Good morning, everyone, and welcome to the Pinnacle Financial Partners second 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 to your questions following the presentation. If you would like to ask a question at that time, please press star and then one on your touch-tone telephone. Analysts will be given preference during the Q&A. We ask that you please pick up your handset to allow optimal sound quality.
Pinnacle does not provide earnings guidance or forecasts. During this presentation, we may make comments which may constitute forward-looking statements. All forward-looking statements are subject to risks, uncertainties, and other facts that may cause the actual results, performances, 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.
These remarks may include certain non-GAAP financial measures and are defined by the SEC Regulation G. Presentation of the most directly compared GAAP financial measures and a reconciliation of non-GAAP measures are to be comparable GAAP measures and will be available on Pinnacle Financial's website at www.pnfp.com. 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. We always begin our quarterly earnings calls with this dashboard to allow you to quickly assess how we're performing on all the critical financial metrics. This particular slide's focused on the GAAP measures. I expect most of you know we closed our acquisition of BNC on June the 16th, less than five months from announcement. All the financials are impacted by that transaction and two weeks of post-merger performance. For the second quarter, we continued to grow the revenue and earnings capacity of the firm. We continued to grow the balance sheet at a very substantial pace, both organically and through M&A, which we believe predictive of future revenue and earnings growth. It also shows that our asset quality is very strong.
As I say, each quarter, at least for me, given all the transition and merger integration going on in the company, the non-GAAP measures actually provide greater insight into the core run rates on these important metrics. We'll move on to those. Looking at the non-GAAP measures, since the arrows are all nicely sloped in the right direction, I won't walk through each metric. I'll just highlight two that'll get a little more discussion as Harold reviews the quarter in greater detail in just a few minutes. Let's look first at the ROTCE on the first row and, the reductions there over the last two quarters. As you'll recall, in conjunction with the BNC acquisition and to support the future growth needs of the firm, we issued 3.2 million shares on January 27, 2017, totaling $192 million in net proceeds.
We had a partial quarter impact of those additional shares in Q1 and a full quarter impact in Q2. Nevertheless, we're thrilled to have growth prospects that warrant the additional capital, and I promise you this, we'll be diligent in both protecting it and in leveraging it through growth to optimize the returns. Secondly, just below the ROTCE chart is the tangible book value chart. I've commented any number of times on these earnings calls regarding the correlation between growing tangible book value and growing the share price. We take it seriously. In fact, we've been dogged about it. As you can see, in conjunction with our acquisition, we protected it and, in fact, grew it over the last two quarters. As I mentioned, Harold will review that in greater detail shortly.
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. After having achieved the originally targeted levels, we've actually increased the return on average assets target range twice, now to its current level of 1.30%-1.50%. In conjunction with that return on average asset target, we continue to publish targets for the key performance measures that lead to that overall level of profitability, specifically the margin, the fees to assets, the expenses to assets, and net charge-offs. As you can see on this slide reflecting the GAAP measurements, second quarter 2017 was another good quarter with a return on average assets of 1.30%, just inside the new target. In general, the component measures are all performing pretty well against their targets.
As I've already said, due to the meaningful impact of merger-related charges, I personally tend to focus more on the profitability metrics adjusted for those merger-related charges. On that basis, you can really get a picture of our operating momentum here. The second quarter return on average assets is well within our new target range at 1.35%. Net interest margin was 3.68%, and net charge-offs were just 17 basis points, both better than the top end of the range. Expenses compared to assets are very low in the target range, even with very little in the way of our BNC cost savings. Fees to assets has actually slipped below the target range in the second quarter, primarily as a result of the BNC acquisition.
I promise you, we view that as upside in the revenue synergies we intend to produce there, which I'll talk in greater detail about later in the call. One of the things that I think distinguishes Pinnacle from many is our continuous focus on building additional infrastructure in the current period in order to continue propelling the firm forward in terms of revenue and earnings growth in the future periods. This slide's intended to give you a snapshot of how that went during the second quarter. Of course, in this quarter, the BNC acquisition's the most significant investment. We continue to march down through our implementation timeline. Since I've been over this on previous calls, I won't review it in detail. I'll just highlight the next last bullet point.
We now intend to merge Pinnacle's Jack Henry files with BNC's Jack Henry files at year-end, which is a two-month acceleration in the timetable, and therefore, a two-month acceleration in the completing of the cost takeouts. In short, we still expect to realize our original target of $40 million in cost saves in 2018. The second largest investment in future growth is the hiring of additional revenue producers. As you can see, year-to-date, we've added 33 in total, 14 of which were added by Rick Callicutt and his team. We've been asked a number of times if the M&A activity in North Carolina would afford us additional opportunities, I think, the answer to that is yes.
Finally, our organic loan growth during Q2 was extremely strong, both in the legacy Pinnacle footprint and the legacy BNC footprint, which is really incredible during this period of merger integration. With that overview, I'm going to turn it over to Harold for a more detailed review of the quarter.
Thanks, Terry. Revenues for the quarter increased from $119 million in the first quarter to $142 million in the second quarter, or about $23 million quarter-over-quarter. Revenues from BNC contributed $14.1 million to the quarter for the half months of its operations post-merger. As a result, we believe the legacy Pinnacle franchise experienced 29% annualized linked quarter growth in revenues between the second quarter and the first quarter due to increased yields on earning assets, as well as strong fee growth in a number of areas. More on that in a moment. Total spread income increased $18 million between second and first quarter, as shown on the blue bars on the chart. Discount accretion represented $1.4 million of the increase, less than 10%. The dark green line on the chart denotes revenue per share.
Impacting our revenue per share in the first quarter was the capital raise, which we believe diluted our first quarter revenue per share by $0.12, which is the reason for the decrease in the chart in the first quarter. We reported $2.46 revenue per share in Q1 with the capital raise and reporting revenue per share at $2.64 this quarter. We believe revenue per share will increase in the third quarter as the capital raise in the early part of the year has already been fully absorbed in our second quarter run rates, while the BNC revenue impact and the corresponding share issuance were included in our results for only two weeks. BNC will have a larger impact in the coming quarters. We believe the BNC revenue per share in the last two weeks would have calc'd out at slightly more than $3 per weighted average share post-merger.
As we look forward to the third quarter, purchase accounting related to our mergers with Avenue, CapitalMark, and Magna should continue to decrease. With the BNC acquisition, we should experience a significant increase in discount accretion in the third quarter. In the aggregate, we have around $196 million in loan discount accretion, of which a significant amount is expected to amortize into income over the next few years. A little more on loans and deposits. Concerning loans, as the chart indicates, average loans for the second quarter of $9.82 billion compared to $8.56 billion, or an increase of $1.26 billion in average loan balances, of which the BNC footprint contributed $923 million. We believe it was a strong second quarter for us concerning loan growth, which in Tennessee was up $478 million compared to $192 million in the first quarter.
BNC's organic loan growth increased to $196 million in the second quarter, compared to $165 million in the first quarter. $668 million in second quarter organic loan growth has us all pretty excited. As the chart indicates, our loan yields increased to 4.66 this quarter compared to 4.60 last quarter. Impacting our loan yields this quarter was purchase accounting accretion, which positively impacted yields by 26 basis points compared to 23 basis points in the prior quarter. Excluding the impact of purchase accounting, core loan yields have increased from 4.23 in the fourth quarter of 2016 to 4.26 in the first quarter of 2017, and up 14 basis points to 4.4% in the second quarter of 2017. As to deposits, again, here in the second quarter, we were able to grow our funding base while deposit costs increased from 25 basis points to 32 basis points.
We continue to anticipate increases in deposit rates as rate hikes continue, we don't expect anything dramatic in the short term. Average deposit balances were up $1.3 billion, of which BNC contributed $1 billion to that amount. We preliminarily assigned a core deposit intangible of $48 million to the BNC core deposits, of which $316,000 was amortized in the last two weeks of the quarter. Switching now to non-interest income. We're reporting $35.1 million in fees, up more than 60% linked quarter annualized. We also had a record fee quarter this quarter for the Tennessee footprint. Fees for the Tennessee footprint amounted to $33.4 million, compared to $30.1 million in the first quarter. Our residential mortgage group had another outstanding quarter in terms of production, with approximately $262 million in loan sales this quarter at a yield spread of 2.81%.
We feel very positive regarding our mortgage pipeline as we head into the third quarter. Income related to insurance commissions decreased quarter-over-quarter due to the annual incentive payment we received in the first quarter from carriers for positive claims experience. We're reporting Bankers Healthcare Group revenues of $8.75 million this quarter, up $932,000 from the first quarter. We expected a meaningful uptick in Bankers Healthcare Group revenues in the second quarter compared to the first quarter, and we continue to anticipate that net growth for Bankers Healthcare Group revenues will be up approximately 20% for Pinnacle Financial Partners in 2017. We also believe their third and fourth quarters will see strong growth. Interchange revenues continue to show positive traction as we approach the impact to us from the Durbin amendment on July 1 of this year.
Had the Durbin amendment been in effect in the second quarter, our interchange revenues would have been approximately $1.8 million less. We believe the Durbin amendment will impact third quarter fees by approximately $2.5 million, with a full quarter of BNC interchange revenues in our operations. We experienced a meaningful uptick in other non-interest income in the second quarter. SBA loan sales were up $333,000 this quarter over last quarter, with BNC contributing $170,000 to that amount. Gain on the sales of both commercial and residential loans were $854,000 in the second quarter, compared to $217,000 in the first quarter. To operating leverage. Our efficiency ratio on a GAAP basis was 50.7%, while our core efficiency ratio, excluding merger-related charges, was 48.4%. First, concerning personnel costs, we've got 2,200 FTEs at June quarter end, of which almost 1,000 were from the Bank of North Carolina.
Salary costs are up $6 million, which was attributable to the BNC footprint, increased headcount, and increased incentive expenses. We project our annual incentive costs for the full year and then begin accruing to that amount proportionally each quarter. Those of you that have followed our story for many years know our one incentive plan system works, and that it's based on corporate results and not based on the individual sales goals. We are still accruing at less than target award for 2017. You also know we set big targets around here, so we'll be working hard to get back these reduced incentives, but we only get it back if we hit our numbers. Just to emphasize the point, incentive expense and earnings are not indirectly linked but directly linked. If we hit our revenues and earnings targets, our incentive costs will obviously increase.
If we don't, our incentive accruals will get reduced. This is a new slide and probably the last time we'll show it, but we wanted to get on the table our position that when we announced the BNC merger, we felt our tangible book value would not be diluted, inclusive of our capital raise. There are a blue million things that go on to get from then to now, but all things considered, we were confident then as well as now. The two charts on the top are the charts from a previous slide that Terry went over discussing our accretion of tangible book value over the last few years. The table at the bottom rolls forward our equity accounts in a summary fashion so that we can detail a quick calculation of our tangible book value.
Appreciate that we are reporting a $1.60 plus-ish in GAAP earnings for the first six months of 2017, less about $0.28 per share in dividends to shareholders. Rough numbers, you would expect tangible book value accretion for those two components to accrete capital by, call it, $1.30. Our tangible book value is up $2.50 plus, an incremental $1.20 is due to many factors, but mostly due to the impact of our January equity raise and the BNC transaction. This is a slide we showed on the merger call back in 2017. We anticipated tangible book value accretion of approximately 5% now and feel like we were all over that number. We anticipated tangible book value accretion of approximately 5% then and feel like we are all over that number now.
Looking at the capital ratios, we are also pleased that we are within what we believe are acceptable tolerances for sure. We are higher on the 100, 300 due to more loan growth in both footprints than we anticipated, but we have ample room to fund CRE lending going forward based on current pipelines. What is left for us to accomplish with respect to what we told you all in January is obviously the accretion target of approximately 10% in 2018. We feel really good about our synergy case. We feel really good about our earnings momentum in our new markets in the Carolinas and Virginia. We are also working a long list of potential revenue synergies which were not contemplated in the merger model in January and are optimistic about those, particularly around C&I and wealth management. With that, I will turn it over to Terry to wrap up.
Thanks, Harold. Okay. After a pretty thorough review of where we have been and where we are, I want us to focus now on the growth potential that we see going forward. To get behind the growth potential that we have going forward, I think it is really critical to get behind and understand the growth model that we have successfully deployed over the last 17 years. In my opinion, Shakespeare got it right, "What is Past Is Prologue." Many of you remember in the years immediately following the recession, frankly, at a time when we felt our share valuation did not really reflect the balance sheet and earnings growth we intended to produce, we published the three-year organic loan growth targets and the ROA target to make it more clear to investors as to our expectations for earnings growth.
In that period, from 2012 to 2014, we consistently produced double-digit loan growth and exceeded our published target, while at the same time, muscle building the ROA to its target at a time when not many banks were able to do either. What you are looking at here is Greenwich Associates Research, as it pertains to businesses with annual revenues from $1 million to $500 million, which is effectively the entire business market in Nashville, Knoxville, Memphis, and Chattanooga. For each market, banks are plotted left to right based on the percentage of their clients who rate their satisfaction as excellent. As you can see by the fact that Pinnacle, for the most part, is the right-most plot point on each chart, we have truly built a distinctive client experience when compared to the large regional and national franchises with whom we compete.
Banks are plotted north and south, based on their market penetration of businesses with sales between $1 million and $500 million. The conclusion for me is that we have been able to build a client experience that's so distinctive versus these larger regional national franchises, that we've successfully taken their clients away at a very rapid pace. In Nashville, as an example, we've gone from 0% to approximately 26% share, and opened up a pretty large lead over all the three banks who previously dominated the Nashville marketplace, and who continue to show great vulnerability. In Knoxville, we started on a de novo basis there seven years later. You can see fundamentally the same story.
In just 10 years now, we've already built a $1.4 billion bank, if you will, and unseated one of the three previous market leaders and are on the dance floor with the other two. In Chattanooga, we entered by way of acquisition. CapitalMark Bank & Trust was a 2007 de novo that we acquired in 2015. It's virtually an identical story to Knoxville. In Memphis, Magna Bank, the bank we also acquired in 2015, would not have even appeared on the chart, and now you can see that we're taking share based on a distinctive client experience with tons of upside versus highly vulnerable competition.
Here's a chart intended to move beyond the competitive vulnerabilities and the client experience in order to help you get a grip on the actual growth we've been able to create with the market-extending acquisitions we've done, specifically in Memphis and Chattanooga, both of which were done in 2015. Starting at the bottom of that slide, you see in addition to creating a great client experience, we overlay our hiring philosophy and methodologies, which have generally been very successful against those larger national and regional competitors. Again, having entered both markets in 2015, look at the growth in revenue producers in 2016 and year to date in 2017. You can see that the hiring momentum's been strong and, frankly, that it continues to be strong. As you move up the slide, look at the core deposit growth and the loan growth.
You can see that this combination of a distinctive client experience and the ability to attract so many of the best bankers and brokers and mortgage originators in the market is having the desired results. Our growth trajectory in these relatively newly acquired markets is extremely strong. With that as a foundation, I want to show you why we believe the Carolinas and Virginia, and most particularly North Carolina, why they're so attractive to us, and why BNCN is the perfect platform from which to launch. Identical to the other charts we've been looking at, this is Greenwich Associates on businesses with annual sales from $1 million to $500 million in the state of North Carolina. In my opinion, the same two broad observations apply here as to the Tennessee markets we just looked at.
Number one, the large regional national players in North Carolina appear extremely vulnerable based on their lower levels of client satisfaction. Number two, BNCN indeed already possesses a distinctive client experience versus these large regional national banks. Like in Tennessee, when you overlay Pinnacle's larger lending limits and advantage treasury management platform and our hiring philosophy and methodologies, which Rick Callicutt and his team are already successfully deploying, we'd expect to see similar balance sheet and fee growth in North Carolina, to that we've seen in our recent acquisitions in Chattanooga and Memphis, which as you saw, has been extraordinary. One last observation on this chart.
In addition to the larger regional national franchises in North Carolina that we typically target, I've also left two of the smaller, more recently acquired franchises in North Carolina, because I currently believe that they will represent great opportunities for us in addition to those banks we typically target. This slide is similar to the previous slide, I included it to help you peel the onion back on the vulnerability that we intend to attack. Again, this is Greenwich Associates on businesses in the state of North Carolina with sales from $1 million to $500 million, comparing BNCN's current reputation to the two large national franchises and the two large regional franchises that are headquartered in North Carolina.
You see each bank's rank on overall satisfaction, each bank's rank on each of the key drivers of overall satisfaction, and each bank's rank on the willingness of their clients to recommend them. When you look at those key drivers of client satisfaction like being trustworthy, being easy to do business with, and value in long-term relationships, it doesn't seem to me that these are gaps that our competitors can close quickly. With all that data, I hope you begin to see why we're so excited about the incredible organic growth opportunity that the BNCN acquisition affords us. With the strategic opportunity established, the primary question remains: Can we execute? To that end, I want to spend just a minute on the cultural integration. My guess is some won't care, and many will wonder what this has to do with anything.
Frankly, I agree with Peter Drucker when he said, "Culture eats strategy for lunch." We've got a good strategy, but we've got a great culture, and honestly, nothing could be more important in terms of both our short-term and our long-term success. Those of you who know our company well know the thoughtfulness and intentionality with which we built the culture of this firm, and the primary foundational method for inculcating that culture, with new associates is a three-day orientation. It's largely conducted by me and the other key leaders of our firm. Among other things, these sessions are intended to build buy-in to our mission, to our vision, to our values. Every associate in our firm has been through it. We have already conducted four of these three-day sessions, and have taken about 234 BNCN associates through the process. We'll do seven more of these before year-end.
In fact, Harold and I are in North Carolina this morning, taking time out from one of those sessions to conduct this call. We'll get roughly 80% of our new BNCN associates through this exercise by year-end, and then finish up in the first quarter of 2018. The third day of orientation is primarily team-building exercises, which are intended to demonstrate important Pinnacle values. The day culminates with everyone going over a 12-foot wall, which is intended to paint the picture that what we do at Pinnacle is accomplish the seemingly impossible by all working together. In this picture, about halfway up the wall, you can see Rick Callicutt, BNCN CEO, leaning over the wall, cheering his teammates on as one by one each associate makes it over.
In terms of how well the orientation's being received at BNCN, we're getting 85% top box ratings on their evaluations, which is extraordinarily high and comparable to what we get among our new recruits in the legacy Pinnacle footprint, which to me, is perhaps one of the best indicators of both buy-in and cultural compatibility. These are verbatim comments from a number of those evaluations that have been completed by associates after having gone through the orientation. As you can see, the comments illustrate the level of excitement and associate engagement we're achieving. I might just point to that last comment, "Exactly what I needed to understand exactly where we want to go and how we'll get there." When associates already know where we're going and how we're going to get there and excited to do it, we're more than halfway home.
As we've just discussed, all important cultural integration is well underway. I indicated earlier, we currently contemplate merging the BNCN and PNFP Jack Henry files together at year-end versus February 2018, which we'd previously published, which should put us in a position to get roughly $40 million in cost takeouts in 2018, despite the fact that we won't harvest 100% of the cost takeout until mid first quarter 2018. Guys, as you think about earnings growth, it's pretty easy to calculate the earnings associated with $40 million in cost savings. And while we don't need any revenue synergies to hit the earnings accretion that we've projected, we believe there should be substantial revenue synergies. Perhaps the most obvious is associated with incremental loan volumes. Our original case contemplated $500 million in net new loans from BNCN during 2017.
Through June 30, 2017, they're up roughly $300 million, which on a straight line should translate to $600 million for the year, $100 million ahead of target, which at even a 2% spread is $2 million in spread income. And then on the fee side, we currently expect to realize meaningful synergies with our treasury management platform, which is more robust, including things like business credit cards and purchasing cards that BNCN has not offered in the past. Swaps, client swaps, back-to-back client swaps, a product BNCN has heretofore not been able to sell to help clients convert fixed to floating or floating to fixed. Permanent commercial mortgage brokerage, a capability BNCN has not had heretofore despite the concentration of commercial real estate loans.
The residential mortgage origination process, converting BNCN from a best efforts basis to a mandatory delivery basis, which should widen the yield spread premium by roughly 40 basis points on all their residential mortgage production, which is forecast to be approximately $450 million in 2017, just to name a few. All right, guys, if we're successful just moving back to the low end of our previous fees to asset target, that's a pick-up of five basis points or roughly $10 million in incremental fees. My guess right now is it may take up to two years to build all the way back to that level, but we'll pick up meaningfully in 2018. Of course, we've already discussed that we contemplate building out a meaningful C&I business. The hiring momentum's already been established.
When you layer that on to the $40 million in cost takeouts, the above plan loan growth year to date, perhaps as much as $10 million in fee synergies which weren't contemplated in the original business case. The balance sheet and EPS growth trajectory is truly exciting. Now, in an effort to translate all of that into financials, much like in 2011 when we felt the market didn't really understand the earnings potential of our firm, we've already given you the ROA target of 1.30%-1.50%. Here's the organic asset growth we intend to produce through 2020 in the new combined existing footprint. Let me just say right now, it won't grow in a straight line. First quarter's growth will almost always be less than second and third quarter. The ROA won't be exactly on the midpoint of the range every quarter.
My guess is some quarters it'll be higher and some it'll be lower. With the ROA target and with the asset target, which is relying on no additional M&A, you begin to get some sense of our current expectation for future earnings growth. Now, all we've talked about thus far is organic growth in our existing footprint. As you know, we've highlighted other high growth markets in the southeast that we've targeted. Obviously, we don't have to do anything. As you just saw, our growth trajectory is fabulous if we don't do another thing. My guess is we'll be afforded additional opportunities to layer on more growth. I don't intend to rehash this slide today since I've discussed it pretty fully on previous earnings calls. I will point out one change as it relates to M&A opportunities.
When we were a smaller company, we targeted something greater than 5% earnings accretion. Given our larger size and share count, we modified that target to 3%-5% earnings accretion. We have no interest in doing deals that provide de minimis or no earnings accretion, and we've never done deals that meaningfully diluted our tangible book value. Let me say this as we wrap it up. Much of what I've talked about in the latter half of this call has been focused on crystallizing the earnings growth potential as we move forward. I want to conclude with this idea. What we're really focused on is long-term shareholder value. To that end, we'll continue to focus on taking advantage of both large high growth markets and the meaningful vulnerabilities in those large and regional national franchises that dominate those markets.
We'll do that in order to produce outsized organic growth in our existing footprint. As I just mentioned, that's an extraordinary opportunity. Frankly, it's enough. My guess is we'll have other high-value opportunities to do accretive market extensions or fill in M&A in our existing footprint. We're in the luxurious position of having a lot of incremental opportunities, but not being pressed in any way to do anything other than what's in the long-term best interest of the shareholder. Operator, I'll stop there, and we'll open it up for questions.
Thank you, Mr. Turner. The floor is now open for your questions following the presentation. If you would like to ask a question at this time, please press star and then one on your touch-tone telephone. 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 will come from the line of Stephen Scouten with Sandler O'Neill. Please proceed.
Hey, guys. Good morning. Congrats on a great quarter here.
Thank you, Steve.
Question for you. The loan growth, especially within the Tennessee legacy footprint, was extremely strong. Can you give any additional color there on segments of that growth, where it came from, either geographically or type of loan? If you think we should be thinking about a faster rate of growth than maybe the legacy 10% to 12%, 13% that you guys have traditionally put up.
Stephen, that's a great question. I think in terms of the growth here in the second quarter, I guess to give you a little color commentary, I would say in terms of industry segments, it's pretty broad in its distribution. It's not like you're doing it all in healthcare or name another sector there. It's broad and diversified in the growth. I think the thing I would comment is, this is just a back-of-the-envelope estimate, but it looked like to me about 40% of that growth came from market share takeaway, which seems important to me. Again, I think there's been a lot of talk about limited C&I loan demand and those kinds of things. We are getting some growth from our existing client set, I'm sure some of that has to do with this idea of hiring folks, and they're consolidating books of business.
Even among existing clients, loans continue to fund and move and those kinds of things. To have 40% coming through market share movement is a big, I guess, boon to the growth rate. Stephen, I think over the long term, we'll have quarters. My guess is that the third quarter is likely to resemble the second quarter in terms of growth. I think, just over an extended period of time, I sort of like a low to mid double-digit growth rate for the loan category. I don't know if that's helpful to you, but that's how I see it.
Yeah. No, that's very helpful. Then maybe on the NIM, nice move there, especially on the core NIM. Harold, can you give any color into what drove that? Is that predominantly from the March hike and the effect there, or is that new loan yields coming on a bit higher? What's the, I guess, kind of puts and takes between those two dynamics within that core NIM?
Stephen, what we've kind of come down on or what we've concluded is that of the 14 basis points increase in the core, probably about 8 basis points was attributable to the March rate hike. Yeah, probably about half of it.
Okay, great. That's really helpful. Then maybe one last kind of more high-level question is, obviously things look like they're going great. I think there's a ton of potential in the North Carolina, Virginia markets from BNCN. I think that's pretty clear. What do you feel like could trip you guys up? What do you worry about a little bit? Last quarter, we were talking more about healthcare loans and exposure there. Some people are focused on retail now. Credit for a bank obviously can always be the easiest way to trip up. What is it that you guys are really focused on as you think about what could derail the kind of trajectory you have today?
Yeah, I think, I'll just give you some random thoughts, Stephen. I think, for me, I'm always interested in containing CRE exposure. Many folks will remember we took meaningful losses going through the last recession. One of the things we committed to was concentration limits, and we've got a number of sub-limits, but just from 30,000 feet, the two most familiar limits are the 100% construction, 300% total CRE exposure. We intend to stay inside of that. I do think in terms of our guidance to lenders, we've put a caution flag out and really told particularly the commercial real estate lenders that, if you're doing many firms or loans with either actual maturities in the three to five or seven-year timeframe or rate maturities at 10 years, you're almost certainly going to intersect with the cycle here on commercial real estate.
Our guidance has really been, they're not red flags, what we've said is, "Hey, if we're going to do deals, it needs to be on our terms and our price," we're in a position to miss deals. Again, I don't want you to interpret that we're on the panic button. I'm not on the panic button. I just think we're later in the cycle than we once were. Now is the time for a little more caution there. I think that's probably the biggest area, I guess, if you're trying to highlight things like credit that would stump us.
Okay. Great, guys. Well, congrats again on a fantastic quarter. Appreciate the time.
All right. Thanks, Stephen.
Thank you. Our next question will come from the line of Catherine Mealor with KBW. Please proceed.
Hey, thanks. Good morning, guys.
Hey, Catherine.
I want to follow up on the margin. Can you talk about your outlook for the margin when we layer in a full quarter of BNCN, both with and without the accretion? Then kind of a follow-up to that is, as we think about BNCN, they're naturally not as asset sensitive as you are, and could argue probably have more risk to the flatter end of the curve. Can you talk about how you think about that incremental margin in a higher but flatter yield curve at BNCN? Thanks.
Yeah, Catherine. What we've been talking about probably for the last, well, I guess since January, is that we really believe that our core margins will stay relatively stable. We're not seeing any kind of big upticks in funding costs just yet, but we think that'll eventually happen, of course. The core margins ought to be pretty flat. There's a lot of discount accretion that's going to be coming to us in the short end. We've always talked about there's going to be accretion with respect to the, call it the GAAP margin. We've got $192 million. We allocated about $170 million of that to Bank of North Carolina. A lot of that money will be coming in here in the next, call it four to eight to 12 quarters.
Got it. Would you say that's going to start higher and then trail off as we get into the out years?
That's for sure.
A larger portion of that $170 is going to really start hitting next quarter.
That's right.
The life of that, you're saying it's going to come over the, is the life of that $170, it's got to be longer than eight quarters, though.
Oh, yeah. The life of it, well, the consultants have it going out as far as eight to 10 years.
Okay. Got it. Just a large percentage of it over the next eight quarters.
Yeah. It's definitely an accelerated kind of accretion.
Got it. Okay. That's really helpful. Thank you.
Thank you. Our next question will come from the line of Jennifer Demba with SunTrust Robinson. Please proceed.
Good morning. Back to your loan growth in the quarter. Terry, do you have a guesstimate of how much of that came from new hires that were made this year? Can you give us any detail on those hires, where they came from or what types of banks they came from, if you don't want to give specifics?
Well, let me say, I don't know the number, but I have a perception about it, and I'll be glad to share that. There's no doubt that the growth is concentrated in recent hires. I guess, Jennifer Demba, your question had to do with hires this year. I'd probably rather expand that to hires over the last 12 to 18 months, might be a better way to think about where the growth comes from. If you're growing at a double-digit pace, say you're growing at 12%-14% on a normalized basis, the way that typically breaks down is among your legacy guys who are running $200 million and $300 million loan books, you're growing at 4%-6%, and among your new guys, you're growing at 40% and 45% and so forth. The growth dramatically comes from the new hires.
Okay. Any color on where these hires have come from, particularly in the BNCN footprint?
I would say that in the Tennessee footprint, it's the same large regions from whom we've been taking people. I would think that over the last 12 to 18 months, SunTrust might be the largest contributor there. In the BNCN footprint
It's scattered out a little bit among large regional banks. I probably would rather see that thing mature a little bit more. We've got a big pipeline of people that we're recruiting, and I'd probably rather see a little bit more before I start talking about, "Hey, here's where the big contributors are going to be." It is primarily from the larger regional banks.
Okay. If I could ask one follow-up question. Your Bankers Healthcare Group fees were up obviously sequentially, but down year-over-year. Can you just talk about that, the color behind that?
Yeah, Jennifer, they had a big quarter in the second quarter of last year, the largest quarter they've ever had. Their business flows were significant call it first half of last year. They've been working it back over the last, say, four quarters. They changed some of their disciplines within some of their internal areas, and I think the way it's shaping up for the rest of the year, we're really excited about what's going to happen in the third and fourth quarters of this year. We're still thinking that we'll experience close to a 20% growth in that line item in our P&L once all is said and done for 2017.
Thank you.
Thank you. Our next question will come from the line of Tyler Stafford with Stephens. Please go ahead.
Hey, good morning, guys.
Hey, Tyler.
Congratulations on a nice quarter. Harold, maybe just to start, would there be any major balance sheet repositioning from BNC that we should expect to see or potentially could see in the third quarter?
Yeah, we're still working through the bond books. David Spencer is running through that for us. I think we'll continue to see some repositioning there, over the next, call it one to two quarters. I think what you'll likely see is more in the loan portfolio as these C&I lenders get hired. That's what we're most excited about as far as where the balance sheet might go. I think you'll see a shift from longer-term fixed-rate commercial real estate into the shorter-term C&I.
Okay. Got it. Maybe over on the reserve, clearly that took a hit with the fair value impact from BNC down to 42 basis points at quarter end. I realize you've got the $192 million of discount, any thoughts, Harold, on the GAAP reserve and where that should trend if you plan to rebuild that from here, obviously assuming no change in the credit environment?
Yeah, it's going to be difficult to reduce that reserve from this point forward. I think you'll continue to see that the provision will exceed charge-offs. Harvey and I talk frequently about the credit environment and where he's seeing weakness, and right now we feel like where we are with credit is really good, and that we're not going to see any kind of big surprises here, at least in the short term.
That ratio would be stable to maybe increasing slightly going forward?
Yeah, I don't think you'll see that number going down very much from here, if at all.
Okay, got it. Then just last one from me on the $170 million of discount from BNC. Is that purely the fair value interest rate mark, or does that also include their credit mark that you took?
That's everything.
That's everything. Okay. Great.
Both the interest rate and the credit.
Okay. Congratulations again, guys. Thanks.
Thanks, Tyler.
Thank you. Our next question will come from the line of Nancy Bush with NAB Research. Please proceed.
Good morning. Two questions for you. Number one, the 14 producers that you acquired with BNC, can you just kind of give us the distribution across markets?
Nancy, I don't have notes in front of me, I'm familiar with a good number of those hires personally. I would just say that there have been hires made in Raleigh, several hires made in Raleigh. There've been hires made in Charlotte. There's a big hire in Roanoke. There are a number of mortgage originators in there also that would be scattered around in sort of the large urban markets.
Okay.
I hope that's helpful.
It is. Thank you. Secondly, when I talk to people about the BNC deal, one of the comments that comes up consistently is, what about the rural markets? Because they did have more in rural markets than you have. Your strategy has been an urban strategy. I guess the question is sort of what do you do with the rural markets? What is the strategy?
Well, I'll just say this, I think to be clear, Nancy, as you highlight, we focus on urban areas. That's really where we try to grow. As we've done acquisitions over the years, even in Tennessee, we have some markets that might be described as rural markets. Just as an example, Shelbyville and Bedford County. That's a handsome office there that throws off handsome cash flow, we got no desire to eliminate that market. We do well in that market, do just fine.
In terms of receiving incremental investment, we channel all the incremental investment into the large urban markets. I think that really will extend into the BNC footprint. We have markets that, again, some people might describe as more rural, that do well for us and provide great funding. We'll continue to operate those offices to the extent they meet our performance standards. We'll channel all the incremental investment, I think you ought to expect the incremental investment, for us to be in key markets, specifically Raleigh and Charlotte, also in Greenville, South Carolina, and probably in Charleston.
In doing one of these deals, Terry, do you get the regulatory flexibility to exit markets or to sell places that don't make sense for you? Is that something that you would think about?
Sure. I think that we said when we announced the deal that we would go through a branch rationalization, not driven so much, Nancy, by the fact of whether it's rural or urban, just driven by the fact that BNC had been a rapid acquirer and I think had done 10 deals since 2012. You know how it is. Anytime you do that, there's some branch rationalization opportunity. That's been an intent all along. We're moving forward with that analytical construct and believe that there'll be some opportunity in there. But, again, I don't want to characterize it as rural versus urban, as much as just achieving our performance targets versus not achieving our performance targets.
Okay. Thank you.
All right.
Thank you. Our next question will come from the line of Tyler Agee with Hilliard Lyons. Please proceed.
Hey, good morning.
Good morning.
Hey, going back to your asset sensitivity, could you provide some color regarding what your simulation model is showing for an increase in interest rates of, say, 100 or 200 basis points?
Yeah. I think in the past, we've talked about anywhere from 3%-4% on the first 100. It won't be nearly that high going forward.
Okay.
That's for two reasons. One is we've got Bank of North Carolina in our numbers now, and two, we've already experienced over the last, call it six, seven months, 75 basis points of uptick. We still believe we're asset sensitive on the short end of the curve, but it won't be nearly that large.
Okay. Do you happen to have a breakout of merger-related expenses by each line item that we could have?
No, I don't have that with me. It would be largely compensation related here in the second quarter and probably more than half of it is. We will talk about that more as we go through the next couple of quarters.
Okay. Lastly, do you have a good run rate for the effective tax rate for the rest of the year?
The tax rate this quarter was impacted by the change in the accounting rules for equity comp. That was about a, call it $780,000 adjustment. It won't be nearly as large in the third or fourth quarter. We should have a fairly meaningful credit in the first quarter of next year. The first quarter will be the largest beneficiary of the change in the accounting rules. Second quarter will be second, and the third and fourth will be much less.
Okay. All right. That's all I had.
Thank you. Our next question will come from the line of Brock Vandervliet with UBS. Please proceed.
Thanks for taking my question. Just a little bit of a different take on the prior one regarding your asset sensitivity. Clearly, that's been the right approach in the most recent quarters. It sounds like that's getting less as a result of the merger integration now. What's your view on rates in general, and may you rack in that sensitivity here in the next coming quarters?
Yeah, Brock. I guess if the question is, what are we modeling currently, then I'd tell you that we're modeling a 25 basis point increase in December, and then two or three next year, both around the first quarter and mid-year, or first quarter, mid-year, and then one towards the end of next year. That's what we're putting in our modeling currently.
Got it. Okay. Separately on mortgage banking, the purchase component of that alone was up very materially. Was that simply the impact of plugging in the BNC portion into the pipe or something more at play there?
Yeah, I think I would probably characterize it as principally seasonality. You're in the high selling season, generally second, third quarter is where you peak the volumes. I would say that was the principal contributor, although we did have two weeks worth of production from BNC that would have been included in the hedge and sold on a mandatory basis. There is a little bit of pickup from that. It would just primarily be the seasonal growth volumes.
Got it. Okay. Thank you.
All right. Thanks, Brock.
Thank you. Our next question will come from the line of Brian Martin with FIG Partners. Please proceed.
Hey, guys. Nice quarter. Say, maybe just one question, Harold, back to the margin, where you kind of talked about maybe the core margin being kind of flattish going forward. This quarter was up, whatever, maybe five basis points or so with the yield benefit. I guess, in your expectations on rates still going higher, at least kind of as you guys are thinking about them, and not much change in the funding costs. That core margin ought to I guess, your take on it being flat versus up is am I guess, not understanding what you're saying? Or I guess, kind of what's the outlook on that core margin, which, as you look forward, is it kind of flattish at the current level? Is that what you're suggesting?
Yeah, I think it'll be flattish. We'll probably pick up a few basis points based on the increase in rates. BNC's core margin was a little less than ours, so we'll have that fully weighted in in the third quarter. Our estimates are that the core will likely be right around where it is. It might be a few ticks up. I think where you'll see the biggest increase, though, is in the GAAP margin.
Okay. Yeah, just in your comments, Harold, in the past, on the deals you guys have done, kind of talking about that accretion income, when you look in the year one period, how much of that accretion has kind of typically come in? Is it kind of in that 30%-40% type of range? Is that kind of out of the ballpark?
Yeah, we're not planning that kind of number in the first four quarters. It's pretty meaningfully less than that.
Okay
That's what we're looking.
Yep. All right. Just going back to Terry's comment about M&A, I guess, as you kind of work through getting the BNC and kind of integration and all that done, kind of being the near-term priority, but still looking at the opportunities that are out there, Terry, I guess, is there any indication time-wise? If you look at opportunities today, I guess, how quickly could you, or would you be willing to step into another transaction, potentially another opportunity if it came up? I guess, are you ready currently, or would it be a little bit?
Yeah. I guess I might go at it this way. Your question is, what would you do, and that's not necessarily the same as what could you do. My sense is on the what could you do, I don't think I would make a large acquisition right this minute. I probably want to finish the system integration, do those kinds of things. I've generally tried to indicate that, if things go as we intend for them to go and so forth, early next year, you'd probably be in a position where you could consider taking on other meaningful M&A. I get most questions about M&A, I believe there's some of those opportunities.
I also believe there may be some de novo opportunity in there as well, and, at least for me, that's a significantly different integration challenge, and honestly, not much different than the volume of hiring we would normally do on a quarterly basis. If you say, "Well, would you do a de novo now?" I probably would if I had the right opportunity, had the right group of people, and so forth. That'd be something I'd be willing to do. Again, I don't want you to walk away and say, "Hey, he said he's getting ready to do a de novo start here." I'm not telling you that. I'm just sort of trying to answer your question, what would you do? I'd be willing to do a de novo start. I probably wouldn't be willing to do a really large acquisition. Need a little more time for that.
Again, I do hope that the message comes through that this is a luxurious position to be in, where we're going to throw up really outsized earnings growth for a period of time, it feels to me, and without taking on these other projects. That's kind of my outlook is, hey, if it fits and it's good for long-term shareholder value, it'd be something we'd do. We're not compelled to. Every now and then somebody will say, "Well, what's your timeline to get to Atlanta?" Or something like that. I say, "Man, there's no timeline. I don't care if I ever get there." I bet we do, but I don't care if we get there or not. We've got a great hand to play just like it is.
Okay. That's helpful. Maybe just one more for Harold, just on the You talked about some of the items on the fee side as you kind of look forward. I guess, was there anything that's unusual, Harold, or not sustainable from the current level, maybe kind of in those other areas that as you look forward? I know you highlighted a couple of things in that other line item, anything that's really not sustainable going forward?
Yeah, Brian, I don't think there's anything in there that we'd classify as an outlier. All the gains that we had on those loans were from businesses that we are currently involved in, and we've devoted resources to. There's not like a one-off deal in any of that.
Okay. All right. Got it. Thanks, guys.
Thank you, Brian.
Thank you. Ladies and gentlemen, this concludes our question and answer session today. We'd like to thank you for your participation on today's conference, this does conclude the program. You may all disconnect. Everybody, have a wonderful day.