First Horizon Corporation (FHN) Earnings Call Transcript & Summary

All right. Up next, we have First Horizon. Before we start, I'm going to get some disclosures out of the way. For important disclosures, please see the Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. The taking of photographs and use recording devices is also not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. We're delighted to have with us today Hope Dmuchowski, Chief Financial Officer of First Horizon.

The disclosures get me choked up too.

Yes, I know. All right. So Hope, when First Horizon announced termination of the TD deal in early May, you also announced that you will be hosting an Investor Day in 1 month. And that was at a time when the industry was going through a lot of turmoil. Can you talk a little bit about that?

Yes. Hard to believe that we've pulled it off in 30 days, so proud of our team and what we were able to accomplish. But we had 15 months of not talking to investors, not because we didn't want to talk to investors, but nobody called us. We released earnings, releases every quarter. We still put out a deck. And with the $25 share price, everyone kind of looked at what you did and moved on. And there is so much information that we were not sharing at that point. We didn't have normal Q&A during conferences and investor calls that there -- the information vacuum, the only way that I could see to solve it was to hold an Investor Day. Short of having an Investor Day, we couldn't really talk to our investors. The top questions we were getting were around retention, deposits. And you can't -- because of Reg FD, you can't answer that for one person. And so days seems like the most that we thought we could buy with, "Hey, just give us 30 days and we'll get our story back out there." And we -- it was so exciting. We weren't sure telling people in 30 days when you come to Nashville. We had almost 40 people attend. A lot of the sell-side analysts have reengaged with us since. And so it was great to tell our story, but a little bit unnerving to host an Investor Day in the middle of a banking crisis, bank stocks overreact every single day. I was actually meeting with investors today when the news dropped that we'd have no rate hike and the next thing investors said to me was all bank stocks are down. It's like, well, would they have been up, if we were up 25 basis points, there's no tailing. And so really excited to have it behind us, really excited about the outcome we've heard from the sell side, investors and glad to be able to tell our story again. We've been doing great things for the last 1.5 years.

Perfect. I think sometime we can get not blindsided, but we can have blinkers and just look at the near term. But as we look at the longer term, talk about what attracted you to First Horizon because you joined right before the TD deal was announced, right?

I did. On my 60th day, I actually woke up that morning got e-mail that says, "Congratulations on your 2-month anniversary at First Horizon" I felt all good about myself. Walked into the office, and Bryan Jordan came in my office and said that we had an unsolicited offer from TD to purchase at $25 a share and ask me how I thought about it. I said my personal side or my professional side. And so start with the professional side of, it's a great deal and we had to accept it. The personal side with I had to go home and tell 3 kids that I had moved the third time in 4 years from my career that we didn't know where we were living next. So it was a little bit chaotic. We went into a 30-day due diligence. Typically, you have a much longer due diligence banks when they enter into mergers will enter right after quarter end, give themselves some time TD being on a Canadian calendar. We had they kind of worked right between that. So we had a 10-Q coming out. So we only had -- or we had an earnings release coming out. So we only had 30 days to do all the due diligence with TD. And so my first 60 days was trying to figure out my team and had my first earnings call, the next 30 days, we're doing due diligence on TD in the 15 months since we're working under a TD merger agreement. So it's been a little bit of a unique experience as a CFO to start your career with a bank and have this much change in uncertainty in the bank. And then you add what's happened in the macro banking environment, it's been a fun ride. What I'll say though is, it has been great to see how First Horizon rises to every challenge, whether it's an unexpected merger for us. We had just completed the IBERIABANK conversion 7 days before we announced the TD merger. Bryan and I said on an earnings call 6 weeks before we announced the merger and told our company, we're done with mergers. We're going to take a break, both IBERIA and First Verizon had done a lot of mergers. And we said we're going to -- we're proud of the company we've built. This is the right size and scale for us. And then 6 weeks later, we tell them all were bought. So it has been amazing to see how the First Horizon employees at every turn, have risen to the challenge. And everyone keeps asking, well, what happened at May 4. It was just one more opportunity for First Horizon to show up and say, okay, so we're not going to be bought by TD, but we have a great franchise. We have great products and let's start talking to our clients again.

So that's great. You provided a lot of great information last week at the Investor Day. One of the things that investors were surprised about what are the retention numbers, right? So that just goes into what you are saying right now. Can you talk a little bit more about the retention efforts and also any ongoing initiatives that you have there?

Yes, absolutely. So we did share that in bank space, we've kept all of our regional presidents. 98% of our top bankers -- or top half of the bankers we've retained through the last 2022 and 2023 and 96% of our top-tier employees across the company, we've kept in the last 1.5 years. And so there's a couple of pieces that. One is people that are at First Horizon have a long tenure. They're at First Horizon because they like the culture, they like the client environment. They like the decisions are made closer to the client. And the second part is we did add a very nice retention payment in with the TD acquisition. Right after the TD acquisition was announced, we had $150 million of retention that was pretty broad-based, hit almost all of our employees and that stays in place after the merger was terminated. And so what happens is the legal day 1 was considered day 1 for the merger for the retention payment, and it accrues over 2 -- 1, 2 or 3 years. And now the termination date of May 4 is when that will lap over the next 3 years, we still have our attention on our employees.

Got it. Let's take a step back. Let's talk about the macro environment a little bit. It's changed a lot over the past year. We had the Fed speak today, keep rates flat I guess. What's your view on where interest rates are going to go from here and your outlook for the economy as a whole?

Well, I'm glad to speak after the Fed made their decision. I'm glad to see that they held flat. I'm hopeful that we're going to see a stabilized interest rate environment for the rest of the year. Hopefully, no decreases, no rate increases. I think the economy and the banking system, the customers can all use some stabilization. And for me, stabilization, no increases, no decreases. I do think for the next 6 months today really signals that we're probably at the rate we need to be at, that they're seeing the economy respond the way that they wanted to and that hopefully we're going to be stable for the rest of this year. And then we'll talk about 2024 as to whether we see rate cuts or not.

And what are you hearing from clients on the macro front as well, right? Because there's clearly a lot of uncertainty out there. So can you talk a little bit about what you're hearing from clients?

Absolutely. Our clients are adjusting to a changing environment quicker than they've ever seen in their lifetimes. And so whether it's rising inflation that they're dealing within their businesses. We hear from our clients all the time about the competition on getting labor, the cost for labor as well as the rising cost of running their business with inflation. And so we're really looking to -- our clients are looking to us as to how do I think about the next couple of years. What is the right credit facility for me. Recently, they have become hyper aware post Silicon Valley of the very highly competitive deposit industry. And so we're coming out of almost 10 years of near record low where your deposits filed your primary relationship. And most of our core clients weren't hopping money between different banks. If you were their client, their primary client relations with you. Now they're shopping their deposits. And we're seeing even different behavior. And so having to talk to the clients about a full relationship, how does that look? How do you think about not just the cost of your loans, but how do you put your deposits to work for you?

So it's a lot about the all-in relationship, right? Like you have to have the deposits come through if you want the loan.

We prefer that. I won't say I don't want it out there that we're only doing it, but we do prefer to -- and we have had a long-tenured client relationships. One of the stats that we shared in our first quarter deck as well as an Investor Day. We've had 98% client retention in 2022 and 2023, and that comes from having a long, deep relationships.

Got it. Maybe talk a little bit about the geography that you're in. You're across the Southeast. It's a pretty attractive geographical footprint. You have a sizable market share there. Talk about what you're seeing in the markets today.

Yes, the Southeast markets are just booming right now. They continue to see growth. We chose Nashville as our site for our Investor Day and the question I asked everybody, they would ask me, why did you choose Nashville and we go through a thriving market and ask them all, "How many cranes did you see?" And nobody gave me the same answer because if you'd come from one side of the airport depending on where your hotel is, there is at least 12 construction projects going on in Nashville, and there has been for the last decade, and we see that in the Southeast cities. When we look at data on what's happening in the U.S., the influx is leaving the West Coast and the Northeast and coming to the Southeast markets that we operate in. There's a great slide in our investor deck of our top 20 markets and how they overlap with the best performing markets in the U.S. So I think it's a great time to run a Southeast franchise. I think when we look forward to how is our credit going to perform, which is one of the big questions, I always tell one look at geography, use these national numbers of office vacancy and that's not what we're seeing in the Southeast.

So what are you seeing in the Southeast? Is there like fewer vacancies in office, lot more household growth.

We're seeing fewer vacancies in office, household growth. Mortgage prices continuing to rise in some of our markets, very, very competitive competition for top credit.

So what does that mean for deposit balances, right? Like that's been theme of this conference, everyone is focused on deposit balances, migration from NIB to IB deposit betas. I think you disclosed at Investor Day that you actually grew deposits versus the end of the fourth quarter I think -- versus the end of the first quarter. And I think you mentioned that deposits were up $1.5 billion in May. So can you talk a little bit more about what you've seen so far and what your efforts have been in the deposit side?

Yes. We saw a great May. I think one of the biggest questions we had going into our Investor Day, and we had dinner with the investors the night before, and we said, how bad was your deposit runoff after May 4. How bad was it after you announced TD? And so we got up on stage, I got to say, you all asked the wrong question. It wasn't how bad it is, it's how good was it? And so we are operating in the Southeast, which has the ability to grow household growth, ability to grow deposits. But we've seen significantly positive momentum in the last 30 and 45 days as we've distanced ourselves from the uncertainty of the TD merger. And so we did have high deposit runoff in 2022 and 2023. But when you look at our balance sheet, we were sitting on approximately $15 billion sitting at the Fed of 2022. And we let that run off because we were seeing very, very competitive deposit pricing close to Fed funds. And to just park it at the Fed, we didn't need the deposits. And so we turned the corner really in January and say, okay, we've now let our excess deposits run off. We have a normalized balance sheet on the deposit side, we need to get aggressive with deposit campaigns. So we did launch in February deposit campaign. We've relaunched our virtual bank, but we really didn't see the traction until after the uncertainty of the merger was taken out. We saw more new-to-bank clients come in. Clients move their deposit balances back to us. When you're talking to a client and you're guaranteeing them rate for 12 months or 18 months and indexing off Fed funds, they know that we're going to honor that. They didn't know what was going to come on the other side of the merger. We've continued to see a lot of momentum and a ton of engagement from our bankers with both existing clients and prospects.

All right. Perfect. And then I guess the flip side of deposits is loan growth. Can you talk a little bit about what you're seeing in the markets? A lot of banks have been tightening their credit standards. So what are you doing? And what are you seeing from competitors?

We're absolutely tightening our credit standards, and we have been since last year as we're starting to see the outlook, that was going to be recessionary. We started to look at our book at just a little bit of a tighter glance. We always lend with a risk profile on credit that says, how is this credit going to perform through a cycle, not how is it the big -- best spread today? Is it the biggest amount that we can book, how is it going to perform. And so we feel we have a diversified portfolio that will performs well and as far as new originations, as deposits are shrinking out of the banking system, we do have to slow loan growth. I said in Investor Day that we expect it to moderate in the second half. We're about 3% to 4% in the first half of the year, and we expect that to moderate in the back half. We're being selective. We'll start with -- our balance sheet is for clients. We are a client-focused bank. We like to have long, deep relationships. We want to make sure that we have the capital to service our existing clients and when we go out to market to bring new clients in, we're looking at full relationships. We're looking at good spreads. And so when you're sitting -- coming off 3 years of near 0 interest rates with so much excess liquidity, the question we got was, why aren't you lending more, why aren't you lending more? And to your point, the question every CFO is getting today is, how quickly are you shutting that down lending? And so we're being very, very thoughtful about every new lending relationship we enter into right now.

And is that true across the different loan categories, whether it's C&I or CRE, resi it goes in to top 3?

It is. Yes, we're -- absolutely we've not shut anything down. We're not announcing that we're shutting down any verticals or getting out of any businesses. We're still here to use our balance sheet to support our clients.

Got it. And then can you talk a little bit about the credit environment? We've -- we're coming out of a pretty benign credit environment. A lot of investors are concerned about CRE more so than anything else right now. But you are -- you do have charge-offs, delinquencies normalizing across different types of loans. So can you talk a little bit about the credit environment in general? Specifically in your markets? And then also how you're feeling about your portfolio?

Yes. As I mentioned earlier, our markets are performing better from a credit perspective in the Southeast since we don't have the vacancy and the outflow of people. We're actually seeing an influx of people in our market. On the credit side, we've worked really hard in recent years through multiple acquisitions to be really thoughtful about how do we position our balance sheet. What is the right diversification mix. And we really focus on diversification mix. So if you look at our Investor Day, we talked about our regional banking. And then we talked about our verticals that exist in the specialty bank, and we really look at not having any significant concentration risk either by a vertical or geographic within one state or one MSA.

So I guess when you think about the macro overall and you think down 1 year, 2 years, 3 years, there's a big debate out there, right? Do you see credit spiking as we go into the next year or 2? Or does it play out over a period of time? Do you have any thoughts about what that means for the industry?

My personal opinion is that we are going to see credit increase. You're going to see charge-offs increase, you're going to see nonperforming increase, where we are in a rapidly rising interest rate environment. Sometimes that has a lag on the impact it has on the business' performance. We have rapid inflation that we're still trying to get under control. And I think as some of these credits go to renew, there's going to be less people willing to take that credit. And it used to be easy in the last couple of years, there was a lot of excess liquidity that if you don't want the credit, somebody else would take it. If somebody else is not willing to know that it will turn into a workout. I do think we'll perform better through that, but I do think we're heading into a credit cycle. Whether we head into a deep recession, a long recession, I think it's just the lingering impact of everything that's happened in the last 18 months that hasn't completely hit the client's balance sheet yet.

And where do you think private credit comes in here. We've seen a lot of articles out there about private credit willing to become partner with banks, willing to be the balance sheet -- or willing to provide the capital that banks have historically provided. Any thoughts on where that goes for the industry?

I think there's a lot of talk about it right now because of the liquidity coming out of the big system. I'm not hearing that anybody is doing in that market. They're all looking for a discount. And so if you see some of the portfolios that have been sold off, they were sold at a pretty big discount. So I don't see that as a near-term option for us unless we start seeing it more of a partnership level. I think the private capital firms are out there are trying to make a pretty big turnaround on this. And they have enough banks that are willing to sell their assets or partner in an asset relationship like that, but I don't think it's in our near-term future.

All right. So maybe let's go to capital. Your capital levels are really strong. You noted a pro forma CET1 of 11.3%, how are you thinking about capital deployment?

So although everyone doesn't like my answer, I've got beaten up on this quite a few times today, and I expect more this afternoon and tomorrow, I meet with investors. In the near term, we're only 42 days right now past the TD deal kind of falling through. We're a week past our Investor Day. We're just got it added back to the KBW Index as of next week. And so we need to have a little bit of distance from the storyline that we had, the crisis that the banking industry has gone through. And then we're going to pay our capital to work. Whether we see that stabilization in 1 quarter or 2 quarters or 3 quarters, I don't have that looking glass right now, but our long-term -- as soon as we see the stabilization, our long-term goals to get 10% to 10.5%, and so we will return that shareholders -- that capital to shareholders in the best way possible as soon as we see some stabilization in both the banking industry and the economy.

There's also a lot of uncertainty around regulation. We had a report from the Fed on Silicon Valley Bank from the FDIC on signature. And it's clear that regulation is going to move up for banks of your size. What do you think about that? And how does that impact? How you manage your capital right now as well?

Yes. We're not sure if it's going to impact us just yet. Right now, there's a lot of talk of stopping at $100 million bank, so we'd be falling under that, but not leaving out that we could be scoped in the near future. So when I talk about what should be our longer-term capital target of 10% to 10.5%, I do think even if they move the regulatory minimum up to 7.5% to 8%, that's still 200 basis points over that. It does play into how we think about how much capital we would deploy how quickly, though, in the near future. We do need that to settle down. We need to know what are the new capital requirements for banks, when are they going to go into effect and make sure that we have adequate cushion to cover that.

What do you think the regulators will change. There's a lot of talk about mark-to-market on AFS securities going away. LCR, potentially TLAC, maybe even the stress test although not for banks of your size, but any thoughts on what the regulators will do here?

I wish I had a looking glass on that in rates, and I'd be the best CFO in the business if I had those nailed down. But I think it's going to be iterative. I think there's going to be a proposal. There's going to be a lot of feedback too. We just had a CEO roundtable in D.C. last week where we got to talk to the regulators about some of this. I think it's going to be an evolving landscape. We saw the request for capital to increase through the U.S. Bank acquisition. And so in order for U.S. Bank to acquire MUFG, they had to agree to that higher capital. And I think it's not new coming out of Silicon Valley. I think they're still trying to figure out what is the right capital level and what does that look like longer term for all the banks. And whether it's the G-SIB, the mid-cap, the large caps, I think we're going to have to iterate on that. I think they're looking at Silicon Valley and because of Silicon Valley, they're saying, well, let's take the held to maturity and the AFS portfolio and lump that in for everybody up to a certain point. I don't know they're going to be dumb coming up with capital rules anytime soon as a CFO, whether we get through this crisis, the next one, I think it's just something we're always going to be talking about in our industry, especially as we see bank consolidation in the coming decade or so.

And I think the regulators have been pretty clear that there will be a long phase-in period as well for any regulations that come in. What about on the liquidity side? Is that something you're focused on even if you don't get a formal LCR regulation, how do you think about managing your liquidity.

Liquidity is a top question we all have always, but has definitely gotten a heightened sense post Silicon Valley. The amount of money that can lead your bank very quickly, especially as Fed now is going in, and you're going to be able to see it move even quicker, 24/7. So we're looking at how do you think about liquidity in more of a stress scenario. We really haven't done a stress scenario as an industry of what happens in a 24 hour, what happens in a 48-hour, really what happened to First Republic and Silicon Valley, I think, has us all rethinking how we think about those funds. One of the interesting things coming out of the Silicon Valley kind of postmortem was they were -- they had their assets to pledge to get their liquidity, and they just ran out of time. And so that hasn't all thinking are we pledged in the right place the FHLB certain days couldn't meet all the funding. So a completely different way of thinking from a more of a stress scenario than how we were thinking before. We haven't seen a 24-hour run on the bank in the last decade or so, at least not in my career. And we're having to think about how would you play that out. I will tell you with the TD deal following through. We had those discussions of what could 1-day run in our bank look like? How do we position's for that? So you're constantly -- I think every bank out there is constantly thinking about what could a 1- or 2-day run look like.

And what does that mean for the balance sheet? So clearly, it means holding more cash, but does it also change how you manage the duration of the securities book?

I don't know that it changes for us because we have a very prudent model when it comes to securities. We only have 13% of our assets in securities, which compares to our peer group of 22%. We were already pretty late light on that portfolio, a lot of that's used for hedging downside risk. But I think as an industry, absolutely, you look at duration, but at the same point, those assets can be pledged and they cause liquidity. So think about the assets you put on your balance sheet from an interest rate sensitivity as well as the ability for them to be pledged and create liquidity in the right environment.

Got it. Maybe shifting gears to your -- at your Investor Day, you announced that you've been investing a portion of the merger termination fee. I think it was about $225 million. I think you're -- you plan on investing that in your technology, people, platforms. Can you dig in a little bit on your plans there?

We -- for the 15 months that we sat under the TD merger agreement, we're still doing technology investments. We weren't doing major system overhauls. We weren't implementing new systems. We were doing [ McCarran ] feeding the run the bank stuff. Prior to that, we spent 18 months with the MOE between IBERIA and First Horizon getting to the best of both. So we have a lot of enhancements, a lot of overhauls, new systems that we can and will put into play. We look at what the timing for that is. And we thought 3 years was the right horizon from our duration perspective for what is the amount of change that our bank and our clients. And you can say, why don't you go do it all in 1 year? All clients can only handle so much the company, we can only put so many new systems or enhancement in 1 year. So over the next 3 years, we're going to -- we're working on a road map right now. What are the systems that need to be enhanced, what are the new systems we have, what are the end-of-life systems, and we're rolling out a 3-year road map to get us back to where we want to be at the bank, and then we'll return to a more normalized spending level. One of the things we shared at Investor Day is we did lose a lot of technology resources in the last year. I don't know that we lost any more than anybody else. We were in a highly competitive recruiting environment. So people were seeing 15% and 20% turnover [indiscernible] was recruiting. It's really hard to recruit somebody new into the bank saying, we're not sure what your job will be after TD comes in. We're not sure what city it will be in. We're not sure what system you'll be supporting. And so we have a lot of contractors in. So part of that is getting back to a really strong employee base.

And how quickly do you think you can do that in terms of getting a -- getting the employee base at the right size?

It's an interesting recruiting environment right now. I -- myself; I'm recruiting for multiple key roles. People are a little bit nervous about changing banks now. And so a year ago, people were chasing the highest retention bonus, the highest buyout. And right now, people are a little bit more uncertain about changing banks. It's kind of the situation you know you feel a little bit more comfortable with. And so I think it's going to take us a lot longer to hire than it probably would have a year ago. Even though a year ago, it was more competitive. I've seen in my own recruiting that people are more willing to move the year ago. It's not just First Horizon. Even friends I have that were out there interviewing are now like, well, I know my bank and I know how my bank is going to perform and how my incentive plan is going to work. I'm not sure about the other banks. So I do think it's going to take us a little bit longer because of the uncertainty in the banking environment to build back up some of our core functions.

Got it. And maybe pivoting over to the business outlook. I mean, I think you spoke a lot at your Investor Day about your business model, the countercyclical businesses that you have, how should we think about how those will perform over the next several quarters?

Yes. One of the reasons I'm excited about a rate pause today and hopefully not seeing any more rate decreases or increases years, it helps our bonds. It's really hard for our FHN business, our capital markets to sell bonds in an environment where you're looking at this year, rate hikes in the first half of the year, decrease in the back half is like, what do you want to bond for. And so hoping that our FHN business will come back in a more normalized rate environment where we don't see as much volatility. Also, we're seeing some pickup in mortgage warehouse the last couple of months. We're starting to see that business pick back up from really a pretty significantly lows. I'm hoping both of those businesses are starting to recover and that we'll see positive momentum in the back half of this year and going into next year that will help offset the NII offset -- the NII compression we have.

And is some of the competition moving out also helping the mortgage warehouse business?

We just had that announced yesterday -- or 2 days ago here at your conference. So we'll see. I don't know if they're actually out of that yet, but I'll call my mortgage warehouse guy in a week or 2 and ask him how you're seeing it. But definitely less competition always helps.

All right. Perfect. And then maybe to wrap up, can you talk about how we should think about your longer-term targets?

Sure. we're really thinking about being a top quartile performer, where we have a slide in our investor deck where we talk about our margin, our efficiency ratio, ROE, ROA. And we are top quartile right now against the BKX peer group. And we continue to do that. We're not taking our foot off the accelerator that our target is long-term shareholder return and consistent returns through the cycle. We think we're well positioned to do that with our countercyclical businesses as well as our asset-sensitive balance sheet and 66% of our balance sheet is in floating rate.

Perfect. And then maybe if you can just touch on what is the one part of the FHN story that is not well understood from investors? What is the one message you'd like people to go out with.

I think the one thing that everyone is still reacquainting themselves with is how strong First Horizon is after the MOE. We had just completed the conversion of our IBERIA clients, we hit our $200 million of cost saves. We have 66% year-over-year growth in Q1 and it's a show-me story now. It's -- we were telling you that we're a strong franchise. We're telling you that we have strong countercycles. We're telling you that we're a top quartile performer where we can. We were telling you that we have top capital that we can return to shareholders. And so we are going to continue to do that because we have a really, really strong franchise of dedicated employees with long client relationships that are here and they're fueling this momentum through whatever cycles to come. for me, whether you talk about increasing 50 basis points or decreasing 50 basis points, I have a top-performing bank.

All right. Perfect. Hope, hanks so much for joining us today.

Thank you.