First Horizon Corporation (FHN) Earnings Call Transcript & Summary

After a 1-year hiatus, we're pleased to welcome back First Horizon at our conference. It's been a busy year since reintroducing its strategy of the market, FHN has produced solid results across both lending and deposits, continues to maintain best-in-class capital. Here to tell us more about the story is Chairman and Chief Executive Officer, Bryan Jordan; and CFO, Hope Dmuchowski. Bryan is going to walk us through several slides, and then we will have a fireside chat. Bryan?

Thank you. I will attempt to be fairly brief with these. I'll start the forward-looking slide. And I'll actually pause longer on it today than I probably ever had in my entire career. There's a footnote on one of these slides somewhere that says, we're using the forward curve, I think, it's November 28. This is kind of an environment where you've got to put 3:00 a.m. or 8:00 a.m. curve because they're moving that much. So everything is to mention based on how rapidly the market is moving, but we'll give you our best sense of where things are headed. I'm very optimistic about our business. I feel very, very good about the trajectory of the business. We've been through an interesting year maybe to understate what's happened over the course of, really, the last 2 years with respect to our business. But our people have hit the ground running hard. We're very, very well positioned. We've seen great customer engagement. We've seen great associate engagement and excitement. And we feel very optimistic about the outlook for our business given a bit of an uncertain backdrop where the Fed is having its intended impact of slowing the economy. So we're very optimistic. You can see sort of the key drivers of our business: Strong capital base, with a little over 11% CET1 ratio. We feel very, very good about our associate retention and tenure. And then we've got some of the best footprint in the U.S. We serve the South. We've got great markets that we serve, and our associates are doing a fantastic job of growing with these markets. In this Slide 4, we've laid out a little bit of information with respect to our outlook for 2024. I think this is where we actually have, using the 3:00 p.m. curve on 28th, we believe as we look out across the year that we are going to grow PPNR in the course of 2024. In the past, we've talked -- in fact, in our earnings release in the third quarter, I talked about operating leverage, with rates coming down a little bit. I don't know whether it is, in fact, positive operating leverage if you focus exclusively on the overhead efficiency ratio. But I do feel very good about our ability to grow revenue at a faster rate than we grow expenses, thus driving positive PPNR results for 2024. We've talked a lot about the net interest margin over the last several months. And we have -- I think in a unique position, we -- coming out of the termination of the merger agreement, we hit the ground running. We raised about $6 billion in deposits, about 32,000 new-to-bank relationships, great customer activity. And in those results, we took a lot of the deposit beta out of our deposit cost. And in the last few months, we have been working on repricing that. And at a point in time, we have actually seen a slight drop in deposit costs. It's a mixture of a couple of things. One is, these maturing specials are being repriced at slightly lower rates; and 2, you're getting a little bit of a mix shift in that noninterest-bearing deposits continue to run down, and you see a continued growth in interest-bearing deposits. I look at the balance sheet, as you would expect, on a daily basis. And if you look at our balance sheet today, for the quarter, loans are down something like 1% or so, about $800 million or $900 million, and deposits are essentially flat. You have to keep in mind that these numbers can move $300 million, $500 million in a given day. So essentially, the balance sheet will be flat. Deposit retention and deposit growth is still good. We're still seeing growth in our noninterest-bearing deposits. You see the drivers that we've enumerated here. Loan spreads are improving a little bit. We're not -- we think we've got the capital base to grow loans. We're not expecting a tremendous amount of loan growth over the next year or so simply because the economy is slowing and fewer and fewer deals actually pencil out. But all in all, we think there are many more tailwinds to improving our margin, not only here in the fourth quarter, but over the course of 2024. We're focusing a lot on operating the business efficiently. We've got an expense guide here that shows somewhere in the 4% to 6% range. It's really a multitude of factors impacting that. Some of that is the onetime retention awards that we made in connection with the merger. Second is, we've made about somewhere -- we're going to make somewhere between $75 million and $100 million of investments in technology and infrastructure. These are things that, at the end of the day, will position us in a very strong position. Some of it is deferred maintenance where we're on release 3 of a system where we ought to be on release 6, 7, whatever it happens to be. All of that will work its way into the expense base. But at a very core level, we're expecting to manage other costs essentially flat to up just slightly. We expect wage costs will be up slightly in the 3.5% area for 2024. But overall, we're very focused on controlling expenses and trying to invest in the business, and at the same time, keep our cost structure under control. We've delivered on credit quality throughout a number of cycles. You can go all the way back to the Great Financial Crisis, and the work we did really from 2009 forward to reposition the portfolio. This gives you a multiquarter, multiyear view of it. We obviously had the non- the idiosyncratic loss in the third quarter of this year. But as we look at credit for the rest of this year, and really into 2024, we don't see a tremendous amount of deterioration. And while we haven't laid out sort of a range for it, I would expect that credit costs in 2024 will not look a whole lot different than it did in 2023 in the aggregate. I think credit continues to perform well. Borrowers are in a good position. We feel good about, not only where we do business, but the approach we've had to diversification, borrower selection, terms and structure of relationships. So we're fairly constructive on credit cost as we look forward. We have, as I said, a tremendous capital base. We're focused on using that capital base to drive shareholder value. We focus very much on return on tangible common equity. We're still targeting in the 15-plus percent area. We're running a little more tangible CET1 today than we would run typically in a normal cycle. But as we look into 2024, it feels asymmetrical. There's probably less upside than there is downside in the economy. We will, as we get into '24, work with our Board and talk about the possibilities for capital return of -- as opposed to allowing capital to continue to build. So, in my view, it's probably a period in '24 where we don't bring capital down very much, but we're not likely to let it grow a whole lot unless the outlook for the economy looks very, very different. So we think, working with the Board, we will have the opportunity to evaluate capital repatriation through buyback. We're in extraordinarily strong markets, and we feel very, very good about our ability to create shareholder value. So with that, I will stop, and Ryan will start the fireside chat without the fire side.

It feels like there's a fire in front of us giving the temperature of the room.

And that -- somebody put an extra log on.

I wanted to make sure we didn't fall asleep. Bryan, so maybe to kick it off. So we're now 7 months post termination of the TD deal. Maybe just broadly, how are things feeling at FHN? Are they back to normal? And are clients reengaging with the team?

Yes. It was -- it's really been an amazing time for me in the sense that I've had a very strong belief system about the engagement of our associates and the strength of the customer relationships that we have across our franchise. And it has really been an amazing thing to watch not only the strength of those relationships with customers, but the excitement and the engagement of our associates. And while it was an unexpected event in early May of this year, I'm really proud of not only the way our team landed on their feet, but the way they hit the ground running, and it was demonstrated in attracting $6 billion of new deposits in that time period in the second quarter, principally by getting out there and telling our story about First Horizon, that we're in the marketplace, not only for the near term, but for the long term and that commitment to customers and communities, and it's really shown a great deal of momentum. So our retention has been good, and I think we've got very strong momentum as we turn the year in a bit of an uncertain backdrop.

So despite an uncertain backdrop, Slide 4 showed expectations into 2024, which show NII growth, some fee growth and expenses, which are better than the last time we spoke. And you made reference that obviously, interest rate expectations are moving around a lot. I believe you said you used the forward curve to derive this. But maybe just talk about how you think about the ranges that you've outlined today, what is driving the different movements and how the different rate environment is going to impact your ability to potentially generate positive operating leverage.

I'll start and then Hope can clean up for me. We have used the forward curve. I think we did use the end of November. I think it's got implied in that forward curve, 4 rate cuts pretty much over the course of 2024. So we've used that. I personally don't think the Fed cuts that much in 2024, but that's -- we got to use something, so that's what we've used. I would say as we model the -- use that to model net interest income, we probably didn't flow that through to the same extent in our fee-oriented businesses, basically the countercyclical businesses, the mortgage and fixed income. So I think we've probably been a little bit conservative there. All of that said, I think the way we look at the business, we think we've got a lot of levers on the margin. We don't think loan growth will be a significant driver. So we think we have the ability to drive pretty strong net interest margin, net interest income improvement next year. We think our fee businesses will continue to do well. And when you couple that with pretty strong expense control, we think there's a pretty good opportunity to grow PPNR. To the extent that the margin comes in differently because rates are at a different point, fewer rate cuts or more rate cuts, we think we have the ability to manage through that piece of it. So I'm pretty optimistic when you take those ranges that you'll come up with a scenario that delivers a fair amount of shareholder value next year. I don't know what you'd add to that.

Yes. The only other thing I'd add is uniquely to us a little bit after the TD story is we did get to the top of our deposit betas. So part of our improving margin story is that we are going to be able to walk back deposit costs. A lot of our peers are just starting to come up to where we are, and we've seen good success with that.

Bryan, Hope, you both referenced deposit costs. I think they were 3.36% last quarter. They ended the quarter at 3.39%. Bryan, you made reference in your prepared remarks that they're down a little bit. Do you think we've seen the peak for deposit costs for FHN? What is helping you bend the deposit curve? Is it the repricing of the $6 billion? And what other levers do you have to drive deposit costs lower?

I think we probably have seen the peak, and I will stipulate before I go any further that we're not playing Solitaire. We're in a competitive marketplace and there are a lot of dynamics at play. But it does feel like the deposit betas have sort of run their cycle. And we've seen, at least through 3 to 4 weeks of starting to reprice some of these specials that we've got the ability to price these at lower levels. And most importantly, we've had pretty good deposit growth this quarter at -- I think the number, if I remember right, in the billion -- $950 million area. And they're at significantly lower levels than we priced in the second quarter of this year. So it feels like that has sort of worked its way through the cycle. And it also feels like, given the lack of aggregate loan demand in the economy, the competition has moderated its deposit pricing as well. So we think we've got the levers to moderate deposit cost, improve margin. And if I step back from that, I would say, look, we're not going to put ourselves in a position where we're losing core relationships. We'll continue to be competitive in the way we price deposits. We want to protect our customer relationships. But given the liquidity in our balance sheet, we've got strong liquidity. We're holding, in our view, excess cash at the Fed. We don't really -- have used any of our true wholesale sources of funds like the Federal Home Loan Bank, et cetera. And we've got strong liquidity. So we've got the flexibility to be dynamic and respond to customers, but at the same time, manage our balance sheet and our income statement.

Maybe to dig deeper, you talked about starting to see some renewals on the $6 billion of deposits that have come up. Maybe just talk about the repricing trends you've seen. And given the deposit growth you've seen, I'm assuming retention of these deposits have been pretty high. Can you maybe just talk to what you're seeing on the retention side?

Yes. We've seen good retention so far. As Bryan said, we're only a few weeks into the majority of this repricing. But we mentioned right out of the gate, we didn't see this as transactional money when -- we brought this in, in May and June. We said this is the opportunity to bring clients into First Horizon. We've been calling on these clients. We've been setting up appointments. We've been proactive with rate. We're not waiting for the rate to decrease on the statement and have them call us. We're reaching out, we're talking to them, and we're currently at about 100 basis points less is our existing deepening relationship. If they're willing to deepen it and bring more money to [ 490 ], but we're also not losing relationships. And so where we have to when we have to negotiate a rate, we're seeing that. We're being front-footed on that and seeing the rate come down and retain balances. So we feel really good about where we're sitting right now, Ryan.

And where we're using promotional rates -- excuse me, it chokes me up to talk about deposit. Where we're setting promotional rates, we're using 3-month promos as opposed to 6-month promos. So it gives you a lot more elasticity at the end of the day, if rates start moving at a rapid pace.

So maybe to talk a little bit about loan growth. I know you mentioned a couple of times that loan growth is likely to be soft. Maybe just talk, Bryan, about what you're hearing from your clients, what is the sentiment like? And how are you thinking about loan growth into next year? Where are you really seeing the best opportunities?

Yes. We think loan growth will be fairly soft next year. We will have some fund up of existing commitments, particularly in some of our commercial real estate relationships. I was with a great cross-section of customers last week in our South Central region. And I would characterize customer sentiment as still generally pretty positive. I didn't get the sense that people were completely pulled back. People were engaged. They're still forward looking and looking at opportunities. But we clearly have seen loan pipelines diminish. And given what we look at through the balance sheet flows, it just feels like next year will be a slower opportunity. We think we're pretty well positioned in that we're not overly concentrated in any one sector. We think we have adequate capital, adequate liquidity that we can lean in for opportunities, but it does feel like customer activity has slowed some.

And then I guess, given that you've seen slowing, but you've also seen improvement in pricing. And given how competitive you are, can you maybe just speak to what is actually driving the improvement in pricing? I know you were expecting that we could see further improvement given the slower loan growth into next year.

Yes. I think you're seeing it industry-wide, and it's easiest to see when you have multibank deals, whether it's a syndication or a club deal, everybody is looking for either better pricing or deposits or ancillary business. So those things are playing out across the industry. New-to-bank originations, we're seeing higher spreads than we saw a year ago. And on renewals, we're seeing somewhere in the 25- to 30-basis-point improvement in the renewal activity that we're seeing. And I think what you're seeing is a natural progression in that the cost of deposits has gone up and that's translating into a higher cost of borrowing, and our bankers have had pretty good success in managing through that. Again, we're not overly committed to dogma on it. We're trying to do what's right for the customer, with the idea that we're building long-term relationships and driving the profitability and the capital to be there for our customers for the long term.

And on Slide 5, you laid out a lot of the moving pieces on the margin. And based on your commentary regarding loan growth, it appears that the margin will likely have an upward bias to it over the next few quarters. Maybe just speak to some of the risks to that. So obviously, deposit costs would be one further mix shift. Maybe just talk about some of the assumptions that are underlying that, and where there could be risks to it.

Yes. The biggest one for us is really the forward curve. We are asset sensitive. So coming down quicker is not great for us. Higher for longer is better for our balance sheet. But as Bryan said, we're not playing Solitaire. And so it's really the competitive market where we've seen the competitive market for deposits really kind of come back to more normalized in the last quarter -- 3, 4 months as banks have kind of seen their loan growth slowdown. But if competitors were all start to increase their -- we're going to have to match it to retain clients. I think that's one of our biggest risks that we can't control. On the loan spread side, we're being disciplined. We're making sure that we're looking at the loans that we want to book the client relationships we want to be in from both a credit and spread perspective. So for me, the 2 biggest are a decreasing rate environment sooner and quicker and the competitive landscape changing on the deposit cost side from our peer group.

Maybe before we get into credit, you referenced in the slides, the countercyclical businesses. Obviously, this has not been an easy operating environment for the fixed income or the mortgage businesses given QT in the shape of the curve. Maybe just talk a little bit about what's baked into your expectations. It sounds like you took a conservative approach. And if we do start to see the forward curve come to fruition, as an example, in the capital markets business, how do you think performance can look different entering the year versus exiting?

Yes. We think that fixed income and mortgage, given the forward curve, is likely to build across the year. It's interesting, I watch the fixed income business weekly and average daily revenue last week was up, and it's moving all around. And as you see activity in the markets particularly with a big backup in the long end of the yield curve last week, you had a fair amount of activity. So we think that it will likely pick up. The fixed income business, we think, has troughed, and it's profitable at the low -- it's breakeven, not profitable at the levels we have in round numbers. So we think we're sort of at the bottom, and we think that's largely true of the mortgage business. But we have average daily revenue moving from that $300 million area up a little bit over the course of next year. The way to think about the rule of thumb in fixed income is $100,000 a day, in average daily revenue is in round numbers about $10 million a year in pretax. So if it moves from $300 million to $400 million, you're talking about another $10 million in pretax. So I don't think it's going to be a huge driver of next year, but we expect there will be some offset if rates decline significantly. And if the unthinkable were to happen and the Fed were to cut rates [ $100 million, $200 million, $300 million ] based on something happening in the world or something in the economy, we think that will be a nice countercyclical offset for that business, both mortgage and fixed income.

I guess more near term before we move on to 2024. Any near-term updates to expectations? I know you had put out guidance regarding -- you had full year guidance that had implied guidance, including a big uptick in expenses. Hope, any sort of updates in terms of how things have progressed across the fourth quarter?

Sure, Ryan. As we're just talking, we think our NIM is continuing to improve. We troughed the last quarter, and we do believe our -- we know our margin will improve this quarter. On the expense side, we are going to come in a little bit on the lower side than our guidance. We're not seeing FHN come back as quickly as we had hoped when we gave guidance in June on the back half when we gave it, when we gave our Investor Day guidance, we haven't moved off that with the exception of our provision guidance. And FHN hasn't come back as quickly, and that's a highly commissioned business, and there's a little bit less expense. The second part is we announced that we were going to spend $100 million over 3 years in technology. It's taken us a little longer to get all those projects spun up than we thought. We originally thought, hey, we say, we're going to spend $100 million, everyone we're going to be able to get this kind of all known in 3, 4, 5 months were not as we haven't seen those costs come into the run rate this year, but they're accounted for in a 2024 forecast.

Got it. Makes sense. So as you highlighted last quarter credit was obviously impacted by the one-off charge-off. I think you're talking about 25% to 35% full year and it's encouraging to say you expect to be around that level next year. Just broadly speaking, how are you feeling about credit? Which portfolio are you the most focused on at this point?

I'm very constructive about credit so far. And as you would expect in a tightening set of financial conditions and economy slowing and rising rates, you would expect you're going to see pockets that show up. This one we dealt with last quarter was truly idiosyncratic, not so much economic-driven. We're seeing things slowdown in isolated cases, but there's nothing that we sit there and say, we're concerned about this portfolio or that portfolio based on current trends. Classified criticized assets have been largely pretty stable. And that's not to say that it won't change dramatically over the course of 2024 as rates continue to bite. But as we sit here today, there's nothing that seems particularly problematic. We like a lot of folks in that we're paying more attention to commercial real estate and things that are happening in certain sectors of the portfolio in our deep dives, we go through a lot of deep dive activity and try to understand, at a very granular level, credits. And at the end of the day, as of us sitting here in early December, it feels like credit quality will continue to hold up as we transition into 2024, and we're very constructive right now on the ability to sort of have a touch and go or soft landing.

Maybe just to dig a little bit more on the office portfolio, maybe just talk a little bit about what you're seeing in terms of renewals and restructurings, and how are you feeling about the multifamily book? We've had ample of Southeastern banks talk about different parts of the Southeast, Raleigh, [ Austin ], where they've seen oversupply and the like. Just curious what you guys are seeing there?

Yes. I'll start with multifamily and work backwards. In the multifamily portfolio, we really have had very good results. There's a few projects that are leasing up more slowly than people anticipated, but they continue to look like they will be fine. And given the markets that they're in, large markets in the South, we're not overly worried about that given structure that we have around it. But things have slowed down and leased up a little more slowly in a few places here and there. On the office side, offices continue to look pretty good from our perspective. We have really a bifurcated portfolio. A lot of our office is medical office, and that tends to be very different in terms of performance. It's not as -- it's not returned-to-work centric. And so that piece of the portfolio continues to work well. And broadly speaking, where we have office -- business office, office business, that is a portfolio that tends to be 10 stories or less. It tends to have more of a suburban feel to it, and it's not as subject to being a 30-story building where you're not having First Horizon or somebody return to office. So that portfolio continues to perform well also. And we're paying a lot of attention to it. But so far, things feel good.

Bryan, maybe switching to capital, Slide 8. I think there was 5 capital targets on their near-term 11%, 10% to 10.5% over time, deploying above 10.5%. Maybe just clarify for us, as we think about '24, what do you expect to be the binding level of capital? And maybe just talk a little bit more what do you need to see to get us from that 11% near-term target to the 10.5% intermediate-term target?

Are you suggesting there was a capital base that we didn't have covered? Yes. We have, as I said, an orientation towards returning excess capital and driving return on tangible common equity, CET1 is the easiest way to talk about it. And through the cycle, we think 11% CET1 is higher than we need to operate given the risks in our portfolio and our balance sheet. And that sort of is proven out in some cases by the credit quality that we showed and you just look at the trend on the line in terms of net charge-offs. We will bring that down. It just feels like it's an asymmetric world at this point and that more capital is better than less if the economy goes bump in the night for some unexpected reason. As I suggested, we'll talk with the Board, we'll work with the Board. If it were me, my view is, we don't need to let capital build from 11%, and I don't think there's any urgency to bring it down. But given that the stock, in our view, is relative to price to tangible book or our expectations ability to create earnings, I think it's on sale. So if we have excess capital generation in '24, there's a chance that we'll think about how we buy back some stock and return it in a flexible way that gives us the ability to adapt to changing financial conditions, but at the same time, doesn't accumulate excess capital that we can't deploy in the business. Over time, I think we could easily operate at the middle of that 10% -- 9.5% to 10.5% range. We could clearly be at that 10% through the cycle CET1 ratio.

Maybe to shift for a second talk about regulation. The cost of being a $100 billion bank, I think you sized that $50 billion to $100 billion. Maybe unpack a little bit what that includes, and help us understand a time frame for you to prepare for that.

Yes. I think, based on just going -- Hope and her team did a lot of work around what is the true cost of issuing TLAC or total loss absorbing capital if Basel III gets implemented in that fashion. What is the implications of all the reporting, and it's probably somewhere between $100 million and $150 million and all-in cost is our view. Given the significance of that to what a logical estimate of our pretax earnings is, we're not going to just stumble up against or meet that. We don't see it as a short-term barrier. We think that we've got just a natural growth in the balance sheet. We've got 2 or 3, 4 years before it becomes an issue. And we also think we've got the ability to tread water fairly significantly for longer than that. So we're not feeling any urgency in terms of ability to having to deal with that in the near term. I do believe the FDIC proposal on banks over $50 billion have to have resolution planning. Some of that is embedded in that cost structure. So I suspect, given the regulatory nature of things, we'll start building in that cost gradually over time. But we're not feeling any urgency right now around the $100 billion threshold other than just don't bump up against it and cross it.

So I know in the past, you said it could be a couple of years before the industry sees M&A pickup given balance sheet marks impact on capital. You just noted that you're not going to stumble up against this, and therefore, maybe you could consider another MOE. Maybe just flesh out your thoughts and what would you look for in a partner? Would you look to expand outside the footprint or improve market density in the current footprint?

Well, I would start with, given our recent experiences with merger approval, accounting markers, it's not a great urgency for us. I would say, that said, if you're going to do something, you've got to make sure that you have good cultural fit and you've got to have the ability to continue to serve your customers in a consistent fashion and not destroy a lot of value by putting together essentially 2 organizations that merge like oil and water. So it's not something we're spending any time on right now. Our focus is on doing the remedial deferred maintenance things that we've talked about. It is operating our business and driving profitability. And given that we don't have to get over that threshold in the near term, we've got a lot of time to see how the regulatory world plays out, both in terms of approval processes and what capital ratios and those things play out over time. So at this point, we think time is our friend, and we have optionality. And so we're focusing on our business and just operating that.

Maybe one last question for me. I asked you a similar question at the Investor Day. Obviously, PPNR growth would be a good start to achieving your ROTCE goals in the mid-teens. Can you maybe help us understand key drivers? And what do you think is a reasonable time frame to getting back to? Or what would the environment need to look like to get back to mid-teens core returns?

Yes. I think for every 0.5% or so, we reduced the CET1 ratio, you add about 200 basis points to -- I've done the math right, Hope, you check me, but at about 200 basis points to our ROTCE. And I think improving and stabilizing our margins and then being in a position to leverage the relationships we have more broadly over and improved product set over the next 2 or 3 years, I think you're looking at the end of this cycle and in the next couple of years, that's approaching that mid-teens area. So I think it's in the next 24 months or so, we ought to be moving in that direction fairly significantly.

Great. Well, we are out of time. So please join me in thanking Bryan and Hope.

Thank you. Thanks for having us.

Absolutely.