Pinnacle Financial Partners Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 19, 2023

There are 11 speakers on the call.

Operator

Morning, everyone, and welcome to the Pinnacle Financial Partners Second Quarter 2023 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.

Operator

Today's call is being recorded and will be available for replay on Pinnacle's website for the next 90 days. At this time, all participants have been placed on a listen only mode. The floor will be open for your questions following the presentation. All forward looking statements are subject to risks, uncertainties and other facts that may cause the actual results performed 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.

Operator

A more detailed description of these and other risks is contained in Pinnacle Financial's annual report on Form 10 ks for the year ended December 31, 2022, and its subsequently filed quarterly reports. 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 For measures as defined by SEC Regulation GA presentation, a presentation of the most directly Comparable GAAP financial measures and a reconciliation of non GAAP measures at the comparable non GAAP measures will be available on Pinnacle Financial's website at www.pnfp.com. With that, I am now going to turn the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.

Speaker 1

Thank you, Paul. Those of you that have followed us for a while, no one expect I'm going to begin every quarterly earnings call with This dashboard of what we believe are the primary things that matter over time in terms of bank performance. GAAP measures first, followed by the non GAAP measures, which provide the best insight into what I focus on and consequently what we focus on at Pinnacle. My guess is that as 2Q earnings continue to roll out, we'll see some pretty wide variability in performance among the banks. But for us, 2Q was a really good quarter.

Speaker 1

On an adjusted basis, we grew revenues 11.7% linked quarter annualized, EPS 10.8 percent linked quarter annualized and pre tax pre provision net income 24.8 percent linked quarter annualized. We continued the dramatic growth in loans and deposits at 11.3% and 9.1% linked quarter annualized respectively, which are generally the best predictors of our ability to continue growing revenue and earnings going forward. Tangible book value per share grew meaningfully during the quarter, Aided by a sale leaseback transaction that Harold will review in greater detail shortly. And the key asset quality metrics like NPAs, classified assets, net charge offs

Speaker 2

So in summary, 2nd quarter was

Speaker 1

a great quarter for us. Now I'm going to Let Harold review the quarter in greater detail and I'll come back and give some thoughts on the shares later.

Speaker 2

Thanks, Terry. Good morning, everybody. We will again start with deposits reporting linked quarter annualized average growth of 12% in the 2nd quarter was again a real positive for us. As we've mentioned previously, growing deposits in 2023 is a key focus The 2nd quarter was another indication that obtaining deposits in an environment where competitors can be fairly unpredictable is very much doable for this franchise. Several factors contributed to increased deposit rates in the 2nd quarter.

Speaker 2

Competitive pressures were heightened during the quarter primarily from large regional banks offering at some fairly incredible rates and an apparent effort to achieve funding goals. We also have an important public funds client base with much of these balances Lastly, the mix shift of reduced non interest bearing to interest bearing continued in the 2nd quarter, albeit at a lesser pace. All these factors contributed to average deposit cost increasing to 2.52% with a spot rate at quarter end of 2.77%. We're optimistic about the pace of deposit rate increases as we head into the 3rd quarter. Several factors to consider.

Speaker 2

Over the last few weeks, our costs do not appear to be moving up at the same pace as we experienced through the end of the first quarter And most of the Q2, a contributor to the slower pace is the slowing of the mix shift of deposits from non interest bearing to interest bearing. Also, we intend to reduce the absolute size of our more expensive wholesale funding base in the Q3, absorbing some of the added liquidity, which has been acquired over the last In other words, we do not believe we need to be nearly as aggressive on gathering funding as we have been over the last few months. Deposit rates will continue to increase in the second half of this year as we hopefully approach a terminal value for Fed funds. We just believe with all the liquidity noise in the first half of the year, a more deliberate stance for gathering deposits is available to us as we move into the Q3. Lastly, on the supplemental slides is more information on uninsured deposits, which are down to 28% of total deposits at quarter end.

Speaker 2

We won't go into this on the call, but just making sure everyone knows the information is there. The Q2 was another strong loan growth quarter for us. That said, Our line leadership successfully managed our loan growth down to the 11% linked quarter annualized rate. We are maintaining our loan guidance For 2023 at lowtomidteens growth, as we mentioned over the last several quarters, we've tightened the credit box for construction and deployed more discipline on loan pricing, which should serve to reduce our normally outsized growth. Spreads on floating and variable rate loans have continued to be very respectable.

Speaker 2

We also are seeing spreads on fixed rate lending improve given emphasis by our line leadership. Our loan data thus far is Essentially the same as the deposit beta, which we believe reflects a great deal of effort on the part of our relationship managers. Our aim with respect to loan pricing is to maintain our spreads on floating and variable rate loans and achieve 7% to 8% plus As the top chart reflects, our GAAP NIM decreased 20 basis increased by approximately $1,200,000,000 in cash during the Q2 and our quarter end liquidity is slightly higher. So we have a lot of cash Going into the Q3, which should help us eliminate some wholesale funding as well as provide for loan growth in the second half of the year. Contributing to the cash build this quarter was the impact of the sale leaseback transaction we mentioned in the press release last night.

Speaker 2

We received approximately $199,000,000 from the sale of non earning fixed assets. We also sold $174,000,000 from the sale of investment securities. These two transactions allowed us to reposition under earning assets into interest bearing cash in order to eliminate The negative near term impact from increased lease costs. Our rate forecast is consistent with most rate forecasts out there. We are optimistic that a July raise by the Fed is the terminal point for Fed funds, but we may be slightly more pessimistic in that we don't Again, presenting our traditional credit metrics.

Speaker 2

Pinnacle's loan portfolio continued to perform very well in the Q2. Our belief is that credit should remain fairly For the remainder of this year, we did increase the ratio of our allowance for credit losses to total loans during the quarter to 1.08%. We reworked several of our CECL models during the quarter and are implementing these changes this quarter. We don't anticipate seller increases during the second half of Any increases from this point should be fairly modest dependent, we believe primarily on macro trends. As noted for the last few quarters, we continue to have a very limited, if any, appetite for new construction.

Speaker 2

Also, the CRE appetite chart on the bottom right It's basically unchanged from the prior quarter, but does give you a real perspective on how we have reduced our appetite in commercial real estate over the last year or more. In summary, our outlook for our loan portfolio from a credit perspective remains strong. So as negative macro trends begin to develop, we believe we are advantaged as we enter any potential recession from a position of strength. Again, and consistent with last time, more information around credit, the top left chart deals with trends in construction originations. We began reducing, eliminating our appetite for new construction originations last summer, which is consistent with the chart.

Speaker 2

The chart would indicate that our limited appetite A quick note about new residential commitments. The gold bars on the chart are new lines or new homes under old guidance lines for a limited set of long time residential builders. We continue to support our resi builders under guidance lines that have been in place in some cases for years. As you likely know, residential builders are very busy right now given the state of the housing market and the lack of existing home inventories, which is especially relevant in our markets, which have a lot of in migration from around the country. Secondly, the chart on the top left top right, we are providing updated information about the status of Our yield target for these loans has increased into the 7% to 8% range.

Speaker 2

Two comments regarding this chart. The absolute size of the fixed rate volumes coming up for renewal remains manageable and that with rental increases over the last 3 to 5 years and occupancy levels remain strong, we believe that our borrowers will continue to be able to afford the incremental interest cost. Additionally, our underwriting for several years has required that any new commercial real estate or construction commitment be underwritten at higher rates than the contract rate, which In most cases, it's 200 to 300 basis points higher. Again, we believe our borrowers have the resources to afford these increased rates, both due to increased revenues on their part and based on our previous conclusions from our underwriting practices. Now on to fees and as always, I'll speak to BSG in a few minutes.

Speaker 2

Excluding BSG, the impact of the gain on sale of fixed assets and the loss on the sale of investment securities, fee revenues were up slightly from the Q1. That said, we're pleased with the effort our fee generating units during what is proving to be a challenging banking environment. We continue to Anticipate that fee revenues excluding BSG and all these other items will come in at around a high single digit growth rate linked quarter expenses were essentially flat as personnel costs were down And other expenses were up by similar amounts. Signal decreases in payroll taxes and other benefit categories from the Q1 were the cause for the reduced personnel costs, While the sale leaseback lease expense, offset in part by reduced depreciation costs, was the primary contributor to the increased occupancy cost. Additionally, we reduced our anticipated annual cash incentive payout from 70% to approximately 67% of target awards At the end of the Q2, so not much change quarter over quarter with respect to our outlook for incentive costs for either cash or equity incentives.

Speaker 2

Again, the reduced incentive accrual speaks to the variable cost nature of our incentives, which are all substantially performance based. Additionally, along with deferred projects or slowing our hiring, we feel like we have enough leverage to throttle back on expenses should we need to. We have again lowered our expense growth forecast for this year and have incorporated that into our updated outlook. As it stands, our expense guidance was Previously lowtomidteensgrowthfor2023, we have lowered to high single digits to low teens growth for 2023 over 2022. Our tangible book value per common share increased to $48.85 at quarter end, up 16%.

Speaker 2

Influenced in this increase was the sale leaseback transaction, which provided almost $86,000,000 in pretax gains offset in part by $10,000,000 in In view of the macro environment, we anticipate retaining this incremental capital at least through the end of this year. We believe the actions we've taken to preserve tangible book value and our tangible capital ratio have served us well and have no plans currently to alter our Tier 1 capital stack Via any sort of common or preferred offering. The chart on the bottom left of the slide compares several capital ratios as of the end of March to our peers. Although we don't anticipate significant changes to the capital rules, we are pleased with these results and our ability to withstand any changes to the capital rules that potentially could come our way. Now a few comments about BSG before we look at the outlook for the rest of the year.

Speaker 2

The top right chart is consistent with various calls and details that production has been consistent Over the last several quarters at $1,000,000,000 to $1,200,000,000 per quarter. Placements to the bank network were less in the same quarter, while placements to Investors were at the highest level ever and signaled that demand for BHG paper by some of the most respected asset management in the country is really strong. BSG has been able to penetrate a very liquid channel over the last few years, which during some of these times has proven to be somewhat fickle for some of BHG's competitors. Over the last several years, BHG has made periodic calls to pivot between on balance Investors paper and off balance sheet bank placements. Historically, as institutional investors come to the table, their orders may receive a level of Priority asset funding which BHG has to manage.

Speaker 2

That said, BHG's unique bank network, which we believe can't be replicated by any other BHG This is a new slide where we're trying to provide additional clarity with negotiated 2 private whole loan sales with $550,000,000 of capacity. These are slightly different in that in both cases, These were large purchases structured similar to the bank network. Gain on sale treatment is afforded these sales as the investors acquired the loans with no recourse. BHG has negotiated 3 warehouse lines with 3 well known and respected asset managers' private equity firms. Performance of BHGE's loans sold to the capital markets have been such that many of the firms that have participated in the past are in constant contact to acquire more loans in the future.

Speaker 2

The bank auction platform remains very liquid and able to meet the necessary funding that DSG requires of it. All in these funding channels can collectively provide several $1,000,000,000 in capacity and the flexibility to manage liquidity risk effectively between The various channels. This is the usual information we've shown in the past detailing spread trends just in a slightly different format. The top chart represents the gain on sale of the off balance sheet bank network and the bottom chart is a blended chart of all balance sheet funding strategies, which incorporates the historical buildup of balances. As anticipated, spreads have come in with higher rates with the bank auction rates being consistent with pre COVID During the Q2, the blended spreads for on balance sheet was slightly higher than the bank network given the balance sheet loans reflect the buildup of balances over the last 3 years.

Speaker 2

As it stands today, BHG expects spreads to be fairly consistent going into the second half of twenty twenty three. As we noted in the previous quarters, BSG has tightened its credit box over the last several quarters, particularly with respect to the lower tranches of its borrowing base. This As we've stated in prior quarters, BHG has been modifying their credit models towards originating less risky assets. Production bonds remain strong even with tighter credit underwriting. BSU refreshes its credit score monthly, always looking for indications of weakness in its borrowing base.

Speaker 2

Credit scores are up from previous years. Additionally, approximately 22% of BHG's production is with repeat borrowers And all balance sheet loans. As we mentioned in previous quarters, BHG determined that loss rates in several lower tranches of their production was exceeding internal tolerances and elected to stop lending into these lower tranches. Their conclusion was that for loans written in 2021 and for most of 2022, Several contained an element of grade inflation, which required remediation. As a result, we believe outsized losses could occur over the next couple of quarters at a similar place Similar pace as the last two quarters.

Speaker 2

Typically for BSG, approximately 70% of the loss content is incurred within the 1st 3 years of origination. To bulk up collection activities, including hiring more loggers, and we'll be instituting in person closings for new borrowers, which was suspended during COVID. BHG had another strong quarter with approximately $1,100,000,000 in originations and are on track to achieve $3,800,000,000 to $4,000,000,000 originations this year, which is slightly less than last year. Thus far, the 3 2 quarters production is slightly more than the prior year even with efforts to tighten the credit box. BSG has a conservative bias that production in the last half of the year will likely be lower in the first half, but should be close to what they had last year.

Speaker 2

Net earnings are being forecasted at $175,000,000 to $190,000,000 which is A tighter forecast from last quarter's production of a 30% to 40% reduction from prior year's results. The numbers now work out to be a 35% to 40% reduction. Quickly, again, the usual slide Our current financial outlook for 2023, we continue to plan for a recession, but how severe it will be, neither we nor anyone else really knows. Our job is to manage the risks that face this franchise every day. What we know is that our business model is relationship based, nimble and resilient.

Speaker 2

Our management team has significant experience and have tackled economic downturns before. We have great confidence that we will be able to manage the high quality banking franchise that our And with that, I'll turn it back over to Terry.

Speaker 1

Thanks, Harold. I mentioned at the outset, I've come back to offer my thoughts on the shares. Obviously, the Primary goal of the call is to have an in-depth review of quarterly performance, which we've now completed. But beyond that, we work hard to make sure that investors have an opportunity to understand more than just what went up and what went down during the quarter, but to get to a better understanding of our approach for producing long term shareholder value, AKA, total shareholder returns or TSR. So perhaps the best place to begin is just to examine what kind of total shareholder return we've produced historically.

Speaker 1

As you can see here over the last decade, PNFP has produced the single best total shareholder return among peers. And I'd invite you, if you get a chance, to go back and look at it since our inception in 2000, look at it over our first Look at it over our 2nd decade, over the last 15 years, over the last 20 years, I think you'd find us at or near the top in all those time segments, Absolutely consistent performance irrespective of the various economic rate cycles over the last 23 years. And so what I want to examine now is how that happened. The analyses of a number of bank stock experts and I suspect that of yours would show that There are 3 primary metrics that are highly correlated to TSR over time and there are revenue growth, reported EPS growth I suppose that there are an infinite number of metrics that bear little or no correlation with TSR over time, But they include metrics like net interest margin percentage, cost of funds, deposit cost betas, loan yields, non interest bearing deposits, Total deposits, operating leverage and efficiency ratios, just to name a few. In fact, you've already seen our track record for total shareholder returns over the last decade, yet I'm confident that our NIM percentage is rarely, if ever, been above 1,000,000.

Speaker 1

Our cost of funds has likely never been better than 1,000,000. Our deposit beta is always high both when rates go up and when they come down. Loan yields have generally been no better than median and our non interest bearing deposits Total deposits ratio has generally been less than most of our peers. There's nothing wrong with any of those metrics. In fact, we measure and study all of them.

Speaker 1

It'd be hard to build a model without many of those inputs, but I'm just making the point that we focus much more on growing revenues, growing EPS And creating tangible book value, then we do standard model inputs like the NIM percentage or the cost beta or the Percentage of non interest bearing deposits to total deposits because historically revenue growth, EPS growth and tangible book value accretion And then more highly correlated with TSRs, which honestly is the main thing I care about. When I say we focus much Our annual cash incentive pool, 100%. No annual cash incentive is paid to virtually any salary associated in firm if our classified asset ratio exceeds a certain level. But assuming we had made a bunch of bad loans, the metrics that determine virtually every Sired associates payout Included mine is the revenue growth and EPS growth rate. Since revenue growth and EPS growth have been highly correlated with TSRs, We have literally focused every single salary associated in this firm on those two variables.

Speaker 1

And I believe that's one of the critical reasons our firm continues Compound revenue and earnings growth like few other can. My personal incentive along with every other salary associated with this firm depends on those two growth rates. In terms of long term equity incentive plan, 100 percent of our associates are granted shares. For most associates, those shares are time vested, but Annual award vesting is performance based and the 2 primary measurements are peer relative tangible book value accretion and peer relative ROATCE. In other words, for the leadership of this firm to maximize investing of the restricted share grants from our long term incentive plan Beyond clearing an asset quality threshold, which in this case is an NPA ratio, we have to outrun 75% of the banks in our in terms of the tangible book value accretion in ROA TCE.

Speaker 1

Parenthetically, that may give you a little insight on why By the extraordinary liquidity that we and virtually every other bank had on our balance sheets following the pandemic, leadership of this firm did not load the bond book When yields were at near all time lows. So here's how that plays out. Within the last 5 calendar years, we've seen a COVID pandemic, quantitative easing, a mammoth influx of liquidity from all the government In response to the pandemic, inflation or CPI as high as 9%, the most precipitous increase in Fed funds rates in recent history In addition to quantitative tightening and a dramatic decrease in money supply and associated deposits, An inverted yield curve and a number of failures at otherwise high flying banks. And through all that, on the upper right, you can see the dramatic out performance of our 5 year EPS growth versus peers. On the lower left, you can see that the primary driver of that EPS growth was the dramatic growth in revenue Regardless of all the macroeconomic volatility.

Speaker 1

And then on the lower right, you see the very dramatic compounding of tangible book value. So I believe that continual compounding of revenue, EPS and tangible book value has been the primary contributor to producing the peer leading total shareholder return you saw Several slides back. So now when you begin to think about what the TSR chart is going to look like over the next 5 years or over the next 10 years or over the next 20 years, you might begin here. The Southeastern markets we serve have a dramatically different growth profile than the rest The nation, which has the potential to turbocharge our revenue and EPS growth. I'd hate to think I had to compound earnings and revenue at the pace we intend to And some of the other regions in this country.

Speaker 1

But even more important than the dynamic growth that the markets we serve are likely to enjoy It's the competitive advantage that we've built. We're a market share taker. We've been one of the fastest growing banks over the last 23 years and serving vibrant markets Certainly been a tailwind, but you can be sure that substantially more important contributor to our growth has been our ability to take market share from vulnerable competitors. What you're looking at here is market data produced by Greenwich Associates, the foremost provider of research to U. S.

Speaker 1

Banks on the commercial market segment. This is from their client satisfaction dashboard. Down the left side of the chart, you see critical satisfaction variables based on their research, things like Ease of doing business, being trustworthy, value long term relationships, creative insights, the digital experience, the quality of the relationship manager, Cash management capabilities and so forth. As you can see by the scale at the bottom, elements that are colored dark green are market leading, Elements that are colored red would be trailing or at the bottom of the market and elements colored all the various shades from lighter green to yellow to orange are all scores in between the best and the worst. So in the three rightmost columns, you see Pinnacle scores for all these important satisfaction metrics for small businesses That's companies with sales from $1,000,000 to $10,000,000 middle market businesses, that's $10,000,000 to $500,000,000 in sales segment And then on the far right, the combined score for the $100,000,000 to $500,000,000 in sales segment throughout our multistate footprint.

Speaker 1

I've studied the chart very long to say that Pinnacle is a market leader for virtually every single one of these metrics. And this is critically important to understand these charts cover our entire footprint and compare the 5 or 6 market share leaders in addition to Pinnacle, Including Truist, Bank of America, Wells Fargo, P&C, First Citizens and First Horizon. I obviously don't know if Greenwich identify any other banks that dominate their markets as overwhelmingly as we do, but I'd be surprised across our footprint, we're far and away the market It seems to me the most important Score Ball is the net promoter score. Most of you know that it's a comparison of the number of clients that are so engaged with your brand that they fully intend to advocate for you with friends and colleagues, less the clients that are so disengaged with your brand that they're detracting from your reputation in the community. And you can see here our net promoter score is a league leading 86 among small businesses, companies with sales from 1,000,000 to 10,000,000 and a league leading 82 in the middle market companies with sales from $10,000,000 to $500,000,000 Connecting this slide with the last, Regardless of all the money spent by our largest regional and national competitors on technology and on the digital experience, our clients rate our digital more highly than their clients rate theirs throughout our footprint.

Speaker 1

So much has been said about a potential migration of regional bank clients to the national providers. When you look at these scores, it should be apparent why we lost virtually no large clients following the Silicon Valley failure And while we continue to grow deposits at a dramatic pace in the aftermath, look at the dramatic difference in net promoter scores between us at the top and our large national competitors at the bottom. It'd be very hard to leave a bank you absolutely love and honestly it's not hard to leave a bank you hate. Some banks compete on price, some just wait for a yield curve that suits their balance sheet, but for us, it's this relentless pursuit of creating raving fans that Explains our ability to grow revenue and EPS almost regardless of the economic ups and downs. So not surprisingly, when Greenwich probe businesses and our about which banks are likely to earn a share of their business over the next 12 months, Pinnacle has far and away the most frequent response.

Speaker 1

As you can see at year end, 42% of small business respondents named Pinnacle and 50% of middle market business respondents Named Pinnacle as the bank most likely to receive a share of their business. That's incredibly strong momentum. And when credit probe clients regarding which banks are most at Risk for losing a share of their business, Pinnacle was far and away the least frequently mentioned response. Consequently, our net momentum among businesses in our Market is market leading at 3842 in

Speaker 2

the two

Speaker 1

segments. It's further substantiation of the point I've been making about our relative lack of vulnerability versus Large national banks in our markets, the thesis that regional banks are more vulnerable to the large national banks might be true for undifferentiated banks, The business clients in these segments within our footprint might suggest otherwise given our net business momentum scores. So Really to sum it up, what I'm trying to say is it's our belief that revenue growth, EPS growth and tangible book value accretion have Historically been most highly correlated with TSR. That's why we focus our entire firm on it through our short term and long term incentives. We believe our relationship based model has historically produced strong TSR with more manageable risks than many.

Speaker 1

The proof is in the pudding. When you think about the fact that the markets that we serve are likely to outperform the nation and the fact that we've got a differentiated high touch and tech model that generally attracts more and attracts less clients. That's the key to compounding earnings over time irrespective of We'll stop there, operator, and take questions.

Operator

Thank you, Mr. Turner. The floor is now open for your questions. Analysts will be given preference during the Q and A. Please hold while we poll for questions.

Operator

And the first question today is coming from Jared Shaw from Wells Fargo. Jared, your line is live.

Speaker 3

Hey, good morning.

Speaker 2

Hi Jared.

Speaker 3

Thanks for taking the questions. I guess, the deposit growth is great, seeing that we've seen some deposit growth And some of your peers today as well. Where is that coming from? Is that really just the biggest national players? Or are you taking more Wallet share from your existing customers, I guess maybe just a little more detail on where that money is coming from and how much More runway you think there is to take that market share?

Speaker 2

Yes, Jared, that's a great question. I'll give you several things to think about. One is we've got a lot of people we've hired over the last couple of years that are still out there bringing their clients to our firm. I think also that when you get into this time of the year, we start seeing seasonality play into our deposit book. And so consequently, we fully anticipate that we'll see swell here in the Q3 and Q4.

Speaker 2

And then lastly, our public funds, we won, call it, a handful of public fund clients here over the last A quarter or so, and they're also building their balances in a more outsized way and in a more I'll say it that way.

Speaker 1

Jared, I might add to Harold's comments. I think in terms of getting to where it comes from, I think his first point is important. The folks that we have hired, the largest contributor of revenue producers to us has It's been true as the 2nd largest, it's been Wells Fargo. And so they are about consolidating relationships here based on their ability to serve clients better and so forth. So anyway, I think that's a big part of it.

Speaker 1

But I wouldn't want it to be unsaid I think if you were to come inside this firm and talk to people, you would hear them say, hey, we're about to transition this firm from being one of the best Asset generators to be in one of the best deposit generators. And so there's a lot of energy inside the firm on a number of different specialties that we've built. I've mentioned them In the past, deposit verticals that attack large pools of money where we have some value added product offering For things like property managers, homeowners associations, A variety of pools of money like that where we've got a value added product that we've introduced over the last couple of years. So those things have really good momentum and there are a number of other of those verticals that are being rolled out literally as we speak. So Again, my hope and belief is you'll see a little bit of a transition in our ability to gather beyond just the relationship approach That we Harold and I both commented on, but also through those specialties.

Speaker 3

That's great color. Thanks. And Yes, looking at the pace of hiring, you've done a great job hiring people in market expansion. How should we be thinking about Your pace of hiring new revenue producers at this point and can you give an update on maybe some of the expansion markets that you recently targeted?

Speaker 1

Yes. I'll just, I guess, maybe start with the second part of it, comment on The expansion markets that we're in, I think we've already given indications for the Atlanta market that I think their commitments are about $1,600,000,000 north of $1,000,000,000 in loan outstanding. The more recent large market DC, I believe that they have generally been a net provider of funding, if you can believe that. And generally in pretty short order approaching $700,000,000 in funding, I think maybe about 6 $1,000,000 in loan outstanding. Commitments are well above that and the momentum is really strong in both those markets.

Speaker 1

I think if you were To talk to Rob Garcia or Caroline Pelton that lead our effort in those markets, they would say they're enjoying great So that's both recruiting people and recruiting clients in a large measure based on the strength of our treasury management capabilities and so forth. So At any rate, we continue to be excited about those expansions. I think in terms of hiring people, We continue to recruit. I think we continue to do well. My guess is we might not hire quite as many people this year as we did last year, but we'll hire a lot.

Speaker 1

There's still a lot of hiring momentum and I Always try to hold out as a possibility that it's conceivable to me we might find our way to a market extension or 2. In the event we feel like we've got a team that could build us a big bank, you've heard us talk about that in the past. We're not Just hiring anybody and we're not trying to build an LPO, but if we had the opportunity to build a big bank, we would proceed with that. And so Anyway, I hope I'm responding to your question there.

Speaker 3

Yes, that's great. That's great. And then just finally for me, maybe for Harold, How should we be thinking about or where cash balances go in the near term? And then I guess From what you said, we should assume that any reduction in cash either goes directly to loan growth or just FHLB reduction? Any targets?

Speaker 2

Yes, that's right. It's probably going to be around broker deposits. We've got about, Call it upwards of $2,000,000,000 that we think that we can use to kind of to help fund Loan growth here in the over the year and also help reduce the size of our wholesale book.

Speaker 3

Great. Thank you.

Speaker 2

It won't all happen at once. It will happen consistently through the next 6 months and probably into the 1st part of next year.

Speaker 3

Great. Thank

Speaker 2

you.

Operator

Thank you. The next question is coming from Stephen Scouten from Piper Sandler. Stephen, your line is live.

Speaker 4

Hey, good morning. Thanks guys.

Speaker 2

Hi, Steve.

Speaker 5

I guess one of the

Speaker 4

things I'm curious about is just the strength of the deposit base and you've spoken a lot about how you your people and noted that you feel like this has really been a shift, but I'm guessing I guess I'm asking how has this shift really occurred? Have you had to Change your incentives to drive that kind of culture shift towards deposits? Or is it really continuing to focus on revenue growth and telling these people, you want to book your loans, you got to book the deposits first. How can we think about that cultural migration, I guess, that's occurred?

Speaker 1

Yes. Stephen, that's a great question and I appreciate it because it's important to me. We've not changed our incentive at all. And As you know, I'm a believer. I'm hoping I'm going to convince you to be a believer that when you get all the associates of this firm aimed at revenue Growth and EPS growth, it's not hard to illustrate at all, guys.

Speaker 1

We got to buy More money or we can't book our loans, guys. We got to buy more money at a lower price. It is so easy to move our company To whatever really is important in order to grow the revenues and EPS, I think it would shock you how easy it is to illustrate How that works? I think in the last quarterly all associate meeting, we just put a slide up there and Show what the financial performance is and you show them, okay, look, we're off On our margin here and it's largely a function of cost of funds. And so then you go down and show on the expenses, We're right on track, but don't miss the reason we're on track is because we reduced our incentive accrual.

Speaker 1

And so guys to be clear, What just happened here in this quarter is we took money out of mine in your pocket and our incentive crew and we put it in our clients' pocket in And so again, we have not altered the incentive by doubt that we're going to. It is We are able to move people back and forth, not that we're constrained by.

Speaker 4

That's very helpful. Thanks, Terry. And then I guess in terms of the margin outlook, I think, Harold, you guys give the cost of deposits at June 30. Not sure if you give like a June or end of period kind of margin relative to where the margin was for the quarter as a whole, but how do you think about incremental progression and compression from here? And can you speak to the amount of floors you might have in the loan book if and when we get rates lower?

Speaker 2

Yes. We've got loans we've got floors on loans and we're pushing for floors on loans. We're also pushing for Folks will be very conscious about what rates they're paying on their deposits. I think we can be more deliberate with respect to our deposit As we go into the second half of the year, as to margin performance in the 3rd and Q4, it's going to be down in all likelihood. We think there's one more rate increase coming to us that we'll have to support in some way with our depositors.

Speaker 2

But that said, Don't miss, we think our net interest income is likely to be flat to up. So as Terry said, we're going to be focused on the revenue line And we're going to try to make sure that we don't sacrifice any of the ground that we've gained here over the last, call it, 2 or 3 quarters With respect to some of these clients that we've gathered, so I'll stop there, Stephen, and see if I've gotten to your question.

Speaker 4

Yes. No, I think that makes a lot of sense. I think it speaks to that slide you guys had in maybe a year ago where you showed your deposit betas, but your NII outperformance irrespective That's a good point. Maybe just lastly for me around the new hires, you had some particular strength in wealth management.

Operator

Can you give us a

Speaker 4

view on where kind of those new hires have been concentrated? And I guess have more of them been into that wealth management platform over time? Has that driven some of the strength there?

Speaker 1

Well, there's no doubt that we have hired a good number of People in the Wealth Management segment and it's really across the Wealth Management segment. When I say that, I mean, a lot of Hiring in trust, which believe it or not, it's a double digit growth business for us, as well as hiring in brokerage, As well as hiring what some might refer to as private bankers, they're relationship managers that are focused on well in the individual. We've had hiring across all those segments. I think that we probably have had a little more hiring in the wealth management segment over the last year or So a year or 2, than is normal, but I don't think that's necessarily by design. I think it is more Availability of people.

Speaker 1

And so again, we just had, as you know, what we do is try to aim at high producers That are frustrated in the organizations that they work for. And so I think there's sort of been elevated frustration there, which has fueled our ability to hire their people. I wouldn't look for that to be the ongoing norm at all. I would say I wouldn't expect much different about the hiring mix In 2024 as an example that I would have expected in 2022.

Speaker 4

Got it. Extremely helpful, guys. Appreciate all the color and keep up the good work.

Speaker 2

Thanks, Darrin.

Operator

Thank you. The next question is coming from Steven Alexopoulos from JPMorgan. Steven, your line is live.

Speaker 6

Hey, good morning, everyone.

Speaker 2

Hi, Steve.

Speaker 6

I want to start so you had favorable commentary in terms of the outflows of Donatrice Barings starting to abate and then even the pace of Positive increase starting to abate. You also cited Harold, I think you said the competitive environment is unpredictable. Is that a function of the competition lessening that you saw? Are you starting to see that abate a bit? Maybe you could drill down a little bit And so what gives you comfort here?

Speaker 2

Yes. I think it's primarily around the trends when we watch our deposit book every day over the last, Call it 90 days, 120 days. It feels like the pace is lower. It feels like the calls coming into our units It's less anxious. It's there's a lot more opportunity coming from some of the new hires that we've had around deposit gathering, Those sort of things.

Speaker 2

Terry and I were talking about price based competitors before we start this before we started the call today. What I believe is price based competitors, generally, that's a short term phenomenon. Eventually, they have to go back to whatever is necessary to create the profit Margins, they need to have and we feel like that a lot of this recent activity from some of these regional competitors It will have to be short lived. I don't think that they can be competitive at the rates they're offering. And so consequently, hopefully, that competitive Kind of environment we've been in will also abate to some extent.

Speaker 2

I can be completely wrong on that, but I think history is that price competitors can't be price competitors for a long period of time.

Speaker 6

Yes, yes. That's helpful, Harold. On the That's it. I appreciate taking down the expense guidance and outlook a bit. But where we stand today, what's your bias in terms of where you think right now, I know there's a lot of variables, Where you'll likely end up in this high single digit to low teens percent increase range?

Speaker 2

On expenses? Yes. Yes. I think if you were to just kind of twist my arm and put it behind my back and make me really Be in pain. I have to go probably to a, call it, 9 to 11, somewhere in that neighborhood.

Speaker 2

Okay.

Speaker 6

Perfect. That's helpful. And then final question In terms of the sale leaseback, Harold, can you walk us through the P and L impact on a go forward basis from the transaction? Just want to make sure.

Speaker 2

Yes. Just from 30,000 peak, our lease expense less the depreciation savings from selling those properties It's probably over a 12 month period about a, call it, a $14,000,000 kind of additional rate run rate increase. But The cash that we were able to generate from moving the $200,000,000 in fixed assets from 0 to now call it 5.25 And the cash we generated from taking investment securities, dollars 174,000,000 of those from, call it, dollars 2,000,000 to 2.5 to now 5.5 That increase in yield basically offsets all of the depreciation all the lease Expense increase and just to be completely candid around the sale leaseback, when we started looking at this back in the Q4 of last year, The kind of the play was that we would reposition more of the bond book. And consequently, we thought we could probably reposition as much as another, call it, $700,000,000 or $800,000,000 in bonds with the gain we got on the sale leaseback. But with all the activity in the Q1 And now going into the Q2 and whether or not there's going to be a recession or not, we elected just to warehouse the capital that we created from the game.

Speaker 6

Got it. So the benefit is you create excess capital and from an overall earnings view it's fairly neutral

Speaker 2

That's exactly the point. And that's basically why we did the sale of the investment securities Just to neutralize the impact of the lease expense. Thanks, Steve.

Operator

Thank you. The next question is coming from Brandon King from Truist Securities. Brandon, your line is live.

Speaker 7

Hey, good morning.

Speaker 1

Hey, good morning, Brandon.

Speaker 7

Hey. So I wanted to get Updated assumptions on deposit mix included in your guide. I know Harold you mentioned previously that By year end, we could get to below 20%. So I wanted to see if you still feel comfortable with that sort of trajectory, Just given where things stand today.

Speaker 2

Yes. I think we still feel like that that's a reasonable kind of number to put on the Board. I don't think we or anybody else, Brandon, has any idea where non interest bearing deposits are going to go here in this environment. But It does seem like things are feeling better about that and that we're at the end of the day, 2 things have to be in play. One is our clients have to get to a level of operating cash where they feel like I need this in an operating cash account.

Speaker 2

And on our side, Our sales force, our people, our treasury management people have to talk to our clients about this seems to be a reasonable amount for you to keep in this deposit account that you need to manage your business. And so I think those conversations are occurring every day And I think it just leans into this relationship based model that we continue to kind of hold on to as why we think this whole Non interest bearing reduction is feeling better for us.

Speaker 7

Got it. Got it. Makes sense. And then I wanted to talk about the allowance There was increase in the quarter and I understand the increase in commercial real estate, but I saw that consumer real estate had a pretty sizable jump as well. So just wanted to see if there's any context

Speaker 2

around that increase. Yes. I think the increase in the consumer real estate Allocation is primarily related to the macro case And the duration of those assets. So we're not going to argue about whether or not we're a big fan of CECL or not, but At the end of the day, when rates go up and those assets extend out, then the CECL model automatically penalizes those loans And the decisions you made on those loans back several years ago. Does that make sense to you, Brandon?

Speaker 7

Yes, yes. So nothing kind of qualitative there, just Security quantity.

Speaker 2

No. To be honest, I can't remember the last time we had any kind of loss on a 1 to 4 residential fixed rate mortgage.

Speaker 7

Okay, got it. Just confirming. Thanks for taking my questions.

Speaker 2

Thank you.

Operator

Thank you. The next question is coming from Catherine Mealor from KBW. Catherine, your line is live.

Speaker 8

Thanks. I want to circle back to the margin and extend Just your thoughts into next year. And it's helpful to think about or you've given guidance that you think NII is still Flat to up in the back half of the year. But as we think about 2024 and let's just say we get a hike in July and then we're At that level of Fed funds, but we don't get rate cuts as we move into next year. How do you think about how your NII might look next year in kind of a Higher for longer scenario.

Speaker 2

Yes. Well, I think one big factor in that Assumption would be what does the intermediate log in of the curve do. As you know, no banker is a fan of an inverted curve. And so it's just going to require a lot more work on our part in front of our sales force and how we price with clients and all that sort of stuff. So far, we don't think Credit is going to be we don't see that moving going into 2024.

Speaker 2

We think we're well positioned there. But as far as our ability to grow net interest income In kind of a mid teens level, it would be very hard as we look at 2024. But It all depends on what we believe is going to happen at the intermediate and long end of the curve.

Speaker 8

And as you Get to a point where you think your NII growth might pull back to maybe the low teens, maybe the high single digit kind of pace in that scenario. How quickly do you think you'll reconsider the expense growth going into next year to be at a lower pace kind of like what we saw this quarter?

Speaker 2

Yes. That's a great question. We'll have to consider A lot of things going into the expense book next year. One would be replenishment of our incentive cost, Whatever that ends up being for 2023 and going back to try to figure out how to achieve a full incentive again next year. And Where we are with respect to hiring, we're today, we are, call it, very conservative On our what we would call our support level positions, we're not as far as revenue producers, We still are out there actively looking for revenue producers.

Speaker 2

We've asked our support units to kind of hold it in And do what they need to do in order to meet whatever objectives they have internally, but not to get a grasp on their hiring. Okay. I'll just leave it with that, Catherine.

Speaker 8

Okay. Yes, that's great. That's very helpful. And then maybe just one follow-up on credit. It seems like The guidance, it feels like loan growth should still be strong, but slow a little bit in the back half of the year relative to the first half.

Speaker 8

And it didn't feel like You expect a big increase in the reserve ratio, maybe just a modest. And so is it fair to assume outside of some unexpected change in what you're seeing on the credit front that the absolute dollar number of the Dollar number of the provision expense should be lower in the back half of the year relative to the $37,000,000 number we saw this quarter?

Speaker 2

Yes. Yes, we don't anticipate provision being that high in the second half as it was in the second quarter.

Speaker 8

Okay, great. Thanks for taking my questions. Sure.

Operator

Thank you. The next question is coming from Matt Olney from Stephens. Matt, your line is live.

Speaker 9

Thank you. I want to make sure I understand the strategy on liquidity. It sounds like the excess liquidity amount as you view this is around $2,000,000,000 and you want to be patient deploying this Could take up to a year. Did I get that right? And then I guess kind of part 2, the broker deposits that could be paid down that you mentioned, Harold.

Speaker 9

Any more color on these products? Are these CDs? And when do they start to roll? Thanks.

Speaker 2

Yes, they'll roll off over the call it the next 6 months. I've got some public fund money that I think we'll also be paying off over the next 6 months. So it will be those kind of things. I don't think it will take a year. I think it's more like probably 6 to 7 to 8 months, Matt, if I remember my maturity schedule, is kind of where we're looking at on this liquidity number.

Speaker 10

Okay. That's

Speaker 9

helpful. And then I guess kind of part 2 of that and thinking about the interest rate sensitivity on that, I think it's on Slide 49 of your deck there. Where do you see that migrating over the next year, especially as we get closer to any kind of Fed funds cut? I would assume as you pull out liquidity, The bank would become more rate neutral, but just curious kind of how you see that moving into the next year?

Speaker 2

No, I think you're exactly right on that. I think once we get to a terminal value on Fed funds, I think our sensitivity will get kind of go back to historical norms. There will likely be deposit creep, but it won't be in leaps and bounds. It will be in small numbers. But we'll also have the advantage of repricing fixed rate loans going into kind of a stabilized rate environment if there is such a thing.

Speaker 9

Yes. Okay. Okay, that's helpful. And then just lastly on the loan growth front, You've talked about managing the growth lower in recent months and being more selective and very careful. I'm also surprised that you didn't take down the loan growth guidance This quarter, it looks like the full year guidance implies will be flattish from what we saw in 2Q.

Speaker 9

Can you just kind of speak to The pipelines as far as what you're seeing today and currently versus a few months ago?

Speaker 1

Yes, Matt, I think You know our approach well, so much of the loan growth is generated by the And that phenomenon occurs sort of irrespective of Whatever other economic factors exist and some people say, why don't you just take it to 0? Well, that's No good for anybody. I mean, we hire people that have clients, they need to move them or otherwise they won't be their clients anymore. And So at any rate, that fuels some of the growth. What we do, I think to Harold's point is we Use pricing, which curves things on the margin.

Speaker 1

We've said as an asset class constructions asset class, we We won't list obvious things like HLTs and those kinds of things. And so there are marginal changes that are really what Tapped down the growth. But in terms of what the economic loan demand looks like, I would say that That is having an impact. I do believe that the pure economic loan request that we see today would be easily less And what they would have been a quarter or 2 ago.

Speaker 7

Okay.

Speaker 1

Both CRE and C and I, Matt.

Speaker 9

All right. That's helpful, Terry. Thanks for taking my questions.

Speaker 2

Yes.

Operator

Thank you. The next question is coming from Brody Preston from UBS. Brody, your line is live.

Speaker 5

Hey, good morning, everyone. Thanks for taking my questions. I wanted to ask, just if I could start on the fixed rate portion of the Loan portfolio, I just wanted to ask if you knew what the dollar amount of fixed rate loans that were repricing over the next 12 months were? And then when I Kind of go back to your previous decks, it looks like fixed rate origination yields were about 4.75 to 5, About 4, 4.5 years ago, is that a good yield to use when we think about what's rolling off the book for fixed rate loans right now?

Speaker 2

Yes, Brody, I don't have what the fixed rate maturities in the C and I book are with me. I just got what's in the commercial real estate And construction book on the slide, but I wouldn't imagine that the yield difference would be terribly different between What's in the commercial real estate versus the C and I book? I just don't know what the volume would be with respect to that. Most of my C and I book Is, floating or variable. And so I mean, it would be slightly higher, but I don't know how much more.

Speaker 5

Got it. Okay. So I can just use that CRE portion as a proxy. Also wanted to ask just on the negotiated deposit book, I wanted to ask just what portion of that book has recently renegotiated on rate? And for those that have recently renegotiated, where are the new rates moving to?

Speaker 2

Yes. My I think that number would be in the mid-3s, somewhere in that range. And I would imagine a substantial amount of that book has been renegotiated. I've not seen a bell curve of my deposit book lately, where you track like what the rate is, The low rates versus the high rates and all that, but substantially all of those deposits have repriced in one way, shape or form.

Speaker 5

Got it. Thank you. And on the sale leaseback transaction, do you happen to know what the cap rate was on that transaction for the buyer?

Speaker 2

No, I really don't. That would be an interesting thing to know, but I don't.

Speaker 5

Got it. Okay. And then you did have $100,000,000 or just under $100,000,000 of fixed rate CRE and construction loans that were maturing in the 2nd quarter, at least for the slide deck last time. I wanted to ask just what happened to those loans? Did they re up with you at your targeted rate?

Speaker 5

Did any of them leave the bank? And I guess, did any of them struggle with the increase in rate?

Speaker 2

I'll go back and look at my numbers, but I think there was Only a small percentage that left the bank. I think, probably a third, maybe 25% to a third left the bank and went to the firm end market. I think the rest are probably still hanging with us.

Speaker 5

Got it. Okay. And just a couple of last ones. On the AFS portfolio, do you happen to know what the The duration of that portfolio is and what the conditional prepayment rate you're assuming in that duration calculation?

Speaker 2

I think the average length of the AFS book, if you're talking about years, is that right?

Speaker 4

Are you talking about percentage?

Speaker 2

Yes. I think the life in the AFS book now is somewhere around 8 And the percentage duration, I think, is around 5%.

Speaker 5

Okay. Do you know what the CPR is in that duration calculation?

Speaker 2

I don't. I don't. But I can get that for you, Brody, and I'll get it to you.

Speaker 5

Awesome. I appreciate it. And then just last one, just I think you might have touched on it earlier, but I'm sorry if I misheard you, just the increase in the CRE reserve. Was there any specific kind of metric that drove that increase within your CECL model just because it had been declining for the last several quarters?

Speaker 2

No, I don't I can't point to any kind of anything specific in the CRE book. There's no individual Loans in there that contributed to it or anything like that? I don't know of anything.

Speaker 5

I was more interested, Harold, within the ACL modeling, if there was any specific variable where maybe there was A larger price decline that you were factoring in within the ACL modeling, I just that's what

Speaker 4

I was more getting at.

Speaker 2

So I really I don't know the answer to that question if there was one. I don't think there is one.

Speaker 5

Okay, great. Well, thank you very much for taking my questions, everyone. I appreciate it.

Speaker 1

Thanks, Brian.

Operator

Thank you. The next question is coming from Brian Martin from Janney Montgomery. Brian, your line is live.

Speaker 10

Hey guys, most of my stuff was just asked through the last couple of questions. But just one thing Harold, you gave a spot rate on I think deposits. Just Do you have what the spot rate was on the margin at the end of the quarter? Or it just sounds as though it's going to You talked about the dollars of net interest income, but just the margin itself is going to drop the next couple of quarters and maybe stabilize later in the year. Is that Based on kind of your outlook on rates today, is that fair?

Speaker 2

Yes, that's fair. I don't have my monthly financial information in front of me, But we think it's going to the margin will decline over the next couple of quarters. But again, our focus is on that net Income number that we think is flat to up.

Speaker 10

Yes, got you. Okay. And the liquidity normalizes by end of year. That's kind of what you're suggesting that 6, 7 months or so. Yes,

Speaker 2

I think we'll be close by the end of the year.

Speaker 10

Okay. All right. And then just last 2, just on BHG, Just kind of the outlook narrowed a little bit more. Just as we think about 2024, any high level, How we should be thinking about BHG next year, Harold, with depending on how these the losses potentially play out or I know CECL is in there. Yes.

Speaker 2

I would not first of all, we're not giving guidance on 2024, but At the same time, I think BSG's outsized growth rates from over the last several years and depending on which one you look at, I think they'll become a lot more normalized going into 2024.

Speaker 10

Okay. All right, perfect. That's all I had. Thank you.

Speaker 2

Thanks, Brian.

Operator

Thank you. And we had another question coming from Jared Shaw from Wells Fargo. Jared, your line is live.

Speaker 3

Hey, thanks. Just a quick follow-up on the BHG. You called out The loan sales to the institutional investors, were those also covered under a substitution agreement? Or when you say there's no recourse, that's just truly No recourse there off the balance sheet and any losses will be absorbed by those borrowers or purchasers.

Speaker 2

That's right. That's right. From my understanding is they bought those loans and they're theirs.

Speaker 7

So the

Speaker 2

gain on those wasn't quite at the same level, But at the same time, they don't have the recourse.

Speaker 3

Okay, great. Thank you.

Speaker 2

Thanks,

Operator

Jared. Thank you. There were no other questions in queue at this time and this does conclude today's conference. You may disconnect your lines at this time and have a wonderful day. Thank you for your participation.

Powered by Quartr
Earnings Conference Call
Pinnacle Financial Partners Q2 2023
00:00 / 00:00