First Horizon Corporation (NYSE:FHN) Q3 2023 Earnings Call Transcript

First Horizon Corporation (NYSE:FHN) Q3 2023 Earnings Call Transcript October 18, 2023

First Horizon Corporation beats earnings expectations. Reported EPS is $0.27, expectations were $0.25.

Operator: Thank you for joining. I would like to welcome you to the First Horizon Corp. Third quarter 2023 earnings conference call. My name is Frida [Ph] and I’ll be your moderator for today’s call. All lines are on mute for the presentation portion of the call. There’s an opportunity for questions and answers at the end. [Operator Instructions] I would now like to pass the conference over to your host, Natalie Flanders, head of investor relations to begin. So Natalie, you may begin when you are ready.

Natalie Flanders: Thank you, Frida. Good morning. Welcome to our third quarter 2023 results conference call. Thank you for joining us. Today our Chairman, President and CEO, Bryan Jordan and Chief Financial Officer Hope Dmuchowski will provide prepared remarks and then we’ll be happy to take your questions. We’re also pleased to have our Chief Credit Officer Susan Springfield here to assist with questions as well. Our remarks today will reference our earnings presentation which is available on our website at ir.firsthorizon.com. As always, I need to remind you that we will make forward-looking statements that are subject to risks and uncertainties. Therefore, we ask you to review the factors that may cause our results to differ from our expectations on page two of our presentation and in our SEC filing.

Additionally, please be aware that our comments will refer to adjusted results which exclude the impact of notable items. These are non-GAAP measures, so it’s important for you to review the GAAP information in our earnings release and on page three of our presentation. And last but not least, our comments reflect our current views and you should understand that we are not obligated to update them. And with that, I’ll turn things over to Bryan.

Bryan Jordan: Thank you, Natalie. Good morning, everyone. Thank you for joining our call. Our third quarter results reflect the quality of our franchise and we have highlighted some of our key strengths on slide five. Over the past five months, I’ve become increasingly confident in our ability to serve our customers and communities and deliver strong shareholder returns. Our team of associates are highly experienced. We’ve retained 90% of our talent over the past year who have been with us over nine years on average. We have an extraordinary client base that’s been with us a long time with a medium tenure of 16 years. Our team’s dedication to serving clients is the key driver of our ability to retain 91% of our clients over this past year.

With our experienced bankers focus on excellent customer service and our ability to deploy capital through loan and deposit growth, we’re seeing solid momentum in our businesses right now. I’m grateful for the hard work of our associates as they deliver value for our clients, communities, and shareholders. On slide six are some of the financial highlights from this quarter, which Hope will cover with you in more detail. We delivered adjusted EPS of $0.27 per share on pre-tax pre-provisioned net revenue of $318 million, resulting in a return on tangible common equity of 9.2%. Our results were impacted by an idiosyncratic charge off of $72 million that we communicated earlier this quarter. This credit loss was related to a company who unexpectedly converted from a chapter 11 to chapter 7 bankruptcy.

Otherwise, the balance sheet continues to perform very well. Period end deposits are up $1.6 billion or 2.4% from last quarter as we continue to have success in acquiring customers throughout our deposit franchising campaigns. We opened over 19,000 new deposit accounts this quarter, bringing in $1 billion in balances with over a third of the balances going into checking products. Our loan to deposit ratio improved to 92% as deposit growth outpaced loan growth of just under 1%. Fees are relatively flat to the prior quarter as our countercyclical businesses have stabilized cyclical lows. Though we need to make some investments over the next year or two, we have a proven track record of managing our expense base and will be disciplined in our reinvestment strategy.

Our capital position continues to be very strong with our CET1 ratio flat to the prior quarter at 11.1%. As we look toward 2024, we will be evaluating our options to repatriate capital to our shareholders with an eye toward the longer term CET1 ratio range of 9.5% to 10.5%. Overall, sentiment of our bankers and clients remains cautious but positive. Inflation and labor supply continue to be a challenge. However, the economies in our footprint are performing well. Additionally, we recently released the results of our most recent stress test, which demonstrated our capacity to maintain capital levels well in excess of regulatory bounds even in the Fed’s severely adverse scenarios. In short, given our stable diversified business mix, attractive footprint, and strong credit culture, we feel confident in our ability to profitably navigate any economic scenario.

Our experienced team has a proven track record of delivering high-quality service to meet our clients’ and communities’ needs. This yields long tenure, deep relationships, and enables us to produce top quartile returns over the cycle. With that, I’ll hand the call over to Hope to run through this quarter’s financial results. Hope?

Hope Dmuchowski: Thank you, Bryan. Good morning, everyone. Turning to slide seven, we provide adjusted financials and key performance metrics for the quarter. We generated PPNR of $318 million down modestly from second quarter. The main driver was a $26 million decline in net interest income driven by higher deposit costs. Fees and expenses are relatively stable to the prior quarter. As Bryan already mentioned, we experienced an idiosyncratic credit loss of $72 million, which drove the $60 million increase in provision expense to $110 million in the quarter. This single credit impacted adjusted earnings per share by approximately $0.10. Other charge-offs of $23 million were in line with the prior quarters. Tangible book value per share came in at $11.22, with adjusted earnings per share of $0.27, partially offsetting the $0.41 impact of higher marks on securities and hedges and $0.15 of dividends.

On slide eight, we outline a couple of notable items in the quarter which reduced our results by $0.04 per quarter. Third quarter notable items include a pre-tax restructuring expense of $10 million related to streamlining our market structure in addition to some reductions in force primarily within mortgage as we continue to look at operational efficiencies within our businesses to offset increasing costs. In addition to the tax impact of the restructuring, there are two notable tax items. A 24 million tax liability related to the book value surrender of approximately 214 million of separate accountable. This was triggered by the Fitch downgrade of the U.S. from AAA to AA+, which caused noncompliance with the underlying investment guidelines of the RAP [Ph] provider.

Lower corporate tax rates and higher interest rates made a surrender of the policy the most attractive option to exit this low yielding asset and redeploy the cash into higher yielding and more liquid alternatives. Partially offsetting this is an $11 million of tax benefits primarily related to amended returns on prior acquisitions. On slide nine, I will walk through net interest income and margin. NII of $609 million and net interest margin of 3.17 remains strong despite moderating from cyclical highs. Interest bearing deposit costs increased 81 basis points, partially driven by a full quarter impact of the second quarter deposit campaign. Offsetting this increase was a partial quarter benefit of the July rate hike on floating rate assets as we remain asset sensitive.

In fourth quarter, we will have the opportunity to reprice the promotional money market accounts acquired in second quarter, as well as the full benefit of July’s rate hike, giving us the ability to improve our NII and margin from third quarter’s level. The cumulative interest bearing deposit data reached 63% this quarter. We expect this to be the high watermark for us in this cycle. Our success in continuing to grow customer deposits enabled the payoff of all remaining FHLB borrowings this quarter. Over time, margin will also benefit from the continued repricing of fixed rate cash flows and widening credit spread. As two thirds of our loan portfolio is floating rate, we remain well positioned to benefit in a rising rate environment. As you can see on slide 10, we’re still seeing strong inflows from our deposit campaign.

Period end deposits were up 2.4% from last quarter, demonstrating our ability to expand market share. As the Fed’s H8 data shows, deposits essentially flat for the industry as a whole. Deposit growth was driven by new customer acquisitions and deepening existing relationships. We opened over 19,000 new to bank deposit accounts, bringing over 1 billion, including approximately 400 million of checking account balances. The average rate on our new customer deposits was 4.2% down over 100 basis points from our second quarter promotional rate. Additionally, the customers we brought in during last quarter’s promotion increased their balances by approximately 200 million. The full quarter impact of the successful deposit campaign and a higher Fed funds rate drove an increase in interest bearing deposit costs from 255 in Q2 to 336 in Q3.

With our strong liquidity position, our focus is on primacy. We are launching a promotional cash offer for checking accounts that meet primacy benchmarks over time. For customers acquired in second quarter, the rate guarantees on money markets will come up for repricing in the back half of the fourth quarter. We will have the opportunity to moderate funding costs as we focus on converting from promo to primacy. On slide 11, you’ll see that period end loans of $61.8 million were up $483 million or 1% linked quarter. Loans to mortgage companies declined $454 million due to seasonality and the impact on volumes from higher mortgage rates. Loan growth was diversified across our markets and portfolios. C&I growth was diversified across multiple industries, geographies, and lines of businesses.

CRE growth was largely driven by fund ups from existing loans, primarily in multifamily, while commitments remained flat. We have focused our on-balance sheet mortgage production on the medical doctor program, with over 60% of new balances coming through that channel this quarter. This has been an attractive vertical for us as we can deepen these relationships with wealth management and other products. Our bankers are focused on expanding spreads and deepening relationships through increased cross-sell depository, treasury, and wealth management products. Spreads on new funding have increased almost 30 basis points since last quarter and approximately 60 basis points year-over-year. I will cover fee income trends on slide 12. Fee income is stable at $173 million versus $175 million in the prior quarter.

However, excluding deferred compensation, fee income increased by $6 million. Other non-interest income was up $8 million, including an increase of $5 million in FHLB dividends from higher borrowing levels last quarter and a $1 million increase in swap fees. Again, I’ll reiterate we have paid off all of our FHLB borrowings in Q3 with a new-to-bank customer deposit. Our counter-cyclical fee businesses are stabilizing near the cyclical lows. We saw a modest decrease of $2 million in fixed income with average daily revenues down due to the challenging market conditions. Mortgage banking income was up $1 million as we slightly modified our pricing strategy to drive volume into the secondary market. Moving on to expenses on slide 13. Excluding deferred compensation, adjusted expenses are up $12 million.

This is largely driven by the $11 million of merger-related retention expenses moving into core results this quarter. Personnel expenses declined 2% or $4 million, and there are a couple different moving parts. First, deferred compensation declined by $8 million, which is offset in the corresponding fee income line. Second, as I previously mentioned, the geography change of the $11 million of merger-related retention expense moving into core results. Lastly, we had an $8 million reduction in other variable compensation. Other expenses were up $7 million as the prior quarter included the benefit of a few discrete non-recurring items, which included lower franchise and realty taxes. With a challenging economic environment, expense discipline remains a focus, and we continue to look for operational efficiencies within our business.

This quarter, we restructured our regional bank by consolidating into two fewer regions and moderated our mortgage business. Our efficiency ratio was at 59% in Q3. I will cover asset quality and reserves on slide 14. Loan loss provision increased by $60 million from Q2 to $100 million in Q3. The increase was driven by a single C&I charge-off of $72 million. This loan was a shared national credit where we were the lead bank. We initially anticipated a recovery through a Chapter 11 bankruptcy sale. However, there was an unexpected conversion to Chapter 7 in August, at which point we charged off the full amount of the loan. We did not have a specific reserve for this credit as we had an updated third-party valuation that supported our carrying value, and we anticipated an imminent sale within the quarter.

We are working with outside counsel to identify, evaluate, and pursue potential recoveries. At this time, we have no estimate of the timing or ultimate amount of recoveries, if any. Total charge-offs were $95 million in Q3. Excluding the idiosyncratic loss, charge-offs would have been $23 million in line with the prior quarter. ACL coverage ratio increased one basis point to 1.36, reflecting loan growth and continued caution around the macroeconomic outlook. The vacancy rate in our office CRE portfolio is 11%, which compares favorably to the industry, which is experiencing vacancy of 19% in the Southeast. Like others, we are seeing credit normalized from historically low loss levels during the pandemic. Though, credit can be variable, we do not expect significant broad-based deterioration in our portfolios.

On slide 15, you can see that we continue to have exceptionally strong capital levels. Our CET1 ratio of 11.1% remained flat to the prior quarter, even as we organically deployed capital to loan growth. Even after adjusting for the marks on our security portfolio and loan book, our pro forma CET1 ratio would be 8.6%. Tangible book value per share was $11.22 in Q3, a slight decrease from the prior quarter due to a $0.41 reduction from higher mark-to-mark impacts that were partially offset by $0.29 of adjusted NIAC. Total capital also remained very strong at 13.6%. On slide 16, we have made a couple of tweaks to our outlook, though we continue to believe that PPNR will be within the guidance we gave at Investor Day in June. We updated our loan growth expectations from 3% to 5% to 7% to 9%, as our success in raising deposits has enabled us to organically deploy excess capital into meeting our clients’ borrowing needs and strategically acquiring new clients.

The net charge-off outlook is updated to include this quarter’s idiosyncratic loss, but we expect other charge-offs to be within prior guidance. The new capital range, RWA [Ph] impact of the updated loan guidance. This assumes no share buybacks, but as Bryan mentioned, we intend to evaluate capital deployment as we head into 2024. To wrap up on slide 17, I am very proud of how this team navigated 2023 so far with passion and commitment to our clients, despite the macroeconomic environment and the unique challenges we have faced. Our success in client retention and acquisition would not be possible without the consistent focus of our associates that they have on serving our clients through any cycle or challenge. We are well-positioned to capitalize on the opportunities of our diversified business model, highly attractive franchise, and asset-sensitive balance sheet.

We are making strategic investments to support clients with products, services, and technology upgrades that will result in improved efficiency. We will continue to look for operational efficiencies to offset our investments. We remain committed to delivering attractive returns for shareholders through the cycle. Now, I will hand it back to Bryan.

Bryan Jordan: Thank you, Hope. I’ll roughly reiterate something Hope said a moment ago. Over the course of our history, we have demonstrated our ability to execute in changing and sometimes unusual economic environments. We know how to pull the necessary levers in order to operate profitably. Our footprint and our team give me tremendous confidence in our ability to generate strong returns for our shareholders. While 2024 economic conditions are likely to soften somewhat, I expect that we will grow revenue, control expenses, and record positive operating leverage next year. I am confident that this company has the people, the resources, and the determination to do what’s necessary to support our communities and shareholders throughout the economic cycle. Frida, we can now open it up for call for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] We have the first question from Ebrahim Poonawala from Bank of America.

Ebrahim Poonawala: Hey, good morning.

Bryan Jordan: Good Morning, Ebrahim.

Ebrahim Poonawala: Morning. I guess maybe first question, just Hope, thanks for running through kind of the promotion rates where they were this quarter versus last. As we think about the NII guide, I guess, full year or looking back into 4Q, 6% to 9%, give us a sense of how fourth quarter shakes out higher end versus lower end of that guidance range. And then as we think about moving forward, you still have promotional CDs or promotional deposits rolling off. Just if this, should this be the trough in NII and that growth continues to at least the first half of 2024. Is that the right way to think about it? And again the 69% could it what makes it 9 versus 6?

Hope Dmuchowski: Thank you Ebrahim for many questions in one. I’ll try to get all of them covered. Apologies if I missed one you can hold me accountable. First, we have not updated our ranges to a very specific percentage, but we expect next quarter to look similar to current quarter trends with the exception of NII that we do expect to increase our and non-interest margin net interest margin that we do expect to increase next quarter as we’re able to take advantage of the expanding yields and lower deposit costs. Our Investor Day guidance that we’ve reiterated here we believe will end up on a PPNR basis right in the middle of that with revenue being a little bit towards the lower side as well as expenses coming in on the lower side. On how we learn about… Sorry go, ahead.

Ebrahim Poonawala: No, go ahead.

Hope Dmuchowski: As to how we think about going into next quarter and next year as we said in our prepared remarks we continue to be focused on disciplined lending and bringing down our core deposit rates that you know we did as we’ve talked about multiple times in Q2 we went out with a very large promotion in order to re-energize our franchise our bankers and our clients and we plan to walk those rates back and I believe that the billion six that we were able to bring in a quarter at 420 shows that we’re able to acquire new clients and walk back existing client rates.

Ebrahim Poonawala: Got it. Thanks. Thanks for that. And this is a separate question, so I completely get this the credit that you had this quarter was very idiosyncratic but Bryan you’ve done a ton of heavy lifting for GFC in cleaning up this balance sheet. As you went through this credit does this that caused you to revisit the loan book to look at some of the larger credits kind of do another deep dive on the portfolio review to make sure there are no other kind of big chunky surprises. Just talk to us about that?

Susan Springfield: Ebrahim, this is Susan Springfield. I’ll take that and then hopefully Bryan can add any comment. During really any economic downturn we take an opportunity to do portfolio reviews across sectors as well as markets. So we are we are doing that. We — for all of our lines of business specialty lines as well as regional banks. The other thing is anytime we have any kind of loss we do a I call it a spilled milk analysis to look at where there are things that we could have done differently whether it was original original underwriting servicing timing communication, etcetera. So we obviously do take that very seriously or and are in the process of evaluating anything that could be improved related to the outcome of that credit. That being said, I do feel as both Bryan and Hope has indicated very good about the portfolio. We have a history of strong client selection being consistent and conservative in our underwriting and staying on top of our services.

Bryan Jordan: I would add to Susan’s comments that the economy has started to tighten financial conditions and slow down to some extent. Higher interest cost is going to have impact and so when you see those things happening as Susan said, we not only are continuing what we typically do in terms of credit monitoring, we do some focused reviews and we expect this credit will soften some, but we think we start in an extraordinarily good place with strong borrower selection strong underwriting and credit structure and ultimately strong collateral value. So we have and as Susan said an effort that we undertook to understand what happened with this one individual idiosyncratic credit and we will learn from that but we believe the fundamentals of our credit selection underwriting and delivery process will position us very well for our economy that’s likely to soften some over the course of the next year or so.

Ebrahim Poonawala: Got it. Thanks for taking my questions.

Bryan Jordan: Thank you.

Operator: Thank you. Your next question comes from Casey Haire with Jefferies. Your line is now open.

Casey Haire: Great. Thanks. Good morning, everyone. Wanted to touch on expenses. So if I’m looking at the guide, I mean year-to-date they’re up 3% versus last year and you guys are still talking holding to that 6% to 8%, which would imply a pretty big step up in the fourth quarter. Is that accurate, or is that guide conservative? And then, yes I’ll stop there.

Hope Dmuchowski: Casey, thank you for the question. I would say reiterating my response to Ebrahim on expenses, we’re probably going to be on the low side. We are trying to deploy a lot of new projects and technology that have not yet come into a run rate. Some of those will start in Q4. And then, the bigger unknown is really where our cyclical businesses have Q4. They have such a variable revenue base. And so, even though we’re at 3%, we have sat at pretty low levels for FHN, and we are expecting a little bit of an uptick in Q4 that would drive that expense up.

Casey Haire: Okay. It feels like it would have to come in below that, unless… Anyway, okay. And then, Bryan, just following up on your comments about positive operating leverage next year, I believe at your investor day, you were talking about expenses being up another 6% to 8% next year. Does that – your hope for positive operating leverage in 2024, does that still contemplate that 6% to 8% expense guide, or is there a possibility to flex that lower?

Bryan Jordan: Well, I do think expenses will be up somewhat next year. Part of it is what Hope just talked about in terms of the reinvestment in the franchise and making some investments in technology and really doing some of the remedial work that we have talked about in the past. That said, I do still believe that we can drive positive operating leverage. I’m very optimistic in our ability to continue to drive loan growth and particularly wider spreads on our lending portfolios. And as Hope mentioned a couple of different times in the way, we think we have the ability to bring the cost of deposits down over the course of the next year. All that said, I think expenses can be up. We’re not going to spend the dollar that we don’t need to spend. And so we’re going to control expenses. At the end of the day, though, I think we can still generate with even slightly higher expenses positive operating leverage.