Pinnacle Financial Partners Inc
NASDAQ:PNFP
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Good morning, everyone, and welcome to the Pinnacle Financial Partners Second 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. [Operator Instructions]
During this presentation, we may make comments, which may constitute forward-looking statements. All forward-looking statements are subject to risks and uncertainties and other factors that may cause the actual results, performance or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond Pinnacle Financial’s ability to control or predict, and listeners are cautioned not to put undue reliance on such forward-looking statements. A more detailed description of this and other risks is contained in the 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 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 turning the call over to Mr. Terry Turner, Pinnacle’s President and CEO.
Thank you, operator, and thank you for joining us this morning. Q2 was an outstanding quarter in my view. As most of you know that have been following us for some time, we took a number of actions in the early stages of the pandemic like modifying our incentive, focus on PPNR growth during 2020, to ensure that we'd be in a position to quickly return to our pre-pandemic growth trajectory, as the pandemic waned. I think the first two quarters of 2021 would suggest that we've been largely successful in that. We begin every quarterly call with this dashboard reflecting our key performance metrics on a GAAP basis, but as we most always do, because there are so many adjustments required in order to focus on the variables that we're truly managing here at Pinnacle, I'll move quickly to the chart reflecting the adjusted non-GAAP measures.
As you can see, the second quarter was another fabulous quarter for us. Linked-quarter annualized loan growth ex-PPP was 12.6%. Linked-quarter annualized core deposit growth was 14.2%. Linked-quarter annualized revenue growth was 20.1%, and already strong asset quality got even better. On a lot of these earnings calls, I try to provide more color on all or several of the key metrics that are on this chart, but today I want to focus more on the big picture. And that's really the speed and the reliability of the growth over an extended period of time.
Look at the CAGR for virtually every important growth metric. And I think that demonstrates the speed and reliability of our growth, even in the face of the various headwinds we've encountered over time. Take EPS as an example. The 17% CAGR, you got a dip in 1Q, 2Q 2020 associated with the COVID-triggered reserve bill. But other than that, the growth is extremely reliable. Look at the revenue CAGR, the loan CAGR, the deposit CAGR, all very fast, all very reliable.
Most of you know we conducted a three-day orientation program for every single new associate of this firm conducted by me and other key leaders here. We invested time to help associates understand this culture why it is what it is, and what makes the difference. It's intended to inspire a high level of associate excitement and engagement. One of the topics that we covered in great detail is how we produce shareholder value.
The hour-long sessions conducted by Harold and it's intended to help every single associate personalize specifically what they do individually that increases shareholder value and the kinds of things they might do that destroy shareholder value. But the principal take-away we expect every single associate to get is that two things are required for us to produce outsized shareholder returns. Number one, speed of growth. And number two, reliability of growth. So how is it that we produce such fast and reliable growth and how is it that we expect to continue reliable growth going forward – excuse me – even as many of our peers are being overwhelmed by the current headwinds like slack loan demand and heavy payouts.
First of all, we've positioned ourselves in fabulous markets with extraordinary size and growth dynamics. Most of you heard me talk about our outlook in markets like Nashville, Charlotte and Raleigh, North Carolina, Greenville and Charleston, South Carolina, and Atlanta, one of the biggest and best markets in the country. And, of course, those size and growth dynamics are critical to growth. It's just hard to have a large high-growth bank without large high-growth markets.
On last quarter's call, I talked about the fact that I expected to continue hiring revenue producers in our existing footprint at a rapid pace and that we'd likely have opportunities to expand to other southeastern markets due to the high level of M&A activity and all the associated vulnerabilities that, that creates. And so, as you can see here, primarily as a result of integration turmoil, we were the most desirable alternative for a good number of high-profile revenue producers in Birmingham, the Southeast 13th largest market, and Huntsville, the Southeast 13th fastest growing market in terms of GDP.
I want you this that our reputation as a highly successful challenger brand with those large regional and national franchises called it frustrated teams to seek us out. And I'm not trying to foreshadow anything in particular here, but I'll be shocked that we don't have more of those hiring opportunities going forward as M&A appears to be picking up and the bureaucratic grind at many of our larger competitors continues to weigh on their associates. So the markets we currently serve and the markets that are likely available to us over time would suggest an ability to grow rapidly on an organic basis, even at a time when many are going to struggle to grow revenue and earnings organically.
Now, in my judgment, more important even than the size and growth dynamics of our market is the fact that this firm has been built to create raving fans. I'm confident virtually every bank you listen to talk will talk about service. I know not one of them has ever said we're trying to give poor service and bad advice. But trust me, many do. So let me spend a minute on just how differentiated our service and advice is from every other bank in our footprint. What you're looking at here is data from Greenwich Associates, the foremost provider of commercial market research to large banks in the United States. This data is based on client responses across our entire footprint. That means businesses with annual sales from $1 million to $500 million in Tennessee, North Carolina, South Carolina, Atlanta and Roanoke.
So let's focus on the Pinnacle line at the bottom of the chart. You see the navy-blue portion bar that 80% of the Pinnacle client survey rated us a nine or a 10 on the question, how likely are you to recommend your lead provider to a friend or colleague, using a scale of zero to 10, where zero means not at all likely and 10 means extremely likely. So in other words, 80% of our clients are highly engaged active promoters. Trust me, that's an extremely unusual level of engagement. Another 19% rated us a seven or eight, that's not bad. Combining the two, 99% of our clients rated as a seven or better on a 10-point scale. But that 19%, that gold portion of the bar, scored us a seven or eight. They're referred to as passive, because while they generally rate you well, they're not so fired up just to being vocal advocates for you in the market. And then that last 1%, the red portion of the bar, are detractors, meaning they rated you somewhere between zero and six.
Out beside that blue bar, out beside our bar there you can see a 79. That's the Net Promoter Score. The number of promoters less the number of detractors. As you can see, that score is widely differentiated from all our major competitors in our footprint. And not only is that a fabulous Net Promoter Score in the Southeast. According to Greenwich, it's the second best Net Promoter Score in the country.
Now, if you bare with me just another minute here on this slide, it's not just that our Net Promoter Score is high. It's also that the banks with the most clients to lose have very low Net Promoter Scores with loss of detractors. When you look at the gold boxes at the top of the slide, you see that top five banks in terms of market share have an average Net Promoter Score of 40.2%. And the top 10 banks in terms of market share have an average Net Promoter Score of 51. One of the top five banks in our footprint from a market share perspective has a Net Promoter Score of six and 36% of their clients are actively detracting from their reputation. So the banks that have the most share are extraordinarily vulnerable.
The differential between their client perception of their service versus ours, where we have a Net Promoter Score of 79, is really wide or differentiated as they say. I've already talked about the size and growth dynamics of our market and how that barrels growth, but more importantly, in our attractive footprint, the banks who currently have the share lead are extraordinarily vulnerable. So as you think about the speed and reliability of growth, which is largely dependent on taking share as opposed to economic loan demand, this explains why we've been so successful taking share over the last 20 years while we grew loans ex-PPP 12.6% on an annualized basis this quarter and why I believe will continue to produce outsized growth for the foreseeable future.
I know for some Net Promoter Score seem much more abstract than ROTCEs and efficiency ratio. So let me take two minutes to see if I'd make it a little more tangible for you. Many of you may be familiar with an app called Nextdoor, an app that allows neighbors to see, can give tips to each other. Here, in the gray box at the top left of the slide, someone is looking for a new bank. The blue dialog boxes on the right are a sampling of the tips provided by neighbors. You can see Pinnacle clients raving about Pinnacle. Obviously, clients speaking well about our service. These are promoters. At last check, there were 125 comments or recommendations on this request. Pinnacle received 34. The next most frequently mentioned tip received eight. Now multiply that across our entire footprint and that's what promoters do for you. We have achieved that kind of differentiated client engagement, because this wowing of clients permeates everything we do in this firm.
Let me take a second to illustrate how it works. Over the last year or so, we've had ample opportunity to talk about our approach to the pandemic, beginning with an offensive outreach to our clients in the very early stages of the pandemic to see if they needed a deferral. Some banks focused on short-term asset quality metrics and were slow to defer payments. We focused on helping our clients, about whom we're passionate and, as an aside, our asset quality performed extremely well, but more importantly, clients were ready. This chart shows our relative outperformance versus the large banks with whom we compete. Here, we're just comparing each bank's percentage of national loans outstanding versus the percentage of national PPP loans originated for each bank.
Most banks were less successful on PPP than the size of their loan book would have suggested. As you can see, all the large banks with whom we compete underperformed, but we outperformed. And I believe it's because it was a matter of urgency for us to take care of our clients who were struggling. It was a [indiscernible] in this firm to get our clients taken care of. I won't take the time today to develop it fully, but Greenwich developed a Crisis Response Index to measure how well clients perceived their banks' response during the pandemic. And in the fourth quarter of 2020, Pinnacle had the highest Crisis Response Index of Greenwich's entire coverage universe.
In the most recent round of PPP, there has been a great deal of risk about how many applications didn't get processed, how many applicants got left at the station. There was recently a syndicated article in many of the nation's business journals like the Nashville Business Journal as an example, where our competitors talk about the dissolution with the SBA for cutting the program off, leaving them with so many unprocessed applications. Those comments are listed on the right hand side of this slide.
My view is that many of them just played ignorant and were often excuses as to why they didn't get their clients taken care of. In the last round of PPP, we took 9,790 applications. Guess how many didn't get submitted to the SBA. Just 71. This entire program worked feverishly, reallocated available resources, knowing that we were competing for a limited pool of funding and we got them all done, but 71. So we got 99.3% of our clients taken care of. So, on the right side, you can see what our clients said about us. Those are promoters.
As far as I know, there is no chance of creating that kind of client experience without creating an highly engaging associate experience. We measure our associate experience primarily via work environment survey of all associates. We hold each leader accountable for receiving 70% top-box ratings from their associates. In other words, for each statement that associates rate their level of agreement, the leader should have created an environment where their associates write and strongly agree 70% of the time. I'm not aware of any firms that set that kind of target or achieve that kind of result. But even in a disastrous year like 2020, handling difficult process and procedural changes, quarantines, reduced cash incentives and so forth, we still hit the 70% top-box target. That's an engaged workforce.
One of the reasons that we've created such a high level trust with our associates is that we operate with a 'win together, lose together' philosophy. If we earned our incentives, we all get paid. If we earned diminished incentives, we all earn diminished incentives. If we failed our incentive, we all failed our incentive. We win together and we lose together. Not only has that been a powerful team builder throughout our 20-year history, but it puts us in great stead at a time like this when there is increased emphasis on equity.
In 2020, 99% of our employees of color feel management shows a sincere interest in them as a person versus an industry benchmark of 80%. 96% of female employees feel they receive a fair share of profits versus benchmark of 75%. 91% of female employees feel that managers avoid playing favorites. 93% of female employees feel that promotions go to those who deserve them best. 90% of employees of color feel that they are paid fairly for the work that they do. And that's versus a benchmark of 72%.
And so this alignment that we've created results in extraordinary retention of all our associates, which means two things that barrel in growth. Number one, since associate turnover is the number one to turn to give great service, associate engagement continues to create promoters, which leads to more organic growth. And number two, since associate turnover leads to client turnover generally, this level of associate retention minimizes client attrition, which of course barrels on that growth. So what I'm trying to do is bring into focus for you this quarter the speed and the reliability of our growth over time, as well as the structure for reasons we'd expect our sales growth to continue for the foreseeable future.
So, Harold, let me turn it over to you for more detailed review of the quarter.
Thanks, Terry. Good morning, everybody.
We're obviously pleased with our second quarter loan growth results. Excluding PPP, average loans were up 9% between the first and second quarters. Excluding PPP, end of period loans at June 30 compared to March 31 were up 12.6% annualized. As to loan yields, the yield curve remained volatile during the second quarter and we have mentioned for at least the last two conference calls, loan yields will be a fight in 2021. We will lean into our relationships even harder to maintain our yields.
Overall loan rates were basically flat with the first quarter, but that was assisted by a big quarter and likely a high watermark for PPP forgiveness. PPP forgiveness boosted the second quarter yield on PPP loans to 5.47% from 4.51% in the first quarter. It will continue to be difficult to model loan yields for the next few quarters, given the impact of PPP. Excluding PPP loans, our average loan yield approximated 3.98% compared to approximately 4.07% in the first quarter. So where to from here?
Our market leaders continue to believe that a loan growth forecast, excluding PPP in the high single-digits for 2021 to be a reasonable growth target for our firm. As always, we will lean on our new recruits to give us an advantage on loan growth coupled with our markets, which we believe to be some of the best banking markets with many of the best bankers in the Southeast, we're optimistic about our loan growth goals this year.
We also recently announced our expansion in the Huntsville and Birmingham with seven relationship managers in total. We and they are both very excited about our opportunities in these two markets. As the loan volumes were modeled around $150 million in loan growth this year, from those two markets, I'm expecting P&L breakeven from our new associates in late 2022. As to yields, we have some reason to be optimistic that our core yields are stabilizing, so additional dilution of our loan yields, excluding PPP will likely occur, but should slow.
Obviously the yield curve does impact all of this, so hopefully we get some stabilization to help curtail the decrease in loan yields. As to PPP yield, it's anybody's guess. And even though we will continue to work our borrowers proactively, we don't believe we will see quite the pace of forgiveness in 3Q that we experienced in 2Q. That said, since the start of PPP, we recorded $125 million in fees associated with the program, of which we've recognized 60% of those fees thus far. So we still have $48 million in unrecognized fees, which we believe will help bolster loan yields at least over the near term.
Now on deposits, we had another big deposit quarter but not quite as large as several of our previous quarters. Core deposits were up almost $900 million in the second quarter. We had experienced significant growth in non-interest bearing deposits ending up at $8.9 billion at quarter end, up 29.5% since the end of last year. Our average loans to average deposit ratio was up slightly in the second quarter at 82.7%. So we consider that a small victory and this is the first increase in our loan to deposit ratio since the first quarter of last year.
Our average deposit rates were 20 basis points, while EOP deposit rates were at 18 basis points, so we continue to see downward momentum for 2021 and look to be around 10 to 15 basis points by the fourth quarter of 2021, assuming our short-term rate forecast plays out for the remainder of this year. Helping us get there will be about a $1 billion or so in maturing CDs over the next few quarters that have an average rate of approximately 70 basis points curve.
Liquidity continues to gain attention from all banks. The yield curve remains on everyone's mind. We did put some excess liquidity to work this quarter, approximately $650 million in additional investment securities. We don't currently anticipate any more big security purchases this year. As to the interest rate risk management, we do have a balance sheet bias today of rates being neutral to up slightly over the next year or two.
So before all the bond experts beat me up for deploying money in the fixed rate bonds in the second quarter, we did execute an interest rate swap on the front-end cash flows of about 50% of those bonds we acquired swapping the cash flows from fixed to variable, so our interest – so our asset sensitivity position is essentially the same before and after the bond transaction, but we did pick up, say, 100 basis points in yields over what we received on the cash purchases.
Our securities to assets ratio an increase of 15% in 2Q and we expect that the hold for the foreseeable future. Our estimate is that peers, say the banks $20 billion to $60 billion assets are running a good bit more than that, say, in the 25% range. We continue to look at ways to create increased momentum through deployment of excess liquidity in the higher yielding assets or elimination of wholesale funding sources.
All those lines, and in addition to the – in addition to bond purchases we made in the second quarter, we increased our repo instrument we acquired in the first quarter from $450 million to $500 million in the second quarter. As I mentioned last time, this repo instrument is secured by the counterparties investment securities portfolio in yields around 40 basis points. We're looking at another somewhat similar repo product, but it will likely be somewhat less in balances than the repo we have on our balance sheet curve.
We also reduced our wholesale funding book in the second quarter by almost $1 billion. Many of you might recall that we bolstered our liquidity in the historic pandemic with additional broker and other funds by more than $2.4 billion. At this time, a significant amount of that has been redeemed. We have about $250 million left for redeeming this year and $400 million in 2022 and 2023. Additionally, we have about $900 million is Federal Home Loan Bank borrowings that cost us an annual rate of 2%. We continue to explore prepaying of those FHLB borrowings, but the prepayment penalty remains too rich for us right now.
Lastly, we do fully anticipate redeeming $130 million in bank level sub-debt in a few weeks using available cash. The sub-debt instruments holiday was during the pandemic last year, but we elected the whole loan of capital at that time and now feel the current environment provides us enough confidence to eliminate this funding, which is costing us about 3.3% annually and as all that's going to lose some of its favorable capital treatment.
In the supplemental information, we've updated our interest rate sensitivity, which with all these initiatives we accomplished in the second quarter points toward an increased asset sensitivity in the up-100 scenario. As it stands currently, we like where our balance sheet is positioned with no big moves planned on our current agenda.
As the chart at the top left of the slide illustrates our net interest margin after PPP and liquidity was approximately 3.25% in the second quarter, which compares to a similar calculation last quarter at 3.29%. Thus our adjusted NIM after being up for four quarters in a row retreated slightly, but has held steady over the last year or so.
As to credit, obviously Tim is not here, but rest easy, he's on the job, doing what he does best, working both our relationship managers and clients and making sure we continue on our focus on being a well-run and very sound financial institution. Using the big – the four big traditional credit metrics, the net charge-offs, classified assets, NPAs, and past due accruing loans, Pinnacle's loan portfolio continues to perform very well and in many cases, these are the best credit metrics we've experienced in quite some time.
In the second quarter as was the case in prior quarters, during COVID our bankers and credit teams continued their diligence around conducting thorough credit reviews with particular emphasis placed on non-pass credits, our hotel portfolio and credits in the COVID specific low pass risk grade categories.
Our second quarter credit metrics remain very encouraging. As noted on the slide, net charge-offs are running at a respectable 17 basis points, our classified asset ratio declines with a very strong 6.8%. NPA has also decreased this quarter down to 27 basis points and pass risk were down to just 7 basis points, which collectively points to the great effort of our relationship managers and credit officers across our firm keeping a strong focus on soundness.
Many of us appreciate that in order to obtain these sort of credit trends, it takes discipline and active management. During the second quarter our relationship managers and credit officers not only experienced an uptick in credit request and loan growth, they also work to see all four of the major credit metrics improve as well. Great work, everybody. Our credit team continues to bounce back and forth between offense and defense, as they worked diligently to assist our relationship managers and structuring new loans appropriately as well as maintain an alertness toward the existing portfolio and looking for any trends pointing toward incremental deterioration.
Tactically, during the second quarter, the credit team essentially accomplished the detailed credit reviews like hotels and non-pass exposures. For the second half of the year, our attention will remain on the COVID segments, particularly hotels. Again, it's a good report on hotel occupancy, revenue per room, average daily rate, all trending in the right direction. As to occupancy, we continue to run about 5% higher than natural rates with our hotel portfolio saying 65% occupancy through the first two months of the same quarter.
We expect June occupancy to be even higher as the national occupancy rates trended up in June as well. If you recall, we downgraded all our hotels to criticize last spring at the onset of the pandemic, it's now time to review what has transpired and begin to look to establish upgrade targets over the next few quarters. Our credit officers have initiated a hotel upgrade plan for our criticized hotels loans, as such the credit officers will be looking at year ago support, operating trends over the last 12 months, and the ability to meet – PNFP debt service coverage ratios. Hopefully we will have another report for you on hotels at our next call in October.
As noted on the slide, we expect continued reductions in our allowance to total loss ratio over the next several quarters, as the overall economic outlook continues to improve and our COVID impact at loan segments continue to trend positive. All in all Pinnacle’s credit metrics have held up really well, and even though we have shifted back to a more offensive stance, we will continue our thorough defensive work, particularly in the COVID impact, et cetera.
Now to fee income. While lots of good news here, for the quarter, fee revenues were up more than 34% over the same quarter number of last year wealth management, which is investment services, trust and insurance had a great in comparison to last year, up more than 35%. We continue to be very active on the hiring front across our franchise, particularly as we continue to build wealth management in the Carolinas and Atlanta and eventually Birmingham and Huntsville.
You might think that we were disappointed in our mortgage results for the second quarter, quite contrary, mortgage has had a phenomenal last four or so quarters at $6.7 million for the second quarter, we are pleased and believe they have an excellent chance in holding that run rate for the rest of the year assuming the rate environment holds. SBA loan sales had a great quarter and we're optimistic that this business should hold for the remaining two quarters of this year.
We also had a great quarter with respect to our equity investments, excluding BHG, one of our investments completed a fall on equity raise during the quarter, the results of which provided a significant insight into an updated valuation of that investment and thus we booked a two point million dollar increase for this one investment. I'll talk more about BHG in just a second.
As expenses specifically incentives, I think everyone is familiar with the impact of incentive costs, our expense base and if our earnings hit our targets costs go up, if not costs go down. Last year, we did not hit our targets thus incentives were significantly below expectations with our eventual payout equating to 65% of our targets. We again fully anticipate based the current operating environment that 2021 will come back strong, and hopefully our associates will recoup some of the lost incentive from 2020.
Along those lines, we provided an opportunity in 2021 for our associates to earn and outside of incentive as much as 160% of target. However, and as we've said repeatedly, there is no free lunch, increased incentives, only occur if our earnings growth supports the incentive. Additionally, we anticipate max payout retreating back to the traditional 125% of target in 2022. All-in incentive costs are higher than anticipated this quarter, as we began accruing at the maximum award for 2021, thus we experienced a catch up from the first quarter, we believe the incentive calls for third and fourth quarter will be slightly less than the second quarter. As to our overall total expense run rate, we now believe that expenses for the third and fourth quarter should be flat to down from the amounts we booked in the second quarter.
Quickly some comments on capital. I mentioned the sub-debt retention earlier, we also intend to redeem another $120 million in sub-debt issues. Later this year, we'll work with our regulators on that matter after the next – over the next few months. And as I mentioned last time, and I want to just reinforce the point, we've intensified our focus on tangible book value growth by adding a peer relative component to our leadership's equity compensation plan.
We're currently calculating an annualized increase for 13.5% in our tangible book value per share thus far this year. Our plan is designed that we will compare our tangible book value per share growth with that of our figures along with relative return on tangible common equity and relative total shareholder return and determine the best in results for our leadership.
As our outlook for the rest of 2021, I won't go into this slide in depth as we've covered much of this previously. So this, again is really a summary for the model builders of what we currently believe. Obviously, we realize that we appear more optimistic than most, that said, we have great confidence in our people, our markets and our class and renewed optimism about where the Pinnacle is headed.
Now BHG. This is a slide that we've shown for several quarters. The blue bars on the chart are originations with record demand sets for the past four quarters. In fact, they've almost doubled loan originations over that time period. BHG would also tell you that their market share is less than 1%, so we believe much room for growth. As their research would indicate that the personal, small and mid-size business lending, home improvement and patient finance businesses are collectively of $925 billion annual loan origination business and BHG intends to be competitive in all.
The green bar represents loans on which gain-on-sale has been recorded as these loans are sold to downstream banks. This is the traditional BHG model, which generates revenues associated with our gain-on-sale model. As to the bottom left chart, borrower coupons have fluctuated only slightly over the last few years ending at 13.4% for the second quarter. Bank borrowings failed to new records at just under 4% in the second quarter, so net spread remained in the mid-9%, which overtime is up from previous years.
As noted on the slide, BHG executed on their securitization in the second quarter last year, the first securitization was approximately $177 million, this year securitization approximate $375 million. They also are looking to conduct another similar style securitization before the end of 2021. Doing this allows them to take advantage of some of the very attractive funding rates, as well as diversify both the revenue strength and funding sources. We consider the diversification strategy a good idea, even though the gang wholesale model results in more near-term earnings for BHG.
Of note, is that BHG is rapidly approaching a 50-50 revenue split between the gang wholesale and all balance sheet models and believe in 2023, they could in fact be there, much sooner than we anticipate. The bottom right chart now shows over 1,200 banks in BHG’s network and almost 700 individual banks acquired BHG loans over the last 12 months. Again, one of the strongest funding platforms for a gang wholesale model in the United States.
As credit we've updated BHG’s recourse obligation chart, on the chart on the left, the green bars detail loans that BHG has sold and their network of – and other banks which currently amounts to just over $4 billion in credits sold through their network. The blue line on the chart detailed the recourse of growth as a percentage of outstanding loans with these other banks. As noted the recourse obligation is a reserve for future loss absorption.
As noted on the chart during 2020, BHG increased their reserves in anticipation of potential losses from the pandemic with the reserve standing at 7.65% of outstanding loans at year end 2020. During the second quarter of 2021, the result of a better outlook BHG decreased the pandemic related reserves in the second quarter, as a percentage of loan, it was down approximately 100 basis points.
As noted on the chart at the bottom, right, the trailing 12 month loss has landed at 4.5%, basically consistent with the last few years and during the year where who knew how COVID would impact loss rates. This chart has also been updated from our previous presentations to better split the actual credit loss from losses BHG absorbed from reimbursing banks for the unamortized premium the acquiring bank paid to get the loan. As the chart indicates the prepayment portion has gotten somewhat larger over the last few years.
Keep in mind, prepayment losses are for good loans, they're just paid off prior to maturity. This could be a – for the several reasons, but primarily the actual premium type for BHG credit has gotten somewhat lower. Consumer credit, which is occupying more of BHG’s business, tends to have a higher prepayment track record and loans are being paid off earlier as rates have decreased.
We have again updated these two charts, the quality of BHG’s borrowers has improved steadily in the past and over the last few years. BHG continues to refine their scorecard and they increased the quality of its borrowing base. Again the right chart and as I've said before may be the most powerful chart I have to offer related to BHG steadily improving credit quality. Looking at losses by vintage, losses continue to level out in earlier months from originations thus pointing toward a lower loss percentage over the life of the underlying loan. The quality of the borrowing base in our opinion is very impressive and much better than just from a few years ago.
Lastly, BHG had another great operating quarter in the same quarter and exceeded everyone's expectations yet again. We've upped our expectations for 2021, now expecting 2021 to produce outsized growth in relation to 2020 of approximately 40% compared to our prior estimate of 20% to 25% or more. We were also adding a growth factor for 2022 of approximately 30%, thus no rest for BHG, as they continue to build a strong and more revenue diverse franchise.
As the slide indicates, they've got more ideas or in some phase of development, which should foster continued growth over the next several years. All the – and we believe PNFP had a fabulous quarter and our one that continues to give us much confidence that our franchise and as people are poised for outside of growth for the foreseeable future.
With that operator, we'll open it up for any questions.
Thank you, sir. The floor is now open for questions. [Operator Instructions] Our first question is from Steven Alexopoulos from JPMorgan. Your line is open.
Good morning, everyone.
Good morning, Steve.
Good morning, Steve.
I would start to the pace of hiring seems to have picked up pretty nice, right 36 revenue producers added in the quarter. Is this a function of you guys having more of an appetite to increase hiring here, or are you just seeing more opportunities from other banks?
Yes, I think that's a great question. The short answer is, we are seeing more opportunities from other banks. I think you've probably heard us talk about, our approach to hire revenue producers that sort of the top of the waterfall for us. And I would say it all along, we've got an unlimited appetite, if we have experienced people that were competent can move large books of business, we'll hire as many of those as we come across as many of those we have opportunities to hire. But the case is that we are finding greater opportunities to hire people.
And as I said in comments, Steve, I think a lot of that’s tied to M&A activity, just the frustrations that go along with being acquired, maybe in case some of them are just in your market, you have to be on the wrong end of the stick there, if you will, that’s creating a lot of opportunity. And then I think a couple of the big banks are just in a difficult spot, whether it's with regulators or whatever, but the bureaucratic grind is really working on their people, and so there is a lot of vulnerability that comes out of that.
Okay. That's helpful. That's good color. I'm curious if we look at the 216 revenue producers that you onboarded over the past two and a half years, given that we've basically been in a pandemic for about half the time they've been at your bank. Is the economy now more fully reopened, right, people are getting back to in-person meetings? Are you starting to see an acceleration in terms of that group being able to move the relationships over to Pinnacle?
I can't give you the definite answer on that Steve, I don't have the data just yet to say that for sure, but that is my intuition. I think a lot of the growth is coming from new hires, moving their books to us, that's a large part of what the growth is. And I do think it's a true statement that during the pandemic, people were – that they were able to move business, but it definitely had a longer sales cycle and it took them longer to get it done, and so that growth was somewhat retarded during the pandemic, and so our expectation is that, it should pick up.
Okay. And thanks. And just finally on BHG with quarterly originations, as Harold pointed out, running at 2 times, the pre-pandemic level. What would explain that, and is it sustainable? Thanks.
Yes, Steve. I've had quite a few conversations with BHG about that. They believe it's very sustainable, they attribute the growth rate to better analytics, they’d hire more people in their analyst group, they think they're going after a market with much more pinpoint precision and believe that there is plenty of business out there for them to go try to target. So relaying what they told us and then looking at what they're asserting for the rest of this year and next year. We're pretty excited about what they've gotten in front of them.
Okay, great. Thanks for all the color.
All right.
Your next question is from Stephen Scouten from Piper Sandler. Your line is open.
Hey, good morning, everyone.
Hey, Steve.
So I wanted to dig down into loan growth a little bit. It looked like the C&I growth was particularly strong, which has always been one of the all strong suits. But I'm wondering if there is been any changes as the bank has grown, have you had to look at larger loan sizes or if the balance sheet becoming any less granular over time? And then also the growth in consumer real estate look like a lot of that from Nashville. So if you could just dig down into what you're seeing on the loan growth side a little bit more.
Yes. I think there were one or two larger credits call it $30 million, $40 million in the first quarter that came – I mean, in the second quarter that were booked that helped bolster loan volumes. But I wouldn't think that's any different than call it over the last several quarters. There is always been some larger credits mixed up in there. As the consumer real estate, we are seeing some increased traffic with respect to that product, we're seeing with where the market is right now and Nashville particularly I think is unique in some respects with a lot of smaller businesses and also with call it sons and daughters of clients that are looking to get into the – get their first home acquired or otherwise find a house that they may not want to go through the traditional mortgage market with.
And so, we accommodate them as do, I think a lot of other banks with particular products designed to meet that need. And so, I think that's what's causing some of the increase, particularly in Nashville.
Steve, I might add to that, I do think it's important. We've not increased our house limits in years. And so again, there is not a intentional intent to drive credit sizes larger. And we're always cautious about that game, because obviously, particularly to – upper and middle market credits, the higher the credit sides, generally the lower the rate and so forth. So anyway, I would just say we've not increased our house limits or done anything that would cause us to focus on higher tickets in particular.
Great.
I might add to that Steve, whatever it's worth, I think in our North and South Carolina footprint and let's call it the old BNC footprint, their growth was very strong. I think Rick Callicutt might tell you that it was his best loan growth quarter in the history of him running that organization there. And you can see that it is more skewed towards C&I, which was what our thesis is, don't screw up their CRE business, but bolster on of seeing that business and so we're getting increased activity in the C&I sector there.
Got it. Okay. And then it looked like commercial construction picked up a good bit in the quarter as well. And I'm just kind of wondering what you guys are seeing in terms of new projects coming online, if you've seen a material pickup there kind of your customer sentiment and new investments in some of these projects.
Yes. I don't know if it's any significant new projects. We are seeing some come across, but I think a lot of the construction funding that was in the second quarter were projects that had worked through their equity phase. And now they're into – they're using bank money to fund the additional construction requirement. So I'm not, maybe Terry has got some updated information on that, but I don't – we don't see – there is obviously some incoming traffic with respect to multifamily and warehouse, we're not seeing a whole lot of additional requests for call it hospitality or spec office.
Okay, great. And then maybe last one for me, just kind of thinking about the fees for a minute. I think you guys said you would expect mortgage to kind of be similar to this quarter in the back half of the year. But if I'm looking at your slide, I guess at slide 60, it looks like production and even gain-on-sale margins are still fairly well elevated to 2019 levels. So I'm just kind of wondering why that revenue would kind of decline more to – or sustain it a more 2019 sort of level if that's the case?
Well, we think there is a lot of things going on in mortgage right now. They’ve had a great last year or so like produced a lot of revenues for us. But the housing markets I think in our most vibrant markets call it Nashville, Raleigh, Charlotte, Atlanta, the inventory is really getting depleted and then they're finding a lot of cash buyers. And so the mortgage tickets are either nonexistent or reducing. And so we're trying to kind of anticipate that a little bit here going into the last part of the year, which typically would be slower.
Steve, I think the other aspect of that is compared to 2019, we're in markets that we weren't in like Atlanta, Birmingham, and Huntsville. And if you look at the number of mortgage originators, there is an incremental headcount versus 2019. So we've added origination capability.
Yes, okay. Yes, that’s a great point. Okay. Well that's great. And then, sorry, maybe one last tack on just the SBA run rate it did look like it jumped pretty significantly in the quarter. Is that sustainable or is that more kind of a one-time increase on some buildup production on balance sheet that you sold off?
Yes. Runs through Rick Callicutt and had a couple of conversations with Rick about that. He believes it’s sustainable, he believes well there'll be a big kind of a congressional proposal here over the next month or so. Right now we can sell up to 90% of loan from 75%. And we believe in the next month or so we're hopeful congress will renew that and extend it, so we're hopeful for that and – because that would play into that assertion about maintaining that same volume here over the next couple of quarters.
Perfect. Thanks so much for the color guys and congrats on all the continued progress.
Thanks, Steve.
Our next question is from Jennifer Demba from Truist Securities. Your line is open.
Hi, good morning.
Hi, Jennifer.
Hi, Jennifer, how are you?
I’m good. How are you?
Good. Great.
A question, you hired some revenue producers in Birmingham and Huntsville. Could we see more hires in what are currently non-Pinnacle markets in the coming months and quarters as you guys – as you indicated before you – I guess you're seeing more proactive incoming calls, people interested in working for you?
Yes. I think the answer to that is yes, Jennifer. I was saying there in the comments. I'm not – I don't want to necessarily force you out on it. We will go to additional markets, but on the other hand, I'd be shocked if we don't have other opportunities going forward, I think your take on our sentiment is right, that there is increased vulnerability and we are having more people reach out to us and so forth. So I expect – I don't have a market that we're ready to announce, but our base price over the next 12 months, if we didn't add one or two.
Could those options stretch out over to Texas or other markets you might not necessarily think of for Pinnacle?
I don't think so, Jennifer. I mean, I don't want to rule Texas out, because it's a fabulous market. There might be a day and time we want to go there. But I'm just saying most of the thrust and most of the energy right now I would classify is in the Southeast. And so, again, I think it's markets East of us and South of us and so forth.
Okay. And when you’re hiring, how much wage pressure are you seeing right now?
I would say we are seeing a little wage pressure. But at this point, I don't see it as overwhelming in the hiring part of the equation. But I think you're on the right track in that we have to work hard, there's sort of two aspects to it, one is offense and one is defense. So we're constantly on offense trying to hire new people. We're also constantly on defense trying to protect our associates, and so we do see some pressure as people come after and target our associates. We don't let them – we're not likely to let good associates get away, and so you do see some price pressure there.
Okay. Thanks, guys.
Your next question is from Jared Shaw from Wells Fargo Securities. Your line is open.
Hey guys. Good morning.
Hi Jared.
Hi Jared.
I guess maybe sticking to theme Jennifer brought up, when you look at Slide 8, there's a lot of Florida markets in the Southeast. Do you think that as you go forward over the next few years, you can sort of pick off those markets individually with the same strategy you did in Atlanta? Or is that an area where you really need to start thinking about potentially doing some type of a deal to get into those markets and hit more of them it at one time?
Yes. Let me see if I can be clear on that. One is we like the top 25 markets is the Southeast, period, which, as you say, a good number of them are included in Florida. And so those are attractive markets to us. I think the second thing I would say is I tried to be clear although evidently was not clear in our last call that I think M&A is on the table. What I'd tried to say to people is – the only reason I say is on the table is because I've said before it wasn't on the table. And so I'm really just trying, hey, look, I've said we wouldn't do it, I'm saying we might do it. But all that said, that is not the most likely path for us. The most likely path, I love de novo starts and I think the opportunity for de novo starts are perhaps better now than I ever remember them.
And so to Jennifer's question, we are having people that are reaching out to us, and the more people that reach out to us and if we hire, the more that creates a dialogue that opens opportunities for other markets and those kinds of things. So I guess, Jared, in trying to be as direct as I could be, I don't want to rule M&A out, but I wouldn't view it to be the most likely. The most likely is we would extend on a de novo basis and I do believe we're likely to have some opportunities over the next few years and kind of most of those top 25 markets.
That's great color. Thanks. And then shifting a little bit to BHG, BHG sort of expands their mandate and grows beyond first the medical professionals and the licensed professionals into these newer areas. Are the bank buyers, do the bank buyers have the same appetite for that new form of customer or do you expect that, that paper is going to be what really fuels future securitizations?
Yes, well, I think they'll pay for a left-right, left-right through securitizations and gain-on-sale. Carefully, I was speaking into the individual that runs their outplacement group, the person that positions loans with other banks. And he told me, I guess, this was four or five months ago that he could put 3x through that pipeline. So there is plenty of appetite that's available to BHG to run loans through that gain-on-sale model.
But that said, I think they still believe that revenue diversification and funding source diversification is where they want to go. I think a 50/50 split maybe where they think they'll end up and start maybe with less frequency going to the balance sheet model, just to kind of – just – because I think at that time, there'll be pushing more loans through gain-on-sale. So the great point in all this is that they have the option. They can always reduce their appetite from the balance sheet model and running more loans through gain-on-sale and thus generate more near-term profit if they so desire. But as it sits right now, they're trying to get to that 50/50 split.
Okay, great. Thanks. And then just finally from me, Harold, you talked about the maturing CDs coming due over the next few quarters. Should we expect that you just sort of let those run off and CD balances decline and potentially cash balances run out or will most likely be renewed into a lower…
Well, I think there’s $300 million or $400 million of that, that's in the wholesale group, so those will get redeemed. But the rest are client CDs and we fully intend to renew those. And so they'll probably get renewed down into the, call it, the 25-basis point categories, somewhere along in that line.
Great. Thank you.
Your next question is from Brett Rabatin from Hovde Group. Your line is open.
Hey, good morning, everyone.
Hi, Brett.
Hi, Brett.
I wanted just to talk about the guidance for a second on NII. And I realize that the PPP income is likely to impact the margin negatively in the back half of the year. And it's hard to predict what that income will be, but it would seem like your guidance around NII approximating the first half of the year could be conservative, just kind of given the growth or it essentially implies that the margin pressure could be like 10 basis points or maybe a little more. Harold, can you maybe just walk through how you're giving that guidance and the components of it?
Yes, sure. But – well, first of all, you're right on your point about PPP. We don't anticipate nearly the revenue traffic or revenue flow that we got in the second quarter in the third and fourth quarters. The round two loans are the ones that will have most of the forgiveness opportunities here over the next, call it, three or four quarters, they have an extended tail, they're five-year credits, it's all that kind of stuff. But we will work with those borrowers and try to accelerate to get us best we can.
But that said, I've got currently an 18-basis point kind of deposit rate right now on my deposit book. I think it's going to be a slower more methodical downdraft on that to get to 10 to 15 basis points over the next quarter or two. So I don't have the same opportunity that I had in the earlier part of the year to get any kind of additional momentum out of the – out of interest expense.
Loan yields, we think they're going to hold. We hope they're going to hold. There is probably some more downdraft there. But all things considered, Brett, we just believe that the second half of the year, my NII number ought to be fairly close to what my – what the first half of the year on my list.
Okay.
Does that make sense?
Yes. Yes. I know there's a lot of moving pieces to it, so my understanding of guidance. The other thing I wanted to ask was just you had questions around BHG and sustainability of the recent trend and production. 3Q is actually typically their strongest quarter. Was there any inkling that maybe 2Q pulled forward some volume from 3Q or can you talk maybe about just thinking about obviously really strong numbers, but it would seem like 3Q is typically where you really have the growth? Any thoughts around seasonality.
Yes, I’ve got no feedback from them on that point. I don't think there was any pull-through of 3Q volume into 2Q. I don't think there was any kind of acceleration there. So we believe that they gave us a 40% kind of pre-tax growth number this year. So based on what we're seeing, that's very visible.
Okay, great. Congrats on the quarter. And thanks for the color.
All right.
Thanks, Brett.
Your next question is from Catherine Mealor from KBW. Your line is open.
Thanks. Good morning, everyone.
Hey, Catherine.
Maybe one question on credit. There is a lot of conversation today about reserve levels kind of heading back toward the day-one CECL number, which I think for you is about 67 basis point. How do you think, Harold, about – do you think that feels low? Do you feel like you'll get that low or where do you feel like your gut is at the reserve ratio may bottom?
Yes, I don't know, I don't think we'll get that low, Catherine, to be candid. When we are in that area, our reserve levels were at the low end of the peer group. So we're not targeting anywhere near that number. But we do think we've got some more room to go with respect to our allowance. We've been able to march it down so far, and we think we're going to be able to march it down some more, but I don't think we'll see that 70-basis point number you're talking about.
Okay. And then back to the question on the NII guide in the back half of the year, is there any kind of change to excess liquidity incorporated into that guidance or how should we think about the size of the balance sheet outsize of – outside of just the high single-digit loan growth?
Yes, I think my balance sheet will come up some over the next two quarters. We've got some opportunities to get some more wholesale funding off our balance sheet, so that will be – that will come into it. But we're not looking to do another big investment securities kind of transaction here in the second half. We'll just try to maintain what we have.
Got it. The still core NII should still be up, it's just really lower PPP that is driving the second half of the year to be kind of equal to the first half of the year.
Yes. That’s it.
Okay, got it. And then one last one if I could. Any updated thoughts on how BHG is thinking about a liquidity event? What are their kind of pros and cons in thinking about the timing of that for this year?
Yes, I think what we've said all along, they continue to study the markets, and like we've said, they're having fun, but they're not doing it for fun. They've increased their sophistication around whether the hedge funds or spikes or IPOs or whatever. So there'll be a liquidity event. I'm not sure when it's going to be. But the two founders that remain in the company that have significant, they believe, equity tied up in the company will want to see a liquidity event at some point and it's hard. You just can't blame them for that. We just don't know when it's going to occur. They – it's their company, they get to kind make those big decisions. We speak with them about it periodically. And – but so far so good, the runway for growth for them appears to be pretty long.
Great. That’s helpful. Congrats on a great quarter. Thanks.
Thanks, Catherine.
Our next question is from Brock Vandervliet from UBS. Your line is open.
Hey, guys. It's Vilas Abraham for Brock. Just a follow-up on C&I, just on utilization, what are you guys seeing now relative to pre-pandemic levels? Has there been any kind of bounce there and what are your assumptions in terms of the high single-digit loan guide as far as that goes?
Yes. That's a good question. We're not seeing any sign of increased utilization from commercial lines. It's still pretty flattish over the last two quarters. And we're not anticipating that move and significantly over the next two quarters. So I don't know what you might be hearing from other banks, but for us, it's kind of a non-event right now.
Okay. And then just beneath the surface on that CRE portfolio, is it still payoffs there that's driving some of the pressure and just competitive dynamics overall from your commentary there?
Yes. We had another kind of a big quarter for payoffs in the second quarter. We just happened to have enough new business to overcome it. But it was – it did accelerate some in the second quarter and commercial real estate was part of it. So I think the commercial real estate guys would tell you that they are seeing increased payoff traffic with projects going to Department of Finance a lot sooner. And I think that's just kind of the environment we're in and we want to stay in.
Terry, I don't know, if you've got any.
Yes, I think that's right. There is an immense amount of money available for permanent financing. And so generally most of our bank borrowers who are here on a recourse basis like to get it into a long-term product of that recourse, and so there is a ton of that money available right now.
Okay. And just maybe one more, on deposit growth pretty sharp contrast in interest bearing deposit growth versus non-interest bearing. Just outside of the CD paydowns, is there anything special going on there that we should be aware of in terms of that divergence?
I don't think there's anything. We typically have toward the end of the quarter some larger deposits come into the bank, but I'm not aware of any big ones this quarter that I can kind of think about that come to mind right now.
Okay, thanks, guys.
Thank you.
Our next question is from Michael Rose from Raymond James. Your line is open.
Hey. Good morning, guys. How are you?
Good. How are you?
Good. Hey, just following up on Catherine's BHG question and the liquidity event. Is there any reason – you guys have spent a lot of time with this business, you've watched to grow in floors, it's been a great contributor for you. I mean if there were to be a liquidity event at some point in the future, would you guys consider just buying the whole thing, just given all the positive benefits that it's brought? It seems like it would be a good fit, just given your investment and what it's done for the company.
Yes. I think on that, Michael, I always hate these questions with would you ever, because when you get into say, oh, I'd never do something, that's not a good spot to be in, so I don't want to say, oh, well, we would never do. I will say this. Our motivations have always been as we've had discussions about that topic in the past is that there are two things that have been important to us in terms of how we liked our current ownership interest being less than a majority interest.
And one is we like those guys having more stake than us. That's a good spot, because they are really good at it. But we want to make sure they're as interested as we are in its ongoing success. And two, honestly we like the equity method accounting treatment. And so were to buy more or all of that would change all that and so forth. So anyway, I don't mean to give a co-answer. Those are the reasons that we've structured the way we have. They seem to continue to make sense to me. But I wouldn't want to rule out and say, oh, well, we would never consider that.
Okay, that's helpful. And maybe just as a follow-up back to the loan growth, obviously great momentum. This quarter you've made a bunch of hires. You reiterated the high kind of single-digit growth for this year. And I understand obviously those hires are going to take time to ramp and everything like that. But any reason to think that, that outlook wouldn't be conservative? And as we go into next year and hopefully the economy continues to strengthen that you wouldn't be above that? Thanks.
Yes. I think obviously where the economy to strengthen and economic loan demand pick up, that would be a boost to what we think we could produce. We're relying on modest economic loan demand and primarily market share movement. Right now, the market share movement component shouldn't change drastically. But if the economic loan demand portion changed, then that would increase the likelihood of loan growth.
Okay. Thanks for taking my questions.
All right. See you, Michael.
Our next question is from David Bishop from Seaport Research Partners. Your line is open.
Yes. Good morning, gentlemen.
Hi, Dave.
Hey, Harold, quick question. I wasn't sure if I heard this right but in the preamble, did I hear that one of the equity investments that you had a valuation gain on or appreciation this quarter gave you a little bit of an insight into updated BHG valuation or so, if I heard that right, could you – just any color you can provide around that number?
Yes. We had – we run, I don't know, how many we have, maybe 30 or 40 kind of investments and venture funds and other kind of side investments in addition to BHG. BHG is by far away the most significant and largest. So, but we have others that we invested in over time. And one of those funds had a company, a portfolio company that developed product and as a result, that product has been a hit. And as a result of that, they did a follow-on offering and now valuation for that portfolio company went up 2X basically and we got to participate in that. And so that was the $2.4 million. I think we mentioned $3.3 million or so, sort of like that in the press release, because there were other companies that also had enhanced valuations. And so the $2.4 million was just the biggest one of that 3-point whatever it was in the press release.
But David, if I understood your question, I think you thought that Harold was indicating that gave further insight into the BHG valuation.
That's correct.
I don't think that's the case.
No, that's not the case. Two separate...
Okay, got it. Got it. Okay. I misheard. And then turning to loan yields; just curious within your various markets here, if you're seeing any opportunities for better or even conversely are you seeing more competitive pricing? Just curious how pricing is shaping across your various markets?
Yes, I'll start. Let Terry kind of finish. But loan yields are a fight and have been for the last couple of quarters. We can't get a yield curve that stays stable for fixed rate credit. So we need that to occur, but other than that, it's just – we're negotiating as hard as we can to keep those loan yields where they are.
Yes. I don't think there's – I don't think there's a lot I can add to that. I think Harold somewhat said, we're pushing hard, trying to keep the accountability and pressure in the system. We're doing the best we can on pricing, but it's going to be a slugfest I think for the remainder of the year. There's a lot of money chasing on a limited number of deals, so.
Got it. Then one final question and I realize payoffs and there can be some diverse granularity here, but I notice Memphis has been down here in the past couple of quarters and obviously there's a lot of M&A in the background with that market. Just curious any color you can provide in that market and how you view that market holistically overall? Thanks.
David, I couldn't quite understand the first part of the question. Are you asking for color commentary on the Memphis market?
Correct.
Yeah. Well, we like the Memphis market. I think we believe we have and can continue to produce outsized growth there. We're making really good headway. We've done well in the CRE segment for some time. We were making really good headway in the C&I segment. And so we've hired a good number of relationship managers, financial advisors, as we call them in that market like we have most markets and we expect that to continue to produce outsized growth.
Got it. Appreciate the color.
All right.
Our next question is from Brian Martin from Janney Montgomery. Your line is open.
Hey. Good morning, guys.
Hi, Brian.
Hey, just one follow-up, Harold, on that balance sheet question earlier. I guess, did you say it was your expectation was that it was up, the balance sheet would be up slightly or down slightly, it was down slightly?
Up slightly over the next two quarters.
Up slightly, Okay.
And we're trying to limit that as much as we can. So we'll try to get rid of our wholesale deposits that come due and we'll work with other depositors and try to get rates down as fast as we can.
Yeah. Okay. And then just to be clear on the PPP, I appreciate the comments on being less the next couple of quarters, but your expectation would be that the majority of that $48 million or so is likely collected in back half of the year. I mean, some of it bleeds in the next year, but the bulk of it your expectation, you hope to get it this year.
Yeah, we should get most of the $48 million that's left in the next two quarters, but that'll be, as you schedule it out, will be less than what we've collected in the second quarter. The third and fourth quarter will be less than what's in the second quarter.
Got you. Yes. Okay. And then you talked about the hotel – the plan on the hotel upgrades. I guess it sounds like there's some pretty good opportunity for upgrades in the next couple of quarters. I guess if that plays out, is that how you think about it and I guess, in return the Classifieds and Criticized and kind of bakes into the reserve release continuing?
Yes. I think, yes, that'll have something to do with the reserve release, but we should expect some upgrades this quarter, but I think most of the upgrades will likely be in the fourth quarter and the first quarter of next year, because some of those hotel loans went through a modification process and I think the due dates for that or maturity dates on those loans are coming up here in the fourth quarter or in the first quarter. Okay. Got you.
Brian, I think the other thing that might be important there is that it's – very few of those loans are Classified assets. Vast majority are Criticized assets. And so we're expecting the migration from Criticized to pass.
Got you. Okay. I appreciate that, Terry. And then maybe, Harold, just outside of the NII guide, I mean, just the core margin if you strip out the – I get the drag from the PPP, but just kind of the core NIM, ex the PPP, I guess how are you thinking about that the next couple of quarters? I know you mentioned the sub-debt and some other items on the cost of funds moving modestly lower. Just a little bit slower downdraft here.
Yes. We're just – we don't see it going up. We're going to try to keep it flat. I don't have as much renewable deposit costs to pick up any kind of additional increase in margins from that. So it will all depend on how well we do on loan pricing over the next couple of quarters.
Got you. Okay. Perfect. I appreciate the color and nice quarter, guys.
Thanks, Brian.
I am showing no further questions at this time. Thank you very much presenters. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation and have a wonderful day. You may all disconnect.