Oct 17, 2008
Executives
Dave Miller – IR Bryan Jordan – President & CEO Greg Olivier – Chief Credit Officer Tom Adams – Interim CFO
Analysts
Brian Foran – Goldman Sachs Steven Alexopoulos – JP Morgan Paul Miller – Friedman, Billings, Ramsey Robert Patten – Morgan, Keegan & Company Adam Barkstrom – Sterne, Agee Heather Wolf – Merrill Lynch Kevin Fitzsimmons – Sandler O'Neill Kevin Reynolds – Janney Montgomery Anthony Davis – Stifel Nicolaus Christopher Marinac – FIG Partners Jefferson Harrison – Keefe, Bruyette & Woods Justin Mauer – Lord Abbott Jason Goldberg – Barclay’s Capital Al Savastano – Fox-Pitt Kelton
Operator
Good day everyone and welcome to the First Horizon National Corporation’s third quarter earnings conference call. (Operator instructions) Mr.
Miller, you may begin.
Dave Miller
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 website at www.fhnc.com. Before we begin, we need to inform you that this conference call contains forward-looking statements which may include guidance involving significant 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 information may be noted in this conference call.
A reconciliation of that non-GAAP information to comparable GAAP information will be provided as needed in the Appendix of the slide presentation available in the Investor Relations area of our website. Listeners are encouraged to review any such reconciliations after this call.
Also please remember that this webcast on our website is the only authorized record of this call. This morning’s speakers include our CEO, Bryan Jordan, our Chief Credit Officer, Greg Olivier, and our Interim CFO, Tom Adams.
With that I’ll turn it over to Bryan.
Bryan Jordan
Thanks Dave, good morning and thanks for joining our call. As you are aware financial services companies faced and extremely challenging third quarter operating environment as well as unprecedented industry turmoil.
During this period First Horizon continued to take steps to maintain sufficient, liquidity and reserves throughout these tough times. Additionally we completed the sale of The National Mortgage business and further reduced our balance sheet risk.
In this difficult operating environment we maintained solid pre-tax pre-provision earnings of $137 million anchored by encouraging trends in our core businesses. Third quarters loss of $0.59 per share reflected both continuing proactive efforts to deal with credit quality issues as well as costs associated with the mortgage sale.
Tom will cover the quarter’s financial details and Greg will discuss our credit performance, but first I want to spend a few minutes elaborating on third quarter actions and the progress we’re making in repositioning First Horizon. Capital and liquidity are paramount in these times and First Horizon is well positioned in both areas.
Our capital ratios improved during the third quarter even as we significantly increased loan loss reserves. Our Tier 1 ratio rose to 10.9% and our tangible common equity ratio improved to 7.2%; both among the highest in the industry.
We expect further balance sheet shrinkage and solid pre-provision pre-tax earnings power to drive additional improvement in our ratios moving forward. We believe our capital position is sufficient to withstand significantly higher credit losses should the current economic downturn continue to worsen.
We are also improving our liquidity position in a challenging environment. We reduced assets on our balance sheet allowing us to decrease our dependence on unsecured wholesale funding and retire maturing debt.
Importantly our core deposit franchise in Tennessee has been stable. Our customer bases increased in third quarter as we initiated targeted promotions, continued to open branches, and proactively communicated with customers.
We are reducing risk by deleveraging the balance sheet. We reduced owned balance sheet assets by nearly $3 billion in the third quarter driven by The National Mortgage platform sale and continued wind-down of our national specialty lending portfolios.
Construction portfolios represented approximately $600 million of this decrease with OTC and residential CRE balances each coming down approximately $300 million. We expect another $1 billion to $2 billion in balance sheet reduction by year end.
We have continued to proactively recognize losses on non performing loans and aggressively work them out. Net charge-offs came in as expected at $155 million in the quarter, up $27 million [linked] quarter reflecting prolonged weakness in the housing market.
Our full year 2008 expectations for charge-offs remain towards the upper end of the $485 million to $585 million forecasted range. We have remained aggressive in recognizing losses on non performing loans and are aggressively working them out.
On average our non performing loans have been written down by over 20% and roughly 40% below their appraised value. We strengthened our reserves to $760 million or 3.5% of loans as we continued to carefully analyze our portfolios to ensure timely identification of problem loans.
We continue to perform detailed assessments of inherent losses and our liquidating portfolios, especially the approximately $3 billion in short duration construction loans. This led us to substantially increase reserves for these portfolios.
Given current economic conditions we expect our provision to decline over 2009 as charge-offs are increasingly covered by existing reserves. We believe that our current reserve level coupled with our strong capital position are sufficient to absorb higher then expected credit costs.
This also permits us to explore more aggressive near-term asset disposition approaches. Lastly our core franchise remains strong as we refocus on being a dynamic regional financial services company.
Our two core businesses, our regional banking franchise in and around Tennessee and our capital markets business FTN Financial, continue to perform well given the tough climate. Together they drove $82 million in pre-tax pre-provision third quarter income.
We continue to invest in new branches, opening three during the quarter and in targeting marketing while taking a leadership position in our communities to communicate about turmoil in the financial industry. Our customer base grew throughout the turbulent quarter.
In capital markets we reduced our average trading portfolio and continued to carefully manage counter party risk. Fixed income sales remained strong benefiting from the environment.
Let me spend a few minutes on the core bank trends which have been relatively good in spite of some dramatic market events. As you can see on slide five, deposits in our Tennessee bank franchise were largely stable over the quarter although there was some volatility in July in the face of high profile industry problems.
We also saw competitors offer more aggressive retail rates, but we choose not to compete for non relationship deposits, especially CDs. While deposit balances remained basically flat over the third quarter we took a number of actions that produced encouraging results in August and September.
We reached out through phone calls, emails, seminars, and personal visits to educate consumers on FDIC insurance and offer financial advice. We worked with business clients to move some deposits into overnight repos.
We introduced the CDARs program allowing us to provide expanded insurance coverage through a network of banks. We booked $175 million in CDARs deposit over the latter part of the quarter; much of this new money.
We offered a money market savings account promotion in which existing checking account customers were able to take advantage of attractive rates for three to six months. This drove roughly $150 million in new account balances in August and September.
And in September we had an all time record for money market savings account growth. We grew a net 3,700 accounts as we opened approximately 5,500 new accounts; triple our normal level.
As a result of our proactive efforts customer deposits including repos were relatively flat during the third quarter while primary consumer and business deposit accounts grew at an annualized 6.2%; significantly faster then prior quarters. In summary we continue to make progress refocusing our company and remain well positioned to operate in this challenging environment.
I will be back to make some closing comments, but now I’ll turn it over to Greg to discuss asset quality.
Greg Olivier
Thank you Bryan, I’ll start on page eight. These are certainly unprecedented and uncertain times during which managing asset quality has been quite challenging to say the least.
We do not expect improvement in the economic environment in the short-term, and intend to continue to manage our portfolio as we have over the past several quarters, by pursuing aggressive loss recognition and remediation efforts, building adequate reserves for losses we can determine to be inherent, and reducing as quickly as possible the national construction loan portfolios. In the third quarter our loss recognition strategy continued to drive higher non performing loan and charge-off numbers for us and some others in the industry but we believe it will eventually allow us to emerge from our challenges sooner then many others.
Charge-offs totaled $155 million for the quarter reflecting continued weakness in both the residential CRE portfolio, which is what we call our home builder finance and condominium construction loans, and in C&I sub segments impacted by housing, an example of which would be loans to financial institutions. We built our loan loss reserves to 3.52% of total loans continuing a four quarter trend focused on ensuring reserve adequacy.
Our effort in the third quarter was particularly focused around the OTC portfolio. We feel we have now reserved for the currently observable inherent loss content in this book.
We reduced the one-time close direct to consumer or residential construction loan portfolio 40% from where we started the year and we reduced the national residential CRE portfolio 36% during the same period. Additionally we actively pursued asset disposition strategies on an individual transaction and small pool basis with some success.
Going forward we are expanding the exploration of a wider range of asset disposition strategies including those that may present themselves in connection with recent governmental actions. The top priority is to focus on working down our level of problem assets.
I’ll now review key trends in each of our portfolios, starting with our home equity portfolio on slide nine. This portfolio continues to perform relatively well and better then many others in the industry.
We believe its performance is driven by its underlying origination characteristics. We have shown these to you before but as a reminder it’s a seasoned portfolio with 53% of the portfolio originated before 2006, its about 86% retail originated with an average refreshed FICA score of 732.
The weighted average CLTV at origination was 78% and approximately 43% of these are fixed rate loans. The utilization rate on lines has been fairly stable at 54%, up slightly and a reflection of our work to selectively curtail lines in recent quarters.
And the portfolio has good geographic diversity. We continue to reduce our home equity exposure out of footprint having stopped originations in our national portfolio in early 2008.
On page 10 you’ll see that the home equity portfolio performed about as expected in the third quarter. Delinquency remained below peaks experienced earlier in the year but did increase in the latter half of the quarter, particularly in the national HELOC portfolio.
Net charge-offs for the quarter totaled $27 million or 1.41% annualized, down from $36 million in the second quarter. Loss expectations for 2008 remain as previously forecasted.
Loss expectations going forward will be a function of delinquency or frequency as loss severity is now modeled at 100%. Continued economic stress on the consumer will impact losses in this book, however our modeling continues to show cumulative loss content in the 3% to 6% range.
Next I’ll discuss our construction portfolios starting with our discontinued one-time close portfolio on slide 11. OTC balances declined $320 million in linked quarter and commitments are down 50% year-to-date.
We modified $90 million of performing OTC construction loans to the balance sheet’s permanent mortgage portfolio in the third quarter. These are loans on homes where construction is complete yet a secondary market no longer exists for this product type.
As Bryan mentioned previously due to the extensive portfolio management efforts we have expended on this portfolio and the short-term nature of these construction loans we have gained increased visibility into the currently observable inherent loss content of this book. As a result we have increased OTC reserves to a total of $242 million this quarter.
OTC charge-offs for the quarter were $41 million, up $3 million from second quarter. As communicated in early September we expect full year 2008 OTC losses to be towards the upper end of the $110 million to $160 million range.
Moving on to our residential CRE portfolio on slide 12, balances in our discontinued national res CRE book decreased another $260 million during the quarter. National commitments are now down 44% year-to-date.
Not surprisingly the housing market’s prolonged weakness is negatively affecting the builder portfolio, driving non performing loans up $60 million quarter to quarter to 24% of outstandings. More problematic national markets continue to drive the majority of problem loans but even previously strong builders in better markets including Tennessee are experiencing stress.
Total residential CRE charge-offs increased $19 million linked quarter to $49 million. In 2008, loss expectations for res CRE remain moderately above targeted range we laid out in April.
We do think that we are getting closer to the peak in terms of absolute dollar losses in this portfolio given the fairly rapid portfolio run off of this book. Now let me turn to our C&I and income CRE portfolios on slide 13, as a reminder income CRE is the term we use to refer to traditional commercial real estate property types like retail, office, industrial, and multi family projects.
C&I and commercial real estate borrowers were feeling the effects of the weakening economy especially businesses correlated to the housing industry, again this is true not only in the higher risk national markets but in Tennessee as well. Our line bankers and credit staff continue to proactively review loans each quarter and adjust grades appropriately.
Income CRE losses were about $1 million in third quarter, down from second quarter. Accruing delinquency in this portfolio was elevated at quarter end but was largely driven by [administrative] delinquency rather then payment delinquency.
C&I charge-offs were up $15 million linked quarter to $30 million driven by anticipated losses in three sizable credits. Generally we are seeing weakness in borrower segments impacted by residential housing including financial institutions.
Appropriately we undertook an intensive review of our $1.2 billion correspondent loan portfolio during the quarter, focusing specifically on our exposure to financial institutions. As background the correspondent portfolio is comprised of 35% traditional C&I loans, 25% loans to financial institutions or secured by the stock of financial institutions, 20% mortgage warehouse lines, and 20% commercial and real estate loans, primarily income CRE.
Additionally we reviewed the portion of our approximately $0.5 billion trust preferred portfolio that is extended to financial institutions. Both reviews resulted in significant downward grade migration and result and reserve build.
We expect ongoing stress in the financial system to create additional pressure on these credits and we will continue to factor that into our loan grading. As you can see on slide 14 we remain aggressive in recognizing losses on non performing loans and in working them out.
As a reminder we apply the FAS 114 process to all impaired commercial assets, $1 million and larger, charging collateral dependent loans down to the net realizable value rather then holding reserve against them for loss recognition at a later date. On average our non performing loans have been written down by 23% and stand at roughly 40% below their appraised values.
On page 15 you can see that non performing loans and foreclosed real estate levels both grew in third quarter but at a slower pace then in prior quarters. Inflows remain stable linked quarter while dispositions increased in both categories.
Non performing loan pay offs and sales increased to $76 million this quarter at prices generally in line with carrying values. [inaudible] spreads in the market on asset sales have widened as inventory has increased and buyers become more reluctant to act given the level of economic uncertainty.
In summary we still expect 2008 total net charge-offs to be at the upper end of our $485 million to $585 million forecast range driven by continued weakness in residential CRE and increased deterioration in the C&I portfolio. A major focus continues to be building and maintaining adequate reserves for loan loss, the third quarter provision expense exceeded charge-offs by $185 million in consideration of the observed inherent loss content in the OTC portfolio and the ongoing downward migration of commercial loan grades as the economy deteriorates.
This increased our consolidated reserve to loan coverage to 3.52% and 5.21% in our liquidating national specialty lending segment. As our national portfolios contract we believe that we are close to a peak in our aggregate reserve level absent a significant change in our already negative market assumptions.
Our best view today is that aggregate provision should trend down as we move through 2009. Finally I’d like to restate a point made earlier, given our strong capital position and the way we’ve approached our credit challenges by being fairly aggressive and writing down our problem loans, and steadily building reserves, we think we are better positioned then many to dispose of assets in the marketplace.
We are exploring several options that have promise but it could affect the timing of credit costs. With that I’ll turn it over to Tom who will discuss third quarter financial results.
Tom Adams
Thanks Greg, I’ll begin with an overview of the quarter on slide 18. Earnings per share were a loss of $0.59.
This was impacted by a handful of unusual items totaling approximately $31 million and a $185 million net increase in loan loss reserve. Pre-tax pre-provision earnings were $137 million with $82 million generated from our core businesses, regional banking and capital markets.
The net interest margin remained stable at 3.01% and capital ratios increased from their already strong levels. Slide 19 provides a summary of the third quarter’s unusual items.
As in prior quarters we provided a summary in our financial supplement to explain which line items and business segments they impact. Most of the charges relate to our ongoing efficiency and restructuring initiatives.
Loss on sale related to the divestiture of our National Mortgage platform was $18 million. Efficiency and restructuring expenses driven by the mortgage sale and other efforts were $16 million.
We had a charge of $16 million in a mortgage origination income adjustment. We repurchased $92 million of bank notes which generated a $19 million gain.
Going forward we expect $5 million to $15 million of remaining charges in the fourth quarter of 2008. On slide 20 as Bryan mentioned we reduced assets by roughly $2.7 billion from the end the second quarter to the end of the third quarter.
Loans held for sale decreased by $1.9 billion as we delivered the largely conforming mortgage warehouse. Loans held to maturity declined by $600 million driven by declines in our wind-down national construction portfolios and mortgage servicing assets declined by $470 million due to bulk servicing sales and natural run off.
We expect assets to decline another $1 billion to $2 billion by the end of the year as the result of continued contraction of loans and national specialty lending through run off, continued liquidation of the mortgage warehouse and ongoing mortgage servicing run off. The consolidated net interest margin remains stable linked quarter.
Less balance sheet usage in capital markets and pricing discipline in the core bank helped offset the impact of higher non-accrual loans. Funding costs did increase over the quarter as liquidity became tight across the system and retail deposit competition intensified.
Over the near-term the margin may be adversely impacted by an elevated LIBOR, increased core funding costs, and slight asset sensitivity in the core bank. Longer term however, we should see the margin expansion as lower margin national businesses are reduced.
As an aside, we did not have any direct balance sheet exposure to Fannie Mae or Freddie Mac preferred stock and our direct counter party exposure to Lehman and WaMu was minimal. Let’s turn to a more detailed discussion of liquidity on slide 21, while liquidity has become tight industry wide we have actually improved our liquidity position generating cash flows by reducing assets as just discussed.
This allowed us to reduce our dependence on unsecured wholesale funding and retire maturing debt. We ended the third quarter with no Fed funds purchased on the street.
Funds were purchased from downstream correspondent banks only and we carried $200 million of excess reserves in our Fed account on that date. We retired $1.5 billion of maturing CDs, bank notes and extendable notes during the third quarter.
And through further balance sheet contraction we can more then cover another $1.1 billion of debt maturities due by January, 2009 as well as all 2009 maturities. At the same time we shifted our wholesale funding mix to non credit sensitive sources like term auction facility, federal home loan bank borrowings and insured network deposits.
We have virtually no reliance on commercial paper for short-term funding. Throughout 2009 we would expect to maintain about $4 billion in excess funding sources should they be needed.
As Bryan detailed deposits in our core bank remain fairly stable at $11 billion during the third quarter but there were a couple of non customer related impacts worthy of note. Wholesale CDs declined $500 million as we retired them at maturity and escrow balances were reduced roughly another $500 million following the sale of the national mortgage business.
I’ll also remind you that the recently published June 2008 FDIC data reflects declines in deposits due to $6 billion of unsecured wholesale funding booked in our Memphis headquarters which was either eliminated by the national balance sheet contraction or replaced with secured borrowings like FHLD, or TAF borrowings to reduce rollover risk. This is an anomaly in how the data is reported not a reflection of our customer deposit trends since all of these deposits had been issued to institutional money funds or asset management firms.
Turning to capital on slide 22, our tangible common equity to tangible assets ratio improved to 7.2% at the end of third quarter while Tier 1 capital improved 40 basis points to 10.9%. With continued balance sheet shrinkage ratios should build further through the end of this year.
Each $1 billion of asset reduction improves tangible common equity to total assets ratio by about 25 basis points. Combined with our loan loss reserve this gives us the ability to withstand significantly higher credit losses should the economy worsen more then expected.
Let me illustrate, with an additional $1 billion of balance sheet shrinkage, no cash dividend, broker estimates of pre-provision earnings for the remainder of 2008 and assuming $200 million of provision expense in fourth quarter, our capital ratios would improve over current levels and we could sustain over $2 billion of additional pre-tax losses and still be considered well capitalized. As Greg said this capital cushion should give us the flexibility to explore options for accelerating the wind-down of our national loan portfolios.
In summary our capital position is very strong today and should remain so as we move through 2008 and 2009. I’ll now cover results from our key business segments beginning with regional banking on slide 23, as a result of refocusing our banking businesses in and around Tennessee; core franchise trends are generally good in this challenging operating environment.
Pre-tax pre-provision earnings were $52 million in the third quarter. The linked quarter decline of $11 million was driven largely by higher expenses from investments in marketing, new branches and improvement to our online banking platform, also lower cash management fees and weakness in market sensitive wealth management fees.
Loans were essentially flat as we selectively exited non relationship watch list credits. The banks net interest margin was increased five basis points sequentially to 4.43% as we chose not to compete aggressively on deposit pricing.
Nonetheless we did see higher funding costs as the quarter progressed caused by increased competition and promotional activities. The pressure on deposit rates may persist given current challenges in the industry.
Provision expense decreased $31 million linked quarter but remained elevated as we proactively down graded commercial loans in light of the softening economy. Next up on slide 24 is capital markets which had another solid quarter generating pre-provision pre-tax income of $30 million.
Although down from the first and second quarters’ very strong levels fixed income sales remained above the long-term average producing $80 million in revenues. Increased provision expenses associated with problem credit and correspondent banks did however drive a pre-tax loss of $9 million for the quarter.
Without affecting customer business we continued to manage balance sheet usage at FTN Financial with average third quarter trading inventory at about $1.4 billion, a decline of 17% linked quarter and down 25% year-over-year. We also continued to reduce our correspondent lending exposure focusing on relationship customers who generate deposit and fee income.
Going forward we expect capital markets pre-tax pre-provision earnings power to remain solid. Slide 25 shows mortgage banking pre-tax income was $46 million for the quarter.
Results included two months of origination activity prior to the August 31 sale of our National Mortgage platform and about 20% of our servicing to MetLife. Results were driven by hedging gains of $51 million from positive carry on swap hedges due to the steepness of the yield curve and market volatility benefit on swaps and options coupled with slower then expected prepayments on mortgage servicing rights.
Origination fee income of $20 million on $5 billion of deliveries which included negative payback due to an adoption of accounting standards during 2008 regarding the fair value election of warehouse loans. Lower servicing run off due to market constraints on refinanced activity and a sequential expense decline of $60 million due to the lower run rate of sale.
We provided an activity breakout of mortgages third quarter pre-tax income to help you forecast future results in this wind-down business. Originations were a $32 million loss in the quarter reflecting two months of origination activity in July and August.
Servicing accounted for $79 million. Going forward we expect that revenues and expenses associated with origination will be largely eliminated as the Tennessee part of the business produces only about $500 million to $1 billion in originations annually.
Servicing income and expenses will remain but should decline in proportion to the size of the portfolio. Now I’ll turn it back to Bryan for some final comments.
Bryan Jordan
Thank you Tom, summing up we believe that First Horizon is set on the right course to successfully manage through today’s industry challenges. Our capital ratios are strong and getting stronger, we have ample liquidity, we are realistically and proactively dealing with credit issues and we are well along in refocusing the company on its core regional banking and capital markets businesses.
Recently enacted legislation and other steps taken by the Treasury, we think are steps in the right direction towards restoring confidence in the financial system. We are carefully examining opportunities for First Horizon to participate in the new programs and determine if they can be of benefit.
We have additional work to do over the next several quarters as we complete the wind-down of our national businesses, focus aggressively on expense control and efficiency and continue to build our strong banking and capital markets businesses. The employees of First Horizon are an outstanding group focused on serving our customers and building our business for the long-term.
I offer my thanks to them for what they do day in and day out for our company and our customers. Thank you for joining us this morning and now we’ll be glad to take your questions.
Operator
(Operator Instructions) Your first question comes from the line of Brian Foran – Goldman Sachs
Brian Foran – Goldman Sachs
The earnings are worse then I would have thought but the reserves are a lot higher, the capital is higher, and there’s some signs of deceleration and inflows, so do you think about this quarter accelerating the process of getting ahead of things and so as a result the turnaround time is kind of the same as you would have thought three months ago, or are things just worse and the timeline is the same or longer because of what’s going on with the economy?
Bryan Jordan
I think you’ve made a pretty accurate assessment in the sense that we think we’re right on track. I think we’re actively and aggressively trying to identify these problems and get them behind us.
So I think we’ve been very proactive. I think we, our credit guys and our line bankers have done an outstanding job of trying to identify problems, build adequate reserves, so that we can deal with those on a go forward basis.
An example that Greg mentioned are the one-time close loans where we have we think much greater visibility in that portfolio as it winds down. It was down $300 million this quarter.
We expect it wind down over the course of 2010. We’ve built on a simple math basis based on the $40 million of losses we took this quarter six quarters of reserves for that portfolio at $242 million.
So I think we’re doing a good job of being proactive and building these reserves. Our business units, capital markets and bank are right on track.
We’re pleased with how they’re performing. I think we’re closer to seeing that turn.
Brian Foran – Goldman Sachs
You’ve talked about $100 to $125 million of pre-provision in the past is that still the outlook or where do you stand relative to that goal?
Bryan Jordan
That’s still the outlook and that’s still where we think we’ll be. The near-term you’re facing some headwinds with higher funding costs.
You’re facing some headwinds with increased foreclosure expenses in the banking unit. Market sensitive revenues like trust and wealth were down a little bit this quarter driven by the market, there’s some seasonality in the business so I’m still very comfortable with the $100 to $125.
We’ve got some work to do on efficiency, we’ve got some work to do but we’re very comfortable with that outlook for the long-term.
Brian Foran – Goldman Sachs
American BB&T have both sold VISA stock at this point, I think you’ve got about $125 million of shares, any opportunity to do that and then if you compare Southern California versus Florida considering you’ve got loans in both and they’re interesting markets to compare, California some of the data I look at seems like it might be nearing a bottom while Florida seems a long way off, interested to see if you’re seeing the same thing.
Bryan Jordan
On the VISA stock, we do still have a significant unrealized gain there. We’ll consider opportunities but we’re not actively pursuing it right now.
Greg Olivier
I guess we’d share your observation a bit although in terms of improvement Southern California we haven’t seen inflection in any market right now. Our view is that it will continue to bounce along.
We don’t see it improving significantly. Florida is definitely further behind then just about anywhere else right now.
Operator
Your next question comes from the line of Steven Alexopoulos – JP Morgan
Steven Alexopoulos – JP Morgan
I know you reaffirmed the charge-off guidance I’m wondering what economic scenario you’re basing that on and do you assume a recession here related to the losses on the home equity loans.
Greg Olivier
Yes, I think that’s true. When we look at our modeling for home equity there’s modeling we do for reserve purposes and then other stress scenarios we run and our modeling for reserve purposes assumes a stressed view of, when we look at that modeling for reserve purposes now, what we found to be the most predictive in stable modeling is really a segmented roll rate view of our delinquency and what rolls to charge-off here in 2008.
That’s proven to be over the past four to six months a fairly predictive tool and we’ve stayed within the bounds of our base case and that stress case. Answer is yes, we reserve at that stressed rate level.
We do run other stress models if things get worse then that stress model on which we can justify reserves.
Bryan Jordan
There’s a fair amount of imprecision as you look at charge-offs. charge-offs in the third quarter came in probably a little bit better then we thought they might have 30 days ago and we still think we’re in that range that we reiterated.
We say we think we’re going to be at the higher end of that range but we don’t know what we don’t know at this point. We’re trying to give you our best estimate today and we’re building in for some deterioration in the economy.
Steven Alexopoulos – JP Morgan
You said that the provisions expected to go down in 2009 do you assume we get at least one more quarter of an increase from where we are now going into the fourth quarter?
Bryan Jordan
At this point I’m not certain but my gut would tell me we’re much closer to seeing that provision build stop and see it start to turn the other way particularly when you look at the reserves we built around some of the national construction portfolios. I don’t know with precision but I think we’re a lot closer to that turn today then we were 90 days ago.
Greg Olivier
I think that’s right, the drivers of increased provision expense over and above charge-offs in 2008 have really been threefold. One has been the OTC portfolio and the level of losses there.
We think we’ve recognized and provided for what we view as the inherent losses left in that portfolio. The second driver has been deterioration in commercial loan grades and obviously our national real estate portfolio, res CRE portfolio is in that number.
Those balances are coming down and you don’t have to reserve for balances that are no longer there so even if we have grade deterioration in the fourth quarter we’ll have lower balances because of the run down on which to calculate them. If we have incremental provision expense in fourth quarter it will likely be associated with any net of those the grade deterioration outpacing run off.
The other point of provision build or reserve build provision expense would be any change in our home equity modeling. And we’ve been fairly consistent with our modeling on that portfolio.
We did see an uptick in delinquencies here in August and September. That always as we get to the end of the quarter and look at reserve levels that could incrementally drive some provision expense in excess of charge-offs.
Steven Alexopoulos – JP Morgan
Looking at the balance sheet from a high level why would deposits be running down faster then loans here, every category deposits was down and where do you see the loan to deposit ratio heading over the next couple of quarters.
Tom Adams
There were a lot of moving parts on that on deposits for the quarter. We had the sale of the mortgage servicing rights to MetLife which had some escrow deposits attached to it; September 15 was a big tax date.
We did have some shifts in deposits on the retail side from non interest bearing to interest bearing and on the corporate side from into repurchase agreements. That was really kind of the deposit flows we saw during the quarter.
Dave Miller
You do see some of that on the average balance sheet, if you look at the period end balance sheet at the consolidated level, you’ll see linked quarter increase of almost $300 million in savings and time deposits and some other categories. You actually do see a little bit of a different story if you look period end to period end.
Operator
Your next question comes from the line of Paul Miller – Friedman, Billings, Ramsey
Paul Miller – Friedman, Billings, Ramsey
Regarding your outlook, you think that we’re getting closer to the turn then before, but a lot of high profile bankers have been saying for a long time that they thought the peak in charge-offs will be early 2009 and some have even predicted later half of this year, but this crisis is going to be a lot deeper and longer as a consumer led recession then we’ve ever seen before, what do you see out there that we’re not seeing that gives you that confidence. As you know the syndicated loan data that was released a couple of weeks ago showed some pretty significant deterioration in syndicated C&I loans across the country, almost in a recession levels and so what do you seeing out there?
Do you think that we’re almost at the end of this thing?
Bryan Jordan
I don’t think that’s the message we were trying to send, I think what we were trying to indicate is that with the reserves we’ve built particularly for some of these contracting portfolios which were declining in balance we’ve built very significant reserves and in the very near-term next quarter or two you should start to see the turn in provision because you’re taking charge-offs against reserve versus provision. We’re not different then anybody else in seeing a very soft economy and likely deteriorating for a period of time and I’ve said in the past that I thought that the economy would probably not bottom out until sometime in the middle of 2009, I’m less optimistic about that today in it being closing to 2010 before that happens.
I don’t want to confuse the message but we’re talking more about reserves and provisions and charge-offs as a combination as opposed to where losses end up.
Paul Miller – Friedman, Billings, Ramsey
Can you add some color on C&I, you said the C&I losses if the increase was roughly $15 million and it was three sizable credits, can you give us more color about those credits?
Greg Olivier
All the credits are related to housing, two are related to financial institutions or businesses very closely tied to housing. That’s about all I can tell you.
Operator
Your next question comes from the line of Robert Patten – Morgan, Keegan & Company
Robert Patten – Morgan, Keegan & Company
What I’m hearing today is you are gearing up for asset dispositions and obviously with NPAs going to the 4.6 level it gets scary in terms of what are you going to do with this, we understand how you write these things down under FAS 114, but talk in terms of your appetite for starting to hit the loan sale market over the next couple of quarters and what we should expect.
Bryan Jordan
I think with our reserve levels and our reserve levels and our capital we’ve got the flexibility to do that. In the last part of the third quarter we saw spreads starting to widen out some and I attribute a lot of that to illiquidity in the market and lack of leverage.
We are very actively and aggressively looking at asset dispositions. We don’t want to take imprudent steps and sell in bulk just to sell in bulk and not get good value for the assets we’re resolving.
We’re looking at a number of auctions in places like other owned real estate and looking at loan sales so we’re very actively considering it and in all likelihood you’ll see more of that over the next couple of quarters.
Robert Patten – Morgan, Keegan & Company
In terms of the TARP, obviously the capital program as well as the asset disposition program, I know you said you were examining it do you think you’ll be participants on the asset disposition side.
Bryan Jordan
We think that the programs under the TARP are attractive. We have less clarity about what happens and the mechanics of the asset disposition side, what assets qualify and some of the mechanics are starting to get fleshed out around auctions and pricing mechanisms, but as I said in general we think they’re very attractive programs.
We will actively consider them and give them serious consideration. We think they provide a lot of flexibility both to resolve assets and grow the organization.
Operator
Your next question comes from the line of Adam Barkstrom – Sterne, Agee
Adam Barkstrom – Sterne, Agee
On the other of the TARP, the preferred issue, would you even consider that at this point? The strategy has been we’re trying to deleverage the balance sheet; we’re trying to exit non core businesses, why would that even be a consideration to you?
Bryan Jordan
It would be a consideration for a couple of reasons; it’s a very attractive program in terms of capital. It provides added flexibility; it provides the ability to grow the organization.
It provides the ability to more rapidly resolve problem assets and it could potentially provide a cushion for what we don’t know about the economy so there are a lot of reasons to consider it in my view.
Adam Barkstrom – Sterne, Agee
It seemed to me that one of the big arguments in looking at the First Horizon story; potentially you didn’t need capital so why would you take on capital if you don’t it. I understand the attractiveness of it and the flexibility of it but if you really don’t need it, why bring it on?
Bryan Jordan
It’s hard to define need in a market like we’re facing today and if you, as you look at that program if it makes sense from an affordability standpoint, an attractive cushion standpoint, I think you have to consider it.
Operator
Your next question comes from the line of Heather Wolf – Merrill Lynch
Heather Wolf – Merrill Lynch
Can you address the income CRE portfolio I think your 30 plus day delinquencies more then doubled there, is that all retail or are there other products that are starting to turn there?
Greg Olivier
Yes, the delinquency increase you see in income CRE is exclusive to the national portfolio and when you did into the particular credits that caused that there was one of those credits about $13 million that was related to a payment delinquency. The balance in that portfolio were maturity issues.
Two of the four maturity issues are driving the balance of that delinquency and it’s been extended. So we had a bit of an administrative issue in that piece of the portfolio.
If you look at our regional banking delinquency in that book, its 1.2% for the quarter. If you look at the capital market exposure, its 1.3%.
And if you pull out the administrative delinquency the number is 163. So there has been some deterioration but the numbers is overstated, if you just look at the delinquency we have seen great deterioration in that portfolio we have seen performance issues in that portfolio.
But if you look at 30 plus delinquency for third quarter and there’s some noise in that particular number. The property that was problematic in third quarter was a multi family deal.
It was not retail.
Operator
Your next question comes from the line of Kevin Fitzsimmons – Sandler O'Neill
Kevin Fitzsimmons – Sandler O'Neill
Your comments about provisions nearing a turn where net charge-offs aren’t necessarily, does that basically imply we could see a quarter or two from now you are willing to under provide relative to net charge-offs or are you only talking about matching and not doing the massive reserve build that you have been doing? When you’ve been doing this reserving now that you’re considering this more aggressive disposition of assets, sales, auctions, is that baked into how much you’ve been reserving for losses or if losses were more based on inherent losses over time, would we have to see some step up in provisions next quarter to position you for the disposition strategy or is it fully baked in at this point?
Bryan Jordan
I think your first conclusion is the right one, that in all likelihood you could see us in the next several quarters start to under provide as some of these portfolios continue to run down and we get closer to the end, under provide charge-offs and use reserves. On the asset dispositions, it will depend on the portfolio but in all likelihood there’s probably going to be some marginal cost of an accelerated disposition strategy.
Greg Olivier
I think that’s right. We’ve talked in previous quarters and executed transaction by transaction or small potential bulk sale type strategy.
We’re anxious to get more of the problem behind us and when you pursue a strategy that is more of a bulk strategy the discount that you’ve got to accept is going to be incrementally higher so that’s part of what we’re weighing this quarter to get some of these numbers behind us. On a transaction by transaction disposition we’ve been, what we’ve marked them down to has been about what we got and we’ve had a gain here or an incremental charge-off there but it’s about net its carrying value both in ORE and in PLs.
Operator
Your next question comes from the line of Kevin Reynolds – Janney Montgomery
Kevin Reynolds – Janney Montgomery
Expense leverage after the sale of the mortgage company we had two-thirds of the quarter with it specifically, what’s a good run rate right now for salaries expense as we go forward. Is there more to get there or have we gotten most of the reduction we’re going to see?
Bryan Jordan
You’ve essentially got two months of expense from the mortgage company in the quarter so you didn’t get to a good run rate this quarter. You’re going to see it drop down.
Dave Miller
You’d have a couple of things; number one you’d have about $15 million in the expenses that are related to the charges. We said we’ve have some charges lingering in the fourth quarter but you’d have that dynamic and then its actually on that mortgage banking slide, slide 25, there’s about $76 million of expenses in the Q3 numbers related to mortgage origination.
You’ll have some going forward but it will really just be limited to what’s in the Tennessee franchise so I think that starts to give you a sense that you move significantly south even from the third quarter reported number because of the impact of having mortgage origination business there for two months out of the quarter.
Kevin Reynolds – Janney Montgomery
You talked about not having any GSE exposure in the form of securities, do you have any, you’ve been a big originator of the pool, do you have any lingering risk on your balance sheet there? I guess the concern out there is as there’s more and more banks that are suffering in the marketplace that there could be some impact on those pools, what risk do you retain on your balance sheet there that we need to consider?
Tom Adams
We have roughly $470 to $500 million of trust preferred loans on the balance sheet. Those are not securities, haven’t been tranched up so we have that portfolio.
Greg Olivier
There’s about $475 million or so in trust preferred loans on the balance sheet, about $310 of those are to financial institutions banks, the balance are to other entities so and then within that $310 or within the entire pool there’s no interest deferrals to date. There are less then half a dozen that we view as potentially problematic at this point.
Bryan Jordan
Remember we wrote those down by about $40 million in the first quarter in terms of low [com] adjustment so they came over with an embedded reserve. The other place that we have a very minor exposure is we have some trading portfolio in capital markets that we purchased.
We’ve written them down on a mark-to-market basis and it probably is $8 to $10 million range at the end of the quarter.
Dave Miller
There is nothing in the securities portfolio.
Greg Olivier
On that $40 million reserve it shows up as a separate reserve, not in loan loss reserve.
Operator
Your next question comes from the line of Anthony Davis – Stifel Nicolaus
Anthony Davis – Stifel Nicolaus
Could you give us more detail on the mortgage repurchase activity and the adequacy of the reserve that you have in place there today based on what you’re seeing.
Bryan Jordan
We did not see any pick up of any significance at all in mortgage repurchase activity and we think that the reserves that we set up continue to be adequate.
Anthony Davis – Stifel Nicolaus
How about the recent staff changes, at FTN Capital Markets, your sense of how that business is configured today for the realistic opportunities to grow it over the next couple of years.
Bryan Jordan
I feel very good about how that business is positioned today. Over the last several months I think Frank and the management team and all of Capital Markets have done a really good job of looking at the various pieces of the business.
We have reconfigured the business to essentially get out of some businesses where we didn’t think that with the market on a go forward we could be competitive where it made sense to try to be competitive. We worked very hard to put more of our cost structure on a highly variable basis, less on a fixed basis and so we’re being very flexible in the way we look at that business.
I think we’re making the right moves there. It’s been a good quarter in the business and so we thing we’re well positioned for the next several quarters.
Operator
Your next question comes from the line of Christopher Marinac – FIG Partners
Christopher Marinac – FIG Partners
On the one-time close portfolio the $90 million that shifted to the permanent mortgages were any of those non performing?
Greg Olivier
No we have a pretty strict practice to review any of those loans coming out of OTC where construction is complete and it’s ready to modify into permanent mortgage. It goes through a credit committee that looks and if it has not performed or has a delinquency or shows any sort of performance issues during the construction period it’s not eligible to come to the balance sheet.
What we do with those is they would remain in the construction book as either criticized or classified assets depending on performance. You’d continue to see ones that had reached construction, reached completion but are non performing remain in that OTC pre mod book.
Christopher Marinac – FIG Partners
The loss content inherent with the reserves should we look at those relative to the commitment or to the total balance, is that commitment level still falling?
Greg Olivier
I guess stepping back on OTC we did obviously established pretty significant reserves this quarter for what we view as left in that book. If you think back to April when we talked about what we thought how that book would play out, we thought we’d take up to 160 this year in losses and we think we’re going to be in that range at the high end of that range.
And then we said we’d probably add up to about $150 million more in loss in the life of that portfolio, we had a post 2008 loss expectation number so that took it to about 310. We’re in a very different place now in that portfolio, having worked it down to the number of loans are down by almost 60%, commitments down by 50% and balances down by 40% and we’ve got about four times the resources working the problems on that portfolio.
So we’ve got enough insight to establish what we think of the remaining losses. So if you look at the 160 or so we’ll take plus or minus this year, and what remains, we’re within 10% of that estimate we made in April so we feel pretty good about that.
Operator
Your next question comes from the line of Jefferson Harrison – Keefe, Bruyette & Woods
Jefferson Harrison – Keefe, Bruyette & Woods
You talked about the customer deposits being unstable, you said the regional banks had slippage of deposits can you square what caused the shrinkage at the regional bank while the customer deposits remained stable?
Greg Olivier
A lot of that deposit movement in the quarter had to do with the sale of MSRs to MetLife and the escrows associated with those. Also there are seasonal outflows of custodials and there’s a corporate tax date so there’s a lot of fluidity in the quarter in terms of deposits and those were the primary drivers.
Jefferson Harrison – Keefe, Bruyette & Woods
And the escrows were primarily DDA or are they in other--?
Greg Olivier
Yes, DDAs.
Dave Miller
You’ll also notice that the, part of what we’re trying to show on slide six is that some of those deposits did move into repos so you can even see that inside the retail commercial bank but you still have customer funding that you kept that you ended up securing. So that would be another dynamic.
Jefferson Harrison – Keefe, Bruyette & Woods
Have you talked to the regulators about how the eligibility for this preferred program, is your understanding that from what you know now that you are eligible, you don’t really need the capital but if you wanted to draw down the TARP preferred program, is it your understanding that you are eligible?
Bryan Jordan
In a word yes, we’ve had conversations with the regulators about how they perceive that the program will work and I have no reason to believe that we would not be eligible, no.
Operator
Your next question comes from the line of Justin Mauer – Lord Abbott
Justin Mauer – Lord Abbott
Most importantly what are you thinking in going forward, obviously a lot of what if’s out there, but with all the noise this quarter, stuff moving in and out, are you comfortable that we’ll be talking less about this issue after the fourth quarter?
Tom Adams
One thing that I did fail to mention and I apologize for that, we had largely been, our retail bank had largely been out of the high rate CD competition however about the third week of August we introduced what we call first resource savings which is a three or six month high rate savings account, about 4% was the initial rate, that’s available to checking account customers with $10 to $25,000 and its designed to encourage those customers where we’re the primary relationship to bring money from other banks to qualify for this three or six month money market rate. Over the five weeks that that was active in the third quarter we brought in about $150 million of new money so we changed out tactics a little bit, that rate is lower now, but we’re seeing nice core deposit growth as a result of that.
Justin Mauer – Lord Abbott
Just looking at the HELOC, obviously delinquencies came down and they’re ticking back up a little bit, you are obviously doing best efforts to get out ahead of most of this stuff, but what’s your broader view in terms of best efforts to stay out in front of this stuff, you take whacks at things, you bring it down you put it in reserve, and then it start to drift again as the economy continues to deteriorate.
Bryan Jordan
As we look at the HELOC portfolio we start with a very high quality home equity portfolio. We’ve got strong borrowers; the aggregate performance has been good by just about any standards you measure it by.
You’re going to see delinquencies tick up and trend down like they have during the course of this year with the softening economy we would expect them to tick up a little bit more. We’ve been very conservative in the way we’ve estimated loss severities.
We saw a little bit of improvement there in the third quarter but all said I think we still feel very comfortable with our outlook on our home equity portfolio. We think it will perform significantly better then most.
Operator
Your next question comes from the line of Jason Goldberg – Barclay’s Capital
Jason Goldberg – Barclay’s Capital
On slide 22 when you talked about excess capital you made a reference to a fourth quarter provision of $200 million was that your expectations or that was just an example?
Bryan Jordan
That was just illustrative.
Jason Goldberg – Barclay’s Capital
Don’t take that as guidance.
Bryan Jordan
Don’t take that as guidance.
Jason Goldberg – Barclay’s Capital
You made the comment that the excess capital allows you to divest of loans more quickly, how much capital would you be willing to eat into in order to get rid of some of these problem assets?
Bryan Jordan
That’s a complex question to answer because it also depends on how many problem loans you’re divesting with it, but it will be a call that we’ll make based on individual transactions and the relative level of non performing or potential non performing assets that we can resolve. But we don’t expect to see a tremendous deterioration in our capital ratios.
We think that our capital ratios are strong and they’ll continue to get stronger over the course of the year and but specific answer, it’s hard to tell without seeing the exact portfolios and how many problem assets you resolve at the time.
Operator
Your final question comes from the line of Al Savastano – Fox-Pitt Kelton
Al Savastano – Fox-Pitt Kelton
You seem to have a lot of confidence that you have everything identified in the OTC portfolio in terms of reserves what kind of, what do you need to get confidence in some of the other portfolios?
Greg Olivier
I think every portfolio is a bit different in terms of how you get to the point of confidence. On OTC what’s helped there is that we’re down so much in terms of commitments and number of loans and balances so if you’ve got 60% less loans to look at, you’ve got four times the resources working the portfolio and focusing analytics on it, those sort of efforts have given us a pretty view to the future on that book that we feel comfortable with.
When you talk about portfolios like our national real estate portfolio, those assets are not as homogenous and easily understood in terms of any sort of modeling techniques so what we try to do there is really increase our efforts around grading and now in third quarter we mentioned we have monthly processes that look at every single loan performing or non performing in that national res CRE book to make sure we keep up with it. The way I think about that national res CRE that’s left is about $930 million in balances left almost $300 million of which are non performing and have been taken to net realized full value, we got roughly 10% reserve left on the rest of that book and our severity in real estate deals has been about 23% of what we’re writing things down to so that would indicate another 13 left.
If everything went bad and was as bad as average that would indicate there’s another $80 million left in that book so that’s kind of the wide end range I think in terminal losses left in that book. It’s going to play out differently then that but if I were to mention it, we try to keep things as current as possible, reserve appropriately, identify problems and then what’s a little different about this book is that it’s paying down pretty rapidly.
It’s a limited number and we can kind of [dimension] it as I just did.
Operator
There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.
Bryan Jordan
We appreciate you joining us this morning. We’re very pleased with the progress we’ve been making in the company and repositioning our company, our business units, our core banking business and our capital markets business are doing very well.
Again we appreciate you joining us this morning.