Pinnacle Financial Partners Inc
NASDAQ:PNFP
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Pinnacle Financial Partners Inc
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Good morning, everyone, and welcome to the Pinnacle Financial Partners' Third Quarter 2018 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 also be available for replay on Pinnacle's website for the next 90 days. [Operator Instructions]
Before we begin, Pinnacle does not provide earnings guidance or forecast.
During this presentation, we may make comments which may constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties and other facts that may cause the actual results, performance or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many 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 most recent annual report on Form 10-K. 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 financial measures to the comparable GAAP measures will be available on Pinnacle Financial's website at www.pnfp.com.
With that, I'm now going to turn the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.
Thank you, operator. As we have every quarter for a number of years now, I'll begin with this dashboard, which is intended to give a quick snapshot of our performance during the quarter, highlighting not only the absolute level of performance during the quarter but the trends as well.
The dashboard is particularly focused on revenue growth, earnings growth and asset quality because we have believed and we continue to believe that short-term things will come and go, but over time, the three most highly correlated measures to long-term shareholder return are revenue growth, earnings growth and asset quality. Consequently, those three, above all else, have been, for an extended period of time, and are currently the guidepost for how we run our business. Measures on this slide are all presented on a GAAP basis.
Here, I particularly want to focus on some revenue growth, one of our key things for today's call. In the chart on the top left, you can see total revenues continue to set a new high each quarter, up 4.7% on a linked-quarter basis or 18.5% in terms of annualized rate of growth during the quarter. Harold will break down the revenue growth in greater detail in just a few minutes. But I do want to just point out that the largest component of revenue is net interest income, which was up in a mid-double digit annualized rate of growth during the quarter, roughly 15%.
Regarding our growth in balance sheet volumes, which for the most part is best predictor of future revenue growth, looking now just below the revenue chart is the loan chart. Organic loan growth during the quarter was an excess of $421 million, which is an annualized growth rate for the quarter of nearly 10%. So much have been talked about relative to slowing loan demand and elevated payoffs. But here in the third quarter, we think we produced low double-digit growth, which leads to year-to-date annualized growth of 15.7% in 2018, which is consistent with our long-held belief that we would produce at least low to mid double digit growth in 2018. So to be clear, our loan and revenue growth outlook hadn't changed.
I don't want to spend too much time on it right now, but I might just offer my own commentary around loan demand and loan growth. Even though the annualized rate of growth during the quarter is right at 10% and while that's consistent with our belief that we'll grow loans this year to low- to mid double digit pace, it is less than the prior two quarters. And what I want to point out, is so people to understand, we're not just trying to produce loan growth come hell or high water. If it's not there or our payoffs are very high, we're not booking loans just to get the growth.
But with that said, despite the fact, as we've stated, that overall loan demand lending is slow and CRE payoffs may remain high, because of the extraordinary success that we've had and are continuing to have hiring highly experienced relationship managers just away from our larger regional national competitors, we believe these experienced relationship managers will substantially move their books of business, allowing us to continue the low to mid double digit growth on a very sound basis. As far as I can tell, that's a truly differentiated strategy. So the third quarter was the fastest quarter in terms of current revenue growth and outlook for future revenue growth as well.
Now, switching to some non-GAAP measures. Because of all the noise associated with the BNC merger over the last year or so and the restructures in conjunction with the tax law change at the end of 2017, in some cases, non-GAAP measures may better illustrate the relative performance of the firm. So on this chart, I'd like to focus first on EPS, net of merger-related expenses, at $1.21, which is in the chart on the top row in the middle. Of course, 3Q '18 had no merger charges. So when adjusting for the merger-related charges in the prior period, fully diluted EPS is up nearly 35% over the same quarter last year.
And then immediately to the right on the first row is the tangible book value per share chart, which paints a nice picture of our ability to increase capital and grow tangible book value on a rising reliable basis with a 4.75 year CAGR of 14.2%. Harold pointed out in our earnings release this quarter that since the BNC transaction in 2Q '17, our tangible book value per share has increased by more than 16%, even after absorbing nearly $40 million in merger-related charges, a really strong indicator of the success of that transaction.
Immediately below the tangible book value chart, I want to highlight the ROTCE chart at 18.44% this quarter. As you review the trend line post-recession, you can see it progressed nicely until the first and second quarter of 2017. That's when we did the large capital raise in advance of and in order to make the BNC acquisition. As a reminder, the BNC deal closed at the end of the second quarter. So you can see the very nice lift in ROTCE following the deal closing, another strong indicator of the power of that acquisition.
Lastly, I want to highlight core deposit growth in the middle chart on the second row. Core deposits grew in an annualized rate of over 17% in the third quarter, substantially exceeding the annualized rate of growth for loans during the quarter. Again, there's been somewhat of a discussion about whether or not we could attract core funding at a sufficient level to fund on our rapid loan growth. Hopefully, we're now demonstrating again this quarter that we can. So third quarter was a great quarter with loan growth of nearly 10% annualized, core deposit growth of over 17% annualized, net interest income growth of over 15% annualized, revenue growth of more than 18% annualized, EPS growth were roughly 35% annualized and ROAA of 1.54% and an ROTCE of 18.44%.
Now, here's what we want to get done today. Harold will review 3Q '18 financial performance in greater detail. Following that, I'll provide an update on our success with the BNC integration, and then I want to do again with several questions that are being asked about all banks, I guess, including us, believing this answers, for us, are slightly different than many of our peers.
So Harold, with that, I'll let you begin a review of the third quarter.
Thanks, Terry. As we turn into revenue for the quarter, we're up $10.7 million from the previous quarter of $241 million, an increase of more than 18.5%. Linked-quarter annualized net interest income was up from the second quarter by $7.2 million, reflecting an annualized growth rate of 15.6% for the quarter. Much of this was attributable to increased average earning asset balances and improved yields. The impact of fair value accretion increased $987,000 during the quarter to $17.1 million. We anticipate decreases in discount accretion in future quarters at the level of acquired loans on recent merger becomes less impactful and post-merger prepayment slow. Best guess at this point is the fair value accretion is likely to remain around $60 million total for all of 2018 and perhaps $14 million to $15 million in 4Q. We're still forecasting around $40 million for 2019.
The dark green line on the chart denotes our non-GAAP revenue per share. We reported $2.80 adjusted revenue per share in third quarter of 2017, and we're reporting $3.11 this quarter, a little over 11% growth. Obviously, that's the goal, to keep the revenue trending to the north. We will keep an eye on our profitability metrics. But as it stands today, we can afford to gather funds as well as invest in our platform via ramp-up hiring activity. Now, we're all about increasing our earnings per share on a reliable and sustaining way and building tangible book value per share through the cycle.
We talked about this slide last quarter. This slide focuses on revenue per share growth using trailing 12-month information. Two things we'd like to communicate here. We continue to see double-digit revenue per share growth. Now, this is during the time of significant internal focus around the Bank of North Carolina deal, systems conversions, not to mention cultural integration and getting folks aimed in the right direction. That's why we believe, currently, there's a great deal of energy in our franchise right now. We're playing offense in Tennessee, the Carolinas and Virginia. In some cases, it's 3 yards and a cloud of dust. In some cases, we catch a big fish. But in all cases, some 2300 associates working to build something better today than yesterday.
Secondly, the dotted line represents the peer group's year-over-year growth, which is the cumulative last 12 months' revenue of our peer group divided by the aggregate number of shares. We've consistently outpaced the peers over the last 21 months and are widening the spreads so far this year. We have all worked at places where the only way you were, where you're going to hit your bottom line number was through some expense initiatives. We pay attention to expenses, but trust me, it's a whole lot more fun to work for a firm with growing revenues.
We've had this chart for a long time concerning loans. As the chart indicates, average loans for the third quarter were $17.3 billion compared to $16.8 billion at the end of the second quarter. Thus, average loans increased by almost $529 million, an annualized growth rate of better than 12%. This is on the heels of a strong growth in the first and second quarters of 2018. Comparing 3Q average loans to 4Q '17 average loans, our annualized growth is 15%. So we're going into the fourth quarter with roughly $200 million more in the EOP loan balances over the average for the third quarter, which is another great head start as we head into the last quarter of the year. We continue to believe that our loan growth for 2018 will average low to middle-double-digits for the year.
In the Carolinas and Virginia, their organic loan growth through the third quarter of 2018 was around 13% annualized. There's a chart in the back that shows what each market has achieved. Importantly, C&I and owner-occupied commercial real estate is up roughly 33% annualized. We're seeing growth in C&I in all of our markets in the Carolinas and Virginia. Right now, their C&I and owner-occupied book approximates 28% of their total loans. If they keep growing at a 33% clip, they will create a very robust C&I platform in the Carolinas and Virginia much faster than we anticipated.
Creating this franchise is key to our growth realms as with the C&I platform comes core deposit and related fee growth. Profits and paydowns were heavier in the third quarter over previous quarters, primarily in construction and non-owner-occupied commercial real estate. Our internal records indicate final payoffs and paydowns in this segment were $460 million in the first quarter compared to $580 million in the second quarter and grown to $760 million in the third quarter. Don't get us wrong here. We want these things to occur. They just are occurring earlier than we hoped. This will be another hit win as we go in the fourth quarter and next year, but believe our scheduled construction payoffs will normalize in the early 2019.
As the chart indicates and as expected, our loan yields increased to 5.15% from 5.04% last quarter, an 11 basis point increase linked-quarter. Our modeling had one more rate increase in December and 3 rate increases in 2019. This chart reflects our quarterly loan, loan growth for each quarters have skewed since 2015. The blue bars on the slide have been adjusted to remove acquired loans. That said, these are the real quarterly annualized growth numbers, thus reflecting, we believe, the impact of growing our revenue producers. As shown, our loan growth continues to outperform our peer group quarter-after-quarter without sacrificing credit quality or accepting undue concentration risk.
Keep in mind, we don't know what 3Q '18 peer information is. But based on what we hear so far, it'll be consistent with the first and second quarters of 2018, so another strong loan growth quarter for the Pinnacle in comparison to peers. The small chart in the middle of the slide is average account balances comparing early 2015 to 3Q '18, our portfolio is not about a lot of large credits. We've got larger loans, but we're talking average ticket sizes, commitments of just over $1 million to $1.25 million for CRE and construction as all construction, commercial and residential, concerning commercial constructions, specifically our average commercial construction commitment is just over $2.4 million through the third quarter of 2018.
Again, we believe, a very granular portfolio aimed at local builders and developers in our market. Another fact about our credit metrics that we think is further indication of the type of lending we go after, that 90% of our collateral for construction, non-owner-occupied commercial real estate multifamily, is located in the state of Tennessee, North Carolina, South Carolina and Virginia. The 2 hurricanes in recent weeks have impacted a lot of people and we're helping throughout to the families of those affected by these big storms. We've had some Pinnacle associates that have been significantly impacted as well. We did set aside a reserve of $2.5 million for Hurricane Florence in the quarter after surveying our relationship managers through repeat collateral maps in the impacted areas and talk to their clients.
We think $2.5 million is a good number. We've still got some work to do, but we've been in touch with the borrowers that we were most concerned about. Our bias today is that, that number is conservative. We are in early stage review with respect to Hurricane Michael. Most of our loans here are vacation properties in the panhandle of Florida, so we're not that concern about our aggregate loss exposure with that storm. No idea if we're in the seventh inning or the eighth inning or the fourth inning. What we do know is that credit continues to hold on nicely, so we're obviously proud of our client selection processes throughout the franchise.
We're presenting this slide again. We're still targeting a 35% fixed rate loan book for our loan portfolio. We also executed a forward interest rate swap earlier this year and then added to it in the third quarter in order to accelerate our floating rate component by an additional 5%. The first 4 tranche of $150 million started in October. As of today, the average paid fixed rate on those swaps is 40 basis points more than the received variable rate. The October tranche amounts to approximately 38 basis points difference between the pay rate and the receive rate.
Also, we've updated the slide with additional information on rates in various rate categories. For prime rate, we feel like we've captured substantially all the short-term rate increases since September 2017. The LIBOR spread reduction that occurred over the last few months have impacted us, but we feel like that spread, especially the spread between the 30-day in fed funds has likely normalized. Fixed rate loan yields have not moved much for the loan book yet, but it takes a long new loans to move away the average yield of fixed rate portfolio. As the last 2 columns on the chart at the bottom indicate, we are seeing some lift in fixed rate pricing this year. So we should see the book yield beginning to move north in a more noticeable way over the next several quarters. We've also worked on repositioning our bond book. And as of this day, more than 1/3 of our bond book is now on a variable rate. So we should see improvements in yields as rates increase.
Average deposit balances were up $1.16 billion while EOP balances were up $550 million. End of period, core deposit increased by $677 million during the quarter. Our deposit cost did increase 19 basis points in the third quarter from the second quarter and currently stands at 97 basis points. We compute a beta of 36% on deposit costs, given those figures, since the most recent rate cycle began in the fourth quarter of 2015. As to the future, deposit cost will continue to increase for several factors. The 2 most prominent are general pressure for increased deposit rates in a rising rate environment, but also, we'll need to fund the loan pipeline. Our relationship manager are out in the markets selling our ability to serve commercial and affluent consumer depositors with a value equation, we think, is far superior to our competitors.
We still believe we're in markets that have ample liquidity to match our loan growth expectations. Terry, Rob and Rick are driving our sales efforts towards depositors. We will play our customary shoe-leather gain. We still believe we've got adequate room in our plans to fund our loan growth with a payer rate paid on deposits. Don't get me wrong, deposit betas are important. We will pay attention. But right this minute, we're focused on gathering clients.
Again, a big quarter for deposit growth. In the third quarter, the core deposit growth was up more than $675 million and more than 17% annualized. Over the last 4 quarters, core deposit growth has funded 93% of our loan growth, which is more than the 85% we would typically roll out on our model to produce, we may sometimes have to go over those on the rates, but we ask our relationship managers to get flat. Also, in the chart is loan-to-deposit ratio for us compared to our peers, as you might expect, our line balances around, but it appears the peer line will nudge up closer to us after third quarter's results.
Fees amounted to greater than $51 million, up $3.5 million over the last quarter. BHG had a great quarter and look to have another great quarter in the fourth quarter. Their contribution was up $4.8 million in the third quarter. We had anticipated the net growth of BHG in 2018 will be 12% to 15% for 2018. We now believe it will likely exceed 20% for the year.
Residential mortgage income was up slightly from last quarter. I know the rate environment has not been helpful to this business line for the past several months, but our folks continue to hire mortgage originators and worked hard to getting their share of the deals.
Wealth management revenues were essentially flat in the third quarter compared to the second quarter. Keep in mind, we remain in phase one of the build-out of investment services platform in the Carolinas. There was a solid base but one of our key goals from the C&I build-out is to ramp up investment efforts in that footprint meaningfully. We've had several significant hires in both footprints that have contributed to our success in investment services.
Insurance revenues were steady, and trust up the second quarter, which saw the decrease in the third quarter. In other noninterest income, we have positive $2 million pickup in the second quarter from revaluation of our, of certain of our joint venture investments, which did not repeat in the third quarter.
Then operating leverage, our efficiency ratio was 47%, which was slightly more than the adjusted 46.6% we reported in the second quarter. We expect that our noninterest expense would be higher this quarter, and we're hopeful we can afford increased incentive accruals as we head into year-end.
Salary expense is up, almost $2 million this quarter, largely attributable to increased headcount throughout the franchise. Since year-end, we are about 117 FTEs this year as we continue to hire revenue producers and other critical support functions.
Although we continue to accrue less than our targeted work for our corporate incentive plan, we did increase the accrual to 9% of target. Our corporate incentive targets were set to level, we believe, will equate to top quartile performance within our peer group. As many of you know, we get paid to hit numbers. If we don't hit our numbers, we don't get our incentives. We've had years when we paid more than target. We've had years when we paid no incentives. The critical thing is that the associate base understand why we do it and the way we do it. Keep in mind that Terry and myself and the entire leadership team of this firm are on the same incentive plan with everyone else. Thus, if the CEO gets paid, we all get paid and vice versa. Incentives are important, and it's one of the things that makes us unique.
Excluding merger costs, other expenses were up $3.5 million this quarter. Ad expenses associated with our deposit campaigns in the Carolinas, lending expenses and technology costs all contributed to the increase. All in all, we believe about $1.5 million to $2 million of this was nonrecurring.
So with that, I'll turn it back over to quarter, Terry to wrap up.
All right. Thank you, Harold. Let me comment quickly on the return on average assets. We first published our targeted operating range for ROAA for the year 2012. Over the years, we've increased that targeted operating range three times before, most recently moving to a range of 1.50% to 1.70%. As you've seen in the third quarter, we continue to operate in the targeted range for ROAA with a 1.54% ROAA in the third quarter, same as last quarter. I might also point out that all four components that builds that overall ROAA target are either operating comfortably within the targeted range or better than the targeted range.
Let me switch now to the BNC integration. As a reminder, since the beginning, when we discussed the deal rationale, we always talk about the fact that BNC had a double-digit growth CRE platform and our goal was to not disturb or diminish that in any way. But in addition to that, the bolt-on high-growth C&I platform which then has the impact of steepening the already high growth rate.
To that end, we communicated our extent to hire roughly 65 C&I private banking relationship managers in the Carolinas and Virginia over a five-year period of time, beginning in July 2017. To be on that pace, we would need to hire roughly 16 in the Carolinas and Virginia by September of 2018. So you see, having hired 26, we're roughly 62% ahead of schedule in terms of the number of C&I and private bankers in the new market or, said another way, roughly three quarters ahead of schedule in terms of the time line.
I also want to comment that it's not just about the number hired, but qualitatively, Rick Callicutt has done a fabulous job of seizing on market vulnerabilities to hire some of the best bankers in this market. While the sources for new hire has been broad, clearly, the majority of the new management advisers are coming from those large regional national players with whom we like to compete. And impressively, the average experience level of these 26 commercial and private bankers is 22 years, which is consistent with Pinnacle's long-term results of hiring experienced bankers.
I don't want to overdo this, but I just want to make sure everyone understands the connectivity between hiring and loan and deposit growth. They go hand-in-hand. Because we've hired so many, we should grow fast within the market as a result of the market share movement. And because of their long tenure with the larger regional national players, we should produce an outsize growth on a sound basis. In my judgment, our ability to move existing loans that are currently performing and are well known to the lender of this movement is a substantially safer play than banks having to press for volumes late in the cycle when the market demand is weakening.
And so how are we doing on the success criteria that we originally laid out? Year-to-date in 2018, it appears to be working like we drew it on the board. During the first three quarters of 2018 in the Carolinas and Virginia, we saw a continued double-digit growth in the CRE platform and a meaningful acceleration in the C&I business. Couple that with the outsized core deposit growth that we're getting, I think you'd have to agree, this has been a fabulous transaction. I'm not aware of any recent transaction where they've been able to elevate loan volume merely to the extent as Rick Callicutt and his team in Carolinas and Virginia has. In other words, we are accomplishing exactly what we set out as the original success criteria.
Turning now to the two questions I highlighted in my introductory comments. Let me begin with the question regarding the likelihood that we can continue the pace of loan growth. Past success does not assure of future outcomes, meaning to say the best predictor of future outcomes is the current results. Most of you recall that we closed our merger with BNC in June of 2017. So these are the quarter-end loan numbers for the entire firm following the close of that transaction. We've weathered the deal announcement and whatever laws of momentum generally occurs in conjunction with that. We weathered the brand change and whatever mourning typically occurs with that. We've weathered the system convergence and all of the internal focus that generally required for that. And through it all, quarter-after-quarter, we've consistently put a low to mid double digit loan growth.
Honestly, as I've said a minute ago, the reasons we've been able to grow the loans on substantially outsized pace versus peers, is because of the hiring success that we continue to have, not just in the Carolinas and Virginia, but throughout our entire footprint. So that hiring success not only explains how we have produced the outsized loan growth. It explains why we continue to expect the level of loan growth going forward.
Regarding our ability to fund that growth, this is a very busy chart. It breaks our funding down to three product categories: number one, core funding; number two, additional funding from our clients, which is not considered core funding, things like repos and so forth, we call that relationship-based funding; and number three, wholesale funding. We post the funding makeup over the last year, a time of very rapid loan growth, as we've indicated several times on the call, 15.7% year-to-date. And as you can see, the percentage of core funding has remained essentially flat as our dependence on wholesale funding. You heard Harold say a minute ago that it's our intent to fund at least 85% of our loan growth with core deposits, and we have well exceeded that over the course of the last year. So we have indeed gathered sufficient core funding.
And so finally, let me address the third question regarding whether despite our deposit betas, we can produce rapid growth in net interest income and EPS, which, to be clear, are the primary objectives of this firm. Seems to me the answer to that question is yes. We showed this same chart in the second quarter call with a comparison at that time based on first quarter results, which, by the way, led to a similar conclusion. We've now updated it for second quarter results. Here, you can see we brought in our peers. Some of them are really low deposit beta companies plotting the year-over-year increase in total deposit costs on the y-axis and the year-over-year increase in net interest income per share on an x-axis in order to normalize for acquisitions itself.
And our performance on net interest income growth in the first half of 2018 was peer-leading, despite a relatively high beta. I believe that was the case because we were able to grow our client base by taking market share and, consequently, growing earning asset volumes at pretty dramatic pace. I think that's maybe the most important difference between us and many of our peers.
So in summary, let me tell you this, we're primarily focused on long-term shareholder value. Third quarter '18 was obviously the fastest quarter, as evidenced by the low-double digit loan growth, the core deposit growth greater than 17% annualized, net interest income growth of 15% annualized, revenue growth of more than 18% annualized, EPS growth of roughly 35% annualized and ROAA of 1.54% and an ROTCE of 18.44%.
But here's what really demonstrates our focus on long-term shareholder value. We did all that while we increased our associates' incentive accrual meaningfully, while we set aside special reserves for potential damages associated with Hurricane Florence and while hiring 23 revenue producers in the third quarter, along with all the support staff necessary to support them. And just so, just think about that, what company our size could be on pace to increase the number of revenue producers by more than 100 people this year, plus all those folks that are associated support personnel, which generally run in a ratio of 2 support to one revenue producer and still grow earnings roughly 35% with a 1.54% ROAA and a 47% efficiency ratio?
In other word, we had a great quarter in terms of quarterly financial results, but we continue to invest in the infrastructure intended to let us continue doing this and reliably grow the tangible book value of our shares for quite some time to come.
Operator, we'll stop there and take questions.
Thank you, Mr. Turner. The floor is now open for questions. [Operator Instructions] Our first question comes from Jared Shaw with Wells Fargo Securities. Your line is now open.
Hi, good morning.
Hi, Jared.
Actually, just first quick question. Did you say accretion for 2019 should be $20 million? Is that the expectation?
We think the discount accretion for 2019 will be probably around $40 million, so the decrease will be $20 million.
Great, okay. Thank you. And then in terms of the growth that you're seeing in the Carolinas, that's a, those are great trends. What's the advantage, I guess, of the loan officers that are creating that loan growth? How long is it taking them to actually start producing new customers for the bank after they're hired?
Jared, this is Terry. I'm not sure I can give you a crisp answer to that question. There's wide variability on how that works. As you would guess, some of the relationship managers that have been hired are constrained and, to some extent, with non-solicit agreements and things like that. But again, I would say that the, some growth occurs through all of those relationship managers literally from the beginning. Our expectation continues to how we believe people will be successful, moving roughly 80% of their book, and they'll get that done in over 3 to, say, 4-year period of time.
And in terms of that book coming over, you're still seeing good trends with the loans and the deposit relationships falling?
We are.
And then on BHG, that was great growth that we saw there as well. How was rising rates impacting the BHG business? Are they able to move, continue to move rates, observing in line with what we're seeing? And is that changing the end borrower's dynamic at all?
Jared, they track that information. Probably, well, the information we get over the last probably 3 or 4 years. And so far, they've not been impacted very much, if at all, based on what the yield curve has done because most of those loans are going to be priced off of, call it, 5 to 7 years, and so that the top line rate that the borrower's paying has not moved much at all, probably 14.5%, 15%, while the buy rate that the bankers are requesting hasn't moved either. So the spread has stayed pretty consistent.
And then on the target for fee income, so that 90 to 100 basis points of assets, is that so good for a long-term target? And I guess, with the increased BHG revenue, you think we could get there earlier?
Jared, our current target is 80 to 100, and we were at 85 with the enhanced BHG number this quarter. So yes, I think BHG will help pull us into that range.
And our next question comes from Stephen Scouten with Sandler O'Neill. Your line is now open.
I guess, maybe continuing on BHG for a second. I was curious if the jump here in this quarter was just related to some of their sales activities, increased volumes? Or if any of the new product initiatives you talked about the Investor Day, kind SBA opportunities, patient lending, if any of those things had come online as of yet and increased the kind of optionality for revenue in that platform yet?
Yes, I think the new products had some impact but it wasn't that, one that large. So I don't think it moved the needle significantly. I think what has happened in the third quarter and will likely go into the fourth quarter is credit metrics have improved. They have also, over time, have built out a, we call it a warehouse, but it's really just, they kept some loans on their balance sheet, they built up their balance sheet over time. They decided this quarter that they would take some of the 2018 production and sell it into the market or into the auction platform.
So they've been, I guess, keeping this pool of loans on their balance sheet and they started releasing some of that pool into the auction platform because the appetite for those loans has been pretty strong here over the course of the last, well, it's been strong for the, over the last year or so, but they finally decided, said, based on what the buy rates are, they let some of those loans go.
Stephen, I might just add to Harold's comment. As we think about going forward, the appetite for their product increases as other loan demand slows, though there's a lot of banks who have a greater appetite to use that as a filler for loan growth. So that's good for BHG.
Okay. Yes, that makes sense, that makes sense. And maybe as it pertains to overall loan growth, I mean, obviously, year-to-date, your growth has still been far above what I would have expected at beginning of the year. So congratulations there again. But were there any impact in the quarter from Hurricane Florence in terms of pushing any loans that might have closed this quarter, end of 4Q? I mean, would you expect, even with payouts in CRE and other impacts that you might see an uptick in fourth quarter without the hurricane effects?
Stephen, I don't know. I would say there's no doubt that people get bogged down in the, all the people being out, clients being out, all that sort of stuff associated with the hurricane and sort of recovering from the hurricane. So I can't imagine that had some impact. I guess what I want to reinforce is, look, we have believed and we continue to believe we're going to put up low- to mid-double digit loan growth over an extended period of time. We'll have some quarters that'll be a little higher, and some quarters that'll be a little lower, but over an extended period of time, it'll work that way. It is a little lumpy to your point, sometimes that takes but a few deals in a quarter to take the volumes down or up in a recognizable way. But again, just over time, that's what we expect to occur. And I want to reinforce the reason we think it's going to occur that way is not so much to do with what the pure loan demand is. It has to do with the hiring methodology, hiring these people and have them move those books. So that's the principal determinant of where these loan growth numbers will go. It'll be a function of our ability to hire the people and get them on track to move the business.
Makes sense. Thanks Terry. And one last, kind of housekeeping question for me is just, on the CD rates, I want to make sure I understand this properly. It looks like on Slide 12, you're listing 1.83% as the current quoted CD rate, if I'm reading that properly, and your average CD rate is 1.76%. So would it be fair to assume that the degree of pressure we've seen on time deposits over the last 2 quarters could slow pretty appreciably if that gap has narrowed so much between your average rate and what you're offering out there now?
Yes, now that rate is on Slide 12 is the, in the period rates. So that's the rate that the current book would average out.
Okay.
Now there's a little bit, it's not much, Stephen, but there's a little bit of purchase accounting that impacts that 1.83%, so it would be, it might be a 1.81%, something like that. We have some purchase accounting that comes into play out of that book.
Got you. Well, I guess, maybe along with that, can you tell us what kind of an average rate is that you're offering on new CD production maybe then, so I can think about how that might play in over the next coming quarters.
Yes. I think our 12-month rate is somewhere around 2, somewhere in that range.
Great. All right guys. Thanks so much. Congrats on that quarter.
If it's different from that, I'll call you.
Perfect.
Thank you. And our next question comes from Jennifer Demba with SunTrust. Your line is now open.
Thank you, good morning. Curious, a couple of questions. You had a big increase in your tax exempt securities yield. What drove that up sequentially? And what are the new reinvestment rates on that line item?
Yes, the new reinvestment rates are going to be fairly consistent. I think we've got maybe about 2 to 3 basis points of increased yield in that book that we're forecasting for the fourth quarter. So the buy-out rates, the new rates are coming in at about that same number. Now as far as what drove the increase between 3Q to 2Q is we did go out on the curve and we did acquire some additional municipal securities during the quarter. We had anticipated giving those securities towards the, call it, the end of the year or first part of next year, but with the spike in loan pay downs, we want to end, put that money to work in the third quarter. And I think, Jennifer, one more added point there is, that early in the fourth quarter, we'd taken a lot of those securities that we acquired and we flipped them to floating rate securities.
Okay. All right. And Harold, you said you had $1 million or $2 million of nonrecurring, $1.5 million to $2 million of nonrecurring expenses, and your run rate is set in third quarter. Do you have any sense of kind of a range of expenses you're anticipating in the fourth quarter, given the payout you're likely looking at, at this point?
Yes. It's, I appreciate the difficulty in trying to kind of develop a run rate for us, because the way that incentive accrual bounces around. We'd expect expenses to increase, if the revenue numbers come in, we would expect the expenses to increase slightly. I'll say it like that.
Meaning low-single digit?
Yes, for sure. Yes, I'll just leave it at that.
Yes, okay. And Terry, can you just talk about deposit funding strategy? You guys talked about four or five different strategies you have at the Investor Day last summer. Can you just talk about where you're seeing maybe the most traction or the least amount of traction or what have you?
Yes, I would just say that in terms of the strategy that we laid out, one had to do with hiring. Of course we're having good success, a lot of those people are moving deposit books. We hire people that are focused on deposits. We've made several of those hires, and so as I would say that's progressing nicely. I think, underneath that, maybe more important than that is we're active communicators. We got a really active communication with our sales force that occurs at least weekly, if not more frequently about what we're looking for, what we need, and those kinds of things. And so there's a lot of directions to the deposit side, aimed at folks and clients that have deposits and so forth and I would say that's working well.
We talked about doing some product-based advertising in the Carolinas and Virginia, if you'll recall. And we don't normally advertise. We've never been an advertiser, but we decided that we would do that, use some rate-based advertising in the Carolinas and Virginia, where we generally had lower share positions and felt like we wouldn't be just cannibalizing a big deposit base to do some rate-based promotion. So you can feel that the rate that we've used is a 1.69% money market rate. So it's a relatively attractive rate, but it's not a 2% rate, to Harold's point earlier. So again, we feel like it's a good barrel of money. We think it worked, it has worked well in that market. We bought a fair amount of money. We just say this, as we go into Carolinas and Virginia, some people would say, "My goodness, how are they going to do, having to compete with those large regional national franchises that dominate those markets?" And as you know, those large regional national franchises have no incentive or desire to take that sleepy deposit funding base up, and so we can step in there and buy money at a pretty attractive rate in that market and so that has worked well for us, also.
How about the Artist Growth product that you invested in, can you give us an update there?
Yes, Artist Growth, I think it's in, what, I guess, what you'd call the last sort of pilot phase. It is live with a handful of clients. I think the receptivity has been great. And so our optimism about that continues to be the same. In terms of its specific impact, either on our balance sheet or P&L, it would be minimal at this point. But again, all the early returns on the folks that are on it would let us believe we'll do at least as well we thought we would.
And our next question comes from Brock Vandervliet with UBS. Your line is now open.
On the loan growth, I'm clear on the long term. Just, Harold, in terms of the shorter term, and looking at the average growth and especially the end of period growth, it looked like you're hit harder by payoffs. Can you talk about how that looks the next couple of quarters or the next quarters? Should we anticipate a pickup in loan growth? Or still too early to tell?
Yes, Brock. I think the payoff that we're looking at in the fourth quarter should be fairly consistent with what we had in the third quarter, which were, I don't think we'll see a decrease in those payoffs likely until the first quarter of 2019. So we're anticipating kind of a similar kind of quarter in 4Q that we had in 3Q.
And circling to the deposit dynamics, it looked like part of the CD growth, may be part of an intentional strategy to reduce FHLB borrowings. Is that the way we should read this? Or was that kind of just an accidental thing in terms of how the rate shook out this quarter between the two products?
Yes, I think we are getting some CD lift in the Carolinas just through the sales process in that market. There's more kind of depositors up there than over in Tennessee. But yes, we will flip based on what we think our balance sheet's requiring between brokered CDs and Federal Home Loan Bank borrowing. So there could be some intentionality around those two products.
And incremental raising of money market and CDs, those are, say, 1.70% and 2% right now?
Yes, we have the 1.69% to 1.72%, something like that kind of rate offering in the Carolinas. The advertising to support that campaign has now been completed, but I think they're more on a kind of a hand-to-hand combat on that product in the Carolinas and continue to kind of sell it over there.
Brock, if I could, I might just make this comment. It's not exactly what you're focused on, but again, just give you some sense of our mindset. As you know, we had tipped slightly above the 300% total risk-based capital ratio there on commercial real estate. And so I think we had signaled to the market that we would drive that down, that we expected the combination of capital accretion and paydowns, payoffs in the CRE book to bring that in line. And so that's happened, and we didn't spend a lot of time talking about that on the earnings call, but it is an important thing. And so it's sort of a mixed blessing when we think about the real estate paydowns. Most of that is for a good reason and matches what we're trying to get down from a risk management standpoint.
Got it okay. Thanks sir.
Thank you. And our next question comes from Tyler Stafford with Stephens Incorporated. Your line is now open
Hi good morning guys.
Hi Tyler.
Hey. Just a question around the core margin trajectory from here. Harold, with the core funding that you're seeing and the loan growth expectations you talked about for the fourth quarter, just where do you see the core margin trending from third quarter levels?
Yes, we're always hopeful that we will see core margin, kind of stabilization. I think it went down, call it, 3 to 4 basis points this quarter. I'm hopeful that we can keep it kind of flattish going in the fourth quarter.
Okay. Got it. Following up on one of the earlier questions or stuff in incentive accruals, and thinking about that in, toward, into 2019. Would you expect another sizable step down in the first quarter within incentive accruals or the incentive comp as you've seen in the past 2 years?
Yes, I think so. I think we've built it over the last 2 to 3 quarters and so we'll get more on kind of a standard run rate in the first quarter.
Okay. And then just one more on BHG. I saw they acquired a 20% ownership interest in a health care tech company in the third quarter, did that, driving you to higher 3Q fee income growth? And then just any idea of what the potential from that ownership of that new business could be?
Yes, they're real excited about all of that new business around healthcare lending, particularly around high deductible plans. So they're very excited about what they're, they're all over the place talking to hospital units and surgery centers, and all those kind of folks to get signed up in that product, but I don't think it impacted third quarter that materially. And it's not likely to impact fourth quarter. There will be a little bit of revenue from it, but it won't be much.
Yes. So on the fourth quarter, so you guys took up guidance to over 20% BHG for this year. The fourth quarter is typically seasonally the strongest, but even if you just kind of flatline 4Q or 3Q, I think that would be over right at 25% growth for the year. So can you just speak a little bit more specifically to 4Q, your expectations for BHG? Would you expect 4Q to be stronger than 3Q levels?
We think 4Q will be as strong as 3Q.
As strong, okay. And then just lastly for me, I know you guys don't focus on core NII, or core EPS, ex the accretion as much as we do from our side of the table. But if you were to exclude the accretion for next year, can you just talk about what pace of core NII growth and core earnings that would be reasonable for Pinnacle?
Yes, I mean, Tyler, I think we're going to be down probably $20 million next year with respect to net interest income growth. So if we can hit our loan numbers that we're planning to hit, call it in 2019, which we think will still be low to mid-double digit, we think we've got, call it somewhere around that 10%, maybe 12% lift in NII.
In core NII?
Yes. Well, that will be, yes. Now what I'm talking about is GAAP NII as far as where we think we can go.
I'm sorry. Can you just clarify that? The 10% to 12%, not to pin you down, but were you referring to core or GAAP NII?
We're talking about trying to get to core NII of about, call it, 10%.
And our next question comes from Brian Martin with FIG Partners. Your line is now open.
Hey Harold, just one bigger question on BHG, and that's just the long-term outlook. So when you look at '19, just forgetting '18 and its pool of loans and kind of that process they're going through, I mean, there's a run, the 20% or 20-plus percent growth you're seeing in '18, does that decline as you go to '19? It's more of a 12% to 15% type of rate. Is that how to think about BHG, with some of the new initiatives they've got?
Yes. I need to kind of go back and revisit our 2019 targets in light of what's going on with the third and fourth quarter and figure out what's repeatable. But they are, they, standard, their standard response to me has always been 12% to 15%.
Okay. So the 12% to 15% could potentially be higher if some of these other things kick in that they're kind of expecting or kind of looking at recent events.
That's right.
Okay, and that expense, Harold, those onetime items this quarter, I mean, were they in one particular line item, or kind of spread around?
Yes, they were all below salary, so if they were spread throughout equipment cost, other expenses, all of those kind of things.
Okay. Yes, and that slight increase potentially that you'd expect in 4Q, I guess, is that off of the actual base sale or the core basis? So just to be clear on that.
Well, in the third quarter, we think core and actual were the same. So, I'm not sure I follow your question, Brian.
Yes, I guess I was assuming you said there's about $1.5 million in nonrecurring expense in the fourth quarter. So I'm just trying to understand, is it just the, the reported expense you would expect could potentially be slightly higher in, the expense in fourth quarter could be slightly higher than the reported number in...
Yes. Quarter-over-quarter actual. It'll, it all depends on where that incentive accrual shakes out.
Okay, got you. Okay. But it was off of the actual number, not core, is all I was trying to get at. So that's, it's all, okay. And then just the margin, Harold. I mean, I guess, when you kind of look at your long-term guide as far as where that band shakes out, if you see the accretion number decline, the $20 million or so that you're anticipating next year, I mean, it seems like that margin number is going to fall outside of that range. I guess, am I thinking about that wrong? Or I guess, is that how it probably shakes out?
Yes, I think we're going to be at the low end of that range for sure. I don't know if I'm ready to say we need to adjust our target range just yet, though.
Okay. And just, the puts and the takes on the core margin change, I guess, Harold, when you look at fourth quarter. If you hope to hold it or see it go a little bit lower, I mean, what are the puts and takes that move it up or down in the fourth quarter, just in, more near-term.
Well, I think, as we get more floating rate assets on our books that will be helpful to us. And I think as deposit pricing, if we can slow the beta on deposit pricing that ought to be helpful.
Okay. All right, and then just the last one for me, Harold, was just the tax rate. I mean, I guess kind of the 21% level, is that a fair way to think about, now that you had a couple of quarters at that level, is kind of the way I think about it, the effective rate going forward?
Yes, we think our long-term rate's going to be 20% to 22%.
20% to 22%. Okay. All right. That's all I had guys. Thanks for taking the questions and nice quarter.
Thanks Brian.
Thank you. And our next question comes from Michael Rose with Raymond James. Your line is now open.
Hey guys, thanks for taking my question. Not to beat a dead horse on the margin but as we think about the incentive comp moving forward, if you guys are below that margin range, how does that translate into the incentives that you accrue for next year, particularly if you don't hit the efficiency target? Thanks.
Yes, Michael, let me just remind you, our incentive targets is a, all for one, one for all, in other words, we all win and lose together on that. It's one we either hit or miss or pay out of the comp percentage for everybody. The determinants to that are we have a clear asset quality threshold, which is generally a function of credit size and classified assets, if we don't clear that, nobody gets any incentive and none is accrued. If we do clear that, then the rest is a function of how well we grow our earnings and how well we grow our revenues. The earnings would make up 80% of the weight. The revenue growth would make up 20% of the weight. And so what happens to all those other things makes no difference whatsoever as long as we grow, hit, to clear the asset quality number, hit the revenue growth numbers and hit the earnings growth numbers.
Okay. Thank you for that. And I think, as I heard earlier, you guys are modeling three rate hikes for next year. Can you just talk about what you would expect in terms of sensitivity and maybe what happens if we don't get 3? Thanks.
Yes, I think the rate hikes are becoming less impactful. I think if you were to do our sensitivity analysis around what the regulators require, we'd be still asset sensitive, but I think the way the real world works. As the rate increases go, we're going to need depositors to fund that loan growth. So I'm not really sure if the rate increases will impact our margins that much.
Okay. Maybe just one final one for me. I think a lot of talk about BHG, but I just want to make sure I heard you correctly. Did you say that 12% to 15% for next year is a good target on top of the 25% or so this year?
Yes, that's what they keep telling us. I've not been able to re, to visit with them about this third and fourth quarter uptick, to try to figure out how we gauge 2019. I'd be hesitant to kind of layer in a large, kind of increase for 2019 off of this big kind of late second half 2018 increase.
And our next question comes from Catherine Mealor with KBW. Your line is now open.
I just want to follow up on the incentive comp. Did you give, Harold, earlier in the call the dollar amount of incentive comps this quarter?
I don't think we did, but I think it's on that slide.
Got it. I'll go back to check. Okay. So, and then outside of that, my next question is on buyback. So you've, on managing capital, with the paydown this quarter, we're now below 300%, which is great, and I think earlier than I expected. Your stock had pulled back a lot. You're still growing a lot, but at this valuation, would you consider a buyback? Or is gross still a better place to put your capital?
Catherine, that's a great question, and I guess, the direct answer is, I'm not sure. So let me kind of give you the color commentary on that. The, over the year, we've been asked a lot of times about, "Well what about buyback? What about a buyback?" It's always seemed like an absurd idea to me. We've been such a high-growth company. We've sort of delivered capital just in time, and it's just, it was never anything that I would even entertain, looking at a model or any of those kind of things. I would say at this point and at this price, I am studying and just beginning to look at, think about the strategies that would center around other capital management, specifically stock buybacks and so forth. This is probably the first time in 18 years that I would ever have considered that alternative. I don't want to overplay that. I'm not saying we're going to do a stock buyback, but I am saying that we are staying and thinking and running models and so forth. So yes, it would be a consideration.
And you don't have an authorization out there right now, correct?
We do not.
And our next question comes from Brian Zabora with Hovde Group. Your line is now open.
Just a question on that $2.5 million reserve for the hurricane. How much is the loan exposure to the impacted area?
That's a difficult question, Brian. We probably talked to around on, call it, $250 million or $350 million in credit. We're not that exposed into the Eastern North Carolina kind of footprint, but the flooding that was the result of the hurricane is what we're more concerned about.
Understood. I just figured, I know there's a lot of factors with the provision expense. But if I exclude that, it's, your run rate or the level was around $6 million this quarter. Is that, anything else that was kind of positively impacting the provision expense? Or anything else we should think about going forward?
Yes, I think what really does help us in this environment is the performance of the construction portfolio. I think we're net recovered on construction over the last, call it, 3.5 years, and then the commercial real estate book to has, the losses there are negligible.
And I am not showing any further questions at this time. Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a wonderful day.