Earnings Call: Q2 2019

Jul 17, 2019

Good morning, everyone, and welcome to the Pinnacle Financial Partners Second Quarter 20 19 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. 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's Financial's most recent Annual Report on Form 10 ks. 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's GA 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's financial 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. Thank you, JJ. Good morning. As we always do, I'll begin with this dashboard. As a reminder, it's particularly focused on revenue growth, earnings growth and asset quality, because we believe and have believed for a long time that short term themes like M and A or deposit betas come and go. But over time, the 3 most highly correlated metrics for long term shareholder returns are revenue growth, earnings growth and asset quality. Q2 was an extraordinary quarter for our firm, largely on the strength of fee income and specifically the fee income associated with BHG. We had GAAP EPS of $1.31 after roughly $12,000,000 in adjustments. In the press release, we highlighted the 4 adjustments of consequence, $4,500,000 in net losses on the sale of investment securities to better position our balance sheet for declining rates, a $1,500,000 loss associated with selling the remaining non prime auto portfolio, which finalizes our exit from that business, a $2,400,000 write down on land and facilities at B and C had held for potential expansion and a $3,200,000 non cash impairment charge related to the proposed consolidation of 5 offices across the firm's footprint. So because of all the noise and adjustments this quarter as well as the prior periods, many cases, the non GAAP measures better illustrate the relative performance of the firm. I know some people wonder why we began a quarterly earnings call with quarterly data that goes back to 1Q 'fourteen. And the reason for that is, as I just mentioned, over the period of time, there have been all sorts of investment thesis, periods of risk on and risk off, preference for growth stocks, preference for defensive stocks, concerns over loan growth and concerns over deposit growth, preference for low deposit betas, M and A has been in and out of favor. And I don't mean to say we don't care about any of that, but I will say regardless of all that, we are laser focused on achieving 3 things, strong revenue growth, strong EPS growth and strong asset quality. And our thesis is that folks that can reliably grow their tangible book value per share at an accelerated rate over an extended period of time will ultimately produce the highest shareholder value regardless of the various hot buttons that come and go. And that's what these charts really show. You can look at the slope on any of those growth metrics there. We've got a 31% 5 year CAGR for revenues, a 22% 5 year CAGR for EPS, a 15% 5 year CAGR for tangible book value, a 31% 5 year CAGR for loans, 29% 5 year CAGR for deposits and ROTC now north of 19% and pristine asset quality metrics quarter in and quarter out. One of Peter Drucker's more famous quotes that I've used in the past is the culture eats strategy for lunch. I think that the folks at Gallup and the Great Place TO Work Institute subsequently developed the empirical data that proves that, specifically the companies that have higher levels of employee engagement produce better sales results, lower employee turnover, which frankly is or should be a critical success criteria for most every bank, better productivity and better profitability. So in my opinion, our obsession culture is the explanation for the reliable slope on all those charts we just looked at. On this slide, you see a list of the workplace recognitions we've received in the last 12 months and the ones in the green shaded area are the ones we received during the Q2. Going back to the BNC transaction we announced in 2017, I think many assumed that because of the larger size and spread out footprint that we'd lose our distinctive culture. The truth is on a good number of the rankings, we've actually moved up since that time. We have now moved up to the 12th best workplace in the country for millennials. And with Rick Calico's leadership, we're now being recognized in North and South Carolina markets, just as we long have been in the Tennessee markets. I want to be clear, this isn't just fluff, this is how we produce those outside of CAGR we just looked at on the previous slide. I hope by now everyone's familiar with the business case we made for the BMC acquisition, our plan to transform the franchise and the success that we've had on that initiative. The plan was to continue the high growth CRE platform that BNC had and bolt on to that a C and I platform, which is the principal strength of our firm. The critical path to make that happen was to lever our ongoing recruitment confidence in order to attract and retain the best C and I Private Bankers in the market. Specifically, we said we would hire 65 of them over a 5 year period of time. And so from that perspective, the transactions work exactly like we drew it up or better. As you can see, it now looks to me like Rick Calicut and his team will surpass the hiring target by 2 fold. The environment for lifting out great bankers in the Carolinas and Virginia has only gotten better since we launched our transaction there. And we're in fact maintaining their high growth CRE platform while bolting on a highly successful C and I platform. In my experience, it's a rare thing to get this far into a transaction and still be saying, I like this deal better than the day we made it. Before I turn it over to Harold to review the quarter in greater detail, I'd like to offer my perspective on BXG. You've already seen BXG posted record results this quarter. It's my view and expectation that they'll likely repeat first half twenty nineteen results in the second half. As has always been the case, while the annual growth trajectory is fairly predictable, they'll likely always be quarterly volatility. In other words, I don't view this as a one time spike. Quarterly volumes may go up and down, but we should see similar second half of twenty nineteen compared to the first half. I want to make sure I'm clear on this. My view is that this is sort of the logical outcome for BHG. For starters, they've been on a high growth trajectory for 18 years. They were profitable all through the last downturn, I think many pipeline banks were unable to achieve. This is not an experiment. They've invested heavily in a sophisticated quant staff. In their history, they've made over 50,000 of these loans. For each of the loans, they've maintained extensive performance data. They've gathered 2 years tax returns for each of the borrowers and all this data combined with the data they source primarily from credit bureaus, put them in an extraordinary position to continuously refine their methodologies with all manner of predictive models. Harold will talk a little more about that in a minute. Over the last couple of years, I've been, I guess, amused by the various speculations about BHG selling and even the PMFP would be the buyer. We've been as straightforward as I know how to be. We've said from the beginning, we have no desire to increase our stake beyond the 49% stake that we currently hold, primarily because of the unfavorable accounting implications of consolidating their financials onto our balance sheet, including all that goodwill. We've always believed that at some point in the future, there would be a liquidity event associated with the firm. Frankly, I still believe that, but we've tried to say that key for us is the principal visionary, Al Crawford, who's the CEO of the business, simply said, if Al wanted to exit, we would want to exit with him. As a reminder, the ownership structure in practical terms has been that each of the 3 founders owned 17% each and Pinnacle owned the other 49%. Honestly, my view has been that one of the potential catalysts for a liquidity event was likelihood that one of the principals would want to exit, which might force the hands of the other owners. In fact, we now put that to rest. In the Q2, one of the founders and principals was bought out by the other 2 founders. So now Al Crawford, the CEO and Eric Castro, Head of Operations, owned 25.5 percent each, a really strong expression of their view of the future growth of the company. We still control our 49%. So it's my belief that this transaction puts BHG and its leadership in a position to continue their focus on growing this business for the foreseeable future, which in my judgment is the best outcome for the shareholders of PNFP. So with that backdrop, let me turn it over to Harold to review the quarter in greater detail. Thanks, Terry. Good morning, everybody. We've been talking about this slide for several quarters. It detailed our revenue per share and revenue per share growth. 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 basically since the Q2 of last year. Secondly, the dotted line represents the peer group's year over year growth. As shown in the chart, we continue to outpace the peers on revenue per share by a wide margin. Keep in mind, this is during a time of significant internal focus around integration of the Bank of North Carolina. While we spent quite a bit of time on managing and strategizing around the inverted yield curves, our folks remain focused on gathering clients. We're very proud of our team's efforts in the Carolinas and Virginia. We believe by any objective measure, whether it's loans, deposits, new hires, employee retention, tangible book value creation, earnings growth, we have significantly outperformed investor expectations and likely those of our peers with respect to our entry into those markets. Obviously, BHG had a meaningful influence on our 2nd quarter results. However, backing out BHG's contribution, we still grew revenue per share over the last 12 months by more than 9%, consistent with the last quarter. There's a lot of positive energy in our franchise right now. Our firm is on offense 20 fourseven. Our associates are engaged, focused and excited about our opportunities for the remainder of 2019. Now comparing Q2 2019 average loans to Q2 2018 average loans, our annualized growth was greater than 11%. We continue to believe that our loan growth for 2019 will be low double digits in comparison to 2018. In the Carolinas and Virginia, their organic loan growth in the Q1 of 2019 over the Q1 of 2018 was a similar amount between 10% and 11%. Importantly, C and I and owner occupied commercial real estate is up more than 21% year over year. Currently, they've grown their C and I and CRE owner occupied book to greater than 28% of total loans. As we look to the Q3, we anticipate loan growth to be low double digits for the remainder of the year based on current pipelines. The blue bars on the large graph detail annualized organic loan growth rates adjusted to remove acquired loans, so it's all organic growth. The green bars are peer medians each quarter. Excluding the Q4 of 2018, our firm has traditionally out respect to loan growth quarter in and quarter out. We also provide information in the small chart regarding the granularity of our loan book by loan type. We offer this information so that you can better appreciate that we're not relying on the extra large ticket sizes to hit our growth goals. The chart on the right is somewhat dizzy, but it details the impact of discount accretion on net interest income. As you can see by the goal line, discount accretion continues to be less impactful to our results at 4.7% of our net interest income in the Q2 and will continue to be less impactful in the future. We all knew that a big headwind to our GAAP revenue growth was the impact of less for less discount accretion and the primary way we're going to overcome this balance sheet growth. Anyway, the blue bars on this particular chart are obviously where our attention is and growing those blue bars is key to our ability to deliver increased value to our shareholders. Very much anticipate continued growth for those blue bars for the remainder of 2019. Capital deposit average deposit balance were up $1,900,000,000 year over year. During the year end, period deposit balances were up 1,600,000,000 Our deposit costs did increase 5 basis points in the Q2 of 2019 from the Q1 and currently stand at 1.25%. The rights like get that volume changes in the Q2 of 2019, we are at war on deposit growth, particularly low cost core deposits. We do believe the rate of change in deposit pricing is slowing, but we will still need to fund loan growth. Sourcing deposits and developing strong depositor relationships is a key business activity that has to be job 1. We believe our markets are strong and have ample liquidity and that our associates are engaged. We also believe we will find the deposits at a reasonable price to fund loan growth. That said, we'll work to fit our margins, but net interest income will trump margins at this point in the rate cycle. Next, an update on our loan portfolio composition by rate index. We continue to believe an allocation of approximately 35% fixed rate loans with maturities greater than 1 year is an optimal loan for us to manage interest rate risk over the long term. In light of the recent rapid shift in the interest rate environment and outlook, we have slowed the variable versus fixed rate mix shift with several structural initiatives, including unwinding approximately $900,000,000 in fixed and floating rate swaps and acquiring approximately $1,300,000,000 in interest rate floors for LIBOR based credit. More on interest rate risk in a second, as the spreads, it does appear with respect to LIBOR prime based loans, our spreads continue to hold in this volatile rate environment. LIBOR based loans did see some decrease in absolute pricing in the 2nd quarter, but we believe the spreads are consistent with a year ago, same thing on prime based credit. If there's a winner in this rate environment, it's fixed rate loan pricing. If you use the 5 year treasury as the benchmark, our spreads have actually widened over the last years. As I mentioned previously, we've taken some steps to better position our balance sheet in case of a down rate cycle when Fed funds occurs. We will continue to reposition wholesale funding and work our bond book to optimize the performance of the wholesale bank and manage our interest rate risk. I mentioned earlier the unwinding of the fixed portfolio rate swaps and the acquisition of loan floors. The key to all this will be the last bullet on the slide and the contribution our sales force makes to neutralize the impact of a Fed funds cut. We have met with the sales force many times to get them in a position to plan how they will communicate with clients to manage our deposit rates on a down rate cycle. We will specifically target those clients that have negotiated rates with us over the last year or so. Many of you remember that last year, we were cited as a high beta bank as rates were rising. We also believe we can be a high beta bank on the way down. With the inverted yield curve in place now for several weeks months, the speculation of a credit cycle change should a recession occur has been on investors' minds for quite some time. We have no idea as to whether a recession is likely, but what we get paid to do to manage credit risk in both good times and bad. Right now, as far as credit is concerned, times are pretty darn good. We've shown these charts before attempting to provide further insight as the granularity of our real estate book as well as the metrics we seek out for our underwriting. Hopefully, this chart provides comfort that we're not booking the very large CRE and construction projects. Credit remains at the forefront of our mind, so I hope we never appear complacent when we talk about credit. In the Q2, we experienced relatively minor increases in our classified assets and net charge offs, while non performers decreased. So credit in the 2nd quarter was steady as she owes. We too will agree with other bankers that we're not seeing any systemic issues that would cause us to be less optimistic about credit in 2019. During the Q2, we executed a bulk sale of our remaining non prime auto credit with a loss of approximately $1,500,000 If you go back a few years, we entered into that business as an experiment to see if it was a business we generate enhanced shareholder returns. We will likely, from time to time, discuss new business ventures and why we believe it's a good idea to enter such ventures as to non prime auto credit, we have exited. Now turning to fees. Fees totaled more than $70,000,000 up more than 47% over the Q2 of 2018. As Terry mentioned, BSG had a phenomenal quarter. Contribution was up 23,000,000 or greater than 200% year over year. With BHG's strong second quarter, we currently believe that their contribution for the 1st 6 months of 2019 will basically be replicated in the last half of the year, but more on BSG in a second. All of our fee businesses are having a strong 2019 with resi mortgage leading the way. As we all know, the resi environment was not helpful to residential mortgage in 2018. They've had a great first half of twenty nineteen, 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 this line of business, so we anticipate a strong second half in mortgage. Now, let's spend a few minutes on digging is exactly what contributed to BHG's substantial growth in the Q2. The box on the left is attempting to answer that question. BHG has been working several initiatives for several quarters. First, as to credit, BHG is consistently refining their scorecards and have in recent quarters added scorecards for other disciplines aimed at other licensed professionals. However, the work they've done to enhance their marketing, closing and lead distribution analytics has likely been the biggest contributor to their growth. You can see the green bars on the bottom chart and how lead flow has increased significantly over the last few quarters. This has been directly related to better targeting analytics within the 3rd party databases that BSG acquires from the various credit reporting vendors. BSG has been at this for 19 years, so they've amassed a great deal of data. They do acquire 3rd party data from the credit reporting agency, but they also enhance this data with their own historical information, which has been accumulated since they started. So they don't depend totally on other people's information. In 2012, BSG had 1 person in the data analytics group. Now they have 33, of which 5 are PhDs and with a few of those individuals having multiple PhD certifications. These professionals have developed more sophisticated tools and with these tools, BHG can better anticipate closings. Additionally, BHG routes the most profitable leads to their best sales personnel to enhance their hit ratios. So overall, as the top right chart indicates, the business model is working very well at Bankers Healthcare Group now. Another question that you might have is with all this volume as DHT loosen credit standards to allow for increased loan closings. Our opinion is that no such loosening of credit has occurred at all. From our perspective, it's about the number of ABBAS and the quality of those ABBAS. As the chart on the top left portion of the slide indicates, over time, the quality of BSG's borrowers has improved steadily from the early years of the firm. The green line on the bottom right chart details the recourse accrual they recorded on their books for substitution prepaid and other losses associated with honoring the substitution clause with banks that have purchased credit from BHT. They've been keeping the recourse accrual at about 4.5% 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 bank clients doing business with BHG. As you can see, there's been a steady decline over the last few years. 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 BSG about their credit profiles. We believe that their business model is top shelf in identifying potential clients who have the credit profile to be a good borrower for the banks that buy BHG's credit. Approximately 67% of Bankers Healthcare Group's revenue base has historically been made up of gain wholesale revenues. However, BHG also generates interest income from loans that are either currently held on BHG balance sheet or being held on their balance sheet prior to being released to the auction platform for sale of the downstream bankers. Since the second half of twenty eighteen, BSG has been building their balance sheet with on balance sheet loans with approximately $260,000,000 in loans currently held on balance sheet compared to approximately $99,000,000 as of June 30, 2018. They have been able to generate the cash required to be able to fund this loan growth. Given what has already been sold this year, their own balance sheet volume represents about 2 to 3 months of potential loan sales. Meanwhile, the green bars 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 money bars. The blue bars have ramped up with more placements either through auction or one off sales. The blue bars drive gain on sale revenues. As we look to the last half of twenty nineteen, BHG is anticipating increasing their balance sheet loans at a fairly steady pace for the remainder of 2019, potentially as high as $400,000,000 to $500,000,000 on balance sheet by year end. To accomplish this, DHT is working to secure incremental funding from various bikers who will lend into their loan closing so that DHT can warehouse more credit, but keep the flexibility to go to auction should they determine the need to do so. This represents a great choice for DSG as in that they will have the option to reduce their balance sheet in order to harvest gain on sale revenues if they so choose. For me, the auction platform is the most valuable component of DSG's unique business model. Currently, they now have more than 1,000 banks in their network. As you can see from the small text box on the chart, almost half of these banks acquired loans last year at rates and spreads that have not changed materially over the last 18 months. Their funding platform is alive and well. BHG's management spends a great deal of time on making sure that this platform is ready to acquire their loans at a competitive price. Lastly, on BSG, as you can see on the chart, BSG is expanding its product offering and such products as SBA and patient lending. They're expanding a great deal of energy into these 2 new revenue streams and we're excited to see what will come of these initiatives. Additionally, Pinnacle has been involved with credit cards for many years, and we too are looking to expand that relationship. As to expansion into lawyers, accounts and other disciplines, currently those expanded lines represent less than 10% of BHG's business, but that number was effectively 0 last year. So call me optimistic on that. One last item before I turn to expenses, BHT now employs almost 400 people, which is almost double the number of people they had in 2015 when we acquired our first investment. They employ 6 headhunters, so they hire their own people as does Pinnacle. Additionally, BHC has been cited as the best place to work on numerous occasions, so like Pinnacle, they have a strong commitment to culture and that includes delivering results. So with that, let's talk a little bit about expenses. In the press release last night, we noted 2 items related to rationalization of our branch network. 1st, we absorbed a charge to accelerate the disposition of potential expansion sites we acquired with the Bank of North Carolina acquisition. And secondly, we announced that we're looking to consolidate approximately 5 branches. 2 of those branches are in middle Tennessee and 3 are in the Carolinas. Our goal is that with these decisions, we'll be able to operate a leaner, more efficient branch distribution system. Absent these charges, expenses came in about where we thought with a run rate increase of 7% compared to the Q1 of 2019, with most of this increase related to personnel costs. Our annual incentive accrual was up $5,000,000 compared to the last quarter, causing the increase in personnel. We also are pleased to report that retention rates continue to decline, signaling 2 important things for us. Our clients can count on consistent service as employee turnover continues to shrink and our workforce engagement initiatives are taking hold in our newer markets as those associates are leaning in and buying into our culture. Finally, we're pleased to report that our efficiency ratio as adjusted for non GAAP measures was 45.9%, down from both the Q1 of 2019 and the Q2 of 2018. We've been talking about modifying our longer term operating ranges for a few quarters. Our previous metric we put in place in 2012 and believe the granularity provided by those previous measurements has served its purpose. We're opting to go with a higher level of guidance and thus we're offering operating ranges for ROA, ROTCE and tangible equity as our current guideposts. Management met with the Board in June at its annual strategic planning retreat and successfully involved with them at that meeting. For ROA, we are adjusting our operating range by 5 basis points for the new range of $145,000,000 to $165,000,000 For the Q2, we're operating above that range of $169,000,000 BHG's 2nd quarter performance was a big tailwind to our ROA in the 2nd quarter. We anticipate and I think I'm being somewhat conservative for the second half of the year that BSG's contribution will be consistent with the first half, but the level of quarterly contribution should be less in quarters 34 than in quarter introducing ROTCE and tangible equity ratio as 2 new measures that we'll highlight going forward. As you can see, we're above the range on ROTCE and in the higher levels of the tangible equity ratio. Our goal is to maintain these ratios in the top quartile of our peer group over time. We've been fortunate to have a long track record of top quartile performance and look forward to many years of similar performance. Before I turn it over to Terry, we're going to talk about EPS and tangible book value per share. We've shown these charts before. We continue to believe that we are top core top growers of EPS and tangible book value within our peer group. We're really focused on its 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 almost 20%. And as you know, EPS and tangible book value over time will produce best shareholder returns. As you can see on these charts, growth here is rapid and reliable. With that, I'll turn it back over to Terry to finish up. Okay. Thank you, Harold. I think really to sum it up, I would start here and just say nothing's really changed. This slide that you're looking at is the same slide I used to close the Q1 earnings call, trying to set expectations for 2019. You can see here that we're producing double digit loan growth. We've had a great deal of energy and focus on deposit growth. Our core EPS growth is, in fact, top quartile. We're having extraordinary success hiring revenue producers. We continue to be optimistic about that hiring landscape as we go forward. And as Harold just discussed, we continue to grow tangible book value at a rapid pace. So, JJ, we'll stop there and take questions. Thank you, Mr. Turner. The floor is now open for your questions. And our first question is from Steven Skowin from Sandler O'Neill. Your line is now open. Hey guys, good morning. Good morning. Hey, I appreciate all the color on BHG. I think a lot of that makes sense moving forward. I'm just curious if you guys have maybe concerns or bothered at all by the size of that business relative to earnings now? I mean, I think it was around 20% EPS this quarter versus 8% last quarter. So I mean, how do you think about that in normalizing maybe the contribution of that business relative to the bank as a whole? Yes, Stephen, that's a great question. You know, that's one of those things where it's difficult to go to them and say, hey, I'll need to slow this down. And we're not going to do that. We think we're going to continue to work with BHG to try to enhance the partnership. We think they've got a strong business model and that they will continue to grow. Here in this quarter, they've outgrown us. So hopefully, in future quarters, we'll level that playing field a little bit and potentially get that number back below that 20% threshold. We don't anticipate it will be 20% for 2019, but it likely will be pretty close. Okay. Okay. That's helpful. And then just Harold, I might have missed some of your commentary there on the NIM. And obviously, you've done a lot to reduce the asset sensitivity this quarter. Do you have any further plans to kind of continue to reduce some of that rate sensitivity in the coming quarters? Or did you get most of that done? And will you be putting out a new kind of NIM target moving forward or is that not in the cards? Yes, I don't think we'll be putting out any more NIM targets. I think the key to our ability to hold our core margins will be whether or not we can get our sales force to get those rate decreases that we anticipate will occur. Right now, they we feel like that's going to happen. We feel like they're in contact with their clients currently and that we should be able to accomplish it, whether it's 25 or 50 basis points. We're optimistic about that. We'll aim at those negotiated rates that have been escalating over the last, call it, 2 years. Yes. No, that makes sense. And I would think that good really strong C and I growth you had this quarter should help some of that core deposit growth normalize moving forward. Is that fair to assume? Yes. I think traditionally, especially in Tennessee, our deposit flows are such that we will create growth in our core deposits over the last half of the year in comparison to the first half of the year. So our thoughts are that we'll get that money. Okay, nice. And then one just last kind of clarifying question. I noticed, it looks like Memphis and Chattanooga have been really strong contributors to loan growth year over year. But then I noticed Memphis seemed to have kind of an outflow from a deposit perspective year over year. Is there anything worth noting there? Or can you give any color as to what kind of is driving those numbers in the direction of those combined? Yes. Memphis, I don't know if you remember last quarter we talked about some strategic moves we made with respect to a particular depositor or 2. One of those depositors was a Memphis deposit. And I think it was a $250,000,000 deposit that we eventually thought was too high and moved that money off our balance. Perfect, perfect. Very helpful. Thanks guys and congrats on a great quarter. Thanks, Steve. Thank you. Our next question is from Brett Rabatin from Piper Jaffray. Your line is now open. Hey, guys. Good morning. Hi, Brett. I wanted to first just, I guess go back to BHG and think about their product set and talk about, is that fully built out here? And then if so, are the numbers sort of in there in terms of they've developed all of that and it's already operating through? Or could you have additional leverage from what they've been doing with product set? Yes. They're looking at other disciplines to go after to expand the product set. But I think what they're going to focus on are these new disciplines around lawyers, accountants, engineers, insurance guys, all that all those new disciplines are going to try to kind of figure out ways to get more mail to those particular disciplines and try to expand those first before I think they go into other type disciplines. Does that make sense? That does. And then the other thing I was curious about was I thought you guys might decide to update your revenue producer goal, but you're obviously getting close to being where you wanted to be by 2022. I was just curious if you might update that slide and how you're thinking about net adds from here? Yes. Brent, just to be clear, I always try to create a clarification. We talk about 2 sorts of targets. 1 is revenue producers in general, which is all manner of revenue producers, relationship managers, brokers, insurance agents, mortgage originators and so forth. So we talk about that. The slide that we've used over the last period of time is tied specifically to the C and I and private banking relationship managers that we targeted in the Carolinas and Virginia in order to transition BNC from CRE platform to C and I platform. And so as you hit there, I think what I tried to say in going through that slide was that we'll exceed that target twofold. I don't guess I technically changed the number, but there's no intent to sort of say, okay, now we've hired our 65, we're done. I think the expectation is that we'll continue to hire at a similar pace for the foreseeable future. Our outlook about hiring, particularly in the Carolinas and Virginia is we're very optimistic. There is, I guess, a high degree of vulnerability. Most of those large banks out there, there are a lot of people moving around. And the principal contributors in that market thus far, the number one contributor to us has been Wells Fargo and we would expect that to continue for quite some time. Okay, great. Thanks for the color and congrats on the quarter. Thanks, Brett. Thank you. Our next question is from Jared Shaw from Wells Fargo Securities. Your line is now open. Hi, good morning. This is Timur Braziler filling in for Jared. Hi, Timur. Hey, guys. Maybe the first one on expenses. Just wondering what percentage of the incentive accruals are now baked into numbers? Are we nearing 100 percent or is there additional Yes, we are. We're nearing 100%. Right now, we're counting around 85% to 90% of the target incentive. So at the end of Q1, it was around 75%. So there were some catch up in the second quarter. Okay. And then looking at the linked quarter growth in time deposits, any color around that? It's pretty big numbers. Is that shorter term that you're going to be looking to replace? Or I guess just any color on the growth in time deposits? Yes. Not any kind of meaningful color. There obviously are more, depositors coming in, want to keep money for a longer period of time. And most of that's occurring in the Carolinas and Virginia. So it's not a significant move for us, But it is, I think, kind of consistent with what others are experiencing with kind of these consumer books. Okay. And if I can just ask one more on BHG. The charts are all showing up into the right and I think you guys mentioned that as part of their ongoing strategy, they're going to be portfolioing more of the loans that they originate. Does that change the risk profile at all? Or I guess with them growing their balance sheet, how does that make you guys think about the risk profile of that institution? Yes, I don't think it changes the risk profile at all. They've been honoring the mayop clause for substitutions. And so now we just move over as to an on balance sheet loss. So we're not thinking there's a significant change with respect to their credit profile. Okay. And any color you can provide on the 1 partner's exit? I'll just say this. I think Bobby just came to a point where he was he had expended a lot of energy into BHG and that he was ready to go into the next step of his life. And there was no animosity or anything like that. It was just he was ready to go. And Al and Eric and Bobby all worked the transaction and we Pemphill considers it a fabulous thing where our 2 partners bought out the 3rd partner. And so I think from an operating perspective, BHG is as healthy as it's ever been. Great. Thank you. Thank you. Our next question is from Brock Vandervliet from UBS. Your line is now open. Great. Good morning. Hey, good morning. Hey, good morning. Hey. Just to follow-up on that deposit, the CD question, most of that growth coming Carolinas and Virginia. It sounded in your prepared remarks, Harold, that we should expect better core deposit growth in the second half? I just wanted to sort of triangulate that with the strength in CDs. Yes, I think we should see stronger client core deposit growth in the second half and we lean on the Tennessee footprint primarily for that. That's been kind of the traditional year in and year out move for our depositors this footprint is that during the first half of the year, deposits will either dilute away or be slow and then in the second half of the year is when they build balances for incentives and taxes and those kind of things. Okay. And I guess more importantly, just looking at that Slide 14 in your asset sensitivity and one of the few institutions that seems that is beat and repositioned this quarter. Could you walk through some of those repositioning moves you made, the cost of them and whether you're done at this point? I think for all practical purposes, the wholesale bank has pretty much gotten through all it's going to do. There are still some bond transactions that are closing here in the early part of Q3. But I think and when we speak in terms of the wholesale bank, we're talking about the bond book and wholesale funding. The unwinding of the $900,000,000 fixed floating rate swap, I think that cost was around 33 basis points and that will be amortized off over the life of the underlying loans. The floors that we acquired were, I think, somewhere around 35 basis points and I think that's a 2.5 year product. So those are kind of the nitty gritties about that. Again, I can't overemphasize, the key to all of it will be our sales force's ability to lower those client deposit rates. Got it. Okay. Thanks for the color. Thanks, Rob. Thank you. Our next question is from Michael Rose from Raymond James. Your line is now open. Hey, guys. Just wanted to go back to BHG again. So if I take your comments, Terry, about the second half of the year kind of replicating the first half of the year that puts you at somewhere over 90,000,000 dollars in BHG income, perhaps a little higher. As we move forward into 2020 and given the fact that you've or that they've expanded the customer base, so to speak, I wanted to get a sense for, A, is there any differences in the different product categories that they're going after? Because if memory serves correct, the loans to doctors and dentists were somewhere in the mid teens in terms of yields. Just wanted to see, A, if there was any differences between the different sets of clients and B, if you actually think you can build upon that 90 or 1,000,000 or so revenue as you move into 2020? Yes, Michael, I'll take it. I don't know of any meaningful differences and what the top line rate charge those borrowers may be for those different disciplines. I don't think there was any kind of initial kind of rate special they offered, any kind of lawyers or accounts or anything like that. I'm not aware of that, but I'm not totally into the details with respect to that particular issue. As far as looking into 2020, I'm imagining that we're talking about $90,000,000 for this year. For them, that's 180,000,000 dollars I'm sure Al will be targeting at least 10% for 2020. Okay. That's helpful. And then as it relates to the additional hires that Terry that you mentioned, I think perhaps a 2 fold increase above your original guidance. How should we think of that in terms of expense leverage and efficiency from here? Clearly, this is one of the best quarters from an efficiency perspective that we've seen from you guys, if not ever, obviously, helped by the BHG quarter. But how should we think about the ability to operate an efficiency at least close to this? Or is it or should we expect it to move higher just given the projected lending hires? Thanks. Yes. Well, it's a good question. I think you don't have expectation that if it's not producing operating leverage, we'll stop it. I think we believe that it will continue to produce operating leverage. That's really been our history, as you know, going back to 2000. Our approach to hiring begins with hiring revenue producers. There's great profit leverage in those. In round terms, we generally have to hire 2 support people, either direct or indirect for every revenue direct for every revenue producer we hire. So that tail follows. And the operating leverage that comes from that model right there has been positive since the get go. Since we announced that hiring 65 people and sort of ran twice as fast as we said we would, you have seen that we've continued to have a declining efficiency rate, a better efficiency ratio during that period. And so my expectation is that we'll continue to produce operating leverage with the hires. Okay. Maybe one final one for me. So you guys purchased a little bit of stock here. Looks like you got somewhere in the order of $42,000,000 or so remaining under your current plan. Would the expectation be to use that and given that your targeted capital ratio is higher than currently is higher than where your target is, could we expect to see another share repurchase program announced when this one finishes out? Thanks. Yes, I think we're likely to kind of keep 1 on the shelf. I don't know if we'll be as aggressive with share repurchase going into 2020 or not. But I think it would probably be a good idea for us to make sure that we've got the authority to go back to the market and buy shares next year. Okay. Thanks for taking my questions. Thanks, Mike. Thank you. Our next question is from Jennifer Demba from SunTrust. Your line is now open. Thank you. Good morning. Hi, Jennifer. Question on the increase in classified assets, was that related to any certain loan or industry? And Harold, just wondered if you have any updated CECL guidance. I know you gave some preliminary thought last quarter, wondering if that's changed at all? As far as classified assets, I don't think there were there's not any kind of industry or group of credits group of unrelated credits that's causing that increase. So I can't really, I can't conclude, there's no indication there that a segment of our portfolio is beginning to weaken. As to CECL, the way it's kind of calculated out now is, it's probably going to be, call it 70 to 80 basis points, maybe somewhere in that range. Now some of that is that accounting entry where we're beefing up loans and beefing up the accrual for purchase credit impaired. And so that's additive to that ratio. So Jennifer, I don't know if that's helpful to you or not, but that would be So just to clarify increasing the loan loss reserve by 70 to 80 basis points. Yes, 270 to 70 to that number. But as part of that, there's the transfer of the reserve on the PCI loans that goes into the allowance account. So that does impact equity. Okay. Thank you so much. All right, Jennifer. Thank you. Thank you. Our next question is from Tyler Stafford from Stephens. Your line is now open. Hey, this is actually Andrew Terrell on for Tyler this morning. Good morning. Hey, Andrew. Maybe just to go back to BHG, just given the discussion around the liquidity event earlier, what was the valuation that the 2 remaining owners purchased Mr. Castro's 17% stake at? The valuation that was used was $1,000,000,000 And I think, if you were talking to the acquiring parties, they would be quick to say that's based on 2018 revenues. And so they believe that they've made a very good deal for that additional 17% interest. Great. And that was $1,000,000,000 for the entire business or just the 17% just to clarify? No, no. That's $1,000,000,000 for the that's the franchise value that was used. Got it. Okay. Thank you. And then maybe just going back to the comments about BHG adding funding sources, so that they can balance sheet more loans. Will Pinnacle be one of the potential banks that provide funding for BHG, just to allow them to keep those loans on the balance sheet? No, that would not be our intent. Okay. And then maybe lastly for me, just looking at the ROA guidance, what was the driver to lowering this guidance by 5 basis points given the strength in BSG? Does it now assume any Fed rate cuts? And if so, how many and when? Yes. I think the lowering the guidance was there were several factors involved in that. And first of all, we're only lowering it 5 basis points. And I think generally that's still going to be in a top quartile or near top quartile kind of number. But the DHT had a phenomenal second quarter, so that was a strong tailwind to our ROA number. We're not anticipating replicating the Q2 into the Q3. We're thinking that's going to back up probably, I don't know, dollars 8,000,000 to $10,000,000 to $12,000,000 here in the 3rd quarter. So that will impact ROA. Now as the rate cuts, we're still anticipating a 25 basis point rate cut in July and then another one towards the end of the year. So we believe that it will take us some period of time to absorb that rate cut with our depositors and with our sales force contacting those depositors. So we're trying to hedge our bets a little bit. We think over time, we'll be able to bring that ROA back. But in a down cycle like that, it'll we'll have to spend some time to get that pricing back to where we want it. Understood. Thanks for taking my questions and congrats on the quarter. Thanks, Andrew. Thank you. Our next question is from Catherine Mealor from KBW. Your line is now open. Thanks. One more question on the margin. Harold, is it fair to say that well, maybe here's the question. Would you say that this quarter could be the bottom in the margin given all of the moves that you've made to kind of protect yourself if rates do go lower? Or do you feel like if rates are cut, we've got a couple of quarters where to your point, it's going to take some time to get your sales force to reduce the deposit costs. And so maybe you have a couple of quarters where you see some more downside and then things kind of stabilize at a lower level from here? Kind of trying to think directionally from this lower level than we have this quarter where we're going. We're limited in some comments on this, but many people are counting a core margin, which would be without discount accretion of around, call it, 3.30, 3.31. So we think that's pretty close to a bottom number. We can run different scenarios that show it going less and we can run different scenarios, but we're that's showing going up, but we ought to be getting pretty close to that model. Down. That said, with a rate decrease and depending on the significance of the rate decrease, that margin could suffer over a period of time as we work to get those deposit rates lower. So as part of our modeling, and I think this is true for every bank, is that in a write down environment, you're going to depend on some decrease in deposit rates over and above what sheet rate deposits may do for you. So there's obviously our ability to go into our systems and lower deposit rates on a wide variety of clients. But a lot of our clients have negotiated rates where we've developed relationships with those clients and we'll honor those relationships with a conversation. Got it. And then taking a step back to just thinking about just core spread growth, so take out some of the movement in accretable yield. Historically, you have been able to grow your core spread at a double digit pace. Even when your margin was under pressure, when rates were moving higher, I feel like the growth was a little bit higher than it is today and you were still able to grow core spread by double digit. The 1st couple of quarters of this year, the core spread growth has moved more to a mid single digit range, it was 2% last quarter, 7% this quarter. Are we in a period of time where core spread growth is more in the single digit range or do you feel like you have the business model where that can improve back to the double digit range at some point in time? Well, we think the business model is still intact and we think we can continue to grow that spread revenue. Going back to some discussions we had last year with loan growth, this quarter was we had a strong loan growth quarter. And with that, we funded probably with higher price deposits than we think we will fund over a longer period of time. So we still think that spread revenues, core spread revenues can grow in that low double digit or mirror what we think our loan growth goals should be. We're not seeing any kind of issue or new item that would come to the forefront that would say that we that would challenge our business model to the point where we need to back off of what we think the resulting margin should be for us. Got it. Okay. That's helpful. Thank you. Thank you. Our next question is from Brian Martin from Janney Montgomery. Your line is now open. Hey, guys. Hey, Ryan. Hey, Harold. Just a last just following up on the margin. Your outlook going forward, I mean, what's the scenario where the margin you talked about some kind of bottoming here, but maybe a little of upside, a little downside. The potential to have it go up from here, even if it's modestly, I mean, is it just your comments about these negotiated rates? I mean, what percentage of the deposits are currently negotiated with clients as opposed to kind of sheet rates are tied to an index? Well, yes, it's a large number that are negotiated. It's about 34%, something like that. That we'll have to kind of go at what I was trying to think of was, in our planning assumption in these write down scenarios is that our beta target for these clients is somewhere around 50%. So we don't necessarily need to get 25 basis points out of these negotiated rate clients. We need to get half of that. And that's what we're coaching our sales. Okay. And I guess as far as the success, I mean, I guess are you seeing success in that so far? I mean, obviously with the change in rate outlook here, I guess I don't know how long you've been at it, but just kind of early indications of how that's progressing. I mean, maybe it won't all be in there obviously in Q3, but I guess the you'd expect to see some I guess, how much did you expect to see of that improvement or potential improvement in 3Q versus maybe all of it in 4Q? Is that kind of how you're thinking about it here? Yes. Well, we're optimistic if you get a rate decrease in July that we can get all of those clients, all of those accounts managed down before the end of the quarter. Now it will take the average, the averages won't work out just right, but hopefully by end of period, Q3, we would have that challenge met and achieved. Okay. And then just going back to the kind of expenses and efficiency, just kind of how you guys are thinking about that going forward. I think you said expenses were kind of as you expected this quarter. I mean, just thinking about, let's say, full year efficiency and how you're thinking about that relative to last year. It sounds like you still expect full year 2019 core efficiency to be below last full year 2019 to be below 2018? And then that still seems kind of the outlook that's a fair outlook at this point? Yes, I think so, Brad. I think we still have room to improve that efficiency ratio this year. Obviously, the Q1 is very helpful to that. But for the rest of the year, we ought to beat last year. Okay. All right. I think that's it for me. I appreciate it. Thanks, guys. Thank you, Brent. Thank you. Our next question is from Brett Rabatin from Piper Jaffray. Your line is now open. Hey, guys. I just had one follow-up. Wanted to ask, I'm thinking about different loan segments and I know you've in the past said maybe you don't want to do more hotels. I'm just curious if you're looking out at the risk spectrum, is there an asset class that you view as something you don't want to do more of today? And is there anything out there that you're seeing in any of your markets that give you any pause? Yeah, Brad, this is Harold. Talking to Harvey and our credit guys, right now, I don't think there's a particular asset class that we've looked at and said, we'll shy away from the deal. We are full on hotels. So it's not that we think that asset class has weakened from a credit perspective, it's just our concentrations at the point where we're not we can't put any more hotel loans on the books without hotel loans paying off. So and we'll do that as that as those payoffs occur. Multifamily, I think we're still interested in garden apartments out in the suburbs and good school districts. We're less those kind of things. So I can't really say there's a specific asset class that Harvey and our credit administrators had pointed to say, we're out of that. Okay. And then maybe one other quick one, just you guys have always had a really strong growth outlook and I think you've got the runway for the next few years and you've talked about Atlanta in the past. Maybe is there any updates you could give us on sort of things you might have in the works or what your preference would be as you continue to expand the franchise? Yeah, Brad, I think we have we sort of published a map that gives the geographic markets we have an interest in. I think as it relates to M and A, our approach is, 1, trying to identify who the target are that meet all the criteria and I'm happy to walk through those criteria with you, if you like, but we've published them in terms of urban, rural and commercial, not retail and 3% to 5% earnings accretion. If it's a small deal, 8% to 10% earnings accretion, it's a big deal. So we try to figure out who those targets are, know the people, cultivate relationships and get in a position in the event those banks desire to be acquired, to be the acquirer in a negotiated transaction. That's really what our strategy is. And so, it's difficult to say, okay, well, we've got this plan and we're marching down and we're going to get to this market through acquisition and that market through acquisition and so forth, because it's really, we're every deal we've ever done has been a negotiated transaction with somebody who wants to sell us their bank. And so anyway, as I say, we've sort of published our guidance. I think that all remains consistent. I think beyond that, we've always said we could go either by we could do market extensions either by acquisition or de novo. And so I think de novo has a lot of appeal, particularly given the such great volatility or great vulnerability at these large regional banks in some of the markets that we want to get to. And so I think in that vein, we've identified, Atlanta has been on our list for a long time, but I think the merger activity down there has created more vulnerability and therefore enhanced the likelihood that we find our way to Atlanta. So anyway, I don't know if that's helpful to you. Yeah, no, it's really helpful. I appreciate the color. Okay. Thank you. Our next question from Nancy Bush from Nav Research. Your line is now open. Good morning, gentlemen. Good morning, Nancy. Two questions for you. The first on this issue of renegotiating rates. I appreciate that you've got a very dynamic sales force and they're going to go out to their clients and tell them or talk to them about the need to give something up in bad times. But I guess if I were one of those clients, my question would be, okay, what do I get for doing this? So if you're going to get a lesser rate, are you going to have to give up something in fees? Is there going to be some kind of offset here? Yes. Nancy, I think, I understand the question and it has a good basis, but let me see if I can characterize how I would envision the process working. So as Harold has already indicated, 34% of our deposits are negotiated rates. I don't know what other banks percentage would be, but I won't guess we're probably 2x most of our peers on that sort of measure. In other words, the percentage of negotiated rates would be higher here. And it has to do with the fact that our client base is such a relationship managed strategy as opposed to a mass market strategy where you price an operating sheet and those kinds of things. And so I think if you go back and look at our history, we had we've marched the rates down in previous periods. We've moved them up as rates have gone up. We've been characterized as a high deposit by the bank. And it just gets back to every for that 34%, no rate is going to change until somebody is talking to somebody on the phone saying, hey, here's what we need to do. But my belief is I'm not saying nobody would say what you just said, I'm sure somebody would, but I don't think that's going to be the prevailing discussion. I think it's going to be, hey, let's work together on this and what seems fair. And so, to Harold's point, you're looking for a 50% beta, you're not looking to get it all. You're looking to work it down and there'll be some people you'll get it all from and some people you won't get any from and you just have to work through that. But again, our experience in both the down rate cycles and up rate cycles, we've been pretty effective at moving those rates based on this technique. Again, just to help you get it, somebody asked a question earlier about, I think it was Brian Martin asked a question earlier about why is it going thus far. We're not negotiating rates down today. What we have done is put the list in front of everybody and we've begun the discussion through the sales management change on, hey, what about this client? What do you think the right target is here? Those kinds of things. And so there's sort of a predetermined agreement about what the right targets are. And that effort will begin when you get a movement rates. So anyway, I guess what I'm trying to say is, I'm certain there'll be a conversation or exactly like the one you illustrated, but I don't believe that will be the preponderance of the conversation to give. I just think it will be more negotiation back and forth here on how low can we move the rate. So you don't believe that non interest income will suffer any meaningful impact as a result? I do not. Okay. Secondly, I mean, there's been a lot of talk about BHG this morning. And obviously, the percentage of your income that's coming from BHG is something that gets discussed a lot in the investment community, etcetera, etcetera. And as you said, there may be periods when you go over 20% and particularly if BHG is successful with this new product set, new distribution strategies, etcetera, etcetera. Is there any philosophical or structural reason, let's say you've got an out year here where they're doing very well, but the banking business is slowing, that you say, okay, we will let BHG contribute 20% to the bottom line and anything over that will pay out in a special dividend. Would that alleviate some of the concerns about BHG? Yeah, Nancy, it's Harold. I don't know. What we're trying to do this morning is make sure that, A, people are informed and B, people understand that Pinnacle Bank is excited about this partnership and where it's headed. How it impacts our strategic positioning or tactical initiatives or how we go about capital returns and all that, We will obviously consider all that information. But right now, what we want to do is try to get people to start thinking about BHG as a core component of our growth and not some extension or something that's ancillary to us that we're going to work this partnership even harder on the go forward. And we're excited about what opportunities it presents for us and they're excited about the opportunities it presents for them. Okay. All right. Thank you. Thank you. Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.