-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PXtK0yEJvbAnnfWTokCGMf6xeCDTJXpg8YA9KLBMNvCJoG3/1RILP/442yl6lTyR vIitlKRcv6LTPpyol9Ybaw== 0001171843-06-000098.txt : 20060509 0001171843-06-000098.hdr.sgml : 20060509 20060509160511 ACCESSION NUMBER: 0001171843-06-000098 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20060331 FILED AS OF DATE: 20060509 DATE AS OF CHANGE: 20060509 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST HORIZON NATIONAL CORP CENTRAL INDEX KEY: 0000036966 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 620803242 STATE OF INCORPORATION: TN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-15185 FILM NUMBER: 06821104 BUSINESS ADDRESS: STREET 1: 165 MADISON AVENUE CITY: MEMPHIS STATE: TN ZIP: 38103 BUSINESS PHONE: 9018186232 MAIL ADDRESS: STREET 1: 165 MADISON AVENUE CITY: MEMPHIS STATE: TN ZIP: 38103 FORMER COMPANY: FORMER CONFORMED NAME: FIRST TENNESSEE NATIONAL CORP DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: FIRST TENNESSEE BANKS INC DATE OF NAME CHANGE: 19600201 10-Q 1 f10q_05042006.htm FORM 10-Q

FORM 10-Q

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

 

(Mark one)

(X)      QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2006

 

OR

( )TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

 

For the transition period from______ to______

 

Commission file number 001-15185

 

CIK number 0000036966

 

FIRST HORIZON NATIONAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Tennessee

62-0803242

 

 

(State or other jurisdiction of

(I.R.S. Employer

 

incorporation or organization)

Identification No.)

 

 

 

165 Madison Avenue, Memphis, Tennessee

38103

 

 

(Address of principal executive offices)

(Zip Code)

 

(901) 523-4444

(Registrant's telephone number, including area code)

 

(Former name, former address and former fiscal year,

if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

 

Yes x   No___

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

 

 

x  

Large accelerated filer

____ Accelerated filer

____ Non-accelerated filer

 

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

 

 

Yes       

No x    

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 

Common Stock, $.625 par value
Class

                 123,230,240
Outstanding on March 31, 2006

 


 

FIRST HORIZON NATIONAL CORPORATION

 

INDEX 

 

 

 

Part I. Financial Information

 

 

Part II. Other Information

 

 

Signatures

 

Exhibit Index

 

2

 


PART I.

 

FINANCIAL INFORMATION

 

 

 

Item 1.

Financial Statements

 

 

The Consolidated Condensed Statements of Condition

 

 

The Consolidated Condensed Statements of Income

 

 

The Consolidated Condensed Statements of Shareholders’ Equity

 

 

The Consolidated Condensed Statements of Cash Flows

 

 

The Notes to Consolidated Condensed Financial Statements

 

This financial information reflects all adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the interim periods presented. On March 1, 2006, FHN sold its national merchant processing business. This divestiture was accounted for as a discontinued operation, and accordingly, current and prior periods were adjusted to exclude the impact of merchant operations from the results of continuing operations. Additionally, FHN adopted SFAS No. 123 (revised 2004), "Share-Based Payment" (SFAS No. 123-R) in first quarter 2006 and retroactively applied the provisions of the standard. Accordingly, results for periods prior to 2006 have been adjusted to reflect expensing of share-based compensation.

  

 

3


CONSOLIDATED CONDENSED STATEMENTS OF CONDITION     First Horizon National Corporation
March 31 December 31
(Dollars in thousands)(Unaudited)     2006 2005 2005
Assets:
Cash and due from banks  $      887,539   $      770,844   $      945,547 
Federal funds sold and securities
  purchased under agreements to resell              1,347,577           1,598,995           1,485,199 
    Total cash and cash equivalents              2,235,116           2,369,839           2,430,746 
Investment in bank time deposits               25,319                10,731                10,687 
Trading securities           2,508,615           1,826,595           2,133,428 
Loans held for sale          3,604,010           5,277,158           4,435,343 
Securities available for sale          2,944,443           2,899,474           2,912,103 
Securities held to maturity (fair value of $388 on March 31, 2006; $454 on 
   March 31, 2005; and $390 on December 31, 2005)                    383                     442                     383 
Loans, net of unearned income        21,186,991         17,183,781         20,600,922 
  Less:  Allowance for loan losses                 195,011              164,195              189,705 
    Total net loans            20,991,980         17,019,586         20,411,217 
Mortgage servicing rights, net          1,475,448           1,135,645           1,314,629 
Goodwill             281,475              260,517              281,440 
Other intangible assets, net               76,666                78,104                76,647 
Capital markets receivables             858,072  2,435,505  511,508 
Premises and equipment, net             422,346              377,887              408,539 
Real estate acquired by foreclosure               48,959                25,695                27,410 
Discontinued assets               56,712              126,213              163,545 
Other assets     1,771,431      1,314,032      1,461,436 
Total assets      $ 37,300,975   $ 35,157,423   $ 36,579,061 
Liabilities and shareholders' equity:
Deposits:
  Checking interest and money market  $   4,834,547   $   4,338,516   $   4,425,664 
  Savings 287,894  298,958  279,408 
  Certificates of deposit under $100,000 and other time 2,692,046  2,145,312  2,478,946 
  Certificates of deposit $100,000 and more     8,228,543  10,781,020  10,931,695 
     Interest-bearing        16,043,030         17,563,806         18,115,713 
  Noninterest-bearing              5,474,017           5,444,485           5,201,844 
     Total deposits            21,517,047         23,008,291         23,317,557 
Federal funds purchased and securities
  sold under agreements to repurchase          4,337,243           2,788,158           3,735,742 
Trading liabilities             766,479              924,027              793,638 
Commercial paper and other short-term borrowings             749,979              967,701              802,017 
Term borrowings          4,299,539           2,591,354           3,437,643 
Other collateralized borrowings     299,800                          -                          - 
  Total long-term debt     4,599,339           2,591,354           3,437,643 
Capital markets payables 941,911  1,283,766  591,404 
Discontinued liabilities 233,402  77,926  122,026 
Other liabilities              1,460,693           1,095,542           1,136,221 
    Total liabilities            34,606,093         32,736,765         33,936,248 
Preferred stock of subsidiary                  295,274              295,858  295,274 
Shareholders' equity
Preferred stock - no par value (5,000,000 shares authorized,  but unissued)                         -                          -                          - 
Common stock - $.625 par value (shares authorized - 400,000,000;
   shares issued and outstanding - 123,230,240 on March 31, 2006;
  124,131,336 on March 31, 2005; and 126,222,327 on December 31, 2005)               77,019                77,582  78,889 
Capital surplus             269,564              331,779              404,964 
Undivided profits          2,065,285           1,751,618           1,905,930 
Accumulated other comprehensive loss, net                  (12,260)              (36,179)              (42,244)
    Total shareholders' equity              2,399,608           2,124,800           2,347,539 
Total liabilities and shareholders' equity      $ 37,300,975   $ 35,157,423   $ 36,579,061 
See accompanying notes to consolidated condensed financial statements.
Certain previously reported amounts have been reclassified to agree with current presentation.

 

4


 

CONSOLIDATED CONDENSED STATEMENTS OF INCOME First Horizon National Corporation
             Three Months Ended
              March 31      
(Dollars in thousands except per share data)(Unaudited)         2006 2005 
Interest income:
Interest and fees on loans $   363,483  $   231,558 
Interest on investment securities  35,855           29,703 
Interest on loans held for sale  76,342           79,085 
Interest on trading securities  38,515           33,649 
Interest on other earning assets          19,174           10,881 
    Total interest income          533,369         384,876 
Interest expense:
Interest on deposits:
  Savings   105                  77 
  Checking interest and money market account  20,792           11,206 
  Certificates of deposit under $100,000 and other time   25,338           17,172 
  Certificates of deposit $100,000 and more  119,296           64,782 
Interest on trading liabilities  18,347           16,807 
Interest on short-term borrowings  56,244           26,600 
Interest on long-term debt  47,526           20,785 
    Total interest expense          287,648         157,429 
Net interest income  245,721         227,447 
Provision for loan losses          17,799           13,109 
Net interest income after provision for loan losses          227,922         214,338 
Noninterest income:
Mortgage banking  88,815         118,763 
Capital markets  92,858           95,162 
Deposit transactions and cash management  38,023           33,255 
Insurance commissions  14,686           14,749 
Revenue from loan sales and securitizations  11,357           13,234 
Trust services and investment management  10,657           11,164 
Equity securities losses, net  (1,003)               (66)
Debt securities losses, net  (79,278)                    - 
All other income and commissions          29,629           36,617 
    Total noninterest income          205,744         322,878 
Adjusted gross income after provision for loan losses          433,666         537,216 
Noninterest expense:
Employee compensation, incentives and benefits  260,141         240,297 
Occupancy  30,102           24,011 
Operations services  17,440           16,445 
Equipment rentals, depreciation and maintenance  20,264           17,485 
Communications and courier  14,912           12,468 
Amortization of intangible assets  2,888             2,536 
All other expense          97,468           71,295 
    Total noninterest expense          443,215         384,537 
Pre-tax (loss)/income   (9,549)        152,679 
(Benefit)/provision for income taxes          (12,959)          49,864 
Income from continuing operations  3,410         102,815 
Income from discontinued operations, net of tax          210,273             3,015 
Income before cumulative effect of changes in accounting principle  213,683         105,830 
Cumulative effect of changes in accounting principle, net of tax  1,345                     - 
Net income         $    215,028 $   105,830 
Earnings per common share from continuing operations $           .03   $           .82 
Earnings per common share from discontinued operations, net of tax  1.67        .03 
Earnings per common share from cumulative effect of changes in accounting principle, net of tax    .01                     - 
Earnings per common share  (Note 8)         $         1.71   $           .85 
Diluted earnings per common share from continuing operations $           .03   $           .80 
Diluted earnings per common share from discontinued operations, net of tax  1.63        .03 
Diluted earnings per common share from cumulative effect of changes in accounting principle, net of tax  .01                     - 
Diluted earnings per common share  (Note 8)         $         1.67   $           .83 
Weighted average common shares (Note 8)          125,489         124,717 
Diluted average common shares (Note 8)          129,100         128,032 
See accompanying notes to consolidated condensed financial statements.
Certain previously reported amounts have been reclassified to agree with current presentation.

 

5


 

CONSOLIDATED CONDENSED STATEMENTS OF SHAREHOLDERS' EQUITY

First Horizon National Corporation
(Dollars in thousands)(Unaudited)                2006                 2005
Balance, January 1  $  2,347,539   $  2,040,983 
Adjustment to reflect change in accounting for employee share-based compensation -  33,151 
Net income                215,028  105,830 
Other comprehensive income:
  Unrealized fair value adjustments, net of tax
    Cash flow hedges                       613  - 
    Securities available for sale                  29,371                 (26,251)
Comprehensive income                  245,012    79,579 
Cash dividends declared                (55,673) (53,315)
Common stock repurchased              (159,734)                     (488)
Common stock issued for:
  Stock options and restricted stock                  21,795  13,061 
  Acquisitions                       185  3,895 
Change in tax benefit from incentive plans                    3,592                        (22)
Adjustment to reflect change in accounting for employee stock option forfeitures (1,780) - 
Stock-based compensation expense                  (1,328)                    7,958 
Other   -    (2)
Balance, March 31    $  2,399,608     $  2,124,800 
See accompanying notes to consolidated condensed financial statements.
Certain previously reported amounts have been reclassified to agree with current presentation.

 

6


 


CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS First Horizon National Corporation
Three Months Ended March 31
(Dollars in thousands)(Unaudited) 2006  2005 
Operating  Net income $     215,028  $   105,830 
Activities Adjustments to reconcile net income to net cash provided/(used) by operating activities:
 Provision for loan losses 17,799  13,109 
 Provision for deferred income tax/(deferred income tax benefit) 12,826  (322)
 Depreciation and amortization of premises and equipment 12,983  12,261 
 Amortization and impairment of mortgage servicing rights -  58,713 
 Amortization of intangible assets 3,113  3,362 
 Net other amortization and accretion 25,625  20,675 
 Decrease in derivatives, net 35,236  114,235 
 Market value adjustment on mortgage servicing rights (95,175) -
 Provision for foreclosure reserve 7,051  2,588 
 Cumulative effect of changes in accounting principle (1,345) -
 Gain on divestiture (208,488) -
 Stock-based compensation (benefit)/expense (1,328) 6,359 
 Excess tax (benefit)/expense from stock-based compensation arrangements (3,592) 22 
 Equity securities losses, net 1,003  66 
 Debt securities losses, net 79,278  -
 Net losses on disposal of fixed assets 983  168 
 Net (increase)/decrease in:
  Trading securities (375,187) (149,404)
  Loans held for sale 830,448  (86,305)
  Capital markets receivables (346,564) (2,159,208)
  Interest receivable (2,138) (27,123)
  Other assets (305,913) (222,184)
 Net increase/(decrease) in:
  Capital markets payables 350,584  893,443 
  Interest payable 12,064  35,369 
  Other liabilities 295,908  (56,130)
  Trading liabilities (27,159) 497,684 
    Total adjustments 318,012  (1,042,622)
Net cash provided/(used) by operating activities 533,040  (936,792)
Investing Available for sale securities:
Activities  Sales 2,208,878  21,630 
 Maturities 198,781  98,023 
 Purchases (2,470,650) (382,915)
Premises and equipment:
 Purchases (27,443) (17,691)
Net increase in loans (663,817) (772,187)
Net increase in investment in bank time deposits (14,632) (5,402)
Proceeds from divestitures, net of cash and cash equivalents 421,737  -
Acquisitions, net of cash and cash equivalents acquired (186) (843,543)
Net cash used by investing activities (347,332) (1,902,085)
Financing Common stock:
Activities  Exercise of stock options 21,275  13,043 
 Cash dividends paid (56,680) (53,020)
 Repurchase of shares (159,734) (488)
 Excess tax benefit/(expense) from stock-based compensation arrangements 3,592  (22)
Long-term debt:
 Issuance 1,179,137  -
 Payments (113) (69)
Issuance of preferred stock of subsidiary - 295,400 
Net increase/(decrease) in:
 Deposits (1,919,152) 3,290,286 
 Short-term borrowings 549,463  345,658 
Net cash (used)/provided by financing activities (382,212) 3,890,788 
Net (decrease)/increase in cash and cash equivalents (196,504) 1,051,911 
Cash and cash equivalents at beginning of period 2,431,620  1,320,499 
Cash and cash equivalents at end of period 2,235,116  2,372,410 
Cash and cash equivalents from discontinued operations at beginning of period, included above $              874  $       1,115 
Cash and cash equivalents from discontinued operations at end of period, included above -  2,571 
Total interest paid 275,147  121,896 
Total income taxes paid 1,329  3,290 
See accompanying notes to consolidated condensed financial statements.
Certain previously reported amounts have been reclassified to agree with current presentation.

7


Note 1 - Financial Information

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

 

Real Estate Acquired by Foreclosure. Prior to 2006, properties acquired by foreclosure in compliance with HUD servicing guidelines were classified as receivables in “Other assets” on the Consolidated Condensed Statements of Condition. Beginning in 2006, these loans are included in “Real estate acquired by foreclosure” and are carried at the estimated amount of the underlying government insurance or guarantee. On March 31, 2006, FHN had $19.9 million in these foreclosed properties. All other real estate acquired by foreclosure consists of properties that have been acquired in satisfaction of debt. These properties are carried at the lower of the outstanding loan amount or estimated fair value less estimated cost to sell the real estate. Losses arising at foreclosure are charged to the appropriate reserve. Required developmental costs associated with foreclos ed property under construction are capitalized and included in determining the estimated net realizable value of the property, which is reviewed periodically, and any write-downs are charged against current earnings.

 

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

 

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

 

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

 

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

 

 

8


 

 

Note 1 - Financial Information (continued)

 

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

 

The fair values of the certificated residual interests, the excess interest, and the interest-only strips are determined using market prices from closely comparable assets such as MSR that are tested against prices determined using a valuation model that calculates the present value of estimated future cash flows. To determine the fair value of the principal-only strips, FHN uses the market prices from comparable assets such as publicly traded FNMA trust principal-only strips that are adjusted to reflect the relative risk difference between readily marketable

securities and privately issued securities. The fair value of subordinated bonds is determined using a spread to an interpolated Treasury rate, which is supplied by broker dealers. The fair value of these retained interests typically changes based on changes in the discount rate and differences between modeled prepayment speeds and credit losses and actual experience.

 

On January 1, 2006, FHN began initially recognizing all classes of MSR at fair value and elected to irrevocably continue application of fair value accounting to its MSR. Classes of MSR are determined in accordance with FHN’s risk management practices and market inputs used in determining the fair value of the servicing asset. Since sales of MSR tend to occur in private transactions and the precise terms and conditions of the sales are typically not readily available, there is a limited market to refer to in determining the fair value of MSR. As such, like other participants in the mortgage banking business, FHN relies primarily on a discounted cash flow model to estimate the fair value of its MSR. This model calculates estimated fair value of the MSR using predominant risk characteristics of MSR such as interest rates, type of product (fixed vs. variable), age (new, seasoned, or moderate), agency type and other factors. F HN uses assumptions in the model that it believes are comparable to those used by brokers and other service providers. FHN also periodically compares its estimates of fair value and assumptions to brokers, service providers, and recent market activity and against its own experience.

 

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

 

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

 

For all stock option awards granted prior to adoption of SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123-R), FHN permits vesting of the option to continue after retirement. To account for these stock option awards, FHN uses the nominal vesting period approach. Under the nominal vesting period approach, awards granted to employees near retirement eligibility are expensed over the option’s normal vesting period until an employee’s actual retirement date, at which point all remaining unamortized compensation expense is immediately accelerated. Awards granted after the adoption of SFAS No. 123-R will be amortized using the nonsubstantive vesting methodology. The nonsubstantive vesting methodology requires that expense associated with options that continue vesting after retirement be recognized over a period ending no later than an employee’s retirement eligibility date. Had FHN followed th e nonsubstantive vesting period method for all awards previously granted, the effect of the change in expense attribution on earnings and per share amounts would have been negligible.


9


Note 1 - Financial Information (continued)

 

Accounting Changes. Effective January 1, 2006, FHN elected early adoption of Statement of Financial Accounting Standards No. 156, “Accounting for Servicing of Financial Assets” (SFAS No. 156). This amendment to SFAS No. 140 requires servicing rights be initially measured at fair value. Subsequently, companies are permitted to elect, on a class-by-class basis, either fair value or amortized cost

accounting for their servicing rights. FHN elected fair value accounting for its MSR. Accordingly, FHN recognized the cumulative effect of a change in accounting principle totaling $.2 million, net of tax, representing the excess of the fair value of the servicing asset over the recorded value on January 1, 2006.

 

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

 

FHN adopted SFAS No. 123-R as of January 1, 2006. SFAS No. 123-R requires recognition of expense over the requisite service period for awards of share-based compensation to employees. The grant date fair value of an award will be used to measure the compensation expense to be recognized over the life of the award. For unvested awards granted prior to the adoption of SFAS No. 123-R, the fair values utilized equal the values developed in preparation of the disclosures required under the original SFAS No. 123. Compensation expense recognized after adoption of SFAS No. 123-R will incorporate an estimate of awards expected to ultimately vest, which requires estimation of forfeitures as well as projections related to the satisfaction of performance conditions that determine vesting. As permitted by SFAS No. 123-R, FHN retroactively applied the provisions of SFAS No. 123-R to its prior period financial statements. The Consolidated Co ndensed Statements of Income were revised to incorporate expenses previously presented in the footnote disclosures. The Consolidated Condensed Statements of Condition were revised to reflect the effects of including equity compensation expense in those prior periods. Additionally, all deferred compensation balances were reclassified within equity to capital surplus. Since FHN’s prior disclosures included forfeitures as they occurred, a cumulative effect adjustment, as required by SFAS No. 123-R, of $1.1 million net of tax, was made for unvested awards that are not expected to vest due to anticipated forfeiture. The following table summarizes the effect of adoption of SFAS No. 123-R on the income statement for the three months ended March 31, 2006 and 2005:

 

       Three Months Ended
            March 31
(Dollars in thousands except per share data)         2006   2005
Income before income taxes $(2,976) $(5,391)
Income from continuing operations (1,812) (3,379)
Net income            (708)   (3,379)
Earnings per common share from continuing operations $    (.01) $    (.03)
Earnings per common share      (.01)     (.03)
Diluted earnings per common share from continuing operations     (.01)     (.02)
Diluted earnings per common share              (.01)       (.02)

 

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

 

Effective January 1, 2005, FHN adopted AICPA Statement of Position 03-3, “Accounting for Loans or Certain Debt Securities Acquired in a Transfer” (SOP 03-3), which modifies the accounting for certain loans that are acquired with evidence of deterioration in credit quality since origination. SOP 03-3 does not apply to loans recorded at fair value 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

 

10


 

Note 1 - Financial Information (continued)

 

initial investment in the loan. SOP 03-3 also prohibits the “carrying over” of valuation allowances on applicable loans. The impact of adopting SOP 03-3 was immaterial to the results of operations.

 

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

 

Accounting Changes Issued but Not Currently Effective. In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”, which permits fair value remeasurement for any hybrid financial instruments that contain an embedded derivative that otherwise would require bifurcation. Additionally, SFAS No. 155 clarifies the accounting guidance for beneficial interests in securitizations. SFAS No. 155 is effective for fiscal years beginning after September 15, 2006. Since FHN accounts for its beneficial interests in securitizations as trading securities, the adoption of SFAS No. 155 is not expected to have a significant impact on the results of operations.

 

 

11


  

Note 2 - Acquisitions/Divestitures

 

On March 1, 2006, FHN sold substantially all the assets of its national merchant processing business conducted primarily through First Horizon Merchant Services, Inc. (FHMS) and Global Card Services, Inc. The sale was to NOVA Information Systems (NOVA), a wholly-owned subsidiary of U.S. Bancorp. This transaction resulted in a pre-tax gain of approximately $340 million. In addition, a supplement to the purchase price may be paid to FHN if certain performance goals are achieved during a period following closing. This divestiture was accounted for as a discontinued operation, and prior periods were adjusted to exclude the impact of merchant operations from the results of continuing operations. In conjunction with the sale, FHN entered into a transitional service agreement with NOVA to provide or continue on-going services such as telecommunications, back-end processing and disaster recovery until NOVA converts the operations to their systems. On March 31, 2006, discontinued assets and liabilities primarily consist of operating account balances remaining from operations prior to the sale, operating receivables due from NOVA from post-sale activity and federal tax liabilities recognized on the gain on the sale.

 

On December 9, 2005, First Tennessee Bank National Association (FTBNA) sold three financial centers in Dyersburg, Tennessee, to First South Bank. This transaction resulted in a divestiture gain of $7.0 million. Immediately preceding the sale, the financial centers had loans of approximately $80 million and deposits of approximately $70 million.

 

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

 

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


On March 1, 2005, First Horizon Home Loan Corporation, a subsidiary of FTBNA, acquired Greenwich Home Mortgage Corporation of Cedar Knolls, New Jersey, for an initial payment of approximately $7.8 million in cash and FHN common stock. Net assets purchased, combined with the operating performance of the acquired business, will impact future payments owed to the sellers. The acquisition was immaterial to FHN. In first quarter 2006 an additional payment of approximately $ .4 million in cash and FHN common stock was made.

 

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

 

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

 

12


  

Note 3 - Loans


The composition of the loan portfolio is detailed below:

  March 31 December 31
(Dollars in thousands)                2006                2005           2005 
Commercial:    
   Commercial, financial and industrial  $   6,538,798   $   5,781,307   $   6,578,117 
   Real estate commercial          1,232,021           1,030,052              1,213,052 
   Real estate construction          2,277,825           1,427,955              2,108,121 
Retail:
   Real estate residential          8,486,345           7,358,940              8,357,143 
   Real estate construction          2,001,916           1,190,155              1,925,060 
   Other retail             161,617              160,457                 168,413 
   Credit card receivables             194,908              234,915                 251,016 
   Real estate loans pledged against other collateralized 
     borrowings                   293,561                            -                             - 
  Loans, net of unearned income     21,186,991         17,183,781            20,600,922 
Allowance for loan losses                 195,011                164,195                 189,705 
Total net loans        $ 20,991,980     $ 17,019,586   $ 20,411,217 
The following table presents information concerning nonperforming loans:
  March 31 December 31
(Dollars in thousands)                  2006                2005           2005 
Impaired loans  $ 45,912   $ 34,701   $ 36,635 
Other nonaccrual loans*                   19,420                  14,723  15,624 
Total nonperforming loans      $ 65,332     $ 49,424   $ 52,259 
* On March 31, 2006 and 2005, and on December 31, 2005, other nonaccrual loans included $16.0 million, $9.3 million, and
  $11.5 million, respectively, of loans held for sale. 

On March 31, 2006, $3.8 billion of real estate residential qualifying loans were pledged to secure potential Federal Home Loan Bank borrowings. Qualifying loans are comprised of residential mortgage loans secured by first and second liens and home equity lines of credit. In addition, $5.6 billion of commercial, financial and industrial loans were pledged to secure potential discount window borrowings from the Federal Reserve Bank.

Nonperforming loans consist of loans which management has identified as impaired, other nonaccrual loans and loans which have been restructured. On March 31, 2006 and 2005, there were no outstanding commitments to advance additional funds to customers whose loans had been restructured. The following table presents nonperforming loans on March 31:


 

             Three Months Ended
            March  31
(Dollars in thousands)           2006   2005
Total interest on impaired loans  $        179  $      284 
Average balance of impaired loans          43,806    36,072 
An allowance for loan losses is maintained for all impaired loans.  Activity in the allowance for loan losses related to non-impaired loans, impaired loans, and for the total allowance for the three months ended March 31, 2006 and 2005, is summarized as follows:
(Dollars in thousands)       Non-impaired     Impaired   Total  
Balance on December 31, 2004 $ 147,672  $   10,487  $ 158,159 
Provision for loan losses  12,951   158    13,109 
Charge-offs  (9,189)  (1,833)  (11,022)
Recoveries         2,572     1,377        3,949 
    Net charge-offs  (6,617)  (456)    (7,073)
Balance on March 31, 2005     $ 154,006    $   10,189    $ 164,195 
Balance on December 31, 2005 $ 179,635  $   10,070  $ 189,705 
Provision for loan losses    14,849    2,950     17,799 
Adjustment due to divestiture   (1,195)          -    (1,195)
Charge-offs    (12,381)  (2,410)    (14,791)
Recoveries          2,666       827       3,493 
    Net charge-offs        (9,715)     (1,583)      (11,298)
Balance on March 31, 2006     $ 183,574    $   11,437    $ 195,011 

 

13


 

Note 4 - Mortgage Servicing Rights

 

On January 1, 2006, FHN elected early adoption of SFAS No. 156, which requires servicing rights be initially measured at fair value. Subsequently, companies are permitted to elect, on a class-by-class basis, either fair value or amortized cost accounting for their servicing rights. Accordingly, FHN began initially recognizing all its classes of mortgage servicing rights (MSR) at fair value and elected to irrevocably continue application of fair value accounting to all its classes of MSR. Classes of MSR are determined in accordance with FHN’s risk management practices and market inputs used in determining the fair value of the servicing asset. FHN recognized the cumulative effect of a change in accounting principle totaling $.2 million, net of tax, representing the excess of the fair value of the servicing asset over the recorded value on January 1, 2006. The balance of MSR included on the Consolidated Condensed Statement s of Condition represents the rights to service approximately $96.3 billion of mortgage loans on March 31, 2006, for which a servicing right has been capitalized. Following is a summary of changes in capitalized MSR for first quarter 2006:

 

First      Second 
(Dollars in thousands)     Liens     Liens   HELOC  
Fair value on January 1, 2006 $1,318,219  $  5,470  $14,384 
Addition of mortgage servicing rights 95,624  6,360  1,971 
Reductions due to loan payments (58,641) (797) (2,317)
Changes in fair value due to:
  Changes in current market interest rates 94,249  49  506 
  Other changes in fair value 21  (20) 370 
Fair value on March 31, 2006     $1,449,472  $11,062  $14,914 

 

In 2005 these amounts were included at the lower of cost, net of accumulated amortization, or fair value. The cost basis of MSR qualifying for SFAS No. 133 fair value hedge accounting was adjusted to reflect changes in fair value. MSR were amortized over the period of and in proportion to the estimated net servicing revenues. MSR were periodically evaluated for impairment. Impairment occurred when the current fair value of the servicing right was less than its recorded value. A quarterly value impairment analysis was performed using a discounted cash flow analysis which was disaggregated by strata representing predominant risk characteristics, including fixed and adjustable rate loans. Impairment, if any, was recognized through a valuation allowance for individual strata. However, if the impairment was determined to be other than temporary, a direct write-off of the asset was made. With the adoption of SFAS No. 156, MSR are v alued at fair value, both initially and prospectively; impairment tests are no longer performed. Following is a summary of changes in capitalized MSR for first quarter 2005:

 

(Dollars in thousands)          
Balance on December 31, 2004         $1,036,458 
Addition of mortgage servicing rights                 85,339 
Amortization               (48,338)
Market value adjustments                 72,561 
Permanent impairment               (11,632)
Decrease in valuation allowance                   1,257 
Balance on March 31, 2005         $1,135,645 

 

MSR on March 31, 2005, had an estimated market value of approximately $1,149.3 million. This balance represents the rights to service approximately $85.1 billion of mortgage loans on March 31, 2005, for which a servicing right has been capitalized. On March 31, 2005, valuation allowances due to temporary impairment of $3.0 million were required. Following is a summary of changes in the valuation allowance for first quarter 2005:


(Dollars in thousands)          
Balance on December 31, 2004 $  4,231 
Permanent impairment (11,632)
Servicing valuation provision         10,375 
Balance on March 31, 2005          $  2,974 

 

Since sales of MSR tend to occur in private transactions and the precise terms and conditions of the sales are typically not readily available, there is a limited market to refer to in determining the fair value of MSR. As such, like other participants in the mortgage banking business,

14

 

Note 4 - Mortgage Servicing Rights (continued)

 

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

 

The sensitivity of the current fair value of all retained or purchased interests for MSR to immediate 10 percent and 20 percent adverse changes in assumptions on March 31, 2006, are as follows:


(Dollars in thousands First    Second   
except for annual cost to service)     Liens   Liens      HELOC    
March 31, 2006
Fair value of retained interests  $1,449,472    $11,062    $14,914  
Weighted average life (in years)  6.8    2.9    2.0  
Annual prepayment rate 11.3% 30.0% 49.0%
  Impact on fair value of 10% adverse change  $    (53,989)   $    (537)   $    (913) 
  Impact on fair value of 20% adverse change  (104,182)   (1,017)   (1,738) 
Annual discount rate on servicing cash flows 10.5% 14.0% 18.0%
  Impact on fair value of 10% adverse change  $    (59,670)   $    (297)   $    (342) 
  Impact on fair value of 20% adverse change  (114,684)   (580)   (666) 
Annual cost to service (per loan) *  $            55    $       50    $       50  
  Impact on fair value of 10% adverse change        (14,988)         (226)         (237) 
  Impact on fair value of 20% adverse change  (26,976)   (451)   (474) 
Annual earnings on escrow 4.6% 2.5% 4.4%
  Impact on fair value of 10% adverse change  $    (34,541)   $    (176)   $    (600) 
  Impact on fair value of 20% adverse change      (68,331)   (351)   (1,199) 

* The annual cost to service includes an incremental cost to service delinquent loans. Historically, this fair value sensitivity disclosure has not included this incremental cost. The annual cost to service loans without the incremental cost to service delinquent loans was $49 as of March 31, 2006.


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


First Second 
      Liens Liens HELOC
March 31, 2006
Weighted average life (in years) 6.1-6.9 2.7-2.9 1.7-2.0
Annual prepayment rate 13.9%-15.9% 30% 45%-55%
Annual discount rate 9.9%-11.4% 14% 18%
Annual cost to service (per loan) * $56-$57 $50 $50
Annual earnings on escrow     4.2%-4.6% 2.0%-4.6% 2.0%-4.4%


* The annual cost to service includes an incremental cost to service delinquent loans. Historically, the disclosure of annual cost to service assumptions has not included this incremental cost. The range of annual cost to service loans without the incremental cost to service delinquent loans was $49-$50 for MSR capitalized during first quarter 2006.


15

Note 5 - Intangible Assets

 

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

 

      Other
    Intangible
(Dollars in thousands)       Goodwill          Assets*
December 31, 2004         $160,067      $22,520   
Amortization expense   -      (2,536)  
Acquisitions**     100,450     58,120   
March 31, 2005         $260,517      $78,104   
December 31, 2005   $281,440      $76,647   
Amortization expense   -      (2,888)  
Acquisitions**  1,145     3,000   
Divestitures   (1,110)     (93)  
March 31, 2006         $281,475      $ 76,666   
 * Represents customer lists, acquired contracts, premium on purchased deposits, covenants not to compete
    and assets related to the minimum pension liability.
** Preliminary purchase price allocations on acquisitions are based upon estimates of fair value and are
    subject to change.
Certain previously reported amounts have been reclassified to agree with current presentation.

 

The gross carrying amount of other intangible assets subject to amortization is $141.9 million on March 31, 2006, net of $65.3 million of

accumulated amortization. Estimated aggregate amortization expense for the remainder of 2006 is expected to be $7.8 million and is expected to be $9.8 million, $8.5 million, $6.8 million and $6.4 million for the twelve-month periods of 2007, 2008, 2009, and 2010 respectively.

 

The following is a summary of goodwill detailed by reportable segments for the three months ended March 31:

 

Commercial Mortgage Capital 
(Dollars in thousands)   Banking    Banking  Markets Total    
December 31, 2004   $  87,208  $  55,214  $  17,645  $160,067 
Acquisitions*     -    3,936    96,514    100,450 
March 31, 2005   $  87,208  $  59,150  $114,159  $260,517 
December 31, 2005 $104,781  $  61,593  $115,066  $281,440 
Acquisitions*   30    1,115    -    1,145 
Divestitures (1,110)   -    -    (1,110)
March 31, 2006    $103,701   $  62,708   $115,066   $281,475 
* Preliminary purchase price allocations on acquisitions are based upon estimates of fair value and
  are subject to change.
Certain previously reported amounts have been reclassified to agree with current presentation.



16

  

Note 6 – Long-Term Debt

 

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

 

March 31   December 31
(Dollars in thousands)   2006   2005   2005  
First Tennessee Bank National Association:
Subordinated notes (qualifies for total capital under the Risk-Based Capital guidelines):
    Matures on January 15, 2015 -- 5.05%  $   380,242   $   391,246   $   392,279 
    Matures on May 15, 2013 -- 4.625%        244,572         252,065  251,135 
    Matures on December 1, 2008 -- 5.75%        135,784         137,358  136,847 
    Matures on April 1, 2008 -- 6.40%          89,859           89,789  89,841 
    Matures on April 1, 2016 -- 5.65%        247,014                    -                    - 
Bank notes*     1,504,674      1,249,960  874,672 
Extendible notes**
    Final maturity of November 17, 2010 -- 4.7425% on March 31, 2006, and 
       4.36% on December 31, 2005     1,249,148                    -  1,249,110 
Federal Home Loan Bank borrowings***            4,297  4,648  4,381 
Other****                   -             1,322                    - 
First Horizon National Corporation:
Subordinated capital notes (qualifies for total capital under the Risk-Based Capital guidelines):
    Matures on May 15, 2013 -- 4.50% 97,860        100,882  100,478 
    Matured on November 15, 2005 -- 6.75%                   -           22,881                    - 
Subordinated notes:
    Matures on January 6, 2027 -- 8.07%        100,356         100,332  99,737 
    Matures on April 15, 2034 -- 6.30%        200,431         195,637  193,878 
FT Real Estate Securities Company, Inc.
Cumulative preferred stock (qualifies for total capital under the Risk-Based Capital guidelines):
    Matures on March 31, 2031 -- 9.50%          45,302           45,234  45,285 
First Horizon ABS Trust 
Other collateralized borrowings
    Matures on October 25, 2034--5.01%        299,800                    -                    - 
Total      $4,599,339   $2,591,354   $3,437,643 
    * The bank notes were issued with variable interest rates and have remaining terms of 1 to 5 years. These bank notes had weighted
       average interest rates of 4.91 percent and 2.88 percent on March 31, 2006 and 2005, respectively and 4.66 percent on December 31,
       2005.
   ** As of March 31, 2006, the extendible notes had a contractual maturity of April 17, 2007, but are extendible at the investors' option to the
       final maturity date of November 17, 2010.
 *** The Federal Home Loan Bank (FHLB) borrowings were issued with fixed interest rates and have remaining terms of 3 to 23 years.
      These borrowings had weighted average interest rates of 3.36 percent and 3.53 percent on March 31, 2006 and 2005, respectively
       and 3.40 percent on December 31, 2005. 
**** Other long-term debt was comprised of an unsecured obligation issued with a fixed interest rate of 5.00 percent on March 31, 2005.

 

Annual principal repayment requirements as of March 31, 2006, are as follows:

(Dollars in thousands)              
2006  $   350,254 
2007     1,400,338 
2008        606,963 
2009        220,321 
2010               138 
2011 and after                 2,068,987 

 

All subordinated notes are unsecured and are subordinate to other present and future senior indebtedness. FTBNA’s subordinated notes and FHN’s subordinated capital notes qualify as Tier 2 risk-based capital under the Office of the Comptroller of the Currency and Federal Reserve Board guidelines for assessing capital adequacy. Prior to February 2005, FTBNA had a bank note program under which the bank was able to borrow funds from time to time at maturities of 30 days to 30 years.  This bank note program was terminated in connection with



17

 

Note 6 – Long-Term Debt (continued)

 

the establishment of a new program.  That termination did not affect any previously issued notes outstanding.  In February 2005, FTBNA established a new bank note program providing additional liquidity of $5.0 billion.  This bank note program provides FTBNA with a facility under which it may continuously issue and offer short- and medium-term unsecured notes.  On March 31, 2006, $3.7 billion was available under current conditions through the bank note program. 

 

In November 2005, FTBNA entered into a $3.0 billion floating rate extendible note program. The extendible note program provides FTBNA with a facility under which it may issue and offer unsecured and unsubordinated notes with initial maturities of thirteen months and final maturities of five years. On March 31, 2006, $1.7 billion was available under current conditions through the extendible note program.


18

  

Note 7 - Regulatory Capital

 

FHN is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on FHN's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines that involve quantitative measures of assets, liabilities and certain derivatives as calculated under regulatory accounting practices must be met. Capital amounts and classification are also subject to qualitative judgment by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require FHN to maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets (leverage). Management believes, as of March 31, 2006, that FHN met all capital adequacy requirements to which it was subject.

 

The actual capital amounts and ratios of FHN and FTBNA are presented in the table below. In addition, FTBNA must also calculate its capital ratios after excluding financial subsidiaries as defined by the Gramm-Leach-Bliley Act of 1999. Based on this calculation FTBNA’s Total Capital, Tier 1 Capital and Leverage ratios were 12.18 percent, 8.24 percent and 6.71 percent, respectively, on March 31, 2006, and were 12.35 percent, 8.73 percent and 6.95 percent, respectively, on March 31, 2005.


       First Horizon National       First Tennessee Bank
              Corporation          National Association
(Dollars in thousands) Amount   Ratio             Amount   Ratio
On March 31, 2006:
Actual:
Total Capital $ 3,902,841  13.38%  $ 3,725,324  12.50%  
Tier 1 Capital  2,558,302  8.77  2,480,785  8.33
Leverage  2,558,302  6.86  2,480,785  6.70
For Capital Adequacy Purposes:
Total Capital  2,333,344  > 8.00  2,383,592  > 8.00
Tier 1 Capital  1,166,672  > 4.00  1,191,796  > 4.00
Leverage  1,492,581  > 4.00  1,481,261  > 4.00
To Be Well Capitalized Under Prompt                                                                                 
    Corrective Action Provisions:                                  
Total Capital  2,979,491  >     10.00
Tier 1 Capital  1,787,694  > 6.00
Leverage          1,851,576  > 5.00
On March 31, 2005:
Actual:
Total Capital $ 3,433,186  13.34%  $ 3,307,677  12.61%  
Tier 1 Capital  2,324,346  9.03  2,298,837  8.77
Leverage  2,324,346  6.90 2,298,837  6.87
For Capital Adequacy Purposes:
Total Capital  2,058,937  > 8.00  2,097,716  > 8.00
Tier 1 Capital  1,029,468  > 4.00  1,048,858  > 4.00
Leverage  1,347,401  > 4.00  1,337,566  > 4.00
To Be Well Capitalized Under Prompt                                                                                 
    Corrective Action Provisions: 
Total Capital  2,622,145  >     10.00
Tier 1 Capital  1,573,287  > 6.00
Leverage          1,671,958  > 5.00

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


19

                                                                                               

 

Note 8 - Earnings Per Share
The following table shows a reconciliation of earnings per common share to diluted earnings per common share:
Three Months Ended
March 31
(In thousands, except per share data)         2006 2005
Net income from continuing operations  $     3,410   $ 102,815 
Income from discontinued operations, net of tax   210,273    3,015 
Cumulative effect of changes in accounting principle, net of tax       1,345                           - 
Net income          $ 215,028   $ 105,830 
Weighted average common shares                125,489                124,717 
Effect of dilutive securities                           3,611                    3,315 
Diluted average common shares                       129,100                128,032 
Earnings per common share:
Net income from continuing operations  $         .03   $         .82 
Income from discontinued operations, net of tax           1.67            .03 
Cumulative effect of changes in accounting principle, net of tax           .01                           - 
Net income          $       1.71   $         .85 
Diluted earnings per common share:
Net income from continuing operations  $         .03   $         .80 
Income from discontinued operations, net of tax         1.63          .03 
Cumulative effect of changes in accounting principle, net of tax           .01                           - 
Net income          $       1.67   $         .83 
Outstanding stock options of 5,656 and 3,014 with weighted average exercise prices of $42.76 and $45.46 per share as of March 31, 2006 and 2005, respectively, were not included in the computation of diluted earnings per common share because such shares would have had an antidilutive effect on earnings per common share.
Certain previously reported amounts have been reclassified to agree with current presentation.


On March 1, 2006, FHN purchased 4 million shares of its common stock to minimize the potentially dilutive effect of the merchant divestiture on future earnings per share. This share repurchase was accomplished through an accelerated share repurchase program for an initial purchase price of approximately $158 million in first quarter 2006. The final settlement, after the repurchase period, is expected to occur in second quarter 2006.


20

Note 9 - Contingencies and Other Disclosures

Contingencies. Contingent liabilities arise in the ordinary course of business, including those related to litigation. Various claims and lawsuits are pending against FHN and its subsidiaries. Although FHN cannot predict the outcome of these lawsuits, after consulting with counsel, management 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 FHN.

In November 2000, a complaint was filed in state court in Jackson County, Missouri against FHN’s subsidiary, First Horizon Home Loans. The case generally concerns the charging of certain loan origination fees, including 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-lien mortgage loans. Among other relief, plaintiffs seek a refund of fees, a repayment and forgiveness of loan interest, prejudgment interest, punitive damages, and loan rescission. In response to pre-trial motions, the court has ruled that Missouri law governs the loan transactions and has certified a statewide class action involving approximately 4,000 loans. Discovery is ongoing and additional pre-trial motions are pending. Trial is currently scheduled for November 2006. FHN believes that it has meritorious defenses and inte nds to continue to protect its rights and defend this lawsuit vigorously, through trial and appeal, if necessary.

 

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

 

First Horizon Home Loans services a first-lien mortgage loan portfolio of approximately $97.3 billion as of March 31, 2006, a significant portion of which is held by GNMA, FNMA, FHLMC or private security holders. In connection with its servicing activities, First Horizon Home Loans guarantees the receipt of the scheduled principal and interest payments on the underlying loans. In the event of customer non-performance on the loan, First Horizon Home Loans is obligated to make the payment to the security holder. Under the terms of the servicing agreements, First Horizon Home Loans can utilize payments received from other prepaid loans in order to make the security holder whole. In the event payments are ultimately made by First Horizon Home Loans to satisfy this obligation, for loans sold with no recourse, all funds are recoverable from the government agency at foreclosure sale.

 

First Horizon Home Loans is also subject to losses in its loan servicing portfolio due to loan foreclosures and other recourse obligations. Certain agencies have the authority to limit their repayment guarantees on foreclosed loans resulting in certain foreclosure costs being borne by servicers. In addition, First Horizon Home Loans has exposure on all loans sold with recourse. First Horizon Home Loans has various claims for reimbursement, repurchase obligations, and/or indemnification requests outstanding with government agencies or private investors. First Horizon Home Loans has evaluated all of its exposure under recourse obligations based on factors, which include loan delinquency status, foreclosure expectancy rates and claims outstanding. Accordingly, First Horizon Home Loans had an allowance for losses on the mortgage servicing portfolio of approximately $22.1 million and $16.5 million as of March 31, 2006 and 2005, r espectively. First Horizon Home Loans has sold certain mortgage loans with an agreement to repurchase the loans upon default. As of March 31, 2006 and 2005, First Horizon Home Loans had single-family residential loans with outstanding balances of $150.6 million and $190.5 million, respectively that were sold on a recourse basis. For the single-family residential loans, in the event of borrower nonperformance, First Horizon Home Loans would assume losses to the extent they exceed the value of the collateral and private mortgage insurance, FHA insurance or VA guarantees. As of March 31, 2006 and 2005, the outstanding principal balance of loans sold with limited recourse and serviced by First Horizon Home Loans was $3.1 billion and $3.4 billion, respectively.

 

FHN has securitized and sold HELOC and second-lien mortgages which are held by private security holders, and on March 31, 2006, the outstanding principal balance of these loans was $555.8 million and $130.0 million, respectively. On March 31, 2005, the outstanding principal balance of securitized and sold HELOC and second-lien mortgages was $1.1 billion and $210.3 million, respectively. In connection with its servicing activities, FTBNA does not guarantee the receipt of the scheduled principal and interest payments on the underlying loans but does have residual interests of $57.2 million and $61.1 million on March 31, 2006 and 2005, respectively, which are available to make the security holder whole in the event of credit losses. FHN has projected expected credit losses in the valuation of the residual interest.


21

  

Note 10 – Pension and Other Employee Benefits

 

Pension plan. FHN provides pension benefits to employees retiring under the provisions of a noncontributory, defined benefit pension plan. Employees of FHN’s mortgage subsidiary and certain insurance subsidiaries are not covered by the pension plan. Pension benefits are based on years of service, average compensation near retirement and estimated social security benefits at age 65. The annual funding is based on an actuarially determined amount using the entry age cost method. FHN also maintains a nonqualified supplemental executive retirement plan that covers certain employees whose benefits under the pension plan have been limited under Tax Code Section 415 and Tax Code Section 401(a)(17), which limit compensation to $210,000 for purposes of benefit calculations. Compensation is defined in the same manner as it is under the pension plan. Participants receive the difference between th e monthly pension payable, if tax code limits did not apply, and the actual pension payable. All benefits provided under this plan are unfunded and payments to plan participants are made by FHN.

 

Other employee benefits. FHN provides postretirement medical insurance to full-time employees retiring under the provisions of the FHN Pension Plan. The postretirement medical plan is contributory with retiree contributions adjusted annually. The plan is based on criteria that are a combination of the employee’s age and years of service and utilizes a two-step approach. For any employee retiring on or after January 1, 1995, FHN contributes a fixed amount based on years of service and age at time of retirement. FHN’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. FSP F AS 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003,” requires a plan sponsor to determine if benefits offered through a postretirement health care plan are actuarially equivalent to Medicare Part D. Plan benefits were determined to be actuarially equivalent in 2005.

 

The components of net periodic benefit cost for the three months ended March 31 are as follows:

 

Pension Benefits Postretirement Benefits
(Dollars in thousands) 2006   2005   2006   2005
Components of net periodic benefit cost
Service cost  $  4,520   $  3,945   $    83   $    199 
Interest cost          5,486          5,318           279           438 
Expected return on plan assets        (8,945)       (8,123)        (421)        (417)
Amortization of prior service cost/(benefit)             211             207           (44)          (44)
Recognized losses/(gains)          1,769          1,014         (140)               - 
Amortization of transition obligation                  -                  -             247           247 
Net periodic cost $  3,041     $  2,361     $      4     $    423 

 

FHN plans to contribute approximately $20 million to the pension plan in second quarter 2006, and does not anticipate making any further contributions to this plan during the remainder of 2006. FHN does not anticipate making a contribution to the other employee benefit plan in 2006.


22

 

Note 11 - Stock Option, Restricted Stock Incentive, and Dividend Reinvestment Plans

 

Stock option plans. FHN 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 FHN common stock at a price equal to its fair market value at the date of grant. However, if the grantee agreed to receive the options in lieu of compensation, the exercise price was less than the fair market value. The foregone compensation plus the exercise price equaled the fair market value of the stock on the date of grant. This deferral program was discontinued in 2005, and any options issued below market on the date of grant during 2005 were related to 2004 salary deferrals for employees and 2004 board compensation for directors. All options vest within 3 to 5 years and expire 7 years or 10 years from the date of grant, except for those options that were previously part o f compensation deferral, which vest immediately or after 6 months and expire 20 years from the date of grant. After January 2, 2004, stock options granted that are part of the compensation deferral vest immediately or after 6 months and expire 10 years from the date of grant. There were 1,596,761 shares available for option or share grants on March 31, 2006.

 

The summary of stock option activity during quarter ended March 31, 2006, is shown below:


Weighted 
Weighted Average Aggregate
 Options Average Remaining Intrinsic Value
  Outstanding   Exercise Price  Contractual Term   (thousands)
January 1, 2006 20,289,455  $32.87       
Options granted                   -    -       
Options exercised (876,896)    25.58       
Options canceled (193,148)    41.13       
March 31, 2006 19,219,411       33.12        7.09   $174,204 
Options exercisable 14,169,967    $29.91        7.64   $168,354 


The total intrinsic value of options exercised during the quarters ended March 31, 2006 and 2005, was $12.7 million and $7.6 million, respectively. As of March 31, 2006, there was $16.6 million of unrecognized compensation cost related to nonvested stock options. That cost is expected to be recognized over a weighted-average period of 2.85 years. The following data summarizes information about stock options granted during quarters ended March 31:

 

Weighted 
Average Fair
  Number Value per Option
         Granted   at Grant Date
2006:            
Options granted             N/A    N/A 
2005:
Options granted                    87,302    $  19.81         


FHN used the Black-Scholes Option Pricing Model to estimate the fair value of stock options granted in the quarters ended March 31, 2006 and 2005, with the following assumptions:

 

Three months ended
March 31,
        2006   2005    
Expected dividend yield N/A 3.98%
Expected lives of options granted N/A 5.29 years
Expected volatility N/A 21.65%
Risk-free interest rates       N/A   3.68%


23


Note 11 - Stock Option, Restricted Stock Incentive, and Dividend Reinvestment Plans (continued)

Expected lives of options granted are determined based on the vesting period, historical exercise patterns and contractual term of the options. Expected volatility is estimated using average of daily high and low stock prices, excluding swings in volatility caused by unique infrequent circumstances. Expected volatility assumptions are determined over the period of the expected lives of the options.

 

Restricted stock incentive plans. FHN has authorized the issuance of its common stock for awards to executive employees who have a significant impact on the profitability of FHN under a performance accelerated restricted stock program. The performance stock units vest only if predetermined performance measures are met. Additionally, one of the plans allows stock awards to be granted to non-employee directors upon approval by the board of directors. It has been the recent practice of the board to grant 8,000 shares of restricted stock to each new non-employee director upon election to the board, with restrictions lapsing at a rate of ten percent per year. FHN also grants restricted stock awards to management employees which typically vest over 3 and 4 years. The summary of restricted stock activity during the quarter ended March 31, 2006, is presented below:


                  Weighted
                  average
                Share grant date
                Units fair value
Nonvested at January 1, 2006               1,228,282    $41.10       
Share units granted                            52,950  38.58       
Share units vested                             (8,522) 21.61       
Share units canceled                         (133,930) 41.97       
Nonvested at March 31, 2006               1,138,780    $41.03       

 

As of March 31, 2006, there was $14.4 million of unrecognized compensation cost related to nonvested restricted stock plans. That cost is expected to be recognized over a weighted-average period of 3.34 years. The total fair value of shares vested during the quarter ended March 31, 2006, was $.3 million. No restricted stock shares vested during the quarter ended March 31, 2005.

 

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. Due to deferred compensation legislation passed in 2004, participants are no longer allowed to make voluntary deferral elections under the stock programs.

 

The compensation (benefit)/cost that has been included in income from continuing operations pertaining to both stock option and restricted stock plans was ($1.3) million and $6.4 million for the quarters ended March 31, 2006 and 2005, respectively. The corresponding total income tax (expense)/benefit recognized in the income statement was ($.5) million and $2.4 million for the quarters ended March 31, 2006 and 2005, respectively.

 

Consistent with Tennessee state law, only new shares may be utilized in connection with any issuance of FHN common stock which may be required as a result of share based compensation awards. FHN historically obtains authorization from the Board of Directors to repurchase any shares that may be issued at the time a plan is approved or amended. Repurchases are authorized to 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. FHN does not currently expect to repurchase a material number of shares related to the plans during the next annual period.

 

Dividend reinvestment plan. The Dividend Reinvestment and Stock Purchase Plan (the Plan) authorizes the sale of FHN’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. The price of shares purchased on the open market is the average price paid.


24

 

Note 12 – Business Segment Information

 

FHN has four business segments, Retail/Commercial Banking, Mortgage Banking, Capital Markets and Corporate. The Retail/Commercial Banking segment offers financial products and services, including traditional lending and deposit taking, to retail and commercial customers. Additionally, Retail/Commercial Banking provides investments, insurance, financial planning, trust services and asset management, credit card, cash management, check clearing, and correspondent services. On March 1, 2006, FHN sold its national merchant processing business. The divestiture was accounted for as a discontinued operation which is included in the Retail/Commercial Banking segment. The Mortgage Banking segment consists of core mortgage banking elements including originations and servicing and the associated ancillary revenues related to these businesses. The Capital Markets segment consists of traditional capital markets securities activities, equi ty research and investment banking. The Corporate segment consists of unallocated corporate expenses, expense on subordinated debt issuances and preferred stock, bank-owned life insurance, unallocated interest income associated with excess equity, net impact of raising incremental capital, funds management and venture capital. Periodically, FHN adapts its segments to reflect changes in expense allocations between segments. In 2005, FHN adapted its segments to reflect the reclassification of certain trust preferred assets and related net interest income to the Capital Markets segment from Retail/Commercial Banking. Previously reported amounts have been reclassified to agree with current presentation. Effective January 1, 2006, FHN adopted SFAS No. 123-R and retroactively applied the provisions of the standard. Accordingly, results for prior periods have been adjusted to reflect expensing of share-based compensation.

 

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 months ended March 31:


Three Months Ended
March 31
(Dollars in thousands)                          2006         2005
Total Consolidated
Net interest income   $      245,721    $      227,447 
Provision for loan losses        17,799         13,109 
Noninterest income        205,744         322,878 
Noninterest expense                 443,215          384,537 
   Pre-tax (loss)/income               (9,549)        152,679 
(Benefit)/provision for income taxes                       (12,959)                49,864 
Income from continuing operations                3,410             102,815 
Income from discontinued operations, net of tax                  210,273                   3,015 
Income before cumulative effect            213,683             105,830 
Cumulative effect of changes in accounting principle, net of tax                    1,345                           - 
Net income     $      215,028      $      105,830 
Average assets             $ 37,689,523      $ 34,091,441 
Retail/Commercial Banking
Net interest income   $      224,869    $      198,653 
Provision for loan losses        18,026         13,069 
Noninterest income        106,493         100,859 
Noninterest expense                 215,555          179,750 
   Pre-tax income        97,781         106,693 
Provision for income taxes                        27,899                 33,857 
Income from continuing operations              69,882               72,836 
Income from discontinued operations, net of tax                  210,273                   3,015 
Income before cumulative effect            280,155               75,851 
Cumulative effect of changes in accounting principle, net of tax                       522                           - 
Net income             $      280,677      $        75,851 
Average assets             $ 23,045,183      $ 19,793,641 
Certain previously reported amounts have been reclassified to agree with current presentation.


25

   

Note 12 – Business Segment Information (continued)

 

Three Months Ended
March 31
(Dollars in thousands)                          2006         2005
Mortgage Banking
Net interest income   $        25,415    $        33,248 
Provision for loan losses                  (227)        40 
Noninterest income        94,704         122,575 
Noninterest expense                 125,699          109,900 
   Pre-tax (loss)/income   (5,353)        45,883 
(Benefit)/provision for income taxes                         (2,114)                16,458 
(Loss)/income before cumulative effect               (3,239)              29,425 
Cumulative effect of changes in accounting principle, net of tax                       414                           - 
Net (loss)/ income            $         (2,825)     $        29,425 
Average assets             $   6,206,548      $   5,662,802 
Capital Markets
Net interest expense  $         (5,563)  $         (5,225)
Noninterest income        98,903         96,427 
Noninterest expense                 86,379          81,813 
   Pre-tax income        6,961         9,389 
Provision for income taxes                          1,745                   4,049 
Income before cumulative effect                5,216                 5,340 
Cumulative effect of changes in accounting principle, net of tax                       179                           - 
Net income             $          5,395      $          5,340 
Average assets             $   4,867,762      $   5,396,616 
Corporate
Net interest income   $          1,000    $             771 
Noninterest (expense)/ income             (94,356)                3,017 
Noninterest expense                        15,582                 13,074 
   Pre-tax loss           (108,938)               (9,286)
Income tax benefit                       (40,489)                 (4,500)
Loss before cumulative effect             (68,449)               (4,786)
Cumulative effect of changes in accounting principle, net of tax                       230                           - 
Net loss    $       (68,219)    $         (4,786)
Average assets             $   3,570,030      $   3,238,382 
Certain previously reported amounts have been reclassified to agree with current presentation.


26


Note 13 – Derivatives


In the normal course of business, FHN utilizes various financial instruments, through its mortgage banking, capital markets and risk management operations, which include derivative contracts and credit-related arrangements, as part of its risk management strategy and as a means to meet customers’ needs. These instruments are subject to credit and market risks in excess of the amount recorded on the balance sheet in accordance with generally accepted accounting principles. The contractual or notional amounts of these financial instruments do not necessarily represent credit or market risk. However, they can be used to measure the extent of involvement in various types of financial instruments. 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 financial instruments. ALCO, in conjun ction with credit officers, also periodically reviews counterparty creditworthiness.

 

Credit risk represents the potential loss that may occur because a party to a transaction fails to perform according to the terms of the contract. The measure of credit exposure is the replacement cost of contracts with a positive fair value. FHN 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. FHN manages market risk by establishing and monitoring limits on the types and degree of risk that may be undertaken. FHN continually measures this risk through the use of models that measure value-at-risk and earnings-at-risk.

 

Derivative Instruments. FHN enters into various derivative contracts both in a dealer capacity, to facilitate customer transactions, and also as a risk management tool. Where contracts have been created for customers, FHN enters into transactions with dealers to offset its risk exposure. Derivatives are also used as a risk management tool to hedge FHN’s exposure to changes in interest rates or other defined market risks.

 

Derivative instruments are recorded on the Consolidated Condensed Statements of Condition as other assets or other liabilities measured at fair value. Fair value is defined as the amount FHN 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. For a fair value hedge, changes in the fair value of the derivative instrument and changes in the fair value of the hedged asset or liability are recognized currently in earnings. For a cash flow hedge, changes in the fair value of the derivative instrument, to the extent that it is effective, is recorded in accumulated other comprehensive income and subsequently reclassified to earnings as the hedged transaction impacts net income. Any ineffective portion of a cash flow hedge is recognized currently in earnings. For free-standing derivative instru ments, changes in fair value are recognized currently in earnings. Cash flows from derivative contracts are reported as operating activities on the Consolidated Condensed Statements of Cash Flows.

 

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. Futures contracts are exchange-traded contracts where two parties agree to purchase and sell a specific quantity of a financial instrument at a specific price, with delivery or settlement at a specified date. 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.

 

Mortgage Banking

 

Mortgage banking interest rate lock commitments are short-term commitments to fund mortgage loan applications in process (the pipeline) for a fixed term at a fixed price. During the term of an interest rate lock commitment, First Horizon Home Loans has the risk that interest rates will change from the rate quoted to the borrower. First Horizon Home Loans enters into forward sales contracts with respect to fixed rate loan commitments and futures contracts with respect to adjustable rate loan commitments as economic hedges designed to protect the value of the interest rate lock commitments from changes in value due to changes in interest rates. Under SFAS No. 133 interest rate lock commitments qualify as derivative financial instruments and as such do not qualify for hedge accounting treatment. As a result, the interest rate lock commitments are recorded at fair value with changes in fair value recorded in current earnings as gain or loss on the sale of loans in mortgage banking noninterest income. Changes in the fair value of the derivatives that serve as economic hedges of interest rate lock


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Note 13 – Derivatives (continued)

commitments are also included in current earnings as a component of gain or loss on the sale of loans in mortgage banking noninterest income.

 

First Horizon Home Loans’ warehouse (mortgage loans held for sale) is subject to changes in fair value, primarily due to fluctuations in interest rates from the loan closing date through the date of sale of the loan into the secondary market. Typically, the fair value of the warehouse declines in value when interest rates increase and rises in value when interest rates decrease. To mitigate this risk, First Horizon Home Loans enters into forward sales contracts and futures contracts to provide an economic hedge against those changes in fair value on a significant portion of the warehouse. These derivatives are recorded at fair value with changes in fair value recorded in current earnings as a component of the gain or loss on the sale of loans in mortgage banking noninterest income.

 

To the extent that these interest rate derivatives are designated to hedge specific similar assets in the warehouse and prospective analyses indicate that high correlation is expected, the hedged loans are considered for hedge accounting under SFAS No. 133. Anticipated correlation is determined based on historical regressions between the change in fair value of the derivatives and the change in fair value of hedged mortgage loans. Beginning in fourth quarter 2005, anticipated correlation is determined by projecting a dollar offset relationship for each tranche based on anticipated changes in the fair value of the hedged mortgage loans and the related derivatives, in response to various interest rate shock scenarios. Hedges are reset daily and the statistical correlation is calculated using these daily data points. Retrospective hedge effectiveness is measured using the regression correlation results. First Horizon Home L oans generally maintains a coverage ratio (the ratio of expected change in the fair value of derivatives to expected change in the fair value of hedged assets) of approximately 100 percent on warehouse loans hedged under SFAS No. 133. Effective SFAS No. 133 hedging results in adjustments to the recorded value of the hedged loans. These basis adjustments, as well as the change in fair value of derivatives attributable to effective hedging, are included as a component of the gain or loss on the sale of loans in mortgage banking noninterest income.

 

Warehouse loans qualifying for SFAS No. 133 hedge accounting treatment totaled $1.5 billion and $.7 billion on March 31, 2006 and 2005, respectively. The balance sheet impacts of the related derivatives were net assets of $9.4 million and $5.0 million on March 31, 2006 and 2005, respectively.

 

First Horizon Home Loans also enters into hedges of the MSR to minimize the effects of loss in value of MSR associated with increased prepayment activity that generally results from declining interest rates.  In a rising interest rate environment, the value of the MSR generally will increase while the value of the hedge instruments will decline.  First Horizon Home Loans enters into interest rate contracts (including swaps, swaptions, and mortgage forward sales contracts) to hedge against the effects of changes in fair value of its MSR. Substantially all capitalized MSR are hedged for economic purposes.

 

Prior to the adoption of SFAS No. 156, First Horizon Home Loans hedged the changes in MSR value attributable to changes in the benchmark interest rate (10-year LIBOR swap rate).  The vast majority of MSR routinely qualified for hedge accounting. For purposes of measuring effectiveness of the hedge, time decay and recognized net interest income, including changes in value attributable to changes in spot and forward prices, if applicable, were excluded from the change in value of the related derivatives. Interest rate derivative contracts used to hedge against interest rate risk in the servicing portfolio were designated to specific risk tranches of servicing.   Hedges were reset at least monthly and more frequently, as needed, to respond to changes in interest rates or hedge composition.  Generally, a coverage ratio approximating 100 percent was maintained on hedged MSR.  Prior to acquiring a new hedge instrument, First Horizon Home Loans performed a prospective evaluation of anticipated hedge effectiveness by reviewing the historical regression between the underlying index of the proposed hedge instrument and the mortgage rate.  At the end of each hedge period, the change in the fair value of the hedged MSR asset due to the change in benchmark interest rate was calculated and became a historical data point.  Retrospective hedge effectiveness was determined by performing a regression analysis of all collected data points over a rolling 12-month period.  Effective hedging under SFAS No. 133 resulted in adjustments to the recorded value of the MSR.  These basis adjustments, as well as the change in fair value of derivatives attributable to effective hedging, were included as a component of servicing income in mortgage banking noninterest income. MSR subject to SFAS No. 133 hedges totaled $1.1 billion on March 31, 2005. The balance sheet impact of the related derivatives was a net asset o f $3.2 million on March 31, 2005. The following table summarizes certain information related to mortgage banking hedging activities for the quarters ended March 31:


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Note 13 – Derivatives (continued)

 

            Three Months Ended
            March 31,
(Dollars in thousands)   2006 2005
Warehouse loans      
     Fair value hedge ineffectiveness net losses   $ (3,627) $ (2,281)
Mortgage servicing rights      
     Fair value hedge ineffectiveness net losses                    N/A**                      (831)
     Net gains excluded from assessment of effectiveness*                    N/A**                     8,346 
  * Represents the derivative gain from net interest income on swaps, net of time decay.
** Due to adoption of SFAS No. 156, MSR are no longer hedged under SFAS No. 133. First Horizon Home Loans
    continues to enter into interest rate contracts to provide an economic hedge against changes in fair value of MSR.

 

In 2005, First Horizon Home Loans used different MSR stratification for purposes of determining hedge effectiveness pursuant to SFAS No. 133 and performing impairment testing pursuant to SFAS No. 140. The hedge results were evaluated under SFAS No. 133 using specific risk tranches that were established for hedging purposes. For risk tranches that were successfully hedged pursuant to SFAS No. 133, the MSR basis adjustments were allocated to small pools of loans within the risk tranches. These pools of loans were then aggregated into the less granular SFAS No. 140 strata. This adjusted MSR carrying value was then compared to the fair value of the MSR for each stratum to test for asset impairment. MSR basis was reduced to the extent that carrying value exceeds fair value. Any reduction in carrying value as a result of this impairment test was included as a component of servicing income in mortgage banking noninterest income.  In 2006, First Horizon revalues MSR to current fair value each month. Changes in fair value are included in servicing income in mortgage banking noninterest income.

 

First Horizon Home Loans utilizes derivatives (including swaps, swaptions, and mortgage forward sales contracts) that change in value inversely to the movement of interest rates to protect the value of its interest-only securities as an economic hedge. Changes in the fair value of these derivatives are recognized currently in earnings in mortgage banking noninterest income as a component of servicing income. Interest-only securities are included in trading securities with changes in fair value recognized currently in earnings in mortgage banking noninterest income as a component of servicing income.

 

Capital Markets

 

Capital Markets trades U.S. Treasury, U.S. Agency, mortgage-backed, corporate and municipal fixed income securities and other securities for distribution 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, futures and floors for its customers. In addition, Capital Markets enters into futures contracts to economically hedge interest rate risk associated with its securities inventory. 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 other assets and any liabilities are recognized as other liabilities. Credit risk related to these transactions is controlled through credit approvals, risk control limits and ongoing monitoring procedures through ALCO.

 

In fourth quarter 2005, Capital Markets utilized a forward contract as a cash flow hedge of the risk of change in the fair value of a forecasted sale of certain loans. In first quarter 2006, $77 thousand of net losses which were recorded in other comprehensive income on December 31, 2005, were recognized in earnings. The amount of SFAS No. 133 hedge ineffectiveness related to this cash flow hedge was immaterial.

 

Interest Rate Risk Management

 

FHN’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. FHN uses derivatives, including swaps, caps, options, and collars, that are designed to moderate the impact on earnings as interest rates change. FHN’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. In addition, FHN has entered into certain interest rate swaps and caps as a part of a product offering to commercial customers with customer derivatives paired with offsetting market instruments that, when completed, are designed to eliminate market risk. These contracts do not qualify for hedge accounting and are measured at fair value with gains or losses included in current earnings in noninterest income.


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Note 13 – Derivatives (continued)

 

FHN has entered into pay floating, receive fixed interest rate swaps to hedge the interest rate risk of certain large institutional certificates of deposit, totaling $60.9 million and $210.8 million on March 31, 2006 and 2005, respectively. These swaps have been accounted for as fair

value hedges under the shortcut method. The balance sheet impact of these swaps was a liability of $1.6 million and $1.7 million on March 31, 2006 and 2005, respectively. Interest paid or received for these swaps was recognized as an adjustment of the interest expense of the liabilities whose risk is being managed.

 

FHN has entered into pay floating, receive fixed interest rate swaps to hedge the interest rate risk of certain long-term debt obligations, totaling $1.1 billion and $.9 billion on March 31, 2006 and 2005, respectively. These swaps have been accounted for as fair value hedges under the shortcut method. The balance sheet impact of these swaps was $34.5 million in other liabilities on March 31, 2006, and was $2.9 million in other assets and $11.9 million in other liabilities on March 31, 2005. Interest paid or received for these swaps was recognized as an adjustment of the interest expense of the liabilities whose risk is being managed.

 

FHN has determined that derivative transactions used in hedging strategies to manage interest rate risk on subordinated debt related to its trust preferred securities did not qualify for hedge accounting under the shortcut method. As a result, any fluctuations in the market value of the derivatives should have been recorded through the income statement with no corresponding offset to the hedged item. While management believes these hedges would have qualified for hedge accounting under the long haul method, that accounting cannot be applied retroactively. FHN evaluated the impact to all quarterly and annual periods since the inception of the hedges and concluded that the impact was immaterial in each period. In first quarter 2006, FHN recorded an adjustment to recognize the cumulative impact of these transactions that resulted in a negative $15.6 million impact to noninterest income, which was included in current earnings. FHN has subsequently redesignated these hedge relationships under SFAS No. 133 using the long haul method. For the period of time during first quarter 2006 that these hedge relationships were not redesignated under SFAS No. 133, the swaps were measured at fair value with gains or losses included in current earnings. FHN has entered into pay floating, receive fixed interest rate swaps totaling $291.6 million and $286.8 million on March 31, 2006 and 2005, respectively. The balance sheet impact of these swaps was $24.8 million and $13.2 million in other liabilities on March 31, 2006 and 2005, respectively. Fair value hedge ineffectiveness was immaterial for first quarter 2006.

 

In first quarter 2006, FHN utilized an interest rate swap as a cash flow hedge of the interest payment on floating-rate bank notes with a maturity in first quarter 2009. The balance sheet impact of this swap was $.5 million net of tax, recognized in other comprehensive income. There was no ineffectiveness related to this swap.


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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

GENERAL INFORMATION

 

FHN is a national financial services institution. From a small community bank chartered in 1864, FHN has grown to be one of the 30 largest bank holding companies in the United States in terms of asset size.

Approximately 13,000 employees provide a broad array of financial services to individual and business customers through hundreds of offices located in 46 states.

FHN companies have been recognized as some of the nation’s best employers by AARP, Working Mother and Fortune magazine. FHN also was named one of the nation’s 100 best corporate citizens by Business Ethics magazine.

FHN provides a broad array of financial services to its customers through three national businesses. The combined strengths of these businesses create an extensive range of financial products and services. In addition, the corporate segment provides essential support within the corporation.

 

•

Retail/Commercial Banking offers financial products and services, including traditional lending and deposit-taking, to retail and commercial customers. Additionally, the retail/commercial bank provides investments, insurance, financial planning, trust services and asset management, credit card, cash management, check clearing, and correspondent services. On March 1, 2006, FHN sold its national merchant processing business. The divestiture was accounted for as a discontinued operation which is included in the Retail/Commercial Banking segment.

 

•

Mortgage Banking helps provide home ownership through First Horizon Home Loans, which operates offices in 44 states and is one of the top 15 mortgage servicers and top 20 originators of mortgage loans to consumers. This segment consists of core mortgage banking elements including originations and servicing and the associated ancillary revenues related to these businesses.

 

•

Capital Markets provides a broad spectrum of financial services for the investment and banking communities through the integration of capital markets securities activities, equity research and investment banking.

 

•

Corporate consists of unallocated corporate expenses, expense on subordinated debt issuances and preferred stock, bank-owned life insurance, unallocated interest income associated with excess equity, net impact of raising incremental capital, funds management and venture capital.

 

For the purpose of this management discussion and analysis (MD&A), earning assets have been expressed as averages, and loans have been disclosed net of unearned income. The following is a discussion and analysis of the financial condition and results of operations of FHN for the three-month period ended March 31, 2006, compared to the three-month period ended March 31, 2005. To assist the reader in obtaining a better understanding of FHN and its performance, this discussion should be read in conjunction with FHN’s unaudited consolidated condensed financial statements and accompanying notes appearing in this report. Additional information including the 2005 financial statements, notes, and management’s discussion and analysis is provided in the 2005 Annual Report.


FORWARD-LOOKING STATEMENTS


This MD&A contains forward-looking statements with respect to FHN’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 dec isions 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, including the slope of the yield curve (which can have a significant impact on a financial services institution); market and monetary fluctuations; inflation or deflation; customer and investor responses to these conditions; the financial condition of borrowers and other counterparties; competition within and outside the financial services industry; geopolitical developments including possible terrorist activity; natural disasters; effectiveness of FHN’s hedging practices; technology; demand for FHN’s product offerings; new products and services in the industries in which FHN operates; and critical accounting estimates. Other factors are those inherent in originating and servicing loans including prepayment ri sks, 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

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other regulators; regulatory and judicial proceedings and changes in laws and regulations applicable to FHN; and FHN’s success in executing its business plans and strategies and managing the risks involved in the foregoing, could cause actual results to differ. FHN assumes no obligation to update any forward-looking statements that are made from time to time. Actual results could differ because of several factors, including those presented in this Forward-Looking Statements section.


FINANCIAL SUMMARY (Comparison of First Quarter 2006 to First Quarter 2005)

 

FINANCIAL HIGHLIGHTS

Earnings for first quarter 2006 were $215.0 million or $1.67 per diluted share. Earnings for first quarter 2005 were $105.8 million or $.83 per diluted share. The results for first quarter 2006 included earnings from discontinued operations of $210.3 million or $1.63 per diluted share related to the sale of FHN’s national merchant processing business. In 2005 earnings from discontinued merchant operations were $3.0 million or $.03 per diluted share. First quarter 2006 earnings also included a favorable impact of $1.3 million or $.01 per diluted share from the cumulative effect of changes in accounting principles.

 

Business operations reflected continued strong growth within Retail/Commercial Banking, with loan growth of 24 percent and an 11 percent increase in deposits. While Capital Markets revenues were only up 2 percent as compared to first quarter 2005, these revenues experienced an 18 percent increase on a sequential quarter basis. Compared to first quarter 2005, Mortgage Banking originations have fallen 10 percent related to a tightening in the overall mortgage market; however, the expected industry decline for the same period is 17 percent. Mortgage Banking earnings were also unfavorably impacted by hedge performance this quarter.

 

Comparisons between reported earnings are directly and significantly affected by a number of factors that were present in first quarter 2006 but not present (or present to a much lesser degree) in first quarter 2005. FHN’s performance in first quarter 2006 was impacted by the gain on the merchant divestiture, transactions through which the incremental capital provided by the divestiture was utilized, various other transactions, and accounting matters. The following discussion highlights these items:

 

On March 1, 2006, FHN sold its national merchant processing business for an after-tax gain of $208 million. This divestiture was accounted for as a discontinued operation, and accordingly, current and prior periods were adjusted to exclude the impact of merchant operations from the results of continuing operations. In tandem with the merchant sale, FHN purchased 4 million shares of its common stock to minimize the potentially dilutive effect of the merchant divestiture on future earnings per share. This share repurchase was accomplished through an accelerated share repurchase program for an initial purchase price of approximately $158 million in first quarter 2006. The final settlement, after the repurchase period, is expected to occur in second quarter 2006. Also included in results from continuing operations are securities losses of $80.3 million, predominantly related to repositioning approximately $2.3 billion of in vestment securities. This restructuring, undertaken in view of the current interest rate environment, increased the average yield on the investment portfolio by approximately 120 basis points.

 

FHN determined that certain derivative transactions used in hedging strategies to manage interest rate risk did not qualify for hedge accounting under the "short cut" method, as have a number of other banks. As a result, any fluctuations in the market value of the derivatives should have been recorded through the income statement with no corresponding offset to the hedged item. While management believes these hedges would have qualified for hedge accounting under the "long haul" method, that accounting method cannot be applied retroactively. FHN evaluated the impact to all quarterly and annual periods since the inception of the hedges and concluded that the impact was immaterial in each period. In first quarter 2006, FHN recorded an adjustment to recognize the cumulative impact of these transactions that resulted in a negative $15.6 million impact to noninterest income, which was included in continui ng operations. FHN has subsequently redesignated these hedge relationships under SFAS No. 133 using the “long haul” method.

 

Various other items impacted results from continuing operations in first quarter 2006. A pre-tax loss of $12.7 million was recognized from the sale of home equity lines of credit (HELOC) upon which the borrower had not drawn funds. The loss represents deferred loan origination costs, generally recognized over the life of the loan, which were recognized when the line of credit was sold. Mortgage banking experienced foreclosure losses and other expenses of $13.2 million compared to historical levels of approximately $2 million to $3 million related to nonprime mortgage loans. Going forward, these expenses are expected to return to historical expense levels as management has implemented improved procedures to address more stringent investor requirements and to ensure a more disciplined approach to managing the risk of this held for sale portfolio of loans. FHN underwent a change in the dynamics of its business relationship wit h the U.S. Mint, through which collectible coins are distributed, and recognized expenses of $9.3 million this quarter, representing the devaluation of packaging inventories and costs of closing retail locations. Continually looking for ways to better align the cost structure and implement enterprise-wide synergies, FHN incurred expenses of $6.4 million related to consolidating operations, closing certain offices, and incurring incremental expenditures on technology designed to enhance efficiencies and increase productivity. Compensation expense of

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$4.5 million related to early retirement, severance and retention was recognized in the current quarter but will reduce costs and should improve performance going forward.

 

First quarter 2006 earnings also included a favorable impact of $1.3 million or $.01 per diluted share from the cumulative effect of changes in accounting principles. FHN adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123-R) in first quarter 2006 and retroactively applied the provisions of the standard. Accordingly, results for periods prior to 2006 have been adjusted to reflect expensing of share-based compensation. A cumulative effect adjustment of $1.1 million was recognized, reflecting the change in accounting for share-based compensation expense based on estimated forfeitures rather than actual forfeitures. FHN also adopted SFAS No. 156, “Accounting for Servicing of Financial Assets,” which allows servicing assets to be measured at fair value with changes in fair value reported in current earnings. The adoption of this standard was applied on a prospective basis and resulte d in a cumulative effect adjustment of $.2 million, representing the excess of the fair value of the servicing asset over the recorded value on January 1, 2006.

 

Return on average shareholders’ equity and return on average assets were 37.3 percent and 2.31 percent, respectively, for first quarter 2006. Return on average shareholders’ equity and return on average assets were 20.8 percent and 1.26 percent, respectively, for first quarter 2005. Total assets were $37.3 billion and shareholders’ equity was $2.4 billion on March 31, 2006, compared to $35.2 billion and $2.1 billion, respectively, on March 31, 2005.

 

BUSINESS LINE REVIEW

 

Retail/Commercial Banking

Total revenues for Retail/Commercial Banking increased 11 percent to $331.4 million for first quarter 2006 compared to $299.5 million for first quarter 2005.

 

Net interest income increased 13 percent to $224.9 million in first quarter 2006 from $198.6 million in first quarter 2005 as earning assets grew 17 percent, or $3.1 billion. Loans grew 24 percent or $4.0 billion while loans held for sale decreased 53 percent or $.9 billion and deposits increased 11 percent or $1.1 billion over first quarter 2005. The Retail/Commercial Banking net interest margin was 4.25 percent in first quarter 2006 compared to 4.22 percent in fourth quarter 2005 and 4.38 percent in the first quarter of last year.

 

Noninterest income increased 6 percent to $106.5 million in first quarter 2006 from $100.9 million in first quarter 2005. Fees from deposit transactions and cash management increased 14 percent or $4.7 million compared to first quarter 2005 due to deposit growth and pricing initiatives. Revenue from loan sales and securitizations remained stable in first quarter 2006 due to increased volume of loans sold, while profit margins were unfavorably impacted by a shift in equity lending originations from variable rate HELOC to fixed-rate second-lien mortgages combined with competitive pricing pressures, and due to a gain of $11.4 million from the sale of a portfolio of non-strategic and non-core customer credit card receivables. Also impacting this revenue stream was the $12.7 million loss from the sale of no-balance HELOC.

 

Provision for loan losses increased to $18.0 million in first quarter 2006 from $13.1 million last year, primarily reflecting loan growth and a gradual trend away from the recently experienced low levels of net charge-offs.

 

Noninterest expense was $215.6 million in first quarter 2006 compared to $179.6 million last year. The increase in noninterest expense was impacted by costs associated with the coin inventory valuation and closing of retail sites; consolidation of remittance processing operations and office closing; and early retirement and severance costs. In addition, higher personnel costs resulted from national expansion initiatives.

 

Pre-tax income for Retail/Commercial Banking decreased 8 percent to $97.8 million for first quarter 2006, compared to $106.8 million for first quarter 2005. Including the impact of discontinued merchant operations, which reflected the gain on the sale and the cumulative effect of accounting changes, net income increased to $280.7 million from $75.9 million in 2005.

 

Mortgage Banking

Total revenues for Mortgage Banking were $120.1 million in first quarter 2006 compared to $155.8 million in first quarter 2005.

 

Net interest income decreased 24 percent to $25.4 million in first quarter 2006 from $33.2 million in first quarter 2005. The flattening of the yield curve resulted in compression of the spread on the warehouse, which was 1.77 percent in first quarter 2006 compared to 2.89 percent for the same period in 2005.


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Noninterest income decreased to $94.7 million in first quarter 2006 compared to $122.6 million in first quarter 2005. 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 (MSR) net hedge gains or losses. Mortgage servicing noninterest income prior to the adoption of SFAS No. 156 in first quarter 2006 was net of amortization, impairment and other expenses related to MSR and related hedges. Subsequent to the adoption of SFAS No. 156, mortgage servicing noninterest income reflects the change in fair value of the MSR asset combined with net hedging results, whether positive or negative.

 

Mortgage loan originations decreased to $6.9 billion in first quarter 2006 from $7.6 billion in 2005 as refinance activity dropped 22 percent. Home purchase origination volume remained stable and represented 59 percent of total originations during first quarter 2006 compared to 53 percent last year. The aggregate decline in origination volume of 10 percent was better than the national market’s expected decline of 17 percent. Loans delivered into the secondary market decreased 8 percent to $6.8 billion as originations slowed. Net revenue from mortgage loans sold decreased 28 percent to $72.3 million from $100.0 million in first quarter 2005 as loans delivered into the secondary market slowed and margins compressed by 23 basis points.

 

The mortgage-servicing portfolio grew 11 percent to $97.3 billion on March 31, 2006, from $88.0 billion on March 31, 2005. Total fees associated with mortgage servicing increased 15 percent to $77.8 million from $67.9 million, reflecting this growth. The growth in the servicing portfolio and rising interest rates led to a 29 percent increase in the average value of capitalized MSR to $1.3 billion in first quarter 2006.


Changes in the value of the MSR asset due to runoff reduced servicing revenue by $58.8 million in first quarter 2006. In addition, favorable MSR valuation adjustments of $96.0 million, which are not reflected in servicing fees, were primarily due to rising interest rates. The valuation adjustment was offset by hedge losses on MSR derivatives of $98.3 million. During first quarter 2005, the MSR value loss due to runoff was $59.4 million and MSR change due primarily to interest rates was an increase of $74.8 million, which was partially offset by hedge losses totaling $55.1 million. The net impact related to MSR valuation adjustments and a related change in the value of the hedge portfolio was a decline of $21.4 million in 2006, primarily due to lower interest earned on swaps resulting from the flattening of the yield curve. Trading asset performance and option expense further reduced servicing revenue by $5.9 million in 2006 compared to $14.3 million in 2005.


In total, servicing income declined by $3.1 million as increased servicing fees were offset by the lower performance of hedge instruments.

 

Noninterest expense increased to $125.7 million in first quarter 2006 from $110.0 million in first quarter 2005 due to the unusually high level of losses associated with the nonprime origination business, higher expense - offset by a related increase in noninterest income - related to a deferred compensation plan, and costs associated with branch closings, including lease abandonment and severance expenses.

 

Mortgage Banking had a pre-tax loss of $5.4 million for first quarter 2006, compared to pre-tax income of $45.8 million for first quarter 2005.

 

Capital Markets

Total revenues for Capital Markets were $93.3 million in first quarter 2006 compared to $91.2 million in first quarter 2005.

 

Revenues from fixed income sales were $50.6 million in first quarter 2006 compared to $63.0 million in first quarter 2005. However, on a sequential-quarter basis fixed income sales increased 14 percent from fourth quarter 2005. The current interest rate environment has created a challenging operating environment for fixed income sales as reflected in the lower revenues experienced since the Fed began raising interest rates in the second quarter of 2004.

 

Revenues from other products were $45.9 million in first quarter 2006, an increase of $11.1 million, or 32 percent, from first quarter 2005. Revenues from other products include fee income from activities such as loan sales, investment banking, equity research, portfolio advisory and the sale of bank-owned life insurance. These other sources of revenue represented 48 percent of total product revenues in first quarter 2006 compared to 36 percent in first quarter 2005. The increase from first quarter 2005 was primarily due to increased fees from investment banking and structured finance activities. Other non-product revenues relating to a deferred compensation plan increased $3.9 million from first quarter 2005. This revenue increase was offset by a related $3.9 million increase in noninterest expense associated with this plan.

 

Noninterest expense increased $4.6 million compared to first quarter 2005 primarily due to the $3.9 million increase in deferred compensation plan expense discussed above. Noninterest expense increased $10.6 million from fourth quarter 2005 primarily due to increased variable compensation expense associated with the increase in product revenues, a cyclical increase in statutory fringe benefits expense, and an increase in deferred compensation plan expense which was offset by a related increase in other non-product revenues.

 

Capital Markets pre-tax earnings were $6.9 million in first quarter 2006 compared to $9.4 million in first quarter 2005.

 

Corporate

The Corporate segment’s results yielded a pre-tax loss of $108.9 million in first quarter 2006 compared to a pre-tax loss of $9.3 million in first quarter 2005. The first quarter 2006 results include $80.3 million of net securities losses, primarily related to the restructuring of the investment portfolio which resulted in securities losses of $79.3 million. Noninterest income was negatively impacted by $15.6 million due to


34

  

the hedge accounting adjustment. Noninterest expense increased in 2006 due to $4.1 million dividend expense on $300 million of the bank’s noncumulative perpetual preferred stock.

 

INCOME STATEMENT REVIEW  


Total revenues (net interest income and noninterest income) decreased to $451.4 million in first quarter 2006 from $550.3 million in 2005, primarily due to the securities losses of $80.3 million. Noninterest income was $205.7 million in first quarter 2006 compared to $322.9 million in 2005, and net interest income was $245.7 million in 2006 compared to $227.4 million in 2005. A more detailed discussion of the major line items follows.

 

NET INTEREST INCOME

 

Net interest income increased 8 percent to $245.7 million as earning assets grew 13 percent to $33.1 billion and interest-bearing liabilities grew 12 percent to $28.6 billion in first quarter 2006.

 

The activity levels and related funding for FHN’s mortgage production and servicing and capital markets activities affect the net interest margin.  These activities typically produce different margins than traditional banking activities.  Mortgage production and servicing activities can affect the overall margin based on a number of factors, including the size of the mortgage warehouse, the time it takes to deliver loans into the secondary market, the amount of custodial balances, and the level of MSR.  Capital markets activities tend to compress the margin because of its strategy to reduce market risk by economically hedging a portion of its inventory on the balance sheet. As a result of these impacts, FHN’s consolidated margin cannot be readily compared to that of other bank holding companies.

 

The consolidated net interest margin was 2.99 percent for first quarter 2006 compared to 3.12 percent for first quarter 2005.  This compression in the margin occurred as the net interest spread decreased to 2.44 percent from 2.80 percent in 2005 while the impact of free funding increased from 32 basis points to 55 basis points. The decline in margin is attributable to a flatter yield curve, which decreased spread on the warehouse by 112 basis points to 1.77 percent.


Table 1 - Net Interest Margin
First Quarter
March 31
              2006   2005
Consolidated Yields and Rates:
   Loans, net of unearned income 7.07%   5.63%  
   Loans held for sale        6.39            5.95   
   Investment securities        4.76             4.27   
   Capital markets securities inventory        5.02             4.39   
   Mortgage banking trading securities      10.17           12.68   
   Other earning assets        4.13             2.15   
Yields on earning assets                6.50               5.29   
   Interest-bearing core deposits        2.53             1.73   
   Certificates of deposits $100,000 and more        4.55             2.59   
   Federal funds purchased and securities sold under agreements to repurchase        4.09             2.24   
   Capital markets trading liabilities        5.70             4.64   
   Commercial paper and other short-term borrowings        4.46             2.68   
   Long-term debt                  5.00               3.18   
Rates paid on interest-bearing liabilities              4.06               2.49   
Net interest spread                  2.44             2.80   
   Effect of interest-free sources                  .55                 .32   
FHN - NIM             2.99%     3.12%  
Certain previously reported amounts have been reclassified to agree with current presentation.


In the near-term, a modest compression of the net interest margin is expected as flattening in the spread between short-term and long-term interest rates generally has an unfavorable impact on net interest margin, primarily from narrower spreads on the mortgage warehouse.



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NONINTEREST INCOME

 

Mortgage Banking Noninterest Income

First Horizon Home Loans, an indirect subsidiary of FHN, offers residential mortgage banking products and services to customers, which consist primarily of the origination or purchase of single-family residential mortgage loans. First Horizon Home Loans originates mortgage loans through its retail and wholesale operations and also purchases mortgage loans from third-party mortgage bankers for sale to secondary market investors and subsequently services the majority of those loans.

 

Origination income includes origination fees, net of costs, gains/(losses) recognized on loans sold including the capitalized net present value of MSR, and the value recognized on loans in process including results from hedging. Origination fees, net of costs (including incentives and other direct costs), are deferred and included in the basis of the loans in calculating gains and losses upon sale. 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. Origination income decreased 28 percent to $72.3 million from $100.0 million in first quarter 2005 as originations and loans delivered into the secondary market slowed by 8 percent and margins compressed by 23 basis points.

 

Servicing income includes servicing fees and net gains or losses from hedging MSR. Prior to the adoption of SFAS No. 156 in first quarter 2006, mortgage servicing noninterest income was net of amortization, impairment and other expenses related to MSR and related hedges. Subsequent to the adoption of SFAS No. 156, mortgage servicing noninterest income reflects the change in fair value of the MSR asset combined with net hedging results, whether positive or negative. First Horizon Home Loans employs hedging strategies intended to counter changes in the value of MSR and other retained interests due to changing interest rate environments (refer to discussion of MSR under Critical Accounting Policies). Total fees associated with mortgage servicing increased 15 percent to $77.8 million from $67.9 million, reflecting growth in the servicing portfolio. The growth in the servicing portfolio and rising interest rates led to a 29 percent increase in capitalized MSR to $1.3 billion in first quarter 2006. The net impact of MSR valuation adjustments and hedge portfolio performance reduced servicing income by $21.4 million compared to 2005. Trading asset performance and reduced option expense resulted in an $8.4 million increase in servicing income.

 

Other income includes FHN’s share of earnings from nonconsolidated subsidiaries accounted for under the equity method which provide ancillary activities to mortgage banking and fees from retail construction lending.


Table 2 - Mortgage Banking Noninterest Income
Three Months Ended Percent
  March 31 Change
(Dollars in thousands and volumes in millions)                     2006           2005 (%)
Noninterest income:
Origination income   $   72,339   $   99,964  27.6   -
Servicing income                  10,717                13,767  22.2   -
Other                           5,759                  5,031  14.5  +
 Total mortgage banking noninterest income           $   88,815   $ 118,762  25.2   -
 Refinance originations    $  2,792.5   $  3,587.7  22.2   -
 Home-purchase originations                       4,072.2               4,030.6  1.0  +
     Mortgage loan originations           $  6,864.7   $  7,618.3  9.9   -
 Servicing portfolio           $97,303.3   $88,010.1  10.6  +
Certain previously reported amounts have been reclassified to agree with current presentation.


Capital Markets Noninterest Income

Capital markets noninterest income, the major component of revenue in the Capital Markets segment, is primarily generated from the purchase and sale of securities as both principal and agent, and from other fee sources including investment banking, loans sales, portfolio advisory and equity research activities. 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 fair value due to changes in interest rates.

 

Revenues from fixed income sales decreased $12.4 million compared to first quarter 2005, but increased $6.2 million from fourth quarter 2005. The interest rate environment created challenging conditions for fixed income sales in 2005 as reflected in the lower revenues experienced through third quarter of last year.


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Revenues from other fee sources increased $10.1 million primarily due to increased fees from investment banking and structured finance activities.

 

Table 3 - Capital Markets Noninterest Income
Three Months Ended
  March 31 Growth
(Dollars in thousands)         2006 2005 Rate (%)
Noninterest income:
 Fixed income  $50,602 $63,020 19.7   -
 Other products and services          42,256 32,142 31.5  +
     Total capital markets noninterest income        $92,858 $95,162 2.4   -
Certain previously reported amounts have been reclassified to agree with current presentation.

 

Other Noninterest Income

Other noninterest income includes deposit transactions and cash management fees, insurance commissions, revenue from loan sales and securitizations, trust services and investment management fees, net securities gains and losses and other noninterest income. First quarter 2006 noninterest income included $80.3 million of net securities losses, primarily related to the restructuring of the investment portfolio which resulted in securities losses of $79.3 million. Deposit transactions and cash management fees increased $4.7 million or 14 percent, reflecting deposit growth and pricing initiatives. Revenue from loan sales and securitizations remained stable in first quarter 2006 due to increased volume of loans sold, while profit margins were unfavorably impacted by a shift in equity lending originations from variable rate HELOC to fixed-rate second-lien mortgages combined with competitive pricing pressures, and a $11.4 million gain from the sale of a portfolio of non-strategic and non-core customer credit card receivables. Also impacting this revenue stream was the $12.7 million loss from the sale of no-balance HELOC. Other noninterest income decreased $7.0 million reflecting the negative $15.6 million cumulative impact of derivative transactions used in hedging strategies to manage interest rate risk that management determined did not qualify for hedge accounting under the "short cut" method. Other revenues related to deferred compensation plans increased $6.9 million which is offset by a related increase in noninterest expense associated with these plans.


NONINTEREST EXPENSE

 

Total noninterest expense for first quarter 2006 increased 15 percent to $443.2 million from $384.5 million in 2005. Employee compensation, incentives and benefits (personnel expense), the largest component of noninterest expense, increased 8 percent to $260.1 million from $240.3 million in 2005 primarily due to national expansion initiatives, an increase in deferred compensation plan expense which was offset by a related increase in noninterest income discussed above, and early retirement, severance and retention costs. All other noninterest expense increased 27 percent, or $38.9 million, which included incremental expenses related to nonprime mortgage loans, the collectible coin business, consolidating operations, closing offices, technology, and dividends on the bank’s noncumulative perpetual preferred stock, as previously discussed.

 

PROVISION FOR LOAN LOSSES / ASSET QUALITY

 

The provision for loan losses is the charge to earnings that management determines to be necessary to maintain the allowance for loan losses at an adequate level reflecting management’s estimate of probable incurred losses in the loan portfolio. An analytical model based on historical loss experience adjusted for current events, trends and economic conditions is used by management to determine the amount of provision to be recognized and to assess the adequacy of the loan loss allowance. The provision for loan losses was $17.8 million in first quarter 2006 compared to $13.1 million in first quarter 2005, reflecting loan growth and a gradual trend away from the recently low levels of net charge-offs. The net charge-off ratio was 22 basis points in first quarter 2006 compared to 17 basis points in first quarter 2005 as net charge-offs grew to $11.3 million from $7.1 million during a period of strong loan growth.


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Table 4 - Net Charge-off Ratios *
     Three Months Ended
March 31
              2006   2005
Commercial .12% .06%
Retail real estate          .24               .16   
Other retail         1.79             1.06   
Credit card receivables        2.04             3.64   
Total net charge-offs                    .22                 .17   
  *   Table 6 provides information on the relative size of each loan portfolio.


Nonperforming loans in the loan portfolio were $49.3 million on March 31, 2006, compared to $40.2 million on March 31, 2005. The ratio of nonperforming loans in the loan portfolio to total loans was .23 percent on March 31, 2006 and 2005, reflecting the underlying stability of the loan portfolio. Nonperforming assets were $94.4 million on March 31, 2006, compared to $75.1 million on March 31, 2005. This increase reflects growth in the loan portfolio and an increase of $6.7 million in nonperforming loans held for sale due to deterioration in nonprime lending.

 

Potential problem assets in the loan portfolio, which are not included in nonperforming 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. Loans 30 to 89 days past due, which are not included in potential problem assets, increased to $83.6 million on March 31, 2006, from $63.4 million on March 31, 2005. This increase was primarily related to loan growth as reflected in the past due loan ratio of .39 percent for first quarter 2006 compared to .37 percent for first quarter 2005. In total, potential problem assets were $195.2 million on March 31, 2006, compared to $96.5 million on March 31, 2005 . The increase reflects a return to historical levels of potential problem assets from the low levels experienced early in 2005. This includes the impact from the identification of certain misrepresentation by customers in a pool of collateralized retail real estate loans in 2005. The current expectation of losses from potential problem assets has been included in management’s analysis for assessing the adequacy of the allowance for loan losses.

 

Going forward the level of provision for loan losses should fluctuate primarily with the strength or weakness of the economies of the markets where FHN does business over the long-run and will experience quarterly fluctuations depending on the type and quantity of loan growth and impacts from quarterly asset quality movements. Additionally, asset quality in general should remain relatively stable based on expected economic conditions with normal quarterly fluctuations around recent levels; however, levels during 2006 have been relatively strong.


38


Table 5 - Asset Quality Information
First Quarter
(Dollars in thousands)                        2006                  2005
Allowance for loan losses:
Beginning balance on December 31  $      189,705   $      158,159 
      Provision for loan losses              17,799               13,109 
      Divestiture               (1,195)                       -  
      Charge-offs             (14,791)             (11,022)
      Recoveries                3,493                 3,949 
Ending balance on March 31          $      195,011     $      164,195 
Reserve for off-balance sheet commitments       9,420        8,212 
Total allowance for loan losses and reserve for off-balance
   sheet commitments		  $      204,431     $      172,407 

March 31
                           2006                  2005
Retail/Commercial Banking:
Nonperforming loans  $        49,332   $        40,160 
Foreclosed real estate              19,556               17,958 
  Total Retail/Commercial Banking                      68,888                 58,118 
Mortgage Banking:
Nonperforming loans - held for sale              16,000                 9,264 
Foreclosed real estate                          9,538                   7,737 
  Total Mortgage Banking                        25,538                 17,001 
Total nonperforming assets          $        94,426     $        75,119 
Total loans, net of unearned income  $ 21,186,991   $ 17,183,781 
Insured loans                     (811,638)             (801,093)
Loans excluding insured loans          $ 20,375,353     $ 16,382,688 
Foreclosed real estate from GNMA loans*  $        19,865       $                 - 
Potential problem assets**            195,184               96,490 
Loans 30 to 89 days past due              83,554               63,392 
Loans 30 to 89 days past due - guaranteed***                   564                 1,156 
Loans 90 days past due              28,279               28,623 
Loans 90 days past due - guaranteed***                   441                 5,482 
Loans held for sale 30 to 89 days past due              43,890               57,574 
Loans held for sale 30 to 89 days past due - guaranteed***              39,113               45,604 
Loans held for sale 90 days past due            159,695             177,552 
Loans held for sale 90 days past due - guaranteed***            159,239             176,210 
Off-balance sheet commitments****                 7,787,356            6,465,179 
Allowance to total loans .92% .96%
Allowance to loans excluding insured loans                  .96                   1.00   
Allowance to nonperforming loans in the loan portfolio                 395                    409   
Nonperforming assets to loans, foreclosed real estate and other assets
  (Retail/Commercial Banking)                  .33                     .34   
Nonperforming assets to unpaid principal balance of
   servicing portfolio (Mortgage Banking)		                  .03                     .02   
Allowance to annualized net charge-offs  4.32x     5.80x
*    Prior to 2006 properties acquired by foreclosure through GNMA's repurchase program were classified as
      receivables in "Other assets" on the Consolidated Condensed Statements of Condition.
**   Includes past due loans.
***  Guaranteed loans include FHA, VA, student and GNMA loans repurchased through the GNMA repurchase
      program.
**** Amount of off-balance sheet commitments for which a reserve has been provided.  As of March 31, 2006, a
       reserve has been provided for unfunded credit card commitments.
Certain previously reported amounts have been reclassified to agree with current presentation.


39

  

STATEMENT OF CONDITION REVIEW


EARNING ASSETS

 

During first quarter 2006, earning assets consisted of loans, loans held for sale, investment securities, trading securities and other earning assets. Earning assets grew 13 percent and averaged $33.1 billion in first quarter 2006 compared to $29.4 billion in 2005, primarily due to loan growth.

 

LOANS

 

Average total loans increased 25 percent for first quarter 2006 to $20.8 billion from $16.7 billion in 2005. Average loans represented 63 percent of average earning assets in first quarter 2006 and 57 percent in 2005.


Commercial, financial and industrial loans increased 17 percent, or $935.3 million, since first quarter 2005 reflecting greater demand for loans as the economy improved and increased market share in Tennessee. Commercial construction loans grew 68 percent since first quarter 2005 or $891.7 million, primarily from growth in loans to single-family residential builders made through First Horizon Home Loans, reflecting the demand for single-family housing and expansion of the sales force and geographic reach. Retail real estate residential loans increased 17 percent or $1.2 billion reflecting growing demand for second-lien mortgages. The retail real estate construction portfolio increased 78 percent or $856.3 million since first quarter 2005. Retail real estate construction loans are made to individuals for the purpose of constructing a home where FHN 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. Additional loan information is provided in Table 6 – Average Loans.


FHN has a significant concentration in loans secured by real estate which is geographically diversified nationwide. In 2006, 67 percent of total loans are secured by real estate compared to 65 percent in 2005 (see Table 6). Three lending products have contributed to this level of real estate lending including significant levels of retail residential real estate which comprise 42 percent of total loans. The risk profile of the retail residential real estate portfolio remains stable reflecting a significant concentration of high credit score products. Also contributing to the level of real estate lending are commercial construction lending which comprises 10 percent of total loans and includes loans to single-family builders, and retail real estate construction loans, which comprise 9 percent of total loans. Retail real estate construction loans are a one-time close product where First Horizon Home Loans provides construc tion financing and a permanent mortgage to individuals for the purpose of constructing a home. Upon completion of construction, the permanent mortgage is classified as held for sale and sold into the secondary market. FHN's commercial real estate lending is well-diversified by product type and industry. On March 31, 2006, FHN did not have any concentrations of 10 percent or more of total commercial, financial and industrial loans in any single industry.


Table 6 - Average Loans
Three Months Ended
March 31
Percent Growth Percent
(Dollars in millions)           2006 of Total Rate           2005 of Total
Commercial:
  Commercial, financial and industrial   $  6,415.4  31% 17.1 %   $  5,480.1  33%
  Real estate commercial           1,225.0             6            21.9              1,004.5           6   
  Real estate construction           2,197.7           10            68.3              1,306.0           8   
Total commercial             9,838.1           47            26.3              7,790.6         47   
Retail:
  Real estate residential           8,629.4           42            16.8              7,385.8         44   
  Real estate construction           1,961.7             9            77.5              1,105.4           7   
  Other retail              164.6             1              2.4                 160.7           1   
  Credit card receivables              238.1             1          NM                 238.1           1   
  Real estate loans pledged against other collateralized borrowings                  6.5           -           NM        -    -   
Total retail         11,000.3           53            23.7              8,890.0         53   
Total loans, net of unearned     $ 20,838.4  100% 24.9 %   $ 16,680.6  100%
Certain previously reported amounts have been reclassified to agree with current presentation.


40

Commercial loan growth should be strong as a result of the national expansion of single-family residential construction lending and greater market demand for commercial and industrial loans. Year-over-year growth in retail loans will be primarily driven by the national sales platform.


LOANS HELD FOR SALE

 

Loans held for sale consist of first-lien mortgage loans (warehouse), HELOC, second-lien mortgages, student loans, small issuer trust preferred securities and credit card receivables. The mortgage warehouse accounts for the majority of loans held for sale. Loans held for sale decreased 10 percent to $4.8 billion in 2006 from $5.3 billion in 2005. This decline is related to the lower demand for HELOC, while second-lien mortgages and small issuer trust preferred securities held for sale increased. FHN continues to fund loan growth and maintain a stable liquidity position through whole-loan sales and securitizations.


DEPOSITS / OTHER SOURCES OF FUNDS

 

Core deposits increased 7 percent to $12.3 billion in first quarter 2006 compared to $11.5 billion in 2005, primarily due to 9 percent growth in Retail/Commercial Banking deposits reflecting expansion strategies which emphasize a focus on convenient hours, free checking and targeted financial center expansion. The increase in Retail/Commercial Banking deposits was partially offset by a 2 percent decline in Mortgage Banking escrow deposits. Short-term purchased funds averaged $17.4 billion for first quarter 2006, up 7 percent or $1.1 billion from first quarter 2005. In first quarter 2006, short-term purchased funds accounted for 52 percent of FHN’s total funding, which is comprised of core deposits, purchased funds (including federal funds purchased, securities sold under agreements to repurchase, trading liabilities, certificates of deposit greater than $100,000, and short-term borrowings) and long-term debt, and accounted for 54 percent of total funding in first quarter 2005. Long-term debt includes senior and subordinated borrowings, advances with original maturities greater than one year and other collateralized borrowings. Long-term debt averaged $3.8 billion in first quarter 2006 compared to $2.6 billion in first quarter 2005 (see Note 6 – Long-Term Debt for additional detail).

 

CAPITAL

 

Management’s objectives are to provide capital sufficient to cover the risks inherent in FHN’s businesses, to maintain excess capital to well-capitalized standards and to assure ready access to the capital markets.

 

Average shareholders’ equity increased 13 percent in first quarter 2006 to $2.3 billion from $2.1 billion, reflecting internal capital generation. Period-end shareholders’ equity was $2.4 billion on March 31, 2006, up 13 percent from March 31, 2005. This increase in shareholders’ equity came principally from retention of net income after dividends and the effects of stock repurchases and option exercises. Pursuant to board authority, FHN may repurchase shares from time to time and will evaluate the level of capital and take action designed to generate or use capital as appropriate, for the interests of the shareholders. In order to maintain FHN’s well-capitalized status while sustaining strong balance sheet growth, First Tennessee Bank National Association (FTBNA) has issued approximately $250 million of subordinated notes which qualify as Tier 2 capital under the risk-based capital guidelines since March 31, 2005.

 

On March 1, 2006, FHN entered into an agreement with Goldman Sachs & Co. to purchase four million shares of FHN common stock in connection with an accelerated share repurchase program under an existing share repurchase authorization. The initial purchase price of the shares was $39.43 per share or approximately $158 million excluding transaction costs. The share repurchase was funded with a portion of the proceeds from the merchant processing sale and settled on March 3, 2006. The repurchased shares are subject to a purchase price adjustment that will be based upon the actual volume weighted average price during the repurchase period and certain other provisions. The final settlement is expected to occur in second quarter 2006. The divestiture of merchant operations is not expected to have a material impact on future capital resources.



41

 

Table 7 - Issuer Purchases of Equity Securities
Total Number of Maximum Number 
Total Number  Shares Purchased of Shares that May 
of Shares Average Price as Part of Publicly Yet Be Purchased
(Volume in thousands)   Purchased   Paid per Share   Announced Programs   Under the Programs
2006
January 1 to January 31  -    -    -     30,010 
February 1 to February 28  -     -     -    30,010 
March 1 to March 31 4,000  39.43  4,000  26,010 
  Total     4,000    $39.43      4,000   
Compensation Plan Programs:
- A consolidated compensation plan share purchase program was approved on July 20, 2004, and was announced on August 6, 2004.  This plan consolidated into a single share purchase program all of the previously authorized compensation plan share programs as well as the renewal of the authorization to purchase shares for use in connection with two compensation plans for which the share purchase authority had expired. The total amount authorized under this consolidated compensation plan share purchase program is 25.1 million shares which may be purchased over the option exercise period of the variou s compensation plans on or before December 31, 2023.  Stock options granted after January 2, 2004, must be exercised no later than the tenth anniversary of the grant date (see also Subsequent Events). On March 31, 2006, the maximum number of shares that may yet be purchased under the program was 24.3 million shares.
Other Programs:
- A non-stock option plan-related authority was announced on October 18, 2000, authorizing the purchase of up to 9.5 million shares.  On October 16, 2001, it was announced that FHN's board of directors extended the expiration date of this program from June 30, 2002, until December 31, 2004. On October 19, 2004, the board of directors extended the authorization until December 31, 2007.  On March 31, 2006, the maximum number of shares that may yet be purchased under the program was 1.7 million shares.

 

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 March 31, 2006, FHN and FTBNA had sufficient capital to qualify as well-capitalized institutions as shown in Note 7 – Regulatory Capital.

 

RISK MANAGEMENT


FHN has an 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 other executive officers of FHN. 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), Capital Management Committee and Operational Risk Committee. The EVP and Chief Credit Of ficer, EVP of Interest Rate Risk Management, EVP and Chief Financial Officer and EVP of Risk Management chair these committees respectively. Reports regarding Credit, Asset/Liability, Market, Capital Management and Operational Risks are provided to the Executive and/or Audit Committees of the Board and to the full 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

 

Interest rate sensitivity risk is defined as the risk that future changes in interest rates will adversely impact income. The primary objective of managing interest rate risk is to minimize the volatility to earnings from changes in interest rates and preserve the value of FHN’s capital. ALCO, a committee consisting of senior management that meets regularly, is responsible for coordinating the financial management of


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interest rate risk. FHN primarily manages interest rate risk by structuring the balance sheet to attempt to maintain the desired level of net interest income while managing interest rate risk and liquidity.  

Net interest income and the financial condition of FHN 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 earning assets reprice more quickly than liabilities, this position will benefit net interest income in a rising interest rate environment and will negatively impact net interest income in a declining interest rate environment. In the case of floating-rate assets and liabilities, FHN may also be exposed to basis risk, which results from changing spreads between loan and deposit rates. Generally, when interest rates decline Mortgage Banking faces increased prepayment risk associated with its MSR.

 

In certain cases, derivative financial instruments are used to aid in managing the exposure of the balance sheet and related net interest income and noninterest income to changes in interest rates. For example, Mortgage Banking uses derivatives to protect against MSR prepayment risk and against changes in fair value of the mortgage pipeline and warehouse. Capital Markets uses derivatives to protect against the risk of loss arising from adverse changes in the fair value of its inventory due to changes in interest rates. The prepayment risk in the loan portfolio is not hedged with derivatives or otherwise.

 

In addition to the balance sheet impacts, fee income and noninterest expense may be affected by actual changes in interest rates or expectations of changes. Mortgage banking revenue, which is generated from originating, selling and servicing residential mortgage loans, is highly sensitive to changes in interest rates due to the direct effect changes in interest rates have on loan demand. In general, low or declining interest rates typically lead to increased origination fees and profit from the sale of loans but potentially lower servicing-related income due to the impact of higher loan prepayments on the value of mortgage servicing assets. Conversely, high or rising interest rates typically reduce mortgage loan demand and hence income from originations and sales of loans while servicing-related income may rise due to lower prepayments. The earnings impact from originations and sales of loans on total earnings is more s ignificant than servicing related income. Net interest income earned on warehouse loans held for sale and on swaps and similar derivative instruments used to protect the value of MSR increases when the yield curve steepens and decreases when the yield curve flattens. In addition, a flattening yield curve negatively impacts the demand for fixed income securities and, therefore, Capital Markets’ revenue, as well as trading inventory spreads.

 

LIQUIDITY MANAGEMENT  


ALCO focuses on being able to fund assets with liabilities of the appropriate duration, 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. This objective is met by maintaining liquid assets in the form of trading securities and securities available for sale, maintaining sufficient unused borrowing capacity in the national money markets, growing core deposits, and the repayment of loans and the capability to sell or securitize loans. ALCO 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. Funds are available from a number of sources, including core deposits, the securities availa ble for sale portfolio, the Federal Home Loan Bank, the Federal Reserve Banks, access to capital markets through issuance of senior or subordinated bank notes and institutional certificates of deposit, availability to the overnight and term Federal Funds markets, access to retail brokered certificates of deposit, dealer and commercial customer repurchase agreements, and through the sale or securitization of loans.


Core deposits are a significant 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 extent authorized by law. For first quarter 2006 and 2005, the total loans, excluding loans held for sale and real estate loans pledged against other collateralized borrowings, to core deposits ratio was 157 percent and 141 percent, respectively. As loan growth currently exceeds core deposit growth, alternative sources of funding loan growth may be necessary in order to maintain an adequate liquidity position. One means of maintaining a stable liquidity position is to sell loans either through whole-loan sales or loan securitizations. During first quarter 2006, FHN sold loans through an on-balance sheet securitization, which is structured as a financing for accounting purposes. FHN periodically evaluates its liquidity position in conjunctio n with determining its ability and intent to hold loans for the foreseeable future.


FTBNA also has the ability to enhance its liquidity position by issuing preferred equity or incurring other debt. FHN 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. Due to considerable growth of the HELOC portfolio, whole-loan sales and securitizations of this loan type are an important funding source.

 

Prior to February 2005, FTBNA had a bank note program under which the bank was able to borrow funds from time to time at maturities of 30 days to 30 years. This bank note program has been terminated in connection with the establishment of a new program. That termination


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does not affect any previously-issued notes outstanding. In February 2005, FTBNA established a new bank note program providing additional liquidity of $5.0 billion. This bank note program provides FTBNA with a facility under which it may continuously issue and offer short- and medium-term unsecured notes. On March 31, 2006, $3.7 billion was available under current conditions through the bank note program as a funding source.

 

Liquidity has also been obtained through FTBNA’s issuance of 300,000 shares of noncumulative perpetual preferred stock which provided approximately $295 million additional capital. In addition, liquidity has been obtained through issuance of $300.0 million of guaranteed preferred beneficial interests in FHN’s junior subordinated debentures through two Delaware business trusts wholly owned by FHN and through preferred stock issued by an indirect wholly-owned subsidiary of FHN ($45.3 million on March 31, 2006).


The Consolidated Condensed Statements of Cash Flows provide information on cash flows from operating, investing and financing activities for the three-month periods ending March 31, 2006 and 2005. In 2006, net cash decreased slightly to $2.2 billion from $2.4 billion on December 31, 2005. Significant cash flows for the quarter from investing activities included the sale of $2.2 billion investment securities and the subsequent purchase of $2.5 billion investment securities as the portfolio was repositioned in response to the current interest rate environment. Cash flows from financing activities reflect a decrease of $1.9 billion in deposits, primarily from certificates of deposit greater than $100,000, as long term borrowings, which increased $1.2 billion, and short-term borrowings, which increased $.5 billion, were utilized to fund the balance sheet. Also included in cash flows from financing activities is a decrease o f $159.7 million related to the share repurchase. The impacts to cash flows from loan growth and an increase in capital markets balances were largely offset by a decrease in loans held for sale. The cash flows from the merchant divestiture, which was accounted for as a discontinued operation, are included in the consolidated results. The sale resulted in a $421.7 million increase in cash and cash equivalents, of which $208.5 million, the gain on the sale, is included in net income. The divestiture of merchant operations is not expected to have a material impact on future liquidity. In first quarter 2005, net cash flows from operating activities were negative primarily due to increased liquidity demands from the acquisition of the fixed income business of Spear, Leeds and Kellogg (SLK). Growth in deposits comprised a significant portion of FHN’s positive cash flows from financing activities in 2005, and these funds were utilized to meet the liquidity needs related to the strong loan growth that was refle cted in negative cash flows from investing activities. In addition, the issuance of preferred stock by FTBNA contributed to positive cash flows from financing activities in first quarter 2005. Negative cash flows from investing activities also resulted from a larger investment portfolio due to balance sheet repositioning in 2005.

 

Parent company liquidity is maintained by cash flows 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 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, FHN, as of March 31, 2006, may offer from time to time at its discretion, debt securities, and common and preferred stock aggregating up to $125 million. In addition, $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.

OFF-BALANCE SHEET ARRANGEMENTS AND OTHER CONTRACTUAL OBLIGATIONS

First Horizon Home Loans originates conventional conforming and federally insured single-family residential mortgage loans. Likewise, FTN Financial Capital Assets Corporation purchases the same types of loans from customers. Substantially all of these mortgage loans are exchanged for securities, which are issued through investors, including government-sponsored enterprises (GSE), such as GNMA for federally insured loans and FNMA and FHLMC for conventional loans, and then sold in the secondary markets. Each of the GSE has specific guidelines and criteria for sellers and servicers of loans backing their respective securities. Many private investors are also active in the secondary market as issuers and investors. 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 loans are subsequently determi ned not to meet the agreed upon qualifications or criteria, the purchaser has the right to return those loans to FHN. 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). After sale, these loans are not reflected on the Consolidated Condensed Statements of Condition.


FHN’s use of government agencies as an efficient outlet for mortgage loan production is an essential source of liquidity for FHN and other participants in the housing industry. During first quarter 2006, $3.4 billion of conventional and federally insured mortgage loans were securitized and sold by First Horizon Home Loans through these investors.


Certain of FHN's originated loans, including non-conforming first-lien mortgages, second-lien mortgages and HELOC originated primarily through FTBNA, do not conform to the requirements for sale or securitization through government agencies. FHN pools and securitizes these non-conforming loans in proprietary transactions. After securitization and sale, these loans are not reflected on the Consolidated Condensed Statements of Condition. These transactions, which are conducted through single-purpose business trusts, are the most efficient way for FHN and other participants in the housing industry to monetize these assets. On March 31, 2006, the outstanding principal


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amount of loans in these off-balance sheet business trusts was $21.4 billion. Given the significance of FHN's origination of non-conforming loans, the use of single-purpose business trusts to securitize these loans is an important source of liquidity to FHN.

 

FHN has various other financial obligations which may require future cash payments. Purchase obligations represent obligations under agreements to purchase goods or services that are enforceable and legally binding on FHN 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, FHN 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.

 

MARKET RISK MANAGEMENT

 

Capital markets 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 with the objective of limiting the risk in managing this inventory.

 

CAPITAL MANAGEMENT

 

The capital management objectives of FHN are to provide capital sufficient to cover the risks inherent in FHN’s businesses, to maintain excess capital to well-capitalized standards and to assure ready access to the capital markets.  Management has a Capital Management committee that is responsible for capital management oversight and provides a forum for addressing management issues related to capital adequacy.  The committee reviews sources and uses of capital, key capital ratios, segment economic capital allocation methodologies, and other factors in monitoring and managing current capital levels, as well as potential future sources and uses of capital.  The committee also recommends capital management policies, which are submitted for approval to the Enterprise-wide Risk/Return Management Committee and the Board.

 

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. FHN 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.


FHN has processes and management committees in place that are designed to assess and monitor credit risks. Management’s Asset Quality Committee has the 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 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 ente rprise-wide credit risk oversight and provides a forum for addressing management issues. The committee also recommends credit policies, which are submitted for approval to the Executive Committee of the Board, 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. FHN’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.< /font>


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 EVP of Risk Management. Key representatives from the business segments, legal, shared services, risk management, and insurance are represented on the committee. Subcommittees manage and report on business continuity planning,


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information technology, data security, insurance, compliance, records management, product and system development, customer complaint, and reputation risks. 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

 

FHN’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition. The consolidated condensed financial statements of FHN 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 FHN’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.

 

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

 

MORTGAGE SERVICING RIGHTS AND OTHER RELATED RETAINED INTERESTS

When FHN 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. An amount is capitalized as MSR on the Consolidated Condensed Statements of Condition. In 2005 these amounts were included at the lower of cost, net of accumulated amortization, or fair value. The cost basis of MSR qualifying for SFAS No. 133 fair value hedge accounting was adjusted to reflect changes in fair value. With the adoption of SFAS No. 156 on January 1, 2006, these amounts are included at current fair value. The changes in carrying value of MSR are included as a component of Mortgage Banking – Noninterest Income on the Consolidated Condensed Statements of Income.


MSR Estimated Fair Value

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

 

Since sales of MSR tend to occur in private transactions and the precise terms and conditions of the sales are typically not readily available, there is a limited market to refer to in determining the fair value of MSR. As such, like other participants in the mortgage banking business, FHN relies primarily on a discounted cash flow model to estimate the fair value of its MSR. This model calculates estimated fair value of the MSR using predominant risk characteristics of MSR, such as interest rates, type of product (fixed vs. variable), age (new, seasoned, moderate), agency type and other factors. FHN 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. FHN also compares its estimates of fair value and assumptions to rece nt market activity and against its own experience.

 

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


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

 

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

 

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

 

Float Income: Estimated float income is driven by expected float balances (principal, interest and escrow payments that are held pending remittance to the investor or other third party) 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 value of MSR.

 

First Horizon Home Loans engages in a process referred to as “price discovery” on a quarterly basis to assess the reasonableness of the estimated fair value of MSR. Price discovery is conducted through a process of obtaining the following information: (a) quarterly informal (and an annual formal) valuation of the servicing portfolio by an independent third party: a prominent mortgage-servicing broker, and (b) a collection of surveys and benchmarking data made available by independent third parties that include peer participants in the mortgage banking business. Although there is no single source of market information that can be relied upon to assess the fair value of MSR, First Horizon Home Loans reviews all information obtained during price discovery to determine whether the estimated fair value of MSR is reasonable when compared to market information. On March 31, 2006 and 2005, First Horizon Home Loans det ermined that its MSR valuations and assumptions were reasonable based on the price discovery process.


The First Horizon Risk Management Committee (FHRMC) submits the overall assessment of the estimated fair value of MSR monthly for review. The FHRMC is responsible for approving the critical assumptions used by management to determine the estimated fair value of First Horizon Home Loans’ MSR. Each quarter, FHN’s MSR Committee reviews the initial capitalization rates for newly originated MSR, the current valuation of MSR and the source of significant changes to the MSR carrying value. In addition, each quarter the Executive Committee of FHN’s board of directors reviews the initial capitalization rates and, prior to implementing SFAS No. 156, approved the amortization expense.

 

Hedging the Fair Value of MSR

First Horizon Home Loans enters into financial agreements to hedge MSR in order to minimize the effects of loss in value of MSR associated with increased prepayment activity that generally results from declining interest rates.  In a rising interest rate environment, the value of the MSR generally will increase while the value of the hedge instruments will decline.  Specifically, First Horizon Home Loans enters into interest rate contracts (including swaps, swaptions, and mortgage forward sales contracts) to hedge against the effects of changes in fair value of its MSR. Substantially all capitalized MSR are hedged for economic purposes.

 

Prior to the adoption of SFAS No. 156, First Horizon Home Loans hedged the changes in MSR value attributable to changes in the benchmark interest rate (10-year LIBOR swap rate).  The vast majority of MSR routinely qualified for hedge accounting.  For purposes of measuring effectiveness of the hedge, time decay and recognized net interest income, including changes in value attributable to changes in spot and forward prices, if applicable, were excluded from the change in value of the related derivatives. Interest rate derivative contracts used to hedge against interest rate risk in the servicing portfolio were designated to specific risk tranches of servicing. Hedges were reset at least monthly and more frequently, as needed, to respond to changes in interest rates or hedge composition. Generally, a coverage ratio approximating 100 percent was maintained on hedged MSR. Prior to acquiring a new hedge instrument, First Horizon Home Loans performed a prospective evaluation of anticipated hedge effectiveness by reviewing the historical regression between the underlying index of the proposed hedge instrument and the mortgage rate. At the end of each hedge period, the change in the fair value of the hedged MSR asset due to the change in benchmark interest rate was calculated and became a historical data point. Retrospective hedge effectiveness was determined by performing a regression analysis of all collected data points over a rolling 12-month period. Effective hedging under


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SFAS No. 133 resulted in adjustments to the recorded value of the MSR. These basis adjustments, as well as the change in fair value of derivatives attributable to effective hedging, were included as a component of servicing income in mortgage banking noninterest income.

 

MSR subject to SFAS No. 133 hedges totaled $1.1 billion on March 31, 2005. Related derivative net assets were $3.2 million on March 31, 2005. Pursuant to SFAS No. 133, the basis in MSR that qualify for hedge accounting are adjusted for the impact of hedge performance in net servicing income. Included in servicing income in mortgage banking noninterest income was a net loss of $.8 million, representing fair value hedge ineffectiveness and a net gain of $8.3 million, representing derivative gains from net interest income on swaps, net of time decay, which was excluded from the assessment of hedge effectiveness.

 

With the adoption of SFAS No. 156, First Horizon Home Loans no longer evaluates prospective or retrospective hedge performance for qualification as a SFAS No. 133 hedge. The hedges are economic hedges only, and are terminated and re-established as needed to respond to changes in market conditions. Changes in the value of the hedges continue to be recognized as a component of net servicing income in mortgage banking noninterest income. Successful economic hedging will help minimize earnings volatility that may result when carrying MSR at fair value.

 

First Horizon Home Loans 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 MSR associated with new production. This provides for a “natural hedge” in the mortgage-banking business cycle. New production and origination does not prevent First Horizon Home Loans from recognizing losses due to reduction in carrying value of existing servicing rights as a result of prepayments; rather, the new production volume results in loan origination fees and the capitalization of MSR 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 reduction in MSR carrying value during a period of low interest rates. In a period of increased borrower prepayments, these losses can be significantly offset by a strong replenishment rate and strong net margins on new loan originations. To the extent that First Horizon Home Loans is unable to maintain a strong replenishment rate, or in the event that the net margin on new loan originations declines from historical experience, the value of the natural hedge may diminish, thereby significantly impacting the results of operations in a period of increased borrower prepayments.

 

First Horizon Home Loans does not specifically hedge the change in fair value of MSR attributed to other risks, including unanticipated 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 rate), discount rates, cost to service and other factors. To the extent that these other factors result in changes to the fair value of MSR, First Horizon Home Loans experiences volatility in current earnings due to the fact that these risks are not currently hedged.

 

Actual vs. Estimated Prepayment Assumptions

As discussed above, the estimate of the cash flow components of net servicing income associated with MSR requires management to make several critical assumptions based upon current market and loan production data, including prepayment speeds, discount rate, cost to service and float income. Inherent in estimating such assumptions are uncertainties associated with the mortgage banking business (primarily, the change in market interest rates which vary significantly due to multiple economic and non-economic factors) as well as the composition of the MSR portfolio, which is not static and changes significantly based upon the production and sale of new loans, customer prepayment experience and other factors. As a result, the estimated assumptions used to value MSR – particularly the estimate of prepayment speeds – can vary significantly from actual experience, resulting in the recognition of additional losses in c urrent earnings. Table 8 provides a summary of actual and estimated weighted average prepayment speeds used in determining the estimated fair value of MSR for the quarters ended March 31, 2006 and 2005.

 

Each month the actual cash flows of the last 12 months from the total servicing portfolio are compared with the expected cash flow assumptions. Although actual cash flows of individual components differ from expected cash flows, the difference for overall cash flows from the entire servicing portfolio for each of the 12-month periods ending March 31, 2006 and 2005 was negligible.


While actual runoff rates tend to lag interest rate changes, fair values generally respond immediately to changes in the prevailing interest rate environment. FHN’s valuation model incorporates all current market drivers when generating future cash flow estimates.  To the extent that reductions in future cash flows are not completely hedged using derivative instruments, losses may be incurred.  Actual runoff in excess of anticipated runoff reduces the MSR fair value as of March 31, 2006, through paydowns and reduces the carrying value of MSR as of March 31, 2005, through impairment charges.  There were $10.4 million of impairment charges in first quarter 2005.  


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Table 8 - Mortgage Banking Prepayment Assumptions
Three Months Ended
March 31
              2006      2005   
Prepayment speeds
  Actual  16.7% 22.7% 
  Estimated*                             11.0                         22.5   
* Estimated prepayment speeds represent monthly average prepayment speed estimates for each of the periods presented.


Interest-Only Certificates Fair Value – Residential Mortgage Loans

In certain cases, when First Horizon Home Loans sells mortgage loans in the secondary market, it retains an interest in the mortgage loans sold primarily through interest-only certificates. Interest-only certificates are financial assets, which represent rights to receive earnings from serviced assets that exceed contractually specified servicing fees. Consistent with MSR, the fair value of an interest-only certificate typically rises as market interest rates increase and declines as market interest rates decrease. Additionally, similar to MSR, the market for interest-only certificates is limited, and the precise terms of transactions involving interest-only certificates are not typically readily available. Accordingly, First Horizon Home Loans relies primarily on a discounted cash flow model to estimate the fair value of its interest-only certificates.

 

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

 

Hedging the Fair Value of Interest-Only Certificates

First Horizon Home Loans utilizes derivatives (including swaps, swaptions, and mortgage forward sales contracts) that change in value inversely to the movement of interest rates to protect the value of its interest-only securities as an economic hedge. 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 in mortgage banking noninterest income as a component of servicing income. Interest-only securities are included in trading securities with changes in fair value recognized currently in earnings in mortgage banking noninterest income as a component of servicing income.

 

The extent to which the change in fair value of interest-only securities is offset by the change in fair value of the derivatives used to hedge these instruments depends primarily on the hedge coverage ratio maintained by First Horizon Home Loans. Also, as noted above, to the extent that actual borrower prepayments do not react as anticipated by the prepayment model (i.e., the historical data observed in the model does not correspond to actual market activity), it is possible that the prepayment model could fail to accurately predict mortgage prepayments, which could significantly impact First Horizon Home Loans’ ability to effectively hedge certain components of the change in fair value of interest-only certificates and could result in significant earnings volatility.

 

Residual-Interest Certificates Fair Value – HELOC and Second-lien Mortgages

In certain cases, when FHN sells HELOC or second-lien mortgages in the secondary market, it retains an interest in the loans sold primarily through a residual-interest certificate. Residual-interest certificates are financial assets which represent rights to receive earnings to the extent of excess income generated by the underlying loan collateral of certain mortgage-backed securities, which is not needed to meet contractual obligations of senior security holders. The fair value of a residual-interest certificate typically changes based on the differences between modeled prepayment speeds and credit losses and actual experience. Additionally, similar to MSR and interest-only certificates, the market for residual-interest certificates is limited, and the precise terms of transactions involving residual-interest certificates are not typically readily available. Accordingly, FHN relies primarily on a discounted cash flow model, which is prepared monthly, to estimate the fair value of its residual-interest certificates.


Estimating the cash flow components and the resultant fair value of the residual-interest certificates requires FHN to make certain critical assumptions based upon current market and loan production data. The primary critical assumptions used by FHN to estimate the fair value of residual-interest securities include prepayment speeds, credit losses and discount rates, as discussed above. FHN’s residual-interest certificates are included as a component of trading securities on the Consolidated Condensed Statements of Condition, with realized and


49

 

unrealized gains and losses included in current earnings as a component of other income on the Consolidated Condensed Statements of Income. FHN does not utilize derivatives to hedge against changes in the fair value of residual-interest certificates.

 

PIPELINE AND WAREHOUSE

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

 

First Horizon Home Loans’ warehouse (first-lien mortgage loans held for sale) is subject to changes in fair value, primarily due to fluctuations in interest rates from the loan closing date through the date of sale of the loan into the secondary market. Typically, the fair value of the warehouse declines in value when interest rates increase and rises in value when interest rates decrease. To mitigate this risk, First Horizon Home Loans enters into forward sales contracts and futures contracts to provide an economic hedge against those changes in fair value on a significant portion of the warehouse. These derivatives are recorded at fair value with changes in fair value recorded in current earnings as a component of the gain or loss on the sale of loans in mortgage banking noninterest income.

 

To the extent that these interest rate derivatives are designated to hedge specific similar assets in the warehouse and prospective analyses indicate that high correlation is expected, the hedged loans are considered for hedge accounting under SFAS No. 133. Anticipated correlation is determined based on the historical regressions between the change in fair value of the derivatives and the change in fair value of hedged mortgage loans. Beginning in fourth quarter 2005, anticipated correlation is determined by projecting a dollar offset relationship for each tranche based on anticipated changes in the fair value of the hedged mortgage loans and the related derivatives, in response to various interest rate shock scenarios. Hedges are reset daily and the statistical correlation is calculated using these daily data points. Retrospective hedge effectiveness is measured using the regression results. First Horizon Home Loans ge nerally maintains a coverage ratio (the ratio of expected change in the fair value of derivatives to expected change in the fair value of hedged assets) of approximately 100 percent on warehouse loans accounted for under SFAS No. 133.

 

Warehouse loans qualifying for SFAS No. 133 hedge accounting treatment totaled $1.5 billion and $.7 billion on March 31, 2006 and 2005, respectively. The balance sheet impacts of the related derivatives were net assets of $9.4 million and $5.0 million on March 31, 2006 and 2005, respectively. For first quarter 2006 and 2005, net losses of $3.6 million and $2.3 million, respectively, representing the hedge ineffectiveness of these fair value hedges, were recognized as a component of gain or loss on sale of loans.

 

Mortgage banking interest rate lock commitments are short-term commitments to fund mortgage loan applications in process (the pipeline) for a fixed term at a fixed price. During the term of an interest rate lock commitment, First Horizon Home Loans has the risk that interest rates will change from the rate quoted to the borrower. First Horizon Home Loans enters into forward sales contracts with respect to fixed rate loan commitments and futures contracts with respect to adjustable rate loan commitments as economic hedges designed to protect the value of the interest rate lock commitment from changes in value due to changes in interest rates. Under SFAS No. 133 interest rate lock commitments qualify as derivative financial instruments and as such do not qualify for hedge accounting treatment. As a result, the interest rate lock commitments are recorded at fair value with changes in fair value recorded in current earnings as gain or loss on the sale of loans in mortgage banking noninterest income. 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 Home Loans will approve the potential borrower for the loan. Therefore, First Horizon Home Loans makes estimates of expected "fallout” (locked pipeline loans not expected to close), using models which consider cumulative historical fallout rates and other factors. Fallout can occur for a variety of reasons including falling rate environments when a borrower will abandon an 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 a ssociated mortgage loan is included in the mortgage loan warehouse.

 

The extent to which First Horizon Home Loans is able to economically hedge changes in the mortgage pipeline depends largely on the hedge coverage ratio that is maintained relative to mortgage loans in the pipeline. The hedge coverage ratio can change significantly due to


50

 

 

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 FHN.

 

For the periods ended March 31, 2006 and 2005, the valuation model utilized to estimate the fair value of interest rate lock commitments assumes a zero fair value on the date of the lock with the borrower. Subsequent to the lock date, the model calculates the change in value due solely to the change in interest rates resulting in net liabilities with estimated fair values of $4.2 million and $5.2 million on March 31, 2006 and 2005, respectively.

 

FORECLOSURE RESERVES

As discussed above, First Horizon Home Loans typically originates mortgage loans with the intent to sell those loans to GSE 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 March 31, 2006 and 2005, $3.1 billion and $3.4 billion, respectively, of mortgage loans were outstanding which were sold under limited recourse arrangements where some portion of the principal is at risk. On March 31, 2006 and 2005, $150.6 million and $190.5 million, respectively, 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 the Federal Housing Administration (FHA) and Veterans Administration (VA). First Horizon Home Loans continues to absorb losses due to uncollected interest and foreclosure costs and/or limited risk of credit losses in the event of foreclosure of the mortgage loan sold. Generally, the amount of recourse liability in the event of foreclosure is determined based upon the respective government program and/or the sale or disposal of the foreclosed property collateralizing the mortgage loan. Another instance of limited recourse is the VA/No bid. In this case, the VA guarantee is limited and First Horizon Home Loans may be required to fund any deficiency in excess of the VA guarantee if the loan goes to foreclosure.

 

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 servicing 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. On March 31, 2006 and 2005, the foreclosure reserve was $22.1 million and $16.5 million, respectively. This increase is primarily due to the performance of nonprime loans. The servicing portfolio has grown from $88.0 billion on March 31, 2005, to $97.3 billion on March 31, 2006.

 

ALLOWANCE FOR LOAN LOSSES

Management’s policy is to maintain the allowance for loan losses at a level sufficient to absorb estimated probable incurred losses in the loan portfolio. Management performs periodic and systematic detailed reviews of its loan portfolio to identify trends and to assess the overall collectibility of the loan portfolio. Accounting standards require that loan losses be recorded when management determines it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Management believes the accounting estimate related to the allowance for loan losses is a "critical accounting estimate" because: changes in it can materially affect the provision for loan losses and net income, it requires management to predict borrowers’ likelihood or capacity to repay, and it requires management to distinguish between losses incurred as of a balance sheet date and losses expected to be incurred in the future. Accordingly, this is a highly subjective process and requires significant judgment since it is often difficult to determine when specific loss events may actually occur. 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 Retail/Commercial Banking segment. The Executive Committee of FHN’s board of directors reviews quarterly the level of the allowance for loan losses.

 

FHN’s methodology for estimating the allowance for loan losses is not only critical to the accounting estimate, but to the credit risk management function as well. Key components of the estimation process are as follows: (1) commercial loans determined by management to be individually impaired loans are evaluated individually and specific reserves are determined based on the difference between the outstanding loan amount and the estimated net realizable value of the collateral (if collateral dependent) or the present value of expected future cash flows; (2) individual commercial loans not considered to be individually impaired are segmented based on similar credit risk characteristics and evaluated on a pool basis; (3) retail loans are segmented based on loan types 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 b y management to reflect current


51

 

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.

 

FHN 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 FHN 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 adj ustments estimated by management for current events, trends, and conditions, utilized in the process reflect an estimate of losses that have been incurred as of the date of the financial statements.


While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses and methodology may be necessary if economic or other conditions differ substantially from the assumptions used in making the estimates or, if required by regulators, based upon information at the time of their examinations. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels vary from previous estimates. There have been no significant changes to the methodology for the quarters ended March 31, 2006 and 2005.


GOODWILL AND ASSESSMENT OF IMPAIRMENT

FHN’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 assessment of impairment at least annually. As of October 1, 2005, FHN 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. The valuation as of October 1, 2005, indicated n o 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 FHN’s future performance and cash flows, as well as other prevailing market factors (interest rates, economic trends, etc.). FHN’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 Retail/Commercial Banking, Mortgage Banking, and Capital Markets business segments. Reporting units have been defined as the same level as the operating business segments.

 

The impairment testing process conducted by FHN begins by assigning net assets and goodwill to each reporting unit. FHN 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.

 

In connection with obtaining the independent valuation, management provided certain data and information that was utilized by the third party in its determination of fair value. This information included budgeted and forecasted earnings of FHN at the reporting unit level. 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.


52

 

 

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

 

CONTINGENT LIABILITIES

A liability is contingent if the amount or outcome is not presently known, but may become known in the future as a result of the occurrence of some uncertain future event. FHN 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.

 

OTHER


ACCOUNTING CHANGES


FHN adopted SFAS No. 123-R as of January 1, 2006. Prior to the adoption of SFAS No. 123-R, FHN accounted for its equity compensation awards using Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”. As permitted, FHN retroactively applied the provisions of SFAS No. 123-R to its prior period financial statements. The Consolidated Condensed Statements of Income were revised to incorporate expenses previously presented in the footnote disclosures. The Consolidated Condensed Statements of Condition were revised to reflect the effects of including equity compensation expense in those prior periods. Additionally, all deferred compensation balances were reclassified within equity to capital surplus. Since FHN’s prior disclosures included forfeitures as they occurred, a cumulative effect adjustment, as required by SFAS No. 123-R, of $1.1 million was made for unvested awards that are not expected to vest due to anticipated forfeiture. FHN has made recent changes to its equity compensation plans, including increased use of restricted shares rather than stock options for management employees and extension of the eligibility date for, and/or removal of, automatic continued vesting of stock options upon retirement. See Note 1-Financial Information and Note 11-Stock Option, Restricted Stock Incentive, and Dividend Reinvestment Plans for additional information regarding SFAS No. 123-R.

 

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”, which permits fair value remeasurement for any hybrid financial instruments that contain an embedded derivative that otherwise would require bifurcation. Additionally, SFAS No. 155 clarifies the accounting guidance for beneficial interests in securitizations. SFAS No. 155 is effective for fiscal years beginning after September 15, 2006. Since FHN accounts for its beneficial interests in securitizations as trading securities, the adoption of SFAS No. 155 is not expected to have a significant impact on the results of operations.

 

SUBSEQUENT EVENTS

 

On April 18, 2006, the shareholders approved an amendment of FHN’s 2003 Equity Compensation Plan. The amendment increased the maximum number of shares which may be issued with respect to awards under that Plan from 4,000,000 to 8,500,000 and increased the maximum number of shares which may be issued with respect to awards other than stock options under the Plan from 1,300,000 to 4,800,000. The shareholders also re-approved the Plan in its entirety.

 

In connection with that Plan amendment, the Board of Directors increased by 4,500,000 shares the previously-announced consolidated compensation plan share purchase program referred to in connection with Table 7 and its related footnotes under the “Capital” section of this Item (the “Program”). Further, the Board also approved a change to the Program which would automatically authorize share repurchases for all subsequent increases in an existing plan's authority or the approval of any new plans.  On April 18, 2006, approximately 28.8 million shares remained available under the Program, inclusive of the increase. Repurchases are authorized to 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.


53

 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

The information called for by this item is contained in (a) Management’s Discussion and Analysis of Financial Condition and Results of Operations included as Item 2 of Part I of this report at pages 31-53, (b) the section entitled “Risk Management – Interest Rate Risk Management” of the Management’s Discussion and Analysis of Results of Operations and Financial Condition section of FHN’s 2005 Annual Report to shareholders, and (c) the “Interest Rate Risk Management” subsection of Note 1 to the Consolidated Financial Statements included in FHN’s 2005 Annual Report to shareholders.

 

Item 4. Controls and Procedures

 

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

 

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


54

 

 

 

Part II.

 

OTHER INFORMATION

 

Items 1, 1A, 3, 4 and 5

 

As of the end of the first quarter 2006, the answers to Items 1, 1A, 3, 4, and 5 were either inapplicable or negative, and therefore, these items are omitted.

 

 

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

(a)

On March 1, 2005, FHN purchased all of the outstanding stock of Greenwich Home Mortgage Corporation. A portion of the total purchase price was paid to ten shareholders of Greenwich in the form of a total of 90,867 shares of FHN's common stock, par value $0.625 per share, inclusive of shares issued into escrow accounts established under the acquisition agreement. The agreement calls for possible additional shares to be issued over certain periods based on certain actions or results (collectively, “adjustment shares”). There was no underwriter associated with the privately negotiated transaction. The issuance of FHN shares in connection with the transaction was and is exempt from registration pursuant, among other things, to Section 4(2) of the Securities Act of 1933, as amended. On January 13, 2006, a total of 4,712 adjustment shares were distributed to Greenwich shareholders pu rsuant to the agreement.

 

 

(b)

Not applicable

 

(c)

The Issuer Purchase of Equity Securities Table is incorporated herein by reference to the table included in Item 2 of Part I - First Horizon National Corporation - Management's Discussion and Analysis of Financial Condition and Results of Operations at page 42.


55

 

 

Item 6

Exhibits

 

(a)

Exhibits.

 

 

Exhibit No.

Description

 

 

 

4

Instruments defining the rights of security holders, including indentures.*

 

 

10.16

Form of master confirmation related to an accelerated stock repurchase of 4 million of the registrant’s common shares on March 1, 2006, incorporated by reference to Exhibit 10.16 to the registrant’s Current Report on Form 8-K dated March 1, 2006.

 

 

10.17**

Conformed copy of Larry B. Martin Retirement Agreement, incorporated by reference to Exhibit 10.17 to the registrant’s Current Report on Form 8-K dated March 30, 2006.

 

 

10.18

Form of Merchant Asset Purchase Agreement dated January 31, 2006, among several subsidiaries of the registrant and NOVA Information Systems, Inc. Certain information in this exhibit has been omitted pursuant to a request for confidential treatment. The omitted information has been submitted separately to the Securities and Exchange Commission.

 

 

13

The “Risk Management-Interest Rate Risk Management” subsection of the Management’s Discussion and Analysis section and the “Interest Rate Risk Management” subsection of Note 25 to the Corporation’s consolidated financial statements, contained, respectively, at pages 23-25 and page 107 in the Corporation’s 2005 Annual Report to shareholders furnished to shareholders in connection with the Annual Meeting of Shareholders on April 18, 2006, and incorporated herein by reference. Portions of the Annual Report not incorporated herein by reference are deemed not to be “filed” with the Commission with this report.

 

 

31(a)

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

 

 

31(b)

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

 

 

32(a)

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

 

 

32(b)

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

 

 

*

The Corporation agrees to furnish copies of the instruments, including indentures, defining the rights of the holders of the long-term debt of the Corporation and its consolidated subsidiaries to the Securities and Exchange Commission upon request.

 

 

**

This is a management contract or compensatory plan required to be filed as an exhibit.

 

In many agreements filed as exhibits, each party makes representations and warranties to other parties. Those representations and warranties are made only to and for the benefit of those other parties in the context of a business contract. They are subject to contractual materiality standards. Exceptions to such representations and warranties may be partially or fully waived by such parties in their discretion. No such representation or warranty may be relied upon by any other person for any purpose.


56

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

FIRST HORIZON NATIONAL CORPORATION

 

(Registrant)

 

 

 

 

 

DATE:

May 9, 2006

By: /s/ Marlin L. Mosby III  

Marlin L. Mosby III

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


57

 

 

EXHIBIT INDEX

 

 

Exhibit No.

Description

 

 

 

4

Instruments defining the rights of security holders, including indentures.*

 

 

10.16

Form of master confirmation related to an accelerated stock repurchase of 4 million of the registrant’s common shares on March 1, 2006, incorporated by reference to Exhibit 10.16 to the registrant’s Current Report on Form 8-K dated March 1, 2006.

 

 

10.17**

Conformed copy of Larry B. Martin Retirement Agreement, incorporated by reference to Exhibit 10.17 to the registrant’s Current Report on Form 8-K dated March 30, 2006.

 

 

10.18

Form of Merchant Asset Purchase Agreement dated January 31, 2006, among several subsidiaries of the registrant and NOVA Information Systems, Inc. Certain information in this exhibit has been omitted pursuant to a request for confidential treatment. The omitted information has been submitted separately to the Securities and Exchange Commission.

 

 

13

The “Risk Management-Interest Rate Risk Management” subsection of the Management’s Discussion and Analysis section and the “Interest Rate Risk Management” subsection of Note 25 to the Corporation’s consolidated financial statements, contained, respectively, at pages 23-25 and page 107 in the Corporation’s 2005 Annual Report to shareholders furnished to shareholders in connection with the Annual Meeting of Shareholders on April 18, 2006, and incorporated herein by reference. Portions of the Annual Report not incorporated herein by reference are deemed not to be “filed” with the Commission with this report.

 

 

31(a)

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

 

 

31(b)

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

 

 

32(a)

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

 

 

32(b)

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

 

 

*

The Corporation agrees to furnish copies of the instruments, including indentures, defining the rights of the holders of the long-term debt of the Corporation and its consolidated subsidiaries to the Securities and Exchange Commission upon request.

 

 

**

This is a management contract or compensatory plan required to be filed as an exhibit.

 

In many agreements filed as exhibits, each party makes representations and warranties to other parties. Those representations and warranties are made only to and for the benefit of those other parties in the context of a business contract. They are subject to contractual materiality standards. Exceptions to such representations and warranties may be partially or fully waived by such parties in their discretion. No such representation or warranty may be relied upon by any other person for any purpose.


58

EX-31 2 exh_31a.htm EXHIBIT 31A

Exhibit 31(a)

FIRST HORIZON NATIONAL CORPORATION

RULE 13a – 14(a) CERTIFICATIONS OF CEO

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

(QUARTERLY REPORT)

 

CERTIFICATIONS

 

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

 

1.

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

 

2.

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

 

3.

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

 

4.

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

 

a)

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

 

 

b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

 

c)

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

 

 

d)

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

 

5.

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

 

 

a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

 

 

b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

 

Date

May 9, 2006

 

/s/ J. Kenneth Glass

J. Kenneth Glass

Chairman of the Board, President and Chief Executive Officer

 

1

 

 EX-31 3 exh_31b.htm EXHIBIT 31B

Exhibit 31(b)

FIRST HORIZON NATIONAL CORPORATION

RULE 13a – 14(a) CERTIFICATIONS OF CFO

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

(QUARTERLY REPORT)

 

CERTIFICATIONS

 

I, Marlin L. Mosby III, Executive Vice President and Chief Financial Officer of First Horizon National Corporation, certify that:

 

1.

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

 

2.

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

 

3.

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

 

4.

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

 

a)

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

 

 

b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

 

c)

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

 

 

d)

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


5.

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

 

 

a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

 

 

b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

 

Date

May 9, 2006

 

/s/ Marlin L. Mosby III

Marlin L. Mosby III

Executive Vice President and Chief Financial Officer

 

1

 EX-32 4 exh_32a.htm EXHIBIT 32A

Exhibit 32(a)

CERTIFICATION OF PERIODIC REPORT

RULE 1350 CERTIFICATIONS OF CEO

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,

As Codefied at 18 U.S.C. Section 1350

 

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

 

1.

The Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934.

 

2.

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

 

Dated: May 9, 2006

 

 

/s/ J. Kenneth Glass

J. Kenneth Glass

Chairman of the Board, President and Chief Executive Officer

 

1

 

 EX-32 5 exh_32b.htm EXHIBIT 32B

Exhibit 32(b)

CERTIFICATION OF PERIODIC REPORT

RULE 1350 CERTIFICATIONS OF CFO

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,

As Codefied at 18 U.S.C. Section 1350

 

I, the undersigned Marlin L. Mosby III, Executive Vice President and Chief Financial Officer of First Horizon National Corporation (“Corporation”), hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, as follows:

 

1.

The Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934.

 

2.

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

 

Dated: May 9, 2006

 

 

/s/Marlin L. Mosby III

Marlin L. Mosby III

Executive Vice President and Chief Financial Officer

 

 

1

 

 EX-10 6 exh_1018.htm EXHIBIT 10.18

EXHIBIT 10.18

[Form of]

MERCHANT ASSET PURCHASE AGREEMENT

by and among

FIRST HORIZON MERCHANT SERVICES, INC.,

GLOBAL CARD SERVICES, INC.,

FIRST TENNESSEE BANK NATIONAL ASSOCIATION

and

NOVA INFORMATION SYSTEMS, INC.

 

JANUARY 31, 2006

 

 


 

 

Table of Contents

 

SCHEDULES

2.3

Merchant Security Arrangement Sharing

 

4.2

Schedule of Relationship Merchants Subject to the Holdback Amount

4.5

Items to be Prorated

 

11.4(f)

Schedule of Annual Net Revenue of Assigned Merchants

 

 

EXHIBITS

Exhibit "A" - Bill of Sale and Assignment and Assumption Agreement

Exhibit "B" - Interim Services Agreement

Exhibit "C" - Merchant Services Agreement

Exhibit "D" - Non-Competition Agreement

Exhibit "E" - Opinion of Counsel to Parent, GCS and Seller

Exhibit "F" - Opinion of Counsel to Buyer

Exhibit "G" - Forms of Merchant Agreements

Exhibit "H" – Form of Employee Retention, Sale Participation and Non-Solicitation Agreement

Exhibit "I" – Form of Residual Commission Buyout Agreement

 

 


 

 

MERCHANT ASSET PURCHASE AGREEMENT

THIS MERCHANT ASSET PURCHASE AGREEMENT (this "Agreement") is made and entered into as of January 31, 2006, by and among FIRST HORIZON MERCHANT SERVICES, INC., a Tennessee corporation ("Seller"), GLOBAL CARD SERVICES, INC., a Florida corporation ("GCS"), FIRST TENNESSEE BANK NATIONAL ASSOCIATION, a national banking association ("Parent") and NOVA INFORMATION SYSTEMS, INC., a Georgia corporation ("Buyer").

R E C I T A L S:

Seller is a former division and a current indirect subsidiary of Parent. Parent is the owner of certain of the fixed assets related to the Business (as defined in Section 1.1 of this Agreement).

 

GCS is a wholly owned subsidiary of Seller.

Both Parent, Seller and GCS, on the one hand, and Buyer, on the other hand, are engaged in the Merchant Processing Business, including the business of providing Merchant Services to commercial establishments which accept Credit Cards, Private Label Cards, Gift Cards, Travel and Entertainment Cards, Debit Cards and other Financial Transaction Devices. Seller, Parent and GCS desire to sell and transfer to Buyer, and Buyer desires to acquire and assume, certain assets and liabilities related to the Business on the terms and subject to the conditions set forth in this Agreement (the "Transaction"). The parties also desire to enter into certain other agreements in connection with the Transaction.

Certain capitalized terms used in this Agreement are defined in Section 1.1.

NOW, THEREFORE, in consideration of these premises and the mutual covenants set forth herein, the parties hereby agree as follows:

ARTICLE I

DEFINITIONS

1.1          Definitions. Except as otherwise expressly provided, the capitalized terms set forth below shall have the meanings set forth below. Capitalized terms used in this Agreement and defined elsewhere in this Agreement shall have the meanings given to them where defined herein.

"Acquiring Merchant" means a Merchant for whom Parent, Seller or GCS provides Merchant Services in connection with which Parent, Seller or GCS bears the risk (whether by Payment Network Regulation, contract, or otherwise) for Chargebacks or Credit Losses.

"Acquiror" shall have the meaning set forth in Section 8.4(b).

"Acquisition Transaction" shall have the meaning set forth in Section 8.4(a).

 

 


 

 

"Affiliate" of a Person means any other Person directly, or indirectly through one or more intermediaries, controlling, controlled by or under common control with such Person. For this purpose, "control" shall exist when a Person owns beneficially, directly or indirectly, more than 50% of the outstanding voting securities or equity interests of another Person or where a Person has the ability to elect or to cause the election of a majority of the directors, partners, members or managers of another Person.

"Agent Bank" means a financial institution sponsored by Seller and for which services related to the Business are provided to such financial institution and/or its merchants by or on behalf of Seller.

"Agent Bank Agreement" means an agreement between Parent, Seller or GCS and an Agent Bank pursuant to which the Agent Bank and Parent, Seller or GCS provide services relating to the Business.

"Agreed Allocation" shall have the meaning set forth in Section 4.2.

"Applicable Period" means, with respect to any Buyer Confidential Information, Transferred Business Confidential Information or Seller Confidential Information that qualifies as a trade secret under applicable Law, the maximum survival period allowed thereby, and as to all other Buyer Confidential Information, Transferred Business Confidential Information or Seller Confidential Information, five (5) years after the date of this Agreement.

"Assets" of a Person means all of the assets, properties, businesses and rights of such Person of every kind, nature, character and description, whether real, personal or mixed, tangible or intangible, accrued or contingent, or otherwise relating to or utilized in such Person's business, directly or indirectly, in whole or in part, whether or not carried on the books and records of such Person, and whether or not owned in the name of such Person or any Affiliate of such Person and wherever located.

"Assigned Acquiring Merchant" means any Acquiring Merchant that is a party to an Assigned Merchant Agreement.

"Assigned Acquisition Contract" means any of those certain contracts described in Section 2.1(c).

"Assigned Merchant" means any Merchant that is a party to an Assigned Merchant Agreement.

"Assigned Merchant Agreement" means any Merchant Agreement to which Parent, Seller or GCS is party as of the Effective Time, except for those Merchant Agreements identified on Section 2.2(d)(i) of the Seller Disclosure Schedule.

"Assigned Other Contracts" shall have the meaning set forth in Section 2.1(e).

"Assigned Other Merchant" means any Other Merchant that is a party to an Assigned Merchant Agreement.

 

 

 

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"Assigned Real Property Leases" shall have the meaning set forth in Section 2.1(d).

"Assumed Liabilities" shall have the meaning set forth in Section 3.1.

"Bill of Sale and Assignment and Assumption Agreement" shall have the meaning set forth in Section 5.2(a)(i).

"BINs" and "ICAs" means the VISA bank identification numbers and MasterCard interchange clearing account numbers owned by Seller and/or Parent and used in the Business which shall be transferred to Buyer or its designee in connection with the Transaction.

"Books and Records" shall have the meaning set forth in Section 2.2(e).

"Business" means the Merchant Processing Business conducted by Parent, Seller and GCS.

"Business Day" means a day other than a Saturday, Sunday, or a legal holiday on which federally chartered banks in Memphis, Tennessee are generally closed for business.

"Buyer Confidential Information" shall have the meaning set forth in Section 9.2(a)(i).

"Buyer Consents" shall have the meaning set forth in Section 7.3.

"Buyer Disclosure Schedule" means the written information entitled "Buyer Disclosure Schedule to Merchant Asset Purchase Agreement" delivered to Seller on the date of this Agreement describing the matters contained therein. Parent, GCS and Seller shall not be entitled to claim that any fact or combination of facts constitutes a breach of any of the representations or warranties of Buyer contained in this Agreement if and to the extent that such fact or combination of facts has been fairly disclosed in the numbered section of the Buyer Disclosure Schedule that corresponds to the Section of this Agreement in respect of which such disclosure is made (in each case in sufficient detail to put a reasonable person on notice of the relevance of the facts or circumstances so disclosed); provided, however, that the burden of proof in this regard shall, with respect to the Buyer Disclosure Schedule, always rest with Buyer. The inclusion, in and of itself, of any matter in the Buyer Disclosure Schedule shall not be deemed an admission or an acknowledgement or otherwise to imply that any such matter is material or outside the ordinary course of business for purposes of this Agreement (unless such conclusion or inference is to be reached on the basis of the representation(s) that such matter qualifies, or unless such matter is included as part of the certificate to be delivered by Buyer pursuant to Section 10.3(c)).

"Buyer Group" shall have the meaning set forth in Section 11.2(a).

"Buyer Standard of Care" shall have the meaning set forth in Section 11.5.

"Buyer Threshold" shall have the meaning set forth in Section 11.4(b).

"Card" means any of a Credit Card, Gift Card, Travel and Entertainment Card, electronic benefits transfer Card, Private Label Card and/or Debit Card.

 

 

 

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"Cash Payment" shall have the meaning set forth in Section 4.1.

"Chargeback" means a transaction that has been presented to either the cardholder or the issuer of a Financial Transaction Device and for which payment has been refused or reversed in accordance with the Payment Network Regulations or Card issuer policies.

"Claim" shall have the meaning set forth in Section 11.1(c).

"Closing" shall have the meaning set forth in Section 5.1.

"Closing Date" shall have the meaning set forth in Section 5.1.

"Confidentiality Agreement" means that certain confidentiality agreement dated October 21, 2005 by and among Buyer, Parent and Seller.

"Consent" means any consent, approval, authorization, clearance, exemption, waiver, or similar affirmation by any Person pursuant to any Contract, Law, Order, or Permit.

"Consequential Damages" means consequential damages, including without limitation lost profits and/or damages calculated on the basis of a multiple of revenue, earnings, or other financial measure.

"Contest" shall have the meaning set forth in Section 4.3(d).

"Contract" means, with respect to any Person, any written or oral agreement, arrangement, authorization, commitment, contract, indenture, instrument, lease, obligation, plan, practice, restriction, understanding or undertaking of any kind or character, or other document to which such Person is a party or that is binding on such Person or its capital stock, Assets or business.

"Conversion Date" means the Business Day following the Closing of the Transaction as agreed to by the Parties in the Interim Services Agreement when the Buyer (or its designee) assumes the obligations from Parent, GCS and/or Seller for providing the services identified in the Interim Services Agreement as required to process, clear and settle the Financial Transaction Device transactions of Assigned Merchants. Such process shall include without limitation the transfer to Buyer (or its designee) of the BINs and ICAs used in the Business, as approved by VISA and MasterCard.

"Credit Card" means (i) a VISA card or other card bearing the symbol(s) of VISA U.S.A., Inc. or VISA International, Inc., or (ii) a MasterCard card or other card bearing the symbol(s) of MasterCard International Incorporated, or (iii) any card bearing the symbols of any other Credit Card Association.

"Credit Card Associations" means (i) VISA U.S.A., Inc., (ii) VISA International, Inc., (iii) MasterCard International Incorporated and any successor organization or association to any of the foregoing.

 

 

 

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"Credit Loss" means any loss resulting from the failure by a Merchant to pay amounts owed by it under a Merchant Agreement or any other loss incurred for any reason attributable to a Merchant.

"Damages" shall have the meaning set forth in Section 11.2(a).

"Debit Card" means a card bearing the symbol(s) of one or more EFT Networks which enables the holder to pay for goods or services by authorizing an electronic debit to the cardholder's designated deposit account.

"Default" means (i) any breach or violation of or default under any Contract, Order or Permit, (ii) any occurrence of any event that with the passage of time or the giving of notice or both would constitute a breach or violation of or default under any Contract, Order or Permit, or (iii) any occurrence of any event that with or without the passage of time or the giving of notice would give rise to a right to terminate or revoke, change the current terms of, or renegotiate, or to accelerate, increase, or impose any Liability under, any Contract, Order or Permit.

"Default Allocation" shall have the meaning set forth in Section 4.2(a).

"Deferred Transferred Assets" shall have the meaning set forth in Section 5.3(c).

"Designated Employee Transfer Date" shall have the meaning set forth in Section 8.5(b).

"Designated Employees" shall have the meaning set forth in Section 6.11(a).

"Effective Time" shall have the meaning set forth in Section 5.1.

"EFT Networks" means electronic funds transfer networks such as STAR, Pulse, and NYCE, Interlink, Maestro and other similar networks.

"Equipment" shall have the meaning set forth in Section 2.1(i).

"Equipment Contracts" shall have the meaning set forth in Section 2.1(b).

"Evaluation Material" shall have the meaning set forth in Section 9.2(i).

"Excluded Events" shall have the meaning set forth in the last sentence of Section 11.4(e).

"FHN" means First Horizon National Corporation, the parent company of Parent.

"Financial Transaction Device" or "FTD" means any Card and any other financial transaction device, such as a stored value card or "smart" card, that is used for the purpose of obtaining credit or debiting consumer accounts at the point of sale and is effected through transactions with merchants, and other reasonably related products and services provided pursuant or ancillary to or in connection with transactions effected pursuant to the rules and regulations, to the extent applicable, of one or more Payment Networks.

 

 

 

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"GAAP" means United States generally accepted accounting principles.

"Gift Card" means a prepaid Credit Card issued by a Merchant in accordance with the rules of the Credit Card Associations.

"Group One Representations and Warranties" shall mean (a) as to Parent, GCS and Seller, the representations and warranties contained in Sections 6.2 (Power; Authority; Enforceable Obligations), 6.6 (Title to Assets) and 13.14 (Brokers and Finders), and (b) as to Buyer, the representations and warranties contained in Sections 7.2 (Power; Authority; Enforceable Obligations) and 13.14 (Brokers and Finders).

"Group Two Representations and Warranties" means the representations and warranties made by Parent, GCS and Seller in Sections 6.8(a) and (c) (but solely as such representations and warranties relate to Assigned Merchants and Assigned Merchant Agreements), Sections 6.3(a)(iii), 6.3(b), 6.4, 6.8(b), (d), (f) and (g), and Section 6.12.

"Holdback Amount" has the meaning set forth in Section 4.2.

"HSR Act" means the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.

"Indemnified Party" shall have the meaning set forth in Section 11.3(a).

"Indemnifying Party" shall have the meaning set forth in Section 11.3(a).

"Interim Services Agreement" shall have the meaning set forth in Section 5.2(a)(iii).

"ISO" and "ISA" means an independent sales organization or an independent sales association, respectively, that is a party to an ISO Agreement or an ISA Agreement.

"ISO Agreement" and "ISA Agreement" means an agreement or arrangement whether oral or in writing by and between Parent, Seller or GCS and an ISO, or Parent, Seller or GCS and an ISA, respectively, providing for the referral of prospective Merchants.

"Knowledge" of a party means, in the case of Parent, Seller and GCS, the actual knowledge of executive officers and of the persons listed in Section 1.1(k) of the Seller Disclosure Schedule (which in all events includes the senior executive officers of the Business) and in the case of Buyer, the persons listed in Section 1.1(k) of the Buyer Disclosure Schedule, in all cases after due investigation and reasonable inquiry.

"Law" means any code, law, ordinance, regulation, reporting or licensing requirement, rule or statute applicable to a Person or its Assets, Liabilities or business, including those promulgated, interpreted or enforced by any Regulatory Authority.

"Liability" means any liability, indebtedness, obligation, penalty, cost or expense (including costs of investigation, collection and defense and reasonable attorneys' fees), deficiency, guaranty or endorsement of or by any Person (other than endorsement of notes, bills, checks, and drafts presented for collection or deposit in the ordinary course of business) of any

 

 

 

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type, whether accrued, absolute or contingent, liquidated or unliquidated, matured or unmatured, direct or indirect, primary or secondary, or otherwise.

"Licensed Software" shall mean Software and other technology which is licensed by Parent, Seller and/or GCS from third parties and which is used by Parent, Seller and/or GCS (including their Merchants) in the Business, including the Seller Proprietary Rights, as described and identified in Section 6.12(e) of the Seller Disclosure Schedule. Licensed Software excludes any Software licensed from third parties (i) by Seller, GCS and/or Parent or any of Seller's, GCS's and/or Parent's Affiliates that is not used in the Business, (ii) by Seller, GCS and/or Parent or any of Seller's, GCS's and/or Parent's Affiliates that is "off the shelf" licensed software, unless such "off the shelf" licensed software is assignable and (iii) by Parent or any of Parent's Affiliates other than Seller or GCS that is not "off the shelf" licensed software and that is licensed for use in FHN's and its Affiliates' corporate operations.

"Lien" means any conditional sale agreement, default of title, easement, encroachment, encumbrance, hypothecation, infringement, lien, mortgage, pledge, reservation, restriction, security interest, title retention or other security arrangement, or any adverse right or interest, charge, or claim of any nature whatsoever of, on, or with respect to any property or property interest.

"Litigation" means any action, suit, claim, indictment, grievance, arbitration, complaint, criminal prosecution, governmental or other examination or investigation, hearing, inquiry, administrative or other proceeding relating to or affecting a party, its business, its Assets, Contracts, or the Transaction.

"Material Adverse Effect" means a circumstance, state of facts, event, change or occurrence which, either alone or when taken together with other circumstances, states of facts, events, changes or occurrences, does or could reasonably be expected to have a material adverse effect on (i) in the case of or with respect to Buyer, the ability of Buyer to perform its obligations under this Agreement and the other Operative Documents or to consummate the Transaction, (ii) in the case of or with respect to Seller, GCS or the Business, the condition (financial or otherwise), properties, assets, liabilities, position, business or results of operations of Seller and GCS with respect to the Business or the Transferred Assets, taken as a whole, or the ability of Seller and GCS to perform their respective obligations under this Agreement and the other Operative Documents or to consummate the Transaction, and (iii) in the case of or with respect to Parent, the ability of Parent to perform its obligations under this Agreement and the other Operative Documents or to consummate the Transaction.

"Merchant" means any person or entity (other than Seller and/or Parent or GCS) that is a party to a Merchant Agreement and specifically includes both (a) Acquiring Merchants and (b) Other Merchants.

"Merchant Accounts Receivable" shall have the meaning set forth in Section 2.1(a).

"Merchant Agreement" means an agreement between or among Parent, Seller or GCS, as applicable, and a Merchant, pursuant to which the Merchant undertakes to honor Financial Transaction Devices and Parent, Seller or GCS, as applicable, undertakes to provide Merchant

 

 

 

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Services. The parties acknowledge and agree that a Merchant Agreement may be constituted of (i) an application page duly executed by the Merchant together with (ii) a pricing schedule and (iii) terms and conditions, as amended from time to time, provided to the Merchant, all of which taken together are legally binding upon the Merchant and Parent, Seller or GCS, as applicable.

"Merchant Processing Business" means, with respect to any Person, the business of providing Merchant Services.

"Merchant Security Arrangements" shall have the meaning set forth in Section 2.3.

"Merchant Security Arrangement Allocation Period" shall have the meaning set forth in Section 2.3.

"Merchant Services" means acceptance of FTD transaction records in documentary or electronic form from merchants (i) in the case of GCS, in connection with the routing of such transaction records to the appropriate sources for authorizations, settlement, retrievals, Chargebacks, and other transactions by such merchants' processors and (ii) in the case of FHMS, in connection with the processing and clearing of such records for settlement and payment to such merchants, and such activities as are incidental, reasonably complementary or reasonably similar thereto, including general ledger posting, retrievals and Chargebacks, as are conducted or engaged in by Buyer or its Affiliates, respectively, from time to time; provided, that "Merchant Services" specifically excludes commercial treasury management, cash management, check clearing and other commercial bank customer payment systems products or services offered by FTB, its Affiliates, successor or assigns, respectively, from time to time, so long as none of such products or services implicate the acceptance and/or processing of association-branded or association-supported payment devices for goods or services.

"Merchant Services Agreement" shall have the meaning set forth in Section 5.2(a)(iv).

"Net Revenue" shall mean, with respect to any Assigned Merchant, for purposes of Section 11.4(f), (i) if applicable, the annual net revenue received by FHMS or GCS, as applicable, for providing Merchant Services to such Assigned Merchant during the twelve (12) months ended November 30, 2005, as particularly set forth on Schedule 11.4(f), and (ii) if such Assigned Merchant was not a Merchant for such full twelve month period ending November 30, 2005, the annualized net revenue received by FHMS or GCS, as applicable, for providing Merchant Services to such Assigned Merchant calculated with respect to the period beginning on the date such Assigned Merchant became a Merchant and ending on the Closing Date.

"Non-Competition Agreement" shall have the meaning set forth in Section 5.2(a)(v).

"Operative Documents" means this Agreement, the Merchant Services Agreement, the Interim Services Agreement, the Non-Competition Agreement, and the Transfer Documents.

"Order" means any administrative decision or award, decree, injunction, judgment, order, quasi-judicial decision or award, ruling, or writ of any federal, state, local or foreign or other court, arbitrator, mediator, tribunal, administrative agency or Regulatory Authority.

 

 

 

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"Ordinary Course of Business" means, with respect to actions and operations conducted by Parent, Seller and/or GCS with respect to the Business, actions and operations that are (a) consistent with the past practices of the Business, (b) taken in the ordinary course of the normal, day-to-day operations of the Business, and (c) not required to be authorized by the Board of Directors of Parent, Seller or GCS.

"Other Contracts" shall have the meaning set forth in Section 6.8(j)(iv).

"Other Merchant" means a Merchant for whom Parent, Seller or GCS provides Merchant Services in connection with which Parent, Seller or GCS does not bear any risk (whether by Payment Network Regulation, contract, or otherwise) for Chargebacks or Credit Losses.

"Other Representations and Warranties" means the representations and warranties made by Parent, GCS and Seller in this Agreement (or any certificate delivered pursuant to Section 10.2(c)) other than any Group One Representations and Warranties and Group Two Representations and Warranties.

"Owned Software" shall mean (a) all Software which is owned by Seller or GCS, whether developed by Seller, GCS, any other Person, (b) all Software which is owned by Parent, whether developed by Parent or any other Person, that is designed for use in or which is used in the Business, and (c) with respect to (a) and (b), any Software that is included in Seller Proprietary Rights. The Owned Software is identified in Section 6.12(d) of the Seller Disclosure Schedule.

"Parent Transaction" shall have the meaning set forth in Section 8.4(b).

"Payment Network" means any Credit Card Association, EFT Network and any other organization or association that issues or sponsors a Financial Transaction Device.

"Payment Network Regulations" means, collectively, the rules and regulations promulgated by any Payment Network.

"Permit" shall mean any federal, state, local, and foreign governmental approval, authorization, certificate, easement, franchise, license, notice, permit, or right to which any Person is a party or that is or may be binding upon or inure to the benefit of any Person or its securities, Assets or business.

"Permitted Liens" means Liens for Taxes not yet due and payable and such Liens or other imperfections of title, if any, as do not materially detract from the value of or materially interfere with the present use of the property or asset affected thereby.

"Person" shall mean a natural person or any legal, commercial or governmental entity, including a corporation, general partnership, joint venture, limited partnership, limited liability company, trust, business association, or person acting in a representative capacity.

"Post-Closing Period" shall have the meaning set forth in Section 4.3(e).

 

 

 

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"Pre-Closing Period" shall have the meaning set forth in Section 4.3(e).

"Private Label Card" means a Credit Card issued by and bearing the symbols of Merchants enabling their customers to purchase such Merchant's products and services through the extension of credit.

"Purchase Price" shall have the meaning set forth in Section 4.1.

"Regulatory Authorities" shall mean, collectively, the United States Federal Trade Commission, the United States Department of Justice, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, all federal or state regulatory agencies having jurisdiction over Parent, Buyer or Seller, the Securities and Exchange Commission, the Payment Networks, the New York Stock Exchange and any other federal or state governmental agency or regulatory body.

"Relationship Merchant" shall mean any one of the five Top 100 Acquiring Merchants identified on Schedule 4.2.

"Representative" means, with respect to any Person, any investment banker, financial advisor, attorney, accountant, employee, officer, director, consultant, or other agent or representative of such Person.

"Retained Assets" shall have the meaning set forth in Section 2.2.

"Retained Books and Records" shall have the meaning set forth in Section 2.2(e).

"Retained Contracts" shall have the meaning set forth in Section 2.2(d).

"Retained Liabilities" shall have the meaning set forth in Section 3.2.

"Seller Confidential Information" shall have the meaning set forth in Section 9.2(e).

"Seller Consents" shall have the meaning set forth in Section 6.3.

"Seller Disclosure Schedule" means the written information entitled "Seller Disclosure Schedule to Merchant Asset Purchase Agreement" delivered on the date of this Agreement to Buyer describing the matters contained therein. Buyer shall not be entitled to claim that any fact or combination of facts constitutes a breach of any of the representations or warranties of Parent, Seller or GCS contained in this Agreement if and to the extent that such fact or combination of facts has been fairly disclosed in the numbered section of the Seller Disclosure Schedule that corresponds to the Section of this Agreement in respect of which such disclosure is made (in each case in sufficient detail to put a reasonable person on notice of the relevance of the facts or circumstances so disclosed); provided, however, that the burden of proof in this regard shall, with respect to the Seller Disclosure Schedule, always rest with Seller, GCS and/or Parent, as applicable. The inclusion, in and of itself, of any matter in the Seller Disclosure Schedule shall not be deemed an admission or an acknowledgement or otherwise to imply that any such matter is material or outside the ordinary course of business for purposes of this Agreement (unless such conclusion or inference is to be reached on the basis of the representation(s) that such matter

 

 

 

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qualifies (e.g., Section 6.8(j)), or unless such matter is included as part of the certificate to be delivered by Parent and Seller pursuant to Section 10.2(c)).

"Seller Financial Information" shall have the meaning set forth in Section 6.4.

"Seller Group" shall have the meaning set forth in Section 11.2(b).

"Seller Proprietary Rights" shall have the meaning set forth in Section 6.12(a).

"Seller Threshold" shall have the meaning set forth in Section 11.4(a).

"Software" means the Owned Software and the Licensed Software, collectively, in the form and condition that such Software exists on the Closing Date.

"Specified Consents" shall have the meaning set forth in Section 5.3(b).

"Specified Merchant" means any Assigned Merchant that (a) is involved in the airline, cruise line, or tour operator business (whether as an Acquiring Merchant or Other Merchant), (b) is a Top 100 Acquiring Merchant, or (c) is a Top 10 Other Merchant.

"Specified Merchant Agreement" means any Merchant Agreement to which a Specified Merchant is a party.

"Straddle Period" shall have the meaning set forth in Section 4.3(e).

"Survival Period" shall have the meaning set forth in Section 11.1(a).

"Tax" or "Taxes" shall mean all taxes, charges, fees, levies or other assessments, including all gross receipts, sales, use, value added, ad valorem, real estate transfer, documentary stamp, gains, bulk sales, profits, license, withholding, payroll, employment, social security, unemployment, excise, severance, property or other similar taxes, duties, fees, assessments or charges of any kind whatsoever, including any interest, penalties or additional amounts attributable thereto imposed by any United States federal, state, local or foreign governmental authority, and specifically including any taxes, duties, fees or charges imposed on or measured by net or gross income, capital stock or net worth or in the nature of an income, capital, franchise, or net worth tax.

"Tax Return" shall mean any return, report, information return, statement, declaration or other document (including any related or supporting information) filed or required to be filed with any United States federal, state, local or foreign governmental authority in connection with any determination, assessment or collection of any Tax or other administration of any Laws, regulations or administrative requirements.

"Termination Date" shall have the meaning set forth in Section 12.1(b).

"Third Party Claim Notice" shall have the meaning set forth in Section 11.3(a).

"Third Party Claims" shall have the meaning set forth in Section 11.3.

 

 

 

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"Tier 1 Relationship Merchant" shall mean any one of the three Relationship Merchants identified as such on Schedule 4.2.

"Tier 2 Relationship Merchant" shall mean any one of the two Relationship Merchants identified as such on Schedule 4.2.

"Top 100 Acquiring Merchants" means the one hundred (100) Assigned Acquiring Merchants with the highest dollar value of Card transactions processed during the twelve (12) month period ending November 30, 2005.

"Top 10 Other Merchants" means the ten (10) Assigned Other Merchants with the highest dollar value of revenue earned by the Business during the twelve (12) month period ending November 30, 2005.

"Transaction" means collectively the various transactions contemplated by the Operative Documents.

"Transfer Documents" shall have the meaning set forth in Section 5.2(a)(ii).

"Transfer Taxes" shall have the meaning set forth in Section 4.3(a).

"Transferred Assets" shall have the meaning set forth in Section 2.1 and shall include any Deferred Transferred Asset from and after the time such Asset is transferred to Buyer.

"Transferred Books and Records" shall have the meaning set forth in Section 2.1(j).

"Transferred Business Confidential Information" shall have the meaning set forth in Section 9.2(a)(ii).

"Transferred Contracts" shall have the meaning set forth in Section 2.1(f).

"Transferred Employees" shall have the meaning set forth in Section 8.5(b).

"Transferred Permits" shall have the meaning set forth in Section 2.1(g).

"Transferred Vendor Contracts" shall have the meaning set forth in Section 2.1(f).

"Transition Period" means the period from the Closing Date through and including the Conversion Date.

"Travel and Entertainment Card" means any and all of the credit or charge cards issued by any of American Express Company, Discover Bank, Carte Blanche, JCB International Credit Card Co., Ltd. and Diners Club International Ltd.

"WARN Act" shall have the meaning set forth in Section 3.2(c).

 

 

 

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ARTICLE II

PURCHASE AND SALE OF ASSETS

2.1          Purchase and Sale of Assets. On the terms and subject to the conditions set forth in this Agreement, at the Closing and effective as of the Effective Time, Parent, Seller and GCS shall sell, transfer, convey, assign and deliver to Buyer, free and clear of all Liens (other than Permitted Liens), and Buyer shall purchase, acquire and accept from Parent, GCS and Seller, all of Parent's, GCS's and Seller's respective right, title and interest in and to the following assets, rights, properties, claims and contracts, whether tangible or intangible, real, personal or mixed, accrued, contingent or otherwise, described in paragraphs (a) through (o) below ("Transferred Assets"):

(a)          all Assigned Merchant Agreements, including any rights and interests of Parent, Seller or GCS under any guaranty agreements and, subject to Section 2.3, any Merchant Security Arrangements established or maintained in connection with the Assigned Merchant Agreements, but not including (i) any right to receive payment for or in connection with transactions processed before the Effective Time (including all accounts receivable, all notes, bonds, guarantees, and other evidence of indebtedness and all other rights to receive payments arising out of the Assigned Merchant Agreements before the Effective Time) (the "Merchant Accounts Receivable") or (ii) any right to assert claims or take other actions in respect of Defaults under the Assigned Merchant Agreements that arise out of or relate to events occurring before the Effective Time;

(b)          all Contracts for the provision by third parties of point-of-sale terminals to Assigned Merchants in connection with the Business in which Parent, Seller or GCS has any economic interest or with respect to which Seller or GCS derives any revenue (the "Equipment Contracts"), but not including any right to receive payment or to assert claims or take other action in respect of Defaults under the Equipment Contracts that arise out of or relate to events occurring prior to the Effective Time;

(c)          all Contracts identified on Section 2.1(c) of the Seller Disclosure Schedule pursuant to which, in the last five (5) years, (x) Parent, Seller or GCS acquired any Merchant Processing Business or any business which is incidental to and in support of the Business from any Person, whether by acquisition of substantially all of the assets or the capital stock, or by merger, of such Merchant Processing Business or business, or (y) Parent, Seller or GCS sold certain assets and liabilities of the Business to another Person (collectively, the "Assigned Acquisition Contracts");

(d)          the real property leases identified on Section 2.1(d) of the Seller Disclosure Schedule (the "Assigned Real Property Leases"), but not including any right to receive payment or to assert claims or take other action in respect of Defaults under the Assigned Real Property Leases that arise out of or relate to events occurring prior to the Effective Time;

(e)          the Contracts identified in Section 2.1(e) of the Seller Disclosure Schedule (the "Assigned Other Contracts"), but not including any right to receive payment or to

 

 

 

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assert claims or take other action in respect of Defaults under the Assigned Other Contracts that arise out of or relate to events occurring prior to the Effective Time;

(f)           all Contracts (other than Assigned Merchant Agreements, Assigned Acquisition Contracts, Equipment Contracts, Assigned Other Contracts, Assigned Real Property Leases, and insurance policies) pursuant to which Parent, Seller or GCS obtains goods, benefits or services from, or provides goods, benefits or services to, a third party in connection with the Business and which are to be assigned to Buyer as identified on Section 2.1(f) of the Seller Disclosure Schedule (collectively, the "Transferred Vendor Contracts," and together with the Assigned Merchant Agreements, the Equipment Contracts, the Assigned Acquisition Contracts, the Assigned Other Contracts and the Assigned Real Property Leases, the "Transferred Contracts"), including any right to receive goods, services or payments pursuant to the Transferred Vendor Contracts, but not including any right to assert claims or take other actions in respect of Defaults under the Transferred Vendor Contracts that arise out of or relate to events occurring before the Effective Time;

(g)          to the extent transferable, the Permits identified on Section 2.1(g) of the Seller Disclosure Schedule, if any (the "Transferred Permits");

(h)          the BINs and ICAs used by Parent, Seller and/or GCS in connection with the Business, as identified on Section 2.1(h) of the Seller Disclosure Schedule;

(i)           all equipment set forth in Section 2.1(i) of the Seller Disclosure Schedule, any applicable related revenues accruing on or after the Effective Time, and all warranties and guarantees, if any, expressed or implied, existing for the benefit of Seller in connection with any of the same (collectively, the "Equipment");

(j)           the books, records, operating data, and documents, including Assigned Merchant Agreements (whether in hard copy or electronic form), relating to the Transferred Assets or the Business (including manuals, operating guidelines and practices, sales and promotional data, advertising materials, customer lists, credit information, historical cost and pricing information, supplier lists, reference catalogs, and other similar property) (the "Transferred Books and Records"); provided, however, that in no event shall such Transferred Books and Records include books or records involving operations other than of the Business, and further provided that Parent, GCS and/or Seller may retain copies of such Transferred Books and Records;

(k)          to the extent assignable or otherwise transferable, but subject to the obligations in Section 5.3, all rights in and to the Licensed Software;

(l)           the trademarks and trademark registrations identified on Section 2.1(l) of the Seller Disclosure Schedule;

(m)         the Owned Software, including copyright, trademark (unless and to the extent trademark rights include the names "First Horizon," "First Horizon Merchant

 

 

 

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Services," "FHMSi," or "FHMS"), patent, trade secret and other rights thereto, and all copies of the Owned Software;

(n)          all copies in Seller's or GCS's possession of the Software and any other materials comprising or containing Seller's Proprietary Rights retaining no copies thereof; and

(o)          the goodwill associated with the Business as a going concern, to the extent any such goodwill exists.

2.2          Retained Assets. Parent, Seller and GCS shall retain all assets held by Parent, Seller, GCS or any of their respective Affiliates which are not included in the Transferred Assets (the "Retained Assets"), including:

(a)          all (i) cash and cash equivalents, including debt and equity securities owned by Seller or Parent, bank accounts and deposits, investments in money market funds, commercial paper, certificates of deposit, treasury bills and accrued interest thereon and (ii) accounts receivable and other rights to receive payments in respect of the Business including all Merchant Accounts Receivable; provided that, with respect to rights to receive payments in respect of the Business other than the Merchant Accounts Receivable, only those rights which arose prior to the Effective Time;

(b)          subject to such rights as may be licensed to Buyer under the other Operative Documents and except for rights in the Owned Software and the trademarks and trademark registrations identified on Section 2.1(l) of the Seller Disclosure Schedule, all ownership rights in all U.S. and foreign trademarks and trademark registrations, copyright registrations, trade name registrations, service marks and service mark registrations, logos and any applications or pending applications related to any of the foregoing, all confidential information (other than as embodied in the Transferred Books and Records or relating to or comprising the Transferred Assets), trade secrets, compilations, know-how, drawings, techniques, and processes, and all invention disclosures and common law trademarks, service marks, copyrights and trade names owned or controlled by Seller, GCS or Parent, pursuant to license or otherwise and whether or not used in the Business;

(c)          all rights in Licensed Software not transferred to Buyer under this Agreement;

(d)          all Contracts that are not Transferred Contracts, including (i) any Contracts identified on Section 2.2(d)(i) of the Seller Disclosure Schedule, and (ii) any Contracts of insurance in respect of the Business or the Transferred Assets (collectively, the "Retained Contracts");

(e)          all corporate charters, minute books, stock records and corporate seals, and all other books and records that are not included in the Transferred Books and Records ("Retained Books and Records"; the Transferred Books and Records and the

 

 

 

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Retained Books and Records are sometimes collectively referred to herein as the "Books and Records");

(f)           any refunds, credits or other assets or rights (including interest thereon or claims therefor) with respect to any Taxes paid or incurred by Parent, Seller or GCS;

(g)          any rights (including rights to indemnification and any policy of insurance) and claims and recoveries under litigation against third parties arising out of or relating to events in respect of the Business occurring before the Effective Time; and

(h)          any assets used in the Business that are transferred or otherwise disposed of by Seller, GCS or Parent in compliance with the terms of this Agreement between the date of signing of this Agreement but before the Closing Date.

2.3          Access to Merchant Security Arrangements. The parties acknowledge and agree that Chargebacks resulting from transactions occurring prior to the Effective Date (a "Pre-Closing Chargeback") are for the sole account of Seller and that Chargebacks resulting from transactions occurring on or after the Effective Date (a "Post-Closing Chargeback") are for the sole account of Buyer. Seller has required certain Assigned Merchants to establish reserve accounts, letters of credit, and other forms of security (collectively, "Merchant Security Arrangements") for such Assigned Merchants' obligations and liabilities under the Assigned Merchant Agreements. Accordingly, during the twelve (12) month period following the Closing Date (the "Merchant Security Arrangement Allocation Period"), Seller and Buyer shall each be entitled to reimbursement from the then remaining funds in the applicable Merchant Security Arrangement on the sliding scale proportionate basis set forth in Schedule 2.3 attached hereto. In order to be entitled to reimbursement, the party having liability for such Chargeback (whether Buyer or Seller) shall notify the other party in writing and shall provide documentation reasonably requested showing that a Pre-Closing Chargeback or Post-Closing Chargeback, as applicable, has occurred with respect to the applicable Assigned Merchant and that the balance in the Assigned Merchant's account is not sufficient to cover the Chargeback. Following the termination of the Merchant Security Arrangement Allocation Period as to any Assigned Merchant, Buyer shall be entitled to the funds in such Merchant Security Arrangement, and Seller shall have no further interest in any such Merchant Security Arrangement. Notwithstanding the foregoing, (a) in no event shall Seller be entitled to more than fifty percent (50%) of the funds in any Merchant Security Arrangement as of the Effective Date, and (b) Buyer shall in no event be obligated to provide Seller with access to, and Seller shall have no rights to, or obligations relating to, any reserve accounts, letters of credit or other security established, created or collected, as applicable, by Buyer after the Effective Date with respect to any Assigned Merchant.

ARTICLE III

ASSUMPTION OF LIABILITIES

3.1          Transfer and Assumption of Assumed Liabilities. Effective as of the Effective Time and subject to the terms and conditions of the Operative Documents, as part of the consideration for the Transferred Assets to be transferred and sold to Buyer hereunder, Buyer shall agree to be bound by the Transferred Contracts and Transferred Permits and shall assume

 

 

 

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and agree to pay, perform and discharge, when due, only the following liabilities and obligations of Seller, GCS or Parent (the "Assumed Liabilities"):

(a)          the Liabilities and obligations of Seller, GCS and/or Parent arising at or after the Effective Time to perform under the Transferred Contracts and Transferred Permits assigned to Buyer pursuant to this Agreement, to the extent such Liabilities and obligations (i) are disclosed in or discernible from the face of such Transferred Contracts and Transferred Permits, (ii) are fairly disclosed on Section 3.1 of the Seller Disclosure Schedule, or (iii) are consistent with Seller's historical operation of the Business in the Ordinary Course of the Business and which Liabilities and obligations do not individually exceed $10,000 or collectively exceed $200,000 (excluding, for purposes of clauses (i), (ii) and (iii), any claim, Liability or obligation arising out of or relating to an actual or alleged Default of Seller, GCS or Parent that occurred prior to the Effective Time);

(b)          the obligations of Seller, GCS or Parent to pay assessments, interchange fees, transaction fees, fines, penalties or other fees or charges to the Credit Card Associations or EFT Networks, provided such obligations relate to transactions which occur both (i) under the Assigned Merchant Agreements and (ii) at or after the Effective Time;

(c)          Chargebacks in respect of any Credit Card transaction processed by Buyer pursuant to an Assigned Merchant Agreement with an Acquiring Merchant at and after the Effective Time and other Credit Losses at and after the Effective Time, but only to the extent that such Chargeback or other Credit Loss relates to or arises out of an original sales transaction occurring at or after the Effective Time; and

(d)          commissions payable to the Designated Employees as further described on Section 3.1(d) of the Seller Disclosure Schedule, to the extent that such commissions relate to sales generated after the Closing Date and prior to the Designated Employee Transfer Date; and

(e)          any other claims, Liabilities or Litigation in respect of the Transferred Assets, and the business conducted in connection with the foregoing, provided that any such claims, Liabilities or Litigation relate to or arise out of events, transactions or actions or omissions of Buyer on or after the Effective Time.

 

3.2

Retained Liabilities.

(a)          Buyer shall not assume or become liable for, in whole or in part, the payment or performance of any debts, Taxes (except as and to the extent provided in Section 4.3), Liabilities, Litigation, losses, Credit Losses, Chargebacks, accounts payable, indebtedness, mortgages, or other obligations of Seller, GCS, Parent or any Merchant or other third party, whether the same are known or unknown, now existing or hereafter arising, of whatever nature or character, whether absolute or contingent, liquidated or disputed, that are not Assumed Liabilities, including those items provided in Section 3.2(b) below (the "Retained Liabilities"). Without limiting the foregoing, Buyer shall not

 

 

 

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assume, and Seller and/or Parent shall retain, discharge and pay any and all liabilities and obligations, direct or indirect, absolute or contingent:

(i)           arising before the Effective Time, or relating to any time prior to the Effective Time, in connection with the ownership or operation of the Business or the Transferred Assets, including (x) any claim by any Person alleging any failure by Seller, GCS or Parent to comply with the terms and conditions of any Transferred Contract or Transferred Permit before the Effective Time and (y) any and all Chargebacks and Credit Losses in respect of any Assigned Merchant Agreement that relate to or arise out of transactions, events, acts or omissions of Seller, GCS, Parent or a Merchant or other third party which occurred prior to the Effective Time;

(ii)          in respect of any other claims, Liabilities or Litigation with respect to (A) the Retained Assets and the Business conducted in connection with the foregoing, and (B) the Transferred Assets and the Business conducted in connection with the foregoing, provided that any such claims, Liabilities or Litigation in respect of the Transferred Assets relate to or arise out of events, transactions or actions or omissions prior to the Effective Time; or

(iii)         arising out of or related to the matters set forth on Section 3.2(a)(iii) of the Seller Disclosure Schedule.

(b)          Buyer shall not adopt, assume or otherwise become responsible for, either primarily or as a successor employer, any assets or liabilities of any employee benefit plans, arrangements, commitments or policies currently provided by Seller, GCS, Parent, or by any member of Seller's, GCS's or Parent's controlled group of corporations, including any employee retention agreements or commission buyout agreements with any Designated Employees as referenced in Section 8.1(k). In particular, Buyer shall not assume liability for any group health continuation coverage or coverage rights under Internal Revenue Code Section 4980B and ERISA Section 606 which exist as of the Closing Date, the Effective Time or the Designated Employee Transfer Date, or which may arise as a result of termination of any group health plan or plans in existence in connection with the Business.

(c)          To the extent that, if required due to the sale of the Transferred Assets hereunder, adequate notice (or pay and benefits) is not provided by Seller, GCS or Parent under the Worker Adjustment and Retraining Notification Act, 29 U.S.C. §§2101-2109 (the "WARN Act"), or Seller, GCS and/or Parent otherwise fail to comply with the WARN Act, Parent, Seller and GCS agree to retain, and Buyer shall not assume or otherwise become responsible for, any liability arising under the WARN Act with respect to the Designated Employees whose employment is terminated on or before the Closing Date, the Effective Time or the Designated Employee Transfer Date. To the extent the Buyer determines in its sole discretion to hire any Designated Employees after the Closing Date, Buyer agrees to provide adequate notice or assume any liability as may be required under the WARN Act or applicable state or local law for any terminations of such employment after hire by Buyer after the Effective Time.

 

 

 

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ARTICLE IV

PURCHASE PRICE

4.1          Purchase Price. The aggregate purchase price for the Transferred Assets shall be (i) $432,700,000.00 in cash payable at the Closing (the "Cash Payment"), (ii) the assumption by Buyer of the Assumed Liabilities by execution of the Bill of Sale and Assignment and Assumption Agreement at the Closing and (iii) at the time and to the extent owed, as further provided by Section 4.2, the Holdback Amount (collectively, the "Purchase Price"). On the Closing Date, Buyer will deliver the Cash Payment to Parent by wire transfer of immediately available funds to such bank account or accounts as shall be designated in writing by Seller to Buyer at least two (2) Business Days prior to the Closing.

 

4.2

Holdback.

(a)          Holdback Amount. Seventeen Million Three Hundred Thousand Dollars ($17,300,000) of the Purchase Price (the "Holdback Amount") shall not be paid to Seller at the Closing, but shall instead be retained by Buyer and paid to Parent if and to the extent provided by this Section 4.2.

 

(b)

Tier 1 Relationship Merchants.

(i)           If on the second anniversary of the Closing Date, and provided the provisions of Section 4.2(b)(iv) do not apply, a Tier 1 Relationship Merchant then maintains its business relationship with Buyer and such relationship has not suffered a material adverse change (except where such material adverse change was caused by an Excluded Event with respect to such Tier 1 Relationship Merchant), then Buyer shall pay to Parent within five (5) Business Days after such anniversary one-third (1/3) of the portion of the Holdback Amount set forth on Schedule 4.2 opposite the name of such Tier 1 Relationship Merchant.

(ii)          If on the third anniversary of the Closing Date, and provided the provisions of Section 4.2(b)(iv) do not apply, a Tier 1 Relationship Merchant then maintains its business relationship with Buyer and such relationship has not suffered a material adverse change (except where such material adverse change was caused by an Excluded Event with respect to such Tier 1 Relationship Merchant), then Buyer shall pay to Parent within five (5) Business Days after such anniversary one-third (1/3) of the portion of the Holdback Amount set forth on Schedule 4.2 opposite the name of such Tier 1 Relationship Merchant.

(iii)        If on the fourth anniversary of the Closing Date, and provided the provisions of Section 4.2(b)(iv) do not apply, a Tier 1 Relationship Merchant then maintains its business relationship with Buyer and such relationship has not suffered a material adverse change (except where such material adverse change was caused by an Excluded Event with respect to such Tier 1 Relationship Merchant), then Buyer shall pay to Parent within five (5) Business Days after such anniversary one-third (1/3) of the portion of the Holdback Amount set forth on Schedule 4.2 opposite the name of such Tier 1 Relationship Merchant.

 

 

 

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(iv)         Notwithstanding the other provisions of this Section 4.2(b), if on or before the fourth yearly anniversary of the Closing Date, a Tier 1 Relationship Merchant has executed a merchant agreement with Buyer on terms and conditions satisfactory to Buyer in the exercise of its commercially reasonable judgment, then Buyer shall pay to Parent within five (5) Business Days any then unpaid portion of the Holdback Amount set forth on Schedule 4.2 opposite the name of such Tier 1 Relationship Merchant.

(v)          For the avoidance of doubt, in no event will Parent entitled to be paid in respect of any Relationship Merchant more than the amount set forth opposite such Relationship Merchant's name on Schedule 4.2.

(c)          Tier 2 Relationship Merchants. If, on the first anniversary of the Closing Date, a Tier 2 Relationship Merchant then maintains its business relationship with Buyer and such relationship has not suffered a material adverse change (except where such material adverse change was caused by an Excluded Event with respect to such Tier 2 Relationship Merchant), then Buyer shall pay to Parent within five (5) Business Days after such anniversary the portion of the Holdback Amount set forth on Schedule 4.2 opposite the name of such Tier 2 Relationship Merchant. Further, if on or before the first anniversary of the Closing Date, a Tier 2 Relationship Merchant has executed a merchant agreement with Buyer on terms and conditions satisfactory to Buyer in the exercise of its commercially reasonable judgment, then Buyer shall pay to Parent within five (5) Business Days the portion of the Holdback Amount set forth on Schedule 4.2 opposite the name of such Tier 2 Relationship Merchant.

(d)          Manner of Payment. Any amounts payable under this Section 4.2 shall be paid by wire transfer of immediately available funds to such bank account or accounts as shall be designated in writing by Parent to Buyer at least two (2) Business Days prior to date such payment is due.

(e)          Commercially Reasonable Efforts to Procure Merchant Agreement. Beginning on the Closing Date and continuing throughout the first anniversary of the Closing Date (with respect to Tier 2 Relationship Merchants) and the fourth anniversary of the Closing Date (with respect to Tier 1 Relationship Merchants), Buyer shall, with such reasonable assistance from Parent, Seller and GCS as Buyer may from time to time request and as may be practicable, use its commercially reasonable efforts to cause each Relationship Merchant to execute a merchant agreement with Buyer on terms and conditions satisfactory to Buyer in the exercise of its commercially reasonable judgment.

 

(f)

Right to Withhold Payment.

(i)           Upon prior written notice to Parent, Seller and GCS, which notice shall set forth in reasonable detail the basis therefor, Buyer, acting in good faith, shall be entitled to withhold from any amount with respect to any Relationship Merchant that otherwise would be payable to Parent pursuant to this Section 4.2 any amount to which it may be entitled under Article XI, to the extent Buyer's claim under Article XI arises or results from Buyer's relationship with such

 

 

 

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Relationship Merchant (and does not arise or result from Buyer's breach of the Buyer Standard of Care or an Excluded Event with respect to such Relationship Merchant), so long as Buyer has properly given notice to Parent, Seller and GCS of such claim as required by this Agreement and either (i) such claim has been finally resolved in Buyer's favor, or (ii) in the event that Parent, Seller and GCS dispute such claim, such claim is in the process of resolution as provided by this Agreement.

(ii)          Nothing in this Section 4.2(f) shall operate to limit the amount of a claim that Buyer may recover upon the proper resolution of such claim as provided by this Agreement. Without limiting the foregoing, this Section 4.2(f) shall not be deemed to limit Buyer's right to recovery in respect of any claim with respect to a Relationship Merchant to the amount initially withheld from the obligation otherwise payable to Parent, Seller and GCS if, upon final resolution thereof, the amount of the award to Buyer is greater than the amount withheld. Similarly, in the event that the final resolution of a claim with respect to a Relationship Merchant awards Buyer an amount less than that withheld, then NOVA shall pay over to Parent that portion of the withheld monies that is in excess of the amount of the award within two (2) Business Days following the date of the final resolution of such claim.

 

4.3

Allocation of Purchase Price.

(a)          The Purchase Price shall be allocated among the Transferred Assets and the Merchant Services Agreement, if applicable, in the manner set forth in a schedule that shall be jointly prepared by Buyer and Seller on or prior to the Closing Date (the "Agreed Allocation"); provided, that if Buyer and Seller fail to agree after good faith efforts on the part of each of them on the allocation in such schedule on or prior to the Closing Date, the Purchase Price shall be allocated first to tangible personal property in accordance with Seller's net book value of such property as of the last day of the most recent month prior to the Closing Date for which Seller has completed the closing of its consolidated balance sheet, and the balance of the Purchase Price shall be allocated to the intangible Transferred Assets and goodwill (the "Default Allocation").

(b)          Each party agrees that it will adopt and utilize the amounts allocated pursuant to Section 4.2(a) to each of the Transferred Assets and such other assets and benefits for all tax purposes, including in preparation of all Tax Returns (including, if required, IRS Form 8594 and any supplements thereto) filed by it and that it will not voluntarily take any tax position inconsistent therewith, or on any such Tax Returns or in any legal or administrative proceeding or otherwise. Each party agrees to prepare and timely file all applicable Internal Revenue Service and applicable State tax forms (including, if required, IRS Form 8594 and any required supplements thereto), to cooperate with the other party in the preparation of such forms, and to furnish the other party with a copy of such forms prepared in draft, within a reasonable period before the filing due date thereof. Neither party will assert that such allocation was not separately bargained for at arm's-length and in good faith. Each party recognizes that the Purchase

 

 

 

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Price does not include Buyer's acquisition expenses and that Buyer will allocate such expenses appropriately.

 

4.4

Transfer Taxes.

(a)          All sales taxes, use taxes, gross receipts taxes, value added taxes, goods and services taxes, excise taxes, real estate transfer taxes, recordation taxes, documentary taxes, stamp taxes, and other similar taxes, charges, fees, levies, or other assessments, but specifically excluding any taxes, duties, fees or charges imposed on or measured by net or gross income, capital stock or net worth or in the nature of an income, capital, franchise, or net worth tax, arising from or in connection with the transfers by Parent, Seller and GCS of the Transferred Assets to Buyer ("Transfer Taxes") shall be borne by Buyer.

(b)          To the extent that any Transfer Taxes apply to the transfers by Parent, Seller and GCS of the Transferred Assets to Buyer, the relevant Tax Return shall be prepared by the party required by law to file such return and shall be submitted to the other party for its review and approval (which shall not be unreasonably withheld or delayed). Upon such approval, the preparing party shall timely file the relevant Tax Return and remit the Transfer Taxes shown on such Tax Returns, but if the preparing party is Seller, then Buyer shall reimburse Seller and GCS therefor. The parties shall cooperate to the extent reasonably necessary to file all relevant Tax Returns relating to Transfer Taxes.

(c)          Parent, Seller and GCS shall cooperate with, and subject to the other terms of this Agreement, take any action reasonably requested by Buyer provided that such action does not cause Parent, Seller or GCS to incur any material cost or material inconvenience in order to minimize any such Transfer Taxes, including adopting, supporting, and defending any reasonable position that the transactions contemplated under this Agreement qualify for an exemption or exemptions from Transfer Taxes. In this regard, with respect to any tangible personal property included in the Transferred Assets that will be held for resale by Buyer, Buyer shall furnish Parent, Seller and GCS at Closing with valid and proper exemption certificates and Parent, Seller and GCS shall accept such certificates with respect to any such tangible personal property. Buyer shall also furnish Parent, Seller and GCS with any applicable exemption certificates, letter rulings, notifications or similar documents, including those furnished to Buyer from the appropriate taxing authority with respect to Transfer Taxes. The parties further acknowledge and agree that, where applicable, the transfer of the Transferred Assets by Parent, Seller and GCS to be effectuated pursuant to this Agreement will be treated by the parties as a sale of the entire operating assets of one or more businesses, or of one or more separate divisions, branches, or identifiable segments of a business. The parties agree that they will adopt positions that are consistent with the foregoing characterization in any Tax Return, tax audit, tax contest, tax proceeding, or tax ruling request.

(d)          If a state taxing authority formally or informally proposes to issue an assessment to Parent, Seller or GCS for unpaid Transfer Taxes arising from the sale of the Transferred Assets, Buyer shall cooperate with Parent, Seller and GCS in providing

 

 

 

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proof that it paid such Transfer Taxes directly to the state taxing authority. To the extent that a state taxing authority issues an assessment for unpaid Transfer Taxes arising from the sale of the Transferred Assets against Parent, Seller and GCS, Buyer agrees to fully indemnify Parent, Seller and GCS for such liability, including all related penalties and interest. Parent, Seller and GCS shall notify Buyer in writing of any claim or demand for any Transfer Taxes promptly after Parent, Seller or GCS obtains knowledge thereof. Buyer may direct, at Buyer's sole cost and expense through counsel selected by Buyer and reasonably acceptable to Parent, Seller and GCS, any such claim or proceeding for such Transfer Taxes, and shall keep Parent, Seller and GCS informed of all actions taken by Buyer; provided that at Parent's, Seller's or GCS's request, Parent, Seller and GCS may participate (at its sole cost and expense) in such claim or proceeding. Parent, Seller and GCS shall cooperate with Buyer, and Buyer shall cooperate with Parent, Seller and GCS in good faith in the defense, prosecution, compromise or settlement of any claim, demand or proceeding involving Transfer Taxes (a "Contest"), except that neither party shall agree to a settlement or compromise of a Contest without the prior written consent of the other party. The parties' obligations under this Section 4.3 shall remain notwithstanding any other provisions of this Agreement.

(e)          For purposes of this Section, (i) the term "Straddle Period" shall mean any Tax period that begins before and ends on or after the Effective Time; (ii) the term "Pre-Closing Period" shall mean any Tax period ending before the Effective Time, and, in the case of any Straddle Period, the portion of such Straddle Period ending before the Effective Time; and (iii) the term "Post-Closing Period" shall mean any Tax period beginning at or after the Effective Time, and, in the case of any Straddle Period, the portion of such Straddle Period beginning at or after the Effective Time. Parent, Seller and GCS shall be jointly and severally liable for any and all Taxes (other than Transfer Taxes for which Buyer is responsible pursuant to Section 4.3(a) above), including property, income and franchise Taxes, which are attributable to or connected with the ownership or operation of the Transferred Assets or the Business during any Pre-Closing Period. Buyer shall be liable for any and all Taxes, including income and franchise Taxes, which are attributable to or connected with the ownership or operation of the Transferred Assets or the Business during any Post-Closing Period. In the case of Straddle Periods, the portion of Taxes (and, where applicable, property, income and franchise Taxes) attributable to the Pre-Closing Period and the Post-Closing Period, respectively, shall be determined on the basis of an interim closing of the books of Seller, except that Taxes imposed on a periodic basis shall be allocated to such periods on a daily basis.

(f)           Buyer shall promptly pay to Parent, Seller and GCS the net amount, after subtracting any applicable reasonably incurred out-of-pocket attorney's fees or other Contest costs, of any credit or refund received directly or indirectly by, or credited to, Buyer of Taxes attributable to any Pre-Closing Period with respect to Parent's, Seller's or GCS's ownership or operation of the Business or Transferred Assets that were paid by or on behalf of Seller. Parent, Seller and GCS shall promptly pay to Buyer the net amount, after subtracting any applicable reasonably incurred out-of-pocket attorneys' fees or other Contest costs, of any credit or refund received directly or indirectly by, or credited to,

 

 

 

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Parent, Seller or GCS of Taxes attributable to any Post-Closing Period with respect to Buyer's ownership or operation of the Business or Transferred Assets and that are paid by or on behalf of Buyer. Buyer shall be entitled to all refunds of Transfer Taxes. In cases where Buyer is not permitted to directly claim refunds or credits of overpayments of Transfer Taxes paid by or on its behalf, Parent, Seller and GCS shall use reasonable efforts to claim credits on their Tax Returns for such overpayments of Transfer Taxes paid by or on behalf of Buyer or, to the extent it is not feasible to claim such credits, then to claim refunds of such overpayments of Transfer Taxes.

4.5          Prorations. Those expenditures arising from the conduct of the Business set forth on Schedule 4.5 shall be (i) prorated between Buyer, on the one hand, and Parent, Seller and GCS, on the other hand, in accordance with the principle that Parent, Seller and GCS shall be responsible for all such expenses, payables, costs, obligations and liabilities allocable to the conduct of the Business for the period ending on or prior to the Closing, and Buyer shall be responsible for all such expenses, payables, costs, obligations and liabilities allocable to the conduct of the Business for the period after the Closing or (ii) allocated between Buyer and Parent as the parties may otherwise mutually agree in writing on the Closing Date. Notwithstanding the foregoing, there shall be no proration with regard to, and Parent, Seller and GCS shall collectively remain solely liable with respect to, any Retained Assets or Retained Liabilities.

ARTICLE V

CLOSING AND CLOSING DELIVERIES

5.1          Closing. Subject to the satisfaction or waiver of the conditions set forth herein, the consummation of the purchase and sale of the Transferred Assets and the transfer and assumption of the Assumed Liabilities (the "Closing") shall take place at the offices of Baker, Donelson, Bearman, Caldwell & Berkowitz, located at 165 Madison Avenue, Suite 2000, Memphis, Tennessee, at 9:00 a.m. on the third Business Day after the satisfaction or waiver of the conditions set forth in Article X hereof, or at such other date and time and at such other location as the parties shall mutually agree in writing (the "Closing Date"), and shall be effective as of 12:01 a.m. Central Standard Time on March 1, 2006 (the "Effective Time"). Subject to the provisions of Article XII, failure to consummate the purchase and sale provided for in this Agreement on the date and time and at the place determined pursuant to this Section 5.1 will not result in the termination of this Agreement and will not relieve any party of any obligation under this Agreement.

 

5.2

Deliveries at the Closing.

(a)          At the Closing, Parent, Seller and GCS will duly execute (to the extent applicable) and deliver or cause to be delivered to Buyer:

(i)           a bill of sale for the Transferred Assets and assignment and assumption agreement for the Assumed Liabilities in the form of Exhibit "A" attached hereto (together with appropriate schedules and exhibits, the "Bill of Sale and Assignment and Assumption Agreement");

 

 

 

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(ii)          such other deeds, endorsements, transfers, assignments and other instruments as Buyer may reasonably request and as are reasonably necessary to transfer to Buyer good and marketable title to the Transferred Assets (the "Transfer Documents");

(iii)         an interim services agreement substantially in the form of Exhibit "B" (together with appropriate schedules and exhibits, the "Interim Services Agreement");

(iv)         a merchant services agreement in the form of Exhibit "C" (together with appropriate schedules and exhibits, the "Merchant Services Agreement");

(v)          a non-competition agreement in the form of Exhibit "D" (together with appropriate schedules and exhibits, the "Non-Competition Agreement");

(vi)         an opinion of Baker, Donelson, Bearman, Caldwell & Berkowitz, counsel to Parent, Seller and GCS, in the form attached hereto as Exhibit "E";

 

(vii)

the certificates referred to in Section 10.2(c);

(viii)      Employee Retention, Sale Participation and Non-Solicitation Agreements in the form attached hereto as Exhibit "H", duly executed by Parent, Seller and each employee listed on Section 8.1(k) of the Seller Disclosure Schedule;

(ix)         copies of any and all releases, termination statements and other documents and instruments as are reasonably necessary to evidence the removal and release of any Liens (other than Permitted Liens) which may encumber any of the Transferred Assets;

(x)          copies of all required applications and notices which have been submitted to VISA and MasterCard to request approval of the transfer of the BIN and ICA from Parent and/or Seller to Buyer and/or U.S. Bank National Association on the books and records of VISA and MasterCard together with any consents and responses thereto; and

(xi)         all copies in Seller's or GCS's possession of the Software and any other materials comprising or containing Seller's Proprietary Rights.

(b)          At the Closing, Buyer will duly execute (to the extent applicable) and deliver or cause to be delivered to Parent, Seller and/or GCS, as applicable:

 

(i)

the Cash Payment pursuant to the terms of Section 4.1;

 

 

(ii)

the Bill of Sale and Assignment and Assumption Agreement;

 

(iii)

the Interim Services Agreement;

 

 

 

 

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(iv)

the Merchant Services Agreement;

 

(v)

the Non-Competition Agreement;

 

(vi)         an opinion of McKenna Long & Aldridge LLP, counsel to Buyer, in the form attached hereto as Exhibit "F", and

 

(vii)

the certificates referred to in Section 10.3(c).

 

 

5.3

Certain Consents; No Unlawful Transfers; Further Assurances.

(a)          Parent, Seller, GCS and Buyer shall use commercially reasonable efforts to obtain at the earliest practicable date, and in all instances prior to the Closing, all Seller Consents and Buyer Consents related to the consummation of the Transaction, and will provide to each other copies of each such Consent promptly after such Consent is obtained. If any third party imposes a condition as a term of giving its Consent, then Parent, Seller, GCS and Buyer shall cooperate in good faith to find a mutually acceptable means of satisfying the requirements of such third party.

(b)          To the extent that the rights of Parent, Seller or GCS under any of the Transferred Assets or obligations under the Assumed Liabilities intended to be transferred or assigned to Buyer hereunder may not be transferred or assigned without the Consent of another Person which Consent has not been obtained prior to the Closing Date (any such unobtained Consents to be identified in writing by Seller to Buyer not later than two (2) Business Days before the Closing Date and are referred to herein as the "Specified Consents"), this Agreement shall not constitute an agreement to transfer or assign the same if an attempted transfer or assignment would constitute a Default thereunder or be unlawful.

(c)          If, on the Closing Date, (i) Parent, Seller or GCS has not obtained any Specified Consent necessary to transfer or assign any of its right, title or interest in or to any of the Transferred Assets after having used commercially reasonable efforts to obtain such Specified Consent, or an attempted transfer or assignment of any of the Transferred Assets would be ineffective, or the failure to obtain such Specified Consent would constitute a Default thereunder or would otherwise adversely affect the ability of Parent, GCS and/or Seller to convey any such Transferred Asset to Buyer as required by Section 2.1, (ii) the conditions precedent to the Closing set forth in Article X otherwise have been satisfied or waived as provided therein, and (iii) the failure to transfer or assign such asset(s), either individually or in the aggregate, is not reasonably likely to have a Material Adverse Effect on the Business, then such Transferred Assets shall constitute "Deferred Transferred Assets" and shall not be transferred to Buyer at the Closing.

 

(d)

After the Closing:

(i)           Parent, Seller, GCS and Buyer will continue to use commercially reasonable efforts to obtain such Specified Consent and/or to remove any other impediments to the transfer or assignment of each Deferred Transferred Asset, in

 

 

 

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accordance with Section 5.3(a), and will transfer or assign each Deferred Transferred Asset to Buyer within five (5) Business Days after the receipt of such Specified Consent and/or removal of such impediment;

(ii)          until the transfer or assignment with respect to any Deferred Transferred Asset is accomplished, Parent, GCS and Seller will continue to perform all of their respective obligations with respect to such Deferred Transferred Asset as reasonably requested by Buyer, and will, with such reasonable cooperation of Buyer as Parent, GCS or Seller may from time to time request, take commercially reasonable actions to assure that Buyer shall receive all benefits of such Deferred Transferred Asset or the economic equivalent thereof, and allow Buyer to perform its obligations under the Assumed Liabilities, to the same extent as if the Deferred Transferred Asset were transferred or assigned to Buyer at Closing, and each party shall bear its own incidental administrative expenses incurred in connection with any such arrangement; and

(iii)        until the transfer or assignment with respect to any Deferred Transferred Asset is accomplished, Parent, GCS and Seller, at the reasonable request and for the account of Buyer, shall enforce, at Buyer's expense, their respective rights thereto or interests therein against any other parties thereto (including the right to extend or terminate any such Deferred Transferred Asset in accordance with its terms, provided that Buyer shall pay any cancellation or other fee due upon such termination).

(e)          Buyer shall reimburse Parent, GCS and/or Seller for the reasonable out-of-pocket costs incurred with respect to its or their performance under this Section 5.3 with respect to the Deferred Transferred Assets, subject to Buyer's receipt of reasonable documentation detailing such costs.

(f)           As soon as reasonably practicable following the Closing Date, Parent, GCS, Seller and Buyer shall cooperate to deliver to each of the Assigned Merchants, at Buyer's expense, a notice in a mutually agreed form of the assignment of such Assigned Merchant Agreements to Buyer. In Buyer's discretion, such notice may inform each Assigned Merchant of Buyer's intention to convert the Assigned Merchant to Buyer's network, as well as to a merchant accounting system designated by Buyer.

(g)          In addition to any other further assurances or covenants of cooperation contained in this Agreement, each party will execute, acknowledge, file and deliver (or will cause to be executed, acknowledged, filed and delivered), upon the reasonable request of the other party, such documents as may be reasonably necessary or appropriate to further document or evidence the respective obligations of the parties under this Agreement, including documents to further evidence the transfer or assignment of the Transferred Assets to Buyer and the assumption of the Assumed Liabilities by Buyer. Each of the parties to this Agreement will cooperate with the other in good faith to obtain Consents in a cost-effective and efficient manner and to execute and deliver to the other party such other instruments and documents and take such other actions as may be

 

 

 

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reasonably requested from time to time by the other parties as necessary to carry out, evidence and confirm the intended purpose of this Agreement.

 

5.4

Books and Records.

(a)          As soon as practicable after the Closing Date, and in no event later than the conclusion of the Transition Period, Parent, Seller and GCS shall cause the Transferred Books and Records to be delivered to Buyer. In addition, Parent, Seller and GCS shall, at their expense, provide all the Transferred Books and Records to Buyer that are in intangible (i.e., computer-readable) form, including information necessary or desirable for the transfer of clearing bank responsibilities contemplated hereby.

(b)          All Books and Records relating to the Transferred Assets shall be maintained by Buyer, Seller, GCS or Parent, as the case may be, in accordance with Buyer's, Parent's, GCS's and Seller's ordinary document retention policies; provided, however that, in the event that, as of the end of such period, any taxable year of Buyer, Parent, GCS or Seller is still under examination or open for examination by any Taxing authority and that party has given notice of that fact to the other party, such books and records shall be maintained until the date, determined reasonably and in good faith, specified for maintenance of such records in such notice.

ARTICLE VI

REPRESENTATIONS AND WARRANTIES OF PARENT AND SELLER

Except as set forth in the corresponding numbered section of the Seller Disclosure Schedule, and subject to the definition of "Seller Disclosure Schedule," Parent, Seller and GCS jointly and severally represent and warrant to Buyer as follows as of the date hereof and as of the Closing Date:

6.1          Organization; Existence and Qualification. Parent is a national banking association chartered and organized under the laws of the United States of America and is authorized to conduct its business as presently conducted under those laws. Parent owns one hundred percent (100%) of the issued and outstanding shares of capital stock of FHMSH, Inc., a Delaware corporation which owns one hundred percent (100%) of the issued and outstanding shares of capital stock of Seller. Seller is a corporation duly organized and validly existing under the laws of the State of Tennessee and is authorized to conduct its business as presently conducted under those laws. GCS is a corporation duly organized and validly existing under the laws of the State of Florida and is authorized to conduct its business as presently conducted under those laws. Seller owns one hundred percent (100%) of the issued and outstanding shares of capital stock of GCS. Seller and GCS each has full corporate power and authority, and Parent has full power and authority, to carry on their respective businesses as now being conducted and to own, operate and lease the Transferred Assets. Seller and GCS each is duly qualified to do business as a foreign corporation and is in good standing in each jurisdiction where such qualification is necessary, except where the failure to so qualify would not have a Material Adverse Effect on Seller, GCS or the Business.

 

 

 

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6.2          Power; Authority; Enforceable Obligations. Seller and GCS each has the corporate power and authority, and Parent has the power and authority, to execute and deliver this Agreement and the other Operative Documents. Seller and GCS each has the corporate power and authority, and Parent has the power and authority, to perform their respective obligations hereunder and thereunder. Parent, Seller and GCS each has taken all action required by Law, their respective articles of association, certificate of incorporation and bylaws, and otherwise to authorize the execution and delivery of this Agreement and the other Operative Documents, the performance of their respective obligations hereunder and thereunder, and the consummation of the Transaction. This Agreement has been duly executed and delivered by each of Seller, GCS and Parent. At the Closing (subject to the conditions to closing set forth in Article X), each of the other Operative Documents will be duly executed and delivered by Parent, GCS and/or Seller, as applicable. This Agreement is a valid and binding agreement of Parent, Seller and GCS, enforceable against each of them in accordance with its terms, except as such validity, binding effect or enforceability may be limited by applicable bankruptcy, insolvency, reorganization, receivership, conservatorship, fraudulent transfer, moratorium (whether general or specific) or other Law now or hereafter in effect affecting the enforceability of creditors' rights generally or the rights of creditors of depository institutions the accounts of which are insured by the Federal Deposit Insurance Corporation, and except that the availability of equitable remedies such as specific performance or injunctive relief are subject to the discretion of the court before which any proceeding may be brought. Each of the Operative Documents other than this Agreement to which Parent, Seller or GCS will be a party, when executed and delivered at the Closing, will be valid and binding and enforceable against Parent, Seller and/or GCS, respectively, in accordance with its terms, except as such validity, binding effect or enforceability may be limited by applicable bankruptcy, insolvency, reorganization, receivership, conservatorship, fraudulent transfer, moratorium (whether general or specific) or other Law now or hereafter in effect affecting the enforceability of creditors' rights generally or the rights of creditors of depository institutions the accounts of which are insured by the Federal Deposit Insurance Corporation, and except that the availability of equitable remedies, such as specific performance or injunctive relief, are subject to the discretion of the court before which any proceeding may be brought.

 

6.3

No Conflicts.

(a)          None of the execution or delivery by Parent, Seller or GCS of this Agreement or any other Operative Document, performance by Parent, Seller or GCS of its respective obligations hereunder or thereunder, or consummation by Parent, Seller or GCS of the Transaction will:

(i)           require Parent, Seller or GCS to obtain the Consent of, or deliver any notice, filing or application to, any Regulatory Authority or any other Person with respect to the transfer of the Transferred Assets, the assumption of the Assumed Liabilities, or the performance of any obligations under any other Operative Document, other than the Consents identified on Section 6.3(a)(i) of the Seller Disclosure Schedule ("Seller Consents");

 

 

 

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(ii)          conflict with or result in any violation of any provision of the articles of association, certificate of incorporation or bylaws, each as amended to date, of Parent, Seller or GCS;

 

(iii)

result in any conflict with, termination of, or Default under, any:

 

(A)

Specified Merchant Agreement, or

 

(B)         any other agreement, indenture, mortgage or lease to which Parent, Seller or GCS is a party or any other Transferred Contract, except for conflicts, terminations or Defaults which are not reasonably likely to have a Material Adverse Effect on Seller or the Business;

(iv)         violate any term of any Law or Order applicable to Parent, Seller or GCS or the Business, except for violations which are not reasonably likely to have a Material Adverse Effect on Seller or the Business; or

(v)          result in the creation of, or impose on Parent, Seller or GCS the obligation to create, any Lien (other than a Permitted Lien) upon the Transferred Assets, except for Liens which are not reasonably likely to have a Material Adverse Effect on Parent, Seller, GCS or the Business.

(b)          Seller has properly compared the Assigned Merchants against the required government lists (including the Office of Foreign Assets Control SDN List) and has taken appropriate actions with regard to all Assigned Merchants that appear on any of the government lists. The latest comparison of the Assigned Merchants against the Office of Foreign Assets Control SDN List occurred not more than forty-five (45) days prior to the date of this Agreement (or, in the case of Assigned Merchants that became Merchants more recently than the date forty-five (45) days prior to the date of this Agreement, as of the date each such Assigned Merchant became a Merchant).

 

6.4

Financial Information; Controls and Procedures.

(a)          The financial and other information concerning the Business set forth in Section 6.4 of the Seller Disclosure Schedule (the "Seller Financial Information") has been prepared in accordance with the books and records of Parent, Seller and GCS, is true, correct and complete in all material respects and presents fairly the financial condition, results of operations and performance of the Business as of the respective dates thereof and periods contained therein. The Seller Financial Information has been prepared on a basis consistent with the accounting principles and practices used to prepare periodic divisional financial statements (or financial information) for all prior reporting periods during 2005 (and 2004) and are consistent with the financial information used by Parent and FHN to prepare their respective financial statements in accordance with GAAP.

(b)          The books of account and other financial records of Seller, Parent and GCS with respect to the Business, all of which have been made available to Buyer, are

 

 

 

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complete and correct in all material respects and represent actual, bona fide transactions and have been maintained in accordance with sound business practices.

(c)          Seller, GCS and Parent collectively maintain a system of accounting controls with respect to the Business sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management’s general or specific authorization, (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets, (iii) access to assets is permitted only in accordance with management’s general or specific authorization and (iv) the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences.

6.5          Absence of Changes. Since September 30, 2005, Parent, Seller and GCS has each:

(a)          operated the Business only in the Ordinary Course of Business and used its reasonable efforts to preserve business relationships with employees and with Merchants and parties to other Transferred Contracts;

(b)          except as set forth on Section 6.5(b) of the Seller Disclosure Schedule, paid and performed all obligations under the Transferred Contracts;

(c)          not permitted or allowed any of the Transferred Assets to be subjected to any Liens, other than Permitted Liens;

(d)          not sold, leased, transferred or otherwise disposed of any asset that, but for such sale, lease, transfer or disposition, would have been a Transferred Asset, in each case other than in the Ordinary Course of Business;

(e)          not paid, discharged, waived or satisfied any claim or Liability with respect to the Business, other than payment, discharge, waiver or satisfaction in the Ordinary Course of Business;

(f)           not amended, released or canceled any obligations, liabilities, rights or claims included in the Transferred Assets or amended or terminated any Transferred Contract, in each case except in the Ordinary Course of Business;

 

(g)

maintained and serviced the Equipment consistent with past practice;

 

(h)

not suffered any Material Adverse Effect;

 

(i)           except (i) for customary increases based on term of service or regular promotion of non-officer employees and (ii) as set forth on Section 6.5(i) of the Seller Disclosure Schedule, not increased (or announced any increase in) the compensation payable or to become payable to any Designated Employee, or increased (or announced any increase in) any bonus, insurance, pension or other employee benefit plan, payment

 

 

 

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or arrangement for Designated Employees, or entered into or amended any employment, consulting, severance or similar agreement with any Designated Employee;

(j)           except as set forth on Section 6.5(j) of the Seller Disclosure Schedule, not (1) amended or terminated any Specified Merchant Agreement, or (2) amended in any material respect any other material Contract which is included in the Transferred Contracts;

(k)          not made any change in any method, practice or principle of financial or tax accounting that in any manner materially affected the Business or any financial information relating to or derived from the Business; and

(l)           not agreed in writing, or otherwise, to take any action inconsistent with this Section 6.5.

6.6          Title to Assets. Parent, Seller and GCS collectively are the sole owners of all right, title and interest in and to the Transferred Assets, free and clear of all Liens (other than Permitted Liens), and no Person other than Parent, Seller or GCS has any interest in the Transferred Assets (except for the Assigned Merchants under the related Assigned Merchant Agreements and the other parties to the other Transferred Contracts under those Transferred Contracts). Parent, Seller and GCS have good and marketable title to, or hold the valid right to use, all of the Transferred Assets, free and clear of all Liens, other than Permitted Liens. Parent, Seller and GCS warrant that at the Closing the Transferred Assets will be free and clear of all Liens other than Permitted Liens. Except for the Retained Assets, the Transferred Assets constitute (i) all of the assets necessary to operate the Business in the manner presently conducted by Parent, Seller and GCS, except as would not reasonably be expected to have a Material Adverse Effect on the Business, and (ii) all of the assets and properties used in the operation of the Business since September 30, 2005, except for assets and properties disposed of or consumed since such date in the Ordinary Course of Business (or, if disposed of or consumed after the date of this Agreement, in compliance with the terms of this Agreement).

6.7          Condition of Tangible Personal Property Assets. Except as provided in Sections 6.5(c), 6.5(d), 6.5(g), 6.6, 6.12 (solely as such Section relates to tangible copies of intellectual property), 6.14 and 6.16, all tangible personal property to be transferred to Buyer pursuant to this Agreement, whether owned or leased, is being transferred "as is," "where is," and "with all faults," and NEITHER PARENT, SELLER NOR GCS MAKES ANY WARRANTY WITH RESPECT TO THE VALUE, CONDITION OR USE OF ANY OF THE TANGIBLE PERSONAL PROPERTY INCLUDED IN THE TRANSFERRED ASSETS, WHETHER EXPRESSED OR IMPLIED, INCLUDING ANY IMPLIED WARRANTY OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE.

 

6.8

Transferred Contracts.

(a)          Each Transferred Contract is valid, binding and in full force and effect and is enforceable in accordance with its terms against Seller, GCS or Parent, as applicable, and each other party thereto, in each case except as such validity, binding effect or enforceability may be limited by applicable bankruptcy, insolvency, reorganization,

 

 

 

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receivership, conservatorship, fraudulent transfer, moratorium (whether general or specific) or other Law now or hereafter in effect affecting the enforceability of creditors' rights generally or the rights of creditors of depository institutions the accounts of which are insured by the Federal Deposit Insurance Corporation.

(b)          Section 6.8(b) of the Seller Disclosure Schedule includes a complete list of all Assigned Merchants. Neither Parent, Seller nor GCS nor, to the Knowledge of Parent, Seller and GCS, any other party to any Transferred Contract is in Default thereunder and, to the Knowledge of Parent, Seller and GCS, there are no material disputes with respect thereto, no notice of Default has been received in connection therewith, and, to the Knowledge of Parent, Seller and GCS, no event has occurred that would constitute a Default thereunder. Neither Parent, Seller nor GCS has received any notice of fraud by, or bankruptcy or contemplated bankruptcy of, any party or guarantor to any of the Assigned Merchant Agreements.

(c)          Except as set forth on Section 6.8(c) of the Seller Disclosure Schedule, none of Parent, Seller or GCS has either given or received notice of election to terminate any Specified Merchant Agreement or any other material Transferred Contract which would be a Transferred Contract if the Closing occurred as of the date of this representation and warranty is made. None of Parent, Seller or GCS has any Knowledge that the consummation of the Transaction would have a material adverse effect on its relationship with any Specified Merchant or any other party to a material Transferred Contract as relates to the Business.

(d)          Except as set forth on Section 6.8(d) of the Seller Disclosure Schedule, all agreements between Seller and the Assigned Merchants are in the form of one of the Merchant Agreements attached hereto as Exhibit "G", and may be assigned by Seller pursuant to this Agreement without the consent of the applicable Merchant or any other party. Except as set forth on Section 6.8(d) of the Seller Disclosure Schedule, (i) each Assigned Merchant is a party to a written Merchant Agreement with Seller or GCS, as applicable, (ii) Seller and GCS has each provided Buyer with true, correct and complete copies of all Specified Merchant Agreements, and (iii) Seller and GCS have in their possession, and will deliver to Buyer in accordance with Section 5.4 of this Agreement, an executed original (or copy of an executed original) of each Specified Merchant Agreement. GCS has no Acquiring Merchants. The Specified Merchants are listed on Section 6.8(d) of the Seller Disclosure Schedule. As between Seller or GCS and any other party (except the Assigned Merchant party to each such Assigned Merchant Agreement), Seller or GCS, as applicable, owns and controls the business relationship with each such Assigned Merchant as it relates to the Business. The Top 100 Acquiring Merchants accounted for approximately [redacted*]% of the revenues of the Business (excluding revenues generated by GCS) earned in the twelve-month period ended November 30, 2005. Except as set forth in Section 6.8(d) of the Seller Disclosure Schedule, Seller has in its possession, and will deliver to Buyer in accordance with Section 5.4 of this Agreement, (i) an executed original (or a copy of an executed original) of at least [redacted*] percent ([redacted*]%) of all Assigned Merchant Agreements, and

* Information omitted herefrom and submitted separately to the Commission under Rule 24b-2.

 

 

 

 

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(ii) an executed original (or a copy of an executed original) of each Agent Bank Agreement, ISO Agreement, ISA Agreement and each other material Transferred Contract.

(e)          Except as set forth in Section 6.8(e) of the Seller Disclosure Schedule, Seller has no Agent Bank Agreements nor any Agent Banks. Each Agent Bank is party to a written Agent Bank Agreement, a true, correct and complete copy of which has been made available to Buyer. The ISOs and ISAs are identified on Section 6.8(e) of the Seller Disclosure Schedule. Each ISO is party to a written ISO Agreement, and each ISA is party to a written ISA Agreement, true, correct and complete copies of which have been made available to Buyer.

(f)           Except as set forth and detailed in Section 6.8(f) of the Seller Disclosure Schedule, there are no Merchant Security Arrangements established and maintained with Seller by Assigned Merchants or other third parties in connection with the Transferred Assets. The Merchant Security Arrangements may be assigned by Seller pursuant to this Agreement without the consent of the applicable Merchant or any other party.

(g)          Except for disputes that have arisen in the Ordinary Course of Business and that are not material or otherwise significant in nature or amount taken as a whole, and except as identified on Section 6.8(g) of the Seller Disclosure Schedule, none of Parent, Seller nor GCS is engaged in any dispute with any Assigned Merchant or any party to any other Transferred Contract. To the Knowledge of Parent, Seller and GCS, consummation of the Transaction will not have a material adverse effect on the business relationship of Buyer with any Specified Merchant or party to a material Transferred Contract.

(h)          Seller is a member in good standing of (i) the Credit Card Associations and (ii) the EFT Networks applicable to the Business. Parent, Seller, GCS and the Business are in compliance in all material respects with all applicable Payment Network Regulations.

(i)           Section 6.8(i) of the Seller Disclosure Schedule sets forth the Travel and Entertainment Cards, Gift Cards and other credit and charge cards, other than those of the Credit Card Associations, for which Seller or GCS has contracted to provide authorization and data capture services, and also identifies the Assigned Merchants to whom such non-Credit Card Association services are provided as of the date hereof.

(j)           Section 6.8(j) of the Seller Disclosure Schedule lists all material Contracts (whether or not a Transferred Contract, but excluding Merchant Agreements, Agent Bank Agreements, ISA Agreements and ISO Agreements) between Parent, Seller or GCS and any third party which provides for any one or more of the following:

 

(i)

the deposit of Card transaction records;

 

 

 

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(ii)

the settlement of Card transactions;

 

 

(iii)

the processing of Card transactions; or

(iv)         the referral of prospective Merchants to, or of prospective merchants from, Seller, Parent or GCS (collectively, the "Other Contracts").

6.9          Permits. Parent, GCS and Seller each owns or validly holds all material Permits that are required in connection with the conduct of the Business or the ownership or use of the Transferred Assets. All Transferred Permits (if any) owned or held by Parent, Seller or GCS are valid and in full force and effect. No proceeding is pending or, to the Knowledge of Parent, Seller or GCS, threatened which would reasonably be expected to result in the revocation or termination of any Transferred Permits, and to the Knowledge of Parent, Seller and GCS, there is no valid basis for any such proceeding. The consummation of the Transaction will not affect the continued validity or effectiveness or alter the terms and conditions of any material Transferred Permits. Neither Parent, Seller nor GCS has received notice from any Regulatory Authority indicating that such Regulatory Authority would oppose or not grant or issue its Consent or approval, if required, with respect to the Transaction.

6.10       Compliance With Law. With respect to the Business generally, neither Parent, Seller nor GCS is and neither has been in violation of any applicable Law, Order or Permit, except such violations as are not reasonably likely to have a Material Adverse Effect on Parent, Seller, GCS or the Business. The terms of the Merchant Agreements and all other Transferred Contracts comply in all material respects with all applicable Laws, Orders and Permits.

 

6.11

Employment and Labor Matters.

(a)          Section 6.11(a) of the Seller Disclosure Schedule sets forth the names and compensation (broken down by category, e.g., salary, bonus, commission), together with the date and amount of the last increase in compensation for each such person, and the title and functional positions of all employees of Parent, Seller and GCS who work either full or part-time with respect to the Business ("Designated Employees"). Except as set forth in Section 6.11(a) of the Seller Disclosure Schedule, none of the Designated Employees is a party to any employment agreement, arrangement or understanding with Parent, Seller or GCS as of the date hereof.

(b)          Neither Parent, Seller nor GCS has entered into any, and there are no, collective bargaining agreements, labor contracts, letters of understanding, or other formal or informal agreements or arrangements with any union or labor organization covering any Designated Employee, and no Designated Employee is represented by any union or labor organization. There is no labor strike, dispute, slowdown or work stoppage or lockout involving the Designated Employees that is pending or, to the Knowledge of Seller and GCS, threatened against or affecting the Business. Further, (i) to the Knowledge of Seller and GCS, no union organizational campaign is in progress with respect to the Designated Employees and no question concerning representation exists respecting such employees, (ii) there is no unfair labor practice charge or complaint against the Business or Parent, Seller or GCS with respect to the Designated Employees

 

 

 

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pending or, to the Knowledge of Parent, Seller or GCS, threatened before the United States National Labor Relations Board, and (iii) none of Parent, Seller or GCS has received any notice of the intent of any Regulatory Authority responsible for the enforcement of labor or employment Law to conduct any formal compliance review (other than routine investigation of individual charges and complaints) with respect to or relating to the Designated Employees and no such review is in progress.

 

6.12

Intellectual Property Rights.

(a)          Except as set forth on Section 6.12(a) of the Seller Disclosure Schedule, Seller, GCS and/or Parent owns or possesses licenses or other rights to use or has title to all patents, patent applications, trademarks, trademark applications, trade secrets, service marks, service mark applications, trade names, copyrights, inventions, drawings, designs, customer lists, processing systems, technology, software, programs, equipment, proprietary know-how information, or other rights with respect thereto used in and material to the Business, including the Software (the "Seller Proprietary Rights"). To the Knowledge of Seller, GCS and/or Parent, the current operations of Parent, Seller and GCS and the Seller Proprietary Rights do not, and the proposed operations of Buyer with respect to the Transaction (so long as such are reasonably consistent with Seller's, GCS's and/or Parent's past practices in the Business), will not conflict with or infringe, and no one has asserted to Seller, GCS and/or Parent that such current or proposed operations materially conflict with or infringe, or might conflict with or infringe, any proprietary rights claimed, owned, possessed or used by any third party.

(b)          There are no material claims, disputes, actions, proceedings, suits or appeals pending against Parent or Seller with respect to any Seller Proprietary Rights and none has been threatened against Parent or Seller. Except as set forth on Section 6.12(b) of the Seller Disclosure Schedule, to the Knowledge of Parent and Seller, there are no facts or alleged facts which would reasonably serve as a basis for any claim that Parent or Seller does not have the unrestricted right to use, free of any rights or material claims of others, all Seller Proprietary Rights in the development, manufacture, use, sale or other disposition of any or all products or services presently being used, furnished or sold in the Business or contemplated to be used, furnished or sold in the Business.

(c)          To the Knowledge of Parent and Seller, the Seller Proprietary Rights have not been infringed upon by others.

(d)          Seller, GCS and/or Parent own all right, title and interest in and to the Owned Software and have the right to transfer and assign all such right, title and interest to Buyer as provided under this Agreement.

(e)          Seller, GCS and/or Parent hold valid licenses in and to the Licensed Software and, except as set forth on Section 6.12(e) of the Seller Disclosure Schedule, have the right to transfer and assign all such rights and licenses to Buyer as provided under this Agreement.

 

 

 

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(f)           Except as set forth in Section 6.12(f) of the Seller Disclosure Schedule, the Owned Software performs consistent with current and past practice as used by Parent, Seller and GCS in the Ordinary Course of Business.

6.13       Litigation. Except as set forth on Section 6.13 of the Seller Disclosure Schedule, there is no Litigation pending, or to the Knowledge of Parent, Seller and GCS, threatened against or involving or arising in connection with the Transferred Assets or the Business. None of the Business or the Transferred Assets is subject to any Order entered into in any Litigation.

6.14       Leases. Except as set forth on Section 6.14 of the Seller Disclosure Schedule, there are no leases (including any capital leases), lease-purchase arrangements or similar agreements relating to the Equipment.

 

6.15

Agreements, Contracts and Commitments.

(a)          Except for the Transferred Contracts, neither Parent, Seller nor GCS has any agreement, contract, commitment or relationship, whether written or oral, related to the Business, by which Buyer could be bound;

(b)          Except as set forth on Section 6.15(b) of the Seller Disclosure Schedule, neither Parent, Seller nor GCS is subject to any contract or agreement related to the Business containing covenants which would restrict in any way Parent's, Seller's or GCS's ability to fulfill its obligations under the Operative Documents (excluding for purposes of this Section 6.15(b) any Transferred Contract requiring Parent, Seller or GCS to obtain a Seller Consent) or which limit the freedom of Parent, Seller or GCS to compete in any line of business related to the Business; and

(c)          Except as set forth on Section 6.15(c) of the Seller Disclosure Schedule, with respect to the Business, there is no contract, agreement or other arrangement entitling any Person to any profits, revenues or cash flows of Parent, Seller or GCS or requiring any payments or other distributions based on such profits, revenues or cash flows.

 

6.16

Real Property.

(a)          Seller has furnished to Buyer true, correct and complete copies of the leases for all of the real property leased by Parent, Seller or GCS in connection with the Business or the Transferred Assets (the "Leased Real Property"). The Leased Real Property constitutes all of the real property utilized by the Parent, Seller and GCS in the operation of the Business.

(b)          No portion of the Leased Real Property or any buildings or improvement located thereon violates any Law, including Laws relating to zoning, building, land use, environmental, health and safety, fire, air, sanitation and noise control, except to the extent such violation would not cause a Material Adverse Effect on Seller, GCS or the Business.

 

 

 

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(c)          To the Knowledge of Parent, Seller and GCS, except for the Permitted Liens, no Leased Real Property is subject to (i) any governmental decree or order or threatened or proposed order or (ii) any rights of way, building use restrictions, exceptions, variances, reservations or limitations of any nature whatsoever.

(d)          The improvements and fixtures on the Leased Real Property are in good operating condition and in a state of good maintenance and repair, ordinary wear and tear excepted, and are adequate and suitable for the purposes for which they are presently being used.

(e)          To the Knowledge of Parent, Seller and GCS, there is no condemnation, expropriation or similar proceeding pending or threatened against any of the Leased Real Property or any improvement thereon.

6.17       Affiliated Transactions. Except as set forth in Section 6.17 of the Seller Disclosure Schedule, (a) other than Parent, no Affiliate of Seller or GCS has, or since September 30, 2005 has had, any interest in any Asset used in the operation of the Business and (b) no Affiliate of Seller is, or since September 30, 2005 has owned an equity interest or any other financial or profit interest in, a Person that has (i) had business dealings with or a material financial interest in any transaction with Seller or GCS, or (ii) engaged in competition with any of Seller or GCS related to the Business. Except as set forth in Section 6.17 of the Seller Disclosure Schedule, no Affiliate of Seller or GCS is a party to any contract with, or otherwise provides services to, or has any claim of right against, Seller or GCS in connection with the Business.

6.18       No Other Representations. Except for the representations and warranties expressly contained in this Agreement or in the other Operative Documents, neither Parent, Seller, GCS nor any other Person makes any express or implied representation or warranty on behalf of Parent, Seller or GCS, and Parent, Seller and GCS hereby disclaim any such representation or warranty whether by Parent, Seller, GCS or any of their respective Affiliates, any of their respective officers, directors, employees or Representatives, or any other Person.

ARTICLE VII

REPRESENTATIONS AND WARRANTIES OF BUYER

Except as set forth in the corresponding numbered section of the Buyer Disclosure Schedule, and subject to the definition of "Buyer Disclosure Schedule," Buyer represents and warrants to Parent, Seller and GCS as follows as of the date hereof and as of the Closing Date:

7.1          Organization; Existence and Qualification. Buyer is a corporation duly organized and validly existing under the laws of the State of Georgia. Buyer has full corporate power and authority to carry on its business as now being conducted and to own, operate and lease its Assets.

7.2          Power; Authority; Enforceable Obligations. Buyer has the corporate power and authority to execute and deliver this Agreement and the other Operative Documents and to perform its obligations hereunder and thereunder. Buyer has taken all action required by Law,

 

 

 

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its articles of incorporation and bylaws, or otherwise to authorize the execution and delivery of this Agreement and the other Operative Documents, the performance of its obligations hereunder and thereunder, and the consummation of the Transaction. This Agreement has been duly executed and delivered by Buyer. At the Closing (subject to the conditions to closing set forth in Article X), each of the other Operative Documents will be duly executed and delivered by Buyer. This Agreement is a valid and binding agreement of Buyer, enforceable against Buyer in accordance with its terms, except as such validity, binding effect or enforceability may be limited by applicable bankruptcy, insolvency, reorganization, receivership, conservatorship, fraudulent transfer, moratorium (whether general or specific) or other Law now or hereafter in effect affecting the enforceability of creditors' rights generally, and except that the availability of equitable remedies, such as specific performance or injunctive relief, are subject to the discretion of the court before which any proceeding may be brought. Each of the Operative Documents other than this Agreement to which Buyer will be a party, when executed and delivered at the Closing, will be valid and binding and enforceable against Buyer in accordance with its terms, except as such validity, binding effect or enforceability may be limited by applicable bankruptcy, insolvency, reorganization, receivership, conservatorship, fraudulent transfer, moratorium (whether general or specific) or other Law now or hereafter in effect affecting the enforceability of creditors' rights generally, and except that the availability of equitable remedies, such as specific performance or injunctive relief, are subject to the discretion of the court before which any proceeding may be brought.

7.3          No Conflicts. None of the execution or delivery by Buyer of this Agreement or any other Operative Document to which it is a party, performance by Buyer of its obligations hereunder or thereunder, or consummation by Buyer of the Transaction will: (i) require Buyer to obtain the Consent of, or deliver any notice, filing or application to, any Regulatory Authority or any other Person with respect to the transfer of the Transferred Assets, the assumption of the Assumed Liabilities, or the performance of any obligations under any other Operative Document, other than the Consents identified on Section 7.3 of the Buyer Disclosure Schedule ("Buyer Consents"); (ii) conflict with or result in any violation of any provision of the articles of incorporation or bylaws, each as amended to date, of Buyer; (iii) result in any conflict with, or Default under, any material agreement, indenture, mortgage or lease to which Buyer is a party; or (iv) violate any term of any Law or Order applicable to Buyer.

7.4          Litigation. To the Knowledge of Buyer, there is no Litigation pending or threatened against Buyer or involving or arising in connection with Buyer's Merchant Processing Business, which questions or challenges the validity of this Agreement or the other Operative Documents or any action taken or to be taken by Buyer pursuant hereto or thereto or the consummation of the transactions contemplated hereby or thereby.

7.5          Sufficient Funds. At the Closing, Buyer will have sufficient funds to enable Buyer to consummate the transactions contemplated by this Agreement and the other Operative Documents.

7.6          Permits. Buyer owns or validly holds all Permits that are required in connection with the conduct of Buyer's Merchant Processing Business, except such Permits as are not reasonably likely to have a Material Adverse Effect on Buyer. All such Permits are valid and in full force and effect, except where the failure to be in full force and effect is not reasonably

 

 

 

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likely to have a Material Adverse Effect on Buyer. No proceeding is pending or, to the Knowledge of Buyer, threatened which would reasonably be expected to result in the revocation or termination of any Permits, and to the Knowledge of Buyer, there is no valid basis for any such proceeding, except in all cases where such revocation or termination is not reasonably likely to have a Material Adverse Effect on Buyer. Buyer is in compliance with the rules and regulations of the Credit Card Associations that are applicable to its Merchant Processing Business, except where the failure to be in compliance would not reasonably be expected to have a Material Adverse Effect on Buyer.

7.7          Compliance With Law. With respect to Buyer's Merchant Processing Business generally, Buyer is not in violation of any applicable Law, Order or Permit, except such violations as are not reasonably likely to have a Material Adverse Effect on Buyer.

7.8          No Other Representations. Except for the representations and warranties expressly contained in this Agreement or in the other Operative Documents, neither Buyer nor any other Person makes any express or implied representation or warranty on behalf of Buyer, and Buyer hereby disclaims any such representation or warranty whether by Buyer or any of its Affiliates, any of their respective officers, directors, employees or Representatives, or any other Person.

ARTICLE VIII

COVENANTS

8.1          Conduct of Business Pending Consummation. From the date of this Agreement until the earlier of the Closing or the termination of this Agreement in accordance with Article XII, except as expressly contemplated by this Agreement or as set forth in Section 8.1 of the Seller Disclosure Schedule, unless the prior written consent of Buyer shall have been obtained, which consent shall not be unreasonably withheld or delayed (or, with respect to Section 8.1(b), unless Seller has given Buyer prior written notice and Seller is modifying or drawing upon a Merchant Security Arrangement in good faith and consistent with its historical past practice), Parent, Seller and GCS, as applicable, shall:

(a)          operate the Business only in the ordinary course, consistent with past practice, and use its reasonable efforts to preserve business relationships with employees and with Merchants and parties to other Transferred Contracts;

 

(b)

not modify or draw upon any Merchant Security Arrangement;

(c)          pay and perform all obligations under the Transferred Contracts consistent with past practice;

 

(d)

not permit or allow any of the Transferred Assets to be subjected to any

Liens, other than Permitted Liens;

(e)          not sell, lease, transfer or otherwise dispose of any asset that, but for such sale, lease, transfer or disposition, would have been a Transferred Asset;

 

 

 

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(f)           not pay, discharge, or satisfy any material claim or Liability with respect to any Transferred Assets in respect of the Business, other than payment, discharge or satisfaction in the Ordinary Course of Business;

(g)          not amend, release or cancel any obligations, liabilities, rights or claims included in the Transferred Assets except in the Ordinary Course of Business;

(h)          not make any change in any method, practice or principle of financial or tax accounting in any manner materially affecting the Business or any financial information relating to or derived from the Business;

 

(i)

maintain and service the Equipment consistent with past practice;

(j)           use its reasonable efforts to comply with and perform its obligations and duties imposed by all Laws applicable to the Transferred Assets, the Business and the Designated Employees;

(k)          not grant any increase in the compensation of Designated Employees (including any such increase pursuant to any bonus, pension, profit sharing or other plan or commitment) except in the Ordinary Course of Business pursuant to existing employee benefits plans, or enter into any employment agreement with any Designated Employee; provided, however, that this Section 8.1(k) shall not prohibit Seller, Parent or GCS from entering into employee retention agreements with the Designated Employees named on Section 8.1(k) of the Seller Disclosure Schedule, so long as such agreement is in the form of the Employee Retention, Sale Participation and Non-Competition Agreement attached hereto as Exhibit "H" or the Residual Commission Buyout Agreement attached hereto as Exhibit "I";

(l)           not amend, modify, terminate or supplement any Specified Merchant Agreement;

(m)         not amend, modify or supplement in any material respect or terminate any other material Transferred Contract;

(n)          not amend, modify, supplement or terminate any other Merchant Agreement or immaterial Transferred Contract, except in the Ordinary Course of Business;

(o)          take no action, or omit to take any action, which would materially adversely affect the ability of any party to obtain any Consents required for the transactions contemplated hereby, or which would materially adversely affect the ability of any party to perform its covenants and agreements under this Agreement and the other Operative Documents; and

(p)          not agree, whether in writing or otherwise, to do any of the acts prohibited by clauses (a)-(o) above.

 

8.2

Consummation of Transactions; Consents.

 

 

 

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(a)          Subject to the terms and conditions of this Agreement, each party agrees to use all reasonable efforts to take, or cause to be taken, all actions, and to do, or cause to be done, all things necessary, proper, or advisable under applicable Laws to consummate and make effective, as soon as practicable after the date of this Agreement, the Transaction; provided, that nothing herein shall preclude any party from exercising its rights under this Agreement.

(b)          As promptly as practicable after the execution of this Agreement, Parent, Seller, GCS and Buyer, as appropriate, shall (i) file all reports, notifications, applications and other documents that may be required to be filed with any and all Regulatory Authorities having proper jurisdiction over Parent, Seller, GCS and Buyer in connection with the Transaction, including a premerger notification form under the HSR Act; (ii) cooperate with each other in connection with such filings or responses to requests for additional information; and (iii) use all reasonable efforts to resolve any objections raised by any of such authorities. To the extent permitted by Law, the parties will furnish to each other such necessary information and reasonable assistance as each may request in connection with their preparation of necessary filings with such Regulatory Authorities. Each party also shall use all reasonable efforts to obtain all required Consents. Each party shall cooperate fully with the other to the extent reasonable in connection with the foregoing. Each party shall promptly notify the other, and keep the other advised as to the status of, any Litigation or administrative proceeding pending and known to such party, or to its Knowledge threatened, which challenges the Transaction.

(c)          Each party agrees to give written notice promptly to the others upon becoming aware of the occurrence or impending occurrence of any change, fact, condition, event or circumstance relating to it which (i) is reasonably likely to have, individually or in the aggregate, a Material Adverse Effect on such party (or in the case of Parent, Seller or GCS, a Material Adverse Effect on the Business), (ii) would cause or constitute a breach of any of such party's representations and warranties (made either as of the date of this Agreement or as if made at the time of the occurrence, or such party's discovery, of such change, fact, condition, event or circumstance) or a material breach of such party's covenants contained herein, or (iii) prevents or is reasonably likely to prevent such party from complying with its obligations hereunder. Each party further agrees to use its reasonable efforts to prevent or promptly to remedy any such change, fact, condition, event or circumstance.

(d)          Should any change, fact, condition, event, or circumstance referred to in Section 8.2(c) require any change to either the Seller Disclosure Schedule or the Buyer Disclosure Schedule delivered as of the date of this Agreement, then Parent and Seller, or Buyer, as applicable, will deliver to the other applicable party or parties at least two (2) Business Days prior to the Closing Date a supplement thereto specifying such change. Any such supplement shall not be given effect for purposes of the representations and warranties contained herein.

(e)          No party shall take or cause to be taken any action that is inconsistent with its obligations under this Agreement, that would materially adversely affect the ability of any party to perform its covenants and agreements under this Agreement, that would

 

 

 

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materially adversely affect the ability of any party to obtain any Consents or Permits required for consummation of the Transaction, or that would materially hinder or delay the consummation of the Transaction.

8.3          Force Majeure. No party shall be liable for defaults or delays due to acts of God or the public enemy, acts or demands of government or any government agency, terrorism, strikes, fires, flood, accident, or other unforeseeable causes beyond its control and not due to its fault or negligence. Each party shall notify the other of the cause of such delay within five (5) days after the beginning thereof. In the event of such a delay or inability to perform, the time for performance shall be extended for a period of time equal to the length of the delay or inability to perform. Each party shall take such steps as are reasonably necessary to overcome and mitigate the cause of the defaults or delays as promptly as possible.

 

8.4

No Solicitation.

(a)          Parent, Seller and GCS will not, and each will ensure that its directors, officers, employees, Affiliates and Representatives do not, directly or indirectly encourage, solicit, participate in or initiate discussions or negotiations with, provide any information to, or enter into any confidentiality agreement, letter of intent, purchase agreement, merger agreement, or other similar agreement, with, any Person (other than Buyer or its directors, officers, employees and Representatives) with respect to (i) any sale, disposition, lease or other transfer of any of the Transferred Assets or the Business (except as permitted pursuant to Section 8.1(e)), (ii) any merger, consolidation, business combination or sale of all or a significant portion of the capital stock of Seller or GCS, or (iii) the liquidation or similar extraordinary transaction with respect to Seller or GCS (an "Acquisition Transaction"). Parent, Seller and GCS shall notify Buyer orally (within one Business Day) and in writing (as promptly as practicable) upon receipt of any bona fide inquiry or proposal concerning an Acquisition Transaction and the material terms thereof.

(b)          Nothing in this Section 8.4 shall prohibit Parent or FHN from entering into negotiations with respect to, or any confidentiality agreement, letter of intent, purchase agreement, merger agreement or other similar agreement with any Person (an "Acquiror") with respect to the sale of all or any portion of the assets of Parent or FHN, or a merger, consolidation, business combination, sale of all or any substantial portion of the capital stock of Parent or FHN or the liquidation or similar extraordinary transaction with respect to Parent or FHN (any such transaction, a "Parent Transaction"), provided that, as a condition to the consummation of any such Parent Transaction, all of the obligations of Parent under this Agreement or any other Operative Document shall be expressly assumed by such Acquiror in accordance with Section 13.3 and provided, further, that neither Parent nor FHN shall enter into any agreement with respect to a Parent Transaction the effect of which does or could reasonably be expected to prevent or materially delay the ability of Parent or Seller to consummate the Transaction in accordance with its terms, and provided, further, that a Parent Transaction shall in no event include any negotiations with respect to, or any confidentiality agreement, letter of intent, purchase agreement, merger agreement or other similar agreement with any Person other than Buyer with respect to the assets of Seller or GCS or the Transferred Assets, or a merger, consolidation, business combination, sale of all or any portion of the

 

 

 

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capital stock of Seller or GCS or the liquidation or similar extraordinary transaction with respect to Seller, GCS or the Transferred Assets.

 

8.5

Employees.

(a)          Immediately following the execution of this Agreement and until the earlier of the termination of this Agreement in accordance with Article XII or the Designated Employee Transfer Date, Parent, Seller, and GCS shall permit Buyer (and/or its Representatives) to initiate discussions with any or all of the Designated Employees, specifically including job interviews, so that Buyer may determine which, if any, of the Designated Employees it desires to hire as of the Designated Employee Transfer Date. Buyer may conduct individual or group meetings, discussions or interviews with Designated Employees in the offices of Seller or GCS (or such other locations as are mutually agreed by the parties) during normal business hours (or at such other times as are mutually agreed by the parties)

(b)          Seller, GCS and Parent shall continue to employ the Designated Employees from the date of the execution of this Agreement until the earlier of (i) the date designated by Buyer as the hire date of the Designated Employees identified in writing by Buyer to Parent (the "Transferred Employees") or (ii) 60 days following the Closing Date (the "Designated Employee Transfer Date"). Seller's, GCS's and Parent's continued employment of the Designated Employees shall be on the same terms and conditions, including but not limited to the payment of compensation or wages and the provision of employee benefits, as Seller, GCS and Parent employed such Designated Employees on the date immediately preceding the Closing Date (subject to the terms of those certain Employee Retention, Sale Participation and Non-Solicitation Agreements to be entered into pursuant to Section 8.5(d) of this Agreement). Subject to reimbursement of costs and expenses for the period between the Closing Date and the Designated Employee Transfer Date, as provided in the Interim Services Agreement (which shall require detail and supporting documentation as reasonably requested by Buyer), Seller, GCS and Parent shall continue to be responsible and liable for all payroll, compensation, benefits or other expenses related to the Designated Employees up to the Designated Employee Transfer Date. Buyer shall not be obligated to reimburse Seller, GCS or Parent for any "Special Payment," "Commission Payment" or "Additional Payment" pursuant to, and as defined in, those certain Employee Retention, Sale Participation, and Non-Solicitation Agreements entered into pursuant to Section 8.5(d) of this Agreement or the Residual Commission Buyout Agreement, or for any other expenses related to the continued employment of the Designated Employees which are not directly attributable to the services performed by the Designated Employees on or after the Closing Date. Seller, GCS and Parent shall terminate the Transferred Employees as of the Designated Employee Transfer Date and, on or after the Designated Employee Transfer Date, Seller, GCS and Parent may at their option terminate one or more of the Designated Employees who are not Transferred Employees. Nothing herein shall be construed as requiring or creating any obligation on the part of Buyer to offer employment to or to hire any Designated Employee or to continue to employ any Transferred Employee for any period of time following the Designated Employee Transfer Date.

 

 

 

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(c)          Except to the extent prohibited by applicable Law, Seller, GCS and Parent shall assist Buyer in the transition of any Transferred Employees by providing true and correct copies of any information or records requested by Buyer (or its Representatives) related to the Transferred Employees, including initial employment dates, termination dates, reemployment dates, hours of service, compensation or tax withholding history or any other information, that Buyer (or its Representatives) reasonably deems necessary in connection with the employment of any Transferred Employee. Seller, GCS and Parent agree to provide any information or records reasonably requested by Buyer (or its Representatives) related to the Transferred Employees in such format(s) as are reasonably requested by Buyer (or its Representatives).

(d)          As soon as practicable after the execution of this Agreement, Parent and Seller will enter into employee retention agreements in the form of the Employee Retention, Sale Participation and Non-Solicitation Agreement attached hereto as Exhibit "H" with those Designated Employees named on Section 8.1(k) of the Seller Disclosure Schedule.

ARTICLE IX

INVESTIGATION AND CONFIDENTIALITY

9.1          Investigation. Prior to the Closing, each party shall keep each other party advised of all material developments relevant to its business, and to consummation of the Transaction, and shall permit each other party to make or cause to be made such reasonable investigation of the business and properties of it and its financial and legal conditions as the other party reasonably requests, provided that such investigation shall be reasonably related to the Transaction and shall, to the extent reasonably practicable, be made upon reasonable notice and during regular business hours and in a manner not to unreasonably interfere with normal operations.

 

9.2

Agreements Regarding Confidentiality.

(a)          Parent, Seller and GCS each covenants that, from and after the date of this Agreement (including after the Closing), it will not, during the Applicable Period, without the prior written consent of Buyer, use or disclose to any Person confidential information relating to or concerning:

(i)           Buyer and its Affiliates' respective business, customers, financial condition, performance or operations, obtained by or in the possession of Parent or Seller prior to the Closing ("Buyer Confidential Information"), except for disclosure to, and use by the officers, directors, employees and Representatives of Parent, Seller, GCS and their respective Affiliates who need to know or use such information for purposes of the Transaction, unless, in the opinion of counsel to Parent or Seller, disclosure is required to be made under the Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, other Law or the rules of the New York Stock Exchange or any other relevant securities exchange.

 

 

 

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(ii)          The Transferred Assets, Assumed Liabilities, the Operative Documents, or the Business, in each case obtained by or in the possession of Parent, Seller or GCS at or prior to the Closing ("Transferred Business Confidential Information"), except for disclosure to, and use by its and its Affiliates' officers, directors, employees and Representatives to the extent such Persons need to know or use such information for purposes of the Transaction, Taxes, accounting, litigation and other matters necessary in respect of the ownership by Seller prior to the Closing of the Transferred Assets or the Business, unless, in the opinion of counsel to Parent and Seller, disclosure is required to be made under the Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, other Law or the rules of the New York Stock Exchange or any other relevant securities exchange; further, provided, in the event disclosure of an Operative Document is required to be made under the Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, other law or the rules of the New York Stock Exchange or any other relevant securities exchange, all as herein contemplated, Parent and Seller agree to give Buyer prior written notice thereof and to use reasonable efforts, in cooperation with Buyer, to obtain confidential treatment for any Buyer Confidential Information contained in the Operative Documents.

(b)          The term "Buyer Confidential Information" does not include information which (i) becomes generally available to the public other than as a result of wrongful disclosure by Parent, Seller, GCS or its Affiliates, agents or Representatives, (ii) was available on a non-confidential basis prior to its coming into the possession of Parent or Seller, or (iii) becomes available after the Closing to Parent, GCS or Seller on a non-confidential basis from a source other than Buyer or its Affiliates, provided that, to the Knowledge of Parent, GCS or Seller, as applicable, such source is not bound by a confidentiality agreement with Buyer or any of its Representatives. The term "Transferred Business Confidential Information" does not include information which becomes generally available to the public other than as a result of wrongful disclosure by Parent, GCS, Seller or their respective Affiliates, agents or Representatives provided that, to the Knowledge of Parent, GCS or Seller, such source is not bound by a confidentiality agreement with Buyer, its Affiliates, or their respective Representatives.

(c)          Notwithstanding the foregoing, Parent, Seller, GCS and their respective Affiliates may use and disclose Transferred Business Confidential Information to the extent (i) reasonably required to bring any claim against, or resolve any dispute with, any Person who is party to any Transferred Contract which arises under such Transferred Contract relating to events prior to the Effective Time, or (ii) reasonably required to defend any Litigation, claim or other dispute relating to any matter that is or relates to, or is asserted to be or relate to, a Retained Asset or a Retained Liability or any other matter that is or is asserted to be covered by Parent or Seller's indemnification obligations under Article XI; (iii) required by applicable Laws or Payment Network Regulations, (iv) reasonably required to prepare any financial statements (including the notes thereto), or (v) reasonably necessary to be disclosed to banking authorities or regulators, including as may result from Seller's status as an Affiliate of Parent, and related disclosure to Seller's,

 

 

 

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GCS's and Parent's Corporate and Compliance departments. Prior to any use or disclosure of such Transferred Business Confidential Information, Parent, GCS or Seller will notify Buyer that it intends to use or disclose Transferred Business Confidential Information and will consult with Buyer in good faith regarding the scope of the use and disclosure.

(d)          In the event that Parent, GCS, Seller or any of its Affiliates is requested or required by document subpoena, civil investigative demand, interrogatories, requests for information, or other similar process to disclose any Buyer Confidential Information or Transferred Business Confidential Information which otherwise may not be disclosed except as set forth in Section 9.2(a) or (c), Parent, GCS or Seller will provide Buyer with prompt notice of such request or demand or other similar process so that Buyer may seek an appropriate protective order or, if such request, demand or other similar process is mandatory, waive compliance with the provisions of this Section 9.2, as appropriate.

(e)          Buyer covenants that, from and after the date of this Agreement (including after the Closing), it will not during the Applicable Period, without the prior written consent of Parent and Seller use or disclose to any Person confidential information relating to or concerning (i) Parent, Seller, GCS, their respective Affiliates, or their respective businesses, customers, financial condition, performance or operations or (ii) the Operative Documents obtained by Buyer at or prior to the Closing Date, excluding any Transferred Business Confidential Information and such other information as it relates to the Transferred Assets and/or included in the Transferred Books and Records (the "Seller Confidential Information"), except for disclosure to, and use by, Buyer's and its Affiliates' officers, directors, employees and Representatives to the extent such Persons need to know such information for purposes of the Transaction, Taxes, accounting, Litigation and other matters necessary in respect of the ownership by Buyer, subsequent to the Closing, of the Transferred Assets, Buyer's assumption of the Assumed Liabilities or Buyer's conduct of its Merchant Processing Business, unless, in the opinion of counsel to Buyer, disclosure is required to be made under the Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, other applicable Law or the rules of the New York Stock Exchange or any other relevant securities exchange; further, provided, in the event disclosure of an Operative Document is required to be made under the Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, other law or the rules of the New York Stock Exchange or any other relevant securities exchange, all as herein contemplated, Buyer agrees to give Parent and Seller prior written notice thereof and to use all reasonable efforts, in cooperation with Parent and Seller, to obtain confidential treatment for any Seller Confidential Information contained in the Operative Documents. The term "Seller Confidential Information" does not include information which (i) becomes generally available to the public other than as a result of disclosure by Buyer or its Affiliates, agents or Representatives, (ii) was available on a non-confidential basis prior to its coming into the possession of Buyer, or (iii) becomes available after the Closing to Buyer on a non-confidential basis from a source other than Parent, GCS or Seller, provided that, to the Knowledge of Buyer, such source is not bound by a confidentiality agreement with Parent, Seller or their Representatives.

 

 

 

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(f)           Notwithstanding the foregoing, Buyer and its Affiliates may use and disclose Seller Confidential Information to the extent (i) reasonably required to bring any claim against, or resolve any dispute with, any Person who is party to any Transferred Contract that arises under such Transferred Contract relating to events at or after the Effective Time, (ii) reasonably required to defend any Litigation, claim or other dispute relating to any matter that is or relates to, or is asserted to be or relate to, a Transferred Asset or an Assumed Liability or any other matter that is or is asserted to be covered by Buyer's indemnification obligations under Article XI, (iii) required for Buyer to provide Merchant Services under this Agreement or the other Operative Documents, or otherwise in connection with Buyer's performance of its obligations hereunder or thereunder, (iv) required by applicable Laws or Payment Network Regulations, (v) reasonably required to prepare any financial statements (including the notes thereto), or (vi) reasonably necessary to be disclosed to banking authorities or regulators, including as may result from Buyer's status as an Affiliate of a bank, and related disclosure to Buyer's Corporate and Compliance Units. Prior to any use or disclosure of such Seller Confidential Information, Buyer will notify Parent and Seller that Buyer intends to use or disclose Seller Confidential Information and will consult with Parent and Seller in good faith regarding the scope of the use and disclosure.

(g)          In the event that Buyer is requested or required by documents subpoena, civil investigative demand, interrogatories, requests for information, or other similar process to disclose any Seller Confidential Information which otherwise may not be disclosed except as set forth in Section 9.2(e) or (f), Buyer will provide Parent and Seller with prompt notice of such request or demand or other similar process so that Parent, GCS and Seller may seek an appropriate protective order or, if such request, demand or other similar process is mandatory, waive compliance with the provisions of this Section 9.2, as appropriate.

(h)          Notwithstanding any other provision under this Section 9.2, no party shall be prohibited from publicly disclosing information related to the effect of the Transaction on such party's financial condition and results of operations in connection with customary investor relations activities consistent with past practice.

(i)           The parties agree that the confidentiality provisions of the Confidentiality Agreement shall be superseded by this Section 9.2, and that all information and material which constitutes "Evaluation Material" under the confidentiality provisions of the Confidentiality Agreement shall constitute Seller Confidential Information or Transferred Business Confidential Information, as applicable, for purposes of this Section 9.2. The parties further agree that as of the Effective Time, the Confidentiality Agreement shall be terminated and of no further force or effect.

9.3          Publicity. In connection with the execution of this Agreement and in connection with the Closing, Parent, Seller, GCS and Buyer jointly will plan, coordinate in good faith and release any related press release and other public announcements, statements or communications. Prior to the Closing Date, no party will issue any press release or make any other public disclosures, announcements, statements or communications concerning this Transaction or the contents of this Agreement without the prior written consent of the other party. Notwithstanding

 

 

 

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the above, nothing in this Article IX will preclude any party from making any disclosures which are, in the opinion of counsel of the party seeking to disclose, required by Law or, in the case of Parent and FHN, by the New York Stock Exchange, or necessary and proper in conjunction with the filing of any Tax Return or other document required to be filed with any governmental body, authority or agency; provided, that the party required to make the release or statement shall to the extent practicable allow the other party reasonable time to comment on such release or statement in advance of such issuance.

ARTICLE X

CONDITIONS TO CLOSING

10.1       Conditions to Obligations of Each Party. The respective obligations of each party to perform this Agreement and consummate the Transaction are subject to the satisfaction of the following conditions, unless waived by each of Parent, Seller, GCS and Buyer pursuant to Section 13.1.

(a)          All Consents of, filings and registrations with, and notifications to, all Regulatory Authorities identified on Sections 10.1(a) of the Buyer Disclosure Schedule and Seller Disclosure Schedule and/or required for consummation of the Transaction, including as necessary under the HSR Act, shall have been obtained or made and shall be in full force and effect and all waiting periods required by Law shall have expired.

(b)          All Consents identified on Sections 10.1(b) of the Buyer Disclosure Schedule and Seller Disclosure Schedule shall have been obtained.

(c)          No court or governmental or Regulatory Authority of competent jurisdiction shall have enacted, issued, promulgated, enforced or entered any Law or Order (whether temporary, preliminary or permanent) or taken any other action which prohibits, materially restricts or makes consummation of the Transaction illegal.

(d)          There shall not have been commenced or threatened against Parent, Seller, GCS or Buyer (or any of their respective Affiliates) any Litigation (i) involving any challenge to, or seeking damages or other relief in connection with, the Transaction or (ii) that may have the effect of preventing, delaying, making illegal, imposing limitations or conditions on or otherwise interfering with the Transaction.

10.2       Conditions to Obligations of Buyer. In addition to the conditions set forth in Section 10.1, the consummation by Buyer of the Transaction is expressly subject to the following conditions, unless waived in writing by Buyer pursuant to Section 13.1:

(a)          (i) The representations and warranties contained in Article VI that are qualified by materiality or Material Adverse Effect shall be true and correct on and as of the date of this Agreement and as of the Closing Date (except to the extent such representations and warranties shall have been expressly made as of an earlier date, in which case such representations and warranties shall have been true and correct as of such earlier date) with the same force and effect as if made on such date, and (ii) the representations and warranties contained in Article VI that are not qualified by

 

 

 

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materiality or Material Adverse Effect shall be true and correct on and as of the date of this Agreement and the Closing Date (except to the extent such representations and warranties shall have been expressly made as of an earlier date, in which case such representations and warranties shall have been true and correct as of such earlier date) with the same force and effect as if made on such date, except to the extent that any failures of such representations and warranties in this clause (ii) to be so true and correct, individually or in the aggregate, would not reasonably be expected to have a Material Adverse Effect on Parent, Seller, GCS or the Business.

(b)          Parent, GCS and Seller shall have performed and complied in all material respects with each and every agreement, covenant and obligation required by this Agreement to be performed or complied with by each of them at or prior to the Closing.

(c)          Parent, GCS and Seller shall have furnished Buyer with such certificates of its officers and others to evidence compliance with the conditions set forth in this Section 10.2 as may be reasonably requested by Buyer.

(d)          Buyer shall have received from or on behalf of Parent, GCS and Seller delivery of all the items listed in Section 5.2(a).

(e)          Since the date of this Agreement, none of Parent, Seller, GCS nor the Business shall have suffered a Material Adverse Effect, nor shall there have occurred any development likely to result in a Material Adverse Effect on Parent, Seller, GCS or the Business.

10.3       Conditions to Obligations of Parent, GCS and Seller. In addition to the conditions set forth in Section 10.1, the consummation by Parent, GCS and Seller of the Transaction is expressly subject to the following conditions, unless waived in writing by Seller pursuant to Section 13.1:

(a)          (i) The representations and warranties contained in Article VII that are qualified by materiality or Material Adverse Effect shall be true and correct on and as of the date of this Agreement and as of the Closing Date (except to the extent such representations and warranties shall have been expressly made as of an earlier date, in which case such representations and warranties shall have been true and correct as of such earlier date) with the same force and effect as if made on such date, and (ii) the representations and warranties contained in Article VII that are not qualified by materiality or Material Adverse Effect shall be true and correct on and as of the date of this Agreement and the Closing Date (except to the extent such representations and warranties shall have been expressly made as of an earlier date, in which case such representations and warranties shall have been true and correct as of such earlier date) with the same force and effect as if made on such date, except to the extent that any failures of such representations and warranties in this clause (ii) to be so true and correct, individually or in the aggregate, would not reasonably be expected to have a Material Adverse Effect on Buyer.

 

 

 

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(b)          Buyer shall have performed and complied in all material respects with each and every agreement, covenant and obligation required by this Agreement to be performed or complied with by it at or prior to the Closing.

(c)          Buyer shall have furnished Parent, GCS and Seller with such certificates of its officers and others to evidence compliance with the conditions set forth in this Section 10.3 as may be reasonably requested by Parent, GCS and Seller.

(d)          Parent, Seller and GCS, as applicable, shall have received from or on behalf of Buyer delivery of all the items listed in Section 5.2(b).

(e)          Since the date of this Agreement, Buyer shall not have suffered a Material Adverse Effect, nor shall there have occurred any development likely to result in a Material Adverse Effect on Buyer.

ARTICLE XI

SURVIVAL, INDEMNIFICATION AND LIMITATIONS ON LIABILITY

 

11.1

Survival.

(a)          Except as provided in the immediately following sentence, the representations and warranties of the parties contained herein and the statements in any certificate or other writing delivered pursuant hereto shall survive the Closing and shall remain in full force and effect until the date which is fifteen (15) months after the Closing Date. The Group One Representations and Warranties shall survive the Closing indefinitely, and the representations and warranties set forth in Section 6.12 shall survive the Closing and shall remain in full force and effect until the third anniversary of the Closing Date. The covenants and agreements of the parties contained herein (other than those contained in Article VIII) shall survive the Closing and remain in full force and effect in accordance with their terms. The covenants and agreements of the parties contained in Article VIII shall terminate upon the Closing, except that claims for indemnification in respect of any breach thereof shall survive until the first anniversary of the Closing. The period of time a representation and warranty or covenant or agreement survives the Closing pursuant to this Section 11.1(a) shall be the "Survival Period" with respect to such representation and warranty, covenant or agreement.

(b)          For purposes of determining the amount of Damages sustained or incurred with respect to the breach of any representation or warranty, and for purposes of determining whether there has been a breach of any representation or warranty, those representations and warranties set forth in Article VI that are qualified by "material," "Material Adverse Effect" or variations thereof shall be deemed not to include those qualifications.

(c)          Any right of indemnification pursuant to this Article XI with respect to a claimed breach of (i) a representation or warranty and (ii) any covenant or agreement (other than with respect to any Retained Liability or Assumed Liability) shall expire on the expiration of the applicable Survival Period, unless in each case on or prior to the

 

 

 

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expiration of the applicable Survival Period a Claim (as defined below) has been made to the party from whom indemnification is sought; provided that, if a Claim is timely made, it may continue to be asserted and pursued beyond expiration of the applicable Survival Period of the representation, warranty, covenant or agreement to which such Claim relates. A "Claim" means a written notice asserting a breach of a representation, warranty, covenant, agreement or obligation specified in this Agreement, which shall set forth, in light of the information then known to the party giving such notice, a reasonably detailed description of and estimate (but only if then reasonable to make and only to the extent then known) of the amount involved in such breach. The right to bring claims or causes of action pursuant to this Article XI relating to the responsibility of Parent, Seller and GCS to indemnify the Buyer Group with respect to any Retained Liability, and the responsibility of Buyer to indemnify the Seller Group with respect to any Assumed Liability, shall survive without limitation, except as may be limited by Law.

(d)          Subject to and not in limitation of the definitions of "Seller Disclosure Schedule" and "Buyer Disclosure Schedule," the right to indemnification, reimbursement or other remedy based upon the representations, warranties, covenants and obligations contained herein shall not be affected by any investigation conducted with respect to, or any knowledge acquired (or capable of being acquired) at any time, whether before or after the date of this Agreement or the Closing Date, with respect to the accuracy of or compliance with any such representation, warranty, covenant or obligation. The waiver of any condition based upon the accuracy of any representation or warranty, or based upon the performance or compliance with any covenant or obligation, will not affect the right to indemnification, reimbursement or other remedy based upon such representations, warranties, covenants and obligations.

 

11.2

Indemnification.

(a)          Parent, Seller and GCS jointly and severally hereby agree to defend, indemnify and hold harmless Buyer, its Affiliates and their respective successors and assigns (collectively, the "Buyer Group") from and against all past, present and future demands, claims, suits, actions or causes of action, assessments, losses, damages, liabilities, fines, judgments, costs and expenses (including reasonable attorneys' fees), and specifically including, as and to the extent provided by this Article XI, Consequential Damages (collectively, "Damages"), imposed upon or incurred by any member of the Buyer Group by reason of or arising or resulting from (i) a breach or inaccuracy of any Group One Representation and Warranty of Parent, Seller or GCS contained in this Agreement or in any certificate delivered pursuant to Section 10.2(c), (ii) a breach or warranty of any Group Two Representation and Warranty of Parent, Seller or GCS contained in this Agreement or in any certificate delivered pursuant to Section 10.2(c), (iii) a breach or inaccuracy of any Other Representation and Warranty of Parent, Seller or GCS contained in this Agreement or in any certificate delivered pursuant to Section 10.2(c), (iv) a breach of any covenant or agreement of Parent, Seller or GCS contained in this Agreement, and (v) the Retained Liabilities; provided, that in no event shall Parent, Seller or GCS be required to indemnify any member of the Buyer Group for any Damages that a court of competent jurisdiction shall have determined by final judgment resulted primarily from the bad faith or willful misconduct of Buyer.

 

 

 

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(b)          Buyer hereby agrees to defend, indemnify and hold harmless Parent, Seller, GCS, each of their respective Affiliates and their respective successors and assigns (collectively, the "Seller Group") from and against all Damages imposed upon or incurred by any member of the Seller Group by reason of or resulting from (i) a breach or inaccuracy of any Group One Representation and Warranty of Buyer contained in this Agreement or in any certificate delivered pursuant to Section 10.3(c), (ii) a breach of inaccuracy of any other representation or warranty of Buyer contained in this Agreement or in any certificate delivered pursuant to Section 10.3(c), (iii) a breach of any covenant or agreement of Buyer contained in this Agreement, and (iv) the Assumed Liabilities; provided, that in no event shall Buyer be required to indemnify any member of the Seller Group for any Damages that a court of competent jurisdiction shall have determined by final judgment resulted primarily from the bad faith or willful misconduct of Parent or Seller.

(c)          From and after the Effective Time, except for Claims relating to actual fraud, intentional breach or willful misconduct and except for equitable remedies, the remedies provided in this Article XI constitute the sole and exclusive remedies between the parties for Damages or any other Claims arising under this Agreement or under any other Operative Document (other than the Non-Competition Agreement, the Interim Services Agreement and the Merchant Services Agreement), including Claims based upon the inaccuracy, untruth, incompleteness or breach of any representation or warranty contained in this Agreement or in such other Operative Documents or based upon the failure to perform any covenant, agreement or undertaking contained in this Agreement or in such other Operative Documents. The parties agree (i) that there are other Articles in this Agreement which set forth certain covenants, agreements and obligations expressly requiring the payment of money or certain reimbursements, and (ii) that in the event of a Claim arising from an alleged failure to make such payments and/or reimbursements, the exclusive remedy for such Claim is provided by this Article XI; provided, that there shall not be any duplication of reimbursement or indemnification with respect to any such matter.

11.3       Third Party Claims. The obligations of the parties provided for under Section 11.2 in respect of any claims made or asserted by a third party ("Third Party Claims") shall be performed in accordance with the following procedures:

(a)          Each Person seeking indemnification under Section 11.2 (each an "Indemnified Party") shall give the party from whom it is seeking indemnification hereunder (each an "Indemnifying Party") written notice (a "Third Party Claim Notice") as promptly as reasonably practicable after the written assertion of any Third Party Claim or commencement of any action, suit or proceeding in respect thereof describing in reasonable detail the nature of the Third Party Claim to the extent then known to the Indemnified Party; provided, that if an Indemnified Party fails to give the Indemnifying Party a Third Party Claim Notice on a timely basis, the Indemnifying Party shall not be relieved of its obligations under this Article XI in respect of such Third Party Claim except to the extent that the Indemnifying Party is materially prejudiced thereby.

 

 

 

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(b)          Upon receipt of any Third Party Claim Notice, the Indemnifying Party may undertake the defense, compromise and settlement thereof by representatives of its own choosing, and at its own cost and expense. The assumption of the defense, compromise and settlement of any such Third Party Claim by the Indemnifying Party will not be an acknowledgment of the obligation of the Indemnifying Party to indemnify the Indemnified Party with respect to such claim. If the Indemnified Party desires to participate in, but not control, any such defense, compromise and settlement, it may do so at its sole cost and expense. If, however, the Indemnifying Party fails or refuses to undertake the defense of such Third Party Claim within twenty (20) Business Days after such Third Party Claim Notice has been given to the Indemnifying Party, the Indemnified Party will have the right to undertake the defense, compromise and settlement of such Third Party Claim with counsel of its own choosing. In the circumstances described in the immediately preceding sentence, the Indemnified Party shall, upon undertaking the defense of such Third Party Claim, provide written notice thereof to the Indemnifying Party. If the Indemnifying Party undertakes the defense of a Third Party Claim and if in the reasonable opinion of counsel to the Indemnified Party there may exist material defenses available to the Indemnified Party that are different from or in addition to those available to the Indemnifying Party or if the Indemnified Party otherwise believes that its interests would be materially adversely affected by the Indemnifying Party assuming sole control of the defense of such Third Party Claim, the Indemnified Party shall be entitled to retain separate counsel to participate in (and the Indemnifying Party shall cooperate with the Indemnified Party so as to allow it to participate in and jointly control) the defense of such Third Party Claim. Each party will provide the other with access to all of its records, documents and personnel to the extent reasonably related to any Third Party Claim.

(c)          No settlement of a Third Party Claim involving the asserted liability of the Indemnifying Party under this Article XI shall be made without the prior written consent by or on behalf of the Indemnifying Party, which consent shall not be unreasonably withheld, conditioned or delayed. If the Indemnifying Party assumes the defense of a Third Party Claim, (i) no compromise or settlement thereof may be effected by the Indemnifying Party without the Indemnified Party's prior written consent (which consent shall not be unreasonably withheld, conditioned or delayed) unless (A) there is no finding or admission of any violation of Law, (B) the sole relief provided is monetary damages that are paid in full by the Indemnifying Party and (C) the compromise or settlement includes, as an unconditional term thereof, the giving by the claimant or the plaintiff to the Indemnified Party of a release, in form and substance reasonably satisfactory to the Indemnified Party, from all liability in respect of such Third Party Claim, and (ii) the Indemnified Party shall have no liability with respect to any compromise or settlement thereof affected without its consent.

 

11.4

Limitation of Liability.

(a)          No indemnification shall be required to be made by Parent, GCS or Seller under Sections 11.2(a)(i), (ii) or (iii) unless the aggregate amount of Damages under such Sections, taken together, exceeds $4,000,000 in the aggregate (the "Seller Threshold"), in which event Parent, GCS and Seller shall be obligated to indemnify the Indemnified

 

 

 

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Party for all such Damages in excess of the Seller Threshold incurred by such Indemnified Party. Notwithstanding anything to the contrary in this Agreement, the Seller Threshold shall not apply in any respect to any Damages arising out of or related to (i) any breach of any covenant or agreement of Parent, Seller or GCS contained in this Agreement, (ii) the Retained Liabilities, (iii) fraud, intentional breach or willful misconduct on the part of Parent, GCS or Seller, or (iv) the failure of Parent, Seller or GCS, as contemplated by this Agreement, to provide to Buyer a true, correct and complete copy of a Merchant Agreement with any Top 100 Acquiring Merchant.

(b)          No indemnification shall be required to be made by Buyer under Sections 11.2(b)(i) or (ii) unless the aggregate amount of Damages under such Sections, taken together, exceeds $4,000,000 in the aggregate (the "Buyer Threshold"), in which event Buyer shall be obligated to indemnify the Indemnified Party for all such Damages in excess of the Buyer Threshold incurred by such Indemnified Party. Notwithstanding anything to the contrary in this Agreement, the Buyer Threshold shall not apply in any respect to any Damages arising out of or related to (i) any breach of any covenant or agreement of Buyer contained in this Agreement, (ii) the Assumed Liabilities or (iii) fraud, intentional breach or willful misconduct on the part of Buyer.

 (c)

Subject to the remainder of this Section 11.4(c):

(i)           Buyer's maximum liability, in the aggregate, for all indemnification amounts owing pursuant to this Article XI (other than with respect to fraud, intentional breach, willful misconduct or the Assumed Liabilities) shall not exceed $112,500,000;

(ii)          Subject to Section 11.4(c)(iv), Parent's, Seller's and GCS's maximum liability, in the aggregate, for all indemnification amounts owing for any breach of any Group Two Representations and Warranties and any Other Representations and Warranties (other than, in each instance, with respect to fraud, intentional breach, willful misconduct or the Retained Liabilities) shall not exceed $175,000,000;

(iii)         Subject to Section 11.4(c)(iv), Parent's, Seller's and GCS's maximum liability, in the aggregate, for all indemnification amounts owing for any breach of any Group One Representations and Warranties and any breach of any covenant or agreement of Parent, Seller or GCS contained in this Agreement (other than, in each instance, with respect to fraud, intentional breach, willful misconduct or the Retained Liabilities) shall not exceed $450,000,000;

(iv)         In no event shall Parent's, Seller's and GCS's maximum liability, in the aggregate, for all indemnification amounts owing with respect to any Group One Representations and Warranties, Group Two Representations and Warranties, any Other Representations and Warranties, or any breach of any covenant or agreement of Parent, Seller or GCS contained in this Agreement (other than, in each instance, with respect to fraud, intentional breach, willful misconduct or the Retained Liabilities) exceed $450,000,000; and

 

 

 

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(v)          Notwithstanding the foregoing, the limitations set forth above in this Section 11.4(c) shall not be applicable to any Damages arising out of or related in any way to (A) fraud, intentional breach or willful misconduct on the part of the Indemnifying Party, (B) in the case of Parent, Seller and GCS, Parent's, Seller's and GCS's obligation to indemnify with respect to the Retained Liabilities, or (C) in the case of Buyer, Buyer's obligation to indemnify with respect to the Assumed Liabilities.

(d)          Except as otherwise set forth in this Section 11.4, none of Parent, Seller or GCS, on the one hand, or Buyer, on the other hand, shall be liable for special, indirect, incidental, exemplary or punitive damages or Consequential Damages arising out of or in connection with this Agreement. An Indemnifying Party shall be liable for exemplary or punitive damages with respect to the subject matter of this Agreement only in the instance of fraud or intentional and malicious misconduct on the part of such Indemnifying Party.

(e)          Parent, Seller and GCS shall be liable for Consequential Damages imposed upon or incurred by a member of the Buyer Group arising or resulting from (i) a breach of any of the representations, warranties, covenants or agreements of Parent, Seller and GCS made in respect of (A) the Assigned Merchant Agreements and (B) the Software, and (ii) the Retained Liabilities; provided, that, for the avoidance of doubt, none of Parent, Seller or GCS shall be liable for Consequential Damages in respect of any Relationship Merchant identified on Schedule 4.2 to the extent that Buyer has permissibly retained the portion of the Holdback Amount attributable to such Relationship Merchant. For the avoidance of doubt, none of Parent, Seller or GCS shall be liable to Buyer for Buyer's relationship with any Relationship Merchant under the terms of any merchant agreement Buyer may execute with such Relationship Merchant after the Closing Date; the parties further acknowledge and agree that Parent, Seller and GCS shall be liable to Buyer with respect to any such Relationship Merchant only as expressly set forth in this Agreement (e.g., a breach by Parent, Seller or GCS of a representation or warranty in Article VI hereof). Parent, Seller and GCS shall not be liable for Consequential Damages imposed upon or incurred by a member of the Buyer Group in respect of any other Transferred Asset. Notwithstanding anything contained in this Agreement to the contrary, none of Parent, Seller or GCS shall have any liability whatsoever for any Damages imposed upon, incurred or suffered by any member of the Buyer Group arising or resulting from:

(i)           the loss or diminution in value of any Assigned Merchant Agreement or of Card transaction volume or revenue associated with any Assigned Merchant Agreement following the Closing Date, to the extent such Damages or any other losses result from or arise out of:

 

(A)

general economic conditions;

(B)

 the condition (financial or otherwise), properties, assets, liabilities, position, business or results of operations of such Assigned
      

 

 

 

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Merchant (except to the extent such matters are otherwise the subject of the representations and warranties made in Article VI hereof);

(C)         events or circumstances that occur in the ordinary course of Buyer's business;

(D)         events or circumstances constituting Force Majeure as described in Section 8.3 of this Agreement; or

(E)         with respect to any Assigned Merchant, Buyer's breach of the Buyer Standard of Care with respect to such Assigned Merchant.

(ii)          the Software, to the extent that such Damages or other losses result from or arise out of:

(A)         facts and circumstances that do not constitute a breach or inaccuracy of any of the representations and warranties made by Parent, Seller and GCS in Section 6.12;

 

(B)

a breach by Buyer of the Buyer Standard of Care.

(the foregoing, collectively, the "Excluded Events").

(f)           Notwithstanding the amount of any Consequential Damages actually imposed upon or incurred by a member of the Buyer Group in connection with any Assigned Merchant Agreement, Parent, Seller's and GCS's maximum liability for Consequential Damages in respect of any Assigned Merchant Agreement (except with respect to Retained Liabilities) shall be five (5) times the Net Revenue of such affected Assigned Merchant.

(g)          Parent's, Seller's and GCS's maximum liability for Consequential Damages in respect of any Software included in the Transferred Assets shall be Buyer's lost profits directly resulting or arising from Parent's, Seller's and GCS's breach of a representation, warranty, covenant or agreement in respect of the Software included in the Transferred Assets, conditioned upon fulfillment of Buyer's requirements in this Agreement in respect of the Software (including with respect to Buyer's mitigation of any such Consequential Damages), as (i) such lost profits may be acknowledged and agreed to in writing by Parent, Seller or GCS, as applicable, or (ii) as determined in a court of competent jurisdiction.

(h)          Notwithstanding anything else to the contrary contained in this Agreement and in addition to any of the other conditions, limitations and exclusions set forth in this Agreement, none of Parent, Seller or GCS, as applicable, shall be required to indemnify any member of the Buyer Group (or to credit any member of the Buyer Group with amount towards the satisfaction of the Seller Threshold), and no member of the Buyer Group shall seek indemnity from Parent, Seller of GCS, as applicable, for any:

 

 

 

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(i)           Damages (including without limitation Consequential Damages) attributable to or arising from overhead allocations or general and administrative costs or the costs of administering or complying with the requirements imposed by or under this Agreement other than those requirements which require Buyer to mitigate Parent's, Seller's and GCS's indemnity obligations;

(ii)          Damages, with respect to any Assigned Merchant, that are caused by the failure of Buyer or another member of the Buyer Group to comply with the procedures and covenants in this Article XI, but only to the extent that such noncompliance (A) materially and adversely affects Parent's, Seller's and GCS's, as applicable, ability to administer a claim made by Buyer or another member of the Buyer Group or (B) materially and adversely affects the ability to cure a breach, mitigate Damages or defend a claim or otherwise results in or increases the amount of Damages, in which case Parent, Seller and/or GCS may contest such claim for indemnity in the amount by which such noncompliance increases the amount of such Damages; or

(iii)        Damages recovered by or paid to any member of the Buyer Group by any Person other than Parent, Seller or GCS (including, by way of example, from an insurance policy).

(i)           Notwithstanding anything else to the contrary contained in this Agreement and in addition to any of the other conditions, limitations and exclusions set forth in this Agreement, Buyer shall not be required to indemnify any member of the Seller Group (or to credit any member of the Seller Group with amount towards the satisfaction of the Buyer Threshold), and no member of the Seller Group shall seek indemnity from Buyer for:

(i)           Damages (including without limitation Consequential Damages) attributable to or arising from overhead allocations or general and administrative costs or the costs of administering or complying with the requirements imposed by or under this Agreement other than those requirements which require Parent, Seller and GCS to mitigate Buyer's indemnity obligations;

(ii)          Damages that are caused by the failure of Parent, Seller, GCS or another member of the Seller Group to comply with the procedures and covenants in this Article XI, but only to the extent that such noncompliance (A) materially and adversely affects Buyer's ability to administer a claim made by Parent, Seller, GCS or another member of the Seller Group or (B) materially and adversely affects the ability to cure a breach, mitigate Damages or defend a claim or otherwise results in or increases the amount of Damages, in which case Buyer may contest such claim for indemnity in the amount by which such noncompliance increases the amount of such Damages; or

(iii)        Damages recovered by or paid to any member of the Seller Group by any Person other than Buyer (including, by way of example, from an insurance policy).

 

 

 

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11.5       Buyer Standard of Care. As used in this Article XI, "Buyer Standard of Care" means, with respect to the Merchant Services provided to each Assigned Merchant (including without limitation material modifications to pricing, material modifications to any other terms of the related Assigned Merchant Agreement and material changes in operational policies or procedures), that degree of care which constitutes not less than the degree of care exercised by similar providers of Merchant Services with respect to similarly situated merchants, taking into account industry classification, processing history, credit and risk factors, and general business and economic conditions. The parties acknowledge and agree that the Buyer Standard of Care is intended solely as a prerequisite for Buyer's ability to be indemnified by Parent, Seller and GCS under this Agreement, and accordingly, notwithstanding anything to the contrary in this Agreement, that Buyer's failure to comply with the Buyer Standard of Care with respect to any Assigned Merchant shall not create any liability on the part of Buyer or any other member of the Buyer Group, including any obligation to indemnify Parent, Seller, GCS or any other member of the Seller Group.

 

11.6

Mitigation of Damages.

(a)          Each of Buyer, on the one hand, and Parent, Seller and GCS, on the other hand, shall at all times use its commercially reasonable efforts to minimize the Damages for which Parent, Seller or GCS, or Buyer, as applicable, may be liable, including without limitation Consequential Damages, pursuant to this Agreement (or would be liable for but for the operation of the Seller Threshold or Buyer Threshold, as applicable). Without limiting the foregoing, in carrying out its duty to mitigate Damages each party shall, as appropriate, take the actions described in this Section 11.6.

(b)          If there is a reasonable good faith basis for doing so, Parent, Seller and GCS, or Buyer, as applicable, shall appeal, through such processes as are reasonably available, any fines or other Damages imposed or threatened to be imposed by any Credit Card Association or EFT Network if Buyer's, or Parent's, Seller's and GCS's, as applicable, liability for the related actual or threatened Damages is reasonably likely to be reduced.

(c)          Buyer shall notify Parent in writing within three (3) Business Days following Buyer's discovery of any security breach, material service level interruption or other material defect in respect of the Software and Seller's Proprietary Rights included in the Transferred Assets, and shall, with Parent's reasonable cooperation (to the extent practicable), diligently pursue all commercially reasonable means to expeditiously cure such event or condition.

(d)          With respect to any matter for which Parent, Seller or GCS, or Buyer, as applicable, may be liable pursuant to this Article XI, Buyer, or Parent, Seller and GCS, as applicable, shall diligently pursue (including without limitation the commencement and pursuit of litigation) any and all rights and remedies under agreements and contracts with third parties reasonably likely to be successful, including insurance policies or other agreements or contracts (including, in the case of Buyer, the Assigned Merchant Agreements and/or Merchant Security Arrangements) pursuant to which such party has rights of recourse or is indemnified or of which such party is the beneficiary.

 

 

 

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(e)          Before either Buyer, on the one hand, or Parent, Seller or GCS, on the other hand, shall initiate, agree or consent to any course of action that may result in Damages (including Consequential Damages) for which Parent, Seller or GCS, or Buyer, as applicable, may be liable pursuant to the provisions of this Agreement, such party shall use commercially reasonable efforts to pursue any defenses to all claims against it (including any claims made by any Assigned Merchant or by any third party with respect to the Software).

(f)           Subject to any other requirements imposed by this Agreement, any expenses borne by Buyer, on the one hand, or Parent, Seller and GCS, on the other hand, in fulfillment of its covenants and agreements set forth in this Section 11.6 shall be deemed to be Damages for which the Seller Group or the Buyer Group, as applicable, shall be liable to the extent that such matter is otherwise indemnifiable under the terms of this Agreement.

ARTICLE XII

TERMINATION

12.1       Termination. This Agreement and the transactions contemplated hereby may be terminated at any time prior to the Closing, as follows:

 

(a)

By the mutual written consent of Parent, Seller, GCS and Buyer;

(b)          By Parent, Seller and GCS or by Buyer, if the Closing has not occurred on or before March 31, 2006 (the "Termination Date"), if the failure to consummate the transactions contemplated hereby on or before such date is not caused by any material breach of this Agreement by the party (or any Affiliate thereof) electing to terminate pursuant to this Section 12.1(b);

(c)          By Parent, Seller and GCS or by Buyer, if there shall have occurred a breach of any representation, warranty, covenant or agreement contained in this Agreement that would give rise to the failure of the conditions to the obligations of such party or parties set forth in Section 10.2(e) or 10.3(e), as the case may be, and such breach is (i) not capable of being cured prior to the Termination Date or (ii) is capable of being cured prior to the Termination Date but the breaching party has failed to cure such breach within 30 days after receiving notice of such breach from the non-breaching party or parties; provided that Parent, Seller and GCS or Buyer shall only be entitled to terminate this Agreement pursuant to this Section 12.1(c) if such party (or any Affiliate thereof) is not in breach in any material respect in the performance of its obligations under this Agreement; or

(d)          By Parent, Seller and GCS or by Buyer, if any court, governmental entity or other Regulatory Authority of competent jurisdiction shall have issued or entered an order, writ, injunction or decree which shall have the effect of prohibiting or making illegal the transactions contemplated by this Agreement and such order, writ, injunction or decree shall have become final and non-appealable.

 

 

 

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12.2       Effect of Termination. The party desiring to terminate this Agreement pursuant to Section 12.1 shall give written notice to the other party of such desire. If the transactions contemplated by this Agreement are terminated and/or abandoned as provided herein:

(a)          if and to the extent requested, and except to the extent such materials are required for pursuing any claims or remedies under this Agreement, each party will destroy or redeliver to the party furnishing the same all documents, work papers and other material of any other party relating to the transactions contemplated hereby, whether so obtained before or after the execution hereof (including any Evaluation Material);

(b)          this Agreement shall forthwith become void and there shall be no liability or obligation on the part of any party hereto except (i) with respect to Section 9.2 (Agreements Regarding Confidentiality), Section 9.3 (Publicity), Article XIII, and this Section 12.2, all of which shall survive the Termination Date. Notwithstanding the foregoing, nothing contained in this Section 12.2 shall relieve any party hereto from liability for any breach of this Agreement occurring prior to the Termination Date; and

(c)          no party hereto and none of their respective directors, officers, shareholders, Affiliates or controlling persons shall have any liability or further obligation to any other party to this Agreement except as stated in subparagraphs (a) and (b) of this Section 12.2.

ARTICLE XIII

MISCELLANEOUS

 

13.1

Waiver.

(a)          Prior to or at the Closing, Buyer shall have the right to waive any Default in the performance of any term of this Agreement by Parent, Seller or GCS, to waive or extend the time for the compliance or fulfillment by Parent, Seller or GCS of any and all of their respective obligations under this Agreement, and to waive any or all of the conditions precedent to the obligations of Parent, Seller or GCS under this Agreement, except any condition which, if not satisfied, would result in the violation of any Law. No such waiver shall be effective unless in writing signed by a duly authorized officer of Buyer.

(b)          Prior to or at the Closing, Parent, GCS and Seller shall have the right to waive any Default in the performance of any term of this Agreement by Buyer, to waive or extend the time for the compliance or fulfillment by Buyer of any and all of its obligations under this Agreement, and to waive any or all of the conditions precedent to the obligations of Parent, GCS and Seller under this Agreement, except any condition which, if not satisfied, would result in the violation of any Law. No such waiver shall be effective unless in writing signed by a duly authorized officer of Parent, GCS and Seller.

(c)          The failure of any party at any time or times to require performance of any provision hereof shall in no manner affect the right of such party at a later time to enforce

 

 

 

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the same or any other provision of this Agreement. No waiver of any condition or of the breach of any term contained in this Agreement in one or more instances shall be deemed to be or construed as a further or continuing waiver of such condition or breach or a waiver of any other condition or of the breach of any other term of this Agreement.

13.2       Amendment. This Agreement may be modified, supplemented or amended only by a written instrument executed by all of the parties hereto.

13.3       Nonassignability. All terms and provisions of this Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and permitted assigns. This Agreement may not be assigned by any party without the prior written consent of the other party; provided, that such consent shall not be required (a) for the assignment by any party of its rights and privileges hereunder to any if its Affiliates (it being understood that no such assignment shall relieve the assigning party of its duties or obligations hereunder), or (b) for the assignment and delegation by any party of its rights, privileges, duties and obligations hereunder to any Person into or with which the assigning party shall merge or consolidate or to which the assigning party shall sell all or substantially all of its assets, provided that the assignee agrees in writing to assume all the rights and obligations of the assigning party created hereby.

13.4       Entire Agreement. This Agreement (including any schedules, exhibits or attachments hereto), taken together with the other Operative Documents, shall constitute the entire agreement among the parties. This Agreement and the other agreements referred to in the preceding sentence collectively supersede all prior and contemporaneous agreements, statements, understandings, and representations of the parties, whether written or oral, except as provided in the preceding sentence. There are no representations, warranties, agreements, arrangements, or understandings, oral or written between the parties relating to the subject matter of this Agreement which are not fully expressed herein or in another Operative Document. The parties agree that the traditional formulation of the parol evidence rule (whereby extrinsic evidence may not be used to vary or contradict the unambiguous terms of a document that represents a final and complete expression of the parties' agreement) shall govern in any action or proceeding that may ensue concerning this Agreement.

13.5       No Third-Party Beneficiaries. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective legal representatives, successors and assigns. This Agreement is not for the benefit of any other person, and no other person shall have any rights against the parties hereunder.

13.6       Choice of Law. This Agreement is made and entered into under the laws of the State of Tennessee, and the laws of that State applicable to agreements made and to be performed entirely thereunder (without giving effect to the principles of conflicts of laws thereof) shall govern the validity and interpretation hereof and the performance by parties hereto of their respective duties and obligations hereunder.

13.7       Rules of Construction. The headings in this Agreement are inserted only as a matter of convenience and in no way affect the terms or intent of any provision of this Agreement. Unless otherwise indicated, all references to particular Articles or Sections shall

 

 

 

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mean and refer to the referenced Articles and Sections of this Agreement. Any singular term in this Agreement shall be deemed to include the plural, and any plural term the singular. Whenever the words "include," "includes" or "including" are used in this Agreement, they shall be deemed followed by the words "without limitation." In the event that the last day for performance of an act or the exercise of a right hereunder falls on a day other than a Business Day, then the last day for such performance or exercise shall be the first Business Day immediately following the otherwise last day for such performance or such exercise. Neither this Agreement nor any uncertainty or ambiguity herein shall be construed or resolved against any party, whether under any rule of construction or otherwise. No party to this Agreement shall be considered the draftsman. The parties acknowledge and agree that this Agreement has been reviewed, negotiated, and accepted by all parties and their attorneys and shall be construed and interpreted according to the ordinary meaning of the words used so as fairly to accomplish the purposes and intentions of all parties hereto.

13.8       Delivery; Counterparts. This Agreement shall not become effective until executed by each party and delivered to the other. This Agreement may be executed in one or more counterparts. Each such counterpart shall be considered an original and all of such counterparts shall constitute a single agreement binding all the parties as if all had signed a single document. The parties acknowledge that delivery of executed counterparts of this Agreement may be effected by a facsimile transmission or other comparable means, with an original document to be delivered promptly thereafter via overnight courier. The parties agree that time is of the essence under this Agreement.

13.9       Enforcement of Agreement. The parties hereto agree that irreparable damage would occur in the event that any of the provisions of this Agreement was not performed in accordance with its specific terms or was otherwise breached. It is accordingly agreed that the parties shall be entitled to seek an injunction or injunctions to prevent breaches of this Agreement and to enforce specifically the terms and provisions hereof in any court of the United States or any state having jurisdiction, provided that nothing contained herein shall be construed as prohibiting any party from pursuing any other rights and remedies available to it for such breach or threatened breach.

13.10     Severability. If any provision of this Agreement shall be contrary to the internal laws of the State of Tennessee or any other applicable law, at the present time or in the future, such provision shall be deemed null and void, but shall not affect the legality of the remaining provisions of this Agreement and such provision shall not be deemed null and void in any other jurisdiction. This Agreement shall be deemed to be modified and amended so as to be in compliance with applicable law and this Agreement shall then be construed in such a way as will best serve the intention of the parties at the time of the execution of this Agreement.

13.11     Notices. All notices, requests, consents, or other communications required or permitted to be given under this Agreement shall be in writing, may be delivered in person, by overnight air courier, by certified or registered mail (return receipt requested with all fees prepaid), and shall be deemed to have been duly given and to have become effective upon the date actually delivered to the parties or their assignees at the following addresses:

 

 

 

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If to Parent, Seller or GCS:

First Tennessee Bank National Association

165 Madison Avenue, Third Floor

Memphis, Tennessee 38103

Attention:              Milton A. Gutelius, Jr.

Senior Vice President Corporate

Development and Treasurer

 

with a copy to:
(which shall
not constitute notice)

First Tennessee Bank National Association

165 Madison Avenue, Third Floor

Memphis, Tennessee 38103

Attention:              Clyde A. Billings, Jr.

Senior Vice President and

Assistant General Counsel

 

with a copy to:
(which shall
not constitute notice)

Baker, Donelson, Bearman, Caldwell & Berkowitz

165 Madison Avenue, Suite 2000

Memphis, Tennessee 38103

Attention:               Desiree M. Franklin

 

If to Buyer:

NOVA Information Systems, Inc.
One Concourse Parkway, Suite 300
Atlanta, Georgia 30328
Attention:               Mindy M. Doster
                                  General Counsel

with a copy to:
(which shall
not constitute notice)

NOVA Information Systems, Inc.
One Concourse Parkway, Suite 300
Atlanta, Georgia 30328
Attention:               Edward M. O’Hare
                                  Senior Vice President

with a copy to:
(which shall
not constitute notice)

McKenna Long & Aldridge LLP
SunTrust Plaza, Suite 5300
303 Peachtree Street, N.E.
Atlanta, Georgia 30308
Attention:               Marc C. D’Annunzio

The persons or addresses to which mailings or deliveries shall be made may be changed from time to time by notice given pursuant to the provisions of this Section.

13.12     Waiver of Jury Trial. The parties hereto hereby waive their respective right to trial by jury of any cause of action, claim, counterclaim or cross-complaint in any action, proceeding or hearing brought by any party against another on any matter whatsoever relating to, resulting from, arising out of, or in any way connected with this Agreement, or any amendment or breach hereof, including any claim or injury or damage, or the enforcement of any remedy under any Law, emergency or otherwise, now or hereafter in effect.

 

 

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13.13     Expenses. Except as otherwise specifically provided in this Agreement, each party shall bear and pay all direct costs and expenses incurred by it or on its behalf in connection with the transactions contemplated hereunder, including filing, registration and other applicable fees, and fees and expenses of its own financial or other consultants, investment bankers, accountants, and counsel.

13.14     Brokers and Finders. Except for Goldman, Sachs & Co. in the case of Parent, GCS and Seller, each of the parties represents and warrants that neither it nor any of its officers, directors, employees, or Affiliates has employed any broker or finder or incurred any Liability for any financial advisory fees, brokerage fees, commissions, or finders' fees in connection with this Agreement or the transactions contemplated hereby. Buyer shall not have any obligation to pay any fees, expenses or other charges to Goldman, Sachs & Co. In the event of a claim by any broker or finder based upon his or its representing or being retained by or allegedly representing or being retained by any party, such party agrees to indemnify and hold each other party harmless from and against any Liability in respect of such claim.

13.15     Relationship of Parties. The relationship between Parent, GCS and Seller on the one hand and Buyer on the other hand established by this Agreement is solely that of vendor and vendee and nothing contained herein shall be deemed to create a joint venture between Parent, GCS or Seller and Buyer. No party, or its directors, officers, employees or Representatives shall be deemed the agent or servant of another party and no party shall have the right or authority to enter into any contract or commitment, in the name of or on behalf of the other party, or purport to bind the other party in any manner whatsoever.

(Remainder of page intentionally left blank.)

 

 

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IN WITNESS WHEREOF the undersigned hereto execute this Agreement as of the date first written above.

 


PARENT:

FIRST TENNESSEE BANK NATIONAL ASSOCIATION

By:                                                         
Name:                                                   
Title:                                                     

 

SELLER:

FIRST HORIZON MERCHANT SERVICES, INC.

By:                                                         
Name:                                                   
Title:                                                     

 

GCS:

GLOBAL CARD SERVICES, INC.

By:                                                         
Name:                                                   
Title:                                                     

 

BUYER:

NOVA INFORMATION SYSTEMS, INC.

By:                                                         
Name:                                                   
Title:                                                     

 

 

 

 

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INDEX OF EXHIBITS

TO MERCHANT ASSET PURCHASE AGREEMENT

 

EXHIBIT

DESCRIPTION

A

Form of Bill of Sale and Assignment and Assumption Agreement

B

Form of Interim Services Agreement

C

Form of Merchant Services Agreement

D

Form of Non-Competition Agreement

E

Opinion of Counsel to Parent, GCS and Seller

F

Opinion of Counsel to Buyer

G

Standard Merchant Agreements

H

Form of Employee Retention, Sale Participation and Non-Solicitation Agreement

I

Form of Residual Commission Buyout Agreement

 

 

SCHEDULE

DESCRIPTION

2.3

Merchant Security Arrangement Sharing

4.2

Schedule of Relationship Merchants Subject to the Holdback Amount

4.5

Items to be Prorated

11.4(f)

Schedule of Annual Net Revenue of Assigned Merchant


 

 

 

 

 

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