Apr 17, 2008
Executives
Dave Miller - Director of Investor Relations Gerald Baker - Chief Executive Officer Bryan Jordan - Chief Financial Officer
Analysts
Steven Alexopoulos - J. P.
Morgan Paul Miller - FBR Ken Zerbe - Morgan Stanley Brian Foran - Goldman Sachs Kevin Fitzsimmons - Sandler O'Neill Robert Patten - Morgan Keegan James Schutz - Stearne Agee Chris Marinac - Fig Partners Kevin Reynolds - Janney Montgomery Scott Keith Horowitz - Citi Frederick Cannon - JBW Howard Chapman - Columbia Management Heather Wolf - Merrill Lynch John Newell - Barrington
Operator
Welcome to the
Dave Miller - Director of Investor Relations
Thank you, operator. Before we begin, we need to inform you that this conference call contains forward-looking statements involving significant risks 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 may be noted in this conference call.
A reconciliation of that non-GAAP information to comparable GAAP information will be provided as needed in the Investor Relations area of the company’s website at www.fhnc.com. Listeners are encouraged to review any such reconciliations after this call.
Also, please remember that this audio webcast on our website is the only authorized record of this call. With that, I’ll turn it over to our CEO, Gerry Baker.
Gerald Baker - Chief Executive Officer
Good morning and thank you for joining our call. As you have seen from our release this morning, our reported earnings were $8 million or $0.06 per share in the first quarter, impacted by a few favorable unusual items, soft market dynamics, and cost to increase our loan loss reserves.
Bryan will cover the details of the quarter, but first I would like to tell you what we are doing to navigate successfully through a very challenging industry and economic environment. Against the backdrop of this difficult market, we continue to change course and to improve our financial position for the future.
Let's begin with asset quality, which has been severely impacted by the softening economy, falling home prices, and limited credit availability. In the light of these unprecedented real estate market conditions, we are actively identifying and addressing problem loans resulting in increased reserves.
During the first quarter, we continued to conduct extensive detailed reviews of our commercial real estate and C&I portfolios. We also reviewed our home equity and one-time close loss models and determined that additional reserves were appropriate given greater loss rates in certain products and markets.
Through these efforts, we determined that additional provisioning in reserves were needed to reflect the current challenging market. As a result, our loan loss reserves grew from 1.55% of total loans in fourth quarter to 2.20% this quarter.
We have not only been actively identifying problem loans but also are writing them down to realizable values taking a weakening economy into account. In fact, as Bryan will cover in more detail, these actions contributed to increased charge-offs of approximately $100 million this quarter.
The bottom-line is that asset quality is a big challenge, but we believe we have a handle on the issues and we are hitting our problems head-on. We remain very committed to shrinking our balance sheet and freeing up capital.
As we've previously discussed, we are winding down our national real estate portfolios. During the first quarter, we announced our decision to discontinue National Construction Lending and stopped most Consumer Lending outside our bank footprint.
As a result, our portfolio of real estate construction loans contracted by over $300 million from the end of the fourth quarter through the end of the first quarter. We are also committed to reducing our mortgage banking business significantly over 2008.
After selling more than 7 billion of servicing in the fourth quarter, we sold another 8 billion in first quarter and have a commitment to sell 9 billion more in the second quarter. These bulk transactions along with a recently executed flow sale agreement should bring our servicing portfolio to approximately $90 billion by the end of second quarter.
On the origination side, we have eliminated virtually all non-GSE eligible product originations and continue to close unproductive offices including 16 locations in first quarter. We are pursuing additional near-term opportunities to further reduce both our servicing and origination platforms and concentrate more heavily on our Tennessee footprint.
We will update you as progress is made. We also recognize that in the current environment, a strong capital position and adequate liquidity are essential.
As of the end of the first quarter, all capital ratios remain above well capitalized levels and meet or exceed our own minimum guidelines, but we believe it is prudent to build capital even further. As we continue to downsize the balance sheet, we expect our capital ratios to increase over 2008, providing a cushion or potential additional weakening in asset quality.
We are also taking steps to improve liquidity. We expect that reducing our balance sheet should lower our need for wholesale funding and we are focused on growing core deposit funding in our Regional Bank.
After considering our capital and liquidity position and other factors, the Board declared a quarterly dividend of $0.20 payable in July. As we strengthened the balance sheet, address asset quality problems, and improve liquidity, we also continue to refocus our strategy on being a strong regional financial services company.
To reflect that new focus, we changed our segment disclosure this quarter to better highlight our two core businesses; our Regional Banking franchise in and around Tennessee and our capital markets business, FTN Financial. Our Regional Banking business continues to gain customers in our home banking markets with a particular emphasis on attracting economically valuable deposits.
In the near-term, we are facing margin pressures in this segment from falling short-term rates, but believe that that will subside in times since we don’t fundamentally compete on price. We also sold 10 First Horizon Bank branches in Texas during the quarter and expect the last locations in Atlanta to be divested by early May.
And in capital markets, fixed income sales benefited from the rate environment, generating good profitability in first quarter and substantially overcoming higher provision in Correspondent banking. We expect the rest of 2008 will remain tough for financial services companies.
At the same time, we believe that we are doing the right things to put this company on solid footing and position us well for the future. We are addressing problem loans and meaningfully increasing loan loss reserves to reflect portfolio and market weaknesses.
We are focused on reducing our balance sheet and lower return businesses such as mortgage which should improve our capital position. We are taking steps to improve liquidity and we are refocusing on core businesses with competitive advantages, good earnings power, and returns on equity that should be 20% plus over the long-term.
We are confident that the more focused, less volatile, more efficient, more profitable First Horizon will ultimately reward shareholders. Now, I will turn it over to Bryan to review the details of the quarter and then we will take your questions together.
Bryan Jordan - Chief Financial Officer
Thank you, Gerry. Good morning everyone.
As Gerry said earlier, earnings per share were $0.06 in the first quarter included a number of significant items. As in prior quarters, we have provided a summary of the significant items in our financial supplement on Page 4 that explains which line items and business segments they impact.
Second, accounting changes in our mortgage banking segment added arrogate $40 million pre-tax benefit during the first quarter. On January 1 of this year, we adopted FAS 157 and FAS 159, which in combination with SAB 109 accelerated the timing of revenue recognition, a mortgage loan commitment, and loans in our warehouse.
The steady effect of accelerating gain on sale income on loans originated, but not so during the first quarter. The related effect is that origination expenses are no longer treated as a counter revenue item through FAS 91, increasing our non-interest income and non-interest expense run rates by approximately $55 million this quarter.
Lastly, we incurred net charges of $21 million this quarter from structuring, repositioning and efficiency initiatives. This amount includes employee severance and retention, facilities and other cost, primarily associated with divestiture of our remaining First Horizon Bank branch in Texas and Georgia, and the contraction of our National Construction Lending and mortgage operation.
Now I will spend a few minutes on our consolidated results beginning with asset quality. Pressured by weakness in housing market and a foreign economy, our portfolio showed signs of further deterioration during the quarter.
A wind down of National Specialty Lending portfolios continue to represent the greatest challenge especially in One-Time Close and Homebuilder Finance. Given the deteriorating market condition, as Gerry said, we continue to be proactive in identifying problem loans and in writing them down to realizable value, which includes disposition costs and adjustments for market declines since the last appraisal.
To help you understand our processes better, we have included a summary on Page 32 of our financial supplement highlighting both our processes and the enhancements we continue to make. I think it is important to understand our credit metric and the context of our approach.
In our One-Time Close portfolio, we continue to take steps to actively identify problem loans through monthly portfolio reviews. We work closely at inherent risks in credits based on draw inactivity and borrower conditions, often classifying loans as non-accrual that are not yet delinquent.
And when OTC loans are classified substandard, they are reappraised and charged down and charged down further as conditions warrant. Let me give you an example.
We observed the draw inactivity on construction projects in California City. Our investigation identify that the local city had placed a stock order on construction by this customer due to past due real estate pattern and additional lengths placed on the property.
Although, the loan remained current due to interest reserves, the credit was classified substandard in a new appraisal order. Following receipt and review of the appraisal, the loan was charged down to the estimated current realizable value.
Turning to our commercial loan portfolios, we continue to strengthen our processes in both commercial real estate and C&I so the reserves keep pace with the borrower and market conditions. In the fourth quarter, relationship managers received additional training and tools to ensure timely identification of weakening credits and we introduced quarterly portfolio reviews conducted by senior credit officers to provide independent oversight.
In the first quarter, the portfolio review process was enhanced and expanded to include C&I credits related to the homebuilding industry. All RMs also reviewed the assigned grade for all C&I and CRE, resulting in further grade updates, identification of additional potential problem credits and increased provision.
We view most of the non-accrual commercial loans as collateral dependent and assess them using a Fair Value of Collateral approach. When a loan is classified non-accrual, collateral values are assessed with third-party appraisal, adjusted down for costs associated with asset disposal and for our estimate of any further deterioration in values since the most recent appraisal.
We have been charged off the full difference between book value and our most likely estimate of net realizable value. There is an example from our homebuilder finance portfolio.
We have a residential builder in the southeast with several single family residential loans totaling $6.5 million. Recent appraisals indicate aggregate value plus estimated cost to $6 million.
Local market conditions are appreciably worse for more expensive home, while values for lower priced homes are relatively stable with a slow inventory turn. For the lower priced homes, appraised values were reduced by 20% to reflect weak market conditions and the life extended 12 to 18 months absorption period.
Appraised values on the higher priced homes were lowered by 30%. The resulting values will further reduce the cost and expenses of anticipated selling periods.
These included 6% brokerage fee, taxes and insurance, attorney's fees, appraisal fees, and cost to complete. As we use the fair value of collateral approach, we've charged-off the resulting loan down to roughly $4 million.
Turning to our home equity portfolio, higher loss severities trends continued in the first quarter especially in markets like California where home prices have fallen meaningfully. 30-day delinquencies, however, grows all in modestly.
The 1.48% at the end of the fourth quarter, the 1.55% at the end of the first quarter and actually showed signs of stabilizing in February and March. We continue to see that loss frequency remains principally driven by borrower LIFO bits such as job law.
Certainly home equity trends have softened. We believe that our portfolio has held up because of its quality.
85% of the portfolio is retail-originated. Roughly 30% are in Tennessee, where we typically have other relationships with borrower.
Our average refresh FICO score is approximately 730, 26% are in the first lien position. Two-thirds are full documentation and our utilization rate has held steady at about 53%.
In total, given persistent economic weaknesses, our active processes identified increased problem loans and charge-offs this quarter that also necessitated additional reserve. Charge-offs increased to $99 million, much of which was due to our proactive efforts to recognize losses.
Our non-performing assets ratio increased from 166 basis points last quarter to 178 basis points at the end of the first quarter, but we'd attribute part of the increase to our active decision and would also note that most of our non-accrual loans are charged down to appraised values well below. Provision exceeded net charge-offs by roughly $140 million during the first quarter.
Increase in our reserve to loans to 2.20% overall and 2.83% within our wind-down National Specialty Lending segment. You will note that we added considerable detail on asset quality metrics by product and segment to our financial supplement this quarter.
The obvious question is where do we think credit cost go from here? It's difficult to answer.
Last quarter, I shared with you our view that charge-offs and provision costs would be in the range of $50 million a quarter. We underestimated that.
As the economy worsened over the past 90 days and we remain proactive, losses increased and further reserves were needed in the first quarter. We can't tell you with certainty where those go from here.
But as we sit here today, our view is that the economy and the housing market will remain soft through 2008. Given this, we expect the charge-offs are likely to remain in the neighborhood of $100 million per quarter for the foreseeable future.
Provisioning cost will remain dependent on the need for additional reserves, but also likely to be in that $100 million quarterly range. As Jerry indicated, our capital ratios are above well capitalized standards at quarter-end and were at or above our own conservative minimum guidelines.
Tier-I capital of 8.1%, total capital at 12.8%, and tangible common equity to risk weighted assets 6.1%. Given the economic environment, we will continue to focus on improving our capital position by shrinking the balance sheet over 2008 since each billion dollars of assets we can reduce improves our Tier-I ratio by roughly 30 basis points.
Our consolidated net interest margin increased 4 basis points over fourth quarter to 2.81% in the first quarter. The reduction of short-term rates lowered wholesale borrowing costs and improved the net interest margin in mortgage, capital markets and corporate, offsetting margin compression in the regional bank.
Going forward, we expect the margin to be relative stable or perhaps show some improvement given a steeper yield curve and the reduction of lower margin businesses from the balance sheet. We continue to make progress on our efficiency and restructuring initiatives as we have completed roughly 55 projects across the enterprise.
We estimate that approximately $175 million of annual pre-tax benefit from these projects are now in our run rate. In addition, we completed the sale of 10 First Horizon Bank locations in Dallas in the first quarter.
We expect the remaining Atlanta locations and deposits to be sold in May. In total, the First Horizon Bank divestitures should produce in aggregate $30 million in annual pre-tax operating improvement by the second quarter, roughly $10 million annualized of which was in our first quarter run rate.
We have again provided a detailed schedule in the financial supplement that explains the charges and benefits. Now I will cover the highlights from each of our business segment.
As Gerry mentioned, we changed our segment disclosure this quarter to highlight our core businesses and allow investors better visibility into our wind-down national businesses. We have included a summary on Page 3 of the financial supplement to describe the context of the new segment.
Regional Banking continues to show strong fundamental customer trend as a result of efforts to increase marketing spending, refined segmentation, and improve relationship pricing with a renew focus on growing core deposit. At the same time, we are enhancing our competitive advantage and convenience by opening eight new financial centers by year-end including a new Middle Tennessee location this month.
Average core deposit excluding divestitures increased 2% linked quarter. Our loans remained flat sequentially.
However, net interest income declined as the banks margin declined 35 basis points in the first quarter, primarily reflecting history of deposit rates grew 175 basis points of Fed rate cuts during the quarter. Positively, expenses declined 6% linked quarter, primarily driven by our own efficiency and restructuring efforts.
While Regional Banking had a pre-tax loss of $18 million in the first quarter driven largely by higher provisioning cost, profitability and growth should resume in this business when the need to build reserves arise. The capital market segment, which now includes correspondent banking, had another big quarter, reducing $23 million in pre-tax income in the first quarter.
Fixed income sales have improved sharply as the Fed reduced rate and market volatility increased, producing a record $152 million in revenue compared to $77 million last quarter. Other product revenue declined $45 million linked quarter by $36 million LOCOM adjustment to our pooled trust preferred warehouse as CDO spread widened over the quarter.
Despite this, we believe the underlying collateral is of greater quality than current pricing reflects. We continue to manage balance sheet usage in capital markets including our trading inventory and trust preferred warehouse.
Near-term profitability in this business should remain solid, driven mainly by fixed income sales. In the first quarter, we stopped most of the originations in our National Specialty Lending businesses, driving approximately $100 million of contraction in their portfolios from fourth quarter end to first quarter end.
Despite continued funding of some existing homebuilder and one-time close commitment, we expect loans in this segment to be significantly lower by the end of year 2008. Mortgage banking pre-tax income for the first quarter was $51 million, up from last quarter's loss of $254 million.
Excluding first quarter's $40 million accounting change benefit, pre-tax income was approximately $11 million. This quarter's results were primarily driven by four factors.
First, hedging performance improved from a loss last quarter to a positive $33 million in the first quarter, reduced portfolio complexity and Fed funds rate changes both contributed to the improvement. Second, net interest income increased $8 million linked quarter, reflecting the larger warehouse and higher net interest margin.
Third, originations grew to $8 billion in the first quarter as lower rates drove periods of increased refinance activity. And finally, gain on sale margins were negative 17 basis points in the first quarter, again reflecting significant spread widening on non-conforming and agency ARM reduction.
Regarding the servicing portfolio, we completed an $8 billion bulk sale during the first quarter and have committed to sell another $9 billion in the second quarter. Both sales were executed inline with book carrying value and together they should free up approximately $30 million in Tier 1 capital.
With the run-off rate of about 19% plus further bulk and flow sale, the servicing portfolio will continue to be reduced, freeing up capital and lowering hedge accounts. The corporate segment results for this first quarter reflects the net charges of $21 million from our restructuring, repositioning and efficiency initiative, and the $96 million of pre-tax benefits related to leasing.
Net interest income in the segment improved $8 million linked quarter reflecting a reduction and an unusually wide spread between LIBOR and Fed Fund and lower wholesale borrowing costs. In conclusion, we continue to make progress on refocusing our company and we are positioning ourselves to what was likely to be a difficult 2008.
We are actively identifying, providing for and charging down problem loans. We are shrinking our National Lending portfolios and mortgage banking businesses, contributing to improve capital and liquidity.
And finally, we have good core businesses and regional banking and capital markets. With that, Gerry and I will be pleased to take any questions you might have.
Operator
Thank you. (Operator Instructions).
We will take our first questions today from Steven Alexopoulos with J. P.
Morgan.
Steven Alexopoulos
Hi. Good morning guys.
Gerald L. Baker
Hey Steve, good morning.
Bryan Jordan
Good morning, Steve.
Steven Alexopoulos
Bryan, I am curious with the reserve doubling over the past two quarters, why, when you expect to not to continue to increase, giving you the impression the loan portfolio, I am now referring to your comments to expect provision and net charges-offs to be about equal in the next couple of quarters?
Bryan Jordan
Yeah. Couple of factors and that: one, and maybe foremost is with respect to the National Lending portfolio, particularly the construction portfolios, Homebuilder Finance, One-Time Close and in the home equity portfolios, those are the portfolios that were not increasing at all.
Essentially they are in run-off mode. So, we look at them and over time have the expectation as they require and the reserve we set aside will be used for charge-offs and as a result won't necessitate the re-provisioning or rebuilding of reserves.
The total of those portfolios is roughly 9 to $10 billion as we see here today. Second to this is Gerry and I both commented in the call, we have spent tremendous amount of time looking at the portfolio, trying to factor in our expectations around the near-term realizability of assets.
We have got new appraisals on a lot of properties. We have done a top to bottom review of all of our One-Time Close portfolios.
We have tried to make conservative assumptions about net realizable value. So we think we have built a fair amount of reserves for the portfolios as they stand today.
I will use the example of our One-Time Close portfolio. Typically we are seeing severities on the One-Time Close portfolio in the high 20%s range.
If you take the existing portfolio and you look at the reserves we have build for, which is something like $118 million, a little over 6%, you got reserves set out that the results says you can have 25% or so with the portfolio default and you can incur 25 to 30% losses on that and still have adequate reserves. So we think as these portfolios liquidate that's going to necessitate that reserves will come down over time, but won't be replenished.
Steven Alexopoulos
That’s very helpful. Just one another question, given how much mortgage banking seems to be moving next quarter, each quarter ex-servicing, are you considering closure of the businesses one of your strategic alternatives?
Gerald Baker
Steve, I guess that could always be an option, but we believe we have a valuable franchise, good people, that it has value over time and we will continue to just look at strategic options that can take advantage of those capabilities.
Bryan Jordan
We will -- this is Bryan again Steve. We will continue to look at the productivity of various offices we have in the footprint and to the extent that we see opportunities to reduce the size and the footprint of the business and ensuring you over time as we said for several quarter, we will continue to do that as well.
Gerald Baker
I think, Steve, also (inaudible) for your question, but our focus is on and ultimately that’s where we are wind up and remain focused on this area and the surrounding market.
Operator
Moving on, we will go next to Paul Miller with FBR.
Paul Miller
Yeah. On the sale of the servicing rights, can you give us any color on what type of valuation, what type of multiple servicing you got for those sales?
Bryan Jordan
Paul, this is Bryan, good morning. I can’t recall off the top of my head the multiples.
What I can recall is we sold them right at book value where we haven’t recorded based on the valuation adjustments that were factored in our valuation in the fourth quarter. We sold them right on top of those valuations.
If you would like, I will ask Dave to follow up with you with the exact multiples.
Paul Miller
Yeah, I would love to have that. And the other issue is – the other question I have is, your 30-89 day past dues, do you know where you – I mean that type of growth, is that stabilizing or is it still growing or where are you at that point?
Gerald Baker
I guess it depends on the portfolio you are looking at. We saw some stabilization in home equity lending.
In general, I would say that there is a slight increase in run rates from 30 to 89 past due rates over the past three months and has probably not stabilized yet.
Paul Miller
Okay. And, you know, the dividend.
With the current guidance of $100 million of provision that you guys have given, it's going to be hard to make money this year, we believe. Is there any discussion of getting that dividend further to conservative capital?
Gerald Baker
We continue to believe that the dividend is important. We certainly have a large reach of shareholder base particularly here in Tennessee that's important to us.
We see over the long-term our ability to earn the dividend with the guidance or parameters we mentioned before, the 45 to 50% payout over the long-term. So we will continue to be mindful of our capital and our capital adequacy needs, but at this point in time, as I stand here today, that would be our view.
Bryan Jordan
Paul, this is Bryan. What I can also add to that is if you go to the effort to pull out the unusual items in the quarter and you sort of get back to the core operating run rate, even with $100 million of provision, that number depend on which include and exclude, it's going to come out around the level of dividend.
And as Gerry said, when you normalize that dividend -- our provision levels over the long-term, you are especially getting back down over the long-term to a Tennessee-only portfolio which only drive on average 50 basis points or less than annual losses. You got a lot of earnings pick up it comes from that, so we factor that and as Gerry said into our long-term view, but we need to pay out around 50% of our earnings and dividend.
Operator
Our next question today is from Ken Zerbe with Morgan Stanley.
Ken Zerbe
Thanks. Can you just give me a little more detail on the commercial loan deterioration you are seeing in Regional Banking?
I mean, was that one or two large loans or a lot smaller ones, is it focused on Tennessee? And the second part of that question is, does this, you know, new $100 million of provisions and charge-offs relate predominantly to the National Lending which is why we expect or you are also looking at increasing your loss expectations for your Regional Banking business as well?
Thanks.
Bryan Jordan
Ken, it's Bryan. I'll start with the Tennessee portfolio.
There are a couple of large charge-offs that we took in the credits. There are a couple of large specific credits we took charge-offs in the quarter, but also provisioning was driven by our conservative and proactive look and essentially all of the C&I credits in our Tennessee franchise making sure that we had an accurate view of those credits.
And a couple of examples anecdotally were we have taken a loan and downgraded it where we have got very strong -- gearing to our strength, but we have downgraded it based on the results of operations of the underlying promotional activity. So we are trying to take a conservative view of it and that's what really drove our reserve levels.
I think you come out with something like a 1.7% reserve level in our Tennessee franchise. Now, with respect to the losses going forward, the vast majority of that will come out of the national portfolios; particularly we think the construction portfolios, homebuilder finance and one-time close.
Ken Zerbe
Okay. Thank you.
Gerald Baker
You are welcome.
Operator
(Operator Instructions). We will go to Brian Foran with Goldman Sachs.
Brian Foran
Hi guys.
Gerald Baker
Hey, good morning.
Bryan Jordan
Good morning, Brian.
Brian Foran
Before any other opportunities, you raised capital ratios, monetizing the rationale, be the state because you are selling other branches or anything like that that maybe would be in the balance sheet right now?
Bryan Jordan
Yeah, there are those kinds of opportunities although those are -- the Visa IPOs is a good example. We have got a lot of inherent value in that, but with the restrictions that lapse over a bank of three year period, we don’t have the ability or to take knowledge to do that today, but clearly those opportunities exist.
As we said, the biggest opportunity for us is to continue to reduce the size of the balance sheet particularly the non-essential asset we think from a customer perspective to going back to our National Lending portfolio, home equity, construction, reducing the size of our servicing portfolio. And so, those are the levers that we are working most immediately before to reduce the size of the overall balance sheet.
Brian Foran
And then, on the dividend again. I mean, not to repeat it that for us, but can you just remind us of exactly what the tax are around dividends versus profitability that you have to meet and any issues with the ability of the bank to dividend up to the holding company?
Bryan Jordan
Yeah, in general and it is little more technical than I can describe it, but the bank has the ability to do the demand up. Current year earnings plus prior year earnings, I think we noted in our 10-K that we currently have a limitation on how much dividend capacity the bank has to their holding company.
We have -- there is a fair statement out that talks about earnings and dividend levels and preference to earn the dividend. We have adequate cash in the holding company to pay the dividend for a period of time.
But as Gerry said earlier, the dividend is something that we consider with our Board on a quarterly basis. We will continue to do so and it will be influenced by how we view our capital ratio, how we view our earnings capability over the long run.
And again, we think over the long run based on what the returns we can create in the business, we are going to have the capability to pay out a fair amount of earnings over the next several years.
Operator
We will take our next question today from Kevin Fitzsimmons with Sandler O'Neill.
Kevin Fitzsimmons
Good morning Gerry and Bryan.
Gerald Baker
Good morning.
Bryan Jordan
Good morning, Kevin.
Kevin Fitzsimmons
Just I know there has been a few questions on the reserve and the expected losses, but I just -- you mentioned in your comments, Bryan, I believe, that you guys gave an estimate for future losses and obviously underestimated that. And now going forward and establishing these reserves, was it more of just a loan-by-loan type of approach, was it a change in a macro-assumption on what you have been expecting for housing or was it more -- just more of a watch, but change of methodology and how you are determining your reserve and tweaking some of the assumptions, if you could just give us a little color on that?
Thanks.
Bryan Jordan
Yeah, Kevin, I think you hit really all three of the key underpinnings of what we have done here. One, we did estimate -- in our view, the economy is significantly softer today than it was 90 days ago.
That factored into our desire to go through and do a loan-by-loan review, engaging all -- essentially all of our credit folks, all of our line folks and looking at credits and taking a real pragmatic and thorough look at the potential for loss in our portfolio. And so, as we’ve looked at it, we think that all of those things factor in, and it's tough to tell if you get out in front of it, you get hands around it, because we are not certain, anymore certain today about how the economy is going to look in the next 90 days.
But knowing what we know about the portfolio, knowing how we believe the economy is unfolding today, we've tried to build a substantial level of reserves in 2.2%, we’ve got very substantial reserves set aside.
Dave Miller
And now, Kevin this is Dave. Let me also remind you, we added a page with a pretty good amount of detail on our processes and really highlighted some of the enhancements that we continue to make this quarter.
It’s in the latter – one of the latter pages in the supplement, Page 32 I guess.
Bryan Jordan
Yeah, Dave raises a good point and you alluded to this Kevin and I will probably expand on. One thing we did is we made some process changes that drove charge-offs.
The example is our One-Time Close portfolio where in the past we would let -- it won’t get to a 120 days passthrough before we put it on non-accrual and take write-downs as a matter of course. We accelerated that to 90 days in the current quarter.
So you are picking up four months of charge-offs in the current quarter and the reserving impact to that, but all that kind of thing in an effort to at least get our hands around the problem to be proactive and identifying it.
Operator
Thank you. Our next question today is from Bob Patten with Morgan Keegan.
Robert Patten
Hey guys. Most of my questions have been answered.
But I guess, Bryan, how can -- you talked about about capital. And when you plug in the loss rates on the doubled assumptions from the fourth quarter, I think everybody’s miles are going to drop who are not paying the dividend, and I know there is going to be things that are going to happen during the year.
But I guess strategically how confident can you guys be in Cap, I mean, Tier-1 actually declined this quarter when we thought it was going to go up. And I am just not clear how the capital is going to build.
Can you just one more time go through this with us?
Bryan Jordan
Yeah, the Tier-1 ratio I think ended up by 8.12 or 8.1% something like that, so it was down just a tick or two from where it was at the end of the fourth quarter. Our total capital ratios, our risk weighted, our intangible capital risk weighted asset stayed about 6.1%.
In relative to our board guidelines, relative to well capitalized standard, we are in excess of our well capitalized standard. The dividend is going to be a function of capital level.
It's going to be a function of earnings and it’s going to be a function of where we think the economy is going and the impact of that on credit losses and our results over the long-term. So as we sit here today, it’s impossible to tell you what’s going to happen 90 days out or 180 days out as we evaluate capital, but we think we’ve got adequate capital as we sit in this environment, knowing what we know.
I will also say that the efforts we have in place to shrink the size of the balance sheet significantly increase our capital ratios. We saw about $300 million of contraction in our construction portfolios.
I think the ratio is something like for every billion dollars we reduce the balance sheet, we improve our capital ratios by 30 basis point, and we are working very diligently to reduce the size of the balance sheet and those actions would show up in our capital ratios as we work through the rest of this year.
Robert Patten
Okay, got you. And for the 300 million of contraction, how much was charge-offs and how much was actually run-off?
Gerald Baker
The charge-off number, I guess Dave to confirm it later, but in the aggregate, you said all of the charge-offs related to the national portfolios would still be about 2 to 3 to 1 ratio. So and all of those charge-offs were not the national portfolio.
I think the number was about $60 million in charge-offs in those portfolio. So we have $300 million write-off, 60 million of it was charged off.
Bryan Jordan
Yeah, that would be right, a little over 60.
Operator
Our next question today is from Jim Schutz with Stearne Agee.
James Schutz
Good morning.
Gerald Baker
Good morning.
Bryan Jordan
Good morning, Jim.
James Schutz
I don't want to be the dead horse here, but notwithstanding your well capitalized posture at this time, have you internally considered any possibility for the need to raise additional capital as the year progresses? And if so, would you prefer issue common stock or another type of security?
Gerald Baker
It will be naïve not to consider all alternatives and we are always evaluating capital levels. We are always evaluating what's going on in the marketplace and trying to make our best estimates.
So, although we have not made any firm decisions about what we would do, we are going to keep our options open and we will evaluate those opportunities as things unfold.
James Schutz
Thank you.
Gerald Baker
Sure.
Operator
Moving on, we'll go next to Chris Marinac with Fig Partners.
Chris Marinac
Thanks. Good morning.
I wanted to get some detail, if you would, what would be the level 2 and 3 securities for the new accounting rules and how that shook out as you place securities in various markets?
Gerald Baker
Thank you. We don't have very much that gives in the fair value accounting.
The vast majority of what we have in capital markets and just being in a level 1 asset I believe, we don't have very much in getting to level 2 or level 3. In fact, I can't think of anything right now off the top of my head of any significance.
Chris Marinac
That's great. And then just a follow-up.
On the other portion of securities, Bryan, how much is in trust preferred securities and things like that and were there any marks there, I don’t know, it maybe washed out by other gains, but just curious also how that may have played out with the change in the capital markets?
Bryan Jordan
The only capital markets numbers included -- we had about, if you pull out the correspondent side of the business, which had some provisioning in that that rose in the capital market business, the capital markets business, fixed income sales, pool trust preferred business, et cetera, et cetera, we have about $30 million pre-tax. Embedded in that is a net LOCOM adjustment only of $360 million inventory of pool trust preferred assets of $24 million.
So, the business did $30 million after a $24 million LOCOM adjustment on pool trust preferred. We haven't really booked any new pool trust preferred asset.
That's the inventory that's really being carried forward since the fourth quarter of this year. It's still a soft market for CDO.
We still think the collateral value is good. And if you run the math, on the yield to maturities with the reserves we got to set aside, it has got very very attractive yields.
But we think that inventory is better than the March and we think over time that will come back. If you look at it in terms of the way we grade the loans, we are still very very high graded from a grading perspective albeit in the top 4 or 5 grades of our risk rating system out of the say 15 or 16 grade risk rated system.
So the quality is good. It's really just a mark based on interest rates and spreads.
Operator
Our next question today is from Kevin Reynolds with Janney Montgomery Scott.
Kevin Reynolds
Good morning, gentlemen.
Bryan Jordan
Good morning, Kevin.
Kevin Reynolds
We hate to keep going over the same things over and over again, but I would like to ask this question so if you can answer it. For several years, the concern has been that loan loss reserving maybe was blamed on the accountants but the reserves and provisioning practices were inadequate or potentially inadequate should the economy turn.
Now the economy has turned. We got a national portfolio that seems to be deteriorating rapidly right before our eyes.
As in my calculation I see the national portfolio or the $4 billion portfolio, the expected runoff is about 11% non-performers right now combined. And it seems again, correct me if I am wrong, it seems that the $2 billion runoff is sort of the hopeful runoff, the loans that can't find another home would go find another home and you would be left with $2 billion of loans that may not be able to find another home.
Thus, there is actually more risk in the portfolio potentially than it appears today. How do we get confidence today that as we go forward that you have got your arms around the credits?
In the last quarter we heard, we looked at every loan, we re-graded every loan, we added reserves, we think we got our hands around it or arms around it. They are all hearing it again.
How do we get confidence in that for next quarter that we are not going to see the same kind of thing? And I know it's a tough question to answer but I just feel like for what I am saying that it needs to be asked.
Bryan Jordan
Yeah, Kevin this is Bryan again. Clearly, the loan loss reserve modeling in most environments is more art than it is science.
And when you get into these extreme loss environments like we seem to be in now, further out on the tail per se, modeling becomes much more of an art and much less of a science. So we look -- we go through the modeling, we go through the build out then we get the input of our internal credit folks, we look at it from accounting perspective, we get the handful of extra lawyers and regulators and others and we try to make our best estimates of what those reserves are.
But I will go back to our One-Time Close portfolio, and you are absolutely right that over time the good loans will most likely modify and go into the secondary marketers and something or/and you will see more problem if this lingers all the while. But as I said earlier, if you look in the aggregate, we get about 6.4 to 9%, it’s above $118 million reserve set up on One-Time Close.
That essentially based on the severities we've assumed that we have seen something in the 20 to low 20s depending on the market to the high 28, 29, 30% level in some of the more severe markets. So you will see, just take a mid point of 25% severities, you can have something like 25% of that entire portfolio go into the fall and incur 25% kind of a loss rate.
So yeah, I will note what trigger out over time is what those real severities are, but 25% seems pretty severe estimates in this environment as we see it today and only time will tell.
Gerald L. Baker
I will add on to Bryan's response, because I think this is important, we believe that we need to continue to identify any problem while and we have encourage our relationship managers to be aggressive in doing that. As soon as we recognize the potential problem, the better opportunity that we have to work it out or get into action.
So you are seeing slowly elevate the amount of aggressiveness if you will and doing that throughout all of our relationship manager portfolios. So I think that's important to keep in mind in terms of staying inside of it and we have turned even the non-performing loans into what I would call a professional work out people to maximize recovery rate and work through the problems on the back-end.
So we are not originating anymore that portfolio so how we manage those assets now and how we identify problem loans is important and I think that the team is fully focused on doing that and that’s the reason why you are seeing a big increase quarter-over-quarter.
Operator
Our next question today is from Keith Horowitz with Citi.
Keith Horowitz
Good morning guys.
Gerald Baker
Hey Steve.
Bryan Jordan
Good morning. How are you?
Gerald L. Baker
Hey, Keith.
Keith Horowitz
How are you?
Gerald L. Baker
Okay.
Keith Horowitz
I am sorry. I was a little late on the call.
So if you so to say I apologize. Do you topple that the kind of appraisals, do you have any sense on what percentage of your construction loans have kind of appraisals within the live kind of 3 to 6 months?
Bryan Jordan
3 to 6 months, most of them are going to be originated less than 12 months, so it's going to be a fairly half percentage within a year. Anything that is of a nonstop spanner level non-performing, we have got current appraisals on those.
As I think Kevin or somebody pointed out earlier, you might get 11% or so during non-performing, which we have got very reasonable prices on, but given the nature of a construction portfolios and the fact that they generally have somewhere between 9 and 15 month wide, the appraisals process is fairly current.
Keith Horowitz
Okay. On your breakout where you show your allowance for the National Specialty Lending?
Bryan Jordan
Yeah.
Keith Horowitz
The allowance for the Homebuilder portfolio nationally is 3.5%?
Bryan Jordan
Right.
Keith Horowitz
The charge-offs were 7.5 in the first quarter and 4% in the fourth quarter, the allowance of the non-performing loans is 0.2, allowance charge-offs is 0.5, those reserves are little bit late, why do you have comfort in that reserve?
Gerald Baker
We have -- one way, this is true of the vast majority of our non-performing assets and it may be we came in at the size of the -- there are some things in non-performing asset category. Generally speaking, we have charged those down to net realizable values so that means we have taken a fairly estimate to value, its appraisal on collateral dependent loans, or other measures and charge them down to what we believe are net realizable values or appraised value as to the selling company.
So in that homebuilder portfolio, those non-performing assets have been charged down to net realizable value that are non-performing today and we went through very detailed analysis in the fourth quarter, the first quarter. So the reserve levels are really for what is the performing asset portion of that portfolio.
Operator
Moving on, we will take our next question today from Fred Cannon with JBW.
Frederick Cannon
Thanks. I wanted to ask about your unused home equity commitments.
Particularly from Bryan’s comments; I am kind of getting right now about $7 billion of outstanding unused commitments. I want to see if you guys could talk about how you are managing those, whether you are cutting those lands to certain borrowers and do you have a reserve against that?
And I asked this because as you try to wind down these portfolios, the home equity portfolio continues to grow. In part, I would imagine because you have a fair amount of outstanding unused loans.
Bryan Jordan
Fred, this is Bryan. The national home equity portfolio is a mixture of lines and loans.
We have got about 4 to $5 billion or $4.5 billion of unused lines in that portfolio. We have -- historically we have managed lines and limits of lines based on appraised values, quality performance, delinquency standards and so we are continuing to look at lines and where we have home price depreciation.
We are looking at lines where we have borrower delinquency and where appropriate, we have the ability to reduce the level of those lines.
Frederick Cannon
So you are actually doing that and we have heard other national lenders such as Washington News for actively sending out letter and reducing lines, even that -- in that process today doing that in places where home prices have declined?
Bryan Jordan
In word, yes, we are not doing it reflexively across the Board, but we have taken a thoughtful approach and looking at it, even more particularly in Tennessee, where 30% of our home equity loans are really in the State of Tennessee, but yes in a word we are looking at those lines, and we would have been very proactive in how we address that.
Operator
Our next question today is from Howard Chapman with Columbia Management.
Howard Chapman
Good morning. Could you brush up funding requirements for the remainder of the year?
Bryan Jordan
Yeah. We have -- over the past several quarters, we have addressed, we have a fair amount of short-term funding roll off.
We put it in the longer-term sources. We have a little bit of maturities in the back half of this year as we estimate available sources, we have got more than adequate liquidity to address continued refundings of the balance sheets particularly as we look at reducing the size in order to get balance sheet that has dollar per dollar reduction benefit and the need for wholesale fundings.
So we have got more than adequate liquidity to fund, maturity over the next while.
Dave Miller
Can we take the next question operator?
Operator
Thank you. And we will take that question from Heather Wolf with Merrill Lynch.
Heather Wolf
Hi there.
Gerald Baker
Hi Heather.
Heather Wolf
Bryan. Just a clarification.
When you are talking about the reserves being able to withstand 25% profitability of defaulting 25% loss severity. Can you break that down into hillock One-Time Close and construction for us?
Bryan Jordan
Yeah. I didn’t mean to -- maybe I got my language confused, but that’s what I was talking about was specifically the One-Time Close portfolio.
Heather Wolf
Okay. Can you give us some color around construction and home equity as well?
Bryan Jordan
Well, construction you've got about 3.5% reserve levels, home equity in total you got to be about 21 and 21.5% reserves and so you can sort of back in to that based on the severities. I will get the calculator out and do the math later.
I hate to do it here.
Heather Wolf
Sure. I see what you are saying.
So, you're using 20 to 30% severity portfolios roughly?
Bryan Jordan
No. Those -- that's OTC.
Heather Wolf
Okay.
Bryan Jordan
That's OTC. It depends -- I think there is a page in the supplement, I think it's like 30 or 31 that shows you by state, home equity to show you by state the loss severities we see.
And so the home equity portfolio if I recall quite correctly the highest loss severities we've seen have been in the states of Virginia and Florida in that order I think. But we showed you the severities in the supplement by market, by product so you get a handle around that.
Heather Wolf
Okay. And on the construction portfolio, are you thinking severities around the same level?
Bryan Jordan
In terms of the One-Time Close, it depends on the market for all of these portfolios. And even in the home builder side of it, it depends on the market.
In the middle part of the country, you're seeing lower severity of losses. In parts of the country like California, Florida, you're seeing higher severities.
So we're trying to differentiate by market. So generally, we're thinking something in the -- depending on portfolio in that 20% range, 20% plus.
Operator
And we do have a couple of minutes remaining for questions. We'll go next to John Newell with Barrington.
John Newell
Yeah. Hi guys.
Bryan Jordan
Good morning.
John Newell
I was wondering on the reduction in the mortgage servicing rates that comes from the change in the evaluation model inputs. You got a consolidated number of 258 million or 259 million.
Does that does run its way through the income statement?
Bryan Jordan
It does, but it's offset by the impact of the hedge.
Gerald Baker
So part of that’s going to be the MSR sale that we talked about, part of it's just going be the change in the value of the MSR due to interest rates and so there is going to be an offset to the hedge. David, you want call me I can take you to the geography on the P&L.
Operator
And we will go back to Bob Patten with Morgan Keegan with a follow-up question.
Robert Patten
Hey guys. I was going through my notes.
I'm looking -- following up on Steve's question on the mortgage company. Obviously Gerry says there is value.
The first part of the strategical term is we're not going to shut it down because there's value there. So that flips you over to so what is the value and what is the value in this market?
And I'm just going to ask you guys where are you trying to sell the mortgage company? And if you did, the full par, what would be net impact of this company in terms of capital freed up in terms of earnings and the balance sheet shrinkers?
Gerald Baker
Well Bob, as there is value in it, we have been looking and looking for strategic partners. We think that’s certainly an option.
And I do think that we -- if that were to occur, we would have -- the benefit of course is freeing up the warehouse from our mortgage portfolio of $4 billion on a monthly basis. So when you think about it in those terms, it has a big pick up to reducing the balance sheet.
Bryan Jordan
We've talked about mortgage in fair amount over the last 6 to 9 months and the one thing we've tried to convey is that we think we need to get the business smaller. We need to reduce the size of the servicing assets.
And we try to be careful not to take any options off the table and we're looking at strategic alternatives. We're trying to manage our way through a difficult environment in the business.
But as Gerry said we've got a good business. It is a good management team and they have a very good platform.
But it’s a big asset to our balance sheet and creates a lot of volatility. The easiest way to do the math is you've probably got on the balance sheet somewhere between 6 and $6.5 billion of assets associated, we would call it $4 billion in the origination side and a couple of billion or so in the servicing side.
And so bigger capital ratio that you want to work off, but if you work off of a tangible capital ratio and pick something to 20 or say call it 6% to make it easy math and $6 billion you get free up the $360 million of capital by reducing the size of that balance sheet.
Operator
Mr. Patten, anything further.
Robert Patten
No, thank you.
Operator
Great. Thank you.
Gerald Baker
Thanks Bob.
Operator
And there are no further questions at this time. I would like to turn the conference back over to Mr.
Baker for concluding remarks. Please go ahead, sir.
Gerald Baker
Thank you very much. We appreciate everyone's interest in calling in.
We continue to stay focused on building our Tennessee Bank and improving our shareholder value over time and we look forward to sharing with you over the coming quarters our progress and realizing that. So thank you very much.
Operator
Once again that does conclude today's conference. I would like to thank everyone for joining us and wish you a good day.