Pinnacle Financial Partners, Inc.
Q2 2013 Earnings Call Transcript

Published: 17 Jul 2013

[Operator:]

Good morning, everyone, and welcome to Pinnacle Financial Partners Second Quarter 2013 Earnings Conference Call. Hosting the call today from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer. He's joined by 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 factors that may cause the actual results, performance or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond Pinnacle Financial's ability to control or predict, and listeners are cautioned not to put undue reliance on such forward-looking statements. A more detailed description of 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 the comparable GAAP measures will be available on Pinnacle Financial's website at www.pnfp.com. With that, I would now like to hand the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.

[M. Terry Turner:]

Thank you, operator. Before we delve too deeply into today's presentation, I want to take just a minute and try to set our company in context given some of the broader forces that are changing bank performance these days. I believe personally that we're probably at another inflection point as many investors are now looking for banks that, due to the structure of their balance sheet, will have outsized earnings lift as a result of potential rising rates. The most obvious impact for assets since the banks is an acceleration in the growth in net interest income, everything else being equal. A related impact might be a reduction in fee income due to declining mortgage rate finance volumes. Another critical factor for investors is the amount and type of capital required going forward, given the fed's recent guidance on the implementation of Basel III. The impact of the rising cost of regulation on bank expense structures is another critical factor concerning bank stock investors. And I don't want to minimize those kinds of factors in any way. I believe all of those are important things to focus on, so as we won't -- through today's presentation, we'll try to crystallize those potential impacts on Pinnacle. I believe we're well positioned on each of those points. But the more important thing and the thing I really want to make clear today is that our approach at Pinnacle is to increase shareholder value the old-fashioned way, in other words, to build a firm that has a sustainable competitive advantage and can wield that advantage to take clients away from competitors and grow client-based revenues even when the market's not advantageous. In other words, growing net interest income by adding new clients and cross-selling existing ones is likely the best path to yield long-term shareholder value, and that's what we do here at Pinnacle. We now have grown our net interest income 11 quarters in a row. I expect that to continue for the foreseeable future. In addition, we've grown our fee income, core fee income, 5 quarters in a row. This kind of growth in client and product sales, largely from our existing expense base, is resulting in sustainable earnings growth and excellent operating leverage. And it's my belief that, that's how Pinnacle continues to build long-term shareholder value as we go forward. Now let me focus on the slides. I believe we began publicly discussing our long-term profitability targets on our 4Q 2011 earnings call. As you can see on the slide, we've made progress every quarter since then toward the achievement of those targets, and we're now operating at the lower end of the target range for ROAA at a 1.10% return. Also, as you can see, for each of the components required to sustain a 1.10% to 1.30% ROAA in 2Q '13, we're now operating better than or within targeted range except for the net charge-off ratio. Technically, we're 1 tick above the cap there. But given the commercial nature of our portfolio, charge-offs will be lumpy. But year-to-date, we're at 30 basis points, well within the target range. Although the noninterest expense to average asset ratio dipped into the target range for the second quarter of 2013, we don't really believe that we've achieved our targeted run rate. We'll elaborate further on that in today's call, but the key for us to drive that number into the targeted range on a permanent basis is to contain expenses while growing assets and revenues, which has been our stated plan for some time and which we continued to do meaningfully in the second quarter of 2013. As you look under the hood to see how we're achieving that rapid growth in profitability and earnings, I think you can see that we're hitting on all cylinders. Net interest income, provision expense, noninterest income and noninterest expenses, those are the 4 basic components of bank earnings despite Harold's caution regarding me comparing that to a 4-cylinder engine. First, as I mentioned at the outset, we continue to grow net interest income, largely based on our ability to grow loans and lower our cost of funds. Secondly, we continue to make meaningful progress on asset quality, whether you look at NPLs, NPAs or virtually any asset quality metric. Given the relatively high level of our reserve versus the continuing quarterly asset quality improvements, reserve releases have and should continue to provide relatively lower provision expenses through 2014 than what would otherwise be required for a company growing loans as rapidly as we should. Third, noninterest income excluding securities gains and losses is up 15.7% in 2Q '13. That's versus the same quarter last year. And core noninterest income, which we'll talk about further here in just a moment, is up 23.6% year-over-year. And then fourth, consistent with our strategic objective to contain expenses while growing loans and revenues at a rapid pace, our core noninterest expense to asset ratio continued to improve -- it's continued to improve every quarter. Expenses in the second quarter were favorably impacted by an expense credit of $2 million that Harold will discuss further in just a few minutes. But nevertheless, eliminating that and holding everything else constant, our core noninterest expense to asset ratio would have been 2.42% for the quarter, still outside the targeted range but continued forward progress during the quarter and consistent with our plans. The pre-tax, pre-provision earnings for 2Q '13 grew by 48.7% over the same quarter last year. Perhaps a slightly more telling indicator of the pace at which we're expanding the core earnings capability of the firm is the adjusted pre-tax, pre-provision earnings for 2Q '13, which grew by 36.8% over the same quarter last year. You can see on the slide the adjustments we've made to the pre-tax, pre-provision number to best reflect core pre-tax, pre-provision earnings. Again, Harold had covered the $2 million other expense credit that I just mentioned and we noted in the press release last night, and he'll provide a little more color commentary on that in just a minute. Looking a little further at the growth in net interest income, despite some contraction in the margin percentage, there were 3 primary contributors

[Harold R. Carpenter:]

Thanks, Terry. As Terry mentioned, we're going to switch gears now and eventually discuss operating leverage in a few current topics. But first, a few comments about growth in loans and deposits. We've been highlighting this chart since January of 2012, and that it was our belief that our existing relationship managers plus several new relationship managers that we've hired have the capacity to produce $1.3 billion in net loan growth over roughly a 3-year period of time. In the chart, we're plotting the actual production to date against the 3-year target that we outlined 1.5 years ago. We've always cautioned that you shouldn't expect that we'll produce the loan growth on a straight line quarterly basis. During 2012, we had a quarterly low of $46.5 million in growth and a quarterly high of $187 million. In round numbers, we're up a net $420 million in 2012, and that's an annual growth rate of 12.8%. We added net growth of $60.2 million in the first quarter of this year and $153 million in the second quarter. That represented a 6-quarter CAGR of 12.5%. The required CAGR for loans in order to hit that $1.3 billion target by the end of 2014 is 11.5%. So to date, we're right on plan. We've discussed this concept in various forms over the last several quarters. Our communication objective here is to highlight our sales force's efforts in moving market share to our firm in order to produce outsized growth in a slow-growth economy. We surveyed our relationship managers and asked them to determine where the new loans were coming from. A new relationship was determined to be a loan with a tax ID that was not on our records at the end of 2012, and our loan officers also determined the new tax ID was not an existing relationship. All in, over the first 6 months, we recorded almost $600 million of new loan volumes, excluding any net changes in lines of credit. As the chart indicates, 48% were to existing Pinnacle clients who likely chose to undertake deferred capital expenditures at growing working capital requirements or perhaps a new venture, while 52% were the new clients. This capability to capture or move market share is tied to our hiring philosophy of hiring well-known lenders in our market who have the potential to move a large book of clients to Pinnacle. As you can see, and especially if you consider amortization of paydowns of existing loans, without this ability to take share, loan growth would be much more muted. We've been providing this as supplemental information for quite some time, but we thought we'd move it to the front and highlight it for you this time. The chart reflects commercial lines of credit, and as you can see, we have more than $2 billion of total commitments, of which a little more than 1/2 is funded. Again, reflecting our ability to take market share, total commitments are up more than 13% in the last year and unfunded commitments are up more than 17.5% in the last year. Obviously, this presents us an opportunity for future growth, and hopefully, more unfunded commitments will turn into loans over the next several quarters. This slide is new. We've included it this time because one of our ongoing critical to do's will be to fund loan growth with quality funding, which is low-cost core deposits or DDA, interest checking, customer repos and money market accounts. The chart on the left depicts our deposit book transition from being predominantly CD-funded to now predominantly transaction- and money market account-funded. This didn't happen by accident. This was an intentional effort of our entire sales force. More so, traditional bank investors recognize that transaction account deposits are likely to be the most valuable product on any bank's balance sheet, and the more you have, the better. Now the chart on the right. The question has been how will we fund our loan growth and hit our 12/31/14 targets. The answer is simple

[M. Terry Turner:]

Okay. Thanks, Harold. We need to comment on our outlook for net interest margin. We've made significant progress on our net interest margin from its low of 2.72% in March of 2009 to its peak of 3.90% last quarter and now back to 3.77% in 2Q '13. There are really 3 factors that should positively impact our margin going forward

[Operator:]

[Operator Instructions] And our first question comes from Michael Rose from Raymond James.

[Michael Rose:]

I just wanted to get a little context and color on the margin going into 2014. With everything you laid out, your expectations for rates remaining low, these are floors which I expect are -- would continue to fall from here given the competitive nature of your markets. Is it plausible that the margin over a period of time during these low interest rate dynamic that we're in, that you could dip below your longer-term range? And can you kind of walk us through how that could play out assuming rates stay where they are?

[Harold R. Carpenter:]

Yes, Mike, we've been looking at that over the last several months and whether or not we'll go below our long-term sustainable targets. Right now, we're not anticipating that of any significant amount. We think we can keep these rates -- or keep our margin within the target range. But I think we'll be very much at the low end. So to say that I've got a box that will be above the 3.70%, but I think there's a distinct probability when you go through our modeling that we could fall into the 3.60%s for sure.

[M. Terry Turner:]

Mike, I might just add to Harold's comment. While it would appear to us that we'll operate in the margin on an annual basis, it would be more conceivable you might miss it on a quarterly basis here and there.

[Michael Rose:]

Understood. And then, I don't think you touched on this, Terry, but any other thoughts on expanding into other markets, as you talked about in prior calls?

[M. Terry Turner:]

Michael, I don't think I can say anything that's additive to what's already been said. As you know, we look at those markets. We believe they may represent opportunity for us. And if we find the right group, we'll proceed with those markets and commence on a de novo basis, when and if we find them. If we don't find them, we won't go there. I don't really have any update on that.

[Michael Rose:]

Okay. And then just one more if I could. As it relates to the growth this quarter, which was really nice, how much of that came from, I guess, more recent hires, the hires that you brought over that kind of lead us to this $1.3 billion in capacity over the 12-quarter period?

[M. Terry Turner:]

Michael, I don't know the number exactly, but I would estimate $20 million to $25 million gained from new hires.

[Operator:]

Our next question comes from Jefferson Harralson from KBW.

[Jefferson Harralson:]

I wanted to ask you about pricing on new loans. Has it increased for you guys? And competition with the rates going up or is it still -- is it relatively unchanged?

[Harold R. Carpenter:]

I think loan pricing is relatively unchanged, Jefferson. The -- I think what we try to communicate, I think, through press releases in here today is that, you got -- theoretically, with longer-term rates moving, you think the associated or comparable loan yields would move similarly. I think the overriding factor is the competitive landscape. And so honestly, I don't look for any easing in loan pricing myself.

[Jefferson Harralson:]

Okay. On the margin, if rates go up -- I guess, if I'm just trying to put everything together that you guys said, should I expect the margin to go down initially as rates go up because of the floors not giving you some increase while you might have an increase in your cost of funds?

[Harold R. Carpenter:]

Yes, Jefferson, I think that's correct. We've got to get through the floor. So if rates were to go up today, we're 88 basis points floor to contract rate difference on the loans with floors, so we'd have to get through that -- do in order to see some revenue lift on that book of business.

[Jefferson Harralson:]

Okay. And lastly, you talked about the swap. Can you just give us the details on what the swap is? And does it help earnings every quarter or is just effect -- does it just kind of hedge book value?

[Harold R. Carpenter:]

Yes, it's a forward hedge, so there's not really any current impact on earnings. It just -- it does impact tangible book. It's a forward start 3 years out. It's about $200 million in Federal Home Loan Bank borrowings that are at various rates. I think I've got 6 tranches built over a 3- to 6-year period. So that's the swap.

[Operator:]

Our next question comes from Matt Olney from Stephens.

[Matt Olney:]

Terry, in previous quarters, you've talked about the payoffs and paydowns being a little bit elevated. How would you characterize the payoffs and paydowns at some of your loans in 2Q? And what's your outlook for this going forward?

[M. Terry Turner:]

The -- I think I would generally characterize payoffs as slightly slower than the peak levels that we saw, but we still are running a relatively high level -- in a higher-than-normal level, I would say, of accelerated payoffs.

[Matt Olney:]

Okay. And then...

[M. Terry Turner:]

Trying to say it clear, I'm trying to say it's a little better than it has been, but it's still an elevated level.

[Matt Olney:]

And it sounds like you're expecting that to continue the next few quarters. Is that fair, Terry?

[M. Terry Turner:]

I don't have any reason to think it will not. Matt, we had a -- based on some data I'm looking at, we had about $100 million in amortization of paydowns, so that's about consistent with what it was in the first quarter.

[Matt Olney:]

And then piggybacking on Michael's question before on new lenders. Did you make any new hires in the second quarter? And how would you characterize the pipeline for new hires today?

[M. Terry Turner:]

We did make hires in the first quarter and in the second quarter, and I expect we'll make hires in the third quarter and fourth quarter.

[Operator:]

Your next question comes from Kevin Fitzsimmons from Sandler O'Neill.

[Kevin Fitzsimmons:]

Just real quick on some of the capital planning issues you talked about. I hear you on the dividend, that it kind of depends on the loan growth. So if I hear that right, is it almost that we would need almost a pullback in this pace of loan growth for you to feel comfortable going forward with the dividend? Or it sounds like you're saying you're comfortable, you can do both, but you want to watch it for a while. And is it almost that if the pace pulls back, then you're more comfortable stepping forward with the dividend?

[Harold R. Carpenter:]

I wouldn't say that if the pace pulls back, we're more comfortable. I think, based on what we've talked about and our targets for 2014, we still think we can do both. Now as to the timing of when we might want to start a dividend program or if we start a dividend program, we're unsure of that. But we believe that based on what we've been able to do with loan growth here over the last, say, 6 quarters, we think a dividend could be affordable.

[Kevin Fitzsimmons:]

Okay. And a quick follow-up. Terry, I know M&A has never been a big part of the strategy here, and it sounds like you still have a lot of organic loan growth opportunity. But you're sitting with a very nice multiple on tangible book compared to a lot of banks, and we've seen some transactions where the buyer stock actually racks very positively and there's more reception to the accretion that comes from some of these deals. How do you -- how would you characterize your -- how constructive you're looking at those kind of opportunities these days?

[M. Terry Turner:]

Kevin, I would say that if we could find in-market bank deals in Nashville or Knoxville, those would be very attractive to us. I guess we're interested in and have dialogue and pursue internally those kinds of things. I guess in order to be candid, though, I'd need to say that's a relatively short list of possibilities. And so I think you're right

[Kevin Fitzsimmons:]

And I guess, based on your answer from earlier about entering new markets, you definitely have a preference for hiring a team as opposed to going and buying your way into a new market.

[M. Terry Turner:]

We definitely do. I know everybody likes their company, but we do think our brand is distinctive, our reputation is distinctive and so forth. And so we just have a bias that to go in and buy somebody else's brand, particularly if it's not a particularly high-performing company, it's just hard to convince anybody that it's a great company just because you changed the signs out front.

[Operator:]

Our next question comes from Peyton Green from Sterne Agee.

[Peyton N. Green:]

I was just wondering, maybe Terry, if you could comment a little bit about the loan pipeline. Certainly, the loan growth in the quarter was very good. I know it was maybe a little short of where it was in the fourth quarter, which was a very extraordinary loan growth quarter for you all. But maybe just talk about to what degree the pipeline refilled in the quarter and how you would feel about loan growth going forward.

[M. Terry Turner:]

Well, I think, Peyton, I don't want to give you a cheap answer here, but let me give you this and see if this tells you what you need. I'll be glad to try again if it doesn't. But we're sort of -- we've been pretty transparent about what our loan growth targets are, round numbers if you do, $1.2 billion to $1.3 billion over a 3-year period. You've got to grow a little better than $400 million a year, and we're about $200 million into 2013 at the halfway point. My belief is we'll hit or exceed our loan growth target for the year. So does that tell you what you need to know?

[Peyton N. Green:]

Yes, no, I guess if I heard the number right, you mentioned that only about $20 million to $25 million of the volume was from new hires, which I guess, in a way, would lead me to believe that the existing capacity may be greater than you may have set 1.5 years or so ago when you put out the $1.3 billion in terms of capacity. I guess I'm just trying to kind of rationalize those 2 statements.

[M. Terry Turner:]

Yes. I think -- I guess I would say I like, if you will, I like the commitment that we have on the table, and we'll deliver against that. That's my best -- enough...

[Peyton N. Green:]

Okay. I'll ask maybe a different way. A couple of quarters ago, you indicated -- maybe 3 quarters ago, maybe even a year ago now, you mentioned that this was the point in the cycle where you started to gain an advantage in terms of hiring bankers and also in pulling customers away from other banks, just given that all the above had been through the credit cycle and were feeling better about their own businesses and maybe their own opportunities going forward. How would you feel about that today compared to last June?

[M. Terry Turner:]

I would say it was accurate then, and I think it's still accurate today. As I mentioned, we continue to hire people. We have hired a number of revenue producers in the first quarter and the second quarter. I believe we'll hire more in the third quarter. We're in discussions with a number of people that I believe will get hired in the third and the fourth quarter this year. So again, I think we're taking people. And if you look at that market share chart that Harold showed really dividing the production through the first 6 months, more than 1/2 of that growth is market share movement. And so again, I think that and I believe our pipelines will continue to look like that for an extended period of time as the folks that had been on our payroll when we said we could produce it -- I mean, you know our company well, Peyton. I mean, all those people came from somewhere else, and so the folks that they know and are moving are from other banks, and of course the new hires that we're hiring will be moving largely from other banks. So I expect our ability to hire people from other banks to continue to be strong, and I expect their ability to consolidate their books from those other banks to continue to be strong for the foreseeable future.

[Peyton N. Green:]

Okay. And then maybe one other question. On the line utilization, I think you all put a slide in the deck that indicated that it went up fairly noticeably, I guess. Was that because the utilization rate was higher on the new volume? Or was it a combination of existing and new volume?

[M. Terry Turner:]

Peyton, I've got to say I don't know the answer to that. I just -- I know what the overall utilization rate is, but I can't break it apart for you.

[Operator:]

Your next question comes from Brian Martin from FIG Partners.

[Brian Joseph Martin:]

My question was answered, but I guess really the other point was, Terry, your thought as far as that targeted loan growth, if you will, over a 3-year period. With you talking about the capacity from the new people you're adding, I guess, it's kind of fair to say that we should be thinking about that maybe as being somewhat conservative, as that target was back from a couple of years ago, with all the people you've been adding, I guess, it was kind of in line with Peyton's question, that seems the fairer way to look at it?

[M. Terry Turner:]

Well, I guess, again, Brian, the thing I'm hesitant about -- obviously, to the extent we hire more people, that ought to propel our growth into the future. And so that's a true statement. And as a general rule of thumb, when we hire, say, middle-market, commercial relationship managers or private banking relationship managers, generally, it takes about 3 years for them to consolidate their book of business from their previous bank to here. And so, I guess, we sort of put a target out that makes sense. It drives the profitability of the company to a targeted level, and we're excited and pleased about that. I tend to view the hiring as my path to the future beyond what we've talked about. So to the extent I keep hiring people, I can continue a rapid growth and market share capture gain for an extended period of time. I guess, again, yes, hiring more people and their ability to produce loans will be additive to what we had originally said. But I just don't want to get into having to put out new targets and then talk about the old targets and the new targets and all that sort of stuff. I'd rather just sort of say, conceptually, hiring more people ought to be additive to capacity.

[Operator:]

And our final question comes from Bill Dezellem from Tieton Capital Management.

[William J. Dezellem:]

I'd actually like to continue on the path with loan officers for a moment. How many did you hire, new ones, in the Q1? And how many in the Q2? And then how does that first half hire number compare to the first half of '12?

[M. Terry Turner:]

We hired 3 in the first quarter and 4 in the second. That's the -- those are relationship managers. Again, there would be other hiring that might go in the company to support new branch openings and other things. But in terms of relationship managers, 3 in the first quarter, 4 in the fourth. And what was the second part of the question?

[William J. Dezellem:]

How does that 7 for the first half of 2013 compare to the first half of 2012?

[M. Terry Turner:]

In 2012, I think actually when we communicated our capacity, I think we said we -- included in that capacity was that we would hire 11 people during 2012. And we did hire those people in 2012. And I would say they were concentrated in the first half, but I couldn't go back and tell you how many got hired in Q1, Q2, Q3, Q4 of 2012. But -- so I would say it's a similar number, would probably be a fair thing to say.

[William J. Dezellem:]

And then a remedial question for you. The difference in contract rates versus your floors, why has that decreased over the last 2.5 years from that, what, I think it was 133 basis points to 88 or so?

[M. Terry Turner:]

Yes, Bill, I think there's 2 things going on, as we talked about. First is, and maybe more importantly, the borrowers, I think, are more keenly aware of where we are in the rate cycle and where rates -- when the fed funds rate may actually get increased and all that sort of stuff. So they're taking a little more interest rate risk on their own balance sheet. So they're willing to play a float -- maybe get a floating rate loan or something like that on their own balance sheet. There's -- and then secondly is that competitively, it's getting more difficult to get a significant lift in the floor rate over the contract rate.

[Operator:]

Thank you. I'm showing no further questions at this time. I'd like to hand the conference back over for any closing remarks.

[M. Terry Turner:]

Yes. I would just say, hopefully what we've tried to do is highlight our performance in the second quarter, which we view to be very strong; and at the same time, give some information, continue to expand this thesis of operating leverage producing revenue growth more rapidly than expense growth; and then thirdly, to try to give some insight into things that we think are likely to influence our ongoing growth capabilities, valuations and so forth. Thank you for joining us.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program. You may all disconnect, and have a wonderful day.