-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Bk+w7WDA+WXlpLGMN9BVH8s+Q3OPHS/pBW8j0KJ511RM4tIxYQqJMRbCjwkE63NG HKAQmf/iogJa348CAM68uw== 0001157523-03-004073.txt : 20030812 0001157523-03-004073.hdr.sgml : 20030812 20030811191815 ACCESSION NUMBER: 0001157523-03-004073 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20030630 FILED AS OF DATE: 20030812 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST TENNESSEE NATIONAL CORP CENTRAL INDEX KEY: 0000036966 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 620803242 STATE OF INCORPORATION: TN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-15185 FILM NUMBER: 03835677 BUSINESS ADDRESS: STREET 1: 165 MADISON AVE CITY: MEMPHIS STATE: TN ZIP: 38103 BUSINESS PHONE: 9015234638 MAIL ADDRESS: STREET 1: 165 MADISON AVE CITY: MEMPHIS STATE: TN ZIP: 38103 FORMER COMPANY: FORMER CONFORMED NAME: FIRST TENNESSEE BANKS INC DATE OF NAME CHANGE: 19600201 10-Q 1 a4447741_10q.htm FIRST TENNESSEE 10-Q

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 June 30, 2003

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

CIK number 0000036966

FIRST TENNESSEE NATIONAL CORPORATION

(Exact name of registrant as specified in its charter)

 

  Tennessee
(State or other jurisdiction of
incorporation or organization)
  62-0803242
(I.R.S. Employer
Identification No.)
 

  165 Madison Avenue, Memphis, Tennessee
(Address of principal executive offices)
  38103
(Zip Code)
 

(901) 523-4444
(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       

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

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         
Class
                                   125,830,063                                    
Outstanding on July 31, 2003

  



FIRST TENNESSEE NATIONAL CORPORATION

INDEX

 

Part I. Financial Information

 

 

 

Part II. Other Information

 

 

 

Signatures

 

 

 

Certifications

 

 

 

Exhibit Index

 



2



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 that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the interim periods presented.


3



CONSOLIDATED STATEMENTS OF CONDITION

First Tennessee National Corporation


 

 

 

June 30

 

December 31

 

 

 


 


 

(Dollars in thousands)(Unaudited)

 

2003

 

2002

 

2002

 






 

 

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

922,268

 

$

890,972

 

$

1,068,110

 

Federal funds sold and securities purchased under agreements to resell

 

 

280,614

 

 

225,540

 

 

260,607

 








 

 

Total cash and cash equivalents

 

 

1,202,882

 

 

1,116,512

 

 

1,328,717

 








 

 

Investment in bank time deposits

 

 

890

 

 

1,140

 

 

1,906

 

Trading securities

 

 

885,569

 

 

633,464

 

 

893,997

 

Loans held for sale

 

 

5,851,079

 

 

2,243,146

 

 

4,797,565

 

Securities available for sale

 

 

2,266,751

 

 

2,044,435

 

 

2,419,908

 

Securities held to maturity (market value of $197,579 on June 30, 2003;
$367,052 on June 30, 2002; and $284,510 on December 31, 2002)

 

 

194,433

 

 

362,493

 

 

280,377

 

Loans, net of unearned income

 

 

12,766,889

 

 

10,544,657

 

 

11,345,445

 

Less:Allowance for loan losses

 

 

159,080

 

 

147,417

 

 

144,298

 








 

 

Total net loans

 

 

12,607,809

 

 

10,397,240

 

 

11,201,147

 








 

 

Premises and equipment, net

 

 

305,249

 

 

247,774

 

 

254,132

 

Real estate acquired by foreclosure

 

 

16,414

 

 

21,499

 

 

11,451

 

Mortgage servicing rights, net

 

 

419,917

 

 

624,645

 

 

440,482

 

Goodwill

 

 

173,750

 

 

163,213

 

 

164,617

 

Other intangible assets, net

 

 

32,099

 

 

33,175

 

 

29,648

 

Capital markets receivables and other assets

 

 

3,982,392

 

 

1,927,536

 

 

1,999,148

 








 

 

Total assets

 

$

27,939,234

 

$

19,816,272

 

$

23,823,095

 








 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and shareholders’ equity:

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

Interest-bearing

 

$

9,717,578

 

$

8,875,425

 

$

10,564,489

 

Noninterest-bearing

 

 

5,775,228

 

 

3,520,655

 

 

5,149,414

 








 

 

Total deposits

 

 

15,492,806

 

 

12,396,080

 

 

15,713,903

 








 

 

Federal funds purchased and securities sold under agreements to repurchase

 

 

4,255,579

 

 

3,132,475

 

 

3,126,350

 

Commercial paper and other short-term borrowings

 

 

668,029

 

 

313,673

 

 

361,208

 

Capital markets payables and other liabilities

 

 

3,999,825

 

 

1,615,453

 

 

1,856,347

 

Term borrowings

 

 

1,584,789

 

 

650,968

 

 

929,715

 








 

 

Total liabilities

 

 

26,001,028

 

 

18,108,649

 

 

21,987,523

 








 

 

Guaranteed preferred beneficial interests in First Tennessee’s junior
subordinated debentures

 

 

100,000

 

 

100,000

 

 

100,000

 

Preferred stock of subsidiary

 

 

44,442

 

 

44,236

 

 

44,392

 








 

 

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 - 125,536,982 on June 30, 2003; 125,434,878 on June 30, 2002;
and 125,600,024 on December 31, 2002)

 

 

78,461

 

 

78,397

 

 

78,500

 

Capital surplus

 

 

137,122

 

 

116,790

 

 

119,318

 

Undivided profits

 

 

1,561,648

 

 

1,335,102

 

 

1,461,946

 

Accumulated other comprehensive income

 

 

16,698

 

 

30,012

 

 

26,487

 

Deferred compensation on restricted stock incentive plans

 

 

(12,572

)

 

(7,070

)

 

(5,796

)

Deferred compensation obligation

 

 

12,407

 

 

10,156

 

 

10,725

 








 

 

Total shareholders’ equity

 

 

1,793,764

 

 

1,563,387

 

 

1,691,180

 








 

 

Total liabilities and shareholders’ equity

 

$

27,939,234

 

$

19,816,272

 

$

23,823,095

 








 

 

See accompanying notes to consolidated financial statements.


4



CONSOLIDATED STATEMENTS OF INCOME

First Tennessee National Corporation


 

 

 

Three Months Ended
June 30

 

Six Months Ended
June 30

 

 

 


 


 

(Dollars in thousands except per share data)(Unaudited)

 

2003

 

2002

 

2003

 

2002

 










 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

159,894

 

$

166,322

 

$

316,571

 

$

333,285

 

Interest on investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

 

25,456

 

 

36,357

 

 

56,430

 

 

72,401

 

Tax-exempt

 

 

90

 

 

196

 

 

213

 

 

492

 

Interest on loans held for sale

 

 

66,339

 

 

32,046

 

 

121,383

 

 

72,463

 

Interest on trading securities

 

 

12,692

 

 

11,935

 

 

23,678

 

 

24,906

 

Interest on other earning assets

 

 

1,328

 

 

1,844

 

 

2,463

 

 

3,133

 














 

Total interest income

 

 

265,799

 

 

248,700

 

 

520,738

 

 

506,680

 














 

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest on deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings

 

 

281

 

 

586

 

 

562

 

 

1,157

 

Checking interest and money market account

 

 

6,323

 

 

9,954

 

 

12,482

 

 

20,039

 

Certificates of deposit under $100,000 and other time

 

 

14,508

 

 

18,356

 

 

29,808

 

 

36,934

 

Certificates of deposit $100,000 and more

 

 

17,564

 

 

18,308

 

 

35,313

 

 

39,379

 

Interest on short-term borrowings

 

 

17,443

 

 

17,328

 

 

31,877

 

 

34,045

 

Interest on term borrowings

 

 

9,929

 

 

7,002

 

 

17,522

 

 

13,608

 














 

Total interest expense

 

 

66,048

 

 

71,534

 

 

127,564

 

 

145,162

 














 

Net interest income

 

 

199,751

 

 

177,166

 

 

393,174

 

 

361,518

 

Provision for loan losses

 

 

27,501

 

 

23,286

 

 

54,951

 

 

49,208

 














 

Net interest income after provision for loan losses

 

 

172,250

 

 

153,880

 

 

338,223

 

 

312,310

 














 

Noninterest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage banking

 

 

276,562

 

 

129,926

 

 

548,410

 

 

251,183

 

Capital markets

 

 

158,598

 

 

98,289

 

 

298,273

 

 

197,775

 

Deposit transactions and cash management

 

 

38,626

 

 

36,393

 

 

71,402

 

 

68,817

 

Trust services and investment management

 

 

10,825

 

 

13,324

 

 

22,208

 

 

27,413

 

Insurance premiums and commissions

 

 

15,185

 

 

12,393

 

 

29,648

 

 

25,913

 

Merchant processing

 

 

13,860

 

 

12,627

 

 

26,436

 

 

22,840

 

Equity securities losses, net

 

 

(67

)

 

(2,196

)

 

(1,566

)

 

(2,196

)

Debt securities losses, net

 

 

(685

)

 

(121

)

 

(242

)

 

(155

)

All other income and commissions

 

 

35,716

 

 

35,946

 

 

72,201

 

 

69,923

 














 

Total noninterest income

 

 

548,620

 

 

336,581

 

 

1,066,770

 

 

661,513

 














 

Adjusted gross income after provision for loan losses

 

 

720,870

 

 

490,461

 

 

1,404,993

 

 

973,823

 














 

Noninterest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

Employee compensation, incentives and benefits

 

 

362,340

 

 

222,558

 

 

681,322

 

 

440,157

 

Occupancy

 

 

19,789

 

 

18,452

 

 

39,394

 

 

35,587

 

Equipment rentals, depreciation and maintenance

 

 

16,616

 

 

16,594

 

 

33,806

 

 

32,512

 

Operations services

 

 

17,330

 

 

14,867

 

 

35,088

 

 

29,383

 

Communications and courier

 

 

15,876

 

 

12,215

 

 

30,665

 

 

25,542

 

Amortization of intangible assets

 

 

1,738

 

 

1,357

 

 

3,512

 

 

2,955

 

All other expense

 

 

115,647

 

 

68,554

 

 

228,028

 

 

141,137

 














 

Total noninterest expense

 

 

549,336

 

 

354,597

 

 

1,051,815

 

 

707,273

 














 

Pretax income

 

 

171,534

 

 

135,864

 

 

353,178

 

 

266,550

 

Applicable income taxes

 

 

53,182

 

 

45,399

 

 

115,797

 

 

89,004

 














 

Net income

 

$

118,352

 

$

90,465

 

$

237,381

 

$

177,546

 














 

Earnings per common share (Note 3)

 

 

.93

 

 

.71

 

 

1.87

 

 

1.40

 














 

Diluted earnings per common share (Note 3)

 

 

.90

 

 

.69

 

 

1.81

 

 

1.36

 














 

Weighted average shares outstanding

 

 

127,161,135

 

 

126,680,703

 

 

126,963,666

 

 

126,732,470

 














 

See accompanying notes to consolidated financial statements.


5



CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

First Tennessee National Corporation


 

(Dollars in thousands) (Unaudited)

 

2003

 

2002

 






 

Balance, January 1

 

$

1,691,180

 

$

1,477,762

 

Net income

 

 

237,381

 

 

177,546

 

Other comprehensive income:

 

 

 

 

 

 

 

Unrealized loss on cash flow hedge, net of tax

 

 

137

 

 

(1,320

)

Unrealized market adjustments, net of tax

 

 

(9,926

)

 

8,054

 








 

Comprehensive income

 

 

227,592

 

 

184,280

 








 

Cash dividends declared

 

 

(75,618

)

 

(62,819

)

Common stock issued for exercise of stock options

 

 

52,152

 

 

34,597

 

Tax benefit from non-qualified stock options

 

 

19,148

 

 

10,109

 

Common stock repurchased

 

 

(127,367

)

 

(88,060

)

Amortization on restricted stock incentive plans

 

 

1,248

 

 

1,225

 

Other

 

 

5,429

 

 

6,293

 








 

Balance, June 30

 

$

1,793,764

 

$

1,563,387

 








 

See accompanying notes to consolidated financial statements.


6



CONSOLIDATED STATEMENTS OF CASH FLOWS

First Tennessee National Corporation


 

 

 

 

 

Six Months Ended June 30

 

 

 

 

 


 

(Dollars in thousands)(Unaudited)

 

2003

 

2002

 






 

Operating

 

Net income

 

$

237,381

 

$

177,546

 

Activities

 

Adjustments to reconcile net income to net cash (used)/provided by operating activities:

 

 

 

 

 

 

 

 

 

Provision for loan losses

 

 

54,951

 

 

49,208

 

 

 

Provision for deferred income tax

 

 

65,758

 

 

43,788

 

 

 

Depreciation and amortization of premises and equipment

 

 

27,906

 

 

27,518

 

 

 

Amortization and impairment of mortgage servicing rights

 

 

178,525

 

 

115,927

 

 

 

Amortization of intangible assets

 

 

3,512

 

 

2,955

 

 

 

Net other amortization and accretion

 

 

33,987

 

 

9,959

 

 

 

Net (increase)/decrease in net derivative product assets

 

 

(31,831

)

 

(18,001

)

 

 

Market value adjustment on foreclosed property

 

 

6,783

 

 

8,118

 

 

 

Equity securities losses

 

 

1,566

 

 

2,196

 

 

 

Debt securities losses

 

 

242

 

 

155

 

 

 

Net (gains)/losses on disposal of fixed assets

 

 

1,001

 

 

(441

)

 

 

Net (increase)/decrease in:

 

 

 

 

 

 

 

 

 

Trading securities

 

 

295

 

 

12,715

 

 

 

Loans held for sale

 

 

(1,053,514

)

 

1,156,163

 

 

 

Capital markets receivables

 

 

(1,834,336

)

 

(287,958

)

 

 

Interest receivable

 

 

(855

)

 

7,004

 

 

 

Other assets

 

 

(369,527

)

 

(66,176

)

 

 

Net increase/(decrease) in:

 

 

 

 

 

 

 

 

 

Capital markets payables

 

 

1,387,367

 

 

96,389

 

 

 

Interest payable

 

 

(699

)

 

(7,669

)

 

 

Other liabilities

 

 

789,524

 

 

41,649

 










 

 

 

Total adjustments

 

 

(739,345

)

 

1,193,499

 










 

 

 

Net cash (used)/provided by operating activities

 

 

(501,964

)

 

1,371,045

 










 

Investing

 

Maturities of held to maturity securities

 

 

84,998

 

 

98,093

 

Activities

 

Available for sale securities:

 

 

 

 

 

 

 

 

 

Sales

 

 

520,380

 

 

157,651

 

 

 

Maturities

 

 

866,583

 

 

549,718

 

 

 

Purchases

 

 

(1,245,550

)

 

(673,142

)

 

 

Premises and equipment:

 

 

 

 

 

 

 

 

 

Sales

 

 

13

 

 

2,088

 

 

 

Purchases

 

 

(74,692

)

 

(20,098

)

 

 

Net increase in loans

 

 

(1,493,792

)

 

(331,443

)

 

 

Net decrease in investment in bank time deposits

 

 

1,016

 

 

600

 

 

 

Acquisitions, net of cash and cash equivalents

 

 

(1,930

)

 

(1,433

)










 

 

 

Net cash used by investing activities

 

 

(1,342,974

)

 

(217,966

)










 

Financing

 

Common stock:

 

 

 

 

 

 

 

Activities

 

Exercise of stock options

 

 

52,175

 

 

34,171

 

 

 

Cash dividends

 

 

(75,392

)

 

(62,919

)

 

 

Repurchase of shares

 

 

(127,452

)

 

(88,060

)

 

 

Term borrowings:

 

 

 

 

 

 

 

 

 

Issuance

 

 

725,432

 

 

102,792

 

 

 

Payments

 

 

(70,558

)

 

(2,368

)

 

 

Net increase/(decrease) in:

 

 

 

 

 

 

 

 

 

Deposits

 

 

(221,152

)

 

(1,210,260

)

 

 

Short-term borrowings

 

 

1,436,050

 

 

75,454

 










 

 

 

Net cash provided/(used) by financing activities

 

 

1,719,103

 

 

(1,151,190

)










 

 

 

Net (decrease)/increase in cash and cash equivalents

 

 

(125,835

)

 

1,889

 










 

 

 

Cash and cash equivalents at beginning of period

 

 

1,328,717

 

 

1,114,623

 










 

 

 

Cash and cash equivalents at end of period

 

$

1,202,882

 

$

1,116,512

 










 

 

 

Total interest paid

 

$

127,847

 

$

152,459

 

 

 

Total income taxes paid

 

 

58,557

 

 

49,750

 










 

See accompanying notes to consolidated financial statements.


7



Note 1 – Financial Information

The unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. 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 six-month periods ended June 30, 2003 and June 30, 2002, 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 financial appendix to the 2003 Proxy Statement.

Stock options. First Tennessee National Corporation (FTNC) accounts for its employee stock-based compensation plans under the intrinsic value based method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Had compensation cost for these plans been determined consistent with SFAS No. 123, FTNC’s net income and earnings per share would have been reduced to the following pro forma amounts:

 

(Dollars in thousands except per share data)

   

Three Months
Ended

March 31

   

Three Months
Ended

June 30

   

Six Months
Ended

June 30

 








 

2003

   

 

 

   

 

 

   

 

 

 

Net income, as reported

 

$

119,029

 

$

118,352

 

$

237,381

 

Add: Stock-based employee compensation expense included in reported net income, net of related tax effects

 

 

3,438

 

 

1,424

 

 

4,862

 

Less: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects

 

 

3,679

 

 

12,292

 

 

15,971

 











 

Pro forma net income

 

$

118,788

 

$

107,484

 

$

226,272

 











 

Earnings per share, as reported

 

$

.94

 

$

.93

 

$

1.87

 

Pro forma earnings per share

 

 

.94

 

 

.85

 

 

1.78

 

Diluted earnings per share, as reported

 

 

.91

 

 

.90

 

 

1.81

 

Pro forma diluted earnings per share

 

 

.91

 

 

.82

 

 

1.73

 











 

2002

 

 

 

 

 

 

 

 

 

 

Net income, as reported

 

$

87,081

 

$

90,465

 

$

177,546

 

Add: Stock-based employee compensation expense included in reported net income, net of related tax effects

 

 

2,618

 

 

1,207

 

 

3,825

 

Less: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects

 

 

6,537

 

 

6,200

 

 

12,737

 











 

Pro forma net income

 

$

83,162

 

$

85,472

 

$

168,634

 











 

Earnings per share, as reported

 

$

.69

 

$

.71

 

$

1.40

 

Pro forma earnings per share

 

 

.66

 

 

.67

 

 

1.33

 

Diluted earnings per share, as reported

 

 

.67

 

 

.69

 

 

1.36

 

Pro forma diluted earnings per share

 

 

.64

 

 

.65

 

 

1.29

 











 


Other disclosures – Indemnification agreements and guarantees. In the ordinary course of business, FTNC enters into indemnification agreements for legal proceedings against its directors and officers and standard representation warranties for underwriting agreements, merger and acquisition agreements, sold loans and other similar types of arrangements. It is not possible to estimate a maximum potential amount of payouts that could be required with such agreements.

First Horizon Home Loan Corporation (FHHLC) services a mortgage loan portfolio of approximately $64.0 billion as of June 30, 2003, a significant portion of which is held by Government Sponsored Enterprises (GSE’s) or private security holders. In connection with its servicing activities, FHHLC guarantees the receipt of the scheduled principal and interest payments on the underlying loans. In the event of customer non-performance on the loan, FHHLC is obligated to make the payment to the security holder. Under the terms of the servicing agreements, FHHLC can utilize payments received from other prepaid loans in order to make the security holder whole. In the event payments are


8



Note 1 – Financial Information (continued)

ultimately made by FHHLC to satisfy this obligation, for loans sold with no recourse, all funds are recoverable from the GSE’s at foreclosure sale.

FHHLC is also subject to losses in its loan servicing portfolio due to loan foreclosures and other recourse obligations. Certain agencies have the authority to limit their repayment guarantees on foreclosed loans resulting in certain foreclosure costs being borne by servicers. In addition, FHHLC has exposure on all loans sold with recourse. FHHLC has various claims for reimbursement, repurchase obligations, and/or indemnification requests outstanding with government agencies or private investors. FHHLC has evaluated all of its exposure under recourse obligations based on factors, which include loan delinquency status, foreclosure expectancy rates and claims outstanding. Accordingly, FHHLC had an allowance for losses on the mortgage servicing portfolio of approximately $31.3 million and $30.2 million as of June 30, 2003 and 2002, respectively. FHHLC has sold certain mortgage loans with an agreement to repurchase the loans upon default. As of June 30, 2003 and 2002, FHHLC had single-family residential loans with outstanding balances of $140.5 million and $210.6 million, respectively, that were sold on a recourse basis. For the single-family residential loans, in the event of borrower nonperformance, FHHLC would assume losses to the extent they exceed the value of the collateral and private mortgage insurance, FHA insurance or VA guarantees. As of June 30, 2003 and 2002, the outstanding principal balance of loans sold with limited recourse and serviced by FHHLC was $4.0 billion and $4.8 billion, respectively.

Standby letters of credit are conditional commitments issued by FTNC to guarantee the performance and/or payment of a customer to a third party in connection with specified transactions. The credit risk involved in issuing these commitments is essentially the same as that involved in extending loan facilities to customers, as performance under any of the facilities would result in a loan being funded to the customer. Standby letters of credit outstanding as of June 30, 2003 and 2002, were $462.9 million and $450.4 million, respectively.

Accounting changes. On January 1, 2003, FTNC adopted SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. This statement requires that a liability for the cost associated with an exit or disposal activity be recognized and measured initially at fair value in the period in which the liability is incurred. Prior to the effective date of this statement, costs associated with an exit or disposal plan were recognized at the date of commitment, as required under EITF Issue 94-3. This statement does not apply to costs associated with an exit activity that involves an entity newly acquired in a business combination or with a disposal activity covered by SFAS No. 144. The impact of adopting this statement was immaterial to FTNC.

On January 1, 2003, FTNC adopted the final provisions of Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”. This interpretation elaborates on the disclosures to be made by a guarantor in interim and annual financial statements about obligations assumed under certain guarantees it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. This interpretation does not prescribe a specific approach for subsequently measuring the guarantor’s liability over the term of the related guarantee. This interpretation also incorporates, without change, the guidance in Financial Accounting Standards Board (FASB) Interpretation No. 34, “Disclosure of Indirect Guarantees of Indebtedness of Others”, which is superceded. The impact of adopting this statement was immaterial to FTNC.

In December 2002, FTNC adopted SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”. This statement amends SFAS No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods for voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. As FTNC continues to account for stock-based employee compensation under APB 25, the adoption of this statement did not have a material impact on the financial statements or results of operations.

On October 1, 2002, FTNC adopted SFAS No. 147, “Acquisitions of Certain Financial Institutions (an amendment of FASB Statement No. 72 and 144 and FASB Interpretation No. 9)”. This statement requires acquisitions of all or part of a financial institution meeting the definition of a business combination to be accounted for by the purchase method in accordance with SFAS No. 141. Any previously recorded unidentified intangible asset related to the acquisition of a financial institution must now be classified as goodwill and is subject to the impairment testing provisions of SFAS No. 142. Impairment testing of previously identified long-term customer-relationship intangible assets will be subject to the impairment testing provisions of SFAS No 144. Provisions of this statement were effective for acquisitions on or after October 1, 2002. The impact of adopting this statement was immaterial to FTNC.


9



Note 1 – Financial Information (continued)

On October 1, 2002, FTNC adopted SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections”. SFAS No. 145 rescinds SFAS No. 4, which required all gains and losses from extinguishment of debt to be classified as an extraordinary item, net of related income tax effect, if material in the aggregate. Due to the rescission of SFAS No. 4, the criteria in Opinion 30 are now used to classify those gains and losses. SFAS No. 64 amended SFAS No. 4, and is no longer necessary because of the rescission of SFAS No. 4. SFAS No. 44, is no longer necessary because the transition of the Motor Carrier Act of 1980 has been completed. SFAS No. 145 also amends SFAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. In addition this statement also makes technical corrections to existing pronouncements which are generally not substantive in nature.

On January 1, 2002, FTNC adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS No. 144 addresses accounting and reporting issues related to the impairment of long-lived assets and for long-lived assets to be disposed of. The impact of adopting this statement was immaterial to FTNC.

On January 1, 2002, FTNC adopted SFAS No. 142, “Goodwill and Other Intangible Assets”. Under SFAS No. 142, goodwill is no longer subject to amortization over its estimated useful life, but is subject to an assessment for impairment using a fair-value-based test at least annually. FTNC has not recognized any impairment of the goodwill currently on its books during 2003 or 2002.

On January 1, 2002, FTNC adopted the final provisions of SFAS No. 141, “Business Combinations” which requires that all business combinations initiated after June 30, 2001, be accounted for using the purchase method. The impact of adopting this statement was immaterial to FTNC.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” which requires certain financial instruments with both liability and equity characteristics to be classified as liabilities on the Consolidated Statement of Condition. The statement updates the accounting for certain financial instruments that, under previous guidance, registrants could account for as equity. This statement is effective on July 1, 2003, and restatement of prior periods is not permitted. Upon adoption of this statement, FTNC expects to classify its mandatorily redeemable financial instruments (preferred stock of subsidiary ($44.4 million on June 30, 2003) and guaranteed preferred beneficial interests in FTNC’s junior subordinated debentures ($100.0 million on June 30, 2003)) as liabilities on the Consolidated Statement of Condition. Historically, the related distributions on these instruments ($12.6 million annually) have been classified as noninterest expense on the Consolidated Statements of Income and will be classified as interest expense on a prospective basis.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments”, which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. The provisions of SFAS No. 149 are effective for fiscal quarters beginning after June 15, 2003. The impact of adopting this standard will be immaterial to results of future operations.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities”, which requires consolidation by a business enterprise of variable interest entities. This interpretation applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. While certain implementation issues related to this standard continue to undergo interpretation, the impact at implementation of adopting this standard will be immaterial to the results of future operations.


10



Note 2 - Acquisitions/Divestitures

On August 1, 2003, First Horizon Merchant Services, Inc., a wholly owned subsidiary of First Tennessee Bank National Association (FTBNA), the primary banking subsidiary of FTNC, acquired Global Card Services, Inc., a merchant processing company based in Orlando, Florida, for approximately $15.8 million in cash. The acquisition was immaterial to FTNC.

On September 16, 2002, FTBNA sold a portfolio of loans originated through First Horizon Money Centers totaling $208.3 million to American General Finance, Inc. of Evansville, Indiana and closed the related Money Center offices. This transaction resulted in a divestiture gain of $2.3 million.

On June 1, 2002, First Horizon Home Loan Corporation (FHHLC), a wholly owned subsidiary of FTBNA, acquired certain assets and assumed certain liabilities of Real Estate Financial Services (REFS), a mortgage lending company based in Alpharetta, Georgia, for approximately $2.2 million in cash. This transaction was immaterial to FTNC.

On April 1, 2002, FTNC acquired First Premier Financial Services, Inc. (First Premier), a South Dakota based merchant processor, for approximately $11.9 million in cash. First Premier was merged into First Horizon Merchant Services, Inc., a wholly owned subsidiary of FTBNA. The acquisition was immaterial to FTNC.

On June 6, 2001, FTBNA completed the sale of its interests in Check Solutions Company to Carreker Corporation of Dallas, Texas. FTNC recognized a divestiture gain of $42.7 million in 2001. An additional gain of $2.3 million was recognized in 2002.

Note 3 - Earnings Per Share

The following table shows a reconciliation of earnings per share to diluted earnings per share:

 

 

 

Three Months Ended
June 30

 

Six Months Ended
June 30

 

 

 


 


 

(Dollars in thousands, except per share data)

 

2003

   

2002

   

2003

   

2002

 










 

Net income

 

$

118,352

 

$

90,465

 

$

237,381

 

$

177,546

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

 

126,055,169

 

 

125,636,978

 

 

125,872,197

 

 

125,750,059

 

Shares attributable to deferred compensation

 

 

1,105,966

 

 

1,043,725

 

 

1,091,469

 

 

982,411

 














 

Total weighted average shares

 

 

127,161,135

 

 

126,680,703

 

 

126,963,666

 

 

126,732,470

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share

 

$

.93

 

$

.71

 

$

1.87

 

$

1.40

 














 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

 

127,161,135

 

 

126,680,703

 

 

126,963,666

 

 

126,732,470

 

Dilutive effect due to stock options

 

 

4,702,822

 

 

3,905,567

 

 

4,117,179

 

 

3,726,491

 














 

Total weighted average shares, as adjusted

 

 

131,863,957

 

 

130,586,270

 

 

131,080,845

 

 

130,458,961

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

.90

 

$

.69

 

$

1.81

 

$

1.36

 














 



11



Note 4 – Loans

The composition of the loan portfolio on June 30 is detailed below:

 

(Dollars in thousands)

 

2003

 

2002

 






 

Commercial:

 

 

 

 

 

 

 

Commercial, financial and industrial

 

$

4,473,933

 

$

3,901,851

 

Real estate commercial

 

 

1,007,811

 

 

1,023,200

 

Real estate construction

 

 

638,664

 

 

504,963

 

Retail:

 

 

 

 

 

 

 

Real estate residential

 

 

5,678,988

 

 

4,177,188

 

Real estate construction

 

 

433,766

 

 

256,884

 

Other retail

 

 

270,077

 

 

419,629

 

Credit card receivables

 

 

263,650

 

 

260,942

 








 

Loans, net of unearned income

 

 

12,766,889

 

 

10,544,657

 

Allowance for loan losses

 

 

159,080

 

 

147,417

 








 

Total net loans

 

$

12,607,809

 

$

10,397,240

 








 


The following table presents information concerning nonperforming loans on June 30:

 

(Dollars in thousands)

 

2003

 

2002

 






 

Impaired loans

 

$

48,657

 

$

33,462

 

Other nonaccrual loans

 

 

17,938

 

 

25,990

 








 

Total nonperforming loans

 

$

66,595

 

$

59,452

 








 


Nonperforming loans consist of impaired loans and other nonaccrual 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:

 

 

 

Three Months Ended
June 30

 

Six Months Ended
June 30

 

 

 


 


 

(Dollars in thousands)

 

2003

 

2002

 

2003

 

2002

 










 

Total interest on impaired loans

 

$

169

 

$

130

 

$

272

 

$

205

 

Average balance of impaired loans

 

 

49,915

 

 

38,738

 

 

50,859

 

 

40,262

 














 


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 six months ended June 30, 2003 and 2002, is summarized as follows:

 

(Dollars in thousands)

 

Non-Impaired

        

Impaired

        

Total

 








 

Balance on December 31, 2001

 

$

133,668

 

$

16,946

 

$

150,614

 

Provision for loan losses

 

 

35,802

 

 

13,406

 

 

49,208

 

Charge-offs

 

 

(37,540

)

 

(21,637

)

 

(59,177

)

Loan recoveries

 

 

6,173

 

 

599

 

 

6,772

 











 

Net charge-offs

 

 

(31,367

)

 

(21,038

)

 

(52,405

)











 

Balance on June 30, 2002

 

$

138,103

 

$

9,314

 

$

147,417

 











 

Balance on December 31, 2002

 

$

129,229

 

$

15,069

 

$

144,298

 

Provision for loan losses

 

 

47,361

 

 

7,590

 

 

54,951

 

Charge-offs

 

 

(37,428

)

 

(9,816

)

 

(47,244

)

Loan recoveries

 

 

6,312

 

 

763

 

 

7,075

 











 

Net charge-offs

 

 

(31,116

)

 

(9,053

)

 

(40,169

)











 

Balance on June 30, 2003

 

$

145,474

 

$

13,606

 

$

159,080

 











 



12



Note 5 – Business Segment Information

FTNC provides traditional retail/commercial banking and other financial services to its customers through various regional and national business lines, including First Tennessee Banking Group, First Horizon, FTN Financial, Transaction Processing , and Corporate. First Tennessee Banking Group includes the Retail/Commercial Bank, Investments, Insurance, Financial Planning, Trust Services and Asset Management, Credit Card and Cash Management. This segment offers traditional banking financial services and products and also promotes comprehensive financial planning to address customer needs and desires for investments, insurance, estate planning, education funding, cash reserves and retirement goals. First Horizon includes First Horizon Home Loans, First Horizon Equity Lending and First Horizon Money Centers. During third quarter 2002, FTNC sold the loan portfolio and closed the offices of First Horizon Money Centers as a part of an ongoing plan to improve long-term growth by enhancing overall business mix. FTN Financial includes Capital Markets, Equity Research, Investment Banking, Strategic Alliances, and Correspondent Services. Transaction Processing continues to offer credit card merchant processing, nationwide bill payment processing, check clearing operations and other products and services. The Corporate segment includes certain corporate expenses, expense on trust preferred and REIT preferred stock, select components of SFAS 133 hedge ineffectiveness (see also Note 1 - Financial Information) and other items not allocated or not specifically assigned to business segments.

Total revenue, expenses 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 amounts of consolidated revenue, expense, tax, and assets for each segment for the three months and six months ending June 30:

 

 

   

Three Months Ended
June 30

 

Six Months Ended
June 30

 

 

 


 


 

(Dollars in thousands)

 

2003

 

2002

 

2003

 

2002

 










 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income, FTE*

   

$

200,056

   

$

177,542

   

$

393,812

   

$

362,290

 

Other revenues

 

 

548,620

 

 

336,581

 

 

1,066,770

 

 

661,513

 

Other expenses**

 

 

576,837

 

 

377,883

 

 

1,106,766

 

 

756,481

 














 

Pre-tax income, FTE*

 

 

171,839

 

 

136,240

 

 

353,816

 

 

267,322

 

Income taxes, FTE*

 

 

53,487

 

 

45,775

 

 

116,435

 

 

89,776

 














 

Net income

   

$

118,352

   

$

90,465

   

$

237,381

   

$

177,546

 














 

Average assets

   

$

25,111,850

   

$

19,436,423

   

$

24,218,621

   

$

19,685,398

 














 

*Fully taxable-equivalent adjustment

   

$

305

   

$

376

   

$

638

   

$

772

 














 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First Tennessee Banking Group

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income, FTE*

   

$

96,930

   

$

116,048

   

$

201,416

   

$

234,022

 

Other revenues

 

 

80,391

 

 

75,441

 

 

153,519

 

 

149,162

 

Other expenses**

 

 

151,137

 

 

128,081

 

 

293,156

 

 

254,915

 














 

Pre-tax income, FTE*

 

 

26,184

 

 

63,408

 

 

61,779

 

 

128,269

 

Income taxes, FTE*

 

 

(818

)

 

18,638

 

 

7,754

 

 

38,090

 














 

Net income

   

$

27,002

   

$

44,770

   

$

54,025

   

$

90,179

 














 

Average assets

   

$

10,753,339

   

$

10,419,845

   

$

10,684,258

   

$

10,444,073

 














 

  *

Fully taxable-equivalent basis.

**

Includes loan loss provision.

13



Note 5 – Business Segment Information (continued)

 

 

 

Three Months Ended
June 30

    

Six Months Ended
June 30

 

 

 


 


 

(Dollars in thousands)

 

2003

    

2002

 

2003

    

2002

 










 

First Horizon

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income, FTE*

   

$

85,965

   

$

48,165

   

$

159,374

   

$

100,750

 

Other revenues

 

 

279,416

 

 

137,843

 

 

557,886

 

 

267,491

 

Other expenses**

 

 

255,027

 

 

141,696

 

 

487,706

 

 

282,698

 














 

Pre-tax income, FTE*

 

 

110,354

 

 

44,312

 

 

229,554

 

 

85,543

 

Income taxes, FTE*

 

 

40,813

 

 

16,299

 

 

84,895

 

 

31,352

 














 

Net income

   

$

69,541

   

$

28,013

   

$

144,659

   

$

54,191

 














 

Average assets

   

$

10,969,396

   

$

6,417,590

   

$

10,277,291

   

$

6,556,113

 














 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FTN Financial

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income, FTE*

   

$

10,681

   

$

7,959

   

$

19,758

   

$

16,698

 

Other revenues

 

 

161,076

 

 

100,192

 

 

303,014

 

 

201,312

 

Other expenses**

 

 

119,183

 

 

73,583

 

 

223,904

 

 

144,581

 














 

Pre-tax income, FTE*

 

 

52,574

 

 

34,568

 

 

98,868

 

 

73,429

 

Income taxes, FTE*

 

 

19,975

 

 

13,136

 

 

37,563

 

 

27,903

 














 

Net income

   

$

32,599

   

$

21,432

   

$

61,305

   

$

45,526

 














 

Average assets

   

$

2,593,896

   

$

1,916,751

   

$

2,435,329

   

$

1,986,195

 














 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Transaction Processing

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income, FTE*

   

$

4,454

   

$

4,961

   

$

8,895

   

$

9,633

 

Other revenues

 

 

26,834

 

 

25,819

 

 

52,157

 

 

49,326

 

Other expenses**

 

 

26,267

 

 

25,110

 

 

51,787

 

 

47,386

 














 

Pre-tax income, FTE*

 

 

5,021

 

 

5,670

 

 

9,265

 

 

11,573

 

Income taxes, FTE*

 

 

1,951

 

 

2,155

 

 

3,564

 

 

4,398

 














 

Net income

   

$

3,070

   

$

3,515

   

$

5,701

   

$

7,175

 














 

Average assets

   

$

646,731

   

$

654,970

   

$

663,455

   

$

660,456

 














 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income, FTE*

   

$

2,026

   

$

409

   

$

4,369

   

$

1,187

 

Other revenues

 

 

903

 

 

(2,714

)

 

194

 

 

(5,778

)

Other expenses

 

 

25,223

 

 

9,413

 

 

50,213

 

 

26,901

 














 

Pre-tax income, FTE*

 

 

(22,294

)

 

(11,718

)

 

(45,650

)

 

(31,492

)

Income taxes, FTE*

 

 

(8,434

)

 

(4,453

)

 

(17,341

)

 

(11,967

)














 

Net income

   

$

(13,860

)   

$

(7,265

)   

$

(28,309

)   

$

(19,525

)














 

Average assets

   

$

148,488

   

$

27,267

   

$

158,288

   

$

38,561

 














 

  *

Fully taxable-equivalent basis.

**

Includes loan loss provision.


14



 

Note 6 - Intangible Assets

Following is a summary of intangible assets, net of accumulated amortization, included in the Consolidated Statements of Condition:

 

(Dollars in thousands)

 

Goodwill

 

Other
Intangibles*

 






 

Balance on December 31, 2001

 

$

143,147

 

$

41,857

 

Amortization expense

 

 

 

 

(2,955

)

Reclass**

 

 

12,573

 

 

(12,573

)

Acquisitions**

 

 

7,493

 

 

6,846

 








 

Balance on June 30, 2002

 

$

163,213

 

$

33,175

 








 

Balance on December 31, 2002

 

$

164,617

 

$

29,648

 

Amortization expense

 

 

 

 

(3,512

)

Divestitures

 

 

 

 

(19

)

Acquisitions

 

 

9,133

 

 

5,982

 








 

Balance on June 30, 2003

 

$

173,750

 

$

32,099

 








 

  *

Represents premium on purchased deposits, covenants not to compete and non-mortgage servicing rights.

**

Purchase price allocations on acquisitions are based upon estimates of fair value and are subject to change.

The gross carrying amount of other intangible assets subject to amortization is $97.9 million on June 30, 2003, net of $65.8 million of accumulated amortization. Estimated aggregate amortization expense for the remainder of 2003 is expected to be $3.5 million and is expected to be $6.4 million, $4.7 million, $3.2 million and $3.1 million for the twelve-month periods of 2004, 2005, 2006 and 2007, respectively.

The following is a summary of goodwill detailed by reportable segments for the six months ended June 30:

 

(Dollars in thousands)

 

First Tennessee
Banking Group

 

First
Horizon

 

FTN
Financial

 

Transaction
Processing

 

Total

 












 

December 31, 2001

 

$

75,462

       

$

51,353

      

$

12,968

       

$

3,364

       

$

143,147

 

Reclass*

 

 

12,573

 

 

 

 

 

 

 

 

12,573

 

Acquisitions*

 

 

249

 

 

1,028

 

 

326

 

 

5,890

 

 

7,493

 

















 

June 30, 2002

 

$

88,284

       

$

52,381

      

$

13,294

       

$

9,254

       

$

163,213

 

















 

December 31, 2002

 

$

88,070

       

$

52,378

      

$

13,294

       

$

10,875

       

$

164,617

 

Acquisitions

 

 

5,757

 

 

(1,526

)

 

 

 

4,902

 

 

9,133

 

















 

June 30, 2003

 

$

93,827

       

$

50,852

      

$

13,294

       

$

15,777

       

$

173,750

 

















 

*

Purchase price allocations on acquisitions are based upon estimates of fair value and are subject to change.


15



Note 7 - Mortgage Servicing Rights

Following is a summary of changes in capitalized mortgage servicing rights (MSR’s), net of accumulated amortization, included in the Consolidated Statements of Condition:

 

(Dollars in thousands)

 

 

 




 

Balance on December 31, 2001

 

$

665,005

 

Addition of mortgage servicing rights

 

 

168,963

 

Amortization

 

 

(59,604

)

Market value adjustments

 

 

(93,508

)

Sales of mortgage servicing rights

 

 

112

 

Impairment

 

 

(56,323

)





 

Balance on June 30, 2002

 

$

624,645

 





 

Balance on December 31, 2002

 

$

440,482

 

Addition of mortgage servicing rights

 

 

256,655

 

Amortization

 

 

(63,733

)

Market value adjustments

 

 

(92,454

)

Sales of mortgage servicing rights

 

 

(6,241

)

Impairment

 

 

(114,792

)





 

Balance on June 30, 2003

 

$

419,917

 





 

The MSR’s on June 30, 2003 and 2002, had estimated market values of approximately $444.2 million and $646.6 million, respectively. These balances represent the rights to service approximately $56.9 billion and $45.2 billion of mortgage loans on June 30, 2003 and 2002. On June 30, 2003 and 2002, valuation allowances due to impairment of $70.9 million and $24.9 million were required, respectively.

Estimated MSR’s amortization expense for the twelve month periods ending June 30, 2004, 2005, 2006, 2007 and 2008, are $84.1 million, $63.4 million, $53.0 million, $43.5 million and $35.2 million, respectively. The assumptions underlying these estimates are subject to modification based on changes in market conditions and portfolio behavior (such as prepayment speeds). As a result, these estimates are subject to change in a manner and amount that is not presently determinable by management.

For purposes of impairment evaluation and measurement, the MSR’s are stratified based on the predominant risk characteristics of the underlying loans. These strata currently include adjustable and fixed-rate loans. The MSR’s are amortized over the period of and in proportion to the estimated net servicing revenues. A quarterly value impairment analysis is performed using a discounted cash flow methodology that is disaggregated by predominant risk characteristics. Impairment, if any, is recognized through a valuation allowance for individual strata. However, if the impairment is determined to be other than temporary, a direct write-off of the asset is made.


16



Note 8 - Term Borrowings

The following table presents information pertaining to term borrowings (debt with original maturities greater than one year) for FTNC and its subsidiaries on June 30:

 

(Dollars in thousands) 

 

2003

    

2002

 






 

First Tennessee National Corporation:

 

 

 

 

 

 

 

Subordinated capital notes (qualifies for total capital under the Risk-Based Capital guidelines):

 

 

 

 

 

 

 

Matures on May 15, 2013 — 4.50%

 

$

100,000

 

$

 

Matures on November 15, 2005 — 6.75%

 

 

74,806

 

 

74,724

 

First Tennessee Bank National Association:

 

 

 

 

 

 

 

Subordinated notes (qualifies for total capital under the Risk-Based Capital guidelines):

 

 

 

 

 

 

 

Matures on May 15, 2013 — 4.625%

 

 

250,000

 

 

 

Matures on December 1, 2008 — 5.75%

 

 

140,804

 

 

140,653

 

Matures on April 1, 2008 — 6.40%

 

 

89,666

 

 

89,596

 

Bank notes:*

 

 

 

 

 

 

 

Matures on June 30, 2004 — 1.05%

 

 

174,974

 

 

 

Matures on October 6, 2003 — 1.26%

 

 

150,000

 

 

 

Matures on October 8, 2004 — 1.36%

 

 

149,962

 

 

 

Matures on January 21, 2004 — 1.28%

 

 

100,000

 

 

 

Matures on June 30, 2005 — 1.14%

 

 

99,980

 

 

 

Matures on November 26, 2004 — 1.36%

 

 

74,979

 

 

 

Matures on July 6, 2004 — 1.48% and 2.21% on June 30, 2003 and 2002, respectively

 

 

59,971

 

 

59,942

 

Matures on July 9, 2004 — 1.49% and 2.21% on June 30, 2003 and 2002, respectively

 

 

50,000

 

 

50,000

 

Matures on March 6, 2007 — 1.49%

 

 

49,929

 

 

49,910

 

Matured on April 17, 2003 — 1.387%

 

 

 

 

50,000

 

Matured on May 23, 2003 — 2.03% on June 30, 2002

 

 

 

 

69,982

 

Federal Home Loan Bank borrowings**

 

 

4,040

 

 

54,322

 

Other***

 

 

6,692

 

 

6,692

 

First National Bank of Springdale:

 

 

 

 

 

 

 

Federal Home Loan Bank borrowings** 

 

 

8,986

 

 

5,147

 








 

Total

 

$

1,584,789

 

$

650,968

 








 

    *

FTBNA has an ongoing bank note program under which the bank may offer an aggregate principal amount of up to $3.0 billion. Bank notes with original maturities of one year or less are included in other short-term borrowings. Bank notes with original maturities greater than one year are classified as term borrowings. On June 30, 2003, unused capacity under this program was $1.2 billion.

  **

The Federal Home Loan Bank (FHLB) borrowings were issued with fixed interest rates and terms of 2 to 26 years. These borrowings had weighted average interest rates of 4.37 percent and 4.17 percent for FTBNA and 4.48 percent and 5.23 percent for Springdale on June 30, 2003 and June 30, 2002, respectively.

***

Other long-term debt is comprised of unsecured obligations issued with fixed interest rates and terms of 1 to 2 years. These borrowings had a weighted average interest rate of 4.60 percent on June 30, 2003 and June 30, 2002.

Annual principal repayment requirements as of June 30, 2003, are as follows:

 

(Dollars in thousands)

 

 

 




 

2003

 

$

154,904

 

2004

 

 

612,588

 

2005

 

 

177,299

 

2006

 

 

3,502

 

2007

 

 

51,738

 

2008 and after

 

 

586,312

 





 



17



Note 8 - Term Borrowings (continued)

All subordinated notes are unsecured and are subordinate to other present and future senior indebtedness. These notes qualify as Tier 2 risk-based capital under the Federal Reserve Board and Office of the Comptroller of the Currency guidelines for assessing capital adequacy. Certain of the subordinated bank notes may require prior regulatory approval to be prepaid prior to maturity.


18



ITEM 2. FIRST TENNESSEE NATIONAL CORPORATION - MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

GENERAL INFORMATION

First Tennessee National Corporation (FTNC) is headquartered in Memphis, Tennessee, and is a nationwide, diversified financial services institution which provides banking and other financial services to its customers through various regional and national business lines. FTNC’s segments are First Tennessee Banking Group (previously referred to as FTN Banking Group), First Horizon, FTN Financial, Transaction Processing, and Corporate. First Tennessee Banking Group includes the Retail/Commercial Bank, Investments, Insurance, Financial Planning, Trust Services and Asset Management, Credit Card and Cash Management. This segment offers traditional banking financial services and products, commercial insurance and also promotes comprehensive financial planning to address customer needs and desires for investments, insurance, estate planning, education funding, cash reserves and retirement goals. First Horizon includes First Horizon Home Loans, First Horizon Equity Lending and First Horizon Money Centers. During third quarter 2002, FTNC sold the loan portfolio and closed the offices of First Horizon Money Centers as part of an ongoing plan to improve long-term growth by enhancing overall business mix. FTN Financial includes Capital Markets, Equity Research, Investment Banking, Strategic Alliances and Correspondent Services. Transaction Processing includes credit card merchant processing, nationwide bill payment processing, check clearing operations and other products and services. The Corporate segment includes unallocated corporate expenses, interest expense on trust preferred and REIT preferred stock, and select components of SFAS 133 hedge ineffectiveness (see Note 1 – Financial Information).

Based on management’s best estimates, certain revenue and expenses are allocated and equity is assigned to the various segments to reflect the inherent risk in each business line. These allocations are periodically reviewed and may be revised from time to time to more accurately reflect current business conditions and risks; the previous history is restated to ensure comparability.

For the purpose of this management discussion and analysis (MD&A), earning assets, including loans, have been expressed as averages, net of unearned income. First Tennessee Bank National Association, the primary bank subsidiary, is also referred to as FTBNA in this discussion.

The following is a discussion and analysis of the financial condition and results of operations of FTNC for the three-month and six-month periods ended June 30, 2003, compared to the three-month and six-month periods ended June 30, 2002. To assist the reader in obtaining a better understanding of FTNC and its performance, this discussion should be read in conjunction with FTNC’s unaudited consolidated financial statements and accompanying notes appearing in this report. Additional information including the 2002 financial statements, notes, and management’s discussion and analysis is provided in the 2002 Annual Financial Disclosures included as an appendix to the 2003 Proxy Statement.

FORWARD-LOOKING STATEMENTS

Management’s discussion and analysis contains forward-looking statements with respect to FTNC’s beliefs, plans, goals, expectations, and estimates. Forward-looking statements are statements that are not a representation of historical information but rather are related to future operations, strategies, financial results or other developments. The words “believe”, “expect”, “anticipate”, “intend”, “estimate”, “should”, “is likely”, “will”, “going forward”, and other expressions that indicate future events and trends identify forward-looking statements. Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, operational, economic and competitive uncertainties and contingencies, many of which are beyond a company’s control, and many of which, with respect to future business decisions and actions (including acquisitions and divestitures), are subject to change. Examples of uncertainties and contingencies include, among other important factors, general and local economic and business conditions; expectations of and actual timing and amount of interest rate movements (which can have a significant impact on a financial services institution); market and monetary fluctuations; inflation; the financial condition of borrowers and other counterparties; competition within and outside the financial services industry; geo-political developments including possible terrorist activity; technology; and new products and services in the industries in which FTNC operates. Other factors are those inherent in originating and servicing loans, including prepayment risks and fluctuation of collateral values and changes in customer profiles. Additionally, the actions of the Securities and Exchange Commission (SEC), the Financial Accounting Standards Board (FASB), the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System, and other regulators; regulatory and judicial proceedings and changes in laws and regulations applicable to FTNC; and FTNC’s success in executing its business plans and strategies and managing the risks involved in the foregoing, could cause actual results to differ. FTNC assumes no obligation to update any forward-looking statements that are made from time to time.


19



FINANCIAL SUMMARY (Comparison of second quarter 2003 to second quarter 2002)

Earnings for second quarter 2003 were $118.4 million, an increase of 31 percent from last year’s second quarter earnings of $90.4 million. Diluted earnings per common share were $.90 in 2003 compared to $.69 in 2002. Return on average shareholders’ equity was 26.5 percent and return on average assets was 1.89 percent for second quarter 2003. Return on average shareholders’ equity was 23.7 percent and return on average assets was 1.87 percent for second quarter 2002.

On June 30, 2003, FTNC was ranked as one of the top 50 bank holding companies nationally in market capitalization ($5.6 billion) and total assets ($27.9 billion). On June 30, 2002, market capitalization was $4.8 billion and total assets were $19.8 billion.

Total revenue grew 46 percent from second quarter 2002, with a 63 percent increase in noninterest income and a 13 percent increase in net interest income.

BUSINESS LINE REVIEW

First Horizon

Pre-tax income for First Horizon increased 149 percent to $110.4 million for second quarter 2003, compared to $44.3 million for second quarter 2002. Total revenues were $365.4 million, an increase of 96 percent from $186.0 million in 2002 reflecting a 177 percent increase in originations. Also contributing to the growth in pre-tax income were improvements in operating efficiencies and a decline in provision for loan losses.

Net interest income increased 78 percent to $86.0 million in 2003 from $48.1 million. Net interest income in First Horizon Equity Lending increased $7.2 million primarily due to an increase of 132 percent in home equity lines of credit which averaged $1.9 billion in second quarter 2003 compared to $.8 billion in 2002. Also impacting the growth in net interest income was an increase of $2.5 million related to growth in residential construction lending. The remaining increase of $28.2 million in net interest income reflects the impact of a larger portfolio of warehouse loans (mortgage loans that are awaiting sale and delivery into the secondary market) which grew 156 percent to $5.2 billion from $2.0 billion in second quarter 2002. Net interest spread on the warehouse, however, was negatively impacted by lower mortgage rates.

Total noninterest income increased 103 percent to $279.4 million in 2003 compared to $137.9 million in 2002. Noninterest income consists primarily of mortgage banking-related fees from the origination process, fees from mortgage servicing and MSR’s net hedge gains or losses. Total noninterest income is net of amortization, impairment and other expenses related to MSR’s and related hedges.

Origination activity increased to $15.3 billion compared to $5.5 billion in 2002. Driven by low mortgage interest rates, refinance activity increased 348 percent to $11.6 billion and represented 76 percent of total originations during 2003 compared to 47 percent in 2002.  Contributing to the growth in originations was a 48 percent increase in the size of the sales force. Home purchase related originations grew 26 percent in 2003, demonstrating First Horizon Home Loans’ success in penetrating the purchase market. First Horizon Home Loans’ access to the less volatile purchase market should help support production levels when mortgage rates rise. Due to the high origination volumes, loan sales into the secondary market increased 171 percent to $14.1 billion in 2003 compared to last year. Fees derived from the mortgage origination process increased 149 percent in 2003, to $293.0 million from $117.5 million in 2002. This increase reflects growth in origination fees, in revenue recognized on loans sold, in the value recognized on loans in process, and higher net secondary marketing trading gains, which were influenced by the favorable interest rate environment experienced during the year. Secondary marketing activities increased $105.7 million as revenues from mortgage servicing rights created grew $53.2 million (to $112.6 million) primarily due to the increased production and net secondary marketing trading gains increased $52.5 million (to $67.7 million) primarily from increased production and the favorable interest rate environment experienced during 2003.

While the growth in refinance activity produced increased origination fee income, it also increased actual and projected MSR’s prepayment speeds, resulting in a 9 percent increase, to $32.6 million in MSR’s amortization expense. In addition, MSR’s impairment loss increased 191 percent to $72.3 million due primarily to lower interest rates and changes in short term prepayment expectations. MSR’s amortization was $29.9 million in 2002 and there was a MSR’s impairment loss of $24.9 million. The decrease in fair value of MSR’s attributed to declining interest rates was partially offset by an increase in the value of the derivative financial instruments used to hedge the change in fair value of the hedged MSR’s. MSR’s net hedge gains, excluding select components of SFAS 133 hedge ineffectiveness that are included in the Corporate segment, were $38.3 million in 2003 compared to $23.7 million in 2002 (both years represent a net increase in the value of hedges over the decrease in the value of hedged MSR’s).


20



The mortgage-servicing portfolio (which includes servicing for ourselves and others) totaled $64.0 billion on June 30, 2003, compared to $48.7 billion on June 30, 2002. The sustained growth of this asset in a period of historically high prepayment levels was made possible, in part, by the recapture of refinances from the existing servicing portfolio. Servicing fees increased 17 percent as a result of this increase in the servicing portfolio. However, total fees associated with mortgage servicing decreased 1 percent to $43.0 million in second quarter 2003 due to the unfavorable impact of early payoff interest expense. As a result of the strong originations, there was an increase in capitalized MSR’s during second quarter 2003 of $127.4 million, net of sales (see Note 7 – Mortgage Servicing Rights for information summarizing changes in MSR’s).

The provision for loan losses was $7.8 million in 2003 compared to $9.3 million in 2002. The decreased provision reflects the impact of improvements in the risk profile of the retail loan portfolio due to the sale of Money Center loans in 2002, certain classified and nonperforming loans being transferred to available for sale and whole-loan insurance being provided for a segment of the retail loan portfolio.

Total noninterest expense increased 87 percent to $247.2 million in 2003 compared to $132.4 million in 2002. The growth was primarily the result of a 109 percent increase in employee compensation, incentives and benefits (personnel expense), the largest component of noninterest expense, that includes the impact of increased salary and commission expense related to the increased mortgage origination volume produced during 2003. The impact of First Horizon’s initiative to grow the retail sales force is also reflected in this expense growth. In addition to the increased personnel expense, the higher activity levels also impacted various other categories of noninterest expense.

Going forward, the existing level of loans in process (pipeline) due to an as yet unabated surge in applications currently indicates a continuation of strong origination levels. Excluding the impact of the pipeline, fee income from refinance loan originations will generally depend on mortgage interest rates. An increase in rates should reduce origination fees and profit from the sale of loans, but should also reduce MSR’s amortization expense and impairment losses, while a decrease in rates should increase this net revenue. Flat to rising interest rates should reduce net secondary marketing trading gains, while falling rates should increase this net revenue. If total origination volume increases and/or the yield curve steepens, net interest income from the warehouse should increase, while if volume decreases and/or the yield curve flattens, this revenue should decrease. Home purchase-related originations should reflect the relative strength or weakness of the economy and will also be influenced by the size of the sales force. Continued success of national cross-sell strategies should increase revenues from products other than traditional mortgage origination and servicing. Actual results could differ because of various factors, including those presented in the Forward-Looking Statements section of the MD&A discussion.

First Tennessee Banking Group

Pre-tax income for First Tennessee Banking Group decreased 59 percent to $26.1 million for second quarter 2003, compared to $63.4 million for second quarter 2002. Total revenues for the segment were $177.3 million, a decrease of 7 percent from $191.5 million in 2002 due to compression in the net interest margin (NIM). Also impacting the decline in pre-tax income were increased provision for loan losses and growth in noninterest expense that includes investments in initiatives designed to enhance future earnings.

Net interest income decreased to $96.9 million in 2003 or 16 percent, compared to $116.0 million in 2002. The decline in net interest income was related to compression in the NIM, primarily due to the repricing of term assets in this low interest rate environment and due to a change in the mix of the loan portfolio to floating rate products. NIM (based on net interest income of $96.9 million and earning assets of $10.1 billion for second quarter 2003 compared to $116.0 million and $9.7 billion, respectively, for second quarter 2002) fell to 3.82 percent in 2003 from 4.78 percent in 2002.

Noninterest income increased 7 percent to $80.4 million compared to $75.5 million in 2002. This increase was due to growth in insurance revenue, deposit account service charges, and cash management fees. The positive impact of these items was partially offset by a decrease in trust and investment management fees as difficult equity market conditions continued to impact results.

The provision for loan losses was $19.2 million in second quarter 2003 compared to $13.9 million in second quarter of last year primarily due to an increase in historical loss factors on commercial loans used in the allowance model and due to loan growth. The loss factors on commercial loans were influenced by the inclusion of 2002 charge-offs in the historical loss calculation and reflect the impact of an extended period of slow economic growth on our customer base. Going forward the level of provision for loan losses should fluctuate primarily with the strength or weakness of the Tennessee economy.

Total noninterest expense increased 16 percent in 2003 to $132.0 million from $114.2 million last year. Expenses associated with initiatives focused on benefiting future earnings, including marketing programs, severance and professional fees, represent the largest component of this increase.


21



FTN Financial

Pre-tax income for FTN Financial increased 52 percent to $52.5 million for second quarter 2003, compared to $34.5 million for second quarter 2002.

Total revenues were $171.7 million, an increase of 59 percent from $108.1 million in 2002. Noninterest income increased 61 percent to $161.1 million in 2003. This increased revenue reflects continued growth and penetration into FTN Financial’s targeted customer base through strengthened product and service lines. Revenue growth has also been influenced by the increased liquidity that capital markets’ depository customers have experienced, as well as continued growth in capital markets’ non-depository account base. FTN Financial’s enhanced institutional product and service lines, which include investment banking, equity research and sales, correspondent services and portfolio advisory services, increased 36 percent compared to 2002. Total securities bought and sold increased 49 percent to $596.5 billion from $400.2 billion in 2002.

Total noninterest expense increased 61 percent to $118.6 million compared to $73.5 million in 2002. This growth was primarily due to an increase of 64 percent in personnel expense resulting from commissions and incentives associated with the higher fee income this year.

Going forward, revenues will fluctuate based on factors which include the expansion or contraction of the customer base, the volume of investment banking transactions and the introduction of new products, as well as the strength of loan growth in the U.S. economy and volatility in the interest rate environment and the equity markets. Actual results could differ because of various factors, including those presented in the Forward-Looking Statements section of the MD&A discussion.

Transaction Processing

Pre-tax income for Transaction Processing decreased 11 percent to $5.0 million for second quarter 2003, compared to $5.7 million for second quarter 2002. Total revenues were $31.3 million, an increase of 2 percent from $30.8 million in 2002. The volume of merchant bank card transactions processed grew 20 percent over second quarter 2002. Total noninterest expense increased 5 percent to $26.3 million from $25.1 million, which includes investments in initiatives designed to enhance future earnings. Both revenue and expense levels were influenced by recent acquisitions.

Corporate

The Corporate segment’s results showed a pre-tax loss of $22.2 million in 2003, compared to a pre-tax loss of $11.7 million in 2002. Included in the pre-tax loss for 2003 is the $9.8 million contribution made to the First Tennessee Foundation, a non-profit entity dedicated to supporting on an annual basis charitable causes in the communities where FTNC does business. FTNC has made contributions to the Foundation in three of the last four quarters. These contributions, which are discretionary, have been made and may continue to be made when a favorable economic environment or other favorable factor (such as the second quarter tax settlement discussed below – see Income Taxes) enables FTNC to produce strong earnings. Also included in the Corporate segment’s results for this quarter were an increase in consulting fees and issuance costs related to the issuance of subordinated notes (see Balance Sheet Review below).

INCOME STATEMENT REVIEW

NONINTEREST INCOME

Noninterest income provides the majority of FTNC’s revenue and contributed 73 percent to total revenue in second quarter 2003 compared to 66 percent in second quarter 2002. Second quarter 2003 noninterest income increased 63 percent to $548.7 million from $336.6 million in 2002. A more detailed discussion of the major line items follows.

Mortgage Banking

First Horizon Home Loans, an indirect subsidiary of FTNC and the major component of the First Horizon business segment, offers residential mortgage banking products and services to customers, which consist primarily of the origination or purchase of single-family residential mortgage loans for sale to secondary market investors and the subsequent servicing of those loans.


22



First Horizon Home Loans originates mortgage loans through its retail and wholesale operations and also purchases mortgage loans from third-party mortgage bankers (known as “correspondent brokers”).

The secondary market for mortgages allows First Horizon Home Loans to sell mortgage loans to investors, including government-sponsored enterprises (GSE’s), such as Fannie Mae (FNMA), Ginnie Mae (GNMA), and Freddie Mac (FHLMC). Many private investors are also active in the secondary market as issuers and investors. The majority of First Horizon Home Loans’ mortgage loans are sold through transactions with GSE’s. The risk of credit loss with regard to the principal amount of the loans sold is generally transferred to investors upon sale to the secondary market. To the extent that transferred mortgage loans are subsequently determined not to meet the agreed-upon qualifications or criteria, the purchaser has the right to return those loans to First Horizon Home Loans. In addition, certain mortgage loans are sold to investors with limited or full recourse in the event of mortgage foreclosure (refer to discussion of foreclosure reserves under Critical Accounting Policies).

When First Horizon Home Loans sells mortgage loans in the secondary market to investors, it generally retains the right to service the loans sold in exchange for a servicing fee that is collected over the life of the loan as the payments are received from the borrower. The expected present value of the anticipated cash flows received for servicing the loan, net of the estimated costs of servicing the loan, is capitalized as an asset known as Mortgage Servicing Rights (MSR’s) on the Consolidated Statements of Condition (refer to discussion of MSR’s under Critical Accounting Policies).

Origination fees and gains or losses from the sale of loans are recognized at the time a mortgage loan is sold into the secondary market. A portion of the gain or loss is recognized at the time an interest rate lock commitment (IRLC) is made to the customer. Secondary marketing activities include gains or losses from secondary marketing trading gains, product pricing decisions, and gains or losses from the sale of loans into the secondary market including the capitalized net present value of the MSR’s. As discussed under Critical Accounting Policies, First Horizon Home Loans employs hedging strategies intended to counter a change in the value of its MSR’s through changing interest rate environments. MSR’s hedge gains/(losses) reflect effects of hedging including servicing rights net value changes (see Other - Accounting for Derivative Instruments and Hedging Activities). Other income includes income from the foreclosure repurchase program, bulk sales of MSR’s, and other miscellaneous items. Mortgage trading securities gains/(losses) relate to market value adjustments primarily on interest-only strips that are classified as trading securities and related hedges. As shown in Table 1, total mortgage banking fee income increased 113 percent in 2003.

Table 1 - Mortgage Banking

 

 

 

 

Three Months Ended
June 30

 

 

Percent

    

 

Six Months Ended
June 30

    

 

Percent

 

 

 

 


 

 

 


 

 

(Dollars and volumes in millions)

 

 

2003

    

 

2002

 

Change (%)

 

 

2003

    

 

2002

 

Change (%)

 


















 

Noninterest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loan origination fees

 

$

112.7

 

$

42.9

 

162.5

+

$

197.3

 

$

91.4

 

115.8

+

Secondary marketing activities

 

 

180.3

 

 

74.6

 

141.6

+

 

340.7

 

 

151.6

 

124.8

+

Mortgage servicing fees

 

 

43.0

 

 

43.4

 

.9

-

 

88.4

 

 

84.8

 

4.3

+

MSR’s net hedge results*

 

 

39.0

 

 

21.0

 

86.4

+

 

76.3

 

 

32.9

 

131.9

+

Other income

 

 

9.1

 

 

6.9

 

32.9

+

 

24.7

 

 

14.0

 

76.5

+

Mortgage trading securities net losses

 

 

(2.6

)

 

(4.1

)

35.7

-

 

(.5

)

 

(7.6

)

93.5

-

Amortization of MSR’s

 

 

(32.6

)

 

(29.9

)

9.2

+

 

(63.7

)

 

(59.6

)

6.9

+

MSR’s impairment loss

 

 

(72.3

)

 

(24.9

)

190.7

+

 

(114.8

)

 

(56.3

)

103.8

+








     




   

 

Total mortgage noninterest income

 

$

276.6

 

$

129.9

 

112.9

+

$

548.4

 

$

251.2

 

118.3

+








     




   

 

Refinance originations

 

$

11,584.9

 

$

2,587.0

 

347.8

+

$

20,662.0

 

$

5,863.6

 

252.4

+

New loan originations

 

 

3,664.1

 

 

2,915.6

 

25.7

+

 

6,095.6

 

 

4,940.9

 

23.4

+








     




 

 

 

Mortgage loan originations

 

$

15,249.0

 

$

5,502.6

 

177.1

+

$

26,757.6

 

$

10,804.5

 

147.7

+








     




   

 

Servicing portfolio

 

$

63,952.2

 

$

48,678.7

 

31.4

+

$

63,952.2

 

$

48,678.7

 

31.4

+








     




   

 

*

MSR’s net hedge results represent the net gain or loss resulting from the change in value of the hedged component of MSR’s and the offsetting change in value of servicing hedges.

Certain previously reported amounts have been reclassified to agree with current presentation.


23



Origination activity increased 177 percent to $15.3 billion compared to $5.5 billion in second quarter 2002. Driven by low mortgage interest rates, refinance activity increased 348 percent to $11.6 billion and represented 76 percent of total originations during second quarter 2003 compared to 47 percent in second quarter 2002. Due to the high origination volumes, loan sales into the secondary market increased 171 percent to $14.1 billion in 2003 compared to last year. Home purchase related originations grew 26 percent in 2003, demonstrating First Horizon Home Loans’ success in penetrating the purchase market. Due to the more stable nature of this market, which is not as vulnerable to interest rates, First Horizon Home Loans’ access to the purchase market should help support production levels when mortgage rates rise. Fees derived from the mortgage origination process increased 149 percent in 2003, to $293.0 million from $117.5 million in 2002. This increase reflects growth in origination fees, in revenue recognized on loans sold, in the value recognized on loans in process, and higher net secondary marketing trading gains, which were influenced by the favorable interest rate environment experienced during the year. Secondary marketing activities increased $105.7 million as revenues from mortgage servicing rights created grew $53.2 million (to $112.6 million) primarily due to the increased production and net secondary marketing trading gains increased $52.5 million (to $67.7 million) primarily from increased production and the favorable interest rate environment experienced during 2003.

While the growth in refinance activity produced increased origination fee income, it also increased actual and projected MSR’s prepayment speeds, resulting in a 9 percent increase, to $32.6 million in MSR’s amortization expense. In addition, MSR’s impairment loss increased 191 percent to $72.3 million due primarily to lower interest rates and changes in short term prepayment expectations. MSR’s amortization was $29.9 million in 2002 and there was a MSR’s impairment loss of $24.9 million in 2002. The decrease in fair value of MSR’s attributed to declining interest rates was partially offset by an increase in the value of the derivative financial instruments used to hedge the change in fair value of the hedged MSR’s. MSR’s net hedge gains were $39.0 million in 2003 compared to $21.0 million in 2002 (both quarters represent a net increase in the value of hedges over the decrease in the value of hedged MSR’s).

The mortgage-servicing portfolio (which includes servicing for ourselves and others) totaled $64.0 billion on June 30, 2003, compared to $48.7 billion on June 30, 2002. The sustained growth of this asset in a period of historically high prepayment levels was made possible, in part, by the recapture of refinances from the existing servicing portfolio. Servicing fees increased 17 percent as a result of this increase in the servicing portfolio. However, total fees associated with mortgage servicing decreased 1 percent to $43.0 million in second quarter 2003 due to the unfavorable impact of early payoff interest expense. As a result of the strong originations, there was an increase in capitalized MSR’s during second quarter 2003 of $127.4 million, net of sales (see Note 7 – Mortgage Servicing Rights for information summarizing changes in MSR’s).

Other mortgage income increased 33 percent to $9.1 million for 2003 compared to $6.9 million in 2002 primarily due to increased earnings from investments in joint ventures and other partnerships.

Capital Markets

Capital markets fee income, the major component of revenue in the FTN Financial segment, is primarily generated from the purchase and sale of securities as both principal and agent and from investment banking, portfolio advisory and equity research services. 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.

For second quarter 2003, capital markets fee income increased 61 percent to $158.7 million from $98.3 million in 2002. This increase reflects continued growth and penetration into the targeted customer base through strengthened product and service lines. This growth has also been influenced by the increased liquidity that capital markets’ depository institution customers have experienced, as well as continued growth in capital markets’ non-depository account base. As shown in Table 2, revenue from depository and non-depository customers has increased in 2003. The enhanced institutional product and service lines, which include investment banking, equity research and sales, and portfolio advisory services, increased 36 percent compared to 2002. Total securities bought and sold increased 49 percent to $596.5 billion from $400.2 billion in 2002.


24



Table 2 - Capital Markets

 

 

 

Three Months Ended
June 30

    

Growth
Rate (%)

      

Six Months Ended
June 30

    

Growth
Rate (%)

 

 

 


 

 


 

 

(Dollars in millions)

 

2003

    

2002

 

 

2003

    

2002

 

 














 

Noninterest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income - depository

 

$

65.9

 

$

36.1

 

82.5

+

$

136.6

 

$

77.6

 

76.0

+

Fixed income - non-depository

 

 

42.2

 

 

25.1

 

68.1

+

 

80.2

 

 

51.7

 

55.1

+

Other products

 

 

50.6

 

 

37.1

 

36.4

+

 

81.5

 

 

68.5

 

19.0

+


















 

Total capital markets noninterest income

 

$

158.7

 

$

98.3

 

61.4

+

$

298.3

 

$

197.8

 

50.8

+


















 

Securities bought and sold (billions)

 

$

596.5

 

$

400.2

 

49.0

+

$

1,151.0

 

$

772.9

 

48.9

+


















 

Certain previously reported amounts have been reclassified to agree with current presentation.


Other Noninterest Income

Fee income from deposit transactions and cash management for second quarter 2003 increased 6 percent to $38.6 million compared to $36.4 million in 2002 due to growth in deposit account service charges and cash management fees. Total noninterest income from insurance premiums and commissions increased 23 percent, to $15.2 million from $12.4 million in 2002 due in part to growth in revenues from Synaxis, a commercial insurance broker. Trust services and investment management fees decreased 19 percent to $10.8 million from $13.3 million in 2002 as difficult equity market conditions continued to impact results. Assets under management fell 3 percent to $7.4 billion on June 30, 2003, from $7.7 billion on June 30, 2002. Second quarter 2003 fee income from merchant processing increased 10 percent to $13.8 million from $12.6 million in 2002 primarily due to portfolio acquisitions. Net security losses were $.7 million in 2003 compared to net security losses of $2.3 million in 2002. In 2002, the losses were primarily related to impairment of equity investments held by FTNC’s venture capital subsidiaries. All other income and commissions decreased 1 percent to $35.7 million for second quarter 2003 from $36.0 million in 2002.

Going forward, other noninterest income should fluctuate primarily with the strength or weakness of the economy.

NET INTEREST INCOME

Net interest income increased 13 percent to $199.8 million from $177.1 million in second quarter 2002, reflecting a larger portfolio of mortgage warehouse loans which grew 154 percent to $5.1 billion from $2.0 billion in second quarter 2002. Also impacting the growth in net interest income was an increase of 18 percent in the loan portfolio primarily due to growth in equity lending. These positive impacts on net interest income were largely offset by compression in the net interest margin resulting from the repricing of assets to lower yields while liability rates have become less sensitive to rate movements in this historically low interest rate environment and due to a change in the mix of the loan portfolio to a higher percentage of floating rate products. The consolidated margin decreased to 3.72 percent in second quarter 2003 compared to 4.36 percent for the same period in 2002. The activity levels and related funding for FTNC’s mortgage production and servicing and capital markets activities affect the margin. These activities typically produce different margins than traditional banking activities. Mortgage production and servicing activities can affect the overall margin based on a number of factors, including the size of the mortgage warehouse, the time it takes to deliver loans into the secondary market, the amount of custodial balances, and the level of MSR’s. Capital markets activities tend 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, FTNC’s consolidated margin cannot be readily compared to that of other bank holding companies.


25



Table 3 - Net Interest Margin

 

 

 

Second Quarter
June 30

 

 

 


 

 

 

2003

       

2002

 






 

Consolidated Yields and Rates:

 

 

 

 

 

Investment securities

 

4.26

%

6.01

%

Loans, net of unearned

 

5.13

 

6.22

 

Other earning assets

 

4.70

 

5.37

 






 

Yields on earning assets

 

4.90

 

6.01

 






 

Interest bearing core deposits

 

1.46

 

1.98

 

CD’s over $100,000

 

1.41

 

2.18

 

Fed funds purchased and repos

 

1.11

 

1.52

 

Commercial paper and other short-term borrowings

 

3.78

 

4.25

 

Long-term debt

 

3.30

 

4.37

 






 

Rates paid on interest-bearing liabilities

 

1.59

 

2.15

 






 

Net interest spread

 

3.31

 

3.86

 

Effect of interest-free sources

 

.37

 

.39

 

Loan fees

 

.05

 

.11

 

FRB interest and penalties

 

(.01

)

 






 

FTNC - NIM

 

3.72

%

4.36

%






 


Going forward, in the near-term, net interest margin should decline further as term assets continue to reprice to lower rates. The adoption of SFAS No. 150 in third quarter 2003 will also result in further compression of the consolidated net interest margin. Historically, the expenses associated with FTNC’s trust preferred and REIT preferred stock have been classified as noninterest expense, but upon adoption of SFAS No. 150 will be classified as interest expense on a prospective basis. Over the long-term, FTNC’s asset sensitive balance sheet position should allow the net interest margin to improve when interest rates begin to rise.

NONINTEREST EXPENSE

Total noninterest expense for second quarter 2003 increased 55 percent to $549.3 million from $354.6 million in 2002. Expenses in First Horizon and FTN Financial fluctuate based on the type and level of activity. Going forward, FTN Financial and First Horizon will continue to influence the level of noninterest expense (see also Business Line Review for additional information). Based on the strong earnings experienced in recent quarters, noninterest expense also has been impacted by investments made to enhance FTNC’s ability to produce future earnings.

Personnel expense increased 63 percent from second quarter 2002, primarily due to higher activity levels in First Horizon and FTN Financial. Occupancy expense increased 7 percent to $19.8 million compared to $18.4 million in 2002 primarily related to realty taxes. Operations services increased 17 percent to $17.4 million from $14.9 million in 2002 primarily due to business expansion and costs related to transitioning to a new information technology provider. Equipment rentals, depreciation and maintenance expenses remained flat in 2003 at $16.6 million. Communications and courier expense increased 30 percent to $15.9 million in 2003 from $12.2 million in 2002 primarily due to increased expenses related to higher activity levels in First Horizon and Midwest Research. All other expense increased 69 percent to $115.6 million in 2003 from $68.5 million in 2002. Contributing to this increase was a $9.8 million contribution made to the First Tennessee Foundation, a non-profit entity dedicated to supporting charitable causes in the communities where FTNC does business. Also contributing to the increase in all other expense was the growth in expense associated with higher activity levels in First Horizon and increased advertising and professional fee expense.


26



PROVISION FOR LOAN LOSSES / ASSET QUALITY

The provision for loan losses is the charge to earnings that management determines to be necessary to maintain the allowance for loan losses at an adequate level reflecting management’s estimate of probable incurred losses in the loan portfolio. An analytical model based on a three-year moving average of historical loss experience adjusted for current events, trends and economic conditions is used by management to determine the amount of provision to be recognized and to assess the adequacy of the loan loss allowance. The provision for loan losses increased 18 percent in 2003 to $27.5 million from $23.3 million in 2002. This increase is primarily due to higher historical loss factors on commercial loans and rapid growth in retail loans. The loss factors on commercial loans were influenced by the inclusion of 2002 charge-offs in the historical loss calculation and reflect the impact of an extended period of slow economic growth on our customer base. These negative impacts were partially offset by improvement in asset quality of retail loans due to a change in risk profile, including the effects of whole-loan insurance being provided for a segment of the loan portfolio and the sale of Money Center loans. Additional asset quality information is provided in Table 4 – Asset Quality Information and Table 5 – Charge-off Ratios.

Net charge-offs decreased to $12.9 million in 2003 compared to $24.5 million last year. Net charge-offs were impacted in second quarter 2003 by improvement in both the consumer and commercial loan portfolios. The ratio of allowance for loan losses to total loans, net of unearned income (coverage ratio), decreased to 1.25 percent on June 30, 2003, compared to 1.40 percent on June 30, 2002, primarily reflecting improvements in the retail loan portfolio’s risk profile, including the effects of the whole loan insurance, the sale of Money Center loans and the transfer of certain loans to held for sale.

Nonperforming loans were $66.6 million on June 30, 2003, compared to $59.5 million on June 30, 2002. The ratio of nonperforming loans in the loan portfolio to total loans was .46 percent on June 30, 2003, compared to .56 percent on June 30, 2002. Nonperforming assets totaled $83.1 million on June 30, 2003, compared to $81.1 million on June 30, 2002. On June 30, 2003, FTNC had no concentrations of 10 percent or more of total loans in any single industry.

Going forward, the level of provision for loan losses should fluctuate primarily with the strength or weakness of the economy. In addition, asset quality indicators could be affected by balance sheet strategies and shifts in loan mix to and from products with different risk/reward profiles. Actual results could differ because of several factors, including those presented in the Forward-Looking Statements section of the MD&A discussion.


27



Table 4 - Asset Quality Information

 

 

 

June 30

 

 

 


 

(Dollars in thousands)

 

2003

 

2002

 






 

Lending Activities*:

 

 

 

 

 

 

 

Nonperforming loans

 

$

57,324

 

$

40,300

 

Foreclosed real estate

 

 

8,000

 

 

7,493

 

Other assets

 

 

52

 

 

99

 








 

Total Lending Activities

 

 

65,376

 

 

47,892

 








 

Mortgage Production Activities*:

 

 

 

 

 

 

 

Nonperforming loans - held for sale

 

 

7,245

 

 

 

Nonperforming loans - loan portfolio

 

 

2,026

 

 

19,152

 

Foreclosed real estate

 

 

8,414

 

 

14,006

 








 

Total Mortgage Production Activities

 

 

17,685

 

 

33,158

 








 

Total nonperforming assets

 

$

83,061

 

$

81,050

 








 

Loans and leases 30 to 89 days past due

 

$

88,698

 

$

114,210

Loans and leases 90 days past due

 

 

32,208

 

 

34,710

Potential problem assets**

 

119,991

 

 

125,606

 








 

 

 

 

 

 

 

 

 

 

 

Second Quarter

 

 

 


 

 

 

2003

 

2002

 






 

Allowance for loan losses:

 

 

 

 

 

 

 

Beginning balance on March 31

 

$

144,484

 

$

148,602

 

Provision for loan losses

 

 

27,501

 

 

23,286

 

Charge-offs

 

 

(16,383

)

 

(27,842

)

Loan recoveries

 

 

3,478

 

 

3,371

 








 

Ending balance on June 30

 

$

159,080

 

$

147,417

 








 

 

 

 

 

 

 

 

 

 

 

June 30

 

 

 


 

 

 

2003

 

2002

 






 

Allowance to total loans

 

 

1.25

%

 

1.40

%

Allowance to nonperforming loans in the loan portfolio

 

 

268

 

 

248

 

Nonperforming assets to total loans, foreclosed real estate and other assets (Lending Activities only)

 

 

.51

 

 

.45

 

Nonperforming assets to unpaid principal balance of servicing portfolio (Mortgage Production Activities only)

 

 

.03

 

 

.07

 








 

  *

Lending activities include all activities associated with the loan portfolio. Mortgage production includes activities associated with the mortgage warehouse.

**

Includes loans and leases 90 days past due.

Certain previously reported amounts have been adjusted to agree with current presentation.


28



Table 5 - Charge-off Ratios

 

 

 

Three Months Ended
June 30

 

 

 


 

 

 

2003

 

2002

 






 

Commercial

 

 

.18

%

 

.68

%

Retail real estate

 

 

.43

 

 

.81

 

Other retail

 

 

.83

 

 

2.94

 

Credit card receivables

 

 

5.12

 

 

5.12

 

Total net charge-offs

 

 

.42

 

 

.94

 








 


INCOME TAXES

The effective tax rate decreased to 31.0 percent for second quarter 2003 compared to 33.4 percent for the same period in 2002. This decline reflects a decrease of $6.2 million, or $9.8 million on a pre-tax equivalent basis, related to the settlement of prior years’ tax returns.

BALANCE SHEET REVIEW

Earning assets

Earning assets primarily consist of loans, loans held for sale and investment securities. For second quarter 2003, earning assets averaged $21.6 billion compared with $16.3 billion for second quarter 2002. The 32 percent increase in earning assets was primarily due to growth in the mortgage warehouse of 154 percent and an 18 percent increase in loans. Average total assets increased 29 percent to $25.1 billion from $19.4 billion in second quarter 2002.

Loans

Average total loans increased 18 percent for second quarter 2003 to $12.3 billion primarily due to an increase of 27 percent in retail loans principally from growth in equity lending. Commercial loans increased 10 percent to $6.0 billion. Additional loan information is provided in Table 6.

Table 6 - Average Loans

 

 

 

Three Months Ended
June 30

 

 

 



(Dollars in millions)

 

2003

 

Percent
of Total

 

Growth
Rate

         

2002

 

Percent
of Total

 













Commercial:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, financial and industrial

 

$

4,274.6

 

35

%

8.9

%

$

3,926.2

 

37

%

Real estate commercial

 

 

1,091.3

 

9

 

6.8

 

 

1,021.5

 

10

 

Real estate construction

 

 

616.4

 

5

 

21.1

 

 

508.8

 

5

 

Retail:

 

 

 

 

 

 

 

 

 

 

 

 

 

Real estate residential

 

 

5,409.7

 

44

 

33.3

 

 

4,056.9

 

39

 

Real estate construction

 

 

396.4

 

3

 

69.4

 

 

234.0

 

2

 

Other retail

 

 

265.3

 

2

 

(37.6

)

 

425.4

 

4

 

Credit card receivables

 

 

260.6

 

2

 

(1.6

)

 

264.7

 

3

 















Total loans, net of unearned

 

$

12,314.3

 

100

%

18.0

%

$

10,437.5

 

100

%
















During years prior to 2003 certain retail loans have been securitized. The majority of these securities are owned by subsidiaries of FTNC, including FTBNA, and are classified as investment securities.


29



Loans Held for Sale / Investment Securities

Loans held for sale, consisting primarily of mortgage loans, increased 155 percent to $5.2 billion in 2003 from $2.0 billion in 2002 due to the high level of originations in 2003. Average investment securities remained flat at $2.4 billion in 2003.

Deposits / Other Sources of Funds

Since second quarter 2002, average core deposits increased 16 percent to $10.8 billion from $9.3 billion while interest-bearing core deposits remained relatively flat at $5.8 billion compared to $5.9 billion in 2002. Noninterest-bearing deposits increased 44 percent in second quarter 2003 to $5.0 billion from $3.5 billion due to growth in mortgage escrow accounts and a cash management product. Short-term purchased funds increased 40 percent to $9.6 billion from $6.8 billion for the previous year. Short-term purchased funds accounted for 44 percent of FTNC’s funding (core deposits plus purchased funds and term borrowings) for second quarter 2003 compared to 41 percent for second quarter 2002. Term borrowings increased to $1.2 billion for second quarter 2003 compared to $.6 billion for second quarter 2002. This increase reflects the issuance in second quarter 2003 of $250 million of unsecured, subordinated notes by FTBNA and $100 million of unsecured, subordinated notes by FTNC (see Note 8 – Term Borrowings for additional information).

LIQUIDITY MANAGEMENT

The objective of liquidity management is to ensure the continuous availability of funds to meet the demands of depositors, other creditors and borrowers. The Asset/Liability Committee, a committee consisting of senior management that meets regularly, is responsible for managing these needs by taking into account the marketability of assets; the sources, stability and availability of funding; and the level of unfunded commitments. Core deposits are FTNC’s primary source of funding and have been a stable source of liquidity for banks. These deposits are insured by the Federal Deposit Insurance Corporation to the maximum extent authorized by law. For second quarter 2003, the average total loan to core deposit ratio was 114 percent compared with 112 percent in second quarter 2002. FTBNA has a bank note program available for additional liquidity, under which the bank may borrow funds from time to time, at maturities of 30 days to 30 years. On June 30, 2003, approximately $1.2 billion was available under the bank note program as a long-term (greater than one year) funding source. FTNC also evaluates alternative sources of funding, including loan sales, securitizations, syndications, and debt offerings in its management of liquidity.

First Horizon Home Loans originates conventional conforming and federally insured single-family residential mortgage loans. Likewise, First Tennessee Capital Assets Corporation frequently purchases the same types of loans from our customers. Substantially all of these mortgage loans are exchanged for securities, which are issued through GNMA for federally insured loans and FNMA and FHLMC for conventional loans, and then sold in the secondary markets. In many cases First Horizon Home Loans retains the right to service and receive servicing fees on these loans. After sale, these loans are not reflected on the Consolidated Statements of Condition. Each of these GSE’s has specific guidelines and criteria for sellers and servicers of loans backing their respective securities. During second quarter 2003, approximately $11.8 billion of conventional and federally insured mortgage loans were securitized and sold by First Horizon Home Loans through these GSE’s. FTNC’s use of these GSE’s as an efficient outlet for mortgage loan production is an essential source of liquidity for FTNC and other participants in the housing industry.

Certain of First Horizon Home Loans’ originated loans do not conform to the requirements for sale or securitization by FNMA and FHLMC due to exceeding the maximum loan size of approximately $323 thousand (jumbo loans). First Horizon Home Loans pools and securitizes these jumbo loans in proprietary transactions. After securitization and sale, these loans are not reflected on the Consolidated Statements of Condition except as described hereafter. These transactions, which are conducted through single-purpose business trusts, are the most efficient way for First Horizon Home Loans and other participants in the housing industry to monetize these assets. In most cases First Horizon Home Loans retains the right to service and receive servicing fees on these loans and, on occasion, has retained senior principal-only certificates or interest-only strips that are classified on the Consolidated Statement of Condition as trading securities. On June 30, 2003, the outstanding principal amount of loans in these off-balance sheet business trusts was $5.2 billion. Given the significance of First Horizon Home Loans’ origination of non-conforming loans, the use of single-purpose business trusts to securitize these loans is an important source of liquidity to FTNC.

In addition to these transactions, liquidity has been obtained in prior years through issuance of guaranteed preferred beneficial interests in FTNC’s junior subordinated debentures through a Delaware business trust wholly owned by FTNC ($100.0 million on June 30, 2003) and through preferred stock issued by an indirect wholly owned subsidiary of FTNC ($44.4 million on June 30, 2003).


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Parent company liquidity is maintained by cash flows stemming from dividends and interest payments collected from subsidiaries, which represent the primary source of funds to pay dividends to shareholders and interest to debtholders. The parent company also has the ability to enhance its liquidity position by raising equity or incurring debt. Under an effective shelf registration statement on file with the Securities and Exchange Commission (SEC), FTNC, as of June 30, 2003, may offer from time to time at its discretion, debt securities, and common and preferred stock aggregating up to $125 million. In addition, FTNC also has an effective capital securities shelf registration statement on file with the SEC under which up to $200 million of capital securities is available for issuance. See Part II, Item 5 – Other Information (paragraph 1) of this Form 10-Q for discussion of subordinated debt purchased during the tender offer period which ended August 8, 2003, which discussion is incorporated herein by reference.

CAPITAL

Capital adequacy is an important indicator of financial stability and performance. Management’s objectives are to maintain a level of capitalization that is sufficient to sustain asset growth, take advantage of profitable growth opportunities and promote depositor and investor confidence.

Shareholders’ equity was $1.8 billion on June 30, 2003, an increase of 15 percent from $1.6 billion on June 30, 2002. The increase in capital was primarily due to the retention of net income after dividends. The change in capital was reduced by share repurchases, primarily related to stock option exercises, which totaled $150.5 million, or 3.6 million shares since June 30, 2002. Pursuant to board authority, FTNC plans to continue to repurchase shares from time to time for its stock option and other compensation plans and will evaluate the level of capital and take action designed to generate or use capital as appropriate for the interests of the shareholders. On October 16, 2001, the board of directors extended from June 30, 2002, until December 31, 2004, the non-stock option plan-related repurchases of up to 9.5 million shares, previously approved in October 2000. Repurchases will be made in the open market or through privately negotiated transactions and will be subject to market conditions, accumulation of excess equity and prudent capital management. Through June 30, 2003, 2.5 million shares have been repurchased pursuant to this authority.

Average shareholders’ equity increased 17 percent since second quarter 2002 to $1.8 billion from $1.5 billion, reflecting internal capital generation. The average shareholders’ equity to average assets ratio was 7.13 percent for second quarter 2003 compared to 7.87 percent for second quarter 2002. Unrealized market valuations had no material effect on the ratios during second quarter 2003.

On June 30, 2003, the corporation’s Tier 1 capital ratio was 8.68 percent, the total capital ratio was 12.88 percent and the leverage ratio was 6.70 percent. On June 30, 2003, FTNC’s bank affiliates had sufficient capital to qualify as well-capitalized institutions.

FINANCIAL SUMMARY (Comparison of first six months of 2003 to first six months of 2002)

For the first six months of 2003, earnings totaled $237.4 million or $1.81 diluted earnings per share. For the same period in 2002, earnings were $177.5 million or $1.36 diluted earnings per share. Return on average shareholders’ equity was 27.1 percent and return on average assets was 1.98 percent for the first six months of 2003 compared to 23.7 percent and 1.82 percent, respectively, for the first six months of 2002.

For the first six months of 2003, total revenues were $1,460.0 million, an increase of 43 percent from 2002. Noninterest expense increased 49 percent to $1,051.8 million for the six-month period in 2003 compared to $707.3 million in 2002.

BUSINESS LINE REVIEW

First Horizon

For the first six months of 2003, pre-tax income increased 168 percent to $229.6 million from $85.5 million in 2002. Total revenues for the six-month period were $717.3 million, an increase of 95 percent from $368.2 million in 2002. During this period, fees from the mortgage origination process increased $295.0 million and MSR’s net hedge results increased $43.4 million compared to the first six months of 2002. Amortization of capitalized mortgage servicing rights was $63.7 million compared to $59.6 million in 2002 and MSR’s impairment loss in 2003 increased to $114.8 million from $56.3 million in 2002. See Table 1 – Mortgage Banking for a breakout of noninterest income as well as mortgage banking origination volume and servicing portfolio levels. Total noninterest expense for the six-month period increased 79 percent to $468.1 million from $262.1 million in 2002. Total noninterest expense increased primarily due to an 89 percent increase in personnel expense primarily due to increased origination volume. In addition, a $14.0 million loss was incurred related to the termination of a lease arrangement with a single purpose entity for First Horizon’s main office headquarters. The reasons for the year-to-date trends were similar to the quarterly trend information already discussed.


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FTN Banking Groups

For the first six months of 2003, pre-tax income decreased 52 percent to $61.7 million from $128.3 million. Total revenues for the six-month period were $354.9 million, a decrease of 7 percent from $383.2 million in 2002. Total noninterest expense for the six-month period increased 14 percent to $258.1 million from $225.6 million in 2002. The reasons for the year-to-date trends were similar to the quarterly trend information already discussed.

FTN Financial

For the first six months of 2003, pre-tax income increased 35 percent to $98.8 million from $73.4 million in 2002. Total revenues for the six-month period were $322.7 million, an increase of 48 percent from $218.0 million in 2002. Total noninterest expense for the six-month period increased 54 percent to $223.6 million from $145.3 million in 2002 primarily due to an increase of 54 percent in personnel expense resulting from commissions and incentives associated with the higher fee income this year. The reasons for the year-to-date trends were similar to the quarterly trend information already discussed.

Transaction Processing

For the first six months of 2003, pre-tax income decreased 20 percent to $9.3 million from $11.6 million in 2002. The reasons for the year-to-date trends were similar to the quarterly trend information already discussed.

Corporate

For the first six months of 2003, Corporate had a pre-tax loss of $45.6 million compared to a pre-tax loss of $31.5 million in 2002. Included in the pre-tax loss for 2003 is the $9.8 million contribution made to the First Tennessee Foundation and $12.4 million of expense related to modifications in and funding of an old deferred compensation plan, primarily for retirees. In 2002, $6.6 million of expense was related to a specific litigation matter.

INCOME STATEMENT REVIEW

Noninterest income for the first six months of 2003 was $1,066.8 million and contributed 73 percent to total revenue as compared to $661.5 million, or 65 percent of total revenues in 2002. Mortgage banking fee income increased 118 percent to $548.4 million from $251.2 million. During this period, fees from the mortgage origination process increased $295.0 million and MSR’s net hedge results increased $43.4 million compared to the first six months of 2002. Amortization of capitalized mortgage servicing rights increased 7 percent to $63.7 million from $59.6 million in 2002 and MSR’s impairment loss in 2003 was $114.8 million compared to $56.3 million in 2002. See Table 1 – Mortgage Banking for a breakout of noninterest income as well as mortgage banking origination volume and servicing portfolio levels. Fee income from capital markets increased 51 percent to $298.3 million from $197.8 million for 2002. For the first six months of 2003, fee income in deposit transactions and cash management grew 4 percent to $71.4 million from $68.8 million. Insurance premiums and commissions increased 14 percent to $29.7 million from $25.9 million in 2002. Trust services and investment management fees decreased 19 percent to $22.2 million from $27.4 million, and merchant-processing fees increased 16 percent to $26.4 million from $22.8 million. Security losses declined 23 percent to $1.8 million from $2.3 million in 2002. All other income and commissions increased 3 percent to $72.2 million from $69.9 million. The reasons for the year-to-date trends were similar to the quarterly trend information already discussed.

Net interest income increased 9 percent to $393.2 million from $361.5 million for the first six months of 2002 while earning assets increased 26 percent to $20.6 billion from $16.4 billion in 2002. Year-to-date consolidated margin decreased to 3.83 percent in 2003 from 4.43 percent in 2002. The reasons for the year-to-date trends were similar to the quarterly trend information already discussed.

Total noninterest expense for the first six months of 2003 increased 49 percent to $1,051.8 million from $707.3 million in 2002. Personnel expense increased $241.1 million or 55 percent in 2003 primarily due to higher activity levels in First Horizon and FTN Financial. This increase also includes $11.7 million of expense related to modifications in and funding of an old deferred compensation plan, primarily for retirees. Occupancy expense increased 11 percent in 2003 to $39.4 million from $35.6 million in 2002 due to higher costs in First Horizon associated with the opening of new offices related to the increased origination volumes and the higher realty taxes in second quarter 2003. Equipment rentals, depreciation and maintenance expense increased 4 percent in 2003 to $33.8 million from $32.5 million in 2002.


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Communications and courier expense increased 20 percent to $30.7 million in 2003 from $25.5 million in 2002 primarily due to the increased activity levels of First Horizon and FTN Financial. Operations services increased 19 percent to $35.1 million from $29.4 million in 2002. Amortization of intangible assets increased 19 percent to $3.5 million from $3.0 million in 2002. All other expense increased 62 percent to $228.0 million in 2003 from $141.1 million. Included in this increase was the $9.8 million contribution to the First Tennessee Foundation and a loss of $14.0 million related to the termination of a lease arrangement with a single purpose entity for First Horizon’s main office headquarters. Also contributing to the increase in all other expense was the growth in expense associated with higher activity levels in First Horizon and increased advertising and professional fee expense. The provision for loan losses increased 12 percent to $55.0 million from $49.2 million in the first six months of 2002. The effective tax rate decreased to 32.8 percent compared to 33.4 percent. Unless otherwise noted, the reasons for the year-to-date trends were similar to the quarterly trend information already discussed. See also Business Line Review for additional information.

BALANCE SHEET REVIEW

For the first six months of 2003, total assets averaged $24.2 billion compared with $19.7 billion in 2002. Average loans grew 15 percent to $11.9 billion from $10.4 billion for the first six months of 2002. Average commercial loans increased 6 percent to $5.8 billion compared $5.5 billion in 2002. Retail loans increased 25 percent to $6.1 billion in 2003 compared to $4.9 billion in 2002. Average investment securities increased 1 percent to $2.5 billion from $2.4 billion for 2002. Loans held for sale, consisting primarily of mortgage loans, increased 105 percent for the six-month period to $4.7 billion from $2.3 billion in 2002.

For the first six months of 2003, average core deposits increased 13 percent to $10.6 billion from $9.3 billion. While interest-bearing core deposits decreased 1 percent to $5.8 billion from $5.9 billion, noninterest-bearing deposits increased 36 percent to $4.7 billion from $3.5 billion in 2002. Short-term purchased funds increased 29 percent for the six-month period to $9.1 billion from $7.1 billion.

APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

FTNC’s accounting policies are fundamental to understanding management’s discussion and analysis of financial condition and results of operations. The consolidated financial statements of FTNC are prepared in conformity with accounting principles generally accepted in the United States and follow general practices within the industries in which it operates. The preparation of the financial statements requires management to make certain judgments and assumptions in determining accounting estimates. Accounting estimates are considered critical if (a) the estimate requires management to make assumptions about matters that were highly uncertain at the time the accounting estimate was made, and (b) different estimates reasonably could have been used in the current period, or changes in the accounting estimate are reasonably likely to occur from period to period, that would have a material impact on the presentation of FTNC’s financial condition, changes in financial condition or results of operations.

It is management’s practice to discuss critical accounting policies with the Board of Directors’ Audit Committee, including the development, selection and disclosure of the critical accounting estimates. Management believes the following critical accounting policies are both important to the portrayal of the company’s financial condition and results of operations and require subjective or complex judgments. These judgments about critical accounting estimates are based on information available as of the date of the financial statements.

Mortgage Servicing Rights and Other Related Retained Interests

When First Horizon Home Loans sells mortgage loans in the secondary market to investors, it generally retains the right to service the loans sold in exchange for a servicing fee that is collected over the life of the loan as the payments are received from the borrower. The expected present value of the anticipated cash flows received for servicing the loan, net of the estimated costs of servicing the loan, is capitalized as MSR’s on the Consolidated Statements of Condition. In certain cases, when First Horizon Home Loans sells mortgage loans in the secondary market, it retains an interest in the mortgage loans sold primarily through interest-only certificates. Interest-only certificates are financial assets, which represent rights to receive earnings from serviced assets that exceed contractually specified servicing fees.


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MSR’s Estimated Fair Value

The fair value of MSR’s typically rises as market interest rates increase and declines as market interest rates decrease; however, the extent to which this occurs depends in-part on (1) the magnitude of changes in market interest rates, and (2) the differential between the then current market interest rates for mortgage loans and the mortgage interest rates included in the mortgage servicing portfolio.

Since sales of MSR’s tend to occur in private transactions and the precise terms and conditions of the sales are typically not readily available, there is a limited market to refer to in determining the fair value of MSR’s. As such, like other participants in the mortgage banking business, First Horizon Home Loans relies primarily on a discounted cash flow model to estimate the fair value of its MSR’s. This model calculates estimated fair value of the MSR’s using numerous tranches of MSR’s, which share similar key characteristics, such as interest rates, type of product (fixed vs. variable), age (new, seasoned, moderate), agency type and other factors. First Horizon Home Loans uses assumptions in the model that it believes are comparable to those used by other participants in the mortgage banking business and reviews estimated fair values and assumptions with third-party brokers and other service providers on a quarterly basis. First Horizon Home Loans also compares its estimates of fair value and assumptions to recent market activity and against its own experience.

Estimating the cash flow components of net servicing income from the loan and the resultant fair value of the MSR’s requires First Horizon Home Loans to make several critical assumptions based upon current market and loan production data.

Prepayment speeds: Generally, when market interest rates decline and other factors favorable to prepayments occur there is a corresponding increase in actual and expected borrower prepayments as customers refinance existing mortgages under more favorable interest rate terms. When a mortgage loan is prepaid, or is expected to prepay faster than originally expected, the anticipated cash flows associated with servicing that loan are terminated or reduced, resulting in a reduction, or impairment, to the fair value of the capitalized MSR’s. To estimate prepayment speeds, First Horizon Home Loans utilizes a third-party prepayment model, which is based upon statistically derived data linked to certain key principal indicators involving historical borrower prepayment activity associated with mortgage loans in the secondary market, current market interest rates and other factors. For purposes of model valuation, estimates are made for each product type within the MSR’s portfolio on a monthly basis.

Discount rate: Represents the rate at which the expected cash flows are discounted to arrive at the net present value of servicing income. Estimated discount rates will change with market conditions (i.e., supply vs. demand) and be reflective of the yields expected to be earned by market participants investing in MSR’s.

Cost to service: Expected costs to service are estimated based upon the costs that a market participant would use in evaluating the potential acquisition of MSR’s.

Float income: Estimated float income is driven by expected float balances (principal and interest payments that are held pending remittance to the investor) and current market interest rates, including the thirty day London Inter-Bank Offered Rate (LIBOR) and five-year swap interest rates, which are updated on a monthly basis for purposes of estimating the fair market value of MSR’s.

First Horizon Home Loans engages in a process referred to as “price discovery” on a monthly basis to assess the reasonableness of the estimated fair value of MSR’s. Price discovery is conducted through a process of obtaining the following information: (a) monthly informal valuation of the servicing portfolio by a prominent mortgage-servicing broker, and (b) a collection of surveys and benchmarking data available through third party participants in the mortgage banking business. Although there is no single source of market information that can be relied upon to assess the fair value of MSR’s, First Horizon Home Loans reviews all information obtained during price discovery to determine whether the estimated fair value of MSR’s is reasonable when compared to market information. On June 30, 2003 and 2002, based upon the information obtained through price discovery, First Horizon Home Loans determined that its MSR valuations and assumptions were reasonable based on the price discovery process.

The overall assessment of the estimated fair value of MSR’s is submitted monthly for review by the First Horizon Risk Management Committee (FHRMC). The FHRMC is responsible for approving the critical assumptions used by management to determine the estimated fair value of First Horizon Home Loans’ MSR’s. Each quarter, First Tennessee’s MSR’s Committee reviews the original valuation, impairment, and the initial capitalization rates for newly originated MSR’s. In addition, the Executive Committee of First Tennessee’s board of directors reviews the initial capitalization rates and approves the calculation of amortization expense.

MSR’s are included on the Consolidated Statements of Condition, net of accumulated amortization. The changes in fair value of MSR’s are included as a component of Mortgage Banking – Noninterest Income on the Consolidated Statements of Income.


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Hedging the Fair Value of MSR’s

In order to provide protection from a decline in the fair value of MSR’s, First Horizon Home Loans employs a hedging strategy. This strategy uses derivative financial instruments expected to change in fair value in response to changes in a certain benchmark interest rate (specifically, the 10-year LIBOR) in amounts which will substantially offset the change in fair value of certain MSR’s. On June 30, 2003 and 2002, hedged MSR’s approximated 92 percent and 95 percent of the total MSR’s portfolio, as measured on a dollar at risk basis. In order to substantially hedge the change in fair value of the hedged MSR’s, First Horizon Home Loans generally maintains a coverage ratio (the ratio of the notional amount of derivatives to the carrying amount of the hedged MSR’s) approximating 100 percent of the hedged MSR’s portfolio. As noted above, to the extent that actual borrower prepayments do not react as anticipated by the prepayment model (i.e., the historical data observed in the model does not correspond to actual market activity), it is possible that the prepayment model could fail to accurately predict mortgage prepayments and could result in significant earnings volatility. Pursuant to SFAS No. 133, in any hedge period the difference between the change in fair value of the hedged MSR’s, attributed to the change in the benchmark interest rate, and the change in fair value of the derivatives used to hedge the change in fair value of the MSR’s is recognized as gains or losses in current earnings. First Horizon Home Loans generally attempts to hedge 100 percent of the exposure to a change in the fair value of the hedged MSR’s attributed to a change in the benchmark interest rate, which requires a regular assessment of the amount of derivative financial instruments required to maintain a 100 percent hedge ratio. On June 30, 2003 and 2002, the hedge coverage ratio was approximately 100 percent of the hedged MSR’s portfolio.

Certain components of the fair value of derivatives used to hedge certain MSR’s are excluded from the assessment of hedge effectiveness. Although those amounts are excluded from the assessment of hedge effectiveness, they are included as a component of current earnings in the Consolidated Statements of Income.

The derivative financial instruments used to hedge the change in fair value of hedged MSR’s primarily include interest rate floors, interest rate swaps, swaptions and forward purchase contracts of mortgage backed securities (known as “to be announced” mortgage backed securities, or TBA’s).

First Horizon Home Loans generally experiences increased loan origination and production in periods of low interest rates, which result in the capitalization of new MSR’s associated with new production – this provides for a “natural hedge” in the mortgage banking business cycle. The “replenishment rate” during 2003 – meaning the ratio of new loans originated for every existing customer mortgage loan that prepays – was almost two to one, which includes the retention of existing First Horizon Home Loans customers who prepay their mortgage loans. First Horizon Home Loans capitalized $127.4 million of MSR’s during second quarter 2003, thereby providing a significant offset to the impairment charges recognized related to MSR’s. This new production volume contributed significantly to the overall positive results experienced during 2003, despite significant prepayments and MSR’s impairment charges. New production and origination does not prevent First Horizon Home Loans from recognizing impairment expense on existing servicing rights as a result of prepayments; rather, the new production volume results in loan origination fees and the capitalization of MSR’s as a component of realized gains related to the sale of such loans in the secondary market, thus the “natural hedge” which tends to offset a portion of the MSR’s impairment charges during a period of low interest rates. In a period of increased borrower prepayments, impairment can be significantly offset by a strong replenishment rate and strong net margins on new loan originations. To the extent that First Horizon Home Loans is unable to maintain a strong replenishment rate, or in the event that the net margin on new loan originations declines from historical experience, the value of the natural hedge may diminish, thereby significantly impacting the results of operations in a period of increased borrower prepayments.

First Horizon Home Loans does not specifically hedge the change in fair value of MSR’s attributed to other risks, including anticipated prepayments (representing the difference between actual prepayment experience and estimated prepayments derived from the model, as described above), basis risk (meaning, the risk that changes in the benchmark interest rate may not correlate to changes in the mortgage market interest rates), discount rates, cost to service and other factors. To the extent that these other factors result in changes to the fair value of MSR’s, First Horizon Home Loans experiences volatility in current earnings due to the fact that these risks are not currently hedged.

Actual vs. Estimated MSR’s Critical Assumptions

As discussed above, the estimate of the cash flow components of net servicing income associated with MSR’s requires management to make several critical assumptions based upon current market and loan production data, including prepayment speeds, discount rate, cost to service and float income. Inherent in estimating such assumptions are uncertainties associated with the mortgage banking business (primarily, the change in market interest rates which vary significantly due to multiple economic and non-economic factors) as well as the composition of the MSR’s portfolio, which is not static and changes significantly based upon the production and sale of new loans, customer prepayment experience and other factors. As a result, the estimated assumptions used to value MSR’s – particularly the estimate of prepayment speeds – can vary significantly from actual experience, resulting in the recognition of additional impairment charges in current earnings. Table 7 provides a summary of actual and estimated weighted average prepayment speeds and float income used in determining the estimated fair value of MSR’s for the quarters ended June 30, 2003 and 2002. Although the estimates of discount rates and cost to service assumptions used in determining the estimated fair value of MSR’s can vary from actual experience, such differences have not been material for the quarters ended June 30, 2003 and 2002.


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Table 7 - MSR’s Critical Assumptions

 

 

 

Three Months Ended
June 30

 

 

 


 

(Dollars in millions) 

 

2003

 

2002

 






 

Prepayment speeds

 

 

 

 

 

Actual

 

59.9

%

34.0

%

Estimated*

 

69.1

 

29.0

 

Float income           

 

 

 

 

 

Actual

 

11.2

 

8.9

 

Estimated 

 

8.6

 

8.8

 






 

*

Estimated prepayment speeds represent monthly average prepayment speed estimates for each of the periods presented.

During the quarter ended June 30, 2003 and 2002, impairment charges associated with MSR’s of $72.3 million and $24.9 million, respectively, were recognized, which were principally associated with differences between actual and estimated prepayment speeds and other factors, including basis risk associated with benchmark interest rates and actual float income earnings. The decrease in value of MSR’s was partially offset by an increase in fair value of the derivative financial instruments used to hedge the change in fair value of the hedged MSR’s (see Table 1 – Mortgage Banking).

Interest-Only Certificates Fair Value

Consistent with MSR’s, the fair value of an interest-only certificate typically rises as market interest rates increase and declines as market interest rates decrease. Additionally, similar to MSR’s, the market for interest-only certificates is limited, and the precise terms of transactions involving interest-only certificates are not typically readily available. Accordingly, First Horizon Home Loans relies primarily on a discounted cash flow model to estimate the fair value of its interest-only certificates.

Estimating the cash flow components and the resultant fair value of the interest-only certificates requires First Horizon Home Loans to make certain critical assumptions based upon current market and loan production data. The primary critical assumptions used by First Horizon Home Loans to estimate the fair value of interest-only securities include prepayment speeds and discount rates, as discussed above. First Horizon Home Loans interest-only certificates are included as a component of trading securities on the Consolidated Statements of Condition, with realized and unrealized gains and losses included in current earnings as a component of mortgage banking income on the Consolidated Statements of Income.

Hedging the Fair Value of Interest-Only Certificates

First Horizon Home Loans employs an economic hedging strategy for interest-only certificates, which uses derivative financial instruments expected to change in fair value in response to changes in a certain benchmark interest rate (specifically, the 10-year LIBOR) in amounts which will substantially offset the change in fair value of certain interest-only certificates. Realized and unrealized gains and losses associated with the change in fair value of derivatives used in the economic hedge of interest-only certificates are included in current earnings on the Consolidated Statements of Income. The extent to which the change in fair value of interest-only securities is offset by the change in fair value of the derivatives used to hedge these instruments depends primarily on the hedge coverage ratio maintained by First Horizon Home Loans. Also, as noted above, to the extent that actual borrower prepayments do not react as anticipated by the prepayment model (i.e., the historical data observed in the model does not correspond to actual market activity), it is possible that the prepayment model could fail to accurately predict mortgage prepayments, which could significantly impact First Horizon Home Loans’ ability to effectively hedge certain components of the change in fair value of interest-only certificates and could result in significant earnings volatility. The derivative financial instruments used to hedge the change in fair value of hedged interest-only certificates primarily include interest rate floors, interest rate swaps, swaptions and TBA’s.


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Pipeline and Warehouse

During the period of loan origination, and prior to the sale of mortgage loans in the secondary market, First Horizon Home Loans has exposure to mortgage loans that are in the “mortgage pipeline” and the “mortgage warehouse”. The mortgage pipeline consists of loan applications that have been received, but have not yet closed as loans. Pipeline loans are either “floating” or “locked”. A floating pipeline loan is one on which an interest rate has not been locked by the borrower. A locked pipeline loan is one on which the potential borrower has set the interest rate for the loan by entering into an IRLC resulting in interest rate risk to First Horizon Home Loans. Once a mortgage loan is closed and funded, it is included within the mortgage warehouse, or the “inventory” of mortgage loans that are awaiting sale and delivery (currently an average of approximately 30 days) into the secondary market. First Horizon Home Loans is exposed to credit risk during the short period a mortgage loan is in the warehouse.

An IRLC binds First Horizon Home Loans to lend funds to the potential borrower at the set interest rate, which expires on a fixed date regardless of whether or not interest rates change in the market. IRLC’s generally have a term of up to 60-days before the closing of the loan. The IRLC, however, does not bind the potential borrower to entering into the loan, nor does it guarantee that First Horizon Home Loans will approve the potential borrower for the loan. Therefore, First Horizon Home Loans makes estimates of expected “fallout” (locked pipeline loans not expected to close) using models, which consider cumulative historical fallout rates and other factors. Fallout can occur for a variety of reasons including falling rate environments when a borrower will abandon an IRLC at one lender and enter into a new lower IRLC at another, when a borrower is not approved as an acceptable credit by the lender, or for a variety of other non-economic reasons. Note that once a loan is closed, the risk of fallout is eliminated and the associated mortgage loan is included in the mortgage loan warehouse. Under SFAS No. 133, IRLC’s qualify as derivative financial instruments and, therefore, the changes in fair value of IRLC’s are included in current earnings in the Consolidated Statements of Income. Third party models are also used to manage interest rate risk related to price movements on loans in the pipeline and the warehouse.

Like other participants in the mortgage banking business, First Horizon Home Loans relies primarily on an internal valuation model and one of several industry valuation techniques to estimate the fair value of IRLC’s and the mortgage warehouse. This model calculates the estimated fair value using tranches of mortgage loans that are determined to share similar key characteristics, including product type and interest rate bands. For purposes of determining the market interest rates for forward commitments to sell mortgage loans in the secondary market, First Horizon Home Loans obtains market interest rates from independent third parties, which represent actual trade activity in the secondary market. For purposes of determining the fair value of IRLC’s, management utilizes the median broker price information obtained in the secondary market, resulting in an asset with an estimated fair value of $27.4 million and an asset of $22.5 million on June 30, 2003 and 2002, respectively.

To hedge against changes in fair value of the mortgage pipeline and warehouse due to changes in interest rates, First Horizon Home Loans utilizes various derivative financial instruments, which management expects will experience changes in fair value opposite to the change in fair value of the loans in the pipeline and warehouse, thus minimizing earnings volatility. The instruments and techniques used to hedge the pipeline and warehouse include forward sales commitments and other interest rate derivatives. The extent to which First Horizon Home Loans is able to economically hedge changes in the mortgage pipeline depends largely on the hedge coverage ratio that is maintained relative to mortgage loans in the pipeline. The hedge ratio can change significantly due to changes in market interest rates and the associated forward commitment prices for sales of mortgage loans in the secondary market. Increases or decreases in the hedge coverage ratio can result in significant earnings volatility to First Horizon Home Loans. First Horizon Home Loans does not specifically hedge the change in fair value of the mortgage pipeline attributed to other risks, including basis risk and other factors.

Foreclosure Reserves

As discussed above, First Horizon Home Loans typically originates mortgage loans with the intent to sell those loans to GSE’s and other private investors in the secondary market. Certain of the mortgage loans are sold with limited or full recourse in the event of foreclosure. On June 30, 2003 and 2002, approximately $4.0 billion and $4.8 billion of mortgage loans were outstanding which were sold under limited recourse arrangements. On June 30, 2003 and 2002, approximately $140.5 million and $210.6 million of mortgage loans were outstanding which were sold under full recourse arrangements.

Loans sold with limited recourse include loans sold under government guaranteed mortgage loan programs including Department of Housing and Urban Development (HUD), Federal Housing Administration (FHA) and Veterans Administration (VA). First Horizon Home Loans continues to absorb limited risk of credit losses in the event of foreclosure of the mortgage loan sold. Generally, the amount of recourse liability in the event of foreclosure is determined based upon the respective government program and/or the sale or disposal of the foreclosed property collateralizing the mortgage loan. Another instance of limited recourse is the VA/No bid. In this case, the VA guarantee is limited and First Horizon Home Loans may be required to fund any deficiency in excess of the VA guarantee if the loan goes to foreclosure.


37



Loans sold with full recourse generally include mortgage loans sold to investors in the secondary market which are uninsurable under government guaranteed mortgage loan programs, due to issues associated with underwriting activities, documentation or other concerns.

Management closely monitors historical experience, borrower payment activity, current economic trends and other risk factors, and establishes a reserve for foreclosure losses for loans sold with limited and full recourse which management believes is sufficient to cover incurred foreclosure losses in the portfolio. The reserve for foreclosure losses is based upon a historical progression model using a rolling 12-month average, which predicts the probability of a mortgage loan entering foreclosure. In addition, other factors are considered, including qualitative and quantitative factors (e.g., current economic conditions, past collection experience, risk characteristics of the current portfolio and other factors), which are not defined by historical loss trends. On June 30, 2003 and 2002, the foreclosure reserve was $31.3 million and $30.2 million, respectively.

Allowance for Loan Losses

Management’s policy is to maintain the allowance for loan losses at a level sufficient to absorb estimated probable incurred losses in the loan portfolio. Management performs periodic and systematic detailed reviews of its loan portfolio to identify trends and to assess the overall collectibility of the loan portfolio. Accounting standards require that loan losses be recorded when management determines it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Management believes the accounting estimate related to the allowance for loan losses is a “critical accounting estimate” because: changes in it can materially affect the provision for loan losses and net income, it requires management to predict borrowers’ likelihood or capacity to repay, and it requires management to distinguish between losses incurred as of a balance sheet date and losses expected to be incurred in the future. Accordingly, this is a highly subjective process and requires significant judgment since it is often difficult to determine when specific loss events may actually occur. This critical accounting estimate applies primarily to the First Tennessee Banking Group, First Horizon and FTN Financial business segments.

FTNC’s methodology for estimating the allowance for loan losses is not only critical to the accounting estimate, but to the credit risk management function as well. Key components of the estimation process are as follows: (1) commercial loans determined by management to be individually impaired loans are evaluated individually and specific reserves are determined based on the difference between the outstanding loan amount and the estimated net realizable value of the collateral (if collateral dependent) or the present value of expected future cash flows; (2) individual commercial loans not considered to be individually impaired are segmented based on similar credit risk characteristics and evaluated on a pool basis; (3) retail loans are segmented based on loan types; (4) reserve rates for each portfolio segment are calculated based on historical charge-offs and are adjusted by management to reflect current events, trends and conditions (including economic factors and trends); and (5) management’s estimate of probable incurred losses reflects the reserve rate applied against the balance of loans in each segment of the loan portfolio.

Principal loan amounts are charged off against the allowance for loan losses in the period in which the loan or any portion of the loan is deemed to be uncollectible.

FTNC believes that the critical assumptions underlying the accounting estimate made by management include: (i) the commercial loan portfolio has been properly risk graded based on information about borrowers in specific industries and specific issues with respect to single borrowers; (ii) borrower specific information made available to FTNC is current and accurate; (iii) the loan portfolio has been segmented properly and individual loans have similar credit risk characteristics and will behave similarly; (iv) all known significant loss events have been considered at the time of assessing the adequacy of the allowance for loan losses; (v) the economic factors utilized in the allowance for loan losses estimate are used as a measure of actual incurred losses; (vi) the period of history used for historical loss factors is indicative of the current environment; and (vii) the reserve rates, as well as other adjustments estimated by management for current events, trends, and conditions, utilized in the process reflect an estimate of losses that have been incurred as of the date of the financial statements.

While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses and methodology may be necessary if economic or other conditions differ substantially from the assumptions used in making the estimates or, if required by regulators, based upon information at the time of their examinations. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels vary from previous estimates.

In first quarter 2002, management allocated as a component of its allowance for loan losses a general reserve to reflect management’s estimate of additional probable losses that have been incurred but not specifically identified in the commercial portfolio. This reserve helped to minimize the risks related to the margin of imprecision inherent in the estimation of the allowance for loan losses and provided for other factors not considered in computation of reserve rates applied to loan pools. As of December 31, 2002, management decided to specifically quantify risks previously identified and provided for by the general reserve and adjust reserve rates accordingly to reserve for these items in the appropriate pools, and no longer separately presents a general reserve as a component of the allowance for loan losses. As a result of this decision, management has presented the prior period reserves to reflect this methodology change. Except as noted in this paragraph, there have been no significant changes to the methodology for the quarters ended June 30, 2003 and 2002.


38



Goodwill and Assessment of Impairment

FTNC’s policy is to assess goodwill for impairment at the reporting unit level on an annual basis or between annual assessments if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. Accounting standards require management to estimate the fair value of each reporting unit in making the annual assessment of impairment. Upon adoption of the new accounting standards on January 1, 2002, goodwill is no longer amortized with a periodic charge to earnings. FTNC performed the initial impairment test as of January 1, 2002. Subsequent to the initial evaluation, the annual impairment test will be performed each year as of October 1. The valuations as of January 1, 2002, and October 1, 2002, indicated no goodwill impairment for any of the reporting units.

Management believes the accounting estimates associated with determining fair value as part of the goodwill impairment test is a “critical accounting estimate” because estimates and assumptions are made about FTNC’s future performance and cash flows, as well as other prevailing market factors (interest rates, economic trends, etc.). FTNC’s policy allows management to make the determination of fair value using internal cash flow models or by engaging independent third parties. If a charge to operations for impairment results, this amount would be reported separately as a component of noninterest expense. This critical accounting estimate applies to the First Tennessee Banking Group, First Horizon, FTN Financial, and Transaction Processing business segments. Reporting units have been defined as the same level as the operating business segments.

The impairment testing process conducted by FTNC begins by assigning net assets and goodwill to each reporting unit. FTNC then completes “step one” of the impairment test by comparing the fair value of each reporting unit (as determined based on the discussion below) with the recorded book value (or “carrying amount”) of its net assets, with goodwill included in the computation of the carrying amount. If the fair value of a reporting unit exceeds its carrying amount, goodwill of that reporting unit is not considered impaired, and “step two” of the impairment test is not necessary. If the carrying amount of a reporting unit exceeds its fair value, step two of the impairment test is performed to determine the amount of impairment. Step two of the impairment test compares the carrying amount of the reporting unit’s goodwill to the “implied fair value” of that goodwill. The implied fair value of goodwill is computed by assuming all assets and liabilities of the reporting unit would be adjusted to the current fair value, with the offset as an adjustment to goodwill. This adjusted goodwill balance is the implied fair value used in step two. An impairment charge is recognized for the amount by which the carrying amount of goodwill exceeds its implied fair value.

As noted above, a key estimate made by management during the assessment of impairment is the fair value of each reporting unit. During first quarter 2002, FTNC engaged an independent valuation firm to compute the fair value estimates of each reporting unit as part of its initial impairment assessment as of January 1, 2002. The independent valuation utilized three separate valuation methodologies and applied a weighted average to each methodology in order to determine fair value for each reporting unit. As of October 1, 2002, FTNC performed an internal analysis of each reporting unit to determine whether impairment existed at that date.

In connection with obtaining the independent valuation, management provided certain data and information that was utilized by the third party in their determination of fair value. This information included the 2002 budget and forecasted earnings of FTNC. Management believes that this information is a critical assumption underlying the estimate of fair value. The independent third party made other assumptions critical to the process, including discount rates, asset and liability growth rates, and other income and expense estimates, through discussions with management.

While management uses the best information available to estimate future performance for each reporting unit, future adjustments to management’s projections may be necessary if economic conditions differ substantially from the assumptions used in making the estimates.

Contingent Liabilities

A liability is contingent if the amount is not presently known, but may become known in the future as a result of the occurrence of some uncertain future event. FTNC estimates its contingent liabilities based on management’s estimates about the probability of outcomes and their ability to estimate the range of exposure. Accounting standards require that a liability be recorded if management determines that it is probable that a loss has occurred and the loss can be reasonably estimated. In addition, it must be probable that the loss will be confirmed by some future event. As part of the estimation process, management is required to make assumptions about matters that are by their nature highly uncertain.


39



The assessment of contingent liabilities, including legal contingencies and income tax liabilities, involves the use of critical estimates, assumptions and judgments. Management’s estimates are based on their belief that future events will validate the current assumptions regarding the ultimate outcome of these exposures. However, there can be no assurance that future events, such as court decisions or I.R.S. positions, will not differ from management’s assessments. Whenever practicable, management consults with third party experts (attorneys, accountants, claims administrators, etc.) to assist with the gathering and evaluation of information related to contingent liabilities. Based on internally and/or externally prepared evaluations, management makes a determination whether the potential exposure requires accrual in the financial statements.

OTHER

ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

SFAS No. 133, which was adopted on January 1, 2001, establishes accounting standards requiring that every derivative instrument be recorded on the balance sheet as either an asset or liability measured at its fair value. It requires that changes in the instrument’s fair value be recognized currently in earnings (or other comprehensive income). If certain criteria are met, changes in the fair value of the asset or liability being hedged are also recognized currently in earnings. The initial impact of adopting SFAS No. 133 resulted in a net transition adjustment that was recognized as the cumulative effect of a change in accounting principle.

Fair value is determined on the last business day of a reporting period. This point in time measurement of derivative fair values and the related hedged item fair values may be well suited to the measurement of hedge effectiveness, as well as reported earnings, when hedge time horizons are short. The same measurement however may not consistently reflect the effectiveness of longer-term hedges and, in FTNC’s view, can distort short-term measures of reported earnings. FTNC uses a combination of derivative financial instruments to hedge certain components of the interest rate risk associated with its portfolio of capitalized MSR’s, which currently have an average life of approximately three years. Over this long-term time horizon this combination of derivatives can be effective in significantly mitigating the effects of interest rate changes on the value of the servicing portfolio. However, these derivative financial instruments can and do demonstrate significant price volatility depending upon prevailing conditions in the financial markets. If a reporting period ends during a period of volatile financial market conditions, the effect of such point in time conditions on reported earnings does not reflect the underlying economics of the transactions or the true value of the hedges to FTNC over their estimated lives. The fact that the fair value of a particular derivative is unusually low or high on the last day of the reporting period is meaningful in evaluating performance during the period only if FTNC sells the derivative within the period of time before fair value changes and does not replace the hedge coverage with another derivative. FTNC believes the effect of such volatility on short-term measures of earnings is not indicative of the expected long-term performance of this hedging practice.

FTNC believes a review of the trend, if any, of the servicing rights net value changes under SFAS No. 133 over a long period of time, preferably over an interest rate business cycle, is a more meaningful measure to determine the effectiveness of hedging strategies.

For its internal evaluation of performance, for an applicable period, FTNC reclassifies select components of SFAS 133 hedge ineffectiveness from the reported net income of the First Horizon segment to the Corporate segment. The internal evaluation of long-term performance will include the long-term trend, if any, in these select components of SFAS 133 hedge ineffectiveness.

FURTHER INTERPRETATIONS OF SFAS NO. 133

Certain provisions of SFAS No. 133 continue to undergo significant discussion and debate by the Financial Accounting Standards Board (FASB). One such potential issue involves the assessment of hedge effectiveness (and its impact on qualifying for hedge accounting) when hedging fair value changes of prepayable assets due to changes in the benchmark interest rate. As the FASB continues to deliberate interpretation of the new rules, the potential exists for a difference between FTNC’s interpretation and that of the FASB, the effects of which cannot presently be anticipated but failure to obtain hedge accounting treatment could be significant to results of operations.


40



ACCOUNTING CHANGES

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” which requires certain financial instruments with both liability and equity characteristics to be classified as liabilities on the Consolidated Statement of Condition. The statement updates the accounting for certain financial instruments that, under previous guidance, registrants could account for as equity. This statement is effective on July 1, 2003, and restatement of prior periods is not permitted. Upon adoption of this statement, FTNC expects to classify its mandatorily redeemable financial instruments (preferred stock of subsidiary ($44.4 million on June 30, 2003) and guaranteed preferred beneficial interests in First Tennessee’s junior subordinated debentures ($100.0 million on June 30, 2003)) as liabilities on the Consolidated Statement of Condition. Historically, the related distributions on these instruments ($12.6 million anually) have been classified as noninterest expense on the Consolidated Statements of Income and will be classified as interest expense on a prospective basis.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments”, which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. The provisions of SFAS No. 149 are effective for quarters beginning after June 15, 2003. The impact of adopting this standard will be immaterial to results of future operations.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities”, which requires consolidation by a business enterprise of variable interest entities. This interpretation applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. While certain implementation issues related to this standard continue to undergo interpretation, the impact at implementation of adopting this standard will be immaterial to the results of future operations.


41



Item 3.    Quantitative and Qualitative Disclosures about Market Risk

The information called for by this Item is contained in (a) Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 2 of this report at pages 18 through 41, (b) the Section entitled “Risk Management-Interest Rate Risk Management” of the Management’s Discussion and Analysis of Results of Operations and Financial Condition section of the Financial Appendix to First Tennessee’s 2003 Proxy Statement at pages F-38 through F-42 and (c) the “Interest Rate Risk Management” subsection of Note 1 to FTNC’s consolidated financial statements at pages F-65 through F-66 of the Financial Appendix to FTNC’s 2003 Proxy Statement, and which information is incorporated herein by reference.

Item 4.    Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures.      FTNC’s management, with the participation of FTNC’s chief executive officer and chief financial officer, has evaluated the effectiveness of the design and operation of FTNC’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this quarterly report. Based on that evaluation, the chief executive officer and chief financial officer have concluded that FTNC’s disclosure controls and procedures are effective to ensure that material information relating to FTNC and FTNC’s consolidated subsidiaries is made known to such officers by others within these entities, particularly during the period this quarterly report was prepared, in order to allow timely decisions regarding required disclosure.

(b) Changes in Internal Control over Financial Reporting.       There have not been any changes in FTNC’s internal control over financial reporting during FTNC’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, FTNC’s internal control over financial reporting.


42



Part II.

OTHER INFORMATION

Items 1, 2 and 3

As of the end of the second quarter 2003, the answers to Items 1, 2 and 3 were either inapplicable or negative, and therefore, these items are omitted.

Item 4

Submission of Matters to Vote of Security Holders

(a)

The Corporation’s annual Meeting of Shareholders was held April 15, 2003.

(b)

Proxies for the Annual Meeting were solicited pursuant to Regulation 14 under the Securities Exchange Act of 1934. There were no solicitations in opposition to management’s nominees for election to Class I (Messrs. Martin, Sansom and Ward and Ms. Palmer). The Class I nominees were elected for a three-year term or until their respective successors are duly elected and qualified. Directors continuing in office are Messrs. Blattberg, Cates, Glass, Haslam, Horn, Rose and Yancy.

(c)

At the Annual Meeting, the shareholders also approved the 2003 Equity Compensation Plan and ratified the appointment of KPMG LLP as auditors. The shareholder vote was as follows:

 

Class I Nominees

 

For

 

 

 

Withheld

 

 

 


 

 

 


 

R. Brad Martin

 

104,354,122

 

 

 

4,733,650

 

Vicki R. Palmer

 

104,326,967

 

 

 

4,760,805

 

William B. Sansom

 

107,443,606

 

 

 

1,644,166

 

Jonathan P. Ward

 

107,370,771

 

 

 

1,717,001

 


 

 

 

For

 

Withheld

 

Abstained

 

 

 


 


 


 

2003 Equity Compensation Plan

 

92,804,561

 

14,512,744

 

1,770,467

 

Ratification of Appointment of Auditors

 

105,984,079

 

1,956,442

 

1,147,251

 


There were no “broker non-votes” with respect to any of the nominees, the 2003 Equity Compensation Plan, or the ratification of the appointment of the auditors and no abstentions with respect to any of the nominees.


43



Item 5    Other Information

1)          Debt Repurchase

On August 8, 2003, FTNC completed its tender offer for its 6.75% November 2005 subordinated debt by purchasing $52.1 principal amount (of $75.0 million outstanding on June 30, 2003). Form 8-K filed July 30, 2003, provides further details.

2)          Blackout Notice

The following information is provided in lieu of a filing on Form 8-K, Item 11 [Temporary Suspension of Trading under Registrant’s Employee Benefit Plans], and is reported herein under this Item 5 in accordance with the instructions in SEC Release No. 2003-41.

On July 3, 2003, the Corporation provided notice to its directors and executive officers that the Corporation was moving the recordkeeping administration of its Savings Plan and Trust (the “Plan”) to another provider and that, as a result of the transition to the new provider, participants in the Plan would be restricted in their ability to make changes under the Plan for a period of time (the “blackout period”). Section 306 of the Sarbanes-Oxley Act of 2002 restricts certain transactions in the Corporation’s common stock by directors and executive officers when a blackout period occurs with respect to plans such as the Corporation’s Plan.

The following notice was provided to the Corporation’s directors and executive officers:

Notice of Trading Restrictions on First Tennessee National Corporation Common Stock under the Sarbanes-
Oxley Act of 2002 (July 3, 2003)


This Notice is provided to you pursuant to Section 306(a)(6) of the Sarbanes-Oxley Act of 2002. Under the Sarbanes-Oxley Act, it is unlawful for any director or executive officer of First Tennessee National Corporation or their affiliates to buy, sell or otherwise acquire or transfer any First Tennessee Common Stock, whether directly or indirectly, during a “blackout period” which suspends the ability of participants in the First Tennessee National Corporation Savings Plan and Trust (the “Plan”) to make trades in First Tennessee Common Stock. This prohibition applies to any First Tennessee Common Stock that you now have or may receive in connection with your service or employment as a director or executive officer.

Please be on notice that a “blackout period” is going into effect during which you are prohibited by law from making the transactions in First Tennessee Common Stock described above.

The blackout period will begin on the close of business July 31, 2003, and it is expected to end sometime during the week of September 15, 2003. During the week of September 15, 2003, you may obtain, free of charge, information as to whether the blackout period has ended by contacting Bill Schwindt at wjschwindt@firsttennessee.com or (901)523-5317.

This blackout period is imposed in connection with the conversion of the Plan to a new recordkeeper. The class of equity securities subject to the blackout period is First Tennessee Common Stock.

If you have any questions about the blackout period or this Notice, please contact Gardiner Gruenewald at ggruenewald@firsttennessee.com or (901) 523-5909.

During the blackout period and for two years after the end of the blackout period, a security holder or other interested person may obtain, without charge, the actual beginning and ending dates of the blackout period by contacting Bill Schwindt.


44



No notification of the blackout period was required to be given to the Corporation under Section 101(i)(2)(E) of ERISA because the Corporation participated in the determination of the blackout period.

Item 6

Exhibits and Reports on Form 8-K.

(a)        Exhibits.

 

Exhibit No.

Description

 

 

4

Instruments defining the rights of security holders, including indentures*

 

 

**10(h)

Directors and Executives Deferred Compensation Plan, as amended and restated.

 

 

**10(n)

Non-Employee Directors’ Deferred Compensation Stock Option Plan, as amended and restated.

 

 

**10(r)

2003 Equity Compensation Plan, incorporated herein by reference to Appendix A to the Corporation’s Proxy Statement furnished to shareholders in connection with the annual meeting on April 15, 2003, filed March 18, 2003.

 

 

31(a)

Rule 13a-14(a) Certifications of CEO (pursuant to Section 302 of the Sarbanes-Oxley Act of 2002)

 

 

31(b)

Rule 13a-14(a) Certifications of CFO (pursuant to Section 302 of the Sarbanes-Oxley Act of 2002)

 

 

32(a)

Rule 1350 Certifications of CEO (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)

 

 

32(b)

Rule 1350 Certifications of CFO (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)

 

 

99(a)

The “Risk Management-Interest Rate Risk Management” subsection of the Management’s Discussion and Analysis of Results of Operations and Financial Condition section and the “Interest Rate Risk Management” subsection of Note 1 to FTNC’s consolidated financial statements, contained, respectively, at pages F-38 through F-42 and pages F-65 through F-66, in the Financial Appendix to FTNC’s 2003 Proxy Statement furnished to shareholders in connection with the Annual Meeting of Shareholders on April 15, 2003, filed March 18, 2003, and incorporated herein by reference.

 

 

   *

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 required to be filed as an exhibit.

(b)        Reports on Form 8-K.

The following reports on Form 8-K, with the Date of Report as indicated, were filed during second quarter 2003:

1.

4-14-03 - Item 9: earnings release for first quarter 2003 was furnished.

2.

5-07-03 - Item 5: computation of ratio of earnings to fixed charges for 5 years ended 12-31-02 was filed.

3.

5-12-03 - Item 5: underwriting agreement, terms agreement, supplemental indenture, and form of security related to $100 million of 4.50% subordinated notes due 5-15-03 were filed.

4.

6-09-03 - Item 5: reconciliation of non-GAAP financial measures incorporated into 2002 Form 10-K from financial appendix to 2003 proxy statement was filed.


45



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)



 

By: 


/s/ James F. Keen

     

 

 

 

James F. Keen

DATE:  8/11/03

 

Executive Vice President,
Chief Financial Officer and
Corporate Controller
(Duly Authorized Officer and
Principal Financial Officer)


46



EXHIBIT INDEX

 

Exhibit No.

Description

 

 

4

Instruments defining the rights of security holders, including indentures*

 

 

**10(h)

Directors and Executives Deferred Compensation Plan, as amended and restated.

 

 

**10(n)

Non-Employee Directors’ Deferred Compensation Stock Option Plan, as amended and restated.

 

 

**10(r)

2003 Equity Compensation Plan, incorporated herein by reference to Appendix A to the Corporation’s Proxy Statement furnished to shareholders in connection with the annual meeting on April 15, 2003, filed March 18, 2003.

 

 

31(a)

Rule 13a-14(a) Certifications of CEO (pursuant to Section 302 of the Sarbanes-Oxley Act of 2002)

 

 

31(b)

Rule 13a-14(a) Certifications of CFO (pursuant to Section 302 of the Sarbanes-Oxley Act of 2002)

 

 

32(a)

Rule 1350 Certifications of CEO (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)

 

 

32(b)

Rule 1350 Certifications of CFO (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)

 

 

99(a)

The “Risk Management-Interest Rate Risk Management” subsection of the Management’s Discussion and Analysis of Results of Operations and Financial Condition section and the “Interest Rate Risk Management” subsection of Note 1 to FTNC’s consolidated financial statements, contained, respectively, at pages F-38 through F-42 and pages F-65 through F-66, in the Financial Appendix to FTNC’s 2003 Proxy Statement furnished to shareholders in connection with the Annual Meeting of Shareholders on April 15, 2003, filed March 18, 2003, and incorporated herein by reference.

 

 

  *

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 required to be filed as an exhibit.


47


EX-10 3 a4447741_ex10h.htm EXHIBIT 10H

Exhibit 10(h)

FIRST TENNESSEE NATIONAL CORPORATION
DIRECTORS AND EXECUTIVES DEFERRED COMPENSATION PLAN
(Amended and Restated March 20, 2003)

I.            PURPOSE

The purpose of the First Tennessee National Corporation Directors and Executives Deferred Compensation Plan (hereinafter referred to as the “Plan”) is to advance the interests of First Tennessee National Corporation, and any successor thereto, and its subsidiaries (hereinafter collectively referred to as the “Company”) by encouraging and enabling the Company to attract, motivate and retain executives and nonemployee members of the Board of Directors.

II.          EFFECTIVE DATE

The effective date of the Plan is July 1, 1985.

III.        DEFINITIONS

A.         “Accrual Account” means a bookkeeping account maintained for each Participant which will reflect the sum of each deferral plus interest payable at the Applicable Rate, compounded annually, on the original amount of deferral less Interim Distributions, if any.

B.         “Administrator”, for the purpose of this agreement, means the Vice President, Compensation.

C.         “Applicable Rate” means that rate approved annually by the Committee, to be not less than the Guaranteed Rate nor more than the Projected Rate, which is credited on the Total Compensation deferred.

D.         “Board” means the Board of Directors of First Tennessee National Corporation.

E.          “Base Salary” means the gross monthly salary paid to the Participants, not including Nonemployee Directors.

F.          “Cause.” Termination by the Company of a Participant’s employment for “Cause” shall mean termination upon (a) the willful and continued failure by a Participant to perform substantially his or her duties with the Company (other than any such failure resulting from his or her incapacity due to physical or mental illness) after a demand for substantial performance is delivered to the Participant by the Chairman of the Board or President of the Company which specifically identities the manner in which such executive believes that the Participant has not substantially performed his or her duties, or (b) the willful engaging by a Participant in illegal conduct which is materially and demonstrably injurious to the Company. For purposes of this subsection (F), no act, or failure to act, on a Participant’s part shall be considered “willful” unless done, or omitted to be done, by the Participant in bad faith and without reasonable belief that the Participant’s action or omission was in, or not opposed to, the best interests of the Company. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board or based upon the advice of counsel for the Company shall be conclusively presumed to be done, or omitted to be done, by a Participant in good faith and in the best interests of the Company. It is also expressly understood that a Participant’s attention to matters not directly related to the business of the Company shall not provide a basis for termination for Cause so long as the Board has approved the Participant’s engagement in such activities. Notwithstanding the foregoing, a Participant shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to the Participant a copy of a resolution duly adopted by the affirmative vote of not less than three quarters of the entire membership of the Board at a meeting of the Board called and held for the purpose (after reasonable notice to the Participant and an opportunity for Participant, together with his or her counsel, to be heard before the Board), finding that in the good faith opinion of the Board the Participant was guilty of the conduct set forth above in (a) or (b) of this subsection (F) and specifying the particulars thereof in detail.


1



G.         “Change in Control” means the occurrence of any one of the following events:

(i) individuals who, on January 21, 1997, constitute the Board (the “Incumbent Directors”) cease for any reason to constitute at least a majority of the Board, provided that any person becoming a director subsequent to January 21, 1997, whose election or nomination for election was approved by a vote of at least three-fourths (3/4) of the Incumbent Directors then on the Board (either by a specific vote or by approval of the proxy statement of the Company in which such person is named as a nominee for director, without written objection to such nomination) shall be an Incumbent Director; provided, however, that no individual elected or nominated as a director of the Company initially as a result of an actual or threatened election contest with respect to directors or as a result of any other actual or threatened solicitation of proxies or consents by or on behalf of any person other than the Board shall be deemed to be an Incumbent Director;

(ii) any “Person” (as defined under Section 3(a)(9) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and as used in Section 13(d) or Section 14(d) of the Exchange Act) is or becomes a “beneficial owner” (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing 20% or more of the combined voting power of the Company’s then outstanding securities eligible to vote for the election of the Board (the “Company Voting Securities”); provided, however, that the event described in this paragraph (ii) shall not be deemed to be a change in control by virtue of any of the following acquisitions: (A) by the Company or any entity in which the Company directly or indirectly beneficially owns more than 50% of the voting securities or interests (a “Subsidiary”), (B) by an employee stock ownership or employee benefit plan or trust sponsored or maintained by the Company or any Subsidiary, (C) by any underwriter temporarily holding securities pursuant to an offering of such securities, or (D) pursuant to a Non-Qualifying Transaction (as defined in paragraph (iii));

(iii) the consummation of a merger, consolidation, share exchange or similar form of corporate transaction involving the Company or any of its Subsidiaries that requires the approval of the Company’s shareholders, whether for such transaction or the issuance of securities in the transaction (a “Business Combination”), unless immediately following such Business Combination: (A) more than 50% of the total voting power of (x) the corporation resulting from such Business Combination (the “Surviving Corporation”), or (y) if applicable, the ultimate parent corporation that directly or indirectly has beneficial ownership of 100% of the voting securities eligible to elect directors of the Surviving Corporation (the “Parent Corporation”), is represented by Company Voting Securities that were outstanding immediately prior to the consummation of such Business Combination (or, if applicable, is represented by shares into which such Company Voting Securities were converted pursuant to such Business Combination), and such voting power among the holders thereof is in substantially the same proportion as the voting power of such Company Voting Securities among the holders thereof immediately prior to the Business Combination, (B) no person (other than any employee benefit plan sponsored or maintained by the Surviving Corporation or the Parent Corporation), is or becomes the beneficial owner, directly or indirectly, of 20% or more of the total voting power of the outstanding voting securities eligible to elect directors of the Parent Corporation (or, if there is no Parent Corporation, the Surviving Corporation) and (C) at least a majority of the members of the board of directors of the Parent Corporation (or, if there is no Parent Corporation, the Surviving Corporation) were Incumbent Directors at the time of the Board’s approval of the execution of the initial agreement providing for such Business Combination (any Business Combination which satisfies all of the criteria specified in (A), (B) and (C) above shall be deemed to be a “Non-Qualifying Transaction”); or


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(iv) the shareholders of the Company approve a plan of complete liquidation or dissolution of the Company or a sale of all or substantially all of the Company’s assets.

Notwithstanding the foregoing, a Change in Control of the Company shall not be deemed to occur solely because any person acquires beneficial ownership of more than 20% of the Company Voting Securities as a result of the acquisition of Company Voting Securities by the Company which reduces the number of Company Voting Securities outstanding; provided, that if after such acquisition by the Company such person becomes the beneficial owner of additional Company Voting Securities that increases the percentage of outstanding Company Voting Securities beneficially owned by such person, a Change in Control of the Company shall then occur.

H.         “Committee”, for the purpose of this agreement, means the Human Resources Committee of the Board of Directors.

I.           “Director’s Compensation” means the total sum of fees and retainer earned by a Nonemployee Director.

J.          “Deferral and Acknowledgment Agreement” means an agreement substantially in the form of Exhibit A attached hereto.

K.         “Guaranteed Rate” means the annualized rate on ten (10) year United States Treasury obligations during each Plan Year as published by Data Resources, Inc.

L.          “Incentive Compensation” means the gross amount earned by a Participant during the Plan Year under the Company’s Management Incentive Plan, Annual Bonus Plan or the Bond Division Management Bonus Plan.

M.        “Nonemployee Director” means a member of the Board of Directors of the Company who is not concurrently a common law employee of the Company.

N.         “Normal Retirement” means any termination by a Participant after attaining the age of 65.

O.         “Participant” means an individual who is authorized by the Committee to participate in this Plan and who has executed a Deferral and Acknowledgment Agreement.

P.          “Plan Year” means (i) July 1, 1985 through December 31, 1985 and (ii) each and every calendar year thereafter.

Q.         “Projected Rate” means that rate applicable to each Participant group as set forth below which will be credited on each date for which interest is to be credited under the Plan:

 

Attained Age At End of
Year of Deferral Election

 

 

Projected Rate

 


 

 


 

39 & Under

 

19%

 

40 - 44

 

20%

 

45 - 49

 

21%

 

50 - 54

 

22%

 

55 - 59

 

23%

 

60 & Over

 

24%

 


R.         “Total Compensation” means the sum of Base Salary and Incentive Compensation, or, in the case of a Nonemployee Director, the sum of the Director’s retainer and fees.


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IV.        TERM

This plan is effective on the date hereof and shall be effective until terminated by the Board; however, this Plan provides only for a deferral and corresponding interest rate for the first Plan Year with subsequent deferrals and corresponding interest rates to be approved by the Committee for each separate Plan Year. This Plan may be amended, renewed, restated or extended for additional Plan Years by the Committee and the Committee may in its sole discretion, on the basis of financial or other considerations, not authorize the execution of Deferral and Acknowledgment Agreements by Participants prospectively deferring compensation for additional years. Notwithstanding the foregoing, neither the termination nor any amendment of the Plan or any Deferral and Acknowledgment Agreement shall, without the consent of the Participant, affect the Participant’s rights under any Deferral and Acknowledgment Agreement in existence on the date of such termination or amendment.

V.          DEFERRAL AND ACKNOWLEDGMENT AGREEMENT

A.         Election to Defer. As hereinafter provided and subject to acceptance by the Company, a Participant may elect to reduce the amount of Total Compensation which will be paid to him or her during the Plan Year by executing and delivering to the Company in a timely fashion a Deferral and Acknowledgment Agreement. Notwithstanding anything herein to the contrary, during the ten consecutive Plan Years commencing with the Plan Year with respect to which a Participant is first authorized to participate in the Plan, such Participant may elect to make no more than five deferrals. The preceding sentence does not confer upon any Participant the right to make a deferral with respect to any Plan Year; it merely places a limitation upon the total number of deferrals a Participant may make if otherwise authorized to participate in the Plan, except for Participants who are Nonemployee Directors who may elect to make no more than six deferrals. Notwithstanding the 10-year limitation in this Section V(A), employee Participants may make salary deferrals for the 1995 Plan Year unless such a deferral would cause the Participant to exceed the five deferral limitation.

B.         Creation of Contractual Obligation. The Company, by acceptance of a properly executed and timely delivered Deferral and Acknowledgment Agreement agrees to pay to the Participant or his or her Designated Beneficiary, as defined in Paragraph VII, the benefits described in Paragraph VI, which shall be calculated based upon (i) the amount of the Total Compensation deferred by each Participant, (ii) the interest rate established for the Plan Year by the Committee applied to the amount deferred, (iii) the time which elapses between the date of deferral and the date of the benefit payments, and (iv) other factors established in this Plan and by the Committee.

C          Acceptance. The Administrator is authorized to accept and approve a properly executed Deferral and Acknowledgment Agreement on behalf of the Company.

D.         Timing of Election. A Participant may execute and deliver to the Company a Deferral and Acknowledgment Agreement:

1.          on or before December 15 of any calendar year, however, such a Deferral and Acknowledgment Agreement shall be effective to reduce a Participant’s Total Compensation only for the next subsequent Plan Year;

2.          in the first Plan Year only, on or before July 31, 1985, however, such a Deferral and Acknowledgment Agreement may be executed an delivered only by a Participant who is employed as an employee or is a Nonemployee Director on June 1, 1985 and is only effective to reduce a Participant’s Total Compensation earned during the period from the date of the execution and delivery of the Deferral and Acknowledgment Agreement until the end of the first Plan Year of this Plan;

 


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3.          notwithstanding any other provision of this Plan or any Deferral and Acknowledgment Agreement, no Deferral and Acknowledgment Agreement shall be effective to defer compensation which is earned by any Participant on or before the date upon which the Deferral and Acknowledgment Agreement is properly executed and timely delivered to the Company.

E.          Amount of Deferral. A Participant who is not a Nonemployee Director may elect to defer during any Plan Year any dollar amount which is less than or equal to thirty-five percent (35%) of a Participant’s Total Compensation applicable to the Plan Year. However, a Nonemployee Director may defer any dollar amount which is less than or equal to one hundred percent (100%) of his or her Director’s Compensation. Notwithstanding any provision of any Deferral and Acknowledgment Agreement or this Plan to the contrary, the Deferral and Acknowledgment Agreement of a Participant shall be modified automatically if necessary such that all actual reductions pursuant to his or her Deferral and Acknowledgment Agreement are made from his or her Base Salary or Incentive Compensation or, in the case of a Nonemployee Director, from his or her Director’s Compensation.

F.          Accrual of Interest. Where applicable under the terms of this Plan, interest on the amounts in an Accrual Account shall accrue interest at the Applicable Rate, commencing on the date on which the Total Compensation deferred under the Deferral and Acknowledgment Agreement would have been paid. The Applicable Rate may be adjustable only on an annual basis, effective January 1 of each Plan Year; provided, however, that no adjustment to the Applicable Rate may affect amounts previously accrued. Notwithstanding the provisions of the prior sentence, the Applicable Rate will be replaced by the Guaranteed Rate if the Plan otherwise requires a recalculation of interest at the Guaranteed Rate. The Applicable Rate for the first Plan Year shall be the Projected Rate and shall remain so unless adjusted by the Committee as set forth herein. Notwithstanding any provisions of the Plan to the contrary, the Applicable Rates for (i) Participants who terminated employment on or before December 31, 2002 and were entitled to a Retirement Benefit under Section VI.A or an Early Retirement Benefit under Section VI.G and (ii) any other Participants designated by the Committee (the Participants referred to in clauses (i) and (ii) are hereinafter referred to collectively as the “2002 Retired Participants”) shall in no event be less than the Applicable Rates in effect as of December 31, 2002 with respect to the 2002 Retired Participants (subject to the provisions of Section VI.B).

VI.        PAYMENT OF BENEFITS

A.         Retirement Benefit. If a Participant terminates employment with the Company and such termination constitutes a Normal Retirement, then the Company shall pay to the Participant the monthly benefit defined in Paragraph 2 of each of his or her Deferral and Acknowledgment Agreements on those dates specified in this paragraph. The first benefit payable under Paragraph 2 of a Deferral and Acknowledgment Agreement shall be paid on the thirty-first (31st) day of January following the calendar year in which the Participant attains Normal Retirement. Notwithstanding the foregoing, any Deferral and Acknowledgment Agreement executed by a Participant which defers compensation which would otherwise be payable to the Participant in or after the Plan Year in which he or she attains Normal Retirement shall provide that the first benefit payable shall be paid on the thirty-first (31st) day of January following the later of (i) the fifth (5th) anniversary of the date upon which the Deferral and Acknowledgment Agreement is accepted by the Company or (ii) his or her Normal Retirement.

B.         Alternative Retirement Benefit. If a Participant, prior to a Change in Control, is, on the date of Normal Retirement, or becomes thereafter, but prior to a Change in Control, a proprietor, officer, partner, or employee of, or otherwise is or becomes, prior to a Change in Control, affiliated with any business that is in competition with the Company, then, upon that date, no further benefit payments shall be made to the Participant or any other person under any provision of this Plan, except that, the Participant shall be paid in lump sum on the thirty-first (31st) day of January following that date, an amount equal to the value of the Accrual Account recalculated over the entire period of deferral at an interest rate equal to the Guaranteed Rate, compounded annually, from the date on which the deferred compensation would have been paid to the date on which the act occurs or status is first attained. In the event Interim Distributions are made to the Participant, said payments shall reduce the amount to which the Guaranteed Rate is applied. If the above calculation results in a negative amount, such amount shall not be collected from, or enforced against the Participant as a claim by the Company.


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C.         Interim Distributions. A Participant shall be paid the benefits defined in Paragraph 3 of his or her Deferral and Acknowledgment Agreement on those dates stated in that paragraph of each Deferral and Acknowledgment Agreement (hereinafter referred to as “Interim Distributions”). However, no Interim Distribution shall be paid to any Participant as a result of the Deferral and Acknowledgment Agreement if the Participant is age fifty-eight (58) or older on any day during the Plan Year in which a Deferral and Acknowledgment Agreement is executed. No Interim Distribution shall be paid to a Participant on or after the date upon which the Participant or his or her Designated Beneficiary receives any benefit or payment under any other paragraph of this Plan or any other paragraph of his or her Deferral and Acknowledgment Agreement.

D.         Pre-Retirement, Pre-Disability Death Benefit. If a Participant dies on or before the date upon which he or she is first entitled to receive a benefit under this paragraph, then his or her Designated Beneficiary, as defined in Paragraph VII, shall be paid in lump sum or, at the discretion of the Administrator, in five (5) annual installments with interest paid on the unpaid balance at the Applicable Rate, an amount equal to the value of the Accrual Account. In the event Interim Distributions are made to the participant, said payments shall reduce the amount to which the Applicable Rate is applied. If the above calculation results in a negative amount, such amount shall not be collected from or enforced against the Designated Beneficiary or the Participant’s estate as a claim by the Company. If the Participant’s Designated Beneficiary receives or is entitled to receive a benefit hereunder, then no person or persons shall receive or be entitled to receive any benefit or payment under any other paragraph of this Plan or under any Deferral and Acknowledgment Agreement, notwithstanding any other provision of this Plan or any Deferral and Acknowledgment Agreement. The benefit payable under this paragraph, if lump sum, shall be paid on the thirty-first day of January following the Participant’s date of death (including interest thereon at the Applicable Rate). In the event installment payments are elected, said payments shall commence on the thirty-first day of January following the Participant’s death and continue thereafter on January 31st of each successive year.

E.          Pre-Retirement Disability Benefit. If a Participant suffers a Disability or becomes Disabled, as those terms are defined in the First Tennessee National Corporation Long Term Disability Income Plan, as amended from time to time, prior to that date upon which he or she receives or is entitled to receive a benefit under this paragraph, then he or she shall be paid by the Company in lump sum, or at the discretion of the Administrator, in five (5) annual installments with interest paid on the unpaid balance at the Applicable Rate, an amount equal to the value of the Accrual Account. In the event Interim Distributions are made to a Participant, said payments shall reduce the amount to which the Applicable Rate is applied. If the above calculation results in a negative amount, such amount shall not be collected from, or enforced against the Participant as a claim by the Company. If the Participant receives or is entitled to receive a benefit hereunder, then no person or persons shall receive or be entitled to receive any benefit or payment under any other paragraph of this Plan or under any Deferral and Acknowledgment Agreement, notwithstanding any other provisions of this Plan or any Deferral and Acknowledgment Agreement. The benefit payable under this paragraph, if lump sum, shall be paid on the thirty-first (31st) day of January following the Participant’s date of Disability (including interest thereon at the Applicable Rate). In the event installments payments are elected, said payments shall commence on the thirty-first day of January following the Participant’s Disability and continue thereafter on January 31st of each successive year.


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F.          Termination of Employment Prior to Retirement. If a Participant, prior to a Change in Control, terminates employment with the Company or is terminated by the Company for Cause and if such termination is prior to death, disability and Normal Retirement (and is not pursuant to Section VI. G.), then he or she shall be paid in lump sum on the thirty-first (31st) day of January following his or her date of termination an amount equal to the value of the Accrual Account recalculated over the entire period of deferral at an interest rate equal to the Guaranteed Rate, compounded annually, from the date on which the deferred compensation would have been paid to the date on which the benefit herein is paid. In the event Interim Distributions are made, said payments shall reduce the amount to which the Guaranteed Rate is applied. If the above calculation results in a negative amount, such amount shall not be collected from, or enforced against the Participant as a claim by the Company. If the Participant receives or is entitled to receive a benefit hereunder, then no person or persons shall then or thereafter receive any benefit or payment under any other paragraph of this Plan or any Deferral and Acknowledgment Agreement, notwithstanding any other provision of this Plan or any Deferral and Acknowledgment Agreement. Notwithstanding the foregoing, if the Participant’s termination occurs prior to a Change in Control and prior to death, disability and Normal Retirement and is as the result of any reason other than voluntary termination, or a termination by the Company for Cause, then the value of the Accrual Account distributed to such Participant shall be calculated over the entire period of deferral at the Applicable Rate.

G.         Early Retirement Benefit. If a Participant other than a Nonemployee Director terminates employment with the Company after the date on which he or she qualifies for early retirement (as such term is defined in the First Tennessee National Corporation Pension Plan or upon satisfaction of a “Rule of 75,” where the sum of a Participant’s age and years of service with the Company equals at least 75), or if a Participant who is a Nonemployee Director terminates as a director of the Company after at least 10 years of service as a director of the Company, then the Participant shall be entitled to receive a monthly benefit as described in paragraph 2 of each of his or her Deferral and Acknowledgment Agreements (or at the discretion of the Committee, a lump sum payment equal to the value of the Accrual Account), however, the Accrual Account shall be recalculated over the entire period of deferral using an interest rate equal to the Guaranteed Rate (unless a higher rate is approved by the Committee). In addition, said benefit shall commence on the later of (i) the thirty-first (31st) day of January following the calendar year in which the Participant commences early retirement, or (ii) the January 31 of the year immediately following the fifth anniversary of the execution date of the Deferral and Acknowledgment Agreement (unless an earlier or later date, which is prior to or coincident with the Participant’s attainment of the age of 65, is approved by the Committee). In the event Interim Distributions are made, said payments shall reduce the amount to which the Guaranteed Rate is applied. If the above calculation results in a negative amount, such amount shall not be collected from, or enforced against the Participant as a claim by the Company. If the Participant receives or is entitled to receive a benefit hereunder, then no person or persons shall then or thereafter receive any benefit or payment under any other paragraph of this Plan or any Deferral and Acknowledgment Agreement, notwithstanding any other provision of this Plan or any Deferral and Acknowledgment Agreement.

H.         Change in Control.

(i) This Section VI.H(i) applies solely to Participants who are current or former Nonemployee Directors. After a Change in Control, the value of the Accrual Account distributed to a Participant or to the trustee of a trust for the benefit of one or more Participants shall be calculated over the entire period of deferral through the date of the Change in Control at the Applicable Rate. Thereafter, interest shall accrue at the Applicable Rate unless the Participant voluntarily terminates or is terminate by the Company for Cause, in which case interest shall accrue from the date of the Change in Control at the Guaranteed Rate. Thus, if a Participant’s termination occurs on or after a Change in Control and is the result of any reason other than a voluntary termination or a termination by the Company for Cause, then the value of the Accrual Account distributed to such Participant shall be calculated over the entire period of deferral at the Applicable Rate.


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(ii) Notwithstanding any provision of this Plan to the contrary, in the event a Change in Control or “Pre-Change in Control Date” (as defined below) occurs, the Company shall make a lump sum payment (a “Payment”) to each Participant other than current or former Nonemployee Directors (except as provided below) on a date (the “Payment Date”) no later than 2 business days after the Change in Control has occurred (or, if an agreement to effectuate a Change in Control pursuant to a Business Combination has been executed, on the date (the “Pre-Change in Control Date”) that is the third business day prior to the date the Chief Executive Officer of the Company believes in good faith will be the effective date of the Change in Control, but in any event prior to the effective date of such Change in Control). For purposes of this Section VI.H (ii), “Determination Date” shall mean the date of the Change in Control (or, if an agreement to effectuate a Change in Control pursuant to a Business Combination has been executed, the date one month prior to the date such agreement was executed). If a Payment is to be made, the amount of the Payment shall be determined as follows:

(1)        (a) If on the Payment Date a Participant is (I) employed by the Company or any Subsidiary (provided that any Participant whose employment is terminated by the Company other than for Cause (as defined below) on or after the Determination Date shall be deemed solely for purposes of this Section VI.H(ii)(1)(a) to be employed on the Payment Date by the Company or any Subsidiary), (II) receiving or entitled to receive benefits under Section VI.A, or (III) otherwise designated by the Committee as eligible to receive benefits under this Section VI.H(ii)(1)(a), the Company shall pay on the Payment Date to such Participant a Payment in an amount equal to the present value as of the Payment Date of the remaining scheduled Interim Distributions and retirement distributions to be made to such Participant as of December 31, 1996 (based upon assumed continued accruals at an interest rate equal to the Applicable Rate effect on December 31, 1996, as disclosed to such Participant by the Company in its statement of benefits under this Plan), to the extent such distributions have not been made; provided, that in the event a Participant eligible for a Payment under this Section VI.H(ii)(1)(a) has already received prior to the Payment Date a lump sum benefit under Section VI.F, the amount of Payment to such Participant shall be an amount equal to the excess, if any, of (x) the amount of the Payment determined under this Section VI.H(ii)(1)(a) (without regard to this proviso), over (y) the amount of the lump sum benefit already received pursuant to Section VI.F. For purposes of this Section VI.H(ii)(1)(a), the “present value” shall be determined on an interest-only basis (i.e., without discount for mortality) using a discount rate of 4.2%, compounded annually (see Exhibit B for an illustration of such present value calculation).

(b)        For purposes of Section VI.H(ii), termination by the Company of a Participant’s employment for “Cause” shall mean termination upon (I) the willful and continued failure by such Participant to perform substantially such Participant’s duties with the Company (other than any such failure resulting from such Participant’s incapacity due to physical or mental illness) after a written demand for substantial performance is delivered to such Participant by the Chairman of the Board, Chief Executive Officer or President of the Company which specifically identifies the manner in which such person believes that such Participant has not substantially performed such Participant’s duties, which failure to perform causes material and demonstrable economic harm to the Company or its Affiliates (as defined below), (II) the willful engaging by such Participant in illegal conduct which is materially and demonstrably injurious to the Company, or (III) the conviction of such Participant of, or a plea of guilty or nolo contendere by such Participant to, a felony. For purposes of this Section VI.H(ii)(1)(b), no act, or failure to act, on such Participant’s part shall be considered “willful” unless done, or omitted to be done, by such Participant in bad faith and without reasonable belief that such Participant’s action or omission was in, or not opposed to, the best interests of the Company or its Affiliates. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board or based upon the advice of counsel for the Company or upon the instructions of the Chief Executive Officer or other senior executive officer of the Company shall be conclusively presumed to be done, or omitted to be done, by such Participant in good faith and in the best interests of the Company and its Affiliates. For purposes of this Section VI.H(ii)(1)(b), “Affiliate” means any person directly or indirectly controlling, controlled by, or under common control with the Company. It is also expressly understood that such Participant’s attention to matters or such Participant’s engagement in activities not directly related to the business of the Company shall not provide a basis for termination for Cause so long as the Board has approved such Participant’s engagement in such activities prior to or following a Change in Control. Notwithstanding the foregoing, in the case of clause (I) or (II) of this Section VI.H(ii)(1)(b), such Participant shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to such Participant a copy of a resolution duly adopted by the affirmative vote of not less than three-fourths (¾) of the entire membership of the Board (excluding such Participant if such Participant is a Board member) at a meeting of the Board called and held for such purpose (after reasonable notice to such Participant and an opportunity for such Participant, together with such Participant’s counsel, to be heard before the Board), finding that in the good faith opinion of the Board such Participant was guilty of the conduct set forth above in clause (I) or (II) of this Section VI.H(ii)(1)(b) and specifying the particulars thereof in detail. The Company must notify such Participant of any event constituting Cause within ninety (90) days following the Company’s knowledge of its existence or such event shall not constitute Cause under this Section VI.H(ii)(1)(b).


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(2)        If on the Payment Date a Participant is (a) entitled to receive a lump sum benefit under Section VI.B or (b) entitled to receive a lump sum benefit under Section VI.F (other than any Participant eligible to receive a Payment pursuant to the proviso in clause (I) of Section VI.H(ii)(1)(a)), the Company shall pay on the Payment Date to such Participant a Payment in an amount equal to the amount of such lump sum benefit otherwise payable under such applicable Section to such Participant (with continued interest accruals through the Payment Date only).

(3)        If on the Payment Date a Participant is receiving or entitled to receive benefits under Section VI.G (other than any Participant designated by the Committee as eligible to receive benefits under Section VI.H(ii)(1)(a)(III) above), the Company shall pay on the Payment Date to such Participant a Payment in an amount equal to the unpaid balance as of the Payment Date of the Accrual Account (as recalculated under Section VI.G) in respect of such Participant; provided, that if such Participant has begun receiving monthly payments under Section VI.G, the Payment shall be in an amount equal to the present value as of the Payment Date of the remaining monthly payments to be made to such Participant under Section VI. G. For purposes of this Section VI.H(ii)(3), the “present value” shall be determined in the same manner as under Section VI.H(ii)(1)(a), except that the discount rate of 4.2% shall be replaced by the discount rate used to determine (under such Participant’s applicable Deferral and Acknowledgment Agreement or Agreements) the monthly payments that are currently being paid to such Participant.

(4)        If on the Payment Date a Participant (or such Participant’s Designated Beneficiary) is receiving or entitled to receive a benefit under Section VI.D or Section VI.E, the Company shall pay on the Payment Date to such Participant (or such Participant’s Designated Beneficiary) a Payment in an amount equal to the amount of such lump sum benefit otherwise payable under such applicable Section to such Participant (or such Participant’s Designated Beneficiary) (with continued interest accruals through the Payment Date only); provided, that if such Participant (or such Participant’s Designated Beneficiary) is scheduled to receive such benefit in installments, the Company shall pay to such Participant (or such Participant’s Designated Beneficiary) the unpaid balance as of the Payment Date of the Accrual Account in respect of such Participant; provided, further, that if such Participant (or such Participant’s Designated Beneficiary) has begun to receive installment payments under Section VI.D or Section VI.E, the Payment shall be in an amount equal to the present value as of the Payment Date of the remaining installment payments to be made to such Participant under such applicable Section. For purposes of this Section VI.H(ii)(4), the “present value” shall be determined in the same manner as under Section VI.H(ii)(1)(a), except that the discount rate of 4.2% shall be replaced by the discount rate used by the Administrator to determine the installment payments that are currently being paid to such Participant.

 


9



If any Participant receives a payment pursuant to this Section VI.H(ii), then no persons or persons shall receive or be entitled to receive any benefit or payment under any other paragraph of this Plan or under any Deferral and Acknowledgment Agreement, notwithstanding any other provision of this Plan or any Deferral and Acknowledgment Agreement.

(iii) The provisions of Section VI.H(ii) shall not apply to a Participant who is a current or former Nonemployee Director; provided, however, that the provisions of Section VI.H(ii) shall apply to the extent any Participant defers Base Salary or Incentive Compensation earned while such Participant was not a Nonemployee Director.

I.           Source of Payment. The Company shall establish a grantor trust to provide a source of payment of the monthly benefits defined in Paragraph 2 of each of the Deferral and Acknowledgment Agreements of the 2002 Retired Participants (the “Specified Retirement Benefits”). As soon as practicable, but in no event later than 30 days following the establishment of such grantor trust, the Company shall make an irrevocable contribution to such grantor trust in an amount which is sufficient to pay the Specified Retirement Benefits. The Company shall, on a basis no less frequent than annually, thereafter make any additional contributions to such grantor trust which are necessary so that the grantor trust holds assets which provide a sufficient amount to pay the Specified Retirement Benefits.

VII.      BENEFICIARY DESIGNATION

Upon the death of the Participant, any benefit or benefits remaining to be paid to the Participant under the terms and conditions of this Plan, shall be paid to that person or persons designated by the Participant in the Deferral and Acknowledgment Agreement governing said benefit or benefits. If no Designated Beneficiary has been chosen by the Participant or if no Designated Beneficiary is then living on the date of the Participant’s death, then the remaining benefit or benefits shall be paid to the personal representative, executor, or administrator of the Participant’s estate who shall be deemed to be a Designated Beneficiary.

 


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VIII.     RECALCULATION EVENTS

A.         Treatment of This Plan Under Applicable Federal Income Tax Laws. The adoption and maintenance of the Plan is conditioned upon (i) the applicability of Section 451 (a) of the Internal Revenue Code of 1986 (“Code”) to the Participant’s recognition of gross income as a result of his or her participation, (ii) the fact that Participants will not recognize gross income as a result of participation in this Plan until and to the extent that benefits are received, (iii) the applicability of Code Section 404 (a) (5) to the deductibility of the amounts paid to Participants hereunder, (iv) the fact that the Company will not receive a deduction for amounts credited to any accounting reserve created as a result of this Plan until and only to the extent that benefits are paid, and (v) the very limited applicability of the provisions of the Employee Retirement Income Security Act of 1974. If the Internal Revenue Service, the Department of Labor or any court determines or find as a fact or legal conclusion that any of the above conditions is untrue and issues or intends to issue an assessment, determination, opinion or report stating such, or if the opinion of the legal counsel of the Company based upon legal authorities then existing is that any of the above assumptions is incorrect, then, if the Committee so elects, a Recalculation Event shall be deemed to have occurred. If a Recalculation Event occurs under this or any other section of this Plan, then the Participant thereafter, or a Designated Beneficiary, shall be paid benefits on the dates stated in Paragraph VI, herein, or in the Deferral and Acknowledgment Agreement; however, the amount of each benefit stated in Paragraphs 2 and 3 of the Deferral and Acknowledgment Agreement shall be recalculated and restated, at the Committee’s discretion, using a rate of interest not less than the Guaranteed Rate nor more than the Projected Rate on each date upon which interest should have been or will be calculated, compounded annually. If the Participant receives or is entitled to receive a benefit as a result of the occurrence of a Recalculation Event, then no person or persons shall receive or be entitled to receive any benefit or payment under any other Paragraph of this Plan or under any Deferral and Acknowledgment Agreement, notwithstanding any other provision of the Plan or the Deferral and Acknowledgment Agreement.

B.         Changes in the Internal Revenue Code of 1986. Subsequent to December 15, 1992, and prior to a Change in Control, (1) if Code Section 11(b) is deleted or amended or a surtax or other addition to tax is imposed hereafter and, as a result thereof, the amount of federal income tax imposed on taxable income of corporations in excess of One Hundred Thousand Dollars ($100,000) is less than thirty-four percent (34%), (2) if a tax is imposed by the federal government on income, sales, consumption, or the value of goods and services which is not currently contained in the Code, or (3) if the Code is amended or restated so extensively that in the opinion of the legal counsel of the Company the tax treatment of this Plan to the Company has materially changed to the detriment of the Company, then, if the Committee so elects, a Recalculation Event shall be deemed to have occurred and a benefit will be payable only as described in Paragraph VIII.A.

[Plan does not contain a Section IX.]


11



X.          CLAIMS PROCEDURE

A.         Administration. The Plan shall be administered by the Administrator.

B.         Benefit Payments. All benefits described in this Plan shall be paid when due. In the event the Participant or Designated Beneficiary fails to receive a benefit which he or she feels is due, a written claim for the benefit shall be submitted in writing to the Administrator. The Administrator shall review the claim when filed and advise the claimant as to whether the claim is approved or denied. If the claim is wholly or partially denied, the Administrator shall furnish a written denial within 90 days after receipt of the filed claim unless special circumstances required an extension of time for processing the claim, in which case the Administrator shall furnish the written denial within 180 days after receipt of the filed claim. The written denial shall contain (a) the specific reason or reasons for denial; (b) specific reference to pertinent Plan provisions on which the denial is based; (c) a description of any additional information necessary for the claimant to perfect the claim and an explanation of why such material or information is necessary; and (d) appropriate information as to the steps to be taken if the claimant wishes to appeal the denial of the claim.

C.         Appeal. The claimant may appeal the denial of the claim to the Committee within 90 days after receipt of such decision. The appeal shall be in writing addressed to the Committee and shall state the reason why it should grant the appeal. The Committee shall conduct a full and fair review of the claim and shall issue its decision within 60 days of the receipt of the appeal unless there are special circumstances, in which case a decision shall be rendered within 120 days of the receipt of the appeal. The Committee’s decision shall be in writing, stating the reasons therefor and shall make specific references to the pertinent Plan provisions on which the decision is based.

D.         Binding Effect. The Committee’s decision upon appeal, or the Administrator’s initial decision if no appeal is taken, shall be final, conclusive and binding on all parties.

E.          Claims after Change in Control. Notwithstanding anything in Section X to the contrary, after a Change in Control:

1.

Subsection (D) shall be inoperative;

2.

the “90” and “180” day periods in subsection (B) shall be changed to “15” and “30” day periods, respectively;

3.

the “90”, “60” and “120” day periods in subsection (C) shall be changed to “30”, “15” and “30” day periods, respectively; and

4.

if the claim has not been wholly approved within 90 days after receipt by the Administrator, then the claimant may bring a lawsuit in a court of competent jurisdiction to enforce claimant’s rights under the Plan. All attorneys’ fees and all other costs and expenses incurred by claimant in connection with such litigation shall be the obligation of and shall be paid on a timely basis by the Company regardless of whether claimant prevails in such litigation.

XI.        MISCELLANEOUS PROVISIONS

A.         Governing Law. This Plan and the Deferral and Acknowledgment Agreements are subject to the laws of the State of Tennessee.

B.         Successors This Plan shall bind any successor of the Company, its assets or its businesses (whether direct or indirect, by purchase, merger, consolidation or otherwise), in the same manner and to the same extent that the Company would be obligated under this Plan if no succession had taken place. In the case of any transaction in which a successor would not by the foregoing provision or by operation of law be bound by this Plan, the Company shall require such successor expressly and unconditionally to assume and agree to perform the Company’s obligations under this Plan, in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place. The term “Company,” as used in the Plan, shall mean the Company as hereinbefore defined and any successor or assignee to the business or assets which by reason hereof becomes bound by this Plan.


12



C.         Discharge of Company’s Obligation. The payment by the Company of the benefits due under each and every Deferral and Acknowledgment Agreement to the Participant or to the Designated Beneficiary discharges the Company’s obligations hereunder, and the Participant has no further rights under this Plan or the Deferral and Acknowledgment Agreements upon receipt by the appropriate person of all benefits.

D.         Social Security and Income Tax Withholding. The Participants agree as a condition of participation hereunder that the Company may withhold federal, state, and local income taxes and Social Security taxes from any distribution or benefit paid hereunder.

E.          Notice; Delivery of Deferral and Acknowledgment Agreement. Any notice required to be delivered hereunder and any Deferral and Acknowledgment Agreement is properly delivered to the Company when personally delivered to, or actually received from the United States mail, postage prepaid, by the Administrator.

F.          Nature of Obligations Created Hereunder. The Participants agree as a condition of participation hereunder that:

1.          the Company only has a contractual obligation to make payments to or on behalf of the Participants, and the rights of Participants under this Plan and the Deferral and Acknowledgment Agreements are no greater than the rights of any general unsecured creditor of the Company;

2.          to the extent that any person, other than a Participant, acquires a right to receive payments from the Company under this Plan or any Deferral and Acknowledgment Agreement, such right is no greater than the rights of any general unsecured creditor of the Company;

3.          nothing contained in this Plan or any Deferral and Acknowledgment Agreement shall create or be construed to create a trust of any kind or a fiduciary relationship between the Company and any Participant;

4.          the rights of any Participant may not be sold, assigned, transferred, pledged, or encumbered, nor shall any interest of the Participant be liable to the claim of any creditor of the Participant or subject to any judicial process involving the Participant;

5.          no Participant shall have any rights in any specific assets of the Company, and any accounting reserve established as a result of the Plan only reflects a contractual obligation of the Company on its books of accounting and does not constitute a segregated fund of assets or separation of assets, and the obligations of the Company only are payable from its operating assets at the time the payment is due;

6.          neither this Plan nor any Deferral and Acknowledgment Agreement constitutes a modification of the employment conditions of any Participant, and no right to continued employment is created by this Plan or the Deferral and Acknowledgment Agreement.

G.         Non-Uniform Determinations. The Committee’s determinations under the Plan need not be uniform and may be made by it selectively among persons who receive, or are eligible to receive, benefits under the Plan, regardless of whether such persons are similarly situated.


13


EX-10 4 a4447741_ex10n.htm EXHIBIT 10N

Exhibit 10(n)

FIRST TENNESSEE NATIONAL CORPORATION
2000 NON-EMPLOYEE DIRECTORS’ DEFERRED
COMPENSATION STOCK OPTION PLAN
(AS AMENDED AND RESTATED APRIL 15, 2003)

1.

Purpose. The 2000 Non-Employee Directors’ Deferred Compensation Stock Option Plan of the First Tennessee National Corporation has been adopted to advance the interests of shareholders by encouraging non-employee members of the Board of Directors to acquire proprietary interests in the Company in the form of Stock Options granted in lieu of Retainer/Fees that otherwise would have been paid in cash for serving on the Board of Directors or any committee thereof.

2.

Definitions. As used in the Plan, the following terms shall have the respective meanings set forth below:

(a)

“Board” means the Board of Directors of the Company.

(b)        “Common Stock” means the common stock, par value $0.625 per share (appropriately adjusted for subsequent stock splits), of the Company.

(c)        “Company” means the First Tennessee National Corporation, a corporation established under the laws of the State of Tennessee.

(d)        “Deferred Compensation Stock Option” or “Stock Option” means a right granted at the election of a Non-Employee Director pursuant to Section 6.

(e)        “Disability” means total and permanent disability, which if the Participant were an employee of the Company, would be treated as a total and permanent disability under the terms of the Company’s long-term disability plan for employees, as may be in effect from time to time.

(f)         “Early Retirement” means retirement from Board service after the age of 55 with 120 or more full months of aggregate Board service.

(g)        “Fair Market Value” means the average of the high and low sales prices at which shares of Common Stock are traded, as publicly reported by the Wall Street Journal, on the applicable date or, if there were no sales of Common Stock reported for such date, the last prior date for which a sale is reported.

(h)        “Grant Date” means the applicable date, as specified in Section 7, on which a Stock Option is granted to a Non-Employee Director by reason of an election made pursuant to Section 6.

(i)         “Non-Employee Director” means a member of the Board who is not an employee of the Company or any subsidiary or affiliate of the Company at the time such person elects to receive Retainer/Fees in the form of Stock Options.

(j)         “Normal Retirement” means the date at which any Non-Employee Director is no longer qualified to serve on the Board based on the then-current retirement age policy contained in the Company’s by-laws or, if not in the by-laws, as adopted by the Board.

(k)        “Participant” means a person who has received one or more Stock Options or the legal representative, heir or estate of such person.

(l)         “Plan” means the 2000 Non-Employee Directors’ Deferred Compensation Stock Option Plan.


1



(m)      “Retainer/Fees” means the retainer and meeting attendance fees payable to a Non-Employee Director for service as member of the Board and/or member of any committee of the Board.

(n)        “1934 Act” means the Securities Exchange Act of 1934, as amended from time to time.

3.

Effective Date. The Plan shall be effective on the date it is approved by the shareholders of the Company and shall remain in effect through the last Grant Date occurring with respect to calendar year 2004, unless the Plan is terminated by the Board earlier than such date subject to the provisions of Section 11. If shareholder approval is not obtained by June 30, 2000, the Plan shall be nullified and all elections to receive Stock Options shall be rescinded and all Non-Employee Directors shall receive cash equal to all Retainer/Fees that had been the subject of an election hereunder. Upon termination of the Plan, the applicable terms of the Plan shall continue to apply to all Stock Options which are outstanding on the date the Plan is terminated and to any Stock Options which are granted subsequent to such date pursuant to Section 11.

4.

Plan Operation. The Plan is intended to meet the requirements of a “formula plan” for purposes of Rule 16b-3 under the 1934 Act as currently applicable to the Plan and accordingly is intended to be self-governing. To this end the Plan is expected to require no discretionary action by any administrative body except as contemplated by Section 5(b). However, should any questions of interpretation arise, they shall be resolved by the Human Resources Committee of the Board or such other Committee as the Board may from time to time designate. The Plan shall be interpreted to comply with Rule 16b-3 under the 1934 Act, as then applicable to the Company’s employee benefit plans, and any action under this Plan that would be inconsistent with the requirements of Rule 16b-3 as then applicable shall be null and void.

5.

Common Stock Available for Stock Options.

(a)        A maximum of 400,000 shares of Common Stock may be issued upon the exercise of Stock Options granted under the Plan. Shares of Common Stock shall not be deemed issued until the applicable Stock Option has been exercised and, accordingly, any shares of Common Stock represented by Stock Options which expire unexercised or which are canceled shall remain available for issuance under the Plan. For purposes of computing the maximum number of shares that may be issued under the Plan, if shares are tendered in payment of all or portion of the exercise price, then the number of shares issued in connection with such exercise is the number of shares subject to option that was exercised, net of the number tendered in payment.

(b)

Any increase in the number of outstanding shares of Common Stock occurring through stock splits or stock dividends after the adoption of the Plan shall be reflected proportionately in an increase in the aggregate number of shares then available for the grant of Stock Options under the Plan, or becoming available through the termination or forfeiture of Stock Options previously granted but unexercised and in the number subject to Stock Options then outstanding, and a proportionate reduction shall be made in the per-share exercise price as to any outstanding Stock Options or portions thereof not yet exercised. Any fractional shares resulting from such adjustments shall be eliminated. If changes in capitalization other than those considered above shall occur, the Board, as it deems appropriate to preserve Participant’s benefits and to meet the intent of the Plan, may make equitable adjustments to the number of shares available under the Plan and covered by outstanding Stock Options and to the exercise prices of outstanding Stock Options in the event of any change in capitalization or similar action affecting Common Stock. Such actions may include, but are not limited to, any combination or exchange of shares, merger, consolidation, recapitalization, spin-off or other distribution (other than normal cash dividends) of Company assets to shareholders, or any other change affecting the Common Stock.

6.

Elections to Receive Stock Options. Each Non-Employee may make a one-time irrevocable election to receive Stock Options under the Plan, provided that such election conforms to the following:


2



(a)        Each Non-Employee Director serving as of October 20, 1999, must make his or her election under the Plan no later than December 31, 1999. Such election, if any, shall be applicable to Retainer/Fees otherwise payable to such Non-Employee Director for service from January 1, 2000 through December 31, 2004, subject to the requirements of Section 9.

(b)        Each Non-Employee Director who is newly appointed or elected to the Board after October 20, 1999, must make his or her election, if any, under the Plan no later than 30 days following the commencement of such person’s Board service. Such election, if any, shall be applicable to Retainer/Fees earned by such Non-Employee Director from the date of such election (but not before January 1, 2000) through December 31, 2004, subject to the requirements of Section 9. The above notwithstanding, no election under the Plan shall be permitted after June 30, 2004.

(c)        In making an irrevocable election to receive Retainer/Fees in the form of Stock Options, the Non-Employee Director must designate that the election is for all or a specified portion of the Retainer/Fees payable to him or her through December 31, 2004.

7.

Effective Grant Dates.

(a)        The Grant Dates for Stock Options granted pursuant to an election covered by Section 6(a) made by a Non-Employee Director serving on the Board as of October 20, 1999 for each of the calendar years such election is in effect shall be the first business day of July of such calendar year and the first business day of January of the following calendar year.

(b)        The Grant Dates for Stock Options granted pursuant to an election covered by Section 6(b) made by a Non-Employee Director elected or appointed to the Board after October 20, 1999, shall be:

(i)         For the initial Stock Option granted, the earliest calendar date specified by Section 7(a) to occur after such election, or, if then required by Rule 16b-3 under the 1934 Act as then applicable to the Plan, the first business day following the last day of the second full calendar quarter of Board service after an election pursuant to Section 6 has been made.

(ii)        For all Stock Options granted subsequent to the initial Stock Option, for each of the calendar years such election is in effect the first business day of each subsequent July of such calendar year and each subsequent January of the following calendar year.

8.

Stock Option Grants. Stock Options granted under the Plan shall have the following terms and conditions:

(a)        Each Stock Option shall have a per share exercise price equal to 50% of the Fair Market Value on the Grant Date.

(b)        Each Stock Option shall cover the number of shares represented by “A” in the following formula:

A = B/C, where

B = Amount of Retainer/Fees Earned

C = 50% of Fair Market Value of one share of Common Stock on the Grant Date.

If the number of Common Shares resulting from this calculation is not a whole number, the amount will be rounded up to the next whole number. The “Amount of Retainer/Fees Earned” for purposes of this calculation shall be such amount as was payable to the Participant since the prior applicable Grant Date or since January 1, 2000 in the case of an election pursuant to Section 6(a), or the date of the election (but not before January 1, 2000) in the case of an election pursuant to Section 6(b).


3



(c)        Each Stock Option shall expire on the twentieth anniversary of its Grant Date, subject to earlier or later expiration in accordance with Section 9.

(d)        Each Stock Option shall be immediately exercisable upon grant, except, however, that the Board may postpone the exercise of a Stock Option during such period of time that is deemed reasonably necessary to prevent any acts or omissions that the Board reasonably believes could result in the violation of any state or federal law.

9.

Termination of Board Service.

(a)

If a Non-Employee Director terminates Board service for any reason (or becomes an employee of the Company) prior to a Grant Date upon which he or she would otherwise receive a Stock Option under the Plan, no future Stock Options shall be granted to him or her and any Retainer/Fees that have been earned, but which were to be paid in the form of a Stock Option will be paid in cash instead.

(b)

If a Participant terminates Board service with less than 120 full months of aggregate Board service or prior to Normal or Early Retirement for any reason other than death or Disability, all outstanding Stock Options held by such Participant shall expire on the first anniversary of such person’s termination of Board service.

(c)

If a Participant terminates Board service due to death, Disability or because of Normal or Early Retirement, each outstanding Stock Option held by such Participant shall terminate at the earlier of the fifth anniversary of such Participant’s termination of Board service or the end of the term of the Stock Option.

(d)

The above notwithstanding, any Stock Option held by a Participant at the time of the Participant’s death shall expire on the later of the date provided for by Section 9(b) or 9(c), or the first anniversary of the Participant’s death.

10.

Exercise Payment. A Stock Option, or portion thereof, may be exercised by written notice of the exercise delivered to the Human Resources Committee of the Board, or its designee, accompanied by payment of the exercise price. Such payment may be made by cash, personal check or Common Stock already owned by the Participant, valued at the Fair Market Value on the date of exercise, or a combination of such payment methods. As soon as practicable after notice of exercise and receipt of full payment for shares of Common Stock being acquired, the Company shall deliver a certificate to the Participant representing the Common Stock purchased through the Stock Option.

11.

Termination, Suspension and Amendment of the Plan. The Board may at any time terminate, suspend or amend the Plan, except that the Plan may not be amended in any manner which knowingly would: (a) cause the Plan not to comply with Rule 16b-3 under the 1934 Act as then applicable to the Company’s employee benefit plans; (b) cause Participants not to be deemed “non-employee directors” for purposes of Rule 16b-3 under the 1934 Act as then applicable to the Company’s employee benefits plans; or (c) adversely affect a Participant’s rights under the Plan, without the consent of the Participant. If the Plan is terminated or suspended prior to December 31, 2004, any Retainer/Fees which have been earned but not paid as of the effective date of termination of the Plan and which are the subject of an election pursuant to Section 6, will be delivered in the form of Stock Options on the appropriate Grant Date, notwithstanding that such date is subsequent to the date the Plan has otherwise been terminated or suspended.


4



12.

Reload Option Grants.

(a)        Reload Grants. Automatically upon the compliance by the Participant with the following, the Participant will receive an additional option (a “Reload Option”) at the time and subject to the terms and conditions described in this Section 12(a):

1.          The Participant must exercise a Stock Option, using the attestation method of exercise to pay all or a portion of the exercise price of the Stock Option. Under the “attestation method” the Participant or other person who holds legal title to shares of Common Stock beneficially owned by the Participant attests to the ownership of a sufficient amount of shares of Common Stock to pay all or a portion of the exercise price of the Stock Option without actually tendering such shares, and as a result the Company issues to the Participant (or defers delivery of) that number of shares equal to the number of shares subject to Stock Option or Reload Option being exercised net of the shares attested to.

2.          The Participant must not have previously received the grant of a Reload Option in connection with the exercise of a portion of the Stock Option.

3.          The Participant must be a current Director of the Corporation at the time of the exercise of the Stock Option.

4.          There must be at least one year remaining in the term of the Stock Option at the time of its exercise.

5.          The Reload Option will be granted on and as of the time and date of the valid exercise of the Stock Option by the Participant.

6.          The exercise price per share of the Reload Option will be the Fair Market Value of one share of Common Stock on the date of exercise of Stock Option.

7.          The number of shares of Common Stock with respect to which the Reload Option will be granted will be equal to the number of shares attested to by the Participant in payment in all or a portion of the exercise price of the Stock Option.

8.          The Reload Option will be exercisable during a term commencing at the time of the valid exercise of the Stock Option and ending on the same date at the same time as the original term of the Stock Option ends.

9.          No Reload Option will be granted upon the exercise of a Reload Option.

10.        A Participant who has received more than one Stock Option and who otherwise complies with this Section 12(a) will receive a Reload Option with respect to each such Stock Option.

11.        The sale or other transfer of certain of the shares received upon the exercise of a Reload Option will be restricted, as follows:

(i)         No restriction will apply to the shares received upon the exercise of a Reload Option if the Reload Option was granted in connection with the exercise of an option in which the Participant elected to defer receipt of shares.

(ii)        Subject to (v), the restriction will apply to that number of shares received upon the exercise of a Reload Option equal to the product of x times y times z divided by w, where “x” is the number of shares received upon the exercise of the Reload Option, “y” is .50, “z” is the difference between the fair market value of one share at the time of exercise minus the exercise price of one share, and “w” is the fair market value of one share at the time of exercise.


5



(iii)      The restriction period will last until the earliest to occur of the following: five years following the exercise of the Reload Option, death, disability, Normal Retirement, Early Retirement, a change in control as defined in the Company’s 1997 Employee Stock Option Plan or termination of service as a director for any reason.

(iv)      During the restriction period the Participant cannot sell or otherwise transfer the shares, and the shares either will be legended accordingly or will be held in book-entry form by the Company’s transfer agent with appropriate limitations on transfer ability in place.

(v)        In the event that the Participant determines to sell shares of Common Stock to pay the taxes associated with the exercise of a Reload Option, then 50% of the shares so sold to pay the taxes may be shares that otherwise would be restricted pursuant to the provisions hereof.

(b)        General. The term “Stock Option” as used in Sections 2(k), 3 (the last sentence), 5, 8(d), 9(b), 9(d), 10 and 12 shall be deemed to include a “Reload Option” for all purposes of such Sections.

13.

General Provisions.

(a)        Stock Options shall not be transferable or assignable other than by (a) will or the laws of descent and distribution, or (b) to the extent permitted by Rule 16b-3 under the 1934 Act as then applicable to the Company’s employee benefits plans, by gift or other transfer to any “family member” of a Non-Employee Director as the term “family member” is defined in the instructions to Form S-8 promulgated by the Securities and Exchange Commission.

(b)        Stock Options shall be evidenced by written agreements or such other appropriate documentation prescribed by the Human Resources Committee of the Board or its designee.

(c)        Neither the Plan nor the granting of Stock Options nor any other action taken pursuant to the Plan, shall constitute or be evidence of any agreement or understanding, express or implied, that the Company shall retain the services of a Participant for any period of time or at any particular rate of compensation as a member of the Board. Nothing in the Plan shall in any way limit or affect the right of the Board or the shareholders of the Company to remove any Participant from the Board or otherwise terminate his or her service as a member of the Board.

(d)        The validity, construction and effect of the plan and any such actions taken under or relating to the Plan shall be determined in accordance with the laws of the State of Tennessee and applicable federal law.


6


EX-31 5 a4447741_ex31a.htm EXHIBIT 31A

Exhibit 31(a)

FIRST TENNESSEE NATIONAL CORPORATION
RULE 13a – 14(a) CERTIFICATIONS OF CEO
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(QUARTERLY REPORT)

CERTIFICATIONS

I, J. Kenneth Glass, the President and Chief Executive Officer of First Tennessee National Corporation, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of First Tennessee National Corporation;

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.

The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a)

Designed such disclosure controls and procedures, or caused such disclosure controls and prodcedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.

The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls.

 

Date   August 11, 2003

 

 

 


/s/ J. Kenneth Glass  

 

 

 

J. Kenneth Glass
President and Chief Executive Officer

 

 

 

 


1


EX-31 6 a4447741_ex31b.htm EXHIBIT 31B

Exhibit 31(b)

FIRST TENNESSEE NATIONAL CORPORATION
RULE 13a – 14(a) CERTIFICATIONS OF CFO
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(QUARTERLY REPORT)

CERTIFICATIONS

I, James F. Keen, Executive Vice President, Chief Financial Officer and Corporate Controller of First Tennessee National Corporation, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of First Tennessee National Corporation;

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.

The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.

The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls.

 

Date   August 11, 2003

 

 

 


/s/ James F. Keen  

 

 



James F. Keen
Executive Vice President, Chief Financial Officer and Corporate Controller

 

 

 

 


1


EX-32 7 a4447741_ex32a.htm EXHIBIT 32A

Exhibit 32(a)

CERTIFICATION OF PERIODIC REPORT
RULE 1350 CERTIFICATIONS OF CEO
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
As Codefied at 18 U.S.C. Section 1350

I, the undersigned J. Kenneth Glass, President and Chief Executive Officer of First Tennessee National Corporation (“Corporation”), hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, as follows:

1.

The Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934.

2.

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation.

Dated: August 11, 2003

 

 

 

 

 



 

 


/s/ J. Kenneth Glass  

 

 

 

J. Kenneth Glass
President and Chief Executive Officer

 


1


EX-32 8 a4447741_ex32b.htm EXHIBIT 32B

Exhibit 32(b)

CERTIFICATION OF PERIODIC REPORT
RULE 1350 CERTIFICATIONS OF CFO
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
As Codefied at 18 U.S.C. Section 1350

I, the undersigned James F. Keen, Executive Vice President, Chief Financial Officer and Corporate Controller of First Tennessee National Corporation (“Corporation”), hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, as follows:

1.

The Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934.

2.

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation.

Dated: August 11, 2003

 

 

 

 

 



 

 


/s/ James F. Keen  

 

 

 

James F. Keen
Executive Vice President, Chief Financial Officer and
Corporate Controller

 


1


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