First Horizon Corp (FHN) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the First Horizon National Corp second-quarter 2013 earnings conference call.

At this time, all participants are in a listen-only mode.

Later we will conduct a question-and-answer session, and instructions will be given at that time.

(Operator Instructions)

As a reminder, today's conference call is being recorded.

I'd now like to turn the conference over to your host, Ms. Aarti Bowman, Head of Investor Relations.

Please go ahead.

Thanks, Allie.

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

In this call, we will mention forward-looking and non-GAAP information.

Actual results may differ from the forward-looking information for a number of reasons outlined in our earnings announcement materials, and our most recent annual and quarterly reports.

Our forward-looking statements reflect our views today, and we are not obligated to update them.

The non-GAAP information is identified as such in our earnings announcement materials and in the slide presentation for this call, and is reconciled to GAAP information in those materials.

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

This morning's speakers include our CEO, Bryan Jordan, and our CFO, BJ Losch.

Additionally, our Chief Credit Officer, Susan Springfield, will be available with Bryan and BJ for questions.

I'll now turn it over to Bryan.

Thanks, Aarti.

Good morning, and thank you for joining our call.

I'm pleased with our continued progress in the second quarter.

Our core businesses delivered solid results.

We made headway in realizing our efficiency initiatives.

The non-strategic segments' drag diminished, and we prudently deployed capital.

We're managing our Company for improved, sustainable profitability and higher returns.

Our focus is on structuring a profitable balance sheet that will drive long-term earnings growth.

We're not where we want to be yet, but with each quarter we're getting closer.

The economic environment is, of course, a factor in how quickly we reach our goals.

We've seen some recent improvement or positive data points, and with rising employment, higher consumer confidence, solid home-price appreciation, and reasonably steady, yet modest, GDP growth.

While our markets in and around Tennessee are generally in line with national trends, certain areas such as middle and southeast Tennessee are doing better than average.

We're increasingly well-positioned to make the most of our region's opportunities.

In late May, Fed comments sparked concerns that monetary tightening would occur sooner than had been expected, causing the 10-year Treasury rate to jump, and igniting fears about the effect of higher rates on the economy, businesses, and the banking industry.

As BJ will discuss later, First Horizon is well-positioned for higher rates, and should be the beneficiary over the long term.

Near term though, our borrower seems somewhat cautious about the strength of the recovery, resulting in restrained credit demand.

Our second-quarter loan production was steady, and our bankers' focus on making quality relationship-oriented loans will ultimately benefit our balance sheet and enhance long-term profitability.

On the mortgage front, rising rates have slowed refinancing, but purchase activity has picked up, impacting our loans to mortgage companies line of business.

Mortgage warehouse lending is a good, profitable lending area for us, and we don't expect that to change in the second half of 2013.

We're taking market share, adding new customers, and expanding lines to existing customers.

FTN Financial, our fixed income business, was negatively affected by the unprecedented rate volatility and a significant rise in rates which occurred in the latter part of the quarter.

Through the first two months of the second quarter, fixed income average daily revenue was $1.05 million, in line with the past several quarters.

However, market factors experienced in late May and June led to an overall average daily revenue for the second quarter of $915,000.

We've recently begun to see some pick-up in activity and, with greater market stability, we expect this business to generate average daily revenue in the range of $1 million to $1.5 million per day.

As you're aware, revenue headwinds have intensified cost-cutting efforts across the banking industry.

We've been lowering costs for the past several years, and have shown significant progress.

We're looking at all of our businesses, but the regional bank's improvement in its efficiency ratio and revenue per FTE clearly shows that our productivity initiatives are paying off.

Keep in mind that we don't want to reach our targeted cost-cutting goals and stop.

We want efficiency and productivity to be ingrained in our way of doing business.

Credit quality strength is also a priority for us.

As anticipated, non-performing loans did increase in the second quarter, reflecting further implementation of a regulatory change that required us to classify second liens as non-accrual if the first lien was non-performing.

Core asset quality trends, though, cause us to expect stable credit quality metrics in the second half of 2013.

Our capital ratios remain strong, and the Basel III framework recently approved by regulators does not have a significant impact.

The Tier 1 common ratio under a fully implemented Basel III would be approximately 9.8%.

In the second quarter, we deployed capital through continued share buybacks, and we also acquired a small bank in East Tennessee from the FDIC.

Again, I'm pleased with our second-quarter performance.

We're improving our cost structure, building our core businesses, broadening our customer base, and continuing to wind down the non-strategic businesses.

I'll now turn it over to BJ to discuss our financials.

BJ?

Thanks, Bryan.

Good morning, everybody.

I'll start on Slide 6. Our net income available to common shareholders for the second quarter was $41 million, with diluted EPS of $0.17.

Our total revenues declined 5% linked quarter, NII held up relatively well, regional bank revenues were up, and fixed income and mortgage-related revenue accounted for all of the linked-quarter decline, due to the back-up in rates in the latter part of the quarter.

Expenses were down 5% link quarter, or $14 million, with most expense categories decreasing.

Our loan loss provision was flat to last quarter's level of $15 million, as credit trends continue to remain solid.

Moving to segment highlights on Slide 7, our core businesses continued to show solid performance.

In the regional bank, net income was $43 million in the second quarter.

Pretax pre-provision net revenue was $80 million, or 7% above first quarter in the Bank.

Linked-quarter non-interest income grew 5%, driven by growth in deposit transactions, brokerage management, and trust fees, while expenses in the Bank decreased 1%.

Loan loss provision was $13 million in the second quarter, compared to a provision credit of $2.5 million in the first, simply reflecting a continuing conservative view of reserving for the commercial loan portfolio.

In our FTN business, net income was $8 million positive in the second quarter of '13.

As I said, fixed income revenue declined 14% linked quarter, and as everyone knows, Fed's commentary around tapering led to significant market volatility and spike in rates adversely impacting our fixed income revenues in the quarter.

Expenses also decreased 3% linked quarter, reflecting lower variable comp as expected, which was somewhat offset by some modestly higher legal and professional expenses.

As Bryan stated earlier, during the first two months of the quarter, average daily revenue was a little over $1 million, but June was substantially lower.

Our management team and our traders at FTN did an excellent job managing our [loan] positions down efficiently during June to keep our business as efficient and nimble as possible.

Moving to the non-strategic segment, I may never get to say this again so I'm going to say it now.

We actually had a positive net income in that segment for the quarter.

It was $2.5 million in the second quarter positive, compared to a loss of $9 million in the first.

Revenues declined 17%, mainly driven by mortgage warehouse valuation adjustments of $2.5 million in the second quarter.

Expenses were down 31% from lower litigation, reduction in professional fees, occupancy costs, as well as other expenses related to continued wind down of our legacy businesses.

Loan loss provision was down significantly from $17.5 million in the first to just under $2 million in the second.

The provision decrease there was a result of lower loan balances, improvement in the home equity portfolio from lower delinquencies, and a decline in charge-offs and improved recoveries in the commercial portfolio.

Moving to the regional bank balance sheet trends on Slide 8. Our average core deposits remain steady at $14.6 billion, and average loans were relatively steady as well at $12.2 billion.

Period-end loans to mortgage companies were up 23%, but down 6% on an average basis.

In that business, yields are around 4.5% to 4.75%, making these loans a significant contributor to net interest income.

As Bryan mentioned, the recent rise in rates has slowed mortgage refi volume.

However, we still expect relative strength in this business since rates remain historically low.

Purchase activity is likely to become more of a driver versus refi's over time, and we have started to see that shift in our mix.

For the remainder of the year, we anticipate balances to fluctuate up and down in line with market conditions.

Our commercial pipeline remains solid, with existing customers representing about 60% of the pipeline or so.

Linked-quarter uptick in fundings reflected a higher volume of loans leaving the pipeline and closing in the second quarter.

Moving on to the consolidated balance sheet trends on Slide 9, our total assets are $25 billion, roughly flat to last quarter.

Our consolidated loans decreased just slightly, reflecting modest growth in our Bank, and run-off in the non-strategic.

Our average core deposits in aggregate were stable, and we also repaid about $250 million of debt at the Bank level and $100 million at the parent.

Our securities portfolio averaged $3.2 billion in the quarter, and linked-quarter yields declined 12 basis points, as reinvestment rates faced continued pressure.

Securities that are rolling off yield about 3% to 4%, and we're now reinvesting at about 2% to 2.5%, given the recent rise in longer rates.

The recent rising mortgage rates caused our unrealized gain to decrease from a positive $80 million in the first quarter to a positive $16 million in the second.

Our investment portfolio strategy continues to be to buy securities with structure, not stretch for yield, thus protecting us a bit more in shock scenarios.

Our net interest spread was stable linked quarter.

While loan yields decreased 3 basis points, deposit costs also declined 3 basis points, reflecting strong discipline around pricing across all of our businesses.

And if you look at Slide 10, our consolidated net interest income was relatively flat, due to lower average loan balances, which were partially mitigated by higher day count, lower deposit rates, and an increase in loan fees.

Our net interest margin was up slightly linked quarter at 2.96% in the second.

Lower cash balances improved the margin, and was somewhat offset by continued yield declines in securities and fixed rate loan portfolios.

Sitting here today, we continue to expect a quarterly net interest margin in the range of 285 to 295 basis points by fourth quarter of 2013.

Currently our assumptions include macro rates staying at current levels or rising modestly over time, continued modest loan yield declines due to competitive pressures, loans to mortgage companies somewhat below current levels, limited buying opportunities with the securities portfolio, Fed balances similar to 2Q, and flat to modest growth in our loan portfolio in aggregate.

Over the long term, our asset sensitivity has positioned us well for rising rates.

Our consolidated loan portfolio is comprised of about 67% floating rate loans tied to LIBOR.

So all else equal, in a rising rate scenario, a 100-basis-point increase would equal about a 6% increase in net interest income, and a 200-basis-point rise would be about 11% increase to NII.

We continue to believe that an asset-sensitive balance sheet is key to our ability to generate strong profitability and returns over time.

Moving to Slide 11 and mortgage repurchase trends, GSE mortgage repurchase expense was $0 for the fourth consecutive quarter.

Linked quarter, the repurchase pipeline declined 9% to $235 million, and our ending reserve was down to $123 million.

New requests were up 24%, reflecting an anticipated acceleration of requests.

Our total expected aggregate requests remain unchanged, and we still expect any ongoing GSE-related provision to be immaterial.

We have not been named in any new lawsuits related to our private securitization since October '12, and we had no loan repurchase requests from our first lien private securitizations.

And at this time, based on our private securitization, origination mix, deal size, age, and performance, we continue to believe that losses from our private securitizations should be significantly less than our GSE [expense].

Moving to expenses on Slide 12, we continue to be proud of what our employees have been able to accomplish with expense efficiency efforts, and you can see that in the bottom graph.

Total expenses this quarter declined 5%, or $14 million, and our consolidated efficiency ratio also improved.

We lowered expense across several categories, including compensation, occupancy, FDIC premiums, and foreclosed real estate costs.

We've seen continued benefits from our efficiency initiatives, and they continue to show up in our numbers.

Year over year, the regional bank's efficiency ratio improved 500 basis points from 62% to -- excuse me, from 67% to 62%.

We now expect to exceed our original goal, and anticipate consolidated annual expenses below $925 million by the end of 2013.

Moving to asset quality on Slide 14, our total net charge-offs declined 32% linked quarter, and linked-quarter total loan loss reserve decreased $3 million to $262 million.

As Bryan mentioned, non-performing loans were up as a result of the implementation of regulatory guidance around first and second liens.

Since we do not service or own the majority of our fist liens in front of seconds, we needed a third-party vendor to provide first lien status, which we received information on in the second quarter.

The increase in NPLs did not have a material effect on our allowance, since we already had contemplated the risk associated with the standalone junior liens in prior quarters.

We do not expect further significant impact on the NPLs or reserve from this regulatory guidance, and you'll note that our ORE levels were up due to the Mountain National acquisition.

Moving to Basel III highlights, our actual 2Q '13 Tier 1 common ratio is 10.3%, and as you might recall, the originally proposed Basel III rules about a year ago would have had more of a negative impact on us, primarily because of the higher risk weighting applied to our home equity portfolio.

You would remember probably a 240-basis-point spot rate impact.

However, the recently approved Basel III final rule did not raise the residential loan risk ratings.

We now anticipate only an incremental 50-basis-point hit to our 2Q '13 Tier 1 common ratio.

This would put 2Q '13's estimated Tier 1 common ratio at a 9.8% spot rate under fully phased in Basel III, well above the 7% threshold.

Wrapping up on Slide 15, core business trends are generally encouraging, as we've discussed with our 12-month trailing core ROA at 1.02%, and our core ROTCE at 11.8%.

Solid returns in our core operating businesses of regional banking and capital markets continue to demonstrate the progress we're making towards our long-term goals by controlling what we can control.

So with that, I'll turn it back over to Bryan.

Thanks, BJ.

We're building the platform for long-term success, a platform that will enable us to fully take advantage of the opportunities that our attractive operating regions and a strengthening economy offer.

We're executing on our strategic priorities of differentiating our customer service, improving our productivity and efficiency, and prudently managing our capital.

We also have significant asset sensitivity embedded in our balance sheet.

We will continue to work towards improving profitability, reducing the overhang of our legacy businesses, and achieving our long-term bonefish targets.

Please remember that we're hosting an Analyst Day on November 21 here in Memphis.

Finally, thanks to the First Horizon employees for their commitment and hard work.

With their ongoing support, I'm confident in our ability to make additional progress in the second half of 2013.

Allie, with that, we'll now take some questions.

(Operator Instructions)

Our first question comes from Steven Alexopoulos of JP Morgan.

Hey, good morning everyone.

Good morning, Steve.

Bryan, I wanted to start regarding the commentary in the 10-Q for potential update on HUD this quarter, is there anything you could share with us?

I did see in the slides that you met with them during the quarter, and any initial thoughts on potential for a settlement here?

Yes, there is an update in one of the slides on mortgage repurchase.

You'll remember that's a matter that's been out there for about a year.

I think that HUD investigation or file request was about a year or so ago.

As you noted, we mentioned on that slide that we have had one meeting at this point.

We have -- they exchanged some information that they provided us to review, they looked at a small sample.

It will take us awhile to evaluate that.

As we noted on that slide, we don't have the ability at this point to estimate any range of losses, or provide any estimates around reserves.

My guess is, at this point, given the time its taken to get to this point in their investigation, what we need to do in terms of evaluating the loan files and so on and so forth, it's going to take quite a while before we have any real information that is helpful in providing estimates around potential impact.

Okay, that's helpful, and I just had one other question on the buyback.

Why was it so light this quarter at $8 million, and then why step it up to $40 million and then accelerate it in 3Q?

Are you just making up for it being a bit light in 2Q, or is this a new run rate, given the updated capital rules?

Yes, if you look at the -- it's an accounting thing more than anything.

We bought back in the open market the $8 million shares, the shares in the capital came out.

The prepaid repurchase, you actually saw the capital come out but not the shares.

It started in the middle of the quarter and it's running across quarter end.

So it will take some time to complete it, but that's sort of a continuation.

The actual buying under the $40 million program will occur throughout the latter half of the second quarter into the third quarter.

So it's just a timing thing in terms of the way we account for it, but the capital has already been reduced.

Should we think of $40 million as a good quarterly run rate of buybacks?

Well, if you look back on the last couple of quarters that's where we've been, but as we look forward, we'll do as we always have, we'll look for opportunities to invest capital in organic growth.

We'll continue to evaluate transactions like Mountain National and things that are going on in the economy and otherwise, and we'll evaluate the opportunity to put capital back as in the past.

To the extent we have excess capital, we view using the dividend and buyback as a way to return that to shareholders.

Okay, thanks for all the color.

Our next question comes from Nicholas Karzon of Credit Suisse.

Good morning.

I guess first on the capital markets business, just a couple of questions.

I think that capital markets expenses are down around $2 million quarter-over-quarter and trading revenues were down about $10 million.

If we're going to stay in this rate environment, are there additional costs that can come out of that business?

Hey, it's BJ.

That business out there is very efficient from a fixed cost versus variable.

I'd probably peg it at two-thirds or more variable versus fixed.

So it does actually look disproportionate, if you will, the revenue versus the expense decline.

We did mention that there was some legal and professional fees cost that offset the decline in the variable comp, but you should generally see something like 40% to 50% variable to the fluctuation in the revenue.

Okay, thanks.

That's helpful.

And then within the mortgage company balances, can you give us an idea of the mix between refi and purchase in that portfolio, and how that's changed quarter-over-quarter?

Yes, I think we had been running in the 70%, 75% refi range.

I think we are still positive, but it come down.

It's more in the 60, 60/40 range refi, and I think as we go out, we think that starts to continually shift more towards purchase volume than refi.

I can't sit here today and tell you when that's actually going to cross over, but we certainly have started to see that mix shift.

Thanks for taking my questions this morning.

Sure.

Our next question comes from John Pancari of Evercore Partners.

Good morning.

Good morning, John.

Could you give us some additional color on the existing FHFA litigation?

I know there's probably limited amount you can say, being that it's ongoing, but I guess if you could just update us on the status, and maybe just help us think about the likelihood of settlement there, or just how we can think about it?

Hey, John, it's BJ.

Yes, not too much new on the FHFA front.

Last quarter you would have seen us put up a RPL in that, and that had taken probably 12 to 18 months to get to that point.

So it's a pretty slow and complex process, as you might imagine.

So there's unfortunately I can't give you much of an update, because there just isn't one at this point.

John, this is Bryan.

Keep in mind, this is a process where there are a number of people involved in this litigation.

The litigation has been divided up into tranches, and we're in one of the later tranches of litigation.

So right now we're just in a bit of a holding pattern as this continues to unfold.

Okay that's helpful.

And then on the capital market side, can you give us a little bit more color in your confidence in that reiterated ADR range of $1 million to $1.5 million, particularly given the back-up in rates here?

I mean, is there risk that you are going to start communicating a lower normalized range here?

Hey, John, it's BJ.

If you look at what happened, again, as Bryan and I both mentioned, April and May were over the $1 million a day threshold, and then June gets really tanked.

And if you think about what happened in fixed income businesses, there were multiple players trying to reduce loan inventory as quickly as they possibly could to avoid marks as rates continued to spike up, and so there wasn't a lot of buying activity in the markets.

So, everybody was kind of doing the same thing, trying to reduce their positions.

But what we've seen in the last couple weeks, and we'll see if it continues to stay, is much less variability in what the 10-year has been doing.

So just to give you an example, I think the intraday range as a 10-year over the quarter was something like 8 or 9 basis points, whereas usually historically over time it's 1 or 2. And that is just massive dislocation, and it started to come back and start to normalize it a little bit more in terms of intraday.

So all of that leads us to a cautious outlook on it, but the belief that getting back to that lower end of the range where we were in April and May is certainly possible.

Okay.

All right, thank you.

Our next question comes from Marty Mosby of Guggenheim.

Please go ahead.

Hey

Hey, Marty.

BJ, good morning.

I wanted to ask a question.

You went out of the way on Page 10 to say that no expected material actions to reduce asset sensitivity.

When you look at the long end performance of about $9 million favorable, four basis points, and then if you look at the increase in short-term rates, which is much more material, can you see how at some point if we keep getting this, let's say two years before short-term rates go up, that you would begin to reconsider that last bullet point and start to accelerate the benefit if we could see a little more movement on the long end?

Yes.

What we've got is we've naturally got some fixed rate lending in our non-strategic portfolio that we are purposely letting run-off.

So we're not trying to retain a lot of that.

So what that's giving us is incremental opportunity to build more relationship-oriented lending in the regional bank that might have fixed rate characteristics.

So in aggregate though, as fixed rate on non-strategic is running off, you're adding fixed rate relationship in the bank, your net asset sensitivity isn't changing all that much.

So again, that's why we don't think we're going to see a material change in what our profile is.

We think we're well-positioned, but we are taking advantage of pockets of opportunity to grow relationship-oriented lending on the left side of the balance sheet to help us a little bit more, both in the near term and the long term.

Marty, this is Bryan.

As BJ described, we want to use our long term interest rate exposure or positioning to do customer activity, to do customer business.

Fundamentally, we don't believe in putting the carry trade on just to generate short-term earnings.

Taking interest rate risk is not where we think we create a lot of value for shareholders, and so we're very deliberate about how we use the balance sheet.

We think the securities portfolio in particular ought to be used to provide liquidity, to provide collateral, and to manage that aggregate interest rate risk, but we don't believe that we ought to put on long term rates just to generate carry.

And so when we do, as BJ described, we do it for customer-oriented activities.

Got you, and that kind of transitions me, Bryan, to my follow-up question was, this is a kind of an inflection quarter.

BJ highlighted that the non-strategic actually now was making a little money, at least for this quarter.

So a lot of the overhang issues are kind of dealt with, and now we're kind of starting to move over to the profitability and the overall kind of returns that you can generate.

A lot of the catalysts are things that happen, like you kind of condition it long term.

How does that timeframe accelerate, or how do you start to see the earnings power begin to improve as you're able to find more strategic opportunities?

Yes, I'm going to go back and look at the transcript of what BJ said to make sure.

I think he said he was going to point it out because he might not get to it again.

You're right, yes.

We're not looking at that non-strategic segment as a profit center.

I think a lot of it had to do with improvement in credit quality and credit trends, and who knows how that plays out?

But we think we've made significant progress there.

The non-strategic portfolio is down about 18% year-over-year, and we feel good about where we're positioned there, but we also want to see it run-off and get that segment of our history behind us.

We're still doing the same fundamental things as we think about our balance sheet for the long term.

We want to focus on growing our customer relationships in the core banking business.

We want to win all the business that we can win on a profitable basis in the State of Tennessee and beyond.

We're expanding our efforts in the Mid-Atlantic region.

Under John Fox's leadership, we're making progress there, and our capital markets FTN financial business is doing very, very well.

We're adding to our municipal capabilities.

So our focus is to continue to focus our capital allocation and our resources towards driving those activities that allow us to produce what we've laid out in the bonefish, those high teen to 20% range ROEs, and so we're taking a real disciplined approach about the balance sheet and how we deploy that capital to grow the business for sustainable long term shareholder returns.

Thanks.

Thank you.

Our next question comes from Ken Zerbe of Morgan Stanley.

Please go ahead.

Thanks.

Just a question in terms of your net interest margin, it sounds like one of the reasons that it went up a little bit this quarter was because of the excess liquidity reduction.

How much excess liquidity do you have left?

I mean, could -- I've got the 285 to 295 margin guidance, but I'm just wondering if this potentially could be an area where it might actually drive margin above your current guidance?

Thanks.

Hey, Ken.

It's BJ.

Yes, there's not a lot of more that you would see in the second quarter in terms of excess balance opportunity going forward.

Now again, that's going to fluctuate, and it's actually a good thing sometimes if it happens, which means more customer deposit inflows that we can't find a short-term way to put to work.

So I'm not sure if you're going to see a lot there, but I did in my opening comments give you some of the assumptions that I had around the outlook, and you'll generally see that they're pretty realistic, maybe more towards the cautious side.

So if we see a little bit more loan growth, that could certainly help.

We certainly have done a good job.

Our bankers have done a good job of managing deposit costs down.

That can certainly be helpful, and depending on what the competitive environment does to pricing pressures, we could do better there.

So all that said, I think I still feel pretty good about our range, and hopefully we can get more towards the higher end of that range than the lower.

And with the range that you're referencing, is there anything -- what would materially get you out of that range?

I mean, aside from, or is there anything aside from like materially higher interest rates?

Because it just seems a little bit stronger loan growth, a little bit less or more of something else might keep you in that range.

So I'm just wondering if there's anything where we could be surprised, one way or the other, aside from rates?

Yes, well I'll give you three impacts that are always material, and there were three that really impacted us in the first quarter, when you saw from fourth to first we saw pretty material decline in margin.

The first is fluctuation in balances from loans to mortgage companies.

Those yield 450 to 475, and they can move around pretty materially from quarter to quarter, and so they could have a pretty big impact up or down on a net interest margin in any given quarter.

The second is, like you've mentioned, excess balances at the Fed.

They can have a pretty material impact, depending on the size of the excess in any given quarter on the margin, and the third is our capital markets net interest margin.

Now, we don't focus on that in that business.

That's a fee-based business, but depending on whether or not we've use the balance sheet to hedge our positions on the balance sheet or off the balance sheet can have a material impact, and that's what we saw from fourth to first.

It was pretty benign from first to second, but those three are probably the biggest that are going to move it around, one way or the other.

Our next question comes from Paul Miller of FBR.

Hey, thank you very much.

Can you talk a little bit about your C&I lending in your market?

Are you seeing relief over the last -- we know short-term rates haven't really moved, but on the competitive front from some of the bigger players, or even some of the smaller players?

Hey, Paul.

This is Bryan.

I'll start, and then I'll ask Susan to go into detail.

This is still an extraordinarily competitive environment out there.

We're seeing still a lot of cautious activity from borrowers in terms of new investment.

There might be just a marginal leaning towards a little bit more activity this quarter than there has been, but it's still very competitive, and so most of the opportunities are opportunities to win existing debt from competitors or so on and so forth, but it's still a very, very competitive environment.

Paul this is Susan.

I would agree with Bryan.

I think a little bit more activity in the second quarter, some additional conversations with clients and prospects about potential growth, but a lot of what we're seeing are opportunities to refinance debt away from other banks.

I think our bankers are doing a great job of staying focused, talking about the fact that we're a relationship-bank oriented, so that we get great asset quality maintenance, as well as good pricing.

And are you guys going after some of the multi-family stuff that's out there?

Yes, Paul, we are.

We're seeing some good opportunities in multi-family.

We typically stick within our footprint and surrounding areas as it relates to that.

We've got some great commercial real estate clients who are active in that market, and we've done a very good job in the multi-family lending arena.

And back to the C&I, my last question is, are you seeing any movement in the utilization rates?

Are they still, I believe, in the high 20%s?

Actually, on the commercial side, our utilization rates are at 43%.

They've been roughly that same amount the last three quarters.

In a more normalized environment, you would see C&I commercial utilization in the 55% to 58% range.

Thank you very much.

Thank you.

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

Please go ahead.

Good morning, everyone.

Good morning, Kevin.

You all spent some time earlier talking about the asset sensitivity and that your positioned well for it.

Can you give a little color on what part of the curve the margin's most sensitive to?

Specifically, do you need the short-term rates to move up to get the margin benefit, or is there another part of the curve that you would benefit from as we look forward?

Hey, Kevin.

It's BJ.

Primarily the short end of the curve.

I mean, if you think about our floating rate assets, 67% of them are tied to LIBOR, and it's virtually all of those are tied to one-month LIBOR.

So we really need over time the short end of the curve to rise to really see the most positive impact to our asset sensitivity.

Okay.

Just a quick follow-up.

I know you just recently had a failed bank acquisition, and there hasn't been all that many of them in your footprint.

But how has that process gone, and what's your latest outlook on M&A opportunities in or around your current footprint in terms of, do you get a sense there's more conversations activity, or is there less willingness to sell out there?

Thanks.

Kevin, this is Bryan.

The Mountain National transaction has gone very, very well to date.

We're very pleased with the progress that we've seen there.

We've brought on a great group of folks.

We acquired 12 branches.

There will be some consolidation opportunities for us as we convert later in the year.

The integration process is working well.

Rolling out our credit processes and credit standards and reengaging our lending efforts, or their lending efforts, in that market have gone very, very well.

So we're pleased with the progress we see there.

We think the conversion for later this year is -- the planning for that is going very, very well.

This is an integration conversion process.

It's not something that First Tennessee, First Horizon has done organizationally for a few years, so it's a great opportunity to test those processes and do it in a way that we insure that it positions us to do additional activity in the future.

I don't know what happens in Tennessee in the short run.

We run screens all the time and look at things.

My guess is that we want to get very far down the path of getting Mountain National integrated and done right before we do anything else.

But as I said we think later this year we'll have Mountain National converted, and we'll see what unfolds between now and then.

I don't sense in terms of the overall M&A market a significant pick-up in conversation of any real significance.

I hear anecdotes from time to time about what may be going on in the smaller institution market, but my sense is probably a whole lot -- today, it's a whole lot like it has been for the last 12, 18 months.

It's still fairly slow.

Okay, thank you.

Thank you.

Our next question comes from Emlen Harmon of Jefferies.

Please go ahead.

Good morning.

Good morning, Emlen.

Just on the expense progress in the quarter, you guys have kind of gotten to where you're hoping to be in terms of fourth quarter run rate, and could you give us a sense of, just a reflection of your ability to get expense, say, sooner than expected, or is this more a reflection of, as you said, just kind of like ongoing expense controls, and maybe finding a little bit more there than you'd thought initially?

It's BJ.

I think it's a little bit of all of that.

I think we started really focusing on this effort maybe three years ago.

And so it takes awhile to really kind of get through the entire organization and not just identify efficiencies, but build a culture around efficiency.

And so I think we've really started, more towards the end of last year and on into this year, really has started to see the fruits of those workings from the last two years.

So we've certainly seen, we identified efficiencies coming out, and we're very pleased with that, but culturally it's showing us more and more better ways to do things, which is giving us incremental expense reductions that we hadn't been planning on.

So we're pleased with that, and again, we updated our guidance to say we're now believe we're going to exceed our goal, and as we've talked about in the past, as revenues continue to be pressured, we'll manage to our bonefish, and understand that there are thins that we can control and things we can't, and the ones that we can control, like the expenses, we'll continue to work those down as effectively as we can without sacrificing revenue opportunity in the process.

Emlen, this is Bryan.

I want to sort of echo BJ's last point.

Cost control is important, and as he said, we've done a lot of work in that area, but growing revenue, supporting our customer activity, providing high levels of quality services is very, very important, and so reducing cost is not a strategy in and of itself.

It is a part of our strategy to improve profitability.

BJ and his team have done a lot of great work over the last several years on it, but -- and continuing to disaggregate the organization, allowing us to continue to look at our organization in greater and greater levels of granularity, and when you do that, you see more and more pockets of opportunities.

They may not be as big dollar-wise, but you continue to see opportunity to improve profitability around products or regions, or the way we're doing this or that activity.

And so as I said in my comments earlier, this is not so much a target-driven process, it's a process driven around driving long term sustainable profitability, which necessitates that you do things in a high quality manner, but you also do them as efficiently as you possibly can, and so I'm encouraged by the progress we've made to date.

I think BJ, as well as our line of business leaders, our bankers, and our folks all throughout the organization and support areas are doing a great job focusing on how we get more efficient, more profitable over the long term.

Got it.

Okay, thanks.

And then additionally, just are your expectations for the pace of run-off in the non-strategic book changing at all?

Have you got kind of a mix of economic factors, I guess, to consider between improving home prices, and at least in the near term, kind of rising rates?

How are you thinking about just the pace at which that book comes down?

This is Bryan again.

It hasn't changed an awful lot.

I guess in the last couple quarters, the CPR rate on the home equity portfolio's picked up to about 20%.

I think it's down, non-strategic is down about 18% year-over-year.

I think there's some natural acceleration as rates pick up, and as that portfolio continues to age.

The vast majority, if not all of it, was originated five years or more ago.

More of it gets into amortization phase.

It continues to run down.

So it may pick up a little bit, but there's nothing as we sit here today that we think is going to cause it to pick up significantly or change significantly over the next several quarters.

Our next question comes from Matt Burnell of Wells Fargo.

Good morning.

Thanks for providing the update on what's going on in the capital market side of things, but I guess I'm just curious as to whether or not what was contributed to the downturn in the capital markets revenues, aside from the market volatility was just your bank customers holding off and buying securities until they felt a little bit more confidence about where yields were going?

And if the 10-year does continue to rise a little bit, does that potentially bode for pressure on capital markets revenues going forward?

Or how sensitive is that revenue line to rising rates?

Matt, this is Bryan.

Movement in rates is going to influence it in short-term windows.

We think with stability in 10-year rates, or stability in the market, all of the fundamentals are still there for customer activity in terms of investing or reinvesting in their securities portfolio.

So we think rates sort of gapped up a little bit here.

That created some instability.

It did lead to lower activity in terms of customer buying.

As I noted in my opening comments, we do -- have seen a little bit of pick-up in the early part of the third quarter.

The third quarter seasonally is a little more difficult, but we're overall reasonably optimistic about where we see those average daily revenues for the foreseeable future.

I mentioned the $1 million to $1.5 million range.

A lot of the impact in the second quarter was the impact of not only customer activity, but as you see these moves, the value relations on inventory and all that impacts the revenues, and all gets reported on a net basis.

So I think our folks out at FTN did a fantastic job managing through it.

I think we're well-positioned.

I think we brought good liquidity.

The customers that wanted to move securities during this period, and the market in general, and I think we're extraordinarily well-positioned for the next -- for the cycle that we're about to go through.

Bryan, maybe a bigger picture question for you.

Given your out look for loan growth, which still, I think, remains relatively muted and in line with a lot of other banks we've heard from this week, and your better than expected Basel III ratios, does that give you any greater level of confidence as you head into the capital planning process for '14?

And if that's the case, are buybacks any less attractive as your share price gets closer to 1.5 times book than they might have been at 1.1, 1.2?

Well, yes.

I guess in broad terms, as Susan pointed out, utilization rates are low.

We think in some respects, we've put a lot of very high quality relationship activity on the balance sheet over the last several years.

That's going to lead to a lot of fundings when the economy picks up.

We think we're going to be the beneficiary of an upturn in the economy.

That will allow us to use some of that capital, and I was never quite as pessimistic on Basel III as the original proposal dictated.

I felt like it would come back.

So, I never really thought about the full impact of Basel III and impacting our capital strategies.

As we said in the past, we've looked at capital in the context of what are our growth opportunities.

Clearly if we have opportunities to put the work, the capital to work in the business that allows us to produce our bonefish-type returns, that is our first choice, whether it's organic or whether that's something like a Mountain National.

And to the extent we have excess capital, buyback and dividend are important tools in our ability to return that.

We're analytical about it, too.

We look at what price and so on and so fourth, but as we sit here today, it's hard to think about any big differences about how all this might impact 2014 and beyond.

Our next question comes from Christopher Marinac of FIG partners.

Thanks, Bryan and BJ.

Just wanted to ask about the increased fee income from higher rates, whether it's 100 or 200.

What are some of your thoughts about of the ability to lag on deposit pricing, as well as for retention of deposits as a higher rate scenario plays out?

Yes, good question.

Generally speaking, I think the first maybe 50, 75 basis points of move you'll see very little movement in deposit rates in terms of historical proportional movements as banks try to recapture some of the lost fee income and some of the lost net interest income that we've seen over the last couple of years.

After that it starts to get a little bit more interesting because in aggregate deposits are very valuable.

So it remains to be seen what the competitive pressures will be.

The other wildcard, I think from my perspective, is what happens to the money funds?

The money funds have historically been a very strong competitor to deposits, and there's a lot of pressure on that side, on those money funds.

So in the first moves of a rising rate environment I don't think they are going to be very competitive, and depending on what rules change there, they may not be as competitive as they might have been in the past.

So all of that to say is we're expecting some modestly better deposit rate lag than what we would historically see, but we're not -- we're a little bit more cautious on what competitive pressures are going to be over the long term.

I guess the caution is more after the first 75, to your point?

Yes.

Okay, very good.

Thank you.

Our next question comes from Ryan Nash of Goldman Sachs.

Hey, thanks guys.

Just a follow-up on the rate sensitivity question.

It seems like it has come down a little bit over the past quarter or so.

And I just wanted to ask, given that a lot of your sensitivity comes from the C&I book, as well as the home equity portfolio, which is in run-off, or parts of the home equity have run-off.

I guess what are you doing to maintain the level of sensitivity, whether it's reducing duration, or is it adding floating rate securities to the securities portfolio?

And in addition to that, BJ, you talked about competition on the deposit side, but what are your underlying assumptions in terms of competition on the lending side?

Are you assuming that as rates rise, we see more competitive pressures weighing on spreads?

Good question.

Maybe I'll start with the last.

As rates do start to rise, we continue to believe there will be competitive pressures, but I don't think that they -- we don't believe that they intensify.

So generally speaking, in rising rates we would expect, on like assets, to maintain the spreads that we have today on the asset side.

Where we would see the benefit certainly is lagging on the deposit side.

Got it.

And then just Bryan, as a follow-up to one of the questions that we heard before regarding capital.

Now that we know the final rules and they have come in more positive, just in terms of both AOCI and lower mortgage risk weights, does this at all change the way, the level of which you think you have to run at?

So I know we've talked, as part of the bonefish at 8% to 9%, but given that the capital volatility will probably be lower, do you think this ends up pushing you to the closer to the lower end of that target relative to the higher end?

I don't know that I feel any differently about that range at this point.

I think what's going to be important, as you know, the $10 billion to $50 billion banks are going to start the stress testing process in the late part of this year on a formal basis with the OCC and the Fed.

We'll submit results in 2014.

We'll go through it again in 2015, and actually report the results, and I think the way the rules are set up, in 2015.

We'll learn a lot through this process this year, but as we sit here today, I don't feel any -- I don't think I feel any different about the 8% to 9%.

I think I would have said if the rules came out with 220, 240 basis point impact, you'd probably say given those high capital levels of some of the portfolios you might lean towards a lower end of the range, but I think at this point we'll continue to be dictated by our stress test.

I think the 8% to 9% is still a fair range to think about for long term capitalization of an organization with a business mix that looks like ours.

Our next question comes from Jon Arfstrom of RBC Capital Markets.

Hey, thanks.

Good morning.

Just two quick ones here.

BJ, on the provision, just with the non-strategic being down and the regional bank being up.

Are either of those shifts permanent, or is this just kind of quarterly nuances?

It's probably quarterly nuances, but generally speaking we think that non-strategic continues to improve.

Whether or not it's the magnitude of improvement that you saw first to second, that's probably a little bit big.

It will probably normalize a little bit more.

On the regional bank side, we're still seeing very good asset quality trends and metrics.

But if you look back at our quarterly results there, we've actually had a provision credit in the regional bank for the last several quarters, and this time we moved to an actual provision.

So I think the charge-offs in the regional bank were somewhere in the $8 million to $9 million range, which is still a fantastic result.

It's just dependent on what our reserving models tell us about individual portfolios and where we believe it's prudent to set those reserves.

Okay, and then Bryan just a quick one for you.

You talked earlier about middle Tennessee and southeast Tennessee being better.

So I'm guessing that Nashville, Chattanooga, Knoxville, but give us an update on Memphis.

What's going on there, how you see the recovery progressing, and a little bit on the outlook?

Yes, the Memphis, West Tennessee market continues to recover at a modest pace.

Unemployment is latently a little bit higher in this marketplace, but it continues to recover nicely, sort of in line with the US recovery.

I am very, very pleased with the work that I see our bankers doing here, and across the state, but here in terms of winning customer relationships and growing in a market where we have a significant presence to begin with, and I'm encouraged how we're positioned here.

And as the West Tennessee, Memphis recovery continues to pick up pace, I think we'll do very, very well here.

Okay.

All right, thanks.

Thank you.

Ladies and gentlemen, that is all the time we have for today.

I'd now like to turn the conference back over to Mr. Bryan Jordan for any closing remarks.

Thank you, Allie.

Thank you all for joining our call this morning.

Please let us know if you have any additional questions and need additional information.

Please remember our Investor Day in November, we would love to have you join us.

I hope you all have a great weekend.

Thank you.

Ladies and gentlemen, this does conclude today's conference.

You may all disconnect, and have a wonderful day.