Jul 17, 2008
First Horizon National Corporation (NYSE:FHN) Q2 2008 Earnings Call Transcript July 17, 2008 9:00 am ET
Executives
Dave Miller – IR Jerry Baker – President and CEO Greg Olivier – Chief Compliance Officer Bryan Jordan – EVP and CFO
Analysts
Steven Alexopoulos – J.P. Morgan Kevin Fitzsimmons – Sandler O'Neill & Partners Paul Miller – Friedman, Billings, Ramsey & Co.
Anthony Davis – Stifel Nicolaus & Company, Inc. Christopher Marinac – Fig Partners Ken Zerbe – Morgan Stanley Heather Wolf – Merrill Lynch Tom Purcell – Viking Global Investors Eric Wasserstrom – UBS Bob Patten – Morgan, Keegan & Company
Operator
Good day and welcome to this First Horizon National Corporation’s Second Quarter Earnings Conference Call. Today's call is being recorded.
In addition, you can listen simultaneously at www.fhnc.com at the Investor Relations link. (Operator instructions) Mr.
Miller, you may begin.
Dave Miller
Thank you, operator. Please note that our press release and financial supplement as well as the slide presentation we’ll use this morning are posted in the Investor Relations section of our Web site at www.fhnc.com.
Before we begin, we need to inform you that this conference call, which may include guidance, involving significant risks and uncertainties. A number of factors could cause actual results to differ materially from those in the forward-looking information.
Those factors are outlined in the recent earnings press releases 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. Also, please remember, that this webcast on our Web site is the only authorized record of this call.
This morning’s speakers’ include our CEO, Jerry Baker; our Greg Olivier, and our CFO, Bryan Jordan. With that I’ll turn it over to Jerry.
Jerry Baker
Thank you, Dave, and good morning. Given the turmoil in the market through yesterday, we determined that it was appropriate to release earnings earlier than planned, so we did that last evening rather than wait until Thursday.
As always on these calls, we will discuss our strategic direction and review our financial performance trends, and given the importance of providing clear direction regarding managing asset quality, Greg Olivier will review current asset quality trends. At the end of our formal comments, Bryan, Greg, Dave and I will take your questions.
Our market conditions including economic, credit and housing related issues continue to impact our results. We see progress as we execute our refocused strategy and second quarter results were generally in line with expectations.
We did build additional reserves and earnings were a loss of $19 million. Bryan and Greg will provide more detail, but let me first provide a brief strategic overview of the second quarter as shown on slide 4.
During the quarter, we bolstered our capital position by issuing $690 million in new common equity to better navigate through the persistent economic risks as we liquidated our national real estate portfolios. With this added equity, we should be able to avoid returning to the market for additional capital.
We contributed $610 million of this new capital to First Tennessee Bank boosting its strength as well. We also replaced the quarterly cash dividend with a stock dividend until the operating improves.
We reduced our balance sheet by nearly $2 billion over the quarter, there in by to wind down of our national businesses and we expect roughly $4 billion of additional contraction by year end, and as a result, our capital ratio has improved significantly in the second quarter and should continue to improve as the balance sheet tracks [ph]. We also entered into an agreement to divest our mortgage business other than in our Tennessee markets.
We are selling our origination and servicing platforms as well as $20 billion in servicing to MetLife. The transaction should close during the third quarter and transition activities are progressing as planned.
They’ve also contracted to sell additional MSR’s, which should reduce the total servicing portfolio to about $65 billion by the end of next quarter, and by the end of the year, as a result of these transactions, we would expect our balance sheet and mortgage to decline further, driving the previously mentioned balance sheet contraction and creating up capital. We continue to wind down our national real estate lending businesses, and as a result, our National Specialty Lending real estate portfolio contracted by more than $400 million over the quarter.
We expect this portfolio to contract another $600 million or more by year end. We are actively managing problem loans, and despite weakening housing market conditions and the strain on borrowers and consumers, (Indiscernible) energy costs and a slower economy, our 2008 expectations for losses in our loan portfolios remain within the previously communicated range of $385 million to $485 million.
We continue to proactively and aggressively review our portfolios, recognize losses on non-performing loans quickly. And when collateral dependant, write them down to net realizable value rather than reserving for them.
As a result, on average, non-performing loans have been written down by about 20%, which is 40% below appraised value. And we also continue to ensure that we have adequate reserves for losses, and therefore increased reserves this quarter by an additional $90 million, strengthening coverage to 2.6%.
While all these matter are being actively managed, we have at the same time remained focused on our two core businesses, regional, retail and commercial banking and capital markets. These two businesses continue to show good trends, even as we prudently provide for loan losses.
Our capital markets organization continues to benefit from the rate environment, and strong penetration of targeted financial institutions. We are successfully managing through the challenges of the trust preferred market.
And there was no low comp [ph] this quarter, but we did elect to move our inventory of trust preferred loans from held for sale to held to maturity. In our regional banking, we sold remaining out of Tennessee market branches, but we continue to invest in new branches in Nashville, Noxell, and Memphis.
As a result of these and other investments, our core regional banking franchises continue to gain customers in targeted segments. Recent third party surveys indicate that we continue gain customer share across most Tennessee metros as you can see on slide 5.
However, June FDIC data will show a decline of roughly $5 billion in deposits due to intentional reduction of high cost wholesale funding in the Memphis bank. That’s the result of our strategic decision to reduce national lending and not due to any real decline in our market share or core customer deposits.
Let me conclude on slide 6. With our priorities for the balance of 2008, which remains as we have communicated previously.
We are standing on plan to improve capital ratios and reduce balance sheet risk. We are aggressively managing our asset quality problems, recognizing losses and maintaining the full engagement of our workout resources.
We are winding down our real estate businesses. We are eliminating infrastructure cost associated with liquidating those national businesses, and we are maintaining our focus on building on our strong regional banking franchise and continuing to diversify our strong capital markets business.
Much has been done over the last 15 months, and we have also strengthened our organization in key positions. So, as we announced last evening, we have been developing my succession plan over the last several months, and we are ready to execute that plan.
I believe we can move forward with great confidence as Bryan takes over as Chief Executive Officer in September. And he and our team together execute our focused strategy.
We have done a lot of heavy lifting, but today’s First Horizon is far different, far stronger, better positioned company. We still have work to do.
But I know that Mike Rose, the Board, Bryan and I believe these efforts will pay off. With that, let me turn it over to Greg Olivier.
Greg?
Greg Olivier
Thanks Jerry. I’ll begin with the asset quality overview on slide 8.
Charge-offs in the second quarter totaled $128 million. Provision expense this quarter includes a reserve build up of about $90 million, driven by great deterioration in the commercial loan portfolio and by higher loss severity rate in home equity, which offset favorable delinquency trends in that book.
This increased our coverage ratio to 2.59% into 3.33% for liquidating national specialty lending segment. NPLs increased with inflows in the second quarter about equal to inflows in the first quarter of 2008.
Perhaps more importantly, our outlook for full year 2008 net charge-offs remains within the expected range of $385 million to $485 million, which we outlined almost three months ago. Turing to slide 9, we are actively managing the asset quality of our June – of our $22 billion loan portfolio, which this slide shows by major category.
Our national specialty portfolios represent a lion’s share of problems which we continue to attack. We’ve remained aggressive in identifying problem, recognizing losses by writing most non-performing loans down to net realizable values and adding to our work out resources.
I’ll walk through what we are doing and seeing in each of our portfolios starting with consumer. On slide 10, gives an update of our discontinued one time closed portfolio, which we continue to work down.
Commitments are down 35% and balances are down 25% from the first of the year. This has been accomplished by putting resources in place to keep pace of the portfolio’s performance, most importantly by adding experienced and always dedicated to mediation [ph] efforts.
Performing prime jumbo loans on which construction is complete and forwards there is no secondary market are being moved to the balance sheet. So far about $200 million of these loans have been taken to the permanent portfolio.
Second quarter losses were somewhat higher than expected, influenced by our focused effort to clean up a pocket of problem loans in Florida. Our 2008 OTC loss expectations remain well within the range previously communicated, but keep in mind this is a stress portfolio with potential for some variability given aside some of the commitment.
Moving to home equity on slide 11, we continue to believe our portfolio is better than average in quality relative to the industry. As a reminder, this portfolio is 85% retail originated, 27% is in the state of Tennessee, 26% is (inaudible), 54% is 2005 or earlier vintage, and 45% are fixed rate loans.
We did see an increase in losses during second quarter. So, let me explain why on slide 12.
Delinquency trends in our home equity portfolio have been favorable as total delinquency has decreased in every month since reaching its peak in February, beyond 18% in absolute delinquent dollar at June 30. However, home equity losses for the quarter were larger than anticipated, primarily due to two factors.
First, the delinquency peak in Q1 working its way to loss and second from increased loss severity, particularly in the national footprint where home prices have fallen more and where we have less first line product. Additionally, we modified loss recognition practices on certain accounts resulting in a one time $6 million increase in charge-offs in the month of May.
Losses were driven by home equity loans and high-risk national markets, home builder [ph] loans and (inaudible) valued loans. Going forward, we have remodeled home equity loss expectations, assuming 100% of our 150 to 180 day accounts, wrote the charge-offs so as to reflect the increased severity being observed.
Given these more conservative assumptions, revived modeling indicates that our home equity losses for 2008 could be roughly $20 million above the previous range that had been communicated. Therefore, we determine that it was necessary to include provision expense and accept the charge off this quarter in order to maintain appropriate reserve level.
Given the rapidly evolving market, we continue to refine our loans modeling, while a number of eluding factors makes prediction difficult, the performance of our portfolio indicate cumulative loss assumptions remain well within the range previously communicated. Slide 13, is an update on our residential CRE or home builders finance portfolio.
As you will remember, we discontinued our national home builders finance business in January, choosing to maintain that line of business only within our traditional regional bank. National commitments and balances are down significantly.
We are on track, have an outstanding of about $1.5 billion in total and below $1 billion in the national home builder book by the end of 2008. The home builder portfolio continues to deteriorate as NPLs increased second quarter although the absolute dollar increase was less than in the prior quarter.
Let me make a point here about the issue of interest reserves, which continues to be a hot topic. 28% of our national residential CRE loans have interest reserves, but these loans are not kept current, so we did to these reserves, rather we regularly review borrower conditions in loan covenant, placed in loans are non-performed status based on those factors.
Charge-offs in the total residential CRE book were within expectations during the second quarter, and are expected to remain so through 2008. Moving to slide 14, national markets continue to drive the majority of problem loans.
In the second quarter, we again conducted detailed portfolio overviews to ensure grading keeps pace with weakening market condition. This let us to increase the loan loss reserve again this quarter while also continuing to write down FAS-114 loans to net realizable value.
On slide 15, the C&I in commercial real estate portfolios are feeling the effects of the poor economy. We see continued loan grade deterioration (inaudible) problems but it had some success moving early stage problems out of the bank to alternative financing sources.
C&I in income fee charge-offs were at expected levels in Q2, and are expected to continue to perform as forecast for the remainder of 2008. Employees in the regional banking footprint continue to find business opportunities and support customer relationships, but an increased focus has been placed on credit risk management to the broad weakening in the economy.
So, throughout our loan portfolios, we have reinforced problem identification protocols and processes, enhance our mediation capabilities and continue to recognize losses aggressively. As you can see on slide 16, substantially all of our impaired assets greater than $1 million are considered collateral dependant and written down to net realizeful value.
A percentage of appraised value, net of disposition cost. On average, we’ve already written these loans down by about 20% below their pre-charge down balance, and about 40% below appraised value.
We hold no reserves again collateral dependant FAS-114 loans, as we proactively recognize their expected loss content. For this reason, reserves to NPL ratios for institutional are less meaningful, and for institutions that do not follow the spreads.
In the second quarter, we also began to see an increase an early stage asset disposition activity as investors are beginning to engage the process. In summary, on slide 17, we continue to believe that 2008 total charge-offs will fall within the previously communicated range $385 million to $485 million with moderately higher losses than expected in our home equity portfolio.
Now I’ll turn the call over to Bryan, who’ll discuss second quarter financial results.
Bryan Jordan
Thank you, Greg, and good morning everyone. As highlighted on slide 19, earnings per share in the second quarter were a loss of $0.11 per share, or $19 million.
Fees and net interest income, excluding securities transaction grew as our net interest margin expanded 20 basis points. Pretax income was a loss of $48 million, excluding provision, pretax income was a positive $172 million in the quarter, with our core businesses contributing the majority of that amount.
The provision decreased linked quarter to $220 million. Capital ratios improved significantly and tangible book value ended the quarter at $12.52.
Slide 20, shows that earnings were impacted by handful of other significant items. Our efficiency and restricted initiatives resulted in $16 million of employee and other costs associated with exiting the national businesses as well as a transfer of cost of $10 million on mortgage servicing sales.
We expect $35 million to $50 million of similar charges in the second half of 2008, as the mortgage sale to MetLife and additional book servicing sales are completed. Two other items deserve mentioning.
First, a positive impact. We had a gain from the repurchase of $152 million of bank note and second, we increased repurchase reserves for home equity and mortgage loans by $25 million.
Repurchase requests have risen, and although we are successful in resolving those, higher repurchases are likely going forward. Slide 21 shows our balance [ph] trends and outlook.
We reduced assets by almost $2 billion from March 31 to June 30. Loans (inaudible) decreased due primarily to our move in roughly $380 million of trust preferred loans, $330 million of prime jumbo mortgages and the unsold First Horizon bank loans into loans held to maturity.
Loans held to maturity declined as reductions in our wind down national portfolios more than offset increases associated with held for sale loan transfers. While MSRs increased in the quarter due to higher valuations driven by slower prepaid (inaudible), this increase was offset by reductions in related servicing asset such as (inaudible) and hedges, and also by servicing sell this quarter.
We expect assets to decline by $3.5 billion to $4.5 billion as a result of continued contraction of real estate loans, international specialty lending businesses, the MetLife transaction including their purchase of $20 billion in servicing and related assets, continued bulk servicing sale, and the orderly liquidation of our remaining mortgage warehouse. The net interest margin improved this quarter as a result of lower wholesale borrowing cost, the benefit of free funding resulting from a capital raise and fewer HFS reversals on non-accrual construction loans.
Over the near term, the margin will be influenced by the change in balance sheet dynamic associated with investor mortgage asset, but should remain above first quarter level. Longer term, the margin should be positively influenced by the reduction of lower margin business assets and the core banks assets sensitivity position, heading into a likely rather than short term rate environment.
Slide 22 highlights our capital ratio has improved significantly during the second quarter, as out tangible common equity to tangible to assets improved by 191 basis points to 7%, while tier one capital improved by 214 basis points, 10.4%. These ratios should build further through the end of 2008.
All other things being equal, $4 billion by year end 2008, our balance sheet shrinkage would improve our tangible common equity tangible asset ratio by approximately 90 basis points. As Jerry mentioned, our capital position and balance sheet actions give us the ability to withstand significantly higher than expected credit losses, should the economy significantly worsens.
This slide illustrates that, assuming $4 billion of balance sheet shrinkage and no-cash dividend and using brokered pre-provisioned estimated for the remainder of 2008, our tangible capital ratio would improve to about 8% with $200 million of provisioning for credit losses in the second half of the year, and tangible book value would remain essentially flat to second quarter’s $12.52. At these levels, we’d have a significant amount of excess capital based on any capital ratio used.
Now I’ll move on to the highlights from our business segments. Slide 23 shows that our regional banking total revenue increased 3% linked quarter, reflecting our refocus on driving customer growth.
For instance, deposit fee income increased 10% sequentially. The bank’s net interest margin stabilized, helped by our slightly less competitive environment and targeted deposit rate adjustments.
Expenses were flat sequentially and declined year over year, driven by ongoing efficiency efforts, including the successful divestiture of our outside of Tennessee First Horizon Bank. We recognized that more work is needed to further reduce our infrastructure costs.
Second quarter, pre-tax provision, pre-tax pre-provision income increased sequentially to $62 million, although continued provisioning drove a pre-tax loss of $27 million for the quarter. Slide 24 recaps performance in capital markets, which had another good quarter.
Pre-tax income increased sequentially to $24 million. Fixed income sales remained strong, although reduced market volatility resulted in a decline from first quarter’s record low.
Other products revenue improved primarily due to the valuation adjustments recognized on the trust preferred warehouse in the prior quarter. Despite ongoing strong demand from a financial institution client base to raise capital to trust preferred issuances, investor demand for such products remains largely non-existent.
Accordingly, during the second quarter, we elected to move all of our trust preferred warehouse loans to held to maturity status. These loans still held in raw loan forms rather than securities are both geographically diversed and granular, representing approximately 40 individual bank and insurance issuers from around the country.
The transfer was an economically attractive decision giving favorable yield and the low-comm mark of roughly 10%, we had already taken on these loans. We are currently operating accrued trust preferred business on a best efforts basis going forward.
We remain focused on managing the cross fund of banking credit portfolio, while still recognizing the value of this business overall. We have approximately $1.3 billion of correspondent banking loans, and we are focused on relationship customers with whom we have non-lending business.
Turing to mortgage on slide 25, pretax income for the second quarter was $69 million, an improvement in operating results from first quarter, which included $40 million benefit from accounting changes. The improved results were driven by higher gain on sale margins largely resulting from an increased mix of government loans, better-than-expected originations as ongoing low rates continue to drive refinance activity, flat expenses and continued favorable net hedging performance.
We’ve also tried to give you a better view of the earnings comp position of this segment. Looking at the table in the bottom right, originations drove roughly $27 million of pretax income including production revenues, expenses as well as net interest income from our warehouse and small permanent loan portfolio.
Servicing produced $43 million of pretax income through servicing fees, net of runoff expenses and net interest income from IO’s, custodial balances and $3 million of our small portfolio of permanent mortgage loan. As we complete the MetLife transaction, we expect that revenues and expenses with origination will largely be eliminated, while earnings from servicing and permanent loans will remain, but should decline naturally over time and as we self-servicing.
We expect asset in the mortgage business to decline another $3 billion to $4 billion over the remainder of the year. In summary, First Horizon has a refocused, well thought out viable business strategy in place.
We’ve made good headway in implementing needed changes, and strengthening our position in the second quarter. We are aggressively identifying, reserving for, and charging down problem loans and our expectations for losses in 2008 remain within the range of our prior expectations.
We have a strong core business in regional banking and capital markets. We are divesting our national mortgage business and reducing its balance sheet usage.
We are shrinking our national lending portfolios in mortgage business to further reduce the balance sheet. We continue to focus on driving down expenses and being an increasingly efficient organization, and finally we are improving our capital ratios and reducing balance sheet risk.
We still got work to do, but we are excited about the opportunities that lie ahead. I’m honored to leave the continued successful transformation of our company with our talented hard working employees, and experienced management team, I’m confident that First Horizon will succeed in building a highly profitable, dominant regional franchise.
Thanks and operator, we’ll now take questions.
Operator
Thank you, Mr. Jordan.
(Operator instructions) Our first question comes from Steve Alexopoulos, J.P. Morgan.
Steven Alexopoulos – J.P. Morgan
Hi, good morning every one.
Bryan Jordan
Good morning.
Steven Alexopoulos – J.P. Morgan
First question, if you look at the $876 million of non performers, what portion of those have been written down to the net realizable value?
Bryan Jordan
Steve, there’s a schedule in the financial supplement that shows that paid I think upon page 31 – I’m sorry – bear with me, we got a total – I’m sorry it’s given in the slide presentation on slide 16 will show you the FAS 114 loans, so it’s up $370 million or so that are in the FAS 114 process, and $334 million of those have been charged down to net realizable value. The balance will have a reserve against them for what we think is the loss content.
Steven Alexopoulos – J.P. Morgan
The $334 million of the $876 million, in other words?
Bryan Jordan
That’s correct. The balance – so that gets – that from a commercial side NPLs it’s get you about $376 million, and the balance of that’s going to be OTC.
And then in the OTC portfolio we talked about our charge-off policies I believe in the last page of the supplement. In 90 days, we moved those to non accrual, we write them down to appraise the value at that point in time, and then write them down further 180 days.
Steven Alexopoulos – J.P. Morgan
Bryan, do you expect at this point to match provision to charge-offs for rest of the year? Or do you think at some point, you might start using the reserve to cover losses?
Bryan Jordan
We expect it to turn. I’m not certain that it would be in the last half of this year.
It’s just here today, I think we would match, at least match charge-offs over the remaining six months of this year. We expect that to turn sometime in 2009 as we reach the end of the life on the portfolios in home builder finance and one time close.
Steven Alexopoulos – J.P. Morgan
Perfect. And just final.
Do you expect the delinquency trend in home equity to continue to decline here in near term?
Jerry Baker
I think that’s a great question. We keep watching that.
In fact, I looked at the delinquency trends this morning through yesterday for the month of July, and they are about flat to June. So, that’s going to be heavily influenced what happens to the economy, we are pleased with the trend we’ve seen so far.
We are certainly hopeful they continue but time can tell.
Steven Alexopoulos – J.P. Morgan
Thanks guys.
Bryan Jordan
Thank you.
Jerry Baker
Thanks Steve.
Operator
And our next question comes from Kevin Fitzsimmons – Sandler O'Neill.
Kevin Fitzsimmons – Sandler O'Neill & Partners
Good morning everyone.
Bryan Jordan
Good morning, Kev.
Kevin Fitzsimmons – Sandler O'Neill & Partners
Good morning. Just looking at page 22 of the slide deck, you outlined the capital ratios and your outlook that are going through that you expect the capital raise to strengthen, yet you have tangible book value per share really staying even.
And then if you could just talk through that, is that just a matter of shrinking the balance sheet and essentially may be your outlook for pretax, pre-provision earnings just basically being an up to match the expected provisions and any restructuring charges that we’d expect?
Bryan Jordan
Yes. Kevin, this is Bryan.
That’s a mechanical thing. What that reflects is the fact that sheer count will go up with the payment of our dividend and stock in the third quarter in the declaration in the fourth quarter.
All of that gets reflected in equity. So, all it’s really doing – all things being equal, that number would go up based on the pretax, pre-provision earnings that we’ve used in this now, its’ $200 million are reserve.
What’s happening there though is the share count goes up as you reflect the dividend paid in stock dividend form.
Kevin Fitzsimmons – Sandler O'Neill & Partners
Okay, okay. Can you just also comment on, you noted that severity in home equity going up, if you can – if you have it in hear, and I missed so I apologize for that, but if you can go into just what specific states that you might be seeing more of that severity?
Thanks.
Jerry Baker
Yes, we talk in general in here about the national portfolio verses the regional bank on the bottom slide 12, bottom right corner. You get a view on the severities we’ve experienced by quarter, and you can see that in national specialty we are approaching 100%, so there’s a cap I guess on how bad that can continue to get to influence our numbers.
In our modeling, we’ve tried to incorporate that by low rate models, assuming that everything 150 rolls to charge-off, stimulating. It’s best possible in the low rate model, the pre-(inaudible) level.
Operator
Our next question comes from Paul Miller, FBR Capital Market
Paul Miller – Friedman, Billings, Ramsey & Co.
Can you guys go through because you guys that you’ve made a lot of changes, which I think all are very good. But how do we look at your company’s pretax pre-provision going forward?
Like what is the core earnings power of your company as we stand today because you are more big chunk in your mortgage bank, and your servicing would go away. And is there any other thing that you are looking to sell?
And the bottom line is what do you think is your core pretax pre-provisions on the businesses that you are going to keep?
Bryan Jordan
Well, this is Bryan, Paul. There are a lot of moving parts.
And as you highlighted, you highlighted a number of them, the changes in the mortgage business were certainly impacted in the short run, particularly as the origination business goes away. The servicing business will go away.
We’ll probably call it $65 billion servicing portfolio at the end of August when the mortgage transaction is probably completed. That’ll wind down over time.
You’ve got a fair amount of friction I would call it due to the higher level of non-performing assets that we’ve experienced today, part of it is the net interest income that were not earning, and part of it is the amount of infrastructure that we’ve appropriately built in credit and other areas of the organization to continue to work on problem assets. That will decline over time.
And then the other factor that’s not factored in today is the build up in – or assuming the remaining benefit from the divestiture of the First Horizon Bank branches, we’ve continued to take costs out of that. That coupled with the capital markets business and a banking business that did over $100 million in the quarter on a pretax, pre-provision basis, coupled with our efficiency initiatives efforts we have in place to get more efficient in the organization as we continue to structure.
I think give us a pretty solid foundation of the 100 to 125 range that we can achieve over the next several quarters as we work through these various initiatives.
Paul Miller – Friedman, Billings, Ramsey & Co.
And I mean you might not want to do this, but on your expenses, how much additional expenses per quarter are you spending on these workouts?
Bryan Jordan
Well, just in terms of direct expenses I think in the second quarter, our fore-closed property expense was not quite double [ph]. I think it went from $6 million to $10 million or $11 million, which you can see in the supplement.
And then the infrastructure cost probably run in the neighborhood of $2 million to $3 million a quarter to work though the process. All of that should wind itself down but right now it’s a reasonable investment to maximize the management and the portfolio.
Operator
And we are going next to Tony Davis, Stifel Nicolaus.
Anthony Davis – Stifel Nicolaus & Company, Inc.
Good morning, and congratulations Bryan.
Bryan Jordan
Thank you, Tony.
Anthony Davis – Stifel Nicolaus & Company, Inc.
Just following up on that question. Where are you right now in terms of run rate savings from the various initiatives as we sit here in the middle of the year?
Bryan Jordan
As we said here today, we are forming the initial $175 million of run rate savings. We’ve had an initiative ongoing since really the early part of this year to continue to reduce costs in infrastructure, first focus on the cost associated, the centralized cost associated with supporting our mortgage business and the national business and how we want that down as we want those business down.
As we look at the infrastructure and support functions for our operations in credit and capital markets, if you may bank and how we support the capital markets and banking businesses going forward. We think we’ve got additional opportunity to reduce costs and overhead, and although we haven’t tried to pin the tail on a target, that’s a strong area of focus for us, and we’ve made a fair amount of progress in identifying those costs over the last several months.
Anthony Davis – Stifel Nicolaus & Company, Inc.
I wonder too, what was the impact Bryan on the margin this past quarter of the truck [ph] transfer, that 20-point move was pretty significant?
Bryan Jordan
It really had – that didn’t have any impact to speak of. Those where in the margin last quarter, and we are not arcading the 10% we’ve taken on that.
So, that had no impact on the margin. The two big benefits were one, the reduction in wholesale borrowing cost, lower costs of fund coupled with margin management in the banking franchise where I think our bankers did an outstanding job managing deposit pricing, and then the third element would be about 2 to 4 basis points of improvement associated with the $690 million of capital that we raised.
Anthony Davis – Stifel Nicolaus & Company, Inc.
Got you. One follow up question, any time that you owned Fannie Marie, Freddy Mac exposures there in March [ph]?
Bryan Jordan
We don’t have any Fannie Marie or Freddy Mac preferred stocks. Our Fannie Marie, Freddy Mac securities are mortgage back passed through instruments.
For the most part I think 95% and 98%, but we don’t have any exposure to the preferred stock.
Operator
And we’ll take our next question from Christopher Marinac, Fig Partners.
Christopher Marinac – Fig Partners
Thanks. Good morning.
Bryan, curious if you could comment on the home equity portfolio from the perspective of the break out of each year’s vintage, and that which year is worse, which year is better, if you can color on that?
Bryan Jordan
Chris, I’m going to let Greg do that because he’s better at it, than I’m.
Greg Olivier
Hi, good morning, Chris. Yes, separating home equity since (inaudible) loans from home equity lines of credit.
Installment loans, the vintage performance going back to 2000 for some years that are lower, but it’s fairly consistent around 1% or 1.5% kind of that range or cumulative loss content. You see the difference in our HELOC vintages and our peak year for losses.
This point appears to be 2007, materially different from the other years. You look at HELOC is exclusively ’05 to ’08, we are looking at somewhere between 4% and 5% team loss on this four years line.
Christopher Marinac – Fig Partners
And then separately, Bryan, on the low comp adjustment for the truck [ph] loans, any of that get accredited later? I know it’s not part of the earnings now, but would that come over to (inaudible) of the loan?
Bryan Jordan
Yes. At some point that will come back in, and those securities or loans typically have 5-year no call period, where probably at a minimum a half year end of that, in some cases closer to a year.
The discount we’ve taken there as I mentioned earlier is roughly 10%. Right now it’s set up as a contra-asset, it’s not sitting in our loan loss reserve, but it essentially functions like a loan loss reserve on those securities.
But at some point, that will come back and earn but I expect that expect that to be down the road Chris.
Operator
And we’ll take our next question form Ken Zerbe, Morgan Stanley.
Ken Zerbe – Morgan Stanley
Great. Thanks.
I guess the first question I had, just in terms of slide 10, the (inaudible) the OTC construction loans down below $1 billion. Given that you seem to be moving, I think it was $200 million in the permanent loans in second quarter.
How much of that reduction to below $1 billion is going to come from sort of internal transfers as opposed to reducing the actual exposure?
Greg Olivier
Yes, good question. We created basically a score card for you was included in the national specialty segment, the permanent mortgages associated with one time close.
So, we intend to be pretty transparent about those that reach final stage, we end up having take you back to that, help maturing portfolio. We do anticipate the construction piece of that book to be $1 billion or below, certainly below $1 billion by the end of the year.
We do anticipate that we’ll move a portion of permanence in there. It’s been 200 so far.
The amount we have to move beyond that will vary based on market conditions, but we’ll keep track of that so every quarter you’ll see what the results of that that effort is. We are making a conservative effort internally and externally to encourage this permanent mortgage as to move elsewhere to incentive both sales staff and customers because it’s not our intent to create a massive permanent mortgage portfolio.
Bryan Jordan
Ken, this is Bryan. The scorecard Greg referred to is in the financial supplement, which is also filed this morning, page 30 I think.
Keep in mind these are loans that if modified, that gotten through the construction phase. They are loans that have modified in as a permanent phase, and essentially could be looked at as a new first mortgage loan.
The issue with them is the lock up in the jumbo market whether it’s fixed or (inaudible), and that there’s not really a favorable product today. So, that changes will be (inaudible) end of the market, but for the time being, it’s a converted first permanent mortgage, just got to go on the balance sheet until we can find a market that opens up for them.
Ken Zerbe – Morgan Stanley
Okay. That makes sense.
The second question I had was, yes, maybe it’s more of a qualitative question, but how can we get comfortable? How are you guys comfortable with your initial guidance remaining unchanged given the sharp deterioration that we’ve seen in the non-performing assets this quarter, and it was that increase planned for in your guidance last quarter, or what’s changing because I think over the last several quarters we have seen increase in loss estimate, early loss guidance.
So, I’m just wondering if that’s going to change going forward.
Greg Olivier
That’s good question. We certainly feel comfortable communicating through 2008 we will be within that range.
I think we all acknowledge and we’ll be in the upper half of that range based on what we’ve seen but your question on what within our heads we came up with the estimate three or so months ago, we did anticipate further deterioration of residential decree. We did anticipate the wind down impact of OTC.
We did anticipate, not as well as we should have, based on our comments this morning on home equity and where our loss expectations are in that portfolio. But I think we are comfortable saying we are in that range.
I think it's fair to say we will be in the upper half of that range right now.
Bryan Jordan
Ken, this is Bryan. I'll add to Greg's comment.
We would be the first to say we don't know what we don't know about where the economy is going to go and how things could play out from here. But, we believe we've got a head start on identifying and recognizing problem assets.
As you know, we have been building reserves. We got approximately $575 million of reserves built on our existing portfolio.
Greg and his team and our line bankers have been very proactive in addressing problem assets, identifying them, making sure that we are getting them graded properly and starting early on the resolution process. So, as we sit here today, we expected some further deterioration.
We expect that over the course of the year, and as we analyze what we think the loss potential, we still think, as Greg said, we can be in the range we discussed earlier.
Greg Olivier
Yes, a couple of more points on that. With things like the one-time close, portfolio becomes smaller and smaller every month and therefore somewhat easier to predict and manage.
On the commercial side, where you are seeing deterioration more recently and has sort of been a wave running through the portfolio, starting with residential for your homebuilder and starting to impact income in the C&I business. In those types of loans, there is more of an opportunity for a successful work-out strategy.
You have a cash flow stream that you can work with, so you can work the business that is being impact, for example, by commodity prices and work to restructure successfully, rehabilitate that credit. With the homebuilders a little more difficult that there is no appetite in the market and no financing for the appetite that might be there, there is far fewer resolution opportunities, of rehabilitation opportunities.
So, we expect a loss (inaudible) and some of the non-performing build that we have seen in the income, CRE and C&I portfolio to be less than what we have seen in the CRE portfolio, if that makes sense.
Operator
And we'll go next to Heather Wolf, Merrill Lynch.
Heather Wolf – Merrill Lynch
Hi, good morning. Bryan, I know you said that the pop in the gain on sale margin was due to a better mix of governments.
But when I dug into it, it looks like a lot of it came from trading gains, and I am wondering if you can kind of reconcile that for me.
Bryan Jordan
There was a little bit in trading gains just due to rate movements. And the other thing that I think is reflected in there is probably $6 million of gains associated with expiration of jumbo commitments.
But, largely, it was the benefit of having more government production a little north of 40% and it tends to price a little bit better at the end of the day.
Heather Wolf – Merrill Lynch
And does the higher mix of government impact the trading gains at all or is that really just in like the OMSR portion of it?
Bryan Jordan
It's mostly in the OMSR portion of it. The trading gain is really the positioning P&L that our hedgers and traders at the mortgage company execute.
Heather Wolf – Merrill Lynch
Okay. And then, just another question on the construction and one-time close portfolios.
Can you guys talk a little bit about the types of loss severities you are seeing for each of those portfolios and where you think those might go?
Greg Olivier
Sure, Heather. This is Greg.
I'll point you to slide 16 again and look at the – particularly at the bottom right, the chart's down information. We began to have some resolutions in the second quarter when we talked about the market becoming a little more active there and our resolutions are tending to come right at about what we have written exact that's down to – from small recoveries in some cases and some additional incremental charge-offs and others that by and large are coming about at the mark.
Most of the FAS 114 charge-downs account are residential CRE accounts. So, the marks we are taking, the 20% write-down to the book and 40% or so, 38% to appraisals is about what we are seeing things clear at.
That there is a lot of variability underneath that, though as you are aware, it is the land deal that is far bigger hit than that. If it sounds in a stable market, it is far better than that.
So, some variability there. On OTC, we continue to be right in the high 20% to 30% mark severity.
That continues to hold up pretty well.
Operator
And we'll go next to Tom Purcell, Viking Global Investors.
Tom Purcell – Viking Global Investors
Hi guys, just had a question on the earnings that you talked about earlier. Looking at the numbers, the $100 million to $125 million CRE provisions, I guess that gets to me that you guys are trading right now at about two times CRE provision.
Greg Olivier
Yes.
Tom Purcell – Viking Global Investors
That's all I had. That was a good quarter.
Thanks.
Bryan Jordan
Yes, thanks Tom.
Operator
And we'll go next to Eric Wasserstrom, UBS
Eric Wasserstrom – UBS
Thanks, I just wanted to circle back to asset quality for a moment. I'm looking on page 27 of your supplement and I'm just trying to reconcile what I'm saying here on the commercial C&I and the income, CRE delinquency in MPL trends with the loss guidance.
It looks like those portfolios are starting to feel some pressure just in terms it may look like in both cases MPL is at 50% to 100% and yet the charge-off rate is down in the period. So, I got two questions, one is, could you explain what’s occurring there in terms of the increase in MPLs versus the charge-off experienced?
And two, can you just reconcile it again with a go forward charge-off guidance?
Greg Olivier
Sure, and glad too. What we see – what we saw beginning in probably fourth quarter, first quarter of ’08 was an increase what we call a watch list accounts there, as we started to see deterioration in the early part of the year.
Watch list balances have actually neutralized a bit since March. March, April, May were relatively flat, slightly down in CNI.
So, we saw that partially because of market deterioration, partially because of the emphasis that we’ve put on getting loan grade, the accurate problems identified, kind of identification in first quarter end of the watch list, a bit of a neutral flow into watch. From that point forward, within a recognition once we’ve got a hand on watch list (inaudible) for problems we see from migration down to classified which is driving more provision based on the factors associated with substandard and special mention account.
Again talking about income CRE and CNI, there’s more resolution opportunities, a lot of these down grades have been driven. Some are being driven by structural weaknesses with covenant like deals, we’ve done a couple of years ago.
But a lot are being driven the impact to commodity prices. So, we feel that a lot of the businesses will have an opportunity to recover and rehabilitate from their current condition.
In any event, we take the resolution plans will be more protracted as we work through those things. So, the impact on third and fourth quarter will be as we forecasted.
But as those numbers build, there’s more of an opportunity to miss somewhat on this portfolio. At this point we still focus with those numbers.
Eric Wasserstrom – UBS
Okay. And just more specifically on the income CRE, obviously a lot of deterioration from you end.
Can you just discuss what’s driving that?
Greg Olivier
Well, I think there’s a couple of things driving that. One is the retail part of the income CRE book.
It’s been impacted the most as you would imagine because it’s impacted by roof tops more than any other segment. So, we think that’s been the primary stimulus there.
The other issue there is that the availability of permanent financing for income property has decreased with what’s happened in the market, so there’s more credit that gets to the end of construction and there’s an opportunity, the refinance opportunities gone, the market – the cap rates have increased as the value of the property if you are looking many permanent (inaudible) there has decreased if for the equity round is increased and that’s the struggle for some of the borrowers. So, it’s driven primarily from what’s happened at housing, it’s impacted mostly retail, but the – what’s going on (inaudible) market and income CRE’s also impacted that.
Operator
We’ll take our next question from Bob Patten – Morgan, Keegan.
Bob Patten – Morgan, Keegan & Company
Good morning everyone.
Greg Olivier
Hi, Bob.
Bob Patten – Morgan, Keegan & Company
Congratulations, Jerry and Bryan.
Jerry Baker
Thank you.
Bryan Jordan
Thanks, Bob.
Bob Patten – Morgan, Keegan & Company
Greg, the slide on 16, which shows the write downs of net realizable value, I just wanted to say it’s a good slide, but two I want to talk about the loan sale market and what values are today and how you are going to tie that together. Obviously, everybody is looking at MP [ph] is growing in absolute basis with very little activity going on in terms of loan sales.
What are you seeing in this market, and how aggressive can First Horizon start to get to mitigate that sort of the growth of the NPA number? Obviously with your write down aggressiveness, you could probably I guess the question is do you expect further marks in the NPA is based on current market pricing, that’s question number one.
Two, with the increase of fraud or home equity in mortgage repurchase agreement, are you seeing fraud occurrences increase? And then I guess just in general – I’ll stop there.
Jerry Baker
Okay. (inaudible) I started to trying to do just in my head, and I started to writing things down Bob.
First of all on the charge down slide, I guess your question is really about the loan sale market. We are starting to see more activity there.
So, I think investors are starting to become a little more – I guess both are meeting each other a bit. Institutions are willing to take more of a head to dispose the properties investors are willing to pay incrementally more.
So, you’ve seen the increase, I think from first quarter to second quarter, and that gap between what you’ve written an asset down to what an investor is going to pay for it is narrowed. So, I think that what’s driving some of the activity.
Bryan and I talk every week with our work out people and assess the viability of strategy for select loan sales, where we think it makes some sense. But Bryan I’ll let you comment, but I don’t think we intend to vary dramatically from our strategy of using that as a selective method to disposing off a bulk of assets.
Bryan Jordan
As we said here today, I agree with (inaudible).
Jerry Baker
Secondly, a question on increased incidents of fraud. It’s a question from a commercial side of things have not an increase in commercial fraud.
It’s about more on the mortgage side. I think on the home equity side, yes, I mean if you will get the types home equities that are having problems that tend to be even more of the wholesaler originated, which has more of an opportunity for misrepresentation, more of the stated income which has more of an opportunity for misrepresentation.
There really hasn’t been an increase in that, that’s been a characteristic of that book on a on going basis.
Bob Patten – Morgan, Keegan & Company
Right. Thank you.
Operator
And at this time, I would like to turn the conference back over to Mr. Baker for any additional or closing remarks.
Jerry Baker
Well, let me just conclude by congratulating Bryan and thanking all of you for calling in and showing your interest, a great confidence in this team and our ability to go forward. I believe we made a lot of important changes.
We focused, restructured ourselves and I’m – well, I would always like to see the market be a better environment in which to operate. I can certainly feel good about the changes we’ve made and I appreciate all your interest and attention this morning.
So, thank you and have a great day.
Operator
Thank you, and again that does conclude this conference call. We thank you for your participation, you may disconnect at this time.
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