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First Horizon National Corporation 10-Q 2010 Documents found in this filing:Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended September 30, 2010
Or
For the transition period from to
Commission File Number 001-15185
First Horizon National Corporation
(Exact name of registrant as specified in its charter)
(Registrant’s telephone number, including area code) (901) 523-4444
(Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files). þ Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated
filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
(Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). o Yes þ No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as
of the latest practicable date.
FIRST HORIZON NATIONAL CORPORATION
INDEX
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PART I.
FINANCIAL INFORMATION
This financial information reflects all adjustments that are, in the opinion of management,
necessary for a fair presentation of the financial position and results of operations for the
interim periods presented.
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CONSOLIDATED CONDENSED STATEMENTS OF CONDITION
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CONSOLIDATED CONDENSED STATEMENTS OF INCOME
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CONSOLIDATED CONDENSED STATEMENTS OF EQUITY
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See
accompanying notes to consolidated condensed financial statements.
Certain previously reported amounts have been reclassified to agree with current presentation.
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Notes to Consolidated Condensed Financial Statements
Note 1 – Financial Information
The unaudited interim Consolidated Condensed Financial Statements of First Horizon National
Corporation (“FHN”), including its subsidiaries, have been prepared in conformity with accounting
principles generally accepted in the United States of America and follow general practices within
the industries in which it operates. This preparation requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and accompanying notes.
These estimates and assumptions are based on information available as of the date of the financial
statements and could differ from actual results. In the opinion of management, all necessary
adjustments have been made for a fair presentation of financial position and results of operations
for the periods presented. The operating results for the interim 2010 periods are not necessarily
indicative of the results that may be expected going forward. For further information, refer to
the audited consolidated financial statements in the 2009 Annual Report to shareholders.
FHN historically presented charges related to repurchase obligations for junior lien consumer
mortgage loan sales in noninterest income while similar charges arising from first lien mortgage
originations and sales through the legacy national mortgage banking business were reflected in
noninterest expense. In order to present such charges consistently, FHN determined that charges
relating to repurchase obligations should be reflected in noninterest expense in the line item
called Repurchase and foreclosure provision on the Consolidated Condensed Statements of Income.
Consequently, FHN retroactively applied this change which resulted in a reclassification of charges
related to junior lien mortgage loan sales from noninterest income into noninterest expense. All
applicable tables and associated narrative have been revised to reflect this change. This
reclassification did not impact FHN’s net income and all effects are included in the non-strategic
segment.
Principles of Consolidation and Basis of Presentation. The consolidated financial statements
include the accounts of FHN and other entities in which it has a controlling financial interest.
Variable Interest Entities (“VIE”) for which FHN or a subsidiary has been determined to be the
primary beneficiary are also consolidated. Following adoption of the provisions of Financial
Accounting Standards Board (“FASB“) Accounting Standards Update 2009-17 on January 1, 2010, the
assets and liabilities of FHN’s consolidated residential mortgage securitization trusts have been
parenthetically disclosed on the face of the Consolidated Condensed Statements of Condition as
restricted in accordance with the presentation requirements of ASC 810, as amended, due to the
assets being pledged to settle the trusts’ obligations and the trusts’ security holders having no
recourse to FHN.
Loans Held for Sale and Securitization and Residual Interests. Prior to fourth quarter 2008, FHN
originated first lien mortgage loans (“the warehouse”) for the purpose of selling them in the
secondary market, through sales to agencies for securitization, proprietary securitizations, and to
a lesser extent through other whole loan sales. In addition, FHN evaluated its liquidity position in
conjunction with determining its ability and intent to hold loans for the foreseeable future and
sold certain of the second lien mortgages and home equity lines of credit (“HELOC”) it produced in
the secondary market through securitizations and whole loan sales through third quarter 2007. For
periods ending prior to January 1, 2010, loan securitizations involved the transfer of the loans to
qualifying special purpose entities (“QSPE”) that were not subject to consolidation in accordance
with ASC 860, “Transfers and Servicing”. Upon the effective date of the provisions of FASB
Accounting Standards Update 2009-16 and FASB Accounting Standards Update 2009-17 on January 1,
2010, the concept of a QSPE was removed from Generally Accepted Accounting Principles (“GAAP”) and
the criteria in ASC 810, “Consolidation”, for determining the primary beneficiary of a VIE were
amended, resulting in the re-evaluation of all securitization trusts to which FHN had previously
transferred loans for consolidation under ASC 810’s revised consolidation criteria. Following the
re-evaluation of the trusts for consolidation upon adoption of the amendments to ASC 810, the
majority of the mortgage securitization trusts to which FHN transferred loans remains
unconsolidated as FHN is deemed not to be the primary beneficiary based on the interests it
retained in the trusts. Under ASC 810, as amended, continual reconsideration of conclusions
reached regarding which interest holder is the primary beneficiary of a trust is required. See
Note 14 – Variable Interest Entities for additional information regarding FHN’s consolidated and
nonconsolidated mortgage securitization trusts.
Accounting Changes. Effective September 30, 2010, FHN adopted the provisions of FASB Accounting
Standards Update 2010-11, “Scope Exception Related to Embedded Credit Derivatives” (“ASU 2010-11”).
ASU 2010-11 amends ASC 815 to provide clarifying language regarding when embedded credit
derivative features are not considered embedded derivatives subject to potential bifurcation and
separate accounting. Upon adoption of the provisions of ASU 2010-11, re-evaluation of certain
preexisting contracts is required to determine whether the accounting for such contracts is
consistent with the amended guidance in ASC 815. If the fair value option is elected for an
instrument upon adoption of the amendments to ASC 815, re-evaluation of such preexisting contracts
is not required. As FHN does not have any preexisting contracts which require re-evaluation, the
adoption of the Codification update to ASC 815 had no effect on FHN’s statement of condition,
results of operations, or cash flows.
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Note 1 – Financial Information (continued)
Effective upon its issuance in February 2010, FHN adopted the provisions of FASB Accounting
Standards Update 2010-09, “Subsequent Events – Amendments to Certain Recognition and Disclosure
Requirements” (“ASU 2010-09”). ASU 2010-09 amends ASC 855 to clarify that an entity must disclose
the date through which subsequent events have been evaluated in both originally issued and restated
financial statements unless the entity has a regulatory requirement to review subsequent events up
through the filing or furnishing of financial statements with the Securities and Exchange
Commission. Upon adoption of the provisions of ASU 2010-09, FHN revised its disclosures
accordingly.
Effective January 1, 2010, FHN adopted the provisions of FASB Accounting Standards Update 2010-06,
“Improving Disclosures about Fair Value Measurements” (“ASU 2010-06”), with the exception of the
requirement to provide the activity of purchases, sales, issuances, and settlements related to
recurring Level 3 measurements on a gross basis in the Level 3 reconciliation which is effective
for quarters beginning after December 15, 2010. ASU 2010-06 updates ASC 820 to require disclosure
of significant transfers into and out of Level 1 and Level 2 of the fair value hierarchy, as well
as disclosure of an entity’s policy for determining when transfers between all levels of the
hierarchy are recognized. The updated provisions of ASC 820 also require that fair value
measurement disclosures be provided by each “class” of assets and liabilities, and that disclosures
providing a description of the valuation techniques and inputs used to measure fair value be
included for both recurring and nonrecurring fair value measurements classified as either Level 2
or Level 3. Under ASC 820, as amended, separate disclosure is required in the Level 3
reconciliation of total gains and losses recognized in other comprehensive income. Comparative
disclosures are required only for periods ending subsequent to initial adoption. Upon adoption of
the amendments to ASC 820, FHN revised its disclosures accordingly.
Effective January 1, 2010, FHN adopted the provisions of FASB Accounting Standards Update 2009-16,
“Accounting for Transfers of Financial Assets” (“ASU 2009-16”). ASU 2009-16 updates ASC 860 to
provide for the removal of the QSPE concept from GAAP, resulting in the evaluation of all former
QSPEs for consolidation in accordance with ASC 810 on and after the effective date of the
amendments. The amendments to ASC 860 modify the criteria for achieving sale accounting for
transfers of financial assets and define the term participating interest to establish specific
conditions for reporting a transfer of a portion of a financial asset as a sale. The updated
provisions of ASC 860 also provide that a transferor should recognize and initially measure at fair
value all assets obtained (including a transferor’s beneficial interest) and liabilities incurred
as a result of a transfer of financial assets accounted for as a sale. ASC 860, as amended,
requires enhanced disclosures which are generally consistent with, and supersede, the disclosures
previously required by the Codification update to ASC 810 and ASC 860 which was effective for
periods ending after December 15, 2008. Upon adoption of the amendments to ASC 860, FHN applied
the amended disclosure requirements to transfers that occurred both before and after the effective
date of the Codification update, with comparative disclosures included only for periods subsequent
to initial adoption for those disclosures not previously required. The adoption of the
Codification update to ASC 860 had no material effect on FHN’s statement of condition, results of
operations, or cash flows.
Effective January 1, 2010, FHN adopted the provisions of Accounting Standards Update 2009-17,
“Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities” (“ASU
2009-17”). ASU 2009-17 amends ASC 810 to revise the criteria for determining the primary
beneficiary of a VIE by replacing the quantitative-based risks and rewards test previously required
with a qualitative analysis. While ASC 810, as amended, retains the previous guidance in ASC 810
which requires a reassessment of whether an entity is a VIE only when certain triggering events
occur, it adds an additional criteria which triggers a reassessment of an entity’s status when an
event occurs such that the holders of the equity investment at risk, as a group, lose the power
from voting rights or similar rights of those investments to direct the activities of the entity
that most significantly impact the entity’s economic performance. Additionally, the amendments to
ASC 810 require continual reconsideration of conclusions regarding which interest holder is the
VIE’s primary beneficiary. Under ASC 810, as amended, separate presentation is required on the
face of the balance sheet of the assets of a consolidated VIE that can only be used to settle the
VIE’s obligations and the liabilities of a consolidated VIE for which creditors or beneficial
interest holders have no recourse to the general credit of the primary beneficiary. ASC 810, as
amended, also requires enhanced disclosures which are generally consistent with, and supersede, the
disclosures previously required by the Codification update to ASC 810 and ASC 860 which was
effective for periods ending after December 15, 2008. Comparative disclosures are required only
for periods subsequent to initial adoption for those disclosures not required under such previous
guidance.
Upon adoption of the amendments to ASC 810, FHN re-evaluated all former QSPEs and entities already
subject to ASC 810 under the revised consolidation methodology. Based on such re-evaluation,
consumer loans with an aggregate unpaid principal balance of $245.2 million were prospectively
consolidated as of January 1, 2010, along with secured borrowings of $236.3 million, as the
retention of mortgage servicing rights (“MSR”) and other retained interests, including residual
interests and subordinated bonds, resulted in FHN being considered the related trusts’ primary
beneficiary under the qualitative analysis required by ASC 810, as amended. MSR and trading assets
held in
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Note 1 – Financial Information (continued)
relation to the newly consolidated trusts were removed from the mortgage servicing rights and
trading securities sections of the Consolidated Condensed Statements of Condition, respectively,
upon adoption of the amendments to ASC 810. As the assets of FHN’s consolidated residential
mortgage securitization trusts are pledged to settle the obligations due to the holders of the
trusts’ securities and since the security holders have no recourse to FHN, the asset and liability
balances have been parenthetically disclosed on the face of the Consolidated Condensed Statements
of Condition as restricted in accordance with the presentation requirements of ASC 810, as amended.
Since FHN determined that calculation of carrying values was not practicable, the unpaid principal
balance measurement methodology was used upon adoption, with the allowance for loan losses (“ALLL”)
related to the newly consolidated loans determined using FHN’s standard practices. FHN recognized
a reduction to the opening balance of undivided profits of approximately $10.6 million for the
cumulative effect of adopting the amendments to ASC 810, including the effect of the recognition of
an adjustment to the ALLL of approximately $24.6 million ($15.6 million net of tax) in relation to
the newly consolidated loans. Further, upon adoption of the amendments to ASC 810, the
deconsolidation of certain small issuer trust preferred trusts for which First Tennessee Bank National
Association (“FTBNA”) holds the majority
of the mandatorily redeemable preferred capital securities (trust preferreds) issued but is not
considered the primary beneficiary under the qualitative analysis required by ASC 810, as amended,
resulted in reduction of loans net of unearned income and term borrowings on the Consolidated
Condensed Statements of Condition by $30.5 million.
Effective January 1, 2010, FHN adopted the provisions of FASB Accounting Standards Update 2010-10,
“Amendments for Certain Investment Funds” (“ASU 2010-10”). ASU 2010-10 delays the application of
ASU 2009-17 for a reporting entity’s interest in an entity that has the attributes of an investment
company or for which it is industry practice to apply measurement principles for financial
reporting purposes that are consistent with those followed by investment companies. For entities
that do not qualify for the deferral, ASU 2010-10 clarifies that related parties should be
considered when evaluating whether each of the criteria related to permitted levels of decision
maker or service provider fees in ASC 810 are met. Additionally, ASU 2010-10 amends ASC 810 to
provide that when evaluating whether a fee is a variable interest in situations in which a decision
maker or servicer provider holds another interest in the related VIE, a quantitative calculation
may be used but should not be the sole basis for evaluating whether the other variable interest is
more than insignificant. The adoption of the Codification update to ASC 810 had no effect on FHN’s
statement of condition, results of operations, or cash flows.
Accounting Changes Issued but Not Currently Effective. In July 2010, the FASB issued
Accounting Standards Update 2010-20, “Disclosures about the Credit Quality of Financing Receivables
and the Allowance for Credit Losses” (“ASU 2010-20”). ASU 2010-20 provides enhanced disclosures
related to the credit quality of financing receivables and the allowance for credit losses, and
provides that new and existing disclosures should be disaggregated based on how an entity develops
its allowance for credit losses and how it manages credit exposures. Under the provisions of ASU
2010-20, additional disclosures required for financing receivables include information regarding
the aging of past due receivables, credit quality indicators, and modifications of financing
receivables. The provisions of ASU 2010-20 are effective for periods ending after December 15,
2010, with the exception of the amendments to the rollforward of the allowance for credit losses
and the disclosures about modifications which are effective for periods beginning after December
15, 2010. Comparative disclosures are required only for periods ending subsequent to initial
adoption. FHN is currently assessing the effects of adopting the provisions of ASU 2010-20.
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Note 2 – Acquisitions and Divestitures
In first quarter 2010, FHN exited its institutional research business, FTN Equity Capital
Markets (“FTN ECM”), and incurred a pre-tax goodwill impairment of $3.3 million (approximately $2 million after
taxes). FHN exited this business through an immediate cessation of operations on February 1, 2010.
Additional charges, primarily representing severance and contract terminations, of $6.1 million
were included within the Loss from discontinued operations, net of tax line on the
Consolidated Condensed Statements of Income in first quarter 2010 related to the effects of closing
FTN ECM. These charges are included with the amounts described in Note 17 — Restructuring,
Repositioning, and Efficiency. FHN had initially reached an agreement for the sale of this
business which resulted in a pre-tax goodwill impairment of $14.3 million (approximately $9 million
after taxes) in 2009; however, the contracted sale failed to close and was terminated in early
2010. The financial results of this business, including the goodwill impairments, are reflected in
the Loss from discontinued operations, net of tax line on the Consolidated Condensed
Statements of Income for all periods presented.
In fourth quarter 2009, FHN executed the sale and closure of its Atlanta insurance business and Louisville First
Express Remittance Processing location (“FERP”). FHN recognized a loss of $7.5 million on the sale
of the Atlanta insurance business and a $1.7 million loss on the FERP divestiture. These losses
are reflected on the Consolidated Condensed Statements of Income as a loss on divestiture within
noninterest income. The losses on divestitures primarily reflect goodwill write-offs associated
with the sale. FHN continues to have an insurance business within its Tennessee banking footprint
and continues to operate other remittance processing locations.
In addition to the divestitures mentioned above, FHN acquires or divests assets from time to time
in transactions that are considered business combinations or divestitures but are not material to
FHN individually or in the aggregate.
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Note 3 – Investment Securities
The following tables summarize FHN’s available for sale securities on September 30, 2010 and
2009:
National banks chartered by the federal government are, by law, members of the Federal Reserve
System. Each member bank is required to own stock in its regional Federal Reserve Bank (“FRB”).
Given this requirement, Federal Reserve stock may not be sold, traded, or pledged as collateral for
loans. Membership in the Federal Home Loan Bank (“FHLB”) network requires ownership of capital
stock. Member banks are entitled to borrow funds from the FHLB and are required to pledge mortgage
loans as collateral. Investments in the FHLB are non-transferable and, generally, membership is
maintained primarily to provide a source of liquidity as needed.
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Note 3 – Investment Securities (continued)
Provided below are the amortized cost and fair value by contractual maturity for the available
for sale securities portfolio on September 30, 2010:
Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with
or without call or prepayment penalties.
For the three months ended September 30, 2010 and 2009, recognized gains and losses from the
sale of available for sale securities were immaterial.
The following tables provide information on investments within the available for sale portfolio
that have unrealized losses on September 30, 2010 and 2009:
FHN has reviewed investment securities that are in unrealized loss positions in accordance with its
accounting policy for other-than-temporary impairment and does not consider them
other-than-temporarily impaired. FHN does not intend to sell the debt securities and it is
more-likely-than-not that FHN will not be required to sell the securities prior to recovery. The
decline in value is primarily attributable to interest rates and not credit losses. For the three
and nine months ended September 30, 2010 and 2009, there were no realized gains or losses related
to debt securities within the available for sale securities portfolio. For equity securities, FHN
has both the ability and intent to hold these securities for the time necessary to recover the
amortized cost. There were no other-than-temporary impairments for the three months ended
September 30, 2010 and 2009. For the nine months ended September 30, 2010 and 2009,
other-than-temporary impairments were recognized of $.2 million and $.5 million, respectively.
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Note 4 – Loans
The composition of the loan portfolio is detailed below:
FHN has a concentration of loans secured by residential real estate (47 percent of total
loans), the majority of which is in the retail real estate residential portfolio (39 percent of
total loans). This portfolio is primarily comprised of home equity lines and loans. Restricted
real estate loans, which is primarily HELOC but also includes some first and second mortgages, is 5
percent of total loans. The remaining residential real estate loans are primarily in the
construction portfolios (3 percent of total loans) with national exposures being significantly
reduced since 2008. Additionally, on September 30, 2010, FHN had bank-related and trust preferred
loans (including loans to bank and insurance-related businesses) totaling $.7 billion (4 percent of
total loans) that are included within the Commercial, Financial, and Industrial portfolio. Due to
higher credit losses experienced throughout the financial services industry and the limited
availability of market liquidity, these loans have experienced stress during the economic downturn.
On September 30, 2010, FHN did not have any concentrations of Commercial, Financial, and Industrial
loans in any single industry of 10 percent or more of total loans.
On September 30, 2010 and 2009, FHN had
loans classified as troubled debt restructurings of $253.7 million and $67.6 million, respectively.
Additionally, FHN had restructured $46.3 million of loans held for sale as of September 30, 2010.
For restructured loans in the portfolio, FHN had loan loss reserves of $47.7 million or 19 percent
as of September 30, 2010. On September 30, 2010 and 2009, there were no significant outstanding
commitments to advance additional funds to customers whose loans had been restructured.
Nonperforming loans consist of loans which management has identified as individually impaired,
other nonaccrual loans, and loans which have been restructured. Generally, classified nonaccrual
commercial loans over $1 million are deemed to be individually impaired. The following table
presents information concerning nonperforming loans:
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Note 4 – Loans (continued)
It is our policy that interest payments received on impaired and nonaccrual loans are applied to
principal. Once all principal has been received, additional payments are recognized as interest
income on a cash basis. The following table presents information concerning impaired loans:
Activity in the allowance for loan losses related to non-impaired and impaired loans for the
nine months ended September 30, 2010 and 2009 is summarized as follows:
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Note 5 – Mortgage Servicing Rights
FHN recognizes all classes of mortgage servicing rights (“MSR”) at fair value. Classes of MSR are
determined in accordance with FHN’s risk management practices and market inputs used in determining
the fair value of the servicing asset. See Note 16 – Fair Value, the “Determination of Fair Value”
section for a discussion of FHN’s MSR valuation methodology. The balance of MSR included on the
Consolidated Condensed Statements of Condition represents the rights to service approximately $31.0
billion of mortgage loans on September 30, 2010, for which a servicing right has been capitalized.
In first quarter 2010, FHN adopted the amendments to ASC 810 which resulted in the consolidation of
loans FHN previously sold through proprietary securitizations but retained MSR and significant
subordinated interests subsequent to the transfer. In conjunction with the consolidation of these
loans, FHN derecognized the associated servicing assets which are reflected in the rollfoward
below.
In third quarter 2009, FHN reviewed the allocation of fair value between MSR and excess interest
from prior first lien loan sales and securitizations and as a result, $11.1 million was
reclassified from trading securities to MSR. The reclassification had no effect on FHN’s
Consolidated Condensed Statements of Income as excess interest and MSR are highly correlated in
valuation and both are recognized at fair value with changes in fair value being included within
mortgage banking income. The reclassification to MSR is reflected in the rollforward below.
Following is a summary of changes in capitalized MSR for the nine months ended September 30, 2010
and 2009:
Servicing, late, and other ancillary fees recognized within mortgage banking income were
$21.4 million and $29.7 million for the three months ended September 30, 2010 and 2009,
respectively, and $75.0 million and $92.6 million for the nine months ended September 30, 2010 and
2009, respectively. Servicing, late, and other ancillary fees recognized within other income and
commissions were $.9 million and $3.5 million for the three months ended September 30, 2010 and
2009, respectively, and $3.1 million and $10.9 million for the nine months ended September 30,
2010 and 2009, respectively.
FHN services a portfolio of mortgage loans related to transfers performed by other parties
utilizing securitization trusts. The servicing assets represent FHN’s sole interest in these
transactions. The total MSR recognized by FHN related to these transactions was $4.1 million and
$7.2 million at September 30, 2010 and 2009, respectively. The aggregate principal balance
serviced by FHN for these transactions was $.7 billion and $1.0 billion at September 30, 2010 and
2009, respectively. FHN has no obligation to provide financial support and has not provided any
form of support to the related trusts. The MSR recognized by FHN has been included in the first
lien mortgage loans column within the rollforward of MSR.
In prior periods FHN transferred MSR to third parties in transactions
that did not qualify for sales treatment due to certain recourse provisions that were included
within the sale agreements.
On September 30, 2010, FHN had $21.8 million of MSR related to these transactions.
These MSR are included within the first liens mortgage loans column
within the rollforward of MSR. The proceeds from these transfers have been recognized within other
short term borrowings and commercial paper in the Consolidated Condensed Statements of Condition as
of September 30, 2010 and 2009.
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Note 6 – Intangible Assets
The following is a summary of intangible assets, net of accumulated amortization, included in
the Consolidated Condensed Statements of Condition:
The gross carrying amount of other intangible assets subject to amortization is $125.8 million
on September 30, 2010, net of $91.5 million of accumulated amortization. Estimated aggregate
amortization expense is expected to be $1.4 million for the remainder of 2010, and $5.3 million,
$4.3 million, $3.9 million, $3.6 million, and $3.4 million for the twelve-month periods of 2011,
2012, 2013, 2014, and 2015, respectively.
The following is a summary of gross goodwill and accumulated impairment losses and write-offs
detailed by reportable segments included in the Consolidated Condensed Statements of Condition
through December 31, 2009. Gross goodwill and accumulated impairments and divestiture-related
write-offs were determined beginning on January 1, 2002, when a change in accounting requirements
resulted in goodwill being assessed for impairment rather being amortized.
Certain previously reported amounts have been reclassified to agree with current presentation.
There is no goodwill associated with the Corporate segment.
The following is a summary of goodwill detailed by reportable segments for the nine months
ended September 30:
Certain previously reported amounts have been reclassified to agree with current presentation.
There is no goodwill associated with the Corporate segment.
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Note 6 – Intangible Assets (continued)
The following is a summary of gross goodwill and accumulated impairment losses and write-offs
detailed by reportable segments included in the Consolidated Condensed Statements of Condition
through September 30, 2010. Gross goodwill and accumulated impairments and divestiture-related
write-offs were determined beginning on January 1, 2002, when a change in accounting requirements
resulted in goodwill being assessed for impairment rather than being amortized.
Certain previously reported amounts have been reclassified to agree with current presentation.
There is no goodwill associated with the Corporate segment.
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Note 7 – Regulatory Capital
FHN is subject to various regulatory capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and
possibly additional discretionary actions by regulators that, if undertaken, could have a direct
material effect on FHN’s financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, specific capital guidelines that involve
quantitative measures of assets, liabilities, and certain derivatives as calculated under
regulatory accounting practices must be met. Capital amounts and classification are also subject
to qualitative judgment by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require FHN to maintain
minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets, and of Tier 1
capital to average assets (leverage). Management believes, as of September 30, 2010, that FHN met
all capital adequacy requirements to which it was subject.
The actual capital amounts and ratios of FHN and FTBNA are presented in the table below. In
addition, FTBNA must also calculate its capital ratios after excluding financial subsidiaries as
defined by the Gramm-Leach-Bliley Act of 1999. Based on this calculation, FTBNA’s Total Capital,
Tier 1 Capital, and Leverage ratios were 19.97 percent, 16.34 percent, and 13.13 percent,
respectively, on September 30, 2010, and were 19.51 percent, 15.08 percent, and 12.47 percent,
respectively, on September 30, 2009.
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Note 8 – Earnings per Share
The following tables show a reconciliation of the numerators used in calculating basic and
diluted earnings per share attributable to common shareholders:
The following table provides a reconciliation of weighted average common shares to diluted
average common shares:
The following table provides a reconciliation of earnings/(losses) per common and diluted
share:
For the three months ended September 30, 2009 and the nine months ended September 30, 2010 and
2009, all outstanding potential common shares were antidilutive due to the net loss attributable to
common shareholders for those periods. Stock options of 11.5 million and 14.6 million with a
weighted average exercise price of $27.56 and $28.07 per share for the three months ended September
30, 2010 and 2009, respectively, were excluded from diluted shares. Stock options of 12.3 million
and 15.4 million with a weighted average exercise price of $27.58 and $28.24 per share for the nine
months ended September 30, 2010 and 2009, respectively, were excluded from diluted shares. Other
equity awards of .3 million and 2.0 million for the three months ended September 30, 2010 and 2009,
respectively, were excluded from diluted shares, while other equity awards of 3.4 million and 1.8
million for the nine months ended September 30, 2010 and 2009, respectively, were excluded from
diluted shares. Additionally, 14.6 million potentially dilutive common shares related to the CPP
common stock warrant were excluded from the computation of diluted loss per common share for the
three months ended September 30, 2009, and the nine months ended September 30, 2010 and 2009,
because such shares would have been antidilutive.
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Note 9 – Contingencies and Other Disclosures
Contingencies. Contingent liabilities arise in the ordinary course of business, including
those related to litigation. Various claims and
lawsuits are pending against FHN and its subsidiaries. In view of the inherent difficulty of
predicting the outcome of legal matters, particularly
where the claimants seek very large or indeterminate damages, or where the cases present novel
legal theories or involve a large number of parties, FHN cannot reasonably determine what the
eventual outcome of the pending matters will be, what the timing of the ultimate resolution of
these matters will be, or what the eventual loss or impact related to each pending matter may be.
FHN establishes loss contingency reserves for litigation matters when estimated loss is both
probable and reasonably estimable as prescribed by applicable financial accounting guidance. A
reserve generally is not established when a loss contingency either is not probable or its amount
is not reasonably estimable. If loss for a matter is probable and a range of possible loss
outcomes is the best estimate available, accounting guidance generally requires a reserve to be
established at the low end of the range. Based on current knowledge, and after consultation with
counsel, management is of the opinion that loss contingencies related to pending matters should not
have a material adverse effect on the consolidated financial condition of FHN, but may be material
to FHN’s operating results for any particular reporting period depending, in part, on the results
from that period.
Two subsidiaries of FHN, FTN Financial Securities Corp. (“FTNFS”) and First Tennessee Bank National
Association, along with an executive, a current employee, and a former employee, have received
written “Wells” notices from the Staff of the United States Securities and Exchange Commission (the
“SEC”) stating that the Staff intends to recommend that the SEC bring enforcement actions for
allegedly aiding and abetting a former FTNFS customer, Sentinel Management Group, Inc., in
violations of the federal securities laws. This matter is discussed in Note 9 of FHN’s Quarterly
Report on Form 10-Q for the period ended March 31, 2010, and in Note 18 of FHN’s Annual Report to
shareholders for the year 2009. There have been no material developments in this matter since the
March 31 Quarterly Report was issued.
During the second quarter of 2010, a shareholder, Cranston Reid, filed a putative derivative
lawsuit in the U.S. District Court for the Western District of Tennessee against various former and
current officers and directors of FHN. FHN is named as a nominal defendant, though no relief is
sought against it. The complaint alleges the following causes of action: breach of fiduciary duty,
abuse of control, gross mismanagement, and unjust enrichment. The claimed breach of fiduciary duty
and other causes of action stem from a number of alleged events, including: certain litigation
matters, both pending and previously disposed, unrelated to this plaintiff; certain matters that
allegedly could become litigation matters, unrelated to this plaintiff; a matter that previously
had been investigated and concluded, unrelated to this plaintiff; and an alleged general use of
allegedly unlawful and high-risk banking practices. FHN believes the defendants have meritorious
defenses to this complaint – including that the complaint fails to state any legally cognizable
claim – and intends to advance those defenses vigorously.
Visa Matters. FHN is a member of the Visa USA network. On October 3, 2007, the Visa organization
of affiliated entities completed a series of global restructuring transactions to combine its
affiliated operating companies, including Visa USA, under a single holding company, Visa Inc.
(“Visa”). Upon completion of the reorganization, the members of the Visa USA network remained
contingently liable for certain Visa litigation matters. Based on its proportionate membership
share of Visa USA, FHN recognized a contingent liability of $55.7 million within noninterest
expense in fourth quarter 2007 related to this contingent obligation.
In March 2008, Visa completed its initial public offering (“IPO”). Visa funded an escrow account
from its IPO proceeds to be used to make payments related to the Visa litigation matters. Upon
funding of the escrow, FHN reversed $30.0 million of the contingent liability previously recognized
with a corresponding credit to noninterest expense for its proportionate share of the escrow
account. A portion of FHN’s Class B shares of Visa were redeemed as part of the IPO resulting in
$65.9 million of equity securities gains in first quarter 2008.
In October 2008, Visa announced that it had agreed to settle litigation with Discover Financial
Services for $1.9 billion. Of this settlement amount, $1.7 billion was funded from the escrow
account established as part of Visa’s IPO. In connection with this settlement, FHN recognized
additional expense of $11.0 million within noninterest expense in third quarter 2008. In December
2008, Visa deposited additional funds into the escrow account and FHN recognized a corresponding
credit to noninterest expense of $11.0 million for its proportionate share of the amount funded.
In July 2009, Visa deposited an additional $700 million into the escrow account. Accordingly, FHN
reduced its contingent liability by $7.0 million through a credit to noninterest expense.
In May 2010, Visa deposited an additional $500 million into the escrow account and FHN
recognized a corresponding reduction of its contingent liability and a credit to noninterest
expense of $5.0 million for its proportionate share of the amount funded. Visa deposited an
additional $800 million into the escrow account during October 2010. FHN will reduce its
contingent liability by $8.0 million through a credit to noninterest expense during fourth quarter
2010. After the partial share redemption in conjunction with the IPO, FHN holds approximately 2.4
million Class B shares of Visa, which are included in the Consolidated Condensed Statements of
Condition at their historical cost of $0. Conversion of these shares into Class A shares of Visa
and, with limited exceptions, transfer of these shares is restricted until the later of the third
anniversary of the IPO or the final resolution of the covered litigation. The final
conversion ratio, which is currently estimated to approximate 51 percent, will fluctuate based on
the ultimate settlement of the Visa litigation matters for which FHN has a proportionate contingent
obligation. Future funding of the escrow will dilute this exchange rate by an amount that is yet
to be determined.
Other Disclosures – Indemnification Agreements and Guarantees. In the ordinary course of business,
FHN enters into indemnification agreements for legal proceedings against its directors and officers
and standard representations and warranties for underwriting agreements, merger and acquisition
agreements, loan sales, contractual commitments, and various other business transactions or
arrangements. The extent of FHN’s obligations under these agreements depends upon the occurrence
of future events; therefore, it is not possible to estimate a maximum potential amount of payouts
that could be required with such agreements.
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Note 9
– Contingencies and Other Disclosures (continued)
FHN is subject to potential liabilities and losses in relation to loans that it services, and in
relation to loans that it originated and sold. FHN evaluates those potential liabilities and
maintains reserves for potential losses. In addition, FHN has agreements with the purchaser of its
national home loan origination and servicing platforms that create obligations and potential
liabilities.
Servicing. FHN services, through a sub-servicer, a predominately first lien mortgage loan
portfolio of $31.0 billion as of September 30, 2010, a significant portion of which is held by FNMA
and private security holders, with less significant portions held by GNMA and FHLMC. In connection
with its servicing activities, FHN collects and remits the principal and interest payments on the
underlying loans for the account of the appropriate investor. In the event of delinquency or
non-payment on a loan in a private or agency securitization: (1) the terms of the private
securities agreements require FHN, as servicer, to continue to make monthly advances of principal
and interest (“P&I”) to the trustee for the benefit of the investors; and (2) the terms of the
majority of the agency agreements may require the servicer to make advances of P&I, or to
repurchase the delinquent or defaulted loan out of the trust pool. For servicer advances of P&I
under the terms of private and GSE securitizations, FHN can utilize payments of P&I received from
other prepaid loans within a particular loan pool in order to advance P&I to the trustee for the
benefit of the investors. In the event payments are ultimately made by FHN to satisfy this
obligation, P&I advances and servicer advances are recoverable from: (1) the liquidation proceeds
of the property securing the loan, in the case of private securitizations and (2) the proceeds of
the foreclosure sale by the government agency, in the case of government agency-owned loans. As of
September 30, 2010, FHN has recognized servicing advances of $239.9 million. Servicing advances
are included in Other Assets on the Consolidated Condensed Statements of Condition.
FHN is also subject to losses in its loan servicing portfolio due to loan foreclosures.
Foreclosure exposure arises from certain government agency agreements which limit the agency’s
repayment guarantees on foreclosed loans, resulting in certain foreclosure costs being borne by
servicers. Foreclosure exposure also includes real estate costs, marketing costs, and costs to
maintain properties, especially during protracted resale periods in geographic areas of the country
negatively impacted by declining home values.
FHN is also subject to losses due to unreimbursed servicing expenditures made in connection with
the administration of current loss mitigation and loan modification programs. Additionally, FHN is
required to repurchase GNMA loans prior to modification in connection with its modification
program.
Other Disclosures – Home Loans Originated and Sold. Prior to 2009, FHN originated loans through
its legacy mortgage business, primarily first lien home loans, with the intention of selling them.
Sales typically were effected either as non-recourse whole loan sales or through non-recourse
proprietary securitizations. Sometimes the loans were sold with full or limited recourse, but much
more often the loans were sold without recourse. For loans sold with recourse, FHN has indemnity
and repurchase exposure if the loans default. For loans sold without recourse, FHN has exposure
for repurchase of loans arising from claims that FHN breached its representations and warranties
made to the purchasers at closing, and exposure for investment rescission or damages arising from
claims that the offering documents under which the loans were securitized were materially
deficient. From 2005 through 2008, FHN originated and sold
$69.5 billion of first lien mortgage loans to GSEs. Although additional GSE sales occurred in earlier years, a substantial majority
of GSE repurchase requests have
come from that period. In addition, from 2000 through 2007, FHN securitized $40.8 billion of
such loans without recourse in proprietary transactions.
Loans Sold With Full or Limited Recourse. FHN has sold certain government agency mortgage loans
with full recourse under agreements to repurchase the loans upon default. Loans sold with full
recourse generally include mortgage loans sold to investors in the secondary market which are
uninsurable under government guaranteed mortgage loan programs due to issues associated
with underwriting activities, documentation, or other concerns. For mortgage insured single-family
residential loans, in the event of borrower nonperformance, FHN would assume losses to the extent
they exceed the value of the collateral and private mortgage insurance, FHA insurance, or VA
guaranty. On September 30, 2010 and 2009, the current UPB of single-family residential loans that
were sold on a full recourse basis with servicing retained was $60.7 million and $71.6 million,
respectively.
Loans sold with limited recourse include loans sold under government guaranteed mortgage loan
programs including the Federal Housing Administration and Veterans Administration. FHN continues
to absorb losses due to uncollected interest and foreclosure costs and/or limited risk of credit
losses in the event of foreclosure of the mortgage loan sold. Generally, the amount of recourse
liability in the event of foreclosure is determined based upon the respective government program
and/or the sale or disposal of the foreclosed property collateralizing the mortgage loan. Another
instance of limited recourse is the VA/No bid. In this case, the VA guarantee is limited and FHN
may be required to fund any deficiency in excess of the VA guarantee if the loan goes to
foreclosure. On September 30, 2010 and 2009, the outstanding principal balance of loans sold with
limited recourse arrangements where some portion of the principal is at risk and serviced by FHN
was $3.2 billion and $3.3 billion, respectively. Additionally, on September 30, 2010 and 2009, $.8
billion and $1.1 billion, respectively, of mortgage loans were outstanding which were sold under
limited recourse arrangements where the risk is limited to interest and servicing advances.
The reserve for foreclosure losses for loans sold with full or limited recourse is based upon a
historical progression model using a rolling 12-month average, which predicts the frequency of a
mortgage loan entering foreclosure. In addition, other factors are considered, including
qualitative and quantitative factors (e.g., current economic conditions, past collection
experience, risk characteristics of the current portfolio, and other factors), which are not
defined by historical loss trends or severity of losses.
Loans Sold Without Recourse – GSE Whole Loan Sales. For loans sold without recourse to GSEs, FHN
generally has obligations to either repurchase the loan for the unpaid principal balance or make
the purchaser whole for the economic benefits of a loan if it is determined that the loans sold
were in violation of representations or warranties made by FHN at closing.
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Note 9
– Contingencies and Other Disclosures (continued)
The estimated inherent losses that result from these obligations are derived from loss severities
that are reflective of default and delinquency trends in residential real estate loans and
declining housing prices, which result in fair value marks below par for repurchased loans when the
loans are recorded on FHN’s balance sheet within loans held for sale upon repurchase.
FHN utilizes multiple techniques in assessing the adequacy of its repurchase and foreclosure
reserve for loans sold without recourse for which it has continuing obligations under
representations and warranties. FHN tracks actual repurchase or make-whole losses by GSE, loan
pool, and vintage (year loan was sold) and this historical data is applied to more recent sale
vintages to estimate inherent loss content observed within its
vintages of loan sales.
Due to the historical nature of this calculation, as well as the increasing volume of requests
from GSEs, FHN performs additional analyses of repurchase and make-whole
obligations. Management then applies qualitative adjustments to the initial baseline to incorporate
known current trends in repurchase and make-whole requests, loss severity trends, alternative
resolutions, primary mortgage insurance (“PMI”) cancellation notices, and rescission rates
(successful resolutions) in the determination of the appropriate reserve level. Currently, FHN
services only $12 billion in UPB of the loans sold to GSEs which limits visibility into the current
status (i.e. current UPB, delinquency, refinance activity, etc.) of the loans that were sold. This
presents an additional level of uncertainty in estimating inherent loss content because it is
difficult to predict future repurchase requests from GSEs.
Loans Sold Without Recourse – Proprietary Securitizations. Securitized loans generally were sold
indirectly to investors as interests, commonly knows as certificates, in trusts or other vehicles.
In most cases, the certificates were tiered into different risk classes, with subordinated classes
exposed to trust losses first and senior classes exposed only after subordinated classes were
exhausted. Representations and warranties were made to the trustees for the benefit of investors.
The certificates were sold to a variety of investors, including GSEs
in some cases, through securities offerings under a prospectus or
other offering documents. None of FHN’s proprietary first lien securitizations involved the use of monoline insurance for the benefit of all classes of
security holders. Monoline insurance is a
form of credit enhancement provided to a securitization by a third party insurer. Subject to
the terms and conditions of the policy, the insurer
guarantees payments of accrued interest and principal due to the investors. In certain limited
situations, insurance was provided for a specific senior retail class of holders within individual
securitizations. The aggregate insured certificates totaled
$128.4 million of original certificate
balance. The remaining outstanding certificated balance for these classes was $99.2 million as
of September 30, 2010.
For loans sold in proprietary securitizations, FHN has exposure for repurchase of loans arising
from claims that FHN breached its representations and warranties made at closing, and exposure for
investment rescission or damages arising from claims by investors that the offering documents under
which the loans were securitized were materially deficient. As of September 30, 2010, the
repurchase request pipeline contained no repurchase requests related to securitized loans based on
representations and warranties.
FHN has been subpoenaed by the conservator for two GSE investors
in six securitizations in connection with an ongoing investigation which may or may not result in
claims based on representations and warranties. Since the investigation is neither a repurchase
claim nor litigation, the associated loans are not considered part of the repurchase pipeline and
FHN is unable to estimate any liability for this matter. At the time this report is filed, FHN was
a defendant in lawsuits by three investors in securitizations which claim that the offering documents
under which certificates were sold to them were materially deficient. Although these suits are in
very early stages, FHN intends to defend itself vigorously. These lawsuit matters have been
analyzed and treated as litigation matters under applicable
accounting standards. At September 30, 2010 and at the time this report was filed, FHN was unable
to determine a probable loss or estimate a range of loss due to the uncertainty related to these matters
and no reserve had been established. Similar claims may be pursued by other investors.
At September 30, 2010, FHN had not reserved for exposure for
repurchase of loans arising from claims that FHN breached its representations and warranties made at closing,
nor for exposure for investment rescission or damages arising from claims by investors that the offering documents
under which the loans were securitized were materially deficient.
Loans Sold Without Recourse – Other Whole Loan Sales. FHN originated through its former national
retail and wholesale channels and subsequently sold HELOC and second lien mortgages through whole
loan sales. These loans were underwritten to the guidelines of that channel as either combination
transactions with first lien mortgages or stand alone transactions. The whole loan sales were
generally done on a service retained basis and contained representations and warranties customary
to such loan sales and servicing agreements in the industry with specific reference to seller’s
underwriting and servicing guidelines. Loans were subject to repurchase in the event of early
payment defaults and for breaches of representations and warranties. In 2009, FHN settled a
substantial portion of its repurchase obligations for these loans through an agreement with the
primary purchaser of HELOC and second lien loans. This settlement included the transfer of retained
servicing rights associated with the applicable second lien and HELOC loan sales. FHN does not
guarantee the receipt of the scheduled principal and interest payments on the underlying loans but
does have an obligation to repurchase the loans excluded from the above settlement for which there
is a breach of representations and warranties provided to the buyers. The remaining repurchase
reserve for these loans is minimal, reflecting the settlement discussed above.
FHN has also sold first lien mortgages without recourse through whole loan sales to non-GSE
purchasers. As of September 30, 2010, 15 percent of the active repurchase pipeline (inclusive of
PMI cancellation notices and all other claims) were claims from private whole loan sales. These
claims are included in FHN’s liability methodology and the assessment of the adequacy of the
repurchase and foreclosure liability.
Private Mortgage Insurance. PMI was required by GSE rules for certain of the loans sold to GSEs
and was also provided for certain of the loans that were securitized. PMI generally was provided
for the first lien loans having a loan-to-value ratio at origination of greater than 80 percent
that were sold to GSEs or securitized. Although unresolved PMI cancellation notices are not formal
repurchase requests, FHN includes these in the active repurchase request pipeline when analyzing
and estimating loss content in relation to the loans sold to GSEs. For purposes of estimating loss
content, FHN also considers reviewed PMI cancellation notices where coverage has been rescinded or
cancelled for all loan sales and securitizations. In determining adequacy of the repurchase reserve, FHN considered $87.2 million in
UPB of loans sold where PMI coverage was rescinded or cancelled for all loan sales and
securitizations. To date, a majority of PMI cancellation notices have involved loans sold to GSEs.
At September 30, 2010, all estimated loss content arising from PMI rescission and cancellation
matters related to loans sold to GSEs.
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Note 9
– Contingencies and Other Disclosures (continued)
Repurchase Obligations Related to Branch Sale. FHN also sold loans as part of branch sales that
were executed during 2007 as part of a strategic decision to exit businesses in markets FHN
considered non-strategic. Unlike the loans sold to GSEs or sold privately as discussed above, these
loans were originated to be held to maturity as part of the loan portfolio. FHN has received
repurchase requests related to HELOC from one of the purchasers of these branches. On September
30, 2010, the unpaid principal balance of unresolved repurchase requests related to this sale was
$28.9 million. These amounts are not included in the repurchase pipeline. Those unresolved
repurchase requests are the subject of an arbitration proceeding. Based on an analysis of the
circumstances, FHN has established an immaterial reserve at September 30, 2010 based on its
interpretation of the sale agreement. Because of the uncertainty of the potential outcome of the
arbitration proceedings, and also due to uncertainties regarding potential remedies that are within
the discretion of the arbitration panel, FHN otherwise cannot determine probable loss or estimate a
range of losses at this time that may result from these arbitration proceedings. FHN expects to
re-assess the reserve each quarter as the arbitration progresses.
Repurchase and Foreclosure Liability. Based on its experience to date, FHN has evaluated its loan
repurchase exposure as mentioned above, and has accrued for losses of $177.6
million and $63.9 million as of September 30, 2010 and 2009, respectively. A vast majority of this
liability relates to obligations associated with the sale of first lien mortgages to GSEs through
the legacy mortgage banking business. Accrued liabilities for FHN’s estimate of these obligations
are reflected in Other liabilities on the Consolidated Condensed Statements of Condition. Charges
to increase the repurchase liability are included within Repurchase and foreclosure provision on
the Consolidated Condensed Statements of Income. Refer to the Repurchase and Related Obligations
from Loans Originated for Sale and Critical Accounting Policies sections of MD&A for
additional discussion related to FHN’s repurchase obligations.
Other.
Foreclosure Practices. The current focus on foreclosure practices of financial institutions
nationwide could impact FHN through increased operational and legal costs and could have compliance
and reputational impacts. FHN owns and services residential loans. In addition, FHN’s national
mortgage and servicing platforms were sold in August 2008 and the related servicing activities,
including foreclosure proceedings, of the still-owned portion of FHN’s mortgage servicing portfolio
is outsourced through a subservicing arrangement with the platform buyer. FHN has reviewed its
processes relating to foreclosure on loans it owns and services, and has instructed its subservicer
to undertake a similar review. FHN’s review is completed and no material issues were identified.
The subservicer review, covering many more mortgages, is expected to be completed in the fourth
quarter of 2010. If compliance issues are discovered with respect to the subservicer, under the
subservicing agreement FHN may be financially responsible in some cases, and the subservicer may be
in others. FHN can not predict the amount of operating costs, costs for foreclosure delays
(including costs connected with servicing advances), legal expenses, or other costs (including
title company indemnification) that may be incurred as a result of the internal reviews or external
actions, nor can FHN determine presently that any such expenses are probable in material amounts;
accordingly, no reserve for these matters has been established. Refer to the Market Uncertainties
and Prospective Trends – Foreclosure Practices section of MD&A for additional discussion related to
FHN’s foreclosure practices and subservicing arrangement.
Reinsurance Arrangements. A wholly-owned subsidiary of FHN entered into agreements with several
providers of private mortgage insurance whereby the subsidiary agreed to accept insurance risk for
specified loss corridors for pools of loans originated in each contract year in exchange for a
portion of the private mortgage insurance premiums paid by borrowers (i.e., reinsurance
arrangements). The loss corridors vary for each primary insurer for each contract year. The
estimation of FHN’s exposure to losses under these arrangements involves the determination of FHN’s
maximum loss exposure by applying the low and high ends of the loss corridor range to a fixed
amount that is specified in each contract. FHN then performs an estimation of total loss content
within each insured pool of loans to determine the degree to which its loss corridor has been
penetrated. Management obtains the assistance of a third party actuarial firm in developing its
estimation of loss content. This process includes consideration of factors such as delinquency
trends, default rates, and housing prices which are used to estimate both the frequency and
severity of losses. By the end of second quarter 2009, substantially all of FHN’s reinsurance
corridors had been fully reflected within its reinsurance reserve for the 2005 through 2008 loan
vintages. No new reinsurance arrangements have been initiated after 2008.
In 2009 and 2010, FHN agreed to settle certain of its reinsurance obligations with primary
insurers through termination of the related reinsurance agreements, which resulted in a decrease in
the reserve balance totaling $48.7 million and the transfer of the associated trust assets. As of
September 30, 2010, FHN has accrued $11.5 million for its estimated liability under the reinsurance
arrangements. The accrued liability is reflected in Other Liabilities on the Consolidated
Condensed Statements of Condition. In accordance with the terms of the contracts with the primary
insurers, as of September 30, 2010, FHN has placed $9.4 million of prior premium collections in
trust for payment of claims arising under the reinsurance arrangements.
2008 Sale of National Origination and Servicing Platforms. In conjunction with the sale of its
servicing platform in August 2008, FHN entered into a three year subservicing arrangement with the
purchaser for the unsold portion of FHN’s servicing portfolio. As part of the subservicing
agreement, FHN has agreed to a make-whole arrangement whereby if the number of loans subserviced by
the purchaser falls below specified levels and the direct servicing cost per loan is greater than a
specified amount (determined using loans serviced on behalf of both
FHN and the purchaser), FHN will make a payment according to a contractually specified formula.
The make-whole payment is subject to a
cap, which is $15.0 million if triggered during the eight quarters following the first anniversary
of the divestiture. As part of the 2008 transaction, FHN recognized a contingent liability of $1.2
million representing the estimated fair value of its performance obligation under the make-whole
arrangement.
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Note 10 – Pension, Savings, and Other Employee Benefits
Pension plan. FHN sponsors a noncontributory, qualified defined benefit pension plan to
employees hired or re-hired on or before September 1, 2007, excluding certain employees of FHN’s
insurance subsidiaries. Pension benefits are based on years of service, average compensation near
retirement, and estimated social security benefits at age 65. The contributions are based upon
actuarially determined amounts necessary to fund the total benefit obligation. FHN contributed $50
million to the qualified pension plan in 2009. At this time, FHN does not expect to make a
contribution to the qualified pension plan in 2010.
FHN also maintains non-qualified plans including a supplemental retirement plan that covers certain
employees whose benefits under the pension plan have been limited. These other non-qualified
pension plans are unfunded, and contributions to these plans cover all benefits paid under the
non-qualified plans. Contributions were $4.3 million for 2009, and FHN anticipates this amount
will be $4.6 million in 2010.
In 2009, FHN’s Board of Directors determined that the accrual of benefits under the qualified
pension plan and the supplemental retirement plan would cease as of December 31, 2012. After that
date employees currently in the pension plan, and those currently in the Employee Non-voluntary
Elective Contribution (“ENEC”) program, will be able to participate in the FHN savings plan with a
profit sharing feature and an increased company match rate. After that time pension status will
not affect a person’s ability to participate in any savings plan feature.
Savings plan. The ENEC program was added under the FHN savings plan and is provided only to
employees who are not eligible for the pension plan. With the ENEC program, FHN will generally
make contributions to eligible employees’ savings plan accounts based upon company performance.
Contribution amounts will be a percentage of each employee’s base salary (as defined in the savings
plan) earned the prior year. FHN contributed $1.2 million for this plan in
2010 related to the 2009 plan year.
Other employee benefits. FHN provides postretirement life insurance benefits to certain employees
and also provides postretirement medical insurance to retirement-eligible employees. The
postretirement medical plan is contributory with retiree contributions adjusted annually and is
based on criteria that are a combination of the employee’s age and years of service. For any
employee retiring on or after January 1, 1995, FHN contributes a fixed amount based on years of
service and age at the time of retirement. FHN’s postretirement benefits include prescription drug
benefits. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (“the Act”)
introduced a prescription drug benefit under Medicare Part D as well as a federal subsidy to
sponsors of retiree health care that provide a benefit that is actuarially equivalent to Medicare
Part D. FHN currently anticipates receiving a prescription drug subsidy under the Act through
2012.
The components of net periodic benefit cost for the three months ended September 30 are as follows:
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Note 10 – Pension, Savings, and Other Employee Benefits (continued)
The components of net periodic benefit cost for the nine months ended September 30 are as
follows:
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Note 11 – Business Segment Information
Periodically, FHN adapts its segments to reflect managerial or strategic changes. FHN may also
modify its methodology of allocating expenses among segments which could change historical segment
results. In first quarter 2010, FHN revised its operating segments to better align with its
strategic direction, representing a focus on its regional banking franchise and capital markets
business. Key changes include the addition of the non-strategic segment which combines the former
mortgage banking and national specialty lending segments, the movement of correspondent banking
from capital markets to regional banking, and the shift of first lien mortgage production in the
Tennessee footprint to the regional banking segment. For comparability, previously reported items
have been revised to reflect these changes.
FHN has four business segments: regional banking, capital markets, corporate, and non-strategic.
The regional banking segment offers financial products and services, including traditional lending
and deposit taking, to retail and commercial customers in Tennessee and surrounding markets.
Regional banking provides investments, insurance services, financial planning, trust services and
asset management, health savings accounts, cash management, and first lien mortgage originations
within the Tennessee footprint. Additionally, the regional banking segment includes correspondent
banking which provides credit, depository, and other banking related services to other financial
institutions. The capital markets segment consists of fixed income sales, trading, and strategies
for institutional clients in the U.S. and abroad, as well as loan sales, portfolio advisory and
derivative sales. The corporate segment consists of gains on the repurchase of debt, unallocated
corporate expenses, 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, low income housing investment activities, and various charges related to restructuring,
repositioning, and efficiency. The non-strategic segment consists of the wind-down consumer and
construction lending activities, legacy mortgage banking elements including servicing fees, and the
associated ancillary revenues and expenses related to these businesses. Non-strategic also includes
the wind-down trust preferred loan portfolio and exited businesses along with the associated
restructuring, repositioning, and efficiency charges.
Total revenue, expense, and asset levels reflect those which are specifically identifiable or which
are allocated based on an internal allocation method. Because the allocations are based on
internally developed assignments and allocations, they are to an extent subjective. This assignment
and allocation has been consistently applied for all periods presented. The following table
reflects the amounts of consolidated revenue, expense, tax, and assets for each segment for the
periods ended September 30:
Certain previously reported amounts have been reclassified to agree with current presentation.
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Note 11 – Business Segment Information (continued)
Certain previously reported amounts have been reclassified to agree with current presentation.
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Note 12 – Preferred Stock and Other Capital
FHN Preferred Stock and Warrant
On November 14, 2008, FHN issued and sold 866,540 preferred shares of Fixed Rate Cumulative
Perpetual Preferred Stock, Series CPP, along with a Warrant to purchase common stock. The issuance
occurred in connection with, and is governed by, the Treasury Capital Purchase Program (“Capital
Purchase Program”) administered by the U.S. Treasury (“UST”) under the Troubled Asset Relief
Program (“TARP”). The Preferred Shares have an annual 5 percent cumulative preferred dividend
rate, payable quarterly. The dividend rate increases to 9 percent after five years. If a dividend
payment is missed it is not a default; however, dividends compound if they accrue in arrears.
Preferred Shares have a liquidation preference of $1,000 per share plus accrued dividends. The
Preferred Shares have no mandatory redemption date and are not subject to any sinking fund. The
Preferred Shares carry certain restrictions. The Preferred Shares have a senior rank and also
provide limitations on certain compensation arrangements of executive officers along with the
twenty most highly compensated employees. During the first three years following the issuance, FHN
may not reinstate a cash dividend on its common shares nor purchase equity shares without the
approval of the UST, subject to certain limited exceptions. If preferred dividends are missed, FHN
may not reinstate a cash dividend on its common shares to the extent preferred dividends remain
unpaid. Generally, the Preferred Shares are non-voting. However, should FHN fail to pay six
quarterly dividends, the holder may elect two directors to FHN’s Board of Directors until such
dividends are paid. In connection with the issuance of the Preferred Shares, a Warrant to purchase
12,743,235 common shares was issued with an exercise price of $10.20 per share. The Warrant is
immediately exercisable and expires ten years after issuance. The Warrant is subject to
proportionate anti-dilution adjustment in the event of stock dividends or splits, among other
things. As a result of the stock dividends distributed through October 1, 2010, the Warrant was
adjusted to cover 14,578,136 common shares at a purchase price of $8.916 per share.
The Preferred Shares and Warrant qualify as Tier 1 capital and are presented in permanent equity on
the Consolidated Condensed Statements of Condition as of September 30, 2010, in the amounts of
$811.0 million and $83.9 million, respectively. Proceeds received were allocated between the
common stock warrant and preferred shares based on their relative fair values. The fair value of
the preferred shares was determined by calculating the present value of expected cash flows using a
9.40 percent discount rate. The fair value of the common stock warrant was determined using the
Black Scholes Options Pricing Model. Both fair value determinations assumed redemption prior to
the increase in dividend rate on the five year anniversary of the issuance. The preferred shares
discount is being amortized over the initial five-year period using the constant yield method. FHN
will work with regulators to determine the appropriate timing and method for redeeming the
preferred shares and resolving the common stock warrant issued to the UST.
Subsidiary Preferred Stock
On September 14, 2000, FT Real Estate Securities Company, Inc. (“FTRESC”), an indirect
subsidiary of FHN, issued 50 shares of 9.50 percent Cumulative Preferred Stock, Class B (“Class B
Preferred Shares”), with a liquidation preference of $1.0 million per share. An aggregate total of
47 Class B Preferred Shares have been sold privately to nonaffiliates. These securities qualify as
Tier 2 capital and are presented in the Consolidated Condensed Statements of Condition as Term
borrowings. FTRESC is a real estate investment trust (“REIT”) established for the purpose of
acquiring, holding, and managing real estate mortgage assets. Dividends on the Class B Preferred
Shares are cumulative and are payable semi-annually.
The Class B Preferred Shares are mandatorily redeemable on March 31, 2031, and redeemable at the
discretion of FTRESC in the event that the Class B Preferred Shares cannot be accounted for as Tier
2 regulatory capital or there is more than an insubstantial risk that dividends paid with respect
to the Class B Preferred Shares will not be fully deductible for tax purposes. They are not
subject to any sinking fund and are not convertible into any other securities of FTRESC, FHN or any
of its subsidiaries. The shares are, however, automatically exchanged at the direction of the
Office of the Comptroller of the Currency for preferred stock of FTBNA, having substantially the
same terms as the Class B Preferred Shares in the event FTBNA becomes undercapitalized, insolvent
or in danger of becoming undercapitalized.
First Horizon Preferred Funding, LLC and First Horizon Preferred Funding II, LLC have each issued
$1.0 million of Class B Preferred Shares. On September 30, 2010 and 2009, the amount of Class B
Preferred Shares that are perpetual in nature that was recognized as Noncontrolling interest on the
Consolidated Condensed Statements of Condition was $.3 million for both periods. The remaining
balance has been eliminated in consolidation.
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Note 12 – Preferred Stock and Other Capital (continued)
On March 23, 2005, FTBNA issued 300,000 shares of Class A Non-Cumulative Perpetual Preferred
Stock (“Class A Preferred Stock”) with a liquidation preference of $1,000 per share. These
securities qualify as Tier 1 capital. On September 30, 2010 and 2009, $294.8 million of Class A
Preferred Stock was recognized as Noncontrolling interest on the Consolidated Condensed Statements
of Condition for both periods.
Due to the nature of the subsidiary preferred stock issued by First Horizon Preferred Funding, LLC,
First Horizon Preferred Funding II, LLC, and FTBNA, all components of other comprehensive
income/(loss) included in the Consolidated Condensed Statements of Equity have been attributed
solely to FHN as the controlling interest holder. The table below presents the amounts included in
the Consolidated Condensed Statements of Income for the three and nine months ended September 30,
2010 and 2009, which are attributable to FHN as controlling interest holder:
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Note
13 – Loan Sales and Securitizations
Historically, FHN utilized loan sales and securitizations as a significant source of liquidity
for its mortgage banking operations. With FHN’s shift to originations of mortgages within its
regional banking footprint following the sale of national mortgage origination offices, loan sale
and securitization activity has significantly decreased. Generally, FHN no longer retains
financial interests in any loans it transfers to third parties. During third quarter 2010, FHN
transferred $191.6 million of single-family residential mortgage loans in whole loan sales
resulting in $1.8 million of net pre-tax gains. In third quarter 2009, FHN transferred $259.0
million of residential mortgage loans and HELOC in whole loan sales or proprietary securitizations
resulting in net pre-tax gains of $2.4 million. During the nine months ended September 30, 2010,
FHN transferred $545.4 million of single-family residential mortgage loans in whole loan sales
resulting in $4.8 million of net pre-tax gains. During the nine months ended September 30, 2009,
FHN transferred $1.1 billion of residential mortgage loans and HELOC in whole loan sales or
proprietary securitizations resulting in net pre-tax gains of $13.8 million.
Retained Interests
Interests retained from prior loan sales, including Government-Sponsored Enterprises (“GSE”)
securitizations, typically included MSR and excess interest. Interests retained from proprietary
securitizations included MSR and various financial assets (see discussion below). MSR were
initially valued at fair value and the remaining retained interests were initially valued by
allocating the remaining cost basis of the loan between the security or loan sold and the remaining
retained interests based on their relative fair values at the time of sale or securitization.
In certain cases, FHN continues to service and receive servicing fees related to the transferred
loans. Generally, FHN received annual servicing fees approximating .29 percent in third quarter
2010 and .28 percent in third quarter 2009, of the outstanding balance of underlying single-family
residential mortgage loans. FHN received annual servicing fees approximating .50 percent in third
quarter 2010 and 2009, of the outstanding balance of underlying loans for HELOC and home equity
loans transferred. MSR related to loans transferred and serviced by FHN, as well as MSR related to
loans serviced by FHN and transferred by others, are discussed further in Note 5 – Mortgage
Servicing Rights. There were no significant additions to MSR in either comparative period.
Other financial assets retained in proprietary or GSE securitizations may include certificated
residual interests, excess interest (structured as interest-only strips), interest-only strips,
principal-only strips, or subordinated bonds. Residual interests represent rights to receive
earnings to the extent of excess income generated by the underlying loans. Excess interest
represents rights to receive interest from serviced assets that exceed contractually specified
rates. Principal-only strips are principal cash flow tranches and interest-only strips are interest
cash flow tranches. Subordinated bonds are bonds with junior priority. All financial assets
retained from off balance sheet securitizations are recognized on the Consolidated Condensed
Statements of Condition in trading securities at fair value with realized and unrealized gains and
losses included in current earnings as a component of noninterest income on the Consolidated
Condensed Statements of Income. In first quarter 2010, in conjunction with the adoption of
amendments to ASC 810, FHN consolidated certain proprietary securitization trusts for which
residual interests and subordinated bonds were held. Accordingly, these amounts were removed from
the Consolidated Condensed Statements of Condition as of January 1, 2010.
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Note
13 – Loan Sales and Securitizations (continued)
The sensitivity of the fair value of all retained or purchased MSR to immediate 10 percent and
20 percent adverse changes in assumptions on September 30, 2010 and 2009 are as follows:
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Note
13 – Loan Sales and Securitizations (continued)
The sensitivity of the fair value of other retained interests to immediate 10 percent and 20
percent adverse changes in assumptions on September 30, 2010 and 2009 are as follows:
These sensitivities are hypothetical and should not be considered predictive of future performance.
As the figures indicate, changes in fair value based on a 10 percent variation in assumptions
cannot necessarily be extrapolated because the relationship between the change in assumption and
the change in fair value may not be linear. Also, the effect on the fair value of the retained
interest caused by a particular assumption variation is calculated independently from all other
assumption changes. In reality, changes in one factor may result in changes in another, which might
magnify or counteract the sensitivities. Furthermore, the estimated fair values, as disclosed,
should not be considered indicative of future earnings on these assets.
For the three and nine months ended September 30, 2010 and 2009, cash flows received and paid
related to loan sales and securitizations were as follows:
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Note
13 – Loan Sales and Securitizations (continued)
As of September 30, 2010, the principal amount of loans transferred through loan sales and
securitizations and other loans managed with them, the principal amount of delinquent loans, and
the net credit losses during the three and nine months ended September 30, 2010 are as follows:
As of September 30, 2009, the principal amount of loans transferred through loan sales and
securitizations and other loans managed with them, the principal amount of delinquent loans, and
the net credit losses during the three and nine months ended September 30, 2009 are as follows:
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Note
13 – Loan Sales and Securitizations (continued)
Secured Borrowings. FTBNA executed several securitizations of retail real estate
residential loans for the purpose of engaging in secondary market financing. Since the related
trusts did not qualify as QSPE under the applicable accounting rules at that time and since the
cash flows on the loans are pledged to the holders of the trusts’ securities, FTBNA recognized the
proceeds as secured borrowings in accordance with ASC’s Transfers and Servicing Topic (“ASC
860-10-50”). With the prospective adoption of ASU 2009-17 in first quarter 2010, all amounts
related to consolidated proprietary securitization trusts have been included in restricted balances
on the Consolidated Condensed Statements of Condition. On September 30, 2009, FTBNA recognized
$669.5 million of loans net of unearned income and $661.3 million of other collateralized
borrowings on the Consolidated Condensed Statements of Condition related to consolidated
proprietary securitizations of retail real estate residential loans.
In 2007, FTBNA executed a securitization of certain small issuer trust preferred for which the
underlying trust did not qualify as a sale under ASC 860. Therefore, FTNBA has accounted for the
funds received through the securitization as a secured borrowing. On September 30, 2010, FTBNA had
$112.5 million of loans net of unearned income, $1.7 million of trading securities, and $51.0
million of term borrowings on the Consolidated Condensed Statements of Condition related to this
transaction. On September 30, 2009, FTBNA had $143.0 million of loans net of unearned income, $1.7
million of trading securities, and $49.8 million of other collateralized borrowings on the
Consolidated Condensed Statements of Condition related to this transaction. See Note 14 – Variable
Interest Entities for additional information.
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Note
14 – Variable Interest Entities
Effective January 1, 2010, FHN adopted the provisions of ASU 2009-16 and ASU 2009-17. The
provisions of ASU 2009-16 updates ASC 860, “Transfers and Servicing,” to provide for the removal of
the qualifying special purpose entity (“QSPE”) concept from GAAP, resulting in these entities being
considered variable interest entities (“VIE”) which must be evaluated for consolidation on and
after its effective date. The provisions of ASU 2009-17 amends ASC 810, “Consolidation,” to revise
the criteria for determining the primary beneficiary of a VIE by replacing the quantitative-based
risks and rewards test previously required with a qualitative analysis. The updated provisions of
ASC 810 clarify that a VIE exists when the equity investors, as a group, lack either (1) the power
through voting rights, or similar rights, to direct the activities of an entity that most
significantly impact the entity’s economic performance, (2) the obligation to absorb the expected
losses of the entity, (3) the right to receive the expected residual returns of the entity, or (4)
when the equity investors, as a group, do not have sufficient equity at risk for the entity to
finance its activities by itself. A variable interest is a contractual ownership, or other
interest, that fluctuates with changes in the fair value of the VIE’s net assets exclusive of
variable interests. Under ASC 810, as amended, FHN is deemed to be the primary beneficiary and
required to consolidate a VIE if it has a variable interest in the VIE that provides it with a
controlling financial interest. For such purposes, the determination of whether a controlling
financial interest exists is based on whether a single party has both the power to direct the
activities of the VIE that most significantly impact the VIE’s economic performance and the
obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could
potentially be significant. As amended, ASC 810, requires continual reconsideration of conclusions
reached regarding which interest holder is a VIE’s primary beneficiary. The consolidation
methodology provided in this footnote for the three and nine months ended September 30, 2010, has
been prepared in accordance with ASC 810 as amended by ASU 2009-17.
Prior to the adoption of the provisions of the Codification update to ASC 810 in first quarter
2010, FHN was deemed to be the primary beneficiary and required to consolidate a VIE if it had a
variable interest that would absorb the majority of the VIE’s expected losses, receive the majority
of expected residual returns, or both. A VIE existed when equity investors did not have the
characteristics of a controlling financial interest or did not have sufficient equity at risk for
the entity to finance its activities by itself. Expected losses and expected residual returns were
measures of variability in the expected cash flow of a VIE. Reconsideration of conclusions reached
regarding which interest holder was a VIE’s primary beneficiary was required only upon the
occurrence of certain specified events. The consolidation methodology provided in this footnote
for the three and nine months ended September 30, 2009, has been prepared in accordance with the
provisions of ASC 810 prior to its amendment by ASU 2009-17.
Three and Nine Months Ended September 30, 2010
Consolidated Variable Interest Entities. FHN holds variable interests in proprietary residential
mortgage securitization trusts it established prior to 2008 as a source of liquidity for its
mortgage banking and consumer lending operations. Except for recourse due to breaches of standard
representations and warranties made by FHN in connection with the sale of the loans to the trusts,
the creditors of the trusts hold no recourse to the assets of FHN. Additionally, FHN has no
contractual requirements to provide financial support to the trusts. Based on their restrictive
nature, the trusts are considered VIE as the holders of equity at risk do not have the power
through voting rights or similar rights to direct the activities that most significantly impact the
trusts’ economic performance. In situations where the retention of MSR and other retained
interests, including residual interests and subordinated bonds, results in FHN potentially
absorbing losses or receiving benefits that are significant to the trusts, FHN is considered the
primary beneficiary, as it is also assumed to have the power as servicer to most significantly
impact the activities of such VIE. Consolidation of the trusts results in the recognition of the
trusts’ proceeds as restricted borrowings since the cash flows on the securitized loans can only be
used to settle the obligations due to the holders of the trusts’ securities.
FHN has established certain rabbi trusts related to deferred compensation plans offered to its
employees. FHN contributes employee cash compensation deferrals to the trusts and directs the
underlying investments made by the trusts. The assets of these trusts are available to FHN’s
creditors only in the event that FHN becomes insolvent. These trusts are considered VIE because
either there is no equity at risk in the trusts or because FHN provided the equity interest to its
employees in exchange for services rendered. FHN is considered the primary beneficiary of the rabbi
trusts as it has the power to direct the activities that most significantly impact the economic
performance of the rabbi trusts through its ability to direct the underlying investments made by
the trusts. Additionally, FHN could potentially receive benefits or absorb losses that are
significant to the trusts due to its right to receive any asset values in excess of liability
payoffs and its obligation to fund any liabilities to employees that are in excess of a rabbi
trust’s assets.
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Note
14 – Variable Interest Entities (continued)
The following table summarizes VIE consolidated by FHN as of September 30, 2010:
Nonconsolidated Variable Interest Entities. Since 1997, First Tennessee Housing Corporation
(“FTHC”), a wholly-owned subsidiary, makes equity investments as a limited partner in various
partnerships that sponsor affordable housing projects utilizing the Low Income Housing Tax Credit
(“LIHTC”) pursuant to Section 42 of the Internal Revenue Code. The purpose of these investments is
to achieve a satisfactory return on capital and to support FHN’s community reinvestment
initiatives. The activities of the limited partnerships include the identification, development,
and operation of multi-family housing that is leased to qualifying residential tenants generally
within FHN’s primary geographic region. LIHTC partnerships are considered VIE because FTHC, as the
holder of the equity investment at risk, does not have the ability to direct the activities that
most significantly affect the success of the entity through voting rights or similar rights. While
FTHC could absorb losses that are significant to the LIHTC partnerships as it has a risk of loss
for its initial capital contributions and funding commitments to each partnership, it is not
considered the primary beneficiary of the LIHTC partnerships. The general partners are considered
the primary beneficiaries because managerial functions give them the power to direct the activities
that most significantly impact the partnerships’ economic performance and the general partners are
exposed to all losses beyond FTHC’s initial capital contributions and funding commitments.
FTBNA holds variable interests in trusts which have issued mandatorily redeemable preferred capital
securities (“trust preferreds”) for smaller banking and insurance enterprises. FTBNA has no voting
rights for the trusts’ activities. The trusts’ only assets are junior subordinated debentures of
the issuing enterprises. The creditors of the trusts hold no recourse to the assets of FTBNA.
These trusts meet the definition of a VIE because the holders of the equity investment at risk do
not have the power through voting rights, or similar rights, to direct the activities that most
significantly impact the trusts’ economic performance. Based on the nature of the trusts’
activities and the size of FTBNA’s holdings, FTBNA could potentially receive benefits or absorb
losses that are significant to the trusts regardless of whether a majority of a trust’s securities
are held by FTBNA. However, since FTBNA is solely a holder of the trusts’ securities, it has no
rights which would give it the power to direct the activities that most significantly impact the
trusts’ economic performance and thus it cannot be considered the primary beneficiary of the
trusts. FTBNA has no contractual requirements to provide financial support to the trusts.
In 2007, FTBNA executed a securitization of certain small issuer trust preferreds for which the
underlying trust meets the definition of a VIE because the holders of the equity investment at risk
do not have the power through voting rights, or similar rights, to direct the activities that most
significantly impact the entity’s economic performance. FTBNA could potentially receive benefits
or absorb losses that are significant to the trust based on the size and priority of the interests
it retained in the securities issued by the trust. However, since FTBNA did not retain servicing
or other decision making rights, it has determined that it is not the primary beneficiary as it
does not have the power to direct the activities that most significantly impact the trust’s
economic performance. Accordingly, FTBNA has accounted for the funds received through the
securitization as a term borrowing in its Consolidated Condensed Statements of Condition as of
September 30, 2010. FTBNA has no contractual requirement to provide financial support to the
trust.
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Note
14 – Variable Interest Entities (continued)
FHN has previously issued junior subordinated debt totaling $309.0 million to First Tennessee
Capital I (“Capital I”) and First Tennessee Capital II (“Capital II”). Both Capital I and Capital
II are considered VIE because FHN’s capital contributions to these trusts are not considered “at
risk” in evaluating whether the holders of the equity investments at risk in the trusts have the
power through voting rights, or similar rights, to direct the activities that most significantly
impact the entities’ economic performance. FHN cannot be the trusts’ primary beneficiary because
FHN’s capital contributions to the trusts are not considered variable interests as they are not “at
risk”. Consequently, Capital I and Capital II are not consolidated by FHN.
FHN holds variable interests in proprietary residential mortgage securitization trusts it
established prior to 2008 as a source of liquidity for its mortgage banking operations. Except for
recourse due to breaches of standard representations and warranties made by FHN in connection with
the sale of the loans to the trusts, the creditors of the trusts hold no recourse to the assets of
FHN. Additionally, FHN has no contractual requirements to provide financial support to the trusts.
Based on their restrictive nature, the trusts are considered VIE as the holders of equity at risk
do not have the power through voting rights, or similar rights, to direct the activities that most
significantly impact the trusts’ economic performance. While FHN is assumed to have the power as
servicer to most significantly impact the activities of such VIE, in situations where FHN does not
potentially participate in significant portions of a securitization trust’s cash flows, it is not
considered the primary beneficiary of the trust. Thus, such trusts are not consolidated by FHN.
Prior to third quarter 2008, FHN transferred first lien mortgages to government agencies, or GSE,
for securitization and retained MSR and other various interests in certain situations. Except for
recourse due to breaches of standard representations and warranties made by FHN in connection with
the sale of the loans to the trusts, the creditors of the trusts hold no recourse to the assets of
FHN. Additionally, FHN has no contractual requirements to provide financial support to the trusts.
The Agencies’ status as Master Servicer and the rights they hold consistent with their guarantees
on the securities issued provide them with the power to direct the activities that most
significantly impact the trusts’ economic performance. Thus, such trusts are not consolidated by
FHN as it is not considered the primary beneficiary even in situations where it could potentially
receive benefits or absorb losses that are significant to the trusts.
In relation to certain agency securitizations, FHN purchased the servicing rights on the
securitized loans from the loan originator and holds other retained interests. Based on their
restrictive nature, the trusts meet the definition of a VIE since the holders of the equity
investments at risk do not have the power through voting rights, or similar rights, to direct the
activities that most significantly impact the trusts’ economic performance. As the Agencies serve
as Master Servicer for the securitized loans and hold rights consistent with their guarantees on
the securities issued, they have the power to direct the activities that most significantly impact
the trusts’ economic performance. Thus, FHN is not considered the primary beneficiary even in
situations where it could potentially receive benefits or absorb losses that are significant to the
trusts. FHN has no contractual requirements to provide financial support to the trusts.
FHN holds securities issued by various agency securitization trusts. Based on their restrictive
nature, the trusts meet the definition of a VIE since the holders of the equity investments at risk
do not have the power through voting rights, or similar rights, to direct the activities that most
significantly impact the entities’ economic performance. FHN could potentially receive benefits or
absorb losses that are significant to the trusts based on the nature of the trusts’ activities and
the size of FHN’s holdings. However, FHN is solely a holder of the trusts’ securities and does not
have the power to direct the activities that most significantly impact the trusts’ economic
performance, and is not considered the primary beneficiary of the trusts. FHN has no contractual
requirements to provide financial support to the trusts.
FHN holds collateralized debt obligations (“CDOs”) from various trusts related to FTNF’s efforts to
pool and securitize small issuer trust preferreds. FHN has no voting rights for the trusts’
activities. The trusts’ only assets are trust preferreds of the issuing banks’ trusts. The trusts
associated with the CDOs acquired by FHN as market maker meet the definition of a VIE as there are
no holders of an equity investment at risk with adequate power to direct the trusts’ activities
that most significantly impact the trusts’ economic performance. While FHN could potentially
receive benefits or absorb losses that are significant to the trusts, as FHN does not have decision
making rights over whether interest deferral is elected by the issuing banks on the junior
subordinated debentures that underlie the small issuer trust preferreds, it does not have the power
to direct the activities that most significantly impact the trusts’ economic performance.
Accordingly, FHN has determined that it is not the primary beneficiary of the associated trusts.
FHN has no contractual requirements to provide financial support to the trusts.
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Note
14 – Variable Interest Entities (continued)
For certain troubled commercial loans, FTBNA restructures the terms of the borrower’s debt in
an effort to increase the probability of receipt of amounts contractually due. Following a
troubled debt restructuring, the borrower entity typically meets the definition of a VIE as the
initial determination of whether the entity is a VIE must be reconsidered and economic events have
proven that the entity’s equity is not sufficient to permit it to finance its activities
without additional subordinated financial support or a restructuring of the terms of its
financing. As FTBNA does not have the power to direct the activities that most significantly
impact such troubled commercial borrowers’ operations, it is not considered the primary beneficiary
even in situations where, based on the size of the financing provided, FTBNA is exposed to
potentially significant benefits and losses of the borrowing entity. FTBNA has no contractual
requirements to provide financial support to the borrowing entities beyond certain funding
commitments established upon restructuring of the terms of the debt that allows for preparation of
the underlying collateral for sale.
FHN serves as manager over certain discretionary trusts, for which it makes investment decisions on
behalf of the trusts’ beneficiaries in return for a reasonable management fee. The trusts meet the
definition of a VIE since the holders of the equity investments at risk do not have the power,
through voting rights or similar rights, to direct the activities that most significantly impact
the entities’ economic performance. The management fees FHN receives are not considered variable
interests in the trusts as all of the requirements related to permitted levels of decision maker
fees are met. Therefore, the VIE are not consolidated by FHN because it cannot be the trusts’
primary beneficiary. FHN has no contractual requirements to provide financial support to the
trusts.
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Note
14 – Variable Interest Entities (continued)
The following table summarizes VIE that are not consolidated by FHN:
See Other disclosures — Indemnification agreements and guarantees section of Note 9 -
Contingencies and Other Disclosures for information regarding FHN’s repurchase exposure for claims
that FHN breached its standard representations and warranties made in connection with the sale of
loans to proprietary and agency residential mortgage securitization trusts.
Three and Nine Months Ended September 30, 2009
Consolidated Variable Interest Entities. In 2007 and 2006, FTBNA established several Delaware
statutory trusts (“Trusts”), for the purpose of engaging in secondary market financing. Except for
recourse due to breaches of standard representations and warranties made by FTBNA in connection
with the sale of the retail real estate residential loans by FTBNA to the Trusts, the creditors of
the Trusts hold no recourse to the assets of FTBNA. Additionally, FTBNA has no contractual
requirements to provide financial support to the Trusts. Since the Trusts did not qualify as QSPE,
FTBNA treated the proceeds as secured borrowings in accordance with ASC 860. FTBNA determined that
the Trusts were VIE because the holders of the equity investment at risk did not have adequate
decision making ability over the trusts’ activities. Thus, FTBNA assessed whether it was the
primary beneficiary of the associated trusts. Since there was an overcollateralization
of the Trusts, any excess of cash flows received on the transferred loans above the amounts passed
through to the security holders would revert to FTBNA. Accordingly, FTBNA determined that it was
the primary beneficiary of the Trusts because it absorbed a majority of the expected losses of the
Trusts.
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Note
14 – Variable Interest Entities (continued)
FTBNA holds variable interests in trusts which have issued mandatorily redeemable trust
preferreds for smaller banking and insurance enterprises. FTBNA has no voting rights for the
trusts’ activities. The trusts’ only assets are junior subordinated debentures of the issuing
enterprises. The creditors of the trusts hold no recourse to the assets of FTBNA. These trusts
met the definition of
a VIE because the holders of the equity investment at risk do not have adequate decision making
ability over the trusts’ activities. In situations where FTBNA holds a majority of the trust
preferreds issued by a trust, it was considered the primary beneficiary of that trust because FTBNA
will absorb a majority of the trust’s expected losses. FTBNA has no contractual requirements to
provide financial support to the trusts. In situations where FTBNA holds a majority, but less than
all, of the trust preferreds for a trust, consolidation of the trust resulted in recognition of
amounts received from other parties as debt.
FHN has established certain rabbi trusts related to deferred compensation plans offered to its
employees. FHN contributes employee cash compensation deferrals to the trusts and directs the
underlying investments made by the trusts. The assets of these trusts are available to FHN’s
creditors only in the event that FHN becomes insolvent. These trusts are considered VIE because
either there is no equity at risk in the trusts or because FHN provided the equity interest to its
employees in exchange for services rendered. Given that the trusts were created in exchange for
the employees’ services, FHN is considered the primary beneficiary of the rabbi trusts because it
is most closely related to their purpose and design. FHN has the obligation to fund any
liabilities to employees that are in excess of a rabbi trust’s assets.
The following table summarizes VIE consolidated by FHN as of September 30, 2009:
Nonconsolidated Variable Interest Entities. Since 1997, First Tennessee Housing Corporation
(“FTHC”), a wholly-owned subsidiary, makes equity investments as a limited partner, in various
partnerships that sponsor affordable housing projects utilizing the Low Income Housing Tax Credit
(“LIHTC”) pursuant to Section 42 of the Internal Revenue Code. The purpose of these investments is
to achieve a satisfactory return on capital and to support FHN’s community reinvestment
initiatives. The activities of the limited partnerships include the identification, development,
and operation of multi-family housing that is leased to qualifying residential tenants generally
within FHN’s primary geographic region. LIHTC partnerships were considered VIE because FTHC, as
the holder of the equity investment at risk, does not have the ability to significantly affect the
success of the entity through voting rights. FTHC was not considered the primary beneficiary of
the LIHTC partnerships because an agent relationship existed between FTHC and the general partners,
whereby the general partners cannot sell, transfer or otherwise encumber their ownership interest
without the approval of FTHC. Because this resulted in a de facto agent relationship between the
partners, the general partners were considered the primary beneficiaries because their operations
were most closely associated with the LIHTC partnerships’ operations. FTHC has no contractual
requirements to provide financial support to the LIHTC partnerships beyond its initial funding
commitments.
FTBNA holds variable interests in trusts which have issued mandatorily redeemable trust preferreds
for smaller banking and insurance enterprises. FTBNA has no voting rights for the trusts’
activities. The trusts’ only assets are junior subordinated debentures of the issuing enterprises.
These trusts met the definition of a VIE because the holders of the equity investment at risk do
not have adequate decision making ability over the trusts’ activities. In situations where FTBNA
did not hold a majority of the trust preferreds issued by a trust, it was not considered the
primary beneficiary of that trust because FTBNA does not absorb a majority of the expected losses
of the trust. FTBNA has no contractual requirements to provide financial support to the trusts.
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Note
14 – Variable Interest Entities (continued)
In third quarter 2007, FTBNA executed a securitization of certain small issuer trust
preferreds for which the underlying trust did not qualify as a QSPE under ASC 860. This trust was
determined to be a VIE because the holders of the equity investment at risk do not have adequate
decision making ability over the trust’s activities. FTBNA determined that it was not the primary
beneficiary of the trust due to the size and
priority of the interests it retained in the securities issued by the trust. Accordingly, FTBNA
accounted for the funds received through the securitization as a collateralized borrowing in its
Consolidated Condensed Statement of Condition. FTBNA has no contractual requirement to provide
financial support to the trust.
FHN has previously issued junior subordinated debt to Capital I and Capital II totaling $309.0
million. Both Capital I and Capital II were considered VIE because FHN’s capital contributions to
these trusts are not considered “at risk” in evaluating whether the equity investments at risk in
the trusts have adequate decision making ability over the trusts’ activities. Capital I and
Capital II were not consolidated by FHN because the holders of the securities issued by the trusts
absorb a majority of expected losses and residual returns.
Prior to September 30, 2009, wholly-owned subsidiaries of FHN served as investment advisors and
administrators of certain “fund of funds” investment vehicles, whereby the subsidiaries received
fees for management of the funds’ operations and through revenue sharing agreements based on the
funds’ performance. The funds were considered VIE because the holders of the equity at risk did
not have voting rights or the ability to control the funds’ operations. The subsidiaries did not
make any investment in the funds. Further, the subsidiaries were not obligated to provide any
financial support to the funds. The funds were not consolidated by FHN because its subsidiaries
did not absorb a majority of expected losses or residual returns.
The following table summarizes VIE that are not consolidated by FHN as September 30, 2009:
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Note
15 – Derivatives
In the normal course of business, FHN utilizes various financial instruments (including
derivative contracts and credit-related agreements) through its legacy mortgage servicing
operations, capital markets, and risk management operations, as part of its risk management
strategy and as a means to meet customers’ needs. These instruments are subject to credit and
market risks in excess of the amount recorded on the balance sheet as required by GAAP. The
contractual or notional amounts of these financial instruments do not necessarily represent credit
or market risk. However, they can be used to measure the extent of involvement in various types of
financial instruments. Controls and monitoring procedures for these instruments have been
established and are routinely re-evaluated. The Asset/Liability Committee (“ALCO”) monitors the
usage and effectiveness of these financial instruments.
Credit risk represents the potential loss that may occur because a party to a transaction fails to
perform according to the terms of the contract. The measure of credit exposure is the replacement
cost of contracts with a positive fair value. FHN manages credit risk by entering into financial
instrument transactions through national exchanges, primary dealers or approved counterparties, and
using mutual margining and master netting agreements whenever possible to limit potential exposure.
FHN also maintains collateral posting requirements with its counterparties to limit credit risk.
With exchange-traded contracts, the credit risk is limited to the clearinghouse used. For
non-exchange traded instruments, credit risk may occur when there is a gain in the fair value of
the financial instrument and the counterparty fails to perform according to the terms of the
contract and/or when the collateral proves to be of insufficient value. Market risk represents the
potential loss due to the decrease in the value of a financial instrument caused primarily by
changes in interest rates, mortgage loan prepayment speeds, or the prices of debt instruments. FHN
manages market risk by establishing and monitoring limits on the types and degree of risk that may
be undertaken. FHN continually measures this risk through the use of models that measure
value-at-risk and earnings-at-risk.
Derivative Instruments. FHN enters into various derivative contracts both in a dealer capacity, to
facilitate customer transactions, and also as a risk management tool. Where contracts have been
created for customers, FHN enters into transactions with dealers to offset its risk exposure.
Derivatives are also used as a risk management tool to hedge FHN’s exposure to changes in interest
rates or other defined market risks.
Derivative instruments are recorded on the Consolidated Condensed Statements of Condition as Other
assets or Other liabilities measured at fair value. Fair value is defined as the price that would
be received to sell a derivative asset or paid to transfer a derivative liability in an orderly
transaction between market participants on the transaction date. Fair value is determined using
available market information and appropriate valuation methodologies. For a fair value hedge,
changes in the fair value of the derivative instrument and changes in the fair value of the hedged
asset or liability are recognized currently in earnings. For a cash flow hedge, changes in the
fair value of the derivative instrument, to the extent that it is effective, are recorded in
accumulated other comprehensive income and subsequently reclassified to earnings as the hedged
transaction impacts net income. Any ineffective portion of a cash flow hedge is recognized
currently in earnings. For freestanding derivative instruments, changes in fair value are
recognized currently in earnings. Cash flows from derivative contracts are reported as Operating
activities on the Consolidated Condensed Statements of Cash Flows.
Interest rate forward contracts are over-the-counter contracts where two parties agree to purchase
and sell a specific quantity of a financial instrument at a specified price, with delivery or
settlement at a specified date. Futures contracts are exchange-traded contracts where two parties
agree to purchase and sell a specific quantity of a financial instrument at a specified price, with
delivery or settlement at a specified date. Interest rate option contracts give the purchaser the
right, but not the obligation, to buy or sell a specified quantity of a financial instrument, at a
specified price, during a specified period of time. Caps and floors are options that are linked to
a notional principal amount and an underlying indexed interest rate. Interest rate swaps involve
the exchange of interest payments at specified intervals between two parties without the exchange
of any underlying principal. Swaptions are options on interest rate swaps that give the purchaser
the right, but not the obligation, to enter into an interest rate swap agreement during a specified
period of time.
On September 30, 2010 and 2009, respectively, FHN had approximately $212.6 million and $125.8
million of cash receivables and $130.0 million and $106.5 million of cash payables related to
collateral posting under master netting arrangements, inclusive of collateral posted related to
contracts with adjustable collateral posting thresholds, with derivative counterparties. Certain
of FHN’s agreements with derivative counterparties contain provisions that require that FTBNA’s
debt maintain minimum credit ratings from specified credit rating agencies. If FTBNA’s debt were
to fall below these minimums, these provisions would be triggered, and the counterparties could
terminate the agreements and request immediate settlement of all derivative contracts under the
agreements. The net fair value, determined by individual counterparty, of all derivative
instruments with credit-risk-related contingent accelerated termination provisions was $33.9
million of liabilities on September 30, 2010 and $20.0 million of assets and $14.1 million of
liabilities on September 30, 2009. FHN had posted collateral of $34.0 million as of September 30,
2010 in the normal course of business related to these contracts. As of September 30, 2009, FHN
had received collateral of $14.6 million and posted collateral of $12.6 million in the normal
course of business related to these contracts.
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Note
15 – Derivatives (continued)
Additionally, certain of FHN’s derivative agreements contain provisions whereby the collateral
posting thresholds under the agreements adjust based on the credit ratings of both counterparties.
If the credit rating of FHN and/or FTBNA is lowered, FHN would be required to post additional
collateral with the counterparties. The net fair value, determined by individual counterparty, of
all derivative instruments with adjustable collateral posting thresholds was $146.7 million of
assets and $208.1 million of liabilities on September 30, 2010 and was $154.9 million of assets and
$100.3 million of liabilities on September 30, 2009. As of September 30, 2010 and 2009, FHN had
received collateral of $130.0 million and $117.5 million and posted collateral of $209.8 million
and $96.7 million, respectively, in the normal course of business related to these agreements.
Legacy Mortgage Servicing Operations
Retained Interests
FHN revalues MSR to current fair value each month with changes in fair value included in Servicing
income in Mortgage banking noninterest income on the Consolidated Condensed Statements of Income.
FHN hedges the MSR to minimize the effects of loss in value of MSR associated with increased
prepayment activity that generally results from declining interest rates. In a rising interest
rate environment, the value of the MSR generally will increase while the value of the hedge
instruments will decline. FHN enters into interest rate contracts (potentially including swaps,
swaptions, and mortgage forward purchase contracts) to hedge against the effects of changes in fair
value of its MSR. Substantially all capitalized MSR are hedged for economic purposes.
FHN utilizes derivatives as an economic hedge (potentially including swaps, swaptions, and mortgage
forward purchase contracts) to protect the value of its interest-only securities that change in
value inversely to the movement of interest rates. Interest-only securities are included
in Trading securities on the Consolidated Condensed Statements of Condition. Changes in the fair
value of these derivatives and the hedged interest-only securities are recognized currently in
earnings in Mortgage banking noninterest income as a component of Servicing income on the
Consolidated Condensed Statements of Income.
The following tables summarize FHN’s derivatives associated with legacy mortgage servicing
activities for the three and nine months ended September 30, 2010 and 2009:
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Note
15 – Derivatives (continued)
Capital Markets
Capital markets trades U.S. Treasury, U.S. Agency, mortgage-backed, corporate and municipal fixed
income securities, and other securities principally for distribution to customers. When these
securities settle on a delayed basis, they are considered forward contracts. Capital markets also
enters into interest rate contracts, including options, caps, swaps, and floors for its customers.
In addition, capital markets enters into futures contracts to economically hedge interest rate risk
associated with a portion of its securities inventory. These transactions are measured at fair
value, with changes in fair value recognized currently in capital markets noninterest income.
Related assets and liabilities are recorded on the Consolidated Condensed Statements of Condition
as Other assets and Other liabilities. The FTN Financial Risk and the Credit Risk Management
Committees collaborate to mitigate credit risk related to these transactions. Credit risk is
controlled through credit approvals, risk control limits, and ongoing monitoring procedures. Total
trading revenues were $113.2 million and $127.3 million for the three months ended September 30,
2010 and 2009, respectively, and $325.8 million and $508.6 million for the nine months ended
September 30, 2010 and 2009, respectively. Total revenues are inclusive of both derivative and
non-derivative financial instruments. Trading revenues are included in capital markets noninterest
income.
The following table summarizes FHN’s derivatives associated with capital markets trading
activities as of September 30, 2010 and 2009:
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Note 15 – Derivatives (continued)
Interest Rate Risk Management
FHN’s ALCO focuses on managing market risk by controlling and limiting earnings volatility
attributable to changes in interest rates. Interest rate risk exists to the extent that
interest-earning assets and liabilities have different maturity or repricing characteristics. FHN
uses derivatives, including swaps, caps, options, and collars, that are designed to moderate the
impact on earnings as interest rates change. FHN’s interest rate risk management policy is to use derivatives to hedge interest rate risk or
market value of assets or liabilities, not to speculate. In addition, FHN has entered into certain
interest rate swaps and caps as a part of a product offering to commercial customers with customer
derivatives paired with offsetting market instruments that, when completed, are designed to
mitigate interest rate risk. These contracts do not qualify for hedge accounting and are measured
at fair value with gains or losses included in current earnings in Noninterest expense on the
Consolidated Condensed Statements of Income.
FHN has entered into pay floating, receive fixed interest rate swaps to hedge the interest rate
risk of certain long-term debt obligations totaling $1.0 billion and $1.1 billion on September 30,
2010 and 2009, respectively. These swaps have been accounted for as fair value hedges under the
shortcut method. The balance sheet impact of these swaps was $129.7 million and $107.2 million in
other assets on September 30, 2010 and 2009, respectively. Interest paid or received for these
swaps was recognized as an adjustment of the interest expense of the liabilities whose risk is
being managed. In first quarter 2010, FHN repurchased $96.0 million of debt that was being hedged
in these arrangements and terminated the related interest rate swap and hedging relationship.
FHN designates derivative transactions in hedging strategies to manage interest rate risk on
subordinated debt related to its trust preferred securities. These qualify for hedge accounting
under ASC 815-20 using the long-haul method. FHN entered into pay floating, receive fixed interest
rate swaps to hedge the interest rate risk of certain subordinated debt totaling $.2 billion on
both September 30, 2010 and 2009. There was no balance sheet impact of these swaps as of September
30, 2010. The balance sheet impact of these swaps was $2.6 million in other liabilities on
September 30, 2009. There was no ineffectiveness related to these hedges. Interest paid or
received for these swaps was recognized as an adjustment of the interest expense of the liabilities
whose risk is being managed. In second quarter 2010, FHN’s counterparty called the swap associated
with the $.2 billion of subordinated debt. Accordingly, hedge accounting was discontinued on the
date of the settlement and the cumulative basis adjustments to the associated subordinated debt are
being prospectively amortized as an adjustment to interest expense over its remaining term. FHN
subsequently re-hedged the subordinated debt with a new interest rate swap using the long-haul
method of effectiveness assessment. In first quarter 2009, FHN’s counterparty called the swap
associated with $.1 billion of subordinated debt. Accordingly, hedge accounting was discontinued
on the date of settlement and the cumulative basis adjustments to the associated subordinated debt
are being prospectively amortized as an adjustment to interest expense over its remaining term.
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Note 15 – Derivatives (continued)
The following tables summarize FHN’s derivatives associated with interest rate risk management
activities for the three and nine months ended September 30, 2010 and 2009:
Certain previously reported amounts have been reclassified to agree with current presentation.
FHN hedges held-to-maturity trust preferred loans with a principal balance of $211.6 million
and $233.1 million as of September 30, 2010 and 2009, respectively, which have an initial fixed
rate term of five years before conversion to a floating rate. FHN has entered into pay fixed,
receive floating interest rate swaps to hedge the interest rate risk associated with this initial
five year term. These hedge relationships qualify as fair value hedges under ASC 815-20. The
impact of those swaps was $20.2 million and $21.5 million in Other liabilities on the Consolidated
Condensed Statements of Income as of September 30, 2010 and 2009, respectively. Interest paid or
received for these swaps was recognized as an adjustment of the interest income of the assets whose
risk is being hedged. Gain/(loss) is included in Other income and commissions on the Consolidated
Condensed Statements of Income.
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Note 15 – Derivatives (continued)
The following tables summarize FHN’s derivative activities associated with these loans for the
three and nine months ended September 30, 2010 and 2009:
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Note
16 – Fair Value of Assets & Liabilities
FHN elected the fair value option on a prospective basis for almost all types of mortgage
loans originated for sale purposes in accordance with the Financial Instruments Topic of the FASB
Accounting Standards Codification (“ASC 825”). FHN determined that the election reduced certain
timing differences and better matched changes in the value of such loans with changes in the value
of derivatives used as economic hedges for these assets. FHN accounts for mortgage loans held for
sale that were originated prior to 2008 at the lower of cost or market value. Mortgage loans
originated for sale are included in loans held for sale on the Consolidated Condensed Statements of
Condition. Other interests retained in relation to residential loan sales and securitizations are
included in trading securities on the Consolidated Condensed Statements of Condition. Effective
January 1, 2009, FHN adopted the provisions of ASC 820-10 for existing fair value measurement
requirements related to non-financial assets and liabilities which are recognized at fair value on
a non-recurring basis.
FHN groups its assets and liabilities measured at fair value in three levels, based on the markets
in which the assets and liabilities are traded and the reliability of the assumptions used to
determine fair value. This hierarchy requires FHN to maximize the use of observable market data,
when available, and to minimize the use of unobservable inputs when determining fair value. Each
fair value measurement is placed into the proper level based on the lowest level of significant
input. These levels are:
Transfers between fair value levels are recognized at the end of the fiscal quarter in which the
associated change in inputs occurs.
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Note
16 – Fair Value of Assets & Liabilities (continued)
The following table presents the balance of assets and liabilities measured at fair value on a
recurring basis as of September 30, 2010:
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Note
16 – Fair Value of Assets & Liabilities (continued)
The following table presents the balance of assets and liabilities measured at fair value on a
recurring basis at September 30, 2009:
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Note
16 – Fair Value of Assets & Liabilities (continued)
Changes in Recurring Level 3 Fair Value Measurements
In third quarter 2009, FHN reviewed the allocation of fair value between MSR and excess interest
from prior first lien loan sales and securitizations. As a result, $11.1 million was reclassified
from trading securities to MSR within level 3 assets measured at fair value on a recurring basis.
The reclassification had no effect on FHN’s Consolidated Condensed Statements of Income as excess
interest and MSR are highly correlated in valuation and as both excess interest and MSR are
recognized at elected fair value with changes in fair value being included within Mortgage Banking
income.
In first quarter 2009, FHN changed the fair value methodology for certain loans held for sale. The
methodology change had a minimal effect on the valuation of the applicable loans. Consistent with
this change, the applicable amount is presented as a transfer into Level 3 loans held for sale in
the following rollforward for the nine months ended September 30, 2009. See Determination of Fair
Value for a detailed discussion of the changes in valuation methodology.
The changes in Level 3 assets and liabilities measured at fair value for the three months ended
September 30, 2010 and 2009, on a recurring basis are summarized as follows:
Certain previously reported amounts have been reclassified to agree with current presentation.
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Note
16 – Fair Value of Assets & Liabilities (continued)
The changes in Level 3 assets and liabilities measured at fair value for the nine months ended
September 30, 2010 and 2009, on a recurring basis are summarized as follows:
Certain previously reported amounts have been reclassified to agree with current presentation.
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Note
16 – Fair Value of Assets & Liabilities (continued)
Nonrecurring Fair Value Measurements
From time to time, FHN may be required to measure certain other financial assets at fair value on a
nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from the
application of LOCOM accounting or write-downs of individual assets. For assets measured at fair
value on a nonrecurring basis which were still held on the balance sheet at September 30, 2010 and
2009, respectively, the following tables provide the level of valuation assumptions used to
determine each adjustment, the related carrying value, and the fair value adjustments recorded
during the respective periods.
Certain previously reported amounts have been reclassified to agree with current presentation.
Fair Value Option
FHN elected the fair value option on a prospective basis for almost all types of mortgage loans
originated for sale purposes under the Financial Instruments Topic (“ASC 825”). FHN determined
that the election reduced certain timing differences and better matched changes in the value of
such loans with changes in the value of derivatives used as economic hedges for these assets.
Prior to 2010, FHN transferred certain servicing assets in transactions that did not qualify for
sale treatment due to certain recourse provisions. The associated proceeds are recognized within
Other Short Term Borrowings and Commercial Paper in the Consolidated Condensed Statements of
Condition as of September 30, 2010 and 2009. Since the servicing assets are recognized at fair
value and changes in the fair value of the related financing liabilities will exactly mirror the
change in fair value of the associated servicing assets, management elected to account for the
financing liabilities at fair value. Since the servicing assets have already been delivered to the
buyer, the fair value of the financing liabilities associated with the transaction does not reflect
any instrument-specific credit risk.
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Note
16 – Fair Value of Assets & Liabilities (continued)
The following table reflects the differences between the fair value carrying amount of
mortgages held for sale measured at fair value in accordance with management’s election and the
aggregate unpaid principal amount FHN is contractually entitled to receive at maturity.
Assets and liabilities accounted for under the fair value election are initially measured at fair
value with subsequent changes in fair value recognized in earnings. Such changes in the fair value
of assets and liabilities for which FHN elected the fair value option are included in current
period earnings with classification in the income statement line item reflected in the following
table:
For the three months ended September 30, 2010 and 2009, the amounts for loans held for sale
include approximately $3.5 million of losses and $2.2 million of gains, respectively, included in
pretax earnings that are attributable to changes in instrument-specific credit risk. For the nine
months ended September 30, 2010 and 2009, the amounts for loans held for sale include approximately
$6.2 million and $10.9 million, respectively, of losses included in pretax earnings that are
attributable to changes in instrument-specific credit risk. The portion of the fair value
adjustments related to credit risk was determined based on both a quality adjustment for
delinquencies and the full credit spread on the non-conforming loans.
Interest income on mortgage loans held for sale measured at fair value is calculated based on the
note rate of the loan and is recorded in the interest income section of the Consolidated
Condensed Statements of Income as interest on loans held for sale.
Determination of Fair Value
In accordance with ASC 820-10-35, fair values are based on the price that would be received to
sell an asset or paid to transfer a liability in an orderly transaction between market participants
at the measurement date. The following describes the assumptions and methodologies
used to estimate the fair value of financial instruments and MSR recorded at fair value in the
Consolidated Condensed Statements of Condition and for estimating the fair value of financial
instruments for which fair value is disclosed under ASC 825-10-50.
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Note
16 – Fair Value of Assets & Liabilities (continued)
Short-term financial assets. Federal funds sold, securities purchased under agreements to
resell, and interest bearing deposits with other financial institutions are carried at historical
cost. The carrying amount is a reasonable estimate of fair value because of the relatively short
time between the origination of the instrument and its expected realization.
Trading securities and trading liabilities. Trading securities and trading liabilities are
recognized at fair value through current earnings. Trading inventory held for broker-dealer
operations is included in trading securities and trading liabilities. Broker-dealer long positions
are valued at bid price in the bid-ask spread. Short positions are valued at the ask price.
Inventory positions are valued using observable inputs including current market transactions, LIBOR
and U.S. treasury curves, credit spreads, and consensus prepayment speeds. Trading loans are
valued using observable inputs including current market transactions, swap rates, mortgage rates,
and consensus prepayment speeds.
Trading securities also include retained interests in prior securitizations that qualify as
financial assets, which may include certificated residual interests, excess interest (structured as
interest-only strips), principal-only strips, or subordinated bonds. Residual interests represent
rights to receive earnings to the extent of excess income generated by the underlying loans. Excess
interest represents rights to receive interest from serviced assets that exceed contractually
specified rates. Principal-only strips are principal cash flow tranches, and interest-only strips
are interest cash flow tranches. Subordinated bonds are bonds with junior priority. All financial
assets retained from a securitization are recognized on the Consolidated Condensed Statements of
Condition in trading securities at fair value with realized and unrealized gains and losses
included in current earnings as a component of noninterest income on the Consolidated Condensed
Statements of Income.
The fair value of excess interest is determined using prices from closely comparable assets such as
MSR that are tested against prices determined using a valuation model that calculates the present
value of estimated future cash flows. Inputs utilized in valuing excess interest are consistent
with those used to value the related MSR. The fair value of excess interest typically changes
based on changes in the discount rate and differences between modeled prepayment speeds and credit
losses and actual experience. FHN uses assumptions in the model that it believes are comparable to
those used by brokers and other service providers. FHN also periodically compares its estimates of
fair value and assumptions with brokers, service providers, recent market activity, and against its
own experience.
The fair value of certificated residual interests was determined using a valuation model that
calculates the present value of estimated future cash flows. Inputs utilized in valuing residual
interests are generally consistent with those used to value the related MSR. However, due to the
lack of market information for residual interests, at September 30, 2009, FHN applied an
internally-developed assumption about the yield that a market participant would require in
determining the discount rate for its residual interests. The fair value of residual interests
typically changes based on changes in the discount rate and differences between modeled prepayment
speeds and credit losses and actual experience. All residual interests were removed from the
balance sheet upon adoption of ASU 2009-17 on January 1, 2010.
In some instances, FHN retained interests in the loans it securitized by retaining certificated
principal only strips or subordinated bonds. Subsequent to the August 2008 reduction of mortgage
banking operations, FHN uses observable inputs such as trades of similar instruments, yield curves,
credit spreads, and consensus prepayment speeds to determine the fair value of principal only
strips. Previously, FHN used the market prices from comparable assets such as publicly traded FNMA
trust principal only strips that were adjusted to reflect the relative risk difference between
readily marketable securities and privately issued securities in valuing the principal only
strips. The fair value of subordinated bonds was determined using the best available market
information, which included trades of comparable securities, independently provided spreads to
other marketable securities, and published market research. Where no market information was
available, the company utilized an internal valuation model. As of September 30, 2009, no market
information was available, and the subordinated bonds were valued using an internal discounted cash
flow model, which included assumptions about timing, frequency and severity of loss, prepayment
speeds of the underlying collateral, and the yield that a market participant would require. All
subordinated bonds were removed from the balance sheet upon adoption of ASU 2009-17 on January 1,
2010.
Securities available for sale. Securities available for sale includes the investment portfolio
accounted for as available for sale under ASC 320-10-25, federal bank stock holdings, short-term
investments in mutual funds, and venture capital investments. Valuations of available-for-sale
securities are performed using observable inputs obtained from market transactions in similar
securities. Typical inputs include LIBOR and U.S. treasury curves, consensus prepayment estimates,
and credit spreads. When available, broker quotes are used to support these valuations. Certain
government agency debt obligations with limited trading activity are valued using a discounted cash
flow model that incorporates a combination of observable and unobservable inputs. Primary
observable inputs include contractual cash flows and the treasury curve. Significant unobservable
inputs include estimated trading spreads and estimated prepayment speeds.
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Note
16 – Fair Value of Assets & Liabilities (continued)
Stock held in the Federal Reserve Bank and Federal Home Loan Banks are recognized at
historical cost in the Consolidated Condensed Statements of Condition which is considered to
approximate fair value. Short-term investments in mutual funds are measured at the funds’
reported closing net asset values. Venture capital investments are typically measured using
significant internally generated inputs including adjustments to referenced transaction values and
discounted cash flows analysis.
Loans held for sale. In conjunction with the adoption of the provisions of the FASB codification
update to ASC 820-10 in second quarter 2009, FHN revised its methodology for determining the fair
value of certain loans within its mortgage warehouse. FHN now determines the fair value of the
applicable loans using a discounted cash flow model using observable inputs, including current
mortgage rates for similar products, with adjustments for differences in loan characteristics
reflected in the model’s discount rates. For all other loans held in the warehouse (and in prior
periods for the loans converted to the discounted cash flow methodology), the fair value of loans
whose principal market is the securitization market is based on recent security trade prices for
similar products with a similar delivery date, with necessary pricing adjustments to convert the
security price to a loan price. Loans whose principal market is the whole loan market are priced
based on recent observable whole loan trade prices or published third party bid prices for similar
product, with necessary pricing adjustments to reflect differences in loan characteristics.
Typical adjustments to security prices for whole loan prices include adding the value of MSR to the
security price or to the whole loan price if FHN’s mortgage loan is servicing retained, adjusting
for interest in excess of (or less than) the required coupon or note rate, adjustments to reflect
differences in the characteristics of the loans being valued as compared to the collateral of the
security or the loan characteristics in the benchmark whole loan trade, adding interest carry,
reflecting the recourse obligation that will remain after sale, and adjusting for changes in market
liquidity or interest rates if the benchmark security or loan price is not current. Additionally,
loans that are delinquent or otherwise significantly aged are discounted to reflect the less
marketable nature of these loans.
Loans held for sale includes loans made by the Small Business Administration (“SBA”). The fair
value of SBA loans is determined using an expected cash flow model that utilizes observable inputs
such as the spread between LIBOR and prime rates, consensus prepayment speeds, and the treasury
curve.
The fair value of other non-mortgage loans held for sale is approximated by their carrying values
based on current transaction values.
Loans, net of unearned income. Loans, net of unearned income are recognized at the amount of funds
advanced, less charge offs and an estimation of credit risk represented by the allowance for loan
losses. The fair value estimates for disclosure purposes differentiate loans based on their
financial characteristics, such as product classification, loan category, pricing features, and
remaining maturity.
The fair value of floating rate loans is estimated through comparison to recent market activity in
loans of similar product types, with adjustments made for differences in loan characteristics. In
situations where market pricing inputs are not available, fair value is considered to approximate
book value due to the monthly repricing for commercial and consumer loans, with the exception of
floating rate 1-4 family residential mortgage loans which reprice annually and will lag movements
in market rates. The fair value for floating rate 1-4 family mortgage loans is calculated by
discounting future cash flows to their present value. Future cash flows are discounted to their
present value by using the current rates at which similar loans would be made to borrowers with
similar credit ratings and for the same time period.
Prepayment assumptions based on historical prepayment speeds and industry speeds for similar loans
have been applied to the floating rate 1-4 family residential mortgage portfolio.
The fair value of fixed rate loans is estimated through comparison to recent market activity in
loans of similar product types, with adjustments made for differences in loan characteristics. In
situations where market pricing inputs are not available, fair value is estimated by discounting
future cash flows to their present value. Future cash flows are discounted to their present value
by using the current rates at which similar loans would be made to borrowers with similar credit
ratings and for the same time period. Prepayment assumptions based on historical prepayment speeds
and industry speeds for similar loans have been applied to the fixed rate mortgage and installment
loan portfolios.
Individually impaired loans are measured using either a discounted cash flow methodology or the
estimated fair value of the underlying collateral less costs to sell, if the loan is considered
collateral-dependent. In accordance with accounting standards, the discounted cash flow analysis
utilizes the loan’s effective interest rate for discounting expected cash flow amounts. Thus, this
analysis is not considered a fair value measurement in accordance with ASC 820. However, the
results of this methodology are considered to approximate fair value for the applicable loans.
Expected cash flows are derived from internally-developed inputs primarily reflecting expected
default rates on contractual cash flows.
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Note
16 – Fair Value of Assets & Liabilities (continued)
For loans measured using the estimated fair value of collateral less costs to sell, fair value
is estimated using appraisals of the collateral. Collateral values are monitored and additional
write-downs are recognized if it is determined that the estimated collateral values have declined
further. Estimated costs to sell are based on current amounts of disposal costs for similar
assets. Carrying value is considered to reflect fair value for these loans.
Mortgage servicing rights. FHN recognizes all classes of MSR at fair value. Since sales of MSR
tend to occur in private transactions and the precise terms and conditions of the sales are
typically not readily available, there is a limited market to refer to in determining the fair
value of MSR. As such, FHN primarily relies on a discounted cash flow model to estimate the fair
value of its MSR. This model calculates estimated fair value of the MSR using predominant risk
characteristics of MSR such as interest rates, type of product (fixed vs. variable), age (new,
seasoned, or moderate), agency type and other factors. FHN uses assumptions in the model that it
believes are comparable to those used by brokers and other service providers. FHN also periodically
compares its estimates of fair value and assumptions with brokers, service providers, recent market
activity, and against its own experience.
Derivative assets and liabilities. The fair value for forwards and futures contracts used to hedge
the value of servicing assets and the mortgage warehouse are based on current transactions
involving identical securities. These contracts are exchange-traded and thus have no credit risk
factor assigned as the risk of non-performance is limited to the clearinghouse used.
Valuations of other derivatives (primarily interest rate related swaps, swaptions, caps, and
collars) are based on inputs observed in active markets for similar instruments. Typical inputs
include the LIBOR curve, option volatility, and option skew. Credit risk is mitigated for these
instruments through the use of mutual margining and master netting agreements as well as collateral
posting requirements. Any remaining
credit risk related to interest rate derivatives is considered in determining fair value through
evaluation of additional factors such as customer loan grades and debt ratings.
Real estate acquired by foreclosure. Real estate acquired by foreclosure primarily consists of
properties that have been acquired in satisfaction of debt. These properties are carried at the
lower of the outstanding loan amount or estimated fair value less estimated costs to sell the real
estate. Estimated fair value is determined using appraised values with subsequent adjustments for
deterioration in values that are not reflected in the most recent appraisal. Real estate acquired
by foreclosure also includes properties acquired in compliance with HUD servicing guidelines which
are carried at the estimated amount of the underlying government assurance or guarantee.
Nonearning assets. For disclosure purposes, nonearning assets include cash and due from banks,
accrued interest receivable, and capital markets receivables. Due to the short-term nature of
cash and due from banks, accrued interest receivable, and capital markets receivables, the fair
value is approximated by the book value.
Other assets. For disclosure purposes, other assets consist of investments in low income housing
partnerships and deferred compensation assets that are considered financial assets. Investments in
low income housing partnerships are written down to estimated fair value
quarterly based on the estimated value of the associated tax credits. Deferred compensation assets
are recognized at fair value, which is based on quoted prices in active markets.
Defined maturity deposits. The fair value is estimated by discounting future cash flows to their
present value. Future cash flows are discounted by using the current market rates of similar
instruments applicable to the remaining maturity. For disclosure purposes, defined maturity
deposits include all certificates of deposit and other time deposits.
Undefined maturity deposits. In accordance with ASC 825, the fair value is approximated by the
book value. For the purpose of this disclosure, undefined maturity deposits include demand
deposits, checking interest accounts, savings accounts, and money market accounts.
Short-term financial liabilities. The fair value of federal funds purchased, securities sold under
agreements to repurchase, commercial paper, and other short-term borrowings are approximated by the
book value. The carrying amount is a reasonable estimate of fair value because of the relatively
short time between the origination of the instrument and its expected realization. Commercial
paper and short-term borrowings includes a liability associated with transfers of mortgage
servicing rights that did not qualify for sale accounting. This liability is accounted for at
elected fair value, which is measured consistent with the related MSR, as previously described.
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Note
16 – Fair Value of Assets & Liabilities (continued)
Long-term debt. The fair value is based on quoted market prices or dealer quotes for the
identical liability when traded as an asset. When pricing information for the identical liability
is not available, relevant prices for similar debt instruments are used with adjustments being made
to the prices obtained for differences in characteristics of the debt instruments. If no relevant
pricing information is available, the fair value is approximated by the present value of the
contractual cash flows discounted by the investor’s yield which considers FHN’s and FTBNA’s debt
ratings.
Other noninterest-bearing liabilities. For disclosure purposes, other noninterest-bearing
liabilities include accrued interest payable and capital markets payables. Due to the short-term
nature of these liabilities, the book value is considered to approximate fair value.
Loan commitments. Fair values are based on fees charged to enter into similar agreements taking
into account the remaining terms of the agreements and the counterparties’ credit standing.
Other commitments. Fair values are based on fees charged to enter into similar agreements.
The following fair value estimates are determined as of a specific point in time utilizing various
assumptions and estimates. The use of assumptions and various valuation techniques, as well as the
absence of secondary markets for certain financial instruments, will likely reduce the
comparability of fair value disclosures between financial institutions. Due to market illiquidity,
the fair values for loans, net of unearned income, loans held for sale, and long-term debt as of
September 30, 2010 and 2009, involve the use of significant internally-developed pricing
assumptions for certain components of these line items. These assumptions are considered to reflect
inputs that market participants would use in transactions involving these instruments as of the
measurement date. Assets and liabilities that are not financial instruments (including MSR) have
not been included in the following table such as the value of long-term relationships with deposit
and trust customers, premises and equipment, goodwill and other intangibles, deferred taxes, and
certain other assets and other liabilities. Accordingly, the total of the fair value amounts does
not represent, and should not be construed to represent, the underlying value of the company.
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Note
16 – Fair Value of Assets & Liabilities (continued)
The following table summarizes the book value and estimated fair value of financial
instruments recorded in the Consolidated Condensed Statements of Condition as well as off-balance
sheet commitments as of September 30, 2010 and 2009.
Certain previously reported amounts have been reclassified to agree with current presentation.
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Note
17 – Restructuring, Repositioning, and Efficiency
Beginning in 2007, FHN conducted a company-wide review of business practices with the goal of
improving its overall profitability and productivity. In order to redeploy capital to higher-return
businesses, FHN sold 34 full-service First Horizon Bank branches in its national banking markets,
discontinued national homebuilder and commercial real estate lending through its First Horizon
Construction Lending offices, and executed various MSR sales. In 2008, FHN sold its national
mortgage origination and servicing platform including substantially all of its mortgage pipeline,
related hedges, servicing assets, certain fixed assets, and other associated assets.
In 2009, FHN contracted to sell its institutional equity research business, a division of FTN
Financial. During first quarter 2010, the sale failed to close and FHN incurred an additional
goodwill impairment, severance and contract terminations costs, and asset write-offs. Additionally,
in late 2009 FHN sold and closed its Louisville remittance processing operations and the Atlanta
insurance business and also cancelled a large services/consulting contract.
Net costs recognized by FHN during the nine months ended September 30, 2010, related to
restructuring, repositioning, and efficiency activities were $11.8 million. Of this amount, $7.1
million represented exit costs that were accounted for in accordance with the Exit or Disposal Cost
Obligations Topic of the FASB Accounting Standards Codification (“ASC 420”).
Significant expenses recognized year to date 2010 resulted from the following actions:
Net cost recognized by FHN during the nine months ended September 30, 2009, related to
restructuring, repositioning, and efficiency activities were $20.7 million. Of this amount, $4.6
million represented exit costs that were accounted for in accordance with ASC 420.
Significant expenses recognized year to date 2009 resulted from the following actions.
The financial results of FTN ECM (the institutional equity research business) including goodwill
impairment are reflected in the Loss from discontinued operations, net of tax line on the
Consolidated Condensed Statements of Income for all periods presented. Transaction costs
recognized in the periods presented from selling mortgage servicing rights are recorded as a
reduction of mortgage banking income in the noninterest income section of the Consolidated
Condensed Statements of Income. All other costs associated with the restructuring, repositioning,
and efficiency initiatives implemented by the management are included in the noninterest expense
section of the Consolidated Condensed Statements of Income, including severance and other
employee-related cost recognized in relation to such initiatives which are recorded in employee
compensation, incentives, and benefits; facilities consolidation costs and related asset impairment
costs are included in occupancy; cost associated with the impairment of premises and equipment are
included in equipment rentals; depreciation and maintenance and other costs associated with such
initiatives, including professional fees, and intangible asset impairment costs are included in all
other expense.
Activity in the restructuring and repositioning liability for the nine months ended September 30,
2010 and 2009, is presented in the following table, along with other restructuring and
repositioning expenses recognized. For repositioning actions initiated prior to 2010, costs
associated with the reduction of national operations and termination of product and service
offerings are included within the non-strategic segment while costs associated with efficiency
initiatives affecting multiple segments and initiatives that occurred within regional banking and
capital markets are included in the corporate segment. For repositioning actions initiated in
2010, the related costs are included in the segment that has decision-making responsibility.
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Note
17 – Restructuring, Repositioning, and Efficiency (continued)
FHN began initiatives related to restructuring in second quarter 2007. Consequently, the
following table presents cumulative amounts incurred to date as of September 30, 2010, for costs
associated with FHN’s restructuring, repositioning, and efficiency initiatives:
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FIRST HORIZON NATIONAL CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION GENERAL INFORMATION
First
Horizon National Corporation (“FHN”) began as a community
bank chartered in 1864 and as of June 30, 2010, was
one of the 50 largest bank holding companies in the United States in terms of asset size.
Approximately 5,500 FHN employees provide financial services through more than 180 bank locations
in and around Tennessee and 18 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 21 counties in Tennessee and surrounding metropolitan
areas 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.
In first quarter 2010, FHN revised its operating segments to better align with its strategic
direction, representing a focus on its regional banking franchise and capital markets business.
Key changes include the addition of the non-strategic segment that combines the former mortgage
banking and national specialty lending segments, the movement of correspondent banking from capital
markets to regional banking, and the shift of first lien mortgage production in the Tennessee
footprint to the regional banking segment. Exited businesses were moved to the new non-strategic
segment.
Consistent with the treatment of exited operations and product lines, FHN has also revised its
presentation of historical charges incurred related to its restructuring, repositioning, and
efficiency initiatives. Past charges that resulted from the reduction of national operations and
termination of product and service offerings have been included within the non-strategic segment.
Additionally, past charges affecting multiple segments and initiatives that occurred within
regional banking and capital markets have been included in the corporate segment to reflect the
corporate-driven emphasis on execution of the repositioning efforts.
FHN is composed of the following operating segments:
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 is a discussion and analysis of
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the financial condition and results of operations of FHN for the three and nine-month periods ended
September 30, 2010, compared to the three and nine-month periods ended September 30, 2009. To
assist the reader in obtaining a better understanding of FHN and its performance, the following
discussion should be read with the accompanying unaudited Consolidated Condensed Financial
Statements and Notes in this report. Additional information including the 2009 financial
statements, notes, and MD&A is provided in the 2009 Annual Report.
FHN historically presented charges related to repurchase obligations for junior lien consumer
mortgage loan sales in noninterest income while similar charges arising from first lien mortgage
originations and sales through the legacy national mortgage banking business were reflected in
noninterest expense. In order to present such charges consistently, FHN determined that charges
relating to repurchase obligations should be reflected in noninterest expense in the line item
called Repurchase and foreclosure provision on the Consolidated Condensed Statements of Income.
Consequently, FHN retroactively applied this change which resulted in a reclassification of charges
related to junior lien mortgage loan sales from noninterest income into noninterest expense. All
applicable tables and associated narrative have been revised to reflect this change. This
reclassification did not impact FHN’s net income and all effects are included in the non-strategic
segment.
FORWARD-LOOKING STATEMENTS
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 level and length
of deterioration in the residential housing and commercial real estate markets; potential
requirements for FHN to repurchase previously sold or securitized mortgage loans; potential claims
relating to foreclosure processes; 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”), the Federal Deposit Insurance Corporation (“FDIC”), Financial
Industry Regulatory Authority (“FINRA”), U.S. Department of the Treasury, the Bureau of Consumer
Financial Protection, the Financial Stability Oversight Council, 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, possibly materially, because of
several factors, including those presented in this Forward-Looking Statements section, in other
sections of this MD&A, in other parts of and exhibits to this Quarterly Report on Form 10-Q for the
period ended September 30, 2010, and in documents incorporated into this Quarterly Report.
FINANCIAL SUMMARY (Comparison of third quarter 2010 to third quarter 2009)
For third quarter 2010, FHN reported net income available to common shareholders of $15.9 million,
or $.07 diluted earnings per share compared to a loss of $52.9 million, or $.23 diluted loss per
share in third quarter 2009. The prior year included $10.2
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million of losses from discontinued operations related to a contracted sale of FTN Equity Capital
Markets (“FTN ECM); the sale was abandoned in the first quarter 2010 and this business was closed.
Results in third quarter 2010 were primarily driven by a $135.0 million decline in the loan loss
provision with lower revenues and flat expenses. Provision expense was lower in third quarter 2010
reflecting reduced inherent loss content of the loan portfolio as a result of lower period-end
balances. Loan balances continued to decline because of continued efforts to wind down the
higher-risk non-strategic construction portfolios and weak loan demand. Additionally, FHN saw some
improvement in certain components of the C&I portfolio and performance stabilized in the consumer
portfolios when compared to third quarter 2009. Overall, revenue was down as net interest income
declined $4.8 million to $186.1 million, consistent with shrinkage of the balance sheet and
noninterest income was down $53.9 million to $248.2 million. While still strong compared to
historical levels, fixed income sales revenue declined $13.6 million, reflecting normalizing of
market conditions that were very favorable in 2009. Other noninterest income declined as 2009
included gains on the repurchase of bank debt and miscellaneous fee income associated with exited
businesses decreased from the prior year. While the low interest rate environment continues to
facilitate positive net hedging results, mortgage banking income declined $6.1 million on lower
servicing fees due to shrinkage of the servicing portfolio. Regulation E, which became effective in third
quarter 2010, negatively affected deposit-related fee income as retail customers must now elect to
recieve certain overdraft protection services that have historically been routinely provided to all
retail customers.
Noninterest expense was flat at $347.6 million in third quarter 2010 when compared with third
quarter 2009. Losses related to foreclosed assets declined $16.1 million as collateral values
stabilized in certain markets. Numerous other expenses declined as FHN continues to wind-down
non-strategic businesses. However, these declines in noninterest expense were partially offset by
charges associated with repurchase obligations which increased $24.6 million from last year as
elevated repurchase requests and rising mortgage insurance (“MI”) cancellation notices
drove expenses higher. Restructuring, repositioning and efficiency charges were minimal in both
periods and did not significantly contribute to quarter-over-quarter results.
Return on average common equity and return on average assets for third quarter 2010 were 2.86
percent and .52 percent, respectively, compared to negative 9.02 percent and negative .52 percent
in 2009. Tier 1 capital ratio was 17.34 percent as of September 30, 2010, compared to 16.20
percent on September 30, 2009. Total assets were $25.4 billion and shareholders’ equity was $3.3
billion on September 30, 2010, compared to $26.5 billion and $3.4 billion, respectively, on
September 30, 2009.
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BUSINESS LINE REVIEW
Regional Banking
The regional banking segment had pre-tax income of $48.3 million in third quarter 2010 compared to
a pre-tax loss of $48.0 million in third quarter 2009. Improvement in pretax results was primarily
due to an $86.1 million decline in loan loss provisioning. Total revenues were $220.0 million in
2010 and were relatively flat when compared to third quarter 2009.
The provision for loan losses decreased to $10.3 million in third quarter 2010 from $96.4 million
in third quarter 2009. The decrease in provision was primarily driven by the more recent
stabilization experienced in the C&I portfolio.
Net interest income increased 3 percent to $142.6 million in third quarter 2010 from $137.8 million
in third quarter 2009. The increase in net interest income was primarily attributable to growth in
mortgage warehouse lending in third quarter 2010 and improved commercial loan pricing. Net
interest margin in regional banking improved to 5.11 percent in third quarter 2010 from
4.74 percent in third quarter 2009. The margin expansion is primarily attributable to improved
commercial loan pricing combined with lower loan balances.
Noninterest income declined 7 percent, or $5.6 million, to $77.5 million in third quarter 2010.
Deposit transactions and cash management fees were down $6.6 million from third quarter 2009
primarily due the negative effect of Regulation E which was effective beginning in third quarter
2010.
Regulation E requires retail customers to elect to recieve overdraft protection for debit card and ATM
transactions. Prior to the effective date of Regulation E, retain customers automatically recieved this service which generated fee income for the regional bank.
Insurance commissions and mortgage banking income each declined $.8 million from third
quarter 2009. In third quarter 2010, FHN executed a sale of student loans generating a $2.7
million gain which partially offset declines in noninterest income.
Noninterest expense decreased to $161.4 million in third quarter 2010 from $172.4 million in third
quarter 2009. Foreclosure losses decreased $9.2 million in third quarter 2010, primarily due to
higher negative valuation adjustments recognized in third quarter 2009 as the rate of decline in
property values stabilized in 2010 in certain markets. Additionally, in third quarter 2010, FHN
recognized minimal credit losses on customer derivatives compared to $5.1 million credit losses
recognized in third quarter 2009.
Capital Markets
Pre-tax income in the capital markets segment decreased from $51.8 million in third quarter 2009 to
$43.1 million in third quarter 2010 due to a decline in fixed income sales revenue. Revenue from
fixed income sales decreased to $106.9 million in third quarter 2010 from $120.5 million in third
quarter 2009. While still strong compared to historical levels, this decrease in fixed income
sales revenue reflects normalizing market conditions which were very favorable in 2009. Average
daily revenue was $1.7 million in third quarter 2010 compared with $1.9 million in 2009. Revenue
from other products, including fee income from activities such as loan sales, portfolio advisory,
and derivative sales decreased from $8.6 million in third quarter 2009 to $7.1 million in third
quarter 2010. Noninterest expense was relatively flat at $79.5 million in third quarter 2010
compared with $80.3 million in 2009: the decline in revenue from third quarter 2009 to 2010 did not
result in lower variable compensation expense because of a reduced rate of incentive provisioning
in third quarter 2009.
Corporate
The corporate segment’s pre-tax loss was $13.9 million in third quarter 2010 compared to pre-tax
income of $15.3 million in third quarter 2009. The corporate segment recognized net interest
expense of $2.4 million in third quarter 2010 compared to net interest income of $8.5 million in
third quarter 2009 primarily due to lower yielding, smaller investment portfolio and changing
balance sheet mix. Noninterest income was $7.9 million in third quarter 2010 compared to $24.7
million in third quarter 2009. The decline in noninterest income was primarily due to $12.8
million of gains recognized on the repurchase of bank debt in third quarter 2009. Additionally,
deferred compensation income decreased $3.9 million, which is mirrored by a decline in deferred
compensation expense. Noninterest expense increased to $19.5 million in third quarter 2010 from
$17.8 million in third quarter 2009. In 2009, FHN reversed $7.0 million of the contingent liability
for certain Visa legal matters which contributed to the increase in noninterest expense. This
increase was partially offset by a decline in deferred compensation expense and legal and
professional fees.
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Non-Strategic
The pre-tax loss for the non-strategic segment was $40.7 million in 2010 compared with $59.4
million in 2009. Net interest income declined $4.2 million to $37.4 million as the wind-down of
the national construction portfolios was the primary source of the lower net interest income from
2009. Provision expense declined $48.9 million from third quarter 2009 primarily due to reduced
exposure from the national construction portfolios and stabilization in the consumer portfolios.
Noninterest income decreased $13.5 million from $65.2 million in third quarter 2009 primarily due
to a decline in mortgage banking. Servicing income, which comprises the majority of mortgage
banking income, declined by $5.3 million as servicing fees decreased $8.3 million, net hedging
results increased slightly, and the value of MSR was more adversely affected by runoff in 2009. Servicing fees declined consistent with the
continued reduction in the size of the servicing portfolio and hedging results continue to be
favorable due to the interest rate environment. Remittance processing income and insurance
commissions declined a combined $4.1 million as a result of the exit of Louisville remittance
processing and the Atlanta insurance businesses in fourth quarter 2009.
Noninterest expense was $87.1 million in 2010 compared with $77.7 million 2009. The provision for
repurchase and foreclosure losses increased $24.7 million from third quarter 2009 to $48.7 million
during 2010. The increase in repurchase obligations is primarily the result of elevated repurchase
requests and rise of MI cancellation notices related to loans originated and sold through the
legacy mortgage banking business. See the Repurchase and Related Obligations from Loans Originated for Sale section of MD&A for additional discussion of these repurchase
obligations. This rise in expenses was mitigated by a reduction in expenses primarily due to the
continued wind down of businesses in this operating segment. Additionally, losses related to
foreclosed real estate declined $7.0 million from $11.6 million in third quarter 2009 as the rate
of decline in property values stabilized in certain markets.
INCOME STATEMENT
Total consolidated revenue decreased 12 percent to $434.4 million from $493.0 million in third
quarter 2009 as nearly all revenue categories contributed to the decline.
NET INTEREST INCOME
Net interest income declined to $186.1 million in third quarter 2010 from $190.9 million in 2009 as
average earning assets declined 5 percent to $23.0 billion and average interest-bearing liabilities
declined 6 percent to $17.1 billion in third quarter 2010. The decline in net interest income is
primarily attributable to a decrease in the size of the loan portfolio and lower returns on the
investment securities portfolio. This decline in net interest income from third quarter 2009 was
partially mitigated by improved pricing on commercial loans and certain deposit products.
The consolidated net interest margin improved to 3.23 percent for third quarter 2010 compared to
3.14 percent for 2009. The widening in the margin occurred as the net interest spread increased to
3.01 percent from 2.89 percent in third quarter 2009 and the impact of free funding decreased from
25 basis points to 22 basis points. The increase in the margin is primarily attributable to an
overall decline in lower-rate earning assets, improved deposit pricing, and lower wholesale funding
costs. These favorable impacts were offset by a significant increase in excess deposits at the
Federal Reserve Bank.
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Table 1 — Net Interest Margin
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