First Horizon National Corp. Q4 2008 Earnings Call Transcript

Jan.16.09 | About: First Horizon (FHN)

First Horizon National Corp. (NYSE:FHN)

Q4 2008 Earnings Call

January 16, 2009 9:00 am ET

Executives

Dave Miller – Investor Relations

Bryan Jordan – President and Chief Executive Officer

Greg Olivier – Chief Credit Officer

William C. Losche III – Chief Financial Officer

Tom Adams – Treasurer

Analysts

Steve Alexopoulos - J.P. Morgan

Ken Zerbe - Morgan Stanley

Anthony Davis - Stifel Nicolaus & Company, Inc.

Heather Wolfe - Banc of America

Robert Patten - Morgan Keegan

Paul Miller - FBR Capital Markets

Kevin Fitzsimmons - Sandler O'Neill and Partners, L.P.

Adam Barkstrom – Sterne, Agee

Christopher Marinac – FIG Partners

Stephen L. Covington - Stieven Capital

Jefferson Harralson - Keefe, Bruyette & Woods, Inc.

Operator

Good day and welcome to the First Horizon National Corp. fourth quarter earnings conference call. (Operator Instructions)

Mr. Miller, you may begin.

Dave Miller

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

Before we begin we need to inform you that this conference call contains forward-looking statements which may include guidance involving significant risk and uncertainties. A number of factors could cause actual results to differ materially from those in forward-looking information. Those factors are outlined in the recent earnings press release and more details are provided in the most current 10-Q and 10-K. First Horizon National Corp. disclaims any obligation to update any forward-looking statements that are made from time to time to reflect future events or developments.

In addition, non-GAAP financial information may be noted in this conference call. A reconciliation of that non-GAAP information to comparable GAAP information will be provided as needed in the Appendix of the slide presentation available in the Investor Relations area of our website. Listeners are encouraged to review any such reconciliations after this call.

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

This morning's speakers include our CEO, Bryan Jordan, our Chief Credit Officer, Greg Olivier, and our new CFO, B.J. Losche. Also joining us is our Treasurer, Tommy Adams.

With that, I'll turn it over to Bryan.

Bryan Jordan

Thank you, Dave. Good morning. Thanks for joining our call.

2008 was unquestionably one of the most difficult years the financial service industry has ever faced, yet it marked a year of significant strategic change for the better at First Horizon. Our fourth quarter results, while negatively affected by a worsening economy and further housing market deterioration, showed real signs of progress and benefits of actions taken this year.

Earnings per share were a loss of $0.27 for the fourth quarter, an improvement over last quarter's loss of $0.61. Full year 2008 EPS was a loss of $1.06.

Pre-tax pre-provision income for the quarter was $193 million as our earnings power remained strong in the Regional Banking and Capital Markets businesses.

Before Greg and B.J. give you more details about fourth quarter results, let's spend a few minutes reviewing the strategic headway that we made in 2008 and where we're headed in 2009.

Even as the operating environment became increasingly challenging, we delivered on our commitment to refocus on higher return core franchise businesses. We exited our national lending platforms outside of Tennessee, most notably through the sale of our mortgage business to Met Life. As a result, we reduced our balance sheet by $6 billion over the year, substantially reducing risk in the process.

We bolstered our already strong capital position by raising additional common equity back in April, replacing our cash dividend with stock, and participating in the TARP capital purchase program.

We improved our liquidity position as we retired about $3.5 billion of maturing bank debt through deleveraging and shifted funding to more reliable and cost-effective sources.

And we proactively addressed problem loans. As the economy and the housing market weakened, we repeatedly reviewed our portfolios, re-graded loans, wrote nonperformers down to net realizable values, and worked hard so that our reserving models kept pace with challenging conditions.

With the actions we took throughout the year, we have built a strong foundation for the company and we are well positioned for what is likely to be a tough operating environment through the end of 2009. We have a strong capital base, including a tangible common equity to tangible assets ratio over 7%, which we think is critical. Our liquidity position is good and we have significant excess sources available to us. We have loan loss reserves of nearly 4% and we have the flexibility to build reserves further if dictated by the environment.

Perhaps most importantly, we have good core franchises that have meaningful competitive advantages for developing relationships with our target customers. Those businesses remain strong in the face of a very difficult climate and are well positioned to grow when the economy rebounds.

In the Regional Bank, our deposits and customers are growing. We've invested in marketing, systems enhancements, and new branches, opening our 50th branch in [Middle], Tennessee during the fourth quarter. Customer service remains among the best in the industry, so we believe our market share and our share of wallet with target clients can move much higher. We are aggressively pursuing new ways to become more efficient and opportunities to improve pricing to combat these adverse effects in the low rate, weaker economic environment.

Capital Markets produced record earnings this quarter on record fixed income sales. Our extensive distribution platform remains a competitive advantage, and we're also benefiting from market volatility and rate movements.

Our work is not complete, but we've come a long way and done it under trying conditions. The strength of First Horizon today is a real testament to the hard work of our people and our management team.

Along those lines, I extend my thanks to Tommy Adams for serving as Interim CFO over the last several months. He has done a tremendous job while maintaining his role as Corporate Treasurer in this most unusual environment. The balance sheet is well positioned today thanks to his efforts. Tommy will remain a major contributor of our finance group and our company.

Second, it is a pleasure to welcome B.J. to our team. His solid financial services background and finance experience will be extremely valuable as we focus on our core Banking and Capital Markets businesses during this challenging period for the financial services industry. B.J. will be a real asset to us as we continue to refine our strategies, grow our businesses, and become more efficient.

Finally, thank you to all of our First Horizon co-workers for all they are doing to serve their customers and our communities.

In summary, we've made a lot of progress repositioning this company, putting us on a strong footing. Conditions will likely be very tough in 2009 and perhaps into next year, but our company is strong and our core businesses have compelling growth potential. We look forward to making further progress on the path back to profitability this year.

Now I'll turn the call over to Greg to discuss asset quality, and I'll be back in a few minutes to help answer your questions. Greg?

Greg Olivier

Thanks, Brian, and good morning, everyone. I'll begin on Slide 6 with an overview of asset quality during the fourth quarter.

As you know, market conditions remain very challenging. We continue to manage our portfolio by being aggressive in loan loss recognition, continually assessing the adequacy of our reserves, and remaining focused on the reduction of our discontinued national construction portfolios.

As expected, net chargeoffs for the fourth quarter were $191 million or 3.61% annualized compared to last quarter's $155 million. For the full year 2008, net chargeoffs were $573 million, which was within our announced range of expectations.

We provisioned about $89 million in excess of net chargeoffs in the fourth quarter, increasing the total reserve to $849 million or 3.99% of loans.

Nonperforming loans increased 79 basis points linked quarter to 4.91%, slightly higher than the 70 basis point increase last quarter.

It's especially important to note that about half of our net chargeoffs and reserve additions in 2008 were driven by our OTC and national residential CRE portfolios, and these portfolio currently represent 70% of our nonperforming loans. So much of the bottom line impact of these wind-down portfolios has been felt.

I'll now review our portfolios in detail, starting with the home equity portfolio on Slide 7. This portfolio ended the year at $7.7 billion, down slightly over the prior quarter as runoff continues to be modest in a tight credit market. Given rising unemployment, we saw a deterioration in the home equity portfolio this quarter, although our trends still compare favorably to the industry due to the solid underwriting and strong borrower quality in this book. Overall, 30plus delinquencies increased 1.97% from third quarter's 1.49%, with the greatest increase in our national segment.

Tennessee market conditions have been more stable than those seen nationally, and we also benefit from a higher mix of first lien product, which is 58% of our portfolio in our home market. We continue to see borrower life events, most predominantly job loss, as the key driver of loss frequency. In light of the softening national job market, we expect home equity delinquencies to continue to rise.

Loss trend by vintage suggest that our cumulative loss estimate of 3% to 6% for this portfolio remain reasonable, again due to the quality of the underwriting and characteristics of our borrowers versus comparable portfolios elsewhere.

Next I'll update you on our OTC portfolio on Slide 8. This book continues to wind down. Balances declined $221 million linked quarter and commitments are down 61% year to date to less than $1.2 billion. Chargeoffs in the fourth quarter were $40 million.

Since we had increased OTC reserves meaningfully in the third quarter of 2008 to reflect the increasing visible inherent losses in this portfolio, no provision was required this quarter and the reserve was reduced in line with chargeoffs.

Upon completion of construction, these loans are either moved into the secondary market, refinanced or, as a last resort, taken to the permanent mortgage portfolio. We moved approximately $100 million of completed OTC to the permanent mortgage portfolio this quarter and had a total of $417 million of permanent as a result of OTC originations on the balance sheet at the end of the year. The remaining loss content in this portfolio is expected to be consistent with the reserve held currently of $200 million.

Moving on to residential CRE on the same slide, we reduced our residential CRE portfolio by $192 million linked quarter, $147 million of which was a reduction in our national residential CRE wind-down portfolio. Chargeoffs in the quarter were $55 million compared to third quarter's $49 million. Given that the housing market remains very weak, we expect performance in the residential CRE portfolio to remain stressed in 2009, but we will have a significantly smaller portfolio to deal with in comparison to 2008.

I'll turn next to our income CRE portfolio on Slide 9, which had a balance of about $2 billion at the end of the fourth quarter. As shown on the slide, this portfolio is well diversified by collateral type and 74% of the portfolio is managed out of the core Regional Bank. Additionally, almost half of this portfolio relates to long-term relationships in our Tennessee market, where the economy has fared somewhat better than many other areas. Importantly, this is a largely stabilized portfolio that was underwritten to hold on our balance sheet rather than to sell into a conduit. In fact, two-thirds of it is stabilized mini-permanent loans.

Fourth quarter chargeoffs in income CRE were $14 million, largely driven by one Tennessee credit, an income CRE relationship in a contiguous state, and land intended for income CRE development in Florida. This compares to third quarter's chargeoffs of $1 million.

We do expect this portfolio to see additional stress in 2009, particularly in retail projects but also in office and industrial product types. That being said, we think that the product mix, level of minipermanent loans, geographic diversity, and lack of tenant concentrations will moderate the level of deterioration realized.

Moving on to Slide 10, I'll now discuss our C&I portfolio, which was at $7.8 billion at the end of the fourth quarter. The C&I portfolio is primarily Tennessee based and diverse across industry types. We include in this portfolio our exposures to bank stock loans and our trust preferred loans, against which we took a LOCOM adjustment when they were transferred from held for sale to held to maturity several quarters ago.

The C&I portfolio continues to show pockets of stress as chargeoffs were $41 million in the fourth quarter, up from third quarter's $31 million, mainly driven by four individual credits. Our sense is the aggressive portfolio management and proactive risk processes implemented in the past 18 months have surfaced unique problem credits, driving chargeoffs in 2008. The instance of these situations should diminish in 2009, such that losses will be driven by incremental portfolio deterioration.

While delinquency trends showed improvement in the fourth quarter, dropping to 53 basis points, we still expect asset quality to remain stressed in 2009 as a function of the economy. The reserve build driven by credit grade migration reinforces this expectation; however, it is important that this reserve build was less than in prior quarters due to some stabilization in grade migration.

As a reminder, we remained aggressive on recognizing losses on nonperforming loans rather than reserving for them. Generally, we apply the FAS 114 process to all impaired commercial assets that are $1 million or greater, charging collateral-dependent loans down to net realizable value rather than holding reserves against them for loss recognition at a later date.

As you can see on Slide 11, inflows of nonperforming loans related to the commercial and OTC portfolios increased slightly from the third quarter to fourth quarter. Resolutions of nonperforming loans and ORE increased somewhat as well. As a result, NPLs increased 17% or $144 million linked quarter, similar to last quarter's growth.

Since there is virtually no reasonable investor market for bulk sales, most resolutions are individual transactions that continue to occur generally in line with carrying values.

Moving on now to Slide 12, as I mentioned earlier, we did increase our reserves again in the fourth quarter, but the increase was the smallest in the past five quarters.

The reserve increase in fourth quarter 2008 was largely driven by three factors - first, our home equity portfolio, where deteriorating delinquency trends from rising unemployment suggests the likelihood of higher losses going forward; second, deterioration in the performance of our small permanent mortgage portfolio, combined with the depletion of LOCOM marks taken against these loans when they were brought to the balance sheet; and third, we increased our reserves due to negative grade migration in the C&I and income CRE portfolios.

Since reserves actually declined in OTC and res CRE, total provision expense this quarter declined $60 million linked quarter.

Let me close on Slide 13 with a review of our 2008 losses and our outlook for 2009. As I mentioned earlier, fourth quarter net chargeoffs met our expectations at $191 million and we increased our aggregate allowance to $849 million. While predicting the future with precision is very difficult in any environment, it is especially difficult given the rapidly changing economic and policy conditions we now face. We anticipate the economic environment to remain weak through 2009. Based on that, this slides provides you a sense of how we expect our losses and our reserve to trend over the first and second halves of the year.

Losses in the national construction portfolio should remain elevated for several quarters, but reserves should continue to decline since these portfolios are winding down. We expect losses in the home equity and permanent portfolio to trend upward as unemployment rises, potentially requiring additional reserves.

We expect C&I losses to increase throughout 2009, but losses in the first half of the year should be less than fourth quarter 2008 levels based on our knowledge of specific portfolio activity at this point in time. Reserve levels should remain relatively stable.

We expect income CRE losses to increase in the first half of 2009, but moderate later in the year. Reserve levels should remain relatively stable in this portfolio.

In total, we expect the net chargeoffs in the aggregate will remain at or increase somewhat above the current quarterly run rate during the first half of 2009, then decline to below the current run rate in the second half of the year. As you can see, this improving outlook is the result of the interplay between various portfolios and the impact of the wind-down portfolios, and it's certainly not based on an assumption the economy is nearing an inflection point.

We expect to end 2009 with less reserve than we now have, largely due to the reserve build for the inherent losses in the OTC portfolio in the third quarter of 2008. Clearly, the main risk to our guidance is economic deterioration beyond what we are currently anticipating.

With that, I'll turn it over to B.J. to go over the financial results.

William C. Losche III

Thanks, Greg, and good morning, everyone.

If we could turn to Slide 15 for an overview of the quarter, as Bryan mentioned, our earnings per share were a loss of $0.27 for the fourth quarter, which was an improvement over last quarter's loss of about $0.61 a share.

Pre-tax pre-provision income was at $193 million, an increase of $67 million linked quarter, favorably impacted by outstanding fixed income results in our core Capital Markets business as well as about $34 million of significant items, which I'll detail a bit more for you in just a minute. Also of note, tangible book value ended the quarter at $10.98 on a slightly higher share count of $206 million.

Turn with me to Page 16, as mentioned, here's a quick summary of significant items for the quarter.

First, in our mortgage business we increased our reserve for our captive reinsurance this quarter to account for increased loss expectations in light of market conditions.

We've also adjusted down the value in our mortgage warehouse by about $15 million.

Third, we had $10 million in expenses from our ongoing efficiency and restructuring efforts, including the early exit of a sponsorship deal in one of our former national banking markets, which will save us money over time.

Fourth, as a result of VISA funding and escrow in the fourth quarter, we recorded an $11 million reversal of our VISA liability accrual through non-interest expense.

Lastly, we generated net mortgage MSR hedging gains of $65 million as falling rates and a steeper yield curve combined with changes in our convexity profile of the serving portfolio benefited our hedged position. As a note, we continue to strive to set the valuation of our MSR to reflect market conditions, and our carrying value remains just below comparable peer median.

Turning to the balance sheet trends on the next slide, we reduced assets on our balance sheet by $1.8 billion in the fourth quarter as our national loan portfolios and mortgage servicing assets continued to wind down, slightly offset by a small increase in our investment portfolio. Since last year, we have reduced our balance sheet by $6 billion and significantly reduced our mix of real estate loans.

With continued runoff in our national lending portfolios more than offsetting expected new loan production, we do expect further reduction in our total loans in 2009. In addition, we'll have runoff in our mortgage servicing portfolio and we also anticipate opportunities to sell servicing in bulk, much as we did in 2008. In total we expect assets to decline another $1 billion to $2 billion this year.

Fourth quarter's net interest margin was 296 basis points, a linked quarter decline of about 5 basis points. The compression here was driven primarily by three factors -- first, an ongoing competitive deposit pricing environment; second, asset sensitivity in the bank against rapidly falling short-term rates; and third, as a result of the disruption in the fed funds market and excess liquidity, we maintained unusually high balances at the Fed during the fourth quarter. Now in earning assets since we received interest on these balances, these low-yielding [reserve loan] lowered our margin by roughly 7 basis points in the quarter.

In the short term our margin should remain under pressure given the low rate environment and practical limitations on core deposit rates. Over the long term, however, as we continue to reduce our lower-margin national businesses and assuming market conditions normalize at some point, the NIM should expand.

Taking a look at liquidity sources on the next page, Page 18, as a result of core deposit growth and deleveraging, liquidity continues to improve. Core deposits were up $550 million linked quarter. We retired another billion and a half maturing bank debt in the fourth quarter. We should also be able to cover approximately $1 billion more in 2009 maturities through balance sheet contraction alone. And in light of both asset reductions and growth in core deposits in the quarter, our sources of excess liquidity improved to over $5 billion. And we have and we will continue to shift wholesale funding away from less reliable credit sensitive sources through the rest of 2009.

Moving on to capital on Slide 19, as you know we sold $866 million of preferred stock and warrants to the Treasury in the quarter as part of the CPP program, again improving our capital position. We've shown in our financial supplement where the CPP flows through the balance sheet as well as where the dividend and warrant accretion of the preferred stock to its par value will be recognized in the P&L in subsequent quarters.

The amount of preferred equity is $783 million, which will increase each quarter, the common equity created by the warrants is $84 million, and the reduction in net income available to common shareholders caused by the preferred dividends and amortization will be roughly $15 million each quarter for the next five quarters, starting in the first quarter of 2009.

With our continued balance sheet reduction and the CPP, our capital ratios improved again in the fourth quarter, all to levels that keep us among the best in the industry. Tier 1 ended the year at 14.9%, total capital was over 20%, and tangible common equity to tangible assets was 7.3%. Given the writedowns we've already taken on our NPLs, significant loss reserves, and our preprovision earnings capabilities, our stress analyses continue to indicate that we can withstand even a severe recession with a comfortable cushion well above well-capitalized standards.

On Slide 20, let me spend a minute on how we're using the TARP capital. We take the responsibility associated with this investment very seriously. With an even stronger capital position, we've begun leveraging the Treasury funds through prudent business and consumer lending in our core Banking franchise. We're able to support commercial customers with their credit needs while maintaining consistent standards of creditworthiness. We've also begun investing in infrastructure and productivity efforts to increase our lending capacity going forward and extend banking services to the communities that we serve.

Now let's move on and discuss the business segment performance highlights starting with Regional Banking on Slide 21. Customer trends improved in the fourth quarter as third quarter's market turmoil subsided and our customer outreach efforts continued to pay off. Period end core deposits increased $459 million linked quarter, while loans were slightly up linked quarter as demand remained fairly muted.

Pre-provision earnings in the Regional Bank declined $20 million linked quarter, driven by environmental impacts on revenue. On the fee income side, fee income declined linked quarter as weak consumer confidence pressured our wealth and deposit piece.

And on the NII side, that decreased due to a 21 basis point contraction in net interest margin as our deposit pricing remained unusually competitive and short-term rates dropped. We are seeing opportunities, however, to improve new loan pricing and believe this will be the new paradigm going forward, ultimately paving the way towards improved margins.

Expenses in the Regional Bank increased by $9 million linked quarter driven mainly by environmental items like increased foreclosure costs, investments in infrastructures retained following divestiture of our national platforms.

Let me note here that we're not at all satisfied with this area. We're aggressively working to optimize our cost structure, to right-size the expense base, help offset uncontrollable short-term market impacts, and make us more productive in the long run.

Provision in the Regional Bank remained elevated at $106 million as we continue to proactively update loan grades.

In terms of outlook, shorter term Regional Bank earnings will continue to be adversely impacted by the difficult economic and operating environment, but the good core fundamental trends in terms of customer growth, along with opportunities for both revenue growth and expense efficiency tell us there's an attractive upside in this business when the economy turns.

Moving on to Slide 22, as mentioned in my opening comments, the Capital Markets segment performed very well in the fourth quarter, as the fixed income business produced a record $157 million in revenues. As a result, pre-tax pre-provision earnings in the business increased to $83 million on positive operating leverage of a well-managed fixed cost base.

After accounting for provision expense of $8 million, which declined linked quarter, Capital Markets produced pre-tax income of $74 million, the best quarter we believe ever in the 80year history of the business.

Going forward we expect Capital Markets earnings power to remain strong, although the magnitude and duration of the current elevated performance level is difficult to predict.

Turning to Slide 23, in summary as 2009 progresses we're likely to face both unusual headwinds and benefits of a weak economic environment as we did this quarter. We expect these will abate in time, providing improved visibility into our bottom line earnings capability. We'll continue to focus on controlling the controllables, growing business with our targeted customer segments, delivering good customer service, improving productivity, pricing with discipline, and driving further expense efficiency across all of our businesses.

To sum it up, I'm excited to be part of First Horizon. I've been impressed with our management team and our people and the actions that they've taken to build a strong company which is prepared for the current challenges, and we're poised to take advantage of opportunities going forward. I look forward to working with the team to improve our performance even further.

In addition, I also look forward to meeting our shareholders, our analysts and other members of the investment community over the coming weeks.

Thanks and now we'll be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Steve Alexopoulos - J.P. Morgan.

Steve Alexopoulos - J.P. Morgan

Can you clarify, is your credit outlook suggesting you're going to match provision to chargeoffs in the first half of the year? Is that what you're saying?

Bryan Jordan

Steve, this is Bryan, and I'll let Greg expand on it. He walked through a fair amount of detail by portfolio. In some portfolios we're likely to build reserves over the course of the first part of the year and other portfolios, like the one-time closed portfolio and the residential CRE, we expect that those will come down.

I think what Greg tried to signal is that over the course of 2009 we would expect that the level of reserves would come down, particularly as we finish working through the one-time close and the homebuilder portfolios and realize those losses.

Greg Olivier

Yes, I think that's right. I think we have a pretty good degree of confidence provision expense will - the impact of having reserved for the OTC losses in Q3 will allow some provision release. And we feel that on the home equity portfolio and the commercial portfolios are the ones where there's a potential for increase that may or may not offset that release we get from OTC, depending on what we experience in the environment.

If the view of the portfolio gets worse and the migration increases - and that migration has slowed on the commercial side - we should be fine on commercial, but we are vulnerable there. And we're further vulnerable to additional deterioration and delinquency in home equity quarter to quarter.

Steve Alexopoulos - J.P. Morgan

Maybe I could just follow up on that. When we look at the chargeoffs in C&I and income CRE, they were both up this quarter. When you think through 2009 for loss content there, which of those do you think could be more of a pressure point?

Greg Olivier

I think in terms of absolute dollars, C&I because the portfolio's so much larger for us. It's two or three times the size of our income CRE book.

Steve Alexopoulos - J.P. Morgan

What about loss rate?

Greg Olivier

I think what we see is income CRE, that cycle following res CRE as furthest along through the portfolio, so we expect - I think we're communicating that we'd have income CRE losses elevate in the first half and moderate in the second half. On the C&I side, we see more of a steady build in deterioration through the year, but we do expect to start the first half of the year in a better position than we were in fourth quarter because of a lot of the portfolio management activities we instituted over the past 15 months flushed out a number of issues that we dealt with, we think, pretty effectively in 2008.

Steve Alexopoulos - J.P. Morgan

Maybe just one quick final question. Bryan, 2008, clearly a transition year. What's your best guess when we actually turn the corner and you guys are profitable on the bottom line.

Bryan Jordan

Well, Steve, that's a hard one. The question really is going to be mostly driven by how credit performs and how the economy around us performs. I think we've taken a lot of significant steps in the last 15 months in this transition year, as you suggested, to position the business. We've been very aggressive in identifying credit. We've build strong reserves. I'm optimistic today that we'll start to see the turn in the economy and turn in credit in the latter half of 2009. And with that, I think we can return to profitability.

So I think the key driver is going to be your outlook on credit and with the movement in the economy in the last 90 days, it's really hard to pinpoint exactly when that turn will be, whether that's late 2009 or early 2010.

Operator

Your next question comes from Ken Zerbe - Morgan Stanley.

Ken Zerbe - Morgan Stanley

I was hoping you could provide a little more color on the Tennessee market or your Regional Banking. We've just had such a sharp deterioration in this level of provision expense that are due to commercial deterioration. And just maybe drill down a little bit more on what exactly are you seeing on the commercial side? Is this, you know, broad based throughout the entire market? Is it specific loan types, borrower types that you're seeing deterioration at?

Greg Olivier

I think the short answer on C&I deterioration is it's pretty broad based. I think going back to what we and the reason the provision expense build is in the Regional Bank is because that's where the majority of our C&I assets are and that's where the most recent deterioration, third and fourth quarter, has occurred.

With respect to the experience we had in '08, the drivers of losses in C&I were housing-related businesses, occasionally they were deals that were maybe underwritten to pro forma cash flow and there was a lot of non-bank money chasing those sorts of deals two or three years ago. And then a real driver for us were more business banking/commercial customers whose principals had diversified into real estate, particularly Florida real estate, and those losses impacted their businesses pretty substantially.

So it's a bit of an anomaly for '08. Going into '09, the deterioration's pretty broad based.

Ken Zerbe - Morgan Stanley

And just on that, I think it was Slide 13 that said that you expect C&I losses, I guess, had an arrow going across - no, it was going down - so just to be clear, was it that you expect C&I losses to actually go down from fourth quarter levels, but still be above 2008? And I guess, if the economy's going into such a recession, which it is, why would C&I actually go down to flat going forward?

Greg Olivier

That's a good question. I think when you think about 2009, our view is that we're going to see pretty steady deterioration in C&I performance throughout the year, so sort of a steady increase quarter to quarter. Our starting point in '09 will be lower, in our view, due to a lot of the intense portfolio actions we took in 2008, uncovering latent problems in the portfolio and dealing aggressively with those problems. And, based on our knowledge of the portfolio, what's in a watch or worse status right now, we have a pretty good view on at least kind of the inventory of potential problems going into '09, and that view would indicate a lower level of losses than we saw in Q4 of '08.

Operator

Your next question comes from Anthony Davis - Stifel Nicolaus & Company, Inc.

Anthony Davis - Stifel Nicolaus & Company, Inc.

I guess, Greg, for you, can you give us a little more color on loss severity today in home equity versus, say, back in the August/September? And particularly what you're seeing, again, between first and second lien and the contrast, too, between end market and the national market

Greg Olivier

Sure, Tony. In terms of loss severity on home equity, second lien, it's been really our policy since May to bias towards charging off rather than charging down. In other words, we assume in virtually every case 100% severity and going ahead and charge off and have any recoveries after the fact. And that's just because it just wasn't proving worth it to foreclosure out and try to obtain that equity. It cost you too much to do that. So that picture hasn't changed.

The severities on first lien I don't think have moved much since third quarter. I think we might still have that in an appendix slide for you.

Tom Adams

Yes, I think so. My recollection is it's obviously significantly lower, maybe 40% or something like that.

Anthony Davis - Stifel Nicolaus & Company, Inc.

Did you mention that one-time close and [inaudible] loan volumes that were sold in the quarter and kind of what your expectations are in terms of what you might be able to do this year on that front?

Greg Olivier

Just to be clear, Tony, are you asking about OTC, being able to sell the completed loans into the secondary market?

Anthony Davis - Stifel Nicolaus & Company, Inc.

Right.

Greg Olivier

Or troubled asset disposition?

Anthony Davis - Stifel Nicolaus & Company, Inc.

Yes.

Greg Olivier

Which one?

Anthony Davis - Stifel Nicolaus & Company, Inc.

Disposition, yes.

Greg Olivier

Troubled asset disposition? You know, we've - I guess a general comment on residential CRE, which is homebuilder, and OTC, we went into the quarter with a focus on moving beyond transactional dispositions and into more bulk sales, but as most of you know that market was very tough in Q4, the market for asset sales. Because of the level of uncertainty out there, investors have pretty much pulled to the sidelines.

When we do dispose of troubled assets, we continue to realize about what we've got them marked down to, so we do continue to have transaction by transaction disposal about at our NRVs.

Operator

Your next question comes from Heather Wolfe - Banc of America.

Heather Wolfe - Banc of America

Just a couple of questions on both the banking segments. In the Regional Bank I appreciate that you guys are looking to bring your expenses down a little bit there. I'm wondering if you can just address how much of the expense increase is related to credit management?

William C. Losche III

I think if we look at the expense increase in the Regional Bank linked quarter, it's about $9 million. I would say that roughly half of it was related to those environmental factors we talked about, foreclosure and so on, with roughly the other half or so in some infrastructure things.

Heather Wolfe - Banc of America

And then just in the national specialty lending, I know you had addressed the margin issues on a consolidated basis, but in that division I thought that we were going to see some margin improvement as some of the more toxic credits rolled off. Can you sort of address that going forward?

Dave Miller

I don't know that you would or wouldn't necessarily, and there's also some interplay between the segments and then what shows up in corporate because so much of that national specialty lending segment is funded effectively with wholesale funding. But you also during the quarter saw the impacts of the drop in rates on the home equity portfolio, which actually, I think, based on the way the loans reprice, they to the previous statement date, so it actually has an adverse effect on the margin. So I think that's what you're seeing there.

Operator

Your next question comes from Robert Patten - Morgan Keegan.

Robert Patten - Morgan Keegan

Can you just give us a quick update on the correspondent portfolios and the TruPS portfolios, where you think they are in terms of performance?

Also, big picture, Greg, if you could address how management is looking at the potential cramdown legislation that may or may not get done and how that's going to be impacted, how do you deal with that in terms of strategically planning the company?

And then Bryan, a question for you, bank M&A. Are you with your capital positions and where you guys are now at this point anticipating that the FDIC is going to become more aggressive at encouraging transactions, both small and mid caps?

Greg Olivier

I'll start on correspondent, Bob, which is our loans to banks, bank stock loans. That portfolio continues to be stressed, particularly banks that are heavy real estate. We feel good in general about that portfolio in terms of the majority of the banks out there. I think the TARP's helping. We do pay a lot of attention to the portfolio on a quarterly basis in terms of making sure it gets regraded and we have the proper reserves against it. We did have less provision built in correspondent banking, as B.J. pointed out, in fourth quarter than we did in third quarter.

Mortgage cramdown, you know, we're watching that. We're, as you know, primarily a second lienholder, so we're trying to sort through the impacts on second lienholders of that legislation. As you also know, we're at about 100% severity in most of our at-risk home equity portfolio not at risk, but national portfolio. The majority of that is second lien and therefore we're already assuming 100% severity.

So what we're really focused on is the impact on frequency, how many more potentially issues that would drive in terms of events of default. There's a couple of schools of thought, you know, that it might drive events down because there'd be an incentive to avoid bankruptcy and more of an emphasis on loan modifications. But I guess time will tell on how that works out.

Robert Patten - Morgan Keegan

Greg, there's been some speculation back and forth. The way I'm understanding it is that if a borrower were to take a cramdown, they would have to file bankruptcy. Is that true?

Greg Olivier

I think the whole - the way I read it, Bob, is this comes into play when it's in front of a judge, so it would have to be in bankruptcy.

Bryan Jordan

And you have to try to negotiate at least to some extent prior to getting in front of the judge.

Robert Patten - Morgan Keegan

Okay. And Bryan, your question.

Bryan Jordan

Thank you. You know, the M&A environment is sort of murky right now. I wouldn't presume to prognosticate what the FDIC may do, but my guess is there's going to be more activity in 2009 than there was in 2008. We would be very interested in things that fit in our footprint in our marketplace if we had the opportunity to participate in an FDIC transaction.

But day to day we're working very hard on managing through credit, being prepared for what is an otherwise tough economy, and so, as we focus day to day, it's working through the challenges that the economy has presented in terms of some of these residential construction portfolios and repositioning our business with a longer-term eye of being in a position to grow our market share as we have opportunities that present themselves.

So in the short run I don't know exactly what will happen, but I do believe our focus is best spent today focusing on working through this economic environment and being in a position to participate in the convergence of the business long term when the economy turns better.

Operator

Your next question comes from Paul Miller - FBR Capital Markets.

Paul Miller - FBR Capital Markets

You did very well in the Capital Markets side of the business and you said that that's going to be probably decent going forward. Can you give us some color or where is that revenue exactly coming from and then what type of volatility? I know you say it's not going to be exactly that number, but are you talking about like 20% volatility, 40% volatility on that line item? I'm just trying to use it to model.

Bryan Jordan

The Capital Markets business has been most recently driven by very strong fixed income sales activity. As you know, the marketplace in terms of competitors in the fixed income business has gone through a lot of change, there's been a lot of volatility in the fixed income capital markets. Our platform is very well positioned for a market like this. We have used this opportunity to really step up and make a market in liquidity in fixed income securities. We have a national business and it has been a very strong business and a great opportunity for us to grow it.

While revenues have been strong in the fourth quarter and they started off to be very strong in the first quarter of this year, we recognize that that can ebb and flow depending on what's happening in the fixed income market. So it's almost impossible to assign a volatility to that individual line item, but we expect it'll be strong for awhile.

We expect over time that volumes will moderate, but we think they'll stay at a somewhat higher level because we think we have consolidated some shares as a number of competitors in our marketplace are no longer in that marketplace and we've had an opportunity to increase our share and grow our level of business with our customer base.

Paul Miller - FBR Capital Markets

You guys are really strong in the [TruPS] business and whatnot and I haven't seen that business really come back. What type of fixed income securities are you guys really picking up share on or is it the TruPS?

Bryan Jordan

Well, the TruPS business has almost been nonexistent since really the - it started declining in the middle of 2007 and I think our last transaction was in 2008. We still make a market in certain securities, but there's not really been any underwriting.

We've got a full service fixed income division. We have a very strong agency business. But we service the entire gamut of needs from corporates to agency securities, and so it's really a sales and trading activity where we help our customers manage their balance sheet needs and we facilitate buyers and sellers in various fixed income securities.

Operator

Your next question comes from Kevin Fitzsimmons - Sandler O'Neill and Partners, L.P.

Kevin Fitzsimmons - Sandler O'Neill and Partners, L.P.

Two quick questions. Number one, the tangible common equity to tangible asset ratio, notwithstanding the improvement of regulatory capital, but that ratio is probably going to be increasingly scrutinized and you guys did take it up this quarter. And I'm just curious, Bryan, with all your projections on the balance sheet and still coming in and looking at the margin, looking at expenses, looking at credit, what's your best guess, what's your goal for that ratio looking out into year end 2009?

And then second, talking about expenses, I know a big driver of the increase was foreclosure costs. How should we think about FDIC premiums in the run rate of expenses? Specifically, I think that's going to go up starting in first quarter '09 and then maybe even more in second quarter '09. If you can give us some kind of guidance or just a ballpark on where that is on a quarterly basis and where that might go to?

Bryan Jordan

I'm going to let Tommy answer the FDIC insurance question first because he spends the most time with it. Start on capital and I'll follow up.

Tom Adams

All right. On the FDIC insurance costs, I think we're talking about $10 million for us on an annualized run rate basis.

Kevin Fitzsimmons - Sandler O'Neill and Partners, L.P.

That it is now or that it will go to?

Tom Adams

That it will be on a run rate basis in 2009.

Kevin Fitzsimmons - Sandler O'Neill and Partners, L.P.

And is that already baked in or is that going to jump up considerably from where it is right now?

Tom Adams

Well, it'll be higher in 2009 than it was in 2008 because of the expanded coverage.

Bryan Jordan

Tangible capital ratios, we're at 7.3%. We expect the balance sheet to come down close to another couple billion dollars in the course of 2009. We expect that that capital ratio will continue to grow. I don't today sit around and worry about having too much tangible capital. I think that ratio being strong and growing is a good thing, and so clearly we want to keep it north of the 7% ratio and we expect it to move towards 7.5% to 8% as we continue to reduce the size of that balance sheet.

We don't have a specific target because I think the flexibility required in this economic environment says when you have the opportunity to improve your capital ratios you do so.

Kevin Fitzsimmons - Sandler O'Neill and Partners, L.P.

One last question, Bryan. If the Capital Markets unit is really on a high right now and it's doing well due to the fixed income results and you expect it will continue to do well. Long term when you look out, do you really look at that business as there being a strong fit within a core Tennessee-based regional bank that you guys have, you know, that's your end game, or is it a possible option if [all that] business is doing well to look to sell it and why or why not?

Bryan Jordan

Yes. Well, one of the comments that I started to make in my opening comments was that they just had the best quarter in their 80-year history, so that's a business we've been in for an awful long time. And that's been a core business for us. It's been a stable business. It doesn't require a tremendous amount of capital commitment from us.

And if you focus on what the Capital Markets team, Frank Gusmus and Mike Waddell and the entire team have done, over the last year they've reduced the size of their trading inventories, they've reduced the amount of capital committed to the business and drove greater profitability out of the business.

So I'm very pleased with how that business is performing. I'm pleased with the progress that we've made there. I think we're positioned well. I think it's an important business.

So, no, I don't anticipate that we would be interested in doing anything with it.

Operator

Your next question comes from Adam Barkstrom – Sterne, Agee.

Adam Barkstrom – Sterne, Agee

I wanted to follow up on one thing and you guys may have talked about this specifically in your opening comments, but Bryan a second ago you just mentioned the TCE levels potentially continuing to go up, especially with the balance sheet deleveraging going forward. In 2008 you guys laid out some fairly specific goals as far as deleveraging and you pretty much hit those goals. I guess from here how much do you think we would expect in balance sheet deleveraging?

Bryan Jordan

Adam, in broad terms probably a couple of billion dollars of deleveraging. A fair amount of that will come out of the one-time close and the homebuilder portfolios, which today on a national basis are still in the $1.7 to $1.8 billion range. So in the aggregate I would guess something in the $2 billion plus or minus range. So that's roughly on a $31 billion balance sheet, percentage wise that's going to be a 6% - 7% reduction in the balance sheet.

Adam Barkstrom - Sterne, Agee

I guess to flip it around, the other side, it was mentioned certainly in your released remarks but maybe not quite as focused on, but maybe give us some more color. You mentioned $900 million of loan growth this quarter. Could you take a minute and give us some more color on what areas, what industries, some more detail on that?

Bryan Jordan

Let me be clear. What B.J. referred to was $900 million of new lending, and what we were reporting was progress that we've made in the TARP. As B.J. pointed out, we have taken our responsibilities there very seriously, and we are focused on new lending. In round numbers we had a little over $150 million in new consumer lending, about $90 million in additional mortgage lending. And then, oh, probably $500 - $600 million in additional commercial, commercial real estate lending throughout the franchise.

What we were trying to point out is its not net loan growth of $900 million, but we did in our footprint put new loans on the books to meet the needs of our communities and serve our customer base.

Operator

Your next question comes from Christopher Marinac – FIG Partners.

Christopher Marinac – FIG Partners

I was curious about Slide 18 on liquidity. The change from the FHLB debt to the TAF debt, was that done purely because of interest rate or is there another rationale, other flexibility that the FRB gives you?

Tom Adams

That was done primarily because of a rate differential. A different collateral margin was the second consideration. And also we had faster than forecasted deleveraging of the construction loan portfolios and greater deposit growth than we had forecasted during the quarter. So all of those things allowed us to increase our liquidity over the course of the quarter and the Home Loan Bank advances were our highest cost of funds at the time and that's what we repaid.

Christopher Marinac - FIG Partners

So you would revisit the FHLB debt if necessary?

Tom Adams

Certainly.

Christopher Marinac - FIG Partners

And then Bryan, just a follow up on Bob's question earlier about M&A. Do you have any ideas in mind in terms of the footprint and how you'd like to see it evolve the next couple of years outside of Tennessee, if at all?

Bryan Jordan

Yes, Chris, the footprint around - Tennessee is an interesting state in just the sheer number of states that touch Tennessee. There's a lot of geography around us that will look and feel very much like our Tennessee markets, where we've been so very successful. And so we think there are a lot of opportunities for us to expand over time.

I would expect that as we continue to grow this business and as the economy improves we'll see opportunities on principally our eastern and southern sides of the states around Tennessee. And those markets, as I just said, will look very much like the Chattanoogas and the Knoxvilles and the Nashvilles and the Memphises, where we've been so very successful and been able to build a customer service model, a density of branch network, and a market share that gives us the ability to compete with very advantaged capabilities. So yes, I think there's going to be a lot of opportunity.

But I go back to what I said in response to Bob's question. Our focus today is continuing to reposition the business, continuing to work through what we think will be a difficult economy, to continue to serve the markets that we're in today, and position ourselves long term with the infrastructure and the systems and the processes that will make us advantaged and allow us to take advantage of the things I just described for you.

Operator

Your next question comes from Stephen L. Covington - Stieven Capital.

Stephen L. Covington - Stieven Capital

On the deposit side, I think you mentioned you had pretty strong growth in the transaction account area. Can you talk a little bit about what that was driven by or is there anything unusual in there and would you expect that to continue?

Tom Adams

We did enjoy good deposit growth over the course of the quarter. Two primary drivers there we had some very successful savings program promotions during the quarter that brought in probably $250 million to $300 million worth of new money, and then we also had a buildup in our custodial deposits relative to the third quarter. The custodials are associated with the mortgage servicing rights we own.

Stephen L. Covington - Stieven Capital

Will those run out then in the first quarter, do you think?

Tom Adams

No, that's seasonal. We'll actually probably see in the custodials a build up because of more refinancings of existing mortgages. And actually during the fourth quarter a lot of the custodials go out to pay property taxes, so we'll see a build up in that.

Stephen L. Covington - Stieven Capital

And then secondly, I noticed you did some debt buybacks during the quarter and created a little capital and I'm just wondering is that something you have the ability to continue to do and even get a little bit more aggressive?

Tom Adams

Yes. We actually had muted activity in the fourth quarter compared to the prior two quarters. But the answer is yes, we do look to buy our debt back at a discount. We didn't see much in the broker markets during the fourth quarter, so our activity was muted as a result.

Bryan Jordan

I think gains in the second and third quarter were $15 - $18 million per quarter $15 to $18 million $3.5 million or so in the fourth quarter.

Tom Adams

We just had to be opportunistic there.

Operator

Your next question comes from Jefferson Harralson - Keefe, Bruyette & Woods, Inc.

Jefferson Harralson - Keefe, Bruyette & Woods, Inc.

Bryan, this is kind of far in the future but the market seems to be looking at TARP money as increasingly temporary. How are you thinking about strategically repaying TARP? Are you thinking common or preferred or just kind of waiting the full five years because it's a good rate or how should we think about - or how are you guys thinking about repaying it and how temporary versus permanent the capital is?

Bryan Jordan

Yes. Jefferson, good morning. This environment that we're in today sort of makes it hard to think that far out. But, as you know, for the first three years, to pay it back in the first three years you have to raise qualifying capital to replace it. From year three to three five before the step up in rates you have the ability then to repay it.

I think a lot will depend on what happens with the overall economy. And as we sit here today, I mentioned earlier our capital position - tangible was at 7.3%. That's likely to improve as we continue to reduce the size of these national nonessential businesses. Our Tier 1 ratio is just a hair under 15%, which in more normalized times would be extraordinarily high.

So you can come up with a number of different scenarios about what you believe about the economy and how the balance sheet will change, but if you assume that we continue just to push through, there's a possibility that we wouldn't need that additional Tier 1 capital and then, to the extent that the economy gets much more severe, we have other need for it, we'd look at all of the things that you just considered and at some point make a decision on how we would replace it.

So today it's very well priced and timely capital. We think it's a good thing for the system. We're happy to be participating in the program and we're starting to think about that, but that's way down the road at this point.

Jefferson Harralson - Keefe, Bruyette & Woods, Inc.

And you kind of touched on a lot of these things so maybe this might be summarizing a little bit, but is it fair to say that your expectations of cumulative loss rates within all your portfolios, that maybe the riskier portfolios, the already identified portfolios, they probably didn't change much this quarter, but maybe the C&I and CRE, the expectations got a little worse there and that maybe in total if you had to, over that last 90 days, think about the change internally of thinking about cumulative losses, it may have increased a bit over the last 90 days?

Bryan Jordan

I'll start and then I'll let Greg sort of pick up. We've laid out ranges of losses and some of them tended to be a little wider than others just because of the imprecision. Clearly with the softness that we've seen in the economy and we think the softness that's going into 2009 that we're moving higher in those ranges of losses. We still feel pretty good about the generalized ranges, probably towards the higher end of some of them, but a lot of it is going to be affected by or depend on how long and deep the duration of the recession is.

So yes, on margin I would say yes, we think cumulative losses have gone up a little bit in the last 90 days and as a result of softness in the fourth quarter and what we think going into the first.

Greg?

Greg Olivier

Yes, Bryan, I think you're right on. We think about the OTC and res CRE portfolios, I think we're in a more mature point in the cycle in res CRE and I think we've got fences around OTC just naturally in the economy. The income CRE portfolio is cycling behind res CRE and C&I's a little bit behind that, so that's where the reserve build has occurred because the grade migration has shifted down.

But also important to note that reserve build on those portfolios was higher in third quarter than fourth quarter, so we have seen some moderation in the level of deterioration over the quarter.

Operator

Ladies and gentlemen, that does conclude today's question-and-answer session. I'd like to turn the conference back over to Mr. Jordan for any additional or closing remarks.

Bryan Jordan

We want to thank you for joining us. We know this is a busy morning. We thought we'd picked a quiet Friday morning to release earnings.

We're pleased with how we're positioned. We're pleased with the continued progress that we've made in repositioning the business. Please feel free if there's any other information that we can help you with to reach out to Dave or to Artie throughout the course of the day.

Thank you again for joining us. Have a great day and a great weekend.

Operator

Ladies and gentlemen, that does conclude today's conference. We appreciate your participation. You may disconnect at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!