Earnings Call Transcript
Pinnacle Financial Partners, Inc. (PNFP)
Earnings Call Transcript - PNFP Q4 2022
Operator, Operator
Good morning, everyone, and welcome to the Pinnacle Financial Partners' Fourth Quarter 2022 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 in 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, 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 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, 2021, 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 the 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
Good morning. Thank you for joining us for our fourth quarter earnings call. Looking at the performance in the fourth quarter, key success measures like net interest income growth, tangible book value accretion, core loan growth, core deposit growth, asset quality, all continue to be strong. There is a fair amount of noise in our fourth quarter numbers. So, we're going to move quickly to the performance detail for the fourth quarter to create clarity, then to the outlook for 2023 to help with model builders, and finally, I’ll spend some time detailing why I believe we have a unique ability to continue producing outsized shareholder value. As you likely know, we believe asset quality, revenue growth, earnings per share growth, and tangible book value accretion result in long-term shareholder returns. That's why our incentives are linked to them, and that's why we show this dashboard every single quarter where you can see the relentless upward flow for those metrics, most closely tied to the shareholder returns. GAAP measures first, followed by the non-GAAP measures, which I'm personally most focused on. If you believe that asset quality, revenue growth, earnings per share growth, and tangible book value accretion mostly influence shareholder returns, which I do, then you have to appreciate the persistent excellent performance against those variables year in and year out. As I mentioned a minute ago, there is considerable noise in our fourth quarter financials, so we're anxious to get to the details. The most impactful of those items was BHG's election to fund roughly $500 million in originations on their balance sheet, thereby deferring the income on those loans over the life of the loans as opposed to directing them into their auction platform, which would have resulted in taking the gain on sale upfront, significantly increasing their and our earnings during the fourth quarter. Nevertheless, I believe you should be able to look through to see that the core banking business continues to have great momentum. So, Harold, let's move on and walk through the quarter.
Harold Carpenter, CFO
Thanks, Terry. Good morning, everybody. As usual, we'll start with loans. The fourth quarter was another strong loan growth quarter for us, and we believe annualized mid-teens loan growth going into 2023 is reasonable for us, as we anticipate loan yield growth in the fourth quarter, and we expect further escalation in loan yields in the first quarter. Along with that, we are forecasting Fed increases of 25 basis points in February and 25 basis points in March. Our modeling indicates that loan yields will be up 40 basis points to 50 basis points or so in the first quarter. The talent we've added over the last several years results in extraordinary balance sheet momentum. As we've done over the past few quarters, we're again dissecting net loan growth based on the categories noted on the slide to help everyone better understand the source of our growth. It’s been a huge year for us as far as loan growth is concerned, and it works out with the new markets and our new hires contributing to more than half of our growth. That said, this represents more than just an annuity stream for interest income, those are new clients with new opportunities for our firm across all types of financial products. We are definitely in a broader footprint with new markets, but also a much deeper footprint given our model. Now, deposits, we are really pleased to report the growth in deposits for the fourth quarter. Growing deposits at a reasonable price in 2023 is a key focus for our current environment. We are actively building out our deposit-gathering franchise around HSAs, community housing associations, non-profits, and others, and we believe we are making headway with these and other special deposit initiatives. Our average deposit cost came in heavier at a 74 basis point increase over the third quarter. Although we believe we remain inside of our total deposit beta guidance of 40% through the end of 2022, we experienced an acceleration in deposit cost in the fourth quarter above our expectations by about 15 basis points. Competitive pressure around deposit costs is significant, so we fully anticipate that increases in Fed rates will continue to add a tailwind for increased deposit costs in 2023. Average deposit costs, we believe, may approach 1.5% to 2% in the first quarter of this year. As for mix, we are seeing deposits move more to noninterest-bearing and lower-yielding interest accounts with the higher interest products and current deposits. Our average noninterest-bearing deposits were down approximately $440 million in the quarter from 3Q averages and even more based on end-of-period balances. Our plan will contemplate this decrease to continue at a lesser pace in the first half of 2023. About 90% of our noninterest-bearing balances are commercial, with approximately 25% of that number being annualized. Over the last year, annualized commercial has dropped from around $425,000 per account to around $350,000, while non-annualized commercial has dropped from $35,000 to $30,000. Pre-COVID levels were around $300,000 per annualized and a little less than $25,000 for non-annualized. So, average account size is still 10% or so higher than pre-COVID levels. Our number one objective remains developing strategies and tactics around funding our growth. We continue to like our chances given the significant investment we’ve made in both relationship managers and new markets over the last few years. Hopefully, you'll not hear this bank's leadership ever talk about having too many deposits. Our belief is that we have and will fund our deposit growth effectively and prudently maintain the appropriate balance between profitability and growth. Now, liquidity. We believe we have ample liquidity to fund our near-term growth. As investment securities, our allocation to bonds was flattish in the quarter. We don't anticipate any significant growth in bonds this year. As the top left chart reflects, our GAAP NIM increased by 13 basis points compared to 28 basis points to 30 basis points in the previous two quarters. As we mentioned last time, a decrease in our NIM expansion was not unexpected, although we felt like the NIM would expand in the fourth quarter by a few more basis points than it did. Our planning assumption is that our NIM will likely be flat to down next year and likely down in the first quarter, given the first quarter is burdened by fewer days. That said, our growth model should provide for increases in net interest income. As we enter 2023, we believe net interest income guidance of high-teens percentage growth for 2023 over 2022 is reasonable at this time. As for credit, we're again presenting our traditional credit metrics; Pinnacle's loan portfolio continues to perform very well. Our current ACL is 1.04%, which again compares to the pre-CECL, pre-COVID reserves of 48 basis points at the end of 2019. We did modify our CECL modeling this quarter with a more pessimistic assumption set with a baseline at 20% stagflation, 30%, and with a pessimistic scenario at 50%. We continue to have conversations with borrowers about supply chain, inflation, and how it's impacting our businesses. We've been all about sustainable credit diligence efforts with the intent to actively identify any weaknesses in our borrowings. We continue to have a very limited appetite for new construction, whether it be residential or commercial. Thus, the growth of our construction portfolio is limited to funding previously approved commitments with no new projects being added at least through the first quarter of 2023. We also remain attentive to our concentration limits in all areas of our portfolio, particularly in CRE. The table on the bottom right of the slide details no changes regarding our CRE appetite from last quarter. In summary, our outlook for credit remains strong as we entered 2023 from a position of strength. So, if negative trends begin to develop, we believe we're advantaged. Now, on the fees, and as always, I’ll speak to BHG in a few minutes. Excluding BHG, fee revenues were flattish for the third quarter. All that said, we're pleased with the effort of our fee-generating units. Several units are negatively impacted by the current operating environment in a meaningful way. Obviously, residential mortgage volumes were down this year. Mortgages do see their pipelines building back modestly in the first quarter as rates hopefully will be less volatile when the spring home buying season begins. Gains on SBA loan sales are also down significantly from the third quarter, as their business was impacted by the elimination of incentives from the CARES Act, which drove more business to SBA lenders in the previous quarter. We've gotten a few questions on earnings credit rates and the impact on deposit fees. So, here's a stab at that. We have approximately $2.5 billion in annualized commercial noninterest-bearing accounts. Our current ECR is around 35 basis points, which is competitive. At the moment, our run rate analysis fee with labor is about $4.5 million per quarter. For every 25 basis points we raise the ECR, it reduces our analysis fee by $400,000 to $500,000 each quarter. Our goal is to stay in the middle of our competition peer group on earnings credit rates, so we have to release some lift in the ECR that's coming, but it will come in small bites. We had anticipated 2022 to return a high single-digit growth in fees over 2021. Excluding BHG and other non-equity investments, we believe 5% growth, and we achieved 5% growth for the year. We think mortgage should recover modestly in 2023, and we've also added some strong revenue producers in Wealth Management late in 2022. Excluding BHG and the impact of other equity investments, we believe that high single-digit to low-teens growth in '23 over '22 in the region. Expenses came in about where we thought for the quarter. We did see non-compensation expense decline from 4Q to 3Q, but attributable to the reversal of franchise tax accruals, with some of that being added to the tax line. So, it was a reclassification between franchise tax expense and income tax expense. All in, we are anticipating an effective tax rate of approximately 20% in 2023. Our incentive costs also decreased in 4Q from 3Q. This was primarily the result of the impact of 4Q '22 PPNR results on a cash plan, which came in below target, and overall performance metrics on the performance-based equity incentive awards, which came in below our expectations. All of this is a segue into a few comments about the variable cost nature of our expense base. We feel like our expense base should result in mid-teens growth for '23 over '22. As to how we can manage expenses, as I mentioned, we've reduced our '22 payouts due for not achieving selected incentive targets, particularly on our quarterly PPNR targets and various other measurements when it comes to equity compensation, which, by the way, primarily impacts senior leadership. That's how it works. Our cash incentive plans are always tied to EPS growth targets, and for 2022, they were also tied to PPNR targets for each quarter. We missed our fourth quarter PPNR target; thus, incentives were reduced. Our leadership equity plans were tied to results in relation to our peers, some are return-based, tangible common equity, some are tangible book value accretion, some are PE and tangible book value. It's all based on ranking in relation to our peers. We believe we have a very shareholder-friendly compensation system that is objective, not subjective, which is a meaningful variable cost component. The other element that brings the variable cost attribute to our expense growth is our hiring level. We can always back down or overrecruiting and have done that a few times in our history. I can recall once during the financial crisis and the other during COVID-19 when we slowed recruiting until we better understood the depth of the macro environment. Lastly, and as we mentioned in the press release, we've got the ability to modify, cancel and postpone various events and projects as needed, and we will do so should our targets be in jeopardy. On the capital, tangible book value per common share increased to $44.74 at quarter-end, up slightly from last quarter. Our capital ratios remain above well-capitalized levels. We like our tangible common equity ratio, which stands at 8.5% currently. We are mindful of our Tier 2 capital levels, particularly at Pinnacle Bank. We'll be monitoring our capital levels as we get into 2023. We believe the action we've taken to preserve tangible book value and our tangible capital ratio have served us well and have no plans currently to alter our PNFP Tier 1 capital stack via any sort of common or preferred offering. Now, a few comments about BHG before we look at the outlook for the rest of the year. As the slide indicates, BHG had another great quarter on originations, the second best in its history. Originations did decrease from the prior quarter with BHG's implementation of a tighter credit mark, so fewer of the lower credit score loans, which are typically more profitable, were funded in the fourth quarter. As a result, spreads did come down from the last quarter, from 9.7% to 8.9% as the chart on the bottom left indicates. That's more spread shrinking than originally planned, but as the chart indicates, for several quarters in 2020, current spreads remained above or near historical norms. The accrual for loan substitutions and prepayments increased to 5.66% and 5.28% last quarter as a result of a more precautionary posture from BHG management. BHG accrual for loan substitutions and prepayments for the sole loan portfolio increased from $270 million at September 30 to $314 million at December 31. As the blue bars in the bottom right chart show, recourse losses fell slightly from 4% to 3.96% at year-end. Additionally, given the macro environment and as we mentioned last quarter, BHG also increased on-balance sheet reserves for loan losses to $147 million, or 4.59% of its on-balance sheet loans from 3.53% last quarter. Of course, CECL is still on the radar for adoption on October 1, 2023. We continue to anticipate the CECL reserve to be between 8% to 9%, but that certainly is an estimate at this point. The quality of BHG's borrowing base, in our opinion, remains impressive. As mentioned earlier, BHG has modified its credit mark, particularly with respect to lower tranches of its borrowing base. This will have an impact on both production and spreads going forward. BHG refreshes its credit score monthly, always looking for indications on weakness in its borrowing base. Credit scores were at a consistent level with the previous quarters, so their borrowers have remained resilient during the cycle thus far. In comparison to other consumer lenders, we believe BHG remains well-positioned; BHG borrowers remain well compensated with average borrower earnings around $293,000 annually. BHG's trailing 12-month charge-off ratio has increased from 1.98% to 2.94%. Similarly, its delinquency ratio has increased from 1.22% to 1.78%. Although these ratios are in line with early 2021 ratios, BHG recognizes the macro environment may lead to further deterioration of similar credits. To keep performance near historical levels, BHG has made a number of credit cuts to both their marketing and underwriting models. We believe that BHG's management team has taken a proactive approach to managing credit as they entered 2023. Lastly, BHG had another great year in 2022. As I mentioned during our earnings call this year, we have always believed BHG's earnings in the first half of 2022 would likely be stronger than the second half, as they set more loans to the bank auction platform in the first half of the year rather than whole loans on their balance sheet. As you know, the bank auction platform delivers an immediate gain on sale, while loans that they retain on the balance sheet and fund through various funding options deliver interest income over the life of the loan. BHG accomplished three securitizations this year, aggregating almost $1.3 billion in volume. During the last part of December, they added $550 million in new facilities with Goldman and Truist. This represents incremental funding available to BHG in 2023. A third facility for $500 million was closed in late December as well. Closing on this facility required more loans to remain on the balance sheet than initially anticipated. This facility was fully funded at year-end 2022. Here's a simple example: $100 million issuance through the bank auction platform could generate anywhere from $30 million to $40 million in gains immediately, while going through the securitization platform at an 8% spread would yield approximately $7 million to $8 million in interest income annually. In the fourth quarter, BHG set more on the balance sheet than originally anticipated with loans sold through the GMS model. Again, looking forward, some key points I'd like to reemphasize, which are basically the same comments I mentioned three months ago. BHG management has responded to the macro environment in a very real way. BHG is and will be increasing reserves based on macroeconomic data at least over the next few quarters. BHG has been modifying their credit model scores by focusing on less risky assets, which may lead to spread shrinkage in 2023. Production volumes are strong, and we believe they will maintain production levels going into 2023. BHG's new funding alternatives will broaden their already strong liquidity platform, which we also believe is unmatched by their peers. Lastly, a few weeks ago, BHG took steps to limit its headcount with job eliminations and the elimination of most open positions, as well as other expense reductions, which should yield a 10% reduction in its expense burn in 2023 from 2022. For all those reasons, we have great confidence in our partners at Bankers Healthcare Group to deliver strong results over the long term.
Terry Turner, CEO
Quickly, here's our final initial outlook for 2023, along with a comparison of our comments on 2022, the third quarter conference call in October. We expect mid-teens growth in loans, low to mid-teens growth in deposits. This correlates to a similar outlook for net interest income, which should result, we believe, in high-teens growth in net interest income. Our plan for 2023 contemplates our NIM being flat to down for the year, which will obviously be a challenge and we need to be nimble with respect to product, especially on the cards. Fee revenues may be our biggest challenge as many fee units are facing more than their fair share of economic headwind, but we've had some key hires in several of these areas and are optimistic that we should see a lift from those new associates. We believe BHG's results will be flat to slightly up for 2023. We've reduced our expense growth outlook to mid-teens. Our senior leaders are still committed to a strong recruiting year, especially as it pertains to revenue hires. Asset quality, we believe, is in great shape currently, and we believe we are entering the year from a position of strength, which should be advantageous if negative trends begin to develop. We are putting the final touches on our strategic and financial plans for 2023 with just as many unknowns now as they were last year, but our goal remains the same: top quartile earnings performance, no matter what gets thrown at us. With that, I will turn it back over to Terry. All right. Thank you, Harold. There are two things that I hate, and I know most of you do as well. One is noise in the numbers. In my opinion, no one just forces discussion to be around trying to create clarity about the noise and take focus off the underlying ability to produce outsized shareholder returns, which, of course, where I think the focus should be. The second thing I hate is economic uncertainty. Frequently, it forces investors to the sidelines regardless of the potential for shareholder value creation. I will take just a minute to ensure understanding of how we intend to produce outsized shareholder returns regardless of whether BHG has elected to put more loans on its balance sheet, regardless of the economic uncertainties that persist. It's not lost on anyone on this call that there's a broad sentiment that we're headed into a difficult economic landscape. Greenwich's long survey commercial executives as to their view of the direction of the economy going forward. Their optimism index is simply a net score of deposits less or negative. As you can see here, commercial executives have not been so pessimistic since the great recession. The economic headwinds bearing on commercial banks are widely known and include shrinking money supply, which means a shrinking deposit pool, increased rate-based competition for deposits and an inverted yield curve, inflation, and, ultimately, a recession, just to name a few. There's no doubt that the banking business is subject to the economic environment. But our growth model is more a function of our ability to take both talent and market share, and therefore, is substantially less dependent on short-term interest rate movements, inflation ups and downs, and those kinds of things. We have been pursuing this model for 23 years. I find it hard to understand how our competitors, who have not built this differentiation, can either catch up or defend against it. It is the classic sustainable advantage. Beginning with the far right, objective is total shareholder returns. Here you can see the dramatic outperformance over the last 10 years. Generally, that would be true if you look at our first 10 years of existence; true, if you looked at our first 20 years of existence. While past results are no guarantee of future performance, I believe it will be true over the next 10 years because this model is intended to produce value through thick and thin over the long term. The reason I say that is because we built a demonstrably different client experience. Every bank says they give great service, and in our case, it's our clients who say that. They tell that to the independent researchers that prepares the data for Pinnacle and for virtually all of our competitors. You can see in the center of the chart that our clients' engagement with this firm is literally unparalleled. At the risk of oversimplifying, that differentiated service is largely contingent on our ability to excite and engage our associates. I'm not going to read you the list, but to say it simply, in 2022, we've been rated as the best place to work in virtually every market we operate in; and on a national scale, we've been ranked as the second-best workplace for women and the seventh-best workplace for millennials in the country. We excite and engage our associates. It's hard for me to imagine that competitors who have not been building this over an extended period will be very successful, either taking our associates or clients, or stopping us from taking theirs. Moving on to the advantaged markets, using the United Van Lines' Movers Study, the Southeast continues to attract people from all over the country. Our challenge is to find a bank with a more advantaged footprint than ours in terms of population migration and growth. Within that region, we operate in a vast majority of the largest high-growth urban markets. So, we're located in the most advantaged region of the country. Beyond incredibly attractive size and growth dynamics of our markets, the more important attraction is the competitive landscape. Given the Net Promoter Score is the best indicator of a bank's ability to protect or expand market share, according to Greenwich's national study, you can see scores are horrifically low for the national franchises, slightly better while defining at super regionals, and surprisingly better while defining the community banks. Moving to the right, you can see the Pinnacle stores are unmatched and getting better. I fully expect that gap to widen as the industry adopts a work-from-home platform while we operate a work-from-office platform primarily for the purpose of further differentiating our service level. Keep in mind that Net Promoter Score measured clients' willingness to recommend. This is how you continue to grow safely in the face of a declining economy. Speaking of the competitive vulnerability, never in our existence do I remember a time when the banks that have the bulk of the share in our markets were more likely to give it up than now. Here's a smattering of recent headlines in our markets regarding our competitors. My goal here is not to spare them but simply to crystallize the sustainability of our ongoing market share taking for both associates and clients. Here's further demonstration of our winning war for talent. I believe we've become the employer of choice for bankers frustrated with the large bank employers in our markets. It seems like every year, we set a new record for hiring many of the most experienced and successful revenue producers from those banks that still have the largest market shares. When they work in a company without bureaucracy and which is universally focused on winning clients, these revenue producers create literally the best experience in the market. Now to the label point, but the three banks on the left of that chart are the market leaders. So, I expect nothing but rapid growth over the long term, completely independent of economic conditions when you recognize that those banks are where most of our revenue producers come from, and you see the differentiated service that they're now able to provide. Here's another way to visualize that opportunity: banks above the crosshairs have share dominance; banks to the left of the crosshairs are least successful in engaging their clients; they're vulnerable. Banks to the right of the crosshairs are most successful in engaging their clients and best positioned to capitalize on those competitive vulnerabilities; PNFP being the most advantageous amongst the market share leaders, all of them look vulnerable. Much has been written about the competitive advantage created by the tech spend at the nation's largest banks. In Greenwich's study of the national franchise, there is a strong correlation between clients' perceptions of a bank's digital capabilities and a client's willingness to add them as a bank provider. According to Greenwich, in our markets, the best overall digital experience is being provided by Pinnacle, the best product capabilities, the best service professionals, and the best overall experience. Thinking about long-term shareholder value creation, Greenwich research has long isolated three pillars on which client loyalty is built: number one, value in long-term relationships; number two, ease of doing business; number three, a bank you can trust. Over the last couple of years, they've expanded to a fourth pillar, which is data and analytics-driven insights, a key area of investment, again, for those largest competitors. In our markets, we dominate all four of those metrics, further indication that our net growth of clients is likely to continue. Now I'm trying to connect the dots. I understand many in the associate engagement and client service have little or no bearing on earnings and shareholder returns. Some will think of things as expenses to be cut, but hopefully, this slide illustrates why we believe our growth should be insulated from economic conditions because the people we hire and the service we give mean very few clients would consider leaving and a great many intend to add us as a provider on their next product needs. As you scan the net momentum percentages for the banks in our market, irrespective of economic conditions, our net momentum is huge. In the case of small businesses, we are seeing more than double the next best competitor. In the case of the middle market, we have total dominance, particularly when compared to the market share leaders, the top three banks on both of those charts. Without understanding our unique approach to penetrating the market, largely by hiring experienced bankers who understand that we should not be out prospecting for new clients, but simply supporting our relationship managers in calling on their clients that they've known for decades. We believe that strategy provides us with better protection than our peers in the event of adverse credit terms. Q4 was a noisy quarter. Economic uncertainties abound. My encouragement is to keep the focus on what’s right. As it relates to BHG, the fundamentals remain strong. Originations were the second highest in their history. They've restored their loan book and scores have not deteriorated again, gaining strength in the loan book. They continue to add liquidity sources and utilize those liquidity sources from some of the most sophisticated investors in the market. At the end of the day, nearly $300 million in pre-tax earnings, 22% growth over the prior year, it’s an incredible story and continues to be a handsome asset. Beyond that, and I think this is most important to me, we run a core banking franchise that continues to dominate and continues to have momentum regardless of the circumstances. We compete in the advantaged Southeastern footprint. We have a cultural focus that results in a differentiated client experience, and there is no more sustainable advantage than that. Our organic growth model is having proven successes that resonate throughout our markets. We are one of the best loan growth stories in the U.S., one of the best tangible book value growers in the country. From a credit perspective, we're top quartile in terms of NPAs, loans, and OREO, clearly the place you want to start, if credit does turn. Lastly, I’ll just hit on the slide there. Harold has talked about it a little bit, but I think an important consideration as people begin to focus on how we get to 2023 estimate sets has to do with our compensation systems and how those goals are set, particularly regarding leadership compensation. Specifically, those incentive plans focus on tangible book value generation, which provides insight into why our tangible book value grew at the pace it did versus peers in 2022. We do a peer-relative target setting; so we have to outrun the peers. As Harold indicated, we are looking for top quartile performance on things like EPS and revenue growth in 2023. As many of you are trying to develop those 2023 estimates, perhaps you can reflect on this information regarding 2022. Generally, the outlook for the industry was that there would be negative earnings growth in 2022 due to a belief that the industry didn't have sufficient momentum to outrun the loss of PPP income. Regardless of what those industry expectations were, we targeted top quartile growth, which was not negative, and we based our incentive plans on this idea. That methodology continues to be how we view our momentum in the core banking franchise in order to achieve that target.
Operator, Operator
Thank you, Mr. Turner. The floor is now open for your questions.
Jared Shaw, Analyst
Good morning, guys. Thank you. Maybe just starting on margin and the guidance. Harold, when you're saying it's down, should we assume it's down from fourth quarter's 3.60% or the full-year-over-full-year number should be slightly down?
Harold Carpenter, CFO
Yes. We believe that it will be flat to down from the fourth quarter. We think the first quarter is probably going to be penalized more because it just has fewer days. But we believe it could be 3 basis points to 5 basis points, something like that.
Jared Shaw, Analyst
Okay. And then, when we look at the asset sensitivity disclosure, it looks like you became more asset sensitive in the fourth quarter. So, is this just anticipating increased acceleration of deposit funding pressure?
Harold Carpenter, CFO
Yes. We are planning to still see rates increase here in the near term. We think our deposit beta might level off at somewhere around 45% by mid-year, maybe a little more than that by mid-year.
Jared Shaw, Analyst
Okay. All right. Thanks for that. And then, on BHG, what are some of the assumptions you have for provision in '23 with the weakening credit backdrop? And how sensitive is your BHG outlook to the provision?
Harold Carpenter, CFO
Yes, that's a great question. They plan on not nearly as significant of increases in their provisioning or their reserves going forward. So, I think they've gotten the bulk of it done here this quarter, but they'll just have to monitor what past dues and charge-offs are looking like to see if they can stay within that guidance.
Jared Shaw, Analyst
Could you please provide an update on the estimate for the Day 1 CECL impact in October for Pinnacle?
Harold Carpenter, CFO
For Pinnacle? Well, the number I've seen from BHG would be about $190 million. So, we'd be 49% of that; that would run through our equity.
Jared Shaw, Analyst
Okay. Thanks. I'll step back. Thanks for the questions.
Harold Carpenter, CFO
Thanks, Jared.
Terry Turner, CEO
Thanks, Jared.
Stephen Scouten, Analyst
Thanks. Good morning, guys. I think, Terry and Harold, you guys have said, you spend NII, you don't spend the NIM, but obviously, some of the optics around the deposit betas can be tough. You guys laid out a really good slide, I think, in the second quarter kind of showing you guys have traditionally had higher betas, but also higher NII growth. Is there anything today within the balance sheet that makes you think moving forward will be any different in terms of funding mix, the reduction in noninterest-bearing deposits, or the scale of funding pressures? Or do you think that the story will continue to play out that, "Yes, we'll have higher betas, but we'll also have this better NII growth resulting in better earnings over time?"
Harold Carpenter, CFO
Yes, for sure. We're talking about high-teens growth in net interest income this year, and with a margin that could be flat to down. So that thesis is how we operate. Several years ago, I remember on a call somebody asked a question about how we're going to deal with this thrift-like margin? And that was back when it was down around 2.50%. So, there is a point where our pricing and margins get too low for us to live with, and we have to adjust. As we sit right now, our growth engine appears more than capable of providing significant net interest income growth with this, I would say, higher deposit beta.
Stephen Scouten, Analyst
Okay, great. And within that composition, Harold, you mentioned some other niche verticals and I noticed it appeared in the slide deck that indexed deposits jumped maybe to 17.2% of deposits from like 11.3%. Was there any meaningful changes there in terms of product or verticals that drove that increase?
Harold Carpenter, CFO
Yes, I think most of that would be public funds. We've attracted some public fund clients here locally as well as in Washington. I think most of those are tied to some kind of index.
Stephen Scouten, Analyst
Okay. And just last thing for me. Just on that share repurchase, the $125 million plan, as well as you noted a potential sub debt raise. Can you give us an idea about how you're thinking about that into '23? How aggressive you might plan to be? And what the size of a potential sub-debt raise might look like?
Harold Carpenter, CFO
Yes. We modeled out $200 million to $300 million. Right now, we think we can step through the year without any need to go out and raise sub-debt. But we'll just have to see how that pans out, how loan growth performs, and all that.
Stephen Scouten, Analyst
Okay, great. Thanks a lot for the color. Appreciate it.
Harold Carpenter, CFO
Thanks, Steve.
Steven Alexopoulos, Analyst
Hey, good morning, everyone.
Harold Carpenter, CFO
Hey, Steve.
Steven Alexopoulos, Analyst
I want to start on expenses. If the revenue environment proves to be worse than expected, could you walk us through which levers would you expect to pull early on, right? What's like first to go, last to go? And how quickly could you throttle down expense levels, if needed?
Harold Carpenter, CFO
Yes. There are several things that we can respond to fairly quickly. One is that if Terry believes the revenue number appears to be kind of consistent for the year, then, like we've done in the past, we can always reduce our hiring profile or hiring plans for the year. We also anticipate what the payout is going to be on the incentive plan, so those accruals would also come down. We've got plans for various events throughout the year that could get on the table for complete elimination, reduction, or whatever. Given what we've reported in earnings, I think there's going to be an intense focus on not only expenses but revenue growth, pricing, all of that by this management group to ensure we achieve our targets this year. Terry has allocated time in his senior-level meeting to review those kinds of factors. Our senior leadership is committed to hitting our targets and doing whatever we need to accomplish that.
Terry Turner, CEO
Hey, Steven, I might just tag on there a little bit, maybe not exactly what you asked, but I think some color related to that topic. As you know, in terms of our annual cash incentive plan, we generally have clear sound and threshold; we can't make bad loans and win. So, we clear that, most of our existence, the two variables that determine payout were earnings per share growth and revenue growth that were required to hit that earnings per share growth. Last year, we looked at PPNR, and I guess for a year or two during a difficult period where allowances were being built, we relied on PPNR more than revenue. Our Board has not technically approved the compensation plan; they'll do that here in February. But the anticipation is that they'll go back to two performance variables being earnings per share growth and revenue growth. So, again, I’m just putting that in perspective. I get it, you're asking about expenses, but it does create a great focus on getting the revenue generated, which drives up the odds of success there.
Steven Alexopoulos, Analyst
Got it. Okay, that's helpful. If I could change to the margin, to follow up on your answer to Jared's question, and all the commentary you gave about the competitive environment for deposits, Harold, how should we think about the trajectory for NIM? Do you think it's slow and steady declines through the year? Or do you think we bottom out in the first half, recover in the second half? How are you thinking about that?
Harold Carpenter, CFO
Yes. As far as the rate increases and impact on our margin, we think they will drive some of the reduction in our margins. So, we believe the margin is probably going to rotate around this 3.55% to call it 3.60% number, we believe, all year long. If funding pressures mean we aren’t able to hit our deposit targets, then obviously, that's going to impact that assertion. But as it sits right now, we believe we're just going to be in that 3.55% to 3.60% range.
Steven Alexopoulos, Analyst
Okay, that's helpful. And then, finally, on BHG, if we look at the prior expectations for 2023 versus what you're coming out with now, right, through reduced outlook for the contribution, it doesn't sound like that's related to you anticipating higher provisions at BHG. Is this all related to them just holding more production in portfolio? Is that really what's driving this? Or is there something else?
Harold Carpenter, CFO
I believe there will be an increase in credit costs year-over-year related to provisioning by around 10% to 20%. They plan to reduce some of their balance sheet and direct more funds through the auction platform this year. To achieve their revenue targets, they will likely need to address the removal of lower-tier accounts with higher credit risk. Therefore, I anticipate they will allocate more to the auction platform and continue to increase their reserves, although not at the same rate as in the fourth quarter.
Michael Rose, Analyst
Hey, good morning. Thanks for taking my questions. Harold, I think last quarter you talked about a cumulative deposit beta somewhere in the 60% range and you kind of estimated 40% by the end of this year, which you kind of had. Any changes to that just given the competitive pressure for that longer-term cumulative beta? And if the Fed does stay higher for longer, does that impact that? Thanks.
Harold Carpenter, CFO
Yes. I don't know. I've not really thought about or put any kind of math to what deposit costs could look like at the end of '23 as far as beta calculations and into 2024. We've kind of talked about beta through the middle of the year of somewhere between 45% and 50% given the two rate hikes here in the near term. I don't know how long we would discuss deposit rates, but I think when you get into the latter part of the year and, like you said, Mike, assuming the Fed remains in a higher rate environment for a longer period of time, we fully anticipate that deposit ratio will continue to improve north in kind of a flat rate environment.
Michael Rose, Analyst
Thank you for the information. I have a follow-up question regarding the BHG investment. It's clearly been beneficial over the years, and I understand you might be considering reducing your stake in the future. Given that the earnings contribution is expected to decrease over the next few years compared to the past, do you have any strategic insights on how you plan to approach this in the short to intermediate term? Additionally, how do you view that business, and what is the long-term strategic reasoning behind the investment? Thank you.
Harold Carpenter, CFO
Yes. I'll start and Terry can add his comments. First of all, I want to say that the partnership between us and BHG is strong. Matter of fact, I’ll have a Board meeting with the BHG folks here in about a couple of hours. The valuation of Bankers Healthcare Group, we understand, we realize, we believe is part of the bear case on our shares and trying to figure out what that number is is important, but absent an arms-length transaction, it’s difficult to discern. We think we and BHG are on the same page. There have been opportunities to reduce our stake, but right now the pricing is just not at a point we believe that makes it worthwhile for us. We think it's a valuable asset. We think it has created quite a bit of earnings momentum for us. We believe BHG on another day could be worth quite a bit of money. All of that said, our opinion about BHG is that a lesser ownership interest on our part probably wouldn't be that bad, and we should consider any worthwhile transaction carefully.
Terry Turner, CEO
Yes. I think, Michael, maybe just to echo Harold's comments, you started with the right assumption. I think what I’ll try to say is that if nobody had to be happy, we would like to reduce our dependence on BHG as a function of our earnings stream, not because we're not bullish on the company and not because of any reason other than, it has just become difficult from an investor conversation standpoint. It’s hard to keep telling a story that so many people disagree with or don't understand. I'd like to lessen our dependence on BHG as a function of our earnings stream. Two, at Harold's point, we've been good with that and BHG will be good with that. There are a number of people interested in ownership interest in BHG. The question then comes down to what's the price. If we find the right price, we would express a preference to lighten our load some; if we don't find the right price, we continue to believe BHG will be a strong investment and how it fuels our ongoing growth.
Casey Haire, Analyst
Yes, thanks. Good morning, guys. Question on the fee guide ex BHG. I was just wondering, what are the drivers, because to get to the low end of the guide implies kind of a mid-teens growth from the current run rate on average to hit the low end of that guide in 2023. Just wondering what the drivers are.
Harold Carpenter, CFO
Yes. I think mortgage is going to be impactful. They had a big hit in the fourth quarter because of the valuation of the hedge. Their pipeline is down to the lowest level it's been at in, I don't know, seven or eight years, Casey. The absolute size of the pipeline drives the valuation of that hedge. We think we're going to get a tailwind going into the early part of 2023 into the spring. We've also hired a meaningful number of wealth management people. We're particularly interested in a few that have been at this for decades. Their client base is broad and well-supported, so we anticipate some significant revenue bumps from that. We are also targeting quite a bit of commercial accounts, having both annualized fees and unannualized fees that would be coming to us.
Casey Haire, Analyst
Okay, understood. And then, just digging in a little more on BHG. Just wondering what kind of spread you guys are assuming, just given the bank buy rate has increased and that spread has kind of come in? Does the guide for '23 assume that spread holds, or is there a little bit of deterioration in that?
Harold Carpenter, CFO
Spread that I'm looking at for them for next year is 8.5% to 9%, something like that.
Casey Haire, Analyst
Okay, very good. And then just last one for me. I know it’s tricky, but the noninterest-bearing deposits settling down to 28%, any sense as to how much more attrition is possible before you start getting into core working capital and you hit a floor there?
Harold Carpenter, CFO
Yes, that's a great question. And you need kind of a crystal ball to figure it out. The best data that we've looked at is when we start looking at average account sizes and what they were pre-COVID and what they are now, and so it could be anywhere from, call it, 5% or so to something north of that, but our planning assumption is around that.
Matt Olney, Analyst
Hi, thanks. Good morning. First question for Harold. With Michael Rose’s earlier question, you mentioned a flat rate environment and what this means for the margin. But what if the Fed starts to cut its fed funds rate? What are some incremental levers you guys could pull to help protect the margin and NII?
Harold Carpenter, CFO
Yes. We have entered into a few swap transactions, specifically four, totaling about $2 billion in coverage on the loan book, with an interest rate around 4.25%. We believe we have been fair with our clients. In the previous rate decline, we were also fair as rates went down. This requires good communication with clients, which we've prioritized since 2022. If we find ourselves in a rate-down environment, our relationship managers will quickly begin to reduce those deposit prices.
Terry Turner, CEO
Matt, I might add to Harold's comments. There is a lot of energy in the company on loan floors. If you know, going into this cycle, we had a lot of protection from the loan floors we negotiated with our relationships. So that's applicable as well.
Matt Olney, Analyst
Yes. Okay, good points. And shifting over towards the loan growth, the mid-teens guidance, just trying to get a better idea of the assumptions behind this. I know the bank always does kind of a bottoms-up analysis for each of its producers. Any other commentary you can share with us about the process for 2023, especially in light of the slide in the deck you guys put out there on 2023 where you include that the optimism index of commercial executives is at very low levels? Thanks.
Terry Turner, CEO
Yes. If I understand your question correctly, Matt, you are asking about our expectations for growth in a declining economy. Am I correct?
Matt Olney, Analyst
I understand, Terry. You conducted a detailed analysis with each producer, but I'm curious if there were any additional adjustments made at the end compared to what you usually do each year with your preliminary guidance.
Terry Turner, CEO
The point I'm making is that we followed the same process as always this year, which involves both top-down and bottoms-up analysis. We review each relationship manager's status, their expected production, and their targets. These targets typically surpass our overall company targets. A significant aspect is that many of these targets are substantial due to the hiring we've done over the past three years. We engage in detailed discussions with relationship managers, and their expectations tend to exceed what we believe we can achieve or what we communicate at the highest level.
Catherine Mealor, Analyst
Thank you. Good morning, everyone. I have a quick question regarding BHG and expenses. Looking back at the past few years, BHG has played a key role in funding your hiring efforts and developing the core bank. It seems that the contribution from BHG is stabilizing and might even decrease a bit. What would need to happen for you to consider adjusting the expense outlook beyond the mid-15% range? Is there a specific profitability threshold that you think shouldn't be crossed, which could prompt additional expense measures? Or is the focus solely on ensuring that revenue growth outpaces expense growth to support EPS growth?
Harold Carpenter, CFO
Yes, the ROA is not at the top of our list. We do have ROTCE and all that. Ultimately, Catherine, we have earnings targets and revenue targets per share. BHG is a component in that. We’ll get to that bottom-line number in the most effective way we can. If that means cutting costs, we'll cut costs. If it means figuring out how to grow revenues in some way that’s not in the plan, we’ll do that. BHG has provided us some tailwind with respect to growth. It typically outgrows our number year in and year out, providing extra resources to support our hiring platform. This year, it looks like their growth is going to be fairly flat to slightly up, which might imply we may need to back off on hiring in order to meet our EPS targets.
Catherine Mealor, Analyst
Got it. That makes sense. So, you're saying in a moment where BHG revenue is less than expected, the core bank is better, and so that's why you don't have to tap into expenses. But if from here, revenue becomes more challenging or BHG falls more than expected, that's when you start to flex the expense lever?
Harold Carpenter, CFO
That's exactly right, Catherine. I've got about $125 million in cash bonuses at this point, and so that's all subject to hitting EPS growth targets.
Catherine Mealor, Analyst
Great. Okay, that's super helpful. And then, this is a really small nit, but just wanted to do it for modeling purposes. The FTE adjustment typically pops up a little bit in the fourth quarter then normalizes. Should we expect to see that kind of normalize back down in the first quarter like we've seen historically?
Harold Carpenter, CFO
Yes, I think so.
Jennifer Demba, Analyst
Thank you. Good morning.
Harold Carpenter, CFO
Good morning.
Jennifer Demba, Analyst
Harold, let's discuss this further. You provided a tight net interest margin guidance. Would it be accurate to say that the margin is likely the most vulnerable aspect of the fundamental guidance you outlined for 2023?
Harold Carpenter, CFO
Yes, I think so. Deposit pricing will be key to it. We feel pretty good about where loan pricing is. We feel good about that. Our fixed rate loan pricing is definitely improving. We've been beating that drum for quarters now and I think it's finally getting traction. Loan yields we think will hang in there. The competition for deposit pricing extends beyond what Truist is paying, what Regions is paying, or what some of these other franchises are paying around our competitive peers to also include what the money market accounts are doing, what high-yield savings accounts are doing, and what brokers are trying to do with folks. The point is that there is a limit to how high deposit costs will go. We don't think we have to increase rates all the way to those levels. We’ve told our salesforce that we will not lose a deposit because of price. Their instructions are to protect our deposit portfolios.
Jennifer Demba, Analyst
Okay. And the deposit growth that you're projecting for this year would be very strong. Is this a permanent shift for Pinnacle in terms of just putting a more intense focus on deposit growth overall?
Terry Turner, CEO
Jennifer, I think the answer to that question is yes. I mean, since the founding of the company, we’ve had an intense focus on deposit acquisition. If you have a mature company, you got a mature retail deposit book and you can sort of milk and ride that. In our case, we have to fund it as we go, and so there's a different energy and emphasis around that always and has been from the beginning. The pandemic and all the inflows and liquidity made it less necessary to concentrate on deposit defense. It’s a different day as the money supply decreases and deposit books evolve; it requires a different level of energy. Happily, during that pandemic period, we built three or four specialty deposit businesses that are all seeing some level of traction. I would guess that in 2022 those specialty segments probably produced $800 million to $900 million in deposits for us. We expect that growth to continue. We're in the early stages with still positive momentum in all four of those specialties.
Brian Martin, Analyst
Hey, guys. Good morning. I'll be brief. Just, Harold, Terry, just the hiring outlook for this year. I think you talked last quarter about where you thought it might be, but given the fourth quarter is wrapped up and some of the commentary earlier, how are you thinking about hiring in '23 relative to '22?
Terry Turner, CEO
Yes. One important thing, Brian, when we talk about hiring, most of the time, we talk about hiring revenue producers because that's really the thrust of our company. What we're trying to do is grow our revenues, grow our top line in order to grow our bottom line. That said, those revenue producers are generally going to be supported two-to-one by non-revenue producers. While we expect a similar number of revenue producers, we expect to hire less support personnel in 2023 than in 2022. We made significant investments in our controlled infrastructure, and so there was a stair-step kind of expense approach applied to that. Therefore, total number of associates hired should decrease in 2023 from 2022.
Harold Carpenter, CFO
Yes, that's helpful. I have a question for Harold. Regarding the reserve level, you mentioned possibly being a bit more cautious about credit, similar to Terry's views. How should we approach the reserve level as you navigate through the upcoming quarters, considering your outlook? Yes. I made a lot of conversations with the credit officers. Right now, they still have the same posture that our credit book is strong. We're not seeing any systemic kind of weakness in it. So, our planning assumption today is that our reserves probably will be fairly flat here on out. We’ll obviously monitor that. If we start seeing weaknesses, we will adjust accordingly. But as of now, we think credit is in check as best we know today.
Brian Martin, Analyst
Got you. Okay. And then, just going back to your comment about the fee income, you highlighted wealth. When considering the mortgage and SBA components, do you expect those to significantly rebound as part of your overall planning? I'm trying to understand the fee income growth you mentioned, which was projected in the high single digits or low double digits, excluding those more volatile figures. It seems like there might be additional factors at play that you're not mentioning. For example, regarding the mortgage and SBA, do you anticipate a meaningful recovery in those areas in the next couple of quarters, despite the recent declines?
Harold Carpenter, CFO
Yes, for sure; in mortgage, I don't know about SBA. SBA has some other headwinds. Mortgages should have a better year this year than last year, and this whole wealth management investment that we've made should produce tangible results. We've also hired some very capable individuals in our capital markets area that should help us as they have a long resume of success.
Brian Martin, Analyst
Got you. Okay. And last one, Harold, I’ll let you go: is the margin outlook you discussed based on the two rate hikes you mentioned? If the Fed lowers rates at all, how does that affect the margin outlook, especially as we move later into this year and next year? If there are no significant declines, does it remain mostly unchanged from your current forecast or outlook?
Harold Carpenter, CFO
Yes, we actually have some rate decreases in November and December in our forecast right now, but they're pretty much inconsequential.
Operator, Operator
Thank you. And that does conclude today's conference. You may disconnect your lines at this time, and have a wonderful day. Thank you for your participation.