Good morning, and welcome to the First Horizon Corporation Second Quarter 2021 Earnings Release Conference Call. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Mr. Bryan Jordan, President and CEO. Please go ahead.

Ellen Taylor - Head of Investor Relations

Hi, everyone. First it's Ellen Taylor. I have got to do a little housekeeping. Thanks so much for joining us this morning. We really greatly appreciate your support and interest. To start things off, our CEO, Bryan Jordan; and CFO, BJ Losch will provide opening comments and an overview of our results, and then of course, we'll be happy to take your questions. We're also pleased to have with us today are our Chief Operating Officer, Anthony Restel, who will be taking on the role as Interim CFO; and our Chief Credit Officer, Susan Springfield.

Our remarks today, we're going to reference the earnings presentation, which you may find at ir.fhnc.com. As always, I need to remind you that we will make forward-looking statements that are subject to risks and uncertainties and we ask that you review the factors that may cause our results to differ from our expectations, which you can find on Page 2 of our presentation and in our SEC filings. We also will address adjusted results, which exclude the impact of notable items. You should understand that these are non-GAAP measures, so it's really important for you to review the GAAP information in our earnings release and on Page 3 of our presentation. And then of course, last but not least, our comments reflect our current views and you should understand that we aren't obligated to update them.

And now with that, I'll give it to Bryan.

Bryan Jordan - President & Chief Executive Officer

Thank you, Ellen. Good morning, everyone, and thank you for joining our call. I'm proud of the First Horizon team as we continue to deliver solid performance. The economy continues to strengthen. Loan demand and activity is continuing to build and our strong credit quality is performing well. Liquidity and cash levels are strong broadly in the economy, which is leading to higher loan payoffs, more competition for new lending opportunities and compressing loan spreads. Our diversified business model, including mortgage banking, mortgage warehouse lending, and FHN Financial continue to provide an effective offset to some of these headwinds.

We delivered adjusted EPS of $0.58 with a return on tangible common equity of 22% in the quarter. Our capital levels remain healthy with a common equity Tier 1 ratio at 10.33%, and we grew tangible book value per share by 4% in the quarter to $10.74. Our revenues this quarter were down from first - strong first quarter levels. FHN Financial and mortgage remained strong, but also extraordinarily strong first quarter levels. Our results this quarter were bolstered by the impact of continued rapid improvement in the overall economy and asset quality, which resulted in a provision credit of $115 million.

We're encouraged by the uptick in activity across the franchise as markets and sectors reopen. Our associates are having lots of constructive dialog with clients and prospects and we feel we are in a relatively strong position to benefit from further economic improvement. Loan pipeline certainly continue to reflect the strengthening economy in May and June. Still near-term, the industry is confronting continued lower rates, our levels of excess liquidity and very little incremental loan demand. Clients are still cautious about new investments and are still facing supply chain and labor force constraints that are problematic. We are also starting to see PPP loan forgiveness pick up. All of this translates to a fiercely competitive landscape for loan outstanding.

We're continuing to focus on controlling the things that we can't control, driving toward completing our merger integration, capturing revenue synergies, being good risk managers, all while focusing on serving our clients and anticipating their needs. We continue to do a great job of capturing revenue synergies across the markets and product lines by leveraging our expanded suite of products, services and expertise, all instrumental in retaining and growing our client relationships. Excuse me - at the same time, we are committed to continuing to drive enhanced efficiency by delivering $200 million in cost savings and controlling costs while still making prudent investments in technology and products to drive future revenue growth.

We also continue to opportunistically deploy capital through share repurchases. We've bought back 3.1 million shares this quarter, including dividends. We returned a total of $141 million of capital to our common shareholders. We continue to be optimistic about the path of the economic recovery and the increased activity levels we are seeing across our footprint, as our markets continue to reopen. But like many, we are keeping a watchful eye on supply chain and labor constraints as well as signs of inflation. I continue to be highly confident that our business model and benefits of the merger of equals position us well to deliver top quartile returns over the medium term.

And now, I'll turn it over to BJ for some comments on the results. BJ?

William Losch - Chief Financial Officer

Thanks, Bryan. Good morning, everybody. Let's start off on Slide 6. As Bryan mentioned, we're really pleased with the continued execution in the first half of the year. The merger is delivering the enhanced efficiencies that we expected and we're capturing the benefits of the merger savings and really starting to see the additional revenue synergies across the platform, which we think will only ramp from here. As Bryan said, we delivered GAAP EPS of $0.53 or $0.58 on an adjusted basis, reflecting the resiliency of our balanced business model, an exceptionally strong credit quality performance.

Our results this quarter from a revenue and expense perspective were in line with expectations. And as expected, net interest income headwinds persist and we experienced continued strong fee income, albeit, lower than the outsized levels in the first quarter, and we delivered continued improvement in expenses with an incremental $4 million of merger-related cost saves. From a credit quality perspective, the combination of the improving macro environment and our own asset quality, including the benefit of upward great migration in the loan portfolio exceeded expectations and drove a provision credit of $115 million in the quarter with net recoveries, I repeat net recoveries of $10 million. In fact, for the first half of the year we have an aggregate net recovery of $2 million on a $57 billion loan portfolio, outstanding performance.

We remain on track for our final systems conversion in the fall and continue to make progress towards our $200 million net savings target with $92 million of those annualized savings in the quarter. At the same time, we're making nice progress on those revenue synergies I talked about briefly via cross-sell and leveraging our balance sheet to serve the broader customer base. We currently estimate that we're on track for roughly $20 million of annualized revenue synergies across various commercial and consumer businesses with more to come across all of those platforms.

Turning to Slide 7, I'll quickly review the notable and merger-related items in the quarter. As you can see, we had $26 million after tax or $0.05 a share of merger-related notable items. And as you know, in January we raised our expected net merger cost saves from $170 million to $200 million consisting of gross cost saves of $250 million and reinvestment of $50 million. We continue to be confident in achieving these savings. In addition, we're now expecting our pretax merger cost to total about $500 million. And this increase is largely driven by three components.

First is tied to more recent developments related to product and capability enhancements we've elected to make in connection with the integration. So think of it as making the engine more durable and powerful are the cards on the lift, so to speak, as we prepare for our systems conversion. Secondly, we are seeing post pandemic vendor and staffing constraints that have caused an increase in both the level and the cost of estimated man hours required to complete our technology integration. And third, as we finalized our decisions around accelerating our branch closures given the shift towards digital adoption, we still have plans to close a total of 50 branches, but now expect to see a higher level of impairment costs given the ultimate mix of those branch closures that we've decided upon. So we believe spending an incremental 3 basis points of capital to position us far better for the future makes good long-term business sense. And it's important to note that the payback period on the increased cost saves and the addition of the revenue synergies we're already seeing, it's still well in line with our original estimate of about two years.

Slide 8 provides an overview of our adjusted financials for the quarter. We generated PPNR of $321 million. As expected, revenues decreased 3% from strong 1Q '21 levels given expected reductions, fixed income and mortgage banking fees, along with continued NII pressure. Adjusted expense of $465 million remained relatively stable linked quarter as the benefit of our incremental merger cost saves was muted by some higher long-term incentive costs. And this quarter, the provision credit which we talked about at a $115 million was compared to $45 million in the first. And as we sit here today, we see opportunity for more reserve releases in the future dependent of course upon several factors, including further macroeconomic improvement, low levels of net charge-offs, and positive grade migration. The pace of macroeconomic improvement is likely to be less pronounced that it was in Q2, but there is opportunity for further positive grade migration as updated financial statements will be received from borrowers over the next few quarters. Bottom line, though, we expect the net impact of all those factors to be positive with further reserve releases quite likely. And as Bryan mentioned, we grew tangible book value per share by a strong 4% and generated an adjusted ROTCE of 20% or 16% before the impact of that provision credit, very, very strong performance.

Moving to Slide 9. NII performed in line with expectations, declining $11 million linked quarter on an FTE basis. Both reported and core NIM were down 16 basis points linked quarter, driven by about 12 basis points of impact tied to higher excess cash. We ended the quarter with increasing levels of cash at about $12.7 billion, up from $10.8 billion in the first quarter. We did also see pressure from lower loan balances and given the competitive landscape experienced spread tightening on new originations compared to the run-off, which collectively translated to about 2 basis points on the NIM. Given the change in rates and housing supply constraints, our mortgage warehouse outstandings decreased and we saw increased pressure from premium amortization and lower LIBOR. In the face of these environmental pressures, we are very, very focused on controlling what we can control, and our continued deposit pricing discipline is helping to mitigate the impact of those lower rates and overall muted loan demand. Interest bearing deposit costs of 20 basis points in the quarter remained stable and were down 2 basis points, excluding purchase accounting. And as we look forward, we continue to believe we're well positioned to benefit from an improving economy. At quarter end, our interest rate sensitivity or NII sensitivity to an up 100 shock was about 10% and about 6% on a gradual basis.

Moving to Slide 10. Taking a look at fee income dynamics, fixed income ABR came in at $1.4 million compared to the very strong first quarter of $1.9 million, reflecting continued favorable operating environment for the business given high levels of cash in the banking system and immediate loan demand. Mortgage banking and title fees came in at $38 million compared with higher first quarter levels. While fee income was lower in our mortgage banking business, overall mortgage originations across our platform were very strong, up 21% quarter-over-quarter with an intentional shift on balance sheet mortgages. The lower mortgage fee income reflects the impact of housing supply constraints, lower gain on sale spreads and that intentional shift in origination mix toward portfolio.

Our focus here is on customer oriented relationships, which we believe is a better alternative for adding interest earning assets as compared to securities purchases. Importantly, given the overall economic momentum across our footprint, we saw a $4 million lift in card and digital banking fees with the benefit of an increase in transaction volumes. And finally I'd note that you will see a $15 million increase in other income, which was driven by a nice $9 million securities gain largely related to a legacy at IBERIABANK equity investment.

Slide 11, taking a look at expenses. Adjusted expense was $465 million and stable relative to the first quarter. Personnel expense decreased $7 million linked quarter, driven by a $6 million decline in incentives and commissions, partially offset by increases in long-term revenue and performance-based incentives. In occupancy and equipment, we saw a $3 million increase largely tied more to the equipment line which was related to some strategic software investments. And finally, increased activity levels given the reopening of markets post pandemic caused about a $2 million increase in our outside services line.

Slides 12 and 13, we take a look at our loan growth and our funding profile. You can see that our average loan balances were down about $1.4 billion in the quarter with commercial down about $800 million and consumer down about $580 million. Commercial was impacted by about $1.1 billion decrease in our loans to mortgage companies, partially offset by a $272 million increase in PPP balances. Last quarter, our mortgage warehouse volume was around 67% refi, and that's moderated in the second quarter to 47%. And as we look forward, we do believe that some of our volume related strategies in that business will allow us to gain more share in mortgage warehouse lending with a net benefit to profitability. And outside of PPP and mortgage warehouse, we did see a lift in overall commercial balances, which we're hopeful will continue in the second half of the year. As Bryan mentioned, we continue to be optimistic about the path of the economic recovery and the increased activity levels as markets continue to reopen.

Quickly on the liability side, we saw a continued inflow of deposits driven by $2.1 billion average increase in non-interest bearing deposits with commercial balances including benefits from the second round of PPP. Total deposit costs are at a very low 13 basis points with interest bearing deposit costs at 20.

On asset quality, starting with Slide 14. Our overall credit quality continues to surprise to the upside. We had net recoveries again up $10 million or 7 basis points, down 13 basis points from last quarter with non-performing loans decreasing $50 million. Given the large provision credit, the allowance for credit losses coverage ratio came in at 157 basis points compared with 170 last quarter, driven by the continued improvement in the outlook, positive grade migration, those net recoveries and lower loan balances. As you can see, our overall loss absorption capacity excluding mortgage warehouse and PPP as well as the unrecognized discount on our acquired loan stands at a very healthy 2.23%. Our credit quality is excellent. And while all peers are experiencing low levels of net charge-offs, our performance is among the best in class and we expect that to continue.

Turning to capital on Slide 16. As Bryan mentioned, CET1 ratio is at a healthy 10.3%, up about 30 basis points or so in the quarter, driven by growth in retained earnings and a reduction in risk-weighted assets. Increase was partially offset by the capital return Bryan talked about through repurchases and dividends. We expect capital levels to remain strong with flexibility to both deploy and optimize our capital structure.

Moving on to merger integration on Slide 17. It's been a little more than a year since we closed our merger with IBERIABANK and we continue to make very good progress. We're focused on retaining and growing the client base with our expanded products and services. As we talked about, we achieved $92 million in annualized run rate savings. In early July, you see, we successfully converted virtual bank customers onto a new fully cloud-based Finxact core and in the coming months as we prepare for our fall 2021 core systems conversion, we plan to complete our wealth, trust and credit card conversions as well, our first round of banking center consolidations and training for all associates on our new systems.

Turning to our outlook on Slide 18. Our results this quarter were in line with the outlook we provided to you in April and we're providing an outlook for both the third quarter and the full year of 2021. You can see in the third quarter we do expect NII to decrease modestly given the outlook for lower PPP and the impacts of continued low rates and reduced merger accretion. While we anticipate relatively resilient results in our fixed income business, we do expect fee income to be down in the low double digit to low teens range due to lower mortgage banking fees. We expect non-interest expense to decrease in the low single digit range as our ongoing focus on efficiency and merger cost saves comes through.

We expect charge-offs to be in the range of 0 to 10 basis points and it's reasonable to see continued reserve outflows. We expect our CET1 to remain in the 10% to 10.5% range. We now expect a mid single-digit decrease in non-interest income with net charge-offs in the 0 to 10 basis point range and the CET1 10% and 10.5%. As Bryan mentioned, we feel good about the positioning and our ability to perform well given the current economic environment.

Finally, on Slide 19, we are well positioned to capitalize on opportunities of our business model and franchise. Our fee income businesses are performing just as we would have expected. We're controlling expenses. We're driving down deposit costs. We're making good prudent long-term investments in talent and technology. We're seeing good business activity as markets reopen, credit quality is excellent, and we believe we'll continue to deliver attractive returns near term and in the future.

Just a quick note, as many of you know, today's my 51st and final earnings call with First Horizon. In fact, it is exactly 12.5 years since my first earnings call on January 16, 2009. That day, we reported a loss of $0.27, whereas today we report positive results of $0.58. And it's been quite a ride. And I started here at a time when the company was arguably at its weakest. And I'm proud to say confidently I'm leaving here when its at its strongest. I've put my heart and soul into this place and its returned to me so much more than I could have ever given it, and I'm forever grateful for that. I want to thank Bryan, the Board, my executive team colleagues, my finance accounting procurement properties groups and all my friends and colleagues at First Horizon that have been an absolute pleasure to work with. And finally, thanks to the investor community for your support of our company. I've enjoyed the performance, accountability, and intellectual challenge you provide to people fortunate enough to be in my seat. I know I wasn't always right, but I always tried to do the right thing and I hope you experienced that.

So with that, I'll turn it back over to Bryan.

Bryan Jordan - President & Chief Executive Officer

Thank you, BJ. I'm exceptionally proud of the team's continued execution and the results we're delivering. We are seeing activity levels pick up across our franchise and many of our specialty business. We are continuing to execute well on our merger integration while making prudent investments to position us well for the future. Our strong risk management posture showcased by our asset quality metrics. I'm grateful to our associates for their diligence around serving our customers and our communities. And I continue to be confident in our continued progress towards becoming a top regional bank and in our ability to drive long-term shareholder value.

And now before I open it up for questions, I'll also make a couple of comments about BJ. As BJ just stated, he did join us in 2009 in the midst of the financial crisis. Over the past 12, 12.5 years, he's been a key leader in helping us reposition and position our business. He has been critical to developing our strategies, controlling our costs and many of the great accomplishments that we've had over the past 12 years. BJ is a trusted friend and a partner. We will miss him. While I'm disappointed to see him leave, I fully support him in his new endeavors. You will be missed.

So with that Betsy, we'll now take questions.

Question & Answers

Operator

[Operator Instructions] Our first question comes from Jared Shaw with Wells Fargo Securities. Please go ahead.

Jared Shaw - Wells Fargo Securities - Analyst

Hi, good morning, everybody.

Bryan Jordan - President & Chief Executive Officer

Hi, Jared.

Susan Springfield - Chief Credit Officer

Good morning.

Jared Shaw - Wells Fargo Securities - Analyst

Maybe just starting on the expense side - with the additional $40 million investment, is there an opportunity to see that $200 million ultimate cost save level increase from there or is that really more just the cost to get there has gone up in that we should - that we'll probably see some additional negative operating leverage here in the next next few quarters as that gets rolled in?

William Losch - Chief Financial Officer

Hey Jared, it's BJ. I'll take that one. As you know, since you've known us for quite some time and followed us, we're never done with cost saves and expense efficiencies, and so we started at 170, were up to 200, and in an environment like what we're operating in, I think we'll continue to look for additional opportunities over time. Right now, we are all laser-focused on getting to our conversion in the fall, which is our most important hurdle. The annualized $200 million is to be expected to be out of the run rate by the first half of 2022. And between now and then, we'll continue building on additional expense opportunities beyond that to continue to find more efficiencies in the expense line.

Bryan Jordan - President & Chief Executive Officer

Hey Jared, this is Bryan. I'll piggyback on BJ's comments. We feel very, very good about our ability to hit $200 million. And we think if anything, there is very little of any downside to it and we think there's potential upside as BJ said. We consistently look for opportunities to drive efficiency and I think the nature of the business is such that we've continually got to look for opportunities to reduce cost and changing our non-value added areas and put that into areas that require future investment in technology and infrastructure. So we continue to use our all of our levers around expense control to make sure we position the business for the long-term.

Jared Shaw - Wells Fargo Securities - Analyst

Okay, great, thanks. And then as I follow-up maybe just on the - on the mortgage side. What ultimately do you think you could be retaining from that production as we go forward versus versus selling, and I guess the impact of that on the gain on sale margin?

William Losch - Chief Financial Officer

So I think what you'll see from us is a continued shift to on-balance-sheet, portfolio originations. I do expect that you'll see net increases in originations, maybe not as high as the 20% that we had seen, but the secondary volume that we're seeing and still strong and we're capturing many opportunities. Our clients have seen more opportunity in our portfolio originations, particularly around seven-year ARMs or 15-year fixed, which we've seen quite a bit of interest. And so I think you'll see that continued shift with overall originations continuing to go up, probably secondary continuing to moderate down, portfolio up. In terms of gain on sale, it is continuing to moderate. We expect that to continue to come down over the next few quarters.

Jared Shaw - Wells Fargo Securities - Analyst

Okay, thanks, and congratulations BJ on your next step. It's been great working with you.

William Losch - Chief Financial Officer

Thank you, as well.

Operator

The next question comes from Jennifer Demba with Truist Securities. Please go ahead.

Jennifer Demba - Truist Securities - Analyst

Thank you. Good morning.

Bryan Jordan - President & Chief Executive Officer

Hi, Jennifer.

Jennifer Demba - Truist Securities - Analyst

Hi, just to talk about the revenue synergies you've seen today with IBERIA and what's been kind of better-than-expected and what's kind of lag versus your expectations? And where you see the biggest opportunities in the next 12, 18 months or so?

Bryan Jordan - President & Chief Executive Officer

Hey Jennifer, this is Bryan. I'll start. We feel very, very good about the trend on revenue synergies. And I would say there are very few areas that we're concerned about lagging at this point. As you might expect, there are some natural synergies that come from just being a larger organization, larger whole positions. But we're seeing very, very good momentum across specialty lines of businesses, where either organization may not have had an opportunity in the past, our equipment finance business, our asset-based lending business, our private client wealth management businesses. Some of those take a little longer to build the infrastructure around it. But at the end of the day, we feel very, very good about the progress that we're seeing. We're seeing opportunities continue to multiply. And at this point, we feel very, very good that we're on track to exceed the $35 million that I've talked about in the past. We think we are in that $20 million annualized area today and building momentum. Once we get through this integration, we think that - we think it will pick up further momentum in the first or second quarters of next year.

Jennifer Demba - Truist Securities - Analyst

Okay. Great. And in terms of the loan loss reserve you said more releases are likely assuming these credit trends and economic trends continue. Do you, could you see the reserve going lower than it was below the day one CECL level?

William Losch - Chief Financial Officer

Hey Jennifer, it's BJ. Likely not. I think day one CECL would have been around 110 basis points for us I think on a combined basis. So it's hard for me to think about it going much lower than that. It certainly could, but I don't think that we would get there for a while. But with that said, if you exclude PPP and loans to mortgage companies which carry very, very little, we've got 60 basis points or 70 basis points from where we're at today to get down to those levels. So again, we do believe that the macro environment will continue to improve. Credit quality is excellent. The way we've managed both portfolios, both legacy portfolios are really starting to shine now. So we do believe there is very healthy reserve releases to come over the next several quarters.

Bryan Jordan - President & Chief Executive Officer

Jennifer, I'll pickup up on BJ's last comments, so Susan that have to do it. Now a year ago as we got into the pandemic and not knowing how the economy was going to play out, there was a lot of concern industrywide about how credit would play out. And at that time, we said - we thought that our portfolios would do as well or better than most, and albeit, admittedly the fiscal policy in the country reduced losses across the industry. We do believe very strongly that our portfolios, both legacy IBERIABANK portfolio and the first Horizon portfolio, now the combined portfolio has performed in a very strong fashion and we believe while it's tough performance today, we think that will continue given the way we approach credit and risk in the portfolio. So I'm very, very proud of the results. I can't say that I'm a big fan of CECL and the reserve methodologies, but I do believe that we will migrate back down towards those day one levels as quickly as anybody. And I think we will continue to deliver that very strong and consistent credit performance as a result of our efforts to manage risk in appropriate way.

Jennifer Demba - Truist Securities - Analyst

Okay, thank you. Look forward to continuing the work with you BJ.

William Losch - Chief Financial Officer

Thanks, Jennifer.

Operator

The next question comes from Brett Rabatin with Hovde Group. Please go ahead.

Brett Rabatin - Hovde Group - Analyst

Hey, good morning, everyone, and congrats BJ on your role.

William Losch - Chief Financial Officer

Thank you, Brett.

Bryan Jordan - President & Chief Executive Officer

Good morning, Brett.

Susan Springfield - Chief Credit Officer

Good morning.

Brett Rabatin - Hovde Group - Analyst

Wanted to just talk about just the liquidity on the balance sheet. If you think about the cash balances are now 16% of average earning assets and with the guidance for that, for the cash to continue to build, obviously not a great environment for reinvesting cash and securities, but just high in terms if anything to maybe manage some of the liquidity if you might do some securities purchases from here and just thinking about trying to manage. Obviously, you managed NII more than the margin, but just thinking about the margin and possible ways to kind of offset the margin pressure?

William Losch - Chief Financial Officer

Yeah, it's BJ. So, yeah, we're actively thinking about that and we are seeing accelerated levels of cash that were reinvesting in the securities portfolio. In aggregate, we have not materially increased it at this point. We're buying mostly agency, CMO, MBS, with a little bit of high quality municipal and we could modestly look at something there over time as well. But we're more focused on trying to create interest earning assets on the portfolio that have a customer relationship to it. And going back to our earlier comments on mortgage originations and finding ways to give clients more opportunities from a portfolio usage perspective, is likely where we're going to go.

We've also been a bit more active in owner-occupied commercial real estate on the commercial side and offering some attractive opportunities across our footprint there. So a little bit more fixed rate type lending opportunities that we're looking to try to build upon. So I think we're a little bit more focused there. So, you know, I think fortunately or unfortunately, I think it's a high-class problem to have. But I think we will have these deposit, excess cash balances for a while. But to your point, we're much more focused on NII. And I think we're hopeful that the core NII, its really bottoming out at this level and we see going forward opportunity for growth in the core NII. So that's what we're - that's what we're planning on and executing upon.

Brett Rabatin - Hovde Group - Analyst

Okay. I appreciate the color BJ on that. And then, I guess the other thing I wanted to address was just the guidance around the 2Q non-interest income, low double-digit to low-teens decrease. Can you talk maybe about the components of that? What percentage of that might be fixed income versus other segments that are in fee income?

William Losch - Chief Financial Officer

Hey, Brett, it's BJ again. I think it's going to be mostly on the mortgage side, and again it's related to some comments I made earlier around secondary originations probably continuing to trend lower, plus continued moderation in gain on sale fixed income, we still expect to be relatively strong around the levels that we're at, maybe $100,000, $200,000 plus or minus where we're at. But it's mostly on the mortgage side.

Brett Rabatin - Hovde Group - Analyst

Okay. I must say a mortgage effect. Great. I appreciate all the color.

William Losch - Chief Financial Officer

Thanks, Brett.

Operator

The next question comes from Ebrahim Poonawala from Bank of America. Please go ahead.

Ebrahim Poonawala - Bank of America - Analyst

Good morning.

Susan Springfield - Chief Credit Officer

Good morning.

William Losch - Chief Financial Officer

Good morning.

Bryan Jordan - President & Chief Executive Officer

Good morning.

Ebrahim Poonawala - Bank of America - Analyst

I guess, so first just around loan growth, Bryan. Some of the comments you made around the headwinds, be it inventory, lack of inventory, labor shortage, etc. How should we think about any chances of loan growth picking up meaningfully this year for the bank? Like do you see this being a third quarter event, fourth quarter, or most likely a first half '22 event where you actually see net loan growth coming in a meaningful way?

Bryan Jordan - President & Chief Executive Officer

Yeah, so used the term meaningful a couple of times some - that's a term of ours, some we try to avoid defining making for with. We're pretty optimistic about the back half of the year in terms of our loan pipelines as I mentioned in and BJ mentioned in his comments. We saw loan pipelines building in May and June. When we look across where we see those pipeline building is very broad based, it's in our - really high growth markets that are sort of a combination of IBERIA, First Horizon, markets like Texas, we see strength in Louisiana, the Carolinas. It's very broad-based there. And we also see very strong pipelines in our specialty businesses, particularly those specialty businesses like asset-based lending, franchise, finance, equipment finance, which in many ways sort of lead or are early signs of a strengthening economy. So we're encouraged by that.

The other specialty businesses are mortgage warehouse, lending business. Our balances came down a bit this quarter. We expected that will strengthen in the third and the fourth quarter given the pipelines that we see there. So we do see the signs of strengthening pipelines and loan growth. On the cover [Phonetic] side of that, we believe based on what we know that there's still going to be a relatively high level of payoffs, paydowns in certain sectors, particularly real estate oriented sectors, for example, where refinance activity taking stuff into the capital markets or using significant liquidity is reducing outstanding. But on the whole, we feel good about how we're positioned with growth markets. We feel well positioned with the pipelines that we see, the specialty businesses that we have and to the extent that there is growth in the overall economy is driving loan growth, we think we're going to get our fair share and maybe more.

Susan Springfield - Chief Credit Officer

One thing I would add to that is, as you know we were big participant in the PPP program in both legacy banks, and well, that obviously the PPP is contributing to runoff. We've got really good feedback across our markets and some of our specialty areas about the ability and we're working on all these to pick up additional business where we were able to service both clients and prospects and help them with PPP linear, potentially their existing bank could not. And what we're seeing is that, that could really be an additional benefit for us later this year and into 2022 as well.

Ebrahim Poonawala - Bank of America - Analyst

Got it. And just as a follow-up. You talked about revenue synergies, in particular Bryan, if you could address? When we think about the mortgage business and the capital markets business, where do you see the greatest synergies, now that you had one year since the deal closed from the merger and how quickly do you think you can start monetizing on those opportunities in terms of its impact on revenue growth?

Bryan Jordan - President & Chief Executive Officer

Yeah. So if you take the mortgage business as example, [Indecipherable] and his team have done a really good job of taking the mortgage product, we've integrated our systems, we're rolling out the expanded capability across the First Horizon footprint. And I would say that over 12 years if we develop a bad habit, the bad habit will be. We didn't really and no First Horizon legacy footprint view the mortgage as a critical part of the consumer banking relationship simply because we were outsourced on the delivery of that product. Now that we've got it in stores, we're seeing tremendous momentum pick up as people are leveraging that muscle again to really ask for the mortgage and build out that capability and as BJ alluded to in his comments a few minutes ago, we're seeing our bankers originate more mortgages for customers and a lot of that is going on to the balance sheet. So I'm optimistic that that our FHN business will continue to see opportunities to grow. We've added debt capital markets capabilities and our fixed income business, which we're seeing significant momentum building over the last two or three quarters. So I'm optimistic that on the revenue synergies side that the goals we set, which I think based on capital bank integration were relatively modest, will lead to significant revenue growth down the road.

Ebrahim Poonawala - Bank of America - Analyst

Got it. Thanks, and BJ Congratulations on the move, awesome move. Thank you.

William Losch - Chief Financial Officer

Thanks, Ebrahim.

Bryan Jordan - President & Chief Executive Officer

Thanks, Ebrahim.

Operator

The next question comes from Christopher Marinac with Janney Montgomery Scott. Please go ahead.

Christopher Marinac - Janney Montgomery Scott - Analyst

Hey, thanks, good morning. Just wanted to go back on, again getting some more color on green shoots in the loan business. I know you touched on this already, but from the perspective of kind of using the new systems to drive new business, will we see some examples of that in third and fourth quarter or will that kind of implementation post conversion kind of be seen more next year?

Bryan Jordan - President & Chief Executive Officer

Yeah, from a systems perspective, you'll see that principally next year. We're implementing the incentive system, for example, which is a complete rollout across the entire organization, IBERIABANK used, that we're putting in a new installation. That momentum and the technology drivers of speed will really start to show up in the fourth quarter and in the first and second quarters of next year.

Christopher Marinac - Janney Montgomery Scott - Analyst

Got it. And then as you think about the continued build-out of the digital bank and what you talked about with Finxact, will you do kind of more sort of public announcements on that or even have more visible examples of sort of additional cost saves kind of beyond what you've already pledged on the $200 million? I'm just sort of curious if will see some signs of that as you continue to go forward.

Bryan Jordan - President & Chief Executive Officer

Yeah, Anthony, is on the line answer. Anthony, do you want to take that one?

Anthony Restel - Chief Operating Officer

Sure, Bryan. So, Chris, what I'll tell you is, certainly we are a big believer in technology being able to drive overall efficiency for the corporation as we move forward. So I think the simple answer to your question is our expectation would be as we continue to invest in technology and then you overlay kind of the - I'll call the shifting preference of our customer base, we should be able to drive more efficiency and leverage the technology moving forward. So I think you'll see that kind of bleed in continuously as we kind of cross the conversion period into next year and then hopefully continue thereafter.

Christopher Marinac - Janney Montgomery Scott - Analyst

Great, thanks for the color, I appreciate it. And BJ, best of luck to you as well.

Operator

The next question comes from John Pancari with Evercore ISI. Please go ahead.

John Pancari - Evercore ISI - Analyst

Good morning.

Bryan Jordan - President & Chief Executive Officer

Good morning, John.

John Pancari - Evercore ISI - Analyst

BJ, congrats. All the best in the future and really enjoyed working with you. On the margin, just wanted to see if you can give us your thoughts on the outlook for the margin from here? I know you saw the impact of the liquidity drive a portion of the 16 basis point compression this quarter. So wanted to see how you think about the NIM progression? And then also, I know you mentioned competition a couple of times and pressure on loan spreads. Can you give us a bit of color there, like for example, where some of your new money loan yields are coming in at this point? Thanks.

William Losch - Chief Financial Officer

Sure. It's a - it's a slippery slope trying to forecast the margin at this point, right? We've just seen continued buildup of excess cash here and across the industry. And with the $3.5 trillion infrastructure program and more child tax credit payments come, I mean, I think that build up is going to continue. So that's why we are more focused obviously on NII. And we do think that the core NII for us is bottoming out for a couple of different reasons. One is, we still think that there is opportunity to move deposit costs down modestly. We've got some exception priced deposits that are still at higher levels than we would want and will continue to move those those down We do expect that we're going to start to see a pickup in loan demand as markets reopen. So that's going to add to our NII. So we are optimistic that we're going to see some there.

In terms of what kind of loan yields we're seeing right now. From a commercial perspective, we're seeing new loan yields in the regional bank just over 3%, with average durations in the five-year range. Our specialty businesses are probably a little bit lower than that, maybe 2% and 3/4% with slightly lower durations. So those yields are probably 40 to 50 basis points lower than our portfolio yields across those portfolios right now. So you know there is - there is yield compression and margin compression out there across the industry.

John Pancari - Evercore ISI - Analyst

Yeah, and then secondly is on the capital front [Technical Issues] on your CET1 target. I know your internal target is about 9.5% to 10%. And I know you mentioned some [Technical Issues] and optimize your capital structure. Any consideration around the potential reduction [Technical Issues].

Bryan Jordan - President & Chief Executive Officer

Yeah, John, for reason you were breaking up a bit, but I think you were asking about CET1 target and that were a little bit above where we said not have to [Indecipherable] We are not uncomfortable seeing it move up or down a little bit around those areas as we pointed out a couple of different ways. We have been using capital to repatriate shareholders through our stock repurchase program. We have plenty of capacity available in that and we will continue to be opportunistic and we think that today's valuations are very attractive vis-a-vis a long-term value. We are, as you know, and one of the great legacies that BJ will leave is the ambition of our drive towards capital efficiency, and we focus very much on excess capital in the organization and don't believe letting it build up and being deployed for bad uses as a good thing and that we will use excess capital to repatriate to our shareholders. So at the end of the day, we still believe in that 9.5% to 10% we think given some of the signs of opportunistic growth we will absorb it between growth, organic growth, and our share repurchase programs.

John Pancari - Evercore ISI - Analyst

Got it. All right, thanks, Bryan.

Bryan Jordan - President & Chief Executive Officer

Sure thing.

Operator

The next question is from Ken Zerbe with Morgan Stanley. Please go ahead.

Ken Zerbe - Morgan Stanley - Analyst

Hi, great, thanks. Actually just wanted to go back to the net interest income guidance just a little bit. If I take your third quarter guidance and sort of put it in with the actual numbers in the first half, it still feels actually numerically looks like your net interest income has to decline in 3Q and then it also has to decline even further in 4Q to get to your full year guidance sort of that mid single digit decline, I'm using 5% is sort of the mid-point. But it just feels like that's a bit contradictory to your more optimistic outlook around, I think BJ just mentioned your core NII is stable because you expect a pickup in loan demand, presumably you mean in the second half, but it's just unclear. And I was hoping you can clarify all that? Thank you.

William Losch - Chief Financial Officer

Hey, Ken, thanks. Yeah, it's BJ. So we still had a healthy amount of PPP accretion and we still had a very healthy amount of loan accretion from the marks on the IBERIA loans. And if you look at kind of a walk forward that we have for you on the NII page, you can kind of see that the moderation in our total NII is coming down. So while we do expect that core NII will continue to strengthen and increase, its likely to be more than offset by lower loan accretion and less PPP benefits than we have had in the first half of the year. So that's really the dynamic that is going on there. On our outlooks slide, we gave you total NII outlook, but that's the underlying dynamics as to why it looks the way it does.

Ken Zerbe - Morgan Stanley - Analyst

Got it. Okay, now that is helpful. And just to go back to a prior question on loan growth in the back half of the year, I think Bryan, when you mentioned - when you were answering the question, it feels like you spoke a lot about pipelines. And because I just want to make sure that - I know you said you're optimistic about pipelines improving. But as we all know pipeline and balances are sort of two different things. Are you also and just to be clear on this, but are you also optimistic that loan balances actually improve in the back half of the year or is it just pipelines? Thank you.

Bryan Jordan - President & Chief Executive Officer

Yeah, Ken, I did, I spoke about pipelines, but also spoke about the outlook for payoffs and the significant liquidity. The short answer is, we're optimistic about loan growth. I think in our mortgage warehouse business and others we should see some growth, but it's in this part of the cycle with a significant amount of liquidity in the markets, its hard to know what payoffs might be. And so that is the sort of toggle factor that we just don't know. So our outlook is optimistic, but we don't - we don't control - we don't control which is pay-offs, which is the PPP balances are clearly going to come down with forgiveness, etc. So depending on what part, its little bit like the net interest margin question that BJ - it really depends on what line or what sector of the line item you're looking at. But I think on the core business, we're reasonably optimistic about our ability to grow if we can retain the balances that sit out there today.

Susan Springfield - Chief Credit Officer

And Ken, we did. Looking at May and June in terms of new commitments production now granted to your point, it doesn't necessarily translate into the balances yet, but very strong new commitment production in both May and June. And really across so many of the areas that Bryan mentioned in earlier question with - on the number of our specialty areas, [Indecipherable] equipment finance, franchise finance, health care, and then in the regional banks, Alabama, Texas, Louisiana, East Tennessee, North Carolina, etc. So we - and now the credit team is busy working with the line on looking at these opportunities to increase both for existing clients, but also opportunities that we have with prospects. So the activity level has definitely picked up.

Ken Zerbe - Morgan Stanley - Analyst

Got it, okay. Thank you.

Operator

The next question comes from Michael Rose with Raymond James. Please go ahead.

Michael Rose - Raymond James - Analyst

Hey, thanks for taking my question. I just wanted to go back to capital. You guys have used a little bit of your buyback here. I think you got around $385 million left just with the stock coming in here along with al bank stocks seemingly in the past couple of weeks. Would you expect to be a little bit more active on the repurchase front as we move into the back half of the year? Thanks.

Bryan Jordan - President & Chief Executive Officer

Michael, this is Bryan. We're always opportunistic. And as I said a minute or so ago, I think we're attractively valued at these levels vis-a-vis the long-term value that will create vis-a-vis peers. The strong momentum that I think we see in our business coming out of this integration. So yes, we'll pick our spots. But we'll be opportunistic and use the authorization to repurchase shares to manage our capital levels, particularly our excess capital levels in the organization.

Michael Rose - Raymond James - Analyst

Okay, thanks. And then maybe just as a follow-up to go back to the fee income outlook. It does imply, its seemingly another decent step down in fourth quarter. I guess my question is, you said earlier that a lot of that has to do with mortgage, but obviously has probably to do with some fixed income headwinds through just off really high levels. But that said, I mean do you think fourth quarter will be the trough and do you think you can actually grow fee income as you move into next year? Thanks.

William Losch - Chief Financial Officer

Yeah, hey, its BJ, Michael. And yeah, I actually - I'm happy you brought that up because one thing I forgot to mention when I was talking about that step down was don't forget that we had about $11 million or so of securities gains in this quarter, which is kind of part of the adjusted baseline, if you will. So obviously, those security gains on the legacy IBERIA investment and another smaller one aren't going to - aren't going to reoccur. So that's part of the step down. Then the majority of the rest of it is related to mortgage. And like I said, fixed income continues to remain strong with all the excess cash in the system. And what I said earlier was we at Indecipherable] I think to put a fine point on it. And so being somewhere around that range, plus or minus is likely where it will be at least over the next quarter if not through the rest of the year.

Michael Rose - Raymond James - Analyst

All right, thanks for taking my questions.

Bryan Jordan - President & Chief Executive Officer

Thank you.

Operator

The next question is from Steven Alexopoulos with J.P. Morgan. Please go ahead.

Steven Alexopoulos - J.P. Morgan - Analyst

Hey everybody.

Bryan Jordan - President & Chief Executive Officer

Hey, Steve.

Steven Alexopoulos - J.P. Morgan - Analyst

So I know that overall deposit levels continue to rise for the industry, right? Just given stimulus and other factors. But I'm curious when you guys look to your typical mid market customer in your markets, are they starting to draw down deposits to fund investments or are there deposit balances still also rising?

Bryan Jordan - President & Chief Executive Officer

Its like any generalization that will be wrong, but for the most part their balances are still rising. There is still a fair amount of cautiousness around new investments and to pick an example fiscal policy and what capital gains rates look like, what the tax rate, corporate tax rates look like, what is the return on investment. All of those things are still affecting peoples psychology about making investments. This is an anecdote, but we had a equipment lease that was actually repaid with cash in spite of prepaid penalties, etc. So people are taking cash and they're being fairly cautious with it and reducing debt and putting it on the sidelines until they get a little bit more clarity about where the economy and the pandemic are headed and quite bluntly, where we end up from a monetary and more importantly maybe a fiscal policy as we work through this period of uncertainty around corporate tax rate etc.

Steven Alexopoulos - J.P. Morgan - Analyst

Yeah. But Bryan, regarding the optimism around loan growth resuming in the second half, your customer is signaling they plan to draw in credit lines despite that they're still sitting on excess liquidity themselves?

Bryan Jordan - President & Chief Executive Officer

Yeah, credit line utilization hasn't changed much, it sort of hung in there at 45% area and and we see customers, it's a mixed bag. We see some customers that are looking at things, they're booking new commitments and they're indicating that they're going to roll on these commitments and others that are being more costs. So it is one of the things where I guess everybody, us included, has a little bit fuzzy crystal ball about how things are going to play out. If you spun back 18 months ago or 15 months ago or even six months ago, we wouldn't have been able to predict how things have played out with a whole lot of certainty and I think we look at the next six months and say there's a lot of things in motion and on the whole what we see in terms of building pipelines, what we see in terms of customer acquisition, calling efforts, we're more optimistic than not. But there is still a certain amount of uncertainty. There is a fair amount of uncertainty.

Steven Alexopoulos - J.P. Morgan - Analyst

Okay, thanks. And then for my follow-up question, with the 10 year trending lower despite the firming inflation data, the million question everybody has is outside of central banks, who is exactly purchasing treasuries here? And you guys have a very unique vantage point into this, ADR was very strong again in the quarter. So maybe could you give us some color on what types of investors you guys see in your fixed income business actively buying treasuries here and is it banks? Thanks.

William Losch - Chief Financial Officer

Hey, Steve, it's BJ here. It's interesting what I think our fixed income people would tell us is that it's actually predominantly the largest U.S. banks. So we haven't really seen any material of change in how they're holding liquidity. So they are the ones that are are buying up a lot of the treasuries. We're seeing a little bit of purchasing from Japan and Europe. But predominantly it's being driven by the largest U.S. banks, which is interesting dynamic.

Steven Alexopoulos - J.P. Morgan - Analyst

Okay, that's great color. And congratulations, BJ. We'll talk to you soon.

William Losch - Chief Financial Officer

Thanks, Steve.

Operator

The next question comes from Brady Gailey with KBW. Please go ahead.

Brady Gailey - KBW - Analyst

Hey, thanks. Good morning, guys.

Bryan Jordan - President & Chief Executive Officer

Good morning, Brady.

Brady Gailey - KBW - Analyst

So the mortgage warehouse was down I think a little more than people had expected. Linked quarter was down about 20%, which is kind of a big move. I know that has been very robust over the last year so with COVID and everything. Maybe just talk about the warehouse from here. Do you expect it to recover at all? Is this, or is this a good level? Or could we see maybe some additional weakness as mortgage continues to cool down?

Bryan Jordan - President & Chief Executive Officer

Yeah, Brady, this is Bryan. As we sit here today, we're optimistic we'll see some recovery in those balances over the next couple of quarters. There are a lot of things going on in the mortgage space right now. Some of it is just a constraint around housing supply and the inability for new purchase money transactions actually occur, refinance activity is leveled off, its going to ebb and flow given the tenure that Steve just pointed out. But given some some tweaks that we've been making, which we think will allow us to pick up additional market share of our existing customer base or warehouse here of existing customer base, we're expecting the balances will probably drift up over the next couple of quarters.

Brady Gailey - KBW - Analyst

Okay, that's good to hear. And then my second question is just on PPP fees. I think you guys had about $35 million in this quarter, which was a high watermark so far. Just remind us what's the level of PPP fees that are left? And any thoughts on the timing of that realization?

William Losch - Chief Financial Officer

Hey, Brady, it's BJ. At the end of the second quarter we had about $27 million left and we think that that will continue to come down probably over the next 15 months or so.

Brady Gailey - KBW - Analyst

Okay, great. We'll, BJ, great working with you, and good luck [Indecipherable]

William Losch - Chief Financial Officer

Thanks, Brady.

Operator

The next question is from Brock Vandervliet with UBS. Please go ahead.

Brock Vandervliet - UBS - Analyst

Thanks for taking the question. If we could just go back to mortgage business in terms of the gain on sale and the gain on sale trajectory, how should we think about that? I hear it's lower. But should we look at that as lower for the duration that overall mortgage volume may be falling? Or is this - do you see this as more of a shorter-term adjustment driven by competition in the market?

Bryan Jordan - President & Chief Executive Officer

Brock, this is Bryan. I'll start. I tend to think the gain on sale spreads are probably not going to expand as much. Pricing was a leverage to slowdown volume and periods of fee volume where everybody was having trouble meeting demand and did that volume particularly refinance activity is decided, I'd be surprised to gain on some mortgages expanded back out. As you know, in our income statement, particularly in the fee income line, its really a function of two things. The level of secondary sales. And two, the gain on sale percentages. And you made some real simplifying assumptions and said okay, we booked probably $350 million or so into our portfolio that might otherwise have been sold in the secondary markets and assume that they were sold at the same gain on sale spreads, which I know are overly simplifying and that's probably $12 million of pre-tax earnings that comes back to us through enhanced yield over time. So we're looking at the volumes and spreads and thinking about how - what's the right mix of balance sheet, non balance sheet. We asked and answered earlier in the call about duration and expanding the size of our securities and using excess cash. We clearly want to use our balance sheet to support customer activity and where that is driven through duration and mortgage product, we'll look at it. But on the whole, we think as you summarized earlier the directionally mortgage gains will likely be down and that spreads in our view are not going to expand out significantly from here.

Brock Vandervliet - UBS - Analyst

Okay, thanks for that. And just going back to your earlier comment on mortgage, my understanding was that that is still primarily the IBERIA part of the franchise and that once you knit together the systems, then you can introduce it on the legacy FHN side, is that accurate or is that already happened?

Bryan Jordan - President & Chief Executive Officer

I would say that it's inaccurate in the sense that we have that product available across the broader franchise. It is accurate in the sense that we are not practiced at originating the kinds of volumes we think we can originate out of the First Horizon franchise. So we believe that we have much more capacity in the legacy first arrived and franchise because we have trained our sales and not be in that business and have sort of indirect fulfillment model. Given the direct fulfillment model and the success we're seeing with that, we think that we will see much greater mortgage volume out of the legacy First Horizon franchise over time.

Brock Vandervliet - UBS - Analyst

Okay, thank you, and good luck.

Bryan Jordan - President & Chief Executive Officer

Thanks, Brock.

Operator

The next question is from Casey Haire with Jefferies. Please go ahead.

Casey Haire - Jefferies - Analyst

Yeah, thanks. Good morning, everyone. I wanted to circle back on capital. So the CET1 ratio you're taking that up about 50 bps. I'm just curious why? I mean, you sound like you're going to be pretty opportunistic on the buyback. I'm just curious why you're taking up the capital floor when you feel good about credit? And just some color there.

William Losch - Chief Financial Officer

Yeah, Casey, I wouldn't necessarily say we're taking up the capital forward just giving you kind of our view of where capital is likely to be. As Bryan alluded to, we'll be opportunistic on share repurchases and that will use some capital wisely. RWA growth is going to continue to be to be muted. And so the combination of those two will, if we're at 10.3% today, we're giving you a range of 10% to 10.5%. If we start to see some RWA and loan growth coupled with some share repurchase, it flows to the lower end and conversely. If we don't, it goes towards the higher end. But I think Bryan's point earlier was ultimately we're more comfortable from a balance sheet perspective and a capital optimization perspective, more in the 9.5% range, but just given kind of the dynamics of the environment today will likely be more in the 10% to 10.5%.

Casey Haire - Jefferies - Analyst

Okay, okay, got it. And then on the M&A front, obviously a pretty active environment still. Can you just give us some updated thoughts on First Horizon's appetite today?

William Losch - Chief Financial Officer

Yeah, I don't think very much has changed from our perspective. We're still very, very focused on getting our integration completed and then really following that, delivering on what we think are the huge opportunities that exist in our existing franchise with the significant growth markets that we have the opportunity to serve in our 12th state footprint, our combined banking footprint. And what we think are the opportunities to just grow organically. So we don't - we're not thinking that M&A is critical to our strategy. Its not built into our strategy. Our strategy is designed around, let's execute in a very seamless and thoughtful way for our customers, delivering the best products and technology to capitalize on the huge growth opportunities that we have in our footprint and invest organically. And then if something comes up along the way, we will certainly consider it. But at the end of the day, it's not something that we're taking our eye off the ball in terms of execution today. We're really focused on delivering the promise of the IBERIABANK, First Horizon merger of equals.

Casey Haire - Jefferies - Analyst

Excellent. BJ, its been a pleasure. Miss you.

William Losch - Chief Financial Officer

Thanks, Casey.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Bryan Jordan for any closing remarks.

Bryan Jordan - President & Chief Executive Officer

Thank you, Betsy. Thank you all for joining us this morning. We appreciate your time, we appreciate your interest in the company. If you have any further questions, please reach out to any of us. We'll be more than happy to try to gather the additional information. Thank you all. Hope you all have a great weekend. And thanks to all of our associates for the great work you're doing. Have a great weekend, bye-bye.

Operator

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Q2 2021

Earnings Transcript

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