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 Fourth Quarter 2017 Earnings Conference Call. Hosting the call today from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer; and Mr. Harold Carpenter, Chief Financial Officer.
Please note, Pinnacle’s earnings release and this morning’s presentation are available on the Investor Relations page of their website at www.pnfp.com. Today’s call is being recorded and will be available for replay on Pinnacle’s website for the next 90 days. At this time, all participants have been placed in a listen-only mode. The floor will be opened for your questions following the presentation. [Operator Instructions]
Before we begin, Pinnacle does not provide earnings guidance or forecasts. During this presentation, we may make comments, which may constitute forward-looking statements. All forward-looking statements are subject to risks and uncertainties and other 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 reconciliation of the non-GAAP measures to the comparable GAAP measures will be made 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. Good morning. We appreciate you being on the call with us this morning from snowy icy Nashville. We always begin our quarterly earnings call with this dashboard, really two slides. The first reflecting the GAAP measures and second reflecting non-GAAP measures. We like this dashboard because it quickly analyzes the performance and momentum on virtually all the metrics that we use to drive our business.
We’ve always believed that revenue growth, earnings growth and asset quality are the three metrics most tightly correlated with share price performance, and so that’s really the focus of the slide. Companies that grow tangible book value typically grow their share price, companies that consistently produce well above median ROTCEs typically trade well above medium PE multiples and so-forth. And so, I think in our case we’re roughly 80% shred business, balance sheet growth is really the key to the revenue growth going forward. So, you got to look at revenue growth, earnings growth and asset quality and some ability to see the pace of growth and the future growth based on what is going on the balance sheet.
As most of you know, this quarter was immediately impacted by pretax merger-related charges of $19.1 million, pretax security loss of $8.3 million, and after-tax charges related to the revaluation of our firm’s deferred tax assets of $31.5 million. So, as I say each quarter at least for me given all of the transition, the merger integration, and now the tax law changes the non-GAAP measures that takes these realities into account actually provide greater insight into the core run rates on these important measures, so let me move to those quickly.
Looking at those non-GAAP measures, adjusting for the merger-related expenses, the revaluation of our deferred tax assets and loss associated with the restructuring of roughly $300 million in our bond book. Since [indiscernible] nicely floats in the right direction, I won't walk through each metric. I do want to point out two. The first one is, ROTCE on the first row. I think most of you will recall in conjunction with the BNC acquisition and to support the future growth needs of the firm. We issued 3.2 million shares in January 2017, totaling $192 million in net proceeds.
So, we had a partial quarter impact to those additional shares in Q1 fourth quarter impact in Q2, and as you can see it is now escalating quickly already back to a 16.11 ROTCE. Secondly, just below the ROTCE chart, the tangible book value chart, as I have already commented on this call, correlation between tangible book and share prices is obvious. We take it seriously and again as you can see in conjunction with our acquisition we have continued to grow it nicely.
Those obviously have followed our current [indiscernible] length of time those are coming out of recession back in 2011. We published our profit model and associated performance targets. I think over the years that we have achieved the initial targets. We have actually increased our ROA target twice, since then to its current level of 1.3% to 1.5%.
In conjunction with the ROAA target, we continue to publish the targets for the four key components that lead to that overall level of profitability and specifically I’m talking about the margin, the expenses to assets, the fees to assets and the net charge-offs. And so, as you can see on this slide, which reflects both the GAAP and the non-GAAP measurements fourth quarter 2017 was another good quarter with a non-GAAP return on average assets at 1.36%, and with the exception of the fees to assets, the component measures are all performing pretty well against the targets.
Those non-GAAP measures are adjusted for merger-related expenses invested in gains and losses to sales on security and the revaluation of our deferred tax assets in the fourth quarter, as a result of the tax law change. I might just comment quickly on the target range for each of those measures.
As most of you know, we have conducted a strategic planning process each year in the third quarter. This year, we plan to focus on the remainder of 2017 through 2020 and this year's three-year plan we didn’t alter the overall target range for ROAA, it remained at the 1.3% to 1.5% level, but we did as a result of the business mix changes associated with our BNC acquisition adjust the target range for margin up to a range of 360 to 380, expenses to assets down to a range of 1.8 to 2.0, and the fees to assets down to a range of 0.9 to 1.10.
It has been and it continues to be my strong belief that the revenue potential in the BNC footprint is very strong, particularly as we build out the C&I platform and leverage our wealth management businesses there. As I indicated before, I’d expect, it may take 6-day a quarter before we built into that target range for the fees to asset component. Nevertheless, we intend to take advantage of the outperformance that we’re likely to have on the other three components to enable to still operate in the high-end of the ROAA target range until we muscle build lead generation capability in the BNC footprint.
Additionally, we will now go back and recalibrate the targets in-light of the Tax Job act, expecting further meaningful lift in the ROAA target range. I might just comment here, fourth quarter 2017 was a huge quarter in the history of our firm. We continued the rapid growth in earnings, balance sheet growth in both loan and deposit, and hiring, we did all that in the middle of completing the BNC integration.
Our trades have really worked tireless to get that transaction done, completed all the systems converted during the fourth quarter 2017. They aren’t really consistent with the timeline that we laid out at the beginning. We now believe that we’re fundamentally through with producing the synergy case that we had originally indicated. There are a few associates that are still on the payroll that will depart early in the first quarter, having now stabilized the systems and all those kinds of things. Perhaps are a few market related charges in the first quarter as well, but generally all the work has been done.
I think the second thing I always try to hit on in these calls is our aggressive hiring plan. You can see that on the slide. In 2017, we added 77 revenue producers to our roster, 27 of those where in the BNC markets and that’s 13 of those 27 since the closing of the merger. That’s a really important thing in addition to hiring the revenue producers we hired, and the support staff that are needed to support those people and get all of that done inside our operating targets for expenses to assets and so forth, I think will help people understand how we drive our revenue growth and efficiencies going forward.
Again, I would say that the third quarter was a strong loan and deposit growth quarter. They - both loan and deposit growth where good. The deposit growth was a highlight in particular and I think most of you heard me talk about this in the past. I think, for any community bank the ability to grow core deposits is the indiscernible ability to grow core deposits is the principle measure and its abilities to succeed over time. And so, to produce the balance sheet growth at those growth rates in the middle of taking on the most monumental system and operation conversion that we have ever undertaken, I think really bodes well as we move into 2018 with that now in the rearview mirror.
I think I want to make one more clarification for you just to again try and set the stage as we go forward. Over the years, I have always talked about revenue producers, and of course revenue producers include relationship manager and broker, mortgage originator, trust administrators, and so forth, and so I think most of you know we think ourselves as a revenue growth company, and so consequently our ability to hire people is the key to that revenue growth.
Again, just trying to draw distinctions, I know a lot of companies are trying to manage the expenses down that’s not really our approach, we’re trying to manage revenues up. But I do think when I - if I make those points, I do detect in some people a skepticism or maybe better said, the concern that the bill now is going to grab the expense levels too high and so I guess I just want to reiterate that we intend to get this hiring done inside the expense to asset targets that we set. As you can see in 2017, hired 77 revenue producers and finished the year with a non-GAAP efficiency ratio of roughly 47%, and 1.87% experience to asset ratios. So again, just trying to clarify that we don’t view the adding of people to begin expense bill would view it to be a revenue bill.
One other clarification on that point, even though we definitely talked about all the revenue producers there is no doubt in the North Carolina footprint that really the exponential growth we expect to achieve there has to do with continuing the growth rates that they have enjoyed for a long time in the commercial real estate business, but really adding to that a C&I practice, that’s substantial and so we have communicated in the past, within this category revenue producers that we intend to add 64 C&I or private banking financial advisors over a five-year period of time. And again, we will continue to report on that so you can see our progress on that because of the strategic importance of that initiative.
So, Harold, I’ll stop there with overview and let you take further details.
Thanks Terry. Revenues excluding securities losses for the quarter increased from $216 million in the third quarter to almost $220 billion in the fourth quarter. Total spread income increased $1.4 million between the third and fourth quarters. Discount accretion decreased $1.3 million during the quarter thus offset the overall spread increase. As always, the dark green line in the chart denotes revenue per share. We reported $2.80 adjusted revenue per share in Q3 and are reporting $2.83 this quarter, again excluding investment securities losses.
Obviously, our goal is to continue increase our revenue per share over time. As you all know, it is a lot easier to grow earnings per share with a growing balance sheet and we think we have a great shot at doing that as we enter 2018. As to purchase accounting as many of you know, purchase accounting will be impacted for an extended period of time, but should gradually lessen over time. We have approximately $163 million in loan discount accretion of which a significant amount is expected to amortize over the next two to three years.
We recognized $19.1 million in the fourth quarter and anticipate at least $15 million to $18 million in loan discount accretion in the first quarter of 2018. That said, it is important to realize that our balance sheet produces outsider’s growth, which continue to produce ongoing positive traction for our revenues in the future.
Concerning loans in the chart indicate average loans for the fourth quarter were $15.5 billion, compared to 15 billion at the end of the third quarter, or an increase of $500 million in average loan balances or an annualized growth rate of better than 13%. We believe we had a strong fourth quarter, particularly in Tennessee where we saw increased loans of $308 million and the Carolinas and Virginia, their organic loan growth was approximately $66 million in the fourth quarter, compared to $61 million in the third quarter.
Thus far in 2017, including the $330 million of net organic loan growth, the Bank of North Carolina posted prior the merger the two firms have produced net loan growth in an excess of $1.7 billion in 2017. This obviously excites us as we go into 2018 with the combined firm, pressing forward to grow our franchise. As the chart indicates, our loan yields decreased slightly to 4.87% this quarter compared to 4.91% last quarter, excluding the impact of purchase accounting, core loan yields were basically flat at 4.36% in the third quarter compared to 4.37 in the fourth quarter.
The mid-December Fed funds rate increase did help our core loan yield slightly and should drive a core rate increase in the first quarter of 2018 that we anticipate to be 5 basis points to 10 basis points. As to the deposits, again here in the fourth quarter we were able to grow our funding base, while maintaining low funding costs. Our aggregate funding cost did increase 7 basis points in the fourth quarter from the third quarter and currently stands at 73 basis points for the fourth quarter.
As to the 7-basis point increase, wholesale funding did drop a lot of the increase, while deposit cost were up 5 basis points. As for the future, deposit costs will continue to increase at a measured pace for several factors. The two most prominent are general pressure from increased deposit rates and a rising rate environment, we also need to fund a significant loan pipeline.
Our relationship managers were out in the market selling our ability to serve commercial and affluent consumer depositors with a value equation we think is far superior to our competitors. Funding our growth has and will remain a key focus of our firm. We are elated with $856 million in increased core deposits for the quarter endpoint to endpoint.
Switching now to noninterest income, fees amounted to $36 million, compared to $43 million in the third quarter. Our residential mortgage group had another outstanding quarter in terms of production with approximately $290 million in loan sales this quarter, and a yield spread of 2.55%. However, the contributions in the fourth quarter was down from 3Q, primarily due to the seasonality of their funded pipeline. This typically incurs occurs at this time of the year before the ramp-up occurs in the spring.
We always expect the fourth quarter to be the most difficult quarter for mortgage as December is the worst in the real estate market, but the spring is at hand and we are in great residential mortgage markets with the best mortgage originators in those markets. So, we remain optimistic about what residential mortgage will do in 2018. As expected, we are reporting banker sales here in group revenues of $12.4 million this quarter a $4.3 million or almost 50% from the fourth quarter of 2016.
We continue to anticipate the net growth of BAC in 2018 should be in the 12% to 15% range. Year-over-year our equity investment revenues increased 20.9%. We did see a decrease in other non-interest income in the fourth quarter, due primarily to losses on venture capital investments and a reduction in capital market advisory fees during the quarter. That number should stabilize in the first quarter of 2018.
As to investment securities losses, during the fourth quarter, we sold approximately $300 million in securities at a loss of $8.2 million. More sales are likely, but we don’t anticipate any meaningful P&L gain or loss from those sales in the first quarter. We anticipate buying back into the market this quarter such that bond should approach 2.9 billion by quarter-end March 31. We anticipate continued increases in short rates, while loans rate may remain relatively stable, thus a flatter yield curve.
So, we are buying in anticipation of these events, which equates to floating-rate securities and securities with average lives of moderate duration. Thus, we don’t anticipate significant increases in the duration of our portfolio. Our Barbeau [ph] strategy for a better flattening yield curve. We anticipate that this strategy should impact our net interest margin in 2018, positively by 425 basis points.
Now operating leverage. Our efficiency ratio on a GAAP basis was 58.2%, while our core efficiency ratio, excluding merger-related charges and/or expense was 47.2%. Our fourth quarter total noninterest expense increase amounted to $13.2 million with the merger calls accounting for $10.3 million of net increase. First, concerning personnel costs, we’ve got 2,100 FTEs at December quarter-end, of which 844 are signed with the Carolinas and Virginia.
Salary costs are down approximately $1 million from the third quarter of 2017, which was attributable to a reduction in the Carolina and Virginia footprint as the synergy case was being deployed. Those of you that have followed our story for many years know how our 2017 [ph] plan system works and is based on corporate results, not based on individual sales goals.
You will remember that in the third quarter, we were recurring at less than targeted levels, but we continue to work during the fourth quarter and got those reduced incentives back into our P&L in the fourth quarter. Just to emphasize the point, incentive expense and earnings are indirectly linked. If we hit our revenues and earnings targets, our incentive costs will increase. If we don’t, incentive accrual get reduced.
Obviously, one of the keys to anticipating our expense run rate going forward is how quickly the synergy case will be deployed. A critical component of the synergy case was the technology conversion, which Terry has spoke earlier, is now complete. As a result, we continue to believe our synergy case will largely be fully deployed in the first quarter of 2018.
We’ve got about 40 jobs left to come out for the synergy case to be fully realized. We experienced an overall increase in admin cost in the fourth quarter, primarily due to FDIC insurance and franchise taxes as we look forward to 2018, and excluding any additional merger expenses, our operating leverage should improve from the 47.2% in the fourth quarter next year.
Finally, taxes have become an interesting investor conversation. Lots of numbers on the slide behind with me. The blue part of the slide was basically discussed last night in the press release. Excluding merger expenses and investment securities losses and the deferred tax revaluation loss, we think 2017 was about 3.57 fully diluted EPS kind of the year, basically about 16% growth rate over last year.
The way we are choosing to present the impact of the tax act is to use the pro forma method that is as if the tax act was implemented at the first part of 2017 with the tax rates pursuant to the new tax laws. We've considered in this calculation the various non-deductible items that would have come out of the Tax act, which negates some of these savings. We think that number if had been deployed in 2017, we would have saved $33.5 million from the Tax act.
Also, like many firms, we’re considering several items as investments from the Tax act in order to reward associates, as well as provide a placeholder or award shift [ph] to build a better firm quicker. We're considering increase the match for our K plan, as well as providing more funds to enhance our infrastructure and accelerate both client attraction and new hires. Our place holder as of this minute is approximately $8 million pretax.
Net, net we think 2017 would add increased earnings of approximately $0.43 per fully diluted shares with an annual effective tax rate of approximately 22%. Looking forward to 2018, the relationships between all of these factors seem reasonable. We totally realize what the Street expects of our firm next year both pre-and-post the Tax Cuts and Jobs Act. So here we go, it is a great time to be at Pinnacle.
With that, I’ll turn it back over to Terry.
All right. I’d just comment quickly, I guess made this point the time to coming down to the presentation, but I want to reiterate that we have completed the integration of BNC. It has been a way over here to announce the transaction early to get it approved closed and now fully implement as a great thing as Harold mentioned, we are fundamentally through the synergy case, a few jobs left and that will be departed during first quarter for the synergy case, they fully realize, but again the work has been done.
I think the call through integration, I would say it is well underway and has gone extremely well. We have spent some time in several of the quarterly calls this year talking about the cultural integration, but as a reminder we conducted roughly 10 three-day orientation sessions, largely conducted by Harold and I and other key leaders in the firm, and we will finish that group buyout, we probably got four or five that we will have to do in 2018 to get all those done and completed.
I have commented on the revenue synergies. We believe this deal has great revenue synergies that were not included in the 10% accretion target that we’ve already disclosed and now believe we will deliver and that is an important aspect how we drop them out to our revenue fees to asset and target that we talked about earlier in the call.
Again, my expectation is, we will be building throughout 2018 towards that level well and again the confidence that we have in Rick Callicutt and hiring momentum that needs to establish we’ve already talked about, 164 C&I bankers over a five-year period of time. The hiring during or since the completion of the merger is on that pace. I guess there have been C&I banker specifically hired in the last five months. And now we are talking with Rick that since year-end team [indiscernible] have been added and the pipeline looks strong.
So again, we’re excited about where we are and haven’t completed the BNC integration and now able to turn our full focus to the hiring revenue producers and building the balance sheet, which is our principal revenue generation tactics. On this next slide, we have used it for a number of quarters, I like to go back to it because it is instructive. For those that are less familiar with our approach to market extensions and how we tried to lay our own hiring and cultural components, and then allow that to be the driver of balance sheet growth, which is the driver to revenue growth in our company.
So, on this slide, I just might say, we’re looking at the two most recent market extensions Memphis and Chattanooga, we were not in those markets in 2014. We entered those markets in 2015, and so if you look at the second column from the right you can see how many revenue producers we have there at the bottom of each of those markets with a baseline for core deposits was at the end of 2015 and what the base line for loans was at the end of 2015 for both of those markets.
In the right most column, you can see the growth rates between 2015 and 2016, which where substantial, and again I would just start to hit the bottom looking at the growth rate for the hiring revenue producers and again as you move up the chart is not surprising you generate loan and deposit growth. Generally, consistent with the kind of success in general on the revenue producers. And so then moving across that slide you can see where we have finished 2016, where we have finished 2017, and again right there in the center the growth rates associated with our hiring and with loans and deposits, core deposits in both of those markets in the most recent year, again very strong.
So, again, we just highlight that and try to draw a clear parallel for you. This is exactly the game that we will be playing throughout the BNC footprint, try to indicate the success that we’ve had in hiring revenue producers and as a sir component of that C&I financial advisors thus far, which again we believe we will translate into balance sheet growth and revenue growth just as we have in Chattanooga and Memphis.
I guess, I would just conclude with this out there, really all the information we have provided really comes back to this point, we are focused on long-term shareholder value. We are focused on taking advantage of the large high-growth markets that we are in, and we are focused on taking advantage of the vulnerabilities of large regional and national franchises that dominate these markets. That’s really what we do, simply said, we have got higher growth model that has proven.
We just reviewed for the two most recent market extensions in Memphis and Chattanooga and that’s the methodology that we are now deploying in Carolinas and Virginia. I always feel compelled to hit on this point, when you think about what we just talked about, the growth potential really is extraordinary and I think would be a [indiscernible] for our shareholders that that’s all we do is optimize that opportunity. They do feel compelled to say that we are likely to have other opportunities to create market extensions or filling in our footprint.
We’ve tried to indicate as we have gone down through this BNC integration, we are not overly anxious to do that, but we want to print a quarter to demonstrate our ability to hit the revenue targets and operate as a bigger company and those kind of things, I have done that once. We will do that again before we - at the end of the year enter into the M&A phase, but again we always want to make sure that no body walks away [indiscernible] just told me that he is going back another acquisition after he prints one more quarter that’s really not what I'm saying, I don't care whether we make an acquisition or not, the growth potential is strong without it, but I do think as a practical matter we will have those opportunities.
So, operator, we will stop there and be glad to take questions.
Thank you, Mr. Turner. [Operator Instructions] Our first question comes from David Feaster with Raymond James. Your line is now open.
Hi, good morning guys.
Hi Dave.
Congratulations on getting BNC in fully integrated and all that. It’s exciting and it sounds that things are progressing well. I just wanted to get your best estimate of how much of that, if you can quantify, how much of the $40 million cost save estimate is already in your run rate? Given that the technology conversion happened late in the fourth quarter, I would suspect that there is a pretty decent step down still left to actually hit the first quarter numbers? And I guess there is a follow on, was there anything one-time in nature in that other expense line item that kind of popped up in the quarter?
Yes, David this is Harold. I think what we wanted - there is about 40 jobs left to come out of the footprint over there. Many of the jobs did come out at the end of December. So, I think as you look forward into the first quarter and our expense run rate, we think our expense run rate is going to be fairly flat. What we do here, as you might expect is, we will give all the races and all that kind of stuff in the first quarter so you will see the legacy footprint and see increased personnel cost from personnel expenses so and so forth. So, we think net-net that our expense run rate will be barely consistent going into the first quarter of next year.
Okay. As we look out into 2018 in your crystal ball, how do you think about loan growth. What regions do you expect to see the more strength and have you seen any increased demand thus far from tax reform in your pipeline and pay downs were also expected to be heavy in the fourth quarter, how is that trending?
Dave this is Terry. That’s two or three things. I think in terms of just a broad outlook, if you are looking for a percentage growth rate we would expect to have percentage growth rates to occur in the principal BNC markets, in other words Charlotte, Raleigh, Greenville, and Charleston and I say that because as you know there have been double-digit growers largely based on their CRE practice. We would expect that generally to continue, but we expect to really augment that with building out the C&I platform as we’ve already talked and hired a good number of bankers in the last half of 2017, and they are off to a great start in 2018.
So that incremental hiring would accelerate the growth rate over there. I did think it is important to try to make this point, you know we had nice growth in the fourth quarter, I expect the growth to be better in 2018, but I don’t see that primarily as a functional loan demand, in other words what we do for a living, primarily take market share and so my belief is that, so a good part of the growth that we’ve enjoyed thus far and I will project going forward as to move the market share from the large regional and national franchises, perhaps more than loan growth is really tied to the economic growth.
I think as it relates to your question, have we seen increased loan demand as a result of the tax law change, my honest answer to that is not yet. I detect some optimism. I believe all along, once you get the tax rate firm that people know what the rate is and when it is effective that will begin the [indiscernible] and so I do have an expectation it will get benefit from the tax law change and you will see some escalation in loan demand, but candidly, I couldn't say that I have seen thus far. And let’s see, you had one more thing there. Pay down, thank you.
We - I would say pay down is in the fourth quarter or very high and it’s concentrated I think more in commercial real estate than C&I and as you know the permanent markets are wide on lot of alternatives, a 30-year fixed non-recourse kinds of paper out there for commercial real estate. So, pay downs have been very high in the fourth quarter and we do expect that to continue here in the first half of 2018.
Okay. Last one from me. You talked about your CRE concentration and given that the strength, you know BNC is expertise in CRE, you’re expecting that concentration to actually go up near term, but then diminish going forward. I just kind of wanted to hear how you plan on doing that. Are you actually pumping the brakes on CRE lenders or is it simply that the new C&I hires that you’ve made are going to drive C&I growth in excess of CRE in the future?
Well I think it is the true stage that we’re expecting to see in our line of growth faster than the CRE. And again, going back to this idea that’s where the hiring focus is. David, I think we said from the very beginning that our - what the beauty of this transaction and strategy involved with it is that we want to continue the double-digit growth that BNC has enjoyed, but then both on that C&I business, and so the mix will change, but again without an effort to diminish their CRE practice.
I think the issue, as it relates to the concentration is generally focused on total risk-based capital in the 100% and 300% guidelines, and so it has been our intent just generally at the firm to stay underneath those two concentration guidelines, and I think what we tried to say here is that in the most recent quarter we had the $31 million revaluation on the deferred tax asset and $8.3 million charge on the boundary structure and so those obviously shrink capital that’s an unplanned shrinkage in capital.
So, what we're really trying to communicate was, a we’re closing those concentration limits as exacerbated by those write-downs, and so it may take a few quarters for us to rebuild the equity back associated with those write-downs and so that’s the phenomenal and that we’re talking about there what was - and we may temporarily breach those guidelines, but late in the year we ought to have produced enough capital to get back inside those guidelines.
Got it. That’s terrific. Thank you.
All right. Thank you.
Our next question comes from the line of Stephen Scouten with Sandler O’Neill. Your line is now open.
Great. Hi guys, good morning.
Hi Stephen.
Question for you, I guess maybe more for Harold on the core NIM, Harold, I was thinking, you had said after last quarter, we would see flat or maybe increasing core NIM, and I’m wondering what kind of changed during the quarter that led to the downside there, and maybe, I know you spoke a little bit on the 7 basis points of higher deposit cost, but that obviously came in a quarter where we saw no fed rate hikes. I’m wondering on your thoughts on deposit costs next quarter with the impact of the Fed hike.
Yes, we think that the core NIM decrease is primarily attributable to increased funding cost. The - I think we have got a lot of calls during the quarter about raising rates the - about 25% of our interest-bearing deposits are on our sheet rates, so we do negotiated rates for about 75% of our funding book. So, it was on the - we believe it is on the funding side Steve.
Okay that makes sense, and then in 1Q, I mean do you think we will see more, I mean will we see disproportionately more than a 7-basis point increase, could that be more like 12 to 14 just with the rate hike or…?
Yes, we are not planning for that kind of increase going into the first quarter of next year, but we should see measured increases in funding cost for the rest of the year.
Okay. So, from here I guess that core NIM do you think it will be flattish from here is that kind of your…
That’s what we believe. We got the benefit of a rate increase in December to help us in the first quarter. What’s going to go against us in the first quarter is, we have got two less days in the first quarter, so that is not helpful, but we think we will be able to defend the margin within rate increase.
Okay. And on the North Carolina, kind of Virginia franchise growth, I know I think 2Q growth was like $190 million in the last two quarters have been in the low to mid 60s, what’s the main driver at change there, is that just more rapid CRE payoffs, is that some sort of just mind shift change or pricing changes relative to what BNC used to do or - and I guess more importantly is that 190 million range something we can expect you to get back to at any point soon or is that kind of the longer term goal once the C&I folks come online.
Yes, I think - so you’re right, I think the production and the net production in the latter half of 2017 was less than a production in the first half 2017, but Steve I guess I would may be try to help you think about what’s going on in that footprint, we have changed all the size, we have shut down 8 to 10 houses, we rolled out new computer software for every person in that system refreshed all their - not computer software, but the computer itself, the PCs. We have reached [ph] in the phone system.
We’ve retrained every person in that footprint with a significant amount of training on the upgrade because even though they were on the Jack Henry SilverLake, they weren't on the current version and the new version required procedural modifications and so forth, and so it is just an extraordinary amount of change that requires an internal focus, which I think would be the principal driver. It is a fact that the pay downs have been higher than usual as we just don't see or read as well, but our expectations for the growth in 2018 is significantly higher than their growth in 2017, and again the budgets have been built that reflect that and so forth.
Okay. That’s really helpful thanks Terry. And then maybe one just last housekeeping item following up on David's question on that. Other expense line item, was there anything unusual that cost that jump? I know you said, kind of flattish expense run rate as a whole for 1Q 2018, but just curious about that specific jump and what kind of drove that 4 million [indiscernible]?
Yes, what drove is for FDIC and franchise tax expenses and so those numbers stabilize going into the first quarter of next year. So, we have a little extra money accrued to those at the end of December.
Okay, so that kind of 16 million is probably the right run rate moving forward?
Yes. Think so.
Okay. Thanks guys appreciate it and congrats on a great year.
Thank you.
Our next question comes from the line of Jared Shaw with Wells Fargo Securities. Your line is now open.
Hi good morning.
Hi good morning.
If you could circle back on the expenses on the compensation cost, you were saying that the benefit from some of the headcount reduction in fourth quarter will probably be offset by some of the seasonality of going into first quarter, shall we see that shall we see that then come down with those 40-additional people come offline when we lose some of that accelerated FICA cost? Should you see second quarter salaries and benefits decline for the third quarter?
Yes Jared, I think you will see some of that as we look at our plan for 2018, our expense line, we don't think is going to deviate very much quarter-to-quarter. So, particularly with the hiring plan that we have given our line managers, I don't know if you would see a big win fall from the 40-people coming out.
Okay thanks. And then on the C&I side, I heard you when you were saying you haven't seen the demand coming out from the tax side, but do you think that tax uncertainty impacted sort of the trends in fourth quarter that we had that we saw on the C&I side in terms of the high levels of pay downs or people not making decision to do much or trying to come in early?
Jared that’s an interesting question, I guess specific answer to the question is, I don’t know. I guess this is a sort of personal opinion and kind of feel. I do believe that uncertainty has weighed on loan demand here in 2017. I think I have said this before and I know if it gets when, I guess Sandler's conference in November last year. I guess 2016 people wanted to know if loan demand had increased in the first week since Trump was elected and of course you know it doesn’t work like that. But I don’t think we ever saw a real increase in loan demand in sort of the first year, the new administration, I do think that was primarily a function of just an uncertainty around the tax law. But I guess to your question is, is that it account for any slowing in the fourth quarter. I don't know.
I wouldn't think it would be different in the fourth quarter versus quarter 3, 2, or 1 as it relates to just the uncertainty itself. Jared, I'll say this, I don't really want to spend a lot of time on politics other than say the demand and political discourse is difficult and choppy and changes every day. And you can see the move, the sentiment changing. And so, I think that, well I believe you will see increased loan demand as a result of the tax law. I did think there is just such volatility and headline risk that it's hard for people to really get comfortable and say, okay, I think things are solid, let’s go. So that is a long way to say, I think loan demand will pick up as a result of certainly around the tax law change, but I do think that may be muted a little bit just difficult international situation and the political discourse domestically.
Okay, thank you. And then how does the pipeline, how does the C&I pipeline look now as we are going into the first quarter?
Our pipelines are good. You know, we use a methodology here where generally people are forecasted in the quarter at a time, and so the general focus is on what you - what are the high gaining items that are supposed to occur in a 90-day period, and so you rebuild that forecast at the beginning of each quarter. So, there is still some work going on there, but I would say that our pipelines would feel solid as we go into the first quarter and we expect that good loan demand in the first quarter.
Okay and then just finally from me on the securities restructuring, we have got - mostly on the meaning side, mostly on the mortgage side and I have been hearing you're saying that you changed duration, but did you change product type at all? And then with the stuff that is so well to do where do you expect to see that going up?
Yes, I think what you'll see is probably less of our bond book in mortgage backs. We will probably see a little increase in the municipals and more into some floating rate security. So, other than that it is not going to be a big change Jared.
Okay. Thank you.
Our next question comes from the line of Will Curtiss with Piper Jaffray. Your line is now open.
Good morning guys.
Hi Will.
Harold, can we just go back real quick, in terms of the core NIM thoughts, I think you said, the 333 you expect to hold that flat in the first quarter and then if I heard correctly, the securities purchase will add another 4 basis points to 5 basis points throughout the course of the year, is that correct?
Yes, I think that is true Will. We think this core NIM is going to be fairly flat. We think the GAAP NIM is probably going to be fairly flat. So, over time we think the bond book restructure, we think maybe some increased yields from our loan book will be helpful, but the critical think that we have got to keep an eye on are these funding costs, and so that will be what we monitor all year long.
Okay. And then maybe another clarification question here, in terms of the expenses it sounds like the 104-core rate that you guys had, the core number you had this quarter that seems to be a pretty good number, I guess for the near-term, you know in terms of expenses and increment 104 should it hold pretty steady with the caveat that that increases with as you bring in additional talent or how should we think about that 104 number going forward?
That 104 is probably a good run rate for us based on what we have in our plan, which includes additional hires. If we are able to exceed our revenue goals that number is going to go with increased incentive cost.
Okay.
So, 104 seems to be a pretty good number.
Got it. All right and then, this is the last one from me and in the slides tax rate, I think you had 22% in your pro forma exercise their slide 13, is that what you are assuming would guide us to use for the tax rate going forward 22%?
Yes, we think 21% to 22% will be a good number for us in 2018 all things in.
Got it. Okay. Thank you very much.
Our next question comes from the line of Tyler Stafford with Stephens. Your line is now open.
Hi, good morning everyone.
Hi Tyler.
Hi, I wanted to just follow up one more time on the core margin outlook from here, does that - I guess the commentary for holding both the core and GAAP margin relatively flat, does that assume any further interest rate increases this year?
Yes, we’ve got three increases in our plan, one early part of the year, one mid-year and one at the end of the year.
So, three translates into flattish margins. Okay got it. I think you guys don't have the disclosure in the queue just in terms of your asset sensitivity from here with the combined to franchises, can you just help us, you know how much of the loan portfolio repriced with December and how much actual benefit are you getting from each incremental rate hike?
It is about [indiscernible] so outlook or reprice. So, and I think we put in the Q that we will modestly assess at the end of September.
Okay, got it. And then just maybe lastly from me just housekeeping I just want to make sure I understood on the BHG expectations for the year, the net contribution to Pinnacle would be that 12% to 15% year-over-year growth rate?
Yes, we think so. We were about 38 million for the year, so we’re targeted to about 12% to 15%.
Okay. Got it. The rest of my questions have been answered, thanks so much.
Thank you.
Our next question comes from the line of Catherine Mealor with KBW. Your line is now open.
Thanks, good morning.
Good morning.
Most of my questions have been asked and answered, but wanted to follow-up just on the commercial real estate conversation, so is there, I guess how do you think this could - could managing to this 300% level impacted growth in any ways you know maybe in the latter half of the year, and if not is something that you may consider as a way to stay under the 300% level is growth really to take off as it seems like it will?
Yes, let me talk about the volume side of that first and then let Harold comment on sub-debt component of the question there. I think on the CRE side [indiscernible] you know what are these growth for the company ought to be that’s a pretty dramatic growth rate you know generally what we do for a dividend buyout, which is modest. So, you can see the growth in the tangible capital of the company, which again will try to light into the risk-based capital there, and so if you are in 2017 as an example, we grow the tangible book value 18%, you know maybe you do 15% is something like that, but the point is, as you are growing your capital base, you can generally run the CRE growth rate at a similar percentage and so I don't view it to be a meaningful constraint, I’m not saying we don't have to pay attention toward any of that count, but I would not view it to be a meaningful constraint on loan volume, but Harold you want to comment on the [indiscernible].
Yes, Catherine we have - we get a lot of inbound calls from your colleagues on the other side of the wall about the sub-debt market that was wide open and pricing is very good right now on all that staff, but I guess where we are is, we'd rather not - we want to see if we can press the needle as Terry is talking about right now and just seeing if we can kind of maintain our own growth curve as it currently exists with the subject we have on the books. We think we will generate a lot of capital this year to help support that commercial real estate book.
Yes, it makes sense. And then to your point, if C&I growth really starts to take off as it seems like it will particularly with all the hires you’ve had and you’re generating capital as quickly as you are then I mean you're not going to be growing that ratio probably very much from here, so yes, I appreciate that comment thank you so much. And finally, last just [indiscernible] question, was there anything in the investment security the investment services line that’s kind of temporary this quarter that was a little bit higher than we had modelled, or is that a good run rate to grow from next year?
Well there is a couple of things going on in that number in the fourth quarter. One is, that there is a kind of an annual number in there. I don't think it was so a large number, I want to say it was $400,000 or something like that that we get annually, but I think that program has suspended so it is not going to repeat, but I think the larger number or the more important thing are the hires that we got out of SunTrust in October. Those people have hit the ground running and they are here in Nashville and so that number is being impacted by that group that is building the book of a pretty sizable amount during the fourth quarter and will continue to build it for next year.
All right great. All right thank you so much.
Thanks Catherine.
Our next question comes from the line of Jennifer Demba with SunTrust. Your line is now open.
Thank you, good morning.
Hi Jennifer.
Hi. My question is on deposit. You said about 75% of your interest-bearing deposits are negotiated rates, can you just talk about specifically give us some color on what you did during the quarter in terms of rate adjustments and secondly can you talk about the incentives for core deposit growth all the way up the line to the C-suite?
Okay on the first question on funds, on funding cost, we did adjust sheet rates in November. I believe at the end of October, I think we raised sheet rates 15 basis points, 20 basis points during that time and Jennifer what was the second question?
Can you talk about the incentive system for growing core deposits from the line all the way up to the C-suite?
I mean we don’t have any kind of one off programs to provide people additional incentive for just core deposits. Our incentive system is based totally on what core earnings are and what revenues are. So, that is how we measure.
Hi Jennifer, I might just add a little color to Harold comments. Just as a reminder, 100% of the associates in this firm participate in annual cash incentives, excluding commission based people, so everybody is participating in annual cash incentives, but we all make our number the same way from the bottom of the organization to the C-suite, everybody is eyeing that three things, we have got to clear nonperforming assets threshold, we have got to grow our earnings and we have to grow our revenues. They will grow the top line, grow the bottom line and maintain strong asset quality. And if we do that all our associates participate in the annual cash payout to target, if we overachieve they get more, but if we underachieve they get less.
And I would just say that we did that and a lot of companies run the score cards that I think it produced outcomes like what we saw at Wells Fargo and I would say they are not the disparity I’m just saying it is drives people to worry about this product this cross-sell, this sort of thing. We have decided not to do that, we try to aim at our company in producing top line growth and bottom-line growth, but within that context you can be sure and I think we have demonstrated track record of mobilizing our associates to gathering deposit because we are able to make this point a, here is how the earnings plan works. You know, the number one revenue item we have is loan growth. To get that loan growth done we have got to produce this amount of core deposit growth. You know we give them the funding percentage that we'll accept for noncore. You got to produce this in core deposit and people will go out and build initiatives together core deposit. So, there are plenty of incentives in the system, but it is not tied specifically to that number.
Okay. Thank you. My last question is on NIM, I know we beat this subject to death, but Harold just a clarification, so if the GAAP margin is going to be essentially flat doesn't that mean there needs to be some expansion in the core margin to offset the lower accretion?
Yes, you’re right on that, but I don't think you don't see meaningful movement throughout the course of this year either way on that. We just are planning to depend this core margin for the rest of this year.
Okay, terrific. Thanks a lot.
All right.
[Operator Instructions] Our next question comes from the line of Brian Martin with FIG Partners. Your line is now open.
Hi guys.
Hi Brian.
Harold just going back to the [indiscernible] you talked about the sheet rates being up 10, 15 basis points in November, the other was 75% I guess what was going on with those [indiscernible] suggesting maybe you won’t see as much pressure in the next quarter, I guess is that what you are thinking about?
Yes Brian, the 75% is all one-off negotiations with individual depositors and so our financial - our relationship managers, financial advisors have a great deal of attitude with respect to how they manage their individual clients. So, over the course of the quarter each month during the month, we are watching what those deposit costs are, how they are moving. Obviously, the larger depositors are the ones we hear about more often and so we get that information anecdotally.
Okay. All right. Just going back to easy question on the margin just you talked about being kind of flat, is that flat in the full-year 2017 level or is the fourth quarter kind of - in the fourth quarter GAAP number?
Yes, we are looking at our GAAP margins for our plan are to be fairly flat for the rest of the year. We’re not seeing a whole lot of dilution of our GAAP margins.
Right. And that is the GAAP margin at fourth quarter or for the full year 2017?
For the fourth quarter.
For the fourth quarter. Got you. Okay, and then just a couple of other housekeeping in terms of, you talked about the losses on the capital market, how much of an impact was that, is that meaningful in the number is it - so that we have that?
I think it was about - run rate difference was about $700,000, I believe.
Okay. They should go back in. And then just on, you talked about the mortgage revenue fourth quarter being weak based on kind of the outlook, when you look at it - similarly like BHG when you look at the year-over-year growth in mortgage, kind of your expectations, I mean is there a similar range as the BHG when you look at full year mortgage for 2017 versus 2018?
Yes, we will count on mortgage to continue to hit their strive for 2018. We think we operate in great markets and there is no reason to expect that we will see any kind of decrease in the mortgage in our mortgage plan.
Okay. But I mean something in the range of what you are expecting on BHG, I mean if it is over 10% of growth than mortgage is a reasonable expectation today?
Yes. I would say 12% is a good number for them. I don't know exactly what I have in their plan for next year, but it all will be somewhere in the 70 [ph].
Okay, got you. And then I think Terry talked about this but just those target ranges Terry, you guys kind of going back to revisit those at least on the ROA numbers, tax rate change, but just over the next couple of quarters it sounds like the ranges where raising, especially with the - I guess with the fees being a little bit light, but the others being a little bit strong, that trend kind of plays out the next couple of quarters, but maybe begins to kind of normalize at your targeted range out in maybe six quarters out or four quarters to six quarters out, is that how to think about a three-year kind of stay above the range one being below and [indiscernible]?
Yes, I think that is the right. So, Brian let me just back up and say generally we like those targets out, they - if you sort of hit the mid-point of each of the third component ranges, you would hit the mid-point of ROA range. We believe we are going to operate relatively high and it takes the tax law of the table for a minute, we believe that we are going to operate relatively high in the ROA range and the way we will do that is we will be short of the fee range as we build out the fee businesses in North Carolina, but we will either be north of the range or high in the range above the mid-point on those other three measures.
Okay. I got you. That’s helpful and then the tax benefit will be a positive to the ROA, I guess as you kind of go back [indiscernible]?
Yes, it ought to be meaningful impact.
Okay all right. And just a last thing from me, maybe I missed it when you guys mentioned it but the, you talked about the 64 people Terry you kind of monitor that going forward, how many, maybe I missed it, but of the 64 how many are in board already or currently?
Seven. Well seven through 1231, I think we've actually hired a couple since year-end as well, but probably the way to keep track of it is just think about three quarter ends seven, I guess in the first five months.
Seven in the first five months. All right that's all I had guys. I appreciate it. Thanks.
Thank you, Brian.
Our next question comes from the line of Nancy Bush with NAB Research. Your line is now open.
Just a broad question about the rural versus the urban markets, Harold do you have sort of a rough estimate of the difference in deposit funding cost between those two markets or types of markets?
I really don't. I don't know what we have as far as funding cost as some of our smaller markets.
Okay. And have you - Terry this is probably a question for you, do you expect that you are going to be able to make sort of a significant difference in the trajectory of growth between, you know the rural markets and the urban markets because one of the questions when you what BNC was look at all the rural markets therein, are they going to dampen their growth et cetera et cetera.
Nancy, I guess I would say two or three things. Maybe first let’s try to create I guess a common language here on rural versus urban, I believe that our company is primarily in urban markets, and when I say primarily I don't mean like north of 50%, I mean like 98%, you know, and so if you- SNL has a tool that you’re probably familiar with, we are now scoring that out. We will be extraordinarily high in urban and in fact I don’t know, but wanted two franchises in the country that might be more urban than we. So, I guess I would start there.
And then underneath that as you know, we in conjunction with the BNC transaction and I guess there were either 9 or 10 offices that were closed. Again those weren't exclusively rural markets by definition, but they were underperforming markets, some of which would might fit that description and so again that will be an influence on growth rates as well, but on the, in your comment about transition in the rural footprint, we don’t have an initiative to focus on candidly, you know how we take this, whatever it is, 1% or 2% of rural franchise and develop initiatives to optimize that to be honest with you, we’re looking to Rick Callicutt and his team and I have a high degree of confidence that when he overlays the staffing methodology that we use the larger legal limits that we have and bolting on the C&I business that it will transform the growth rate on both sides of the balance sheet in that footprint. So…
Okay, and I just have another question on mortgage banking, I mean it looks like or it sounds like you guys are really projecting sort of a step-up in growth there. I mean are you hiring producers on that side or is this product that you are going to be taking to the BNC market or if you could just give us a little color on your expectations because as rates rise theoretically, mortgage production should be going down, but obviously you’re not expecting that and are you moving market share in some significant markets?
Yes, I think Nancy, I will think about it this way. As I have been saying there are two components or two main thrusts that lead us to believe we'll increase mortgage. I think if you were to talk to Rick Callicutt or any of his market leads and so forth, they would describe the mortgage business that they ran as a siloed business. In other words, it was run as if it were almost a standalone mortgage company. So, they hired originators. And the vast majority of the production in that company came directly from those mortgage originators in their personal contacts.
Our model is different than that substantially. If you look in the legacy Pinnacle footprint, the mortgage originators here and as a rule we will generally get at least half their production from referral from bankers. In other words, the bankers control these clients and therefore we will have opportunities to look at mortgage request or able to hand those to our mortgage origination staff. And so that swing is a big swing in the case of BNC to harvest because they have, as you know a great client set that has been virtually and test.
Speaking of the banking clients as supposed to the mortgage clients. So, the banking clients have been virtually untapped in terms of the mortgage capabilities there, and so we view that to be substantially and the second major thrust is we are hiring mortgage originators. And so, to your question about market share that is generally I believe market share is, we hire additional people who have books of business or client contacts from a separate source and so it is a market share move play.
Okay. I think I'll just ask one final question, do you expect that, I know you have said, okay we are not thinking about deals, we are not et cetera, but you got to think about into the future I mean how scalable do you see your platform right now, I mean is there is some tens of billions that you can give us in terms of it is scalable of the here and then we have to add, I mean can you just give us some thoughts about your sort of technological ability to expand?
Nancy if I can be honest, I don’t know the answer to that question. I know that it is substantially larger than where we are now. But yes, I'd be hesitant just to throw a number out there without having a little more structured analysis behind. So, I am not sure I am really prepared to give you an answer to that question. I might go at it this way, I think you know, we have said with no acquisition we believe we will grow to be a $28 billion asset company.
So, without any of that organic growth and so forth. So, we are we are confident that what we are doing it is easily inside that. My guess is that you could probably do another $20 billion in assets with the basic operating platform that we have, but I’m just giving you a guess, Nancy. I'd want to qualify it as that. I don't have a structured analysis behind that, but obviously we will be working on that as far as strategic planning process.
Okay great. I appreciate the effort.
Thank you.
I’m not showing any further questions in queue at this time. Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect at this time. Everybody have a great day.