Good morning, everyone, and welcome to the Pinnacle Financial Partners' fourth quarter 2017 earnings conference call. Hosting the call today from Pinnacle Financial Partners is Mr. Terry Turner, Chief Executive Officer, and Mr. Harold Carpenter, Chief Financial Officer. Please note, Pinnacle's earnings release and this morning's presentation are available on the investor relations page of their website at www.pnfp.com. Today's call is being recorded and will be available for replay on Pinnacle's website for the next 90 days. At this time, all participants have been placed in a listen-only mode. The floor will be 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 and uncertainties and other facts that may cause the actual results, performance, or achievements of Pinnacle Financial to differ materially from any results expressed or implied by such forward-looking statements. Many of such factors are beyond Pinnacle Financial's ability to control or predict, and listeners are cautioned not to put undue reliance on such forward-looking statements. A more detailed description of these and other risks is contained in Pinnacle Financial's most recent annual report on Form 10-K. Pinnacle Financial disclaims any obligation to update or revise any forward-looking statements contained in this presentation, whether as a result of new information, future events, or otherwise. In addition, these remarks may include certain non-GAAP financial measures as defined by SEC Regulation G.
A presentation of the most directly comparable GAAP financial measures and 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'm now going to turn the presentation over to Mr. Terry Turner, Pinnacle's President and CEO.
Thank you, operator. Good morning. We appreciate you being on the call with us this morning from snowy, icy Nashville. We always begin our quarterly earnings call with this dashboard, really two slides, the first reflecting the GAAP measures and the second reflecting non-GAAP measures. We like this dashboard because it quickly highlights performance and momentum, virtually all the measures that we use to drive our business. We've always believed that revenue growth, earnings growth, and asset quality are the three metrics most tightly correlated with share price performance, and so that's really the focus of the slide. Companies that grow tangible book value typically grow their share price. Companies that consistently produce well above million ROTCEs typically trade well above the million PE multiples and so forth. I think in our case, we're roughly an 80% spread business.
Balance sheet growth is really the key to the revenue growth going forward. You've got a chance to look at revenue growth, earnings growth, and asset quality, and some ability to see the pace of growth and the future growth, based on what's going on in the balance sheet. As most of you know, this quarter was meaningfully impacted by pre-tax merger related charges of $19.1 million, pre-tax security loss of $8.3 million, and after-tax charges related to the revaluation of our firm's deferred tax assets of $31.5 million. As I say, each quarter, at least for me, given all the transition, the merger integration, and now the tax law change, the non-GAAP measures that take these realities into account actually provide greater insight into the core run rates on these important metrics. Let me move to those quickly.
Looking at those non-GAAP measures, adjusting for the merger related expenses, the revaluation of our deferred tax assets, and the loss associated with the restructuring of roughly $300 million in our bond book. Since the arrows are all nicely sloped in the right direction, I won't walk through each metric. I do want to point out two. The first one is ROTCE on the first row. I think most of you will recall, in conjunction with the BNC acquisition, and to support the future growth needs of the firm, we issued 3.2 million shares on 27 January 2017, totaling $192 million in net proceeds. We had a partial quarter impact of those additional shares in Q1, full quarter impact in Q2, and as you can see, it is now escalating quickly, already back to a 16.11 ROTCE.
Secondly, just below the ROTCE chart, tangible book value chart, as I've already commented on this call, the correlation between tangible book and share price is obvious. We take it seriously, and again, as you can see, in conjunction with our acquisition, we have continued to grow it nicely. Those of you that have followed our firm for any length of time know that coming out of the recession back in 2011, we published our profit model and associated performance targets. I think over the years after we achieved the initial targets, we've actually increased our ROA target twice since then to its current level of 1.3%-1.5%.
In conjunction with the ROAA target, we continue to publish the targets for the four key components that lead to that overall level of profitability, and specifically, I'm talking about the margin, the expenses to assets, the fees to assets, and the net charge-offs. As you can see on this slide, which reflects both the GAAP Fourth quarter 2017 was another good quarter with a non-GAAP return on average assets of 1.36%. With the exception of the fees to assets, the component measures are all performing pretty well against the targets. Those non-GAAP measures are adjusted for merger related expenses, investment gains and losses of sales on security, and the revaluation of our deferred tax assets in the fourth quarter, as a result of the tax law change. I might just comment quickly on the target range for each of those measures.
As most of you know, we conduct a strategic planning process each year in the third quarter. This year's plan focused on the remainder of 2017 through 2020. In this year's three-year plan, we didn't alter the overall target range for ROAA. It remained at the 1.3%-1.5% level. We did, as a result of the business mix changes associated with our BNC acquisition, adjust the target range for margin up to a range of 360 to 380, expenses to assets down to a range of 1.8 to 2.0, and the fees to assets down to a range of 0.9 to 1.10. It has been, and it continues to be my strong belief that the revenue potential in the BNC footprint is very strong, particularly as we build out the C&I platform and leverage our wealth management businesses there.
As I've indicated before, I'd expect it may take six to eight quarters before we build into that target range for the fees to asset components. Nevertheless, we intend to take advantage of the outperformance that we're likely to have on the other three components to enable us to still operate in the high end of the ROAA target range until we muscle build the fee generation capability in the BNC footprint. Additionally, we'll now go back and recalibrate the targets in light of the Tax Cuts and Jobs Act, expecting a further meaningful lift in the ROAA target range. I might just comment here, fourth quarter 2017 was a huge quarter in the history of our firm. We continued the rapid growth in earnings, balance sheet growth, both loan and deposit, and hiring. We did all that in the middle of completing the BNC integration.
Our troops have really worked tirelessly to get that transaction done, completed, all the systems converted, during the fourth quarter of 2017, generally consistent with the timeline that we laid out at the beginning. We now believe that we're fundamentally through with producing the synergy case that we had originally indicated. There are a few associates that are still on the payroll that will depart early in the first quarter, having now stabilized systems and all those kinds of things. Perhaps a few merger related charges in the first quarter as well, but generally all the work has been done. I think the second thing I always try to hit on in these calls is our aggressive hiring plan. You can see there on the slide, in 2017, we added 77 revenue producers to our roster.
27 of those were in the BNC markets, and that's 13 of those 27 since the closing of the merger. That's a really important thing. In addition to hiring the revenue producers, we hired the support staff that are needed to support those people and to get all of that done inside our operating targets for expenses to assets and so forth, I think, will help people understand how we drive our revenue growth and efficiencies going forward. Again, I would say that the third quarter was a strong loan and deposit growth quarter. Both loan and deposit growth were good. The deposit growth was a highlight, in particular. Again, I think most of you've heard me talk about this in the past. I think for any community bank, the ability to grow core deposits is the principal measure of its ability to succeed over time.
To produce the balance sheet growth at those growth rates in the middle of taking on the most monumental system and operation conversion that we've ever undertaken, really bodes well as we move into 2018 with that now in the rear view mirror. I want to make one more clarification for you, just again, trying to set the stage as we go forward. Over the years, I've always talked about revenue producers, and of course, revenue producers include relationship managers, brokers, mortgage originators, trust administrators, and so forth. I think most of you know we think of ourselves as a revenue growth company. Consequently, our ability to hire people is the key to that revenue growth. Again, just trying to draw distinctions. I know a lot of companies are trying to manage expenses down. That's not really our approach.
We're trying to manage revenues up. I do think as I make those points, I do detect in some people a skepticism or maybe better said, a concern that, hey, that build-out is going to drive the expense levels too high. I guess I just want to reiterate that we get this hiring done inside the expense to asset targets that we've set. As you can see in 2017, hired 77 revenue producers and finished the year with a non-GAAP efficiency ratio of roughly 47% and a 1.87% expense to asset ratio. Again, just trying to clarify that we don't view the adding of the people to be an expense bill. We view it to be a revenue build.
One other clarification on that point, even though we typically talk about all the revenue producers, there's no doubt in the North Carolina footprint that really, the exponential growth we expect to achieve there has to do with continuing the growth rates that they've enjoyed for a long time in the commercial real estate business, but really adding to that a C&I practice that's substantial. We have communicated in the past within this category of revenue producers that we intend to add 64 C&I or private banking financial advisors over a five-year period of time. Again, we'll continue to report on that so you can see our progress on that because of the strategic importance of that initiative. Harold, I'll stop there with the overview and let you take it for the details.
Thanks, Terry. Revenues excluding securities losses for the quarter increased from $216 million in the third quarter to almost $220 million in the fourth quarter. Total spread income increased $1.4 million between the third and fourth quarters. Discount accretion decreased $1.3 million during the quarter. Thus, that offset the overall spread increase. As always, the dark green line on the chart denotes revenue per share. We reported $2.80 adjusted revenue per share in Q3 and are reporting $2.83 this quarter, again, excluding investment securities losses. Obviously, our goal is to continually increase our revenue per share over time. As you all know, it's a lot easier to grow earnings per share with a growing balance sheet, and we think we have a great shot at doing that as we enter 2018.
As to purchase accounting, as many of you know, purchase accounting will be impacted for an extended period of time but should gradually lessen over time. We have approximately $163 million in loan discount accretion, of which a significant amount is expected to amortize and ending over the next two to three years. We recognized $19.1 million in the fourth quarter and anticipate at least $15 million-$18 million in loan discount accretion in the first quarter of 2018. That said, it's important to realize that our balance sheet produces outsized growth, which continue to produce ongoing positive traction for our revenues in the future. Concerning loans, as the chart indicates, average loans for the fourth quarter were $15.5 billion, compared to $15 billion at the end of the third quarter, or an increase of $500 million in average loan balances, or an annualized growth rate of better than 13%.
We believe we had a strong fourth quarter, particularly in Tennessee, where we saw increased loans of $308 million. In the Carolinas and Virginia, their organic loan growth was approximately $66 million in the fourth quarter compared to $61 million in the third quarter. Thus far in 2017, including the $330 million of net organic loan growth, the Bank of North Carolina posted prior to our merger, the two firms have produced net loan growth in excess of $1.7 billion in 2017. This obviously excites us as we go into 2018 with the combined firm pressing forward to grow our franchise. As the chart indicates, our loan yields decreased slightly to 487 this quarter compared to 491 last quarter. Excluding the impact of purchase accounting, core loan yields were basically flat at 436 in the third quarter compared to 437 in the fourth quarter.
The mid-December Fed funds rate increase did help our core loan yield slightly and should drive a core rate increase in the first quarter of 2018 that we anticipate to be five to 10 basis points. As to deposits, again, here in the fourth quarter, we're able to grow our funding base while maintaining low funding costs. Our aggregate funding cost did increase seven basis points in the fourth quarter from the third quarter and currently stands at 73 basis points for the fourth quarter. As to the seven basis point increase, wholesale funding did drive a lot of the increase while deposit costs were up 5 basis points. As to the future, deposit costs will continue to increase at a measured pace for several factors. The two most prominent are general pressure from increased deposit rates in a rising rate environment.
We also need to fund a significant loan pipeline. Our relationship managers are out in our markets selling our ability to serve commercial and affluent consumer depositors with a value equation we think is far superior to our competitors. Funding our growth has and will remain a key focus of our firm. We are elated with $856 million in increased core deposits for the quarter endpoint to endpoint. Switching now to non-interest income. These amounted to $36 million compared to $43 million in the third quarter. Our residential mortgage group had another outstanding quarter in terms of production with approximately $290 million in loan sales this quarter at a yield spread of 2.55%. However, their contributions in the fourth quarter was down from 3Q, primarily due to the seasonality of their funded pipeline. This typically occurs at this time of the year before the ramp-up occurs in the spring.
We always expect the fourth quarter to be the most difficult quarter for mortgage as December is the worst in the resi real estate market. The spring is at hand, and we are in great residential mortgage markets with the best mortgage originators in those markets. We remain optimistic about what residential mortgage will do in 2018. As expected, we're reporting Bankers Healthcare Group revenues of $12.4 million this quarter, up $4.3 million or almost 50% from the fourth quarter of 2016. We continue to anticipate the net growth for BHG in 2018 should be in the 12%-15% range. Year-over-year, our equity investment revenues increased 20.9%. We did see a decrease in other non-interest income in the fourth quarter due primarily to losses on venture capital investments and a reduction in capital market advisory fees during the quarter.
That number should stabilize in the first quarter of 2018. As to investment security losses, during the fourth quarter, we sold approximately $300 million in securities at a loss of $8.2 million. More sales are likely, but we don't anticipate any meaningful P&L gain or loss from those sales in the first quarter. We anticipate buying back into the market this quarter, such that bonds should approach $2.9 billion by quarter end, March 31. We anticipate continued increases in short rates while long rates remain relatively stable, thus a flatter yield curve. We are buying in anticipation of these events, which equate to floating-rate securities and securities with average lives of moderate duration. Thus, we don't anticipate significant increases in the duration of our portfolio. A barbell strategy for a bear flattening yield curve.
We anticipate that this strategy should impact our net interest margin in 2018 positively by four to five basis points. Now to operating leverage. Our efficiency ratio on a GAAP basis was 58.2%, while our core efficiency ratio, excluding merger-related charges and ORE expense, was 47.2%. Our fourth quarter total non-interest expense increase amounted to $13.2 million, with merger costs accounting for $10.3 million of that increase. First, concerning personnel costs, we've got 2,100 FTEs at December quarter end, of which 844 are assigned to the Carolinas and Virginia. Salary costs are down approximately $1 million from the third quarter of 2017, which was attributable to a reduction in the Carolina and Virginia footprint as the synergy case was being deployed.
Those of you that have followed our story for many years know how our one incentive plan system works. It's based on corporate results, not based on individual sales goals. You'll remember then in the third quarter, we were accruing at less than targeted levels. We continued to work during the fourth quarter and got those reduced incentives back into our P&L in the fourth quarter. Just to emphasize the point, incentive expense and earnings are directly linked. If we hit our revenues and earnings targets, our incentive costs will increase. If we don't, incentive accruals get reduced. Obviously, one of the keys to anticipating our expense run rate going forward is how quickly the synergy case will be deployed. A critical component of the synergy case was the technology conversion, which Terry, as you spoke earlier, is now complete.
As a result, we continue to believe our synergy case will largely be fully deployed in the first quarter of 2018. We've got about 40 jobs left to come out for the synergy case to be fully realized. We experienced an overall increase in admin costs in the fourth quarter, primarily due to FDIC insurance and franchise taxes. As we look forward to 2018 and excluding any additional merger expenses, our operating leverage should improve from the 47.2% in the fourth quarter next year. Finally, taxes have become an interesting investor conversation. Lots of numbers on the slide. Hang with me. The blue part of the slide was basically discussed last night in the press release.
Excluding merger expenses, investment security losses, and the deferred tax revaluation loss, we think 2017 was about a $3.57 fully diluted EPS kind of year, basically about a 16% growth rate over last year. The way we choose to present the impact of the Tax Act is to use the pro forma method, that is, as if the Tax Act was implemented at the first part of 2017 with the tax rates pursuant to the new tax laws. We've considered in this calculation the various non-deductible items that would have come out of the Tax Act, which negate some of these savings. We think that number, if it had been deployed in 2017, we would have saved $33.5 million from the Tax Act.
Also, like many firms, we're considering several items as investments from the Tax Act in order to reward associates as well as provide a placeholder or award chest to build a better firm quicker. We're considering increasing the match for our 401 plan, as well as providing more funds to enhance our infrastructure and accelerate both client attraction and new hires. Our placeholder as of this minute is approximately $8 million pre-tax. Net net, we think 2017 would have had increased earnings of approximately $0.43 per fully diluted shares with an annual effective tax rate of approximately 22%. Looking forward to 2018, the relationships between all of these factors seem reasonable. We totally realize what the Street expects of our firm next year, both pre and post the Tax Cuts and Jobs Act. Here we go. It's a great time to be at Pinnacle.
With that, I'll turn it back over to Terry.
All right. I'll just comment quickly. We've, I guess, made this point a time or two coming down through the presentation, but want to reiterate that we have completed the integration of BNC. It's been a while of a year to announce the transaction early, get it approved, closed, and now fully implemented is a great thing. As Harold mentioned, we're fundamentally through with the synergy case, a few jobs left that'll be departing during the first quarter for the synergy case to be fully realized. Again, the work's been done. I think the cultural integration, I would say, is well underway and has gone extremely well. We spent some time in several of the quarterly calls this year talking about the cultural integration. As a reminder, we conducted roughly 10 three-day orientation sessions, largely conducted by Harold and I and other key leaders in the firm.
We'll finish that group out. We've probably got four or five that we'll have to do in 2018 to get all those done and completed. I've commented on the revenue synergies. We believe this deal has great revenue synergies that were not included in the 10% accretion target that we've already disclosed and now believe we will deliver. That's an important aspect of how we drive out to our revenue, our fees to asset target that we talked about early in the call. Again, my expectation is we'll be building throughout 2018 toward that level. Again, the confidence that we have in Rick Callicutt and the hiring momentum that he's established, we've already talked about hiring 64 C&I bankers over a five-year period of time.
The hiring during, or since the completion of the merger is on that pace, I guess seven C&I bankers specifically were hired in the last five months. I know in talking with Rick that since year-end, two more have been added, and the pipelines look strong. Again, we're excited about where we are, having completed the BNC integration and now able to turn our full focus to the hiring revenue producers and the building of the balance sheet, which is our principal revenue generation tactic.
On this next slide, we've used this for a number of quarters, and I'd like to go back to it because it is instructive for those that are less familiar with our approach to market extensions and how we try to layer on our hiring and cultural components, and then allow that to be the driver of balance sheet growth, which is the driver to revenue growth in our company. On this slide, I just might say we're looking at the two most recent market extensions, Memphis and Chattanooga. We were not in those markets in 2014. We entered those markets in 2015.
If you look at the second column from the right, you can see how many revenue producers we had there at the bottom in each of those markets, what the baseline for core deposits was at the end of 2015, what the baseline for loans was at the end of 2015 for both of those markets. In the rightmost column, you can see the growth rates between 2015 and 2016, which were substantial. Again, I would just start you at the bottom, looking at the growth rate for the hiring of revenue producers. Again, as you move up the chart, it's not surprising you generate loan and deposit growth generally consistent with the kind of success that you have on the revenue producers.
Moving across that slide, you can see where we finished 2016, where we finished 2017, and again, right there in the center of that, the growth rates associated with our hiring and with loans and deposits, core deposits in both of those markets in the most recent year, again, very strong. Again, we just highlight that to try to draw a clear parallel for you. This is exactly the game that we'll be playing throughout the BNC footprint, trying to indicate the success that we've had in hiring revenue producers, and as a subcomponent of that, C&I financial advisors thus far, which again, we believe will translate into balance sheet growth and revenue growth, just as we have in Chattanooga and Memphis. I guess I'll just conclude with this idea. Really, all the information that we've provided really comes back to this point.
We're focused on long-term shareholder value. We focus on taking advantage of the large high-growth markets that we're in, and we focus on taking advantage of the vulnerabilities of large regional and national franchises that dominate these markets. That's really what we do, simply said. We've got a hiring growth model that's proven. We just reviewed it for the two most recent market extensions in Memphis and Chattanooga, and that's the methodology that we're now deploying in the Carolinas and Virginia. I always feel compelled to hit on this point. When you think about what we just talked about, the growth potential really is extraordinary. I think it would be a fabulous thing for our shareholders if that's all we do is optimize that opportunity.
I do feel compelled to say that we're likely to have high-bank opportunities to do accretive market extensions or fill in M&A in our footprint. We've tried to indicate, as we've gone down through this BNC integration, that we're not overly anxious to do that. We want to print a quarter or two to demonstrate our ability to hit the revenue targets and operate the bigger company and those kinds of things. Having done that once, we'll do that again before we attempt to enter into the M&A phase. Again, I always want to make sure that nobody walks away saying, "Terry just told me that he's going to make another acquisition after he prints one more quarter." That's really not what I'm saying. I don't care whether we make an acquisition or not. The growth potential is strong without it.
I do think as a practical matter, we will have those opportunities. Operator, we'll stop there and be glad to 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 *1 on your touch-tone 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. Our first question comes from David Feaster with Raymond James. Your line is now open.
Hey, good morning, guys.
Hey, Dave.
Congratulations on getting BNC in, fully integrated and all that. It's exciting, and it sounds like things are progressing well. I just wanted to get your best estimate of how much of that, if you can quantify, how much of the $40 million cost save estimate is already in your run rate? Given that the technology conversion happened late in the fourth quarter, I would suspect that there's a pretty decent step down still left to actually hit the first quarter number. I guess as a follow-on, was there anything one time in nature in that other expense line item that kind of popped up in the quarter?
Yeah, Dave, this is Harold. There's about 40 jobs left to come out of the footprint over there.
Many of the jobs did come out at the end of December.
I think as you look forward into the first quarter at our expense run rate, we think our expense run rate's going to be fairly flat. What we do here, as you might expect, is we'll give all the raises and all that kind of stuff in the first quarter. You'll see the legacy footprint see increased personnel costs from personnel expenses, so on and so forth. We think net net, that our expense run rate will be fairly consistent going into the first quarter of next year.
Okay. As we look out into 2018 in your crystal ball, how do you think about loan growth? What regions do you expect to see the most strength, have you seen any increased demand thus far from tax reform in your pipeline? Pay downs were also expected to be heavy in the fourth quarter. How's that trending?
David, this is Terry. I'd say two or three things. I think in terms of just broad outlook, if you're looking for % growth rates, we would expect the highest % growth rates to occur in the principal BNC markets. In other words, Charlotte, Raleigh, Greenville, and Charleston. I say that because, as you know, they've been double-digit growers, largely based on their CRE practice. We would expect that generally to continue, we expect to really augment that with building out the C&I platform, as we've already talked. They've hired a good number of bankers in the last half of 2017, they're off to a great start in 2018. That incremental hiring would accelerate the growth rate over there. I do think it's important to try to make this point. We had nice growth in the fourth quarter.
I expect the growth to be better in 2018, I don't see that primarily as a function of loan demand. In other words, what we do for a living is primarily take market share. My belief is that a good part of the growth that we've enjoyed thus far and I would project going forward, has to do with moving market share from the large regional and national franchises perhaps more than loan growth that's really tied to the economic growth. I think as it relates to your question on have we seen increased loan demand as a result of the tax law change, my honest answer to that is not yet. I detect some optimism. I have believed all along, once you get the tax rate firm, let people know what the rate is and when it's effective, that'll begin to spur demand.
I do have an expectation that we'll get benefit from the tax law change, and you will see some escalation in loan demand. Candidly, I couldn't say that I've seen that thus far. Let's see, you had one more thing there.
Pay downs.
Oh, pay downs. Yeah, thank you. Yeah, I would say pay downs in the fourth quarter were very high. It is concentrated, I think, more in commercial real estate than C&I and as you know, the permanent market are wide open, lots of alternatives, 30-year fixed, non-recourse kinds of paper out there for commercial real estate. So pay downs have been very high in the fourth quarter, and we do expect that to continue here in the first half of 2018.
Okay. Last one from me. You talked about your CRE concentration, and given that the strength, that BNC's expertise in CRE, you're expecting that concentration to actually go up near term, then diminish going forward. I just kind of wanted to hear how you plan on doing that. Are you actually pumping the brakes on CRE lenders, or is it simply that the new C&I hires that you've made are going to drive C&I growth in excess of CRE in the future?
Well, I think it is a true statement that we would expect the C&I line to grow faster than the CRE line. Again, going back to this idea of that's where the hiring focus is. David, I think we've said from the very beginning that the beauty of this transaction and the strategy involved with it is that we want to continue the double-digit growth that BNC has enjoyed, then bolt on that C&I business. So the mix will change, again, without an effort to diminish their CRE practice. I think the issue as it relates to the concentration is generally focused on total risk-based capital in the 100% and 300% guidelines. So it has been our intent, just generally as a firm, to stay underneath those two concentration guidelines.
I think what we've tried to say here is that in the most recent quarter, we had the $31 million revaluation on the deferred tax asset, the $8.3 million charge on the bond restructure. Those obviously shrink capital. That's an unplanned shrinkage in capital. What we were really trying to communicate was, hey, we're close to those concentration limits that's exacerbated by those write-downs. It may take a few quarters for us to rebuild the equity back associated with those two write-downs. That's the phenomenon that we're talking about there, where we say, hey, we may temporarily breach those guidelines, but late in the year, we ought to have produced enough capital to get back inside those guidelines.
Got it. That's terrific. Thank you.
All right. Thank you.
Our next question comes from the line of Stephen Scouten with Sandler O'Neill. Your line is now open.
Great. Hey, guys. Good morning.
Hey, Stephen.
Question for you, I guess maybe more for Harold on the core NIM. Harold, I was thinking you had said after last quarter we'd see a flat or maybe increase in core NIM. I'm wondering what kind of changed during the quarter that led to the downside there. I know you spoke a little bit on the seven basis points of higher deposit costs, but that obviously came in a quarter where we saw no Fed rate hike. I'm wondering on your thoughts on deposit costs next quarter with the impact of the Fed hike.
Yeah, we think that the core NIM decrease is primarily attributable to increased funding costs. I think we got a lot of calls during the quarter about raising rates. About 25% of our interest-bearing deposits are on a sheet rate, we do negotiated rates for about 75% of our funding book. We believe it's on the funding side, Steve.
Okay, that makes sense. In one Q, do you think we'll see disproportionally more than a seven basis point increase? Could that be more like 12 to 14 just with the rate increase?
Yeah, we're not planning for that kind of increase going into the first quarter of next year. We should see measured increases in funding costs for the rest of the year.
Okay. From here, I guess that core NIM, do you think it will be flattish from here? Is that kind of your area?
Yeah, that's what we believe. We've got the benefit of a rate increase in December to help us in the first quarter. What's going to go against us in the first quarter is we've got two less days in the first quarter, that's not helpful. We think we'll be able to defend the margin with the rate increase.
On the North Carolina kind of Virginia franchise growth, I think 2Q growth was like $190 million. The last 2 quarters have been in the low to mid-60s. What's the main driver of change there? Is that just more rapid CRE payoffs? Is that some sort of just mind shift change or pricing changes relative to what BNC used to do? I guess more importantly, is that $190 million range something we can expect you to get back to at any point soon, or is that kind of the longer-term goal once the C&I folks come online?
Yeah, you're right. I think the net production in the latter half of 2017 was less than the production in the first half of 2017. Stephen, I guess I would maybe try to help you think about what's gone on in that footprint. We've changed all the signs. We rolled out new computer software for every person in that system, refreshed all the, not computer software, but the computer itself, the PCs. We've regen-ed the phone system. We've retrained every person in that footprint with a significant amount of training on the upgrades, because even though they were on Jack Henry SilverLake, they weren't on the current version, and the new version required procedure modifications and so forth. It's just an extraordinary amount of change that requires an internal focus, which I think would be the principal driver.
It is a fact that the paydowns have been higher than usual, as we just talked on CRE as well. Our expectation for their growth in 2018 is significantly higher than their growth in 2017. Again, the budgets have been built that reflect that and so forth.
Okay. That's really helpful. Thanks, Terry. Maybe one just last housekeeping item, following up on David's question on that other expense line item. Was there anything unusual that caused that jump? I know you said kind of flattish expense run rate as a whole for 1Q 2018, but just curious about that specific jump and what drove that, I don't know, maybe $4 million.
Yeah. What drove is for FDIC and franchise tax expenses, those numbers ought to stabilize going into the first quarter of next year. We had a little extra money accrued for those at the end of December.
Okay, thac t kind of $16 million is probably the right run rate moving forward.
Yeah, I think so.
Okay. Thanks, guys. I appreciate it, congrats on a great year.
Thank you.
Our next question comes from the line of Jared Shaw with Wells Fargo Securities. Your line is now open.
Hi, good morning.
Hi, good morning.
If we can circle back on the expenses, on the compensation costs, you're saying that the benefit from some of the headcount reduction in fourth quarter will probably be offset by some of the seasonality of going into first quarter. Should we see that then come down as those 40 additional people come offline and you lose some of that accelerated FICA costs? Should we see second quarter salaries and benefits decline from first quarter?
Yeah, Jared, I think you'll see some of that. As we look at our plan for 2018, our expense line, we don't think it's going to deviate very much quarter to quarter. Particularly with the hiring plan that we've given our line managers, I don't know if you'll see a big windfall from the 40 people coming out.
Okay, thanks. On the C&I side, I hear you when you're saying you haven't seen the demand coming up from the tax side, do you think that tax uncertainty impacted sort of the trends in fourth quarter that we saw on the C&I side in terms of maybe higher levels of paydowns or people not making a decision to do much or trying to come in early?
Jared, that's an interesting question. I guess the specific answer to the question is, I don't know. I guess just as a sort of personal opinion and kind of feel, I do believe that uncertainty has weighed on loan demand during 2017. I think I've said this before. I'll never forget being at, I guess, Sandler conference in November, last year, I guess, 2016, people wanted to know if loan demand had increased in the first week since Trump was elected, and of course, it doesn't work like that. I don't think we ever saw a real increase in loan demand in sort of the first year of the new administration. I do think that was primarily a function of just uncertainty around the tax law. I guess your question is, did it account for any slowing in the fourth quarter? I don't know.
I wouldn't think it would be different in the fourth quarter versus quarter three, two or one, as it relates to just the uncertainty itself. Jared, I say this, I don't really want to spend a lot of time on politics other than to say that, man, the political discourse is difficult and choppy and it changes every day, and you can see mood and sentiment changing. I think that, while I believe you'll see increased loan demand as a result of the tax law, I do think there's just such volatility and headline risks that it's hard for people to really get comfortable and say, "Okay, I think things are solid.
Let's go." That's a long-winded way to say, I think loan demand will pick up as a result of certainty around the tax law change, but I do think that may be muted a little bit by just the difficult international situation and the political discourse domestically.
How does the C&I pipeline look now as we're going into first quarter?
Our pipelines are good. We use a methodology here where generally people are forecasting a quarter at a time, the general focus is on what are the high gain items that are supposed to occur within a 90-day period, you rebuild that forecast at the beginning of each quarter. There's still some work going on there. I would say that our pipelines would feel
Solid as we go into the first quarter, we would expect that good loan demand in the first quarter.
Okay. Just finally for me, on the securities restructuring, is that mostly on the muni side, mostly on the mortgage side? I hear you when you're saying that you didn't really change duration, did you change product type at all? With the stuff that's still left to do, where do you expect to see that following up?
Yeah, I think what you'll see is probably less of our bond book in mortgage-backs. We'll probably see a little increase in municipals, and more into some floating rate security. Other than that, it's not going to be a big change, Jared.
Great. Thank you.
Our next question comes from the line of Will Curtis with Piper Jaffray. Your line is now open.
Morning, guys.
Hey, Will.
Hey, Will.
Harold, can we just go back real quick in terms of the core NIM thoughts? I think you said the 333, you expect to hold that flat in the first quarter, and then, if I heard correctly, the securities purchase will add another four to five basis points throughout the course of the year. Is that correct?
Yeah, I think that's true, Will. We think this core NIM is going to be fairly flat. We think the GAAP NIM is probably going to be fairly flat. Over time, we think the bond book restructure, we think maybe some increased yields from our loan book will be helpful. The critical thing that we've got to keep an eye on are these funding costs. That'll be what we monitor all year long.
Okay. Maybe another clarification question here. In terms of the expenses, it sounds like the 104 core rate that you guys had, the core number you had this quarter, that seems to be a pretty good number, I guess, for the near term. In terms of expenses and from that 104, should it hold pretty steady with the caveat that that increases as you bring in additional talent, or how should we think about that 104 number going forward?
Yeah, that 104 is probably a good run rate for us based on what we have in our plan, which includes additional hires. If we're able to exceed our revenue goals, that number's going to go up with increased incentive cost. 104 seems to be a pretty good number.
Got it. All right. Then, let's see, just the last one for me, in the slides, tax rate. I think you had 22% in your pro forma exercise there, slide 13. Is that what you're assuming or would guide us to use for the tax rate going forward, 22%?
Yeah, we think 21%-22% will be a good number for us in 2018, all things in.
Got it. Okay. Thank you very much.
Our next question comes from the line of Tyler Stafford with Stephens. Your line is now open.
Hey, good morning, everyone.
Hey, Tyler.
Hey, I wanted to just follow up one more time on the core margin outlook from here. Does that, I guess, the commentary for holding both the core and GAAP margin relatively flat, does that assume any further interest rate increases this year?
Yeah, we've got three increases in our plan, one in the early part of the year, one mid-year, and one at the end of the year.
Three translates into flattish margins. Okay, got it. I think you guys don't have the disclosure in the Q just in terms of your asset sensitivity from here with the combined two franchises. Can you just help us, how much of the loan portfolio repriced with December and how much actual benefit are you getting from each incremental rate hike?
Yeah, it's about 30%-40% of the loan book will reprice. I think we put in the Q that we were modestly asset sensitive at the end of September.
Okay, got it. Just maybe lastly for me, just housekeeping, I just want to make sure I understood. On the BHG expectations for the year, the net contribution to Pinnacle will be that 12%-15% year-over-year growth rate?
Yeah, we think so. We're about $38 million for the year, we're talking to them about 12%-15%.
Okay, got it. The rest of my questions have been answered. Thanks so much.
Thank you.
Our next question comes from the line of Catherine Mealor with KBW. Your line is now open.
Thanks. Good morning.
Good morning.
One follow-up just on the commercial real estate conversation. I guess, how do you think could managing to this 300% level impact growth in any way, maybe in the latter half of the year? And if not, is sub-debt something that you may consider as a way to stay under the 300% level if growth really does take off as it seems like it will?
Let me talk about the volume side of that first, Then I'll let Harold comment on the sub-debt component of the question there. I think on the CRE side, my sense, just sort of back of the envelope, Catherine, you know what the earnings growth for the company ought to be. That's a pretty dramatic growth rate
Generally what we do for a dividend payout, which is modest. You can see the growth in the tangible capital of the company, which again, will translate into the risk-based capital there. If you're in 2017 as an example, we grew the tangible book value 18%, maybe you do 15%, something like that. The point is, as you're growing your capital base, you can generally run the CRE growth rate at a similar percentage. I don't view it to be a meaningful constraint. I'm not saying we don't have to pay attention to it or any of that kind of thing, but I would not view it to be a meaningful constraint on loan volume. Harold, you want to comment on the sub-debt?
Catherine, we get a lot of inbound calls from your colleagues on the other side of the wall about the sub-debt market and how it's wide open and pricing is very good right now and all that stuff. I guess where we are is we'd rather not. We want to see if we can thread the needle, as Terry's talking about right now, and just see if we can maintain our own growth curve as it currently exists with the sub-debt we have on the books. We think we'll generate a lot of capital this year to help support that commercial real estate book.
Makes sense. To your point, if C&I growth really starts to take off as it seems like it will, particularly with all the hires you've had, and you're generating capital as quickly as you are, then you're not going to be growing that ratio probably very much from here. Yeah. I appreciate that comment. Thank you so much. My only last just nitty question, was there anything in the investment security or the investment services line that's kind of temporary this quarter that was a little bit higher than we had modeled? Or is that a good run rate to grow from next year?
There's a couple of things going on in that number in the fourth quarter. One is that there is a kind of an annual number in there. I don't think it was a large number. I want to say it was $400,000 or something like that we get annually. I think that program has suspended, so it's not going to repeat. I think the larger number, or the more important thing, are the hires that we got out of SunTrust in October. Those people have hit the ground running, and they're here in Nashville. That number is being impacted by that group that's building a book of a pretty sizable amount during the fourth quarter. We'll continue to build it for next year.
Great. Thank you so much.
Thanks, Catherine.
Our next question comes from the line of Jennifer Demba with SunTrust. Your line is now open.
Thank you. Good morning.
Hey, Jennifer.
Hi. My question's on deposits. You said about 75% of your interest-bearing deposits are negotiated rates. Can you just talk about specifically, give us some color on what you did during the quarter in terms of rate adjustments? Secondly, can you talk about the incentives for core deposit growth all the way up the line to the C-suite?
Okay, on the first question on funding costs, we did adjust sheet rates in November, I believe, or at the end of October. I think we raised sheet rates 15, 20 basis points during that time. Jennifer, what was the second question?
Can you talk about the incentive system for growing core deposits from the line all the way up to the C-suite?
Yeah, we don't have any kind of one-off programs to provide people additional incentive for just core deposits. Our incentive system is based totally on what core earnings are and what revenues are. That's how we measure it.
Hey, Jennifer, I might just add a little color to Harold's comment. Just as a reminder, 100% of the associates in this firm participate in annual cash incentives, excluding commission-based people. Everybody's participating in annual cash incentives. We all make our numbers the same way. From the bottom of the organization to the C-suite, everybody's aimed at three things. We've got to clear a non-performing asset threshold, we've got to grow our earnings, and we have to grow our revenue. Grow the top line, grow the bottom line, and maintain strong asset quality. If we do that, all of our associates participate in the annual cash payouts at target. If we overachieve, they get more, but if we underachieve, they get less. I'll just say that we do that by design.
A lot of companies run scorecards that I think have produced outcomes like what we saw at Wells Fargo. Again, I say that not to disparage them, I'm just saying it drives people to worry about this product, this cross-sell, this sort of thing. We've decided not to do that. We've tried to aim our company at producing top-line growth and bottom-line growth. Within that context, you can be sure, and again, I think we've demonstrated a track record of mobilizing our associates toward gathering deposits because we're able to make this point, "Hey, here's how the earnings plan works." The number one revenue item we have is loan growth. To get that loan growth done, we've got to produce this amount of core deposit growth. We give them the funding percentage that we'll accept for non-core.
You got to produce this in core deposit, people go out and build initiatives to gather core deposits. There's plenty of incentive in the system, but it's not tied specifically to that number.
Okay. Thank you. My last question is on NIM. I know we've beat this subject to death, Harold, just a clarification. If the GAAP margin is going to be essentially flat, doesn't that mean there needs to be some expansion in the core margin to offset the lower accretion?
Yeah. You're right on that. I don't think you're going to see meaningful movement throughout the course of this year either way on that. We just are planning to defend this core margin for the rest of this year.
Okay. Terrific. Thanks a lot.
All right.
As a reminder, ladies and gentlemen, if you'd like to ask a question at this time, that's star then one. Our next question comes from the line of Brian Martin with FIG Partners. Your line is now open.
Hey, guys.
Hi, Brian.
Hey, Harold, just going back to that deposit. You talked about the sheet rates being up 10 or 15 basis points in November. The other 75%, I guess, what was going on with what you did there? Was this some one-time catch-up and that's why you're suggesting maybe you won't see as much pressure in the next quarter, I guess, is that how we're thinking about it? Or am I?
Yeah, Brian, the 75% is all one-off negotiations with individual depositors. Our relationship managers, financial advisors, have a great deal of latitude with respect to how they manage their individual clients. So, over the course of the quarter, each month, during the month, we're watching what those deposit costs are, how they're moving. Obviously, the larger depositors are the ones we hear about more often. We get that information anecdotally.
Okay. All right. Just going back, easy question on the margins. You talked about it being kind of flat. Is that flat the full year 2017 level or the fourth quarter core and the fourth quarter GAAP number?
Yeah, we're looking at our GAAP margin for our plan ought to be fairly flat for the rest of the year. We're not seeing a whole lot of dilution of our GAAP margin.
Right. That's a GAAP margin at fourth quarter or for the full year 2017?
For the fourth quarter.
For the fourth quarter. Got you. Okay. All right. Just a couple other housekeepings. Harold, you talked about the losses on the capital markets. How much of an impact was that? I mean, is that meaningful in the number? Just so we have that.
Yeah, I think it was about, run rate difference was about $700,000, I believe.
Okay. It should go back in. You talked about the mortgage revenue, fourth quarter being weakest based on kind of the outlook. Similar like a BHG, when you look at the year-over-year growth in mortgage, your expectations, I mean, is it in a similar range as the BHG? I mean, when you look at full year mortgage for 2017 versus 2018, you know.
Yeah. We're counting on mortgage to continue to hit their stride for 2018. We think we operate in great markets, and there's no reason to expect that we'll see any kind of decrease in our mortgage plan.
Okay. I mean, something in the range of what you're expecting on BHG, I mean, if it's over 10% growth in mortgage is a reasonable expectation today.
Yeah, I think 12% is a good number for them. I don't know exactly what I have in their plan for next year, but it ought to be somewhere in that vicinity.
Yeah. Got you. Okay. I think Terry talked about this, just those target ranges, Terry, you guys kind of going back to revisit those, at least on the ROA now that the tax rate changed. Just over the next couple of quarters, it sounds like the ranges we're in, I guess with the fees being a little bit light, but the others being a little bit strong, that trend kind of plays out the next couple of quarters, but maybe begins to kind of normalize at your targeted range out in maybe six quarters out or four to six quarters out. Is that how to think about it? Three kind of stay above the range, one being below, it all nets out.
Yeah. I think that's right. Brian, let me just back up and say, generally, when we laid those targets out, the idea is if you sort of hit the midpoint of each of the subcomponent ranges, you would hit the midpoint of the ROA range. We have believed we're going to operate relatively high, take the tax law off the table for a minute, we have believed that we're going to operate relatively high in the ROA range. The way we'll do that is we'll be short on the fee range as we build out the fee businesses in North Carolina, we'll either be north of the range or high in the range above the midpoint on those other three measures.
Okay. I got you. That's helpful. Then the tax benefit will be a positive to the ROA, I guess, as you kind of go back and revisit that.
Yes. It ought to be a meaningful impact.
Yeah. Okay. All right. Just the last thing for me, maybe I missed it, and you guys mentioned it, but you talked about the 64 people, Terry, and you kind of monitor that going forward. Maybe I missed it, but of the 64, how many are on board already or currently?
Seven. Well, seven through 12/31, I think. We've actually hired a couple since year-end as well. Probably the
Way to keep track of it is just think about three quarter ends, seven, I guess, in the first five months.
Seven in the first five months. Okay. All right. That's all I had, guys. I appreciate it. Thanks.
Thank you, Brian.
Our next question comes from the line of Nancy Bush with NAB Research. Your line is now open.
Hello. Just a broad question about the rural versus the urban markets. Harold, do you have sort of a rough estimate of the difference in deposit funding costs between those two markets or types of markets?
Nancy, I really don't. I don't know what we have as far as funding costs in some of our smaller markets.
Okay. Have you, Terry, this is probably a question for you. Do you expect that you're going to be able to make sort of a significant difference in the trajectory of growth between the rural markets and the urban markets? One of the questions when you bought BNC was look at all the rural markets they're in, are they going to dampen their growth, et cetera.
Nancy, I guess I'd say two or three things. Maybe first, let's try to create, I guess, a common language here on rural versus urban. I believe that our company is primarily in urban markets. When I say primarily, I don't mean like north of 50%, I mean like 98%. SNL has a tool that you're probably familiar with.
Right
Where they'll score that out, we'll be extraordinarily high in the urban. In fact, I don't know but one or two franchises in the country that might be more urban than we. I guess I'd start there. Underneath that, as you know, in conjunction with the BNC transaction, I guess there were either nine or 10 offices that were closed. Again, those weren't exclusively rural markets by definition, but they were underperforming markets, some of which might fit that description. Again, that'll be an influence on growth rates as well. In your comment about transitioning in the rural footprints, we don't have an initiative to and don't focus on candidly, how do we take this, whatever it is, 1% or 2% of the rural franchise and develop initiatives to optimize that to be honest with you.
We're looking to Rick Callicutt and his team and have a high degree of confidence that when he overlays the staffing methodologies that we use, the larger legal limits that we have, and bolting on the C&I business, that it will transform the growth rate on both sides of the balance sheet in that footprint.
Okay. I just have another question on mortgage banking. It looks like, or it sounds like you guys are really projecting sort of a step-up in growth there. Are you hiring producers on that side, or is this product that you're going to be taking to the BNC market, or if you could just give us a little color on your expectations, because as rates rise, theoretically, mortgage production should be going down, but obviously, you're not expecting that. Are you moving market share in some significant markets?
Yeah. Nancy, I would think about it this way. I would say there are two components or two main thrusts that lead us to believe we'll increase mortgage production. I think if you were to talk to Rick Callicutt or any of his market leads and so forth, they would describe the mortgage business that they ran as a siloed business. In other words, it was run as if it were almost a standalone mortgage company, they hired originators, and the vast majority of the production in that company came directly from those mortgage originators and their personal contacts. Our model is different than that substantially. If you look in the legacy Pinnacle footprint, the mortgage originators here, as a rule, would generally get at least half their production from referrals from bankers.
In other words, the bankers control these clients and therefore have opportunities to look at mortgage requests and are able to hand those to our mortgage origination staff. That swing is a big swing in the case of BNC to harvest because they have, as you know, a great client set that's been virtually untapped, and I'm speaking of the banking clients as opposed to the mortgage clients. The banking clients have been virtually untapped in terms of the mortgage capabilities there, and so we view that to be substantial. The second major thrust is we are hiring mortgage originators. To your question about market share, that is generally how we move market share is we hire additional people who have books of business or client contacts from a separate source, and so it's a market share move play.
Okay. If I could just ask one final question. Do you expect that I know you've said, okay, we're not thinking about deals, we're not et cetera, but you got to think about into the future. How scalable do you see your platform right now? Is there some tens of billions that you can give us in terms of it's scalable up to here, and then we have to add? Can you just give us some thoughts about your sort of technological ability to expand?
Nancy, if I can be honest, I don't know the answer to that question. I know that it's substantially larger than where we are now, but I'd be hesitant just to throw a number out there without having a little more structured analysis behind it. I'm not sure I'm really prepared to give you an answer to the question. I might go at it this way. I think you know we've said with no acquisition, we believe we'll grow to be a $28 billion asset company without M&A, organic growth, and so forth.
Right.
We're confident that what we're doing is easily inside of that. My guess is that you could probably do another $20 billion in assets with the basic operating platform that we have. Again, I'm just giving you a guess, Nancy, and I want to qualify as that. I don't have a structured analysis behind that. Obviously, we'll be working on that as part of the strategic planning process.
Okay, great. I appreciate the effort.
Thank you.
I'm not showing any further questions in queue at this time. Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, and you may now disconnect at this time. Everybody, have a great day.