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 2018 Earnings Conference Call. Hosting the call today from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer; and Mr. Harold Carpenter, Chief Financial Officer.
Please note, Pinnacle's earnings release and this morning's presentation are available on the Investor Relations page of their website at www.pnfp.com. Today's call is being recorded and will be available for replay on Pinnacle's website for the next 90 days. [Operator Instructions]
Before we begin, Pinnacle does not provide earnings guidance or forecast. During this presentation, we may make comments which may constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties and other facts that may cause the actual results, performance or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond Pinnacle Financial's ability to control or predict, and listeners are cautioned not to put undue reliance on such forward-looking statements.
A more detailed description of these and other risks is contained in Pinnacle Financial's most recent annual report on Form 10-K. Pinnacle Financial disclaims any obligation to update or revise any forward-looking statements contained in this presentation, whether as a result of new information, future events or otherwise.
In addition, these remarks may include certain non-GAAP financial measures, as defined by SEC Regulation G. A presentation of the most directly comparable GAAP financial measures and a reconciliation of the non-GAAP measures to comparable GAAP measures will be available on Pinnacle Financial's website at www.pnfp.com.
With that, I'm now going to turn the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.
Thank you, operator. Good morning. As we always do, I’ll begin with this dashboard. It’s particularly focused on revenue growth, earnings growth, and asset quality, because we have believed and we continue to believe that short-term themes like M&A or deposit betas and so forth will come and go, but over time, the three most highly correlated metrics for long term shareholder return are revenue growth, earnings growth, and asset quality.
So, looking at these metrics, all presented on a GAAP basis. It seems to me we continue to be a reliable grower. Revenue growth, which is the primary emphasis of this firm as opposed to expense containment, it continues at a reliable and rapid pace. I don’t want anyone to interpret my comments that we’re cavalier about expenses, we’re not. In fact, our expense to asset ratio was very low by industry standards. I simply mean that we don’t reject outside expense growth so long as we grow revenue still faster. Harold will develop that idea a little further when he reviews the quarter in greater detail.
The revenue growth is primarily attributable to the fact that we continue to grow loans and deposits at a rapid and reliable basis. And asset quality continues to bounce along the bottom in terms of the level of problem loans or level of net charge-offs. And consequently, we continue to grow the fully diluted EPS at a rapid and reliable pace, which in turn grows the tangible book value and elevates ROTCE, now north of 18%.
Because of all the noise that is associated with BNC merger and the restructuring in conjunction with the tax law change at the end of 2017, in some cases, non-GAAP measures may better illustrate the relative performance of the firm. So, on this chart, I’d like to focus first on revenue on the top left, since this is so critical in terms of the operating philosophy of this firm, I love the slope and reliability of this metric. Total revenues, adjusted for gains and losses on transactions in the investment portfolio, were up 13.8% over the fourth quarter of 2017. The much debated net interest income was up nearly 9% year-over-year and the fee income was up 34% year-over-year.
Next, I want to focus on EPS, net of merger-related expenses, at $1.25 for the quarter, which is in the chart on the top row in the middle. Of course, 4Q18 had no merger charges. So when adjusting for the merger-related charges in the previous periods, fully diluted EPS was up roughly 29% over the same quarter of last year. And then immediately to the right, on the first row is the tangible book value per share chart which paints a nice picture of our ability to accrete capital and grow tangible book value on a rapid and reliable basis with a roughly 5-year CAGR of 14.4%.
Harold pointed out in our earnings release this quarter that since the BNC transaction in 2Q17, our tangible book value per share has increased by more than 20%, even as we're absorbing nearly 40 million in merger related charges, 10.5 million in restructuring charges in the bond book, and roughly 32 million in after tax losses associated with revaluing our deferred tax assets in conjunction with the federal tax cut in the fourth quarter of last year. I think that’s a really strong indicator of the success of that transaction as well as just generally how we manage the firm.
Immediately below the tangible book value chart, I want to highlight ROTCE at 18.46% this quarter. As you review the trend line post recession, you can see that it progressed nicely until the first and second quarter of 2017, which is when we did the large capital raise in advance of and in order to make the BNC acquisition. As a reminder, the BNC deal closed at the end of the second quarter of ’17, so you can see a very nice lift in ROTCE following the deal closing, again another strong indicator of the power of that acquisition.
And lastly, I want to highlight the core deposit growth in the middle chart on the second row. Core deposits grew at an annualized rate of growth of over 10% in the fourth quarter, exceeding the annualized rate of growth for loans during the quarter. Again, there’s been so much discussion about whether or not we can attract core funding at a sufficient level to fund our rapid loan growth, and hopefully we’re demonstrating that we can.
So fourth quarter was a great quarter with core deposit growth over 10% annualized, linked quarter revenue growth of 14.6%, due in part to an expanding core margin, EPS growth of roughly 29% year-over-year, and adjusted ROAA of 1.56% and adjusted ROTCE of 18.46%, all in all a great fourth quarter and a great year for us.
Now here is what we want to get done today, and Harold will review 4Q18 financial performance in greater detail, and then I’ll try to come back and put our 2018 performance in context and comment on our outlook for 2019. So Harold, let me turn it over to you to review the quarter.
Thanks, Terry. Revenues, excluding gains and losses on sale of securities for the quarter were up 8.9 million from the previous quarter at almost 250 million, an increase of approximately 14.6, linked-quarter annualized. Net interest income is up almost 800,000 from the third quarter of 2018. The fair value accretion negatively impacted the quarter’s results, as it decreased 3.9 million during the quarter to 13.2 million. We anticipate decreases in discount accretion in future quarters, as the level of acquired loans and recent mergers becomes less impactful and post-merger prepayment slows. We’re now forecasting around $38 million of discount accretion for 2019, more on that in a second.
The dark green line on the chart denotes our non-GAAP revenue per share. We reported $2.83 adjusted revenue per share in the fourth quarter of 2017 and reporting $3.22 this quarter, nearly 14% growth. Obviously, that's the goal to keep the revenue train moving north, we will continue to keep an eye on our profitability metrics, but as it stands today, we can afford to invest in our platform with robust hiring activity aimed primarily at C&I and private bankers. As we noted last quarter, our targets are all designed to increase our earnings per share on a reliable and sustainable way and build tangible book value per share through the cycle.
This slide focuses on revenue per share growth, even on trailing 12 month, as the basis for the amounts, we continue to experience double digit revenue per share growth. Now, this is during a time of significant internal focus around integration of the Bank of North Carolina. Let me assure you, there is a great deal of energy in our franchise right now. We’re definitely on offense in Tennessee, the Carolinas and Virginia. Our associates are engaged, focused and excited about our opportunities in 2019.
Secondly, the dotted line represents the peer group’s year-over-year growth, which is cumulative last 12 months revenue of our peer group divided by aggregate number of shares. As shown in the chart, we've continued to and consistently outpace the peers and revenue per share growth through those time periods. Concerning loans, as the chart indicates, average loans for the fourth quarter were 17.6 billion compared to 17.3 billion at the end of the third quarter, plus average loans increased by almost 371 million, resulting in an annualized growth rate of nearly 9%. This is on the heels of strong growth in the first, second quarters of 2018.
Comparing 4Q18 average loans to 4Q17 average loans, our annualized growth is better than 13%. We continue to believe that our loan growth for 2019 will be low to middle double digit loan grow, with growth being more spread out in comparison to 2018, which had significant growth in the first half of the year. In the Carolinas and Virginia, their organic loan growth in 2018 over 2017 was more than 11%. Importantly, C&I and owner-occupied commercial real estate is up roughly 27% year-over-year. We’re seeing solid growth in C&I in all of our markets in the Carolinas and Virginia. Right now, they’ve growth their C&I and CRE owner-occupied book to greater than 20% of total loans. Creating a robust franchise is obviously key to our growth bills, as with the C&I platform comes core deposit and related fee growth.
Payoffs and paydowns were again heavier in 4Q over the previous quarters, primarily in construction and non-owner-occupied commercial real estate. Our internal records would indicate payoffs and paydowns in these segments ramp from 460 in the first quarter to 580 in the second quarter, 765 in the third quarter and finally, 950 million in the fourth quarter. This will obviously be a headwind as we move forward into 2019. Our commercial real estate lenders are optimistic that as we approach the middle part of 2019, balances should begin to increase, given our new projects that should begin to fund. As the chart indicates and as expected, our loan yields increased to 5.22% from 5.15% last quarter, a 7 basis point increase linked quarter or a forecast to increases in fed funds rates this year.
The blue bar on the slide details annualized quarterly loan growth rates and I’ve adjusted to remove acquired loans in comparison to peer medians. As shown, our loan growth continues to outperform our peer group quarter over quarter, without sacrificing credit quality or accepting undue concentration risk. Coupling our hiring strategies with the quality of our markets gives us much optimism and we should be able to outpace peers for the foreseeable future.
In the chart on the right, we’ve detailed the impact of discount accretion on net interest income. As you can see, discount accretion continues to be less impactful to our results at 7.4% of our net interest income in the fourth quarter and continue to be so in the future. There's a lot of information here. We've discussed in recent quarters that we're targeting an allocation of 35% of our loan book to fixed rate loans with maturities greater than one year. That level would be consistent with our allocation prior to the Bank of North Carolina merger and we believe matches well against our funding profile.
While we're making progress towards this goal, we've also executed $900 million in forward interest rate swaps to help expedite this reallocation. This strategy will increase our floating rate allocation by a total of 5% over the term of the swaps, which approximates 2.5 years. The first $300 million tranche of these swaps started in the fourth quarter with the remaining 600 million set to begin evenly over the first and second quarters of 2019. As of today, the average fixed rate on these swaps is only 14 basis points higher than the received variable component.
We've also disclosed rate index trends on this slide for the entire portfolio and also about loan type. As you can see, our LIBOR and primary indexed portfolios captured 97% and 95% respectively in the 2018 Fed Funds rate hikes. That success has served our margin well, as we look -- as we booked approximately two-thirds of our loans this year in those categories. The exceptional growth we're experiencing now in the C&I portfolio serves as our primary catalyst in booking credits to these indexes, because as you can see that portfolio has over 65% allocation to variable and floating rates.
You can also see that our construction portfolio is also about three-fourths allocated to variable and floating rate structures, while our CRE portfolio carries a heavier slant towards fixed rate terms. Keep in mind though that 40% of the fixed rate exposed in the CRE book is allocated to owner occupied commercial real estate. These loans generate a tremendous number of transaction and deposit counts, many of which are non-interest bearing, and as we get a full relationship with these business owners, so while there is largely a fixed rate slant in the owner occupied product, the interest rate risk is offset by obtaining the full banking relationship.
Average deposit balances are up 255 million, while EOP balances were up 432. In the period, core deposits increased 412 during the quarter. Our deposit costs did increase 11 basis points in the fourth quarter from the third and currently stand at 108. We compute a beta of 39% on deposit costs, given those figures since the most recent rate cycle began in the fourth quarter of 2015. As to the future, deposit costs will continue to increase for several factors, the two most prominent are general pressure from increased deposit rates in a rising rate environment, but also we will need to fund the loan pipeline.
Our relationship managers are out in the market, selling our ability to serve commercial and affluent consumer deposits with a value equation we think is far superior to our competitors. We still believe we’re in markets that have ample liquidity to match our loan growth expectations. As noted, core deposits are up 14.6 while loans are up 13.3%. You can also see the core deposit growth in Tennessee and the Carolinas at 15.7% and 16.3% respectively.
We are driving our sales force efforts towards these depositors. We will play the customer game, we still believe we’ve got adequate room in our plans to fund our loan growth with a fair rate on deposits, deposit betas are important. We do pay attention, but we also believe clients need to be acquired and for 2018, it was a pretty good year for Pinnacle.
Again, a big quarter for deposit growth in the fourth quarter with core deposit growth up more than 412 and more than 9.5% annualized. Over the last four quarters, core deposit growth has funded 80% of our loan growth. In comparison with peers, we continue to have success with core deposit growth. Also in the chart is the loan to deposit ratio for us compared to our peers. As you might expect, our line balances around, but the peer line will nudge up closer to that after fourth quarter results.
This is a new chart and as many know, late last year, we anticipated bridging 100, 300 ratios and strengthening our intention to bring those back in line in short order. We’ve worked diligently to reduce our CRE and construction balances in relation to this total risk based capital and have also experienced like many bankers additional paydowns and payoffs to assist in all of this. These charts are intended to give you some additional insight into the granularity of our real estate portfolio as well as the metrics we seek out on our projects. I have to commend our lenders and credit administrators as it takes a lot more effort to work many smaller projects than a wiggle project, but that’s our bread and butter and we may as keep trying and not be lured into the business of lending.
Concerning the left chart, we aggregated [indiscernible]. The results of this effort are shown in the table. As you can see that while we have some larger, greater than $20 million credits, we also had a significantly larger number of projects that are below 10 million. The chart on the right shows the top 10 projects within each segment for both construction and commercial real estate investment properties. We’ve also included the loan to value, loan to cost and debt service coverage ratios on these projects so the top 10 projects in the 12 segments noted above account for 2.4 billion in balances, which is about a third of all the loans in these segments and will calculate an average balance of around $20 million per project.
Now, before I move to fees and expenses, just some additional words on credit. Obviously, market volatility over the last few months has been extraordinary with many stating the signs are emerging that the credit cycle is beginning to turn. We considered the soundness of our loan book to be relatively stable with prior quarters. Credit is always at the forefront of our minds, so I hope we never appear relaxed or frivolous when we talk about credit. As you know, there is a lot of gray hair, and in some cases, nowhere to run around this place and we’ve all experienced credit cycles and although experience is a great teacher, it can also be a pain.
For the fourth quarter, we saw improvement in classified asset ratios, a 1 tick increase in our net charge-offs and as previously mentioned, reductions in our 100, 300 exposures. We also experienced an increase in non-performing loans of about $10 million. This increase involves two credits. One is storaging the facility where we’re adequately collateralized, but have informed the borrower to find another banker. The other is a specialty pharmacy that [indiscernible] where we have a first mortgage owner occupied building that is appraised at 3x the loan balance.
With market volatility over the last few weeks, this management team feels very accountable to shareholders and I’d ask everyone to remember that this management team has been working this franchise for many years and like the old story of our breakfast and ham and eggs where the chicken is involved that the pig is committed, make no mistake, this management team is committed.
Now turning to fees, fees amounted to greater than 57 million, up 5.8 million over last quarter. BHG had a great year in 2018. Their contribution was up 3.7 million in the fourth quarter. We had anticipated the net growth in Bankers Healthcare Group in 2018 would be in the 12% to 15% range, it actually ended up in excess of 35% for the year. We don’t expect a repeat performance in 2019, so we're anticipating modest growth for BHG next year, call it 5% to 10%. A few people ask about credit performance at Bankers Healthcare Group. Widely credited, BHG has been the best it's been in many years. Substitution losses were flat in 2018 compared to 2017 with a significant increase in sold loans.
They’ve been in the business for 18 years and have never lost money in any year and they stick to medical professionals who are likely the most credit worthy borrowers in the credit stack and that has served them well. Wealth management revenues were up slightly in the fourth quarter compared to the third. We've had several significantly hires in both footprints that have contributed to our success in investment services, insurance and trust remain relatively stable, lending and related fee income was up slightly from last quarter.
As we all know, the rate environment has not been helpful to residential mortgage for the past several months, but our team continue to work to get their share of the deals. SBA and our back to back customer swap program had strong fourth quarters. The government shutdown is having an effect on our SBA program and even though this business line is really important to us, it is a fairly modest component of our total revenues. Other income was bolstered by increased BOLI revenues and valuation of certain other assets. Non-operating leverage, our adjusted efficiency ratio of 48%, which was slightly more than the 47.3 we reported in the third.
We expect our non-interest expense to be higher this quarter and we’re hopeful we can afford increased incentive accruals as we head into year-end. Salary expense was up 5.6, largely attributable to increased incentives this quarter of 3.6 and increased headcount. Since year end, we're up about 165 FTEs, as we continue to hire revenue producers and other critical support functions. We're also beginning to see positive trends in our retention ratios. This is critical to our service levels to our franchise and our relationship based banking model. Terry will discuss associate engagement and its importance to our growth in a minute.
In the fourth quarter, we increased our incentive accrual to 1% of target award. You know that our corporate incentive targets are set at levels we believe would equate to top quartile performance within our peer group. As many of you know, we get paid to hit numbers. If we don't hit our numbers, we don’t get our incentives. We've had years where we’ve paid more than target, we've had years where we paid nothing. The critical thing is that the associate base understands why we do it that way and the way we do it and the shareholders are informed. Keep in mind that Terry, myself and the entire leadership of this firm are on the same incentive plan with everyone else. Incentives are important and it’s one of the things that makes us unique and different from other peer banks. Like I said, there's much energy in this workforce and the associates of this firm appreciate the confidence the shareholders have placed in us.
Lastly, a brief report on the repurchase program. We announced a $100 million repurchase program on November the 13. We stated that we would engage that program over the -- over all of 2019. Thus far, we’ve acquired a little more than $405,000 shares, almost $21 million in cost which works out to be about $51 per share price. The impact to 2018 was minimal, but we believe the impact to 2019 will be more impactful.
With that, I'll turn it back over to Terry.
Okay. Thanks, Harold. Well, I did want Harold to get ahead with the M&A analogy, so I've got a quote from Ferdinand Foch, the Supreme Allied Commander at the conclusion of World War I. He once famously said, my center is giving way, my right is retreating, situation excellent and I’m attacking. For me, I think the 2018 battle felt something like that and our share price gave way and our PE and price to tangible book value retreated, but our position in the market was excellent and we executed our plan well all year long. I don't think it’s news to anybody on this call that 2018 was the vast major for small cap bank stocks, they were particularly difficult for PNFP.
You can see here on the left that despite the fact that our EPS outgrew the peers and the consensus is that we will continue to outgrow peers in 2019, our share price lasts more than peers and our price to tangible book value collapsed dramatically more than peers. But on the right, you can see that post recession, PNFP has generally traded well above peers until this year and now trades less than peers and that was a 33% growth in EPS for 2018, which some believe may provide a unique opportunity for investors. Generally, investors punished acquirers in 2018, many feared the integration risk for us, it was associated with our BNC merger. In fact, our deal rationale was that we would protect BNC’s high growth CRE business but that we have built out a high growth C&I business that would have the impact to turbocharge the total loan growth in the Carolinas and Virginia.
In order to do that, we plan to hire 65 C&I and private bankers in the Carolinas and Virginia over a 5 year period of time. That would suggest by year end 2018, we should have hired roughly 20. In fact, we've hired roughly 33, which puts us a full year ahead of schedule. And for those who get concerned about that expense burden, keep in mind 100% of that expense burden is already in our run rate, while a significant or a smaller portion of the expected revenue is in our current run rate. I think that bodes well for future revenue and earnings growth, as Harold just pointed out.
And the key measures of success for the integration from our perspective have all been met. We did not meaningfully deserve BNC’s very successful CRE business, producing 10.6% growth in CRE outstandings during the year in that footprint. And we did in fact transformed the growth model to more of a C&I growth engine, with 27% growth in C&I and owner occupied commercial real estate and we were able to grow core deposits at nearly 14%, again significantly transformed the growth model in that footprint. I can’t tell you how proud I am [indiscernible] and his market presence with their leadership and his transition.
CRE was another elevated concern, regarding the industry throughout 2018. Of course, as Harold has already mentioned, we tipped above the 103, 100% CRE guidelines in the first quarter, largely due to two factors. Number one, our margin with BNC and then number 2, the revaluation, the writedown of our deferred tax asset, in conjunction with the tax cut in the fourth quarter of last year. We indicated we intended to retrieve below those concentration guidelines in the second half of 2018, which we did on the construction threshold, we’re now at 85%, which approximates the pre-merger level and as Harold did add on the total CRE guideline, we’re now down to 278%, expect further movement closer to the 260% range, which we operated in pre-BNC.
I think beyond the general concentration thresholds, some were concerned about through all content in CRE loan books. You can see on the right, performance of our CRE book has been outstanding, meaningfully better than peers with our worst year at 20 basis points charge-offs and actually being net recovered three of the last four years. I believe the granularity of our CRE book, which Harold just talked about versus peers is one of the reasons we continue to expect outperformance of our CRE book. And as already been discussed, during this period, a reduce in the CRE concentration level, we were still able to grow total loans greater than 13% in 2018 and largely did that on strength of a 20% growth rate for C&I and owner occupied CRE.
Of course, most discussed a variable way on smid cap bank stocks all year with deposit betas. I think our view on that topic was that number one, we would be a deposit beta firm. But number 2 that we would produce above average growth in average net interest income. Because by taking share and growing volumes, we would be able to run fast enough to outrun the margin compression.
The chart on the left, lastly net interest income per share, for our peer group, against the delta owned deposit costs. The crosshairs are situated on the median performance and the chart on the right is the similar comparison plotting net interest income per share for our peers against the deposit cost betas. It seems to me that our thesis was right, it was indeed possible to produce outsized growth I net interest income, despite the increasing deposit costs in our higher deposit betas. In fact, the peer with the highest deposit beta produced the highest growth in net interest income per share and of course PNFP performed well better than the peer median under either analysis.
Expectations for smid cap bank stocks seem to diminish throughout 2018. Nevertheless, you can see on the left, we generally performed in line or better than our targets for ROAA and each of the four components that are generally required to produce that ROAA. Similarly, we outperformed the consensus estimate for 2018 that was established immediately following the year end 2017 results.
So one of the primary reason that I believe Pinnacle was able to continue its rapid growth despite so many negative factors, including low and slowing loan demand, is that according to Greenwich Associates, we truly have a differentiated brand. The chart on the left plots the five large competitors in the national market in terms of market share and client satisfaction among businesses with sale between 1 million and 500 million, essentially with the entire business market. As you can see, we’re dominating this market on both variables and interestingly, the 2018 trend ran for both of those variables remains positive. Honestly, you can see why I am so optimistic in terms of future growth and actually, when you look at where we are on this chart, and compare that to the vulnerability of all three of our next most important competitors, it just doesn't get much better than that.
The chart on the right provides still more insight into client perceptions of our firm on important variables like ease of doing business, likelihood to recommend our relationship managers, our branch officers and treasury management. Dark green indicates that we’re the market leader, light green would indicate that we're number two. As you can see, we’re overwhelmingly dominating this market and have positive trends on virtually every single measure. When you see things like 92% of our clients will recommend us and the next best competitor in the market only has 80% of their clients willing to recommend, you begin to see the power of a differentiated franchise. However, this provides a little more insight into not only how we have, but why we expect to continue to produce growth and take market share.
And then finally, many have been concerned about lower large numbers limiting our ability to continue to grow. Who knows, but most of you know, my belief is that it we continue to execute and engage our associates, they will continue to provide a differentiated experience for our clients. We will be able to capitalize on the vulnerability of those large banks that are competitors that we just discussed and we can translate that into a rapid and reliable earnings growth stream.
As you can see, our size and market expansion has not diminished our ability to execute and engage our clients. In 2018 alone, we were ranked number 22 in terms of the 100 best companies to work for, number 40 in terms of the best workplaces for parents, number 3 in terms of the best workplace and financial services and insurance, number 16 best workplace among banks in America, and number 12 best workplaces for women and number 20 best workplaces for millennials and then in addition to being an Hall of Fame in the national market, we've also been recognized as a best place to work in both Memphis and Knoxville.
On the right, using FDIC market share data, you can see that we did indeed translate that workforce engagement into share growth in virtually every market in which we operate. So we remain committed to long term shareholder value through growing the top line and bottom line. I would expect our emphasis in 2019 to be fundamentally the same as 2018. First of all, you might think about the comment that Harold made, we set our targets to be a top quartile performer in terms of EPS growth. We know what the peers are expected to produce and obviously set our targets to ensure that we will be a top quartile in the peer group in terms of the EPS growth.
Secondly, we are projecting that we will continue to grow low and mid double digit annualized rate for loans. As has been mentioned several times in the call, the mechanism for this is not just asking our FAs to produce more, but it is the emphasis on hiring great bankers in our market and asking them to move those books of business as a mechanism that lets us grow both quickly and with strong asset quality. And then like 2018, when the core deposit growth rate exceeded the double digit loan growth rate, we will continue to place very heavy emphasis on core deposits in terms of the managerial emphasis.
So when you think about long term shareholder value creation, I think Harold did a nice job to highlight that the focus here is that we hire these high profile revenue producers, that enables us to grow our revenues faster than our expenses and we focus keenly on translating that to tangible book value growth and so that will be what we will focus on again in 2019.
Operator, with that, I’ll stop and take questions.
[Operator Instructions] Our first question comes from Jared Shaw with Wells Fargo Securities.
Maybe if we could start with just a little discussion on the deposit side, it’s great to see that the beta slowed. Do you think that that's sustainable, and when you look at the – on slide 12, you have your rate chart with the rate sheet where the posted rates went down, negotiated rates went up, but beta slowed. Can you sort of talk to some of the dynamics there? What portion of those relationships are coming with negotiated rate versus the rate sheet? And do you think that we could see a continued slowdown or a sustained lower beta as we go into 2019?
Yeah. Jared, I think what we'll see -- I'll start with the larger question first. I think we will see slowing deposit cost increases. I think that’s because the rate environment is becoming less -- doesn't require those kind of significant increases. I think that’s because we’ve repriced a lot of our deposits to a much more competitive price previously, and I also believe we've got some higher priced wholesale money that we're going to see leave the bank here in the first quarter. So, we're cautiously optimistic that we will see continued growth in our core margin here in the first quarter and into the second quarter. Did I get to all that?
Yeah. I think that's good. And then sort of as a corollary to that, how is the progress going on, having the relationship managers go into the commercial customers and try to get a bigger market share of – or wallet share of deposits. You were talking about that at the Investor Day, is that showing good progress or do you think there's still room for that to accelerate as you go into 2019?
Yeah. Thanks for that, back in the summer, we asked our relationship managers to build lists of depositors that they were doing business with and find those deposits that were at other franchises, and we think that went well. It's like a lot of different tactics, you have to revisit it occasionally, you can't do it every week or every month. What you have to do is kind of pull that project to the front, let it work and then 3 or 4 months later, let it -- do it again. But I think we saw -- the last part of the year, we saw core deposit growth that was in line with some of the best quarters we’ve ever had.
And then just finally, you mentioned that you see – you expect to see some wholesale money leaving in the first quarter. How much – what’s the balance of that wholesale book that you think could leave?
It will be north of $300 million.
Our next question comes from Stephen Scouten with Sandler O'Neill.
A question for you, Terry, on the pace of new hires, obviously, it's been phenomenal and you guys are well ahead of schedule. Do you guys think about intentionally trying to slow that at all to kind of ladder in these new hires and their related production or do you kind of just let momentum run as long as you can bring new people in. How do you think about that and the pace of those hires?
Yeah. I think generally, we would continue to let the momentum run. Generally, as you have heard us talk about before, the process here is to target high-producing relationship managers. When you start looking at salary multiples on a high-producing relationship manager, you get numbers like 20 to 25 times salary. And so the question to me is, why would I ever want to slow down hiring revenue producers that can produce that sort of salary multiple, and again you’ve got to hire the support that goes with it and so forth to get to a bottom line number. But again, I think you get that idea here. If you can hire an high-producing relationship manager, I've never understood why you wouldn’t hire them. And so to that extent, we’ll continue to let the momentum run, and we will seize the opportunity as long as we can.
Stephen, I might just hit at this. We talk so much about being ahead on the hiring plan in the Carolinas and Virginia, but we’re still hiring at a dramatic pace in Tennessee as well, and again, it just goes back to that idea of we have a continuous recruitment cycle for our returning relationship managers.
And then as that pertains to loan growth, I mean, obviously, you're still guiding to the low to mid double digits. Is that -- to hit that range, do we need to see paydowns move back into that 400 million to 500 million a quarter that we saw in the first half of ’18, or is that loan growth in your minds really predicated on all these new hires, delivering even in spite of heavy paydowns, how can we think about the likelihood of delivering on that number I guess?
Yeah. We’ve sent out all the financial plans for 2019 to all the market managers, and so they’ve all signed up for what they have to do. And they're all creating lists of potential clients to go get that business from, but I think it's going to take a little bit of both. We will need some kind of slowdown in these projects that are getting paid off, and a lot of it has to do with the timing of when these projects were signed up initially, and they were likely a year or more ago. And so, we're hopeful that we'll see some retrenchment in these paydowns and payoffs as we go through 2019.
Stephen, I might add to Harold’s comments just to make a pretty interesting stake as it relates to CRE. As you know, when we projected that we would create the 100 or really the 300 guideline there on CRE, we did tap the brakes internally and then beyond that, we tapped the brakes in conjunction with some specific asset classes like hospitality and multifamily and so those phenomenon are now playing through what the net loan growth is, but I guess I want to reiterate having come back inside our guidelines, we have commitments that would indicate, we will outrun paydowns at a pretty meaningful pace for CRE, but it really turns into sort of a second, really third quarter item before that find its way, the fundings find their way on to our balance sheet.
Okay. That makes a lot of sense. And maybe one last quick one, Harold, you said you were modeling in two rate hikes for 2019. As you model that out, if say, we didn't get either of those rate hikes, do you know what the kind of basis point impact would be or even directional impact would be to your NIM, if we were to not get any rate hikes here in 2019?
Yeah. I think if we hit our growth goals this year, it could be impactful. I don’t know what that number might be if – we’re still growing the loan book and we have to go raise, if we have to replicate 2018 into 2019, and have to go find a bunch of deposits to fund the loan growth, then it will be more impactful. Here currently, it doesn’t appear that it’s going to be. It looks like our deposit models are working and that we'll be able to grow these deposits to fund this loan growth, but if we have to go out and secure deposits to fund this loan growth at these elevated rates, then I think we'll have some pressure on our long term sustainable business model on net interest margin.
Our next question comes from Brett Rabatin with Piper Jaffray.
Wanted to first ask just on BHG and the great year you had in ’18, can you maybe just give a little more color around the fourth quarter and then what your assumptions are for that 5% to 10% growth in ’19, what kind of market does that anticipate for those guys?
Yeah. I’ll try to answer that. They too have a lot of confidence in what their business model is producing right now. Al’s been very adamant with me that his revenue streams that he's producing this year are 2018 revenues that he's not pulling out loans that were booked in prior years and selling those or going into any kind of cookie jar. He's very excited about the advances they’ve made with respect to their marketing programs, with respect to their credit programs. He thinks those investments that they made over the last one, two, three years have produced the results we're seeing today. He feels like that next year, 2019, they will beat 2018. They're going to focus on management intention on new products, this patient lending product that we think will become more relevant towards the end of 2019 will be helpful.
As far as near term results and what we're looking at in the first and second quarters, I think we’ve been looking at probably a consistent kind of, maybe a little better in the first and second quarter than what they did in the first and second quarter of 2018 in relation to the total year, if that makes sense. That might be more the target for, but we're excited about this relationship and where it’s headed.
Okay. That’s great color there. And then just want to make sure I understood on the core deposit initiatives and I’m thinking about ’19, are you guys changing anything that you're doing in ’19 to continue to fund the loans with core deposits, are there new initiatives relative to ’18 that you're looking to roll out?
Brett, I think I’ll describe that this way. I think the initiatives that we outlined for 2018 have been fruitful and so we would expect a continuation of those same initiatives.
Okay. And then maybe just one last one if I could sneak in, any update on what you guys are thinking there. I know it's been kind of meaningful potential increase in the reserve?
Yeah. I don’t think – I think we’re still working through our models to put a little finer point on those. But I think we are on plan to begin booking that day one entry in the first quarter of next year.
Our next question comes from Jennifer Demba with SunTrust.
You mentioned earlier in the call that the credit performance continues to be stellar. Just curious as to what you're expecting in terms of charge-off levels in 2019 and where you see the most credit risk in terms of asset classes?
Yeah. I think from an absolute perspective, we’re not anticipating any kind of decrease in credit quality. Like everyone knows, credit quality over the last several years for the banking industry has been remarkable. And we're not seeing any kind of matter that would cause us to say, okay, we need to try to look at our budgets for 2019 and say, increase our charge-off forecast. So as far as asset classes, Terry, you got any color?
Our view is that when you sort of go through the various industry analyses and so forth, that you've got movement around the edges, but Jennifer, we've talked about some of these asset classes like multifamily in downtown Nashville, we’ve had a hard stop on that in the past. That’s an area where I would say, we have a caution flag now, which makes this better than we used to believe it was. And I think hospitality is an area that we would still look pretty hard at before we want to do another transaction there, but I think with those two modest exceptions there, but they don’t believe we feel good about risk in the loan book.
Our next question comes from William Curtiss with Hovde Group.
I wanted to make sure -- I want to make sure I heard some correctly. It sounds like you guys might be fairly active with buybacks this year and if so, can you kind of give us a sense of how you're thinking about it and or maybe just some updated thoughts on buybacks?
Yeah. Well, that one slide in there, I think 2019 will use all that money in buyback programs in all likelihood. I hope we don’t, but we're hoping to be able to take it all. The share price obviously will have impacts on our decisioning. But at the same time, we want to be able to have enough dry powder so that we can use it throughout the year.
And then wanted to go back -- you had mentioned I think the 38 million of accretion income that you expect for this year, any sense for where that may go in 2020, is it still too early to put something out there?
I think it’s early. For sure. It was a significant decrease between 2018 and 2019.2020 will not have that kind of decrease, but that component of our revenue stream will become less and less impactful overtime.
And then just the last one for me, on the other fees and I think you've called it out I think in your remarks and also in the release, but just curious if you can kind of help us size up the other fee income and maybe what the appropriate base would be going forward, so it sounds like there may have been some unusual items this quarter?
Yeah. I mean, the increases, the volatility I guess in that line item was primarily around valuation of some other assets and there was like a $600,000 increase. We had a similar increase in the second quarter and a decrease in the third quarter and then an increase again in the fourth quarter. So it pops around quite a bit. So call it maybe $300,000 of run rate impact.
Our next question comes from Tyler Stafford with Stephens.
Hey Harold, I want to start on just the expenses this quarter and around the incentive comp. So obviously you guys hit the numbers and not surprising that the incentive piece stepped up. I'm just curious if you could give any color for the magnitude that we should see that stepping down in the first quarter, as we just kind of reset the bar on the accruals on the incentive comp?
Yeah. I think while we’re up 3.5 million, 4 million bucks in incentive comps in the fourth quarter, that won’t get replicated, that will come down in the first quarter. There is a slide in the back that’s got cash and equity incentives. I think we’ve booked like $10 million in the first quarter of last year. It will be more than that, but it won’t be a lot more.
And then I just wanted to maybe clarify one of your answers to Stephen’s questions earlier, just about the core NIM and the impact from rate hikes, but maybe thinking about it just in terms of NIIs, so you guys have the slide 10, the graph just showing the core ex-accretion NII growth you’ve seen and obviously despite the softer loan growth this quarter, you still put up mid-teens, 15% plus core NII growth. If we are thinking about it just in terms of NII and we don't get to rate hikes, can you just size up the magnitude of core NII growth that you would expect to see in 2019?
Yeah. I mean that -- our budgets would say that we would have consistent growth in net interest income next year. If we don't get the rate hikes, I'm not really as concerned about that today as I would have been call it, 9 months ago. Because the rate hikes gave us some cover on rising deposit costs. I don't think -- if we don't get the right hikes, I don't think we have as bigger delta to overcome on deposit cost increases as we did in 2018. Because I think we’ve rebooked, we've already repriced a lot of our deposit book currently. And the wholesale market was what, really kind of got to us in the 2018. I mentioned a beta of 39%. If you parse that apart and say the wholesale beta was up around 70 or 80, the client beta was around 20 to 25. So I feel better about a no rate increase rate environment today than I did call it 6, 9 months ago.
And then just last one for me.
Sorry, let me just tack on to that one comment too. And a lot of it has to do with the way we’ve repositioned this balance sheet. I know intuitively you think, okay, they’re putting more floating rate assets on, so they want more rate increases to take advantage of that. But in reality, when these rate increases come and your growth base, you got to go find that funding, and typically, you'll have to rely more on the wholesale target and that’s a more expensive proposition.
Yeah. So maybe just simplistically, if your loan growth outlook is low to mid double digits, there is not going to be that much absent rates up or down pressure on the margin, should kind of core NII at least be kind of 10% type plus.
Yeah. I think that's a better way -- you said better not yet.
And then just lastly, going back to the dry powder comment around the buyback, for the year, how is M&A at this point kind of playing into your thinking from an executive level?
Tyler, I think we try to be candid about the markets we want to be in. We try to be candid about the kinds of targets that we would pursue in those markets, the kind of financial results we would expect those things to produce in order to be attractive. We've not really changed any of that guidance and so you can sort of do the math with the socket, these levels need multiples, I wouldn't expect a lot of M&A to take place. But you get the expansion in advantaged stock, again, we’ve pretty well spelled what play we would like to run.
And our next question comes from Michael Rose with Raymond James.
Just a couple of quick questions. Just wanted to talk about the expense growth, if you guys continue to hire at a pretty elevated rate, which it seems like that is in the cards. You guys have historically grown expenses at at least a double digit rate, it's obviously been stronger and executed by some of the deal metrics here recently, but should that be the expectation going forward if you continue to outpace on the hiring side? I guess it gets to my broader question, if reported NII is going to be under a bit of pressure from the client purchase accounting accretion and I don't know if the explicit expectations are for fee income, but do you think you could actually still generate positive operating leverage in 2019?
Yeah. That would be the plan, Michael. We still believe we’ve got enough energy to generate these loan growth goals that we have. And with that comes opportunity to hire people. Now, when you want to focus directly on the expense base, I think it is important to understand how flexible we can be with our incentive accruals and granted, you’ve taken sense away from associates that’s painful, but at the same time, that's the way our system works, so that if Terry goes out and hires a bunch of people, we don't get a pass on that from an incentive perspective from our board. So we've got to figure out way to cover those costs, even though we might ramp up hiring. I think also that operating leverage is critical to the shareholder base.
They tend to like to talk about operating leverage. We may miss on revenues from time to time, but you shall be good operator. So it’s a meaningful component of our internal discussions here as to how we can continue to improve our operating leverage.
And maybe just one final question for me, for Terry, can you just talk about those -- the general level of competition. It seems like it's got a lot of people that have gone after C&I, particularly in the Tennessee market, how does that translate into your ability to grow and I know a lot of your ability to grow is based on hiring lenders and then bringing over the books of business, but do you get to a point where you purposely begin to maybe slow down, because the loans that are out there just don't make sense from an incremental return on investment point of view?
Yeah. Michael, thank you for that question, because that’s a really important thing. When I told to institutional investors, I detect there is questions a lot of times about, how are you getting this growth, I mean, you guys look to spread asset quality, you must be stretching on pricing, you must be stretching on these things and I believe that a lot of large companies, if they are producing assets, loan growth, they probably are doing that, but here, the growth is primarily driven by hiring people and moving market share. And I think it's important to get who it is that we're hiring, we don’t hire people that are circulating resumes, we don’t hire inexperienced people.
We're looking for people at least 10 years of experience. The average experience of the people that we hire is 24 years. And so when we're hiring these people that have been managing the book of business for 2.5 decades at a large regional bank and when they bring that book to us, you get two things, you get rapid growth, which is what we're talking about, but you also get outstanding asset quality and that occurs for two reasons. Number one, because they know that book will. Their wealth for me was going on and while it might be new to our balance sheet, it is not new to the lender.
And then the second aspect of that is, to the extent they have any bad loans, they just leave them where they are. It’s kind of opposite of an adverse selection problem here. We get kind of a turbo charged asset quality when you do that. And so again I think you’re buoyant to grade when in this economic landscape, if I were out here trying to produce double digit loan growth just by asking my existing salesforce to run a step faster, that would be a bad idea in my judgment and I wouldn't be interested in trying to grow the portfolio in that way, we're only interested in producing this growth by a virtue of hiring experienced people and having them move well from loan books, from their bank to us.
And our next question comes from Brock Vandervliet with UBS.
Just going back to the Bankers Healthcare Group, I mean, the performance there's just been monstrous for 2018. The 2019 guide looks like a pretty hard step down. Is that partly conservatism or was there a meaningful pull forward in performance into ’18? How should we think about that?
Well, I think there is conservatism in the forecast. They outperformed their plan meaningfully for 2018 and I guess there is just some degree of hesitancy to say they're going to repeat that in 2019. They’ve not outperformed a plan like that in the previous two years that we've been associated with them. But in 2018, they did quite well. I think they’ll also be trying to figure out how they can bring on these new business lines and try to make those more meaningful to them.
But Harold, I might just add to your comment. I think if you were talking to the CEO of BHG, he – again, I’m not -- we're not the owner of that company, we don't control everything there. We are a partial owner of the company, but I think where you talking to the CEO of that company, he would be very optimistic about what his revenue growth capabilities are in 2019.
And one thing you haven't talked too much about is loan pricing, particularly on the commercial real estate components. Are you seeing any ability to widen spreads there?
Yes. I think spreads have been fairly consistent. The chart kind of puts a five year treasury there to kind of gauge it throughout the year. I think what is important to me is that the absolute rate that we will get on fixed rate commercial lending, commercial real estate lending has increased this year and it's caused for the whole book, the average for the whole book, the weighted average for the whole book to increase. So, we're in better shape today than we were a year ago on that. And I think it's because a lot of our leaders in these markets are paying particular attention to how they price both investment and owner occupied properties.
And our final question comes from Brian Martin with FIG Partners.
Just a couple of things, just follow-up, just on the loan growth, either one of you guys, it sounds like the first half growth, I mean, Terry, I think you said somewhere somebody did that the growth may be a little bit more even throughout the year as opposed to last year, but given your comments about the real estate being in the construction in the first half, it makes sense that the first half is maybe a little bit less than the second half in terms of loan growth or I'm misreading that.
I guess that’s true, but I wouldn't put too much emphasis on that, Brian. I think my point was that we've had a meaningful contraction in CRE lending in the latter half of 2018. I think you ought to expect it to be similar in early 2019 and I guess the point that I was really making is we have made loans and commitments where that construction funding is slated to take place later in the year. So, the loan to book to so forth will materialize there. But I think you know this, we're relying on C&I to be the principal engine of growth for the company. We saw that roughly 20% last year and again, we have a similar outlook going into 2019
And then just Harold just going back to the margin for a minute and the NII, I guess, the margin, if you don't get the rate increases, it sounds as though, I guess, in general, you're outlook on the margin -- the core margin would be for it to be relatively stable, given where it was at this quarter. Does that seem kind of fair? Is that what you're suggesting, given the less pressure on funding costs?
Yeah. I think that would be an accurate assessment. If the rate increases don’t occur and with the reduction in discount accretion, increase in the GAAP margin would be very difficult, but at the same time, we believe in that and I know rate increase environment, pressure on deposit funding will be less, so as far as pricing for deposits.
Okay. So maintaining the core margin without that discount accretion Harold, I guess, if you don't have the rate increases, it sound as though it's pretty stable or maybe up a little bit if you're getting rid of some of these wholesale funding?
I think so, because I don't sense that we will have to be as aggressive on the wholesale side to fund loan growth.
You said, the wholesale funding is leaving in the first quarter. If the reduction is 300 million, is that what it was?
Yeah. We will either reduce or we’ll reallocate to another wholesale provider, but it will be – we’re likely to pick up 100 basis points easy in that money.
And then just last one Harold, on the fee income, I think you said, it sounds like there was minimal that was non-recurring in the quarter at kind of an unusual couple of $100,000, so this quarter's run rate of fees is pretty good way to think about how you go into 2019 first quarter.
Yeah. I don't – since BHG had a – if you look at total fees, I think BHG had a big number, a significant contemplate, but otherwise, I’m not sensing any large adjustments that came in in the fourth quarter. There will be run up in deposit service charges, just because of seasonality. We’ll pick up again some of that in January, but other than that, I don't know of any unusual adjustments.
Okay. And that BHG, that seasonality that we saw play out this year mean it should be similar next year, I mean, if you're talking what are 5% or 10% increase, each quarter would be up year-over-year, is that the way to think about it or is it more, as that seasonality continues?
There's always going to be seasonality in their numbers. This year, it was accentuated because of some of these improvements, particularly with respect to 2018, their substitution losses improved significantly towards the end of the year. So in the third and fourth quarter, they had fewer substitution losses and they attributed that to the quality of their underwriting that they put in place over the last several years.
So could the year over year increase in the first quarter Harold be greater because of that better performance you saw on the second half, was it in the first half of last year?
Yes.
And last and just I think it’s obvious, but if you got the buyback in place, any updated thoughts on M&A. I guess, you came over stock prices and is it obviously less attractive or just how are you thinking about M&A. Has anything changed on that front?
I would say nothing has changed, Brian. I think we’ve sort of laid out where we like to go, what the criteria for transactions would be and I think at this share price, this loan pool, many transactions have been worked, but if we get a expansion and a more advantaged stock, again, we’re sort of being clear on what we’re interested in doing.
Ladies and gentlemen, thank you for participating in the question-and-answer session of today's call as well as today's conference. This does conclude the program. You may all disconnect and have a wonderful day.