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 September 30, 1999 -------------- 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 130,374,434 - ----------------------------- ------------------------------- Class Outstanding at October 31, 1999
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 - ----------------------------------------------------------------------------------------------------------- September 30 December 31 ---------------------------- ------------ (Dollars in thousands)(Unaudited) 1999 1998 1998 - -------------------------------------------------------------------------------------------- ------------ <S> <C> <C> <C> ASSETS: Cash and due from banks $ 860,519 $ 726,605 $ 811,881 Federal funds sold and securities purchased under agreements to resell 297,398 134,011 124,239 - -------------------------------------------------------------------------------------------- ------------ Total cash and cash equivalents 1,157,917 860,616 936,120 - -------------------------------------------------------------------------------------------- ------------ Investment in bank time deposits 1,598 2,786 1,211 Capital markets securities inventory 502,796 397,980 358,304 Mortgage loans held for sale 2,910,874 2,841,957 4,227,443 Securities available for sale 1,953,055 1,910,299 1,816,485 Securities held to maturity (market value of 785,065 at September 30, 1999; $686,156 at September 30, 1998; and $610,364 at December 31, 1998) 810,394 684,491 609,804 Loans, net of unearned income 8,956,320 8,315,716 8,557,064 Less: Allowance for loan losses 139,426 135,413 136,013 - -------------------------------------------------------------------------------------------- ------------ Total net loans 8,816,894 8,180,303 8,421,051 - -------------------------------------------------------------------------------------------- ------------ Premises and equipment, net 304,553 236,908 254,292 Real estate acquired by foreclosure 17,065 15,513 16,242 Mortgage servicing rights, net 868,589 518,991 664,438 Intangible assets, net 131,162 129,052 132,845 Capital markets receivables and other assets 1,627,100 1,469,113 1,295,726 - -------------------------------------------------------------------------------------------- ------------ TOTAL ASSETS $ 19,101,997 $ 17,248,009 $ 18,733,961 ============================================================================================ ============ LIABILITIES AND SHAREHOLDERS' EQUITY: Deposits: Interest-bearing $ 9,674,515 $ 8,384,401 $ 8,665,175 Noninterest-bearing 2,748,857 2,716,088 3,057,864 - -------------------------------------------------------------------------------------------- ------------ Total deposits 12,423,372 11,100,489 11,723,039 - -------------------------------------------------------------------------------------------- ------------ Federal funds purchased and securities sold under agreements to repurchase 1,979,934 2,136,500 2,912,018 Commercial paper and other short-term borrowings 1,494,301 1,336,243 1,427,274 Capital markets payables and other liabilities 1,480,796 1,257,096 1,057,646 Term borrowings 376,877 266,468 414,450 - -------------------------------------------------------------------------------------------- ------------ Total liabilities 17,755,280 16,096,796 17,534,427 - -------------------------------------------------------------------------------------------- ------------ 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 - 130,681,481 at September 30, 1999; 128,087,054 at September 30, 1998; and 128,974,362 at December 31, 1998) 81,676 80,054 80,609 Capital surplus 159,144 78,128 96,778 Undivided profits 1,018,112 867,918 908,977 Accumulated other comprehensive income (9,157) 25,392 12,872 Deferred compensation on restricted stock incentive plans (6,245) (1,434) (1,209) Deferred compensation obligation 3,187 1,155 1,507 - -------------------------------------------------------------------------------------------- ------------ Total shareholders' equity 1,246,717 1,051,213 1,099,534 - -------------------------------------------------------------------------------------------- ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 19,101,997 $ 17,248,009 $ 18,733,961 ============================================================================================ ============ <FN> See accompanying notes to consolidated financial statements. </FN> </TABLE>
5 <TABLE> <CAPTION> CONSOLIDATED STATEMENTS OF INCOME First Tennessee National Corporation - ------------------------------------------------------------------------------------------------------------------------ Three Months Ended Nine Months Ended September 30 September 30 ----------------------------- ------------------------------ (Dollars in thousands except per share data)(Unaudited) 1999 1998 1999 1998 - ------------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> INTEREST INCOME: Interest and fees on loans $ 189,399 $ 181,038 $ 552,229 $ 541,827 Interest on investment securities: Taxable 46,001 42,654 127,250 115,324 Tax-exempt 602 895 2,093 2,838 Interest on mortgage loans held for sale 55,458 51,112 179,570 130,170 Interest on capital markets securities inventory 7,746 9,351 25,057 21,442 Interest on other earning assets 4,006 3,217 10,456 9,828 - ------------------------------------------------------------------------------------------------------------------------ Total interest income 303,212 288,267 896,655 821,429 - ------------------------------------------------------------------------------------------------------------------------ INTEREST EXPENSE: Interest on deposits: Savings 1,450 1,812 4,317 5,466 Checking interest and money market account 25,900 28,317 78,547 85,415 Certificates of deposit under $100,000 and other time 30,326 35,921 93,431 110,581 Certificates of deposit $100,000 and more 38,878 29,836 115,056 72,790 Interest on short-term borrowings 53,155 52,482 144,403 139,053 Interest on term borrowings 6,176 5,238 19,041 14,134 - ------------------------------------------------------------------------------------------------------------------------ Total interest expense 155,885 153,606 454,795 427,439 - ------------------------------------------------------------------------------------------------------------------------ NET INTEREST INCOME 147,327 134,661 441,860 393,990 Provision for loan losses 14,110 13,127 43,915 39,427 - ------------------------------------------------------------------------------------------------------------------------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 133,217 121,534 397,945 354,563 - ------------------------------------------------------------------------------------------------------------------------ NONINTEREST INCOME: Mortgage banking 158,919 160,063 503,393 375,120 Capital markets 27,832 35,370 102,397 103,590 Deposit transactions and cash management 27,431 23,358 77,255 66,125 Trust services and investment management 15,715 12,619 45,059 38,080 Merchant processing 12,880 10,074 37,805 25,023 Cardholder fees 7,084 5,392 18,098 15,258 Equity securities gains 1,871 -- 1,863 38 Debt securities gains/(losses) (12) 9 (76) (91) All other income and commissions 34,592 21,035 81,302 54,677 - ------------------------------------------------------------------------------------------------------------------------ Total noninterest income 286,312 267,920 867,096 677,820 - ------------------------------------------------------------------------------------------------------------------------ ADJUSTED GROSS INCOME AFTER PROVISION FOR LOAN LOSSES 419,529 389,454 1,265,041 1,032,383 - ------------------------------------------------------------------------------------------------------------------------ NONINTEREST EXPENSE: Employee compensation, incentives and benefits 154,175 145,038 490,461 391,452 Amortization of mortgage servicing rights 22,784 28,851 83,619 70,796 Operations services 16,886 14,931 49,449 42,889 Occupancy 19,706 13,543 52,408 36,958 Equipment rentals, depreciation and maintenance 14,618 11,636 41,731 32,023 Communications and courier 13,816 10,636 38,853 30,340 Advertising and public relations 6,724 7,398 23,323 18,628 Amortization of intangible assets 2,629 2,726 7,806 8,021 All other expense 63,102 57,948 194,278 150,878 - ------------------------------------------------------------------------------------------------------------------------ Total noninterest expense 314,440 292,707 981,928 781,985 - ------------------------------------------------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES 105,089 96,747 283,113 250,398 Applicable income taxes 35,671 34,927 99,694 89,477 - ------------------------------------------------------------------------------------------------------------------------ NET INCOME $ 69,418 $ 61,820 $ 183,419 $ 160,921 ======================================================================================================================== EARNINGS PER SHARE $ .53 $ .48 $ 1.41 $ 1.26 - ------------------------------------------------------------------------------------------------------------------------ DILUTED EARNINGS PER SHARE $ .52 $ .47 $ 1.37 $ 1.22 - ------------------------------------------------------------------------------------------------------------------------ WEIGHTED AVERAGE SHARES OUTSTANDING 131,128,788 128,264,415 130,546,944 128,104,556 - ------------------------------------------------------------------------------------------------------------------------ <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) 1999 1998 - ------------------------------------------------------------------------------------- <S> <C> <C> BALANCE, JANUARY 1 $ 1,099,534 $ 954,096 Net income 183,419 160,921 Other comprehensive income: Unrealized market adjustments, net of tax and reclassification adjustment (22,029) 10,059 - ------------------------------------------------------------------------------------- Comprehensive income 161,390 170,980 - ------------------------------------------------------------------------------------- Cash dividends declared (74,285) (63,369) Common stock issued: Keystone Mortgage, Inc. acquisition (66) 5,221 Cambridge Mortgage Company acquisition 704 -- For exercise of stock options 29,933 17,868 Tax benefit from non-qualified stock options 11,320 15,315 Common stock repurchased (2,908) (61,835) Amortization on restricted stock incentive plans 1,579 988 Common stock adjustment McGuire Mortgage Co. acquisition (259) -- Other 19,775 11,949 - ------------------------------------------------------------------------------------- BALANCE, SEPTEMBER 30 $ 1,246,717 $ 1,051,213 ===================================================================================== <FN> See accompanying notes to consolidated financial statements. </FN> </TABLE>
7 <TABLE> <CAPTION> CONSOLIDATED STATEMENTS OF CASH FLOWS First Tennessee National Corporation - -------------------------------------------------------------------------------------------- Nine Months Ended September 30 ---------------------------- (Dollars in thousands)(Unaudited) 1999 1998 - -------------------------------------------------------------------------------------------- <S> <C> <C> OPERATING ACTIVITIES: Net income $ 183,419 $ 160,921 Adjustments to reconcile net income to net cash provided/(used) by operating activities: Provision for loan losses 43,915 39,427 Provision for deferred income tax 83,665 48,158 Depreciation and amortization of premises and equipment 38,329 27,931 Amortization of mortgage servicing rights 83,619 70,796 Amortization of intangible assets 7,806 8,021 Net other amortization and accretion 42,615 9,393 Market value adjustment on foreclosed property 4,240 13,250 Gain on sale of securitized loans -- (643) Equity securities gains (1,863) (38) Debt securities losses 76 91 Net gains on disposal of fixed assets (232) (385) Gain on sale of bank branches (4,245) (567) Net (increase)/decrease in: Capital markets securities inventory (134,976) (144,740) Mortgage loans held for sale 1,316,569 (1,599,573) Capital markets receivables (278,343) (341,203) Interest receivable 3,483 (14,859) Other assets (477,836) (532,390) Net increase/(decrease) in: Capital markets payables 381,491 273,909 Interest payable (947) (7,675) Other liabilities 2,937 268,180 - -------------------------------------------------------------------------------------------- Total adjustments 1,110,303 (1,882,917) - -------------------------------------------------------------------------------------------- Net cash (used)/provided by operating activities 1,293,722 (1,721,996) - -------------------------------------------------------------------------------------------- INVESTING ACTIVITIES: Held to maturity securities: Maturities 174,341 86,291 Purchases -- -- Available for sale securities: Sales 32,056 42,387 Maturities 568,600 640,262 Purchases (697,010) (439,318) Premises and equipment: Sales 9,301 1,872 Purchases (91,822) (55,382) Net decrease in loans (853,938) (845,589) Increase in investment in bank time deposits (387) (264) Proceeds from loan securitizations -- 72,756 Sale of bank branches, net of cash and cash equivalents (4,778) (7,654) Acquisitions, net of cash and cash equivalents acquired (8,505) (9,311) - -------------------------------------------------------------------------------------------- Net cash used by investing activities (872,142) (513,950) - -------------------------------------------------------------------------------------------- FINANCING ACTIVITIES: Common stock: Exercise of stock options 32,027 18,111 Cash dividends (73,857) (84,587) Repurchase of shares (2,908) (61,854) Term borrowings: Issuance 52,421 99,218 Payments (90,273) (1,811) Net increase/(decrease) in: Deposits 747,874 1,441,188 Short-term borrowings (865,067) 684,676 - -------------------------------------------------------------------------------------------- Net cash (used)/provided by financing activities (199,783) 2,094,941 - -------------------------------------------------------------------------------------------- Net increase/(decrease) in cash and cash equivalents 221,797 (141,005) - -------------------------------------------------------------------------------------------- Cash and cash equivalents at beginning of period 936,120 1,001,621 - -------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 1,157,917 $ 860,616 ============================================================================================ Total interest paid $ 455,527 $ 434,922 Total income taxes paid 18,472 22,499 - -------------------------------------------------------------------------------------------- <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 and nine month periods ended September 30, 1999, 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 the 1999 Proxy Statement & 1998 Financial Information. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement requires that an entity recognize all derivatives as either assets or liabilities in the statement of condition and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. This Statement has been amended by SFAS No. 137 which delayed the effective date to fiscal years beginning after June 15, 2000; which for First Tennessee will mean the first quarter of 2001. Earlier adoption is allowed. Because of the complexity of this standard and uncertainties associated with predicting future derivative usage and related fair values, it is not practicable at this time to predict what the impact of adopting this Statement will be to First Tennessee's financial position and results of operations. 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 - BUSINESS COMBINATIONS/DIVESTITURES On March 31, 1999, First Tennessee acquired Cambridge Mortgage Company of Seattle, Washington, for approximately 22,000 shares of its common stock. Cambridge was merged into FT Mortgage Companies, an indirect wholly-owned subsidiary of First Tennessee. This acquisition was accounted for as a purchase and was immaterial to First Tennessee. On June 1, 1999, First Tennessee Bank National Association, a wholly-owned subsidiary of First Tennessee National Corporation, acquired from National Processing Co. their remittance processing business locations in Atlanta, Dallas, Louisville and Phoenix for approximately $6.0 million. The acquisition of these units was accounted for as a purchase and was immaterial to First Tennessee. On July 20, 1999, First Tennessee completed the sale of substantially all of the assets and liabilities of Planters Bank of Tunica, Mississippi, a wholly-owned subsidiary, to First Security Bank of Batesville, Mississippi. This transaction was completed for approximately $10.5 million and was immaterial to First Tennessee. On October 1, 1999, First Tennessee acquired Elliot Ames, Inc. of Los Altos, California, for approximately 242,000 shares of its common stock. Elliot Ames was merged into FT Mortgage Companies, an indirect wholly-owned subsidiary of First Tennessee. This acquisition was accounted for as a purchase and was immaterial to First Tennessee.
10 NOTE 3 - EARNINGS PER SHARE The following table shows a reconciliation of earnings per share to diluted earnings per share. <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30 September 30 --------------------------- --------------------------- (Dollars in thousands, except per share data) 1999 1998 1999 1998 - -------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> EARNINGS PER SHARE COMPUTATION: Net income $69,418 $61,820 $183,419 $160,921 Weighted average shares outstanding 130,685,907 127,987,844 130,153,949 127,965,200 Shares attributable to deferred compensation 442,881 276,571 392,995 139,356 - -------------------------------------------------------------------------------------------------------------- Total weighted average shares per income statement 131,128,788 128,264,415 130,546,944 128,104,556 Earnings per share $ .53 $ .48 $ 1.41 $ 1.26 - -------------------------------------------------------------------------------------------------------------- DILUTED EARNINGS PER SHARE COMPUTATION: Net income $69,418 $61,820 $183,419 $160,921 Weighted average shares outstanding 131,128,788 128,264,415 130,546,944 128,104,556 Dilutive effect due to stock options 3,046,877 3,215,503 3,661,797 3,669,142 - -------------------------------------------------------------------------------------------------------------- Weighted average shares outstanding, as adjusted 134,175,665 131,479,918 134,208,741 131,773,698 Diluted earnings per share $ .52 $ .47 $ 1.37 $ 1.22 - -------------------------------------------------------------------------------------------------------------- <FN> *As a result of the Real Estate Mortgage Investment Conduit (REMIC) certain securitized consumer and permanent mortgage loans are now classified as REMIC securities </FN> </TABLE>
11 NOTE 4 - LOANS The composition of the loan portfolio at September 30 is detailed below: <TABLE> <CAPTION> (Dollars in thousands) 1999 1998 - ------------------------------------------------------------------------------- <S> <C> <C> Commercial $4,330,516 $4,076,573 Consumer* 3,136,311 2,832,518 Permanent mortgage* 470,550 408,034 Credit card receivables 578,370 573,248 Real estate construction 407,882 397,686 Nonaccrual - Regional banking group 11,476 8,437 Nonaccrual - Mortgage banking 21,215 19,220 - ------------------------------------------------------------------------------- Loans, net of unearned income 8,956,320 8,315,716 Allowance for loan losses 139,426 135,413 - ------------------------------------------------------------------------------- Total net loans $8,816,894 $8,180,303 =============================================================================== <FN> *As a result of the Real Estate Mortgage Investment Conduit (REMIC) certain securitized consumer and permanent mortgage loans are now classified as REMIC securities </FN> </TABLE> The following table presents information concerning nonperforming loans at September 30: <TABLE> <CAPTION> (Dollars in thousands) 1999 1998 - ------------------------------------------------------------------------------- <S> <C> <C> Impaired loans $12,599 $ 9,270 Other nonaccrual loans 20,092 18,387 - ------------------------------------------------------------------------------- Total nonperforming loans $32,691 $27,657 =============================================================================== </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 Nine Months Ended September 30 September 30 ------------------ ------------------ (Dollars in thousands) 1999 1998 1999 1998 - ------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Total interest on impaired loans $ 50 $ 488 $ 365 $ 845 Average balance of impaired loans 12,792 8,668 13,027 8,904 - ------------------------------------------------------------------------------- </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 nine months ended September 30, 1999 and 1998, is summarized as follows: <TABLE> <CAPTION> (Dollars in thousands) Non-impaired Impaired Total - ------------------------------------------------------------------------------- <S> <C> <C> <C> Balance at December 31, 1997 $ 122,107 $ 3,752 $ 125,859 Allowance for acquisitions 140 -- 140 Provision for loan losses 39,487 (60) 39,427 Securitization adjustment (3,575) -- (3,575) Charge-offs 33,562 1,634 35,196 Less loan recoveries 8,126 632 8,758 - ------------------------------------------------------------------------------- Net charge-offs 25,436 1,002 26,438 - ------------------------------------------------------------------------------- Balance at September 30, 1998 $ 132,723 $ 2,690 $ 135,413 =============================================================================== Balance at December 31, 1998 $ 133,572 $ 2,441 $ 136,013 Provision for loan losses 36,492 7,423 43,915 Securitization adjustment (1,790) -- (1,790) Adjustment due to divesture (893) -- (893) Charge-offs 37,416 6,593 44,009 Less loan recoveries 4,885 1,305 6,190 - ------------------------------------------------------------------------------- Net charge-offs 32,531 5,288 37,819 - ------------------------------------------------------------------------------- BALANCE AT September 30, 1999 $ 134,850 $ 4,576 $ 139,426 =============================================================================== </TABLE>
12 NOTE 5 - 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 national lines of business include mortgage banking, capital markets and transaction processing. The other segment is used to isolate corporate items. 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 quarterly and year to date periods ending September 30, 1999 and 1998. <TABLE> <CAPTION> Regional Banking Mortgage Capital Transaction (Dollars in thousands) Group Banking Markets Processing Other Consolidated - ----------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> 3Q99 Interest income $ 223,418 $ 66,213 $ 9,112 $ 4,469 $ -- $ 303,212 Interest expense 94,536 52,718 8,183 448 -- 155,885 - ----------------------------------------------------------------------------------------------- Net interest income 128,882 13,495 929 4,021 -- 147,327 Other revenues 66,842 161,135 27,846 28,631 1,858 286,312 Other expenses* 127,136 153,709 20,886 24,284 2,535 328,550 - ----------------------------------------------------------------------------------------------- Pre-tax income 68,588 20,921 7,889 8,368 (677) 105,089 Income taxes 21,716 8,058 2,974 3,180 (257) 35,671 - ----------------------------------------------------------------------------------------------- Net income $ 46,872 $ 12,863 $ 4,915 $ 5,188 $ (420) $ 69,418 =============================================================================================== Average assets $12,206,651 $5,182,985 $749,903 $493,788 $ -- $18,633,327 - ----------------------------------------------------------------------------------------------- 3Q98 Interest income $ 214,816 $ 58,051 $ 11,234 $ 4,166 $ -- $ 288,267 Interest expense 96,997 46,191 10,064 354 -- 153,606 - ----------------------------------------------------------------------------------------------- Net interest income 117,819 11,860 1,170 3,812 -- 134,661 Other revenues 54,087 161,171 35,374 17,277 11 267,920 Other expenses* 113,887 146,623 26,625 16,667 2,032 305,834 - ----------------------------------------------------------------------------------------------- Pre-tax income 58,019 26,408 9,919 4,422 (2,021) 96,747 Income taxes 20,457 9,835 3,723 1,680 (768) 34,927 - ----------------------------------------------------------------------------------------------- Net income $ 37,562 $ 16,573 $ 6,196 $ 2,742 $(1,253) $ 61,820 =============================================================================================== Average assets $11,240,955 $4,343,648 $827,575 $464,932 $ -- $16,877,110 - ----------------------------------------------------------------------------------------------- <FN> *Includes loan loss provision. </FN> </TABLE> <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 99 Interest income $ 646,458 $ 205,716 $ 30,846 $ 13,635 $ -- $ 896,655 Interest expense 268,399 157,861 26,909 1,626 -- 454,795 - ----------------------------------------------------------------------------------------------- Net interest income 378,059 47,855 3,937 12,009 -- 441,860 Other revenues 183,234 508,807 102,409 70,859 1,787 867,096 Other expenses* 374,292 507,805 77,567 59,584 6,595 1,025,843 - ----------------------------------------------------------------------------------------------- Pre-tax income 187,001 48,857 28,779 23,284 (4,808) 283,113 Income taxes 62,778 19,043 10,852 8,848 (1,827) 99,694 - ----------------------------------------------------------------------------------------------- Net income $ 124,223 $ 29,814 $ 17,927 $ 14,436 $(2,981) $ 183,419 =============================================================================================== Average assets $11,887,829 $5,342,462 $841,211 $494,518 $ -- $18,566,020 - ----------------------------------------------------------------------------------------------- Year To Date 98 Interest income $ 632,625 $ 147,854 $ 27,345 $ 13,605 $ -- $ 821,429 Interest expense 287,548 113,902 23,827 2,162 -- 427,439 - ----------------------------------------------------------------------------------------------- Net interest income 345,077 33,952 3,518 11,443 -- 393,990 Other revenues 151,444 377,957 103,597 44,873 (51) 677,820 Other expenses* 328,282 363,318 77,912 45,808 6,092 821,412 - ----------------------------------------------------------------------------------------------- Pre-tax income 168,239 48,591 29,203 10,508 (6,143) 250,398 Income taxes 59,336 17,516 10,966 3,992 (2,333) 89,477 - ----------------------------------------------------------------------------------------------- Net income $ 108,903 $ 31,075 $ 18,237 $ 6,516 $(3,810) $ 160,921 =============================================================================================== Average assets $11,074,389 $3,732,501 $682,448 $493,300 $ -- $15,982,638 - ----------------------------------------------------------------------------------------------- <FN> *Includes loan loss provision. </FN> </TABLE>
13 ITEM 2. FIRST TENNESSEE NATIONAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION DESCRIPTION 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 national and regional business lines. The Regional Banking Group includes the retail/commercial bank, the credit card division and trust services. The National Lines of Business include FT Mortgage Companies and affiliates (also referred to as mortgage banking), First Tennessee Capital Markets (also referred to as capital markets) and transaction processing (credit card merchant processing, automated teller machine network, check clearing operations and retail lockbox operations). INTRODUCTION Certain revenues 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. If a revision is made, the previous history is restated to ensure comparability. For purposes of this management discussion and analysis (MD&A), noninterest income (also called fee income) and total revenues 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. Growth rates in the various tables are computed using numbers rounded to the nearest thousand. The following is a discussion and analysis of the financial condition and results of operations of First Tennessee for the three month and nine month periods ended September 30, 1999, compared to the three month and nine month periods ended September 30, 1998. 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 1998 financial statements, notes, and management's discussion and analysis is provided as an appendix to the 1999 proxy statement. 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 Year 2000. 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. 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, are subject to change. Examples of uncertainties and contingencies include, among other important factors, general and local economic and business conditions; interest rate, market and monetary fluctuations; inflation; competition within and without the financial services industry; 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 fluctuating collateral values and changes in customer profiles. Additionally, the policies of the Office of the Comptroller of the Currency and the Board of Governors of the Federal Reserve System, unanticipated regulatory and judicial proceedings, and changes in laws and regulations applicable to First Tennessee and First Tennessee's success in managing the risks involved in the foregoing could cause actual results to differ. The forward-looking statements related to Year 2000 reflect management's best current estimates, which are based on numerous assumptions about future events, including the continued availability of certain resources, representations received from third party service providers and other third parties, and additional factors. Those additional factors include, but are not limited to, uncertainties in the cost
14 of hardware and software, the availability and cost of programmers and other systems personnel, inaccurate or incomplete execution of the phases, ineffective remediation of the computer code, and whether First Tennessee's customers, vendors, competitors and counterparties effectively address the Year 2000 issue. There can be no guarantee that these estimates, including Year 2000 costs, will be achieved, and actual results could differ materially from those estimates. First Tennessee assumes no obligation to update any forward-looking statements that are made from time to time. SECURITIZATION ACTIVITY First Tennessee Bank National Association (FTBNA) securitized approximately $73 million of direct automobile loan receivables during 1998. During 1998 and 1999, FTBNA securitized $711 million and $378 million, respectively, of its consumer real estate loans from the consumer loan and permanent mortgage portfolios through the use of a Real Estate Mortgage Investment Conduit (REMIC). All of the interests in the REMIC are owned by subsidiaries of First Tennessee, including FTBNA. This transaction affects categorization of individual line items on the balance sheet. Consequently, loans have been reduced and investment securities have been increased. For a more complete understanding, where significant, these transactions are discussed and identified as "Managed" information, which adds data on these securitized loans to "Reported" data for loans. "Reported" information has been prepared in conformity with generally accepted accounting principles. "Managed" information treats loans securitized and sold with servicing retained and loans securitized through the REMIC as if they had not been securitized and/or sold. "Managed" information does not include the mortgage banking servicing portfolio. FINANCIAL HIGHLIGHTS (COMPARISON OF THIRD QUARTER 1999 TO THIRD QUARTER 1998) - - Record earnings of $69.4 million for the third quarter of 1999 were achieved, up 12 percent from last year's third quarter earnings of $61.8 million. - - Diluted earnings per share were $.52 in 1999, up 11 percent over the $.47 earned in 1998. Basic earnings per share were $.53 in 1999 and $.48 in 1998, an increase of 10 percent. - - Total revenues grew 7 percent with growth in fee income of 6 percent and growth in net interest income of 9 percent. Fee income contributed 66 percent to total revenues in 1999 compared with 67 percent in 1998. - - Return on average assets was 1.48 percent in 1999 compared with 1.45 percent in 1998. Return on average shareholders' equity was 22.6 percent in 1999 compared with a return on shareholders' equity of 24.4 percent in 1998. Strong internal equity generation caused the decline in this ratio. - - The consolidated net interest margin was 3.82 percent in 1999 compared with 3.75 percent in 1998. The improvement in the margin was primarily related to strong loan growth and lower funding costs. - - At September 30, 1999, First Tennessee was ranked as one of the top 50 bank holding companies nationally in market capitalization ($3.7 billion) and assets ($19.1 billion). FT Mortgage Companies continued to rank as one of the top retail mortgage originators in the nation, and First Tennessee Capital Markets continued to rank as one of the largest U.S. agency underwriters in the nation during the quarter.
15 INCOME STATEMENT ANALYSIS NONINTEREST INCOME - ------------------ Fee income (noninterest income excluding securities gains and losses) provides the majority of First Tennessee's revenue. During the third quarter of 1999, fee income increased 6 percent (from $267.9 million to $284.5 million) and contributed 66 percent to total revenue. In comparison, fee income contributed 67 percent to total revenue in the third quarter of 1998. The growth rate in fee income was positively impacted by the acquisition of several processing units of National Processing Co. (NPC). Excluding this acquisition, total fee income growth would have been 3 percent. MORTGAGE BANKING Mortgage banking fee income, First Tennessee's largest contributing business line to noninterest income, experienced a 1 percent decline (from $160.1 million to $158.9 million) from the third quarter of 1998 as shown in Table 1. Also included in Table 1 is the statistical information related to originations and servicing volume. <TABLE> <CAPTION> TABLE 1 - MORTGAGE BANKING Third Quarter Nine Months ----------------------- Growth ----------------------- Growth (Dollars in millions) 1999 1998 Rate(%) 1999 1998 Rate(%) - ------------------------------------------------------------------------------------------------------------------ <S> <C> <C> <C> <C> <C> <C> NONINTEREST INCOME: Secondary marketing activities $ 73.0 $ 69.8 4.6 $ 213.5 $ 157.6 35.5 Loan origination fees 38.9 41.0 (5.1) 140.9 100.3 40.5 Servicing fees 43.4 30.8 40.6 126.0 83.6 50.7 Sale of mortgage servicing rights .2 -- NM 3.9 -- NM Miscellaneous 3.4 18.5 (81.6) 19.1 33.6 (43.4) - ----------------------------------------------------------------------------------------------------------------- Total noninterest income $ 158.9 $ 160.1 (.7) $ 503.4 $ 375.1 34.2 ================================================================================================================= Refinance originations $ 852.5 $ 2,728.6 (68.8) $ 6,382.4 $ 7,816.0 (18.3) New loan originations 3,534.6 2,907.7 21.6 9,612.5 7,359.4 30.6 - ----------------------------------------------------------------------------------------------------------------- Mortgage loan originations $ 4,387.1 $ 5,636.3 (22.2) $15,994.9 $15,175.4 5.4 ================================================================================================================= Servicing portfolio $48,656.8 $35,292.6 37.9 $48,656.8 $35,292.6 37.9 - ----------------------------------------------------------------------------------------------------------------- <FN> NM = not meaningful </FN> </TABLE> Total income derived from the mortgage origination process (loan origination fees and secondary marketing activities) increased 1 percent (from $110.8 million to $111.9 million) from the third quarter of 1998, and was impacted by the higher interest rate environment in 1999. Total origination volume decreased 22 percent. Home purchase-related mortgages were up 22 percent while refinance volume declined 69 percent. Loan origination fees decreased 5 percent from the third quarter of 1998. The primary driver of this decline was less fees from wholesale brokers. Total income from secondary marketing activities (recognition of mortgage servicing rights (MSRs) and hedging and other loan sale activities) increased 5 percent from the third quarter of 1998. Net gains from hedging and other loan sale activities offset a 22 percent decrease in income generated from MSRs retained. The 22 percent decline in the recognition of MSRs retained was consistent with the decline in origination volume. Mortgage servicing income increased 41 percent from the third quarter of 1998 (from $30.8 million to $43.4 million). As rising interest rates led to a decline in origination volume, it also contributed to a decline in mortgage prepayments resulting in continued growth in the servicing portfolio. The mortgage servicing portfolio (which includes servicing for ourselves and others) grew to $48.7 billion at September 30, 1999, up 38 percent from $35.3 billion at September 30, 1998. The majority of this growth was generated through FT Mortgage's retail loan origination network. The change in the portfolio since third quarter 1998 resulted from originations of $24.1 billion, less $1.3 billion in sales of
16 servicing released originations and principal reductions of $9.4 billion from payments and payoffs received in the normal course of business. Included in the loan servicing portfolio was $1.7 billion of servicing rights previously sold but not yet transferred. The decrease in mortgage miscellaneous income, (from $18.5 million to $3.4 million) was primarily due to gains from the sale of servicing hedges recognized in the third quarter of 1998. Servicing hedges are used to protect the value of the servicing portfolio which can erode when declining interest rates accelerate prepayments. 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. Fee income in capital markets decreased 21 percent from the previous year's third quarter (from $35.4 million to $27.8 million). These results are primarily due to a change in product mix driven by the customer base regarding their cash needs over the millennium. As a result of liquidity concerns, many customers put their money in cash and other short-term liquid securities. Volume, however, continued to be strong with an 18 percent increase in total securities bought and sold for customers from the previous year (from $109.1 billion to $128.8 billion). Total underwritings declined from the third quarter of 1998 (from $12.8 billion to $5.9 billion). OTHER FEE INCOME Noninterest income from deposit transactions and cash management increased 17 percent from the third quarter of 1998 (from $23.4 million to $27.4 million) primarily from growth in customer service charges. Since the third quarter of 1998, trust services and investment management fees grew 25 percent (from $12.6 million to $15.7 million). This growth was primarily due to increased assets under management from growth in customer accounts. Assets under management were up 11 percent (from $8.2 billion to $9.1 billion) from the third quarter of 1998. Fee income from merchant processing grew 28 percent (from $10.1 million to $12.9 million) from both a change in the mix of the customer base from more indirect to more direct customer volume and pricing changes. Total merchant transactions processed declined 23 percent since the third quarter of 1998 (from 43 million transactions in the third quarter of 1998 to 33 million transactions for the quarter in 1999). During this same period, direct customer volume increased 23 percent while indirect customer volume declined 92 percent. Cardholder fees increased 31 percent (from $5.4 million to $7.1 million) during this same period due to price increases and higher interchange collections. All other income and commissions increased 64 percent from the third quarter of 1998 (from $21.0 million to $34.6 million). This growth was principally in the other category which grew 97 percent (from $12.4 million to $24.4 million). Both of these growth rates were impacted by the NPC acquisition. Excluding the NPC acquisition, all other income and commissions would have grown 31 percent. Additional contributors to this growth included: the sale of a bank branch in Tunica, Mississippi ($4.2 million pre-tax), insurance premiums and commissions which increased 48 percent (from $2.1 million to $3.2 million) and check clearing fees which increased 19 percent (from $2.5 million to $3.0 million) due to customer base expansion. Securities gains and losses during the third quarter of 1999 included the $1.8 million gain from the sale of a software application company investment at First Tennessee's subsidiary, Hickory Venture Capital Company. NET INTEREST INCOME - ------------------- Net interest income increased 9 percent (from $135.7 million to $148.1 million) from the third quarter of 1998, primarily due to the 7 percent increase in earning assets (from $14.4 billion to $15.5 billion). The consolidated net interest margin (margin) improved from 3.75 percent in the third quarter of 1998 to 3.82 percent in the third quarter of 1999, principally from strong loan growth and lower funding costs. Table 2 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 third quarters of 1999 and 1998.
17 <TABLE> <CAPTION> TABLE 2 - NET INTEREST MARGIN Third Quarter ------------------ 1999 1998 - ---------------------------------------------------------------------------- <S> <C> <C> REGIONAL BANKING GROUP: Yields on earning assets 7.98 % 8.23 % Rates paid on interest-bearing liabilities 3.90 4.38 - ---------------------------------------------------------------------------- Net interest spread 4.08 3.85 - ---------------------------------------------------------------------------- Effect of interest-free sources .74 .90 Loan fees .15 .13 - ---------------------------------------------------------------------------- Net interest margin - Regional banking group 4.97 % 4.88 % MORTGAGE BANKING (1.00) (.96) CAPITAL MARKETS (.17) (.20) TRANSACTION PROCESSING .02 .03 - ---------------------------------------------------------------------------- Net interest margin 3.82 % 3.75 % ============================================================================ </TABLE> As shown in Table 2, the margin is affected by the activity levels and related funding for First Tennessee's specialty lines of business, as these nonbank business lines typically produce different margins than traditional banking activities. For example, in mortgage banking because the spread between the rates on mortgage loans temporarily in the warehouse and the related short-term funding rates is less than the comparable spread earned in the regional banking group, the overall margin is compressed. Consequently, as the warehouse volume increases, the margin also compresses. 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. The regional banking group's margin increased from 4.88 percent in the third quarter of 1998 to 4.97 percent in the third quarter of 1999. This improvement came from loan growth and lower funding costs both in deposits and purchased funds.
18 NONINTEREST EXPENSE - ------------------- Total noninterest expense (operating expense) for the third quarter of 1999 increased 7 percent (from $292.7 million to $314.4 million) over the same period in 1998. This growth rate was affected by the NPC acquisition. Excluding this acquisition, total operating expense would have increased 5 percent. Additionally, expense growth in mortgage banking and capital markets fluctuates based on activity levels and mix of products sold. Excluding the NPC acquisition and these two business lines, the remaining operating expense grew 10 percent. Employee compensation, incentives and benefits (personnel expense), the largest component of noninterest expense, increased 6 percent from the previous year. Excluding NPC, personnel expenses increased 3 percent. Personnel expense decreased 25 percent at capital markets and increased only 2 percent at mortgage banking due to lower commissions, workforce reductions, and changes in management incentive compensation plans, offset by increases in non-origination functions at mortgage banking. Additional business line information related to expenses is provided in Table 3 and the discussion that follows. <TABLE> <CAPTION> TABLE 3 - OPERATING EXPENSE COMPOSITION Third Quarter Nine Months ----------------------- Growth ----------------------- Growth (Dollars in millions) 1999 1998 Rate(%) 1999 1998 Rate(%) - ------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Regional banking group $ 114.7 $ 102.8 11.6 $ 336.7 $ 293.0 14.9 Mortgage banking 152.1 144.6 5.1 501.5 359.2 39.6 Capital markets 20.8 26.6 (21.6) 77.5 77.9 (.4) Transaction processing 24.3 16.7 45.7 59.6 45.8 30.1 Other 2.5 2.0 24.9 6.6 6.1 8.3 - ------------------------------------------------------------------------------------------------------------------- Total operating expense $ 314.4 $ 292.7 7.4 $ 981.9 $ 782.0 25.6 =================================================================================================================== </TABLE> Mortgage banking accounted for 34 percent of the overall expense growth and grew 5 percent from the previous year. Expense growth for this business line varies with volume and type of activity. The increase was mainly due to higher amortization expense of servicing hedge instruments related to a substantially larger servicing portfolio. During this period, amortization of capitalized mortgage servicing rights decreased 21 percent (from $28.9 million to $22.8 million). Mortgage banking expense growth was also affected by additional technology-related conversion and training programs, lease abandonment costs and expenditures related to the process of consolidating corporate facilities. The regional banking group accounted for 55 percent of the overall expense growth and increased 12 percent from the previous year. This growth rate was affected by technology-related costs, investments in our nationwide expansion strategy for consumer lending, growth in the insurance business, costs for the marketing campaign to increase awareness of our new brand, and branch expansion in targeted growth markets. Transaction processing accounted for 35 percent of the overall expense growth and grew 46 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 22 percent in expenses from third quarter of 1998. INCOME TAXES - ------------ The effective tax rate decreased to a 33.9 percent rate in the third quarter of 1999 from a 36.1 percent rate in the third quarter of 1998. This decrease was largely due to an adjustment of deferred tax liabilities resulting from a lower effective state tax rate.
19 PROVISION FOR LOAN LOSSES/ASSET QUALITY The provision for loan losses increased 7 percent (from $13.1 million to $14.1 million) from the third quarter of 1998, 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 4 - Asset Quality Information and Table 5 - Charge-off Ratios. <TABLE> <CAPTION> TABLE 4 - ASSET QUALITY INFORMATION September 30 ----------------------- (Dollars in thousands) 1999 1998 - ----------------------------------------------------------------------- <S> <C> <C> Nonperforming loans $11,476 $ 8,437 Foreclosed real estate 5,825 4,703 Other assets 85 207 - ----------------------------------------------------------------------- Total Regional Banking Group 17,386 13,347 - ----------------------------------------------------------------------- Mortgage Banking nonperforming loans 21,215 19,220 Mortgage Banking foreclosed real estate 11,240 10,810 - ----------------------------------------------------------------------- Total nonperforming assets $49,841 $43,377 ======================================================================= Loans and leases 90 days past due $24,004 $34,012 Potential problem assets* $68,532 $70,464 <CAPTION> Third Quarter ------------------------ 1999 1998 ------------------------ <S> <C> <C> ALLOWANCE FOR CREDIT LOSSES: Beginning balance at June 30 $138,595 $129,858 Provision for loan losses 14,110 13,127 Allowance from acquisition -- 140 Adjustment due to divestiture (893) -- Charge-offs (14,366) (11,081) Loan recoveries 1,980 3,369 - ----------------------------------------------------------------------- Ending balance at September 30 $139,426 $135,413 ======================================================================= <CAPTION> September 30 ----------------------- 1999 1998 ----------------------- <S> <C> <C> Allowance to total loans 1.56% 1.63% Nonperforming loans to total loans .37 .33 Nonperforming assets to total loans, foreclosed real estate and other assets .56 .52 Allowance to nonperforming assets 280 312 - ----------------------------------------------------------------------- <FN> *Includes loans and leases 90 days past due. </FN> </TABLE> The allowance for loan losses increased 3 percent or $4.0 million from third quarter 1998. Period-end loans grew 8 percent over this same period. The ratio of allowance for loan losses to total loans, net of unearned income, was 1.56 percent at September 30, 1999, compared with 1.63 percent at September 30, 1998. The ratio of net charge-offs to average loans increased from .38 percent for the third quarter of 1998 to .56 percent for the third quarter of 1999. This increase was due to higher consumer loan charge-offs, a change in the mix of consumer loan products to those with higher risk/return profiles, and a return to a more normal level of commercial loan charge-offs. The credit card receivables charge-off ratio remained stable at 3.55 percent for the third quarter of 1999 compared to 3.52 percent for the third quarter of 1998.
20 The ratio of nonperforming loans to total loans was .37 percent for the third quarter of 1999 compared with .33 percent for the same period in 1998. At September 30, 1999, First Tennessee had no concentrations of 10 percent or more of total loans in any single industry. <TABLE> <CAPTION> TABLE 5 - CHARGE-OFF RATIOS Third Quarter ------------------ 1999 1998 - ------------------------------------------------------------------- <S> <C> <C> Commercial and commercial real estate .10 % (.04)% Consumer .74 .36 Credit card receivables 3.55 3.52 Permanent mortgage (.09) .01 Total net charge-offs .56 .38 - ------------------------------------------------------------------- </TABLE>
21 BALANCE SHEET LOANS AND DEPOSITS - ------------------ As previously discussed, for a more complete understanding of loan growth trends it is helpful to analyze information on a "reported" as well as a "managed" basis. "Reported" information is derived from consolidated financial statements that have been prepared in conformity with generally accepted accounting principles. "Managed" information treats consumer loans securitized and sold with servicing retained and loans securitized through the REMIC and held by First Tennessee as if they had not been securitized and/or sold. "Managed" information does not include the mortgage banking servicing portfolio. Table 6 - Selected Loans includes information for reported and managed assets and Table 7 - - Investment Securities includes reported information and information excluding the REMIC. At September 30, 1999, First Tennessee reported total assets of $19.1 billion compared with $17.2 billion at September 30, 1998. The growth in the period-end balance sheet was primarily funded by a 25 percent increase in short-term purchased funds (from $5.6 billion to $7.0 billion). <TABLE> <CAPTION> TABLE 6 - SELECTED LOANS 1999 1998 AS As Growth 1999 1998 Growth (Dollars in millions) REPORTED Reported Rate(%) MANAGED* Managed* Rate(%) - -------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> SEPTEMBER 30 PERIOD-END Consumer loans $3,136.3 $2,832.5 10.7 $3,713.2 $3,209.3 15.7 Permanent mortgages 470.6 408.0 15.3 677.8 697.3 (2.8) Total loans 8,956.3 8,315.7 7.7 9,740.5 8,981.8 8.4 - -------------------------------------------------------------------------------------------------------- THIRD QUARTER AVERAGES Consumer loans $3,048.7 $2,698.7 13.0 $3,645.0 $3,094.5 17.8 Permanent mortgages 460.2 390.9 17.7 674.2 690.8 (2.4) Total loans 8,803.2 8,102.2 8.7 9,613.6 8,797.9 9.3 - -------------------------------------------------------------------------------------------------------- YEAR-TO-DATE AVERAGES Consumer loans $3,046.1 $2,750.1 10.8 $3,515.7 $2,980.4 18.0 Permanent mortgages 444.4 503.2 (11.7) 677.0 675.1 .3 Total loans 8,709.3 8,174.5 6.5 9,411.5 8,576.6 9.7 - -------------------------------------------------------------------------------------------------------- <FN> *Excludes managed loans in the mortgage banking servicing portfolio. </FN> </TABLE> <TABLE> <CAPTION> TABLE 7 - INVESTMENT SECURITIES 1999 1998 1999 1998 EXCLUDING Excluding AS As Growth SECURITIZATION Securitization Growth (Dollars in millions) REPORTED Reported Rate(%) ACTIVITY Activity Rate(%) - -------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> September 30 period-end $2,763.4 $2,594.8 6.5 $1,980.8 $1,956.8 1.2 Third quarter averages 2,792.7 2,615.8 6.8 1,978.4 1,950.7 1.4 Year-to-date averages 2,640.3 2,380.9 10.9 1,942.9 1,999.4 (2.8) - -------------------------------------------------------------------------------------------------------- </TABLE> Average total assets grew 10 percent (from $16.9 billion to $18.6 billion) from the third quarter of 1998. Over the same period, the mortgage warehouse increased 5 percent (from $2.9 billion to $3.0 billion) and accounted for 15 percent of the increase in total earning assets. Total managed loans grew 9 percent for the third quarter of 1999 (from $8.8 billion to $9.6 billion). Average commercial loans increased 7 percent (from $4.0 billion to $4.3 billion) and represented 45 percent of total managed loans. The 18 percent increase in managed consumer loans (from $3.1 billion to $3.6 billion) came primarily
22 from real estate-related lending, and these loans represented 38 percent of total managed loans. First Horizon Equity Lending (previously known as Gulf Pacific Mortgage), which is active in originating home equity loans and second mortgages, continued to experience strong growth. On an average basis for both the third quarters of 1999 and 1998, credit card receivables were $.6 billion, managed permanent mortgages were $.7 billion and real estate construction loans were $.4 billion. Average investment securities increased 7 percent from third quarter 1998 (from $2.6 billion to $2.8 billion). Excluding the securitization activity, the growth would have been relatively flat to 1998 as shown in Table 7 - - Investment Securities. Since the third quarter of 1998, average core deposits grew 1 percent (from $9.0 billion to $9.1 billion) while interest-bearing core deposits decreased 1 percent (from $6.3 billion to $6.2 billion). Noninterest-bearing deposits increased 7 percent (from $2.7 billion to $2.9 billion) over this same period with growth in demand deposit balances accounting for 58 percent of this increase. Short-term purchased funds were up 20 percent (from $5.9 billion to $7.1 billion), and long-term debt increased 26 percent (from $266.5 million to $335.0 million) from the previous year. The increase in purchased funds was used to fund a larger balance sheet principally due to strong loan growth. CAPITAL - ------- Total capital (shareholders' equity plus qualifying capital securities) at September 30, 1999, was $1.3 billion, up 17 percent from $1.2 billion at September 30, 1998. Shareholders' equity (excluding the qualifying capital securities) was $1.2 billion at September 30, 1999, an increase of 19 percent from $1.1 billion at September 30, 1998. Average shareholders' equity increased 21 percent (from $1.0 billion to $1.2 billion) since the third quarter of 1998, reflecting strong internal capital generation. The average total capital to average assets ratio was 7.07 percent and the average shareholders' equity to average assets ratio was 6.53 percent for the third quarter of 1999. This compares with 6.55 percent and 5.96 percent, respectively, for the third quarter of 1998. Unrealized market valuations had no material effect on these ratios for the third quarters of 1998 or 1999. Diluted shares outstanding have increased 2.7 million since the third quarter of 1998 primarily as a result of minimal share repurchases for stock option exercises. This increase in shares created the difference between net income growth of 12 percent and diluted earnings per share growth of 11 percent. At September 30, 1999, the corporation's Tier 1 capital ratio was 8.79 percent, the total capital ratio was 12.18 percent and the leverage ratio was 6.53 percent. On September 30, 1999, First Tennessee's bank affiliates had sufficient capital to qualify as well-capitalized institutions.
23 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 as "Lending related," "Mortgage banking," "Interest rate risk management," and "Capital markets" as noted in Table 8. <TABLE> <CAPTION> TABLE 8 - OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AT SEPTEMBER 30, 1999 (Dollars in millions) Notional value - ------------------------------------------------------------------------------------------ <S> <C> <C> LENDING Commitments to extend credit: RELATED: Consumer credit card lines $ 2,401.9 Consumer home equity 585.3 Commercial real estate and construction and land development 639.2 Mortgage banking 1,420.5 Other 1,250.0 Other commitments: Standby letters of credit 261.7 Commercial letters of credit 8.7 - ------------------------------------------------------------------------------------------ MORTGAGE Mortgage pipeline and warehouse hedging: BANKING: Interest rate contracts: Forward contracts - commitments to sell $ 2,970.3 Option contracts*: Put options - purchased 1,700.0 Call options - written 160.0 Servicing portfolio hedging: Interest rate contracts*: Caps - purchased 500.0 Caps - written 500.0 Floors - purchased 20,275.0 Floors - written 2,000.0 - ------------------------------------------------------------------------------------------ INTEREST Interest rate contracts: RATE RISK Swaps - receive fixed/pay floating $ 415.0 MANAGEMENT: Swaps - receive floating/pay floating 741.7 Caps - purchased 20.0 Caps - written 20.0 Equity contracts: Purchased options 1.9 - ------------------------------------------------------------------------------------------ CAPITAL Forward contracts: MARKETS: Commitments to buy $ 975.9 Commitments to sell 1,141.7 Option contracts: Written 65.0 Purchased 65.0 Securities underwriting commitments 11.6 - ------------------------------------------------------------------------------------------ <FN> *Mortgage banking option contracts had a value of $146.2 million recognized in the Consolidated Statements of Condition at September 30, 1999. </FN> </TABLE>
24 FINANCIAL HIGHLIGHTS (COMPARISON OF FIRST NINE MONTHS OF 1999 TO FIRST NINE MONTHS OF 1998) - - Earnings for 1999 were $183.4 million, up 14 percent from last year's earnings of $160.9 million. - - Diluted earnings per share were $1.37 in 1999, up 12 percent over the $1.22 earned in 1998. Basic earnings per share were $1.41 in 1999 and $1.26 in 1998. - - Total revenues grew 22 percent with growth in fee income of 28 percent and growth in net interest income of 12 percent. Mortgage banking led the increase with growth of 34 percent. Fee income contributed 66 percent to total revenues in 1999 compared with 63 percent in 1998. - - Return on average assets was 1.32 percent in 1999 compared with 1.35 percent in 1998. The decline in the return on average assets was due to growth in assets, largely from growth in the mortgage warehouse. Return on average shareholders' equity was 20.9 percent in 1999 compared with a return on shareholders' equity of 22.1 percent in 1998. Strong internal equity generation caused the decline in this ratio. - - The consolidated net interest margin was 3.80 percent in 1999 compared with 3.87 percent in 1998. NINE MONTH INCOME STATEMENT REVIEW - ---------------------------------- Noninterest income, excluding securities gains and losses, increased 28 percent (from $677.9 million to $865.3 million) over the same period last year. Excluding NPC, growth for the nine-month period would have been 26 percent. Fee income represented 66 percent of total revenues during the first nine months of 1999 and 63 percent for the same period in 1998. Mortgage banking fee income grew 34 percent (from $375.1 million to $503.4 million). See Table 1 - Mortgage Banking for a breakout of noninterest income as well as mortgage banking origination volume and servicing portfolio levels. For the first nine months of 1999, fee income from capital markets decreased only 1 percent (from $103.6 million to $102.4 million) compared to the record performance experienced during the same nine-month period in 1998. Fee income in deposit transactions and cash management grew 17 percent (from $66.1 million to $77.2 million). Trust services and investment management fees increased 18 percent (from $38.1 million to $45.1 million), and merchant processing fees grew 51 percent (from $25.0 million to $37.8 million). Cardholder fees increased 19 percent (from $15.3 million to $18.1 million). All other income and commissions increased 49 percent (from $54.7 million to $81.3 million). Excluding NPC, all other income and commissions would have increased 31 percent. The remaining growth was spread over a number of categories, with other service charges increasing 18 percent (from $11.2 million to $13.2 million) which included growth in investment/mutual fund sales and servicing fees from securitizations. Insurance premiums and commissions increased 40 percent (from $5.7 million to $8.0 million) and check clearing fees increased 16 percent (from $7.0 million to $8.2 million). The other category increased 69 percent (from $30.8 million to $51.9 million). Excluding NPC, the other category would have grown 37 percent. Additional reasons for the year-to-date trends have already been identified in the quarterly comparison. Net interest income increased 12 percent (from $397.0 million to $444.1 million) from the first nine months of 1998 primarily due to the 14 percent increase in earning assets. Year-to-date consolidated margin declined from 3.87 percent in 1998 to 3.80 percent in 1999, primarily from the build-up of the mortgage warehouse which produced 49 percent of the increase in earning assets. In the regional banking group the year-to-date margin improved from 4.83 percent in 1998 to 4.95 percent in 1999. Noninterest expense increased 26 percent (from $782.0 million to $981.9 million) primarily from increased costs to support the higher levels of activity in mortgage banking. See Table 3 - Operating Expense Composition for a breakdown of total expenses by business line. Mortgage banking accounted for 71 percent of the overall expense growth and grew 40 percent from the previous year. Expense growth for this business line varies with the volume and type of activity. During this period, amortization of capitalized mortgage servicing rights increased 18 percent (from $70.8 million to $83.6 million). The regional banking group accounted for 22 percent of the overall expense growth and increased 15 percent from the previous year. The reasons for the year-to-date trends were similar to the quarterly trend information already discussed.
25 For the nine-month period, the effective tax rate was 35.2 percent in 1999 compared with a rate of 35.7 percent for the same period in 1998. The provision for loan losses increased 11 percent (from $39.4 million to $43.9 million) from the previous year. The increase reflects the inherent risk in the loan portfolio from loan growth and a change in the loan mix partially due to securitizations and growth in loans with higher risk/reward profiles. NINE MONTH BALANCE SHEET REVIEW - ------------------------------- Average total assets grew 16 percent (from $16.0 billion to $18.6 billion) and average managed loans (including loans securitized) grew 10 percent (from $8.6 billion to $9.4 billion) from the first nine months of 1998. Average loans (excluding loans securitized) grew 7 percent (from $8.2 billion to $8.7 billion) during this same period. For a better understanding of the effect of securitizations on these growth trends, refer to Table 6 - Selected Loans and Table 7 - Investment Securities. Average commercial loans increased 8 percent (from $3.9 billion to $4.2 billion), average consumer loans grew 11 percent (from $2.8 billion to $3.0 billion) and credit card receivables increased slightly while averaging $.6 billion. The permanent mortgage portfolio decreased 12 percent (from $.5 billion to $.4 billion) due to securitization activity, and real estate construction loans averaged $.4 billion while experiencing a decline of 7 percent from 1998. Average investment securities increased 11 percent (from $2.4 billion to $2.6 billion) from 1998. With the strong origination volume, the mortgage warehouse grew 39 percent (from $2.4 billion to $3.4 billion). Average core deposits increased 3 percent (from $8.9 billion to $9.2 billion) and interest-bearing core deposits remained level while averaging $6.4 billion. Noninterest-bearing deposits increased 10 percent (from $2.6 billion to $2.8 billion). Short-term purchased funds increased 36 percent (from $5.2 billion to $7.0 billion), and long-term debt grew 58 percent (from $234.7 million to $371.8 million) for the nine-month period. The increase in total purchased funds was primarily used to fund the growth in mortgage banking and loan growth.
26 YEAR 2000 - --------- Many computer programs were originally designed to store and process data using two digits rather than four to define a calendar year. This could cause programs that have date sensitive software to recognize a date using "00" as the year 1900 rather than the year 2000. The "Year 2000 computer issue" can create risk for a company from unforeseen problems in its own computer systems and from the company's vendors and customers. First Tennessee began planning its Year 2000 remediation strategy to fix this computer issue in 1995. Among other things, the process included the formation of a company-wide project team that meets regularly to coordinate and review the status of conversion initiatives. First Tennessee's senior executives and the board of directors also regularly review the Year 2000 program and its progress. The main phases involved in the Year 2000 project are assessment (determining the magnitude of the problem and assessing necessary effort), renovation (making changes or enhancements to hardware and software and associated components), validation (testing and verifying changes), and implementation (certification, acceptance and initial installation). A comprehensive review to assess the systems affected by this issue has been completed, estimated cost projections have been determined and an implementation plan has been compiled. As a result of the assessment review, First Tennessee has modified or replaced certain existing systems. New systems are providing additional functionality to meet the expanding needs of customers and will be Year 2000 compliant. As of September 30, 1999, all mission critical and noncritical systems with date processing functions have been renovated and validated as Year 2000 compliant. All these systems have been implemented. Management believes the efforts described above will provide reasonable assurance that its systems will be adequately prepared for the Year 2000. Costs of new systems are being capitalized and amortized, and spending for maintenance and modification associated with Year 2000 is expensed as incurred. The total gross cost of Year 2000 compliance is estimated to be $40 million, and all but an immaterial amount had been incurred as of September 30, 1999, with approximately 45 percent of this cost being capitalized. The remaining costs will be used to finish rolling out systems already validated and certified. Consistent with current corporate accounting policy, the capitalized costs are being amortized on a straight-line basis over a maximum period of five years once the systems project is substantially complete and ready for its intended use. First Tennessee is also assessing Year 2000 readiness on the part of external entities, particularly mission critical vendors, significant credit customers, business partners, funds providers, and financial market counterparties. During 1998, First Tennessee initiated a review process with its large commercial customers to identify, assess and mitigate potential risks, including credit risk, associated with customers' failure to adequately address their Year 2000 issues. First Tennessee is continuing, when it deems appropriate, to discuss these matters with, obtain written certification from, and test the systems of other companies as to their Year 2000 compliance. If Year 2000 issues are not adequately addressed by First Tennessee and significant third parties, First Tennessee's business, financial condition or results of operations could be materially adversely affected. However, our regular contingency planning processes have been adapted and are continuing to be tested and monitored to aid us in preparing for the most significant potential risks from both internal and external sources. The contingency plans include such items as outsourcing options, business resumption plans for all of the business units, identification of alternative sources of liquidity, and evaluation of alternative manual processes. As a financial institution, First Tennessee's Year 2000 efforts are subject to regulation and monitoring by bank and bank holding company regulatory agencies. These agencies, under the auspices of the Federal Financial Institutions Examination Council ("FFIEC") have established specific deadline requirements for achieving Year 2000 compliance. First Tennessee is current in meeting these requirements. The Office of the Comptroller of the Currency, which is our primary bank regulator, also includes a review of the risk assessments and contingency plans in its quarterly examination of Year 2000 preparedness. The foregoing statements are forward looking. Actual results could differ because of several factors, including those presented in the Introduction section at the beginning of this MD&A discussion. The Year 2000 disclosures contained in this report are designated as Year 2000 Readiness Disclosures related to the Year 2000 Information and Readiness Disclosure Act.
27 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 Note 1 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 Financial Information Appendix to the Corporation's proxy statement furnished to shareholders in connection with the Annual Meeting of Shareholders held on April 20, 1999, filed March 17, 1999.
28 Part II. OTHER INFORMATION Items 1, 2, 3, 4 and 5 - ---------------------- As of the end of the third quarter, 1999, the answers to Items 1, 2, 3, 4 and 5 were either inapplicable or negative, and therefore, these items are omitted. Item 6 - Exhibits and Reports on Form 8-K. - ------------------------------------------ (a) Exhibits. Exhibit No. Description ----------- ----------- 3(b) Bylaws, as amended. 4 Instruments defining the rights of security holders, including indentures.* **10(a) Management Incentive Plan, as amended and restated. **10(b) 1997 Employee Stock Option Plan, as amended and restated. **10(n) 2000 Employee Stock Option Plan **10(o) 2000 Non-Employee Directors' Deferred Compensation Stock Option Plan. 27 Financial Data Schedule (for SEC use only). * 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. ** This is a management contract or compensatory plan or arrangement required to be filed as an exhibit. (b) Reports on Form 8-K. No reports on Form 8-K were filed during the third quarter of 1999.
29 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. FIRST TENNESSEE NATIONAL CORPORATION (Registrant) DATE: 11/12/99 By: Elbert L. Thomas Jr. --------------------- ----------------------------------------- Elbert L. Thomas Jr. Executive Vice President and Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer)
30 EXHIBIT INDEX Exhibit No. Description ----------- ----------- 3(b) Bylaws, as amended. 4 Instruments defining the rights of security holders, including indentures.* **10(a) Management Incentive Plan, as amended and restated. **10(b) 1997 Employee Stock Option Plan, as amended and restated. **10(n) 2000 Employee Stock Option Plan **10(o) 2000 Non-Employee Directors' Deferred Compensation Stock Option Plan. 27 Financial Data Schedule (for SEC use only). * 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. ** This is a management contract or compensatory plan or arrangement required to be filed as an exhibit.