comments.

Bryan if you could just make a quick comment on the loan sale market and how you are looking at the rest of the year in terms of dispositions?

Two, second question, really slide 16 which is one of the more important slides here, BJ outlined a number of one timers but there's also going to be some ongoing stuff in the wind down and the mortgage so could you just give a little more color on what he considers more a one-time expense and maybe ongoing numbers that we will see over the next couple of quarters and maybe comment about the wind down of mortgage.

When does that volatility go away?

And then last but not at least, BJ, if you can just fill in all the numbers in slide 24 and make our life a lot easier.

I will start with the easy stuff first, then, Bob.

This is Bryan.

On the loan sale market, we, BJ and Greg mentioned we sold a small portfolio of ORE, the loan sale market seems to be slightly more active.

We are, we keep an eye on it and we continue to look at opportunities to sell.

We have not gotten to a point at this point where we feel that the market is improved so significantly that we have, that our strategy is changed but we will keep an eye on it over the quarter and the rest of the year.

My guess is that as the economy improves that market improves and if we do see the turn we will see opportunities to further reduce MPAs over the next several quarters through sales.

BJ you want to pick up the other two.

Hey Bob, good morning.

I think a couple of things, one I just want to reiterate that we seen some really encouraging trends in our core businesses.

So, while over the long term, we don't know how long the capital markets business will remain as strong as it is, we do think that it will remain strong.

So could it come down, 10, 15%?

It definitely could, but we also see encouraging trends in the regional bank that would offset that.

So, we like what we are seeing in the core businesses and would expect those positive upwards trends to continue.

In the mortgage business, really is where we saw most of the volatility, to be honest first quarter was not nearly as good as it looked, and second quarter was not nearly as bad as it looked.

And so you can see as we outlined the hedge gains in the first quarter, were $85 million even though we did have modest positive hedging effectiveness we only had hedge gains of $7 million in the second, and what we would assume is that we would have much closer to those types of hedge gains that we saw in the second quarter versus those in the first.

On the expense side, we do continue to see as delinquencies rise on consumer loan portfolios and mortgage portfolios, we do see repurchase activity continuing.

But it probably, is it at the $29 million level, probably not.

It might be modestly lower than that.

But we have also got a really good program approach and team together to actively minimize and mitigate our expenses there going forward.

We also had some things that were a little bit more one-time in nature as it relates to foreclosures and valuation adjustments that we saw.

So, while not actually just giving you actual numbers for guidance, I think you can see that there were certain things on the expense side, and mortgage that won't be repeatable, and that are, our hedge gains should be much, much lower and look more like second quarter than they would have looked in the first.

Okay.

Thanks, BJ.

Hey, Bob let me add to BJ, the slide on page 24 is somewhat named it the -- we've somewhat affectionately named it the bone fish slide is a framework or a lens that we look at, our decisioning our financial metrics, and we have tried to fill in a few of the pieces on this call, and the difficulty in putting the right numbers in the box is a lot of combinations work but if you start with 6 to 7% tangible common equity a margin that runs probably 3.50 to 4% fee income and the 50% range which is slightly lower than where it is today and given the expenses in the low 60s, a lot of combinations will work but we think with that we can drive 15 to 20% ROEs and we use this as a framework for evaluating business decisions and strategies, and so we have laid it out, not say that there is a precise answer for each one of these boxes but this is the way we look at the business.

Our next question is from Tony Davis with Stifel Nicolaus.

Good morning, Bryan, Greg, BJ.

I guess for Greg, the deterioration in the mortgage book how much of the one to four family is out of footprint right now and what have you really seen in terms of modification impacts or other changes in asset quality drivers there?

Tony, just to be specific you are talking about the $1.1 -billion in permanent mortgages--?

Permanent mortgages.

Right.

That book is, is primarily a legacy book from the national business.

So the properties are nationwide.

I think in terms of impact from mortgage modifications it is tough to break that out as an individual impact, I think what we are seeing is increased stress on that portfolio, just due to economic conditions, unemployment, and then the most serious driver or increase in losses has been the severities we have been experiencing the severities have seen an increase over the past six months.

Can you talk a bit more, Greg, about the potential repurchase risk by loan type or maybe business segment?

Just any color you can give us on that as you look at it today?

Sure.

The repurchase risk exists in any portfolio where obviously we sold loans which is primarily the first mortgage book from the legacy mortgage business and secondarily, our home equity business.

The volume of repurchases, I guess industry-wide probably picked up in fourth quarter, as the agencies put more of an emphasis on, on putting back problems on the originators.

So the majority of the volume is coming right now from Fannie.

We, in response have built that team as BJ said and have actually improved our decision rate over the past six months on the claims.

A lot of the claims with the increased volume have been a little less realistic or based on, on factors that would typically drive a repurchase or our recision rate has increased but it is primarily Fannie and it is picked up because of their attempts to minimize their loss.

BJ, a final question for you I guess is sort of the timing on your resizing initiative.

You have got several things going on there, obviously there's still a fair amount of embedded costs from the legacy national businesses in the book.

Any color you can give us there in terms of where you are and complete these new initiatives you have got going?

You are probably talking about more on the expense side?

Yes.

Yes.

So we showed in here, first of all that we probably think we have 60 million, 70 million, $80 million in the second quarter of what we call environmental costs which is higher credit related expenses, FDIC assessment, all of those kinds of things and so over time, we certainly think those will abate.

That is stuff that we can't 100% control.

So what we have been working on is internally trying to drive costs out of the organization that we can control and what we have identified so far is about 50 million to $75 million of core expense that we expect to get out of the organization over the next 12 to 18 months.

And so we have definitely seen that showing up in our core numbers, but it has been masked if you look at our numbers here by some of the more one-time or environmental costs.

So, we talked about the consumer lending transformation that we've done.

That has saved us several million dollars and that is every month accreting back to us through our expense line.

Closing teller only facilities, we are just in the process of doing that and over time, that will save us a significant amount of money.

We have reduced corporate support and infrastructure expenses that again accrete to us over time.

So, we need a couple more quarters to be able to moderate these environmental costs and really show continued improvement in our core run rate but I am pretty pleased with the progress that I have seen so far.

We will take our next question from Kevin Fitzsimmons with Sandler O'Neill.

Good morning, everyone.

Morning, Kevin.

I just wanted to get a little more, drill down a little more on home equity and get a little clearer on the outlook.

On one hand, the net charge offs off definitely shot up this quarter and I think that's consistent with what you said last quarter that you thought they were going to go up but I think you indicated that home equity you feel a little more positive on it for the second half of the year in that net charge offs were going be roughly stable with this run rate.

Is that more that it is stable with a rate that was higher than you thought this quarter?

In other words did it shoot up more than you thought and now you are base lining it off of a higher loss rate in the second half?

And then just additionally if you can give us a little color specifically on how you feel about California?

I know California is a big chunk of that national portfolio and why you are running off home equity, it is tough to run that off as aggressively as you did construction.

So just kind of how you feel, and kind of reconcile how you are feeling that things are going to be stable in the second half of the year?

Thanks.

Sure, Kevin.

I will start with the caveat, I think all of us have put on our best attempts to give you a view of what we expect to happen in the next six months, as economic further economic deterioration beyond our expectations can throw all of our views off.

I think I will start with that.

Secondly, you are right, this is the view on home equity is what we had talked about, in first quarter, we saw those delinquency buckets fill up in fourth quarter and early first quarter and then the stabilization and the delinquency occurred.

So what we experienced in terms of charge offs in second quarter as a result of those buckets filling up it takes a while for those charge offs to flow through.

Delinquency at this point has been fairly stable through the quarter so that's allowed us to look out six months and say we think the level of charge offs we have taken in second quarter will be fairly consistent with what we will see in the near term and third and fourth quarter.

So we have a, I think a fairly solid view of what to expect for the balance of the year.

Does that answer all of your questions, Kevin?

The California.

California.

Yes, our success in getting in people to refinance out is absolutely contingent upon their ability to refinance the first, and end markets like California, Florida and Arizona that remains more difficult with the lack of availability of jumbo financing.

So I think if you saw prepayment speeds via markets you would see a difference in California.

Our next question comes from Steven Alexopoulos with JPMorgan.

Hey.

Good morning, everyone.

Hey Steve.

Morning.

Bryan, I'm curious in your conversations with the regulators, do you have a sense if they were require you to raise more common before you could actually repay the TARP?

We haven't gotten that far in the discussion.

As I indicated earlier we are still looking for signs of economic improvement, real downturn in credit -- improvement in credit trends, and economic environment.

We've had of course discussions about the strength of our capital and the CPP, but we have not got to that point in the discussion that we would have any sense as to whether that's an expectation of our regulators.

Okay.

And I'd just like to have one other question, can you--.

Sure.

--touch on the drivers of your outlook for margin expansion the rest of the year, and where do you really think fed funds would need to go to get even to the low ends of your long-term range of 350 number?

Yes.

This is, this is BJ.

I think, the drivers of our margin expansion throughout the rest of 2009, and what I would say is we expect it to expand modestly.

So you can interpret what that means, but we think the loan pricing work we have done, we have soft demand but we are seeing probably 80 basis points of expansion on newly funded loans from a year ago on that demand.

So eventually, that is going to roll through our portfolios but it just takes a little bit of time and we will see incrementally better results from that.

We also in one of the slides here today showed you the drag that we have on MPAs both interest reversals when we put credits into MPA as well as the on going head wind of nonearning assets.

That continues to decline, and so not that we are saying necessarily it will be a huge change that we think we're near the peak on MPAs, the additions to MPAs and the interest reversals we believe will get incrementally less than they have been in the past, therefore expanding our margin.

Thirdly, continuing to wind down those national businesses which are low in margin, are going to incrementally help us going forward.

And fourth, we have just seen the early signs of our repricing on our deposit promo balances that we are very encouraged by, and so we continue to look for ways to put more and more signs around our deposit pricing to be able to keep those as optimized as possible to be able to expand the margin.

So again we think it is a modest improvement throughout the rest of '09 but then going forward, we think those will have a material impact over time.

As it relates to fed funds, I think that the steepness of the yield curve is actually fairly good right now, but that we need a parallel shift in rates and this is an estimate, but we would probably need 200 basis point parallel shift or so in rates upwards to be able to get to our long-term rates of 350 to 375.

So, until that happens, we will have a tough time getting all the way home to our long term goals but we are doing everything we can to improve the stuff that we can control.

Next we'll go to Kevin Reynolds with Wunderlich Securities.

Good morning, everyone.

Morning, Kevin.

Most of my questions have been answered but I had a couple.

The first one specifically you have probably answered it in one form or another but I am trying to get a better feel across the industry this quarter.

How you to feel about the economy today, not your specific asset quality on a quarterly basis but do you really feel better about the local conditions not so much the macro economy in the big picture, do you feel better about the local conditions or do you feel worse this quarter versus last?

And then, I guess kind of a follow up to that is can you comment on the competitive environment, big banks and small banks since you seem to be right in the middle from a size perspective in your markets?

And then maybe the final piece I have heard you say that over the long run your capital could be deployed in some acquisitions but you are in no rush to do it.

How is that environment shaping upright now, and do you think there's going to be more potential sooner than later or is that the same.

Kevin, this is Bryan.

Thank you.

Maybe the first part of the first question and the last one in some sense go hand in glove.

The economy is, is we are not seeing big signs or any significant signs of improvement today.

Loan demand continues to be very low.

We are somewhat maybe incrementally a little, little less optimistic on the economy at this point than we were 90 days ago simply because we are not seeing the signs of traction parallel, maybe a better way to describe it.

We just don't see it getting a lot better right now.

There are clearly a lot of talk about encouraging signs, we are optimistic that we will see some of those later in the year but to date we haven't seen those.

From a competitive standpoint, we feel very, very good about our competitive standpoint, and our footprint.

We have seen very good traction across all of our markets, very good opportunities with our existing customer base to deepen the level of service that we have with them to grow new relationships, deposit trends, we have been very encouraged by.

We have seen very good growth in the underlying customer relationships through our deposit base.

We feel very, very good about the, our competitive position.

Competitive environment is I think probably no worse than it was 90 days ago.

In fact maybe in some ways it's better, deposit pricing may have -- competition may have lessened a little bit in the last few weeks of the quarter.

So, we think that the competitive environment is probably a pretty decent one.

With respect to deploying capital and acquisition, that is not an end objective.

That is a way to deploy capital.

We think there are likely to be some opportunities when the economy turns, but there again I will go back to the slide 24, the filter for looking at them.

We look at -- our goal is to drive returns and drive profitability in the business.

We look at acquisition as a way to deploy capital.

We feel like we can do it and drive those 15 to 20% range returns throughout the cycle.

That's probably an attractive way to do it.

But it is going to take a lot more clarity about the economy, I think before you would see significant interest from us and pursuing acquisition.

Our next question comes from Matt O'Connor with Deutsche Bank.

All of my questions have been answered.

Thanks, guys.

Thank, Matt.

And next we go to Gary Tenner with Soleil Securities.

Just a couple of questions.

Bryan, I wondered, you talked about long-term ROE expectation or goal of 15 to 20%.

Can you talk about that in the context of reregulation of the industry and what that might do potentially to profitability for you guys over the long term?

And (inaudible) on that side of things do you have a sense of what your thoughts are on it?

Yes.

You are right.

It is not certain.

Our expectation would be really on two fronts.

One, that capital levels are likely to be higher for the industry, and so embedded in the 6 to 7% tangible common assumption is that we operate at a higher tangible level and inherently we have got a higher Tier 1 ratio we think as a result of that.

So we think the industry will face higher capitalization.

Probably directionally speaking I think costs of complying with increased regulation of the industry is likely.

I think it is likely to have an impact on fee structures as we go forward.

And that will offset some of the impact of improved relationship pricing, and so we think in some sense returns will come down for the industry as a result of the fundamental trends but until you get a lot more clarity about what that, those changes in regulation, what that means to us, it is hard to pin it down to a financial cost.

We will take our next question from Christopher Marinac with FIG Partners.

Just to follow up on Kevin's question about acquisitions before, to what extent do FDIC failed banks change the dynamic to how you answered the previous statement?

Well, Chris, good morning.

It can change it, but in some sense, the lens that I am approaching it through is those will be opportunities, they haven't been a lot in our footprint today, and I am not sure when or if that ever changes.

Our focus today is on winding down these national businesses.

And keeping our focus on that ball is real important to us, and we want to do that because we think that minimizes the impact to shareholders, minimizes losses and reserves our capital base.

I think, clearly something could come up with an FDIC assisted transaction that would make sense, but right now our emphasis is covering as much ground as we possibly can on nonperforming assets, and repositioning our business model, make it more efficient and more effective.

And our next question comes from Al Savastano with Fox-Pitt Kelton.

Good morning.

Morning, Al.

Can you talk to us about the dividend policy, and what would have to happen for you to change it?

Well, we have got the stock dividend policy in place, and I guess there are a couple of ways of answering that.

One would be what is the impact of the stock dividend and should we continue to do that, and two, when will we flip back into a cash dividend.

Clearly it is our desire to get back into paying the dividend and cash we have, we have got to see the turn in problem assets and the turn in profitability before we do that.

The mechanics of the stock dividend we understand are somewhat more difficult from a modeling perspective, somewhat may be an understatement.

They are more difficult.

The value originally was to our retail shareholder base that they appreciated the cash-like yield that it afforded and the ability to sell the additional shares.

So, I don't know what our policy will be, it is something we discuss with the Board but I think the key driver is the return to profitability and the focus on paying the cash dividend when we get to that point.

And next we will go to Joe Stieven with Stieven Capital.

Morning, Bryan.

Morning, Joe.

Listen, all my questions have an answered, and my last one was just on an assisted deal.

Thank you.

Good quarter.

Sure thing.

Thank you.

And next we go to Paul Miller with FBR Capital Markets.

Thank you.

This is actually (inaudible) from FBR.

I just had a couple of questions on the fixed income and mortgage banking.

In terms of the mortgage warehouse valuation adjustment you discussed briefly in the release, is that tied to not hedging the mortgage pipeline?

No.

That's the mortgage valuation adjustment is really made up of two factors, one is we had a slightly smaller UPB and the mortgage warehouse, and number two is as we look at that and we have to fair value market, we also look at the underlying credit quality of it as well.

And run it through our valuation models relative to what is out there in the industry, and so the combination of smaller UPB plus incremental deterioration and underlying credit quality is what, what caused the valuation adjustment.

Keep in mind that this warehouse that we are valuing is mortgages that were originated into the warehouse in the early part of 2008 that haven't been sold.

We elected fair value accounting for them and even in the permanent portfolio, they carry fair value accounting.

So we still account for them on a fair value basis.

So these are somewhat older.

Jessica, it is Dave Miller.

You would also, warehouse valuation also is impacted by the level of rates.

So as mortgage rates ose during the quarter that actually causes the warehouse in IDCF to be worth less, and the opposite effect a little bit in the first quarter.

So there's a number of dynamics.

Next we will go to Jon Arfstrom with RBC Capital Markets.

Thanks, guys.

I know the call is getting long.

So just a real quick question here.

How did the capital markets revenue trend during the quarter?

Was it something that was fairly stable by month or did it generally get weaker as the quarter moved on?

This is Bryan, Jon.

Thank you.

We are, in the summer months it always slows down so you see the seasonal effect.

So it slowed down some as you got into late May and early June and we would expect the summer months to be a little bit softer, still been very healthy but we are seeing the summer effect, where vacations and the slow time of summer takes over.

With no more questions in the queue, I would like to turn the call back over to our presenters for any additional or closing remarks.

Thank you, operator.

This is Bryan Jordan.

We appreciate your joining us on this call.

We appreciate your following the Company.

We think we have made a tremendous amount of progress on the strategic initiatives that we have pursued.

We are optimistic about our positioning for the future.

Thank you to the First Horizon, First Tennessee employees across the franchise for what you are doing.

If you have any further questions please don't hesitate to contact Dave, or any of us.

We appreciate your time and interest.

Have a great weekend.

This does conclude today's conference.

We thank you for your participation.