First Horizon National Corporation (NYSE:FHN)
March 06, 2013 8:20 am ET
Susan Springfield - Chief Credit Officer, Executive Vice President, Chief Credit Officer of First Tennessee Bank National Association and Executive Vice President of First Tennessee Bank National Association
Thank you. Thanks for having us. Good morning, everyone, here in the room and on the phone. We appreciate your interest in our company. I'd also ask you to note on our slides the disclaimers on Slide 2 about non-GAAP information, forward-looking statements and the like.
Starting on Slide 3. While the industry and the earnings sources from the industry have changed significantly and continue to evolve in today's environment, we believe that our firm is well-positioned for long-term earnings power. We're focused on driving higher returns on equity and assets. We're very focused on controlling what we can control in this environment, things like expenses, balance sheet, pricing, credit discipline, capital flexibility, customer focus. We have dominant market share in our core businesses of regional banking and capital markets. We have a steady fee income mix. Almost 50% of our total revenue comes from fee income. We've already delivered on a significant amount of expense reduction across our organization, and we expect further improvement in the coming year and years related to things like reduction and pension cost and targeted efficiencies going forward. We have latent earnings in our asset-sensitive balance sheet with significant upside once rates do rise, and we believe we continue to possess capital flexibility. We've been returning capital to shareholders via dividends and buybacks, while maintaining strong capital levels, and we have the capability and resources overtime to participate in the coming consolidation of the industry. So we are very pleased with our progress and we continue to look forward to positive momentum over the long-term.
If you look at Slide 4. It really shows our 2013 strategic priorities. Internally, as a company, we call these our blue chips. We communicate these frequently throughout the organization. Three things: profitability and return focus through our model called the bonefish, which those of you who have followed us would know that we talk about quite a bit. Second is easy-to-do-business-with, and third is providing differentiated customer service. We want everyone in our firm from the front line to the back office to senior management, thinking about doing business every day through this lens, and we believe that in 2013, these are the key controllable levers that we have to significantly improve our performance.
Turning to Slide 5. We pay a significant amount of attention to pure comparisons, externally, benchmarks, internally and externally, which along with our bonefish model, helps us drive continuous improvement and focus on the key drivers of returns and profitability. If you look at our core business performance of regional banking capital markets in our corporate segment, our returns on equity and returns on assets compare very favorably to peers today. We're not done improving, but we feel pretty good about our positioning today. And if you look at the key drivers of those return metrics on charge-offs and credit quality, we are very pleased with our progress here, and we continue to see good credit quality going forward. Our fee income mix, we believe, again, is a significant differentiator for us overtime, to efficiently drive returns on assets, in particular. And the 2 areas that we continue to focus on to improve our bonefish-type performance are the efficiency ratio, which is both, as you know, a numerator and a denominator issue, we've taken significant action on the numerator on the expense side and expect more reduction this year. And the denominator will be helped overtime by continued pricing discipline, defending our margins, improving our fee income streams and eventually, improvement in the rate environment.
We expect that the efficiency ratio today -- I'm sorry, throughout -- by the end of 2013, will be more in the 70% to 75% range, trending much closer towards our long-term bonefish targets as a company of 60% to 65%. And the fourth key driver, our net interest margin is, as you know, across the industry currently under pressure, but we believe that we are doing a lot of things to defend that better. And we will continue to do so in addition to having long-term significant earnings power coming out of our balance sheet overtime as rates do rise.
Slide 6. Looking at our first core business, regional banking, which does business as First Tennessee, we start from a position of strength in our banking business. We have #1 combined market share in the Tennessee markets in where we operate, and we're growing faster than the market across many of our markets. In Middle Tennessee, in particular, where we don't have #1 market share from '11 to '12 according to the FDIC, we grew at 6x the market rate in terms of deposit gathering so we're very pleased with what we're doing here. In a difficult environment, it's very important to take care of your customers. External results and internal benchmarking would show that we're doing a great job there both on the retail side through retention and recommendation from our customers, as well as external on the commercial side with some excellence awards that we're receiving.
We have strong well-established specialty businesses such as mortgage, loans to mortgage companies, asset-based lending, regional corporate banking that have compelling value propositions, high-risk-adjusted returns and continued opportunity for growth. We will continue to focus on those to be able to work smarter, and put our capital to work in a more efficient way. You'll see on the bottom right that our regional banking loans and deposits grew double-digits last year, which we're very proud of, while also maintaining good pricing and credit structure discipline, particularly on the loan side. And on the bottom right, you'll see that our fundings were strong and our pipelines remain solid in this environment. So our bankers are out calling, they're looking for deals. We're open for business and we're pleased with the type of quality lending that we're continuing to see through our pipeline.
On Slide 7. Our bankers, again, have done an excellent job maintaining discipline on pricing and structure as competition has intensified. And from a balance sheet management perspective, we're also very mindful of not creating duration risk in search of current yields. And so if you look at our relative asset sensitivity, we are meaningfully more asset-sensitive than our peers if you look at the chart on the upper right. We have significant, we believe, incremental earnings potential overtime because we have a predominantly floating rate, about 65% floating rate book on the loan side, lower cost, less rate-sensitive deposits, as well as a smaller, more conservative investment portfolio, which is less than 20% of our earning assets, which all help us to both maintain asset sensitivity, and we believe to moderate the impact of further margin compression potentially going forward. So if you look at the lower right, you can see, over the last 2 years, our margin and as it's compressed and come down over those 2 years, versus what the weighted average margins of the BKX have done. And so while we started at a lower base, we've been compressing moderately less, we believe, because of some of the characteristics on the upper left, and we believe that we should be able to defend that margin well -- as well going forward even in a low-rate environment.
And on the bottom left-hand side, you can see our net interest income sensitivity, long-term more leverage to the upside in NII and NIM, which we expect to maintain from a relative position. We do believe that this year, the NIM will continue to be tough to defend. While we may see different-size fluctuations quarter-to-quarter, we do continue to expect modest compression of the margin on average throughout the rest of 2013.
Our second core business, capital markets, which does business as FTN Financial, is focused on fixed income sales and distribution and for our company, it delivers strong risk adjusted returns and steady fee income. It's a unique -- we believe fixed income business model focused on sales and distribution, not proprietary trading. We have deep customer relationships and a broad range of accounts. We do business with over 6,000 accounts. And we do business with 1/3 of all the banks in the United States and over 50% of the banks with securities portfolio of $250 million and larger. So we see a wide swath of the fixed income market as it relates to banks. Even with that, we have a balanced platform. We do about 60% of our business with banks or depositories and about 40% with non-depositories so very balanced flow of business. And we have some incremental opportunities to grow that business as well. In 2012, we established the public finance group that complements the municipal trading and competitive underwriting capabilities, and so we're very pleased with how well that business has started. We continue to add to that platform and incrementally grow it, and we're pleased so far with its progress.
In terms of average daily revenues and what drives this business, it's really 3 things: volatility, level of rates and directions of rates. This is a difficult environment right now. For this, what would be the biggest driver today would be volatility. And so while we continue to believe that this will perform very well and very efficiently from our returns and on assets and equity perspective, we do believe that our average daily revenues this year will be more towards the lower end of our normalized range, which is about $1 million to $1,500,000 a day.
Slide 9. Taking a look at our non-strategic segment. We haven't talked about this in a while in aggregate. We used to talk about it in components, but with the GSE mortgage repurchase seemingly behind us, the impact of our non-strategic segment is becoming much less of a drag and should be less volatile going forward. Wind down of our non-strategic portfolios are on track with both reduced balances and improving credit quality. Our period end loans at 4Q '12 were $3.8 billion in this segment, down 33% from year end 2010, and down from almost $9 billion at the peak about 4 years ago.
If you look at the bottom left, it shows by portfolio type how the runoff has come down over the last couple of years. You'll see the largest component is our home equity in the dark blue at the bottom. That is coming down at a rate of about 15% to 20% a year. So again, we're pleased with how that portfolio is running off. The MSR servicing portfolio is at about $18.6 billion as of the end of the year. That's down 35% over the last 2 years and down from about $106 billion at the peak, 4 or 5 years ago. So we're moving things in the right direction in terms of de-risking this book, making it less volatile and less of a drag.
If you look at the right-hand side of the page, it gives you a little bit more color on what the major components of revenue and expense are here. The NII coming up from the book is a somewhat meaningful number. Noninterest income is really related to the MSR hedging results for the most part. And the major components of expense are really sub-servicing expense of that MSR, environmental cost related to working out loans and managing the loan portfolios down, as well as our mortgage repurchase workout group, as well as other fixed and variable costs. So we're pleased again that we're taking cost out of this and making it less volatile on the expense line as you can see on the bottom right.
On the efficiency front, we have executed successfully on cost reduction efforts over the last 3 years, and we still have more opportunity to take out costs. We achieved about $1 billion annualized level of consolidated expenses by the end of 2012, which we had committed to publicly, which was about a 22% reduction from our 4Q '10 levels. That's a lot of good work by our people across the organization. We took out $139 million of core expenses out of the business, while losing a minimal amount of revenue in the process, which we were proud of.
Our 2013 efficiency opportunities remain as further leverage to earnings improvement. I mentioned briefly earlier, pension changes. We closed our pension at the end of last year in terms of year-over-year expense that will be worth to us about $30 million or $35 million of reduction in 2013, and we're targeting $50 million of additional reduction, about $20 million or so, we believe we've already executed through our voluntary separation program, which was announced in the fourth quarter. In addition, we believe that a continuous focus on efficiency and expense improvement in this environment is critical, and so we'll continue to dynamically manage our expense base according to how we're going to get to our bonefish levels, as the operating environment dictates. We won't ever be done with making sure that we're trying to be as efficient with our expense base as we possibly can.
On the asset quality side, all of our trends seem to be in the right direction. We're very pleased with our performance from an asset quality perspective, both our existing book and the pricing and structure of the production that we're putting on the balance sheet. Trends continue to improve. Our net charge-offs were down meaningfully last year, as well as our nonperforming assets. Our reserves are strong, and we currently expect continued improvement in net charge off levels and modest reserve decreases though at a slower pace than what you would have seen over the last couple of years.
Turning to capital deployment on Slide 12. Our first priority with our capital base is always safety and strength. With anticipated organic earnings, combined with strong existing capital levels, we do believe we can smartly deploy excess capital to improve returns for our shareholders. And we really think about deploying capital in 3 different ways. First is investing it internally, which means profitable loan growth, emphasis on risk -- better risk adjusted return businesses and where we can continue to incrementally grow that. The second is returning it to shareholders via buybacks and dividends. And the third would be investing it externally, participating in the M&A and the consolidation of the industry. Over the last year and a half, we believe that the first 2 components; investing it in our customers, as well as returning it to shareholders have been most advantageous for our shareholders. You've seen us do that. You've seen us increase our -- or the board increase our authorization to repurchase shares, as well as increase our dividends. We think that those are appropriate in the near-term and our best opportunities, and that's what we'll continue to focus on. But over the long term, we do believe that we have the capabilities and resources from a capital and a talent perspective to be able to participate on the third leg of this stool as the opportunities do arise.
Looking at the first way that we deployed capital, which is investing it internally, I mentioned a couple of times that we focus a lot on where we have specialty or niche opportunities to be able to drive higher risk-adjusted returns across our business. We spend a considerable amount of time and effort understanding, evaluating and analyzing capital allocation opportunities across businesses and customer segments. Our main businesses, First Tennessee and FTN, generate positive economic profit, but within these, we need to be smart about investing in higher growth, higher return businesses while managing lower growth, lower return businesses for better profitability to improve our mix, particularly in an environment where demand is somewhat muted on the loan side, where competitive pressures have made it difficult to make more money, we have to be smarter about the business mix that we are focused on. And if you look at the right side, it just kind of gives you an idea of, when we're looking at our businesses and our customer segments, we're looking for different types of characteristics in our performance metrics that are going to allow us to be more efficient with how we deploy capital and how we look at returns on assets and equity.
If you look at the bottom left, it highlights a few of those specialty businesses that we have been in for quite some time that have been very successful: our loans-to-mortgage companies business, high returns, solid risk management capabilities and continued opportunity for improved performance, as well as our asset-based lending group. Both have been around almost 15 years at least. We have deep knowledge and experience in these businesses, and we continue to look for ways to grow them. We recognized opportunities in these types of businesses a couple of years ago, looking at our business returns in capital allocation through this lens. Just a few examples of how we've looked at it, we've got other opportunities that we're looking at in the pipeline and we'll continue to invest and make business decisions along these lines.
I mentioned the bonefish and our model for driving returns and profitability several times. It's our roadmap for operating our businesses and generating outsize returns and profitability over the long-term. It's used both externally to communicate what our targets are for investors and tracking towards them and it's also how we manage and make decisions everyday internally across the company. Everyone here knows that long-term valuation enhancement in the banking industry comes from delivering excess returns above cost to capital. And as we continually study how to make our company high-performing, it's been proven that no one lever is most important. What is important is we focus on what's most opportunistic at any given time, and execution over the long-term is key. So that's why you would have seen us focus on capital 3 or 4 years ago. You would have focused on -- seen us focus on credit, then liquidity and deposits, then expenses, then pricing discipline, then efficient allocation of capital across our different businesses and being smarter about that. All of these things are driven by how we think through this model and this lens.
If you look at the middle, again, our core businesses are performing and trending very nicely today versus our long-term targets. We're not there, but we continually manage and track this both at the core business level and the consolidated level to make sure that we're continually improving this such that we are improving our valuation and our capabilities.
So again, to wrap up, on Slide 15. We believe our firm is well-positioned for long-term earnings power. We're focused on driving returns on equity and returns on assets in a meaningful way by controlling what we can control, focusing on the bonefish to take advantage of those opportunities and levers, which are most opportunistic at the time, using our dominant market share in both regional banking and capital markets to leverage better performance. Our steady fee income mix provides us with very efficient earnings streams. We do have a big opportunity, further opportunity to improve our expenses and will continue to do so. We're very well-positioned for uprising [ph] rates and to defend the margin with our asset-sensitive balance sheet and returning capital to shareholders efficiently through share repurchase and dividends is what we're currently focused on from a capital flexibility perspective. So with that, I appreciate your time and I'll stop and take questions.
[indiscernible] on the efficiencies and the expenses, if we think of that 9.26 number? And then also thinking about the non-core portfolio as running off, the expenses associated with that also continue to run-off in 2013, how should we think about the cost of maybe going off from that versus the non-core business, and that's -- there's no opportunity from that [indiscernible] to that 9.26 number?
Sure. So the question was around efficiency and expenses, and it was about our slide that kind of implies a fourth quarter '13 run rate of 9.26 and corollary to that question is, as the non-core non-strategic portfolio runs off and as expenses come down, is there are incremental opportunity for that. And so on the first, we created this waterfall that kind of gives you an idea of where we thought those efficiencies would come out. And we still believe that we're on track for that. We'll continue to update you on that through the year. But as it relates to the non-strategic, yes, as that loan portfolio comes down. We believe that environmental costs, things like foreclosure costs, workout costs, legal costs related to those workouts, et cetera, working down our mortgage repurchase pipeline, and those types of associated expenses. Yes, those will continue to come down and that will aid our expense numbers coming down towards that 9.26 and even through it.
Could you give us a mid-quarter update on how loan growth has been doing, deposit flows, just kind of how the environment's working for you and your market?
Sure. Susan, do you want to give a little color on loan growth?
Sure. So we continue to attract new clients, which obviously, you can't create demand that's not there. But our bankers are actively out calling on those existing clients, talking to them about refinancing any debt they may have with other banks. We also continue to call on key prospects within our footprint. And if I look at what we did last year in terms of attracting even some very long-term clients of other institutions over to our bank, we've done a great job even though organic loan demand, obviously, is still weak, we've had above market growth, and so we continue to see good things in the pipeline. One of our differentiators from a credit perspective is we continue to have credit risk managers with significant lending authority embedded in our core market. So they're available to go on calls, both client and prospect calls, and many times, then the client or prospect is meeting with the team that can make the final loan decision. And we continue to hear from clients and prospects what a differentiator that is in terms of being able to meet the whole decision team. So we continue to see -- I mean, we can't, again, can't create the demand, but our bankers are doing everything they can to set us apart, and we're getting more than our fair share at this point.
And on the deposit flow slide, still continued positive deposit flows, both on the consumer side and the commercial side. The commercial has actually been particularly strong in several areas. So our customer relationships, and that's the foundation of customer relationships is looking at deposit flows, we're very pleased with what we're continuing to see.
So, FHN, obviously, through your slide presentation as well, you've talked a lot about your asset sensitivity. If we were to think about the environment and rates staying low for an extended period of time as a signal, how do you see -- how do you think about your levers and your opportunities to protect NIM going forward?
Sure. So I think fortunately or unfortunately, we started at a lower place because of the predominantly floating rate loan book that we have. So what that means is that as higher rate, fixed-rate loans are running off, we're replacing them with floating rates. But because the majority of our book is already floating rate, it's not as much of a step down in aggregate if you're looking at portfolios, at the portfolio, going forward. So that's why we believe that this asset sensitivity helps -- potentially helps us both in the short-term and the long-term. In the short-term, it has less of a bite in terms of repricing fixed to floating or floating to floating. So we'll be able to defend the margin there. I've talked a lot about our pricing discipline and what our bankers are doing. We're doing everything we can to get paid fairly for the balance sheet that our customers are going to use. So we're doing a good job there. We do have modest incremental opportunities on the deposit rate side to defend the margin. We've harvested a lot of that, but there's pockets of opportunity to continue to do that. So we'll continue to use those levers to try to defend the margin as best we can. But again, we're not looking to change materially the composition of our balance sheet and create duration risk in search of current yields. So we're just going to do the best we can to defend those margins as they continue to be more and more challenging.
One of your competitors was out yesterday making comments that mortgage warehouse business was a little bit softer this quarter. I'm curious to get your comments on that, and then also are there ways to mitigate that business if it slows down? I'm not sure if you guys syndicate out or use participations at all whenever the refi boom slows down.
So our loans to mortgage companies businesses, as you know, has done very well, has great returns, good, strong relationships. It's been around for quite some time. But as we said, it's going to be a cyclical business, it's not directly tied to mortgage originations, but largely tied to mortgage originations. So as those ebb and flow, you're going to see that business ebb and flow. I think we had a record balance of $1,800,000,000 or so in the fourth quarter. That was a high watermark, I would say, but it still has quite a bit of strength in the business, and so we continue to see it have quite a bit of strength throughout 2013.
Can you just talk about your longer term view on consolidation trends? There's been a lot of questions over yesterday's discussions about acquirer versus acquiree, who is in each camp and clearly, you're one of the survivors. So -- and I think you've talked about this as your third pillar of deploying excess capital. So '14, '15, '16, how do you see it playing out, your best guess today?
Yes, I think, again, we think it's been more appropriate for a variety of reasons, including our valuation to look at the first 2 pillars of deploying capital. As we continue to improve our core business, we do believe that, that improves our valuation, which then allows our currency to be more valuable as we participate in M&A. Frankly, we don't believe that we've missed all too much by -- over the last couple of years by not participating and focusing on some of the other ways to deploy capital, make our business better. So we've been fortunate in that respect. We do see a little bit more activity at the much smaller end of banks, banks less than $1 billion, even less than $0.5 million, looking for ways to get out. But we're continuing to remain active and thoughtful about how we do that, and we'll continue to be that way. In terms of '14, '15, '16, what we will be thinking about, we really like the markets that look and feel like the markets that we compete in. They're good, solid MSAs, but maybe not the largest MSAs that you'll see around the country. Tennessee borders 8 states, so that's a natural way to think about expansion into markets that look and feel like ours. But generally, we believe there are many markets in the Southeast, where commercially speaking from a lending perspective through some of our specialty businesses, we might already do business in and know quite a bit about. So we think that, that is a longer-term way to efficiently deploy capital. But again, for the short-term, we're generally more focused on the first 2.
I think this may be our last question, but just as a corollary to that question, what would you say is FHN's position on the other side as an acquiree? And has that position changed at all over the last 12 to 18 months?
Yes, so we think there's probably only 5 banks in the country that can truly say that they're not a potential acquiree, right? The other 7,900 of us have to think about that every day, right? So what we focused on is continually improving our company to improve our valuation, to continually earn the right to be independent and provide optionality such that we can continue to participate from an acquirer perspective if that's the most appropriate thing to do. And so again, we talk quite a bit about controlling what we can control. That's the only thing that we can control and try to control our own destiny.
Okay, great. Thank you very much, First Horizon and thank you so much, everyone [indiscernible].
All right, thank you.
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