Earnings Call Transcript - PNFP Q3 2021

Operator, Operator

Good morning, everyone, and welcome to the Pinnacle Financial Partners Third Quarter 2021 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 that may constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties and other factors 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 31, 2020, and its subsequently filed quarterly reports. Pinnacle Financial disclaims any obligation to update or revise any forward-looking statements contained in this presentation whether as a result of new information, future events or otherwise. In addition, these remarks may include certain non-GAAP financial measures as defined by SEC Regulation G. A presentation of the most directly comparable GAAP financial measures and a reconciliation of the non-GAAP measures to the comparable GAAP measures will be available on Pinnacle Financial's website at www.pnfp.com. With that, I am now going to turn the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.

Terry Turner, CEO

Thank you, operator, and thank you to the rest of you for being with us this morning. In my view, the third quarter was an exceptional quarter with very strong loan growth, very strong core deposit growth, strong net interest income growth, and strong non-interest income growth. Asset quality shows the best numbers from most key asset quality metrics, and importantly, our relentless focus on tangible book value accretion continued to yield strong results. I believe what is evident is that our decade-long approach to attracting the best bankers in the market and empowering and enabling them to create raving clients is, in fact, enriching shareholders. Because of the sustained execution of that model, I expect that to continue to produce exceptional results for an extended period of time to come. There have been various studies over the years on key shareholder returns for banks that generally show the returns will be about EPS growth rates, revenue growth rates, and asset quality. Our business model is generally a roughly 80% spread business, which means an ability to consistently take share and grow the balance sheet is the key to revenue and EPS growth rates. That's why we focus intently on loan and deposit growth rates. We begin every shareholder presentation with this dashboard, which gives us a read on revenue and EPS growth, balance sheet growth, and asset quality. Of course, we always start with the GAAP measure, but I personally focus on several non-GAAP measures that help me better ascertain how well we’re performing on the key variables that we’re trying to manage here at Pinnacle. As you look across the top row, you can see remarkably consistent growth in revenues, EPS, and adjusted pre-tax pre-provision net revenues. Similarly, across the second row, we produced net loan growth this quarter even with meaningful PPP paydowns and forgiveness. Annualized organic loan growth, excluding the impacts of PPP, was 15.3%. Core deposits, specifically non-interest-bearing deposits, continued to soar in Q3. All this resulted in a tangible book value per share CAGR of 12.7% since 2016. Along the bottom row, you can see our asset quality has performed exceptionally well even during COVID. Net charge-offs were within our targets and the other key private loan categories we monitor are at decade-long lows. I’d like to provide better insight into what causes the key growth metrics to be so consistently effective. We’re positioned in some of the best markets in this country for growth, which is the simplest part of our growth formula. We should produce outsized growth simply because the markets in which we operate are expected to continue to outgrow the nation. Additionally, our ability to attract the best bankers and their proven ability to wow our clients in an environment where our largest competitors have many angry and frustrated clients should yield meaningful outsized growth. Our formula of hiring highly experienced revenue producers allows us to produce outsized growth while maintaining attractive asset quality metrics since the market share movement occurs as these experienced bankers move their borrowers within their expertise and leave problem credits behind. It’s the only way I know to reliably produce rapid growth on a sound basis. This model has, in fact, produced rapid reliable growth over an extended period, but I want to focus on our model and why I expect it to continue producing outsized growth. While the model is simple, it’s our relentless execution over 21 years that differentiates us. As I’ve said, our model attracts the best bankers, empowers them to create raving clients, which translates into shareholder returns. Our associate engagement is among the best employers in the country as recognized across virtually all associate groups. We’ve built a unique hiring model and a value-based culture, where every associate wins and loses together based on achieving corporate performance targets. We’ve seen many bankers claim to run the Pinnacle model, but virtually none of them have executed on those principles as we have. These engaged associates are empowered to wow their clients, which creates raving banks. Our Net Promoter Score is market-leading in both Tennessee and North Carolina and ranks extremely high in every metropolitan market in which we have a sufficient presence. According to Greenwich, we hold the second-highest Net Promoter Score in the U.S. Overall, a highly engaged client base recommends us to their peers, resulting in strong momentum. We have successfully translated this focus into shareholder value and returns, which have been remarkably outsized. Our current growth pace is exciting as we attract market-based revenue producers, especially as some of the largest market shareholders in our areas are vulnerable and losing talent. Pinnacle has gained recognition as an employer of choice, and our strategy allows us to capitalize on the vulnerability of these large banks, creating extraordinary market opportunities in the Southeast. Roughly 22% of our revenue producers have been with us for less than two years, and it typically takes a relationship manager four to five years to fully transition their book of business. This suggests we are incurring expenses that will lead to substantial revenue production in the next two to three years. Thus, the balance sheet and earnings growth will accelerate. In summary, I have illustrated our uptrend in key metrics, and I'm optimistic about our ongoing growth potential. Now, I’ll turn it over to Harold for a more in-depth analysis of the quarter.

Harold Carpenter, CFO

Thanks, Terry. Good morning, everybody. We're, again, pleased with our third quarter loan growth results. Excluding PPP, average loans were up 14.2% between the third and second quarters. At September 30, compared to June 30, we were up 15.3%. Overall loan rates were slightly up from the second quarter, assisted by PPP forgiveness. We believe we will see another meaningful quarter of PPP forgiveness in the fourth quarter, minimizing its impact on 2022. Due to accelerated forgiveness, the third quarter yield on PPP loans rose to 8.54% from 5.47% in the second quarter. We recognized $21 million of PPP revenues in the third quarter, down from $26 million in the second quarter. With PPP balances dropping to approximately $700 million at the end of the third quarter, we anticipate fourth quarter PPP revenues will range between $12 million and $15 million. Excluding PPP loans, our average loan yield approximated 3.93%, down from about 3.98% in the second quarter. We've stated that maintaining loan yields will be challenging, but with some upward momentum on rising rates, we are hopeful about increasing loan yields soon. Our sales team has performed remarkably well this year. In our new markets, Huntsville and Birmingham, we've recruited seven revenue producers from a standing start and, after only a few weeks of operations, have approximately $40 million in loans and slightly more in deposits. Atlanta continues to excel with 18 revenue producers and $345 million in loans at September 30. Our optimism for these markets, along with our new hires in equipment finance and franchise lending, gives us greater expectations for loan growth targets next year. Previously, we targeted high single-digit growth for this year, but our market leaders are now estimating a likely low double-digit growth rate for 2021. Regarding 2022, considering current economic conditions and our confidence in new markets and business lines, we believe a loan growth rate in low double digits, inclusive of PPP payoffs, is a reasonable target for our company. As for deposits, we achieved significant growth with core deposits increasing nearly $1.3 billion in the third quarter. We saw notable growth in non-interest-bearing deposits, ending up at $9.8 billion, a 32.4% increase since year-end. Average deposit rates were at 17 basis points, while end-of-period deposit rates were at 15 basis points, indicating a continued downward trend in costs for 2021. This trend will help us reduce costs further with about $691 million in maturing CDs in the fourth quarter, carrying an average rate of around 57 basis points. We are strategically deploying excess liquidity into higher-yielding assets and reducing wholesale funding sources, aiming for a gradual decrease in overall liquidity as loan volume growth is expected to aid this effort. Our objective is to earn a more favorable return on assets while preserving tangible book value growth. Credit remains strong as traditional credit metrics of net charge-offs, classified assets, non-performing assets and past due accruing loans continue to show exceptional performance. Our loan portfolio exhibits some of the best credit metric ratios in history. We anticipate further declines in our allowance for loan loss to total loans ratio over the next several quarters due to continued improvements and macroeconomic factors. On fee income, the news is promising. For the quarter, fee revenues were up over 25% compared to the third quarter of last year. Wealth management, which encompasses investment services, trust, and insurance, performed well year over year. Our mortgage sector rebounded as its pipeline rebuilt toward the end of the third quarter. Concerning our 4Q run rate, we achieved a strong quarter regarding equity investments, excluding BHG. We booked $4.7 million from one investment and approximately $4 million from other valuation adjustments. However, we don't expect similar increases in the fourth quarter. We received about $1.5 million in vendor incentives on checking accounts. As for expenses, specifically regarding incentives, we anticipate high incentive costs for 2021. However, increased incentives are contingent on our earnings and PPNR growth supporting the incentive structure. We expect our maximum payout target to revert to the traditional 125% in 2022. For our total expense outlook, we now believe fourth-quarter expenses should be flat to down from amounts experienced in both the second and third quarters, anticipating an 8% to 11% growth rate in 2022, primarily due to headcount growth and expansion into new markets and business lines. Regarding capital, we plan to redeem $120 million in subordinated debt in mid-November. We’ve sharpened our focus on tangible book value growth by adding a peer-relative component in our leadership’s equity compensation plan. We are currently seeing an annualized increase of 13.4% in tangible book value per share thus far in 2021, which is quite good relative to peers. Our goal is to compare our tangible book value per share growth with that of peers, alongside relative ROTCE and total shareholder return when determining results for our leadership group. Lastly, regarding our 2021 outlook, I won't delve deeply into this slide, as we've previously covered much of it. This serves as a summary for model builders about our fourth-quarter expectations. Now to BHG. Many of you participated in the BHG investor call last month. Al Crawford and Dan McSherry provided great insights into BHG’s activities. Since there haven’t been significant changes, I will spend less time on that. However, BHG completed its third securitization since the last call and may conduct another in the first quarter of next year. The chart on the top left details originations, which have set records nearly every quarter recently. The green bar represents loans with gain on sale recorded, occurring when these loans are sold to downstream banks. The gap between loan originations and loans sold will either reflect on BHG’s balance sheet awaiting future sales or securitization. Loan yields were 13.9% for the third quarter. The bank buy rate fell to 3.4%, yielding net spreads in the 10% range. The bottom right chart outlines BHG’s widespread network with over 1,200 banks, almost 700 individual banks acquired BHG loans last year. The securitization process combined with this network keeps BHG as one of the strongest funding platforms in the country. Credit-wise, we updated BHG’s recourse obligation chart, showing loans sold to banks amounting to $4.1 billion, with the green bars detailing these loans. The blue line illustrates the recourse accrual as a percentage of outstanding loans. BHG further reduced pandemic-related recourse reserves to about $230 million at quarter-end, approximately 5.67%, down roughly 75 basis points. The trailing losses for 2021 came in at 4.73%. Notably, the quality of BHG’s borrowers has steadily improved, as losses by vintage continue to stabilize, leading to lower loss percentages over the life of the underlying loans. Even with pandemic-related events potentially causing upward movements in losses, we view the quality of the borrowing base as very impressive compared to several years ago. For loans sold to other banks, substitution losses reached about 2.8% year-to-date, with third quarter losses at 2.4%. For loans held for investment, year-to-date losses totaled approximately 1.3%, with third quarter losses at about 1.4%. BHG had another great quarter, exceeding our expectations once again. We maintain our hopes for 2021 growth at approximately 40%, sticking with a 30% growth factor for 2022. BHG is planning their growth over the next several years, projecting that interest income from own balance sheet loans will likely exceed gain on sale income. This will influence the timing of income recognition. Lastly, we are optimistic about loan growth and pricing for Pinnacle in 2021. We believe it will demand significant effort, yet we remain positive. Deposit growth has been remarkable, with declining pricing. Net interest income is projected to stabilize in the fourth quarter. BHG continued to flourish, and we remain confident in that franchise. We anticipate expenses to remain flat to down again in the fourth quarter relative to the third. Operator, with that, I’ll turn it back over to you for questions.

Operator, Operator

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

Stephen Scouten, Analyst

Hey, good morning, everyone.

Terry Turner, CEO

Good morning.

Stephen Scouten, Analyst

Terry, you did a really good job of kind of talking through the hiring strategy and how it's benefited you over these 21 years. I was wondering if you could go even a little deeper into that and talk about what you're seeing on the economic growth front versus the hiring growth front, and how you think about that within your forward growth guidance? Is that still primarily in anticipation of growth from your hires? Or are you seeing any positive economic growth trends as well?

Terry Turner, CEO

Yes. I would say that we have not seen a lot of what I would call pure economic growth. It's probably better than zero, but it wouldn't be robust by any means. Looking at things like lines of credit, working capital, C&I lines — those types of funding are not seeing significant increases. We have economic growth greater than zero, but it's not large. Our new hires are the primary drivers of volumes.

Stephen Scouten, Analyst

Okay. And when you think about forecasting growth for your franchises, how do you approach that? Is it, if we experience 5% economic growth, could we actually grow at 15%? Or do you break it down in that fashion?

Terry Turner, CEO

Yes, we look at it from multiple perspectives to see what makes the most sense. Ultimately, we focus on a bottoms-up outlook based on what the financial advisers estimate they can produce. Aggregating those estimates from market leaders provides a clearer picture. It's some combination of various indicators, but I personally trust what the market leaders predict.

Stephen Scouten, Analyst

Great. I'm also curious about the expansions you mentioned in Birmingham, Huntsville, and Atlanta. Are there other near-term expansions on the horizon, like new product verticals or other markets you could highlight? Or do you feel like your plate is full with current activities?

Terry Turner, CEO

No, we don’t feel our plate is too full. There are lots of opportunities ahead. Our core focus remains talent acquisition. We previously limited hiring to local markets, but our expanded market presence has generated interest from many potential hires across regions where large banks operate. Moreover, our specialty lending areas are seeing an influx of talent from our competitors. This encourages us that we can expand into other large urban Southeastern markets in the near term, and we anticipate building one or two additional specialty lending businesses.

Stephen Scouten, Analyst

Great. Very helpful. Finally, do you have a number for how many new BHG loans you added to the balance sheet this quarter, and how you think about the concentration limit for that?

Terry Turner, CEO

Harold, do you want to take that?

Harold Carpenter, CFO

Yes. The number was about $50 million. I'll follow up with you on that later.

Stephen Scouten, Analyst

Okay, great. Thanks, and congratulations on another great quarter.

Terry Turner, CEO

Thanks, Steve.

Operator, Operator

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

Jared Shaw, Analyst

Hey, good morning, everybody.

Terry Turner, CEO

Hey, Jared.

Jared Shaw, Analyst

Yes. Sticking with the growth conversation, can you update us on how the conversion of new PPP customers is going? How are these customers transitioning to full-service banking relationships?

Terry Turner, CEO

Harold, feel free to jump in. I don't have detailed numbers for specific PPP clients, but it looks good overall. Greenwich data indicates a high percentage of our clients view us as their primary bank—around 84%—which is an exceptional penetration rate. Our programs and incentives focus on meeting all the needs of our clients.

Jared Shaw, Analyst

That's good color.

Harold Carpenter, CFO

To just add one point, we instructed our sales force to focus on current clients, not using PPP as a business development tool. However, Atlanta had an exception because it’s a new market, and we've seen strong retention along this route.

Jared Shaw, Analyst

Got it. Thank you. Concerning the expected expense growth rate for '22, how is this linked to the hiring of revenue producers? Will it be stable or increase compared to '21?

Terry Turner, CEO

Our expectation for 2021 will be higher than the before-mentioned range. I anticipate it could be above 100 hires, with the fourth quarter likely being a strong hiring period.

Harold Carpenter, CFO

We've seen substantial interest in hiring, and our upcoming plans reflect the number of new revenue producers. The anticipated expense growth will support this hiring leap.

Jared Shaw, Analyst

I appreciate the insights once again. Thank you, guys.

Terry Turner, CEO

Thanks, Jared.

Operator, Operator

Our next question comes from Michael Rose of Raymond James. Your line is open.

Michael Rose, Analyst

I wanted to delve into the comments regarding liquidity from the PPP program. The securities to earning assets ratio is about 17%. How much could the securities portfolio grow from here?

Harold Carpenter, CFO

We don’t anticipate significant securities growth. We are analyzing potential investments based on rate curves to ensure tangible book value remains intact. Our discussions emphasize the importance of deposits maintaining their stickiness.

Michael Rose, Analyst

That's insightful. If we look forward, do you think there's potential for positive operating leverage, excluding PPP fees, given your loan growth and expense outlook for next year?

Harold Carpenter, CFO

I believe there are always opportunities for operating leverage, with significant potential to drive our efficiency ratio down.

Michael Rose, Analyst

Thank you. Lastly, could you clarify plans regarding the recourse obligation for BHG loans this quarter?

Harold Carpenter, CFO

We anticipate a reduction in recourse obligations to about 5.5% by year-end and potentially further decreases by next year.

Operator, Operator

Our next question comes from Brett Rabatin with Hovde Group. Your line is open.

Brett Rabatin, Analyst

Can you provide insight on growth in the construction and commercial construction sector, particularly in Tennessee? Are you seeing clients drawing lines of credit?

Terry Turner, CEO

Harold, do you want to take that?

Harold Carpenter, CFO

Overall, lines of credit have not seen significant increases, but construction is indeed improving.

Terry Turner, CEO

It’s an interesting line item known for its volatility. We've observed extraordinary paydowns in loans, often before stabilization or even completion. However, we have meaningful construction commitments with substantial equity upfront before funding. The construction sector remained active, indicating higher project volumes.

Harold Carpenter, CFO

Looking at some numbers, construction and land development funding stood at 41.5% at June 30 and 42.4% at September 30, with approximately $6.6 billion in exposure, of which $2.8 billion is funded, revealing considerable room in our construction book.

Brett Rabatin, Analyst

Great, that helps. Regarding fintech investments, do you view this more passively, or are there opportunities to create your own Banking as a Service platform?

Terry Turner, CEO

We likely won't pursue a major Banking as a Service operation. Our focus has been partnerships through fintech investments aimed at deal flow and deposit flow. We seek to stay close to industry advancements, enable a fast-following approach, and explore synergies as possible.

Brett Rabatin, Analyst

Thanks, Terry. Finally, regarding the details on the revenue producers, is that primarily from larger regional banks or smaller community banks?

Terry Turner, CEO

It includes both, but the majority would stem from other large banks.

Operator, Operator

Our next question comes from Michael Rose of Raymond James. Your line is open.

Michael Rose, Analyst

Can we delve into the comments concerning the liquidity? The securities to earning assets ratio stands at 17%. How much could the securities portfolio continue to grow from here?

Harold Carpenter, CFO

We don't foresee significant securities growth. Our main study surrounds whether deposits will remain sticky in light of rate curves, leading us to strategic investment considerations.

Michael Rose, Analyst

That helps clarify. Regarding the expectation for positive operating leverage excluding PPP fees, do we anticipate it being achievable with your loan growth and expense outlook for next year?

Harold Carpenter, CFO

There are always opportunities for operating leverage. Expect significant potential for driving our efficiency ratio down.

Michael Rose, Analyst

Great, I appreciate that. On BHG, you mentioned a recourse reserve reduction this quarter; could you discuss the implications as BHG transitions to CECL?

Harold Carpenter, CFO

Currently, CECL is projected for 2023 or 2024. The main focus surrounds on-balance sheet credit modeling as they adapt to transition processes. Given that loans have an average life of about four years, with a charge-off rate around $1.30 or $1.40, that equates to reserves between 5% to 8%.

Brock Vandervliet, Analyst

Thanks for the insight. Regarding revenue producers, can you provide a basic estimate of their average contributions after three to four years?

Terry Turner, CEO

Harold, do you want to take that?

Harold Carpenter, CFO

Typically, a commercial lender adds about $60 million in loans and a similar amount in deposits over an average of five years.

Brock Vandervliet, Analyst

Thanks for that clarity.

Operator, Operator

Our next question comes from Brian Martin with Janney Montgomery Scott. Your line is open.

Brian Martin, Analyst

Could you provide insight into the allowance for loan loss trends?

Terry Turner, CEO

Yes. Harold, can you take that?

Harold Carpenter, CFO

We anticipate continued decreases in the allowance for loan loss, contributing to steady overall performance in these factors into 2022. Our analysis shows a positive trajectory for reserve reductions.

Brian Martin, Analyst

Thank you. Shifting over to margins, how do we expect loan yields and margins to trend based on current market conditions?

Harold Carpenter, CFO

As for loan yields, we're approaching the bottom, but we still expect some slight decreases over the next few quarters, albeit modestly. The pipeline shifts towards LIBOR to SOFR pricing won't significantly affect our outlook, restricting major impacts on loan yield.

Brian Martin, Analyst

Got it. Thank you for the insights.

Operator, Operator

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

Catherine Mealor, Analyst

I'd like to discuss margin expectations further.

Harold Carpenter, CFO

In terms of operating leverage, we're not expecting significant movement in the upcoming year due to the considerable force of recruitment and branch establishments in new markets. Therefore, our margins may remain stable.

Catherine Mealor, Analyst

Thank you for the clarity. That helps frame everything nicely.

Operator, Operator

Our next question comes from Matt Olney with Stephens. Your line is open.

Matt Olney, Analyst

I wanted to clarify the adjustments regarding recourse obligations. What was the specific amount for the adjustment this quarter?

Harold Carpenter, CFO

The adjustment was around $35 million, similar to second quarter figures.

Matt Olney, Analyst

Thank you for your insights.

Operator, Operator

This concludes the Q&A session. Thank you for participating. This concludes today's conference call. You may now disconnect.