First Horizon Corporation (FHN) Earnings Call Transcript & Summary

Good afternoon. I'm Gerry Benson with Fidelity Institutional Asset Management. Welcome to the last Zoom session of our inaugural and, hopefully, final virtual BAAB conference. Today, I have BJ Losch, CFO of First Verizon; and Anthony Restel, COO of First Horizon and former CFO of IBERIA; and Ellen Taylor, Investor Relations. This is the first time we've had BJ and Anthony presenting together, which follows a successful merger of First Horizon and IBERIA in July. As we've done with the majority of the presentations so far this year, we're going to do a fireside chat. And I want to remind listeners that they can submit questions for management to answer via the webcast. But first, before we get started, and I wanted to hand it over to BJ, who had some opening remarks.

Great. Thanks, Gerry, and I appreciate everybody hanging in there for the last meeting of the day. We really appreciate it, and we appreciate your interest in our company. We've got a lot going on. And so Anthony and I are glad to be here and talk about what we've just put together with 2 great companies, and look forward to a lot more. So just quickly, reminding you on Slide 2, the disclaimers about forward-looking statements that we will make as well as referring to non-GAAP items. And with that, what I'll do is start with where we started our journey in November of 2019, which is looking at the attractiveness that we felt that putting our 2 companies together would give us in terms of the footprint that we would have, the diversity of our product offering and our revenue mix, the size and scope of the companies that we would have, the efficiency opportunities, of course, that come with scale that we thought were critically important then and certainly now. And that, combined with our combined expertise in putting together mergers and merger integration, we felt at the time, and we feel even more confident now that we are almost a year into it, that we are well positioned for success. And the end of 2020 and 2021 will be key execution years for us, and we look forward to it and talking to you a little bit about it today. If you look at Page 4 and think about the theme of the BAAB conference, living with low rates for long again. And that, combined with what we've all just gone through or are going through with the pandemic and what that has done to rates, to customer and client behavior, to personal behavior, to credit and what's going on in the environment. And we actually believe from a company perspective, that there's actually a silver lining to the pandemic for us. And by that, I mean, we knew that putting together our organizations was going to take a lot of focus. And candidly, a lot of internal focus, as you well know, to put and knit 2 companies together the right way from a technology perspective, from a people perspective as well as from a customer perspective. And if you think about pre pandemic, others would have continued to be focused on a relatively benign credit environment, they would have been focused on revenue growth opportunities and those types of things. And we would have as well, but we would have also been a little bit more internally focused. Well, now, that's kind of flipped on its head. Generally speaking, the banking industry is in a very defensive posture because of what's going on in the environment. And we believe that we have 3 primary advantages now as it relates to the operating environment in banking. Number one, we have natural, if you will, cost saves from the merger efficiencies to take out, almost 10 plus percent of our combined expense base, and we are well on our way to doing that and believe that we can do more over time. So that's certainly helpful. On the -- second, around credit costs, we have now marked about 45% of our loan book, in addition to having very healthy reserves on the [ loan ] [indiscernible] First Horizon portfolios. That, combined with generally conservative lending practices and portfolios across both legacy companies, make us very comfortable that we have the right positioning for any uncertainty that will continue to come. The third is around our countercyclical businesses. We knew that they were very valuable to us in times like this, and that has shown through quite tremendously over the last couple of quarters. On the legacy IBERIA side, we have the mortgage business that has done incredibly well. On the legacy First Horizon side, we have the loans to mortgage companies business that has done well, as well as our fixed income business. Those have done a lot to offset the rate challenges that we have on the net interest income side. And so that counter balance, we believe, has worked quite well. Page 5, just reiterating for you some of the key messages that we delivered coming out of our third quarter earnings, both in terms of what we believed was going to happen in the fourth quarter around our net interest income, where our CET1 levels would be as well as where we expected merger expense savings to stand as of the end of the fourth quarter. So all of these are consistent with what we talked about, but we thought that we would remind you of those. And then importantly, in 2021, we are clearly focused on putting our companies together prudently in the right way, and Anthony will talk a little more about that. But expenses will come out of our organization. We are highly confident we are still expecting $170 million in annualized savings out of the run rate by year-end 2021 following a fall systems conversion, and we expect that total expenses, excluding incentives and commissions, to be down in the low single-digit range relative to our 3Q '20 annualized number. So we believe that we're well on our way financially to top-tier profitability, as measured by ROTCE, and we feel good about our ability to get there. So to wrap up and give you a few takeaways. We're very pleased with the countercyclical businesses and how they're performing. We're uniquely positioned, we believe, with merger cost savings to deliver substantial value and EPS from those cost savings. We feel very good about our reserves and capital levels as well as our funding. And we believe that, that, combined with our diversified business model, will serve us well over the coming year and years. So with that, I will stop and stop sharing my screen. And Gerry, we're happy to take some questions.

Okay, sounds good. Thank you, BJ. I appreciate that. Why don't we kick off, I mean, you did touch upon some of this in your slides and we can refer back. But just an integration update, recognizing the merger with IBERIA, only closed on July 1. Kind of give us early thoughts on how the transaction is progressing, not only from a financial perspective, but also the cultural integrations and such.

Yes. Let me give you an update on where we are, right? So I think you have to step back and recognize that really activity began in November of last year when we announced the deal. I think if you look at where we are and what we've accomplished to date, I think we've made -- we've crossed some major milestones. We've announced the formal leadership for the company going forward. Basically, we've got through most of the organizational structure on a go-forward basis. With that, we've been able to make some system decisions. I will say that about 95% of our go-to-model decisions have been made at this point. We've made -- almost all employee decisions have been made. And right now, we're in the process of bringing through, I'll say, some of the early conversion work to really derisk some of the bigger items, which we always typically think about, the loan and deposit system. So we were able to migrate into a common HR platform. So today, all of our associates remain on a single payroll basis through one system, which is great. We've got a number of, I'll say, integrations coming up relative to our mortgage business, the wealth platform, et cetera, coming up in the next couple of months. So what I would say where we are today, and I'm going to go back a little bit on my history of going through about 30 of these integrations over my history, is I feel like we're just now kind of reaching a really good stride. We're working through kind of an assessment of gap work that needs to be kind of finalized as we kind of really push forward into the integration. But I think we're right on target in terms of time frame, in terms of ability to deliver on our commitments and quite honestly, the real interesting thing is although COVID, from an outside view, might look like it creates a little bit of a wrench that you've got to work your way through, it really hasn't caused us too much in terms of challenges as we kind of put our plans in place.

Good. I mean you laid out your cost savings targets in a time line. I'm just curious, what are the opportunities substantially to upsize that target?

Yes. I'll take that one, Gerry. We feel highly confident getting to the $170 million. And we were pretty transparent on our third quarter call that we expected to go through that number. We haven't given a specific target about the $170 million because we want to put that in the bank, so to speak, before we do so. But if you just think about how the pandemic has changed customer behavior and accelerated even further the migration to digital and online and some of the things that Anthony talked about, we believe that, that will allow us to, again, look even harder at our physical network and take even more branches out over time than what we would have originally thought. We have about 5.5 million square feet of space across our company. And I would expect that we could take out anywhere from 10% to 15% of that space, maybe even more, over the next couple of years as we figure out what work from home or back to work looks like. It's going to be different. We're going to need less space because of our merger, of course, but the pandemic is accelerating changes in the amount of office space that we'll need. And so those are two. Anthony is expert at a lot of process improvement that we've seen from IBERIA, and we're porting a lot of that to the First Horizon side over time in terms of robotics and RPA and those types of things. So those will also be part of our ongoing plan. So I feel very good, again, about the $170 million. I feel like we're going to get beyond that. And we've -- we'll continue to -- as we have as separate companies over the last several years, continuously look for expenses to take out that we don't need anymore.

Okay. Great. Anthony, did you want to say something as well? Or are you good?

Look, the only other thing you asked about that, I guess, we really haven't officially touched on, so I want to make sure we're very thorough in answering the questions you ask us. Culturally, we thought the banks coming together, we were very culturally aligned. I'd say now that we've kind of been married for effectively a year, I think that we can tell you that, that still is the case, and we feel really good about where we are from a culture perspective.

Great. Why don't we just talk about -- remind us of some of the revenue synergies, opportunities there are with the combination and kind of when do you think they could start to materialize?

Sure, Gerry. I'll take a stab at that one. 2 that we've already seen pretty good traction on already are from legacy IBERIA bankers utilizing First Horizon's asset-based finance business. We've seen several referrals coming across already there. And then from First Horizon to the IBERIA side, on equipment finance. So those 2 areas have been fairly active. And so we're pleased to see some early performance there. Longer term, we believe that private decline in wealth is a big opportunity for us in terms of penetration, particularly on the legacy IBERIA side and in that footprint. And then on the treasury services side, cash management side, we believe that there's much opportunity for us. Anthony will probably touch on the technology and the improvements that we're going to make to our platforms there, which are needed as we become bigger, but we're confident that we can capture more revenue opportunity there as well.

Yes. Look, I would just echo kind of from an IBERIABANK, legacy IBERIABANK perspective. I think the big thing that I look at kind of coming from my old CFO chair is really the ability to broaden the product set that our bankers on the legacy IBERIABANK side have access to now. So BJ hit on a bunch of them. I particularly think, over the long term, the wealth products themselves are really something that we would had made a, I'll call it, a dedicated effort to try to really improve on. And so we, as IBERIABANK, jumps really significant steps ahead. So I would expect to see some really good traction particularly in that one category over the next couple of years. And then certainly, the loan product and the loan suite, really, for both organizations is so much broader and deeper, should be a natural fit for us. And not to mention the capacity of the balance sheet and much larger organization really gives us the opportunity to step up for some of our larger clients and possibly lead the -- sorry about that, and possibly lead on some transactions and really drive some nice revenue to the institution.

Okay. So equipment finance and asset-based lending is kind of the low-hanging fruit of where you're already getting traction initially. And then private client, wealth management, treasury, client services, all that is going to be, is that in motion at this point? Have you started to get those -- the synergies working through both organizations at this point?

We have. And we have started the early tracking on those. So we update that monthly. And we have specifics around where the referral came from, and too, the size of it in terms of the balance sheet or revenue opportunity. So once we have a good amount of traction there, we would expect to share those types of results like we did on the legacy First Horizon side with the Capital Bank acquisition.

Okay. Great. Let's move on to something not in your control at this point, the macro and the environment. First Horizon, similar to all banks, you're products of your environment. So I was curious if you could generally speak to your macroeconomic expectations across the different markets in which you operate?

Yes. Well, I would say that we are fortunate to be, we believe, in one of the most attractive footprints in the country. Even in the pandemic, we believe that the Southern states in which we operate will grow at a pace that could be 25% faster than the rest of the United States. And if you look at the metrics around economic growth, or income, or the bounce back in the unemployment rate, that bears out in terms of how the Southern states are being resilient. So we're pleased to be operating in those markets. It's hard to beat the Fed when they drop rates as quickly as they do, and give the commentary that they do for low for long. But again, I think that's why we feel really good about the countercyclical businesses that we have in addition to the attractive footprint. So while we can't control, as you said, the environment, we can try to mitigate it as much as we can and take advantages of businesses that will be helpful to offsetting any rate impacts.

Okay. Thanks, BJ. I mean looking at the -- based upon the duration of your securities and loan portfolios, how long will it take for the portfolios to reprice so that the yield in the books are equal to the reinvestment rate, assuming a stable interest rate environment?

Yes, it's a good question. So I'll start with the biggest on the loan side. So the loan book, we've got about 60%, 62% of the loan book that is variable, really tied to 1 month LIBOR. So those have obviously repriced already. The balance of the portfolio is fixed. And we would expect it to reprice probably over a 4-year time period. And on the securities portfolio, we just marked the IBERIA book, as everybody obviously knows. So that book probably makes up 35% to 37% of our current securities portfolio. So they have been marked-to-market already. And then we expect that the duration of the portfolio, in general, is going to be about 3 years. So it's going to take a while, obviously, to work through, much like we saw coming out of 2008, 2009, it did take a couple of years to work through the reinvestment versus [ back ] book rates. But we're managing it as best as we can, and we'll continue to do so.

Okay. Why don't we shift gears just over -- I mean, it's been a popular topic for the industry and just kind of wonder if you could share your thoughts and describe some of First Horizon's specific technology investment spend plans, and maybe speak to the motivation behind these investments, efficiency, competitiveness, customer satisfaction. And I'll throw it all in at once, and just kind of maybe touch upon like how COVID-19, the pandemic, has perhaps even accelerated some of these plans?

Yes. So what I'll tell you is, what COVID did is it really accelerated all the things that we've been watching as an industry happening for the last 5 years. So if you think about online account opening, activity through digital channels, right, branch traffic being reduced. What COVID did is it basically just accelerated that pace. And so all the same trends that we all worried about for years, those have just been pushed forward and are now more pronounced. I think what that means for us at First Horizon is really a focus on the quality of our digital experience. How good is our customer experience working through this digital channel, the ease of use? So what I'll tell you is, certainly, we've got a huge focus in terms of our integration, making sure we get those systems right. And what I mean by right is that they work for our customers, they're scalable for us for the long term. And there's some -- they're resilient and we're not having to do rip and replace 2 years after we go through this exercise. At the same time, we're really focused on investing our capital around what drives our business. And in particular, how patterns are shifting for our customers, right? So with that, you've seen some fairly significant expenditures really in the digital space. We just recently moved all of our digital off to the cloud, for instance, which gives us unlimited scalability, the ability to create numerous test environments so we can rapidly introduce new feature functionality within the digital mobile app. We're in the process of doing a large, I'll call it replacement replenishment of almost the majority of our treasury management products, really to bring us, I'll call it, well above peer average in terms of capabilities. And at the same time, right, as BJ alluded to, we are focused on using some of our knowledge with RPA, for instance, to really, to analyze what can we do from an efficiency, back office perspective? And what we've seen is that, that technology is slowly starting to ramp-up in terms of utilization within the new company. So again, it'd be hard to sit here and tell you there's one pre-defined focus that we're working on. I think what I would tell you is we recognize that the ground is moving. We are reacting to that movement with a real focus on making sure that we put dollars against really what drives revenue and creates the best experience for our customers that we can.

When you -- I mean, obviously, you have a lot of things you've touched upon there. I mean, when you think about it, and I don't know if there is a rule of thumb for you guys at this point. But you think about your operating expenses and you think about the investment spend dedicated to tech. Like what percent do you think is the right level on an annual basis?

So like here's what I'll tell you. I think on a go-forward basis, we'll probably land somewhere between 7% and 10% of revenue in technology spend. I would caveat that, though, with -- and you say, wow, that's a big range. And the reason for that is, it will be interesting to see where revenue goes over the next couple of years. I can't give you a good number of where we exactly sit today because we're kind of doubled up on a lot of expense. But I do think that 7% to 10%, using the backdrop of what does the environment look like and what's a prudent level of spend, will kind of push us one way or another with inside that band. The other thing I'll tell you as a company is I think you're going to find that we're really going to move away from, I'll call it, waves of investments more into a steady state. I'm not a big fan of kind of going through the hills and the valleys of investments. I think it leads you to be naturally where you fall behind, and you play catch-up, which really constrains your ability to really advance the ball on things that you want to. So I think you should be expecting from us to have a more steady state of investment relative to technology moving forward.

Okay. Unless there is anything else you want to add on tech, I want to switch over, you talked about the fee income businesses, and maybe we can touch upon those for a bit. First Horizon is -- it is unique for a bank its size to have such a strong fixed income business. I'm just curious how activity levels are today, and maybe we can talk a little bit about this typical seasonal impact versus the elevated activity levels from existing market conditions.

Sure. Yes. So our fixed income business has done exactly what we thought it would do, which is in an environment with market volatility with falling rates, it has worked and worked incredibly well. What we're seeing so far in the fourth quarter is activity levels about on par with what we were seeing in the third. Now the holiday seasons around Thanksgiving and Christmas and New Year's always are a little bit slower. But generally, we're still seeing very good fixed income results into the fourth quarter, which is great. And we would expect that to continue for the foreseeable future, given our assumption on continued market volatility as well as low rates. And if you step back, Gerry, and again, I'll talk about all of our countercyclical businesses: fixed income, the mortgage origination business and the loans to mortgage company business. Just to give you an idea of the magnitude of offset that they're worth, from -- if you look at 2019 on a combined company basis to 2020, we would expect that we would have an incremental $300 million of revenue above 2019 levels from mortgage origination, loans to mortgage companies and fixed income. That is a significant offset to rate headwinds. It's up 3x in the mortgage origination business. It's up 2x in the loans to mortgage company business, and it's up about 70-ish percent or so in the fixed income business. So this is why we think that the business mix that we've got now and going forward is helpful, because when rates do eventually come back, those businesses will certainly moderate. But they are a great counterweight to what we're seeing today, and it's allowed our revenues to be higher than what they would be with a predominantly spread income business. So we'll continue to foster those fee income business and augment them, like Anthony and I talked about earlier, with private client and wealth introduction across the IBERIA footprint and then a deeper penetration in treasury services across our commercial client portfolio. So we've got continued opportunities to grow fee income, which is a big focus of ours.