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, 2003

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 000-4491

CIK number 0000036966

FIRST TENNESSEE NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)

(901) 523-4444
(Registrant’s telephone number, including area code)

None
(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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

Yes  |X|    No  |_|

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.

FIRST TENNESSEE NATIONAL CORPORATION

INDEX

Part I. Financial Information

Part II. Other Information

Signatures

Certifications

Exhibit Index

2

PART I.

FINANCIAL INFORMATION

This financial information reflects all adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the interim periods presented.

3

See accompanying notes to consolidated financial statements.

4

See accompanying notes to consolidated financial statements.

5

See accompanying notes to consolidated financial statements.

6

See accompanying notes to consolidated financial statements.

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Note 1 – Financial Information

The unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. 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 three-month period ended March 31, 2003, are not necessarily indicative of the results that may be expected going forward. For further information, refer to the audited consolidated financial statements and footnotes included in the financial appendix to the 2003 Proxy Statement.

Stock options. First Tennessee National Corporation (FTNC) accounts for its employee stock-based compensation plans under the intrinsic value based method in accordance with Accounting Principals Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Had compensation cost for these plans been determined consistent with SFAS No. 123, FTNC’s net income and earnings per share would have been reduced to the following pro forma amounts:

Other disclosures – Indemnification agreements and guarantees. In the ordinary course of business, FTNC enters into indemnification agreements for legal proceedings against its directors and officers and standard representation warranties for underwriting agreements, merger and acquisition agreements, sold loans and other similar types of arrangements. It is not possible to estimate a maximum potential amount of payouts that could be required with such agreements.

First Horizon Home Loan Corporation (FHHLC) services a mortgage loan portfolio of approximately $58.2 billion as of March 31, 2003, a significant portion of which is held by Government Sponsored Enterprises (GSE’s) or private security holders. In connection with its servicing activities, FHHLC guarantees the receipt of the scheduled principal and interest payments on the underlying loans. In the event of customer non-performance on the loan, FHHLC is obligated to make the payment to the security holder. Under the terms of the servicing agreements, FHHLC can utilize payments received from other prepaid loans in order to make the security holder whole. In the event payments are ultimately made by FHHLC to satisfy this obligation, for loans sold with no recourse, all funds are recoverable from the GSE’s at foreclosure sale.

FHHLC 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, FHHLC has exposure on all loans sold with recourse. FHHLC has various claims for reimbursement, repurchase obligations, and/or indemnification requests outstanding with government agencies or private investors. FHHLC has evaluated all of its exposure under recourse obligations based on factors, which include loan delinquency status, foreclosure expectancy rates and claims outstanding. Accordingly, FHHLC had an allowance for losses on the mortgage servicing portfolio of approximately $30.9 million and $25.7 million as of March 31, 2003 and 2002, respectively. FHHLC has sold certain mortgage loans with an agreement to repurchase the loans upon default. As of March 31, 2003 and 2002, FHHLC had single-family residential loans with outstanding balances of $162.9 million and $209.6 million, respectively, that were sold on a recourse basis. For the single-family residential loans, in the event of borrower nonperformance, FHHLC 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, 2003 and 2002, the outstanding principal balance of loans sold with limited recourse and serviced by FHHLC was $4.3 billion and $5.0 billion, respectively.

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Note 1 – Financial Information (continued)

Standby letters of credit are conditional commitments issued by FTNC to guarantee the performance and/or payment of a customer to a third party in connection with specified transactions. The credit risk involved in issuing these commitments is essentially the same as that involved in extending loan facilities to customers, as performance under any of the facilities would result in a loan being funded to the customer. Standby letters of credit outstanding as of March 31, 2003 and 2002, were $489.7 million and $430.1 million, respectively.

Accounting changes. On January 1, 2003, FTNC adopted SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. This statement requires that a liability for the cost associated with an exit or disposal activity be recognized and measured initially at fair value in the period in which the liability is incurred. Prior to the effective date of this statement, costs associated with an exit or disposal plan were recognized at the date of commitment, as required under EITF Issue 94-3. This statement does not apply to costs associated with an exit activity that involves an entity newly acquired in a business combination or with a disposal activity covered by SFAS No. 144. The impact of adopting this statement was immaterial to FTNC.

On January 1, 2003, FTNC adopted the final provisions of Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”. This interpretation elaborates on the disclosures to be made by a guarantor in interim and annual financial statements about obligations assumed under certain guarantees it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. This interpretation does not prescribe a specific approach for subsequently measuring the guarantor’s liability over the term of the related guarantee. This interpretation also incorporates, without change, the guidance in Financial Accounting Standards Board (FASB) Interpretation No. 34, “Disclosure of Indirect Guarantees of Indebtedness of Others”, which is superceded. The impact of adopting this statement was immaterial to FTNC.

In December 2002, FTNC adopted SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”. This statement amends SFAS No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods for voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. As FTNC continues to account for stock-based employee compensation under APB 25, the adoption of this statement did not have a material impact on the financial statements or results of operations.

On October 1, 2002, FTNC adopted SFAS No. 147, “Acquisitions of Certain Financial Institutions (an amendment of FASB Statement No. 72 and 144 and FASB Interpretation No. 9)”. This statement requires acquisitions of all or part of a financial institution meeting the definition of a business combination to be accounted for by the purchase method in accordance with SFAS No. 141. Any previously recorded unidentified intangible asset related to the acquisition of a financial institution must now be classified as goodwill and is subject to the impairment testing provisions of SFAS No. 142. Impairment testing of previously identified long-term customer-relationship intangible assets will be subject to the impairment testing provisions of SFAS No 144. Provisions of this statement were effective for acquisitions on or after October 1, 2002. The impact of adopting this statement was immaterial to FTNC.

On October 1, 2002, FTNC adopted SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections”. SFAS No. 145 rescinds SFAS No. 4, which required all gains and losses from extinguishment of debt to be classified as an extraordinary item, net of related income tax effect, if material in the aggregate. Due to the rescission of SFAS No. 4, the criteria in Opinion 30 are now used to classify those gains and losses. SFAS No. 64 amended SFAS No. 4, and is no longer necessary because of the rescission of SFAS No. 4. SFAS No. 44, is no longer necessary because the transition of the Motor Carrier Act of 1980 has been completed. SFAS No. 145 also amends SFAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. In addition this statement also makes technical corrections to existing pronouncements which are generally not substantive in nature.

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Note 1 – Financial Information (continued)

On January 1, 2002, FTNC adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS No. 144 addresses accounting and reporting issues related to the impairment of long-lived assets and for long-lived assets to be disposed of. The impact of adopting this statement was immaterial to FTNC.

On January 1, 2002, FTNC adopted SFAS No. 142, “Goodwill and Other Intangible Assets”. Under SFAS No. 142, goodwill is no longer subject to amortization over its estimated useful life, but is subject to an assessment for impairment using a fair-value-based test at least annually. FTNC has not recognized any impairment of the goodwill currently on its books during 2003 or 2002.

On January 1, 2002, FTNC adopted the final provisions of SFAS No. 141, “Business Combinations” which requires that all business combinations initiated after June 30, 2001, be accounted for using the purchase method. The impact of adopting this statement was immaterial to FTNC.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments”, which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. The provisions of SFAS No. 149 are effective for fiscal quarters beginning after June 15, 2003. While FTNC continues to evaluate the impact of adopting this standard it is expected to be immaterial to results of future operations.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” which requires consolidation by a business enterprise of variable interest entities which have either (1) insufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) no equity investor with the essential characteristics of a controlling financial interest, as defined in the interpretation. When an entity meets either of these criteria, a business enterprise with a variable interest (as defined in the interpretation) in the entity must evaluate whether it should be consolidated into the enterprise’s financial statements. This interpretation applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The interpretation may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated.

Upon adoption of the provisions of this interpretation, FTNC believes it is reasonably possible that consolidation of its loan funding arrangement with a commercial paper conduit facility would be required. Beginning in first quarter 2003, FTNC discontinued the practice of referring loans to this facility. Loans that would have been referred to the conduit are currently being funded by FTNC. Loans for which FTNC previously provided a liquidity facility and a credit enhancement to the conduit had decreased to $74.5 million on March 31, 2003 from $217.0 million on March 31, 2002. The loans in the conduit are not currently reflected on FTNC's Consolidated Statement of Condition. FTNC does not anticipate any loans remaining in the conduit by the end of second quarter 2003.

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Note 2 – Acquisitions/Divestitures

On September 16, 2002, First Tennessee Bank National Association (FTBNA), the primary banking subsidiary of First Tennessee, sold a portfolio of loans originated through First Horizon Money Centers totaling $208.3 million to American General Finance, Inc. of Evansville, Indiana and closed the related Money Center offices. This transaction resulted in a divestiture gain of $2.3 million.

On June 1, 2002, First Horizon Home Loan Corporation (FHHLC), a wholly owned subsidiary of FTBNA, acquired certain assets and assumed certain liabilities of Real Estate Financial Services (REFS), a mortgage lending company based in Alpharetta, Georgia, for approximately $2.2 million in cash. This transaction was immaterial to First Tennessee.

On April 1, 2002, First Tennessee acquired First Premier Financial Services, Inc. (First Premier), a South Dakota based merchant processor, for approximately $11.9 million in cash. First Premier was merged into First Horizon Merchant Services, Inc., a wholly owned subsidiary of FTBNA. The acquisition was immaterial to First Tennessee.

On June 6, 2001, FTBNA completed the sale of its interests in Check Solutions Company to Carreker Corporation of Dallas, Texas. First Tennessee recognized a divestiture gain of $42.7 million in 2001. An additional gain of $2.3 million was recognized in 2002.

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Note 3 – Earnings Per Share

The following table shows a reconciliation of earnings per share to diluted earnings per share:

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Note 4 – Loans

The composition of the loan portfolio on March 31 is detailed below:

The following table presents information concerning nonperforming loans on March 31:

Nonperforming loans consist of impaired loans, other nonaccrual loans and certain restructured loans. An impaired loan is a loan that management believes the contractual amount due probably will not be collected. Impaired loans are generally carried on a nonaccrual status. Nonaccrual loans are loans on which interest accruals have been discontinued due to the borrower’s financial difficulties. Management may elect to continue the accrual of interest when the estimated net realizable value of collateral is sufficient to recover the principal balance and accrued interest.

Generally, interest payments received on impaired loans are applied to principal. Once all principal has been received, additional payments are recognized as interest income on a cash basis. The following table presents information concerning impaired loans:

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, 2003 and 2002, is summarized as follows:

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Note 5 – Business Segment Information

FTNC provides traditional retail/commercial banking and other financial services to its customers through various regional and national business lines, including First Tennessee Banking Group, First Horizon, FTN Financial, Transaction Processing, and Corporate. First Tennessee Banking Group includes the Retail/Commercial Bank, Investments, Insurance, Financial Planning, Trust Services and Asset Management, Credit Card and Cash Management. This segment offers traditional banking financial services and products and also promotes comprehensive financial planning to address customer needs and desires for investments, insurance, estate planning, education funding, cash reserves and retirement goals. First Horizon includes First Horizon Home Loans, First Horizon Equity Lending and First Horizon Money Centers. During third quarter 2002, FTNC sold the loan portfolio and closed the offices of First Horizon Money Centers as part of an ongoing plan to improve long-term growth by enhancing overall business mix. FTN Financial includes Capital Markets, Equity Research, Investment Banking, Strategic Alliances, and Correspondent Services. Transaction Processing continues to offer credit card merchant processing, nationwide bill payment processing, check clearing operations and other products and services. The Corporate segment includes certain corporate expenses, interest expense on trust preferred and REIT preferred stock, select components of SFAS 133 hedge ineffectiveness (see also Note 1 – Financial Information), and other items not allocated or not specifically assigned to business segments.

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 ending March 31:

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Note 5 – Business Segment Information (continued)

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Note 6 – Intangible Assets

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

The gross carrying amount of other intangible assets subject to amortization is $98.9 million on March 31, 2003, net of $65.8 million of accumulated amortization. Estimated aggregate amortization expense for the remainder of 2003 is expected to be $5.0 million and is expected to be $6.1 million, $4.6 million, $3.2 million and $3.1 million for the twelve-month periods of 2004, 2005, 2006 and 2007, respectively.

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

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Note 7 – Mortgage Servicing Rights

Following is a summary of changes in capitalized mortgage servicing rights (MSR’s), net of accumulated amortization, included in the Consolidated Statements of Condition:

The MSR’s on March 31, 2003 and 2002, had estimated market values of approximately $514.1 million and $770.9 million, respectively. These balances represent the rights to service approximately $53.1 billion and $43.2 billion of mortgage loans on March 31, 2003 and 2002. On March 31, 2003 and 2002, valuation allowances due to impairment of $45.1 million and $24.3 million were required, respectively.

Estimated MSR’s amortization expense for the twelve-month periods ending March 31, 2004, 2005, 2006, 2007 and 2008, are $90.4 million, $70.2 million, $58.8 million, $48.5 million and $39.6 million, respectively. The assumptions underlying these estimates are subject to modification based on changes in market conditions and portfolio behavior (such as prepayment speeds). As a result, these estimates are subject to change in a manner and amount that is not presently determinable by management.

For purposes of impairment evaluation and measurement, the MSR’s are stratified based on the predominant risk characteristics of the underlying loans. These strata currently include adjustable and fixed-rate loans. The fixed-rate loans are further stratified by 100 basis-point interest rate bands. In 2002, the fixed-rate loans were stratified by 150 basis-point interest rate bands. As a result of this change, additional impairment of $9.2 million was recorded. The MSR’s are amortized over the period of and in proportion to the estimated net servicing revenues. A quarterly value impairment analysis is performed using a discounted cash flow methodology that is disaggregated by predominant risk characteristics. Impairment, if any, is recognized through a valuation allowance for individual strata. However, if the impairment is determined to be other than temporary, a direct write-off of the asset is made.

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GENERAL INFORMATION

First Tennessee National Corporation (FTNC) is headquartered in Memphis, Tennessee, and is a nationwide, diversified financial services institution which provides banking and other financial services to its customers through various regional and national business lines. FTNC’s segments are First Tennessee Banking Group (previously referred to as FTN Banking Group), First Horizon, FTN Financial, Transaction Processing, and Corporate. First Tennessee Banking Group includes the Retail/Commercial Bank, Investments, Insurance, Financial Planning, Trust Services and Asset Management, Credit Card and Cash Management. This segment offers traditional banking financial services and products, commercial insurance and also promotes comprehensive financial planning to address customer needs and desires for investments, insurance, estate planning, education funding, cash reserves and retirement goals. First Horizon includes First Horizon Home Loans, First Horizon Equity Lending and First Horizon Money Centers. During third quarter 2002, FTNC sold the loan portfolio and closed the offices of First Horizon Money Centers as part of an ongoing plan to improve long-term growth by enhancing overall business mix. FTN Financial includes Capital Markets, Equity Research, Investment Banking, Strategic Alliances and Correspondent Services. Transaction Processing continues to offer credit card merchant processing, nationwide bill payment processing, check clearing operations and other products and services. The Corporate segment includes unallocated corporate expenses, interest expense on trust preferred and REIT preferred stock and select components of SFAS 133 hedge ineffectiveness (see Note 1 – Financial Information).

Based on management’s best estimates, certain revenue and expenses are allocated and equity is assigned to the various segments to reflect the inherent risk in each business line. These allocations are periodically reviewed and may be revised from time to time to more accurately reflect current business conditions and risks; the previous history is restated to ensure comparability.

For the purpose of this management discussion and analysis (MD&A), earning assets, including loans, have been expressed as averages, net of unearned income. First Tennessee Bank National Association, the primary bank subsidiary, is also referred to as FTBNA in this discussion.

The following is a discussion and analysis of the financial condition and results of operations of FTNC for the three-month period ended March 31, 2003, compared to the three-month period ended March 31, 2002. To assist the reader in obtaining a better understanding of FTNC and its performance, this discussion should be read in conjunction with FTNC’s unaudited consolidated financial statements and accompanying notes appearing in this report. Additional information including the 2002 financial statements, notes, and management’s discussion and analysis is provided in the 2002 Annual Financial Disclosures included as an appendix to the 2003 Proxy Statement.

FORWARD-LOOKING STATEMENTS

Management’s discussion and analysis contains forward-looking statements with respect to FTNC’s beliefs, plans, goals, expectations, and estimates. Forward-looking statements are statements that are not a representation of historical information but rather are related to future operations, strategies, financial results or other developments. The words “believe”, “expect”, “anticipate”, “intend”, “estimate”, “should”, “is likely”, “will”, “going forward”, and other expressions that indicate future events and trends identify forward-looking statements. Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, operational, economic and competitive uncertainties and contingencies, many of which are beyond a company’s control, and many of which, with respect to future business decisions and actions (including acquisitions and divestitures), are subject to change. Examples of uncertainties and contingencies include, among other important factors, general and local economic and business conditions; expectations of and actual timing and amount of interest rate movements (which can have a significant impact on a financial services institution); market and monetary fluctuations; inflation; the financial condition of borrowers and other counterparties; competition within and outside the financial services industry; geo-political developments including possible terrorist activity; technology; and new products and services in the industries in which FTNC operates. Other factors are those inherent in originating and servicing loans, including prepayment risks and fluctuation of collateral values and changes in customer profiles. Additionally, the actions of the Securities and Exchange Commission (SEC), the Financial Accounting Standards Board (FASB), the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System, and other regulators; regulatory and judicial proceedings and changes in laws and regulations applicable to FTNC; and FTNC’s success in executing its business plans and strategies and managing the risks involved in the foregoing, could cause actual results to differ. FTNC assumes no obligation to update any forward-looking statements that are made from time to time.

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FINANCIAL SUMMARY (Comparison of first quarter 2003 to first quarter 2002)

Earnings for first quarter 2003 were $119.0 million, an increase of 37 percent from last year’s first quarter earnings of $87.1 million. Diluted earnings per common share were $.91 in 2003 compared to $.67 in 2002. Return on average shareholders’ equity was 27.7 percent and return on average assets was 2.07 percent for first quarter 2003. Return on average shareholders’ equity was 23.6 percent and return on average assets was 1.77 percent for first quarter 2002.

On March 31, 2003, FTNC was ranked as one of the top 50 bank holding companies nationally in market capitalization ($5.0 billion) and total assets ($24.8 billion). On March 31, 2002, market capitalization was $4.4 billion and total assets were $19.6 billion.

Total revenue grew 40 percent from first quarter 2002, with a 59 percent increase in fee income (noninterest income) and a 5 percent increase in net interest income.

NONINTEREST INCOME

Fee income provides the majority of FTNC’s revenue and contributed 73 percent to total revenue in first quarter 2003 compared to 64 percent in first quarter 2002. First quarter 2003 fee income increased 59 percent to $518.1 million from $324.9 million in 2002. A more detailed discussion of the major line items follows.

Mortgage Banking

First Horizon Home Loans, an indirect subsidiary of FTNC and the major component of the First Horizon business segment, offers residential mortgage banking products and services to customers, which consist primarily of the origination or purchase of single-family residential mortgage loans for sale to secondary market investors and the subsequent servicing of those loans.

First Horizon Home Loans originates mortgage loans through its retail and wholesale operations and also purchases mortgage loans from third-party mortgage bankers (known as “correspondent brokers”).

The secondary market for mortgages allows First Horizon Home Loans to sell mortgage loans to investors, including government-sponsored enterprises (GSE’s), such as Freddie Mac, Fannie Mae and Ginnie Mae. Many private investors are also active in the secondary market as issuers and investors. The majority of First Horizon Home Loans’ mortgage loans are sold through transactions with GSE’s. The risk of credit loss with regard to the principal amount of the loans sold is generally transferred to investors upon sale to the secondary market. To the extent that transferred mortgage loans are subsequently determined not to meet the agreed-upon qualifications or criteria, the purchaser has the right to return those loans to First Horizon Home Loans. 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).

When First Horizon Home Loans sells mortgage loans in the secondary market to investors, it generally retains the right to service the loans sold in exchange for a servicing fee that is collected over the life of the loan as the payments are received from the borrower. The expected present value of the anticipated cash flows received for servicing the loan, net of the estimated costs of servicing the loan, is capitalized as an asset known as Mortgage Servicing Rights (MSR’s) on the Consolidated Statements of Condition (refer to discussion of MSR’s under Critical Accounting Policies).

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Origination fees and gains or losses from the sale of loans are recognized at the time a mortgage loan is sold into the secondary market. A portion of the gain or loss is recognized at the time an interest rate lock commitment (IRLC) is made to the customer. Secondary marketing activities include gains or losses from secondary marketing trading gains, product pricing decisions, and gains or losses from the sale of loans into the secondary market including the capitalized net present value of the MSR’s. As discussed under Critical Accounting Policies, First Horizon Home Loans employs hedging strategies intended to counter a change in the value of its MSR’s through changing interest rate environments. MSR’s hedge gains/(losses) reflect effects of hedging including servicing rights net value changes (see Other – Accounting for Derivative Instruments and Hedging Activities). Other income includes income from the foreclosure repurchase program, bulk sales of MSR’s, and other miscellaneous items. Mortgage trading securities gains/(losses) relate to market value adjustments primarily on interest-only strips that are classified as trading securities and related hedges. As shown in Table 1, total mortgage banking fee income increased 124 percent in 2003.

Table 1 – Mortgage Banking

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

Origination activity increased 117 percent to $11.5 billion compared to $5.3 billion in first quarter 2002. Driven by low mortgage interest rates, refinance activity increased 177 percent to $9.1 billion and represented 79 percent of total originations during first quarter 2003 compared to 62 percent in first quarter 2002. Due to the high origination volumes, loan sales into the secondary market increased 84 percent to $11.6 billion in 2003 compared to last year. Home purchase related originations grew 20 percent in 2003, demonstrating First Horizon Home Loans’ success in penetrating the purchase market. Due to the more stable nature of this market, which is not as vulnerable to interest rates, First Horizon Home Loans’ access to the purchase market should help support production levels when mortgage rates rise. Fees derived from the mortgage origination process increased 95 percent in 2003, to $245.0 million from $125.5 million in 2002. The revenue growth was primarily due to increases in origination fees, in revenue recognized on loans sold, in the value recognized on loans in process and higher net secondary marketing trading gains. Secondary marketing activities increased $83.4 million primarily due to an increase of $56.0 million in net secondary marketing trading gains resulting primarily from increased production and the favorable interest rate environment experienced during 2003.

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While the growth in refinance activity produced increased origination fee income, it also increased actual and projected MSR’s prepayment speeds. As a result of the increased mortgage prepayment speeds experienced in 2003, the expected future cash flows that support the carrying values of MSR’s were reduced, resulting in a 5 percent increase, to $31.1 million in MSR’s amortization expense. For purposes of impairment evaluation, the MSR’s are stratified based on the predominant characteristics of the underlying loans. These strata currently include adjustable and fixed-rate loans. The fixed-rate loans are further stratified by 100 basis-point interest rate bands. In 2002, the fixed-rate loans were stratified by 150 basis-point interest rate bands. MSR’s impairment loss increased 35 percent to $42.5 million due in part to the change in interest rate bands. MSR’s amortization was $29.7 million in 2002 and there was a MSR’s impairment loss of $31.4 million in 2002. The decrease in fair value of MSR’s attributed to declining interest rates was significantly offset by an increase in the value of the derivative financial instruments used to hedge the change in fair value of the hedged MSR’s. MSR’s net hedge results were $37.3 million in 2003 compared to $11.9 million in 2002 (both quarters represent an increase in the value of hedges offset by a decrease in the value of hedged MSR’s).

The mortgage-servicing portfolio (which includes servicing for ourselves and others) totaled $58.2 billion on March 31, 2003, compared to $46.7 billion on March 31, 2002 (see Note 7 – Mortgage Servicing Rights for information summarizing changes in MSR’s). As a result of the strong originations, there was an increase in capitalized MSR’s during 2003 of $129.2 million, net of sales. Mortgage servicing fee income increased 10 percent to $45.4 million in 2003 primarily due to a 24 percent increase in the average mortgage-servicing portfolio, the effect of which was partially offset by a negative impact from prepayments.

Other mortgage income increased 119 percent to $15.6 million for 2003 compared with $7.1 million in 2002. The increase was primarily due to a gain of $5.6 million on a bulk sale of MSR’s.

During the “price discovery” process (see discussion in Critical Accounting Policies), management determined that economic conditions required a change in the estimated discount rate used to value FTNC’s interest-only securities. In first quarter 2003 mortgage trading securities net gains were $2.1 million compared to net losses of $3.5 million in 2002. As a result of the change in estimated discount rate, the net gain was reduced by $7.9 million in 2003. Mortgage trading securities net gains or losses represent market value adjustments on interest-only and principal-only strips and related hedges.

Going forward, the existing level of loans in process (pipeline) due to an as yet unabated surge in applications currently indicates a continuation of record origination levels. Excluding the impact of the pipeline, fee income from refinance loan originations will generally depend on mortgage interest rates. An increase in rates should reduce origination fees and profit from the sale of loans, but should also reduce MSR’s amortization expense and impairment losses, while a decrease in rates should increase this net revenue. Flat to rising interest rates should reduce net secondary marketing trading gains, while falling rates should increase this net revenue. Home purchase-related originations should reflect the relative strength or weakness of the economy. Actual results could differ because of several factors, including those presented in the Forward-Looking Statements section of the MD&A discussion.

Capital Markets

Capital markets fee income, the major component of revenue in the FTN Financial segment, is primarily generated from the purchase and sale of securities as both principal and agent and from investment banking, portfolio advisory and equity research services. Inventory positions are limited to the procurement of securities solely for distribution to customers by the sales staff. Inventory is hedged to protect against movements in interest rates.

For first quarter 2003, capital markets fee income increased 40 percent to $139.2 million from $99.4 million in 2002. This increase reflects continued growth and penetration into the targeted customer base through expanded products and services. This growth has also been influenced by the increased liquidity that capital markets’ depository institution customers have experienced, as well as continued growth in the capital markets’ non-depository account base. As shown in Table 2, revenue from depository and non-depository customers has increased in 2003. The enhanced institutional product and services lines, which include investment banking, equity research and sales, and portfolio advisory services, remained relatively flat compared to 2002. Total securities bought and sold increased 49 percent to $554.5 billion from $372.7 billion in 2002.

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Going forward, revenues will fluctuate based on factors which include the expansion or contraction of the customer base, the volume of investment banking transactions and the introduction of new products, as well as the strength of loan growth in the U.S. economy and volatility in the interest rate environment and the equity markets. Actual results could differ because of several factors, including those presented in the Forward-Looking Statements section of the MD&A discussion.

Table 2 – Capital Markets

Other Fee Income

Fee income from deposit transactions and cash management for first quarter 2003 remained relatively flat at $32.8 million compared to $32.4 million in 2002. Total noninterest income from insurance premiums and commissions increased 7 percent, to $14.5 million from $13.5 million in 2002. Trust services and investment management fees decreased 19 percent to $11.4 million from $14.1 million in 2002 primarily due to declining asset management fees related to a contraction in market valuations. Assets under management fell 16 percent to $7.0 billion on March 31, 2003 from $8.4 billion on March 31, 2002. First quarter 2003 fee income from merchant processing increased 23 percent to $12.6 million from $10.2 million in 2002 primarily due to portfolio acquisitions. All other income and commissions increased 9 percent to $36.9 million for first quarter 2003 from $34.0 million in 2002 largely due to income recognized on company owned life insurance.

Going forward, other fee income should fluctuate primarily with the strength or weakness of the economy.

NET INTEREST INCOME

Net interest income increased 5 percent to $193.4 million from $184.4 million in first quarter 2002, reflecting a larger portfolio of loans held for sale (warehouse) which grew 67 percent to $4.1 billion from $2.5 billion in first quarter 2002. Also impacting the growth in net interest income was an increase of 12 percent in the loan portfolio primarily due to growth in equity lending. These positive impacts on net interest income were largely offset by compression in the net interest margin resulting from a change in the mix of the loan portfolio to floating rate products and due to the repricing of term assets in this low interest rate environment. The consolidated margin decreased to 3.97 percent for first quarter 2003 compared to 4.50 percent for the same period in 2002. The activity levels and related funding for FTNC’s mortgage production and servicing and capital markets activities affect the margin. These activities typically produce different margins than traditional banking activities. Mortgage production and servicing activities can affect the overall margin based on a number of factors, including the size of the mortgage warehouse, the time it takes to deliver loans into the secondary market, the amount of custodial balances, and the level of MSR’s. Capital markets activities tend to compress the margin because of its strategy to reduce market risk by hedging its inventory in the cash markets, which effectively eliminates net interest income on these positions. As a result, FTNC’s consolidated margin cannot be readily compared to that of other bank holding companies.

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Table 3 – Net Interest Margin

Going forward, over the near-term, if interest rates remain at current low levels, the net interest margin is likely to compress further. Over the long-term the margin could be unfavorably impacted if the yield curve flattens significantly. The consolidated margin will continue to be influenced by the activity levels of mortgage production and servicing and capital markets. Actual results could differ because of several factors, including those presented in the Forward-Looking Statements section of the MD&A discussion.

NONINTEREST EXPENSE

Total noninterest expense for first quarter 2003 increased 42 percent to $502.5 million from $352.7 million in 2002. Expenses in First Horizon and FTN Financial fluctuate based on the type and level of activity. Going forward, FTN Financial and First Horizon will continue to influence the level of noninterest expense (see also Business Line Review for additional information).

Employee compensation, incentives and benefits (personnel expense), the largest component of noninterest expense, increased 47 percent from first quarter 2002, primarily due to higher activity levels in First Horizon and FTN Financial. This increase also includes $11.7 million of expense recognized related to modifications in and funding of an old deferred compensation plan, primarily for retirees.

Occupancy expense increased 14 percent to $19.6 million compared to $17.2 million in 2002 primarily related to costs associated with the opening of new offices by First Horizon Home Loans due to increased origination volume. Operations services increased 22 percent to $17.7 million from $14.5 million in 2002 primarily due to business expansion and contract termination costs. Equipment rentals, depreciation and maintenance expense increased 8 percent in 2003 to $17.2 million from $15.9 million in 2002. Communications and courier expense increased 11 percent to $14.8 million in 2003 from $13.3 million in 2002 primarily due to increased expenses related to Midwest Research. All other expense increased 55 percent to $112.4 million in 2003 from $72.6 million in 2002. Contributing to this increase was a loss of $14.0 million related to the termination of a lease arrangement with a single-purpose entity for First Horizon’s main office headquarters. Termination of the lease arrangement will result in lower costs in future periods. Also contributing to the increase in all other expense was the growth in expense associated with higher activity levels in First Horizon and increased advertising expense.

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PROVISION FOR LOAN LOSSES / ASSET QUALITY