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 June 30, 2007

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
 126,236,535
 Class
 Outstanding on June 30, 2007
 

 
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
     
June 30
   
December 31
 
(Dollars in thousands)(Unaudited)
   
2007
 
2006
   
2006
 
Assets:
                 
Cash and due from banks
   
 $      799,428
 
 $      825,364
   
 $      943,555
 
Federal funds sold and securities
                 
  purchased under agreements to resell
   
          1,121,052
 
            1,572,143
   
            1,202,537
 
    Total cash and cash equivalents
   
          1,920,480
 
            2,397,507
   
            2,146,092
 
Investment in bank time deposits
   
               58,241
 
                 75,903
   
                 18,037
 
Trading securities
   
          2,291,704
 
            2,183,102
   
            2,230,745
 
Loans held for sale
   
          3,330,489
 
            3,222,735
   
            2,873,577
 
Securities available for sale
   
          3,374,583
 
            3,137,667
   
            3,923,215
 
Securities held to maturity (fair value of $271 on June 30, 2007; $387 on
             
  June 30, 2006; and $272 on December 31, 2006)
   
                    270
 
                      384
   
                      269
 
Loans, net of unearned income
   
        22,382,303
 
          21,717,264
   
          22,104,905
 
  Less:  Allowance for loan losses
   
             229,919
 
               199,835
   
               216,285
 
    Total net loans
   
        22,152,384
 
          21,517,429
   
          21,888,620
 
Mortgage servicing rights, net
   
          1,522,966
 
            1,595,413
   
            1,533,942
 
Goodwill
   
             279,825
 
               281,910
   
               275,582
 
Other intangible assets, net
   
               61,947
 
                 75,055
   
                 64,530
 
Capital markets receivables
   
          1,240,456
 
1,058,690
   
732,282
 
Premises and equipment, net
   
             438,807
 
               431,385
   
               451,708
 
Real estate acquired by foreclosure
   
               67,499
 
                 60,577
   
                 63,519
 
Discontinued assets
   
                         -
 
                      696
   
                      416
 
Other assets
   
    1,654,433
 
    1,430,781
   
    1,715,725
 
Total assets
   
 $ 38,394,084
 
 $ 37,469,234
   
 $ 37,918,259
 
                   
Liabilities and shareholders' equity:
                 
Deposits:
                 
  Savings
   
 $   3,520,757
 
 $   3,246,821
   
 $   3,354,180
 
  Time deposits
   
2,885,307
 
2,819,597
   
2,924,050
 
  Other interest-bearing deposits
   
1,822,076
 
1,894,707
   
1,969,700
 
  Certificates of deposit $100,000 and more
   
8,016,808
 
8,053,119
   
6,517,629
 
     Interest-bearing
   
        16,244,948
 
          16,014,244
   
          14,765,559
 
  Noninterest-bearing
   
          5,516,735
 
            5,679,198
   
            5,447,673
 
     Total deposits
   
        21,761,683
 
          21,693,442
   
          20,213,232
 
Federal funds purchased and securities
                 
  sold under agreements to repurchase
   
          3,841,251
 
            3,387,711
   
            4,961,799
 
Trading liabilities
   
             658,533
 
               929,694
   
               789,957
 
Commercial paper and other short-term borrowings
   
             246,815
 
               721,227
   
            1,258,513
 
Term borrowings
   
          5,828,138
 
            5,325,014
   
            5,243,961
 
Other collateralized borrowings
   
821,966
 
               281,280
   
               592,399
 
  Total long-term debt
   
6,650,104
 
            5,606,294
   
            5,836,360
 
Capital markets payables
   
1,144,029
 
1,057,617
   
799,489
 
Discontinued liabilities
   
                         -
 
8,422
   
6,966
 
Other liabilities
   
          1,332,910
 
            1,327,360
   
            1,294,283
 
    Total liabilities
   
        35,635,325
 
          34,731,767
   
          35,160,599
 
Preferred stock of subsidiary
   
             295,277
 
               295,274
   
295,270
 
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 - 126,236,535 on June 30, 2007;
             
  123,947,391 on June 30, 2006; and 124,865,982 on December 31, 2006)
               78,898
 
                 77,467
   
78,041
 
Capital surplus
   
             352,138
 
               282,563
   
               312,521
 
Undivided profits
   
          2,120,014
 
            2,113,514
   
            2,144,276
 
Accumulated other comprehensive loss, net
   
             (87,568
) 
               (31,351
)
 
               (72,448
    Total shareholders' equity
   
          2,463,482
 
            2,442,193
   
            2,462,390
 
Total liabilities and shareholders' equity
   
 $ 38,394,084
 
 $ 37,469,234
   
 $ 37,918,259
 
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
 
Six Months Ended
 
     
June 30
 
June 30
 
(Dollars in thousands except per share data)(Unaudited)
   
2007
 
2006
 
 2007
2006
 
Interest income:
                 
Interest and fees on loans
   
$413,254
 
$393,451
 
$ 823,681
$756,934
 
Interest on investment securities
   
 47,105
 
 41,747
 
     101,375
       77,886
 
Interest on loans held for sale
   
 65,923
 
 75,832
 
     124,768
     152,174
 
Interest on trading securities
   
 50,069
 
 43,598
 
       90,632
       82,113
 
Interest on other earning assets
   
 18,552
 
 23,954
 
       37,632
       42,844
 
    Total interest income
   
594,903
 
578,582
 
  1,178,088
  1,111,951
 
Interest expense:
                 
Interest on deposits:
                 
  Savings
   
 29,919
 
 21,827
 
       55,950
       37,173
 
  Time deposits
   
 33,555
 
 29,116
 
       66,592
       54,454
 
  Other interest-bearing deposits
   
 6,808
 
 6,361
 
       13,697
       11,912
 
  Certificates of deposit $100,000 and more
   
 110,630
 
 110,068
 
     216,906
     229,364
 
Interest on trading liabilities
   
 14,272
 
 19,923
 
       30,633
       38,270
 
Interest on short-term borrowings
   
 68,932
 
 67,380
 
     136,096
     123,624
 
Interest on long-term debt
   
 91,355
 
 70,309
 
     181,363
     117,835
 
    Total interest expense
   
     355,471
 
     324,984
 
     701,237
     612,632
 
Net interest income
   
     239,432
 
     253,598
 
     476,851
     499,319
 
Provision for loan losses
   
 44,408
 
 18,653
 
       72,894
       36,452
 
Net interest income after provision for loan losses
   
     195,024
 
     234,945
 
     403,957
     462,867
 
Noninterest income:
                 
Capital markets
   
 85,054
 
 102,165
 
     172,167
     195,023
 
Mortgage banking
   
 71,300
 
 116,472
 
     144,397
     197,154
 
Deposit transactions and cash management
   
 43,079
 
 42,756
 
       82,437
       80,779
 
Revenue from loan sales and securitizations
   
 9,615
 
 12,212
 
       19,278
       23,569
 
Insurance commissions
   
 7,674
 
 12,461
 
       17,463
       27,147
 
Trust services and investment management
   
 10,628
 
 10,824
 
       20,316
       21,481
 
Equity securities (losses)/gains, net
   
          (995
) 
         2,517
 
         2,967
         1,514
 
Debt securities (losses)/gains, net
   
            (19
) 
            376
 
         6,292
     (78,902
) 
All other income and commissions
   
 53,963
 
 35,229
 
       98,170
       64,857
 
    Total noninterest income
   
     280,299
 
     335,012
 
     563,487
     532,622
 
Adjusted gross income after provision for loan losses
   
     475,323
 
     569,957
 
     967,444
     995,489
 
Noninterest expense:
                 
Employee compensation, incentives and benefits
   
 258,191
 
 245,796
 
     504,534
     505,937
 
Occupancy
   
 33,402
 
 27,525
 
       62,186
       57,627
 
Equipment rentals, depreciation and maintenance
   
 21,791
 
 17,858
 
       39,404
       38,122
 
Operations services
   
 17,457
 
 17,075
 
       35,278
       34,515
 
Communications and courier
   
 10,746
 
 13,409
 
       22,286
       28,321
 
Amortization of intangible assets
   
 2,623
 
 2,881
 
         5,448
         5,769
 
All other expense
   
 113,030
 
 98,467
 
     191,116
     187,801
 
    Total noninterest expense
   
     457,240
 
     423,011
 
     860,252
     858,092
 
Income before income taxes
   
       18,083
 
     146,946
 
     107,192
     137,397
 
(Benefit)/provision for income taxes
   
(3,861
) 
43,013
 
       14,941
       30,054
 
Income from continuing operations
   
       21,944
 
     103,933
 
       92,251
     107,343
 
Income from discontinued operations, net of tax
   
179
 
376
 
            419
     210,649
 
Income before cumulative effect of changes in accounting principle
       22,123
 
     104,309
 
       92,670
     317,992
 
Cumulative effect of changes in accounting principle, net of tax
   
                -
 
                -
 
                -
         1,345
 
Net income
   
$  22,123
 
$104,309
 
$   92,670
$319,337
 
Earnings per common share from continuing operations
   
 $        .18
 
 $        .84
 
 $         .74
 $        .86
 
Earnings per common share from discontinued operations, net of tax
          -
 
         -
 
         -
      1.69
 
Earnings per common share from cumulative effect of changes in accounting principle 
 -
 
         -
 
         -
       .01
 
Earnings per common share  (Note 7)
   
 $        .18
 
 $        .84
 
 $         .74
 $      2.56
 
Diluted earnings per common share from continuing operations
   
 $        .17
 
 $        .82
 
 $         .72
 $        .84
 
Diluted earnings per common share from discontinued operations, net of tax 
 -
 
         -
 
         -
      1.64
 
Diluted earnings per common share from cumulative effect of changes in accounting principle
 -
 
         -
 
         -
       .01
 
Diluted earnings per common share  (Note 7)
   
 $        .17
 
 $        .82
 
 $         .72
 $      2.49
 
Weighted average common shares (Note 7)
   
     125,873
 
     123,667
 
     125,609
     124,573
 
Diluted average common shares (Note 7)
   
     128,737
 
     127,280
 
     128,720
     128,185
 
See accompanying notes to consolidated condensed financial statements.
Certain previously reported amounts have been reclassified to agree with current presentation.
 
5
 
CONSOLIDATED CONDENSED STATEMENTS OF SHAREHOLDERS' EQUITY
 First Horizon National Corporation
 
(Dollars in thousands)(Unaudited)
 
             2007
 
              2006
 
Balance, January 1
 
 $2,462,390
 
 $2,347,539
 
Adjustment to reflect change in accounting for tax benefits (FIN 48)
                            (862
)
-
 
Adjustment to reflect adoption of measurement date provisions for SFAS No. 158
                           6,233
 
-
 
Adjustment to reflect change in accounting for purchases of life insurance
       
  (EITF Issue No. 06-5)
 
                            (548
)
-
 
Net income
 
                         92,670
 
319,337
 
Other comprehensive income:
         
  Unrealized fair value adjustments, net of tax:
         
    Cash flow hedges
 
                              (29
) 
966
 
    Securities available for sale
 
                       (25,963
) 
                           9,927
 
Comprehensive income
 
                         66,678
 
330,230
 
Cash dividends declared
 
                     (113,450
) 
(111,752
Common stock repurchased
 
                         (1,096
)
                     (165,568
Common stock issued for:
         
  Stock options and restricted stock
 
                         30,506
 
34,878
 
  Acquisitions
 
-
 
487
 
Excess tax benefit from stock-based compensation arrangements
                           6,029
 
                           3,592
 
Adjustment to reflect change in accounting for employee stock option forfeitures
-
 
(1,780
Recognized pension and other employee benefit plans net periodic benefit costs
                           2,562
 
-
 
Stock-based compensation expense
 
                           5,009
 
                           4,567
 
Other
 
31
 
-
 
Balance, June 30
 
 $2,463,482
 
 $2,442,193
 
See accompanying notes to consolidated condensed financial statements.
 
6
 
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
First Horizon National Corporation
     
Six Months Ended June 30
 
(Dollars in thousands)(Unaudited)
 
2007
   
2006
 
Operating 
Net income
   
$     92,670
     
$   319,337
 
Activities
Adjustments to reconcile net income to net cash provided/(used) by operating activities:
               
 
    Provision for loan losses
   
72,894
     
36,452
 
 
    Provision for deferred income tax
   
14,941
     
30,054
 
 
    Depreciation and amortization of premises and equipment
   
27,231
     
26,040
 
 
    Amortization of intangible assets
   
5,448
     
5,995
 
 
    Net other amortization and accretion
   
42,386
     
43,359
 
 
    Decrease in derivatives, net
   
58,724
     
1,643
 
 
    Market value adjustment on mortgage servicing rights
    (100,230 )     (167,031 )
 
    Provision for foreclosure reserve
   
6,101
     
6,421
 
 
    Cumulative effect of changes in accounting principle, net of tax
   
-
      (1,345 )
 
    Gain on divestiture
   
-
      (208,577 )
 
    Stock-based compensation expense
   
5,009
     
4,567
 
 
    Excess tax benefit from stock-based compensation arrangements
    (6,029 )     (3,592 )
 
    Equity securities gains, net
    (2,967 )     (1,514 )
 
    Debt securities (gains)/losses, net
    (6,292 )    
78,902
 
 
    Net losses on disposal of fixed assets
   
588
     
1,925
 
 
    Net (increase)/decrease in:
               
 
      Trading securities
    (60,959 )     (49,674 )
 
      Loans held for sale
    (456,912 )    
1,201,532
 
 
      Capital markets receivables
    (508,174 )     (547,182 )
 
      Interest receivable
   
11,013
      (6,258 )
 
      Other assets
   
119,737
     
12,554
 
 
    Net increase/(decrease) in:
               
 
      Capital markets payables
   
344,540
     
466,290
 
 
      Interest payable
   
5,600
     
21,634
 
 
      Other liabilities
    (48,599 )     (74,303 )
 
      Trading liabilities
    (131,424 )    
136,056
 
 
        Total adjustments
    (607,374 )    
1,013,948
 
 
Net cash (used)/provided by operating activities
    (514,704 )    
1,333,285
 
Investing
Available for sale securities:
               
Activities
  Sales
   
624,240
     
2,261,985
 
 
  Maturities
   
368,577
     
374,135
 
 
  Purchases
    (469,738 )     (2,891,770 )
 
Premises and equipment:
               
 
  Sales
   
-
     
25
 
 
  Purchases
    (15,322 )     (50,711 )
 
Net increase in loans
    (367,402 )     (1,192,658 )
 
Net increase in investment in bank time deposits
    (40,200 )     (65,216 )
 
Proceeds from divestitures, net of cash and cash equivalents
   
-
     
421,756
 
 
Acquisitions, net of cash and cash equivalents acquired
   
-
      (487 )
 
Net cash provided/(used) by investing activities
   
100,155
      (1,142,941 )
Financing
Common stock:
               
Activities
  Exercise of stock options
   
30,571
     
34,676
 
 
  Cash dividends paid
    (112,085 )     (111,950 )
 
  Repurchase of shares
    (1,096 )     (165,568 )
 
  Excess tax benefit from stock-based compensation arrangements
   
6,029
     
3,592
 
 
Long-term debt:
               
 
  Issuance
   
1,076,909
     
2,234,160
 
 
  Payments
    (227,604 )     (18,718 )
 
Issuance of preferred stock of subsidiary
   
8
     
-
 
 
Repurchase of preferred stock of subsidiary
    (1 )    
-
 
 
Net increase/(decrease) in:
               
 
  Deposits
   
1,548,452
      (1,743,091 )
 
  Short-term borrowings
    (2,132,246 )     (428,821 )
 
Net cash provided/(used) by financing activities
   
188,937
      (195,720 )
 
Net decrease in cash and cash equivalents
    (225,612 )     (5,376 )
 
Cash and cash equivalents at beginning of period
   
2,146,092
     
2,402,883
 
 
Cash and cash equivalents at end of period
   
$1,920,480
     
$2,397,507
 
 
Cash and cash equivalents from discontinued operations at beginning of period, included above
   
$              -
     
$          874
 
 
Total interest paid
   
694,751
     
590,066
 
 
Total income taxes paid
   
13,782
     
104,898
 
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 2007 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 2006 Annual Report to shareholders.

Income Taxes.   FHN or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state’s jurisdiction. With few exceptions, FHN is no longer subject to U.S. federal or state and local income tax examinations by tax authorities for years before 2002. The Internal Revenue Service (IRS) has completed its examination of all U.S. federal returns through 2004, although 2003 and 2004 remain open under the statute. All proposed adjustments with respect to examinations of federal returns filed for 2004 and prior years have been settled.

FHN adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48), on January 1, 2007. As a result of the implementation of FIN 48, FHN recognized a $.9 million increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007, balance of undivided profits. The total balance of unrecognized tax benefits at January 1, 2007, was $41.0 million. First Horizon does not expect that unrecognized tax benefits will significantly increase or decrease within the next 12 months.  Included in the balance at January 1, 2007, were $15.6 million of tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest, the disallowance of the shorter deductibility period would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.  FHN recognizes interest accrued related to unrecognized tax benefits in tax expense and penalties in tax expense. FHN had approximately $4.8 million for the payment of interest accrued at January 1, 2007.  As of June 30, 2007, no significant changes to these amounts have occurred since the adoption of FIN 48.

Accounting Changes. Effective January 1, 2007, FHN adopted 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 require an assessment in accordance with SFAS No. 133 to determine if an embedded derivative exists within the instrument. In addition, effective January 1, 2007, FHN adopted Derivatives Implementation Group Issue B40, “Application of Paragraph 13(b) to Securitized Interests in Prepayable Financial Assets” (DIG B40). DIG B40 provides an exemption from the embedded derivative test of paragraph 13(b) of SFAS No. 133 for instruments that would otherwise require bifurcation if the test is met solely because of a prepayment feature included within the securitized interest and prepayment is not controlled by the security holder. Since FHN presents all retained interests in its proprietary securitizations as trading securities and due to the clarifying guidance of DIG B40, the impact of adopting SFAS No. 155 was immaterial to the results of operations.

Effective January 1, 2007, FHN adopted FIN 48 which 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.  As previously mentioned, upon adoption of FIN 48, FHN recognized a cumulative effect adjustment to the beginning balance of undivided profits in the amount of $.9 million for differences between the tax benefits recognized in the statements of condition prior to the adoption of FIN 48 and the amounts reported after adoption.

Effective January 1, 2007, FHN adopted 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).  EITF 06-5 provides that in addition to cash surrender value, the asset recognized for a life insurance contract should consider certain other provisions included in a policy’s contractual terms with additional amounts being discounted if receivable beyond one year.  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.  FHN recognized a reduction of undivided profits in the amount of $.5 million as a result of adopting EITF 06-5.

Effective January 1, 2007, FHN elected early adoption of the final provisions of 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 required that the annual measurement date of a plan’s assets and liabilities be as
 
8

 
Note 1 - Financial Information (continued)

of the date of the financial statements. As a result of adopting the measurement date provisions of SFAS No. 158, total equity was increased by $6.2 million on January 1, 2007, consisting of a reduction to undivided profits of $2.1 million and a credit to accumulated other comprehensive income of $8.3 million. Effective December 31, 2006, FHN adopted the provisions of SFAS No. 158 related to the requirements to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in the statements of condition. SFAS No. 158 did 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. As a result of adopting the recognition provisions of SFAS No. 158, unrecognized transition assets and obligations, unrecognized actuarial gains and losses, and unrecognized prior service costs and credits were recognized as a component of accumulated other comprehensive income resulting in a reduction in equity of $76.7 million, net of tax, on December 31, 2006.

In fiscal 2006, FHN adopted SEC Staff Accounting Bulletin No. 108 (SAB No. 108).  SAB No. 108 requires that registrants assess the impact on both the statement of condition and the statement of income 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 to a reporting period presented within the financial statements, after considering all relevant quantitative and qualitative factors.  The adoption of SAB No. 108 had no effect on FHN’s statement of condition or results of operations.

Effective January 1, 2006, FHN elected early adoption of SFAS No. 156, “Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140”.  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, “Share-Based Payment”, 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 is 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.

Accounting Changes Issued but Not Currently Effective. In June 2007, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 07-1, “Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies” (SOP 07-1), which provides guidance for determining whether an entity is within the scope of the AICPA’s Investment Companies Guide.  Additionally, SOP 07-1 provides certain criteria that must be met in order for investment company accounting applied by a subsidiary or equity method investee to be retained in the financial statements of the parent company or an equity method investor.  SOP 07-1 also provides expanded disclosure requirements regarding the retention of such investment company accounting in the consolidated financial statements.  In May 2007, FASB Staff Position No. FIN 46(R)-7, “Application of FASB Interpretation No. 46(R) to Investment Companies” (FIN 46(R)-7) was issued.  FIN 46(R)-7 amends FIN 46(R) to provide a permanent exception to its scope for companies within the scope of the revised Investment Companies Guide under SOP 07-1.  SOP 07-1 and FIN 46(R)-7
 
9

 
Note 1 - Financial Information (continued)

are effective for fiscal years beginning on or after December 15, 2007.  FHN is currently assessing the financial impact of adopting SOP 07-1 and FIN 46(R)-7.

In April 2007, FASB Staff Position No. FIN 39-1, “Amendment of FASB Interpretation No. 39” (FIN 39-1) was issued.  FIN 39-1 permits the offsetting of fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement.  Upon adoption of FIN 39-1, entities are permitted to change their previous accounting policy election to offset or not offset fair value amounts recognized for derivative instruments under master netting arrangements.  Additionally, FIN 39-1 requires additional disclosures for derivatives and collateral associated with master netting arrangements.  FIN 39-1 is effective for fiscal years beginning after November 15, 2007, through retrospective application, with early application permitted.  FHN is currently assessing the financial impact of adopting FIN 39-1.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS No. 159), which allows an irrevocable election to measure certain financial assets and financial liabilities at fair value on an instrument-by-instrument basis, with unrealized gains and losses recognized currently in earnings.  Under SFAS No. 159, the fair value option may only be elected at the time of initial recognition of a financial asset or financial liability or upon the occurrence of certain specified events.  Additionally, SFAS No. 159 provides that application of the fair value option must be based on the fair value of an entire financial asset or financial liability and not selected risks inherent in those assets or liabilities.  SFAS No. 159 requires that assets and liabilities which are measured at fair value pursuant to the fair value option be reported in the financial statements in a manner that separates those fair values from the carrying amounts of similar assets and liabilities which are measured using another measurement attribute.  SFAS No. 159 also provides expanded disclosure requirements regarding the effects of electing the fair value option on the financial statements.  SFAS No. 159 is effective prospectively for fiscal years beginning after November 15, 2007.  FHN is currently assessing the financial impact of adopting SFAS No. 159.

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 regarding the effects of fair value measurements on the financial statements.  SFAS No. 157 is effective prospectively for fiscal years beginning after November 15, 2007.  FHN is currently assessing the financial impact of adopting SFAS No. 157.

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 because such obligations are not considered to be 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 undivided profits.  FHN is currently assessing the financial impact of adopting EITF 06-4.
 
10

 
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 $351.5 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. 
 
In addition to the divestitures mentioned above, FHN acquires or divests assets from time to time in transactions that are considered business combinations or divestitures but are not material to FHN individually or in the aggregate.
 
11

 
Note 3 - Loans
 
The composition of the loan portfolio is detailed below:
 
   
 June 30
   
December 31
 
(Dollars in thousands)
 
2007
   
2006
   
2006
 
Commercial:
                 
   Commercial, financial and industrial
   
$  7,218,582
     
$  6,705,925
     
$  7,201,009
 
   Real estate commercial
   
1,389,963
     
1,276,278
     
1,136,590
 
   Real estate construction
   
2,830,856
     
2,453,579
     
2,753,458
 
Retail:
                       
   Real estate residential
   
7,614,887
     
8,562,733
     
7,973,313
 
   Real estate construction
   
2,158,775
     
2,076,004
     
2,085,133
 
   Other retail
   
149,157
     
163,121
     
161,178
 
   Credit card receivables
   
194,715
     
202,117
     
203,307
 
   Real estate loans pledged against other collateralized
                       
     borrowings
   
825,368
     
277,507
     
590,917
 
  Loans, net of unearned income
   
22,382,303
     
21,717,264
     
22,104,905
 
Allowance for loan losses
   
229,919
     
199,835
     
216,285
 
Total net loans
   
$22,152,384
     
$21,517,429
     
$21,888,620
 
Certain previously reported amounts have been reclassified to agree with current presentation.
 
Nonperforming loans consist of loans which management has identified as impaired, other nonaccrual loans and loans which have been restructured.  On June 30, 2007 and 2006, there were no outstanding commitments to advance additional funds to customers whose loans had been restructured.  The following table presents nonperforming loans on:
 
   
June 30
   
December 31
 
(Dollars in thousands)
 
2007
   
2006
   
2006
 
Impaired loans
   
$ 119,043
     
$ 56,394
     
$ 76,340
 
Other nonaccrual loans*
   
21,466
     
19,940
     
17,290
 
Total nonperforming loans
   
$ 140,509
     
$ 76,334
     
$ 93,630
 
* On June 30, 2007 and 2006, and on December 31, 2006, other nonaccrual loans included $12.5 million, $15.0 million, and
   $10.8 million, respectively, of loans held for sale.
 
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
   
Six Months Ended
 
   
June 30
   
June 30
 
(Dollars in thousands)
 
2007
   
2006
   
2007
   
2006
 
Total interest on impaired loans
   
$      154
     
$      165
     
$      495
     
$     344
 
Average balance of impaired loans
   
95,777
     
48,689
     
89,722
     
46,261
 
 
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, 2007 and 2006, is summarized as follows:
 
(Dollars in thousands)
 
Non-impaired
   
Impaired
   
Total
 
Balance on December 31, 2005
   
$179,635
     
$10,070
     
$189,705
 
Provision for loan losses
   
25,589
     
10,863
     
36,452
 
Divestitures/acquisitions/transfers
    (1,195 )    
-
      (1,195 )
Charge-offs 
    (23,034 )     (9,275 )     (32,309 )
Recoveries 
   
5,533
     
1,649
     
7,182
 
    Net charge-offs 
    (17,501 )     (7,626 )     (25,127 )
Balance on June 30, 2006
   
$186,528
     
$13,307
     
$199,835
 
                          
Balance on December 31, 2006
   
$200,827
     
$15,458
     
$216,285
 
Provision for loan losses
   
32,921
     
39,973
     
72,894
 
Divestitures/acquisitions/transfers
    (10,961 )    
1,290
      (9,671 )
Charge-offs 
    (23,181 )     (32,977 )     (56,158 )
Recoveries 
   
4,489
     
2,080
     
6,569
 
    Net charge-offs 
    (18,692 )     (30,897 )     (49,589 )
Balance on June 30, 2007
   
$204,095
     
$25,824
     
$229,919
 
 
 
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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 $106.3 billion of mortgage loans on June 30, 2007, for which a servicing right has been capitalized.

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.

Following is a summary of changes in capitalized MSR as of June 30, 2007 and 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
   
212,821
     
10,627
     
3,862
 
Reductions due to loan payments
    (130,911 )     (1,752 )     (4,338 )
Changes in fair value due to:
                       
  Changes in current market interest rates
   
165,182
     
95
     
1,029
 
  Other changes in fair value
   
338
     
17
     
370
 
Fair value on June 30, 2006
   
$1,565,649
     
$14,457
     
$15,307
 
Fair value on January 1, 2007
   
$1,495,215
     
$24,091
     
$14,636
 
Addition of mortgage servicing rights
   
185,257
     
7,995
     
1,832
 
Reductions due to loan payments
    (124,359 )     (4,547 )     (2,837 )
Changes in fair value due to:
                       
  Changes in current market interest rates
   
100,215
     
66
     
-
 
  Reclassification to trading assets
    (174,547 )    
-
     
-
 
  Other changes in fair value
    (54 )    
3
     
-
 
Fair value on June 30, 2007
   
$1,481,727
     
$27,608
     
$13,631
 
 
In conjunction with capital management initiatives, FHN modified Pooling and Servicing Agreements (PSA) on its private securitizations during the second quarter of 2007 to segregate the retained yield component from the master servicing fee.  The retained yield of $174.5 million was reclassified from mortgage servicing rights to trading securities on the Consolidated Condensed Statements of Condition.
 
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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, 2005
   
$281,440
     
$ 76,647
 
Amortization expense
   
-
      (5,769 )
Additions
   
1,580
     
4,300
 
Divestitures
    (1,110 )     (123 )
June 30, 2006
   
$281,910
     
$ 75,055
 
December 31, 2006
   
$275,582
     
$ 64,530
 
Amortization expense
   
-
      (5,448 )
Divestitures
   
-
      (60 )
Additions**
   
4,243
     
2,925
 
June 30, 2007
   
$279,825
     
$ 61,947
 
 *  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 $138.3 million on June 30, 2007, net of $76.4 million of accumulated amortization.  Estimated aggregate amortization expense for the remainder of 2007 is expected to be $5.3 million and is expected to be $8.9 million, $6.9 million, $6.0 million and $5.7 million for the twelve-month periods of 2008, 2009, 2010 and 2011, respectively.

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

   
Retail/
                   
   
Commercial
   
Mortgage
   
Capital
       
(Dollars in thousands)
 
Banking
   
Banking
   
Markets
   
Total
 
December 31, 2005
   
$104,781
     
$61,593
     
$115,066
     
$281,440
 
Divestitures
    (1,110 )    
-
     
-
      (1,110 )
Additions
   
30
     
1,550
     
-
     
1,580
 
June 30, 2006
   
$103,701
     
$63,143
     
$115,066
     
$281,910
 
December 31, 2006
   
$  94,276
     
$66,240
     
$115,066
     
$275,582
 
Additions*
   
-
     
4,243
     
-
     
4,243
 
June 30, 2007
   
$  94,276
     
$70,483
     
$115,066
     
$279,825
 
* Preliminary purchase price allocations on acquisitions are based upon estimates of fair value and are subject to change.
 
14

 
Note 6 - 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 June 30, 2007, 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 11.73 percent, 8.11 percent and 6.65 percent, respectively, on June 30, 2007, and were 12.07 percent, 8.25 percent and 6.71 percent, respectively, on June 30, 2006.

           
First Horizon National
   
First Tennessee Bank
           
Corporation
   
National Association
(Dollars in thousands)
         
   Amount
 
Ratio
   
          Amount
 
Ratio
On June 30, 2007:
                         
Actual:
                         
Total Capital
         
$4,027,528
 
   12.90%
   
$3,797,809
 
       12.31%
Tier 1 Capital
         
 2,711,329
 
  8.68
   
 2,581,611
 
      8.37
Leverage
         
 2,711,329
 
  7.00
   
 2,581,611
 
      6.72
                           
For Capital Adequacy Purposes:
                         
Total Capital
         
 2,497,928
>
  8.00
   
 2,468,136
>
      8.00
Tier 1 Capital
         
 1,248,964
>
  4.00
   
 1,234,068
>
      4.00
Leverage
         
 1,549,325
>
  4.00
   
 1,537,335
>
      4.00
                           
To Be Well Capitalized Under Prompt
       
    Corrective Action Provisions:
               
Total Capital
                   
 3,085,170
>
     10.00
Tier 1 Capital
                   
 1,851,102
>
      6.00
Leverage
                   
 1,921,669
>
      5.00
On June 30, 2006:
                         
Actual:
                         
Total Capital
         
$3,943,421
 
   13.13%
   
$3,757,888
 
       12.61%
Tier 1 Capital
         
 2,612,228
 
  8.70
   
 2,526,694
 
      8.48
Leverage
         
 2,612,228
 
  6.86
   
 2,526,694
 
      6.69
                           
For Capital Adequacy Purposes:
                         
Total Capital
         
 2,402,466
>
  8.00
   
 2,383,795
>
      8.00
Tier 1 Capital
         
 1,201,233
>
  4.00
   
 1,191,897
>
      4.00
Leverage
         
 1,523,082
>
  4.00
   
 1,511,220
>
      4.00
                           
To Be Well Capitalized Under Prompt
       
    Corrective Action Provisions:
               
Total Capital
                   
 2,979,744
>
     10.00
Tier 1 Capital
                   
 1,787,846
>
      6.00
Leverage
                   
 1,889,025
>
      5.00
Certain previously reported amounts have been reclassified to agree with current presentation.
 
15

 
Note 7 - Earnings Per Share
 
The following table shows a reconciliation of earnings per common share to diluted earnings per common share:
 
     
Three Months Ended
 
Six Months Ended
     
June 30
 
June 30
(In thousands, except per share data)
   
2007   
        2006    
 
            2007
            2006
Net income from continuing operations
   
 $ 21,944
 $ 103,933
 
 $ 92,251
 $ 107,343
Income from discontinued operations, net of tax
   
                     179
                     376
 
                     419
                210,649
Cumulative effect of changes in accounting
             
   principle, net of tax
   
                       -
                       -
 
                       -
                    1,345
Net income
   
 $ 22,123
 $ 104,309
 
 $ 92,670
 $ 319,337
               
Weighted average common shares
   
              125,873
              123,667
 
              125,609
                124,573
Effect of dilutive securities
   
                  2,864
                  3,613
 
                  3,111
                    3,612
Diluted average common shares
   
              128,737
              127,280
 
              128,720
                128,185
               
Earnings per common share:
             
Net income from continuing operations
   
 $       .18
 $         .84
 
 $       .74
 $         .86
Income from discontinued operations, net of tax
   
                       -
                       -
 
                       -
                      1.69
Cumulative effect of changes in accounting
             
   principle, net of tax
   
                       -
                       -
 
                       -
                        .01
Net income
   
 $       .18
 $         .84
 
 $       .74
 $       2.56
               
Diluted earnings per common share:
             
Net income from continuing operations
   
 $       .17
 $         .82
 
 $       .72
 $         .84
Income from discontinued operations, net of tax
   
                       -
                       -
 
                       -
                      1.64
Cumulative effect of changes in accounting
             
   principle, net of tax
   
                       -
                       -
 
                       -
                        .01
Net income
   
 $       .17
 $         .82
 
 $       .72
 $       2.49
Equity awards of 7,850 and 6,124 with weighted average exercise prices of $41.81 and $42.62 per share for the three months ended June 30, 2007 and 2006, respectively, and of 5,843 and 5,891 with weighted average exercise prices of $42.46 and $42.69 per share for the six months ended June 30, 2007 and 2006, 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.
 
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.
 
 
16

 
Note 8 - Contingencies and Other Disclosures
 
Contingencies. Contingent liabilities arise in the ordinary course of business, including those related to litigation. Various claims and lawsuits are pending against FHN and its subsidiaries. Although FHN cannot predict the outcome of these lawsuits, after consulting with counsel, management is of the opinion that when resolved, these lawsuits will not have a material adverse effect on the consolidated financial statements of FHN.
 
In November 2000, a complaint was filed in state court in Jackson County, Missouri against FHN’s subsidiary, First Horizon Home Loans. The case generally concerned the charging of certain loan origination fees, including fees permitted by Kansas and federal law but allegedly restricted or not permitted by Missouri law, when First Horizon Home Loans or its predecessor, McGuire Mortgage Company, made certain second-lien mortgage loans. Among other relief, plaintiffs sought a refund of fees, a repayment and forgiveness of loan interest, prejudgment interest, punitive damages, loan rescission, and attorneys’ fees. In response to pre-trial motions, the court certified a statewide class action involving approximately 4,000 loans and made a number of rulings that could have significantly affected the ultimate outcome of the case in the absence of an appeal.  Trial had been scheduled for the fourth quarter of 2006.

As a result of mediation, FHN entered into a final settlement agreement related to the McGuire lawsuit. In connection with this settlement, FHN agreed to pay, under agreed circumstances using an agreed methodology, an aggregate of up to approximately $36 million.  At the present time, the period during which claims under the settlement can be made has ended, and the claims that have been received are being evaluated. The total amount currently reserved for this matter, based on the claims received and FHN’s evaluation of them to date, is approximately $30 million.  The settlement has received final approval by the court, the court has entered its order making the settlement final, there have been no appeals, and the time for any appeals has expired.

The loss reserve for this matter reflects an estimate of the amount that ultimately would be paid under the settlement. The difference between the maximum amount possible under the settlement and the amount reserved reflects the amount and value of claims received. The ultimate amount paid under the settlement is not expected to be higher than the amount reserved at present, and may be lower in the event some of the claims are reduced or rejected for reasons set forth in the settlement, and in any event cannot exceed the settlement amount.

Other disclosures – Indemnification agreements and guarantees.  In the ordinary course of business, FHN enters into indemnification agreements for legal proceedings against its directors and officers and standard representations and warranties for underwriting agreements, merger and acquisition agreements, loan sales, contractual commitments, and various other business transactions or arrangements.  The extent of FHN’s obligations under these agreements depends upon the occurrence of future events; therefore, it is not possible to estimate a maximum potential amount of payouts that could be required with such agreements.

First Horizon Home Loans services a mortgage loan portfolio of approximately $106.0 billion on June 30, 2007, a significant portion of which is held by GNMA, FNMA, FHLMC or private security holders.  In connection with its servicing activities, First Horizon Home Loans guarantees the receipt of the scheduled principal and interest payments on the underlying loans.  In the event of customer non-performance on the loan, First Horizon Home Loans is obligated to make the payment to the security holder.  Under the terms of the servicing agreements, First Horizon Home Loans can utilize payments received from other prepaid loans in order to make the security holder whole.  In the event payments are ultimately made by First Horizon Home Loans to satisfy this obligation, for loans sold with no recourse, all funds are recoverable from the government agency at foreclosure sale.

First Horizon Home Loans 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, First Horizon Home Loans has exposure on all loans sold with recourse. First Horizon Home Loans has various claims for reimbursement, repurchase obligations, and/or indemnification requests outstanding with government agencies or private investors. First Horizon Home Loans has evaluated all of its exposure under recourse obligations based on factors, which include loan delinquency status, foreclosure expectancy rates and claims outstanding.  Accordingly, First Horizon Home Loans had an allowance for losses on the mortgage servicing portfolio of approximately $14.6 million and $15.1 million on June 30, 2007 and 2006, respectively.  First Horizon Home Loans has sold certain mortgage loans with an agreement to repurchase the loans upon default.  For the single-family residential loans, in the event of borrower nonperformance, First Horizon Home Loans would assume losses to the extent they exceed the value of the collateral and private mortgage insurance, FHA insurance or VA guarantees.  On June 30, 2007 and 2006, First Horizon Home Loans had single-family residential loans with outstanding balances of $110.5 million and $146.2 million, respectively, that were serviced on a full recourse basis. On June 30, 2007 and 2006, the outstanding principal balance of loans sold with limited recourse arrangements where some portion of the principal is at risk and serviced by First Horizon Home Loans was $3.2 billion and $2.9 billion,
 
 
17

 
Note 8 - Contingencies and Other Disclosures (continued)

respectively.  Additionally, on June 30, 2007 and 2006, $4.8 billion and $5.3 billion, respectively, of mortgage loans were outstanding which were sold under limited recourse arrangements where the risk is limited to interest and servicing advances.

FHN has securitized and sold HELOC and second-lien mortgages which are held by private security holders, and on June 30, 2007, the outstanding principal balance of these loans was $303.1 million and $82.5 million, respectively.  On June 30, 2006, the outstanding principal balance of securitized and sold HELOC and second-lien mortgages was $482.5 million and $116.0 million, respectively.  In connection with its servicing activities, FTBNA does not guarantee the receipt of the scheduled principal and interest payments on the underlying loans but does have residual interests of $33.7 million and $56.7 million on June 30, 2007 and 2006, respectively, which are available to make the security holder whole in the event of credit losses. FHN has projected expected credit losses in the valuation of the residual interest.
 
18

 
Note 9 – Pension and Other Employee Benefits

Pension plan.  FHN provides pension benefits to employees retiring under the provisions of a noncontributory, defined benefit pension plan.  Employees of FHN’s mortgage subsidiary and certain insurance subsidiaries are not covered by the pension plan.  Pension benefits are based on years of service, average compensation near retirement and estimated social security benefits at age 65.  The annual funding is based on an actuarially determined amount using the entry age cost method.

FHN also maintains a nonqualified supplemental executive retirement plan that covers certain employees whose benefits under the pension plan have been limited under Tax Code Section 415 and Tax Code Section 401(a)(17), which limit compensation to $225,000 for purposes of benefit calculations. Compensation is defined in the same manner as it is under the pension plan.  Participants receive the difference between the monthly pension payable, if tax code limits did not apply, and the actual pension payable.  All benefits provided under this plan are unfunded and payments to plan participants are made by FHN.

Other employee benefits.  FHN provides postretirement medical insurance to full-time employees retiring under the provisions of the FHN Pension Plan.  The postretirement medical plan is contributory with retiree contributions adjusted annually.  The plan is based on criteria that are a combination of the employee’s age and years of service and utilizes a two-step approach.  For any employee retiring on or after January 1, 1995, FHN contributes a fixed amount based on years of service and age at time of retirement.

Effective December 31,2006, FHN adopted SFAS No. 158, which required the recognition of the overfunded or underfunded status of a defined benefit plan and postretirement plan as an asset or liability in the statements of condition. SFAS No. 158 did not change measurement or recognition requirements for periodic pension and postretirement costs. Effective January 1, 2007, FHN adopted the final provisions of SFAS No. 158, which required that the annual measurement date of a plan’s assets and liabilities be as of the date of the financial statements. As a result of adopting the measurement provisions of SFAS No. 158, undivided profits were reduced by $2.1 million, net of tax, and accumulated other comprehensive income was credited by $8.3 million, net of tax.

The components of net periodic benefit cost for the three months ended June 30 are as follows:
 
   
Pension Benefits
   
Postretirement Benefits
 
(Dollars in thousands)
 
2007
   
2006
   
2007
   
2006
 
Components of net periodic benefit cost/(benefit)
                       
Service cost
   
$  4,327
     
$   4,520
     
$   75
     
$   83
 
Interest cost
   
6,154
     
5,486
     
278
     
279
 
Expected return on plan assets
    (10,637 )     (8,945 )     (441 )     (421 )
Amortization of prior service cost/(benefit)
   
220
     
211
      (44 )     (44 )
Recognized losses/(gains)
   
1,810
     
1,769
      (178 )     (140 )
Amortization of transition obligation
   
-
     
-
     
247
     
247
 
Net periodic cost/(benefit)
   
$  1,874
     
$   3,041
      $  (63 )    
$     4
 
 
The components of net periodic benefit cost for the six months ended June 30 are as follows:
 
   
Pension Benefits
   
Postretirement Benefits
 
(Dollars in thousands)
 
2007
   
2006
   
2007
   
2006
 
Components of net periodic benefit cost/(benefit)
                       
Service cost
   
$  8,654
     
$   9,040
     
$ 150
     
$ 166
 
Interest cost
   
12,308
     
10,971
     
556
     
558
 
Expected return on plan assets
    (21,274 )     (17,889 )     (882 )     (841 )
Amortization of prior service cost/(benefit)
   
440
     
422
      (88 )     (88 )
Recognized losses/(gains)
   
3,620
     
3,537
      (356 )     (281 )
Amortization of transition obligation
   
-
     
-
     
494
     
494
 
Net periodic cost/(benefit)
   
$  3,748
     
$   6,081
      $(126 )    
$     8
 
 
 
19

 
Note 9 – Pension and Other Employee Benefits (continued)

FHN made a contribution of $37 million to the pension plan in fourth quarter 2006 and made an additional contribution of $37 million in first quarter 2007. Both of these contributions were attributable to the 2006 plan year. FHN expects to make no additional contributions to the pension plan or to the other employee benefit plan in 2007.
 
 
20

 
Note 10 – Business Segment Information

FHN has four business segments, Retail/Commercial Banking, Mortgage Banking, Capital Markets and Corporate. The Retail/Commercial Banking segment offers financial products and services, including traditional lending and deposit taking, to retail and commercial customers. Additionally, Retail/Commercial Banking provides investments, insurance, financial planning, trust services and asset management, credit card, cash management, check clearing, and correspondent services. On March 1, 2006, FHN sold its national merchant processing business. The divestiture, which was accounted for as a discontinued operation, is included in the Retail/Commercial Banking segment. The Mortgage Banking segment consists of core mortgage banking elements including originations and servicing and the associated ancillary revenues related to these businesses. The Capital Markets segment consists of traditional capital markets securities activities, structured finance, equity research, investment banking, loan sales, portfolio advisory, and the sale of bank-owned life insurance. The Corporate segment consists of unallocated corporate expenses, expense on subordinated debt issuances and preferred stock, bank-owned life insurance, unallocated interest income associated with excess equity, net impact of raising incremental capital, revenue and expense associated with deferred compensation plans, funds management, and venture capital. Periodically, FHN adapts its segments to reflect changes in expense allocations between segments. Previously reported amounts have been reclassified to agree with current presentation.

Total revenue, expense and asset levels reflect those which are specifically identifiable or which are allocated based on an internal allocation method. Because the allocations are based on internally developed assignments and allocations, they are to an extent subjective. This assignment and allocation has been consistently applied for all periods presented. The following table reflects the amounts of consolidated revenue, expense, tax, and assets for each segment for the three and six months ended June 30:
 
   
Three Months Ended
 
Six Months Ended 
   
June 30
 
June 30
(Dollars in thousands)
 
               2007
 
      2006
 
               2007
 
      2006
Total Consolidated
               
Net interest income
 
  $      239,432
 
  $      253,598
 
  $      476,851
 
  $      499,319
Provision for loan losses
 
       44,408
 
       18,653
 
       72,894
 
       36,452
Noninterest income
 
       280,299
 
       335,012
 
       563,487
 
       532,622
Noninterest expense
 
      457,240
 
      423,011
 
      860,252
 
      858,092
     Pre-tax income
 
              18,083
 
       146,946
 
             107,192
 
       137,397
(Benefit)/provision for income taxes
 
              (3,861
)
             43,013
 
               14,941
 
             30,054
Income from continuing operations
 
              21,944
 
           103,933
 
               92,251
 
           107,343
Income from discontinued operations, net of tax
                   179
 
                  376
 
                    419
 
           210,649
Income before cumulative effect of changes
             
    in accounting principle
 
              22,123
 
           104,309
 
               92,670
 
           317,992
Cumulative effect of changes in
               
    accounting principle, net of tax
 
                       -
 
                       -
 
                        -
 
               1,345
Net income
 
  $        22,123
 
  $      104,309
 
  $        92,670
 
  $      319,337
Average assets
 
  $ 39,070,144
 
  $ 38,494,898
 
  $ 38,859,763
 
  $ 38,094,435
Certain previously reported amounts have been reclassified to agree with current presentation.
 
21

 
Note 10 – Business Segment Information (continued)
 
   
Three Months Ended 
 
Six Months Ended 
   
June 30  
 
June 30  
(Dollars in thousands)
 
               2007
 
      2006
 
               2007
 
      2006
Retail/Commercial Banking
               
Net interest income
 
  $      217,896
 
  $      232,496
 
  $      442,012
 
  $      458,236
Provision for loan losses
 
       36,847
 
       18,361
 
       65,340
 
       36,387
Noninterest income
 
       106,649
 
       113,984
 
       209,608
 
       221,723
Noninterest expense
 
      206,217
 
      214,744
 
      404,412
 
      433,110
   Pre-tax income
 
       81,481
 
       113,375
 
       181,868
 
       210,462
Provision for income taxes
 
              22,774
 
             29,581
 
               53,032
 
             57,210
Income from continuing operations
 
              58,707
 
             83,794
 
             128,836
 
           153,252
Income from discontinued operations, net of tax
                   179
 
                  376
 
                    419
 
           210,649
Income before cumulative effect
 
              58,886
 
             84,170
 
             129,255
 
           363,901
Cumulative effect of changes in
               
    accounting principle, net of tax
 
                       -
 
                       -
 
                        -
 
                  522
Net income
 
  $        58,886
 
  $        84,170
 
  $      129,255
 
  $      364,423
Average assets
 
  $ 23,837,809
 
  $ 23,021,401
 
  $ 23,693,540
 
  $ 22,992,194
                 
Mortgage Banking
               
Net interest income
 
  $        24,353
 
  $        25,494
 
  $        41,696
 
  $        51,332
Provision for loan losses
 
                 (111
) 
       292
 
                  (118
) 
       65
Noninterest income
 
       74,967
 
       119,608
 
       151,701
 
       203,335
Noninterest expense
 
      115,565
 
      115,155