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First Horizon National Corp. (NYSE:FHN)

Q3 2009 Earnings Call

October 16, 2009 8:30 am ET

Executives

[Ardie Bowman]

Bryan Jordan - Chief Executive Officer

Greg Olivier - Chief Credit Officer

BJ Losche - Chief Financial Officer

Analysts

Steve Alexopoulos - JP Morgan

Matt O’Connor - Deutsche Bank

Ken Zerbe – Morgan Stanley

Brian Foran – Goldman Sachs

Tony Davis - Stifel Nicolaus

Kevin Reynolds - Wunderlich Securities

Kevin Fitzsimmons - Sandler O’Neill

Adam Barkstrom – Sterne Agee

Jefferson Harralson – Keefe, Bruyette & Woods

Paul Miller – FBR Capital Markets

Al Savastano - Fox-Pitt Kelton

Craig Siegenthaler - Credit Suisse

Operator

Welcome to today’s First Horizon National Corporation’s third quarter 2009 earnings conference call. At this time it is my pleasure to turn the conference over to [Ardie Bowman]. Please go ahead.

[Ardie Bowman]

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

Before we begin, 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 Corporation disclaims any obligation to update any forward-looking statements that are made from time-to-time to reflect future events or developments. In addition, non-GAAP financial information is noted in this conference call. A reconciliation of that non-GAAP information to comparable GAAP information will be provided as needed as a footnote in the slides and/or the appendix of the presentations available in the Investor Relations section of our website. Listeners are encouraged to review any such reconciliation 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 CFO, B.J. Losche and our Chief Credit Officer, Greg Olivier and Dave Miller.

With that, I will turn it over to Bryan.

Bryan Jordan

Thank you [Ardie]. Good morning everyone and thanks for joining our call. Let’s begin on slide three. During the third quarter we continued to successfully execute our strategy to de-risk our balance sheet and restore First Horizon to consistent profitability.

We reported a third quarter loss of $0.24 per share. This quarter’s loss was significantly lower than first and second quarter’s losses and in line with our expectations. Although they are diminishing, environmental costs mostly credit related and a challenging economy are still taking a toll and impacting reported numbers.

Consolidated third quarter pre-tax, pre-provision income rose to $145 million, up $64 million linked quarter as our core businesses showed continued solid performance while there was lesser drag from costs associated with our wind down business. Looking beyond the bottom line we are making good progress in repositioning First Horizon and delivering on strategic commitments as you will note on slide four.

On asset quality our proactive efforts are paying off as third quarter credit quality trends were generally in line with expectations as a release in our national construction portfolio reserves more than offset an increase in C&I and income CRE reserves. This enabled a drop in third quarter’s provision while leaving our allowance for credit losses at a strong 5.1% of loans.

We also saw a drop in overall net loan charge offs in the third quarter and non-performing assets edged down for the second quarter in a row. Given the ongoing uncertainty about the economy we are not ready to declare victory yet but we definitely believe we are making progress.

During the quarter our capital ratios also improved. At quarter end First Horizon’s tangible common equity to tangible asset ratio was a strong 7.9%, up 60 basis points linked quarter. We are taking aggressive actions to further de-risk our balance sheet. We reduced total assets over $2 billion in the third quarter. This included another $500 million reduction in the size of our wind-down national specialty lending portfolio as well as reductions in trade securities and excess Fed balances.

New loan bookings aren’t keeping pace with loan pay down’s and pay off’s which explained the remainder of third quarter’s balance sheet shrinkage. Looking ahead, we expect another $400 million runoff in the national specialty lending portfolio by year end.

Finally, yet perhaps most importantly, both refocusing on our core regional banking and capital markets businesses is paying off. We are particularly pleased with the continued growth in our customer deposit base, with core deposits up 3% second to third quarter and as anticipated our net interest margin increased another nine basis points reflecting an improved funding mix and greater pricing discipline.

As I mentioned earlier, funds were down in the third quarter despite originating almost $400 million in new and renewed loans. We are proactive in the marketplace lending to individuals and businesses but pay down’s and run off are outstripping loan demand in this uncertain economy.

In the capital markets fixed income revenues were again very good this quarter well above normalized levels but not as strong as the past two quarters when we experienced unusually favorable conditions. While our core businesses third quarter performance was in line with expectations there is still considerable work to do to reach our long-term objectives.

I will be back in a couple of minutes with some final comments. Now BJ will take you through the third quarter financial results.

BJ Losche

Thanks Bryan. Let me start on slide six and go over the third quarter’s consolidated financial results. On a per share basis, as Brian mentioned, we lost $0.24 after discontinued operations with the sale of our capital markets equity research business which was an improvement from last quarter’s loss of $0.57.

We had a net loss of $53 million compared to second quarter’s $123 million loss. A $75 million provision drop along with lower environmental costs drove the linked quarter bottom line improvement. As Brian mentioned total pre-tax, pre-provision income increased to $145 million benefiting from the overall 2% rise in revenue coupled with a 13% drop in expense both of which I will discuss in a little bit more detail in a few minutes.

If you look on slide seven and look at pre-tax, pre-provision contribution by each of our business segments you can see that our core businesses; regional banking, capital markets and our corporate segment booked pre-tax, pre-provision earnings of $118 million, a solid showing but about $13 million below second quarter levels. Regional banking’s pre-tax, pre-provision earnings declined slightly linked quarter to $36 million due to slightly higher foreclosure expense and modestly lower NII even as an eight basis point improvement in the Regional Bank’s net interest margin occurred. That was offset by the decline in the average earnings assets that we had in the regional bank.

On the capital markets side our pre-tax, pre-provision remains very strong at $65 million although down from the record 2Q09 levels. Corporate pre-tax, pre-provision earnings benefited really from two major occurrences. One was a $7 million reserve reduction which shows up in expense related to [deeds] with escrow funding and a $13 million debt repurchase gain which shows up in revenue.

As a side note, the agreement to sell our equity research business resulted in a pre-tax goodwill impairment charge of $14 million which is in the corporate segment under discontinued operations.

As you can see our wind down businesses posted considerably better pre-tax, pre-provision profits in the quarter as mortgage banking was up $20 million versus a loss of $33 million last quarter and national specialty increased to $8 million linked quarter. The mortgage results were helped by a $31 million net hedging gain and a positive $5 million valuation adjustment in our mortgage warehouse as well as lower repurchase expenses.

In national specialty our foreclosure expense remained elevated at $22 million as we continued to move ORE off of our balance sheet. That stayed relatively flat versus last quarter. Importantly as another step in reducing our risk we reached a settlement agreement on our consumer repurchase reserve which lowered that fairly substantially this quarter.

Turning to slide eight, since both net interest margin and balance sheet dynamics are among the keys to returning to sustained profitability for us, let’s take a look at some of the third quarter balance sheet trends. We are continuing to aggressively de-risk and shrink the balance sheet as we wind down the national businesses and we are making really good headway in improving our funding mix and it shows in our solid NIM expansion. Our consolidated average core deposits increased as our bankers focused growing customers and deposits in our core markets. That is paying off in higher levels of commercial and consumer accounts.

Year-to-date through September 30 commercial and consumer checking accounts grew a net 2% and 3% respectively. Our balance sheet shrinkage and core deposit growth enabled us to decrease funding costs, helping to drive the consolidated margin up 9 basis points linked quarter. You will note in the lower left of slide eight that the core franchise net interest margin improved to 3.66% this quarter as the regional banks saw wider spreads from improved deposit rates as well as better pricing on new loans.

Turning to slide nine, I will highlight a few third quarter fee and expense trends which are also obviously also critical elements to our profit improvement strategy. Fee income was relatively stable at 61% of total revenue with an expected decline in fixed income revenue largely offset by stronger net hedging results and mortgage warehouse gains.

Regional banking fees were flat from second quarter 2009 and as a note we are obviously studying the potential legislative impact of NSF OD’s and we are exploring a variety of new overdraft protection products, product enhancements and process changes designed to provide customers effective tools to manage their deposit accounts. Nevertheless, NSF OD fees for us are around 5% of our total revenue and should not significantly impact our profitability.

On the expense side, total expenses declined $53 million or 13% and the reduction in our core business expenses accounted for $19 million of the decline reflecting successes in driving down fixed costs and improving productivity as well as lower variable comp tied to the drop in capital market fee income. Additionally, we calculate that environmental costs declined to approximately $45 million in the third quarter from second quarter’s roughly $70 million. One driver was the FDIC deposit premium costs which were down $13 million due to the absence of second quarter special assessment and the rest was largely made up from lower repurchase reserves and expenses.

Turning to slide 10, to give you a little bit of an idea of returning to sustained profitability and what that means for us, we believe we are on track to return our company to long-term sustained profitability and growth. We have talked about the key drivers of getting there and these largely played out in the third quarter.

First our net interest margin rose for the second consecutive quarter. Second, our environmental costs started to abate as those repurchase expenses declined and foreclosure expense flattened. Third, the provision dropped by $75 million. Fourth, total expenses declined by approximately $50 million as this reflected not only improvement in those environmental costs but the fact that we are realizing benefits from our productivity and efficiency efforts. Lastly, as we expected our capital markets’ fixed income sales remained solid although revenues began to normalize following recent record quarters.

To wrap up although we continue to have elevated expenses from credit and environmental factors, third quarter showed positive trends with solid pre-tax, pre-provision earnings from margin expansion and healthy fee income coupled with lower provision expense.

With that I will turn it over to Greg who will now discuss some encouraging credit trends.

Greg Olivier

Thanks BJ. I will start on slide 12. As a general statement asset quality was largely in line with our expectations. Charge offs totaled $202 million down $37 million from last quarter. The decrease was primarily attributable to lower losses in our one-time close and residential CRE portfolios which offset increases in C&I losses driven by trust preferred loans and bank holding company loans.

Our reserve level was down $17 million from last quarter. As expected the decrease in reserves associated with the National Construction portfolios more than offset an increase in reserves for the income CRE portfolio. As a result of lower charge offs and lower required reserves, total provision expense decreased $75 million for the quarter.

Moving onto slide 13, non-performing assets declined 1% for the quarter continuing last quarter’s marginal improvement in this measure. Non-performing loan levels decreased primarily as a result of winding down the National Real Estate portfolios. As anticipated, we did see higher problem loan inflow from C&I particularly in bank related exposures and in the income CRE portfolio. ORE levels also decreased for the quarter. The increased inflow into ORE are a result of working through our problem real estate loans was more than offset by disposition activity. Disposition activity primarily took the form of single asset dispositions although bulk sales and auctions were used selectively.

Note the valuation adjustments; the expense we incur as a result of continually adjusting the carrying value of ORE to ensure it is valued realistically remained significant totaling $10 million for the quarter.

Now let’s spend a few minutes on the key portfolio trends. As you can see on slide 14 the C&I book had balances of $6.9 billion at quarter end. Overall portfolio metrics deteriorated. However, much of the deterioration was associated with trust preferred and other bank related loans. Excepting these loans, performance was more stable and required reserves would have decreased somewhat. C&I charge offs totaled $44 million for the quarter. $25 million of this amount was associated with trust preferred and other bank related loans while $17 million was associated with all other C&I exposures.

Slide 15 gives you a little more insight into the trust preferred and bank related loans held by First Horizon. In total we have $710 million in these categories. While this entire portfolio receives elevated oversight, certain portions are viewed as potentially more problematic than others and are managed accordingly.

In order of concern, the $301 million of trust preferred loans extended to banks is the area of greatest stress. Over 1/3 of this portfolio is classified and highly reserved for while the balance has a less concerning profile. Loans to bank holding companies are also of elevated risk with 37% classified and well reserved for at quarter end. The balance of this portfolio is of less concern. Most are long-term customers well known to First Horizon. Many are in low risk markets and their ratios are generally in acceptable shape. $164 million of this exposure is trust preferred loans to insurance companies. The majority of the insurance company exposure graded pass and is viewed as lower risk. 19% is graded classified and is reserved for accordingly.

The $105 million in loans extended generally to individuals secured by bank stock often have a primary source of repayment that is not linked to the bank itself. Like the bank holding company loans these are generally relationship loans to individuals well known to First Horizon.

On slide 16 our income CRE balances were $1.8 billion at the end of the third quarter. The $15 million decline in charge off’s from the second quarter was anticipated but should not be read as an improving trend in this portfolio. Market conditions will be adverse for income CRE portfolio to regional banks for the next couple of years. Economic conditions will continue to stress cash flows but more significantly renewal events will force right sizing of loan amounts as property values have declined meaningfully. Our focus is on working through this period in a manner that is sensitive to both regulatory guidance and customer relationship impact.

Expect elevated reserve levels and charge off’s throughout this period as remediation strategies are executed. However, the profile of both is expected to be less severe than residential CRE due to the income producing nature of most of the collateral. We increased reserves related to income CRE meaningfully during the quarter and they now stand at 8.3% of loans.

On slide 17 you can see that the national wind down portfolios remain on track as balances declined by almost $500 million and we were able to reduce reserves held for these portfolios. OTC balances were down $196 million from last quarter and we have now reduced commitments and balances well over 80% from January 2008. OTC charge offs were down $17 million and required reserves decreased $55 million but held at 30% of loans.

National residential CRE balances were down $102 million from last quarter and reserves held flat at 9% of loans. Charge offs were down $13 million from the second quarter as this portfolio continues to show signs that its issues have peaked. Permanent mortgage had balances of $1.1 billion at quarter end and charge offs were $17 million down slightly from last quarter as this portfolio shows signs of stabilization.

Moving onto slide 18, home equity balances were $7.2 billion at quarter end. Our national portfolio decreased by $186 million to $4.5 billion while the core portfolio remained relatively flat at $2.6 million. Portfolio performance was as expected. Delinquency trends were up slightly due to continued economic issues as well as some seasonality impacts. Charge offs were flat and actually down slightly compared to second quarter as the underlying vintage characteristics of this portfolio begin to benefit us marginally.

Our expectation is that this portfolio will continue to generate losses at a level similar to the last two quarters over the next several quarters. This expectation assumes a continued stressed economic environment. However, it assumes not future severe downward trends from current conditions.

On slide 18 we have detailed our credit expectations. Third quarter played out largely as anticipated. Decreased charge offs in the national construction portfolio offset increased C&I losses and decreased reserves in the national construction books offset reserve builds and income CRE and C&I. We have again updated our directional trend arrows to show fourth quarter expectations compared to third quarter. As you can see we expect similar charge off levels for this quarter and somewhat lower required reserves. As we look to 2010 we expect the national construction portfolio should largely be resolved during the year and the home equity portfolio is expected to generate losses and require reserves similar to or somewhat less than recent experience.

Income CRE and bank exposures are expected to continue to be stressed with core C&I expected to fare better. Thanks and I will turn it back to Bryan to conclude the call.

Bryan Jordan

Thanks Greg. In summary due to the hard work of our employees the third quarter demonstrated real progress from our strategic actions as we take steps towards returning First Horizon to sustained profitability. Our core businesses performed well, credit played out as anticipated, our balance sheet de-risking remained on pace contributing to improved liquidity and our capital ratios improved giving us both strength for the near-term and flexibility down the road.

Long term our goal remains to drive strong returns on common equity by smartly deploying capital. Even in an economy that is likely to grow more slowly and an environment where both we and the industry will likely maintain higher capital levels than in the past, we believe that we have the core businesses capable of delivering on that goal.

Thanks and now we will take your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Steve Alexopoulos - JP Morgan.

Steve Alexopoulos - JP Morgan

Looking at slide 13 which shows the reconciliation of the nonperformers, when you look at the pipeline of delinquent loans what is your best guess where that $250 million of new inflow goes over the next couple of quarters?

Greg Olivier

I think our best guess is flat to incremental improvement. We have felt for a couple of quarters we are getting close to peaking on non-performing levels and an expectation of a decline in inflows would be consistent with that.

Steve Alexopoulos - JP Morgan

So you don’t expect that level to drop off materially from here near-term?

Greg Olivier

I expect the level to decrease. I am not ready to say it will be a dramatic decrease at this point. We still have some non-performing formation in the income CRE portfolio and obviously will for some time.

Steve Alexopoulos - JP Morgan

I wanted to talk for a second on the NIM which obviously benefited from a pretty sharp reduction in deposit costs, particularly CD’s. I am just wondering how much room do you think you have to further reduce deposit costs from where we are today.

BJ Losche

I think we have some modest room on the CD book as we are seeing maturities come through and then re-booking at the lower levels and obviously that benefited us this quarter so there is some modest improvement there. We also saw continued improvement this quarter continuing on last quarter’s on the average rate paid on our savings accounts as we brought in balances last fall and we have repriced those downward and retained those in addition to the checking account growth which is obviously very low cost core. So we are really focused on the lower end and managing our deposit rate pay that way. So, we will continue to probably see a little bit of modest improvement there and we will continue to work on it.

Steve Alexopoulos - JP Morgan

You wouldn’t expect another 50 basis point reduction in the time deposit costs near-term?

BJ Losche

No I think that was a pretty substantial reduction and I don’t think looking at our maturity schedules you would see quite that level of improvement.

Operator

The next question comes from the line of Matt O’Connor - Deutsche Bank.

Matt O’Connor - Deutsche Bank

You had more dispositions of OREO this quarter in aggregate than you have had in the last few quarters and I am wondering how much of that is you being more aggressive, how much is buyers being more aggressive or a combination of both?

Greg Olivier

I think it is a combination of both. As we have talked in the past there is a pretty firm market for asset disposition at a price. There are buyers that are active out there. We have also put an emphasis on managing our ORE consolidated that was in the company in the first quarter. I think we are beginning to see some benefits of a paired professional staff working down that portfolio taking advantages of multiple disposition methods. But still very successful on the single asset dispositions which dominated our activity in the third quarter.

Matt O’Connor - Deutsche Bank

Any thoughts on what 4Q sales might look like if current conditions hold?

Greg Olivier

I am hopeful of continued momentum there. I think we are strategically trying to get as much of this behind us as we can but keep in mind getting the best value for shareholders.

Bryan Jordan

I will reemphasize Greg’s point. We are being very opportunistic when we have opportunities to reduce these non-performing particularly in these national portfolios we are taking advantage of those opportunities. We are trying to balance our desire to reduce them with making sure that we get reasonable value for them. We will continue to be opportunistic and if we have the opportunity we will take advantage of it over the next several quarters.

Operator

The next question comes from the line of Ken Zerbe – Morgan Stanley.

Ken Zerbe – Morgan Stanley

Two slides I have questions on. First on slide 15, when you talk about the bank trusts obviously an area of concern. In the table you have on there you actually highlight the percentage of banks that have received TARP funding. Why exactly are we highlighting that? Do you believe those banks are higher quality than the other ones or do you believe they get better recovery if and when they default? I am just trying to understand the importance of that.

Greg Olivier

I will take a stab at that. We get a lot of questions around the trusts and bank holding portfolio regarding the TARP participation of those banks. We thought we would go ahead and disclose it to folks. I think what you see there is that a lot of the very high quality banks may have passed on taking TARP and we look at the week the percentages goes down the government exercises some discretion about who they granted TARP to so I don’t think there is any surprises in the disposition there. The short answer is we have gotten a lot of questions on that so we thought we would provide that estimation.

Ken Zerbe – Morgan Stanley

If those banks that did receive TARP were to fail would you expect to have pretty much 100% severity on this?

Greg Olivier

Yes. I don’t think it impacts the loss given default on the loan.

Bryan Jordan

This is purely just informational with respect to a binary outcome. They either took TARP or they didn’t.

Ken Zerbe – Morgan Stanley

Understood. The second question is on page 19, the arrows; I love this chart by the way. It is very, very helpful. When you look at the allowance or the reserve ratio you are at 9.45 now. Do you expect resi, CRE and one-time closings to come down which actually there are smaller balance loans than smaller reserves but then offset by increases in commercial and income CRE which are both higher balances and higher reserves. Mathematically I just want to make sure I’m thinking about this right or that you are thinking about this right. That is to have the overall reserve come down from 945 would mean very small increases in commercial and income CRE and very big increases in both smaller balance resi and OTC. Is that the right way to think about this? Numerically I would just amount it to the increases in the commercial line might be a little bit larger than the decreases.

Greg Olivier

I think that is the right way to think about it. If you remember on one-time close we established a reserve for what we view as the remaining inherent loss content in that wind down portfolio. So it essentially gets reduced dollar for dollar for charge off’s if our estimate of remaining losses at the end of next quarter remains consistent with this quarter. That provides meaningful relief to this point and did in this quarter offset gains on those larger books.

Operator

The next question comes from the line of Brian Foran – Goldman Sachs.

Brian Foran – Goldman Sachs

As we watch capital ratios build can you just remind us where you feel like long-term you would like to migrate towards? And what you need to see to feel like you have excess capital that can be deployed and then as you walk down that food chain how you are thinking about deploying capital over time?

BJ Losche

I think you see by our capital ratios that through our de-leveraging and smaller loss they jumped fairly substantially I would say on TCE and Tier I is now over 16%. I think we feel very comfortable based on what we see with the credit expectations that we have that our capital is very strong and in any stressed environment even if it got incrementally worse and that is what we prepared for and planned for. As we continue to think that we are at or near the peak of our credit issues we are looking to be a little bit more on our front foot versus our back foot. That is looking at things like internally where can we look for most appropriate loan growth and try to get back in the market as much as we can even with the muted demand that we have got. We are looking for select opportunities to pick up business making sure that the foundation of our company is ready for the anticipated growth over the next couple of years if that includes things like FDIC assisted transactions.

Over time getting back to paying dividends and those types of things. We are actively looking at what the appropriate time is to put that money to work. We are thinking about it. In terms of long-term goals for where we would like to see capital post credit cycle is to have a TCE to TA ratio is somewhere in the 6-7% range. Today it is at 7.9% and a Tier I that is in the 9-11% range is what we are estimating. We will look for big opportunities to put it back to work.

Bryan Jordan

I will add to BJ’s comments or underscore it. We are not uncomfortable letting capital build until this economy stabilizes. We feel that we have very strong opportunities to put the capital to work over the next several years. We see that in customer business. We see that in opportunities with as BJ said FDIC assisted transactions. We are not uncomfortable with where it is today and we feel we have the ability to invest in the business and bring it down over time to as BJ said the high 6-7% range as a regulatory guide.

Operator

The next question comes from the line of Tony Davis - Stifel Nicolaus.

Tony Davis - Stifel Nicolaus

BJ can you bring us up to speed on where you are seeing annual revisions to the incentive plans, the internal reporting enhancements I know you are working on? I guess further there the right sizing of HR and enhanced marketing, all those efforts underway and kind of maybe a completion date that might be reasonable to expect?

BJ Losche

Here is where we are. As you know we have kind of rolled out our high level bone fish so to speak and we are in the process of aligning all of our performance reporting from executive reports and dashboards to score cards more down through the field organization as well as the incentive plans. We are largely on track to have much of that done by the end of this year. That is what we have been focused on doing so going into next year we are at the line with where we need to go long-term as we can. Like I said we are on track there.

As it relates to the efficiency initiatives over and above lower environmental costs we are on track. I would say we have identified over 75-80% of the expense that we need to have come out of the organization over the next probably 12-15 months and what we are driving for is having all of those expense efficiencies identified and executed so that our 2011 run rate is at the appropriate levels. So we saw incremental improvement again this quarter from things like contract re-negotiations, from reductions in contract labor, from continued FTE declines both in our national specialty businesses as well as our regional banking business that we expected based on our action plans. So I am pleased with our progress.

Bryan Jordan

On our cost reduction efforts, as BJ said we have made a lot of progress here. We have had a strong focus on differentiating, as we refer to it, good costs and bad costs. We are trying to make sure that we reduce costs that don’t have an adverse impact on our customer service levels and we are trying to make some investments in what we would consider good costs; technology and infrastructure where we need to improve our processes and our systems to do two things; one is to position us for the long-term and two is to produce additional efficiencies down the road. We are very comfortable with what we are seeing in terms of cost reduction flow through to the income statement today. We will put a little bit of that back into investments in 2010 but overall I am very comfortable with the progress we have made in addressing our infrastructure costs.

Tony Davis - Stifel Nicolaus

As a follow-up I guess [inaudible] and the FDIC assisted loan issue, as you look at the company today do you feel like you are sufficiently along the credit recovery, your performance enhancement payouts to pursue something there now?

Bryan Jordan

I think the short answer is yes. The longer answer would include I think that is right but having another three to six months to continue working down these national portfolios and continuing to make progress on the management reporting things, cost reductions, the focus on improving our operating model is not a bad thing. I think we are far enough along but on the other hand we are not uncomfortable if that is sometime next year either.

Operator

The next question comes from the line of Kevin Reynolds - Wunderlich Securities.

Kevin Reynolds - Wunderlich Securities

I have a quick question and maybe this is sort of not really a big picture in the scheme of things in today’s report but when we look at the trends in fixed income, the fixed income business while still elevated has been coming down because of the more favorable environment. Is that all related to environment or given the nature of your financial institution customer base is there anything you can read inside that with respect to either liquidity going away for some of these banks or maybe some sign of life where loan pay downs and all are starting to slow a little bit?

BJ Losche

What I would say overall is that what we are seeing is lower volumes because we have very few clients where the total return or depositories de-leveraging nearly as much as they were. If you were an optimist you would say that is more a sign that the credit market and liquidity is improving across the various sectors. So that is probably a good thing. A little bit lower volumes and then obviously as we expected, [bid] spreads are starting to come in as well.

So it is not unexpected what we saw coming off a record quarter of average daily revenues of 2.7 to 1.9 is again not totally unexpected by us and it is still probably 80-100% higher than what our overall long-term would be over time. So we are still very pleased with what we are seeing out there. It is just starting slow as expected.

Bryan Jordan

In terms of the mix of the business over the last several quarters it has been more heavily tilted towards the total return customer, away from the financial institution customer. So there is not a big shift in what we are seeing in financial institution activity right now.

Kevin Reynolds - Wunderlich Securities

One other question, and again I apologize with everything that is going on this morning if you have already addressed this, but your balance sheet is down from the mid 30’s to sort of $26.5 billion in total assets at quarter end and I think I have heard you talk around in the past about feeling like $25 billion was the number where it kind of stabilizes if I am not mistaken. Is that still a good number to think about going forward or are you sitting here right now, I know you said $400 million in national runoff in the next quarter ballpark. Do you think you will run it down even more? Is there more to de-risk anywhere or is 25 still the base goal?

Bryan Jordan

You are acting on what we have said in the past. I think that is still a good number plus or minus $25 billion. We saw a little more run off in our core banking lending portfolio principally due to pay downs and lack of utilization. We had a lot of it in our C&I portfolio. I think the answer to your question lay in two factors; one, how rapidly we continue to wind down these national businesses. We do expect another $400 million in pay down over the remainder of this year offset by what our customer base in our core franchise does in terms of net borrowings over the next several quarters. I think we are very comfortable in that $25 billion range over the long term.

Operator

The next question comes from the line of Kevin Fitzsimmons - Sandler O’Neill.

Kevin Fitzsimmons - Sandler O’Neill

Can you remind us again what markets are most attractive for you? I know you have talked in the past about deepening the penetration in Nashville as a priority. What kind of markets within Tennessee and maybe on the outskirts would be of interest to you? On a related note, it seems everyone is talking about the FDIC assisted deals but the pace is going very slow and the quality of franchises being offered always includes the best. Is it a matter of just waiting or do you start to think about getting more constructive in talking with live banks or is it way too early to think about that?

Bryan Jordan

In terms of the markets that are attractive to us in Tennessee, clearly opportunities to build out in markets like Nashville as you mentioned as well as any opportunities in and around our existing markets whether it is southeast Tennessee, the Chattanooga area, east Tennessee around Knoxville or the Johnson City and Tri City Area. We would be opportunistic in any of those markets. Longer term the markets we are particularly attracted to are markets that would look and feel like our existing core Tennessee franchise where we have the ability to build 15-30 branches, build a top 1, 2 or 3 share in those markets, the ability to see at or slightly above national average growth. So we have a long-term plan if anything to continue to build out in a way that allows us to deploy capital in markets like Tennessee and to take our time doing it and building that density and market share.

With respect to FDIC assisted transactions, to my earlier point a little more time is not a bad thing. In a couple of ways it allows us to do the things I said which is to get positioned better for long-term and continue to wind down our national portfolio. The pace of transactions in and around Tennessee has been particularly slow. A lot of what you have seen have been in bigger markets and places that wouldn’t fit our model. We are willing to be patient on that and the key being an opportunity to get us a foothold in a market that allows us to build a tremendous amount of density.

On the regular way transactions I think it is probably still a little bit early in the cycle on that. I’m not sure I could pin the tail on exactly when but as I sit here today I think that is probably a 2nd, 3rd or 4th quarter of next year before that market really starts to get active. I think the key there is credit cycle turns, the ability to get your hands around what a credit portfolio looks like. All in all you net all that out and you sort of walk away with we are going to be patient and make sure we can do the right thing in the right way.

Operator

The next question comes from the line of Adam Barkstrom – Sterne Agee.

Adam Barkstrom – Sterne Agee

A quick question on page 15, if you can get back to that, the whole land portfolio you mentioned 1/3 of that was classified. You also did $140 million bank holding companies. How much of that is classified?

Greg Olivier

It is on the bottom of the loans to bank holding companies here. On the bottom we showed the classified is the $52 million of the $140 million or about 37%.

Adam Barkstrom – Sterne Agee

Then you mentioned on the trust and banks high percentage reserve. Can you give us some sense of how much you are holding reserves against that?

Greg Olivier

At the bottom of the same page we have given you the coverage there by risk category.

Adam Barkstrom – Sterne Agee

Bryan I guess you historically you have fairly significant de-leverage of the balance sheet. You have a lot of moving parts there. Margin continues to improve. In the number I guess we had thrown around from a core, normalized EPS number as I recall seemed to be around the 125 level. Has there been any change in that number or do you have any color on what from a core franchise perspective you think you can earn?

Bryan Jordan

As I recall the way we talked about it was on a core, pre-tax, pre-provision number and I think we talked about something in that $125 million range. There is nothing that has changed in our short or long-term expectations about that. It clearly environment costs impacts it today. The mix of it changes as banking starts to improve. The capital markets continue to normalize but there is nothing any different in our thinking about the core earnings power of the franchise. Clearly the size of the balance sheet impacts that. As I said in the earlier response to Kevin Reynolds our balance sheet came down a little bit more based on customer activity than we might have hoped but as BJ said earlier as well we are trying to be very much on our front foot winning customer business and being very proactive in trying to grow our share and grow our banking business.

Operator

The next question comes from the line of Jefferson Harralson – Keefe, Bruyette & Woods.

Jefferson Harralson – Keefe, Bruyette & Woods

I wanted to ask you about troubled debt restructuring. Can you talk about the changes in trouble debt restructuring just from a quarter-over-quarter? How much of your troubled debt restructurings are in the performing portfolio versus the non-performing portfolio? Generally what your strategy is with regard to doing that sort of thing.

Greg Olivier

I don’t have exact numbers to quote you but the number of loans with which trouble debt restructure is employed as a strategy is increasing. It is certainly a focus of the accountants and the regulators and there has been a lot of additional guidance given on that recently. The majority of that in this stage of the cycle is going to be in the non-performing category as it needs to season before moving to performing status.

Jefferson Harralson – Keefe, Bruyette & Woods

Can you just talk about your strategy, maybe start with the commercial side, and just talk about restructuring plans. Are you restructuring a lot that aren’t going into TDR’s and what your general restructuring strategy is?

Greg Olivier

The portfolio where that strategy is most often an option these days is the income CRE portfolio with the issues of property value decreases and having to face that situation at renewal. Our strategy overall continues to be number one we are a relationship oriented bank and we have a customer focus so we are trying to maintain long-term relationships through a very difficult point in the cycle. That is followed very closely by a desire to maintain compliance with regulatory standards and be very acutely aware of how the regulators are interpreting proper use of TDR.

So when you put those two things together along with the value issues that renewal and income CRE, TDR is becoming a strategy we employ more often to make sure we minimize losses and minimize the time a loan or amount of balances remain in non-accrual status. So TDR strategy would be employed where we have a right sizing and the borrower doesn’t have sufficient cash to fully right-size the loan. TDR is often used as a strategy to do a restructure in that portfolio.

Operator

The next question comes from the line of Paul Miller – FBR Capital Markets.

Paul Miller – FBR Capital Markets

A follow-up on that TDR question. If you addressed this I missed it but the level of TDR’s. How high have they gone, the loan modifications, across the board and are they also being employed in the CRE portfolios? The second question to that is what is your reserve methodology for the TDR?

Greg Olivier

The TDR is a strategy used across the portfolios. I just talked through the income CRE strategy. Levels are going up. Again I don’t have at my fingertips what our numbers are for the third quarter but certainly that will be in the call report data so it will be publicly available.

Paul Miller – FBR Capital Markets

What about your reserve methodology. Do you set aside reserves for your TDR’s?

Greg Olivier

We are consistent with regulatory guidance on that. So if a TDR results in a non-performing loan we follow the reserve methodology that is appropriate whether it is FAS 5 or FAS 114.

Bryan Jordan

You get the same reserve model treatment as any other non-performing asset. So it gets the same risk rating reserve if it is not a specifically reviewed loan. If it is a specifically reviewed loan it gets either a specific reserve or a charge down.

Operator

The next question comes from the line of Al Savastano - Fox-Pitt Kelton.

Al Savastano - Fox-Pitt Kelton

Given the quarterly results here and the balance sheet shrinkage has anything changed with timing in terms of repaying TARP or the cash dividend or deploying the excess capital?

Bryan Jordan

I think in short probably not. I think we are on track with where we expected to be. Our keys to repaying TARP is to let a little more time pass, see stabilization in the economy. We are generally pleased with the signs we have seen over the last 90 days. The trends do seem to be positive. As most folks, we still see a fair number of potential negatives that are potentially out there. We will evaluate that late this year and early next year and make an appropriate decision at that time. I don’t think there is anything that has really changed in our thought process around the timing of CPP or dividends or anything of that.

Operator

The next question comes from the line of Craig Siegenthaler - Credit Suisse.

Craig Siegenthaler - Credit Suisse

My first question is really just on kind of regulatory pressure. I am wondering if you think there will be additional regulatory pressure in the fourth quarter for maybe some or all banks to take excessive charge offs and build reserves in the fourth quarter really essentially speeding up the loss recognition process and leaving some losses behind in 2009?

Bryan Jordan

I don’t have any sense whatsoever that would be the case. No.

Craig Siegenthaler - Credit Suisse

On the TARP repayment are you seeing more pressure from regulators that TARP repayment might come sooner than some of us thought especially for some of the banks looking to carry TARP for another two years?

Bryan Jordan

No. I guess your question is somewhat grounded in the piece that was in the Wall Street Journal yesterday. I haven’t seen anything that leads me to believe that would be the case either. It may or may not be but I don’t have any information that would substantiate that. From our perspective the regulatory environment has been very consistent and I think in my view very appropriate for the kind of environment the banking system is operating in. We haven’t seen any significant change in that over the last several quarters.

Operator

That does conclude our question and answer session for today. Mr. Jordan I would like to turn the call back over to you for any additional or concluding remarks, Sir.

Bryan Jordan

Thank you operator. Thanks for taking time to join the call today. I would like to take a minute and let everyone know that Dave Miller is officially transitioning to a new role in our company as head of retail banking in the regional bank; essentially returning to his roots. As you all know, he has done a great service for our company in very challenging times and we appreciate his extraordinary efforts. Thank you Dave.

Thanks again for participating in our call. We hope everybody has a great day and a great weekend.

Operator

Once again that does conclude today’s conference. Thank you for your participation.

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Source: First Horizon National Corp. Q3 2009 Earnings Call Transcript

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