Overview



April 2004

Scott A. Jaggers, CFA, 312.630.9880 x224

sjaggers@

155 North Wacker Drive ( Chicago, IL 60606

First Horizon National Corporation (FHN – NYSE)

Overview

|Key Positive Arguments |Key Negative Arguments |

|asset quality strong & improving |revenue headwinds from mortgage banking decline |

|banking & cost control to drive continued EPS growth |fixed income capital markets also facing headwinds |

|cross-selling initiatives gaining traction |loss of trust preferred biz could cost $0.12 / year |

|excess mortgage earnings were reinvested wisely |significant investments have increased fixed costs |

Name was changed from First Tennessee National Corp. (ticker FTN) effective 4/21/04.

Q1 EPS of $0.92 was $0.04 above the consensus forecast. Net interest income decreased 0.2% sequentially, a bit weaker than the 0.6% increase expected, on a slightly weaker NIM (down 8 bps sequentially vs. expected flat showing). The loss provision came in $2 million lower than expected, at $16 million, and NCOs decreased by 6 bps to 0.35% vs. the 2 bps decline expected. Core non-interest income (ex-gains) fell 4.5% sequentially vs. a 6.4 fall expected. Total non-interest expenses fell 2.6% sequentially vs. a 3.8% fall expected, pushing the tangible efficiency ratio up to 65.4% from 65.1%. Analyst reaction was positive, but minimal. Both Q2 and ’04 consensus increased to $0.97 ($0.95) and $3.85 ($3.81).

1) Mortgage refinance cycle. FTN benefited tremendously from the mortgage refinance cycle. Bearish analysts worry that these revenues will be difficult to replace as the cycle continues to wane, but the more bullish analysts point to FTN’s conservative MSR accounting as an offset, and its national non-conforming arm as a source of continuing originations. And with rates reaching back toward their lows, even the more bearish admit there is hope for a near-term revenue pop.

2) Fixed-income cycle. Much the same argument has been made about FTN’s capital markets business. FTN has had quite a boost to its capital markets business, to a large extent from providing fixed-income securities to banks with excess liquidity. Capital markets revenues have remained at roughly 20% of total revenue the last several years vs. less than 10% historically. Analysts worry that these revenues, too, will be difficult to replace as the economy improves. The resilience of these markets to-date has surprised many, and the continuing steepness of the yield curve (together with tight spreads) is keeping the cycle alive.

Sales

Prior to the Q1 earnings release, the consensus was calling for 1.5% growth in NII in 2004, and 7.2% decline in core non-interest. Following the release, the NII forecast increased to 2.8%, while the non-interest forecast decreased to –10.3%. The following tables are current as of 5/23/04. Please refer to the spreadsheet for updated forecasts.

Margins

Prior to Q1 earnings, the consensus was calling for a 32.6% pre-tax margin in Q2 and a 32.8% margin for ’04. Afterward, the expectations increased to 31.6% for Q2 and 32.1% for ‘04.

Earnings Per Share

Analyst reaction was positive, but minimal. Both Q2 and ’04 consensus increased to $0.97 ($0.95) and $3.85 ($3.81).

Target Price / Valuation

There were no upgrades or downgrades on Q1 results. One target price was increased, while one was decreased.

Long-Term Growth

Growth in the near-term seems to be a key question for FTN. In the longer-term, however, FTN has great prospects for growth. Its mix of businesses provides it with something to sell at every point in the cycle. Its current focus is on improving cross-sell, providing additional services to existing customers.

Expanding FTN’s footprint also offers significant prospects. Breaking into a new market is generally difficult and expensive, but FTN already does business of some sort in 38 states. Adding banking services in these markets where it has another presence already is less expensive and risky than starting completely from scratch.

Individual Analyst Opinions

POSITIVE RATINGS

FIG Partners – Stock is rated Out-Perform (initiated 12/11/03). FTN represents superb value given a misunderstanding about its EPS prospects amidst slower mortgage activity. FTN can earn $4.00 per share in 2004, aided by lower credit costs, reduced expenses, and improving bank earnings. We assume slower fee revenue from mortgage finance and only modest growth in capital markets. Overall fees are estimated to fall 5% in 2004. EPS visibility is better than perceived, as quarterly EPS should continue to trend upward. As investors realize this after Q4 the P/E discount will be corrected. We think the transition away from mortgage is now quite evident and continues over next several quarters. Retail banking, capital markets, national financial services initiatives, and processing fill the “hole”.

Friedman, Billings – Stock is rated Out-Perform. Strong quarterly results. First Horizon reported $0.92 per share for 1Q04, five cents ahead of FBR's estimate. This compares to $0.90 reported in 4Q03. The key for the quarter was the company's balanced business model. Even as the pretax contribution of the mortgage business declined in this quarter, its core bank improved. For 1Q04, the mortgage bank contributed 51% of pretax earnings, down from 65% in 1Q03. We regard this favorably and indicative of the company's ability to weather different interest rate environments. Average loans grew 2% linked quarter to $14.0 billion. Residential/home equity loans showed considerable growth, fueled by the company's national cross sell efforts. Construction loans also showed good trends, as the company expanded its footprint across the country. We raise our core 2004 EPS estimate to $3.82 from $3.80 and our 2005 EPS estimate to $4.29 from $4.26. We project 12.3% core EPS growth in 2005. We raise our 12-month price target to $52 from $50. Our revised price target represents 12.1x our 2005 EPS estimate and 3.8x 1Q04 estimated tangible book value of $13.64. Our price target implies nearly 25% upside from current levels, including the company's 3.7% dividend yield. First Horizon remains one of our best picks in the mid-cap universe, given its diverse earnings mix. The first quarter continued to prove that due to its suite of businesses, with offsetting interest rate sensitivities, FHN is better positioned that the average bank to weather many different interest rate environments. We remain confident in the company's long-term growth potential and reiterate our Outperform rating.

Merrill – Stock is rated Buy (upgraded 9/25). FTN’s 1Q EPS of $0.92 were $0.05 above Consensus and $0.04 above our estimate. As we expected, lower pre-tax earnings from mortgage banking and capital markets (versus 1Q’03) were about evenly offset by higher earnings within FTN’s regional banking and transaction processing units as well as the elimination of $14mn of discretionary spending. Still, 1Q’04 results included $6.7mn in mortgage servicing hedge gains (net of MSR impairment costs), $2.8mn of securities and divestiture gains, and a slightly below normal tax rate. Thus, core earnings power was closer to Consensus. Positives in the quarter included solid loan and deposit growth, lower operating expenses and improved credit quality. We were also pleased that EPS were up modestly from $0.91 in 1Q’03 despite a 42% drop in mortgage origination revenue. Overall, we are reaffirming our 2004-05 EPS estimates of $3.90 and $4.20. We note that our 2004 estimate is above Consensus of $3.80. However, management continues to indicate comfort with a $4.00 EPS outlook this year. Furthermore, we believe that EPS (of about $1.00 in 2Q’04) will come in well above Consensus (of just $0.94), which we think will have a positive impact on FTN shares. Currently, FTN trades at just 11.2x our 2004E EPS, which represents a 15% discount to our Mid-Cap Bank group. We think at least part of this discount will dissipate as the Company beats the Consensus EPS this year and derives less of its earnings from mortgage origination revenue. Thus, we reaffirm our Buy opinion. Our 12-month price objective of $53 is based on DCF model and our above Consensus earnings outlook. The primary risk to our outlook is that FTN will not be able to control its operating costs as well as we anticipate.

Morgan Keegan – Stock is rated Out-Perform (upgraded 12/11/03). The first quarter once again reflected solid performance, especially when considering the seasonal weakness in the purchase mortgage business. Offsetting the weakness in mortgage and, to a lesser extent, capital markets, the company's counter-cyclical business model performed as designed, insulating bottom line earnings per share from top line volatility. The net result of the quarter was a strong return on average assets of 1.93% versus 2.07% last March, and a cash return on tangible equity of 29.08% versus 31.20% last March. While many investors refuse to believe that First Tennessee can sustain its impressive performance now that the mortgage refinance boom appears to have ended, we continue to believe in the business model. The company differentiates itself from its regional peers by operating a diversified business model that continues to generate excess capital, which management has diligently reinvested across its various business lines to provide for future growth. Understanding First Tennessee today, one must recognize that the company is more than just a mortgage refinance shop, and more than just a bond shop; rather, we believe the company has successfully restructured its segments over the past few years to include multiple counter-cyclical hedges in each segment and across segments. Given the upside to our estimates this quarter, and our expectations for continued solid performance over the course of the current year, we are raising our 2004 GAAP earnings per share estimate from $3.85 to $3.90 and our 2004 cash estimate from $3.90 to $3.95. We are also initiating 2005 earnings per share estimates of $4.20 (GAAP) and $4.25 (cash) at this time, representing approximately 8% growth above our revised 2004 estimates. The company's shares are trading at just 10.9x our revised 2004 cash estimate, a modest discount to our expected long-term growth rate, and a significant discount to the median of 13.3x 2004 cash estimates for our Regional Bank group. We continue to believe that long-term holders of First Tennessee shares will benefit by owning shares of this highly profitable, well-run and diversified financial institution, and we believe that the excesses of the recent mortgage refinance boom have substantially worked through the system in the last two quarter's results. Thus, we believe the most difficult quarter First Tennessee is likely to face is behind the company, and less investor skepticism should prevail. Over the next six months, we believe the company will continue to prove its doubters wrong, and significant P/E multiple expansion is likely.

Ryan Beck – Stock is rated Out-Perform (initiated11/11/03). Earnings for 1Q04 were better than expected, and we would utilize stock price weakness as an opportunity to continue to reiterate our Outperform rating. In our view, FTN's earnings bias for 2004 continues to be positive, based on the early success of rebalancing its business mix and positive operating leverage driven by expense control and revenue growth. For instance, revenue per share grew by 1.3% in 1Q04, while expense per share declined by 2.6%. The trust preferred treatment as Tier I capital continues to be unresolved. The updated negative impact to FTN's 2004 EPS is $0.08-$0.12, which is $0.02-$0.03 less than the year-end guidance simply due to the passage of time. This potential negative impact should continue to decline with the passage of time and with the development of new products that could replace these trust preferreds should they be deemed unacceptable for Tier I purposes in the future. Our 2004 and 2005 EPS estimates are $3.90 and $4.20, respectively. Our target price of $53 represents a 13.5 multiple on our 2004 earnings per share estimate, which is moderately below the median of the mid-cap peer group at 15.6 times. FTN's 5-year price-to-forward consensus earnings range is a high of 21.5 times and a low of 8.0 times, while the median is 13.5 times.

Smith Barney – Stock is rated Buy. First Tennessee reported 1Q EPS of $0.92 ($0.06 above our estimate and $0.04 above consensus), which represents a 1% increase vs. the prior year and a $0.02 linked quarter rise. Overall, it was clean quarter, with no corporate discretionary spending and only $2.9 mil ($0.015 a share) of divestiture gains (carryover from a 4Q transaction) and securities gains. Of the regional banks in our universe, First Tennessee was perhaps the best positioned for the low rate environment due to its business mix, which benefited from a strong mortgage banking and fixed income capital markets environment. However, First Tennessee's stock has been weak recently as the market anticipates what its earnings will look like in a more normal mortgage banking and fixed income capital markets environment and the company now trades at a 15% P/E discount despite its 10-year track record of 15% EPS growth. We believe the market skepticism has created a buying opportunity due to our view that the 2004 EPS estimates are achievable due to the presence of offsets from returns on investment spending made in 2003, improvement in mortgage servicing revenue, market share gains across all businesses, and impact of national cross-sell initiatives.

Sterne, Agee & Leach – Stock is rated Buy (initiated 4/16/04). First Tennessee reported 1Q04 EPS of $0.92, or two cents above our estimate and four cents higher than the consensus outlook. The latest results represent a 1.1% increase over last year. Operating revenues fell 9.6%, while operating costs dropped 10.4%, contributing to negative operating leverage equal to about $0.09 per share. As expected, lower revenues were attributable to mortgage banking and capital markets. We are increasing our estimates for 2004 by $0.04, reflecting stronger than originally expected trends in mortgage banking. For the same reason, we are also boosting our 2005 outlook by a nickel. We are reiterating our BUY rating and confirming our $58 target price. The stock trades at 11.4 times our new 2004 estimate, compared to 13.7 times for our mid-cap bank peer group. We believe this discount is unwarranted, especially in view of the progress in transitioning the franchise.

NEUTRAL RATINGS

AG Edwards – Stock is rated Hold. Several factors limit our enthusiasm about the prospects for FTN shares. While we believe that our estimates are attainable in a reasonably normal environment, we caution that the vagaries of the mortgage business are difficult to anticipate, especially in a rising rate environment. In our opinion, FTN could experience significant earnings fluctuations associated with the mortgage business, which, in turn, could result in an undesirable level of share price volatility. Furthermore, we are cognizant of the earnings at risk should trust preferred securities be denied treatment as Tier 1 capital (a palpable risk, in our opinion). FTN, through its investment banking unit, earns $0.10-$0.15 per share annually from the issuance of trust preferred securities, and a change in regulatory treatment of this type of security could potentially eradicate demand for the product, leaving FTN with an earnings shortfall. Although we believe that FTN is a fine company, we believe that mortgage banking is a low multiple business and that a stock with this level of risk should trade at a discount to the peer group. We also believe that there are other banks with greater outperformance potential in a higher interest rate environment. Trading at 11.3x our 2004 EPS estimate, FTN shares trade at a two multiple discount to the mid-cap bank group. Based on peer comparisons and our sum-of-the-parts valuation model, we believe that shares are fairly valued at current levels. Consequently, we continue to rate FTN shares Hold.

Fox Pitt – Stock is rated In-Line. On-going earnings power is better than anticipated given the earnings leverage from reduced expenses once revenue growth slows (the non-core spending which is negatively impacting current results will drive efficiency and earnings gains in the future). FTN conservatively values its MSR, has been proactive at taking permanent impairment, and is in good shape to see servicing revenue increase when rates rise. Low reserve level is a bit of a concern, but risk profile has improved in the last year. FTN plans to generate some incremental revenue from correspondent lending relationships on the home equity side. The company plans to buy up to $500 million of product quarterly, house it on its balance sheet, and then securitize the product adding $5-7 million of securitization gain on sale per quarter.

Hoefer & Arnett – Stock is rated Neutral (downgraded 11/19/03). First Tennessee reported first quarter earnings of $0.92 per share. This was $0.03 per share above my estimate and $0.02 per share above fourth quarter results. Consequently, the earnings forecast is being increased to $3.83 per share for 2004 from $3.79 per share. The estimate for 2005, on the other hand, is actually being lowered slightly to $4.12 per share from $4.14 per share. Despite the strong first quarter EPS number, the quarter was not a good one for First Tennessee. The strength in earnings was the result of continued good fortunes in the mortgage business, sharply lower other expenses and a lower tax rate than the fourth quarter. The banking business did not produce the improvement in results expected in the quarter. Its profits were down on a sequential basis. In addition, in its recorded call to investors the company raised two risk factors. First, an accounting change will negatively impact second quarter results by an estimated $10 million. Second, a change in the Federal Reserve’s accounting treatment of trust preferred could cost as much as $0.12 per share this year.

Keefe Bruyette – Stock is rated Market-Perform. We are maintaining our Market Perform rating. In anticipation of a weaker mortgage outlook, we are lowering our 2004 and 2005 estimates by $0.05 in each year to $3.88 and $3.90, respectively, and we are lowering our price target $2 to $47. This new target reflects a multiple of 12 times our revised 2005 earnings estimate. In running our model, our outlook largely depends on projections from the Mortgage Bankers Association for total originations. Although projections were recently bumped up again in Mid-April to $2.6 trillion in originations, we are currently anticipating a downward revision from these levels. Specifically, the MBAA's current projection of $2.6 trillion in 2004 is predicated on a 10 year ranging from 4.10% to 4.30%, while its projection of $1.9 trillion in originations during 2005 is assumes a 10 year projection of 4.40% to 4.60%. Although we've seen many false starts in the last few years, our current feeling is that these rate assumptions will prove low and the origination projections will ultimately prove to be too high. In addition, we believe that gain on sale margins and mortgage origination market share will remain moving targets. Our current bias for each is in the downward direction. However, in the very near-term, we expect FTN's numbers to look strong given their exposure to mortgage banking and capital markets. Not surprisingly, mortgage originations along with net interest income from the held for sale portfolio should be very strong during the second quarter, while capital markets is expected to see a nice improvement due to a continuation of high agency trading revenues and the addition of an insurance trust preferred pool.

Lehman – Stock is rated Equal-Weight. FTN reported 1Q EPS of $0.92, compared to consensus expectations of $0.88 and our estimate of $0.86. EPS increased 1.1% y-o-y and rose 2.2% linked quarter. Relative to our forecast, mortgage banking provided the upside. Its 1Q04 pre-tax earnings mix was 20% banking, 65% First Horizon, 25% FTN Financial, 2% transaction processing and -12% corporate. Relative to 4Q03, results evidenced decent balance sheet growth, an 8 bp decline in its margin, slight growth in fee income and lower expenses. Its NPA ratio was relatively stable, while its NCO ratio improved 7 bps to 0.34%. Despite 1Q04 results exceeding our EPS estimate by $0.06 and our belief that 2Q04 results should be robust as mortgage revenues increase, we are maintaining our 2004 and 2005 EPS estimates at $3.80 and $4.25 respectively. We rate FTN 2-Equal weight.

Suntrust RH. – Stock is rated Equal-Weight. First Horizon reported 1Q04 EPS of $0.92, $0.05 above our estimate and $0.04 above Street mean. Compared to our model, higher fees in the mortgage and capital markets lines offset lower than expected spread income as the company’s margin declined nine basis points. FHN continues to focus on its national expansion model. Its First Horizon Bank brand has four branches in the Northern Virginia/Washington DC. Early results have been encouraging and we expect continued expansion of this brand, eventually reaching into other markets. We are raising our 2004 and 2005 estimates to $3.83 and $4.15, respectively. The earnings progression is a bit staggered, however, with 2004 estimates of $1.03 (2Q), $0.94 (3Q), and $0.95 (4Q). Our higher estimate for the second quarter is based on expectations of greater origination levels given the low rates in March as well as the ability for FHN to recover a portion of its $32 million MSR reserve. Assuming stable to rising rates going forward we expect much of the reserve to be recovered in the next one to two quarters. Currently FHN’s MSR asset is $7.08 billion, or 1% of its $70.3 billion servicing portfolio. At 12/31/03 FHN’s mortgage servicing asset was valued at 1.15% of its servicing portfolio. Although FHN trades at a 10% discount to large-cap peers, we are maintaining our rating at Neutral. Given the likelihood of a significant drop in mortgage volumes (latest MBA estimate is $2.6 trillion in 2004 vs. $3.8 trillion in 2003; $1.9 trillion in 2005) we are leery of being more aggressive with the stock at current levels. Capital markets, another significant contributor to earnings is also liable to show declining revenue trends as loan growth improves, possibly a second half of 2004 event.

NEGATIVE RATINGS

Goldman – Stock is rated Under-Perform. FTN’s 1Q results contained improvement in asset quality coupled with healthy loan growth while top-line trends were soft along with soft net interest income (as the net interest margin compressed) and capital markets trends. Credit losses were down 6bps to 34bps while NPLs fell by 9% from the prior quarter. Lending momentum was centered across residential and commercial construction activities and commercial lending continues to show momentum growing at a 4% annualized sequential rate. Top-line trends were soft as capital market fees and net interest income were flat during the quarter while lower expenses aided the bottom line. We are raising our 2004 estimate from $3.55 to $3.75 and raising our 2005 estimate from $3.90 to $4.00 to reflect better expense control. However, resolution on the trust preferred securities issue could cost $0.08−0.12 per share to EPS. We are maintaining our current Underperform rating on FTN shares based on our DCF valuation. Given challenging revenues trends, we are encouraged by the continued expense discipline.

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Research Digest

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