Pinnacle Financial Partners, Inc. (NASDAQ:PNFP) Q1 2024 Earnings Call Transcript

Pinnacle Financial Partners, Inc. (NASDAQ:PNFP) Q1 2024 Earnings Call Transcript April 23, 2024

Pinnacle Financial Partners, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, everyone. And welcome to the Pinnacle Financial Partners First Quarter 2024 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 Web site at www.pnfp.com. Today’s call is being recorded and will be available for replay on Pinnacle’s Web site for the next 90 days. At this time, all participants have been placed on a listen-only mode. The floor will be opened for your questions following the presentation [Operator Instructions]. During the 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 actual results, performance or achievements of Pinnacle Financial Partners 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 to not put undue reliance on such forward-looking statements. A more detailed description of these and other risks is contained in Pinnacle’s financial annual report on Form 10-K for the year ended December 31, 2023, and its subsequently filed quarterly reports. 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 the reconciliation of the non-GAAP measures to the comparable GAAP measures will be available on Pinnacle Financials Web site at www.pnfp.com. With that, I am now going to turn the presentation over to Mr. Terry Turner, Pinnacle’s President and CEO.

Terry Turner: Thank you, Paul. And thank all of you for joining us here this morning. Most of you have endured these calls and so we’re going to begin every one of these calls with this shareholder value dashboard. These metrics are really our North Star. There are a lot of interesting things that can be talked about and obviously, Harold will talk about more things in more detail here in just a few minutes. But ultimately, we’re here to produce shareholder value and this is how we think you do it over time. Looking at the GAAP measures first and then the adjusted numbers, which really better reflect how we run the business. At a glance, you can see that we continue to grow revenue more rapidly and reliably than peers and we continue to grow our balance sheet volumes more rapidly and reliably than peers, which is the fuel for our future revenue growth.

And that we relentlessly focus on compounding tangible book value. And then across the bottom, now the key asset quality metrics we focus on reflecting both problem loan formation and losses. In general, those measures continue to be among the best in the peer group, and as you can see, compare favorably to our longer term historical averages. But that said, during the quarter, we increased our allowance for credit losses on loans from 1.08% to 1.12%, primarily as a result of further deterioration in a previously disclosed problem borrower and to provide additional protection given the higher for longer rate scenario. So from 30,000 feet this quarter, we’ve got the reserve build on one side, largely being offset by the recognition of a conversion mortgage servicing right and lower expenses in the form of reduction in associate incentives.

Nevertheless, for me, there’s a lot to celebrate here, particularly in terms of revenue growth with growth in both noninterest income and net interest income, double digit core deposit growth and even net growth in noninterest bearing deposits. So with that, Harold, let’s take a more in-depth look to quarter.

Harold Carpenter: Thanks, Terry. Good morning, everybody. Another strong quarter of deposit growth. We were also pleased with how our noninterest bearing deposits performed during the quarter, giving us additional optimism about where those balances might be added for the year. As to 2024 deposit growth, still believing we can grow deposits within the previous range of high single to low double digits this year. Obviously, the latest FOMC meeting will impact our rate projections for the remainder of the year. As a result, we’ve taken more time looking at the back book on deposits. Two years ago, 100% of our MMAs had rates less than 2%. Today, only 15% of our rates are less than 2%. Also today, 65% of our money markets are at rates greater than 4%.

So we feel that our deposits are priced very competitively. We have made some preemptive strikes here late in the quarter successfully reducing some of our more expensive accounts as well as a deep dive on our pool of reciprocal deposits. This effort is helpful to our outlook as we enter the second quarter. As to new accounts added to our lenders in the first quarter, the average onboarding rate was around 3.75%. As we’ve said, we like our position as to deposit rates in our markets. So for us, deposit rates will likely be more like a slow creep from here, not any sort of rapid increase. I’ve listened to a few conference calls of late, particularly by large caps as some believe they’ve acknowledged outsized deposit spreads and are letting people know that benefit may be going away in the near future.

That said, we believe as we head into second quarter, deposit rates for us may increase a few basis points, but it won’t be a lot. Loans came in slightly less than we anticipated. We did have some large put payoffs late in the quarter, which impacted our EOP balances, still feel like we will be outside loan growers for the year, call it, 9% to 11% growth. Still believe that we are doing a good job on spreads, particularly for prime and SOFR price credit, and fixed rate spreads continue to come along nicely. One of the keys to our financial plan is repricing our fixed rate loans. We’re expecting about $3 billion in cash flows from our fixed rate loan books, which are scheduled to come in over the remainder of 2024 with, call it, an average yield of around 4.65.

As to renewals and new fixed rate loans originated in the first quarter, we averaged around 7.35% with a target of 7.5% to 8%. I think our RMs are doing a great job here and are looking forward to seeing what happens in the second quarter as it is the most important quarter as far as net interest income growth for 2024 is concerned, given we have a lot of opportunity to influence the success of this initiative in the second quarter. Our loan growth targets, which we feel good about, coupled with our efforts on fixed rate repricing will go a long way to hitting our net interest income outlook for the year. We did see some contraction in the margin this quarter at 3.04 after two quarters of 3.06. We said last time that we were optimistic that we would see NIM expansion in 2024.

We feel confident that we will see margin expansion happen in the second quarter. We modified our interest rate forecast from four cuts to two and with the two not happening until later in the year, one in September and one in November. That said, given the volatility of the data, we could decide that no rate cuts will happen this year as the trend seem to point to fewer at this point. We feel like the no rate cut scenario on the short end of the curve is likely neutral to our current outlook as we move through the year. As you might expect, we just would like to see the intermediate part of the curve continue to steepen. So in March 31, you might ask is PNFP asset sensitive or liability sensitive? Considering our technical balance sheet modeling as well as how we think our RMs and their clients typically respond to these sort of environments where net interest income initially higher for longer is probably helpful, but longer term deposit rates will likely rise somewhat and potentially squeeze the margin over time.

As for credit, we’re again presenting our traditional credit metrics. We mentioned one nonperforming credit in the fourth quarter press release that weakened further during the first quarter. As we noted above, this credit contributed to the 4 basis point increase in our allowance this quarter. This loan started out in 2020 of the $40 million loan to a borrower that leases highly specialized healthcare facilities to operators in various states. We did report a partial charge off of $2 million relating to this credit in the first quarter. The operators of the borrowers’ buildings were impacted by COVID as the operators were unable to collect sufficient and timely reimbursement, which was needed to recover the incremental cost of inflation for their clients and patients.

As a result, operators incurred revenue shortfalls, skilled labor, lab census went down, et cetera. Our borrower is cooperative and is helping facilitate resolution, which could take a few quarters. This is one where the less learned is a hard pill to swallow, much reliance on the wisdom of the management team that we have banked for many years, the management team has executed a simpler business model before and done it successfully and was experienced in the very specific corners of the healthcare industry. We will work to resolve this matter as quickly as possible and minimize the loss to our firm. The buildings are in good markets and are in attractive areas in those markets. So given all the above, we’re anticipating a net charge off rate of 20 to 25 basis points for 2024, inclusive of the loan I mentioned previously.

Currently, we have no reason to believe that our allowance count will increase from here, so we are flattish on the reserves for the rest of 2024. More about commercial real estate. And just so you know, we’ve added some more information on credit primarily for CRE and construction in the supplemental day. Our CRE construction portfolio continues to perform very well. As you might expect, our credit officers continue to pay particular attention through our multifamily, hospitality and office portfolios. We continue to push for lower exposure and construct. Our target of 70% of total risk based capital we believe can be achieved before year end 2024. Our appetite as noted by the almost solid red table on the bottom right is largely unchanged and we don’t anticipate any change as to appetite in 2024 even when we go below 70%.

We continue to be somewhat interested in high quality real estate, primarily warehouse and some multifamily but let me stress, any new commitments to this space are limited to strategic client relationships only, and in no way should anyone perceive we’re on any sort of offense here. As to the impact of higher for longer, lots of discussion around liquidity and takeout availability in the institutional CRE space. We would agree that liquidity is tight for say downtown multi-tenant office, power center retail, high end hospitality and other specific segments where COVID and now inflation has been very impactful. We just don’t have much, if any, exposure to these segments. For our segments, we, like other banks are seeing our institutional borrowers delayed decisioning regarding any sort of exit on these projects, whether it’d be marketing for sale or securing a permanent loan.

I know there’s a lot of noise out there that lenders were panicked and borrowers are desperate to get out of these construction projects, not so for the property type PNFP has long supported. There remains ample liquidity, which recently appears to be getting somewhat more attractive to our borrowers, specifically take out from life insurance companies and the agency lenders, Fannie Mae and Freddie Mac. These capital sources are generally more favorably priced than our bank debt, usually by 1% to 2% in most cases. We are seeing 10 year terms from insurance firms and agencies in the 7% range versus bank rates, call it, between 8% and 8.5%. The CMBS market is available. However, our arrows are typically not big fans given the inherent flexibility of the CMBS debt structures.

All in for now, many borrowers have elected to remain with banks by executing the embedded extension options in their original construction loan contracts rightsizing the outstanding balance, if necessary and thus, waiting for a better rate environment to sell or refinance. Again, some select information on CRE credit and various asset quality measurements. We have added some [LTV] information to this slide. Our LTVs, we believe, are solid, and as the chart indicates with lots of room for valuation adjustments should markets require. We have also analyzed recent loan renewals for nonowner occupied commercial real estate with principal balances greater than $5 million and have seen some modest declines in LTV for these credits. The worst was a $22 million office loan where the LTV went from 34% in January 2020, that was before the start of COVID and before work from home was a thing, to now 45% currently, an 11% reduction but still very comfortable at 45%.

The best result was longer term an $11 million hotel loan that moved from an LTV of 59% to now 38%. Both of these loans are performing and we have no reason to believe there’s any issues with them. We have experienced some increase in credit metrics and classified assets and NPLs from a year ago, but these levels remain enviable in our humble opinion. Additionally, as to our market data, our occupancy levels remain strong and rental rates have experienced several years of increases, which has served to strengthen our sponsors. Some of that information is also in the supplemental deck. Now on the fees, and as always, I’ll speak to BHG in a few minutes. Excluding BHG and various other nonrecurring items, fee revenues were up 11.4% linked quarter.

We are pleased to report that our wealth management units had a strong first quarter and fully expect the efforts of our wealth management professionals will continue in the remainder of 2024. The BOLI work we did last quarter is performing as planned. So we expect to see incremental revenue from that work, some in the second quarter but also into the third quarter. As to the mortgage servicing right asset that Terry mentioned earlier, we elected to report it this quarter. We have been serving Freddie Mac SBL loans since we merged with Magna Bank in Memphis several years ago. SBL is the small business lending program Freddic Mac offers. It’s really the standard for HC Bank’s small apartment financing with loan amounts of $1 million to $7.5 million.

PNFP originates the loan for Freddie who purchased the loan from unit with PNFP retaining the service. Over the years and as we do each year, we perform strategic assessments on various business lines to determine strategic fit, growth potential, cultural alignment, so on and so forth. As rates escalate the value of the servicing right increase, especially over the last several quarters. We’ve also increased the volume of loans being serviced in that unit in recent years. In line of that, we obtained a third party appraisal to determine the value of $11.8 million, which we will now need to revalue every quarter. All in, we are raising guidance for fee revenues this year, primarily driven by the growth in our primary fee businesses. A range of 10% to 14% seems reasonable given the performance of several of our primary business lines in the first quarter.

First quarter expenses came in slightly less than we anticipated after backing out the FDIC special assessment. We, like everyone else, recorded the FDIC special assessment accrual of $7.25 million in additional expense in the first quarter. Importantly, we’ve lowered our incentive target from 100% to 120% payout for fiscal year 2024 to now 80% here at the end of the first quarter. Obviously, our goal is to bring it back to target this year but that can’t happen unless we feel like we’re going to achieve our financial targets. In the end, the relationship we’ve created since we started the firm between our financial performance and our incentive plan works is intentional and helps ensure that we don’t sacrifice one to benefit the other. We have elected to keep our expense outlook unchanged at $950 million to $975 million for the year.

You might ask why not lower it more. We have some reason to believe that we can find our way back into this. So we hope to get back some of the incentives we eliminated in the first quarter, but we also have other ways to manage our costs and we will deploy those as considered necessary. We believe our overall expense outlook for 2024 is largely intact, so we’re going to keep it consistent for now. Now to the BHG. As the slide indicates, our origination trends were down in the first quarter given the tighter credit box and the impact of the macro interest rate environment. Last quarter, we anticipated a flattish year as to production. BHG believes that their 2024 production target is still in reach but a higher for longer rate environment could impact those assumptions.

As to placements, it was again a very strong quarter for sales into the bank network and they also closed on their ninth securitization for $300 million, and as we mentioned in the press release last night with a net spread of greater than 10%, which we were all very excited to see. Also, my understanding is that over 35 firms participated in the issuance, thus, great demand for BHG paper. Also keep in mind this securitization added more than $30 million in provision expense to the first quarter results. BHG doesn’t anticipate another ABS issuance until probably the fourth quarter of this year. As to spreads, auction platform spreads did widen during the first quarter to 8.1%, while the balance sheet spreads are fairly consistent with prior quarter.

All in, BHG believes spreads are holding in this rate environment. BHG believes when rate decreases start that will be a good thing for them, not only from a volume perspective but also from a spread perspective. On reserves, and there’s a lot of information on this slide. BHG did increase reserves during the first quarter for both on and off balance sheet loans, modest uptick in the first quarter for credit losses for the off balance sheet business going from 3.1% to 3.3%. On balance sheet was at 6.8% but the news is good as it pertains to BHG’s credit experience. We have been anticipating for at least a year or more than the first half of 2024 was critical to our assumptions around credit improving. Even though the charge off rates for on balance sheet increased during the first quarter, the actual dollar value of charge offs for on balance sheet decreased along with average balances.

That’s why the charge-off rate increased because the average balance is mid now. Even though the charge-off rate for both on and off balance sheet was up in the first quarter, BHG believes that they may have turned the corner on tackling the COVID overhang of great inflation in 2021 and 2022. As the bottom left chart indicates, client delinquencies, which are past dues greater than 30 days for all of BHG’s loans, both on and off balance sheet, appear to have topped off over the last few months and are bending down at the end of the first quarter, especially in consumer credit. Also, BHG believes, based on information gathered from the rating agencies, their loss experience thus far post COVID will be better than that of other fintech competitors.

Again, as the pass through chart indicates, the consumer line is very encouraging. It’s too early to declare victory but BHG has worked tirelessly get back to their pre-COVID credit environment. More progress to come over the next few quarters. As to origination and earnings, achieving the same level of originations as last year will take great effort. That said, BHG is not an emphasis or not interested in adjusting their credit models to achieve volume goals. Suffice it to say, as to placing BHG’s originated credit, the appetite for BHG’s credit is as strong as ever. That in and of itself should help spreads going forward. As to earnings, BHG is holding to their mid single digit earnings growth target for this year. Additionally, BHG has tactics they can deploy to help their bottom line and increase potential earnings.

The important assumption for BHG this year is what happens with credit. If improvement continues, like we believe it will, BHG will have an impressive year. With that, I’ll turn it back over to Terry.

Terry Turner: Thanks, Harold. In general, it seems to me that the operating environment for banks is both difficult and volatile, inflation appears to be more difficult to tame than predicted even as recently as several weeks ago by Jerome Powell. It seems to me that rates are now more likely to stay higher for longer, resulting in an inverted yield curve for longer. And with all the uncertainty and rapidly changing market conditions, bank stock investors are obviously finding it challenging to forecast bank earnings and discern the dependable creators. And so in my opinion, in this environment, a company like PNFP that over the longer term has been able to generate such reliable growth should be an attractive alternative. We built a truly differentiated model that attracts the industry’s best talents like none of its competitors and creates [raving] fans like none of its competitors, which results in persistent growth of clients and therefore, persistent growth in loans, deposits and net interest income over the long haul.

It’s how we consistently grew our EPS over the last decade without having to take on many of the risks that some in our industry have taken, which almost always come on to roost in times of volatility. In fact, we produced the highest total shareholder return among our peers over the last decade, a decade that witnessed a great deal of volatility. Over the decade, I watch bank management take extraordinary risk and investor themes change with every swing in market conditions. Here in the pandemic, slow growth and no growth banks came into favor and we saw PEs for banks with net negative balance sheet growth to be significantly higher than for the growth banks. During the liquidity crisis, we saw valuations pick up for the money center banks on one end and slow growth in rural markets on the other versus high growth regions like PNFP.

During the Fed tightening cycle, we saw low deposit beta banks highly rewarded while high beta banks like PNFP [indiscernible]. But through all of that, at Pinnacle, we simply focused on rapidly and reliably growing our earnings stream. Not betas, not margins or trending niches, earnings. Our approach at Pinnacle reminds me that old John Houseman commercials for Smith Barney, where he said, they made money the old fashioned way, they earn it. During the last decade, our price the next 12 months EPS contracted meaningfully. So then it becomes obvious that it was our ability to [rightly] grow earnings that accounted for our peer leading total shareholder return and not the pickup in the multiple that investors were signing based on their most recent thesis.

And so let me be clear, at PNFP, our focus is primarily on sustainable long term growth in earnings and tangible book value. And I’m not saying that deposit cost betas are of no importance. I’m not saying it’s merited to screen for NIMs or ROAs or efficiency ratios. I’m just saying at Pinnacle, our principal objective is sustainably compounding earnings and compounded tangible book value. So we could slow hiring, reduce noninterest expense and improve our short term earnings. And we can concentrate on lowering our deposit betas instead of funding a high growth balance sheet before we go the once in a generation opportunity we have to continue taking market share from all our competitors. But instead, our focus is on sustainable growth in earnings and compounded tangible book value.

And if you focus on sustainable earnings growth and compounded tangible book value, there’s no chance you’re going to take a temporary influx of liquidity based on government stimulus and put it in securities to reduce your short term earnings at a time when interest rates are near all time lows. And you can’t accept the duration risk of loading the balance sheet with unhedged long term fixed rate mortgages when yields are at all time lows, you just accept the lower net interest margin in order to protect hard earned tangible book value, that’s your focus, you protect loss absorbing capital. There are banks that win best when rates are falling and there’re banks that win best when rates rising, and there’re banks that have really low average deposit balances, all of which you’ve garnered lofty multiples at 1 time or another over the last decade.

But in the banking business, perhaps the only way to consistently and reliably produce total shareholder returns better than peers over the long haul is to have a sustainable competitive advantage, a differentiated model, and that’s what I believe we have at Pinnacle. This is the 2023 market tracking data from Greenwich Associates, our coalition Greenwich as they refer to themselves now. The is for businesses with annual revenues from $1 million to $500 million in our market area, which for these purposes is defined as Tennessee, North Carolina, South Carolina, Washington, D.C. and Atlanta, Georgia. It compares the top 10 banks in the footprint. More specifically, in addition to Pinnacle, the top 10 banks in that footprint include Truist, Bank of America, Wells Fargo, First Citizens Bank & Trust, PNC, First Horizon, JPMorgan, Regions and SouthState.

Looking at client satisfaction on the left of the slide, the crosshairs are set that mean for the market penetration on the Y-axis and the percentage of excellent client satisfaction ratings on the X-axis. So the banks in the top left quadrant are the large share banks with the lowest level of client satisfaction, that’s what we refer to as vulnerable competitors. Banks in the lower right quadrant are the banks providing the highest level of client satisfaction, theoretically, the market share takers. And as you can see, PNFP provides the single highest level of client satisfaction in our footprint, that’s differentiation and a particularly wide differentiation when compared to the largest, most vulnerable banks in the market. And on the right side of the slide, you can see that the banks at the top with the highest overall client satisfaction are generally the market share takers.

Those are the banks with improving market penetration over the last year as shown in the rightmost column. And the banks at the bottom of the list are the lowest client satisfaction banks and they are indeed giving up market share penetration. Honestly, more important than client satisfaction scores is the Net Promoter Score, satisfied clients will many times leave if they get a better offer, while net promoters are substantially less likely to leave because they’re mostly engaged with the brand. Not surprisingly, PNFP has the highest level of net promoters, not by a little, but by a lot. And not only do we have far and away the highest percentage of promoters, but the Greenwich survey data found no detractors literally zero. Hopefully, as you study this comparison with the top 10 banks in the Southeastern footprint, our sustainable competitive advantage is beginning to crystallize.

It’s no secret that for relationship managed banks like us, the quality of the relationship managers must be the principal differentiator. Greenwich has identified seven important metrics that are valued by business clients. You see them listed in the first column there. In the rightmost column, you see the peer comparison ratings for the same 10 competitors in our footprint that I just walked through. The blue bars represent the range of score for that set of 10 banks on that metric. The white line is the median score and the white circle is the Pinnacle score for that metric. As you can see that PNFP is the market leader for every single relationship management metric. Think about that in terms of a sustainable competitive advantage. Not only are we widely viewed to be the most prolific hirer of relationship managers in our footprint, but the quality of those we’ve attracted are literally the best in the market.

And as a slight [degression] I want to make at this point when we provide our outlook for loan growth, as an example, which is substantially higher than peers, some might fear that the risk profile is elevated as a result of the high growth in loan. But hopefully, as you think about the fact that we’re not only hiring the most relationship managers in our footprint, which explains the high growth but we are in the best relationship managers in our footprint, which in my judgment, should produce a lower risk profile not a high risk. Much has been said and written about the advantage that the large money center banks have as a result of their technology budgets, and there’s no doubt that every money centers techs spend would substantially swamp ours, but using a similar graphic for client percentage and regarding treasury management and the digital experience, for the top ten banks in our footprint, again, you can see that Pinnacle actually has the single best perception among business survey by Greenwich in our footprint, both in terms of terms of capability and delivery.

This is one of the clearest examples of how we combine the tech and touch to create this sustainable competitive advantage. And ultimately, there’s no more powerful brand among businesses in our footprint than Pinnacle. Greenwich has identified five pillars, brand perceptions among businesses. And as you can see the range of scores for the top 10 banks in our footprint is pretty wide, but again, Pinnacle is the leader on every single pillar. And so as you think about sustainable competitive advantage, it’s highly unlikely that competitors can easily address their market perceptions for how easy they are to do business with, how trustworthy they are or whether they value long term relationships and so forth, even if they recognize these substantial deficiencies and even if they have the will to change, and even if they’re successful in addressing all the root causes of why they’re so hard to do business with and why they’re not trusted and why they’re viewed to not value long term relationships, those reputations with customers are more likely built over decades.

And so attempting to connect the dots for you on exactly why we’ve been able to gather clients faster than competitor, while we’ve grown our interest earning assets faster than peers and therefore, our net interest income on faster than peers, and therefore, our EPS faster than peers over the last decade is because of the very hard work we’ve done to build the kind of work environment that attracts not only the most but the best talent in the industry and to create a demonstrably differentiated level of service. That’s why substantially less clients can see any vulnerability in their relationship with us and substantially more clients intend to reward us with more business over the next six to 12 months by far than for any of our competitors.

That’s the linkage from the work environment, which was recently ranked by Forbes Magazine as the 11th best in all the United States to the recruiting effectiveness, to the client experience, to the volume clients intend to move to us. And all of this bears on our outlook for the remainder of 2024 and for the next decade for that matter. So Harold, let me turn it over to you.

Harold Carpenter: Thanks Terry. Now to our slide on our outlook for 2024. We’ve tightened our expectations in some cases and modified others. In the end, we’ve concluded that our overall outlook for 2024 is basically consistent with last quarter. I’ve listened to a few conference calls this quarter. There’s a lot of chatter around world events, inflation, M&A, politics, so on and so forth and how those events are impacting their outlooks for ’24 and ’25. For me, I find myself thinking a lot about interest rates and credit. I have a lot of confidence in where our balance sheet sits with respect to both. I’ve mentioned to a few of my CFO friends over the last few years how it was a bit envious of their asset sensitivity. Our goal is and has been managing our balance sheet with an aim towards interest rate risk neutrality.

We may drift slightly to either asset or liability sensitivity from time to time. But in the end, our belief is that we left the client gathering engine be what drives our earnings growth. As to credit, I personally spend a lot of time with our credit team, also spend a lot of time with RMs and in recent quarters, particularly our real estate lenders. I likely will spend even more time with all of them for the rest of this year to try to better understand what happens to credit when rates go up or go down as I should and as you would expect. For what it’s worth, our folks are at the line of [scrimmage] actively working with our borrowers every day, ensuring we deliver great service and protect the financial silos of this firm. Because of that, I feel good about where we are, where we’re headed in 2024 and what we all hope 2025 will shape up to be even after you consider what we know today about world events, inflation, so on and so forth.

So with that, Paul, the group, I know, is thankful that I am done. And if you would, let’s open it up for Q&A.

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Q&A Session

Operator: [Operator Instructions] And the first question today is coming from Casey Haire from Jefferies.

Casey Haire: Quick question — question on the, I guess, the NIM outlook. You guys mentioned that it’s — you expect it up in the second quarter. And the spot deposit costs are down relative to the first quarter but some of the yields — the loan yields, spot yields are lower than where they were in the first quarter and then the muni bond yields were also lower. Just trying to get a sense of what’s going on the yield side.

Harold Carpenter: I think the muni bond yields, there’s a volume issue there. But I think we should see some of that recover here in the second quarter. The deposit rate forecast, I think, will be just a small creep. What’s really dependent on our NIM forecast is how well we do on fixed rate loan repricing and whether our DDA accounts hang in there like we think they’ll hang in there. So if those two things happen, we think our NIM forecast is solid. Obviously, loan growth is an important element to all that. And so we still feel pretty good about the 9% to 11% loan growth for the year.

Casey Haire: And then I guess just switching to the BHG outlook. The guide implies a pretty steep ramp in the remaining quarters here. Harold, you mentioned credit as a pretty significant wild card. Just wondering what does that — how do you get BHG run rate up to that sort of mid $20 million level to hit that guide? Is it credit or is it more originations? Just some color there.

Harold Carpenter: We think originations are going to be probably a little better here for the rest of the year. What impacted the first quarter a lot was that ABS placement. I don’t think they’re going to spend as much time working on balance sheet kind of growth and they’ll spend more time on the gain on sale part. But you’re right, the credit is the issue. We’re all optimistic to see those bars turn south and they feel pretty good about where they are right now.

Operator: The next question is coming from Steven Alexopoulos from JPMorgan.

Steven Alexopoulos: Harold, maybe to start to go back to the question Casey just asked. When I look at the margin is pretty flat, earnings asset yields were pretty flat, positive was pretty flat this quarter. It’s not really clear to me what’s driving the expectation for NIM expansion in the second quarter?

Harold Carpenter: Well, like I said, we’ve got a lot more fixed rate loans to reprice this quarter. We think also the work we did at the end of the quarter on some deposit preemptive strikes into the deposit book should also be helpful. So those are — that and DDA balance is hanging in there are the primary kind of tailwind to the margin uplift.

Steven Alexopoulos: So you’re expecting earning asset yield to pick up a bit in 2Q and deposit costs to come down a bit, is that what you’re saying?

Harold Carpenter: That’s right, I think mix shift in the earning assets, yes.

Steven Alexopoulos: And then on the expense side, we know you guys took the incentive comp down to 80% of target, but kept the full year expense outlook intact. Could you just run through a little more detail what’s expected to fill that bucket up, why we’re still the same expense outlook?

Harold Carpenter: So what we elected to do is not take it down. So we’re going to keep it the same. We felt like as that played into our overall outlook for 2024 that was the fair thing to do. If the incentive accrual gets reapplied, so we add back to, call it, the $30 million into the incentive accrual for the year, that will come, obviously, with revenue increases. But we have other opportunities to kind of manage our expense outlook to kind of keep that still within that 9.50 to 9.75, if that makes sense.

Steven Alexopoulos: I guess, the one last part the new hiring was really solid as far as 37 new hires. What is embedded in the expense outlook? Like is this going to be a much stronger year than typical for hiring, just given the pipeline?

Harold Carpenter: I think we put in the — as far as the plan for this year, basically the same hiring profile for 2024 as 2023. I’ll have to go back and look at my numbers. But I think overall headcount was up 100 people or so last year, something like that. So that includes revenue producers in every bond. It was 115, something like that. So the revenue producer plan was basically the same this year as it was what we did last year.

Operator: The next question is coming from Catherine Mealor from KBW.

Catherine Mealor: One more on the margin here. So you mentioned that even in a no rate cut scenario that’s neutral to your outlook on your NII guide. How should we think about the downside risk to growth if we don’t see rate cuts later on this year?

Harold Carpenter: I think it will impact growth maybe to the low end of our number. But at the same time, a lot of our growth, if you look — there’s a chart in the back that shows where our loan growth came in the first quarter, and it all came from new markets, new people. And so that’s what we’re leaning into as far as our — basically our loan growth for the whole year. We’re not expecting any significant growth, call it, if it’s not 11 overall, we might be looking in the legacy markets for, call it, 5% to 7%. So that chart in the back would show that we didn’t have partly any [growth], in fact we had negative growth in the legacy markets in the first quarter.

Catherine Mealor: And then similarly, on the margin in a scenario where we don’t have cuts, do you feel like there’s enough momentum in DDA balances holding in and you’ve got better fixed rate loan rate repricing for the back half of the year that the margin continues to expand throughout the rest of the year with cuts or even without cuts?

Harold Carpenter: We’re keeping our fingers crossed on that for sure. Right now, our average DDA balances as far as individual accounts are pretty consistent with pre-COVID. There might be a little excess there that we need to worry about. But so far so good with respect to that. But that’s a really important kind of component to the overall kind of net interest income plan for the year.

Catherine Mealor: And one just really small question, if you don’t mind. Service charges were a lot higher this quarter. Any color on what’s going on there, is that a good run rate to grow from?

Harold Carpenter: I don’t think there’s anything specific that we can talk about, maybe Terry has got some ideas here. But I think we did do some kind of like everybody looking under rocks looking at fee waivers, looking at things like that where we’ve, over the years, kind of just gotten into maybe some places with certain clients where we need to kind of readdress some of those charges. But I don’t think we did any kind of…

Terry Turner: There were no universal price changes. There were some initiatives that were aimed at reviewing long term waivers, long term special pricing, those kinds of things that I think have made a difference.

Operator: The next question is coming from Brandon King from Truist Securities.

Brandon King: So just to round out the deposit cost question, I think I’ve heard mixed names. So are you expecting interest bearing deposit costs to incrementally creep a little higher from here? Is that correct?

Harold Carpenter: Yes, I think they will creep, but it will be 1 to 2 basis points. I don’t think it will be any more than that. I think our group is doing a good job of holding the line on deposit costs. So long as our core deposit kind of growth continues, I think that will be accurate. If for some reason, core deposit growth doesn’t happen and we have to go to the wholesale market that money is really expensive, and we’re hoping not to do that. So so far, so good.

Brandon King: And then, Harold, in your prepared remarks, you mentioned that there could be other ways to manage costs besides the incentive accrual. So do you care to go into more details about what could potentially be done on that front?

Harold Carpenter: Well, we can always delay hiring. For all practical purposes, our hiring plan for support units is really restricted right now, not to put a damper on the call. But we can do that, we can delay hiring. We’ve got some projects that are slated to start this year and we can delay those. There are several things that we can do in order to kind of bring the expense number back in line if we need to.

Brandon King: And then just lastly, on BOLI came in around $11 million in the quarter. I think you mentioned that you could see some incremental revenue from that. So should we expect that kind of $11 million figure to increase incrementally or should that normalize to a smaller amount?

Harold Carpenter: Well, I think probably, call it, $10 million is probably a fair number to think about going forward, there were some death benefits in the first quarter. But yes, I think somewhere, call it, $10 million issue is probably a fair number for BOLI.

Operator: The next question will be from Stephen Scouten from Piper Sandler.

Stephen Scouten: I guess one of my first question here was just curious around customer kind of appetite for the higher fixed rate loan yields today versus maybe last quarter or previous. Do you feel like customers are becoming more maybe acclimated with this rate environment and you’re not getting as much push back, or kind of what are the dynamics there as you reprice these loans?

Terry Turner: I think it is fair that there is more acclamation on the clients’ part to higher fixed rate quotes. So that’s a true statement, but I wouldn’t want to act like it’s easy. I mean, it’s a dog fight for sure. But I think during the quarter, our repricing was at 7.35, the target 7.5 to 8. So we’re within striking distance and it’s way up from where it was. So again, I don’t want to act like it’s easy. It’s not easy but we are getting it done. And I think it’s a combination of the clients’ acclamation to the rate. And I think some of the distinctive service levels and so forth, the client loyalty is an important variable in there as well.

Stephen Scouten: And I would think — I mean, the renewal spreads look like they continue to widen a bit? And is that largely a function of just the 2021 kind of vintage origination has been the lowest yielding fixed rate loans that remain on the books?

Harold Carpenter: I think Stephen, I don’t know if I got all the question. But there’s a chart that’s on the loan side, that first bar is the biggest as far as rates. I think it came in like 4.90 is what the renewal rate is coming into the second quarter. And the reason is that is probably at the tail end of where — before rates started coming down back a few years ago. So that’s why that line on that chart is highest at 4.90 and then it drops pretty meaningfully down into the 4.60s down into the 4.40s over the rest of this year. Does that make sense?

Stephen Scouten: And then just last thing from me. I know there were times in the past 10, 12 years when you guys have done a really good job of having floors in place before rates went down and taken them off as risk remain higher. Do you have any meaningful floors in the portfolio today or has that been a part of the pricing conversation at this point in time?

Harold Carpenter: We’ve got floors in place and we’ve got some balance sheet floors. I think we can — I think we’ve got $3 billion to $4 billion in covering some of the floating rate credit. But largely, we’ve encouraged floors at the line of scrimmage into individual loan contracts. I don’t have the number as to what that is today, but I’ll dig it out and I’ll get it to you.

Operator: The next question will be from Michael Rose from Raymond James.

Michael Rose: Harold, I know you guys have a pretty robust assumption for deposit betas on the way down. Has there been any change in that and what is the kind of swing factor there if we don’t get any cuts this year as it relates to kind of the NII guide?

Harold Carpenter: I think on the short end, I don’t think there’s a whole lot of change to our NII guide today, Michael. We still plan on and our relationship managers are well aware and they’ve been informing their clients that when rates do come down, we will be aggressive on the downside. I think if you — we’ve gone back and looked at what our beta was on the way up on our negotiated rates, it was like 70% or 80%, somewhere in that range. So we intend to be aggressive on the way down. I think the critical question is around what happens if rates don’t move from here. Again, I think on the short end and also for the near term, we feel like it’s fairly neutral.

Michael Rose: And then maybe just on the deposit growth. You guys have done a great job over a very long period of time growing deposits. Can you just talk about the complexion of the growth, maybe how much will come from some of the more expansionary markets that might be higher cost in [nature] just given maybe some introductor to your teaser rates as you build out those markets versus what you’re expecting in the legacy markets and how that could — from a yield or from a cost perspective, how that could be a swing factor if we are higher for longer?

Terry Turner: Michael, I think when we look at the deposit growth that really we generated for the better part of last year and our outlook for 2024, the biggest single component of that deposit growth is the deposit specialties that we’ve developed over the last several years. And I won’t go through or bore you with all those things. But I think you may have heard us talk about deposit products that we have for escrow accounting, deposit products that we have for captive insurance businesses, deposit products that we have for bankruptcy trustees. I mean, there are a variety of these specialties that we’ve focused on and built over the last several years, really trying to make sure we had some value add for particularly large pools of money.

And so we’ve developed a mechanism where we’ve got market champions in every market for all those products and there’s a lot of energy on targeted calling on clients that utilize those particular products. And so in all honestly, I think the biggest piece of the growth comes from what we’re able to produce through those deposit specialties. There is no doubt, we are also benefited by what goes on in our market extensions. You’re growing off a base of zero. So all the numbers look pretty good there. But as it relates to teaser rates and so forth, I just — keep in mind, we’re not — those strategies are not retail in any way, shape or form. So we’re not doing rate promotions or any of that kind of thing. There’s no doubt you’re moving market share.

You’re generally not going to convince the client to move from where they are here and pay them a lot less than what they’re getting paid. So again, I don’t mean to act like there’s no price pressure, there certainly is. But again, it’s not a retail or teaser rate kind of strategy. But again, I’d point you back to the deposit specialties.

Michael Rose: And maybe just last one for me. I know you had two credits that drove a little bit of an increase in NPLs, obviously, very low level. You built the reserves. Can you just help us get comfortable? I know there’s been a lot written about multifamily supply coming online in some of your markets, particularly in Nashville down to Atlanta as being some of the highest just as it relates to kind of your specific reserves against commercial real estate, I think they’re sub 1% for the last call reports. So can you just help us get comfortable that you guys are are kind of well reserved and you’ll see migration, but aren’t overly worried about credit?

Harold Carpenter: Yes, what we’re leaning into is probably one of the, well it is, my most — my high performing segment in my loan portfolio is my commercial real estate segment. And that’s been true for many, many, many years. Where we get choppy is in the C&I book when things happen. So I think it has to do with just looking at the macro environment and where we are with these loan to values. And our multifamily book, we think, is the strongest as it’s ever been, rental rates are at 95%, 98%, loan to value’s in the 60% range. I think it’s by enlarge on the macro side is where we get it. I think where else I get comfort is when I interview my real estate lenders and my credit officers, they’re able to talk in very granular way about all these multifamily projects and sponsors.

So I believe we’re on them and I think we understand what the markets are. I don’t think we have any significant appetite at all for multifamily right now. I think we believe that we like our book and we like our sponsors.

Operator: The next question is coming from Timur Braziler from Wells Fargo.

Timur Braziler: I wanted to follow up on expenses. The 80% incentive kind of accrual rate right now, is that based on the guidance that you’re giving? Like you said you have to — you can work your way back to kind of hitting those numbers. I guess, what is the expectation for performance needed to hit that 80%?

Harold Carpenter: I’m not going to get into actual EPS targets, what it takes to get to 80% kind of award. sYou can look at the proxy and see how it works over time in the tiering and how the revenue component flows through it and all that. But basically, we have to reconcile where we think we’re going to be for the year to what we’re going to accrue in that incentive bucket every quarter. And that’s not only true for cash but also for equity. So we have to go through a process to try to make sure we rightsize that accrual every quarter to where we think the tiering is with the plan for the year. I don’t know if that gets at your question generally but maybe a follow up, maybe I can help you out.

Timur Braziler: I guess just relative to the guidance. If you hit your guidance, does that equal 80% on the incentive or is there upside to that number if the guidance has hit downside to that number if the guidance is hit? I guess is that 80% relative to your broader guidance?

Harold Carpenter: Yes, it is. The outlook would give us a range of results for the year and that’s kind of like where we believe it’s going to end up within that range.

Timur Braziler: And then maybe I guess on the loan book, just looking at linked quarter, construction loans, that reduction there and your broader commentary around where you want to get that as a percentage of capital. I guess what does the contractual funding look like in the construction book, has that already taken place from originations book in prior years or is that comment on working that down on a relative basis to capital more so just other segments growing faster than the construction bucket?

Harold Carpenter: Well we went — effectively, we went pencils down on construction about a year, maybe year and half ago. So new commitments we limited to already kind of to the developer sponsors that we had already previously committed. So we’re still funding up on some of those commitments. But as it’s turning out now, the funding on these older projects is not keeping up with the projects that are giving their certificate of occupancy. So once they get that certificate of occupancy, they move out of construction and they either go to the apartment market, they either get paid off or the project gets sold or we move it into commercial real estate. So we anticipate that over the rest of the year that will still happen that our funding for new construction will not be as — not be large enough to make that 70% — we will still go down on that — towards that 70% based on actual fundings and then projects as they complete we’ll move out of that construction bucket.

Operator: The next question will come from Brett Rabatin from Hovde Group.

Brett Rabatin: I wanted to start with the hires, and I know that you doubled the Jacksonville team already. I’m curious where — what geographies you’re more interested in growing from here. And if anything, that’s going on with interest rates or higher rates for longer maybe that slows some of your projects. Are there any new markets on the table at this point?

Terry Turner: So Brett, I think in terms of hiring Jacksonville, obviously, is a key area of hiring as are the other newer markets, specifically D.C., Atlanta and so forth. So there is incremental hiring all over the footprint. And I would say it’s a pretty good time for us to be attracting talent universally. But clearly, there’s a concentration in the newer markets, which is where the hiring is currently occurring. And then I guess as it relates to new markets, I know you’ve heard me say this before, we love the Southeastern markets, all the large urban markets in the Southeast, the principal voids are in Florida. But the catalyst for when we go is when there’s availability of a team that we feel like can build as a big bank.

And so that was the catalyst for why we went to Jacksonville when we did. We had a fabulous leadership team that I think is really extraordinary and going to build something special there. And we may find our way to other markets when that same phenomenon occurs, but we’re not trying to get to other markets. We’re not working on how to get to other markets and so forth. So I hope I’m addressing what you asked, Brett.

Brett Rabatin: And then the other quick question was around Slide 23 where you have the customer penetration and the overall satisfaction levels. I’m curious if I get that the national banks are the higher customer penetration levels, but is that an area of opportunity for you either client by client or product set to grow the penetration on your clients?

Terry Turner: Absolutely, that’s really the whole point to me, Brett, is across that whole footprint, we have markets we dominate like a Nashville. But across the whole footprint, we’re in some really handsome markets where we’re a low share player. And so as I look at that chart, what I’d say is, okay, what I want to do is attack those banks that are in the top left because they’ve got all the share and all the vulnerability. And so that’s exactly the plan that we have been making, that’s where we produced our share growth over the last almost for a decade now, and that’s where I would expect the growth to continue to come.

Brett Rabatin: And any idea of, Terry, where your national penetration would be versus the overall footprint?

Terry Turner: What our penetration across the United States would be?

Brett Rabatin: No, the Nashville MSA penetration of customers versus…

Terry Turner: I got it. In Nashville, I can’t recite the number, but it would be a 30% sort of penetration.

Operator: The next question will be from Matt Olney from Stephens.

Matt Olney: I want to go back to the discussion around loan yields. And I think the loan yields increased this quarter around 5 bps, and I think you mentioned the benefits of the fixed rate repricing tailwinds could build throughout the year. So any color for us as far as how we can be modeling those loan yields over the next few quarters, assuming no rate changes?

Harold Carpenter: Well, I think if you can — I think our loan growth will be fairly — we should get into that 9% to 11% range. So I don’t think it will be — there’s any kind of meaningful seasonality there, Matt. So as you plan out the loan growth, you know, do that and then I think you’ll have to back into what our margin expectations are. The loan yields, we believe, will be accretive. We think we’ll do more accretion here in the second quarter than we did in the first quarter. Gosh, I’m trying to give you some direction here. I think $3 billion, if you weigh $3 billion of new loans coming in at, call it, 7.35 or 7.40, that would be held.