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Executives

Bryan Jordan - Chief Executive Officer, President, Director, Member of Executive & Risk Committee, Chief Executive Officer of First Tennessee Bank, President of First Tennessee Bank and Director of First Tennessee Bank

Greg Jardine - Chief Credit Officer

Greg Olivier - Chief Compliance Officer

William Losch - Chief Financial Officer, Executive Vice President, Chief Financial Officer of Bank and Executive Vice President of Bank

Gregory Jardine - Chief Credit Officer and Chief Credit Officer of the Bank

Aarti Bowman -

Analysts

Jessica Ribner - FBR Capital Markets & Co.

Anthony Davis - Stifel, Nicolaus & Co., Inc.

John Pancari - Evercore Partners Inc.

Christopher Marinac - FIG Partners, LLC

Marty Mosby - Guggenheim Securities, LLC

Robert Patten - Morgan Keegan & Company, Inc.

Mac Hodgson - SunTrust Robinson Humphrey, Inc.

Steven Alexopoulos - JP Morgan Chase & Co

Kevin Reynolds - Wunderlich Securities Inc.

Ken Zerbe

First Horizon National (FHN) Q1 2011 Earnings Call April 21, 2011 9:30 AM ET

Operator

Good day, ladies and gentlemen. Welcome to the First Horizon National Corp. First Quarter 2011 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to host, Aarti Bowman. You may begin.

Aarti Bowman

Thank you, operator. Please note that the press release and financial supplement with announced earnings, as well as the slide presentation we used in this call this morning, are posted on the Investor Relations section of our website at www.fhnc.com.

In this call, we will mention forward-looking statements and non-GAAP information. Actual results may differ from the forward-looking information for a number of reasons outlined in our earnings announcements materials and our most recent annual and quarterly reports. Our forward-looking statements reflect our views today, and we are not obligated to update them.

The non-GAAP information is identified as such in our earnings announcement materials and in the slide presentation for this call, and it is reconciled to GAAP information in those materials. Also, please remember that this webcast on our website is the only authorized record of this call.

This morning's speakers include our CEO, Bryan Jordan; and our CFO, BJ Losch. Additionally, our Chief Credit Officer, Greg Jardine, will be available with Bryan and BJ for your questions.

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

Bryan Jordan

Thank you, Aarti. Good morning, everyone, and thank you for joining the call. I'm pleased with the progress we've made. Our core business has showed solid performance. We made good headway in our efficiency initiatives, credit quality improved notably and we maintained our strong capital position. In other words, we're executing on our key priorities for 2011, and are getting back to blocking and tackling.

As first quarter results show, we are gradually optimizing our business mix, taking steps to build our higher-return Regional Banking and Capital Markets businesses, while continuing to wind down the lower margin in non-Strategic segment. The Regional Bank's pretax income rose 4% linked quarter and moved from a pretax loss to a pretax profit year-over-year. Capital markets' performance remains solid. The non-Strategic segment continued to be less of a drag on our overall results.

Our proactive steps to identify and provide for problem credits are paying off, as we were able to sharply reduce the loan loss provision as credit trends improved. In fact, the Regional Bank booked a provision credit in the first quarter. At quarter's end, we maintained a reserve of 3.7% of total loans.

Revenue trends in the Regional Bank were also encouraging despite ongoing environmental challenges. Linked-quarter revenues declined from unfavorable seasonal impacts from lower NSF fees, a shorter day count and a lower level of earning assets. Our bankers' intensified calling efforts, along with emphasis on customer service, are helping us deepen and expand profitable customer relationships.

The Regional Bank's loan activity has been good. As a result, we're seeing a positive shift in the loan mix, with attractively priced growth in our corporate asset-based lending and CRE portfolios. Total loans though were down linked quarter due to a decrease in loans to mortgage companies as mortgage refis slowed from the rise in interest rates.

Pricing on new loans remained favorable as spreads were up 9 basis points linked quarter and at 29 basis points above a year ago. We will continue to improve our bank's balance sheet composition as we focus on a diversified, appropriately-priced Loan portfolio.

Even though the current environment is competitive, we plan to stay disciplined with our loan pricing structure while continuing to build market share. We're focused on winning good, relationship-oriented customers, which should help us generate better revenues and fee income.

Our Capital Markets business continues to be a strong contributor to fee income. As expected, average daily revenues were in the range of our normalized levels at $1.3 million in the first quarter. Capital Markets' return on asset was approximately 3%, and we expect it to remain a high-return business for us. Losses on our non-Strategic segment narrowed, reflecting lower credit costs and a decline in mortgage repurchase expense.

We signed agreements to sell our First Horizon Insurance and Highland Capital businesses in the first quarter, reflecting our continued emphasis on improving profitability and returns.

We also made progress in improving productivity and efficiency, with consolidated expenses dropping year-over-year and linked quarter. There is clearly more work to be done, but we're well on our way toward implementing initiatives that should save us more than $100 million annually by 2012.

Approximately 40% to 50% of the targeted savings are currently in our run rate, as BJ will discuss in more detail. We are committed to rightsizing our expense base with the same vigor that we addressed our capital position and our proactive stands on credit quality.

Credit quality notably improved in the first quarter, with total provision cost of only $1 million. Improvement was broad-based across our portfolios. We're experiencing more upgrades and fewer downgrades. In our income CRE portfolio, we're seeing stabilizing property values, as well as guarantors and sponsors stepping up.

Our C&I Consumer portfolios benefited from an improving economic environment. Enhanced efforts in technological upgrades in our collections process helped mitigate losses in our Consumer portfolio. As a result, overall net loan charge offs and non-performers were down in the first quarter to the lowest levels in 3 years.

Our capital position remains strong. During the first quarter, we repurchased a warrant issued to the treasury in 2008. We also declared a $0.01 per share quarterly cash dividend. We will continue to manage our capital smartly, balancing needs and opportunities, as we strive to enhance our shareholders' long-term returns.

To sum up, first quarter results were on track with our expectations. We are successfully executing our strategic priorities and are committed to continued successful execution in what is likely to be a slow growth, low interest rate economic environment this year.

I'll be back for some closing comments, and BJ will now take you through the detailed financial results for the quarter. BJ?

William Losch

Thanks, Bryan. Good morning, everybody. I'll start on Slide 5. As Bryan mentioned, net income available to common shareholders was $40 million compared with a loss of $49 million in 4Q '10. Included in first quarter's numbers were consolidated pretax income of $54 million and core business pretax income of $78 million. We also had some significant items, which you can see at the bottom of the slide, this quarter, which I'll discuss in a few minutes during our segment highlights.

If you turn to Slide 6, this shows our consolidated financial results. Again, diluted EPS was $0.15 a share, up from fourth quarter's loss of $0.20 a share. If you look at our net interest income, it was down primarily due to shorter day count, as well as loans to mortgage companies. Noninterest income, excluding securities gains, climbed a bit from 4Q to 1Q. You can see noninterest expense was down quite a bit from 4Q to 1Q.

Provision. We booked a $1 million provision this quarter to drive our pretax income results of $54 million. You will see in discontinued operations the impact of our First Horizon insurance sale. And down the bottom right of the page, you will see our diluted share count, moving up from 4Q '10 to 1Q '11, which reflects the full quarter impact of our December common equity raise.

Flip to Slide 7, I'll go through some segment highlights. Pretax income in the Regional Bank increased 4% linked quarter. Provision expense in the bank declined from $2 million to a provision credit of $12 million. NII decreased 7% from lower loan balances in mortgage warehouse lending, which offset modest growth in other commercial loan categories, as well as the shorter day count.

Year-over-year, NII was up 1% in the Regional Bank. The increase was driven by higher loan fees, fewer interest reversals and favorable pricing on new loans. Total revenue decreased 7% linked quarter but was only down 1% from a year ago despite regulatory change impacts on NSF and overdraft fees. Capital Markets' pretax income declined $1.5 million or 6% linked quarter. Revenues were down 5%, and lower variable compensation drove expenses down 4%. Fixed income average daily revenue declined slightly from $1.3 million -- from $1.4 million.

Corporate segment had a loss of $8 million compared to fourth quarter's pretax income of $5 million. First quarter included a $5.8 million gain from the redemption of $100 million of TruPS at an 8.07% rate. Fourth quarter included a $14.8 million gain from sale of our Visa shares.

Corporate expenses increased $2 million to $21 million. First quarter included a $3.3 million reversal of Visa contingent liability compared to $8 million in the fourth quarter. Pretax loss in the non-Strategic segment narrowed to $24 million from $77 million linked quarter. Loan loss provision decreased 69% linked quarter, primarily from improved metrics in the Consumer portfolio.

Servicing fees were up modestly, and mortgage hedging results increased to $12.5 million from $7.2 million in the fourth quarter. Mortgage repurchase expense was also lower, which I'll go into more detail about in a few slides.

As for recent regulatory commentary regarding mortgage servicing and foreclosures and the actions outlined against our sub-servicer, we currently believe there is little basis for liability on our part. And in the event we have any exposure, we believe it would be limited.

Moving on to Slide 8, consolidated net interest margin was at 3.22%, up 4 basis points from the prior quarter. Core business NIM was 3.58%, up 2 basis points from fourth to first. NIM was positively impacted by continued business mix shift, better loan pricing, lower deposit costs and a reduction in excess balances at the Fed.

Linked-quarter total average assets decreased to $24.6 billion from lower Fed and loan balances. Our average Fed balances declined by about $700 million quarter-to-quarter. The non-Strategic portfolio continued its run off at about 5%. We also had a reduction in loans to mortgage companies, as I mentioned, as the shorter duration loans were paid off as industry refi activities slowed considerably.

From fourth to first quarter, average total commercial loans decreased 6%, including a $519 million drop from those loans to mortgage companies. Excluding these mortgage warehouse loans, commercial loans actually increased 1%. We saw loan growth in our Corporate, CRE, ABL and Business Banking Loan portfolios. While the decline in higher-yield mortgage warehouse loans contributed to the decline in loan yields, yields on new loan products improved particularly in CRE, where they were up 18 basis points from last quarter.

As anticipated, core deposits were down slightly linked quarter due to roll off of higher-cost deposits associated with our exit from the tag programs. Weighted average cost of total deposits declined again, 3 basis points to 67 basis points.

Moving on to Slide 9, consolidated expenses declined 4% from the fourth quarter and were down 7% from a year ago. As Bryan mentioned, we started to see results from productivity and efficiency efforts in the first quarter. Compensation decreased 5% linked quarter despite seasonally higher employee-related expenses and declined 11% year-over-year.

Areas we've identified as efficiency opportunities, which you can see, include business process simplification, streamlining IT functions and reducing our procurement expenses. Recent examples of how we've achieved about $50 million in cost savings include closures and consolidations of 5 financial centers and FTU reduction of 5% from last quarter and numerous others initiatives across the company. As Bryan said, we are committed to improving our operating efficiency and delivering $100 million to $125 million in annual cost savings by 2012.

Moving on to Slide 10, I'll discuss mortgage repurchase trends. You'll see that our pipeline actually decreased $5 million to $529 million. Mortgage repurchase provision expense declined 16% to $37 million. This was the third consecutive quarter that our repurchase expense declined. The provision balanced against net realized losses of $37 million so that the reserves stayed flat at $183 million.

Rescission rates have actually improved from 40% to 50% to now 45% to 55% range, and severity remained steady at 50% to 60%. New requests were down 16% linked quarter, and resolutions were modestly higher than new requests. Over 90% of our repurchase makeover requests are from Fannie Mae and Freddie Mac. And while the majority of requests in the pipeline are still from the '06 and '07 vintages, we are seeing a continued shift into the '08 vintage.

As you know, we sold our mortgage platform in August of 2008. We did not have any repurchase request or any new litigation related to our product securitizations in 1Q '11. Based on the vintage mix and the fact that we did not originate any new GSE loans after August '08, we believe that GSE mortgage request volume should decline over the next 12 months compared to 2010's levels.

Moving on to asset quality highlights on Slide 11, as Bryan mentioned, our proactive approach to credit quality enabled us to reduce provision to $1 million this quarter. Linked quarter, charge offs declined 23% to $77 million, and we decreased reserve 11% to $589 million. We saw improved credit trends from lower delinquencies in the Consumer portfolio and favorable grade migration across the Commercial Loan portfolios.

Moving to Slide 12, NPAs declined 2% linked quarter and inflows were down 21%. Our ORE balances decreased 15%. While we could experience quarter-to-quarter volatility, we anticipate 2011 NPA levels to decline compared to last year. And as we sit here today, we believe the next several quarters' provision levels are likely to be below what we consider normalized levels of our bonefish targets. However, we are mindful that national and global economic events and subsequent changes in our portfolios could impact this outlook.

I'll wrap up on Slide 12. First quarter marked another step towards achieving our long-term bonefish targets. We still have plenty of work to do, getting there with the right mix of revenue, expense and credit levels in the profitability equation. But our core businesses ROA was at 126 basis points in 1Q '11 compared to our long-term bonefish targets of 125 basis points to 145 basis points. And our consolidated ROA was 71 basis points. We're making continued progress towards higher returns by continuing to optimize our business mix, improving productivity and efficiency, favorably positioning our balance sheet and decreasing our credit costs.

Now I'll turn it back over to Bryan for some closing comments.

Bryan Jordan

Thanks, BJ. We started 2011 on our front foot. Thanks to the hard work of our employees, I'm pleased with the progress -- our progress in executing on our strategic priorities and expect continued success as the year unfolds. There is still challenges to work through. But I believe our superior customer service, unique product set and a market focus give us a competitive advantage, both near term and longer term. We are committed to producing consistently attractive returns for our shareholders.

Thanks. And now, we'll take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] First question is from Bob Patten of Morgan Keegan.

Robert Patten - Morgan Keegan & Company, Inc.

Stock is getting hit a little right now and, obviously, it's sort of like the headline view of what revenue growth is for the franchise. Can you just talk about -- you said there was a lot of activity going on in terms of calls, business development. But clearly, I think, people are focusing on the top line this quarter. How do you ramp that focus up at this point in time?

Bryan Jordan

This is Bryan. First quarter is a hard quarter to get a read on revenue growth, seasonality impacts, day count impacts and number of the loan, line items and day count impacts, fee income business both in banking and in Capital market. So there's always a little bit of volatility. And in our quarter, as with BJ and I both pointed out, we had some contraction in the mortgage warehouse lending, which tended to be tied more to what's going on in interest rates in the refi market. But what we're seeing day in, day out, Customer business, the pricing continues to remain strong. As we pointed out, we're seeing improved spreads. We're seeing improved business mix on our balance sheet. Our pipelines continue to look very strong. In fact, our pipeline for new loan production at the end of the first quarter was up slightly from where it was at the end of the fourth quarter. And so, we're reasonably encouraged with the opportunity for continued customer growth, continued customer activity, and as we both have said, a slower growth environment and a low interest rate environment. We are reasonably optimistic with the opportunity for growing the business and improving the business, or balance sheet mix over the longer term.

Robert Patten - Morgan Keegan & Company, Inc.

Okay. And then just one follow up. On the capital side, can you just talk to your thoughts about what the minimum levels of Tier 1 that you're going to need to keep on the balance sheet over the next couple of years because you've been pretty vocal about saying you're not a warehouser of capital.

Bryan Jordan

Yes, Bob. It's still unfolding a little bit. And capital management, I think, for the foreseeable future is going to be a exercise that we'll all spend a lot of time on in the industry, and it's going to involve our regulators as we lay out our capital plan. We think longer term that we ought to be able to run this company in the 8% to 9% Tier 1 common range. And we think over time, we will migrate to that level. But as I said, it's still a period of change, and we're all working through the guidance that, I guess, we're all trying to gather information from, with the latest S gap or stress testing work that was done on the larger institutions. But we think 8% to 9% Tier 1 common over the longer term.

Robert Patten - Morgan Keegan & Company, Inc.

Okay. Thank you.

Operator

Thank you. Our next question is from Steven Alexopoulos of JPMorgan.

Steven Alexopoulos - JP Morgan Chase & Co

Bryan, I want to start, your quote in the press release talks about deploying capital and being fast and nimble and how you make decisions and respond to changes. When I read that, I think of MNT being given an opportunity of Wilmington and responding quickly. Are you signaling you're more likely to go after a larger distressed deal here? I'm just trying to understand what that message is.

Bryan Jordan

Yes. It's probably less focused on M&A transactions as it is something we're trying to build in into the culture. Very simply put, I would say, we, as a company, we, as an industry, are facing a tremendous amount of change over the next 4 or 5 years. Some of it from the impacts of legislation Dodd-Frank, some of it from the impact of a economic growth environment that is low interest rates and low growth. And so, we're focusing our efforts on adapting to change, being more flexible, being more nimble and being in a position where we can implement new technologies. And if that means integrating an M&A transaction, it means that -- but it doesn't -- but that's not targeted specifically to an M&A transaction at all, Steve.

Steven Alexopoulos - JP Morgan Chase & Co

Okay, that's helpful. And maybe just one follow up on the margin. It looks like loan yields are down in the quarter. Security yields are down, and your cost of funds look like they flattened out. Should we look for NIM pressure over the next couple of quarters from where we ended here in 1Q?

William Losch

It's BJ. I'd say that the NIM -- we still believe that the fundamentals of the margins remain pretty strong. We've talked a lot about business mix and what kind of spreads we're getting on new and renewed loans. I still think we have a modest amount, not a lot of room to move deposit rates down. But you're right, that's getting close to the bottom. We're optimizing the balance sheet, as you can see, in terms of taking down excess balances at the Fed. We are taking advantages when we see them to put on assets in the Securities portfolio at reasonable yields with reasonable structures. But I would, overall, say that our NIM should be relatively flat to maybe modestly up over the next few quarters.

Steven Alexopoulos - JP Morgan Chase & Co

Perfect. Thanks for all the color.

Operator

Thank you. And our next question is from Ken Zerbe of Morgan Stanley.

Ken Zerbe

Okay, thanks. Just on the mortgage repurchase expense, obviously, it has been coming down. Just want to get any status of if you've been in discussions with the GSEs about potentially settling this? Or if your thoughts have changed because the expense is coming down, but you don't feel that is necessary at this point?

William Losch

It's BJ. I think we've talked about before that we're willing to entertain discussions and dialogue with the GSEs. And at the same time, as you can see in our trends, we're also willing to continue to do what we're doing to manage down the exposures. So I think we're going down any and all of those paths and continue to do so. And if there is something that -- some kind of resolution we could work out that's economic with the GSEs, we'll certainly pursue that. And if not, we'll continue to, hopefully, see improving trends like we saw this quarter.

Ken Zerbe

Okay. And then just one follow-up, when you think about M&A, is there any hurdles that you want to, I guess, reach internally before you get more aggressive with thinking about M&A? I mean, maybe it's just finishing off the run-off portfolio, maybe it's something else. But, obviously, cleaning up your book is a priority. But is that going to stop you, at least, near-term from actively looking at deals?

Bryan Jordan

It's Bryan. I don't particularly see it as a linear process. But I do think that we are very focused internally on executing on a number of fronts. As I described it in my opening comments, the blocking and tackling, it's about improving our customer service, implementing the technology changes that we've been working on for the last year or two and getting more efficient as an organization. So we're perfectly content to focus there. And assuming that the right transaction at the right price doesn't come along, we're perfectly content working on the execution in the business. And we think we can do a lot in the next 12 months, focused there to improve our financial performance and to -- as you said, continue to wind down the non-Strategic businesses.

Ken Zerbe

All right, great. Thank you.

Operator

Thank you. Our next question is from Tony Davis of Stifel Nicholas.

Anthony Davis - Stifel, Nicolaus & Co., Inc.

I'm wondering, in view of this latest regulatory directive sort of instructuring banks to consider reserve adequacy, Bryan, for second lien credits, what are your thoughts regarding your disposition options for the non-strategic home equity book?

Bryan Jordan

Well, I'll let Greg sort of talk about the credit elements of it. It's been our experience in the past, and I continue to keep a little bit of an eye on it, that market expectations around financial performance and Home Equity portfolios is going to be significantly worse or consistent across all portfolios. Our experience has been that our portfolio has performed better than other portfolios that we think that will continue given the credit quality inherent in that portfolio. And so, that, in particular, hasn't been an area where we thought it made a heck of a lot of economic sense to pursue.

Greg Jardine

This is Greg. And just to amplify on that, we -- our book is a lot different than the books that have traded in the market. And, therefore, it's very difficult for the market to get a grasp because this is such a higher-quality book compared to what's traded in the markets. So as Bryan mentioned that, that's been the economics of it. It just don't reconcile to how the book performs.

Anthony Davis - Stifel, Nicolaus & Co., Inc.

Fair enough. BJ, to you, the $100 million to $125 million in savings by 2012, I guess, the implication is, are we correct to infer that there's probably still $200 million or so in the environmental cost to be achieved savings there? And kind of what your thinking is about a timeframe for that?

William Losch

That's right. That's exactly the right way to think about it. If you look at the expenses in our non-Strategic segment, primarily, we expect those to go away over time. And I would expect that they should be substantially, not fully, but substantially gone by 2013 and have a lot of it gone by 2012. If you think about the biggest piece of expense that's in there, that's mortgage repurchase. So, I think, if you look at last year, we would have had something like $270 million of expense in non-Strategic, $190 million of that was mortgage repurchase. So we expect that to come down substantially over the next couple of years. And with that being the biggest piece, that will drive those wind down costs lower.

Anthony Davis - Stifel, Nicolaus & Co., Inc.

Greg, if I could ask just final one of you, I guess, is it reasonable that we might expect a consolidated provision credit, some time in the next few quarters?

Greg Olivier

Once again, the reason we'd expect a consolidated provision credit. Well, I think that is -- as we look at the continuation of the healing of the book, we -- I think it's going to be lower, whether it's a credit or whether it's a slightly negative as this quarter, it's going to be close in those ranges. It's going to be less than we have seen in the past.

William Losch

It's BJ. I think I've said in my prepared remarks as well that we think that provision levels consolidated are likely to be below our normalized bonefish targets. And if you go back and do the math, our normalized bonefish targets are 30 to 70 basis points of annualized provision. So if you take that and multiply it by our loan balances, that's kind of how we're thinking about it. With the caveat, again, that global -- Middle East oil, other economic impacts, regulatory changes, et cetera, could change that outlook. But as we sit here today, that's how we see it.

Operator

Thank you. Our next question is from Marty Mosby of Guggenheim.

Marty Mosby - Guggenheim Securities, LLC

I want to talk a little bit about the bonefish actually and exactly what you were just talking about. If you look down the 1Q '11 column on the core, what I was looking at is, we're hitting most everything that we have. And actually, this quarter, we had, I think, about a $12 million recapture in the core number relative to the 30 to 70 basis points of charge-offs. And the only thing left really to kind of show improvement on is the efficiency ratio. So my key question was, forgetting about the non-strategic parts of the business, and just focusing on efficiency ratio and cap markets on the Regional Bank, how fast can we migrate from 79 down to less than 65?

William Losch

It's BJ. As Bryan and I both talked about, this is something that we're absolutely focused on just as hard, executing as we did on improving our capital position and getting out in front of credit. Our folks across the company, literally, in every part of our company, are doing a fantastic job on this. I talked about that $50 million of our targeted $100 million to $125 million is already in our run rate. We are moving towards getting that $100 million to $125 million, executed and in our run rate by the end of this year so that we have a clear glide path into 2012. As I just mentioned, when I was answering Tony's question, the wind down will take a little bit longer, should make meaningful progress in 2012 but take a little bit longer such that we're really targeting to achieve bonefish efficiency ratios in 2013.

Marty Mosby - Guggenheim Securities, LLC

The other part of the equation, I think, that just doesn't get defined is the balance sheet size. Right now if you just look at the core amount, we're talking about $17 billion in core assets. So, I think, yes, the balance sheet size and share count are the other 2 things that, Bryan, you might be able to give us a little bit of feel for given that the earnings assets on the bank this quarter did come back in about $500,000.

Bryan Jordan

The balance sheet, it's been in this plus or minus $25 billion range for a while. We think that's going to be reasonably stable. It's going to ebb and flow just a little here and there. As you correctly point out, the core bank balance sheet is somewhat smaller when you extract the impact these National Strategic portfolios. But I think it's important to note that those aren't going to 0 over a very short period of time. There's components of it that are going to be larger, longer amortization. The Home Equity portfolio is a portion that's running off most rapidly. It's probably running off today in the 15% to 20% CPR range. And so, the opportunity for us is, as the economy picks up, we'll continue to offset that contraction with growth in the core banking and other opportunities. So, as we look at it, we think the balance sheet will remain reasonably stable. Capital and share count is a different question. That really goes back to my earlier comments, which are -- we're going to look at how we smartly manage that capital. It will involve our capital planning process. It's going to involve stress testing the balance sheet, and it's going to involve communicating with our regulators and it's going to take some time. But we're mindful of that. And to the earlier question, I don't think we need to warehouse the capital. We'll manage it at the appropriate times, in the appropriate ways, and we'll be as proactive as we can in doing that.

Marty Mosby - Guggenheim Securities, LLC

The only other thing I was going to say is, if you think about the non-Strategic as a part of the balance sheet size, still, we need to think about that as that some point turning profitable and I'm kind of just kind of wiping it away and saying we're just going to focus on the core, and that's the -- at some point, 3, 5 years down the road, that's not around. But as long as that balance sheet is there to cover the expenses, and we're losing money, I'm just kind of trying to say it, let's say that's 0 and just focus on that core part of the organization or do you think in the short run, we can actually flip positive and thanks for all your time.

Bryan Jordan

Thanks. Marty, look, I think we lost $24 million pretax in the non-Strategic segment. This quarter, we had $37 million of mortage repurchase cost in there. So when we work through that problem, that segment goes back to pretax profitability. So it won't always be as much drag as it's been and that's diminishing. And as we work through the mortgage repurchase and as we get out of some of the cost of foreclosures and credit challenges, that profitability will improve. It's lower profitability. If you look at the net interest margin slide that BJ walked you through, the net interest margin on it is lower than what we have on the bank and what we're putting on the bank, but it can be profitable over time

William Losch

And one more thing, Marty, I might add to Bryan's point on your question about assets as really -- you've heard us talk several times now in the last several months about optimizing the business mix. That's exactly what we're trying to do. The reality is, our asset size will probably bump around at this level for the next several quarters. But it's critical for us to replace things that are running off in the non-Strategic segment at 220 basis points in margin and replace it with 358 basis points in margin and then consolidate in the core businesses. So, that's what we're trying to do, improve the profitably of the balance sheet even if it is the same size.

Operator

Thank you. Our next question is from John Pancari of Evercore Partners.

John Pancari - Evercore Partners Inc.

Just getting back to the comments made around some of the seasonalities on the quarter, particularly around fee income. Can you talk about the seasonal impact at the -- or in other words, I guess, the pick up that you could see on next quarter in, for example, service charges and also, we know there is a degree of seasonality in the Fixed Income business just given where it creates an activity. So I just want to get an idea of what we could be looking at coming out of this quarter and some of these fee lines that got hit pretty hard in 1Q.

William Losch

Yes, I think -- it's BJ. In the Regional Bank, fee income, in terms of lower day count, as well as some of the continuing impacts we're seeing from regulatory changes, was probably $3 million to $5 million in this quarter with probably more than half of that being seasonality. So you could probably see some of that come back in the subsequent quarters. Fixed income is a business where again, we are trading in Distribution business. So we match up buyers and sellers. With the market environment that we're in, it's been a little bit slower than certainly what we saw a year ago. With that said, we're very pleased with what we're seeing out of our folks in fixed income. As a matter of fact, if you break it down a little, we talked about average daily revenues down from 1.4 to 1.3. They were actually down from 1.39 to 1.34. So they were virtually flat on the quarter. So, we expect that to continue, meaning, stay at these relative levels at least for the next quarter or two.

Bryan Jordan

The Fixed Income business is one where there's a lot of money that still, we expect to see invested in the fixed income markets when you have the kind of volatility we saw in the first quarter on days where the market is back and up and rates are up. You see more activity on dates when the rates are falling. And we expect that rates get to sort of a higher level. We expect we'll see some of that market that might come back into the market, and we think we're extraordinarily well positioned to pick up in that.

John Pancari - Evercore Partners Inc.

Okay. All right. And then separately, on the loan demand side, can you talk a little bit about what you're seeing in terms of opportunities to grow C&I and we where your line utilization may stand currently?

William Losch

It's BJ. Yes. So loan demand, we talked about several areas being promising, where we saw modest growth. We saw some in our Corporate segment, which we define as companies over $100 million in annual revenues. So, we continue to see good solid pricing there. So we continue to see growth there. Asset-based Lending business banking, which is roughly $10 million in annual revenue companies, and a little bit in core C&I and CRE. So, really, across a lot of our different Commercial portfolios, we're cautiously optimistic that we're starting to see a little bit of demand. In terms of -- would you give me your second question again?

Gregory Jardine

Utilization.

William Losch

Utilization. We really haven't seen a lot of movement on it. It's still in the mid-30s.

Operator

Thank you. Our next question is from Paul Miller of FBR.

Jessica Ribner - FBR Capital Markets & Co.

This is Jessica in for Paul. We just had a question about the mortgage banking revenue. Was that due to the hedging gain or can you walk me through that?

William Losch

Primarily from the mortgage hedging gain, we're up about from about $7 million in the fourth quarter to $12.5 million in the first quarter. And servicing fees picked up just very modestly, about $2 million.

Jessica Ribner - FBR Capital Markets & Co.

And how do you -- just with the oncoming legislation, how can we think about servicing fees going forward?

William Losch

It still remains to be seen. But depending on where that goes, they certainly could be challenged. In terms of our MSR asset, the valuation is predominantly related to delinquencies, and we have seen improvement in delinquencies over the last several months as well as prepayments, and prepayments fees have slowed quite considerably this quarter. So we're, obviously, actively monitoring what the events that are going on external to us and making appropriate adjustments.

Jessica Ribner - FBR Capital Markets & Co.

Okay, great. Thanks.

Operator

Thank you. Our next question is from Chris Marinac of FIG Partners.

Christopher Marinac - FIG Partners, LLC

Thanks. Just wanted to ask one more question about this non-strategic versus strategic top line income. Do you think that this type of the thing, that below watermark, is it fair to say that and then what changes in pipeline that you articulated that this probably should increase in linked quarter the next quarter or 2?

William Losch

I'm sorry Chris, I couldn't quite hear you. Sorry about that.

Christopher Marinac - FIG Partners, LLC

If we look at the core net interest income, is this first quarter most likely going to be at the low watermark compared to the rest of this year?

Bryan Jordan

In terms of net interest income?

Christopher Marinac - FIG Partners, LLC

Correct.

Bryan Jordan

Yes, in all likelihood, yes.

Christopher Marinac - FIG Partners, LLC

Okay. And then just a general question, Bryan, can you show us, I guess, the various parts of the franchise, whether it's middle Tennessee, Memphis or Eastern Tennessee in terms of how they're

acting for loan growth as well as it's stable in asset quality?

Bryan Jordan

Yes. I'll let Greg pickup the asset quality piece for any distinctions. There doesn't seem to be as much distinction geographically around loan demand as it does to be line of business. We're still seeing strength in all areas that stayed in our corporate borrowing. And as BJ pointed out, we're seeing some pick up in terms of our Commercial Real Estate businesses. If you look at our pipeline growth from December year end to March first quarter end, the strongest area of growth was in Commercial Real Estate. Geographically -- and then, the area we're seeing probably the least growth right now tends to be on consumer demand. But it tends to be more a line of business than it does geographic. We see the recovery taking hold across the entire state.

Greg Olivier

Yes. I'd say, from a credit quality standpoint, overall, in the -- because of the economic environment in Eastern Tennesse, that the metrics there look pretty good. And across the state, they're improving the mid-South market or the Memphis market in business banking is a bit slower than some of the others in terms of healing. But to Bryan's point then, across the segments that we have, business banking would be the slowest to heal, and we're seeing healing across all the other segments. But the improvement in business banking is apparent. It's just at a slower rate.

Operator

Thank you. Our next question is from Kevin Reynolds of Wunderlich Securities.

Kevin Reynolds - Wunderlich Securities Inc.

Bryan, quick question, if you could -- sorry, I think I ask you this every quarter, but how do you feel today versus last quarter.? And then, specifically -- I mean, you're talking, it sounds more optimistically, modestly so about the environment, but what about the competitive environment? Are other of your more traditional competitors starting to become more active as well and kind of see -- are they seeing the same things or is the near-term story going to be one of -- more of a market share gains than net loan growth and increased business activity out there?

Bryan Jordan

Yes. Thank you. I am more optimistic. I'm more optimistic that the economy is picking up traction. It's gaining some momentum. There is still risk to it, but it seems to be recovering slowly, and we're getting more confident about that. I'm more optimistic about our positioning. I feel good about the traction I see on the initiatives that we've talked about around technology and efficiency, as well as our customer acquisition efforts. We've, I think, made good progress there, and we continue to do very well in terms of bringing -- hiring and bringing additional relationship managers into the organization. And all that said, the competitive environment is still very competitive. There is a lot of competition for customer transactions that come up. We don't expect that to abate simply because the economic recovery is at a lower growth rate. But we expect there to be a fair amount of competition, particularly on the C&I side. As I said in my earlier comments, we're trying to build long-term relationships with customers. We're trying to grow our market share. We're being mindful of the pricing and structure implications of what's going on in the competitive environment. But on the whole, I'm much more optimistic.

William Losch

It's BJ as well. I just might add on the competitive environment, particularly as it relates to loans, we are seeing a bit more aggressiveness on structure than we probably would have seen 90 days ago, particularly from some of the larger competitors. As Bryan said in our prepared comments and what we are emphasizing with our bankers, we are very focused on the right price and the right structure. And we believe that some of the competitive advantages we have in terms of what Bryan talked about, customer service, the talents of our bankers, our abilities and capabilities, we'd rather compete on that then start to get the structures. So that's what we're going to continue to do.

Kevin Reynolds - Wunderlich Securities Inc.

Okay. And then one other question and I'll just ask you this as straightforwardly as I can. I don't want to get the cart before the horse too much, but any thoughts on the dividend, on raising the dividend? And I mean, if we're in as slow-growth environment, and your risk with capital, if the M&A environment doesn't come your way, could we see that move higher or more quickly?

Bryan Jordan

This is Bryan. I don't know how to define more quickly. That's a term of art, so I'm going to try to avoid that. I think we, in the industry, probably learned a lot from what the Federal reserve and the stress testing work in the dividend activity that occurred with the larger institutions. We recognize that it's a process where we need to have interaction with our regulators and work with them. But our capital has stayed strong. Our capital ratios remained strong this quarter, and we actually redeemed the CPP warrant this quarter. So we're taking all that into context. We will work on it. We'll lay out our capital plans, and we'll evaluate the right way to manage dividend policy and capital repatriation with what's going on in the business, what's going on in terms of organic opportunities, what's going on in credit quality and what we see as a need for capital in the business.

Operator

Thank you. And our final question is from Matt Hodgson of SunTrust Robinson.

Mac Hodgson - SunTrust Robinson Humphrey, Inc.

Bryan, on M&A, I just wanted to see if you could clarify for us again. As you look at kind of current potential M&A opportunities, the companies' interest in distressed transactions versus healthy end market versus deals that might extend the footprint a state or two out?

Bryan Jordan

Mac, I think it still -- the first or second inning in terms of the M&A environment. I think that there is going to be plenty of time to deal with that. So our first and foremost interest is to be disciplined and to only focus on what we can do at the right price and in the right way that makes us a better franchise for the long term. In terms of priorities, there is probably as equal balance between the ability to sort of fill in where appropriate here in Tennessee with the opportunity to open up contiguous markets that would be additive to our business model, where we can operate our business model in a similar fashion to what we do here in Tennessee, where we can build strong market shares. We can provide a differentiated product and service model that allows us to be differentiated and put capital to work in attractive ways for our shareholders. And back to where I started, given that it's the early stages, we're willing to be patient and couple of the -- what we have going on in the organization in terms of key initiatives that we think are important like getting the cost savings identified and executed in 2012 that BJ and I have talked about of $100 million to $125 million and getting our systems upgrades completed. We feel like we need to be patient, we will be patient, and we'll only do the right thing at the right time.

Mac Hodgson - SunTrust Robinson Humphrey, Inc.

And is there -- given the headquarters in Memphis, is there more of a preference to go West or Southwest of Tennessee? Is that a market as opposed to East?

Bryan Jordan

No. We don't have biases in that regard, no.

Mac Hodgson - SunTrust Robinson Humphrey, Inc.

Okay, thank you.

Bryan Jordan

All right. Thank you.

Operator

There are no further questions in the queue at this time. I'll turn the call back over to Bryan.

Bryan Jordan

Thank you, operator. Thank you, all, for joining our call this morning. We appreciate your questions and your interest. I hope everyone has a great day and a great holiday weekend. Please let us know if you have any follow-up questions. Please contact any of us or Aarti if you have any follow ups. Thank you, all.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Good day.

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