Pinnacle Financial Partners Inc (PNFP) Q2 2017 Earnings Call Transcript

Transcript

Speaker 0

Good morning, everyone, and welcome to the Pinnacle Financial Partners Second Quarter twenty seventeen Earnings Conference Call. Hosting the call today from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer and Mr. Harold Carpenter, Chief Financial Officer. Please note Pinnacle's earnings release and this morning's presentation are available on the Investor Relations page of their website at www.pnfp.com.

Today's call is being recorded and will be available for replay on Pinnacle's website for the next ninety days. At this time, all participants have been placed in a listen only mode. The floor will be open to your questions following the presentation. Call. Before we begin, Pinnacle does not provide earnings guidance or forecasts.

During this presentation, we may make comments, which may constitute forward looking statements. All forward looking statements are subject to risks, uncertainties and other facts that may cause the actual results, performances or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward looking statements. Many of such factors are beyond Pinnacle Financial's ability to control or predict, and listeners are cautioned not to put undue reliance on such forward looking statements. A more detailed description of these and other risks is contained in Pinnacle Financial's most recent annual report on Form 10 ks. Pinnacle Financial disclaims any obligation to update or revise any forward looking statements contained in this presentation, whether as a result of new information, future events or otherwise.

In addition, these remarks may include certain non GAAP financial measures and are defined by the SEC Regulation G. A. Presentation of the most directly compared GAAP financial measures and a reconciliation of non GAAP measures are to be comparable GAAP measures and will be available on Pinnacle Financial's website at www.pnfp.com. With that, I'm now going to turn the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.

Speaker 1

Thank you, operator. Good morning. We appreciate you being on the call with us this morning. We always begin our quarterly earnings calls with this dashboard to allow you to quickly assess how we're performing on all the critical financial metrics. This particular slide is focused on the GAAP measures.

I expect most of you know, we closed our acquisition of BNC on June 16, less than five months from announcement. And so all the financials are impacted by that transaction and two weeks of post merger performance. So for the second quarter, we continue to grow the revenue and earnings capacity of the firm. We continue to grow the balance sheet at a very substantial pace, both organically and through M and A, which we believe predictive of future revenue and earnings growth. And it also shows that our asset quality is very strong.

As I say each quarter, at least for me, all the transition and merger integration going on in the company, the non GAAP measures actually provide greater insight into the core run rates on these important metrics. So we'll move on to those. Looking at the non GAAP measures, since the arrows are all nicely sloped in the right direction, I won't walk through each metric. I'll just highlight two that will get a little more discussion as Harold reviews the quarter in greater detail in just a few minutes. So let's look first at the ROTCE on the first row and the reductions there over the last two quarters.

As you'll recall in conjunction with the BNC acquisition and to support the future growth needs of the firm, we issued 3,200,000.0 shares on January 2737, totaling $192,000,000 in net proceeds. So we had a partial quarter impact of those additional shares in Q1 and a full quarter impact in Q2. Nevertheless, we're thrilled to have growth prospects that warrant additional capital. And I promise you this, we'll be diligent in both protecting it and in leveraging it through growth to optimize the returns. Secondly, just below the ROTCE chart is the tangible book value chart.

I've commented any number of times on these earnings calls regarding the correlation between growing tangible book value and growing the share price. We take it seriously. In fact, we've been dogging about it. And as you can see in conjunction with our acquisition, we protected it and in fact grew it over the last two quarters. As I mentioned, Harold will review that in greater detail shortly.

Those of you that followed our firm for any length of time know that coming out of the recession back in 2011, we published our profit model and associated performance targets after having achieved the originally targeted levels. We've actually increased the return on average asset target range twice now to its current level of 1.3% to 1.5%. In conjunction with that return on average asset target, we continue to publish targets for the key performance measures that lead to that overall level of profitability, specifically the margin, the fees to assets, the expenses to assets and net charge offs. As you can see on this slide reflecting the GAAP measurements, second quarter twenty seventeen was another good quarter with a return on average assets of 1.3% just inside the new target. And in general, the component measures are all performing pretty well against their targets.

As I've already said, due to the meaningful impact of merger related charges, I personally tend to focus more on the profitability metrics adjusted for those merger related charges. On that basis, you can really get a picture of our operating momentum here. The second quarter return on average assets is well within our new target range at 1.35%. Net interest margin was 3.68% and net charge offs were just 17 basis points, both better than the top end of the range. Expenses compared to assets are very low in the target range even with very little in the way of our B and C cost savings.

And fees to assets is actually slipped below the target range in the second quarter primarily as a result of the B and C acquisition. But I promise you, we view that as upside in the revenue synergies we intend to produce there, which I'll talk in greater detail about later in the call. One of the things that I think distinguishes Pinnacle from many is our continuous focus on building additional infrastructure in the current period in order to continue propelling the firm forward in terms of revenue and earnings growth in the future periods. This slide is intended to give you a snapshot of how that went during the second quarter. Of course, this quarter, the BNC acquisition is the most significant investment.

We continue to march down through our implementation timeline. Since I've been over this on previous calls, I won't review it in detail. I'll just highlight the next to last bullet point. We now intend to merge Pinnacle's Jack Henry files with BNC's Jack Henry files at year end, which is a two month acceleration in the timetable and therefore two month acceleration in the completing of the cost takeout. And so in short, we still expect to realize our original target of $40,000,000 in cost saves in 2018.

The second largest investment in future growth is the hiring of additional revenue producers. As you can see year to date, we've added 33 in total, 14 of which were added by Rick Gallicutt and his team. We've been asked a number of times if the M and A activity in North Carolina would afford us additional opportunities. And I think the answer to that is yes. And then finally, our organic loan growth during 2Q was extremely strong, both in the legacy Pinnacle footprint and the legacy footprint, which is really incredible during this period of merger integration.

So now with that overview, I'm going to turn it over to Harold for a more detailed review of the quarter.

Speaker 2

Thanks, Terry. Revenues for the quarter increased from $119,000,000 in the first quarter to $142,000,000 in the second quarter or about $23,000,000 quarter over quarter. Revenues from BNC contributed $14,100,000 to the quarter for the half months of its operations post merger. As a result, we believe the legacy Pinnacle franchise experienced 29% annualized linked quarter growth in revenues between the second quarter and the first quarter due to increased yields on earning assets as well as strong fee growth in a number of areas. More on that in a moment.

Total spread increased total spread income increased $18,000,000 between second and first quarter as shown on the blue bars on the chart. Discount accretion represented $1,400,000 of the increase, so less than 10%. The dark green line on the chart denotes revenue per share, impacting our revenue per share in the first quarter was the capital raise, which we believe diluted our first quarter revenue per share by $0.12 which is the reason for the decrease in the chart in the first quarter. We reported $2.46 revenue per share in Q1 with the capital raise and reporting revenue per share at $2.64 this quarter. We believe revenue per share will increase in the third quarter as the capital raise in the early part of the year has already been fully absorbed in our second quarter run rates, while the BNC revenue impact and the corresponding share issuance were included in our results for only two weeks.

Thus BNC will have a larger impact in the coming quarters. We believe the BNC revenue per share in the last two weeks would have calc out at slightly more than $3 per weighted average share post merger. As we look forward to the third quarter purchase accounting related to our mergers with Avenue, Capital Market and Magna should continue to decrease. However, with the BNC acquisition, we should experience a significant increase in discount accretion in the third quarter. In aggregate, we have around $196,000,000 in loan discount accretion of which a significant amount is expected to amortize into income over the next few years.

Now a little more on loans and deposits. Concerning loans, as the chart indicates, average loans for the second quarter of $9,820,000,000 compared to 8,560,000,000.00 or an increase of $1,260,000,000 in average loan balances of which the BNC footprint contributed $923,000,000 We believe it was a strong second quarter for us concerning loan growth, which in Tennessee was up $478,000,000 compared to $192,000,000 in the first quarter. BNC's organic loan growth increased to $190,000,000 in the second quarter compared to $165,000,000 in the first quarter, Obviously, $668,000,000 in second quarter organic loan growth has us all pretty excited. As the chart indicates, our loan yields increased to 4.66% this quarter compared to 4.6% last quarter. Impacting our loan yields this quarter was purchase accounting accretion, which positively impacted yields by 26 basis points compared to 23 basis points in the prior quarter.

Excluding the impact of purchase accounting, core loan yields have increased from 4.23% in the 2016 to 4.26% in the 2017 and up 14 basis points to 4.4% in the second quarter of twenty seventeen. As to deposits, again, here in the second quarter, were able to grow our funding base, while deposit costs increased from 25 basis points to 32 basis points. We continue to anticipate increases in deposit rates as rate hikes continue, but we don't expect anything dramatic in the short term. Average deposit balances were up $1,300,000,000 of which BNC contributed $1,000,000,000 to that amount. We preliminarily assigned a core deposit intangible of $48,000,000 to the BNC core deposits of which $3.16 was amortized in the last two weeks of the quarter.

Switching now to non interest income, we're reporting $35,100,000 in fees, up more than 60% linked quarter annualized. We also had a record fee quarter this quarter for the Tennessee footprint. Fees for the Tennessee footprint amounted to $33,400,000 compared to $30,100,000 in the first quarter. Our residential mortgage group had another outstanding quarter in terms of production with approximately $262,000,000 in loan sales this quarter at a yield spread of 2.81%. We feel very positive regarding our mortgage pipeline as we head into the third quarter.

Income related to insurance commissions decreased quarter over quarter due to the annual incentive payment we received in the first quarter from carriers for positive claims experience. We're reporting BHG revenues of $8,750,000 this quarter, up $932,000 from the first quarter. We expected a meaningful uptick in BHG revenues in the second quarter compared to the first quarter and we continue to anticipate that net growth for BHG revenues will be up approximately 20% for Pinnacle in 2017. We also believe their third and fourth quarters will see strong growth. Interchange revenues continue to show positive traction as we approach the impact to us from the Durbin Amendment on July 1.

Had the Durbin Amendment been in effect in the second quarter, our interchange revenues would have been approximately $1,800,000 less. We believe the Durbin amendment will impact third quarter fees by approximately $2,500,000 with a full quarter of BNC interchange revenues in our operations. We experienced a meaningful uptick in other non interest income in the second quarter. SBA loan sales were up $333,000 this quarter over last quarter with BNC contributing $170,000 to that amount. Gain on the sales of both commercial and residential loans were $854,000 in the second quarter compared to $217,000 in the first quarter.

Now to operating leverage, our efficiency ratio on a GAAP basis was 50.7%, while our core efficiency ratio excluding merger related charges was 48.4%. First concerning personnel costs, we've got 2,200 FTEs at June, of which almost 1,000 were from the Bank of North Carolina. Salary costs were up $6,000,000 which was attributable to the BNC footprint, increased headcount and increased incentive expenses. We project our annual incentive costs for the full year and then begin accruing to that amount proportionally each quarter. Those of you that have followed our story for many years know our one incentive plan system works and that is based on corporate results and not based on the individual sales goals.

We're still accruing at less than target award for 2017. You also know we set big targets around here, so we'll be working hard to get back these reduced incentives, but we only get it back if we hit our numbers. Just to emphasize the point, incentive expense and earnings are not indirectly linked, but directly linked. If we hit our revenues and earnings target, our incentive costs will obviously increase. If we don't, our incentive accruals will get reduced.

This is a new slide and probably the last time we'll show it, but we wanted to get on the table our position that when we announced the BNC merger, we felt our tangible book value would not be diluted inclusive of our capital raise. Now there are blue million things that go on to get from then to now, but all things considered, we're confident then as well as now. The two charts on the top are the charts from a previous slide that Terry went over discussing our accretion of tangible book value over the last few years. The table at the bottom rolls forward our equity accounts in a summary fashion so that we can detail a quick calculation of our tangible book value. Appreciate that we're reporting $1.6 plus ish in GAAP earnings for the first six months of 2017, less about $0.28 per share in dividends to shareholders.

So rough numbers, you'd expect tangible book value accretion for those two components to accrete capital by call it $1.3 Our tangible book value is up $2.5 plus, so an incremental $1.2 is due to many factors, but mostly due to the impact of our January equity raise and the BNC transaction. This is a slide we showed on the merger call back in 2017. We anticipated tangible book value accretion of approximately 5% now and feel like we are all over that number. We anticipated tangible book value accretion of approximately 5% then and feel like we're all over that number now. Looking at the capital ratios, we are also pleased that we're within what we believe are acceptable tolerances for sure.

We are higher on the 100 to 300,000 due to more loan growth in both footprints that we anticipated, but we have ample room to fund CRE lending going forward based on current pipelines. So what's left for us to accomplish with respect to what we told you all in January is obviously the accretion target of approximately 10% in 2018. We feel really good about our synergy case. We feel really good about our earning momentum in our new markets in the Carolinas and Virginia. We're also working a long list of potential revenue synergies, which were not contemplated in the merger model in January and are optimistic about those particularly around C and I and wealth management.

With that, I'll turn it over to Terry to wrap up.

Speaker 1

Thanks, Harold. Okay. After a pretty thorough review of where we've been and where we are, I want us to focus now on the growth potential that we see going forward. And so to get behind the growth potential that we have going forward, I think it's really critical to get behind and understand the growth model that we've successfully deployed over the last seventeen years. In my opinion, Shakespeare got it right, was passed as prologue.

Many of you remember in the years immediately following the recession, frankly at a time when we felt our share valuation didn't really reflect the balance sheet and earnings growth we intended to produce, we published the three year organic loan growth targets and the ROA target to make it more clear to investors as to our expectations for earnings growth. And so in that period from 2012 to 2014, we consistently produced double digit loan growth and exceeded our published target, while at the same time muscle building the ROA to its target at a time when not many banks were able to do either. What you're looking at here is Greenwich Associates Research as it pertains to businesses with annual revenues from $1,000,000 to $500,000,000 which is effectively the entire business market in Nashville, Knoxville, Memphis and Chattanooga. For each market, banks are plotted left to right based on the percentage of their clients who rate their satisfaction as excellent. As you can see by the fact that Pinnacle for the most part is the rightmost plot point on each chart, we have truly built a distinctive client experience when compared to the large regional and national franchises with whom we compete.

Banks are plotted north and south based on their market penetration of businesses with sales between $1,000,000 and $500,000,000 And so the conclusion for me is that we have been able to build a client experience that's so distinctive versus these larger regional and national franchises that we've successfully taken their clients away at a very rapid pace. In Nashville, an example, we've gone from 0% to approximately 26% share and opened up a pretty large lead over all the three banks who previously dominated the national marketplace and who continue to show great vulnerability. In Knoxville, we started on a de novo basis there seven years later, but you can see fundamentally the same story. In just ten years now, we've already built a $1,400,000,000 bank, if you will, and unseated one of the three previous market leaders and are on the dance floor with the other two. In Chattanooga, we entered by way of acquisition.

Capital Mark Bank and Trust was a 2007 de novo that we acquired in 2015. It's virtually an identical story to Knoxville. And in Memphis, Magna Bank, the bank we also acquired in 2015, would not have even appeared on the chart. And now you can see that we're taking share based on a distinctive client experience with tons of upside versus highly vulnerable competition. Here's a chart intended to move beyond the competitive vulnerabilities and the client experience in order to help you get a grip on the actual growth we've been able to create with the market extending acquisitions we've done, specifically in Memphis and Chattanooga, both of which were done in 2015.

Starting at the bottom of that slide, you see in addition to creating a great client experience, we overlay our hiring philosophy and methodologies, which have generally been very successful against those larger national and regional competitors. Again, having entered both markets in 2015, look at the growth in revenue producers in 2016 and year to date in 2017, you can see that the hiring momentum has been strong and frankly that it continues to be strong. As you move up the slide, look at the core deposit growth and the loan growth, you can see that this combination of a distinctive client experience and the ability to attract so many of the best bankers and brokers and mortgage originators in the market is having the desired results. Our growth trajectory in these relatively newly acquired markets is extremely strong. So with that as a foundation, I want to show you why we believe the Carolinas and Virginia and most particularly North Carolina, why they're so attractive to us and why BNCN is the perfect platform from which to launch.

Identical to the other charts we've been looking at, this is Greenwich Research on businesses with annual sales from $1,000,000 to $500,000,000 in the state of North Carolina. In my opinion, the same two broad observations apply here as to the Tennessee markets we just looked at. Number one, the large regional national players in North Carolina appear extremely vulnerable based on their lower levels of client satisfaction. And number two, BNC and indeed already possesses a distinctive client experience versus these large regional national banks. So like in Tennessee, when you overlay Pinnacle's larger lending limits and advantaged treasury management platform and our hiring philosophy and methodologies, which Rick Callicutt and his team are already successfully deploying, we'd expect to see similar balance sheet and fee growth in North Carolina to that that we've seen in our recent acquisitions in Chattanooga and Memphis, which as you saw has been extraordinary.

One last observation on this chart. In addition to the larger regional national franchises in North Carolina that we typically target, I've also left two of the smaller more recently acquired franchises in North Carolina because I currently believe that they will represent great opportunities for us in addition to those banks we typically target. This slide is similar to the previous slide, but I included it to help you peel the onion back on the vulnerability that we intend to attack. Again, is Greenwich Research on businesses in the state of North Carolina with sales from $1,000,000 to 500,000,000 comparing BNCN's current reputation to the two large national franchises and the two large regional franchises that are headquartered in North Carolina. You see each bank's rank on overall satisfaction.

Each bank's rank on each of the key drivers of overall satisfaction and each bank's rank on the willingness of their clients to recommend them. And so when you look at those key drivers of client satisfaction like being trustworthy, being easy to do business with and value and long term relationships, it doesn't seem to me that these are gaps that our competitors can close quickly. So now with all that data, I hope you begin to see why we're so excited about the incredible organic growth opportunity that the BNC and acquisition affords us. So now with the strategic opportunity established, the primary question remains, can we execute? To that end, I want to spend just a minute on the cultural integration.

My guess is some won't care and many will wonder what this has to do with anything. But frankly, agree with Peter Drucker when he said culture eats strategy for lunch. We've got a good strategy, but we've got a great culture. And honestly, nothing could be more important in terms of both our short term and our long term success. So those of you know our company well know the thoughtfulness and intentionality with which we built the culture of this firm.

And the primary foundational method for inculcating that culture with new associates is a three day orientation. It's largely conducted by me and the other key leaders of our firm. Among other things, these sessions are intended to build buy in to our mission, to our vision, to our values. Every associate in our firm has been through it. We have already conducted four of these three day sessions and have taken about two thirty four BNC and associates through the process.

We'll do seven more of these before year end. In fact, Harold and I are in North Carolina this morning, taking time out from one of those sessions to conduct this call. We'll get roughly 80% of our new BNC and associates through this exercise by year end and then finish up in the first quarter of twenty eighteen. The third day of orientation is primarily team building exercises, which are intended to demonstrate important Pinnacle values. The day culminates with everyone going over a 12 foot wall, which is intended to paint the picture that what we do at Pinnacle is accomplish the seemingly impossible by all working together.

In this picture, about halfway up the wall, can see Rick Callicut, BNCN's CEO, leaning over the wall, cheering his teammates on as one by one each associate makes it over. In terms of how well the orientation is being received at BNCN, we're getting 85% top box ratings on their evaluations, which is extraordinarily high and comparable to what we get among our new recruits in the legacy Pinnacle footprint, which to me is perhaps one of the best indicators of both buy in and cultural compatibility. These are verbatim comments from a number of those evaluations that have been completed by associates after having gone through the orientation. As you can see, the comments illustrate the level of excitement and associate engagement we're achieving. I might just point to that last comment exactly what I needed to understand exactly where we want to go and how we'll get there.

When associates already know where we're going and how we're going to get there and excited to do it, we're more than halfway home. So as we've just discussed, important cultural integration is well underway. I indicated earlier, we currently contemplate merging the BNCN and PNFP Jack Henry files together at year end versus February 2018, which we've previously published, which should put us in a position to get roughly $40,000,000 in cost take outs in 2018 despite the fact that we won't harvest 100% of the cost take out until mid first quarter twenty eighteen. Guys, as you think about earnings growth, it's pretty easy to calculate the earnings associated with $40,000,000 in cost savings. And while we don't need any revenue synergies to hit the earnings accretion that we projected, we believe there should be substantial revenue synergies.

Perhaps the most obvious is associated with incremental loan volumes. Our original case contemplated $500,000,000 in net new loans from BNC during 2017. Through June 3037, they're up roughly $300,000,000 which on a straight line should translate to $600,000,000 for the year, dollars 100,000,000 ahead of target, which at even a 2% spreads, dollars 2,000,000 in spread income. And then on the fee side, we currently expect to realize meaningful synergies with our treasury management platform, which is more robust, including things like business credit cards and purchasing cards that BNCN has not offered in the past, swaps, client swaps, back to back client swaps, a product BNCN has heretofore not been able to sell to help clients convert fixed to floating or floating to fixed. Permanent commercial mortgage brokerage, a capability BNCN has not had heretofore despite the concentration of commercial real estate loans.

The residential mortgage origination process converting BNC in from a best efforts basis to a mandatory delivery basis, which should widen the yield spread premium by roughly 40 basis points on all their residential mortgage production, which is forecast to be approximately $450,000,000 in 2017, just to name a few. All right, guys, if we're successful, just moving back to the low end of our previous fees to asset target, that's a pickup of five basis points or roughly $10,000,000 in incremental fees. My guess right now is it may take up to two years to build all the way back to that level, but we'll pick up meaningfully in 2018. And then of course, we've already discussed that we contemplate building out a meaningful C and I business. The hiring momentum has already been established.

When you layer that on to the $40,000,000 in cost takeouts, the above planned loan growth year to date, perhaps as much as $10,000,000 in fee synergies, which weren't contemplated in the original business case, the balance sheet and EPS growth trajectory is truly exciting. Now in an effort to translate all of that into financials, much like in 2011 when we felt the market didn't really understand the earnings potential of our firm, we've already given you the ROA target of 1.3% to 1.5%. And so here's the organic asset growth we intend to produce through 2020 in the new combined existing footprint. Let me just say right now, it won't grow on a straight line. First quarter growth will almost always be less than second and third quarter.

The ROA won't be exactly on the midpoint of the range every quarter. My guess is some quarters it will be higher and some it will be lower. But with the ROA target and with the asset target, which is relying on no additional M and A, you begin to get some sense of our current expectation for future earnings growth. Now, all we've talked about thus far is organic growth in our existing footprint. But as you know, we've highlighted other high growth markets in the Southeast that we've targeted.

Obviously, we don't have to do anything. As you just saw, our growth trajectory is fabulous if we don't do another thing. But my guess is we'll be afforded additional opportunities to layer on more growth. I don't intend to rehash this slide today since I've discussed it pretty fully on previous earnings calls. But I will point out one change as it relates to M and A opportunities.

When we were a smaller company, we targeted something greater than 5% earnings accretion. Given our larger size and share count, we modified that target to 3% to 5% earnings accretion. But we have no interest in doing deals that provide de minimis or no earnings accretion. And we've never done deals that meaningfully diluted our tangible book value. So let me say this as we wrap it up, much of what I've talked about in the latter half of this call has been focused on crystallizing the earnings growth potential as we move forward.

But I want to conclude with this idea. What we're really focused on is long term shareholder value. To that end, we'll continue to focus on taking advantage of both large high growth markets and the meaningful vulnerabilities in those large and regional national franchises that dominate those markets. And we'll do that in order to produce outsized organic growth in our existing footprint. As I just mentioned, that's an extraordinary opportunity.

Frankly, it's enough. But my guess is we'll have other high value opportunities to do accretive market extensions or fill in M and A in our existing footprint. And so we're in the luxurious position, having a lot of incremental opportunities, but not be impressed in any way to do anything other than what's in the long term best interest of the shareholders. So operator, I'll stop there and we'll open it up for questions.

Speaker 0

Thank you, Mr. Turner. The floor is now open for your questions following the presentation. Our first question will come from the line of Stephen Scouten with Sandler O'Neill. Please proceed.

Speaker 3

Hey guys, good morning. Congrats on a great quarter here. You, A question for you. The loan growth, especially within the Tennessee legacy footprint was extremely strong. Can you give any additional color there on kind of segments of that growth, where it came from either geographically or type of loan?

And if you think we should be thinking about a faster rate of growth than maybe the legacy 10% to 12%, 13% that you guys have traditionally put up?

Speaker 1

Steve, that's a great question. I think in terms of the growth during the second quarter, I guess, give you a little color commentary, I would say in terms of industry segments, it's pretty broad in its distribution. So it's not like you're doing it all in healthcare or name another sector there. It's broad and diversified in the growth. I think the thing I would comment is and this is just a back of the envelope estimate, but it looked like to me about 40% of that growth came from market share takeaway, which seems important to me.

Again, I think there's been a lot of talk about limited C and I loan demand and those kinds of things. We are getting some growth from our existing client set and I'm sure some of that has to do with this idea of hiring folks and they're consolidating books of business. And so even among existing clients, loans continue to fund and move and those kinds of things. But to have 40% coming through market share movement is a big, I guess, boon to the growth rate. Stephen, I think over the long term, I mean, we'll have quarters.

I mean, my guess is that the third quarter is likely to resemble the second quarter in terms of growth. But I think just over an extended period of time, I sort of like a low to mid double digit growth rate for the loan category. So I don't know if that's helpful to you, but that's how I see it.

Speaker 3

Yes. No, that's very helpful. And then maybe on the NIM, nice move there, especially on the core NIM. Harold, can you give any color into what drove that? I mean, is that predominantly from the March hike and the effect there?

Or is that new loan yields coming on a bit higher? What's the I guess kind of puts and takes between those two dynamics within that core NIM?

Speaker 2

Yes, Steve. What we've kind of come down on or what we concluded is that of the 14 basis point increase in the core, probably about eight basis points was attributable to the March rate hike. So yes, probably about half of it.

Speaker 3

Okay, great. That's really helpful. And then maybe one last kind of more high level question is, I mean, obviously things look like they're going great. I think there's a ton of potential in the North Carolina, Virginia markets from BNCN. I think that's pretty clear.

What do you feel like could trip you guys up? What do you worry about a little bit? I mean, last quarter we were talking more about health care loans and exposure there and some people are focused on retail now and credit for a bank obviously can always be the easiest way to strip up. But what is it that you guys are really focused on as you think about what could derail the kind of trajectory you have today?

Speaker 1

Yes. I think I'll just give you some random thoughts, Steve. I think for me, I'm always interested in containing CRE exposure. Many folks will remember we took meaningful losses going through the last recession. One of the things we committed to was concentration limits.

And we've got a number of sub limits, but just from 30,000 feet, the two most familiar limits are the 100% construction, 300% total CRE exposure. And we intend to stay inside of that. I do I think in terms of our guidance to lenders, we put a caution flag out and really told particularly the commercial real estate lenders that if you're doing many firms or loans with either actual maturities in the three to five or seven year timeframe or rate maturities at ten years, you're almost certainly going to intersect with the cycle here on commercial real estate. And so our guidance has really been and they're not red flags, but what we've said is, hey, if we're going to do deals, it needs to be on our terms and our price or and we're in a position to miss deals. Again, I don't want you to interpret that, that we're on the panic button.

I'm not on the panic button. I just think we're later in the cycle than we once were. And so now is the time for a little more caution there. I think that's probably the biggest area, I guess, if you're trying to highlight things like credit that would stump us.

Speaker 3

Okay, Great guys. Well, congrats again on a fantastic quarter. Appreciate the time.

Speaker 1

All right. Thanks, Stephen.

Speaker 0

Thank you. Our next question will come from the line of Kathryn Miller with KBW. Please proceed.

Speaker 4

Hey, thanks. Good morning, guys.

Speaker 5

Hi, Kathryn.

Speaker 4

One follow-up on the margin. Can you talk about your outlook for the margin when we layer in a full quarter of BNCN both with and without the accretion? And then kind of a follow-up to that is, as we think about BNCN, they're naturally not as asset sensitive as you are. And could argue probably have more risk to the flatter end of the curve. So can you talk about how you think about that incremental margin in a higher but flatter yield curve at BNCN?

Thanks.

Speaker 2

Speaker 6

Good morning. Back to your loan growth in the quarter. Terry, do you have a guesstimate of how much of that came from new hires that were made this year? And can you give us any detail on those hires? Where they came from?

Or what types of banks they came from if you don't want to give specifics?

Speaker 2

Yes.

Speaker 1

Well, let me say, I don't know the number, but I have a perception about it and I'll be glad to share that. There's no doubt that the growth is concentrated in recent hires. And so I guess, Jennifer, your question had to do with hires this year. I'd probably rather expand that to hires over the last twelve to eighteen months might be a better way to think about where the growth comes from. But if you're growing at a double digit pace, say you're growing at 12% to 14% on a normalized basis, the way that typically breaks down is among your legacy guys who are running $200,000,000 loan books, you're growing at 4% to 6%.

Among your new guys, you're growing at 4045% and so forth. So the growth dramatically comes from the new hires.

Speaker 6

Okay. And any color on where these hires have come from, particularly in the BNC and footprint?

Speaker 1

I would say that in the Tennessee footprint, it's the same large region from whom we've been taking people. And I would think that over the last twelve to eighteen months, SunTrust might be the largest contributor there. And then in the BNC and footprint, it's scattered out a little bit among large regional banks. I probably would rather see that thing mature a little bit more. We've got a big pipeline of people that we're recruiting and I'd probably rather see a little bit more before I start talking about, hey, here's where the big contributors are going to be.

But it is primarily from the larger regional banks.

Speaker 6

Okay. And if I could ask one follow-up question. Your Bankers Healthcare Group fees were down year up obviously sequentially, but down year over year. Can you just talk about that the color behind that?

Speaker 2

Yes, Jennifer. They had a big quarter in the second quarter of last year, the largest quarter they've ever had. We've that was primarily they had a lot their business flows were significant last, call it, first half of last year. They've been working it back over the last, say, four quarters. They changed some of their disciplines within some of their internal areas.

And I think the way it's shaping up for the rest of the year, we're really excited about what's going to happen in the third and fourth quarters of this year. So we're still thinking that we'll experience close to a 20% growth in that line item in our P and L once all is said and done for 2017.

Speaker 0

Thank you. Thank you. Our next question will come from the line of Tyler Stafford with Stephens. Please go ahead.

Speaker 7

Hey, good morning guys. Hey Tyler. Congratulations on a nice quarter. Harold, maybe just to start, would there be any major balance sheet repositioning from BNC that we should expect to see or potentially could see in the third quarter?

Speaker 2

I hope that's helpful.

Speaker 8

Yes, it is. Thank you. And secondly, when I talk to people about the B and C deal, one of the comments that comes up consistently is what about the rural markets? Because they did have more in rural markets than you have. Your strategy has been an urban strategy.

I guess the question is sort of what do you do with the rural markets? What is the strategy?

Speaker 1

Well, I'll just say this. I think to be clear, Nancy, as you highlight, we focus on urban areas. That's really where we try to grow. But as we've done acquisitions over the years, even in Tennessee, we have some markets that might be described as rural market. Just as an example, shovelable in Bedford County.

That's a handsome office there that throws off handsome cash flow. And so we got no desire to eliminate that market. We did well in that market, they're just fine. But in terms of receiving incremental investment, we channel all the incremental investment into the large urban markets. And so I think that really will extend into the BNC footprint.

I mean, we have markets that again, some people might describe as more rural that do well for us and provide great funding. We'll continue to operate those offices to the extent they meet our performance standards. But we'll channel all the incremental investment. I think you ought to expect the incremental investment for us to be in key markets, specifically Raleigh and Charlotte and also in Greenville, South Carolina and probably in Charleston.

Speaker 8

In doing one of these deals, Terry, do you get the flex the regulatory flexibility to exit markets or to sell places that don't make sense for you? Is that something that you would think about?

Speaker 1

So we still believe we're asset sensitive on the short end of the curve, but it won't be nearly that large.

Speaker 9

Okay. And then do you happen to have a breakout of merger related expenses by each line item that we could have?

Speaker 1

No, I don't have that with

Speaker 2

me. It would be largely compensation related here in the second quarter and probably more than half of it is. But we will talk about that more as we go through the next couple of quarters.

Speaker 9

Okay. And then lastly, do you have a good run rate for the effective tax rate for the rest of the year?

Speaker 2

Yeah. The tax rate this year this quarter was impacted by the change in the accounting rules for equity comp. That was about a call it $780,000 adjustment. It won't be nearly as large in the third or fourth quarter. And then we should have a fairly meaningful credit in the first quarter of next year.

So the first quarter will have the largest will be the largest beneficiary of the change in the accounting rules. Second quarter will be second and then the third and fourth will be much less.

Speaker 9

Okay. All right. That's all I had.

Speaker 0

Thank you. Our next question will come from the line of Brock Vandervliet with UBS. Please proceed.

Speaker 5

Thanks for taking my question. Just a little bit of a different take on the prior one regarding your asset sensitivity. Mean clearly that's been the right approach in the most recent quarters. It sounds like that's getting less as a result of the merger integration now. But what's your view on rates in general?

And may you rack in that sensitivity here in the next coming quarters?

Speaker 2

Yes, Brock. I guess if the question is what are we modeling currently, then I'd tell you that we're modeling a 25 basis point increase in December and then two or three next year, both around the first quarter and midyear or first quarter midyear and then one towards the end of next year. So that's what we're putting in our modeling currently.

Speaker 5

Got it. Okay. Separately on mortgage banking, the purchase component of that alone was up very materially. Was that simply the impact of plugging in the BNC portion into the pipe or something more at play there?

Speaker 1

Yes. I think I would probably characterize it as principally seasonality. You're in the high selling season, generally second, third quarters where you pick the volumes. And so I would say that was a principal contributor. Although we did have two weeks worth of production from BNC that would have been included in the hedge and sold on a mandatory basis.

So there is a little bit of pickup from that, but it would just primarily be the seasonal growth volumes.

Speaker 5

Got it. Okay. Thank you.

Speaker 1

All right. Thanks, Brock.

Speaker 0

Thank you. Our next question will come from the line of Brian Martin with FIG Partners. Please proceed.

Speaker 10

Hey, guys. Nice quarter. Say maybe Hi, just one question, Harold, back to the margin. We kind of about maybe the core margin being kind of flattish going forward. I mean, this quarter was up, whatever, maybe five basis points or so with the yield benefit, I guess, your expectations on rates still going higher, at least kind of as you guys are thinking about them and not much change in the funding costs.

I mean, that core margin, guess, you're taking it being flat versus up is, am I I guess, not understanding what you're saying here? I guess, kind of what's the outlook on that core margin, as you look forward, is it kind of flattish at the current level? Is that what you're suggesting?

Speaker 2

Yes. I think it'll be flattish. We'll probably pick up a little a few basis points based on the rate based on the increase in rates. But BNC's core margin was a little less than ours. So we'll have that fully weighted in, in the third quarter.

So our estimates are that the core will likely be right around where it is. It might be a few ticks up. I think where you'll see the biggest increase though is in the GAAP margin.

Speaker 10

Okay. Yes. And just in your comments, Harold, in the past and the deals you guys have done kind of talking about that accretion income, mean, I is it what's kind of been in like when you look in the year one period, how much of that accretion is kind of typically come in? Is it kind of in that 30% to 40% type of range? Is it or is that kind of out of the ballpark?

Speaker 2

Yes. We're not planning that kind of number in the first four quarters. It's pretty meaningfully less than that. So that's

Speaker 10

Okay. What we're Yes. All right. And then just from a going back to Terry's comment about M and A, I guess, given kind of you've as you kind of work through getting the BNC and kind of integration and all that done kind of being the near term priority, but still looking at the opportunities that are out there, Terry, I guess, is there any indication time wise? I mean, once you look at opportunities today, I guess, how quickly could you or would you be willing to step into another transaction potentially, another opportunity if it came up?

I guess, are you ready currently? Or would it be a little bit?

Speaker 1

Yes, I think I guess I might go at it this way. Your question is what would you do and that's not necessarily the same as what could you My sense is on the what could you do, I don't think I would make a large acquisition right this minute. I probably want to finish the system integration, do those kinds of things. I've generally tried to indicate that things go as we intend for them to go and so forth. Early next year, you'd probably be in a position where you could consider taking on other meaningful M and A.

But we I get most questions about M and A and I believe there's some of those opportunities. But I also believe there might be some de novo opportunity in there as well. And at least for me, that's a significantly different integration challenge and honestly not much different than the volume of hiring we would normally do on a quarterly basis. So if you say, well, would you do a de novo now? I probably would if I had the right opportunity, had the right group of people and so forth, that'd be something I'd be willing to do.

Again, I don't want you to walk away and say, hey, he's getting ready to do a de novo start here. I'm not telling you that. I'm just sort of trying to answer your question, what would you do? I'd be willing to do de novo start. I probably wouldn't be willing to do a really large acquisition, need a little more time for that.

But again, I do hope that the message comes through that the we this is a luxurious position to be in where we're going to throw up really outsized earnings growth for a period of time. It feels to me and without taking on these other projects. And so that's kind of my outlook is, hey, if it fits and it's good for long term shareholder value, it'd be something we do. But we're not compelled to every now and somebody will say, what's your timeline to get to Atlanta, something like that. So there's no timeline.

I don't care if I ever get there. I bet we do, but I don't care if we get there or not. We've got a great hand to play just like it is.

Speaker 10

Okay, that's helpful. And then maybe just one more for Harold. Just on the you talked about some of the items on the fee side as you kind of look forward. Guess, was there anything that's unusual Harold or not sustainable from the current level maybe kind of in those other areas that as you look forward or is there I know you highlighted a couple of things in that other line item, but anything that's really not sustainable going forward?

Speaker 2

Yes, Brian, I don't think there's anything in there that we classify as an outlier. All the gains that we had on those loans were from businesses that we are currently involved in and we've devoted resources to. So there's not like a one off deal in any of that.

Speaker 10

Okay. All right. Got it. Thanks guys.

Speaker 1

Thank you, Brian.

Speaker 0

Thank you. Ladies and gentlemen, this concludes our question and answer session today. We'd like to thank you for your participation on today's conference. And this does conclude the program. You may all disconnect.

Everybody have a wonderful day.

Pinnacle Financial Partners - Earnings Call - Q2 2017

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