SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the Securities
Exchange Act of 1934
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FIRST TENNESSEE NATIONAL CORPORATION
--------------------------------------------------------------------------------
(Name of Registrant as Specified in Its Charter)
--------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement if other than the Registrant)
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[LOGO FIRST TENNESSEE'r'
ALL THINGS FINANCIAL 'r']
First Tennessee
All Things Financial
Who We Are
First Tennessee National Corporation, soon to be renamed First Horizon National
Corporation pending shareholder approval, is a high-performing, nationwide
financial services institution. From our roots as a small bank in 1864, today we
have grown to be one of the 50 largest bank holding companies in the U.S. in
asset size and market capitalization, with $24.5 billion in assets and $5.6
billion in market capitalization at year-end 2003.
In the past year, we earned national recognition:
Named one of the 100 Best Corporate Citizens by Business Ethics magazine
Listed in Standard and Poor's 500 Index, one of the most widely watched
benchmarks of the stock market's performance.
Ranked in the top-10 in overall customer satisfaction among mortgage companies
nationwide by JD Power and Associates
Listed by Business Week magazine in the top 20 percent of the S&P 500
companies, and we ranked seventh out of 29 banks based on market value, sales
and profitability
Named one of the nation's top underwriters of U.S. government agency
securities
Among the nation's top 15 in mortgage originations and servicing
One of the largest processors of credit card payments for the travel and
entertainment industry
Named to the AARP Best Employers for Workers over 50 list
Earned ninth straight spot on Working Mother magazine's annual list of the 100
Best Companies for Working Mothers
Made Fortune magazine's list of one of the "100 Best Companies to Work For"
for the seventh consecutive year
These recognitions and awards are due to the hard work and results that our team
of almost 12,000 employees achieved in 2003. More information is available by
visiting www.FirstTennessee.com.
[FIRST TENNESSEE LOGO
ALL THINGS FINANCIAL'r']
March 10, 2004
Dear Shareholders:
You are cordially invited to attend First Tennessee National Corporation's
2004 annual meeting of shareholders. We will hold the meeting on April 20, 2004,
in the Auditorium, First Tennessee Building, 165 Madison Avenue, Memphis,
Tennessee, at 10:00 a.m. CDT. We have attached the formal notice of the annual
meeting, our 2004 proxy statement, and a form of proxy.
At the meeting, we will ask you to elect four Class II directors and one
Class III director, approve an amendment to our Charter changing our name to
First Horizon National Corporation, approve an amendment to our 2003 Equity
Compensation Plan, and ratify the appointment of KPMG LLP as our independent
auditors for 2004. The attached proxy statement contains information about these
matters.
An appendix to this proxy statement contains detailed financial information
relating to our activities and operating performance during 2003. We have also
enclosed our 2003 Summary Annual Report.
Our registered shareholders that have access to the Internet have the
opportunity to receive proxy statements electronically. If you have not already
done so for this year, we encourage you to elect this method of receiving the
proxy statement next year. Not only will you have access to the document as soon
as it is available, but you will be helping us to save expense dollars. If you
vote electronically, you will have the opportunity to give your consent at the
conclusion of the voting process.
Your vote is important. You may vote by telephone or over the Internet or by
mail, or if you attend the meeting and want to vote your shares, then prior to
the balloting you should request that your form of proxy be withheld from
voting. We request that you vote by telephone or over the Internet or return
your proxy card in the postage-paid envelope as soon as possible.
Sincerely yours,
J. KENNETH GLASS
J. KENNETH GLASS
Chairman of the Board,
President and Chief Executive Officer
FIRST TENNESSEE NATIONAL CORPORATION
165 MADISON AVENUE
MEMPHIS, TENNESSEE 38103
-------------------
NOTICE OF ANNUAL SHAREHOLDERS' MEETING
APRIL 20, 2004
-------------------
The annual meeting of shareholders of First Tennessee National Corporation
will be held on April 20, 2004, at 10:00 a.m., CDT, in the Auditorium, First
Tennessee Building, 165 Madison Avenue, Memphis, Tennessee.
The items of business are:
1. Election of four Class II directors to serve until the 2007 annual
meeting of shareholders, or until their successors are duly elected and
qualified, and of one Class III director to serve until the 2005 annual
meeting of shareholders, or until her successor is duly elected and
qualified.
2. Approval of an amendment to our Charter changing our name to 'First
Horizon National Corporation.'
3. Approval of an amendment to our 2003 Equity Compensation Plan.
4. Ratification of the appointment of auditors.
These items are described more fully in the following pages, which are made
a part of this notice. The close of business February 27, 2004, is the record
date for the meeting. All shareholders of record at that time are entitled to
vote at the meeting.
Management requests that you vote by telephone or over the Internet
(following the instructions on the enclosed form of proxy) or that you sign and
return the form of proxy promptly, so that if you are unable to attend the
meeting your shares can nevertheless be voted. You may revoke a proxy at any
time before it is exercised at the annual meeting in the manner described on
page 1 of the proxy statement.
CLYDE A. BILLINGS, JR.
CLYDE A. BILLINGS, JR.
Senior Vice President,
Assistant General Counsel
and Corporate Secretary
Memphis, Tennessee
March 10, 2004
IMPORTANT NOTICE
PLEASE (1) VOTE BY TELEPHONE OR (2) VOTE OVER THE INTERNET
OR (3) MARK, DATE, SIGN AND PROMPTLY MAIL THE ENCLOSED
FORM OF PROXY IN THE ENCLOSED ENVELOPE SO THAT YOUR SHARES
WILL BE REPRESENTED AT THE MEETING.
PROXY STATEMENT
FIRST TENNESSEE NATIONAL CORPORATION
TABLE OF CONTENTS
PAGE
----
General Matters............................................. 1
Corporate Governance and Board Matters...................... 2
Introduction............................................ 2
Structure and Composition of Board and Committees....... 2
Independence and Categorical Standards.................. 3
The Board Committees.................................... 4
Audit Committee Financial Expert........................ 5
Audit Committee Report.................................. 5
Nominations of Directors................................ 7
Shareholder Recommendations of Director Nominees........ 7
Board Compensation Committee Report on Executive
Compensation........................................... 8
Board and Committee Meeting Attendance.................. 12
Executive Sessions...................................... 12
Shareholder Communication with Board of Directors....... 12
Compensation of Directors............................... 12
Stock Ownership Information................................. 14
Stock Ownership Table................................... 14
VOTE ITEM NO. 1 -- ELECTION OF DIRECTORS.................... 15
Nominees for Director................................... 15
Continuing Directors.................................... 16
VOTE ITEM NO. 2 -- APPROVAL OF AN AMENDMENT TO OUR CHARTER
CHANGING OUR NAME......................................... 16
VOTE ITEM NO. 3 -- APPROVAL OF AN AMENDMENT TO OUR 2003
EQUITY COMPENSATION PLAN.................................. 17
Plan Benefits Table..................................... 21
Equity Compensation Plan Information.................... 21
VOTE ITEM NO. 4 -- RATIFICATION OF APPOINTMENT OF
AUDITORS.................................................. 23
Other Matters............................................... 25
Shareholder Proposal Deadlines.............................. 25
Executive Compensation...................................... 25
Summary Compensation Table.............................. 26
Option/SAR Grants in Last Fiscal Year................... 28
Aggregated Option/SAR Exercises in Last Fiscal Year and
Fiscal-Year End Option/SAR Values...................... 30
Long-Term Incentive Plans-Awards in Last Fiscal Year.... 30
Pension Plan Table...................................... 31
Employment Contracts and Termination of Employment and
Change-in-Control Arrangements......................... 32
Compensation Committee Interlocks and Insider
Participation.......................................... 33
Certain Relationships and Related Transactions.......... 33
Total Shareholder Return Performance Graph.............. 34
Section 16(a) Beneficial Ownership Reporting
Compliance............................................. 35
Availability of Annual Report on Form 10-K.................. 36
APPENDICES
A -- 2003 Equity Compensation Plan, as amended and
restated............................................... A-1
B -- Corporate Governance Guidelines.................... B-1
C -- Audit Committee Charter and Audit and Non-Audit
Services Pre-Approval Policy........................... C-1
D -- Nominating & Corporate Governance Committee
Charter................................................ D-1
E -- Compensation Committee Charter..................... E-1
F -- Financial Information & Discussion................. F-1
PROXY STATEMENT
FIRST TENNESSEE NATIONAL CORPORATION
165 MADISON AVENUE
MEMPHIS, TENNESSEE 38103
-------------------
GENERAL MATTERS
The following proxy statement is being mailed to shareholders beginning on
or about March 10, 2004. The Board of Directors is soliciting proxies to be used
at our annual meeting of shareholders to be held on April 20, 2004, at
10:00 a.m., CDT, in the Auditorium, First Tennessee Building, 165 Madison
Avenue, Memphis, Tennessee, and at any adjournment or adjournments thereof. In
this proxy statement, First Tennessee National Corporation will be referred to
by the use of 'we,' 'us' or similar pronouns, or simply as 'First Tennessee,'
and First Tennessee and its consolidated subsidiaries will be referred to
collectively as 'the Corporation.'
The accompanying form of proxy is for use at the meeting if you will be
unable to attend in person. You may revoke your proxy at any time before it is
exercised by writing to the Corporate Secretary, by timely delivering a properly
executed, later-dated proxy (including a telephone or Internet vote) or by
voting by ballot at the meeting. All shares represented by valid proxies
received pursuant to this solicitation, and not revoked before they are
exercised, will be voted in the manner specified therein. IF NO SPECIFICATION IS
MADE, THE PROXIES WILL BE VOTED IN FAVOR OF ITEMS 1-4 BELOW:
1. Election of four Class II directors to serve until the 2007
annual meeting of shareholders, or until their successors
are duly elected and qualified, and one Class III director
to serve until the 2005 annual meeting of shareholders, or
until her successor is duly elected and qualified.
2. Approval of an amendment to our Charter changing our name to
'First Horizon National Corporation.'
3. Approval of an amendment to our 2003 Equity Compensation
Plan.
4. Ratification of the appointment of auditors.
We will bear the entire cost of soliciting the proxies. In following up the
original solicitation of the proxies by mail, we may request brokers and others
to send proxies and proxy material to the beneficial owners of the shares and
may reimburse them for their expenses in so doing. If necessary, we may also use
several of our regular employees to solicit proxies from the shareholders,
either personally or by telephone or by special letter, for which they will
receive no compensation in addition to their normal compensation. We have hired
Innisfree M&A Incorporated to aid us in the solicitation of proxies for a fee of
$15,000 plus out-of-pocket expenses.
Our common stock is the only class of voting securities. There were
124,077,101 shares of common stock outstanding and entitled to vote as of
February 27, 2004, the record date for the annual shareholders' meeting. Each
share is entitled to one vote. A quorum of the shares must be represented at the
meeting to take action on any matter at the meeting. A majority of the votes
entitled to be cast constitutes a quorum for purposes of the annual meeting. A
plurality of the votes cast is required to elect the nominees as directors. A
majority of the votes cast is required to approve the amendment to our Charter
and the amendment to our 2003 Equity Compensation Plan and to ratify the
appointment of auditors. Both 'abstentions' and broker 'non-votes' will be
considered present for quorum purposes, but will not otherwise have any effect
on any of the vote items.
1
CORPORATE GOVERNANCE AND BOARD MATTERS
Introduction
First Tennessee is dedicated to operating on the basis of sound corporate
governance principles. We believe that these principles not only form the basis
for our reputation of integrity in the marketplace but also are essential to our
efficiency and continued overall success. During the past year, we have
committed many of these principles to writing. Our Corporate Governance
Guidelines, adopted by our Board of Directors in January 2004 but which include
long-standing corporate policies and practices, provide our directors with
guidance as to their legal accountabilities, promote the functioning of the
Board and its committees and set forth a common set of expectations as to how
the Board should perform its functions. Our Corporate Governance Guidelines are
attached to this proxy statement at Appendix B. We have also adopted a Code of
Business Conduct and Ethics, which incorporates many of our long-standing
policies and practices and sets forth the overarching principles that guide the
conduct of every aspect of our business, and a Code of Ethics for Senior
Financial Officers, which promotes honest and ethical conduct, proper disclosure
of financial information and compliance with applicable governmental laws, rules
and regulations by our senior financial officers and other employees who have
financial responsibilities. These codes are available on our web site at
www.firsttennessee.com under the 'Corporate Governance' heading in the 'Investor
Relations' area of the 'Company Information' page.
Structure and Composition of Board and Committees
Our Board of Directors currently has eleven members. All of our directors
are also directors of First Tennessee Bank National Association (the 'Bank' or
'FTB'). The Bank is our principal operating subsidiary. The Board has four
standing committees: the Executive Committee, the Audit Committee, the
Compensation Committee and the Nominating and Corporate Governance Committee.
Prior to January 20, 2004, the Compensation Committee, which was then known as
the Human Resources Committee, had compensation and nomination duties assigned
to it, and it performed certain corporate governance functions as well. On
January 20, 2004, the duties and responsibilities of the Human Resources
Committee relating to nominations were assigned to the newly formed Nominating
and Corporate Governance Committee, and the Human Resources Committee was
renamed the Compensation Committee.
The Audit Committee, the Compensation Committee and the Nominating and
Corporate Governance Committee are each composed of directors who are
'independent,' as defined in the next section. The membership of each committee
during 2003 is set forth in the table below.
NOMINATING
AND
CORPORATE
EXECUTIVE AUDIT COMPENSATION GOVERNANCE
NAME OF DIRECTOR COMMITTEE COMMITTEE COMMITTEE** COMMITTEE**
---------------- --------- --------- ------------ -----------
Robert C. Blattberg X X
George E. Cates X
J. Kenneth Glass X*
James A. Haslam, III X X
Ralph Horn*** (X*)
R. Brad Martin X* X*
Joseph Orgill, III*** (X) (X)
Vicki R. Palmer X* (X)
Michael D. Rose X
Mary F. Sammons
William B. Sansom X (X*)
Jonathan P. Ward X
Luke Yancy III X
X = committee member
X* = committee chairperson
(X) or (X*) = individual who served as a committee member or committee
chairperson during 2003 but is no longer serving as such
** = Prior to January 21, 2004, the duties and responsibilities of these
committees were carried out by only one committee which was then known as the
Human Resources Committee.
*** = retired
2
Independence and Categorical Standards
Our common stock is listed on the NYSE. The NYSE listing standards, which
become effective for us at this annual meeting of shareholders, require a
majority of our eleven directors and all of the members of the Compensation
Committee, the Nominating and Corporate Governance Committee and the Audit
Committee of the Board of Directors to be 'independent.' Under these standards,
our Board of Directors is required to affirmatively determine that a director
has no material relationship with the Corporation for that director to qualify
as 'independent.' In order to assist in making independence determinations, the
Board, as permitted by the NYSE standards and upon the recommendation of the
Human Resources Committee (which was then acting as our nominating and corporate
governance committee prior to the establishment by the Board of a separate
committee as described in the previous section), has adopted the categorical
standards set forth below. In making its independence determinations, each of
the Board and the Human Resources Committee considered all relationships between
each director and the Corporation, including those that fall within the
categorical standards. Based on its review and the application of the
categorical standards, the Board, upon the recommendation of the Human Resources
Committee, determined that all of the non-employee directors (Messrs. Blattberg,
Cates, Haslam, Sansom, Martin, Ward and Yancy and Mesdames Palmer and Sammons)
are 'independent' except Mr. Rose, as to whom there is a compensation committee
interlock. While the Board has determined that Mr. Cates is currently
independent for purposes of the NYSE listing standards, as a result of the
application of the NYSE's three-year 'look-back' provisions that will become
operative on November 3, 2004, Mr. Cates will cease to meet the 'independence'
requirements of the NYSE on that date, as a result of an impermissible
compensation committee interlock that terminated in 2002. In addition, the
Board, upon the recommendation of the Human Resources Committee, determined that
each member of the Audit Committee met the independence standards of the rules
of the Securities and Exchange Commission ('SEC') promulgated under the
Sarbanes-Oxley Act of 2002 and the independence requirements of the NYSE listing
standards in effect prior to this annual meeting of shareholders. The
categorical standards established by the Board are set forth in the following
paragraphs.
Each of the following relationships between the Corporation and its
subsidiaries, on the one hand, and a director, an immediate family member of a
director, or a company or other entity as to which the director or an immediate
family member is a director, executive officer, employee or a shareholder, on
the other hand, will be deemed to be immaterial and therefore will not preclude
a determination by the Board of Directors that the director is 'independent' for
purposes of the NYSE listing standards:
1. Depository and other banking and financial services relationships
(excluding extensions of credit which are covered in paragraph 2),
including transfer agent, registrar, indenture trustee, other trust and
fiduciary services, personal banking, capital markets, investment
banking, equity research, asset management, investment management,
custodian, securities brokerage, financial planning, cash management,
insurance brokerage, broker/dealer, express processing, merchant
processing, bill payment processing, check clearing, credit card and
other similar services, provided that the relationship is in the ordinary
course of business and on substantially the same terms and conditions as
those prevailing at the time for comparable transactions with
non-affiliated persons.
2. An extension of credit, provided that, at the time of the initial
approval of the extension of credit as to (1), (2) and (3), (1) such
extension of credit was in the ordinary course of business,(2) such
extension of credit was made in compliance with applicable law, including
Regulation O of the Federal Reserve, Section 23A and 23B of the Federal
Reserve Act and Section 13(k) of the Securities and Exchange Act of 1934,
(3) such extension of credit was on substantially the same terms as those
prevailing at the time for comparable transactions with non-affiliated
persons, and (4) a determination is made annually that if the extension
of credit was not made or was terminated in the ordinary course of
business, in accordance with its terms, such action would not reasonably
be expected to have a material adverse effect on the financial condition,
income statement or business of the borrower, and (5) no event of default
has occurred.
3. Contributions (other than mandatory matching contributions) made by the
Corporation or any of its subsidiaries or First Horizon Foundation to a
charitable organization as to which the director is an executive officer,
director, or trustee or holds a similar position or as to which an
immediate family member of the director is an executive officer; provided
that the amount of the contributions to the charitable organization in a
fiscal year does not exceed the greater of $500,000 or 2% of the
3
charitable organization's consolidated gross revenue (based on the
charitable organization's latest available income statement).
4. Any transaction or series of similar transactions, as to which disclosure
is not required in the Corporation's proxy statement pursuant to SEC
Regulation S-K, Item 404(a) or 404(b).
5. All compensation and benefits provided to non-employee directors for
service as a director.
6. All compensation and benefits provided in the ordinary course of business
to an immediate family member of a director for services to the
Corporation or any of its subsidiaries as long as such immediate family
member is compensated comparably to similarly situated employees and is
not an executive officer of the Corporation or based on salary and bonus
within the top 1,000 most highly compensated employees of the
Corporation.
Excluded from relationships considered by the Board is any relationship
(except contributions included in category 3) between the Corporation and its
subsidiaries, on the one hand, and a company or other entity as to which the
director or an immediate family member is a director or, in the case of an
immediate family member, an employee (but not an executive officer or
significant shareholder), on the other hand.
The fact that a particular relationship or transaction is not addressed by
these standards or exceeds the thresholds in these standards does not create a
presumption that the director is or is not independent.
The following definitions apply to the categorical standards listed above:
'Corporation' means First Tennessee National Corporation and its
consolidated subsidiaries.
'Executive Officer' means an entity's president, principal financial
officer, principal accounting officer (or, if there is no such accounting
officer, the controller), any vice president of the entity in charge of a
principal business unit, division or function, any other officer who
performs a policy-making function, or any other person who performs similar
policy-making functions for the entity.
'Immediate family members' of a director means the director's spouse,
parents, children, siblings, mothers-in-law, fathers-in-law, sons-in-law,
daughters-in-law, brothers-in-law, sisters-in-law and anyone (other than
domestic employees) who shares the director's home.
'Significant shareholder' means a passive investor [meaning a person who
is not in control of the entity] who beneficially owns more than 10% of the
outstanding equity, partnership or membership interests of an entity.
'Beneficial ownership' will be determined in accordance with Rule 13d-3 of
the Securities Exchange Act of 1934.
The Board Committees
The Executive Committee. The Executive Committee was established by our
Board of Directors and operates under a written charter that authorizes and
empowers it to exercise all authority of the Board of Directors, except as
prohibited by applicable law. In addition, except as to matters specifically
required by credit policy to be acted upon by the Board of Directors, the
Executive Committee acts as a credit policy committee, monitors the quality,
liquidity, and concentrations of credit extended by First Tennessee and by its
affiliates and establishes such credit policy and controls as may be deemed
necessary for the preservation of a sound loan portfolio consistent with overall
corporate objectives.
The Audit Committee. The Audit Committee was established by our Board of
Directors and operates under a written charter, which is attached to this proxy
statement at pages C-1 through C-5 of Appendix C and which was last amended and
restated on January 20, 2004. The charter is also available on our website at
www.firsttennessee.com under the 'Corporate Governance' heading in the 'Investor
Relations' area of the 'Company Information' page. Subject to the limitations
and provisions of its charter, the committee assists our Board in its oversight
of our accounting and financial reporting principles and policies, internal
audit controls and procedures, the integrity of our financial statements, our
compliance with legal and regulatory requirements, the independent auditor's
qualifications and independence, and the performance of the independent auditor
and our internal audit function. The Committee is directly responsible for the
appointment (subject, if applicable, to shareholder ratification), retention,
compensation and termination of the independent auditor as well as for
overseeing the work of and evaluating the independent auditor and its
independence. The members of the Committee are themselves 'independent,' as that
term is defined in the
4
NYSE listing standards (described above), and meet the additional independence
requirements prescribed by Section 10A(m)(3) of the Securities Exchange Act of
1934, as amended, and the rules of the SEC promulgated thereunder. In addition,
the Board of Directors has detemined that all the members of the Committee are
financially literate as required by the NYSE listing standards. The Audit
Committee's Report is included below.
Audit Committee Financial Expert
The Board of Directors has determined that at least one member of our Audit
Committee, Vicki R. Palmer (chairperson of the Committee), is an audit committee
financial expert, as that term is defined in Item 401(h) of Regulation S-K.
After receiving her B.A. in economics and business administration from Rhodes
College and her M.B.A. in finance from The University of Memphis, Ms. Palmer was
employed as a commercial loan officer with First Tennessee, where she was
trained in and worked daily in evaluating financial statements of corporate
customers in connection with their credit applications. In 1978, she joined
Federal Express Corporation as Manager of Corporate Finance, and her major areas
of responsibility included debt financing, cash management and pension asset
management. Ms. Palmer joined The Coca-Cola Company in 1983 as Manager of
Pension Investments, thus becoming responsible for the company's worldwide
pension assets. Upon moving to Coca-Cola Enterprises, Inc. ('CCE') in 1986, she
was involved at the inception of the company with the evaluation of company-wide
financial results and the establishment of internal controls. Until January
2004, Ms. Palmer served as Senior Vice President, Treasurer and Special
Assistant to the CEO. In this position, she was responsible for management of
CCE's $12 billion multi-currency debt portfolio; its $2.5 billion pension plan
and 401(k) plan investments; currency management; global cash management and
commercial and investment banking relationships. Effective in January 2004, she
became Executive Vice President, Financial Services and Administration, and is
now responsible for overseeing treasury, pension and retirement benefits, asset
management, internal audit and risk management. Ms. Palmer also served for
over ten years on CCE's Financial Reporting Committee, which reviews the
company's financial statements and deals periodically with accounting issues,
and she currently supervises the treasurer who serves on this committee. She is
a member of CCE's Risk Committee, which is charged with establishing policy and
internal controls for hedging and financial and non-financial derivatives. In
addition, she serves on CCE's Senior Executive Committee and has oversight
responsibility for CCE's enterprise-wide risk assessment process. She was a
member of our Audit Committee from January 1995 to April 1999 and chaired the
committee from April 1996 to April 1999, and she returned to the committee as
chairperson in April 2003. She is also a member of the audit committee of
another public company, Haverty Furniture Companies Inc.
Ms. Palmer meets in all respects the independence requirements of the NYSE
and Section 10A(m)(3) of the Securities Exchange Act of 1934, as amended, and
the rules of the SEC promulgated thereunder.
Notwithstanding anything to the contrary set forth in any of our previous
filings under the Securities Act of 1933, as amended, or the Securities Exchange
Act of 1934, as amended, that might incorporate future filings by reference,
including this proxy statement, in whole or in part, the following Audit
Committee Report, the Audit Committee Charter attached at pages C-1 through C-5
of Appendix C hereto, and the statements regarding the independence of the
members of the Committee shall not be incorporated by reference into any such
filings.
Audit Committee Report
The role of the Audit Committee ('Committee') is (1) to assist our Board of
Directors in its oversight of (a) our accounting and financial reporting
principles and policies and internal audit controls and procedures, (b) the
integrity of our financial statements, (c) our compliance with legal and
regulatory requirements, (d) the independent auditor's qualifications and
independence, and (e) the performance of the independent auditor and our
internal audit function; and (2) to prepare this report to be included in our
annual proxy statement pursuant to the proxy rules of the SEC. The Committee
operates pursuant to a charter that was last amended and restated by the Board
on January 20, 2004. As set forth in the Committee's charter, management of
First Tennessee is responsible for preparation, presentation and integrity of
the Corporation's financial statements and for maintaining appropriate
accounting and financial reporting principles and policies
5
and internal controls and procedures to provide for compliance with accounting
standards and applicable laws and regulations, and the internal auditor is
responsible for testing such internal controls and procedures. The independent
auditor is responsible for planning and carrying out a proper audit of the
Corporation's annual financial statements, reviews of the Corporation's
quarterly financial statements prior to the filing of each quarterly report on
Form 10-Q, and other procedures.
In the performance of its oversight function, the Committee has considered
and discussed the audited financial statements with management and the
independent auditors. The Committee has also discussed with our Chief Executive
Officer and Chief Financial Officer their respective certifications that will be
included in our Annual Report on Form 10-K for the year ended December 31, 2003.
The Committee has also discussed with the independent auditors the matters
required to be discussed by Statement on Auditing Standards No. 61,
Communication with Audit Committees, as currently in effect. Finally, the
Committee has received the written disclosures and the letter from the
independent auditors required by Independence Standards Board Standard No. 1,
Independence Discussions with Audit Committees, as currently in effect, has
adopted an audit and non-audit services pre-approval policy and considered
whether the provision of non-audit services by the independent auditors to First
Tennessee is compatible with maintaining the auditor's independence and has
discussed with the auditors the auditors' independence.
While the Board of Directors has determined that each member of the Audit
Committee has the broad level of general financial experience required to serve
on the Committee and that Ms. Palmer is an audit committee financial expert as
that term is defined in Item 401(h) of Regulation S-K, none of the members of
the Committee devotes specific attention to the narrower fields of auditing or
accounting or is professionally engaged in the practice of auditing or
accounting, nor are they performing the functions of auditors or accountants or
are they experts in respect of auditor independence. Members of the Committee
rely without independent verification on the information provided to them and on
the representations made by management and the independent auditors.
Accordingly, the Committee's oversight does not provide an independent basis to
determine that management has maintained appropriate accounting and financial
reporting principles or appropriate internal controls and procedures designed to
assure compliance with accounting standards and applicable laws and regulations.
Furthermore, the Committee's considerations and discussions referred to above do
not assure that the audit of our financial statements has been carried out in
accordance with generally accepted auditing standards, that the financial
statements are presented in accordance with generally accepted accounting
principles or that our auditors are in fact 'independent.'
Based upon the reports and discussions described in this report, and subject
to the limitations on the role and responsibilities of the Committee referred to
above and in the Committee's charter, the Committee recommended to the Board of
Directors that the audited financial statements be included in our Annual Report
on Form 10-K for the year ended December 31, 2003, to be filed with the SEC.
Submitted by the Audit Committee of our Board of Directors.
Audit Committee
Vicki R. Palmer, Chairperson
Jonathan P. Ward
Luke Yancy III
6
The Nominating and Corporate Governance Committee. The Nominating and
Corporate Governance Committee was formed on January 20, 2004. Prior to that
time, the role and duties of the committee related to nominations and certain
corporate governance functions were carried out by our Human Resources
Committee. The Nominating and Corporate Governance Committee operates under a
written charter, which is attached to this proxy statement as Appendix D and
also is available on our website at www.firsttennessee.com under the 'Corporate
Governance' heading in the 'Investor Relations' area of the 'Company
Information' page. The purposes of the Nominating and Corporate Governance
Committee are (1) to identify and recommend to the Board individuals for
nomination as members of the Board and its committees, (2) to develop and
recommend to the Board a set of corporate governance principles applicable to
the Corporation, and (3) to oversee the evaluation of the Board and management.
Nominations of Directors
With respect to the nominating process, the Nominating and Corporate
Governance Committee discusses and evaluates possible candidates in detail and
suggests individuals to explore in more depth. The Committee recommends new
nominees for the position of independent director based on the following
criteria:
Personal qualities and characteristics, experience, accomplishments
and reputation in the business community.
Current knowledge and contacts in the communities in which the
Corporation does business and in the Corporation's industry or other
industries relevant to the Corporation's business.
Diversity of viewpoints, background, experience and other
demographics.
Ability and willingness to commit adequate time to Board and
committee matters.
The fit of the individual's skills and personality with those of other
directors and potential directors in building a Board that is
effective and responsive to its duties and responsibilities.
The Nominating and Corporate Governance Committee does not set specific,
minimum qualifications that nominees must meet in order for the Committee to
recommend them to the Board of Directors, but rather believes that each nominee
should be evaluated based on his or her individual merits, taking into account
the needs of the Corporation and the composition of the Board of Directors.
Once a candidate is identified whom the Committee wants seriously to
consider and move toward nomination, the Chairman of the Board, the Chief
Executive Officer and/or other directors as the Committee determines will enter
into a discussion with that nominee.
Shareholder Recommendations of Director Nominees
The Nominating and Corporate Governance Committee will consider individuals
recommended by shareholders as director nominees, and any such individual is
given appropriate consideration in the same manner as individuals recommended by
the Committee. Shareholders who wish to submit individuals for consideration by
the Nominating and Corporate Governance Committee as director nominees may do so
by submitting in writing such individuals' names in compliance with the
procedures and along with the other information required by our Bylaws (as
described below), to the Chairperson of the Nominating and Corporate Governance
Committee, in care of the Corporate Secretary. Our Bylaws require that to be
timely, a shareholder's nomination must be delivered to or mailed and received
at our principal executive offices not less than 90 days nor more than 120 days
prior to the date of the meeting. However, if fewer than 100 days' notice or
prior public disclosure of the date of the meeting is given or made to
shareholders, a nomination by a shareholder to be timely must be so delivered or
received not later than the close of business on the 10th day following the
earlier of (i) the day on which such notice of the date of such meeting was
mailed or (ii) the day on which such public disclosure was made. A shareholder's
nomination must state:
the name of the shareholder's nominee and the reasons for the
nomination;
the name and address, as they appear on our books, of the shareholder
making the nomination and any other shareholders known by such
shareholder to be supporting the nomination;
7
the class and number of shares of our stock which are beneficially
owned by such shareholder on the date of shareholder's nomination and
by any other shareholders known by the nominating shareholder to be
supporting the nomination on the date of such shareholder's
nomination; and
any material interest of the shareholder in the nomination.
The Compensation Committee. Until January 20, 2004, the role and duties of a
compensation committee were carried out by our Human Resources Committee. On
that day, the duties of the Human Resources Committee with respect to
nominations were assigned to the newly established Nominating and Corporate
Governance Committee, and the Human Resources Committee was renamed the
Compensation Committee and retained its duties with respect to compensation. The
Compensation Committee operates under a written charter that was last amended
and restated by the Board of Directors on January 20, 2004 and is attached to
this proxy statement as Appendix E. The purposes of the Compensation Committee
are (1) to discharge the Board's responsibilities relating to the compensation
of our executive officers, (2) to produce an annual report on executive
compensation for inclusion in our proxy statement, in accordance with the rules
and regulations of the SEC [the current report is set forth following this
paragraph], (3) to identify and recommend to the Board individuals for
appointment as officers, (4) to evaluate our management, and (5) to carry out
certain other duties as set forth in the Committee's charter.
Notwithstanding anything to the contrary set forth in any of our previous
filings under the Securities Act of 1933, as amended, or the Securities Exchange
Act of 1934, as amended, that might incorporate future filings by reference,
including this proxy statement, in whole or in part, the following Board
Compensation Committee Report on Executive Compensation shall not be
incorporated by reference into any such filings.
Board Compensation Committee Report on Executive Compensation
Our Bylaws require that the Board of Directors or a committee of the Board
determine the compensation of executive officers. The Board has designated the
Compensation Committee ('Committee') to perform this function. The Committee is
composed entirely of non-employee directors who are independent under the NYSE
listing standards. The Committee has set forth below its report on the
compensation policies applicable to executive officers and the basis for the
compensation of the Chief Executive Officer (CEO) during 2003.
Our executive compensation programs are designed to align the interests of
the executive officers with our performance and the interests of our
shareholders. Approximately 60 to 75 percent of the executive officers' annual
compensation potential is at risk based on corporate performance and total
shareholder return (defined below). Compensation programs are designed to reward
executive officers with both cash and our common stock based on performance that
also rewards shareholders. When corporate performance does not meet criteria
established by the Committee, incentive compensation is reduced accordingly. In
addition, the executive compensation program is designed to attract and retain
qualified executive officers. Executive compensation consists generally of the
following components:
base salary
annual incentive bonus
long-term incentive awards
deferral of compensation through stock option grants, or at market
interest rates (or for compensation deferred before 1996 at
above-market rates), or at a rate equal to the performance of selected
mutual funds
customary employee and other benefits typically offered to similarly
situated executives
Base salary and annual bonus are determined through an evaluation of the
individual's position and responsibilities based on independent criteria and
external market data and personal and corporate performance. The Committee does
not assign a specific weight to any of the factors but places greater emphasis
on corporate performance in the overall mix.
Long-term incentive awards include restricted stock awards that contain
provisions for acceleration of vesting upon achievement of corporate performance
criteria, a Long-Term Incentive Program that combines restricted stock and cash
awards, and stock options. It is not our practice to 'reprice' stock options or
to
8
price them at less than fair market value on the date of grant. Although
deferred compensation options have an exercise price of 50 percent (80 percent
for options granted for 2001 and 2000 and 85 percent for options granted for
years prior to the year 2000) of fair market value on the grant date, to receive
the option the participant must forego the right to receive cash compensation.
Under our deferral option plans, the amount of the foregone cash compensation
plus the option exercise price must equal or exceed 100% of fair market value.
In the past, we have offered deferred compensation at above-market rates and
deferrals through the use of stock options. Deferrals since 1995 have been
limited to stock options or a 10-year Treasury rate of interest. A new
non-qualified deferral program that offers rates of return equal to the rates of
return on certain mutual fund investments was approved in 2003. Executive
officers may also defer the receipt of shares upon the exercise of stock options
and defer the receipt of restricted stock prior to the lapse of restrictions.
The Committee reviewed external market data provided by a non-affiliated
consulting firm that included some of the highest-performing companies in the
American Banker Top 50, a peer group of banking organizations against which we
measure our strategic performance, as well as other independent compensation
surveys. We selected the highest-performing companies based generally on the
following one-and five-year return measures: earnings per share growth rate,
historical earnings consistency, return on equity, and to a lesser degree return
on assets, percentage of fee income versus total revenue, and net loan charge
offs.
The purpose of the review was to determine compensation levels of similar
positions at these companies. The compensation peer group used by the
non-affiliated consulting firm did not include all of the banking organizations
listed in the Total Shareholder Return Performance Graph ('TSR graph') for the
2003 peer group. The median asset size of the compensation high performing peer
group was $40.7 billion. In actual practice, over the past three years the total
compensation of the executive officers has ranged from 33 percent of the 75th
percentile of the compensation of the high-performing peer group in 2001 to 68
percent of the 75th percentile of the compensation of that group in 2003. We do
not, however, have a specific policy that mandates how compensation will be
determined relative to external market data.
Section 162(m) of the Internal Revenue Code of 1986, as amended ('Tax
Code'), generally disallows a tax deduction to public companies, including us,
for compensation exceeding $1 million paid during the year to the CEO and the
four other highest paid executive officers at year-end. Certain
performance-based compensation is not, however, subject to the deduction limit.
Under Tax Code regulations the salary and TARSAP (defined below) portions of
compensation do not meet the performance-based compensation criteria of Section
162(m). The restricted stock plan permits deferral by participants of the
receipt of restricted stock prior to the lapse of restrictions. Any such
deferral does not represent compensation paid during the year, and thus, is not
currently subject to the Section 162(m) limitation. The Committee's practice is
to continue to consider ways to maximize the deductibility of executive
compensation while retaining the discretion deemed necessary to compensate
executive officers in a manner commensurate with performance and the competitive
market for executive talent.
(i) The CEO's Compensation
Base Salary: The Committee establishes the CEO's base salary annually based
on corporate performance, achievement of objectives in his individualized
written personal plan, and competitive practices within the industry. Corporate
performance is compared to the high-performing peer group referenced above.
Annual salary is targeted at the 75th percentile of that group based on
consistent high-performing results.
The CEO develops his personal plan and submits it to the Committee for
review and approval. The Board of Directors also reviews the plan, which
generally contains strategic, quality and financial goals. A salary increase of
6.0 percent was approved for Mr. Glass in February of 2003 based on substantial
achievement of personal plan objectives and competitive practices. Although no
specific weight is assigned to these factors, the Committee places greater
emphasis on corporate performance than on competitive practices within the
industry. The Committee used a non-affiliated consulting firm to obtain
recommendations regarding the appropriate remuneration of Mr. Glass. Base salary
is intended to represent approximately 10 percent to 20 percent of the CEO's
total compensation potential.
Annual Bonus: The CEO's annual bonus is based entirely on our corporate
performance against financial objectives established by the Committee at the
beginning of each year. The financial objectives for
9
2003 were based on EPS growth. The CEO may be awarded a target annual bonus of
up to 125 percent of his salary dollars earned during the year. The degree of
success in reaching corporate objectives determines a payout of zero percent to
125 percent of the CEO's target annual bonus. Zero percent payout is warranted
when EPS does not exceed the previous Plan year's results. The EPS growth
objective that qualifies for 100 percent payout of target annual bonus is equal
to the lower end of the market expected growth range for the high-performing
peer group. A payout of 125 percent of target annual bonus is equivalent to a
growth rate that equals the high end of the expected growth range of the same
high-performing peer group. During 2003, corporate performance resulted in a
payout of 125 percent of targeted bonus.
Long-Term Awards: The CEO's long-term incentive compensation consists of
restricted stock, cash, and stock options.
Our restricted stock program includes performance criteria as a condition to
early vesting of awards to executive officers. The objective of this time
accelerated restricted stock award plan (TARSAP) feature is to associate more
closely the long-term compensation of executive officers with shareholder
interests. Under the TARSAP feature, restricted stock is granted with
accelerated vesting if performance criteria established by the Committee are met
with respect to specified performance periods.
Performance periods are for three years and overlap: e.g., 2001-2003,
2002-2004, 2003-2005. Performance criteria, for all participants including the
CEO, have always been based on total shareholder return (appreciation in the
market value of our stock with dividends reinvested-TSR) targets established at
the beginning of each performance period. Targets are based on our percentile
ranking in a peer group (the '100-bank peer group') of approximately the 100
largest banking organizations by asset size traded on U.S. exchanges, with the
condition that TSR must be a positive number. The 100-bank peer group is
different from the peer group used to compare shareholder returns. The 100-bank
peer group was originally selected in 1990, prior to the adoption of SEC rules
requiring disclosure of a shareholder return performance graph, because the
Committee believed that it was an appropriate index with which to associate more
closely long-term compensation of executives with shareholder interests. The
restricted stock program which contains the 100-bank peer group has produced the
desired results, and thus, the Committee has continued to use it. In addition to
the TSR targets, the Committee adopted alternative criteria for the accelerated
vesting of TARSAP awards made in 1996 and future years based upon our percentile
ranking within the 100-bank peer group with respect to operating EPS growth rate
(or exceeding a minimum operating EPS growth rate) and average operating ROE,
with the condition that TSR must be a positive number. In January 2004, the
Committee approved the accelerated vesting of the TARSAP shares for the
2001-2003 performance period because the primary criteria, as described above,
were met.
The Long-Term Incentive Program is designed to provide a three-year
cumulative award of up to 225 percent of the CEO's annual bonus potential and is
paid (or settled) with restricted stock and cash. The amount of the award is
based on First Tennessee's P/E ratio relative to a peer group (the American
Banker Top 50 banks as identified at the beginning of the performance period) as
of the measurement date (January 31, 2006) provided the ratio increases during
the performance period. The alternative criterion is based on the compound
average annual growth rate in our stock price over the performance period. The
initial performance period covers three years (2003-2005). This program is
designed to tie the executive's long-term compensation directly to an increase
in shareholder value.
In addition to performance-based restricted stock awards, the Committee
generally awards stock options to executive officers, including the CEO, as part
of a broad-based stock option program under which awards are made to all
employees, both full-time and part-time. The CEO's option award (which is
disclosed in the 'Option/SAR Grants in Last Fiscal Year Table') was based on an
estimated value of the option that in combination with the other awards provides
the basis for a competitive long-term incentive package. The option grant
contained a performance-based, accelerated vesting feature, which is described
in part (ii) of this report. Because the value of the option to the CEO is a
function of the price growth of our stock, the amount realized by the CEO is
tied directly to an increase in shareholder value.
Other Benefits: The CEO's compensation reported in the Summary Compensation
Table also includes accrual of above-market rates of interest on compensation
deferred prior to 1996 and the cost of a life insurance benefit, which are not
directly based on corporate performance. Above-market rates are accrued for
deferred compensation of the CEO and other named executive officers, who
deferred prior to 1996, for
10
retention purposes. Generally, the plan under which this benefit was offered
requires that the amount deferred be automatically recalculated at market rates
if termination occurs prior to retirement.
(ii) Other Executive Officer Compensation
Base Salary: The CEO recommends and the Committee approves the base salary
for executive officers other than the CEO. Recommendations are generally based
on corporate performance (as measured by financial, quality and strategic
objectives), individual overall performance during the prior year, and
competitiveness in the market place. It is our policy to maintain a competitive
salary commensurate with the duties and responsibilities of the executive
officers. Salary represents approximately 25 percent to 40 percent of an
executive officer's potential annual compensation.
Annual Bonus: For executive officers other than the CEO, the annual bonus is
based on achievement of corporate financial objectives and performance against
personal objectives for the year, which are recorded in individualized written
personal plans. Individual objectives include financial, quality and strategic
goals. The degree of completion of goals determines the award. Financial
objectives for 2003 were based on EPS growth. The maximum target annual bonus of
executive officers other than the CEO is between 75 percent and 100 percent of
salary dollars earned during the year. During 2003, our corporate performance
resulted in a payment of 125 percent of target annual bonus for all executive
officers.
Long-Term Awards: All of the executive officers currently participate in the
TARSAP program described above in part (i) of this report. The performance
criteria are identical. The number of shares awarded for a three-year
performance period is generally 150 percent of the greater of the participant's
salary or salary grade mid-point, based on market value of the shares at the
time of the award. We do not provide a federal income tax gross-up to executive
officers at the vesting of restricted stock.
All of the executive officers also participate in the Long-Term Incentive
Program discussed in part (i) of this report. The performance measures and the
terms of the program are identical. The maximum three-year cumulative award is
225 percent of the executives' annual bonus potential and is paid (or settled)
with restricted stock and cash.
In addition to performance-based restricted stock awards, the Committee
generally awards stock options annually to executive officers, including the
CEO, as a part of the option program discussed in part (i) of this report. The
number of shares awarded to executive officers is equal to a percentage of
salary (ranging from 100 percent to 200 percent, with 200 percent used for the
CEO) divided by the market value (or for the CEO, the Black-Scholes value) of
one share of our stock at the time of grant. Executive officers may also be
awarded shares in addition to those calculated as a percent of salary if in the
opinion of the Committee additional shares are required to ensure a competitive
compensation package. The exercise price is the market value at the time of
grant. Options are awarded based on personal performance and to encourage future
performance as well as for retention purposes (with a seven-year term and
vesting at 50 percent after three years and 100 percent after four years). The
exercise price of the February 2003 grant is $38.74. This grant contains a
provision for accelerated vesting if the closing market price per share equals
at least $52.98 for five consecutive business days in the three years following
the grant or at the end of the three-year period. Options granted annually
beginning March 2000 to the CEO were based in part on prior corporate
performance.
Other Benefits: We have adopted certain broad-based employee benefit plans
in which executive officers participate and certain other retirement, life and
health insurance plans and we provide customary personal benefits. Except for
our stock fund (ESOP) within our 401(k) plan, the benefits under these plans are
not tied to corporate performance. The executive officers named in the Summary
Compensation Table participate in the other benefits described above with
respect to the CEO.
Compensation Committee
R. Brad Martin, Chairperson
Robert C. Blattberg
James A. Haslam, III
11
Board and Committee Meeting Attendance
During 2003, the Board of Directors held four meetings. The Human Resources
Committee, which was the predecessor of both the Compensation and Nominating and
Corporate Governance Committees, held six meetings, and the Audit Committee held
ten meetings. The Executive Committee held nine meetings. The average attendance
at Board and committee meetings exceeded 95 percent. No director attended fewer
than 75 percent of the meetings of the Board and the committees of the Board on
which he or she served.
It is our practice to invite the directors to attend our annual meeting of
shareholders each year. For the last 10 years, all of our directors have been in
attendance at every annual meeting of shareholders, including the annual meeting
that took place on April 15, 2003, except for one director in 1999 and one
director in 1996.
Executive Sessions
To ensure free and open discussion and communication among the
non-management directors of the Board, the non-management directors will meet in
regularly scheduled executive sessions and as often as the Board shall request,
with no members of management present. During 2003, the non-management directors
met four times. In addition, if any non-management directors are not
'independent' under NYSE listing standards, the independent, non-management
directors will meet in executive session at least once a year. The Chairperson
of the Nominating and Corporate Governance Committee, currently Mr. Martin,
presides at the executive sessions.
Shareholder Communication with the Board of Directors
Shareholders desiring to communicate with the Board of Directors on matters
other than director nominations should submit their communication in writing to
the Chairperson of the Nominating and Corporate Governance Committee, c/o
Corporate Secretary, First Tennessee National Corporation, 165 Madison Avenue,
Memphis, Tennessee 38103 and identify themselves as a shareholder. The Corporate
Secretary will forward all such communications to the Chairperson for a
determination as to how to proceed.
Compensation of Directors
On April 15, 2003, several changes were approved by the Board that related
to the compensation paid for service as one of our non-employee directors. Prior
to these changes, director compensation was last revised in April 2001. Until
April 15, 2003, each non-employee director was paid a retainer quarterly at an
annual rate of $25,000 plus a fee of $1,000 for each day of each Board and each
committee meeting attended. The chairpersons of the Audit and Human Resources
Committees were paid quarterly an additional retainer at an annual rate of
$3,000 each. After April 15, 2003, the annual retainer was increased to $36,000
and the daily board meeting attendance fee was increased to $2,000, while the
daily committee meeting attendance fee remained at $1,000. The additional
retainer for the chairpersons of the Audit, Compensation, and Nominating and
Corporate Governance Committees was raised to $2,000 per committee meeting (in
addition to the regular attendance fees).
We also reimburse our directors for their expenses incurred in attending
meetings. In addition, the following benefits have been approved by the Board as
additional compensation to non-employee directors for service as a director: a
personal account executive, a no fee personal checking account for the director
and his or her spouse, a FirstCheck card, a no fee VISA gold card, no fee for a
safe deposit box, no fee for traveler's checks and cashier's checks, and if the
Board has authorized a stock repurchase program, the repurchase of shares of our
common stock at the day's volume-weighted average price with no payment of any
fees or commissions if the repurchase of the director's shares is otherwise
permissible under the repurchase program that has been authorized. Directors who
are officers are not separately compensated for their services as directors.
Our practice is to hold Board and committee meetings jointly with the Bank's
Board and committees. All of our directors are also directors of the Bank.
Directors are not separately compensated for Bank Board or committee meetings
except for those infrequent meetings that do not occur jointly.
12
Under the terms of our 1992 Restricted Stock Incentive Plan (the '1992
Plan'), which was approved by the shareholders, all non-employee directors
received an automatic, nondiscretionary award of 6,000 shares (adjusted for
stock splits) of restricted stock on May 1, 1992, and all new non-employee
directors received such award upon election to the Board until the 1992 Plan
terminated in April 2002. Since the 1992 Plan terminated, the 6,000 share
restricted stock awards to new non-employee directors have been made under the
2003 Equity Compensation Plan, which permits the Board to approve a variety of
types of awards to non-employee directors. An additional award to each
non-employee director of 200 shares of restricted stock times the lesser of (i)
10 or (ii) the number of years remaining until the director's normal retirement
age was made on April 17, 2003 or the later date of the director's election to
Board, as applicable. Restrictions on the restricted stock granted to the
non-employee directors under both plans lapse at the rate of 10 percent
annually, and such shares are forfeited if the director terminates for any
reason other than death, disability, retirement, or a change in control. Upon
termination for any of the four listed reasons, all shares vest.
Directors may elect to defer their retainers and fees. Under the 2000
Non-Employee Directors' Deferred Compensation Stock Option Plan, all
non-employee directors elected to receive stock options in lieu of fees through
2004. The exercise price per share is 50 percent (80 percent prior to April 15,
2003 and 85 percent under a prior plan for options granted prior to the year
2000) of fair market value of one share of our common stock on the date of
grant, and the number of shares subject to option granted equals the amount of
fees deferred divided by 50 percent (20 percent prior to April 15, 2003 and 15
percent under a prior plan with respect to options granted prior to the year
2000) of the fair market value of one share on the date of grant. Under the
Directors and Executives Deferred Compensation Plan, not offered with respect to
compensation earned since 1995, under which up to six annual deferrals may be
elected, amounts deferred accrue interest at rates ranging from 17-22 percent
annually, based on age at the time of deferral, with a reduction to a guaranteed
rate based on 10-year Treasury obligations if a participant terminates prior to
a change-in-control for a reason other than death, disability or retirement.
Interim distributions in an amount between 85 percent and 100 percent of the
amount originally deferred are made in the eighth through the eleventh years
following the year of deferral, with the amount remaining in a participant's
account and accrued interest generally paid monthly over the 15 years following
retirement at age 65. Certain restrictions and limitations apply on payments and
distributions. Under other deferral agreements, non-employee directors have
deferred and may defer amounts, which generally accrue interest at a rate tied
to 10-year Treasury obligations. Finally, under the First Tennessee National
Corporation Nonqualified Deferred Compensation Plan, non-employee directors are
permitted to defer compensation. Returns on amounts deferred by a non-employee
director are indexed to the performance of certain mutual funds selected from a
menu of mutual funds by the non-employee director. These mutual funds merely
serve as the measuring device to determine the director's rate of return, and
the director has no ownership interest in the mutual funds selected. First
Tennessee hedges its obligations under this plan.
13
STOCK OWNERSHIP INFORMATION
We know of no person who owned beneficially, as that term is defined by
Rule 13d-3 of the Securities Exchange Act of 1934, more than five percent (5%)
of our common stock on December 31, 2003.
The following table sets forth certain information as of December 31, 2003,
concerning beneficial ownership of our common stock by each director and
nominee, each executive officer named in the Summary Compensation Table, and
directors and executive officers as a group:
STOCK OWNERSHIP TABLE
NAME OF SHARES BENEFICIALLY STOCK UNITS IN DEFERRAL TOTAL AND PERCENT
BENEFICIAL OWNER OWNED(1) ACCOUNTS(2) OF CLASS(3)
---------------- -------- ----------- -----------
Robert C. Blattberg............................ 38,502(4) -- 38,502
Charles G. Burkett............................. 117,747(5) -- 117,747
George E. Cates................................ 71,268(4) -- 71,268
J. Kenneth Glass............................... 758,570(5) 91,373 849,943
James A. Haslam, III........................... 62,048(4) -- 62,048
Ralph Horn..................................... 1,598,253(5) 319,487 1,917,740(1.5%)
Larry B. Martin................................ 149,375(5) 19,535 168,910
R. Brad Martin................................. 77,622(4) -- 77,622
Vicki R. Palmer................................ 76,886(4) -- 76,886
Michael D. Rose................................ 104,159(4) -- 104,159
Mary F. Sammons................................ 8,023(4) -- 8,023
William B. Sansom.............................. 100,760(4) -- 100,760
Elbert L. Thomas, Jr........................... 256,011(5) 34,309 290,320
Jonathan P. Ward............................... 8,341(4) -- 8,341
Luke Yancy III................................. 16,653(4) -- 16,653
Directors and Executive Officers as a Group
(22 persons)................................. 4,556,856(5) 526,427 5,083,283(4%)
(1) The respective directors, nominees and officers have sole voting and
investment powers with respect to all of such shares except as specified in
notes (4) and (5). Amounts in the second column do not include stock units
in the third column.
(2) Our stock option program permits participants to defer receipt of shares
upon the exercise of options and our restricted stock incentive plan
permitted participants to defer receipt of shares prior to the lapsing of
restrictions imposed on restricted stock awards. Amounts in the third
column reflect the number of shares deferred that a participant has the
right to receive on a future date. These shares are not currently issued
and are not considered to be beneficially owned for purposes of Rule 13d-3,
but are reflected in a deferral account on our books as phantom stock units
or restricted stock units.
(3) No individual director, nominee or executive officer, except for Mr. Horn,
who retired on December 31, 2003, beneficially owns more than one (1%)
percent of our common stock that is outstanding. Mr. Horn beneficially
owns 1.5% including stock units (or 1.3% excluding stock units). The
percentage of common stock outstanding owned by the director and executive
officer group (4%) includes stock units. The percentage would be 3.6% with
stock units excluded.
(4) Includes the following shares of restricted stock with respect to which the
non-employee director possesses sole voting power, but no investment power:
Dr. Blattberg -- 1,400; Mr. Cates -- 2,200; Mr. Haslam -- 3,800; Mr. Martin
-- 2,600; Ms. Palmer -- 2,600; Mr. Rose -- 800; Ms. Sammons -- 8,000;
Mr. Sansom -- 1,200; Mr. Ward -- 8,000; and Mr. Yancy -- 6,800. Includes
the following shares as to which the named non-employee directors have the
right to acquire beneficial ownership through the exercise of stock options
granted under our director plans, all of which are 100% vested: Dr.
Blattberg -- 30,742; Mr. Cates -- 55,806; Mr. Haslam -- 43,986; Mr. Martin
-- 35,009; Ms. Palmer -- 68,778; Mr. Rose -- 64,972; Ms. Sammons -- 0;
Mr. Sansom -- 84,916; Mr. Ward -- 91; and Mr. Yancy -- 7,094.
(5) Includes the following shares of restricted stock with respect to which the
named person or group has sole voting power but no investment power: Mr.
Burkett -- 32,409; Mr. Glass -- 115,645; Mr. Horn -- 49,258; Mr. Martin
-- 32,409; Mr. Thomas -- 29,209 and the director and executive officer
group -- 398,525. Includes
14
the following shares as to which the named person or group has the right to
acquire beneficial ownership within 60 days through the exercise of stock
options granted under our stock option plans: Mr. Burkett -- 38,434;
Mr. Glass -- 354,057; Mr. Horn -- 730,448; Mr. Martin -- 74,640; Mr. Thomas
-- 147,889 and the director and executive officer group -- 1,800,747. Also
includes shares held at December 31, 2003 for 401(k) Savings Plan accounts.
VOTE ITEM NO. 1 -- ELECTION OF DIRECTORS
The Board of Directors is divided into three classes. The term of office of
each class expires in successive years. The term of Class II directors expires
at this annual meeting. The terms of Class III and Class I directors expire at
the 2005 and 2006 annual meetings, respectively. The Board of Directors proposes
the election of four Class II directors, each of whom is an incumbent, and one
Class III director, Ms. Sammons, who was elected by the Board of Directors in
October 2003 and whose term, under Tennessee law, expires at the next annual
meeting of shareholders following her election by the Board. Ms. Sammons was
recommended as a nominee for a position on our Board by a non-management
director. Each Class II director elected at the meeting will hold office until
the 2007 annual meeting of shareholders or until his or her successor is elected
and qualified, and if she is elected at the meeting, Ms. Sammons will hold
office until the 2005 annual meeting of shareholders or until her successor is
elected and qualified.
If any nominee proposed by the Board of Directors is unable to accept
election, which the Board of Directors has no reason to anticipate, the persons
named in the enclosed form of proxy will vote for the election of such other
persons as management may recommend, unless the Board decides to reduce the
number of directors pursuant to the Bylaws.
We have provided below certain information about the nominees and directors
(including age, current principal occupation, which has continued for at least
five years unless otherwise indicated, name and principal business of the
organization in which his or her occupation is carried on, directorships in
other reporting companies, and year first elected to our Board). All of our
directors are also directors of the Bank. Director committee appointments are
disclosed in a table in the 'Corporate Governance and Board Matters' section of
this proxy statement above.
NOMINEES FOR DIRECTOR
Class II
For a Three Year Term Expiring at 2007 Annual Meeting
ROBERT C. BLATTBERG (61) is the Polk Brothers Distinguished Professor of
Retailing, J. L. Kellogg Graduate School of Management, Northwestern University,
Evanston, Illinois. Dr. Blattberg has been a director since 1984.
J. KENNETH GLASS (57) is Chairman of the Board, President and Chief
Executive Officer of First Tennessee and the Bank. Mr. Glass was elected
Chairman of the Board in October 2003, effective January 1, 2004, and President
and Chief Executive Officer in July 2002. From July 2001 through July 2002,
Mr. Glass was President and Chief Operating Officer of First Tennessee and the
Bank. From April 1999 through July 2001, he was President -- Retail Financial
Services of the Bank and from April 2000 through July 2001, President -- Retail
Financial Services of First Tennessee. Prior to April 1999, he was
President-Tennessee Banking Group of the Bank and prior to April 2000, he was
Executive Vice President of First Tennessee. Mr. Glass is a director of two
other public companies, FedEx Corporation and GTx, Inc. He has been a director
since 1996.
MICHAEL D. ROSE (62) is Chairman of Gaylord Entertainment Company,
Nashville, Tennessee, a diversified hospitality and entertainment company. Prior
to April 2001, Mr. Rose was a private investor. Mr. Rose is a director of five
other public companies, Gaylord Entertainment Company, Darden Restaurants, Inc.,
FelCor Lodging Trust, Inc., General Mills, Inc., and Stein Mart, Inc. Mr. Rose
has been a director since 1984.
LUKE YANCY III (54) is President and Chief Executive Officer of Mid-South
Minority Business Council, Memphis, Tennessee, a nonprofit organization that
promotes minority and women business enterprises. Prior
15
to June 2000, Mr. Yancy was President, West Region, of AmSouth Bank and, prior
to its acquisition by AmSouth in 1999, First American Bank. Mr. Yancy has been a
director since October 2001.
Class III
For the Remainder of a Three Year Term
Expiring at 2005 Annual Meeting
MARY F. SAMMONS (57) has been President and Chief Executive Office of Rite
Aid Corporation ('Rite Aid'), a retail drug store chain, since June 25, 2003,
and she has been a member of the Rite Aid Board of Directors since December 5,
1999. She served as President and Chief Operating Officer of Rite Aid from
December 5, 1999 to June 25, 2003. From January 1998 to December 1999,
Ms. Sammons was President and Chief Executive Officer of Fred Meyer Stores,
Inc., which during that period was acquired by The Kroger Company. Ms. Sammons
has been a director since her election by the Board of Directors in October
2003.
CONTINUING DIRECTORS
Class III
Term Expiring at 2005 Annual Meeting
GEORGE E. CATES (66) is the retired Chairman of the Board of Mid-America
Apartment Communities, Inc. ('Mid-America'), Memphis, Tennessee, a real estate
investment trust. Mr. Cates retired as Chairman of Mid-America in September
2002. Prior to October 2001, he was also Chief Executive Officer of Mid-
America. Mr. Cates is a director of one other public company, Mid-America.
Mr. Cates has been a director of the Corporation since 1996.
JAMES A. HASLAM, III (49) is Chief Executive Officer of Pilot Travel
Centers, LLC, Knoxville, Tennessee, a national operator of travel centers, and
he is CEO of Pilot Corporation. Mr. Haslam is a director of one other public
company, Ruby Tuesday, Inc. Mr. Haslam has been a director since 1996.
Class I
Term Expiring at 2006 Annual Meeting
R. BRAD MARTIN (52) is Chairman of the Board and Chief Executive Officer of
Saks Incorporated, Birmingham, Alabama, a retail merchandising company.
Mr. Martin is a director of two other public companies, Saks Incorporated and
Harrah's Entertainment, Inc. He has been a director since 1994.
VICKI R. PALMER (50) is Executive Vice President, Financial Services and
Administration, Coca-Cola Enterprises Inc. ('CCE'), Atlanta, Georgia, a bottler
of soft drink products. Until January 2004, Ms. Palmer served as Corporate
Senior Vice President, Treasurer, and Special Assistant to the CEO of CCE. Prior
to December 1999, she was Corporate Vice President and Treasurer of CCE. Ms.
Palmer is a director of one other public company, Haverty Furniture Companies,
Inc. She has been a director since 1993.
WILLIAM B. SANSOM (62) is Chairman of the Board and Chief Executive Officer
of The H. T. Hackney Co., Knoxville, Tennessee, a diversified wholesale
distribution firm serving the food, gas, oil and industrial markets in the
Southeast. He is a director of two other public companies, Martin Marietta
Materials, Inc. and Astec Industries, Inc. Mr. Sansom has been a director since
1984.
JONATHAN P. WARD (49) is Chairman and Chief Executive Officer of The
ServiceMaster Company ('ServiceMaster'), Downers Grove, Illinois, a company that
provides outsourcing services for residential and commercial customers. Prior to
April 2002, Mr. Ward was President and Chief Executive Officer of ServiceMaster,
and prior to January 2001, he was President and Chief Operating Officer of R. R.
Donnelly & Sons Company. Mr. Ward is a director of two other public companies,
ServiceMaster and J. Jill Group, Inc. Mr. Ward has been a director since 2003.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT THE SHAREHOLDERS VOTE FOR
ITEM NO. 1.
16
VOTE ITEM NO. 2 -- APPROVAL OF AN AMENDMENT TO OUR CHARTER
CHANGING OUR NAME
At its January 20, 2004 meeting, the Board of Directors unanimously adopted
resolutions to change our name to First Horizon National Corporation, subject to
the approval of our shareholders. The change in corporate name is accomplished
by adopting and approving an amendment to our Charter and will become effective
upon the filing of an amended and restated Charter with the Secretary of State
of the State of Tennessee. We intend to file the amended and restated Charter
promptly after the annual meeting, should our shareholders approve the change in
corporate name. The proposed amendment to our Charter is as follows:
RESOLVED, that, contingent upon shareholder approval at the Annual Meeting
of Shareholders on April 20, 2004, Article 1 of the Charter be, and it hereby
is, deleted in its entirety, and that the following be substituted therefor:
1. NAME.
The name of the Corporation shall be: FIRST HORIZON NATIONAL CORPORATION.
Reason for the Name Change
The Board of Directors believes that it is in the best interests of First
Tennessee and our shareholders to change First Tennessee's name to one that we
believe more accurately reflects our current national presence as well as our
national business strategy and eliminates the regional focus suggested by the
current name. First Tennessee and its subsidiaries have more than 800 offices in
40 states with more than half of our customers residing outside of the State of
Tennessee. Our lead bank, First Tennessee Bank National Association, which is
headquartered in Tennessee, will retain its name.
Effect of the Name Change
Voting and other rights that accompany our common stock will not be affected
by the change of our corporate name. All outstanding stock certificates
representing common stock issued prior to the effective date of the change in
corporate name will continue to represent our shares, remain authentic, and will
not be required to be returned to us or our transfer agent for re-issuance. New
stock certificates issued upon the transfer of shares of common stock after the
change in corporate name will bear the new corporate name, First Horizon
National Corporation, and will have a new CUSIP number. Our trading symbol,
'FTN,' will also change to 'FHN' as a result of the change in corporate name.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT THE SHAREHOLDERS VOTE FOR
ITEM NO. 2.
VOTE ITEM NO. 3 -- APPROVAL OF AN AMENDMENT TO OUR 2003 EQUITY COMPENSATION PLAN
General
The 2003 Equity Compensation Plan was adopted by the Board of Directors and
approved by our shareholders on April 15, 2003. In January and February of 2004,
our Board of Directors and the Compensation Committee adopted and approved an
amendment to the 2003 Equity Compensation Plan (as amended, the '2003 Plan')
which increases the maximum number of shares which may be issued with respect to
awards under the 2003 Plan from 3,000,000 to 4,000,000 and increases the maximum
number of shares of that 4,000,000 which may be issued with respect to awards
other than options from 300,000 to 1,300,000, subject to the approval of our
shareholders. Another amendment added stock appreciation rights as a new type of
award that can be made under the 2003 Plan. Under this vote item, shareholders
are being asked to approve the increase in the number of shares that may be
awarded and the increase in the number of shares that may be issued with respect
to awards other than options under the 2003 Plan. The Amended and Restated 2003
Equity Compensation Plan is attached to this Proxy Statement as Appendix A.
As of the Record Date, 200,444 shares of restricted stock had been awarded
under the 2003 Plan, options to purchase an aggregate of 876,301 shares of
common stock were outstanding under the 2003 Plan, and there was a total of
1,923,255 shares available for future grant under the 2003 Plan, 99,556 of
17
which were available for grants of restricted stock. The Board of Directors
believes that it is necessary to continue to grant awards under the 2003 Plan in
order to attract, retain and motivate officers, employees, and non-employee
directors. The Board of Directors believes that the current remaining shares are
insufficient for this purpose.
The following is a summary of the material features of the 2003 Plan and is
qualified in its entirety by reference to the complete text of the 2003 Plan.
Purpose of the 2003 Plan
The purpose of the 2003 Plan is to promote the interests of First Tennessee
by attracting, retaining and motivating officers, employees and non-employee
directors of First Tennessee and its subsidiaries by means of performance
related incentives designed to achieve long range performance goals and linking
their compensation to the long-term interests of shareholders. All officers,
employees and non-employee directors of First Tennessee and its subsidiaries and
all 'regional board members' (as defined under the 2003 Plan) are eligible to
receive awards ('Awards') under the 2003 Plan which may consist of grants of
options, restricted stock, restricted stock units, performance awards, and stock
appreciation rights, or any combination thereof. As of February 17, 2004, First
Tennessee and its subsidiaries had approximately 1,351 officers, 10,552
employees and 10 non-employee directors, and there were approximately 131
regional board members.
Administration
The Board has appointed the Corporation's Compensation Committee to
administer the 2003 Plan. Committee eligibility requirements are described in
Section 2 of the 2003 Plan. The members of the Committee may be removed by the
Board at its discretion. The Board, in its discretion, may also administer the
2003 Plan and, in such a case, has all of the rights, powers and authority of
the Committee.
Subject to certain limitations, the Committee has the power and authority in
its discretion to, among other things, (i) select the persons to whom Awards
will be made, (ii) determine the type, timing, terms and conditions of any
Awards, including the number of shares of common stock subject to any Award,
(iii) interpret and administer the 2003 Plan and any instrument or agreement
relating to the 2003 Plan or any Awards granted pursuant to the 2003 Plan, and
(iv) establish, amend, suspend or waive such rules and regulations as it shall
deem appropriate for the proper administration of the 2003 Plan.
Notwithstanding the immediately preceding paragraph, only the Board has the
power and authority to make Awards to non-employee directors and to determine
the type, timing, terms and conditions of those Awards.
Amendment
The Board may amend, alter, modify, suspend, discontinue or terminate the
2003 Plan at any time, except that the Board may not amend the 2003 Plan in
violation of any law. However, no such action may materially prejudice the
rights of any holder of an Award that was granted prior to the date of such
action, without the consent of such holder. In addition, the NYSE listing
standards require certain amendments to equity compensation plans like the 2003
Plan to be approved by shareholders.
Maximum Number of Shares Available
Subject to adjustment as described below, the maximum number of shares of
common stock which may be issued with respect to Awards is 3,000,000 of which no
more than 300,000 may be issued with respect to Awards other than options, and
no participant may, in any calendar year, receive options with respect to more
than 500,000 shares of common stock. If the amendment to the 2003 Plan is
approved, the maximum number of shares of common stock which may be issued with
respect to Awards will be 4,000,000 of which no more than 1,300,000 may be
issued with respect to Awards other than options. The maximum number of shares
of common stock available for Awards under the 2003 Plan, the number of shares
of common stock covered by each outstanding Award, the number of shares of
common stock that may be subject to Awards to any one participant and the price
per share of common stock covered by each outstanding Award shall
18
be proportionately adjusted for any increase or decrease in the number of issued
shares of common stock resulting from a stock split, reverse stock split, stock
dividend, recapitalization, combination or reclassification of the common stock,
and may be proportionately adjusted, as determined by the Board in its sole
discretion, for any other increase or decrease in the number of issued shares of
common stock effected without receipt of consideration by First Tennessee, or to
reflect any distributions to holders of shares of common stock other than
regular cash dividends.
If any shares of common stock covered by an Award are forfeited, or if such
Award is settled for cash or otherwise terminates, expires unexercised or is
cancelled without delivery of such shares, such shares of common stock (or
portion thereof) will again be available for issuance under the 2003 Plan. If
any option or other Award granted under the 2003 Plan is exercised through the
delivery of shares of common stock by a participant or if withholding tax
liabilities arising from such Award are satisfied by the withholding of shares
of common stock by First Tennessee from the total number of shares that would
otherwise have been delivered to the participant, the number of shares of common
stock available for Awards under the 2003 Plan shall be increased by the number
of shares so surrendered or withheld.
On February 27, 2004, the closing price of the common stock on the New York
Stock Exchange was $46.24 per share.
Types of Awards
Options. The Committee may grant options to purchase a specified number of
shares of common stock. Options granted under the 2003 Plan will not qualify as
'incentive stock options' under Section 422 of the Tax Code. The number of
shares of common stock subject to any grant of options, the exercise price and
all other conditions and limitations applicable to the exercise of any options
will be determined by the Committee. Notwithstanding the preceding sentence,
except in limited circumstances described in the 2003 Plan, the exercise price
of an option may not be less than 100% of the fair market value of the shares of
common stock with respect to which the option is granted on the date of such
grant. No option shall be exercisable after the expiration of ten years from the
date such option was granted.
Restricted Stock and Restricted Stock Units. Awards of restricted stock and
restricted stock units are grants of common stock or stock units that are
subject to a risk of forfeiture or other restrictions that lapse upon the
occurrence of certain events and the satisfaction of certain conditions, as
determined by the Committee in its discretion. The value of a restricted stock
unit must equal the fair market value of one share of common stock on the date
of the grant. Any awards of restricted stock or restricted stock units will be
subject to such conditions, restrictions and contingencies as the Committee
determines. Restricted stock units are payable, at the Committee's discretion,
in cash, shares of common stock, other securities or other property.
Performance Awards. The Committee may, in its discretion, grant a
performance award consisting of a right that is denominated in cash and/or
shares of common stock, valued in accordance with the achievement of certain
performance goals during certain performance periods as determined by the
Committee, and payable at such time and in such form as the Committee shall
determine. In determining the performance goals applicable to any performance
award, the Committee must select one or a combination of the following financial
performance measures of First Tennessee, its subsidiaries, or any operating
unit, division, line of business, department, team or business unit thereof:
stock price; dividends; total shareholder return; earnings per share;
price/earnings ratio; market capitalization; book value; revenues; expenses;
loans; deposits; non-interest income; net interest income; fee income; operating
income before or after taxes; net income before or after taxes; net income
before securities transactions; net or operating income excluding non-recurring
charges; return on assets; return on equity; return on capital; cash flow;
credit quality; service quality; market share; customer retention; efficiency
ratio; strategic business objectives, consisting of one or more objectives based
on meeting specified cost targets, business expansion goals and goals relating
to acquisitions or divestitures; and except in the case of a 'covered officer'
(as defined under the 2003 Plan), any other performance criteria established by
the Committee. Each goal may be expressed on an absolute and/or relative basis,
may be based on or otherwise employ comparisons based on internal targets, the
past performance of First Tennessee (consolidated or unconsolidated) and/or the
past or current performance of other companies, the performance of other
companies over one or more years or an index of the performance of other
companies, markets or economic metrics over one or more years, and in the
19
case of earnings-based measures, may use or employ comparisons relating to
capital, shareholders' equity and/or shares of common stock outstanding, or to
assets or net assets.
The Committee may also grant restricted stock and restricted stock units to
'covered officers' (as defined under the 2003 Plan) that vest or become
exercisable upon the achievement of certain performance goals specified by the
Committee, subject to the limitations described in the immediately preceding
paragraph.
The maximum annual number of shares of common stock in respect of which all
performance-based Awards (whether restricted stock, restricted stock units or
performance awards) may be granted to a participant under the 2003 Plan is
100,000 and the maximum annual amount of any Awards settled in cash to a
participant under the 2003 Plan is $4,000,000.
Stock Appreciation Rights. Stock appreciation rights ('SARs') may be granted
under the 2003 Plan. Upon exercise of an SAR, the participant will be entitled
to receive the excess of the fair market value on the exercise date of the
common shares underlying the SAR over the aggregate base price applicable to
such shares; provided that the base price per share may not be less than the
fair market value of such shares on the grant date. Distributions to the
participant may be made in common stock, in cash, or in a combination of stock
and cash, as determined by the Committee or the Board.
Change in Control
Upon a 'change in control' (as defined under the 2003 Plan) of First
Tennessee, all Awards outstanding under the 2003 Plan will vest, become
immediately exercisable or payable or have all restrictions lifted, as the case
may be.
Effect of Termination of Employment
The Committee has discretion to determine the terms and conditions that will
apply to any outstanding Award upon the 'termination of employment' (as defined
under the 2003 Plan) of a participant, and such terms and conditions will be set
forth in an Award agreement.
Federal Income Tax Consequences
The following is a summary of the current federal income tax treatment
related to grants of Awards under the 2003 Plan. This summary is not intended
to, and does not, provide or supplement tax advice to participants. Participants
in the 2003 Plan are advised to consult with their own independent tax advisors
with respect to the specific tax consequences that, in light of their particular
circumstances, might arise in connection with their receipt of any Awards under
the 2003 Plan, including any state or local tax consequences and the effect, if
any, of gift, estate and inheritance taxes.
Options. No taxable income is realized by a participant upon the grant of an
option under the 2003 Plan. Upon exercise of an option granted under the 2003
Plan, the participant would include in ordinary income an amount equal to the
excess, if any, of the fair market value of the shares of common stock issued to
the participant pursuant to such exercise (the 'Option Shares') at the time of
exercise over the purchase price. First Tennessee would be entitled to a
deduction on exercise of the option for the amount includible in the
participant's income.
Restricted Stock. No taxable income is realized by a participant upon the
award of restricted common stock. Prior to the lapse of restrictions on such
shares, any dividends received on such shares will be treated as ordinary
compensation income. Upon the lapse of restrictions, the participant would
include in ordinary income the amount of the fair market value of the shares of
common stock at the time the restrictions lapse.
Any participant may, however, make an election under Section 83(b) of the
Tax Code (an '83(b) election') within 30 days after receipt of restricted common
stock to take into income in the year the restricted common stock is transferred
by First Tennessee to such participant an amount equal to the fair market value
of the restricted common stock on the date of such transfer (as if the
restricted stock were unrestricted). If such election is made, the participant
(i) will have no taxable income at the time the restrictions actually lapse,
(ii) will have a capital gains holding period beginning on the transfer date and
20
(iii) will have dividend income with respect to any dividends received on such
shares. If the restricted common stock subject to the 83(b) election is
subsequently forfeited, however, the participant is not entitled to a deduction
or tax refund.
Any appreciation or depreciation in such shares from the time the
restrictions lapse (or the 83(b) election is made) to their subsequent
disposition should be taxed as a short-term or long-term gain or loss, as the
case may be. First Tennessee would be entitled to a federal income tax deduction
for the year in which the participant realizes ordinary income with respect to
the restricted common stock in an amount equal to such income.
Restricted Stock Units. No taxable income will be realized by a participant
upon the grant of restricted stock units and no taxable income will be realized
at the times the restricted stock units vest. At the time payment is made with
respect to restricted stock units granted under the 2003 Plan, the participant
will realize ordinary income in an amount equal to the cash received or the fair
market value of the shares of common stock received. First Tennessee would be
entitled to a deduction at the time of payment in an amount equal to such
income.
Stock Appreciation Rights. A participant does not recognize ordinary income
upon the receipt of a stock appreciation right under the 2003 Plan. Upon
exercise of the stock appreciation right and receipt of cash or unrestricted
stock, the participant would recognize ordinary income in an amount equal to the
payment received or the fair market value of the unrestricted stock. First
Tennessee would be entitled to a deduction at the time of payment in an amount
equal to such income.
PLAN BENEFITS
2003 PLAN
NUMBER OF AWARDS GRANTED FROM ITS
INCEPTION TO DECEMBER 31, 2003 (1)
---------------------------------------
NAME AND PRINCIPAL POSITION(2) DOLLAR VALUE ($) RESTRICTED STOCK (#)
------------------------------ ---------------- --------------------
Ralph Horn.................................................. -- --
J. Kenneth Glass............................................ 3,275,534 78,900
Charles G. Burkett.......................................... 498,180 12,000
Larry B. Martin............................................. 498,180 12,000
Elbert L. Thomas, Jr........................................ 440,059 10,600
All Executive Officers as a Group........................... 7,209,692 172,644
All Directors (who are not Executive Officers) as a Group... 1,167,637 27,800
All Employees (who are not Executive Officers) as a Group... -- --
(1) No options were granted under the 2003 Plan during 2003.
(2) See Summary Compensation Table for principal position.
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT THE SHAREHOLDERS VOTE FOR
ITEM NO. 3.
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information as of December 31, 2003 with
respect to shares of First Tennessee common stock that may be issued under our
existing equity compensation plans, including the 1990 Stock Option Plan (the
'1990 Plan'), the 1995 Employee Stock Option Plan (the '1995 Plan'), the 1997
Employee Stock Option Plan (the '1997 Plan'), the 2000 Employee Stock Option
Plan (the 'Executive Plan'), 2003 Equity Compensation Plan, not including the
1,000,000 shares for which shareholder approval is being sought under Vote Item
No. 3, (the '2003 Plan'), the 2000 Non-employee Directors' Deferred Compensation
Stock Option Plan (the 'Directors' Plan'), the 1995 Non-employee Directors'
Deferred Compensation Stock Option Plan (the '1995 Directors' Plan'), the 1991,
1997 and 2002 Bank Director and Advisory Board Member Deferral Plans (the
'Advisory Board Plans') and the 2002 Management Incentive Plan (the 'MIP'). Of
the 21,122,661 options outstanding, approximately 42 percent were issued in
connection with employee and director cash deferral elections. The Corporation
received approximately $55,020,000 in employee cash deferrals and $3,560,000 in
non-employee directors and advisory board retainer and meeting fee deferrals.
21
The table includes information with respect to shares subject to outstanding
options granted under equity compensation plans that are no longer in effect.
Footnotes (4) and (5) to the table set forth the total number of shares of First
Tennessee common stock issuable upon the exercise of options under the expired
plans as of December 31, 2003. No additional options may be granted under those
expired plans.
EQUITY COMPENSATION PLAN INFORMATION
A B C
-------------------- ---------------- ------------------------------
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR FUTURE
NUMBER OF SECURITIES WEIGHTED AVERAGE ISSUANCE UNDER EQUITY
TO BE ISSUED UPON EXERCISE PRICE COMPENSATION PLANS
EXERCISE OF OF OUTSTANDING (EXCLUDING SECURITIES
PLAN CATEGORY OUTSTANDING OPTIONS OPTIONS REFLECTED IN COLUMN A)
------------- ------------------- ------- ----------------------
Equity Compensation Plans Approved by
Shareowners(1)....................... 4,132,145(4) $23.97 4,010,751(2)
Equity Compensation Plans Not Approved
by Shareowners(3).................... 16,990,516(5) $30.86 1,605,790
Total.................................. 21,973,275(6) $29.51 5,827,353(7)
(1) Consists of the Executive Plan, Directors' Plan, 1995 Directors' Plan, 1995
Plan, 1990 Plan, the 2003 Plan and the MIP.
(2) Includes shares available for future issuance under the MIP. As of
December 31, 2003, an aggregate of 200,000 shares of First Tennessee
common stock were available for issuance under the MIP. As of December 31,
2003, an aggregate of 99,556 shares were available for restricted stock
grants under the 2003 Plan.
(3) Consists of the 1997 Plan and the Advisory Board Plans.
(4) Includes 1,034,589 outstanding options issued in connection with employee
and non-employee director cash deferrals of approximately $3,870,000. Also
includes information for equity compensation plans that have expired. The
Directors' Plan and the 1990 Plan were approved by shareholders in 1995
and 1990, respectively. The plans expired June 1999 and April 2000. As of
December 31, 2003, a total of 1,003,248 shares of First Tennessee common
stock were issuable upon the exercise of outstanding options under these
expired plans. No additional options may be granted under these expired
plans.
(5) Includes 7,791,281 outstanding options issued in connection with employee
and advisory board cash deferrals of approximately $54,710,000. Also
includes information for equity compensation plans that have expired. The
1997 Bank Director and Advisory Board Member Deferral Plan and the 1991
Bank Director and Advisory Board Member Deferral Plan expired in January
2002 and January 1997, respectively. As of December 31, 2003, a total of
111,201 shares of First Tennessee common stock were issuable upon the
exercise of outstanding options under the expired plans. No additional
options may be granted under these expired plans.
(6) Includes 850,614 shares of First Tennessee common stock to be issued at the
end of specified deferral periods set forth in individual deferral
agreements.
(7) Includes 210,812 shares of First Tennessee common stock underlying
restricted stock units granted under the 1992 Restricted Stock Plan.
Description of Equity Compensation Plans Not Approved by Shareholders
The 1997 Plan. The 1997 Plan was adopted by the Board of Directors on April
16, 1996 and will expire in April 2006. The 1997 Plan provides for granting of
nonqualified stock options.
Options granted under the 1997 Plan have been granted to all employees of
the Corporation under our FirstShare and management option programs. The
FirstShare program is a broad-based employee plan, where all employees of the
Corporation receive a stock option award annually, except for management level
employees who receive annual stock option awards under the management option
program. The FirstShare options vest 100 percent after three years and have a
term of 10 years. The management options vest 50 percent after 3 years and 50
percent after 4 years, unless a specified stock price is achieved within the 3
year period. The management options have a term of 7 years. In addition to the
above, certain employees
22
may elect to defer a portion of their annual compensation into stock options.
These options vest after 6 months and have a term of 20 years. The options vest
on an accelerated basis in the event of a change in control of First Tennessee.
All options granted under the 1997 Plan have an exercise price equal to the fair
market value on the date of grant. Notwithstanding the above, the option price
per share may be less than 100 percent of the fair market value of the share at
the time the option is granted if the employee has entered into an agreement
with the Corporation to receive a stock option grant in lieu of compensation and
the amount of compensation foregone when added to the cash exercise price of the
options equals at least the fair market value of the shares on the date of
grant.
As of December 31, 2003, options covering 16,863,717 shares of First
Tennessee common stock were outstanding under the 1997 Plan, 1,422,112 shares
remained available for future option grants, and options covering 3,743,083
shares had been exercised during the year. Of the options outstanding,
approximately 45 percent were issued in connection with employee cash deferral
elections. The Corporation received approximately $53,260,000 in cash deferrals
to offset a portion of the exercise price. Of the 1,422,122 shares remaining
available for future option grants, approximately 90 percent of options to be
granted will have an option term of 10 years or less.
The 1997 Plan is included as Exhibit 10(c) in our Form 10-Q for the quarter
ended September 30, 2002, filed with the SEC.
The Advisory Board Plans. The Advisory Board Plans were adopted by the Board
of Directors in October 2001, January 1997 and January 1991. The 2002 Advisory
Board Plan will expire on January 1, 2007 and the 1997 and 1991 plans expired in
2002 and 1997, respectively. The 2002 Advisory Board Plan provides granting of
nonqualified stock options to bank regional and advisory board members who
choose to forego board fees and retainers in exchange for stock options on
shares of First Tennessee common stock.
Options granted under the Advisory Board Plans have been granted only to
regional and advisory board members who are not employees. The options are
granted in lieu of the participants receiving retainers or attendance fees for
bank board and advisory board meetings. The number of shares subject to grant
will be the amount of fees/retainers earned divided by one half of the fair
market value of one share of common stock on the date of option grant. The
exercise price plus the amount of fees foregone will equal the fair market value
of the stock on the date of the grant. The options vest after 6 months and have
a term of 20 years. In February 2004, the Compensation Committee recommended
that the Board of Directors amend the 2002 Advisory Board Plan at the April
Board meeting to limit the terms of the options granted under the plan to 10
years.
As of December 31, 2003, options covering 126,799 shares of First Tennessee
common stock were outstanding under the Advisory Board Plans, 183,678 shares
remained available for future option grants, and options covering 16,596 shares
had been exercised during the year.
The Advisory Board Plans are included as Exhibits 10(s), 10(t) and 10(u) to
our 2002 Form 10-K.
VOTE ITEM NO. 4 -- RATIFICATION OF APPOINTMENT OF AUDITORS
Appointment of Auditors for 2004
KPMG LLP audited our annual financial statements for the year 2003. The
Audit Committee has appointed KPMG LLP to be our auditors for the year 2004.
Although not required by law, regulation or the rules of the New York Stock
Exchange, the Board has determined, as a matter of good corporate governance and
consistent with past practice, to submit to the shareholders as Vote Item No. 4
the ratification of KPMG LLP's appointment as our auditors for the year 2004,
and with the recommendation that the shareholders vote for Item No. 4.
Representatives of KPMG LLP are expected to be present at the annual meeting of
shareholders with the opportunity to make a statement and to respond to
appropriate questions.
Change in Auditors During 2002
On May 15, 2002, we dismissed our independent public accountants, Arthur
Andersen LLP ('Arthur Andersen'), and engaged KPMG LLP to serve as our
independent public accountants for fiscal year 2002.
23
The decision was approved by our Board of Directors upon the recommendation of
the Audit Committee of the Board of Directors.
Arthur Andersen's reports on the consolidated financial statements of First
Tennessee as of and for the years ended December 31, 2001 and 2000 did not
contain any adverse opinion or disclaimer of opinion, nor were they qualified or
modified as to uncertainty, audit scope or accounting principles.
During the two fiscal years of First Tennessee ended December 31, 2001 and
the subsequent interim period through May 15, 2002, there were no disagreements
with Arthur Andersen on any matter of accounting principles or practices,
financial statement disclosure or auditing scope or procedure, which
disagreements, if not resolved to the satisfaction of Arthur Andersen, would
have caused Arthur Andersen to make reference to the subject matter of the
disagreement in connection with its reports.
None of the reportable events described in Item 304(a)(1)(v) of Regulation
S-K occurred within the two fiscal years of First Tennessee ended December 31,
2001 or within the subsequent interim period through May 15, 2002.
We provided Arthur Andersen with a copy of the foregoing disclosures and
attached a copy of Arthur Andersen's letter, dated May 15, 2002, stating its
agreement with such statements as an exhibit to the Form 8-K that we filed on
May 16, 2002.
During the two fiscal years of First Tennessee ended December 31, 2001, and
the subsequent interim period through May 15, 2002, we did not consult with KPMG
LLP regarding any of the matters or events set forth in Item 304(a)(2)(i) or
(ii) of Regulation S-K.
Fees Billed to Us by Auditors During 2002 and 2003
The table below and the paragraphs following it provide information
regarding the fees billed to us by KPMG LLP during 2002 and 2003 for services
rendered in the categories of audit fees, audit-related fees, tax fees and all
other fees.
2002 2003
---- ----
Audit Fees.................................................. $ 751,500 $1,031,500
Audit-Related Fees.......................................... 328,500 385,000
Tax Fees.................................................... 1,052,770 17,200
All Other Fees.............................................. 27,000 61,638
---------- ----------
Total................................................... $2,159,770 $1,495,338
---------- ----------
---------- ----------
Audit Fees. For the years 2002 and 2003, the aggregate fees billed to us by
KPMG LLP for professional services rendered for the audit of our financial
statements and review of the financial statements in our Form 10-Q's or for
services that are normally provided by KPMG LLP in connection with statutory and
regulatory filings or engagements were, respectively, $751,500 and $1,031,500.
Audit-Related Fees. For the years 2002 and 2003, the aggregate fees billed
to us by KPMG LLP for assurance and related services that are reasonably related
to the performance of the audit or review of our financial statements and are
not reported under 'Audit Fees' above were, respectively, $328,500 and $385,000.
The amount for 2002 consists of ERISA audits, audits of subsidiaries, compliance
attestation and other procedures, and the amount for 2003 includes all of these
and, in addition, reports on controls placed in operation and tests of operating
effectiveness.
Tax Fees. For the years 2002 and 2003, the aggregate fees billed to us by
KPMG LLP for professional services for tax compliance, tax advice, and tax
planning were, respectively, $1,052,770 and $17,200. Included in the amount for
2002 is $1 million for tax planning services rendered prior to KPMG LLP's
engagement as our auditor. The amount for 2003 consists primarily of fees for
tax compliance.
All Other Fees. For the years 2002 and 2003, the aggregate fees billed to us
by KPMG LLP for products and services other than those reported under the three
preceding paragraphs were, respectively, $27,000 and $61,638. The amount for
both years relates to certain sales training for employees of a division of the
Bank and tax preparation and planning for executives.
24
In July 2003, the Audit Committee adopted a policy providing for
pre-approval of all audit and non-audit services to be performed by KPMG LLP, as
the registered public accounting firm that performs the audit of our
consolidated financial statements that are filed with the SEC. A copy of the
policy is attached to this proxy statement at pages C-6 through C-10 of Appendix
C. None of the services provided to us by KPMG LLP and described in the three
paragraphs immediately preceding this one were approved pursuant to the de
minimis exception of SEC Rule 2-01(c)(7)(i)(C).
THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT THE SHAREHOLDERS VOTE FOR
ITEM NO. 4.
OTHER MATTERS
The Board of Directors, at the time of the preparation and printing of this
proxy statement, knew of no other business to be brought before the meeting
other than the matters described in this proxy statement. If any other business
properly comes before the meeting, the persons named in the enclosed proxy will
have discretionary authority to vote all proxies in accordance with their best
judgment.
SHAREHOLDER PROPOSAL DEADLINES
If you intend to present a shareholder proposal at the 2005 annual meeting,
it must be received by the Corporate Secretary, First Tennessee National
Corporation, P. O. Box 84, Memphis, Tennessee, 38101, not later than November
19, 2004, for inclusion in the proxy statement and form of proxy relating to
that meeting.
In addition, Sections 2.8 and 3.6 of our Bylaws provide that a shareholder
who wishes to nominate a person for election to the Board or submit a proposal
at a shareholder meeting must comply with certain procedures whether or not the
matter is included in our proxy statement. These procedures require written
notification to us, generally not less than 90 nor more than 120 days prior to
the date of the shareholder meeting. If, however, we give fewer than 100 days'
notice or public disclosure of the shareholder meeting date to shareholders,
then we must receive the shareholder notification not later than 10 days after
the earlier of the date notice of the shareholder meeting was mailed or publicly
disclosed. The shareholder must disclose certain information about the nominee
or item proposed, the shareholder and any other shareholders known to support
the nominee or proposal. Section 2.4 of our Bylaws provides that the date and
time of the annual meeting will be the third Tuesday in April (or, if that day
is a legal holiday, on the next succeeding business day that is not a legal
holiday) at 10:00 a.m. Memphis time or such other date and/or such other time as
our Board may fix by resolution. The meeting date for 2005, determined according
to the Bylaws, is April 19, 2005. Thus, shareholder proposals submitted outside
the process that permits them to be included in our proxy statement must be
submitted to the Corporate Secretary between December 20, 2004 and January 19,
2005, or the proposals will be considered untimely. Untimely proposals may be
excluded by the Chairman or our proxies may exercise their discretion and vote
on these matters in a manner they determine to be appropriate.
EXECUTIVE COMPENSATION
The Summary Compensation Table provides information for the last three years
about Mr. Glass, who served during 2003 as Chief Executive Officer ('CEO') and
our other four most highly compensated executive officers at year end 2003. All
of the named officers are officers of both First Tennessee and the Bank. The
amounts include all compensation earned during each year, including amounts
deferred (which, if deferred into options, are disclosed only in the notes to
the table and in column (g)), by the named officers for all services rendered in
all capacities to us and our subsidiaries. Information is provided for each
entire year in which an individual served during any portion of the year as an
executive officer. Additional information is provided in tabular form below
about option grants and exercises in 2003, year-end option values, long-term
incentive plan awards and pension benefits, along with certain other information
concerning compensation of executive officers. The report of the Board's
Compensation Committee on executive compensation and information on compensation
of directors are located in the 'Corporate Governance and Board Matters' section
of this proxy statement above.
25
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG-TERM COMPENSATION
------------------------------------------- ---------------------------------
AWARD(S) PAYOUTS
------------------------ -------
(A) (B) (C) (D) (E) (F) (G) (H) (I)
SECURITIES
OTHER RESTRICTED UNDERLYING
ANNUAL STOCK OPTIONS/ LTIP ALL OTHER
NAME AND SALARY BONUS COMPENSATION AWARD(S) SARS PAYOUTS COMPENSATION
PRINCIPAL POSITION YEAR ($) ($) ($)(7) ($)(1) (#)(2) ($) ($)(9)
------------------ ---- ------ ----- ------------ ---------- ---------- ------- ------------
Ralph Horn 2003 $920,426 $ -- $ -- $ -- -- $ -- $206,100
Chairman 2002 912,411 1,305,033 11,913 1,380,686 162,438 -- 231,486
of the Board (retired)(3) 2001 861,122 1,076,403 11,544 -- 76,416 -- 238,535
J. Kenneth Glass 2003 764,346(4) 1,272,416 11,913 2,075,750 133,365(4) -- 122,684
Chairman of the Board, 2002 683,923(4) 1,014,420 11,913 1,065,269 237,353(4) -- 142,429
President & CEO(3) 2001 556,235(4) 454,676(4) 9,505 -- 65,569(4) -- 138,336
Charles G. Burkett 2003 420,308 472,847 6,376 -- 13,681 -- 46,209
President -- Retail Fin Svs/ 2002 381,615(5) 432,692 6,376 600,016 14,390(5) -- 47,005
Memphis Fin Services 2001 246,923(5) 155,952(5) 6,376 -- 19,194(5) -- 33,812
Larry B. Martin 2003 420,308(8) 459,712(8) 6,376 -- 13,681 -- 51,107
President -- Business Fin 2002 384,615(8) 384,615(8) 6,376 600,016 14,229 -- 51,176
Svs/Tennessee Fin Svs 2001 267,641 160,260 6,376 -- 7,101 -- 38,167
Elbert L. Thomas, Jr. 2003 371,030 463,788(6) -- -- 12,077 -- 29,821
Executive Vice President & 2002 336,447 420,559 -- 529,630 12,561 -- 32,759
Interest Rate Risk Mgr 2001 317,098 267,098(6) -- -- 22,275(6) -- 35,247
(1) Restricted stock awards are valued on the basis of a share of stock on the
date of the award: $41.515 (4-17-2003) and $35.14 (2-26-2002). On 12-31-03,
the named officers held the following shares of restricted stock (including
RSU's described in the following sentence) with market values as indicated:
Mr. Horn -- 159,192 shares ($7,028,327); Mr. Glass -- 135,961 shares
($6,002,678); Mr. Burkett -- 20,409 shares ($901,057); Mr. Martin -- 20,409
shares ($901,057); and Mr. Thomas -- 40,285 shares ($1,778,583)). The
number of shares disclosed in the preceding sentence includes restricted
stock units ('RSU's), described in note (2) to the Stock Ownership Table,
with respect to which restrictions had not lapsed at 12-31-03, as follows:
Mr. Horn -- 109,934 RSU's; Mr. Glass -- 49,216 RSU's; Mr. Thomas -- 21,676
RSU's; Messrs. Burkett and Martin -- 0 RSU's. Dividends are paid on
restricted stock (and dividend equivalents are paid on RSU's) at the same
rate as all other shares of common stock. Deferred dividend equivalents on
RSU's accrue interest at a 10-year Treasury rate and are settled only in
cash.
(2) All amounts represent shares subject to option. No stock appreciation
rights (SAR's) were awarded.
(3) Mr. Horn retired on December 31, 2003. Mr. Glass was elected Chairman of
the Board on October 20, 2003, effective January 1, 2004, following Mr.
Horn's retirement.
(4) In 2002, 2001 and 2000 Mr. Glass elected to receive a deferred compensation
stock option in lieu of $50,000, $50,000, and $50,000 of his salary earned
for the following year. The amounts in column (c) do not include these
amounts, in lieu of which options for 1,142 shares, 1,139 shares, 1,368
shares, 1,315 shares, 3,482 shares and 3,546 shares (included in the
amounts in column (g)) were granted on 1-2-04, 7-1-03, 1-2-03, 7-1-02,
1-2-02 and 7-2-01, respectively. In 2001 Mr. Glass received a deferred
compensation stock option in lieu of $151,559 of his annual bonus. The
amount in column (d) for 2001 does not include this amount, in lieu of
which options for 21,565 shares (included in the amount in column (g))
were granted on 2-26-02.
(5) In 2001 and 2000 Mr. Burkett elected to receive a deferred compensation
stock option in lieu of $3,000 and $3,000 of his salary earned for the
following year. The amount in column (c) does not include this amount, in
lieu of which options for 82, 79, 209 and 213 shares (included in the
amounts in column (g)) were granted on 1-2-03, 7-1-02, 1-2-02 and 7-2-01,
respectively. In 2000 Mr. Burkett elected to receive a deferred
compensation stock option in lieu of $47,001 of his annual bonus for the
following year. The amount in column (d) for 2001 does not include this
amount, in lieu of which options for 6,686 shares (included in the amount
in column (g)) were granted on 2-26-02. In 2001 Mr. Burkett received a
deferred
(footnotes continued on next page)
26
(footnotes continued from previous page)
compensation stock option in lieu of $39,317 of his annual bonus earned for
2001. The amount in column (d) for 2001 does not include this amount, in
lieu of which options for 5,594 shares (included in the amount in column
(g)) were granted on 2-26-02.
(6) In 2003, Mr. Thomas elected to defer $347,841 of his annual bonus for the
2003 year into the First Tennessee National Corporation Nonqualified
Deferred Compensation Plan that accrues earnings based on returns of
various mutual fund investments. This amount is included in column (d) for
the year 2003. In 2000 Mr. Thomas elected to receive a deferred
compensation stock option in lieu of a portion of his annual bonus for the
following year. The amount in column (d) for 2001 does not include bonus of
$50,000 in lieu of which options for 7,112 shares (included in the amounts
in column (g)) were granted on 2-26-02.
(7) The amounts in column (e) for all years represent automobile allowance tax
gross-up payments.
(8) In 2003, Mr. Martin elected to defer $275,827 of his annual bonus for the
2003 year into the First Tennessee National Corporation Nonqualified
Deferred Compensation Plan that accrues earnings based on returns of
various mutual fund investments. This amount is included in column (d) for
the year 2003. In 2002 Mr. Martin elected to defer $288,461 of his annual
bonus into the U.S. Treasury rate program. This amount is included in
column (d) for the year 2002.
(9) Elements of 'All Other Compensation' for 2003 consist of the following:
ALL OTHER COMPENSATION
ABOVE AUTO
MARKET RATE SUR BEN FLEX $ 401K MATCH ALLOWANCE TOTAL
----------- ------- ------ ---------- --------- -----
Mr. Horn............................. $102,672 $ 90,428 $ 7,000 $ 6,000 $ -- $206,100
Mr. Glass............................ $ 54,955 $ 38,579 $ 7,000 $ 6,000 $16,150 $122,684
Mr. Burkett.......................... $ -- $ 22,559 $ 7,000 $ 6,000 $10,650 $ 46,209
Mr. Martin........................... $ 445 $ 27,012 $ 7,000 $ 6,000 $10,650 $ 51,107
Mr. Thomas........................... $ -- $ 20,328 $ 7,000 $ 2,493 $ -- $ 29,821
'Above Mkt Rate' represents above-market interest accrued on deferred
compensation.
'Sur Ben' represents insurance premiums with respect to our supplemental
life insurance plan. Under our Survivor Benefits Plan a benefit of 2 1/2 times
final annual base salary is paid upon the participant's death prior to
retirement (or 2 times final salary upon death after retirement). The 'Sur Ben'
column previously included premiums paid by First Tennessee on life insurance
policies purchased to fund our Pension Restoration Plan ('SERP') obligations to
Messrs. Horn and Glass. Since neither officer is entitled to receive this
insurance, these premiums have been eliminated from the 2002 and 2001 numbers.
The SERP benefit is already disclosed in the text following the Pension Plan
table below.
'Flex $' represents First Tennessee's contribution to the Flexible Benefits
Plan, based on salary, service and corporate performance.
'401(k) Match' represents First Tennessee's 50 percent matching contribution
to the 401(k) Savings Plan, which is based on the amount of voluntary
contributions by the participant to the FTNC stock fund, up to 6 percent of
compensation.
27
The following table provides information about stock options granted during
2003 to the officers named in the Summary Compensation Table. No stock
appreciation rights (SAR's) were granted during 2003.
OPTIONS/SAR GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
-------------------------------------------------------------------------------------------------
(B) NUMBER OF (C) % OF (H) ALTERNATIVE
SECURITIES TOTAL TO (F) AND (G)
UNDERLYING OPTIONS/SARS GRANT DATE VALUE.
OPTIONS/SAR'S GRANTED TO (D) EXERCISE OR GRANT DATE
GRANTED EMPLOYEES IN BASE PRICE(2) (E) EXPIRATION PRESENT VALUE
(A) NAME (#)(1) FISCAL YEAR ($ PER SHARE)(1) DATE ($)(4)
-------- ------ ------------ ---------------- ---- ------
Mr. Horn....................... --
Mr. Glass...................... 1,368(2) 0.03% 18.28 1/2/2023 $ 25,089
42,411 1.42% 38.74 3/3/2010 $ 401,632
131,084 4.38% 38.74 3/3/2010 $1,241,365
1,139(2) 0.03% 21.94 7/1/2023 $ 24,990
Mr. Burkett.................... 82(2) 0.00% 18.28 1/2/2023 $ 1,504
13,681 0.35% 38.74 3/3/2010 $ 124,497
Mr. Martin..................... 13,681 0.35% 38.74 3/3/2010 $ 124,497
Mr. Thomas..................... 5,431(3) 0.14% 37.80 4/16/2007 $ 48,933
11,539(3) 0.29% 37.80 2/24/2017 $ 103,966
4,499(3) 0.11% 37.80 7/1/2017 $ 40,536
12,077 0.30% 38.74 3/3/2010 $ 109,901
13,260(3) 0.33% 43.23 2/19/2018 $ 142,147
5,046(3) 0.13% 43.23 7/1/2018 $ 54,093
4,231(3) 0.11% 43.23 1/3/2020 $ 45,356
3,807(3) 0.10% 44.65 1/2/2018 $ 40,659
5,270(3) 0.13% 44.65 1/4/2019 $ 56,284
4,478(3) 0.11% 44.65 2/26/2022 $ 47,825
10,317(3) 0.26% 44.80 2/23/2011 $ 119,471
3,501(3) 0.09% 44.80 7/1/2019 $ 40,542
(1) All options except those marked with footnote (2) or (3) were granted on
3-03-03 and vest 50% after three years from the date of grant and 100%
after four years, with accelerated vesting if certain performance
criteria (our stock price equals or exceeds $52.98 on 3-03-06 or on 5
consecutive days before 3-03-06) are met. No SAR's were granted. The
exercise price per share equals the fair market value of one share of our
common stock on the date of grant. Under the terms of all options,
including those marked with footnote (2) and (3), participants are
permitted to pay the exercise price of the options with our stock;
participants are permitted to defer receipt of shares upon an exercise and
thereby defer gain; options exercised more than one year prior to the end
of their term are eligible for a reload option grant when the exercise
price is paid with our stock, with the reload option grant for the number
of shares surrendered and having an exercise price equal to fair market
value at the time of the first exercise and a term equal to the remainder
of the first option's term; the option plan provides for tax withholding
rights upon approval of the plan committee; and upon a Change in Control
(as defined in the subsection entitled Employment Contracts and Termination
of Employment and Change-in-Control Arrangements), all options vest.
Effective February 17, 2004, the Compensation Committee terminated the
reload program, and no further reload options will be granted subsequent to
this date.
(2) Options indicated by footnote (2) were granted during 2003 in lieu of
compensation earned during 2002 and 2003. Mr. Glass was granted 1,368
shares on 1-2-2003 in lieu of $25,000 of his 2002 salary and 1,139 shares
on 7-1-03 in lieu of $25,000 of his 2003 salary. Mr. Burkett was granted
82 shares on 1-2-03 in lieu of $1,500 of his 2002 salary. The exercise
price per share equals 50% of the fair market value ('FMV') of one share of
First Tennessee common stock on the grant date on 1-2-03 and 7-1-03. The
options vest six months after the grant date. No SAR's were granted. FMV on
the grant dates was $36.56 and $43.88 on 1-02-03 and 7-1-03, respectively.
(footnotes continued on next page)
28
(footnotes continued from previous page)
(3) Options indicated by footnote (3) were granted in accordance with a reload
option as explained in footnote (1). Mr. Thomas was awarded options of
5,431, 11,539 and 4,499 shares on 2-11-03; 13,260, 5,046 and 4,231 shares
on 4-24-03; 3,807, 5,270 and 4,478 shares on 5-27-03; and 10,317 and
3,501 shares on 2-11-03. FMV on the grant date was $37.795 on 2-11-03;
$43.23 on 4-24-03; $44.65 on 5-27-03 and $44.80 on 11-26-03.
(4) A variation of the Black-Scholes option-pricing model has been used. The
following assumptions were made for purposes of calculating the Grant Date
Value of the options granted 1-2-2003 (options in lieu of compensation),
3-3-2003 (management grants), 7-1-2003 (options in lieu of compensation),
three reloads dated 2-11-03; three reloads dated 4-24-03; three reloads
dated 5-27-03 and two reloads dated 11-26-03 respectively: an exercise
price of $18.28, $38.735, $21.94, $37.795, $37.795, $37.795, $43.23,
$43.23, $43.23, $44.65, $44.65, $44.65, $44.80 and $44.80; an option term
of 20 years, 7 years, 20 years, 4 years, 14 years, 14 years, 15 years, 15
years, 17 years, 15 years, 16 years, 19 years, 8 years and 16 years; an
interest rate of 2.71%, 3.32%, 2.10%, 3.63%, 3.63%, 3.63%, 3.61%, 3.61%,
3.61%, 3.04%, 3.04%, 3.04%, 3.85% and 3.85%; volatility of 27.67%, 27.67%,
29.60%, 27.67%, 27.67%, 27.67%, 27.07%, 27.07%, 27.07%, 27.07%, 27.07%,
27.07%, 27.30% and 27.30%; a dividend yield of 3.28%, 3.10%, 2.73%, 3.18%,
3.18%, 3.18%, 2.78%, 2.78%, 2.78%, 2.69%, 2.69% 2.69%, 2.68% and 2.68%;
and an expected life of 4, 7, 4, 7, 7, 7, 7, 7, 7, 7, 7, 7, 7 and 7 years
to reflect the probability of a shortened option term due to exercise prior
to the option expiration date. The actual value, if any, realized by a
participant upon the exercise of an option may differ and will depend on
the future market price of our common stock.
29
The following table provides information about stock options and SARs held
at December 31, 2003, and exercises during 2003 by the officers named in the
Summary Compensation Table. The values in column (c) represent the difference
between the fair market value of the shares on the exercise date and the
exercise price of the option. The values in column (e) reflect the spread
between the market value at December 31, 2003, of the shares underlying the
option and the exercise price of the option.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTIONS/SAR VALUES
(A) (B) (C) (D) (E)
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS/SARS AT IN-THE-MONEY OPTIONS/SARS
SHARES FISCAL YEAR-END(1) AT FISCAL YEAR-END(1)
ACQUIRED VALUE --------------------------- ---------------------------
ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
NAME (#) ($) (#) (#) ($) ($)
---- --- --- --- --- --- ---
Mr. Horn.................. -- $ -- 730,448 181,750 $16,730,916 $1,541,201
Mr. Glass................. 10,236 $ 318,442 352,918 418,649 $ 7,460,116 $2,964,599
Mr. Burkett............... -- $ -- 38,434 30,234 $ 533,914 $ 211,560
Mr. Martin................ 6,780 $ 236,893 74,640 30,452 $ 1,595,715 $ 212,436
Mr. Thomas................ 117,713 $1,922,405 147,889 29,778 $ 791,294 $ 199,174
(1) No SARs are attached to any of the options in the table.
Option values are based on $44.15 per share, the average of
the high and low sales price on December 31, 2003.
The following table provides information about Long-Term Incentive Program
('LTIP') awards made during 2003 to the officers named in the Summary
Compensation Table.
LONG-TERM INCENTIVE PLANS -- AWARDS IN LAST FISCAL YEAR
ESTIMATED FUTURE PAYOUTS UNDER
NON-STOCK PRICED-BASED PLANS(1)(2)
-----------------------------------
(A) (B) (C) (D) (E) (F)
PERFORMANCE OR
NUMBER OF SHARES, OTHER PERIOD
UNITS OR UNTIL MATURATION THRESHOLD TARGET MAXIMUM
NAME OTHER RIGHTS (#) OR PAYOUT ($) ($) ($)
---- ----------------- --------- --- --- ---
Mr. Horn.......................... -- -- $ -- $ -- $ --
Mr. Glass......................... 28,900 2003 - 2005 $ -- $2,310,469 $2,310,469
Mr. Burkett....................... 12,000 2003 - 2005 $ -- $ 954,000 $ 954,000
Mr. Martin........................ 12,000 2003 - 2005 $ -- $ 954,000 $ 954,000
Mr. Thomas........................ 10,600 2003 - 2005 $ -- $ 842,150 $ 842,150
(1) Dollar amounts in columns (e) and (f) include the market value of the
restricted stock shown in column (b).
(2) The target and maximum payouts listed in the table above may differ
slightly from the amounts actually paid because the payouts under this
program are based in part on the participants' base salary, which may
increase or decrease over the course of the three-year performance period.
The Long-Term Incentive Program's objective is to provide a total cumulative
award of up to 225 percent of our executives' annual bonus potential and is paid
(or settled) with restricted stock and cash. The amount of the award is based on
First Tennessee's P/E ratio relative to a peer group (the American Banker Top 50
banks as identified at the beginning of the performance period) as of the
measurement date (January 31, 2006) provided the ratio increases during the
performance period. Payouts under this criterion range from 20 percent of the
maximum shown in the table above if a minimum threshold for the P/E ratio is
30
achieved to 100 percent of the maximum if the goal for the P/E ratio is fully
achieved or exceeded. The alternative criterion is based on the compound average
annual growth rate in our stock price over the performance period. Payouts under
the alternative criterion range from zero percent of the maximum shown in the
table above if the minimum threshold is not achieved to 100 percent if the goal
for the compound average annual growth rate in our stock price is fully achieved
or exceeded. No payout will be made if performance falls below the threshold on
both criteria, and the payout for achievement under either criterion that falls
between the threshold and the goal will be calculated using straight-line
interpolation. The initial performance period covers three years (2003-2005). A
portion of the awards under the program is made at the beginning of the
performance period in shares of restricted stock. To the extent that the market
value of the restricted stock at the end of the performance period exceeds the
payout achieved under the program by a participant, the participant will forfeit
shares of the restricted stock. To the extent that the market value of the
restricted stock at the end of the performance period is less than the payout
achieved under the program by a participant, the participant will be paid the
shortfall in cash. This program is designed to tie the executive's long-term
compensation directly to an increase in shareholder value.
The following table provides information about estimated combined benefits
under both our Pension Plan and our Pension Restoration Plan.
PENSION PLAN TABLE
COVERED COMPENSATION
15 YRS. 20 YRS. 25 YRS. 30 YRS. 35 YRS. 40 YRS.
$ 100,000............................ $ 47,135 $ 55,676 $ 64,218 $ 67,825 $ 71,432 $ 75,040
150,000............................ 61,937 75,412 88,888 94,962 101,036 107,111
200,000............................ 76,739 95,148 113,558 122,099 130,640 139,182
250,000............................ 91,541 114,884 138,228 149,236 160,244 171,253
300,000............................ 106,343 134,620 162,898 176,373 189,848 203,324
350,000............................ 121,145 154,356 187,568 203,510 219,452 235,395
400,000............................ 135,947 174,092 212,238 230,647 249,056 267,466
450,000............................ 150,749 193,828 236,908 257,784 278,660 299,537
500,000............................ 165,551 213,564 261,578 284,921 308,264 331,608
550,000............................ 180,353 233,300 286,248 312,058 337,868 363,679
600,000............................ 195,155 253,036 310,918 339,195 367,472 395,750
650,000............................ 209,957 272,772 335,588 366,332 397,076 427,821
700,000............................ 224,759 292,508 360,258 393,469 426,680 459,892
750,000............................ 239,561 312,244 384,928 420,606 456,284 491,963
800,000............................ 254,363 331,980 409,598 447,743 485,888 524,034
850,000............................ 269,165 351,716 434,268 474,880 515,492 556,105
900,000............................ 283,967 371,452 458,938 502,017 545,096 588,176
950,000............................ 298,769 391,188 483,608 529,154 574,700 620,247
1,000,000............................ 313,571 410,924 508,278 556,291 604,304 652,318
1,050,000............................ 328,373 430,660 532,948 583,428 633,908 684,389
1,100,000............................ 343,175 450,396 557,618 610,565 663,512 716,460
* Benefit shown is subject to limitations fixed by the Secretary of the Treasury
pursuant to Section 415 of the Tax Code. The limitation is $160,000 for 2003
or 100% of the employee's average income in his three highest paid years,
whichever is less.
Our Pension Plan is integrated with social security under an 'offset'
formula, applicable to all participants. Retirement benefits are based upon a
participant's average base salary for the highest 60 consecutive months of the
last 120 months of service ('Covered Compensation'), service, and social
security benefits. Benefits are normally payable in monthly installments after
age 65. The normal form of benefit payment for a married participant is a
qualified joint and survivor annuity with the surviving spouse receiving for
life 50 percent of the monthly amount the participant received. The normal form
of benefit payment for an unmarried participant is an annuity payable for life
and 10 years certain. For purposes of the plan, 'compensation' is defined as the
total cash remuneration reportable on the employee's IRS form W-2, plus pre-tax
contributions under the Savings Plan and employee contributions under the
Flexible Benefits
31
Plan, excluding bonuses, commissions, and incentive and contingent compensation.
Our Pension Restoration Plan is an unfunded plan covering employees in the
highest salary grades, including all executive officers, whose benefits under
the Pension Plan have been limited under Tax Code Section 415, as described in
the note to the Pension Table, and Tax Code Section 401(a)(17), which limits
compensation to $200,000 for purposes of certain benefit calculations.
'Compensation' is defined in the same manner as it is for purposes of the
Pension Plan. Under the Pension Restoration Plan participants receive the
difference between the monthly pension payable, if Tax Code limitations did not
apply, and the actual pension payable. The amounts shown in the table are annual
benefits payable (including any social security payments) in the event of
retirement on December 31, 2003 at age 65 of a participant with a spouse who is
age 65, assuming receipt of a qualified joint and 50 percent survivor annuity.
The estimated credited years of service and the compensation covered by the
plans for each of the individuals named in the Summary Compensation Table are as
follows: Mr. Horn (40) $835,892, Mr. Glass (30) $590,432, Mr. Burkett (34)
$272,328, Mr. Martin (34) $235,834, and Mr. Thomas (14) $252,129.
Employment Contracts and Termination of Employment and Change-in-Control
Arrangements
We have contracts with approximately 70 officers, including each of the
named executive officers, which may be terminated upon three years' prior
notice. These contracts provide generally for a payment (which, for the named
executive officers, is equal to three times annual base salary plus annual
target bonus) in the event of a termination of the officer's employment by us
other than 'for cause' or by the employee for 'good reason' (as such terms are
defined in the contracts) within 36 months after a 'Change-in-Control' or the
officer's termination of employment for any reason (other than 'cause') during
the 30-day period commencing one year after a Change-in-Control. The contracts
provide generally for an excise tax gross-up with respect to any taxes incurred
under Tax Code Section 4999 following a Change-in-Control and for 3 years
continued welfare benefits. The term 'Change-in-Control' is defined to include:
a merger or other business combination, unless (i) more than
50 percent of the voting power of the corporation resulting
from the business combination is represented by our voting
securities outstanding immediately prior thereto, (ii) no
person or other entity beneficially owns 20 percent or more
of the resulting corporation, and (iii) at least a majority
of the members of the board of directors of the resulting
corporation were our directors at the time of board approval
of the business combination (solely for purposes of the
severance contracts, but not for purposes of their 30-day
termination period, the '50 percent' test in clause (i) is
changed to '60 percent' and the 'majority of the board' test
in clause (iii) is changed to 'two-thirds of the board'),
the acquisition by a person or other entity of 20 percent or
more of our outstanding voting stock,
a change in a majority of the Board of Directors, or
shareholder approval of a plan of complete liquidation or a
sale of substantially all of our assets.
A Change-in-Control has the following effect on certain benefit plans in
which the named executive officers participate:
Target annual bonuses are prorated through the date of the
Change-in-Control and paid.
Restricted stock, restricted stock units, phantom stock
units and unvested stock options vest.
Under our Pension Restoration Plan, a lump sum payout is
made to participants of the present value, using a discount
rate of 4.2 percent, of the participant's scheduled
projected benefits, assuming periodic distributions of the
participant's accrued benefit in the normal form under the
plan, actuarially adjusted according to a formula for the
participant's age at the time of the Change-in-Control.
Excess funding in the Pension Plan is allocated, according
to a formula, to participants and retirees.
Deferred compensation under individual deferral agreements
which accrue interest based on the 10-year Treasury rate and
certain other benefits are paid over to previously
established rabbi trusts. Funds in such trusts will remain
available for the benefit of our general creditors prior to
distribution.
Our Survivor Benefits Plan generally cannot be amended to
reduce benefits.
Under the Directors and Executives Deferred Compensation
Plan under which new deferrals have not been permitted since
1995, a lump sum payout is made to participating employees
and certain
32
terminated employees of the present value, using a discount
rate of 4.2 percent, of the participant's scheduled
projected distributions, assuming employment through normal
retirement date and continued interest accruals at
above-market rates, described in the 'Compensation of
Directors' section above.
Mr. Horn has elected to accept an early retirement as defined in our Pension
Plan. We have entered into an agreement providing for a special separation
package with Mr. Horn. The agreement provides for retirement benefits under the
Pension Plan and Pension Restoration Plan to be computed and supplemental
retirement payments to be made as though Mr. Horn had continued in employment
until age 65. It also provides for the continued accrual of interest under the
Directors' and Executives' Deferred Compensation Plan at the applicable rate (as
defined in the plan). Under the agreement, the restrictions on Mr. Horn's shares
of restricted stock will lapse on an accelerated basis, and his outstanding
options will continue to vest as originally scheduled, with unexercised
management options and unexercised deferral options expiring three years and
five years, respectively, after his date of retirement. Like other early
retirees, Mr. Horn will retain his medical coverage with us so long as he pays
the necessary premiums, and our Survivor Benefit Plan will remain in effect. Mr.
Horn will be provided office space and administrative support, as well as tax
preparation and financial planning services, until he reaches age 75. The
agreement also contains confidentiality obligations, as well as non-disclosure
and non-compete provisions that will remain in effect for a period of three
years after Mr. Horn's retirement.
Compensation Committee Interlocks and Insider Participation
Messrs. Haslam, Martin and Blattberg and Ms. Palmer, all of whom are
non-employee directors, served as members of the Board of Director's
Compensation Committee ('Committee'), during all or a portion of 2003. Refer to
the Table in 'Corporate Governance and Board Matters -- Structure and
Composition of the Board and Committees' above for additional committee
information. No interlocking relationships existed with respect to any of the
members of the Committee. Mr. Horn, however, who retired December 31, 2003,
served during 2003 on the compensation committee of Gaylord Entertainment
Company, of which Mr. Rose is Chairman.
Certain Relationships and Related Transactions
Our banking subsidiaries have had banking transactions in the ordinary
course of business with our executive officers, directors, nominees, and their
associates which are reported in a note to our financial statements, and they
expect to have such transactions in the future. Such transactions, which at
December 31, 2003, amounted to 4.03 percent of our shareholders' equity, have
been on substantially the same terms, including interest rates and collateral on
loans, as those prevailing at the same time for comparable transactions with
others and have not involved more than the normal risk of collectibility or
presented other unfavorable features.
During 2003, the Bank made lease payments on one of its branches to Lacey
Mosby & Sons, Inc., a business in which an equity investment is owned by Marlin
L. Mosby, Jr., the father of Marlin L. Mosby, III, who was designated as an
executive officer of First Tennessee in October 2002. The lease, which was an
arm's length transaction at market rates, was entered into in 1997, has a 30
year term, provides for monthly payments of $3,000, increasing in increments to
$7,000 per month in 2017, and has renewal options. The Bank has leased this
location or an adjacent property from this business for over 30 years.
During 2003, Luke Yancy IV and Tanika C. Yancy, the son and daughter-in-law
of Luke Yancy III, were employed as a commercial loan officer and as an
operations coordinator, respectively, by the Bank. Together they received an
aggregate of approximately $140,000 in total compensation in 2003 in connection
with their employment. Both Mr. Yancy and Mrs. Yancy were compensated comparably
to similarly situated employees, and neither of them is one of our executive
officers.
During 2003, a family limited partnership controlled by Mr. Rose entered
into a five-year interest rate swap agreement with the Bank to hedge floating
rate interest exposure on a loan. Under the swap transaction, which was in the
ordinary course of business on terms comparable to what the Bank would offer to
non-affiliated parties, the partnership made a payment of $79,779 to the Bank.
The Bank offset its exposure on the swap by entering into a mirror-image swap
with a non-affiliated counter-party.
33
Notwithstanding anything to the contrary set forth in any of our previous
filings under the Securities Act of 1933, as amended, or the Securities Exchange
Act of 1934, as amended, that might incorporate future filings by reference,
including this proxy statement, in whole or in part, the following Total
Shareholder Return Performance Graph shall not be incorporated by reference into
any such filings.
Total Shareholder Return Performance Graph
The following graph compares the yearly percentage change in our cumulative
total shareholder return with returns based on the Standard and Poor's 500 index
and a peer group index, which is described below and in a footnote to the graph.
It should be noted that the 'total shareholder return' reflected in the graph is
not comparable to the 'total shareholder return' described in the Compensation
Committee Report because the former has a different measurement period and it
has been adjusted and weighted for the market capitalization of the companies in
the peer group, as required by SEC regulations. Our peer group consists of the
American Banker Top 50 banking organizations (excluding First Tennessee) as
measured by market capitalization as of the end of the most recent fiscal year.
TOTAL SHAREHOLDER RETURN
1998 - 2003
[LINE GRAPH]
1998 1999 2000 2001 2002 2003
---- ---- ---- ---- ---- ----
First Tennessee $100 $ 76 $ 81 $ 95 $107 $135
S&P 500 100 121 110 143 76 93
American Banker Top 50 100 110 135 132 116 153
* The graph assumes $100 is invested on December 31, 1998 and dividends are
reinvested. Returns are market-capitalization weighted.
The American Banker Top 50 consists of the following (with First Tennessee
excluded): AmSouth Bancorporation, Associated Banc Corp, Bank Hawaii, Banknorth
Group, Inc., Banc One Corporation, BankAmerica Corporation, Bank of New York
Co., Inc., BOK Financial, Branch Banking and Trust Company, Charter One
Financial, Inc., Citigroup Inc., City National Corp., Comerica Incorporated,
Commerce Bancorp, Commerce Bancshares, Inc., Compass Bancshares, Inc., Fifth
Third Bancorp, First Merit Corp, Fleet Boston Financial Corp., Fulton Financial
Corp., Hibernia Corporation, Huntington Bancshares Incorporated, J.P. Morgan
Chase & Co., KeyCorp, M & T Bank Corporation, Marshall & Ilsley Corporation,
Mellon Financial Corporation, Mercantile Bankshares Corporation, National City
Corporation, National Commerce Bancorp, North Fork Bancorporation, Northern
Trust Corporation, PNC Financial Services, Popular Inc., Regions Financial Corp,
Sky Financial Group, Inc. SouthTrust Corporation, State Street Corporation,
SunTrust Banks, Inc., Synovus Financial Corporation, TCF Financial Corp,
UnionBanCal Corporation, Union Planters
34
Corporation, U.S. Bancorp, Valley National Bancorp, Wachovia Corporation, Wells
Fargo & Company, Wilmington Trust, and Zions Bancorporation.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended ('Exchange
Act') requires our directors and officers to file with the SEC initial reports
of ownership and reports of changes in ownership of our common stock and to
furnish us with copies of all forms filed.
To our knowledge, based solely on a review of the copies of such reports
furnished to us and written representations that no other reports were required,
during the past fiscal year all Section 16(a) filing requirements applicable to
our officers and directors were complied with.
35
-------------------
AVAILABILITY OF ANNUAL REPORT ON FORM 10-K
-------------------
A COPY OF OUR ANNUAL REPORT ON FORM 10-K, INCLUDING THE FINANCIAL STATEMENTS
AND SCHEDULES THERETO, WHICH IS FILED WITH THE SEC, IS AVAILABLE FREE OF CHARGE
TO EACH SHAREHOLDER OF RECORD UPON WRITTEN REQUEST TO THE TREASURER, FIRST
TENNESSEE NATIONAL CORPORATION, P. O. BOX 84, MEMPHIS, TENNESSEE, 38101. Each
such written request must set forth a good faith representation that as of the
record date specified in the notice of annual shareholders' meeting the person
making the request was a beneficial owner of a security entitled to vote at the
annual meeting of shareholders.
The exhibits to the Annual Report on Form 10-K will also be supplied upon
written request to the Treasurer and payment to us of the cost of furnishing the
requested exhibit or exhibits. A document containing a list of each exhibit to
Form 10-K, as well as a brief description and the cost of furnishing each such
exhibit, will accompany the Annual Report on Form 10-K.
BY ORDER OF THE
BOARD OF DIRECTORS
CLYDE A. BILLINGS, JR.
CLYDE A. BILLINGS, JR.
Senior Vice President,
Assistant General Counsel and
Corporate Secretary
March 10, 2004
36
APPENDIX A
FIRST TENNESSEE NATIONAL CORPORATION
2003 EQUITY COMPENSATION PLAN
(AS AMENDED AND RESTATED FEBRUARY 17, 2004)
SECTION 1 -- PURPOSE
This plan shall be known as the 'First Tennessee National Corporation 2003
Equity Compensation Plan' (the 'Plan'). The purpose of the Plan is to promote
the interests of First Tennessee National Corporation, a Tennessee corporation
(the 'Company'), and its shareholders by (i) attracting and retaining officers,
employees, and non-employee directors of the Company and its Subsidiaries, (ii)
motivating such individuals by means of performance-related incentives to
achieve long-range performance goals, (iii) enabling such individuals to
participate in the long-term growth and financial success of the Company, (iv)
encouraging ownership of stock in the Company by such individuals, and (v)
linking compensation to the long-term interests of shareholders. With respect to
any awards granted under the Plan that are intended to comply with the
requirements of 'performance-based compensation' under Section 162(m) of the
Code (as defined below), the Plan shall be interpreted in a manner consistent
with such requirements.
SECTION 2 -- DEFINITIONS
As used in the Plan, the following terms shall have the meanings set forth
below:
'AWARD' shall mean any Option, Stock Appreciation Right, Restricted Stock,
Restricted Stock Unit or Performance Award granted under the Plan, whether
singly or in combination, to a Participant pursuant to such terms, conditions,
restrictions and/or limitations, if any, as may be established from time to
time.
'AWARD AGREEMENT' shall mean any written or electronic agreement, contract,
notice or other instrument or document evidencing any Award, which may, but need
not, be executed or acknowledged by a Participant.
'BOARD' shall mean the Board of Directors of the Company.
'CAUSE' shall mean (i) a Participant's conviction of, or plea of guilty or
nolo contendere (or similar plea) to, (A) a misdemeanor charge involving fraud,
false statements or misleading omissions, wrongful taking, embezzlement,
bribery, forgery, counterfeiting or extortion, (B) a felony charge or (C) an
equivalent charge to those in clauses (A) and (B) in jurisdictions which do not
use those designations; (ii) the engaging by a Participant in any conduct which
constitutes an employment disqualification under applicable law (including
statutory disqualification as defined under the Exchange Act); (iii) a
Participant's failure to perform his or her duties to the Company or its
Subsidiaries; (iv) a Participant's violation of any securities or commodities
laws, any rules or regulations issued pursuant to such laws, or the rules and
regulations of any securities or commodities exchange or association of which
the Company or any of its Subsidiaries or affiliates is a member; (v) a
Participant's violation of any policy of the Company or its Subsidiaries
concerning hedging or confidential or proprietary information, or a
Participant's material violation of any other policy of the Company or its
Subsidiaries as in effect from time to time; (vi) the engaging by a Participant
in any act or making any statement which impairs, impugns, denigrates,
disparages or negatively reflects upon the name, reputation or business
interests of the Company or its Subsidiaries; or (vii) the engaging by the
Participant in any conduct detrimental to the Company or its Subsidiaries. The
determination as to whether Cause has occurred shall be made by the Committee in
its sole discretion. The Committee shall also have the authority in its sole
discretion to waive the consequences under the Plan or any Award Agreement of
the existence or occurrence of any of the events, acts or omissions constituting
Cause.
'CHANGE IN CONTROL' shall mean, unless otherwise defined in the applicable
Award Agreement, the occurrence of any one of (and shall be deemed to have
occurred on the date of the earliest to occur of) the following events:
(i) individuals who, on January 21, 1997, constitute the Board (the
'Incumbent Directors') cease for any reason to constitute at least a
majority of the Board, provided that any person becoming a director
A-1
subsequent to January 21, 1997, whose election or nomination for election
was approved by a vote of at least three-fourths (3/4) of the Incumbent
Directors then on the Board (either by a specific vote or by approval of the
proxy statement of the Company in which such person is named as a nominee
for director, without written objection to such nomination) shall be an
Incumbent Director; provided, however, that no individual elected or
nominated as a director of the Company initially as a result of an actual or
threatened election contest with respect to directors or as a result of any
other actual or threatened solicitation of proxies or consents by or on
behalf of any person other than the Board shall be deemed to be an Incumbent
Director;
(ii) any 'Person' (for purposes of this definition only, as defined
under Section 3(a)(9) of the Exchange Act as used in Section 13(d) or
Section 14(d) of the Exchange Act) is or becomes a 'beneficial owner' (as
defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of
securities of the Company representing 20% or more of the combined voting
power of the Company's then outstanding securities eligible to vote for the
election of the Board (the 'Company Voting Securities'); provided, however,
that the event described in this paragraph (ii) shall not be deemed to be a
Change in Control by virtue of any of the following acquisitions: (A) by the
Company or any Subsidiary, (B) by an employee stock ownership or employee
benefit plan or trust sponsored or maintained by the Company or any
Subsidiary, (C) by any underwriter temporarily holding securities pursuant
to an offering of such securities, or (D) pursuant to a Non-Qualifying
Transaction (as defined in paragraph (iii) hereof);
(iii) the shareholders of the Company approve a merger, consolidation,
share exchange or similar form of corporate transaction involving the
Company or any of its Subsidiaries that requires the approval of the
Company's shareholders, whether for such transaction or the issuance of
securities in the transaction (a 'Business Combination'), unless immediately
following such Business Combination: (A) more than 50% of the total voting
power of (x) the corporation resulting from such Business Combination (the
'Surviving Corporation'), or (y) if applicable, the ultimate parent
corporation that directly or indirectly has beneficial ownership of 100% of
the voting securities eligible to elect directors of the Surviving
Corporation (the 'Parent Corporation'), is represented by Company Voting
Securities that were outstanding immediately prior to the consummation of
such Business Combination (or, if applicable, is represented by shares into
which such Company Voting Securities were converted pursuant to such
Business Combination), and such voting power among the holders thereof is in
substantially the same proportion as the voting power of such Company Voting
Securities among the holders thereof immediately prior to the Business
Combination, (B) no Person (other than any employee benefit plan sponsored
or maintained by the Surviving Corporation or the Parent Corporation), is or
becomes the beneficial owner, directly or indirectly, of 20% or more of the
total voting power of the outstanding voting securities eligible to elect
directors of the Parent Corporation (or, if there is no Parent Corporation,
the Surviving Corporation) and (C) at least a majority of the members of the
board of directors of the Parent Corporation (or, if there is no Parent
Corporation, the Surviving Corporation) were Incumbent Directors at the time
of the Board's approval of the execution of the initial agreement providing
for such Business Combination (any Business Combination which satisfies all
of the criteria specified in (A), (B) and (C) above shall be deemed to be a
'Non-Qualifying Transaction'); or
(iv) the shareholders of the Company approve a plan of complete
liquidation or dissolution of the Company or a sale of all or substantially
all of the Company's assets.
Computations required by paragraph (iii) shall be made on and as of the date of
shareholder approval and shall be based on reasonable assumptions that will
result in the lowest percentage obtainable. Notwithstanding the foregoing, a
Change in Control of the Company shall not be deemed to have occurred solely
because any Person acquires beneficial ownership of more than twenty percent
(20%) of the Company Voting Securities as a result of the acquisition of Company
Voting Securities by the Company which reduces the number of Company Voting
Securities outstanding; provided, that if after such acquisition by the Company
such Person becomes the beneficial owner of additional Company Voting Securities
that increases the percentage of outstanding Company Voting Securities
beneficially owned by such Person, a Change in Control of the Company shall then
occur.
'CODE' shall mean the Internal Revenue Code of 1986, as amended from time to
time.
'COMMITTEE' shall mean a committee of the Board composed solely of not less
than two Non-Employee Directors, all of whom shall (i) satisfy the requirements
of Rule 16b-3(b)(3) of the Exchange Act, (ii) be
A-2
'outside directors' within the meaning of Section 162(m) and (iii) otherwise
meet any 'independence' requirements promulgated by any stock exchange on which
the shares are listed. The members of the Committee shall be appointed by and
serve at the pleasure of the Board.
'COMPANY' shall mean First Tennessee National Corporation, a Tennessee
corporation, and its successors and assigns.
'COVERED OFFICER' shall mean at any date (i) any individual who, with
respect to the previous taxable year of the Company, was a 'covered employee' of
the Company within the meaning of Section 162(m); provided, however, that the
term 'Covered Officer' shall not include any such individual who is designated
by the Committee, in its discretion, at the time of any Award or at any
subsequent time, as reasonably expected not to be such a 'covered employee' with
respect to the current taxable year of the Company, and (ii) any individual who
is designated by the Committee, in its discretion, at the time of any Award or
at any subsequent time, as reasonably expected to be such a 'covered employee'
with respect to the current taxable year of the Company or with respect to the
taxable year of the Company in which any applicable Award will be paid.
'DISABILITY' shall mean, unless otherwise defined in the applicable Award
Agreement, a disability that would qualify as a total and permanent disability
under the long-term disability plan then in effect at the Employer employing the
Participant at the onset of such total and permanent disability.
'EMPLOYEE' shall mean an employee of any Employer.
'EMPLOYER' shall mean the Company or any Subsidiary.
'EXCHANGE ACT' shall mean the Securities Exchange Act of 1934, as amended
from time to time.
'FAIR MARKET VALUE' with respect to the Shares, shall mean, as of any date,
(i) the mean between the high and low sales prices at which Shares were sold on
the New York Stock Exchange, or, if the shares are not listed on the New York
Stock Exchange, on any other such exchange on which the Shares are traded, on
such date, or, in the absence of reported sales on such date, the mean between
the high and low sales prices on the immediately preceding date on which sales
were reported, or (ii) in the event there is no public market for the Shares on
such date, the fair market value as determined in good faith by the Committee in
its sole discretion.
'NON-EMPLOYEE DIRECTOR' shall mean a member of the Board who is not an
Employee.
'OPTION' shall mean an option to purchase Shares from the Company that is
granted under Section 6 or 9 of the Plan and is not intended to meet the
requirements of Section 422 of the Code or any successor provision thereto.
'OPTION PRICE' shall mean the purchase price payable to purchase one Share
upon the exercise of an Option.
'PARTICIPANT' shall mean any Employee, Non-Employee Director or Regional
Board Member who receives an Award under the Plan.
'PERFORMANCE AWARD' shall mean any right granted under Section 8 of the
Plan.
'PERSON' shall mean any individual, corporation, partnership, association,
joint-stock company, limited liability company, trust, unincorporated
organization, government or political subdivision thereof or other entity.
'PLAN' shall mean this First Tennessee National Corporation 2003 Equity
Compensation Plan.
'REGIONAL BOARD MEMBER' shall mean any First Tennessee Bank National
Association regional board member and any member of the board of directors of
any bank subsidiary of the Company, other than First Tennessee Bank National
Association, in each case excluding any Employee.
'RESTRICTED STOCK' shall mean any Share granted under Section 7 or 9 of the
Plan.
'RESTRICTED STOCK UNIT' shall mean any unit granted under Section 7 or 9 of
the Plan.
'RETIREMENT' shall mean, unless otherwise defined in the applicable Award
Agreement, the Termination of Employment of a Participant after the Participant
has fulfilled all age and service requirements for retirement under the terms of
the First Tennessee National Corporation Pension Plan, as amended from time to
time.
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'SEC' shall mean the Securities and Exchange Commission or any successor
thereto.
'SECTION 16' shall mean Section 16 of the Exchange Act and the rules
promulgated thereunder and any successor provision thereto as in effect from
time to time.
'SECTION 162(m)' shall mean Section 162(m) of the Code and the rules
promulgated thereunder or any successor provision thereto as in effect from time
to time.
'SHARES' shall mean shares of the common stock, $0.625 par value, as
adjusted from time to time for stock splits or reverse stock splits, of the
Company.
'STOCK APPRECIATION RIGHT OR SAR' shall mean a right granted under Section 6
or 9 of the Plan that entitles the holder to receive, with respect to each Share
encompassed by the exercise of such SAR, the amount determined by the Committee,
or in the case of an Award granted under Section 9 hereof, by the Board, and
specified in an Award Agreement. In the absence of such a determination, the
holder shall be entitled to receive, with respect to each Share encompassed by
the exercise of such SAR, the excess of the Fair Market Value on the date of
exercise over the Fair Market Value on the date of grant.
'SUBSIDIARY' shall mean any Person of which a majority of its voting power
or its equity securities or equity interest is owned directly or indirectly by
the Company.
'SUBSTITUTE AWARDS' shall mean Awards granted solely in assumption of, or in
substitution for, outstanding awards previously granted by a Person acquired by
the Company or with which the Company or one of its Subsidiaries combines.
'TERMINATION OF EMPLOYMENT' shall mean the termination of the
employee-employer relationship between a Participant and the Employer for any
reason, with or without Cause, including, but not by way of limitation, a
termination by resignation, discharge, death, Disability, Workforce Reduction or
Retirement, but excluding (i) terminations where there is a simultaneous
reemployment or continuing employment of the Participant by another Employer;
(ii) at the discretion of the Committee, terminations which result in a
temporary severance of the employee-employer relationship; and (iii) at the
discretion of the Committee, terminations which are followed by the simultaneous
establishment of a consulting relationship by an Employer with the Participant.
The Committee, in its absolute discretion, shall determine the effect of all
matters and questions relating to Termination of Employment, including, but not
by way of limitation, the question of whether a Termination of Employment
resulted from a discharge for Cause, and all questions of whether particular
leaves of absence constitute Terminations of Employment. However,
notwithstanding any provision of this Plan, an Employer has an absolute and
unrestricted right to terminate an Employee's employment at any time for any
reason whatsoever, with or without Cause.
'WORKFORCE REDUCTION' shall mean any termination of the employee-employer
relationship between a Participant and the Employer as a result of the
discontinuation by the Company of a business or line of business or a
realignment of the Company, or a part thereof, or any other similar type of
event, provided that the Committee or the Board has designated such
discontinuation, realignment or other event as a 'Workforce Reduction' for
purposes of this Plan.
SECTION 3 -- ADMINISTRATION
(A) Authority of Committee. Except as provided by Section 9 hereof, the Plan
shall be administered by the Committee, it being understood that the Board
retains the right to make Awards under the Plan. Subject to the terms of the
Plan and applicable law, and in addition to other express powers and
authorizations conferred on the Committee by the Plan, the Committee shall have
full power and authority in its discretion to: (i) designate Participants; (ii)
determine the type or types of Awards to be granted to a Participant; (iii)
determine the number of Shares to be covered by, or with respect to which
payments, rights, or other matters are to be calculated in connection with,
Awards; (iv) determine the timing, terms, and conditions of any Award; (v)
accelerate the time at which all or any part of an Award may be settled or
exercised; (vi) determine whether, to what extent, and under what circumstances
Awards may be settled or exercised in cash, Shares, other securities, other
Awards or other property, or canceled, forfeited, or suspended, and the method
or methods by which Awards may be settled, exercised, canceled, forfeited, or
suspended; (vii) determine whether, to what extent, and under what circumstances
cash, Shares, other securities, other Awards, other property, and other amounts
payable with respect to an Award shall be deferred either
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automatically or at the election of the holder thereof or of the Committee;
(viii) interpret and administer the Plan and any instrument or agreement
relating to, or Award made under, the Plan; (ix) amend or modify the terms of
any Award after grant; (x) establish, amend, suspend, or waive such rules and
regulations and appoint such agents as it shall deem appropriate for the proper
administration of the Plan; and (xi) make any other determination and take any
other action that the Committee deems necessary or desirable for the
administration of the Plan subject to the exclusive authority of the Board under
Section 13 hereunder to amend, suspend or terminate the Plan.
(B) Committee Discretion Binding. Unless otherwise expressly provided in the
Plan, all designations, determinations, interpretations, and other decisions
under or with respect to the Plan or any Award shall be within the sole
discretion of the Committee, may be made at any time and shall be final,
conclusive, and binding upon all Persons, including any Employer, any
Participant, any holder or beneficiary of any Award, any Employee, any
Non-Employee Director and any Regional Board Member.
(C) Action by the Committee. Except as otherwise provided by the Board, the
provisions of this Section 3(C) shall apply to the Committee. The Committee
shall select one of its members as its chairperson and shall hold its meetings
at such times and places and in such manner as it may determine. A majority of
its members shall constitute a quorum. Any decision or determination reduced to
writing and signed by all of the members of the Committee shall be fully
effective as if it had been made by a majority vote at a meeting duly called and
held. The Committee may appoint a secretary and may make such rules and
regulations for the conduct of its business, as it shall deem advisable.
(D) Delegation. Subject to the terms of the Plan, the Board or the Committee
may, to the extent permitted by law, delegate to (i) a subcommittee of the
Committee, (ii) one or more officers or managers of an Employer or (iii) a
committee of such officers or managers, the authority, subject to such terms and
limitations as the Board or the Committee shall determine, to grant Awards to,
or to cancel, modify or waive rights with respect to or to alter, discontinue,
suspend, or terminate Awards held by, Participants who are not officers or
directors of the Company for purposes of Section 16 or who are otherwise not
subject to Section 16, and who are not Covered Officers.
(E) Indemnification. No member of the Board or the Committee or any Employee
(each such person a 'Covered Person') shall have any liability to any person
(including any grantee) for any action taken or omitted to be taken or any
determination made in good faith with respect to the Plan or any Award. Each
Covered Person shall be indemnified and held harmless by the Company against and
from any loss, cost, liability, or expense (including attorneys' fees) that may
be imposed upon or incurred by such Covered Person in connection with or
resulting from any action, suit or proceeding to which such Covered Person may
be a party or in which such Covered Person may be involved by reason of any
action taken or omitted to be taken under the Plan or any Award Agreement and
against and from any and all amounts paid by such Covered Person, with the
Company's approval, in settlement thereof, or paid by such Covered Person in
satisfaction of any judgment in any such action, suit or proceeding against such
Covered Person, provided that the Company shall have the right, at its own
expense, to assume and defend any such action, suit or proceeding and, once the
Company gives notice of its intent to assume the defense, the Company shall have
sole control over such defense with counsel of the Company's choice. The
foregoing right of indemnification shall not be available to a Covered Person to
the extent that a court of competent jurisdiction in a final judgment or other
final adjudication, in either case, not subject to further appeal, determines
that the acts or omissions of such Covered Person giving rise to the
indemnification claim resulted from such Covered Person's bad faith, fraud or
willful misconduct. The foregoing right of indemnification shall not be
exclusive of any other rights of indemnification to which Covered Persons may be
entitled under the Company's Restated Charter or Bylaws, as a matter of law, or
otherwise, or any other power that the Company may have to indemnify such
persons or hold them harmless.
SECTION 4 -- SHARES AVAILABLE FOR AWARDS
(A) Shares Available. Subject to the provisions of Section 4(B) hereof, the
stock to be subject to Awards under the Plan shall be Shares and the maximum
number of Shares which may be issued with respect to Awards shall be 4,000,000,
of which no more than 1,300,000 shall be issued with respect to Awards other
than Options. If, after the effective date of the Plan, any Shares covered by an
Award granted under this Plan, or to which such an Award relates, are forfeited,
or if such an Award is settled for cash or
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otherwise terminates, expires unexercised, or is canceled without the delivery
of Shares, then the Shares covered by such Award, or to which such Award
relates, or the number of Shares otherwise counted against the aggregate number
of Shares which may be issued with respect to Awards, to the extent of any such
settlement, forfeiture, termination, expiration, or cancellation, shall again
become Shares which may be issued with respect to Awards. In the event that any
Option or other Award granted hereunder is exercised through the delivery of
Shares by the Participant or in the event that withholding tax liabilities
arising from such Award are satisfied by the withholding of Shares by the
Company from the total number of Shares that otherwise would have been delivered
to the Participant, the number of Shares which may be issued with respect to
Awards shall be increased by the number of Shares so surrendered or withheld.
Notwithstanding the foregoing and subject to adjustment as provided in Section
4(B) hereof, the number of Shares with respect to which Options and SARs may be
granted to any one Participant in any one calendar year shall be no more than
500,000 Shares.
(B) Adjustments. The number of Shares covered by each outstanding Award, the
number of Shares available for Awards, the number of Shares that may be subject
to Awards to any one Participant, and the price per Share covered by each such
outstanding Award shall be proportionately adjusted for any increase or decrease
in the number of issued Shares resulting from a stock split, reverse stock
split, stock dividend, recapitalization, combination or reclassification of the
Shares, and may be proportionately adjusted, as determined in the sole
discretion of the Board, for any other increase or decrease in the number of
issued Shares effected without receipt of consideration by the Company or to
reflect any distributions to holders of Shares other than regular cash
dividends. Except as expressly provided herein, no issuance by the Company of
shares of stock of any class, or securities convertible into shares of stock of
any class, shall affect, and no adjustment by reason thereof shall be made with
respect to, the number or price of Shares subject to an Award. After any
adjustment made pursuant to this paragraph, the number of Shares subject to each
outstanding Award shall be rounded to the nearest whole number.
(C) Substitute Awards. Any Shares issued by the Company as Substitute Awards
shall not reduce the Shares available for Awards under the Plan.
(D) Sources of Shares Deliverable Under Awards. Any Shares delivered
pursuant to an Award may consist, in whole or in part, of authorized and
unissued Shares or of issued Shares which have been reacquired by the Company.
SECTION 5 -- ELIGIBILITY
Any Employee (including any officer or employee-director of an Employer),
Non-Employee Director or Regional Board Member shall be eligible to be
designated a Participant; provided, however, that Non-Employee Directors shall
only be eligible to receive Awards granted pursuant to Section 9 hereof.
SECTION 6 -- STOCK OPTIONS AND STOCK APPRECIATION RIGHTS
(A) Grant. Except as provided by Sections 3 and 9 hereof, the Committee
shall have sole and complete authority to determine the Participants to whom
Options and SARs shall be granted, the number of Shares subject to each Award,
the exercise price and the conditions and limitations applicable to the exercise
of Options and SARs. A person who has been granted an Option or SAR under this
Plan may be granted additional Options or SARs under the Plan if the Committee
shall so determine.
(B) Option Price. The Committee, in its sole discretion, shall establish the
Option Price at the time each Option is granted. Except in the case of
Substitute Awards, the Option Price of an Option may not be less than 100% of
the Fair Market Value of the Shares with respect to which the Option is granted
on the date of grant of such Option. Notwithstanding the prior sentence, the
Option Price of an Option may be less than 100% of the Fair Market Value of the
Shares with respect to which the Option is granted on the date of grant of such
Option if (i) the grantee of the Option has entered into an agreement with the
Company pursuant to which the grant of the Option is in lieu of the payment of
compensation and (ii) the amount of such compensation when added to the Option
Price of the Option equals at least 100% of the Fair Market Value of the Shares
with respect to which the Option is granted on the date of grant of such Option.
Notwithstanding the foregoing and except as provided by Sections 4(B) and 13(C)
hereof, the Committee shall not have the power to (i) amend the terms of
previously granted Options to reduce the Option Price of
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such Options, or (ii) cancel such Options and grant substitute Options with a
lower Option Price than the cancelled Options, without shareholder approval.
(C) Term. Subject to the Committee's authority under Section 3(A) hereof,
each Option and SAR and all rights and obligations thereunder shall expire on
the date determined by the Committee and specified in the Award Agreement. The
Committee shall be under no duty to provide terms of like duration for Options
or SARs granted under the Plan. Notwithstanding the foregoing, no Option shall
be exercisable after the expiration of ten (10) years from the date such Option
was granted.
(D) Transfer Restrictions. Except as otherwise provided in this Section
6(D), no Option shall be sold, assigned, transferred, pledged, hypothecated or
otherwise encumbered, hedged or disposed of, in any manner, whether voluntarily
or involuntarily, including by operation of law (other than by will or the laws
of descent and distribution). The Committee may in its discretion permit the
transfer of an Option by a Participant to or for the benefit of the
Participant's Immediate Family (including, without limitation, to a trust for
the benefit of the Participant's Immediate Family or to a partnership or limited
liability company for one or more members of the Participant's Immediate
Family), subject to such limits as the Committee may establish, and the
transferee shall remain subject to all the terms and conditions applicable to
the Option prior to such transfer. The foregoing right to transfer the Option
shall apply to the right to consent to amendments to any Award Agreement
evidencing such Option and, in the discretion of the Committee, shall also apply
to the right to transfer ancillary rights associated with the Option. For
purposes of this paragraph, the term 'Immediate Family' shall mean the
Participant's spouse, parents, children, stepchildren, adopted relations,
sisters, brothers, grandchildren and step-grandchildren.
(E) Exercise.
(i) Each Option and SAR shall be exercisable at such times and subject
to such terms and conditions as the Committee may, in its sole discretion,
specify in the applicable Award Agreement or thereafter. The Committee shall
have full and complete authority to determine whether an Option or SAR will
be exercisable in full at any time or from time to time during the term of
the Option or SAR, or to provide for the exercise thereof in such
installments, upon the occurrence of such events and at such times during
the term of the Option or SAR as the Committee may determine.
(ii) The Committee may impose such conditions with respect to the
exercise of Options, including without limitation, any relating to the
application of federal, state or foreign securities laws or the Code, as it
may deem necessary or advisable. The exercise of any Option granted
hereunder shall be effective only at such time as the sale of Shares
pursuant to such exercise will not violate any state or federal securities
or other laws, as determined by the Committee in its sole discretion.
(iii) An Option or SAR may be exercised in whole or in part at any time,
with respect to whole Shares only, within the period permitted thereunder
for the exercise thereof, and shall be exercised by written notice of intent
to exercise the Option or SAR, delivered to the Company at its principal
office, and payment in full to the Company at said office of the amount of
the Option Price for the number of Shares with respect to which the Option
is then being exercised.
(iv) Payment of the Option Price shall be made in cash or cash
equivalents, or, at the discretion of the Committee, (i) by tendering,
either by way of actual delivery of Shares or attestation, whole Shares that
have been owned by the Option holder for not less than six (6) months, if
acquired directly from the Company, or that have been owned for any period
of time, if acquired on the open market, prior to the date of exercise,
valued at the Fair Market Value of such Shares on the date of exercise,
together with any applicable withholding taxes, (ii) by a combination of
such cash (or cash equivalents) and such Shares or (iii) by such other
method of exercise as may be permitted from time to time by the Committee;
provided, however, that the optionee shall not be entitled to tender Shares
pursuant to successive, substantially simultaneous exercises of an Option or
any other stock option of the Company. Subject to applicable securities laws
and at the discretion of the Committee, an Option may also be exercised by
delivering a notice of exercise of the Option and simultaneously selling the
Shares thereby acquired, pursuant to a brokerage or similar agreement or
program approved in advance by the Committee. Until the optionee has been
issued the Shares subject to such exercise, he or she shall possess no
rights as a shareholder with respect to such Shares and shall not be
entitled to any dividend or distribution the record date of which is prior
to the date of issuance of such Shares. At the
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Committee's discretion, the amount payable as a result of the exercise of an
SAR may be settled in cash, Shares, or a combination of cash and Shares. A
fractional Share shall not be deliverable upon the exercise of a SAR but a
cash payment will be made in lieu thereof.
(v) Notwithstanding anything in this Plan to the contrary, a Participant
shall be required to pay to the Company an amount equal to the spread
realized in connection with the Participant's exercise of an Option within
six months prior to such Participant's termination of employment by
resignation in the event that such Participant, within six months following
such Participant's termination of employment by resignation, engages
directly or indirectly in any activity determined by the Committee, in its
sole discretion, to be competitive with any activity of the Company or any
of its Subsidiaries. This subsection (v) shall be void and of no legal
effect upon a Change in Control.
SECTION 7 -- RESTRICTED STOCK AND RESTRICTED STOCK UNITS
(A) Grant.
(i) Except as provided by Sections 3 and 9 hereof, the Committee shall
have sole and complete authority to determine the Participants to whom
Restricted Stock and Restricted Stock Units shall be granted, the number of
shares of Restricted Stock and/or the number of Restricted Stock Units to be
granted to each Participant, the duration of the period during which, and
the conditions under which, the Restricted Stock and Restricted Stock Units
may be forfeited to the Company, and the other terms and conditions of such
Awards. The Restricted Stock and Restricted Stock Unit Awards shall be
evidenced by Award Agreements in such form as the Committee shall from time
to time approve, which agreements shall comply with and be subject to the
terms and conditions provided hereunder and any additional terms and
conditions established by the Committee that are consistent with the terms
of the Plan.
(ii) Each Restricted Stock or Restricted Stock Unit Award made under the
Plan shall be for such number of Shares as shall be determined by the
Committee and set forth in the agreement containing the terms of such
Restricted Stock or Restricted Stock Unit Award. Such agreement shall set
forth a period of time during which the grantee must remain in the
continuous employment of one or more Employers in order for the forfeiture
and transfer restrictions to lapse. If the Committee so determines, the
restrictions may lapse during such restricted period in installments with
respect to specified portions of the Shares covered by the Restricted Stock
or Restricted Stock Unit Award. The agreement may also, in the discretion of
the Committee, set forth performance or other conditions that, if satisfied,
will result in the lapsing of any applicable forfeiture and transfer
restrictions. The Committee may, at its discretion, waive all or any part of
the restrictions applicable to any or all outstanding Restricted Stock and
Restricted Stock Unit Awards.
(B) Delivery of Shares and Transfer Restrictions. The Company may implement
the grant of a Restricted Stock Award by (i) book-entry issuance of Shares to
the Participant in an account maintained by the Company at its transfer agent or
(ii) delivery of certificates for Shares to the Participant who must execute
appropriate stock powers in blank and return the certificates and stock powers
to the Company. Such certificates and stock powers shall be held by the Company
or any custodian appointed by the Company for the account of the grantee subject
to the terms and conditions of the Plan, and the certificate shall bear such a
legend setting forth the restrictions imposed thereon as the Committee, in its
discretion, may determine. Unless otherwise determined by the Committee, the
grantee shall have all rights of a shareholder with respect to the shares of
Restricted Stock, including the right to receive dividends and the right to vote
such Shares, subject to the following restrictions: (i) in the case of
certificated Shares, the grantee shall not be entitled to delivery of the stock
certificate until the expiration of the restricted period and the fulfillment of
any other restrictive conditions set forth in the Award Agreement with respect
to such Shares; (ii) none of the Shares may be sold, assigned, transferred,
pledged, hypothecated or otherwise encumbered, hedged or disposed of, in any
manner, whether voluntarily or involuntarily, including by operation of law
(other than by will or the laws of descent and distribution) until the
expiration of the restricted period and the fulfillment of any other restrictive
conditions set forth in the Award Agreement with respect to such Shares; and
(iii) except as otherwise determined by the Committee, all of the Shares shall
be forfeited and all rights of the grantee to such Shares shall terminate,
without further obligation on the part of the Company, unless the grantee
remains in the continuous employment of one or more Employers
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for the entire restricted period in relation to which such Shares were granted
and unless any other restrictive conditions relating to the Restricted Stock
Award are met. Any Shares, any other securities of the Company and any other
property (except for cash dividends) distributed with respect to the Shares
subject to Restricted Stock Awards shall be subject to the same restrictions,
terms and conditions as such Restricted Stock.
(C) Termination of Restrictions. At the end of the restricted period and
provided that any other restrictive conditions of the Restricted Stock Award are
met, or at such earlier time as otherwise determined by the Committee, all
restrictions set forth in the Award Agreement relating to the Restricted Stock
Award or in the Plan shall lapse as to the restricted Shares subject thereto,
and, if certificated, a stock certificate for the appropriate number of Shares,
free of the restrictions and restricted stock legend imposed thereon by the
Committee as described in the second sentence of Subsection (B) of this Section
7, shall be delivered to the Participant or the Participant's beneficiary or
estate, as the case may be.
(D) Payment of Restricted Stock Units. Each Restricted Stock Unit shall have
a value equal to the Fair Market Value of a Share. Restricted Stock Units shall
be paid in cash, Shares, other securities or other property, as determined in
the sole discretion of the Committee, upon the lapse of the restrictions
applicable thereto, or otherwise in accordance with the applicable Award
Agreement. The Committee may, in its sole and absolute discretion, credit
Participants with dividend equivalents on any Restricted Stock Units credited to
the Participant's account at the time of any payment of dividends to
shareholders on Shares. The amount of any such dividend equivalents shall equal
the amount that would have been payable to the Participant as a shareholder in
respect of a number of Shares equal to the number of Restricted Stock Units then
credited to him. Any such dividend equivalents shall be credited to the
Participant's account as of the date on which such dividend would have been
payable and shall be converted into additional Restricted Stock Units based upon
the Fair Market Value of a Share on the date of such crediting. Restricted Stock
Units may not be sold, assigned, transferred, pledged, hypothecated or otherwise
encumbered, hedged or disposed of, in any manner, whether voluntarily or
involuntarily, including by operation of law (other than by will or the laws of
descent and distribution) until the expiration of the applicable restricted
period and the fulfillment of any other restrictive conditions relating to the
Restricted Stock Unit Award. Except as otherwise determined by the Committee,
all Restricted Stock Units and all rights of the grantee to such Restricted
Stock Units shall terminate, without further obligation on the part of the
Company, unless the grantee remains in continuous employment of one or more
Employers for the entire restricted period in relation to which such Restricted
Stock Units were granted and unless any other restrictive conditions relating to
the Restricted Stock Unit Award are met.
SECTION 8 -- PERFORMANCE AWARDS
(A) Grant. The Committee shall have sole and complete authority to determine
the Participants who shall receive a Performance Award, which shall consist of a
right that is (i) denominated in cash and/or Shares, (ii) valued, as determined
by the Committee, in accordance with the achievement of such performance goals
during such performance periods as the Committee shall establish, and (iii)
payable at such time and in such form as the Committee shall determine. The
Committee may, in its sole and absolute discretion, designate whether any
Performance Award being granted to any Participant is intended to be
'performance-based compensation' as that term is used in Section 162(m). Any
Performance Awards designated by the Committee as 'performance-based
compensation' shall be subject to the terms and provisions of Section 10 hereof.
(B) Terms and Conditions. Subject to the terms of the Plan, the Committee
shall determine the performance goals to be achieved during any performance
period, the length of any performance period, the amount of any Performance
Award and the amount and kind of any payment or transfer to be made pursuant to
any Performance Award, and may change specific provisions of the Performance
Award, provided, however, that such change may not adversely affect existing
Performance Awards made within a performance period commencing prior to
implementation of the change.
(C) Payment of Performance Awards. Performance Awards may be paid in a lump
sum or in installments following the close of the performance period or, in
accordance with the procedures established by the Committee, on a deferred
basis. If a Participant ceases to be employed by any Employer during a
performance period because of death, Disability, Retirement or other
circumstance in which the Committee
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in its discretion finds that a waiver would be appropriate, that Participant, as
determined by the Committee, may be entitled to a payment of a Performance
Award, or a portion thereof, at the end of the performance period; provided,
however, that the Committee may provide for an earlier payment in settlement of
such Performance Award in such amount and under such terms and conditions as the
Committee deems appropriate or desirable. Unless otherwise determined by the
Committee, Termination of Employment prior to the end of any performance period
will result in the forfeiture of the Performance Award, and no payments will be
made. A Participant's rights to any Performance Award may not be sold, assigned,
transferred, pledged, hypothecated or otherwise encumbered, hedged or disposed
of in any manner, whether voluntarily or involuntarily, including by operation
of law (other than by will or the laws of descent and distribution).
SECTION 9 -- NON-EMPLOYEE DIRECTOR AWARDS
The Board may provide that all or a portion of a Non-Employee Director's
annual retainer and/or meeting fees, or other forms of compensation, be payable
(either automatically or at the election of a Non-Employee Director) in the form
of Options, SARs, Restricted Stock or Restricted Stock Units. The Board shall
determine the terms and conditions of any such Awards, including the terms and
conditions which shall apply upon a termination of the Non-Employee Director's
service as a member of the Board, and shall have full power and authority in its
discretion to administer such Awards, subject to the terms of the Plan and
applicable law.
SECTION 10 -- PROVISIONS APPLICABLE TO COVERED OFFICERS AND PERFORMANCE-BASED
AWARDS
Notwithstanding anything in the Plan to the contrary, unless the Committee
determines otherwise, all performance-based Restricted Stock Awards, Restricted
Stock Unit Awards or Performance Awards shall be subject to the terms and
provisions of this Section 10.
(A) Restricted Stock Awards, Restricted Stock Unit Awards and Performance
Awards to Covered Officers shall vest or become exercisable upon the attainment
of performance targets related to one or more performance goals selected by the
Committee from among the goals specified below. For the purposes of this Section
10, performance goals shall be limited to one or a combination of the following
Employer, operating unit, division, line of business, department, team or
business unit financial performance measures: stock price; dividends; total
shareholder return; earnings per share; price/earnings ratio; market
capitalization; book value; revenues; expenses; loans; deposits; non-interest
income; net interest income; fee income; operating income before or after taxes;
net income before or after taxes; net income before securities transactions; net
or operating income excluding non-recurring charges; return on assets; return on
equity; return on capital; cash flow; credit quality; service quality; market
share; customer retention; efficiency ratio; strategic business objectives,
consisting of one or more objectives based on meeting specified cost targets,
business expansion goals and goals relating to acquisitions or divestitures;
and, except in the case of a Covered Officer, any other performance criteria
established by the Committee. Each goal may be expressed on an absolute and/or
relative basis, may be based on or otherwise employ comparisons based on
internal targets, the past performance of the Company (consolidated or
unconsolidated) and/or the past or current performance of other companies, the
performance of other companies over one or more years or an index of the
performance of other companies, markets or economic metrics over one or more
years, and in the case of earnings-based measures, may use or employ comparisons
relating to capital, shareholders' equity and/or Shares outstanding, or to
assets or net assets.
(B) The maximum annual number of Shares in respect of which all
performance-based Restricted Stock Awards, Restricted Stock Unit Awards and
Performance Awards may be granted to a Participant under the Plan is 100,000 and
the maximum annual amount of any Awards settled in cash to a Participant under
the Plan is $4,000,000.
(C) To the extent necessary to comply with Section 162(m), with respect to
performance-based Restricted Stock Awards, Restricted Stock Unit Awards and
Performance Awards, no later than 90 days following the commencement of each
performance period (or such other time as may be required or permitted by
Section 162(m)), the Committee shall, in writing, (1) select the performance
goal or goals applicable to the performance period, (2) establish the various
targets and bonus amounts which may be earned for such performance period, and
(3) specify the relationship between performance goals and targets
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and the amounts to be earned by each Covered Officer for such performance
period. Following the completion of each performance period, the Committee shall
certify in writing whether the applicable performance targets have been achieved
and the amounts, if any, payable to Covered Officers for such performance
period. In determining the amount earned by a Covered Officer for a given
performance period, subject to any applicable Award Agreement, the Committee
shall have the right to reduce (but not increase) the amount payable at a given
level of performance to take into account additional factors that the Committee
may deem relevant to the assessment of individual or corporate performance for
the performance period.
SECTION 11 -- TERMINATION OF EMPLOYMENT
The Committee shall have the full power and authority to determine the terms
and conditions that shall apply to any Award upon a Termination of Employment
and shall provide such terms in the Award Agreement. Notwithstanding the
foregoing and subject to the limitation contained in the last sentence of
Section 6(c) hereof, upon the Termination of Employment as a result of a
Workforce Reduction of an Employee who has received an Award of Options, such
Options shall expire on the date specified by the Committee at the time of the
Termination of Employment, not to exceed five (5) years after the date of such
Termination of Employment.
SECTION 12 -- CHANGE IN CONTROL
Upon a Change in Control, all outstanding Awards shall vest, become
immediately exercisable or payable or have all restrictions lifted, as the case
may be.
SECTION 13 -- AMENDMENT, SUSPENSION AND TERMINATION
(A) Termination, Suspension or Amendment of the Plan. The Board may amend,
alter, modify, suspend, discontinue, or terminate the Plan or any portion
thereof at any time, except that the Board shall not amend the Plan in violation
of law. No such amendment, alteration, modification, suspension, discontinuation
or termination shall materially and adversely affect any right acquired by any
Participant or beneficiary of a Participant under the terms of an Award granted
before the date of such amendment, alteration, modification, suspension,
discontinuation or termination, unless such Participant or beneficiary shall
consent.
(B) Termination, Suspension or Amendment of Awards. Subject to the
restrictions of Section 6(B) hereof, the Committee may waive any conditions or
rights under, amend any terms of, or modify, alter, suspend, discontinue, cancel
or terminate, any Award theretofore granted, prospectively or retroactively;
provided that any such waiver, amendment, modification, alteration, suspension,
discontinuance, cancellation or termination that would materially and adversely
affect the rights of any Participant or any holder or beneficiary of any Award
theretofore granted shall not to that extent be effective without the consent of
the affected Participant, holder, or beneficiary; provided, however, that it
shall be conclusively presumed that any adjustment for changes in capitalization
as provided in Section 4 hereof does not materially and adversely affect any
such rights.
(C) Adjustments of Awards Upon the Occurrence of Certain Unusual or
Nonrecurring Events. The Committee is hereby authorized to make adjustments in
the terms and conditions of, and the criteria included in, Awards in recognition
of unusual or nonrecurring events (including, without limitation, the events
described in Section 4(B) hereof) affecting the Company, any Subsidiary, or the
financial statements of the Company or any Subsidiary, or of changes in
applicable laws, regulations, or accounting principles, whenever the Committee
is required to make such adjustments pursuant to section 4(B) hereof or whenever
the Board, in its sole discretion, determines that such adjustments are
appropriate in order to prevent dilution or enlargement of the benefits or
potential benefits intended to be made available under the Plan; provided that,
with respect to Awards intended to comply with Section 162(m), no such
adjustment shall be authorized to the extent that such authority would be
inconsistent with having either the Plan or any Awards granted hereunder meeting
the requirements of Section 162(m).
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SECTION 14 -- GENERAL PROVISIONS
(A) Dividend Equivalents. In the sole and complete discretion of the
Committee, an Award (other than an Option) may provide the Participant with
dividends or dividend equivalents, payable in cash, Shares, other securities or
other property on a current or deferred basis. All dividend or dividend
equivalents which are not paid currently may, at the Committee's discretion,
accrue interest, be reinvested into additional Shares, or in the case of
dividends or dividend equivalents credited in connection with Performance
Awards, be credited as additional Performance Awards and paid to the Participant
if and when, and to the extent that, payment is made pursuant to such Award. The
total number of Shares available for Awards under Section 4 hereof shall not be
reduced to reflect any dividends or dividend equivalents that are reinvested
into additional Shares or credited as Performance Awards.
(B) No Rights to Awards. No Person shall have any claim to be granted any
Award, and there is no obligation for uniformity of treatment of Employees,
Non-Employee Directors, Regional Board Members or holders or beneficiaries of
Awards. The terms and conditions of Awards need not be the same with respect to
each recipient.
(C) Share Certificates. All certificates for Shares or other securities of
the Company or any Subsidiary delivered under the Plan pursuant to any Award or
the exercise thereof shall be subject to such stop transfer orders and other
restrictions as the Committee may deem advisable under the Plan or the rules,
regulations, and other requirements of the SEC, any stock exchange upon which
such Shares or other securities are then listed, and any applicable federal,
state or foreign laws, and the Committee may cause a legend or legends to be put
on any such certificates to make appropriate reference to such restrictions.
(D) Withholding. A Participant may be required to pay to an Employer, and
each Employer shall have the right and is hereby authorized to withhold from any
Award, from any payment due or transfer made under any Award or under the Plan
or from any compensation or other amount owing to a Participant, the amount (in
cash, Shares, other securities, other Awards or other property) of any
applicable withholding or other taxes in respect of an Award, its exercise, or
any payment or transfer under an Award or under the Plan and to take such other
action as may be necessary in the opinion of the Company to satisfy all
obligations for the payment of such taxes.
(E) Award Agreements. Each Award hereunder shall be evidenced by an Award
Agreement that shall specify the terms and conditions of the Award and any rules
applicable thereto. An Award shall be effective only upon delivery to a
Participant, either electronically or by paper means, of an Award Agreement. In
the event of a conflict between the terms of the Plan and any Award Agreement,
the terms of the Plan shall prevail.
(F) No Limit on Other Compensation Arrangements. Nothing contained in the
Plan shall prevent the Company or any Subsidiary from adopting or continuing in
effect other compensation arrangements, which may, but need not, provide for the
grant of Options, Restricted Stock, Shares and other types of Awards provided
for hereunder.
(G) No Right to Employment. The grant of an Award shall not be construed as
giving a Participant the right to be retained in the employ of any Employer.
Further, an Employer may at any time dismiss a Participant from employment, free
from any liability or any claim under the Plan, unless otherwise expressly
provided in the Plan or in any Award Agreement.
(H) No Rights as Shareholder. Subject to the provisions of the applicable
Award, no Participant or holder or beneficiary of any Award shall have any
rights as a shareholder with respect to any Shares to be distributed under the
Plan until such Shares are issued to such Participant, holder or beneficiary and
shall not be entitled to any dividend or distribution the record date of which
is prior to the date of such issuance.
(I) Governing Law. The validity, construction, and effect of the Plan and
any rules and regulations relating to the Plan and any Award Agreement shall be
determined in accordance with the laws of the State of Tennessee without giving
effect to the conflict of law principles thereof.
(J) Severability. If any provision of the Plan or any Award is, or becomes,
or is deemed to be, invalid, illegal, or unenforceable in any jurisdiction or as
to any Person or Award, or would disqualify the Plan or any Award under any law
deemed applicable by the Committee, such provision shall be construed or deemed
amended to conform to the applicable laws, or if it cannot be construed or
deemed amended
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without, in the determination of the Committee, materially altering the intent
of the Plan or the Award, such provision shall be stricken as to such
jurisdiction, Person or Award and the remainder of the Plan and any such Award
shall remain in full force and effect.
(K) Other Laws. The Committee may refuse to issue or transfer any Shares or
other consideration under an Award if, acting in its sole discretion, it
determines that the issuance or transfer of such Shares or such other
consideration might violate any applicable law or regulation (including
applicable non-U.S. laws or regulations) or entitle the Company to recover the
same under Section 16(b) of the Exchange Act, and any payment tendered to the
Company by a Participant, other holder or beneficiary in connection with the
exercise of such Award shall be promptly refunded to the relevant Participant,
holder, or beneficiary. Without limiting the generality of the foregoing, no
Award granted hereunder shall be construed as an offer to sell securities of the
Company, and no such offer shall be outstanding, unless and until the Committee
in its sole discretion has determined that any such offer, if made, would be in
compliance with all applicable requirements of the U.S. federal or non-U.S.
securities laws and any other laws to which such offer, if made, would be
subject.
(L) No Trust or Fund Created. Neither the Plan nor any Award shall create or
be construed to create a trust or separate fund of any kind or a fiduciary
relationship between the Company or any Subsidiary and a Participant or any
other Person. To the extent that any Person acquires a right to receive payments
from the Company or any Subsidiary pursuant to an Award, such right shall be no
greater than the right of any unsecured general creditor of the Company or any
Subsidiary.
(M) No Fractional Shares. No fractional Shares shall be issued or delivered
pursuant to the Plan or any Award, and the Committee shall determine whether
cash, other securities, or other property shall be paid or transferred in lieu
of any fractional Shares or whether such fractional Shares or any rights thereto
shall be canceled, terminated or otherwise eliminated.
(N) Headings. Headings are given to the Sections and subsections of the Plan
solely as a convenience to facilitate reference. Such headings shall not be
deemed in any way material or relevant to the construction or interpretation of
the Plan or any provision thereof.
(O) Binding Effect. The terms of the Plan shall be binding upon the Company
and its successors and assigns and the Participants and their legal
representatives, and shall bind any successor of the Company (whether direct or
indirect, by purchase, merger, consolidation or otherwise), in the same manner
and to the same extent that the Company would be obligated under this Plan if no
succession had taken place. In the case of any transaction in which a successor
would not by the foregoing provision or by operation of law be bound by this
Plan, the Company shall require such successor expressly and unconditionally to
assume and agree to perform the Company's obligations hereunder, in the same
manner and to the same extent that the Company would be required to perform if
no such succession had taken place.
(P) No Third Party Beneficiaries. Except as expressly provided herein or
therein, neither the Plan nor any Award Agreement shall confer on any person
other than the Company and the grantee of any Award any rights or remedies
hereunder or thereunder. The exculpation and indemnification provisions of
Section 3(E) shall inure to the benefit of a Covered Person's estate and
beneficiaries and legatees.
(Q) Additional Transfer Restrictions. No transfer or an Award by a grantee
by will or by laws of descent and distribution shall be effective to bind the
Company unless the Company shall have been furnished with written notice thereof
and an authenticated copy of the will and/or such other evidence as the
Committee may deem necessary to establish the validity of the transfer.
SECTION 15 -- TERM OF THE PLAN
(A) Effective Date. The Plan shall be effective as of the date it has been
approved by the Company's shareholders (the 'Effective Date').
(B) Expiration Date. No new Awards shall be granted under the Plan after the
tenth (10th) anniversary of the Effective Date. Unless otherwise expressly
provided in the Plan or in an applicable Award Agreement, any Award granted
hereunder may, and the authority of the Board or the Committee to amend, alter,
modify, adjust, suspend, discontinue, or terminate any such Award or to waive
any conditions or rights under any such Award shall, continue after the
authority for grant of new Awards hereunder has been exhausted.
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APPENDIX B
FIRST TENNESSEE NATIONAL CORPORATION
CORPORATE GOVERNANCE GUIDELINES
(AMENDED AND RESTATED JANUARY 20, 2004)
I. INTRODUCTION
The Board, on the recommendation of its Human Resources Committee (which was
acting as the Company's corporate governance committee prior to the
establishment by the Board of a separate Nominating and Corporate Governance
Committee in January of 2004), has developed and adopted a set of corporate
governance principles to provide directors with guidance as to their legal
accountabilities, to promote the functioning of the Board and its committees and
to set forth a common set of expectations as to how the Board should perform its
functions. The Board's role is to oversee management, and it retains the
decisive voice on certain major corporate actions. The following principles
include existing policies, procedures and practices of the Company, many of
which have been in place or evolved over a number of years.
Nine functions have been identified as central to the role and function of
the Board or its committees. These functions are as follows:
Oversight of the conduct of the business.
Selection, evaluation, compensation and succession of Chief Executive
Officer and other executive officers, and the periodic review of
personnel policies.
Approval of major corporate plans and strategies, policies, decisions,
contracts (including certain acquisitions and divestitures) and other
actions legally required of the Board or, in the determination of the
Board, appropriate for its consideration.
Selection, compensation, and tenure of members of the Board and Board
meeting guidelines.
Establishment of Board committees, their duties and membership.
Oversight of financial performance and condition.
Oversight of corporate legal and ethical conduct.
Requirement of appropriate flow of information from management to the
Board for the purpose of keeping Board informed and providing an
appropriate basis for decision-making.
Performance of such other functions as may be prescribed by law or
assigned to the Board under the Charter, Bylaws or other appropriate
document.
It is recognized that the role and many of the functions of the Board are
evolving and may in the future be altered to reflect changes that occur, such as
in the Company's culture, management style, size, industry and applicable legal
and regulatory environment.
II. BOARD COMPOSITION
The composition of the Board should balance the following goals:
A majority of the Board will consist of directors who are
'independent' under the listing standards of the New York Stock
Exchange, Inc.
The composition of the Board should encompass a broad range of skills,
expertise, industry knowledge, diversity and contacts relevant to the
Company's business.
The size of the Board should facilitate substantive discussions of the
whole Board in which each director can participate meaningfully.
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III. SELECTION OF CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER
The Board is free to select its Chairman and the Company's Chief Executive
Officer in the manner it considers in the best interests of the Company at any
given point in time. These positions may be filled by one individual or by two
different individuals. Generally, it has been our practice to consolidate these
positions because the Board believes that this facilitates the execution of the
Company's strategy.
IV. SELECTION OF DIRECTORS
Nominations. The Board is responsible for selecting the nominees for
election to the Company's Board of Directors. The Company's Nominating and
Corporate Governance Committee is responsible, with input from the Chairman of
the Board and the Chief Executive Officer, for recommending to the Board
nominees for the class of directors whose term expires at the next annual
meeting of the shareholders or one or more nominees to fill vacancies occurring
between annual meetings of shareholders. The Nominating and Corporate Governance
Committee will discuss and evaluate possible candidates in detail and suggest
individuals to explore in more depth. Once a candidate is identified whom the
Nominating and Corporate Governance Committee wants to seriously consider and
move toward nomination, the Chairman of the Board, the Chief Executive Officer
and/or other directors as the Nominating and Corporate Governance Committee
determines will enter into a discussion with that nominee. The Nominating and
Corporate Governance Committee will consider nominees recommended by
shareholders, and any such nominee is given appropriate consideration in the
same manner as other nominees. Shareholders who wish to submit nominees for
director for consideration by the Nominating and Corporate Governance Committee
for election may do so by submitting in writing such nominees' names in
compliance with the procedures and along with the other information required by
the Company's By-laws, to the Chairperson of the Nominating and Corporate
Governance Committee, in care of the Corporate Secretary.
Criteria. The Board should, based on the recommendation of the Nominating
and Corporate Governance Committee, select new nominees for the position of
independent director considering the following criteria:
Personal qualities and characteristics, experience, accomplishments
and reputation in the business community.
Current knowledge and contacts in the communities in which the Company
does business and in the Company's industry or other industries
relevant to the Company's business.
Diversity of viewpoints, background, experience and other
demographics.
Ability and willingness to commit adequate time to Board and
committee matters.
The fit of the individual's skills and personality with those of other
directors and potential directors in building a Board that is
effective and responsive to its duties and responsibilities.
The Nominating and Corporate Governance Committee does not set specific,
minimum qualifications that nominees must meet in order for the Nominating and
Corporate Governance Committee to recommend them to the Board of Directors, but
rather believes that each nominee should be evaluated based on his or her
individual merits, taking into account the needs of the Company and the
composition of the Board of Directors.
Invitation. The invitation to join the Board should be extended by the Board
itself via the Chairman of the Board and the Chief Executive Officer of the
Company, together with an independent director.
Orientation and Continuing Education. Management, working with the Board,
will provide an orientation process for new directors, including background
material on the Company, its business plan and its risk profile, and meetings
with senior management. Periodically, management should prepare additional
materials or educational sessions for the directors on matters relevant to the
Company, its business plan and risk profile.
V. BOARD TENURE
The Board does not believe it should establish term limits, but believes it
is important to monitor overall Board performance. A director who would be age
65 or older at the time of election shall not stand for re-election. In
addition, to maintain a Board of active business and professional persons,
directors leaving the
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occupation or position held at their last election (by retirement or otherwise)
will be expected to tender their resignation for consideration at the next
regularly scheduled meeting of the Board. A resignation will be accepted unless
the Board in its judgment determines the director has assumed another position
deemed to be appropriate, or the director is so engaged in a specific project
for the Board as to make the resignation detrimental to the Company, or it is
beneficial to the Board and in the best interests of the Company for the
director to continue for such period of time as the Board deems appropriate.
VI. BOARD AND COMMITTEE MEETINGS
The Board currently plans at least four meetings each year, with further
meetings to occur (or action to be taken by unanimous written consent) at the
discretion of the Board or Chairman of the Board. The committees have their own
meeting schedules appropriate for the accomplishment of the duties assigned to
them, which include meetings held on the day before or the day of the Board
meeting and at such other times as the committee shall determine.
The agenda for each Board meeting will be developed by the Chairman of the
Board in conjunction with the Office of the Corporate Secretary. In addition, at
each regularly scheduled Board meeting, the Chairman will solicit agenda items
for the upcoming meeting from the directors. Management will seek to provide to
all directors an agenda and appropriate materials in advance of meetings,
although the Board recognizes that this will not always be consistent with the
timing of transactions and the operations of the business and that in certain
cases it may not be possible.
Materials presented to the Board or its committees should be as concise as
possible, while still providing the desired information needed for the directors
to make an informed judgment.
VII. EXECUTIVE SESSIONS
To ensure free and open discussion and communication among the
non-management directors of the Board, the non-management directors will meet in
regularly scheduled executive sessions and as often as the Board shall request,
with no members of management present. In addition, if any non-management
directors are not 'independent' under NYSE listing standards, the independent,
non-management directors will meet in executive session at least once a year.
The Chairperson of the Nominating and Corporate Governance Committee will
preside at the executive sessions, and his or her name will be disclosed in the
Company's annual proxy statement to facilitate communication by employees and
shareholders directly with the non-management directors.
VIII. THE COMMITTEES OF THE BOARD
The Company shall have an Executive Committee and at least the committees
required by the rules of the New York Stock Exchange, Inc. Currently, these are
the Audit Committee, the Compensation Committee and the Nominating and Corporate
Governance Committee, each of which must have a written charter satisfying the
rules of the New York Stock Exchange, Inc.
All directors, whether members of a committee or not, are invited to make
suggestions to a committee chairperson for additions to the agenda of his or her
committee or to request that an item from a committee agenda be considered by
the Board. Each committee chairperson will give a periodic report of committee
activities to the Board.
Each of the Audit Committee, the Compensation Committee and the Nominating
and Corporate Governance Committee shall be composed of at least three directors
who are not officers or employees of the Company, who the Board has determined
are 'independent' under the listing standards of the New York Stock Exchange,
Inc. The required qualifications for the members of each committee shall be set
out in the respective committees' charters. A director may serve on more than
one committee for which he or she qualifies.
IX. MANAGEMENT SUCCESSION
At least annually, the Board shall review and concur in a succession plan,
developed by management, addressing the policies and principles for selecting a
successor to the Chief Executive Officer, both in an
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emergency situation and in the ordinary course of business. The succession plan
should include an assessment of the experience, performance, skills and planned
career paths for possible successors to the Chief Executive Officer.
X. EXECUTIVE COMPENSATION
The Board, acting through the Compensation Committee, evaluates the
performance of the Chairman and Chief Executive Officer and the Company against
Company strategic and annual goals and the provisions of the incumbent's annual
personal plan, and has the sole authority to determine the compensation of the
Chairman and Chief Executive Officer, which is based on corporate performance,
achievement of personal plan objectives and competitive practices within the
banking and financial services industry.
The Board, acting through the Compensation Committee and upon the
recommendation of the Chief Executive Officer, evaluates the performance of all
other executive officers and approves the compensation of such officers.
XI. BOARD COMPENSATION
The Board should conduct a review at least once every 3 years of the
components and amount of Board compensation in relation to other similarly
situated companies. Board compensation should be consistent with market
practices but should not be set at a level that would call into question the
Board's objectivity. The Nominating and Corporate Governance Committee will make
a recommendation to the Board based on the foregoing factors.
XII. EXPECTATIONS OF DIRECTORS
The nine functions that are central to the role of the Board, are identified
in Section I above. In performing their duties, the primary responsibility of
the directors is to exercise their business judgment in good faith and the best
interest of the Company. The Board has developed a number of specific
expectations of directors to promote the discharge of this responsibility and
the efficient conduct of the Board's business.
Commitment and Attendance. All directors should make every effort to attend
every meeting of the Board and every meeting of committees of the Board of which
they are members. Members may attend by telephone to mitigate conflicts.
Participation in Meetings. Each director should be sufficiently familiar
with the business and strategy of the Company, including its financial
statements and capital structure, and the risks and competition it faces, to
facilitate active and effective participation in the deliberations of the Board
and of each committee on which he or she serves. Upon request, management will
make appropriate personnel available to answer any questions a director may have
about any aspect of the Company's business. Directors should also review the
materials provided by management and advisers in advance of the meetings of the
Board and its committees and should arrive prepared to discuss the issues
presented.
Loyalty and Ethics. In their roles as directors, all directors owe a duty of
loyalty to the Company. This duty of loyalty mandates that the best interests of
the Company take precedence over any interests possessed by a director. The
Company has adopted a Code of Business Conduct and Ethics, including a
compliance program to enforce the Code. Certain portions of the Code deal with
activities of directors, particularly with respect to transactions in securities
of the Company, potential conflicts of interest, the taking of corporate
opportunities for personal use, and competing with the Company. Directors should
be familiar with the Code's provisions in these areas and should consult with
the Company's counsel in the event of any issues.
Other Directorships. The Company values the experience directors bring from
other boards on which they serve, but recognizes that those boards may also
present demands on a director's time and availability and may present conflicts
or legal issues. Non-employee directors should advise the Chairman of the Board
and employee directors should advise the Chairperson of the Nominating and
Corporate Governance
B-4
Committee before accepting any new directorship or officer position with an
entity not affiliated with the Company.
Contact with Management. All directors are invited to contact the Chief
Executive Officer at any time to discuss any aspect of the Company's business.
Directors also have complete access to other members of management. The Board
expects that there will frequent opportunities for directors to meet with the
Chief Executive Officer and other members of management in Board and committee
meetings or in other formal or informal settings. The Board encourages
management to, from time to time, bring managers into Board meetings who
(a) can provide additional insight into items being discussed because of
personal involvement and substantial knowledge in those areas, and/or (b) are
managers with future potential that the senior management believes should be
given exposure to the Board.
Contact with other Constituencies. It is important that the Company speak to
employees and outside constituencies with a single voice and that management
serve as the primary spokesperson for the Company.
Confidentiality. The proceedings and deliberations of the Board and its
committees are confidential. Each director shall maintain the confidentiality of
information received in connection with his or her service as a director.
XIII. EVALUATING BOARD PERFORMANCE
The Board, acting through the Nominating and Corporate Governance Committee,
should conduct a self-evaluation at least annually to determine whether it is
functioning effectively. The Nominating and Corporate Governance Committee will
periodically consider the mix of skills and experience that directors bring to
the Board to assess whether the Board has the necessary tools to perform its
oversight function effectively. Each committee of the Board should also conduct
a self-evaluation at least annually and report the results to the Board acting
through the Nominating and Corporate Governance Committee. Each committee's
evaluation must compare the performance of the committee with the requirements
of its written charter, if any.
XIV. RELIANCE ON MANAGEMENT AND OUTSIDE ADVICE
In performing its functions, the Board is entitled to rely on the advice,
reports and opinions of management, counsel, accountants, auditors and other
expert advisers. The Board shall have the authority to retain and approve the
fees and retention terms of its outside advisers. In performing their functions,
the Committees of the Board may hire consultants to aid in their evaluations,
determinations, and recommendations as they deem appropriate.
XV. SHAREHOLDER COMMUNICATION WITH THE BOARD
Shareholders desiring to communicate with the Board of Directors on matters
other than Section IV above should submit their communication in writing to the
Chairperson of the Nominating and Corporate Governance Committee, c/o Corporate
Secretary, First Tennessee National Corporation, 165 Madison Avenue, Memphis,
Tennessee 38103 and identify themselves as a shareholder. The Corporate
Secretary will forward all such communications to the Chairperson for a
determination as to how to proceed.
B-5
APPENDIX C
AUDIT COMMITTEE CHARTER
FIRST TENNESSEE NATIONAL CORPORATION
(AS AMENDED AND RESTATED JANUARY 20, 2004, EFFECTIVE MARCH 31, 2004)
Establishment and Purposes of the Committee
Acting pursuant to Tennessee Code Annotated Section 48-18-206,
Article 11(b)(8) of the Corporation's restated charter, as amended, and
Section 3.5 of the Corporation's bylaws, as amended, the Board of Directors of
First Tennessee National Corporation hereby creates the Audit Committee (the
'Committee') of the Board of Directors, which shall: (1) assist the Board of
Directors in its oversight of (a) the Corporation's accounting and financial
reporting principles and policies and internal audit controls and procedures,
(b) the integrity of the Corporation's financial statements, (c) the
Corporation's compliance with legal and regulatory requirements, (d) the
independent auditor's qualifications and independence, and (e) the performance
of the independent auditor and Corporation's internal audit function; and
(2) prepare the report to be included in the Corporation's annual proxy
statement pursuant to the proxy rules of the Securities and Exchange Commission
('SEC').
The function of the Committee is oversight. Management of the Corporation is
responsible for preparation, presentation and integrity of the Corporation's
financial statements. Management is responsible for maintaining appropriate
accounting and financial reporting principles and policies and internal controls
and procedures to provide for compliance with accounting standards and
applicable laws and regulations, and the internal auditor is responsible for
testing such internal controls and procedures. The independent auditor is
responsible for planning and carrying out a proper audit of the Corporation's
annual financial statements, reviews of the Corporation's quarterly financial
statements prior to the filing of each quarterly report on Form 10-Q, and other
procedures. It is recognized that, in fulfilling their responsibilities
hereunder, members of the Committee are not full-time employees of the
Corporation and are not, and do not represent themselves to be, performing the
functions of accountants or auditors . As such, it is not the duty or
responsibility of the Committee or its members to conduct 'field work' or other
types of auditing or accounting reviews or procedures or to set auditor
independence standards, and each member of the Committee shall be entitled to
rely on (1) the integrity of those persons and organizations within and outside
the Corporation from which it receives information, (2) the accuracy of the
financial and other information provided to the Committee by such persons or
organizations absent actual knowledge to the contrary (which shall be promptly
reported to the Board) and (3) the representations made by management as to any
non-audit services provided by the independent auditor to the Corporation.
Further, in fulfilling their responsibilities hereunder, the members of the
Committee will incorporate the use of reasonable materiality standards,
including the size of the Corporation and the nature, scope and risks of the
activities conducted.
The independent auditor for the Corporation is accountable to the Committee
as representatives of the shareholders and must report directly to the
Committee. The Committee has the authority and responsibility directly to
appoint (subject, if applicable, to shareholder ratification), retain,
compensate, evaluate and terminate the Corporation's independent auditor and to
oversee the work of such independent auditor.
The independent auditor shall submit to the Committee annually a formal
written statement (the 'Auditor's Statement') describing: the independent
auditor's internal quality-control procedures; any material issues raised by the
most recent internal quality-control review or peer review of the independent
auditor, or by any inquiry or investigation by governmental or professional
authorities, within the preceding five years, respecting one or more independent
audits carried out by the independent auditor, and any steps taken to deal with
such issues; and (to assess the independent auditor's independence) all
relationships between the independent auditor and the Corporation addressing
each non-audit service provided to the Corporation and at least the matters set
forth in Independence Standards Board Standard No. 1.
The independent auditor shall submit to the Committee annually a formal
written statement of the aggregate fees billed for each of the last two fiscal
years for professional services rendered by the independent auditor in the
following categories (as defined by the rules of the SEC): audit, audit-related,
tax and all other services.
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Qualifications of Committee Members
The Committee shall consist of at least three members appointed annually by
a majority of the entire Board on the recommendation of the Human Resources
Committee of the Board of Directors, acting in its capacity as the nominating
committee. Members shall be directors who meet the independence and experience
requirements of the NYSE and Section 10A(m)(3) of the Securities Exchange Act of
1934, as amended, and the rules of the SEC promulgated thereunder. Under these
requirements as currently adopted, the Board must determine:
that each member has no material relationship, either direct or
indirect, with the Corporation;
that each member is financially literate, or shall become financially
literate within a reasonable period of time after his or her
appointment to the Committee; and
that at least one of the members has accounting or related financial
management expertise,
as such requirements are interpreted by the Board of Directors in the exercise
of its business judgment. Members may be replaced by the Board.
No director may serve as a member of the Committee if such director serves
on the audit committees of more than two other public companies unless the Board
of Directors determines that such simultaneous service would not impair the
ability of such director to serve effectively on the Committee, and discloses
this determination in the Corporation's annual proxy statement. No member of the
Committee may be an affiliated person (as such term is defined in SEC
Rule 10A-3, including any exceptions or exemptions permitted thereby) of the
Corporation or any subsidiary thereof or may receive any compensation from the
Corporation other than (i) director's fees, which may be received in cash, stock
options or other in-kind consideration ordinarily available to directors;
(ii) a pension or other deferred compensation for prior service that is not
contingent on future service; and (iii) any other regular benefits that other
directors receive; provided, however, that notwithstanding the foregoing, it
shall be permissible for Committee members to receive those types of
compensation permitted by the rules of the SEC and the NYSE regarding the
independence of audit committee members.
Operation of the Committee
Meetings shall be held at least four times yearly, or more frequently if
circumstances dictate, and may be called at any time by the Committee
Chairperson or by any two members of the Committee upon written or oral notice
to a majority of the members of the Committee prior to the meeting. A quorum
shall consist of a majority of the members and the vote of a majority of the
members present at a meeting at which a quorum is present shall be the act of
the Committee. Proceedings of the Committee over the signature of a member in
attendance shall be recorded in a minute book and reflect the names of those in
attendance. The Chairperson of the Committee, or acting Chairperson of the
meeting, will present a report of Committee activities to the full Board of
Directors at its next regularly scheduled meeting. The Secretary of the Board
will permanently maintain the minutes of Committee meetings. Meetings may be
held jointly with a similar committee of First Tennessee Bank National
Association ('Bank') if either the members of the Bank's committee and the
members of this Committee are identical or all of the members of the Bank's
committee would meet the eligibility requirements of the NYSE,
Section 10A(m)(3) and the rules of the SEC, including any exceptions permitted
thereby. The Committee may, in its discretion, delegate all or a portion of its
authority and duties to a subcommittee of the Committee, and may delegate to the
Chairperson the authority to grant pre-approvals of audit and permitted
non-audit services as provided herein, provided that the decisions of such
Chairperson to grant pre-approvals shall be presented to the full Committee at
its next regularly scheduled meeting.
The Committee shall have unrestricted access to Corporation personnel and
documents. The Committee will be given the resources and authority appropriate
to discharge its duties and responsibilities, including (i) the authority to
retain and compensate special or independent counsel, accountants or other
experts or consultants to advise the Committee, without seeking approval of the
Board or management, and (ii) appropriate funding, as determined by the
Committee, for payment of compensation to such counsel, accountants or other
experts and consultants. The Committee may request any officer or employee of
the Corporation or of the Corporation's outside counsel or independent auditor
to attend a meeting of the Committee or to meet with any members of, or
consultants to, the Committee. It will be the responsibility of
C-2
the Committee to maintain free and open means of communication between the
directors and management of the Corporation. The Committee shall meet separately
periodically with management, the internal auditor, and the independent auditor
in separate executive sessions to discuss any matters that the Committee or any
of these persons or firms believes should be discussed privately.
Duties and Responsibilities of the Committee
The Committee is hereby delegated full authority with respect to the
following matters and such additional matters as may be provided in the bylaws
of the Corporation or as the Board of Directors may from time to time by
resolution adopted by a majority of the entire Board specify:
1. with respect to the independent auditor,
a. directly appoint (subject, if applicable, to shareholder
ratification), retain, compensate, oversee the work of,
evaluate and terminate the independent auditor.
b. adopt a policy for the Corporation regarding preapproval of
all audit and non-audit engagement fees and terms and
approve, in advance, all such fees and terms in accordance
with such policy.
c. ensure that the independent auditor prepares and delivers
annually an Auditor's Statement (it being understood that
the independent auditor is responsible for the accuracy and
completeness of this Statement) and consider such Auditor's
Statement in assessing the independence of the independent
auditor.
d. ensure that the independent auditor timely reports on all
critical accounting policies and practices to be used; all
alternative treatments of financial information within
generally accepted accounting principles that have been
discussed with management, ramifications of the use of such
alternative disclosures and treatments, and the treatment
preferred by the independent auditor; and other material
written communications between the independent auditor and
management, such as any management letter or schedule of
unadjusted differences.
e. review and evaluate the qualifications, performance and
independence of the lead partner of the independent auditor.
f. discuss with management the timing and process for
implementing the rotation of the lead audit partner, the
concurring partner, and any other active audit engagement
team partner and consider whether there should be a regular
rotation of the audit firm itself.
g. instruct the independent auditor that the independent
auditor is ultimately accountable to the Committee as
representatives of the shareholders.
2. with respect to the internal audit department,
a. make recommendations to the Board concerning the appointment
and removal of the Corporation's internal auditor and
approve the salary and annual bonus of the internal auditor.
b. advise the internal auditor that he or she is expected to
provide the Committee summaries of and, as appropriate,
significant reports to management prepared by the internal
audit department and management's responses thereto.
c. approve the charter of the internal audit department and all
significant changes thereto.
3. with respect to financial reporting principles and policies and internal
audit controls and procedures,
a. advise management, the internal auditor and the independent
auditor that each is expected to provide to the Committee a
timely analysis of significant financial reporting issues
and practices.
b. consider any reports or communications (and management's
and/or the internal auditor's responses thereto) submitted
to the Committee by the independent auditor required by or
referred to in SAS 61 (as codified by AU Section 380), as
may be modified or supplemented.
c. meet with management, the independent auditor and, if
appropriate, the internal auditor (i) to discuss the scope
of the annual audit; the audited financial statements and
quarterly financial statements; any significant matters
arising from any audit, including any audit problems or
difficulties and management's response thereto; any
significant matters arising from changes to the
Corporation's auditing and accounting principles, policies,
controls, procedures and practices
C-3
proposed or contemplated by the independent auditor, the
internal auditor or management; any major issues regarding
accounting principles and financial statement presentations;
any major issues as to the adequacy of the Corporation's
internal controls and any special audit steps adopted in
light of material control deficiencies; analyses prepared by
management and/or the independent auditor setting forth
significant financial reporting issues and judgments made in
connection with the preparation of the financial statements;
the effect, if significant, of regulatory and accounting
initiatives, as well as off-balance sheet structures, on the
financial statements of the Corporation; (ii) to review the
form of opinion the independent auditor proposes to render
to the Board of Directors and shareholders; and (iii) to
discuss the Corporation's risk assessment and risk
management policies and to inquire about significant risks
and exposures, if any, and the steps taken to monitor and
minimize such risks.
d. obtain from the independent auditor assurance that the audit
was conducted in a manner consistent with Section 10A of the
Securities Exchange Act of 1934, as amended, which set forth
certain procedures to be followed in any audit of financial
statements required under that act.
e. review the Corporation's compliance policies and any
employee complaints or material reports or inquiries
received from regulators or government agencies and
management's responses and, with the Corporation's General
Counsel, pending and threatened claims that may have a
material impact on the financial statements.
f. discuss earnings press releases, including the use of
'proforma' or 'adjusted' non-GAAP information, as well as
financial information and earnings guidance provided to
analysts and rating agencies; provided, however, that the
Committee's responsibility to discuss earnings releases as
well as financial information and earnings guidance may be
done generally and may be limited to the types of
information to be disclosed and the types of presentations
to be made.
g. establish hiring policies for employees or former employees
of the independent auditor.
h. review and oversee related party transactions.
i. establish procedures for the receipt, retention and
treatment of complaints received by the Corporation
regarding accounting, internal accounting controls or
auditing matters, and for the confidential anonymous
submission by the Corporation's employees of concerns
regarding questionable accounting or auditing matters.
j. review disclosures made to the Committee by the
Corporation's CEO and CFO during their certification process
for the Form 10-K and Form 10-Q about any significant
deficiencies in the design or operation of internal controls
or material weaknesses therein and any fraud involving
management or other employees who have a significant role in
the Corporation's internal controls.
4. with respect to reporting and recommendations,
a. prepare any report or other disclosures, including any
recommendation of the Committee, required by the rules of
the SEC to be included in the Corporation's annual proxy
statement.
b. review this Charter at least annually and recommend any
changes to the Board.
c. report its activities to the full Board of Directors on a
regular basis and make such recommendations with respect to
the above and other matters as the Committee may deem
necessary or appropriate.
d. prepare and review with the Board an annual performance
evaluation of the Committee, which evaluation must compare
the performance of the Committee with the requirements of
this Charter. The performance evaluation by the Committee
shall be conducted in such manner as the Committee deems
appropriate. The report to the Board may take the form of an
oral report by the chairperson of the Committee or any other
member of the Committee designated by the Committee to make
this report.
C-4
AUDIT AND NON-AUDIT SERVICES
PRE-APPROVAL POLICY
FIRST TENNESSEE NATIONAL CORPORATION
(AS AMENDED AND RESTATED JANUARY 20, 2004)
-------------------
I. GENERAL STATEMENT OF POLICY
As required by the Sarbanes-Oxley Act of 2002 and Securities and Exchange
Commission rules, the Audit Committee of the Board of Directors of First
Tennessee National Corporation (the 'Company') is required to pre-approve all
audit and non-audit services provided to the Company or any of its subsidiaries,
which are to be performed by the registered public accounting firm (the
Company's 'Independent Auditor') that performs the audit of the Company's
consolidated financial statements that are filed with the Securities and
Exchange Commission (the 'Company's consolidated financial statements').
Pre-approval is required to provide assurance that such services do not impair
the Independent Auditor's independence from the Company. This policy sets forth
the requirements pursuant to which proposed services to be provided by the
Independent Auditor will be submitted for pre-approval and the conditions and
limitations on the provision of services by the Independent Auditor.
II. IMPLEMENTATION OF POLICY
A. PRE-APPROVAL PROCESS AND LIMITATIONS
Pre-approval of services to be provided by the Independent Auditor may be
obtained in either of two different ways. Services either may be approved in
advance by the Audit Committee specifically on a case-by-case basis ('specific
pre-approval') or may be approved in advance ('advance pre-approval') in the
manner specified in the following sentence. Advance pre-approval requires the
Audit Committee to identify in advance in an appendix to this policy (the
'Appendix') the specific types of service that may be provided and the fee
limits applicable to such types of service, which limits may be expressed as a
limit by type of service or by category of services ('type of service'). Unless
the type of service to be provided by the Independent Auditor has received
advance pre-approval under this policy and the fee for such service is within
the limit pre-approved, the service will require specific pre-approval by the
Audit Committee. With respect to each proposed pre-approved service (whether a
specific pre-approval or an advance pre-approval), the independent auditor will
provide detailed back-up documentation, which will be provided to the Audit
Committee, regarding the specific services to be provided.
The terms of and fee for the annual audit engagement must receive the
specific pre-approval of the Audit Committee.
'Audit,' 'Audit-related,' 'Tax,' and 'All Other' services, as those terms
are defined below, have the advance pre-approval of the Audit Committee but only
to the extent such services are specified in the Appendix and only in amounts
that do not exceed the fee limits specified in such Appendix. Such advance
pre-approval shall be for a term of 12 months following the date of pre-approval
unless the Audit Committee specifically provides for a different term.
Periodically, the Audit Committee will review and pre-approve the Appendix,
which will specify the services, and the fee limits applicable to such services,
that may be provided by the Independent Auditor for the fiscal year without
obtaining the specific pre-approval of the Audit Committee. Any proposed
services exceeding these fee limits will require specific pre-approval by the
Audit Committee.
The Audit Committee may determine the appropriate ratio between the total
amount of fees for Audit, Audit-related and Tax services and the total amount of
fees for services classified as All Other services. Unless the Audit Committee
specifically determines otherwise, the aggregate amount of the fees pre-
approved for All Other services for the fiscal year must not exceed seventy-five
percent (75%) of the aggregate amount of the fees pre-approved for the fiscal
year for Audit services, Audit-related services, and those types of Tax services
that represent tax compliance or tax preparation.
C-5
B. 'AUDIT' SERVICES
As provided above, the annual audit engagement terms and fee must be
specifically pre-approved by the Audit Committee. The Audit Committee will also
pre-approve any changes in terms, conditions and fees resulting from changes in
the audit scope, Company structure or other matters.
Audit services include the annual audit of the Company's consolidated
financial statements (including required quarterly reviews), subsidiary audits,
equity investment audits and other procedures required to be performed by the
Independent Auditor to be able to form an opinion on the Company's consolidated
financial statements. These other procedures include information systems and
procedural reviews and testing performed in order to understand and place
reliance on the systems of internal control over financial reporting, and
consultations relating to the audit or quarterly review. Audit services also
include the attestation engagement for the Independent Auditor's report on
management's report on internal control over financial reporting. Other audit
services may include statutory audits or financial audits for subsidiaries or
affiliates of the Company and services associated with SEC registration
statements, periodic reports and other documents filed with the SEC or other
documents issued in connection with securities offerings. The Audit Committee
has pre-approved the Audit services listed in the Appendix. All other Audit
services not listed in the Appendix must be specifically pre-approved by the
Audit Committee.
C. 'AUDIT-RELATED' SERVICES
Audit-related services are assurance and related services that are
reasonably related to the performance of the audit or review of the Company's
consolidated financial statements or that are traditionally performed by the
Independent Auditor. Audit-related services include due diligence services
pertaining to potential business acquisitions/dispositions, accounting
consultations related to accounting, financial reporting or disclosure matters
not classified as Audit services, assistance with understanding and implementing
new accounting and financial reporting guidance from rulemaking authorities,
financial audits of employee benefit plans, agreed-upon or expanded audit
procedures relating to accounting and/or billing records required to respond to
or comply with financial, accounting or regulatory reporting matters, and
assistance with internal control reporting requirements. The Audit Committee
believes that the provision of Audit-related services does not impair the
independence of the Independent Auditor. The Audit Committee has pre-approved
the Audit-related services listed in the Appendix. All other Audit-related
services not listed in the Appendix must be specifically pre-approved by the
Audit Committee.
D. 'TAX' SERVICES
The Audit Committee believes that the Independent Auditor can provide Tax
services to the Company such as tax preparation and compliance services
(including preparation and review of tax returns, including research necessary
to reflect events and transactions in the returns; advice and assistance with
respect to tax audits; and analysis of law or rule changes and proposed changes)
and tax planning services (advice and planning other than preparation and
compliance services) without impairing the auditor's independence, and the
Securities and Exchange Commission ('SEC') has stated that the Independent
Auditor may provide such services. Thus, the Audit Committee believes it may
grant advance pre-approval to those Tax services that the Audit Committee
believes would not impair the independence of the auditor, and that are
consistent with the SEC's rules on auditor independence. The Audit Committee
will not permit the retention of the Independent Auditor in connection with a
transaction initially recommended by the Independent Auditor, the sole business
purpose of which may be tax avoidance and the tax treatment of which may not be
supported in the Internal Revenue Code and related regulations. The Audit
Committee will consult with the Company's Manager of Corporate Tax to determine
that the tax planning and reporting positions are consistent with this policy.
Pursuant to the preceding paragraph, the Audit Committee has pre-approved
the Tax services in the Appendix. All Tax services involving large and complex
transactions and therefore not listed in the Appendix must be specifically
pre-approved by the Audit Committee. Tax services proposed to be provided by the
Independent Auditor to any executive officer or director of the Company, in his
or her individual capacity, where such services are paid for by the Company
require specific pre-approval by the Audit Committee. It is a permitted
exception to the foregoing sentence that Tax services proposed to be provided by
the Independent Auditor to an executive officer may be approved in advance and
included in the Appendix
C-6
under All Other Services provided the amounts paid by the Company and the
individual do not exceed two hundred fifty thousand dollars ($250,000) in the
aggregate for all executive officers.
E. 'ALL OTHER' SERVICES
All Other services consist of any services that are not Audit, Audit-related
or Tax services and are not prohibited from being provided by the Independent
Auditor by law or this policy. The Audit Committee may grant advance
pre-approval to those permissible non-audit services classified as All Other
services that it believes are routine and recurring services and would not
impair the independence of the Independent Auditor. The Audit Committee has
pre-approved the All Other services listed in the Appendix. Permissible All
Other services not listed in the Appendix must be specifically pre-approved by
the Audit Committee.
The following non-audit services are prohibited from being provided by the
Independent Auditor:
Bookkeeping or other services related to the accounting
records or financial statements of the Company
Financial information systems design and implementation
Appraisal or valuation services, fairness opinions or
contribution-in-kind reports
Actuarial services
Internal audit outsourcing services
Management functions
Human resources
Broker-dealer, investment adviser or investment banking
services
Legal services
Expert services unrelated to the audit
The Company's Chief Accounting Officer (the 'CAO') shall consult SEC rules
and relevant guidance to determine whether any proposed All Other service falls
within a prohibited non-audit service under the SEC's rules and any exceptions
that might apply to the prohibition.
III. DELEGATION OF AUTHORITY
All requests to provide services to the Company or any of its subsidiaries
that require specific pre-approval by the Audit Committee must be submitted to
the CAO in advance of the provision of any such services by the Independent
Auditor. The CAO shall receive all such requests, confirm with the Independent
Auditor whether it believes that such services will not affect its independence,
and present a joint statement with the Independent Auditor as to any recommended
requests to the Audit Committee for pre-approval. All requests to provide
services that have been pre-approved in advance must be submitted to the CAO
prior to the provision of such services for a determination that the service to
be provided is of the type and within the fee limit that has been pre-approved.
In addition, on a quarterly basis the Company's Internal Auditor will report to
the Audit Committee on the services provided by and the fees paid to the
Independent Auditor during the prior quarter.
Notwithstanding anything herein to the contrary, the authority granted
herein to the Audit Committee to pre-approve services, other than the annual
audit engagement and any changes thereto, to be provided by the Independent
Auditor is delegated to the Chairperson of the Audit Committee. The Chairperson
may not, however, under delegated authority make a determination that causes the
ratio of fees pre-approved for All Other services to the aggregate amount of
fees pre-approved for Audit, Audit-related and tax compliance and tax
preparation services to exceed the ratio established or set forth in
Section II. A. Any service pre-approved by the Chairperson of the Audit
Committee will be reported to the Audit Committee at its next regularly
scheduled meeting.
The Internal Auditor is directed to monitor the services provided by the
Independent Auditor for the purpose of determining whether such services are in
compliance with this policy, and report to the Audit Committee periodically on
the results of such monitoring.
The Audit Committee does not delegate any of its responsibility to
pre-approve services to be performed by the Independent Auditor to management.
C-7
APPENDIX D
NOMINATING AND CORPORATE GOVERNANCE COMMITTEE CHARTER
FIRST TENNESSEE NATIONAL CORPORATION
(ADOPTED JANUARY 20, 2004)
-------------------
Acting pursuant to Tennessee Code Annotated Section 48-18-206, Article
11(b)(8) of the Corporation's restated charter, as amended, and Article III(6)
of the Corporation's bylaws, as amended, the Board of Directors of First
Tennessee National Corporation hereby creates the Nominating and Corporate
Governance Committee (the 'Committee') of the Board of Directors, which shall
serve as a nominating committee and as a corporate governance committee for the
Corporation, with such specific authority as is herein provided.
Purposes of the Committee
The purposes of the Committee are (1) to identify and recommend to the Board
individuals for nomination as members of the Board and its committees, (2) to
develop and recommend to the Board a set of corporate governance principles
applicable to the Corporation, and (3) to oversee the evaluation of the Board
and management.
Qualifications of Committee Members
The Committee shall be appointed annually by a majority of the entire Board,
upon recommendation of the Committee, and shall consist of at least three
members of the Board, each of whom is 'independent' under the rules of the New
York Stock Exchange ('NYSE'). Members of the Committee may be replaced by the
Board.
Operation of the Committee
Meetings shall be held at least two times yearly and may be called at any
time by the Committee Chairperson or by any two members of the Committee upon
written or oral notice to a majority of the Committee prior to the meeting. A
quorum shall consist of a majority of the members, and the vote of the majority
of the members present at a meeting at which a quorum is present shall be the
act of the Committee. Proceedings of the Committee over the signature of a
member in attendance shall be recorded in a minute book and reflect the names of
those in attendance. The Chairperson of the Committee, or acting Chairperson of
the meeting, will present a report of the Committee activities to the full Board
of Directors at its next regularly scheduled meeting. The Secretary of the Board
will permanently maintain the minutes of Committee meetings. Meetings may be
held jointly with a similar committee of First Tennessee Bank National
Association ('Bank') if either the members of the Bank's committee and the
members of this Committee are identical or all of the members of the Bank's
committee meet the independence requirements of the NYSE. The Committee may
invite to its meetings such members of management as it may deem desirable or
appropriate. It will be the responsibility of the Committee to maintain free and
open means of communication between the directors and management of the
Corporation.
The Committee shall have unrestricted access to Corporation personnel and
documents and shall have the resources and authority appropriate to discharge
its duties and responsibilities, including the authority to select, retain,
terminate and approve the fees and other retention terms of special counsel or
other experts or consultants, as it deems appropriate, without seeking approval
of the Board or management. The Committee shall have the authority to retain (i)
compensation consultants to assist in the evaluation of director compensation
and (ii) consultants or search firms used to identify director candidates,
including authority to approve the fees and other retention terms. The Committee
may, in its discretion, delegate all or a portion of its duties and
responsibilities to a subcommittee of the Committee.
Duties and Responsibilities of the Committee
The Committee is hereby delegated full authority with respect to the
following matters and such additional matters as may be provided in the bylaws
of the Corporation or as the Board of Directors may from time to time by
resolution adopted by a majority of the entire Board specify:
D-1
1. WITH RESPECT TO THE NOMINATING FUNCTION,
a. To consider recommendations to the Board from time to time
as to changes that the Committee believes to be desirable to
the size of the Board or any committee thereof;
b. To identify individuals believed to be qualified to become
Board members, and to recommend to the Board the individuals
to stand for election or reelection as directors. In the
case of a vacancy in the office of a director (including a
vacancy created by an increase in the size of the Board),
the Committee shall recommend to the Board an individual to
fill such vacancy either through appointment by the Board or
through election by shareholders and (for a vacancy created
by an increase in the size of the Board) shall recommend to
the Board the class of directors in which the individual
should serve. In nominating candidates, the Committee shall
take into consideration such factors as it deems
appropriate. These factors may include:
personal qualities and characteristics, experience,
accomplishments and reputation in the business community;
current knowledge and contacts in the communities in which
the Corporation does business and in the Corporation's
industry or other industries relevant to the Corporation's
business;
diversity of viewpoints, background, experience and other
demographics;
ability and willingness to commit adequate time to Board and
committee matters; and
the fit of the individual's skills and personality with
those of other directors and potential directors in building
a Board that is effective and responsive to its duties and
responsibilities and the needs of the Corporation.
The Committee may consider candidates proposed by
management, but is not required to do so;
c. To develop and recommend to the Board, in connection with
its assessment of director independence, guidelines to be
applied in making determinations as to the absence of
material relationships between the Corporation and a
director;
d. To identify Board members qualified to fill vacancies on any
committee of the Board (including the Committee) and to
recommend that the Board appoint the identified member or
members to the respective committee. In nominating a
candidate for committee membership, the Committee shall take
into consideration the factors set forth in the charter of
the committee, if any, as well as any other factors it deems
appropriate, including without limitation the consistency of
the candidate's experience with the goals of the committee
and the interplay of the candidate's experience with the
experience of other committee members;
e. To make recommendations to the Board concerning compensation
for directors; and
f. To review, monitor and make recommendations to the Board or
management, as appropriate, with respect to any
communications directed to the Corporation or one or more of
the directors relating to performance, nomination or removal
of directors.
2. WITH RESPECT TO CORPORATE GOVERNANCE AND OTHER MATTERS,
a. To exercise oversight of the evaluation of the Board and
management;
b. To develop and recommend to the Board a set of corporate
governance principles applicable to the Corporation, to
review and reassess those principles at least once a year,
and recommend any proposed changes to the Board for
approval; and
c. To prepare and provide to the Board an annual performance
evaluation of the Committee, which evaluation shall compare
the performance of the Committee with the requirements of
this Charter. The performance evaluation shall also
recommend to the Board any improvements to the Committee's
Charter deemed necessary or desirable by the Committee. The
performance evaluation by the Committee shall be conducted
in such manner as the Committee deems appropriate. The
Report to the Board may take the form of an oral report by
the chairperson of the Committee or any other member of the
Committee designated by the Committee to make this report.
D-2
APPENDIX E
COMPENSATION COMMITTEE CHARTER
FIRST TENNESSEE NATIONAL CORPORATION
(AS AMENDED AND RESTATED JANUARY 20, 2004)
Acting pursuant to Tennessee Code Annotated Section 48-18-206, Article
11(b)(8) of the Corporation's restated charter, as amended, and Article III(6)
of the Corporation's bylaws, as amended, the Board of Directors of First
Tennessee National Corporation hereby creates the Compensation Committee (the
'Committee') of the Board of Directors, which shall serve as a compensation
committee for the Corporation, with such specific authority as is herein
provided. This Committee was known prior to January 20, 2004 as the Human
Resources Committee, and all references to the Human Resources Committee in any
of the plans named in Section 7 herein shall be understood to refer to this
Committee.
Purposes of the Committee
The purposes of the Committee are (1) to discharge the Board's
responsibilities relating to the compensation of the Corporation's executive
officers, (2) to produce an annual report on executive compensation for
inclusion in the Corporation's proxy statement, in accordance with the rules and
regulations of the Securities and Exchange Commission ('SEC'), (3) to identify
and recommend to the Board individuals for appointment as officers, (4) to
evaluate the Corporation's management, and (5) to carry out certain other duties
set forth herein.
Qualifications of Committee Members
The Committee shall be appointed annually by a majority of the entire Board,
upon recommendation of the Committee, and shall consist of at least three
members of the Board, each of whom is 'independent' under the rules of the New
York Stock Exchange ('NYSE'). In addition, at least two members of the Committee
must be directors of the Corporation who are 'outside directors' for purposes of
Section 162(m) of the Internal Revenue Code of 1986, as amended, and at least
two members of the Committee must be directors of the Corporation who are
'non-employee directors' for purposes of Section 16 of the Securities Exchange
Act of 1934. Only members who meet the Section 162(m) test may participate in
decisions required to be made by 'outside directors' under Section 162(m), and
any other member of the Committee must recuse himself or herself with respect to
those issues. Only members who meet the Section 16 test may participate in
decisions required to be made by 'non-employee directors' under Section 16, and
any other member of the Committee must recuse himself or herself with respect to
those issues. If a quorum of the Committee is present in accordance with the
requirements of the 'Operation of the Committee' section of this charter, then
the action taken by at least two 'outside directors' (with respect to matters
required to be acted upon by 'outside directors') and the action taken by at
least two 'non-employee directors' (with respect to matters required to be acted
upon by 'non-employee directors') each shall be the valid action of this
Committee and is fully authorized by the Board of Directors, as long as such
action is taken by a majority of the 'outside directors' or a majority of the
'non-employee directors,' as applicable. Members of the Committee may be
replaced by the Board.
Operation of the Committee
Meetings shall be held at least four times yearly and may be called at any
time by the Committee Chairperson or by any two members of the Committee upon
written or oral notice to a majority of the Committee prior to the meeting. A
quorum shall consist of a majority of the members, and the vote of the majority
of the members present at a meeting at which a quorum is present shall be the
act of the Committee. Proceedings of the Committee over the signature of a
member in attendance shall be recorded in a minute book and reflect the names of
those in attendance. The Chairperson of the Committee, or acting Chairperson of
the meeting, will present a report of the Committee activities to the full Board
of Directors at its next regularly scheduled meeting. The Secretary of the Board
will permanently maintain the minutes of Committee meetings. Meetings may be
held jointly with a similar committee of First Tennessee
E-1
Bank National Association ('Bank') if either the members of the Bank's committee
and the members of this Committee are identical or all of the members of the
Bank's committee meet the independence requirements of the NYSE. The Committee
may invite to its meetings such members of management as it may deem desirable
or appropriate, consistent with the maintenance of the confidentiality of
compensation discussions. The Corporation's Chief Executive Officer ('CEO')
should not attend the portion of any meeting where the CEO's performance or
compensation are discussed, unless specifically invited by the Committee. It
will be the responsibility of the Committee to maintain free and open means of
communication between the directors and management of the Corporation.
The Committee shall have unrestricted access to Corporation personnel and
documents and shall have the resources and authority appropriate to discharge
its duties and responsibilities, including the authority to select, retain,
terminate and approve the fees and other retention terms of special counsel or
other experts or consultants, as it deems appropriate, without seeking approval
of the Board or management. The Committee shall have the authority to retain
compensation consultants to assist in the evaluation of CEO or senior executive
officer compensation, including authority to approve the fees and other
retention terms. The Committee may, in its discretion, delegate all or a portion
of its duties and responsibilities to a subcommittee of the Committee.
Duties and Responsibilities of the Committee
The Committee is hereby delegated full authority with respect to the
following matters and such additional matters as may be provided in the bylaws
of the Corporation or as the Board of Directors may from time to time by
resolution adopted by a majority of the entire Board specify:
1. To recommend to the Board major corporate policies and objectives with
respect to the Corporation's compensation and management of its human
resources.
2. To make regular reports to the Board and to provide a periodic review,
evaluation and reporting link between management and the Board with
respect to the Corporation's compensation and management of its human
resources.
3. To review periodically management's human resources policies,
guidelines, procedures, and practices for conformity with corporate
objectives and policies concerning the Corporation's compensation and
management of its human resources, including a periodic review of
compensation structures for non-executive officers.
4. To review and approve corporate goals and objectives relevant to the
compensation of the CEO, evaluate the performance of the CEO in light of
those goals and objectives, and set the CEO's compensation level based
on this evaluation.
5. To fix the compensation, including bonus and other compensation and any
severance or similar termination payments, of executive officers.
6. To make recommendations to the Board concerning the adoption or
amendment of employee benefit plans, management compensation plans,
incentive compensation plans and equity-based plans, including plans
applicable to executive officers.
7. To serve as the Committee required:
a. by the terms of the 1992 Restricted Stock Incentive Plan;
b. by the terms of the 1984 and 1990 Stock Option Plans and the
1995, 1997 and 2000 Employee Stock Option Plans;
c. by terms of the Directors & Executives Deferred Compensation
Plan;
d. to resolve questions of interpretation arising under the
Non-Employee Directors' Deferred Compensation Stock Option
Plan and the 2000 Non-Employee Directors' Deferred
Compensation Stock Option Plan;
e. by the terms of the 2002 Management Incentive Plan;
f. to review the appropriateness of the issuance of Corporation
common stock under the terms of the Savings Plan as required
by resolutions of the Board as adopted from time to time;
E-2
g. to designate those eligible to participate in the Pension
Restoration Plan and Survivor Benefit Plan;
h. by the terms of the 2002 Bank Director and Advisory Board
Member Deferral Plan, the Bank Director and Advisory Board
Member Deferral Plan and the Bank Advisory Director Deferral
Plan;
i. by the terms of the 2003 Equity Compensation Plan; and
j. by the terms of the First Tennessee National Bank
Nonqualified Deferred Compensation Plan and the First
Horizon Nonqualified Deferred Compensation Plan.
8. In consultation with management, to oversee regulatory compliance with
respect to compensation matters, including (a) overseeing the
Corporation's policies on structuring compensation programs to maximize
tax deductibility while retaining the discretion deemed necessary to
compensate executive officers in a manner commensurate with performance
and the competitive market for executive talent, and (b) as and when
required, establishing performance goals and certifying that performance
goals have been attained for purposes of Section 162(m) of the Internal
Revenue Code.
9. To produce annually a Report of the Compensation Committee for inclusion
in the Corporation's proxy statement in accordance with applicable SEC
rules and regulations.
10. To make recommendations to the Board concerning the creation of
corporate offices and the defining of authority and responsibility of
such offices and concerning nominees to fill such offices.
11. To make recommendations to the Board regarding the appointment of
incumbent officers, including consideration of their performance in
determining whether to nominate them for reelection, and to review
succession plans for executive officers, including the CEO.
12. To review, monitor and make recommendations to the Board or management,
as appropriate, with respect to any communications directed to the
Corporation or one or more of the directors relating to performance,
nomination or removal of officers.
13. During the period of time between the annual appointment of officers by
the Board at its organizational meeting following the annual meeting of
shareholders, to create corporate offices and define the authority and
responsibility of such offices, except to the extent such authority or
responsibility would not be consistent with the law, the charter or the
bylaws, to appoint persons to any office of the Corporation except
Chairman of the Board, Chief Executive Officer, President, Auditor, and
any office the incumbent in which is designated by the Board as an
Executive Officer, and to remove from office any person that was, or
could have been, so appointed by the Committee.
14. To evaluate the Corporation's management.
15. To prepare and provide to the Board an annual performance evaluation of
the Committee, which evaluation shall compare the performance of the
Committee with the requirements of this Charter. The performance
evaluation shall also recommend to the Board any improvements to the
Committee's Charter deemed necessary or desirable by the Committee. The
performance evaluation by the Committee shall be conducted in such
manner as the Committee deems appropriate. The report to the Board may
take the form of an oral report by the chairperson of the Committee or
any other member of the Committee designated by the Committee to make
this report.
16. To serve as the committee required by the Bylaws and resolutions of the
Corporation to be responsible for and with authority to make and record
all requests of directors, officers and employees of the Corporation, or
any of its subsidiaries, to serve other business entities at the
Corporation's request and to be indemnified against liability arising
from such service.
17. To review compliance with the Management Interlocks Acts and approve
indemnification for officers and directors.
E-3
FINANCIAL INFORMATION AND DISCUSSION
TABLE OF CONTENTS
Selected Financial and Operating Data....................... F-2
Management's Discussion and Analysis........................ F-3
General Information....................................... F-3
Forward Looking Statements................................ F-4
Financial Summary......................................... F-4
Income Statements Analysis -- 2003 compared to 2002....... F-5
Business Line Review...................................... F-15
Income Statements Analysis -- 2002 compared to 2001....... F-18
Balance Sheet Review...................................... F-19
Risk Management........................................... F-25
Critical Accounting Policies.............................. F-40
Quarterly Financial Information........................... F-49
Other..................................................... F-50
Accounting Changes........................................ F-50
Glossary.................................................... F-51
Consolidated Statements of Condition........................ F-54
Consolidated Statements of Income........................... F-55
Consolidated Statements of Shareholders' Equity............. F-56
Consolidated Statements of Cash Flows....................... F-57
Notes to Consolidated Financial Statements.................. F-58
Report of Independent Public Accountants.................... F-110
Consolidated Historical Performance Statements of Income.... F-111
Consolidated Average Balance Sheets and Related Yields and
Rates....................................................... F-112
First Tennessee National Corporation F-1
SELECTED FINANCIAL AND OPERATING DATA
-----------------------------------------------------------------------------------------------------------------------------
(Dollars in millions except per share data) 2003 2002 2001 2000 1999 1998
-----------------------------------------------------------------------------------------------------------------------------
NET INCOME BEFORE CUMULATIVE ADJUSTMENT* $ 473.3 $ 376.5 $ 326.4 $ 232.6 $ 247.5 $ 226.4
NET INCOME 473.3 376.5 318.2 232.6 247.5 226.4
-----------------------------------------------------------------------------------------------------------------------------
COMMON STOCK DATA
Earnings per share before cumulative adjustment* $ 3.73 $ 2.97 $ 2.55 $ 1.79 $ 1.90 $ 1.77
Earnings per share 3.73 2.97 2.49 1.79 1.90 1.77
Diluted earnings per share before
cumulative adjustment* 3.62 2.89 2.48 1.77 1.85 1.72
Diluted earnings per share 3.62 2.89 2.42 1.77 1.85 1.72
Cash dividends declared per share 1.30 1.05 .91 .88 .79 .685
Year-end book value per share 15.01 13.35 11.66 10.70 9.52 8.50
Closing price of common stock per share:
High 47.98 40.45 37.25 29.06 45.19 38.06
Low 36.14 30.05 27.38 16.06 27.56 23.81
Year-end 44.10 35.94 36.26 28.94 28.50 38.06
Dividends per share/year-end closing price 2.9% 2.9% 2.5% 3.0% 2.8% 1.8%
Dividends per share/diluted earnings per share 35.9 36.3 36.7 49.7 42.7 39.8
Price/earnings ratio 12.2X 12.4x 15.0x 16.3x 15.4x 22.1x
Market capitalization $ 5,552.0 $ 4,553.9 $ 4,597.0 $ 3,744.7 $ 3,715.1 $ 4,920.8
Average shares outstanding (thousands) 126,765 126,714 127,777 129,865 130,573 128,235
Period-end shares outstanding (thousands) 124,834 125,600 125,865 128,745 129,878 128,974
Volume of shares traded (thousands) 176,528 139,946 110,154 99,469 96,207 107,837
--------------------------------------------------------------------------------------------------------------------------------
SELECTED AVERAGE BALANCES
Total assets $25,133.6 $20,704.0 $19,227.2 $19,325.3 $18,625.3 $16,724.7
Total loans** 12,656.3 10,634.5 10,104.3 9,932.0 8,818.8 8,242.1
Investment securities 2,544.9 2,466.4 2,595.3 2,862.7 2,702.7 2,425.8
Earning assets 21,328.9 17,397.4 16,125.4 16,095.5 15,583.7 14,320.5
Deposits 15,859.4 13,495.2 12,421.7 12,860.8 12,302.1 10,996.4
Term borrowings 1,342.9 685.5 521.5 384.3 371.1 252.7
Shareholders' equity 1,800.4 1,568.3 1,401.3 1,276.6 1,186.8 996.0
-----------------------------------------------------------------------------------------------------------------------------
SELECTED PERIOD-END BALANCES
Total assets $24,506.7 $23,823.1 $20,621.6 $18,559.6 $18,378.0 $18,738.1
Total loans** 13,990.5 11,345.4 10,283.1 10,239.5 9,363.2 8,557.1
Investment securities 2,470.4 2,700.3 2,525.9 2,839.0 3,101.3 2,426.3
Earning assets 20,621.1 19,999.8 17,085.7 15,193.3 14,944.2 15,694.6
Deposits 15,680.0 15,713.9 13,606.3 12,188.7 11,358.7 11,723.0
Term borrowings 1,726.8 929.7 550.4 409.7 358.7 414.5
Shareholders' equity 1,890.3 1,691.2 1,477.8 1,384.2 1,241.5 1,099.5
-----------------------------------------------------------------------------------------------------------------------------
SELECTED RATIOS
Return on average shareholders' equity before
cumulative adjustment* 26.29% 24.00% 23.29% 18.22% 20.86% 22.73%
Return on average shareholders' equity 26.29 24.00 22.71 18.22 20.86 22.73
Return on average assets before
cumulative adjustment* 1.88 1.82 1.70 1.20 1.33 1.35
Return on average assets 1.88 1.82 1.66 1.20 1.33 1.35
Net interest margin 3.78 4.35 4.29 3.75 3.82 3.81
Allowance for loan losses to loans** 1.15 1.27 1.46 1.36 1.44 1.54
Net charge-offs to average loans** .54 .93 .80 .62 .59 .46
Average shareholders' equity to average assets 7.16 7.58 7.29 6.61 6.37 5.96
Average tangible equity to average tangible assets 6.37 6.70 6.66 5.98 5.70 5.23
Average shareholders' equity to average net loans 14.41 14.96 14.07 13.04 13.67 12.28
-----------------------------------------------------------------------------------------------------------------------------
RETURN TO SHAREHOLDERS
Stock appreciation 22.7% (.9)% 25.3% 1.5% (25.1)% 14.0%
Dividend yield 3.6 2.9 3.1 3.1 2.1 2.1
Total return 26.3 2.0 28.4 4.6 (23.0) 16.1
-----------------------------------------------------------------------------------------------------------------------------
* Cumulative adjustment reflects the effect of changes in accounting principles
related to derivatives.
** Net of unearned income.
See accompanying notes to consolidated financial statements. Common stock data
reflects the 1998 two-for-one stock split.
Certain previously reported amounts have been reclassified to agree with current
presentation.
F-2 First Tennessee National Corporation
MANAGEMENT'S DISCUSSION AND ANALYSIS
GENERAL INFORMATION
First Tennessee National Corporation (FTNC), soon to be renamed First Horizon
National Corporation (pending shareholder approval in April 2004), is a
nationwide, financial services institution founded in 1864. Today we have grown
to be one of the top 50 largest bank holding companies in the U.S.
FTNC FACTS:
Had $24.5 billion in assets and $5.6 billion in market capitalization on
December 31, 2003
Is listed in Standard and Poor's 500 Index, one of the most widely watched
benchmarks of the stock market's performance
Since 1989, has delivered to shareholders an average annual increase in
stock price of 18 percent
Enjoys customers that are among the most loyal of the top financial
institutions in the country
Fortune magazine's list of one of the '100 Best Companies to Work For' for
the seventh consecutive year
Named to the AARP Best Employers for Workers over 50 list
Ninth straight spot on Working Mother magazine's annual list of the 100 Best
Companies for Working Mothers
FTNC provides a broad array of financial services to its customers through
various regional and national business lines. The combined strengths of our
business lines create an extensive range of financial products and services.
BUSINESS LINES:
FIRST HORIZON helps provide home ownership through First Horizon Home Loans,
one of the 15 largest providers of mortgage loans to consumers, which
operates offices in 42 states. In addition First Horizon provides Equity
Lending, Investments, Insurance, Financial Planning and Retail/Commercial
Banking to its customers. The First Horizon Bank division recently opened
its inaugural financial center in the Washington, D.C. area. Other First
Horizon financial centers will open in markets where First Horizon Home
Loans has established a strong customer base.
FIRST TENNESSEE BANKING GROUP offers financial products to retail and
commercial customers through its Retail/Commercial Bank, Investments,
Insurance, Financial Planning, Trust Services, Asset Management, Credit Card
and Cash Management divisions. This business line offers traditional
financial services and products, commercial insurance and also promotes
comprehensive financial planning to address customer needs and desires for
investments, insurance, estate planning, education funding, cash reserves
and retirement goals.
FTN FINANCIAL provides a full spectrum of financial services for the
investment and banking communities through the integration of Capital
Markets, Equity Research, Investment Banking, Correspondent Services, and
Strategic Alliances.
TRANSACTION PROCESSING provides credit card merchant processing, nationwide
bill payment processing, check clearing operations and other products and
services.
First Tennessee National Corporation F-3
For the purpose of this management discussion and analysis (MD&A), earning
assets, including loans, have been expressed as averages, net of unearned
income. Under SFAS No. 91, certain nonrefundable fees associated with
originating loans are deferred at the point they are incurred and generally are
recognized over the life of the loan. In the case of mortgage loans sold, the
deferred costs are recognized when the loan is sold. These loan origination
costs have been classified as a component of the gain or loss on the sale of the
loans in this period, and previously reported amounts have been reclassified to
agree with the current presentation. The following financial discussion should
be read with the accompanying consolidated financial statements and notes. A
glossary is included at the end of the MD&A to assist with terminology. In
addition to the four major business lines, FTNC's segments include the Corporate
segment, which contains unallocated corporate expenses and expense on trust
preferred and REIT preferred securities. A portion of FTNC's funds transfer
credit associated with allocated capital is also included in the Corporate
segment's net interest income.
FORWARD-LOOKING STATEMENTS
Management's discussion and analysis may contain forward-looking statements with
respect to FTNC's beliefs, plans, goals, expectations, and estimates.
Forward-looking statements are statements that are not a representation of
historical information but rather are related to future operations, strategies,
financial results or other developments. The words 'believe', 'expect',
'anticipate', 'intend', 'estimate', 'should', 'is likely', 'will', 'going
forward', and other expressions that indicate future events and trends identify
forward-looking statements. Forward-looking statements are necessarily based
upon estimates and assumptions that are inherently subject to significant
business, operational, economic and competitive uncertainties and contingencies,
many of which are beyond a company's control, and many of which, with respect to
future business decisions and actions (including acquisitions and divestitures),
are subject to change. Examples of uncertainties and contingencies include,
among other important factors, general and local economic and business
conditions; expectations of and actual timing and amount of interest rate
movements (which can have a significant impact on a financial services
institution); market and monetary fluctuations; inflation or deflation; the
financial condition of borrowers and other counterparties; competition within
and outside the financial services industry; geo-political developments
including possible terrorist activity; ineffectiveness of FTNC's hedging
practices; technology; and new products and services in the industries in which
FTNC operates. Other factors are those inherent in originating and servicing
loans including prepayment risks, pricing concessions, fluctuation in U.S.
housing prices, fluctuation of collateral values, and changes in customer
profiles. Additionally, the actions of the Securities and Exchange Commission
(SEC), the Financial Accounting Standards Board (FASB), the Office of the
Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve
System, and other regulators; regulatory and judicial proceedings and changes in
laws and regulations applicable to FTNC; and FTNC's success in executing its
business plans and strategies and managing the risks involved in the foregoing,
could cause actual results to differ. FTNC assumes no obligation to update any
forward-looking statements that are made from time to time.
FINANCIAL SUMMARY
FTNC's diverse business mix, while subject to fluctuations in the operating
environment, including interest rates and equity market conditions, provides a
balance that has produced a stable and growing return for our shareholders over
the course of this past economic cycle. The benefit of this diverse and balanced
business mix was evidenced through the successful execution of FTNC's strategies
in 2003's challenging economic environment.
There were several factors during 2003 that had a significant impact on FTNC's
ability to continue our high-performing growth. This past year's performance,
while steady on a quarterly earnings per share basis, reflected the planned
rebalancing of earnings within and among the business segments. At the beginning
of 2003, the positive effects from historically low interest rates gave First
Horizon an opportunity to generate record mortgage loan refinance volumes and
enabled the capital markets businesses to significantly increase revenues over
2002. For the first half of 2003, the mortgage servicing portfolio experienced
reduced
F-4 First Tennessee National Corporation
profitability due to increased amortization and impairment expenses.
Additionally, exceptional earnings were utilized to significantly invest in
strategic growth opportunities designed to support business expansion and
curtail costs that benefit future performance. During the latter part of the
year, the effects of an upward transition in interest rates were exhibited
within the business lines. Due to this change in the operating environment,
First Horizon experienced a decline in mortgage origination related revenues and
FTN Financial reported modestly lower depository and non-depository revenues
from fixed income sales. A counterbalance to the impact of the changes in the
operating environment is the positive effect of the macro-hedge. A period of
high or rising interest rates results in lower demand for mortgage loan
refinancings while the servicing portfolio exhibits improved profitability. The
macro-hedge is an essential element of FTNC's strategy to produce sustained,
growing income. Several operational initiatives have begun to affect or will
affect future performance, including a reduction in discretionary investing, the
returns from prior period discretionary investments, the repositioning of the
balance sheet, and FTNC's ability to continue to find and execute strategic
growth opportunities.
Earnings for 2003 were $473.3 million, or $3.62 diluted earnings per share. This
represents 26 percent growth from 2002 earnings of $376.5 million, or $2.89
diluted earnings per share. Return on average shareholders' equity and return on
average assets for 2003 were 26.3 percent and 1.88 percent, respectively, and
were 24.0 percent and 1.82 percent in 2002. Total assets were $24.5 billion,
shareholders' equity was $1.9 billion and market capitalization was $5.6 billion
on December 31, 2003, compared to $23.8 billion, $1.7 billion and $4.6 billion,
respectively, on December 31, 2002.
INCOME STATEMENTS ANALYSIS - 2003 COMPARED TO 2002
Total revenue grew 18 percent to $2,445.8 million from $2,067.5 million in 2002,
with a 25 percent increase in noninterest income and a 7 percent increase in net
interest income.
NONINTEREST INCOME
Noninterest income provides the majority of FTNC's revenue. During 2003
noninterest income increased to $1,640.0 million from $1,311.9 million, and
contributed 67 percent to total revenue in 2003 compared with 63 percent in
2002. Table 1 provides six years of detailed information concerning FTNC's
noninterest income. The following discussion provides additional information on
various line items reported in the table.
First Tennessee National Corporation F-5
TABLE 1 - ANALYSIS OF NONINTEREST INCOME
Compound
Annual
Growth
Rates (%)
-----------------
(Dollars in thousands) 2003 2002 2001 2000 1999 1998 03/02 03/98
-----------------------------------------------------------------------------------------------------------------------------
NONINTEREST INCOME:
Mortgage banking $ 616,564 $ 436,706 $ 285,032 $122,454 $298,211 $281,875 41.2 + 16.9 +
Capital markets 538,919 448,016 344,278 118,709 126,900 147,353 20.3 + 29.6 +
Deposit transactions and cash
management 146,701 143,315 133,631 116,080 106,240 90,444 2.4 + 10.2 +
Insurance premiums and
commissions 57,811 50,446 16,844 12,203 10,912 8,725 14.6 + 46.0 +
Merchant processing 57,609 48,403 45,426 48,232 49,711 37,462 19.0 + 9.0 +
Trust services and investment
management 45,873 48,369 56,705 65,817 59,807 51,198 5.2 - 2.2 -
Gains on divestitures 22,498 4,550 80,357 157,635 4,246 567 NM NM
Equity securities
gains/(losses), net 8,491 (9,435) (3,290) 754 2,313 3,940 NM NM
Debt securities
(losses)/gains, net (6,113) 255 (1,041) (4,961) (56) 36 NM NM
All other income:
Cardholder fees 22,698 20,145 20,137 29,666 25,579 21,046 12.7 + 1.5 +
Other service charges 19,810 21,204 24,932 23,199 17,430 14,863 6.6 - 5.9 +
Check clearing fees 11,839 13,180 11,615 11,129 11,143 9,199 10.2 - 5.2 +
Other 97,314 86,781 80,395 96,180 76,108 42,304 12.1 + 18.1 +
---------------------------------------------------------------------------------------------------------
TOTAL OTHER INCOME 151,661 141,310 137,079 160,174 130,260 87,412 7.3 + 11.7 +
---------------------------------------------------------------------------------------------------------
TOTAL NONINTEREST INCOME $1,640,014 $1,311,935 $1,095,021 $797,097 $788,544 $709,012 25.0 + 18.3 +
---------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------
Certain previously reported amounts have been reclassified to agree with current
presentation.
NM - Due to the variable nature of these items the growth rate is considered to
be not meaningful.
MORTGAGE BANKING
First Horizon Home Loans, an indirect subsidiary of FTNC and the major component
of the First Horizon business segment, offers residential mortgage banking
products and services to customers. First Horizon originates mortgage loans
through its retail and wholesale operations and also purchases mortgage loans
from third-party mortgage bankers (correspondent brokers) for sale to secondary
market investors and subsequently services the majority of those loans. Table 2
provides a summary of First Horizon's production/origination of mortgage loans
during 2003, 2002 and 2001.
TABLE 2 - PRODUCTION/ORIGINATION OF MORTGAGE LOANS
2003 2002 2001
------------------------------------------------------------------------------------------------
Retail channel 56% 57% 55%
Wholesale channel 35 33 33
Correspondent brokers 9 10 12
------------------------------------------------------------------------------------------------
Origination fees, net of costs, and gains or losses from the sale of loans are
recognized at the time a mortgage loan is sold into the secondary market. A
portion of the gain or loss is recognized at the time an interest rate lock
commitment is made to the customer (see Other - Further Interpretations of
SFAS
F-6 First Tennessee National Corporation
No. 133). Secondary marketing activities include gains or losses from secondary
marketing trading gains, product pricing decisions, and gains or losses from the
sale of loans into the secondary market including the capitalized net present
value of the MSRs. First Horizon employs hedging strategies intended to counter
a change in the value of its MSRs through changing interest rate environments
(see Critical Accounting Policies). MSRs hedge gains/(losses) reflect effects of
hedging including servicing rights net value changes (see Other - Accounting
for Derivative Instruments and Hedging Activities). Other income includes income
from the foreclosure repurchase program, gains from a strategic risk management
portfolio sale, and other miscellaneous items. Mortgage trading securities
gains/(losses) relate to market value adjustments primarily on interest-only
strips that are classified as trading securities and related hedges. As shown in
Table 3, total mortgage banking noninterest income increased 41 percent in 2003.
TABLE 3 - MORTGAGE BANKING
Compound Annual
Growth Rates(%)
---------------------
(Dollars and volume in millions) 2003 2002 2001 03/02 03/01
--------------------------------------------------------------------------------------------------------------------
NONINTEREST INCOME:
Origination and secondary marketing activities $ 569.8 $ 413.7 $ 303.2 37.7 + 37.1 +
Mortgage servicing fees 186.7 168.0 157.1 11.1 + 9.0 +
MSRs net hedge results* 115.2 100.8 33.8 NM NM
Other income 38.5 33.2 24.7 16.0 + 24.8 +
Mortgage trading securities net losses (3.1) (11.0) (9.1) 71.8 - 41.6 -
Amortization of MSRs (132.3) (117.8) (109.3) 12.3 + 10.0 +
MSRs impairment loss (158.3) (150.2) (115.4) 5.4 + 17.1 +
-----------------------------------------------------------------------------------------
Total mortgage noninterest income $ 616.5 $ 436.7 $ 285.0 41.2 + 47.1 +
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
Refinance originations $34,268 $22,094 $15,373 55.1 + 49.3 +
New loan originations 13,491 10,837 9,991 24.5 + 16.2 +
-----------------------------------------------------------------------------------------
Mortgage loan originations $47,759 $32,931 $25,364 45.0 + 37.2 +
-----------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------
Servicing portfolio $68,914 $55,993 $45,460 23.1 + 23.1 +
-----------------------------------------------------------------------------------------
* MSRs net hedge results represent the net gain or loss resulting from the
change in value of the hedged component of MSRs and the offsetting change in
value of servicing hedges including time decay of MSRs hedges
(see Note 1 - Summary of Significant Accounting Policies).
NM - Due to the variable nature of these items the growth rate is considered
to be not meaningful.
Certain previously reported amounts have been reclassified to agree with current
presentation.
In 2003 First Horizon received fees derived from the mortgage origination
process (loan origination fees - net of costs, profits from the sale of loans,
and other secondary marketing activities) of $569.8 million compared to $413.7
million in 2002. Origination activity increased 45 percent to $47.8 billion
compared to $32.9 billion in 2002. Heavily influenced by low mortgage interest
rates, refinance activity increased 55 percent to $34.3 billion and represented
72 percent of total originations in 2003 compared to 67 percent in 2002. Home
purchase-related originations grew 24 percent in 2003 due to the continued
expansion of the sales force. In addition, loans securitized and sold into the
secondary market increased 60 percent to $49.6 billion.
While growth in refinance activity produced increased net revenue from
originating and selling mortgage loans, it also increased actual and projected
MSRs prepayment speeds, resulting in a 12 percent increase in MSRs amortization
expense and a 5 percent increase in MSRs impairment loss. The decrease in fair
value of MSRs was partially offset by an increase in the value of the derivative
financial instruments used to hedge the change in fair value of the hedged MSRs.
MSRs net hedge gains were $115.2 million in 2003 compared to $100.8 million in
2002 (both years represent a net increase in the value of hedges over the
decrease in the value of hedged MSRs).
The mortgage-servicing portfolio (which includes servicing for ourselves and
others) totaled $68.9 billion on December 31, 2003, compared to $56.0 billion on
December 31, 2002. The sustained growth of this asset
First Tennessee National Corporation F-7
in a period of high prepayment levels was made possible, in part, by the
recapture of refinances from the existing servicing portfolio. Servicing fees
increased 20 percent as a result of this increase in the servicing portfolio.
However, total fees associated with mortgage servicing increased only 11 percent
to $186.7 million due to the unfavorable impact of early payoffs. Primarily as a
result of the strong originations, there was an increase in capitalized MSRs
during 2003 of $530.4 million, net of sales (see Note 6 - Mortgage Servicing
Rights).
Other mortgage income increased 16 percent to $38.5 million for 2003 compared
with $33.2 million in 2002. The increase was primarily due to an increase of
$5.5 million in earnings from investments in joint ventures and other
partnerships. Income from the agency insured foreclosure repurchase program and
from a strategic risk management portfolio sale, under which First Horizon
repurchased delinquent loans to reduce future foreclosure costs, remained
relatively flat in 2003 at $25.0 million as compared to $25.7 million in 2002.
In 2003 mortgage trading securities net losses were $3.1 million compared to net
losses of $11.0 million in 2002. Mortgage trading securities net gains or losses
represent market value adjustments on interest-only and principal-only strips
and related hedges.
Going forward, revenue from refinance loan originations will depend on mortgage
interest rates. Over time, an increase in rates should reduce origination fees
and profit from the sale of loans, but should also reduce MSRs amortization
expense and impairment losses, while a decrease in rates should increase this
net revenue. Flat to rising interest rates should reduce net secondary marketing
trading gains, while falling rates should increase this net revenue. Home
purchase-related originations should reflect the relative strength or weakness
of the economy. Actual results could differ because of several factors,
including those presented in the Forward-Looking Statements section of the MD&A
discussion.
CAPITAL MARKETS
Capital markets noninterest income, the major component of revenue in the FTN
Financial segment, is primarily generated from the purchase and sale of
securities as both principal and agent and from investment banking, portfolio
advisory and equity research services. Inventory positions are limited to the
procurement of securities solely for distribution to customers by the sales
staff. Inventory is hedged to protect against movements in interest rates.
For 2003 capital markets noninterest income increased 20 percent to $538.9
million from $448.0 million in 2002. This increased revenue reflects continued
growth and penetration into FTN Financial's targeted institutional customer base
through enhanced product and service lines. Revenue growth has also been
influenced by increased liquidity on the part of capital markets' depository
customers (i.e., banks, savings and loans, credit unions) as well as a continued
marketing focus on developing capital markets' non-depository account base
(other institutional investors) through a broad offering of products and
services. Capital markets revenues from depository customers increased 25
percent in 2003 and represented 42 percent of capital markets noninterest income
compared to 41 percent in 2002. Revenues from non-depository customers increased
15 percent and represented 26 percent of capital markets noninterest income
compared to 27 percent in 2002. Noninterest income from other products and
services, which includes investment banking, equity research and sales, and
portfolio advisory services, increased 18 percent and represented 32 percent of
capital markets noninterest income in 2003 compared to 32 percent in 2002. As
shown in Table 4, revenue from depository and non-depository customers as well
as from other sources increased in 2003.
Going forward, revenues will fluctuate based on factors which include the
expansion or contraction of the customer demand for fixed income products which
can be influenced by the strength of loan growth in the U.S. economy and
volatility in the interest rate environment and the equity markets. Also
impacting revenue is the volume of investment banking transactions and the
continued broadening of product offerings. The regulatory environment can also
impact FTN Financial's performance as demonstrated by the current debate over
the regulatory capital treatment of trust preferred securities that have been
deconsolidated under
F-8 First Tennessee National Corporation
FIN 46. If the regulators eventually decide to disallow trust preferred
securities as Tier I regulatory capital, demand for this product may diminish
and, exclusive of any alternative product that may be designed to replace it,
the negative impact to FTNC's earnings in 2004 could be in the range of $.10 to
$.15 per share. The impact on 2004 would be lessened if the implementation of
any disallowance is deferred beyond the first quarter or a redesigned product
attains Tier I capital classification. Actual results could differ because of
several factors, including those presented in the Forward-Looking Statements
section of the MD&A discussion.
TABLE 4 - CAPITAL MARKETS
Compound Annual
Growth Rates(%)
------------------------
(Dollars in millions) 2003 2002 2001 03/02 03/01
----------------------------------------------------------------------------------------------------------------------
NONINTEREST INCOME:
Fixed income - depository $228.4 $182.2 $142.1 25.4 + 26.8 +
Fixed income - non-depository 138.1 119.9 88.5 15.2 + 24.9 +
Other products and services 172.4 145.9 113.7 18.2 + 23.1 +
-------------------------------------------------------------------------------------
Total capital markets noninterest income $538.9 $448.0 $344.3 20.3 + 25.1 +
-------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------
Certain previously reported amounts have been reclassified to agree with current
presentation.
DEPOSIT TRANSACTIONS AND CASH MANAGEMENT
Deposit transactions include services related to retail deposit products (such
as service charges on checking accounts), cash management products and services
such as electronic transaction processing (automated clearing house and
Electronic Data Interchange), account reconciliation services, cash vault
services, lockbox processing, and information reporting (Prime Connection).
Noninterest income from deposit transactions and cash management increased 2
percent in 2003, to $146.7 million from $143.3 million primarily due to an
increase in return check charges.
INSURANCE PREMIUMS AND COMMISSIONS
Insurance premiums and commissions are derived from the sale of insurance
products and annuities. During 2003 total noninterest income from insurance
premiums and commissions increased 15 percent, to $57.8 million from $50.4
million in 2002 primarily due to Synaxis, a wholly owned insurance broker, which
experienced increased revenues from internal expansion and the 2003 acquisition
of an insurance agency. Synaxis contributed $43.9 million to insurance premiums
and commissions in 2003 compared to $38.8 million in 2002.
MERCHANT PROCESSING
Merchant processing involves converting transactions from plastic media such as
debit cards, credit cards, purchase cards, and private label credit cards into
cash for merchants that sell goods and services to consumers and businesses. Fee
income from merchant processing increased 19 percent in 2003, to $57.6 million
from $48.4 million in 2002, primarily due to portfolio acquisitions.
TRUST SERVICES AND INVESTMENT MANAGEMENT
Trust services and investment management fees result from the product lines of
investment management, personal trust, employee benefits, and custodial trust
services. During 2003 total noninterest income from trust services and
investment management decreased 5 percent, to $45.9 million from $48.4 million
in 2002 as difficult equity market conditions negatively impacted results early
in 2003, the effect of which was diminished by the slow recovery experienced
during the second half of 2003. Assets under management increased 3 percent to
$7.6 billion on December 31, 2003, from $7.3 billion on December 31, 2002. The
net decrease in fee income was as follows: the asset management business
decreased 6 percent; personal
First Tennessee National Corporation F-9
trust was down 3 percent; and employee benefits decreased 6 percent primarily
due to exiting less profitable product lines.
GAINS ON DIVESTITURES
Gains from divestitures totaled $22.5 million in 2003 and $4.6 million in 2002.
The gain in 2003 reflects FTNC's divestiture of substantially all of the assets
and liabilities of its wholly owned subsidiary, First National Bank of
Springdale, as well as, the sale of certain merchant relationships referred by
selected agent banks within the merchant portfolio. The gain in 2002 reflects
First Horizon Money Centers' loan portfolio sale and an adjustment to the gain
recognized on the sale of Check Solutions Company in 2001. (See Note 2 -
Acquisitions/Divestitures)
SECURITIES GAINS/(LOSSES)
In 2003 there were $2.4 million of net securities gains compared to $9.2 million
of net securities losses for 2002. Included in this amount were net gains of
$8.6 million from FTNC's wholly-owned venture capital subsidiary, Hickory
Venture Capital Corporation, primarily resulting from the sale of a venture
capital investment, and net losses of $5.9 million primarily resulting from
sales of lower-yielding securities in the investment portfolio. The losses in
2002 were primarily related to other-than-temporary impairment of equity
investments held by FTNC's venture capital subsidiaries.
NET INTEREST INCOME
During 2003 net interest income increased 7 percent to $805.8 million from
$755.6 million in 2002, reflecting a larger portfolio of mortgage warehouse
loans, which grew 46 percent on average to $4.4 billion from $3.0 billion in
2002. This positive impact on net interest income was largely offset by
compression in the net interest margin resulting from the repricing of assets to
lower yields while liability rates have become less sensitive to rate movements
in this historically low interest rate environment, and also due to a change in
the mix of the loan portfolio to a higher percentage of floating rate products.
Investment yields declined as accelerated prepayments of investments in
mortgage-backed securities resulted in increased amortization of premiums in
addition to the effect of proceeds from the prepaid investments being reinvested
at lower rates.
The consolidated margin decreased to 3.78 percent in 2003 compared with 4.35
percent for the same period in 2002. The activity levels and related funding for
FTNC's mortgage production and servicing and capital markets activities affect
the margin. These activities typically produce different margins than
traditional banking activities. Mortgage production and servicing activities can
affect the overall margin based on a number of factors, including the size of
the mortgage warehouse, the time it takes to deliver loans into the secondary
market, the amount of custodial balances, and the level of MSRs. Capital markets
activities tend to compress the margin because of its strategy to reduce market
risk by hedging its inventory in the cash markets, which reduces the term and
accordingly the interest income earned on these positions. As a result, FTNC's
consolidated margin cannot be readily compared to that of other bank holding
companies. Table 5 details the computation of the net interest margin for FTNC
for the last three years.
F-10 First Tennessee National Corporation
TABLE 5 - NET INTEREST MARGIN
2003 2002 2001
-------------------------------------------------------------------------------------------------
CONSOLIDATED YIELDS AND RATES:
Investment securities 4.40% 5.83% 6.53%
Loans, net of unearned income 5.08 6.07 7.83
Other earning assets 4.65 5.43 6.47
-------------------------------------------------------------------------------------------------
Yields on earning assets 4.87 5.88 7.33
-------------------------------------------------------------------------------------------------
Interest-bearing core deposits 1.38 1.91 3.36
Certificates of deposit $100,000 and more 1.34 2.08 4.36
Federal funds purchased and securities sold under
agreements to repurchase .99 1.45 3.66
Commercial paper and other short-term borrowings 3.74 4.02 5.11
Term borrowings 2.64 4.17 5.79
-------------------------------------------------------------------------------------------------
Rates paid on interest-bearing liabilities 1.48 2.04 3.84
-------------------------------------------------------------------------------------------------
NET INTEREST SPREAD 3.39 3.84 3.49
Effect of interest-free sources .32 .40 .67
Loan fees .07 .12 .14
FRB interest and penalties - (.01) (.01)
-------------------------------------------------------------------------------------------------
FTNC - NIM 3.78% 4.35% 4.29%
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------
Certain previously reported amounts have been reclassified to agree with current
presentation.
Table 6 shows how the changes in yields or rates and average balances compared
to the prior year affected net interest income.
First Tennessee National Corporation F-11
TABLE 6 - ANALYSIS OF CHANGES IN NET INTEREST INCOME
2003 Compared to 2002 2002 Compared to 2001
(Fully taxable equivalent) Increase/(Decrease) Due to* Increase/(Decrease) Due to*
-------------------------------- ---------------------------------
(Dollars in thousands) Rate** Volume** Total Rate** Volume** Total
------------------------------------------------------------------------------------------------------------------
INTEREST INCOME - FTE:
Loans $(123,854) $115,334 $ (8,520) $(186,790) $40,832 $(145,958)
Investment securities:
U.S. Treasury and other
U.S. government agencies (33,631) 14,508 (19,123) (13,504) 3,975 (9,529)
States and municipalities (163) (876) (1,039) (113) (1,168) (1,281)
Other (1,095) (10,635) (11,730) (4,121) (10,639) (14,760)
-------------------------------------------- -------- ---------
Total investment securities (36,339) 4,447 (31,892) (17,440) (8,130) (25,570)
-------------------------------------------- -------- ---------
Other earning assets:
Loans held for sale (30,385) 75,438 45,053 (22,318) 40,456 18,138
Investment in bank time deposits (21) (2) (23) (81) (10) (91)
Federal funds sold and securities
purchased under agreements to resell (3,020) 2,515 (505) (5,195) 3,685 (1,510)
Mortgage banking trading securities 1,965 2,413 4,378 90 368 458
Capital markets securities inventory (3,849) 6,288 2,439 (8,070) 2,661 (5,409)
-------------------------------------------- -------- ---------
Total other earning assets (37,362) 88,704 51,342 (39,209) 50,795 11,586
-------------------------------------------- -------- ---------
Total earning assets (201,607) 212,537 10,930 (249,546) 89,604 (159,942)
------------------------------------------------------------------------------ --------------------------------
Total interest income - FTE $ 10,930 $(159,942)
------------------------------------------------------------------------------ --------------------------------
INTEREST EXPENSE:
Interest-bearing deposits:
Savings $ (1,379) $ 24 $ (1,355) $ (1,631) $ (22) $ (1,653)
Checking interest and money market (15,353) 1,036 (14,317) (48,031) 221 (47,810)
Certificates of deposit under $100,000 and
other time (11,589) (2,526) (14,115) (32,100) (7,748) (39,848)
Certificates of deposit $100,000 and more (33,191) 22,683 (10,508) (83,024) 25,773 (57,251)
------------------------------------------- -------- ---------
Total interest-bearing deposits (64,502) 24,207 (40,295) (165,947) 19,385 (146,562)
------------------------------------------- -------- ---------
Federal funds purchased and securities
sold under agreements to repurchase (15,966) 7,412 (8,554) (69,122) (1,027) (70,149)
Commercial paper and other
short-term borrowings (1,748) 4,776 3,028 (6,311) (1,418) (7,729)
Term borrowings (13,304) 20,130 6,826 (9,668) 8,093 (1,575)
------------------------------------------- -------- ---------
Total interest-bearing liabilities (88,251) 49,256 (38,995) (250,264) 24,249 (226,015)
------------------------------------------------------------------------------ --------------------------------
Total interest expense $(38,995) $(226,015)
------------------------------------------------------------------------------ --------------------------------
Net interest income - FTE $ 49,925 $ 66,073
-----------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------
* The changes in interest due to both rate and volume have been allocated to
change due to rate and change due to volume in proportion to the absolute
amounts of the changes in each.
** Variances are computed on a line-by-line basis and are non-additive.
F-12 First Tennessee National Corporation
NONINTEREST EXPENSE
Total noninterest expense for 2003 increased 16 percent to $1,640.1 million from
$1,417.2 million in 2002. Expenses in First Horizon and FTN Financial fluctuate
based on the type and level of activity. Going forward, FTN Financial and First
Horizon will continue to influence the level of noninterest expense. Based on
the strong earnings experienced in recent years, noninterest expense has also
been impacted by investments in cost savings initiatives and revenue enhancing
activities which will impact FTNC's future performance. Table 7 provides detail
by category for the past six years with growth rates.
TABLE 7 - ANALYSIS OF NONINTEREST EXPENSE
Compound
Annual
Growth
Rates(%)
---------------
(Dollars in thousands) 2003 2002 2001 2000 1999 1998 03/02 03/98
------------------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSE:
Employee compensation,
incentives and benefits $ 980,306 $ 830,672 $ 670,934 $508,335 $488,759 $438,648 18.0 + 17.4 +
Occupancy 83,583 76,669 69,069 80,453 73,052 51,421 9.0 + 10.2 +
Equipment rentals,
depreciation and
maintenance 68,973 68,736 74,106 68,230 57,807 45,771 .3 + 8.5 +
Operations services 67,948 60,238 59,635 70,875 64,545 58,505 12.8 + 3.0 +
Communications and courier 50,535 45,085 42,191 41,892 45,311 33,975 12.1 + 8.3 +
Amortization of intangible
assets 7,980 6,200 10,805 11,738 10,492 11,114 28.7 + 6.4 -
All other expense:
Legal and professional
fees 60,001 37,340 32,087 26,794 22,492 24,551 60.7 + 19.6 +
Advertising and public
relations 43,955 35,982 35,508 26,693 30,187 25,184 22.2 + 11.8 +
Travel and entertainment 37,432 22,501 17,489 13,891 18,698 19,485 66.4 + 13.9 +
Contract employment 33,790 28,987 30,082 28,157 40,804 32,615 16.6 + .7 +
Computer software 28,828 26,140 25,107 19,205 15,410 11,629 10.3 + 19.9 +
Supplies 18,783 15,145 13,765 16,411 19,087 16,948 24.0 + 2.1 +
Charitable contributions 13,370 48,337 1,745 1,188 1,335 1,499 72.3 - 54.9 +
Foreclosed real estate 13,137 21,479 25,452 16,080 6,585 31,019 38.8 - 15.8 -
Fed service fees 9,195 9,597 7,761 7,112 6,471 5,307 4.2 - 11.6 +
Distributions on
guaranteed preferred
securities 8,070 8,070 8,070 8,070 8,070 8,070 - -
Deposit insurance premium 2,703 2,393 2,463 2,589 1,790 1,578 13.0 + 11.4 +
Distributions on
preferred stock of
subsidiary 2,282 4,564 4,535 1,178 - - 50.0 - NM
Other 109,231 69,171 71,348 44,636 32,511 29,611 57.9 + 29.8 +
-------------------------------------------------------------------------------------------------
Total other expense 380,777 329,706 275,412 212,004 203,440 207,496 15.5 + 12.9 +
-------------------------------------------------------------------------------------------------
Total noninterest expense $1,640,102 $1,417,306 $1,202,152 $993,527 $943,406 $846,930 15.7 + 14.1 +
-------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------
NM - not meaningful
Certain previously reported amounts have been reclassified to agree with current
presentation.
First Tennessee National Corporation F-13
Personnel expense increased 18 percent to $980.3 million from $830.6 million in
2002. This increase is primarily due to higher activity levels in FTN Financial
and First Horizon. This increase also includes $17.5 million of expense related
to discretionary initiatives including modifications in and funding of an old
deferred compensation plan, primarily for retirees; severance; and a
non-management performance award to build employee value. Also included in the
increase is $3.0 million related to the retirement after 40 years of service of
Ralph Horn as chairman of the board effective December 31, 2003.
Occupancy expense increased 9 percent to $83.6 million compared to $76.7 million
in 2002 primarily due to higher costs in First Horizon associated with the
opening of new offices related to increased origination volumes. Equipment
rentals, depreciation and maintenance expense remained flat in 2003 at $69.0
million compared to $68.7 million in 2002. Operations services increased 13
percent to $67.9 million compared to $60.2 million in 2002, primarily due to
business expansion and costs related to transitioning to a new information
technology provider. Communications and courier expense increased 12 percent to
$50.5 million in 2003 from $45.1 million in 2002 primarily due to the increased
activity levels of First Horizon and FTN Financial. All other expense increased
15 percent to $380.8 million in 2003 from $329.7 million. Contributing to this
increase were investments in initiatives focused on benefiting future
performance, including professional fees, debt restructuring and marketing
programs. Also contributing to the increase was a loss of $16.3 million related
to the termination of a lease arrangement with a single purpose entity for First
Horizon's main office headquarters, the growth in expense associated with higher
activity levels in First Horizon, an increase of $5.3 million related to
insuring certain real estate residential loans, and a $9.8 million contribution
to First Horizon Foundation (previously referred to as First Tennessee
Foundation), a non-profit entity dedicated to supporting charitable causes in
the diverse communities where FTNC does business. Partially offsetting these
increases was a decline in foreclosure losses. In 2002 charitable contributions
included a $45.0 million contribution to First Horizon Foundation. Additional
information related to expenses by business line is provided in Table 8 (see
also Business Line Review for additional information).
TABLE 8 - NONINTEREST EXPENSE COMPOSITION
(Dollars in millions) 2003 2002 2001
--------------------------------------------------------------------------------------------
First Horizon $ 512.6 $ 406.1 $ 348.4
First Tennessee Banking Group 517.3 473.9 423.3
FTN Financial 401.6 329.6 247.7
Transaction Processing 115.9 108.0 92.9
Corporate 92.7 99.6 46.4
Strategic Initiative Items - - 43.4
--------------------------------------------------------------------------------------------
Total noninterest expense $1,640.1 $1,417.2 $1,202.1
--------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------
Certain previously reported amounts have been reclassified to agree with current
presentation.
PROVISION FOR LOAN LOSSES
The provision for loan losses is the charge to operating earnings that
management determines to be necessary to maintain the allowance for loan losses
at an adequate level reflecting management's estimate of probable incurred
losses in the loan portfolio. An analytical model based on historical loss
experience adjusted for current events, trends and economic conditions is used
by management to assess the adequacy of the loan loss allowance and to determine
the amount of provision to be recognized. The provision for loan losses
decreased 6 percent to $86.7 million in 2003 compared to $92.2 million in 2002.
The decline in provision would have been greater except for a combined net
increase of approximately $13 million resulting from the change in risk profile
due to the sale of Money Centers' loans and the transfer of certain
nonperforming loans to held for sale in 2002 which decreased the prior year's
provision and the transfer of certain retail loans to held for sale in 2003
which increased the current year's provision. The improvement in 2003's
provision is related to the positive shift in the mix of the loan portfolio and
F-14 First Tennessee National Corporation
improvement in specific allocations related to large commercial credits. A more
detailed discussion follows in the Risk Management - Credit Risk Management
section.
INCOME TAXES
The effective tax rate for 2003 was 34.2 percent compared to 32.5 percent for
2002. The effective tax rate for 2003 was impacted by the sale of First National
Bank of Springdale which, in addition to tax expense of $4.9 million recognized
from the gain on the sale, resulted in an additional $4.9 million of tax expense
primarily due to the difference in the book value and the tax basis of goodwill
(a total of $9.8 million tax expense). First National Bank of Springdale's
assets were recorded at fair value for book purposes but not for tax purposes
when acquired by FTNC in 1995. Also impacting 2003's tax expense was a decrease
of $6.2 million related to the settlement of prior years' tax returns. In 2002
the change in tax status of a subsidiary of First Tennessee Bank National
Association (FTBNA) resulted in a one-time decrease in tax expense of $7.5
million.
BUSINESS LINE REVIEW
FIRST HORIZON
Pre-tax income for First Horizon increased 58 percent to $428.7 million for
2003, compared to $271.9 million for 2002.
Total revenues were $974.7 million in 2003, an increase of 38 percent from
$705.3 million in 2002.
Noninterest income increased 39 percent to $639.3 million in 2003 compared to
$460.6 million in 2002. Noninterest income consists primarily of mortgage
banking-related revenue, net of costs, from the origination and sale of mortgage
loans, fees from mortgage servicing and mortgage servicing rights (MSRs) net
hedge gains or losses. Total noninterest income is net of amortization,
impairment and other expenses related to MSRs and related hedges.
Loan origination volume increased 45 percent in 2003 to $47.8 billion compared
to $32.9 billion in 2002. Contributing to the growth in origination activity
were home purchase-related originations of $13.5 billion which grew 24 percent
in 2003 due to continued expansion of the sales force. Heavily influenced by low
mortgage interest rates, refinance activity represented 72 percent of total
originations during 2003 compared to 67 percent in 2002. In addition, loans
securitized and sold into the secondary market increased 60 percent to $49.6
billion. Net revenue from originating and selling mortgage loans (generally
driven by either origination volumes or loans securitized and sold) increased
38 percent to $569.8 million compared to $413.7 million in 2002.
The mortgage-servicing portfolio (which includes servicing for ourselves and
others) was $68.9 billion on December 31, 2003, an increase of 23 percent
compared to $56.0 billion on December 31, 2002. Servicing fees increased 20
percent as a result of this increase in the servicing portfolio. Servicing fees
were negatively impacted by a lower level of GNMA mortgages, which earn higher
servicing fees. Total fees associated with mortgage servicing increased only 11
percent to $186.7 million due to the unfavorable impact of early payoffs.
MSRs amortization was $132.3 million in 2003 compared with $117.8 million in
2002. In 2003 there was a MSRs impairment loss of $158.3 million compared to a
$150.2 million loss in 2002. The decrease in fair value of MSRs was partially
offset by an increase in the value of the derivative financial instruments used
to hedge the change in fair value of the hedged MSRs. Net MSRs hedging gains
(including the effect of time decay) were $115.2 million in 2003 compared to
$100.8 million net gains in 2002. The interest rate environment in 2003 impacted
both increased net hedge gains and increased MSRs amortization and impairment
losses.
First Tennessee National Corporation F-15
The provision for loan losses was $33.4 million in 2003 compared to $27.3
million in 2002. The change in provision reflects a decrease of approximately
$10 million in 2002 resulting from a change in risk profile due to the sale of
Money Center loans and from certain nonperforming loans being transferred to
held for sale. An increase of approximately $3 million in 2003 resulted from
retail loans being transferred to held for sale. Considering the effect of these
items, 2003's provision reflects a net reduction that is related to the
improvement in the risk profile of the retail loan portfolio.
Net interest income increased 37 percent to $335.4 million in 2003 from $244.7
million in 2002. Net interest income in First Horizon Equity Lending increased
$34.2 million, primarily due to an increase of 118 percent in home equity lines
of credit which averaged $2.1 billion in 2003 compared to $1.0 billion in 2002.
The remaining increase of $56.5 million in net interest income primarily
reflects the impact of a larger portfolio of loans held for sale (warehouse),
which grew 46 percent on average to $4.4 billion in 2003 from $3.0 billion in
2002. Construction lending contributed $11.6 million to the growth in net
interest income as the construction loan portfolio grew 60 percent to
$.7 billion in 2003. Net interest spread on the warehouse, however, was
negatively impacted by lower mortgage rates compared to 2002.
Noninterest expense increased 26 percent in 2003 to $512.6 million compared to
$406.1 million in 2002. The growth was primarily the result of a 17 percent
increase in personnel expense resulting from higher commission expense related
to the increased mortgage origination volume produced during 2003. The impact of
First Horizon's initiative to grow the retail sales force is also reflected in
this expense growth. In 2003 the sales force increased by approximately
50 percent. In addition to the increased personnel expense, the higher activity
levels also impacted various other categories of noninterest expense.
Going forward, revenue from refinance loan originations will generally depend on
mortgage interest rates. Over time, an increase in rates should reduce
origination fees and profit from the sale of loans, but should also reduce MSRs
amortization expense and impairment losses, while a decrease in rates should
increase this net revenue. Flat to rising interest rates should reduce net
secondary marketing trading gains, while falling rates should increase this net
revenue. Competitive pricing pressures can also reduce net secondary marketing
trading gains. If total origination volume increases and/or the yield curve
steepens, net interest income from the warehouse should increase, while if
volume decreases and/or the yield curve flattens, this revenue should decrease.
Continued success in national cross-sell strategies should continue to increase
revenues from products other than traditional mortgage origination and
servicing. In addition, third party agreements are expected to begin adding
incremental consumer loan origination volume during 2004, gradually reaching a
level of approximately $300 million a quarter.
FIRST TENNESSEE BANKING GROUP
Pre-tax income for First Tennessee Banking Group decreased 17 percent to
$174.8 million for 2003, compared to $210.5 million for 2002. This decline was
driven by a $42.4 million drop in net interest income; however, balance sheet
leveraging capacity which is normally used within First Tennessee Banking Group
has been employed by the First Horizon segment as growth in the mortgage
warehouse produced approximately $45 million in net interest income growth over
2002.
Total revenues were $744.4 million for 2003 compared to $748.6 million for 2002.
Net interest income decreased 9 percent to $411.2 million in 2003 from $453.6
million in 2002. The decline in net interest income was related to compression
in the net interest margin primarily due to the repricing of assets to lower
yields while liability rates have become less sensitive to rate movements in the
historically low interest rate environment experienced in 2003 and due to a
change in the mix of the loan portfolio to a higher percentage of floating rate
products. Investment yields declined as accelerated prepayments of investments
in mortgage-backed securities resulted in increased amortization of premiums in
addition to the effect of proceeds from the prepaid investments being reinvested
at lower rates.
Noninterest income increased 13 percent in 2003 to $333.2 million compared to
$295.0 million in 2002. This increase was due, in part, to a pre-tax divestiture
gain of $12.5 million from the sale of FTNC's wholly owned subsidiary, First
National Bank of Springdale (see also Income Taxes above). Net securities gains
F-16 First Tennessee National Corporation
were $2.4 million in 2003, compared with net losses of $9.2 million in 2002.
Included in the 2003 securities gains were net gains of $8.6 million from FTNC's
wholly owned venture capital subsidiary, Hickory Venture Capital Corporation,
primarily resulting from the sale of a venture capital investment and net losses
of $5.9 million primarily resulting from sales of lower-yielding securities in
the investment portfolio. The losses in 2002 were primarily related to
other-than-temporary impairment of equity investments held by FTNC's venture
capital subsidiaries. Also contributing to the increase in noninterest income
was growth of 14 percent in insurance revenue due to FTNC's focus on growing
this business, including the effect of recent acquisitions and a 13 percent
increase in return check charges.
The provision for loan losses decreased to $52.3 million in 2003 from $64.2
million in 2002, primarily due to improvement in specific allocations related to
large commercial credits. (Further discussion of asset quality trends is
included in the Risk Management - Credit Risk Management section below.) Going
forward, the level of provision for loan losses should fluctuate primarily with
the strength or weakness of the Tennessee economy.
Noninterest expense increased 9 percent in 2003 to $517.3 million from
$473.9 million in 2002. Contributing to this increase were investments in
initiatives promoting expense efficiencies and enhancing revenue growth of
approximately $23 million in 2003 compared to approximately $9 million in 2002,
higher personnel costs of $4.4 million related to growth in Synaxis, and
$1.4 million of incentives associated with the sale of a venture capital
investment.
FTN FINANCIAL
Pre-tax income for FTN Financial increased 15 percent to $184.5 million for
2003, compared to $159.8 million for 2002.
Total revenues increased 20 percent to $587.1 million compared to
$490.1 million in 2002. Noninterest income increased 20 percent in 2003 to
$548.3 million from $455.2 million in 2002. This increased revenue reflects
continued growth and penetration into FTN Financial's targeted institutional
customer base through enhanced product and service lines. Revenue growth has
also been influenced by increased liquidity on the part of capital markets'
depository customers as well as continued growth in capital markets'
non-depository account base. Capital markets' revenues from depository customers
increased 25 percent and represented 39 percent of revenue, while revenues from
non-depository customers increased 15 percent and represented 24 percent of
revenue. Other revenue sources, which include investment banking, equity
research and sales, correspondent services and portfolio advisory services,
increased 17 percent and contributed 37 percent of revenue.
The provision for loan losses was $1.0 million in 2003 compared to $.7 million
in 2002.
Noninterest expense increased 22 percent in 2003 to $401.6 million compared to
$329.6 million in 2002. This growth was primarily due to an increase of
20 percent in personnel expense, the largest component of noninterest expense,
resulting from commissions and incentives associated with the higher revenue
this year.
Going forward, revenues will fluctuate based on factors which include the
expansion or contraction of customer demand for fixed income products which can
be influenced by the strength of loan growth in the U.S. economy and volatility
in the interest rate environment and equity markets. Also impacting revenue is
the volume of investment banking transactions and the continued broadening of
product offerings. The regulatory environment can also impact FTN Financial's
performance as demonstrated by the current debate over the regulatory capital
treatment of trust preferred securities that have been deconsolidated under
FIN 46. If the regulators eventually decide to disallow trust preferred
securities as Tier I regulatory capital, demand for this product may diminish
and, exclusive of any alternative product that may be designed to replace it,
the negative impact to FTNC's earnings in 2004 could be in the range of $.10 to
$.15 per share. The impact on 2004 would be lessened if the implementation of
any disallowance is deferred beyond the first quarter or a redesigned product
attains Tier I capital classification.
First Tennessee National Corporation F-17
TRANSACTION PROCESSING
Pre-tax income for Transaction Processing increased 51 percent to $18.7 million
for 2003, compared to $12.4 million for 2002.
Total revenues were $134.6 million in 2003, an increase of 12 percent from
$120.4 million in 2002. Merchant revenues increased 35 percent in 2003, due
largely to a divestiture gain of $10.0 million resulting from the sale of
certain merchant relationships referred by selected agent banks within the
merchant portfolio, as management further isolates core competencies. Also
impacting merchant revenue growth were acquisitions and limited recovery in the
hospitality industry as transactions processed increased 18 percent. Express
processing revenues decreased 6 percent as the volume of transactions processed
for customers declined 9 percent compared to 2002.
Noninterest expense increased 7 percent in 2003 to $115.9 million compared to
$108.0 million in 2002. Losses of $8.7 million in 2003 were related to
chargebacks of a failed merchant client. In 2002, operational processing errors
resulted in losses of $8.5 million, primarily related to research adjustment
items that were initially mishandled, causing them to become uncollectible.
CORPORATE
The Corporate segment's results showed a pre-tax loss of $86.5 million in 2003,
compared to a pre-tax loss of $95.0 million in 2002. 2003's pre-tax loss
included investments in cost saving initiatives and revenue enhancing activities
of approximately $48 million, primarily incurred in the first three quarters of
2003. These investments focused on initiatives to develop an infrastructure to
support business expansion and to curtail costs. In 2002 the pre-tax loss
included approximately $54 million of similar investment initiatives.
INCOME STATEMENT ANALYSIS - 2002 COMPARED TO 2001
Earnings in 2002 were $376.5 million, an increase of 18 percent from
$318.2 million earned in 2001. Diluted earnings per common share increased
19 percent to $2.89 in 2002 from $2.42 in 2001. Return on average assets was
1.82 percent in 2002 compared with 1.66 percent in 2001, and return on average
shareholders' equity was 24.0 percent in 2002 compared with 22.7 percent in
2001.
Noninterest income increased 20 percent during 2002, to $1,311.9 million from
$1,095.0 million and contributed 63 percent to total revenue in 2002 compared to
61 percent in 2001. During 2002 mortgage-banking noninterest income increased
53 percent to $436.7 million from $285.0 million, due to increased origination
volumes resulting from declining interest rates. This increased activity
resulted in higher net fees from the mortgage origination process which
increased 36 percent to $413.7 million in 2002. While growth in refinance
activity produced increased origination fee income, it also substantially
increased actual and projected MSRs prepayment speeds, which was the primary
reason for the 8 percent increase to $117.8 million, in MSRs amortization
expense, and a $150.2 million impairment loss in 2002 compared to a $115.4
million loss in 2001. The decrease in fair value of MSRs attributed to declining
interest rates was significantly offset by an expected increase in the value of
the derivative financial instruments used to hedge the change in fair value of
the hedged MSRs. MSRs net hedge gains were $100.8 million in 2002 compared to
$33.8 million in 2001 (both years represent an increase in the value of hedges
offset by a decrease in the value of hedged MSRs). See Table 3 for a breakout of
mortgage banking noninterest income. In 2002 capital markets noninterest income
increased 30 percent to $448.0 million from $344.3 million. This increase
reflects continued growth and penetration into the targeted institutional
customer base through expanded products, services, sales force and marketing
efforts. Additionally, revenue was favorably impacted in 2002 by increased
liquidity of depository institution customers as deposit growth exceeded loan
growth and by changes in the interest rate environment and the equity markets.
During 2002 deposit transactions and cash management fees increased 7 percent to
$143.3 million from $133.6 million, primarily due to growth in cash management
fees related primarily to a lower earnings credit rate on corporate deposits.
During 2002 insurance premiums and commissions increased 199 percent to $50.4
F-18 First Tennessee National Corporation
million from $16.8 million. This increase was due to the acquisition of Synaxis,
a Nashville-based insurance broker operating through a network of major regional
and community-based insurance agencies in Georgia, Kentucky and Tennessee, on
December 31, 2001. Synaxis contributed $38.8 million to insurance premiums and
commissions in 2002. Merchant processing fees increased 7 percent to $48.4
million from $45.4 million, primarily due to a portfolio acquisition in second
quarter 2002. During 2002 total noninterest income from trust services and
investment management decreased 15 percent, to $48.4 million from
$56.7 million. This decrease was primarily due to declining asset management
fees related to a contraction in equity market valuations. Assets under
management fell 15 percent to $7.3 billion on December 31, 2002, from
$8.7 billion on December 31, 2001. Gains from divestitures totaled $4.6 million
and $80.4 million in 2002 and 2001, respectively. The gains in 2002 reflect
First Horizon Money Centers' loan portfolio sale and an adjustment to the gain
recognized on the sale of Check Solutions Company in 2001. The gains in 2001
reflect FTNC's divestitures of its interests in Check Solutions Company, the
sale of Peoples and Union Bank, the sale of a portfolio of student loans, the
final phase of the sale of certain single relationship credit card accounts, and
an earn-out related to the 2000 divestiture of FTNC's corporate and municipal
trust business (see Note 2 - Acquisitions/Divestitures). In 2002 there were
$9.2 million of net securities losses compared with $4.3 million of net
securities losses for 2001. In 2002 and 2001, the losses were primarily related
to impairment of equity investments held by FTNC's venture capital subsidiaries.
All other noninterest income increased 3 percent in 2002, to $141.3 million from
$137.1 million, with the growth being spread over several categories.
During 2002 net interest income increased 10 percent to $755.6 million from
$688.9 million. Earning assets growth of 8 percent generated most of this
increase and was primarily related to rising levels of mortgage originations
pushing the mortgage warehouse higher and the increase in home equity lines of
credit. The consolidated net interest margin increased to 4.35 percent for 2002
compared with 4.29 percent for 2001. See Table 5 for detailed computation of the
net interest margin for FTNC.
The provision for loan losses decreased 1 percent, to $92.2 million in 2002
compared with $93.2 million in 2001, reflecting improvement in asset quality of
retail loans, the impact of whole-loan insurance being provided for a segment of
the retail loan portfolio and the change in risk profile after the sale of the
Money Centers' loans.
Total noninterest expense for 2002 increased 18 percent to $1,417.2 million from
$1,202.1 million in 2001. The acquisition of Synaxis impacted the results in
2002, adding $34.2 million to noninterest expense. Expenses in First Horizon and
FTN Financial fluctuate based on the type and level of activity. Employee
compensation, incentives and benefits increased 24 percent to $830.6 million
from $670.9 million in 2001, due to higher activity levels for both FTN
Financial and First Horizon and the Synaxis acquisition. Occupancy expense
increased 11 percent to $76.7 million compared to $69.1 million in 2001
primarily due to costs associated with the opening of new offices by First
Horizon Home Loans due to increased origination volume and due to expenses
incurred by Synaxis. Equipment rentals, depreciation and maintenance expense
decreased 7 percent in 2002 to $68.7 million from $74.1 million in 2001
primarily due to losses in 2001 on disposals of fixed assets including those
related to office closings. Operations services remained relatively flat at
$60.2 million compared to $59.6 million in 2001. Communications and courier
expense increased 7 percent to $45.1 million from $42.2 million in 2001,
primarily due to the increased activity levels of FTN Financial. All other
expense increased 20 percent to $329.7 million from $275.4 million in 2001. This
increase includes the $45.0 million contribution to First Horizon Foundation.
BALANCE SHEET REVIEW
On December 31, 2003, FTNC reported total assets of $24.5 billion compared with
$23.8 billion at the end of 2002 and $20.6 billion at the end of 2001. Average
assets were $25.1 billion in 2003 compared with $20.7 billion in 2002 and
$19.2 billion in 2001. In 2003 an increase in earning assets accounted for
89 percent of the growth in average assets.
First Tennessee National Corporation F-19
EARNING ASSETS
Earning assets primarily consist of loans, loans held for sale and investment
securities. During 2003, earning assets averaged $21.3 billion compared with
$17.4 billion and $16.1 billion for 2002 and 2001, respectively. Average earning
assets were 85 percent of total average assets in 2003, compared with
84 percent in 2002 and 2001.
LOANS
Average loans increased 19 percent to $12.7 billion during 2003 principally as a
result of the 37 percent increase in retail residential loans, and grew 5
percent to $10.6 billion during 2002. FTNC sold substantially all of the assets
and liabilities of First National Bank of Springdale with total loans of
approximately $165 million on December 31, 2003, and sold approximately $200
million of loans originated through its Money Centers in 2002. Average loans
represented 59 percent of average earning assets in 2003; 61 percent in 2002;
and 63 percent in 2001. In prior years, FTNC has securitized certain real estate
loans through a real estate mortgage investment conduit (REMIC) and retained all
of the securitized assets. The retained assets were classified on the
Consolidated Statements of Condition in 'Securities held to maturity'. During
2003, FTNC elected to purchase all of the mortgage loans remaining in the REMIC
($136.3 million at repurchase). Subsequent to the repurchase of the mortgage
loans, these assets are classified as retail real estate residential loans.
Additional loan information is provided in Table 9 and Note 4 - Loans.
TABLE 9 - AVERAGE LOANS
2003 2002
PERCENT GROWTH Percent Growth Percent
(Dollars in millions) 2003 OF TOTAL RATE 2002 of Total Rate 2001 of Total
------------------------------------------------------------------------------------------------------------------------
Commercial:
Commercial, financial and
industrial $ 4,304.6 34% 8.0 % $ 3,986.6 37% (2.2)% $ 4,075.2 40%
Real estate commercial 1,056.4 8 2.7 1,028.7 10 9.3 941.2 9
Real estate construction 632.9 5 22.4 516.7 5 18.4 436.2 4
------------------------------------------------------ ------------------ --------------------
Total commercial 5,993.9 47 8.3 5,532.0 52 1.5 5,452.6 53
------------------------------------------------------ ------------------ --------------------
Retail:
Real estate residential 5,716.9 45 36.6 4,185.1 39 15.8 3,613.6 36
Real estate construction 424.0 4 61.9 261.9 2 40.4 186.5 2
Other retail 259.5 2 (33.6) 390.7 4 (32.2) 575.9 6
Credit card receivables 262.0 2 (1.1) 264.8 3 (4.0) 275.7 3
------------------------------------------------------ ------------------ --------------------
Total retail 6,662.4 53 30.6 5,102.5 48 9.7 4,651.7 47
------------------------------------------------------ ------------------ --------------------
Total loans, net of unearned $12,656.3 100% 19.0 % $10,634.5 100% 5.2 % $10,104.3 100%
------------------------------------------------------ ------------------ --------------------
------------------------------------------------------ ------------------ --------------------
Commercial loans consist of commercial, financial and industrial; commercial
real estate; and commercial construction loans. Commercial, financial and
industrial loans continued as the single largest loan category within commercial
loans and represented 72 percent of the commercial loan portfolio in 2003 and
2002 compared to 75 percent in 2001. Commercial, financial and industrial loans
increased 8 percent, or $318.0 million, in 2003 largely due to management's
decision to discontinue its loan funding arrangement with a commercial paper
conduit facility. Loans that were referred to this facility were not reflected
on FTNC's Consolidated Statements of Condition. Loans that previously would have
been referred to the conduit are now included in FTNC's commercial portfolio.
Commercial construction loans grew 22 percent in 2003 or $116.2 million, after
increasing 18 percent or $80.5 million in 2002. Commercial construction lending
increased in 2003, primarily from growth in loans to single-family residential
builders made through First Horizon, reflecting the strong demand for
single-family housing and expansion of the sales force and geographic reach.
Additional commercial loan information is provided in Table 10.
F-20 First Tennessee National Corporation
TABLE 10 - CONTRACTUAL MATURITIES OF COMMERCIAL LOANS ON DECEMBER 31, 2003
After 1 Year
(Dollars in thousands) Within 1 Year Within 5 Years After 5 Years Total
-------------------------------------------------------------------------------------------------------------------
Commercial, financial and industrial $2,375,062 $1,849,213 $278,642 $4,502,917
Real estate commercial 312,414 522,166 133,484 968,064
Real estate construction 521,134 167,744 1,524 690,402
-------------------------------------------------------------------------------------------------------------------
Total commercial loans, net of unearned income $3,208,610 $2,539,123 $413,650 $6,161,383
-------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------
For maturities over one year:
Interest rates-floating $1,462,043 $153,618 $1,615,661
Interest rates-fixed 1,077,080 260,032 1,337,112
-------------------------------------------------------------------------------------------------------------------
Total $2,539,123 $413,650 $2,952,773
-------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------
The retail loan portfolio consists of residential real estate (principally
secured by first and/or second liens on residential property), other retail
(automobile and other retail installment loans requiring periodic payments of
principal and interest), credit card, and retail construction loans. Residential
real estate loans accounted for 86 percent of the retail loan portfolio in 2003,
82 percent in 2002 and 78 percent in 2001. The residential real estate loan
portfolio grew 37 percent or $1.5 billion in 2003, and grew 16 percent or $571.5
million in 2002, primarily due to growth in home equity lines of credit. The
retail real estate construction portfolio increased 62 percent or $162.1 million
in 2003, after growing 40 percent or $75.4 million in 2002. Retail real estate
residential construction loans are made to individuals for the purpose of
constructing a home where First Horizon is committed to make the permanent
mortgage. The increase in these loans reflects the favorable housing environment
and expansion of the sales force and geographic reach. Other retail loans
decreased 34 percent or $131.2 million in 2003 largely due to a decline in
automobile lending, and decreased 32 percent or $185.2 million in 2002, due in
part to the divestiture of the Money Centers' loans in 2002 (See
Note 2 - Acquisitions/Divestitures for additional information).
Going forward, FTNC expects loan growth to reflect the relative strength of the
economy and the continued success of the sales force and national expansion
efforts. FTNC will continue to evaluate alternative sources of funding which may
include loan sales, securitizations, syndications, equity offerings and debt
offerings.
INVESTMENT SECURITIES
The investment portfolio of FTNC consists principally of debt securities used as
a source of income, liquidity and collateral for repurchase agreements or public
fund deposits. Additionally, the investment portfolio is used as a tool to
manage risk from movements in interest rates. On December 31, 2003, the
investment portfolio totaled $2.5 billion. The investment portfolio is
classified into two categories: securities available for sale (AFS) and
securities held to maturity (HTM). Table 11 shows information pertaining to the
composition, yields and contractual maturities of the investment securities
portfolio.
First Tennessee National Corporation F-21
TABLE 11 - CONTRACTUAL MATURITIES OF INVESTMENT SECURITIES ON DECEMBER 31, 2003
(AMORTIZED COST)
After 1 Year After 5 Years
Within 1 Year Within 5 Years Within 10 Years After 10 Years
----------------- ------------------ ------------------- --------------------
(Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield
-----------------------------------------------------------------------------------------------------------------------------
SECURITIES HELD TO MATURITY (HTM):
States and municipalities* $ 569 8.42% $ 459 8.27% $ - -% $ - -%
-----------------------------------------------------------------------------------------------------------------------------
Total $ 569 8.42% $ 459 8.27% $ - -% $ - -%
-----------------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE (AFS):
Mortgage-backed securities and
collateralized mortgage obligations** $ 8 7.69% $ 1,342 7.13% $45,861 4.60% $2,149,621 4.48%
U.S. Treasury and other U.S.
government agencies 12,666 1.04 35,739 2.15 364 4.26 92 2.43
States and municipalities* 200 9.58 991 7.32 - - 11,885 6.90
Other 5,175 8.10 7,887 6.08 3,538 5.76 188,793*** 3.75
-----------------------------------------------------------------------------------------------------------------------------
Total $18,049 3.16% $45,959 3.08% $49,763 4.68% $2,350,391 4.44%
-----------------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------------
* Weighted average yields on tax-exempt obligations have been computed by
adjusting allowable tax-exempt income to a fully taxable equivalent basis
using a tax rate of 34 percent.
** Represents government agency issued mortgage-backed securities and
collateralized mortgage obligations which, when adjusted for early paydowns,
have an estimated average life of 3.6 years.
*** Represents equity securities with no stated maturity.
Investment securities averaged $2.5 billion in both 2003 and 2002. During 2002
average investment securities decreased 5 percent or $128.9 million, primarily
due to declining balances of retained securitization interests, which paid down
without being replenished. Investment securities represented 12 percent of
earning assets in 2003, 14 percent in 2002 and 16 percent in 2001.
On December 31, 2003, the AFS securities totaled $2.5 billion and consisted
primarily of mortgage-backed securities, collateralized mortgage obligations
(CMOs), U.S. Treasuries, U.S. government agencies, and equities. On
December 31, 2003, these securities had $5.2 million of net unrealized gains
that resulted in an increase in book equity of $3.2 million, net of $2.0 million
of deferred income taxes (see Note 3 - Investment Securities for additional
detail). On December 31, 2002, the AFS securities portfolio totaled $2.4 billion
and had $45.5 million of net unrealized gains that resulted in an increase in
book equity of $28.0 million, net of $17.5 million of deferred income taxes. On
December 31, 2001, the AFS securities portfolio totaled $2.1 billion and had
$39.9 million of net unrealized gains that resulted in an increase in book
equity of $24.5 million, net of $15.4 million of deferred income taxes.
On December 31, 2003, the HTM securities represented $1.0 million of municipal
securities with a fair value of $1.1 million. On December 31, 2002, and
December 31, 2001, HTM securities included privately issued CMOs and municipal
securities. The privately issued CMOs represent retail real estate loans that
have been securitized and retained through a REMIC (see also Balance Sheet
Review - Loans). On December 31, 2002, the HTM securities totaled $280.4
million and had a fair value of $284.5 million, and on December 31, 2001,
totaled $461.3 million and had a fair value of $459.1 million.
LOANS HELD FOR SALE/RETAINED INTERESTS
Loans held for sale consist of the mortgage warehouse, student loans, small
issuer trust preferred securities, and home equity lines of credit. The
warehouse accounts for the majority of loans held for sale. Loans held for sale
represented 21 percent of total earning assets in 2003 compared with 17 percent
in 2002 and 15 percent in 2001. During 2003 loans held for sale averaged $4.4
billion and increased 46 percent or $1.4 billion from 2002 as a result of a
higher level of originations. During 2002 loans held for sale averaged $3.0
billion and increased 27 percent or $636.2 million from 2001. Since the mortgage
warehouse loans are generally held in inventory for a short period of time,
there may be significant differences between average
F-22 First Tennessee National Corporation
and period-end balances. At year-end 2003, loans held for sale totaled $3.0
billion compared with $4.8 billion and $3.4 billion at year-end 2002 and 2001,
respectively.
When First Horizon sells mortgage loans in the secondary market to investors, it
generally retains the right to service the loans sold in exchange for a
servicing fee that is collected over the life of the loan as the payments are
received from the borrower. The expected present value of the anticipated cash
flows received for servicing the loan, net of the estimated costs of servicing
the loan, is capitalized as an asset known as MSRs on the Consolidated
Statements of Condition (refer to discussion of MSRs under Critical Accounting
Policies). During 2003, First Horizon originated $536.7 million of MSRs in
connection with sales of mortgage loans in the secondary market compared to
$401.9 million in 2002. On December 31, 2003 and 2002, the total outstanding
principal amount of First Horizon's servicing portfolio aggregated $68.9 billion
and $56.0 billion, respectively.
In certain cases, when mortgage loans are sold in the secondary market, First
Horizon retains an interest in the mortgage loans sold through an interest-only
or principal-only certificate. During 2003, $165.3 million and $3.7 million of
interest-only and principal-only certificates, respectively, were retained
through the sale of mortgage loans in the secondary markets. This compares to
$124.8 million of interest-only and $1.5 million of principal-only certificates
retained in 2002 (see Note 24 - Securitizations for additional information on
retained interests).
DEPOSITS AND OTHER SOURCES OF FUNDS
DEPOSITS
During 2003 core deposits increased 11 percent, or $1.0 billion, and averaged
$10.7 billion. In 2002 core deposits increased 4 percent, or $373.2 million, to
an average balance of $9.7 billion from $9.3 billion in 2001. Interest-bearing
core deposits averaged $5.8 billion in 2003 and 2002, after decreasing 2 percent
or $147.6 million from 2001, primarily due to the loss of funds related to one
institutional investor. Noninterest-bearing core deposits, which averaged $4.9
billion in 2003, grew 26 percent or $1.0 billion. This growth was largely due to
an increase in mortgage custodial and clearing accounts resulting from the
strong mortgage origination volume experienced in 2003 and an increase in
corporate deposits. In 2002, noninterest-bearing core deposits grew 16 percent
or $520.9 million for the same reasons and averaged $3.9 billion.
Noninterest-bearing core deposits averaged $3.3 billion in 2001.
OTHER SOURCES OF FUNDS
Short-term purchased funds averaged $9.5 billion for 2003, up 27 percent or $2.0
billion from the previous year. The increase in short-term purchased funds was
used to fund earning assets growth of 23 percent or $3.9 billion in 2003.
Short-term purchased funds increased 9 percent or $644.0 million in 2002 and
averaged $7.5 billion and $6.9 billion during 2002 and 2001, respectively.
Short-term purchased funds accounted for 44 percent of FTNC's funding (core
deposits plus purchased funds and term borrowings) in 2003, 42 percent in 2002,
and 41 percent in 2001 (see Note 9 - Short-Term Borrowings for additional
information).
Term borrowings included senior and subordinated borrowings and advances with
original maturities greater than one year. Term borrowings averaged $1.3 billion
in 2003, an increase of 96 percent or $657.4 million, compared to an average of
$.7 billion in 2002 and an increase of 31 percent from $.5 billion in 2001.
2003's increase in term borrowings was also utilized in funding earning asset
growth. Term borrowings on December 31, 2003, were $1.7 billion, an increase of
86 percent, or $797.1 million from 2002 year-end (see Note 10 - Term Borrowings
for additional information). This increase includes the effect of adopting
FIN 46, which resulted in the deconsolidation of First Tennessee Capital I
(Capital I), subsequent to which $100.0 million of capital securities previously
included in mezzanine capital are no longer included on FTNC's balance sheet.
However, $103.0 million in junior subordinated debentures issued by FTNC to
Capital I are no longer eliminated in consolidation and appear in term
borrowings as of December 31, 2003. Also reflected in the increase in term
borrowings is the effect of adopting SFAS No. 150, which resulted in the
First Tennessee National Corporation F-23
reclassification of mandatorily redeemable preferred stock of subsidiary,
previously included in mezzanine capital, to term borrowings (see Note 1 -
Summary of Significant Accounting Policies for additional information).
CAPITAL
Capital adequacy is an important indicator of financial stability and
performance. Management's objectives are to maintain a level of capitalization
that is sufficient to sustain asset growth, take advantage of profitable growth
opportunities and promote depositor and investor confidence. Overall, FTNC's
capital position remained strong as shown in Table 12. Unrealized market
valuations had no material effect on the ratios.
TABLE 12 - CAPITAL RATIOS
2003 2002 2001
--------------------------------------------------------------------------------------------
Average shareholders' equity to average assets 7.16% 7.58% 7.29%
Period-end shareholders' equity to assets 7.72 7.10 7.17
Period-end double leverage 105.2 106.6 105.9
--------------------------------------------------------------------------------------------
Banking regulators define minimum capital ratios for bank holding companies and
their bank subsidiaries. Based on the capital rules and definitions prescribed
by the banking regulators, should any depository institution's capital ratios
decline below predetermined levels, it would become subject to a series of
increasingly restrictive regulatory actions. The system categorizes a depository
institution's capital position into one of five categories ranging from
well-capitalized to critically under-capitalized. For an institution to qualify
as well-capitalized, Tier 1 Capital, Total Capital and Leverage capital ratios
must be at least 6 percent, 10 percent and 5 percent, respectively. As of
December 31, 2003, FTNC and FTBNA had sufficient capital to qualify as
well-capitalized institutions as shown in Note 13 - Regulatory Capital. As
discussed in Deposits, Other Sources of Funds and Liquidity Management, First
Horizon uses single-purpose business trusts to securitize and sell
non-conforming (due to exceeding the FNMA and FHLMC allowable size of loans)
loans, which, therefore, are not reflected on FTNC's Statements of Condition.
Even if these loans had not been securitized and sold and were included on the
Statements of Condition, FTNC and FTBNA would have been well capitalized.
Shareholders' equity was $1.9 billion at year-end 2003, up 12 percent from 2002,
which increased 14 percent from year-end 2001. The increase in shareholders'
equity during 2003 and 2002 came from retention of net income after dividends
and the effects of stock option exercises reduced by shares repurchased. The
Consolidated Statements of Shareholders' Equity highlight the changes in equity
since December 31, 2000.
On December 31, 2003, the closing sales price of FTNC's common stock was $44.10
per share. The annual dividend yield for 2003 was 3.6 percent based on dividends
declared in 2003 and the closing market price of $35.94 on December 31, 2002.
FTNC's board of directors has previously approved the purchase of shares
authorized for issuance under each of FTNC's various benefit plans. During 2003,
FTNC repurchased 4.4 million shares while 4.1 million shares were issued for
benefit plans. During 2002, FTNC repurchased 2.9 million shares while 2.8
million shares were issued for benefit plans. During 2001, FTNC repurchased 4.9
million shares while 4.4 million shares were issued for benefit plans. On
October 16, 2001, FTNC's board of directors extended from June 30, 2002, until
December 31, 2004, the non-stock option plan-related authority to repurchase up
to 9.5 million shares, previously approved in October 2000. Repurchases will be
made in the open market or through privately negotiated transactions and will be
subject to market conditions, accumulation of excess equity and prudent capital
management. In total, repurchases by FTNC pursuant to this authority were
..5 million shares during 2003, .2 million shares during 2002 and 2.3 million
shares during 2001. Pursuant to board authority, FTNC plans to continue to
repurchase shares from time to time for its stock option and other compensation
plans and will evaluate the level of capital and take action designed to
generate or use capital as appropriate for the interests of the shareholders.
F-24 First Tennessee National Corporation
On December 31, 2003, book value per common share was $15.01 compared to $13.35
for 2002 and $11.66 for 2001. Average shares outstanding for the three-year
period were: 126.8 million in 2003, 126.7 million in 2002 and 127.8 million in
2001. Period-end shares outstanding for this same three-year period were: 124.8
million, 125.6 million and 125.9 million, respectively. The decline in shares
outstanding in 2003 was primarily related to the buyback of shares in connection
with the divestiture of First National Bank of Springdale. FTNC's shares are
traded on The New York Stock Exchange under the symbol FTN. The sales price
ranges, net income per share and dividends declared by quarter, for each of the
last two years, are presented in Table 24.
RISK MANAGEMENT
During 2003, FTNC evolved to a refined enterprise-wide approach to risk
governance, measurement, management, and reporting including an economic capital
allocation process that is tied to risk profiles used to measure risk-adjusted
returns. The Enterprise-wide Risk/Return Management Committee oversees risk
management governance. Committee membership includes the CEO and direct reports.
The Executive Vice President (EVP) of Risk Management oversees reporting for the
committee. Risk management objectives include evaluating risks inherent in
business strategies, monitoring proper balance of risks and returns, and
managing risks to minimize the probability of future negative outcomes. The
Enterprise-wide Risk/Return Management Committee oversees and receives regular
reports from the Senior Credit Policy Committee, Asset/Liability Committee
(ALCO), and Operational Risk Committee. The EVP and Chief Credit Officer, EVP of
Financial Strategy and Interest Rate Risk Management, and EVP of Risk Management
chair these committees respectively. Reports regarding Credit, Asset Liability,
Market, and Operational Risks are provided through the Executive and Audit
Committees of the Board.
Risk management practices include key elements such as independent checks and
balances, formal authority limits, policies and procedures, and portfolio
management all executed through experienced personnel. The internal audit
department also evaluates risk management activities. These activities include
performing internal audits, the results of which are reviewed with management
and the Audit Committee, as appropriate.
INTEREST RATE RISK MANAGEMENT
The primary purpose of managing interest rate risk is to minimize the volatility
to earnings from changes in interest rates and preserve the value of FTNC's
capital. The Asset/Liability Committee is responsible for coordinating the
financial management of net interest income, liquidity, mortgage banking
interest rate risk, investment portfolio, hedging and other such activities.
Interest rate risk is managed by structuring the balance sheet to attempt to
maximize overall profitability, increase revenue, and achieve the desired level
of net interest income while managing interest sensitivity risk and liquidity.
Derivative financial instruments are used to aid in managing the exposure of the
balance sheet, net interest income, fee income, and expenses to changes in
interest rates. Interest rate sensitivity risk is defined as the risk that
future changes in interest rates will impact income.
FTNC's net interest income and its financial condition are affected by changes
in the level of market interest rates as the repricing characteristics of its
loans and other assets do not necessarily match those of its deposits, other
borrowings and capital. To the extent that the interest rates on earning assets
reprice less quickly than liabilities, this position will benefit net interest
income in a declining interest rate environment and will negatively impact net
interest income in a rising interest rate environment. In the case of floating-
rate assets and liabilities, FTNC may also be exposed to basis risk, which
results from changing spreads between loan and deposit rates.
FTNC uses simulation analysis as its primary tool to manage interest rate risk
exposure. This type of analysis computes net interest income at risk under a
variety of market interest rate scenarios to dynamically identify interest rate
risk exposures. This simulation, which considers forecasted balance sheet
changes, prepayment speeds, deposit mix, pricing impacts, and other changes in
the net interest spread,
First Tennessee National Corporation F-25
provides an estimate of the annual net interest income at risk for given changes
in interest rates. The results help FTNC develop strategies for managing
exposure to interest rate risk. Like any forecasting technique, interest rate
simulation modeling is based on a number of assumptions and judgments. In this
case, the assumptions relate primarily to loan and deposit growth, asset and
liability prepayments, interest rates, and on- and off-balance sheet management
strategies. Management believes the assumptions used in its simulations are
reasonable. Nevertheless, simulation modeling provides only a sophisticated
estimate, not a precise calculation of exposure to changes in interest rates.
The simulation models used to analyze the retail/commercial bank's net interest
income create various at-risk scenarios looking at increases and/or decreases in
interest rates from an instantaneous movement or a staggered movement over a
certain time period. In addition, the risk to yield curve movement is estimated
by flattening and steepening the yield curve to historical levels. Management
reviews these different scenarios to determine probable actions. The models are
then updated to incorporate management action. Scenarios that produce a net
interest income at risk of 3 percent or more are presented to the Board
quarterly. A 300 basis point staggered increase or decrease in interest rates
over a one-year period is a key scenario analyzed. These moves are used to
estimate net interest income exposure to historically extreme movements in
interest rates. Due to the current abnormally low level of rates, the Fed funds
rate was modeled into the simulation analysis using a floor of 25 basis points.
Based on the rate sensitivity position on December 31, 2003, net interest income
exposure over the next 12 months to these interest rate scenarios is estimated
to be less than 1 percent of projected net interest income. A 300 basis point
staggered increase or 75 basis point staggered decrease in interest rates is a
hypothetical rate scenario. These scenarios are used as one estimate of risk,
and do not necessarily represent management's current view of future interest
rates or market developments. Actual results will differ from simulated results
due to timing, magnitude and frequency of interest rate changes and changes in
market conditions, and management's strategies, among other factors, including
those presented in the Forward-Looking Statements section of this MD&A.
Rate shock analysis using multiple interest rate movements up and down is used
by mortgage banking to determine the amount of interest rate risk and market
value exposure of loan commitments in the pipeline, loans in the mortgage
warehouse and MSRs. Various factors are used in this analysis including the
magnitude and direction of interest changes, prepayment speeds, and other
factors that could affect mortgage banking. As discussed in Critical Accounting
Policies, derivative financial instruments are used by mortgage banking for two
purposes. First, forward contracts and option contracts are used to protect the
value of the pipeline and mortgage warehouse against rises in interest rates
between the time an interest rate is committed to the customer and the mortgage
is sold into the secondary market. Secondly, interest rate contracts are
utilized to protect against MSRs prepayment risk that generally accompanies
declining interest rates. As interest rates fall, the value of MSRs should
decrease and the value of the servicing hedge should increase. The converse is
also true. Ineffectiveness in these hedging strategies is reflected in
noninterest income.
Management uses the results of interest rate exposure models to formulate
strategies to improve balance sheet positioning, earnings, or both, within
FTNC's interest rate risk, liquidity and capital guidelines.
The derivative financial instruments listed in Table 13 are shown at both
notional and fair values. Table 13 also details FTNC's interest rate sensitivity
profile on December 31, 2003, based on projected cash flows using anticipated
sale date on loans held for sale, contractual maturity for loans and expected
repayment dates for securities. The information provided in this section
including the discussion regarding simulation analysis and rate shock analysis
is forward-looking. Actual results could differ because of interest rate
movements, the ability of management to execute its business plans and other
factors, including those presented in the Forward-Looking Statements section of
this MD&A.
F-26 First Tennessee National Corporation
TABLE 13 - RISK SENSITIVITY ANALYSIS
CAPITAL MARKETS
Fair
(Dollars in millions) 2004 2005 2006 2007 2008 2009+ Total Value
---------------------------------------------------------------------------------------------------------------------------------
ASSETS:
Capital markets securities inventory:
Floating $ 603 - - - - - $ 603 $603
Average interest rate 2.97% - - - - - 2.97%
---------------------------------------------------------------------------------------------------------------------------------
INTEREST RATE DERIVATIVES (NOTIONAL
VALUE):
Forward contracts:
Commitments to buy $(2,320) - - - - - $(2,320) $ (2)
Weighted average settlement price 100.36% - - - - - 100.36%
Commitments to sell $ 2,499 - - - - - $ 2,499 $ 1
Weighted average settlement price 100.71% - - - - - 100.71%
Caps purchased $ 70 $ 70 $ 10 - - - $ 150 $ (2)
Weighted average strike price 6.23% 5.36% 3.50% - - - 5.64%
Caps written $ (70) $(70) $(10) - - - $ (150) $ 2
Weighted average strike price 6.23% 5.36% 3.50% - - - 5.64%
Option contracts purchased $ 5 - - - - - $ 5 *
Weighted average strike price 99.98% - - - - - 99.98%
Option contracts written $ (5) - - - - - $ (5) *
Weighted average strike price 99.98% - - - - - 99.98%
Swap contracts $ 70 - $ 30 $ 29 $ 29 $ 25 $ 183 $ (4)
Average pay rate (floating) 4.00% - 4.33% 3.97% 3.60% 2.11% 3.73%
Average receive rate (fixed) 7.06% - 6.84% 6.42% 4.95% 7.37% 6.63%
Swap contracts $ (70) - $(30) $(29) $(29) $ (25) $ (183) $ 4
Average pay rate (fixed) 7.06% - 6.84% 6.42% 4.95% 7.37% 6.63%
Average receive rate (floating) 4.00% - 4.33% 3.97% 3.60% 2.11% 3.73%
---------------------------------------------------------------------------------------------------------------------------------
* Amount is less than $500,000
First Tennessee National Corporation F-27
TABLE 13 - RISK SENSITIVITY ANALYSIS (CONTINUED)
HELD FOR PURPOSES OTHER THAN TRADING
Fair
(Dollars in millions) 2004 2005 2006 2007 2008 2009+ Total Value
---------------------------------------------------------------------------------------------------------------------------------
ASSETS:
Loans, net of unearned income*:
Floating $ 3,262 $590 $328 $233 $326 $4,450 $9,189 $9,194
Average interest rate 4.12% 3.53% 3.38% 3.47% 3.32% 4.42% 4.16%
Fixed $ 668 $325 $513 $512 $696 $2,045 $4,759 $4,816
Average interest rate 5.60% 6.35% 6.18% 5.98% 5.36% 6.84% 6.26%
Loans held for sale - floating $ 957 - - - - - $ 957 $ 957
Average interest rate 4.75% - - - - - 4.75%
Loans held for sale - fixed $ 2,021 - - - - - $2,021 $2,027
Average interest rate 6.22% - - - - - 6.22%
Investment securities - fixed $ 583 $355 $325 $352 $270 $ 585 $2,470 $2,470
Average interest rate 4.45% 4.30% 4.52% 4.61% 4.58% 4.32% 4.44%
Liquid assets - floating** $ 382 - - - - $ 198 $ 580 $ 580
Average interest rate .81% - - - - 11.30% 4.39%
---------------------------------------------------------------------------------------------------------------------------------
LIABILITIES:
Interest-bearing deposits:
Floating $ 2,701 $512 $ 16 $ 10 - $ 260 $3,499 $3,499
Average interest rate .87% 1.22% .98% .98% - .76% .91%
Fixed $ 5,327 $549 $231 $212 $142 $1,180 $7,641 $7,667
Average interest rate 1.14% 3.50% 2.75% 3.52% 2.14% .80% 1.35%
Short-term borrowings:
Floating $ 3,270 - - - - - $3,270 $3,270
Average interest rate .93% - - - - - .93%
Fixed $ 37 - - - - - $ 37 $ 37
Average interest rate 1.60% - - - - - 1.60%
Term borrowings - floating $ 610 $300 - $ 50 - - $ 960 $ 960
Average interest rate 1.21% 1.18% - 1.41% - - 1.21%
Term borrowings - fixed $ 1 $ 23 - - $231 $ 512 $ 767 $ 788
Average interest rate 5.76% 6.75% - - 6.00% 5.72% 5.83%
---------------------------------------------------------------------------------------------------------------------------------
* Excludes nonaccrual loans.
** Consists of federal funds sold, securities purchased under agreements to
resell, investments in time deposits, and mortgage banking trading
securities.
F-28 First Tennessee National Corporation
TABLE 13 - RISK SENSITIVITY ANALYSIS (CONTINUED)
HELD FOR PURPOSES OTHER THAN TRADING
Fair
(Dollars in millions) 2004 2005 2006 2007 2008 2009+ Total Value
---------------------------------------------------------------------------------------------------------------------------------
DERIVATIVES (NOTIONAL VALUE):
MORTGAGE BANKING:
Pipeline and warehouse hedging
Forward contracts-
Commitments to sell $ 2,506 - - - - - $ 2,506 $(19)
Weighted average settlement price 100.50% - - - - - 100.50%
Interest rate lock commitments $ 2,242 - - - - - $ 2,242 $ 21
Average interest rate 5.69% - - - - - 5.69%
Servicing portfolio hedging
Swaptions $ 1,900 - - - - $ 300 $ 2,200 $ 22
Weighted average strike price 4.70% - - - - 4.35% 4.65%
Swaps - - - - - $2,510 $ 2,510 $218
Average pay rate (floating) - - - - - 1.16% 1.16%
Average receive rate (fixed) - - - - - 5.53% 5.53%
Forward contracts purchased $ 775 - - - - - $ 775 $ 10
Weighted average strike price 5.50% - - - - - 5.50%
INTEREST RATE RISK MANAGEMENT:
Swaps - $ 27 $ 17 $ 12 $196 $ 375 $ 627 $ 17
Average pay rate (floating) - 1.18% 1.16% 1.17% 1.17% 1.18% 1.18%
Average receive rate (fixed) - 5.45% 5.50% 3.79% 4.09% 4.91% 4.67%
Swaps - $ 27 $ 17 $ 12 $ 54 $ 25 $ 135 $ (6)
Average pay rate (fixed) - 5.16% 5.48% 3.60% 4.93% 3.86% 4.73%
Average receive rate (floating) - 1.18% 1.16% 1.17% 1.17% 1.17% 1.17%
Swaps $ 100 - - - - - $ 100 *
Average pay rate (floating) 1.16% - - - - - 1.16%
Average receive rate (floating) 1.14% - - - - - 1.14%
Caps purchased - $ 7 - - - - $ 7 *
Weighted average strike price - 4.00% - - - - 4.00%
Caps written - $ (7) - - - - $ (7) *
Weighted average strike price - 4.00% - - - - 4.00%
---------------------------------------------------------------------------------------------------------------------------------
* Amount is less than $500,000
First Tennessee National Corporation F-29
LIQUIDITY RISK MANAGEMENT
Liquidity risk is the risk of being unable to fund assets with liabilities of
the appropriate duration and interest rate, as well as the risk of not being
able to meet unexpected cash needs. The objective of liquidity management is to
ensure the continuous availability of funds to meet the demands of depositors,
other creditors and borrowers, and the requirements of ongoing operations. The
Asset/Liability Committee, a committee consisting of senior management that
meets regularly, is responsible for managing these needs by taking into account
the marketability of assets; the sources, stability and availability of funding;
and the level of unfunded commitments (see Note 18 - Restrictions,
Contingencies, Commitments, and Other Disclosures). Core deposits are FTNC's
primary source of funding and have been a stable source of liquidity for banks.
These deposits are insured by the Federal Deposit Insurance Corporation to the
maximum extent authorized by law. For 2003, the average total loan to core
deposit ratio was 118 percent compared with 110 percent and 109 percent in 2002
and 2001, respectively.
FTBNA has a bank note program available for additional liquidity under which the
bank may borrow funds from time to time at maturities of 30 days to 30 years. On
December 31, 2003, $1.0 billion was available under current conditions through
the bank note program as a long-term (greater than one year) funding source
compared to $1.6 billion in 2002. Borrowings under the bank note program
increased $355.1 million during 2003 in order to meet increased liquidity needs
related to strong loan growth. FTNC also evaluates alternative sources of
funding, including loan sales, securitizations, syndications, Federal Home Loan
Bank borrowings, debt offerings and equity offerings in its management of
liquidity.
In addition, liquidity has been obtained in prior years through issuance of
$100.0 million of guaranteed preferred beneficial interests in FTNC's junior
subordinated debentures through a Delaware business trust wholly owned by FTNC
(Note 11 - Guaranteed Preferred Beneficial Interests in FTNC's Junior
Subordinated Debentures) and through preferred stock issued by an indirect
wholly owned subsidiary of FTNC ($45.6 million and $44.4 million on
December 31, 2003 and 2002, respectively) (see Note 10 - Term Borrowings and
Note 12 - Preferred Stock of Subsidiary).
The Consolidated Statements of Cash Flows provide information on cash flows from
operating, investing and financing activities for the three years ending
December 31, 2003. In 2003, cash flows from operating activities were positive
as the mortgage warehouse decreased from 2002 levels due to the rising mortgage
interest rate environment experienced in 2003. As previously mentioned, FTNC's
use of GSEs as an outlet for mortgage loan production is an essential source of
liquidity. In both 2002 and 2001, growth in the mortgage warehouse resulted in
negative cash flows from operating activities. Earnings represent a significant
source of liquidity, consistently providing positive cash flows in each of the
three years. The issuance of term-borrowings comprised a significant portion of
FTNC's positive cash flows in 2003 as term borrowings were utilized to better
match the increased liquidity needs related to the strong loan growth that is
reflected in the negative cash flows from investing activities during the
three-year period. In 2002 and 2001, deposit growth provided considerable
positive cash flows which were utilized to fund the balance sheet growth. Sales
and maturities of investment securities largely offset purchases in each of the
three years.
Parent company liquidity is maintained by cash flows stemming from dividends and
interest payments collected from subsidiaries, which represent the primary
source of funds to pay dividends to shareholders and interest to debt holders.
The amount of dividends from FTBNA is subject to certain regulatory restrictions
that are described in Note 18 - Restrictions, Contingencies, Commitments, and
Other Disclosures. The parent company statements are presented in
Note 26 - Parent Company Financial Information. The parent company also has
the ability to enhance its liquidity position by raising equity or incurring
debt. Under an effective shelf registration statement on file with the SEC,
FTNC, as of December 31, 2003, may offer from time to time at its discretion,
debt securities, and common and preferred stock aggregating up to $125 million.
In addition, FTNC also has an effective capital securities shelf registration
statement on file with the SEC under which up to $200 million of capital
securities is available for issuance.
F-30 First Tennessee National Corporation
OFF-BALANCE SHEET ARRANGEMENTS AND OTHER CONTRACTUAL OBLIGATIONS
First Horizon originates conventional conforming and federally insured
single-family residential mortgage loans. Likewise, FTN Financial Capital Assets
Corporation frequently purchases the same types of loans from our customers.
Substantially all of these mortgage loans are exchanged for securities, which
are issued through investors, including Government Sponsored Enterprises (GSEs),
such as GNMA for federally insured loans and FNMA and FHLMC for conventional
loans, and then sold in the secondary markets. After sale, these loans are not
reflected on the Consolidated Statements of Condition. Each of the GSEs has
specific guidelines and criteria for sellers and servicers of loans backing
their respective securities. FTNC's use of GSEs as an efficient outlet for
mortgage loan production is an essential source of liquidity for FTNC and other
participants in the housing industry. During 2003 and 2002, approximately
$40.9 billion and $23.9 billion, respectively, of conventional and federally
insured mortgage loans were securitized and sold by First Horizon through these
GSEs (see Note 18 - Restrictions, Contingencies, Commitments and Other
Disclosures).
Certain of First Horizon's originated loans do not conform to the requirements
for sale or securitization by FNMA and FHLMC due to exceeding the maximum loan
size of approximately $334 thousand (jumbo loans). First Horizon pools and
securitizes these jumbo loans in proprietary transactions. After securitization
and sale, these loans are not reflected on the Consolidated Statements of
Condition except as described hereafter (see Credit Risk Management - Mortgage
Banking). These transactions, which are conducted through single-purpose
business trusts, are the most efficient way for First Horizon and other
participants in the housing industry to monetize these assets. On December 31,
2003 and 2002, the outstanding principal amount of loans in these off-balance
sheet business trusts was $6.0 billion and $4.5 billion, respectively. Given the
significance of First Horizon's origination of non-conforming loans, the use of
single-purpose business trusts to securitize these loans is an important source
of liquidity to FTNC (see Note 24 - Securitizations).
FTNC has various other financial obligations, which may require future cash
payments. Table 14 sets forth contractual obligations representing required and
potential cash outflows as of December 31, 2003. Purchase obligations represent
obligations under agreements to purchase goods or services that are enforceable
and legally binding on FTNC and that specify all significant terms, including:
fixed or minimum quantities to be purchased; fixed, minimum or variable price
provisions; and the approximate timing of the transaction. In addition, FTNC
enters into commitments to extend credit to borrowers, including loan
commitments, standby letters of credit, and commercial letters of credit. These
commitments do not necessarily represent future cash requirements, in that these
commitments often expire without being drawn upon (See Note 18 - Restrictions,
Contingencies, Commitments and Other Disclosures).
TABLE 14 - CONTRACTUAL OBLIGATIONS
Payments due by period
---------------------------------------------------------------------------
Less than 1-3 4-5 After 5
(Dollars in thousands) 1 year years years years Total
-----------------------------------------------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS:
Term borrowings* $610,565 $323,467 $282,195 $502,565 $1,718,792
Annual rental commitments under
noncancelable leases** 50,763 79,279 48,822 36,578 215,442
Purchase obligations 13,949 18,075 5,000 - 37,024
-----------------------------------------------------------------------------------------------------------------------
Total contractual obligations $675,277 $420,821 $336,017 $539,143 $1,971,258
-----------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------
* See Note 10 - Term Borrowings for further details.
** See Note 5 - Premises, Equipment and Leases for further details.
First Tennessee National Corporation F-31
CREDIT RATINGS
Maintaining adequate credit ratings on debt issues is critical to liquidity
because it affects the ability of FTNC to attract funds from various sources,
such as brokered deposits or wholesale borrowings of which FTNC had $3.6 billion
and $3.5 billion on December 31, 2003 and 2002, respectively, on a
cost-competitive basis. The various credit ratings are detailed in Table 15. The
availability of funds other than core deposits is also dependent upon
marketplace perceptions of the financial soundness of FTNC, which include such
issues as capital, asset quality and reputation. The availability of core
deposit funding is dependent upon federal deposit insurance, which can be
removed only in extraordinary circumstances, but may also be influenced to some
extent by the same factors that affect other funding sources.
TABLE 15 - CREDIT RATINGS
Standard & Poor's Moody's Fitch
-------------------------------------------------------------------------------------------------------------------
FIRST TENNESSEE NATIONAL CORPORATION
Overall credit rating A-/Stable A2/Stable A/Positive/F1
Subordinated debt BBB+ A3 A-
Capital securities* BBB A3 A-
-------------------------------------------------------------------------------------------------------------------
FIRST TENNESSEE BANK NATIONAL ASSOCIATION
Overall credit rating A/Stable/A-1 A1/Stable A/Positive/F1
Long-term/short-term deposits A/A-1 A1/P-1 A+/F1
Other long-term/short-term funding** A A1/P-1 A
Subordinated debt A- A2 A-
-------------------------------------------------------------------------------------------------------------------
FT REAL ESTATE SECURITIES COMPANY, INC.
Preferred stock BBB+ A3
-------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------
* Guaranteed preferred beneficial interests in First Tennessee's junior
subordinated debentures issued through a wholly-owned unconsolidated business
trust.
** Other funding includes senior bank notes.
A rating is not a recommendation to buy, sell or hold securities and is subject
to revision or withdrawal at any time and should be evaluated independently of
any other rating.
MARKET RISK MANAGEMENT
FTN Financial buys and sells various types of securities for its customers. When
these securities settle on a delayed basis, they are considered forward
contracts. Inventory positions are limited to the procurement of securities
solely for distribution to customers by the sales staff, and ALCO policies and
guidelines have been established to limit the risk in managing this inventory.
CREDIT RISK MANAGEMENT
Credit risk is the risk of loss due to adverse changes in a borrower's ability
to meet its financial obligations under agreed upon terms. FTNC is subject to
credit risk in lending, trading, investing, liquidity/funding and asset
management activities. The nature and amount of credit risk depends on the types
of transactions, the structure of those transactions and the parties involved.
In general, credit risk is incidental to trading, liquidity/funding and asset
management activities, while it is central to the profit strategy in lending. As
a result, the majority of credit risk is associated with lending activities.
FTNC has processes and management committees in place that are designed to
assess and monitor credit risks. Management's Asset Quality Committee has
responsibility to evaluate its assessment of current asset quality for each
lending product. In addition, the Asset Quality Committee evaluates the
projected changes in classified loans, non-performing assets and charge-offs. A
primary objective of this committee is to provide information about changing
trends in asset quality by region or loan product, and to provide to senior
management a current assessment of credit quality as part of the estimation
process for determining the
F-32 First Tennessee National Corporation
allowance for loan losses. The Senior Credit Watch Committee has primary
responsibility to enforce proper loan risk grading, to identify credit problems,
and to monitor actions to rehabilitate certain credits. Management also has a
Senior Credit Policy Committee that is responsible for enterprise-wide credit
risk oversight and provides a forum for addressing management issues and setting
policy limits for risk taking. The committee also develops credit policies and
underwriting guidelines to manage the level and composition of credit risk in
its loan portfolio and review performance relative to these policies. In
addition, the Financial Counterparty Credit Committee, composed of senior
managers, assesses the credit risk of financial counterparties and sets limits
for exposure based upon the credit quality of the counterparty. FTNC's goal is
to manage risk and price loan products based on risk management decisions and
strategies. Management strives to identify potential problem loans and
nonperforming loans early enough to correct the deficiencies. It is management's
objective that both charge-offs and asset write-downs are recorded promptly,
based on management's assessments of current collateral values and the
borrower's ability to repay.
FTNC has a significant concentration in loans secured by real estate. In 2003,
62 percent of total loans are secured by real estate compared to 56 percent in
2002 (see Table 9). Two lending products have contributed to this increased
level of real estate lending - (1) significant growth in second mortgages
identified as home equity lines of credit which grew 61 percent; (2) single
family builders which grew 62 percent. FTNC's real estate lending is
well-diversified by industry and geographically. On December 31, 2003, FTNC did
not have any concentrations of 10 percent or more of total loans in any single
industry.
ALLOWANCE FOR LOAN LOSSES AND CHARGE-OFFS
Management's policy is to maintain the allowance for loan losses at a level
sufficient to reflect the estimated probable incurred losses in the loan
portfolio. The allowance for loan losses is increased by the provision for loan
losses and recoveries and is decreased by charged-off loans. The adequacy of the
allowance for loan losses is analyzed quarterly. The Chief Credit Officer has
the responsibility for performing a comprehensive review of the allowance for
loan losses and making a recommendation to the Executive Committee of the Board
for approval of the allowance for loan losses at each quarterly reporting
period. An analytical model based on historical loss experience, adjusted for
current events, trends and economic conditions is used to assess the adequacy of
the allowance for loan losses. This methodology determines an estimated loss
percentage (reserve rate), which is applied against the balance of loans in each
segment of the loan portfolio at the evaluation date. The nature of the process
by which FTNC determines the appropriate allowance for loan losses requires the
exercise of considerable judgment. After review of all relevant factors,
management believes the allowance for loan losses is adequate and reflects its
best estimate of probable incurred losses.
The total allowance for loan losses increased 11 percent or $16.0 million from
year-end 2002, at which time it had decreased 4 percent or $6.3 million since
year-end 2001. Period-end loans increased 23 percent in 2003 after increasing 10
percent in 2002. The ratio of allowance for loan losses to loans, net of
unearned income, decreased to 1.15 percent on December 31, 2003, from 1.27
percent on December 31, 2002, primarily reflecting improvement in the retail
loan portfolio's risk profile, the effect of obtaining whole loan insurance on
$862.7 million of real estate residential loans and the transfer of certain
classified and nonperforming residential mortgage loans to held for sale. The
ratio of allowance for loan losses to loans was 1.46 percent on December 31,
2001.
Table 17 summarizes by category loans charged off and recoveries of loans
previously charged off. This table also shows the additions to the reserve
(provision), which have been charged against operating earnings. Table 16 shows
net charge-off ratios. Net charge-offs decreased to $68.0 million for the year
ended December 31, 2003. Net charge-offs were $98.5 million for 2002 and $80.5
million for 2001. The decrease in the 2003 level of net charge-offs was impacted
by improvement in both the consumer and commercial loan portfolios. Total
commercial and commercial real estate related loan net charge-offs decreased to
$20.6 million in 2003 from $41.4 million in 2002. The commercial loan net
charge-offs were not concentrated in any one industry or region. Residential
real estate loan net charge-offs decreased to $31.0 million in 2003 from $32.0
million in 2002. Other retail loan net charge-offs decreased to $4.3 million
First Tennessee National Corporation F-33
in 2003 from $13.6 million in 2002. The ratio of net charge-offs to average
loans decreased to .54 percent for 2003 from .93 percent for 2002 and .80
percent for 2001.
TABLE 16 - NET CHARGE-OFF RATIOS*
2003 2002 2001
----------------------------------------------------------------------------------------------------------
Commercial .34% .75% .47%
Retail real estate** .48 .64 .65
Other retail 1.64 3.47 2.72
Credit card receivables 4.65 4.35 4.22
Total net charge-offs .54 .93 .80
----------------------------------------------------------------------------------------------------------
Loans are averages expressed net of unearned income.
* Table 9 provides information on the relative size of each loan portfolio.
** Excludes $1.6 million, $3.6 million and $3.2 million of net charge-offs for
2003, 2002 and 2001, respectively, related to loans classified as
nonperforming from the warehouse and the repurchase of loans originated and
previously sold by First Horizon Home Loans.
Within the course of normal mortgage banking activities, a small percentage of
mortgage loan originations are classified as nonperforming assets when FHA/VA
borrowers are delinquent in their monthly payments prior to the completion of
the insuring process. Additionally, loans that have been sold may be required to
be repurchased if they are found not to meet an investor's origination criteria.
From this pool, there were net charge-offs of $1.6 million in 2003, down from
$3.6 million in 2002 due to changes in the disposition of these assets.
Going forward, asset quality indicators should reflect the relative strength of
the economy and the resolution of existing asset quality issues. In addition,
asset quality ratios could be affected by balance sheet strategies and shifts in
loan mix to and from products with different risk/return profiles. Actual
results could differ because of several factors, including those presented in
the Forward-Looking Statements section of this MD&A discussion.
F-34 First Tennessee National Corporation
TABLE 17 - ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
(Dollars in thousands) 2003 2002 2001 2000 1999 1998
---------------------------------------------------------------------------------------------------------------------------------
ALLOWANCE FOR LOAN LOSSES:
Beginning balance $ 144,298 $ 150,614 $ 139,210 $ 134,979 $ 131,906 $ 121,816
Provision for loan losses* 86,698 92,184 93,220 67,491 57,406 51,287
Allowance from acquisitions - - - - - 140
Securitizations/divestitures (2,652) - (1,337) (2,173) (2,683) (3,575)
Charge-offs:
Commercial:
Commercial, financial and industrial 12,460 37,241 22,596 6,583 9,714 5,379
Real estate commercial 3,067 2,966 4,156 857 510 -
Real estate construction 7,642 3,367 968 47 - 442
Retail:
Real estate residential** 35,809 36,726 30,532 17,348 9,742 8,725
Other retail 9,920 19,979 20,603 20,868 17,392 9,734
Credit card receivables 13,538 12,862 13,369 25,485 22,867 24,242
---------------------------------------------------------------------------------------------------------------------------------
Total charge-offs 82,436 113,141 92,224 71,188 60,225 48,522
---------------------------------------------------------------------------------------------------------------------------------
Recoveries:
Commercial:
Commercial, financial and industrial 2,438 2,136 1,991 2,903 2,082 2,751
Real estate commercial 166 41 280 480 228 641
Real estate construction 1 - - - 8 148
Retail:
Real estate residential** 4,820 4,693 2,788 857 510 788
Other retail 5,653 6,419 4,953 3,937 3,725 4,253
Credit card receivables 1,347 1,352 1,733 1,924 2,022 2,179
---------------------------------------------------------------------------------------------------------------------------------
Total recoveries 14,425 14,641 11,745 10,101 8,575 10,760
---------------------------------------------------------------------------------------------------------------------------------
Net charge-offs 68,011 98,500 80,479 61,087 51,650 37,762
---------------------------------------------------------------------------------------------------------------------------------
Ending balance $ 160,333 $ 144,298 $ 150,614 $ 139,210 $ 134,979 $ 131,906
---------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------
Reserve for off-balance sheet commitments $ 7,804 $ 5,368 $ 4,759 $ 4,486 $ 4,624 $ 4,107
Total of allowance for loan losses and
reserve for off-balance sheet commitments $ 168,137 $ 149,666 $ 155,373 $ 143,696 $ 139,603 $ 136,013
---------------------------------------------------------------------------------------------------------------------------------
LOANS AND COMMITMENTS:
Period end loans, net of unearned $13,990,525 $11,345,445 $10,283,143 $10,239,450 $9,363,158 $8,557,064
Insured loans 862,675 785,270 - - - -
---------------------------------------------------------------------------------------------------------------------------------
Loans excluding insured loans $13,127,850 $10,560,175 $10,283,143 $10,239,450 $9,363,158 $8,557,064
---------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------
Off-balance sheet commitments**** $ 5,464,097 $ 3,398,534 $ 2,895,681 $ 2,069,143 $1,679,237 $1,703,258
---------------------------------------------------------------------------------------------------------------------------------
Average loans, net of unearned $12,656,318 $10,634,530 $10,104,277 $ 9,931,955 $8,818,766 $8,242,135
---------------------------------------------------------------------------------------------------------------------------------
RATIOS***:
Allowance to loans 1.15% 1.27% 1.46% 1.36% 1.44% 1.54%
Allowance to loans excluding insured loans 1.22 1.37 1.46 1.36 1.44 1.54
Net charge-offs to average loans .54 .93 .80 .62 .59 .46
Net charge-offs to allowance 42.4 68.3 53.4 43.9 38.3 28.6
---------------------------------------------------------------------------------------------------------------------------------
* Provision was negatively impacted by $3.1 million in 2003 related to the
transfer of certain retail loans to held for sale. Provision was positively
impacted by $10.0 million in 2002 related to the change in FTNC's risk
profile after the sale of a portfolio of loans originated through First
Horizon Money Centers and the transfer of certain classified and
nonperforming loans to held for sale. Provision was also positively
impacted by $1.3 million in 2001 and $10.7 million in 2000 related to
credit card loans sold.
** Real estate residential net charge-offs include $1.6 million, $3.6 million,
$3.2 million, $5.2 million, $2.1 million, and $3.4 million of net
charge-offs for the years 2003 through 1998, respectively, related to loans
classified as nonperforming from the warehouse and the repurchase of loans
originated and previously sold by First Horizon Home Loans.
*** Net of unearned income.
**** Amount of off-balance sheet commitments for which a reserve has been
provided. See Note 18 - Restrictions, Contingencies, Commitments and Other
Disclosures for further details on off-balance sheet commitments.
First Tennessee National Corporation F-35
TABLE 18 - LOANS AND FORECLOSED REAL ESTATE ON DECEMBER 31
2003 2002
----------------------------------------------------------------------- ---------------
Construction % Allowance %
and Commercial of for Loan of
(Dollars in millions) Commercial Development Real Estate TOTAL Total Losses Total Total
---------------------------------------------------------------------------------------------------------------------------
Internal grades:
1 $ 276 $ - $ - $ 276 2% $ 1 $ 210 2%
2 400 - 46 446 3 4 359 3
3 405 - 16 421 3 6 380 3
4 2,485 446 685 3,616 26 46 3,653 32
5 763 234 182 1,179 9 16 877 8
6 77 8 21 106 1 4 90 1
7 40 - 3 43 - 5 46 -
8, 9, 10 (Classifieds) 35 - 5 40 - 9 59 1
---------------------------------------------------------------------------------------------------------------------------
4,481 688 958 6,127 44 91 5,674 50
Impaired loans:
Contractually past due 20 2 10 32 - 10 44 -
Contractually current 2 - - 2 - - 5 -
---------------------------------------------------------------------------------------------------------------------------
Total commercial and commercial
real estate loans 4,503 690 968 6,161 44 101 5,723 50
---------------------------------------------------------------------------------------------------------------------------
Retail:
Real estate residential 6,817 49 39 4,721 42
Real estate construction 527 4 2 342 3
Other retail 213 1 5 286 3
Credit card receivables 273 2 13 273 2
---------------------------------------------------------------------------------------------------------------------------
Total retail loans 7,830 56 59 5,622 50
---------------------------------------------------------------------------------------------------------------------------
Total loans $13,991 100% $160 $11,345 100%
---------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------
Foreclosed real estate:
Commercial $ 5 $ - $ 4 $ 9 $ 2
Retail 5 5
Mortgage banking 10 4
---------------------------------------------------------------------------------------------------------------------------
Total foreclosed real estate $ 24 $ 11
---------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------
2002
---------
Allowance
for Loan
(Dollars in millions) Losses
------------------------------------------
Internal grades:
1 $ 1
2 3
3 4
4 35
5 12
6 5
7 5
8, 9, 10 (Classifieds) 8
------------------------------------------
73
Impaired loans:
Contractually past due 13
Contractually current 2
------------------------------------------
Total commercial and commercial
real estate loans 88
------------------------------------------
Retail:
Real estate residential 37
Real estate construction 2
Other retail 3
Credit card receivables 14
------------------------------------------
Total retail loans 56
------------------------------------------
Total loans $144
------------------------------------------
------------------------------------------
Foreclosed real estate:
Commercial
Retail
Mortgage banking
------------------------------------------
Total foreclosed real estate
------------------------------------------
------------------------------------------
Loans are expressed net of unearned income. All amounts in the Allowance for
Loan Losses columns have been rounded to the nearest million dollars. Certain
previously reported amounts have been reclassified to agree with current
presentation.
All data is based on internal loan classifications. Definitions of each credit
grade are provided below:
Grade 1: Established, stable companies with excellent earnings,
liquidity, and capital. Possess many of the same
characteristics as Standard & Poor's (S&P) AA rated
companies.
Grade 2: Well established, stable companies with good to very good
earnings, liquidity, and capital. Possess many of the same
characteristics as S&P A rated companies.
Grade 3: Reasonably well established, stable companies with above
average to good earnings, liquidity, and capital and with
consistent, positive trends relative to industry norms.
Grade 4: Reasonably well established, stable companies with average
earnings, liquidity, and capital.
Grade 5: New and established companies with some potential weakness.
Capital considered less than average and history of average
to below average earnings without consistent positive
trends. Overall acceptable credits with minor weaknesses
which warrant additional servicing.
Grade 6: Financial condition adversely affected by temporary lack of
earnings or liquidity or changes in the operating
environment. An action plan is required to rehabilitate the
credit or have it refinanced elsewhere.
Grade 7: Significant developing weaknesses or adverse trends in
earnings, liquidity, capital, or operating environment.
Limited alternate financing is available.
Grade 8: Significantly higher than normal probability that:
(1) legal action will be required; (2) liquidation of
collateral will be required; (3) there will be a loss; or
all three will occur. This grade is believed to be
substantially equivalent to the regulators' classification
of substandard.
Grade 9: Excessive degree of risk. Financial and management
deficiencies are well defined and make the obligor's ability
to repay from anticipated sources under existing terms and
conditions uncertain. Collateral shortfall and/or
undeterminable collateral values exist. Timing and amount of
loss are uncertain. This grade is believed to be
substantially equivalent to the regulators' classification
of doubtful.
Grade 10: Borrowers are deemed incapable of repayment and debt is
deemed uncollectible. Loans should no longer be carried as
an active bank asset. This grade is believed to be
substantially equivalent to the regulators' classification
of loss.
Impaired: A loan for which it is probable that all amounts due,
according to the contractual terms of the loan agreement,
will not be collected and the loan is placed on non-accrual
status. Reserves for impaired loans are based on the value
of the collateral or the cash flow of the entity compared to
the outstanding balance.
F-36 First Tennessee National Corporation
COMPONENTS OF THE ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is composed of the following components: reserves
for individually impaired commercial loans, reserves for commercial loans
evaluated based on pools of credit graded loans, and reserves for pools of
smaller-balance homogeneous retail and commercial loans. Reserves for
individually impaired commercial loans are computed in accordance with SFAS No.
114, and are based on either the estimated collateral value less selling costs
(if the loan is a collateral dependent loan), or the present value of expected
future cash flows discounted at the loan's effective interest rate. Reserves for
commercial loans evaluated based on pools of credit graded loans and reserves
for pools of smaller-balance homogeneous retail and commercial loans are
determined in accordance with SFAS No. 5. The reserve factors applied to these
pools are an estimate of probable incurred losses based on management's
evaluation of historical losses from loans with similar characteristics,
adjusted for current economic factors and trends. Table 18 gives a breakdown of
the allowance allocation by major loan types and commercial loan grades on
December 31, 2003, compared with December 31, 2002.
To assess the quality of individual commercial loans, all commercial loans are
internally assigned a credit grading, ranging from grades 1 to 10. The credit
grading system is intended to identify and measure the credit quality of lending
relationships by analyzing the migration of loans between grading categories. It
is also integral to the estimation methodology utilized in determining the
allowance for loan losses since an allowance is established for pools of
commercial loans based on the credit grade assigned. The appropriate
relationship manager performs the process of classifying commercial loans into
the appropriate credit grades initially as a component of the approval of the
loan and has responsibility for insuring that the loan is properly graded
throughout the life of the loan. The proper loan grade for all commercial loans
in excess of $1 million is confirmed by a senior credit officer in the approval
process. To determine the most appropriate credit grade for each loan, based on
the size of the loan, credit officers examine and consider both financial and
non-financial data as discussed in the credit grade definitions disclosed in
Table 18. Loan grades are frequently reviewed by commercial loan review to
determine if any changes in the circumstances of the loan require a different
risk grade.
A reserve rate is established for each loan grade based on a historical
three-year moving average of actual charge-offs. The reserve rate is then
adjusted for current events, trends, and economic conditions that affect the
asset quality of the loan portfolio. Some of the factors considered in making
these adjustments include: levels of and trends in delinquencies; classified
loans and nonaccrual loans; trends in outstandings and maturities; effects of
changes in lending policies and underwriting guidelines; introduction of new
loan products with different risk characteristics; experience, ability and depth
of lending management and staff; migration trends of loan grades; and charge-off
trends that may skew the historical three-year moving average. Finally, the
reserve rates for each loan grade are reviewed quarterly to reflect local,
regional and national economic trends; concentrations of cyclical industries;
and the economic prospects for industry concentrations. To supplement
management's process in setting these additional adjustments, an economic model
is used that evaluates the correlation between historical charge-offs and a
number of state and national economic indicators. Also, all classified loans $1
million and greater are reviewed individually in accordance with SFAS No. 114,
and a specific reserve is set based on the exposure (the difference between the
outstanding loan amount and either the present value of expected future cash
flows or the estimated net realizable value of the collateral) and the
probability of loss.
Table 19 shows the reserve rates (percentage of allowance for loan losses to
outstanding balances) by loan category. The average reserve rate for all
commercial loans increased to 1.49 percent in 2003 from 1.29 percent in 2002 and
1.31 percent in 2001. This increase is due to the higher charge-offs experienced
in 2002 and 2001 being included in the historical three-year moving average
calculation.
First Tennessee National Corporation F-37
TABLE 19 - AVERAGE RESERVE RATES
LOANS Loans Loans Loans Loans
% OF % of % of % of % of
2003 TOTAL 2002 Total 2001 Total 2000 Total 1999 Total
----------------------------------------------------------------------------------------------------------------
Commercial, commercial real
estate and commercial
construction* 1.49% 43.8 1.29% 50.0 1.31% 54.1 1.29% 51.6 1.30% 51.1
Impaired 29.41 .2 30.61 .5 44.74 .4 36.59 .4 42.86 .1
Retail real estate .56 52.5 .77 44.6 .99 38.3 .69 36.7 .92 31.5
Other retail 2.35 1.5 1.05 2.5 1.96 4.5 1.67 8.2 1.77 10.8
Credit card receivables 4.76 2.0 5.13 2.4 4.63 2.7 5.02 3.1 4.12 6.5
----------------------------------------------------------------------------------------------------------------
* Excludes impaired loans.
The allowance for loan losses for smaller-balance homogenous loans (retail
loans) is determined based on pools of similar loan types that have similar
credit risk characteristics, which is consistent with industry practice. FTNC
manages retail loan credit risk on a portfolio basis. Reserve rates are
established for each segment of the retail loan portfolio based on historical
loss experience and are adjusted to reflect current events, trends and economic
conditions. Some of the factors for making these adjustments include: changes in
underwriting guidelines or credit scoring models; trends in consumer payment
patterns, delinquencies and personal bankruptcies; staffing levels in the
collection area; changes in the mix of loan products outstanding; experience,
ability and depth of lending management and staff; value of underlying
collateral; and charge-off trends.
The average reserve rate for retail real estate loans was .56 percent in 2003 as
compared to .77 percent in 2002 and .99 percent in 2001. The decrease in the
retail real estate loan reserve rate for 2003 was impacted primarily by the
improvement in the retail loan portfolio's risk profile including the effect of
providing whole loan insurance on certain real estate residential loans. The
reserve rate for other retail loans increased to 2.35 percent in 2003 from 1.05
percent in 2002 primarily due to the changing risk profile of this portfolio of
loans. The other retail loans reserve rate was 1.96 percent in 2001.
NONPERFORMING ASSETS
Nonperforming loans consist of impaired, other nonaccrual and restructured
loans. These, along with foreclosed real estate and other assets, represent
nonperforming assets. Impaired loans are those loans for which it is probable
that all amounts due, according to the contractual terms of the loan agreement,
will not be collected and for which recognition of interest income has been
discontinued. Other nonaccrual loans are residential and other retail loans on
which recognition of interest income has been discontinued. Restructured loans
generally take the form of an extension of the original repayment period and/or
a reduction or deferral of interest or principal because of deterioration in the
financial position of the borrower.
Nonperforming assets were $76.2 million in 2003 compared to $75.7 million in
2002. Nonperforming assets related to lending activities were $57.0 million, a
decrease of 9 percent, or $5.9 million. This decline is primarily due to
improvement in the commercial loan portfolio and reflects the impact on our
customer base of a strengthened economy. Nonperforming assets related to
mortgage production activities increased 51 percent to $19.1 million from $12.7
million as foreclosed real estate increased by $6.3 million. The level of
foreclosed assets in both mortgage production and lending activities increased
primarily due to foreclosure of single-family homes in certain residential
developments.
Information regarding nonperforming assets and loans is presented in Table 21.
As shown in the table, the ratio of nonperforming assets to total loans related
to lending activities was .42 percent on December 31, 2003. Table 20 gives
additional information related to changes in nonperforming assets for 2001
through 2003.
F-38 First Tennessee National Corporation
TABLE 20 - CHANGES IN NONPERFORMING ASSETS
(Dollars in millions) 2003 2002 2001
--------------------------------------------------------------------------------------------------
Beginning balance $ 75.7 $ 85.1 $ 77.7
Additional nonperforming assets 111.0 165.5 134.2
Payments, sales and other dispositions (88.2) (130.6) (97.2)
Charge-offs (22.3) (44.3) (29.6)
--------------------------------------------------------------------------------------------------
Ending balance $ 76.2 $ 75.7 $ 85.1
--------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------
TABLE 21 - NONPERFORMING ASSETS ON DECEMBER 31
(Dollars in thousands) 2003 2002 2001 2000 1999 1998
----------------------------------------------------------------------------------------------------------------
LENDING ACTIVITIES*:
Nonperforming loans** $ 42,488 $ 55,060 $ 41,539 $ 41,541 $ 7,753 $12,246
Foreclosed real estate 14,224 7,891 8,852 3,997 5,777 5,091
Other assets 336 33 130 97 91 199
----------------------------------------------------------------------------------------------------------------
Total lending activities 57,048 62,984 50,521 45,635 13,621 17,536
----------------------------------------------------------------------------------------------------------------
MORTGAGE PRODUCTION ACTIVITIES*:
Nonperforming loans-held for sale 8,754 5,733 - - - -
Nonperforming loans-loan portfolio** 542 3,394 21,417 19,761 21,365 15,561
Foreclosed real estate 9,851 3,560 13,137 12,293 12,093 11,151
----------------------------------------------------------------------------------------------------------------
Total mortgage production activities 19,147 12,687 34,554 32,054 33,458 26,712
----------------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 76,195 $ 75,671 $ 85,075 $ 77,689 $47,079 $44,248
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Loans and leases 30 to 89 days past due $ 91,930 $104,084 $117,298 $105,705 $88,389 $87,832
Loans and leases 90 days past due 27,240 37,083 37,665 42,606 29,849 31,603
Potential problem assets*** 119,083 128,657 123,535 107,605 75,001 63,307
----------------------------------------------------------------------------------------------------------------
RATIOS:
Allowance to nonperforming loans in the loan
portfolio 373% 247% 239% 227% 464% 474%
Nonperforming assets to total loans plus
foreclosed real estate and other assets (lending
activities only) .42 .57 .51 .47 .15 .21
Nonperforming assets to unpaid principal balance
of servicing portfolio (mortgage production
activities only) .03 .02 .08 .07 .07 .07
----------------------------------------------------------------------------------------------------------------
* Lending activities include all activities associated with the loan
portfolio. Mortgage production includes activities associated with the
mortgage warehouse. During fourth quarter 2002, certain nonperforming
residential mortgage loans were transferred to held for sale.
** Total impaired loans included in nonperforming loans were $34.4 million,
$49.3 million, $37.8 million, $41.2 million, $7.5 million, and $12.1 million
for the years 2003 through 1998, respectively.
*** Includes loans and leases 90 days past due.
Certain previously reported amounts have been reclassified to agree with current
presentation.
PAST DUE LOANS AND POTENTIAL PROBLEM ASSETS
Past due loans are loans contractually past due 90 days or more as to interest
or principal payments, but which have not yet been put on nonaccrual status. The
ratio of past due loans to total loans was .19 percent at year-end 2003, down
from .33 percent on December 31, 2002. The improvement in past due loans is due
primarily to a positive change in the risk profile of retail real estate loans.
Additional historical past due loan information can be found in Table 21. Loans
30 to 89 days past due decreased to $91.9 million or .66 percent of total loans
on December 31, 2003, from $104.1 million or .92 percent of total loans on
December 31, 2002.
First Tennessee National Corporation F-39
Potential problem assets, which are not included in nonperforming assets,
decreased to $119.1 million, or .85 percent of total loans, on December 31,
2003, from $128.7 million, or 1.13 percent of total loans, on December 31, 2002.
Potential problem assets represent those assets where information about possible
credit problems of borrowers has caused management to have serious doubts about
the borrower's ability to comply with present repayment terms. This definition
is believed to be substantially consistent with the standards established by the
Office of the Comptroller of the Currency for loans classified substandard.
MORTGAGE BANKING
First Horizon originates mortgage loans through its retail and wholesale
operations and also purchases mortgage loans from third-party mortgage bankers
(known as correspondent brokers) for sale to secondary market investors and
subsequently services the majority of those loans. The secondary market for
mortgages allows First Horizon to sell mortgage loans to investors, including
Government Sponsored Enterprises (GSEs), such as FNMA, FHLMC and GNMA. Many
private investors are also active in the secondary market as issuers and
investors. The majority of First Horizon's mortgage loans are sold through
transactions with GSEs. The risk of credit loss with regard to the principal
amount of the loans sold is generally transferred to investors upon sale to the
secondary market. To the extent that transferred mortgage loans are subsequently
determined not to meet the agreed-upon qualifications or criteria, the purchaser
has the right to return those loans to First Horizon. In addition, certain
mortgage loans are sold to investors with limited or full recourse in the event
of mortgage foreclosure (refer to discussion of foreclosure reserves under
Critical Accounting Policies).
OPERATIONAL RISK MANAGEMENT
Operational risk is the risk of loss from inadequate or failed internal
processes, people, and systems or from external events. This risk is inherent in
all businesses. Management, measurement, and reporting of operational risk are
overseen by the Operational Risk Committee, which is chaired by the Executive
Vice President of Risk Management. Key representatives from the business
segments, legal, shared services, risk management, and insurance are represented
on the committee. Summary reports of the committee's activities and decisions
are provided to the Enterprise-wide Risk/Return Management Committee.
Significant emphasis is dedicated to refinement of processes and tools to aid in
measuring and managing material operational risks and providing for a culture of
awareness and accountability.
CRITICAL ACCOUNTING POLICIES
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
FTNC's accounting policies are fundamental to understanding management's
discussion and analysis of financial condition and results of operations. The
consolidated financial statements of FTNC are prepared in conformity with
accounting principles generally accepted in the United States of America and
follow general practices within the industries in which it operates. The
preparation of the financial statements requires management to make certain
judgments and assumptions in determining accounting estimates. Accounting
estimates are considered critical if (a) the estimate requires management to
make assumptions about matters that were highly uncertain at the time the
accounting estimate was made, and (b) different estimates reasonably could have
been used in the current period, or changes in the accounting estimate are
reasonably likely to occur from period to period, that would have a material
impact on the presentation of FTNC's financial condition, changes in financial
condition or results of operations.
It is management's practice to discuss critical accounting policies with the
Board of Directors' Audit Committee including the development, selection and
disclosure of the critical accounting estimates. Management believes the
following critical accounting policies are both important to the portrayal of
the company's financial condition and results of operations and require
subjective or complex judgments. These judgments about critical accounting
estimates are based on information available as of the date of the financial
statements.
F-40 First Tennessee National Corporation
MORTGAGE SERVICING RIGHTS AND OTHER RELATED RETAINED INTERESTS
When First Horizon sells mortgage loans in the secondary market to investors, it
generally retains the right to service the loans sold in exchange for a
servicing fee that is collected over the life of the loan as the payments are
received from the borrower. The expected present value of the anticipated cash
flows received for servicing the loan, net of the estimated costs of servicing
the loan, is capitalized as an asset known as MSRs on the Consolidated
Statements of Condition. In certain cases, when First Horizon sells mortgage
loans in the secondary market, it retains an interest in the mortgage loans sold
primarily through interest-only certificates. Interest-only certificates are
financial assets, which represent rights to receive earnings from serviced
assets that exceed contractually specified servicing fees.
MSRS ESTIMATED FAIR VALUE
The fair value of MSRs typically rises as market interest rates increase and
declines as market interest rates decrease; however, the extent to which this
occurs depends in-part on (1) the magnitude of changes in market interest rates,
and (2) the differential between the then current market interest rates for
mortgage loans and the mortgage interest rates included in the mortgage
servicing portfolio.
Since sales of MSRs 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 MSRs. As such, like
other participants in the mortgage banking business, First Horizon relies
primarily on a discounted cash flow model to estimate the fair value of its
MSRs. This model calculates estimated fair value of the MSRs using numerous
tranches of MSRs, which share similar key characteristics, such as interest
rates, type of product (fixed vs. variable), age (new, seasoned, moderate),
agency type and other factors. First Horizon uses assumptions in the model that
it believes are comparable to those used by other participants in the mortgage
banking business and reviews estimated fair values and assumptions with third-
party brokers and other service providers on a quarterly basis. First Horizon
also compares its estimates of fair value and assumptions to recent market
activity and against its own experience.
Estimating the cash flow components of net servicing income from the loan and
the resultant fair value of the MSRs requires First Horizon to make several
critical assumptions based upon current market and loan production data.
Prepayment speeds: Generally, when market interest rates decline and other
factors favorable to prepayments occur there is a corresponding increase in
actual and expected borrower prepayments as customers refinance existing
mortgages under more favorable interest rate terms. When a mortgage loan is
prepaid, or is expected to prepay faster than originally expected, the
anticipated cash flows associated with servicing that loan are terminated or
reduced, resulting in a reduction, or impairment, to the fair value of the
capitalized MSRs. To estimate prepayment speeds, First Horizon utilizes a
third-party prepayment model, which is based upon statistically derived data
linked to certain key principal indicators involving historical borrower
prepayment activity associated with mortgage loans in the secondary market,
current market interest rates and other factors. For purposes of model
valuation, estimates are made for each product type within the MSRs portfolio on
a monthly basis.
Discount rate: Represents the rate at which the expected cash flows are
discounted to arrive at the net present value of servicing income. Estimated
discount rates will change with market conditions (i.e., supply vs. demand) and
be reflective of the yields expected to be earned by market participants
investing in MSRs.
Cost to service: Expected costs to service are estimated based upon the costs
that a market participant would use in evaluating the potential acquisition of
MSRs.
Float income: Estimated float income is driven by expected float balances
(principal and interest payments that are held pending remittance to the
investor) and current market interest rates, including the thirty day London
Inter-Bank Offered Rate (LIBOR) and five-year swap interest rates, which are
updated on a monthly basis for purposes of estimating the fair market value of
MSRs.
First Tennessee National Corporation F-41
First Horizon engages in a process referred to as 'price discovery' on a monthly
basis to assess the reasonableness of the estimated fair value of MSRs. Price
discovery is conducted through a process of obtaining the following information:
(a) monthly informal valuation of the servicing portfolio by a prominent
mortgage-servicing broker, and (b) a collection of surveys and benchmarking data
available through third party participants in the mortgage banking business.
Although there is no single source of market information that can be relied upon
to assess the fair value of MSRs, First Horizon reviews all information obtained
during price discovery to determine whether the estimated fair value of MSRs is
reasonable when compared to market information. On December 31, 2003, 2002 and
2001, based upon the information obtained through price discovery, First Horizon
determined that its MSRs valuations and assumptions were reasonable based on the
price discovery process.
The overall assessment of the estimated fair value of MSRs is submitted monthly
for review by the First Horizon Risk Management Committee (FHRMC). The FHRMC is
responsible for approving the critical assumptions used by management to
determine the estimated fair value of First Horizon's MSRs. Each quarter, FTNC's
MSRs Committee reviews the original valuation, impairment, and the initial
capitalization rates for newly originated MSRs. In addition, the Executive
Committee of FTNC's board of directors reviews the initial capitalization rates
and approves the amortization expense.
MSRs are included on the Consolidated Statements of Condition, net of
accumulated amortization. The changes in fair value of MSRs are included as a
component of Mortgage Banking - Noninterest Income on the Consolidated
Statements of Income.
HEDGING THE FAIR VALUE OF MSRS
In order to provide protection from a decline in the fair value of MSRs, First
Horizon employs a hedging strategy. This strategy uses derivative financial
instruments expected to change in fair value in response to changes in a certain
benchmark interest rate (specifically, the 10-year LIBOR) in amounts, which will
substantially offset the change in fair value of certain MSRs. On December 31,
2003 and 2002, hedged MSRs approximated 95 percent and 90 percent of the total
MSRs portfolio, as measured on a dollar at risk basis.
In order to substantially hedge the change in fair value of the hedged MSRs,
First Horizon generally maintains a coverage ratio (the ratio of expected change
in fair value of derivatives to expected change in fair value of MSRs)
approximating 100 percent of the hedged MSRs portfolio. As noted above, to the
extent that actual borrower prepayments do not react as anticipated by the
prepayment model (i.e., the historical data observed in the model does not
correspond to actual market activity), it is possible that the prepayment model
could fail to accurately predict mortgage prepayments and could result in
significant earnings volatility. Pursuant to SFAS No. 133, in any hedge period
the difference between the change in fair value of the hedged MSRs, attributed
to the change in the benchmark interest rate, and the change in fair value of
the derivatives used to hedge the change in fair value of the MSRs is recognized
as gains or losses in current earnings. First Horizon generally attempts to
hedge 100 percent of the exposure to a change in the fair value of the hedged
MSRs attributed to a change in the benchmark interest rate, which requires a
regular assessment of the amount of derivative financial instruments required to
maintain a 100 percent hedge ratio.
Certain components of the fair value of derivatives used to hedge certain MSRs
are excluded from the assessment of hedge effectiveness. Although those amounts
are excluded from the assessment of hedge effectiveness, they are included as a
component of current earnings in the Consolidated Statements of Income.
The derivative financial instruments used to hedge the change in fair value of
hedged MSRs primarily include interest rate floors, interest rate swaps,
swaptions and forward purchase contracts of mortgage backed securities (known as
'to be announced' mortgage backed securities, or TBAs).
First Horizon generally experiences increased loan origination and production in
periods of low interest rates, which at the time of sale result in the
capitalization of new MSRs associated with new production - this
F-42 First Tennessee National Corporation
provides for a 'natural hedge' in the mortgage banking business cycle. The
'replenishment rate' during 2003 - meaning the ratio of new loan volume
originated for every existing customer mortgage loan that prepays - was
approximately 191 percent, which includes the retention of existing First
Horizon customers who prepay their mortgage loans. First Horizon capitalized
$536.7 million of MSRs during 2003, resulting in a significant offset to the
impairment charges recognized related to MSRs. This new production volume
contributed significantly to the overall positive results experienced during
2003, despite significant prepayments and MSRs impairment charges (see Table 22
for additional information). New production and origination does not prevent
First Horizon from recognizing impairment expense on existing servicing rights
as a result of prepayments; rather, the new production volume results in loan
origination fees and the capitalization of MSRs as a component of realized gains
related to the sale of such loans in the secondary market, thus the 'natural
hedge' which tends to offset a portion of the MSRs impairment charges during a
period of low interest rates. In a period of increased borrower prepayments,
impairment can be significantly offset by a strong replenishment rate and strong
net margins on new loan originations. To the extent that First Horizon is unable
to maintain a strong replenishment rate, or in the event that the net margin on
new loan originations declines from historical experience, the value of the
natural hedge may diminish, thereby significantly impacting the results of
operations in a period of increased borrower prepayments.
First Horizon does not specifically hedge the change in fair value of MSRs
attributed to other risks, including anticipated prepayments (representing the
difference between actual prepayment experience and estimated prepayments
derived from the model, as described above), basis risk (meaning, the risk that
changes in the benchmark interest rate may not correlate to changes in the
mortgage market interest rates), discount rates, cost to service and other
factors. To the extent that these other factors result in changes to the fair
value of MSRs, First Horizon experiences volatility in current earnings due to
the fact that these risks are not currently hedged.
ACTUAL VS. ESTIMATED MSRS CRITICAL ASSUMPTIONS
As discussed above, the estimate of the cash flow components of net servicing
income associated with MSRs requires management to make several critical
assumptions based upon current market and loan production data, including
prepayment speeds, discount rate, cost to service and float income. Inherent in
estimating such assumptions are uncertainties associated with the mortgage
banking business (primarily, the change in market interest rates which vary
significantly due to multiple economic and non-economic factors) as well as the
composition of the MSRs portfolio, which is not static and changes significantly
based upon the production and sale of new loans, customer prepayment experience
and other factors. As a result, the estimated assumptions used to value
MSRs - particularly the estimate of prepayment speeds - can vary
significantly from actual experience, resulting in the recognition of additional
impairment charges in current earnings. Table 22 provides a summary of actual
and estimated weighted average prepayment speeds and float income used in
determining the estimated fair value of MSRs for the years ended December 31,
2003, 2002 and 2001. Although the estimates of discount rates and cost to
service assumptions used in determining the estimated fair value of MSRs can
vary from actual experience, such differences have not been material for the
years ended December 31, 2003, 2002, and 2001.
During 2003, 2002 and 2001, impairment charges associated with MSRs of $158.3
million, $150.2 million and $115.4 million, respectively, were recognized, which
were principally associated with differences between actual and estimated
prepayment speeds and other factors, including basis risk associated with
benchmark interest rates and actual float income earnings. The decrease in value
of MSRs was partially offset by an increase in fair value of the derivative
financial instruments used to hedge the change in fair value of the hedged MSRs
(see 'MSRs net hedge results' in Table 3).
Table 22 summarizes First Horizon's MSRs activity and critical assumptions for
the years ended December 31, 2003, 2002 and 2001.
First Tennessee National Corporation F-43
TABLE 22 - MSRS ACTIVITY AND CRITICAL ASSUMPTIONS
(Dollars in millions) 2003 2002 2001
------------------------------------------------------------------------------------------------------------
Mortgage servicing income $ 186.7 $ 168.0 $ 157.1
Originated mortgage servicing rights, net 530.4 401.9 232.3
Amortization (132.3) (117.8) (109.3)
Impairment (158.3) (150.2) (115.4)
MSRs hedge ineffectiveness, net* 115.2 100.8 33.8
------------------------------------------------------------------------------------------------------------
Prepayment speeds
Actual 55.3% 42.7% 34.5%
Estimated** 67.0 42.9 24.8
Float income
Actual $ 35.1 $ 41.7 $ 45.2
Estimated 40.0 36.8 38.5
------------------------------------------------------------------------------------------------------------
* MSRs hedge ineffectiveness is expressed net of time decay of MSRs hedges.
** Estimated prepayment speeds represent monthly average prepayment speed
estimates for each of the years presented.
INTEREST-ONLY CERTIFICATES FAIR VALUE
Consistent with MSRs, the fair value of an interest-only certificate typically
rises as market interest rates increase and declines as market interest rates
decrease. Additionally, similar to MSRs, the market for interest-only
certificates is limited, and the precise terms of transactions involving
interest-only certificates are not typically readily available. Accordingly,
First Horizon relies primarily on a discounted cash flow model to estimate the
fair value of its interest-only certificates.
Estimating the cash flow components and the resultant fair value of the
interest-only certificates requires First Horizon to make certain critical
assumptions based upon current market and loan production data. The primary
critical assumptions used by First Horizon to estimate the fair value of
interest-only securities include prepayment speeds and discount rates, as
discussed above. First Horizon's interest-only certificates are included as a
component of trading securities on the Consolidated Statements of Condition,
with realized and unrealized gains and losses included in current earnings as a
component of mortgage banking income on the Consolidated Statements of Income.
HEDGING THE FAIR VALUE OF INTEREST-ONLY CERTIFICATES
First Horizon employs an economic hedging strategy for interest-only
certificates, which uses derivative financial instruments expected to change in
fair value in response to changes in a certain benchmark interest rate
(specifically, the 10-year LIBOR) in amounts which will substantially offset the
change in fair value of certain interest-only certificates. Realized and
unrealized gains and losses associated with the change in fair value of
derivatives used in the economic hedge of interest-only securities are included
in current earnings on the Consolidated Statements of Income. The extent to
which the change in fair value of interest-only securities is offset by the
change in fair value of the derivatives used to hedge these instruments depends
primarily on the hedge coverage ratio maintained by First Horizon. Also, as
noted above, to the extent that actual borrower prepayments do not react as
anticipated by the prepayment model (i.e., the historical data observed in the
model does not correspond to actual market activity), it is possible that the
prepayment model could fail to accurately predict mortgage prepayments, which
could significantly impact First Horizon's ability to effectively hedge certain
components of the change in fair value of interest-only certificates and could
result in significant earnings volatility. The derivative financial instruments
used to hedge the change in fair value of hedged interest-only certificates
primarily include interest rate floors, interest rate swaps, swaptions and TBAs.
F-44 First Tennessee National Corporation
PIPELINE AND WAREHOUSE
During the period of loan origination, and prior to the sale of mortgage loans
in the secondary market, First Horizon has exposure to mortgage loans that are
in the 'mortgage pipeline' and the 'mortgage warehouse'. The mortgage pipeline
consists of loan applications that have been received, but have not yet closed
as loans. Pipeline loans are either 'floating' or 'locked'. A floating pipeline
loan is one on which an interest rate has not been locked by the borrower. A
locked pipeline loan is one on which the potential borrower has set the interest
rate for the loan by entering into an interest rate lock commitment resulting in
interest rate risk to First Horizon. Once a mortgage loan is closed and funded,
it is included within the mortgage warehouse, or the 'inventory' of mortgage
loans that are awaiting sale and delivery (currently an average of approximately
30 days) into the secondary market. First Horizon is exposed to credit risk
while a mortgage loan is in the warehouse.
An interest rate lock commitment binds First Horizon to lend funds to the
potential borrower at the set interest rate, which expires on a fixed date
regardless of whether or not interest rates change in the market. Interest rate
lock commitments generally have a term of up to 60-days before the closing of
the loan. The interest rate lock commitment, however, does not bind the
potential borrower to entering into the loan, nor does it guarantee that First
Horizon will approve the potential borrower for the loan. Therefore, First
Horizon makes estimates of expected 'fallout' (locked pipeline loans not
expected to close), using models, which consider cumulative historical fallout
rates and other factors. Fallout can occur for a variety of reasons including
falling rate environments when a borrower will abandon an interest rate lock
commitment at one lender and enter into a new lower interest rate lock
commitment at another, when a borrower is not approved as an acceptable credit
by the lender, or for a variety of other non-economic reasons. Note that once a
loan is closed, the risk of fallout is eliminated and the associated mortgage
loan is included in the mortgage loan warehouse. Under SFAS No. 133, interest
rate lock commitments qualify as derivative financial instruments and,
therefore, the changes in fair value of interest rate lock commitments are
included in current earnings in the Consolidated Statements of Income. Third
party models are also used to manage interest rate risk related to price
movements on loans in the pipeline and the warehouse.
Like other participants in the mortgage banking business, First Horizon relies
primarily on an internal valuation model and one of several industry valuation
techniques to estimate the fair value of interest rate lock commitments and the
mortgage warehouse. This model calculates the estimated fair value using
tranches of mortgage loans that are determined to share similar price behavior,
which is determined by historical relationships of various product types, terms
and interest rates. For purposes of determining the market values for forward
commitments to sell mortgage loans in the secondary market, First Horizon
obtains market prices from independent third parties, which represent actual
trade activity in the secondary market. For purposes of determining the fair
value of interest rate lock commitments, management utilizes the median broker
price information obtained in the secondary market, resulting in an asset with
an estimated fair value of $21.3 million and an asset with an estimated fair
value of $59.9 million on December 31, 2003 and 2002, respectively.
To hedge against changes in fair value of the mortgage pipeline and warehouse
due to changes in interest rates, First Horizon utilizes various derivative
financial instruments, which management expects will experience changes in fair
value opposite to the change in fair value of the loans in the pipeline and
warehouse, thus minimizing earnings volatility. The instruments and techniques
used to hedge the pipeline and warehouse include forward sales commitments and
other interest rate derivatives. The extent to which First Horizon is able to
economically hedge changes in the mortgage pipeline depends largely on the hedge
coverage ratio that is maintained relative to mortgage loans in the pipeline.
The hedge coverage ratio can change significantly due to changes in market
interest rates and the associated forward commitment prices for sales of
mortgage loans in the secondary market. Increases or decreases in the hedge
coverage ratio can result in significant earnings volatility to First Horizon.
First Horizon does not specifically hedge the change in fair value of the
mortgage pipeline attributed to other risks, including basis risk and other
factors.
First Tennessee National Corporation F-45
FORECLOSURE RESERVES
As discussed above, First Horizon typically originates mortgage loans with the
intent to sell those loans to GSEs and other private investors in the secondary
market. Certain of the mortgage loans are sold with limited or full recourse in
the event of foreclosure. On December 31, 2003 and 2002, approximately $3.7
billion and $4.5 billion of mortgage loans were outstanding which were sold
under limited recourse arrangements. On December 31, 2003 and 2002,
approximately $199.3 million and $175.9 million of mortgage loans were
outstanding which were sold under full recourse arrangements.
Loans sold with limited recourse include loans sold under government guaranteed
mortgage loan programs including Department of Housing and Urban Development
(HUD), Federal Housing Administration (FHA) and Veterans Administration (VA).
First Horizon continues to absorb limited risk of credit losses in the event of
foreclosure of the mortgage loan sold. Generally, the amount of recourse
liability in the event of foreclosure is determined based upon the respective
government program and/or the sale or disposal of the foreclosed property
collateralizing the mortgage loan. Another instance of limited recourse is the
VA/No bid. In this case, the VA guarantee is limited and First Horizon may be
required to fund any deficiency in excess of the VA guarantee if the loan goes
to foreclosure.
Loans sold with full recourse generally include mortgage loans sold to investors
in the secondary market which are uninsurable under government guaranteed
mortgage loan programs, due to issues associated with underwriting activities,
documentation or other concerns.
Management closely monitors historical experience, borrower payment activity,
current economic trends and other risk factors, and establishes a reserve for
foreclosure losses for loans sold with limited and full recourse which
management believes is sufficient to cover incurred foreclosure losses in the
portfolio. The reserve for foreclosure losses is based upon a historical
progression model using a rolling 12-month average, which predicts the
probability or frequency of a mortgage loan entering foreclosure. In addition,
other factors are considered, including qualitative and quantitative factors
(e.g., current economic conditions, past collection experience, risk
characteristics of the current portfolio and other factors), which are not
defined by historical loss trends or severity of losses. Table 23 provides a
summary of reserves for foreclosure losses for the years ended December 31,
2003, 2002 and 2001.
TABLE 23 - RESERVES FOR FORECLOSURE LOSSES
(Dollars in millions) 2003 2002 2001
---------------------------------------------------------------------------------------------------
Beginning balance $ 33.0 $ 25.2 $ 17.8
Provision for foreclosure losses 10.0 19.1 15.7
Charge-offs (22.7) (17.5) (11.2)
Recoveries 2.0 6.2 2.9
---------------------------------------------------------------------------------------------------
ENDING BALANCE 22.3 33.0 25.2
---------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------
ALLOWANCE FOR LOAN LOSSES
Management's policy is to maintain the allowance for loan losses at a level
sufficient to absorb estimated probable incurred losses in the loan portfolio.
Management performs periodic and systematic detailed reviews of its loan
portfolio to identify trends and to assess the overall collectibility of the
loan portfolio. Accounting standards require that loan losses be recorded when
management determines it is probable that a loss has been incurred and the
amount of the loss can be reasonably estimated. Management believes the
accounting estimate related to the allowance for loan losses is a 'critical
accounting estimate' because: changes in it can materially affect the provision
for loan losses and net income, it requires management to predict borrowers'
likelihood or capacity to repay, and it requires management to distinguish
between losses incurred as of a balance sheet date and losses expected to be
incurred in the future. Accordingly, this is a highly subjective process and
requires significant judgment since it is often difficult to determine when
F-46 First Tennessee National Corporation
specific loss events may actually occur. The allowance for loan losses is
increased by the provision for loan losses and recoveries and is decreased by
charged-off loans. This critical accounting estimate applies primarily to the
First Tennessee Banking Group, First Horizon and FTN Financial business
segments.
FTNC's methodology for estimating the allowance for loan losses is not only
critical to the accounting estimate, but to the credit risk management function
as well. Key components of the estimation process are as follows: (1) commercial
loans determined by management to be individually impaired loans are evaluated
individually and specific reserves are determined based on the difference
between the outstanding loan amount and the estimated net realizable value of
the collateral (if collateral dependent) or the present value of expected future
cash flows; (2) individual commercial loans not considered to be individually
impaired are segmented based on similar credit risk characteristics (a summary
is provided in Table 18) and evaluated on a pool basis; (3) retail loans are
segmented based on loan types and credit score bands and loan to value; (4)
reserve rates for each portfolio segment are calculated based on historical
charge-offs and are adjusted by management to reflect current events, trends and
conditions (including economic factors and trends); and (5) management's
estimate of probable incurred losses reflects the reserve rate applied against
the balance of loans in each segment of the loan portfolio.
Principal loan amounts are charged off against the allowance for loan losses in
the period in which the loan or any portion of the loan is deemed to be
uncollectible.
FTNC believes that the critical assumptions underlying the accounting estimate
made by management include: (1) the commercial loan portfolio has been properly
risk graded based on information about borrowers in specific industries and
specific issues with respect to single borrowers; (2) borrower specific
information made available to FTNC is current and accurate; (3) the loan
portfolio has been segmented properly and individual loans have similar credit
risk characteristics and will behave similarly; (4) known significant loss
events that have occurred were considered by management at the time of assessing
the adequacy of the allowance for loan losses; (5) the economic factors utilized
in the allowance for loan losses estimate are used as a measure of actual
incurred losses; (6) the period of history used for historical loss factors is
indicative of the current environment; and (7) the reserve rates, as well as
other adjustments estimated by management for current events, trends, and
conditions, utilized in the process reflect an estimate of losses that have been
incurred as of the date of the financial statements.
While management uses the best information available to establish the allowance
for loan losses, future adjustments to the allowance for loan losses and
methodology may be necessary if economic or other conditions differ
substantially from the assumptions used in making the estimates or, if required
by regulators, based upon information at the time of their examinations. Such
adjustments (discussed below) to original estimates, as necessary, are made in
the period in which these factors and other relevant considerations indicate
that loss levels vary from previous estimates.
In first quarter 2002 management allocated as a component of its allowance for
loan losses a general reserve to reflect management's estimate of additional
probable losses that have been incurred but not specifically identified in the
commercial and consumer portfolios. This reserve helped to minimize the risks
related to the imprecision inherent in the underwriting and grading process and
provided for other factors not considered in computation of reserve rates
applied to loan pools. As of December 31, 2002, management decided to
specifically quantify risks previously identified and provided for by the
general reserve and adjust reserve rates accordingly to reserve for these items
in the appropriate pools, and no longer separately presents a general reserve as
a component of the allowance for loan losses. Except as noted in this paragraph,
there have been no significant changes to the methodology for the three years in
the period ended December 31, 2003. The change in reserve rates is a function of
the consistent application of the current methodology and those changes are
further discussed in the Risk Management - Credit Risk Management section.
First Tennessee National Corporation F-47
GOODWILL AND ASSESSMENT OF IMPAIRMENT
FTNC's policy is to assess goodwill for impairment at the reporting unit level
on an annual basis or between annual assessments if an event occurs or
circumstances change that would more likely than not reduce the fair value of a
reporting unit below its carrying amount. Impairment is the condition that
exists when the carrying amount of goodwill exceeds its implied fair value.
Accounting standards require management to estimate the fair value of each
reporting unit in making the annual assessment of impairment. Upon adoption of
the new accounting standards on January 1, 2002, goodwill is no longer amortized
with a periodic charge to earnings. FTNC performed the initial impairment test
as of January 1, 2002. Subsequent to the initial evaluation, the annual
impairment test will be performed each year as of October 1. The valuations as
of October 1, 2003, indicated no goodwill impairment for any of the reporting
units.
Management believes the accounting estimates associated with determining fair
value as part of the goodwill impairment test is a 'critical accounting
estimate' because estimates and assumptions are made about FTNC's future
performance and cash flows, as well as other prevailing market factors (interest
rates, economic trends, etc.). FTNC's policy allows management to make the
determination of fair value using internal cash flow models or by engaging
independent third parties. If a charge to operations for impairment results,
this amount would be reported separately as a component of noninterest expense.
This critical accounting estimate applies to the First Tennessee Banking Group,
First Horizon, FTN Financial, and Transaction Processing business segments.
Reporting units have been defined as the same level as the operating business
segments.
The impairment testing process conducted by FTNC begins by assigning net assets
and goodwill to each reporting unit. FTNC then completes 'step one' of the
impairment test by comparing the fair value of each reporting unit (as
determined based on the discussion below) with the recorded book value (or
'carrying amount') of its net assets, with goodwill included in the computation
of the carrying amount. If the fair value of a reporting unit exceeds its
carrying amount, goodwill of that reporting unit is not considered impaired, and
'step two' of the impairment test is not necessary. If the carrying amount of a
reporting unit exceeds its fair value, step two of the impairment test is
performed to determine the amount of impairment. Step two of the impairment test
compares the carrying amount of the reporting unit's goodwill to the 'implied
fair value' of that goodwill. The implied fair value of goodwill is computed by
assuming all assets and liabilities of the reporting unit would be adjusted to
the current fair value, with the offset as an adjustment to goodwill. This
adjusted goodwill balance is the implied fair value used in step two. An
impairment charge is recognized for the amount by which the carrying amount of
goodwill exceeds its implied fair value.
As noted above, a key estimate made by management during the assessment of
impairment is the fair value of each reporting unit. As of October 1, 2003, FTNC
engaged an independent valuation firm to compute the fair value estimates of
each reporting unit as part of its annual impairment assessment. The independent
valuation utilized three separate valuation methodologies and applied a weighted
average to each methodology in order to determine fair value for each reporting
unit.
In connection with obtaining the independent valuation, management provided
certain data and information that was utilized by the third party in their
determination of fair value. This information included budgeted and forecasted
earnings of FTNC. Management believes that this information is a critical
assumption underlying the estimate of fair value. The independent third party
made other assumptions critical to the process, including discount rates, asset
and liability growth rates, and other income and expense estimates, through
discussions with management.
While management uses the best information available to estimate future
performance for each reporting unit, future adjustments to management's
projections may be necessary if economic conditions differ substantially from
the assumptions used in making the estimates.
F-48 First Tennessee National Corporation
CONTINGENT LIABILITIES
A liability is contingent if the amount is not presently known, but may become
known in the future as a result of the occurrence of some uncertain future
event. FTNC estimates its contingent liabilities based on management's estimates
about the probability of outcomes and their ability to estimate the range of
exposure. Accounting standards require that a liability be recorded if
management determines that it is probable that a loss has occurred and the loss
can be reasonably estimated. In addition, it must be probable that the loss will
be confirmed by some future event. As part of the estimation process, management
is required to make assumptions about matters that are by their nature highly
uncertain.
The assessment of contingent liabilities, including legal contingencies and
income tax liabilities, involves the use of critical estimates, assumptions and
judgments. Management's estimates are based on their belief that future events
will validate the current assumptions regarding the ultimate outcome of these
exposures. However, there can be no assurance that future events, such as court
decisions or I.R.S. positions, will not differ from management's assessments.
Whenever practicable, management consults with third party experts (attorneys,
accountants, claims administrators, etc.) to assist with the gathering and
evaluation of information related to contingent liabilities. Based on internally
and/or externally prepared evaluations, management makes a determination whether
the potential exposure requires accrual in the financial statements. Note
18 - Restrictions, Contingencies, Commitments and Other Disclosures provides
additional information.
Note 1 - Summary of Significant Accounting Policies provides more detail on
the accounting policies applied in the preparation of FTNC's financial
statements.
QUARTERLY FINANCIAL INFORMATION
TABLE 24 - SUMMARY OF QUARTERLY FINANCIAL INFORMATION
2003 2002
------------------------------------- -------------------------------------
(Dollars in millions except FOURTH THIRD SECOND FIRST Fourth Third Second First
per share data) QUARTER QUARTER QUARTER QUARTER Quarter Quarter Quarter Quarter
------------------------------------------------------------------------------------------------------------------
SUMMARY INCOME INFORMATION:
Interest income $253.3 $277.4 $266.9 $255.8 $272.7 $261.4 $249.4 $258.7
Interest expense 56.8 63.3 66.0 61.5 69.5 71.9 71.6 73.6
Provision for loan losses 15.4 16.3 27.5 27.5 22.8 20.2 23.3 25.9
Noninterest income 386.5 392.3 431.4 429.8 398.4 335.6 297.1 280.8
Noninterest expense 382.0 409.9 433.2 415.0 426.3 365.8 315.8 309.3
Net income 117.6 118.3 118.4 119.0 103.4 95.6 90.4 87.1
------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE .93 .93 .93 .94 .82 .75 .71 .69
DILUTED EARNINGS PER COMMON
SHARE .90 .91 .90 .91 .80 .73 .69 .67
------------------------------------------------------------------------------------------------------------------
COMMON STOCK INFORMATION:
Closing price per share:
High $46.60 $44.98 $47.98 $39.96 $37.95 $39.70 $40.45 $36.06
Low 42.37 38.97 39.05 36.14 30.05 32.62 34.55 33.49
Period-end 44.10 42.46 43.91 39.71 35.94 34.67 38.30 35.05
Dividends declared per share .40 .30 .30 .30 .30 .25 .25 .25
------------------------------------------------------------------------------------------------------------------
First Tennessee National Corporation F-49
OTHER
FURTHER INTERPRETATIONS OF SFAS NO. 133
Certain provisions of SFAS No. 133 continue to undergo significant discussion
and debate by the Financial Accounting Standards Board (FASB). One such
potential issue involves the determination of the fair value of mortgage banking
interest rate lock commitments (IRLCs) accounted for as derivatives and if IRLCs
can be reported as assets. Another such potential issue involves the assessment
of hedge effectiveness (and its impact on qualifying for hedge accounting) when
hedging fair value changes of prepayable assets due to changes in the benchmark
interest rate. As the FASB continues to deliberate interpretation of the new
rules, the potential exists for a difference between FTNC's interpretation and
that of the FASB, the effects of which cannot presently be anticipated but
failure to obtain hedge accounting treatment could be significant to results of
operations.
In December 2003, the SEC staff announced that it will soon issue a Staff
Accounting Bulletin (SAB) on the accounting treatment of loan commitments that
are recognized as derivatives pursuant to SFAS No. 133. Based on preliminary
indications, the SAB would require registrants to utilize a written option model
in valuation of their loan commitments. This would result in the recognition of
a liability, with entries to expense, at the inception of the loan commitment or
lock date, through origination of the loan. As the SEC continues to deliberate
this issue, the effect of implementing this change cannot presently be
determined, but upon adoption this one-time accounting adjustment could be
significant, however, the ongoing economic value of the business would be
unaffected.
ACCOUNTING CHANGES
On January 17, 2003, the FASB issued FASB Interpretation No. 46, 'Consolidation
of Variable Interest Entities (revised December 2003)' (FIN 46-R). FIN 46-R
clarified certain aspects of FIN 46 and provided certain entities with
exemptions from the requirements of FIN 46. Additionally, FIN 46-R incorporated
the guidance found in eight final FASB Staff Positions (FSPs) that were issued
as of the release of FIN 46-R. FIN 46-R required the application of either FIN
46 or FIN 46-R to all special purpose entities (SPEs) created prior to February
1, 2003, for interim or annual reporting periods ending after December 15, 2003
(December 31, 2003 for FTNC). All entities created after January 31, 2003, are
currently required to be analyzed under FIN 46 unless FIN 46-R is adopted early.
FIN 46-R is applicable to all non-SPEs created prior to February 1, 2003 that
are not small business issuers for interim or annual reporting periods ending
after March 15, 2004 (March 31, 2004 for FTNC). FTNC anticipates the impact of
adopting the remaining provisions of this standard to be immaterial.
On December 31, 2003, FTNC adopted FASB Staff Position (FSP) FAS No. 106-1,
'Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003'. The Medicare Prescription
Drug, Improvement and Modernization Act of 2003 (the Act) introduces a
prescription drug benefit under Medicare Part D as well as a federal subsidy to
sponsors of retiree health care benefit plans that provide a benefit that is at
least actuarially equivalent to Medicare Part D. FSP 106-1 allows either
immediate recognition or deferred recognition. FTNC elected to defer recognition
and will not recognize the effect of the Act until the earlier of: (1) when the
underlying accounting issues are resolved by FASB; or (2) when plan costs have
to be remeasured (e.g. for a plan amendment). FTNC does not expect the impact of
recognizing this benefit to be material to results of operations.
In October 2003, the FASB approved the AICPA's issuance of SOP 03-3, 'Accounting
for Loans or Certain Debt Securities Acquired in a Transfer', 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 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. SOP 03-3 is effective for fiscal years beginning after
December 15, 2004. The impact at implementation of adopting SOP 03-3 is expected
to be immaterial to the results of future operations.
F-50 First Tennessee National Corporation
GLOSSARY
ALLOWANCE FOR LOAN LOSSES - Valuation reserve representing the amount
considered by management to be adequate to cover estimated probable incurred
losses in the loan portfolio.
BASIS POINT - The equivalent of one-hundredth of one percent (0.01). One
hundred basis points equals one percent. This unit is generally used to measure
movements in interest yields and rates.
BASIS RISK - Refers to changes in the relationship between various interest
rate segments (e.g. the difference between the Prime and the Fed Funds Rates).
BOOK VALUE PER COMMON SHARE - A ratio determined by dividing shareholders'
equity at the end of a period by the number of common shares outstanding at the
end of that period.
BULK SALES - Refers to sales of mortgage servicing rights that are transacted
separately from the sale of the related loans.
CHARGE-OFFS - The amount charged against the allowance for loan losses to
reduce specific loans to their net realizable value.
CLASSIFIED LOAN - A loan that has caused management to have serious doubts
about the borrower's ability to comply with present repayment terms. Included in
this category are grades 8, 9 and 10 performing and nonperforming loans. In
compliance with the standards established by the Office of the Comptroller of
the Currency (OCC) these loans are classified as substandard, doubtful, and loss
depending on the severity of the loan's deterioration.
COMMERCIAL PAPER - A short-term unsecured debt obligation of the parent
company with maturities typically of 30 days to 270 days.
COMMERCIAL AND STANDBY LETTERS OF CREDIT - Commercial letters of credit are
issued or confirmed by an entity to ensure the payment of its customers'
payables and receivables. Standby letters of credit are issued by an entity to
ensure its customers' performance in dealing with others.
COMMITMENT TO EXTEND CREDIT - Agreements to make or acquire a loan or lease as
long as agreed-upon terms (e.g., expiration date, covenants, or notice) are met.
Generally these commitments have fixed expiration dates or other termination
clauses and may require payment of a fee.
CORE DEPOSITS - Core deposits consist of all interest-bearing and
noninterest-bearing deposits, except certificates of deposit over $100,000. They
include checking interest deposits, money market deposit accounts, time and
other savings, plus demand deposits.
DERIVATIVE FINANCIAL INSTRUMENT - A contract or agreement whose value is
derived from changes in interest rates, foreign exchange rates, prices of
securities or commodities, or financial or commodity indices.
DILUTED EARNINGS PER COMMON SHARE - Net income, divided by average shares
outstanding plus the number of shares that would be outstanding if all dilutive
common shares had been issued. Dilutive common shares, for example, would
represent outstanding options where the average stock price exceeds the price at
which the option was granted.
DOUBLE LEVERAGE RATIO - A ratio that measures the degree to which parent
company debt supports investments in subsidiaries. It is calculated by dividing
the parent company's investment in subsidiaries by total consolidated equity.
EARNING ASSETS - Assets that generate interest or dividend income or
yield-related fee income, such as loans and investment securities.
EARNINGS PER COMMON SHARE - Net income, divided by the average number of
common shares outstanding in the period. (See also diluted earnings per share)
FEDERAL FUNDS SOLD/PURCHASED - Excess balances of depository institutions
which are loaned to each other, generally on an overnight basis.
First Tennessee National Corporation F-51
FLOW SALES - Refers to sales of loans where the servicing right is released at
the time the related loan is sold.
FULLY TAXABLE EQUIVALENT INCOME (FTE) - Income which has been adjusted by
increasing tax-exempt income to a level that would yield the same after-tax
income had that income been subject to taxation.
HEDGE - An instrument used to reduce risk by entering into a transaction which
offsets existing or anticipated exposures to changes in interest rates or fair
value of assets or liabilities.
INTEREST FREE SOURCES - Noninterest bearing liabilities (such as demand
deposits, other liabilities, and shareholders' equity) net of nonearning assets
(such as cash, fixed assets, and other assets).
INTEREST ONLY STRIP - Mortgage security consisting of the interest rate
portion of a stripped mortgage backed security.
INTEREST RATE CAPS AND FLOORS - Contracts with notional principal amounts that
require the seller, in exchange for a fee, to make payments to the purchaser if
a specified market interest rate exceeds a fixed upper 'capped' level or falls
below a fixed lower 'floor' level on specified future dates.
INTEREST RATE FORWARD CONTRACTS - Contracts representing commitments either to
purchase or sell at a specified future date a specified security or financial
instrument at a specified price, and may be settled in cash or through delivery.
These obligations are generally short term in nature.
INTEREST RATE OPTIONS - A contract that grants the holder (purchaser), for a
fee, the right to either purchase or sell a financial instrument at a specified
price within a specified period of time or on a specified date from the writer
(seller) of the option.
INTEREST RATE SENSITIVITY - The relationship of changes in interest income and
interest expense to fluctuations in interest rates over a defined period of
time.
INTEREST RATE SWAP - An agreement in which two entities agree to exchange, at
specified intervals, interest payment streams calculated on an agreed upon
notional principal amount with at least one stream based on a floating rate
index.
INTEREST SENSITIVITY GAP - The difference between interest-rate sensitive
assets and interest-rate sensitive liabilities over a designated time period. A
net asset exists when interest-rate sensitive assets exceed interest-rate
sensitive liabilities. A net liability position exists when liabilities exceed
assets.
LEVERAGE RATIO - Tier 1 capital divided by quarterly average assets excluding
any adjustments for available for sale securities unrealized gains/(losses),
goodwill, and certain other intangible assets.
LIQUIDITY - The ability of a corporation to generate adequate funds to meet
its cash flow requirements. It is measured by the ability to quickly convert
assets into cash with minimal exposure to interest rate risk, by the size and
stability of the core deposit base, and by additional borrowing capacity within
the money markets.
MARKET CAPITALIZATION - Market value of a company computed by multiplying the
number of shares outstanding by the current stock price.
MORTGAGE BACKED SECURITIES - Investment securities backed by a pool of
mortgages or trust deeds. Principal and interest payments on the underlying
mortgages are used to pay principal and interest on the securities.
MORTGAGE PIPELINE - Interest rate commitments made to customers on mortgage
loans that have not yet been closed and funded.
MORTGAGE WAREHOUSE - A mortgage loan that has been closed and funded and is
awaiting sale and delivery into the secondary market.
MORTGAGE SERVICING RIGHTS (MSRS) - The right to service mortgage loans,
generally owned by someone else, for a fee. Loan servicing includes collecting
payments; remitting funds to investors, insurance
F-52 First Tennessee National Corporation
companies, and taxing authorities; collecting delinquent payments; and
foreclosing on properties when necessary.
NET INTEREST INCOME (NII) - Interest income less interest expense.
NET INTEREST MARGIN - A measurement of how effectively the bank utilizes its
earning assets in relationship to the interest cost of funding them. It is
computed by dividing fully taxable-equivalent net interest income by average
earning assets.
NET INTEREST SPREAD - The difference between the average yield earned on
earning assets on a fully taxable equivalent basis and the average rate paid for
interest-bearing liabilities.
NONACCRUAL LOANS - Loans on which interest accruals have been discontinued due
to the borrower's financial difficulties. Interest income on these loans is
reported on a cash basis as it is collected after recovery of principal.
NONPERFORMING ASSETS - Interest earning assets on which interest income is not
being accrued, restructured loans on which interest rates or terms of repayment
have been materially revised, real estate properties acquired through
foreclosure, and repossessed assets.
NOTIONAL PRINCIPAL AMOUNT - An amount on which payments for interest rate
swaps and interest rate options, caps and floors are based. The 'notional
amount' is not paid or received.
PROVISION FOR LOAN LOSSES - The periodic charge to earnings for potential
losses in the loan portfolio.
PRINCIPAL ONLY STRIP - Mortgage security consisting of the principal portion
of a stripped mortgage backed security.
PURCHASED FUNDS - The combination of certificates of deposit greater than
$100,000, federal funds purchased, securities sold under agreement to
repurchase, bank notes, commercial paper, and other short-term borrowings.
RECOVERIES - The amount added to the allowance for loan losses when funds are
received on a loan which was previously charged off.
REPURCHASE AGREEMENT - A method of short-term financing where one party agrees
to buy back, at a future date (generally overnight) and an agreed-upon price, a
security it sells to another party.
RESTRUCTURED LOANS - Loans where the institution, for economic or legal
reasons related to the debtor's financial difficulties, grants a concession to
the debtor that it would not otherwise consider.
RETURN ON AVERAGE ASSETS (ROA) - A measure of profitability that indicates how
effectively an institution utilized its assets. It is calculated by dividing
annualized net income by total average assets.
RETURN ON AVERAGE EQUITY (ROE) - A measure of profitability that indicates
what an institution earned on its shareholders' investment. ROE is calculated by
dividing net income by total average shareholders' equity.
REVENUE - The sum of net interest income and noninterest income. For some
comparisons, securities gains/losses are excluded.
RISK-ADJUSTED ASSETS - A regulatory risk-based calculation that takes into
account the broad differences in risks among a banking organization's assets and
off-balance sheet instruments.
SECURITIZED ASSETS OR SECURITIZATION - The process by which financial assets
are packaged, underwritten and sold as securities.
TIER 1 CAPITAL RATIO - Ratio consisting of shareholders' equity before any
adjustments for available for sale securities unrealized gains/(losses), reduced
by goodwill, certain other intangible assets and the disallowable portion of
mortgage servicing rights divided by risk-adjusted assets.
TOTAL CAPITAL RATIO - Tier 1 capital plus the allowable portion of the
allowance for loan losses and qualifying subordinated debt divided by
risk-adjusted assets.
First Tennessee National Corporation F-53
CONSOLIDATED STATEMENTS OF CONDITION
December 31
-------------------------
(Dollars in thousands) 2003 2002
---------------------------------------------------------------------------------------
ASSETS:
Cash and due from banks (Note 18) $ 773,294 $ 1,068,110
Federal funds sold and securities purchased under agreements
to resell 381,500 260,607
---------------------------------------------------------------------------------------
Total cash and cash equivalents 1,154,794 1,328,717
---------------------------------------------------------------------------------------
Investment in bank time deposits 498 1,906
Trading securities 800,490 893,997
Loans held for sale 2,977,723 4,797,565
Securities available for sale (Note 3) 2,469,342 2,419,908
Securities held to maturity (fair value of $1,077 on
December 31, 2003,
and $284,510 on December 31, 2002) (Note 3) 1,028 280,377
Loans, net of unearned income (Note 4) 13,990,525 11,345,445
Less: Allowance for loan losses 160,333 144,298
---------------------------------------------------------------------------------------
Total net loans 13,830,192 11,201,147
---------------------------------------------------------------------------------------
Premises and equipment, net (Note 5) 350,202 254,132
Real estate acquired by foreclosure 24,075 11,451
Mortgage servicing rights, net (Note 6) 795,938 440,482
Goodwill (Note 7) 174,807 164,617
Other intangible assets, net (Note 7) 38,742 29,648
Capital markets receivables and other assets 1,888,859 1,999,148
---------------------------------------------------------------------------------------
TOTAL ASSETS $24,506,690 $23,823,095
---------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits:
Interest-bearing (Note 8) $11,139,758 $10,564,489
Noninterest-bearing 4,540,213 5,149,414
---------------------------------------------------------------------------------------
Total deposits 15,679,971 15,713,903
---------------------------------------------------------------------------------------
Federal funds purchased and securities sold under agreements
to repurchase (Note 9) 3,079,248 3,126,350
Commercial paper and other short-term borrowings (Note 9) 227,976 361,208
Capital markets payables and other liabilities 1,901,959 1,856,347
Term borrowings (Note 10) 1,726,766 929,715
---------------------------------------------------------------------------------------
Total liabilities 22,615,920 21,987,523
---------------------------------------------------------------------------------------
Guaranteed preferred beneficial interests in First
Tennessee's
junior subordinated debentures (Note 11) - 100,000
Preferred stock of subsidiary (Note 12) 452 44,392
---------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY:
Preferred stock - no par value (5,000,000 shares
authorized, but unissued) - -
Common stock - $.625 par value (shares
authorized - 400,000,000; shares
issued - 124,834,272 on December 31, 2003 and 125,600,024
on December 31, 2002) 78,021 78,500
Capital surplus 145,817 119,318
Undivided profits 1,662,699 1,461,946
Accumulated other comprehensive income (Note 15) 682 26,487
Deferred compensation on restricted stock incentive plans (9,044) (5,796)
Deferred compensation obligation 12,143 10,725
---------------------------------------------------------------------------------------
Total shareholders' equity 1,890,318 1,691,180
---------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $24,506,690 $23,823,095
---------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-54 First Tennessee National Corporation
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31
------------------------------------------
(Dollars in thousands except per share data) 2003 2002 2001
--------------------------------------------------------------------------------------------------------
INTEREST INCOME:
Interest and fees on loans $ 657,546 $ 665,980 $ 811,744
Investment securities:
Taxable 110,891 142,197 166,774
Tax-exempt 366 812 1,451
Loans held for sale 229,091 184,038 165,900
Trading securities 50,515 43,679 48,551
Other earning assets 4,961 5,489 7,090
--------------------------------------------------------------------------------------------------------
Total interest income 1,053,370 1,042,195 1,201,510
--------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Deposits:
Savings 832 2,187 3,840
Checking interest and money market 22,739 37,055 84,865
Certificates of deposit under $100,000 and other time 57,139 71,254 111,102
Certificates of deposit $100,000 and more 69,336 79,844 137,095
Short-term borrowings 62,130 67,657 145,535
Term borrowings 35,410 28,584 30,159
--------------------------------------------------------------------------------------------------------
Total interest expense 247,586 286,581 512,596
--------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 805,784 755,614 688,914
Provision for loan losses 86,698 92,184 93,220
--------------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 719,086 663,430 595,694
--------------------------------------------------------------------------------------------------------
NONINTEREST INCOME:
Mortgage banking 616,564 436,706 285,032
Capital markets 538,919 448,016 344,278
Deposit transactions and cash management 146,701 143,315 133,631
Insurance premiums and commissions 57,811 50,446 16,844
Merchant processing 57,609 48,403 45,426
Trust services and investment management 45,873 48,369 56,705
Gains on divestitures 22,498 4,550 80,357
Equity securities gains/(losses), net 8,491 (9,435) (3,290)
Debt securities (losses)/gains, net (6,113) 255 (1,041)
All other income (Note 14) 151,661 141,310 137,079
--------------------------------------------------------------------------------------------------------
Total noninterest income 1,640,014 1,311,935 1,095,021
--------------------------------------------------------------------------------------------------------
ADJUSTED GROSS INCOME AFTER PROVISION FOR LOAN LOSSES 2,359,100 1,975,365 1,690,715
--------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSE:
Employee compensation, incentives and benefits 980,306 830,672 670,934
Occupancy 83,583 76,669 69,069
Equipment rentals, depreciation and maintenance 68,973 68,736 74,106
Operations services 67,948 60,238 59,635
Communications and courier 50,535 45,085 42,191
Amortization of intangible assets 7,980 6,200 10,805
All other expense (Note 14) 380,777 329,706 275,412
--------------------------------------------------------------------------------------------------------
Total noninterest expense 1,640,102 1,417,306 1,202,152
--------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 718,998 558,059 488,563
Applicable income taxes (Note 16) 245,689 181,608 162,186
--------------------------------------------------------------------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING
PRINCIPLES 473,309 376,451 326,377
Cumulative effect of changes in accounting principles, net
of tax - - (8,168)
--------------------------------------------------------------------------------------------------------
NET INCOME $ 473,309 $ 376,451 $ 318,209
--------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE BEFORE CUMULATIVE EFFECT OF
CHANGES IN ACCOUNTING PRINCIPLES (Note 17) $ 3.73 $ 2.97 $ 2.55
--------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE (Note 17) $ 3.73 $ 2.97 $ 2.49
--------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER COMMON SHARE BEFORE CUMULATIVE
EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES (Note 17) $ 3.62 $ 2.89 $ 2.48
--------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER COMMON SHARE (Note 17) $ 3.62 $ 2.89 $ 2.42
--------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 126,765,423 126,714,413 127,777,356
--------------------------------------------------------------------------------------------------------
Certain previously reported amounts have been reclassified to agree with current
presentation.
See accompanying notes to consolidated financial statements.
First Tennessee National Corporation F-55
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated Deferred Deferred
Other Compen- Compen-
Common Common Capital Undivided Comprehensive sation sation
(Amounts in thousands) Shares Total Stock Surplus Profits Income Asset Liability
---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 128,745 $1,384,156 $80,465 $115,775 $1,172,548 $ 14,598 $(4,183) $ 4,953
Net income - 318,209 - - 318,209 - - -
Other comprehensive income:
Unrealized market adjustments on
securities available for sale,
net of tax - 8,680 - - - 8,680 - -
--------------------------------------------------------------------------------------------
Comprehensive income - 326,889 - - 318,209 8,680 - -
--------------------------------------------------------------------------------------------
Cash dividends declared
($.91/share) - (115,260) - - (115,260) - - -
Common stock issued for exercise
of stock options 4,346 77,114 2,716 71,738 - - - 2,660
Tax benefit from non-qualified
stock options - 28,293 - 28,293 - - - -
Common stock repurchased (7,217) (238,701) (4,510) (122,343) (111,848) - - -
Amortization on restricted stock
incentive plans - 2,168 - - - - 2,168 -
Other (9) 13,103 (5) 13,219 - - (111) -
---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 125,865 1,477,762 78,666 106,682 1,263,649 23,278 (2,126) 7,613
Net income - 376,451 - - 376,451 - - -
Other comprehensive income:
Unrealized market adjustments on
cash flow hedges, net of tax - (137) - - - (137) - -
Unrealized market adjustments on
securities available for sale,
net of tax - 4,735 - - - 4,735 - -
Minimum pension liability, net of
tax (1,389) (1,389)
--------------------------------------------------------------------------------------------
Comprehensive income - 379,660 - - 376,451 3,209 - -
--------------------------------------------------------------------------------------------
Cash dividends declared
($1.05/share) - (131,982) - - (131,982) - - -
Common stock issued for exercise
of stock options 2,613 50,700 1,633 45,955 - - - 3,112
Tax benefit from non-qualified
stock options - 11,395 - 11,395 - - - -
Common stock repurchased (3,053) (111,187) (1,909) (63,106) (46,172) - - -
Amortization on restricted stock
incentive plans - 2,499 - - - - 2,499 -
Other 175 12,333 110 18,392 - - (6,169) -
---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 125,600 1,691,180 78,500 119,318 1,461,946 26,487 (5,796) 10,725
Net income - 473,309 - - 473,309 - - -
Other comprehensive income:
Unrealized market adjustments on
cash flow hedges, net of tax - 137 - - - 137 - -
Unrealized market adjustments on
securities available for sale,
net of tax - (24,813) - - - (24,813) - -
Minimum pension liability, net of
tax (1,129) (1,129)
--------------------------------------------------------------------------------------------
Comprehensive income - 447,504 - - 473,309 (25,805) - -
--------------------------------------------------------------------------------------------
Cash dividends declared
($1.30/share) - (163,452) - - (163,452) - - -
Common stock issued for exercise
of stock options 3,889 77,876 2,431 74,027 - - - 1,418
Tax benefit from non-qualified
stock options - 27,842 - 27,842 - - - -
Common stock repurchased (4,855) (209,125) (3,035) (96,972) (109,118) - - -
Amortization on restricted stock
incentive plans - 5,121 - - - - 5,121 -
Other 200 13,372 125 21,602 14 - (8,369) -
---------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2003 124,834 $1,890,318 $78,021 $145,817 $1,662,699 $ 682 $(9,044) $12,143
---------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
F-56 First Tennessee National Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
-----------------------------------------
(DOLLARS IN THOUSANDS) 2003 2002 2001
------------------------------------------------------------------------------------------------------------------
OPERATING Net income $ 473,309 $ 376,451 $ 318,209
ACTIVITIES Adjustments to reconcile net income to net cash
provided/(used) by operating activities:
Provision for loan losses 86,698 92,184 93,220
Provision/(benefit) for deferred income tax 113,716 42,248 (157,870)
Depreciation and amortization of premises and equipment 60,507 55,396 56,906
Amortization and impairment of mortgage servicing rights 290,597 268,003 224,775
Amortization of intangible assets 7,980 6,200 10,805
Net other amortization and accretion 66,147 24,073 14,480
Net decrease/(increase) in net derivative product assets 58,298 (186,734) 87,970
Market value adjustment on foreclosed property 11,644 18,811 14,442
Loss on early retirement of debt 5,766 3,724 5,107
Equity securities (gains)/losses (8,491) 9,435 3,290
Debt securities losses/(gains) 6,113 (255) 1,041
Net losses on disposals of fixed assets 1,437 936 5,528
Gains on divestitures (22,498) (4,550) (80,357)
Net (increase)/decrease in:
Trading securities 85,374 (247,818) (237,659)
Loans held for sale 1,819,842 (1,398,256) (1,664,239)
Capital markets receivables (327,190) 137,820 (272,601)
Interest receivable (8,369) 8,535 26,430
Other assets (427,934) (260,014) (134,061)
Net increase/(decrease) in:
Capital markets payables 282,070 (7,732) 293,452
Interest payable 579 (6,799) (32,497)
Other liabilities (193,188) 289,922 299,358
------------------------------------------------------------------------------------------------------------------
Total adjustments 1,909,098 (1,154,871) (1,442,480)
------------------------------------------------------------------------------------------------------------------
Net cash provided/(used) by operating activities 2,382,407 (778,420) (1,124,271)
------------------------------------------------------------------------------------------------------------------
INVESTING Maturities of held to maturity securities 142,723 179,628 175,856
ACTIVITIES Available for sale securities:
Sales 992,017 170,819 124,632
Maturities 1,546,914 1,247,002 810,913
Purchases (2,745,032) (1,768,354) (945,823)
Premises and equipment:
Sales 847 8,032 6,514
Purchases (149,600) (56,794) (27,694)
Net increase in loans (2,808,349) (1,394,641) (646,859)
Net decrease/(increase) in investment in bank time deposits 1,346 (166) 1,889
Proceeds from divestitures, net of cash and cash equivalents 21,577 206,664 453,279
Acquisitions, net of cash and cash equivalents acquired (1,930) (13,433) (11,495)
------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (2,999,487) (1,421,243) (58,788)
------------------------------------------------------------------------------------------------------------------
FINANCING Common stock:
ACTIVITIES Exercise of stock options 77,591 51,015 78,183
Cash dividends paid (150,863) (125,736) (112,093)
Repurchase of shares (209,263) (111,187) (238,701)
Term borrowings:
Issuance 925,887 481,816 324,151
Payments (287,207) (106,569) (245,595)
Issuance of preferred stock of subsidiary 260 - -
Net increase/(decrease) in:
Deposits 267,068 2,107,554 1,565,300
Short-term borrowings (180,316) 116,864 (33,962)
------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 443,157 2,413,757 1,337,283
------------------------------------------------------------------------------------------------------------------
Net (decrease)/increase in cash and cash equivalents (173,923) 214,094 154,224
------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of period 1,328,717 1,114,623 960,399
------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 1,154,794 $ 1,328,717 $ 1,114,623
------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------
Total interest paid $ 246,136 $ 292,618 $ 544,336
Total income taxes paid 159,188 123,071 250,607
------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
First Tennessee National Corporation F-57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF ACCOUNTING. The consolidated financial statements of First Tennessee
National Corporation (FTNC), including its subsidiaries, are 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.
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION. The consolidated
financial statements include the accounts of FTNC and its majority-owned
subsidiaries. Affiliates that are not majority owned are accounted for by the
equity method. All significant intercompany transactions and balances have been
eliminated. For purposes of comparability, certain prior period amounts have
been reclassified to conform to current year presentation. None of these
reclassifications had any effect on net income or earnings per share for any of
the periods presented. Early adoption of Statement of Financial Accounting
Standards (SFAS) No. 145 (see Accounting Changes section) eliminated the
calculation of earnings per share before debt restructurings.
Business combinations accounted for as purchases are included in the financial
statements from the respective dates of acquisition.
REVENUE RECOGNITION. FTNC derives a significant portion of its revenues from fee
based services. Revenues from transaction based fees are recognized when the
transactions are completed. Revenues for service based fees are recognized over
the period in which FTNC provides the service.
STATEMENTS OF CASH FLOWS. For purposes of these statements, cash and due from
banks, federal funds sold, and securities purchased under agreements to resell
are considered cash and cash equivalents. Federal funds are usually sold for
one-day periods, and securities purchased under agreements to resell are
short-term, highly liquid investments.
TRADING SECURITIES. Inventories purchased in connection with underwriting or
dealer activities are carried at market value. Gains and losses, both realized
and unrealized, on these inventories are reflected in noninterest income as
capital markets income. In addition, retained interests, in the form of
interest-only and principal-only strips, from mortgage banking securitizations
are recognized at fair value with gains and losses both realized and unrealized,
recognized in mortgage banking income.
INVESTMENT SECURITIES. Securities that FTNC has the ability and positive intent
to hold to maturity are classified as securities held to maturity and are
carried at amortized cost. The amortized cost of all securities is adjusted for
amortization of premium and accretion of discount to maturity, or earlier call
date if appropriate, using the level yield method. Such amortization and
accretion is included in interest income from securities. Realized gains and
losses and declines in value judged to be other than temporary are determined by
the specific identification method and reported in noninterest income.
Securities that may be sold prior to maturity for asset/liability management
purposes and equity securities are classified as securities available for sale
and are carried at fair value. The unrealized gains and losses on securities
available for sale are excluded from earnings and are reported, net of tax, as a
component of other comprehensive income within shareholders' equity. Venture
capital investments for which there are not active market quotes are initially
valued at cost. Subsequently, these investments are adjusted to reflect changes
in valuation as a result of initial public offerings or other-than-temporary
declines in value.
SECURITIES PURCHASED UNDER RESALE AGREEMENTS AND SECURITIES SOLD UNDER
REPURCHASE AGREEMENTS. FTN Financial (see Note 22 - Business Segment
Information) enters into short-term purchases of securities under agreements to
resell which are accounted for as collateralized financings except where FTNC
does not have an agreement to sell the same or substantially the same securities
before maturity at a fixed or
F-58 First Tennessee National Corporation
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
determinable price. Securities delivered under these transactions are delivered
to either the dealer custody account at the Federal Reserve Bank or to the
applicable counterparty. Collateral is valued daily and FTNC may require
counterparties to deposit additional collateral or return collateral pledged
when appropriate.
Securities sold under agreements to repurchase (securities sold) are offered to
cash management customers as an automated, collateralized investment account.
Securities sold are also used by FTN Banking Group (see Note 22 - Business
Segment Information) to obtain favorable borrowing rates on its purchased funds.
Under these transactions, securities are delivered to the counterparty's custody
account.
MORTGAGE BANKING. FTNC's mortgage lenders originate first-lien mortgage loans
primarily for the purpose of selling them in the secondary market. Mortgage
loans held for sale (the warehouse) are recorded at the lower of aggregate cost
or market value adjusted for gains or losses resulting from hedging activities.
The carrying value of mortgage loans held for sale is net of deferred
origination fees and costs. Net origination fees and costs are deferred on loans
sold and included in the basis of the loans in calculating gains and losses upon
sale. Previously, deferred loan origination costs were recognized at the time of
sale as a component of the expense category from which they originated. These
loan origination costs have been classified as a component of the gain or loss
on the sale of the loans in 2003, and previously reported amounts have been
reclassified to agree with the current presentation. Also included in the lower
of cost or market analysis are the estimated costs and market values of the
mortgage loan commitments. Gains and losses realized from the sale of these
assets and adjustments to market value are included in noninterest income. Some
of these loans are sold with provisions of recourse.
As of December 31, 2003 and 2002, respectively, the outstanding principal amount
of these single-family residential loans that were sold on a recourse basis was
$199.3 million and $175.9 million. In the event of borrower nonperformance, FTNC
would assume losses to the extent they exceed the value of the collateral and
private mortgage insurance, Federal Housing Administration (FHA) insurance or
Veterans Administration (VA) guarantees. In addition, FTNC originates, sells and
services loans guaranteed by the VA. In the event of foreclosure, FTNC, as a
servicer of VA loans, has credit risk to the extent that the outstanding loan
balance exceeds the VA guarantee and the value of the underlying real estate. As
of December 31, 2003 and 2002, the outstanding principal balance of VA loans
serviced was $3.7 billion and $4.5 billion, respectively. These loans are
reviewed on a regular basis, and a reserve has been established to cover
estimated probable incurred losses.
In certain cases, mortgage banking continues to service securitized mortgage
loans and has also retained interest-only strips or principal-only strips. The
retained interests are initially valued by allocating the total cost basis of
the securitized assets between the assets sold and the retained interests based
on their relative fair values at the time of securitization. The interest-only
strips are financial assets that represent rights to receive cash flows from
serviced assets that exceed contractually specified servicing fees and are
recognized on the balance sheet in trading securities at fair value.
Principal-only strips are financial assets which represent principal cash flow
tranches retained as a result of FTNC's securitization transactions. The fair
value of the interest-only strips is determined using market prices from closely
comparable assets such as mortgage servicing rights (MSRs) 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, FTNC 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.
First Horizon Home Loan Corporation (First Horizon Home Loans), an indirect
wholly-owned subsidiary of FTNC, has also completed proprietary securitizations
of loans from the warehouse with prime quality jumbo fixed rate loans through
its subsidiary First Horizon Asset Securities, Inc. The resulting securities are
sold as senior and subordinate bonds, while servicing rights and in certain
cases a principal cashflow tranche (principal-only strip) have been retained.
Gain or loss on sale of the securities is recognized in noninterest income.
First Tennessee National Corporation F-59
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MSRs are initially valued by allocating the total cost between the loan and the
servicing right based on their relative fair values. Since sales of MSRs 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 MSRs. As such, like other participants in the
mortgage banking business, First Horizon Home Loans relies primarily on a
discounted cash flow model to estimate the fair value of its MSRs. This model
calculates estimated fair value of the MSRs using numerous tranches of MSRs,
which share similar key characteristics such as interest rates, type of product
(fixed vs. variable), age (new, seasoned, moderate), agency type and other
factors. First Horizon Home Loans uses assumptions in the model that it believes
are comparable to those used by brokers and other service providers on a
quarterly basis. First Horizon Home Loans also compares its estimates of fair
value and assumptions to recent market activity and against its own experience.
For purposes of impairment evaluation and measurement, the MSRs are stratified
based on the predominant risk characteristics of the underlying loans. These
strata currently include adjustable and fixed-rate loans. The MSRs are amortized
over the period of and in proportion to the estimated net servicing revenues. A
quarterly value impairment analysis is performed using a discounted cash flow
methodology that is disaggregated by predominant risk characteristics.
Impairment, if any, is recognized through a valuation allowance for individual
strata. However, if the impairment is determined to be other than temporary, a
direct write-off of the asset is made.
LOANS. Loans are stated at principal amounts outstanding, net of unearned
income. Interest on loans is recognized on an accrual basis at the applicable
interest rate on the principal amount outstanding. Loan origination fees and
direct costs as well as premiums and discounts are amortized as level yield
adjustments over the respective loan terms. Unamortized net fees or costs are
recognized upon early repayment of the loans. Loan commitment fees are generally
deferred and amortized on a straight-line basis over the commitment period.
Impaired loans are generally carried on a nonaccrual status. Commercial loans
are ordinarily placed on nonaccrual status when, in management's opinion, the
collection of principal or interest is unlikely, the loan has been classified as
'doubtful', or when the collection of principal or interest is 90 days or more
past due. Retail real estate loans and other retail loans are not placed on
nonaccrual status, but any uncollectible portions of these loans are charged off
when that portion of the loan is deemed to be uncollectible.
Accrued but uncollected interest is reversed and charged against interest income
when the loan is placed on nonaccrual status. On retail loans, accrued but
uncollected interest is reversed when the loan is fully or partially charged
off. 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. Interest payments received on nonaccrual and
impaired loans are normally applied to principal. Once all principal has been
received, additional interest payments are recognized on a cash basis as
interest income.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is maintained at a
level that management determines is adequate to absorb estimated probable
incurred losses in the loan portfolio. Management's evaluation process to
determine the adequacy of the allowance utilizes an analytical model based on
historical loss experience, adjusted for current events, trends and economic
conditions. The actual amounts realized could differ in the near term from the
amounts assumed in arriving at the allowance for loan losses reported in the
financial statements.
All losses of principal are charged to the allowance for loan losses in the
period in which the loan is deemed to be uncollectible. Additions are made to
the allowance through periodic provisions charged to current operations and
recovery of principal on loans previously charged off.
PREMISES AND EQUIPMENT. Premises and equipment are carried at cost less
accumulated depreciation and amortization and include additions that materially
extend the useful lives of existing premises and equipment.
F-60 First Tennessee National Corporation
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
All other maintenance and repair expenditures are expensed as incurred. Gains
and losses on dispositions are reflected in noninterest income and expense.
Depreciation and amortization are computed principally on the straight-line
method over the estimated useful lives of the assets and are recorded as
noninterest expense. Leasehold improvements are amortized over the lesser of the
lease periods or the estimated useful lives using the straight-line method.
Useful lives utilized in determining depreciation for furniture, fixtures and
equipment and buildings are three to fifteen and seven to forty-five years,
respectively.
REAL ESTATE ACQUIRED BY FORECLOSURE. 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 the
estimated fair market value minus the estimated cost to sell the real estate.
Losses arising at foreclosure are charged to the allowance for loan losses.
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. During the normal course of
business, First Horizon Home Loans may purchase real estate at foreclosure sale.
Losses arising from the purchase of real estate at foreclosure sale are charged
to the foreclosure reserve.
INTANGIBLE ASSETS. Intangible assets consist of 'Other intangible assets' and
'Goodwill.' The 'Other intangible assets' represents identified intangible
assets, including customer lists, covenants not to compete, retained interests
from securitizations and premium on purchased deposits, which are amortized over
their estimated useful lives, except for those assets related to deposit bases
that are primarily amortized over 10 years. Management evaluates whether events
or circumstances have occurred that indicate the remaining useful life or
carrying value of amortizing intangibles should be revised. 'Goodwill'
represents the excess of cost over net assets of acquired subsidiaries less
identifiable intangible assets. Prior to the January 1, 2002, adoption of SFAS
No. 142 (see Accounting Changes section) goodwill was amortized to noninterest
expense using the straight-line method over periods ranging from 15 to 40 years.
Beginning in 2002, goodwill amortization was ceased. On an annual basis, FTNC
tests goodwill for impairment. For the three year period ended December 31,
2003, no impairment of 'Other intangible assets' or 'Goodwill' was recognized.
DERIVATIVE FINANCIAL INSTRUMENTS. FTNC utilizes, through its mortgage banking,
capital markets and risk management operations, various derivative financial
instruments, which include interest rate forward contracts, interest rate floors
and caps, options and interest rate swap agreements, as part of its risk
management strategy and as a means to meet customers' needs. These instruments
are subject to credit and market risks. Controls and monitoring procedures for
these instruments have been established and are routinely reevaluated. The
Asset/Liability Committee (ALCO) monitors the usage and effectiveness of these
derivative financial instruments. ALCO, in conjunction with credit officers,
also periodically reviews counterparty credit worthiness.
Credit risk represents the maximum potential loss due to possible
non-performance by obligors and counterparties under the terms of contracts.
FTNC manages credit risk by entering into financial instrument transactions
through national exchanges, primary dealers or approved counterparties, and
using mutual margining agreements whenever possible to limit potential exposure.
With exchange-traded contracts, the credit risk is limited to the clearinghouse
used. For non-exchange traded instruments, credit risk may occur when there is a
gain in the fair value of the financial instrument and the counterparty fails to
perform according to the terms of the contract and/or when the collateral proves
to be of insufficient value.
Market risk represents the potential loss due to the decrease in the value of a
financial instrument caused primarily by changes in interest rates, mortgage
loan prepayment speeds or the prices of debt instruments.
Interest rate forward contracts are over-the-counter contracts where two parties
agree to purchase and sell a specific quantity of a financial instrument at a
specified price, with delivery or settlement at a specified date.
First Tennessee National Corporation F-61
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Interest rate option contracts give the purchaser the right, but not the
obligation, to buy or sell a specified quantity of a financial instrument, at a
specified price, during a specified period of time. Caps and floors are options
that are linked to a notional principal amount and an underlying indexed
interest rate. Interest rate swaps involve the exchange of interest payments at
specified intervals between two parties without the exchange of any underlying
principal. Notional amounts are used in such contracts to calculate interest
payments and do not represent credit exposure. Exposure to interest rate
contracts will increase or decrease as interest rates fluctuate.
SFAS No. 133, 'Accounting for Derivative Instruments and Hedging Activities',
which was adopted on January 1, 2001, establishes accounting standards requiring
that every derivative instrument be recorded on the balance sheet as either an
asset or liability measured at its fair value. Fair value is defined as the
amount FTNC would receive or pay in the market to replace the derivatives as of
the valuation date. Fair value is determined using available market information
and appropriate valuation methodologies. SFAS No. 133 requires that changes in
the instrument's fair value be recognized currently in earnings or other
comprehensive income. If certain criteria are met, changes in the fair value of
the asset or liability being hedged are also recognized currently in earnings.
The initial impact of adopting SFAS No. 133 resulted in a net transition
adjustment that was recognized as the cumulative effect of a change in
accounting principle. The following accounting policies reflect the adoption of
SFAS No. 133.
Mortgage Banking
Mortgage banking interest rate lock commitments, which have been currently
determined to be derivative instruments, are recorded at fair value with changes
in fair value recorded currently in earnings and are not a hedgable asset.
Mortgage banking enters into forward sales commitments to protect the value of
mortgage banking's short-term commitments to fund mortgage loan applications in
process (the pipeline) and mortgage loans held for sale (the warehouse) from
changes in fair value due to fluctuations in interest rates. These forward
contracts are derivatives that are recorded at fair value under SFAS No. 133.
The forward contracts related to loans in the warehouse are fair value hedges
used to hedge the risk of change in the total fair value of the warehouse.
Forward contracts used by mortgage banking operations to hedge against interest
rate risk in the warehouse are reviewed periodically for correlation with
expected changes in value. For 2003, 2002, and 2001, gains of $1.2 million,
losses of $9.8 million, and gains of $12.1 million, respectively, that represent
the amount of hedge ineffectiveness for these fair value hedges were recognized
in mortgage banking noninterest income.
Mortgage banking also enters into interest rate contracts (including swaps,
swaptions, principal-only swaps, floors, and mortgage forward sales (TBAs)) to
hedge against the effects of changes in fair value of its MSRs due solely to
changes in the benchmark rate (10-year LIBOR). For purposes of measuring
effectiveness of the hedge, volatility and time decay are excluded from the
effectiveness measurement of option-based derivatives. Interest rate derivative
contracts used to hedge against interest rate risk in the servicing portfolio
are designated to specific risk tranches of servicing. FTNC enters into hedges
of the MSRs to minimize the effects of loss in value of MSRs associated with
increased prepayment activity that generally results from declining interest
rates. In a rising interest rate environment, the value of the MSRs generally
will increase while the value of the hedge instruments will decline. For
purposes of measuring hedge effectiveness under SFAS No. 133, increases in
values of hedge instruments exceeded the change in value of hedged MSRs by
$131.7 million, $122.0 million and $48.0 million in 2003, 2002 and 2001,
respectively. This amount, after reductions of $16.5 million, $21.2 million and
$14.2 million in 2003, 2002 and 2001, respectively, representing the component
of the derivative instruments' losses excluded from the assessment of hedge
effectiveness, was recognized in mortgage banking noninterest income. The
increase in the value of the derivative financial instruments used to hedge the
change in value of the hedged MSRs was significantly offset by increased
amortization and impairment charges (see also Note 6 - Mortgage Servicing
Rights). First Horizon Home Loans utilizes financial instruments that change in
value inversely to the movement of interest rates to protect the value of its
interest-only securities. Interest-only securities do
F-62 First Tennessee National Corporation
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
not qualify for hedge accounting under SFAS No. 133 and therefore, gains and
losses are recognized currently in earnings.
Fair value is determined on the last business day of a reporting period. This
point in time measurement of derivative fair values and the related hedged item
fair values may be well suited to the measurement of hedge effectiveness, as
well as reported earnings, when hedge time horizons are short. The same
measurement however may not consistently reflect the effectiveness of
longer-term hedges and, in FTNC's view, can distort short-term measures of
reported earnings. FTNC uses a combination of derivative financial instruments
to hedge certain components of the interest rate risk associated with its
portfolio of capitalized mortgage servicing rights, which currently have an
average life of four years. Over this long-term time horizon this combination of
derivatives can be effective in significantly mitigating the effects of interest
rate changes on the value of the servicing portfolio. However, these derivative
financial instruments can and do demonstrate significant price volatility
depending upon prevailing conditions in the financial markets. If a reporting
period ends during a period of volatile financial market conditions, the effect
of such point in time conditions on reported earnings does not reflect the
underlying economics of the transactions or the true value of the hedges to FTNC
over their estimated lives. The fact that the fair value of a particular
derivative is unusually low or high on the last day of the reporting period is
meaningful in evaluating performance during the period only if FTNC sells the
derivative within the period of time before fair value changes and does not
replace the hedge coverage with another derivative. FTNC believes the effect of
such volatility on short-term measures of earnings is not indicative of the
expected long-term performance of this hedging practice.
Capital Markets
Capital markets buys and sells treasuries, agencies, mortgage securities,
municipal bonds and other securities for resale to customers. When these
securities settle on a delayed basis, they are considered forward contracts.
Capital markets also enters into interest rate contracts, including options,
caps, swaps and floors for its customers. These transactions are measured at
fair value, with changes in fair value recognized currently in capital markets
noninterest income. Related assets are recorded on the balance sheet as capital
markets securities inventory or receivables and any liabilities are recognized
as capital markets payables. Capital markets utilizes futures contracts, from
time to time, to manage exposure arising from the inventory position. Credit
risk related to these transactions is controlled through credit approvals, risk
control limits and on-going monitoring procedures through ALCO.
Interest Rate Risk Management
FTNC's ALCO focuses on managing market risk by controlling and limiting earnings
volatility attributable to changes in interest rates. Interest rate risk exists
to the extent that interest-earning assets and liabilities have different
maturity or repricing characteristics. FTNC uses derivatives, including swaps,
caps, options, and collars, that are designed to moderate the impact on earnings
as interest rates change. FTNC's interest rate risk management policy is to use
derivatives not to speculate but to hedge interest rate risk or market value of
assets or liabilities.
Interest rate risk management uses interest rate swaps to hedge the interest
rate risk of certain liabilities that qualify as fair value and cash flow
hedges. Interest paid or received for swaps is recognized as an adjustment of
the interest expense of the liabilities whose risk is being managed. For 2003
and 2002, there was no hedge ineffectiveness for qualifying fair value or cash
flow hedges. Interest rate swaps and caps not designated as hedging instruments
are also used to moderate the impact on earnings as interest rates change. Any
contracts that fail to qualify for hedge accounting are measured at fair value
with any gains or losses included in current earnings in noninterest income. For
derivatives designated as cash flow hedges, the effective portion of the gain or
loss on derivatives is reported as a component of accumulated other
comprehensive income.
First Tennessee National Corporation F-63
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Cash flows from derivative contracts are reported as operating activities on the
Consolidated Statements of Cash Flows.
INCOME TAXES. The provision for income taxes is based on income reported for
consolidated financial statement purposes and includes deferred taxes resulting
from the recognition of certain revenues and expenses in different periods for
tax reporting purposes. FTNC files a consolidated federal income tax return
except for a credit life insurance company and a real estate investment trust
which both file separate returns.
EARNINGS PER SHARE. Earnings per share is computed by dividing net income by the
weighted average number of common shares outstanding for each period. Diluted
earnings per share is computed by dividing net income by the weighted average
number of common shares outstanding adjusted to include the number of additional
common shares that would have been outstanding if the dilutive potential common
shares resulting from options granted under FTNC's stock option plans had been
issued. FTNC utilizes the treasury stock method in this calculation.
STOCK OPTIONS. FTNC accounts for its employee stock-based compensation plans
under the intrinsic value based method in accordance with Accounting Principals
Board Opinion No. 25, 'Accounting for Stock Issued to Employees.' Had
compensation cost for these plans been determined consistent with SFAS No. 123,
FTNC's net income and earnings per share would have been reduced to the
following pro forma amounts:
December 31
------------------------------
(Dollars in thousands except per share data) 2003 2002 2001
--------------------------------------------------------------------------------------------
NET INCOME, AS REPORTED $473,309 $376,451 $318,209
Add: Stock-based employee compensation expense included
in reported net income, net of related tax effects 6,402 7,548 8,282
Less: Total stock-based employee compensation expense
determined under fair value method for all awards, net of
related tax effects 27,139 22,087 19,727
--------------------------------------------------------------------------------------------
PRO FORMA NET INCOME $452,572 $361,912 $306,764
--------------------------------------------------------------------------------------------
EARNINGS PER SHARE, AS REPORTED $ 3.73 $ 2.97 $ 2.49
--------------------------------------------------------------------------------------------
Pro forma earnings per share 3.57 2.86 2.40
Diluted earnings per share, as reported 3.62 2.89 2.42
Pro forma diluted earnings per share 3.46 2.78 2.33
--------------------------------------------------------------------------------------------
ACCOUNTING CHANGES. On December 31, 2003, FTNC adopted FASB Staff Position (FSP)
FAS 106-1, 'Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003'. The Medicare
Prescription Drug, Improvement and Modernization Act of 2003 (the Act)
introduces a prescription drug benefit under Medicare Part D as well as a
federal subsidy to sponsors of retiree health care benefit plans that provide a
benefit that is at least actuarially equivalent to Medicare Part D. FSP 106-1
allows either immediate recognition or deferred recognition. FTNC elected to
defer recognition and will not recognize the effect of the Act until the earlier
of: (1) when the underlying accounting issues are resolved by the Financial
Accounting Standards Board (FASB); or (2) when plan costs have to be remeasured
(e.g. for a plan amendment). FTNC does not expect the impact of recognizing this
benefit to be material to results of operations.
On December 31, 2003, FTNC adopted SFAS No. 132 (revised 2003), 'Employers'
Disclosures about Pensions and Other Postretirement Benefits'. This standard
does not change the measurement or recognition of those plans required by SFAS
No. 87 and SFAS No. 106. Additionally, the disclosure requirements of the
original SFAS No. 132 have been retained. SFAS No. 132 (revised 2003) requires
additional disclosure about the assets, obligations, cash flows, and net
periodic benefit cost of defined
F-64 First Tennessee National Corporation
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
benefit pension plans and other defined benefit postretirement plans. The
adoption of SFAS 132 (revised 2003) did not have an impact on the results of
operations.
On December 31, 2003, FTNC adopted Emerging Issues Task Force (EITF) Issue
No. 03-1, 'The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments'. EITF Issue No. 03-1 requires disclosures concerning
unrealized losses related to investments in debt and marketable equity
securities that are accounted for under SFAS No. 115. Disclosures include the
length of time investments have been in a loss position and discussion
pertaining to the nature of the impairment. The adoption of EITF Issue No. 03-1
did not have an impact on the results of operations.
In December 2003, the FASB issued Interpretation No. 46, 'Consolidation of
Variable Interest Entities (revised December 2003)' (FIN 46-R). FIN 46-R
required the consolidation by a business enterprise of variable interest
entities (VIEs) in which it is the primary beneficiary.
FIN 46-R also required the adoption of FIN 46, as of December 31, 2003, for all
entities previously considered as special purpose entities and for all VIEs
created after January 31, 2003. FIN 46-R permitted its early adoption, as of
December 31, 2003, in lieu of adopting FIN 46.
Effective December 31, 2003, FTNC adopted FIN 46, 'Consolidation of Variable
Interest Entities'. Upon adoption of this standard, FTNC deconsolidated its
subsidiary, First Tennessee Capital I (Capital I), which has issued $100.0
million of capital securities that are fully and unconditionally guaranteed by
FTNC. As a result of this deconsolidation the capital securities are no longer
included on FTNC's balance sheet. However, $103.0 million of junior subordinated
debentures issued by FTNC to Capital I are no longer eliminated in consolidation
and appear in term borrowings as of December 31, 2003. FTNC identified certain
of its nonconsolidated interests as VIEs but did not meet the criteria of
primary beneficiary and, therefore, has not consolidated any of its VIEs. See
Note 25 - Variable Interest Entities for additional information.
Effective July 1, 2003, FTNC adopted SFAS No. 150, 'Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity', and
classified its mandatorily redeemable preferred stock of subsidiary ($45.1
million on July 1, 2003) as term borrowings. Historically, the related
distribution on these instruments ($4.6 million annually) were classified as
noninterest expense on the Consolidated Statements of Income, but as of July 1,
2003, are classified as interest expense on a prospective basis. As required by
SFAS No. 150, prior periods were not restated.
On July 1, 2003, FTNC adopted SFAS No. 149, 'Amendment of Statement 133 on
Derivative Instruments', which amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities under SFAS No. 133,
'Accounting for Derivative Instruments and Hedging Activities'. The impact of
adopting this standard was immaterial to FTNC.
On January 1, 2003, FTNC adopted SFAS No. 146, 'Accounting for Costs Associated
with Exit or Disposal Activities'. This statement requires that a liability for
the cost associated with an exit or disposal activity be recognized and measured
initially at fair value in the period in which the liability is incurred. Prior
to the effective date of this statement, costs associated with an exit or
disposal plan were recognized at the date of commitment, as required under EITF
Issue 94-3. This statement does not apply to costs associated with an exit
activity that involves an entity newly acquired in a business combination or
with a disposal activity covered by SFAS No. 144. The impact of adopting this
statement was immaterial to FTNC.
On January 1, 2003, FTNC adopted the final provisions of Interpretation No. 45,
'Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others'. This interpretation elaborates
on the disclosures to be made by a guarantor in interim and annual financial
statements about obligations assumed under certain guarantees it has issued. It
also clarifies that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the
First Tennessee National Corporation F-65
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
obligation undertaken in issuing the guarantee. This interpretation does not
prescribe a specific approach for subsequently measuring the guarantor's
liability over the term of the related guarantee. This interpretation also
incorporates, without change, the guidance in FASB Interpretation No. 34,
'Disclosure of Indirect Guarantees of Indebtedness of Others', which is
superceded. The impact of adopting this statement was immaterial to FTNC.
In December 2002, FTNC adopted SFAS No. 148, 'Accounting for Stock-Based
Compensation - Transition and Disclosure'. This statement amends SFAS
No. 123, 'Accounting for Stock-Based Compensation', to provide alternative
methods for voluntary change to the fair value based method of accounting for
stock-based employee compensation. In addition, this statement amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. As FTNC continues to account for stock-based employee compensation
under APB 25, the adoption of this statement did not have a material impact on
the financial statements or results of operations.
On October 1, 2002, FTNC adopted SFAS No. 147, 'Acquisitions of Certain
Financial Institutions (an amendment of FASB Statement No. 72 and 144 and FASB
Interpretation No. 9)'. This statement requires acquisitions of all or part of a
financial institution meeting the definition of a business combination to be
accounted for by the purchase method in accordance with SFAS No. 141. Any
previously recorded unidentified intangible asset related to the acquisition of
a financial institution must now be classified as goodwill and is subject to the
impairment testing provisions of SFAS No. 142. Impairment testing of previously
identified long-term customer-relationship intangible assets will be subject to
the impairment testing provisions of SFAS No 144. Provisions of this statement
were effective for acquisitions on or after October 1, 2002. The impact of
adopting this statement was immaterial to FTNC.
On October 1, 2002, FTNC adopted SFAS No. 145, 'Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections'. SFAS No. 145 rescinds SFAS No. 4, which required all gains and
losses from extinguishment of debt to be classified as an extraordinary item,
net of related income tax effect, if material in the aggregate. Due to the
rescission of SFAS No. 4, the criteria in Opinion 30 are now used to classify
those gains and losses. SFAS No. 64 amended SFAS No. 4, and is no longer
necessary because of the rescission of SFAS No. 4. SFAS No. 44, is no longer
necessary because the transition of the Motor Carrier Act of 1980 has been
completed. SFAS No. 145 also amends SFAS No. 13 to require that certain lease
modifications that have economic effects similar to sale-leaseback transactions
be accounted for in the same manner as sale-leaseback transactions. In addition
this statement also makes technical corrections to existing pronouncements which
are generally not substantive in nature. The adoption of this standard resulted
in a loss of $5.1 million related to a 2001 debt restructuring being
reclassified as noninterest expense. This item had previously been presented,
net of taxes ($1.9 million), as an extraordinary item on the Consolidated
Statements of Income. In 2002, a debt restructuring resulted in a $3.7 million
pre-tax loss.
On January 1, 2002, FTNC adopted SFAS No. 144, 'Accounting for the Impairment or
Disposal of Long-Lived Assets'. SFAS No. 144 addresses accounting and reporting
issues related to the impairment of long-lived assets and for long-lived assets
to be disposed of. The impact of adopting this statement was immaterial to FTNC.
On January 1, 2002, FTNC adopted SFAS No. 142, 'Goodwill and Other Intangible
Assets'. Under SFAS No. 142, goodwill is no longer subject to amortization over
its estimated useful life, but is subject to an assessment for impairment using
a fair-value-based test at least annually. FTNC has not recognized any
impairment of the goodwill currently on its books during 2003 or 2002. The
impact of adopting this statement resulted in no goodwill amortization in 2003
and 2002 compared to $6.3 million in 2001. See Note 7 - Intangible Assets for
additional information.
F-66 First Tennessee National Corporation
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
On January 1, 2002, FTNC adopted the final provisions of SFAS No. 141, 'Business
Combinations' which requires that all business combinations initiated after June
30, 2001, be accounted for using the purchase method. The impact of adopting
this statement was immaterial to FTNC.
On April 1, 2001, FTNC adopted the final provisions of SFAS No. 140, 'Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities'. This statement replaced SFAS No. 125, 'Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities.' SFAS
No. 140 revises the standards for accounting for securitizations and other
transfers of financial assets and collateral and requires substantial
disclosures, but carries over most of SFAS No. 125's provisions without
reconsideration. This statement provided accounting and reporting standards for
transfers and servicing of financial assets and extinguishment of liabilities.
Those standards are based on consistent application of a financial-components
approach that focuses on control. Under that approach, after a transfer of
financial assets, an entity recognizes the financial and servicing assets it
controls and the liabilities it has incurred, derecognizes financial assets when
control has been surrendered, and derecognizes liabilities when extinguished.
This statement provided consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured borrowings. The
disclosure provisions of the statement were adopted by First Tennessee in 2000.
The adoption of SFAS No. 140 did not have a material impact on FTNC's
consolidated financial position or results of operations.
On January 1, 2001, FTNC adopted SFAS No. 133 and EITF Issue 99-20, 'Recognition
of Interest Income and Impairment on Purchased and Retained Beneficial Interests
in Securitized Financial Assets'. SFAS No. 133 established accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded on the
balance sheet as either an asset or liability measured at its fair value. SFAS
No. 133 required that changes in the derivative instrument's fair value be
recognized currently in earnings or other comprehensive income. Special
accounting for qualifying hedges allows a derivative instrument's gains and
losses to offset related results on the hedged item in the income statement, and
requires that a company formally document, designate, and assess the
effectiveness of transactions that receive hedge accounting.
In anticipation of adopting this standard, FTNC repositioned the portfolio of
mortgage banking derivatives during 2000, which involved terminating certain
derivative contracts or taking offsetting positions to nullify existing
contracts and allocating others to trading securities. In accordance with the
provisions of SFAS No. 133, FTNC designated anew all hedging relationships on
January 1, 2001. Also, in connection with the adoption of SFAS No. 133, $155
million of securities available for sale were moved to trading at which point in
time gross losses of $3.6 million were recognized. On January 1, 2001, FTNC
measured all derivative instruments at fair value and differences between the
previous book value and fair value were reported as part of a cumulative effect
adjustment on the income statement, except to the extent that they related to
hedges of the variable cash flow exposure of forecasted transactions. Offsetting
gains and losses on hedged assets and liabilities were recognized as adjustments
of their respective book values at the adoption date as part of this cumulative
effect adjustment. Additionally, EITF Issue 99-20, which provides impairment and
interest income recognition and measurement guidance for interests retained in a
securitization transaction accounted for as a sale, was adopted. The initial
impact of adopting SFAS No. 133 and EITF Issue 99-20 was an $8.2 million loss
(after-tax) net transition adjustment that was recognized as the cumulative
effect of a change in accounting principle in first quarter 2001. The adoption
adjustment related to hedges of the variable cash flow exposure of a forecasted
transaction, a $1.4 million gain (after-tax), was reported as a cumulative
effect adjustment of comprehensive income in first quarter 2001.
Certain provisions of SFAS No. 133 continue to undergo significant discussion
and debate by the FASB. One such potential issue involves the determination of
the fair value of mortgage banking interest rate lock commitments (IRLCs)
accounted for as derivatives and if IRLCs can be reported as assets. Another
such potential issue involves the assessment of hedge effectiveness (and its
impact on qualifying for hedge accounting) when hedging fair value changes of
prepayable assets due to changes in the benchmark interest rate. As the FASB
continues to deliberate interpretation of the new rules, the potential exists
for a
First Tennessee National Corporation F-67
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
difference between FTNC's interpretation and that of the FASB, the effects of
which cannot presently be anticipated but failure to obtain hedge accounting
treatment could be significant to results of operations.
On January 17, 2003, the FASB issued FASB Interpretation No. 46, 'Consolidation
of Variable Interest Entities (revised December 2003)' (FIN 46-R). FIN 46-R
clarified certain aspects of FIN 46 and provided certain entities with
exemptions from the requirements of FIN 46. Additionally, FIN 46-R incorporated
the guidance found in eight final FASB Staff Positions (FSPs) that were issued
as of the release of FIN 46-R. FIN 46-R required the application of either
FIN 46 or FIN 46-R to all special purpose entities (SPEs) created prior to
February 1, 2003, for interim or annual reporting periods ending after
December 15, 2003 (December 31, 2003 for FTNC). All entities created after
January 31, 2003, are currently required to be analyzed under FIN 46 unless
FIN 46-R is adopted early. FIN 46-R is applicable to all non-SPEs created prior
to February 1, 2003 that are not small business issuers for interim or annual
reporting periods ending after March 15, 2004 (March 31, 2004 for FTNC). FTNC
anticipates the impact of adopting the remaining provisions of this standard to
be immaterial.
In December 2003, the SEC staff announced that it will soon issue a Staff
Accounting Bulletin (SAB) on the accounting treatment of loan commitments that
are recognized as derivatives pursuant to SFAS No. 133. Based on preliminary
indications, the SAB would require registrants to utilize a written option model
in valuation of their loan commitments. This would result in the recognition of
a liability, with entries to expense, at the inception of the loan commitment or
lock date, through settlement of the loan sale. As the SEC continues to
deliberate this issue, the effect of implementing this change cannot presently
be determined, but upon adoption this one-time accounting adjustment could be
significant, however, the ongoing economic value of the business would be
unaffected.
In October 2003, the FASB approved the AICPA's issuance of SOP 03-3, 'Accounting
for Loans or Certain Debt Securities Acquired in a Transfer', 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 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. SOP 03-3 is effective for fiscal years beginning after
December 15, 2004. The impact at implementation of adopting SOP 03-3 is expected
to be immaterial to the results of future operations.
NOTE 2 ACQUISITIONS/DIVESTITURES
On December 31, 2003, FTNC completed the sale of substantially all of the assets
and liabilities of its wholly owned subsidiary, First National Bank of
Springdale (FNB) of Springdale, Arkansas to First Security Bank of Searcy,
Arkansas. This transaction resulted in a divestiture gain of $12.5 million.
Immediately preceding the sale, FNB had investment securities of approximately
$125 million, loans of approximately $165 million, deposits of approximately
$300 million and equity of approximately $40 million.
On December 31, 2003, First Horizon Merchant Services, Inc., a wholly owned
subsidiary of First Tennessee Bank National Association (FTBNA), recognized a
divestiture gain of $10.0 million resulting from the sale of certain merchant
relationships referred by selected agent banks within the merchant portfolio to
NOVA Information Systems, Inc., a subsidiary of U.S. Bancorp.
On August 1, 2003, First Horizon Merchant Services, Inc. acquired Global Card
Services, Inc., a merchant processing company based in Orlando, Florida, for
approximately $15.8 million in cash. The acquisition was immaterial to FTNC.
On September 16, 2002, FTBNA, the primary banking subsidiary of FTNC, sold a
portfolio of loans originated through First Horizon Money Centers totaling
$208.3 million to American General Finance, Inc. of
F-68 First Tennessee National Corporation
NOTE 2 ACQUISITIONS/DIVESTITURES (CONTINUED)
Evansville, Indiana and closed the related Money Center offices. This
transaction resulted in a divestiture gain of $2.3 million.
On June 1, 2002, First Horizon Home Loans, a wholly owned subsidiary of FTBNA,
acquired certain assets and assumed certain liabilities of Real Estate Financial
Services (REFS), a mortgage lending company based in Alpharetta, Georgia, for
approximately $2.2 million in cash. This transaction was immaterial to FTNC.
On April 1, 2002, First Horizon Merchant Services, Inc. acquired First Premier
Financial Services, Inc. (First Premier), a South Dakota based merchant
processor, for approximately $11.9 million in cash. First Premier was merged
into First Horizon Merchant Services, Inc. The acquisition was immaterial to
FTNC.
On December 31, 2001, FTBNA acquired Synaxis Group, Inc., a Nashville-based
insurance broker operating through a network of major regional and
community-based insurance agencies in Georgia, Kentucky and Tennessee. This
transaction was completed for approximately $29.0 million and was immaterial to
FTNC.
On June 6, 2001, FTBNA completed the sale of its interests in Check Solutions
Company to Carreker Corporation of Dallas, Texas. FTNC recognized a divestiture
gain of $42.7 million in 2001. An additional gain of $2.3 million was recognized
in 2002.
On April 27, 2001, FTNC completed the sale of its wholly owned subsidiary,
Peoples and Union Bank, of Lewisburg, Tennessee to First Farmers & Merchants
National Bank, of Columbia, Tennessee. FTNC recognized a divestiture gain of
$13.1 million.
On April 2, 2001, FTBNA sold its existing portfolio of education loans totaling
$342.1 million to Educational Funding of the South, Inc. The transaction
resulted in a divestiture gain of $11.8 million.
On January 17, 2001, FTBNA completed the sale of $31.4 million of its affinity,
co-branded, and certain single relationship credit card accounts and assets to
MBNA Corporation. On December 27, 2000, FTBNA sold $265.8 million of its single
relationship credit card accounts and assets to MBNA Corporation. These
transactions resulted in divestiture gains of $8.2 million in 2001 and $50.2
million in 2000.
On January 2, 2001, FTN Financial Securities Corporation, a wholly owned
subsidiary of FTBNA, acquired certain assets of Midwest Research-Maxus Group
Limited, a Cleveland-based institutional equity research firm. This transaction
was completed for approximately $13.7 million and was immaterial to FTNC.
First Tennessee National Corporation F-69
NOTE 3 INVESTMENT SECURITIES
The following tables summarize FTNC's securities held to maturity and available
for sale on December 31, 2003 and 2002:
ON DECEMBER 31, 2003*
-------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
----------------------------------------------------------------------------------------------------------------------
SECURITIES HELD TO MATURITY:
States and municipalities $ 1,028 $ 49 $ - $ 1,077
----------------------------------------------------------------------------------------------------------------------
Total securities held to maturity $ 1,028 $ 49 $ - $ 1,077
----------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE:
U.S. Treasury and other U.S. government agencies $ 48,861 $ 291 $ (11) $ 49,141
Government agency issued MBSs 957,236 6,234 (9,449) 954,021
Government agency issued CMOs 1,239,596 11,234 (3,989) 1,246,841
States and municipalities 13,076 321 (2) 13,395
Other 16,600 754 (13) 17,341
Equity 188,793 227 (417) 188,603
----------------------------------------------------------------------------------------------------------------------
Total securities available for sale $2,464,162 $ 19,061 $(13,881) $2,469,342
----------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------------
* Includes $2.1 billion of securities pledged to secure public deposits,
securities sold under agreements to repurchase and for other purposes.
On December 31, 2002*
-------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
----------------------------------------------------------------------------------------------------------------------
SECURITIES HELD TO MATURITY:
States and municipalities $ 6,302 $ 166 $ (4) $ 6,464
Private issue CMOs** 274,075 8,811 (4,840) 278,046
----------------------------------------------------------------------------------------------------------------------
Total securities held to maturity $ 280,377 $ 8,977 $ (4,844) $ 284,510
----------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE:
U.S. Treasury and other U.S. government agencies $ 83,623 $ 959 $ (7) $ 84,575
Government agency issued MBSs 450,504 12,173 - 462,677
Government agency issued CMOs 1,632,595 27,881 (698) 1,659,778
States and municipalities 22,963 418 (793) 22,588
Other 18,219 1,075 (39) 19,255
Equity 166,458 13,336 (8,759) 171,035
----------------------------------------------------------------------------------------------------------------------
Total securities available for sale $2,374,362 $55,842 $(10,296) $2,419,908
----------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------------
* Includes $2.1 billion of securities pledged to secure public deposits,
securities sold under agreements to repurchase and for other purposes.
** Represents FTNC's Real Estate Mortgage Investment Conduit.
F-70 First Tennessee National Corporation
NOTE 3 INVESTMENT SECURITIES (CONTINUED)
Provided below are the amortized cost and estimated fair value by contractual
maturity for the securities portfolios on December 31, 2003:
Held to Maturity Available for Sale
------------------------------------------------------------
Estimated Estimated
By Contractual Maturity Amortized Fair Amortized Fair
(Dollars in thousands) Cost Value Cost Value
---------------------------------------------------------------------------------------------------------------------
Within 1 year $ 569 $ 579 $ 18,041 $ 18,092
After 1 year; within 5 years 459 498 44,617 45,391
After 5 years; within 10 years - - 3,902 4,118
After 10 years - - 11,977 12,276
---------------------------------------------------------------------------------------------------------------------
Subtotal 1,028 1,077 78,537 79,877
---------------------------------------------------------------------------------------------------------------------
Mortgage-backed securities and CMOs - - 2,196,832 2,200,862
Equity securities - - 188,793 188,603
---------------------------------------------------------------------------------------------------------------------
Total $1,028 $1,077 $2,464,162 $2,469,342
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.
The table below provides information on realized gross gains and realized gross
losses on sales from the available for sale portfolio for the years ended
December 31:
(Dollars in thousands) AFS Debt* AFS Equity* Total
---------------------------------------------------------------------------------------------------------------------
2003
Gross gains on sales $ 847 $11,444 $ 12,291
Gross losses on sales (6,973) - (6,973)
---------------------------------------------------------------------------------------------------------------------
2002
Gross gains on sales $ 1,309 $ 43 $ 1,352
Gross losses on sales (1,056) - (1,056)
---------------------------------------------------------------------------------------------------------------------
2001
Gross gains on sales $ 311 $ 991 $ 1,302
Gross losses on sales (208) (26) (234)
---------------------------------------------------------------------------------------------------------------------
*AFS - Available for sale
Losses totaling $3.0 million, $9.5 million and $5.5 million for the years 2003,
2002 and 2001, respectively, were recognized for securities that, in the opinion
of management, have been permanently impaired.
First Tennessee National Corporation F-71
NOTE 3 INVESTMENT SECURITIES (CONTINUED)
The following table provides information on investments that have unrealized
losses on December 31, 2003:
ON DECEMBER 31, 2003
--------------------------------------------------------------------------
Less than 12 months 12 Months or Longer Total
-------------------------------------------------------------------------------------------------------------------
Estimated Estimated Estimated
Fair Unrealized Fair Unrealized Fair Unrealized
(Dollars in thousands) Value Losses Value Losses Value Losses
-------------------------------------------------------------------------------------------------------------------
U.S. Treasury and other U.S. government
agencies $ 168 $ (11) $ - $ - $ 168 $ (11)
Government agency issued MBSs 686,482 (9,449) 686,482 (9,449)
Government agency issued CMOs 391,461 (3,989) - - 391,461 (3,989)
State and municipalities 663 (2) 663 (2)
Other 1,017 (13) - - 1,017 (13)
-------------------------------------------------------------------------------------------------------------------
Total debt securities 1,079,791 (13,464) - - 1,079,791 (13,464)
Equity - - 1,583 (417) 1,583 (417)
-------------------------------------------------------------------------------------------------------------------
Total temporarily impaired securities $1,079,791 $(13,464) $1,583 $(417) $1,081,374 $(13,881)
-------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------
The investment security that has been in a continuous unrealized loss position
for 12 or more months is a venture capital investment. Venture capital
investments historically have three to five year investment cycles. In
determining whether impairment is other-than-temporary, management performs
comprehensive reviews of venture capital investments that take into
consideration qualitative as well as intangible criteria that make up the
developmental aspect of early stage, start-up companies.
F-72 First Tennessee National Corporation
NOTE 4 LOANS
A summary of the major categories of loans outstanding on December 31 is shown
below:
(Dollars in thousands) 2003 2002
------------------------------------------------------------------------------------------------
Commercial:
Commercial, financial and industrial $ 4,502,917 $ 4,134,158
Real estate commercial 968,064 1,037,341
Real estate construction 690,402 551,449
Retail:
Real estate residential* 6,817,122 4,721,307
Real estate construction 527,260 342,127
Other retail 212,362 286,069
Credit card receivables 272,398 272,994
------------------------------------------------------------------------------------------------
Loans, net of unearned income 13,990,525 11,345,445
Allowance for loan losses 160,333 144,298
------------------------------------------------------------------------------------------------
Total net loans $13,830,192 $11,201,147
------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------
* Includes $1.0 billion of loans pledged to secure FHLB borrowings.
Nonperforming loans consist of loans which management has identified as
impaired, other nonaccrual loans and loans which have been restructured. On
December 31, 2003 and 2002, there were no outstanding commitments to advance
additional funds to customers whose loans had been restructured. The following
table presents nonperforming loans on December 31:
(Dollars in thousands) 2003 2002
------------------------------------------------------------------------------------------------
Impaired loans $34,369 $49,346
Other nonaccrual loans 17,415 14,841
------------------------------------------------------------------------------------------------
Total nonperforming loans $51,784 $64,187
------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------
Interest income received during 2003 for impaired loans was $.4 million and for
other nonaccrual loans was $14,000. Under their original terms, interest income
would have been approximately $2.9 million for the impaired loans and $.7
million for the other nonaccrual loans outstanding on December 31, 2003.
Interest income received during 2002 for impaired loans was $1.6 million and for
other nonaccrual loans was $.4 million. Under their original terms, interest
income would have been approximately $4.7 million for the impaired loans and
$1.3 million for the other nonaccrual loans outstanding on December 31, 2002.
Interest income received during 2001 for impaired loans was $.5 million and for
other nonaccrual loans was $.4 million. Under their original terms, interest
income would have been approximately $2.5 million for the impaired loans and
$1.8 million for the other nonaccrual loans outstanding on December 31, 2001.
The average balance of impaired loans was approximately $45.4 million for 2003,
$44.1 million for 2002 and $49.8 million for 2001. All impaired loans have an
associated allowance for loan loss.
First Tennessee National Corporation F-73
NOTE 4 LOANS (CONTINUED)
Activity in the allowance for loan losses related to non-impaired and impaired
loans for years ended December 31 is summarized as follows:
(Dollars in thousands) Non-impaired Impaired Total
--------------------------------------------------------------------------------------------------------------
Balance on December 31, 2000 $123,853 $ 15,357 $ 139,210
Adjustment due to divestiture (1,337) - (1,337)
Provision for loan losses* 67,612 25,608 93,220
Charge-offs (66,100) (26,124) (92,224)
Loan recoveries 9,640 2,105 11,745
--------------------------------------------------------------------------------------------------------------
Net charge-offs (56,460) (24,019) (80,479)
--------------------------------------------------------------------------------------------------------------
Balance on December 31, 2001 133,668 16,946 150,614
--------------------------------------------------------------------------------------------------------------
Provision for loan losses* 54,955 37,229 92,184
Charge-offs (72,973) (40,168) (113,141)
Loan recoveries 13,579 1,062 14,641
--------------------------------------------------------------------------------------------------------------
Net charge-offs (59,394) (39,106) (98,500)
--------------------------------------------------------------------------------------------------------------
Balance on December 31, 2002 129,229 15,069 144,298
--------------------------------------------------------------------------------------------------------------
Adjustment due to divestiture (2,652) - (2,652)
Provision for loan losses* 73,249 13,449 86,698
Charge-offs (63,113) (19,323) (82,436)
Loan recoveries 12,440 1,985 14,425
--------------------------------------------------------------------------------------------------------------
Net charge-offs (50,673) (17,338) (68,011)
--------------------------------------------------------------------------------------------------------------
BALANCE ON DECEMBER 31, 2003 $149,153 $ 11,180 $ 160,333
--------------------------------------------------------------------------------------------------------------
* Provision was negatively impacted by $3.1 million in 2003 related to the
transfer of certain retail loans to held for sale. Provision was positively
impacted by $10.0 million in 2002 related to the change in FTNC's risk profile
after the sale of a portfolio of loans originated through First Horizon Money
Centers and the transfer of certain classified and nonperforming loans to held
for sale. Provision was also positively impacted by $1.3 million in 2001 and
$10.7 million in 2000 related to credit card loans sold.
Included in other assets and in other liabilities on the Consolidated Statements
of Condition are amounts due from customers on acceptances and bank acceptances
outstanding of $3.0 million and $5.6 million on December 31, 2003 and 2002,
respectively.
F-74 First Tennessee National Corporation
NOTE 5 PREMISES, EQUIPMENT AND LEASES
Premises and equipment on December 31 are summarized below:
(Dollars in thousands) 2003 2002
----------------------------------------------------------------------------------------------
Land $ 48,391 $ 35,185
Buildings 239,353 184,637
Leasehold improvements 52,770 50,397
Furniture, fixtures and equipment 307,067 290,238
----------------------------------------------------------------------------------------------
Premises and equipment, at cost 647,581 560,457
Less accumulated depreciation and amortization 297,379 306,325
----------------------------------------------------------------------------------------------
Premises and equipment, net $350,202 $254,132
----------------------------------------------------------------------------------------------
FTNC is obligated under a number of noncancelable operating leases for premises
and equipment with terms up to 26 years, which may include the payment of taxes,
insurance and maintenance costs.
Minimum future lease payments for noncancelable operating leases on premises and
equipment on December 31, 2003, are shown below:
(Dollars in thousands)
----------------------------------------------------------------------
2004 $ 50,763
2005 43,440
2006 35,839
2007 28,901
2008 19,921
2009 and after 36,578
----------------------------------------------------------------------
Total minimum lease payments $215,442
----------------------------------------------------------------------
----------------------------------------------------------------------
Payments required under capital leases are not material.
Aggregate minimum income under sublease agreements for these periods is $10.2
million.
Rent expense incurred under all operating lease obligations was as follows for
the years ended December 31:
(Dollars in thousands) 2003 2002 2001
-------------------------------------------------------------------------------------------------------------
Rent expense, gross $64,260 $67,457 $58,166
Rent income (4,543) (5,959) (6,776)
-------------------------------------------------------------------------------------------------------------
Rent expense, net $59,717 $61,498 $51,390
-------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
First Tennessee National Corporation F-75
NOTE 6 MORTGAGE SERVICING RIGHTS
Following is a summary of changes in capitalized mortgage servicing rights
(MSRs), net of accumulated amortization, included in the Consolidated Statements
of Condition:
(Dollars in thousands)
------------------------------------------------------------------------
December 31, 2000 $ 743,714
Addition of mortgage servicing rights 378,810
Amortization (109,343)
Market value adjustments (68,966)
Sales of mortgage servicing rights (146,501)
Impairment (115,432)
Cumulative adjustment due to adoption of SFAS No. 133 (17,277)
------------------------------------------------------------------------
December 31, 2001 665,005
Addition of mortgage servicing rights 401,972
Amortization (117,841)
Market value adjustments (358,492)
Impairment (150,162)
------------------------------------------------------------------------
December 31, 2002 440,482
Addition of mortgage servicing rights 536,655
Amortization (132,273)
Market value adjustments 115,673
Sales of mortgage servicing rights (6,275)
Impairment (158,324)
------------------------------------------------------------------------
DECEMBER 31, 2003 $ 795,938
------------------------------------------------------------------------
------------------------------------------------------------------------
The MSRs on December 31, 2003 and 2002, had estimated market values of
approximately $838.5 million and $464.1 million, respectively. These balances
represent the rights to service approximately $65.1 billion and $50.0 billion of
mortgage loans on December 31, 2003 and 2002. On December 31, 2003 and 2002,
valuation allowances due to impairment of $36.5 million and $33.7 million were
required, respectively.
Estimated MSRs amortization expense for the years ending 2004, 2005, 2006, 2007
and 2008 are $120.7 million, $107.4 million, $91.7 million, $77.2 million, and
$64.5 million, respectively. The assumptions underlying these estimates are
subject to modification based on changes in market conditions and portfolio
behavior (such as prepayment speeds). As a result, these estimates are subject
to change in a manner and amount that is not presently determinable by
management.
For purposes of impairment evaluation and measurement, the MSRs are stratified
based on the predominant risk characteristics of the underlying loans. These
strata currently include adjustable and fixed-rate loans. The MSRs are amortized
over the period of and in proportion to the estimated net servicing revenues. A
quarterly value impairment analysis is performed using a discounted cash flow
methodology that is disaggregated by predominant risk characteristics.
Impairment, if any, is recognized through a valuation allowance for individual
strata. However, if the impairment is determined to be other than temporary, a
direct write-off of the asset is made.
F-76 First Tennessee National Corporation
NOTE 7 INTANGIBLE ASSETS
Following is a summary of intangible assets, net of accumulated amortization,
included in the Consolidated Statements of Condition:
Other
Intangible
(Dollars in thousands) Goodwill Assets*
-----------------------------------------------------------------------------------
December 31, 2000 $103,765 $ 17,859
Amortization expense (6,340) (4,465)
Acquisitions** 45,722 28,463
-----------------------------------------------------------------------------------
December 31, 2001 143,147 41,857
-----------------------------------------------------------------------------------
Amortization expense - (6,200)
Reclass** 12,359 (12,359)
Acquisitions** 9,111 6,350
-----------------------------------------------------------------------------------
December 31, 2002 164,617 29,648
-----------------------------------------------------------------------------------
Amortization expense - (7,980)
Divestitures (13,303) (1,632)
Acquisitions** 23,493 18,706
-----------------------------------------------------------------------------------
DECEMBER 31, 2003 $174,807 $ 38,742
-----------------------------------------------------------------------------------
-----------------------------------------------------------------------------------
* Represents premium on purchased deposits, covenants not to compete, assets
related to the minimum pension liability and retained interests from
securitizations.
** 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
$101.4 million on December 31, 2003, net of $62.7 million of accumulated
amortization. Estimated aggregate amortization expense is expected to be $8.1
million, $6.4 million, $5.1 million, $4.9 million and $4.3 million for 2004,
2005, 2006, 2007, and 2008, respectively.
On January 1, 2002, FTNC adopted the provisions of SFAS No. 142 (see
Note 1 - Summary of Significant Accounting Policies). The following table
presents on a proforma basis net income and related per share amounts exclusive
of amortization expense (net of tax effect) recognized in 2001 related to
goodwill no longer being amortized.
(Dollars in thousands) 2003 2002 2001
--------------------------------------------------------------------------------------------
Reported net income $473,309 $376,451 $318,209
Goodwill amortization (net of tax effect) - - 5,787
--------------------------------------------------------------------------------------------
Adjusted net income $473,309 $376,451 $323,996
--------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE:
Reported net income $ 3.73 $ 2.97 $ 2.49
Goodwill amortization (net of tax effect) - - .05
--------------------------------------------------------------------------------------------
Adjusted net income $ 3.73 $ 2.97 $ 2.54
--------------------------------------------------------------------------------------------
DILUTED EARNINGS PER COMMON SHARE:
Reported net income $ 3.62 $ 2.89 $ 2.42
Goodwill amortization (net of tax effect) - - .04
--------------------------------------------------------------------------------------------
Adjusted net income $ 3.62 $ 2.89 $ 2.46
--------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------
First Tennessee National Corporation F-77
NOTE 7 INTANGIBLE ASSETS (CONTINUED)
The following is a summary of goodwill, net of accumulated amortization,
detailed by reportable segments for the three years ended December 31, 2003:
First Tennessee First FTN Transaction
(Dollars in thousands) Banking Group Horizon Financial Processing Total
-------------------------------------------------------------------------------------------------------------------
December 31, 2000 $ 46,083 $54,168 $ - $ 3,514 $103,765
Amortization expense (2,693) (2,815) (682) (150) (6,340)
Acquisitions* 32,072 - 13,650 - 45,722
-------------------------------------------------------------------------------------------------------------------
December 31, 2001 75,462 51,353 12,968 3,364 143,147
-------------------------------------------------------------------------------------------------------------------
Reclass* 12,359 - - - 12,359
Acquisitions* 249 1,025 326 7,511 9,111
-------------------------------------------------------------------------------------------------------------------
December 31, 2002 88,070 52,378 13,294 10,875 164,617
-------------------------------------------------------------------------------------------------------------------
Divestitures (13,303) - - - (13,303)
Acquisitions* 9,450 (390) - 14,433 23,493
-------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2003 $ 84,217 $51,988 $13,294 $25,308 $174,807
-------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------
* Preliminary purchase price allocations on acquisitions are based upon
estimates of fair value and are subject to change.
NOTE 8 TIME DEPOSIT MATURITIES
Following is a table of maturities for time deposits outstanding on
December 31, 2003, which include 'Certificates of deposit under $100,000 and
other time' and 'Certificates of deposit $100,000 and more'. 'Certificates of
deposit $100,000 and more' totaled $5.3 billion on December 31, 2003. Time
deposits are included in 'Interest-bearing' deposits on the Consolidated
Statements of Condition.
(Dollars in thousands)
------------------------------------------------------------------------
2004 $5,578,335
2005 982,375
2006 171,311
2007 141,132
2008 76,552
2009 and after 167,508
------------------------------------------------------------------------
Total $7,117,213
------------------------------------------------------------------------
------------------------------------------------------------------------
F-78 First Tennessee National Corporation
NOTE 9 SHORT-TERM BORROWINGS
Short-term borrowings include federal funds purchased and securities sold under
agreements to repurchase, commercial paper, and other borrowed funds which
include term federal funds purchased and short-term bank notes.
Federal funds purchased and securities sold under agreements to repurchase and
commercial paper generally have maturities of less than 90 days. Other
short-term borrowings have original maturities of one year or less.
The detail of these borrowings for the years 2003, 2002 and 2001 is presented in
the following table:
Federal Funds
Purchased and
Securities Sold Other
Under Agreements Commercial Short-term
(Dollars in thousands) to Repurchase Paper Borrowings
--------------------------------------------------------------------------------------------------------
2003
Average balance $3,712,768 $20,902 $638,961
Year-end balance 3,079,248 31,793 196,183
Maximum month-end outstanding 4,703,454 31,793 988,855
Average rate for the year .99% .93% 3.92%
Average rate at year-end .79 .78 3.52
--------------------------------------------------------------------------------------------------------
2002
Average balance $3,134,379 $19,899 $517,499
Year-end balance 3,126,350 25,695 335,513
Maximum month-end outstanding 4,283,364 26,461 625,299
Average rate for the year 1.45% 1.31% 4.24%
Average rate at year-end .99 .98 3.14
--------------------------------------------------------------------------------------------------------
2001
Average balance $3,162,728 $19,704 $545,602
Year-end balance 2,921,543 22,273 426,878
Maximum month-end outstanding 4,065,909 22,391 733,202
Average rate for the year 3.66% 3.62% 5.36%
Average rate at year-end 1.31 1.44 3.37
--------------------------------------------------------------------------------------------------------
On December 31, 2003, $50 million of borrowings under unsecured lines of credit
from non-affiliated banks were available to the parent company to provide for
general liquidity needs at an annual facility fee of .10 percent.
First Tennessee National Corporation F-79
NOTE 10 TERM BORROWINGS
The following table presents information pertaining to term borrowings (debt
with original maturities greater than one year) for FTNC and its subsidiaries on
December 31:
(Dollars in thousands) 2003 2002
-----------------------------------------------------------------------------------
FIRST TENNESSEE BANK NATIONAL ASSOCIATION:
Subordinated notes (qualifies for total capital under the
Risk-Based Capital guidelines):
Matures on May 15, 2013 - 4.625% $ 257,529 $ -
Matures on December 1, 2008 - 5.75% 141,191 140,729
Matures on April 1, 2008 - 6.40% 89,701 89,630
Bank notes:*
Matures on June 30, 2004 - 1.12% 174,987 -
Matures on October 8, 2004 - 1.23% and 1.84%
on December 31, 2003 and 2002, respectively 149,977 149,947
Matures on January 21, 2004 - 1.13% 100,000 -
Matures on May 3, 2005 - 1.16% 99,987 -
Matures on June 1, 2005 - 1.17% 100,000 -
Matures on June 30, 2005 - 1.21% 99,985 -
Matures on November 26, 2004 - 1.25% and 1.51% on
December 31, 2003 and 2002, respectively 74,987 74,971
Matures on July 6, 2004 - 1.35% and 1.96% on
December 31, 2003 and 2002, respectively 59,985 59,957
Matures on July 9, 2004 - 1.35% and 1.96% on
December 31, 2003 and 2002, respectively 50,000 50,000
Matures on March 6, 2007 - 1.41% and 1.65% on
December 31, 2003 and 2002, respectively 49,939 49,920
Matured on October 6, 2003 - 1.75% on December 31, 2002 - 150,000
Matured on April 17, 2003 - 1.387% on December 31, 2002 - 50,000
Matured on May 23, 2003 - 1.55% on December 31, 2002 - 19,998
Federal Home Loan Bank borrowings** 3,897 4,181
Other*** 280 6,692
FIRST TENNESSEE NATIONAL CORPORATION:
Subordinated capital notes (qualifies for total capital
under the Risk-Based Capital guidelines):
Matures on May 15, 2013 - 4.50% 103,229 -
Matures on November 15, 2005 - 6.75% 22,850 74,765
Subordinated notes (Note 11):
Matures on January 6, 2027 - 8.07% 103,093 N/A
FT REAL ESTATE SECURITIES COMPANY, INC.
Cumulative preferred stock (qualifies for total capital
under the Risk-Based Capital guidelines) (Note 12):
Matures on March 31, 2031 - 9.50% 45,149 N/A
FIRST NATIONAL BANK OF SPRINGDALE:
Federal Home Loan Bank borrowings** - 8,925
----------------------------------------------------------------------------------
Total $1,726,766 $929,715
----------------------------------------------------------------------------------
----------------------------------------------------------------------------------
* FTBNA has an ongoing bank note program under which the bank may offer an
aggregate principal amount of up to $3.0 billion. Bank notes with original
maturities of one year or less are included in other short-term borrowings.
Bank notes with original maturities greater than one year are classified as
term borrowings. On December 31, 2003, unused term-borrowing capacity under
this program was $1.0 billion.
** The Federal Home Loan Bank (FHLB) borrowings were issued with fixed
interest rates and have remaining terms of 6 to 26 years. These borrowings
had weighted average interest rates of 4.29 percent and 4.44 percent for
FTBNA on December 31, 2003 and December 31, 2002, respectively, and 4.56
percent for FNB on December 31, 2002.
*** Other long-term debt is comprised of unsecured obligations issued with
fixed interest rates and have remaining terms of approximately one year.
These borrowings had weighted average interest rates of 5.00 percent and
4.60 percent on December 31, 2003 and December 31, 2002, respectively.
F-80 First Tennessee National Corporation
NOTE 10 TERM BORROWINGS (CONTINUED)
Annual principal repayment requirements as of December 31, 2003, are as follows:
(Dollars in thousands)
----------------------------------------------------------------------
2004 $610,565
2005 323,182
2006 285
2007 50,285
2008 231,910
2009 and after 502,565
----------------------------------------------------------------------
All subordinated notes are unsecured and are subordinate to other present and
future senior indebtedness. FTBNA's subordinated notes and FTNC's subordinated
capital notes qualify as Tier 2 risk-based capital under the Federal Reserve
Board and Office of the Comptroller of the Currency guidelines for assessing
capital adequacy. The subordinated and bank notes may not be redeemed or prepaid
prior to maturity.
First Tennessee National Corporation F-81
NOTE 11 GUARANTEED PREFERRED BENEFICIAL INTERESTS IN FIRST TENNESSEE'S JUNIOR
SUBORDINATED DEBENTURES
On December 30, 1996, FTNC, through its underwriters, sold to institutional
investors $100 million of capital securities. First Tennessee Capital I (Capital
I), a Delaware business trust wholly owned by FTNC, issued $100 million of
Capital Securities, Series A at 8.07%. The proceeds were upstreamed to FTNC as
junior subordinated debt. FTNC has, through various contractual arrangements,
fully and unconditionally guaranteed all of Capital I's obligations with respect
to the capital securities. The sole asset of Capital I is $103 million of junior
subordinated debentures issued by FTNC. These junior subordinated debentures
also carry an interest rate of 8.07 percent. Both the capital securities of
Capital I and the junior subordinated debentures of FTNC will mature on January
6, 2027; however, under certain circumstances, the maturity of both may be
shortened to a date not earlier than January 6, 2017. The capital securities
qualify as Tier 1 capital and have historically been presented in the
Consolidated Statements of Condition as 'Guaranteed preferred beneficial
interests in First Tennessee's junior subordinated debentures.' Effective
December 31, 2003, FTNC adopted FIN-46 (see Note 1 - Summary of Significant
Accounting Policies) which required the deconsolidation of Capital I and also
resulted in the junior subordinated debentures no longer being eliminated in
consolidation. On December 31, 2003, the junior subordinated debentures are
included in the Consolidated Statements of Condition in 'Term borrowings' (see
Note 10 - Term Borrowings).
NOTE 12 PREFERRED STOCK OF SUBSIDIARY
On September 14, 2000, FT Real Estate Securities Company, Inc. (FTRESC), an
indirect wholly owned subsidiary of FTNC, issued 50 shares of 9.50% Cumulative
Preferred Stock, Class B (Class B Preferred Shares), with a liquidation
preference of $1.0 million per share. An aggregate total of 47 Class B Preferred
Shares have been sold privately to nonaffiliates. These securities qualify as
Tier 2 capital and are presented in the Consolidated Statements of Condition as
'Term borrowings' in 2003 and 'Preferred stock of subsidiary' in 2002. FTRESC is
a real estate investment trust (REIT) established for the purpose of acquiring,
holding and managing real estate mortgage assets. Dividends on the Class B
Preferred Shares are cumulative and are payable semi-annually.
The Class B Preferred Shares are mandatorily redeemable on March 31, 2031, and
redeemable at the discretion of FTRESC in the event that the Class B Preferred
Shares cannot be accounted for as Tier 2 regulatory capital or there is more
than an insubstantial risk that dividends paid with respect to the Class B
Preferred Shares will not be fully deductible for tax purposes. They are not
subject to any sinking fund and are not convertible into any other securities of
FTRESC, FTNC or any of its subsidiaries. The shares are, however, automatically
exchanged at the direction of the Office of the Comptroller of the Currency for
preferred stock of FTBNA, having substantially the same terms as the Class B
Preferred Shares in the event FTBNA becomes undercapitalized, insolvent or in
danger of becoming undercapitalized.
On July 1, 2003, FTNC adopted certain provisions of SFAS No. 150, which requires
certain financial instruments with both liability and equity characteristics to
be classified as liabilities on the statement of condition. Upon adoption of
this statement, FTNC classified its mandatorily redeemable preferred stock of
subsidiary in 'Term borrowings' (See Note 10 - Term Borrowings). Historically,
the related distributions on these instruments ($4.6 million annually) were
classified as noninterest expense on the Consolidated Statements of Income, but
as of July 1, 2003, are classified as interest expense on a prospective basis.
Restatement of prior periods was not permitted.
On December 31, 2003, $.5 million of preferred stock that is perpetual in nature
and not subject to the provisions of SFAS No. 150 was recognized as 'Preferred
stock of subsidiary' on the Consolidated Statements of Condition. The following
indirect, wholly owned subsidiaries of FTNC have also issued preferred stock.
First Horizon Mortgage Loan Corporation has issued $1.0 million of Class B
Preferred Shares. Additionally, FHRIII, LLC and FHRIV, LLC have issued $1.0
million of Class B Preferred Units each. The remaining balance has been
eliminated in consolidation.
F-82 First Tennessee National Corporation
NOTE 13 REGULATORY CAPITAL
FTNC 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 FTNC'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 FTNC 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
December 31, 2003, that FTNC met all capital adequacy requirements to which it
was subject.
The actual capital amounts and ratios of FTNC and FTBNA (the banking subsidiary
of FTNC) 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 12.12 percent, 8.94 percent and
7.16 percent, respectively, on December 31, 2003, and were 10.96 percent, 8.67
percent and 6.80 percent, respectively, on December 31, 2002.
First Tennessee
National First Tennessee Bank
Corporation National Association
----------------------- ------------------------
(Dollars in thousands) Amount Ratio Amount Ratio
-------------------------------------------------------------------------------------------------------------------
ON DECEMBER 31, 2003:
Actual:
Total Capital $2,509,835 13.19% $2,384,981 12.63%
Tier 1 Capital 1,754,367 9.22 1,734,092 9.18
Leverage 1,754,367 7.19 1,734,092 7.25
For Capital Adequacy Purposes:
Total Capital 1,522,301 >= 8.00 1,510,952 >= 8.00
Tier 1 Capital 761,151 >= 4.00 755,476 >= 4.00
Leverage 975,794 >= 4.00 956,384 >= 4.00
To Be Well Capitalized Under Prompt
Corrective Action Provisions:
Total Capital 1,902,877 >= 10.00 1,888,690 >= 10.00
Tier 1 Capital 1,141,726 >= 6.00 1,133,214 >= 6.00
Leverage 1,219,742 >= 5.00 1,195,480 >= 5.00
-------------------------------------------------------------------------------------------------------------------
On December 31, 2002:
Actual:
Total Capital $2,014,888 11.54% $1,944,850 11.23%
Tier 1 Capital 1,558,505 8.93 1,521,425 8.78
Leverage 1,558,505 6.91 1,521,425 6.86
For Capital Adequacy Purposes:
Total Capital 1,396,931 >= 8.00 1,385,680 >= 8.00
Tier 1 Capital 698,466 >= 4.00 692,840 >= 4.00
Leverage 902,711 >= 4.00 886,992 >= 4.00
To Be Well Capitalized Under Prompt
Corrective Action Provisions:
Total Capital 1,746,164 >= 10.00 1,732,100 >= 10.00
Tier 1 Capital 1,047,698 >= 6.00 1,039,260 >= 6.00
Leverage 1,128,388 >= 5.00 1,108,739 >= 5.00
------------------------------------------------------------------------------------------------------------------
First Tennessee National Corporation F-83
NOTE 14 OTHER INCOME AND OTHER EXPENSE
Following is detail concerning 'All other income' and 'All other expense' as
presented in the Consolidated Statements of Income:
(Dollars in thousands) 2003 2002 2001
---------------------------------------------------------------------------------------------------------
ALL OTHER INCOME:
Cardholder fees $ 22,698 $ 20,145 $ 20,137
Other service charges 19,810 21,204 24,932
Check clearing fees 11,839 13,180 11,615
Other 97,314 86,781 80,395
---------------------------------------------------------------------------------------------------------
Total $151,661 $141,310 $137,079
---------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------
ALL OTHER EXPENSE:
Legal and professional fees $ 60,001 $ 37,340 $ 32,087
Advertising and public relations 43,955 35,982 35,508
Travel and entertainment 37,432 22,501 17,489
Contract employment 33,790 28,987 30,082
Computer software 28,828 26,140 25,107
Supplies 18,783 15,145 13,765
Charitable contributions 13,370 48,337 1,745
Foreclosed real estate 13,137 21,479 25,452
Fed service fees 9,195 9,597 7,761
Distributions on guaranteed preferred securities 8,070 8,070 8,070
Deposit insurance premium 2,703 2,393 2,463
Distributions on preferred stock of subsidiary 2,282 4,564 4,535
Other 109,231 69,171 71,348
---------------------------------------------------------------------------------------------------------
Total $380,777 $329,706 $275,412
---------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------
Certain previously reported amounts have been reclassified to agree with current
presentation.
F-84 First Tennessee National Corporation
NOTE 15 COMPONENTS OF OTHER COMPREHENSIVE INCOME
Following is detail of 'Accumulated other comprehensive income' as presented in
the Consolidated Statements of Condition:
Accumulated
Tax Other
Before-Tax (Expense)/ Comprehensive
(Dollars in thousands) Amount Benefit Income
-----------------------------------------------------------------------------------------------------
December 31, 2000 $ 14,598
Other comprehensive income:
Cumulative effect of change in accounting principle $ 2,307 $ (858) 1,449
Realized gain on cash flow hedge (2,307) 858 (1,449)
Unrealized market adjustments on securities
available for sale 6,212 (2,459) 3,753
Less: adjustment for net losses included in net income (7,970) 3,043 (4,927)
------------------------------------------------------------------------------------- -------------
December 31, 2001 $ 14,182 $(5,502) 23,278
-------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------
Other comprehensive income:
Unrealized market adjustments on cash flow hedge $ (224) $ 87 (137)
Minimum pension liability (2,196) 807 (1,389)
Unrealized market adjustments on securities
available for sale (1,613) 739 (874)
Less: adjustment for net losses included in net income (9,180) 3,571 (5,609)
------------------------------------------------------------------------------------- -------------
December 31, 2002 $ 5,147 $(1,938) 26,487
-------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------
Other comprehensive income:
Unrealized market adjustments on cash flow hedge 224 (87) 137
Minimum pension liability (1,786) 657 (1,129)
Unrealized market adjustments on securities
available for sale (37,988) 14,637 (23,351)
Less: adjustment for net gains included in net income 2,378 (916) 1,462
------------------------------------------------------------------------------------- -------------
DECEMBER 31, 2003 $(41,928) $16,123 $ 682
------------------------------------------------------------------------------------- -------------
------------------------------------------------------------------------------------- -------------
First Tennessee National Corporation F-85
NOTE 16 INCOME TAXES
The components of income tax expense/(benefit) are as follows:
(Dollars in thousands) 2003 2002 2001
---------------------------------------------------------------------------------------------------------
Current:
Federal $134,793 $119,258 $ 297,389
State (2,820) 20,102 22,667
Deferred:
Federal 80,779 44,191 (143,273)
State 32,937 (1,943) (14,597)
---------------------------------------------------------------------------------------------------------
Total $245,689 $181,608 $ 162,186
---------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------
The effective tax rates for 2003, 2002 and 2001 were 34.17 percent, 32.54
percent and 33.20 percent, respectively. Income tax expense was different than
the amounts computed by applying the statutory federal income tax rate to income
before income taxes because of the following:
(Dollars in thousands) 2003 2002 2001
---------------------------------------------------------------------------------------------------------
Federal income tax rate 35% 35% 35%
---------------------------------------------------------------------------------------------------------
Tax computed at statutory rate $251,649 $195,321 $170,997
Increase/(decrease) resulting from:
Tax-exempt interest (1,114) (1,155) (1,330)
State income taxes 19,582 11,936 5,472
Sale of preferred stock by subsidiary - - (1,082)
Tax credits (14,703) (9,219) (6,593)
Other (9,725) (15,275) (5,278)
---------------------------------------------------------------------------------------------------------
Total $245,689 $181,608 $162,186
---------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------
A deferred tax asset or liability is recognized for the tax consequences of
temporary differences between the financial statement carrying amounts and the
tax bases of existing assets and liabilities. The tax consequence is calculated
by applying enacted statutory tax rates, applicable to future years, to these
temporary differences. Temporary differences which gave rise to deferred tax
(assets)/liabilities on December 31, 2003 and 2002, were as follows:
(Dollars in thousands) 2003 2002
---------------------------------------------------------------------------------------------------------
DEFERRED TAX ASSETS:
Loss reserves $ (68,952) $ (73,276)
Net operating loss carryforwards - (5,309)
Employee benefits (42,929) (11,325)
Accrued expenses (13,404) (11,830)
Other (19,775) (5,169)
---------------------------------------------------------------------------------------------------------
Gross deferred tax assets (145,060) (106,909)
---------------------------------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES:
Capitalized mortgage servicing rights 355,167 198,809
Interest rate derivatives - 10,317
Depreciation and amortization 23,460 16,698
Investments in debt and equity securities 5,149 31,615
Federal Home Loan Bank stock 10,867 9,103
Deferred fees and expenses 36,763 29,157
Capitalized computer software 2,139 4,012
Other intangible assets 14,299 5,196
Other 7,065 5,148
---------------------------------------------------------------------------------------------------------
Gross deferred tax liabilities 454,909 310,055
---------------------------------------------------------------------------------------------------------
Net deferred tax liabilities $ 309,849 $ 203,146
---------------------------------------------------------------------------------------------------------
F-86 First Tennessee National Corporation
NOTE 17 EARNINGS PER SHARE
The following table shows a reconciliation of earnings per common share to
diluted earnings per common share.
(Dollars in thousands, except per share data) 2003 2002 2001
----------------------------------------------------------------------------------------------------------
Income before cumulative effect of changes
in accounting principles $ 473,309 $ 376,451 $ 326,377
Cumulative effect of changes in accounting principles, net
of tax - - (8,168)
----------------------------------------------------------------------------------------------------------
Net income $ 473,309 $ 376,451 $ 318,209
----------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding 125,686,999 125,682,766 126,982,073
Shares attributable to deferred compensation 1,078,424 1,031,647 795,283
----------------------------------------------------------------------------------------------------------
Total weighted average shares 126,765,423 126,714,413 127,777,356
----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE:
Income before cumulative effect of changes
in accounting principles $ 3.73 $ 2.97 $ 2.55
Cumulative effect of changes in accounting principles, net
of tax - - (0.06)
----------------------------------------------------------------------------------------------------------
Net income $ 3.73 $ 2.97 $ 2.49
----------------------------------------------------------------------------------------------------------
Weighted average shares outstanding 126,765,423 126,714,413 127,777,356
Dilutive effect due to stock options 4,110,618 3,506,756 3,760,267
----------------------------------------------------------------------------------------------------------
Total weighted average shares, as adjusted 130,876,041 130,221,169 131,537,623
----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER COMMON SHARE:
Income before cumulative effect of changes
in accounting principles $ 3.62 $ 2.89 $ 2.48
Cumulative effect of changes in accounting principles, net
of tax - - (0.06)
----------------------------------------------------------------------------------------------------------
Net income $ 3.62 $ 2.89 $ 2.42
----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
NOTE 18 RESTRICTIONS, CONTINGENCIES, COMMITMENTS AND OTHER DISCLOSURES
RESTRICTIONS ON CASH AND DUE FROM BANKS. The commercial banking subsidiaries of
FTNC are required to maintain average reserve and clearing balances with the
Federal Reserve Bank under the Federal Reserve Act and Regulation D. The
balances required on December 31, 2003 and 2002, were $221.0 million and $215.5
million, respectively. These reserves are included in 'Cash and due from banks'
on the Consolidated Statements of Condition.
RESTRICTIONS ON DIVIDENDS. Dividends are paid by FTNC from its assets, which are
mainly provided by dividends from its subsidiaries. Certain regulatory
restrictions exist regarding the ability of FTBNA to transfer funds to FTNC in
the form of cash, dividends, loans or advances. As of December 31, 2003, FTBNA
had undivided profits of $1,578.8 million of which $508.4 million was available
for distribution to FTNC as dividends without prior regulatory approval.
RESTRICTIONS ON INTERCOMPANY TRANSACTIONS. Under Federal banking law, banking
subsidiaries may not extend credit to the parent company in excess of 10 percent
of the banks capital stock and surplus, as defined, or $238.2 million on
December 31, 2003. The parent company had borrowings of $43.2 million from FTBNA
on December 31, 2003. Certain loan agreements also define other restricted
transactions related to additional borrowings.
First Tennessee National Corporation F-87
NOTE 18 RESTRICTIONS, CONTINGENCIES, COMMITMENTS AND OTHER DISCLOSURES
(CONTINUED)
CONTINGENCIES. Contingent liabilities arise in the ordinary course of business,
including those related to litigation. Various claims and lawsuits are pending
against FTNC and its subsidiaries. Although FTNC cannot predict the outcome of
these lawsuits, after consulting with counsel, management has been able to form
an opinion on the effect all of these lawsuits, except the matter mentioned in
the paragraph below, will have on the consolidated financial statements. It is
management's opinion that when resolved, these lawsuits will not have a material
adverse effect on the consolidated financial statements of FTNC.
In November 2000, a complaint was filed in Missouri state court against FTNC's
subsidiary, First Horizon Home Loans. The case concerns the charging of certain
loan origination fees, permitted by Kansas law but allegedly restricted or not
permitted by Missouri law, when First Horizon Home Loans or its predecessor,
McGuire Mortgage Company, made certain second mortgage loans in Kansas which
were secured by Missouri property. Among other relief, plaintiffs seek fees,
loan interest, punitive damages, statutory penalties, and loan rescission.
Discovery is ongoing, and a trial date has not been scheduled. In response to
pre-trial motions, the court has ruled that Missouri law governs the loan
transactions and has certified a statewide class action; plaintiffs contend the
class involves approximately 4,600 loans, but the exact size is in dispute. FTNC
believes that it has meritorious defenses and intends to continue to protect its
rights and defend this lawsuit vigorously, through trial and appeal, if
necessary.
LOAN COMMITMENTS. FTNC enters into fixed and variable loan commitments with
customers. When these commitments have contract rate adjustments that lag
changes in market rates, the financial instruments have characteristics similar
to option contracts. FTNC follows the same credit policies and underwriting
practices in making commitments as it does for on-balance sheet instruments.
Each counterparty's creditworthiness is evaluated on a case-by-case basis. The
amount of collateral obtained, if any, is based on management's credit
evaluation of the counterparty.
Commitments to extend credit are contractual obligations to lend to a customer
as long as all established contractual conditions are met. These commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. The majority of FTNC's loan commitments have
maturities less than one year and reflect the prevailing market rates at the
time of the commitment. Since commitments may expire without being fully drawn
upon, the total contract amount does not necessarily represent future cash
requirements.
Other commitments include standby and commercial letters of credit and other
credit enhancements. Standby and commercial letters of credit and other credit
enhancements are conditional commitments issued by FTNC to guarantee the
performance and/or payment of a customer to a third party in connection with
specified transactions. The credit risk involved in issuing these commitments is
essentially the same as that involved in extending loan facilities to customers,
as performance under any of these facilities would result in a loan being funded
to the customer.
F-88 First Tennessee National Corporation
NOTE 18 RESTRICTIONS, CONTINGENCIES, COMMITMENTS AND OTHER DISCLOSURES
(CONTINUED)
The following is a summary of the maximum credit exposure of each class of
lending related off-balance sheet financial instruments outstanding on
December 31:
(Dollars in millions) 2003 2002
----------------------------------------------------------------------------------------
Commitments to extend credit:
Consumer credit card lines $ 1,668.9 $1,552.8
Consumer home equity 4,119.9 2,446.2
Commercial real estate and construction and land
development 1,453.4 1,050.3
Commercial and other 2,839.2 2,272.0
----------------------------------------------------------------------------------------
Total loan commitments 10,081.4 7,321.3
Other commitments:
Standby letters of credit 522.4 476.2
Other 48.1 264.4
----------------------------------------------------------------------------------------
Total loan and other commitments $10,651.9 $8,061.9
----------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------
OTHER DISCLOSURES - COMPANY OWNED LIFE INSURANCE. FTNC has purchased life
insurance on certain of its employees and is the beneficiary on these policies.
On December 31, 2003, the cash surrender value of these policies, which is
included in 'Capital markets receivables and other assets' on the Consolidated
Statements of Condition, was $235.9 million. There are no restrictions on the
proceeds from these benefits, and FTNC has not borrowed against the cash
surrender value of these policies.
OTHER DISCLOSURES - INDEMNIFICATION AGREEMENTS AND GUARANTEES. In the ordinary
course of business, FTNC enters into indemnification agreements for legal
proceedings against its directors and officers and standard representation
warranties for underwriting agreements, merger and acquisition agreements, sold
loans and other similar types of arrangements. It is not possible to estimate a
maximum potential amount of payouts that could be required with such agreements.
First Horizon Home Loans services a mortgage loan portfolio of approximately
$68.9 billion as of December 31, 2003, a significant portion of which is held by
Government Sponsored Enterprises (GSEs) 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 GSEs at foreclosure sale. See Note 24 - Securitizations for additional
information on loans sold with recourse.
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 $22.3 million and $33.0 million as
of December 31, 2003 and 2002, respectively. First Horizon Home Loans has sold
certain mortgage loans with an agreement to repurchase the loans upon default.
As of December 31, 2003 and 2002, First Horizon Home Loans had single-family
residential loans with outstanding balances of $199.3 million and $175.9
million, respectively, that were sold on a recourse basis. For the single-family
residential loans, in the event of borrower nonperformance, First
First Tennessee National Corporation F-89
NOTE 18 RESTRICTIONS, CONTINGENCIES, COMMITMENTS AND OTHER DISCLOSURES
(CONTINUED)
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.
As of December 31, 2003 and 2002, the outstanding principal balance of loans
sold with limited recourse and serviced by First Horizon Home Loans was $3.7
billion and $4.5 billion, respectively.
NOTE 19 SHAREHOLDER PROTECTION RIGHTS AGREEMENT
On October 20, 1998, FTNC adopted a Shareholder Protection Rights Agreement (the
'Agreement') and declared a dividend of one right on each outstanding share of
common stock held on November 2, 1998, or issued thereafter and prior to the
time the rights separate and thereafter pursuant to options and convertible
securities outstanding at the time the rights separate.
The Agreement provides that until the earlier of the tenth business day (subject
to certain adjustments by the board of directors) after a person or group
commences a tender or exchange offer that will, subject to certain exceptions,
result in such person or group owning 10 percent or more of FTNC's common stock,
or the tenth business day (subject to certain adjustments by the board) after
the public announcement by FTNC that a person or group owns 10 percent or more
of FTNC's common stock, the rights will be evidenced by the common stock
certificates, will automatically trade with the common stock, and will not be
exercisable. Thereafter, separate rights certificates will be distributed, and
each right will entitle its holder to purchase one one-hundredth of a share of
participating preferred stock having economic and voting terms similar to those
of one share of common stock for an exercise price of $150.
If any person or group acquires 10 percent or more of FTNC's common stock, then
each right (other than rights beneficially owned by holders of 10 percent or
more of the common stock or affiliates, associates or transferees thereof, which
rights become void) will entitle its holder to purchase, for the exercise price,
a number of shares of FTNC common stock or participating preferred stock having
a market value of twice the exercise price. Also, if there is a 10 percent
shareholder and FTNC is involved in certain significant transactions, each right
will entitle its holder to purchase, for the exercise price, a number of shares
of common stock of the other party having a market value of twice the exercise
price. If any person or group acquires 10 percent or more (but not more than 50
percent) of FTNC's common stock, FTNC's board of directors may, at its option,
exchange one share of FTNC common stock or one one-hundredth of a share of
participating preferred stock for each right (other than rights which have
become void). The board of directors may amend the Agreement in any respect
prior to the tenth business day after announcement by FTNC that a person or
group has acquired 10 percent or more of FTNC's common stock. The rights will
expire on the earliest of the following times: the time of the exchange
described in the second preceding sentence; December 31, 2009; or the date the
rights are redeemed as described in the following sentence. The rights may be
redeemed by the board of directors for $0.001 per right until 10 business days
after FTNC announces that any person or group owns 10 percent or more of FTNC's
common stock.
NOTE 20 SAVINGS, PENSION AND OTHER EMPLOYEE BENEFITS
SAVINGS PLAN. Substantially all employees of FTNC are covered by a contributory
savings plan in conjunction with a flexible benefits plan. During the year, FTNC
makes contributions to each employee's flexible benefits plan account. These
contributions are based on length of service and a percentage of the employee's
salary. The employees have the option to direct a portion or all of the
contribution into their savings plan accounts. Employees may also make pre-tax
and after-tax personal contributions to the savings plan. FTNC matches the
majority of employee pre-tax contributions invested in FTNC's common stock (or
for employees of First Horizon Home Loans, contributions made to any savings
plan fund) at a rate of $.50 for each $1.00 invested up to 6 percent of the
employee's qualifying salary. Contributions made by FTNC to the flexible
benefits plan were $24.4 million for 2003, $20.4 million for 2002 and $18.3
million for 2001. A
F-90 First Tennessee National Corporation
NOTE 20 SAVINGS, PENSION AND OTHER EMPLOYEE BENEFITS (CONTINUED)
feature of the savings plan allows employees to choose to invest their savings
in one or more of ten various component funds, including a company stock fund.
During 2001, FTNC converted the company stock fund component of its savings plan
to a nonleveraged employee stock ownership plan (ESOP). This component fund
remains part of the savings plan. Compensation cost related to the ESOP is
measured as the amount allocated from matching contributions and discretionary
contributions contributed to the ESOP and is included in the contributions
amount above. Dividends on shares held by the ESOP are charged to retained
earnings and shares held by the ESOP are treated as outstanding in computing
earnings per share. The number of allocated shares held by the ESOP totaled
8,533,548 on December 31, 2003.
PENSION PLAN. The majority of employees of FTNC are covered by a
noncontributory, defined benefit 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.
OTHER EMPLOYEE BENEFITS. FTNC provides postretirement medical insurance to
full-time employees retiring under the provisions of the FTNC 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, FTNC will contribute a fixed amount based
on years of service and age at time of retirement. FTNC's postretirement
benefits include prescription drug benefits. The Medicare Prescription Drug,
Improvement and Modernization Act of 2003 (the Act) introduces a prescription
drug benefit under Medicare Part D as well as a federal subsidy to sponsors of
retiree health care benefit plans that provide a benefit that is at least
actuarially equivalent to Medicare Part D. FASB Staff Position (FSP) FAS 106-1
allows either immediate recognition or deferred recognition. FTNC elected to
defer recognition and will not recognize the effect of the Act until the earlier
of: (1) when the underlying accounting issues are resolved by FASB; or (2) when
plan costs have to be remeasured (e.g. for a plan amendment).
ACTUARIAL ASSUMPTIONS. The actuarial assumptions used in the defined benefit
pension plan and the other employee benefit plan were as follows:
Pension Benefits Postretirement Benefits
----------------------------- ----------------------------
2003 2002 2001 2003 2002 2001
---------------------------------------------------------------------------------------------------------------------
WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE
BENEFIT OBLIGATIONS AS OF SEPTEMBER 30
MEASUREMENT DATE
Discount rate 6.25% 6.75% 7.25% 6.25% 6.75% 7.25%
Rate of compensation increase 4.00 4.00 4.00 N/A N/A N/A
---------------------------------------------------------------------------------------------------------------------
Pension Benefits Postretirement Benefits
---------------------------- ----------------------------
2003 2002 2001 2003 2002 2001
---------------------------------------------------------------------------------------------------------------------
WEIGHTED-AVERAGE ASSUMPTIONS USED TO DETERMINE
NET PERIODIC BENEFIT COST FOR THE FISCAL YEAR
Discount rate 6.75% 7.25% 7.75% 6.75% 7.25% 7.75%
Expected return on plan assets 8.75 10.00 10.00 8.75 10.00 10.00
Expected return on plan assets dedicated to
employees who retired prior to January 1, 1993 N/A N/A N/A 5.75 6.50 6.50
Rate of compensation increase 4.00 4.00 4.00 N/A N/A N/A
---------------------------------------------------------------------------------------------------------------------
First Tennessee National Corporation F-91
NOTE 20 SAVINGS, PENSION AND OTHER EMPLOYEE BENEFITS (CONTINUED)
To develop the expected long-term rate of return on assets assumption, the
company considered the current level of expected returns on risk free
investments (primarily government bonds), the historical level of the risk
premium associated with the other asset classes in which the portfolio is
invested and the expectations for future returns of each asset class. Since the
company's investment policy is to actively manage certain asset classes where
the potential exists to outperform the broader market, the expected returns for
those asset classes were adjusted to reflect the expected additional returns.
The expected return for each asset class was then weighted based on the target
asset allocation to develop the expected long-term rate of return on assets
assumption for the portfolio. This resulted in the selection of the 8.75 percent
assumption.
The assumed health care cost trend rates used in the defined benefit pension
plan and the other employee benefit plan were as follows:
2003 2002
----------------------------------------------------------------------------------------------------------------
ASSUMED HEALTH CARE COST TREND RATES PARTICIPANTS PARTICIPANTS 65 Participants Participants 65
ON SEPTEMBER 30 UNDER AGE 65 YEARS AND OLDER under age 65 years and older
---------------------------------------------------------------
Health care cost trend rate assumed for next
year 9.5% 11.5% 10.0% 12.0%
Rate to which the cost trend rate is assumed to
decline (the ultimate trend rate) 6.0 8.0 6.0 8.0
Year that the rate reaches the ultimate trend
rate 2010 2010 2010 2010
----------------------------------------------------------------------------------------------------------------
The health care cost trend rate assumption has a significant effect on the
amounts reported. A one-percentage-point change in assumed health care cost
trend rates would have the following effects:
(Dollars in thousands) 1% Increase 1% Decrease
----------------------------------------------------------------------------------------------------------------
Adjusted total service and interest cost components $ 2,582 $ 2,391
Adjusted postretirement benefit obligation at end of plan
year 33,635 30,257
----------------------------------------------------------------------------------------------------------------
The components of net periodic benefit cost for the plan years 2003, 2002 and
2001 were as follows:
Pension Benefits Postretirement Benefits
------------------------------- ------------------------------
(Dollars in thousands) 2003 2002 2001 2003 2002 2001
-------------------------------------------------------------------------------------------------------------------
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost $ 12,832 $ 10,418 $ 8,943 $ 732 $ 949 $ 860
Interest cost 17,950 16,210 13,893 1,750 1,941 1,773
Expected return on plan assets (26,645) (29,387) (26,661) (1,376) (1,726) (1,954)
Amortization of prior service cost 736 738 338 (176) (176) (176)
Recognized gains/(losses) 637 184 - - - (299)
Amortization of transition obligation or asset (20) (460) (460) 989 989 989
-------------------------------------------------------------------------------------------------------------------
Net periodic cost/(benefit) $ 5,490 $ (2,297) $ (3,947) $ 1,919 $ 1,977 $ 1,193
-------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------
Previously reported amounts have been restated to agree with current
presentation.
F-92 First Tennessee National Corporation
NOTE 20 SAVINGS, PENSION AND OTHER EMPLOYEE BENEFITS (CONTINUED)
The following table sets forth the plans' funded status reconciled to the
amounts shown in the Consolidated Statements of Condition:
Pension Benefits
---------------------------------------
(Dollars in thousands) 2003 2002
---------------------------------------------------------------------------------------------------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of plan year $270,143 $228,190
Service cost 12,832 10,418
Interest cost 17,950 16,210
Amendments - 38
Actuarial (gain)/loss 19,502 23,689
Benefits paid (8,070) (8,402)
---------------------------------------------------------------------------------------------------
Benefit obligation at end of plan year $312,357 $270,143
---------------------------------------------------------------------------------------------------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of plan year $246,442 $273,126
Actual return on plan assets 49,490 (29,337)
Employer contribution 197 11,055
Benefits paid (8,070) (8,402)
---------------------------------------------------------------------------------------------------
Fair value of plan assets at end of plan year $288,059 $246,442
---------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------
NET FUNDED STATUS ON SEPTEMBER 30 $(24,298) $(23,701)
Unrecognized net actuarial loss 98,144 102,125
Unrecognized net transitional (asset)/obligation - (20)
Unrecognized prior service cost/(benefit) 6,444 7,180
---------------------------------------------------------------------------------------------------
Prepaid benefit cost on September 30 80,290 85,584
Contributions paid from October 1 to December 31 28,835 49
---------------------------------------------------------------------------------------------------
Prepaid benefit cost on December 31 $109,125 $ 85,633
---------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------
Amounts recognized in the Consolidated Statements of
Condition consist of the following:
Prepaid benefit cost $109,125 $ 85,633
Accrued benefit liability* (5,017) (3,320)
Intangible asset 1,035 1,124
Accumulated other comprehensive income 3,982 2,196
---------------------------------------------------------------------------------------------------
Net amount recognized $109,125 $ 85,633
---------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------
Postretirement Benefits
-----------------------------------------------------
(Dollars in thousands) 2003 2002
----------------------------------------------------- -----------------------------------------------------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of plan year $ 26,947 $27,977
Service cost 732 949
Interest cost 1,750 1,941
Amendments - -
Actuarial (gain)/loss 4,276 (1,982)
Benefits paid (1,836) (1,938)
------------------------------------------------------------------------------------------------------------
Benefit obligation at end of plan year $ 31,869 $26,947
------------------------------------------------------------------------------------------------------------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of plan year $ 17,371 $19,683
Actual return on plan assets 4,273 (1,256)
Employer contribution 995 882
Benefits paid (1,836) (1,938)
------------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of plan year $ 20,803 $17,371
------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
NET FUNDED STATUS ON SEPTEMBER 30 $(11,066) $(9,576)
Unrecognized net actuarial loss 2,447 1,068
Unrecognized net transitional (asset)/obligation 8,895 9,884
Unrecognized prior service cost/(benefit) (1,772) (1,948)
------------------------------------------------------------------------------------------------------------
Prepaid benefit cost on September 30 (1,496) (572)
Contributions paid from October 1 to December 31 - 995
------------------------------------------------------------------------------------------------------------
Prepaid benefit cost on December 31 $ (1,496) $ 423
------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
Amounts recognized in the Consolidated Statements of
Condition consist of the following:
Prepaid benefit cost
Accrued benefit liability*
Intangible asset
Accumulated other comprehensive income
------------------------------------------------------------------------------------------------------------
Net amount recognized
------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
* Prior to 2002, the annual expense for the pension restoration plan (which
previously covered only four people) was determined using a simplified
approach rather than the provisions of SFAS No. 87. The difference was not
material. In 2002, the plan was expanded to cover additional participants, and
the expense was determined under SFAS No. 87. The difference between the
accumulated reserve using the prior approach and the reserve that would have
been accumulated under SFAS No. 87 had it always been followed was included as
part of the unrecognized loss in 2002.
Previously reported amounts have been restated to agree with current
presentation.
The accumulated benefit obligation for the pension plan was $266.1 million and
$223.4 million on September 30, 2003 and 2002, respectively. FTNC expects to
contribute between the estimated minimum contribution of zero and the estimated
maximum contribution of $35 million to the pension plan and $6.0 million to the
other employee benefit plan in 2004.
First Tennessee National Corporation F-93
NOTE 20 SAVINGS, PENSION AND OTHER EMPLOYEE BENEFITS (CONTINUED)
The following provides the amount included within other comprehensive income for
the period arising from a change in the additional minimum pension liability:
Pension
Benefits
---------------
(Dollars in thousands) 2003 2002
-----------------------------------------------------------------------------
Increase in minimum pension liability included in other
comprehensive income $1,786 $2,196
-----------------------------------------------------------------------------
The following table sets forth FTNC's pension plan asset allocation on September
30, 2003 and 2002:
Percentage of
Plan Assets
on September 30
----------------------------------------
Targeted Range 2003 2002
----------------------------------------------------------------------------------------------------------------------------------
Equity securities 70% 57.4% 53.3%
Large capital equity 40% 45.7% 43.4%
Small capital equity 20% 11.7 9.9
International equity 10% - -
Other 30% 42.6 46.7
Fixed income 41.7 46.2
Money market .9 .5
----------------------------------------------------------------------------------------------------------------------------------
Total 100.0% 100.0%
----------------------------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------------------------
The primary investment objective is to ensure, over the long-term life of the
pension plan, an adequate pool of sufficiently liquid assets to support the
benefit obligations to participants, retirees and beneficiaries. In meeting this
objective, the pension plan seeks to achieve a high level of investment return
consistent with a prudent level of portfolio risk. Investment objectives are
long-term in nature covering typical market cycles of three to five years. Any
shortfall of investment performance compared to investment objectives should be
explainable in terms of general economic and capital market conditions. In
addition the investment objective will be implemented through traditional
long-term stock and bond strategies.
During 2003 FTNC reviewed its pension portfolio investment strategy and decided
to increase its equity exposure to 70 percent of total plan assets in 2004. The
expected return on plan assets assumption for 2004 will be maintained at 8.75
percent.
Risk Management Practices: The asset allocation policy and the associated risk
budget has been developed based on an evaluation of the organizations' ability
and willingness to assume investment risk in light of the Retirement Investment
Committee's financial and benefits-related goals and objectives.
Frequency of Rebalancing: The Retirement Investment Committee will rebalance the
portfolio assets as necessary to maintain liquidity for benefit payments and or
stay within the established target asset allocation ranges. At a minimum
rebalancing will take place on an annual basis.
F-94 First Tennessee National Corporation
NOTE 20 SAVINGS, PENSION AND OTHER EMPLOYEE BENEFITS (CONTINUED)
The following table sets forth FTNC's other benefit plan asset allocation on
September 30, 2003 and 2002:
Percentage of
Plan Assets
on September 30
----------------------------------------
2003 2002
-----------------------------------------------------------------------------------------------------------
Equity securities 54.0% 45.6%
Large capital equity 43.3% 37.3%
Small capital equity 10.7 8.3
Other 46.0 54.4%
Fixed income 44.7 50.8
Money market 1.3 3.6
-----------------------------------------------------------------------------------------------------------
Total 100.0% 100.0%
-----------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------
The primary investment objective is to ensure, over the long-term life of the
retiree medical obligation, an adequate pool of sufficiently liquid assets to
partially support the obligations to retirees and beneficiaries. The allocation
utilizing a tactical blend of individual securities and registered funds across
the broad asset classes is designed to capture the ideal balance of risk and
return based on historical averages and parameters of Trust policy. In meeting
this objective, the retiree medical plan seeks to achieve a high level of
investment return consistent with a prudent level of portfolio risk. Investment
objectives are long-term in nature (longer than 10 years). It is not
contemplated at this time that any derivative instruments will be used to
achieve investment objectives.
Tactical allocation within the broad strategic objective of 55/45 equity to
fixed blend is contemplated periodically with an attention to the likelihood of
improving the return potential coupled with a reduction of the risk level.
The following table sets forth the amounts and types of mutual funds managed by
FTBNA that are included in plan assets.
Pension Benefits Postretirement Benefits
------------------------------- ----------------------------------------
(Dollars in thousands) 2003 2002 2003 2002
------------------------------------------------------------------------------------------------------------------------
First Funds Capital
Appreciation Portfolio Class I $ 33,795 $ 24,363 $2,220 $1,435
First Funds Core Equity
Portfolio Class I 103,504 83,913 6,463 4,864
First Funds Bond Portfolio
Class I 119,615 113,468 6,833 6,121
------------------------------------------------------------------------------------------------------------------------
FTNC provides benefits to former and inactive employees after employment but
before retirement. The obligation recognized was $3.6 million in 2003, $1.4
million in 2002 and $2.4 million in 2001.
Medical and group life insurance expenses incurred for active employees are
shown in the following table:
(Dollars in thousands) 2003 2002 2001
------------------------------------------------------------------------------------------------------------------------
Medical plan expense based on claims incurred $23,919 $26,157 $18,759
Participants 8,576 7,273 6,668
------------------------------------------------------------------------------------------------------------------------
Group life insurance expense based on benefits incurred $ 2,171 $ 1,649 $ 1,210
Participants 11,653 10,679 9,872
------------------------------------------------------------------------------------------------------------------------
First Tennessee National Corporation F-95
NOTE 21 STOCK OPTION, RESTRICTED STOCK INCENTIVE, AND DIVIDEND REINVESTMENT
PLANS
STOCK OPTION PLANS. FTNC issues non-qualified stock options under various plans
to employees, non-employee directors, and bank advisory board members. The plans
provide for the issuance of FTNC common stock at a price equal to its fair
market value at the date of grant; however, the exercise price may be less than
the fair market value if the grantee has agreed to receive the options in lieu
of compensation. The foregone compensation plus the exercise price equals the
fair market value of the stock on the date of grant. All options expire 7 years
or 10 years from the date of grant, except for those options that were part of
compensation deferral, which expire 20 years from the date of grant. There were
5,416,541 shares available for option plan grants on December 31, 2003.
As a result of plan amendments adopted by the board of directors during 1997,
employees may defer the receipt of shares upon the exercise of stock options.
The summary of stock option activity is shown below:
The following table summarizes information about stock options outstanding on
December 31, 2003:
Weighted
Options Average
Outstanding Exercise Price
---------------------------------------------------------------------------------------------------
January 1, 2001 21,255,816 $22.58
Options granted 5,334,043 28.83
Options exercised* (4,953,435) 18.10
Options canceled (525,334) 30.96
-----------
December 31, 2001 21,111,090 25.00
-----------
-----------
Options exercisable 15,620,729 22.45
---------------------------------------------------------------------------------------------------
January 1, 2002 21,111,090 $25.00
Options granted 4,908,512 33.12
Options exercised* (3,218,704) 20.55
Options canceled (502,155) 32.36
-----------
December 31, 2002 22,298,743 27.26
-----------
-----------
Options exercisable 15,916,332 24.96
---------------------------------------------------------------------------------------------------
January 1, 2003 22,298,743 $27.26
Options granted 3,931,673 36.80
Options exercised* (4,688,153) 24.49
Options canceled (419,602) 34.56
-----------
DECEMBER 31, 2003 21,122,661 29.51
-----------
-----------
Options exercisable 15,290,028 27.08
---------------------------------------------------------------------------------------------------
* Stock options exercised for 2003, 2002 and 2001 respectively, included
178,747, 332,305 and 414,802 options converted to stock equivalents as part of
the deferred compensation program.
Weighted Weighted
Weighted Average Average
Average Exercise Exercise
Remaining Price - Price -
Options Contractual Options Options Options
Exercise Price Range Outstanding Life Outstanding Exercisable Outstanding
--------------------------------------------------------------------------------------------------------------------
$ 4.00 - $20.00 4,145,113 10.04 $15.75 4,137,613 $15.74
$20.01 - $30.00 4,870,793 13.00 25.29 4,426,895 25.47
$30.01 - $40.00 10,229,132 8.01 34.82 5,326,909 33.17
$40.01 - $50.00 1,877,623 8.18 41.93 1,398,611 42.49
--------------------------------------------------------------------------------------------------------------------
F-96 First Tennessee National Corporation
NOTE 21 STOCK OPTION, RESTRICTED STOCK INCENTIVE, AND DIVIDEND REINVESTMENT
PLANS (CONTINUED)
FTNC accounts for these plans under APB Opinion No. 25 pursuant to which
recognized compensation costs are negligible. Total additional compensation cost
that would have been recognized in income under SFAS No. 123 for all stock-based
compensation awards was $32.9 million for 2003, $23.8 million for 2002 and $18.7
million for 2001. See Note 1 - Summary of Significant Accounting Policies for
pro forma information.
FTNC used the Black-Scholes Option Pricing Model to estimate the fair value of
stock options granted in 2003, 2002 and 2001, with the following assumptions:
2003 2002 2001
------------------------------------------------------------------------------------------------------
Expected dividend yield 3.00% 2.81% 2.74%
Expected option lives of options issued at market 5.42 YEARS 4.44 years 6.19 years
Expected option lives of options issued below market* 4.68 YEARS 4.54 years 2.19 years
Expected volatility 30.63% 30.30% 24.56%
Risk-free interest rates 4.24% 4.10% 4.75%
------------------------------------------------------------------------------------------------------
* Options are issued with an exercise price less than the fair market value on
the date of grant if the grantee has agreed to receive the options in lieu of
compensation. The foregone compensation plus the exercise price equals the
fair market value on the date of grant.
Weighted
Average Fair
Number Value per Option
Issued at Grant Date
2003:
------------------------------------------------------------------------------------------------------
Options issued at market on the date of grant 3,258,924 $ 8.52
Options issued below market on the date of grant* 672,749 20.19
------------------------------------------------------------------------------------------------------
2002:
Options issued at market on the date of grant 3,703,159 $ 8.28
Options issued below market on the date of grant* 1,205,353 13.47
------------------------------------------------------------------------------------------------------
2001:
Options issued at market on the date of grant 3,246,384 $ 8.18
Options issued below market on the date of grant* 2,087,659 8.58
------------------------------------------------------------------------------------------------------
* Options are issued with an exercise price less than the fair market value on
the date of grant if the grantee has agreed to receive the options in lieu of
compensation. The foregone compensation plus the exercise price equals the
fair market value on the date of grant.
RESTRICTED STOCK INCENTIVE PLANS. FTNC has authorized the issuance of its common
stock for awards to executive employees who have a significant impact on the
profitability of FTNC under restricted stock incentive plans. Additionally, one
of the plans provides for 6,000 shares of restricted stock to be granted to each
new non-employee director upon election to the board of directors with
restrictions lapsing as defined in the plans. In 2003, FTNC granted 200,444
restricted shares under the plans. In 2002, 175,559 restricted shares were
granted and 9,796 shares were granted in 2001. Compensation expense related to
these plans was $5.1 million, $2.5 million and $2.2 million for the years 2003,
2002 and 2001, respectively.
The board of directors approved amendments to the restricted stock plan during
1998 permitting deferral by participants of the receipt of restricted stock
prior to the lapse of restrictions.
DIVIDEND REINVESTMENT PLAN. The Dividend Reinvestment and Stock Purchase Plan
(the Plan), as amended in October 2002, authorizes the sale of FTNC's common
stock from shares acquired on the open market to shareholders who choose to
invest all or a portion of their cash dividends and make optional cash payments
of $25 to $10,000 per quarter without paying commissions. Prior to the 2002
amendment, the Plan authorized the sale of FTNC's common stock from authorized,
but unissued common stock or from shares acquired on the open market. In 2002,
shares for this plan were purchased on the open market. The price of shares
purchased on the open market is the average price paid.
First Tennessee National Corporation F-97
NOTE 22 BUSINESS SEGMENT INFORMATION
FTNC provides traditional retail/commercial banking and other financial services
to its customers through various regional and national business lines, including
First Tennessee Banking Group (previously referred to as FTN Banking Group),
First Horizon, FTN Financial, Transaction Processing, Corporate, and Strategic
Initiative Items. First Tennessee Banking Group includes the Retail/Commercial
Bank, Investments, Insurance, Financial Planning, Trust Services and Asset
Management, Credit Card and Cash Management. This segment offers traditional
banking financial services and products, commercial insurance and also promotes
comprehensive financial planning to address customer needs and desires for
investments, insurance, estate planning, education funding, cash reserves and
retirement goals. First Horizon includes First Horizon Home Loans, First Horizon
Equity Lending and First Horizon Money Centers. During third quarter 2002, FTNC
sold the loan portfolio and closed the offices of First Horizon Money Centers as
part of an ongoing plan to improve long-term growth by enhancing overall
business mix. FTN Financial includes Capital Markets, Equity Research,
Investment Banking, Strategic Alliances, and Correspondent Services. Transaction
Processing includes credit card merchant processing, nationwide bill payment
processing, check clearing operations and other products and services. The
Corporate segment includes unallocated corporate expenses and expense on trust
preferred and REIT preferred stock. A portion of FTNC's funds transfer credit
associated with allocated capital is also included in the Corporate segment's
net interest income. The Strategic Initiative Items segment isolates items
occurring in 2001 that were related to a strategic initiative to enhance growth
and business mix, as announced by FTNC in 2000.
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 years ended December 31:
(Dollars in thousands) 2003 2002 2001
-------------------------------------------------------------------------------------------------------------
CONSOLIDATED
Net interest income, FTE* $ 807,042 $ 757,117 $ 691,044
Provision 86,698 92,184 93,220
Noninterest income 1,640,014 1,311,935 1,095,021
Noninterest expense 1,640,102 1,417,306 1,202,152
-------------------------------------------------------------------------------------------------------------
Pre-tax income, FTE* 720,256 559,562 490,693
Income taxes, FTE* 246,947 183,111 164,316
-------------------------------------------------------------------------------------------------------------
Income before cumulative effect of
changes in accounting principles 473,309 376,451 326,377
Cumulative effect of changes in
accounting principles - - (8,168)
-------------------------------------------------------------------------------------------------------------
Net income $ 473,309 $ 376,451 $ 318,209
-------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
Average assets $25,133,612 $20,704,008 $19,227,213
-------------------------------------------------------------------------------------------------------------
Depreciation, amortization and MSR impairment $ 423,431 $ 353,672 $ 306,966
Expenditures for long-lived assets 149,600 56,794 27,694
*Fully taxable-equivalent adjustment 1,258 1,503 2,130
-------------------------------------------------------------------------------------------------------------
* Fully taxable-equivalent basis.
Certain previously reported amounts have been reclassified to agree with current
presentation.
F-98 First Tennessee National Corporation
NOTE 22 BUSINESS SEGMENT INFORMATION (CONTINUED)
(Dollars in thousands) 2003 2002 2001
-------------------------------------------------------------------------------------------------------------
FIRST HORIZON
Net interest income, FTE* $ 335,369 $ 244,647 $ 183,509
Provision 33,371 27,296 39,628
Noninterest income 639,344 460,686 306,789
Noninterest expense 512,604 406,177 348,403
-------------------------------------------------------------------------------------------------------------
Pre-tax income, FTE* 428,738 271,860 102,267
Income taxes, FTE* 159,542 103,300 37,637
-------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
Net income $ 269,196 $ 168,560 $ 64,630
-------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
Average assets $10,607,011 $ 7,612,700 $ 6,376,795
-------------------------------------------------------------------------------------------------------------
Depreciation, amortization and MSR impairment $ 346,578 $ 305,870 $ 259,444
Expenditures for long-lived assets 79,418 22,192 6,412
-------------------------------------------------------------------------------------------------------------
FIRST TENNESSEE BANKING GROUP
Net interest income, FTE* $ 411,242 $ 453,615 $ 457,410
Provision 52,336 64,150 51,197
Noninterest income 333,202 295,024 267,507
Noninterest expense 517,341 473,945 423,267
-------------------------------------------------------------------------------------------------------------
Pre-tax income, FTE* 174,767 210,544 250,453
Income taxes, FTE* 43,184 50,490 74,467
-------------------------------------------------------------------------------------------------------------
Net income $ 131,583 $ 160,054 $ 175,986
-------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
Average assets $11,022,694 $10,403,162 $10,614,123
-------------------------------------------------------------------------------------------------------------
Depreciation and amortization $ 63,246 $ 36,747 $ 37,838
Expenditures for long-lived assets 58,667 24,701 8,518
-------------------------------------------------------------------------------------------------------------
FTN FINANCIAL
Net interest income, FTE* $ 38,735 $ 34,905 $ 31,056
Provision 991 738 2,395
Noninterest income 548,339 455,163 350,348
Noninterest expense 401,618 329,556 247,776
-------------------------------------------------------------------------------------------------------------
Pre-tax income, FTE* 184,465 159,774 131,233
Income taxes, FTE* 70,075 60,714 49,869
-------------------------------------------------------------------------------------------------------------
Net income $ 114,390 $ 99,060 $ 81,364
-------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
Average assets $ 2,717,276 $ 1,950,862 $ 1,620,162
-------------------------------------------------------------------------------------------------------------
Depreciation and amortization $ 3,130 $ 2,726 $ 2,451
Expenditures for long-lived assets 7,380 5,540 3,947
-------------------------------------------------------------------------------------------------------------
TRANSACTION PROCESSING
Net interest income, FTE* $ 17,240 $ 19,350 $ 16,564
Noninterest income 117,348 101,062 93,270
Noninterest expense 115,832 107,984 92,897
-------------------------------------------------------------------------------------------------------------
Pre-tax income, FTE* 18,756 12,428 16,937
Income taxes, FTE* 7,108 4,723 6,436
-------------------------------------------------------------------------------------------------------------
Net income $ 11,648 $ 7,705 $ 10,501
-------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
Average assets $ 661,607 $ 661,973 $ 576,761
-------------------------------------------------------------------------------------------------------------
Depreciation and amortization $ 7,045 $ 7,683 $ 6,564
Expenditures for long-lived assets 3,251 4,235 8,727
-------------------------------------------------------------------------------------------------------------
* Fully taxable-equivalent basis.
Certain previously reported amounts have been reclassified to agree with current
presentation.
First Tennessee National Corporation F-99
NOTE 22 BUSINESS SEGMENT INFORMATION (CONTINUED)
(Dollars in thousands) 2003 2002 2001
-------------------------------------------------------------------------------------------------------------
CORPORATE
Net interest income, FTE* $ 4,456 $ 4,600 $ 2,505
Noninterest income 1,781 - -
Noninterest expense 92,707 99,644 46,426
-------------------------------------------------------------------------------------------------------------
Pre-tax income, FTE* (86,470) (95,044) (43,921)
Income taxes, FTE* (32,962) (36,116) (16,631)
-------------------------------------------------------------------------------------------------------------
Net income $(53,508) $(58,928) $(27,290)
-------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
Average assets $125,024 $ 75,311 $ 39,372
-------------------------------------------------------------------------------------------------------------
Depreciation and amortization $ 3,432 $ 646 $ 669
Expenditures for long-lived assets 884 126 90
-------------------------------------------------------------------------------------------------------------
STRATEGIC INITIATIVE ITEMS
Noninterest income $ - $ - $ 77,107
Noninterest expense - - 43,383
-------------------------------------------------------------------------------------------------------------
Pre-tax income, FTE* - - 33,724
Income taxes, FTE* - - 12,538
-------------------------------------------------------------------------------------------------------------
Income before cumulative effect of
changes in accounting principles - - 21,186
Cumulative effect of changes in
accounting principles - - (8,168)
-------------------------------------------------------------------------------------------------------------
Net income $ - $ - $ 13,018
-------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------
* Fully taxable-equivalent basis.
Certain previously reported amounts have been reclassified to agree with current
presentation.
F-100 First Tennessee National Corporation
NOTE 23 FAIR VALUE OF FINANCIAL INSTRUMENTS
Accounting standards require the disclosure of estimated fair values of all
asset, liability and off-balance sheet financial instruments. The following fair
value estimates are determined as of a specific point in time utilizing various
assumptions and estimates. The use of assumptions and various valuation
techniques, as well as the absence of secondary markets for certain financial
instruments, will likely reduce the comparability of fair value disclosures
between financial institutions. In some cases, book value is a reasonable
estimate of fair value due to the relatively short period of time between
origination of the instrument and its expected realization. The following table
summarizes the book value and estimated fair value of financial instruments
recorded in the Consolidated Statements of Condition as well as off-balance
sheet commitments as of December 31, 2003 and 2002:
ON DECEMBER 31, 2003 On December 31, 2002
-----------------------------------------------------------------
Book Fair Book Fair
(Dollars in thousands) Value Value Value Value
---------------------------------------------------------------------------------------------------------------------
ASSETS:
Loans, net of unearned income:
Floating $ 9,188,478 $ 9,194,178 $ 6,985,972 $ 6,989,020
Fixed 4,759,017 4,815,890 4,301,019 4,406,834
Nonaccrual 43,030 43,030 58,454 58,454
Allowance for loan losses (160,333) (160,333) (144,298) (144,298)
---------------------------------------------------------------------------------------------------------------------
Total net loans 13,830,192 13,892,765 11,201,147 11,310,010
Liquid assets 1,182,488 1,182,488 1,156,510 1,156,510
Loans held for sale 2,977,723 2,984,219 4,797,565 4,821,456
Securities available for sale 2,469,342 2,469,342 2,419,908 2,419,908
Securities held to maturity 1,028 1,077 280,377 284,510
Derivative assets 301,196 301,196 478,734 478,734
Nonearning assets 1,443,915 1,443,915 1,404,290 1,404,290
---------------------------------------------------------------------------------------------------------------------
LIABILITIES:
Deposits:
Defined maturity $ 7,117,213 $ 7,143,619 $ 6,723,245 $ 6,780,283
Undefined maturity 8,562,758 8,562,758 8,990,658 8,990,658
---------------------------------------------------------------------------------------------------------------------
Total deposits 15,679,971 15,706,377 15,713,903 15,770,941
Short-term borrowings 3,307,224 3,307,224 3,487,558 3,487,558
Term borrowings 1,726,766 1,748,412 929,715 962,516
Derivative liabilities 38,890 38,890 158,354 158,354
Other noninterest-bearing liabilities 746,947 746,947 462,706 462,706
Guaranteed preferred beneficial interests in
First Tennessee's junior subordinated
debentures (Note 11) - - 100,000 106,637
Preferred stock of subsidiary (Note 12) 452 512 44,392 48,499
---------------------------------------------------------------------------------------------------------------------
Contractual Fair Contractual Fair
Amount Value Amount Value
---------------------------------------------------------------------------------------------------------------------
OFF-BALANCE SHEET COMMITMENTS:
Loan commitments $10,081,353 $ 9,018 $ 7,321,314 $ 7,426
Other commitments 570,504 6,309 740,584 7,143
---------------------------------------------------------------------------------------------------------------------
First Tennessee National Corporation F-101
NOTE 23 FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The following describes the assumptions and methodologies used to estimate the
fair value for financial instruments:
FLOATING RATE LOANS. With the exception of floating rate 1-4 family residential
mortgage loans, the fair value is approximated by the book value. Floating rate
1-4 family residential mortgage loans reprice annually and will lag movements in
market rates; whereas, commercial and consumer loans typically reprice monthly.
The fair value for floating rate 1-4 family mortgage loans is calculated by
discounting future cash flows to their present value. Future cash flows are
discounted to their present value by using the current rates at which similar
loans would be made to borrowers with similar credit ratings and for the same
time period. Prepayment assumptions based on historical prepayment speeds have
been applied to the floating rate 1-4 family residential mortgage portfolio.
FIXED RATE LOANS. The fair value is estimated by discounting future cash flows
to their present value. Future cash flows are discounted to their present value
by using the current rates at which similar loans would be made to borrowers
with similar credit ratings and for the same time period. Prepayment assumptions
based on historical prepayment speeds have been applied to the fixed rate
mortgage and installment loan portfolios.
NONACCRUAL LOANS. The fair value is approximated by the book value.
ALLOWANCE FOR LOAN LOSSES. The fair value is approximated by the book value.
Additionally, the credit exposure known to exist in the loan portfolio is
embodied in the allowance for loan losses.
LIQUID ASSETS. The fair value is approximated by the book value. For the purpose
of this disclosure, liquid assets consist of federal funds sold, securities
purchased under agreements to resell, capital markets securities inventory,
mortgage banking trading securities, and investment in bank time deposits.
LOANS HELD FOR SALE. Fair values are based primarily on quoted market prices.
SECURITIES AVAILABLE FOR SALE. Fair values are based primarily on quoted market
prices.
SECURITIES HELD TO MATURITY. Fair values for marketable securities are based
primarily on quoted market prices. Fair values for securitized loans are based
upon cash flows discounted at a market yield. Market yields are computed by
adding Treasury yields at year-end plus an appropriate spread estimated by
observing quotes on similarly structured marketable securities and changes in
swap spreads.
DERIVATIVE ASSETS. Fair values are based primarily on quoted market prices.
NONEARNING ASSETS. The fair value is approximated by the book value. For the
purpose of this disclosure, nonearning assets include cash and due from banks,
accrued interest receivable and capital markets receivables.
DEFINED MATURITY DEPOSITS. The fair value is estimated by discounting future
cash flows to their present value. Future cash flows are discounted by using the
current market rates of similar instruments applicable to the remaining
maturity. For the purpose of this disclosure, defined maturity deposits include
all certificates of deposit and other time deposits.
UNDEFINED MATURITY DEPOSITS. The fair value is approximated by the book value.
For the purpose of this disclosure, undefined maturity deposits include demand
deposits, checking interest accounts, savings accounts, and money market
accounts.
SHORT-TERM BORROWINGS. The fair value of federal funds purchased, securities
sold under agreements to repurchase, commercial paper, bank notes and other
short-term borrowings is approximated by the book
F-102 First Tennessee National Corporation
NOTE 23 FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
value. The fair value for Federal Home Loan Bank borrowings is determined using
discounted future cash flows.
TERM BORROWINGS. The fair value is approximated by the present value of the
contractual cash flows discounted by the investor's yield which considers FTNC's
and FTBNA's debt ratings.
DERIVATIVE LIABILITIES. Fair values are based primarily on quoted market prices.
OTHER NONINTEREST-BEARING LIABILITIES. For the purpose of this disclosure, other
noninterest-bearing liabilities include accrued interest payable and capital
markets payables. The fair value is approximated by the book value.
GUARANTEED PREFERRED BENEFICIAL INTERESTS. The fair value is approximated by the
present value of the contractual cash flows discounted by the investor's yield
which considers FTNC's debt rating.
PREFERRED STOCK OF SUBSIDIARY. The fair value is approximated by the current
trade amount of similar instruments.
LOAN COMMITMENTS. Fair values are based on fees charged to enter into similar
agreements taking into account the remaining terms of the agreements and the
counterparties' credit standing.
OTHER COMMITMENTS. Fair values are based on fees charged to enter into similar
agreements.
First Tennessee National Corporation F-103
NOTE 24 SECURITIZATIONS
During 2003 and 2002, First Horizon Home Loans securitized $49.6 billion and
$30.9 billion, respectively, of single-family residential mortgage loans in
primarily proprietary and agency securitization transactions, and the resulting
securities were sold as senior and subordinate certificates. In 2003 and 2002,
First Horizon Home Loans recognized net pretax gains of $566.9 million and
$367.6 million, respectively, from the sale of securitized loans which includes
gains recognized on the capitalization of MSRs associated with these loans. In
certain cases, First Horizon Home Loans continues to service and receive
servicing fees related to the securitized mortgage loans, and has also retained
interest-only strips or senior certificates structured as principal-only strips.
First Horizon Home Loans received annual servicing fees approximating .32
percent in 2003 and .35 percent in 2002 of the outstanding balance of the
underlying loans. In 2003 and 2002, First Horizon Home Loans capitalized
approximately $536.7 million and $401.9 million, respectively, in MSRs through
these securitizations. These MSRs, as well as other MSRs held by First Horizon
Home Loans, are discussed further in Note 6 - Mortgage Servicing Rights. The
investors and the securitization trusts have no recourse to assets of First
Horizon Home Loans or FTNC for failure of debtors to pay when due.
The sensitivity of the current fair value of retained interests to immediate 10
percent and 20 percent adverse changes in assumptions on December 31, 2003, are
as follows:
(Dollars in thousands, except for annual cost to service) MSRs IOs POs
-----------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2003
Fair value of retained interests $ 838,541 $193,121 $4,384
Weighted average life (in years) 5.6 5.8 6.5
Annual prepayment rate 14.0% 14.0% 15.0%
Impact on fair value of 10% adverse change $ (55,627) $ (8,952) $ (103)
Impact on fair value of 20% adverse change (102,234) (17,351) (218)
Annual discount rate on residual cash flows 10.3% 10.3% 5.7%
Impact on fair value of 10% adverse change $ (30,947) $ (8,620) $ (124)
Impact on fair value of 20% adverse change (59,296) (15,905) (242)
Annual cost to service $45 per loan N/A N/A
Impact on fair value of 10% adverse change $ (8,822) N/A N/A
Impact on fair value of 20% adverse change (17,644) N/A N/A
Annual earnings on escrow 3.2% N/A N/A
Impact on fair value of 10% adverse change $ (13,584) N/A N/A
Impact on fair value of 20% adverse change (27,593) N/A N/A
-----------------------------------------------------------------------------------------------------------------
These sensitivities are hypothetical and should not be considered to be
predictive of future performance. As the figures indicate, changes in fair value
based on a 10 percent variation in assumptions generally cannot necessarily be
extrapolated because the relationship of the change in assumption to the change
in fair value may not be linear. Also, in this table, the effect of a variation
in a particular assumption on the fair value of the retained interest is
calculated independently from any change in another assumption. In reality,
changes in one factor may result in changes in another, which might magnify or
counteract the sensitivities. Furthermore, the estimated fair values as
disclosed should not be considered indicative of future earnings on these
assets.
F-104 First Tennessee National Corporation
NOTE 24 SECURITIZATIONS (CONTINUED)
First Horizon Home Loans uses assumptions and estimates in determining the fair
value allocated to retained interests at the time of initial securitization. The
key economic assumptions used to measure the fair value of the MSRs,
interest-only strips (IOs) and principal-only strips (POs) at the date of
securitization were as follows:
MSRs IOs POs
-----------------------------------------------------------------------------------------------------------------
2003
Weighted average life (in years) 2.6-5.9 3.5-6.8 6.4-6.5
Annual prepayment rate 12.4%-29.8% 12.4%-29.8% 15.0%
Annual discount rate 10.3%-10.5% 10.3%-10.5% 5.5%-6.9%
Annual cost to service $44-$45 per loan N/A N/A
Annual earnings on escrow 2.3%-3.6% N/A N/A
-----------------------------------------------------------------------------------------------------------------
2002
Weighted average life (in years) 3.5-6.8 3.5-6.8 5.7-10.1
Annual prepayment rate 12.5%-29.6% 12.5%-29.6% 7.5%
Annual discount rate 10.2%-10.5% 10.2%-10.5% 4.8%-6.4%
Annual cost to service $44-$46 per loan N/A N/A
Annual earnings on escrow 2.8%-5.1% N/A N/A
-----------------------------------------------------------------------------------------------------------------
The expected static pool credit losses as of December 31, 2003, were
approximately .06 percent of the original principal balance of loans securitized
during 2003. Static pool losses are calculated by summing the actual and
projected future credit losses and dividing them by the original balance of the
securitized loans. The percentages above represent weighted average credit
losses for all securitizations during the year.
FTN Financial Capital Assets Corporation (FTNFCAC), an indirect wholly-owned
subsidiary of FTNC, enters into transactions where mortgage loans are purchased,
pooled, securitized and sold. During 2003 and 2002, $528.0 million and $340.6
million of mortgage loans were sold for pre-tax gains of $5.3 million and $3.7
million, respectively, that were recognized in capital markets noninterest
income. FTNFCAC does not retain servicing rights or any other form of residual
on these securitizations.
FTNC has also securitized certain real estate loans through a real estate
mortgage investment conduit (REMIC) in prior years and retained all of the
securitized assets. Fair value for these securities was based upon cash flows
discounted at a market yield. Market yields were computed by adding Treasury
yields at year-end plus an appropriate spread estimated by observing quotes on
similarly structured marketable securities and changes in swap spreads. The
retained assets were classified on the Consolidated Statements of Condition in
'Securities held to maturity' in 2002. During 2003, FTNC elected to purchase all
of the mortgage loans remaining in the REMIC ($136.3 million). Subsequent to the
repurchase of the mortgage loans, these assets are classified as retail real
estate residential loans.
For the years ended December 31, 2003, 2002 and 2001, cash flows received and
paid related to securitizations were as follows:
(Dollars in thousands) 2003 2002 2001
------------------------------------------------------------------------------------------------------------------
Proceeds from initial securitizations $ 48,199,855 $ 30,338,111 $ 21,044,776
Servicing fees received 186,728 168,028 157,076
Purchases of delinquent or foreclosed assets 181,512 67,186 27,595
Other cash flows received on retained interests* 33,581 153,734 119,523
------------------------------------------------------------------------------------------------------------------
* Other cash flows include all cash flows from IOs, POs and REMIC securities.
First Tennessee National Corporation F-105
NOTE 24 SECURITIZATIONS (CONTINUED)
As of December 31, 2003, the principal amount of loans securitized and other
loans managed with them, and the principal amount of delinquent loans, in
addition to net credit losses during 2003 are as follows:
Total Principal Principal Amount Net Credit
(Dollars in thousands) Amount of Loans of Delinquent Loans* Losses
------------------------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED
ON DECEMBER 31, 2003 DECEMBER 31, 2003
----------------------------------------------- ---------------------
Type of loan:
Real estate residential $ 62,404,732 $96,971 $45,808
------------------------------------------------------- --------------------- ---------------------
Total loans managed or securitized** 62,404,732 $96,971 $45,808
--------------------- ---------------------
--------------------- ---------------------
Loans securitized and sold (52,737,140)
Loans held for sale or securitization (2,850,470)
-------------------------------------------------------
Loans held in portfolio $ 6,817,122
-------------------------------------------------------
-------------------------------------------------------
* Includes nonaccrual loans and loans 90 days or more past due.
** Securitized loans are real estate residential loans in which
FTNC has a retained interest other than servicing rights.
F-106 First Tennessee National Corporation
NOTE 25 VARIABLE INTEREST ENTITIES
Effective December 31, 2003, FTNC adopted FASB Interpretation No. 46,
'Consolidation of Variable Interest Entities', which requires consolidation by a
business enterprise of variable interest entities (VIEs) in which it is the
primary beneficiary. Upon adoption of this standard, FTNC deconsolidated its
subsidiary, First Tennessee Capital I (Capital I), which has issued $100.0
million of capital securities that are fully and unconditionally guaranteed by
FTNC. As a result of this deconsolidation the capital securities are no longer
included on FTNC's balance sheet. However, $103.0 million of junior subordinated
debentures issued by FTNC to Capital I are no longer eliminated in consolidation
and appear in term borrowings as of December 31, 2003. FTNC identified certain
of its nonconsolidated interests as VIEs but did not meet the criteria of
primary beneficiary and, therefore, has not consolidated any of its VIEs.
Since 1997, First Tennessee Housing Corporation (FTHC), a wholly-owned
subsidiary, makes equity investments as a limited partner, in various
partnerships that sponsor affordable housing projects utilizing the Low Income
Housing Tax Credit (LIHTC) pursuant to Section 42 of the Internal Revenue Code.
The purpose of these investments is to achieve a satisfactory return on capital
and to support FTNC's community reinvestment initiatives. The activities of the
limited partnerships include the identification, development, and operation of
multi-family housing that is leased to qualifying residential tenants generally
within FTNC's primary geographic region. On December 31, 2003, FTHC's maximum
exposure to loss resulting from those LIHTC investments was $118.9 million. This
represents the investment value of $108.7 million included in 'Capital markets
receivables and other assets' on the Consolidated Statements of Condition and
unfunded commitments of $10.2 million.
First Tennessee National Corporation F-107
NOTE 26 PARENT COMPANY FINANCIAL INFORMATION
Following are condensed statements of the parent company:
STATEMENTS OF CONDITION December 31
----------------------------------------------------------------------------------------
(Dollars in thousands) 2003 2002
----------------------------------------------------------------------------------------
ASSETS:
Securities purchased from subsidiary bank under agreements
to resell $ 34,239 $ 26,741
Investment in bank time deposits 153,967 97,967
Securities available for sale 50,485 49,968
Investments in subsidiaries at equity:
Bank 1,953,985 1,763,389
Non-bank 35,136 39,274
Other assets 168,819 51,594
----------------------------------------------------------------------------------------
TOTAL ASSETS $2,396,631 $2,028,933
----------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY:
Commercial paper and other short-term borrowings $ 31,793 $ 27,695
Accrued employee benefits and other liabilities 202,148 89,000
Term borrowings 272,372 221,058
----------------------------------------------------------------------------------------
Total liabilities 506,313 337,753
Shareholders' equity 1,890,318 1,691,180
----------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $2,396,631 $2,028,933
----------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------
STATEMENTS OF INCOME Year Ended December 31
----------------------------------------------------------------------------------------------------
(Dollars in thousands) 2003 2002 2001
----------------------------------------------------------------------------------------------------
Dividend income:
Bank $272,987 $159,332 $265,905
Non-bank 8,545 7,708 8,913
----------------------------------------------------------------------------------------------------
Total dividend income 281,532 167,040 274,818
Interest income 3,848 3,491 6,062
Other income 686 228 13,318
----------------------------------------------------------------------------------------------------
Total income 286,066 170,759 294,198
----------------------------------------------------------------------------------------------------
Interest expense:
Short-term debt 314 395 843
Term borrowings 15,352 16,061 16,617
----------------------------------------------------------------------------------------------------
Total interest expense 15,666 16,456 17,460
Compensation, employee benefits and other expense 59,863 25,685 17,739
----------------------------------------------------------------------------------------------------
Total expense 75,529 42,141 35,199
----------------------------------------------------------------------------------------------------
Income before income taxes and equity in undistributed net
income of subsidiaries 210,537 128,618 258,999
Applicable income taxes (34,125) (18,375) (7,616)
----------------------------------------------------------------------------------------------------
Income before equity in undistributed net income of
subsidiaries 244,662 146,993 266,615
Equity in undistributed net income of subsidiaries:
Bank 229,404 228,949 50,746
Non-bank (757) 509 848
----------------------------------------------------------------------------------------------------
NET INCOME $473,309 $376,451 $318,209
----------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------
F-108 First Tennessee National Corporation
NOTE 26 PARENT COMPANY FINANCIAL INFORMATION (CONTINUED)
STATEMENTS OF CASH FLOWS Year Ended December 31
-------------------------------------------------------------------------------------------------------
(Dollars in thousands) 2003 2002 2001
-------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net income $ 473,309 $ 376,451 $ 318,209
Less undistributed net income of subsidiaries 228,647 229,458 51,594
-------------------------------------------------------------------------------------------------------
Income before undistributed net income of subsidiaries 244,662 146,993 266,615
Adjustments to reconcile income to net cash provided by
operating activities:
Deferred income tax benefit (319) (575) (4,129)
Depreciation and amortization 9,182 3,477 2,702
Loss on debt purchase 5,766 - -
(Gain)/loss on sale of securities (284) 49 27
Gain on divestiture - - (13,132)
Net change in interest receivable and other assets (116,934) (309) (832)
Net change in interest payable and other liabilities 108,740 16,949 16,092
-------------------------------------------------------------------------------------------------------
Total adjustments 6,151 19,591 728
-------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 250,813 166,584 267,343
-------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Securities:
Sales and prepayments 356 212 10,145
Purchases (362) (450) (300)
(Increase)/decrease in investment in bank time deposits (56,000) 14,000 (67,642)
Advances to subsidiaries - (35) (20,000)
Principal collected on advances to subsidiaries - - 20,000
Proceeds from sale of a subsidiary 49,833 - 23,271
Return on investment in subsidiary 1,614 10,000 -
Cash investments in subsidiaries (1,930) (1,945) (4,947)
-------------------------------------------------------------------------------------------------------
Net cash (used)/provided by investing activities (6,489) 21,782 (39,473)
-------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Common stock:
Exercise of stock options 77,591 51,015 78,183
Cash dividends (150,863) (125,736) (112,093)
Repurchase of shares (209,263) (111,187) (238,701)
Term borrowings:
Payment (57,739) - (10,000)
Proceeds from the issuance of debt 99,350 - -
Increase/(decrease) in short-term borrowings 4,098 3,422 5,104
-------------------------------------------------------------------------------------------------------
Net cash used by financing activities (236,826) (182,486) (277,507)
-------------------------------------------------------------------------------------------------------
Net increase/(decrease) in cash and cash equivalents 7,498 5,880 (49,637)
-------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of year 26,741 20,861 70,498
-------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 34,239 $ 26,741 $ 20,861
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
Total interest paid $ 15,326 $ 16,210 $ 17,763
Total income taxes paid 133,950 120,740 247,760
-------------------------------------------------------------------------------------------------------
First Tennessee National Corporation F-109
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS
FIRST TENNESSEE NATIONAL CORPORATION:
We have audited the accompanying consolidated statements of condition of
First Tennessee National Corporation as of December 31, 2003 and 2002, and the
related consolidated statements of income, shareholders' equity and cash flows
for the years then ended. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit. The 2001 financial statements of First
Tennessee National Corporation were audited by other auditors who have ceased
operations. Those auditors expressed an unqualified opinion on those financial
statements, before the restatements described in Notes 1 and 22 and the revision
described in Note 7 to the financial statements, in their report dated
January 15, 2002.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the 2003 and 2002 financial statements referred to above
present fairly, in all material respects, the financial position of First
Tennessee National Corporation as of December 31, 2003 and 2002, and the results
of its operations and its cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of America.
As described in Note 1, the Company changed in 2003 the statement of income
presentation of certain amounts related to nonrefundable, direct fees and costs
associated with originating or acquiring mortgage loans held for sale. The
financial statements for 2002 and 2001 have been reclassified to conform to this
presentation. As discussed above, the 2001 financial statements of First
Tennessee National Corporation were audited by other auditors who have ceased
operations. We audited the reclassifications that were applied to conform the
2001 financial statements to this presentation. In our opinion, such
reclassifications are appropriate and have been properly applied.
As described in Note 22, the Company changed the composition of its
reportable segments in 2002, and the amounts in the 2001 financial statements
relating to reportable segments have been restated to conform to the 2002
composition of reportable segments. We audited the adjustments that were applied
to restate the disclosures for reportable segments reflected in the 2001
financial statements. In our opinion, such adjustments are appropriate and have
been properly applied.
As described in Note 1, these financial statements have been restated to
conform to the 2002 presentation of losses from extinguishment of debt required
by Statement of Financial Accounting Standards (SFAS) No. 145 Rescission of FASB
Statements No. 4 and 64, Amendment of FASB No. 13, and Technical Corrections,
which was adopted by the Company on October 1, 2002. We audited the adjustments
described in Note 1 that were applied to restate the 2001 financial statements
related to the adoption of SFAS No. 145. In our opinion, such adjustments are
appropriate and have been properly applied.
As described in Note 7, these financial statements have been revised to
include the transitional disclosures required by SFAS No. 142, Goodwill and
Other Intangible Assets, which was adopted by the Company as of January 1, 2002.
In our opinion, the disclosures for 2001 in Note 7 related to the adoption of
SFAS No. 142 are appropriate.
We were not engaged to audit, review, or apply any procedures to the 2001
financial statements of First Tennessee National Corporation other than with
respect to the adjustments and disclosures referred to above and, accordingly,
we do not express an opinion or any other form of assurance on the 2001
financial statements taken as a whole.
KPMG LLP
Memphis, Tennessee
February 23, 2004
F-110 First Tennessee National Corporation
CONSOLIDATED HISTORICAL STATEMENTS OF INCOME (UNAUDITED)
------------------------------------------------------------------------------------------------------------
(Dollars in millions except per share data) 2003 2002 2001 2000 1999 1998
------------------------------------------------------------------------------------------------------------
INTEREST INCOME:
Interest and fees on loans $ 657.6 $ 666.0 $ 811.7 $ 915.0 $ 753.7 $ 727.5
Investment securities 111.2 143.0 168.2 198.8 178.6 159.6
Loans held for sale 229.1 184.0 165.9 197.3 231.3 205.7
Trading securities inventory 50.5 43.7 48.6 34.4 31.4 30.5
Other earning assets 5.0 5.5 7.1 20.1 14.4 12.1
------------------------------------------------------------------------------------------------------------
Total interest income 1,053.4 1,042.2 1,201.5 1,365.6 1,209.4 1,135.4
------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Deposits:
Savings .8 2.2 3.8 5.5 5.8 7.1
Checking interest and money market 22.8 37.0 84.9 110.8 104.3 113.2
Certificates of deposit under $100,000 and
other time 57.2 71.3 111.1 129.2 123.8 144.9
Certificates of deposit $100,000 and more 69.3 79.8 137.1 254.9 165.9 111.5
Short-term borrowings 62.1 67.7 145.5 240.0 193.1 196.7
Term borrowings 35.4 28.6 30.2 24.3 24.8 19.9
------------------------------------------------------------------------------------------------------------
Total interest expense 247.6 286.6 512.6 764.7 617.7 593.3
------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 805.8 755.6 688.9 600.9 591.7 542.1
Provision for loan losses 86.7 92.2 93.2 67.5 57.4 51.2
------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION 719.1 663.4 595.7 533.4 534.3 490.9
------------------------------------------------------------------------------------------------------------
NONINTEREST INCOME:
Mortgage banking 616.5 436.7 285.0 122.5 298.2 281.9
Capital markets 538.9 448.0 344.3 118.7 126.9 147.4
Deposit transactions and cash management 146.7 143.3 133.6 116.1 106.2 90.4
Insurance premiums and commissions 57.8 50.4 16.8 12.2 10.9 8.7
Merchant processing 57.6 48.4 45.4 48.2 49.7 37.5
Trust services and investment management 45.9 48.4 56.7 65.8 59.8 51.2
Divestitures 22.5 4.6 80.4 157.6 4.2 .6
Equity securities gains/(losses), net 8.5 (9.4) (3.3) .8 2.3 3.9
Debt securities (losses), gains, net (6.1) .2 (1.0) (5.0) - -
All other income 151.7 141.3 137.1 160.2 130.3 87.4
------------------------------------------------------------------------------------------------------------
Total noninterest income 1,640.0 1,311.9 1,095.0 797.1 788.5 709.0
------------------------------------------------------------------------------------------------------------
ADJUSTED GROSS INCOME AFTER PROVISION 2,359.1 1,975.3 1,690.7 1,330.5 1,322.8 1,199.9
------------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSE:
Employee compensation, incentives and
benefits 980.3 830.6 670.9 508.3 488.7 438.7
Occupancy 83.6 76.7 69.1 80.5 73.1 51.4
Equipment rentals, depreciation and
maintenance 69.0 68.7 74.1 68.2 57.8 45.8
Operations services 67.9 60.2 59.6 70.9 64.6 58.5
Communications and courier 50.5 45.1 42.2 41.9 45.3 34.0
Amortization of intangible assets 8.0 6.2 10.8 11.7 10.5 11.1
All other expense 380.8 329.7 275.4 212.0 203.4 207.5
------------------------------------------------------------------------------------------------------------
Total noninterest expense 1,640.1 1,417.2 1,202.1 993.5 943.4 847.0
------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 719.0 558.1 488.6 337.0 379.4 352.9
Applicable income taxes 245.7 181.6 162.2 104.4 131.9 126.5
------------------------------------------------------------------------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGES
IN ACCOUNTING PRINCIPLES 473.3 376.5 326.4 232.6 247.5 226.4
Cumulative effect of changes in
accounting principles, net of tax - - (8.2) - - -
------------------------------------------------------------------------------------------------------------
NET INCOME $ 473.3 $ 376.5 $ 318.2 $ 232.6 $ 247.5 $ 226.4
------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------
FULLY TAXABLE EQUIVALENT ADJUSTMENT $ 1.3 $ 1.5 $ 2.1 $ 2.6 $ 3.0 $ 3.8
------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE BEFORE CUMULATIVE
EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES $ 3.73 $ 2.97 $ 2.55 $ 1.79 $ 1.90 $ 1.77
------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE $ 3.73 $ 2.97 $ 2.49 $ 1.79 $ 1.90 $ 1.77
------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER COMMON SHARE BEFORE
CUMULATIVE EFFECT OF CHANGES IN
ACCOUNTING PRINCIPLES $ 3.62 $ 2.89 $ 2.48 $ 1.77 $ 1.85 $ 1.72
------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER COMMON SHARE $ 3.62 $ 2.89 $ 2.42 $ 1.77 $ 1.85 $ 1.72
------------------------------------------------------------------------------------------------------------
------------------------------------------- -----------------------------------
Growth Rates (%)
-----------------------------------
(Dollars in millions except per share data) 03/02 03/98*
------------------------------------------- -----------------------------------
INTEREST INCOME:
Interest and fees on loans 1.3 - 2.0 -
Investment securities 22.2 - 7.0 -
Loans held for sale 24.5 + 2.2 +
Trading securities inventory 15.6 + 10.6 +
Other earning assets 9.1 - 16.2 -
-------------------------------------------
Total interest income 1.1 + 1.5 -
-------------------------------------------
INTEREST EXPENSE:
Deposits:
Savings 63.6 - 35.4 -
Checking interest and money market 38.4 - 27.4 -
Certificates of deposit under $100,000 and
other time 19.8 - 17.0 -
Certificates of deposit $100,000 and more 13.2 - 9.1 -
Short-term borrowings 8.3 - 20.6 -
Term borrowings 23.8 + 12.2 +
-------------------------------------------
Total interest expense 13.6 - 16.0 -
-------------------------------------------
NET INTEREST INCOME 6.6 + 8.3 +
Provision for loan losses 6.0 - 11.1 +
-------------------------------------------
NET INTEREST INCOME AFTER PROVISION 8.4 + 7.9 +
-------------------------------------------
NONINTEREST INCOME:
Mortgage banking 41.2 + 16.9 +
Capital markets 20.3 + 29.6 +
Deposit transactions and cash management 2.4 + 10.2 +
Insurance premiums and commissions 14.6 + 46.0 +
Merchant processing 19.0 + 9.0 +
Trust services and investment management 5.2 - 2.2 -
Divestitures NM NM
Equity securities gains/(losses), net NM NM
Debt securities (losses), gains, net NM NM
All other income 7.3 + 11.7 +
-------------------------------------------
Total noninterest income 25.0 + 18.3 +
-------------------------------------------
ADJUSTED GROSS INCOME AFTER PROVISION 19.4 + 14.5 +
-------------------------------------------
NONINTEREST EXPENSE:
Employee compensation, incentives and
benefits 18.0 + 17.4 +
Occupancy 9.0 + 10.2 +
Equipment rentals, depreciation and
maintenance .3 + 8.5 +
Operations services 12.8 + 3.0 +
Communications and courier 12.1 + 8.3 +
Amortization of intangible assets 28.7 + 6.4 -
All other expense 15.5 + 12.9 +
-------------------------------------------
Total noninterest expense 15.7 + 14.1 +
-------------------------------------------
INCOME BEFORE INCOME TAXES 28.8 + 15.3 +
Applicable income taxes 35.3 + 14.2 +
-------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGES
IN ACCOUNTING PRINCIPLES 25.7 + 15.9 +
Cumulative effect of changes in
accounting principles, net of tax - -
-------------------------------------------
NET INCOME 25.7 + 15.9 +
-------------------------------------------
-------------------------------------------
FULLY TAXABLE EQUIVALENT ADJUSTMENT 13.3 - 19.3 -
-------------------------------------------
EARNINGS PER COMMON SHARE BEFORE CUMULATIVE
EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES 25.6 + 16.1 +
-------------------------------------------
EARNINGS PER COMMON SHARE 25.6 + 16.1 +
-------------------------------------------
DILUTED EARNINGS PER COMMON SHARE BEFORE
CUMULATIVE EFFECT OF CHANGES IN
ACCOUNTING PRINCIPLES 25.3 + 16.0 +
-------------------------------------------
DILUTED EARNINGS PER COMMON SHARE 25.3 + 16.0 +
-------------------------------------------
* Compound annual growth rate.
Certain previously reported amounts have been reclassified to agree with current
presentation.
NM - Due to the variable nature of these items the growth rate is considered
to be not meaningful.
First Tennessee National Corporation F-111
CONSOLIDATED AVERAGE BALANCE SHEETS AND RELATED YIELDS AND RATES (UNAUDITED)
-----------------------------------------------------------------------------------------------------------------------------
2003 2002 Average
------------------------------ ------------------------------ Balance
Interest Average Interest Average Growth(%)
(Fully taxable equivalent) Average Income/ Yields/ Average Income/ Yields/ ----------
(Dollars in millions) Balance Expense Rates Balance Expense Rates 03/02
-----------------------------------------------------------------------------------------------------------------------------
ASSETS:
Earning assets:
Loans, net of unearned income** $12,656.3 $ 658.1 5.20% $10,634.5 $ 666.6 6.27% 19.0 +
Investment securities:
U.S. Treasury and other U.S. government
agencies 2,152.9 89.4 4.15 1,875.2 108.5 5.79 14.8 +
States and municipalities 22.1 1.5 6.80 34.9 2.5 7.30 36.7 -
Other 369.9 21.0 5.69 556.3 32.8 5.89 33.5 -
----------------------------------------------------------------------------------------------------------------
Total investment securities 2,544.9 111.9 4.40 2,466.4 143.8 5.83 3.2 +
----------------------------------------------------------------------------------------------------------------
Other earning assets:
Loans held for sale 4,420.7 229.1 5.18 3,024.2 184.0 6.09 46.2 +
Investment in bank time deposits 1.7 .1 .82 1.8 .1 2.07 5.6 -
Federal funds sold and securities purchased
under agreements to resell 656.3 4.9 .75 404.8 5.5 1.35 62.1 +
Mortgage banking trading securities 154.7 16.9 10.94 131.3 12.5 9.55 17.8 +
Capital markets securities inventory 894.3 33.7 3.76 734.4 31.2 4.25 21.8 +
----------------------------------------------------------------------------------------------------------------
Total other earning assets 6,127.7 284.7 4.65 4,296.5 233.3 5.43 42.6 +
----------------------------------------------------------------------------------------------------------------
Total earning assets 21,328.9 1,054.7 4.94 17,397.4 1,043.7 6.00 22.6 +
Allowance for loan losses (160.3) (151.2) 6.0 +
Cash and due from banks 748.3 775.3 3.5 -
Premises and equipment, net 300.7 246.3 22.1 +
Capital markets receivables and other assets 2,916.0 2,436.2 19.7 +
----------------------------------------------------------------------------------------------------------------
Total assets/Interest income $25,133.6 $1,054.7 $20,704.0 $1,043.7 21.4 +
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities:
Interest-bearing deposits:
Savings $ 306.1 $ .8 .27% $ 302.7 $ 2.2 .72% 1.1 +
Checking interest and money market 3,659.7 22.8 .62 3,557.5 37.1 1.04 2.9 +
Certificates of deposit under $100,000 and
other time 1,866.3 57.1 3.06 1,937.1 71.2 3.68 3.7 -
----------------------------------------------------------------------------------------------------------------
Total interest-bearing core deposits 5,832.1 80.7 1.38 5,797.3 110.5 1.91 .6 +
Certificates of deposit $100,000 and more 5,165.5 69.4 1.34 3,843.0 79.8 2.08 34.4 +
Federal funds purchased and securities sold
under agreements to repurchase 3,712.7 36.9 .99 3,134.3 45.5 1.45 18.5 +
Commercial paper and other short-term
borrowings 659.9 25.2 3.82 537.4 22.2 4.13 22.8 +
Term borrowings 1,342.9 35.4 2.64 685.5 28.6 4.17 95.9 +
----------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 16,713.1 247.6 1.48 13,997.5 286.6 2.05 19.4 +
Demand deposits 1,823.8 1,702.4 7.1 +
Other noninterest-bearing deposits 3,038.0 2,152.5 41.1 +
Capital markets payables and other liabilities 1,636.1 1,139.0 43.6 +
Guaranteed preferred beneficial interests in
First Tennessee's junior subordinated
debentures (Note 11) 100.0 100.0 -
Preferred stock of subsidiary (Note 12) 22.2 44.3 49.9 -
Shareholders' equity 1,800.4 1,568.3 14.8 +
----------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders'
equity/Interest expense $25,133.6 $ 247.6 $20,704.0 $ 286.6 21.4 +
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Net interest income-tax equivalent basis/Yield $ 807.1 3.78% $ 757.1 4.35%
Fully taxable equivalent adjustment (1.3) (1.5)
----------------------------------------------------------------------------------------------------------------
Net interest income $ 805.8 $ 755.6
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Net interest spread 3.46% 3.95%
Effect of interest-free sources used to fund
earning assets .32 .40
----------------------------------------------------------------------------------------------------------------
Net interest margin 3.78% 4.35%
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Certain previously reported amounts have been reclassified to agree with current
presentation.
Yields and corresponding income amounts are adjusted to a fully taxable
equivalent. Earning assets yields are expressed net of unearned income. Rates
are expressed net of unamortized debenture cost for long-term debt. Net interest
margin is computed using total net interest income.
F-112 First Tennessee National Corporation
------------------------------------------------------------------------------------------------------------------------
2001 2000
----------------------------------- ------------------------------
Interest Average Interest Average
(Fully taxable equivalent) Average Income/ Yields/ Average Income/ Yields/
(Dollars in millions) Balance Expense Rates Balance Expense Rates
------------------------------------------------------------------------------------------------------------------------
ASSETS:
Earning assets:
Loans, net of unearned income** $10,104.3 $ 812.5 8.04% $ 9,932.0 $ 915.9 9.22%
Investment securities:
U.S. Treasury and other U.S. government
agencies 1,812.5 118.1 6.51 1,767.7 119.8 6.78
States and municipalities 50.8 3.8 7.53 48.7 3.6 7.49
Other 732.0 47.5 6.49 1,046.3 76.8 7.34
------------------------------------------------------------------------------------------------------------------------
Total investment securities 2,595.3 169.4 6.53 2,862.7 200.2 6.99
------------------------------------------------------------------------------------------------------------------------
Other earning assets:
Loans held for sale 2,388.0 165.9 6.95 2,450.8 197.3 8.05
Investment in bank time deposits 1.9 .1 6.56 2.1 .1 5.07
Federal funds sold and securities purchased
under agreements to resell 226.5 7.0 3.07 328.4 20.0 6.10
Mortgage banking trading securities 127.5 12.1 9.48 - - -
Capital markets securities inventory 681.9 36.6 5.37 519.5 34.7 6.68
------------------------------------------------------------------------------------------------------------------------
Total other earning assets 3,425.8 221.7 6.47 3,300.8 252.1 7.64
------------------------------------------------------------------------------------------------------------------------
Total earning assets 16,125.4 1,203.6 7.46 16,095.5 1,368.2 8.50
Allowance for loan losses (145.2) (140.0)
Cash and due from banks 756.5 815.8
Premises and equipment, net 268.7 294.6
Capital markets receivables and other assets 2,221.8 2,259.4
------------------------------------------------------------------------------------------------------------------------
Total assets/Interest income $19,227.2 $1,203.6 $19,325.3 $1,368.2
------------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities:
Interest-bearing deposits:
Savings $ 304.4 $ 3.8 1.26% $ 337.4 $ 5.5 1.64%
Checking interest and money market 3,548.2 84.9 2.39 3,371.5 110.8 3.29
Certificates of deposit under $100,000 and
other time 2,092.3 111.1 5.31 2,310.3 129.2 5.59
-----------------------------------------------------------------------------------------------------------------------
Total interest-bearing core deposits 5,944.9 199.8 3.36 6,019.2 245.5 4.08
Certificates of deposit $100,000 and more 3,142.7 137.1 4.36 3,959.7 254.9 6.44
Federal funds purchased and securities sold
under agreements to repurchase 3,162.7 115.6 3.66 2,899.4 169.4 5.84
Commercial paper and other short-term
borrowings 565.3 29.9 5.30 1,050.4 70.6 6.72
Term borrowings 521.5 30.2 5.79 384.3 24.3 6.34
-----------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 13,337.1 512.6 3.84 14,313.0 764.7 5.34
Demand deposits 1,541.7 1,688.0
Other noninterest-bearing deposits 1,792.3 1,193.9
Capital markets payables and other liabilities 1,010.8 746.3
Guaranteed preferred beneficial interests in
First Tennessee's junior subordinated
debentures (Note 11) 100.0 100.0
Preferred stock of subsidiary (Note 12) 44.0 7.5
Shareholders' equity 1,401.3 1,276.6
-----------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders'
equity/Interest expense $19,227.2 $ 512.6 $19,325.3 $ 764.7
-----------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------
Net interest income-tax equivalent basis/Yield $ 691.0 4.29% $ 603.5 3.75%
Fully taxable equivalent adjustment (2.1) (2.6)
-----------------------------------------------------------------------------------------------------------------------
Net interest income $ 688.9 $ 600.9
-----------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------
Net interest spread 3.62% 3.16%
Effect of interest-free sources used to fund
earning assets .67 .59
-----------------------------------------------------------------------------------------------------------------------
Net interest margin 4.29% 3.75%
-----------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
1999 1998
------------------------------ --------------------
Interest Average Interest
(Fully taxable equivalent) Average Income/ Yields/ Average Income/
(Dollars in millions) Balance Expense Rates Balance Expense
------------------------------------------------------------------------------------------------------
ASSETS:
Earning assets:
Loans, net of unearned income** $ 8,818.8 $ 754.6 8.56% $ 8,242.1 $ 729.0
Investment securities:
U.S. Treasury and other U.S. government
agencies 1,711.1 110.5 6.46 1,795.2 117.8
States and municipalities 50.7 3.8 7.56 69.8 5.4
Other 940.9 66.2 7.04 560.8 38.4
------------------------------------------------------------------------------------------------------
Total investment securities 2,702.7 180.5 6.68 2,425.8 161.6
------------------------------------------------------------------------------------------------------
Other earning assets:
Loans held for sale 3,217.7 231.3 7.19 2,911.2 205.7
Investment in bank time deposits 9.8 .5 4.76 40.8 2.0
Federal funds sold and securities purchased
under agreements to resell 292.6 13.9 4.75 193.4 10.1
Mortgage banking trading securities - - - - -
Capital markets securities inventory 542.1 31.6 5.82 507.2 30.8
------------------------------------------------------------------------------------------------------
Total other earning assets 4,062.2 277.3 6.82 3,652.6 248.6
------------------------------------------------------------------------------------------------------
Total earning assets 15,583.7 1,212.4 7.78 14,320.5 1,139.2
Allowance for loan losses (136.7) (129.1)
Cash and due from banks 779.3 697.6
Premises and equipment, net 288.5 222.4
Capital markets receivables and other assets 2,110.5 1,613.3
------------------------------------------------------------------------------------------------------
Total assets/Interest income $18,625.3 $1,212.4 $16,724.7 $1,139.2
------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities:
Interest-bearing deposits:
Savings $ 350.0 $ 5.8 1.65% $ 347.5 $ 7.1
Checking interest and money market 3,551.2 104.3 2.94 3,403.7 113.2
Certificates of deposit under $100,000 and
other time 2,398.4 123.8 5.16 2,588.7 144.9
-------------------------------------------------------------------------------------------------------
Total interest-bearing core deposits 6,299.6 233.9 3.71 6,339.9 265.2
Certificates of deposit $100,000 and more 3,163.9 165.9 5.24 1,992.5 111.5
Federal funds purchased and securities sold
under agreements to repurchase 2,292.9 104.7 4.57 2,456.4 122.6
Commercial paper and other short-term
borrowings 1,631.4 88.4 5.42 1,285.5 74.1
Term borrowings 371.1 24.8 6.69 252.7 19.9
-------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 13,758.9 617.7 4.49 12,327.0 593.3
Demand deposits 1,866.6 1,749.0
Other noninterest-bearing deposits 972.0 915.0
Capital markets payables and other liabilities 741.0 637.7
Guaranteed preferred beneficial interests in
First Tennessee's junior subordinated
debentures (Note 11) 100.0 100.0
Preferred stock of subsidiary (Note 12) - -
Shareholders' equity 1,186.8 996.0
-------------------------------------------------------------------------------------------------------
Total liabilities and shareholders'
equity/Interest expense $18,625.3 $ 617.7 $16,724.7 $ 593.3
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
Net interest income-tax equivalent basis/Yield $ 594.7 3.82% $ 545.9
Fully taxable equivalent adjustment (3.0) (3.8)
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
Net interest income $ 591.7 $ 542.1
-------------------------------------------------------------------------------------------------------
Net interest spread 3.29%
Effect of interest-free sources used to fund
earning assets .53
-------------------------------------------------------------------------------------------------------
Net interest margin 3.82%
-------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------
1998 Average
------- Balance
Average Growth(%)
(Fully taxable equivalent) Yields/ ---------------
(Dollars in millions) Rates 03/98*
-------------------------------------------------------------- -----------------
ASSETS:
Earning assets:
Loans, net of unearned income** 8.85% 9.0 +
Investment securities:
U.S. Treasury and other U.S. government
agencies 6.56 3.7 +
States and municipalities 7.80 20.5 -
Other 6.84 8.0 -
--------------------------------------------------------------
Total investment securities 6.66 1.0 +
--------------------------------------------------------------
Other earning assets:
Loans held for sale 7.06 8.7 +
Investment in bank time deposits 4.81 47.0 -
Federal funds sold and securities purchased
under agreements to resell 5.22 27.7 +
Mortgage banking trading securities - N/A
Capital markets securities inventory 6.07 12.0 +
--------------------------------------------------------------
Total other earning assets 6.80 10.9 +
--------------------------------------------------------------
Total earning assets 7.95 8.3 +
Allowance for loan losses 4.4 +
Cash and due from banks 1.4 +
Premises and equipment, net 6.2 +
Capital markets receivables and other assets 12.6 +
--------------------------------------------------------------
Total assets/Interest income 8.5 +
--------------------------------------------------------------
--------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest-bearing liabilities:
Interest-bearing deposits:
Savings 2.05% 2.5 -
Checking interest and money market 3.32 1.5 +
Certificates of deposit under $100,000 and
other time 5.60 6.3 -
--------------------------------------------------------------
Total interest-bearing core deposits 4.18 1.7 -
Certificates of deposit $100,000 and more 5.59 21.0 +
Federal funds purchased and securities sold
under agreements to repurchase 4.99 8.6 +
Commercial paper and other short-term
borrowings 5.76 12.5 -
Term borrowings 7.91 39.7 +
--------------------------------------------------------------
Total interest-bearing liabilities 4.81 6.3 +
Demand deposits .8 +
Other noninterest-bearing deposits 27.1 +
Capital markets payables and other liabilities 20.7 +
Guaranteed preferred beneficial interests in
First Tennessee's junior subordinated
debentures (Note 11) -
Preferred stock of subsidiary (Note 12) N/A
Shareholders' equity 12.6 +
--------------------------------------------------------------
Total liabilities and shareholders'
equity/Interest expense 8.5 +
--------------------------------------------------------------
--------------------------------------------------------------
Net interest income-tax equivalent basis/Yield 3.81%
Fully taxable equivalent adjustment
--------------------------------------------------------------
Net interest income
--------------------------------------------------------------
--------------------------------------------------------------
Net interest spread 3.14%
Effect of interest-free sources used to fund
earning assets .67
--------------------------------------------------------------
Net interest margin 3.81%
--------------------------------------------------------------
--------------------------------------------------------------
* Compound annual growth rate
** Includes loans on nonaccrual status.
First Tennessee National Corporation F-113
CORPORATE OFFICERS
J. Kenneth Glass
Chairman of the Board
President and Chief Executive Officer
Ralph Horn
Chairman of the Board
(Retired Dec. 31, 2003)
Charles G. Burkett
President
Retail Financial Services
Larry B. Martin
President
Business Financial Services
John H. Hamilton
Executive Vice President
Product Management and Delivery Services
Herbert H. Hilliard
Executive Vice President
Risk Management
Harry A. Johnson, III
Executive Vice President
General Counsel
James F. Keen
Executive Vice President
Corporate Controller
Sarah L. Meyerrose
Executive Vice President
Corporate and Employee Services
Marty Mosby
Executive Vice President
Chief Financial Officer
John P. O'Connor, Jr.
Executive Vice President
Chief Credit Officer
Elbert L. Thomas, Jr.
Executive Vice President
Interest Rate Risk Manager
Milton A. Gutelius, Jr.
Senior Vice President
Corporate Treasurer
Clyde A. Billings, Jr.
Senior Vice President
Assistant General Counsel
Corporate Secretary
BOARD OF DIRECTORS
Robert C. Blattberg
Polk Brothers Distinguished Professor of Retailing
J.L. Kellogg Graduate School of Management
Northwestern University
George E. Cates
Retired Chairman of the Board
Mid-America Apartment Communities, Inc.
J. Kenneth Glass
Chairman of the Board
President and Chief Executive Officer
James A. Haslam, III
Chief Executive Officer
Pilot Travel Centers LLC
Ralph Horn
Chairman of the Board
(Retired Dec. 31, 2003)
R. Brad Martin
Chairman of the Board and Chief Executive Officer
Saks Incorporated
Vicki R. Palmer
Executive Vice President
Financial Services and Administration
Coca-Cola Enterprises Inc.
Michael D. Rose
Chairman
Gaylord Entertainment Company
Mary F. Sammons
President and Chief Executive Officer
Rite Aid Corporation
William B. Sansom
Chairman of the Board and Chief Executive Officer
The H.T. Hackney Co.
Jonathan P. Ward
Chairman of the Board and Chief Executive Officer
The ServiceMaster Company
Luke Yancy, III
President and Chief Executive Officer
Mid-South Minority Business Council
[FIRST TENNESSEE LOGO]
FIRST
TENNESSEE
NATIONAL
CORPORATION
[LOGO FIRST TENNESSEE'r'
All Things Financial'r']
[LOGO FIRST TENNESSEE'r'
All Things Financial'r']
Appendix 1
[LOGO] FIRST TENNESSEE
First Tennessee National Corporation
Annual Meeting
April 20, 2004
10:00 a.m. Central Daylight Time
First Tennessee Building
M-Level Auditorium
165 Madison Avenue
Memphis, Tennessee 38103
If you consented to access your proxy information electronically, you may
view it by going to the following website on the internet:
http://www.firsttennessee.com
If you would like to access the proxy material electronically next year,
you may do so by giving your consent at the following website:
http://www.econsent.com/ftn/
[LOGO] FIRST TENNESSEE
FIRST TENNESSEE NATIONAL CORPORATION
PROXY SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned appoints George P. Lewis and Lewis R. Donelson, or any one
or more of them with full power of substitution, as Proxy or Proxies, to
represent and vote all shares of stock standing in my name on the books of the
Corporation at the close of business on February 27, 2004, which I would be
entitled to vote if personally present at the Annual Meeting of Shareholders of
First Tennessee National Corporation to be held in the Auditorium, First
Tennessee Building, 165 Madison Avenue, Memphis, Tennessee, April 20, 2004, at
10 a.m. CDT or any adjournments thereof, upon the matters set forth in the
notice of said meeting as stated on the reverse side. The Proxies are further
authorized to vote in their discretion as to any other matters which may come
before the meeting. The Board of Directors, at the time of preparation of the
Proxy Statement, knows of no business to come before the meeting other than that
referred to in the Proxy Statement.
THE SHARES COVERED BY THIS PROXY WILL BE VOTED IN ACCORDANCE WITH THE
AUTOMATED TELEPHONE VOTING INSTRUCTIONS, THE INTERNET VOTING INSTRUCTIONS, OR
THE INSTRUCTIONS GIVEN ON THE REVERSE SIDE AND WHEN NO INSTRUCTIONS ARE GIVEN
WILL BE VOTED FOR PROPOSALS 1, 2, 3 AND 4 WHICH ARE DESCRIBED IN THE
ACCOMPANYING NOTICE OF ANNUAL MEETING AND PROXY STATEMENT AND ON THE REVERSE
SIDE OF THIS PROXY.
YOU CAN VOTE YOUR PROXY BY TELEPHONE, OVER THE INTERNET, OR BY SIGNING AND
RETURNING THIS CARD ON THE REVERSE SIDE.
(Continued and see voting instructions on reverse side.)
COMPANY # _________________
There are three ways to vote your Proxy.
Your telephone or Internet vote authorizes the Named Proxies to vote your shares
in the same manner as if you marked, signed and returned your proxy card.
VOTE BY PHONE- TOLL FREE - 1-800-560-1965 - QUICK *** EASY *** IMMEDIATE
o Use any touch-tone telephone to vote your proxy 24 hours a day, 7 days a
week until 12:00 p.m. (CDT) on April 19, 2004.
o Please have your proxy card and the last 4 digits of your Social Security
Number available. Follow the simple instructions the voice provides you.
VOTE BY INTERNET - http://www.eproxy.com/ftn/ - QUICK *** EASY *** IMMEDIATE
--------------------------
o Use the Internet to vote your proxy 24 hours a day, 7 days a week until
12:00 p.m. (CDT) on April 19, 2004.
o Please have your proxy card and the last 4 digits of your Social Security
Number available. Follow the simple instructions to obtain your records
and create an electronic ballot.
VOTE BY MAIL
Mark, sign and date your proxy card and return it in the postage-paid envelope
we've provided or return it to First Tennessee National Corporation, c/o
Shareowner Services 'sm', P. O. Box 64873, St. Paul, MN 55164-0873.
|X| Please mark votes as in this example.
If you vote by Phone or Internet, please do not mail your Proxy Card.
Please detach here
The Board of Directors unanimously recommends a vote FOR items 1, 2, 3 and
4.
1. Election of four Class II directors to serve until the 2007 Annual
Meeting of Shareholders and one Class III director to serve until the
2005 Annual Meeting of Shareholders.
Class II Nominees: (01) Robert C. Blattberg (02) J. Kenneth Glass
(03) Michael D. Rose and (04) Luke Yancy III
Class III Nominee: (05) Mary F. Sammons
/ / VOTE FOR / / VOTE WITHHELD
all nominees from all nominees
Instructions: To withhold authority to vote for any nominee(s), write the
number(s) of the nominee(s) in the box to the right.
2. Approval of an amendment to FTNC's Charter changing the corporation's
name. / / For / / Against / / Abstain
3. Approval of an amendment to FTNC's 2003 Equity Compensation Plan. / / For / / Against / / Abstain
4. Ratification of appointment of KPMG LLP as auditors. / / For / / Against / / Abstain
The undersigned hereby acknowledges receipt of notice of said meeting
and the related proxy statement.
Address change? Mark Box / / Date_________________, 2004
Indicate changes below:
Shareholders sign here exactly as shown
on the imprint on this card. When signing as
Attorney, Executor, Administrator, Trustee
or Guardian, please give full name. If more
than one Trustee, all should sign. All Joint
Owners should sign.
STATEMENT OF DIFFERENCES
------------------------
The registered trademark symbol shall be expressed as.................. 'r'
The service mark symbol shall be expressed as.......................... 'sm'
The section symbol shall be expressed as............................... 'SS'
The greater-than-or-equal-to sign shall be expressed as................ >=