Jan 19, 2010
Executives
Aarti Bowman – Investor Relations Bryan Jordan – CEO B.J. Losch – CFO Greg Olivier - Chief Credit Officer
Analysts
Brian Foran – Goldman Sachs Bob Patten – Morgan Keegan Ken Usdin – Bank of America Steven Alexopoulos - JP Morgan Ken Zerbe – Morgan Stanley Craig Siegenthaler - Credit Suisse Rob - Deutsche Bank Kevin Fitzsimmons – Sandler O’Neill Jefferson Harralson – KBW Matt Burnell – Wells Fargo Securities Christopher Marinac – FIG Partners Erika Penala – UBS
Operator
(Operator Instructions) Welcome to today’s First Horizon National Corporation Fourth Quarter 2009 Earnings Conference Call. At this time I would like to the conference over to Ms.
Aarti Bowman.
Aarti Bowman
Please note that our press release and financial supplement, as well as the slide presentation we will use this morning, are posted on the Investor Relations section of our website at www.FHNC.com. Before we begin, we need to inform you that this conference call contains forward looking statements which may include guidance involving significant risks and uncertainties.
A number of factors could cause actual results to differ materially from those in forward looking information. Those factors are outlined in the recent earnings press release and more details are provided in the most current 10-Q and 10-K.
First Horizon National Corporation disclaims any obligation to update any forward looking statements that are made from time to time to reflect future events or developments. In addition, non-GAAP financial information may be noted in this conference call.
A reconciliation of that non-GAAP information to comparable GAAP information will be provided as needed in the appendix of the slide presentation, available in the Investor Relations area of our website. Listeners are encouraged to review any such reconciliation after this call.
Also, please remember that this webcast on our website is the only authorized record of this call. This morning’s speakers include our CEO, Bryan Jordan, our CFO, B.J.
Losch and our Chief Credit Officer, Greg Olivier. With that, I will turn it over to Bryan.
Bryan Jordan
Although challenging, 2009 was a year of positive change for First Horizon. Looking beyond our bottom line fourth quarter and full year loss, we made progress in executing our strategic plan to reposition First Horizon for consistent, significant, and long term profitability.
A healthy balance sheet is critical to long term success and we believe that 2009 actions materially bolstered our balance sheet. We have substantially improved liquidity, our core deposits grew significantly last year enabling us to reduce reliance on wholesale funding and retired debt.
Additionally, our capital and reserve position is currently one of the strongest in the industry. We continue to identify and aggressively deal with credit issues.
We increased our allowance to loans for the year, recognized problem loans, and wrote them down to net realizable value. As a result of the work performed on our loan portfolios, non-performers and net charge-offs began to decline in the second half of 2009.
In fact, non-performing assets have now been steady to declining for three consecutive quarters, indicative of the hard work and success of strength and credit policies implemented and overseen by Greg and his very experienced team. We reduced risk by shrinking our balance sheet through the ongoing wind down of our national specialty lending and mortgage businesses.
Since December 2007 we have reduced our national wind down loans by 40% including an 85% reduction in our national residential construction portfolios. As part of de-risking our balance sheet and as a continuation of efforts to exit non-core businesses we sold $14 billion of mortgage servicing in 2009.
Our servicing portfolio is down from a peak of $108 billion to $40 billion at the end of 2009. Competitive business model is also critical to long term success and in 2009 we focused on strengthening our core businesses, regional banking and capital markets.
Emphasis on customer service helped grow our regional banks average core deposits 12% in 2009. Relationship banking and greater pricing discipline enabled the regional banks net interest margin to expand 15 basis points in 2009.
We remain committed to serving our core customers and made nearly $2 billion of new and renewed loans in 2009. Soft demand, weak line usage, credit related actions, and normal portfolio run off led to a decline in loans outstanding over the course of the year, however.
During 2009 we also implemented new line of business structure in our regional bank to incorporate improved performance discipline, support consistent execution across geographies and increase scalability. FTN Financial is an attractive business for us with high returns on capital.
In 2009 our capital markets business had an outstanding year. Fixed income revenues were a record $600 million up 22% from 2008.
Fixed income revenues began to normalize in the second half of 2009 but remained very strong relative to historical levels. During 2009 we also identified cost cutting and efficiency measures that we’ve already begun to implement.
B.J. will provide more insight in a few minutes.
Turning to the fourth quarter on slide four, we took several actions that negatively affected the bottom line but should be beneficial over the long term. We exited a couple of non-core business locations and terminated contracts that had diminished in value as we exited our national businesses.
These actions resulted in a fourth quarter pre-tax impact of $31 million or 35% of our pre-tax loss. Additionally, as part of our focused monitoring of credit issues we increased our mortgage re-purchase reserve, resulting in $59 million of expense significantly driving up our environmental costs for the fourth quarter.
Credit quality trends, which Greg will detail for you, were encouraging. Length quarter provisioning expense declined $50 million and charge-offs decline $19 million and the allowance for credit losses was a strong 4.95% despite a $48 million reserve decrease.
Our capital ratios ended the year on strong footing with tangible common equity to tangible assets at 7.8% and Tier 1 common at 9.8%. Consolidated net interest margin expanded 23 basis points from last year’s fourth quarter levels as we concentrated on better pricing and growing customer deposits, while the impact of non-accruals lessened.
All in all, 2009 was a year during which we took major steps towards accomplishing our goals of returning First Horizon to sustained profitability and driving solid shareholder returns. I’ll be back later for some closing comments.
B.J. will now take you through the fourth quarter financial results.
B.J. Losch
Let me quickly go over the quarter’s consolidated financials on slide six. As Bryan mentioned, our fourth quarter EPS was a loss of $0.32 after discontinued operations and we had net loss of $71 million including $31 million in restructuring related costs.
As you can see, there were a lot of moving parts this quarter and so I’ll try to go over them in a little more detail over the next few minutes. If you turn to slide seven, our pre-tax, pre-provision highlights by business.
You can see our core businesses of regional banking and capital markets posted solid results while high expenses in our wind-down businesses as well as in our corporate segment negatively impacted pre-tax, pre-provision. You can see fourth quarter showed some positive trends in the bank and capital markets business with solid pre-tax, pre-provision earnings, good margin expansion in the bank, good fee income, and reduced non-interest expenses.
If you look specifically at the regional bank, our pre-tax, pre-provision earnings were up 42% from the third quarter as expenses were lower including reduced foreclosure costs in the bank. NII remained steady in the bank as well as the impact from lower loan balances was offset by improved net interest margin.
In fact, in the bank, the margin expanded 17 basis points to 497 and average core deposits were up 4% in the bank. In capital markets, our pre-tax, pre-provision earnings remained solid and steady.
Fixed income revenues were slightly down from last quarter as the average daily revenues declined to $1.8 million a day from $1.9 million. Commensurate with that, expenses declined 5% due to lower variable comp.
Going forward; we expect continued positive trends in regional banking and further normalization over time in capital markets revenues. Mortgage and national specialty lending were a significant drag on our consolidated earnings for the quarter with higher environmental costs from the mortgage repurchase reserve which I’ll give a little more detail on in a few minutes.
During the quarter we took several actions to better position our company for the long term, contributing to a $32 million pre-tax loss that shows up in the corporate segment. I’ll detail these items on slide eight.
If we turn to slide eight, consistent with what we’ve talked about previously and our overall focus on driving efficiencies as well as a review we undertook in 2009 of all of our businesses to better position us for sustained profitability going forward, we took several restructuring actions in the fourth quarter. You can see the pre-tax cash and non-cash impacts shown on slide eight.
The first one, we cancelled a significant vendor contract that resulted in a $13 million charge. We divested our First Horizon Insurance business in Atlanta and we sold a non-strategic remittance processing business.
Collectively these actions negatively impacted pre-tax income by $17 million and included various other smaller charges these items totaled $31 million pre-tax impact. Although these actions negatively impacted the fourth quarter pre-tax earnings, they should improve our efficiency and performance over the long term, beginning in 2010.
If you flip to slide nine, total expenses rose nearly 12% from last quarter due to higher environmental costs and restructuring and efficiency charges. These offset lower expenses in the regional bank that were down 9% and lower capital markets expenses which were down 5%.
In terms of our efficiency actions that we’ve talked to you about previously, we’ve now identified over $100 million in efficiency expense savings, up from an earlier $50 to $75 million target. These cost saves will be achieved by streamlining operations and improving processes.
In 2009 we’ve implemented about two thirds of these actions and expect the remainder to be fully implemented in 2010. We’re still facing significant environmental costs which totaled about $73 million in the fourth quarter compared to third quarter’s $47 million.
We incurred $13 million of foreclosure costs and $59 million of expense related to our mortgage repurchase provision. The addition to our mortgage repurchase reserve is based on an increase in repurchase submissions we’ve seen coming into the pipeline and slower resolutions in the existing, resulting in higher estimated inherent losses.
We had $17 million of actual realized charge-offs in the fourth quarter in repurchase and the total mortgage repurchase reserve now stands at $106 million. Going forward, we’ll continue to carefully monitor changes in the dynamics of this risk.
Going forward, overall our operating expenses should come down as we focus on the efficiency initiatives but the environmental costs which totaled around $250 million for all of 2009 are expected to remain sizeable and volatile in 2010. Flip over to page 10, our balance sheet showed some positive trends this quarter.
National specialty lending loan portfolio shrank by another $500 million or so in the fourth quarter. Our consolidated average core deposits increased 3% in the quarter and during the fourth quarter we repatriated more than $400 million in wealth management customer deposits back onto our balance sheet.
Our consolidated net interest margin expanded again five basis points to 3.19% from the third quarter as the average rate paid on core deposits decreased 11 basis points and loan yields improved nine basis points from last quarter. Notably, our weighted average cost of deposits is below 100 basis points now, 92 basis points in the fourth quarter.
Our wholesale funding has been reduced further, in fact, it’s been reduced by about $4 billion over the past 12 months. We believe the balance sheet in total is most likely near its low point.
Our balance sheet mix is asset sensitive which we believe gives us flexibility in the current rate environment and benefits us if rates rise. To wrap up, I think the challenges are certainly not behind us.
We believe there were a number of encouraging underlying fourth quarter trends. As Bryan said, we believe we’re entering 2010 with a strong balance sheet.
We’re making progress in building our core businesses, we’ve strengthened our net interest margin, we’re identifying and realizing productivity and efficiency benefits, and as Greg’s now going to talk to you about, credit quality is improving though related costs are likely to remain elevated in 2010. With that, I’ll turn it over to Greg.
Greg Olivier
Our asset quality comments start on slide 12. As an overarching statement, asset quality improvements are gaining some positive momentum at First Horizon as more portfolios shows signs of stabilization and progress in winding down the national portfolio continues.
Net charge-offs decreased again in the quarter to $183 million. The decrease is driven by lower losses in the consumer portfolios including one time close, mortgage and home equity lending.
Commercial charge-offs were flat overall, with lower C&I losses offset by higher commercial real estate losses. The loan loss reserve declined $48 million driven primarily by a decrease in reserves held for the one time close portfolio due to better than expected disposition results.
The level of required reserves for the residential pre and home equity portfolios also decreased in the fourth quarter. At 4.95% of total loans, our reserve remains high relative to peers but down somewhat from the 5.1% coverage in the previous quarter.
Provision expense totaled $135 million, a $50 million decrease from the third quarter and the second consecutive quarter of meaningfully lower provisioning expense. Turning to slide 13, we experienced a third consecutive quarter of non-performing asset reduction with NPAs down 14% on a linked quarter basis.
Non-performing loan inflows slowed significantly while dispositions continue to increase and execute at close to carrying value. NPL levels were down significantly and the one time close and residential pre-books and down marginally in the C&I and income CRE portfolio.
ORE balances were up $13 million to $114 million. This increase was expected and should be expected in future quarters as some portion of non-performing loans inevitably cycle through foreclosure process.
We continued focus on minimizing the average age of our ORE inventory and keeping carrying values current as evidenced by our evaluation adjustments. Single asset dispositions continue to be made at or close to carrying value.
With respect to distressed loan and ORE management in 2010, we will continue to balance the dual goals of decreased problem assets while making the best economic decisions for our shareholders. I’ll quickly go through the trends by portfolio beginning on slide 14 with Income CRE.
As expected, charge-offs were up from last quarter to $28 million. While some charge-off activity was associated with new non-performing loans, a significant portion was related to adjusting values on previously identified problems.
Income CRE non-performers were down marginally in the quarter. The increase in accruing delinquencies influenced by one larger transaction.
Reserves were flat compared to the third quarter after being an increase substantially in prior quarters. We expect Income CRE to remain challenging for the next couple of years with elevated levels of problem assets, reserves, and charge-offs but with a risk profile less severe then we were realizing on the residential CRE portfolio.
We feel we are managing this portfolio proactively and have its credit risk profile properly assessed and adequately reserved for. Moving on to slide 15, we continue to see signs of stabilization in the overall C&I portfolio.
Delinquencies declined 29 basis points and non-performing loans declined 23 basis points. Excluding the bank and TRUPS exposures we saw an improvement in the weighted average risk rating in this book which resulted in incrementally lower required reserves.
C&I charge-offs totaled $21 million for the quarter, $23 million lower then last quarter. The decrease in charge-offs was greater then our expectations due to the fact that no losses were taken on the TRUPS or other bank exposures in the quarter.
On to slide 16, we continue to focus significant attention on our TRUPS preferred loan portfolio, on loans extended to bank holding companies and on other loans secured by bank stock. Due to the stressed financial services industry is under, the risk profile of loans in these portfolios is assessed quarterly to ensure proper risk management and the adequacy of reserves.
Here we disclose the risk profile of these portfolios and the level of reserves or low com associated with them. The balances remained flat from last quarter.
We increased reserves for this book again this quarter in response to negative grade migration and management’s qualitative assessment of the state of the industry. Moving on to slide 17, home equity balances were $6.9 billion for the fourth quarter.
Our core portfolio remained flat at $2.6 billion and our national portfolio continued in slow run off, decreasing $171 million to $4.3 billion. Charge-offs decreased modestly from last quarter to $52 million and we decreased home equity reserves by $15 million in response to incrementally lower balances and delinquency trends moderating.
We expect home equity losses to remain flat to recent quarterly results in the first half of 2010 and decrease slightly in the second half of the year. The home equity portfolio has consistently performed better than market expectations due to the higher quality characteristics of this portfolio.
We expect this stable performance to continue barring any further severe economic shocks. On to slide 18, you can see the national wind-down portfolios remain on track.
Again this quarter, balances declined almost $500 million and required reserves decreased by $65 million. OTC balances were down $130 million from last quarter and now stand at $230 million with negligible un-drawn commitments remaining.
Recall that two years ago, one time close commitments were $3 billion. OTC charge-offs were down $11 million and reserves decreased $48 million but remain substantial at 27% of loans.
National residential CRE balances were down $137 million from last quarter to $340 million. Charge-offs for the entire residential CRE book were above expectations due to the continued write down of non-performing loans as a result of declining collateral values, the same issue that was discussed earlier in our income CRE commentary.
Permanent mortgage balances remained relatively flat for the quarter despite some migration of completed OTC loans to this book. While delinquency was up slightly we have seen positive trends in entry level low rate and see deterioration in this portfolio moderating.
Charge-offs were down for the quarter, however, we build reserves due to increases in observed severities and problem asset dispositions and the impact extended foreclosure periods are having on loss content. We are proud of the progress we’ve made winding down the national construction portfolios and expect most of these loans to be worked through in 2010.
On slide 19, fourth quarter in aggregate was a little better then expected from a charge-off perspective but about as expected from a reserve perspective, although there was some variation from expectations of the sub-portfolio level. Overall, 2009 played out as we through it might last January.
Assuming current economic trends continue we expect a further trend of lower losses and lower required reserves in aggregate throughout 2010. We do see the possibility of more quarter to quarter volatility in results, however, as the portfolios most at risk; TRUPS, bank exposures, and income CRE tend to be less granular then the other segments of our portfolio.
Now I’ll turn it back to Bryan for some final comments.
Bryan Jordan
In 2009 we made considerable headway in repositioning First Horizon, enabling us to re-focus on our core businesses and strengthen our business model. Thanks to the hard work of our team we were able to reduce risk in our balance sheet, get ahead of our credit challenges and improve our capital and liquidity.
In 2010 we expect continued progress towards reaching sustained profitability but as B.J. said, the challenges aren’t over.
The economic recovery is likely to be slow and environmental and credit costs are anticipated to remain elevated, although below 2009 levels. Nonetheless we anticipate a gradually improving bottom line as we move through the year, assuming the economic recovery remains in tact.
We have more work to do, deepening customer relationships, building on our core businesses and improving our operating efficiency. Longer term, I’m increasingly confident in First Horizon’s ability to consistently deliver solid, high quality returns for shareholders.
Thank you. Operator we’ll open the call for questions please.
Operator
(Operator Instructions) Your first question comes from Brian Foran – Goldman Sachs
Brian Foran – Goldman Sachs
Can I ask about the mortgage rep and warranty reserves and I realize you’re limited in what you can say given some of the stuff is in negotiations, but any metrics you can give on sizing up the total potential liability or what are the specific areas of weakness and any kind of rescission rates? Also, there was a press release from the HUD out yesterday on FHA rescissions and I guess the question would be is any of that activity already reflected in your reserve or would that be incremental going forward?
B.J. Losch
Mortgage repurchase we obviously look at that closely every month actually instead of for the quarter. What we saw this quarter was higher inflows into the pipeline so higher put backs from our investors as well as slower resolutions coming out of the pipeline.
We’ve done a pretty good job; we have a very experienced team that works these pretty hard. Moving them through the pipeline does take a little bit longer.
With that, we had larger pipeline and therefore looking at both historical loss as well as what we think inherent loss could be from those that’s how we set the reserve and we thought it was appropriate to increase the reserve fairly substantially for that. In terms of the metrics that we look at, we obviously look at the pipeline growth; we look at what’s called the rescission rate which is when a repurchase request is made of us, how often do we put it back to the investors so to speak.
That has remained fairly steady. We obviously look at the severity of loss coming back in which has come down a little bit over the last couple quarters but not alarmingly.
Really most of our repurchase reserve increase was related to the increase in the pipeline. Looking at it, we feel like we’ve done a very good job working the repurchase, we’ve done a very good job of building the reserve and being appropriately reserved for it.
If you look at our numbers, we actually had actual charge offs and losses of about $17 million or about $5 million a month and we have a repurchase reserve of $106 million. We feel like we have pretty good coverage on it.
Bryan Jordan
We built the reserves substantially as we pointed out. The thing that makes all this difficult to estimate is there’s no precedence or history that you can really rely on.
I think it’s important to note that we originated our last mortgage in August of 2008. At some point that tail runs through.
We’ve got about 16 or 18 months of period where we’ve seen it come through the pipeline so we feel like we’re getting closer but again this is an area where without precedence, very difficult to estimate the inherent loss.
Brian Foran – Goldman Sachs
If I could broaden the question to the other environmental costs, I guess clearly they’re a lagging indicator and its positive NPAs have seemed to have peaked. Is there any historical perspective there in terms of what the, if NPAs have in fact peaked how many quarters or years would you expect environmental costs to remain elevated before those start consistently coming down as well?
B.J. Losch
What we expect is that commensurate with asset quality improving we expect those environmental costs to come down. If you look at where we think our long term targets are for annualized provision based on the risk that we want on our balance sheet it’ll take several years, three or four years for us to fully work through all of the elevated environmental costs that we have.
Again, we think that it incrementally steps down over time as our asset quality improves.
Operator
Your next question comes from Bob Patten – Morgan Keegan
Bob Patten – Morgan Keegan
In terms of expense lines and what we think the run rate is going to be, obviously comp expenses were down a lot in the fourth quarter. They can’t stay down on this level but you identified another $100 million of which two thirds were already in the run rate fourth quarter ’09.
How should we think about core expenses outside of what Bryan was talking about with the environmental costs?
B.J. Losch
You should look at those expense efficiencies that we talked about, the $100 million as being in the run rate for 2010. Going forward we expect to implement the rest and see a full impact of that $100 million going forward into 2011.
I think we gave you what our entire 2009 environmental costs were about $250 million or so, you look at that, you look at our normalized run rates less $100 million going forward into 2011 and that should give you a good idea of it.
Bob Patten – Morgan Keegan
Since BofA and the capital raises we saw you guys in December, what has changed in your thinking around TARP? Have you talked with your regulators, is there any view that has changed or maybe more thoughtful in terms of how you maybe exit that in late 2010 or whatever?
Bryan Jordan
I hope we’re being thoughtful about it. We’ve spent a lot of time trying to follow what’s unfolded in the last month and a half.
We’re very in tune with what’s going on there. We are in the process of discussing internally how we work with our regulators through what we consider a process to evaluate the right time and the right way to repay TARP.
I would hope that during 2010 we’d make significant progress in that regard. We’re evaluating it, we’re going to work with our regulators as appropriate and I hope we make significant progress this year.
Operator
Your next question comes from Ken Usdin – Bank of America
Ken Usdin – Bank of America
You guys have clearly made some great progress turning the corner on charge-offs and the allowance. I was wondering if you can help us try and understand a little bit about directional and magnitude.
Now that we’ve seen some of these categories really starting to shrink as far as the national stuff, can you give us just a little bit of granularity in terms of how to understand the progression from here as far as run off versus core charge-offs and the moving parts within the allowance as you continue to work that down as you go forward.
Greg Olivier
I think it’d be helpful to be on slide 19 where we try again to give a view of what we expect and this time really more a year to year view. We’d like to say that we’ll see sequential quarter to quarter decreases in charge-offs and reserves and that would be what we’d expect.
This issue with 2010 is that we’re dealing with portfolios, the ones that are most under stress now tend to be less granular then the balance of our portfolio. From a quarter to quarter basis we could have a surprise in one direction or the other, better than expected or worse than expected.
We think if we drew a trend line through 2010 it would be a progression line that decreased quarter to quarter through the year. Again, we said this last quarter, we’ll say it again this quarter, I think the improvement we’ll see will be incremental quarter to quarter, and we don’t see a sudden turnabout or any major release in any particular quarter but just steady improvement.
Ken Usdin – Bank of America
On the balance sheet, maybe an update on balance sheet size and obviously we still have a good amount of the national stuff to run down but what are you seeing as far as loan demand, if any at all? Do you have an expectation of the point in time in which we’ll get to that steady state for balance sheet size, especially the loan portfolio?
Bryan Jordan
We saw a fair amount of softness in the last half of 2009, demand incrementally better. In the fourth quarter we think, late fourth quarter, we might have seen a stabilization point in demand.
We expect that in the banking business we’ve essentially bottomed out in terms of the loan portfolio and expect to see, based on demand, a little bit of growth in the first quarter. It is still fairly anemic both on the consumer side as well as the real estate side, seeing eyes a little bit stronger.
With respect to the aggregate balance sheet, we’ve seen the significant run off in the rapid portions of the national portfolio, about $500 million decline this past quarter, a lot of that coming in our construction portfolio, income CRE, residential construction, and one time close. We’d expect that to be more stable.
I would guess that the size of the balance sheet is going to be reasonably stable plus or minus $26 billion level with a little bit of growth showing up in the bank in the early part of 2010.
Operator
Your next question comes from Steven Alexopoulos - JP Morgan
Steven Alexopoulos - JP Morgan
A follow up on this question of magnitude on credit. If we look at the year end allowance were up around $50 million from a year ago, would a decline back to around where we were at year end ’08, around $850 million is that a reasonable target to assume where we could head to or when you look at the trends, a bit on the optimistic side?
Greg Olivier
A point of clarification, as you’re getting back to the 2008 level relative to where we’ll end 12 months from now?
Steven Alexopoulos - JP Morgan
Yes
Greg Olivier
I think our expectation is we’ll do better then that. In other words, the reserve level at this time next year will be something less then the ’08 level.
Steven Alexopoulos - JP Morgan
It looks like your work out team is bringing up some capacity. Could you talk about your appetite for FDIC deals here and should we be surprised if we to the mid point of this year and you haven’t announced any?
Bryan Jordan
I would say that Greg and his team have made great progress and at some point they will free up some capacity, we’ve probably got a little bit now we feel like we’re capable of participating in and FDIC transaction. I don’t know that I would be surprised or not surprised.
You take what becomes available in terms of opportunities. We’re going to be very focused on making sure that if we participate or don’t participate we’re doing it in a thoughtful manner.
I wouldn’t read too much into it one way or the other. We’ve got the ability to do it today; we’ll think about it and look for the appropriate opportunities.
In the meantime, Greg will keep the resources focused on continuing to work through the portfolio of problems that we’re working on today.
Operator
Your next question comes from Ken Zerbe – Morgan Stanley
Ken Zerbe – Morgan Stanley
On the balance sheet contraction or your comments about the balance sheet has stabilized. I think prior guidance at one point was something like a $23 or $24 billion low point in terms of the balance sheet.
I heard your comments that you said loan demand was starting to stabilize. What was really the big driver in terms of your expectations that the balance sheet is going to stabilize $3 billion higher then where you guys had mentioned it before?
Bryan Jordan
That may be something that we’ve confused because we talk about it a lot of different ways. I think the way you would get to the $23 billion is if you said the national home equity portfolio were gone today then you would be closer to that range.
That’s a portfolio that is going to take a little more time to work through. The number that I recall is most used and is around $25 billion.
Somewhere between $26 and $25 billion is where I think it would bottom out over time. Part of that is the national portfolios; particularly the home equity is going to be a little slower to run off.
When we start to see growth like we expect in the early part of 2010 in the banking portfolio it will offset some of that. That’s how we got to it.
It may be something we’ve confused and just the various ways we’ve talked about it.
Ken Zerbe – Morgan Stanley
On commercial real estate, you mentioned that lower valuations were the primary driver of the losses this quarter. Has anything changed with your methodology, the way you estimate ultimate loss content on the CRE portfolios.
I’m curious if this is something we should expect to see continue for the next several quarter or if this was due to some unusual or one time adjustment?
Greg Olivier
No we have not changed our methodology, in fact we’ve tried to be very, very consistent and make sure that we mark things on a quarterly basis to what we think the net realizable value is. Really the driver of what we saw here in fourth quarter was some larger properties getting reappraised and values coming in and a lot of it was more land related values coming in lower then would have been anticipated and going ahead and taking those marks.
To the extent appraised values, we have seen a little bit of stabilization across commercial real estate, land continues to be an asset class that can hold some valuation surprises. We haven’t changed methodologies, we continue to be diligent and take our medicine quarter to quarter.
Operator
Your next question comes from Craig Siegenthaler - Credit Suisse
Craig Siegenthaler - Credit Suisse
I want to talk about the net addition to non-performing loan trends which saw a pretty big improvement in the fourth quarter. It was even a much bigger improvement then the early stage delinquency trends.
I’m wondering if you could talk about the drivers here and how you expect this level to trend into the first half of 2010.
Greg Olivier
If you get behind our numbers, the portfolios that have most contributed to non-performing loans have been one time close and our national res CRE portfolios and those things as they wind down there’s to flow in. We also again talk about stabilization we’ve seen in the C&I book too.
We’d anticipate that the net inflows would at this point continue to trend down over time. Again, more volatile portfolios quarter to quarter there could be some changes in that but I think overall we think inflows based on our portfolio will continue on a declining trend.
Craig Siegenthaler - Credit Suisse
On the potential and timing of deployment of excess capital, not to be too forward looking here but the return of cash dividends and buybacks we can all assume is after the repayment of TARP. How can we think about M&A potential, is there any potential for you guys to look at deals in and around your footprint this year?
Bryan Jordan
The dividend question is going to be contingent upon a couple of things. One is return to profitability and two is repayment of the CPT.
With respect to deploying capital, we’ll be very focused in how we deploy capital. We’ve got a strong bias that we want to do it in a smart fashion; we want to be deployed in a way that we can produce very strong returns.
We’ve talked, based on our expectation of normalized capital levels, producing 15% to 20% returns. The M&A environment in my view is likely to be largely an FDIC driven process for the next several quarters.
I think that the regular rate market, as I would define it, would be more likely late 2010 early 2011. I think in the meantime we’ll continue to work on growing the customer business, work on winding down these national businesses.
If FDIC opportunities happen to present themselves in and around our marketplace we’ll consider that. I think the regular rate markets will come back its just going to be another several quarters before we get to that point.
Operator
Your next question comes from Rob - Deutsche Bank
Rob - Deutsche Bank
On the NIM, it continued to increase, up five basis points quarter over quarter. The rate of increase is more modest then the past few quarters.
How should we think about the magnitude of NIM increases in 1Q, 2Q of next year? How much can you continue to reduce funding costs, specifically re-pricing some of your CDs?
B.J. Losch
We’ve been pretty pleased with what we’ve seen on NIM expansion throughout 2009. I think going into next year we do see the opportunity for further improvement in the NIM but it’ll probably be modest, reason being is that as you mentioned, we’ve gotten much improved funding costs particularly on weighted average rate paid for deposits.
We’ll probably see incremental improvement in that as we allow CDs to run off and that will certainly help. We’re getting close to the point where there’s just a natural floor on it.
That’ll be tougher to improve. We’ve also been pretty pleased with what we’ve seen on improving loan yields.
Again, that takes a while to work through the portfolio. I think now we’re getting to the point where we’ve taken a lot of the organic steps, so to speak, to put us on the right track for sustained improved NIM.
Going forward we’ll probably need a little more help from the rate environment, meaning as rates rise we think that’s when we’ll start to see more NIM expansion over time. Until then it’ll probably be much more modest then you’ve seen the last couple quarters.
Operator
Your next question comes from Kevin Fitzsimmons – Sandler O’Neill
Kevin Fitzsimmons – Sandler O’Neill
One quick clarification on the mortgage banking repurchase provision line item, obviously that jumped up this quarter and you guys have talked about that. Looking forward, should we view that as somewhat of a deliberate true up of that reserve this quarter and not necessarily look at that amount as a run rate over the next few quarters?
Should we more look at the last couple quarters as more of a run rate in trying to forecast earnings?
B.J. Losch
I don’t know if we necessarily changed quarter to quarter how we look at it. We look at historical loss rates, inherent loss rates, what’s coming into the pipeline, etc.
At this time we thought that was the most prudent thing to build the reserve fairly substantially over what we had seen the last couple quarters. As Bryan said, we haven’t originated a loan for sales since third quarter 2008.
We do think that at some point the inflows will stop and could stop fairly rapidly. I would be surprised if we saw that magnitude of increase unless the environment got significantly worse then where we sit today.
Operator
Your next question comes from Jefferson Harralson – KBW
Jefferson Harralson – KBW
I have one more rep and warranty reserve question, what’s the amount of the loans that you’ve sold? Said another way, the $106 million what is that in basis points of the amount of loan that could come back to you?
Bryan Jordan
That’s $100 billion plus number of loans that we’ve sold. I commented earlier, one of the difficulties in estimating these reserves is not having any precedent for them.
As B.J. and I both have pointed out, we originated our last loan in August 2008.
One of the factors that intuitively believe is that a problem that is based on a fraud or a mis rep is going to surface earlier in the cycle. If something performs for an 18 month period or thereabouts it may be something other then a fraud or a mis rep.
There’s a strong incentive for a lot of these loans to be pushed back to the originator, particularly on a rep and warranty claim and force us to fight our way through the rescission process. There’s not a lot of good history.
As B.J. pointed out we lost roughly $5 million per month in the fourth quarter, $17 million I think was the number.
We increased our reserve by about $45 million in the quarter, taking it from roughly $60 to $106 million. That’s a long way of saying there’s not a lot of history.
We think that we’re getting a lot of the potential volume through the pipeline in 2009. We’re not sure quite where it goes in 2010 but we’ll stay on top of it and we’ll continue to evaluate it.
Its one of those areas, it’s just going to evolve over time.
Jefferson Harralson – KBW
Is it a better question to ask what percentage of the loans that have gone NPA in your buyers’ portfolios, are they finding some kind of technical issue with and you’re having to pay on? Is that a better way to think about that?
B.J. Losch
I think most of what we see, not all, but most are when loans are delinquent, that’s when the investor will certainly put it back. That’s most of the volume that we’re seeing.
We’ve seen an increase from our largest investors in terms of really trying to work their books to find anything that they can to put back, as Bryan said. We’re working with them and trying to size it as best we can.
One other thing I’ll mention on Bryan, what we said about what we’ve originated. As you obviously know, once its refied away from the investor we don’t have further rep and warranty on that.
As we try to look at total inherent loss content its not quite as easy as just saying how much did we originate and so on, its a little more then that and we do a heck of a lot of work to try to pinpoint it as best we can. It’s as much an art as a science.
Bryan Jordan
If there is a loss inherent in a loan its likely to be pushed back to press a rep and warranty claim and that’s not just a First Horizon questions, that’s an industry wide issue that we’re all going through for what seems to be the very first time on a large scale basis.
Operator
Your next question comes from Matt Burnell – Wells Fargo Securities
Matt Burnell – Wells Fargo Securities
In terms of your comments, in terms of the commercial real estate losses seemed to be more related to land exposures. Can we infer from that the non-land exposures are actually performing maybe in line with your expectations or maybe a little bit better then your expectations at present?
Greg Olivier
Looking at our slides for income CRE is slide 14, in terms of performance by category you can see there on the bottom right, land is clearly the worst performing asset class. My comments earlier around the losses that were realized in fourth quarter, about two thirds or so of the losses that we experienced were related, that’s a rough estimate, to reassessing values of existing non-performers rather then new inflows.
The larger contributor there is where there’s land because the values have dropped more precipitously on that. You can see the category performance by other income CRE types and I think it’s safe to say we’re elevated across the board; we’re concerned about all of income CRE.
I think were we get comfort in terms of our guidance as the loss levels and reserve levels in 2010 is we have pretty aggressively or appropriately migrated loans down through the grading process in 2009, built reserves for those loans, the balances are decreasing. We think we’ve got things set for pretty stable performance in 2010 relative to 2009.
Again, this is a portfolio that we don’t see marked improvement the next couple years. I think that’d be consistent with an industry view.
Operator
Your next question comes from Christopher Marinac – FIG Partners
Christopher Marinac – FIG Partners
I noticed that there was some growth in period end loans for capital markets. I was curious if this was an anomaly or is this an area of potential growth as the balance sheet stabilizes?
B.J. Losch
The growth [inaudible] that’s virtually all.
Greg Olivier
As you know the mortgage warehouse lines usage of those varies pretty significantly quarter to quarter depending on the rate environment. It wasn’t a lot of new commitments being made it was utilization because the rate environment on existing commitments.
Christopher Marinac – FIG Partners
Is there any geographical focus on the C&I growth we saw at period end?
Greg Olivier
The C&I growth you saw at period end fourth quarter was almost exclusively the mortgage warehouse line utilization, about $200 million increase. We did see, sort of as an overall core C&I comment slight up tick on line utilization C&I fourth quarter that’s sort of in line with what you’re hearing in the industry about rebuilding inventories.
It was modest but there was some improvement utilization.
Operator
Your next question comes from Erika Penala – UBS
Erika Penala – UBS
A clarification surrounding the reserve, since any incremental new NPL inflows will likely be lower severity, how comfortable are you and at what floor are you willing to lower the reserve coverage ratio to NPLs in 2010 relative to where we’ve seen it over the past couple of years?
Bryan Jordan
The first part of your question got cut off for some reason. Would you mind repeating it?
Erika Penala – UBS
Surrounding the reserves, I was wondering since any net new NPL inflows will likely be on lower severity products. I was wondering how comfortable are you bleeding down your reserve coverage ratio to NPLs in 2010 from where you’ve been reporting it over the past couple of years?
Bryan Jordan
It’s going to depend on portfolios. If you look at some of these national portfolios, one time close, we’ve got reserve coverage that’s 26% to 27%.
The bank trust preferred portfolio, bank loans we’ve got about 17%. [Inaudible] the construction is likely to be gone throughout 2010 so we’d expect to see those come down.
I would guess that on our commercial real estate loans where we’ve got something like 8.6% or 8.7% reserves they will likely remain elevated for a period of time. With the improvement we’ve seen in C&I and some of these other portfolios like home equity where we reduce reserve slightly this quarter, there’s a chance that they will come down throughout 2010.
As Greg said to the question earlier, we expect to see reserve levels trend down in the aggregate across 2010. As we’ve said in the past, over time we migrate back down to a reserve level that’s probably in the 2% or less range.
Greg Olivier
I think you’ve probably heard us bristle before at reserves to NPLs because so much of our portfolio is real estate dependent because of the national portfolios and we’ve gone ahead and marked the loss content and taken the losses. We did see that coverage ratio reserves to NPLs increase here in fourth quarter but we still think that’s probably not based on our portfolio the best ratio to look at.
Bryan Jordan
A big portion of those non-performing assets have been written down, I think it’s about $290 million of charge-offs or roughly 40% on that piece of the portfolio. I think there’s a graphic in the deck.
Operator
That does conclude today’s question and answer session. I would now like to turn the call back over to Mr.
Bryan Jordan for any additional or closing remarks.
Bryan Jordan
Thank you everyone for joining our call. We appreciate your time and your interest.
Please don’t hesitate to follow up if you have any other questions that we may be helpful on. Aarti will be available and any of us will be happy to help if at all possible.
Thank you all and hope you have a great day.
Operator
That does conclude today’s conference call. We thank you for your participation.