Earnings Call Transcript - PNFP Q4 2020

Operator, Operator

Good morning, everyone. And welcome to the Pinnacle Financial Partners Fourth 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 presentations 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 in a listen-only mode. The floor will be open for your questions following the presentation.

Terry Turner, CEO

Thank you, operator. Thank you for joining us this morning. I know everyone is familiar with the fact that we're coming to you from Nashville, Tennessee, home of Vanderbilt University. There's an accounting professor at Vanderbilt who, in years past, has used Pinnacle as a case for his accounting class. The students have to analyze our financials, our footnotes, follow all our SEC filings, listen to our earnings calls, and so forth. After assigning them to listen to our earnings call, he told me that he opened with an open-ended question to get their overarching reaction to the call. He said that they had two overarching reactions: one, those guys sure sound optimistic; and two, they sure sound Southern. So, my guess is that following our call today, you may have the same reaction. The fourth quarter was an outstanding quarter for us. We had key success measures like asset quality, core deposit growth, fee income growth, pre-provision net revenue growth, and tangible book value accretion, all very strong during the quarter. We begin every quarterly call with this dashboard reflecting our key performance metrics on a GAAP basis. Honestly, there are so many adjustments required to focus on the variables that we are truly managing here at Pinnacle that I want to move quickly to the chart reflecting the adjusted non-GAAP measures. As you can see here on the top row, total revenues, fully diluted EPS, and adjusted PPNR are all up meaningfully on a quarterly basis. 2020 revenues were up roughly 9% year-over-year at a time when many have been predicting banks cannot earn in 2021 what they earned in 2019. We are very proud that our second half 2020 fully diluted EPS exceeded 2019's by 28%. Adjusted PPNR for 2020 is up nearly 9.4% over 2019, while PPNR per share is up 11.4%.

Harold Carpenter, CFO

Thanks, Terry. Good morning, everybody. Many of our slides we've shown for quite some time on fourth quarter results are basically consistent with what we've anticipated from last time. So I don't believe there's a ton of new information. So I'll hit the highlights. We experienced a wealth of loan growth for the fourth quarter. Excluding PPP, we're up almost 8% annualized between the third quarter and fourth quarter. We don't have a trend just yet, but it was a positive signal. We will lean on our new hires over the last few years to give us an advantage on loan growth. As you know, we're in great markets. We don't apologize for any markets where we do business, so we think that too will help us outperform when entrepreneurs begin to see the fog lift and we see loan growth reemerge in a more predictable way. That said, our market leaders believe that loan growth forecast excluding PPP of high single-digit growth in 2021 is a reasonable number for our firm.

Tim Huestis, CLO

Thank you, Harold. Using the traditional credit metrics of net charge-offs, NPAs, classified assets, and past-due loans, Pinnacle's loan portfolio continues to hold up very well. We acknowledge that for some of our clients, the first half of 2021 may prove challenging, but we remain optimistic given the combination of the new stimulus package, additional PPP loans to our clients, and the COVID vaccines. As in the prior two quarters, our bankers and credit teams completed thorough client credit reviews by collecting monthly financial statements and/or rent rolls to reevaluate our borrowers' assigned risk rates. Particular emphasis was placed on our non-pass credits and on the loans that we had rated a low pass risk rate due to COVID. The results for our fourth quarter work were encouraging. Our classified assets decreased by $46 million. For the criticized loan category, we had a modest net increase of $100 million, which was partly attributed to three hotel construction loans that were recently completed during the fourth quarter. We moved these hotel loans into a criticized rating to be consistent with our conservative hospitality grading methodology applied in prior quarters. The remainder was made up of small loans across an assortment of property types and industries. Similar to the second and third quarters, during the last two weeks of December, we conducted a four-question survey of 258 C&I clients with loan balances totaling $653 million. The survey was targeted at our low pass grade clients in various segments, such as entertainment, restaurants, and consumer services. Three of the questions asked the borrowers' estimates of revenue for fourth quarter 2020 compared to fourth quarter 2019, first quarter revenue 2021 to first quarter 2020, full year revenue for 2021 compared to full year 2020, and the last question was regarding months of liquidity on hand to cover operating expenses. The responses remain guardedly optimistic. 60% said fourth quarter 2020 revenue would be between 75% to 100% of fourth quarter 2019. 72% estimated first quarter 2021 revenue would be between 75% to 100% of first quarter 2020. 90% estimated full year revenue for 2021 to be between 75% to 100% of year-end 2020, and 53% reported seven months of liquidity or greater. During the first and second quarters of 2020, when COVID's economic impact was largely unknown, Pinnacle proactively reached out to clients to offer loan payment deferrals. Our payment deferrals range from 90 to 180 days and were administered with minimal credit qualification. Given the challenges at that time, we did not attempt to re-underwrite and assign new borrower risk rates. We approached the deferrals as a short-term solution to help clients in a period of uncertainty with very little incremental risk to us in our view. Pinnacle's philosophy regarding 4013 loan modifications is much different. Our modifications were negotiated from the framework as a longer-term solution to help our clients bridge to the other side of COVID. Our philosophy was to improve the bank's position and simultaneously help our clients. With each modification, we collected very current borrower financial information in our efforts to accurately re-risk rate the borrower and to contemplate the terms of our modification. A key distinction between our deferrals and 4013 modifications is that the vast majority of our clients with the 4013 modification are paying interest monthly. As illustrated in the table, our hotel loans make up 63% of our total 4013 modifications, and 52% of our hotel loans have a 4013 modification. While each individual hotel loan modification was negotiated to fit the borrower's specific circumstances, our modifications generally consisted of changing the loan repayment terms to interest-only for three to 12 months in consideration for borrower concessions, such as paying the accrued interest that accumulated during the earlier deferral period, establishing an interest reserve on deposit with Pinnacle, and shortening the loan maturity. As illustrated in our supplemental deck, our hotel book has held up. Our hotel portfolio occupancy for November was 48.7% compared to STR's national occupancy average of 40.3%. We attribute this to our history of conservative hospitality underwriting and our composition of limited service, economy, and extended stay hotels. This slide is to provide detail around the segments of our loan portfolio that were impacted by COVID. As this slide exemplifies, even within these segments, the performance has held up. We believe a few of the contributing factors for this performance include client selection. We hire experienced bankers. They bring their best clients with them. Pinnacle's very successful PPP program for our clients, along with excellent early problem loan detection coupled with a very experienced special assets team. Pinnacle's credit metrics have held up well. We will continue our client-by-client defensive work throughout 2021. As Harold indicated, we will be working with our clients in the next few weeks to again deliver an outsized PPP loan program to provide them with added security. And now I'll hand it back to Terry to talk about moving forward in this pandemic.

Terry Turner, CEO

Thanks, Tim. As part of our first quarter 2020 earnings call last April, I told you that my expectation was that, in the final analysis, 2020 wouldn't be about 2020's earnings but more about how well we can position our firm to return to our previous earnings trajectory following the pandemic. Harold and Tim have done a great job of highlighting the various moves to shore up liquidity, asset quality, and loss-absorbing capacity in the form of incremental capital and loan loss reserves. Our Board was equally nimble, providing incentive for us to focus on building PPNR, which as you can see, is exactly what we did in the last half of 2020. Additionally, even during this pandemic, we hired 90 revenue producers in 2020, more than any other year in our history, which I believe has served us well as we're beginning to transition back to a more offensive footing and position this firm to capitalize on what some believe will be extraordinary market share-taking opportunities following the pandemic. As I mentioned in my introductory comments, in my view, the fourth quarter was an outstanding quarter with NPAs at 38 basis points, classified assets down to 8.1%, and past-due loans at 19 basis points; asset quality appears excellent. Adjusted EPS was up 24% over the same quarter last year. Adjusted PPNR was up 27% over the same quarter last year, and revenues were up 20% over the same quarter last year. We believe that BHG has validated the power of its differentiated model, as they've continued to originate and sell record volumes of loans through their proprietary auction platform and have also successfully securitized loans in what was the first commercial or consumer loan transaction to be rated AA by CRO on its inaugural issuance, another testament to the quality and value of the assets they generate. All of this during the period some predicted might be disastrous. As we've already pointed out, even with the dramatic EPS and PPNR growth in 2020, we still figured out how to afford to hire 90 revenue producers in 2020. As was our goal, we find ourselves well-positioned to move back to offense as the pandemic subsides and the economy reopens. Happily, my guidance as we move into the first quarter of 2021 is that you should expect us to continue focusing on the same items we've been focused on over the last several quarters. Operator, I'll stop there, and we're glad to take questions.

Operator, Operator

Our first question comes from Stephen Scouten with Piper Sandler.

Stephen Scouten, Analyst

So Terry, as a follow-up on your last statement there that you're back kind of on the more aggressive side of things from a hiring perspective. If I'm doing the math right, it looks like you hired maybe 34 new...

Terry Turner, CEO

Steve, we have some kind of wired connection. I really can't understand what the question is.

Stephen Scouten, Analyst

Okay. I'll hop back in the queue…

Terry Turner, CEO

If you could repeat it.

Stephen Scouten, Analyst

I can just hop back in the queue. Let me make sure my technology is working. Sorry about that, guys.

Operator, Operator

Our next question comes from the line of Jennifer Demba with Truist Securities…

Terry Turner, CEO

Stephen, this is Terry. I'm back in. I'm in a new room where I can -- I think I can hear you now. So would you repeat the question?

Jennifer Demba, Analyst

I think Stephen may have hopped off. This is Jennifer. So two questions for you. Number one, Terry, you said you want to be more aggressive now, again, with hiring, but you also have a premium currency again. I'm wondering what your interest is in M&A now versus your interest in more hiring in '21 and '22? Thanks.

Terry Turner, CEO

Just as a reminder, my view today, as my view has always been, is that we are primarily an organic grower. Our principal mechanism or core capability to get that done is our ability to attract and hire great bankers in the markets. As you know, we're in some really attractive markets with relatively low share positions. So, I think you ought to expect that we're going to continue to push on our organic growth model and our hiring, which we believe will be beneficial. That will be the principal thrust of our company. Jennifer, it's a great question. There's no doubt. I guess over time, I've been asked the last few years about M&A and so forth. My view was that our stock was unfairly treated. I believe it traded at a premium as people began investing in bank stocks based on book value. My thoughts compressed more than others, that’s my view. Others may have a different one. But anyway, to net all that is it didn't cause me to say that I wouldn't be interested in trying to deploy my stock as a currency when it is so significantly disadvantaged. I don't think I would characterize M&A as my principal thrust, but I think it does open up additional possibilities that can be considered and evaluated. My principal mechanism we intend to deploy is organic growth primarily through hiring people.

Jennifer Demba, Analyst

Second question, if I could. What changes in your strategy do you envision post-pandemic, whether it be less need for corporate real estate, or branches, or how you meet with clients and prospects and do business or travel? Can you just talk about how you think that could change the Pinnacle strategy over the long run?

Terry Turner, CEO

Yes. I'm confident there will be changes. But honestly, Jennifer, for us, I believe that they will be modest. To recap why I believe that, as you know, we're principally a commercial bank, so our branching strategy has been built around that. Of course, BNC had a different model, a little heavier in terms of branch distribution in some of their markets. In the attractive growth markets we desire to win in, like Charlotte, Raleigh, and Atlanta where we've de novo, we are at a distribution disadvantage. Unlike many companies with legacy branch distribution networks that need to be trimmed back, we're likely on the other end of that. Since we announced the BNC deal in 2017, I think we've closed about 20 offices in our footprint, concentrated in the BNC footprint. We think we've somewhat rightsized or optimized the distribution that we have. Again, I just want to make sure you get the picture. Our position is that we're investing in Charlotte, Raleigh, Charleston, South Carolina, and Atlanta. Thus, we could use more distribution in those markets. Regarding travel and related variables, our strategy is a geographic strategy, so we're generally calling in local markets. Clients are currently seeing you call them on the phone, and that doesn't represent a meaningful dip in our travel budget. My expectation is that from a strategic standpoint, our investment in technology is focused on two kinds of things: first, keeping us as a fast follower in terms of commercial capabilities—we're focused on the pain points of our clients, not just trying to have the Swiss Bank. We're trying to focus on what clients need in real terms. Additionally, we are trying to put our financial advisers, our client-facing people, in a position to be more effective and productive. All this means that we're trying to gather more information and get it to them in ways they can use to advise clients. So I don't look for major changes in our strategy; I think it will be pretty straightforward.

Operator, Operator

The next question comes from the line of Stephen Scouten with Piper Sandler.

Stephen Scouten, Analyst

Can you hear me this time around?

Terry Turner, CEO

Yes, we can.

Stephen Scouten, Analyst

I'm curious; I know you touched on this with Jennifer's question. But just the pace of new hires in particular. I mean, net-net, you ended up being pretty flat for both of the last two years, but it looks like about 34 new revenue producers here in the fourth quarter. So, do you think, on a relative basis, 2021 could be significantly more active than the last two years on a hiring basis?

Terry Turner, CEO

I think it will be more active. The variable, Stephen, as you know, is that if the vaccine rollout is much slower, those kinds of things could slow the process, since the length of the sales cycle, whether for recruiting or moving business, is lengthened in a COVID environment. But on the positive side, our reputation is really strong in the markets we are trying to grow in. The vulnerability is high among many of the large bank competitors we face, with lots of turnover in several of those organizations. To your point, hiring was actually really robust in the fourth quarter. My expectation is that, one way or another, it ought to be stronger in 2021 than in 2020.

Stephen Scouten, Analyst

I'm curious on the loan growth side of things. I know Harold said overall demand still looks sluggish. You guys have benefited more from these new hires and your continual hiring plan that occurred over time. But I'm wondering, especially in the fourth quarter, what changed to the upside? It seems like growth was better than even you all would have anticipated at this time last quarter. So, I’m curious what transpired in the quarter that came out better than you would have expected, and what you see apart from the new hire growth looking into 2021?

Harold Carpenter, CFO

I wish I could put my finger directly on it. But largely, I believe there were some construction projects that began to fund. Also, we saw some year-end C&I borrowings coming in all lines of credit. I'm hopeful— I can't identify it exactly, but I'm hopeful there’s some optimism with some borrowers that might continue into the first quarter. We think first quarter loan growth will be fairly sluggish. However, I am hopeful that people will begin to see renewed optimism and be willing to take some risks.

Stephen Scouten, Analyst

Last for me, following up on Jenny's M&A question, just where would the size of a potential deal need to be at this point in your life cycle for it to make sense for you to pursue it or move the needle? I mean, it's a lot different from when you would have done M&A three or four years ago. I'm just curious about your views in terms of the asset size for something to be relevant.

Terry Turner, CEO

I would just say that we focus more on EPS accretion than anything else, but you can back into an asset size that would yield that kind of earnings accretion. Generally, we're looking for something that will produce double-digit earnings accretion. It would be hard for us to get interested in doing something that didn't do that. Therefore, you would probably have to look at $5 billion banks or greater to have the chance to produce in that realm of earnings accretion.

Operator, Operator

Our next question comes from Steven Alexopoulos with JP Morgan.

Steven Alexopoulos, Analyst

Maybe to start for Harold. Regarding the high single-digit guidance for expenses in 2021. Is that based on adjusted expenses, the $548 million, or is that on total, $577 million?

Terry Turner, CEO

I think you should use the $577 million, Steven, based on what we think is hiring and the recoupment of that incentive accrual; that will probably be the number you should refer to.

Steven Alexopoulos, Analyst

On BHG, we're seeing the banking industry start to release reserves this quarter. Do you see it likely that BHG starts to release reserves over the near term? Is that included in the high single-digit guidance you are giving in terms of earnings growth?

Terry Turner, CEO

No, based on what I've seen regarding their plans for next year, there's no planned reserve release. However, they'll be monitoring that. If it looks like there should be some, they may consider it in next year's results, but we aren’t thinking about that in our high single-digit number.

Steven Alexopoulos, Analyst

But if we look at where their net charge-offs came for the year relative to where the reserve is now, it seems they are dramatically over-reserved. Would you agree?

Terry Turner, CEO

I would agree. They've built a very healthy balance sheet. We're comforted by that balance sheet, and I would not be surprised to see some reserve release next year.

Steven Alexopoulos, Analyst

Looking at the fee income outlook, you guys, like everyone else, will have this mortgage fee headwind to manage. I think you're calling for strong fee income growth in 2020. Can you help us think about what 'strong' means?

Terry Turner, CEO

Yes. I'll try to elaborate. For mortgages, we're not anticipating a repeat by any stretch. Most of the other business units, we are anticipating strong fee growth from the non-mortgage units. That said, it's probably going to be around mid-single-digit growth we're looking at currently. Hopefully, we can reach that.

Operator, Operator

Our next question comes from Brett Rabatin with Hovde Group.

Brett Rabatin, Analyst

I wanted to first revisit core deposits. You're looking for slower deposit growth going forward, but you had really strong core deposit growth in the fourth quarter. Can you talk about the pace at which you're slowing from here? What drove the strong growth in the fourth quarter versus the anticipation of a slower growth profile going forward?

Terry Turner, CEO

I think there are several factors at play, Brett. Number one, let me put this in broader context. Over the last couple of years, we've said and I've used the term internally that we're about changing the personality of our firm. Reputationally, we’d been viewed as great asset generators, yet not as strong in terms of core deposit generators. Some of that is tied into the commercial thrust of the franchise. However, we have set about changing the personality of the firm, stating that, in 2020, we altered our incentive plan. We have always focused predominantly on earnings and secondarily on revenue growth. In 2020, we changed to prioritize deposit growth both in volume and cost. That was important to help us beat the drum and change the mindset. Additionally, we launched several initiatives, some of which have long lead times, but we believe our great platform for HSAs represents a significant market opportunity for us. We've also built the capability to bank property managers, homeowners associations, and similar organizations through value-added accounting support, which is beginning to pay dividends. Furthermore, we've focused on qualified settlement funds and various other products. We have a product aimed at captive insurance for middle-market businesses, which presents opportunity for us. We're seeing strong growth there, as I don't need to delve into specifics. I expected to convey that many structural changes are underway to better our deposit-gathering efforts, and I anticipate dividends from these changes going forward. Now regarding our current situation, as you know, there's extensive liquidity on our balance sheet, which is solely from the PPP program. A considerable amount of funds was placed on our clients' balance sheets as a result. Additionally, many business clients in this environment are amassing liquidity through various avenues beyond PPP. Some of this is due to COVID, while other aspects are tied to structural changes we are making. We expect diminished liquidity this year because we believe the economy will begin to reopen later this year. Hence, you should expect diminished liquidity associated with PPP and other corporate liquidity factors that should slow growth as we proceed. Conversely, we service these initiatives that we believe will keep paying dividends. I'm just trying to provide you with a complete perspective.

Brett Rabatin, Analyst

Regarding the buyback, do you anticipate being active with it this year, or are you at a re-up stage? Your stock is obviously much higher than it was, and if your growth is to be present, perhaps you won't use it?

Terry Turner, CEO

Right now, the planning assumption is that we'll probably use about 80% of it this year or into the first quarter of next year. We will, obviously, use it to defend the stock when necessary. The impact on earnings may not be nearly as significant as it was given where the share price is. Nonetheless, I think we'll utilize a significant portion of that money at some point during the year.

Operator, Operator

Our next question comes from Jared Shaw with Wells Fargo Securities.

Jared Shaw, Analyst

Looking at the second round of PPP, you were so successful with it in the first round. Can you give us some perspective on the potential size of the second round? Additionally, when you work with your customers on that, how successful are you at targeting those unrated commercial customers that caused earlier concern in getting them a second round?

Terry Turner, CEO

Let me update you based on this morning. We're at about almost $600 million in application flow on the second round. More than 90% of that applies to borrowers who were involved in the first round of PPP last year. If you recall, last year, we did 14,000 to 15,000 loans totaling $2.3 billion to $2.4 billion in balances. We don't anticipate a repeat of that level. Based on our surveys conducted a couple of weeks ago with prior borrowers, we're likely looking at around maybe potentially almost $1 billion if we can achieve that number. So that’s where we’re projecting to end up for the second program. Is that what you were looking for, Jared?

Jared Shaw, Analyst

That’s great. When you lay that $1 billion against your credit profile (i.e. those COVID-sensitive industries), how much penetration do you anticipate gaining with those customers that are still struggling?

Terry Turner, CEO

I think a lot of those will go to hotels, retail, restaurants, and entertainment for sure. However, I believe there will be fewer large dollar loans this time, focusing instead on smaller businesses trying to navigate these next few months.

Stephen Scouten, Analyst

Regarding the 90 hires you made this year, are you sensing or do you anticipate a longer ramp-up period for them to reach breakeven or get their customers based on COVID? When should we anticipate them contributing to the bottom line?

Terry Turner, CEO

Generally, regarding our new revenue producers, our assumptions are that they have large books of business and so forth. Depending on whether it's a middle-market banker, a private banker, a broker, a mortgage originator, and so on, there are varying dynamics pertaining to their book transition. However, we generally expect them to consolidate most of their book over a three to four-year period of time, approximately four years. Our belief is they should reach breakeven within the first 12 months. There may be some slowness, but not a lot. In other words, it may take a month or two longer than pre-COVID, but we don’t anticipate a dramatic elongation. It likely extends a month or two. Therefore, we will not have drastically different planning assumptions about how quickly they navigate breakeven or consolidate their outlook.

Operator, Operator

Our next question comes from Brock Vandervliet with UBS.

Brock Vandervliet, Analyst

I wonder if we could start with BHG. I was curious about the reserve level. Did they adopt CECL or not yet?

Terry Turner, CEO

No, they have not adopted CECL. I think they are two years out from having to formally adopt it, so no, they're not CECL compliant yet.

Brock Vandervliet, Analyst

They might have more flexibility in managing that level. Okay. On the bank buy rate, I appreciate that disclosure. I had assumed that if there was a potential issue with BHG, you might see the bank pull away as soon as COVID broke; obviously, that didn't occur. I wondered if you had any insights regarding the decline in the bank buy rate here in the fourth quarter.

Terry Turner, CEO

From my conversations with the BHG folks—a brief update here in a couple of days—the auction platform is very competitive. They've encountered numbers where bank yields are dipping down into the high 3s because that paper is very appealing to them. It's a solid situation; they somewhat restricted flow into the auction platform with the buildup of their balance sheet, attempting to prepare for the next securitization. Nevertheless, there's considerable interest from a variety of banks for that paper.

Brock Vandervliet, Analyst

I'll follow up on that offline. You mentioned the credit focus; a few construction loans were moved to criticized after completion. What is the outlook for those? Are those considered stabilized financing, or are you waiting for a third-party take-out?

Tim Huestis, CLO

We’re not waiting for a third-party takeout. Several of our construction loans were modified to extend the interest-only period. I would say we moved them into that risk rate category purely to be consistent with prior quarters; we felt like the hospitality industry was such that it was prudent to move them into criticized.

Brock Vandervliet, Analyst

For a loan that transitioned from construction, is there still an issue keeping it on the balance sheet? It should remain there under arguably good terms?

Tim Huestis, CLO

Correct. We had a few of those that we modified, establishing an interest reserve to assist through COVID until travel and hotel occupancy rates improve.

Operator, Operator

Our next question comes from Michael Rose with Raymond James.

Michael Rose, Analyst

Most of my questions have been answered, but I wanted clarification, Harold, on the NII guidance. Is that inclusive of PPP? I think you had about $56 million in 2020. Can you help clarify the base and whether that includes any of the second round you referenced?

Harold Carpenter, CFO

Yes, it does include the forgiveness. I think I've got $40 million in accretion coming from the PPP program, most of which will happen in 2021, but it doesn't include any income from the second round.

Michael Rose, Analyst

So, it is inclusive of PPP. That's helpful. As I think about the average loan and deposit growth targets you laid out, is that based on a full-year average? Because, looking at average deposit growth— it would indicate a notable reduction in deposits year-over-year if I examine the full-year average?

Harold Carpenter, CFO

Normally, when discussing loan and deposit growth, we reference ELP growth. Let me know if you require more specifics around that.

Michael Rose, Analyst

Yes, I can follow up offline. That's all I had. Thanks.

Operator, Operator

Our next question comes from the line of Catherine Miller with KBW.

Catherine Miller, Analyst

You've given a lot of PPNR guidance, which seems helpful, and it clearly shows some upside from where consensus is currently situated. This leaves the provision, which I know is a considerable uncertainty for everyone and hard to predict. Nonetheless, I was hoping you could provide me with an idea of when we might start observing losses emerge and your expectation for when we might see more— I mean, we had a little reserve release this quarter—but potentially a more active reserve release. When do you anticipate these two aspects might converge?

Terry Turner, CEO

Catherine, I'll address reserve release and what we're considering. We anticipate a high likelihood of reserve release this year; we accomplished some in the first quarter. Our planning assumption is that we will carry some reserve this year, although not a lot. A significant hint on when we might see considerable reserve release ties to the rollout success with unemployment rates by the end of the year. Over the last couple of quarters, we've conveyed that you would see reserve build and felt the reserve would remain fairly flat in the fourth quarter. It actually decreased slightly. We thought we could observe a flat reserve through the first half of 2021, with loss content beginning to emerge towards the second to third quarter, leading to more substantial reserve release at the end of the year; however, it seems the reserve release could happen quicker than anticipated. Does this make sense?

Catherine Miller, Analyst

It does. Is unemployment the primary factor driving this, or how much of it is also influenced by your specific credits?

Terry Turner, CEO

Regarding ratio allowance to loans—not the absolute allowance level—charge-off expense has been relatively benign thus far, as well as nonperforming past dues and charge-offs. They all influence reserve. You're correct that the biggest influencer in every model we are using for CECL remains unemployment.

Catherine Miller, Analyst

And what is the anticipated timing for losses?

Tim Huestis, CLO

The vaccine rollout success and fiscal stimulus will help, I believe, as we've established a strong PPP loan program that should mitigate losses. My intuition and anecdotal evidence suggest that losses going into 2021 will be similar, possibly a slight uptick early in the first and second quarters; however, we don't expect a dramatic change.

Operator, Operator

Our next question comes from Brian Martin with Janney Montgomery.

Brian Martin, Analyst

Harold, could you elaborate on the reserve? Can you provide a range for when you'll become more comfortable with credit and expect that to happen? As you monitor that, where do you envision that post-COVID reserve to loan ratio resting?

Terry Turner, CEO

We're not anticipating numbers comparable to pre-COVID levels. We were around 40, 50, or 60 basis points in that range. It's tough to accurately forecast these credit models into the future, making it challenging to project numbers at the end of this year based on particular unemployment forecasts. Therefore, there is considerable uncertainty. However, the trends within loss content and nonperformers indicate a projected decrease. While a side bar, a certain amount will always get you a cup of coffee at Starbucks, I think it will foster interesting discussions over the year not just for us but for all banks as we see reserve releases and regulators' involvement. You shouldn't expect us to return to pre-COVID levels, but we should anticipate meaningful reductions in reserves due to substantial build-up from last year. We honestly don't expect that loss content to materialize.

Brian Martin, Analyst

Could you comment on the pace of reduction in wholesale fundings and the balance sheet size? What is the anticipated timing of that, and how does it influence margins and the core margin?

Terry Turner, CEO

Yes. I think there’s a slide in the deck discussing about $2 billion in wholesale funding. Most of that pertains to broker deposits that we intend to redeem. I think the average yield on those is around 50 or 60 basis points, so that will positively impact our margin and deposit pricing. In the third and fourth quarters, we don’t face many opportunities for wholesale reductions. I’ll state that optimistically. By the time we reach that part of the year, we may reevaluate prepayments related to Federal Home Loan Bank borrowings. I have about a billion dollars remaining on our balance sheet. Currently, the penalties for prepayment are somewhat high, but we may reconsider that toward year’s end.

Brian Martin, Analyst

For Tim; as I understand it, you noted criticized levels may have peaked based on the credit outlook. How does that outlook work moving forward?

Tim Huestis, CLO

I do believe we're at a peak regarding criticized levels. Some minor migration could occur; however, many of our criticized loans, as you know, relate to the hotel segment. After our quarterly reviews, I would characterize that criticized level as very stable. It will take time before those migrate back into a past grade, keeping in mind the severe effects experienced by the hospitality industry. Yet, my intuition following these reviews is that we are nearing the peak.

Operator, Operator

That concludes today's question-and-answer session. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.