First Horizon's Q4: A Discipline-Focused Outperformance in a Challenging Macro

First Horizon's fourth quarter delivered a clear message: disciplined execution can outperform even when the broader market is uncertain. The bank posted adjusted EPS of $0.52, a 12.1% beat against estimates, and revenue of $888 million, which also topped expectations. The standout metric was the net interest margin, which hit 3.51% and beat forecasts by 11 basis points. This wasn't a product of aggressive loan pricing or a surge in volume, but a deliberate, cost-focused strategy.

The core driver was a significant 25 basis point sequential drop in the average rate paid on interest-bearing deposits, falling to 2.53%. This deposit discipline, combined with modest 2% loan growth, allowed the bank to expand its net interest margin. The result was a 7.3% year-on-year growth in net interest income to $676 million. In a quarter where many peers faced margin compression, First Horizon's focus on deposit costs provided a tangible edge.

This sets up the critical question for the coming year. Management has framed the thesis: outperformance was driven by this specific discipline. Yet, the elevated NIM is not expected to persist indefinitely. The real test is sustainability. The bank's leadership has now set a clear target, stating that a 15% return on tangible common equity (ROTCE) is the new sustainable minimum. The Q4 results, which delivered that exact ROTCE level, validate the current model. The challenge ahead is to maintain that profitability target as deposit costs stabilize and loan growth dynamics shift, proving that this quarter's success was more than a one-time beat.

Financial Impact and Capital Deployment

The quarter's results cemented a powerful profitability profile, but also highlighted emerging pressures. The bank achieved a 15% return on tangible common equity (ROTCE) for both the quarter and the full year, a level management has explicitly targeted as the new sustainable minimum. This was the direct outcome of its disciplined deposit strategy, which drove a 25 basis point sequential drop in the average rate paid on interest-bearing deposits to 2.53%. The resulting net interest margin expansion and solid loan growth fueled a 7.3% year-on-year growth in net interest income to $676 million, providing the core earnings engine.

Yet, the path to this ROTCE was not without cost. The bank's efficiency ratio, a key measure of operational effectiveness, missed estimates by 120 basis points, coming in at 61.3%. This widening gap is a direct result of elevated investment spending, with adjusted non-interest expense rising by $4 million sequentially. The increase was driven by a $12 million jump in personnel costs, largely for incentives, and a $16 million surge in outside services for technology and advertising projects. This spending is a bet on future growth, but it pressures near-term margins and raises questions about the sustainability of the high ROTCE if these costs do not translate into proportional revenue gains.

Credit quality also showed early strain. Net charge-offs rose by $4 million to $30 million, resulting in a net charge-off ratio of 19 basis points. While management described this as in line with expectations, it marks a clear uptick from prior periods and signals that economic headwinds are beginning to impact the loan book. The allowance for credit losses, at 1.31% of loans, remains healthy, but the rising charge-off trend is a red flag for future provisioning.

Capital deployment, however, remained aggressive. The bank returned just under $335 million in share repurchases during the quarter, part of a broader $1.2 billion share repurchase program with nearly $1 billion still authorized. This commitment to shareholder returns is a strong vote of confidence in the bank's capital strength, reflected in its 10.64% Common Equity Tier 1 (CET1) ratio. The bottom line is a bank delivering exceptional profitability through disciplined cost control, but investing heavily in its future while navigating nascent credit stress. The quality of earnings is high, but the widening efficiency gap and rising charge-offs are the early costs of that investment.

The Forward View: NIM Sustainability and Macro Headwinds

The central challenge for First Horizon in 2026 is clear: sustaining its 15% return on tangible common equity target through a period of likely margin compression and broader macroeconomic pressure. Management has already signaled the durability of its recent outperformance is limited, stating that the 3.512% net interest margin achieved in the fourth quarter is not expected to be sustained. This sets up a direct test of the bank's model, as the elevated margin was the product of a specific, sequential 25 basis point drop in the average rate paid on interest-bearing deposits to 2.53%. As deposit costs stabilize, the foundation for that margin expansion will erode.

This internal pressure is compounded by a tougher external environment. The broader banking sector faces headwinds in 2026 from lower interest rates and a slowing economy, which could simultaneously pressure net interest income and fee income diversification. The bank's limited commercial real estate exposure provides a relative defensive advantage, but it is not a shield against a general economic slowdown that would affect all loan categories and consumer spending. The early signs of credit strain are already visible, with net charge-offs increasing by $4 million to $30 million last quarter. If economic conditions worsen, this trend could accelerate, forcing higher provisions and further pressuring earnings.

The bottom line is that maintaining the 15% ROTCE target will require exceptional execution. The bank must now manage a dual challenge: navigating the expected compression of its core net interest margin while also containing the widening of its efficiency ratio, which already missed estimates by 120 basis points last quarter. Its aggressive capital deployment, including a $1.2 billion share repurchase program, assumes this profitability can be preserved. The bank's defensive CRE profile is a plus, but it does not insulate it from the macro forces that will test the sustainability of its high-margin earnings. The forward view hinges on whether disciplined cost control and loan pricing can offset the inevitable pressures from a softer rate environment and a slowing economy.

Catalysts, Risks, and What to Watch

The path to delivering on First Horizon's 15% ROTCE target and its aggressive shareholder returns hinges on three critical levers. The bank has shown it can engineer outperformance through disciplined deposit pricing, but sustaining that model requires monitoring the sequential trajectory of its net interest margin and the underlying deposit costs. Any acceleration in deposit repricing would directly threaten the profitability foundation. The bank's ability to maintain its 25 basis point sequential drop in the average rate paid on interest-bearing deposits to 2.53% is paramount. The CFO has flagged macro-level uncertainty, particularly around the Fed's balance sheet, as a key concern for deposit pricing, introducing a new source of volatility to this core cost driver.

Credit quality is the second major watchpoint. The bank's net charge-offs increased by $4 million to $30 million last quarter, a clear uptick that management described as in line with expectations. However, this sets the stage for a more challenging test. With management guiding the net charge-off ratio between 15 and 25 basis points in 2026, the current 19 basis points is near the midpoint. Investors must watch for any further deterioration, especially if economic conditions soften, as this would force higher provisions and pressure earnings. The bank's defensive commercial real estate profile provides a buffer, but it is not a complete shield against a broad economic slowdown.

Finally, the pace and scale of capital allocation will be a key signal of management's confidence. The bank executed just under $335 million of share repurchases in the quarter, part of a $1.2 billion share repurchase program with nearly $1 billion still authorized. This aggressive deployment assumes the capital adequacy and valuation thesis remains intact. The bottom line is that the bank's forward view is a balancing act. It must navigate the expected compression of its elevated net interest margin, contain the widening of its efficiency ratio, and manage rising credit costs-all while continuing to return capital to shareholders. The three levers of margin stability, credit health, and capital allocation will determine whether this disciplined model can deliver sustained outperformance.