First Horizon National Corp. warned its mortgage operation probably would lose $6 million this quarter and turn in only break-even results next quarter, mainly because the recent tumble in long-term interest rates have inverted the yield curve.
In addition, its July and August production have "foreshadowed" that its third-quarter originations will drop about 39% from a year earlier, to about $6.5 billion, the Memphis company said Tuesday. Last quarter originations fell 22%, to $7.5 billion.
The issues caused by the yield curve pressure - which will cut mortgage results by $35 million from last quarter - include lower gain-on-sale margins and higher losses on servicing hedging, First Horizon said. It said the slowing housing market has been hurting origination volume.
First Horizon also said it has agreed to settle a class action over home equity loans made in the Kansas City, Mo., area both before and after the company acquired McGuire Mortgage Co. in 1999. This quarter it will take a pretax charge of $21 million, the amount it says borrowers will probably ultimately collect.
Kevin Fitzsimmons, an analyst at Sandler O'Neill & Partners LP, said a decline in First Horizon's sales margin had been expected, as the lender had reported an exceptionally healthy one for last quarter, after apparently locking in trading gains early in the period.
"The news is it's coming down even more than that," he said.
Falling margins this quarter will be "an industry issue, but the magnitude won't be the same," as it will be at First Horizon, because of its higher start point, Mr. Fitzsimmons said. "It does seem there are mortgage players that - either through their business mix or some of the levers they pull - are able to manage through the volatility a little better," he added.
First Horizon said the drop in long-term bond yields after the Federal Reserve Board stopped cutting rates, which inverted the yield curve, "changed the dynamics within the mortgage secondary market." The company said its gain-on-sale margin, which was 122 basis points last quarter, probably would drop to between 85 and 90 basis points this quarter.
Marty Mosby, its chief financial officer, said in an interview that coming into the quarter it expected its gain-on-sale margin to drop to about 100 to 110 basis points, or about its historical average, but the drop in rates and resulting "disruptions in the market" surprised the company.
On the one hand, Mr. Mosby said, the lower rates reduced the servicing value from recently originated loans it was putting on its books (which is part of the gain-on-sale margin and not hedged by it), since the risk that the loans would be refinanced quickly picks up as rates fall.
On the other hand, the prices paid for the rest of the assets plummeted, he said. "There's going to be as many reasons for that, as you could ask different traders." One explanation, he said, would be that rivals are selling more of what they have originated. "All of a sudden, you're going from a market that's paying a premium to a market that's got an oversupply."
Gary Townsend, an analyst at Friedman, Billings, Ramsey & Co. Inc., downgraded First Horizon's stock to "underperform," from "market perform." He said in an interview that falling originations could also hurt efforts to expand in retail banking.
"First Horizon's banking model is tied wrist and ankle to mortgage origination, as mortgage leads its new customer and deposit acquisition efforts," he wrote in a research note.
Mr. Mosby said his company still plans to try to maintain or increase its origination market share, while continuing to price less aggressively than many rivals. (There were no changes in its front-end pricing strategy that would have caused the gain-on-sale decline, he said.)
He also said the drop in second-quarter originations now looks more in line with the market than his company had originally said while trying to be "very forthcoming" in its last earnings call, when it discussed its strategy of pricing loans "judiciously."
He cited a report the Mortgage Bankers Association released this month estimating that the industry's second-quarter originations dropped 17%, to $633 billion, more than its last guess.
First Horizon agreed to pay up to $36 million to settle the lawsuit - which alleged that about 4,000 borrowers in Missouri were charged origination fees that were prohibited in the state but permitted under Kansas and federal law. In its most recent 10-Q filing Aug. 4, it had warned the case could cost it as much as $92 million.
