Right. Up next, we have First Horizon. Before we start, I'm going to get some disclosures out of the way. For important disclosures, please see the Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. The taking of photographs and use of recording devices is also not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. We're delighted to have with us today, Hope Dmuchowski, Chief Financial Officer at First Horizon. Sorry.
The disclosures get me choked up, too.
I know. All right. Hope, when First Horizon announced the termination of the TD deal in early May, you also announced that you would be hosting an Investor Day in one month. You know, that was at a time when the industry was going through a lot of turmoil. Can you talk a little bit about that?
You know, hard to believe that we pulled it off in 30 days. So proud of our team and what we were able to accomplish. We had 15 months of not talking to investors, not because we didn't want to talk to investors, but nobody called us. We released earnings releases every quarter. We still put out a deck, and with the $25 share price, everyone kind of looked at what you did and moved on. There is so much information that we were not sharing at that point. We didn't have normal Q&A during conferences and investor calls, that the information vacuum, the only way that I could see to solve it was to hold an Investor Day. You know, short of having an Investor Day, we couldn't really talk to our investors.
You know, the top questions we were getting were around retention, deposits, and you can't, you know, because of Regulation FD, you can't answer that for one person. Thirty days seemed like the most that we thought we could buy with, "Hey, just give us 30 days, and we'll get our story back out there." You know, it was so exciting. We weren't sure telling people in 30 days, "Will you come to Nashville?" We had almost 40 people attend. A lot of the sell side analysts have re-engaged with us since. It was great to tell our story, but a little bit unnerving to host an Investor Day in the middle of a banking crisis.
Right.
Bank stocks, you know, overreact every single day. I was actually meeting with investors today when the news dropped that we'd have no rate hike, and the next thing an investor said to me was, "Oh, all bank stocks are down." I was like, "Well, would they have been up if we were up 25 basis points?" There's no telling. Really excited to have it behind us, really excited about the outcome we've heard from the sell side, investors, and, you know, glad to be able to tell our story again, because we've been doing great things for the last year and a half.
Perfect. You know, I think, you know, sometimes, you know, we can get, not blindsided, but we can have blinkers and just look at the near term. You know, as we look at the longer term, you know, talk about what attracted you to First Horizon, because you joined right before the TD deal was announced, right?
I did. On my 60th day, I actually woke up that morning, got an email. It says, "Congratulations on your two-month anniversary at First Horizon." I felt all good about myself. Walked into the office, Bryan Jordan came in my office and said that we had an unsolicited offer from TD to purchase at $25 a share and asked me how I thought about it. I said, "My personal side or my professional side?" I started with the professional side of, "It's a great deal, and, you know, we had to accept it." The personal side was I had to go home and tell three kids that I had moved the 3rd time in four years for my career, that we didn't know where we were living next. It was a little bit chaotic. We went into a 30-day due diligence.
Typically, you have a much longer due diligence. Banks, when they enter into mergers, will enter right after a quarter end, give themselves some time. TD being on a Canadian calendar, they kind of worked right between that, so we had a 10-Q coming out. Or we had an earnings release coming out. We only had 30 days to do all the due diligence once with TD. My first 60 days was trying to figure out, you know, my team and had my first earnings call. The next 30 days were doing due diligence on TD, and the 15 months since were working under a TD merger agreement. It's been a little bit of a unique experience as a CFO to start your career with a bank and have this much change and uncertainty in the bank.
You add what's happened in the macro banking environment, it's been a fun ride. What I'll say, though, is it has been great to see how First Horizon rises to every challenge, whether it's an unexpected merger for us. We had just completed the IBERIABANK conversion seven days before we announced the TD merger. Bryan and I sat on an earnings call six weeks before we announced the merger and told our company, "We're done with mergers. We're going to take a break." Both IBERIA and First Horizon had done a lot of mergers, "We're proud of the company we built. This is the right size and scale for us." Six weeks later, we tell them all we're bought.
It has been amazing to see how the First Horizon employees, at every turn, have risen to the challenge. You know, everyone keeps asking, "Well, what happened at May 4th?" It was just one more opportunity for First Horizon to show up and say, "Okay, so we're not going to be bought by TD, but we have a great franchise, we have great products, and let's start talking to our clients again.
That's great. You know, you provided a lot of great information, last week at the Investor Day. you know, one of the things that investors were surprised about were the retention numbers, right? That just goes into what you were saying right now. Can you talk a little bit more about the retention efforts and also any ongoing initiatives that you have there?
Yeah, absolutely. We did share that, you know, in the regional bank space, we've kept all of our regional presidents. 98% of our top bankers, our top half of the bankers, we've retained through the last 2022 and 2023, and 96% of our top-tier employees across the company we've kept in the last year and a half. There's, you know, a couple pieces to that. People that are at First Horizon and have a long tenure. They're at First Horizon because they like the culture, they like the client environment, they like that decisions are made closer to the client. The second part is we did add a very nice retention payment in with the TD acquisition. Right after the TD acquisition was announced, we had $150 million of retention.
That was pretty broad-based, hit almost all of our employees, and that stays in place after the merger was terminated. What happens is the Legal Day One was considered day one for the merger, for the retention payment, and it accrues over one, two, or three years. Now the termination date of May 4th is when that will lapse. Over the next three years, we still have retention on our employees.
Got it. You know, let's take a step back. Let's talk about the macro environment a little bit. You know, it's changed a lot over the past year. You know, we had the Fed speak today, keep rates flat. I guess, what's your view on where interest rates are going to go from here and your outlook for the economy as a whole?
Well, I'm glad to speak after the Fed-
Right
M ade their decision, and I'm glad to see that they held flat. I'm hopeful that we're going to see a stabilized interest rate environment for the rest of the year. Hopefully, no decreases, no rate increases. I think the economy and the banking system and the customers can all use some stabilization. For me, stabilization is no increases, no decreases. I do think for the next six months, today really signals that we're probably at the rate we need to be at, that they're seeing the economy respond to the way that they want it to, and that hopefully, you know, we're going to be stable for the rest of this year. Then we'll talk about 2024 as to whether we see rate cuts or not.
What are you hearing from clients on the macro front as well, right? Because there's, you know, clearly a lot of uncertainty out there. Can you talk a little bit about what you're hearing from clients?
Absolutely. Our clients are adjusting to a changing environment quicker than they've ever seen in their lifetimes. Whether it's rising inflation that they're dealing with in their businesses, we hear from our clients all the time about, you know, the competition on getting labor, the cost for labor, as well as the rising cost of, you know, running their business with inflation. We're really looking to, you know, our clients are looking to us as to how do I think about the next couple of years? What is the right credit facility for me? Recently, they have become hyper-aware, post-Silicon Valley, of the very highly competitive deposit industry. We're coming out of almost 10 years of near record low, where your deposits followed your primary relationship, and most of our core clients weren't hopping money between different banks.
If you were their client, they'd, you know, they're a primary client relationship with you. Now, they're shopping their deposits, we're seeing even different behavior. Having to talk to the clients about a full relationship, how does that look? How do you think about not just the cost of your loans, but how do you put your deposits to work for you?
It's a lot about the all-in relationship, right? Like, you have to have the deposits come through if you want the loan.
We prefer that. I don't want it out there that we're only doing that.
Right.
We do prefer to have had long-tenured client relationships. You know, one of the stats that we shared in our first quarter deck, as well as in Investor Day, we've had 98% client retention in 2022, and 2023. That comes from having long, deep relationships.
Got it. Maybe talk a little bit about the geography that you're in. You know, you're across the Southeast. It's a pretty attractive geographical footprint. You have a sizable market share there. Talk about what you're seeing in the markets today.
The Southeast markets are just booming right now. They continue to see growth. We chose Nashville as our site for Investor Day, and, you know, the question I asked everybody, they would ask me, "You know, why'd you choose Nashville?" You know, we go through a thriving market, and I'd ask them all: "How many cranes did you see?" Nobody gave me the same answer. Because if you'd come from one side of the airport, depending on where your hotel is, there is at least 12 construction projects going on in Nashville, and there has been for the last decade. We see that in the Southeast cities. When we look at data on what's happening in the U.S., the influx is leaving the West Coast and the Northeast and coming to the Southeast markets that we operate in.
There's a great slide in our investor deck of our top 20 markets and how they overlap with the best performing markets in the U.S. I think it's a great time to run a Southeast franchise. I think when we look forward to how is our credit going to perform, which is one of the big questions, you know, I always tell everyone, look at geography. You know, use these national numbers of office vacancy, and that's not what we're seeing in the Southeast.
What are you seeing in the Southeast? Is there, like, fewer vacancies in office?
We're seeing fewer vacancies-
A lot more household growth.
Household growth, mortgage prices continuing to rise in some of our markets. Very competitive, competition for top credit.
You know, what does that mean for deposit balances, right? Like, that's been a key theme of this conference. You know, everyone's focused on deposit balances, migration from NIB to IB deposit betas. You know, I think you disclosed at Investor Day that you actually grew deposits versus the end of the fourth quarter, I think, versus the end of the first quarter. And I think you mentioned that deposits were up $1.5 billion in May. Can you talk a little bit more about what you've seen so far and what your efforts have been on the deposit side?
Yeah, we saw a great May. I think one of the biggest questions we had going into Investor Day, you know, we had dinner with the investors the night before, and everyone said, "How bad was your deposit runoff after May 4th? How bad was it after you announced TD?" When I got up on stage, I got to say, "Y'all asked the wrong question. It wasn't how bad it is, it's how good was it?" So we are operating in the Southeast, which has the ability to grow household growth, ability to grow deposits. We've seen significantly positive momentum in the last 30 and 45 days, as we've distanced ourselves from the uncertainty of the TD merger.
We did have high deposit runoff in 2022 and 2023, but when you look at our balance sheet, we were sitting on approximately $15 billion sitting at the Fed at the beginning of 2022, and we let that run off because we were seeing very, very competitive deposit pricing close to Fed Funds. To just park it at the Fed, we didn't need the deposits. We turned the corner really in January, saying, "Okay, we've now let our excess deposits run off. We have a normalized balance sheet on the deposit side. We need to get aggressive with deposit campaigns." We did launch in February, a deposit campaign. We've relaunched our VirtualBank, but we really didn't see the traction until after the uncertainty of the merger was taken out.
We saw more new-to-bank clients come in, clients move their deposits balances back to us. When you're talking to a client, and you're guaranteeing them rates for 12 months or 18 months and indexing off Fed Funds, they know that we're going to honor that. They didn't know it was going to come on the other side of the mergers. We've continued to see a lot of momentum and a ton of engagement from our bankers with both existing clients and prospects.
All right. Perfect. Then, you know, I guess the flip side of deposits is loan growth. You know, can you talk a little bit about, you know, what you're seeing in the markets? A lot of banks have been tightening their credit standards. You know, what are you doing, and what are you seeing from competitors?
We're absolutely tightening our credit standards, and we have been since last year. As we're starting to see, you know, the outlook that was going to be recessionary, we started to look at our book just a little bit at a tighter glance. We always lend with a risk profile on credit that says: How is this credit going to perform through a cycle? Not is it the best spread today? Is it, you know, the biggest amount that we can book? How is it going to perform? We feel we have a diversified portfolio that will perform well. As far as new originations, as deposits are shrinking out of the banking system, we do have to slow loan growth. I said in Investor Day that we expect it to moderate in the second half.
We're about you know, 3%-4% in the first half of the year. We expect that to moderate in the back half. We're being selective. We're start with our balance sheet is for clients. We are a client-focused bank. We like to have long, deep relationships. We want to make sure that we have the capital to service our existing clients. When we go out to market to bring new clients in, we're looking at full relationships. We're looking at good spreads. When you're sitting with you know, coming off three years of near zero interest rates with so much excess liquidity, the question we got was: Why aren't you lending more? Why aren't you lending more? To your point, the question every CFO is getting today is: How quickly are you shutting back down lending?
We're being very, very thoughtful about every new lending relationship we enter into right now.
Is that true across the different loan categories, so whether it's C&I, CRE, resi, you know?
It is.
Top three?
Yeah. We're absolutely, we've not shut anything down. We're not announcing that we're shutting down any verticals or getting out of any businesses. We're still here to use our balance sheet to support our clients.
Got it. Can you talk a little bit about the credit environment? We're coming out of a pretty benign credit environment. A lot of, you know, investors are concerned about, you know, CRE, more so than anything else right now. You do have charge-offs, delinquencies normalizing across different types of loans. Can you talk a little bit about the credit environment in general, specifically in your markets, and then also, you know, how you're feeling about your portfolio?
As I mentioned earlier, our markets are performing better from a credit perspective in the Southeast, since we don't have the vacancy and the outflow of people. We're actually seeing an influx of people in our markets. On the credit side, we've worked really hard in recent years, through multiple acquisitions, to be really thoughtful about how do we position our balance sheet? What is the right diversification mix? We really focus on diversification mix. If you look at our Investor Day, we talked about our regional banking, and we talked about our verticals that exist in the specialty bank. We really look at not having any significant concentration risk, either by a vertical or geographic within one state or one MSA.
I guess when you think about the macro overall and you think down, you know, one year, two years, three years, there's a big debate out there, right? Do you see, you know, credit spiking as we go into the next, you know, year or two, or does it play out over a period of time? Do you have any thoughts about what that means for the industry?
My personal opinion is that we are going to see credit increase. You're going to see charge-offs increase. You're going to see non-performance increase. We are, you know, in a rapidly rising interest rate environment. Sometimes that has a lag on the impact it has on the business's performance. We have rapid inflation that we're still trying to get under control. I think as some of these credits go to renew, there's going to be less people willing to take that credit. You know, it used to be easy. In, you know, the last couple of years, there's a lot of excess liquidity that if you didn't want the credit, somebody else would take it. If somebody else is not willing to renew that, it'll turn into a workout.
I do think we'll perform better through that, but I do think we're heading into a credit cycle. Whether we head into a deep recession, a long recession, I think it's just the lingering impact of everything that's happened in the last 18 months that hasn't completely hit the client's balance sheet yet.
Where do you think private credit comes in here? You know, we've seen a lot of, you know, articles out there about private credit willing to come partner with banks, willing to be the balance sheet or, you know, willing to provide the capital that banks have historically provided. Any thoughts on where that goes for the industry?
I think there's a lot of talk about it right now because of the liquidity coming out of the banking system. I'm not hearing that anybody's doing it at market. They're all looking for a discount. If you see some of the portfolios that have been sold off, they were sold at a pretty big discount. I don't see that as a near-term option for us unless we start seeing it at more of a partnership level. I think the private capital firms that are out there are trying to make a pretty big turnaround on this, and they have enough banks that are willing to sell their assets or partner in an asset relationship like that, but I don't think it's in our near-term future.
All right. Maybe let's go to capital. You know, your capital levels are really strong. You noted a pro forma CET1 of 11.3%. How are you thinking about capital deployment?
Although everyone doesn't like my answer, I've gotten beaten up on this quite a few times today, and I expect more this afternoon and tomorrow as I meet with investors. In the near term, we're only 42 days right now past the TD deal kind of falling through. We're a week past our Investor Day. We're just got it added back to the KBW Index as of next week. We need to have a little bit of distance from the storyline that we had, the crisis that the banking industry has gone through, and then we want to put our capital to work. Whether we see that stabilization in one quarter, or two quarters, or three quarters, I don't have that looking glass right now.
Our long term, you know, as soon as we see the stabilization, our long-term goal is to get to 10% to 10.5%. We will return that capital to shareholders in the best way possible, as soon as we see some stabilization in both the banking industry and the economy.
There's also a lot of uncertainty around regulation. You know, we had the report from the Fed on Silicon Valley Bank, from the FDIC on Signature. It's clear that regulation is going to move up for banks of your size. You know, what do you think about that, how does that impact how you manage your capital right now as well?
Yeah. We're not sure if it's going to impact us just yet. Right now, there's a lot of talk of stopping it at a $100 billion bank. We'd be falling under that. Not leaving out that we could be scoped in the near future. When I talk about what should be our longer term capital target of 10-10.5, I do think even if they move the regulatory minimum up to 7.5, you know, eight, that's still 200 basis points over that. It does play into how we think about how much capital we would deploy, how quickly, though, in the near future. We do need that to settle down.
We need to know what are the new capital requirements for banks, when are they going to go into effect, and make sure that we have adequate cushion to cover that.
What do you think the regulators will change? You know, there's a lot of talk about the mark-to-market on AFS securities going away, LCR, potentially TLAC, maybe even the stress test, although, you know, not for banks of your size. Any thoughts on what the regulators will do here?
I wish I had a looking glass on that and rates, and I'd be the best CFO in the business if I had those nailed down. I think it's going to be iterative. I think there's going to be a proposal. There's going to be a lot of feedback. That we just had a CFO roundtable in D.C. last week where we got to talk to the regulators about some of this. I think it's going to be an evolving landscape. We saw the request for capital to increase through the U.S. Bank acquisition, and so in order for U.S. Bank to, you know, acquire MUFG, they had to agree to that higher capital. I think it's not new coming out of Silicon Valley.
I think they're still trying to figure out what is the right capital level and what does that look like longer term for all the banks. Whether it's the G-SIBs, the mid-cap, the large- cap, I think we're going to have to iterate on that. I think they're looking at Silicon Valley. Because of Silicon Valley, they're saying: Well, let's take the, you know, held-to-maturity and the AFS portfolio and lump that in for everybody up to a certain point. I don't know that they're going to be done coming up with capital rules anytime soon as a CFO. Whether we get through this crisis, the next one, I think it's just something we're always going to be talking about in our industry, especially as we see bank consolidation in the coming decade or so.
I think, you know, the regulators have been pretty clear that there will be a long phasing period as well for any regulations that come in. What about on the liquidity side? Is that something you're focused on, even if you don't get a formal LCR regulation? You know, how do you think about managing the liquidity?
Liquidity is a top question we all have, always, but it's definitely gotten a heightened sense post-Silicon Valley. The amount of money that can leave your bank very quickly, especially as FedNow is going in, and you're going to be able to see it move even quicker, 24/7. We're looking at how do you think about liquidity in more of a stress scenario? We really haven't done a stress scenario as an industry of what happens in a 24-hour, what happens in a 48-hour. Really, what happened to First Republic and Silicon Valley, I think, has us all rethinking how we think about those funds. You know, one of the interesting things coming out of the Silicon Valley kind of postmortem was they had their assets to pledge to get their liquidity, and they just ran out of time.
That has us all thinking, are we pledged in the right place? You know, the FHLB, certain days, couldn't meet all the funding. Completely different way of thinking, from a, you know, more of a stress scenario than how we were thinking before. We haven't seen a 24-hour run on a bank in the last decade or so, at least not in my career, and we're having to think about how would you play that out. I will tell you, with the TD deal falling through, we had those discussions of what could a one-day run in our bank look like? How do we position for that? I think every bank out there is constantly thinking about what could a one or two-day run look like.
What does that mean for the balance sheet? Clearly, it means, you know, holding more cash, but does it also change how you manage the duration of the securities book?
I don't know that it changes for us because we have a very prudent model when it comes to securities. We only have 13% of our assets in securities, which compares to our peer group of 22%. We were already pretty light on that portfolio. A lot of that's used for hedging, you know, downside risk. I think as an industry, it absolutely, you look at duration. At the same point, those assets can be pledged, and they cause liquidity. Think about the assets you put on your balance sheet from a interest rate sensitivity, as well as the ability for them to be pledged and create liquidity in the right environment.
Got it. Maybe shifting gears here. At your Investor Day, you know, you announced that you'd be investing a portion of the merger termination fee. I think it was about $225 million. I think you plan on investing that in your technology, people, platforms. Can you dig in a little bit on your plans there?
We, for, you know, the 15 months that we sat under the TD merger agreement, we were still doing technology investments, but we weren't doing major system overhauls. We weren't implementing new systems. We were doing the care and feeding, the run-the-bank stuff. Prior to that, we spent 18 months with the MOE between IBERIA and First Horizon getting to the best of both. We have a lot of enhancements, a lot of overhauls, new systems that we can and will put into place.
We look at what the timing for that is. We thought three years was the right horizon from our duration perspective for what is the amount of change that our bank and our clients. You can say, "Why don't you go do it all in one year?" Our clients can only handle so much change, and the company, we can only put so many, you know, new systems or enhancements in one year. Over the next three years, we're working on a roadmap right now of what are the systems that need to be enhanced, what are the new systems we have, what are the end-of-life systems? We're rolling out a three-year roadmap to get us back to where we want to be as a bank. We'll return to a more normalized spending level.
One of the things we shared in Investor Day is, you know, we did lose a lot of technology resources in the last year. I don't know that we lost any more than anybody else. We were in a highly competitive recruiting environment, people were seeing 15% and 20% turnover. Our issue was recruiting. It was really hard to recruit somebody new into the bank, saying, "We're not sure what your job will be after TD comes in. We're not sure what city it'll be in. We're not sure what system you'll be supporting." We had a lot of contractors in, part of that is getting back to a really strong employee base.
How quickly do you think you can do that in terms of getting the employee base to the right size?
It's an interesting recruiting environment right now.
Right.
You know, I, myself am recruiting for multiple key roles. People are a little bit nervous about changing banks now. You know, a year ago, people were chasing the highest retention bonus, the highest, you know, buyout. Right now, people are a little bit more uncertain about changing banks. It's kind of the situation you know you feel a little bit more comfortable with. I think it's going to take us a lot longer to hire than it probably would have a year ago. Even though a year ago it was more competitive, I've seen in my own recruiting that people are more willing to move a year down the line. It's not just First Horizon.
Even friends I have that were out there interviewing are now like: Well, I know my bank, and I know how my bank's going to perform and how my incentive plan is going to work. I'm not sure about that other bank. I do think it's going to take us a little bit longer because of the uncertainty in the banking environment to build back up some of our core functions.
Got it. Maybe pivoting over to the business outlook. I mean, I think you spoke a lot at your Investor Day about your business model, the countercyclical businesses that you have. How should we think about how those will perform over the next several quarters?
One of the reasons I'm excited about a rate pause today and hopefully, not seeing, you know, any more rate decreases or increases this year is it helps our bond business. It's really hard for our FHN business, our capital markets, to sell bonds in an environment where you're looking at this year, rate hikes in the first half of the year, decrease in the back half. It's like, well, what do you want a bond for? Hoping that our FHN business will come back in a more normalized rate environment where we don't see as much volatility. Also, we're seeing some pickup in Mortgage Warehouse the last couple months. We're starting to see that business pick back up from really a pretty significant low.
I'm hoping both of those businesses are starting to recover, and that we'll see positive momentum in the back half of this year and going into next year. That will help offset the NII compression we have.
Is some of the competition moving out also helping the Mortgage Warehouse business?
We just had that announced yesterday- or two days ago here at your conference. We'll see. I don't know if they're actually out of bed yet, I'll call my Mortgage Warehouse guy in a week or two and ask him how he's seeing it. Definitely, less competition always helps.
All right, perfect. Maybe to wrap up, can you talk about how we should think about your longer-term targets?
You know, we're really thinking about being a top quartile performer, where we have a slide in our investor deck where we talk about our margin, our efficiency ratio, ROE, ROA, and we are top quartile right now against the BKX peer group, and we continue to do that. We're not taking our foot off the accelerator, that our target is long-term shareholder return and consistent returns through the cycle. We think we're well positioned to do that with our, you know, countercyclical businesses, as well as our asset-sensitive balance sheet. 66% of our balance sheet is in floating rate.
Perfect. You know, maybe if you can just touch on, you know, what is the one part of the FHN story that is not well understood from investors? You know, what is the one message you'd like people to go out with?
I think the one thing that everyone's still reacquainting themselves with is how strong First Horizon is after the MOE. We had just completed the conversion of our IBERIA clients. We hit our $200 million of cost saves. We, you know, have 66% year-over-year growth in Q1. It's a show-me story now. We were telling you that we're a strong franchise. We're telling you that we have strong countercyclicals. We're telling you that we're a top quartile performer, and we can be. We're telling you that we have top capital that we can return to shareholders. We are going to continue to do that because we have a really, really strong franchise of dedicated employees with long client relationships that are here, and that they're fueling this momentum through whatever cycle is to come.
You know, for me, whether you talk about increasing 50 basis points or decreasing 50 basis points, I have a top-performing bank.
All right. Perfect. Hope, thanks so much for joining us today.
Thank you.