ITEM 1A. RISK FACTORS
This Item outlines specific risks that could affect the ability
of our various businesses to compete, change our risk profile, or materially impact our operating results or financial condition.
Our operating environment continues to evolve and new risks continue to emerge. To address that challenge we have a risk management
governance structure that oversees processes for monitoring evolving risks and oversees various initiatives designed to manage
and control our potential exposure.
The following discussion highlights risks which could impact
us in material ways by causing our future
results to differ materially from our past results, by causing future results to differ
materially from current expectations, or by causing material changes in our financial condition. In this Item we have outlined
risks that we believe are important to us at the present time. However, other risks may prove to be important in the future, and
new risks may emerge at any time. We cannot predict with certainty all potential developments which could materially affect our
financial performance or condition.
TABLE OF ITEM 1A TOPICS
Forward-Looking
Statements
This report on Form 10-K and our 2016 Annual Report, including
materials incorporated into either of them, may contain forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 with respect to our beliefs, plans, goals, expectations, and estimates. Forward-looking statements
are not a representation of historical information, but instead pertain 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 our control, and many of which, with respect to future business
decisions and actions (including acquisitions and divestitures), are subject to change. Examples of uncertainties and
contingencies include, among other important factors: global, general, and local economic and business conditions, including
economic recession or depression; the stability or volatility of values and activity in the residential housing and
commercial real estate markets; potential requirements for us to repurchase, or compensate for losses from, previously sold
or securitized mortgages or securities based on such mortgages; potential claims alleging mortgage servicing failures,
individually, on a class basis, or as master servicer of securitized loans; potential claims relating to participation in
government programs, especially lending or other financial services programs; expectations of and actual timing and amount of
interest rate movements, including the slope and shape of the yield curve, which can have a significant impact on a financial
services institution; market and monetary fluctuations, including fluctuations in mortgage markets; inflation or deflation;
customer, investor, competitor, regulatory, and legislative responses to any or all of 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 and cost-efficiency of our hedging
practices; technological changes; fraud,
theft, or other incursions through conventional,
electronic, or other means affecting us directly or affecting our customers, business counterparties, or competitors; demand
for our product offerings; new products and services in the industries in which we operate; the increasing use of new
technologies to interact with customers and others; and critical accounting estimates. Other factors are those inherent in
originating, selling, servicing, and holding loans and loan-based assets including prepayment risks, pricing concessions,
fluctuation in U.S. housing and other real estate 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 (Federal Reserve),
the Federal Deposit Insurance Corporation (FDIC), the Financial Industry Regulatory Authority (FINRA), the U.S. Department of
the Treasury (Treasury), the Municipal Securities Rulemaking Board (MSRB), the Consumer Financial Protection Bureau (CFPB),
the Financial Stability Oversight Council (Council), the Public Company Accounting Oversight Board (PCAOB), and other
regulators and agencies; pending, threatened, or possible future regulatory, administrative, and judicial outcomes, actions,
and proceedings; current or future Executive orders; changes in laws and regulations applicable to us; and our success in
executing our business plans and strategies and managing the risks involved in the foregoing, could cause actual results to
differ, perhaps materially, from those contemplated by the forward-looking statements.
We assume no obligation to update or revise any forward-looking
statements that are made in this report on Form 10-K, in our 2016 Annual Report, or in any other statement, release, report, or
filing from time to time. Actual results could differ and expectations could change, possibly materially, because of one or more
factors, including those factors listed above or presented below, in other Items of this report, or in material incorporated by
reference into this report. Readers of this report, including our 2016 Annual Report, should carefully consider the factors discussed
in this Item 1A below, among others, in evaluating forward-looking statements and assessing our prospects.
Competition
Risks
We are subject to intense competition for customers, and
the nature of that competition is
changing quickly
. Our primary areas of competition for customers include: consumer
and commercial
deposits and loans, financial planning and wealth management, personal or consumer loans including home mortgages
and lines of credit, fixed income products and services, and other consumer and business financial products and services. Our competitors
in these areas include national, state, and non-US banks, savings and loan associations, credit unions, consumer finance companies,
trust companies, investment counseling firms, money market and other mutual funds, insurance companies and agencies, securities
firms, mortgage banking companies, hedge funds, and other financial services companies (traditional and otherwise) that serve the
markets which we serve.
Some competitors are traditional banks, subject to the same
regulatory framework as we are, while others are not banks and in many cases experience a significantly different or reduced degree
of regulation. Long-standing examples of less-regulated activity include check-cashing and independent ATM services. A recent example
of unregulated activity is so-called “peer-to-peer” lending, where investors provide debt capital directly to borrowers.
Through technological innovations and changes in customer habits,
the manner in which customers use financial services is changing. We provide a large number of services remotely (desktop, online,
or mobile), and physical branch utilization has been in long-term decline throughout the industry for many years. Technology has
helped us reduce costs and improve service, but also has allowed disruptors to enter traditional banking areas. Some traditional
consumer banking services are largely provided through retailers, especially grocery stores and so-called super-stores which customers
visit frequently. Companies as disparate as PayPal (an online payment clearinghouse) and Starbucks (a large chain of cafes) provide
payment and exchange services which compete directly with banks in ways not possible until recent times.
Also, the nature of technology-driven competition is starting
to change. A number of recent technologies have worked with the existing financial system and traditional banks, such as the evolution
of ATM cards into debit/credit cards and the evolution of debit/credit cards into smart phones. These sorts of technologies often
have expanded the market for banking services overall while siphoning a portion of the revenues from those services away from banks
and disrupting prior methods of delivering those services. Companies which claim to offer applications and services based on artificial
intelligence are beginning to compete much more directly with traditional financial services companies in areas involving personal
advice, including high-margin services such as financial planning and wealth management. The low-cost, high-speed nature of these
“robo-advisor” services can be especially attractive to younger, less-affluent customers and potential customers.
We expect that competition will continue to grow more intense
with respect to most of our products and services. Heightened competition tends to put downward pressure on revenues from affected
items, upward pressure on marketing and other promotional costs, or both. For additional information regarding competition for
customers, refer to the “Competition” heading of Item 1 beginning on page 13
of this report.
We compete for talent
. Our most significant competitors
for customers also are our most significant competitors for top talent. See “Operational Risks” beginning on page 24
of this Item 1A for additional information concerning this risk.
We compete to raise capital in the equity
and debt markets
. See “Liquidity and Funding Risks” beginning on page 29
of this Item 1A for additional information concerning this risk.
Risk
from Economic Downturns and Changes
Generally in an economic downturn our credit losses increase,
demand for our products and services declines, and the credit quality of our loan portfolio declines.
Delinquencies and credit
losses generally increase during economic downturns due to an increase in liquidity problems for customers and downward pressure
on collateral values. Likewise, demand for loans (at a given level of creditworthiness), deposit and other products, and financial
services may decline during an economic downturn, and may be adversely affected by other national, regional, or local economic
factors that impact demand for loans and
other financial products and services. Such
factors include, for example, changes in employment rates, interest rates, real estate prices, or expectations concerning
rates or prices. Accordingly, an economic downturn or other adverse economic change (local, regional, national, or global)
can hurt our financial performance in the form of higher loan losses, lower loan production levels, lower deposit levels,
compression of our net interest margin, and lower fees from transactions and services. Those effects can continue for many
years after the downturn technically ends.
Risks
Associated with Monetary Events
The Federal Reserve has implemented significant economic
strategies that have impacted interest rates, inflation, asset values, and the shape of the yield curve, and currently is transitioning
from many years of easing to what may be an uneven, but extended, period of tightening.
In recent years, in response to the
recession in 2008 and the following uneven recovery, the Federal Reserve implemented a series of domestic monetary initiatives.
Several of these have emphasized so-called quantitative easing strategies, the most recent of which ended during 2014. Since then
the Federal Reserve raised rates once in late 2015 and once in late 2016, in each case by a modest 25 basis points. Further rate
changes reportedly are dependent on the Federal Reserve’s assessment of economic data as it becomes available. This data-dependent
process, now in its third year, may represent a fitful transition to a tightening trend, or it may represent merely an interim
period during which rates have little clear up or down long-term trend.
Federal Reserve strategies can, and often are intended to,
affect the domestic money supply, inflation, interest rates, and the shape of the yield curve.
Effects on the yield curve often
are most pronounced at the short end of the curve, which is of particular importance to us and other banks. Among other things,
easing strategies are intended to lower interest rates, flatten the yield curve, expand the money supply, and stimulate economic
activity, while tightening strategies are intended to increase interest rates, steepen the yield curve, tighten the money supply,
and restrain economic activity. Other things being equal, a transition from easing to tightening should tend to diminish or reverse
downward pressure on rates, and to diminish or end the stimulus effect that low rates tend to have on the economy. Many external
factors may interfere with the effects of these plans or cause them to be changed unexpectedly. Such factors include significant
economic trends or events as well as significant international monetary policies and events.
An example of the former is the substantial
drop in oil prices experienced during 2015 and the first half of 2016. An example of the latter is the July 2016 United Kingdom
referendum calling for the U.K. to leave the European Union. Such strategies also can affect the U.S. and world-wide financial
systems in ways that may be difficult to predict. Risks associated with interest rates and the yield curve are discussed in this
Item 1A under the caption “Interest Rate and Yield Curve Risks” beginning on page 30.
We may be adversely affected by economic and political situations
outside the U.S.
The U.S. economy, and the businesses of many of our customers, are linked significantly to economic and market
conditions outside the U.S., especially in North America, Europe, and Asia, and increasingly in Central and South America. Although
we have little direct exposure to non-US-dollar-denominated assets or non-US sovereign debt, in the future major adverse events
outside the U.S. could have a substantial indirect adverse impact upon us. Key potential events which could have such an impact
include (i) sovereign debt default (default by one or more governments in their borrowings), (ii) bank and/or corporate debt default,
(iii) market and other liquidity disruptions, and, if stresses become especially severe, (iv) the collapse of governments, alliances,
or currencies, and (v) military conflicts. The methods by which such events could adversely affect us are highly varied but broadly
include the following: an increase in our cost of borrowed funds or, in a worst case, the unavailability of borrowed funds through
conventional markets; impacts upon our hedging and other counterparties; impacts upon our customers; impacts upon the U.S. economy,
especially in the areas of employment rates, real estate values, interest rates, and inflation/deflation rates; and impacts upon
us from our regulatory environment, which can change substantially and unpredictably from possible political response to major
financial disruptions.
Strategic
Risks
We may be unable to successfully implement our strategy to
grow our consumer and commercial banking businesses and our fixed income business.
In 2007 and 2008 we modified our strategy
in response to substantial and rapid changes in business conditions. In 2008 we sold our national mortgage platforms and closed
our national lending operations. Since then we have closed a number of other units and sold loans and servicing assets, further
reducing our exposure to legacy operations. More importantly, we renewed our
emphasis on traditional banking and fixed income products
and services.
Although our current strategy is expected to evolve as business
conditions continue to change, at present our strategy is primarily to invest resources in our banking and fixed income businesses.
Growth is expected to be coordinated with a focus on stronger and more stable returns on capital. Our growth in the past three
years has been largely organic but was enhanced by tactical acquisitions. In recent years we have enhanced our
market share in
our traditional banking markets with targeted hires and marketing, expanded into other southeast U.S. markets with similar characteristics,
and expanded with commercial lending and private client banking in the Houston, Texas market. We have made similar moves in
our fixed income business. Our acquisitions in that period have included a bank, bank branches, and commercial loans, and at year-end
we have an agreement to acquire a fixed income firm specializing in government guaranteed loans. In the future, we may rely more
on acquisitions if appropriate opportunities, within or outside of our current markets, present themselves, but we expect to continue
to nurture profitable organic growth as well. We believe that the successful execution of our strategy depends upon a number
of key elements, including:
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our ability to attract and retain customers in
our banking market areas;
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our ability to achieve and maintain growth in our
earnings while pursuing new business opportunities;
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in our fixed income business, our ability to maintain
or strengthen our existing customer relationships while at the same time identifying
and successfully executing upon opportunities to provide new or existing products and
services to new or existing customers;
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our ability to maintain a high level of customer
service while reducing our physical branch count due to changing customer demand, all
while expanding our remote banking services and expanding or enhancing our information
processing, technology, compliance, and other operational infrastructures effectively
and efficiently;
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our ability to manage the liquidity and capital
requirements associated with growth, especially organic growth and cash-funded acquisitions;
and
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our ability to manage effectively and efficiently the changes and adaptations necessitated by a complex, burdensome, and evolving regulatory environment.
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We have in place strategies designed to achieve those elements
that are significant to us at present. Our challenge is to execute those strategies and adjust them, or adopt new strategies, as
conditions change.
To the extent we engage in bank or non-bank business acquisitions,
we face various additional risks, including:
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our ability to identify,
analyze, and correctly assess the execution, credit, contingency, and other risks in
the acquisition and to price the transaction appropriately;
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our ability to integrate
the acquired company into our operations quickly and cost-effectively;
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our ability to manage
any operational or cultural assimilation risks associated with growth through acquisitions;
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our ability to integrate
the franchise value of the acquired company with our own; and,
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our ability to retain
core customers and key employees of the acquired company.
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A type of strategic acquisition—a so-called “merger
of equals” where the company we nominally acquire has similar size, operating contribution, or value—presents unique
opportunities but also unique risks.
Those special risks include:
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the potential for
elevated and duplicative operating expenses if we are unable to integrate the two companies
efficiently in a reasonable amount of time;
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a significant increase
in the time horizon that may be needed before any substantial economies of scale are
realized; and,
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under current laws,
the prospect of substantially increased regulatory burdens and costs if the combined
company exceeds $50 billion in asset size.
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Risks
Related to Businesses We May Exit
We may be unable to successfully implement a disposition
of businesses or units which no longer fit our strategic plans.
We could have closures and divestitures as we continue to adapt
to a changing business and regulatory environment. Key risks associated with exiting a business include:
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our ability to price
a sale transaction appropriately and otherwise negotiate acceptable terms;
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our ability to identify
and implement key customer, technology systems, and other transition actions to avoid
or minimize negative effects on retained businesses;
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our ability to assess
and manage any loss of synergies that the exited business had with our retained businesses;
and
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our ability to manage
capital, liquidity, and other challenges that may arise if an exit results in
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significant
legacy cash expenditures or financial loss.
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Legacy
Mortgage Business Risks
We have risks from the mortgage-related businesses
we have exited, including mortgage loan repurchase and loss-reimbursement risk, claims of improper foreclosure practices, claims
of non-compliance with contractual and regulatory requirements, and the risk of higher default rates on loans made by our former
businesses.
In 2008 we exited our national mortgage and national specialty lending businesses. However, we still retain as
assets a significant amount of loans that those businesses created. Most of those loans are secured by residential or other real
estate situated across the U.S. We retain the risk of liability to customers and contractual parties with whom we dealt in the
course of operating those businesses. These legacy assets and obligations continue to impose risks on us. Key risks include:
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We experienced elevated
losses related to claims that we did not comply with contractual or other legal requirements
when we sold mortgage loans. Losses may continue, irregularly, for some time to come.
In 2012 and 2013 we recognized significant expense as a result of substantial settlements
with the two largest purchasers of our mortgages prior to 2009. Although our expenses
related to these matters have declined substantially, and in two of the last three years
we experienced reserve releases, new information could be received in the future resulting
in adverse adjustments related to exposures not covered by the settlements. Our total
repurchase and foreclosure provision expense was $299.3 million for 2012, $170.0 million
for 2013, negative $4.3 million for 2014, zero for 2015, and negative $32.7 million for
2016.
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We are defending litigation matters associated with claims arising
out of our former mortgage securitization activities. The outcome of those matters is
uncertain; losses in excess of current accruals (reserves) could be material.
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The trustee for those securitizations could demand repurchase
of loans placed into securitizations or make-whole damages if we breached contractual
requirements or obligations, or could demand that we indemnify the trustee if the trustee
is sued. We have received one such indemnity demand, for expenses.
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We have responded to investigations and inquiries by various
parties, including government agencies, related to mortgage loans we originated. Inquiries
have been wide ranging. A few have led to
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litigation. One investigation, involving the
FHA insurance program, led to a settlement of $212.5 million in 2015.
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We could be subject to claims that servicing-related actions were done or not done improperly.
Although we may be able to demand indemnity in cases where servicing was performed on our behalf by another institution, there
is risk that such an indemnity demand could be refused by the institution or rejected by an appropriate court.
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Other trends adverse to us may emerge from this legacy
business. Additional information concerning risks related to our former mortgage businesses and our management of them, all
of which is incorporated into this Item 1A by this reference, is set forth: under the captions “Repurchase Obligations,
Off-Balance Sheet Arrangements, and Other Contractual Obligations” beginning on page 57, “Repurchase and
Foreclosure Liability” beginning on page 61, and “Repurchase and Foreclosure Liability” beginning on page
65 of the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our 2016
Annual Report, which is part of the material from that report that has been incorporated by reference into Item 7 of this
report; and under the captions “Material Matters” and “Obligations from Legacy Mortgage Businesses”
beginning on pages 129 and 131, respectively, which is part of the material from our 2016 Annual Report that has
been incorporated by reference into Item 8 of this report.
Although we sold our mortgage servicing business and many
of our servicing assets in 2008, we have exposures related to the mortgage servicing obligations and assets which we
retained after 2008, especially in relation to the subservicing arrangements we made between 2008 and the sale of substantially
all our remaining servicing assets which we completed in 2014.
Government authorities have announced substantial mortgage-related
settlements with major U.S. and foreign banks. Regulations pertaining to servicing have been changed, imposing stricter duties
and standards upon servicers. State, federal, or private inquiries or investigations into our servicing and foreclosure activities
may be commenced. We cannot predict the ultimate outcome of these inquiries, actions, or regulatory changes or the
impact that
they could have on our financial condition, results of operations, or business.
When we sold our origination and servicing businesses in 2008
we retained significant servicing obligations and assets. At that time we engaged as our subservicer the purchaser of our business.
In 2011 that engagement expired and we engaged a new subservicer. Our 2008 subservicer experienced significant losses in connection
with its servicing business. Our 2008 subservicer has informed us that it expects us to reimburse it for a significant portion
of its losses and costs under our subservicing agreement. We disagree with our 2008 subservicer’s position and have made
no reimbursements. We also believe that certain amounts billed us by agencies for penalties and curtailments of claims by the subservicer
prior to the 2011 subservicing transfer but billed after that date are owed by the subservicer. This disagreement has the potential
to result in litigation and, in any such future litigation, the claim against us may be substantial.
Additional information concerning risks related
to servicing and foreclosure practices and our management of them, all of which is incorporated into this Item 1A by
this reference, is set forth: under the captions “Repurchase and Foreclosure Liability” beginning on page 61,
“Foreclosure Practices” beginning on page 64, and “Repurchase and Foreclosure Liability” beginning on
page 65 of the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our
2016 Annual Report, which is part of the material from that report that has been incorporated by reference into Item 7 of
this report; and under the captions “Servicing Obligations” and “Repurchase and
Foreclosure Liability” in Note 17 – Contingencies and Other Disclosures, beginning on pages 132 and 134,
respectively, of our 2016 Annual Report, which is part of the material from that report that has been incorporated by
reference into Item 8 of this report.
Several large purchasers of mortgage-backed securities have
filed suits against the trustees for those securitizations asserting new theories of liability.
The trustee of our securitizations
is defending or co-defending such matters, and many of our securitizations are among those alleged to have been purchased by the
plaintiffs. The claims for damages are based in part on allegations that the trustee did not properly or timely act against the
originators of the securitizations or the servicers of the loans, and further assert that the trustee has affirmative duties to
act
which were not set forth in the legal trust documents. Some of the legal theories advanced are untested or unsettled. Although
we are not a defendant in these proceedings, these complex suits may progress or evolve so as to compel us to defend ourselves
or our trustee, and could create financial exposure for us.
We have elevated loss exposures associated with past lending
under various government programs.
Like most banks we have participated for many years in government-sponsored lending programs.
At the federal level, during the period before we sold our national mortgage origination and servicing businesses, two prominent
programs for us were the FHA and VA mortgage lending programs. Those programs require lenders like us to comply with various requirements
in originating the loans. Non-compliance can lead to an agency demand that the lender reimburse resulting losses.
An agency also could demand enhanced damages, including treble
damages, under various federal laws. A number of federal laws, including the False Claims Act, provide for substantial recoveries
and penalties if false information is provided to a federal agency, and also provide that private citizens may sue in the name
of the agency and obtain a portion of any recovery as a bounty. Some of these laws provide legal avenues for a wide variety of
governmental agency claims, while others can have a narrower focus but include non-governmental claims. In some cases the laws
provide for bounties if the government agency obtains a recovery. It is possible that suits under the False Claims Act or another
law may be brought regarding our past, present, or future financial business activities, either by a federal agency, by another
party to those activities, or by an unrelated private person interested in pursuing the bounty. In 2012 we settled a private action
of that sort related to a portion of our past VA lending, and in 2015 we settled with government agencies regarding our FHA lending.
In 2015-16 we defended a private action of that sort successfully, obtaining a dismissal which was upheld on appeal.
Additional information concerning these government
program risks, all of which is incorporated into this Item 1A by this reference, is set forth under the caption
“Obligations from Legacy Mortgage Businesses” in Note 17 – Contingencies and Other Disclosures beginning on page 131
of our 2016 Annual Report, which is part of the material from that report that has been incorporated by reference into Item 8
of this report.
Reputation
Risks
Our ability to conduct and grow our businesses, and to obtain
and retain customers, is highly dependent upon external perceptions of our business practices
and financial stability.
Our
reputation is, therefore, a key asset for us. Our reputation is affected principally by our business practices and how those practices
are
perceived and understood by others. Adverse perceptions regarding the practices of our competitors, or our industry as a whole,
also may adversely impact our reputation. In addition, negative perceptions relating to parties with whom we have important relationships
may adversely impact our reputation. Senior management oversees processes for reputation risk monitoring, assessment, and management.
Damage to our reputation could hinder our ability to access
the capital markets or otherwise impact our
liquidity, could hamper our ability to attract new customers and retain existing ones,
could impact the market value of our stock, could create or aggravate regulatory difficulties, and could undermine our ability
to attract and retain talented employees, among other things. Adverse impacts on our reputation, or the reputation of our industry,
may also result in greater regulatory and/or legislative scrutiny, which may lead to laws or regulations that change or constrain
our business or operations. Events that result in damage to our reputation also may increase our litigation risk.
Credit
Risks
We face the risk that our customers may not repay their loans
and that the realizable value of collateral may be insufficient to avoid a charge-off.
We also face risks that other counterparties,
in a wide range of situations, may fail to honor their obligations to pay us. In our business some level of credit charge-offs
is unavoidable and overall levels of credit charge-offs can vary substantially over time. To take the most recent example, net
charge-offs were $131.8 million in 2007, and increased to $572.8 million and $832.3 million in 2008 and 2009, respectively. Beginning
in 2010, net charge-offs began to decline, reaching $48.4 million in 2014, $31.2 million in 2015, and $19.2 million in 2016. In
recent years, our loan loss reserves also have declined from high levels. The allowance for loan loss was $202.1 million as of
December 31, 2016, down substantially from $896.9 million and $849.2 million at year-end 2009 and 2008, respectively.
Our ability to manage credit risks depends primarily upon our
ability to assess the creditworthiness of loan customers and other counterparties and the value of any collateral, including real
estate, among other things. We further manage lending credit risk by diversifying our loan portfolio, by managing its granularity,
by following per-relationship lending limits, and by recording and managing an allowance for loan losses based on the factors mentioned
above and in accordance with applicable accounting rules. We further manage other counterparty credit risk in a variety of ways,
some of which are discussed in other parts of this Item 1A and all of which have as a primary goal the avoidance of having
too much risk concentrated with any single counterparty.
We record loan charge-offs in accordance with accounting and
regulatory guidelines and rules. As indicated in this Item 1A under the caption “Accounting & Tax Risks” beginning
on page 32, these guidelines and rules could change and cause provision expense or
charge-offs to increase, or to be recognized on an accelerated basis, for reasons not always related to the underlying performance
of our portfolio.
Moreover, the SEC or PCAOB could take accounting positions applicable to our holding company that may be inconsistent
with those taken by the Federal Reserve, OCC, or other banking regulators.
A significant challenge for us is to keep the credit and other
models and approaches we use to originate and manage loans updated to take into account changes in the competitive environment,
in real estate prices and other collateral values, in the economy, and in the regulatory environment, among other things, based
on our experience originating loans and servicing loan portfolios. Changes in modeling could have significant impacts upon our
reported financial results and condition. In addition, we use those models and approaches to manage our loan portfolios and lending
businesses. To the extent our models and approaches are not consistent with underlying real-world conditions, our management decisions
could be misguided or otherwise affected with substantial adverse consequences to us.
A significant subset of our home equity lines of credit were
originated prior to our national platform sale in 2008. A large number of those loans recently have been and (through 2018) will
be switching from interest-only payments to full amortization payments of principal and interest combined. In reserving for potential
loss in this portfolio we model an increased rate of default associated with the higher monthly payment requirements when that
switch occurs. Our modeling is based, among other things, on our experience with this portfolio, but risk remains that actual default
rates could exceed our modeling.
The low-interest rate environment has elevated the
traditional challenge for lenders and investors to balance taking on higher risk against the desire for higher income or
yield.
This challenge applies not only to credit risk in our lending activities but also to default and rate risks
regarding investments.
The composition of our loan portfolio inherently increases
our sensitivity to certain credit risks.
At December 31, 2016, approximately 62% of total loans consisted of the commercial,
financial, and industrial (C&I) category, while approximately 23% consisted of the consumer real estate category.
The largest component of the C&I category at year end was
loans to finance and insurance companies, a component which represented about 21% of the C&I category at that time. The second
largest component was loans to mortgage companies. As a result, approximately 38% of the C&I category was sensitive to impacts
on the financial services industry. As discussed elsewhere in this Item 1A with respect to our company, the financial services
industry is more sensitive to interest rate and yield curve changes, monetary policy, regulatory policy, changes in real estate
and other asset values, and changes in general economic conditions, than many other industries. Negative impacts on the industry
could dampen new lending in these lines of business and could create credit impacts for the loans in our portfolio.
The consumer real estate category contains a number of concentrations
which affect credit risk assessment of the category.
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Product concentration
. The consumer real estate category consists primarily of consumer installment loans, and much
of the remainder consists of home equity lines of credit.
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Collateral concentration
. This entire category is secured by residential real estate. Approximately 31% of the category
consists of loans secured on a second-lien basis.
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Geographic concentration
. At year end about 69% of the category related to Tennessee customers, 5% related to California,
and no other state represented more than 3% of the category.
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Legacy concentration
. A significant part of the consumer category still consists of loans originated before 2009 by
our legacy national mortgage lending business. Those are loans we originated and did not sell, along with loans we have repurchased
in the course of resolving claims with loan buyers. Our legacy loans have been shrinking in recent years, but remain substantial.
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The consumer real estate category is highly sensitive to economic
impacts on consumer customers and on residential real estate values. Job loss or downward job migration, as well as significant
life events such as divorce, death, or disability, can significantly impact credit evaluations of the portfolio. Also, in the current
environment regulatory changes, discussed above and elsewhere in this Item 1A, are more likely to affect the consumer category
and our accounting estimates of credit loss than other loan types.
Our exposure to the volatile oil & gas industry is modest
but growing.
Our Houston office, opened in 2014, specializes in commercial lending and private banking. Commercial lending
in that office significantly focuses on three categories: energy, commercial real estate (CRE), and commercial, financial, &
industrial (C&I). Much of our Houston business is connected, at least in part, to the energy industry, especially oil and gas
production and distribution. In addition to general credit and other risks mentioned elsewhere in this Item 1A, the energy business
and related assets are sensitive to a number of factors specific to that industry. Key among those is global demand for energy
and other products from oil and gas in relation to supply. The shifting balance between demand and supply is expressed most simply
in prices. Starting in late 2014 and continuing into 2016, oil prices fell substantially, putting financial pressure on businesses
in that industry, especially highly leveraged businesses. Starting in 2016 and continuing into early 2017, oil prices improved,
though still well below pre-2014 levels. Although the financial impact from recent volatility on our overall loan business was
relatively modest, we did experience elevated charge-offs. The impact was moderate in part because we did not have a substantial
portfolio in the industry before prices started to fall. Going forward, volatility in oil prices could impact our financial performance
and growth of our Houston-based lending business.
Additional information concerning credit risks and our management
of them is set forth under the captions “Asset Quality—Trend Analysis of 2016 Compared to 2015” beginning on
page 26, “Credit Risk Management” beginning on page 52,
and “Allowance for Loan Losses” beginning on page 65 of the Management’s
Discussion and Analysis of Financial Condition and Results of Operations section of our 2016 Annual Report, which is part of the
material from that report that has been incorporated by reference into Item 7 of this report.
Operational
Risks
Our ability to conduct and grow our businesses is dependent
in part upon our ability to create,
maintain, expand, and evolve an appropriate operational and organizational infrastructure,
manage expenses, and recruit and retain personnel with the ability to manage a complex business.
Operational risk can arise
in many ways, including: errors related to failed or inadequate physical, operational, information technology, or other processes;
faulty or disabled computer or other technology systems; fraud, theft, physical security breaches, electronic data and related
security breaches, or other criminal conduct by employees or third parties; and exposure to other external events. Inadequacies
may present themselves in myriad ways. Actions taken to manage one risk may be ineffective against others. For example, information
technology systems may be insufficiently redundant to withstand a fire, incursion, or other major casualty, and they may be insufficiently
adaptable to new business conditions or opportunities. Efforts to make such systems more robust may also make them less adaptable.
Also, our efforts to control expenses, which is a significant priority for us, increases our operational challenges as we strive
to maintain customer service and compliance at high quality and low cost.
A serious information technology security (cybersecurity)
breach can cause significant damage and at the same time be difficult to detect even after it occurs.
Among other things, that
damage can occur due to outright theft of funds, fraud or identity theft perpetrated on customers, or adverse publicity associated
with a breach and its potential effects. Perpetrators potentially can be employees, customers, and certain vendors, all of whom
legitimately have access to some portion of our systems, as well as outsiders with no legitimate access. Because of the potentially
very serious consequences associated with these risks, our electronic systems and their upgrades need to address internal and external
security concerns to a high degree, and our systems have to comply with applicable banking and other regulations pertaining to
bank safety and customer protection. Although many of our defenses are systemic and highly technical, others are much older and
more basic. For example, periodically we train all our employees to recognize red flags associated with fraud, theft, and other
electronic crimes, and we educate our customers as well through regular and episodic security-oriented communications. We expect
our systems and regulatory requirements to continue to evolve as technology and criminal techniques also continue to evolve.
The operational functions we outsource to third parties may
experience similar disruptions that could adversely impact us and over which we may have limited control and, in some cases, limited
ability to obtain quickly an alternate vendor.
To the extent we rely on third party vendors to perform or assist operational
functions, the challenge of managing the associated risks becomes more difficult.
The operational functions of business counterparties may
experience disruptions that could adversely impact us and over which we may have limited or no control.
For example, in recent
years several major U.S. retailers and a major electronic mail provider experienced data systems incursions reportedly resulting
in the thefts of credit and debit card information, online account information, and other data of millions of customers. Retailer
incursions affect cards issued and deposit accounts maintained by many banks, including our Bank. Although our systems are not
breached in retailer incursions, these events can increase account fraud and can cause us to reissue a significant number of account
cards and take other costly steps to avoid significant theft loss to our Bank and our customers. Our ability to recoup our losses
may be limited legally or practically in many situations. Other possible points of incursion or disruption not within our control
include internet service providers, social media portals, distant-server (“cloud”) service providers, electronic data
security providers, telecommunications companies, and smart phone manufacturers.
Failure to build and maintain the necessary operational infrastructure,
failure of that infrastructure to perform its functions, or failure of our disaster preparedness plans if primary infrastructure
components suffer damage, can lead to risk of loss of service to customers, legal actions, and noncompliance with applicable regulatory
standards.
Additional information concerning operational risks and our management of them, all of which is incorporated into
this Item 1A by this reference, appears under the caption “Operational Risk Management” beginning on page 52
of the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our 2016 Annual Report,
which is part of the material from that report that has been incorporated by reference into Item 7 of this report.
The delivery of financial services to customers and others
increasingly depends upon technologies, systems, and multi-party infrastructures which are new, creating or enhancing several risks
discussed elsewhere.
Examples of the risks created or enhanced by the widespread and rapid adoption of relatively untested
technologies include: security incursions; operational malfunctions or other disruptions; and legal claims of patent or other intellectual
property infringement.
Competition for talent is substantial and increasing. Moreover,
revenue growth in some business lines increasingly depends upon top talent
. In 2015 and
2016 the cost to us of hiring and retaining
top revenue-producing talent increased, and that trend is likely to continue. The primary tools we use to attract and retain talent
are: salaries; commission, incentive, and retention compensation programs; retirement benefits; change in control severance benefits;
health and other welfare benefits; and our corporate culture. To the extent we are unable to use these tools effectively, we face
the risk that, over time, our best talent will leave us and we will be unable to replace those persons effectively.
Incentives might operate poorly or have unintended adverse
effects
. Incentive programs are difficult to
design well, and even if well-designed often they must be updated to address changes
in our business. A poorly designed incentive program—where goals are too difficult, too easy, or not well related to desired
outcomes—could provide little useful motivation to key employees, could increase turnover, and could impact customer retention.
Moreover, even where those pitfalls are avoided, incentive programs may create unintended adverse consequences. For example, a
program focused entirely on revenue production, without proper controls, may result in costs growing faster than revenues.
Service
Risks
We provide a wide range of services
to customers, and the provision of these services may create claims against us that we provided
them in a manner that harmed the customer or a third party, or was not compliant with applicable laws or rules.
Our
services include lending, loan servicing, fiduciary, custodial, depositary, funds management, insurance, and advisory services,
among others. We manage these risks primarily through training programs, compliance programs, and supervision processes. Additional
information concerning these risks and our management of them, all of which is incorporated into this Item 1A by this reference,
appears under the captions “Operational Risk Management” and “Compliance Risk Management,” both beginning
on page 52 of the Management’s Discussion and Analysis of Financial Condition
and Results of Operations section of our 2016 Annual Report, which is part of the material from that report that has been incorporated
by reference into Item 7 of this report.
Regulatory,
Legislative, and Legal Risks
The regulatory environment is challenging, and the regulatory
impacts on us have become more restrictive and more costly.
We operate in a heavily regulated industry. The regulatory environment
has changed significantly in the past ten years, and our regulatory burdens generally have increased, as a result of macro events
affecting traditional banking, mortgage banking, and financial markets generally.
We are subject to many banking, deposit, insurance, securities
brokerage and underwriting, and consumer lending regulations in addition to the rules applicable to all companies publicly traded
in the U.S. securities markets and, in particular, on the New York Stock Exchange. Failure to comply with applicable regulations
could result in financial, structural, and operational penalties. In addition, efforts to comply with applicable regulations may
increase our costs and/or limit our ability to pursue certain business opportunities. See “Supervision and Regulation”
in Item 1 of this report, beginning on page 5, for additional information concerning
financial industry regulations. Federal and state regulations significantly limit the types of activities in which we, as a financial
institution, may engage. In addition, we are subject to a wide array of other regulations that govern other aspects of how we conduct
our business, such as in the
areas of employment and intellectual property. Federal and state legislative and regulatory authorities
increasingly consider changing these regulations or adopting new ones. Such actions could further limit the amount of interest
or fees we can charge, could further restrict our ability to collect loans or realize on collateral, could affect the terms or
profitability of the products and services we offer, or could materially affect us in other ways. Additional federal and state
consumer protection regulations also could expand the privacy protections afforded to customers of financial institutions, restricting
our ability to share or receive customer information and increasing our costs.
The following paragraphs highlight certain specific important
risk areas related to regulatory matters currently. These paragraphs do not describe these risks exhaustively, and they do not
describe all such risks that we face currently. Moreover, the importance of specific risks will grow or diminish as circumstances
change.
We and our Bank both are required to maintain certain regulatory
capital levels and ratios.
In 2013 regulators adopted enhancements to U.S. capital standards based on international standards
known as “Basel III.” The revised standards emphasize Common
Equity Tier 1 Capital, restrict eligibility criteria for
regulatory capital instruments, and make more stringent the methodology for calculating risk-weighted assets. The revised standards
began to apply to us in 2015, and are discussed in Item 1 of this report, in tabular and narrative form, under the caption “Capital
Adequacy” starting on page 8.
Pressures to maintain appropriate capital levels and address
business needs in the current economy may lead to actions that could be dilutive or otherwise adverse to our shareholders. Such
actions could include: reduction or elimination of dividends; the issuance of common or preferred stock, or securities convertible
into stock; or the issuance of any class of stock having rights that are adverse to those of the holders of our existing classes
of common or preferred stock.
Additional information concerning these risks and our management
of them, all of which is incorporated into this Item 1A by this reference, appears: under the captions “Capital Adequacy”
and “Prompt Corrective Action (PCA)” in Item 1 of this report beginning on pages
8 and 9, respectively; under the captions “Capital—2016 Compared to 2015,” “Capital Management and
Adequacy,” and “Market Uncertainties and Prospective Trends” beginning on pages
23, 51, and 63, respectively, of the Management’s Discussion and Analysis of Financial Condition and Results of Operations
section of our 2016 Annual Report, which is part of the material from that report that has been incorporated by reference into
Item 7 of this report; and under the caption “Regulatory Capital” in Note 12—Regulatory
Capital and Restrictions, beginning on page 121 of our 2016 Annual Report, which
is part of the material from that report that has been incorporated by reference into Item 8 of this report.
We are required to conduct and submit annual stress tests,
the outcomes of which could further increase our capital requirements and could damage our reputation and our ability to obtain
credit.
Stress testing processes require banks to estimate the impact on capital, liquidity, and other measures of safety of
certain assumed environmental shocks. A failure to satisfy regulatory stress testing, or another significant risk management standard,
could result in the imposition of operating restrictions on us and require us to raise capital, which could adversely affect operating
results or be dilutive to our shareholders. In addition, a summary of a portion of the stress results must be made public. A poor
result could impact our reputation generally and our ability to borrow funds.
New regulatory initiatives under Dodd-Frank and otherwise
may have unintended adverse impacts
upon us or the industry.
For example, stress testing includes “rate shocks”
which model the financial impact of sudden large increases in market interest rates upon us. In practical effect this encourages
banks to shorten the “duration” of their assets (loans and investments), discouraging long-term assets. Shortening
duration should improve a bank’s ability to withstand a very large rate shock. However, it also can reduce the effective
yield a bank receives from its assets, which would put downward pressure on revenues, margins, and earnings.
Legal disputes are an unavoidable part of business; the outcome
of litigation cannot be predicted with any certainty.
We face the risk of litigation from customers, employees, vendors, contractual
parties, and other persons, either singly or in class actions, and from federal or state regulators. We manage those risks through
internal controls, personnel training, insurance, litigation management, our compliance and ethics processes, and other means.
However, the commencement, outcome, and magnitude of litigation cannot be predicted or controlled with any certainty.
Typically we are unable to estimate our loss exposure from
claims against us until relatively late in the litigation process, which can make our financial recognition of loss from litigation
unpredictable and highly uneven from one period to the next.
Currently we are defending a number of legal matters. For most
of them we have established either no accrual (reserve) or no significant reserve. Financial accounting guidance requires that
litigation loss be both estimable and probable before a reserve may be established (recorded as a liability on our balance sheet).
For most litigation matters, under that guidance reserves typically are not established until after preliminary motions to dismiss
or narrow the case are resolved, after discovery is substantially in process, and (in many cases) after preliminary overtures regarding
settlement have occurred. Potentially significant cases often are pending for years before any loss is recognized and a reserve
is established. Moreover, it is not uncommon for a case to experience relatively little progress toward resolution for a long period
followed by a brief period of rapid development. Lastly, although most cases are resolved with little or no loss to us, for the
others loss typically is recognized either all at once (near the time of resolution) or very unevenly over the life of the case.
Additional information concerning litigation risks and our management
of them, all of which is incorporated into this Item 1A by this reference, appears: under the caption “Legacy Mortgage Business
Risks” beginning on page 21 of this report; under the captions “Repurchase
Obligations, Off-Balance Sheet Arrangements, and Other Contractual Obligations,” “Repurchase and Foreclosure Liability,”
“Market
Uncertainties and Prospective Trends,” and “Contingent Liabilities” beginning on pages
57, 61, 63, and 68, respectively, of the Management’s Discussion and Analysis of Financial Condition and Results of
Operations section of our 2016 Annual Report, which is part of the material from that report that has been
incorporated by reference
into Item 7 of this report; and under the caption “Contingencies” in Note 17—Contingencies
and Other Disclosures, beginning on page 128 of our 2016 Annual Report, which is
part of the material from that report that has been incorporated by reference into Item 8 of this report.
Risks
of Expense Control
Our ability to successfully manage expenses is important
to our long-term survival and prosperity but in part is subject to risks beyond our control.
Many factors can influence the
amount of our expenses, as well as how quickly they grow. As our businesses change, either by expansion or contraction, additional
expenses can arise from asset purchases, structural reorganization, evolving business strategies, and changing regulations, among
other things. The importance of managing expenses has been amplified in the current slow growth, low net interest margin business
environment. Overall, our noninterest expenses have
been improving: in 2012, 2013, 2014, 2015, and 2016 noninterest expense was $1,369.5 million, $1,148.5 million, $832.5 million,
$1,053.8 million, and $925.2 million, respectively. Volatility in noninterest expense
has been significantly affected by increasingly idiosyncratic charges related to legacy mortgage activities as discussed in this
Item 1A under the caption “Legacy Mortgage Business Risks” beginning on page
21.
We manage controllable expenses and risk through a variety of
means, including selectively outsourcing or multi-sourcing various functions and procurement coordination and processes. In recent
years we have actively sought to make strategic businesses more efficient primarily by investing in technology, re-
thinking and
right-sizing our physical facilities, and re-thinking and right-sizing our workforce and incentive programs. These efforts usually
entail additional near-term expenses in the form of technology purchases and implementation, facility closure or renovation costs,
and severance costs, while expected benefits typically are realized with some uncertainty in the future.
We have also re-focused our attention on the economic profit
generated by our business activities and prospects rather than merely revenues or ordinary profit. Economic profit analysis attempts
to relate ordinary profit to the capital employed to create that profit with the goal of achieving higher (more efficient) returns
on capital employed overall. Activities with higher capital usage bear a greater burden in economic profit analysis. The process
is intended to allow us to more efficiently manage investment of our resources. Economic profit analysis involves significant judgment
regarding capital allocation. Mistakes in those judgments could result in a misallocation of resources and diminished profitability
over the long run.
Despite our efforts, our costs could rise due to adverse structural
changes or market shifts. For example, the overall cost of our health insurance benefit is highly dependent upon regulatory factors
and market forces beyond our control.
Geographic
Risks
We are subject to risks of operating in various jurisdictions.
To a significant degree our banking business is exposed to economic, regulatory, natural disaster, and other risks that primarily
impact Tennessee and neighboring states where we do our traditional banking business. If the southeastern U.S., and Tennessee in
particular, were to experience adversity not shared by other parts of the country, we are likely to experience adversity to a degree
not shared by those competitors which have a broader or different regional footprint.
We have international assets in the form of loans and letters
of credit. Holding non-U.S assets creates a number of risks: the risk that taxes, fees, prohibitions,
and other barriers
and constraints may be created or increased by the U.S. or other countries that would impact our holdings; the risk that currency
exchange rates could move unfavorably so as to diminish the U.S. dollar value of assets, or to enlarge the U.S. dollar value of
liabilities; and the risk that legal recourse against foreign counterparties may be limited in unexpected ways. Our ability to
manage those and other risks depends upon a number of factors, including: our ability to recognize and anticipate differences in
legal, cultural, and other expectations applicable to customers, regulators, vendors, and other business partners and counterparties;
and our ability to recognize and manage any exchange rate risks to which we are exposed.
Insurance
Our property and casualty insurance may not cover or may
be inadequate to cover the risks that we face, and we are or may be adversely affected by a default by the insurers that provide
us mortgage and bank-owned life insurance.
We use insurance to manage a number of risks, including damage or destruction of
property as well as legal and other liability. Not all such risks are insured, in any given insured situation our insurance may
be inadequate to cover all loss, and many risks we face are uninsurable. For those risks that are insured, we also face the risks
that the insurer may default on its obligations or that the insurer may refuse to honor them. We treat the former risk as a type
of credit risk, which we manage by reviewing the insurers that we use and by striving to use more than one insurer when practical. The
risk of refusal, whether due to honest disagreement or bad faith, is inherent in any contractual situation.
A portion of our consumer loan portfolio involves mortgage default
insurance. If a default insurer were to experience a significant credit downgrade or were to become insolvent, that could adversely
affect the carrying value of loans insured by that company, which could result in an immediate increase in our loan loss provision
or write-down of the carrying value of those loans on our balance sheet and, in either case, a corresponding impact on our financial
results. If many default insurers were to experience downgrades or
insolvency at the same time, the risk of a financial impact
would be amplified.
We own certain bank-owned life insurance policies as assets
on our books. Some of those policies are “general account” and others are “separate account.” The general
account policies are subject to the risk that the carrier might experience a significant downgrade or become insolvent. The separate
account policies are less susceptible to carrier risk, but do carry a higher risk of value fluctuations in securities which underlie
those policies. Both risks are managed through periodic reviews of the carriers and the underlying security values. However, particularly
for the general account policies, our ability to liquidate a policy in anticipation of an adverse carrier event is significantly
limited by applicable insurance contracts and regulations as well as by a substantial tax penalty which could be levied upon early
policy termination.
When we self-insure certain exposures, our estimates of future
expenditures may be inadequate for actual expenditures that occur.
For example, we self-insure our employee health-insurance
benefit program. We estimate future expenditures and establish accruals (reserves) based on the estimates. If actual expenditures
were to exceed our estimates in a future period, our future expenses could be adversely and unexpectedly increased.
Liquidity
and Funding Risks
Liquidity is essential to our business model and a lack of
liquidity or an increase in the cost of liquidity may materially and adversely affect our businesses, results of operations, financial
conditions and cash flows.
In general, the costs of our funding directly impact our costs of doing business and, therefore,
can positively or negatively affect our financial results. Our funding requirements in 2015 and 2016 were met principally by deposits,
by financing from other financial institutions, and by funds obtained from the capital markets.
Deposits traditionally have provided our most affordable funds
and by far the largest portion of funding. However, deposit trends can shift with economic conditions. If the economy improves
or market rates rise, deposit levels in our Bank might fall, perhaps fairly quickly, as depositors become more comfortable with
risk and seek higher returns in other vehicles. This could pressure us to raise our deposit rates, which could shrink our net interest
margin if loan rates do not rise correspondingly.
The market among banks for deposits may be impacted as a result
of the relatively new Basel III capital rules. Those rules generally provide favorable treatment for core deposits. Moreover, institutions
with more than $50 billion of assets are required to maintain a minimum Liquidity Coverage ratio. Larger banks covered by this
rule may be incented to compete for core deposits vigorously. Although mid-sized banks, like ours, are not directly impacted by
this rule, if some large banks in our markets take aggressive actions we could lose deposit share or be compelled to adjust our
deposit pricing and practices in ways that could increase our costs.
We also depend upon financing from private institutional or
other investors by means of the capital markets. In 2014 we issued $400 million of senior bank notes due 2019, and in 2015 we issued
$500 million of senior notes due 2020. The 2015 notes refinanced an earlier five-year notes issue. Presently we believe we could
access the capital markets again if we desired to do so. Risk remains, however, that capital markets may become unavailable to
us for reasons beyond our control.
A number of more general factors could make funding more difficult,
more expensive, or unavailable on affordable terms, including, but not limited to, our financial results, organizational or political
changes, adverse impacts on our reputation, changes in the activities of our business partners, disruptions in the capital markets,
specific events that adversely impact the financial services industry, counterparty availability, changes affecting our loan portfolio
or other assets, changes affecting our corporate and regulatory structure, interest rate fluctuations, ratings agency actions,
general economic conditions, and the legal, regulatory, accounting, and tax environments governing our funding
transactions. In
addition, our ability to raise funds is strongly affected by the general state of the U.S. and world economies and financial markets
as well as the policies and capabilities of the U.S. government and its agencies, and may remain or become increasingly difficult
due to economic and other factors beyond our control.
Events affecting interest rates, markets, and other factors
may adversely affect the demand for our products and services in our fixed income business.
As a result, disruptions in those
areas may adversely impact our earnings in that business unit.
Credit
Ratings
Our credit ratings directly affect the availability and
cost of our unsecured funding.
The Corporation and the Bank currently receive ratings from several rating agencies for unsecured
borrowings. A rating below investment grade typically reduces availability and increases the cost of market-based funding. A debt
rating of Baa3 or higher by Moody’s Investors Service, or BBB- or higher by Standard & Poor’s and Fitch Ratings,
is considered investment grade for many purposes. At December 31, 2016, all three rating agencies rated the unsecured senior debt of FHN and of the Bank as investment
grade, although we were at or near the lowest levels of investment grade. The ratings outlook from one of the ratings agencies
was positive, and from the other two was stable, for both FHN and the Bank. To the extent that in the future we depend on institutional borrowing and the capital markets for funding and capital,
we could experience reduced liquidity and increased cost of unsecured funding if our debt ratings were lowered further, particularly
if lowered below investment grade. In addition, other actions by ratings agencies can create uncertainty about our ratings in
the future and thus can adversely affect the cost and availability of funding, including placing us on negative outlook or on
watchlist. Please note that a credit rating is not
a recommendation to buy, sell, or hold securities, is subject to revision or withdrawal at any time, and should be evaluated independently
of any other rating.
Reductions in our credit ratings could result in counterparties
reducing or terminating their relationships with us.
Some parties with whom we do business may have internal policies restricting
the business that can be done with financial institutions, such as the Bank, that have credit ratings lower than a certain threshold.
Reductions in our credit ratings could allow counterparties
to terminate and immediately force us to settle certain derivatives agreements, and could force us to provide additional collateral
with respect to certain derivatives agreements.
At this time, those of our ISDA master agreements which have ratings triggers
reference the lower of S&P’s or Moody’s ratings. Based on those ratings, for some time we have been required
to post collateral in the amount of our derivative liability positions with most derivative counterparties. Should a credit
rating downgrade occur, the maximum additional collateral we would have been required to post is approximately $1 million
as of December 31, 2016.
Interest
Rate and Yield Curve Risks
We are subject to interest rate risk because a significant
portion of our business involves borrowing and lending money, and investing in financial instruments.
A significant portion
of our funding comes from short-term and demand deposits, while a significant portion of our lending and investing is in medium-term
and long-term instruments. Changes in interest rates directly impact our revenues and
expenses, and could expand or compress our
net interest margin. We actively manage our balance sheet to control the risks of a reduction in net interest margin brought about
by ordinary fluctuations in rates.
A flat or inverted yield curve may reduce our net interest
margin and adversely affect our lending and fixed income businesses.
The yield curve simply shows the interest rates applicable
to short and long
term debt. The curve is steep when short-term rates are much lower than long-term rates; it is flat when short-term
rates are nearly equal to long-term rates; and it is inverted when short-term rates exceed long-term rates. Historically, the yield
curve usually is positively sloped. However, the yield curve can be relatively flat or inverted. A flat or inverted yield
curve tends to decrease net interest margin, which would adversely impact our lending businesses, and it tends to reduce demand
for long-term debt securities, which would adversely impact the revenues of our fixed income business. A goal and effect of certain
actions by the Federal Reserve over the past few years has been to flatten the yield curve, and our net interest margin has declined
over this period.
We may be in a transitional period, from a low-rate environment
to one with more normal, or at least somewhat higher, rates and a somewhat steeper yield curve. If that is correct, the new environment
should be positive for us, overall, in the long term. However, some effects may be negative and the timing of various effects will
be uneven.
Examples include: (i) rising rates may create transitory but significant outflows of deposits, which in turn could
necessitate additional (and more costly) borrowing or raising deposit rates more quickly than anticipated; (ii) rising rates are
likely to dampen consumer demand for mortgages, which could quickly reduce demand for our mortgage warehouse lending products;
and (iii) mortgage demand may change unevenly, with a brief
uptick (to lock in still-low rates) followed by a more pronounced down-trend.
Although our overall balance sheet remains asset-sensitive,
in recent quarters we have partially moderated that sensitivity, which would somewhat diminish the benefits we otherwise would
realize from a general rise in interest rates.
Our management of our assets and liabilities results in our being “asset-sensitive.”
As such, a general rise in rates should benefit us if, as we expect, the deposit and other rates we pay tend to rise more slowly
than the rates we charge or receive on our assets. We believe an asset sensitive balance sheet is still appropriate.
However, as short-term rates begin to rise from near zero, this risk of a future lowering of interest rates becomes more significant.
In light of that risk, in recent quarters we have taken steps to moderate our asset sensitivity. These steps would somewhat
diminish the benefits we otherwise would realize from a general rise in interest rates while reducing the risks from a general
fall in interest rates.
Expectations by the market regarding the direction of future
interest rate movements can impact the demand for fixed income investments which in turn can impact the revenues of our fixed income
business.
That risk is most apparent during times when strong expectations have not yet been reflected in market rates, or
when expectations are especially weak or uncertain.
Securities
Inventories and Market Risks
The trading securities inventories we hold in our fixed income
business are subject to market and credit risks.
In the course of that business we hold trading securities inventory positions
for purposes of distributions to customers, and we are exposed to certain market risks attributable principally to credit risk
and interest rate risk associated with fixed-income securities. We manage the risks of holding inventories of securities through
certain market risk management policies and procedures, including, for example, hedging activities and Value-at-Risk (“VaR”)
limits, trading policies, modeling, and stress analyses. Average fixed income trading securities (long positions) were $1.2 billion
for 2016, $1.3 billion for 2015, and $1.1 billion for 2014. Average fixed income trading liabilities (short positions) were $.8
billion, $.7 billion, and $.6 billion for 2016, 2015, and 2014, respectively. Additional information concerning these risks and
our management of them, all of which is incorporated into this Item 1A by this reference, appears under the caption “Market
Risk Management” beginning on page 48 of the Management’s Discussion
and Analysis of Financial Condition and Results of
Operations section of our 2016 Annual Report, which is part of the material
from that Report that has been incorporated by reference into Item 7 of this report.
Declines, disruptions, or precipitous changes in markets
or market prices can adversely affect our fees and other income sources.
We earn fees and other income related to our brokerage
business and our management of assets for customers. Declines, disruptions, or precipitous changes in markets or market prices
can adversely affect those revenue sources.
Significant changes to the securities market’s performance
can have a material impact upon our assets, liabilities, and financial results.
We have a number of assets and obligations
that are linked, directly or indirectly, to major securities markets. Significant changes in market performance can have a material
impact upon our assets, liabilities, and financial results.
An example of that linkage is our obligation to fund our pension
plan so that it may satisfy benefit claims in
the future. Our pension funding obligations generally depend upon actuarial estimates
of benefits claims, the discount rate used to estimate the present values of those claims, and estimates of plan asset values.
Our obligations to fund the plan can be affected by changes in any of those three factors. Accordingly, our obligations diminish
if the plan’s investments perform better than expectations or if estimates are changed anticipating better performance, and
can grow if those investments perform poorly or if expectations worsen. A rise in interest rates is likely to negatively impact
the values of fixed income assets held in the plan, but could also result in an increase in the discount rate used to measure the
present value of future benefit payments. Similarly, our obligations can be impacted by changes in mortality tables or other actuarial
inputs. We manage the risk of rate changes by investing plan assets in fixed income securities having maturities aligned with the
expected timing of payouts. Because there are no new participants, the actuarial-input risk should diminish over time, although
very slowly.
Changes in our funding obligation generally translate into positive
or negative changes in our pension expense over time, which in turn affects our financial performance. Our obligations and expenses
relative to the plan can be affected by many other things,
including changes in our participating employee population and changes
to the plan itself. Although we have taken actions intended to moderate future volatility in this area, risk of some level
of volatility is unavoidable.
Our hedging activities may be ineffective, may not adequately
hedge our risks, and are subject to credit risk.
In the normal course of our businesses we attempt to create partial or full
economic hedges of various, though not all, financial risks. For example: our fixed income unit manages interest rate risk on a
portion of its trading portfolio with short positions, futures, and options contracts; and, we use derivatives, including swaps,
swaptions, caps, forward contracts, options, and collars, that are designed to moderate the impact on earnings as interest rates
change. Generally, in the latter example these hedged items include certain term borrowings and certain held-to-maturity loans.
Hedging creates certain risks for us, including the risk that
the other party to the hedge transaction will fail to perform (counterparty risk, which is a type of credit risk), and the risk
that the hedge will not fully protect us from loss as intended (hedge failure risk). Unexpected counterparty failure or hedge failure
could have a significant adverse effect on our liquidity and earnings.
Accounting & Tax Risks
The preparation of our consolidated financial statements
in conformity with U.S. generally accepted accounting principles requires management to make significant estimates that affect
the financial statements.
The estimate that is consistently one of our most critical is the level of the allowance for credit
losses.
However, other estimates can be highly significant at discrete times or during periods of varying length. Currently
those include: the level of reserves for loan repurchase, make-whole, and foreclosure losses; the valuation of our deferred tax
assets; and the valuation of our goodwill. Estimates are made at specific points in time; as actual events unfold, estimates are
adjusted accordingly. Due to the inherent nature of these estimates, it is possible that, at some time in the future, we may significantly
increase the allowance for credit losses and/or sustain credit losses that are significantly higher than the provided allowance,
or we may recognize a significant provision for impairment of our goodwill or other assets, or we may make some other adjustment
that will differ materially from the estimates that we make today. Moreover, in some cases, especially concerning litigation and
other contingency matters where critical information is inadequate, we are entirely unable to make estimates until fairly late
in a lengthy process.
We lack first-hand visibility regarding certain
loans, other assets, or liabilities which increases the risk that our estimates may be inaccurate.
For example,
interagency supervisory guidance related to practices for loans and lines of credit secured by junior liens on 1-4 family
residential properties requires that the performance of the first lien should be considered when assessing the collectability
and inherent loss of a performing junior lien. Additionally, the OCC has clarified that an institution’s income
recognition policy should incorporate management’s consideration of all reasonably available information including, for
junior liens, the performance of the associated senior liens as well as trends in other credit quality indicators. We own
and service a consumer real estate portfolio that is primarily composed of home equity lines and installment loans. As
of December 31, 2016, that amount was $4.5 billion. As of December 31, 2016, approximately $1.3 billion, or 28 percent, of
the consumer real estate portfolio consisted of stand-alone second liens while $.1 billion, or 3 percent, were owned or
serviced by FHN. We are not able to actively monitor the performance status of the first liens that are serviced by others.
We obtain first lien performance information from third parties and through loss
mitigation activities, and we place a stand-alone second lien loan on nonaccrual if we discover that there are performance
issues with the first lien loan. It is possible that if our evaluation methods change or information sources otherwise improve
our additions to nonperforming loans may be material.
Changes in accounting rules can significantly affect how
we record and report assets, liabilities, revenues, expenses, and earnings.
Although such changes generally affect all companies
in a given industry, in practice changes sometimes have a disparate impact due to differences in the circumstances or business
operations of companies within the same industry.
An accounting rule change issued in 2016 is likely
to significantly change how we evaluate and record income and estimates of loss associated with loans and debt
securities.
Loans and debt securities make up a majority of our assets, so the effects of this rule change, while
currently unknown, when implemented are likely to be significant and wide-ranging. The rule change will not be effective for
several years. Additional information concerning this new rule, known as ASU 2016-13, is provided under the caption
“Accounting Changes Issued but Not Currently Effective” in Note 1—Summary of Significant Accounting
Policies, beginning on page 96 of our 2016 Annual Report, which is part of the material from that report that has been
incorporated by reference into Item 8 of this report, and under the caption “Accounting Changes Issued but Not
Currently Effective” within the Management’s Discussion and Analysis of Financial Condition and Results of
Operations section of our 2016 Annual Report, beginning on page 68, which is part of the material from that report that has
been incorporated by reference into Item 7 of this report.
Changes in regulatory rules can create significant accounting
impacts for us.
Because we operate in a regulated industry we prepare regulatory financial reports based on regulatory accounting
rules. Changes in those rules can have significant impacts upon us in terms of regulatory compliance. In addition, such changes
can impact our ordinary financial reporting, and uncertainties related to regulatory changes can create uncertainties in our financial
reporting.
A reduction in our taxable earnings outlook, corporate income tax reform, or both could adversely affect
the value of our deferred tax asset.
At December 31, 2016 our gross deferred tax asset after valuation
allowance was approximately $297.0 million and the net deferred tax asset was approximately $199.6 million.
The value of our deferred tax asset depends in part upon our estimation of our ability to realize the asset during
applicable future periods and upon our estimate of our effective tax rate.
Tax reform legislation in 2017 may reduce the maximum corporate income tax rate.
The President has
publicly favored legislation (not yet formally proposed) to reduce corporate income tax rates to 15 to 20
percent, possibly in 2017. Any such rate reduction is likely to be part of a broader tax reform bill. Although a
rate reduction would have a beneficial effect, certain deductions may be eliminated or reduced as a part of tax
reform, which could partially offset the beneficial effect of a rate reduction. Additionally, a rate reduction
would result in the impairment of our deferred tax asset, as mentioned above, in the quarter that it is signed into
law by the President.
Risks
of Holding our Stock
The principal source of cash flow to pay dividends on our
stock, as well as service our debt, is dividends and distributions from the Bank, and the Bank cannot currently pay dividends to
us without regulatory approval.
We primarily depend upon common dividends from the Bank for cash to fund dividends we pay to
our common and preferred stockholders, and to service our outstanding debt. Regulatory constraints may prevent the Bank from declaring
and paying dividends to us in 2017 without regulatory approval. Applying the applicable regulatory rules, as of December 31, 2016
and 2015, the Bank had negative $132.5 million and negative $192.8 million, respectively, available for dividends. On January 1,
2017, the Bank’s total amount available for dividends was negative $132.5 million. That amount will improve during 2017 only
to the extent that the Bank’s earnings for the year exceed preferred and any common dividends for the year.
Also, we are required to provide financial support to the Bank.
Accordingly, at any given time a portion of our funds may have to be used for that purpose and therefore would be unavailable for
dividends.
Furthermore, the Federal Reserve and the OCC have issued policy
statements generally requiring insured banks and bank holding companies only to pay dividends out of current operating earnings.
The Federal Reserve has released a supervisory letter advising bank holding companies, among other things, that as a general matter
a bank holding company should inform the Federal Reserve and should eliminate, defer or significantly reduce its dividends if (i) the
bank holding company’s net income available to shareholders for the past four quarters, net of dividends
previously paid
during that period, is not sufficient to fully fund the dividends; (ii) the bank holding company’s prospective rate
of earnings is not consistent with the bank holding company’s capital needs and overall current and prospective financial
condition; or (iii) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital
adequacy ratios.
Our stockholders may suffer dilution if we raise capital
through public or private equity financings to fund our operations, to increase our capital, or to expand.
If
we raise funds by issuing equity securities or instruments that are convertible into equity securities, the percentage ownership
of our current common stockholders will be reduced, the new
equity securities may have rights and preferences superior to those
of our common or outstanding preferred stock, and additional issuances could be at a sales price which is dilutive to current stockholders.
We may also issue equity securities directly as consideration for acquisitions we may make that could be dilutive to stockholders.
Provisions of Tennessee law, and certain provisions of our
charter and bylaws, could make it more difficult for a third party to acquire control of us or could have the effect of discouraging
a third party from attempting to acquire control of us
. These provisions could make it more difficult for a third party to
acquire us even if an acquisition might be at a price attractive to many of our stockholders.