Earnings Call Transcript - FHN Q4 2023

Operator, 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. I will now hand over to your host, Natalie Flanders, Head of Investor Relations. Please go ahead.

Natalie Flanders, Head of Investor Relations

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, Chairman, President and CEO

Thank you, Natalie. Good morning, everyone, and thank you for joining us. What our company and our associates accomplished in 2023 was nothing short of extraordinary, especially amidst a significant shift in the banking landscape and the termination of our planned merger. We’ve highlighted some of our achievements on slide five. Despite the disruptions this year, our pre-provision net revenue was essentially flat compared to the previous year. Our asset-sensitive balance sheet benefited us with a margin expansion of 32 basis points versus 2022. This growth offset the revenue decline from our counter-cyclical businesses, showcasing the advantages of our diversified business model. I often mention that we manage our company with three key priorities: safety and soundness, profitability, and growth. This was evident when our balance sheet was well-prepared to navigate the crisis faced by several banks this spring. Our prudent balance sheet management allowed us to better serve our clients and strategically increase market share. We experienced growth in both loans and deposits at significantly higher rates than the industry average, bolstered by our strong capital levels. Our deposit growth was initiated by our second quarter campaign, where we raised over $6 billion in new customer funds and have retained 96% of that amount as of year-end. We have established long-term, deep relationships with our clients and look forward to continuing our promotional efforts with those we acquired in 2023. We have some financial highlights for you on the quarter detailed on slide six. We reported adjusted EPS of $0.32 per share on pre-provision net revenue of $298 million, resulting in a return on tangible common equity of 11.1%. We improved our net interest margin by 10 basis points from the third quarter due to better asset pricing and balance sheet mix. We expect this expansion to continue into the first quarter as we normalize pricing on our promotional deposits, which will reduce our interest-bearing deposit costs by roughly 15 basis points by the end of the quarter. We generated 29 basis points of common equity Tier 1 capital this quarter, raising our total to 11.4% at year-end. As I reflect on 2023, I’m extremely grateful for the dedication of our associates, who continue to deliver value for our clients, communities, and shareholders. Now, I’ll hand the call over to Hope to delve into our financial results in more detail.

Hope Dmuchowski, Chief Financial Officer

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 the 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 the 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, expenses 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 that 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. The 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 the 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 the typical 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.

Susan Springfield, Chief Credit Officer

In terms of the retention, the retention has been very, very good and our bankers are executing very well on what we’re referring to as promo-to-primacy. And while it is still early, we think we are making good progress in taking those new-to-bank relationships and broadening and expanding those relationships, and that doesn’t happen instantaneously, but we see early indications that are encouraging.

Bryan Jordan, Chairman, President and CEO

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-ups from some commitments, construction, et cetera, that was set up a couple of 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.

Hope Dmuchowski, Chief Financial Officer

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 of 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.

Bryan Jordan, Chairman, President and CEO

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.

Operator, Operator

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

Jon Arfstrom, Analyst

Thank you. Good morning. Hope, I have a question regarding the outlook for net interest income. You mentioned the 2023 performance in relation to your guidance, and I’d like to know about the 2024 NII outlook range. Specifically, how do the four rate cuts affect your net interest income and margin outlook? What factors might help the company reach either the lower or higher end of that range? Thanks.

Hope Dmuchowski, Chief Financial Officer

Bryan Jordan, Chairman, President and CEO

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 of 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.

Michael Rose, Analyst

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, Chairman, President and CEO

FHN is very sensitive to changes in interest rates, as you mentioned. We did see a slight increase in the fourth quarter of this year, mainly because the market concluded that the Fed had reached peak rates and that rates are more likely to decline. Falling rates generally benefit our fixed income business. We expect somewhat slightly higher average daily revenue next year and anticipate that the markets will continue to stabilize and improve, particularly if the rate cut expectations are realized. While we don't expect FHN Financial to return to the levels of 2000 and 2021, we do anticipate some modest improvement next year.

Michael Rose, Analyst

That's helpful. As a follow-up question, I would like to understand how much flexibility there is in the expense base if revenue doesn't meet expectations. For example, could you delay some technology costs or identify other areas to adjust if revenues come in at the lower end? Thank you.

Bryan Jordan, Chairman, President and CEO

Yeah. Yeah. Our expense base at FHN Financial is very heavily tied to revenue. We have a system that is scalable costs with scalable revenue. Our team has done, I think, a fantastic job in controlling costs and even when you reach the lows in the cycle, we still make money in the business, and clearly, it’s not as profitable as it is at better or higher points in the cycle in terms of average daily revenue. But we’ve got the ability to control those costs and we will flex them, and we expect that no matter how low ADR is likely to drop in the near term, we think we can eke out profitability even at the lowest levels and with some expectation for higher ADRs, we expect to be in a much better position through the course of 2024.

Casey Haire, Analyst

Great. Thanks. Good morning, everyone. Quick follow-up on NII, specifically the funding side of things. So, first off, is the $6 billion deposit promotion, is that fully rolled over and then what kind of deposit beta are you expecting along these four cuts?

Hope Dmuchowski, Chief Financial Officer

Good morning, Casey. Good to hear from you on 2024. Yes. We are fully through that repricing of the second-quarter promo campaign and that 96% retention is an up-to-date number as of yesterday. So it’s not a December 31st number. It is an up-to-date number of what we’ve seen in retention on that. Through the cycle when we think about deposit rates, we really think it’s through the cycle of when do you start cutting rates and we’d probably be right around 60. If we see a May cut, we would end our beta cycle about 60. If it got later in the year, the first cut and the cycle continued, we do think that we can continue to moderate by bringing in client deposits, paying down a little bit more of a wholesale, as well as, as we mentioned in my prepared remarks, we saw a fourth-quarter new-to-bank money at a significantly lower cost than we saw the prior quarter. So we are seeing the ability to step back, not just existing money and retain it, but also bring new money in, about $1 billion in each of the last two quarters, for a lower rate than we saw in the second quarter.

Bryan Jordan, Chairman, President and CEO

Yes, Casey. This is Bryan. At this time, we do not have authorization for share repurchases. I anticipate that this will be one of many items the Board will evaluate as we consider our outlook for the rest of the year. It is one of the strategies we will think about, but ultimately, the decision lies with the Board, taking into account safety, soundness, and economic outlook. We expect to have those conversations, and it’s one of the options we believe is available to manage our capital level.

Ben Gerlinger, Analyst

Good morning. I was wondering if we could discuss the CD campaign. You've received significantly more funds than initially anticipated. While I understand that this indicates retention, how much of this is actually being converted into new business, particularly in terms of revenue and building relationships for lending opportunities?

Bryan Jordan, Chairman, President and CEO

Brady Gailey, Analyst

Hey. Thank you. Good morning, guys. I wanted to start on the credit quality front. Last quarter, we saw the little blip with the shared national credit loss. This quarter we saw NPAs increase by about 17%. They’re still at a relatively low level, but maybe just updated thoughts on, it feels like credit is normalizing here, but just updated thoughts on how you’re thinking about credit into 2024?

Susan Springfield, Chief Credit Officer

Hey, Brady. It’s Susan. I’ll take that. We are being, as I just said in answer to the last question, very disciplined in our approach and we have been, we have been for years and so I do believe that that disciplined approach to client selection, the fact the markets that we’re in are very strong will continue to serve us well. As you pointed out, we’ve had some downgrades into non-performing and classified, but it’s very manageable at this point. We’re not seeing any specific things related to markets, industries, product types at all. We did a lot of deep dive work in 2023. We’ll continue that in 2024. We do really do it all the time, especially in a higher interest rate environment, we’re making sure that we’re touching the portfolio and even at a higher level where more executive management is involved in portfolio reviews. So I feel very good about the fact that we’ve got discipline in how we’re grading and servicing credit. I think the outlook is one where we will perform well, our eyes on the ball, and we’ll continue to be conservative both at origination but also in how we think about grading and marking our loans each and every quarter.

Bryan Jordan, Chairman, President and CEO

As a matter of fact, our next Board meeting is next week. So we always cover financial outlook, capital management, our capital outlook with our Board. So that’s a meeting-to-meeting thing. I don’t want to prognosticate what the Board is likely to do or not do in our next meeting, but capital management is one of those things that we always spend time on.

Operator, Operator

Ladies and gentlemen, this concludes today’s call. Thank you for joining. You may now disconnect your lines. Thank you.