Earnings Call Transcript
Pinnacle Financial Partners, Inc. (PNFP)
Earnings Call Transcript - PNFP Q3 2022
Operator, Operator
Good morning, everyone, and welcome to the Pinnacle Financial Partners' Third 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 our website at 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 actual results, performance, or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond Pinnacle Financial's ability to control or predict and listeners are cautioned not to put undue reliance on such forward-looking statements. A more detailed description of these and other risks is contained in Pinnacle Financial's annual report on Form 10-K for the year ended December 31st, 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 in 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.
Terry Turner, CEO
Thank you, Paul, and thank you for joining us this morning for the third quarter earnings call. As I'm confident you've already seen, the third quarter was another fabulous quarter for us. Last quarter in my introductory comments, I tried to list a number of themes that I believe are critical in order to understand the financial performance for the quarter, but to better ascertain how the firm should perform going forward despite the varying operating environment we might encounter. As a quick reminder, those overarching themes that I mentioned last quarter and which I think you'll see are interwoven again in this quarter's numbers: Number one, management is motivated and incentivized to alter outcomes given various market conditions. As an example, we don’t just accept the current asset sensitivity nor do we take the overall market growth rates as is; we alter outcomes based on our actions and initiatives. Many people are chasing a wide array of metrics such as deposit cost betas, and while I understand that, the specific outcomes we're motivated and incentivized to optimize at Pinnacle are the level of classified assets, PPNR growth, and EPS growth in the case of our annual cash incentive plan, as well as tangible book value accretion and ROTCE in the case of our long-term equity incentive plan. Understanding these metrics will likely help you comprehend why we've upgraded tangible book value in a year when many have not. Number two, we enjoy a reputation for having a great culture. However, our culture isn't just about being fun; numerous studies have shown statistically valid correlations between associate engagement and critical outcomes, such as reduced turnover, increased productivity, improved profitability, better sales outcomes, and total shareholder returns. Nothing is more important in the war for talent, and that helps explain why we continue to hire record numbers of the best bankers and financial services professionals while many others are short-staffed and facing low engagement and high turnover. Number three, our hiring success over the past several years is the primary contributor to our balance sheet growth and ongoing momentum. This explains where much of our loan and deposit growth originates. Due to the extensive experience of our new hires, averaging 20 years or more, we believe we can expand assets without compromising our commitment to credit quality. Unlike others who focus on increasing call frequency programs, our experienced bankers tend to move established relationships, resulting in a different credit profile over the long term. Lastly, number four, BHG is not your typical FinTech. Its ability to attract loans from high-quality borrowers at substantial yields and get them funded through a proprietary auction platform or securitized in the secondary market ensures continuous income, enabling us to significantly invest in our people and seize market opportunities—all while maintaining top quartile profitability. I'm not aware of anyone else able to invest in their business model as extensively as we have while remaining highly profitable. As I mentioned before, metrics such as asset quality, revenue growth, earnings per share, and tangible book value accretion lead to long-term shareholder returns, which is why our incentives are aligned with these metrics. This also explains our continual presentation of this dashboard showing the relentless upward slope of metrics like revenues, earnings per share, and balance sheet volumes that support that growth. In terms of asset quality, we are currently experiencing favorable times. We fully expect our asset quality metrics to normalize going forward, but you can see that NPAs and classified assets remain at extraordinary lows, with charge-offs at just 16 basis points. For some time now, we’ve been in the top quartile for NPAs to Tier 1 capital and classified assets to Tier 1 capital; given our continued reductions in these metrics this quarter, I'd be shocked if we don't maintain that status when we construct peer metrics for the third quarter. As many of you know, given the commercial nature of our loan book, charge-offs can be somewhat erratic. We had one of those instances this quarter, which Harold will discuss further in a moment, but overall, our credit metrics remain robust. I won't spend much time on the non-GAAP measures today as virtually all important growth and earnings metrics are on an upward trend, generally exceeding market expectations, painting a positive story for us over time. As previously mentioned, the talent we have recruited over recent years has contributed to our extraordinary balance sheet momentum. Similar to last quarter, we're dissecting net loan growth based on the categories outlined on the slide to provide better context on the sources of our growth. We categorize our growth into four segments: First, pure asset generation plays like BHG, Advocate Capital, JB&B Leasing; second, strategic market expansions, encompassing geographies like Atlanta, D.C., Birmingham, and SoHo, alongside expansions into specialty lending groups like franchise and equipment lending; third, growth from our recent recruits over the last two and a half years; and finally, our legacy markets contributed by RMs who have been with us for more than two and a half years. Through the first nine months of this year, we've achieved annualized EOP loan growth of 24.5% between December 31st, 2021, and September 30th, 2022, which accounts for PPP pay-downs, denoted in red on the slide. Almost 46% of our $4.3 billion in net loan growth is from our legacy markets; the rest primarily stems from new markets, initiatives, and new hires. We often get inquiries regarding the performance of our new markets and specialties, so I want to provide you with this information highlighting our remarkable success in moving talent and clients to the Pinnacle platform. For those who have challenges grasping the value of our culture emphasis, this serves as one example of paying off. Putting associates in a position to serve clients effectively allows us to attract the best talent and their clients. I'm sure everyone is aware that the annual FDIC deposit market share information was released in the third quarter. First, we're in great markets, evident in the deposit growth rate. This will be a crucial success variable going forward. More importantly, our deposit growth has outpaced the market, indicating our success in gaining market share. While many are worried about a decline in M2 and its potential impact on funding, I believe we wouldn’t have been able to maintain our impressive growth rate without successfully taking deposit share from larger, more vulnerable banks in our markets. Harold will elaborate further on our deposit growth in a moment. To illustrate, we're using data from Greenwich Associates, a premier provider of commercial market research to large banks in the United States. Virtually all of the top 50 banks in the country purchase this data. It is based on client feedback across our entire footprint for businesses with annual sales ranging from $1 million to $500 million in Tennessee, North Carolina, South Carolina, Atlanta, and Roanoke. Let's now focus on the Pinnacle line at the bottom of the Small Business Net Promoter chart on the top left of the slide. Here, 76% of Pinnacle clients surveyed rated us a 9 or 10 on the question, "How likely are you to recommend your lead provider to a friend or colleague?" using a scale from 0 to 10, where 0 means not likely at all and 10 means extremely likely. In other words, 76% of our clients are highly engaged active promoters. This is an unusually high level of client engagement. An additional 22% rated us a 7 or 8; while that's not bad, we refer to these as passive promoters—they generally rate us well, but they aren't vocal advocates in the market. The remaining 2%, the red portion of the bar, are detractors, indicating they rated us between 0 and 6. The Net Promoter Score, which is the difference between promoters and detractors, stands at 74. This score is significantly higher compared to all our major competitors in our footprint, making it not just fabulous in the southeast, but one of the best in the country according to Greenwich. The same holds true and even better for middle market business, where our Net Promoter Score is at 81. You might notice the percentage of detractors across our major competitors; these banks are listed in market share order. All three of the top banks in our footprint have significant volumes of detractors, presenting us with an opportunity we've been seizing for some time and will continue to see. As you consider the effectiveness and reliability of our growth—which is largely dependent on taking share rather than economic loan demand—this justifies our success in taking market share for the past 20 years. This is why we grew loans at a rate of 20.9% on an annualized basis this quarter, why core deposits increased 9.8% on an annualized basis this quarter, and why I believe we will continue to deliver strong growth for the foreseeable future. Excuse me. It’s not simply that many competing banks have upset numerous clients, but also that a considerable percentage of those clients indicate their intention to shifting some or all of their business away from those banks in the next 12 months. Meanwhile, a larger percentage of clients intend to increase their relationship with us significantly more than with any of the major banks we compete against. My aim in sharing this information is to solidify the link between our distinctive culture and our revenue and EPS growth. Therefore, you don’t have to blindly trust that the unique culture we've cultivated at Pinnacle over the last 22 years will manifest in positive outcomes; you can connect the dots with Greenwich data that reflects actual client feedback, allowing for a clearer understanding of the quality and sustainability of our market share and revenue growth. That encapsulates the 30,000-foot view. With that, I'll turn it over to Harold for an in-depth review of the quarter.
Harold Carpenter, CFO
Thanks, Terry. Good morning, everybody. As usual, we will start with loans. The third quarter was another strong loan growth quarter for us, with nearly 22% linked quarter EOP annualized growth. Our current pipeline supports low double-digit loan growth going into the fourth quarter, which would yield low 20% growth for this year. Loan yields rose in the third quarter primarily due to rate hikes. We anticipate further escalation in loan yields with rate increases in November and December. Our current planning assumption is for 75 basis points in November and 50 basis points in December. Given that there were 150 basis point hikes during the third quarter, we haven't yet benefitted fully from the quarter's average rates as noted on the slide. With this in mind, we anticipate fourth quarter yields increasing by roughly 75 to 90 basis points. As of the end of September, our loan yields are around 5%. We've also discussed loan floors over the last few quarters, and we have essentially moved past those, so we should be able to capture a larger share of rate increases moving forward. The bottom left chart summarizes our loan betas for 2022, where we tracked each rate hike and the beta results for each hike. The green bars on the chart are estimates since we don't have the full effects of the September rate hike yet, which we won't assess until the November FOMC meeting. November and December are based on our current planning assumptions, but we think a beta around 60% is a reasonable target for us. Now moving on to deposits, we are pleased to report about 10% linked-quarter annualized growth in deposits for the third quarter. Presently, our relationship managers are both protecting existing deposits and actively seeking new deposits, emphasizing the importance of community engagement at Pinnacle. Like others, we faced a mix shift this quarter as EOP DDA balances decreased from the previous quarter; however, average DDA balances actually increased for the quarter. We are hopeful this trend continues. We're actively expanding our deposit gathering capabilities around HSAs, community housing associations, non-profits, and others, targeting specific types of organizations that consistently provide funding, and we believe we're making strong progress with these specialized deposit initiatives. As for deposit betas, the top right chart attempts to convey our current thinking. This chart is constructed similarly to the loan chart shown earlier. Our planning assumption is that we believe we can maintain a 40% total deposit beta, which we've discussed since the beginning of the year. Historically, our main objective has been to develop strategies and tactics around funding our growth. We continue to feel optimistic considering the significant investments we've made in both relationship managers and new markets over the past few years. Many other banks nationwide are reevaluating their beta assumptions as liquidity has become more challenging. For Pinnacle, we've been consistently investing in our deposit book all year and believe our clients appreciate our pricing discipline, which is fair in the current rising rate environment compared to what we observe from others. We hope never to hear bank leadership mention having too many deposits, as depositors are just as critical as borrowers. We believe we can and will efficiently fund our growth by striking an appropriate balance between profitability and growth—a balance we've proven capable of achieving. Regarding liquidity, our liquid assets have slightly decreased this quarter; however, we continue to believe we possess ample liquidity to support our near-term growth. Regarding investment securities, our allocation to bonds is expected to remain steady in the fourth quarter. The top left chart reflects that with the rate upcycle, our GAAP NIM income increased by 30 basis points compared to 28 basis points last quarter, which we are pleased with entering the fourth quarter. Our planning assumption is that our NAMM will likely peak in the first half of next year, assuming minimal rate hikes during that period. In summary, we expect to see another quarter of NAMM expansion alongside increased net interest income in the fourth quarter. Consequently, we are raising our guidance for net interest income growth to low 20 percentage growth for the entire year 2022 compared to last year. Over to credit, we continue to present our traditional credit metrics, and Pinnacle's loan portfolio remains robust. As Terry mentioned earlier, late in the quarter and extending into October, we experienced a significant weakening in a previously classified C&I credit. This issue arose mainly due to a defective component installed in customer homes. We don't believe this issue stems from broader economic pressures that we are all monitoring. We recorded a partial charge-off effective September 30th and placed this loan on non-accrual status pending further credit evaluation. Despite this isolated credit, we are satisfied with how classified assets ended, supported by nearly three years of declining totals for classified loans and conservative past due levels at quarter-end. Our current ACL stands at 1.04%, compared to a pre-CECL pre-COVID reserve of 48 basis points at the end of 2019. While we initially anticipated a lower ACL for the quarter, recent developments suggest maintaining the ACL around the current level is prudent. Overall, this has resulted in a larger provision expense than we anticipated, totaling $27.5 million. We are maintaining dialogues with borrowers regarding issues like supply chains and labor inflation and their impact on their businesses. We are fully committed to sustainable credit diligence to ensure we identify any weaknesses in our borrowing base. We've received numerous inquiries concerning our strategies in light of the inflationary economy, and here are a few worthwhile points to mention: We've significantly limited our risk appetite for new construction, both residential and commercial. While we believe our portfolio remains healthy with strong sponsors, the macro environment warrants caution regarding asset allocations in this segment. Our credit teams have enhanced diligence and stress testing protocols, primarily focusing on issues such as supply chain impact, interest rates, and profitability. We are also sharpening our focus on traditional metrics like loan-to-value and debt-to-equity ratios. Now addressing fees and expenses, I’ll keep it brief, as I’ve mentioned previously regarding BHG. Fee income in the third quarter fell from a record second quarter; hence, comparisons may appear challenging. Nonetheless, we appreciate the efforts of our fee-generating units. Service charges have been affected by our recent change in NSF and overdraft fee policies, which we implemented in early July. We believe we will observe a rebound in wealth management fees in the fourth quarter owing to recent hires. Excluding BHG and barring impacts from other equity investments, we believe fee growth for 2022 over 2021 remains within reach. Regarding expenses, we are increasing our total expense growth estimate to high teens percentage for 2022, primarily due to headcount growth in new markets, market disruptions across our offerings, and the expanded contributions from JB&B. Moreover, we remain optimistic about achieving maximum payouts of 125% of targeted awards for our annual cash incentive plan. Ultimately, the primary driver for our growth and success lies in recruiting, as we continue to attract the best bankers to our franchise, which is operating at peak capacity. In the third quarter, salary expenses surged due to robust hiring. We anticipate strong hiring in the fourth quarter, although we do not foresee as significant an increase as in the third quarter. Regarding capital, tangible book value rose to $42.44 by quarter-end, up slightly from last quarter. Our capital ratios remain comfortably above the well-capitalized threshold. We are mindful of our Tier 2 capital levels, especially at Pinnacle Bank, given our exceptional growth, and we will closely monitor these levels and the debt markets as we move into the fourth quarter and 2023. Lastly, I’d like to share a few insights on BHG before we discuss our outlook for the remainder of the year. In our view, BHG performed exceptionally well this quarter, slightly exceeding our expectations. We reported over $41 million in fee revenues this quarter, and we've upgraded our growth outlook for 2022 to surpass 25% compared to our previous projection of 15%. As highlighted on the slide, BHG had another record quarter for originations. Spreads have reduced ever so slightly from 9.8% to 9.7%, as depicted in the chart on the bottom left. This is above BHG’s initial estimates at the start of the quarter. They anticipate spreads on the auction platform to contract modestly as short-term rates continue to rise. Borrower rates are expected to approach 17% by year-end, with bank borrower rates moving to the 7% range. Consequently, we expect spreads to fluctuate within historical ranges of approximately 9% to 10%. Overall, we are very pleased with BHG's performance in the third quarter, demonstrating their adaptability in transitioning between the bank network and securitizations to fund their loan growth. The accrual for loan substitutions and prepayments has increased to 5.28% of BHG's sold loan portfolio as of September 30, rising from $235 million to $270 million from June quarter-end. As the blue bars in the bottom right chart illustrate, past credit loss recourse remains among the lowest levels in the past decade. Additionally, given the macro environment, BHG has raised its balance sheet reserve for loan losses to $101 million, equivalent to 3.53% of on-balance sheet loans, compared to 3% last quarter. In light of the macroeconomic landscape, we anticipate BHG will raise reserves again as we approach the fourth quarter and into 2023. We are confident in the quality of BHG's borrower base, which we consider one of their key strengths. BHG conducts monthly refreshes of their credit scores, diligently monitoring for potential weaknesses within their borrower base. Credit scores have remained consistent with previous quarters, illustrating the resilience of their borrowers during this cycle. In terms of past due trends, past due rates over 30 days stood at 1.52% on September 30 compared to 1.37% at June 30 and 1.39% a year prior. Past dues measured 1.77% at the end of December 2020. BHG's consistent portfolio monitoring allows swift adjustments to origination approvals as needed. Over the past few months, they've shifted commercial allocations away from non-medical practices and increased their risk tolerance towards higher credit score borrowers. National and regional unemployment forecasts instill confidence that BHG's borrowers should weather projected inflationary pressures better than others in the sector. Compared to other consumers, BHG's borrowers are well-compensated, with average annual earnings of approximately $287,000. We are confident in their credit models, and their credit experience validates this position. Lastly, BHG enjoyed another strong operational quarter in Q3. As stated in previous earnings calls this year, we believe earnings in the first half of 2022 would likely surpass those in the second half, given more loans directed to the bank auction platform early in the year compared to whole loans on their balance sheet. The bank auction platform offers immediate gain on sale income, while securitization generates interest income over the lifespan of the loans. In September, BHG successfully completed a $412 million securitization at an acceptable rate of 7%, while some other FinTech lenders struggled to adapt their models amid the challenging operating environment. BHG is delighted with their ability to execute this securitization. It’s also worth noting that Kroll has downgraded BHG's first two issuances, such that all tranches from the six prior securitizations are now rated as investment grade, with the senior Class A tranche achieving AAA status. We want to emphasize BHG's adaptability concerning funding sources. Securitization platform spreads have tightened throughout 2022, with the most recent issuance achieving a weighted average rate of 7%, compared to 5.5% in June and 2.5% in Q1. This compression has compelled BHG to reconsider transferring more loans through the auction platform, as they have held better spreads than anticipated this year. Ultimately, profitability and balance sheet stability are the primary factors fueling BHG's success. Looking ahead, BHG has updated its 2022 growth guidance, estimating earnings growth to be approximately 25% relative to 2021. Moving forward, a few key points to reiterate: credit quality remains consistent with previous quarters; however, BHG will be enhancing reserves based on macroeconomic data over the next few quarters. BHG has been adjusting their credit models to prioritize the origination of lower-risk assets, while spreads may revert to historical levels as we transition into Q4 and 2023. Production levels are impressively strong and we anticipate BHG will maintain robust production leading into Q4 and 2023. Notably, BHG expects to unveil two to four new funding alternatives in the near term to broaden their liquidity platform, which we also regard as one of their strongest assets. Now, let’s discuss the outlook for the remainder of 2022. For loans, we have upgraded our outlook to anticipate low 20% growth for 2022. We've revised our rate forecast and now expect a 4.5% Fed funds rate by year-end. We'll continue to monitor the situation and adjust as necessary, but we don't foresee any reasonable changes to our current planning assumptions that would significantly affect our outlook for 2022. Considering this, we expect ongoing growth in net interest income, with overall growth projected to be in the low 20% rate. We still anticipate that rising hires and other factors will bring about high teens expense growth. All these projections pertain to 2022; we will provide further details on our 2023 outlook next quarter. Last year at this time, our focus lay in devising a growth strategy for earnings in 2022, with low single-digit earnings growth initially anticipated—among our peers, 80% were, according to sell-side research, expecting negative EPS growth in 2022. Therefore, we are pleased with our 2022 financial performance thus far and believe we will significantly exceed our loan, deposit, revenue, PPNR, and earnings targets for this year. Trust us, as I'm primarily addressing my Pinnacle teammates listening in, we have already commenced discussions for next year, with the same goal in sight: achieving top quartile earnings performance regardless of challenges ahead.
Operator, Operator
Thank you, Mr. Turner. The floor is now open for your questions. The first question is coming from Steven Alexopoulos from JP Morgan. Steven, your line is live.
Steven Alexopoulos, Analyst
Hi, good morning, everyone.
Terry Turner, CEO
Good morning.
Harold Carpenter, CFO
Hey Steve.
Steven Alexopoulos, Analyst
I want to start. So, Harold first on the non-interest bearing deposits, right? These went from 24% of total before the pandemic which is before QE to 33% today. Do you think you can hold that mix at about that level? Or do you see it migrating back, right, we're in QT now. Do you see it migrating back as you continue to fund strong loan growth?
Harold Carpenter, CFO
Well, no, we don't think it's going to go back to pre-COVID levels. We've had a lot of initiatives around operating accounts and we've gathered a lot of clients. So, we don't think we'll get back down there. We did see the mix shift that we noted previously. But so far in October, now granted, we're only 18 days in, we're feeling pretty good about where this deposit book is hanging in there, particularly on non-interest bearing.
Steven Alexopoulos, Analyst
So, there's enough sources when you look at sources of funding and maybe we could hold the mix about where it is.
Harold Carpenter, CFO
Yes, I think so. We might drift down a couple of notches, but I don’t think it's going to be that dramatic.
Steven Alexopoulos, Analyst
Got you. Okay. And then as we think about expenses, I appreciate next quarter you'll give us 2023, but when we think about the ramp and hiring through 2022, can you just give us some framework about 2023? I mean, should we at least be at a similar level of expense growth next year, just given the hiring that took place through 2022?
Harold Carpenter, CFO
I will share some data points and then let Terry discuss the momentum. We anticipate experiencing at least high teens to mid-high teens expense growth next year, which is our current expectation. Terry?
Terry Turner, CEO
Yes. Steve, I think on higher and momentum, as you saw, third quarter was a record quarter for us. I don't look forward to stay at 53 revenue producers a quarter, but I expect it to remain high going forward. And so I think your data is correct that the hiring more or less occurs on a straight line and I would expect it to continue for the foreseeable future. And so how that bears on the expense growth is just exactly what you say. I mean it will be elevated because we have hired throughout the year and frankly, we intend to continue hiring at a similar rate in 2023.
Steven Alexopoulos, Analyst
Okay, that's helpful. And then finally, there are many investors on the sidelines nervous to own your stock here, not because of Pinnacle's credit quality, but their concern on the credit outlook for most of the FinTech lenders out there, including BHG, particularly given BHG expanded these newer verticals. Could you just share with people on the sidelines, how worried are you on the credit outlook at BHG given the macro environment? Just any additional color you could provide would be really helpful. Thanks.
Terry Turner, CEO
Harold, would you like to go first and then I'll follow up?
Harold Carpenter, CFO
Sure. We've had a lot of conversations with the leadership at Bankers Healthcare Group over the last several quarters about their confidence in their book and their credit models. They believe currently that their models are sound. If there is a significant uptick in inflationary pressure, no doubt their charge-offs could slightly increase. But they are very confident with respect to their ability to find the best borrowers in this environment and continue to monitor their book for any potential cracks or weaknesses.
Terry Turner, CEO
I think I might add a couple more points. As an investor, I have always sought to understand the credit risk involved. One aspect that reassures me is their strong analytics team, which examines a variety of variables. The key factor, however, is their credit scoring mechanism. We provide information on FICO scores because they're widely recognized, but they do not base their credit decisions on FICO scores. Instead, they use their own proprietary model, which is 17% more predictive than FICO. Importantly, they are not new to credit; they have navigated multiple economic cycles, including the Great Recession, without incurring losses—something few banks can claim. They began with a sophisticated credit scorecard that has evolved over time but remains effective. Another reassuring aspect is their performance during previous recessions, which has consistently outperformed both our bank and most others during those periods. Additionally, because their focus is on consumer credit, their borrowers tend to have significant incomes, averaging $287,000. Compared to various other FinTechs, many of which target lower-income borrowers, their clientele is quite different. These are not individuals borrowing for small purchases; they represent a higher class of borrower. So, I wanted to highlight those three observations.
Steven Alexopoulos, Analyst
Okay. That's great color. Thanks for taking my questions.
Terry Turner, CEO
Yes.
Operator, Operator
Thank you. And the next question is coming from Stephen Scouten from Sandler O'Neill. Stephen, your line is live.
Stephen Scouten, Analyst
Thank you. Good morning, everyone. I guess I wanted to dig down into the beta expectations you have that you laid out in the presentation, both on the loan and then especially on the deposit side. 2021 growth and kind of historical growth.
Terry Turner, CEO
Hello? Steve, are you there?
Stephen Scouten, Analyst
Yes, can you hear me?
Terry Turner, CEO
You kind of blanked out on me?
Stephen Scouten, Analyst
Okay, I guess I'm just trying to think about where loan growth expectations you have in 2023 in relation to your deposit beta expectations. It seems that with your guidance for high teens again, we might be looking at high teens growth once more.
Terry Turner, CEO
Steve, I think I understand your question. It seems like there was a moment of technical difficulty. Looking ahead to next year, if we analyze the net interest margin based on historical trends, we expect that as the Fed pauses rate increases, the yields and rates on the left side of the balance sheet will likely stabilize. Additionally, the impact of deposits will probably continue during that time. Reviewing our net interest margin over the past two years, it has remained fairly steady in the range of 2.95% to 3.05% in a generally flat rate environment. Therefore, we anticipate similar performance concerning our margins once the Fed calms their rate hikes. Is that helpful?
Stephen Scouten, Analyst
Yes, that's helpful. Sounds like I might be having technology issues. So, I'll let somebody else hop on. Thanks a lot.
Terry Turner, CEO
Thanks Steve.
Operator, Operator
Thank you. The next question is coming from Michael Rose from Raymond James. Michael, your line is live.
Michael Rose, Analyst
Hey, good morning. Just you gave us a lot of colors on BHG, very much appreciated. On the one hand, you continue to grow, you feel comfortable with that growth, but on the other hand, the recourse reserves or the new terminology you’ve used, is expected to grow as well. I know it’s really hard to forecast. So, you had really good growth through the year in BHG; could you give us some thoughts on the puts and takes of how we should think about 2023 and the growth of that business just going into a slowdown? Thanks.
Harold Carpenter, CFO
Yes, Michael, we've had some preliminary conversations with BHG about their next year's outlook. They have expressed confidence that their production platform will continue performing well next year. They believe they will have opportunities to navigate between the securitization platform and the gain-on-sale, alongside the bank auction platform. I don’t think it would be unreasonable to project that next year’s growth rate could be around 15% or something like that. I’m hesitant to get into too much detail, as we need more discussions with Bankers Healthcare Group.
Michael Rose, Analyst
Certainly understood. And then thanks, thanks for that. Maybe just more broadly speaking, you guys have been obviously very active on the hiring front. And you've touched on dislocations that could also work in your favor next year given the market disruptions. But it has been a while since I think you’ve considered whole bank transactions, and I wanted to see if the dislocated market and the credit issues we might see could reopen that avenue as we consider the next couple of years. Thanks.
Terry Turner, CEO
Michael, I think on that front, you've heard my answer before and it really hasn’t changed. I’m not going to say never—that we absolutely won’t consider it—but I think it’s fair to say that you can see our hiring momentum, which I expect will continue as long as we can continue to capture market share. For us to do that, there would have to be a compelling transaction. Therefore, if we come across one, we would certainly consider it. However, my perspective is more focused on organic growth and continuing our market share strategy; we are in a fortunate position to be a preferred destination for large bank employees seeking to exit their large bank roles. I expect this will primarily be our leverage going forward.
Michael Rose, Analyst
I appreciate it. Maybe just one final quick one. Just putting together some of the expectations you've discussed for next year. Given the rate outlook, the betas you’ve mentioned, as well as your comments regarding BHG and expenses, will it be more challenging to generate positive operating leverage next year? Thanks.
Terry Turner, CEO
Harold, you want to take that?
Harold Carpenter, CFO
Sure. Yes, I don't think it's unreasonable. I believe our efficiency ratio is sub-50%, which opens up many options for improvement in the near term.
Michael Rose, Analyst
Helpful. Thanks for taking my questions.
Operator, Operator
Thank you. And the next question is coming from Jared Shaw from Wells Fargo Securities. Jared, your line is live.
Jared Shaw, Analyst
Sorry about that. Thanks for taking the question. I guess going back to BHG, could you give an update, Harold, on maybe some of the steps that they’re taking to utilize more CECL-friendly disposition avenues? And what a day one potential estimate for BHG could look like right now?
Harold Carpenter, CFO
Yes, sure. There are several options available, a couple of which I’ll mention. One option is within the guidance; they can sell more of the cash flows to avoid CECL, similar to what they do with the gain-on-sale platform with banks, they can do that with institutional investors. Additionally, they can sell partial future cash flows, effectively carving out certain credits from the CECL domain. There are various tactics they can implement to mitigate CECL exposure. As it stands, they are considering their reserves, currently at 3.5%, which could increase to the 9% to 10% range following day one CECL impacts. So I’m not sure if that fully addresses your inquiry, Jared, but that’s what we’ve discussed.
Jared Shaw, Analyst
Okay, and then any update on how you're thinking about your ownership stake in BHG? In the past, you indicated you may travel with the founders, but over recent quarters, it seemed you could forge your own path. How should we consider BHG as a percentage of the Pinnacle balance sheet or earnings stream going forward?
Harold Carpenter, CFO
Terry, I'll start and then let you finish. Right now, there hasn’t been a significant change in our stance regarding our ownership of BHG. We are definitely not interested in acquiring a majority stake in the franchise. I believe both Pinnacle and the founding members of BHG share the same perspective. If presented with a liquidity event or opportunity, we would consider it, but at this time, the market is hesitant regarding transactions. That said, as I mentioned, we’re all aligned and open to discussions if an opportunity arises.
Terry Turner, CEO
Jared, I think I might add to Harold’s comments—what he said is accurate. The valuation—whatever it is—has fluctuated, and if you look at the changes in the value of that company over the last 12 months, nine months, six months, or three months, it’s dramatically different. These changes influence what can actually be executed. When you bring up liquidity events, you essentially need to find a willing buyer and willing seller. There are always individuals scouting for valuations, and so we have reached a point where we and the other two owners are in agreement. We’d be open to reducing our stake if others seek a minority interest in the company. I value the income it produces, and it has offered us significant strategic advantages for funding rapid growth while maintaining very high profitability. Frankly, I don’t want to relinquish that completely, but if it became a smaller percentage of our income, that could enhance investor perceptions, PE multiples, and those types of factors. While I cannot specifically predict what will occur, we would be willing to explore a reduction in stake or a sale of the company, but we are quite content to remain in the current situation for now.
Jared Shaw, Analyst
Okay, all right. Thanks. Shifting over to loan growth in the outlook for 2023: you seem to have good momentum with ongoing hiring. If we're potentially looking at a weaker economic backdrop, when I review slide seven and the various avenues of growth, do you think we might rely more on expansion markets or do you envision maintaining a generally diversified growth approach as we enter 2023?
Terry Turner, CEO
My impression is it should remain relatively similar. I think as the new markets mature, their growth could be more rapid than the legacy markets, but generally speaking, I see the allocation of growth being fairly comparable when viewed 12 months from now.
Jared Shaw, Analyst
Great. Thanks a lot.
Operator, Operator
Thank you. And the next question is coming from Catherine Miller from KBW. Catherine, your line is live.
Catherine Miller, Analyst
Thanks good morning.
Terry Turner, CEO
Hey Catherine.
Catherine Miller, Analyst
I wanted to revisit the margin and the cumulative betas through 2022. I found that chart very helpful showing the 60% loan beta and the 40% cumulative deposit beta. As we look to next year, I know you're not providing direct guidance; however, how do you envision these two metrics trending? And is a 50% cumulative loan beta a suitable estimate for next year, or could the dynamics of pricing for new loans alter this throughout the cycle?
Harold Carpenter, CFO
Yes, I think—well, first and foremost, I want to emphasize more about where the margin is versus where the betas go. We provide the beta information to help keep people informed, but our primary concern is margin performance. As I mentioned earlier, we anticipate the margin will flatten once the Fed begins to ease or minimize additional rate hikes. As for the beta itself, in all likelihood, once the loan beta stabilizes, it could decrease due to competitive pressure. Yet, we believe the ongoing lag on deposits will likely exert more influence on the margin over the longer term.
Catherine Miller, Analyst
Got it. And on that note, how do you think the margin may evolve in the near-term, around Q4?
Harold Carpenter, CFO
Yes, we are not currently anticipating another 30 basis point uptick. It should be around half that—maybe a bit more than half—going into the fourth quarter.
Catherine Miller, Analyst
Half of the increase we saw this quarter?
Harold Carpenter, CFO
That's right.
Catherine Miller, Analyst
Got it, okay. So, you might peak early 2023 and then expect a downward trend as you progress through the year?
Harold Carpenter, CFO
Yes, our planning assumption suggests we expect two 25 basis point rate decreases in the latter half of the year, thereby flattening the margin during Q2.
Catherine Miller, Analyst
Got it. Thanks. On the deposit growth composition, seeing balanced progression is great. In terms of strategy, how do you envision the composition of where that growth will originate? I understand you mentioned you anticipate in increasing net interest-bearing, but how much do you suspect will arise from non-core versus core? Additionally, your comments regarding specialty deposit strategies—could you elaborate on how these might influence your deposit growth outlook?
Harold Carpenter, CFO
Terry, I'll start and then let you take it from here. Traditionally, our client base provides 80% to 90% of the core funding required to support our loan growth. In the past, we’ve relied on the wholesale markets—brokered or Federal Home Loan Bank—to bridge any liquidity gaps. Fortunately, in the past couple of years, we've seen far less of a necessity to tap into the wholesale markets due to our strong funding capabilities. However, we do have some capacity to access those markets if needed. Previously, we operated with a limitation of around 20% in terms of wholesale funding, and I see no indication we may approach that percentage again. Our focus is on maximizing our franchise’s value by ensuring we're diligent in exploring all sources for deposit growth. I believe our relationship managers are diligently pursuing this objective today. As for the new deposit growth, we expect it will largely stem from our new hires and expansion into new markets. Terry?
Terry Turner, CEO
Yes, I would add that in recent years, we have focused on building specialized deposit funding initiatives around HSAs and cross-community associations, such as homeowners’ and property management associations. These have shown positive early performance and are breakeven. We are optimistic these will play a significant role in our overall funding as we progress.
Catherine Miller, Analyst
Great. Thank you so much. That’s all I have.
Terry Turner, CEO
All right.
Operator, Operator
Thank you. Ladies and gentlemen, this does conclude today's conference. You may disconnect your lines at this time and have a wonderful day. Thank you for your participation.
Terry Turner, CEO
Thank you.