1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2000 -------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to _____________ Commission file number 000-4491 -------- FIRST TENNESSEE NATIONAL CORPORATION ------------------------------------------------------ (Exact name of registrant as specified in its charter) Tennessee 62-0803242 ------------------------------- ------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 165 Madison Avenue, Memphis, Tennessee 38103 ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (901) 523-4027 ---------------------------------------------------- (Registrant's telephone number, including area code) None ---------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock, $.625 par value 130,002,907 ----------------------------- ----------------------------- Class Outstanding at April 30, 2000
2 FIRST TENNESSEE NATIONAL CORPORATION INDEX Part I. Financial Information Part II. Other Information Signatures Exhibit Index
3 PART I. FINANCIAL INFORMATION Item 1. Financial Statements. - ------------------------------ The Consolidated Statements of Condition The Consolidated Statements of Income The Consolidated Statements of Shareholders' Equity The Consolidated Statements of Cash Flows The Notes to Consolidated Financial Statements This financial information reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the interim periods presented.
4 <TABLE> <CAPTION> CONSOLIDATED STATEMENTS OF CONDITION First Tennessee National Corporation - ------------------------------------------------------------------------------------------------------------------------------- March 31 December 31 -------------------------------- ------------- (Dollars in thousands)(Unaudited) 2000 1999 1999 - ------------------------------------------------------------------------------------------------------------ ------------- <S> <C> <C> <C> ASSETS: Cash and due from banks $ 799,641 $ 589,789 $ 956,077 Federal funds sold and securities purchased under agreements to resell 359,556 91,701 279,537 - ------------------------------------------------------------------------------------------------------------ ------------- Total cash and cash equivalents 1,159,197 681,490 1,235,614 - ------------------------------------------------------------------------------------------------------------ ------------- Investment in bank time deposits 947 1,416 3,263 Capital markets securities inventory 351,135 420,133 147,041 Mortgage loans held for sale 2,914,024 3,201,792 2,049,945 Securities available for sale 2,190,683 1,882,113 2,332,356 Securities held to maturity (market value of $684,103 at March 31, 2000; $544,529 at March 31, 1999; and $734,853 at December 31, 1999) 736,691 546,844 768,936 Loans, net of unearned income 9,582,450 8,782,802 9,363,158 Less: Allowance for loan losses 140,736 139,387 139,603 - ------------------------------------------------------------------------------------------------------------ ------------- Total net loans 9,441,714 8,643,415 9,223,555 - ------------------------------------------------------------------------------------------------------------ ------------- Premises and equipment, net 304,738 272,736 305,519 Real estate acquired by foreclosure 18,414 16,870 17,870 Mortgage servicing rights, net 800,521 814,827 826,210 Intangible assets, net 132,276 130,925 133,568 Capital markets receivables and other assets 2,021,235 1,712,443 1,329,513 - ------------------------------------------------------------------------------------------------------------ ------------- TOTAL ASSETS $ 20,071,575 $ 18,325,004 $ 18,373,390 ============================================================================================================ ============= LIABILITIES AND SHAREHOLDERS' EQUITY: Deposits: Interest-bearing $ 9,837,514 $ 9,381,365 $ 8,560,462 Noninterest-bearing 2,851,753 2,816,442 2,798,239 - ------------------------------------------------------------------------------------------------------------ ------------- Total deposits 12,689,267 12,197,807 11,358,701 - ------------------------------------------------------------------------------------------------------------ ------------- Federal funds purchased and securities sold under agreements to repurchase 2,507,361 1,615,831 2,856,282 Commercial paper and other short-term borrowings 1,465,142 1,318,451 1,550,229 Capital markets payables and other liabilities 1,688,619 1,535,425 908,048 Term borrowings 359,857 400,501 358,663 - ------------------------------------------------------------------------------------------------------------ ------------- Total liabilities 18,710,246 17,068,015 17,031,923 - ------------------------------------------------------------------------------------------------------------ ------------- Guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures 100,000 100,000 100,000 - ------------------------------------------------------------------------------------------------------------ ------------- SHAREHOLDERS' EQUITY: Preferred stock - no par value (5,000,000 shares authorized, but unissued) -- -- -- Common stock - $.625 par value (shares authorized - 400,000,000; shares issued - 129,920,110 at March 31, 2000; 129,908,808 at March 31, 1999; and 129,878,459 at December 31, 1999) 81,200 81,193 81,174 Capital surplus 138,453 133,857 130,636 Undivided profits 1,064,599 937,339 1,053,722 Accumulated other comprehensive income (20,958) 9,604 (21,752) Deferred compensation on restricted stock incentive plans (5,370) (7,441) (5,674) Deferred compensation obligation 3,405 2,437 3,361 - ------------------------------------------------------------------------------------------------------------ ------------- Total shareholders' equity 1,261,329 1,156,989 1,241,467 - ------------------------------------------------------------------------------------------------------------ ------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 20,071,575 $ 18,325,004 $ 18,373,390 ============================================================================================================ ============= <FN> See accompanying notes to consolidated financial statements. </FN> </TABLE>
5 <TABLE> <CAPTION> CONSOLIDATED STATEMENTS OF INCOME First Tennessee National Corporation - ------------------------------------------------------------------------------------------------------------ Three Months Ended March 31 ----------------------------------- (Dollars in thousands except per share data)(Unaudited) 2000 1999 - ------------------------------------------------------------------------------------------------------------ <S> <C> <C> INTEREST INCOME: Interest and fees on loans $ 209,371 $ 181,248 Interest on investment securities: Taxable 53,476 38,228 Tax-exempt 505 754 Interest on mortgage loans held for sale 45,368 68,735 Interest on capital markets securities inventory 5,942 8,697 Interest on other earning assets 4,637 2,604 - ------------------------------------------------------------------------------------------------------------ Total interest income 319,299 300,266 - ------------------------------------------------------------------------------------------------------------ INTEREST EXPENSE: Interest on deposits: Savings 1,421 1,428 Checking interest and money market account 27,533 26,569 Certificates of deposit under $100,000 and other time 30,363 32,379 Certificates of deposit $100,000 and more 45,295 42,309 Interest on short-term borrowings 63,058 42,621 Interest on term borrowings 6,135 6,793 - ------------------------------------------------------------------------------------------------------------ Total interest expense 173,805 152,099 - ------------------------------------------------------------------------------------------------------------ NET INTEREST INCOME 145,494 148,167 Provision for loan losses 15,497 14,826 - ------------------------------------------------------------------------------------------------------------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 129,997 133,341 - ------------------------------------------------------------------------------------------------------------ NONINTEREST INCOME: Mortgage banking 99,872 168,778 Capital markets 24,364 44,388 Deposit transactions and cash management 26,413 23,216 Trust services and investment management 15,994 14,591 Merchant processing 11,030 10,709 Cardholder fees 7,033 4,962 Equity securities gains/(losses) 475 (8) Debt securities gains/(losses) 1,126 (26) All other income and commissions 36,090 19,953 - ------------------------------------------------------------------------------------------------------------ Total noninterest income 222,397 286,563 - ------------------------------------------------------------------------------------------------------------ ADJUSTED GROSS INCOME AFTER PROVISION FOR LOAN LOSSES 352,394 419,904 - ------------------------------------------------------------------------------------------------------------ NONINTEREST EXPENSE: Employee compensation, incentives and benefits 139,994 173,895 Amortization of mortgage servicing rights 18,429 30,898 Occupancy 18,387 15,651 Operations services 17,361 15,702 Equipment rentals, depreciation and maintenance 15,478 13,469 Communications and courier 12,019 12,367 Amortization of intangible assets 2,671 2,576 All other expense 68,540 72,239 - ------------------------------------------------------------------------------------------------------------ Total noninterest expense 292,879 336,797 - ------------------------------------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES 59,515 83,107 Applicable income taxes 19,992 30,078 - ------------------------------------------------------------------------------------------------------------ NET INCOME $ 39,523 $ 53,029 ============================================================================================================ EARNINGS PER SHARE $ .30 $ .41 - ------------------------------------------------------------------------------------------------------------ DILUTED EARNINGS PER SHARE $ .30 $ .40 - ------------------------------------------------------------------------------------------------------------ WEIGHTED AVERAGE SHARES OUTSTANDING 130,394,379 129,787,078 - ------------------------------------------------------------------------------------------------------------ <FN> See accompanying notes to consolidated financial statements. </FN> </TABLE>
6 <TABLE> <CAPTION> CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY First Tennessee National Corporation - ------------------------------------------------------------------------------------------------------------ (Dollars in thousands)(Unaudited) 2000 1999 - ------------------------------------------------------------------------------------------------------------ <S> <C> <C> BALANCE, JANUARY 1 $ 1,241,467 $ 1,099,534 Net income 39,523 53,029 Other comprehensive income: Unrealized market adjustments, net of tax and reclassification adjustment 794 (3,267) - ------------------------------------------------------------------------------------------------------------ Comprehensive income 40,317 49,762 - ------------------------------------------------------------------------------------------------------------ Cash dividends declared (28,646) (24,668) Common stock issued: Elliot Ames, Inc. acquisition 1,385 -- Cambridge Mortgage Company acquisition -- 421 For exercise of stock options 2,056 13,995 Tax benefit from non-qualified stock options -- 7,850 Common stock repurchased (5,474) -- Amortization on restricted stock incentive plans 533 382 Other 9,691 9,713 - ------------------------------------------------------------------------------------------------------------ BALANCE, MARCH 31 $ 1,261,329 $ 1,156,989 ============================================================================================================ <FN> See accompanying notes to consolidated financial statements. </FN> </TABLE>
7 <TABLE> <CAPTION> CONSOLIDATED STATEMENTS OF CASH FLOWS First Tennessee National Corporation - ------------------------------------------------------------------------------------------------------------ Three Months Ended March 31 ----------------------------------- (Dollars in thousands)(Unaudited) 2000 1999 - ------------------------------------------------------------------------------------------------------------ <S> <C> <C> OPERATING ACTIVITIES: Net income $ 39,523 $ 53,029 Adjustments to reconcile net income to net cash provided/(used) by operating activities: Provision for loan losses 15,497 14,826 Provision for deferred income tax 7,980 32,927 Depreciation and amortization of premises and equipment 14,740 11,801 Amortization of mortgage servicing rights 18,429 30,898 Amortization of intangible assets 2,671 2,576 Net other amortization and accretion 11,454 11,649 Market value adjustment on foreclosed property 1,477 2,400 Equity securities (gains)/losses (475) 8 Debt securities (gains)/losses (1,126) 26 Net (gains)/losses on disposal of fixed assets (21) 219 Net (increase)/decrease in: Capital markets securities inventory (204,094) (61,829) Mortgage loans held for sale (762,507) 1,025,651 Capital markets receivables (649,148) (401,084) Interest receivable 1,429 1,029 Other assets (54,030) (210,960) Net increase in: Capital markets payables 692,476 446,833 Interest payable 6,378 8,612 Other liabilities 82,610 8,538 - ------------------------------------------------------------------------------------------------------------ Total adjustments (816,260) 924,120 - ------------------------------------------------------------------------------------------------------------ Net cash (used)/provided by operating activities (776,737) 977,149 - ------------------------------------------------------------------------------------------------------------ INVESTING ACTIVITIES: Held to maturity securities - maturities 32,394 62,436 Available for sale securities: Sales 133,734 5,504 Maturities 153,538 238,034 Purchases (239,423) (313,098) Premises and equipment: Sales 849 96 Purchases (11,970) (28,931) Net increase in loans (237,448) (241,096) Increase in investment in bank time deposits 2,316 (205) Acquisitions, net of cash and cash equivalents acquired -- (1,755) - ------------------------------------------------------------------------------------------------------------ Net cash used by investing activities (166,010) (279,015) - ------------------------------------------------------------------------------------------------------------ FINANCING ACTIVITIES: Common stock: Exercise of stock options 2,109 15,950 Cash dividends (28,562) (24,411) Repurchase of shares (5,486) -- Term borrowings: Issuance 51,200 1,099 Payments (50,082) (15,150) Net increase/(decrease) in: Deposits 1,331,159 474,768 Short-term borrowings (434,008) (1,405,020) - ------------------------------------------------------------------------------------------------------------ Net cash (used)/provided by financing activities 866,330 (952,764) - ------------------------------------------------------------------------------------------------------------ Net decrease in cash and cash equivalents (76,417) (254,630) - ------------------------------------------------------------------------------------------------------------ Cash and cash equivalents at beginning of period 1,235,614 936,120 - ------------------------------------------------------------------------------------------------------------ Cash and cash equivalents at end of period $1,159,197 $ 681,490 ============================================================================================================ Total interest paid $ 167,296 $ 143,342 Total income taxes paid 44,951 17,460 - ------------------------------------------------------------------------------------------------------------ <FN> See accompanying notes to consolidated financial statements. <FN> </TABLE>
8 NOTE 1 - FINANCIAL INFORMATION The unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles. In the opinion of management, all necessary adjustments have been made for a fair presentation of financial position and results of operations for the periods presented. The operating results for the three month period ended March 31, 2000, are not necessarily indicative of the results that may be expected going forward. For further information, refer to the audited consolidated financial statements and footnotes included in First Tennessee National Corporation's 1999 Annual Report. In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS 133 requires that changes in the derivative instrument's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative instrument's gains and losses to offset related results on the hedged item in the income statement, and requires that a company formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. Upon adoption of SFAS 133, all freestanding derivative instruments will be remeasured at fair value with differences between the derivatives' previous book value and fair value reported as a one-time accounting adjustment. Likewise, offsetting gains and losses on hedged assets, liabilities and firm commitments will be recognized as adjustments of their respective book values at the adoption date as part of this accounting adjustment. Except to the extent that they relate to hedges of the variable cash flow exposure of forecasted transactions, a portion of the net accounting adjustment (net of hedge difference and hedged item difference) will be reported in net income in the period of adoption. To the extent the adoption adjustment relates to hedges of the variable cash flow exposure of forecasted transactions, the remainder of the accounting adjustment will be reported as a cumulative effect adjustment of comprehensive income. SFAS 133, as amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133", is effective for fiscal years beginning after June 15, 2000. First Tennessee will adopt SFAS 133 on January 1, 2001. Management has not yet quantified the effects SFAS 133 will have on its financial statements including the offsetting gains or losses that may be recognized on hedged assets, liabilities and firm commitments. Changes in the fair value of existing and future freestanding derivative instruments, hedged assets, liabilities and firm commitments, changes in the carrying value, including normal amortization, of derivative instruments and hedged assets and liabilities, and changes in hedging practices could have a substantial impact on the amount of the one-time accounting adjustment and its impact on net income. In addition, management is in the process of evaluating the methods and instruments currently used in hedging market exposure. The impact of adopting SFAS 133 could be material at the adoption date. SFAS 133 could also increase the volatility of earnings and other comprehensive income in the future. On January 1, 1999, First Tennessee adopted SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." This Statement amends SFAS No. 65, which required that retained securities be classified as trading securities. SFAS No. 134 allows these securities to be classified as trading, held to maturity or available for sale based on the intent and ability of the enterprise. On January 1, 1999, First Tennessee adopted Statement of Position 98-5, "Reporting on the Costs of Start-up Activities." This Statement requires that the costs of start-up activities, including organization costs, be expensed as incurred. The impact of adopting this standard was immaterial to First Tennessee.
9 NOTE 2 - EARNINGS PER SHARE The following table shows a reconciliation of earnings per share to diluted earnings per share. <TABLE> <CAPTION> Three Months Ended March 31 ---------------------------------- (Dollars in thousands, except per share data) 2000 1999 - ----------------------------------------------------------------------------------------------------------- <S> <C> <C> EARNINGS PER SHARE COMPUTATION: Net income $ 39,523 $ 53,029 Weighted average shares outstanding 129,916,950 129,453,871 Shares attributable to deferred compensation 477,429 333,207 - ----------------------------------------------------------------------------------------------------------- Total weighted average shares per income statement 130,394,379 129,787,078 Earnings per share $ .30 $ .41 =========================================================================================================== DILUTED EARNINGS PER SHARE COMPUTATION: Net income $ 39,523 $ 53,029 Weighted average shares outstanding 130,394,379 129,787,078 Dilutive effect due to stock options 2,150,514 3,976,333 - ----------------------------------------------------------------------------------------------------------- Weighted average shares outstanding, as adjusted 132,544,893 133,763,411 Diluted earnings per share $ .30 $ .40 =========================================================================================================== </TABLE>
10 NOTE 3 - LOANS The composition of the loan portfolio at March 31 is detailed below: <TABLE> <CAPTION> (Dollars in thousands) 2000 1999 - ----------------------------------------------------------------------------------------------------------- <S> <C> <C> Commercial $4,469,783 $4,212,886 Consumer 3,459,704 3,163,967 Permanent mortgage 552,222 444,666 Credit card receivables 555,732 560,674 Real estate construction 513,341 369,814 Nonaccrual - Regional banking group 7,047 12,629 Nonaccrual - Mortgage banking 24,621 18,166 - ----------------------------------------------------------------------------------------------------------- Loans, net of unearned income 9,582,450 8,782,802 Allowance for loan losses 140,736 139,387 - ----------------------------------------------------------------------------------------------------------- Total net loans $9,441,714 $8,643,415 =========================================================================================================== </TABLE> The following table presents information concerning nonperforming loans at March 31: <TABLE> <CAPTION> (Dollars in thousands) 2000 1999 - ----------------------------------------------------------------------------------------------------------- <S> <C> <C> Impaired loans $ 7,435 $ 13,169 Other nonaccrual loans 24,233 17,626 - ----------------------------------------------------------------------------------------------------------- Total nonperforming loans $ 31,668 $ 30,795 =========================================================================================================== </TABLE> Nonperforming loans consist of impaired loans, other nonaccrual loans and certain restructured loans. An impaired loan is a loan that management believes the contractual amount due probably will not be collected. Impaired loans are generally carried on a nonaccrual status. Nonaccrual loans are loans on which interest accruals have been discontinued due to the borrower's financial difficulties. Management may elect to continue the accrual of interest when the estimated net realizable value of collateral is sufficient to recover the principal balance and accrued interest. Generally, interest payments received on impaired loans are applied to principal. Once all principal has been received, additional payments are recognized as interest income on a cash basis. The following table presents information concerning impaired loans: <TABLE> <CAPTION> Three Months Ended March 31 ---------------------------------- (Dollars in thousands) 2000 1999 - ----------------------------------------------------------------------------------------------------------- <S> <C> <C> Total interest on impaired loans $ 95 $ 283 Average balance of impaired loans 7,538 13,000 - ----------------------------------------------------------------------------------------------------------- </TABLE> An allowance for loan losses is maintained for all impaired loans. Activity in the allowance for loan losses related to non-impaired loans, impaired loans, and for the total allowance for the three months ended March 31, 2000 and 1999, is summarized as follows: <TABLE> <CAPTION> (Dollars in thousands) Non-impaired Impaired Total - ---------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Balance at December 31, 1998 $133,572 $2,441 $136,013 Provision for loan losses 11,799 3,027 14,826 Charge-offs 11,768 1,773 13,541 Less loan recoveries 1,669 420 2,089 - ---------------------------------------------------------------------------------------------------------------- Net charge-offs 10,099 1,353 11,452 - ---------------------------------------------------------------------------------------------------------------- Balance at March 31, 1999 $135,272 $4,115 $139,387 ================================================================================================================ Balance at December 31, 1999 $136,978 $2,625 $139,603 Provision for loan losses 14,474 1,023 15,497 Charge-offs 14,771 1,716 16,487 Less loan recoveries 1,631 492 2,123 - ---------------------------------------------------------------------------------------------------------------- Net charge-offs 13,140 1,224 14,364 - ---------------------------------------------------------------------------------------------------------------- BALANCE AT March 31, 2000 $138,312 $2,424 $140,736 ================================================================================================================ </TABLE>
11 NOTE 4 - BUSINESS SEGMENT INFORMATION First Tennessee provides traditional retail/commercial banking and other financial services to its customers. These products and services are categorized into two broad groups: a regional banking group and national lines of business. The regional banking group provides a comprehensive package of financial services including traditional banking, trust services, investments, asset management, insurance and credit card services to its customers. The national lines of business include mortgage banking, capital markets and transaction processing. The Other segment is used to isolate corporate items such as expense related to guaranteed preferred beneficial interests in First Tennessee's junior subordinated debentures and securities gains or losses which include any venture capital gains or losses and related incentive costs. Total revenue, expense and asset levels reflect those which are specifically identifiable or which are allocated based on an internal allocation method. Because the allocations are based on internally developed assignments and allocations, they are to an extent subjective. This assignment and allocation has been consistently applied for all periods presented. The following table reflects the approximate amounts of consolidated revenue, expense, tax, and assets for the year to date periods ending March 31, 1999 and 2000. <TABLE> <CAPTION> Regional Banking Mortgage Capital Transaction (Dollars in thousands) Group Banking Markets Processing Other Consolidated - -------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Year To Date 00 Interest income $ 239,185 $ 67,800 $ 8,507 $ 3,807 $ -- $ 319,299 Interest expense 107,045 58,368 7,907 485 -- 173,805 - -------------------------------------------------------------------------------------------------------------------------------- Net interest income 132,140 9,432 600 3,322 -- 145,494 Other revenues 66,016 103,058 24,449 27,273 1,601 222,397 Other expenses* 133,177 128,991 19,903 24,182 2,123 308,376 - -------------------------------------------------------------------------------------------------------------------------------- Pre-tax income 64,979 (16,501) 5,146 6,413 (522) 59,515 Income taxes 21,970 (6,126) 1,909 2,437 (198) 19,992 - -------------------------------------------------------------------------------------------------------------------------------- Net income $ 43,009 $ (10,375) $ 3,237 $ 3,976 $ (324) $ 39,523 ================================================================================================================================ Average assets $12,625,146 $ 5,115,569 $ 647,417 $ 582,081 $ -- $18,970,213 - -------------------------------------------------------------------------------------------------------------------------------- Year To Date 99 Interest income $ 208,863 $ 76,029 $ 10,513 $ 4,861 $ -- $ 300,266 Interest expense 86,673 56,082 8,694 650 -- 152,099 - -------------------------------------------------------------------------------------------------------------------------------- Net interest income 122,190 19,947 1,819 4,211 -- 148,167 Other revenues 54,556 170,066 44,388 17,587 (34) 286,563 Other expenses* 120,317 181,025 32,605 15,646 2,030 351,623 - -------------------------------------------------------------------------------------------------------------------------------- Pre-tax income 56,429 8,988 13,602 6,152 (2,064) 83,107 Income taxes 19,762 3,626 5,136 2,338 (784) 30,078 - -------------------------------------------------------------------------------------------------------------------------------- Net income $ 36,667 $ 5,362 $ 8,466 $ 3,814 $ (1,280) $ 53,029 ================================================================================================================================ Average assets $11,549,590 $ 5,728,237 $ 845,929 $ 499,387 $ -- $18,623,143 - -------------------------------------------------------------------------------------------------------------------------------- <FN> * Includes loan loss provision. </FN> </TABLE>
12 Item 2. FIRST TENNESSEE NATIONAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION GENERAL INFORMATION - ------------------- First Tennessee National Corporation (First Tennessee) is headquartered in Memphis, Tennessee, and is a nationwide, diversified financial services institution which provides banking and other financial services to its customers through various regional and national business lines. The Regional Banking Group includes the retail/commercial bank, the credit card division, and the trust division. The National Lines of Business include First Horizon Home Loan Corporation (formerly FT Mortgage Companies and also referred to as First Horizon Home Loans and mortgage banking), First Tennessee Capital Markets (also referred to as capital markets), and transaction processing (credit card merchant processing, automated teller machine network, payment processing operation, and check clearing). Certain revenue and expenses are allocated and equity is assigned to the various business lines to reflect the inherent risk in each business line, based on management's best estimates. These allocations are periodically reviewed and may be revised from time to time to more accurately reflect current business conditions and risks; the previous history is restated to ensure comparability. For the purpose of this management discussion and analysis (MD&A), noninterest income (also called fee income) and total revenue exclude securities gains and losses. Net interest income has been adjusted to a fully taxable equivalent (FTE) basis for certain tax-exempt loans and investments included in earning assets. Earning assets, including loans, have been expressed as averages, net of unearned income. First Tennessee Bank National Association, the primary bank subsidiary, is also referred to as FTBNA in this discussion. The following is a discussion and analysis of the financial condition and results of operations of First Tennessee for the three month period ended March 31, 2000, compared to the three month period ended March 31, 1999. To assist the reader in obtaining a better understanding of First Tennessee and its performance, this discussion should be read in conjunction with First Tennessee's unaudited consolidated financial statements and accompanying notes appearing in this report. Additional information including the 1999 financial statements, notes, and management's discussion and analysis is provided in the 1999 Annual Report. FORWARD-LOOKING STATEMENTS - -------------------------- Management's discussion and analysis may contain forward-looking statements with respect to First Tennessee's beliefs, plans, goals, expectations, and estimates. These statements are contained in certain sections that follow such as Noninterest Income, Net Interest Income and Other. Forward-looking statements are statements that are not based on historical information but rather are related to future operations, strategies, financial results or other developments. The words "believe", "expect", "anticipate", "intend", "estimate", "should", "is likely", "going forward", and other expressions which indicate future events and trends identify forward-looking statements. Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond a company's control, and many of which, with respect to future business decisions and actions (such as acquisitions and divestitures), are subject to change. Examples of uncertainties and contingencies include, among other important factors, general and local economic and business conditions; expectations of the timing and amount of interest rate movements (which can have a significant impact on a financial services institution); market and monetary fluctuations; inflation; competition within and outside the financial services industry; technology; and new products and services in the industries in which First Tennessee operates. Other factors are those inherent in originating loans, including prepayment risks and fluctuation of collateral values and changes in customer profiles. Additionally, the policies of the Office of the Comptroller of the Currency (OCC) and the Board of Governors of the Federal Reserve System, unanticipated regulatory and judicial proceedings, and changes in laws and regulations
13 applicable to First Tennessee and First Tennessee's success in executing its business plans and strategies and managing the risks involved in the foregoing, could cause actual results to differ. First Tennessee assumes no obligation to update any forward-looking statements that are made from time to time. FINANCIAL SUMMARY (COMPARISON OF FIRST QUARTER 2000 TO FIRST QUARTER 1999) Earnings for the first quarter of 2000 were $39.5 million, compared with last year's first quarter earnings of $53.0 million. Diluted earnings per share were $.30 in 2000, compared to $.40 earned in 1999. Basic earnings per share were $.30 in 2000 and $.41 in 1999. Return on average shareholders' equity was 13.0 percent in 2000 compared with a return of 19.1 percent in 1999. Return on average assets was .84 percent in 2000 compared with 1.15 percent in 1999. At March 31, 2000, First Tennessee was ranked as one of the top 50 bank holding companies nationally in market capitalization ($2.6 billion) and total assets ($20.1 billion). At March 31, 1999, market capitalization was $4.8 billion and total assets were $18.3 billion. Total revenues declined 16 percent from the first quarter of 1999, with a 23 percent decline in fee income (noninterest income excluding securities gains and losses) and a 2 percent decrease in net interest income. In the first quarter of 2000, fee income contributed approximately 60 percent to total revenues compared with approximately 66 percent for the same period in 1999. NONINTEREST INCOME - ------------------ Fee income provides the majority of First Tennessee's revenue. During the first quarter of 2000, fee income declined 23 percent (from $286.6 million to $220.8 million). The decline in fee income was related to a drastic shift in the operating environment which has created several challenges for mortgage banking and capital markets, compared with their strong performance in last year's first quarter. Conversely, all other fee income line items have realized growth over the past year, led by double-digit increases in deposit transactions and cash management, cardholder fees and other income, which includes such items as insurance and commissions, and check clearing fees. A more detailed discussion follows. MORTGAGE BANKING First Horizon Home Loan Corporation (formerly FT Mortgage Companies), a subsidiary of FTBNA, originates and services residential mortgage loans. Following origination, the mortgage loans, primarily first-lien, are sold to investors in the secondary market while the rights to service such loans are usually retained. Various hedging strategies are used to mitigate changes in the market value of the loan during the time period beginning with a price commitment to the customer and ending when the loan is delivered to the investor. Closed loans held during this time period are referred to as the mortgage warehouse. Origination fees and gains or losses from the sale of loans are recognized at the time a mortgage loan is sold into the secondary market. Secondary marketing activities include gains or losses from mortgage warehouse hedging activities, product pricing decisions, gains or losses from the sale of loans, and the capitalized value of mortgage servicing rights. Servicing rights permit the collection of fees for gathering and processing monthly mortgage payments for the owner of the mortgage loans. First Horizon Home Loans employs hedging strategies to mitigate the loss of value of its mortgage servicing rights in different interest rate environments. The gains related to rebalancing hedges of mortgage servicing rights as well as income from the foreclosure repurchase program are reported in miscellaneous income. Mortgage banking fee income declined 41 percent (from $168.8 million to $99.9 million) from the first quarter of 1999 as shown in Table 1.
14 Table 1 - Mortgage Banking <TABLE> <CAPTION> Three Months Ended ---------------------------- Growth (Dollars in millions) 2000 1999 Rate(%) - ------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> Noninterest income: Loan origination fees $ 25.7 $ 53.9 (52.4) Secondary marketing activities 16.6 72.3 (77.1) - ------------------------------------------------------------------------------------------------------------------ Mortgage origination function 42.3 126.2 (66.5) - ------------------------------------------------------------------------------------------------------------------ Servicing fees 39.2 39.0 .7 Sale of mortgage servicing rights 13.9 -- NM Miscellaneous 4.5 3.6 25.5 - ------------------------------------------------------------------------------------------------------------------ Total noninterest income $ 99.9 $ 168.8 (40.8) ================================================================================================================== Refinance originations $ 656.4 $ 3,497.4 (81.2) Home purchase related originations 2,852.0 2,471.1 15.4 - ------------------------------------------------------------------------------------------------------------------ Mortgage loan originations $ 3,508.4 $ 5,968.5 (41.2) ================================================================================================================== Servicing portfolio $ 43,070.4 $ 42,883.5 .4 - ------------------------------------------------------------------------------------------------------------------ <FN> NM = not meaningful </FN> </TABLE> Origination activity fell 41 percent due to the impact that rising interest rates had on refinance activity, which declined $2.8 billion. Total origination volume, consisting of home purchased-related mortgages and refinances, was $3.5 billion compared with $6.0 billion in the previous year. Despite higher interest rates, home purchase-related mortgage originations increased 15 percent. Although total origination volume declined 41 percent, loans sold into the secondary market decreased 63 percent due to the smaller mortgage warehouse at the start of the first quarter of 2000. Fees from the mortgage origination function (loan origination fees and secondary marketing activities) declined 67 percent from the first quarter of 1999 (from $126.2 million to $42.3 million). This decline came from less production and fewer loans sold into the secondary market, pricing pressures especially related to wholesale originations, a change in product mix and losses of approximately $5 million on certain loans affected by the volatility of recent interest rate movements. The mortgage servicing portfolio (which includes servicing for ourselves and others) totaled $43.1 billion at March 31, 2000, compared to $42.9 billion at March 31, 1999. The change in the portfolio since first-quarter 1999 and year-end 1999 is shown in Table 2. Mortgage servicing fees were relatively flat compared to the previous year, with $39.2 million in the first quarter of 2000 and $39.0 million for the first quarter of 1999. This growth rate was impacted by the slowing growth of originations, a higher percentage of service-released products, bulk sales of mortgage servicing rights, and a reclass of mortgage servicing rights to interest-only servicing strips in the investment securities portfolio. Fee income from other activities increased 409 percent (from $3.6 million to $18.4 million). This increase was primarily due to increased gains from the bulk sales of mortgage servicing rights. Table 2 - Servicing Portfolio <TABLE> <CAPTION> Activity for Activity for 3 Months Ending 12 Months Ending (Dollars in billions) March 31, 2000 March 31, 2000 - ---------------------------------------------------------------------------------------------------------------- <S> <C> <C> Servicing portfolio at beginning of period $ 44.6 $ 42.9 Loans added to servicing system 3.2 16.3 Servicing released originations (.3) (1.4) Bulk sales of servicing released (.2) (1.7) Principal reductions (from payments and payoffs received in the normal course of business) (1.0) (5.5) - ---------------------------------------------------------------------------------------------------------------- Subtotal 46.3 50.6 Bulk sales of servicing not yet transferred (3.2) (9.2) Purchased servicing not yet transferred -- 1.7 - ---------------------------------------------------------------------------------------------------------------- Servicing portfolio at end of period $ 43.1 $ 43.1 ================================================================================================================ </TABLE>
15 Going forward, the growth rate in certain mortgage banking line items will be affected by the HomeBanc sale in the second quarter (see Subsequent Event section). Refinance activity is expected to remain low as interest rates continue to rise. Excluding the HomeBanc sale, the growth in home purchase-related mortgages should continue as the real estate markets are expected to remain strong; however, the current market environment may lead to a change in product mix, resulting in a lower total margin. Rising interest rates and changing markets should continue to put pressure on the profit margin of originated loans and could make it more difficult to make the necessary adjustments to hedge positions in order to mitigate losses in the value of originated loans. In periods of increasing interest rates, the value of mortgage servicing rights generally increases and the value of hedges related to the servicing rights generally declines. Mortgage banking performance is affected by numerous factors including the volume and mix of loans produced and sold, loan pricing decisions, interest rate levels and volatility, the creditworthiness of applicants, the current and future estimated levels of prepayments, the effectiveness of hedging activities, the timing of purchases and sales of bulk servicing rights, as well as other factors referred to in the Forward-Looking Statements section of this MD&A. CAPITAL MARKETS First Tennessee Capital Markets generates fee income primarily from the purchase and sale of securities as both principal and agent. Inventory positions are limited to the procurement of securities solely for distribution to customers by the sales staff. Inventory is hedged to protect against movements in interest rates. During the first quarter of 2000, capital markets fee income decreased 45 percent from the record $44.4 million achieved during the first quarter of 1999 to $24.4 million. Total securities bought and sold were a record $148.0 billion for the first quarter of 2000, up from $145.9 billion in the same period in 1999. However, revenues decreased due to the shift in product mix related to customers' expectations of rising interest rates. The growth in volume was affected as bank customers demanded less investment securities due to loan growth continuing to outpace deposit growth across the banking industry. Total underwritings during first quarter of 2000 were $4.4 billion compared with $18.4 billion for the same period in 1999. Going forward, if the widespread expectation of rising interest rates continues, capital markets' customers are likely to remain liquid, investing in shorter-term securities. Strong loan growth will also affect depository customers if loan growth continues to exceed deposit growth. This trend is expected to put pressure on achieving annual growth in fee income over 1999. Once the expectation of rising interest rates lessens, customers' demand for longer-term securities should return, favorably impacting future revenue production. Actual results could differ because of several factors, including those presented in the Forward-Looking Statements section of the MD&A. OTHER FEE INCOME Noninterest income from deposit transactions and cash management increased 14 percent from the first quarter of 1999 (from $23.2 million to $26.4 million) due to increased customer service charges and sales of various cash management products and services. Since the first quarter of 1999, trust and investment management fees grew 10 percent (from $14.6 million to $16.0 million) as assets under management grew 9 percent (from $9.1 billion to $9.8 billion). Fee income from merchant processing grew 3 percent from the first quarter of 1999 (from $10.7 million to $11.0 million). This growth rate was affected by a special assessment received from a large indirect customer in the first quarter of 1999. Due to reduced emphasis on lower-margin indirect transactions, overall merchant processing volume declined (from 40.2 million transactions in first quarter 1999 to 31.1 million transactions in first quarter 2000). However, direct volume increased approximately 20 percent from the previous year. Cardholder fees increased 42 percent (from $5.0 million to $7.0 million) during this same period due to higher interchange collections and price increases. All other income and commissions grew 81 percent from the first quarter of 1999 (from $20.0 million to $36.1 million). Growth in the other category was positively affected by the revenues generated from the remittance processing operation acquired in June 1999 from National Processing Co. (NPC). Excluding NPC, the growth in other income and commissions would have been 47 percent. This remaining growth was spread over several categories, including earnings from First Tennessee's investment in bank owned life insurance, the sale of
16 properties, other service charges, fees related to the reinsurance program, insurance premiums and commissions, check clearing fees and brokerage fees. NET INTEREST INCOME - ------------------- Net interest income declined slightly (from $148.9 million to $146.1 million) from the first quarter of 1999, primarily due to a decline in earning assets (from $15.9 billion to $15.6 billion). The consolidated net interest margin (margin) remained relatively stable at 3.74 percent for the first quarter of 2000 compared with 3.76 percent in the first quarter of 1999. Strong loan growth and the change in loan mix compared with first quarter 1999 helped mitigate higher funding costs in the regional banking group, while the incremental impacts on the consolidated margin from mortgage banking and capital markets remained flat. Table 3 details the computation of the net interest margin for the regional banking group and the impact that the other business lines had on the consolidated margin for the first quarters of 2000 and 1999. TABLE 3 - NET INTEREST MARGIN <TABLE> <CAPTION> First Quarter ---------------------------- 2000 1999 - ------------------------------------------------------------------------------------------------------------ <S> <C> <C> REGIONAL BANKING GROUP: Yields on earning assets 8.23% 7.84% Rates paid on interest-bearing liabilities 4.25 3.89 - ------------------------------------------------------------------------------------------------------------ Net interest spread 3.98 3.95 - ------------------------------------------------------------------------------------------------------------ Effect of interest-free sources .76 .80 Loan fees .15 .15 FRB interest and penalties .01 .01 - ------------------------------------------------------------------------------------------------------------ Net interest margin - Regional banking group 4.90% 4.91% MORTGAGE BANKING (1.04) (1.03) CAPITAL MARKETS (.13) (.13) TRANSACTION PROCESSING .01 .01 - ------------------------------------------------------------------------------------------------------------ Net interest margin 3.74% 3.76% ============================================================================================================ </TABLE> As shown in Table 3, the margin is affected by the activity levels and related funding for First Tennessee's national lines of business as these nonbank business lines typically produce different margins than traditional banking activities. Mortgage banking can affect the overall margin based on a number of factors, including the size of the mortgage warehouse, the time it takes to deliver loans into the secondary market, the amount of custodial balances, and the level of mortgage servicing rights. Capital markets tends to compress the margin because of its strategy to reduce market risk by hedging its inventory in the cash markets which effectively eliminates net interest income on these positions. As a result, First Tennessee's consolidated margin cannot be readily compared to that of other bank holding companies. Going forward, the consolidated margin will continue to be influenced by the activity levels in the nonbanking lines of business, especially from mortgage banking as the level of origination volume is strongly tied to refinance activity. Information in this section includes forward-looking statements. Actual results could differ because of several factors, including those presented in the Forward-Looking Statements section of the MD&A discussion.
17 NONINTEREST EXPENSE - ------------------- Total noninterest expense (operating expense) for the first quarter of 2000 decreased 13 percent (from $336.8 million to $292.9 million) over the same period in 1999. Expenses in mortgage banking and capital markets fluctuate based on the type and level of activity. Excluding mortgage banking and capital markets, total operating expense increased 16 percent. This growth rate was impacted by the purchase acquisition of NPC which has created additional ongoing costs since June of 1999. Excluding NPC, mortgage banking and capital markets, the total operating expense would have increased 9 percent. Employee compensation, incentives and benefits (personnel expense), the largest component of noninterest expense, decreased 20 percent from the previous year due to significantly lower activity levels in mortgage banking and capital markets in the first quarter of 2000. Excluding these two business lines, total personnel expense increased 17 percent. Excluding NPC and these two business lines, personnel expense would have increased 9 percent. Additional business line information related to expenses is provided in Table 4 and the discussion that follows. TABLE 4 - OPERATING EXPENSE COMPOSITION <TABLE> <CAPTION> Three Months -------------------------- Growth (Dollars in millions) 2000 1999 Rate (%) - -------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Regional banking group $ 117.7 $ 107.4 9.6 Mortgage banking 129.0 179.1 (28.0) Capital markets 19.9 32.6 (39.0) Transaction processing 24.2 15.6 54.6 Other 2.1 2.1 4.5 - -------------------------------------------------------------------------------------------------------------------------- Total operating expense $ 292.9 $ 336.8 13.0 ========================================================================================================================== </TABLE> Mortgage banking expenses decreased 28 percent from the previous year. Expense growth for this business line varies with the volume and type of activity. The decrease was mainly in personnel expense due to lower activity levels in the first quarter of 2000. With the increase in interest rates and lower prepayments, amortization of capitalized mortgage servicing rights declined 40 percent (from $30.9 million to $18.4 million). Expenses for the regional banking group increased 10 percent from the previous year. This increase was due to continuing investments to expand insurance and investment management, new branches that have been opened in targeted growth markets, and amortization of costs associated with new systems. Transaction processing expenses grew 55 percent from the previous year. Virtually all of this expense growth was related to operation of the locations acquired from NPC. Capital markets experienced a decline of 39 percent in expenses from first quarter of 1999 primarily because of lower commissions and incentives recognized in the first quarter of 2000. PROVISION FOR LOAN LOSSES/ASSET QUALITY - --------------------------------------- The provision for loan losses increased 5 percent (from $14.8 million to $15.5 million) from the first quarter of 1999, due to increased inherent risk in the loan portfolio and a change in the loan mix related to growth in loans with higher risk/reward profiles. The provision for loan losses is the charge to operating earnings that management determines to be necessary to maintain the allowance for loan losses at an adequate level reflecting management's estimate of the risk of loss inherent in the loan portfolio. Additional asset quality information is provided in Table 5 - Asset Quality Information and Table 6 - Charge-off Ratios.
18 TABLE 5 - ASSET QUALITY INFORMATION <TABLE> <CAPTION> March 31 -------------------------------- (Dollars in thousands) 2000 1999 - ---------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> Nonperforming loans $ 31,668 $ 30,795 Foreclosed real estate 18,414 16,870 Other assets 91 189 - ---------------------------------------------------------------------------------------------------------------------------- Total nonperforming assets $ 50,173 $ 47,854 ============================================================================================================================ Loans and leases 90 days past due $ 31,259 $ 28,006 Potential problem assets* $ 79,519 $ 64,974 <CAPTION> First Quarter -------------------------------- 2000 1999 -------------------------------- ALLOWANCE FOR LOAN LOSSES: Beginning balance at December 31 $ 139,603 $ 136,013 Provision for loan losses 15,497 14,826 Charge-offs (16,487) (13,541) Loan recoveries 2,123 2,089 - ---------------------------------------------------------------------------------------------------------------------------- Ending balance at March 31 $ 140,736 $ 139,387 ============================================================================================================================ <CAPTION> March 31 -------------------------------- 2000 1999 -------------------------------- Allowance to total loans 1.47% 1.59% Nonperforming loans to total loans .33 .35 Nonperforming assets to total loans, foreclosed real estate and other assets .52 .54 Allowance to nonperforming assets 281 291 - ---------------------------------------------------------------------------------------------------------------------------- <FN> * Includes loans and leases 90 days past due. </FN> </TABLE> An analytical model is used based on historical loss experience, current trends, and reasonably foreseeable events to determine the amount of provision to be recognized and to test the adequacy of the loan loss allowance. The ratio of allowance for loan losses to total loans, net of unearned income, was 1.47 percent at March 31, 2000. At March 31, 1999, the ratio of allowance for loan losses to total loans, net of unearned income, was 1.59 percent. The ratio of net charge-offs to average loans increased from .53 percent for the first quarter of 1999 to .61 percent for the first quarter of 2000. This increase was due to higher consumer loan charge-offs which included those consumer loan products with higher risk/return profiles. The credit card receivables charge-off ratio increased to 3.90 percent for the first quarter of 2000 from 3.65 percent for the first quarter of 1999. The ratio of nonperforming loans to total loans decreased to .33 percent for the first quarter of 2000 compared with .35 percent for the same period in 1999. At March 31, 2000, First Tennessee had no concentrations of 10 percent or more of total loans in any single industry.
19 TABLE 6 - CHARGE-OFF RATIOS <TABLE> <CAPTION> First Quarter -------------------------- 2000 1999 - --------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> Commercial and commercial real estate .10% .12% Consumer .85 .53 Credit card receivables 3.90 3.65 Permanent mortgage .05 .03 Total net charge-offs .61 .53 - --------------------------------------------------------------------------------------------------------------------------- </TABLE> BALANCE SHEET REVIEW EARNING ASSETS - -------------- Earning assets primarily consist of loans, mortgage loans held for sale and investment securities. For first quarter 2000, earning assets averaged $15.6 billion compared with $15.9 billion for first quarter 1999. The decline in earning assets was due to the reduction in mortgage loans held for sale partially offset by strong loan growth and an increase in investment securities. At March 31, 2000, First Tennessee reported total assets of $20.1 billion compared with $18.3 billion at March 31, 1999. Average total assets grew 2 percent (from $18.6 billion to $19.0 billion) from the first quarter of 1999. LOANS Average loans increased 9 percent (from $8.7 billion to $9.5 billion) with growth in all of the primary categories. Average commercial loans increased 8 percent (from $4.2 billion to $4.5 billion) and average consumer loans increased 9 percent (from $3.1 billion to $3.4 billion). First Horizon Equity Lending, a division of FTBNA, is active in originating second mortgages and contributed 82 percent of the increase in consumer loans. Additional loan information is provided in Table 7 - Average Loans. TABLE 7 - AVERAGE LOANS <TABLE> <CAPTION> Three Months ---------------------------------------------------------------- PERCENT Percent GROWTH (Dollars in millions) 2000 OF TOTAL 1999 of Total RATE - ---------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> Commercial $ 4,462.7 47% $ 4,150.9 48% 7.5% Consumer 3,356.7 36 3,090.4 36 8.6 Permanent mortgage 538.5 6 424.3 5 26.9 Credit card receivables 575.8 6 572.9 7 .5 Real estate construction 508.9 5 380.5 4 33.7 Nonaccrual 30.9 -- 34.2 -- (9.6) - ---------------------------------------------------------------------------------------------------------------------------- Total loans, net of unearned $ 9,473.5 100% $ 8,653.2 100% 9.5% ============================================================================================================================ </TABLE> During 1999 certain consumer real estate loans and permanent mortgage loans were securitized. The majority of these securities are owned by subsidiaries of First Tennessee, including FTBNA. If these transactions had been included in the growth rate calculation, total average loans would have grown 11 percent, and average consumer loans would have grown 15 percent from the first quarter of 1999. Average permanent mortgage loans increased 27 percent (from $.4 billion to $.5 billion) and average real estate construction loans increased 34 percent (from $.4 billion to $.5 billion). Growth in both of these loan categories came primarily from mortgage banking activities.
20 MORTGAGE LOANS HELD FOR SALE/INVESTMENT SECURITIES The decline in mortgage originations led to a 41 percent decrease in mortgage loans held for sale (from $3.9 billion to $2.3 billion). Average investment securities increased 28 percent from first quarter 1999 (from $2.4 billion to $3.1 billion) principally from securitization activity. Excluding these transactions, investment securities would have increased 9 percent. DEPOSITS AND OTHER SOURCES OF FUNDS - ----------------------------------- Since the first quarter of 1999, average core deposits declined 3 percent (from $9.3 billion to $8.9 billion) and interest-bearing core deposits declined 4 percent (from $6.4 billion to $6.2 billion). Noninterest-bearing deposits remained relatively flat at $2.8 billion over this period. Short-term purchased funds were up 8 percent (from $7.0 billion to $7.6 billion) from the previous year. CAPITAL - ------- Total capital (shareholders' equity plus qualifying capital securities) at March 31, 2000, was $1.4 billion, up 8 percent from $1.3 billion at March 31, 1999. Shareholders' equity (excluding the qualifying capital securities) was $1.3 billion at March 31, 2000, an increase of 9 percent from $1.2 billion at March 31, 1999. Average shareholders' equity increased 9 percent (from $1.1 billion to $1.2 billion) since the first quarter of 1999, reflecting internal capital generation. The average total equity to average assets ratio was 7.00 percent and the average shareholders' equity to average assets ratio was 6.47 percent for the first quarter of 2000. This compares with 6.58 percent and 6.05 percent, respectively for the first quarter of 1999. Unrealized market valuations had no material effect on the ratios during first quarter of 2000. On March 31, 2000, the corporation's Tier 1 capital ratio was 8.25 percent, the total capital ratio was 11.28 percent and the leverage ratio was 6.48 percent. On March 31, 2000, First Tennessee's bank affiliates had sufficient capital to qualify as well-capitalized institutions.
21 OFF BALANCE SHEET ACTIVITY In the normal course of business, First Tennessee is a party to financial instruments that are not required to be reflected on a balance sheet. First Tennessee enters into transactions involving these instruments to meet the financial needs of its customers and manage its own exposure to fluctuations in interest rates. These instruments are categorized into "Lending related," "Mortgage banking," "Interest rate risk management" and "Capital markets" as noted in Table 8. TABLE 8 - OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AT MARCH 31, 2000 <TABLE> <CAPTION> (Dollars in millions) Notional Value - -------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> LENDING Commitments to extend credit: RELATED: Consumer credit card lines $ 2,350.7 Consumer home equity 624.1 Commercial real estate and construction and land development 770.8 Mortgage banking 1,426.5 Other 1,394.4 Other commitments: Standby letters of credit 260.5 Commercial letters of credit 21.9 - -------------------------------------------------------------------------------------------------------------------------- MORTGAGE Mortgage pipeline and warehouse hedging: BANKING: Interest rate contracts: Forward contracts - commitments to sell $ 3,373.7 Option contracts - purchased caps* 1,900.0 Servicing portfolio hedging: Interest rate contracts*: Caps - purchased 500.0 Caps - written 500.0 Floors - purchased 20,275.0 Swaptions - purchased 1,000.0 Swaps 625.0 - -------------------------------------------------------------------------------------------------------------------------- INTEREST Interest rate contracts: RATE RISK Swaps - receive fixed/pay floating $ 255.0 MANAGEMENT: Swaps - receive floating/pay floating 641.7 Caps - purchased 20.0 Caps - written 20.0 Equity contracts: Purchased options 1.9 - -------------------------------------------------------------------------------------------------------------------------- CAPITAL Forward contracts: MARKETS: Commitments to buy $ 1,104.2 Commitments to sell 1,102.1 Option contracts: Written 5.0 Purchased 5.0 Securities underwriting commitments 16.6 - -------------------------------------------------------------------------------------------------------------------------- <FN> *Mortgage banking option contracts had a net book value of $154.7 million at March 31, 2000. </FN> </TABLE>
22 OTHER - ----- FINANCIAL MODERNIZATION LEGISLATION The Gramm-Leach-Bliley Act (the "Act") was enacted into law on November 12, 1999. The Act repeals or modifies a number of significant provisions of current laws, which impose restrictions on banking organizations' ability to engage in certain types of activities. The Act generally allows bank holding companies such as First Tennessee broad authority to engage in activities that are financial in nature or incidental to such financial activity, including insurance underwriting and brokerage; merchant banking; and securities underwriting, dealing and market-making. A bank holding company may engage in these activities directly or through subsidiaries by qualifying as a "financial holding company". To qualify, a bank holding company must file a declaration with the Federal Reserve and certify that all of its subsidiary depository institutions are well-managed and well-capitalized. Subsequent to year-end 1999, First Tennessee has filed such a declaration. The Act also permits national banks to engage in certain of these activities through financial subsidiaries. To control or hold an interest in a financial subsidiary, a national bank must meet the following requirements: (1) the national bank must receive approval from the Comptroller for the financial subsidiary to engage in the activities, (2) the national bank and its depository institution affiliates must each be well-capitalized and well-managed, (3) the aggregate consolidated total assets of all of the national bank's financial subsidiaries must not exceed 45 percent of the national bank's consolidated total assets or, if less, $50 billion, (4) the national bank must have in place adequate policies and procedures to identify and manage financial and operational risks and to preserve the separate identities and limited liability of the national bank and the financial subsidiary, and (5) if the financial subsidiary will engage in principal transactions and the national bank is one of the one hundred largest banks, the national bank must have outstanding at least one issue of unsecured long-term debt that is currently rated in one of the three highest investment grade rating categories or meet alternative criteria as may be specified for the second fifty largest banks. First Tennessee has two subsidiaries that have filed notifications with the OCC and currently meet all of the other above requirements. No new financial activity may be commenced under the Act unless the national bank and all of its depository institution affiliates have at least "satisfactory" CRA (Community Reinvestment Act) ratings. In addition, the Act contains a number of other provisions that may affect operations, including functional regulation of First Tennessee's securities and investment management operations by the Securities and Exchange Commission, limitations on the insurance powers of the national banks, and limitations on the use and the disclosure to the third parties of customer information. The Act was effective March 11, 2000, although certain provisions take effect later. First Tennessee cannot predict at this time the potential effect that the Act will have on its business and operations, although management expects that the general effect of the Act will be to increase competition in the financial services industry. SFAS NO. 133 - "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain instruments embedded in other contracts) be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS 133 requires that changes in the instrument's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows the instrument's gains and losses to offset related results on the hedged item in the income statement, and requires that a company formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. Upon adoption of SFAS 133, all freestanding derivative instruments will be remeasured at fair value with differences between the previous book value and fair value reported as a one-time accounting adjustment. Likewise, offsetting gains and losses on hedged assets, liabilities and firm commitments will be recognized as adjustments of their respective book values at the adoption date as part of this accounting adjustment. Except to
23 the extent that they relate to hedges of the variable cash flow exposure of forecasted transactions, a portion of the net accounting adjustment (net of hedge difference and hedged item difference) will be reported in net income in the period of adoption. To the extent the adoption adjustment relates to hedges of the variable cash flow exposure of forecasted transaction, the remainder of the accounting adjustments will be reported as a cumulative effect adjustment of comprehensive income. SFAS 133, as amended, is effective for fiscal years beginning after June 15, 2000. First Tennessee will adopt SFAS 133 on January 1, 2001. In Note 23 - Financial Instruments with Off-Balance Sheet Risk presented in the 1999 10-K, the Mortgage Banking and Interest Rate Risk Management sections present the year-end book values and fair values of freestanding derivative instruments that would be required to be recognized in First Tennessee's balance sheet as assets or liabilities at their fair value. Management has not yet quantified the effects SFAS 133 may have on its financial statements including the offsetting gains or losses that may be recognized on hedged assets, liabilities and firm commitments. Changes in the fair value of existing and future freestanding derivative instruments, hedged assets, liabilities and firm commitments, changes in the book value, including normal amortization, of these instruments and hedged assets and liabilities, and changes in hedging practices could have a substantial impact on the amount of the one-time accounting adjustment and its impact on net income. In addition, management is in the process of evaluating the methods and instruments currently used in hedging market exposure. The impact of adopting SFAS 133 could be material at the adoption date. SFAS 133 could also increase the volatility of earnings and other comprehensive income in the future. The actual result of the adoption of SFAS 133 could also be affected by interest rate movements, ability of management to execute its business strategies, various actions management may take to reduce the impact of SFAS 133, ongoing interpretation and amendment activity by the FASB related to SFAS 133, and other factors, including those presented in the Forward-Looking Statements section at the beginning of the MD&A. SUBSEQUENT EVENT - ---------------- SALE OF HOMEBANC MORTGAGE On April 28, 2000, First Tennessee sold HomeBanc Mortgage, a division of First Horizon Loan Corporation. The sales price for the division was approximately $57.5 million in cash and is expected to result in a one-time gain of about $42 million. This gain gives First Tennessee the opportunity to evaluate various alternatives, which are expected to improve future profitability. The result of implementing these alternatives coupled with the effect of the HomeBanc sale is not expected to have a significant impact on First Tennessee's 2000 earnings expectations. However, growth rates in individual line items may be affected by these actions.
24 Item 3. Quantitative and Qualitative Disclosures About Market Risk - ------------------------------------------------------------------- The information called for by this item is incorporated herein by reference to Management's Discussion and Analysis included as Item 2 of Part I of this report and to Notes 1 and 23 of the Consolidated Financial Statements and the "Risk Management--Interest Rate Risk Management" Subsection of the Management's Discussion and Analysis section contained in the Corporation's 1999 Annual Report to shareholders.
25 PART II. OTHER INFORMATION Items 1, 3, 4 and 5 - ------------------- As of the end of the first quarter, 2000, the answers to Items 1, 3, 4 and 5 were either inapplicable or negative, and therefore, these items are omitted. Item 2 - Changes in Securities. - ------------------------------- On February 7, 2000, an additional 49,391 shares of the Corporation's common stock, $0.625 par value, were issued to the former shareholders of Elliot Ames, Inc., Los Altos, California, in addition to the 242,423 shares of the Corporation's common stock issued in the fourth quarter of 1999 at the closing of the Elliot Ames acquisition. The issuance of shares at the closing was described in Item 5 of the Corporation's 1999 Form 10-K.
26 Item 6 - Exhibits and Reports on Form 8-K. - ------------------------------------------ (a) Exhibits. <TABLE> <CAPTION> Exhibit No. Description - ----------- ----------- <S> <C> 4 Instruments defining the rights of security holders, including indentures.* 27 Financial Data Schedule (for SEC use only). <FN> *The Corporation agrees to furnish copies of the instruments, including indentures, defining the rights of the holders of the long-term debt of the Corporation and its consolidated subsidiaries to the Securities and Exchange Commission upon request. </FN> </TABLE> (b) Reports on Form 8-K. A report on Form 8-K was filed on February 29, 2000 (with a Date of Report of February 28, 2000) disclosing under Item 5 a press release, announcing revised earnings for 1999 and the earnings outlook for 2000.
27 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. <TABLE> <S> <C> FIRST TENNESSEE NATIONAL CORPORATION ------------------------------------ (Registrant) DATE: 5/12/00 By: Elbert L. Thomas Jr. --------------------- -------------------------- Elbert L. Thomas Jr. Executive Vice President and Chief Financial Controller (Duly Authorized Officer and Principal Financial Officer) </TABLE>
28 EXHIBIT INDEX <TABLE> <CAPTION> Exhibit No. Description - ----------- ----------- <S> <C> 4 Instruments defining the rights of security holders, including indentures.* 27 Financial Data Schedule (for SEC use only). <FN> *The Corporation agrees to furnish copies of the instruments, including indentures, defining the rights of the holders of the long-term debt of the Corporation and its consolidated subsidiaries to the Securities and Exchange Commission upon request. </FN> </TABLE>