Pinnacle Financial Partners, Inc. Q4 FY2023 Earnings Call

Good morning, everyone, and welcome to the Pinnacle Financial Partners Fourth Quarter 2023 Earnings 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. 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 opened for your questions following the presentation. During the presentation, we may make comments that may constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties, and other facts that may cause actual results, performance or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of those 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. The more detailed description of these and other risks is contained in Pinnacle Financial's annual report on Form 10-K for the year ended December 31st, 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 financial measures as defined by SEC Regulation G, a presentation of the most directly comparable GAAP financial measures and a reconciliation of non-GAAP measures to the comparable non-GAAP measures will be available on Pinnacle Financial's website. With that, I'm now going to turn the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.

Thank you, Matthew. Good morning. Thank you for joining us this morning for the fourth quarter 2023 earnings call. Obviously, we will focus on performance in the fourth quarter of '23 and our outlook for 2024, both of which I think are very good. We always start with the shareholder value dashboard on a GAAP basis and then as adjusted, which is really what I focus on in trying to manage the firm. There's no doubt 2023 presented one of the most difficult operating environments for banks since the Great Recession. I expect few, if any, banks were able to completely outrun the rate environment and its impact on revenue and earnings growth in 2023. But despite the difficult operating environment, we grew our tangible book value 14.8% in 2023 and produced a 20% total shareholder return. Our unusual approach of investing in our business, particularly in terms of acquiring new talent even during difficult times, is one of the primary reasons we've been able to continue to take share and grow balance sheet volumes, which of course has accounted for our rapid and reliable growth in revenue and earnings, which we believe contributes to our extraordinary total shareholder return over nearly 2.5 decades now. We've said for some time that it's our expectation that credit metrics have to normalize. It's impossible to operate over time at the very low level of problem loans that we've enjoyed over the last two years. We saw a little bit of that in the fourth quarter, but NPAs and classified assets still remain below our five-year median, which is itself very low. And net charge-offs during the quarter were just 17 basis points. So, the fourth quarter of '23 was an excellent quarter for us, particularly on those metrics that point to future shareholder value creation. And so, with that in mind, let me turn it over to Harold for a more in-depth look at the quarter.

Thanks, Terry. Good morning, everybody. We'll again start with deposits, reporting linked-quarter annualized average growth of 4.6% in the fourth quarter, which we believe was a real positive for us. We did see some end-of-year deposit outflows that lowered our EOP balances and are hopeful to see those balances return this quarter. EOP deposit rates were up only seven basis points, the smallest increase in quite some time. We felt like the rate of increase for deposit rates would slow as we enter the fourth quarter. So we're pleased with where we ended up. Deposit mix fell down quite a bit with fluctuations in our overall rates, driven somewhat by mix shift as several larger, more expensive depositors built balances at year-end. We will remain disciplined regarding the relationship between pricing and the growth of deposits. We will continue at a more deliberate pace for gathering deposits without leaning heavily on the rate component for our growth. As for loans, the fourth quarter was another strong loan growth quarter for us, as we are reporting a 10.7% linked-quarter annualized average loan growth for the fourth quarter. As we've mentioned over the last several quarters, we are pleased with our results on fixed-rate loan pricing, which ended the quarter at an average fixed rate loan yield on newer rate originations of 7.33%. Spread maintenance on floating and variable-rate loans continues to be strong with coupons in the high-7s to low-8s on new loans. Our NIM was flat quarter-over-quarter. We had hoped to see a modest increase and continue to believe we have a great opportunity to see NIM expansion in 2024. Our interest rate forecast is consistent with most rate forecasts out there. Our planning assumption is that future Fed rate decreases begin in May, and then we see three more before the end of the year. Our yield curve shift is that it will be less inverted by year-end. Pinnacle's loan portfolio continued to perform very well in the fourth quarter. Our belief is that credit should continue to perform well as we move into 2024. Absent a couple of large charge-offs in 2023, it was a good year as to losses realized from our portfolio. We mentioned one non-performing credit in the press release last night, debated on whether to call it out or not, as the charge-off for all of our NPAs is 27 basis points, which is very respectable in comparison to prior quarters. But given the change from the prior quarter, we decided to talk about that one credit. We feel that particular credit is well down the road of being rehabilitated and expect no losses currently. Our goal is to reduce our concentration ratio to approximately 70% over the next few quarters. Our appetite for construction lending will remain limited at this time. We believe the anticipated tax equivalent cash yield on our entire BOLI portfolio, as a result, will approximate 4.5% in 2024 and 5.5% in 2025. This compares to approximately a 3.4% yield currently. I will speak more about our outlook for expenses in 2024 in a few minutes. Capital. Our tangible book value per common share increased to $51.38 at quarter-end, up 14.8% year-over-year. Our focus on book value generation has been a big positive for our firm and we believe it has benefited us meaningfully. Growing tangible book value has been top of mind for leadership over the last several years and has impacted decision-making as management has not been willing to risk significant tangible book value dilution. The chart on the bottom-left of the slide details several pro-forma capital ratios at the end of this quarter. In addition to the BOLI restructuring and the FDIC special assessment, we incurred a capital charge for the adoption of CECL, which was consistent with our expectations for the last year or so. Again, this amount did not impact fourth-quarter earnings but did impact our capital ratios. As we look at fourth quarter originations for BHG, fourth quarter origination volumes were less than the third quarter as they continue to shrink their credit box. We are very supportive of the efforts by our BHG partners with respect to credit discipline and client selection. We're also pleased to see that sales into the bank network during the fourth quarter were consistent with the third quarter. The banks continue to have a strong appetite for BHG credit. BHG also successfully negotiated a $50 million private whole loan sale during the fourth quarter. We fully intend to turn it back over to Terry.

All right. Thank you, Harold. Well, as Harold mentioned earlier, we hired our leadership team for our market extension to Jacksonville, Florida. Earlier when I was discussing the 2023 performance, I highlighted the fact that we continue to invest in our business even during the difficult times, which I believe has been the key to the extraordinary total shareholder return we continue to produce. One of the good things about 2023 was that it showcased our enterprise-wide risk management system, which provided the necessary guardrails to protect us when a number stumbled, but more importantly, put us in a position to stay the course while many are trying to restructure their business model with major expense initiatives which may aid short-term earnings but have a devastating impact on long-term shareholder value creation. Our conservative approach to credit, liquidity, and interest rates put us in a great position to continue investing in our business. Most of you know that our target market has been all the large urban markets in the southeast, where Florida has been our principal focus. The catalyst for when we decide to extend to a new market is when we have the availability of leadership that we believe can build a $3 billion bank over a five-year period in any of those large markets. I think it's evident why Jacksonville and why now. So with that, I think I'll turn it over to Harold and we'll walk you through the 2024 outlook.

Thanks, Terry. Quickly, we'll go through the 2024 financial outlook. We have to maintain consistent, reliable growth in our deposit book at a reasonable price. I believe we've made great headway. I think we have great tools in place. I believe we can achieve high-single to low-double-digit growth. Secondly, BHG. We expect modest growth, mid-single, but I think that comes from a new firm, one that has the ability to achieve sustainable growth with an intense focus on growing core businesses. If credit can get back to its usual run rate by the second half of this year, BHG could have a great year. Loans and loan pricing, primarily fixed rate loan pricing; we've done well to get fixed rate loans pricing to their current levels. We will continue to focus on that as we believe that will be absolutely critical to our ability to grow net interest income high-single to low-double digits in 2024. Now, we expect our expense base for 2024 to be between $960 million and $985 million. Our plan will be comfortably in the top quartile of earnings growth. We have to grow earnings in 2024, so our targets reflect that. To be successful, we can't let expense growth outpace revenues. Hopefully, we can achieve our planning assumptions such that all our associates earn their incentive while simultaneously ensuring that the share price reflects all the hard work they've accomplished. And with that, I'll turn it back over to you for Q&A.

Thank you. Everyone, the floor is now open for questions. Your first question is coming from Ben Gerlinger from Citi. Your line is live.

Hi. Good morning, guys. Curious if we just kind of touch base on the expenses. Harold, good clarity just a second ago. So when you think about just expenses overall, is this entirely going to or mostly going to lenders, or is there some technology or back-office spending that needs to be done? I mean, it just seems like Pinnacle getting back to legacy Pinnacle of kind of low double-digit growth is good but it could put some pressure on PPNR over 2024. Just clarity on where that expense might be going.

Yeah, Ben. I'll start and I'll let Terry add his comments as well. Our non-personnel expense base for next year is fairly reasonable. I think if you exclude incentives, growth rates are probably in the low double-digit range. I think that's pretty conservative. Our IT team has outlined what they believe they're going to need to do this year. We spent a lot of extra time on operational expenses and information technology expenses for 2024. We believe we have a good plan. We think we've got a manageable plan that they can accomplish. And at the same time, not overboard on the expense burden. With that, I'll stop and let Terry finish.

Yeah, Ben, I think to your point, we continue to invest. It would be foolhardy not to invest in technology. I mean, you've got all the digital progression, AI, all those sorts of things. We're not a do-nothing company. We continue to invest in technology and stay current. So certainly, there are expenditures other than incentive type expenditures. But one of the things that I would offer for clarity in this company is that 100% of our salaried employees participate in the annual cash incentive plan and earn incentives based on hitting our revenue and earnings growth targets while keeping asset quality strong. If we don't hit our targets, we won’t pay, and that drives our expense structure.

Sure. No, that's good color. I think just philosophically hitting commission targets and bonus payouts is a good thing because it literally means you've hit your upside targets. If you could kind of just parse through here a little bit. When you think about adding additional lenders and just revenue producers, how are they incentivized or how much flexibility do you give them on gathering deposits in this environment? Given your rapid pace of growth, are you giving them a little bit more slack to gather deposits? Does that kind of put a lid on the margin overall? I'm curious how you guys are structuring their incentive on gathering deposits and any flexibility on rate they might have.

Yeah, Ben, let me just reinforce the point I made earlier. Most people have a hard time understanding the incentive systems here at Pinnacle. Every category of salaried person, their incentive is tied to the company hitting its revenue and earnings targets. Our lenders have the incentive to gather deposits and produce loan volumes to achieve satisfactory deposit volumes. Every quarter, we meet with all our associates and talk to them about our performance on revenue and earnings and how that impacts incentives. It’s really clear for everyone.

Got you. I appreciate it. That's helpful color. Thanks, guys.

Thanks, Ben.

Thank you, Ben.

Thank you. Your next question is coming from Brett Rabatin from Hovde Group. Your line is live.

Hey, guys. Good morning.

Hey, Brett.

Hi, Brett.

Wanted to start with BHG and just try and understand a little better the confidence on the reduced losses by 2Q. Can you just walk us through your thought process on BHG? Obviously, the guidance is for fairly minimal growth and contribution this year, but it sounds like you're thinking it could be a lot better if certain things play out right with credit and perhaps growth.

Yeah, that's a great question. We continue to have conversations with BHG quite frequently. They still believe that the first half of 2022 and the 2021 loans where these outsized losses originate are largely realized quickly. They believe that they are getting through the bulk of the problems, and is looking to manage their charge-offs going forward.

Brett, I just want to emphasize that they are watching their migration analysis, and to Harold's point, losses occur within the first 30 months. They have just a few more months to go before they complete that 30-month cycle for the period when the great inflation occurred.

Okay. That's helpful. And then thinking about fintech, I'm sorry, Terry.

No problem.

Is there a potential for you guys to maybe sell a portion of BHG's ownership to potentially increase capital ratios, or how do you think about BHG ownership from here, especially with the IPO market for fintech being minimal last year?

I think we have decided whenever the time's right, we would like to reduce our ownership interest at BHG in whole or in part. We’d be willing to sell some or all of our position when the markets get to a point where we could enjoy a higher price.

Thank you. Your next question is coming from Timur Braziler from Wells Fargo. Your line is live.

Hi. Good morning. Can we maybe talk through the expectation for net interest margin cadence throughout the course of the year with the expectation for it to be relatively flat in the first quarter and then your outlook with three rate cuts? It seems like there isn't that much NIM upside.

What we expect is that we will see continued increases in our fixed rate lending, which will provide a tailwind for earning asset yields. We will need to maintain constant contact regarding rate cuts to ensure quick responses on our deposits.I appreciate that other banks may be able to lower deposit rates quickly, but we will rely on strong relationships with our clients.

Okay. Got it. And then just looking at the 2024 commercial real estate maturities, can you talk through what years those loans were originated?

Most of our commercial real estate loans are probably on a three to five-year kind of term. By and large, most are ready for rate increases. We've seen some 20% to 30% increase in rentals over the last three to four years.

Thank you. Your next question is coming from Steven Alexopoulos from JPMorgan. Your line is live.

Hey. Good morning, everyone. I'll just start with following up on that. So when I look at the commercial real estate loans that were reset in the fourth quarter, could you share with us what's happening with these loans? Are you able to just renew these without any impact on credit?

I'm not hearing from the credit officers that they're having any kind of particularly onerous time getting renewals accomplished or having to sacrifice concessions to get these new loans booked. We're seeing rent increases and not declines in occupancy rates.

If you go through our 40 largest loans that are being handled by special assets, only two loans in the top 40 are CRE-related. Our client selection processes have been effective, and our portfolio remains strong.

Thank you. Your next question is coming from Casey Haire from Jefferies. Your line is live.

Yeah, thanks. Good morning, everyone. Can you clarify what the GAAP expenses were in '22, and how does that play into your guidance?

What’s on the slide does not include the FDIC insurance special assessment. The mid to high-double-digit expense growth includes various factors that drive us to the high end of the range versus the low end.

That's right. The $30 million in incentive savings was exactly how the plan is supposed to work. If we hit our targets, participants are eligible for target awards. If we don't, then we aren't.

Thank you. Your next question is coming from Michael Rose from Raymond James. Your line is live.

Just a follow-up on BHG. In the press release, you mentioned that they exited some businesses. Can you just discuss what those are and what the impact was to their origination guidance for 2024?

They exited their buy now, pay later franchise. They've also decided to abandon their patient lending franchise. That’s factored into their production guide for this year.

Got it. Thanks. Just a follow-up on the margin as well. It sounds like there's a pretty steep ramp in NIM progression as we move beyond the fourth quarter, even with the expected rate cuts. Can you clarify that?

We see NIM increases this year, but it will be fairly gradual. Our first quarter will be challenging, but after that, we should expect some positive momentum.

Thank you. Your next question is coming from Brandon King from Truist Securities. Your line is live.

Hey, good morning. Is it fair to say that deposit costs have already peaked, considering the spot rate for deposits was lower at the end of the year compared to the average for the quarter?

Well, until we get a formal rate cut, there will be some deposit creep, but it won't be nearly at the pace we saw in 2022.

Thank you. Your next question is coming from Matt Olney from Stephens. Your line is live.

Hey, thanks. Just wanted to go back and revisit the '24 outlook. It feels like you're trying to say that there will be modest year-over-year PPNR growth even with the higher expense guidance. Can you clarify?

Our planning assumption is that we will see PPNR and net earnings accretion in 2024. It probably won't be consistent with years prior but we fully expect to outperform the peer group.

Thank you. Your next question is coming from Stephen Scouten from Piper Sandler. Your line is live.

So, is the belief that this Jacksonville expansion can be a $1 billion to $2 billion asset bank, and what’s the plan for Louisville noted on the map?

Yes. Our target for Jacksonville is a $3 billion bank in a five-year period. We have started a de novo operation in Louisville. We’re expecting a rapid build-out in Jacksonville similar to what we did in DC.

Got it. And what's kind of embedded within the expectations for net charge-offs?

We believe our expectations are aligned with a soft landing, perhaps a modest recession, and we feel our modeling holds up under current market conditions.

We are expecting around 16 basis points in net charge-offs unless there’s a severe economic downturn.

Thank you. That concludes our Q&A session. Everyone, this concludes today's event. You may disconnect at this time and have a wonderful day. Thank you for your participation.