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First Horizon National Corp.’s (FHN - Analyst Report) second quarter 2011 earnings of 16 cents per share came in ahead of the Zacks Consensus Estimate of 11 cents. Results also improved from the prior quarter’s earnings of 15 cents and significantly exceeded from a penny per share earned a year ago.

First Horizon’s second quarter 2011 net income available to common shareholders was $42.6 million, compared with $40.2 million in the prior quarter and $2.7 million in the year-ago period. The year-ago figure reflected preferred dividend payments.

First Horizon’s results benefited from a drop in loan loss provisions and lower expenses. Net loan charge-offs and non-performing assets continued to trend downward. However, this was partially offset by lower-than-expected revenue.

The company reported revenue of $361.6 million, which fell short of the Zacks Consensus Estimate of $366 million. The revenue figure also reported a 15% year-over-year drop. A tardy economic recovery remains an overhang on the company's results and loan demand continues to be weak.

Provision for loan losses was $1.0 million, flat sequentially and down 99% year over year.

Inside the Headline Numbers

The 2% sequential revenue drop at First Horizon was due to a 4% decline in non interest income. However, net interest income of $172.9 million remained flat sequentially. Net interest margin decreased 2 bps sequentially to 3.20%. Period-end loans were up 1% sequentially but down 6% year over year. However, total deposits advanced 4% sequentially and 5% year over year.

On the positive side, non-interest expense decreased 2% sequentially to $309.1 million. The improvement was fueled by lower variable compensation, reduced mortgage repurchase expense and productivity and efficiency gains from technology investments and improvements to business processes and procurement.

First Horizon is implementing over $100 million in annual cost savings. In order to reduce costs, the company started a $100 million investment in 2009 in technology and systems and it is currently wrapping that up.

Credit Quality

Credit quality at First Horizon improved in the quarter. Net loan charge-offs and non-performing assets were down both sequentially and year over year.

Net charge-offs were down 14% sequentially and 50% year over year at $66.0 million. As a percentage of average loans on an annualized basis, net charge-offs were 1.67%, down 26 basis points (bps) from the prior quarter and 144 bps year over year.

Non-performing assets decreased 9% sequentially and 17% year over year to $747.9 million. As a percentage of period-end loans plus foreclosed real estate and other assets, non-performing assets were 4.09%, down 46 bps sequentially and 83 bps year over year.

Evaluation of Capital

First Horizon’s capital ratios experienced a sequential improvement. Tier 1 capital ratio advanced to 14.53% from 14.26% reported in the prior quarter. Tangible common equity ratio increased 11 bps sequentially to 9.02%. Book value came in at $9.13 per share, down from $8.90 per share reported in the prior quarter.

Our Take

Similar to First Horizon, second quarter results at JPMorgan Chase & Company (JPM - Analyst Report) and Citigroup Inc. (C - Analyst Report) also came in better than expected on the back of a slowdown in provision for credit losses. This trend was pretty much expected and we expect it to be exhibited by the other banks reporting next week.

For First Horizon, a protracted economic recovery remains an overhang on its results and loan demand continues to be weak.  The company’s efforts to reduce its exposure to problem loans, control costs, boost capital levels and improve long-term profitability by focusing on growing its core Tennessee banking franchise are encouraging.

Though the wind-down of the non-strategic part of the loan portfolio augurs well, it will remain a drag on First Horizon's earnings going forward. Shrinking revenue base and regulatory issues also remain concerns.

First Horizon currently retains a Zacks #3 Rank, which translates into a short-term 'Hold' rating. Also, considering its fundamentals, we have a long-term Neutral recommendation on the shares.

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