Earnings Call Transcript - PNFP Q2 2020

Operator, Operator

Good morning, everyone, and welcome to the Pinnacle Financial Partners Second Quarter 2020 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 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. During this presentation, we may make comments which may constitute forward-looking statements. All forward-looking statements are subject to risks and uncertainties and other facts that may cause the actual results, performance 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 annual report on Form 10-K for the year ended December 31, 2019 and its quarterly report on Form 10-Q for the quarter ended March 31, 2020. 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 the non-GAAP measures to the comparable GAAP measures 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.

Terry Turner, CEO

Thank you, Jimmy. At the conclusion of our Q1 conference call, I tried to provide some guidance for what our focus would be going forward. I indicated that we continue to manage those things that produce long-term shareholder value but would remain in a more defensive posture until we can see more clearly the depth and duration of the pandemic and its impacts. Specifically, I indicated that we had increased liquidity in Q1, and we continue to do so in Q2, which we did. Harold will review in detail the substantial liquidity build from both wholesale and client funding, all obtained simply out of an abundance of caution, given the uncertainty surrounding the pandemic. I indicated that you should expect us to continue building loan loss reserves in Q2, which we did, not to the extent we did in the first quarter, but still a meaningful increase. Our allowance has moved from 0.48% at year-end now to 1.27% at June 30. Excluding our PPP loans, the allowance would be 1.41%. Regarding capital, I indicated that while we did not intend to cut our dividend at this time, we were still in a mode to increase capital, which we did. Beyond suspending our share buyback and retaining the subordinated debt we had previously intended to redeem, we sold preferred shares totaling approximately $225 million, increasing or topping off Tier 1 capital. I also indicated that for the first time since the Great Recession, we were slowing our planned levels of recruitment and hiring in an effort to avoid the expense build that goes with it, which we've done. Our noninterest expense to asset ratio, as we adjusted, was 1.54%, which is the lowest I can recall in the history of the firm. As I mentioned last quarter, it's inconceivable to me that in the final analysis, 2020 will have been about what our earnings were in 2020. More likely, it will ultimately be about how nimble we were in a rapidly changing environment and how well we build run rates for earnings in 2021. And so while we're taking defensive steps to bolster capital and liquidity and we're scarring the loan book, we're slowing recruitment to avoid the expense bill, it's really our intent to execute on the fundamentals that we control and those that produce long-term shareholder value, like lowering the cost of funds, obtaining floors on loans and the various core deposit initiatives that we have launched in order to better position ourselves for a return to more normal run rates as we go into 2021. Looking at those fundamentals that typically produce long-term shareholder value, Q2 was an outstanding quarter. Loans and deposits were up meaningfully largely due to PPP. We saw improvement in virtually all of our primary asset quality metrics, although we recognize many of them are lagging indicators. We made substantial headway, lowering our cost of deposits and obtaining rate floors on loans. We saw late-quarter growth in revenue, pre-provision net revenue, spread income, and fee income. As always, we will review our standard dashboard to key success measures for our firm. I'll start with the GAAP measures for the quarter but move quickly to the non-GAAP measure because, honestly, for the most part, these are what we manage to. Total revenues were up 5.4% year-over-year and 14.7% linked quarter. Fully diluted EPS for the quarter was $0.89, primarily impacted by the elevated provision. Harold will review that in detail in just a few minutes. Next to the EPS chart, you can see core pre-provision net revenue was up 15% linked quarter and roughly 3% year-over-year, a really important measure when considering our ability to build the 2020 run rate, as I just mentioned earlier. Loan and deposit volumes were meaningfully up during the quarter. In the case of core deposits, it was our largest growth quarter ever. No doubt, PPP had a major impact on that. But when we dig in, we find that our PPP borrowers' deposit balances grew roughly $1.7 billion during the quarter, which means absent that impact, our core deposits grew north of $1 billion, the largest quarterly organic growth in core deposits ever. As you'll recall, we have placed considerable internal emphasis on core deposit acquisition going back into 2019 and modifying our 2020 incentives, which I believe is also having an impact at this time. Of course, loans were up dramatically in the second quarter, almost exclusively due to PPP. I think there were at least two matters to note. The first is I’d expect pure economic loan demand among small and mid-market businesses outside of PPP in the second quarter would have been near zero. Secondly, in our case, specifically, we saw meaningful paydowns in commercial lines of credit after draws had swelled in the previous quarter, likely indicating less requirement for businesses to finance working assets and less urgent need to build and hold liquidity. After that line paydown phenomenon, loan growth would have been better than budgeted for us in the second quarter. Asset quality was strong, even after the significant risk rating effort during the quarter. Both NPAs and classified assets moved lower, and net charge-offs were just 10 basis points. Tim Huestis will review all of that in greater detail shortly. That's a 30,000-foot summary of the quarter: a growing balance sheet, largely aided by PPP, strong revenue growth, well-managed expenses, and solid asset quality metrics. Let me turn it over to Harold to provide a little more color commentary on the quarter before Tim Huestis digs into the loan book and the loan portfolio review process we undertook during the quarter.

Harold Carpenter, CFO

Thanks, Terry, and good morning, everybody. I'm going to talk more about PPP this quarter. I think it's important so you can better understand how we believe our second quarter results were impacted. Excluding PPP from our end-of-period balances results in a $99 million reduction in our loans for the quarter. As Terry mentioned, last quarter, we had about $250 million in commercial line draw increases. This quarter, line draws were down by $380 million. Line draws were at 50.7%, which is the lowest I can remember in recent memory. Loans are coming in at a slower pace, but there are opportunities. We still believe, based on discussions with our market leaders and commercial lenders, that annualized loan growth will land in the low to mid-single digits for this year, of course, after excluding the impact of PPP. Looking forward, we're not anticipating any reduction in PPP loan balances in the third quarter. That may be conservative, but we don't have good forgiveness rules yet, so that's the decision we've made for the third quarter. The SBA told Congress that they hope to have their forgiveness portal up and running by August. We'll just have to see. Average balances for PPP loans were $1.7 billion in the second quarter. Our third-quarter forecast for average PPP loans is slightly more than $2.2 billion. Our yield on PPP loans was 2.89% in the second quarter, so the third quarter should be fairly consistent based on our note paydown assumptions. We're forecasting principal reductions in PPP loans in the fourth quarter. Our internal forecast anticipates that 13% of our $72 million in PPP fees will amortize into income in the third quarter and then 37% in the fourth quarter, given our guests that we will likely get meaningful PPP forgiveness in the fourth quarter. Now to deposits. As Terry mentioned, there was a huge deposit quarter for us. End-of-period deposits were up almost 26%, while core deposits are up 15% over March 31. Significant growth in noninterest-bearing deposits ending at $6.9 billion. There's a chart in the supplemental information that characterizes the second quarter growth for loans and deposits. We're estimating that the PPP program provided about $1.7 billion of our deposit growth for the quarter. This is a rough estimate because it's practically impossible to determine a precise number. That number is simply the net growth in PPP borrowers’ deposits between March 31 and June 30. We do anticipate that a meaningful amount of these deposits will move off our balance sheet over the next few quarters as the PPP borrowers use those funds. The rest of the same quarter growth was split with $1 billion in client growth and $1.4 billion in wholesale deposits. Wholesale deposits were acquired as part of our decision to amp up our liquidity as a result of COVID. In all likelihood, we'll see some of these wholesale deposits decrease in the third and fourth quarters, so we intend to let our liquidity return to more traditional levels over the next 12 months. This is all contingent on COVID and obviously, progress toward the vaccine. Next is the usual update to our loan pricing. Given the circumstances, we're very pleased with how loan spreads have held up when you consider the 30-day LIBOR average was about 1.4% in the first quarter. That fell to 35 basis points in the second quarter and will likely be 15 to 20 basis points in the third quarter. Our relationship managers are working with borrowers to increase LIBOR spreads and are finding success. As noted on the slide, our second-quarter LIBOR rates for new loans were at 3.15% compared to 2.85% of the entire LIBOR portfolio. Prime-based credit is hanging tough, basically trying to keep a handle on these credits, getting more and more successful in achieving loan floors on the prime and LIBOR books. So we are excited to see that occurring. Fixed-rate lending is also stable; we're giving up some yield on new fixed-rate loans as new loans come in at around 4% in the second quarter with a total fixed-rate book yield of around 4.35%. Forecasting loan yields in this environment is pretty difficult right now, given the uncertainty around PPP loans. We should experience some loan yield contraction in the third quarter, given the impact of PPP and where LIBOR is covered. Offsetting these two items for us will be the success we're having in loan floors. At June 30, we had $2.7 billion in shorter-term variable rate credit with a loan floor, and that number is up from $2.1 billion at March 31. We also have $800 million in shorter-term variable rate credit that comes up for renewal between now and year-end 2020 that doesn't have a loan floor yet. One of the big opportunities we have as we work our way through 2020 is to build loan floors into our prime and LIBOR loan books; doing that will obviously help us as we ramp into 2021 in this lower for longer flatter yield curve. I’m not going to spend a great deal of time discussing deposit pricing. This is obviously not a new chart, and it seems like deposit betas are so last year. That said, the other big thing we can do as we focus on building our ramp into 2021 is managing our deposit and total funding costs. We see no reason we should not be targeting a range of less than 25 to 30 basis points for deposit costs by year-end. Our relationship managers have their client list and are working with them aimed at depositors who have higher deposit pricing. We have approximately $1 billion in CD renewals in the second half of the year, and we will be gradually reducing our wholesale funding balances, both of which will serve to reduce funding costs. Now we're bringing this information forward from last quarter; I'm not going to spend a lot of time this quarter as much of the information we've already covered. The NIM chart on the top left goes back to 2007 and tracks our NIM in relation to Fed funds target rates. We should experience some loan yield contraction in the third quarter, given the impact of PPP and where LIBOR is covered. Looking to the third quarter, we're optimistic that the GAAP margin will hold fairly steady and be somewhat dependent on our third-quarter PPP results. Our best guess right now is that we will continue to build reserves in the second half of the year until visibility improves. Lastly, this slide addresses what we think going into the third quarter. No guarantees, but we're more optimistic about things in general than we were at the beginning of March.

Tim Huestis, Credit Analyst

Thank you, Harold. Good morning, everyone. From a credit perspective, the second quarter was a continuation of prior quarters for metrics such as past due loans, nonperforming assets, classified assets, and net charge-offs. We acknowledge COVID's full impact on the economy and our clients is still unfolding, but these standard measures of loan quality continue to hold up well. Before I go into our credit slides, I wanted to outline our loan regrading work during the second quarter because our in-depth credit reviews may be more than many of our peers. During the second quarter, we re-risk graded all loans greater than $1 million with a payment deferral in every hotel loan and every pre-retail loan greater than $1 billion. Our regrading effort was done at the loan level, not from a top of the house portfolio approach. Our method was interaction with each borrower one-on-one. We regraded approximately 1,280 loans. Our regrading process entailed collecting current monthly borrower financial statements or monthly property operating statements, current personal financial statements, liquidity verification, and contingent liability statements on our guarantors. We believe that collecting interim financial statements throughout 2020 will provide us with a baseline, given that borrower 2019 year-end financial statements may not be indicative in assessing their current financial health. For C&I loans, we deployed a survey questionnaire to gather feedback regarding key variables such as revenue forecast for second, third, and fourth quarter compared to the same period in 2019. Client ability to resume regular payments by the second, third, and fourth quarter 2020, a question regarding months of operating liquidity on hand, and finally, supply line disruption. Our bankers will discuss each question with our clients and then record the client response using an online tool that enables easy data aggregation. Our goal during the second quarter was to identify and recognize those borrowers who warranted a non-pass risk grade of criticized or classified. We did have an increase in the criticized risk grade during the second quarter that is largely attributed to our hospitality book. We have moved approximately 78% of the hotel loan balances into the criticized risk grade category. In our regrading work, we placed significant weighting on the hotel industry, given its known challenges. By mid-June, many of our clients in these sectors had occupancy rates in the upper 40%. Many of these clients can cover interest expense at a mid-50% occupancy. But with the anticipated recovery period of the hotel industry now less clear, we believe this conservative risk rate stance is appropriate. Pinnacle's risk rating process is fluid, and should the hospitality sector improve later this year or into 2021, we will revisit the criticized classification of this portfolio. Our second-largest increase in criticized was CRE retail, but its total was modest and only represented 4.4% of the CRE retail loan balances. We acknowledge retail as an impacted sector, but it will take time for the full impact of COVID on retail to be understood. On a very positive note, after concluding our very thorough second-quarter review of all deferrals greater than $1 million and reviewing all hotel loans in all CRE retail loans greater than $1 million, our classified assets at June 30 decreased $12 million from the first quarter. Additionally, our NPAs decreased by $13 million from March 31 to June 30. For our C&I clients with a loan payment deferral, we conducted a seven-question survey during late May and the end of June. Our survey tool aided us as a qualitative overlay in risk rating our clients. We surveyed 443 businesses representing approximately $1 billion in loan balances. The results were guardedly optimistic. Three-quarters of the clients responded by fourth quarter, their top line revenue would be between 75% and 100% of the same quarter in 2019. Three-quarters of the clients responded that by third quarter, their cash flow would be sufficient to resume debt payments as originally agreed. 45% of the clients reported seven months or more of liquidity to cover operating costs, and only 6% reported material supply chain disruption. Pinnacle continues its approach of a well-balanced and granular portfolio. While our second-quarter credit metrics likely don't yet evidence the full impact of COVID on our loan portfolio, we understand that its fiscal stimulus and PPP proceeds are expanded. Absent further stimulus, we may see these credit metrics change. As Harold has elaborated, our provisioning is largely driven by economic forecasts for unemployment and GDP. And as such, we have meaningfully increased our credit loss reserve over the last two quarters. Pinnacle adopted a defensive strategy during the second quarter, and we will regrade most of the remaining portion of our loan portfolio at the loan level during the third quarter. Our emphasis will continue to be on borrowers in highly impacted industries. Our goal is to quickly identify those borrowers who have been meaningfully impacted and bring the appropriate resources of the bank for resolution while there is an opportunity to rehabilitate the credit and assess and improve our collaterals.

Terry Turner, CEO

Okay. Thanks, Tim. In last quarter's call, it was my objective to get everybody on notice that moving forward in this pandemic, it was our intent to move from offense to defense, to slow our investment and growth until the storm has been weathered and the environment is once again conducive to our unusual ability to attract talent and to take share. Defense will continue to be our number one focus as we move into the second half of 2020. We've elevated liquidity meaningfully. We've taken actions to preserve and increase capital. We've built our allowance for credit losses substantially in the first two quarters, and Harold has already indicated a bias toward further elevation in the second half of this year. As you've already heard from Tim, we allocated enormous resources to the re-risk grading of more difficult loans in our portfolio during the second quarter. It's our intent to finish re-risk grading the rest of the graded loan portfolio during the third quarter. That said, I believe our aggressive addition of revenue producers over the last two years, who are still in the early stages of consolidating their client base from where they were before to us, should result in ongoing growth, albeit at a slower pace than what we would have been producing pre-COVID. As we've already discussed, while we won't hire nearly as many as we had planned this year to contain expense growth, we will continue to make important hires. The truth is, from a client perspective, these are the times that firms like ours are able to clearly differentiate ourselves from our competitors in terms of how we value clients, and consequently, we expect to pick up important market share that fuels earnings growth as we come out the other side of the economic slowdown. Specifically, we intend to maintain elevated levels of liquidity until we find a more certain economic footing. Right now, as you heard Harold say, we intend to begin reducing some liquidity over the third and fourth quarters but ultimately will unwind the institutional portion of that and pick up that cost savings when it's appropriate. After our $225 million preferred issuance, we feel like we're in great shape on capital and consequently don't anticipate any further capital actions at this time. As I mentioned before, although we don't intend to cut our dividend at this time, we're still in a capital preservation mode, suspending our share buyback program and retaining the subordinated debt that we had previously intended to redeem. We'd expect that our primary mechanism for growing our capital cushion from this point forward is through retained earnings. Hopefully, our very strong pretax pre-provision ROAA of 1.82% demonstrates that we'll have the flexibility to do just that. We slowed our recruitment and hiring in an effort to avoid the expense build and enable us to maximize pre-provision net revenue as an important aspect of our defensive posture. I want to be clear, we've not frozen hiring completely. We've just slowed it. And of course, relative to our 2020 plan, we'll harvest a significant amount of budgeted incentives that are tied to EPS targets, which will offer expense run rate in 2020 meaningfully. So much of what we've been talking about is defense. But one of the things that governs us during a time like this is the value that we place on our client relationships. Many of our competitors in the past have been viewed as reactionary and heavy-handed and consequently have meaningfully damaged their reputations for valuing long-term relationships. It would surprise me if it were different than that this time. According to Greenwich Associates, following the Great Recession, Pinnacle has earned the best reputation in our markets for valuing long-term client relationships, and that bond remains critical to us now. Keep in mind, I believe that Greenwich is doing research for virtually all of the top 50 banks in the country, plus about 600 more. Among all those banks and all those markets, they are already finding that the differentiation that took place in the Great Recession is, in fact, taking place now. How banks handle deferral thus far in the pandemic makes a difference. How banks manage the PPP process makes a difference. Based on their extensive research with bank clients, Greenwich has recognized we are standing out on those variables that are important to clients, and we're thrilled to be one of them. When you combine the long-standing relationships we've built with our emphasis on providing long-term client considerations, Greenwich has found there has been much angst over the PPP process, which has already eroded bank loyalty among businesses and their owners. This provides a once-in-a-generation opportunity for market share takers like us to harvest significant market share. Last quarter, Greenwich had already found that three in ten companies with annual revenues between $5 million and $500 million intend to switch banks. 30% market share is already up for grabs between two to three times the normal level, and it's still early in the crisis. So even at this point in the crisis, we believe things like our handling of deferrals and the PPP process are bolstering our reputation for valuing clients, making us one of the primary beneficiaries of the market share movement that will inevitably occur as we come out the other side. Jimmy, we'll stop there and be glad to take questions.

Operator, Operator

Thank you, Mr. Terry. The floor is now open for your questions. Our first question comes from Stephen Scouten with Piper Sandler. Your line is now open.

Stephen Scouten, Analyst

Good morning. Thanks for all the detail here this morning. I'm curious on the guidance around BHG. It seems like it was intimated that 3Q revenue could be similar to 2Q. But then looking at the one slide, it also notes that year-over-year earnings growth should be up. So I'm wondering if that implies an extremely large 4Q? And if so, is that driven by the securitization or something altogether?

Terry Turner, CEO

Yes. I think 3Q will be similar to 2Q. We’re not sure about 4Q right now.

Stephen Scouten, Analyst

Okay. Got it. That makes sense. Okay, thank you. And then kind of thinking about the NIM moving forward, I mean, obviously, you noted the 32 basis points of drag from liquidity and PPP loans. But I'm wondering where you think whenever liquidity does normalize, let's call it, sometime early 2021 for argument's sake, where do you think the NIM could normalize at that point in time? Is that kind of back north of 3%?

Harold Carpenter, CFO

We think so. We think that the NIM will begin to increase back into the low 3s, call it, second quarter of next year. At the same time, the accretion from the BNC loans that we acquired will be trailing off to pretty much insignificant amount.

Stephen Scouten, Analyst

Great. Okay. And maybe just last thing for me. Obviously, you guys noted that you will continue hiring slowly. I'm just wondering if you could give some color as to where you are in the pace of the Atlanta plans relative to the 50 RM target longer-term. And then you guys have never really been the bank that focuses on cutting expenses on a net basis, but is there any likelihood in this environment we could see some sort of expense initiatives? Thanks.

Terry Turner, CEO

In the case of Atlanta, I believe these numbers are roughly correct. I think we ended the first quarter with about $40 million in loan outstandings and nearly $30 million in core deposits. I would view that to be successful and ahead of plan for what was effectively in the first quarter operation there. So we continue to be excited both about the recruiting pipeline of associates as well as the recruitment of clients. It looks like major pipelines are solid for another good quarter here in the third quarter. As it relates to the expense initiatives, I think your assumption is basically right. Our approach on expense initiatives, I would characterize it more about trying to drive PPNR up now because that's how we fund some of the activities we've got to fund at this time where we need to be on defense. But I don't think you ought to expect us to have real meaningful expense initiatives where we're going in and making structural changes to the business.

Steven Scouten, Analyst

Okay. That’s very helpful. Thanks for the color, guys.

Operator, Operator

Thank you. Our next question comes from Jared Shaw with Wells Fargo Securities. Your line is now open.

Jared Shaw, Analyst

Hi, good morning.

Terry Turner, CEO

Good morning, Jared.

Jared Shaw, Analyst

Sticking with the margin and NII side. As you talked about the liquidity drawdown. So that $1.4 million, should we assume sort of that $1.4 billion of wholesale coming off, call it, $400 million a quarter? Or is it not quite that linear?

Terry Turner, CEO

Well, it’s definitely not linear, Jared, but we're anticipating about, call it, $700 million between now and the end of the year. Now granted, that's about half of it between now and the next four quarters, but it's not exactly on a straight line.

Jared Shaw, Analyst

Okay. And then on the floors that you're putting in, can you give a little more detail around – I mean, is that actually – should we expect to see some loan yield pickup on those? Are those floors sort of above where we are here? Or is that just more protection for the future?

Harold Carpenter, CFO

Yes. We're optimistic that we will get loan floors, call it with – in the mid-3s or on the LIBOR rate-based credit. So we're hopeful to get some accretion in yield on those particular loans, but we're also doing things with some borrowers to protect against negative rates. So there's some of that going on as well.

Jared Shaw, Analyst

Okay. And then just finally for me, it was great color that Tim gave on credit. Can you give an update on how the non-graded credits are looking, that small business pool? What are you doing to reach out to those customers and how you're trying to evaluate those pools of loans?

Tim Huestis, Credit Analyst

Yes, thanks. We did reach out to those clients. Trying to find my exact note here. I think we reached out and touched 1,379 of our small business loans and the results were very encouraging. I mean, I realize it's preliminary, but out of those 1,379 small business loans and a response rate of 85%, we only identified $80 million that we would call elevated risk. So that continues to be an area of focus for us, but our survey results, and this was done mid-June, came back quite positive.

Jared Shaw, Analyst

Great. Thank you very much.

Terry Turner, CEO

Welcome, Jared.

Operator, Operator

Thank you. Our next question comes from Catherine Mealor with KBW. Your line is now open.

Catherine Mealor, Analyst

Thanks, good morning.

Terry Turner, CEO

Good morning.

Harold Carpenter, CFO

Good morning.

Catherine Mealor, Analyst

One more on credit. Just to dig into the deferrals a little bit, the reduction was really encouraging to see. Is there also a way to dissect that to look at what dollar number have asked for a second round of deferrals? And then maybe the dollar math that you expect to come off deferral over the next, call it, couple of months, just so we can kind of – the decline was great, but just kind of think about how much of that is just from running off and how much is actually renewing into a Phase II?

Tim Huestis, Credit Analyst

That decline was as of yesterday, we all know we were doing deferrals in April, mid-April, late April, early May, and that window will come open soon. And talking with our FAs, we believe the declines will continue. It's hard for me to give you a hard number, but I think that they will continue to decline based on conversations that our FAs have had with clients about deferrals that hit that 90-day window, early August, mid-August, late August.

Catherine Mealor, Analyst

Okay. And what – how does the Phase II look like? What are you doing differently with those modifications?

Tim Huestis, Credit Analyst

When we rolled out our program, it was a 90 plus 90, Catherine. So we would talk to that client before the first 90-day period. If we felt and credit qualified, then we would extend that second 90 days using that same initial document that was executed. I will tell you, with any of the new deferrals, and we've had just an inconsequential number since the 1st of June, we are now asking for all the financial statements upfront before we make a decision so we can grade that credit right then on the spot.

Catherine Mealor, Analyst

Okay, great. And then on – switching to BHG, is there any color you can give on what gain on sale margins have gone this quarter versus last year? Are they still staying steady? Or have you seen those pull back?

Harold Carpenter, CFO

Now, they were pretty steady for most of the quarter. I think in June, they pulled back about 0.5% or so. But I don't think – they're not anticipating to see any kind of trend line lower than what they've experienced for the first, call it, five months of the year.

Catherine Mealor, Analyst

Okay. Great, great to hear. Okay, thank you.

Terry Turner, CEO

Thanks, Catherine.

Operator, Operator

Thank you. Our next question comes from Brock Vandervliet with UBS. Your line is now open.

Brock Vandervliet, Analyst

Thanks. Sticking with BHG, I think the loss rate slide that you cover on the – loss rate stats covered on Slide 21, is very helpful. Where does that – what are you thinking in terms of where that peaks and when? I know that's probably the hardest question, but what's your read on where things peak?

Harold Carpenter, CFO

Yes, Brock, I think it is a great question, and you're right. It's an impossible one to answer. But – and I'm assuming you're talking about the orange line specifically. So they believe that it's probably going to be in this 6% kind of range, somewhere in that neighborhood. It could be more, it could be less.

Brock Vandervliet, Analyst

Okay. And on the securitization, I mean, it looks like very bold timing here. I would have thought you would get better execution if you'd waited. But at the same time, very reassuring that you think you can get this done with BHG. And is this going to be kind of a niche financing vehicle? Or is this really the wave of the future and how BHG finances itself going forward longer-term?

Harold Carpenter, CFO

Yes. I think they will use it as part of their financing package. Last year, when they had the Analyst Day, I think they mentioned somewhere around a 50-50 revenue split between gain on sale and interest income. So it will take a few years to get to that. But they intend to approach the markets in a really active way, and I would guess that might be three times a year probably, something like that. So they want to get some experience with it and use that as kind of a permanent tool in their toolbox.

Brock Vandervliet, Analyst

Okay. That’s exciting. Lastly on the expenses, if I'm doing the math right, I would think the 2020 expense base is around $550 million annualizing the Q4 2019. Is that kind of in the striking essence there, Harold?

Harold Carpenter, CFO

2020? Yes, the 2020 total expenses, I think the guide was based on mid-single-digit increases annualizing the Q4 2019? Yes. And I mentioned on the call that we may include another incentive component, so your number, we ought to come in within that number even with that additional incentive number. So I'm not seeing us but getting above $550 million.

Brock Vandervliet, Analyst

Got it. Okay. Thanks very much.

Operator, Operator

Thank you. Our next question comes from Jennifer Demba with SunTrust. Your line is now open.

Jennifer Demba, Analyst

Thank you very much. Good morning. Terry, I wonder if you could talk about national tourism and how that's gone amid this pandemic. And what kind of impact that has on the total national economy when it's – when rent is really good or when it may be struggling? Thanks.

Tim Huestis, Credit Analyst

Yes. I would – Jennifer, I would tell you just anecdotally, the count of people has rebounded some. Obviously, I'll see them on the streets in the evening when I leave, but it's nowhere what it was pre-COVID. I think the spike in cases and the drop in tourism has been very noticeable and pronounced. But I've been surprised, Jennifer, at the number of people that have returned. So I don't really have specific percentages or dollars for you, just more perception of working downtown. It is off and likely will remain so for a while.

Terry Turner, CEO

Jennifer, I might add to that, that, of course, a lot of what drives tourism is the music city center, and they don't have any conventions and don't anticipate any into 2021. So that's a pretty meaningful indicator. I think in terms of downtown hotels, many are open, but there are still a few that are closed or operating with limited service and so forth. So clearly there's an impact. I think to Tim's point, I'm not sure whether to describe it as fortunate or unfortunate, but I do encounter more pedal taverns these days than I did over the last few months. And so to Tim's point, I think some of the tourism is rebounding, but I'd classify it in early stage; I wouldn't think we would even be a midpoint of the return on tourism in Nashville. Obviously, that has an impact. I think if you look at sort of the reopenings in Nashville, like every city and every state, there's sort of a phased reopening plan with maybe four stages of reopening. We hoped by now we'd be in the third phase, but we've backed up into the second phase of reopening because the coronavirus cases have spiked, like a lot of other cities that are reopening. My belief is what we're seeing there is the same thing we're seeing in other markets where it's concentrated in young people who are perhaps more fearless than 65-year-olds. But anyway, I don't know if that's helpful to you.

Jennifer Demba, Analyst

And have you heard any anecdotes on corporate relocation pipeline for Nashville? Or do you think that's come to a bit of a halt here with the crisis?

Terry Turner, CEO

My sense is that the corporate relocation pipeline is still full. I don't recall any major announcement of late, but I do believe that Amazon announced in addition to their opening of their jobs that they were bringing in. They're adding another, I don't know how many thousand jobs, but it was a big deal. There's a recent announcement out in Henderson. Bill, do you remember what that was – I don't. I can't remember. But Jennifer, it seems to me that the development pipeline continues to be strong.

Jennifer Demba, Analyst

Thanks so much.

Terry Turner, CEO

All right.

Operator, Operator

Thank you. Our last question comes from Steven Alexopoulos with JPMorgan. Your line is now open.

Steven Alexopoulos, Analyst

Hey, good morning everybody.

Terry Turner, CEO

Hi, Steven. Good morning.

Steven Alexopoulos, Analyst

First, regarding the additional potential incentive this year, maybe to set up a stronger 2021, can you give more color on this and maybe what options you're looking at?

Harold Carpenter, CFO

I think we're looking at probably a corporate PPNR measurement, maybe trying to understand what we think 2021 looks like if we can get a nominal amount of loan growth, continue to see strong deposit inflows, what our fee businesses are doing, and what can we think will happen in 2021? And what do we need to do today to ramp into it? So it will be along those kinds of thought processes. Steven, I don't know if that's helpful or not, but we’ll probably likely exclude credit from it because it's difficult to incent people around credit, particularly in this environment. We definitely want to be early in and early out. We want to get our loss content recognized as soon as possible. When you marry that up with some kind of incentive plan, it becomes sometimes difficult.

Terry Turner, CEO

Steve, I might add to Harold's comments. I mean, the key actions to be successful for us on the PPNR are really driving the cost of funds lower, faster, and picking up rate floors at a higher penetration. Those kinds of actions are the things that we're trying to stimulate here.

Steven Alexopoulos, Analyst

Okay. And what's the timing that you think something like this could be rolled out?

Harold Carpenter, CFO

We think probably over the next couple of months. We talked to our Board about it. I think we received favorable responses from them. I think they understand the concept and the benefit that it could drive for shareholders. So I think probably over the next couple of months.

Steven Alexopoulos, Analyst

Okay. That’s helpful. And then on credit, it was nice to see that classified loans come down in the quarter. What was the trend you saw in criticized and watchlist in 2Q?

Tim Huestis, Credit Analyst

On criticized, we moved the bulk of the hotel book into the criticized category. That was about $750 million. So obviously, the percentage of our loans for criticized this quarter have gone up significantly. We did have some in our C&I book and some in the CRE retail, but it was largely driven by our recognition of the distress of the hospitality sector.

Steven Alexopoulos, Analyst

Okay. That’s helpful. And then finally, for Terry, you mentioned there's a good opportunity to take customers, and it depends how peers handle deferrals, PPP, et cetera. Curious, what are you seeing from regional bank peers? Are they struggling to offer PPP in these different programs? And maybe if they are, why? Is it technology or work from home or something else? Thanks.

Terry Turner, CEO

What – I guess, Steve, I'd go ahead just in terms of our personal experience, and then I'll go back to the Greenwich. So I think in terms of our personal experience, most of the big – I shouldn't say most, a number of the big banks within we compete, they were not able to get their system up early. It took them – they were late days, to get the PPP system up to even accept applications. I think they were very slow, which, of course, everybody was slow, but I think their ability to communicate with clients and keep them up to speed on where they were in the process and all those kinds of things was really deficient. And so that was the experience that we saw. And then to some – maybe a little more reliable than just my own observation there, I think in the case of Greenwich, they've seen that there is significant angst throughout the system that's tied to both deferrals and PPP, where – so much of it is how you deal with the client. As an example, I think about what we're doing to go out here and gather all this information, conduct these surveys. If you go out there with a heavy-handed approach, like a lot of those companies are prone to do, you might achieve the same result, but we're out there trying to do it in a way that inspires confidence and make sure that they understand that this review is helpful to them and to us. It not only helps us understand the risk, but it puts us in a position to better take care of them, if we're in a position to document what their path forward is as the economy reopened and so forth. So anyway, anecdotally, we certainly saw it. It was tied to some measure to their ability to get their systems up, and it was tied in some measure to just how they interface with clients and their inability to talk to clients and tell them where they were in the process and so forth.

Steven Alexopoulos, Analyst

Okay. Thanks for all the color. Thanks for taking my questions.

Terry Turner, CEO

Yes.

Operator, Operator

Thank you. Our last question comes from Brian Martin with Janney Montgomery. Your line is now open.

Brian Martin, Analyst

Hey, good morning, guys.

Terry Turner, CEO

Hey, good morning, Brian.

Brian Martin, Analyst

Just one question back to the deferrals, maybe for Tim. Just with the progress you guys have made already, I guess, Tim, what do you anticipate the deferrals – by the end of the year, any of the more troubled properties have been restructured and ultimately come off of deferral? Or should we assume that some of those more troubled ones could be in deferral for a much longer period of time that's allowed under the CARES Act?

Tim Huestis, Credit Analyst

Yes. What we will do in the third might – some of them might spill into early fourth quarter is modify the loans, not a deferral. We'll be looking at collateral guarantees so forth and asking for their cooperation, maybe their putting up cash for part of the deferral. With that modification under the CARES Act 4013, we don’t have to flag it as a TDR. So our goal will be to get all of the hotel loans that are showing signs of recovery modified. It may be a modification that extends an interest-only period into 2021 and then resumes amortization mid-to-later 2021, but we'll be working that with each borrower one-by-one based upon how their property is recovering.

Jared Shaw, Analyst

Okay. So it's current by the end of the year, just maybe current under a new structure as opposed to deferring under the old structure?

Tim Huestis, Credit Analyst

Correct. We will modify the loan before year-end with the new repayment term.

Jared Shaw, Analyst

Great. Thank you.

Operator, Operator

Thank you. And I'm showing no further questions in the queue at this time. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude your program, and you may now disconnect.