A successful strategy anticipates challenges and keeps you moving ahead. At First Horizon National Corp., our commitment to refocus on our core businesses produced steady progress in 2008. Those businesses remain strong in a difficult environment.
Regional banking
With 200 bank locations, First Tennessee Bank has the leading combined deposit market share in the 17 Tennessee counties where it does business. We’ve called Tennessee home since 1864, and our com- munity-focused relationships have resulted in one of the highest customer retention rates of any bank in the country. Only one bank ranked higher than First Tennessee in overall customer satisfaction in the latest J.D. Power rating of banks in the Southeast.
In 2008, we saw strong customer and account growth; our deposit base has been growing since August. We continue to open new branches and extend the reach of our services in and around Tennessee. Given our competitive advantages, we see opportunities to continue to advance in 2009.
As our new marketing campaign conveys, First Tennessee offers the convenience, advice and service that power our customers’ dreams, large and small. We move forward by helping our customers move forward.
Capital markets
FTN Financial provides a broad spectrum of financial services for the investment and banking communities through the integration of traditional capital markets securities activities, equity research, loan sales, portfolio advisory services, structured finance and correspondent banking services. FTN Financial is an industry leader in fixed-income sales, trading and strategies for institutional clients in the U.S. and abroad.
Our extensive distribution platform remains a competitive advantage. As 2008 ended, capital markets produced record earnings on record fixed-income sales, generating strong momentum for the new year.
Our commitment
First Horizon’s distinctive culture attracts the best people and empowers them to empower our customers. The company’s 6,000-plus employees and its management team are focused on delivering value and service. Their hard work brought us this far. Their commitment will keep us moving forward.
We can credit much of our progress to the diligence of our employees in executing the difficult decisions we made early in the year.
CEO message
First Horizon made significant progress in 2008 refocusing our business on our core strengths and preparing for a weakening economy. The combination of the economic slowdown and the seize-up of the credit markets created a set of largely unprecedented financial conditions. Against this backdrop, we delivered on our commitment to refocus on our core regional banking and capital markets businesses.
Our results in the fourth quarter of 2008 showed solid financial performance with pretax, pre-provision income rising in large part because of a record quarter from our FTN Financial capital markets business. Yes, we ended the year with a net loss, but we made strategic progress throughout the year, and we expect to continue to move forward on the path to profitability.
We can credit much of our progress to the diligence of our employees in executing the difficult decisions we
made early in the year.
We exited our national lending business, shrinking our balance sheet and substantially
reducing our risk. We raised our already-strong capital position to among the
strongest in the industry through balance-sheet contraction, the sale of common
stock and our participation in the government’s capital purchase program
(Chart 1). Our liquidity position improved as we retired debt and increased
core deposits. We aggressively addressed problem loans and built our loan loss
reserves. We committed to controlling expenses and increasing efficiency.
We began transforming the areas of consumer and commercial lending, adopting
best practices, shared systems and more effective models. These actions – and
the strategy behind them –made us stronger as our operating environment
grew tougher.
| Chart 1 | TIER 1 CAPITAL RATIO BOLSTERED FROM CAPITAL ISSUANCES AND BALANCE SHEET REDUCTION |
The Troubled Asset Relief Program (TARP) funds ($866 million in First Horizon preferred stock) are an investment in our company. We are responsible for using the TARP funds not just to deal with the current economic troubles but to thrive in the long run. We take our responsibility very seriously – just as we do with our other stakeholders. Among other things,
we’re leveraging the TARP money to facilitate lending to our consumer, small business and commercial customers. The government investment contributed to our ability to originate more than $900 million in new loans in the fourth quarter, while we maintained consistent standards of creditworthiness.
We expect operating conditions and the economy to remain difficult in 2009, likely becoming worse over the next few quarters. First Horizon is well- positioned to endure this difficult period. The additional capital helps cushion against losses if the recession
is lengthy. It increases our options as the industry likely consolidates over the next few years. In short, we’re using the TARP funds to increase lending, strengthen our company and support our customers during this difficult time.
| Chart 2 | CORE DEPOSITS IN REGIONAL BANKING |
The ongoing strength of our core businesses – FTN Financial and First Tennessee Bank – creates optimism for 2009.
The ongoing strength of our core businesses – capital markets and regional banking – creates optimism for 2009. FTN Financial’s fourth quarter pre-tax earnings were the best in its 80-year history. Within First Tennessee Bank, customer numbers and deposits are growing (Chart 2). We’ve invested in new branches and enhanced systems, aiming at increased productivity and market share. We are introducing a new marketing campaign – powering your dreams – to show that in ways small and large our bank offers the service, advice and convenience to support our customers’ hopes. With their record of quality and service, our core brands have solid competitive advantages.
We have made a great deal of progress, but there’s a long way to go. We will continue to focus on factors we can control: remaining vigilant about asset quality, improving efficiency, providing exceptional service to our customers, growing our businesses and taking advantage of opportunities the TARP funds provide. As we follow this course, we’ll stay in front of events, ready for whatever challenges lie ahead. Our strongest asset remains the professionalism of our employees, demonstrated in their hard work and commitment to our customers. When the credit cycle turns, when the economy rebounds, we will be well-positioned to continue to move forward.
Sincerely,
Bryan Jordan
President and Chief Executive Officer
March 1, 2009
[THIS PAGE INTENTIONALLY LEFT BLANK]
FINANCIAL INFORMATION AND DISCUSSION
TABLE OF CONTENTS
|
|
|
|||||
|
2 |
||||||
|
Management’s Discussion and Analysis of Results of Operations and Financial Condition |
|
|
|||||
|
3 |
||||||
|
4 |
||||||
|
4 |
||||||
|
6 |
||||||
|
11 |
||||||
|
21 |
||||||
|
25 |
||||||
|
27 |
||||||
|
27 |
||||||
|
29 |
||||||
|
29 |
||||||
|
47 |
||||||
|
58 |
||||||
|
58 |
||||||
|
60 |
||||||
|
Report of Management on Internal Control over Financial Reporting |
|
63 |
|||||
|
64 |
||||||
|
66 |
||||||
|
67 |
||||||
|
68 |
||||||
|
69 |
||||||
|
70 |
||||||
|
148 |
||||||
|
Consolidated Average Balance Sheets and Related Yields and Rates |
|
150 |
|||||
|
152 |
||||||
|
153 |
||||||
FIRST HORIZON NATIONAL CORPORATION
SELECTED FINANCIAL AND OPERATING DATA
(Dollars in millions except per share data)
2008
2007
2006
2005
2004
2003 Income/(loss) from continuing operations
$
(192.9
)
$
(174.9
)
$
250.8
$
410.7
$
430.1
$
445.2 Income from discontinued operations, net of tax
0.9
4.8
210.8
17.1
15.6
7.4 Income/(loss) before cumulative effect of changes in
(192.0
)
(170.1
)
461.6
427.8
445.7
452.6 Cumulative effect of changes in accounting principle, net of tax
-
-
1.3
(3.1
)
-
- Net income/(loss)
(192.0
)
(170.1
)
462.9
424.7
445.7
452.6 Income/(loss) available to common shareholders
(199.4
)
(170.1
)
462.9
424.7
445.7
452.6 Common Stock Data Earnings/(loss) per common share from continuing operations
$
(1.11
)
$
(1.32
)
$
1.92
$
3.12
$
3.29
$
3.35 Earnings/(loss) per common share
(1.10
)
(1.29
)
3.54
3.22
3.40
3.40 Diluted earnings/(loss) per common share from continuing operations
(1.11
)
(1.32
)
1.87
3.02
3.19
3.24 Diluted earnings/(loss) per common share
(1.10
)
(1.29
)
3.45
3.12
3.31
3.29 Cash dividends declared per common share
.38
1.72
1.72
1.66
1.55
1.24 Year-end book value per common share
12.13
16.03
18.68
17.59
15.87
14.54 Closing price of common stock per share: High
21.07
43.00
40.74
42.45
45.74
45.71 Low
4.80
17.15
35.44
33.47
39.63
34.43 Year-end
10.57
17.29
39.81
36.63
41.07
42.02 Cash dividends per common share/year-end closing price
3.6
%
9.9
%
4.3
%
4.5
%
3.8
%
2.9
% Cash dividends per common share/diluted earnings per common share
NM
NM
49.7
%
53.1
%
46.9
%
37.6
% Price/earnings ratio
NM
NM
11.5
x
11.7
x
12.4
x
12.7
x Market capitalization
$
2,175.5
$
2,303.8
$
5,246.4
$
4,888.7
$
5,368.0
$
5,552.0 Average shares (thousands)
180,711
132,078
130,619
131,692
130,911
133,046 Average diluted shares (thousands)
180,711
132,078
134,321
136,134
134,818
137,361 Period-end shares outstanding (thousands)
205,283
132,627
131,053
132,476
129,653
131,019 Volume of shares traded (thousands)
1,394,389
486,219
184,886
170,258
181,757
185,274 Selected Average Balances Total assets
$
34,422.7
$
38,175.4
$
38,764.6
$
36,560.4
$
27,305.8
$
25,133.6 Total assets – divestiture
182.3
123.1
-
-
-
- Total loans, net of unearned income
21,660.7
22,106.7
21,504.2
18,334.7
15,440.5
12,679.8 Total loans held for sale – divestiture
110.4
117.8
-
-
-
- Investment securities
2,964.0
3,380.2
3,481.5
2,906.2
2,471.1
2,563.5 Earning assets
30,426.2
33,405.4
34,042.3
31,976.2
23,740.3
21,347.5 Deposits
14,920.9
20,313.8
22,751.7
23,015.8
17,635.5
16,111.6 Total deposits – divestiture
48.8
95.3
-
-
-
- Long-term debt
6,108.6
6,567.7
5,062.4
2,560.1
2,248.0
1,342.9 Shareholders’ equity
2,635.4
2,423.5
2,423.0
2,177.0
1,937.7
1,829.4 Selected Period-End Balances Total assets
$
31,022.0
$
37,015.5
$
37,918.3
$
36,579.1
$
29,771.7
$
24,506.7 Total assets – divestiture
-
305.7
-
-
-
- Total loans, net of unearned income
21,278.2
22,103.5
22,104.9
20,612.0
16,441.9
14,021.3 Total loans held for sale – divestiture
-
289.9
-
-
-
- Investment securities
3,125.2
3,032.8
3,923.5
2,941.2
2,704.6
2,491.1 Earning assets
26,895.9
31,785.6
32,353.3
31,606.7
25,975.9
20,641.8 Deposits
14,241.8
17,032.3
20,213.2
23,317.6
19,757.0
15,855.4 Total deposits – divestiture
-
230.4
-
-
-
- Long-term debt
4,767.7
6,828.4
5,836.4
3,437.6
2,616.4
1,726.8 Shareholders’ equity
3,279.5
2,135.6
2,462.4
2,347.5
2,074.1
1,921.6 Selected Ratios Return on average common shareholders’ equity from continuing operations
(7.90
)%
(7.22
)%
10.35
%
18.87
%
22.19
%
24.34
% Return on average common shareholders’ equity before cumulative effect of changes in accounting principle
(7.87
)
(7.02
)
19.05
19.65
23.00
24.74 Return on average common shareholders’ equity
(7.87
)
(7.02
)
19.11
19.51
23.00
24.74 Return on average assets from continuing operations
(.56
)
(.46
)
.65
1.12
1.58
1.77 Return on average assets before cumulative effect of changes in accounting principle
(.56
)
(.45
)
1.19
1.17
1.63
1.80 Return on average assets
(.56
)
(.45
)
1.19
1.16
1.63
1.80 Net interest margin
2.95
2.82
2.93
3.08
3.61
3.78 Allowance for loan losses to loans
3.99
1.55
.98
.92
.96
1.14 Net charge-offs to average loans
2.64
.60
.26
.20
.27
.54 Period-end shareholders’ equity to period-end assets
10.57
5.77
6.49
6.42
6.97
7.84 Average tangible equity to average tangible assets
7.00
5.56
5.39
4.97
6.36
6.48 NM - not meaningful 2 FIRST HORIZON NATIONAL CORPORATION
accounting principle
See accompanying notes to consolidated financial statements.
Certain previously reported amounts have been reclassified to agree with current presentation.
From a small community bank chartered in 1864, First Horizon National Corporation (FHN) has grown to be one of the 40 largest bank holding companies in the United States in terms of asset size. FHN’s 6,000 employees provide financial services through more than 200 bank locations in and around Tennessee and 19 capital markets offices in the U.S. and abroad. The corporation’s two major brands – First Tennessee and FTN Financial – provide customers with a broad range of products and services. First Tennessee has the leading combined deposit market share in the 17 Tennessee counties where it does business and one of the highest customer retention rates of any
bank in the country. FTN Financial (FTNF) is an industry leader in fixed income sales, trading and strategies for institutional clients in the U.S. and abroad. AARP and Working Mother magazine have recognized FHN as one of the nation’s best employers. In first quarter 2008, FHN revised its business line segments to better align with its strategic direction, representing a focus on its regional banking franchise and capital markets business. To implement this change, the prior Retail/Commercial Banking segment was split into its major components with the national
portions of consumer lending and construction lending assigned to a new National Specialty Lending segment that more appropriately reflects the ongoing wind down of these businesses. Additionally, correspondent banking was shifted from Retail/Commercial Banking to the Capital Markets segment to better
represent the complementary nature of these businesses. To reflect its geographic focus, the remaining portions of the Retail/Commercial Banking segment now represent the new Regional Banking segment. All prior period information has been revised to conform to the current segment structure and the business
line reviews below are based on the new segment presentation.
•
Regional Banking offers financial products and services, including traditional lending and deposit-taking, to retail and commercial customers in Tennessee and surrounding markets. Additionally, Regional Banking provides investments, insurance, financial planning, trust services and asset management, credit
card, cash management, and check clearing services. On March 1, 2006, FHN sold its national merchant processing business. The continuing effects of the divestiture, which is included in the Regional Banking segment, are being accounted for as a discontinued operation. • Capital Markets provides a broad spectrum of financial services for the investment and banking communities through the integration of traditional capital markets securities activities, equity research, loan sales, portfolio advisory services, structured finance and correspondent banking services. • National Specialty Lending consists of traditional consumer and construction lending activities outside the regional banking footprint. In January 2008, FHN announced the discontinuation of national home builder and commercial real estate lending through its First Horizon Construction Lending offices. • Mortgage Banking now consists of the origination of mortgage loans in and around the regional banking footprint and servicing activities related to the remaining portfolio. Historically, this division provided mortgage loans and servicing to consumers and operated in approximately 40 states. On August 31, 2008,
FHN completed the sale of its servicing platform, origination offices outside Tennessee, and $19.1 billion in unpaid principal balance of the servicing portfolio to MetLife Bank, N.A., (MetLife). • Corporate consists of unallocated corporate expenses including restructuring, repositioning, and efficiency initiatives, gains and losses on repurchases of debt, expense on subordinated debt issuances and preferred stock, bank-owned life insurance, unallocated interest income associated with excess equity, net
impact of raising incremental capital, revenue and expense associated with deferred compensation plans, funds management and venture capital. 3 FIRST HORIZON NATIONAL CORPORATION
For the purpose of this management’s discussion and analysis (MD&A), earning assets have been expressed as averages, unless otherwise noted, and loans have been disclosed net of unearned income. The following financial discussion should be read with the accompanying consolidated financial statements and
notes. A glossary is included at the end of the MD&A to assist with terminology. This MD&A contains forward-looking statements with respect to FHN’s beliefs, plans, goals, expectations, and estimates. Forward-looking statements are statements that are not a representation of historical information but rather are related to future operations, strategies, financial results or other developments. The
words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “should,” “is likely,” “will,” "going forward," and other expressions that indicate future events and trends identify forward-looking statements. Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to
significant business, operational, economic and competitive uncertainties and contingencies, many of which are beyond a company’s control, and many of which, with respect to future business decisions and actions (including acquisitions and divestitures), are subject to change. Examples of uncertainties and
contingencies include, among other important factors, general and local economic and business conditions; recession or other economic downturns, expectations of and actual timing and amount of interest rate movements, including the slope of the yield curve (which can have a significant impact on a financial
services institution); market and monetary fluctuations; inflation or deflation; customer and investor responses to these conditions; the financial condition of borrowers and other counterparties; competition within and outside the financial services industry; geopolitical developments including possible terrorist activity;
recent and future legislative and regulatory developments; natural disasters; effectiveness of FHN’s hedging practices; technology; demand for FHN’s product offerings; new products and services in the industries in which FHN operates; and critical accounting estimates. Other factors are those inherent in originating,
selling and servicing loans including prepayment risks, pricing concessions, fluctuation in U.S. housing prices, fluctuation of collateral values, and changes in customer profiles. Additionally, the actions of the Securities and Exchange Commission (SEC), the Financial Accounting Standards Board (FASB), the Office of
the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Federal Reserve), Financial Industry Regulatory Authority (FINRA), U.S. Department of the Treasury (UST), and other regulators and agencies; regulatory and judicial proceedings and changes in laws and regulations
applicable to FHN; and FHN’s success in executing its business plans and strategies and managing the risks involved in the foregoing, could cause actual results to differ. FHN assumes no obligation to update any forward-looking statements that are made from time to time. Actual results could differ because of
several factors, including those presented in this Forward-Looking Statements section, in other sections of this MD&A, in Item 1A of FHN’s 2008 annual report on Form 10-K, and in other parts of that annual report. For 2008 FHN reported a net loss available to common shareholders of $199.4 million, or $1.10 diluted loss per share compared to a loss of $170.1 million, or $1.29 diluted loss per share in 2007. Comparisons between reported earnings are directly and significantly affected by a number of factors in both 2008 and 2007. Several significant items including increased provisioning, housing and credit market disruptions, and restructuring, repositioning and efficiency initiatives impacted FHN’s performance in
2008 and 2007. The results of operations for 2008 were significantly impacted by real estate, credit market, and economic conditions which began during the latter half of 2007. The economic downturn was initially confined to the real estate and credit markets. Tightened credit and a large supply of available real estate negatively
impacted collateral values. The impact on FHN was originally limited to high-risk portfolios in certain geographic regions. However, as general economic conditions also declined, credit issues began to surface in other portfolios. Commercial credits were impacted by the difficult business environment in 2008 and
consumer portfolios were impacted by stressed consumer financial circumstances. With financial institutions’ reluctance to lend and increased difficulty of obtaining low cost funding, the U.S. Government, through the Treasury Department (UST), administered the Capital Purchase Program (CPP), among other
programs, for the purpose of bolstering confidence in financial institutions 4 FIRST HORIZON NATIONAL CORPORATION
and reestablishing the availability of credit in the marketplace. While the lending and credit environment was extremely difficult in 2008, favorable interest rate movements positively impacted certain areas of FHN. The deterioration in the loan portfolios affected all segments. The national construction lending and national home equity portfolios, for which originations were curtailed in late 2007, are included in the National Specialty Lending segment. The credit deterioration of these portfolios, specifically the construction
portfolios significantly affected provisioning and net charge-offs during 2008. The Regional Banking and Capital Markets segments were also impacted as the economy’s problems broadened. Commercial loans in the Regional Banking segment began to show stress in 2008 as commercial credits deteriorated and the
portfolio experienced downward credit grading. Commercial loans in the Capital Markets segment, which include loans to banks, showed deterioration due to current stress in the financial system. In 2008, provision expense exceeded net charge-offs building the allowance for loan loss reserve. Due to the tightening credit market and economic stress, the Federal Reserve Bank reduced its target federal funds rate to historical lows. The interest rate movements resulted in increased Capital Markets’ fixed income business and Mortgage Banking income. Hedging gains on mortgage servicing rights (MSR)
more than compensated for fair value declines of MSR. The interest rate movements created opportunity for Capital Markets as customers repositioned fixed income portfolios. Due to credit market disruptions, no pooled trust preferred securities transactions were executed in 2008, effectively eliminating structured
finance transaction revenue for Capital Markets for the year. Additionally, a lower of cost or market (LOCOM) charge was taken on trust preferred loans before they were moved to the loan portfolio in the second quarter. Aside from external market factors, other events affected FHN’s 2008 performance. FHN continued efforts to refocus on its core businesses – Regional Banking and Capital Markets. A component of this effort was completed in the third quarter when FHN sold its national mortgage servicing platform and origination
offices outside Tennessee and $19.1 billion in unpaid principal balance of its servicing portfolio to MetLife. FHN continues to originate mortgage loans in and around the Regional Banking market and continues to service, through sub-servicing arrangements, the remaining servicing portfolio. In the second quarter,
FHN completed the divestitures of the First Horizon Bank branches which were those branches that operated outside of the core Regional Banking footprint. Performance was also affected by charges related to restructuring, repositioning and efficiency initiatives. In 2008, FHN committed to build and conserve capital. In the second quarter, FHN completed the issuance of 69 million common shares which generated approximately $660 million of net cash proceeds. FHN also increased capital through participation in the U.S. Treasury’s CPP mentioned above. Preferred
shares and a common stock warrant were issued to the UST for $866.5 million in cash proceeds. In an effort to conserve capital, the quarterly cash dividend was replaced with a quarterly stock dividend. Capital ratio improvements were also positively affected by balance sheet contraction of $6 billion in total
assets. Beginning in 2007 and continuing throughout 2008, FHN conducted an ongoing, company-wide review of business practices with the goal of improving overall profitability and productivity. In order to redeploy capital to higher-return businesses, origination through national construction lending operations was
discontinued; FHN sold the national mortgage origination and servicing platforms, including servicing on $19.1 billion of unpaid principal balance; and the sale of the remaining First Horizon Bank branches was completed. Total net charges of $91.4 million were recognized in 2008 related to restructuring,
repositioning and efficiency initiatives. See Table 1 and Note 27 for further details. In 2007, a $55.7 million charge related to FHN’s contingent share of certain Visa legal matters negatively impacted results. In 2008, $30.0 million of this charge was reversed due to Visa Inc.’s funding of the escrow account. See Note 18 for further details on this matter. Return on average common equity and return on average assets for 2008 were (7.87) percent and (.56) percent, respectively, compared to (7.02) percent and (.45) percent in 2007. Tangible common equity to tangible common assets ratio improved to 7.34 percent in 2008 from 5.13 percent in 2007. Tier 1
capital ratio was 15.03 percent as of December 31, 2008 compared to 8.12 percent on December 31, 2007. Total assets were $31.0 billion and shareholders’ equity was $3.3 billion on December 31, 2008, compared to $37.0 billion and $2.1 billion, respectively, on December 31, 2007. 5 FIRST HORIZON NATIONAL CORPORATION
FHN’s performance in 2007 was impacted by credit market disruptions, provisioning, restructuring, repositioning, and efficiency initiatives (including goodwill impairments on divested FH Bank), and a Mortgage Banking segment goodwill impairment. In 2007, the industry experienced high levels of adjustable rate
loan defaults and severely curtailed demand in the secondary markets. In 2007, widening credit spreads generated lower gain on sale margins in Mortgage Banking and resulted in lower asset values for those assets measured at fair value. HELOC and second-lien loan sales and securitizations were limited and fair value adjustments on residual values of prior securitizations and LOCOM
adjustments on loans held for sale were taken. Capital Markets’ fees from structured finance, including fees from pooled trust preferred transactions, began to decline as investor demand for credit products weakened. Provision was lower in 2007 than in 2008 as housing market deterioration did not begin until the latter half of 2007 and was largely confined to discontinued product structures in higher risk markets. Restructuring, repositioning, and efficiency initiatives resulted in $98.7 million of net charges. Also impacting 2007
performance was a $71.1 million goodwill impairment associated with the Mortgage Banking business segment. Regional Banking The Regional Banking segment had a pre-tax loss of $125.2 million in 2008 compared to pre-tax income of $220.6 million in 2007. Total revenues decreased 9 percent, or $83.7 million, in 2008. The provision for loan losses increased to $328.8 million in 2008 from $62.6 million in 2007. This increase primarily
reflects deterioration and downward credit grading of the commercial loan portfolio. Net interest income decreased 12 percent to $480.7 million in 2008 from $547.2 million in 2007. The decrease in net interest income was primarily attributable to increased nonaccrual loans and the effects of increased competition for deposits. Net interest margin in Regional Banking was 4.36 percent in 2008
compared to 4.90 percent in 2007. The decrease was primarily driven by increased commercial nonaccrual loans and lower deposit spreads due to Federal Reserve rate reductions. Noninterest income declined 5 percent, or $17.3 million, in 2008 to $350.1 million. Trust revenue decreased by $6.6 million from 2007 as the value of assets under management declined consistent with 2008 market declines. Miscellaneous income declined $6.5 million from $83.6 million in 2007 as FHN
discontinued the sale of U.S. Mint licensed products and positive market adjustments on customer derivatives decreased. Other service charges declined $2.9 million, primarily driven by a decrease in mutual fund sales, while insurance commissions decreased $2.2 million due to a soft property and casualty market.
Bank card fees declined $1.5 million as consumer spending decreased and resulted in lower interchange fees in 2008. Partially offsetting the above declines were increased deposit related service charges primarily driven by higher cash management fees as lower balances reduced associated customer earnings
credits. Noninterest expense declined slightly to $627.3 million in 2008 compared to $631.4 million in 2007. Increased personnel, infrastructure, credit-related costs, public relations and foreclosed property losses were more than offset by expense declines from efficiency initiatives. Capital Markets Pre-tax income increased from $70.4 million in 2007 to $112.7 million in 2008. Total revenues were $611.7 million in 2008 compared to $406.5 million in 2007. Net interest income was $77.3 million in 2008 compared to $54.4 million in 2007. This increase is primarily attributable to a steeper yield curve and the effect of increases in the average trust preferred loan balance. Income from fixed income sales increased to $493.8 million in 2008 from $217.7 million in 2007, reflecting an increase in activity during 2008 as the Federal Reserve aggressively lowered rates resulting in a steeper yield curve as compared to 2007. Other product revenues decreased to $40.6 million in 2008
compared to $134.5 million in 6 FIRST HORIZON NATIONAL CORPORATION
2007 as no pooled trust preferred transactions were executed in 2008 and a $36.2 million LOCOM adjustment was taken on the trust preferred warehouse before the loans were transferred to the portfolio. Revenues from other products include fee income from activities such as equity research, loan sales, portfolio
advisory, structured finance, and correspondent banking services. Provision expense was $80.1 million in 2008 compared to $8.1 million in 2007, primarily as a result of deterioration of commercial loans, including loans to banks, as the housing market and general economic decline impacted financial institutions to which FHN extended credit. Noninterest expense increased 28 percent, or $90.9 million, to $418.9 million in 2008, primarily due to increased personnel costs related to higher production levels in 2008 compared to 2007. Mortgage Banking Effective August 31, 2008, FHN completed the sale of Mortgage Banking’s servicing operations, origination offices outside of Tennessee and servicing on loans with an outstanding principal balance of $19.1 billion to MetLife. As a result of this transaction, components of origination activity and operating expenses
for 2008 are significantly lower when compared to 2007. Pre-tax income was $201.4 million in 2008 compared to a pre-tax loss of $313.3 million in 2007. Total revenues increased by $465.8 million to $655.7 million in 2008. Net interest income decreased slightly to $95.3 million in 2008 from $98.8 million in 2007 primarily due to lower loan volumes combined with lower spreads on reduced custodial deposit balances. In 2007, net interest income was favorably impacted by $15.7 million due to the reclassification of $175 million from
excess mortgage servicing rights to trading securities in second quarter. This reclassification was the outcome of capital management initiatives which resulted in modification of the Pooling and Servicing Agreements (PSA) for private (non-GSE) securitizations which were active as of March 31, 2007. The
modifications separated master servicing from retained yield. Offsetting the increase in net interest income was a decline in servicing fees and a decline in the change of mortgage servicing rights (MSR) value due to runoff. Provision expense increased to $29.1 million in 2008 from deterioration in the permanent
mortgage portfolio. Noninterest income increased to $560.3 million in 2008 compared to $91.1 million in 2007. Noninterest income consists primarily of mortgage banking-related revenue, net of costs, from the origination and sale of mortgage loans, fees from mortgage servicing, and changes in the fair value of MSR net of hedge
gains or losses. Mortgage loan origination volumes decreased to $17.4 billion in 2008 from $27.4 billion in 2007, as home purchase-related originations declined due to the August 2008 divestiture of national origination offices to MetLife. Net revenue from origination activity increased to $223.6 million from $118.4 million in 2007
reflecting the $142.2 million positive impact of adopting new accounting standards in 2008. Loans delivered into the secondary market decreased 24 percent to $19.9 billion from $26.3 billion. Gain on loan sale deliveries increased to $78.4 million despite decreased volume as 2007 was negatively impacted by
credit market disruptions which affected pricing and dealer concessions. Gains in 2008 were negatively impacted by a $15.5 million adjustment to reflect revised cash flow expectations for mortgage origination activity. 2008 origination income was negatively impacted by a $15.2 million fair value adjustment of the
remaining mortgage warehouse in the fourth quarter. Through various servicing portfolio sales executed in 2008, including the $19.1 billion sale to MetLife in the third quarter, the unpaid principal balance (UPB) of the servicing portfolio decreased to $63.7 billion on December 31, 2008 from $103.7 billion on December 31, 2007. The sales reduced servicing rights
assets by $485.8 million. Consistent with the decline in the servicing portfolio, total fees associated with mortgage servicing decreased 26 percent to $231.9 million from $311.4 million. Changes in the balance of MSR due to runoff positively impacted servicing income in 2008 by $109.7 million as the size of the
portfolio declined. Changes in MSR value other than runoff (valuation model inputs or assumptions) negatively impacted net servicing revenues by $384.2 million in 2008 compared to $239.3 million in 2007 as lower interest rates increased prepayment speed model assumptions. Lower interest rates positively
impacted servicing hedge gains by $548.8 million in 2008 compared to $73.2 million 7 FIRST HORIZON NATIONAL CORPORATION
in 2007 resulting in net servicing income of $292.0 million compared to a net servicing loss of $68.9 million in 2007. Noninterest expense was $425.1 million in 2008 compared to $503.2 million in 2007. Noninterest expense in 2008 was negatively impacted by the immediate recognition of $121.8 million of origination costs previously deferred due to accounting for the mortgage warehouse at elected fair value and also by a $6.5
million charge for minimum fee guarantees on prior servicing sales. Offsetting this increase in noninterest expense was a decline due to the divestiture of certain mortgage banking operations in the third quarter 2008. Noninterest expense in 2007 was impacted by a goodwill impairment of $71.1 million and $8.4
million of expense related to a legal settlement. National Specialty Lending National Specialty Lending had a pre-tax loss of $559.3 million in 2008 compared to a pre-tax loss of $67.3 million in 2007. The pre-tax loss in 2008 is primarily a result of an increase in the provision for loan losses to $642.0 million in 2008 compared to $194.4 million in 2007 due to deterioration in the national
construction lending and home equity portfolios. Net interest income declined to $190.0 million in 2008 as compared to $243.9 million in 2007 as a result of the increase in nonaccrual construction loans and the continued contraction of loan portfolios from the wind-down of operations. Noninterest income was a loss of $10.2 million in 2008 compared to a gain
of $21.3 million in 2007. The decrease is primarily due to market disruptions that began in 2007 which resulted in no second-lien or HELOC loan sales in 2008, an increase in HELOC residual write-downs, and a decrease in servicing fees resulting from pay downs and a smaller servicing portfolio. Noninterest
expense was $97.2 million in 2008 compared to $138.1 million in 2007. Noninterest expense declined principally due to lower personnel costs related to the business wind-down initiated during first quarter 2008. Corporate The Corporate segment’s results yielded pre-tax income of $20.8 million in 2008 compared to a pre-tax loss of $226.0 million in 2007. Net interest income was $51.7 million in 2008 compared to a negative $3.6 million in 2007 as the common stock issuance reduced the need for higher cost short term funding.
Noninterest income was $56.6 million in 2008 compared to $28.0 million in 2007. 2008 was positively impacted by a $65.9 million securities gain resulting from the redemption of Visa Inc.’s shares in conjunction with its IPO and $33.8 million of gains related to bank note repurchases. These items were partially
offset by $31.7 million of restructuring related charges and a $30.6 million decrease in deferred compensation income (partially offset by a corresponding decrease in deferred compensation expense). Noninterest income in 2007 included $9.3 million of net gains related to restructuring initiatives and net security
losses of $1.2 million. Noninterest expense decreased to $87.5 million in 2008 from $242.7 million in 2007. The decrease was primarily attributable to a reversal of $30.0 million related to the Visa contingent liability for certain Visa legal matters ($55.7 million was initially recorded in 2007), a $40.6 million decrease related to
restructuring charges, and a $39.3 million decrease in deferred compensation expense. (See Note 18, Contingencies and Other Disclosures for a detailed discussion surrounding FHN’s contingent liability for certain Visa legal matters.) The decrease in deferred compensation expense is partially offset by a $30.6
million decrease in deferred compensation income. Partially offsetting these declines was a $14.2 million increase in legal and professional fees primarily due to consulting fees. RESTRUCTURING, REPOSITIONING, AND EFFICIENCY INITIATIVES Beginning in 2007, FHN conducted a company-wide review of business practices with the goal of improving its overall profitability and productivity. In addition, during 2007 management announced its intention to sell 34 full-service First Horizon Bank branches in its national banking markets. These sales were
completed in second quarter 2008. In the second half of 2007, FHN also took actions to right size First Horizon Home Loans’ mortgage banking operations and to downsize FHN’s national lending operations, in order to redeploy capital to higher-return businesses. As part of its strategy to reduce its national real
estate portfolio, FHN announced in January 2008 that it was discontinuing national homebuilder and commercial real estate lending through its First Horizon Construction 8 FIRST HORIZON NATIONAL CORPORATION
Lending offices. Additionally, FHN initiated the repositioning of First Horizon Home Loans’ mortgage banking operations, which included sales of MSR in fourth quarter 2007 and the first, second and third quarters of 2008. In June 2008, FHN announced that it had reached a definitive agreement with MetLife for the sale of more than 230 retail and wholesale mortgage origination offices nationwide as well as its loan origination and servicing platform. Effective August 31, 2008, the parties completed the initial settlement for MetLife’s
acquisition of substantially all of FHN’s mortgage origination pipeline, related hedges, certain fixed assets and other associated assets. MetLife did not acquire any portion of FHN’s mortgage loan warehouse. First Horizon retained its mortgage operations in and around Tennessee, continuing to originate home loans
for customers in its banking market footprint. FHN also agreed with MetLife for the sale of servicing assets and related hedges on $19.1 billion of first lien mortgage loans and associated custodial deposits. Additionally, FHN has entered into a subservicing agreement with MetLife for the remainder of FHN’s
servicing portfolio. MetLife generally paid book value for the assets and liabilities it acquired, less a purchase price reduction. The assets and liabilities related to the mortgage operations divested were included in the Mortgage Banking segment and were reflected as “divestiture” on the Consolidated Statements of
Condition for the reporting period ending June 30, 2008. In third quarter 2008, FHN recognized a loss on divestiture of $17.5 million related to this transaction which is included in the noninterest income section of the Consolidated Statements of Income as losses on divestitures. In fourth quarter 2008, the parties
completed a post-closing true up which resulted in FHN recognizing a gain on divestiture of $0.9 million within its Consolidated Statements of Income. Net costs recognized by FHN in the year ended December 31, 2008 related to restructuring, repositioning, and efficiency activities were $91.4 million. Of this amount, $49.1 million represented exit costs that were accounted for in accordance with Statement of Financial Accounting Standards No. 146, “Accounting
for Costs Associated with Exit or Disposal Activities” (SFAS No. 146). Significant expenses recognized in 2008 resulted from the following actions:
•
Expense of $49.1 million associated with organizational and compensation changes due to right sizing operating segments, the divestiture of certain First Horizon Bank branches, the divestiture of certain mortgage banking operations and consolidating functional areas. • Loss of $16.6 million on the divestiture of mortgage banking operations. • Loss of $2.4 million from the sales of certain First Horizon Bank branches. • Transaction costs of $12.7 million from the contracted sales of mortgage servicing rights. • Expense of $10.7 million for the write-down of certain premises and equipment, intangibles and other assets resulting from FHN’s divestiture of certain mortgage operations and from the change in FHN’s national banking strategy. Net costs recognized by FHN in the year ended December 31, 2007 related to restructuring, repositioning, and efficiency activities were $98.7 million. Of this amount, $47.9 million represented exit costs accounted for in accordance with SFAS No. 146. Significant expenses recognized in 2007 resulted from the following actions:
•
Expense of $20.4 million associated with organizational and compensation changes for right sizing operating segments and consolidating functional areas. • Non-core business repositioning costs of $17.4 million, including costs associated with the exit of the collectible coin merchandising business and the transition of the non-prime mortgage origination business to a broker model. • Expense of $17.2 million related to other restructuring, repositioning, and efficiency initiatives, including facilities consolidation, procurement centralization, multi-sourcing and the divestiture of certain loan portfolios. • Costs of $24.3 million related to the divestiture of 34 full-service First Horizon Bank locations in Virginia, Maryland, Georgia, and Texas, including $13.9 million for the write-down of goodwill and other intangibles; partially offset by $15.7 million of gains realized in 2007 from the disposition of 15 of these
locations. 9 FIRST HORIZON NATIONAL CORPORATION
• Expense of $11.3 million related to the restructuring of mortgage operations through office closures, associated sales force decreases, and the reduction of management and support staff and downsizing of national lending operations through the reduction of consumer and construction sales forces and
decreasing management, support staff and back-office costs. • Expense of $17.4 million for asset impairments related to the discontinuance of technology projects. • Transaction costs of $6.4 million from sales of mortgage servicing rights. Provision for loan losses of $7.7 million was incurred during 2007 in relation to the divestiture of a non-strategic loan portfolio. Losses from the mortgage banking divestiture and gains and losses from the disposition of the First Horizon Bank branches are included in gains/(losses) on divestitures in the noninterest
income section of the Consolidated Statements of Income. Transaction costs related to transfers of mortgage servicing rights are recorded as a reduction of mortgage banking income in the noninterest income section of the Consolidated Statements of Income. All other costs associated with the restructuring,
repositioning, and efficiency initiatives implemented by management are included in the noninterest expense section of the Consolidated Statements of Income, including severance and other employee-related costs recognized in relation to such initiatives which are recorded in employee compensation, incentives,
and benefits, facilities consolidation costs and related asset impairment costs which are included in occupancy, costs associated with the impairment of premises and equipment which are included in equipment rentals, depreciation, and maintenance, and other costs associated with such initiatives, including
professional fees, intangible asset impairment costs, and asset impairment costs related to the discontinuance of technology projects, which are included in all other expense and goodwill impairment. Settlement of the obligations arising from current initiatives will be funded from operating cash flows. The effect of suspending depreciation on assets held for sale was immaterial to FHN’s results of operations for all periods. As a result of the change in FHN’s national banking strategy, a write-down of other
intangibles of $2.4 million was recognized in first quarter 2008 related to certain banking licenses. As part of the divestiture of certain mortgage banking assets, an impairment of $1.7 million was recognized in second quarter 2008 related to noncompete agreements. The recognition of these impairment losses will
have no effect on FHN’s debt covenants. The impairment loss related to such intangible assets was recorded as an unallocated corporate charge within the Corporate segment and is included in all other expense on the Consolidated Statements of Income. As a result of the restructuring, repositioning, and efficiency
initiatives implemented to date by management, the effects of $175 million in aggregate annual pre-tax improvements were experienced by FHN beginning in its first quarter 2008 run-rate. An additional $70 million in pre-tax annual profitability improvements was experienced by the end of 2008 in relation to the
First Horizon Bank branch divestitures and the restructuring of mortgage operations and national lending operations. Due to the broad nature of the actions being taken, all components of income and expense will be affected from the efficiency benefits. Charges related to restructuring, repositioning, and efficiency initiatives for the twelve months ended December 31, 2008, and 2007 are presented in the following table based on the income statement line item affected. See Note 27 – Restructuring, Repositioning, and Efficiency Charges and Note 2 –
Acquisitions/Divestitures for additional information. 10 FIRST HORIZON NATIONAL CORPORATION
Table 1 - Restructuring, Repositioning, and Efficiency Initiatives
(Dollars in thousands)
2008
2007 Provision for loan losses related to divestiture of a loan portfolio
$
-
$
7,672 Noninterest income: Mortgage banking
(12,667
)
(6,428
) Gains/(losses) on divestitures
(19,019
)
15,695 Total noninterest income
(31,686
)
9,267 Adjusted gross income after provision for loan losses
(31,686
)
1,595 Noninterest expense: Employee compensation, incentives and benefits
24,418
25,665 Occupancy
8,111
14,312 Equipment rentals, depreciation and maintenance
4,340
6,524 Legal and professional fees
4,342
9,977 Operations services
1
359 Communications and courier
42
28 Goodwill impairment
-
13,010 All other expense
18,473
30,438 Total noninterest expense
59,727
100,313 Loss before income taxes
$
91,413
$
98,718 Activity in the restructuring and repositioning liability for the twelve months ended December 31, 2008 is presented in the following table:
(Dollars in thousands)
Liability Beginning Balance: January 1, 2008
$
19,675 Severance and other employee related costs
24,400 Facility consolidation costs
16,751 Other exit costs, professional fees and other
7,902 Total Accrued
68,728 Payments*
38,016 Accrual Reversals
6,545 Restructuring and Repositioning Reserve Balance: December 31, 2008
$
24,167
* Includes payments related to:
Twelve Months Ended Severance and other employee related costs
$
16,235 Facility consolidation costs
14,223 Other exit costs, professional fees and other
7,558
$
38,016 INCOME STATEMENT REVIEW – 2008 COMPARED TO 2007 Total consolidated revenue increased 33 percent to $2.4 billion from $1.8 billion in 2007, primarily from increased mortgage banking and capital markets revenue. A more detailed discussion of the major line items follows. NET INTEREST INCOME Net interest income declined to $895.1 million in 2008 compared to $940.6 million in 2007 as average earning assets declined 9 percent to $30.4 billion and average interest-bearing liabilities declined 10 percent to $26.0 billion in 2008. See also the Consolidated Average Balance Sheet and Related Yields and
Rates table. 11 FIRST HORIZON NATIONAL CORPORATION
December 31, 2008
The activity levels and related funding for FHN’s mortgage production and servicing and capital markets activities affect the net interest margin. These activities typically produce different margins than traditional banking activities. Mortgage production and servicing activities can affect the overall margin based on a
number of factors, including the shape of the yield curve, the size of the mortgage warehouse, the time it takes to deliver loans into the secondary market, the amount of custodial balances, and the level of MSR. Due to the August 2008 divestiture of certain mortgage banking operations to MetLife, origination
activities and the size of the mortgage warehouse have significantly decreased and therefore had less of an impact on net interest margin during the second half of the year. Capital Markets’ activities tend to compress the margin because of the strategy to reduce market risk by economically hedging a portion of its
inventory on the balance sheet. As a result of these impacts, FHN’s consolidated margin cannot be readily compared to that of other bank holding companies. Table 2 details the computation of the net interest margin for FHN for the last three years. The consolidated net interest margin was 2.95 percent for 2008 compared to 2.82 percent for 2007. The widening in the margin occurred as the net interest spread increased to 2.55 percent from 2.19 percent in 2007 while the impact of free funding decreased from 63 basis points to 40 basis points. The
increase in the margin is attributable to a decrease in interest-bearing assets, increased spreads on capital markets’ trading inventory and the mortgage warehouse, and a reduced need for higher cost short-term funding because of the common stock issuance in the second quarter 2008. The positive effects more
than offset the negative impact of an increase in nonaccrual loans. Table 2 - Net Interest Margin
2008
2007
2006 Consolidated yields and rates: Loans, net of unearned income
5.33
%
7.34
%
7.40
% Loans held for sale
5.86
6.54
6.64 Investment securities
5.49
5.59
5.42 Capital markets securities inventory
4.57
5.29
5.33 Mortgage banking trading securities
12.98
12.28
10.84 Other earning assets
1.84
4.88
4.72 Yields on earning assets
5.29
6.91
6.85 Interest-bearing core deposits
2.26
3.34
2.98 Certificates of deposit $100,000 and more
3.79
5.36
5.06 Federal funds purchased and securities sold under agreements to repurchase
2.04
4.72
4.58 Capital markets trading liabilities
4.73
5.42
5.68 Commercial paper and other short-term borrowings
2.33
4.83
5.04 Long-term debt
3.56
5.67
5.55 Rates paid on interest-bearing liabilities
2.74
4.72
4.54 Net interest spread
2.55
2.19
2.31 Effect of interest-free sources
.40
.63
.62 FHN – NIM
2.95
%
2.82
%
2.93
% Certain previously reported amounts have been reclassified to agree with current presentation. In the short term, the net interest margin is expected to remain under pressure as deposit pricing remains challenging. In the longer term, net interest margin should be positively influenced by the reduction of lower margin national businesses. Table 3 shows how the changes in yields or rates and average balances compared to the prior year affected net interest income. 12 FIRST HORIZON NATIONAL CORPORATION
Table 3 - Analysis of Changes in Net Interest Income
(Fully taxable equivalent)
2008 Compared to 2007
2007 Compared to 2006
Rate**
Volume**
Total
Rate**
Volume**
Total Interest income – FTE: Loans
$
(436,294
)
$
(31,897
)
$
(468,191
)
$
(13,408
)
$
44,300
$
30,892 Loans held for sale
(24,906
)
(77,126
)
(102,032
)
(4,394
)
(30,181
)
(34,575
) Investment securities: U.S. Treasury
(1,848
)
(1,859
)
(3,707
)
62
2,033
2,095 U.S. government agencies
(3,297
)
(22,740
)
(26,037
)
5,919
(7,161
)
(1,242
) States and municipalities
328
1,517
1,845
(6
)
(1
)
(7
) Other
1,092
741
1,833
(48
)
(739
)
(787
) Total investment securities
(3,591
)
(22,475
)
(26,066
)
5,635
(5,576
)
59 Capital markets securities inventory
(14,318
)
(31,176
)
(45,494
)
(881
)
(11,708
)
(12,589
) Mortgage banking trading securities
3,118
(17,029
)
(13,911
)
6,251
9,478
15,729 Other earning assets: Federal funds sold and securities purchased under agreements to resell
(34,953
)
(7,747
)
(42,700
)
2,559
(26,012
)
(23,453
) Interest-bearing deposits with other financial institutions
(2,608
)
2,432
(176
)
291
2
293 Total other earning assets
(40,893
)
(1,983
)
(42,876
)
2,961
(26,121
)
(23,160
) Total earning assets/total interest income – FTE
(507,383
)
(191,188
)
$
(698,570
)
20,218
(43,862
)
$
(23,644
) Interest expense: Interest-bearing deposits: Savings
$
(56,064
)
$
20,031
$
(36,033
)
$
16,279
$
11,165
$
27,444 Time deposits
(19,764
)
(15,582
)
(35,346
)
11,268
5,027
16,295 Other interest-bearing deposits
(11,594
)
(396
)
(11,990
)
1,407
(33
)
1,374 Total interest-bearing core deposits
(93,785
)
10,417
(83,369
)
30,000
15,113
45,113 Certificates of deposit $100,000 and more
(86,029
)
(206,992
)
(293,021
)
27,709
(151,572
)
(123,863
) Federal funds purchased and securities sold under agreements to repurchase
(104,633
)
(54,624
)
(159,257
)
6,600
13,581
20,181 Capital markets trading liabilities
(6,102
)
(12,219
)
(18,321
)
(3,363
)
(21,184
)
(24,547
) Other short term borrowings and commercial paper
(48,641
)
103,392
54,751
(1,696
)
26,674
24,978 Long-term debt
(130,088
)
(24,369
)
(154,457
)
6,058
85,225
91,283 Total interest-bearing liabilities/total interest expense
(527,686
)
(125,987
)
$
(653,674
)
51,931
(18,786
)
$
33,145 Net interest income – FTE
$
(44,896
)
$
(56,789
)
*
The changes in interest due to both rate and volume have been allocated to change due to rate and change due to volume in proportion to the absolute amounts of the changes in each. ** Variances are computed on a line-by-line basis and are non-additive. NONINTEREST INCOME Noninterest income contributed 62 percent to total revenue in 2008 compared to 48 percent in 2007 and increased $631.4 million to $1.5 billion in 2008. Impacting this increase were mortgage banking and capital markets noninterest income and securities gains which were partially offset by declines in loan sale
and securitization income and loss on divestitures related to restructuring, repositioning and efficiency initiatives. Table 4 provides six years of detailed information concerning FHN’s noninterest income. The following discussion provides additional information about various line items reported in the table. 13 FIRST HORIZON NATIONAL CORPORATION
(Dollars in thousands)
Increase/(Decrease) Due to*
Increase/(Decrease) Due to*
Table 4 - Noninterest Income
(Dollars in thousands)
2008
2007
2006
2005
2004
2003
Compound
08/07
08/03 Noninterest income: Capital markets
$
524,420
$
334,371
$
383,047
$
353,005
$
376,558
$
538,919
56.8
+
* Deposit transactions and cash management
179,034
175,271
168,599
156,190
148,511
146,696
2.1
+
4.1
+ Mortgage banking
518,034
69,454
370,613
479,619
444,758
649,496
645.9
+
4.4
- Trust services and investment management
33,821
40,335
41,514
44,614
47,274
45,873
16.1
-
5.9
- Insurance commissions
29,104
31,739
46,632
54,091
56,109
57,811
8.3
-
12.8
- Gains/(losses) from loan sales and securitizations
(8,625
)
23,881
51,675
47,575
23,115
-
136.1
-
NM Equity securities gains/(losses), net
65,349
(7,475
)
10,271
(579
)
2,040
8,491
974.2
+
50.4
+ Debt securities gains/(losses), net
761
6,292
(75,900
)
1
18,708
(6,113
)
87.9
-
165.9
+ Gains/(losses) on divestitures
(19,019
)
15,695
-
7,029
1,200
12,498
221.2
-
208.8
- All other income and commissions: Brokerage management fees and commissions
32,234
37,830
37,182
30,865
28,590
23,215
14.8
-
6.8
+ Bank-owned life insurance
25,143
25,172
19,064
16,335
12,842
13,763
*
12.8
+ Bankcard income
22,081
24,874
26,105
27,136
24,993
22,587
11.2
-
* Other service charges
12,630
14,296
14,561
14,330
11,498
11,720
11.7
-
1.5
+ Remittance processing
12,953
13,451
14,737
15,411
19,515
23,666
3.7
-
11.4
- Reinsurance fees
11,919
9,052
6,792
5,850
5,913
6,224
31.7
+
13.9
+ ATM interchange fees
9,224
8,472
7,091
5,995
4,973
4,113
8.9
+
17.5
+ Deferred compensation (a)
(22,901
)
7,727
14,647
7,721
8,633
4,575
396.4
-
238.0
- Letter of credit fees
5,657
6,738
7,271
7,883
6,793
4,944
16.0
-
2.7
+ Electronic banking fees
6,217
6,561
5,975
5,977
6,071
6,311
5.2
-
* Check clearing fees
3,125
4,896
6,385
7,333
10,052
11,839
36.2
-
23.4
- Federal flood certifications
3,645
4,797
4,996
9,359
5,375
4,161
24.0
-
2.6
- Gain on early extinguishment
33,845
-
-
-
-
-
NM
NM Other
12,662
6,520
5,636
11,516
18,310
8,608
94.2
+
8.0
+ Total all other income and commissions
168,434
170,386
170,442
165,711
163,558
145,726
1.1
-
2.9
+ Total noninterest income
$
1,491,313
$
859,949
$
1,166,893
$
1,307,256
$
1,281,831
$
1,599,397
73.4
+
1.4
- NM – not meaningful * Amount is less than one percent. (a) Deferred compensation market value adjustments are offset by a reduction to noninterest other expense. Capital Markets Noninterest Income The major component of revenue in the Capital Markets segment is generated from the purchase and sale of securities as both principal and agent, and from other fee sources including equity research, loan sales, portfolio advisory activities and structured finance. Securities inventory positions are generally
procured for distribution to customers by the sales staff. A portion of the inventory is hedged to protect against movements in fair value due to changes in interest rates. Capital markets noninterest income increased to $524.4 million in 2008 from $334.4 million in 2007. Revenues from other products represented only 6 percent of total noninterest income in 2008 compared to 35 percent in 2007. These revenues decreased $86.1 million primarily due to decreased fees from
structured finance activities. Revenues from fixed income sales increased $276.1 million from 2007 due primarily to a steepened yield curve, market volatility and other factors. 14 FIRST HORIZON NATIONAL CORPORATION
Annual Growth
Rates (%)
of debt
Table 5 - Capital Markets Noninterest Income
(Dollars in thousands)
2008
2007
2006
Compound
Annual
08/07
08/06 Noninterest income: Fixed income
$
493,836
$
217,700
$
180,183
126.8
+
65.6
+ Other product revenue
30,584
116,671
202,864
73.8
-
61.2
- Total capital markets noninterest income
$
524,420
$
334,371
$
383,047
56.8
+
17.0
+ Mortgage Banking Noninterest Income Effective August 31, 2008, FHN completed the sale of Mortgage Banking’s servicing operations, origination offices outside of Tennessee and $19.1 billion of servicing to MetLife. As a result of this transaction, origination activity for 2008 is significantly lower when compared to 2007. Prior to the third quarter 2008
sale of the national origination offices, First Horizon Home Loans, a former division of FTBNA, offered residential mortgage banking products and services to customers, which consisted primarily of the origination or purchase of single-family residential mortgage loans. First Horizon Home Loans originated mortgage
loans through its retail and wholesale operations for sale to secondary market investors and subsequently serviced the majority of those loans. Although origination activity has declined substantially since the sale of the national mortgage offices, FHN continues to service, through a sub-servicing arrangement, the
remaining portfolio. Table 6 provides a summary of First Horizon Home Loans’ production/origination of mortgage loans through December 31, 2008, 2007 and 2006. Table 6 - Production/Origination of Mortgage Loans
2008
2007
2006 Retail channel
44
%
53
%
57
% Wholesale channel
53
47
40 Correspondent brokers
3
-
3 Mortgage banking noninterest income increased by $448.5 million in 2008 to $518.0 million from $69.5 million in 2007 as shown in Table 7. Prior to adoption of new accounting standards in 2008, origination income included origination fees, net of costs, gains/(losses) recognized on loans sold including the capitalized fair value of MSR, and the value recognized on loans in process including results from hedging. Origination fees, net of costs (including
incentives and other direct costs), were deferred and included in the basis of the loans in calculating gains and losses upon sale. Gain or loss was recognized due to changes in fair value of an interest rate lock commitment made to the customer. Gains or losses from the sale of loans were recognized at the time a
mortgage loan was sold into the secondary market. See Critical Accounting Policies and Note 1 – Summary of Significant Accounting Policies for more discussion of the effects of adopting the new accounting standards. Upon adoption of the new accounting standards, origination income includes origination fees, fair value and LOCOM adjustments of the warehouse, gains/(losses) recognized on loans sold including the capitalized fair value of MSR, and the value recognized on loans in process including results from hedging. Upon
election of fair value accounting for substantially all warehouse loans, the value recognized on these loans includes changes in investor prices, MSR and concessions. The related origination fees are no longer deferred but recognized in origination income upon closing of a loan. Net revenue from origination activity increased 89 percent to $223.6 million in 2008 from $118.4 million in 2007 as 2007 was negatively impacted by secondary market disruptions since credit and liquidity risk in the pipeline and warehouse were not hedged. Gain on sale margins were impacted as a result of
significant spread widening on ARM and nonagency eligible production. Origination income in 2008 was impacted by several factors. The 15 FIRST HORIZON NATIONAL CORPORATION
Growth Rates (%)
adoption of accounting standards in the first quarter, including the fair value election for substantially all mortgage warehouse loans, positively impacted gross origination income by $142.2 million. The third quarter 2008 sale of national origination offices to MetLife significantly reduced origination volumes as
compared to 2007 with originations continuing only within FHN’s regional banking footprint. Also in third quarter, origination income was negatively impacted by a $15.5 million charge related to amounts owed to private mortgage insurers on loans previously sold. 2008 origination income was also negatively
impacted by a $15.2 million valuation adjustment of the remaining mortgage warehouse in the fourth quarter. Servicing income includes servicing fees and net gains or losses from hedging MSR. Mortgage servicing noninterest income reflects the change in the fair value of the MSR asset combined with net economic hedging results. FHN employs hedging strategies intended to counter changes in the value of MSR and
other retained interests due to changing interest rate environments (refer to discussion of MSR under Critical Accounting Policies). Net servicing income increased $360.8 million in 2008 from a net servicing loss of $68.9 million in 2007. Through various servicing portfolio sales executed in 2008, including the $19.1 billion sale to MetLife in the third quarter, the servicing portfolio decreased to $63.7 billion compared to $103.7 billion on December 31, 2007. The sales reduced servicing assets by $485.8 million. Consistent with the decline in the
servicing portfolio, total fees associated with mortgage servicing decreased 26 percent to $231.9 million from $311.4 million. Changes in MSR due to runoff positively impacted servicing income in 2008 compared to 2007 by $109.7 million as the size of the portfolio declined. Changes in MSR value other than
runoff (valuation model inputs or assumptions) negatively impacted net servicing revenues by $384.2 million in 2008 compared to $235.0 million in 2007 as lower interest rates increased prepayment speeds. However, lower interest rates positively impacted servicing hedge gains by $548.8 million in 2008 compared
to $73.2 million in 2007 increasing 2008 net servicing income to $292.0 million compared to a net servicing loss of $68.9 million in 2007. Table 7 - Mortgage Banking Noninterest Income
2008
2007
2006
Compound Annual
08/07
08/06 Noninterest income (thousands): Origination income
$
223,596
$
118,436
$
308,099
88.8
+
14.8
- Servicing (expense)/income
291,962
(68,857
)
37,517
524.0
+
179.0
+ Other
2,477
19,875
24,997
87.5
-
68.5
- Total mortgage banking noninterest income
$
518,035
$
69,454
$
370,613
645.9
+
18.2
+ Mortgage banking statistics (millions): Refinance originations
$
8,975.9
$
10,872.2
$
10,226.7
17.4
-
6.3
- Home-purchase originations
8,465.9
16,502.9
16,887.6
48.7
-
29.2
- Mortgage loan originations
$
17,441.8
$
27,375.1
$
27,114.3
36.3
-
19.8
- Servicing portfolio - owned
$
63,660.7
$
103,708.7
$
101,369.2
38.6
-
20.8
- Other income includes FHN’s share of earnings from nonconsolidated subsidiaries accounted for under the equity method, which provided ancillary activities to mortgage banking, and fees from retail construction lending. FHN’s interests in these nonconsolidated subsidiaries were transferred to MetLife in the third
quarter 2008. In the fourth quarter 2008, other mortgage banking income was negatively impacted by the recognition of a $6.5 million liability for minimum fee guarantees on prior servicing sales. Management continues to explore additional opportunities for balance sheet repositioning and the redeployment of capital which includes a reduction of the servicing portfolio and associated MSR. Generally, revenues from mortgage originations and mortgage servicing are principally impacted by interest rates.
Specifically, an increase in interest rates should reduce origination income but increase servicing revenues due to reduced overall originations and the slow down of prepayments, respectively. Weakening of the housing market should decrease origination income but a resulting decrease in payoffs could increase
servicing income. Due to the sale of the national 16 FIRST HORIZON NATIONAL CORPORATION
Growth Rates (%)
origination offices to MetLife, interest rate exposure on origination income will be less significant. In future periods, actual results could differ because of several factors, including those presented in the Forward-Looking Statements section of the MD&A discussion. Deposit Transactions and Cash Management Deposit transactions include services related to retail deposit products (such as service charges on checking accounts), cash management products and services such as electronic transaction processing (automated clearing house and Electronic Data Interchange), account reconciliation services, cash vault services,
lockbox processing, and information reporting to large corporate clients. Noninterest income from deposit transactions and cash management increased to $179.0 million in 2008 from $175.3 million in 2007, reflecting increased corporate cash management fees from lower customer earnings credits. Gains/(Losses) from Loan Sales and Securitizations Gains/(losses) from loan sales and securitizations include net gains recognized on HELOC and second-lien mortgage loans sold, including changes in the fair value of MSR, servicing fees, and gains or losses related to fair value adjustments on retained interests classified as mortgage trading securities. Noninterest
income from loan sales and securitizations decreased to a loss of $8.6 million in 2008 compared to gains of $23.9 million in 2007. The decrease is primarily due to market disruptions beginning in 2007 which resulted in no second-lien or HELOC loan sales in 2008, an increase in HELOC residual write-downs, and
a decrease in servicing fees resulting from run off and a smaller servicing portfolio. Insurance Commissions Insurance commissions are derived from the sale of insurance products, including acting as an independent agent to provide commercial and personal property and casualty, life, long-term care, and disability insurance. Noninterest income from insurance commissions decreased to $29.1 million in 2008 from $31.7
million in 2007 primarily due to a soft property and casualty market and a decline in mortgage related insurance sales. Trust Services and Investment Management Trust services and investment management fees include investment management, personal trust, employee benefits, and custodial trust services and are influenced by equity and fixed income market activity. Noninterest income from trust services and investment management was $33.8 million in 2008 compared
to $40.3 million in 2007 due to market related declines in trust asset values. Gains/(Losses) on Divestitures In 2008, losses from divestitures were $19.0 million and were related to the sale of mortgage banking operations and certain First Horizon Bank branches. Gains from divestitures in 2007 were $15.7 million and were related to the sale of certain First Horizon Bank branches. See the discussion of Restructuring,
Repositioning and Efficiency Initiatives for further details. Securities Gains/(Losses) Net securities gains in 2008 were $66.1 million and primarily related to the redemption of FHN’s Class B shares in connection with Visa Inc.’s IPO which resulted in a gain of $65.9 million. Net securities losses of $1.2 million in 2007 primarily related to changes in the investment portfolio that were made to
compensate for loan growth in first quarter which were offset by impairment charges related to securities that, in the opinion of management, have been other-than-temporarily impaired. All Other Income and Commissions All other income, which includes brokerage management fees and commissions, bankcard fees, revenue from bank-owned life insurance, remittance processing income, revenue related to deferred compensation plans (which 17 FIRST HORIZON NATIONAL CORPORATION
are principally offset by a related item in noninterest expense), other service charges, and various other fees (see Table 4 for additional detail) was $168.4 million in 2008 compared to $170.4 million in 2007. Other income was positively impacted by $33.8 million of debt repurchase gains and an increase in
reinsurance fees. Offsetting these increases was a $30.6 million decrease in income related to deferred compensation plans and a $5.6 million decline in brokerage fees and commissions which were impacted by market conditions. All other components decreased slightly. In 2007, other income was negatively
impacted by $16.8 million related to LOCOM and other consumer lending (HELOC and second-lien) adjustments. NONINTEREST EXPENSE Total noninterest expense for 2008 decreased 10 percent to $1.7 billion from $1.8 billion in 2007. Table 8 provides detail by segment. Table 9 provides detail by category for the past six years with growth rates. Employee compensation, incentives and benefits (personnel expense), the largest component of noninterest expense, decreased $7.2 million from $968.1 million in 2007. Personnel expense was impacted by restructuring, repositioning, and efficiency initiatives previously discussed and increased costs related to
higher capital markets production. These results also reflect reductions in personnel expense in Mortgage Banking and National Specialty Lending directly related to the contraction in revenue. Included in personnel expense is the net periodic benefit cost for FHN’s pension plan of $1.7 million in 2008, as compared
to $10.9 million in 2007. Based on current conditions, FHN anticipates that net periodic benefit cost for the Pension Plan will increase by $9.1 million in 2009 from losses experienced on assets in the qualified pension plan and a decrease in the discount rate. Occupancy costs decreased 20 percent or $26.2 million primarily due to the sale of certain Mortgage Banking operations to MetLife in 2008. Restructuring related charges included in occupancy expense decreased $6.2 million from 2007. Equipment rentals, depreciation and maintenance, communications and
courier, intangible amortization, and all other expense experienced declines consistent with FHN’s focus on restructuring and efficiency initiatives. In 2007, goodwill impairments totaled $84.1 million; including a $71.1 million impairment related to the Mortgage Banking segment goodwill and $13.0 million related to
First Horizon Bank branches. There were no goodwill impairments in 2008. All other noninterest expense decreased $57.4 million in 2008 despite a $25.4 million increase in loan closing costs related to the fair value election for substantially all mortgage warehouse loans. As a result of this election, such costs are immediately recognized compared to previously being deferred and included
in mortgage banking income. Losses and expenses related to foreclosed real estate increased by $17.0 million consistent with declines in the real estate market and increased defaults on insured mortgages resulted in a $16.5 million increase in reinsurance reserves. Contract employment expenses increased by
$12.0 million largely due to higher outsourcing costs in 2008. Deposit insurance premiums increased $11.3 million from 2007. In 2007, a $55.7 million charge was taken to reflect FHN’s proportionate share of Visa, Inc.’s various legal matters while $30.0 million of the charge was reversed in 2008. All other
expense categories decreased consistent with FHN’s focus on efficiency initiatives and reduction of non-core businesses. Table 8 - Noninterest Expense Composition
(Dollars in thousands)
2008
2007
2006 Regional Banking
$
627,273
$
631,356
$
659,790 Capital Markets
418,916
328,062
358,901 National Specialty Lending
97,181
138,077
161,335 Mortgage Banking
425,148
503,207
476,862 Corporate
87,534
242,731
85,733 Total noninterest expense
$
1,656,052
$
1,843,433
$
1,742,621 Certain previously reported amounts have been reclassified to agree with current presentation. 18 FIRST HORIZON NATIONAL CORPORATION
Table 9 - Noninterest Expense
(Dollars in thousands)
2008
2007
2006
2005
2004
2003
Compound
Annual
08/07
08/03 Noninterest expense: Employee compensation, incentives and benefits
$
960,917
$
968,122
$
1,023,685
$
988,946
$
899,803
$
1,004,754
*
* Occupancy
104,968
131,173
116,670
104,161
87,570
81,832
20.0
-
5.1
+ Operations services
77,474
74,200
70,041
71,949
59,642
59,210
4.4
+
5.5
+ Legal and professional fees
63,718
56,882
43,012
43,734
36,730
58,967
12.0
+
1.6
+ Equipment rentals, depreciation and maintenance
57,069
72,926
73,882
74,367
70,400
67,019
21.7
-
3.2
- Communications and courier
39,863
43,909
53,249
54,388
47,930
49,122
9.2
-
4.1
- Amortization of intangible assets
8,229
10,959
11,462
10,700
6,157
5,256
24.9
-
9.4
+ Goodwill Impairment
-
84,084
-
-
-
-
NM
NM All other expense: Computer software
30,389
53,942
34,381
28,542
26,719
27,107
43.7
-
2.3
+ Advertising and public relations
33,014
42,346
47,427
46,321
39,846
43,836
22.0
-
5.5
- Travel and entertainment
17,371
26,099
32,306
31,022
29,914
36,348
33.4
-
13.7
- Low income housing expense
18,734
20,922
17,027
12,987
13,662
12,132
10.5
-
9.1
+ Contract employment
33,545
21,543
27,420
30,344
23,722
34,389
55.7
+
0.5
- Distributions on preferred stock of subsidiary
13,989
18,799
18,146
10,757
-
2,282
25.6
-
43.7
+ Foreclosed real estate
33,002
16,048
4,384
3,933
5,834
13,137
105.6
+
20.2
+ Supplies
10,740
13,909
15,072
17,290
17,185
18,541
22.8
-
10.3
- Loan closing costs
38,221
12,783
12,095
7,969
18,623
3,691
199.0
+
59.6
+ Customer relations
8,875
9,801
8,688
9,868
9,167
7,602
9.4
-
3.1
+ Other insurance and taxes
6,848
8,841
8,615
9,349
8,744
10,122
22.5
-
7.5
- Employee training and dues
6,286
6,562
6,917
6,268
5,956
5,559
4.2
-
2.5
+ Fed service fees
7,053
6,047
6,543
7,568
8,838
9,195
16.6
+
5.2
- Complimentary check expense
4,776
5,058
5,371
4,621
3,482
3,168
5.6
-
8.6
+ Loan insurance expense
5,270
4,610
6,577
7,970
8,070
6,710
14.3
+
4.7
- Bank examinations costs
4,144
4,504
4,367
3,958
3,128
3,150
8.0
-
5.6
+ Deposit insurance premium
14,664
3,327
3,198
3,012
3,024
2,703
340.8
+
40.2
+ Distributions on guaranteed preferred securities
-
-
-
-
-
8,070
NM
NM Other
56,893
126,037
92,086
36,870
27,662
70,062
54.9
-
4.1
- Total all other expense
343,814
401,178
350,620
278,649
253,576
317,804
14.3
-
1.6
+ Total noninterest expense
$
1,656,052
$
1,843,433
$
1,742,621
$
1,626,894
$
1,461,808
$
1,643,964
10.2
-
* NM – not meaningful 19 FIRST HORIZON NATIONAL CORPORATION
Growth Rates (%)
* Amount is less than one percent.
PROVISION FOR LOAN LOSSES The provision for loan losses is the charge to earnings that management determines to be necessary to maintain the allowance for loan and lease losses (ALLL) at a sufficient level reflecting management’s estimate of probable incurred losses in the loan portfolio. Analytical models based on loss experience adjusted
for current events, trends, and economic conditions are used by management to determine the amount of provision to be recognized and to assess the adequacy of the loan loss allowance. In response to economic conditions beginning in 2007, FHN conducted focused portfolio management activities to identify
problem credits and to reach appropriate provisioning and reserve levels. The provision for loan losses increased 296 percent to $1.1 billion in 2008 from $272.8 million in 2007. While all portfolios were affected by the weakening real estate markets and the general decline in economic conditions in 2008, the
increase primarily reflects deterioration in the national residential and commercial real estate construction portfolios (one-time close retail real estate construction loans extended to consumers and loans to homebuilders, including condominium construction loans). See Credit Risk Management and Allowance for Loan
Losses and Charge-offs for further details. Going forward, the level of provision for loan losses will fluctuate based upon the level of performance in the loan portfolios and will be affected by economic conditions. INCOME TAXES The effective tax rate for 2008 and 2007 was 45 percent, reflecting the tax rate effect of the reported loss in 2008. The effective tax rate for 2007 was negatively impacted by the impairment of goodwill related to Mortgage Banking and First Horizon Bank branches. The effective tax rates for both years were
favorably impacted by affordable housing tax credits, settlements of certain prior year’s tax examinations and the tax effects of increases in the cash surrender value of life insurance. Tax rates were negatively affected by the tax effects of preferred stock dividends. FHN and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states’ jurisdictions. With few exceptions, FHN is no longer subject to U.S. federal or state and local income tax examinations by tax authorities for years 2004 and prior. The Internal Revenue Service (IRS) has completed its
examination of all U.S. federal returns through 2004 which are closed under the statute. All proposed adjustments with respect to examinations of federal returns filed for 2004 and prior years have been settled. FHN adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48), on January 1, 2007. As a result of the implementation of FIN 48, FHN recognized a $.9 million increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the
January 1, 2007, balance of undivided profits. The total balance of unrecognized tax benefits at December 31, 2007, was $31.6 million and has decreased to $31.1 million as of December 31, 2008. First Horizon does not expect that unrecognized tax benefits will significantly increase or decrease during 2009. On December 31, 2008, there were no tax positions included in the balance of unrecognized tax benefits for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. FHN’s FIN 48 policy is to recognize accrued interest and penalties related to unrecognized tax benefits as a component of tax expense. Interest accrued as of December 31, 2008 was approximately $6 million. The total amount of interest and penalties recognized in the Consolidated Statements of Income during
2008 was $1.7 million. See also Note 16 – Income Taxes for additional information. DISCONTINUED OPERATIONS Performance in 2008 was favorably impacted by $.9 million related to an earn-out associated with the merchant processing divestiture. On March 1, 2006, FHN sold its national merchant processing business for an after-tax gain of $209.0 million. This divestiture was accounted for as a discontinued operation, and
accordingly, current and prior periods were adjusted to exclude the impact of merchant operations from the results of continuing operations. 20 FIRST HORIZON NATIONAL CORPORATION
STATEMENT OF CONDITION REVIEW – 2008 COMPARED TO 2007 Total assets were $31.0 billion on December 31, 2008, compared to $37.0 billion on December 31, 2007. Average assets decreased to $34.4 billion in 2008 from $38.2 billion in 2007 due to continued efforts to reduce balance sheet risk. Effective January 1, 2008, upon adoption of Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS No. 159), FHN elected the fair value option on a prospective basis for almost all types of mortgage loans originated for sale purposes. Such
loans are carried at fair value, with changes in the fair value of these loans recognized in the mortgage banking noninterest income section of the Consolidated Statements of Income. After adoption of SFAS No. 159, FHN continued to account for all mortgage loans held for sale which were originated prior to 2008
and for mortgage loans held for sale for which fair value accounting was not elected at the lower of cost or market value. For such loans, net origination fees and costs were deferred and included in the basis of the loans in calculating gains and losses upon sale. Also included in the basis of first-lien mortgage
loans was the value accreted during the time that the loan was a locked commitment. The cost basis of loans qualifying for fair value hedge accounting under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS No. 133), was adjusted to
reflect changes in fair value. Gains and losses realized from the sale of these assets were included in noninterest income. Interests retained from the sale of such loans are included as a component of trading securities on the Consolidated Statements of Condition. Effective January 1, 2008, FHN adopted SEC Staff Accounting Bulletin No. 109, “Written Loan Commitments Recorded at Fair Value Through Earnings” (SAB No. 109) prospectively for derivative loan commitments issued or modified after that date. SAB No. 109 rescinds SAB No. 105’s prohibition on inclusion of
expected net future cash flows related to loan servicing activities in the fair value measurement of a written loan commitment. SAB No. 109 also applies to any loan commitments for which fair value accounting is elected under SFAS No. 159. FHN did not elect fair value accounting for any other loan commitments
under SFAS No. 159. The prospective application of SAB No. 109 and the prospective election to recognize substantially all new mortgage loan originations at fair value under SFAS No. 159 resulted in a positive net impact of $1.0 million on 2008 pre-tax earnings. Effective January 1, 2008, FHN adopted SFAS No. 157, “Fair Value Measurements” (SFAS No. 157) for existing fair value measurement requirements related to financial assets and liabilities as well as to non-financial assets and liabilities which are remeasured at least annually. In February 2008, the FASB staff
issued FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157” (FSP FAS 157-2), which delayed the effective date of SFAS No. 157 until fiscal years beginning after November 15, 2008, for non-financial assets and liabilities which are recognized at fair value on a non-recurring basis. SFAS
No. 157 establishes a hierarchy to be used in performing measurements of fair value. Additionally, SFAS No. 157 emphasizes that fair value should be determined from the perspective of a market participant while also indicating that valuation methodologies should first reference available market data before using
internally developed assumptions. SFAS No. 157 also provides expanded disclosure requirements regarding the effects of fair value measurements on the financial statements. Upon the adoption of the provisions of SFAS No. 157 for financial assets and liabilities as well as non-financial assets and liabilities
remeasured at least annually on January 1, 2008, a negative after-tax cumulative-effect adjustment of $12.5 million was made to the opening balance of undivided profits for interest rate lock commitments which FHN previously measured under the guidance of EITF 02-3, “Issues Involved in Accounting for
Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities” (EITF 02-3). The effect of the change in accounting for these interest rate lock commitments produced a positive effect of $19.4 million on 2008 pre-tax earnings as existing commitments were
delivered as loans and additional commitments that would have been deferred under EITF 02-3 were made. Substantially all commitments existing at August 31, 2008 were sold to MetLife. Application of SFAS No. 157 to non-financial assets and liabilities which are recognized at fair value on a non-recurring basis
is not expected to be significant to FHN. Effective January 1, 2008, FHN adopted EITF Issue No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements” (EITF 06-4). EITF 06-4 requires that a liability be recognized for contracts written to employees which provide future
postretirement benefits that are covered by endorsement split-dollar life insurance arrangements because such obligations are not considered to be effectively settled upon entering into the related insurance arrangements. FHN recognized a decrease to undivided profits of $8.5 million, net of tax, upon adoption of
EITF 06-4. 21 FIRST HORIZON NATIONAL CORPORATION
EARNING ASSETS Earning assets consist of loans, loans held for sale, investment securities, trading securities and other earning assets. Earning assets averaged $30.4 billion and $33.4 billion for 2008 and 2007, respectively. A more detailed discussion of the major line items follows. Loans Average loans decreased 2 percent to $21.7 billion during 2008 driven by elevated charge-offs and declines in both commercial and consumer construction portfolios as FHN discontinued loan origination through its national construction lending channel. Average loans were $22.1 billion during 2007. Average loans
represented 71 percent of average earning assets in 2008 and 66 percent in 2007. Additional loan information is provided in Table 10 and Note 4 – Loans. Table 10 - Average Loans
(Dollars in millions)
2008
Percent
2008
2007
Percent
2007
2006
Percent Commercial: Commercial, financial and industrial
$
7,346.4
34
%
3.3 %
$
7,109.9
32
%
6.5 %
$
6,674.9
31
% Real estate commercial (a)
1,431.8
6
12.6
1,271.4
6
3.9
1,223.2
6 Real estate construction (b)
2,317.3
11
(19.1)
2,865.8
13
15.8
2,475.5
11 Total commercial
11,095.5
51
(1.3)
11,247.1
51
8.4
10,373.6
48 Retail: Real estate residential (c)
7,998.9
37
3.3
7,741.2
35
(8.7)
8,481.2
39 Real estate construction (d)
1,501.7
7
(28.4)
2,095.9
9
3.0
2,034.9
10 Other retail
139.1
1
(6.8)
149.3
1
(7.8)
162.0
1 Credit card receivables
193.2
1
(1.6)
196.4
1
(6.2)
209.4
1 Real estate loans pledged against other collateralized borrowings (e)
732.3
3
8.2
676.8
3
NM
243.1
1 Total retail
10,565.2
49
(2.7)
10,859.6
49
(2.4)
11,130.6
52 Total loans, net of unearned
$
21,660.7
100
%
(2.0)%
$
22,106.7
100
%
2.8 %
$
21,504.2
100
%
(a)
Includes nonconstruction income property loans and land loans not involving development. (b) Includes homebuilder, condominium, income property construction and land development loans. (c) Includes primarily home equity loans and lines of credit (average for 2008, 2007, and 2006 $3.7 billion, $3.9 billion and $4.9 billion, respectively). (d) Includes one-time close product. (e) Includes on-balance sheet securitizations of home equity loans. Commercial, financial and industrial (C&I) loans comprised 66 percent of total commercial loans in 2008 as compared to 63 percent in 2007. The C&I portfolio was primarily generated by the Regional Bank and is diversified across industry types. This portfolio grew $236.5 million or 3 percent in 2008 primarily as a
result of approximately $340 million, net of LOCOM, of smaller issuer trust preferred loans that were moved to the loan portfolio in the second quarter of 2008. Income commercial real estate (Income CRE) includes loans for the construction and mini-permanent financing of traditional commercial real estate property types, including office, multi-family, industrial and retail space. Residential commercial real estate (Residential CRE) includes loans to homebuilders and
condominium developers. Both are included in the commercial real estate commercial and commercial real estate construction line items in Table 10 above. In 2008, Income CRE and Residential CRE averaged $3.7 billion as compared to $4.1 billion in 2007. Income CRE loans increased $133.5 million or 7 percent which was the result of loan growth in the first half of 2008 and comprised 19 percent of total commercial loans. Average loan growth in 2008 was largely generated within the Regional Bank. 22 FIRST HORIZON NATIONAL CORPORATION
of Total
Growth
Rate
of Total
Growth
Rate
of Total
Residential CRE consists of loans to developers to finance land, land acquisition and development, and vertical construction of attached and detached single family residences (including condominiums). Residential CRE comprised 15 percent of commercial loans in 2008. Approximately two-thirds of the Residential
CRE portfolio was generated by the national construction lending platform, with the remaining through the Regional Bank. Residential CRE loans decreased 24 percent or $541.2 million from 2007 due to the wind-down of national construction lending products and higher charge-offs since 2007. Additional
commercial loan information is provided in Table 11. Residential real estate loans (inclusive of real estate loans pledged against other collateralized borrowings) comprised 83 percent of the retail loan portfolio in 2008 and 78 percent in 2007. This category of loans includes first and second-lien home equity lines and loans and residential first mortgages. This portfolio
increased 4 percent or $313.2 million as a result of approximately $600 million of permanent mortgages that were transferred from held for sale to the loan portfolio throughout 2008. The one time close (OTC) portfolio comprised 14 percent of the retail portfolio in 2008 compared to 19 percent in 2007 and
contracted by $594.2 million consistent with the discontinuation of national construction lending. These loans were provided for construction and permanent mortgage financing to individuals for the purpose of constructing a home. The credit card and other retail portfolios (automobile and other retail installment loans requiring periodic payments of principal and interest) are relatively modest in size and declined 4 percent in 2008. The commercial and retail construction and home equity portfolios are expected to continue to contract in 2009 due to conditions in the housing market and FHN’s strategic goal to reduce real estate concentrations in general. This contraction will likely more than offset new loan production. Table 11 - Contractual Maturities of Commercial Loans on December 31, 2008
(Dollars in thousands)
Within 1 Year
After 1 Year
After 5 Years
Total Commercial, financial and industrial
$
3,824,664
$
2,931,638
$
1,107,425
$
7,863,727 Real estate commercial
595,840
687,174
171,026
1,454,040 Real estate construction
1,443,699
334,441
-
1,778,140 Total commercial loans, net of unearned income
$
5,864,203
$
3,953,253
$
1,278,451
$
11,095,907 For maturities over one year: Interest rates – floating
$
2,817,344
$
647,299
$
3,464,643 Interest rates – fixed
1,135,909
631,152
1,767,061 Total
$
3,953,253
$
1,278,451
$
5,231,704 Investment Securities The investment portfolio of FHN consists principally of debt securities used as a source of income, liquidity and collateral for repurchase agreements or public fund deposits. Additionally, the investment portfolio is used as a tool to manage risk from movements in interest rates. As of December 31, 2008, all
securities in the portfolio were classified as available-for-sale (AFS). Table 12 shows information pertaining to the composition, yields and contractual maturities of the investment securities portfolio. Investment securities averaged $3.0 billion in 2008 compared to $3.4 billion in 2007 and represented 10 percent of earning assets in both 2008 and 2007. On December 31, 2008, AFS securities totaled $3.1 billion and consisted of government agency issued mortgage-backed securities (MBS), government agency issued collateralized mortgage obligations (CMO), U.S. Treasuries, U.S. government agencies, municipal bonds, and equity securities. On December 31,
2008, these securities had $69.2 million of net unrealized gains that resulted in an increase in book equity of $42.8 million, net of $26.4 million of deferred income taxes. See Note 3 – Investment Securities for additional detail. On December 31, 2007, AFS securities totaled $3.0 billion and had $33.5 million of net
unrealized gains that resulted in an increase in book equity of $20.5 million, net of $13.0 million of deferred income taxes. 23 FIRST HORIZON NATIONAL CORPORATION
Within 5 Years
Table 12 - Contractual Maturities of Investment Securities on December 31, 2008 (Amortized Cost)
(Dollars in thousands)
Within 1 Year
After 1 Year
After 5 Years
After 10 Years
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield Total securities held to maturity
$
-
-
%
$
-
-
%
$
-
-
%
$
-
-
% Securities available for sale (AFS): Government agency issued MBS
$
-
-
%
$
-
-
%
$
135,913
6.16
%
$
2,385,073
6.04
% U.S. Treasuries
7,995
0.73
39,916
2.18
-
-
-
- Other U.S. government agencies
-
-
22,567
4.45
108,649
5.67
-
- States and municipalities*
-
-
1,650
2.55
6,890
3.61
57,375
3.22 Other
1,366
10.00
848
4.93
%
-
-
287,663
***
4.88 Total
$
9,361
2.08
%
$
64,981
2.95
%
$
251,452
5.88
%
$
2,730,111
5.86
%
*
Weighted average yields on tax-exempt obligations have been computed by adjusting allowable tax-exempt income to a fully taxable equivalent basis. ** Represents government agency-issued mortgage-backed securities and collateralized mortgage obligations which, when adjusted for early paydowns, have an estimated average life of 1.41 years. *** Represents equity securities with no stated maturity. Loans Held for Sale/Loans Held for Sale – Divestiture Loans held for sale consists of the mortgage warehouse, student loans, small business loans, and home equity loans. Small issuer trust preferred loans were included in average loans held for sale through the third quarter 2008. The mortgage warehouse accounted for the majority of loans held for sale during 2008,
but declined in the latter half of 2008 as a result of the sale of national mortgage origination offices to MetLife. Loans held for sale represented 9 percent of total earning assets in 2008 compared with 12 percent in 2007. During 2008 loans held for sale averaged $2.6 billion, a decrease of 33 percent, or $1.3
billion from 2007. This decline is primarily related to a smaller warehouse as the national mortgage origination platform was sold in August 2008 and the remaining warehouse is contracting. Also impacting the decrease were moves of first and second-lien mortgages and small issuer trust preferred loans to the loan
portfolio throughout 2008. Since mortgage warehouse loans and other loans held for sale are generally held in inventory for a short period of time, there may be significant differences between average and period-end balances. On December 31, 2008, there were no loans classified as held for sale – divestiture
although these loans averaged $110.4 million as FHN completed the final First Horizon Bank branch sale in the second quarter 2008. Trading Securities/Other Earning Assets Trading securities decreased 30 percent to $1.9 billion in 2008 from $2.7 billion in 2007 primarily as a result of trading inventory management initiatives beginning in 2007. Other earning assets, which are comprised of securities purchased under agreements to resell, federal funds sold and interest-bearing deposits
with other financial institutions, decreased slightly by 3 percent to $1.3 billion in 2008 from $1.4 billion in 2007 due to lower levels of securities purchased under agreements to resell in Capital Markets. Offsetting this decline was an increase in interest bearing cash as the Federal Reserve began paying interest on
these deposits in the fourth quarter 2008. CORE DEPOSITS During 2008, core deposits decreased 4 percent, or $512.6 million and averaged $12.9 billion. Interest-bearing core deposits increased 4 percent or $319.2 million to an average balance of $8.6 billion in 2008. Growth in interest-bearing core deposits is primarily due to growth in savings deposits. Noninterest-
bearing core deposits averaged $4.3 billion in 2008 and $5.1 billion in 2007 as custodial deposits were transferred when the related serviced loans were sold in 2008 and competition for deposits increased in 2008. SHORT-TERM PURCHASED FUNDS/LONG-TERM DEBT Short-term purchased funds (certificates of deposit greater than $100,000, federal funds purchased, securities sold under agreements to repurchase, trading liabilities, commercial paper, and other short-term borrowings), averaged 24 FIRST HORIZON NATIONAL CORPORATION
Within 5 Years
Within 10 Years
and CMO**
$11.3 billion for 2008, down 20 percent from $14.0 billion in 2007. The decrease was primarily driven by a decline in purchased CD’s as FHN focused on lower cost more stable funding sources such as the Federal Reserve term-auction facility and Federal Home Loan Bank borrowings. Purchased federal funds
also decreased as lending among financial institutions tightened in 2008. Short-term purchased funds accounted for 37 percent of FHN’s funding (core deposits plus purchased funds and term borrowings) in 2008, and 41 percent in 2007. See Note 9 – Short-Term Borrowings for additional information. Long-term debt includes senior and subordinated borrowings and advances with original maturities greater than one year. Average long-term debt decreased 7 percent, or $459.1 million, and averaged $6.1 billion in 2008. As of December 31, 2008, long-term debt was $4.8 billion, a decrease of 30 percent, or $2.1
billion from 2007 year-end. The decrease was the result of bank note maturities and repurchases as funding needs decreased due to asset contraction. See Note 10 – Long-Term Debt for additional information. INCOME STATEMENT REVIEW – 2007 COMPARED TO 2006 A net loss was reported for 2007 of $170.1 million, or $1.29 diluted earnings per share. Earnings for 2006 were $462.9 million, or $3.45 diluted earnings per share. Return on average shareholders’ equity and return on average assets for 2007 were (7.02) percent and (.45) percent, respectively, compared to 19.1
percent and 1.19 percent in 2006. There was no cumulative effect of a change in accounting principle adjustment that impacted results in 2007. Earnings in 2006 included a favorable impact of $1.3 million (net of tax) or $.01 per diluted share from the cumulative effect of a change in accounting principle. FHN adopted SFAS No. 123 (revised
2004), “Share-Based Payment” (SFAS No. 123-R) in 2006 and retroactively applied the provisions of the standard. A cumulative effect adjustment of $1.1 million was recognized, reflecting the change in accounting for share-based compensation expense based on estimated forfeitures rather than actual forfeitures.
In 2006, FHN also adopted SFAS No. 156, “Accounting for Servicing of Financial Assets,” which allows servicing assets to be measured at fair value with changes in fair value reported in current earnings. The adoption of this standard was applied on a prospective basis and resulted in a cumulative effect
adjustment of $.2 million, representing the excess of the fair value of the servicing asset over the recorded value on January 1, 2006. Comparisons between reported earnings are directly and significantly affected by a number of factors in both 2007 and 2006. Several significant items including housing and credit market disruptions, increased provisioning, restructuring, repositioning and efficiency initiatives, and goodwill impairment impacted
FHN’s performance in 2007. The sale of FHN’s national merchant processing business and related transactions had a significant impact on 2006 results. Further details on these and other items of significance impacting 2006 are presented below. Following an updated valuation based on strategic cash flow projections and market-to-book values, FHN incurred a fourth quarter 2007 non-cash pre-tax impairment charge of $71.1 million for the write-down of goodwill associated with the Mortgage Banking business segment. FHN engaged an independent
valuation firm to assist in computing the fair value estimate for the impairment assessment by utilizing two separate valuation methodologies and applying a weighted average to each methodology in order to determine fair value for the Mortgage Banking business segment. The valuation methodologies utilized
included a discounted cash flow valuation technique and a comparison of the average price to book value of comparable businesses. Throughout 2007, FHN conducted an ongoing, company-wide review of business practices with the goal of improving overall profitability and productivity. Management announced its intention to sell 34 full-service First Horizon Bank branches in its national banking markets, as well as plans to right size First
Horizon Home Loans’ mortgage banking operations and balance sheet utilization and to downsize national lending operations, in order to redeploy capital to higher-return businesses. Total net charges of $98.7 million were recognized in 2007 related to restructuring, repositioning and efficiency initiatives. See Table
1 for further details. Also impacting results in 2007 were $55.7 million of expenses associated with the recognition of a contingent guarantee related to Visa’s litigation matters. 25 FIRST HORIZON NATIONAL CORPORATION
Net interest income declined to $940.6 million in 2007 compared to $996.9 million in 2006 as earning assets declined 2 percent to $33.4 billion and interest-bearing liabilities declined 1 percent to $28.9 billion in 2007. Net interest margin was 2.82 percent for 2007 compared to 2.93 in 2006. The decline in the
margin was primarily attributable to competitive pricing pressure in a contracting national housing market, additional non-accrual construction loans, and higher deposit rates in Tennessee markets. Noninterest income contributed 48 percent to total revenue in 2007 compared to 54 percent in 2006. Capital markets noninterest income decreased to $334.4 million in 2007 from $383.0 million in 2006. Revenues from fixed income sales increased $37.5 million from 2006 while revenues from other products
decreased $86.2 million. Mortgage banking noninterest income decreased 81 percent in 2007 to $69.5 million from $370.6 million in 2006. Net revenue from origination activity decreased 62 percent to $118.4 million in 2007 from $308.1 million in 2006 reflecting declines in gain on sales margins experienced in 2007 as a result of
secondary market disruptions causing significant spread-widening on ARM and nonagency eligible production throughout the second half of the year. Net servicing income decreased $106.4 million or 284 percent in 2007. Total fees associated with mortgage servicing decreased 5 percent in 2007 to $311.4 million
as the change in PSA reduced income by $36.2 million offset by an increase in the average portfolio. Servicing hedging activities and changes in MSR value other than runoff negatively impacted net servicing revenues by $133.5 million in 2007 as compared to 2006. In 2007, there was a reduction of
approximately $135 million in the carrying value of servicing assets primarily associated with increased weighting of broker quotes and observable trading data. Additionally, the change in the value of MSR due to runoff increased net revenues by $43.9 million in 2007 as compared to 2006 of which $19.7 million is
attributable to the change in PSA mentioned above. Noninterest income from deposit transactions and cash management increased to $175.3 million in 2007 from $168.6 million in 2006, reflecting increased NSF charges and corporate cash management fees. Noninterest income from loans sales and securitizations decreased to $23.9 million in 2007 from $51.7
million in 2006 primarily due to market disruptions experienced during the second half of 2007 which resulted in reduced volume delivered into the secondary market and valuation adjustments on related servicing assets. Results for 2006 included the loss of $12.7 million from the sale of no-balance HELOC.
Noninterest income from insurance commissions decreased to $31.7 million in 2007 from $46.6 million in 2006 due to the sale of two insurance subsidiaries in 2006. Gains on divestitures of $15.7 million were recognized in 2007 related to the sale of certain First Horizon bank branches. Net securities losses of
$1.2 million were recognized in 2007 primarily related to changes in the investment portfolio. In 2006, $65.6 million of net securities losses were principally related to restructuring the investment portfolio in first quarter as well as net securities gains from the sale of MasterCard Inc. securities and venture capital
investments. All other income remained flat at $170.4 million in 2007 compared to $170.5 million in 2006. Other income was negatively impacted incrementally by $16.8 million related to LOCOM and other consumer lending adjustments. Total noninterest expense for 2007 increased 6 percent to $1.8 billion from $1.7 billion in 2006. Personnel expense decreased 5 percent to $968.1 million from $1.0 billion in 2006 primarily due to restructuring, repositioning, and efficiency initiatives and reductions in personnel expense in Regional Banking,
Mortgage Banking, and Capital Markets directly related to revenue contraction. Occupancy costs increased 12 percent or $14.5 million primarily due to restructuring initiatives. In 2007, FHN recognized goodwill impairments of $13.0 million related to certain First Horizon bank branches and $71.1 million for the
Mortgage Banking segment. All other noninterest expense, which includes advertising and public relations costs, computer software expense, travel and entertainment, contract employment, and various other expense items (see Table 9 for additional detail) increased 36 percent, or $33.9 million in 2007. This
increase included the $55.7 million related to FHN’s proportionate share of Visa’s various legal matters. Computer software, legal and professional fees, and other expenses in 2007 were incurred in FHN’s restructuring, repositioning, and efficiency initiatives. The provision for loan losses increased 228 percent to $272.8 million in 2007 from $83.1 million in 2006. The increase primarily reflects deterioration in the national residential real estate construction portfolios (one-time close retail real estate construction loans extended to consumers and loans to homebuilders,
including condominium construction loans). 26 FIRST HORIZON NATIONAL CORPORATION
STATEMENT OF CONDITION REVIEW – 2007 COMPARED TO 2006 During 2007, earning assets averaged $33.4 billion compared with $34.0 billion for 2006. Average earning assets were 88 percent of total average assets in 2007 and 2006. Average loans increased 3 percent to $22.1 billion during 2007 as retail loans decreased by 2 percent which was more than offset by growth
in commercial loans of 8 percent. Average loans represented 66 percent of average earning assets in 2007 compared to 63 percent in 2006. Commercial, financial and industrial loans increased 7 percent in 2007, or $435.0 million, reflecting growth in the regional middle market portfolio. Income commercial real estate (Income CRE) and residential commercial real estate (Residential CRE) averaged $4.1 billion in 2007 as compared to $3.7 billion in
2006. The Income CRE portfolio increased $260.1 million or 16 percent in 2007. Residential CRE grew $149.9 million or 7 percent in 2007. The residential real estate loan portfolio (including real estate loans pledged against other collateralized borrowings) decreased by 4 percent, or $306.3 million in 2007 as a
result of the strategic plan to sell a significant portion of new production through the first half of 2007, and a decrease in production related to policy and strategic changes restricting production beginning in third quarter 2007. The retail real estate construction portfolio increased 3 percent or $61.0 million in 2007. Investment securities averaged $3.4 billion in 2007 and $3.5 billion in 2006. Investment securities represented 10 percent of earning assets in 2007 and 2006. Loans held for sale represented 12 percent of total earning assets in 2007 compared with 13 percent in 2006. During 2007 loans held for sale averaged $3.9 billion, a decrease of 11 percent, or $.5 billion from 2006. This decline was related to lower levels of HELOC, second lien, small issuer trust preferred and
mortgage warehouse loans held for sale. Trading securities decreased 5 percent to $2.7 billion in 2007 from $2.8 billion in 2006. Other earning assets decreased 28 percent to $1.4 billion in 2007 from $1.9 billion in 2006 due to lower levels of securities purchased under agreements to resell in Capital Markets. During 2007, core deposits increased 3 percent, or $417.5 million, and averaged $13.4 billion. Interest-bearing core deposits increased 6 percent or $487.4 million to an average balance of $8.3 billion in 2007. Growth in interest-bearing core deposits was primarily due to growth in savings deposits. Average
noninterest-bearing core deposits decreased slightly from $5.2 billion in 2006 to $5.1 billion in 2007. Short-term purchased funds averaged $14.0 billion for 2007, down 15 percent from $16.4 billion in the previous year. Long-term borrowings increased 30 percent, or $1.5 billion, and averaged $5.6 billion in 2007. The increase in term borrowings was utilized to fund loan growth. Management’s objectives are to provide capital sufficient to cover the risks inherent in FHN’s businesses, to maintain excess capital to well-capitalized standards, and to assure ready access to the capital markets. In the second quarter of 2008, FHN completed a public offering of 69 million shares of common
stock. In the fourth quarter 2008, FHN completed the issuance and sale of preferred stock and a common stock warrant under the U.S. Treasury Capital Purchase Program which generated $866.5 million of proceeds. To conserve FHN’s capital, the quarterly cash dividend was replaced with a quarterly stock
dividend at a rate to be determined quarterly. Average shareholders’ equity increased to $2.6 billion in 2008 from $2.4 billion in 2007 which was flat compared to 2006. Shareholders’ equity was $3.3 billion at year-end 2008, an increase of 54 percent from 2007, which decreased 13 percent from year-end 2006. The increase in shareholders’ equity during
2008 was a result of the second quarter stock issuance that generated approximately $660 million of net proceeds and the proceeds from the CPP preferred issuance. As a result of these equity issuances, shareholder’s equity increased despite a reported net loss and cash dividends paid in 2008. Pursuant to
board authority, FHN may repurchase shares from time to time and will evaluate the level of capital and take action designed to generate or use capital, as 27 FIRST HORIZON NATIONAL CORPORATION
appropriate, for the interests of the shareholders, subject to legal, regulatory, and CPP constraints. In order to maintain FHN’s well-capitalized status while sustaining strong balance sheet growth, FTBNA issued approximately $250 million of subordinated notes which qualify as Tier 2 capital under the risk-based
capital guidelines in 2006. FHN also repurchased 4 million shares of its common stock in 2006 through an accelerated share repurchase program under an existing share repurchase authorization. This share repurchase program was concluded for an adjusted purchase price of $165.1 million. The share
repurchase was funded with a portion of the proceeds from the merchant processing sale. Table 13 - Capital Ratios
2008
2007
2006 Average shareholders’ equity to average assets
7.66
%
6.35
%
6.25
% Period-end shareholders’ equity to assets
10.57
5.77
6.49 FHN’s tier 1 risk-based capital
15.03
8.12
8.87 FHN’s total risk-based capital
20.19
12.75
13.21 FHN’s leverage ratio
12.22
6.64
6.94 Tangible common equity to risk weighted assets ratio
8.80
6.16
6.96 Tangible common equity to tangible assets ratio
7.34
5.13
5.65 Banking regulators define minimum capital ratios for bank holding companies and their bank subsidiaries. Based on the capital rules and definitions prescribed by the banking regulators, should any depository institution’s capital ratios decline below predetermined levels, it would become subject to a series of
increasingly restrictive regulatory actions. The system categorizes a depository institution’s capital position into one of five categories ranging from well-capitalized to critically under-capitalized. For an institution to qualify as well-capitalized, Tier 1 Capital, Total Capital and Leverage capital ratios must be at least 6
percent, 10 percent and 5 percent, respectively. As of December 31, 2008, FHN and FTBNA had sufficient capital to qualify as well-capitalized institutions as shown in Note 13 – Regulatory Capital. In 2009, capital ratios are expected to remain strong and significantly above well-capitalized standards despite a
difficult operating environment. Table 14 - Issuer Purchases of Equity Securities
(Volume in thousands)
Total Number
Average Price
Total Number of
Maximum Number 2008 October 1 to October 31
-
NA
-
37,417 November 1 to November 30
*
8.39
*
37,417 December 1 to December 31
4
10.33
4
37,413 Total
4
$
10.33
4 * Amount is less than 500 shares Compensation Plan Programs:
–
A consolidated compensation plan share purchase program was announced on August 6, 2004. This plan consolidated into a single share purchase program all of the previously authorized compensation plan share programs as well as the renewal of the authorization to purchase shares for use in connection with two compensation plans for which the share purchase authority had expired.
The total amount originally authorized under this consolidated compensation plan share purchase program is 25.1 million shares. On April 24, 2006, an increase to the authority under this purchase program of 4.5 million shares was announced for a new total authorization of 29.6 million shares. Effective October 1, 2008, the authority was increased to reflect the 3.0615% stock dividend
distributed effective October 1, 2008. The shares may be purchased over the option exercise period of the various compensation plans on or before December 31, 2023. Stock options granted after January 2, 2004, must be exercised no later than the tenth anniversary of the grant date. On December 31, 2008, the maximum number of shares that may be purchased under the program
was 29.7 million shares.
Other Programs:
On October 16, 2007, the board of directors approved a 7.5 million share purchase authority that will expire on December 31, 2010. Effective October 1, 2008, the authority was increased to reflect the 3.0615% stock dividend distributed effective October 1, 2008. Purchases will be made in the open market or through privately negotiated transactions and will be subject to market
conditions, accumulation of excess 28 FIRST HORIZON NATIONAL CORPORATION
of Shares
Purchased
Paid per Share
Shares Purchased
as Part of Publicly
Announced Programs
of Shares that May
Yet Be Purchased
Under the Programs
–
On December 31, 2008, book value per common share was $12.13 compared to $16.03 for 2007 and $18.68 for 2006. Average shares for the three-year period were 180.7 million in 2008, 132.1 million in 2007 and 130.6 million in 2006. Period-end shares outstanding for this same three-year period were 205.3
million, 132.6 million and 131.1 million, respectively. FHN’s shares are traded on The New York Stock Exchange under the symbol FHN. The sales price ranges, net income/(loss) available to common shareholders per share and dividends declared by quarter, for each of the last two years, are presented in Table
27. All per share information has been adjusted for the stock dividends declared in July and October 2008. FHN has an enterprise-wide approach to risk governance, measurement, management, and reporting including an economic capital allocation process that is tied to risk profiles used to measure risk-adjusted returns. The Enterprise-wide Risk/Return Management Committee oversees risk management governance.
Committee membership includes the CEO and other executive officers of FHN. The Chief Risk Officer oversees reporting for the committee. Risk management objectives include evaluating risks inherent in business strategies, monitoring proper balance of risks and returns, and managing risks to minimize the
probability of future negative outcomes. The Enterprise-wide Risk/Return Management Committee oversees and receives regular reports from the Credit Risk Management Committee, Asset/Liability Committee (ALCO), Capital Management Committee, Compliance Risk Committee, Operational Risk Committee, and the
Executive Program Governance Forum. The Chief Credit Officer, EVP Funds Management and Corporate Treasurer, Chief Financial Officer, SVP Corporate Compliance, Chief Risk Officer, and EVP and Chief Information Officer chair these committees respectively. Reports regarding Credit, Asset/Liability Management,
Market Risk, Capital Management, Compliance, and Operational Risks are provided to the Credit Policy and Executive and/or Audit Committee of the Board and to the full Board. In response to FHN’s participation in the U.S. Treasury’s Troubled Asset Relief Program (TARP), the Compensation Committee, Chief
Risk Officer, and Chief Credit Officer convene annually to review and assess key business risks and the relation of those risks to compensation and incentives plans in which named executives participate. The first of such meetings occurred in January 2009. Risk management practices include key elements such as independent checks and balances, formal authority limits, policies and procedures, and portfolio management all executed through experienced personnel. The Internal Audit Department, Credit Risk Assurance Group, Credit Policy and Regulations Group,
and Credit Portfolio Management Group also evaluate risk management activities. These evaluations are reviewed with management and the Audit Committee, as appropriate. MARKET UNCERTAINTIES AND PROSPECTIVE TRENDS Given the significant current uncertainties that exist within the housing and credit markets, it is anticipated that 2009 will continue to be challenging for FHN. While the reduction of mortgage banking operations is expected to significantly decrease sensitivity to market pricing uncertainty, FHN will continue to be
affected by market factors as it disposes of the remaining mortgage loan warehouse and attempts to reduce the remaining servicing portfolio. In addition, current volatility and reduced liquidity in the capital markets may adversely impact market execution putting continued pressure on revenues. As difficulties in the
credit markets persist, FHN will continue to adapt its liquidity management strategies. Further deterioration of general economic conditions could result in increased credit costs depending on the length and depth of this market cycle. INTEREST RATE RISK MANAGEMENT Interest rate risk is the risk that changes in prevailing interest rates will adversely affect assets, liabilities, capital, income and/or expense at different times or in different amounts. ALCO, a committee consisting of senior management that meets regularly, is responsible for coordinating the financial management of
interest rate risk. 29 FIRST HORIZON NATIONAL CORPORATION
equity, prudent capital management, and legal and regulatory constraints. Until the third anniversary of the sale of the preferred shares issued in the CPP, FHN may not repurchase common or other equity shares (subject to certain limited exceptions) without the UST’s approval. This authority is not tied to any compensation plan, and replaces an older non-plan share purchase authority
which was terminated. On December 31, 2008, the maximum number of shares that may be purchased under the program was 7.7 million shares.
FHN primarily manages interest rate risk by structuring the balance sheet to attempt to maintain the desired level of associated earnings while operating within prudent risk limits and thereby preserving the value of FHN’s capital. Net interest income and the financial condition of FHN are affected by changes in the level of market interest rates as the repricing characteristics of loans and other assets do not necessarily match those of deposits, other borrowings and capital. When earning assets reprice more quickly than liabilities, net interest
income will benefit in a rising interest rate environment and will be negatively impacted when interest rates decline. In the case of floating rate assets and liabilities with similar repricing frequencies, FHN may also be exposed to basis risk which results from changing spreads between earning and borrowing rates.
Generally, when interest rates decline, Mortgage Banking faces increased prepayment risk associated with MSR. FHN uses simulation analysis as its primary tool to evaluate interest rate risk exposure. This type of analysis computes net interest income at risk under a variety of market interest rate scenarios to dynamically identify interest rate risk exposures. This simulation, which considers forecasted balance sheet changes,
prepayment speeds, deposit mix, pricing impacts, and other changes in the net interest spread, provides an estimate of the annual net interest income at risk for given changes in interest rates. The results help FHN develop strategies for managing exposure to interest rate risk. Like any forecasting technique,
interest rate simulation modeling is based on a number of assumptions and judgments. In this case, the assumptions relate primarily to loan and deposit growth, asset and liability prepayments, interest rates, and on- and off-balance sheet hedging strategies. Management believes the assumptions used in its
simulations are reasonable. Nevertheless, simulation modeling provides only a sophisticated estimate, not a precise calculation of exposure to changes in interest rates. The simulation models used to analyze the regional bank’s net interest income create various at-risk scenarios looking at increases and/or decreases in interest rates from an instantaneous movement or a staggered movement over a certain time period. In addition, the risk of changes in the yield curve is estimated
by flattening and steepening the yield curve to historical levels. These hypothetical rate moves are used to simulate net interest income exposure to historically extreme movements in interest rates. Management reviews these different scenarios to determine alternative strategies and executes based on that
evaluation. The models are regularly updated to incorporate management action. Any scenarios that indicate a change in net interest income of three percent or more from a base NII are presented to the Board quarterly. At December 31, 2008 the interest rate environment was at an unprecedented low level.
Under these market conditions, traditional scenarios forecasting declining rates are no longer meaningful. Accordingly, declining rate shock scenarios (including minus 25 basis points and minus 200 basis points) that had been modeled in prior periods were not performed. The remaining scenarios performed
attempt to capture risk to NII from rising rates and changes in the shape of the yield curve. Based on the rate sensitivity position on December 31, 2008, net interest income exposure over the next 12 months to a rate shock of plus 200 basis points is estimated to be a favorable variance of approximately 7
percent of base net interest income. A flattening yield curve scenario results in a favorable variance in net interest income of approximately 2 percent. Both of these are hypothetical rate scenarios. These scenarios are used as one estimate of risk, and do not necessarily represent management’s current view of
future interest rates or market developments. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions, and management’s strategies, among other factors, including those presented in the Forward-Looking Statements section of
this MD&A. The simulation models used to analyze Regional Banking’s net interest income exclude the potential impacts to certain elements of Mortgage Banking’s net interest income. Net interest income earned on swaps and similar derivative instruments used to protect the value of MSR increases when the yield curve
steepens and decreases when the yield curve flattens. Other than the impact related to the immediate change in market value of balance sheet accounts, such as MSR, these simulation models and related hedging strategies exclude the dynamics related to how fee income and noninterest expense may be affected
by actual changes in interest rates or expectations of changes. Due to the third quarter 2008 sale of certain mortgage banking operations, Mortgage Banking revenue mix was significantly impacted. In 2006, 2007 and through August 2008, Mortgage Banking revenue was primarily generated from originating, selling
and servicing residential mortgage loans and was highly sensitive to changes in interest rates due to the direct effect changes in interest rates have on loan demand. After the third quarter divestiture, Mortgage Banking income was primarily composed of servicing residential mortgage loans and fair value
adjustments to the remaining warehouse. In general, low or declining interest rates typically lead to increased origination fees and profit from the sale of loans but potentially lower servicing-related income 30 FIRST HORIZON NATIONAL CORPORATION
due to the impact of higher loan prepayments on the value of mortgage servicing assets. Conversely, high or rising interest rates typically reduce mortgage loan demand and hence income from originations and sales of loans while servicing-related income may rise due to lower prepayments. Net interest income
earned on warehouse loans held for sale and on swaps and similar derivative instruments used to protect the value of MSR increases when the yield curve steepens and decreases when the yield curve flattens or inverts. Prior to the sale of certain mortgage banking operations to MetLife, the earnings impact from
originations and sales of loans on total earnings was more significant than servicing-related income. Given the repositioning of mortgage banking operations in third quarter 2008, the origination activity has been significantly reduced thereby reducing interest rate risk exposure. Lastly, a steepening yield curve positively impacts the demand for fixed income securities and, therefore, Capital Markets’ revenue. Generally, the effects of a steepening yield curve on FHN’s consolidated pre-tax income are positive, especially when driven by falling short term rates, benefiting Capital Markets’ and Mortgage Banking’s results. As a result of the MetLife transaction, mortgage banking origination activity was significantly reduced in periods after third quarter 2008 as FHN focuses on origination within its regional banking footprint. Accordingly, the following discussion of pipeline and warehouse related derivatives is primarily applicable to
reporting periods occurring through the third quarter 2008. To determine the amount of interest rate risk and exposure to changes in fair value of loan commitments, warehouse loans and MSR, Mortgage Banking uses multiple scenario rate shock analysis, including the magnitude and direction of interest rate changes, prepayment speeds, and other factors that could affect
mortgage banking. In certain cases, derivative financial instruments are used to aid in managing the exposure of the balance sheet and related net interest income and noninterest income to changes in interest rates. As discussed in Critical Accounting Policies, derivative financial instruments are used by mortgage
banking for two purposes. First, forward sales contracts and futures contracts are used to protect against changes in fair value of the pipeline and mortgage warehouse, primarily used from the time an interest rate is committed to the customer until the mortgage is sold into the secondary market due to increases in
interest rates. Second, interest rate contracts are utilized to protect against MSR prepayment risk that generally accompanies declining interest rates. As interest rates fall, the value of MSR should decrease and the value of the servicing hedge should increase. The converse is also true. Prior to the January 1, 2006,
adoption of SFAS No. 156, ineffectiveness in these hedging strategies (when changes in the value of the derivative instruments did not match changes in the value of the hedged portion of MSR for any given change in long-term interest rates) was reflected in noninterest income. Subsequent to the adoption of
SFAS No. 156, mortgage servicing noninterest income reflects the change in fair value of the MSR asset combined with net economic hedging results. Derivative instruments are also used to protect against the risk of loss arising from adverse changes in the fair value of a portion of Capital Markets’ securities inventory due to changes in interest rates. FHN does not use derivative instruments to protect against changes in fair value of loans or loans held for sale
other than the mortgage pipeline, warehouse and certain small issuer trust preferred loans. Management uses the results of interest rate exposure models to formulate strategies to improve balance sheet positioning, earnings, or both, within FHN’s interest rate risk, liquidity and capital guidelines. Table 15 details the interest rate sensitivity profile on December 31, 2008, on capital markets trading securities based on projected cash flows categorized by anticipated settlement date and mortgage banking trading securities categorized by expected maturity dates. Also provided are the average rates earned on
these trading securities. Table 15 also provides both the notional and fair values of derivative financial instruments held for trading. The information provided in this section, including the discussion regarding simulation analysis and rate shock analysis, is forward-looking. Actual results could differ because of interest
rate movements, the ability of management to execute its business plans and other factors, including those presented in the Forward-Looking Statements section of this MD&A. 31 FIRST HORIZON NATIONAL CORPORATION
Table 15 - Risk Sensitivity Analysis
Held for Trading
2009
2010
2011
2012
2013
2014+
Total
Fair Assets: Trading securities
$
781
-
-
-
-
$
165
$
946
$
946 Average interest rate
4.03
%
-
-
-
-
13.99
%
5.77
% Interest Rate Derivatives (notional value): Capital Markets: Forward contracts: Commitments to buy
$
4,567
-
-
-
-
-
$
4,567
$
(28
) Weighted average settlement price
101.24
%
-
-
-
-
-
101.24
% Commitments to sell
$
4,750
-
-
-
-
-
$
4,750
$
28 Weighted average settlement price
101.18
%
-
-
-
-
-
101.18
% Caps purchased
$
10
$
20
-
-
-
$
16
$
46
* Weighted average strike price
5.75
%
4.25
%
-
-
-
7.16
%
5.59
% Caps written
$
(10
)
$
(20
)
-
-
-
$
(16
)
$
(46
)
* Weighted average strike price
5.75
%
4.25
%
-
-
-
7.16
%
5.59
% Floors purchased
$
20
$
50
$
150
$
10
-
-
$
230
$
11 Weighted average strike price
7.75
%
6.20
%
6.50
%
5.50
%
-
-
6.50
% Floors written
$
(20
)
$
(50
)
$
(150
)
$
(10
)
-
-
$
(230
)
$
(11
) Weighted average strike price
7.75
%
6.20
%
6.50
%
5.50
%
-
-
6.50
% Swap contracts purchased
$
43
$
107
$
282
$
336
$
215
$
170
$
1,153
$
(89
) Average pay rate (fixed)
6.70
%
6.23
%
5.72
%
5.21
%
5.51
%
5.28
%
5.55
% Average receive rate (floating)
4.89
%
3.60
%
3.78
%
2.72
%
3.03
%
3.21
%
3.27
% Swap contracts purchased
$
270
$
45
$
75
-
-
-
$
390
$
12 Average pay rate (floating)
4.03
%
3.66
%
3.82
%
-
-
-
3.95
% Average receive rate (fixed)
7.60
%
4.89
%
6.12
%
-
-
-
7.00
% Swap contracts sold
$
(43
)
$
(107
)
$
(282
)
$
(155
)
$
(165
)
$
(157
)
$
(909
)
$
61 Average pay rate (floating)
4.89
%
3.60
%
3.78
%
3.58
%
3.39
%
3.47
%
3.65
% Average receive rate (fixed)
6.70
%
6.23
%
5.72
%
5.48
%
5.99
%
5.71
%
5.83
% Swap contracts sold
$
(270
)
$
(45
)
$
(75
)
-
-
-
$
(390
)
$
(12
) Average pay rate (fixed)
7.60
%
4.89
%
6.12
%
-
-
-
7.00
% Average receive rate (floating)
4.03
%
3.66
%
3.82
%
-
-
-
3.95
% Futures contracts: Commitments to sell
$
4
$
4
-
-
-
-
$
8
* Weighted average settlement price
98.79
%
98.17
%
-
-
-
-
98.48
% * Amount is less than $500,000 LIQUIDITY MANAGEMENT Core deposits are a significant source of funding and have been a stable source of liquidity for banks. The Federal Deposit Insurance Corporation insures these deposits to the extent authorized by law. Total loans, excluding loans held for sale and real estate loans pledged against other collateralized borrowings, to
core deposits ratio was 160 percent in 2008, 156 percent in 2007, and 157 percent in 2006. Should loan growth exceed core deposit growth, alternative sources of funding loan growth may be necessary in order to maintain an adequate liquidity position. The ratio is expected to continue to decline as the national
construction loan portfolios decrease. In 2005, FTBNA established a bank note program providing additional liquidity of $5.0 billion. On December 31, 2008, $2.5 billion was outstanding through the bank note program with $1.6 billion scheduled to mature in 2009. 32 FIRST HORIZON NATIONAL CORPORATION
(Dollars in millions)
Value
ALCO
focuses on the funding of assets with liabilities of the appropriate duration,
while mitigating the risk of not meeting unexpected cash needs. The objective
of liquidity management is to ensure the continuous availability of funds
to meet the demands of depositors, other creditors and borrowers, and the
requirements of ongoing operations. This objective is met by maintaining liquid
assets in the form of trading securities and securities available for sale,
growing core deposits, and the repayment of loans. ALCO is responsible for
managing these needs by taking into account the marketability of assets;
the sources, stability and availability of funding; and the level of unfunded
commitments. See Note 26 – Derivatives and Off-Balance Sheet Arrangements
for additional information. Subject to market conditions and compliance with
applicable regulatory requirements from time to time, funds are available
from a number of sources, including core deposits, the securities available
for sale portfolio, the Federal Home Loan Bank (FHLB), the Federal Reserve
Banks, access to Federal Reserve Bank programs such as the Term Auction Facility
(TAF), availability to the overnight and term Federal Funds markets, and
dealer and commercial customer repurchase agreements.
During 2008 and continuing into early 2009, market and other conditions have been such that FTBNA has not been able to utilize the bank note program, and instead has obtained less credit sensitive sources of funding including secured sources such as FHLB borrowings and Federal Reserve Term Auction
Facility (TAF). FTBNA expects that its inability to use the bank note program will continue for some time to come, and cannot predict when that inability will end. FHN and FTBNA have the ability to generate liquidity by issuing preferred or common equity or incurring other debt subject to market conditions and compliance with applicable regulatory requirements from time to time. In 2008, FHN issued 69 million shares of common stock which generated approximately $660
million in net proceeds. Additionally, in 2008, FHN issued and sold perpetual preferred stock and a common stock warrant to the UST under the CPP which generated $866.5 million in proceeds. Further, liquidity has been obtained through FTBNA’s issuance of approximately $250 million of subordinated notes in
2006. In addition, liquidity has been obtained through issuance of $300 million of guaranteed preferred beneficial interests in FHN’s junior subordinated debentures through two Delaware business trusts, wholly owned by FHN. See Note 10 – Long-Term Debt, Note 11 – Guaranteed Preferred Beneficial Interests in
First Horizon’s Junior Subordinated Debentures and Note 12 – Preferred Stock and Other Capital for additional information. FHN also evaluates alternative sources of funding, including loan sales, syndications, and FHLB borrowings in its management of liquidity. Parent company liquidity is maintained by cash flows stemming from dividends and interest payments collected from subsidiaries along with net proceeds from stock sales through employee plans, which represent the primary sources of funds to pay cash dividends to shareholders and interest to debt holders. The
amount paid to the parent company through FTBNA common dividends is managed as part of FHN’s overall cash management process, subject to applicable regulatory restrictions described in the next paragraph. As discussed above, the parent company also has the ability to enhance its liquidity position by
raising equity or incurring debt subject to market conditions and compliance with applicable regulatory requirements from time to time. Certain regulatory restrictions exist regarding the ability of FTBNA to transfer funds to FHN in the form of cash, common dividends, loans or advances. At any given time, the pertinent portions of those regulatory restrictions allow FTBNA to declare preferred or common dividends without prior regulatory approval in
an amount equal to FTBNA’s retained net income for the two most recent completed years plus the current year to date. For any period, FTBNA’s ‘retained net income’ generally is equal to FTBNA’s regulatory net income reduced by the preferred and common dividends declared by FTBNA. Excess dividends in
either of the two most recent completed years may be offset with available retained net income in the two years immediately preceding it. Applying the applicable rules, FTBNA’s total amount available for dividends was ($222.1) million at December 31, 2008 and at January 1, 2009. Earnings (or losses) and
dividends declared during 2009 will change the amount available during 2009 until December 31. FTBNA has requested approval from the OCC to declare and pay dividends on its preferred stock outstanding payable in April 2009. FTBNA has not requested approval to pay common dividends to its sole common stockholder, FHN. Although FHN has funds available for dividends even without FTBNA dividends,
availability of funds is not the sole factor considered by FHN’s Board in deciding whether or not to declare a dividend of any particular size; the Board also must consider FHN’s current and prospective capital, liquidity and other needs. Under the terms of the CPP FHN is not permitted to increase its cash common
dividend rate for a period of three years without permission of the Treasury. At the time of the preferred share and common stock warrant issuance, FHN did not pay a common cash dividend. On April 27, 2008, FHN’s Board of Directors determined to cease paying cash dividends following the cash dividend of 20 cents per share paid on July 1, 2008. Instead, the Board began declaring a dividend in shares of common stock. Quarterly stock dividends were distributed on October 1, 2008 and January 1,
2009. The Board has approved the stock dividend to be distributed in April 2009. The Board has also approved and FHN paid the 5% dividend on the CPP preferred on February 15, 2009. The Board currently intends to reinstate a cash dividend at an appropriate and prudent level once earnings and other
conditions improve sufficiently, consistent with legal, regulatory, CPP, and other constraints. The Consolidated Statements of Cash Flows provide information on cash flows from operating, investing and financing activities for each of the three years ended December 31, 2008, 2007, and 2006. In 2008, liquidity was 33 FIRST HORIZON NATIONAL CORPORATION
predominantly provided by a contracting balance sheet and common and preferred equity issuances. Net cash provided by operating activities was the primary contributor of liquidity during 2008. Net cash provided by operating activities was $4.3 billion and was primarily the result of balance sheet reductions that
occurred in 2008 as well as the impact of cash-related operating income items. Loans held for sale decreased by $2.9 billion as the mortgage warehouse was significantly reduced due to the national mortgage origination platform sale in third quarter of 2008. While the mortgage warehouse was not sold to MetLife,
a majority of the loans were sold after the transaction. Cash flows were not used to originate new loans through this channel. Trading securities decreased by $.8 billion and the decline was principally from trading inventory management initiatives at capital markets. Net positive cash flows from MSR sales and an
increase in capital markets payables were offset by increases of capital markets receivables and other assets. Operating activities in 2007 and 2006 were also the primary contributor of net positive cash flows. Investing activities provided $.2 billion of net cash in 2008 primarily from a $.4 billion decrease in loans. The net decrease in loans occurred as pay downs and charge-offs more than offset new loan growth. Cash provided through the available for sale securities portfolio was minimal in 2008 as sales and maturities
were slightly higher than securities purchased. In 2007, investing activities had a negligible effect on cash flows while liquidity in 2006 was negatively impacted due to loan growth and restructuring within the investment portfolio. In 2008, FHN’s primary use of cash related to financing activities. Cash provided by deposits and short-term borrowings decreased by $2.3 billion and $2.2 billion, respectively. The decline in deposits is primarily due to a decrease in certificates of deposit greater than $100,000 of $1.7 billion as FHN focused on
lower cost funding. Purchased fed funds declined due to tightened credit markets and were replaced by funding from the Federal Reserve’s TAF. Bank and extendable notes matured or were repurchased, consistent with balance sheet contraction. Cash proceeds were generated through the issuance of 69 million
common shares and through participation in the U.S. Treasury CPP. The common stock issuance provided approximately $660 million net proceeds while the issuance of preferred CPP and common stock warrant to the U.S. Treasury provided $866.5 million. In 2007, liquidity from financing activities was negatively
impacted from deposit declines while cash flow in 2006 was positively impacted by long-term debt issuances and increased short-term borrowings. Off-balance Sheet Arrangements and Other Contractual Obligations First Horizon Home Loans, the former mortgage banking division of FHN, originated conventional conforming and federally insured single-family residential mortgage loans. Likewise, FTN Financial Capital Assets Corporation purchases the same types of loans from customers. Substantially all of these mortgage loans
are exchanged for securities, which are issued through investors, including government sponsored enterprises (GSE), such as Government National Mortgage Association (GNMA) for federally insured loans and Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC) for
conventional loans, and then sold in the secondary markets. Each GSE has specific guidelines and criteria for sellers and servicers of loans backing their respective securities. Many private investors were also active in the secondary market as issuers and investors. The risk of credit loss with regard to the principal
amount of the loans sold was generally transferred to investors upon sale to the secondary market. To the extent that transferred loans were subsequently determined not to meet the agreed upon qualifications or criteria, the purchaser had the right to return those loans to FHN. In addition, certain mortgage loans
were sold to investors with limited or full recourse in the event of mortgage foreclosure (refer to discussion of foreclosure reserves under Critical Accounting Policies). After sale, these loans were not reflected on the Consolidated Statements of Condition. See also Note 18 – Restrictions, Contingencies and Other
Disclosures. FHN’s use of government agencies as an efficient outlet for mortgage loan production was an essential source of liquidity for FHN and other participants in the housing industry in recent years. During 2008 and 2007, approximately $15.6 billion and $18.3 billion, respectively, of conventional and federally insured
mortgage loans were securitized and sold by FHN through these investors. Historically, certain of FHN’s originated loans, including non-conforming first-lien mortgages, second-lien mortgages and HELOC originated primarily through FTBNA, did not conform to the requirements for sale or securitization through government agencies. FHN pooled and securitized these non-conforming loans in
proprietary transactions. After securitization and sale, these loans were not reflected on the Consolidated Statements of Condition, except as 34 FIRST HORIZON NATIONAL CORPORATION
described hereafter (see Credit Risk Management – Mortgage Banking). These transactions, which were conducted through single-purpose business trusts, were an efficient way for FHN to monetize these assets. On December 31, 2008 and 2007, the outstanding principal amount of loans in these off-balance sheet
business trusts was $22.8 billion and $25.6 billion, respectively. FHN has substantially reduced its origination of these loans in response to disruptions in the credit markets and did not execute a securitization of these loans during 2008. Given the historical significance of FHN’s origination of non-conforming loans,
the use of single-purpose business trusts to securitize these loans was an important source of liquidity to FHN. See Note 24 – Loan Sales and Securitizations for additional information. Pension obligations are funded by FHN to provide current and future benefit to participants in FHN’s noncontributory, defined benefit pension plan. On December 31, 2008, the annual measurement date, pension obligations were $472.1 million with $378.5 million of assets in the trust to fund those obligations.
FHN made a contribution of $30.0 million to the qualified pension plan in fourth quarter 2008. A second contribution may be made in 2009 attributable to the 2008 plan year. This decision will be based upon pension funding requirements under the Pension Protection Act, the maximum deductible under the
Internal Revenue Code, and the actual performance of plan assets during 2009. Given these uncertainties, we cannot estimate the amount of a future contribution at this time. The nonqualified pension plans and other postretirement benefit plans are unfunded. FHN contributed $6.2 million in 2008 to the
unfunded plans to cover all benefits paid under the nonqualified plans and anticipates the 2009 contribution to be $5.6 million. The discount rate for 2008 of 6.85 percent for the qualified pension plan and 6.90 percent for the nonqualified supplemental executive retirement plan was determined by using a
hypothetical AA yield curve represented by a series of annualized individual discount rates from one-half to thirty years. The discount rates for the pension and nonqualified supplemental executive retirement plans are selected based on data specific to FHN’s plans and employee population. See Note 20 – Savings,
Pension and Other Employee Benefits for additional information. FHN has various other financial obligations, which may require future cash payments. Table 16 sets forth contractual obligations representing required and potential cash outflows as of December 31, 2008. Purchase obligations represent obligations under agreements to purchase goods or services that are
enforceable and legally binding on FHN and that specify all significant terms, including fixed or minimum quantities to be purchased, fixed, minimum or variable price provisions, and the approximate timing of the transaction. In addition, FHN enters into commitments to extend credit to borrowers, including loan
commitments, standby letters of credit, and commercial letters of credit. These commitments do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon. See Note 26 – Derivatives and Off-Balance Sheet Arrangements for additional information. Table 16 - Contractual Obligations
(Dollars in thousands)
Payments due by period (a)
Less than
1-3
4-5
After 5
Total Contractual obligations: Time deposit maturities (b)
$
2,613,829
$
577,307
$
279,033
$
206,710
$
3,676,879 Long-term debt (c)
1,560,608
911,246
350,296
1,784,574
4,606,724 Annual rental commitments under noncancelable leases (d)
35,064
47,302
24,749
30,280
137,395 Purchase obligations
49,732
68,605
30,149
15,233
163,719 Total contractual obligations
$
4,259,233
$
1,604,460
$
684,227
$
2,036,797
$
8,584,717
(a)
On December 31, 2008, a liability for unrecognized tax benefits of $31.1 million has been excluded from this table as the timing of payment cannot be reasonably estimated. (b) See Note 8 – Time Deposit Maturities for further details. (c) See Note 10 – Long-Term Debt for further details. (d) See Note 5 – Premises, Equipment and Leases for further details. 35 FIRST HORIZON NATIONAL CORPORATION
1 year
years
years
years
Credit Ratings Maintaining adequate credit ratings on debt issues is critical to liquidity because it affects the ability of FHN to attract funds from various sources, such as brokered deposits or wholesale borrowings of which FHN had $1.5 billion and $1.9 billion on December 31, 2008 and 2007, respectively, on a cost-competitive
basis (see also Liquidity Management). The various credit ratings are detailed in Table 17. The availability and cost of funds other than core deposits is also dependent upon marketplace perceptions of the financial soundness of FHN, which include such issues as capital levels, asset quality and reputation. The
availability of core deposit funding is dependent upon federal deposit insurance, which can be removed only in extraordinary circumstances, but may also be influenced to some extent by the same factors that affect other funding sources. Table 17 - Credit Ratings
Standard & Poor’s (a)
Moody’s (b)
Fitch (c) First Horizon National Corporation Overall credit rating: Long-term/Outlook
BBB/Stable
Baa1/Negative
BBB+/Negative Subordinated debt
BBB–
Baa2
BBB Cumulative perpetual preferred stock (issued to US Treasury)
BBB– Capital securities*
BB–
Baa2
BBB– First Tennessee Bank National Association Overall credit rating: Long-term/Short-term/Outlook
BBB+/A-2/Stable
A3/P-2/Negative
BBB+/F2/Negative Non-cumulative perpetual preferred stock
BB
Baa2
BBB Long-term/short-term deposits
BBB+/A-2
A3/P-2
A–/F1 Other long-term/short-term funding**
BBB+/A-2
A3/P-2
BBB+/F2 Subordinated debt
BBB
Baa1
BBB FT Real Estate Securities Company, Inc. Preferred stock
BB
Baa2
*
Guaranteed preferred beneficial interests in First Horizon’s junior subordinated debentures issued through a wholly-owned unconsolidated business trust. ** Other funding includes senior bank notes. A rating is not a recommendation to buy, sell or hold securities and is subject to revision or withdrawal at any time and should be evaluated independently of any other rating.
(a)
Last change in rating was on February 24, 2009. (b) Last change in rating was on January 24, 2008. (c) Last change in rating was on December 3, 2008. MARKET RISK MANAGEMENT Capital markets buys and sells various types of securities for its customers. When these securities settle on a delayed basis, they are considered forward contracts. Securities inventory positions are generally procured for distribution to customers by the sales staff, and ALCO policies and guidelines have been
established with the objective of limiting the risk in managing this inventory. CAPITAL MANAGEMENT The capital management objectives of FHN are to provide capital sufficient to cover the risks inherent in FHN’s businesses, to maintain excess capital to well-capitalized standards and to assure ready access to the capital markets. Management has a Capital Management committee that is responsible for capital
management oversight and provides a forum for addressing management issues related to capital adequacy. The committee reviews sources and uses of capital, key capital ratios, segment economic capital allocation methodologies, and other factors in monitoring and managing current capital levels, as well as
potential future sources and uses of capital. The committee also recommends capital management policies, which are submitted for approval to the Enterprise-wide Risk/Return Management Committee and the Board. 36 FIRST HORIZON NATIONAL CORPORATION
OPERATIONAL RISK MANAGEMENT Operational risk is the risk of loss from inadequate or failed internal processes, people, and systems or from external events. This risk is inherent in all businesses. Management, measurement, and reporting of operational risk are overseen by the Operational Risk Committee, which is chaired by the Chief Risk
Officer. Key representatives from the business segments, legal, risk management, information technology risk, corporate real estate, employee services, records management, bank operations, funds management, and insurance are represented on the committee. Subcommittees manage and report on business
continuity planning, information technology risk, insurance, compliance, records management, customer complaint, and reputation risks. Summary reports of the committee’s activities and decisions are provided to the Enterprise-wide Risk/Return Management Committee. Emphasis is dedicated to refinement of
processes and tools to aid in measuring and managing material operational risks and providing for a culture of awareness and accountability. COMPLIANCE RISK MANAGEMENT Compliance risk is the risk of legal or regulatory sanctions, material financial loss, or loss to reputation as a result of failure to comply with laws, regulations, rules, related self-regulatory organization standards, and codes of conduct applicable to banking activities. Management, measurement, and reporting of
compliance risk are overseen by the Compliance Risk Committee, which is chaired by the SVP of Corporate Compliance. Key executives from the business segments, legal, risk management, and service functions are represented on the committee. Summary reports of the committee’s activities and decisions are
provided to the Enterprise-wide Risk/Return Management Committee, and to the Audit Committee of the Board, as applicable. Reports include the status of regulatory activities, internal compliance program initiatives, and evaluation of emerging compliance risk areas. CREDIT RISK MANAGEMENT Credit risk is the risk of loss due to adverse changes in a borrower’s ability to meet its financial obligations under agreed upon terms. FHN is subject to credit risk in lending, trading, investing, liquidity/funding and asset management activities. The nature and amount of credit risk depends on the types of
transactions, the structure of those transactions and the parties involved. In general, credit risk is incidental to trading, liquidity/funding and asset management activities, while it is central to the profit strategy in lending. As a result, the majority of credit risk is associated with lending activities. FHN has policies and guidelines, and processes and management committees in place that are designed to assess and monitor credit risks. The Credit Risk Management Committee is responsible for enterprise-wide credit risk oversight and provides a forum for addressing management issues. The committee
approves and recommends credit policies, which are submitted for final approval to the Credit Policy and Executive Committee of the Board, and underwriting guidelines to manage the level and composition of credit risk in its loan portfolio and review performance relative to these policies. In addition, the Financial
Counterparty Credit Committee, composed of senior managers, assesses the credit risk of financial counterparties and sets limits for exposure based upon the credit quality of the counterparty. A series of regularly scheduled portfolio review meetings are in place to provide oversight regarding the accuracy of credit risk grading and the adequacy of commercial credit servicing. A series of watch list meetings are in place to oversee the management of emerging potential problem commercial assets. The
Credit Risk Management function assesses the portfolio trends and the results of these meetings and utilizes this information to inform management regarding the current state of credit quality as part of the estimation process for determining the allowance for loan losses. All of the above activities are subject to independent review by FHN’s Credit Risk Assurance Group, which encompasses both Credit Review and Credit Quality Control functions. The EVP of Credit Risk Assurance is appointed by and reports to the Credit Policy & Executive Committee of the Board. Credit Risk
Assurance is charged with providing the Board and executive management with independent, objective, and timely assessments of FHN’s portfolio quality, adequacy of credit policies, and credit risk management processes. 37 FIRST HORIZON NATIONAL CORPORATION
FHN’s goal is to manage risk and price loan products based on risk management decisions and strategies. Management strives to identify potential problem loans and nonperforming loans early enough to correct the deficiencies and prevent further credit deterioration. It is management’s objective that both charge-
offs and asset write-downs are recorded promptly, based on management’s assessments of current collateral values and the borrower’s ability to repay. FHN has a significant concentration of loans secured by residential real estate (52 percent of total loans) primarily in three portfolios. The retail real estate residential portfolio including real estate loans pledged against other collateralized borrowings (41 percent of total loans) was comprised of primarily home equity
lines and loans. While this portfolio has been stressed by the downturn in the housing market and rising unemployment, it contains loans extended to strong borrowers with high credit scores and is geographically diversified. The OTC portfolio (5 percent of total loans) has been negatively impacted by the downturn
in the housing industry, certain discontinued product types, and the decreased availability of permanent mortgage financing. The Residential CRE portfolio (6 percent of total loans) has also been negatively impacted by the housing industry downturn, as builder liquidity has been severely stressed. As of December 31, 2008, loans to banks and bank holding companies, trust preferred loans, and loans participating with downstream correspondents totaling $1.7 billion (8 percent of total loans) are included within the Commercial, Financial and Industrial portfolio. Due to the higher credit losses experienced
throughout the financial services industry and the limited availability of market liquidity, these loans experienced increased stress throughout 2008. On December 31, 2008, FHN did not have any concentrations of 10 percent or more of total commercial, financial and industrial loans in any single industry. Allowance for Loan Losses and Charge-offs Management’s policy is to maintain the ALLL at a level sufficient to absorb estimated probable incurred losses in the loan portfolio. The allowance for loan losses is increased by the provision for loan losses and recoveries and is decreased by charged-off loans. The adequacy of the allowance for loan losses is
analyzed quarterly. The Chief Credit Officer has the responsibility for performing a comprehensive review of the allowance for loan losses and reviewing that analysis with the Credit Policy and Executive Committee of the Board each quarterly reporting period. Analytical models, based on loss experience adjusted for
current events, trends and economic conditions, are used to assess the adequacy of the allowance for loan losses. This methodology determines an estimated loss percentage (reserve rate), which is applied against the balance of loans in each segment of the loan portfolio at the evaluation date. The nature of the
process by which FHN determines the appropriate allowance for loan losses requires the exercise of considerable judgment. After review of all relevant factors, management believes the allowance for loan losses is adequate and reflects its best estimate of probable incurred losses. See Critical Accounting Policies for
more detail. Table 18 summarizes, by category, loans charged-off and recoveries of loans previously charged-off, net charge off ratios, and additions to the ALLL through provision. The total allowance for loan losses increased to $849.2 million on December 31, 2008, from $342.3 million at December 31, 2007. Period-end
loans decreased in 2008 after remaining flat in 2007. The ratio of allowance for loan losses to loans, net of unearned income, was 3.99 percent on December 31, 2008, compared to 1.55 percent on December 31, 2007, and .98 percent on December 31, 2006. Provision for loan losses increased by 296 percent
to $1.1 billion in 2008 compared to $272.8 million in 2007. Deterioration in FHN’s portfolios began with real estate related portfolios; especially those related to high-risk products and were generally confined to high risk geographic locations. However, as broader economic conditions continued to decline in 2008,
deterioration occurred in all portfolios. Net charge-offs increased to $572.8 million for the year ended December 31, 2008, an increase from $131.8 million in 2007 and $55.1 million in 2006. The increase in the 2008 level of net charge-offs was primarily due to increased net charge-offs in the national construction (Res CRE and OTC), commercial
(C&I), and HELOC portfolios. Commercial, financial and industrial (C&I) net charge-offs were $101.1 million in 2008 compared to $35.5 million in 2007, as the weakening economy impacted commercial credits. Commercial real estate 38 FIRST HORIZON NATIONAL CORPORATION
construction and real estate commercial net charge-offs increased to $191.1 million in 2008 from $28.6 million in 2007 due to the significant deterioration in the residential housing market. The retail real estate portfolios, which includes HELOC, home equity installment loans, construction (OTC), and permanent mortgages, also experienced deterioration and higher net charge offs in 2008. OTC net charge-offs increased to $141.3 million in 2008 compared to $23.5 million in 2007 as deterioration that
began in 2007 continued into 2008. HELOC net charge-offs increased to $77.4 million in 2008 from $25.9 million in 2007 and home equity installment loans net charge offs increased to $39.4 million in 2008 from $6.7 million in 2007. Credit card receivable net charge-offs increased to $9.3 million in 2008 from
$6.1 million in 2007 as the decline in the economy impacted consumers’ financial condition. While charge-offs increased due to deteriorating economic conditions, FHN’s methodology of charging down collateral dependent commercial loans to net realizable value (NRV) also impacted charge-off trends, especially in comparison to applicable ALLL. Generally, classified nonaccrual loans over $1 million are
deemed to be impaired in accordance with Statement of Financial Accounting Standards, No. 114, “Accounting by Creditors for Impairment of a Loan” (SFAS No. 114) and are assessed for impairment measurement. A majority of these SFAS No. 114 loans (generally commercial loans over $1 million that are not
expected to pay all contractually due principal and interest) are included in the Residential CRE (Homebuilder and Condominium Construction) portfolio. Once impairment is detected, loans are then written down to the fair value of the underlying collateral, less costs to sell (net realizable value). Fair value is based
on recent appraisals of collateral. Collateral values are monitored and further charge-offs are taken if it is determined that the collateral values have continued to decline. Historically, as problem loans had been identified, estimated probable losses were reserved for in the ALLL and these loans were subsequently
charged-off as appropriate. Given the deterioration in the real estate markets and the growing number of loans determined to be collateral dependent under SFAS No. 114, charge-offs of these loans have been accelerated to the time when the impairments are initially detected as opposed to historical trends which
reflected additions to the ALLL for probable inherent losses. Also impacting increased charge-offs related to SFAS No. 114 loans are the dramatic declines in collateral values experienced due to the prevailing real estate market conditions. Therefore, charge-offs are not only higher due to the increased credit deterioration related to these loans throughout 2008, but also due
to the increased rate at which loans are charged down to net realizable value because of rapidly declining collateral values. As of December 31, 2008, the total value of SFAS No. 114 commercial loans considered collateral dependent carried at net realizable value (NRV) was $414.9 million, while net charge-offs related to these loans were $198.5 million or 35 percent of total net charge-offs during 2008. Because of the accelerated
recognition of impairment of these loans, the elevated charge-offs decrease the ALLL. Compression occurs in the ALLL to net charge-offs ratio as the ALLL is generally not replenished for charge-offs related to SFAS No.114 collateral dependent loans because reserves are not carried for these loans. The OTC
portfolio of the winding-down National Specialty Lending Segment has experienced significant deterioration in 2008. Generally, OTC loans are written down to appraised value if, when the loan becomes 90 days past due or is considered substandard, recently obtained appraisals indicate a decline in fair value.
Subsequent charge downs are taken thereafter in accordance with regulatory guidelines. During 2008, net charge-offs related to OTC loans were $141.3 million, approximately 25 percent of total net charge-offs. Asset quality is expected to remain stressed in 2009 due to the expectation that the housing industry and broader economic conditions may continue to deteriorate. Actual results could differ because of several factors, including those presented in the Forward-Looking Statements section of this MD&A discussion. 39 FIRST HORIZON NATIONAL CORPORATION
Table 18 - Analysis of Allowance for Loan Losses
(Dollars in thousands)
2008
2007
2006
2005
2004
2003 Allowance for loan losses: Beginning balance
$
342,341
$
216,285
$
189,705
$
158,159
$
160,333
$
144,298 Provision for loan losses
1,080,000
272,765
83,129
67,678
48,348
86,698 Loans transferred to held for
-
2,655
-
-
(8,382
)
- Acquisitions/(divestitures), net
(370
)
(17,598
)
(1,470
)
1,386
-
(2,652
) Charge-offs: Commercial: Commercial, financial and
105,626
42,639
28,095
12,789
11,925
12,460 Real estate commercial
22,518
2,504
2,070
498
2,690
3,067 Real estate construction
170,995
26,272
115
2,805
779
7,642 Retail: Real estate residential
131,015
37,345
23,405
18,744
21,271
35,809 Real estate construction
143,541
23,806
1,962
374
-
- Other retail
8,991
7,490
6,753
6,101
7,094
9,920 Credit card receivables
9,742
6,851
6,226
10,839
12,870
13,538 Total charge-offs
592,428
146,907
68,626
52,150
56,629
82,436 Recoveries: Commercial: Commercial, financial and
4,495
7,169
4,725
3,328
3,473
2,438 Real estate commercial
81
223
296
1,173
51
166 Real estate construction
2,305
2
-
-
10
1 Retail: Real estate residential
7,815
4,256
4,307
5,300
4,517
4,820 Real estate construction
2,253
280
-
-
-
- Other retail
2,309
2,458
3,090
3,697
4,211
5,653 Credit card receivables
409
753
1,129
1,134
2,227
1,347 Total recoveries
19,667
15,141
13,547
14,632
14,489
14,425 Net charge-offs
572,761
131,766
55,079
37,518
42,140
68,011 Ending balance
$
849,210
$
342,341
$
216,285
$
189,705
$
158,159
$
160,333 Reserve for off-balance sheet
$
18,752
$
10,726
$
9,378
$
10,650
$
7,904
$
7,804 Total of allowance for loan
$
867,962
$
353,067
$
225,663
$
200,355
$
166,063
$
168,137 Loans and commitments: Period end loans, net of
$
21,278,190
$
22,103,516
$
22,104,905
$
20,611,998
$
16,441,928
$
14,021,318 Insured retail residential and
591,116
913,164
729,842
826,904
665,909
862,675 Loans excluding insured loans
$
20,687,074
$
21,190,352
$
21,375,063
$
19,785,094
$
15,776,019
$
13,158,643 Off-balance sheet
$
6,441,854
$
6,929,299
$
7,587,028
$
9,090,618
$
6,226,245
$
5,464,097 Average loans, net of unearned
$
21,660,704
$
22,106,682
$
21,504,175
$
18,334,684
$
15,440,501
$
12,679,804 Allowance and net charge off Allowance to total loans
3.99
%
1.55
%
.98
%
.92
%
.96
%
1.14
% Allowance to total loans
4.11
1.62
1.01
.96
1.00
1.22 Allowance to net charge-offs
1.48
x
2.60
x
3.93
x
5.06
x
3.75
x
2.36
x Total commercial net
2.63
.57
.24
.13
.18
.34 Retail real estate net charge-offs
2.58
.54
.20
.15
.20
.50 Other retail net charge-offs
4.81
3.37
2.26
1.46
1.55
1.64 Credit card receivables net
4.83
3.11
2.43
4.03
4.25
4.65 Total net charge-offs to average
2.64
.60
.26
.20
.27
.54
(a)
Whole-loan insurance is obtained on certain retail residential and construction loans. Insuring these loans absorbs credit risk and results in lower allowance for loan losses. (b) Amount of off-balance sheet commitments for which a reserve has been provided. See Note 26 – Derivatives and Off-Balance Sheet Arrangements for further details on off-balance sheet commitments. (c) Loans net of unearned income. Net charge-off ratios are calculated based on average loans. Table 10 provides information on the relative size of each loan portfolio. 40 FIRST HORIZON NATIONAL CORPORATION
sale
industrial
industrial
commitments
losses and reserve for off-
balance sheet commitments
unearned
construction loans (a)
commitments (b)
Ratios (c):
excluding insured loans
charge-offs
charge-offs
loans
Components of the Allowance for Loan Losses The allowance for loan losses includes the following components: reserves for commercial loans evaluated based on pools of credit graded loans and reserves for pools of smaller-balance homogeneous retail and commercial loans, both determined in accordance with SFAS No. 5, “Accounting for Contingencies.” Also
included are reserves, determined in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” related to loans determined by management to be individually impaired. The reserve factors applied to these pools are an estimate of probable incurred losses based on management’s
evaluation of historical losses from loans with similar characteristics, adjusted for current economic factors and trends. Table 19 gives a breakdown of the allowance allocation by major loan types and commercial loan grades on December 31, 2008, compared with December 31, 2007. To assess the quality of individual commercial loans, all commercial loans are internally assigned a credit grade. During 2006, a new credit grading system was implemented that assigns credit grades ranging from 1 to 16. However, the allowance for loan losses continues to be based on historical losses which had
assigned grades of 1 to 10. Therefore, to maintain the integrity and accuracy of the allowance methodology, at each reporting period the new assigned loan grades are back-converted to the old grades for proper assignment of reserves. The credit grading system is intended to identify and measure the credit quality
of lending relationships by analyzing the migration of loans between grading categories. It is also integral to the estimation methodology utilized in determining the allowance for loan losses since an allowance is established for pools of commercial loans based on the credit grade assigned. The appropriate
relationship manager performs the process of classifying commercial loans into the appropriate credit grades initially as a component of the approval of the loan and has responsibility for insuring that the loan is properly graded throughout the life of the loan. The proper loan grade for all commercial loans in excess
of $1 million is confirmed by a senior credit officer in the approval process. To determine the most appropriate credit grade for each loan, FHN utilizes a credit risk grading system that employs scorecards to particular categories of loans. The scorecards consist of a number of objective and subjective measures that
are weighted in a manner that produces a rank ordering of risk within pass-graded credits. Loan grades are frequently reviewed by commercial loan review to determine if any changes in the circumstances of the loan require a different risk grade. A reserve rate is established for each loan grade based on a historical three-year moving average of actual charge-offs. The reserve rate is then adjusted for current events, trends, and economic conditions that affect the asset quality of the loan portfolio. Some of the factors considered in making these adjustments
include: levels of and trends in delinquencies; classified loans and nonaccrual loans; trends in outstandings and maturities; effects of changes in lending policies and underwriting guidelines; introduction of new loan products with different risk characteristics; experience, ability and depth of lending management and
staff; migration trends of loan grades; and charge-off trends that may skew the historical three-year moving average. Finally, the reserve rates for each loan grade are reviewed quarterly to reflect local, regional and national economic trends; concentrations of cyclical industries; and the economic prospects for
industry concentrations. To supplement management’s process in setting these additional adjustments, an economic model is used that evaluates the correlation between historical charge-offs and a number of state and national economic indicators. The allowance for loan losses for smaller-balance homogenous loans (retail loans) is determined based on pools of similar loan types that have similar credit risk characteristics, which is consistent with industry practice. FHN manages retail loan credit risk on a portfolio basis. Reserves by portfolio are determined
using analytical models that incorporate various factors including, but not limited to, historical delinquency trends, experienced loss frequencies, and experienced loss severities. Generally, reserves for retail loans reflect inherent losses in the portfolio that are expected to be recognized over the following twelve
months. 41 FIRST HORIZON NATIONAL CORPORATION
Table 19 - Loans and Allowance for Loan Loss on December 31
(Dollars in millions)
2008
2007
C&I
Income
Residential
Total
%
Allowance
Total
%
Allowance Internal grades: 1
$
135
$
-
$
-
$
135
-
%
$
1
$
15
-
%
$
- 2
8
2
-
10
-
-
78
-
- 3
155
6
-
161
1
1
262
1
2 4
296
10
-
306
1
3
476
2
3 5
523
23
3
549
3
6
721
3
6 6
645
96
7
748
4
8
1,036
5
10 7
969
200
6
1,175
6
12
1,565
7
16 8
1,156
302
18
1,476
7
16
2,499
11
30 9
924
261
24
1,209
6
13
1,611
7
22 10
648
94
23
765
4
9
1,028
5
21 11
741
261
129
1,131
5
21
999
5
32 12
280
86
73
439
2
15
421
2
25 13
912
312
242
1,466
7
96
204
1
22 14, 15, 16 (Classifieds)
384
241
427
1,052
5
179
147
1
19
7,776
and
Other
CRE
CRE
of
Total
for Loan
Losses
of
Total
for Loan
Losses