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 2022 Earnings Conference Call. Hosting the call today from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer; and Mr. Harold Carpenter, Chief Financial Officer. Please note Pinnacle's earnings release and this morning's presentation are available on the Investor Relations page of our website at pnfp.com.
Today's call is being recorded and will be available for replay on Pinnacle's website for the next 90 days. At this time, all participants have been placed in a listen-only mode. The floor will be open for your questions following the presentation. [Operator Instructions]
During this presentation, we may make comments which may constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties, and other facts that may cause actual results, performance, or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond Pinnacle Financial's ability to control or predict and listeners are cautioned not to put undue reliance on such forward-looking statements.
A more detailed description of these and other risks is contained in Pinnacle Financial's annual report on Form 10-K for the year ended December 31st, 2021, and its subsequently filed quarterly reports. Pinnacle Financial disclaims any obligation to update or revise any forward-looking statements contained in this presentation, whether as a result of new information, future events, or otherwise.
In addition, these remarks may include certain non-GAAP financial measures as defined in the SEC regulation G. A presentation of the most directly comparable GAAP financial measures and a reconciliation of the non-GAAP measures to the comparable GAAP measures will be available on Pinnacle Financial's website 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, Paul, and thank you for joining us this morning for the third quarter earnings call. As I'm confident you've already seen third quarter was another fabulous quarter for us. Last quarter in my introductory comments, I tried to list a number of themes that I believe are critical in order to not only understand the financial performance for the quarter, but really to better ascertain how the firm should perform going forward despite the varying operating environment we might encounter.
As a quick reminder, those overarching themes that I mentioned last quarter and which I think you'll see are interwoven again in the quarters -- in this quarter's numbers. Number one, management is motivated and incented to alter outcomes given various market conductions.
As an example, we don’t just accept the number asset-sensitivity or we don’t just accept what the current overall market growth rates we said about alter outcomes based on our actions and initiatives.
A lot of people are chasing all kinds of interesting metrics like deposit cost betas and I get it, but specifically the outcomes that we're motivated and incented to optimize at Pinnacle are the level of classified assets, PPNR growth, and EPS growth in the case of annual cash incentive plan and tangible book value accretion and ROTCE in the case of long-term equity incentive plan. And so understanding that will likely help you understand things like why we've upgraded tangible book value in a year when many have not.
Number two, we enjoy a reputation for having a great culture. But our culture isn't just fun and sauced up, any number of studies have demonstrated statistically valid correlations between associate engagement and important outcomes like reduced associate turnover, improved productivity, improved profitability, better sales outcome, and total shareholder returns. And nothing is more important in the war for talent and so I think that helps explain things like while we continue to hire record numbers of the best bankers and financial services professionals at a time, many are short-staffed and suffering low associate engagement and high turnover.
Number three, our hiring success over the last several years is the single largest contributor to our balance sheet growth and ongoing momentum. It explains where so much of our loan and deposit growth comes from. And not only that, because the level of experience of our new hires is equal to or greater than 20 years, we believe we can grow asset without sacrificing our commitment to credit quality.
It's much different than those that are trying to grow by increasing the frequency of the call [PH] program. In fact, in Greenwich Research, we're at or near the top on virtually every sales and service metric that they typically view as important with one notable exception. And that's prospect calling where we are dead last. That's just not how we get our business as opposed to forcing RMs to make prospect calls, in our case, long experienced bankers typically move long standing relationships, which we believe over the long haul results in a meaningfully different credit profile.
And number four, BHG is not your typical FinTech. Its ability to attract loans from high quality borrowers with very high yield and get them funded through their proprietary bank auction platform or alternately securitizing them in the secondary market when many cannot, continues to result in the kind of income that lets us significantly invest in people to seize all the market opportunities that exist for us, while continuing to put up top quartile profitability. I'm not aware of anyone who's been able to invest in their business model to the extent that we have while remaining extremely profitable.
As I've already alluded, we believe metrics like asset quality, revenue growth, earnings per share, and tangible book value accretion, result in long-term shareholder returns. That's why our incentives are linked to them and that's why we show this dashboard quarter in and quarter out, where you can see the relentless upward slope of things like revenues, earnings per share, and the balance sheet volumes that produce that growth.
On asset quality, we've been living in literally the best of times. We fully expect asset quality metrics to more normalized going forward. But you can see that NPAs and classified assets continue to operate at extraordinary lows as the charge-offs at just 16 basis points.
In fact, we've been in the top quartile in terms of NPAs to Tier 1 capital and classified assets to Tier 1 capital for some time and given the continued reductions on those metrics this quarter, I'd be shocked if we aren't there again when we're able to construct the peer metrics for the third quarter.
As most of you know given the very commercial nature of our loan book, charge-offs are generally lumpy. We had one of those this quarter, which Harold will talk more about in a moment, but again, credit metrics continue to be extraordinary.
I won't spend much time on the non-GAAP measures, at least as not as much time as I usually do, because idea is that virtually all the important growth and earnings metrics are up and to the right, generally well exceeding market expectations, and paint the picture of what's been upbeat and ready [PH] story for quite some time.
As I just mentioned, the talent that we've added over the last several years results in extraordinary balance sheet momentum. As we did last quarter where again, we're dissecting net loan growth based on the categories noted on the slide to help everyone better understand the source of our growth.
We begin categorized our growth in the four broader segments. Number one, our pure asset generation plays like BHG, Advocate Capital, JB&B Leasing. B, our strategic market expansions, which are not only the geographies like Atlanta, D.C., Birmingham, and SoHo, but also expansions into specialty lending groups like franchise and equipment lending.
C, growth from our recruiting over the last two and a half years. So, this is the growth of our newer RMs that have been with us for only two and a half years or less, and that are not included in our strategic expansion markets.
And then finally D, our legacy markets and what they contributed from RMs that have been with us more than two and a half years. So, thus far through the first nine months, we've experienced 24.5% EOP loan growth annualized between December 31st, 2021 and September 30th, 2022, which is inclusive of PPP pay-downs, which are denoted in red on the slide. Almost 46% of our $4.3 billion in net loan growth is from our legacy markets, while the rest is primarily from new markets, new initiatives, and new people.
We've said that -- we've said this countless times, we think we're in many of the best bank and markets in the southeast. Many of you know that for lenders to come to work for us, they have to have at least 10 years of experience in our market. And on average, it's more like 20 years.
So, to characterize all this loan growth as new loans is a little bit of a stretch as these borrowers have been working with our 10-year plus experienced lenders for years, the loans are just new to PNFP.
We get asked frequently about how the new markets and specialties are performing, I simply want to get you this information where you can see that we're having extraordinary success, moving talent and clients to the Pinnacle platform.
For those that struggle with the value of the emphasis we place on culture, here's just one of the examples of where it pays off. Putting associates in a position where they can serve their clients well, is what enables us to attract the best associates as well as their clients.
I know everyone is aware that the annual FDIC deposit market share information was released in the third quarter. Here you can see first of all, we're in great markets as evidenced by the rate of deposit growth in the market. That'll be an important success variable going forward. But more importantly, we've been able to grow our deposits faster than the market, which is just another way of saying we've had great success moving market share.
Many are concerned with a shrink in M2 and the impact that could have on funding. And so I would say I don't think we could grow anywhere near the pace that we currently grow if we were unable to take deposit share from these larger, more vulnerable banks in our markets. Harold will comment further on our deposit growth in a minute.
A couple of slides we've used from time-to-time, what you're looking at here is data from Greenwich Associates, the foremost provider commercial market research to large banks in the United States. Virtually all the top 50 banks in the country purchased this same data. So, I would say it's universally accepted by all our primary competitors. It's based on client responses across our entire footprint, meaning 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 Small Business Net Promoter chart, which is on the top left of the slide. You see in the navy blue portion of the bar that 76% of the Pinnacle clients surveyed 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 likely at all and 10 means extremely likely. In other words, 76% of our clients are highly engaged active promoters. Trust me, that's an extremely unusual level of engagement.
Another 22% rated as a seven or eight, that's not bad, combining the two, 98% of our clients rated us seven or better on a 10-point scale. But that 22%, that gold portion of the bar, scoring us seven or eight are referred to as passive, because while they generally write you well, they're not really so fired up as to be vocal advocates for you in the market.
And then the last 2%, the red portion of the bar are detractors, meaning, they rated you somewhere between zero and six. And outside the bar, you see a 74, that's the Net Promoter Score, the number of promoters less the number of detractors. As you can see that score is wildly 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 one of the best in the country.
And the story is the same only better among middle market business on the lower right of the slide, where you can see our Net Promoter Score is 81. Now, you might look at the percentage of detractors for each of our major competitors, that red portion on each of their bars. And keep in mind, the banks are generally listed in market share order. So, as you can see, all the top three banks in our footprint have enormous volumes of detractors and that's the opportunity we have been seizing for some time and expect to continue seeing.
So, as you think about the speed and reliability of our 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, why we grew loans 20.9% on an annualized basis this quarter, why we grew core deposits 9.8% on an annualized basis this quarter, and why I believe will continue to produce outsized growth for the foreseeable future.
Excuse me. And it's not just that many of the banks with whom we compete have upset a great number of their clients, a large percentage of their clients expressly intend to move some or all of their business away from them in the next 12 months. That group, the percentage of their clients who have expressly indicated their intent to move is represented by the blue bar.
And happily more than to any of the major banks with whom we compete, a large percentage of clients intend to increase their relationship with us meaningfully more. My purpose in walking through this is really to tighten the linkage for you between our distinctive culture and the revenue and EPS growth. So, you don't have to just take a leap of faith that distinctive culture we've been building here over the last 22 years, will mysteriously resulted in something good, you can actually connect the dots with Greenwich data reflecting the actual client feedback to better understand the quality and sustainability of our market share and revenue growth. So, that's the 30,000-foot view.
With that, I'll turn it over to Harold for more in-depth review of the quarter.
Thanks Terry. Good morning everybody. As usual, we will start with loans. The third quarter was another strong loan growth quarter for us with almost 22% linked quarter EOP annualized growth.
Our current pipeline support low double-digit loan growth going into the fourth quarter, which would yield low 20% growth for this year. Loan yields were up in the third quarter due primarily to rate hikes. We anticipate further escalation in loan yields with rate increases in November and December. Our current planning assumption is for 75 basis points in November and 50 basis points in December.
Since there were 150 basis point hikes during the third quarter, we've not gotten the full effect of the third quarter average rates noted on the slide. Given that and more increases in the fourth quarter, we anticipate fourth quarter yields we will be up 75 to 90 basis points or so.
As we sit here at the end of September, our loan yields are around 5%. We've also talked about loan floors over the last several quarters, but we're essentially through those, so we should capture a larger share of rate increases moving forward.
The bottom left chart summarizes our loan betas for 2022. We tracked each rate hike and what the beta results were for each hike. The green bars are estimates as we don't have the full effect of the September rate hike yet and we won't until we get to the November FOMC meeting when we will put a stake in the ground and re-measure the September hike. Of course November, December are based on our current planning assumptions, but we feel somewhere around 60% alone beta is a reasonable target for us.
Now on to deposits. Really pleased to report call it 10% linked-quarter annualized growth in deposits for the third quarter. At present, our relationship managers are active deposit book protectors as well as outbound deposit seekers. So, it's like we've always said it's about shoe leather at Pinnacle. It's about being in the community and finding the funding at a reasonable price.
We like others did experience some mix shift during the quarter as EOP DDA balances are down from prior quarter, but average DDA balances were actually up for the quarter. We will keep our fingers crossed that this will hold.
We're actively building out deposit gathering franchises around the edge HAS, Community Housing Associations, non-profit, and others where we talk where we target specific types of organizations that are net providers of funding and we believe we're making strong headway with these special deposit initiatives. More to come as these initiatives continue to grow.
Everybody wants to know about deposit betas, the top right chart attempt to show what we're currently thinking. This chart is constructed similar to the loan chart shown previously. Our planning us assumption is that we think we can hold with a 40% total deposit beta that we've been talking about since earlier in the year.
For the first 20 plus years of our existence, our number one objective was developing strategies and tactics around funding our growth. We continue to like our chances given the significant investment we've made in both Relationship Managers and new markets over the last few years.
We believe many other banks around the country are reassessing their beta assumption as liquidity has gotten more difficult. As to Pinnacle, we have been steadily investing in our deposit book all year long and believe that our clients appreciate a pricing discipline that is more fair in an upright environment in comparison to what we hear from others.
Hopefully you'll not hear this bank leadership ever talk about having too many deposits, depositors are just as if not significantly more important than borrowers. Our belief is that we can and will fund our growth effectively and prudently maintaining the appropriate balance between profitability and growth, something we believe we have a track record of accomplishing.
Now to liquidity. Our liquid assets decreased slightly this quarter, but we continue to believe we have ample liquidity to fund our near-term growth. As to investment securities, our allocation to bonds is anticipated to be flattish in the fourth quarter.
As the top left chart reflects with the rate upcycle, our GAAP NIM income increased by 30 basis points compared to 28 basis points last quarter. So, we're pleased with this going into the fourth quarter. Our planning assumption is that our NAMM will likely top off in the first half of next year, assuming rate hikes stall or are minimal in the first half of next year.
In summary, our belief is that we should see another quarter of NAMM expansion along with increased net interest income in the fourth quarter. Accordingly, we are upping our guidance for net interest income growth to the low 20 percentage growth for the full year 2022 over last year.
As a credit we are again presenting our traditional credit metrics Pinnacle's loan portfolio continues to perform very well. As Terry mentioned earlier, late in the quarter and into October, we had one previously classified C&I credit weakened, due primarily to an alleged failure of the supplier's defective part that had been installed in the homes of our class customers. We don't believe this was the result of all the economic headwinds that we are all paying so much attention to. We recorded a partial charge-off effective September 30, placed a loan on non-accrual pending more credit work.
In spite of this one credit, we're pleased with where classified assets ended, as evidenced by the almost three-year downward trend in our classified loan totals, as well as our past dues, which are again at very conservative levels at quarter end.
Our current ACL is 1.04%, which again compares to a pre-CECL pre-COVID reserve of 48 basis points at the end of 2019. We previously thought our ACL for the quarter would have been less than 1.04%, but given the events over the last month or so, we believe keeping the ACL flattish for us is appropriate right now. All of this culminates in a larger provision expense than we anticipated at $27.5 million.
We continue to have conversations with borrowers about supply chains, labor inflation, and how it's impacting their businesses. We have been an all about sustainable credit diligence effort with the intent to actively identify any weaknesses in our borrowing base.
We get many questions about what changes we are implementing as a result of the inflationary economy. A few things worth mentioning here. We have substantially limited our appetite for new construction, whether it be residential or commercial. We believe our book is very healthy with strong sponsors, but the macro environment gives us a pause as to increasing our asset allocations to this segment.
Our credit officers have increased our due diligence and stress testing, particularly around supply chain impact, rates, and profitability. We're also increasing our diligence around the traditional metrics of loan to value debt coverage, so on and so forth.
Now, on the fees and expenses. I won't spend a lot of time on fees or expenses and as always, I will speak to BHG in a few minutes. Third quarter fees are coming off of a record second quarter, so the optics are difficult and as a reminder, we did note last quarter that we thought we would see decreases in fees in the third quarter.
All that said, we were pleased with the effort our fee generating units are putting forward. Service charges are impacted by a change in how we how we charge NSFs and overdraft fees, which we announced in early July.
We have some reason to believe we will see a rebound in wealth management in the fourth quarter as a result of recent hires. Excluding BHG and barring any additional downdraft from our other equity investments, we're believing that we are near floral fees this quarter and that we should see a stronger fourth quarter fee result. Excluding BHG and the impact of these other equity investments, we continue to believe that high single-digit growth for 2022 over 2021 is still in play.
As to expenses, we're increasing our overall total expense run rate to a high teens percentage growth in 2022. This increase is attributable to headcount growth in the new markets, market disruption across our markets, which was -- which has led to strong recruiting opportunities and the addition of JB&B.
In addition, we continue to believe that we should achieve maximum payouts of 125% of target awards for our annual cash incentive plan. But it's all about recruiting and our success and attracting the best bankers to our franchise, which seems to be operating at peak capacity.
Our third quarter non-compensation expense was fairly flat with the second quarter and we believe that the fourth quarter won't be that different from the prior two quarters.
In conclusion, we had a strong hiring quarter in the third quarter, which was the reason for the increased salary expense. We're anticipating another strong quarter of hiring in fourth quarter, although we don't anticipate the increase will be as great in the fourth quarter as it was in the third quarter.
As to capital tangible book value increased to $42.44 at quarter end, up slightly from last quarter. Our capital ratios remain above well capitalized levels. We like our tangible common equity ratio that stands at 8.3% currently.
We are mindful of our Tier 2 capital levels, particularly at Pinnacle Bank in light of our exceptional growth and we'll be monitoring these levels and the debt markets as we head into the fourth quarter and into 2023.
Aside from that, we believe the actions we've taken to preserve tangible book value and our tangible capital ratio have served us well and have no plans to alter our Tier 1 capital stack via any sort of common or preferred offering.
Now, a few comments about BHG before we look at the outlook for the rest of the year. BHG had a great quarter in our opinion slightly better than we had anticipated. We're booking more than $41 million in fee revenues this quarter and have increased our outlook for 2022 growth over 2021 to more than 25% from a projection of 15% last quarter.
As the slide indicates, BHG had another record quarter on originations. Spreads had come in slightly lower than last quarter from 9.8% to 9.7% as the chart on the bottom left indicates. That's more than the amounts BHG anticipated at the beginning of the quarter. BHG does anticipate that auction platform spreads will come in slightly as rates on the short end continue to rise. They anticipate that borrower rate should be approaching 17% by the end of the year, with bank borrower rates moving into the 7% range.
As a result, we anticipate that spreads will fluctuate within the historical ranges of 9% to 10% or so. That said we're really pleased with BHG's third quarter as the third quarter again highlights their flexibility as to how they can pivot between the bank network and securitizations to fund their loan growth.
Formally titled as the recourse obligation accrual, this slide now titled the accrual for loan substitutions and prepayments, which stood at 5.28% of BHG's sold loan portfolio at September 30, which is more than the accrual at June quarter end as BHG increased this accrual from $235 million to $270 million at September 30.
As the blue bars in the bottom right chart show the credit loss portion of recourse losses for the second quarter remain at some of the lowest levels in the past 10 years. Additionally, given the macro environment BHG also increased its own balance sheet reserve for loan losses to $101 million or 3.53% of on balance sheet loans from 3% last quarter. Given the macro environment, we believe BHG will likely increase reserves again going into the fourth quarter and into 2023.
The quality of BHG's borrowing base in our opinion remains impressive and we believe one of their strongest attributes. BHG refreshes its credit score monthly always looking for weaknesses and its borrowing base.
Credit scores were at the consistent levels with previous quarters, so their borrowers have remained resilient through the cycle thus far. As to pass due trends, past dues greater than 30 days were at 1.52% at September 30 compared to 1.37% at June 30, and 1.39% from a year ago. Past dues were at 1.77% at the end of December 2020.
BHG's consistent monitoring of its portfolio allows it to adjust its origination approvals quickly. They have over the past few months adjusted their commercial allocations away from non-medical practices and on consumer which is about 20% of their business, they have adjusted their risk tolerance, the higher credit score borrowers.
National and regional unemployment forecasts give BHG more confidence that their borrowers should be able to withstand forecasted inflationary increases in a way that allows BHG to better weather this environment than others in their space.
In comparison to other consumers, we believe BHG's borrowers are well paid with average borrower earnings being approximately $287,000 annually. We are comfortable in their credit models and their credit experience bears this out.
Lastly, BHG had another great operating quarter in the third quarter. As I mentioned during the two earnings calls this year -- two previous earnings calls this year, we believe earnings in the first half of 2022 would likely be stronger than the second half, as they sent more loan to the bank auction platform in the first half of the year, rather than whole loans on their balance sheet. As you know, the bank auction platform delivers immediate gain on sale income, while their securitization network delivers interest income over the life of the loans.
Additionally, BHG did accomplish during September a $412 million securitization at acceptable rate of 7% when as it appears to us other FinTech lenders were having to reevaluate their business models given the operating environment. BHG was very pleased to be able to get this securitization done.
Just a side note, Kroll has now rerated BHG's first two issuances, such that all tranches for all six prior securitizations are now investment grade and the senior Class A tranche and all issuances is AAA rated.
We do want to highlight BHG's flexibility as to funding. Securitization platform spreads have compressed in 2022 with the weighted average rate for the most recent issuance at seven compared to 5.5% in June and 2.5% in the first quarter. This compression motivates BHG to reconsider selling more loans through this auction platform as it spreads have held a better this year than anticipated. The key point is that they have the flexibility to do it.
In the end, profitability and balance sheet soundness are the key drivers for BHG. As I mentioned earlier, BHG has updated their 2022 earnings guidance and now estimates about 25% earnings growth over 2021.
Again, looking forward, some key points I'd like to reemphasize. Credit remains consistent with previous quarters, but BHG is and will be increasing reserves based on macro-economic data, at least over the next few quarters. BHG has been modifying their credit models towards originating less risky assets. Spread shrinkage may occur with more historical levels as we head into the fourth quarter and 2023.
Production volumes are very strong and we believe they will continue to have strong production going into the fourth quarter and 2023. Off-note is that BHG anticipates at least two to four new funding alternatives to open up in the near-term as they seek to broaden their already strong liquidity platform, which we also believe is one of their strongest attributes.
Quickly, here's an outlook for the remainder of 2022. For loans, we've increased our outlook to low 20% growth for 2022. We have adjusted our rate forecast and now consider a 4.5% Fed funds rate by year end, we like you will continue to monitor and modify as necessary, but we don't believe any reasonable changes to our current planning assumption will impact our current outlook for 2022 materially.
Given that, we believe we should see continued improvement in net interest income this year, which should result in net interest income growth in the low 20 percentage rate. We still believe increases in hires and other factors should result in expense growth being in the high teens.
All of this is about 2022, we'll provide more information as to our 2023 outlook next quarter. Last year at this time, our concerns were trying to figure out how to put together a 2022 plan just to grow earnings.
We were looking at low single-digit earnings growth rate for 2022 and it got no better by the end of the year. Based on sell side research at the time, 80% of our peer group was anticipating negative EPS growth in 2022.
So, we're pleased with our 2022 financial performance thus far as we believe we will Sally beat our loan deposit revenue, PPNR, and earnings targets for this year. Trust us, as I'm primarily speaking to my Pinnacle teammates who are listening in, we have started building plans for next year and our goal remains the same, top quartile earnings performance no matter what gets thrown at us all.
Paul, with that, I'll stop and see if there are any questions.
Thank you, Mr. Turner [PH], the floor is now open for your questions. [Operator Instructions]
The first question is coming from Steven Alexopoulos from JP Morgan. Steven, your line is live.
Hi, good morning, everyone.
Good morning.
Hey Steve.
I want to start. So, Harold first on the non-interest bearing deposits, right? These went from 24% of total before the pandemic which is before QE to 33% today. Do you think you can hold that mix at about that level? Or do you see it migrating back, right, we're in QT now. Do you see it migrating back as you continue to fund strong loan growth?
Well, no, we don't think it's going to go back to pre-COVID levels. We've had a lot of initiatives around operating accounts and we've gathered a lot of clients. So, we don't think we'll get back down there. We did see the mix shift that we noted in previously. But so far in October now granted, we're only 18 days in, we're feeling pretty good about where this deposit book is hanging in there on -- particularly on non-interest bearing.
So, there's enough sources when you look at sources of funding and maybe we could hold the mix about where it is.
Yes, I think so. We might drift down a couple of notches, but I don't think it's going to be that dramatic.
Got you. Okay. And then as we think about expenses, I appreciate next quarter you'll give us 2023, but when we think about the ramp and hiring through 2022, can you just give us some framework about 2023? I mean, should we at least be at a similar level of expense growth next year, just given the hiring that took place through 2022?
Well, I'll give you some data points, and then I'll let Terry talk about momentum. I think we should see at least high teens -- mid to high teens kind of expense growth next year. That's what we're kind of looking at currently. Terry?
Yes. Steve, I think on higher and momentum, as you saw, third quarter was a record quarter for us. I don't look forward to stay at 53 revenue producers a quarter, but I expect it to remain high going forward. And so I think your data is correct that the hiring more or less occurs on a straight line and I would expect it to continue for the foreseeable future. And so how that bears on the expense growth is just exactly what you say. I mean it will be elevated because we have hired throughout the year and frankly, we intend to continue hiring at a similar rate in 2023.
Okay, that's helpful. And then finally, there are many investors on the sidelines nervous to own your stock here, not because of Pinnacle's credit quality, but their concern on the credit outlook for most of the FinTech lenders out there, including BHG, particularly given BHG expanded these newer verticals. Could you just share with people on the sidelines, how worried are you on the credit outlook at BHG given the macro environment? Just any additional color you could provide would be really helpful. Thanks.
Harold, you want to go first and I’ll add -- go after?
Sure. We've had a lot of conversations with the leadership at Bankers Healthcare Group over the last several quarters about -- their confidence with their book, their confidence in their credit models. They think -- or they believe currently that their models are sound. If there is a significant kind of uptick in inflationary pressure, no doubt their charge-offs could tweak up. But they're very confident with respect to their ability to find the best borrowers in this environment and continue to monitor their book for, call it, cracks or weaknesses.
I think Steve I might add just a couple other things. Obviously, for us as an investor, I'm always have been since we started and continue to try to understand really what all that credit risk is, I think some things that give me great comfort are number one, they've got a huge group of people in analytics, they work on all kinds of variables, you've heard us talk about that in the past.
But the main variable -- the foremost variable, obviously, is their credit scoring mechanism. We provide information to you on the FICO scores, because that's a common thing that you and I and others can all understand, it's quite level set, but they don't underwrite their credit off that FICO score, they're using their own proprietary model, which they can demonstrate is 17% more predictive than the FICO score.
And so again, these are not credit novices, they've been through it through a number of cycles, they went through the Great Recession without sustaining any losses, which not many of the banks they sell credit to good could say that. And so again, I think they started as a credit scorecard analytical grade, its broadened out, but it still is their strength. And so I love the capability that they have, the fact that their model is a little more rich than a FICO score, which is sort of the industry standard. I think that's one thing that gives me a lot of confidence.
As I mentioned, I think the second thing I would say is, again, they -- these guys had been through recessions in the past and their performance was extraordinarily good. It was better than our bank's performance and better than most banks' performance and so that's another item that gives me a great deal of confidence.
I think the third thing is, when -- so much of it is consumer credit. Somebody -- even the business credit has a consumer underwriting orientation to it and so I guess the idea for me here is that the average borrower has income of $287,000. When I think about various other FinTechs and I won't go through the name them all and what their credit products are and so for, I don't know, any of them that are underwriting borrowers with $287,000 in annual income.
It's a different class bar. These are not people that are borrowing money for a washing machine or small home improvement or something. I mean these are substantial people and so again, I think the mix of their borrower is different than what most of their FinTech providers -- other FinTech providers are doing for their borrower. So, anyway, I just ran through those three things.
Okay. That's great color. Thanks for taking my questions.
Yes.
Thank you. And the next question is coming from Stephen Scouten from Sandler O'Neill. Stephen, your line is live.
Thank you. Good morning, everyone. I guess I wanted to dig down into the beta expectations you have that you laid out in the presentation, both on the loan and then especially on the deposit side. 2021 growth and kind of historical growth [Technical Difficulty]
Hello? Steve are you there?
[Technical Difficulty] Yes, can you guys hear me?
You kind of blanked out on me?
Okay, I guess I'm just trying to think about where loan growth -- what kind of loan growth expectations you have in 2023 relative to those deposit beta expectations because it would seem with your offense guidance, if it's going to be high teens again, we might be looking for high teens growth again.
[Technical Difficulty]
Steve, I think I got the gist of the question. You, kind of, blanked out on me, I'm not sure if others on the call experienced the same thing or not. I think going into next year and the -- just looking at the net interest margin if it -- historically if it responds the way it has done in the past, we're anticipating that as the Fed stops raising rates, that the left side of the balance sheets yields and rates will likely start topping off, and that the deposit lag will likely be in effect through that time.
I was looking at our net interest margin performance over the last two years, it stayed fairly consistent at around a 2.95% to 3.05% range for the last two years during a fairly flat rate environment. So, we'd anticipate that kind of performance with respect to our -- at least our margins once the Fed settles down on their rate increases. Is that helpful?
Yes, that's helpful. Sounds like I might be having technology issues. So, I'll let somebody else hop on. Thanks a lot.
Thanks Steve.
Thank you. The next question is coming from Michael Rose from Raymond James. Michael, your line is live.
Hey, good morning. Just you gave us a lot of colors on BHG, very much appreciated. On the one hand, you continue to grow, you feel comfortable that growth, but on the other hand, the recourse reserves or the new terminology for it is expected to grow kind of as well.
I hate that -- I know, it's really hard to kind of forecast. So, you had really good growth through the year in BHG better than expected? Can you give us a stab at kind of the puts and takes of how we should think about 2023? And the growth of that business just going into a slowdown? Thanks.
Yes, Steve, we've had -- I mean, Michael, we've had some preliminary conversations with BHG about their next year's outlook. They have -- they do believe their production platform will continue to deliver at a reasonable pace next year. And they think they have opportunities to continue to kind of pivot between the securitization platform and the gain on sale and the bank auction platform.
I don't think it would be unreasonable to assume that next year's growth rate might be somewhere around a 15% number, something like that. I'm hesitant to get into too much detail, because we need to have some more conversations with Bankers Healthcare Group.
Certainly understood. And then thanks, thanks for that. Maybe just more broadly speaking, you guys have been obviously very active on the hiring front. And you've talked about dislocations maybe getting even more advantageous for you into next year just given the market dislocations.
But it's been a while I think, since you've kind of entertained the thoughts of maybe doing a whole bank transaction and just wanted to see given the dislocations that some banks are going to have and some of the credit issues that I think we're going to see, is that an avenue that you could potentially open up again, as we think about the next couple of years. Thanks.
Michael, I think on that front, you heard my answer before and it's really no different. Our position, I don't think has changed. Never going to say never, that we just absolutely won't do it, I don't say that. But I don't think it's fair to say you can see the hiring momentum that we have, I expect it to continue as long as we can, sort of, continue that market share play for the foreseeable future, which I think we can. You'd have to have a really compelling transaction to want to do it. And so if we find one of those, certainly, we would consider it. But again, I just think the bias is more toward organic growth and continuing our market share play, we're really in a, I think, a luxurious position to have built a preferred bank standing for large bank employees who want to exit their large bank. And so again, I expect that'll be our principal lever.
Appreciate it. Maybe just one final quick one. Just putting together some of the expectations you've talked about initially for next year. Is the expectation that just given the rate outlook and beta assumptions and what you said on BHG and expenses that you could generate positive operating leverage next year. Is that going to be more challenging? Thanks.
Harold, you want to take that?
Sure. Yes, I don't think it's unreasonable. We're I believe at our core sub 50% efficiency ratio kind of franchise and I believe that we've got all the options in the world to increase that are better that here in the near-term.
Helpful. Thanks for taking my questions.
Thank you. And the next question is coming from a Jared Shaw from Wells Fargo Securities. Jared your line of live. Jared, your line is live, please check your mute button. You may go ahead with your question.
Sorry about that. Thanks for taking the question. I guess going back to BHG, could you give an update Harold on -- maybe some of the steps that they're taking to utilize more CECL-friendly disposition avenues? And what a day one potential estimate for BHG could look like right now?
Yes, sure. The -- there's currently several different options, maybe a couple that I'll talk about. One is within the guidance; you can sell more of the cash flows and then avoid CECL, so call it similar to what they do with the gain on sale platform with the banks, they can do that with institutional investors.
They can also sell part of the residual cash flows, maybe carve out some of those future cash flows and sell those and then take those credits out of the CECL kind of, domain. So, there's a variety of different tactics they can deploy to try to avoid CECL.
Right now they are thinking their reserves, which are currently at 3.5% could get into the 9% to 10% range with day one CECL impacts. So, I don't know if that gets you all the way there, Jared, but that's what we've been talking about thus far.
Okay, and then any update on how you're thinking about your ownership stake in that, in the past, you said that you were -- think you said you travel with the founders. And then over the last few quarters, it sounded like maybe you could forge your own path? How should we be thinking about BHG as a percentage of the Pinnacle balance sheet or earnings stream going forward?
Terry, I'll start and then let you finish. But the -- I don't think we've got any real strong change with our perspective on our ownership of BHG, we're definitely not interested in owning our bottom majority stake in the franchise.
I think both Pinnacle and the two founders of the franchise, we're all on the same page. I think if there were a liquidity event, an opportunity for one, I think, the founders and ourselves, we'd entertain it and see where it goes from there.
The market right now is not real supportive of any kind of transaction. But I believe that, like I said, we're all on the same page if there were something to come down the pipe.
Jared, I think, you know, I might add to Harold's comments, I mean, what he said is accurate. I think the case is that as you know the valuation, whatever it is, it bounces around and has moved rapidly if you look at what I would say the value of that company is or what it has been 12 months ago, nine months ago, six months ago, three months ago, it's pretty dramatically different over that time period. And so all those things influence what can, in fact, be done.
When you talk about liquidity event, obviously, what you got to get down to is a willing buyer and a willing seller. And so again, those -- there are people that are always circling and looking for valuations and so forth.
I think the -- I think we as Harold said we and the other two owners are at this point at a really similar spot. We'd be willing to ride valuations, reduce our stakes, or sell the company. And so again, it's just about how the market moves and where find that willing buyer and willing seller. I think I've indicated if nobody had to be happy, but me, I think, some reduction in our state in BHG to the extent people want a minority interest in the company is a good idea. I love the income that it generates, has provided extraordinary flexibility, it's been a tremendous strategic advantage in terms of funding, extraordinary growth, here and allowing us to maintain very high profitability.
And so I don't want to completely give that away to be candid. But if it became a lesser percent of our income, that would probably I think, add to investor perception, PE, multiples, all those kinds of things.
So, any right, it's impossible to say exactly what is going to happen, but we would be willing to consider a reduction or a sale the company and so if that comes about, that'll be fine, but we're very comfortable to continue in the current situation as well.
Okay, all right. Thanks. And I guess the shifting over to loan growth in the outlook as we go into next year. Certainly sounds like you have good momentum with all hiring. If we're looking at a weaker maybe economic backdrop and I look at slide seven and the different avenues or where that growth has come from you, do you think that you can see a shift with a bigger dependence on this expansion markets or having a bigger relative impact from the hiring? Or do you think that we'll see sort of a broad base equally diversified platform of growth going into 2023?
My own sense of it is that it ought to remain relatively similar. I think as the new markets take home, their growth will be faster than in the legacy markets, but I think generally that is -- the allocation of the growth is probably a pretty similar thing when you look at it 12 months from now.
Great. Thanks a lot.
Thank you. And the next question is coming from Catherine Miller from KBW. Catherine, your line is live.
Thanks good morning.
Hey Catherine.
Want to just -- backup to the margin and the cumulative betas through 2022, I thought was really helpful with the 60% loan beta and the 40% cumulative deposit beta. How do you think, as we move into next year, I know you're not giving next year guidance yet, but just kind of generally indirectly between the two, how do you think those two trend next year? And is that 50% cumulative loan beta, is that a good number for next year, or the dynamics kind of pricing of new loans and all that that may kind of change that as we look at it full cycle?
Yes, I think -- well, first of all, I want to make sure that we emphasize more about where the margin is versus where the betas go. We provide the beta information to kind of help people get through it, but we're more interested in what we think the margin is going to do given where the rate cycle is, and -- like I was mentioned earlier, we think the margin, once the rate -- once the Fed begins to kind of stop or ease or just stall that the margin will probably flatten out.
And if -- with deposit competition, we'd probably see some more increases in our deposit rates. But as far as a beta question itself, in all likelihood, the loan beta would probably -- once it stalls, would probably come down as with competitive pressure, but we think the lag on deposits would probably be -- the more -- be more influential on the longer term margin.
Got it. And on that, how are you thinking -- I mean the margin substantial extension this quarter as expect, we'll see it again next quarter, any kind of near-term thoughts on where you think the margin may shake out next quarter?
Yes, we're not currently planning for another 30 basis point uptick. But it ought to be somewhere half -- maybe a little more than half going into the fourth quarter.
Half of the increase we saw this quarter.
That's right.
Got it, okay. And so you probably peak early 2023 and then start to flatten out to come down as you move through the rest of the year?
Yes, our planning assumption is next year that we ought to see two 25 basis point rate decreases in the last half of the year, and so the margin pretty much flattens out in the second quarter.
Got it. Thanks. And then on the composition of deposit growth, just the balanced growth was great to see. Just big picture, how are you strategically thinking about the composition of where that growth will come? I know you mentioned you still expect to grow net interest bearing, but then -- how much do you think comes from non-core versus core?
And then also you talked about some different specialty deposit strategies that you've got, you could kind of talk about how you think that factors into the deposit growth outlook as well?
Terry, I'll start and let you go from there. Traditionally, our client base will provide 80% to 90% of the core funding that we need to fund our loan growth. And so we've always had to go to the wholesale markets, call it, brokered or Federal Home Loan Bank to try to fund the gap with respect -- to try to fund the gap.
So, here over the last couple of years, we've not had that problem. We've not had to go to the wholesale markets much at all to get our liquidity to fund loan growth. So, we do have capacity internally to go to the wholesale markets, to fund loan growth, but there will be a stop gap.
Before we had kind of a 20% wholesale funding, kind of, limitation, I don't see us getting anywhere near that. But we will do it to fund some loan growth, but our -- like I said earlier, our belief is that our franchise -- a lot of value of our franchise a built in our deposit book. And so we've got to make sure that we're looking under rocks for deposits. And I think our relationship managers are doing just that today. I think where this new deposit growth is going to come from is from our new hires and our new markets. Terry?
Yes, I think I would add to that -- Harold commented I think when he went over the slide, we have, over the last year or two, been building some specialty deposit funding around HSAs, around community associations, which is inclusive of homeowners' associations and property managers, some non-profit specialties and so forth.
And those have been built. They're all three breakeven, they are having success, and we believe will be a meaningful part of the funding, as we get out through here as well. So, in addition to new people in the markets, I think the new product specialties are important to us in terms of low cost funding.
Great. Thank you so much. That’s all I got.
All right.
Thank you. The next question is coming from Brian Martin - Janney Montgomery. Brian, your line of live.
Hey, good morning, guys. Thanks for taking the question. Just maybe circling back here. Just one clarification on the comments or questions on expense growth earlier? I know you're not giving the guidance, but just when you were talking about kind of that -- the high teens expense growth, was that more -- from the people you've already hired? Was that really talking about the salary line? Are you talking about total expenses there just for clarity?
Yes, mid to teens -- mid to high teens would be for total expenses. Again, we're going through all of our planning for 2023. Currently, we're pretty much maybe at the first few steps of a many-step journey. But that's probably where it's going to shake out at the end of the day.
But that said, as Terry alluded to earlier in the call, our hiring plan, when you put it in effect, or you start executing it, well, we what we're going to do is we're going to hire the people, whenever we get an opportunity, we're going to be opportunistic hires. And so we may put in the plan that we're going to maybe hire 125 revenue producers next year, or 130, or whatever the number might be, but if we have a chance to double that, we might just go after it.
Got you. Okay, no, it makes sense. How about just shifting gears to the BHG? I think your third quarter, obviously down but strong, Harold, I guess fourth quarter as it shapes up right now. Should -- is expectation that it should drift a bit lower at BHG today?
Don't know if I caught all your -- Brian say that question -- go back through that one more time.
Yes, just the outlook for BHG in 4Q, I mean, relative to third quarter, third quarter was strong, but down, but fourth quarter is also expected to be a bit lower given kind of your comments about your performance?
Yes, I think so what could change our current perspective is if they send more loans to the auction platform, which is what they did this quarter. So, right now, they believe they're going to warehouse more loans on their balance sheet, which could tamp down earnings in the fourth quarter.
Got you. Okay. And then just the maybe just looking at one-line item on fee income, and that was just the -- I guess, the gain or loss and sale of other equity investments, kind of the -- I guess significant drop this quarter, as you guys have talked about kind of that volatility there. But just as we think about that number going forward, I guess, just kind of take an average of the past quarters, or just -- what's the best way to think about that given this quarter's mark relative to last quarters?
Yes, we're not anticipating much movement in that year-to-date number here today. We'll get more information through the quarter on all of our -- on all those investments. And see where it shakes out. But right now, we're not planning on any kind of up or down movement with respect to the anything in the fourth quarter.
Got you. Okay. And then new loan yield, Harold, where are they coming on today? I guess -- whether be the month of September or just kind of whatever most recent data you have, where are they -- where are you putting on new loans today?
Well, I could flip down to the back of the -- end of the supplemental information and look at that number. But at the end of September, we were at 5%. So, that way imply that we're getting in there.
If it's in slide, I'll grab it. I missed that if I did. So, no problem on that.
All right.
Okay. Thanks for taking the questions, guys.
Thanks Brian.
Thank you. And the next question is coming from Jennifer Demba from Truist Securities. Jennifer, your line is live.
Thank you. Good morning.
Hey Jennifer.
Hi Jennifer.
Terry wondering if you could just give us your thoughts on your performance in your expansion markets and especially commercial lending. Just looking at slide eight, just -- if you could just talk about where -- how things have gone and each market versus your expectations? Thank you.
Yes, I'll try to just throw out thoughts. If I'm not addressing what you're interested in, just redirect me and I'll hit it. I would say that the Atlanta market is almost exactly on target for what we would have hoped. We're probably a little ahead on hiring, I think volumes are generally right where we would expect them to be and so we're excited about what's going on here in Atlanta.
I think, in the case of Alabama, both [Indiscernible] and Birmingham, I would say they have outperformed what our expectations were both in terms of hiring and in terms of the balance sheet volumes that they -- early on both sides of the balance sheet, loan and deposit volumes have been really attractive. And so I think we're going to do better in those markets than then what we had said.
And then in the case of D.C., I would say, just for me personally, that's probably the market I am most excited about. As you can see bad months in existence, we're still in the early stages, but their pipelines are building pretty dramatically. You can see they've had great success hiring people and the -- again both sides of the balance sheet for them, what's in the pipeline and what we expect to happen over the next two quarters. They'll do better than what our original pro forma was, as well. So, anyway, that's how I look at those big markets if not addressed what you're interested in, please redirect.
That's great color. Thank you so much. And just question a lot of analysts Investors have asked about normalizing credit. And I just wonder what you think normal is, is normal somewhere between where we have been at these historically low losses and problem asset levels? And the historical median? Or is it -- is it the historical median? Are you -- what do you think normal is?
Well, I think when you start using the term like normal, that obviously has to apply over a period of time to me sort of through the cycle, you get ups and downs. And so I don't think there's any basis under which I would expect to operate our company, the levels of classified assets, non-performing assets and so forth, that we are currently at, through an entire cycle.
So, at any rate, I think those median numbers are -- they're a reasonable way to think about what ought to happen through a whole cycle. Again, I'm partially think we're ways away from that. But -- again, I think we're not -- for me to say, we expect things to normalize, I just want people to understand I don't think we're going to be operating at the level of classified assets and non-performing assets that we've been at over the last handful of quarters. For the foreseeable future, surely, it'll have to go up to some extent now, again, maybe the median numbers are good plan and assumption.
Thanks.
Thank you. And we have Catherine Miller from KBW coming with a follow-up. Catherine, your line is live.
Thanks. I just had a follow-up on expenses, like your stack has started underperform since the call started, when you mentioned, a high teens expense growth rate. So, I just wanted to circle back to that comment, and maybe provide you the opportunity to remind us how nimble you can be on the expense side if the revenue growth is not going to come in as expected. If we see loan growth slow or the margin come in lower than expected, how nimble can you be on pulling back that high teen expense guidance you gave? Thanks?
Harold you want to go first?
Yes, I'll go first. Thanks Catherine for the follow-up. Yes, I mean, we've always got the ability to take money out of out of the expense book. The big thing that we can that we always do around here is our incentive plans are all tied to earnings growth. And so if earnings growth doesn't come around, then we've got opportunities to take quite a large sum of money out of our incentive plan to kind of fortify our P&L and make sure our earnings growth is reasonable under the circumstances.
The other thing -- and we did this back during the financial crisis, is we can always pull back on hiring, that will impact our longer term growth. So, we're not really anxious to do that. But there's a lot of variability in our expense book that we that we can go after when it's absolutely necessary. Terry, I'll stop there.
Yes, Catherine, I guess I had to hit two things. I mean, Harold said it, but just in case, there are people who don't get it, they -- and saying that we have sacrificed 100% of our incentives, if we don't produce our earnings targets and earnings targets are set to be top quartile performance. And so that's the biggest expense lever that you have. We don't get paid unless shareholders do get paid. And I don't think there's a company that I'm familiar with that will do that and protect shareholders to that extent.
I think the second thing is in a pound away on this for a reason, but I don't feel successful. Again, people understand that the hiring that we do, because we do it on a straight line, it's a huge part of the expense base and so we're paying expenses today for revenues that are yet to come.
And so my only message in that is there's an immense amount of profitability that comes when we quit hiring people. All the revenue continues to roll in and the expenses cease to grow and so there's huge profit leverage in just that single idea, right there.
When you think about having -- hired 53 revenue producers this quarter that revenue will come in. And so then if we have difficulties, we quit hiring people and so the expenses stop growing, but the revenue continues to grow.
So, anyway, that's my own view of this why we've operated over an extended period of time. And I'm not sure everybody understands how that works, but you can't quit hiring. And it does produce earnings growth, even though it impacts the longer term balance sheet and earnings growth in the short run, it accelerates earnings growth.
Got it, that’s helpful. Thanks for the follow-up. And I mean just -- if you're going to put a high teens expense growth rate out there, then it's just fair to assume that the revenue growth rate is going to be above that, just given your business model, correct?
No doubt. No doubt.
Awesome. Thank you.
All right. Thanks Catherine.
Thank you. Ladies and gentlemen, this does conclude today's conference. You may disconnect your lines at this time and have a wonderful day. Thank you for your participation.
Thank you.