Good morning, everyone, and welcome to the Pinnacle Financial Partners third quarter 2019 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 open for your questions following the presentation. If you would like to ask a question at that time, please press star one on your touch-tone phone. Analysts will be given preference during the Q&A. We ask that you please pick up your handset to allow optimal sound quality.
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, 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 the comparable GAAP measures will be available on Pinnacle Financial's website at www.pnfp.com. With that, I am now going to turn the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.
Thanks, Joelle. Good morning. As we always do, I'll begin with this dashboard. As a reminder, it's focused on revenue growth, earnings growth, and asset quality because we believe that they're the three most highly correlated metrics to long-term shareholder returns. That's what we focus on quarter in and quarter out. As you can see, Q3 was an extraordinary quarter for our firm, with 15.6% year-over-year growth in revenue, 19% year-over-year growth in EPS, and outstanding asset quality metrics. Due to all the noise and adjustments, primarily in previous periods, in many cases, the non-GAAP measures better illustrate the relative performance of our firm.
As a reminder, the reason we begin each quarterly earnings call with data that goes back to Q1 2014 is because, as you can see, any impact from M&A, high deposit betas, outsized CRE payoffs, or any number of other hot buttons that have come and gone over the last five years, our balance sheet growth, and more importantly, our growth in revenue to EPS, has been remarkably rapid and reliable. Q3 2019 is a continuation of the same. When you look at the slope on any of those growth metrics there, we've got a 34% five-year CAGR for revenues, a 22% five-year CAGR for EPS, a 16% five-year CAGR for tangible book value, a 34% five-year CAGR for loans, a 32% five-year CAGR for deposits, an ROTCE now north of 18%, and pristine asset quality metrics quarter in and quarter out.
One of Peter Drucker's more famous quotes that I've used a number of times on these calls is that, "Culture eats strategy for lunch." The folks at Gallup and the Great Place to Work Institute subsequently developed the empirical data that proves exactly that. Specifically, the companies that have higher levels of employee engagement produce better sales results, lower employee turnover, which frankly is or should be the critical success criterion for most everything, better productivity, and better profitability. In my opinion, our obsession with culture is the explanation for the reliable slope on all those charts we just looked at on the previous slide. On this slide, you see a list of the workplace recognitions that we've received just in the last 12 months, and the ones in green, the green shaded area there, are the ones that we received during the third quarter.
We had two major sightings. Number one, we moved into Memphis in 2015 and quickly were recognized as the best place to work among smaller and mid-sized companies in that market. Now we're recognized as literally the best place to work among the largest employers in Memphis. Number two, last year, immediately following our system conversion associated with the BNC integration, we were still ranked as the 19th best bank in America to work for and the only bank in the top 50 anywhere near our size. This year, we climbed another three spots up to number 16. Why is this important? It appears to me that we're headed into a sloppy operating environment. There's an old saying that you can't tell who's swimming naked till the tide goes out.
Having such a highly engaged workforce not only produces better outcomes in the good times, it's even more critical to performance in the difficult times. I know by now everyone's familiar with the business case that we made for the BNC acquisition. The plan was to continue the high-growth CRE platform that BNC had and bolt on to that a C&I platform, which is the principal strength of our firm. The critical path to make that happen was to lever our ongoing recruitment competence in order to attract and retain the best C&I and private bankers in the market. Specifically, when we announced the merger, we said we would hire 65 C&I and private bankers over a five-year period of time. As you can see, Rick Callicutt and his team surpassed the hiring target for C&I and private bankers in less than half that time.
The environment for looking at great bankers in the Carolinas and Virginia has only gotten better since we launched our transaction there, so we expect to continue to hire at a rapid pace there. Why does this make any difference? Number one, it's an indication that we're diligent about hitting our targets. More importantly, Number two, given all the turmoil in the industry, and particularly in the southeastern markets that we target, there's an unprecedented opportunity to acquire talent from larger, more vulnerable banks, and we're arguably best positioned to seize it. Number three, it should lay fears that our rapid hiring will destroy our efficiency. At the time we announced this deal, our efficiency ratio, as adjusted, was 49.65%, and today we're at 47.58%, a meaningful improvement during the period when we have been doing the rapid hiring.
With that backdrop, I'm going to turn it over to Harold to review the quarter in greater detail.
Thanks, Terry. Good morning, everybody. We've updated our revenue per share slide for third quarter results. We believe one of the best measurements of whether we are winning or losing is shown on this slide. As you can see, we continue to experience double-digit revenue per share growth since the second quarter of last year. Secondly, the red dotted line represents the peer group's year-over-year growth. As shown on the slide, we outpace our peers on revenue per share growth by a wide margin. Keeping in mind, this is during a time of significant internal focus around the integration of the Bank of North Carolina, and more recently, managing and strategizing around inverted yield curves. That said, our relationship managers have remained focused on gathering clients and generating incremental revenues for our firm. Obviously, BHG's outsized performance has had a meaningful influence on these results.
We don't apologize for that at all. It has afforded us opportunities to invest in our franchise by keeping the foot on the accelerator on hiring, accruing for enhanced incentives to motivate our workforce, as well as allowing us to better position our franchise for future growth. Additionally, BHG has provided for outsized tangible book value accretion, all of which benefits our franchise and its shareholders. There remains a lot of positive energy in our franchise right now. We remain on offense 24 seven. It's all about winning. Our associates are engaged, focused, and excited about our opportunities for the remainder of this year and going into 2020. Now comparing the third quarter of 2019 average loans to the third quarter of 2018 average loans, our annualized growth was more than 11%.
We continue to believe that our loan growth for 2019 will be low double digits in comparison to 2018. At this time, we have no reason to believe that our loan growth outlook for 2020 will be any different. We're in the midst of constructing our 2020 plan, and our managers believe that low double digits is still a reasonable target. We can only make this statement because of the robustness of our hiring platform and the continued success we anticipate over the next several quarters. Impacting our volumes in the third quarter was the acquisition of Advocate Capital. We're excited about the opportunities Advocate provides us, including access to a vast network of attorneys where we can offer commercial banking products with emphasis initially on gathering deposits. Advocate has built their franchise on delivering great service and enjoys significant depth in their client relationships.
During the third quarter, Advocate added approximately $155 million in loan balances with a weighted average yield of 8%, plus other fees for the services they provide their client base. I'll speak to loan rates in a second. We've shown this chart for several quarters now. We also provide information in the small chart regarding the granularity of our loan book by loan type. This small chart details the average commitment of our current loan book at origination compared to March 2015, the only outlier being construction. Construction has increased to an average commitment of almost $1.3 million, which we believe is a very reasonable amount for that part of our portfolio. We offer this information so that you can better appreciate that we're not relying on extra large ticket sizes to hit our growth goals.
The chart on the right details the impact of discount accretion on net interest income. As you can see by the gold line, discount accretion continues to be less impactful to our results at 5.7% of our net interest income in the third quarter, and we believe will continue to be less impactful in the future. We all knew that a big headwind to our GAAP revenue growth for 2019 was an impact of less and less discount accretion, and the primary way we're going to overcome it was through balance sheet growth. The blue bars on the chart on the right are obviously where our attention is, and growing those blue bars is key to our ability to deliver increased value to our shareholders. That said, hopefully, in the not-too-distant future, we can stop showing this chart once purchase accounting is even more so in the rear-view mirror.
Here's another slide we've been showing for several quarters. It's an update on our loan portfolio by rate index. Our loan mix averages approximately 50%-55% LIBOR and prime, with substantially all of the LIBOR credit being tied to 30-day LIBOR and about 40% fixed rates, with commercial real estate being the primary contributor. The quarter-over-quarter weighted average coupons for LIBOR and prime-based credits for the loan book decreased by 24 basis points for LIBOR and 43 basis points for prime, which is somewhat of a victory given we experienced 50 basis points in rate cuts. The spreads in these categories actually widened compared to quarter end to quarter end after considering the rate decrease. Of increased significance is the spread on fixed rate credit as a proxy for fixed rate spread performance. To keep it simple, we traditionally use the five-year Treasury as the benchmark.
The five-year Treasury dropped 21 basis points during the quarter, while our weighted average fixed rate loan rate dropped only six basis points. Keeping the coupon on fixed rate loans near these levels would be a nice win for us in an anticipated down rate environment. Now to deposits. Perhaps the most anticipated slide in the deck today. Average deposit balances are up $1.7 billion year-over-year. Our average deposit costs remain the same in the third quarter of 2019 from the second quarter, and currently stand at 1.25%. Oh, did I skip a slide? Wholesale bank.
Wholesale bank assets.
I did skip a slide. Let's go back to wholesale bank assets. We don't usually discuss the bond book for liquidity in our quarterly conference calls, we're here today primarily because it's relevant to margin performance for the third quarter and going forward. These two areas probably had the biggest downside impact on our NIM performance in the quarter. Bond yields decreased by 20 basis points link quarter. This is by no means unexpected. We don't have the peer data yet, we believe peer yields will see decreases this quarter as well. About 50% of the decline was due to reinvested cash flows, while the other 50% was valuation of the book. As rates declined, the value of the book increased, reducing the yield.
We anticipate additional yield contraction in 4Q, but as the middle chart indicates, we've added more fixed rate assets to the bond book, which will help stabilize our yield performance going into next year. As to liquidity, we maintain more this quarter than any quarter in recent memory. Most of this was timing in that we just completed a $300 million sub-debt offering in the second quarter of September, which added to our cash balances, and we acquired a large deposit from a long-time client of a similar amount. Regarding the offering, $180 million was injected into the bank, while $90 million is earmarked for sub-debt reductions at the holding company in January. Most of the client deposit will find its way to our wealth management unit in the fourth quarter, while the remainder will be with us until early next year when that depositor pays their taxes.
Liquidity will likely be back within its normal range in the fourth quarter. In any event, both of these matters pressured our third quarter margin performance. There's a point when NIM trumps net interest income. We will pay attention. Currently, we will work with our clients to create as much spread income as we can and grow net interest income. As a wise buy-side investor once said, there's value in them that are customers, especially those that transition to a relationship based on service and advice. As a result, we remain focused on growing our client base by hiring the best bankers in our markets. Now to deposits. Most of our firm's focus for the third quarter was on the table on the left, which looks at end-of-period rates. Our relationship managers, we believe, did a bang-up job on managing our deposit costs in this rate environment.
In the negotiated rate bucket, we've achieved a 17 basis point decline. At this point in the rate cycle, our target would be a 50 basis point beta or a 50% beta over our 25 basis point reduction, so we're very much pleased on where we are given the most recent rate decreases were late in the quarter. We do think we are getting close to the 25 basis point reduction here in mid-October in that particular rate category. Our relationship managers are very much in tune with the rate environment and are prepared to have more discussions with our client base should rates decrease further. Here's our challenge. We have to reduce deposit rates while at the same time increasing our deposit book to fund loan growth and reduce our dependency on the more expensive wholesale funding.
Our ability to accomplish this rests primarily with our new hires who continue to gather deposits from their client base. More on deposit rates. We don't normally provide monthly information during our quarterly conference calls, but wanted to emphasize the positive work our relationship managers are accomplishing with respect to lowering rates on our interest-bearing transaction accounts. Several may believe that this is merely pushing a button in our deposit systems. Granted, we have those accounts, those are the rate sheet accounts on the previous slide, but 65% of our interest-bearing transaction accounts are negotiated, which means that the only person that can authorize a change to that rate is the relationship manager. It is part of our brand. All banks have rate sheet accounts, and all banks have negotiated rate accounts. We believe our approach is much different and much more intentional.
It's really at the core of relationship banking. The bank's treasury, namely me and a few other number crunchers, would love to call up deposit ops and tell them to lower rates and the deed would be done. At Pinnacle, these bean counter types have to be able to convince the relationship manager, or better said, their supervisors, to call their client to lower their rate, and it's not only a good idea, but a fair idea. So far, so good. Can't tell you where we think we'll be at the end of October, but we are optimistic that we will experience continued progress on reducing rates on our interest-bearing transaction accounts. Our goal is a 50% beta for our interest-bearing deposit book. We've got a ways to go to achieve our targets, but we're off to a great start. It'll take us a while on CDs.
Our CD book is split about 60% customer and 40% wholesale. The wholesale CDs will roll down fairly quickly given it's an average duration of slightly more than six months, while the customer book will take a little longer as its average duration is approximately 10 months. When rates were rising, we took our fair share of criticism regarding increasing our deposit rates. As we enter the front part of what could be an extended down rate cycle, we like our odds. We will be proactive with our clients and not hide behind the curtain to surprise them. We sincerely appreciate our client base, and we will leverage the depth of our relationships to accomplish our objectives. With the inverted yield curve in place now for several months, the speculation of a credit cycle change should a recession occur, has been on investors' minds for quite some time.
We believe we've got the best relationship bankers in the business. We also believe we have the best credit officers. This is not their first rodeo. They can sense when storm clouds are beginning to form. Right now, as far as credit risk is concerned, based on our credit metrics and what Harvey White and his team tell me, times remain pretty darn good. We've shown these charts before. The chart provides us even more comfort that we're not booking the very large commercial real estate projects. Credit remains at the forefront of our minds, so I hope we never appear complacent when we talk about credit. For the third quarter, we experienced relatively small increase in our net charge-off ratio, while non-performing assets and classified asset ratios decreased.
We believe that as to credit in the third quarter, we were steady as she goes, and agreed with other bankers that we're not seeing any systemic issues that will cause us to change our perspectives of our credit in 2019 or into 2020. Concerning CECL, how much will our allowance increase? We're in the final stages of validating the various models we will use to determine the allowance account each quarter. Preliminary, we believe that the allowance account could be in a range of 70 basis points to 80 basis points, up from the 48 currently. This amount includes a meaningful amount of purchase credit compared reserves, which will transfer from loan accounts into the allowance account without an impact to capital. At September 30th, that amount was slightly over $6 million, which approximates to three basis points of the loan portfolio. Turning to fees.
Fees total more than $82.6 million, up more than 60% over the third quarter of 2018. As Terry mentioned, BHG had another phenomenal quarter. Their contribution was up $18 million or greater than 126% year-over-year. More on BHG in a second. Our fee businesses are having a strong 2019 with residential mortgage leading the way up approximately 80% annualized this year-over-last-year. They've had a great first nine months of 2019, correlating not only with drops in long-term rates, but also with increases in the number of mortgage originators. Also, again, great markets are helpful with the flow of business, so we anticipate mortgage to finish this year strong. Additionally, deposit fees and wealth management are having mid double-digit growth years, which we consider to be excellent.
Concerning BHG, during the third quarter, we participated in BHG's Analyst Day in New York with several members of their executive team on hand to provide a more detailed perspective on BHG's business model. We won't go through a repeat here, but if you'd like to hear what was said, I'll direct you to our website, www.pnfp.com, where a recording of the event will be available for replay for, call it, another two months. BHG is having a phenomenal year, period. Originations are at all-time highs, and the business model continues to outperform. That said, BHG will likely begin to keep more of their credit on their balance sheet, thus realizing more interest income rather than rely significantly on gain on sale.
They believe the funding which will allow them to warehouse these loans should be in place within the next few weeks. We expect fee revenues from BHG in the fourth quarter will be less than what has been recorded in the second and third quarters, with it being more consistent with the amounts recorded in the first quarter. The green line on the chart on the right details the recourse accrual they record on their books for substitution, prepayment, and other losses associated with honoring the substitution clause for banks that have purchased credit from Bankers Healthcare Group. They've been keeping the recourse accrual at about 4.5% of total credits outstanding over the last few years. The columns are the actual loss rates in relation to total volume of credit outstanding on the books of all the banks doing business with Bankers Healthcare Group.
The columns include not only the credit loss, primarily substitution losses, but also the prepayment loss associated with reimbursement of the early payoff of these credits. We've had a lot of conversations with BHG about their credit profiles. Their credit models are sophisticated and subject to continual analysis by their analytics group. We believe that their business model is top shelf in identifying potential clients who have the credit profile to be a good borrower for BHG, whether BHG keeps the loan on its balance sheet or sells the loan into its network of community banks. Approximately 67% of Bankers Healthcare Group revenue base has historically been made up of gain on sale revenues. However, BHG also generates interest income from loans that were either held on BHG's balance sheet permanently or being held on their balance sheet prior to being released to the auction platform.
Since the second half of 2018, BHG has been building their balance sheet with on-balance sheet loans, with approximately $307 million in loans currently held on balance sheet compared to $146 million as of the end of September 2018. They've been able to generate the operating cash required to be able to fund this loan growth. The green bars on the left chart represent originations and have ramped up with more loans being funded, which is the result of enhanced analytics and more sophisticated marketing platforms. The blue bars are the loans on which gain on sale has been recorded as these loans are placed with Bankers, with gain on sale revenues being generated. The blue bars have ramped up with more placements, either through auction or one-off sales. The gold bars represent the loans held by BHG on its balance sheet, which BHG will collect interest income.
As we've mentioned on the previous slide, BHG has anticipated increasing their balance sheet loans. We're all in agreement that by balance sheeting loans, this will provide a more reliable income stream for BHG in the future through a more diverse business model. It will take many quarters for BHG to match the gain on sale revenue with interest income. That said, we all believe it's a good idea. As to credit risk, given BHG has been honoring the substitution clause for sold loans, any incremental credit risk associated with keeping more loans on its balance sheet should be minimal. Even with all this change, we still believe that BHG should see 10% growth in earnings in 2020 from what they anticipate realizing in 2019. Now briefly to expenses. No significant run rate matters to discuss other than incentives.
As we mentioned in the press release, we increased our incentive accrual in the third quarter but don't expect our fourth quarter accrual to be nearly as large. We're also pleased to report that retention rates continue to increase, signaling two important things for us. Our clients can count on consistent service, and employee turnover continues to shrink, and our workforce engagement initiatives are taking hold in our newer markets as those associates are buying into our culture. For the last few years, our expense-to-average asset ratio, excluding merger expenses, has been in the 1.9% range. We don't see that changing materially as we head into 2020. Lastly, yesterday, our board of directors approved an additional $100 million share repurchase authorization for open market purchases of our common stock.
This authorization extends through December 2020 and begins upon the exhaustion of our current authorization, which has approximately $30 million of remaining funds available for common stock repurchases. We intend to use every bit of this authorization, but we will do it rationally over the next 15 months. With that, I will turn it back over to Terry.
Thanks, Harold. As Harold discussed on last quarter's call, we modified our longer-term operating ranges. Our previous metrics were put in place in 2012, and we believe the granularity that were provided by those previous measurements were important at that time, and have served its purpose. Now we're opting to go with a higher level of guidance with operating ranges for ROAA, ROTCE, and tangible equity as our current guideposts. For ROAA, we're targeting a 145%-165% range. As you can see, for the third quarter, we're operating high in that range at 1.62%. We've also introduced ROTCE and tangible equity ratio as two new measures that we'll continue to highlight for you going forward. As you can see, we're in the range on ROTCE and at the higher levels with the tangible equity ratio.
Our goal is to maintain these ratios in the top quartile of our peer group over time. Finally, we've shown these charts before. We continue to believe that we're a top quartile grower of EPS and tangible book value within our peer group. We're laser focused on rapid, reliable growth in EPS and tangible book value. Our tangible book value is up by more than $5 a share in the last year, or slightly over 20%. As you know, our incentive systems are designed to take every person and focus them tightly on EPS growth. As I've mentioned a number of times before, our belief that banks that can rapidly and reliably grow EPS and tangible book value over time will produce the best shareholder returns. As you can see on these charts, growth here has been both rapid and reliable.
The slide that you're looking at here is the same slide that I used to close the quarterly earnings call in January, and used it to try to set expectations for 2019. In the third quarter, I think we hit the bullseye. To the first bullet point, we had a 14.5% linked quarter annualized rate of growth for core deposits and took our cost of deposits down 11 basis points during the quarter. To the second bullet point, we had an 11.3% linked quarter annualized rate of growth for loans. To the third bullet point, we had a year-over-year growth rate for adjusted EPS of 19.8%. To the fourth bullet point, we've exceeded our aggressive hiring plan of C&I and private bankers in conjunction with the BNC merger.
We've also had similar success across the entire footprint in considering all types of revenue producers, including not only the relationship managers, but other revenue producers like brokers, mortgage originators, insurance agents, and so forth. We've hired 67 year-to-date, while not damaging the EPS growth rate or the efficiency ratio. That speaks to the fifth bullet point as well. To the last bullet point, we continue to grow tangible book value up 20.6% year-over-year. Joelle, we'll stop there and take questions.
Thank you, Mr. Turner. The floor is now open for your questions. If you would like to ask a question at this time, please press star one on your touchtone phone. Analysts will be given preference during the Q&A. Again, we do ask that while you pose your question that you pick up your handset to provide optimal sound quality. Your first question comes from Jared Shaw with Wells Fargo Securities. Your line is now open.
Hi, good morning, guys.
Hey, Jared.
Good morning.
Just maybe if I could start with on the deposit side, another quarter where you're able to see deposit growth outpace the loan growth. Do you think that we've turned the corner now? If we look at whether it's year-over-year average deposit growth or quarterly deposit growth outpacing loan growth, should we expect to start to see that loan to deposit ratio come down? Do you feel like you've gotten sort of permanent traction there, or is there still going to be some more quarterly fluctuation?
I don't think we'll see the loan deposit ratio go down. We should expect to see deposit growth through natural swell in the fourth quarter. I know I've got some, like we were talking about on the call, I've got that one large depositor whose balances will come down some in the fourth quarter. He's transferring much of that deposit into our wealth management unit. We'll have those kind of fluctuations. As far as, will we see deposits outstrip loans in the fourth quarter, I can't really speak to that. I think we've got a lot of energy around deposit growth. I think our folks are focused on it. We anticipate the fourth quarter having that swell, though.
Okay. On BHG, that's great color and, obviously it was good color on the investor day as well. Can you remind us though, as we look into 2020 with portfolio more on the balance sheet, I guess a couple questions. One, where do you think that reserve, and I know they don't necessarily call it the reserve, but their recourse accrual, where does that ultimately go as they build out that balance sheet? Does it stay in that 4.5% range, or should we expect to see that grow? Where does the revenue split between gain on sale and net interest income sort of flow by the end of 2020 once those funding lines are in place?
Yeah. I think for gain on sale to match interest income, it is going to take at least all of 2020 and probably into 2021 before we get to a 50/50 split that I think Al was talking about on the analyst day. As to the recourse obligation at 4.5%, some of that amount is tied up in prepayment losses. I doubt with the on-balance-sheet numbers, you do not necessarily need to create a reserve for prepayments, because those revenues have not been recognized yet. They are at 4.5%. I do not know for the on-balance-sheet loans whether or not it will need to be that elevated. Does that make sense?
Yep. Okay. That's good color. Thanks. Just finally for me on the incentive comp, are you close to accruing at sort of 100% based on goals, or could we continue to see that drift up as we go through the end of the year?
Yeah, we're at 115% of our target at the end of September. We think we've got a good shot at maintaining that number here in the fourth quarter. As far as what the fourth quarter accrual looks like, it'll look a lot like what we accrued in the second quarter, going into the fourth quarter, we believe right now.
Okay, great. Thanks for the questions.
Thank you. Your next question comes from Jennifer Demba with SunTrust. Your line is now open.
Thank you. Good morning.
Hey, Jennifer.
Hi. Couple of questions. Harold, you had a pretty steep increase in other fee income from 2Q to 3Q. Anything unusual in there? Is that a good run rate going forward, or is it more like 2Q?
I think it'll be a decent run rate going forward. We have some swap revenues that we booked this quarter over the second quarter, so, I'm not anticipating a big drop going into the fourth quarter.
Okay. Terry, could you talk about the rationale for acquiring Advocate Capital and what you like about the business model and your interest in other types of specialty lending companies? Thanks.
Yeah. Advocate Capital is a targeted financier for plaintiff attorneys. It is a great business and great business model. As you can see, they originate high quality loans at higher yields, not dissimilar to the way BHG does it. It's a value-added approach. In their case, the value add is that they provide accounting software that enables plaintiffs' attorneys to recapture the interest expense in the settlement proceeds. That's a thing that requires a specialized accounting mechanism to get done. That's the value that they add. As a result of doing that, they're able to capture the financing, specifically for cases. However, they have blanket liens on all the receivables of the firm. Again, it's a value-added approach to produce a higher yield from a high-quality borrower. As you know, we like those kinds of businesses.
The feel is that it's a business we understand. We know how to underwrite those loans. Not that we're the experts, they are. Again, it's just a business that we understand. Our approach is always make sure you've got some value add, not compete on price. That's what this business does. I think part of the honey for us on this transaction is they've only been
Lending products, we believe that we can perhaps enhance some of their lending products. More importantly, we can sell the full suite of treasury services, and we've got initiatives underway right now to initiate gathering deposits through that client set. On a standalone basis, we feel like it's a handsome transaction and then when you add the revenue synergies that we believe we'll get out of it's a very handsome transaction.
Will the leadership team stay in place there, Terry, and are they locked up for a certain period of time?
Yes, the leadership team does stay in place, and they are locked up, Harold, I believe for three years. Three years, Jennifer.
Thank you very much.
Thank you. Your next question comes from Stephen Scouten with Sandler O'Neill. Your line is now open.
Hey, good morning, guys.
Hey, Steve.
Nice quarter. Nice quarter as usual, it seems. I'm curious what you're seeing in terms of growth trends in your markets. I know to hit your targets, you don't really depend on the underlying growth of the markets. You depend more on your hiring activities. I'm curious how that dynamic will play out in terms of if you're expecting to see or are seeing still overall market growth, or more of your growth is truly dependent today on the new hires.
Yeah, Steve, let me make sure I'm clear. I don't have detailed information where I can say, okay, here's the %, here's how it breaks down, and so forth. I don't mind to give you what my gut feel is for how that works. I think over time, always the biggest portion of our loan and deposit generation is a function of market share takeaway. That is tied to hiring great bankers and having them move their books of businesses. Our belief is that takes probably four years' time on average for them to consolidate that book of business. Again, the people that have been hired, say, over the last four years, are still in the process of consolidating their books, taking market share, and that would be the biggest part of the growth, both of loans and deposits by far.
I think if you're looking for what is just the market condition, I think our relationship managers would tell you that just the volume growth is probably slower today than it would've been several quarters ago. I don't think it's dramatically slower, but I do think it would be modestly slower than three quarters ago, just in terms of pure economic loan growth, pure economic demand.
Okay, perfect. Very helpful. Thanks. Maybe Harold, if we're looking at the core NIM, it looked like that was helped slightly, obviously by Advocate Capital, but may have been down, maybe in the 10-basis point sort of range, ex that, with the detail you give in the slide deck around new loan yields, it looks like those were pressured down maybe 35 basis points or so quarter-over-quarter on new yields. How much downside, I guess, do you think we have from here in that core NIM based on what you're seeing on new loan yields and continued expectations for Fed cuts?
Yeah. Assuming we've got one Fed cut built in our model for December. We believe that our margin, the GAAP margin, is pretty close to getting stabilized. There's probably some more dilution to go here in the fourth quarter, but I think bond yields will stabilize. If we get two more rate cuts next year, then we'll probably have some lags, but we think that we'll be able to drag these deposits down, to help offset that. Assume one rate cut in December, we've probably got anywhere from, call it 10-15 basis points of NIM contraction at a GAAP level. With that, our purchase accounting will obviously be less impactful.
Okay. I know you've got the $38 million estimate for 2019 accretion. Are you discussing at all yet what you expect to see in 2020 from an accretion standpoint?
Yeah, we haven't gotten to that yet. It'll probably be coming out pretty quickly. We went from 64 down to 39, there'll be another probably meaningful drop. You can kind of guess where that might hit.
Okay. One last clarifying question, if I could. On the expense run rate, you were more like $133 million or so this quarter. If we took out the $ seven and a half of where you think the accrual rate will revert back to 2Q levels, is it fair to assume you think expenses will be in that mid to high $120 million level in 4Q?
Yeah, I think that's a fair number.
Great. Thanks for the time, guys. Appreciate it.
Thank you. Your next question comes from Brett Rabatin with Piper Jaffray. Your line is now open.
Hey, guys. Good morning.
Hey, Brett.
Hi, Brett.
Wanted to go back to deposits and just talk about the pace of lowering the deposit costs, and I know the CD book, part of it's wholesale. Can you just talk about, would the pace in the fourth quarter be five or six basis points on an interest-bearing cost basis, and then possibly higher as we go into the first quarter? Can you just give us an idea of the magnitude as you roll the CD book and grow the core deposits as well, kind of what you're expecting on that?
I think we should realize a meaningful decrease in average deposit rates going into the fourth quarter, or for the fourth quarter. We were at 1.25 in the third quarter in average deposit rates. We probably will be maybe as much as, call it, 10 to 12 basis points for that for the fourth quarter. That'll extend into the first quarter of next year. We're thinking we've got anywhere from 15 to 25 basis points of deposit cost reduction here over the next, call it, six months.
Okay. That's good color. The other question I had was just, Terry, you talked early in the call about the sloppy environment. I'm just curious if there are things that you're straying away from or you think is risk in the environment. As we think about 2020 in particular, do we see balance growth in CRE and C&I, or can you give us maybe some color on what you're more emphasizing given the current environment?
Yeah. I think, I would say that if you were at the Monday morning meetings where we meet with all our sales force, the messages that you would hear would primarily be around deposit acquisition and lowering the cost of funds on the existing books. That's where most of the energy and emphasis is. When you think about the credit risk, and so forth in there, I think we've communicated in the past broad areas of concerns, which would be hospitality in particular, and to a lesser extent, multi-family and urban core. Again, we don't have a hard stop on anything with the exception of hospitality. That, I would say, is primarily just because we've got all of that we want. It's not because we think the credits are necessarily difficult, but just from a portfolio management standpoint, we are at or above our concentration guidelines.
That's the only thing that's got a hard stop on it. Again, I think just to maybe help you with some insight for us, I'd just go back to the way we grow our loan book is to hire people, and so people are moving their books, and that's where the loan growth comes from. There certainly are times when we're saying, "Okay, we're not taking any more of this asset class or that asset class," but it's really more driven by the books that the various relationship managers that we hire control.
Okay. Appreciate all the color.
All right. Thanks, Brett.
Thank you. Your next question comes from Tyler Stafford with Stephens. Your line is now open.
Hey, good morning, guys.
Good morning.
Hey, I wanted to circle back on, I think, Jared's earlier question, just around the incentive comp. Did you say you're currently accruing at 115% or 150%?
1:15.
Okay.
For just your information, we have a cap at $125, so we can't go any higher than that.
Okay. I guess that would put you guys at around kind of a $41 million incentive comp expense at the baseline. Then just trying to think about 2020, what that number could look like. Should that kind of grow in the mid-teens kind of range off of a 100% accrual, just given the hiring and?
I think so.
Okay.
I think your math is good. That's probably not a bad number.
Okay, perfect. I appreciate the spot deposit cost at the end of the quarter of 1.07%. I was just wondering, Harold, if you'd be willing to share the spot margin at the end of the quarter at 9.30%?
Yeah, I wish I could. I don't necessarily know if I've got it. I can probably calculate a spread, but we still believe going into the fourth quarter, we've got some dilution in the margin coming. I'll just leave it at that.
Okay. That's fair. Maybe just a minor one within the margin. Just geographically, where are the market index deposits located? My assumption was that it was all in the CDs for some reason, but I'm just curious if you could share where those are, just across deposit product types, where those are at.
I think they're all over the place. I think they're in interest-bearing checking accounts. I think they're in money market accounts. They're to larger depositors, by and large. I'm not saying there's not some smaller depositors in there, but they're primarily to the larger depositors.
Okay. Thanks. Just lastly, just given the transition of BHG over the next several quarters from the gain on sale to the balance sheet, do you think you can maintain your profitability targets within that range over the near term as you kind of digest that transition at BHG?
Say that one more time, Tyler.
I'm just wondering, with the transition of BHG and the revenue outlook you gave there with the step down coming in the fourth quarter and then the year-over-year 10% growth, 2020 versus 2019, I'm just wondering if you can still maintain the ROA and ROE within the range that you've given just over the near term as you digest that transition.
Yeah, I've not run those calculations for them specifically, but it seems like the profitability metrics will be more difficult given the size of the balance sheet. The ROE numbers, probably not so much. They'll probably be fairly consistent. With the ROA numbers, I'm not sure.
Okay. All right. Thanks, Harold.
Thank you. Your next question comes from Steven Alexopoulos with J.P. Morgan. Your line is now open.
Hey, guys. This is Anthony Elian on for Steve.
Hey, Anthony. Hey, Tony.
Hello. Just a follow-up from me on CECL. Appreciate the color you provided for the allowance account on a go-forward basis. Have you calculated what your estimate is for the day one impact to your reserve levels?
I think the day one impact will be that, call it getting into that 70 to 80 basis point threshold. We'll probably be somewhere close to where we are at the end of the third quarter as of the end of the fourth quarter, barring any unforeseen challenges the fourth quarter presents. It's looking like that day one adjustment will be the delta between the 48 that we're at and, call it 70 to 80 that we think we'll be in.
Got it.
Yeah, after tax.
After tax. Yep. Next for me on expenses, came in a little bit higher because of the incentives this quarter. Would you still expect to improve the efficiency ratio for full year 2019 versus 2018 inclusive of the incentives in the third quarter?
Yeah, give me a second. I think what we're looking at now going into 2020 is we don't plan for an outsized incentive accrual. We'll have that savings in the plan we're looking at. We still think we've got some operating leverage to create a lower efficiency ratio, I don't think it'll be meaningful. I don't think it'll be a head turner. I'll just put it like that.
Got it. Finally, from me, your expectation for GAAP NIM to decline 10 to 15 basis points for the December rate cut, is that decline for the fourth quarter specifically, or is that the full impact from the December rate cut, so sometime in early 2020?
That would be for the December rate cut in the fourth quarter. We're not planning on absent any rate cuts in 2020, and we've just not done the sensitivity analysis around additional rate cuts in 2020. Going into that, we think the fourth quarter will be fairly close to the bottom on our GAAP margin. If we get more rate cuts in 2020, which I'm not naive, I think there's strong likelihood of that, then we'll have to go through and recount where we think our margins will go with those. We just haven't gone through that sensitivity analysis. We have, I'm just not ready to talk about it too much right now.
Okay. Thank you.
Thank you. Your next question comes from Stuart Lotz with KBW. Your line is now open.
Hey, guys. Good morning. How's it going?
Hey, Stuart.
Most of my questions have been answered already, I guess just one follow-up on the expenses. I appreciate the color on the incentive comp and kind of where you see that run rating going forward. Just looking at this quarter, operating expenses were down about $3.5 million. Anything one-time in there, and is that kind of the runway we can expect going into 4Q?
We had the write-off in the second quarter. We had some branch assets and some other assets that we charged off in the second quarter. That was primarily the reason for the reduction.
Okay. Got it. Appreciate the color. Just one, in terms of capital, now with the increased buyback authorization, you got $30 million left before year end. Do you expect to peek through that before we get to the $100 million in 2020? In terms of, do you have a plan in place? How should we model that, you utilizing that buyback in 2021?
Yeah, I think you should probably, and not to be curt, just assume that we've got $130 million left, and I got five quarters to spend it, and I fully intend to spend it.
That 30, does that expire at year end?
The 30 expires in the first quarter of next year.
Okay.
The share price will dictate a lot of that.
Yeah.
A lot of people ask us questions about what those share prices might be for us to do the buyback. To be honest with you, I think the overriding statement here is that we're going to spend the money.
Got it. I will take that at face value. All right. That's it for me. Thanks for the color.
All right.
Thank you. Your final question comes from Brian Martin with Janney Montgomery Scott. Your line is now open.
Hey, guys.
Hi, Brian.
Hey, Harold. Just a few clarifying points. The comment on BHG with the step down in 4Q to a more normalized level. If you go back to a first quarter level and you're kind of in the low 90s, your expectation when you were talking earlier is, if we look at that full year number and 10% plus growth in 2020 is how to think about BHG, even with this transition in the model. Is that correct?
I think so.
I think that's right.
Okay. I just want to make sure I heard what you said, and then just as it relates, I think you made comments about the GAAP margin, and given the accretion was a little bit higher this quarter. When you look at fourth quarter and the core margin and your impact, I guess how you think about the core margin, which was what, maybe kind of the mid 320s this quarter, how do you see the core margin in the fourth quarter playing out with the rate cuts and in your outlook for one more in December?
Well, if I get 10-15 basis points in contraction in my GAAP margin, just call it as we sit here today, the core margin shouldn't contract that much because we're not anticipating as large of a purchase accounting hit or contribution in the fourth quarter. We were at $11 million here in the third quarter. We were at $8 million in the second quarter. We think the fourth quarter is going to be less than the $8 million.
Okay. From an accretion standpoint?
Right.
I got you. Okay. The impact from each, when you guys look at it today based on what you've seen with your relationship managers, I mean, your expectation, Harold, for each 25 basis point rate cut, I guess, what do you see as the impact to the margin as you look forward, I guess, if we look to 2020 and potentially seeing more rate decreases out there?
Yeah, I think as we see more rate decreases out there, we will get closer to what we were doing back, call it two years ago. We'll find our way back to deposit rates that were significantly lower than where they are today.
I got you. Okay. Just your earlier comment about the efficiency ratio. I guess I just want to make sure that was you were talking about 2020 versus 2019 as far as kind of maybe holding its own or staying flattish.
That's right.
Full year to full year. Right. Okay. All right. Then just final thing for me was just on M&A. I guess you guys have talked about this in the past. Terry, you've outlined it. Any changes in kind of what you're seeing on the M&A front today, following the addition of Advocate here? Any other non-bank things you're looking at, or is it more bank specific today?
I would say, so let me just sort of recast what I hope we've said before. I think this is what the record would show, which is we've sort of communicated the markets we want to be in. We've communicated kind of what our M&A criteria are. We have said there are not very many deals that would meet that threshold. I think that's particularly exacerbated by relatively low share prices. Our currency is not as strong as it has been in other periods of acquisition. We said we'll go to these expanded markets, which haven't changed, either by acquisition or on a de novo basis. I think we've said on the de novo basis probably has more appeal today than at any time in our history, because of just the tremendous volume of people and talent that are in play.
That's sort of what we think about bank M&A. I wouldn't just give you a hard stop, no never, but again, I just think de novo expansion might be the best route for our company to take. I think in terms of non-bank deals, to be very honest with you, those are a little more opportunistic. Again, in the case of Advocate Capital, that's a company that we've known over a very long period of time. We participated in their credit over an extended period of time. Again, when we can find companies that have some value add in terms of financial services to clients, those are the ones that have appeal to us, and again, with an emphasis on their ability to grow at a rate commensurate with us.
Okay. That's helpful. I appreciate it, Terry. Thanks.
All right.
Thank you. Your next question is a follow-up question from Stuart Lotz with KBW. Your line is now open.
I'm actually good. Sorry about that, guys.
All right. Thanks, Stuart.
Thank you. Your next question is a follow-up question from Tyler Stafford with Stephens. Your line is now open.
Hey, sorry about this, guys. Thanks for taking a follow-up. I just want to make sure I'm understanding the cadence of the margin expectations. Harold, I'm not trying to pin you down, but just, I guess, thinking about it out loud, so the margin should be lower following the September cut. You've got the 10-15 basis points hit from the December cut that you kind of expected to see, and then there's some accretion headwinds in 2020. I'm just trying to flip that to the expectation that the margin should bottom in the fourth quarter. Am I understanding that correctly? Can you walk through just the cadence of that?
Yeah, I think that's right. I think we believe right now, barring any additional rate cuts in 2020, we think the margin will kind of flatten out in the fourth quarter. We're going to have to get more serious on deposit cost reductions, and I think we can do that. We think our fixed rate loans will likely not see further, call it, reduction in their loan yields. Right now, that's where we're modeling.
The 10 to 15, that is from the December cut. Is that right? In terms of just what you're assuming internally?
No, I think most of the 10-15 is going to come from the September cut, and we think we'll be able to cover a lot of the rate cut from December going into 2020.
Got it. Okay. That clears it up. Thanks so much. I appreciate it.
All right. Thank you.
Thank you. I'm not showing any further questions at this time. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.