First Horizon Corporation (NYSE:FHN) Q4 2023 Earnings Call Transcript

First Horizon Corporation (NYSE:FHN) Q4 2023 Earnings Call Transcript January 18, 2024

First Horizon Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello, everyone. And welcome to the First Horizon Fourth Quarter 2023 Earnings Conference Call. My name is Bruno, and I’ll be operating your call today. [Operator Instructions] I will now hand over to your host, Natalie Flanders, Head of Investor Relations. Please go ahead.

Natalie Flanders: Thank you, Bruno. Good morning. Welcome to our fourth 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 us 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 be making forward-looking statements that are subject to risk 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 filings.

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, and thank you for joining us. I think what our company and our associates accomplished in 2023 was nothing short of extraordinary, dealing with a significant shift in the banking landscape and the termination of our plan merger. We’ve detailed some of our highlights on slide five. Despite all the disruption this year, our 2023 provision — pre-provision net revenue was essentially flat to the prior year. We saw the benefit from our asset-sensitive balance sheet with the margin expanding 32 basis points versus 2022. This offset the decline in revenue from our counter-cyclical businesses, demonstrating the benefit of our diversified business model. Most of you have heard me say that we manage our company with three top priorities in mind, safety and soundness, profitability and growth.

You saw the benefit of that when our balance sheet was well-positioned to weather the crisis of a few banks this spring. This prudent balance sheet management enabled us to better serve our clients and strategically expand market share. We grew both loans and deposits at significantly higher rates than the industry as a whole, supported by our exceptionally strong capital levels. Our deposit growth was kick-started by our second quarter campaign. We raised over $6 billion of new-to-bank customer funds and we have retained 96% of that money as of year-end. We have long-tenured deep relationships with our clients and we’re excited to continue to deliver on the promo-to-primacy efforts with the clients we acquired in 2023. We have some of the financial highlights for you on the quarter of — financial highlights of the quarter on slide six.

We delivered adjusted EPS of $0.32 per share on pre-provisioned net revenue of $298 million, resulting in a return on tangible common equity of 11.1%. We grew the net interest margin 10 basis points from the third quarter as we improved our asset pricing and balance sheet mix. We anticipate the continued expansion into the first quarter as we successfully normalize pricing on our promotional deposits, reducing our interest-bearing deposit costs by approximately 15 basis points at the end of the quarter. We generated 29 basis points of common equity Tier 1 capital this quarter, bringing us to 11.4% at year-end. As I reflect on 2023, I’m incredibly thankful for the dedication of our associates as they continue to deliver value for our clients, communities and shareholders.

With that, I’ll hand the call over to Hope to run through our financial results in more detail. Hope?

Hope Dmuchowski: Thank you, Bryan. Good morning. On slide seven, you will find our adjusted financials and key performance metrics for the quarter. We generated pre-provisioned net revenue of $298 million this quarter. Net interest income grew $12 million from third quarter, benefiting from asset rate pricing and our ability to improve the funding mix. This expanded the margin by 10 basis points from the prior quarter. We expect to build upon this momentum into first quarter, which will benefit from our deposit pricing efforts in late fourth quarter. Fees, excluding deferred comp were flat to linked-quarter, benefiting from higher fixed income, which was offset by the timing of a couple discrete items. As expected, expense excluding deferred comp were up $30 million, driven by higher variable compensation tied to revenue and increased strategic investments in the quarter, which we expect to moderate in first quarter.

Provision expense was $50 million this quarter, increasing ACL coverage by 4 basis points, which was largely driven by modest deterioration in the macroeconomic scenarios used for CECL modeling, primarily within commercial real estate and consumer. Tangible book value per share increased 8% to $12.13. On slide eight, we outline a couple of notable items in the quarter, which reduced our results by $0.01 per share. Fourth quarter notable items include the FDIC special assessment of $68 million, a pre-tax gain of $1 million from the net of a small opportunistic FHN Financial asset disposition and equities valuation adjustment. Additionally, we have one notable tax item, a $48 million discrete benefit primarily attributable to the resolution of merger-related tax items related to the IberiaBank merger.

On slide nine, you will see that our margin expanded 10 basis points from the prior quarter to 3.27%, improving NII by $12 million. Fourth quarter benefited from a full three months of the rate hike that occurred in July, which improved asset yields. We were also able to use customer deposits and excess cash to pay down a significant amount of broker deposits, improving our funding profile. The average rate paid on those broker deposits was 5.3%. Though the impact of fourth quarter was modest, our success in repricing the promotional deposits gathered in our second quarter campaign will benefit margin as we head into 2024. As you can see on slide 10, we’ve been successful in executing our deposit strategy this year. Period end deposits are up 4% year-to-date, compared with a 2% decline in the Fed’s H8 data.

Retention of the promotional deposits acquired in the second quarter campaign has been exceptional so far at 96%. Those promotional rate guarantees expired late in fourth quarter and we were able to reprice those deposits down by an average of 76 basis points. This strong retention allowed us to pay down $1.2 billion of higher cost broker deposits. Though we’re continuing to see some rotation out of non-interest-bearing, we’ve been able to acquire just under $1 billion of new-to-bank interest-bearing accounts at a blended cost of 3.3%, which is down from the 4.2% acquisition rate we saw in the third quarter. The interest-bearing rate paid of 3.37% this quarter was essentially flat to the prior quarter, rates peaked in October and came back down as the promotional accounts were repriced in the back half of the quarter.

The end of period rate on interest-bearing deposits declined to approximately 3.25%, while the total deposit rate fell to roughly 2.4%. We expect this to provide upside to NII and margin next quarter. We have an overview of loans on slide 11. Our strong capital position and ability to grow deposits supported 5% year-to-date loan growth. Loan demand softened in the fourth quarter, with period end loans declining 1% from the prior quarter. About half of that decline was due to typically seasonality of loans to mortgage companies. This business experiences some seasonality, tending to peak in the third quarter, then decrease until hitting first quarter lows. C&I production was fairly muted as we entered into the quarter, though we saw that stabilize a bit in the back half of the quarter.

CRE growth continues to be driven by fund ups from existing loans, primarily in multifamily. And as you would expect, total commitments have come down slightly, as there’s not a lot of new production in that sector. Consumer balances are relatively flat, as we’re focused on using the balance sheet for customers, like our Medical Doctor program, where we continue to build deeper relationships. We are continuing to improve pricing with spreads on new loans increasing 21 basis points since last quarter and 64 basis points year-over-year. On slide 12, you can see that fee income, excluding deferred comp, remains stable at $173 million. Our fixed income business saw an increase of $9 million as the market’s expectations that the Fed has finished raising rates brought some participants back into the market.

Mortgage revenue was down $2 million, largely due to seasonally lower volume. Brokerage income increased $2 million, driven by higher annuity sales. Card and digital banking fees were down $4 million, driven by a methodology adjustment on interchange rebates, resulting in a one-time impact of fourth quarter. Lastly, other non-interest income declined $5 million, mostly due to elevated FHLB dividends in third quarter, as well as a modest reduction in BOLI revenue. On slide 13, we show that excluding deferred compensation, adjusted expenses are up $30 million. Personnel, excluding deferred comp, was up $14 million from last quarter with a couple of drivers. First, there is about $4 million of incremental incentives in our variable revenue businesses, driven by higher production this quarter.

We also accrued $5 million of additional expense, primarily related to the retention awards, as the stock price rose almost 30% this quarter. Lastly, medical expenses were up $5 million linked quarter, due to seasonality and a couple of large one-time claims. Moving on to our strategic investments, you can see the technology investments entering the run rate and occupancy and equipment. There should continue to be modest growth here, as we make progress bringing these projects online. Outside services increased this quarter, driven by a couple of items. Marketing was elevated from seasonality and sponsorship and client events that typically occur in fourth quarter, as well as the impact of some of the delayed costs we mentioned last quarter, primarily related to client acquisition and brand campaigns we initiated in late third quarter.

We also engaged additional third-party resources for consulting and resource augmentation on key projects. Fourth quarter had elevated expenses due to these items that will moderate next quarter. Expenses will stabilize as costs and technology investments increase throughout 2024, but are offset by lower retention expense and other operational efficiencies. I’ll cover asset quality reserves on slide 14. Loan loss provision was $50 million this quarter, down from $110 million in third quarter, which includes a $79 million idiosyncratic credit loss last quarter. Net charge-offs were $36 million or 23 basis points across multiple industries and sectors. The ACL coverage ratio increased 4 basis points to 1.4%, driven by marginal deterioration in the macroeconomic scenarios used for CECL modeling, primarily in CRE and consumer, as well as modest grade migration.

We continue to see credit migration, but we are not seeing any specific pockets of stress and what we are observing in this environment feels manageable. On slide 15, you can see that we have continued to build on our strong capital levels. We generated 29 basis points of CET1 this quarter, bringing us to 11.4%. Adjusting for the marks on our security portfolio and loan book, our pro forma CET1 ratio would be 9.1%. Total capital remains strong, reaching 14% this quarter. Tangible book value per share was $12.13, increasing 8%, driven by $0.72 from lower mark-to-market impact and $0.34 of net income, partially offset by $0.15 of dividends. On slide 16, we’ve reiterated the 2024 outlook we gave you in December. We expect to grow pre-provisioned net revenue from 2023 levels, as our ability to generate revenue more than offsets our strategic investments and we continue to look for operational efficiencies to offset rising costs.

Our interest rate outlook assumes four rate cuts, with the first cut occurring in May. Given our ability to reduce funding costs, continued asset repricing and modest balance sheet growth, we expect net interest income to exceed 2023 levels. Fee income improvement will be driven by a modest rebound in the counter-cyclical businesses. The expense outlook includes continued progress on strategic technology investments, as well as a modest amount of incremental investment in personnel, including the annual merit adjustment that went into effect at the beginning of the year. The net charge-off guidance reflects continued macroeconomic uncertainty. As we have previously communicated, we do not see a need to continue to build incremental capital, giving us the opportunity to deploy capital in excess of that 11% CET1 target.

I will wrap up on slide 17. We have shown you this slide several times this year and Bryan opened with a version of it that listed a few of the things that this team accomplished in 2023. It is remarkable to reflect on everything that occurred this year and when I look at this slide, I am proud of everything the company did to serve our clients amidst significant industry disruptions and uncertainty, to deliver on the expectations we laid out during Investor Day in second quarter. To recap 2023, our Investor Day guidance for net interest income was a growth range of 6% to 9%, with actual growth coming in at 6%. Similarly, our fee income guidance was a decline between 6% and 10%, with actual fees down 9%. Lastly, we gave an expense growth range of 6% to 8%, at 5%, we came in favorable to that guidance, as we found efficiencies to offset other investments.

Despite a challenging environment, our dedicated bankers delivered on our commitment to clients and our diversified business model, producing consistent pre-provisioned net revenue year over year in 2023, which we anticipate building on in 2024. We have a strong balance sheet, which weathered the challenges the banking industry faced earlier this year, sorry, earlier last year, demonstrating our ongoing commitment to safety and soundness first. As always, we stayed focused on our clients, communities and associates, which results in strong client and associate retention. We are well positioned to capitalize on our 160-year legacy and I am excited to continue to demonstrate the strength and resiliency of our franchise in 2024 and beyond. And with that, I’ll give it back to Bryan.

Bryan Jordan: Thank you, Hope. Our 2023 results reflect the strength of our franchise and I’m incredibly proud of everything our associates accomplished this year. Their commitment to serving our clients enabled us to navigate an uncertain environment and come out of the other side stronger. I continue to remain confident that this company has the people, the clients and the dedication to build an unparalleled banking franchise in the South. My expectation for 2024 is much like 2023. With all that’s going on in the world, the economy continues to perform well and it still looks like a soft landing is possible. Thank you to our associates for all that you have done for our company, our clients and communities and our shareholders in 2023. Bruno, we can now open up for questions.

Operator: Thank you. [Operator Instructions] We do have our first question comes from Jon Arfstrom from RBC Capital Markets. Jon, you may proceed with your question.

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Q&A Session

Jon Arfstrom: Hey. Thank you. Good morning.

Bryan Jordan: Good morning, Jon.

Hope Dmuchowski: Hi.

Jon Arfstrom: Hey. Maybe a question for you, Hope, on the net interest income outlook. You made some comments on 2023 performance against your guidance and I just — I wanted to ask about the 2024 NII outlook range. I’m curious what kind of an impact do the four cuts have on your net interest income and margin outlook, and what kind of puts and takes do you have for getting the company to the lower end or the higher end of the range? Thanks.

Hope Dmuchowski: Thanks, Jon. I appreciate the question and good to hear from you in 2024. As we look at 2024, I know I’ve seen guidance out there from other different rate scenarios. We did use the four rate cut scenarios. The biggest impact in that range is how many cuts do we get and when. So our first one’s in May. If it happens later in the year than that, we would have a benefit to our margin. The biggest factor that we need that we have in the range when we look at a couple different scenarios is how quickly can we rephrase down those client deposits. We’ve shortened the duration of the promo rates and the deepening rates that we have and so our anticipation would be that as we saw rates decrease, we’d quickly be able to offset that in our funding costs.

Jon Arfstrom: Okay. So it’s safe to say if we’re less than four, you’re probably at the higher end of that range. If we’re at four, we’re mid to lower end. Is that fair?

Hope Dmuchowski: That’s correct, Jon. And also, we could be on the higher range — higher end of the range with four if we can bring down deposit pricing quicker with the rate decreases.

Jon Arfstrom: Okay.

Hope Dmuchowski: It depends on what that lag is.

Jon Arfstrom: And then just — yeah, okay. And then overall thoughts on loan growth for 2024? I was looking for it in here and I think I may have missed it somewhere, but how are you feeling about overall loan growth expectations?

Bryan Jordan: Jon, this is Bryan. We feel pretty good about loan growth expectations. We expect to see the balance sheet growth some. We think, as I said in my closing comments, that the economy is still growing consistently with the end of 2023, financial conditions have sort of ebbed and flowed, but I’d say overall they’re still on the tight side and I expect that loan growth will be more muted this year as a result of that. Our balance sheet benefits a little bit from the spring-loaded nature. We have some fund up of some commitments, construction, et cetera, that was set up a couple years ago or originated a few years ago and we feel very, very good about the opportunities we’re seeing. We’re being very selective in the opportunities that we choose to put on our balance sheet.

So we expect a little bit of modest growth, but we don’t expect it to be outsized given our outlook for the economy. To sort of go back to comments that Hope was making about the margin, the — our modeling is just based on taking a forward curve that’s implied in the market. At some point in time, it could have been $238 on December the 31st. It’s moving around a whole lot, which tells you there’s a fair amount of uncertainty about what interest rates will actually do. The Fed’s comments were interpreted as pretty significant cuts and the market implies. We don’t — I personally don’t feel that strongly that the Fed’s going to cut rates early in the year. I think rates are going to hold up better or higher than the market’s expectations right now.

But I wouldn’t substitute our judgment for the market. So we just use a market curve that ultimately reflects what is a slowing economy and interest rates coming down.

Jon Arfstrom: Yeah. Okay. That’s helpful. I’m more near camp, Bryan, but the framework you provided helps. So thank you for that.

Bryan Jordan: Sure.

Operator: Our next question comes from Michael Rose from Raymond James. Michael, your line is now open.

Michael Rose: Hey. Good morning. Thanks for taking my questions. I just wanted to go to the slide 24 in the appendix as it relates to FHN Financial. I appreciate you guys putting that in there. You guys had a nice uptick in ADRs this quarter. I certainly understand the way this business works. But can you just give us what your baseline expectation is for ADRs as we move through the year, assuming your rate cut expectations and then what it could look like in your estimation if we move a little bit slower? Thanks.

Bryan Jordan: Yeah. This — FHN is as you just implied very sensitive to what interest rates do. We did see a little pick up in the fourth quarter of this year. That was really based on the market reaching a conclusion that the Fed had reached peak rates and that we’re more likely to see rates falling and falling rates tend to be good for our fixed income business. Our expectations are for somewhat slightly higher average daily revenue next year. We think the markets will continue to stabilize and improve, particularly if the market follows the path that is laid out in terms of rate cuts next year. We don’t expect that FHN Financial is going to bounce back to 2000 and 2021 levels, but we do expect some modest improvement next year.

Michael Rose: That’s helpful. And maybe just as my follow-up question, just assuming that you — I just want to get a sense for how much flex there would be in the expense base if the revenues don’t necessarily come through. For instance, is there some technology costs that you could maybe push out or what other areas could you look to address if the revenue expectations come in at the lower end of expectations? Thanks.