First Horizon Corp (FHN) 2021 Q3 法說會逐字稿

Good morning, and welcome to the First Horizon Corporation Third 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 Ellen Taylor, Head of Investor Relations. Please go ahead.

Thanks, Kate. Good morning, everyone. We really appreciate you joining us on such a busy day. This morning, our President and CEO, Bryan Jordan; and our Chief Operating Officer and Interim CFO, Anthony Restel, will provide some prepared remarks, and then we'll be happy to take your questions. And we're pleased to have Susan Springfield, our Chief Credit Officer, in the room with us today to assist us with that effort.

So I need to remind you that we will make forward-looking statements today that are subject to risks and uncertainties, and we ask you to review the factors that may cause our results to differ from expectations on Page 2 of our presentation and in our SEC filings. You can find our earnings materials on our website at ir.fhnc.com.

Additionally, you need to be aware that our comments will refer to adjusted results, which exclude the impact of notable items. These are non-GAAP measures, so it's really important for you to review the GAAP information in our earnings release and on Page 3 of our presentation. And last but not least, you need to understand that our comments reflect our current views, and you should -- and that we aren't obligated to update them.

And with that, I'll hand things over to Bryan.

Thank you, Ellen. Good morning, everyone, and thank you for joining the call. I'm pleased with the continued progress across our company this quarter and believe that our results demonstrate the benefit of our more diversified model. Our attractive base of specialty businesses and higher growth markets are starting to drive our performance. We delivered EPS of $0.50 a share and a return on tangible common equity of over 18% on an adjusted basis despite the near-term headwinds that the industry is facing with continued pressure on short-term rates and strong competition, given growing levels of excess liquidity and muted loan demand.

Given the continued improvement in the macroeconomic environment as markets reopen, I'm increasingly confident that our client-focused value proposition with a broad product set positions us well to be nimble and focus on the key segments where we can differentiate. As a result, there were several bright spots in the quarter that I think are worthy of noting. While net interest income was down in the quarter, given expected reductions in net merger-related and PPP portfolio benefits, we generated core net interest income growth of 1% with underlying loan growth of 1%, which was driven by commercial loan growth of 2%. We continue to see momentum in our commercial pipelines and the quarter ended with unfunded commitments up 5% to just over $19 billion.

Our team remains strongly focused on serving clients and anticipating their needs to continue to deepen relationships across our expanded footprint. Our net interest-bearing deposits declined 3 basis points -- our net interest deposit cost declined 3 basis points in the quarter. The team is intensely focused on moving our cost towards peer median, and we think we are well positioned to hit the target sometime next year.

It's also important to note that we are well positioned to benefit in a rising rate environment and ended the quarter with interest rate sensitivity profile of a 16% increase in net interest income and a 100 basis point shock across the yield curve. And while we expect the total fees to be down given relatively healthy levels of fixed income and mortgage banking fees last quarter, we also saw a return to more normalized levels in traditional banking fees, which were up 2% in the quarter, with particular strength in wealth on strong annuity sales.

Credit quality continues to be excellent with improvement in the overall quality of the loan portfolio highlighted by net charge-offs of only 2 basis points and a 47% decrease in loan balances on deferral in the quarter. That, coupled with improving macroeconomic environment, drove another robust reserve release with a provision credit of $85 million in the quarter. This was a 26% decrease in the provision benefit this quarter versus last quarter. Given the impact of CECL, as we look ahead, provision expense will likely be a headwind for us and the industry overall.

As our capital levels remain strong with a CET1 ratio of around 10.1%, we increased our capital return by nearly 60% in the quarter, repurchasing 9 million shares of common stock and ended the quarter with a tangible book value per share of $10.88. And despite the difficult decision to delay the systems integration until February of next year, we continue to execute on the objectives of the MOE with strong progress on integrating systems and aligning products and capabilities, including piloting a new digital platform for treasury services, launching new relationship and banker profitability tools and completing the first round of banking center consolidations.

Given some higher costs tied to integration of our platforms, along with higher costs due to markets reopening, much of which is marketing as well as the seasonality and the idiosyncratic items in our expenses were up 3% in the quarter. However, as Anthony will cover later, we expect expenses to moderate in the fourth quarter.

Alongside our integration efforts, we continue to invest in technology and people to drive revenue synergies and expense efficiencies and thus far, we've identified approximately $35 million in revenue synergies tied to the merger. We remain confident in our ability to deliver at least $200 million in net annualized savings by the fourth quarter of next year.

As we begin to look ahead in the next year, I'm increasingly optimistic about the pace of the macroeconomic recovery as the world emerges from the pandemic and that the power of our combined organization will continue to be increasingly evident. I'm very grateful for the dedication and hard work of our associates as they continue to work to deliver value for all of our constituents, clients, communities and shareholders and help drive the momentum to achieve our long-term performance objectives.

And now Anthony will run through the financial details. Anthony?

Thanks, Bryan. Good morning to you all. Slide 6 provides the highlights of the quarter, most of which Bryan has already covered.

Overall, we continue to make solid progress across the combined organization, and we are pleased to see evidence of the power of the MOE starting to emerge. I'll briefly touch on Slide 7, where we outline the notable items in the quarter, which reduced our results by $51 million after tax or $0.09 per share. In addition to merger-related notable items of $44 million, we recorded $23 million of noncash pretax costs tied to retiring legacy IBERIABANK trust preferred securities in the quarter and expect to record an additional $3 million next quarter. The redemptions will reduce interest expense by about $5 million annually with an expected payback of approximately 5 years.

Slide 8 provides an overview of our adjusted financials for the quarter. We generated PPNR of $284 million as underlying improvement in core net interest income and traditional banking fees was masked by the impact of expected declines in net merger-related and PPP non-net interest income, along with lower fixed income and mortgage banking fees. Adjusted expenses of $480 million moved higher, largely reflecting idiosyncratic items tied to strategic investments and additional costs we incurred tied to markets reopening.

Given continued improvement in the macro environment, overall credit quality and muted loan growth, we posted a credit to provision of $85 million, which was down from the $115 million credit last quarter. This reduction drove a $0.04 decline in EPS. But overall, we continue to post healthy returns with an adjusted return on tangible common equity of 18.4%, and 14% before the impact of the provision credit. As Bryan mentioned, tangible book value per share came in at $10.88, up 1% as GAAP net income was largely offset by a $0.23 impact tied to the return of capital and a $0.07 decline tied to the mark-to-market on the security portfolio in OCI.

Moving to Slide 9. Net interest income was down $5 million linked quarter given the expected decrease tied to lower merger accretion and PPP portfolio balances. Core net interest income was up 1% as the benefit of lower deposit cost, day count, commercial loan growth and higher investment portfolio income was partially offset by continued declines in consumer loan balances and overall loan spread compression given the continued reductions in LIBOR and the competitive landscape.

During the quarter, we ramped up our security purchases to put more excess cash to work and added around $400 million on a spot basis at a yield of around 1.5%. As a result, our securities to interest earning assets ended the quarter at 11%, up 1%. Our current plan is to have put a total of $1 billion of excess cash to work in securities by year-end, and we will continue to reevaluate opportunities to redeploy additional cash as we move forward.

Reported NIM was down 7 basis points linked quarter with core NIM down 8 basis points, driven by a 5 basis point impact tied to higher excess cash. We ended the quarter with excess cash of $14 billion, up from $12.7 billion in the second quarter.

Core NIM was also lower given a 2 basis point reduction in interest recoveries on nonaccrual loans as well as overall spread tightening with new origination spreads down around 15 basis points linked quarter, which collectively translated to about 3 basis points of pressure on the margin. We also generated a 2 basis point benefit to the margin with further improvement in the deposit mix towards DDA and a decline in interest-bearing deposits. I would also note that this quarter, we added a disclosure to the relationship of core net interest income to risk-weighted assets to help illustrate the impact of NII, excluding the excess cash position. Under this view, you can see that year-over-year, the metric is down about 10 basis points compared to the core margin, which is down about 40 basis points.

And on Slide 10, let's cover the puts and takes on fees. Headline fees were down around 7% in the quarter. This reflected anticipated declines in other noninterest income and fixed income and mortgage that were partially offset by growth in brokerage, trust and insurance tied to higher annuity sales as well as higher service charges and fees as an increase in transaction volume and higher leasing income tied determinations helped to mitigate the impact of a recent change in our NSF pricing structure.

Fixed income average daily revenue came in at $1.3 million compared with $1.4 million last quarter. Mortgage banking and title fees were down $4 million given continued spread tightening and our focus on driving more of our originations on balance sheet. While overall originations were down 11% for the quarter, portfolio originations were up 5%. The reduction in our other noninterest income was driven by an $11 million decrease in security gains tied to a legacy IBKC investment in the second quarter.

With regard to service charges, we recently began aligning key features across the legacy institutions approach to service charges with the goal of simplifying and streamlining the experience for our clients. The new program was launched in late August at First Horizon with the remainder of the change occurring following the system conversions in February for our IBERIABANK franchise. Over time, we expect the changes to reduce our overall NSF overdraft fees in the range of $9 million to $10 million annually, with changes going into production in August for First Horizon and with the February conversion for the IBERIABANK clients.

Let's turn to Slide 11 and review expense trends. Adjusted expenses totaled $480 million, up $15 million in the quarter, largely because of seasonality and some idiosyncratic costs related to strategic investments and additional costs related to markets reopening, which was slightly offset by $1 million tied to incremental merger cost saves. Personnel expense decreased $4 million linked quarter with salaries and benefits stable as a $4 million FICA credit helped mitigate the impact of day count, seasonally higher medical cost and labor supply constraints.

Incentives and commissions remained relatively stable as a $3 million increase from pandemic-related vacation carryover partially offset lower revenue-based payouts and fixed income and mortgage. I should note that as we continue to shift more of our mortgage originations on balance sheet, you will see a reduction in mortgage fee income without a corresponding reduction in incentives. Additionally, higher contractor costs tied to investments and new systems, largely in areas like treasury solutions and business banking online as well as increased advertising spend given our reopening of markets, pushed outside services up $9 million.

And finally, other noninterest expense was up $11 million in the quarter, driven by higher tax credit-related contributions, a $2 million increase in fraud costs and higher travel and entertainment costs also for markets reopening. We are focused on driving efficiencies and identifying opportunities to redeploy expenses toward areas, which provide higher growth for the organization, particularly post the systems conversions in February.

On Slides 12 and 13, we cover our balance sheet profile. Excluding PPP balances, which were down $1.8 billion in the quarter, average loans increased 1% in the quarter. And as Bryan mentioned, this reflected commercial growth of 2%. Our pricing strategies in the mortgage warehouse business helped deliver a 7% increase in balances with purchase volume up 3 percentage points linked quarter to 56%. Additionally, we continue to see traction in other specialty businesses with growth in asset-based lending, equipment finance and franchise finance somewhat offset by a reduction in commercial real estate given higher levels of refinancing activity from the capital markets. This is being somewhat offset by continued pressure in retail, real estate secured refinancings, which drove a 1% decline in consumer loans, but we're reviewing opportunities to increase our recapture of these with refi opportunities.

Overall, we are pleased to see the path of the economic recovery and the increased activity levels across our footprint translate to this level of loan growth. On the liability side, we saw a continued inflow of deposits, driven by a $1.1 billion average increase in DDA or 4%, which helped to further improve the mix of deposits. And with interest-bearing deposit costs down 3 basis points to 17 basis points for the quarter, our total funding costs improved 2 basis points. As Bryan mentioned, we are intensely focused on driving our interest-bearing deposit costs down toward peer median levels.

On Slide 14 and 15, we provide information on asset quality and reserves, where we continue to see exceptional low levels of charge-offs and nonperforming loans and our allowance coverage of loans is healthy at 1.45% and 1.65%, excluding loans to mortgage companies and the PPP portfolio. Additionally, when you consider the unrecognized discount on acquired loans, our total loss absorption is roughly 2%, which is very strong.

Turning to capital on Slide 16. Our CET1 ratio of 10.1%, down from 10.3% in the second quarter tied to the accelerated share repurchases in the quarter, loan growth and higher unfunded commitments. As Bryan mentioned, we returned $224 million in capital to common shareholders during the quarter, including $142 million or 9 million shares of common stock repurchases.

Moving on to merger integration on Slide 17. While we had to delay the core systems conversion to early next year, we continue to make substantial progress across a number of fronts. During the quarter, we completed a couple of mock conversion events and completed our wealth and trust and credit card conversions, finalize the mortgage system conversion and launched a pilot of our new online banking platform for commercial customers. We achieved $96 million in annualized run rate savings against our net target of $200 million. Additionally, we continued making solid traction on revenue synergies and have thus far identified roughly $35 million of annualized revenue synergies that are tied to commercial loans and additional synergies tied to debt capital markets, mortgage and private client wealth. We are extremely focused on retaining and growing our client base by continuing to enhance or expand our set of products and services.

On Slide 18, we provided our fourth quarter outlook. We expect NII to be down at the high end of the low single-digit range with average interest-earning assets and loans down modestly given the outlook for reduced merger accretion and PPP benefits and continued low rates. We expect to continue to see modest loan growth, excluding PPP, and that we will see benefits as we continue to lower deposit costs.

At period end, we had a total of $2 billion in PPP loans, including $600 million related to round 1 and total PPP fees of $45 million. We expect the vast majority of the round 1 portfolio to be forgiven by the end of the year and that the round 2 will largely be forgiven by the third quarter of next year.

Regarding noninterest income, we expect fee income to be down in the high -- in the mid- to high single-digit range with additional decreases tied to our NSF pricing changes and seasonally lower mortgage and wealth fees as well as further moderation in fixed income. We expect noninterest expense to decrease in the low single-digit range, with higher third quarter levels, which included investments, seasonality costs tied to markets reopening and some idiosyncratic items. And our outlook calls for charge-offs to be in the range of 5 to 15 basis points, and that it's reasonable to see continued reserve outflows near term.

Finally, we expect our CET1 ratio to remain in the 9.5% to 10% range. As Bryan mentioned, we feel good about our positioning and our ability to perform well given the current economic environment.

Finally, Slide 19 includes our short- and long-term objectives. We believe our more diversified model and highly attractive franchise will continue to deliver revenue synergies and loan growth. Our MOE objectives to complete the systems integration and to identify other expenses to redeploy to higher growth and higher return opportunities will allow us to continue to support the dynamic digital needs of our clients and associates, and drive continuous improvement in productivity and efficiency beyond the integration. And as we continue to actively manage capital, our balance sheet and credit quality performance position us well to continue to deliver attractive results near term and into the future.

And with that, I'll give the call back to Bryan.

Thank you, Anthony. I'm excited about the momentum and the results of the combined organization, what we've achieved this quarter. The power of our attractive franchise with the benefit of a more diversified business model and higher growth markets is evident in our results. The progress we have made towards our merger integration objectives continues to deliver revenue synergies to provide our clients with improved products and technology. As the macroeconomic environment continues to improve, our capital structure and risk management infrastructure positions us to deliver higher growth and top quartile returns into the future.

I am grateful again to our associates for their dedication towards building and strengthening client relationships and supporting our communities. And I am confident in our ability to become a top-performing regional bank and to drive enhanced shareholder value.

With that, Kate, we'll now open it up for questions.

(Operator Instructions) The first question comes from Casey Haire with Jefferies.

Yes. Just, Anthony, a point of clarification on the NII guide. The low -- the high end of the low single digits, does that mean 3% or 1%?

3%. 3%, Casey.

Okay. Very good. Okay. And on the expense side, the reopening costs continue to tick up and are kind of chewing into the cost saves. I know there wasn't a lot of progress there this quarter. But I'm just curious, as you look forward, are we -- are the reopening costs kind of fully in there? Or is there more potential headwind there that could mute the cost saves that you have remaining?

No. I think the reopening costs are largely kind of in the numbers now.

Okay. Very good. Okay. And then just lastly, on the fee side, the NSF fee policy change and the fixed income is -- or you mentioned as potential drags. Where do you -- can you give us some color on where ADRs you expect to trend this quarter? And then where can the service charges line run rate in the fourth quarter?

Yes, Casey, this is Bryan. The fixed income business is inherently unpredictable. We still feel good about the environment. There's still a tremendous amount of excess liquidity across the financial system and bond activity continues to be good. Our forecast for the year is $1.5 million average daily revenue. And we expect that we'll fall in that range for the full year. So that implies a little lower level in the fourth quarter. But we still expect to be in that $1.5 million in average daily revenue.

The NSF fees, we have done some -- made some changes to, one, reflect our desire to be more customer-friendly, which has some impact on it. And then the fact that liquidity is so strong, it is driven down in [SFOD], service charge fees, et cetera, in this environment. The changes we made on an annual basis amount to about $8 million on an annual basis. So it's -- on a quarterly basis, it will be rather insignificant, but we think it will be better for customer acquisition, retention and growth over the long term.

And then, Casey, I want to just to add, just since I know this somewhat turns into modeling for you. That number that Bryan mentioned on the annual impact is not an equivalent number every quarter, right? So just recognize that typically early in the year, a lot of our consumer customers benefit from tax refunds, et cetera, which kind of keep the number deflated in the early part of the year and then typically it accelerates through the year. So just know that it's not a flat number every quarter.

Okay. Great. And just one more. The deposit growth obviously continues to be very strong. You've got the cash position increased again this quarter. What is the -- do you expect that to continue, the liquidity strength? And then what is a normalized cash position for you guys?

Yes. I do think the cash, unfortunately, probably continues to build, just recognize as we continue through the PPP forgiveness process that we end up receiving cash from that as we kind of go through that exercise. So we do have cash will likely continue to be very strong for us.

What I'll tell you is we probably have, I don't know, Bryan, maybe $10 billion to $12 billion of excess cash relative to what we would typically hold in a kind of more normalized type environment. I'll remind you, although it's painful and we always spend a lot of time talking about what we're going to do to use the cash or dispose of the cash. Just recognize that, that cash is coming in at something lower than -- slightly lower than what we earn on the cash. And so although it's painful, just recognize that we're earning 15 basis points. And in a lot of cases, it's -- yes, it is inflating the balance sheet. But when you look at the growth during the quarter, we're really not paying anything for that. So although I don't like it because it creates a lot of noise for us, I don't mind the concept of picking up a lot of nickels along the way to generate some income.

The other thing it does, too, Anthony, is it adds deposit lag when the Fed starts to increase the rates, it's a tremendous amount of liquidity. And I think across the board for the industry, you'll see more deposit lag than has been historically modeled simply because of that level of liquidity.

The next question is from Brady Gailey of KBW.

So if I look at loan growth for the quarter, ex PPP and ex the warehouse, I think loan growth was about 3% linked quarter annualized. And I was just wondering if you had any thoughts on doing an amount of loan growth better than that. I mean we've seen -- especially this quarter, we've seen some of your peers really start to inflect. Synovus, like, for example, grew 10% linked quarter annualized this quarter. I know Pinnacle was even over that. So some of your peers are putting up notably higher loan growth as we're coming out of COVID. So just wondering if you guys could comment on the idea of better loan growth beyond just the 3% level you saw this quarter?

Yes, I'll start, Brady, and then I'll ask Susan to add any color she likes. She's very, very close to this. This is an interesting environment. And the demand for loan growth is not extraordinarily high even with the recovery. We see the markets being very, very competitive. And if I had to characterize the markets, I'd say that they're becoming very competitive on price, on structure and on term. And we're being selective.

One of the things that we have emphasized and we highlighted in our comments a couple of different ways this morning is we want to protect the integrity of the balance sheet and one, protect credit quality. So we're being very thoughtful about the price structure in term with an eye towards long-term credit quality. That said, we see real opportunity in our customer base. We're seeing real strong momentum across our franchise.

Our pipelines have continued to strengthen. We have highlighted on this call that our commitments were up about 5% quarter-over-quarter, which is, in my view, spring loading the balance sheet for future growth. And so I'm optimistic about our ability to grow loans and to protect credit quality. We don't get fixated on setting a number that we've got to go out and hit. We focus on: one, acquiring good bankers; having our bankers focus on their customers and their communities; and picking up the opportunities and being competitive that exists in the marketplace. I'm not close enough to other's results to have a sense of what drove their growth. But I'm encouraged about our ability to grow loans in a quality fashion.

Susan, anything you want to add to that?

Sure. We are seeing good momentum in pipeline. Also, as was mentioned earlier, the revenue synergies from the combined organization are really, really starting to show up with referrals into asset-based lending, equipment finance, both of those areas had good increases quarter-over-quarter. And if you look at pipeline, there's additional pipeline for revenue synergies.

In addition to those specialty businesses, we're still -- we're seeing strength in our markets, which, as you know, are very, very good, strong growth markets. So Texas, Georgia, North Carolina, Florida, Middle Tennessee, et cetera. We're in some of the best markets in the Southeast and Texas. In addition to that market, those good markets, we've had good success continuing to hire both relationship managers and market leaders in some of those markets that are very, very important to us from a high-growth perspective.

In addition to [new-to-bank] type relationships that we're getting both from existing bankers as well as some of these folks that we're bringing over, these strong producers, we're also selectively taking higher hold limits with our existing clients as a result of our larger balance sheet. So we're very optimistic about the future. But as Bryan said, we will remain prudent and be selective.

All right. And then my second question is on just deploying the cash into the bond book over time. I mean I hear you're going to do another $1 billion by the end of the year. But as Anthony said, you have $10 billion to $12 billion of excess cash, which sounds like it's not going anywhere anytime soon. The long end of the curve is starting to rise here. I mean, as we look into 2022, should we think about more cash being pushed into the bond book over time, kind of similar to what you all do in the back half of this year?

Yes, Brady. So just a point of clarification, right? So we announced putting $1 billion in the last quarterly conference call. We've got about $400-or-so million of that done this -- in the third quarter. So we've got a little bit -- $600 million, I'll call it, tail piece that we expect to get done by the end of the year.

Look, the good news is rates are moving up. But I'll tell you, I think we're going to kind of roll through the end of the year and then reevaluate kind of where we think we are relative to where the economy is at and what makes sense for us, right? So as you know, right, the expectation for an increase in federal funds continues to creep forward. And so I think we're going to -- as opposed to telling you what we're definitely going to do now, what I would tell you is we're going to evaluate it relative to what makes the most sense for us. But I think it's probably prudent here to wait and see what kind of evolves over the next 2 to 3 months before we make that call. So it's a good question for the January conference call.

The next question is from Steven Alexopoulos of JPMorgan.

I want to start -- so Bryan, on the 5% increase in commitments you're calling out, was that from existing customers or new customers? And then when you say that competition is high on price structure and term, is that from peer regional banks, larger banks? Maybe give some color there, too.

The last part is yes. It's across the board. The competition is -- starts with smaller institutions all the way up through some of the bigger players. And it's really trying to show growth in a period where loan demand is not as strong as you might expect, it's reasonably intuitive, I suppose, given the amount of excess liquidity that sits in the system. We talk about the excess liquidity on our balance sheet. That's customers' money. So that means that they don't need to borrow as much.

The 5% commitment is a combination of things. It's -- a lot of it is construction lending. One of the variables that we and everybody else is dealing with, I suppose, is in just a sheer amount of payoffs. Our commercial real estate business, for example, had very strong originations in the second and the third quarter, but payoffs were actually greater. There's an end to that. And so when we book a new loan in commercial real estate, that loan will fund up. That flows into those numbers.

So it's a mixture of existing customers. It's a mixture of new customers. We've got a very nice blend. We're seeing good momentum across the franchise in our higher-growth markets and some of our more stable markets. One of the ones that's done extremely well over the last several quarters is Alabama, for example, we're seeing great growth opportunities there in acquiring new customer relationships.

Okay. That's actually very helpful. I wanted to shift gears and follow up on the $8 million annual impact from the NSF pricing change, which is actually fairly minimal. How much revenue would you have ultimately given up if you just eliminated the $15 transfer fee also?

I'll tell you what, let us see if we can -- we don't have that right in front of us. Let us see if we can dig that up during the call. And if we can get it, we'll come back before we get off.

It will be more than $8 million.

More than $8 million. Okay. It would be helpful to see that number. And maybe, Bryan, just finally, a big picture question. So looking at the list of items on Slide 17 regarding the merger integration, there's still quite a bit of wood to chop, right, particularly with the system conversion being delayed a bit. When do you see the company moving more fully back on offense, right? Let's focus on retaining staff, more focused on recruiting staff. Is this a mid-'22 event? And is that the point where we'll start to see the growth that this new company is capable of delivering?

Yes. So first on the deferral of the integration event. We passed the Columbus Day weekend and like everybody else, we had hoped that we would have it done then. As I reflect back on the decision that we were making in the midst of Ida and being forced to drop customer notifications, et cetera, on the Monday following Ida hitting New Orleans on Sunday. I feel good about that position -- that decision. I think seeing the devastation there, the difficulty in recovery in the market and the impact on our associates and our ability to train and deploy technology, et cetera, and then the impact on our customers, I think that was a good move.

We will get that integration completed in February, I have a high degree of confidence, and we'll make good use of the time. We've talked about the impact on onetime. We've talked about the impact on delay in cost savings.

Now I would say that you will start to see the significant benefits of the integration starting in the last part of the first quarter and clearly picking up on the cost savings side in the second quarter of 2022. I think, as we sort of alluded to in a number of different ways, we're starting to see the benefit of the revenue side of it today. We've mentioned the $35 million in revenue, and we've talked about the acquisition of customers in the franchise.

So I would tell you that our markets, that our bankers are very much front-footed. They're looking to bring talented bankers onto the platform. Susan mentioned that we've hired a new President, for example, in Dallas, has come on to the -- on to our platform into the organization. We're hiring bankers. So I think we're very much front-footed. And I think you will see that momentum start to build over the next couple of quarters and into '22.

Hey, Steve, one -- following up on your question, right? If you look at kind of the kind of run rate where we are, if you adjust for that $8 million number, we're around $40 million, $45 million in remaining NSF fees on an annual basis. Now keep in mind, that's relative to transaction volumes and all today. So that could all change, but that would be the current kind of run rate.

The next question is from Jon Arfstrom of RBC Capital Markets.

Just one clarification on the earlier expense question. Anthony, I think you're saying that Q4 expenses probably dropped back down to the levels we saw in Q1 and Q2. Is that fair?

Yes, the expenses will pull back.

Okay. Okay. And some of the other items, that's what you're talking about that will come out. Is that right?

Yes, like we had some items that are -- that don't reach the definition of kind of, I'll call it, a onetime but from our view that we don't expect them to repeat. And so those will certainly roll down a little bit. And then clearly, as we expect to see some moderation within that fee income, there are several incentive kind of structures tied to those fees, and so that will also roll down. That's what gives us the confidence that we'll see the decline in the expenses in the fourth quarter.

Jon, this is Bryan. We hadn't been spending much on marketing. We increased our marketing spend in the quarter. That's one of the things that we called out. I mentioned that we're piloting a new treasury services platform. We haven't taken out the old treasury services platform on either side, but we're now depreciating the new one as well. So there's a little bit of redundancy that has already gotten built up. That's what drove a lot of the surge in the third quarter.

I would hang my hat on the fact that we have demonstrated in the past that we have the ability to control and take costs out of the organization and that we're focused on that. And I'm confident in -- I think I said in my opening comments, at least $200 million in cost savings. I feel good about our ability to reduce the cost of doing business. And I would look at this as sort of a onetime aberrational trend. And as Anthony said, you'll start to see expenses coming down later this year.

Yes. Okay. Yes, you've been great on expenses. Maybe for Susan and/or Bryan, thoughts on where the reserve could go longer term? It still seems a little bit elevated relative to your credit quality. And I just want to square that, Bryan, with your -- some of your prepared comments saying that provision expense is likely to be a headwind for you and for the industry, help us figure out exactly what you mean on that.

I'll start. Jon, we are assuming that the economy continues to emerge from COVID, which obviously it is doing that now and absent any other events, we believe that we could see coverage get back down to kind of the CECL day 1 coverage in the 115 range or so. So that's kind of what we're thinking.

Yes. And my comments about the headwind, we highlighted we had a reserve release, I think, was $110 million, and while $85 million is great, this quarter is less than it was last quarter and reserve releases will continue down. Inherent in CECL, every dollar of loan growth requires that you're actually booking reserves. So to the extent we brought it down $85 million for the loan growth we booked, we ended up at a 1.65% ex PPP, et cetera, we're setting up reserve.

We're just sort of acknowledging that reserve releases over time will diminish and that as we get into a point where we get to this 115 of CECL day 1 area, prepandemic area that those reserves under CECL build, when you book a loan, you essentially book the [LICA] loan losses. So you front end the credit cost on it. And it's just going to be a headwind for us and the industry is all we're trying to highlight.

Okay. All right. So more of a longer-term comment is what you're saying there. Okay.

The next question is from Michael Rose of Raymond James.

I just wanted to go back to the fixed income business. As we get into a rising rate environment, I think if I look back to the way the business performed last cycle, there was some pressure on ADR as you guys did the coastal securities during that period as well, which helped to soften the decline. But can you just remind us how in a rising rate environment, the ADRs would trend, assuming we get there some time later next year into 2023?

Yes. Thanks, Michael. This is Bryan. The fixed income business is going to be affected by really the shape of the yield curve more in this cycle, I think, than rising rates. A couple of thoughts on our expectations. One, we still have a reasonably steep yield curve and the longer term of the curve -- the longer end of the curve has been moving up. And with the significant liquidity that exists in the financial system and the continued level of prepayment, it's actually been good for the bond business even in a rising rate environment. So our expectation is that the Fed will continue to reduce purchases -- or start to reduce purchases continue -- they sort of telegraphed that they're going to do it later this year. Start to reduce purchases under the quantitative easing program that will diminish over the course of the first half of 2022. That will steepen the yield curve a bit. The long-term expectations will come up. But we think there's a tremendous amount of liquidity and then that will drive a significant fixed income revenue.

If you get a significant move in the short portion of the curve, that would be less attractive for the business. But we've got a significant offset in the extreme interest sensitive -- when I say extreme, very strong interest sensitivity -- interest rate sensitivity that we have to rising short-term rates where the vast majority of our balance sheet is. So we don't expect a significant spike in short-term rates. We do expect that the Fed will start moving up either late next year or early '23, but the bond business will continue to be good because you've got a relatively steep curve.

That's great color. And back a couple of years ago during that cycle, the guidance for ADRs was kind of in the $1 million to $1.5 million a day range. Any reason to think that it would be different this go around just broad strokes?

I'll tell you what I'm not going to -- you might talk to Anthony and to putting that range out there again. And I missed that one for so many quarters that we had to say we were wrong. And I think as I looked into '22, I don't think that's something in that 1 -- call it, $1.1 million to $1.3 million range is a bad range. But I don't know what I don't know about interest rates. And it's a business that we trade every single day. We deliver bonds to our customers. We buy bonds from our customers and the shape of the yield curve will impact it. So while we can have an expectation today, we don't know what rates really look like. We just have to position for them.

The next question is from Ken Zerbe of Morgan Stanley.

All right. Great. Just in terms of the expenses, I'm thinking of that $200 million of cost savings related to the deal. Is there going to be a meaningful step down in expenses when the system conversion happens in February of next year? I mean would we notice it from our end?

Yes, Ken, it's Anthony. I think you're going to see just because the conversion is kind of towards the tail end of February that the more likely scenario is you'll really see the significant move in the second quarter.

Got it. And with -- sorry, would second quarter actually be like absolute dollars lower or just lack of growth? I'm just trying to gauge the magnitude of what we're talking about.

No, no, no, we should see a significant step down as we kind of move between the second and third quarters. Not just that we're not growing, the expenses should start to decline.

I see. All right. Perfect. And then just a clarification question. In the guidance slide, you mentioned that you expect modest loan growth ex PPP in fourth quarter. I know this quarter, you had -- I think it was like up 1% ex PPP on a core basis. when you say modest, are you talking sort of a similar 1%? Or what number are you sort of thinking of there?

Yes. So I think we're looking at total loans ex PPP, something around that 1%-ish is going to be -- it will be up. But -- so that's -- it's a good range to kind of think about.

The next question is from Jennifer Demba of Truist.

Bryan, a question for you on M&A. We've seen a lot of deals this year. I'm wondering where you think First Horizon stands after the merger integration next year. And what are your thoughts on future M&A for First Horizon?

Yes. There have been quite a few number of transactions. My -- I don't know how the world changes. But as we sit here today, my expectation is that we've got so many tremendous growth opportunities in places to deploy capital across our franchise post this integration that merger and acquisition is not really a priority for us. There are a couple of dimensions that go into that. I think when we get this integration, while we will have eliminated the vast majority of any technology deficits that have existed, we still believe that the goal post continue to move on technology, and we have a number of things that we think we'll continue to invest in feature functionality that will be better for our customers and add to our growth rate. We feel strongly about our ability to capitalize on being in 15 of the top 20 MSAs in the south and really the opportunity to leverage the relatively small or new presence that we have in many of those markets.

And finally, the other thing that's a practical consideration is we're in round numbers an $89 billion, $90 billion balance sheet. You don't just sort of stumble across $100 billion threshold. So in our view, we want to focus on organic growth, growing our customer base and taking advantage of these markets. And we think that coming out of this integration, we'll be uniquely positioned to demonstrate the power of this franchise.

So that's a long way of saying M&A is not a priority. And in our view, is not the next logical step. We don't believe you can win a spending game when it comes to technology. Scale matters but it's not the only thing that matters, and we want to execute and demonstrate the power of this footprint and this franchise.

The next question is from Jared Shaw of Wells Fargo.

I guess a couple -- one follow-up on the ACL. When you talk about the -- approaching the day 1 level, the 115 basis points, is that something you think like -- should we be thinking of that by the end of '22 we could get there? Or is that something that, with the improving economy, we can get there faster than that?

Well, there are -- as you mentioned, there are a number of factors. I think the economy continues to improve, and there's not another variant or something else that hits, it's possible it could be midyear next year. As Bryan said earlier, some of it just depends on other things that we can't predict at this point.

Okay. And then taking that extra time for the systems conversion, has that allowed you to find any incremental opportunities to emphasize or expand technology and digital offerings that weren't initially considered?

Yes. So we have not really significantly changed our scope of what we plan to deliver for the conversion. We've taken the extra time really to run through additional mocks and dress rehearsals will be in play just to make sure that the client experience is what we want. Certainly around the edges, there's been a few, I'll call it, client experience opportunities, which we enhance. But for the most part, we haven't really changed the scope of what we intended to do from a conversion perspective.

Then coupled with the declining Delta variant, the time gives us more opportunity to do training on systems and get our people better prepared than they might otherwise have been.

Okay. And just finally for me, how are spreads on the new loan production this quarter? And do you think that we're at a bottom yet on incremental loan yield?

Yes. Look, spreads came in about 15 basis points lower quarter-over-quarter. I always like to say there's a limit to how low they can go. So I think as we think about the core NII, right, we see some stability within that kind of number, but I'll call it, can we have modeled in, in terms of going forward, our expectations for some continued level of spread compression. The wildcard really is a competitive environment where that might drive us. So I think the guidance we've given is pretty clear in terms of we feel good that we're kind of reaching a trough at least in our view on that core. Not core number, but like Bryan said, the competitive environment continues to evolve. And so just recognize that, that data is out there as well.

The next question is from Ebrahim Poonawala from Bank of America.

I guess just first question as a follow-up, Bryan, on some of the responses. But I think when you talk to longer-term holders, I think there's some frustration around just when do we see the power of the franchise. And is it fair from the outside? I think Anthony talked about by the end of 1Q '22 everything starts coming together, should we look at 2022 in terms of ROTCE loan growth, revenue growth as the year where you should be outperforming your peers and kind of delivering on all the great things you've expected post the deal?

Yes. So Ebrahim, this is Bryan. I think 2022, you will start to see the power of the franchise. I think you're actually seeing it's masked a little bit by some of the transition and some of the fee-oriented businesses. But the loan growth pipelines and what we're seeing across the franchise, we're starting to see emerging signs of it. And we feel very strongly that by this time next year, you will see the strength of our ability to grow this franchise given our expectations for the macroeconomic environment, the interest rate environment for 2022.

Yes. And then one other thing, Ebrahim, just to point out, I mean, I realize everybody probably knows this. But as we head into all the various conversions that we're doing, whether it's card conversion, whether we're putting people on TM products, right, we do go into some, I'll call it, some closeout periods where we're not selling legacy IBERIABANK clients into a new product to then have them -- onboard them and then have to convert them, right? So just recognize that there are some natural things that limit our ability to do some sales as we kind of move up to the conversion point. And so all of those, I'll call it, safety nets kind of come off relative to the client experience in terms of making sure we don't have to move them twice. And so I think you'll -- with all of that stuff kind of out of the way. I think you'll start to see some of the incremental kind of push, not only on the loan sales, but really across the other fee categories and the cross-selling efforts that we know are going to be pretty strong.

That's helpful. And just a separate question, and I apologize if you addressed this. I think in September, you announced a partnership with Wipro on the VirtualBank cloud infrastructure. Just talk -- I don't think that's the same provider for all the bank. Just give us a sense of what's the play with VirtualBank? Is there a bigger sort of strategic sort of plan in terms of breaking it out at some point and what Virtual does on both lending and deposit side?

Yes. So look, we're -- so you kind of hit, Ebrahim, a couple of different things. I'll tell you, we're very excited about the VirtualBank. We were the first bank actually to convert off of a legacy system on to that kind of new fintech core in the cloud environment. We continue to build out that. The reception to the kind of the product and the offering has been really good. We haven't quite unveiled to the masses yet our, I'll call it, the strategy that we're really going to employ. You should expect that we'll continue to build out product functionality capabilities within the VirtualBank. And that we'll have a distinct marketing effort in kind of how we're going to brand it and drive it going forward. You'll see that in the next, call it, 3 to 6 months when that will become more apparent to you.

But for the near term, right, our intent is to grow it to where it can support itself and kind of really help us drive not only revenue but learning and experiences in terms of similar takeaways we can bring back to the bigger, larger bank. It will be part of First Horizon for the foreseeable future. So there's no intent right now to do something different other than grow it, learn from it, make profit from it. And then longer term, we'll see what happens.

Got it. And just, Anthony, you spent a lot of time during the last year around the integration, looking at fintech vendors. As you come out of the conversion, talk to us about the top 1, 2, 3 things that the bank needs to do from a system and technology upgrade perspective that I'm assuming will be a multiyear process. And Bryan, if you want to jump in.

Yes.

Yes. Look, I'll tell you that I think the biggest thing as we kind of move -- so Bryan talked about really that we've really closed most of the technology deficits and gaps that we want to get close as we were kind of leading up to it. So I would say as a starting spot, I think that we're in a pretty good position technology-wise related to, call it, peers, still have some work to do around the edges on a few things that we need to do some upgrades on. But I think what really matters to us as we move forward is really about leaning in on those things that can drive significant improvement in either our efficiencies or our delivery. So the credit process is one that really kind of stands out. And so obviously, we've installed nCino. And then with that, whether it's front end side of that or back end side of what we're going to do there, I think is -- it can be pretty powerful. So expect we'll hear more about how we're kind of taking and going further with the whole nCino upgrade to really drive a complete improvement.

The second thing is the treasury management platform. We've had -- both companies have made a strategic priority to invest and recognize growth in the TM space. That should continue. We've started on that journey. We made significant investment. I will tell you that I'm very proud. And I think the TM system that we'll have will put us in kind of a top echelon of available TM systems once we're kind of through all of our pilots and all. And so you should expect to hear us to continue to really lean into that with more investment, more development. And then, of course, with that, you should expect to get some nice growth out of that.

So those are probably the 2 big that kind of land relative to the, I'll call it, driving revenue and that you would see on the backside, we put in some new performance management type tools to help our regional presidents and bankers fully understand the profitability and depth of their books, which should help us not only improve overall profitability just from clarity, but really point out cross-sell opportunities, et cetera. So those -- I had to put 3 kind of items on the table. I'll tell you, those are probably the big 3 that are going to have the most impact for next year.

I would add, Ebrahim, I think Anthony and Randy Bryan have done a fantastic job building the core for us to focus on driving our technology and improving technology over the long term. One of the things I'm really excited about with Anthony putting on a new hat later this year to run our regional banking franchise is him and it is process technology orientation being much closer to the customer and understanding customer needs and competitive landscape. We've got a great push capability. I think, Anthony, leading our regional bank and working with our bankers will create more pull for technology. So I think we'll be better end-to-end as a result of the infrastructure that's been built and having somebody with Anthony's vision to help us get better with that in a customer-facing sense all the time.

And then Ebrahim, I apologize. You asked me about Wipro. I just want to tell you that we use Wipro for a number of things, integration of systems, but a big healthy dose of helping us test -- testing of what we're doing to make sure we're getting it right before we deploy stuff. They've been a fabulous partner for us. And so I just want to give you some context. So they'll be around helping us on a lot of different things through the upcoming years, but they've been a fabulous partner for us.

The next question is from Christopher Marinac of Janney Montgomery Scott.

Susan, I wanted to ask about the modestly lower unfunded commitment reserves when the C&I commitments went off. Is that purely related to credit trends that you outlined earlier? And would we see that reserve slip further?

Yes. I mean we just -- when you look at just the economic environment as well as our own asset quality, those were the main drivers, both for unfunded commitment and funded.

Okay. So it's the same trend even though the [treatments] have gone up?

Yes.

Okay. And then Anthony, back to the service charge commentary, have you seen visibility on behavior changes that lead to transaction volumes? Or is it more just seasonal activity that you were citing earlier?

What I'll tell you, Chris, and I'm sure you can appreciate this, right? Customer behavior dynamics have shifted post-COVID. And so certainly, that is an impact to us. And then there's just a tremendous amount of liquidity, right? If you think about our excess cash, it all sits in not only our commercial customers, but a lot of our consumers have more. So overall, NSF fees, right, in terms of the historical pattern, they probably break from any historical kind of precedent. And so it's too -- probably too early for me to tell you exactly where things are going to go. The number I gave you was kind of the current run rate adjusted for that. So I'm trying to give you the best info I got, but I'll be the first to tell you that transaction volumes are starting to reemerge. I think we said transaction volumes were up about 10%. And so we kind of have to see where things go. It's just -- it's a different world. And so it's a little bit hard to look at historical numbers to give you a real sense that that's going to be the trend going forward.

The next question is from Brett Rabatin of Hovde Group.

I wanted to make sure I understood the guidance around NII in the fourth quarter, the high single digit -- or high end of the low single-digit decrease, which assumes lower accretion on PPP with relatively stable core NII. Can you maybe break that apart a little bit in terms of the core NII versus the linked quarter change in accretion of PPP?

So well, Brett, our core NII was up about $4 million linked quarter. So when you say break it this quarter.

Well, for the fourth quarter?

Right. So I'd say we -- I think we believe that the core NII and margin have relatively bottomed this quarter, and -- but we're going to continue to see some headwinds from merger accretion come in so...

And lower PPP.

And lower PPP. So overall, we think of low single digits as being 1% to 3%. So we're saying it's going to be down that level. But we could see continued probably modest performance in core.

Okay. And then you were talking earlier, I'm curious about the CFO position and if you think you might make some announcements this year that might drag out into '22?

Yes. So first, I would say, I really appreciate what Anthony is doing. He's wearing a number of hats and doing a fantastic job with that. So I'm grateful for what he's doing. I think we're making good progress, Anthony, and really our entire leadership team have been engaged. We've seen a number of good internal and external candidates. And we think that we are making very good progress. And if I had to guess this year or next, I think we will get to a conclusion this year.

Okay. And then maybe one last one. In your prepared comments, you were talking about the revenue synergies, $35 million. I want to make sure I was clear. Would that be fee income? Or would that be more product sets on the lending side for the IBERIA franchise?

It's a little bit of both, right? So we've got -- we've had some expansion of, I'll call it, credit to with using the larger balance sheet to kind of provide larger credit to some of our existing clients. Also our leasing products effectively show up as kind of loan balances as well. At the same time, right, we've been able to cross-sell some wealth, and we've captured some international fees as well as some debt capital market fees. So it's really a combination. If you ask me to kind of [weigh] it in my head, I'd tell you the predominance would show up as loan balances in that number that I gave.

It's pretty impressive to me, Brett, when I look at where the synergies are coming from, we've got something like $10 million to $15 million of the incremental synergy revenue is coming just from referrals between our equipment finance, equipment leasing business and the old First Horizon franchise and then referrals in the ABL business from the old IBERIABANK franchise. And those are opportunities that we wouldn't otherwise have gotten. We've got the other benefits of larger balance sheet. But just the product synergies, the mortgage product, I think, will be a huge one as we go forward. Private client wealth management is starting to build in a significant way. I'm very optimistic about our ability, and we talk a lot about the product set, but I think the bigger franchise and footprint that we can spread this combined product set around will drive, I think, a lot of revenue as we go forward.

The other thing I would add too is just there's a lot of excitement about our relationship managers at both legacy banks because of the expanded product set, being able to now offer, as an example, the equipment leasing equipment finance when we might have had to refer that outside the company. So there's a lot of excitement around that. And we are seeing pipeline growth as a result of that expanded offering from both companies coming together.

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

Thank you, Kate. Thank you all for joining us this morning. We appreciate your time and your interest. Please feel free to reach out to any of us if you have any further questions or need additional color or information. Thank you again, and I hope you have a great day and a great afternoon as well. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.