Unassociated Document

FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

 
(Mark one)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006
 
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 001-15185
 
CIK number 0000036966
 
 FIRST HORIZON NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)

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

 165 Madison Avenue, Memphis, Tennessee
 38103
 (Address of principal executive offices)
  (Zip Code)
 
  
(901) 523-4444
(Registrant's telephone number, including area code)


(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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

  x   Large accelerated filer ____ Accelerated filer ____ Non-accelerated filer

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Yes       No x    
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
124,467,143
                  Class
Outstanding on September 30, 2006
 


FIRST HORIZON NATIONAL CORPORATION

INDEX


 

Part I. Financial Information   

Part II. Other Information   

Signatures   

Exhibit Index
 
2

PART I.
 
FINANCIAL INFORMATION

 
 Item 1.
 Financial Statements
 
 
 The Consolidated Condensed Statements of Condition
 
 
 The Consolidated Condensed Statements of Income
 
 
 The Consolidated Condensed Statements of Shareholders’ Equity
 
 
 The Consolidated Condensed Statements of Cash Flows
 
 
 The Notes to Consolidated Condensed 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 CONDENSED STATEMENTS OF CONDITION
 
  First Horizon National Corporation
 
   
September 30
 
December 31
 
(Dollars in thousands)(Unaudited)
 
2006
 
2005
 
2005
 
Assets:
                   
Cash and due from banks
 
$
903,482
 
$
1,036,816
 
$
945,547
 
Federal funds sold and securities
                   
  purchased under agreements to resell
   
1,992,426
   
1,972,318
   
1,485,199
 
Total cash and cash equivalents
   
2,895,908
   
3,009,134
   
2,430,746
 
Investment in bank time deposits
   
17,798
   
6,373
   
10,687
 
Trading securities
   
2,512,744
   
2,013,535
   
2,133,428
 
Loans held for sale
   
2,808,991
   
5,158,103
   
4,435,343
 
Securities available for sale
   
3,982,680
   
2,841,633
   
2,912,103
 
Securities held to maturity (fair value of $373 on September 30, 2006; $391 on
                   
  September 30, 2005; and $390 on December 31, 2005)
   
369
   
383
   
383
 
Loans, net of unearned income
   
21,944,320
   
19,211,703
   
20,600,922
 
  Less: Allowance for loan losses
   
206,829
   
185,029
   
189,705
 
Total net loans
   
21,737,491
   
19,026,674
   
20,411,217
 
Mortgage servicing rights, net
   
1,498,341
   
1,210,284
   
1,314,629
 
Goodwill
   
274,534
   
282,192
   
281,440
 
Other intangible assets, net
   
70,546
   
76,893
   
76,647
 
Capital markets receivables
   
1,027,927
   
1,453,451
   
511,508
 
Premises and equipment, net
   
441,659
   
404,867
   
408,539
 
Real estate acquired by foreclosure
   
65,224
   
27,856
   
27,410
 
Discontinued assets (Note 2)
   
939,728
   
129,358
   
163,545
 
Other assets
   
1,802,243
   
1,401,571
   
1,461,436
 
Total assets
 
$
40,076,183
 
$
37,042,307
 
$
36,579,061
 
                     
Liabilities and shareholders' equity:
                   
Deposits:
                   
  Checking interest and money market
 
$
4,742,122
 
$
4,331,644
 
$
4,425,664
 
  Savings
   
256,834
   
288,903
   
279,408
 
  Certificates of deposit under $100,000 and other time
   
2,906,424
   
2,338,365
   
2,478,946
 
  Certificates of deposit $100,000 and more
   
11,920,226
   
12,497,183
   
10,931,695
 
Interest-bearing
   
19,825,606
   
19,456,095
   
18,115,713
 
  Noninterest-bearing
   
5,458,935
   
5,813,207
   
5,201,844
 
Total deposits
   
25,284,541
   
25,269,302
   
23,317,557
 
Federal funds purchased and securities
                   
  sold under agreements to repurchase
   
2,416,974
   
2,357,973
   
3,735,742
 
Trading liabilities
   
847,453
   
906,626
   
793,638
 
Commercial paper and other short-term borrowings
   
926,292
   
1,217,904
   
802,017
 
Term borrowings
   
5,226,772
   
2,000,113
   
3,437,643
 
Other collateralized borrowings
   
260,416
   
-
   
-
 
Total long-term debt
   
5,487,188
   
2,000,113
   
3,437,643
 
Capital markets payables
   
989,332
   
1,507,563
   
591,404
 
Discontinued liabilities
   
6,977
   
90,125
   
122,026
 
Other liabilities
   
1,311,628
   
1,105,090
   
1,136,221
 
Total liabilities
   
37,270,385
   
34,454,696
   
33,936,248
 
Preferred stock of subsidiary
   
295,274
   
295,274
   
295,274
 
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 and outstanding - 124,467,143 on September 30, 2006;
                   
  126,002,753 on September 30, 2005; and 126,222,327 on December 31, 2005)
   
77,792
   
78,752
   
78,889
 
Capital surplus
   
301,857
   
390,430
   
404,964
 
Undivided profits
   
2,124,312
   
1,856,776
   
1,905,930
 
Accumulated other comprehensive income/(loss), net
   
6,563
   
(33,621
)
 
(42,244
)
Total shareholders' equity
   
2,510,524
   
2,292,337
   
2,347,539
 
Total liabilities and shareholders' equity
 
$
40,076,183
 
$
37,042,307
 
$
36,579,061
 
See accompanying notes to consolidated condensed financial statements.
Certain previously reported amounts have been reclassified to agree with current presentation.
 
4


CONSOLIDATED CONDENSED STATEMENTS OF INCOME
     First Horizon National Corporation  
   
Three Months Ended
 
Nine Months Ended
 
   
September 30
 
September 30
 
(Dollars in thousands except per share data)(Unaudited)
 
2006
 
2005
 
2006
 
2005
 
Interest income:
                 
Interest and fees on loans
 
$
416,898
 
$
299,100
 
$
1,173,832
 
$
795,477
 
Interest on investment securities
   
53,759
   
31,397
   
131,023
   
92,672
 
Interest on loans held for sale
   
72,135
   
111,572
   
224,309
   
284,554
 
Interest on trading securities
   
44,850
   
35,718
   
126,963
   
101,279
 
Interest on other earning assets
   
24,956
   
19,651
   
68,422
   
46,717
 
Total interest income
   
612,598
   
497,438
   
1,724,549
   
1,320,699
 
Interest expense:
                         
Interest on deposits:
                         
  Savings
   
157
   
108
   
411
   
302
 
  Checking interest and money market account
   
31,488
   
16,153
   
80,319
   
41,015
 
  Certificates of deposit under $100,000 and other time
   
32,090
   
20,466
   
86,544
   
56,371
 
  Certificates of deposit $100,000 and more
   
130,875
   
102,061
   
360,239
   
247,276
 
Interest on trading liabilities
   
19,233
   
23,237
   
57,503
   
60,635
 
Interest on short-term borrowings
   
66,871
   
50,619
   
190,495
   
116,517
 
Interest on long-term debt
   
80,263
   
24,634
   
198,098
   
69,368
 
Total interest expense
   
360,977
   
237,278
   
973,609
   
591,484
 
Net interest income
   
251,621
   
260,160
   
750,940
   
729,215
 
Provision for loan losses
   
23,694
   
22,608
   
60,146
   
51,503
 
Net interest income after provision for loan losses
   
227,927
   
237,552
   
690,794
   
677,712
 
Noninterest income:
                         
Mortgage banking
   
89,393
   
140,482
   
291,656
   
368,237
 
Capital markets
   
95,215
   
82,158
   
290,238
   
272,109
 
Deposit transactions and cash management
   
44,503
   
41,268
   
125,282
   
113,994
 
Insurance commissions
   
10,534
   
12,673
   
37,681
   
40,947
 
Revenue from loan sales and securitizations
   
11,830
   
10,878
   
35,399
   
34,429
 
Trust services and investment management
   
9,609
   
11,299
   
31,090
   
33,741
 
Equity securities gains/(losses), net
   
8,757
   
(407
)
 
10,271
   
(398
)
Debt securities gains/(losses), net
   
-
   
1
   
(78,902
)
 
1
 
All other income and commissions
   
51,544
   
48,247
   
116,401
   
126,530
 
Total noninterest income
   
321,385
   
346,599
   
859,116
   
989,590
 
Adjusted gross income after provision for loan losses
   
549,312
   
584,151
   
1,549,910
   
1,667,302
 
Noninterest expense:
                         
Employee compensation, incentives and benefits
   
260,351
   
259,583
   
766,288
   
744,003
 
Occupancy
   
29,745
   
26,082
   
87,372
   
76,161
 
Operations services
   
17,976
   
18,739
   
52,491
   
53,586
 
Equipment rentals, depreciation and maintenance
   
17,893
   
19,033
   
56,015
   
55,259
 
Communications and courier
   
12,950
   
14,352
   
41,271
   
40,009
 
Amortization of intangible assets
   
3,233
   
2,893
   
9,002
   
8,033
 
All other expense
   
114,209
   
85,493
   
307,119
   
239,883
 
Total noninterest expense
   
456,357
   
426,175
   
1,319,558
   
1,216,934
 
Pre-tax income
   
92,955
   
157,976
   
230,352
   
450,368
 
Provision for income taxes
   
25,776
   
49,862
   
55,830
   
143,293
 
Income from continuing operations
   
67,179
   
108,114
   
174,522
   
307,075
 
(Loss)/income from discontinued operations, net of tax
   
(69
)
 
4,830
   
210,580
   
11,703
 
Income before cumulative effect of changes in accounting principle
   
67,110
   
112,944
   
385,102
   
318,778
 
Cumulative effect of changes in accounting principle, net of tax
   
-
   
-
   
1,345
   
-
 
Net income
 
$
67,110
 
$
112,944
 
$
386,447
 
$
318,778
 
Earnings per common share from continuing operations
 
$
.54
 
$
.86
 
$
1.40
 
$
2.45
 
Earnings per common share from discontinued operations, net of tax
   
-
   
.04
   
1.69
   
.10
 
Earnings per common share from cumulative effect of changes in accounting principle,
  net of tax
   
-
   
-
   
.02
   
-
 
Earnings per common share (Note 8)
 
$
.54
 
$
.90
 
$
3.11
 
$
2.55
 
Diluted earnings per common share from continuing operations
 
$
.53
 
$
.83
 
$
1.36
 
$
2.38
 
Diluted earnings per common share from discontinued operations, net of tax
   
-
   
.04
   
1.65
   
.09
 
Diluted earnings per common share from cumulative effect of changes in accounting
   principle, net of tax
   
-
   
-
   
.01
   
-
 
Diluted earnings per common share (Note 8)
 
$
.53
 
$
.87
 
$
3.02
 
$
2.47
 
Weighted average common shares (Note 8)
   
124,150
   
125,838
   
124,431
   
125,171
 
Diluted average common shares (Note 8)
   
127,523
   
129,924
   
127,962
   
129,135
 
See accompanying notes to consolidated condensed financial statements.
                         

 
5


CONSOLIDATED CONDENSED STATEMENTS OF SHAREHOLDERS' EQUITY
First Horizon National Corporation
(Dollars in thousands)(Unaudited)
 
2006
 
2005
 
Balance, January 1
 
$
2,347,539
 
$
2,040,983
 
Adjustment to reflect change in accounting for employee share-based compensation
   
-
   
33,151
 
Net income
   
386,447
   
318,778
 
Other comprehensive income:
             
  Unrealized fair value adjustments, net of tax:
             
Cash flow hedges
   
434
   
-
 
Securities available for sale
   
48,373
   
(23,693
)
Comprehensive income
   
435,254
   
295,085
 
Cash dividends declared
   
(168,065
)
 
(161,104
)
Common stock repurchased
   
(165,569
)
 
(488
)
Common stock issued for:
             
  Stock options and restricted stock
   
49,432
   
36,363
 
  Acquisitions
   
486
   
24,893
 
Change in tax benefit from incentive plans
   
3,592
   
928
 
Adjustment to reflect change in accounting for employee stock option forfeitures
   
(1,780
)
 
-
 
Stock-based compensation expense
   
9,635
   
22,526
 
Balance, September 30
 
$
2,510,524
 
$
2,292,337
 
See accompanying notes to consolidated condensed financial statements.
             
 
 
6
 
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
First Horizon National Corporation
 
Nine Months Ended September 30
(Dollars in thousands)(Unaudited)
 
2006
   
2005
 
Operating
Net income
$
 386,447
 
$
 318,778
 
Activities
Adjustments to reconcile net income to net cash provided/(used) by operating activities:
           
 
Provision for loan losses
 
60,146
   
51,503
 
 
Provision for deferred income tax
 
55,830
   
32,936
 
 
Depreciation and amortization of premises and equipment
 
39,787
   
38,303
 
 
Amortization and impairment of mortgage servicing rights
 
-
   
178,363
 
 
Amortization of intangible assets
 
9,227
   
10,320
 
 
Net other amortization and accretion
 
61,137
   
62,973
 
 
(Increase)/decrease in derivatives, net
 
(164,317
)  
104,709
 
 
Market value adjustment on mortgage servicing rights
 
(35,830
)  
-
 
 
Provision for foreclosure reserve
 
9,266
   
5,005
 
 
Cumulative effect of changes in accounting principle
 
(1,345
)  
-
 
 
Gain on divestiture
 
(208,581
)  
-
 
 
Stock-based compensation expense
 
9,635
   
20,928
 
 
Excess tax benefit from stock-based compensation arrangements
 
(3,592
)  
(928
)
 
Equity securities (gains)/losses, net
 
(10,271
)  
397
 
 
Debt securities losses, net
 
78,902
   
-
 
 
Net losses on disposal of fixed assets
 
3,193
   
140
 
 
Net (increase)/decrease in:
           
 
  Trading securities
 
(379,316
)  
(336,344
)
 
  Loans held for sale
 
1,622,682
   
32,750
 
 
  Capital markets receivables
 
(516,419
)  
(1,177,153
)
 
  Interest receivable
 
(22,284
)  
(49,819
)
 
  Other assets
 
(1,170,479
)  
(508,439
)
 
Net increase/(decrease) in:
           
 
  Capital markets payables
 
398,005
   
1,117,240
 
 
  Interest payable
 
49,066
   
47,454
 
 
  Other liabilities
 
40,448
   
(83,485
)
 
  Trading liabilities
 
53,815
   
480,283
 
 
Total adjustments
 
(21,295
)  
27,136
 
 
Net cash provided by operating activities
 
365,152
   
345,914
 
Investing
Maturities of held to maturity securities
 
15
   
59
 
Activities
Available for sale securities:
           
 
  Sales
 
2,283,907
   
56,844
 
 
  Maturities
 
514,301
   
327,646
 
 
  Purchases
 
(3,848,857
)  
(581,159
)
 
Premises and equipment:
           
 
  Sales
 
44
   
739
 
 
  Purchases
 
(75,967
)  
(67,781
)
 
Net increase in loans
 
(1,465,040
)  
(2,727,561
)
 
Net increase in investment in bank time deposits
 
(7,111
)  
(1,044
)
 
Proceeds from divestitures, net of cash and cash equivalents
 
280,041
   
-
 
 
Acquisitions, net of cash and cash equivalents acquired
 
(487
)  
(841,950
)
 
Net cash used by investing activities
 
(2,319,154
)  
(3,834,207
)
Financing
Common stock:
           
Activities
  Exercise of stock options
 
49,448
   
36,543
 
 
  Cash dividends paid
 
(167,551
)  
(159,961
)
 
  Repurchase of shares
 
(165,569
)  
(488
)
 
  Excess tax benefit from stock-based compensation arrangements
 
3,592
   
928
 
 
Long-term debt:
           
 
  Issuance
 
2,234,160
   
300,000
 
 
  Payments
 
(189,667
)  
(901,574
)
 
Issuance of preferred stock of subsidiary
 
-
   
295,400
 
 
Net increase/(decrease) in:
           
 
  Deposits
 
1,848,370
   
5,440,940
 
 
  Short-term borrowings
 
(1,194,493
)  
165,676
 
 
Net cash provided by financing activities
 
2,418,290
   
5,177,464
 
 
Net increase in cash and cash equivalents
 
464,288
   
1,689,171
 
 
Cash and cash equivalents at beginning of period
 
2,431,620
   
1,320,499
 
 
Cash and cash equivalents at end of period
 
2,895,908
   
3,009,670
 
 
Cash and cash equivalents from discontinued operations at beginning of period, included above
$
 874
 
$
 1,115
 
 
Cash and cash equivalents from discontinued operations at end of period, included above
 
-
   
536
 
 
Total interest paid
 
923,139
   
543,315
 
 
Total income taxes paid
 
105,799
   
117,451
 
See accompanying notes to consolidated condensed financial statements.
Certain previously reported amounts have been reclassified to agree with current presentation.

 
7

Note 1 - Financial Information

The unaudited interim consolidated financial statements of First Horizon National Corporation (FHN), including its subsidiaries, have been prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industries in which it operates. This preparation requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. These estimates and assumptions are based on information available as of the date of the financial statements and could differ from actual results. 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 interim 2006 periods are not necessarily indicative of the results that may be expected going forward. For further information, refer to the audited consolidated financial statements in the 2005 Annual Report to shareholders.

Real Estate Acquired by Foreclosure. Prior to 2006, properties acquired by foreclosure in compliance with HUD servicing guidelines were classified as receivables in “Other assets” on the Consolidated Condensed Statements of Condition. Beginning in 2006, these properties are included in “Real estate acquired by foreclosure” and are carried at the estimated amount of the underlying government insurance or guarantee. On September 30, 2006, FHN had $21.7 million in these foreclosed properties. All other real estate acquired by foreclosure consists of properties that have been acquired in satisfaction of debt. These properties are carried at the lower of the outstanding loan amount or estimated fair value less estimated cost to sell the real estate. Losses arising at foreclosure are charged to the appropriate reserve. Required developmental costs associated with foreclosed property under construction are capitalized and included in determining the estimated net realizable value of the property, which is reviewed periodically, and any write-downs are charged against current earnings.

Loans Held for Sale and Securitization and Residual Interests. FHN's mortgage lenders originate first-lien mortgage loans (the warehouse) for the purpose of selling them in the secondary market, primarily through proprietary and agency securitizations, and to a lesser extent through loan sales. In addition, FHN evaluates its liquidity position in conjunction with determining its ability and intent to hold loans for the foreseeable future and sells certain of the second-lien mortgages and home equity lines of credit (HELOC) it produces in the secondary market through securitizations and loan sales. Loan securitizations involve the transfer of the loans to qualifying special purposes entities (QSPE) that are not subject to consolidation in accordance with Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (SFAS No. 140). FHN generally retains the right to service the transferred loans.

Loans held for sale include loans originated or purchased for resale, together with mortgage loans previously sold which loans may be unilaterally called by FHN. Loans held for sale are recorded at the lower of aggregate cost or fair value. The carrying value of loans held for sale is net of deferred origination fees and costs. Net origination fees and costs are deferred on loans held for sale and included in the basis of the loans in calculating gains and losses upon sale. Also included in the lower of cost or fair value analysis are the estimated costs and fair values of first-lien mortgage loan commitments. The cost basis of loans qualifying for fair value hedge accounting under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS No. 133), is adjusted to reflect changes in fair value. Gains and losses realized from the sale of these assets, whether sold directly or through securitization, and adjustments to fair value are included in noninterest income.

Mortgage loans insured by the Federal Housing Administration (FHA) and mortgage loans guaranteed by the Veterans Administration (VA) are generally securitized through the Government National Mortgage Association (GNMA). Conforming conventional loans are generally securitized through government-sponsored enterprises (GSE) such as the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC). In addition, FHN has completed proprietary securitizations of nonconforming first-lien and second-lien mortgages and HELOC, which do not conform to the requirements for sale or securitization through government agencies or GSE. Most of these securitizations are accounted for as sales; those that do not qualify for sale treatment are accounted for as financing arrangements.

Interests retained from the sales include mortgage servicing rights (MSR) and various financial assets. Prior to 2006, all of these retained interests were initially valued by allocating the total cost basis of the loan between the security or loan sold and the retained interests based on their relative fair values at the time of securitization or sale. The retained interests, other than MSR, were carried at fair value as a component of trading securities on the Consolidated Condensed Statements of Condition, with realized and unrealized gains and losses included in current earnings as a component of noninterest income on the Consolidated Condensed Statements of Income. With the adoption of Statement of Financial Accounting Standards No. 156, “Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140” (SFAS No. 156), MSR are initially valued at fair value, and the remaining retained interests are initially valued by allocating the remaining cost basis of the loan between the security or loan sold and the remaining retained interests based on their relative
 
8

Note 1 - Financial Information (continued)

fair values at the time of securitization or sale. All retained interests, including MSR, are carried at fair value. The financial assets retained are included as a component of trading securities on the Consolidated Condensed Statements of Condition, with realized and unrealized gains and losses included in current earnings as a component of noninterest income on the Consolidated Condensed Statements of Income.

Financial assets retained in a securitization may include certificated residual interests, excess interest (structured as interest-only strips), interest-only strips, principal-only strips, or subordinated bonds. Residual interests represent rights to receive earnings to the extent of excess income generated by the underlying loans. Excess interest represents rights to receive interest from serviced assets that exceed contractually specified rates. Principal-only strips are principal cash flow tranches and interest-only strips are interest cash flow tranches. Subordinated bonds are bonds with junior priority. All financial assets retained from a securitization are recognized on the balance sheet in trading securities at fair value.

The fair values of the certificated residual interests, the excess interest, and the interest-only strips are determined using market prices from closely comparable assets such as MSR that are tested against prices determined using a valuation model that calculates the present value of estimated future cash flows. To determine the fair value of the principal-only strips, FHN uses the market prices from comparable assets such as publicly traded FNMA trust principal-only strips that are adjusted to reflect the relative risk difference between readily marketable securities and privately issued securities. The fair value of subordinated bonds is determined using a spread to an interpolated Treasury rate, which is supplied by broker dealers. The fair value of these retained interests typically changes based on changes in the discount rate and differences between modeled prepayment speeds and credit losses and actual experience.

On January 1, 2006, FHN began initially recognizing all classes of MSR at fair value and elected to irrevocably continue application of fair value accounting to its MSR. Classes of MSR are determined in accordance with FHN’s risk management practices and market inputs used in determining the fair value of the servicing asset. Since sales of MSR 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. As such, like other participants in the mortgage banking business, FHN relies primarily on a discounted cash flow model to estimate the fair value of its MSR. This model calculates estimated fair value of the MSR using predominant risk characteristics of MSR such as interest rates, type of product (fixed vs. variable), age (new, seasoned, or moderate), agency type and other factors. FHN uses assumptions in the model that it believes are comparable to those used by brokers and other service providers. FHN also periodically compares its estimates of fair value and assumptions with brokers, service providers, and recent market activity and against its own experience.

Prior to 2006, MSR were initially valued by allocating the total carrying value of the loan between the loan, MSR and other retained interests based on their relative fair values, and were thereafter valued at the lower of cost or fair value. MSR were amortized over the period of and in proportion to the estimated net servicing revenues. The cost basis of MSR qualifying for SFAS No. 133 fair value hedge accounting was adjusted to reflect changes in fair value. MSR were periodically evaluated for impairment. Impairment occurred when the current fair value of the servicing right was less than its recorded value. A quarterly value impairment analysis was performed using a discounted cash flow analysis which was disaggregated by strata representing predominant risk characteristics, including fixed rate and adjustable loans. Impairment, if any, was recognized through a valuation allowance for individual strata. However, if the impairment was determined to be other than temporary, a direct write-off of the asset was made. With the adoption of SFAS No. 156, MSR are valued at fair value, both initially and prospectively; impairment tests are no longer performed.

Equity Compensation. FHN accounts for its employee stock-based compensation plans using the grant date fair value of an award to determine the expense to be recognized over the life of the award. For awards with service vesting criteria, expense is recognized using the straight-line method over the requisite service period (generally the vesting period) and is adjusted for anticipated forfeitures. For awards vesting based on a performance measure, anticipated performance is projected to determine the number of awards expected to vest, and the corresponding aggregate expense is adjusted to reflect the elapsed portion of the performance period. The fair value of equity awards with cash payout requirements, as well as awards for which fair value cannot be estimated at grant date, are remeasured each reporting period through vesting date.

For all stock option awards granted prior to adoption of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123-R), FHN permits vesting of the option to continue after retirement. To account for these stock option awards, FHN uses the nominal vesting period approach. Under the nominal vesting period approach, awards granted to employees near retirement eligibility are expensed over the option’s normal vesting period until an employee’s actual retirement date, at which point all remaining unamortized compensation expense is immediately accelerated. Awards granted after the adoption of SFAS No. 123-R are amortized
 
9

Note 1 - Financial Information (continued)

using the nonsubstantive vesting methodology. The nonsubstantive vesting methodology requires that expense associated with options that continue vesting after retirement be recognized over a period ending no later than an employee’s retirement eligibility date. Had FHN followed the nonsubstantive vesting period method for all awards previously granted, the effect of the change in expense attribution on earnings and per share amounts would have been negligible.

Accounting Changes. Effective January 1, 2006, FHN elected early adoption of SFAS No. 156. This amendment to SFAS No. 140 requires servicing rights be initially measured at fair value. Subsequently, companies are permitted to elect, on a class-by-class basis, either fair value or amortized cost accounting for their servicing rights. FHN elected fair value accounting for its MSR. Accordingly, FHN recognized the cumulative effect of a change in accounting principle totaling $.2 million, net of tax, representing the excess of the fair value of the servicing asset over the recorded value on January 1, 2006.

FHN also adopted Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections” (SFAS No. 154), as of January 1, 2006. SFAS No. 154 requires retrospective application of voluntary changes in accounting principle. A change in accounting principle mandated by new accounting pronouncements should follow the transition method specified by the new guidance. However, if transition guidance is not otherwise specified, retrospective application will be required. SFAS No. 154 does not alter the accounting requirement for changes in estimates (prospective) and error corrections (restatement). The adoption of SFAS No. 154 did not affect FHN’s reported results of operations.

FHN adopted SFAS No. 123-R as of January 1, 2006. SFAS No. 123-R requires recognition of expense over the requisite service period for awards of share-based compensation to employees. The grant date fair value of an award will be used to measure the compensation expense to be recognized over the life of the award. For unvested awards granted prior to the adoption of SFAS No. 123-R, the fair values utilized equal the values developed in preparation of the disclosures required under the original SFAS No. 123. Compensation expense recognized after adoption of SFAS No. 123-R incorporates an estimate of awards expected to ultimately vest, which requires estimation of forfeitures as well as projections related to the satisfaction of performance conditions that determine vesting. As permitted by SFAS No. 123-R, FHN retroactively applied the provisions of SFAS No. 123-R to its prior period financial statements. The Consolidated Condensed Statements of Income were revised to incorporate expenses previously presented in the footnote disclosures. The Consolidated Condensed Statements of Condition were revised to reflect the effects of including equity compensation expense in those prior periods. Additionally, all deferred compensation balances were reclassified within equity to capital surplus. Since FHN’s prior disclosures included forfeitures as they occurred, a cumulative effect adjustment, as required by SFAS No. 123-R, of $1.1 million net of tax, was made for unvested awards that are not expected to vest due to anticipated forfeiture.

Effective December 31, 2005, FHN adopted FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (FIN 47). FIN 47 requires recognition of a liability at the time of acquisition or construction for assets that will require certain remediation expenditures when the assets are removed from service. FIN 47 clarified that future expenses to remove asbestos from buildings should be estimated and accrued as a liability at the time of acquisition with an offset to increase the cost of the associated structure. FHN currently owns certain buildings that contain asbestos. As a result of adopting FIN 47, FHN recognized a cumulative effect of a change in accounting principle equaling $3.1 million, net of tax. FHN increased the value of its recorded tangible assets by $4.5 million at the time it recognized an associated conditional retirement obligation in the amount of $9.4 million.

Effective January 1, 2005, FHN adopted AICPA Statement of Position 03-3, “Accounting for Loans or Certain Debt Securities Acquired in a Transfer” (SOP 03-3), which modifies the accounting for certain loans that are acquired with evidence of deterioration in credit quality since origination. SOP 03-3 does not apply to loans recorded at fair value, revolving loans, or to mortgage loans classified as held for sale. SOP 03-3 limits the yield that may be accreted on applicable loans to the excess of the cash flows expected, at acquisition, to be collected over the investor’s initial investment in the loan. SOP 03-3 also prohibits the “carrying over” of valuation allowances on applicable loans. The impact of adopting SOP 03-3 was immaterial to the results of operations. 

In November 2005, the FASB issued FSP FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (FSP FAS 115-1), which supersedes the previously deferred recognition guidance of EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (EITF 03-1). FSP FAS 115-1 was effective January 1, 2006, and references previously existing GAAP. Therefore, adoption of FSP FAS 115-1 did not impact FHN’s accounting for other-than-temporary impairment of investments.
 
10

Note 1 - Financial Information (continued)

Accounting Changes Issued but Not Currently Effective. In February 2006, the FASB issued Statement of Financial Accounting Standards No. 155, “Accounting for Certain Hybrid Financial Instruments” (SFAS No. 155), which permits fair value remeasurement for hybrid financial instruments that contain an embedded derivative that otherwise would require bifurcation. Additionally, SFAS No. 155 clarifies the accounting guidance for beneficial interests in securitizations. Under SFAS No. 155, all beneficial interests in a securitization would require an assessment in accordance with SFAS No. 133 to determine if an embedded derivative exists within the instrument. SFAS No. 155 is effective for fiscal years beginning after September 15, 2006. FHN is currently assessing the financial impact of adopting SFAS No. 155.

In July 2006, FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48) was issued. FIN 48 provides guidance for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on the classification and disclosure of uncertain tax positions in the financial statements. Adoption of FIN 48 requires a cumulative effect adjustment to the beginning balance of retained earnings for differences between the tax benefits recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption. FIN 48 is effective for fiscal years beginning after December 15, 2006. FHN is continuing to assess the effects of adopting FIN 48.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS No. 157), which establishes a hierarchy to be used in performing measurements of fair value. SFAS No. 157 emphasizes that fair value should be determined from the perspective of a market participant while also indicating that valuation methodologies should first reference available market data before using internally developed assumptions. Additionally, SFAS No. 157 provides expanded disclosure requirements about fair value measurement. SFAS No. 157 is effective prospectively for fiscal years beginning after November 15, 2007, with early adoption permitted for fiscal years in which financial statements have not been issued. FHN is currently assessing the financial impact of adopting SFAS No. 157.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (SFAS No. 158), which requires the recognition of the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in the statement of condition. SFAS No. 158 does not change measurement or recognition requirements for periodic pension and postretirement costs. SFAS No. 158 also provides that changes in the funded status of a defined benefit postretirement plan should be recognized in the year such changes occur through comprehensive income. Additionally, SFAS No. 158 requires that the annual measurement date of a plan’s assets and liabilities be as of the date of the financial statements. Upon adoption of SFAS No. 158, unrecognized transition assets and obligations, unrecognized actuarial gains and losses, and unrecognized prior service costs and credits will be recognized as a component of accumulated other comprehensive income. SFAS No. 158 is effective for fiscal years ending after December 15, 2006, for funded status recognition and related disclosure requirements, with a one-time adjustment to the statement of condition. For measurement date requirements, SFAS No. 158 is effective for fiscal years ending after December 15, 2008. FHN expects a reduction in equity of between $60 million and $90 million upon adoption of SFAS No. 158.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (SAB No. 108). SAB No. 108 requires that companies assess the impact on both the balance sheet and income statement when quantifying and evaluating the materiality of a misstatement. Under SAB No. 108, adjustment of financial statements is required when either approach results in quantifying a misstatement that is material, after considering all relevant quantitative and qualitative factors. Upon adoption, prior year errors, which had previously been considered immaterial but are considered material based on the guidance in SAB No. 108, should be recognized by either restating prior year financial statements or recording a one-time transitional cumulative effect adjustment to retained earnings. SAB No. 108 is effective for annual periods ending after November 15, 2006. FHN is currently assessing the guidance of SAB No. 108.

In September 2006, the consensus reached in EITF Issue No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements” (EITF 06-4) was ratified by the FASB. EITF 06-4 requires that a liability be recognized for contracts written to employees which provide future postretirement benefits that are covered by endorsement split-dollar life insurance arrangements as such obligations are not effectively settled upon entering into the related insurance arrangements. EITF 06-4 is effective for fiscal years beginning after December 15, 2007, with the guidance applied using either a retrospective approach or through a cumulative-effect adjustment to beginning retained earnings. FHN is currently assessing the financial impact of adopting EITF 06-4.
 
11

Note 1 - Financial Information (continued)

In September 2006, the consensus reached in EITF Issue No. 06-5, “Accounting for Purchases of Life Insurance—Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance” (EITF 06-5) was ratified by the FASB. EITF 06-5 provides that in addition to the recognition of an asset for the amount that could be realized for a life insurance contract as of the balance sheet date, the amount recognized should also take into consideration certain other amounts included in a policy’s contractual terms. Additionally, EITF 06-5 requires that the determination of the amount that could be realized under an insurance contract be performed at the individual policy level. EITF 06-5 is effective January 1, 2007, with the guidance applied using either a retrospective approach or through a cumulative-effect adjustment to beginning retained earnings. FHN does not anticipate that the effect of adopting EITF 06-5 will be material to its results of operations.
 
12

Note 2 - Acquisitions/Divestitures

On June 28, 2006, First Horizon Merchant Services, Inc. (FHMS) sold all of the outstanding capital stock of Global Card Services, Inc. (GCS), a wholly-owned subsidiary. As a result, tax benefits of $4.2 million were recognized associated with the difference between FHMS’ tax basis in the stock and net proceeds from the sale.

On March 1, 2006, FHN sold substantially all the assets of its national merchant processing business conducted primarily through FHMS and GCS. The sale was to NOVA Information Systems (NOVA), a wholly-owned subsidiary of U.S. Bancorp. This transaction resulted in a pre-tax gain of approximately $340 million. In addition, a supplement to the purchase price may be paid to FHN if certain performance goals are achieved during a period following closing. This divestiture was accounted for as a discontinued operation, and prior periods were adjusted to exclude the impact of merchant operations from the results of continuing operations. In conjunction with the sale, FHN entered into a transitional service agreement with NOVA to provide or continue on-going services such as telecommunications, back-end processing and disaster recovery until NOVA converts the operations to their systems.  On September 30, 2006, discontinued assets primarily consist of operating receivables due from NOVA from post-sale activity.
 
On December 9, 2005, First Tennessee Bank National Association (FTBNA) sold three financial centers in Dyersburg, Tennessee, to First South Bank. This transaction resulted in a divestiture gain of $7.0 million. Immediately preceding the sale, the financial centers had loans of approximately $80 million and deposits of approximately $70 million.

On August 26, 2005, FHN acquired West Metro Financial Services Inc. (West Metro), a Georgia bank holding company. West Metro was merged with and into FHN. At the same time West Metro’s subsidiary, First National Bank West Metro, with total assets of approximately $135 million, loans of approximately $115 million, and deposits of approximately $120 million, was merged with and into FTBNA. Total consideration of $32 million, consisting of approximately $11 million in cash and $21 million in FHN shares (approximately 518,000 shares of common stock), exceeded the estimated fair value of tangible assets and liabilities acquired by approximately $16 million. Intangible assets totaling approximately $3 million have been identified and are being amortized over their expected useful lives. The acquisition was immaterial to FHN.

On April 1, 2005, FTBNA acquired substantially all of the assets of MSAver Resources, L.L.C. of Overland Park, Kansas, a national leader in administering health savings accounts. The acquisition was immaterial to FHN.

On March 1, 2005, First Horizon Home Loan Corporation, a subsidiary of FTBNA, acquired Greenwich Home Mortgage Corporation of Cedar Knolls, New Jersey, for an initial payment of approximately $7.8 million in cash and FHN common stock. Net assets purchased, combined with the operating performance of the acquired business, will impact future payments owed to the sellers. The acquisition was immaterial to FHN. In 2006 additional payments of approximately $1.1 million in cash and FHN common stock were made.

On January 7, 2005, FHN’s capital markets division, FTN Financial, completed the acquisition of the assets and operations of the fixed income business of Spear, Leeds & Kellogg (SLK), a division of Goldman Sachs & Co. for approximately $150.0 million in cash. Total consideration paid exceeded the estimated fair value of tangible and identified intangible assets and liabilities acquired by approximately $97 million. Intangible assets totaling approximately $55 million have been identified and are being amortized over their expected useful lives. The acquisition was immaterial to FHN.

In addition to the acquisitions mentioned above, FHN also acquires assets from time to time in transactions that are considered business combinations but are not material to FHN individually or in the aggregate.
 
13

Note 3 - Loans
 
The composition of the loan portfolio is detailed below:

   
 September 30
 
December 31
(Dollars in thousands)
 
2006
     
2005
 
2005
 
Commercial:
                       
  Commercial, financial and industrial
 
$
6,945,207
       
$
6,354,408
 
$
6,578,117
 
  Real estate commercial
   
1,199,084
         
1,171,606
   
1,213,052
 
  Real estate construction
   
2,660,415
         
1,849,075
   
2,108,121
 
Retail:
                         
  Real estate residential
   
8,417,942
         
7,603,249
   
8,357,143
 
  Real estate construction
   
2,096,440
         
1,814,632
   
1,925,060
 
  Other retail
   
163,134
         
170,684
   
168,413
 
  Credit card receivables
   
202,866
         
248,049
   
251,016
 
  Real estate loans pledged against other collateralized
                         
borrowings
   
259,232
         
-
   
-
 
  Loans, net of unearned income
   
21,944,320
         
19,211,703
   
20,600,922
 
Allowance for loan losses
   
206,829
         
185,029
   
189,705
 
Total net loans
 
$
21,737,491
       
$
19,026,674
 
$
20,411,217
 
 
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. The following table presents information concerning nonperforming loans:

   
 September 30
 
December 31
 
(Dollars in thousands)
 
2006
 
 
 
2005
 
2005
 
Impaired loans
 
$
60,372
       
$
34,243
 
$
36,635
 
Other nonaccrual loans*
   
14,072
         
16,861
   
15,624
 
Total nonperforming loans
 
$
74,444
       
$
51,104
 
$
52,259
 
*
On September 30, 2006 and 2005, and on December 31, 2005, other nonaccrual loans included $10.5 million, $11.9 million, and $11.5 million, respectively, of loans held for sale.

On September 30, 2006, $3.7 billion of real estate residential qualifying loans were pledged to secure potential Federal Home Loan Bank borrowings. Qualifying loans are comprised of residential mortgage loans secured by first and second liens and home equity lines of credit. In addition, $5.0 billion of commercial, financial and industrial loans were pledged to secure potential discount window borrowings from the Federal Reserve Bank.
 
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
 
 Nine Months Ended
 
   
 September 30
 
September 30
 
(Dollars in thousands)
 
2006
     
2005
 
2006
     
2005
 
Total interest on impaired loans
 
$
538
       
$
454
 
$
882
       
$
910
 
Average balance of impaired loans
   
54,227
         
34,353
   
48,945
         
35,686
 
 
An allowance for loan losses is maintained for all impaired loans. Activity in the allowance for loan losses related to non-impaired loans, impaired loans, and for the total allowance for the nine months ended September 30, 2006 and 2005, is summarized as follows:

(Dollars in thousands)
 Non-impaired
 
Impaired
 
Total
 
Balance on December 31, 2004
 
$
147,672
 
$
10,487
 
$
158,159
 
Provision for loan losses
   
48,435
   
3,068
   
51,503
 
Acquisition
   
1,902
   
-
   
1,902
 
Charge-offs
   
(30,265
)
 
(7,299
)
 
(37,564
)
Recoveries
   
7,919
   
3,110
   
11,029
 
Net charge-offs
   
(22,346
)
 
(4,189
)
 
(26,535
)
Balance on September 30, 2005
 
$
175,663
 
$
9,366
 
$
185,029
 
                     
Balance on December 31, 2005
 
$
179,635
 
$
10,070
 
$
189,705
 
Provision for loan losses
   
35,255
   
24,891
   
60,146
 
Adjustment due to divestiture
   
(1,470
)
 
-
   
(1,470
)
Charge-offs
   
(29,414
)
 
(22,677
)
 
(52,091
)
Recoveries
   
7,687
   
2,852
   
10,539
 
Net charge-offs
   
(21,727
)
 
(19,825
)
 
(41,552
)
Balance on September 30, 2006
 
$
191,693
 
$
15,136
 
$
206,829
 
 
14

Note 4 - Mortgage Servicing Rights

On January 1, 2006, FHN elected early adoption of SFAS No. 156, which requires servicing rights be initially measured at fair value. Subsequently, companies are permitted to elect, on a class-by-class basis, either fair value or amortized cost accounting for their servicing rights. Accordingly, FHN began initially recognizing all its classes of mortgage servicing rights (MSR) at fair value and elected to irrevocably continue application of fair value accounting to all its classes of MSR. Classes of MSR are determined in accordance with FHN’s risk management practices and market inputs used in determining the fair value of the servicing asset. FHN recognized the cumulative effect of a change in accounting principle totaling $.2 million, net of tax, representing the excess of the fair value of the servicing asset over the recorded value on January 1, 2006. The balance of MSR included on the Consolidated Condensed Statements of Condition represents the rights to service approximately $100.9 billion of mortgage loans on September 30, 2006, for which a servicing right has been capitalized. Following is a summary of changes in capitalized MSR as of September 30, 2006:

   
First
 
Second
     
(Dollars in thousands)
 
Liens
 
Liens
 
HELOC
 
Fair value on January 1, 2006
 
$
1,318,219
 
$
5,470
 
$
14,384
 
Addition of mortgage servicing rights
   
303,791
   
15,532
   
5,421
 
Reductions due to loan payments
   
(191,239
)
 
(2,924
)
 
(6,143
)
Changes in fair value due to:
                   
  Changes in current market interest rates
   
33,536
   
34
   
1,090
 
  Changes in assumptions
   
-
   
722
   
8
 
  Other changes in fair value
   
53
   
17
   
370
 
Fair value on September 30, 2006
 
$
1,464,360
 
$
18,851
 
$
15,130
 
 
In 2005 these amounts were included at the lower of cost, net of accumulated amortization, or fair value. The cost basis of MSR qualifying for SFAS No. 133 fair value hedge accounting was adjusted to reflect changes in fair value. MSR were amortized over the period of and in proportion to the estimated net servicing revenues. MSR were periodically evaluated for impairment. Impairment occurred when the current fair value of the servicing right was less than its recorded value. A quarterly value impairment analysis was performed using a discounted cash flow analysis which was disaggregated by strata representing predominant risk characteristics, including fixed and adjustable rate loans. Impairment, if any, was recognized through a valuation allowance for individual strata. However, if the impairment was determined to be other than temporary, a direct write-off of the asset was made. With the adoption of SFAS No. 156, MSR are valued at fair value, both initially and prospectively; impairment tests are no longer performed. Following is a summary of changes in capitalized MSR as of September 30, 2005:

(Dollars in thousands)
     
Balance on December 31, 2004
 
$
1,036,458
 
Addition of mortgage servicing rights
   
314,737
 
Amortization
   
(144,492
)
Market value adjustments
   
37,452
 
Permanent impairment
   
(36,613
)
Decrease in valuation allowance
   
2,742
 
Balance on September 30, 2005
 
$
1,210,284
 
 
MSR on September 30, 2005, had an estimated market value of approximately $1,229.5 million. This balance represents the rights to service approximately $91.3 billion of mortgage loans on September 30, 2005, for which a servicing right was capitalized. On September 30, 2005, valuation allowances due to temporary impairment of $1.5 million were required. Following is a summary of changes in the valuation allowance for the nine months ended September 30, 2005:

(Dollars in thousands)
     
Balance on December 31, 2004
 
$
4,231
 
Permanent impairment
   
(36,613
)
Servicing valuation provision
   
33,871
 
Balance on September 30, 2005
 
$
1,489
 
 
Since sales of MSR 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. As such, like other participants in the mortgage banking business,
 
15

Note 4 - Mortgage Servicing Rights (continued)

FHN relies primarily on a discounted cash flow model to estimate the fair value of its MSR. This model calculates estimated fair value of the MSR using predominant risk characteristics of MSR, such as interest rates, type of product (fixed vs. variable), age (new, seasoned, or moderate), agency type and other factors. FHN uses assumptions in the model that it believes are comparable to those used by brokers and other service providers. FHN also periodically compares its estimates of fair value and assumptions with brokers, service providers, and recent market activity and against its own experience.

The sensitivity of the current fair value of all retained or purchased interests for MSR to immediate 10 percent and 20 percent adverse changes in assumptions on September 30, 2006, are as follows:

(Dollars in thousands
 
First
 
Second
     
except for annual cost to service)
 
Liens
 
Liens
 
HELOC
 
September 30, 2006
                   
Fair value of retained interests
 
$
1,464,360
 
$
18,851
 
$
15,130
 
Weighted average life (in years)
   
6.5
   
2.9
   
2.0
 
                     
Annual prepayment rate
   
12.1
%
 
29.1
%
 
49.0
%
  Impact on fair value of 10% adverse change
 
$
(57,861
)
$
(902
)
$
(877
)
  Impact on fair value of 20% adverse change
   
(111,370
)
 
(1,691
)
 
(1,673
)
                     
Annual discount rate on servicing cash flows
   
10.2
%
 
14.0
%
 
18.0
%
  Impact on fair value of 10% adverse change
 
$
(58,443
)
$
(396
)
$
(367
)
  Impact on fair value of 20% adverse change
   
(112,447
)
 
(794
)
 
(714
)
                     
Annual cost to service (per loan)*
 
$
55
 
$
50
 
$
50
 
  Impact on fair value of 10% adverse change
   
(13,272
)
 
(290
)
 
(229
)
  Impact on fair value of 20% adverse change
   
(26,543
)
 
(581
)
 
(457
)
                     
Annual earnings on escrow
   
4.4
%
 
5.2
%
 
5.3
%
  Impact on fair value of 10% adverse change
 
$
(35,522
)
$
(647
)
$
(609
)
  Impact on fair value of 20% adverse change
   
(71,123
)
 
(1,306
)
 
(1,229
)
*
The annual cost to service includes an incremental cost to service delinquent loans. Historically, this fair value sensitivity disclosure has not included this incremental cost. The annual cost to service loans without the incremental cost to service delinquent loans was $49 as of September 30, 2006.

FHN uses assumptions and estimates in determining the fair value allocated to retained interests at the time of initial securitization or sale. The key economic assumptions used to measure the fair value of the MSR at the date of securitization or loan sale were as follows for the nine months ended September 30, 2006:

       
First
Second
 
 
 
 
 
Liens
Liens
HELOC
Nine Months Ended September 30, 2006
 
 
 
 
 
 
Weighted average life (in years)
 
 
 
5.7-7.8
2.7-2.9
1.7-2.0
Annual prepayment rate
 
 
 
10.6%-16.3%
25%-35%
45%-55%
Annual discount rate
 
 
 
9.4%-11.4%
14%
18%
Annual cost to service (per loan)*
 
 
 
$56-$58
$50
$50
Annual earnings on escrow
 
 
 
4.2%-4.9%
2.0%-5.3%
2.0%-5.3%
*
The annual cost to service includes an incremental cost to service delinquent loans. Historically, the disclosure of annual cost to service assumptions has not included this incremental cost. The range of annual cost to service loans without the incremental cost to service delinquent loans was $48-$50 for MSR capitalized during the nine months ended September 30, 2006. 
 
16

Note 5 - Intangible Assets

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

   
 
 
Other
 
 
 
 
 
Intangible
 
(Dollars in thousands)
 
Goodwill
 
Assets*
 
December 31, 2004
 
$
160,067
 
$
22,520
 
Amortization expense
   
-
   
(8,033
)
Acquisitions**
   
122,125
   
62,406
 
September 30, 2005
 
$
282,192
 
$
76,893
 
December 31, 2005
 
$
281,440
 
$
76,647
 
Amortization expense
   
-
   
(9,002
)
Acquisitions**
   
4,871
   
6,124
 
Divestitures
   
(11,777
)
 
(3,223
)
September 30, 2006
 
$
274,534
 
$
70,546
 
*
Represents customer lists, acquired contracts, premium on purchased deposits, covenants not to compete and assets related to the minimum pension liability.
**
Preliminary 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 $141.5 million on September 30, 2006, net of $71.0 million of accumulated amortization. Estimated aggregate amortization expense for the remainder of 2006 is expected to be $2.6 million and is expected to be $9.8 million, $8.2 million, $6.6 million and $5.9 million for the twelve-month periods of 2007, 2008, 2009, and 2010, respectively.

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

   
Retail/
 
 
 
 
 
 
 
 
 
Commercial
 
Mortgage
 
Capital
 
 
 
(Dollars in thousands)
 
 
Banking
 
 
Banking
 
 
Markets
 
 
Total
 
December 31, 2004
 
$
87,208
 
$
55,214
 
$
17,645
 
$
160,067
 
Acquisitions*
   
18,747
   
5,957
   
97,421
   
122,125
 
September 30, 2005
 
$
105,955
 
$
61,171
 
$
115,066
 
$
282,192
 
December 31, 2005
 
$
104,781
 
$
61,593
 
$
115,066
 
$
281,440
 
Acquisitions*
   
1,272
   
3,599
   
-
   
4,871
 
Divestitures
   
(11,777
)
 
-
   
-
   
(11,777
)
September 30, 2006
 
$
94,276
 
$
65,192
 
$
115,066
 
$
274,534
 
* Preliminary purchase price allocations on acquisitions are based upon estimates of fair value and are subject to change.
 
17

Note 6 - Long-Term Debt

The following table presents information pertaining to long-term debt (debt with original maturities greater than one year) for FHN and its subsidiaries:

   
September 30
 
December 31
 
(Dollars in thousands)
 
2006
 
2005
 
2005
 
First Tennessee Bank National Association:
             
Subordinated notes (qualifies for total capital under the Risk-Based Capital guidelines):
             
Matures on January 15, 2015 -- 5.05%
 
$
387,182
 
$
396,763
 
$
392,279
 
Matures on May 15, 2013 -- 4.625%
   
248,060
   
253,925
   
251,135
 
Matures on December 1, 2008 -- 5.75%
   
137,284
   
137,423
   
136,847
 
Matures on April 1, 2008 -- 6.40%
   
89,894
   
89,824
   
89,841
 
Matures on April 1, 2016 -- 5.65%
   
251,361
   
-
   
-
 
Bank notes*
   
2,409,762
   
649,973
   
874,672
 
Extendible notes**
                   
Final maturity of November 17, 2010 -- 5.32% on September 30, 2006, and
                   
  4.36% on December 31, 2005
   
1,249,264
   
-
   
1,249,110
 
Federal Home Loan Bank borrowings***
   
4,127
   
4,465
   
4,381
 
First Horizon National Corporation:
                   
Subordinated capital notes (qualifies for total capital under the Risk-Based Capital guidelines):
                   
Matures on May 15, 2013 -- 4.50%
   
99,268
   
101,627
   
100,478
 
Matured on November 15, 2005 -- 6.75%
   
-
   
22,894
   
-
 
Subordinated notes:
                   
Matures on January 6, 2027 -- 8.07%
   
101,897
   
101,021
   
99,737
 
Matures on April 15, 2034 -- 6.30%
   
203,337
   
196,930
   
193,878
 
FT Real Estate Securities Company, Inc.
                   
Cumulative preferred stock (qualifies for total capital under the Risk-Based Capital guidelines):
                   
Matures on March 31, 2031 -- 9.50%
   
45,336
   
45,268
   
45,285
 
First Horizon ABS Trust
                   
Other collateralized borrowings
                   
Matures on October 25, 2034--5.48%
   
260,416
   
-
   
-
 
Total
 
$
5,487,188
 
$
2,000,113
 
$
3,437,643
 
*
 
The bank notes were issued with variable interest rates and have remaining terms of 1 to 5 years. These bank notes had weighted average interest rates of 5.48 percent and 3.80 percent on September 30, 2006 and 2005, respectively and 4.66 percent on December 31, 2005.
**
 
As of September 30, 2006, the extendible notes had a contractual maturity of October 17, 2007, but are extendible at the investors' option to the final maturity date of November 17, 2010.
***
 
The Federal Home Loan Bank (FHLB) borrowings were issued with fixed interest rates and have remaining terms of 3 to 23 years. These borrowings had weighted average interest rates of 3.26 percent and 3.45 percent on September 30, 2006 and 2005, respectively and 3.40 percent on December 31, 2005.

Annual principal repayment requirements as of September 30, 2006, are as follows:

(Dollars in thousands)
2006
       
$      200,084
2007
       
1,400,340
2008
       
606,965
2009
       
1,070,323
2010
       
140
2011 and after
       
2,234,595

All subordinated notes are unsecured and are subordinate to other present and future senior indebtedness. FTBNA’s subordinated notes and FHN’s subordinated capital notes qualify as Tier 2 capital under the risk-based capital guidelines. Prior to February 2005, FTBNA had a bank note program under which the bank was able to borrow funds from time to time at maturities of 30 days to 30 years.  This bank note program was terminated in connection with the establishment of a new program.  That termination did not affect any previously issued notes outstanding.  In February 2005, FTBNA established a new bank note program providing additional liquidity of $5.0 billion.  This bank note program provides FTBNA with a facility under which it may continuously issue and offer short- and medium-term unsecured notes.  On September 30, 2006, $2.6 billion was available under current conditions through the bank note program. 
 
18

Note 6 - Long-Term Debt (continued)

In November 2005, FTBNA entered into a $3.0 billion floating rate extendible note program. The extendible note program provides FTBNA with a facility under which it may issue and offer unsecured and unsubordinated notes with initial maturities of thirteen months and final maturities of five years. On September 30, 2006, $1.7 billion was available under current conditions through the extendible note program.
 
19

Note 7 - Regulatory Capital

FHN is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on FHN's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines that involve quantitative measures of assets, liabilities and certain derivatives as calculated under regulatory accounting practices must be met. Capital amounts and classification are also subject to qualitative judgment by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require FHN to maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets (leverage). Management believes, as of September 30, 2006, that FHN met all capital adequacy requirements to which it was subject.

The actual capital amounts and ratios of FHN and FTBNA are presented in the table below. In addition, FTBNA must also calculate its capital ratios after excluding financial subsidiaries as defined by the Gramm-Leach-Bliley Act of 1999. Based on this calculation FTBNA’s Total Capital, Tier 1 Capital and Leverage ratios were 11.59 percent, 7.96 percent and 6.61 percent, respectively, on September 30, 2006, and were 11.76 percent, 8.45 percent and 6.59 percent, respectively, on September 30, 2005.

   
First Horizon National
 
First Tennessee Bank
 
   
Corporation
 
National Association
 
(Dollars in thousands)
 
Amount
 
 
 
Ratio
 
Amount
 
 
 
Ratio
 
On September 30, 2006:
                                     
Actual:
                                     
Total Capital
 
$
3,998,431
         
12.67
%
$
3,806,220
         
12.15
%
Tier 1 Capital
   
2,660,264
         
8.43
   
2,568,052
         
8.20
 
Leverage
   
2,660,264
         
6.80
   
2,568,052
         
6.62
 
                                       
For Capital Adequacy Purposes:
                                     
Total Capital
   
2,525,490
   
>
   
8.00
   
2,506,314
   
>
   
8.00
 
Tier 1 Capital
   
1,262,745
   
>
   
4.00
   
1,253,157
   
>
   
4.00
 
Leverage
   
1,564,438
   
>
   
4.00
   
1,552,664
   
>
   
4.00
 
                                       
To Be Well Capitalized Under Prompt
                                     
Corrective Action Provisions:
                                     
Total Capital
                     
3,132,893
   
>
   
10.00
 
Tier 1 Capital
                     
1,879,736
   
>
   
6.00
 
Leverage
                     
1,940,830
   
>
   
5.00
 
On September 30, 2005:
                                     
Actual:
                                     
Total Capital
 
$
3,577,691
         
12.68
%
$
3,441,496
         
11.96
%
Tier 1 Capital
   
2,465,195
         
8.74
   
2,429,000
         
8.44
 
Leverage
   
2,465,195
         
6.54
   
2,429,000
         
6.49
 
                                       
For Capital Adequacy Purposes:
                                     
Total Capital
   
2,257,730
   
>
   
8.00
   
2,302,711
   
>
   
8.00
 
Tier 1 Capital
   
1,128,865
   
>
   
4.00
   
1,151,356
   
>
   
4.00
 
Leverage
   
1,506,736
   
>
   
4.00
   
1,496,133
   
>
   
4.00
 
                                       
To Be Well Capitalized Under Prompt
                                     
Corrective Action Provisions:
                                     
Total Capital
                     
2,878,389
   
>
   
10.00
 
Tier 1 Capital
                     
1,727,034
   
>
   
6.00
 
Leverage
                     
1,870,166
   
>
   
5.00
 
Certain previously reported amounts have been reclassified to agree with current presentation.
 
20

Note 8 - Earnings Per Share
 
The following table shows a reconciliation of earnings per common share to diluted earnings per common share:

 
 
Three Months Ended
 
Nine Months Ended 
 
 
 
September 30
 
September 30
 
(In thousands, except per share data)
 
 2006
 
 2005
 
 2006
 
 2005
 
Net income from continuing operations
 
$
67,179
 
$
108,114
 
$
174,522
 
$
307,075
 
Income from discontinued operations, net of tax
   
(69
)
 
4,830
   
210,580
   
11,703
 
Cumulative effect of changes in accounting
                         
  principle, net of tax
   
-
   
-
   
1,345
   
-
 
Net income
 
$
67,110
 
$
112,944
 
$
386,447
 
$
318,778
 
                           
Weighted average common shares
   
124,150
   
125,838
   
124,431
   
125,171
 
Effect of dilutive securities
   
3,373
   
4,086
   
3,531
   
3,964
 
Diluted average common shares
   
127,523
   
129,924
   
127,962
   
129,135
 
                           
Earnings per common share:
                         
Net income from continuing operations
 
$
.54
 
$
.86
 
$
1.40
 
$
2.45
 
Income from discontinued operations, net of tax
   
-
   
.04
   
1.69
   
.10
 
Cumulative effect of changes in accounting
                         
  principle, net of tax
   
-
   
-
   
.02
   
-
 
Net income
 
$
.54
 
$
.90
 
$
3.11
 
$
2.55
 
                           
Diluted earnings per common share:
                         
Net income from continuing operations
 
$
.53
 
$
.83
 
$
1.36
 
$
2.38
 
Income from discontinued operations, net of tax
   
-
   
.04
   
1.65
   
.09
 
Cumulative effect of changes in accounting
                         
  principle, net of tax
   
-
   
-
   
.01
   
-
 
Net income
 
$
.53
 
$
.87
 
$
3.02
 
$
2.47
 
Outstanding stock options of 6,730 and 4,379 with weighted average exercise prices of $42.34 and $43.03 per share for the three months ended September 30, 2006 and 2005, respectively, and of 6,174 and 3,962 with weighted average exercise prices of $42.56 and $43.63 per share for the nine months ended September 30, 2006 and 2005, respectively, were not included in the computation of diluted earnings per common share because such shares would have had an antidilutive effect on earnings per common share.
 
Certain previously reported amounts have been reclassified to agree with current presentation.
 
In first quarter 2006, FHN purchased four million shares of its common stock. This share repurchase program was concluded for an adjusted purchase price of $165.1 million in second quarter 2006.
 
21