First Horizon Corporation
Q1 2016 Earnings Call Transcript

Published: 16 Sep 2016

[Bryan Jordan:]

Good afternoon. I'll take the next few minutes and then just sort of give a summary update of the waterfront. There are number of times in here that I talk about the future. There is the forward-looking slide which happens to be our second slide, if you take a minute to look at that. We assume no obligation to update any of the forward-looking information that we express in this conference. As we’ve talked about for several years, we think we have very strong capabilities and the franchise. In the following slides you’ll see the progress that we’re making across a number of fronts in our business. We think our execution capabilities are proven out through the loan and deposit growth we’re seeing in the franchise. We think we're uniquely positioned with the footprint centered in Tennessee with expansion markets in our Mid-Atlantic franchise and the Houston franchise, as well as significant growth opportunities in our specialized lending businesses that I’ll talk about. For a number of years we have been focused on productivity and efficiency. We have seen very good progress in controlling our expense base. We brought cost down over the years. We’ve continued to invest in new systems, technology and infrastructure, hiring and I’ll come back and spend a couple of slides on talking about that. And then finally we have our tremendous emphasis in great wealth of capability today that we didn’t have several years ago developed by BJ Losch, our Finance and Credit teams to allocate capital across our lines of business to understand the contributors of profitability both at a very granular level and a aggregated level whether you’re looking at products or lines of business and we use those tools rather extensively and so I'll spend a few minutes on some slides in the future talking about that. This slide is not dissimilar than you’ve seen in the past. We have what we refer to as the bonefish methodology. It starts with return on equity on the far left and works into the parts to construct that essentially the blue box or the guidelines that we've laid out for targeted or longer term expectations around drivers of our profitability. Clearly those factors are influenced by the economic environment what's happening from an interest rate perspective is probably the most obvious driver in that bonefish methodology today. They're not set with the expectation that rates are going to get significantly higher over the long term but they are sort of oriented around a more normalized fed fund rate probably in the 3% area. We’ve made significant progress towards those goals. You can see the performance for the second quarter and the lower half of this slide 11% return on tangible common equity ROE of just under 1%, and see net interest margin and the other drivers of that. We spent an awful lot of our energy focused on how we use this tool to break down into our profitability tools to drive profitability and drive return on equity. We think that is the one factor that will make the longest term impact on improving shareholder returns as drive and higher ROEs in the business. As we look at where returns are and at this point of the ROEs in the quarter of just over 11% and so the building blocks how we get to the 15% plus targeted ROE and the bonefish, you can see the various building blocks. They are not all equal and some of them will depend on the environmental factors. They tend to move from left to right in terms of what's controllable and what’s on controllable in the business. Clearly the most controllable factor will come back as I said and talk about a little bit is the controlling of expense efficiencies. We think we’ve got tremendous growth opportunities and I’ll talk about some of those businesses in a couple of slides where we have had and continue to make investments in growing the business through organic and through acquisitions of talent and smaller loan portfolios and then ultimately to the drivers that are affected or impacted by higher interest rates. And clearly interest rate policies driven at the Federal Reserve but as interest rates normalize we think that can have a significantly positive impact on our net margin as well as our overall results. This is a summary slide on operating leverage, operating efficiency. The lower half of the slide sort of takes second quarter of 2015 and second quarter of 2016 and annualizes those two periods to sort of indicate to you the amount of change in expenses across the lines of business what you see the fundamental picture shows you is that expense growth in the quarter year-over-year was driven by growth and fee revenue, normalization of fee revenues at FTM financial, expenses in the non strategic to corporate, the banking business, all other essentially were flat to down. We have made tremendous efforts to control expenses across the business to keep our expense levels flat to down while at the same time continuing to invest and hiring teams of bankers talented bankers that can grow the business, continue invest in infrastructure around regulatory requirements, continue to invest in infrastructure around our systems and our processes to make sure that we have the products and the features that our customers expect and we continue to look to draw flat expenses across the business. We think there are continued opportunities for expense efficiency in the future. I said to some folks earlier today that as we look at expenses, always the most daunting year is the next year when you are looking at three months out but we feel very optimistic about our ability to continue our expense control, to continue to realize the benefit of horizontal expense opportunities we see in the franchise. Those processes that transcend a number of organizational units would impact the customer experience and ultimately will give us the opportunity to drive expenses down. We continue to close, consolidate branches, we have identified and are in the process of either completing or plan to complete the consolidation of in around numbers about 10% of our branch franchise in 2016 and we think there will be other opportunities to do that in the future particularly as customer traffic patterns in our financial centers change. As we look at customer visits to the branch, they continue to decline on a monthly basis, they continue to climb year-over-year and we expect it has happened, customers choosing alternative delivery mechanism such as online banking, mobile banking, ATMs, other vehicles that the branch network although always an important part of the delivery mechanism will allow us to shrink that footprint and concentrate our effort in fewer numbers of branches. So I don’t ever intend to emphasize that we won’t need the branch because I believe the branch is always going to be an important part of the delivery system but in terms of customer activity it will be less central to customer activity in the long term. Little bit on our deposit share and make up of our deposit base, we do have the leading deposit share in the State of Tennessee we are number four in five of the major MSAs and stake. You see graphically where we are positioned in the market. Most of our branches will fit in those blue boxes. We tend to be very central as to around those major MSAs, you see to make up for the deposit base and nice balance between non-interest bearing and interest bearing very little emphasis on time deposits. We are core deposit funded, a loan deposit ratio of 92% so we have the ability to fund the organic loan growth in the footprint. And you see some of the other statistics on the makeup of the deposit base. We have had very nice growth opportunities. This is a slide that covers a great deal on the loan portfolio. If you don’t mind I’m going to start at the bottom and work up. Many of you know that have followed us for a long time, in 2008 we designated a portfolio of non-strategic and non-core assets that had been running off, 2008 that was about $7 billion portfolio. This chart picks up in the second quarter of 2011. So essentially you have five years of history here. You can see how that portfolio has continued to run down roughly at about 19% annual rate. At the same time we have seen about 8% year-over-year growth over that five year period in our core banking franchise. Total loans have remained flat for a period of time and then started to grow as the size of that non-strategic portfolio diminished. We grew that loan portfolio and what I think is one, a very valuable way and two, it’s in a way that positions us well for the long term. Within our core franchises, where it is showed in the pie chart, in the left corner as well as the commercial real estate business. Those are core footprint businesses. We have very strong share in those market places that fit our deposit shares, our bankers have done a fantastic job calling on what I describe heart of the market opportunities. Those opportunities to do business with customers that you want to build long term relationships or franchise type relationships with for the long term. We are not going after aggressively to incremental transaction in the market, we want to build long term relationships and a lot of the business we won over the last 5 to 8 years in our existing footprint continuing today comes from solid core long term calling efforts by great group of bankers who bring expertise to their customers. Middle Tennessee is an area where we have placed a tremendous amount of effort over the last several years. We have new leadership in the last couple of years in the marketplace with Carol Yochem in the market and Renee Drake who is leading our commercial banking effort. They have built out our commercial banking teams and expanded our commercial banking efforts. They have augmented the efforts that we already had in place. They have or in the process of building out our music industry, our specialized sponsor healthcare finance businesses and we see continued growth opportunities in that marketplace given the tremendous growth that we are seeing in Middle Tennessee. And if you flip back to the previous chart, that’s the place where in the aggregate we start with the smaller shares and we have the greatest relative opportunity for growth in that market as well. We also have good growth opportunities in our view in Mid-Atlantic and our Houston franchises, Mid-Atlantic runs essentially from Richmond, Virginia to Jacksonville, Florida, most of that is centralized in the Central Park to Raleigh, North Carolina we made an acquisition of TrustAtlantic and announced in 2014, closed it in October of 2015. So we think those are good markets for us to grow in and continue allow us to place resources at work there. And then finally our Houston market where we had a presence for about two years growing through a talented and experienced team of bankers that have been long time participants in the Houston banking market, great relationships. We enter that market with essentially a clean pallet when it comes to oil and gas exposure for example and we see there is an opportunity to grow and to continue to expand there. The other part of the big growth effort has been in our specialized lending businesses, essentially the right third or so of the pie chart that you see here in the upper right hand corner. Now we have continued to grow our asset based lending business, our mortgage warehouse finance business. We continue as I said to look for new opportunities to expand those businesses through the acquisition of the restaurant finance, restaurant franchise finance business from GE capital which we close in the next several days. I mentioned music industry lending, I mentioned specialized sponsor finance, healthcare finance so we see those as nice growth opportunities in addition. We think that the opportunities for growth here continue to be very, very good. In terms of loan activity in the quarter, loan activity has continued to be very strong. When we talked about the end of the second quarter, the start of the third quarter on loan pipelines, our pipelines were as strong as they have been for many years, maybe ever. Our loan pipeline at the end of August still was in the $2 billion area, so we feel very good about our loan growth opportunities, our loan growth momentum. Our mortgage warehouse finance business continues to be strong. Last week it was about $2.3 billion in outstanding and that’s going to ebb and flow and some of that is seasonal quarters, particularly if you look at the months in the summer they continue to be a little bit stronger but we expect that our warehouse finance businesses is going to be north of $2 billion for the quarter and in the aggregate we will continue to see pretty steady loan growth throughout the rest of this quarter into the fourth quarter of 2016. In our banking business we have, as I mentioned earlier tremendous focus on driving risk adjusted returns and profitability in the business. This is a chart that at the top half lists a number of the tools, I won’t go through in any detail and describe who is using them and how they are using them but you can see in the bottom half the improvement that it’s making in the ROE in the banking business. We have adjusted the second quarter for the settlement charge in the bottom half of this chart which you can see continued and steadied improvement in risk adjusted returns over the last three years. Maybe the more important graphic in my view is on the next slide, you can see in the upper right hand corner the drivers of economic profitability across the regional banking business as we measure and you have seen this bottom chart for a number of years that’s essentially what we call our waterfall chart. It starts with the most profitable products, the height of the bar is the economic return or margin over the cost of capital, the width of the bar is how much capital it consumes. If you look at this picture over several years, and I am sorry, it’s not graphical, it’s difficult to portray graphically overlay but if you look back at this chart over years you will see that the breakeven line, the point where we have capital deployed in positive generating activities has moved further to the right. So we have done a good job in my view our bankers, our finance teams working together have done a really nice job of looking for concentrations of profitability for opportunities to improve the way we look at profitability, relationship pricing, product packaging and ultimately our cost structure to drive enhanced profitability across this product fit. So we are seeing very positive and important trends in improving profitability and we expect to continue to further that focus. The following chart is sort of a summary about the way we think about investing capital. We have a very strong capital base, we are in the process of wrapping up our examination of our deep dives process with our regulatory authorities, that information will be disclosed in the next 30 to 70 days I guess. With the way we look at capital in our capital base we want to invest internally in organic growth. As you move across the page we are page-rating capital of shareholders and/or investing externally what it be in M&A or reasonably priced economic purchases. A good example is the recent acquisition that’s kind of closed of the GE restaurant finance business. We have repatriated a tremendous amount of capital through our share buyback program and as I demonstrated earlier in the slides on the loan growth we found a number of opportunities to invest in loan growth across the franchise both in an organic fashion and by acquiring or hiring teams of bankers who give us new capabilities to grow the business over the longer term. As it relates to the M&A environment, we believe very strongly, continue to believe that lower premium transactions, MOAs, low premium transactions or by far much more preferable and probably the most logical way to consolidate the industry and create value for both sets of shareholders. We are very conscious about the expected returns that investors expect and again it goes back to our orientation around driving ROE and our expectations that how we deploy capital and the returns we produce on that capital are the long term drivers of shareholder value. And so all of these alternatives investing internally to repatriation to investing externally through M&A or purchase transaction, all relate to how we think it improves or changes the dynamics we have in the bonefish and our ROE hurdle targets. Switching for a few minutes to our fixed income business. We have a very old fixed income business. We have been in the fixed income distribution business for 80 to 90 years. We have a broad calling efforts you can see some of the makeup of the business at the bottom. We do business with about a third of the financial institutions in the U.S. It’s become a much more balanced business over time between financial institutions and non-financial institution, total return investors. Those relationships are very broad and very big. We have benefitted from the transition or changes that are occurring in the fixed income business in a broader sense largely driven in our view by the Volcker Rule. Our model has never been based on a proprietary trading portfolio. We have historically not taken proprietary trading positions, we have been in the transportation business, we match up buyers, we match up sellers and so we have not had to make a significant adaptation of our business to the changes. So while others are reducing their fixed income efforts, we are looking for opportunities to pick up, calling officer sales, men and women who can help us grow the business and open up new relationships. We are looking for opportunities to expand our complimentary products set whether it be the ability to evaluate risk rate and risk rate municipal finance securities to understanding asset liability management and the whole plethora of products and services that we have around this business. So we think we have continued to grow some market share and the activity in an environment where fixed income activities are little better but not particularly great. We ended the second quarter slightly above $1 million a day in average daily revenue at $1.1 million. If you round the numbers all through the first two months of the quarter we are right at a million dollars a day in average revenue in the third quarter. July was a little stronger than August that’s to be expected August is seasonal. We expect based on the first month of September which included the week of Labor Day that will come out somewhere in that million dollar a day average daily revenue zip code but it’s clearly it’s going to be dependent upon what happens over the next couple of weeks and to the extent that the federal reserve or the FOMC policy statements next week impacted it’s hard to anticipate. Quick slide on our asset sensitivity. We have historically maintained a fair amount of asset sensitivity as principally driven because we largely have about 70% of our loan portfolio on a floating rate basis. In the upper left hand corner you can see that the breakdown between one month LIBOR, three month LIBOR and prime, principally all tied to one month LIBOR and to prime, very little exposure to three month LIBOR to the extent that one month LIBOR follows three month LIBOR, it will help us enter net interest margin. The lower right hand corner we have reduced our asset sensitivity a little bit. We have always presented this historically speaking in 200 basis point moves in the longer. We have not moved on the short ended curve the more clearer it’s become that we are unlikely to see a 200 basis point move in this cycle of interest rates. So we have taken the opportunity through a little more fixed rate lending, customer lending on the balance sheet to reduce our asset sensitivity and bring that sensitivity down a little bit, so you can see sort of the comparatives of a year ago and where we are today. We still benefit nicely from rising interest rates into the extent that we got a rate increase whether it’s next month or December or next year. We expect the benefit from that. We have brought the expectation about longer term rate increases down and so we brought the sensitivity down a little bit as well. I would say if anything else is shifted in our thought process around assets sensitivity is that to the extent that rights do move up, we think deposit betas are likely to be higher than we historically modeled in the base. Some of that is the change in behavior we are seeing in particularly some of the larger institutions that are dealing with a liquidity coverage ratio and so we believe fundamentally that those deposit betas could be a little bit higher as interest rate start to move backup. In summary, on Page 14, we are focused on what we call three blue chips. One being easy to do business with, two, providing a differentiated customer service and finally using the bonefish to drive our profitability. We think that our bankers and that our team is doing a fantastic job executing on those priorities. Our customer survey scores, our J.D. Power ratings, our granite scores on the commercial side continue to be very strong and evidence of very good customer support and activity and I would say one of the best barometers of that is the ability to continue to grow loans and deposits across the franchise. So I feel very, very good about the way our bankers are performing and what continues to be a difficult operating environment. And I think our fixed income business has taken an advantage of an opportunity and resetting in a broader fixed income marketplace to grow our fixed income business in an attractive way. As we look into 2017, we don’t expect a significant change in the interest rate environment. We think that the operating environment is likely to be very much like it has been in 2016, 2015 and that the environment while being competitively tough, we think that we can do very well in that environment that we can continue based on the pipelines that we have to produce strong loan growth and show very good momentum as we look at the rest of this year and end of the term of next year. So with that I’ll be happy to stop and take any questions.

[Matt Keating:]

Great. Thanks, Bryan. I was hoping you could clarify the comments around the mortgage warehouse portfolio, you did say that you expected to be north of $2 billion - I guess by the period - by the end of this quarter. Is it on an average basis or a period-end basis?

[Bryan Jordan:]

That's on average basis.

[Matt Keating:]

Average basis.

[Bryan Jordan:]

Yes, with ebbs and flows. It may be a little higher than that.

[Matt Keating:]

Got you. Thank you. Next, moving to some of our audience response questions. If you won't mind, point those questions out, that would be helpful. Okay. So our first question for the audience here is if you do not own shares of First Horizon or might be underweight the stock, what would cause you to change your outlook towards one, additional progress on its profitability targets; two, higher interest rates given its above-average asset sensitivity; three, continued growth in its expansion markets; four, improvement in fixed income units average daily revenue trends; or five, input for bank M&A to reduce its efficiency ratio. We'll take a few seconds to vote. Okay. So the results from the audience are 36% would like to see continued profitability improvement and 29% would like to see the Bank releases its efficiency ratio by participating in M&A. So, I think you mentioned the focus that the Bank has on meeting this bonefish goals. Some of it obviously will be helped by a more constructive interest rate backdrop, but if you had a point that few things that you are focused on in terms of really driving meaningful improvement in profitability, what are the two things in the Bank's control in your view?

[Bryan Jordan:]

The two things that are in our control and I must see M&A after the side because that’s not in our control as driving positive operating leverage by growing our revenue faster and/or controlling expenses. And two, being very, very thoughtful about where we make investments in the business. I mentioned earlier that I think our bankers, our folks have done a fantastic job reducing cost over a very long period of time and controlling those cost but we have continued to invest in revenue producing activities and technology that we think we’ll continue to keep us positioned very well. So as I think about the next handful of years while doing item 5, doing M&A is not important – is not necessary although it could be an important part of controlling cost, we got to be very thoughtful about how we keep those costs largely flat, at the same time continue to invest in fee card products and treasury management products and consumer products like our own line mobile banking that enable us to stay in the advantage position we are today from a products set and the customer service perspective.

[Matt Keating:]

Great. If we could move to next question, please. This question for the audience is, what percentage of First Horizon's total lines do you think originate from outside of Tennessee? Choice one, 0%; choice two, 10%; three, 20%; four, 40%; or five, 50%. So, we'll take a few seconds to vote. Okay. Some most popular answer was choice three at 20% of the footprint, 40% of the audience thinks that, 33% thinks it was higher than at 40% and 7% think it's at 50%. So, what the answer, either Bryan or BJ, could you enlighten us on what their actual percentage of maybe other. So it’s 20%, so, the audience has obviously been closely following the Company and has a good understanding of where that's moving toward. I guess if you include the non-strategic portfolio, where would that percentage look great?

[Bryan Jordan:]

If you included the non-strategic portfolio that percentage would go up a bit because that home equity portfolio was largely originated on a national basis. If you haven't picked up the deck, I would encourage you to pick up the deck because in the appendix there is a makeup of our portfolio of those loans that come from insight the footprint and those that come outside the footprint. When you think back through the pie charts that we’ve looked at, you’ll see it in that graphic it shows what portfolios are originated where. Our mortgage warehouse lending business is largely a national business. It's spread over a very diverse geographic area. Our ABL business tends to be more regional although we have a lot of borrowing outside of footprint. That’s a long way of saying the specialized businesses have a much broader footprint than the Tennessee lending business. If you look at commercial real estate, you look at our other C&I businesses, they largely are originated for C&I and/or commercial real estate customers and our existing footprint. But we look at the nature of the relationship and the bar. We are not chasing relationships outside the footprint. We are looking at building broad deep relationship over the long term and that’s what drives the makeup of our in footprint and our out of footprint lending, the specialty businesses and the nature of where the relationship goes.

[Matt Keating:]

Great. So, when we talk about pipelines being at near record levels for the organization, is that across those intensely and out of footprint pipelines being held.

[Bryan Jordan:]

That’s combined yes, that’s combined.

[Matt Keating:]

Great. Next question, please. The First Horizon's bonefish profitability goals call for significant improvement in its return assets and its return on tangible common equity. Over the next two years, do you consider the low-end of these targets achievable? Pretty simple answer, yes or no. And the results from the audience tell us that, 43% of the audience thinks these results - the low-end of these targets are achievable, 57% do not. Now, for reference, we asked a similar question last year and 32% of the audience thought the low-end of these targets were achievable. So, you guys have certainly, I think, made progress as the Company continues to see stronger loan growth and continues to improve its efficiency over time.

[Bryan Jordan:]

It help to have a little bit help from interest rates but we’re continuing to chip away at it nothing else we’re really focused on it.

[Matt Keating:]

Okay. Our next question please. Over the next two years, First Horizon, in your view is more likely to want to acquire a smaller bank; two, enter into mergers of equal transaction; three, sell to a larger bank; four, refraining from M&A, or five, acquire more targeted loan portfolios similar to the restaurant franchise loan portfolio and GE Capital. And we'll take a few seconds to vote. Okay. The results here show that 40% of the audience think the Bank may be inclined to sell to a larger bank over the next couple of years, followed by 27% think a mergers of equals could be a possibility; 20% look for more loan portfolio acquisition; no one expect the Bank will refrain from M&A over the next couple of years and then 13% think a small bank acquisition could be in the cards. I think you talked about the M&A environment. I mean, obviously, your view on a consolidation for the industry is that mergers of equals low premium transactions make more sense. Have you noticed more discussions? I mean, if you look at industry data on bank M&A, it hasn't been all that robust year-to-date. You have seen a bit of a pick up recently, but overall trend hasn't been all that impressive. Is that your view that consolidation could be coming over the next year or do you think it might extend beyond that?

[Bryan Jordan:]

Yes, I would observe but I don’t see a tremendous pick-up in M&A discussion right now. It feels at a very low level for what I guess around myriads of reasons, some of it are, are related to the regulatory issues sort of exist in the marketplace whether it be BSA/AML, Community Reinvestment Act. The time it takes to get approvals to, the interest rates are going to go up, revenues are going to look better, valuations are going to look different in a year. So just doesn’t feel to me like it’s going to pick up a tremendous amount over the next several months. And as I mentioned earlier, we don’t view the need or there is an absolute need to do M&A. We position the company to be sustainable for the long term, to grow the franchise in an organic fashion. We’ve got the capabilities and the product and infrastructure and surely we can benefit by picking up some efficiencies by making some additional acquisition having a broader asset base to spread this costs over. But we don’t think it’s a necessity, we think we’ve got the ability to continue to grow the business and to do it in a sustainable fashion with the existing footprint that we have.

[Matt Keating:]

Questions from the audience?

[Unidentified Analyst:]

When you look at your fixed income trading revenue, $1 million per day ADR, what you think that could grow to? Will it be the implications for your capital, how much capital does that use and also the implications for your interest ratio?

[Bryan Jordan:]

The key drivers of ADR are going to be volatility and the ability to continue to grow share. Our third driver over the longer term is going to be the product mix and the product mix has shifted some overtime. It's unlikely I'd say in the next five years, that we’re going to get much out of that band of a million on the low end to 1.5 million on the high end, I would expect that we’d probably be in the lower half of it for the next couple of years. So I think its trading environment is still going to be a little more difficult. In terms of drawing capital that business is reasonably efficient in the capital that it droves because we don’t run a proprietary trading business, our book, we have hedged out significantly all of the interest rate risk and the business and so our capital allocation models we say it drives a couple of $100 million that doesn’t tend to ebb and flow a whole lot with average daily revenues. So that number as it goes up our ROE in that business will increase. There is a slide that's been in one of our presentation in the last year or so that sort of shows a return on equity in that business and sort of ranges on the low end from 19% to 20% to all of the charts and here’s like 2009 where we’re doing 6 million a day. So the risk profile doesn’t change a whole lot and I’d expect longer term that will end up in that million to million half range.

[Unidentified Analyst:]

[indiscernible].

[Bryan Jordan:]

Thank you for your time and your interest.